Exhibit 99.3
Avatech Solutions, Inc.
Financial Statements
Page
Independent Auditors' Reports ....................................... 2
Consolidated Balance Sheets ......................................... 4
Consolidated Statements of Operations ............................... 6
Consolidated Statements of Stockholders' Deficiency ................. 7
Consolidated Statements of Cash Flows ............................... 8
Notes to Consolidated Financial Statements .......................... 10
Report of Independent Auditors
The Board of Directors and Stockholders
Avatech Solutions, Inc.
We have audited the accompanying consolidated balance sheet of Avatech
Solutions, Inc. and subsidiaries as of June 30, 2002, and the related
consolidated statements of operations, stockholders' deficiency and cash flows
for the year then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
Since the date of completion of our audit of the accompanying financial
statements and initial issuance of our report thereon dated September 3, 2002,
the Company, as discussed in Note 13, has experienced a decline in working
capital resulting principally from costs incurred to complete the acquisition of
PlanetCAD, Inc. Note 13 describes management's plans to address this liquidity
issue.
In our opinion, the 2002 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Avatech
Solutions, Inc. and subsidiaries at June 30, 2002 and the consolidated results
of its operations and its cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Baltimore, Maryland
September 3, 2002 (except Note 13, as to which
the date is January 25, 2002)
2
Independent Auditors' Report
To the Board of Directors and Stockholders
Avatech Solutions, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Avatech
Solutions, Inc. and Subsidiaries as of June 30, 2001 and 2000, and the related
consolidated statements of operations, stockholders' deficiency, and cash flows
for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Avatech
Solutions, Inc. and Subsidiaries as of June 30, 2001 and 2000, and the
consolidated results of their operations and their cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States of America.
WALPERT & WOLPOFF, LLP
Baltimore, Maryland
October 3, 2001 (except for Note 3 for which the date is September 3, 2002)
3
Avatech Solutions, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30 September 30,
2001 2002 2002
------------------------------------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 309,621 $ 222,562 $ 325,858
Accounts receivable, less allowance of
$212,000 in 2001 and $111,897 in 2002 and
$95,477 at September 30, 2002 5,123,773 4,108,372 3,472,362
Inventory 462,660 356,013 545,597
Deferred income taxes - 373,000 -
Prepaid expenses and other current assets 382,411 113,469 149,014
------------------------------------------
Total current assets 6,278,465 5,173,416 4,492,831
Property and equipment:
Computer software and equipment 2,381,422 2,664,168 2,704,902
Office furniture and equipment 799,526 778,037 743,292
Leasehold improvements 191,908 198,002 198,002
------------------------------------------
3,372,856 3,640,207 3,646,196
Less accumulated depreciation and amortization 2,461,630 2,889,000 2,961,424
------------------------------------------
911,226 751,207 684,772
Goodwill 1,108,920 752,920 752,920
Other assets 78,404 430,870 554,208
------------------------------------------
Total assets $ 8,377,015 $ 7,108,413 $ 6,484,731
==========================================
4
June 30 September 30,
2001 2002 2002
-------------------------------------------
(Unaudited)
Liabilities and stockholders' deficiency
Current liabilities:
Accounts payable and accrued expenses $ 4,021,062 $ 3,655,902 $ 3,952,627
Accrued compensation and related benefits 293,780 223,919 184,971
Borrowings under line-of-credit 1,916,912 1,422,901 1,284,880
Note payable to related party - - 500,000
Current portion of long-term debt 2,968,030 500,000 750,000
Deferred revenue 794,916 650,511 848,482
Other current liabilities 211,215 335,930 307,131
-------------------------------------------
Total current liabilities 10,205,915 6,789,163 7,828,091
Long-term debt (including $775,000 payable to
related parties) 1,595,938 4,057,112 -
Short-term debt subject to refinancing - - 697,426
Short-term debt subject to refinancing-related
parties - - 725,000
Commitments and contingencies - - -
Stockholders' deficiency:
Common stock, $0.01 par value; 10,000,000
shares authorized; issued and outstanding
shares of 5,995,402 at June 30, 2002 and
September 30, 2002 and 6,013,549 at June
30, 2001 60,136 59,954 59,954
Additional paid-in capital 1,726,576 1,661,229 1,661,229
Accumulated deficit (5,211,550) (5,459,045) (4,486,969)
-------------------------------------------
Total stockholders' deficiency (3,424,838) (3,737,862) (2,765,786)
-------------------------------------------
Total liabilities and stockholders' deficiency $ 8,377,015 $ 7,108,413 $ 6,484,731
===========================================
See accompanying notes.
