FORM 10-KSB
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended May 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 01-10076
APPLIED RESEARCH CORPORATION
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(Exact Name of Registrant as Specified in its Charter)
Colorado 86-0585693
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(State or other jurisdiction I.R.S. Employer
of incorporation or organization) Identification number
8201 Corporate Drive, Suite 1120, Landover, Maryland 20785
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(Address of Principal Offices) (Zip Code)
Registrant's telephone number, including area code: (301) 459-8442
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class Name of each exchange on which registered
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Common Stock, par value $0.0005 None
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-KSB. [ ]
The Registrant's revenues for the year ended May 31, 1996 were $8,957,464.
On September 12, 1996, the aggregate market value of the voting stock held
by non-affiliates of the Registrant was $177,059.
On September 12, 1996, there were 6,311,083 shares of $.0005 par value
Common Stock outstanding.
APPLIED RESEARCH CORPORATION
INDEX TO ANNUAL REPORT
ON FORM 10-KSB
PART I Page
Item 1: Business 3
Item 2: Properties 8
Item 3: Legal Proceedings 9
Item 4: Submission of Matters to a Vote of Security Holders 9
PART II
Item 5: Market for the Registrant's Common Stock and
Related Security Holder Matters 10
Item 6: Management's Discussion and Analysis of Financial
Condition and Results from Operation 11
Item 7: Financial Statements and Supplementary Data 17
Item 8: Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 17
PART III
Item 9: Directors and Executive Officers of the Registrant 18
Item 10: Executive Compensation 18
Item 11: Security Ownership of Certain Beneficial
Owners and Management 18
Item 12: Certain Relationships and Related Transactions 18
PART IV
Item 13: Exhibits, Financial Statement Schedules and Reports
on Form 8-K 18
Signatures 19
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant hereby incorporates by reference the following Documents:
PART III
Item 9: Directors and Executive Officers of the Registrant
Item 10: Executive Compensation
Item 11: Security Ownership of Certain Beneficial Owners and Management
Item 12: Certain Relationships and Related Transactions
The foregoing are incorporated by reference from the Registrant's
definitive Proxy Statement relating to its annual meeting of Stockholders,
which will be filed in an amendment within 120 days of May 31, 1996.
PART IV - EXHIBITS
1. Incorporated herein by reference from the Registrant's May 31, 1995,
Annual Report on Form 10-K, filed with Securities and Exchange
Commission on August 29, 1995.
2. Incorporated herein by reference from the Registrant's May 31, 1994,
Annual Report on Form 10-K, filed with Securities and Exchange
Commission on September 6, 1994.
3. Incorporated by reference from Amendment No. 1 to the Registrant's
Registration Statement on Form S-3 filed with the Securities and
Exchange Commission on June 28, 1994, S.E.C. File No. 01-10076.
4. Incorporated herein by reference from the Registrant's Current Report
on Form 8-K, dated June 14, 1994, filed with Securities and Exchange
Commission on June 21, 1994.
5. Incorporated by reference from the Registrant's Registration
Statement on Form S-18, as amended, filed with Securities and
Exchange Commission on June 21, 1989, S.E.C. File No. 33-11943-LA.
PART I
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ITEM 1. DESCRIPTION OF BUSINESS
(A) BUSINESS DEVELOPMENT
Applied Research Corporation was organized under the laws of the State of
Colorado on March 26, 1986, as Dollar Ventures, Inc., for the primary
purpose of engaging in a merger with or acquisition of, one or a small
number of private firms. On December 29, 1987, Dollar Ventures, Inc.
acquired 100% of the outstanding shares of Applied Research Corporation, a
Maryland corporation, common stock in exchange for 5,000,000 shares of
Dollar Ventures, Inc. common stock. The acquisition was legally
classified as a reorganization. For accounting and financial reporting
purposes, the transaction was treated as a reverse acquisition at book
value.
Following the acquisition, Applied Research Corporation (the original
Maryland corporation) changed its name to Applied Research of Maryland,
Inc. ("ARM"), and Dollar Ventures, Inc. changed its name to Applied
Research Corporation ("ARC"). Additionally, ARC changed its fiscal year
end from April 30 to May 31. Applied Research of Maryland, Inc. is a high
technology company specializing in research and development, design and
fabrication of sensors and instrumentation, technical support services and
software development. On April 2, 1996, ARM filed a voluntary petition
for relief under Chapter 11 of the United States Bankruptcy laws. See
Item 6. Management's Discussion and Analysis of Financial condition and
Results of Operations.
ARSoftware Corporation ("ARS"), a Maryland corporation and wholly owned
subsidiary of the Company was formed in April, 1992, to diversify ARC's
business by developing niche markets in the computer software industry.
The objective of ARS is to develop and distribute scientific and technical
software to academic, commercial and federal, state and local government
entities. ARS is currently reselling existing products under licensing
agreements.
ARInternet Corporation ("ARInternet"), a Maryland corporation and majority
owed subsidiary of the Company was formed in November 1994, to diversify
the business base of ARC by developing niche markets in the computer
online services industry. The objective of ARInternet is to become the
place to go on the Internet for information useful to those in search of
scientific knowledge.
As hereinafter used, the term "Company" shall refer to Applied Research
Corporation and its wholly owned subsidiaries Applied Research of
Maryland, Inc. and ARSoftware Corporation and the majority owned (95%)
subsidiary ARInternet Corporation, except when otherwise indicated by
context.
(B) BUSINESS OF ISSUER:
The Company's wholly owned subsidiaries, Applied Research of Maryland,
Inc. and ARSoftware Corporation, and majority owned (95%) subsidiary
ARInternet Corporation, are operating entities.
APPLIED RESEARCH OF MARYLAND, INC.
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On April 2, 1996, ARM filed a voluntary petition for relief under
Chapter 11 of the United States Bankruptcy laws. Under Chapter 11,
certain claims against ARM (the "Debtor") in existence prior to the filing
of the petition for relief under the federal bankruptcy laws are stayed
while the Debtor continues business operations as Debtor-In-Possession.
Prior to the filing of the Chapter 11 petition, management of the Debtor
had been attempting to sell the assets of ARM. Subsequent to the filing,
the Debtor entered into an agreement to sell a majority of ARM's assets.
At a Bankruptcy Court hearing on July 30, 1996, this agreement was
subjected to counter offers, and another company purchased a majority of
ARM's assets for $2.1 Million. Completion of this sale is subject to
approval by the Debtor's principal customer of the transfer of certain
contract rights and obligations, which is expected to take approximately
60 to 90 days to complete. Completion of the sale is also contingent upon
obtaining the approval of a majority of the Company's shareholders. See
Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operation for additional information on the Bankruptcy
proceedings and the sale.
ARM is the principal business of ARC. ARM's activities are divided into
three divisions: Technical Services Division, Instruments Division and
ARInstruments Division, each of which is described in the paragraphs that
follow.
Technical Services Division
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The Technical Services Division provides scientific software design and
development, mathematical analysis, laboratory experiment design and
implementation, and scientific data analysis to support research programs
in the earth and space sciences, optics, electronics, and chemistry. Most
of these support services are performed on-site at U.S. Government
("Government") laboratories (NASA/Goddard Space Flight Center, the Naval
Research Laboratory, and the U.S. Naval Observatory). In addition, during
1993, the Company began work on a subcontract with Hughes Applied
Information Systems, Inc. ("Hughes") where the work is performed on-site
at a Hughes location.
Instruments Division
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The Instruments Division designs and fabricates specialized hardware used
to carryout spaceborne scientific observations. Primary emphasis is in
the development of ultraviolet to near infrared imaging and spectrographic
instruments for use in astrophysical and atmospheric research. The
Instruments Division has expanded into the manufacture of rocket and
spacecraft attitude-control sensors. The Company's classified contracts
are also carried out in the Instruments Division.
ARInstruments Division
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During its many years of performing under government contracts, the
Company has developed expertise in custom design and fabrication work. In
addition, members of the Company's technical staff have investigated and
researched other government and commercial applications for existing
technologies. The Company formed its ARInstruments Division
("ARInstruments") in fiscal 1993 to penetrate the government and
commercial instrumentation markets, and specifically segregate these
activities from other government contract operations in the design,
fabrication, and distribution of instrumentation products. During fiscal
1994, ARInstruments had begun research and development efforts related to
product development and initiated two patent applications. These patents
were granted during fiscal 1995 and, accordingly, the Company began
amortizing the costs associated with the patents during the year ended
May 31, 1995.
ARSOFTWARE CORPORATION
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ARSoftware Corporation ("ARS") was established to diversify the Company's
business base by developing niche markets in the computer software
industry. Currently, ARS is reselling selected products to academic
institutions, industry and government agencies, focusing on end users
working on scientific and engineering applications.
ARINTERNET CORPORATION
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ARInternet Corporation ("ARInternet") provides a reliable, high-speed,
full-service link to the Internet, utilizing state-of-the-art networking
hardware and software with built-in capacity for expansion and
improvement. ARInternet had approximately 1,000 subscribers as of May 31,
1996. ARInternet offers monthly, quarterly, semi-annual and annual
subscription agreements, each requiring payment in advance. ARInternet
offers the ability to pay the subscription amounts by credit card to
facilitate payment.
ARInternet currently hosts, maintains, and provides gateways to numerous
free and commercial scientific databases, refers subscribers to on-line
research and document delivery services, and offers a variety of server
capabilities to facilitate information exchange. Specifically, ARInternet
offers all the "standard" connection options, such as e-mail, telnet, ftp,
WWW, gopher, finger, and so forth, which most people have come to expect
as the basic services of a dial-up account. However, in contrast to a
cheaper, "no-frills" basic account, ARInternet also offers enhanced
customer support in the form of a user-friendly, menu-driven interface,
excellent on-line and phone-in help, access to public ftp, gopher, and WWW
servers, electronic conferencing and publishing services, Internet
training, and a myriad of research services.
To facilitate access to its services, ARInternet has signed an agreement
with the SprintNet packet switching network to allow customers to connect
to ARInternet's Landover, Maryland, facility via a local telephone call
from most U.S. cities. ARInternet has installed an "800" number to
provide access to those subscribers currently residing outside SprintNet's
coverage range. Through its arrangement with SprintNet and installation
of the "800" number, the Company hopes to ensure that its subscriber base
is not constrained by geographical boundaries and to attract the more
mobile professionals in the Washington D.C. area.
RESEARCH AND DEVELOPMENT
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ARM conducts research and development activities in several areas. During
its many years of performing under Government contracts, ARM has developed
expertise in custom design and fabrication work. The Company formed its
ARInstruments Division ("ARInstruments") in fiscal 1993 to penetrate the
government and commercial instrumentation markets. ARInstruments has been
conducting research and development related to the development of a
proprietary technique and instrument, the BIO-UVB Meter, for directly
measuring biological effects of solar UVB. During the years ended May 31,
1996 and 1995, approximately $87,000 and $217,000 was spent, respectively.
Now that BIO-UVB Meter has been designed and the patents granted, ARM
anticipates such expenditures for the year ended May 31, 1997, should be
approximately the same as the fiscal 1996 level. The patents are among
the property being sold under the Consolidated Asset Purchase Agreement
approved by the Bankruptcy Court on July 30, 1996. See Item 6.
Management's Discussion and Analysis of Financial Condition and Results of
Operation for additional information concerning the sale.
ARS does not conduct any significant research and development effort. ARS
does, however, capitalize the cost of producing "product masters", in
accordance with Statement of Financial Accounting Standards No. 86.
During the years ended May 31, 1996 and 1995, approximately zero and
$27,000 was spent and capitalized, respectively. ARS does not anticipate
any such expenditures for the year ended May 31, 1997. ARInternet had no
research and development expenditures during the two years ended May 31,
1996.
INTELLECTUAL PROPERTY
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Patents, copyrights trademarks and trade secrets are the principal
protection source for the Company's intellectual property. The Company
also holds various copyrights covering its published materials and
proprietary software, most of which are derived from original works
created by employees of the Company, its subsidiaries or by independent
contractors hired under agreement for a specific project. The remaining
copyrights are held by the Company through licensing agreements with the
authors.
ARM applied for and has been granted two (2) patents relating to
instrument technology it has developed. These two patents are among the
property being sold under the Consolidated Asset Purchase Agreement
approved by the Bankruptcy Court on July 30, 1996.
All of the patents, copyrights, trademarks and licenses are considered by
the Company to be valuable property rights. The protection afforded by
these intellectual property rights and the law of trade secrets is
believed by the Company to be adequate. However, notwithstanding the
Company's intellectual property rights, it is possible for a competitor to
develop near imitations of the Company's products implementing
modifications, without violating those rights.
SEASONALITY
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Revenues for ARM typically are not seasonal, but will sometimes depend on
the availability of Government funding. The Government budgets and
operates on a fiscal year ending September 30th.
In the past, ARS revenues have been seasonal, with ARS typically showing
greater revenues in the second, third and fourth fiscal quarters. ARS
also had experienced inventory and accounts receivable variations due to
the seasonal nature of its business.
Revenues for ARInternet have not been seasonal.
CUSTOMERS - MARKETS AND MARKETING
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Predominantly all of ARM's revenues (99%) are derived from agencies of the
Government and prime contractors to those agencies. During fiscal 1996,
ARM had one customer that accounted for approximately 35 percent (35%) of
its revenue during the year. This customer, NASA, had 10 contracts with
ARM, of which one contract provided 20 percent (20%) and a second provided
13 percent (13%) of ARM's revenue. Another customer, Hughes Corporation,
had two contracts which accounted for 49 percent (49%) of ARM's revenue,
of which the largest accounted for 37 percent (37%). ARM also has two
contracts with the Naval Research Laboratory which accounted for 3 percent
(3%) of ARM's revenue. ARM also maintained one contract with General
Sciences Corporation, which contributed approximately 3 percent (3%) of
its revenue. The contracts held by ARM are among the property being sold
under the Consolidated Asset Purchase Agreement approved by the Bankruptcy
Court on July 30, 1996.
ARS has no significant major customers.
ARInternet has no significant major customers. At May 31, 1996,
ARInternet had approximately 1,000 subscribers. At May 31, 1995,
ARInternet had approximately 350 subscribers.
On a local level, ARInternet reaches its target market primarily through
advertisements placed in the Washington Post. ARInternet intends to
increase its marketing efforts, particularly on a national level, by
placing advertisements in certain widely distributed scientific journals,
and, possibly, through direct mailings to members of its target market.
ARInternet benefits from word-of-mouth advertising as the number of
subscribers multiplies and ARInternet's exposure on the Internet
increases. Additionally, ARInternet participates in a number of e-mail
discussion groups and cultivates subscribers through ARInternet-sponsored
Internet training sessions.
