UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD ______________ TO ______________
Commission file number: 0-25075
ARTIFICIAL LIFE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3253298
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
FOUR COPLEY PLACE, SUITE 102, BOSTON, MASSACHUSETTS 02116
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (617) 266-5542
Securities registered pursuant to Section 12(b) of the Exchange Act: NONE
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $.01 Par Value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 23, 2001, the Registrant had 10,303,469 shares of Common Stock
outstanding.
The aggregate market value, based upon the closing sale price of the shares as
reported by the Nasdaq National Market System, of voting stock held by
non-affiliates of the Registrant on March 23, 2001 was approximately
$14,570,070.
DOCUMENTS INCORPORATED BY REFERENCE
None.
PART I
ITEM 1. BUSINESS.
GENERAL
Artificial Life, Inc. ("Artificial Life" or the "Company") was incorporated in
Delaware in November 1994 as NeurotecInternational Corp., a wholly owned
subsidiary of Neurotec Hochtechnologie GmbH ("Neurotec GmbH"), a German
multimedia and Internet solutions company owned by Eberhard Schoneburg,
Artificial Life's President, Chief Executive Officer and Chairman, and two
corporate investors: a major German retailer and an industrial conglomerate. In
July 1997, Mr. Schoneburg sold all of his shares of Neurotec GmbH to the two
remaining stockholders and contemporaneously purchased 100% of the shares of
Neurotec International Corp. from Neurotec GmbH (the "Management Buyout"). In
August 1997, the Company's name was changed to Artificial Life, Inc.
We develop, market and support "intelligent" software robots ("bots"). Our
Company's bots, known as "SmartBots," are software programs that we are
developing to automate and simplify time-consuming and complex business-related
Internet functions such as Web navigation, direct sales and marketing, e-mail
automation, user profiling, knowledge management, sales response and call center
automation, electronic customer relationship management (eCRM) and wealth
planning and portfolio management. While each of our SmartBots will function
independently and will be programmed for a particular application, customers
will be able to combine the SmartBots to create what we believe will be the
industry's first integrated commercial, robot-based electronic commerce
("e-commerce") solution. The Company is also developing products for
applications in data mining, statistical analysis and customer service to
support the functionality of the SmartBot products. In addition, we provide
software consulting services to corporations and other entities seeking software
solutions, particularly in the field of "intelligent" software programs.
INDUSTRY BACKGROUND
Computer users and businesses have rapidly adopted the Internet as a means to
gather information, communicate, transact business, interact and be entertained,
making it an important new mass medium. Today, it is estimated that there are
407 million Internet users. International Data Corporation ("IDC"), a market
research firm, estimates that the number of Internet users will grow to over 1
billion by 2005. The Internet enables advertisers to target advertising
campaigns utilizing sophisticated databases of information about the users of
various sites and to directly generate revenues from these users through online
transactions. As a result, the Internet has become a compelling means to
advertise and market products and services. Forrester Research, Inc., another
market research firm, estimates that the total value of goods and services
purchased over the Internet will grow from $57 billion per year in 2001 to
approximately $6.8 trillion per year by the end of 2004.
Consequently, the amount of information available on the Internet has grown
dramatically. Web sites have proliferated along with the data available on such
sites, making it more difficult and time consuming for users to find the
information they want. Users are spending a substantial portion of their on-line
time searching for the specific information, products or services they desire.
Furthermore, once an Internet user locates a desired site or sites, the user
often finds it difficult to navigate such sites. As Web technology has improved,
many Web sites have become more complex by adding new features, products,
services, chat rooms, games, and other services. It is not uncommon for one Web
site to have dozens of different options and links to other associated sites.
While it is generally true that this increase in information and choices
benefits Web users, more effective tools are needed to find information,
products and services efficiently.
For corporations offering products and services on the Internet, the rapidly
increasing number of Internet users offers benefits but also presents
challenges. For example, a company may place a description of a new product on
its Web site and then find that within a few hours, thousands of Internet users
have sent e-mail messages to learn more about the product. While the volume of
inquiries suggests that the company might ultimately generate significant
revenues from selling its new product online, responding to each of these
inquiries in a timely manner can require an expensive customer service force. A
second problem facing e-commerce companies is the dramatic increase in
competition among e-commerce sites. Numerous e-commerce sites are launched
worldwide on the Internet daily. Accordingly, e-commerce retailers must find
increasingly efficient and cost-effective ways to market their products and
services to new customers and maintain or enhance existing customer
relationships.
THE ARTIFICIAL LIFE SOLUTION
We are continuing the development of our ALife SmartBot products and product
suites to assist in solving problems relating to information retrieval, Web
navigation, sales and service support and direct marketing on the Internet and
wealth building and portfolio management. The basis of these products, the
software robots, are designed to communicate in natural language and to respond
"intelligently" to the user's command or inquiry, and in some cases, to act
autonomously.
All of our SmartBot products are based on our ALife- SmartEngine technology. The
ALife-SmartEngine is the core component that gives our products the ability to
converse with their users in natural language to process and respond to natural
language commands or questions. The ALife-SmartEngine contains several
"intelligent" modules that process and interpret manual input. These modules
work together to break down the essential components of human conversation --
detailed knowledge of certain topics, casual talk about topics of interest
("small talk"), short and long term memory of previously discussed topics, and
some emotional content and intentions that drive the conversation -- and use
these components to "understand" and respond to the user in a manner that is
more human-like and less machine-
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like than current "query-based" software. We believe that our products will
allow people to interact with computers in a more natural way -- similar to a
conversation with a human being.
Historically, general natural language understanding and processing software
programs (often classified under the category "artificial intelligence") have
focused on understanding the meaning of a sentence in the same way as a human
would, so that the software program could react appropriately to a spoken
sentence or a sentence typed in at the keyboard. These programs have had only
limited success. Our ALife-SmartEngine instead attempts to mimic comprehension
of a sentence by using complex pattern matching techniques to determine the
actual goals and intentions of the user. By "understanding" the user's goals and
intentions, ALife-SmartEngine-based products are being designed to possess the
ability to actively drive and maintain a conversation about certain topics, and
not merely react to the user.
Our ALife-SmartEngine stores information in "Knowledge Bases," databases which
can be combined or exchanged to give the derived products differing sets of
expertise. Customers can add information to a Knowledge Base using a special
"Knowledge Editor." The ALife-SmartEngine has several linked stages that read
text-based input and produce spoken or text-based output. When a user types in
text, the pre-processed input is routed to a parser. The parser then converts
the input from a stream of text to a series of words and phrases. An analysis
module draws on the topic information in the memory section of the
ALife-SmartEngine as well as the syntactic structure of the sentence derived
from the Knowledge Base. The major control module of the ALife- SmartEngine is a
meta-control module (the "Meta Controller") that is essential for switching
between the different speech processing modules to process the input and prepare
the appropriate response corresponding to a given input. The Meta Controller
picks a reply appropriate to the perceived intention of the user by applying a
set of rules that define the conversational strategy of the bot. All modules
communicate through the Meta Controller, which also coordinates and balances the
weighting of each of the separate modules as the bot prepares its composite
action.
Most of our SmartBots communicate with the user via a life-like three-
dimensional graphical interface known as an "Avatar." Most products come with a
standard human-like Avatar. However, the Avatar may be customized by the
customer, including using pre-existing branded icons or displays. For instance,
an e-commerce retailer of computer equipment might customize its Avatar so that
visitors to its Web site converse with a talking computer. The Company believes
that the use of an animated "talking partner" allows people to interact with
computers in a more natural and personal manner, and that the ability of our
customers to customize the Avatars allows them to develop or maintain brand or
name recognition among visitors to their Web site.
PRODUCTS
We are continuing our development of the following software robots for use
individually or in various combinations as detailed in the Product Suite
descriptions below.
ALIFE-WEBGUIDE: We released the Personal Version 1.0 of this SmartBot in
September 1998, the Professional Version 1.0 in November 1998 and the Enterprise
Version in April 1999. The latest release of ALife-WebGuide, Version 3.0, is
included in the ALife SmartBot Suite, described below. These versions were and
are designed to reside on a Web site and help users navigate the site by
accepting and processing questions, such as search queries, from users in
natural language and responding to users in natural language. These SmartBot
versions engage the user in a "conversation" through questions and answers and,
upon learning of the user's interests, are designed to display Web pages that
match the content of the "conversation" or to suggest links to other locations
on the Web site. In an e-commerce application, the ALife-WebGuide can be
designed by the Web site host to function like a human sales associate at a
retail store, greeting customers coming through the door of the virtual store
and assisting them with advice and background information about products and
prices. This bot allows the use of a customizable animated Avatar interface.
ALife-WebGuide versions run on both Netscape Navigator or Communicator 3.0 or
higher and Microsoft Internet Explorer 3.0 or higher. ALife-WebGuide is designed
with a client/server architecture, requiring a Java virtual machine 1.02 or
higher. The knowledge capture tool for ALife-WebGuide, the ALife
KnowledgeEditor, is a platform-independent application. We believe that the
potential market for this product includes any Internet Web site that needs or
desires a more intuitive, user-friendly, natural language interface. Currently,
we only sell ALife-WebGuide Version 3.0.
ALIFE-MESSENGER: The ALife-Messenger serves as a natural language-based
automated e-mail reply and answering service. By customizing the Knowledge Bases
of the ALife-Messenger, a company can automate replies to incoming e-mail
queries and customer requests. The ALife-Messenger is designed to work like an
off-line ALife-WebGuide by selecting appropriate answers to input queries in an
"intelligent" way. However, instead of displaying Web pages, the ALife-Messenger
is designed to automatically scan an incoming e-mail for certain keywords and
phrases, prepare a reply e-mail and attach, as appropriate, additional
information that matches what this SmartBot determines might be useful to the
user, such as relevant documents, price-lists, e-coupons, and links to other Web
sites. It is intended that, for a corporate purchaser using BotMe!,
ALife-Messenger could subsequently be configured to select the appropriate
BotMe! (a plug-in application based on ALife-WebGuide) to be attached to the
reply e-mails, with the goal of improving and supporting the direct marketing
channel.
ALife-Messenger supports standard e-mail systems. We released Version 1.0 of the
ALife-Messenger in April 1999. We market this product to companies and
institutions that need to extensively interact with clients via e-mail or which
have extensive customer/client service programs using the Internet. The most
current version of ALife-Messenger, Version 3.0, is now incorporated in the
ALife-SmartBot Suite.
ALIFE-PORTFOLIO-MANAGER: ALife-Portfolio-Manager has been developed to monitor
an individual's investment portfolio and is to be expanded into the area of
wealth building and management. Once the user's portfolio guidelines are
established, ALife-Portfolio-Manager can monitor the portfolio 24 hours per day
and autonomously notify the user when the user's price or ratio guidelines are
not being met through one of a variety of predefined media such as e-mail,
telephone or pager. In addition to monitoring
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existing investment portfolios, ALife-Portfolio-Manager continues to be
designed to find other potential investments fitting the user's specified
criteria and to notify the investor about any such investment opportunities once
found.
ALife-Portfolio-Manager is designed to run on personal computers with Microsoft
Windows 98 or NT. The Company released Version 1.0 of ALife-Portfolio-Manager in
November of 1999 on a project application basis only, and had a general release
in May 2000. We have a client-server version of this product as well. Recently,
we released two showcase Web sites, www.Botfolio.com in English and
www.diegeldseite.de in German, to display the general functionality of our
portfolio management tools and services. We believe that the market for this
product will consist of individuals and companies in the financial services
industry, including Internet brokers, as well as individual investors. ALife-
PortfolioManager is a component of the ALife SmartFinance Suite.
PRODUCT SUITES
As we now have attained some experience in the implementation and marketplace
reaction to our products, we are currently using that intelligence to shift our
strategy slightly in a more focused way to provide our products a more flexible
environment in which to work. To that end, we will now offer our products within
both singular and complementary functionality by offering our products through a
series of product suites as detailed below.
ALife SmartBot Suite(TM)
The Internet is rapidly becoming a prime communication medium for companies and
their customers, partners, and employees. Customers are demanding that answers
to their questions and solutions to their problems be readily available at any
time, day or night and at any place in the world and even on any kind of
communication device. Traditional channels of communication such as telephone,
facsimile, and mail are no longer adequate. DataMonitor reported that, in 1999
alone, U.S businesses lost over $6.1 billion in potential e-commerce sales due
to the lack of customer service at Web sites, and forecasts that, at the current
rate, this number will grow to $173 billion through 2005. Our ALife SmartBot
Suite makes this kind of support possible in a friendly, consistent, proactive
and personalized manner.
The ALife SmartBot Suite addresses the needs of the eCRM (Customer Relationship
Management) market as a front-end piece or gateway and will improve the overall
user experience for Web visitors, build strong and loyal customer relationships,
and give companies a distinct competitive advantage in customer relationship
management, sales and support through employment of the following features:
ALife-Webguide to Assist with Online Sales and Customer Service
Whether customized to facilitate online sales or answer frequently asked
questions, ALife-WebGuide SmartBot converses with Web site visitors in natural
language and retrieves relevant Web pages. In a sales mode, this SmartBot can
conduct a needs analysis to make a product recommendation. In a service mode,
this SmartBot can function as a virtual, first tier customer support
representative, providing personalized responses to customer inquiries.
ALife-WebGuide to Relieve E-mail Overload
ALife SmartBot Suite also optimizes customer support via e-mail by quickly and
intelligently responding to high volumes of incoming e-mail. With the
ALife-Messenger SmartBot, these automatic responses can address multiple issues
in a single message using a case-based reasoning approach and sophisticated
natural language pattern matching technology. In addition, ALife SmartBot Suite
enables customer service representatives to manage workflow by routing and
reviewing inbound e-mail sent to a designated account. Finally, customer service
representatives may examine responses automatically prepared by ALife SmartBot
Suite prior to replying to customers.
Escalation to Live Chat
If a SmartBot cannot answer a question, or if a customer needs help finalizing a
transaction, the discussion can be automatically escalated to a human contact
center agent for live chat and resolution. The human agent will see what the
customer and SmartBot have discussed so far, as well as the customer's user
profile.
User Profiling
All user conversations are logged and filed in the ALife User Profiling System.
The user profile enables a SmartBot to recognize a user on a repeat visit, and
to customize the conversation based on known information. In addition, the
analysis tools can examine a user's conversation and e-mail topics to reveal
more about the user's needs and concerns. The results may be used to update the
SmartBots' knowledge bases and to add content to the Web site that caters to
visitor requirements, to better target marketing efforts, and to improve product
and service offerings.
ALife-KnowledgeEditor
ALife SmartBot Suite includes a graphical tool for building and maintaining the
Knowledge Bases that contain the SmartBots' specific knowledge. Knowledge Bases
can be as succinct or extensive as required, and may be built in any language,
including double-byte languages (such as Chinese or Japanese).
ALife-Logator
ALife SmartBot Suite includes a tool for analyzing the logfiles that result from
a user's interactions with the SmartBots. This information can be used not only
to improve the SmartBots' Knowledge bases, but also to gather marketing research
to learn more about customer preferences and product or service issues.
ALife SmartFinance Suite(TM)
As investors have flocked to the Internet to make online trades and online
payments, banks and financial institutions have invested billions of dollars
into deploying new tools and software to advise their customers in how best to
maximize the return on their assets. For those institutions that are not
offering online advice yet, it is expected they will do so shortly. And for good
reason: Forrester estimates that 20
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million U.S. households will use automated online investment advice solutions by
2005, growing from 1.8 million households at the end of 2001.
The ALife SmartFinance Suite is uniquely poised to meet the needs of financial
institutions and their tendency to be early-adopters of emerging technology. It
is a component-based financial service tool that provides an integrated and
personalized software solution for investors' financial portfolio management and
financial planning needs. The Suite has two primary components,
ALife-PortfolioManager and ALife-FinancialPlanner, each with unique features
designed for the benefit of its users.
ALife-PortfolioManager
The Portfolio Manager provides investor profiling via a questionnaire and
Risk-Scoring algorithm. Based on the scoring, it categorizes investors into
different model portfolios. It features risk/return and risk distribution
analysis, and fast, real-time presentation and visualization algorithms. There
is also a fund and security screener to carry the specific products of the
customer. Finally, there is an integrated SmartBot that can help the user
through the process, answer questions, and provide security alerts and news
searches.
ALife-Financial Planner
The ALife-FinancialPlanner interactively assists the user in estimating the
amount of personal investment required to achieve a variety of typical life
events, such as retirement, buying a home, or secondary education. As part of
the planning process, the tool can incorporate `what-if' scenarios that provide
estimations and projections to reach a financial goal. Other features include
the ability to instantaneously update calculation results and graphic displays
based on user inputs and integrating the user's risk profile. As with
PortfolioManager, a SmartBot is there to help the user through every step of the
process.
ALife SmartMobile Suite(TM)
We recognize that over the next few years, Internet and wireless applications
will become synonymous, as users are able to access information any time,
anywhere. According to a report by Datamonitor, the U.S. mobile market alone
will be worth $1.2 billion by 2005. We believe that autonomous agents or
bots will be the primary application for users to retrieve, send, and decipher
information. To ensure that we are setting the standard for these mobile bot
platforms, we have developed applications for today's market to help propagate
our technology for the future.
BannerBot
Advertising companies and marketing departments are struggling with how to get
more customers to click through banner ads and purchase their products.
According to most industry experts, banner click through rates are a dismal
0.5%, while the rate of those who actually purchase is around 3%.
We are uniquely positioned to leverage our technology in this market and offer
an immediate return-on-investment for the customer. In a recent test banner
campaign in Switzerland, the click through rate of embedded bot banners was
5.8%, compared to 0.5% for non-bot banners.
A BannerBot is a an interactive banner advertisement that uses natural language
processing to interact with users and leads visitors to web sites. Visitors to a
BannerBot are greeted by a virtual character that invites them to interact with
the banner, thereby not only increasing click through rates but actually
engaging the user in an interactive discourse. Once a user clicks on the banner,
he or she can begin to converse with the banner and request company information.
A BannerBot converses with the visitor, and based on the information gathered
during the conversation, can bring the user to a targeted Web page. In addition,
it can perform an analysis by asking questions and make product or service
recommendations based on the answers it receives. All conversations are stored
and can be used to enhance and redirect marketing efforts.
BotMail
As more people get connected to the Internet, marketers are increasingly relying
on email to assist them in both customer acquisition and customer retention.
Besides the capability to reach individuals using e-mail, this growing market
offers a cost effective alternative to other forms of direct response channels
such as mail and telephone. According to Forrester, U.S. digital marketing
expenditures will grow from $11 billion in 2000 to $63 billion by 2005; of the
latter amount, $6 billion will be spent in email marketing alone by 2005.
As the email market grows, so will the volume of marketing messages. However,
nobody likes unsolicited email. To be effective, email messages must be
targeted, personal and content rich. Forrester reports that the annual volume of
emails is expected to increase from under 35 billion today to over 200,000
billion by 2004. As consumers are increasingly inundated with emails, marketers
are looking for new ways to make the email more personalized to turn the
recipient into a buyer. Marketers are also looking to their campaigns as a
service to deliver company and product pertinent information. Artificial Life
offers such a solution.
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A BotMail is unlike any other email. Not just another electronic document, a
BotMail contains an animated character that actually greets the recipient by
name and discusses the contents of the email. Once email recipients are greeted,
they can begin to interact with the SmartBot and request company information
using plain words. The SmartBot (virtual character) converses with the visitor
and can display Web pages based on the information gathered. It can even perform
a needs analysis by asking qualifying questions. Based on the information it
receives, the SmartBot then can make product or service recommendations or ask
more detailed questions. All conversations are stored and can be used to learn
about customers needs.
BotMe!
AOL reports that its members spend an average of one hour online each day. For
marketers, this is an opportune time to push relevant information to the user in
a fun and interactive way. Our BotMe! offers such a mechanism.
ALife-BotMe! enhances the Web user's interface by presenting an animated
graphical character known as an "avatar". This avatar can be a branded
character, a cartoon or even a realistic image of a person. Through
sophisticated graphics, BotMe! facilitates the interaction with SmartBots and
offers a natural language way to converse with them. By residing on the desktop,
independent of the browser, BotMe! not only gives access to the traditional
resources of the Web, but also offers a bi-directional communication channel
with other BotMe! users and companies and can represent a direct, friendly,
"push" channel between our clients and their customers.
CONSULTING AND PRODUCT SERVICES
We expect to provide consulting, maintenance, and support services for most or
all of our products. We anticipate that customers will require support for, and
customized versions of, our SmartBot products or additional developments in
order to tailor the product to their needs. In addition, we plan to provide
support for the creation and maintenance of the Knowledge Bases of our bots and
customer specific back-office tools for analyzing client profiles gathered by
our bots.