5
Avatech Solutions, Inc. and Subsidiaries
Consolidated Statements of Operations
Three months ended
Year ended June 30 September 30
--------------------------------------------- --------------------------
2000 2001 2002 2001 2002
--------------------------------------------- --------------------------
(restated) (restated) (Unaudited)
Revenue:
Product sales $ 22,436,739 $ 20,490,029 $ 18,486,676 $ 5,206,351 $ 3,366,703
Service revenue 7,519,169 6,049,275 6,482,160 1,465,247 1,506,269
Commission revenue 3,199,443 4,332,174 4,843,751 857,411 985,765
--------------------------------------------- --------------------------
33,155,351 30,871,478 29,812,587 7,529,009 5,858,737
Cost of revenue:
Cost of product sales 16,228,849 14,249,470 12,464,965 3,402,560 2,244,466
Cost of service revenue 4,664,518 3,813,635 3,773,041 893,218 932,636
--------------------------------------------- --------------------------
20,893,367 18,063,105 16,238,006 4,295,778 3,177,102
--------------------------------------------- --------------------------
Gross margin 12,261,984 12,808,373 13,574,581 3,233,231 2,681,635
Other expenses:
Selling, general and administrative 12,919,902 11,519,199 12,806,324 3,339,214 3,081,340
Depreciation and amortization 692,180 694,503 589,306 165,283 118,645
Impairment loss - - 285,374 - -
--------------------------------------------- --------------------------
13,612,082 12,213,702 13,681,004 3,504,497 3,199,985
--------------------------------------------- --------------------------
Income (loss) from operations (1,350,098) 594,671 (106,423) (271,266) (518,350)
Other income (expense):
Gain on the extinguishment of debt - - - - 1,960,646
Interest and other income (expense) (61,819) 61,488 61,510 64,818 5,183
Interest expense (641,320) (553,823) (487,582) (133,053) (82,403)
--------------------------------------------- --------------------------
(703,139) (492,335) (426,072) (68,235) 1,883,426
--------------------------------------------- --------------------------
Income (loss) before income taxes (2,053,237) 102,336 (532,495) (339,501) 1,365,076
Income tax expense (benefit) - 13,000 (285,000) 21,759 393,000
--------------------------------------------- --------------------------
Net income (loss) $ (2,053,237) $ 89,336 $ (247,495) $ (361,260) $ 972,076
============================================= ==========================
Earning (loss) per common share -
basic and diluted $ (0.34) $ 0.01 $ (0.04) $ (0.06) $ 0.16
============================================= ==========================
Shares used in computation 6,078,374 5,995,904 6,007,074 6,012,536 5,995,402
============================================= ==========================
See accompanying notes.
6
Avatech Solutions, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Deficiency
Years ended June 30, 2002, 2001, 2000 and the three months ended September 30,
2002
Common Stock Additional
----------------------------
Number of Paid-In Accumulated
Shares Par Value Capital Deficit Total
---------------------------------------------------------------------------
Balance at July 1, 1999 5,985,509 $ 59,856 $ 1,578,153 $ (3,247,649) $ (1,609,640)
Issuance of common stock for cash 102,500 1,025 409,600 - 410,625
Issuance of common stock in connection with the 1998
Employee Stock Purchase Plan 18,810 188 67,721 - 67,909
Purchase of common stock from former employees (67,882) (679) (242,019) - (242,698)
Net loss for fiscal year 2000 - - - (2,053,237) (2,053,237)
---------------------------------------------------------------------------
Balance at June 30, 2000 6,038,937 60,390 1,813,455 (5,300,886) (3,427,041)
Issuance of common stock for cash 6,176 62 26,186 - 26,248
Purchase of common stock from former employees (31,564) (316) (113,065) - (113,381)
Net income for fiscal year 2001 - - - 89,336 89,336
---------------------------------------------------------------------------
Balance at June 30, 2001 6,013,549 60,136 1,726,576 (5,211,550) (3,424,838)
Purchase of common stock from current and former
employees (18,147) (182) (65,347) - (65,529)
Net loss for fiscal year 2002 - - - (247,495) (247,495)
---------------------------------------------------------------------------
Balance at June 30, 2002 5,995,402 $ 59,954 $ 1,661,229 $ (5,459,045) $ (3,737,862)
Net income for three months ended September 30, 2002 - - - 972,076 972,076
---------------------------------------------------------------------------
Balance at September 30, 2002 5,995,402 $ 59,954 $ 1,661,229 $ (4,486,969) $ (2,765,786)
===========================================================================
See accompanying notes.
7
Avatech Solutions, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Three months ended
Year ended June 30 September 30
----------------------------------------- --------------------------
2000 2001 2002 2001 2002
----------------------------------------- --------------------------
(Unaudited)
Cash flows from operating activities
Net income (loss) $(2,053,237) $ 89,336 $ (247,495) $ (361,260) $ 972,076
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Provision for bad debts 55,367 73,893 75,542 (158,908) (16,420)
Gain on extinguishment of debt - - - - (1,960,646)
Depreciation and amortization 692,180 694,503 612,918 165,283 118,645
Deferred income taxes 23,802 - (373,000) - 373,000
Impairment loss - - 285,374 - -
Gain on available-for-sale securities (2,205) - - - -
Loss on disposal of property and equipment 17,420 1,420 7,575 - -
Amortization of debt discount charged to interest
expense 3,838 2,694 3,844 - -
Changes in operating assets and liabilities:
Accounts receivable (1,869) (1,027,531) 893,017 733,951 652,430
Inventory 385,182 (7,065) 106,647 45,521 (189,584)
Prepaid expenses and other current assets 437,728 96,987 190,804 157,485 (35,545)
Accounts payable and accrued expenses 272,247 (295,547) (240,179) (737,836) 296,725
Accrued compensation and related benefits 23,451 (23,439) (69,862) (89,945) (38,948)
Deferred revenue 213,915 14,144 (144,405) (186,538) 197,971
Other current liabilities 141,401 29,410 (4,058) (10,394) (28,799)
----------------------------------------- --------------------------
Net cash provided by (used in) operating activities 209,220 (351,195) 1,096,722 (442,641) 340,905
Cash flows from investing activities
Purchase of property and equipment (535,161) (394,060) (258,944) (26,150) (47,527)
Proceeds from sale of property and equipment 4,436 6,343 10,584 - -
Proceeds from sale of available-for-sale securities 16,807 - - - -