BACKLOG
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ARM's total backlog of contracts as of May 31, 1996, was approximately
$27.5 million ($2.8 million funded and $24.7 million unfunded). This
compares with a backlog of approximately $33.1 million ($3.3 million
funded and $29.8 million unfunded) at May 31, 1995. If ARM were to
continue its current business, it would expect that approximately 30
percent (30%) of the total backlog as of May 31, 1996, would be realized
within one year. The contracts held by ARM are among the property being
sold under the Consolidated Asset Purchase Agreement approved by the
Bankruptcy Court on July 30, 1996.
ARS's backlog as of May 31, 1996, was approximately $5,000, consisting of
purchase orders that were received, but not shipped. These purchases
orders were shipped during June and July 1996. ARS's backlog as of
May 31, 1995, was approximately $20,000 also consisting of purchase orders
that were received, but not shipped.
ARInternet's backlog as of May 31, 1996, was approximately $27,600 which
related to prepaid subscriptions received in advance. This amount will be
earned during the current fiscal year. ARInternet's backlog as of May 31,
1995, was approximately $14,400 which related to prepaid subscriptions
received in advance. This amount was earned during fiscal year 1996.
GOVERNMENT CONTRACTS
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ARM's Government contracts contain standard clauses permitting the
termination of contracts and subcontracts at the election of the
Government. The Company's contracts with prime contractors also typically
contain similar clauses permitting termination of the contract at the
election of the Government. In the event of termination of such
contracts, the Company is entitled to receive reimbursement on the basis
of costs incurred plus a reasonable profit. The Company has not had any
significant contracts terminated at the election of the Government during
the past two fiscal years. The contracts held by ARM are among the
property being sold under the Consolidated Asset Purchase Agreement
approved by the Bankruptcy Court on July 30, 1996.
COMPETITION
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Both ARM and ARS face competition from other firms which provide similar
products and services. Some of these firms are larger and better
capitalized than both ARM and ARS. The Company does not consider any one
firm to hold a dominant position in the industry. ARM has established an
excellent reputation within the Government scientific community and
therefore has created a niche market for itself. This is largely due to
its talented employees, more than 50% of which have PhD's. The contracts
held by ARM are among the property being sold under the Consolidated Asset
Purchase Agreement approved by the Bankruptcy Court on July 30, 1996.
ARInternet faces competition from many businesses offering Internet access
ranging in size from sole proprietorships to large corporations. The
services provided by these competitors vary from simply furnishing
Internet connectivity to providing a full complement of services including
e-mail, in-home shopping and banking, and complete on-line research and
document delivery services. Many of these competitors are larger and have
greater financial resources than ARInternet.
ARInternet intends to meet or exceed competitive demands by recognizing
that many disciplines and subdisciplines of science and technology exist,
each with its own needs and level of exposure to Internet resources. By
recognizing these differences, ARInternet provides its subscribers with
easy access to a suite of customized tools and Internet services unique to
the scientific community as a whole, and, more importantly, designed to
provide discipline-specific information, including access to public and
commercial databases, software archives, suppliers of products and
materials, print and electronic publication, and announcements of on-line
and traditional meetings in many different areas of science and
technology, many of which were previously unavailable from more
established sources.
EMPLOYEES
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At May 31, 1996, 117 full-time and 6 part-time employees were employed by
the Company and its wholly owned and majority owned subsidiaries. ARM
employed 110 full-time and 6 part-time employees while ARS employed 2
full-time employees at May 31, 1996. Subsequent to May 31, 1996, ARS
reduced its staff to 1 full-time employee.
ARInternet employed 5 full-time employees at May 31, 1996. Outside
consultants with specialized knowledge and experience in designing and
operating TCP/IP networks, client/server and database application
development, CD-ROM publishing and familiarity with biological and medical
resources and markets have been utilized to extend the Company's
capabilities and to enhance the range of services covered. As resources
permit and circumstances warrant, additional personal with specialized
talents and experience will be added to the present staff. Anticipated
needs include application software developers, customer service
representatives, database specialists, and technical assistants.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's corporate headquarters are located at 8201 Corporate Drive,
Landover, Maryland 20785. This property measures 12,633 sq. ft. and is
currently leased by ARC at $16,960.79 per month through its expiration on
September 30, 1998. This space is occupied as follows: ARM, 7,283 and
2,789 sq. ft. of office and laboratory space, respectively, ARS occupies
1,551 sq. ft. of office space and ARInternet occupies 1,010 sq. ft. of
office space. The Company's corporate headquarters are expected to be
adequate to meet the Company's needs for the foreseeable future. The
space currently occupied by ARM is not covered by the Bankruptcy
proceeding, since the lease is held by ARC. Management of ARC has
enlisted the services of a real estate broker to find a tenant to take
over this space when ARM's operations are sold. The landlord has also
been apprised of the ARM sale and is attempting to find an alternate
tenant, but is under no obligation to release ARC from its obligation
under the lease.
The Company's capital equipment consists primarily of furniture and office
equipment, laboratory equipment and computer hardware located at its
corporate headquarters. ARM's and ARS' capital equipment is believed to
be adequate to meet their projected needs for the foreseeable future.
ARInternet will require additional computer related equipment as its
customer base increases. The amount of such purchases required for fiscal
1997 will depend on growth and therefore cannot be reasonably determined
at this time.
ITEM 3. LEGAL PROCEEDINGS.
Neither the Company, nor ARS or ARInternet is currently a party to any
pending litigation or other material legal proceeding.
On April 2, 1996, ARM filed a voluntary petition for relief under Chapter
11 of the United States Bankruptcy Code. Under Chapter 11, certain claims
against ARM (the "Debtor") in existence prior to the filing of the
petition for relief under the federal bankruptcy laws are stayed while the
Debtor continues business operations as Debtor-In-Possession.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended May 31, 1996.
PART II
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ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(A) MARKET INFORMATION
The Company's common stock commenced trading over the counter on November
23, 1987. The Company's common stock was listed on the Philadelphia Stock
Exchange on November 9, 1988, and began trading on November 17, 1988 under
the symbol "ARL.X". The Company's common stock continued to be listed on
the Philadelphia Stock Exchange until February 7, 1995, when it was
delisted for failure to meet the Philadelphia Stock Exchange's maintenance
requirements.
As a result of its delisting from the Philadelphia Stock Exchange, the
Company's common stock is now traded on the Over-the-Counter Electronic
Bulletin Board ("OTCBB") under the symbol "APLS". The reported high, low
and last prices, as quoted on the Philadelphia Stock Exchange through
February 7, 1995, and thereafter the high and low bid price as quoted on
the OTCBB system, are shown below for the period June 1, 1994 through
August 31, 1996. The high and low bid information as quoted on the OTCBB
represents prices between brokers and dealers and does not include retail
mark-ups and mark-downs or any commissions to the broker-dealer. The
prices may not reflect prices in actual transactions.
High Low Last
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FISCAL 1995
First Quarter 0.37500 0.12500 0.12500
Second Quarter 0.31250 0.12500 0.25000
Third Quarter 0.25000 0.12500 0.18750
Fourth Quarter 0.18750 0.18750 0.18750
FISCAL 1996
First Quarter 0.34375 0.12500 0.34375
Second Quarter 0.87500 0.25000 0.26000
Third Quarter 0.68750 0.15625 0.33375
Fourth Quarter 0.31250 0.06250 0.10000
FISCAL 1997
First Quarter 0.15000 0.06000 0.06000
NUMBER OF SHAREHOLDERS
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The approximate number of shareholders of record for the Company's common
stock as of September 6, 1996, was 420. This amount represents the number
of certificate holders and individual non-objecting beneficial owners of
the Company's common stock held in "street name".
DIVIDENDS
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No cash dividends have been declared on the common stock of the Company
for either of the last two fiscal years ending May 31, 1996 and 1995. In
addition, while there are no limitations on the ability of the Company to
pay dividends, management does not anticipate the declaration of a cash
dividend on any class of common stock of the Company in the foreseeable
future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
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Applied Research Corporation ("the Company") is comprised of two wholly
owned subsidiaries, Applied Research of Maryland, Inc. ("ARM") and
ARSoftware Corporation ("ARS"), and a majority owned subsidiary,
ARInternet Corporation ("ARInternet"). ARM consists of three
unincorporated divisions: Technical Services Division, Instruments
Division and ARInstruments Division ("ARInstruments"). Management's
discussion and analysis of financial condition and results of operations
takes into consideration the activities of the Company as a whole and each
individual operating entity where necessary. Management's discussion and
analysis should be read in conjunction with the Selected Financial Data,
and the Company's Consolidated Financial Statements, including the related
notes thereto, appearing elsewhere in this report.
On April 2, 1996, ARM filed a voluntary petition for relief under Chapter
11 of the United States Bankruptcy Code. Under Chapter 11, certain claims
against ARM (the "Debtor") in existence prior to the filing of the
petition for relief under the federal bankruptcy laws are stayed while the
Debtor continues business operations as Debtor-In-Possession. Prior to
the filing of the Chapter 11 petition, management for the Debtor had been
attempting to sell the assets of ARM. Subsequent to the filing, the
Debtor entered into an agreement to sell the majority of ARM's assets. At
a Bankruptcy Court hearing on July 30, 1996, this agreement was subjected
to counter to offers, and another company purchased the majority of ARM's
assets for $2.1 Million. Completion of this sale is subject to approval
by the Debtor's principal customer of the transfer of certain contract
rights and obligations, which is expected to take approximately 60 to 90
days to complete. The sale is also contingent upon obtaining the approval
of the Company's shareholders.
RESULTS FROM OPERATIONS - 1996 COMPARED TO 1995
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The Company's revenues for the year ended May 31, 1996, were $8,957,464.
This represents a decrease of $(632,649) or (7)% over revenues of
$9,590,113 for the same period during 1995. The decrease in revenues is
primarily attributable to a decrease in ARM's revenues of $(741,655) or
(8)% over 1995 revenues of $9,135,523 and to the decrease of $(167,414) or
(39)% in ARS' 1995 revenues of $429,335. Arinternet however, reported an
increase in revenues of $276,420 from 1995 revenues of $25,255. The
decrease in ARM's revenues was the direct result of a reduction in the
amount of direct labor and other direct costs incurred by ARM. ARS's
decrease in revenues was attributed to a reduction in marketing related
activities as well as the reduction in the number of marketing related
employees.
The Company's direct cost of services decreased $(599,317) or (10)%, from
$6,066,430 in 1995, to $5,467,113 during 1996. Of this amount, ARM and
ARS contributed decreases of $(369,464) and $(285,837), respectively,
while ARInternet's cost of services increased $55,984. Notably, ARM's
decrease in its direct costs was caused by a reduction in its technical
staff as well as a decrease in subcontract and consulting costs. The
decrease in direct costs of ARS was primarily related to a decrease in
amortization of approximately $85,900 of previously capitalized software
development costs, the non-recurring May 31, 1995, write-off of
approximately $118,900 of previously capitalized software development
costs, as well as a decrease in the costs of products being sold.
Indirect operating costs decreased $(414,885) or (18%), from $2,349,084 in
1995, to $1,934,199 during 1996. Of this amount, ARM's indirect operating
costs decreased $(379,494) or (17%) and ARS's decreased $(39,391) or
(55)%. ARM's decrease is directly related to the reduced fringe benefit
costs incurred as a result of fewer technical staff, as well as a decrease
in the amount of indirect labor being charged to overhead. ARS's decrease
was directly related to a decrease in technical staff which occurred
during the fiscal year.
General and administrative ("G&A") expenses increased $25,836 or 2%, from
$1,501,074 in 1995, to $1,526,910 during 1996. Of this amount, ARM's G&A
expenses decreased $(60,113) or (6%), while ARS decreased its G&A costs
$(128,879) or (41)%. ARInternet's G&A costs increased $214,828 or 113%,
reflecting a full years worth of operations during 1996 compared to only 7
months during fiscal 1995. ARM's decrease related to a decrease in bid
and proposal and research and development costs incurred in 1996, as well
as a reduction in ARM's G&A staff. The decrease in ARS's G&A expenses was
directly attributable to a $68,300 reduction in indirect labor charged
during the period, a $47,600 reduction in marketing related expenses, and
a $13,000 decrease in other expenses.
As a result of the foregoing, the Company realized operating income for
the year ended May 31, 1996, of $29,242 compared to an operating loss of
$(326,475) for the same period during 1995. ARM posted an operating
profit of $349,618 in 1996 compared to $286,202 during the same period in
1995. The increase in ARM's operating margin related to higher fees
(profit) being realized on its contracts during fiscal 1996 compared to
same period in 1995. ARM's 1996 indirect rates, in particular its G&A
rate, were lower than those experienced in fiscal 1995. ARS posted an
operating loss of $(118,026) for fiscal 1996, which loss represented an
improvement of $286,693 or 71% from the operating loss of $(404,719)
during the same period in 1995. This net improvement for ARS is directly
attributable to a decrease in salary and related fringe benefit expenses
of approximately $108,200, and reductions in marketing and other expenses
of approximately $60,600, a decrease in the amortization of previously
capitalized software development costs of approximately $185,800, offset
by an increase in the cost of goods sold of approximately $67,900.
ARInternet's operating loss of $(202,350) during the year ended May 31,
1996, was an improvement of $5,608 or 3% over the operating loss of
$(207,958) during the same period in 1995.
Interest and other expenses increased $114,031 or 21%, from $543,504 in
1995, to $657,535 during 1996. Net interest expense increased $31,560 or
9% from 1995. The increase in interest costs was the result of an
increase in interest on unremitted employee 401(k) contributions which
added approximately $49,200 of interest expense during fiscal 1996 when
compared to the same period in 1995. Penalties and other expenses also
decreased $6,592 during 1996. Compensation expenses associated with stock
awards increased $89,063, and resulted from ARC issuing stock as
compensation to two firms. Until such time as the Company is able to
increase its working capital, either through increased income from
operations or through additional equity financing, the likelihood of which
is extremely uncertain, it is anticipated that interest and other expenses
will continue to exert significant pressure on the Company's ability to
generate positive earnings and cash flow.
The Company sustained a net loss of $(657,056) for the year ended May 31,
1996, compared to a net loss of $(895,313) during the prior year. This
loss reflects an increase in ARM's operating margins of $63,416, an
increase in ARS's operating margin of $286,693, and an increase in
ARInternet's operating margins of $5,608. This, net of the increase in
interest and other costs of $114,031, and the increase in professional
fees related to the bankruptcy case of $28,763, and the decrease in income
tax expenses of $(25,334), positively impacted overall margins by $238,257
when compared to fiscal 1995.