Prior to 1999, we had derived substantially all of our revenues from software
consulting services provided to a small number of customers. During the year
ended December 31, 1998, substantially all of our revenue was derived from the
completion of our existing obligations for our sole remaining consulting
contract for 1998 and the resulting license sale thereto. During the year ended
December 31, 1999, approximately 29% of our revenue was derived from license
sales and during the year ended December 31, 2000 approximately 39% of our
revenue was derived from license sales. Although we have shifted our primary
business focus from software consulting to product development, sales, marketing
and support, we anticipate that we will continue to derive a portion of our
revenues from software consulting projects and services. In particular, we
expect that we will provide software solutions for companies and other entities
seeking consulting expertise with agent-based software programs. In the near
term, we believe that a significant percentage of its revenues may continue to
be derived from software consulting services. See "-- Strategic Alliances and
Joint Ventures."
BUSINESS STRATEGY
In our first year as a publicly traded company, we focused on completing the
development of several products, continuing our development of other products,
increasing our sales and support infrastructure, and expanding our international
presence. As evidenced by our product development achievements, our St.
Petersburg, Russia development facility, and our sales and support offices in
Switzerland, Germany and the United States, we feel that we achieved those
initial goals. As our business evolves, we plan to continue to evaluate our
product development and marketing strategies and our international development
plans. With our product development achievements and our initial clients in
place, we plan to focus our attention on global sales and marketing while
continuing product development and Web Services in an efficient and
cost-effective manner.
In 2000, we continued to focus on our sales and product development efforts. On
the technology side, we completed our eCRM suite, our first comprehensive
release demonstrating the combined utility of our software. On the sales side,
revenue growth not only continued at a strong pace, but the revenue mix was much
more broadly distributed among our client base, which continues to expand.
Our objective is to become a worldwide leader in the development and
implementation of commercial software robot-based solutions to solve various
issues confronting today's Internet use. To achieve this objective, our strategy
includes the following key elements:
BUILD BRAND NAME RECOGNITION. We are seeking to achieve rapid and broad adoption
of our products and strong brand recognition. We intend to embark on a
promotional campaign to increase awareness of the Artificial Life brand and the
ALife family of products in the year 2001. The promotional campaign is expected
to involve traditional media (i.e., print and trade shows) together with an
emphasis on Internet channels. The initial campaign in print, online and
television media began in November 1999 and continued throughout 2000. Further,
we have also begun presenting our products at targeted industry trade shows and
events.
We believe that significant brand name recognition can be achieved through the
foregoing channels. We have either been mentioned or featured in a variety of
publications and broadcast media in the United States, Germany and Switzerland
during the past year including Forbes magazine's "Best of the Web" edition,
CNN's CNN.com show (broadcast on January 13, 2001), and Germany's ZDF.
Similarly, our employees and management continue to make presentations at
speaking engagements for trade and other marketing forums. We also receive
exposure from the various industry awards we receive, including, most recently,
the Massachusetts Interactive Media Council (MIMC) award for "Enabling
Technologies-User Applications" for our ALife-WebGuide Product. Lastly, we
believe that references from our existing clients will be the best way to
achieve continued and strengthened brand development and recognition in a cost-
effective manner.
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CREATE MULTIPLE REVENUE STREAMS. We believe that our growing product line,
corporate customization, product Web sites and our future installed user base
will present a significant opportunity to develop and maintain multiple revenue
streams resulting from product sales and maintenance, customization and
consulting, licensing fees and potentially in the future, advertising and
subscription revenues. As these different revenue streams mature, we will make
decisions as to the expansion and contraction of existing programs based on
their success as well as the introduction of new programs.
ESTABLISH STRATEGIC ALLIANCES. We intend to aggressively pursue strategic
alliances to gain access to complementary technologies and distribution
channels. We continually evaluate relationships with companies and other
entities that offer technologies complementary to our SmartBot products (such as
speech integration and high-end graphics and other types of interface
providers). We intend to use strategic alliances wherever possible to gain
economies of scale and additional channel exposure, while focusing on our own
core strengths and using the strengths of our partners to add the complementary
functionality necessary to increase value to users.
In 1999, we signed a cooperation agreement with PricewaterhouseCoopers GmbH
Germany ("PwC") for joint sales and development activities that are intended to
leverage the existing client base and consulting services of PwC to allow for
the sale and integration of our products within the PwC consulting group client
base. In 2000, we entered into several additional domestic and international
partnership arrangements and will continue to focus on the expansion of our
partner network. New technology partners include Triplehop (U.S., matching
engine), Echzeit (Germany, 3D animations), and noDNA (Germany, visual
characters). New marketing and implementation partners include, among others,
Softlab (Germany), Artificial Solutions (Scandinavia)(unrelated to the Company),
and WebAgent (Italy).
EXPAND GLOBALLY. We believe that significant opportunities exist to capitalize
on the growth of the Internet internationally. Because we were once a subsidiary
of a large and well-known German multimedia and Internet solutions company, we
already have significant contacts with a number of European businesses. We
believe that our products can be used worldwide, and accordingly we initiated an
international program of partnering and strategic investment to exploit cross-
marketing, co-branding and promotional opportunities. In the fourth quarter of
1998, we established wholly owned European subsidiaries in Switzerland and
Russia. In October 1998, we formed Artificial Life Europe AG ("Artificial Life
Europe"). Artificial Life Europe, the headquarters of our European activities
focused on strategic investments in Switzerland, joint ventures and product
related consulting and development activities in the areas of e-commerce and
Internet banking and will act as a holding company for Artificial Life Solutions
AG, the Swiss operating company, and Artificial Life Rus, our Russian research
and development arm. In November 1998, Artificial Life Europe AG formed the
wholly-owned subsidiary Artificial Life Rus Ltd. ("Artificial Life Rus") which
is based in St. Petersburg, Russia. The primary focus of Artificial Life Rus is
product development, quality assurance and research. In the second quarter of
1999, we established our German subsidiary Artificial Life Deutschland AG
("Artificial Life Germany"), situated in Frankfurt, Germany. Artificial Life
Germany will focus on strategic investments, product development, product
customization, product-related marketing and sales activities and general
support to German customers. Also in the second quarter 1999, we established
Artificial Life Solutions AG. Headquartered in Switzerland, Artificial Life
Solutions will focus on strategic investments, product development, product
customization, product- related marketing and sales activities and general
support to Swiss customers. In 2000, we renamed Artificial Life Europe to
Artificial Life Schweiz, AG and consolidated our Swiss operations into this
entity while concurrently moving the Swiss operational base to Zurich.
Additionally, in 2000, we began our expansion into the Asian marketplace with
the establishment of Artificial Life Asia Ltd. Artificial Life Asia Limited is
located in Hong Kong, PRC and is intended to provide sales, marketing and
support capacity for the Asian marketplace, with initial business development
efforts focusing on Hong Kong.
Although we continue to focus on our international development and sales
capabilities, we have reached the point in the development of our core product
where we need to re-evaluate our options regarding product development, sales,
and business development and to continue focusing our future resources in those
areas and markets that will offer the best return. To that end, we are currently
evaluating our existing and anticipated product development needs against
existing capacity in order to maintain balance between required development
efforts and cost.
EXPAND AND ENHANCE PRODUCT BASE AND TECHNOLOGY. We believe that we must
regularly provide new products and technologies and improve existing ones to be
successful and consider product development inherently evolutionary in nature at
this point in our life cycle. Our products utilize proprietary
technologies,including the ALife-SmartEngine. Our strategy is to continue to
enhance our existing technologies and develop new technologies that we can
incorporate into future product offerings. Because we are centering our product
lines around core concepts and technology, we believe that we will be able to
develop many complementary products by leveraging our existing competencies and
experience into new ideas. Furthermore, we believe that our overall strategy
will allow us to address issues regarding products and services in a dynamic,
almost real-time basis, thereby allowing rapid response to market feedback and
developments. We believe that we have reached the point in the development of
our core technology and in our product development cycle that will permit us to
expend fewer resources in our future product development efforts.
MARKETING AND SALES
It is the our belief that our products will ultimately serve the World Wide Web
in a horizontal capacity, but until we achieve significant branding, targeted
vertical markets will be our most effective method of achieving installation
success and product acceptance. We plan to sell and market our products through
a variety of methods and channels, including but not limited to direct sales,
distribution and channel agreements, strategic relationships and third party
providers. We believe that joint ventures and strategic relationships provide an
effective means of entering targeted vertical markets while targeted direct
sales are instrumental for obtaining large, must-have clients. It is our belief
that this strategy will provide a cost effective means of achieving maximum
exposure for our products and services.
In the first quarter of 1999, we began selling the ALife-WebGuide via our Web
site and through additional distribution partners. Also, we began distribution
of our ALife-WebGuide "intelligent" software robot for the Benelux market under
a non-exclusive distributor arrangement with MBE Consultants of Belgium. Based
in Brussels, MBE Consultants is marketing and selling the current version of
the ALife-WebGuide, and other products as they are released, and providing
consulting services and training in the application and use of our software
products. In September 1999, we signed a German market exclusive cooperation
agreement with PricewaterhouseCoopers GmbH Germany ("PwC") for joint sales and
development activities. These efforts are intended to leverage the existing
client base and consulting services of PwC that will allow for the sale and
integration of our products within the PwC consulting group client base. In
2000, we entered into partnership arrangements with several additional domestic
and international corporations and will continue to focus on the expansion of
our partner network in the future.
6
In 2000, we experienced a significant shift in our customer base as our two
primary clients from 1999, Liechtenstein Global Trust and net-tissimo.com, which
accounted for approximately 81% of our 1999 sales (64% and 17%, respectively)
accounted for only 35% of our 2000 sales (30% and 5%, respectively). However,
both the number and type of clients that engaged our products and services in
2000 expanded. As a result, we experienced an overall increase in sales.
In addition to our prior marketing efforts for the individual products in the
ALife product suite, we began, in the second half of 1999, to initiate marketing
campaigns to establish recognition of the Artificial Life brand. We expect these
marketing activities to eventually involve traditional media together with an
emphasis on the Internet channels. We will generate marketing material using our
in-house capabilities and multi-media know-how to produce video spots and
innovative interactive advertisement techniques for the Internet. Additionally,
we will use our own products, ALife-Messenger and the ALife-WebGuide, to further
promote our products and services. In 2000, we decided to focus our marketing
efforts in the key vertical markets in which we are presently working, plus in
its technological space as well. These efforts included direct advertising,
email outreaches and trade show and conference representations. We chose, in
general, to attend only trade shows and conferences in which we had a featured
speaking slot in order to be able to best present our offerings. Lastly, we also
developed a key innovative marketing tool in 2000 that we intend to use for
internal purposes as well. This tool is a BannerBot, a SmartBot enabled Banner
Ad that allows a user to maintain a limited, targeted discourse with a SmartBot
through a Banner Ad.
STRATEGIC ALLIANCES AND JOINT VENTURES
In March 1999, we agreed to enter into a joint venture with the Bon Appetit
group of Switzerland in which our technology is being used to offer a software
robot based e-commerce solution. The main focus of this joint venture is to
develop a high traffic, high volume, low cost e-commerce site on the Internet.
We licensed our SmartBot products to the joint venture. Pursuant to a separate
development agreement with the joint venture, we will also provide products and
software development and consulting services to the venture and receive payments
therefor. The joint venture partner will use its purchasing relationships to
obtain certain of the consumer products that will be sold on the joint venture's
e-commerce Website. In 2000, the focus of the site changed to reflect dynamic
change in the marketplace and it currently focuses on promotional and specialty
sales and campaigns. In January 2001, during a subsequent financing round for
the venture, in which we did not participate, our ownership interest in the
venture was reduced from 50% to 19.9%.
In addition, in 1999, we completed a contract for the first phase of a
development and consulting project with a European based global trust. The
project goal was to define and design the trust's future Internet-based
financial services. The successful completion of this phase led to a larger
scale implementation of this development project that continued through fiscal
year 2000. As part of the transaction, we are providing, for fees, licensed
products and software consulting services to the trust.
In September 1999, we signed a German market joint cooperation agreement for the
development and introduction of new technology for e-business with
PricewaterhouseCoopers GmbH Germany ("PwC"). Cooperatively, PwC and Artificial
Life will invest in the development of both sector-specific and multifunctional
products.
We signed several other partner agreements in 2000, the most noteworthy being
our technological investment in TripleHop Technologies, a provider of a
matching engine for e-business. We have agreed to work with Triple Hop
Technologies jointly on combined leads and projects where applicable. Other
partnerships into which we entered in 2000 include, among others, Echzeit
(Germany, 3D animations) and noDNA (Germany, visual characters). New marketing
and implementation partners include, among others, Softlab (Germany), Artificial
Solutions (Scandinavia)(unrelated to the Company), and WebAgent (Italy).
Furthermore, we are constantly evaluating strategic alliances with companies in
the United States, Europe, and Asia for marketing, selling and developing
products.
PRODUCT DEVELOPMENT
We believe that development capabilities are important to our future performance
and the maintenance of our competitive position. Since our formation, we have
developed our technology and products internally to a large extent. We are
exploring the opportunity to extend the functionality of our ALife-SmartEngine-
derived products through the inclusion of third party software and applications
in the development of such products.
Our development organization is arranged in five groups: the Core Technology
Group, which conducts research and designs and develops the technologies; the
Production Group, which specifies, produces and maintains product releases; the
Quality Assurance Group, which verifies that products meet their specifications
and our quality standards; and, the Competence Group, which focuses on rapid
prototyping of new ideas, consulting and adapting customer specific versions of
the product and a research group. We allocate responsibilities among the groups
to optimize the time, cost and quality control issues associated with product
development.
As of December 31, 2000, there were 202 employees on the our development staff.
The total product development expenses for our ALife-SmartEngine product suite
increased significantly through 1999 and 2000. Having expended significant
resources for research and development in 1999 and 2000, we expect to allocate a
decreasing amount of resources to future research and development activities, in
an attempt to minimize significant future research and development outlays while
maintaining substantive research capabilities. Since our products have reached a
development stage ready for marketing and sales, we will need to devote fewer
resources towards product development in the future. Through December 31, 2000,
we have incurred capitalized software development costs from our development
efforts in the amount of $1,465,124.
7
To the extent one or more of our competitors introduce products that more fully
address customer requirements, the Company's business could be materially
adversely affected. There can be no assurance that the Company will be
successful in developing and marketing enhancements to its existing products or
new products, incorporating new technology on a timely basis, or that its new
products will adequately address the changing needs of the marketplace. If the
Company is unable to develop and introduce new products or enhancements to
existing products in a timely manner in response to changing market conditions
or customer requirements, the Company's business, prospects, financial condition
and results of operations will be materially adversely affected.
COMPETITION
The market for our products and services is new, evolving and growing rapidly.
Competition can be expected to intensify significantly as the market matures and
the more established software companies, such as Microsoft Corporation, become
increasingly involved. Barriers to entry are relatively insubstantial. We
believe that the principal competitive factors for companies seeking to become
involved in the software robot industry are core technology, delivery methods,
brand recognition, ease of use and interfaces.
We use our core technology, the ALife-SmartEngine, in a wide variety of business
areas. Although we have not yet identified any competitors in exactly the same
areas in which we are active, there are companies that have overlapping
activities and therefore could be regarded as our competition. Such firms
include, among others: Ask Jeeves, Inc.; Autonomy, Inc.; Brightware, Inc.;
Digital Marketing Concepts, Inc.; eGain, Inc.; Extempo, Inc.; General Magic,
Inc.; GK Intelligent Systems, Inc.; Haptek, Inc.; Intellix A/S; Kinetoscope,
Inc.; Kiwi Logic AG; Microsoft Corporation; Netsage Corp.; NativeMinds, Inc.,
Nuance, Inc.; SRA International, Inc. and Virtual Personalities, Inc. This list
may not be complete and may change and substantially increase over time.
Some of our existing and potential competitors have longer operating histories,
greater name recognition, larger customer bases and significantly greater
financial, technical and marketing resources than us. Such competitors are able
to commit operating resources to product development and enhancement, engage in
more thorough marketing campaigns for their products and services, be more
aggressive from a pricing standpoint and make more attractive offers to
potential employees and partners.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
We rely upon trade secrets, know-how, copyrights and continuing technological
innovations to develop and maintain our competitive position. We seek to protect
such information, in part, by entering into confidentiality agreements with our
corporate partners, collaborators, employees and consultants. These agreements
provide that all confidential information developed or made known during the
course of the individual's or entity's relationship with us is to be kept
confidential and not be disclosed to third parties except in specific
circumstances. We have endeavored to cause our employees to execute forms of
Confidentiality and Inventions Agreements which provide that, to the extent
permitted by applicable law, all inventions conceived by an individual during
the individual's employment will remain our exclusive property. There can be no
assurance that these agreements will not be breached, that we would have
adequate remedies for any breach, or that our trade secrets will not otherwise
become known or be independently discovered by competitors. Further, there can
be no assurance that we will be able to protect our copyrights, trade secrets or
that others will not independently develop substantially equivalent proprietary
information and techniques.
We currently have one patent pending. We do not have any registered copyrights.
There can be no assurance that the existing or future patents of
third parties will not have an adverse effect on our ability to continue to
commercialize our products. Furthermore, there can be no assurance that other
companies will not independently develop similar products or duplicate any of
our planned products or obtain patents that will require us to alter our
products or processes, pay licensing fees or cease development of our planned
products. The occurrence of any such event may have a material adverse effect on
our business, prospects, financial condition, and results of operation.
EMPLOYEES
As of December 31, 2000, we had 275 full-time employees. Of our 275 full-time
employees, 73 are involved in sales, marketing and administrative functions and
202 are involved in engineering and research and development. We will need to
hire additional staff to accomplish our business development goals. There can be
no assurance that we will be able to find, attract or retain such additional
staff.
Our employees are not represented by any labor unions. We consider our relations
with our employees to be good.
SUB-CONTRACTORS AND EXTERNAL HUMAN RESOURCES
To fulfill timely delivery of products, we are currently using external human
resources and sub-contractors to develop our products. There can be no assurance
that these external resources and sub-contractors will be available in the
future, or that the current conditions and agreements with these contractors or
resources will remain reasonable.
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
Statements in this Annual Report on Form 10-K under the captions "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," as well as oral statements that may be made by us or by our
officers, directors or employees, acting on our behalf, that are not historical
fact constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995, Such forward-looking statements
involve known and unknown risks, uncertainties and other factors that could
cause our actual results to be materially
8
different from the historical results or from any results expressed or implied
by such forward-looking statements. Statements that include the words
"believes," "expects," "anticipates," "intend," "possible," "predict,"
"project," or similar expressions are forward-looking statements. Such factors
include, among others, the following factors:
RECENT CHANGE IN STRATEGY. We were incorporated in Delaware in November 1994 as
Neurotec International Corp., a wholly owned subsidiary of Neurotec
Hochtechnologie GmbH ("Neurotec GmbH"), a German multimedia and Internet
solutions company owned by Eberhard Schoneburg, our President, Chief Executive
Officer and Chairman, and two corporate investors: a major German retailer and
an industrial conglomerate. In July 1997, Mr. Schoneburg sold all of his shares
of Neurotec GmbH to the two remaining stockholders and contemporaneously
purchased 100% of the shares of Neurotec International Corp. from Neurotec GmbH
(the "Management Buyout"). In August 1997, our name was changed to Artificial
Life, Inc. Moreover, we have recently changed our primary business focus from
software consulting to the development, marketing and support of our ALife
product suite of "intelligent" software robots (also known as "SmartBots" or
"bots"). Accordingly, we are in the initial phase of rolling out our software
products and are subject to certain risks inherent in launching new products. To
address these risks, we must, among other things, complete development of our
software robot products, enter into strategic relationships, marketing and
distribution arrangements, respond to competitive developments, and attract,
retain and motivate qualified personnel. In addition, because we have adopted
this new business strategy, results of operations to date are not reflective of
our future results of operations. Our decision to develop, market and support
software robot products is predicated on the assumption that the demand for such
products will be large enough to permit us to operate profitably. There can be
no assurance that our assumption will be correct or that we will be able to
successfully compete as a provider of such products. If our assumption is not
accurate, or if we are unable to compete as a provider of agent-based software
products, our business, prospects, financial condition and results of operations
will be materially adversely affected.
MINIMAL REVENUES AND RECENT LOSSES; PERIOD TO PERIOD COMPARISONS; LIMITED
OPERATING HISTORY; ANTICIPATION OF CONTINUED LOSSES. Since our incorporation in
November 1994, we have been engaged primarily in the provision of software
consulting services and to date have generated limited revenues. Through July 3,
1997, we had recorded cumulative net income in predecessor operations of
$138,084 primarily through our software consulting business, a significant
majority of which business was with our former parent company and affiliates
thereof and ceased shortly after the Management Buyout on July 4, 1997. As a
consequence of our recent change in our primary business focus from software
consulting to the development, marketing and support of our ALife suite of
SmartBot software products, we expect that an increasing percentage of our
future revenues will be derived from sales and services associated with our
software robot products and that revenues from our consulting business, as a
percentage of gross revenues, will significantly decrease over time.