Acquisition costs related to PlanetCAD merger - - (302,228) - (128,023)
----------------------------------------- --------------------------
Net cash used in investing activities (513,918) (387,717) (550,588) (26,150) (175,550)
8
Avatech Solutions, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (continued)
Three months ended
Year ended June 30 September 30
-------------------------------------------- ----------------------------
2000 2001 2002 2001 2002
-------------------------------------------- ----------------------------
(Unaudited)
Cash flows from financing activities
Proceeds from borrowings under line-of-credit $ 31,870,180 $ 30,977,721 $ 31,166,171 $ 8,325,625 $ 6,924,526
Repayments of borrowings under line-of-credit (32,571,042) (30,244,758) (31,660,182) (7,992,156) (7,062,546)
Proceeds from issuance of long-term debt 137,269 - - - 1,075,000
Repayments of long-term debt (188,894) (6,810) - - (999,039)
Proceeds from issuance of common stock 478,534 26,248 - - -
Repurchase of common stock (242,698) (113,381) (65,529) - -
Change in other assets related to financing costs 45,891 (13,794) (73,653) (2,308) -
-------------------------------------------- ----------------------------
Net cash provided by (used in) financing activities (470,760) 625,226 (633,193) 331,161 (62,059)
-------------------------------------------- ----------------------------
Net decrease in cash and cash equivalents (775,458) (113,686) (87,059) (137,630) 103,296
Cash and cash equivalents--beginning of period 1,198,765 423,307 309,621 309,621 222,562
-------------------------------------------- ----------------------------
Cash and cash equivalents--end of period $ 423,307 $ 309,621 $ 222,562 $ 171,991 $ 325,858
============================================ ============================
See accompanying notes.
9
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Nature of Business and Basis of Presentation
Avatech Solutions, Inc. provides design automation software, hardware, training,
technical support and professional services to corporations, government agencies
and educational institutions throughout the United States.
The consolidated financial statements include the accounts of Avatech Solutions,
Inc. and its wholly-owed subsidiaries (collectively, the "Company"). All
intercompany accounts and transactions have been eliminated in consolidation.
Unaudited Interim Financial Information
The unaudited interim financial information as of September 30, 2002 and for the
three months ended September 30, 2001 and 2002 has been prepared in accordance
with generally accepted accounting principles for interim financial information
and with instructions to Article 10 of Regulation S-X. In the opinion of
management, such information contains all adjustments, consisting only of normal
recurring adjustments considered necessary for a fair presentation of such
period. The operating results for any interim period are not necessarily
indicative of results for any future period.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Inventory
Inventory, consisting of computer software and hardware, is stated at the lower
of first-in, first-out cost, or market.
10
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Property and Equipment
Property and equipment is stated at cost. Depreciation for computer software and
equipment and office furniture and equipment is provided for by the
straight-line method over estimated useful lives ranging from three to seven
years. Leasehold improvements are depreciated over the lesser of the lease term
or the useful life of the asset using the straight-line method.
Impairment of Long-Lived Assets Excluding Goodwill
Long-lived assets, excluding goodwill, are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
or group of assets may not be fully recoverable. These events or changes in
circumstances may include a significant deterioration of operating results,
changes in business plans, or changes in anticipated future cash flows. If an
impairment indicator is present, the Company evaluates recoverability by a
comparison of the carrying amount of the assets to future undiscounted net cash
flows expected to be generated by the assets. Assets are grouped at the lowest
level for which there is identifiable cash flows that are largely independent of
the cash flows generated by other asset groups. If the assets are impaired, the
impairment recognized is measured by the amount by which the carrying amount
exceeds the fair value of the assets. Fair value is generally determined by
estimates of discounted cash flows. The discount rate used in any estimate of
discounted cash flows would be the rate required for a similar investment of
like risk.
Goodwill
Goodwill is the excess of the purchase price paid over the fair value of the
identifiable net assets acquired in purchase business combinations. Prior to
July 1, 2002, goodwill was amortization on a straight-line basis over 15 years.
Commencing July 1, 2002, goodwill is not amortized but it tested annually for
impairment at the reporting unit level. Impairment is the condition that exists
when the carrying amount of goodwill exceeds its implied fair value. The implied
fair value of goodwill is the amount determined by deducting the estimated fair
value of all tangible and identifiable intangible net assets of the reporting
unit from the estimated fair value of the reporting unit. If the recorded value
of goodwill exceeds its implied value, an impairment charge is recorded for the
excess. (See also Note 1, Recent Accounting Pronouncements).
11
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Stock Options Granted to Employees
The Company uses the intrinsic value method to account for its employee and
director stock option plans. Under the intrinsic value method, compensation
expense is calculated as the difference between the fair value of the underlying
common stock and the exercise price of the option at the date of grant for fixed
stock option awards. Any resulting compensation expense is recognized pro rata
over the vesting period.
The Company discloses in Note 7 the pro forma effects on net income if the
Company had elected the fair value method of accounting for stock options.
12
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Revenue Recognition and Accounts Receivable
The Company generates revenue from three sources, the resale of prepackaged
software products, professional services and commissions.