Loss per common share likewise decreased from $(0.15) in 1995, to $(0.11)
during 1996. During the year ended May 31, 1996, there were an average of
6,214,817 shares outstanding compared to 5,944,416 shares outstanding
during the same period in 1995.
LIQUIDITY AND CAPITAL RESOURCES - 1996 COMPARED TO 1995
- -------------------------------------------------------
Total assets decreased $(322,538) or (15)%, from $2,120,158 at May 31,
1995, to $1,797,620 at May 31, 1996. Total liabilities on the other hand
increased from $3,679,314 to $3,899,769 over the same period, an increase
of $220,455 or 6%.
The most significant reason for the decrease in total assets was the
decrease in accounts receivables of $268,168 and the decrease in other
current assets of $39,726. At May 31, 1996, the Company had $1,090,861
and $433,824 in billed and unbilled receivables, respectively. Billed
receivables increased $22,436 or 2% from May 31, 1995, while unbilled
receivables decreased $290,604 or 40% from May 31, 1995. The increase in
billed accounts receivable was primarily the result of an increase in the
amount of closeout billings outstanding, offset by a decrease in the
average amount billed due to the decrease in revenues. The decrease in
unbilled accounts receivable primarily related to preparing final invoices
on 14 old contracts during November, 1995, as a result of completing
government audits for FY 1991 through FY 1993 during the quarter then
ended.
The most significant reason for the increase in liabilities was the
increase in payroll taxes and withholdings which increased $490,904 from
May 31, 1995 to May 31, 1996. In addition, other accrued expenses
increased $146,557 during the year as a result of increased penalties and
interest associated with unpaid payroll taxes and 401(k) contributions.
The Company's working capital deficit continued to grow during the year
ended May 31, 1996, increasing from a deficit of $(1,781,905) to a deficit
of $(2,273,810). Adding to the Company's working capital deficit during
the year ended May 31, 1996, was an increase in unremitted payroll taxes
withheld of $490,904, from $481,576 at May 31 1995, to $972,480 at May 31,
1996.
INFLATION
- ---------
The Company anticipates increases in costs associated with the operation
of the business and reflects this in the cost of living escalation factors
proposed on all new work. In addition, the Company is continually
researching areas to minimize cost increases and strives for improved
efficiencies in all aspects of its business environment.
SUBSEQUENT EVENTS
- -----------------
The following is a chronology of the events leading up to ARM filing for
Chapter 11 under the United States Bankruptcy laws on April 2, 1996, as
well as a discussion of what has happened since the filing and subsequent
signing of an agreement to sell the majority of ARM's assets to a third
party purchaser.
IMPACT ON CASH FLOW DUES TO THE LOSSES FROM OPERATIONS/CONTINUED
INVESTMENT IN ARS/ARINTERNET.
----------------------------------------------------------------
Because of the continued losses incurred by ARM, ARS and ARInternet
(through November 1995, ARC incurred losses of approximately $(422,000))
as well as the cash drain on ARM by ARS and ARInternet during fiscal 96
(through November 1995, ARM funded approximately $157,800 of ARS and
ARInternet expenses, while an additional $46,800 was expended from
December 1, 1995 through April 2, 1996), ARM continued to fall behind on
remitting its federal withholding taxes throughout the first half of
fiscal 96. Through November 1995, ARM owed the IRS approximately $675,600
in unpaid federal withholding taxes plus an additional $200,000 in
interest and penalties.
DELINQUENT FEDERAL WITHHOLDING TAXES/FILING OF LIENS BY THE IRS.
---------------------------------------------------------------
During September, 1995, ARM made a $50,000 payment to the IRS for
delinquent payroll taxes. The IRS had demanded a $250,000 payment be made
on October 27, 1995, and when the Company was unable to meet this demand,
the IRS filed a lien against ARM on November 7, 1995.
As a result of the IRS lien, ARM defaulted on its loan agreement with
its primary lender, PrinCap, pursuant to a provision requiring it to remit
all federal payroll withholding taxes as they became due. Upon the filing
of the IRS lien, PrinCap issued a letter of default to ARM on November 14,
1995, under which no additional funding was granted and all residuals
received by PrinCap were applied to reduce the loan balances outstanding.
On November 17, 1995, ARM entered into an agreement with a new lender
("CFC"), and on December 4, 1995, CFC paid off the remaining outstanding
PrinCap loan balance of $651,491, plus $18,288 of accrued interest and
other charges. The agreement with CFC allows ARM to borrow 90% against
billed receivables on all assigned contracts. Since the new financing
agreement did not allow ARM to borrow against unbilled receivables, ARM
was required to pay off the $250,000 unbilled loan advance and the
approximate $35,000 equipment loan due to PrinCap at the time of closing
the new loan. To accommodate this, CFC allowed ARM a one-time advance of
approximately 97% against eligible billed receivables.
On December 1, 1995, the Company entered into a new installment
agreement with the IRS which required a $75,000 monthly payment to be made
starting with December, 1995, and continuing until the liability was paid.
As a condition of this installment agreement, the Company's new lender was
required to deduct the monthly payment from the Company's borrowings
against billed receivables and remit this directly to the IRS. The IRS
agreed to give CFC a priority security interest with regards to its loans
against billed receivables. The IRS and CFC initially operated under an
interim subordination agreement while the Company applied for a formal
subordination from the IRS. On January 30, 1996, the IRS issued a
Certificate of Subordination. Through April 1, 1996, the Company's lender
had remitted the first four payments. However, during the period from
November 14, 1995 to March 25, 1996, ARM only made one tax deposit of
$69,000. During this period ARM failed to remit approximately $472,500 of
current federal withholding tax deposits as was required under the
December 1, 1995, installment agreement.
Starting in October 1995, management of the Company started pursuing
the possible sale of ARM, the Company's government contracting subsidiary.
The Company enlisted a broker which made contacts with several companies
who appeared to be interested. Three companies expressed interest in
acquiring essentially all of the operating assets of ARM (principally the
government contracts). Discussions were ongoing with these parties from
late December 1995 through March 1996. During this period, no offers
acceptable to the Company were made. In late March 1996, management was
pursuing discussions with a potential buyer and as a condition of the
negotiations, had a meeting with the IRS to discuss the amount owed the
IRS as well as a potential settlement of the outstanding liability, which
as of April 1, 1996, was approximately $1,155,000.
FILING OF CHAPTER 11 PETITION BY ARM.
------------------------------------
Because ARM was in default of its December 1, 1995, installment
agreement with the IRS, the Company's assets were subject to immediate
seizure and possible sale by the IRS. To that end, on April 1, 1996, the
IRS issued Levy Notices to ARM's bank, financing company and the majority
of its customers. On April 2, 1996, the IRS attempted to close ARM. As a
result, ARM was forced to file for protection under Chapter 11 of the
United States Bankruptcy Code on April 2, 1996.
On April 5, 1996, ARM received an emergency hearing with the
Bankruptcy Court to determine its request to pay its employees their pre-
petition wages as well as continue to operate the business. Prior to the
emergency hearing, ARM reached an agreement with the IRS and CFC (its
lender) to allow the company to continue to operate and borrow money from
CFC against its billed receivables. Under this agreement, ARM agreed to
pay $15,000 a month starting April, 1996, towards its arrearage with the
IRS. The April payment consisted of the $13,600 of cash seized by the IRS
on April 1, 1996. Future monthly payments will be made directly to the
IRS by CFC from borrowings made by ARM. ARM was also required to remit to
the IRS collections on certain billed receivables that were outstanding as
of April 2, 1996 (the final vouchers on 14 old contracts, which totaled
approximately $136,700). In addition, as part of the agreement with the
IRS and as required by the Bankruptcy Court, ARM was required to remit its
post-petition taxes when due and provide proof of such payments to the IRS
and the Court on a timely basis. The Bankruptcy Court approved the
agreements with the IRS and CFC, and approved ARM's operating budget for
15 days through April 21, 1996. These agreements have continued to be
renewed by the Bankruptcy Court.
SALE OF ARM'S GOVERNMENT CONTRACTS.
----------------------------------
ARM informed the Bankruptcy Court and the IRS that it had and would
continue to pursue the sale of the ARM's business. To that end, ARM
placed an ad in several newspapers, including THE WALL STREET JOURNAL.
ARM received approximately 34 inquires to these ads. During May and June
1996, the Company sent information about ARM to 18 Companies and held
serious discussions with 7 Companies concerning the sale of ARM's assets.
On June 24, 1996, the Company accepted a contract for the sale of
certain of ARM's assets for approximately $1.5 Million. The sale was
subject to Bankruptcy Court approval, which was scheduled for July 26,
1996. This hearing was subsequently moved to July 30, 1996. On July 30,
1996, the hearing was conducted. At the hearing, a total of four
qualified bidders attended, and after extensive biding, an offer was
accepted for $2.1 Million. The following is a list of the purchased and
excluded assets:
PURCHASED ASSETS EXCLUDED ASSETS
---------------- ---------------
- - All contracts rights - ARM's charter and status as a
including project contracts), corporation, its minute book, stock
- - All inventory, transfer records, and similar records
- - All books and records, relating to ARM's organization,
- - All furniture, fixtures and existence or capitalization, and the
equipment, capital stock or ARM,
- - All proprietary rights - Billed accounts receivable as of
(patents, etc.) closing,
- - All unbilled accounts - Intercompany receivables,
receivable as of the closing - ARM's rights to occupy real property
date. pursuant to leases of real property
and any leasehold improvements made
thereto.
- Any other property identified by
the Purchaser prior to the closing.
During August 1996, management and ARM's bankruptcy attorney
negotiated a contract, which was signed on August 30, 1996. A court order
documenting the bidding procedure as well as the contract is expected to
be submitted to the Bankruptcy Court for approval during the week ended
September 13, 1996. The sale is subject to the successful novation of
ARM's government contracts. This is expected to take approximately 60 to
90 days from contract execution. The sale must also be approved by a
majority of the Company's shareholders. The Company plans to submit the
matter to a vote at the Company's Annual Meeting of Shareholders currently
scheduled for October 30, 1996. Upon notification of the government's
novation approval, and approval of the Company's shareholders, the sale
will be completed.
PLAN OF REORGANIZATION/PAYMENT AND PRE-PETITION LIABILITIES.
-----------------------------------------------------------
Once the sale referenced above is completed, ARM (the "Debtor") will
file a Plan of Reorganization, which will, among other things, specify how
much of the outstanding pre-petition liabilities will be paid and over
what period of time. It is expected that a Plan of Reorganization will be
filed with the Bankruptcy Court within 30 days of completing the sale.
This Plan is expected to take several months to receive Bankruptcy Court
approval. It is also expected that between the monies generated from the
sale of ARM's contracts rights plus the collection of the outstanding
accounts receivables (which are not part of the sale), there will not be
sufficient monies to liquidate all of ARM's pre-petition liabilities.
Furthermore, it appears that the unsecured creditors (accounts payable)
will receive little or nothing towards their pre-petition claims.
Specifically, it appears that the following will be paid in full as a
result of the Plan of Reorganization: 1) the secured claim of CFC, ARM's
pre-petition and post-petition lender, 2) the amounts owed to the
employees for accrued vacation (up to $325,000), the amount owed to the
401(k) Plan as of April 2, 1996, of approximately $676,000, as well as
their pre-petition claims for unreimbursed travel expenses of
approximately $50,000, and, 3) the principal portion of the tax amounts
owed to both the IRS and the various state authorities. In addition, it
appears that the various taxing authorities will receive a portion of the
pre-petition penalties and interest, but not the full amount. Although
these are the current expectations, there can be no assurances that these
amounts will be paid until the Plan of Reorganization is submitted and
confirmed by the Court.
COLLECTION OF THE INTER-COMPANY AMOUNTS OWED TO ARM.
---------------------------------------------------
As of April 2, 1996, ARS owed ARM approximately $1.2 Million and
ARInternet owed ARM $0.4 Million. These amounts resulted from ARM paying
ARS's and ARInternet's operating expenses during their start-up phases and
providing continued funding thereafter to fund operations. Since these
amounts are owed to ARM, the ultimate collection of these advances will be
supervised and controlled by the Bankruptcy Court. As of May 31, 1996,
ARS has still not achieved break even operations. As of September 6,
1996, ARM has only one full-time employee and its sales are minimal.
Therefore payment of any of the amount its owes ARM is extremely doubtful.
On the other hand, ARInternet has essentially achieved break even
operations as of May 31, 1996. Therefore, it can reasonably be expected
that ARInternet will be required to repay some amount to liquidate its
debt to ARM. The ultimate amount will be determined by the Bankruptcy
Court.
IMPACT ON ARC AFTER THE SALE OF ARM IS COMPLETED.
------------------------------------------------
During the current fiscal year ARM constituted 94% of ARC's total
revenue. The sale currently contemplated will sell essentially all of
ARM's operations to the Purchaser and eliminate all of ARM's revenues.
Therefore, ARS and ARInternet will be the only remaining operating
entities. Up until the bankruptcy filing, ARM had been forced to continue
to fund ARS's and ARInternet's operations. During the current fiscal year
(through April 2, 1996), ARM funded approximately $204,600 of ARS and
ARInternet expenses. From the period from April 2, 1996 on, because of
the bankruptcy proceedings, ARM ceased all such advances and ARS and
ARInternet were forced to fund their own operations. ARS is still not
operating at cash flow break even, so it is doubtful that it can survive
without a substantial infusion of cash or a significant increase in
revenues. Management is considering several options for ARS, including
ceasing its operations. ARInternet on the other hand, has steadily
increased its revenues and as of May 31, 1996, had approximately 1,000
subscribers and had essentially reached break even operations. Management
believes that ARInternet's revenues and business will continue to grow and
that ARInternet will ultimately be a successful business on its own,
however there can be no assurances of this.
The space currently occupied by ARM is not covered by the Bankruptcy
proceeding, since the lease is held by ARC. Management of ARC has
enlisted the services of a real estate broker to find a tenant to take
over this space when ARM's operation are sold. The landlord has also been
apprised of the ARM sale and is attempting to find an alternate tenant,
but is under no obligation to release ARC from its obligation under the
lease. In addition, ARC will continue to incur expenses to maintain its
statusas a public company. Although these expenses will be less because
of having less revenues and expenses, they will have to be borne by the
remaining companies.