Accordingly, past financial results do not reflect the results of our current
business activities. In the years ended December 31, 1998, December 31, 1999 and
December 31, 2000 we incurred a net loss of $2,191,206, $6,758,214 and
$12,588,295, respectively. Furthermore, our limited operating history leads us
to believe that period-to-period comparisons of our operating results are not
meaningful and that the results for any period should not be relied upon as an
indication of future performance. We face the risks and problems associated with
pursuing a new business strategy and have a limited operating history on which
to evaluate our future prospects. Such prospects should be considered in light
of the risks, expenses and difficulties frequently encountered in launching new
products in a new and emerging industry characterized by rapid technological
change, a number of potential market entrants and intense competition. We expect
to incur significant losses until at least the end of fiscal year 2001. There
can be no assurance that we will achieve or sustain significant revenues or
become cash flow positive or profitable in the near future or ever.
NEED FOR ADDITIONAL FINANCING. In 2000, we continued to incur losses from
operations, and have partially funded these losses through three private
placements of Common Stock totaling $8.9 million. We have continued to incur
losses in the first quarter of 2001 and do not anticipate achieving
profitability until late 2001. Our continued losses have severely impacted our
liquidity and cash position. We were unable to pay our Russian operation's
monthly payroll liability due February 28, 2000 and may not be able to pay our
Russian operation's March payroll liability. These payroll liabilities amounted
to approximately $350,000. We are currently negotiating the divestiture of a
substantial portion of our Russian operation, whereby these payroll liabilities
may be assumed by the buyer. In order to fund our cash needs for 2001, we have
taken steps to reduce operating costs, including, a reduction of staffing and
negotiation of the divestiture of a substantial portion of our Russian
operation. In addition, in 2001, our Chief Executive Officer advanced $485,000
to the Company. The advances are expected to be converted into an interest-
bearing term loan. We are also continuing to pursue short-term borrowings and
other direct share placement opportunities. Despite these efforts, we will
continue to incur losses through the majority of 2001. Without obtaining
additional financing or capital, we will not have sufficient resources to fund
our operations through 2001. To that end, we have entered into an irrevocable
stock purchase agreement with Bluefire Capital, Inc. (Bluefire), a Cayman Island
Corporation, on March 22, 2001, to provide us with equity financing. Bluefire
has committed to purchase up to $13,000,000 of common shares over the course of
three years, and such amount may increase if certain conditions are met. The
ability to raise funds through this equity facility and the number and amount of
each equity transaction available under the facility are subject to certain
conditions at the time of each sale of our Common Stock. We do not believe that
financing available from this equity facility will be sufficient to fund our
operations through 2001. We are continuing to pursue short-term borrowings and
other direct share placement opportunities to meet our anticipated liquidity
shortfalls. We cannot assure that we will be able to complete this or any other
financing or that such financings will be adequate to meet our needs.
These factors create a substantial doubt about our ability to continue as a
going concern. The accompanying financial statements do not include any
adjustments that might come from the outcome of this uncertainty.
DEPENDENCE ON EMERGING MARKETS; ACCEPTANCE OF OUR PRODUCTS. Our future
financial performance will depend in large part on the growth in demand for
agent-based software products, such as our suite of SmartBot products. This
market is new and emerging, is rapidly evolving, is characterized by an
increasing number of market entrants and will be subject to frequent and
continuing changes in customer
9
preferences and technology. As is typical in new and evolving markets, demand
and market acceptance for our technologies is subject to a high level of
uncertainty. Because the market for our products is evolving and because we are
an early stage company, it is difficult to assess or predict with any assurance
the size or growth rate, if any, of this market. There can be no assurance that
a significant market for our products will develop, or that it will develop at
an acceptable rate or that new competitors will not enter the market. In
addition, even if a significant market develops for such products, there can be
no assurance that our products will be successful in such market. If a
significant market fails to develop, develops more slowly than expected or
attracts new competitors, or if our products do not achieve market acceptance,
our business, prospects, financial condition and results of operations will be
materially adversely affected.
COMPETITION. The market for our products and services is new, evolving and
growing rapidly. Competition can be expected to intensify significantly as the
market matures and the more established software companies become increasingly
involved. Barriers to entry are relatively low. Although we have not
yet identified any competitors in exactly the same areas in which we are active,
there are companies that have overlapping activities and therefore could be
regarded as our competition. Such firms include, among others: Ask Jeeves;
Autonomy, Inc.; Brightware, Inc.; Digital Marketing Concepts, Inc.; eGain, Inc.;
Extempo, Inc.; General Magic, Inc.; GK Intelligent Systems, Inc.; Haptek, Inc.;
Intellix A/S; Kinetoscope, Inc.; Kiwi Logic AG; Microsoft Corporation; Netsage
Corp.; NativeMinds; Nuance, Inc.; SRA International, Inc. and Virtual
Personalities, Inc. This list may not be complete and may change and
substantially increase over time. We believe that the principal competitive
factors affecting the market for our products include core technology, delivery
methods, brand recognition, ease of use and interfaces. The relative importance
of each of these factors depends upon the specific customer involved. There can
be no assurance that we will be able to compete effectively with respect to any
of these factors.
Our present or future competitors may be able to develop products comparable or
superior to those offered by us or adapt more quickly than the Company to new
technologies or evolving customer requirements. In order to be successful in the
future, we must respond to technological change, customer requirements and
competitors' current products and innovations. In particular, while we are
currently developing products and product enhancements that we believe address
customer requirements, there can be no assurance that we will successfully
complete the development or introduction of these products and product
enhancements on a timely basis or that these products and product enhancements
will achieve market acceptance. Accordingly, there can be no assurance that we
will be able to compete effectively in our market, that competition will not
intensify or that future competition will not have a material adverse effect on
our business, prospects, financial condition and results of operations.
PRODUCT CONCENTRATION. We expect to derive an increasing percentage of our
revenues from sales of our SmartBot software robot products and associated
services. Broad market acceptance of these products is critical to our future
success. As a result, failure to achieve broad market acceptance, or, if
achieved, future declines in demand of these products as a result of
competition, technological change, ease of use or otherwise would have a
material adverse effect on our business, prospects, financial condition and
results of operations. In addition, our future financial performance may depend
in part on the successful development, introduction and customer acceptance of
future versions of our software robot products, and there can be no assurance
that any such future products will achieve market acceptance.
PRODUCT DEFECTS AND PRODUCT LIABILITY. Our software robot products are complex
and could from time to time contain design defects or software errors that could
be difficult to detect and correct. There can be no assurance that, despite
testing by the Company, errors will not be found in our products which could
result in delay in or inability to achieve market acceptance and thus could have
a material adverse effect upon our business, prospects, financial condition and
results of operations.
Because our software robot products can be used by our clients to perform
mission critical functions, design defects, software errors, misuse of our
products, incorrect data from external sources or other potential problems
within or out of our control that may arise from the use of our products could
result in financial or other damages to our clients. We maintain only limited
product liability insurance, and such insurance may likely not be adequate to
effectively protect us against product liability claims and the costs and
expenses associated therewith. We anticipate that our sales and licensing
agreements with our clients will typically contain provisions designed to limit
our exposure to potential claims. Such provisions, however, may not effectively
protect us against such claims and the liability and costs associated therewith.
Accordingly, any such claim could have a material adverse effect upon our
business, prospects, financial condition and results of operations.
RAPID TECHNOLOGICAL CHANGE. To remain competitive, we must continue to enhance
and improve the ease of use, responsiveness, functionality and features of our
family of SmartBot software robot products. The industry in which we operate is
characterized by rapid technological change, changes in user and customer
requirements and preferences, frequent new products and service introductions
embodying new technologies and the emergence of new industry standards and
practices that could render our existing products and proprietary technology and
software obsolete. Our success will depend, in part, on our ability to enhance
our existing products, develop new products and technologies that address the
increasingly sophisticated and varied needs of our customers, and our ability to
respond to technological advances and emerging industry standards and practices
on a cost-effective and timely basis. There can be no assurance that we will
successfully develop, license or acquire and implement new technologies or adapt
our proprietary technology and products to customer requirements or emerging
industry standards. If we are unable, for technical, legal, financial or other
reasons, to adapt in a timely manner in response to changing market conditions
or customer requirements, our business, prospects, financial condition and
results of operations would be materially adversely affected.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL. Our performance is
substantially dependent on the continued services and performance of its senior
management and other key personnel, particularly Eberhard Schoneburg, the
Company's President, Chief Executive Officer and Chairman. We have entered into
an employment agreement with Mr. Schoneburg. We do not maintain key man life
insurance on any of our senior management or key personnel. Our performance also
depends upon our ability to continue to retain and motivate our other officers
and key employees. The loss of the services of, and the failure to promptly
replace, any of our executive officers or other key employees could have a
material adverse effect on our business, prospects, financial condition and
results of operations. Our future success also depends on our ability to
continue to identify, attract, hire, train, retain and motivate other highly
skilled software engineers and managerial and marketing personnel.
10
There is currently a shortage of qualified software engineers and programmers.
Competition for such personnel is intense, and there can be no assurance that we
will be able to continue to successfully attract, integrate or retain
sufficiently qualified personnel. The failure to attract and retain the
necessary personnel could have a material adverse effect on our business,
prospects, financial condition and results of operations.
DEPENDENCE ON THIRD PARTY CONTRACTORS. We intend to utilize consultants to
perform portions of the work on our ALife suite of SmartBot software products
and to assist customers in the installation and support of our SmartBot software
products. Competition for such personnel is intense. There can be no assurance
that we will continue to be successful in attracting or retaining such
consultants. In addition, our ability to provide our software consulting
services and introduce our products is dependent, in part, on the ability of
these independent consultants to complete their engagements in a timely and
cost-effective manner. In particular, consulting resources could be required to
install, support and customize our software products, including creating the
content of the Knowledge Bases (databases which can be combined or exchanged to
give the derived products differing sets of expertise). Therefore, the
availability of such resources could directly impact sales of such products.
Some of these consultants will be employees of other companies who will only be
able to work on our products on a part-time basis. If we are not successful in
continuing to attract necessary consultants or if such consultants cannot
complete the necessary tasks in a timely and cost-effective manner, our
business, prospects, financial condition and results of operations could be
materially adversely affected.
RISKS ASSOCIATED WITH INTERNATIONAL SALES. A key component of our strategy is to
expand our sales in foreign markets, especially in Europe. We anticipate that we
will continue to expend significant financial and management resources to
develop programs of partnering and strategic investments internationally as we
adopt a more sales and marketing oriented business strategy. If the revenues
generated by these marketing programs are insufficient to offset the expense of
establishing and maintaining such programs, our business, prospects, financial
condition and results of operations could be materially adversely affected.
There can be no assurance that we will be able to expand our sales in foreign
markets. Our international sales are subject to certain risks not inherent in
our domestic sales, including political and economic instability in foreign
markets, restrictive trade policies of foreign governments, local economic
conditions in foreign markets, potentially adverse tax consequences and the
burdens on customers of complying with a variety of applicable laws. All of
these factors may suppress demand for our services and products. The impact of
such factors on our business is inherently unpredictable. There can be no
assurance that these factors will not have a material adverse effect upon our
revenues from international sales and, consequently, our business, prospects,
financial condition and results of operations.
DEPENDENCE ON CONTINUED GROWTH OF INTERNET AND ONLINE COMMERCE. Our future
revenues and any future profits are in a large part dependent upon the
willingness of consumers to accept the Internet as an effective medium of
commerce and for obtaining information. We are especially dependent upon the
long-term acceptance and growth of online commerce. Rapid growth in the use of
and interest in online services is a recent phenomenon, and there can be no
assurance that such acceptance and use will continue to develop or that a
sufficiently broad base of consumers will adopt and continue to use the Internet
and other online services as a medium of commerce. Demand and market acceptance
for recently introduced services and products over the Internet are subject to a
high level of uncertainty. For us to be successful, consumers must accept and
utilize this novel way of conducting business and obtaining information.
The Internet may not be accepted by consumers as a viable commercial marketplace
for a number of reasons, including potentially inadequate development of the
necessary network infrastructure or delayed development of enabling technologies
and performance improvements. To the extent that online services continue to
experience significant growth in the number of users, their frequency of use or
an increase in their bandwidth requirements, there can be no assurance that the
infrastructure of the Internet and other online services will be able to support
the demands placed upon them. In addition, Internet services could lose their
viability due to delays in the development or adoption of new standards and
protocols required to handle increased levels of online activity or due to
increased government regulation. Changes in or insufficient availability of
telecommunications services to support Internet services also could result in
slower response times and adversely affect usage of the Internet and other
online services generally. If use of the Internet and other online services does
not continue to grow or grows more slowly than expected, if the infrastructure
for Internet services does not effectively support the growth that may occur, or
if the Internet does not become a viable commercial marketplace, our business,
prospects, financial condition and results of operations would be materially
adversely affected.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS. We will be relying upon
trade secrets, know-how, copyrights and continuing technological innovations to
develop and maintain our competitive position. We seek to protect such
information, in part, by confidentiality agreements with our corporate partners,
collaborators, employees and consultants. These agreements provide that all
confidential information developed or made known during the course of the
individual's or entity's relationship with us is to be kept confidential and not
disclosed to third parties except in specific circumstances. We have endeavored
to cause each of our employees to execute Confidentiality and Inventions
Agreements which provide that, to the extent permitted by applicable law, all
inventions conceived by the individual during the individual's employment are
the exclusive property of the Company. There can be no assurance that these
agreements will not be breached, that we would have adequate remedies for any
breach, or that our trade secrets will not otherwise become known or be
independently discovered by competitors. Further, there can be no assurance that
we will be able to protect our trade secrets and copyrights, or that others will
not independently develop substantially equivalent proprietary information and
techniques.
We currently have one patent pending. We do not have any registered copyrights.
There can be no assurance that the existing or future patents of third parties
will not have an adverse effect on our ability to continue to commercialize our
products. Furthermore, there can be no assurance that other companies will not
independently develop similar products or duplicate any of our planned products
or obtain patents that will require us to alter our products or processes, pay
licensing fees or cease development of our planned products. The occurrence of
any such event may have a material adverse effect on our business, prospects,
financial condition and results of operations.
RISKS ASSOCIATED WITH BRAND DEVELOPMENT. We believe that establishing and
maintaining brand identity is a critical aspect of our strategy. Furthermore, we
believe that brand recognition is becoming increasingly important as low
barriers to entry encourage competition in the software robot industry. In order
to continue to attract and retain customers and strategic partners, and in
response to competitive pressures, we are
11
attempting to increase our financial commitment to the creation and maintenance
of brand development. We plan to accomplish this, although not exclusively,
through advertising campaigns in several forms of media, including print and
trade shows, with a particular emphasis on the Internet channels. If we do not
generate a corresponding increase in revenue as a result of our branding efforts
or otherwise fail to promote our brand successfully, or if we incur excessive
expenses in attempting to promote and maintain our brand, our business,
prospects, financial condition and results of operations would be materially
adversely affected.
RISKS OF DOING BUSINESS ABROAD. We anticipate that some of the consultants we
may hire to complete portions of the development work on our products may be
located in foreign countries. In addition, we intend to organize additional
subsidiaries in foreign countries as required and supported by existing business
conditions. As a result, we may be subject to a number of risks, including,
among other things, difficulties relating to administering our business
globally, managing foreign operations, currency fluctuations, restrictions
against the repatriation of earnings, export requirements and restrictions, and
multiple and possibly overlapping tax structures. The realization of any of the
foregoing could have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
During 2002, all European Union countries are expected to be operating with the
euro as their single currency. Uncertainty exists as to the effect the euro will
have on the market. Additionally, all of the final rules and regulations
have not yet been defined and finalized by the European Commission with regard
to the euro currency. We cannot yet predict the anticipated impact of the euro
conversion on our business.
DEPENDENCE ON THIRD PARTY LICENSES. We are designing our SmartBot software
products to recognize third party voice input as well as text-based input. The
voice recognition capabilities of these products will depend to a large extent
on the availability of highly accurate voice recognition software packages,
which we intend to license from third parties rather than develop ourselves. We
believe that the success of its products will depend to a large extent on our
ability to allow users to interact in a natural conversational manner. There can
be no assurance that we will be successful in identifying third party voice
recognition software which will successfully interact with our products or that
we will be able to license such software products on commercially reasonable
terms, or at all. Our failure to successfully identify viable voice recognition
software or enter into license agreements could have a material adverse effect
on our business, prospects, financial condition and results of operations.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES. We believe that we are not
currently subject to direct regulation by any domestic or foreign governmental
agency, other than regulations applicable to businesses generally. However, due
to the increasing popularity and use of the Internet, a number of domestic and
foreign laws and regulations covering issues such as user privacy, pricing,
content, copyrights, distribution and characteristics and quality of products
and services are being considered and may be enacted. The European Community has
already adopted a directive restricting the use of personal data. The adoption
of such laws or regulations may decrease the growth in use of the Internet,
which would, in turn, decrease the demand for our products and services and
increase our cost of doing business. Moreover, the applicability to online
services of existing domestic and foreign laws in various jurisdictions
governing issues such as intellectual property ownership, sales and other taxes,
libel and personal privacy is uncertain and may take years to resolve. Any such
new legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to our business, or the
application of existing laws and regulations to online services could have a
material adverse effect on our business, prospects, financial condition and
results of operations.
Tax authorities in a number of states are currently reviewing the appropriate
tax treatment of companies engaged in Internet commerce. New state tax
regulations may subject us to additional state sales and income taxes. As some
of our products will be available over the Internet in multiple states and
foreign countries, such jurisdictions may claim that we are required to qualify
to do business as a foreign corporation in each such state and foreign country.
The failure by us to qualify as a foreign corporation in a jurisdiction where we
are required to do so could subject us to taxes and penalties for the failure to
do so. It is possible that the governments of other states and foreign countries
also might attempt to regulate our transmissions of content on its Web sites or
prosecute us for violations of their laws. There can be no assurance that
violations of local laws will not be alleged or charged by state or foreign
governments, that we might not unintentionally violate such law or that such
laws will not be modified, or new laws enacted, in the future.
In addition, several telecommunications carriers are petitioning to have
telecommunications over the Internet regulated by the Federal Communications
Commission (the "FCC") in the same manner as other telecommunications services.
Moreover, because the growing popularity and use of the Internet has burdened
the existing telecommunications infrastructure and many areas with high Internet
use have begun to experience interruptions in phone service, local telephone
carriers, such as Pacific Bell, have petitioned the FCC to regulate Internet
service providers ("ISPs") and online service providers ("OSPs") in a manner
similar to long distance telephone carriers and to impose access fees on the
ISPs and OSPs. If either of these petitions is granted, or the relief sought
therein is otherwise obtained, the costs of communicating on the Internet could
increase substantially, potentially slowing the growth in use of the Internet.
Any such new legislation or regulation or application or interpretation of
existing laws could have a material adverse effect on our business, prospects,
financial condition and results of operations.
INTERNET COMMERCE SECURITY RISKS. A significant barrier to electronic commerce
and communications is the secure transmission of confidential information over
public networks. We rely on encryption and authentication technology licensed
from third parties to provide the security and authentication necessary to
effect secure transmission of confidential information. There can be no
assurance that advances in computer capabilities, new discoveries in the field
of cryptography or other events or developments will not result in a compromise
or breach of the algorithms that we use to protect data. If any such compromise
of our security were to occur it could have a material adverse effect on our
business, prospects, financial condition and results of operations. We may be
required to expend significant capital and other resources to protect against
the threat of such security breaches or to alleviate problems caused by such
breaches. Concerns over the security of Internet transactions and the privacy of
users may also inhibit the growth of the Internet generally, and the Web in
particular, especially as a means of conducting commercial transactions. To the
extent that our activities or those of third party contractors involve the
storage and transmission of proprietary information, security breaches could
expose us to a risk of loss or litigation and liability. There can be no
assurance that our security measures will prevent security breaches or
12
that our failure to prevent such security breaches would not have a material
adverse effect on our business, prospects, financial condition and results of
operations.
ITEM 2. PROPERTIES.
We rent 7,334 square feet of office space at Four Copley Place, Suite 102,
Boston, Massachusetts. Our 60-month lease commenced February 1, 2001, at an
annual rental of $403,370. Additionally, we lease approximately 21,000 square
feet of office space in Saint Petersburg, Russia. This lease commenced
May 18, 2000 at an annual rental of $49,000. We also lease approximately 9,000
and 12,600 square feet of space in Switzerland and Germany, at an approximate
annual rent of $290,000 and $395,000, respectively, for our European operations.
As part of our expansion into the Asian marketplace, in January 2001, we began
renting a small interim office in Hong Kong on a short-term basis.
ITEM 3. LEGAL PROCEEDINGS.