Software products are frequently sold in an arrangement that includes
implementation services or maintenance services. Maintenance services are
limited to help desk support and training. The Company allocates the total
arrangement fee among each element based on vendor-specific objective evidence
of the relative fair value of each of the elements. The Company limits its
assessment of fair value of each element to the price charged when the same
element is sold separately.
Revenues for software product sales are recognized as revenue when four criteria
are met. These four criteria are (i) a signed purchase order has been obtained
(ii) delivery of the software has occurred (iii) the fee is fixed or
determinable and (iv) the fee is probable of collection. Software product sales
billed and not recognized as revenue are included in deferred revenue. The
Company generally does not require collateral The Company provides a 30-day
return policy to its customers. The Company has historically not experienced
significant returns, and accordingly, allowances for returned products are not
recorded.
Revenues from maintenance services are recognized ratably over the contractual
service period. Revenues from implementation and training services are
recognized as the services are provided. Advance payments for these services are
deferred and recognized in the periods when the services are performed.
The Company also receives commissions from vendors for transactions in which the
Company does not take title to the product or have responsibility for the
delivery of the services, has no risk of loss for collection, and has acted as
an agent or broker. These commissions are recorded as revenue when earned.
Cost of Product Sales
Cost of product sales includes the costs of purchasing software and hardware
from suppliers and the associated shipping and handling costs.
13
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Cost of Service Revenue
Cost of service revenue consists primarily of direct employee compensation and
related benefits, the cost of subcontracted services and direct expenses
billable to customers. Cost of service revenue does not include an allocation of
overhead costs.
Warranty Costs
The Company does not provide for warranty costs for its products as such costs
are incurred by the manufacturer of the products.
Advertising Costs
Costs incurred for producing and communicating advertisements are expensed as
incurred and included in selling, general and administrative expenses in the
accompanying statements of operations. Advertising expenses approximated
$549,000, $412,000 and $399,000 for years ended June 30, 2002, 2001 and 2000,
respectively.
Business Segment Reporting
The Company's operating segments are established based on geographical areas
managed by location managers and for which discrete financial information is
prepared and reviewed by the Company's chief operating decision maker. These
segments are aggregated for segment reporting purposes into one reporting
segment because the operating segments have similar economic characteristics and
generate revenues from sales of similar products and services to similar types
of customers.
Income Taxes
The Company uses the liability method to account for income taxes. Income tax
expense includes income taxes currently payable and deferred taxes arising from
temporary differences between financial reporting and income tax bases of assets
and liabilities. Deferred income taxes are measured using the enacted tax rates
and laws that will be in effect when the differences are expected to reverse.
Concentration of Credit Risk
The Company maintains cash in bank accounts, which at times, may exceed
federally insured limits. The Company has not experienced any losses on these
accounts.
14
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Earnings (Loss) Per Share of Common Stock
Basic earnings (loss) per common share is computed as net income (loss) divided
by the weighted-average number of common shares outstanding for the period.
Diluted earnings per common share include the potential dilution that would
occur from common shares issuable upon the exercise of outstanding stock options
and warrants. Basic and diluted earnings (loss) per common share are equal for
all years presented because the assumed exercise of options and warrants is
antidilutive.
Recent Accounting Pronouncements
Goodwill and Other Intangible Assets
As of July 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets ("Statement 142"). Under
the new rules, goodwill and other intangible assets deemed to have indefinite
lives are no longer amortized, but are subject to annual impairment tests in
accordance with the Statement. Other intangible assets with finite lives will
continue to be amortized over their useful lives. The goodwill amortization
expense and net income (loss) of the Company for the three years ended June 30,
2002 and the three months ended September 30, 2001 and 2002 are as follows:
Three Months Ended
Year Ended June 30 September 30
---------------------------------------------------------------
2000 2001 2002 2001 2002
---------------------------------------------------------------
Reported net income $(2,053,237) $ 89,336 $(247,495) $(361,260) $1,345,076
Goodwill amortization, net of income taxes 89,000 87,297 73,000 24,217 -
---------------------------------------------------------------
Adjusted net income (loss) $(1,964,237) $176,633 $(174,495) $(337,043) $1,345,076
===============================================================
Earnings per common share, basic:
Reported net income (loss) $ (0.34) $ 0.01 $ (0.0.4) $ (0.06) $ 0.22
Goodwill amortization, net of income taxes 0.02 0.01 0.01 0.01 -
---------------------------------------------------------------
Adjusted net income $ (0.32) $ 0.02 $ (0.03) $ (0.05) $ 0.22
===============================================================
During the second quarter of fiscal year 2003, the Company completed phase one
of the transitional impairment test under Statement 142. Based on the results of
this test, management believes that the Company is likely to have an impairment
charge for one of its reporting units. The Company will complete phase two of
the transitional impairment test before the end of fiscal year 2003, at which
time it will record the impairment charge as of July 1, 2002. There were no
changes in the carrying amount of goodwill for the three-months ended September
30, 2002.
15
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements (Continued)
Accounting for the Impairment or Disposal of Long-Lived Assets
As of July 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets ("Statement 144"). Statement 144 supersedes and serves to clarify and
further define the provisions of Statement of Financial Accounting Standards No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, and provides a single accounting model for long-lived
assets to be disposed of.