The sale of ARM, if completed, will dramatically change the Company's
balance sheet and statement of operations. Through the bankruptcy
proceeding, all of ARM's debts which total $3.7 million at May 31, 1996,
will be either liquidated or discharged. This will decrease the Company's
interest and penalties costs that it had been incurring. If ARS and
ARInternet's revenues can be increased to produce net profits and a
positive cash flow, the Company may in fact benefit from the sale of ARM.
However, unless and until this occurs, the Company may not have sufficient
capital to achieve its current business plan, which raises substantial
doubt as to the Company's ability to continue as a going concern after the
sale of ARM is completed.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page
Index to Consolidated Financial Statements and Supplementary Data:
- -----------------------------------------------------------------
Report of Independent Auditors 20
Financial Statements:
Consolidated Balance Sheets -
May 31, 1996 and 1995 21-22
Consolidated Statements of Operations -
Years Ended May 31, 1996 and 1995 23
Consolidated Statements of Changes in
Stockholders' Deficit -
Years Ended May 31, 1996 and 1995 24
Consolidated Statements of Cash Flows -
Years Ended May 31, 1996 and 1995 25-26
Notes to Consolidated Financial Statements 27-41
The Financial Statement Schedules and Exhibits
are Listed in Part III Item 13 18
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
--------
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 10. EXECUTIVE COMPENSATION
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Part III, Items 9, 10, 11 and 12, are incorporated by reference from the
Registrant's definitive Proxy Statement relating to its Annual Meeting of
Shareholders which will be filed in an amendment within 120 days of
May 31, 1996.
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Certain documents filed as part of the Form 10-KSB
Page
----
(1) The financial statements included are listed in
Part II Item 8 17
(2) Supporting Financial Schedules for the Years Ended
May 31, 1996 and 1995 42-48
(b) Reports on Form 8-K.
(1) On April 17, 1996, the Company filed a Current Report
on form 8-K dated April 2, 1996, reporting the filing
of a voluntary petition for relief under Chapter 11 of
the Bankruptcy Code by ARM. That report included:
ITEM 3: BANKRUPTCY OR RECEIVERSHIP
(c) Index to Exhibits 49
All schedules not included herewith are presented in the
footnotes to the consolidated financial statements or are not applicable.
APPLIED RESEARCH CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report
The Board of Directors and Stockholders
Applied Research Corporation
We have audited the accompanying consolidated balance sheets of Applied
Research Corporation and subsidiaries as of May 31, 1996 and 1995, and the
related consolidated statements of operations, changes in stockholders'
deficit, and cash flows for the years then ended. In connection with our
audit of the consolidated financial statements referred to above, we have
audited the consolidated financial statement schedules as listed in the
accompanying index. These consolidated financial statements and financial
statement schedules are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated
financial statements and financial statement schedules based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform our audits to
obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Applied Research Corporation and subsidiaries as of May 31, 1996 and 1995,
and the consolidated results of their operations and their cash flows for
the years then ended in conformity with generally accepted accounting
principles. Also in our opinion, the related consolidated financial
statement schedules, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly, in all material
respects, the information set forth therein.
The accompanying consolidated financial statements and financial statement
schedules have been prepared assuming that the Company will continue as a
going concern; however, the Company had net working capital and
stockholders' capital deficits as of May 31, 1996, as well as a history of
losses. As discussed in Note 3, the Company's principal operating
subsidiary has filed for reorganization under Chapter 11 of the United
States Bankruptcy Code and is subject to a pending agreement under which
substantially all of its contract rights and certain other assets are to
be sold to a third party. This subsidiary has served as the main source
of cash flow for the Company and has provided continued funding (through
the date of the bankruptcy filing) to the Company's two other
subsidiaries, both of which have a history of losses and both of which
have substantial working capital and stockholders' capital deficits. The
foregoing factors raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these
matters are also described in Note 3. The consolidated financial
statements and financial statement schedules do not include any
adjustments that might result from the outcome of this uncertainty.
FRIEDMAN & FULLER, P.C.
Rockville, Maryland
August 18, 1996, except for Note 3,
as to which the date is August 31, 1996
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MAY 31, 1996 AND 1995
1996 1995
----------- -----------
ASSETS
- ------
CURRENT ASSETS
Cash (Notes 2 and 5) $ 78,689 $ 15,028
Accounts receivable, net (Notes 3, 4 and 5) 1,524,685 1,792,853
Inventory, at cost 1,492 3,709
Other current assets 21,093 60,819
----------- -----------
TOTAL CURRENT ASSETS 1,625,959 1,872,409
PROPERTY AND EQUIPMENT, AT COST (Notes 3, 4 and 5)
Furniture and equipment 167,405 192,880
Computer equipment 462,206 464,557
Laboratory equipment 121,426 246,365
Leasehold improvements 22,322 22,322
----------- -----------
773,359 926,124
Less accumulated depreciation and amortization 640,589 776,807
----------- -----------
NET PROPERTY AND EQUIPMENT 132,770 149,317
INTANGIBLE ASSETS, NET OF
AMORTIZATION (Notes 2 and 3) 32,276 57,357
OTHER ASSETS 6,615 41,075
----------- -----------
TOTAL ASSETS $1,797,620 $2,120,158
=========== ===========
See accompanying notes to the consolidated financial statements
/TABLE
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - Continued
MAY 31, 1996 AND 1995
1996 1995
----------- -----------
LIABILITIES
- -----------
CURRENT LIABILITIES
Liabilities not subject to compromise:
Notes payable, current maturities (Note 5) $ 689,563 $ 911,681
Notes payable to officers and directors,
current maturities 4,000 -
Accounts payable 162,314 549,295
Accrued salaries and benefits (Notes 6 and 7) 176,574 1,215,284
Accrued payroll taxes and withholdings
(Notes 2 and 8) 57,143 481,576
Other accrued liabilities 77,665 362,580
Billings in excess of costs and
anticipated profits 9,999 59,594
Deferred revenue (Note 2) 27,635 14,444
Income taxes payable (Note 9) 1,411 19,860
Provision for contract losses 60,000 40,000
----------- -----------
Total liabilities not subject to compromise 1,266,304 3,654,314
----------- -----------
Liabilities subject to compromise: (Note 3)
Accounts payable 403,812 -
Accrued salaries and benefits (Notes 6 and 7) 861,151 -
Accrued payroll taxes and withholdings (Note 8) 930,794 -
Accrued interest and penalties (Notes 7 and 8) 437,708 -
----------- -----------
Total liabilities subject to compromise 2,633,465 -
----------- -----------
TOTAL CURRENT LIABILITIES 3,899,769 3,654,314
NOTES PAYABLE, NET OF CURRENT MATURITIES
(Note 5) - 25,000
----------- -----------
TOTAL LIABILITIES 3,899,769 3,679,314
----------- -----------
STOCKHOLDERS' DEFICIT
- ---------------------
Preferred stock, $.10 par value, 40,000,000
shares authorized, none issued - -
Common stock, $.0005 par value, 60,000,000
shares authorized, 6,811,083 shares issued
and 6,311,083 shares outstanding in 1996
and 5,944,416 shares issued and outstanding
in 1995 (Notes 11 and 12) 3,155 2,972
Capital in excess of par value 1,140,529 1,026,649
Accumulated deficit (3,245,833) (2,588,777)
----------- -----------
TOTAL STOCKHOLDERS' DEFICIT (2,102,149) (1,559,156)
COMMITMENTS AND CONTINGENCIES
(Notes 2, 3, 5, 7, 8, 10, 11 and 12) ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $1,797,620 $2,120,158
========== ==========
See accompanying notes to the consolidated financial statements
/TABLE
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED MAY 31, 1996 AND 1995
1996
1995
----------- -----------
Revenue (Notes 2 and 14) $8,957,464 $9,590,113
Operating costs and expenses:
Direct cost of services 5,467,113 6,066,430
Indirect operating costs 1,934,199 2,349,084
General & administrative expenses 1,526,910 1,501,074
----------- -----------
Total operating costs and expenses 8,928,222 9,916,588
----------- -----------
Operating income (loss) 29,242 (326,475)
Other expense:
Interest expense, net 379,173 347,613
Consulting expense associated with stock
awards (Note 11) 89,063 -
Penalties (Note 8) 162,778 180,979
Other, net 26,521 14,912
----------- -----------
Total other expense 657,535 543,504
----------- -----------
Loss before reorganization items and
income taxes (628,293) (869,979)
Reorganization items: (Note 3)
Professional fees (28,763) -
----------- -----------
Loss before income taxes (657,056) (869,979)
Income taxes (Note 9) - 25,334
----------- -----------
Net loss $ (657,056) $ (895,313)
===========
===========
Net loss per common share $ (0.11) $ (0.15)
=========== ===========
Weighted average number of shares outstanding 6,214,817 5,944,416
========= =========
See accompanying notes to the consolidated financial statements
/TABLE
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
YEARS ENDED MAY 31, 1996 AND 1995
Common
Stock Capital in Common
Par Excess of Stock Accumulated Stockholders'
Value Par Value Warrants Deficit Deficit
------ ---------- -------- ------------ ------------
Balance May 31, 1994 $2,972 $1,026,649 $ 5,625 $(1,693,464) $ (658,218)
Refund of common stock
warrants paid (Note 11) (5,625) (5,625)
Net loss (895,313) (895,313)
------ ---------- -------- ------------ ------------
Balance May 31, 1995 2,972 1,026,649 - (2,588,777) (1,559,156)
Conversion of convertible
note to common stock
(Notes 5 and 11) 33 24,967 25,000
Stock awards (Note 11) 150 88,913 89,063
Net loss (657,056) (657,056)
------ ---------- -------- ------------ ------------
Balance May 31, 1996 $3,155 $1,140,529 $ - $(3,245,833) $(2,102,149)
====== ========== ======== ============ ============
See accompanying notes to the consolidated financial statements
/TABLE
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED MAY 31, 1996 AND 1995
1996 1995
----------- -----------
Cash flows from operating activities:
Cash received from customers $ 9,189,228 $10,030,737
Cash paid to suppliers and employees (8,530,333) (9,262,801)
Interest paid (268,729) (292,449)
Income taxes paid (18,449) (5,474)
----------- -----------
Net cash provided from operating
activities before reorganization items 371,717 470,013
----------- -----------
Operating cash flows from reorganization
items:
Professional fees paid for services
rendered in connection with the
Chapter 11 proceeding (28,763) -
----------- -----------
Net cash used by reorganization items (28,763) -
----------- -----------
Net cash provided from operating activities 342,954 470,013
----------- -----------
Cash flows from investing activities:
Capital expenditures (61,175) (109,492)
----------- -----------
Net cash used in investing activities (61,175) (109,492)
----------- -----------
Cash flows from financing activities:
Proceeds from loans to officers and directors 4,000 -
Proceeds from equipment financing - 50,515
Proceeds of loans from receivables
assignment - pre-petition 6,299,537 7,146,885
Proceeds of loans from receivables
assignment - post-petition 1,430,489 -
Repayment of loans from receivables
assignment - pre-petition (6,568,076) (7,536,095)
Repayment of loans from receivables
assignment - post-petition (1,342,530) -
Repayment of notes payable to bank - (25,000)
Repayment of equipment loan - pre-petition (41,538) (8,977)
Refund of common stock warrants - (5,625)
----------- -----------
Net cash used in financing activities (218,118) (378,297)
----------- -----------
Net increase (decrease) in cash 63,661 (17,776)
Cash at the beginning of year 15,028 32,804
----------- -----------
Cash at the end of year $ 78,689 $ 15,028
========== ==========
CONTINUED
See accompanying notes to the consolidated financial statements
/TABLE
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
YEARS ENDED MAY 31, 1996 AND 1995
1996 1995
----------- -----------
Reconciliation of net loss to net cash
provided from operating activities:
Net loss $(657,056) $(895,313)
Adjustments to reconcile net loss to net cash
provided from operating activities:
Depreciation 77,722 71,884
Amortization 25,776 86,251
Loss from write-off of capitalized software - 118,917
Provision for contract losses 20,000 -
Consulting expense associated with stock awards 89,063 -
Changes in assets and liabilities:
Decrease in accounts receivable 268,168 434,757
Decrease in inventory 2,217 4,231
Decrease in other current assets 39,726 382
Increase in intangible assets (695) (50,529)
Decrease (increase) in other assets 34,460 (23,733)
Decrease in accounts payable - pre-petition (145,483) (177,849)
Increase in accounts payable - post-petition 162,314 -
Increase (decrease) in accrued salaries and
benefits - pre-petition (354,133) 314,793
Increase in accrued salaries and
benefits - post-petition 176,574 -
Increase in accrued payroll taxes
and withholdings - pre-petition 449,218 376,038
Increase in accrued payroll taxes
and withholdings - post-petition 57,143 -
Increase in other accrued liabilities -
pre-petition 75,128 269,657
Increase in other accrued liabilities -
post-petition 77,665 -
Decrease in billings in excess of costs
and anticipated profits (49,595) (93,777)
Increase in deferred revenue 13,191 14,444
Increase (decrease) in income taxes payable (18,449) 19,860
----------- -----------
Net cash provided from operating activities $ 342,954 $ 470,013
========= =========
Supplemental disclosure of cash flow information:
During the year ended May 31, 1996, the holder of a $25,000 note converted the
note into 66,667 shares of common stock of the Company (See Notes 5 and 11 for
additional information).
During the year ended May 31, 1996, 300,000 shares were issued to two companies
as compensation for their services under consulting agreements (See Note 11 for
additional information).
See accompanying notes to the consolidated financial statements
/TABLE
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 1996 AND 1995
1. ORGANIZATION
------------
Applied Research Corporation is organized under the laws of the state of
Colorado and is comprised of two wholly owned subsidiaries, Applied Research of
Maryland, Inc. ("ARM") and ARSoftware Corporation ("ARS"), and one majority
owned subsidiary, ARInternet Corporation ("ARInternet"). In addition, the
Company formed ARInstruments Division ("ARInstruments"), an unincorporated
commercial instrumentation division of ARM.
ARM is a high technology company specializing in research and development,
design and fabrication of sensors and instrumentation, technical support
services and scientific related software creation. ARM's major areas of
service include Astronomy and Astrophysics, Atmospheric Sciences, Meteorology,
the Space Sciences and Computer Related Analytical Services. On April 2, 1995,
ARM filed a voluntary petition for relief under Chapter 11 of the United States
Bankruptcy Code. See Note 3 to the Consolidated Financial Statements for
additional information.