During 2000, Artificial Life Rus, our Russian research and development arm, was
assessed approximately $440,000 by the Tax Inspection for the Central Region of
St. Petersburg (TICRP), in connection with additional value added and profit
taxes. Artificial Life Rus appealed the assessment to the St. Petersburg Court,
and on February 26, 2001 received a favorable decision from the Court. On March
16, 2001 the TICRP appealed the Court's decision. In addition, in March 2001,
Artificial Life Rus has received notice that the TICRP intends to make an
additional assessment of approximately $163,500 for additional value added and
profit taxes. We intend to vigorously challenge this appeal and any additional
tax assessment and management believes that the ultimate outcome of this matter
will not have a material adverse effect on our financial position. Therefore, no
provision for any additional taxes incurred as a result of this matter have been
provided for in our financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Our Common Stock commenced trading on the Nasdaq SmallCap Market on December 18,
1998 under the symbol "ALIF," and is currently listed on the Nasdaq National
Market System. Prior to that date, there was no established trading market for
our Common Stock. The following table sets forth for the periods indicated, the
range of the high and low bid quotations for our Common Stock. Such quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commissions
and may not represent actual transactions.
HIGH LOW
---- ---
1999:
First Quarter $ 17.50 $ 9.50
Second Quarter 23.00 12.875
Third Quarter 15.00 9.00
Fourth Quarter 19.75 12.875
2000:
First Quarter $ 38.938 $ 15.875
Second Quarter 31.500 15.125
Third Quarter 20.250 11.938
Fourth Quarter 14.250 3.625
First Quarter (through March 23, 2001) 6.125 1.938
On March 23, 2001, the last reported closing price of our Common Stock was
$3.875 per share. As of March 23, 2001, there were approximately 1,089 holders
of record of our Common Stock. To date, we have neither declared nor paid any
cash dividends on shares of our Common Stock and do not anticipate doing so for
the foreseeable future.
A Registration Statement on Form S-1 (File No. 333-64619) registering 1,600,000
shares of our Common Stock, $.01 par value per share, filed in connection with
our initial public offering ("IPO"), was declared effective by the Securities
and Exchange Commission on December 17, 1998. Our primary offering of 1,400,000
shares and 200,000 shares sold by the Selling Stockholder closed on December 22,
1998. On December 23, 1998, the underwriters exercised an overallotment option
to purchase 150,000 shares from the Selling Stockholder and, on January 19,
1999, exercised an overallotment option to purchase 50,000 shares from the
Selling Stockholder and 40,000 shares from us, exercising a 240,000 share
overallotment in full. The aggregate offering price to the public was
$13,600,000 before underwriter discounts and the costs of the offerings. The
underwriters of the IPO were New York Broker, Inc. and New York Broker
Deutschland AG. The following is a summary of the gross proceeds, underwriter's
discounts and expenses, other expenses and net proceeds in connection with the
IPO.
COMPANY SELLING STOCKHOLDER TOTAL
------- ------------------- -----
Gross proceeds $12,240,000 $3,400,000 $15,640,000
Underwriter discount (979,200) (272,000) (1,251,200)
Underwriter expenses (648,984) (120,216) (769,200)
Other expenses (1,006,443) (119,900) (1,126,343)
----------- --------- -----------
Net proceeds $ 9,605,373 $2,887,884 $12,493,257
None of the above expenses were paid either directly or indirectly to our
directors, officers, general partners, or our associates, or to persons owning
more than 10% of any class of our equity securities or to our affiliates.
In December 1999, New York Broker, Inc. exercised a portion of its warrant for
140,000 shares, utilizing the net exercise feature of its warrant.
Through December 31, 2000, we had temporarily invested excess net proceeds of
the IPO in savings and money market accounts with three major financial
institutions. We allocated up to $2,500,000 of such proceeds to fund certain
strategic alliances but used approximately $1,932,000 for such alliances. The
balance of the proceeds were used as general working capital to fund internal
developmental activities and expanded operations. See "Management's Discussion
and Analysis of Financial Condition and Results of Operation - Liquidity and
Capital Resources."
In February 2000, we concluded two private placements of our Common Stock. Both
transactions occurred at purchase prices that were at a premium to the average
closing price for five days prior to the transaction date. The first transaction
netted $2,562,500 to us in exchange for 102,500 shares of our Common Stock; the
second transaction netted $1,550,000 to us in exchange for 50,000 shares of our
Common Stock. Costs related to these transactions were immaterial.
14
In March 2000, we sold 150,000 shares of voting Common Stock for $32.375 per
share through a private placement to foreign investors. In addition to the
shares issued, we issued warrants to purchase 75,000 additional shares of Common
Stock at $32.375 per share. The total net proceeds to the Company amounted to
$4,856,250. The stock was unregistered and was subject to restrictions on resale
in the United States pursuant to Regulation S promulgated under the Securities
Act of 1933, as amended.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents summary selected historical financial data of the
Company as of and for the year ended December 31, 1996, the periods ended July
3, 1997 and December 31, 1997, and the years ended December 31, 1998, 1999 and
2000 and should be read in conjunction with "Management's Discussion and
Analyses of Financial Conditions and Results of Operations" and the Financial
Statements and the notes thereto included in this Form 10-K.
SELECTED FINANCIAL DATA(1)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
PREDECESSOR SUCCESSOR
----------- ---------
PERIOD FROM PERIOD FROM
YEAR ENDED JANUARY 1 TO JULY 4 TO DECEMBER 31,
------------
DECEMBER 31, JULY 3, DECEMBER 31,
1996 1997 1997 1998 1999 2000
---- ---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Revenues:
Application services $ 2,790 $ 926 $ 420 $ 334 $ 2,554 $ 7,655
Software license agreements -- 117 117 117 1,355 4,810
-------- -------- -------- -------- -------- --------
Total revenues 2,790 1,043 537 451 3,909 12,465
-------- -------- -------- -------- -------- --------
Operating expenses:
Selling, general and administrative 1,193 693 445 1,490 6,039 11,171
Engineering and cost of sales 702 332 220 640 3,566 9,325
Research and development -- -- -- 447 666 1,173
Provision for doubtful accounts -- -- -- -- -- 2,162
-------- -------- -------- -------- -------- --------
Total operating expenses 1,895 1,025 665 2,577 10,271 23,831
-------- -------- -------- -------- -------- --------
Income (loss) from operations 895 18 (128) (2,126) (6,362) (11,366)
Other income (expenses) (15) -- 179 (65) (376) (1,110)
-------- -------- -------- -------- -------- --------
Income (loss) before tax 880 18 51 (2,191) (6,738) (12,476)
Provision for income taxes 337 5 7 -- 20 112
-------- -------- -------- -------- -------- --------
Net income (loss) $ 543 $ 13 $ 44 $ (2,191) $ (6,758) $(12,588)
Net income (loss) per share(2) $ 0.08 $ 00 $ 0.01 $ (0.30) $ (0.70) $ (1.23)
Shares used in computing net
Income (loss) per share(2) 6,967 6,967 6,967 7,289 9,590 10,216
PREDECESSOR SUCCESSOR
----------- --------------------------------------------
AS OF DECEMBER 31, AS OF JULY 3, AS OF DECEMBER 31,
1996 1997 1997 1998 1999 2000
---- ---- ---- ---- ---- ----
BALANCE SHEET DATA:
Cash and cash equivalents $ 30 $ 38 $ 22 $11,688 $ 2,592 $ 730
Working capital (deficit) 74 132 171 11,335 2,565 (871)
15
Total assets 885 1,023 974 12,885 7,988 6,963
Long-term debt -- -- -- 500 -- --
Total stockholders' equity $ 625 $ 638 $ 540 $11,769 $ 5,921 $ 3,417
(1) In connection with the Management Buyout on July 4, 1997, we have presented
our assets at fair value as of such date of the change in control and have
presented separately operations prior to the Management Buyout
(Predecessor) and subsequent to the Management Buyout (Successor). See Note
1 of Notes to Financial Statements.
(2) Net income (loss) per share is determined by dividing the net income (loss)
attributable to common stockholders by the weighted average number of
Common Stock and Common Stock equivalents outstanding during the period.
See Note 2 of Notes to Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
OVERVIEW
We were incorporated in Delaware in November 1994 as Neurotec International
Corp., a wholly-owned subsidiary of Neurotec GmbH, a German multimedia and
Internet solutions company owned by Eberhard Schoneburg, our President, Chief
Executive Officer and Chairman, and two corporate investors: a major German
retailer and an industrial conglomerate. In July 1997, Mr. Schoneburg sold all
of his shares of Neurotec GmbH to the two remaining stockholders and
contemporaneously purchased 100% of the shares of Neurotec International Corp.
(the "Management Buyout"). In August 1997, we changed our name to Artificial
Life, Inc.
As a result of the change in control of the Company in connection with the
Management Buyout, we have presented our assets and liabilities subsequent to
July 3, 1997 to reflect the purchase price paid for our stock. This treatment is
consistent with "push down" accounting as promulgated by the Securities and
Exchange Commission ("SEC"). Our results of operations for 1997 have been
separately presented to reflect the results of operations prior to the
Management Buyout, as Predecessor operations, and for the period subsequent to
the Management Buyout, as Successor operations. In Management's opinion, the
purchase price of our stock in the Management Buyout reflected our fair value at
such time.
The difference between our net book value at July 4, 1997 and the fair value has
been recorded as a reduction of our net deferred tax asset and long-term assets,
resulting in a new depreciation basis for financial statement purposes for such
assets. As of July 4, 1997, the stockholder's equity section reflects cumulative
earnings prior to the Management Buyout as paid-in capital. As a result,
accumulated deficit at December 31, 1999 reflects our results of operations only
from the date of the Management Buyout.
The only difference in accounting policies utilized in the presentation of the
Successor and Predecessor financial statements is the estimated useful lives
utilized in the depreciation of property and equipment, as described in Note 2
of Notes to Consolidated Financial Statements.
Following the Management Buyout, our management made the strategic decision to
shift our primary business focus from providing software consulting services to
the development, marketing and support of its ALife suite of SmartBot software
products. Management's decision to shift our primary business focus has had and
will likely continue to have an adverse effect on our results of operations in
the near term. We expect that an increasing percentage of our future revenues
will be derived from sales and services associated with our SmartBot software
products and that revenues from our consulting business, as a percentage of
gross revenues, will significantly decrease over time. Through 1998, our major
source of revenue has been our software consulting services, and we have
generated minimal revenue from the sale of our SmartBot software products.
However, in 1999, we realized significant software license revenue. Further,
license revenues as a percentage of overall revenues increased from 1999 to
2000. We are in the process of evaluating our current needs with regard to our
research and development requirements as we begin our transition into a more
sales and marketing oriented focus. To that end, research and development costs
are expected to flatten or decrease in 2001 as we implement our new strategy in
this area and we are currently negotiating the divestiture of a substantial
portion of Artificial Life Rus Ltd.
Sales and marketing capabilities associated with the anticipated sale of our
SmartBot products are expected to increase as a result of this transition.
However, as a result, overall operating expenses are not expected to increase
significantly going forward. We expect to continue to incur increasing losses
and generate negative cash flow from operations until at least late 2001. To the
extent that our product development, marketing and sales efforts do not result
in commercially successful products that generate significant net revenues, we
will be materially adversely affected. There can be no assurance that we will
ever generate sufficient revenues from the sale of our products or associated
services to achieve or maintain profitability.
In addition, as a result of our transition in our primary business focus from
software consulting to product development, marketing and support, our research
and development expenditures, excluding amounts included in capitalized software
development costs, increased from $0 in 1997 to $446,317 in 1998, $666,046 in
1999 and $ 1,172,975 in 2000. This increase is due to the fact that prior to
1998, all research and development expenditures were related to consulting
services for which we were reimbursed by our customers and thus, such
expenditures are included in engineering expenses in our financial statements
through December 31, 1997. Conversely, during 1999 and 2000, due to our shift in
business focus, we had the majority of our employees engaged in the research and
development of our SmartBot products.
Because we have shifted our primary business focus from software consulting to
product development, marketing and support, results of operations to date are
not reflective of our business prospects going forward. Moreover, we expect to
experience significant fluctuations in our future operating results due to a
variety of factors. Factors that may affect our operating results include the
success of product development, the amount of software
16
consulting undertaken in the future, market acceptance of our products,
frequency and timeliness of new product releases, success of strategic
alliances, the mix of product and service sales, our response to competitive
pressure and its ability to attract and retain qualified personnel. Gross profit
margins will vary from product to product and between products and services and
although we may have some ability to affect our products and services mix, our
sales mix may vary from period to period and our gross margins will fluctuate
accordingly.
RESULTS OF OPERATIONS
In fiscal year 2000, license revenues increased in the aggregate and as a
percentage of overall revenues and our client base expanded. This is consistent
with the change in our business strategy towards product development and license
sales.
Our principal source of revenue from inception through May 1998 was from the
provision of software consulting services. From inception through July 3, 1997,
the preponderance of those revenues were generated by subcontracts issued from
Artificial Life's former parent company and affiliates thereof, all of which
revenues ceased shortly after the Management Buyout. Of the non-related party
revenues, most were derived from our long-term consulting contract with our
major domestic client. This consulting contract started in late 1996 and
concluded in May 1998.
During the fourth quarter of 1997, we began evaluating the addition of software
product development to its core business of providing software consulting
services. We commenced software development plans while we continued to provide
software consulting services under our existing contracts and to seek new
consulting contracts. In the first quarter of 1998, we began software
development activities while continuing to service our one existing consulting
contract. During this time we limited our efforts in seeking new consulting
contracts as we began to shift our primary business focus to software
development. During the second quarter of 1998, when our major domestic
consulting contract ended, we focused a substantial portion of our available
resources on product development. This change in focus resulted in the
realization of our first significant software license revenue in the fiscal year
ended 1999. In 2000, license revenues increased in both real and relative terms.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Revenues: Revenues for the year ended December 31, 2000 were $12,464,847 as
compared to $3,909,076 for the year ended December 31, 1999. The increase of
$8,555,771 or 218.87% was due to increases in license and related application
services revenue generated from the expansion of our client base both in the
United States and Europe.
Engineering and Cost of Sales: These costs generally consist of salary and
payroll tax expenses, training, consulting, subcontracting and other expenses
incurred to develop and fulfill the engineering (design specifications) of the
products and services from which we derive our revenues. Engineering expenses
for the year ended December 31, 2000 were $9,324,988 as compared to $3,566,192
for the year ended December 31, 1999. The increase of $5,758,796 or 161.48% was
due to support activities related to our product installations and primarily
consulting services related thereto. The significant increases in engineering
costs in 2000 also included salaries and benefits of $2,539,000, consulting
expenses of $603,000, travel related expenses of $185,000, recruitment fees of
$269,000, amortization of capitalized software development costs of $459,000,
occupancy expense of $416,000, depreciation expense of $401,000 and other
miscellaneous expenses of $120,000.
Research & Development Expenses: Research and Development expenses are similar
in nature to engineering expenses with the exception being that they relate to
products in their initial development stage and are expected to generate revenue
at a later date. Research and Development expenses for the year ended December
31, 2000 were $1,172,975 compared to $666,046 in the year ended December 31,
1999. The increase of $506,929 or 76.11% is primarily due to costs associated
with continued product research and development related to our product line.
Significant increases were salaries and benefits of $304,000, travel related
expenses of $112,000, recruiting fees of $19,000, and occupancy expense of
$62,000.
General and Administrative Expenses: General and Administrative expenses consist
of salary and payroll tax expenses of administrative personnel, rent, and
professional fees and costs associated with employee benefits, supplies,
communications, and travel. General and Administrative expenses for the year
ended December 31, 2000 was $7,857,805 as compared to $4,055,881 for the year
ended December 31, 1999. The increase of $3,801,924 or 93.74% was due to
increases in the following: salaries and benefits of $1,491,000, travel related
costs of $432,000, consulting expense of $269,000, accounting and legal fee's of
$243,000, depreciation of $146,000, recruiting fees of $229,000, occupancy
expense of $132,000, communication expense of $184,000 and other office related
expenses of approximately $600,000.
Sales and Marketing Expenses: Sales and Marketing expenses consist of salary,
and payroll tax expenses of marketing personnel, and costs relating to marketing
materials, promotional videos, advertising, trade show related expense, and
public relation activities. Marketing expenses for the year ended December 31,
2000 were $3,312,562 compared to $1,982,694 for the year ended December 31,
1999. The increase of $1,329,868 or 67.07% was due to increases in the
following: salaries and benefits of $598,000, sales conferences and trade shows
of $399,000, travel related costs of $245,000, and recruiting fees of $85,000.
Provision for Doubtful Accounts: Provision for Doubtful Accounts is the reserve
set up for receivables whose collection is in question. Provision for Doubtful
Accounts for the year ended December 31, 2000 was $2,162,000 compared to $0 for
the year ended December 31, 1999. The increase was mainly due to the reserve set
up due to question of collectability of license fees from one customer.
Net Loss: Net Loss for the year ended December 31, 2000 was $12,588,295 as
compared to $6,758,214 for the year ended December 31, 1999. This increase of
$5,830,081 or 86.27% was due to the following factors: the continued buildup of
our infrastructure to support expected growth in the
17
United States and Europe, the provision for doubtful accounts of $2,162,000
during the fiscal year ended December 31, 2000, the increase in the equity
in net loss of joint venture of $699,494, and the increased marketing effort of
approximately another $1,300,000.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Revenues: Revenues for the year ended December 31, 1999 were $3,909,076 as
compared to $450,768 for the year ended December 31, 1998. The increase of
$3,458,308 or 767.20% is primarily due to a contract for licenses and support
entered into with a European trust.
Engineering and Cost of Sales: Engineering expenses generally consist of salary
and payroll tax expenses, training, consulting, subcontracting, and other
expenses incurred to develop and fulfill the engineering design specifications
of the products and service's from which we derive our revenue. Engineering
expenses for the year ended December 31, 1999 were $3,566,192 as compared to
$640,237 for the year ended December 31, 1998. The increase of $2,925,955 or
457.01% was due to support activities related to our product installations and
related consulting thereof. The significant increases in 1999 included salaries
and benefits of $1,312,000, consulting expenses of $515,000, travel of $190,000,
recruitment fees of $158,000, amortization of capitalized software development
costs of $250,000 and depreciation expense of $191,000.
Research & Development Expenses: Research and Development expenses are similar
in nature to engineering expenses with the exception being that they relate to
products in their initial stage and will generate revenue at a later date.
Research and Development expenses for the year ended December 31, 1999 were
$666,046 compared to $446,317 in the year ended December 31, 1998. The increase
of $219,729 or 49.23% is primarily due to costs associated with continued
product research and development related to our product line. As a result the
entire research and development increase related to an increase in salaries and
benefits. The research and development expenses in 1999, like, 1998 are net of
capitalized software development costs.
General and Administrative Expenses: General and Administrative expenses consist
of salary and payroll tax expenses of administrative personnel, rent, and
professional fees and costs associated with employee benefits, supplies,
communications, and travel. General and administrative expenses for the year
ended December 31, 1999 were $4,055,881 as compared to $1,310,875 for the year
ended December 31, 1998. The increase of $2,745,006 or 209.40% was due to
approximate increases in the following: professional fees, $1,000,000; salaries
and benefits of $840,000; travel, $200,000; with the balance mainly due to costs
associated with our worldwide infrastructure buildup.
Sales and Marketing Expenses: Sales and Marketing expenses consist of salary and
payroll tax expenses of marketing personnel, and costs relating to marketing
materials, promotional videos, advertising, trade show related expense, and
public relation activities. Marketing expenses for the year ended December 31,
1999 were $1,982,694 compared to $179,286 for the year ended December 31, 1998.
The increase of $1,803,403 or 1005.88% was due to approximate increases in the
following: $500,000 for the addition of sales personnel, $200,000 for
promotional material and packaging of products; $800,000 was related to a media
marketing campaign and costs associated with trade shows and $200,000 for the
outside consultants to help market the Company.
Net Loss: Net Loss for the year ended December 31, 1999 was $6,758,214 as
compared to $2,191,206 for the year ended December 31, 1998. This increase of
$4,567,008 or 208.42% was due to our expansion in Europe. This expansion,
including net losses of $509,000 attributable to our equity in the joint
venture, accounted for approximately one half of this increase. The increased
marketing effort represented approximately another $1,000,000.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
From inception through July 3, 1997, we funded our operations primarily through
initial equity investments in 1994 and 1995 totaling $500,000 and net income
from operations. Subsequent to July 3, 1997, we incurred operating losses in
connection with our transition from software consulting to product development,
marketing and sales. These losses have been funded to date by a private
placement of Non-Voting Common Stock of $181,367, the net proceeds of which we
received in June 1998 and a private placement of 824,000 shares of Common Stock
which raised $3,946,481 in net proceeds. In December 1998, we received
$9,302,773 net proceeds from our initial public offering. During 1999, option
holders of the Company exercised options netting the Company approximately
$1,300,000, which was received in 1999 and the first quarter of 2000. In
February 2000, we concluded two private placements of Common Stock. Both
transactions occurred at purchase prices that were at a premium to the average
closing price for five days prior to the transaction date. The first transaction
netted $2,562,500 to the Company in exchange for 102,500 common shares; the
second transaction netted $1,550,000 to the Company in exchange for 50,000
common shares. In March 2000, we concluded another private placement of Common
Stock. The transaction occurred at purchase prices that was at a premium to the
average closing price for five days prior to the transaction date. The
transaction netted $4,856,250 to the Company in exchange for 150,000 common
shares and 75,000 warrants. Costs related to all of these transactions were
immaterial. Our requirements for additional capital will depend on many factors,
including but not limited to the progress and costs associated with its research
and development activities, production costs and sales, marketing and
promotional programs, establishment of foreign operations and the levels of
revenues achieved through the sale of our SmartBot suites of products.