Statement 144 does not apply to goodwill and other intangible assets that are
not amortized, and retains the Company's current policy to recognize an
impairment loss only if the carrying amount of a long-lived asset is not
recoverable from its undiscounted future cash flows and to measure the
impairment loss as the difference between the carrying amount and the fair value
of the asset.
Reporting Extraordinary Items
In April 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections (Statement
145). Among other changes, Statement 145 rescinds Statement 4, which required
all gains and losses from extinguishment of debt to be aggregated and classified
as an extraordinary item, net of the related tax effect. Statement 145 provides
that gains and losses from extinguishment of debt should be classified as
extraordinary items only if they are unusual or infrequent or they otherwise
meet the criteria for classification as an extraordinary item, and observes that
debt extinguishment transactions would seldom, if ever, result in extraordinary
item classification of the resulting gains and losses. The Company adopted
Statement 145 in July 2002, and reports as other expenses (income) any
extraordinary losses or gains that it incurs upon the extinguishment of debt.
16
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Accounting for Costs Associated with Exit or Disposal Activities
In July 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, Accounting for Costs Associated with
Exit or Disposal Activities (Statement 146). Statement 146 supersedes EITF Issue
No. 94-3 Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity. Statement 146 requires that costs associated
with an exit or disposal plan be recognized when incurred rather than at the
date of a commitment to an exit or disposal plan. Statement 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002,
with early application encouraged. The adoption of Statement 146 is not expected
to have a significant effect on the Company's results of operations and
financial position.
2. Supplemental Disclosure of Cash Flow Information
The Company paid interest of approximately $416,000, $553,000 and $629,000 in
2002, 2001 and 2000, respectively. Additionally, interest of $130,000 and
$65,000 was paid for the three months ended September 30, 2001 and 2002,
respectively.
3. Restatement of Prior Period Revenues and Expenses
In fiscal year 2002, the Company determined that certain transactions in which
it acted as an agent for a supplier were recorded improperly as if the Company
was the principal in the transaction. Specifically, the Company recorded as
revenues fees collected from customers on behalf of third party vendors for
rights to unspecified future product upgrades, despite the fact that under
generally accepted accounting principles the Company was not the principal
obligor under the arrangement. The fees received from these customers were
remitted, net of a commission to the Company, to the vendor solely obligated to
perform under the arrangement. The amount remitted to the vendor was recorded as
a cost of product sales. Under generally accepted accounting principles, the
amount retained by the Company should be recorded net in the statement of
operations as commission revenue.
17
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. Restatement of Prior Period Revenues and Expenses (continued)
The statements of operations for 2001 and 2000 have been restated to record as
commission revenue only the amount retained by the Company in these
transactions. The following summarizes the adjustments recorded:
Year ended June 30
2001 2000
-------------------------------------
Revenues as previously reported $ 33,010,750 $ 34,194,043
Adjustment to reduce revenue to record commissions net 2,139,272 1,038,692
-------------------------------------
Revenues, as restated $ 30,871,478 $ 33,155,351
=====================================
Cost of product sales, as previously reported $ 16,388,742 $ 17,267,541
Adjustment to eliminate costs incurred as an agent 2,139,272 1,038,692
-------------------------------------
Cost of product sales, as restated $ 14,249,470 $ 16,228,849
=====================================
4. Impairment Loss
In fiscal year 2002, the Company determined that the goodwill and other
long-lived assets of one of its subsidiaries were likely impaired due to
recurring operating losses and changes in the estimates of the future estimated
cash flows from these operations over the remaining amortization period. The
Company determined that the carrying value of these assets exceeded their
estimated fair values by $285,374 and recorded an impairment loss in that
amount. The fair value of the long-lived assets was determined using discounted
cash flows over the remaining estimated useful life of the assets. Of the
recorded impairment loss of $285,374, $283,000 related to goodwill and the
remainder related to fixed assets.
5. Borrowings Under Line-of-Credit
The Company has entered into a revolving line-of-credit agreement with a
financial institution which expires October 30, 2003, but is payable within 60
days of demand by the lender. The credit extended under this financing agreement
is limited to the lesser of $4 million or 75% of the Company's aggregate
outstanding eligible accounts receivable. The balance outstanding under this
line-of-credit was $1,284,880 at September 30, 2002. Borrowings under this
line-of-credit bear interest at the prime rate plus 1.5% and are secured by the
assets of the Company. In addition, the bank has the right to restrict any
prepayment of other indebtedness by the Company.
Because the interest rate adjusts with changes in the prime rate, the estimated
fair value of the borrowings under the line of credit was equal to the carrying
amount.
18
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Long-Term Debt, Warrants and Gain on the Extinguishment of Debt
At June 30, 2000 and 2001, the Company was obligated to one of its suppliers
under a note agreement in the amount of $2.96 million, bearing interest at 6.5%
per annum. The note as modified required interest only payments through
September 30, 2001, with subsequent quarterly payments of principal and interest
of $621,311 until maturity in December 2002. The Company was in default of
specified financial covenants at June 30, 2001, and the note was therefore
classified as current at that date. In August 2002, the Company entered into an
agreement to extinguish the outstanding $2.96 million debt for a cash payment of
$1.0 million and compliance with certain non-financial covenants. The Company
obtained the $1.0 million due the lender from borrowings from a director and
shareholder and from PlanetCAD Inc., each in the amount of $500,000. These
borrowings totaling $1.0 million bear interest at 15% per annum. The loan from
the director and shareholder matures on July 1, 2003 and is recorded as a note
payable to related party in the accompanying balance sheet at September 30,
2002. The loan from PlanetCAD was due at the earlier of (i) the date on which
Avatech became unable or refused to complete the merger, or (ii) July 1, 2003.