ARInstruments was formed in fiscal 1993 to penetrate the government and
commercial instrumentation markets. During its many years of performing under
government contracts, the Company has developed expertise in custom design and
fabrication work. In addition, members of the Company's technical staff have
investigated and researched other government and commercial applications for
existing technologies. The Company formed ARInstruments to segregate these
operations from the government contract operations in the design, fabrication,
and distribution of instrumentation products. During the fiscal year ended May
31, 1994, ARInstruments began research and development efforts related to
product development and initiated two patent applications. These patents were
granted during the fiscal year ended May 31, 1995. The costs associated with
obtaining these patent applications have been capitalized.
ARS was established in April 1992, to diversify the business base of the
Company by developing niche markets in the computer software industry. ARS is
currently reselling existing products under licensing agreements.
ARInternet was established in November 1994, to diversify the business base of
the Company by developing niche markets in the on-line computer services
industry. ARInternet is an Internet provider and plans on providing scientific
and other information to the scientific and engineering communities.
Applied Research Corporation maintains only minimal resources and derives all
of its income from its subsidiaries. As hereinafter used, Applied Research
Corporation or the term "Company" shall refer to Applied Research Corporation
and its subsidiaries, except when otherwise indicated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
PRINCIPLES OF CONSOLIDATION
- ---------------------------
The accompanying consolidated financial statements include the accounts of
Applied Research Corporation and its wholly and majority owned subsidiaries.
All significant intercompany balances and transactions have been eliminated in
consolidation.
CONTRACT REVENUE
- ----------------
Revenue on cost-plus fixed fee contracts is recorded on the basis of
recoverable direct costs incurred plus indirect expenses and the allocable
portion of the fixed fee. Fixed price contracts are accounted for under the
percentage of completion method measured by cost of services performed to total
estimated cost of services. Revenue under time and material contracts is
recorded at negotiated rates as labor hours and other direct costs are
incurred. Cost to complete estimates are reviewed periodically and revised as
required and a provision for estimated losses on contracts is recorded when
identified.
All contract costs, including direct and indirect costs are subject to audit by
the Defense Contract Audit Agency ("DCAA") and ultimate reimbursement of costs
is contingent upon the outcome of such audits. As of May 31, 1996, the DCAA
has completed audits for the years 1982 to 1993 and all adjustments resulting
from these audits are reflected in the consolidated financial statements
presented.
In the opinion of management, adequate provision has been made in the
accompanying consolidated financial statements for adjustments, if any, which
may result from audits for fiscal years 1994 through 1996.
SOFTWARE REVENUE
- ----------------
ARS resells software products developed by other companies as well as state of
the art proprietary software products developed by the Company for use in the
scientific and engineering communities. Revenue is recorded when the software
program is shipped to the customer.
SUBSCRIPTION REVENUE
- --------------------
ARInternet provides online computer access to the internet (information super
highway). ARInternet offers monthly, quarterly, semi-annual and annual
subscriptions to its customers. These subscriptions are billable in advance.
ARInternet recognizes revenue on an as-earned basis. Deferred revenue is
recorded for amounts received from customers in advance. Subscriptions may be
canceled by the customer at any time, upon written notice.
CASH EQUIVALENTS
- ----------------
Cash equivalents are defined as highly liquid short-term investments whose
maturity dates do not extend past three months from the original date of
purchase. At May 31, 1996, the Company held no such investments. At May 31,
1996, ARM held $65,503 of cash that is restricted, as follows.
Description Amount
----------- ------
Held for ARM withholding taxes $43,173
Held for 401(k) Plan (see Note 7
to the Consolidated Financial
Statements) 22,330
-------
Total $65,503
=======
INVENTORY
- ---------
Inventory consists principally of computer software and is stated at the lower
of purchased cost or market. Cost is determined by using the first-in, first-
out (FIFO) method.
DEPRECIATION AND AMORTIZATION
- -----------------------------
Depreciation of furniture, office equipment, lab equipment and computer
equipment is computed on the straight-line method over the estimated useful
economic lives of the assets, generally 3 to 5 years. Leasehold improvements
are amortized over the estimated economic life of the improvement or the
remaining term of the lease, whichever is shorter.
INTANGIBLE ASSETS
- -----------------
Intangible assets consist of capitalized computer software costs and patent
development costs.
Capitalized computer software costs consist of expenses associated with
producing "product masters" for two products developed by ARS. These costs
have been capitalized in accordance with Statement of Financial Accounting
Standard #86 (SFAS No. 86). SFAS No. 86 prescribes that costs of producing
"product masters" incurred subsequent to establishing the technical feasibility
of a product shall be capitalized. In accordance with SFAS No. 86, the annual
amortization of these capitalized costs shall be the greater of the amount
computed using (a) the ratio that current gross revenues for a particular
product bear to the total of current and anticipated future gross revenues for
the product or (b) the straight line method over the remaining estimated
economic life of the product. At May 31, 1996 and 1995, net capitalized
software costs were $9,325 and $33,809, net of accumulated amortization of
$282,796 and $258,313, respectively. ARS began amortizing these costs on a
product-by-product basis as the associated products became available for
general release to customers. During the years ended May 31, 1996 and 1995,
$24,483 and $204,848, respectively, in amortization expense had been recorded
for products associated with the capitalized software development costs.
As of May 31, 1995, the Company wrote off the unamortized balance of one of its
software products, because it believed that the unamortized balance exceeded
the net realizable value of the product. The write-off amounted to $118,917,
and is included in the accumulated amortization above.
During the year ended May 31, 1995, the Company was granted two patents. The
costs associated with obtaining these patents were capitalized and are being
amortized over the life of the patents, which is 20 years from application, or
approximately 18.5 years after notification of receipt.
DEFERRED OFFERING EXPENSES
- --------------------------
During the year ended May 31, 1995, the Company paid approximately $30,500 of
costs that were associated with arranging for the raising of additional capital
in fiscal 1996, which effort was abandoned. These costs are included in other
assets (non current) in the consolidated balance sheet as of May 31, 1995.
During the year ended May 31, 1996, these costs were charged to expense.
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY
- --------------------------------------------
The Company owns 95% of ARInternet which was formed during November 1994.
However, because the minority interest in net losses of ARInternet exceeded the
carrying value of the minority interest amount at May 31, 1996, no minority
interest has been reflected in the consolidated financial statements.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
- -------------------------------------------------------
The preparation of financial statements in conformity with generally-accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
INCOME TAXES
- ------------
Deferred income taxes result from temporary differences resulting in the
recognition of revenue and expense for financial accounting and tax purposes.
The principal source of temporary differences relates to differences in the
amount of financial statement and tax treatment of net operating loss
carryfowards, compensated absences, capitalized software development costs, and
certain accrued contract amounts.
LOSS PER COMMON SHARE
- ---------------------
Loss per share of common stock has been computed by dividing the net loss by
the weighted average number of shares of common stock outstanding during each
of the periods presented. Common stock equivalent shares relating to stock
options and warrants are included in the weighted average only when the effect
is dilutive.
RECLASSIFICATIONS
- -----------------
Certain amounts in the 1995 consolidated financial statements have been
reclassified to conform with the 1996 presentation.
Effective for the year ended May 31, 1996, the Company changed its method of
presenting the statement of cash flows for operating activities from the
indirect method (which adjusts net income to remove the effects of noncash
operating transactions) to the direct method (which shows the principal
components of operating cash receipts and payments). This change has been
applied retroactively to the 1995 statement.
3. VOLUNTARY PETITION FOR RELIEF UNDER CHAPTER 11/SALE OF ARM
----------------------------------------------------------
On April 2, 1996, ARM (the "Debtor") filed a petition for relief under
Chapter 11 of the federal bankruptcy laws in the United States Bankruptcy Court
for the Southern District of Maryland. Neither ARC, ARS nor ARInternet filed
for relief. Under Chapter 11, certain claims against the Debtor in existence
prior to the filing of the petitions for relief under the federal bankruptcy
laws are stayed while the Debtor continues business operations as Debtor-In-
Possession. These claims are reflected in the supplemental consolidating
schedules for May 31, 1996 as "liabilities subject to compromise" (see
page 44). Additional claims (liabilities subject to compromise) may arise
subsequent to the filing date resulting from the rejection of executory
contracts, including leases, and from the determination by the court (or
agreement of the parties in interest) of allowed claims for contingencies and
other disputed amounts. Claims secured against the Debtor's assets ("secured
claims") also are stayed, although the holders of such claims have the right to
move the court for relief from the stay. Secured claims are secured primarily
by liens on the Debtor's property, including the Debtor's accounts receivable.
On April 5, 1996, ARM received an emergency hearing with the Bankruptcy Court
to determine its request to pay its employees their pre-petition wages as well
as continue to operate the business. Prior to the emergency hearing, ARM
reached an agreement with the IRS and CFC (its lender - see Note 5) to allow
the company to continue to operate and borrow money from CFC against its billed
receivables. Under this agreement, ARM agreed to pay $15,000 a month starting
April 1996, towards its arrearage with the IRS. The April payment consisted of
the $13,600 of cash seized by the IRS on April 1, 1996. Future monthly
payments will be made directly to the IRS by CFC from borrowings made by ARM.
ARM was also required to remit to the IRS collections on certain billed
receivables that were outstanding as of April 2, 1996 (the final vouchers on 14
old contracts, which totaled approximately $136,700). In addition, as part of
the agreement with the IRS and as required by the Bankruptcy Court, ARM was
required to remit its post-petition taxes when due and provide proof of such
payments to the IRS and the Court on a timely basis. The Bankruptcy Court
approved the agreements with the IRS and CFC, and approved ARM's operating
budget for 15 days through April 21, 1996. These agreements have continued to
be renewed by the Bankruptcy Court.
The Debtor has determined that there exists insufficient collateral to cover
the interest portion of scheduled payments on its pre-petition debt
obligations, most notably the installment obligation due to the IRS prior to
the filing of the petition. The Debtor has curtailed accruing interest on all
pre-petition obligations except the amounts owed CFC (see Note 5) because of
the Bankruptcy filing. In addition, the Debtor has curtailed accruing interest
on the unpaid amounts due to the 401(k) Plan, because of the Bankruptcy filing.
SALE OF ARM'S GOVERNMENT CONTRACTS.
- ----------------------------------
On June 24, 1996, the Company accepted a contract for the sale of certain of
ARM's assets for approximately $1.5 Million. The sale was subject to
Bankruptcy Court approval, which was scheduled for July 26, 1996. This hearing
was subsequently moved to July 30, 1996. On July 30, 1996, the hearing was
conducted. At the hearing, a total of four qualified bidders attended, and
after extensive biding, an offer was accepted for $2.1 Million. The following
is a list of the purchased and excluded assets:
PURCHASED ASSETS EXCLUDED ASSETS
- - All contracts rights - ARM's charter and status as a
including project contracts), corporation, its minute book, stock
- - All inventory, transfer records, and similar records
- - All books and records, relating to ARM's organization,
- - All furniture, fixtures and existence or capitalization, and the
equipment, capital stock or ARM,
- - All proprietary rights - Billed accounts receivable as of
(patents, etc.) closing,
- - All unbilled accounts - Intercompany receivables,
receivable as of the closing - ARM's rights to occupy real property
date. pursuant to leases of real property and
any leasehold improvements made thereto.
- Any other property identified by the
Purchaser prior to the closing.
During August 1996, management and ARM's bankruptcy attorney negotiated a
contract, which was signed on August 30, 1996. A court order documenting the
bidding procedure as well as the contract is expected to be submitted to the
Bankruptcy Court for approval during the week ended September 13, 1996. The
sale is subject to the successful novation of ARM's government contracts. This
is expected to take approximately 60 to 90 days from contract execution. The
sale must also be approved by a majority of the Company's shareholders. The
Company plans to submit the matter to a vote at the Company's Annual Meeting of
Shareholders currently scheduled for October 30, 1996. Upon notification of
the government's novation approval, and approval of the Company's shareholders,
the sale will be completed.
PLAN OF REORGANIZATION/PAYMENT AND PRE-PETITION LIABILITIES.
- -----------------------------------------------------------
Once the sale referenced above is completed, ARM (the "Debtor") will file a
Plan of Reorganization, which will, among other things, specify how much of the
outstanding pre-petition liabilities will be paid and over what period of time.
It is expected that a Plan of Reorganization will be filed with the Bankruptcy
Court within 30 days of completing the sale. This Plan is expected to take
several months to receive Bankruptcy Court approval. It is also expected that
between the monies generated from the sale of ARM's contracts rights plus the
collection of the outstanding accounts receivables (which are not part of the
sale), there will not be sufficient monies to liquidate all of ARM's pre-
petition liabilities. Furthermore, it appears that the unsecured creditors
(accounts payable) will receive little or nothing towards their pre-petition
claims. Specifically, it appears that the following will be paid in full as a
result of the Plan of Reorganization: 1) the secured claim of CFC, ARM's pre-
petition and post-petition lender, 2) the amounts owed to the employees for
accrued vacation (up to $325,000), the amount owed to the 401(k) Plan as of
April 2, 1996, of approximately $676,000, as well as their pre-petition claims
for unreimbursed travel expenses of approximately $50,000, and, 3) the
principal portion of the tax amounts owed to both the IRS and the various state
authorities. In addition, it appears that the various taxing authorities will
receive a portion of the pre-petition penalties and interest, but not the full
amount. Although these are the current expectations, there can be no
assurances that these amounts will be paid until the Plan of Reorganization is
submitted and confirmed by the Court.
COLLECTION OF THE INTER-COMPANY AMOUNTS OWED TO ARM.
- ---------------------------------------------------
As of April 2, 1996, ARS owed ARM approximately $1.2 Million and ARInternet
owed ARM $0.4 Million. These amounts resulted from ARM paying ARS's and
ARInternet's operating expenses during their start-up phases and providing
continued funding thereafter to fund operations. Since these amounts are owed
to ARM, the ultimate collection of these advances will be supervised and
controlled by the Bankruptcy Court. As of May 31, 1996, ARS has still not
achieved break even operations. As of September 6, 1996, ARS has only one
full-time employee and its sales are minimal. Therefore payment of any of the
amount its owes ARM is extremely doubtful. On the other hand, ARInternet has
essentially achieved break even operations as of May 31, 1996. Therefore, it
can reasonably be expected that ARInternet will be required to repay some
amount to liquidate its debt to ARM. The ultimate amount will be determined by
the Bankruptcy Court.
IMPACT ON ARC AFTER THE SALE OF ARM IS COMPLETED.