In 2000, the Company continued to incur losses from operations, and has
partially funded these losses through three private placements of Common Stock
totaling $8.9 million. The Company has continued to incur losses in the first
quarter of 2001 and the Company does not anticipate achieving profitability
until late 2001. The Company's continued losses have severely impacted the
Company's liquidity and cash position. The Company was unable to pay its Russian
Operation's monthly payroll liability due February 28, 2000 and may not be able
to pay its Russian operation's March payroll liability. These combined payroll
liabilities amounted to approximately $350,000. The Company is currently
negotiating the divestiture of a substantial portion of its Russian operation,
whereby these payroll liabilities may be assumed by the buyer. In order to fund
its cash needs for 2001, the Company has taken steps to reduce operating costs,
including, a reduction of staffing and the negotiation of the divestiture of a
substantial portion of its Russian operation. In addition, in 2001, the
Company's Chief Executive Officer advanced $485,000 to the Company. The advances
are expected to be converted into an interest-bearing term loan. The Company is
also continuing to pursue short-term borrowings and other direct share placement
opportunities. Despite these efforts, the Company will continue to incur losses
through the majority of 2001. Without obtaining additional financing or capital,
the Company will not have sufficient resources to fund its operations through
2001. To that end, the Company has entered into an irrevocable stock purchase
agreement with Bluefire Capital, Inc. (Bluefire), a Cayman Island Corporation,
on March 22, 2001, to provide the Company with equity financing as more fully
described below. The Company does not believe that financing available from this
equity facility will be sufficient to fund its operations through 2001. The
Company is continuing to pursue short-term borrowings and other direct share
placement opportunities to meet its anticipated liquidity shortfalls. The
Company cannot assure that it will be able to complete this or any other
financing or that such financings will be adequate to meet the Company's needs.
These factors create a substantial doubt about the Company's ability to
continue as a going concern. The accompanying financial statements do not
include any adjustments that might come from the outcome of this uncertainty.
Financing Arrangement with Bluefire
Bluefire has committed to purchase up to $13,000,000 of Common Stock of the
Company over the course of thirty-six months after the effective date of the
Company's registration statement in connection with the shares to be sold. Such
registration statement must be filed by May 21, 2001 and be declared effective
generally within 120 days of the date of the filing of the registration
statement. There will be a minimum draw down requirement of $500,000 over the
life of the commitment. The Company will be subject to a maximum penalty of
$250,000 if the minimum draw down is not made. The Company will have the sole
option to set the date of each draw down and the portion of the Subscription to
be drawn down (each, a "Draw Down"), subject to the following conditions:
a) Each Draw Down shall be for a maximum that will be determined according
to the set formula equal to 15% of the volume weighted average price
for our Common Stock for the 40 consecutive trading days immediately
prior to the Draw Down date multiplied by the total trading volume
during that 40-day period.
b) There will be a minimum of 6 trading days between Draw Downs and only
one Draw Down during the 21-day pricing period relating to each Draw
Down is allowed;
c) At each Draw Down we may specify a threshold price representing the
lowest price at which we will sell our Common Stock;
d) The registration statement, registering the Common Stock must be
effective.
The purchase price shall be set at an underwriter discount ("Discount") to the
market price on the day a Draw Down is made. The Discount shall be set at 14%
in the event the market price on the Draw Down date is less than $8 per share.
The Discount shall be adjusted to 12% in the event the market price on a Draw
Down date is greater than $8 per share but less that $12. The Discount will be
adjusted to 10% in the event the market price on a Draw Down date is greater
than $12.
Bluefire must also increase the funding commitment to $25 million upon the one-
year anniversary of the effective date of the registration, and only upon the
achievement of several conditions in the Company's stock performance.
On March 23, 2001, we also issued warrants to Bluefire to purchase up to 150,000
shares of our Common Stock at $3.82 per share. The term of the warrants are
three years, commencing six months after the date of the agreement. The
warrants provide Bluefire with anti-dilutive rights, among others, and provide
for a cashless exercise at the option of Bluefire.
The agreement also provides for certain restrictions on our participation in any
other standby equity-based credit facility. Under the agreement, in the event
that we sell securities at a discount to the then current market price and grant
the purchaser registration rights in connection with the securities offered,
Bluefire would be entitled to notice and negotiation rights with respect to such
a sale. We may not make a Draw Down to such an extent that, after such Draw
Down, Bluefire's beneficial holdings in our Common Stock after such Draw Down
exceeds 9.9% of the then total outstanding shares of the Company's Common Stock.
The Company has agreed not to execute any merger or consolidation unless the
Company's successor agrees to assume the obligations under this agreement.
18
OTHER
We lease office and other space and certain office equipment under various
non-cancelable leases. Minimum annual lease payments, exclusive of additional
operating costs, for the years ended December 31, 2001, 2002, 2003, 2004, 2005
and 2006 are approximately $1,125,000, $1,138,000, $1,138,000, $908,000,
$573,000 and $118,000, respectively.
We have an employment agreement with our President, Chief Executive Officer and
Chairman. The agreement is three years in length, expiring in September 2001,
and provides for a minimum base salary. The agreement includes severance
payments under certain conditions of approximately 300% of annual compensation.
In addition, our President, Chief Executive Officer and Chairman is entitled to
receive an annual incentive bonus of 3% of the our profits from operations.
In May 1999, we entered into a joint venture with an international retailer in
the field of e-commerce. The main focus of this joint venture is to sell
consumer goods over the Internet using deep discounts and high volume, both in
terms of transactions and web visits. As part of the transaction, we licensed
our SmartBot technology to the joint venture. In addition, we provided products
and software development and consulting services to the joint venture and
receive payments therefor. The partner in the joint venture will be responsible
for using its purchasing relationships to obtain certain consumer products which
will be sold on the joint venture's e-commerce Website. We allocated up to
$2,150,000 of the proceeds from our initial public offering to purchase our 50%
interest in this joint venture and to meet our obligations to contribute
additional capital to the joint venture. As of December 31, 2000, we had made a
total investment of $1,932,169 in the joint venture.
We have incurred losses for income tax purposes for fiscal years 1998, 1999, and
2000. These losses will be available to carry forward and reduce income taxes,
if any, in future periods.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
19
We maintain our cash and cash equivalents in checking, savings, and money market
accounts. Approximately 72% of these deposits are denominated in U.S. dollars.
Approximately 28% of these deposits are denominated in Euros. Deposits in both
fixed rate and floating rate interest accounts carry a degree of interest rate
risks. Fixed rate deposits may be adversely impacted due to a rise in interest
rates, while floating rate deposits may produce less income than expected if
interest rates fall. Due in part to these factors, our future interest income
may fall short of expectations due to changes in interest rates. The cash
denominated in non-U.S. currency units is subject to exchange risks as well as
interest rate risks. We believe that a hypothetical 10% increase or decrease in
either interest or exchange rates, however, would not have a material adverse
effect on our financial condition. We do not hold derivative financial
instruments, derivative commodity investments or other financial investments or
engage in foreign currency hedging or other transactions that expose us to
material market risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated Financial Statements and supplementary data, including financial
statement schedules, appear at pages F-1 through S-1 of this report on
Form 10-K.
Index to Consolidated Financial Statements:...........................
Independent Auditors Report...........................................F-1
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1999 and
December 31, 2000.....................................................F-2
Consolidated Statements of Operations for the years ended
December 31, 1998, 1999 and 2000......................................F-3
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 1998, 1999 and 2000......................F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1999 and 2000......................................F-5
Notes to Consolidated Financial Statements............................F-6 - F-23
Schedule 2 - Valuation and Qualifying Accounts........................S-1
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS. The following table sets forth certain information regarding the
directors of the Company as of December 31, 2000:
NAME AGE POSITION
Eberhard Schoneburg........ 44 Chairman of the Board, President,
Chief Executive Officer and Treasurer
Rolf Levenhagen............ 54 Director, President-Sales and Marketing
Gerhard Zink............... 40 Director
Felix Widmer............... 50 Director
EBERHARD SCHONEBURG has been President and a member of the Board of Directors of
the Company since November 1994. He was Chief Executive Officer from November
1994 to May 1996 and from October 1997 to the present. Mr. Schoneburg has been
the Chairman of the Board of Directors of the Company since the founding of the
Company. The Company was founded in November 1994 as Neurotec International
Corp., a wholly owned subsidiary of Neurotec GmbH, a German multimedia and
Internet solutions company owned by Mr. Schoneburg and two corporate investors:
a major German retailer and an industrial conglomerate. Neurotec GmbH was part
of the Neurotec Group, a group of high tech companies founded in
20
Germany by Mr. Schoneburg in 1993. In 1997, he sold all of his shares in
Neurotec GmbH to the remaining stockholders and contemporaneously purchased 100%
of the shares of the Company from Neurotec GmbH. From 1989 to 1994 Mr.
Schoneburg was a professor for industrial applications of artificial
intelligence at Fachhochschule Furtwangen, Germany. From 1988 to 1993, he was
the Chairman of the BIT Group, a group of five German high tech companies which
he founded in 1988. Mr. Schoneburg was awarded the First Prize of the Berlin
Innovation Award in 1990 for the development of the First European Neural
Compiler and again in 1992 for the development of an expert system for detecting
chemical hazards for Procter and Gamble. He has published five course books on a
wide variety of topics such as computer viruses, neural networks, evolution
strategies and genetic programming and over 60 research papers on related
topics. He is also a member of the jury of the Golden Award of Montreux.
ROLF LEVENHAGEN was appointed by the Board of Directors in November 2000 to fill
the vacancy created by Mr. Elmar Wohlgensinger's resignation in February 2000.
Mr. Levenhagen is in charge of global sales and marketing for the Company and
member of the Board of Directors. Since January 1995, Mr. Levenhagen has been
the Executive Partner and Managing Director of Qnet Systems GmbH, headquartered
in Kronberg, Germany. Prior to joining Qnet, he was Managing Partner of ITEM
Information Technology & Management GmbH. ITEM is a distributor of
communications systems for the United States market. Mr. Levenhagen is also the
former Managing Director of AICORP GmbH, Bad Homburg. He established the German
subsidiary of this American company specializing in knowledge-based expert
systems, and quickly led the company to its success in that market. Finally, Mr.
Levenhagen started his professional career at IBM Deutschland GmbH. During his
eleven years at IBM he contributed, among other areas, to customer service,
software development, marketing, and the creation of the international bank
information system S.W.I.F.T. He was also managing distribution for CINCOM, and
contributed substantially to the successful introduction of relational database
management technology and NET/MASTER software into the German market.
GERHARD ZINK was appointed by the Board of Directors in August 2000 to fill the
vacancy created by Mr. Bruno Gabriel's resignation from the Board of Directors
in November 2000. Mr. Zink is the founder and principal of Zink Consulting
Group, Bad Homburg, Germany, focusing on design, implementation and execution of
strategic business initiatives for both start-ups and established firms focusing
on the financial services, healthcare and entertainment industries. Mr. Zink
founded the Zink Consulting Group in 1993. Prior to that, Mr. Zink held various
positions in the financial services and banking industry. Mr. Zink holds a
degree in Economics from the University of Freiburg.
FELIX WIDMER was appointed by the Board of Directors in March 2000 to fill the
vacancy created by Mr. Hartmut Bergmann's resignation from the Board in February
2000. He has worked for Widmer Management, a consulting firm he founded in
Switzerland, since 1997. Prior to that he worked at Guebelin Ltd/Guebelin Inc.
of Lucerne, Switzerland and New York, NY from 1972 to 1996 in a variety of
capacities, including Executive Vice President, Vice President and Director of
Finance and Administration. Previously he worked for the Federal Tax Authority
of Switzerland.
EXECUTIVE OFFICERS. The following table sets forth certain information regarding
the executive officers of the Company as of December 31, 2000:
NAME AGE POSITION
Eberhard Schoneburg........ 44 Chairman of the Board, President,
Chief Executive Officer
Rolf Levenhagen............ 54 Director, President-Sales and
Marketing
Robert Pantano............. 40 Chief Financial Officer
Robert Pantano, the Company's Chief Financial Officer, joined the Company in
April 1995 as an accountant, was appointed Controller and Director of Human
Resources in 1996 and was promoted to his present position in September 1997.
From 1993 until joining the Company, Mr. Pantano worked as the Controller and
General Manager of Intertech International Corp., an international engineering
firm. From 1990 to 1993, he was a Principal with Global Vision International, an
international export trade consulting firm specializing in central and eastern
Europe. Mr. Pantano holds a B.S. in Accountancy from Bentley College.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE. Our executive officers
and directors are required under Section 16(a) of the Exchange Act to file
reports of ownership of Company securities and changes in ownership with the
Securities and Exchange Commission. Copies of those reports must also be
furnished to the Company. Based solely on a review of the copies of reports
furnished to us and written
21
representations that no other reports were required, we believe that during 2000
our executive officers and directors complied with all applicable Section 16(a)
filing requirements except: Mr. Zink, one of our directors, filed a late Form 3
reporting his lack of beneficial ownership of any securities issued by us upon
his becoming a director, for which a Form 3 was due on November 10, 2000; and
Mr. Widmer, one of our directors, filed a late Form 3 reporting his beneficial
ownership of 6,000 shares of our common stock and options to purchase 10,000
shares of our common stock upon his becoming a director, for which a Form 3 was
due on April 10, 2000.
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION. The following tables set forth certain information with
respect to compensation paid or accrued for services rendered to us in all
capacities for the fiscal year ended December 31, 2000 by our Chief Executive
Officers and our four other most highly compensated executive officers whose
salary and bonus exceeded $100,000 (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM COMPENSATION
------------------- ----------------------
OTHER ANNUAL SECURITIES
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS ($) COMPENSATION ($) UNDERLYING OPTIONS
---- --------- --------- --------------- ------------------
Eberhard Schoneburg(1)............. 2000 $267,554 0 $ 0 0
President and Chief 1999 263,538 0 0 300,000
Executive Officer 1998 240,414 0 0 0
Robert Pantano..................... 2000 $163,788 $ 25,000 (2) $ 2,250 (3) 0
Chief Financial Officer 1999 121,923 0 0 61,388
1998 100,080 0 0 41,442
Klaus Kater (4).................... 2000 $127,132 0 $17,800 (5) 0
1999 121,923 0 0 61,388
1998 57,692 0 0 41,442
Manuel Ebner (6)................... 2000 149,930 0 0 0
Chief Executive Officer- 1999 0 0 0 80,000
Artificial Life Schweiz AG
Bruno Gabriel (7).................. 2000 130,457 0 178,005 (8) 0
Chief Executive Officer- 1999 216,496 0 0 200,000
Artificial Life Schweiz AG
Rolf Levenhagen................... 2000 90,833 100,000 (9) 0 0
-------------------------------------------------------------------------------------------------------------
(1) Mr. Schoneburg assumed the position of Chief Executive Officer in October
1997.
(2) Consists of $25,000 merit-based bonus paid to Mr. Pantano for the fiscal
year 2000.
(3) Consists of $2,250 in matching funds the Company contributed to Mr.
Pantano's account under the Company's 401(K) plan.
(4) Mr. Kater became the Company's Chief Technology Officer in September 1997,
but did not have a total compensation which exceeded $100,000 in the fiscal
year ended December 31, 1998. Mr. Kater resigned from his Chief Technology
Officer position effective June 30, 2000 and is currently a Project Manager
in Artificial Life Schweiz AG.
(5) Consists of $17,800 of relocation expenses for which the Company
reimbursed Mr. Kater.
(6) Mr. Ebner joined the Company in February 2000 as Head of Business
Development and Strategy for Artificial Life Schweiz AG (then known as
"Artificial Life Europe AG"). Mr. Ebner was appointed to Chief Executive
Officer of Artificial Life Schweiz, AG in August 2000.
(7) Mr. Gabriel became Chief Executive Officer of Artificial Life Schweiz AG
(then known as "Artificial Life Europe AG") in October 1998. Mr. Gabriel's
total compensation in 1998 amounted to $173,537. He resigned this position
during the fiscal year ended December 31, 2000. Prior to that in 1998, Mr.
Gabriel provided services to the Company as an independent consultant. The
Company has currently engaged Mr. Gabriel as an independent consultant for
an additional two year term expiring in August 2002.
(8) Consists of $178,005 of severance pay, of which $53,825 was paid to Mr.
Gabriel and $124,180 was accrued and remains payable to him.
(9) Consists of the Company's payment to Mr. Levenhagen of a $100,000 advance
against his commission on worldwide sales.
OPTION GRANTS IN LAST FISCAL YEAR. We did not grant options to any Named
Executive Officer during the fiscal year ended December 31, 2000.
OPTION EXERCISES.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS
SHARES FISCAL YEAR-END (#) AT FISCAL YEAR-END ($)
ACQUIRED ON VALUE -------------------------- --------------------------
NAME EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
------------ ------------ ----------- ------------- ----------- -------------
Eberhard Schoneburg............ 0 0 100,000 200,000 0 0
Robert Pantano(2).............. 14,288 399,207 21,388 40,000 0 0
Klaus Kater(3)................. 33,472 935,208 21,388 40,000 0 0
Manuel Ebner................... 0 0 26,667 53,333 0 0
Bruno Gabriel.................. 0 0 0 0 0 0
Rolf Levenhagen................ 0 0 0 0 0 0
(1) The range of the exercise prices for outstanding options held by the named
individuals is $14.50 to $17.94 per share.
(2) Mr. Pantano exercised an option to purchase 16,442 shares of Common Stock
utilizing a net exercise feature, resulting in the issuance of 14,288 shares
of Common Stock.
(3) Mr. Kater exercised options to purchase an aggregate of 41,442 shares of
Common Stock utilizing a net exercise feature, resulting in the issuance of
33,472 shares of Common Stock.
DIRECTOR COMPENSATION. Directors who are not employees of the Company receive
$3,000 for each meeting of the board of directors attended and reimbursed for
reasonable out-of-pocket expenses incurred in attending such meetings.
Non-employee directors are also eligible for participation in our 1998 Equity
Incentive Plan, and we may, in the future grant non-qualified stock options to
non-employee directors as an incentive to join or remain on the board of
directors.
EMPLOYMENT AGREEMENTS. Under an Executive Employment Agreement dated July 1,
1998, and amended and restated as of September 1, 1998, the Company has agreed
to employ Eberhard Schoneburg as President, Chief Executive Officer and Chairman
of the Board of Directors for a period of three years at an initial annual base
salary of $240,000 plus an incentive bonus equal to 3% of the Company's income
from operations. The Agreement also provides that the annual base salary will
increase as determined by the Board but at not less than 10% per year. If Mr.
Schoneburg is terminated without cause (including a failure to renew the
agreement) or if he terminates his employment for "good reason" (as defined in
the agreement), he will be entitled to receive a lump sum payment of one to
three times (depending upon whether such termination occurs before or after a
change of control of the Company) the sum of (i) his base salary plus (ii) the
greater of the average of his two most recent annual bonuses or his annual bonus
payable in the year of termination. The Agreement also contains a non-compete
and non-solicitation provision which covers the longer of the term of his
employment or any time period during which he serves as a director of the
Company, plus a period of one year thereafter.
23
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. Mr. Levenhagen,
President, Marketing and Sales, and Mr. Widmer, a non-employee directors,
constitute the Company's Compensation Committee. Mr. Levenhagen was appointed
to the Compensation Committee to fill the vacancy created by Mr. Elmar
Wohlgensinger's resignation in February 2000.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of March 23, 2001 by (i) each person
known by the Company to own beneficially 5% or more of the Common Stock; (ii)
each Named Executive Officer; (iii) each Director of the Company and each
Director Nominee and (iv) all current Directors and executive officers of the
Company as a group.
SHARES OF COMMON STOCK
BENEFICIALLY OWNED (1)
NAME AND ADDRESS OF BENEFICIAL OWNER (2) SHARES PERCENT(3)
Eberhard Schoneburg (4)................................................... 5,667,377 54.5%
Rolf Levenhagen .......................................................... 500 *
Felix Widmer (5).......................................................... 3,333 *
Gerhard Zink.............................................................. 0 *
Rolf Levenhagen........................................................... 0 *
Robert Pantano (6)........................................................ 41,338 *
Klaus Kater (7)........................................................... 74,810 *
Manuel Ebner (8).......................................................... 26,667 *
Bruno Gabriel............................................................. 729,426 7.1%
All current directors and executive officers as a group (8 persons) (9)... 6,543,451 62.2%
* Less than 1%
(1) Shares of Common Stock that an individual or group has the right to acquire
within 60 days of March 23, 2001, pursuant to the exercise of options are deemed
to be outstanding for the purposes of computing the percentage ownership of such
individual or group, but are not deemed to be outstanding for the purpose of
computing the percentage ownership of any other person shown in the table.