Accordingly, this note is recorded within the current portion of long-term debt
at September 30, 2002. As described more fully in Note 12, the Company completed
its merger with PlanetCAD on November 19, 2002, at which time the $500,000 loan
from PlanetCAD was eliminated in consolidation.
The gain on the extinguishment of the debt of $1.96 million was recorded in
August 2002 upon the settlement of the $2.96 million note for cash of $1.0
million and compliance with certain non-financial covenants.
As of September 30, 2002, the Company issued $1,675,000 of 10% subordinated
notes with attached nontransferable stock purchase warrants to purchase 69,000
shares. The notes bear simple interest at the rate of 10% per annum until all
principal and accrued and unpaid interest has been paid. Interest only is
payable quarterly until maturity. The notes are fully subordinated to the
payment of senior indebtedness (line-of-credit) of the Company. In connection
with the merger with PlanetCAD, Inc., approximately $1.4 million of subordinated
notes outstanding at September 30, 2002 were converted into 570,000 shares of
preferred stock on November 19, 2002. Accordingly, these subordinated notes are
presented as short term debt subject to refinancing at September 30, 2002. Of
the total subordinated notes, $725,000 were issued to related parties and those
notes that were not converted into preferred stock are presented within the
current portion of long term debt as their maturity date is July 1, 2003. The
fair value of the long-term debt approximates its carrying value based on
interest rates available to the Company for similar loans.
The warrants to purchase 69,000 shares of common stock issued in connection with
the 10% subordinated notes are exercisable for $5.75 per share and expire five
years after
19
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Long-Term Debt, Warrants and Gain on the Extinguishment of Debt (continued)
their date of issuance. Warrants for the purchase of 63,000 shares and 1,000
shares of common stock will expire in 2003 and 2004, respectively. The remaining
5,000 stock purchase warrants will expire in 2007. The number of shares or
exercise price will be adjusted in the event of any stock dividend, stock
splits, or recapitalization of the Company.
The warrants issued in conjunction with the 10% subordinated notes were valued
at $19,840, an estimate based on a valuation using the Black-Scholes Pricing
Model, a generally accepted warrant valuation methodology. The estimated value
of the warrants was recorded as additional paid-in capital and the notes have
been recorded net of a discount of $19,840. The estimated fair value of the
options was based on the Black-Scholes Pricing Model. The valuation assumptions
used included an expected life of five years; an expected price volatility of
0.10; no dividend yield; risk-free interest rate of 5.5%; and the stock price at
the date of grant of $4.25. At September 30, 2002, the balance outstanding under
the 10% subordinated notes was $1,672,426.
7. Employee Stock Plans
Effective April 2, 1998, the Company adopted the Avatech Solutions, Inc. 1998
Stock Option Plan. Effective January 1, 2000, the Company adopted the Avatech
Solutions, Inc. 2000 Stock Option Plan. Both plans are administered by the Board
of Directors and provide for the granting of either qualified or non-qualified
stock options to purchase an aggregate of up to 750,000 shares of common stock
to eligible employees, officers, and directors of the Company. The options
granted under this plan vest in three equal installments on the anniversary date
of the grant over a three year period.
A summary of stock option activity and related information is included in the
table below:
Year ended June 30
2002 2001 2000
--------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------------------------------------------------------------------------------------
Outstanding at beginning of
year 399,185 $ 4.25 274,300 $ 4.25 171,720 $ 4.25
Granted 423,022 4.25 176,355 4.25 174,440 4.25
Exercised - - - - - -
Forfeited (126,910) 4.25 (51,470) 4.25 (71,860) 4.25
--------------------------------------------------------------------------------------
Outstanding at end of year 695,297 $ 4.25 399,185 $ 4.25 274,300 $ 4.25
======================================================================================
20
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Exercisable at end of year 378,391 $ 4.25 186,489 $ 4.25 95,499 $ 4.25
======================================================================================
Weighted-average fair value
of options granted during
the year $ 0.66 $ 0.95 $ 1.18
============= ============== =============
Weighted-average remaining
contractual life 8.7 Years 8.8 Years 9.2 Years
============= ============== =============
Pro Forma Information
Year ended June 30
2002 2001 2000
--------------------------------------------------------------
Net income (loss)--historical $ (247,495) $ 89,336 $ (2,053,237)
Net (loss) income--pro forma $ (363,857) $ (99,456) $ (2,163,510)
Basic and diluted net income (loss) per
common share--historical $ (0.04) $ 0.01 $ (0.34)
Basic and diluted net (loss) per common
share--pro forma $ (0.06) $ (0.02) $ (0.36)
For the three years ended June 30, 2002, required pro forma net income (loss)
and income (loss) per share information assuming that stock options were
recorded at their fair value at the grant date was determined using the minimum
value method. The minimum value method calculates the fair value of options as
the excess of the estimated fair value of the underlying stock at the date of
grant over the present value of both the exercise price and the expected
dividend payments, each discounted at the risk-free rate, over the expected life
of the option. In determining the estimated fair value of granted stock options
under the minimum value method, the risk-free interest rate was assumed to be
4.48%, 5.21%, and 5.5% in 2002, 2001 and 2000, respectively, the dividend yield
was estimated to be 0% and the expected life of granted options was assumed to
be five years.