- ------------------------------------------------
During the current fiscal year ARM constituted 94% of ARC's total revenue. The
sale currently contemplated will sell essentially all of ARM's operations to
the Purchaser and eliminate all of ARM's revenues. Therefore, ARS and
ARInternet will be the only remaining operating entities. Up until the
bankruptcy filing, ARM had been forced to continue to fund ARS's and
ARInternet's operations. During the current fiscal year (through April 2,
1996), ARM funded approximately $204,600 of ARS and ARInternet expenses. From
the period from April 2, 1996 on, because of the bankruptcy proceedings, ARM
ceased all such advances and ARS and ARInternet were forced to fund their own
operations. ARS is still not operating at cash flow break even, so it is
doubtful that it can survive without an infusion of cash or a substantial
increase in revenues. Management is considering several options for ARS,
including ceasing its operations. ARInternet on the other hand, has steadily
increased its revenues and as of May 31, 1996, had approximately 1,000
subscribers and had essentially reached break even operations. Management
believes that ARInternet's revenues and business will continue to grow and that
ARInternet will ultimately be a successful business on its own, however there
can be no assurances of this.
The space currently occupied by ARM is not covered by the Bankruptcy
proceeding, since the lease is held by ARC. Management of ARC has enlisted the
services of a real estate broker to find a tenant to take over this space when
ARM's operation are sold. The landlord has also been apprised of the ARM sale
and is attempting to find an alternate tenant, but is under no obligation to
release ARC of its obligation under the lease. In addition, ARC will continue
to incur expenses to maintain its status as a public company. Although these
expenses will be less because of having less revenues and expenses, they will
have to be borne by the remaining companies. (See Note 10.)
The sale of ARM, if completed, will dramatically change the Company's balance
sheet and statement of operations. Through the bankruptcy proceeding, all of
ARM's debts which total $3.7 million at May 31, 1996, will be either liquidated
or discharged. This will decrease the Company's interest and penalties costs
that it had been incurring. If ARS and ARInternet's revenues can be increased
to produce net profits and a positive cash flow, the Company may in fact
benefit from the sale of ARM. However, unless and until this occurs, the
Company may not have sufficient capital to achieve its current business plan,
which raises substantial doubt as to the Company's ability to continue as a
going concern after the sale of ARM is completed. While there can be no
assurance, management believes that ARC will not be adversely affected by the
bankruptcy proceeding and the sale of ARM.
AICPA Accounting Principles Board opinion No. 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal if a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions ("APB
30") provides that the operations of a segment of a business be accounted for
as discontinued operations in the period that management, having the authority
to approve the action, commits itself to a formal plan to dispose of the
segment, whether by sale or abandonment. Although management had expressed its
intent to sell ARM, a formal plan had not been approved prior to May 31, 1996.
In addition, the proposed sale of ARM is contingent on several factors, as
described above, including successful novation of ARM's government contracts
and final approval from the Bankruptcy Court. It is the opinion of management
that the proposed sale does not meet the requirements of APB 30 as of May 31,
1996. Accordingly, ARM's results of operations and the financial impact of the
proposed sale have not been accounted for as discontinued operations.
4. ACCOUNTS RECEIVABLE
-------------------
Accounts receivable are comprised of the following at May 31:
1996 1995
---- ----
Billed accounts receivable, 1995
includes $53,945 of May 1995
expenses billed in June 1995) $1,100,861 $1,068,425
Unbilled costs, fees and retentions
under cost-type contracts 433,824 724,428
------------ ------------
1,534,685 1,792,853
Less: allowance for doubtful accounts 10,000 -
------------ ------------
Accounts receivable - net of allowance $1,524,685 $1,792,853
============ ============
Principally all of the Company's revenues are generated from contracts with
departments or agencies of the U.S. Government ("Government") and are subject
to audit by Government auditors (see Note 2 - Contract Revenue). In 1996 and
1995, net sales to the Government or to prime contractors under Government
contracts amounted to approximately $8,393,900 and $9,153,500, respectively.
The Company extends unsecured credit to essentially all of its customers. As
of May 31, 1996 and 1995, billed accounts receivable included approximately
$1,066,953 and $1,011,192, respectively, due from either the Government or from
prime contractors under Government contracts.
In accordance with industry practice, accounts receivable relating to long-term
contracts are classified as current assets. In 1996 and 1995, accounts
receivable of approximately $166,000 and $193,000 respectively are not expected
to be realized within one (1) year. These amounts are comprised primarily of
retainages on long-term contracts.
5. NOTES PAYABLE
-------------
Notes payable are comprised of the following at May 31:
1996 1995
---- ----
Note payable to an investor, converted
into 66,667 shares of common stock
during October 1995 $ - $ 25,000
Note payable to asset-based lending
organization with interest payable
monthly at 14%, due in installments
over three years, secured by equipment - 41,538
Notes payable to asset-based lending
organization 689,563 870,143
------------ ------------
Total notes payable 689,563 936,681
------------ ------------
Less current maturities 689,563 911,681
------------ ------------
Notes payable - long term $ - $ 25,000
============ ============
On January 7, 1994, the Company's wholly owned subsidiary ARS, entered into an
agreement with an investor, whereby the investor provided a $25,000 loan to ARS
in exchange for a convertible promissory note. The note was to mature on
January 7, 1999. The note bore interest at the rate of 8% per annum and was
converted into 66,667 shares of the Company's common stock pursuant to its
terms. These shares have been registered with the Securities and Exchange
Commission under a Form S-3, which was declared effective on July 1, 1994 (see
Note 11).
Effective April 29, 1994, the Company's wholly owned subsidiary, ARM,
consummated an agreement with an asset-based lender ("PrinCap") as its primary
source of financing under a $1.5 million line of credit facility, which allowed
ARM to borrow against billed and unbilled government receivables on certain
assigned contracts. The cost to ARM associated with the foregoing financing
agreements was prime plus 5% on all borrowings secured by billed receivables
and 18.25% per annum on borrowings secured by unbilled receivables. In
addition, ARM was charged an annual administration fee of $25,000 and a 0.5%
service fee per month on the highest outstanding loan balance (including the
amount outstanding on the equipment note) during each preceding month.
On August 31, 1994, ARM negotiated an agreement with PrinCap to provide $50,515
of equipment financing to ARM. This note was payable over three years, in
monthly installments of $1,726, starting October 15, 1994. The note bore
interest at the rate of 14% per annum, and was secured by the underlying
equipment purchased.
ARM defaulted on its loan agreement with PrinCap pursuant to a provision
requiring it to remit all federal payroll withholding taxes as they became due.
On November 7, 1995, the IRS filed liens against the ARM. As a result, PrinCap
issued a letter of default on November 14, 1995, under which no additional
funding was granted and all residuals received by PrinCap were applied to
reduce the loan balances outstanding.
On November 17, 1995, ARM entered into an agreement with a new lender ("CFC"),
and on December 4, 1995, CFC paid off the remaining outstanding PrinCap loan
balance of $651,491, plus $18,288 of accrued interest and other charges. The
agreement with CFC allows ARM to borrow 90% against billed receivables on all
assigned contracts. Since the new financing agreement did not allow ARM to
borrow against unbilled receivables, ARM was required to pay off the $250,000
unbilled loan advance and the approximate $35,000 equipment loan due to PrinCap
at the time of closing the new loan. To accommodate this, CFC allowed ARM a
one-time advance of approximately 97% against eligible billed receivables. The
new financing agreement provides an interest rate of prime plus 4%, calculated
on the mid-month and end-of-month balances. There is also a 0.65% service
charge for each 15 day period on outstanding invoices.
The IRS agreed to give CFC a priority security interest with regards to its
loans against billed receivables. The IRS and CFC initially operated under an
interim subordination agreement while the Company applied for a formal
subordination from the IRS. On January 30, 1996, the IRS issued a Certificate
of Subordination. Additionally, as part of the installment agreement entered
into with the IRS on December 1, 1995, CFC agreed to deduct the monthly payment
due to the IRS from the amounts ARM borrows against its current billings, and
remit this directly to the IRS (see Notes 3 and 8 for additional information).
Subsequent to the filing of the Chapter 11 petition in the Bankruptcy Court,
CFC was granted a "First Lien" position in all post-petition financing. CFC
has continued lending to ARM against its post-petition receivables. As of
May 31, 1996, CFC was owed $28,400 on unpaid pre-petition receivables. The
underlying receivables were subsequently paid by the customers and this amount
was repaid.
6. ACCRUED SALARIES AND BENEFITS
-----------------------------
Accrued salaries and benefits are comprised of the following at May 31:
1996 1995
---- ----
Liabilities not subject to compromise:
Accrued salaries $ 122,681 $ 349,698
Accrued vacation 35,403 324,068
Retirement plan contributions (employer)
(see Note 7) 3,698 153,558
Retirement plan contributions (employee)
(see Note 7) 14,792 358,317
Retirement plan loan payments (employee) - 29,643
------------ ------------
Total accrued salaries and benefits -
not subject to compromise $ 176,574 $1,215,284
============ ============
Liabilities subject to compromise:
Accrued vacation $ 294,217 $ -
Retirement plan contributions (employer)
(see Note 7) 203,449 -
Retirement plan contributions (employee)
(see Note 7) 326,383 -
Retirement plan loan payments (employee) 37,102 -
------------ ------------
Total accrued salaries and benefits -
subject to compromise $ 861,151 $ -
============ ===========
7. RETIREMENT PLAN
---------------
The Company has a retirement plan (401(k) Plan) which is available to all
qualified employees. Employee contributions up to 10 percent of annual
compensation, up to $9,240 for calendar year 1995, may be made to the plan.
The Company provides matching funds up to 25 percent of the employee's
contributions to the plan. The plan provides that forfeitures may be used to
reduce the Company's contribution. The Company has accrued matching funds, net
of forfeitures, of $49,401 and $78,314 in 1996 and 1995, respectively.
At May 31, 1996, ARM had not remitted employee contributions of $326,383.
During calendar 1995, ARM had an agreement with its previous Lender
("PrinCap"), pursuant to which PrinCap had been authorized to, and had remitted
the 1995 employee contributions as they became due. This arrangement continued
until mid-November 1995, when PrinCap issued a default letter due to ARM's
failure to remit payroll withholding taxes as they became due. Because of the
shortfall of cash caused by the refinancing with CFC (see Note 5), ARM was
unable to remit the remaining 1995 employee contributions totaling $61,331
(included in the above total number). ARM began remitting the 1996 employee
contributions as they became due until April 2, 1996, when ARM filed for
protection form its creditors under Chapter 11 of the United States Bankruptcy
Code. ARM has informed its employees that it intends to pay interest at the
rate of 15% per annum on the unpaid employee withholdings. At April 2, 1996,
ARM had accrued interest payable of approximately $92,900.
At May 31, 1996, ARM had not remitted employer contributions of $237,449. ARM
has informed its employees that it intends to pay interest on these amounts at
the prevailing statutory rates (approximately 5%). At April 2, 1996, ARM had
accrued interest payable of approximately $9,900.
During July, 1995, ARM agreed to and signed contract modifications on its two
largest contracts with NASA. The contract modifications require ARM to remit
an increasing portion of its fee earned on these two contracts directly to the
401(k) plan in order to reduce the past due amounts owed. The portion of the
fees applied to the plan was 25% for the fees earned beginning January 1, 1995
and increased to 75% during calendar year 1995. Effective January 1, 1996, the
percentage increased to 100%. The contract modifications will remain in effect
until all past due amounts owed the 401(k) plan have been repaid. Through
April 2, 1996, $80,274 of fees earned under these contracts had been remitted
to the 401(k) plan in accordance with the contract modifications. From the
period from April 3, 1996 through May 31, 1996, an additional $22,300 in fees
were deposited into a separate bank account as required by these contract
modifications, although these monies cannot be remitted to the Plan without
Bankruptcy Court approval because they are pre-petition claims. As of May 31,
1996, ARM was in compliance with the terms of these contracts, as modified.
The Company's failure to remit 401(k) contributions in a timely fashion and/or
bring its past due obligations current may subject the Company to legal
proceedings seeking to collect said unpaid contributions, together with
interest thereon, liquidated damages and attorney's fees.
During the current fiscal year, the Department of Labor ("DOL") conducted an
investigation into the Company's 401(k) Plan and the status of the past due
contributions. There has been no indication that the DOL will impose any fines
and/or penalties as a result of the past due contributions therefore no
estimates can be made regarding any potential additional liabilities. At May
31, 1996, other than the interest that has already been accrued as discussed
above, no additional amounts have been recorded.
8. WITHHOLDING TAXES
-----------------
As of April 2, 1996, ARM had not remitted federal payroll tax withholdings
totaling approximately $764,755 relating to the fourth calendar quarter of
1994, the second and fourth calendar quarters of 1995, as well as the first
calendar quarter of 1996. ARM has accrued penalties and interest on those
delinquent amounts totaling approximately $328,700 through April 2, 1996.
During September, 1995, ARM remitted a $50,000 payment to the IRS. However,
ARM was unable to meet the October, 1995, payment requested by the IRS, and as
a result, the IRS filed a lien against ARM on November 7, 1995.
On December 1, 1995, ARM entered into a new installment agreement with the IRS
which specified a $75,000 monthly payment to be made by the 15th of each month
starting with December, 1995, and continuing until the total liability was
paid. As part of this agreement, the IRS agreed to give ARM's new lender
("CFC") a priority security interest with regards to its loans against billed
receivables. The interim subordination agreement continued while ARM applied
for a formal subordination from the IRS. On January 30, 1996, the IRS issued
the Certificate of Subordination. As a condition of the new installment
agreement, CFC was required to deduct the monthly payment from ARM's borrowings
against billed receivables and remit this directly to the IRS. CFC remitted
the first four installment payments through March 1996, totaling $300,000.
However, because of the refinancing ARM underwent in December 1996, ARM fell
behind on its current federal payroll taxes due. Between November 14, 1995 and
March 25, 1996, ARM did not remit approximately $472,500 of federal payroll
withholding taxes. As a result, ARM was in default of the new installment
agreement. On April 1, 1996, the IRS issued Levy Notices to ARM's bank,
financing company and the majority of its customers. On April 2, 1996, the IRS
attempted to close ARM. As a result, ARM was forced to file for protection
under Chapter 11 of the United States Bankruptcy Code on April 2, 1996. (See
further discussion in Note 3.)
As of April 2, 1996, ARM was also delinquent in remitting $153,062 of 1995 and
1996 state withholding taxes, as well as $12,977 in state unemployment taxes.
These claims are all pre-petition claims covered by the Bankruptcy proceeding.
Collection of these taxes are stayed by the Bankruptcy proceeding.
9. INCOME TAXES
------------
Statement of Financial Standards No. 109, "Accounting for Income Taxes" ("SFAS
109"), requires an asset and liability approach to financial accounting and
reporting for income taxes. Deferred income tax assets and liabilities are
computed annually for differences between the financial statement and tax bases
of assets and liabilities that will result in taxable or deductible amounts in
the future based on enacted tax laws and rates applicable to the periods in
which the differences are expected to affect taxable income.