Except as indicated in footnotes to this table, the Company believes that the
beneficial owners named in this table have sole voting and investment power with
respect to all shares of Common Stock shown to be beneficially owned by them
based on information provided to the Company by such beneficial owners.
(2) The address of all persons who are executive officers or directors of the
Company is: c/o Artificial Life, Inc., Four Copley Place, Suite 102, Boston,
Massachusetts, 02116.
(3) Percentage of ownership is based on 10,303,469 shares of Common Stock
outstanding as of March 23, 2001 and all stock options which are exercisable
within 60 days of March 23, 2001 for the respective individual(s) listed.
(4) Includes 100,000 shares subject to stock options which are exercisable
within 60 days of March 23, 2001.
(5) Includes 3,333 shares subject to stock options which are exercisable within
60 days of March 23, 2001.
(6) Includes 41,388 shares subject to stock options which are exercisable
within 60 days of March 23, 2001.
(7) Includes 41,388 shares subject to stock options which are exercisable within
60 days of March 23, 2001.
(8) Includes 26,667 shares subject to stock options which are exercisable within
60 days of March 23, 2001.
(9) Includes 212,776 shares subject to stock options which are exercisable
within 60 days of March 23, 2001.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company was founded in November 1994 as Neurotec International Corp., a
wholly-owned subsidiary of Neurotec GmbH, a German multimedia and Internet
solutions company owned by Eberhard Schoneburg, Artificial Life's President,
Chief Executive Officer and Chairman, and two corporate investors: a major
German retailer and an industrial conglomerate. In July 1997, Mr. Schoneburg
sold all of his shares of Neurotec GmbH to the remaining two stockholders for
approximately $1,027,000 and contemporaneously purchased 100% of the shares of
the Company (Neurotec International Corp.) from Neurotec GmbH, for approximately
$500,000. See "Note 1 of Notes to Financial Statements."
On June 29, 1998, Mr. Schoneburg loaned the Company $500,000 at an annual
interest rate of 10%. The full amount of the loan, including principal and all
accumulated interest thereon, was originally due and payable on January 1, 2000.
The due date of the note was extended to April 30, 2000 and repaid on June 6,
2000.
Prior to the date of the Management Buyout, Mr. Schoneburg received fixed
compensation payments of $5,000 each month with additional compensation, if any,
determined by the former parent based on the level of activities dedicated by
Mr. Schoneburg to the Company versus other subsidiaries of the former parent.
Beginning January 1, 1998, Mr. Schoneburg's salary was deferred. During the time
that his salary was deferred, the Company made net advances to Mr. Schoneburg of
approximately $273,000 for living and personal expenses. On September 25, 1998
the Company paid Mr. Schoneburg a total of $175,385 representing 38 weeks of
deferred salary. Mr. Schoneburg used the after tax proceeds of this payment to
repay a portion of the advances made to him during the deferral period. During
the period from September 26, 1998 to December 31, 1999, the Company advanced
Mr. Shoneburg approximately $547,525 for living and personal expenses. Mr.
Shoneburg repaid or applied against amounts owed him a total of $626,893. The
balance due the Company as of December 31, 1999 was $43,479.
Prior to the time that they became directors of the Company in September 1998,
Bruno Gabriel and Elmar Wohlgensinger provided consulting services to the
Company. During that time, Messrs. Gabriel and Wohlgensinger advised the Company
on strategic and logistical issues regarding the establishment of business
opportunities outside the United States. In consideration for such services, in
1998, Mr. Gabriel was paid or had accrued an aggregate of $173,537 by the
Company and on June 30, 1998, Messrs. Gabriel and Wohlgensinger were granted
options to purchase 184,426 and 163,934 shares of Common Stock, respectively.
These options were exercisable immediately for a period of one year at an
exercise price of $3.66 per share and were exercised in fiscal year 1999.
24
In June 1999, the Company acquired 51% of the outstanding stock of Cybermind
Ventures, Inc. ("Cybermind") for $75,000 from two of the Company's stockholders,
Eberhard Schoneburg and Cybermind Interactive AG. Cybermind was inactive with a
net loss in 1999 through the date of acquisition of $5,520. At the time of the
acquisition, Cybermind's name was changed to Artificial Life Ventures, Inc. In
November 1999, the Company acquired the remaining 49% of the outstanding stock
of Artificial Life Ventures, Inc. from Cybermind Interactive AG. The Company
acquired this stock for $75,000 cash and the issuance of 5,000 stock options at
an exercise price of $14.50 per share. The options are valued at $25,000 and
have a three year life and vest in equal amounts on the first, second and third
anniversary of the grant date. Goodwill recognized in connection with this
acquisition amounted to approximately $86,000, and is being amortized over three
years.
In June 2000, we advanced $100,000 against future commissions on worldwide sales
to Mr. Rolf Levenhagen, a Member of our Board of Directors and the Company's
President - Sales and Marketing.
In September 2000, Robert Pantano, our Chief Financial Officer purported to
exercise an option to purchase 25,000 shares of our Common Stock by delivering
to us, a promissory note in the amount of $162,500. As Mr. Pantano did not
deliver proper notice of exercise of this option, the Company never in fact
issued the shares of Common Stock underlying the option to Mr. Pantano in
connection with this purported exercise. In December 2000, in light of the fact
that no payments had been due or tendered from Mr. Pantano under the note and
the fact that the then current market value of the stock was $186,000, the
Company and Mr. Pantano agreed to rescind this purported exercise.
Effective August 31, 2000, the Chief Executive Officer of Artificial Life
Schweiz, a director and greater than five percent stockholder of the Company
resigned his position as Chief Executive Officer and received a severance
payment of 300,000 Swiss Francs (approximately $180,000 US). This individual's
term on the Company's Board of Directors expired on October 31, 2000 and he did
not stand for re-election. As of December 31, 2000, $124,180 was still unpaid
and included in accounts payable. On the date of the former employee's
resignation, the Company also entered into a consulting agreement with the
former employee. The agreement provides for commissions to the former employee
based on sales production, and a monthly payment of 18,000 Swiss Francs
(approximately $11,000) for two years from the date of the Agreement.
In 2001, our President, Chief Executive Officer and Chairman advanced
$485,000 to the Company. The advances are expected to be converted into an
interest-bearing term note.
PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K.
a. Documents filed as part of this Report:
1. Financial Statements
See "Index to Financial Statements" at Item 8 to this Annual Report on
Form 10-K.
2. Financial Statement Schedules
b. Reports on Form 8-K
We filed a Current Report on Form 8-K on December 8, 2000 that concerned
our publicly disseminated press release, dated December 4, 2000, announcing a
fourth quarter charge to our earnings. We did not file any financial statements
with this Current Report on Form 8-K.
c. Exhibits
The following is a list of exhibits filed as part of this Annual Report
on Form 10-K.
EXHIBIT NO. DESCRIPTION
*3.1 Amended and Restated Certificate of Incorporation of the Company. Filed
as Exhibit 3.1 to the Company's Registration Statement on Form S-1
(File No. 333-64619) and incorporated herein by reference.
*3.2 Restated Bylaws of the Company. Filed as Exhibit 3.2 to the Company's
Registration Statement on Form S-1 (File No. 333-64619) and
incorporated herein by reference.
*4.1 Specimen Common Stock Certificate for share of Common Stock of the
Company. Filed as Exhibit 4.1 to the Company's Registration Statement
on Form S-1 (File No. 333-64619) and incorporated herein by reference.
*4.2 Form of Representatives' Warrant issued by the Company to underwriters
New York Broker, Inc. and New York Broker Deutschland AG upon
consummation of the Company's initial public offering. Filed as Exhibit
4.2 to the Company's Registration Statement on Form S-1 (File No.
333-64619) and incorporated herein by reference.
*10.1 Form of the Company's Employee Confidentiality and Inventions
Agreement. Filed as Exhibit 10.1 to the Company's Registration
Statement on Form S-1 (File No. 333-64619) and incorporated herein by
reference.
*10.2 Form of Company's Advisory Board Confidentiality and Inventions
Agreement. Filed as Exhibit 10.2 to the Company's Registration
Statement on Form S-1 (File No. 333-64619) and incorporated herein by
reference.
*10.3 Amended and Restated Executive Employment Agreement between the Company
and Eberhard Schoneburg, dated as of September 1, 1998. Filed as
Exhibit 10.3.1 to the Company's Registration Statement on Form S-1
(File No. 333-64619) and incorporated herein by reference.
*10.4 Employment Agreement between the Company and Robert Pantano, dated as
of May 1, 1998. Filed as Exhibit 10.4 to the Company's Registration
Statement on Form S-1 (File No. 333-64619) and incorporated herein by
reference.
25
*10.5 Employment Agreement between the Company and Klaus Kater, dated as of
May 1, 1998. Filed as Exhibit 10.5 to the Company's Registration
Statement on Form S-1 (File No. 333-64619) and incorporated herein by
reference.
*10.6 Lease Agreement, dated February 6, 1995, between the Company and Copley
Place Associates Nominee Corporation. Filed as Exhibit 10.6 to the
Company's Registration Statement on Form S-1 (File No. 333-64619) and
incorporated herein by reference.
*10.7 Lease Amendment No. 1, dated July 27, 1995, between the Company and
Copley Place Associates Nominee Corporation. Filed as Exhibit 10.7 to
the Company's Registration Statement on Form S-1 (File No. 333-64619)
and incorporated herein by reference.
*10.8 Lease Amendment No. 2, dated February 27, 1997, between the Company and
Copley Place Associates Nominee Corporation. Filed as Exhibit 10.8 to
the Company's Registration Statement on Form S-1 (File No. 333-64619)
and incorporated herein by reference.
*10.9 Consortium Agreement, dated October 10, 1995, between the Company and
Massachusetts Institute of Technology. Filed as Exhibit 10.9 to the
Company's Registration Statement on Form S-1 (File No. 333-64619) and
incorporated herein by reference.
*10.10 1998 Equity Incentive Plan. Filed as Exhibit 10.10 to the Company's
Registration Statement on Form S-1 (File No. 333-64619) and
incorporated herein by reference.
*10.11 Form of Subscription Agreement, dated June 1998, between the Company,
Eberhard Schoneburg and the purchaser of 1,000,000 shares of Common
Stock and the purchasers of an aggregate of 130,000 shares of
Non-Voting Common Stock. Filed as Exhibit 10.11 to the Company's
Registration Statement on Form S-1 (File No. 333-64619) and
incorporated herein by reference.
*10.12 Form of Subscription Agreement dated September 23, 1998 between the
Company and the purchasers of 824,000 shares of Common Stock. Filed as
Exhibit 10.12 to the Company's Registration Statement on Form S-1 (File
No. 333-64619) and incorporated herein by reference.
*10.13 Form of Amendment and Confidential Offering Supplement, dated September
23, 1998. Filed as Exhibit 10.13 to the Company's Registration
Statement on Form S-1 (File No. 333-64619) and incorporated herein by
reference.
*10.14 Lease Agreement dated March 30, 1999 between the Company (Artificial
Life Deutschland A.G.) and Internationales Immobilien. Filed as Exhibit
10.14-CE to the Company's Annual Report on Form 10-K/A for the fiscal
year ended December 31, 1999 and incorporated herein by reference.
*10.15 Lease Agreement dated December 31, 1999 between the Company (Artificial
Life Rus) and the Association of Concert Performers in the Russian
Federation (ARENDODATEL). Filed as Exhibit 10.15-CE to the Company's
Annual Report on Form 10-K/A for the fiscal year ended December 31,
1999 and incorporated herein by reference.
*10.16 Lease Agreement dated October 1, 1999 between the Company (Artificial
Life Solutions) and Vierwaldstatter Bereiligungen AG. Filed as Exhibit
10.16-CE to the Company's Annual Report on Form 10-K/A for the fiscal
year ended December 31, 1999 and incorporated herein by reference.
*10.17 Lease Agreement dated July 1, 1999 between the Company (Artificial Life
Solutions) and Vierwaldstatter Bereiligungen AG. Filed as Exhibit
10.17-CE to the Company's Annual Report on Form 10-K/A for the fiscal
year ended December 31, 1999 and incorporated herein by reference.
*10.18 Lease Agreement dated August 1, 1999 between the Company (Artificial
Life Solutions) and Charles Barrier Immobilien. Filed as Exhibit
10.18-CE to the Company's Annual Report on Form 10-K/A for the fiscal
year ended December 31, 1999 and incorporated herein by reference.
*10.19 A June 1999 Stock Purchase Agreement between the Company and Eberhard
Schoneburg for the Purchase of 490,000 Shares of Cybermind Ventures,
Inc. Filed as Exhibit 10.19-CE to the Company's Annual Report on Form
10-K/A for the fiscal year ended December 31, 1999 and incorporated
herein by reference.
*10.20 A June 1999 Stock Purchase Agreement between the Company and Cybermind
Interactive AG for the Purchase of 20,000 Shares of Cybermind Ventures,
Inc. Filed as Exhibit 10.20-CE to the Company's Annual Report on Form
10-K/A for the fiscal year ended December 31, 1999 and incorporated
herein by reference.
26
*10.21 A Member 1999 Stock Purchase Agreement between the Company and
Cybermind Interactive AG for the Purchase of 490,000 Shares of
Cybermind Ventures, Inc. Filed as Exhibit 10.21-CE to the Company's
Annual Report on Form 10-K/A for the fiscal year ended December 31,
1999 and incorporated herein by reference.
*10.22 Common Stock Purchase Agreement, dated as of March 22, 2001, by and
between the Registrant and Bluefire Capital, Inc. Filed as Exhibit 10.1
to the Company's Current Report on Form 8-K, filed on March 27, 2001
and incorporated herein by reference.
*10.23 Stock Purchase Warrant dated as of March 23, 2001. Filed as Exhibit
10.2 to the Company's Current Report on Form 8-K, filed on March 27,
2001 and incorporated herein by reference.
*10.24 Registration Rights Agreement, dated as of March 23, 2001, between
Bluefire Capital, Inc. and the Registrant. Filed as Exhibit 10.3 to the
Company's Current Report on Form 8-K, filed on March 27, 2001 and
incorporated herein by reference.
10.25 Rental Contract between the Company and the Committee for Managing City
Property of St. Petersburg, dated as of May 18, 2000.
10.26 Employment Agreement between the Company and Rolf Levenhagen, dated as
of November 1, 2000.
10.27 Termination Agreement between the Company and Bruno Gabriel, dated as
of August 24, 2000.
10.28 Agreement between the Company and Bruno Gabriel, dated as of August 24,
2000.
10.29 Lease Amendment No. 3, dated as of December 4, 2000 by and between the
Company and Copley Place Associates, LLC.
21. Subsidiaries of the Company.
23. Consent of Wolf & Company, P.C.
*Previously filed.
SIGNATURES
Pursuant to the requirements of Section 31 or 15(d) of the Securities Exchange
Act of 1934, the Registrant certifies that it has duly caused this Annual Report
on Form 10-K to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Boston, Commonwealth of Massachusetts, on March 29,
2000.
ARTIFICIAL LIFE, INC.
By: /s/ Eberhard Schoneburg
Eberhard Schoneburg
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report on Form 10-K has been signed by the following persons in the capacities
and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Eberhard Schoneburg President, Chief Executive March 29, 2001
----------------------- Officer and Director (Principal
Eberhard Schoneburg executive officer)
/s/ Robert Pantano Chief Financial Officer (Principal March 29, 2001
----------------------- financial and accounting officer)
Robert Pantano
/s/ Rolf Levenhagen Director March 29, 2001
-----------------------
Rolf Levenhagen
/s/ Felix Widmer Director March 29, 2001
-----------------------
Felix Widmer
/s/ Gerhard Zink Director March 29, 2001
-----------------------
Gerhard Zink
/s/ Felix Widmer Director March 29, 2001
-----------------------
Felix Widmer
27
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Artificial Life, Inc.
Boston, Massachusetts
We have audited the accompanying consolidated balance sheets of Artificial
Life, Inc. as of December 31, 1999 and 2000 and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
each of the three years in the period ended December 31, 2000. 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
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Artificial
Life, Inc. as of December 31, 1999 and 2000, and the consolidated results of
operations and cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States of America.
As further discussed in Note 1, Artificial Life, Inc. has suffered
recurring losses and negative cash flows from operations. These factors, among
others, as described in Note 1, create 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 1. The accompanying financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
Wolf & Company, P.C.
Boston, Massachusetts
March 23, 2001
F-1
ARTIFICIAL LIFE, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1999 and 2000
1999 2000
---------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents $ 2,592,388 $ 729,696
Accounts receivable, trade, net of allowance for doubtful
accounts of $0 in 1999 and $2,152,070 in 2000 1,094,430 1,315,074
Accounts receivable, affiliate 346,172 207,766
Due from officer/stockholders 51,708 53,773
Refundable foreign taxes 121,444 81,949
Prepaid expenses and other current assets 426,498 287,381
---------------- ---------------
Total current assets 4,632,640 2,675,639
---------------- ---------------
Property and equipment:
Computer equipment 1,743,792 3,290,916
Furniture and fixtures 499,211 806,885
Leasehold improvements 95,381 642,445
Office equipment 166,087 401,602
---------------- ---------------
2,504,471 5,141,848
Less accumulated depreciation and amortization 638,749 1,719,994
---------------- ---------------
1,865,722 3,421,854
---------------- ---------------
Other assets:
Costs in excess of fair value of net assets acquired, net of
accumulated amortization of $5,306 in 1999 and $33,493 in 2000 99,520 52,482
Capitalized software development costs, net of accumulated
amortization of $246,737 in 1999 and $964,140 in 2000 1,119,356 500,984
Investment in unconsolidated subsidiaries 186,186 250,000
Deposits and other assets 84,887 62,046
---------------- ---------------
1,489,949 865,512
---------------- ---------------
TOTAL ASSETS $ 7,988,311 $ 6,963,005
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 980,979 $ 2,169,086
Note payable - officer/stockholder 500,000 --
Deferred revenue -- 289,554
Accrued expenses 586,283 1,087,587
---------------- ---------------
Total current liabilities 2,067,262 3,546,227
---------------- ---------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized, no shares issued and outstanding -- --
Common stock, $.01 par value; 30,000,000 shares authorized, 9,863,415
shares issued and outstanding in 1999 and 10,303,469 shares issued
and outstanding in 2000 98,634 103,035
Additional paid-in capital 15,563,784 25,379,538
Notes receivable from stockholders (749,981) (198,301)
Accumulated deficit (8,905,480) (21,493,775)
Accumulated other comprehensive loss (85,908) (373,719)
---------------- ---------------
Total stockholders' equity 5,921,049 3,416,778
---------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 7,988,311 $ 6,963,005
================ ===============
See accompanying notes to consolidated financial statements.
F-2
ARTIFICIAL LIFE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1998, 1999 and 2000
1998 1999 2000
------------ ------------- --------------
Revenues:
Trade:
Software license agreements $ 116,667 $ 1,127,500 $ 4,809,534
Application services 334,101 2,099,803 7,075,654
------------- ------------- ---------------
450,768 3,227,303 11,885,188
Affiliate -- 681,773 579,659
------------- ------------- ---------------
Total revenues 450,768 3,909,076 12,464,847
------------- ------------- ---------------
Operating expenses:
General and administrative 1,310,875 4,055,881 7,857,805
Engineering and cost of sales 640,237 3,566,192 9,324,988
Research and development 446,317 666,046 1,172,975
Sales and marketing 179,286 1,982,694 3,312,562
Provision for doubtful accounts -- -- 2,162,194
------------- ------------- ---------------
Total operating expenses 2,576,715 10,270,813 23,830,524
------------- ------------- ---------------
Loss from operations (2,125,947) (6,361,737) (11,365,677)
Other income (expenses):
Foreign exchange loss (985) (112,180) (9,215)
Equity in loss of unconsolidated subsidiary -- (508,884) (1,208,494)
Writedown of investment in unconsolidated subsidiary (49,637) (45,965) --
Interest income 18,620 344,038 136,336
Interest expense (33,257) (53,984) (29,286)
------------- ------------- ---------------
Loss before provision for income taxes (2,191,206) (6,738,712) (12,476,336)
Provision for income taxes -- 19,502 111,959
------------- ------------- ---------------
Net loss $ (2,191,206) $ (6,758,214) $ (12,588,295)
============= ============= ===============
Basic and diluted net loss per share ($0.30) ($0.70) ($1.23)
Weighted average shares outstanding used in per share calculation 7,289,385 9,590,074 10,216,242
See accompanying notes to consolidated financial statements.