Because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the minimum value method and other
methods of estimating fair value do not necessarily provide a single measure of
the fair value of its employee stock options.
21
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. Employee Stock Plans (continued)
Effective May 1, 1998, the Company adopted the 1998 Employee Stock Purchase Plan
for all employees meeting certain eligibility requirements. Under the Plan,
employees may purchase shares of the Company's common stock, subject to certain
limitations, at 85% of its market value as determined by the Board of Directors.
Purchases are limited to 10% of an employee's eligible compensation. A total of
150,000 shares are available for sale to employees under this Plan. The Board of
Directors authorized the suspension of this Plan in March 2000. During 2000, the
Company sold approximately 18,810 shares to employees under this Plan. The Plan
does not contain a provision requiring the Company to repurchase shares from
terminated employees. However, the Company elected to purchase 18,147 shares for
$65,529 in 2002 and 31,564 shares for $113,381 in 2001 from former employees.
At June 30, 2002, the Company has reserved 814,000 shares of common stock for
future issuance upon the exercise of any stock options granted under the 1998
and 2000 Stock Option Plans and upon the exercise of outstanding warrants.
8. Income Taxes
Significant components of the Company's deferred tax assets and liabilities are
as follows:
June 30
2002 2001
-----------------------------
Deferred tax assets:
Net operating loss carryforward $ 1,860,991 $ 1,688,082
Allowance for doubtful accounts 43,214 81,974
Accrued vacation pay - 1,822
Book over tax depreciation 77,341 76,571
---------------------------
Total deferred tax assets 1,981,546 1,848,449
Valuation allowance for deferred tax assets (1,608,546) (1,848,449)
---------------------------
Net deferred tax assets $ 373,000 $ -
===========================
22
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. Income Taxes (continued)
As of June 30, 2001, the Company recorded a valuation allowance equal to its
deferred tax assets due to the inability to conclude that it was more likely
than not that those assets would be realized from future taxable income. In
August 2002, as described more fully in Note 6, the Company realized a $1.96
million taxable gain from the extinguishment of certain debt. This gain provided
significant evidence of the likelihood of taxable income in fiscal year 2003,
and the Company therefore at June 30, 2002 recorded a valuation allowance of
$1.6 million that resulted in net deferred tax assets of $373,000, or the amount
that management estimated was likely to be realizable from taxable income in
2003. In the first quarter of 2003, the Company recorded deferred income tax
expense of $373,000 related to the estimated reduction in deferred tax assets in
2003 upon the use of net operating loss carryforwards to reduce taxable income
resulting from the $1.96 million taxable gain reported in the first quarter upon
the extinguishment of the aforementioned debt. The ultimate amount of the net
operating loss carryforward used to reduce 2003 taxable income may ultimately
differ from the amount estimated, and it is reasonably possible that the
difference may be material.
The Company's provision for income taxes resulted in effective tax rates that
varied from the statutory federal income tax rate of 34%, as summarized in the
table below.
Year ended June 30
2002 2001 2000
----------------------------------------
Expected federal income tax expense (benefit) at 34% $(181,048) $ 30,374 $(698,100)
Expenses not deductible for income tax purposes 153,566 26,879 47,419
State income taxes, net of federal benefit (24,601) 8,580 (94,860)
Change in valuation allowance for deferred taxes (239,903) (54,441) 735,900
Other 6,986 1,608 9,641
----------------------------------------
$(285,000) $ 13,000 $ -
========================================
At June 30, 2002, the Company has net operating loss carryforwards totaling
approximately $4,800,000, which will begin to expire in 2012. Certain net
operating loss carryforwards at June 30, 2002, are related to subsidiaries of
the Company, and are available only to offset future taxable income of those
subsidiaries.
23
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. Commitments and Contingencies
Operating Leases
The Company leases certain office space and equipment under noncancellable
operating lease agreements that expire in various years through 2006, and
generally do not contain significant renewal options. The Company also leases
one office location from an entity controlled by a stockholder under a
noncancellable operating lease, which expires in 2003. Future minimum payments
under all noncancellable operating leases with initial terms of one year or more
consisted of the following at June 30, 2002:
Related
Party Other Total
-------------------------------------------------------
Year ended June 30 $ 42,552 $ 821,490 $ 864,042
2003
2004 - 469,621 469,621
2005 - 115,934 115,934
2006 - 25,515 25,515
------------------------------------------------------
Total minimum lease payments $ 42,552 $ 1,432,560 $ 1,475,112
=======================================================
Rent expense consisted of the following for the years ended June 30:
2002 2001 2000
------------------------------------------------------
Office space $ 1,162,344 $ 1,066,818 $ 1,009,056
Equipment 40,361 69,132 99,915
------------------------------------------------------
$ 1,202,705 $ 1,135,950 $ 1,108,971
======================================================
Rent expense for the years ended June 30, 2002, 2001 and 2000 included amounts
paid to related parties of approximately $85,000, $83,000 and $82,000,
respectively.
24
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. Commitments and Contingencies (continued)
Agreements with Executives
The Company has entered into agreements with three executives that provide for
payments of eighteen months of salary and immediate vesting of all stock options
not previously vested upon termination of the executive or change in control of
the Company, as defined. At September 30, 2002, the total contingency was
approximately $500,000.