SFAS 109 provides that deferred tax assets be reduced by a valuation allowance
if it is more likely than not that some portion of the deferred asset will not
be realized.
The tax effects of temporary differences computed at statutory rates in effect
as of May 31, 1996 and 1995 are as follows:
Net
Deferred tax assets: 1996 1995 Change
------ ------ --------
Section 481 retainages $ - $ 6,000 $ (6,000)
Accrued vacation 78,000 87,000 (9,000)
Bad debt allowances 4,000 - 4,000
Reserves for contract losses 24,000 16,000 8,000
Unfunded pension (employer) 81,000 61,000 20,000
Unfunded pension (employee) 131,000 143,000 (12,000)
Depreciation 2,000 7,000 (5,000)
Accrued interest 72,000 20,000 52,000
Deferred revenue 11,000 6,000 5,000
N.O.L. carryforward 544,000 432,000 112,000
------------ ------------ ------------
947,000 778,000 169,000
Valuation allowance (877,000) (642,000) (235,000)
------------- ------------ ------------
$ 70,000 $ 136,000 $ (66,000)
============= ============ ============
Deferred tax liabilities:
Retainages $ (66,000) $ (75,000) $ 9,000
Capitalized software (4,000) (61,000) 57,000
------------ ------------ ------------
$ (70,000) $(136,000) $ 66,000
============= ============ ============
The net increase in the deferred tax asset valuation allowance during the 1996
was $235,000. In recognizing its deferred tax assets, the Company has used
assumptions about levels of future pretax income that are consistent with
historical results.
The Company had a net loss for federal income tax purposes for fiscal years
1996 and 1995. A provision for current state income tax for fiscal year 1995
of $25,334 has been included in the determination of net income. This
provision arises from the reporting of taxable income by the Company's ARM
subsidiary on its separately filed state returns.
The Company has unused net operating loss (NOL) carryforwards of approximately
$1,359,000 for consolidated federal and state income tax purposes. These
carryforwards expire between fiscal years 2004 and 2010.
10. LEASE COMMITMENTS
-----------------
The Company has noncancelable operating leases primarily for office facilities
and certain equipment which expire at various dates through September 1998.
The office facility leases are subject to standard real estate escalation
factors and building operating expense pass-throughs.
ARM has two short term operating leases for office space that are provided for
three employees who work on certain of its government contracts. The costs of
these leases are charged to the specific contracts that these employees work
on. One of these leases expires on September 30, 1996, while the other, which
is on a cancelable basis, expires September 30, 1998. This latter lease
specifies an 3% escalation in rent each year.
Rental expense for operating leases was approximately $212,200 and $221,100 for
the years ended May 31, 1996, and 1995, respectively.
Future minimum operating lease payments on the noncancelable leases are as
follows:
Fiscal Year
-----------
1997 204,000
1998 204,000
1999 68,000
----------
$476,000
========
11. COMMON STOCK ISSUED/WARRANTS EXERCISABLE
----------------------------------------
During fiscal 1995, the Company prepared a Registration Statement on Form S-3
which registered the resale of all 220,000 shares of restricted common stock
sold and issued during fiscal 1994, and the issuance of the related common
stock underlying the Class A common stock purchase warrants. The Registration
Statement was declared effective by the Securities and Exchange Commission on
July 1, 1994. However, due to the decline in the market value of the Company's
common stock, the Company did not demand the exercise of the Class A common
stock warrants, which became discretionary with the warrantholder through the
expiration of the warrants which was extended by the Company to May 29, 1995.
No warrants were exercised prior to May 29, 1995, and $5,625 was repaid to the
individuals who had prepaid their warrants.
The Registration Statement also covered 920,000 shares of restricted common
stock and 184,000 shares of common stock purchase warrants convertible at $0.75
per share issued to the president of the Company upon conversion of $230,000 of
debt, and 66,667 shares convertible at $0.375 per share issuable upon the
conversion of an outstanding $25,000 convertible note. The holder of the
convertible note converted the note into 66,667 shares of common stock of the
Company. (See Note 5).
During August, 1995, the Company entered into two (2) agreements with New York-
based companies to provide public relations services for the Company and to
find and attract market makers for the Company's common stock. As
compensation, the Companies were to receive up to a total of 400,000 shares of
the Company's common stock. The Company has registered with the Securities and
Exchange Commission the stock issued pursuant to these agreements. Both
agreements can be canceled by the Company at any time. All of the stock
represented by these two agreements (800,000 shares) was issued in escrow
pending release as specified in the agreements. Upon the release of the stock,
the Company records compensation expense equal to the average of the bid and
asked prices (approximately $0.30 a share) on the date the agreements were
signed. During fiscal 1996, a total of 150,000 shares had been released to
each of these Companies, resulting in the recognition of $89,063 in consulting
expense. During December 1995, the Company and the consulting companies agreed
to terminate these agreements. Therefore, the remaining 500,000 shares will
not be released.
During January 1995, the Company entered into consulting agreements with two
individuals. These consultants have agreed to provide various consulting
services to the Company including identifying potential analysts, broker-
dealers, underwriters, market-makers, money managers, financial planners,
investors, and/or other new sources of capital, as well as, providing investor
and stockholder relations and identifying any potential acquisitions and/or
joint ventures. As compensation for these services, the Company has agreed to
pay these individuals up to 3.5% of any capital raised and has granted each of
these individuals Class A common stock warrants exercisable to purchase 100,000
shares of the common stock of the Company at an exercise price of $0.375 per
share. The Company has agreed to register with the Securities and Exchange
Commission the stock underlying these warrants. The warrants are exercisable
for a period of two years, expiring in March 1997.
At May 31, 1996, the Company had the following outstanding warrants:
Exercise Expiration
Amount Price Date
------ --------- ------------------
184,000 $0.75 November 1996
200,000 $0.375 March 1997
12. STOCK OPTION PLAN
-----------------
Under the terms of its 1986 stock option plan, options to purchase shares of
the Company's common stock were granted at $.50 per share, which was the market
price at the time of the reorganization of the Company. All shares were
exercisable over a 5 year period at 20 percent per year and if unexercised,
expire 10 years from the date of grant. As of May 31, 1996, there were options
outstanding to purchase 51,000 shares of the Company's common stock, which
expire during fiscal year 1998.
During fiscal 1995, the Company adopted a new incentive stock option plan.
This plan was approved by the shareholders on November 15, 1995. Under this
plan, the Company may issue options to purchase up to 300,000 shares of the
Company's common stock, at a price not less than the then current market price
of the Company's common stock. All shares are exercisable over a 5 year period
at 20 percent per year and if unexercised, expire no later than 10 years from
the date of grant.
The following is a summary of transactions for common shares under options:
Stock Under Options: 1996 1995
---- ----
Outstanding, beginning of year 220,000 96,000
Granted during the year 40,000 160,000
Canceled or expired during year (9,000) (36,000)
Exercised during year - -
--------- ---------
Outstanding, end of year 251,000 220,000
--------- ---------
Shares eligible for exercise
at end of year 91,000 60,000
========= =========
13. SIGNIFICANT CUSTOMERS
---------------------
For fiscal 1996, one customer accounted for approximately 35 percent (35%) of
total revenue. This customer, NASA, had 10 contracts with the Company of which
one contract provided 18 percent (18%) and a second provided 12 percent (12%)
of total revenue. Another customer accounted for 47 percent (47%) of the
Company's revenue during the year. This customer, Hughes Corporation
("Hughes"), had two contracts with the Company of which one provided 35 percent
(35%) of total revenue. The Company maintained one contract with General
Sciences Corporation ("GSC"), which contributed approximately 4 percent (4%) of
total revenue. The Company has two contracts with the Naval Research
Laboratory ("NRL") which accounted for 3 percent (3%) of the Company's revenue.
For fiscal 1995, one customer accounted for approximately 38 percent (38%) of
total revenue. This customer, NASA, had 21 contracts with the Company of which
one contract provided 17 percent (17%) and a second provided 13 percent (13%)
of total revenue. Another customer accounted for 37 percent (37%) of the
Company's revenue during the year. This customer, Hughes, had two contracts
with the Company of which one provided 29 percent (29%) of total revenue. The
Company has four contracts with NRL, which accounted for 7 percent (7%) of the
Company's revenue. The Company maintained one contract with GSC, which
contributed approximately 6 percent (6%) of total revenue.
14. INDUSTRY SEGMENT INFORMATION
----------------------------
The Company's operations have been classified into three business segments:
ARM ARS ARInternet Consolidated
---------- -------- ---------- ------------
Sales to unaffiliated customers:
YEARS ENDED:
-----------
May 31, 1996 $8,393,868 $261,921 $ 301,675 $8,957,464
May 31, 1995 $9,135,523 $429,335 $ 25,255 $9,590,113
Operating income (loss) from continuing
operations before income taxes and
extraordinary item:
YEARS ENDED:
-----------
May 31, 1996 $349,618 $(118,026) $(202,350) $ 29,242
May 31, 1995 $286,202 $(404,719) $(207,958) $(326,475)
Capital expenditures:
YEARS ENDED:
-----------
May 31, 1996 $22,633 $ - $38,542 $ 61,175
May 31, 1995 $47,485 $470 $61,537 $109,492
Depreciation and amortization:
YEARS ENDED:
-----------
May 31, 1996 $48,149 $29,372 $25,977 $103,498
May 31, 1995 $54,964 $93,892 $ 9,279 $158,135
Research and development costs:
YEARS ENDED:
-----------
May 31, 1996 $ 87,205 $ - - $ 87,205
May 31, 1995 $217,444 $26,661 - $244,105
Identifiable assets at:
May 31, 1996 $1,678,958 $ 33,687 $84,975 $1,797,620
May 31, 1995 $1,947,571 $100,962 $71,625 $2,120,158
Operating income (loss) equals total net revenues less operating expenses. In
computing operating income, items comprising other income (expense) have not
been added or deducted.
Research and development costs include software development costs capitalized
by ARS.
Identifiable assets by segment are those assets that are used in the Company's
operations in each industry segment, net of intercompany eliminations.
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATING SCHEDULES - BALANCE SHEET
YEAR ENDED MAY 31, 1996
ARM Consolidated
(Debtor in Balance
ARC Possession) ARS ARInternet Eliminations Sheet
----------- ------------ ------------ ---------- ------------ ------------
ASSETS
- ------
CURRENT ASSETS
Cash $ - $ 62,878 $ 15,836 $ (25) $ - $ 78,689
Accounts receivable, net
Pre-petition - 611,477 - - - 611,477
Post-petition - 889,300 - - - 889,300
Other - not affected by
bankruptcy - - 3,915 19,993 - 23,908
Due from ARSoftware 25,000 1,181,042 - 13,258 (1,219,300) -
Due from ARInternet - 401,800 21,847 - (423,647) -
Investment in ARM 1,029,621 - - - (1,029,621) -
Inventory - - 1,492 - - 1,492
Other current assets - 20,501 410 182 - 21,093
----------- ------------ ------------ ---------- ------------ ------------
TOTAL CURRENT ASSETS 1,054,621 3,166,998 43,500 33,408 2,672,568) 1,625,959
PROPERTY AND EQUIPMENT, AT COST
Furniture and equipment - 147,013 7,109 13,283 - 167,405
Computer equipment - 355,100 20,308 86,798 - 462,206
Laboratory equipment - 121,426 - - - 121,426
Leasehold improvements - 22,122 200 - - 22,322
----------- ------------ ------------ ---------- ------------ ------------
- 645,661 27,617 100,081 773,359
Less accumulated depreciation
and amortization - 580,425 24,908 35,256 - 640,589
----------- ------------ ------------ ---------- ------------ ------------
NET PROPERTY AND EQUIPMENT - 65,236 2,709 64,825 132,770
INTANGIBLE ASSETS, NET OF
AMORTIZATION - 22,951 9,325 - - 32,276
OTHER ASSETS - 6,615 - - - 6,615
----------- ------------ ------------ ---------- ------------ ------------
TOTAL ASSETS $1,054,621 $ 3,261,800 $ 55,534 $ 98,233 $(2,672,568) $ 1,797,620
========== =========== =========== ========= ============ ===========
CONTINUED
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATING SCHEDULES - BALANCE SHEET - Continued
YEAR ENDED MAY 31, 1996
ARM Consolidated
(Debtor in Balance
ARC Possession) ARS ARInternet Eliminations Sheet
----------- ------------ ------------ ---------- ------------ ------------
LIABILITIES
- -----------
CURRENT LIABILITIES
Liabilities not subject to
compromise:
Notes payable, current
maturities $ - $ 689,563 $ - $ - $ - $ 689,563
Note payable to officers
and directors, current
maturities - - 4,000 - - 4,000
Accounts payable - 14,018 116,153 32,143 - 162,314
Due to ARC - - 25,000 - (25,000) -
Due to ARM - - 1,181,042 401,800 (1,582,842) -
Due to ARS - - - 21,847 (21,847) -
Due to ARInternet - - 13,258 - (13,258) -
Accrued salaries and
benefits - 137,505 24,583 14,486 - 176,574
Accrued payroll taxes
and withholdings - 43,174 1,511 12,458 - 57,143
Other accrued liabilities - 74,388 3,277 - - 77,665
Billings in excess of
costs and anticipated
profits - 9,999 - - - 9,999
Deferred revenue - - - 27,635 - 27,635
Income taxes payable - 1,411 - - - 1,411