F-3
ARTIFICIAL LIFE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 1998, 1999 and 2000
Preferred Stock Common Stock Additional
Comprehensive ------------------------- ----------------------- Paid-in
Loss Shares Amount Shares Amount Capital
------------- ---------- ------------ ---------- ---------- --------------
Balance at December 31,
1997 -- $ -- 6,967,213 $ 69,672 $ 426,567
Issuance of common stock -- -- 2,303,361 23,034 13,503,051
Comprehensive loss:
Net loss $ (2,191,206) -- -- -- -- --
Foreign currency
translation
adjustment (26,549) -- -- -- -- --
-------------
Total comprehensive
loss $ (2,217,755)
============= ---------- ------------ ---------- ---------- --------------
Balance at December 31,
1998 -- -- 9,270,574 92,706 13,929,618
Issuance of common stock -- -- 592,841 5,928 1,609,166
Issuance of stock options in
connection with
acquisition -- -- -- -- 25,000
Repayment of notes
receivable from
stockholders net of
increases for accrued
interest -- -- -- -- --
Comprehensive loss:
Net loss $ (6,758,214) -- -- -- -- --
Foreign currency
translation
adjustment (59,359) -- -- -- -- --
-------------
Total comprehensive
loss $ (6,817,573)
============= ---------- ------------ ---------- ---------- --------------
Balance at December 31,
1999 -- -- 9,863,415 98,634 15,563,784
Issuance of common stock -- -- 454,342 4,544 9,663,229
Stock options issued for
services rendered -- -- -- -- 152,383
Repurchase of common stock -- -- (14,288) (143) 142
Repayment of notes
receivable from
stockholders net of
increases for accrued
interest -- -- -- -- --
Comprehensive loss:
Net loss $(12,588,295) -- -- -- -- --
Foreign currency
translation
adjustment (287,811) -- -- -- -- --
-------------
Total comprehensive
loss $(12,876,106)
============= ---------- ------------ ---------- ---------- --------------
Balance at December 31,
2000 -- $ -- 10,303,469 $ 103,035 $ 25,379,538
========== ============ ========== ========== ==============
Accumulated
Retained Other Total
Notes Earning Comprehensive Shareholders'
Receivable (Deficit) Loss Equity
--------------- ------------- ----------------- -----------------
Balance at December 31,
1997 $ -- $ 43,940 $ -- $ 540,179
Issuance of common stock (79,423) -- -- 13,446,662
Comprehensive loss:
Net loss -- (2,191,206) -- (2,191,206)
Foreign currency
translation
adjustment -- -- (26,549) (26,549)
Total comprehensive
loss
--------------- ------------- ----------------- -----------------
Balance at December 31,
1998 (79,423) (2,147,266) (26,549) 11,769,086
Issuance of common stock (674,999) -- -- 940,095
Issuance of stock options in
connection with
acquisition -- -- -- 25,000
Repayment of notes
receivable from
stockholders net of
increases for accrued
interest 4,441 -- -- 4,441
Comprehensive loss:
Net loss -- (6,758,214) -- (6,758,214)
Foreign currency
translation
adjustment -- -- (59,359) (59,359)
Total comprehensive
loss
--------------- ------------- ----------------- -----------------
Balance at December 31,
1999 (749,981) (8,905,480) (85,908) 5,921,049
Issuance of common stock (175,000) -- -- 9,492,773
Stock options issued for
services rendered -- -- -- 152,383
Repurchase of common stock -- -- -- (1)
Repayment of notes
receivable from
stockholders net of
increases for accrued
interest 726,680 -- -- 726,680
Comprehensive loss:
Net loss -- (12,588,295) -- (12,588,295)
Foreign currency
translation
adjustment -- -- (287,811) (287,811)
Total comprehensive
loss
--------------- ------------- ----------------- -----------------
Balance at December 31,
2000 $ (198,301) $ (21,493,775) $ (373,719) $ 3,416,778
=============== ============= ================= =================
See accompanying notes to consolidated financial statements.
F-4
ARTIFICIAL LIFE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1998, 1999 and 2000
1998 1999 2000
--------------- ------------- -------------
Cash flows from operating activities:
Net loss $ (2,191,206) $ (6,758,214) $ (12,588,295)
Adjustments to reconcile net loss to net cash used by operating
activities:
Depreciation and amortization 110,097 698,403 1,833,601
Writedown of investment in unconsolidated subsidiary 49,637 45,965 --
Equity in loss of unconsolidated subsidiary -- 508,884 1,208,494
Intercompany profit elimination -- 327,200 80,307
Interest income accrued on notes receivable from stockholders -- (66,375) (36,604)
Stock options issued for services rendered -- -- 152,383
(Increase) decrease in due from former parent and affiliates 243,499 (368,547) (54,436)
(Increase) decrease in accounts receivable, trade 273,187 (1,102,426) (187,281)
(Increase) decrease in due to/from officer/stockholders (149,740) 74,261 (5,493)
(Increase) decrease in prepaid expenses and other assets 23,978 (510,279) 197,767
Increase (decrease) in accounts payable and accrued expenses 325,538 984,244 1,667,148
Increase (decrease) in deferred revenue (116,667) -- 38,941
--------------- ------------- -------------
Net cash used by operating activities (1,431,677) (6,166,884) (7,693,468)
--------------- ------------- -------------
Cash flows from investing activities:
Purchases of property and equipment (474,025) (1,820,027) (2,617,360)
Investments in unconsolidated subsidiary and joint venture (99,274) (1,022,269) (909,900)
Expenditures for capitalized software development costs (210,058) (1,100,592) (100,783)
Expenditures for business acquisitions -- (229,937) --
Net assets acquired in business acquisitions -- 147,890 --
Decrease (increase) in notes receivable affiliate (40,000) 40,000 --
--------------- ------------- -------------
Net cash used by investing activities (823,357) (3,984,935) (3,628,043)
--------------- ------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 13,446,662 940,095 9,492,772
Proceeds from note payable - officer/stockholder 500,000 -- --
Repayment of notes receivable from stockholders -- 70,816 763,284
Repayment of note payable - officer/stockholder -- -- (500,000)
--------------- ------------- -------------
Net cash provided by financing activities 13,946,662 1,010,911 9,756,056
--------------- ------------- -------------
Effect of exchange rate changes on cash (26,181) 45,467 (297,237)
--------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents 11,665,447 (9,095,441) (1,862,692)
Cash and cash equivalents at beginning of year 22,382 11,687,829 2,592,388
--------------- ------------- -------------
Cash and cash equivalents at end of year $11,687,829 $ 2,592,388 $ 729,696
=============== ============= =============
Supplemental disclosure of cash flow information:
Income taxes paid $ 2,000 $ 19,502 $ 111,959
Interest paid 8,257 78,984 29,286
Notes receivable received upon exercise of stock options -- 674,999 175,000
Stock options issued in business acquisition -- 25,000 --
Equity investment in unconsolidated subsidiary received for services provided -- -- 250,000
See accompanying notes to consolidated financial statements
F-5
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1998, 1999 and 2000
1. Organization, Risks and Uncertainties
Organization and Nature of Operations
Artificial Life, Inc. ("Artificial Life" or the "Company") develops,
markets and supports "intelligent" software robots ("bots"). The Company's bots,
known as "SmartBots(TM)," are software programs that the Company designs to
automate and simplify time-consuming and complex business-related Internet
functions such as Web navigation, direct marketing, user profiling, information
gathering, messaging, knowledge management, sales response and call center
automation and financial management and planning. In 1998, the Company changed
its primary business focus from software consulting to the development,
marketing and support of its ALife suite of SmartBot software products. As a
consequence of the Company's change in its primary business focus, the Company
expects that an increasing percentage of its future revenues will be derived
from licenses and services associated with its software robot products and that
revenues from its consulting business will, as a percent of gross revenues,
significantly decrease over time.
In addition, because the Company's emerging online agent-based software
products business will require infusions of additional capital, results of
operations to date are not reflective of the Company's future results of
operations. The Company's decision to become a provider of software robot
products is predicated on the assumption that the demand for such products will
be large enough to permit the Company to operate profitably. There can be no
assurance that the Company's assumption will be correct or that the Company will
be able to successfully compete as a provider of such products. If the Company's
assumption is not accurate, or if the Company is unable to compete as a provider
of online agent-based software products, the Company's business, prospects,
financial condition and results of operations will be materially adversely
affected.
The Company's management has obtained funds to support its operations
through a combination of sources including a long-term loan from a stockholder,
private placements of Common Stock and an initial public offering.
In October 1998, the Company formed Artificial Life Schweiz AG ("Artificial
Life Schweiz"), formerly Artificial Life Europe AG, as a wholly owned
subsidiary. Artificial Life Schweiz is located in Zurich, Switzerland and was
established as the Company's European headquarters.
In November 1998, Artificial Life Schweiz formed Artificial Life Rus
Limited ("Artificial Life Rus") as a wholly owned subsidiary. Artificial Life
Rus is located in St. Petersburg, Russian Federation and was formed to perform
software development.
In March 1999, the Company formed a wholly owned subsidiary Artificial Life
Deutschland AG, ("Artificial Life Germany") located in Frankfurt, Germany. The
subsidiary was formed to serve European markets and combine the Company's
European sales and marketing initiatives. The subsidiary commenced operations in
June 1999 and concentrates on the development of Internet applications for banks
and financial service organizations.
Also in, June 1999, the Company acquired 51% of the outstanding stock of
Cybermind Ventures, Inc. ("Cybermind") for $75,000 from two of the Company's
stockholders. Cybermind was inactive with a net loss in 1999 through the date of
acquisition of $5,520. At the time of the acquisition, Cybermind's name was
changed to Artificial Life Ventures, Inc. ("Artificial Life Ventures"). In
November 1999, the Company acquired the remaining 49% of the outstanding stock
of Artificial Life Ventures from a stockholder of the Company. The Company
acquired this stock for $75,000 in cash and the issuance of 5,000 stock options
at an exercise price of $14.50 per share. The options are valued at $25,000,
have a three year life and vest
F-6
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
in equal amounts on the first, second and third anniversary of the grant date.
Goodwill recognized in connection with this acquisition amounted to
approximately $86,000, and is being amortized over three years.
In January 2000, the Company formed a wholly owned subsidiary Artificial
Life USA, Inc. located in Boston, Massachusetts. The subsidiary was formed to
concentrate on sales and support for customers in the United States.
In April 2000, the Company formed a wholly owned subsidiary Artificial Life
Mobile Computing, Inc. located in Boston, Massachusetts. The subsidiary was
formed to serve as the development arm for mobile computing technologies. Mobile
computing represents the next generation of Bot technology where processing is
highly distributed, mobile and accessible on a wide range of computing devices.
In August 2000, the Company formed a wholly owned subsidiary Artificial
Life Hong Kong Limited. Its name was subsequently changed to Artificial Life
Asia Limited. The subsidiary was formed to enter and serve Asian markets. The
subsidiary commenced operations in January 2001 and concentrates on the sales
and marketing and product support of the Company's financial suite products for
banks and financial service organizations in the Asian markets.
Risks and Uncertainties
Need for Additional Financing
In 2000, the Company continued to incur losses from operations, and has
partially funded these losses through three private placements of Common Stock
totaling $8.9 million. The Company has continued to incur losses in the first
quarter of 2001 and the Company does not anticipate achieving profitability
until late 2001. The Company's continued losses have severely impacted the
Company's liquidity and cash position. The Company was unable to pay its Russian
Operation's monthly payroll liability due February 28,2001 and may not be able
to pay its Russian operation's March payroll liability. These combined payroll
liabilities amounted to approximately $350,000. The Company is currently
negotiating the divestiture of a substantial portion of its Russian operation,
whereby these payroll liabilities may be assumed by the buyer. In order to fund
its cash needs for 2001, the Company has taken steps to reduce operating costs,
including, a reduction of staffing and the negotiation of the divestiture of a
substantial portion of its Russian operation. In addition, in 2001, the
Company's Chief Executive Officer advanced $485,000 to the Company. The advances
are expected to be converted into an interest bearing term loan. The Company is
also continuing to pursue short-term borrowings and other direct share placement
opportunities. Despite these efforts, the Company will continue to incur losses
through the majority of 2001. Without obtaining additional financing or capital,
the Company will not have sufficient resources to fund its operations through
2001. To that end, the Company has entered into an irrevocable stock purchase
agreement with Bluefire Capital, Inc. (Bluefire), a Cayman Island Corporation,
on March 22, 2001, to provide the Company with equity financing. Bluefire has
committed to purchase up to $13,000,000 of common shares over the course of
three years, and such amount may increase if certain conditions are met. The
ability to raise funds through this equity facility and the number and amount of
each equity transaction available under the facility are subject to certain
conditions at the time of each sale of the Company's Common Stock. The Company
does not believe that financing available from this equity facility will be
sufficient to fund its operations through 2001. The Company is continuing to
pursue short-term borrowings and other direct share placement opportunities to
meet its anticipated liquidity shortfalls. The Company cannot assure that it
will be able to complete this or any other financing or that such financings
will be adequate to meet the Company's needs.
These factors create a substantial doubt about the Company's ability to
continue as a going concern. The accompanying financial statements do not
include any adjustments that might come from the outcome of this uncertainty.
F-7
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
Financing Arrangement with Bluefire
Bluefire has committed to purchase up to $13,000,000 of Common Stock of the
Company over the course of thirty-six months after the effective date of the
Company's registration statement in connection with the shares to be sold. Such
registration statement must be filed by May 21, 2001 and be declared effective
generally within 120 days of the date of the filing of the registration
statement. There will be a minimum draw down requirement of $500,000 over the
life of the commitment. The Company will be subject to a maximum penalty of
$250,000 if the minimum draw down is not made. The Company will have the sole
option to set the date of each draw down and the portion of the Subscription to
be drawn down (each, a "Draw Down"), subject to the following conditions:
a) Each Draw Down shall be for a maximum that will be determined according
to the set formula equal to 15% of the volume weighted average price
for the Company's Common Stock for the 40 consecutive trading days
immediately prior to the Draw Down date multiplied by the total
trading volume during that 40-day period.
b) There will be a minimum of 6 trading days between Draw Downs and only
one Draw Down during the 21-day pricing period relating to each Draw
Down is allowed;
c) At each Draw Down the Company may specify a threshold price
representing the lowest price at which the Company will sell its
Common Stock;
d) The registration statement, registering the Common Stock must be
effective.
The purchase price shall be set at an underwriter discount ("Discount") to the
market price on the day a Draw Down is made. The Discount shall be set at 14%
in the event the market price on the Draw Down date is less than $8 per share.
The Discount shall be adjusted to 12% in the event the market price on a Draw
Down date is greater than $8 per share but less that $12. The Discount will be
adjusted to 10% in the event the market price on a Draw Down date is greater
than $12.
Bluefire must also increase the funding commitment to $25 million upon the one-
year anniversary of the effective date of the registration, but only upon the
achievement of several conditions in the Company's stock performance.
On March 23, 2001, the Company also issued warrants to Bluefire to purchase up
to 150,000 shares of its Common Stock at $3.82 per share. The term of the
warrants are three years, commencing six months after the date of the agreement.
The warrants provide Bluefire with anti-dilutive rights, among others, and
provide for a cashless exercise at the option of Bluefire.
The agreement also provides for certain restrictions on the Company's
participation in any other standby equity-based credit facility. Under the
agreement, in the event that the Company sells securities at a discount to the
then current market price and grants the purchaser registration rights in
connection with the securities offered, Bluefire would be entitled to notice and
negotiation rights with respect to such a sale. The Company may not make a Draw
Down to such an extent that, after such Draw Down, Bluefire's beneficial
holdings in the Company's Common Stock after such Draw Down exceeds 9.9% of the
then total outstanding shares of the Company's Common Stock.
The Company has agreed not to execute any merger or consolidation unless the
Company's successor agrees to assume the obligations under this agreement.
F-8
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
Concentration of Credit Risk
Financial instruments which potentially subject the Company to a
concentration of credit risk principally consist of cash and cash equivalents
and accounts receivable.
The Company maintains its cash and cash equivalents in checking, savings
and money market accounts. The majority of the Company's cash and cash
equivalents were on deposit in two major financial institutions in 1999 and
three major financial institutions in 2000.
During the year ended December 31, 1998, the substantial majority of the
Company's revenue was derived from one customer.
In 1999, the Company recognized revenues from one customer in the amount of
$2,483,467, representing 63.5% of its total revenues. At December 31, 1999, 83%
of accounts receivable, trade was due from this customer. Also in 1999, the
Company recognized revenues, after elimination of unrealized intercompany
profit, from license and application services sales to a joint venture of the
Company in the amount of $681,773, representing 17.4% of its total revenues. At
December 31, 1999 the entire accounts receivable, affiliate was due from the
joint venture.
In 2000, the Company recognized revenues from three customers in the amount
of $7,333,022 ($3,804,449, $1,970,875 and $1,557,698) representing 58.8% (30.5%,
15.8% and 12.5%) of its total revenue. At December 31, 2000, two customers
accounted for 76.3% (55.5% and 20.8%) of total accounts receivable, trade. The
receivable from the customer representing 55.5% of the total accounts receivable
has been fully reserved at December 31, 2000. See Note 11. Also in 2000, the
Company recognized revenues, after elimination of unrealized intercompany
profit, from license and application services sales to a joint venture of the
Company in the amount of $579,659, representing 4.7% of its total revenues. At
December 31, 2000 the entire accounts receivable, affiliate was due from the
joint venture.
Management Estimates
The process of preparing financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. These
estimates and assumptions involve the areas of collection of receivables,
contract costs, depreciation and amortization and certain accruals, among
others. Actual results could differ from those estimates.
2. Summary of Significant Accounting Policies
Basis of Consolidation
The consolidated financial statements include the accounts of Artificial
Life, Inc., Artificial Life USA, Inc., Artificial Life Schweiz, Artificial Life
Rus, Artificial Life Germany, Artificial Life Ventures and Artificial Life
Mobile Computing, Inc. All significant intercompany balances and transactions
have been eliminated.
All assets and liabilities of Artificial Life Schweiz which has the Swiss
Franc as its functional currency, Artificial Life Rus which has the Russian
Rouble as its functional currency, and Artificial Life Germany, which has the
Euro as its functional currency, are translated at the year-end exchange rate.
The operations of
F-9
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
these companies included in the consolidated statement of operations are
translated using the weighted average exchange rate during the period.
Translation gains and losses are not included in determining net loss but are
accumulated as a separate component of stockholder's equity. Foreign currency
transaction gains and losses are included in determining net loss.
Cash Equivalents
Cash equivalents consist of short-term investments with original maturities
of three months or less when purchased.
Property and Equipment
Property and equipment is stated at cost. Depreciation and amortization is
provided on the straight-line basis over the estimated useful lives of the
respective assets (three to five years). Leasehold improvements are amortized on
a straight-line basis over the lesser of the estimated useful life of the asset
or lease term. Expenditures for maintenance, repairs and minor renewals are
charged to expenses as incurred. Betterments and major renewals are added to the
property and equipment accounts at cost.
Computer Software Costs
Costs of developing software which are incurred beyond the point of
demonstrated technological feasibility are capitalized and, after the product is
available for general release to customers, such costs are amortized based on
the greater of the charge resulting from the straight-line method over a
two-year period or the proportion of current sales to estimated total revenues
of the product.
Revenue Recognition
The Company's revenues consist principally of up front license fees earned
from the licensing of the Company's software, related consulting and
implementation services, and training. American Institute of Certified Public
Accountants' Statement of Position 97-2, "Software Revenue Recognition" (SOP
97-2) provides guidance on applying generally accepted accounting principles in
recognizing revenue on software transactions. In accordance with SOP 97-2,
revenue from up front software license agreements is recognized when delivery
has occurred, collection is deemed probable, the fee is fixed or determinable
and the vendor-specific objective evidence exists to allocate the total fee to
all delivered and undelivered elements of the arrangement.
Application service contract revenue and related costs are recognized as
the services are preformed or upon completion of the contract or certain phases
as defined in each agreement, and upon acceptance by the customer.
There are no significant future costs associated with any of the Company's
revenue transactions. Development costs which are not required to be
capitalized, marketing and installation costs are charged to earnings as
incurred.
Advertising Expense
Advertising costs are charged to expense when incurred. Advertising costs
amounted to $0 in 1998, $660,090 in 1999 and $427,970 in 2000.
F-10
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
Comprehensive Loss
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income," as of January 1, 1998.
Accounting principles generally require that recognized revenue, expenses, and
gains and losses be included in net loss. Although certain changes in assets and
liabilities, such as foreign currency translation adjustments, are reported as a
separate component of the equity section of the balance sheet, such items, along
with net loss, are components of comprehensive income. The Company reports
comprehensive loss in the Consolidated Statement of Changes in Stockholders'
Equity.
Computation of Net Loss Per Share
The Company adopted SFAS No. 128, "Computation of Earnings Per Share,"
during 1997. In accordance with SFAS No. 128, a basic earnings per share is
computed using the weighted average number of common shares outstanding during
the period. Diluted earnings per share is computed using the weighted average
number of common shares outstanding during the period and the weighted average
dilutive common equivalent shares outstanding during the period. Common
equivalent shares consist of the incremental common shares issuable upon the
exercise of stock options and warrants (using the Treasury Stock method); common
equivalent shares are excluded from the calculation if their effect is
anti-dilutive. All common equivalent shares of the Company are not dilutive.