Litigation
On May 21, 2002, a former employee filed a lawsuit against the Company alleging
breach of employment contract in connection with the former employee's
dismissal. The lawsuit alleges damages in the amount of $187,500. As of
September 30, 2002, this lawsuit was settled for an agreed upon cash payment.
10. Employee Benefit and Incentive Compensation Plans
Effective January 1, 1998, the Company adopted the Avatech Solutions, Inc.
401(k) Retirement Savings Plan and Trust (the "Plan"). The Plan is a defined
contribution plan, which covers substantially all employees of the Company, or
its wholly-owned subsidiaries, who have attained age 21 and have completed 6
months of service. Participants may elect to contribute from 1% to 15% of
eligible annual compensation to the Plan. Maximum salary deferrals are currently
$10,000 per year. The Company will match 25% of the participant salary deferrals
up to 6% of a participant's compensation for all participants employed on the
last day of the Plan year. The Company may also make discretionary
profit-sharing contributions to the Plan for all participants who are employed
on the last day of the Plan year. The total amount recorded by the Company as
expense during the years ended June 30, 2002, 2001 and 2000, was approximately
$62,000, $79,000 and $86,000, respectively. The Company did not contribute to
the plans for the three months ended September 30, 2001 and 2002, respectively.
11. Significant Supplier
Approximately 92%, 87% and 80% of the Company's purchases for the years ended
June 30, 2002, 2001 and 2000, respectively, were from one vendor and
approximately 81% and 85% of accounts payable at June 30, 2002 and 2001,
respectively, were due to this vendor.
The Company's purchases for the three months ended September 30, 2002 were 95%
from this same vendor and approximately 60.0% of accounts payable at September
30, 2002 were due to this vendor.
25
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
12. Plan of Merger and Subsequent Events
On November 19, 2002, the Company consummated a merger with PlanetCAD, Inc.,
whereby shareholders of the Company exchanged their shares of the Company's
common stock for common stock of PlanetCAD. Upon completion of the merger, the
shareholders of the Company owned 75% of the outstanding common stock of
PlanetCAD. PlanetCAD develops, markets, and supports cycle time reduction
software solutions that integrate engineering processes and data for the
manufacturing supply chain. Subsequent to the acquisition, PlanetCAD changed its
name to Avatech Solutions, Inc. In connection with the merger, options and
warrants to purchase the common stock of the Company were converted into options
and warrants to acquire common stock of the post-merger entity based on the
merger exchange ratio. In addition, $1.5 million of outstanding subordinated
notes of the Company were converted into 610,000 shares of convertible preferred
stock of the Company. Each share of preferred stock is convertible into 1.1
shares of common stock.
For accounting purposes, the Company was deemed to have acquired PlanetCAD, as
its shareholders own a majority of the outstanding common stock of the surviving
entity. The purchase method of accounting was used to record the acquisition,
and the cost of acquiring PlanetCAD of $2.2 million, including estimated
acquisition costs of $947,000, was assigned to acquired assets and liabilities
based on their estimated fair value, as determined by an independent appraisal.
The cost of the acquisition was allocated to acquired assets and liabilities at
the acquisition date, as summarized below.
Assets
Cash $ 995,000
Accounts receivable 155,000
Prepaid expenses and other current assets 611,000
Property and equipment 314,000
Acquired technology and other amortizable intangible assets 686,000
Goodwill 278,000
------------
Total assets 3,039,000
============
Liabilities
Accounts payable and accrued expenses 860,000
Deferred revenue 229,000
------------
Total liabilities 1,089,000
------------
Cost of net assets acquired, excluding acquired
in-process research and development assets of $282,000 $ 1,950,000
============
Upon the completion of the merger, the new Company has 2,973,556 shares of
outstanding common stock, 2,230,167 of which were issued to shareholders of the
26
Avatech Solutions, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
12. Plan of Merger and Subsequent Events (continued)
Company in connection with the merger. The Company also has 610,000 shares of
outstanding preferred stock.
Unaudited summarized pro forma operating data, assuming that the acquisition
occurred on September 30, 2002 is as follows:
Year ended June 30, Three Months Ended
2002 September 30, 2002
-----------------------------------------
Revenue $31,580,291 $6,170,737
Net loss $(7,818,128) $ (238,490)
Loss per common share, basic and
diluted $ (2.63) $ (0.08)
13. Liquidity and Capital Resources
As discussed more fully in Note 12, in November 2002, the Company completed the
acquisition of PlanetCAD, Inc. In connection with the acquisition, the Company
incurred approximately $0.9 million of merger costs, and PlanetCAD incurred
approximately $1.3 million of merger costs. These costs have reduced the amount
of working capital that the Company has available for its operations. Management
is currently negotiating with service providers to reduce the amounts billed and
extend the terms for payment of unpaid obligations related to the merger. One of
the Company's directors or officers has expressed their intention of lending the
Company, up to $500,000, to fund any needed working capital deficiencies. Based
on an evaluation of the likely cash generated from operations in the near term,
available capital resources and the timing of cash payments to vendors,
management believes that it has sufficient sources of working capital to fund
its operations in the normal course of business through at least June 30, 2003.
The Company has engaged an investment banking firm to assist in obtaining
long-term financing. Additionally, the Company plans to raise between $1.0
million to $2.0 million of short term financing on acceptable terms by June 30,
2003.
27