Provision for contract
losses - 60,000 - - - 60,000
----------- ------------ ------------ ---------- ------------ ------------
Total liabilities not
subject to compromise - 1,030,058 1,368,824 510,369 (1,642,947) 1,266,304
----------- ------------ ------------ ---------- ------------ ------------
Liabilities subject to
compromise:
Accounts payable - 403,812 - - - 403,812
Accrued salaries and
benefits, includes
$109,013 of accrued
interest - 970,164 - - - 970,164
Accrued payroll taxes and
withholdings, includes
$328,695 of accrued
interest and penalties - 1,259,489 - - - 1,259,489
----------- ------------ ------------ ---------- ------------ ------------
Total liabilities subject
to compromise - 2,633,465 - - - 2,633,465
----------- ------------ ------------ ---------- ------------ ------------
TOTAL CURRENT LIABILITIES - 3,663,523 1,368,824 510,369 (1,642,947) 3,899,769
NOTES PAYABLE,
NET OF CURRENT MATURITIES - - - - - -
----------- ------------ ------------ ---------- ------------ ------------
TOTAL LIABILITIES - 3,663,523 1,368,824 510,369 (1,642,947) 3,899,769
----------- ------------ ------------ ---------- ------------ ------------
CONTINUED
/TABLE
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATING SCHEDULES - BALANCE SHEET - Concluded
YEAR ENDED MAY 31, 1996
ARM Consolidated
(Debtor in Balance
ARC Possession) ARS ARInternet Eliminations Sheet
----------- ------------ ------------ ---------- ------------ ------------
STOCKHOLDERS' DEFICIT
- ---------------------
Investment from ARC $ - $ 1,029,621 $ - $ - $(1,029,621) $ -
Preferred stock, $.10
par value, 40,000,000
shares authorized,
none issued - - - - - -
Common stock, $.0005
par value, 60,000,000
shares authorized,
6,811,083 shares issued
and 6,311,083 shares
outstanding 3,155 - - - - 3,155
Capital in excess of
par value 1,140,529 - - - - 1,140,529
Accumulated deficit (89,063) (1,431,344) (1,313,290) (412,136) - (3,245,833)
----------- ------------ ------------ ---------- ------------ ------------
TOTAL STOCKHOLDERS' DEFICIT 1,054,621 (401,723) (1,313,290) (412,136) (1,029,621) (2,102,149)
----------- ------------ ------------ ---------- ------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' DEFICIT $1,054,621 $ 3,261,800 $ 55,534 $ 98,233 $(2,672,568) $ 1,797,620
========== =========== =========== ========= ============ ===========
/TABLE
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATING SCHEDULES - BALANCE SHEET
YEAR ENDED MAY 31, 1995
Consolidated
Balance
ARC ARM ARS ARInternet Eliminations Sheet
----------- ------------ ------------ ---------- ------------ ------------
ASSETS
CURRENT ASSETS
Cash $ - $ 5,270 $ 3,708 $ 6,050 $ - $ 15,028
Accounts receivable, net - 1,735,620 48,616 8,617 - 1,792,853
Due from ARSoftware - 1,119,860 - 2,608 (1,122,468) -
Due from ARInternet - 260,600 7,147 - (267,747) -
Investment in ARM 1,029,621 - - - (1,029,621) -
Inventory - - 3,709 - - 3,709
Other current assets - 57,298 3,521 - - 60,819
----------- ------------ ------------ ---------- ------------ ------------
TOTAL CURRENT ASSETS 1,029,621 3,178,648 66,701 17,275 (2,419,836) 1,872,409
PROPERTY AND EQUIPMENT,
AT COST
Furniture and equipment - 179,775 7,109 5,996 - 192,880
Computer equipment - 388,706 20,310 55,541 - 464,557
Laboratory equipment - 246,365 - - - 246,365
Leasehold improvements - 22,122 200 - - 22,322
----------- ------------ ------------ ---------- ------------ ------------
- 836,968 27,619 61,537 926,124
Less accumulated depreciation
and amortization - 747,508 20,020 9,279 - 776,807
----------- ------------ ------------ ---------- ------------ ------------
NET PROPERTY AND EQUIPMENT - 89,460 7,599 52,258 - 149,317
INTANGIBLE ASSETS, NET OF
AMORTIZATION - 23,548 33,809 - - 57,357
OTHER ASSETS - 36,375 - 4,700 - 41,075
----------- ------------ ------------ ---------- ------------ ------------
TOTAL ASSETS $1,029,621 $ 3,328,031 $ 108,109 $ 74,233 $(2,419,836) $ 2,120,158
========== =========== =========== ========= ============ ===========
CONTINUED
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATING SCHEDULES - BALANCE SHEET - Concluded
YEAR ENDED MAY 31, 1995
Consolidated
Balance
ARC ARM ARS ARInternet Eliminations Sheet
----------- ------------ ------------ ---------- ------------ ------------
LIABILITIES
- -----------
CURRENT LIABILITIES
Notes payable, current
maturities $ - $ 911,681 $ - $ - $ - $ 911,681
Accounts payable - 425,941 123,354 - - 549,295
Due to ARM - - 1,119,860 260,600 (1,380,460) -
Due to ARS - - - 7,147 (7,147) -
Due to ARInternet - - 2,608 - (2,608) -
Accrued salaries and
benefits - 1,193,907 21,377 - - 1,215,284
Accrued payroll taxes and
withholdings - 481,045 531 - - 481,576
Other accrued liabilities - 356,074 6,506 - - 362,580
Billings in excess of costs
and anticipated profits - 59,594 - - - 59,594
Deferred revenue - - - 14,444 - 14,444
Income taxes payable - 19,860 - - - 19,860
Provision for contract
losses - 40,000 - - - 40,000
----------- ------------ ------------ ---------- ------------ ------------
TOTAL CURRENT LIABILITIES - 3,488,102 1,274,236 282,191 (1,390,215) 3,654,314
NOTES PAYABLE, NET OF
CURRENT MATURITIES - - 25,000 - - 25,000
----------- ------------ ------------ ---------- ------------ ------------
TOTAL LIABILITIES - 3,488,102 1,299,236 282,191 (1,390,215) 3,679,314
----------- ------------ ------------ ---------- ------------ ------------
STOCKHOLDERS' DEFICIT
Investment from ARC - 1,029,621 - - (1,029,621) -
Preferred stock, $.10 par
value, 40,000,000 shares
authorized, none issued - - - - - -
Common stock, $.0005 par
value, 60,000,000 shares
authorized, 5,944,416
shares issued and
outstanding 2,972 - - - - 2,972
Capital in excess of par
value 1,026,649 - - - - 1,026,649
Accumulated deficit - (1,189,692) (1,191,127) (207,958) - (2,588,777)
----------- ------------ ------------ ---------- ------------ ------------
TOTAL STOCKHOLDERS' DEFICIT 1,029,621 (160,071) (1,191,127) (207,958) (1,029,621) (1,559,156)
----------- ------------ ------------ ---------- ------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' DEFICIT $1,029,621 $ 3,328,031 $ 108,109 $ 74,233 $(2,419,836) $ 2,120,158
========== =========== =========== ========= ============ ===========
/TABLE
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATING SCHEDULES - STATEMENT OF OPERATIONS
YEAR ENDED MAY 31, 1996
ARM Consolidated
(Debtor in Balance
ARC Posession) ARS ARInternet Eliminations Sheet
----------- ------------ ------------ ---------- ------------ ------------
Revenue $ - $ 8,393,868 $ 261,921 $ 301,675 $ - $ 8,957,464
Operating costs and expenses:
Direct cost of services - 5,207,341 160,496 99,276 - 5,467,113
Indirect operating costs - 1,902,456 31,743 - - 1,934,199
General & administrative
expenses - 934,453 187,708 404,749 - 1,526,910
----------- ------------ ------------ ---------- ------------ ------------
Total operating costs
and expenses - 8,044,250 379,947 504,025 - 8,928,222
----------- ------------ ------------ ---------- ------------ ------------
Operating income (loss) - 349,618 (118,026) (202,350) - 29,242
Other expense:
Interest expense, net - 379,085 575 (487) - 379,173
Consulting expense
associated with stock
awards 89,063 - - - - 89,063
Penalties - 159,067 3,171 540 - 162,778
Other, net - 24,355 391 1,775 - 26,521
----------- ------------ ------------ ---------- ------------ ------------
Total other expense 89,063 562,507 4,137 1,828 - 657,535
----------- ------------ ------------ ---------- ------------ ------------
Loss before reorganization
items and income taxes (89,063) (212,889) (122,163) (204,178) - (628,293)
Reorganization items:
Professional fees - (28,763) - - - (28,763)
----------- ------------ ------------ ---------- ------------ ------------
Loss before income taxes: (89,063) (241,652) (122,163) (204,178) - (657,056)
Income taxes - - - - - -
----------- ------------ ------------ ---------- ------------ ------------
Net loss $ (89,063) $ (241,652) $ (122,163) $(204,178) $ - $ (657,056)
=========== ============ ============ ========== =========== ============
APPLIED RESEARCH CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATING SCHEDULES - STATEMENT OF OPERATIONS
YEAR ENDED MAY 31, 1995
Consolidated
Balance
ARC ARM ARS ARInternet Eliminations Sheet
----------- ------------ ------------ ---------- ------------ ------------
Revenue $ - $ 9,135,523 $ 429,335 $ 25,255 $ - $ 9,590,113
Operating costs and expenses:
Direct cost of services - 5,576,805 446,333 43,292 - 6,066,430
Indirect operating costs - 2,277,950 71,134 - - 2,349,084
General & administrative
expenses - 994,566 316,587 189,921 - 1,501,074
----------- ------------ ------------ ---------- ------------ ------------
Total operating costs
and expenses - 8,849,321 834,055 233,212 - 9,916,588
----------- ------------ ------------ ---------- ------------ ------------
Operating income (loss) - 286,202 (404,719) (207,958) - (326,475)
Other expense:
Interest expense, net - 345,747 1,866 - - 347,613
Penalties - 171,555 9,424 - - 180,979
Other, net - 16,280 (1,368) - - 14,912
----------- ------------ ------------ ---------- ------------ ------------
Total other expense - 533,582 9,922 - - 543,504
----------- ------------ ------------ ---------- ------------ ------------
Loss before income taxes - (247,380) (414,641) (207,958) - (869,979)
Income taxes - 25,334 - - - 25,334
----------- ------------ ------------ ---------- ------------ ------------
Net loss $ - $ (272,714) $ (414,641) $(207,958) $ - $ (895,313)
========== ============ ============ ========== =========== ============
/TABLE
APPLIED RESEARCH CORPORATION
FORM 10-KSB FOR THE YEAR ENDED MAY 31, 1996
INDEX TO EXHIBITS
NUMBER DESCRIPTION
- ------ -----------
1.1 Escrow Agreement (Note 1)
1.2 Underwriting Agreement (Note 1)
2.0 Reorganization Agreement between Dollar Ventures, Inc. and Applied
Research Corporation (Note 1)
3.1 Articles of Incorporation of Dollar Ventures, Inc. (Note 1)
3.2 Amended Articles of Incorporation of Dollar Ventures, Inc. (Note 1)
3.3 Articles of Incorporation of Applied Research Corporation (Note 1)
3.4 Amended Articles of Incorporation of Applied Research Corporation
(Note 1)
3.5 By-Laws of Dollar Ventures, Inc. (Note 1)
3.6 By-Laws of Applied Research Corporation (Note 1)
3.7 401(k) Plan of Applied Research Corporation (Note 1)
4.1 Warrant Agreement (Note 1)
4.2 Specimen Certificate of Common Stock (Note 3)
4.3 Specimen Class A Common Stock Purchase Warrant (Note 3)
4.4 Specimen Subscription Agreement (Note 3)
4.5 Convertible Note (Note 3)
4.6 Convertible Note Purchase Agreement (Note 3)
10.1 Employment Agreements (Note 1)
10.2 Sovran Bank Loan (Note 1)
10.4(b) Lease Agreement on Maryland Property, dated October 22, 1993
(Note 4)
10.4(c) First Amendment to Lease Agreement on Maryland Property, dated
October 22, 1993 (Note 4)
10.4(d) Second Amendment to Lease Agreement on Maryland Property, dated
May 12, 1994 (Note 4)
10.14(b) Patent (Note 5)
10.14(c) Patent (Note 5)
10.21 Contract with Hughes Applied Information Systems, dated 6-03-93
(Note 4)
10.22 Contract with NASA, dated 9-27-93 (Note 4)
10.23 Contract with NASA, dated 1-10-94 (Note 4)
10.24(a) Financing Agreement with PrinCap Finance Company, L.L.C., dated
March 21, 1994 (Note 4)
10.24(b) Amended Financing Agreement with Princeton Capital Finance Company,
L.L.C., dated May 10, 1995 (Note 5)
10.24(c) Default letter from Princeton Capital Finance Company, L.L.C.,
dated November 14, 1995 (Note 6)
10.25 1994 Incentive Stock Option Plan (Note 5)
10.26 Consulting Agreement with William Hayde (Note 5)
10.27 Consulting Agreement with Market Visibility, Inc. (Note 5)
10.28 Fee Agreement with Commerce Funding Corporation, dated November 17,
1995 (Note 6)
10.29 Consolidated Asset Purchase Agreement (Note 6)
11 Computation of Net Income (Loss) per Common Share (Note 6)
16.2 Letter of KPMG Peat Marwick, dated June 20, 1994 (Note 2)
21 Subsidiaries of the Registrant (Note 6)
NOTES TO EXHIBITS:
- -----------------
(1) Previously Filed. The documents are incorporated herein by
reference from the Registrant's Registration Statement on
Form S-18, as amended, filed with Securities and Exchange
Commission on June 2, 1989, S.E.C. File No. 33-11943-LA.
(2) Previously Filed. The documents are incorporated herein by
reference from the Registrant's Current Report on Form 8-K, dated
June 14, 1994, filed with Securities and Exchange Commission on
June 21, 1994, S.E.C. File No. 01-10076.
(3) Previously Filed. The documents are incorporated herein by
reference from the Registrant's Registration Statement on
Form S-3, filed with Securities and Exchange Commission on June 28,
1994, S.E.C. File No. 01-10076.
(4) Previously Filed. The documents are incorporated herein by
reference from the Registrant's Annual Report on Form 10-K for the
fiscal year ended May 31, 1994, filed with Securities and Exchange
Commission on September 6, 1994, S.E.C. File No. 01-10076.
(5) Previously Filed. The documents are incorporated herein by
reference from the Registrant's Annual Report on Form 10-K for the
fiscal year ended May 31, 1995, filed with Securities and Exchange
Commission on August 29, 1995, S.E.C. File No. 01-10076.
(6) Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, Applied Research Corporation has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized:
APPLIED RESEARCH CORPORATION
/s/ S.P.S. Anand September 12, 1996
- ---------------------------------------- ------------------
Dr. S.P.S. Anand, Director, Date
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
/s/ S.P.S. Anand September 12, 1996
- ---------------------------------------- ------------------
Dr. S.P.S. Anand, Director Date
/s/ Manjit K. Anand September 12, 1996
- ---------------------------------------- ------------------
Manjit K. Anand, Director & Treasurer Date
/s/ Dennis H. O'Brien September 12, 1996
- ---------------------------------------- ------------------
Dennis H. O'Brien, Director, Secretary, Date
Vice President & Chief Financial Officer
/s/ Andrew S. Endal September 12, 1996
- ---------------------------------------- ------------------
Dr. Andrew S. Endal, Senior Vice President Date