Therefore, diluted earnings per share is the same as basic earnings per share.
Pursuant to SEC Staff Accounting Bulletin No. 98, common stock issued for
nominal consideration, prior to the anticipated effective date of an IPO, are
required to be included in the calculation of basic and diluted net loss per
share, as if they are outstanding for all periods presented. To date, the
Company has not had any stock issuances for nominal consideration.
Stock-Based Compensation
The Company has adopted SFAS No. 123, "Accounting for Stock-Based
Compensation" As permitted by SFAS No. 123, the Company measures compensation
cost in accordance with Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" and related interpretations. Accordingly, no
accounting recognition is given to stock options granted at fair market value
until they are exercised. Upon exercise, net proceeds are credited to equity.
The pro forma impact on the Company's loss has been disclosed in the Notes to
Consolidated Financial Statements as required by SFAS No. 123 (see note 7).
Stock Dividend, Reverse Stock Split and Changes in Authorized Stock
On June 10, 1998, the Company declared a dividend of 339 shares of common
stock for each share of common stock held to stockholders of record on June 10,
1998. On September 22, 1998 the Company effected a 1-for-2.44 reverse stock
split and amended the total authorized shares of Voting Common Stock to
19,000,000 shares and Non-Voting Common Stock to 1,000,000 shares. Effective
with the consummation of the IPO on December 17, 1998, the Company amended its
articles of organization to amend the total authorized shares of common stock to
30,000,000 shares, all voting, and to authorize 5,000,000 shares of preferred
stock. All references in the financial statements to shares, share prices, per
share amounts, stock options and authorized shares have been retroactively
adjusted for the stock dividend, reverse stock split and change in authorized
stock.
F-11
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
Income Taxes
Deferred tax assets and liabilities are recorded for temporary differences
between the financial statement and tax basis of assets and liabilities.
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. A deferred tax asset is
recorded for any net operating loss, capital loss and tax credit carryforward
for income tax purposes, to the extent their realization is more likely than
not. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities will be adjusted through the provision for income taxes.
Reclassification
Certain items previously reported in specific financial statement captions
have been reclassified to conform with the 2000 presentation.
3. Related Party Transactions
In 1998, the Company's President, Chief Executive Officer and Chairman
entered into an employment agreement with the Company at an annual salary of
$240,000 in 1998, $264,000 in 1999 and $290,400 in 2000.
On June 29, 1998, the Company issued a note payable to an
officer/stockholder in the amount of $500,000. The note was unsecured and
provided for interest at 10%. Payment of principal and accrued interest was
originally due on January 1, 2000 and was extended to April 30, 2000. On June 6,
2000 the note and interest was paid in full. Interest expense incurred during
the years ended December 31, 1998, 1999 and 2000 amounted to $25,000, $50,000
and $20,833, respectively. (See Note 1.)
In 1998, the Company made advances totaling $40,000 to Artificial Life
Ventures, a company originally owned by a stockholder and an officer/stockholder
of the Company. The advances were unsecured, provided for interest at 10% and
were due on December 31, 1999. In 1999, the Company purchased all of the
outstanding stock of this affiliate.
The Company pays expenses on behalf of and provides cash advances to
officer/stockholders from time to time. Amounts outstanding are non-interest
bearing and due on demand.
Effective August 31, 2000, the Chief Executive Officer of Artificial Life
Schweiz and a director/stockholder of the Company resigned his position as Chief
Executive Officer and received a severance payment of 300,000 Swiss Francs
(approximately $180,000 US). This individual's term on the Board of Directors
expired on October 31, 2000 and he did not stand for re-election. As of December
31, 2000, $124,180 (US) was still unpaid and included in accounts payable. On
the date of the former employee's resignation, the Company also entered into a
consulting agreement with the former employee. The Agreement provides for
commissions to the former employee based on sales production, and a monthly
payment of 18,000 Swiss Francs (approximately $11,000) for two years from the
date of the Agreement.
See also Note 7.
F-12
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
4. Income Taxes
The income tax provision (benefit) consists of:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1999 2000
--------------- -------------- --------------
Current:
Federal $ (1,710) $ -- $ --
State -- -- --
Foreign -- 19,502 111,959
--------------- -------------- --------------
(1,710) 19,502 111,959
--------------- -------------- --------------
Deferred (prepaid):
Federal 1,710 -- --
State -- -- --
Foreign -- -- --
--------------- -------------- --------------
1,710 -- --
--------------- -------------- --------------
$ -- $ 19,502 $ 111,959
=============== ============== ==============
The difference between actual income tax expense and expected income tax expense
computed by applying the U.S. federal income tax rate of 34% to loss before
provision for income taxes is explained as follows:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1999 2000
-------------- -------------- -------------
Expected income tax benefit $ (745,010) $(2,291,162) $(4,241,954)
State taxes, net of federal income tax benefit (137,389) (238,022) (492,294)
Foreign tax rate differences -- 233,453 (203,454)
Change in valuation reserve on deferred tax
asset 826,618 2,452,142 5,388,232
Other 55,781 (136,909) (338,571)
-------------- -------------- -------------
Provision for income taxes $ -- $ 19,502 $ 111,959
============== ============== =============
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities at December 31, 1999 and 2000 are presented
below:
December 31,
1999 2000
------------- -------------
Deferred tax assets:
Federal net operating loss carryforwards $ 2,297,796 $ 4,713,631
State net operating loss carryforwards 587,940 1,383,498
Foreign net operating loss carryforwards 593,172 2,041,800
Equity in loss of unconsolidated subsidiary 204,928 691,588
Federal and State R&D credit carryforwards 49,380 49,830
Other 5,269 59,601
------------- -------------
3,738,485 8,939,948
F-13
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
Valuation allowance on deferred tax asset (3,348,622) (8,736,854)
------------- -------------
389,863 203,094
------------- -------------
Deferred tax liabilities:
Capitalized software development costs 381,752 201,746
Other 8,111 1,348
------------- -------------
389,863 203,094
------------- -------------
Net deferred tax asset
$ -- $ --
============ =============
The change in the valuation allowance on deferred tax assets is as follows:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1999 2000
--------------- -------------- --------------
Balance at beginning of year $ 69,862 $ 896,480 $ 3,348,622
Increase in valuation allowance
due to change in deferred tax assets
during the year 826,618 2,452,142 5,388,232
--------------- -------------- --------------
Balance at end of year $ 896,480 $ 3,348,622 $ 8,736,854
=============== ============== ==============
At December 31, 2000, the Company has approximately $14,000,000 of federal
and state net operating loss carryforwards expiring in 2020 and 2005,
respectively. The net operating loss carryforwards may be subject to annual
limitations based on ownership changes in the Company's common stock as provided
in Section 382 of the Internal Revenue Code. In addition, the Company's German
and Swiss subsidiaries have available approximately $3,000,000 and $2,000,000,
respectively, of net operating loss carryforwards that can be used to reduce the
subsidiaries future taxable income. The German net operating loss can be carried
forward indefinitely while the Swiss net operating loss expires in 2007.
5. Commitments and contingencies
Leases
The Company leases office space under noncancellable leases. Future minimum
annual lease payments, exclusive of additional operating costs, are as follows:
Year Ending December 31,
------------------------
2001.......................................... $ 1,125,000
2002.......................................... 1,138,000
2003.......................................... 1,138,000
2004.......................................... 908,000
2005.......................................... 573,000
Thereafter.................................... 118,000
------------
$ 5,000,000
============
F-14
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
Rent expense for the years ended December 31, 1998, 1999 and 2000 amounted
to approximately $253,300, $377,300 and $1,191,700, respectively. The 1998, 1999
and 2000 rent expense is net of approximately $20,400, $86,000 and $2,000,
respectively, which was recorded as part of capitalized software development
costs.
Employment Contract
The Company has an employment agreement with its Chief Executive Officer.
The agreement is three years in length, expiring in 2001 and provides for a
minimum salary level. The agreement includes severance payments under certain
conditions of approximately three times the officer's annual compensation. In
addition the Chief Executive Officer of the Company is entitled to receive an
annual incentive bonus of 3% of the Company's profits from operations.
Tax Assessment
During 2000, Artificial Life Rus was assessed approximately $440,000 by the
Tax Inspection for the Central Region of St. Petersburg (TICRP), in connection
with additional value added and profit taxes. Artificial Life Rus appealed the
assessment to the St. Petersburg Court, and on February 26, 2001 received a
favorable decision from the Court. On March 16, 2001 the TICRP appealed the
Court's decision. In addition, in March 2001, Artificial Life Rus has received
notice that the TICRP intends to make an additional assessment of approximately
$163,500 for additional value added and profit taxes. The Company intends to
vigorously challenge this appeal and any additional tax assessment and
management believes that the ultimate outcome of this matter will not have a
material adverse effect on the Company's financial position. Therefore, no
provision for any additional taxes incurred as a result of this matter have been
provided for in the Company's financial statements.
6. Profit Sharing Plan
Effective October 1, 1995, the Company implemented a 401(k) profit sharing
plan for the benefit of all its United States employees. Employees are eligible
to participate beginning the first April or October after employment begins and
may contribute up to 15% of their compensation subject to statutory limitations.
The Company matches 50% of employee contributions up to 1 1/2% of the employee's
compensation. There is a five year vesting period for Company contributions at a
rate of 20% annually.
Profit sharing expense for the years ended December 31, 1998, 1999 and 2000
amounted to approximately $10,500, $21,100 and $31,700, respectively.
7. Stockholders' Equity
Public Offering
In August 1998, the Company executed a letter of intent to proceed with a
proposed initial public offering of the Company's stock (the "IPO"). The IPO was
consummated on December 17, 1998. Expenses incurred in connection with the IPO
amounted to $2,597,227, resulting in net proceeds of $9,302,773 to the Company.
Upon consummation of the IPO, under the terms of the letter of intent, the
underwriters managing the offering will have the right to appoint one member of
the Board of Directors. The right to have a representative on the Company's
board extends for the term of the Warrant (defined below). The Company
delivered a warrant (the "Warrant") to the underwriters at the closing of the
IPO equal to ten percent of the total number of shares sold pursuant to the IPO,
160,000 shares. The
F-15
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
Warrant is exercisable any time after one year from the date of closing for a
period of four years at a price equal to 120% of the offering price per share,
or $10.20 per share. In December 1999, the underwriters exercised 140,000 shares
of the Warrant using a net exercise feature resulting in the issuance of 54,810
shares of common stock.
In December 1998 and January 1999, the Underwriter exercised its entire
over-allotment option. Under the option, the Underwriter purchased 40,000
additional shares from the Company and 200,000 additional shares from the
Company's major stockholder. The shares were purchased at the public offering
price of $8.50 per share less the underwriting discounts, commissions and
expenses. Net proceeds received by the Company for its portion of the
over-allotment exercised in January amounted to $302,600, net of expenses of
$37,400.
Common Stock
In June 1998, the Company sold 53,278 shares of non-voting common stock and
the majority stockholder of the Company sold 409,836 shares of voting common
stock through private placements to foreign investors based on arms-length
negotiations with unrelated parties. The shares were sold for $3.66 per share.
Expenses incurred in connection with the private placements amounted to $13,633.
As a result, the Company received net proceeds of $181,367. This stock was
unregistered and was subject to restrictions on resale in the United States
pursuant to Regulation S promulgated under the Securities Act of 1933, as
amended. Upon the closing of the IPO, non-voting common stock was converted into
voting common stock.
Subsequent to the sale of stock by the majority stockholder, the Company
received a loan of $500,000 from the stockholder, which was repaid in 2000.
On September 23, 1998, the Company sold 824,000 shares of voting common
stock for $5.00 per share through private placements to foreign investors.
Expenses incurred in connection with the private placements amounted to $173,519
resulting in net proceeds of $3,946,481 being received by the Company. The stock
was unregistered and was subject to restrictions on resale in the United States
pursuant to regulation S promulgated under the Securities Act of 1933, as
amended. Upon the closing of the IPO, the Company registered 164,800 of these
shares for inclusion in the public offering.
In February 2000, the Company sold 102,500 and 50,000 shares of voting
common stock for $25.00 and $31.00 per share, respectively, through private
placements to foreign investors. The total net proceeds to the Company amounted
to $4,112,500. The stock was unregistered and was subject to restrictions on
resale in the United States pursuant to Regulation S promulgated under the
Securities Act of 1933, as amended.
In March 2000, the Company sold 150,000 shares of voting common stock for
$32.375 through a private placement to foreign investors. In addition to the
shares issued, the Company issued warrants to purchase 75,000 additional shares
of common stock at $32.375 per share. The total net proceeds to the Company
amounted to $4,856,250. The stock was unregistered and was subject to
restrictions on resale in the United States pursuant to Regulation S promulgated
under the Securities Act of 1933, as amended.
Stock Option Plan
On April 1, 1998, the Company adopted the 1998 Equity Incentive Plan (the
F-16
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
"Plan") which provides for the issuance of both non-statutory and incentive
stock options to employees, officers, directors and consultants of the Company.
At the time the Company reserved 409,811 shares of common stock to be issued
under the Plan.
On September 25, 1998, the Plan was amended to increase the shares reserved
for issuance under the Plan to a total of 1,200,000 shares; 761,476 shares of
voting common stock and 438,524 shares of non-voting common stock. All options
issued prior to June 30, 1998 were for voting common stock. With the amendment
of the authorized common stock at the time of the IPO, all non-voting common
stock options were converted to voting common stock options.
On July 1, 1999, the Plan was amended to increase the shares reserved for
issuance under the Plan to a total of 2,700,000.
On September 28, 2000, the Company issued 25,000 shares of common stock in
connection with the exercise of outstanding stock options by an Officer of the
Company. The options were scheduled to expire on October 1, 2000. The total
proceeds amounted to $162,500, in the form of a note receivable due
September 28, 2001 with interest at 10% per annum. On December 8, 2000 the
Company agreed to retroactively rescind this exercise. In addition on December
8, 2000 the same Officer sold to the Company 14,288 shares, which he previously
received in 2000 as a result of a cashless stock option exercise, for $1.00.
On October 31, 2000, the Plan was amended to increase the shares reserved
for issuance under the Plan to a total of 3,700,000.
A summary of the status of the Company's stock options under the Plan as of
December 31, 1999 and 2000 and the changes during the years then ended is
presented below:
1999 2000
-------------------------------- ---------------------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
----------------- -------------- ---------------- ---------------
Outstanding at beginning of year 755,569 $ 4.38 1,578,928 $ 13.56
Granted - price equals fair value 1,489,476 14.60 398,800 19.39
Exercised (543,031) 3.66 (167,989) 6.43
Canceled (123,086) 13.61 (506,068) 14.24
---------------- ---------------
Outstanding at end of year 1,578,928 $ 13.56 1,303,671 $ 15.93
================ ===============
Options exercisable at end of year 215,228 322,579
================ ===============
Options available for future grants 551,958 1,659,226
================ ===============
In 1999 and 2000, options for 184,426 and 72,884 shares, respectively, were
exercised using a net exercise feature resulting in the issuance of 139,426 and
56,737 shares, respectively.
F-17
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
The following table summarizes information about stock options outstanding
under the Plan at December 31, 2000:
Options Outstanding Options Exercisable
------------------------------------------------- -------------------------------------------------
Weighted Average Weighted Weighted Average Weighted
Range of Number Remaining Average Number Remaining Average
Exercise Price Outstanding Contractual Life Exercise Price Outstanding Contractual Life Exercise Price
--------------- ----------- ----------------- ---------------- ------------ ---------------- -----------------
$7.56-$12.75 46,400 2.83 $10.24 875 2.79 $12.75
$13.00-$14.50 923,195 1.59 $14.49 299,661 1.56 $14.50
$16.38-$18.75 148,476 2.23 $17.47 22,043 1.85 $17.66
$19.00-$24.00 175,600 2.29 $22.79 -- -- --
$32.50 10,000 2.20 $32.50 -- -- --
The Company applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its Plan.
Pro forma information regarding net loss and net loss per share is required
by SFAS No. 123, which also requires that the information be determined as if
the Company had accounted for its employee stock options under the fair value
method. In 1998, prior to the completion of the initial public offering of
common stock, the fair value of each option grant was estimated using the
minimum value method. The minimum value method differs from other methods of
valuing options, such as the Black-Scholes option-pricing model, because it does
not consider the effect of expected volatility. In 1999 and 2000, the Company
estimated the fair value of options granted using the Black-Scholes option-
pricing model. The fair value of options was estimated at the date of grant
using the following weighted average assumptions:
1999 2000
---- ----
Risk Free interest rate................... 6.0% 6.0%
Dividend yield............................ None None
Expected life of options in years......... 1.50 1.50
Expected volatility....................... 60.0% 84.1%
Option valuation models require the input of highly subjective assumptions
including the expected life of the options and their expected volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. The Company's pro forma
information for 1999 and 2000 is as follows:
1999 2000
---- ----
Pro forma net loss................ $(7,221,251) $(14,185,149)
Pro forma net loss per share...... $ (0.75) $ (1.39)
The pro forma net loss per share above is calculated using the weighted
average number of shares of common stock outstanding as described in Note 2. The
weighted
F-18
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
average fair value of options granted during the years ended December 31, 1999
and 2000 was $2.75 and $8.14, respectively.
Other Stock Options
-------------------
In November 1999, the Company issued stock options for 5,000 shares of
common stock at an exercise price of $14.50 per share in connection with its
acquisition of the remaining 49% of the outstanding stock of Artificial Life
Ventures. The options have a three year life and vest in equal amounts on the
first, second and third anniversary of the grant date. The fair value of the
options, determined using the Black-Scholes option pricing model, was $25,000.
The Company issued stock options to four consultants for 130,000 shares of
common stock at an exercise price of $14.50 per share. The options have a three
year life and vest in equal amounts on the first, second and third anniversary
of the grant date. The fair value of the options, determined using the
Black-Scholes option pricing model, was $348,641. The fair value of the stock
options is being amortized into general and administrative expenses over the
life of the options commencing in 2000. The expense recorded in 2000 in
connection with these options amounted to $152,383.
8. Receivable From Stockholders
In connection with the exercise of options on May 7, 1999, the Company
received a note receivable in the amount of $674,999. The note was due and paid
on May 7, 2000 with interest at 15%. The outstanding balance of this note was
$741,374, including accrued interest of $66,375, at December 31, 1999.
In connection with the exercise of options on February 10, 2000, the
Company received a note receivable in the amount of $175,000. The note is due on
February 10, 2001 with interest at 15%. The outstanding balance of this note was
$198,301, including accrued interest of $23,301, at December 31, 2000. This note
has been extended one year.
9. Accrued Expenses
Accrued expenses at December 31, 1999 and 2000 consist of the following:
December 31,
1999 2000
------------- --------------
Accrued salaries $ 81,401 $ 197,649
Accrued vacations 144,495 308,872
Accrued and withheld payroll taxes 81,803 199,773
Accrued professional fees 214,833 326,391
Accrued state excise tax -- 30,000
Other liabilities 63,751 24,902
------------- --------------
Total accrued expenses $586,283 $1,087,587
============ =============
F-19
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
10. Investments in Unconsolidated Subsidiaries
In April 1999, the Company entered into a joint venture with two
international retailers in the field of e-commerce. The main focus of this joint
venture is to sell consumer goods over the Internet using deep discounts and
high volume, both in terms of transactions and web visits. As part of the
transaction, the Company will license its SmartBot technology to the joint
venture. In addition, the Company will provide products and software development
and consulting services to the joint venture and receive payments therefore. The
partners in the joint venture will be responsible for using their purchasing
relationships to obtain certain consumer products, which will be sold on the
joint venture's e-commerce Website. The Company had allocated up to $2,150,000
of the proceeds from its IPO to purchase its 50% interest in this joint venture
and to meet its obligations to contribute additional capital to the joint
venture. At December 31, 1999, the Company had invested $1,022,269 in the joint
venture. In 2000, the Company invested an additional $909,900 in the joint
venture. Under the terms of the joint venture agreement, the Company may market
any e-commerce applications it develops to other e-commerce companies.
In 1999 and 2000, the Company recorded revenue from the joint venture of
$681,773 and $579,659, respectively, net of intercompany profit eliminations of
$327,200 and $80,307, respectively. Costs incurred in connection with this
revenue amounted to $250,960 and $161,020 in 1999 and 2000, respectively.
The Company accounts for its investment in the joint venture on the equity
method. The summarized unaudited financial information of the joint venture
from its inception to December 31, 1999 and for the year ended December 31,
2000 are as follows:
1999 2000
--------------- -------------
Earnings data:
Revenues $ 31,513 $ 291,044
Operating loss (1,003,357) (2,255,946)
Net loss (1,017,768) (2,416,988)
Company's equity in net loss (508,884) (1,208,494)
Balance sheet data:
Current assets 455,317 309,380
Non-current assets 2,187,530 2,061,976
Current liabilities 1,061,783 847,481
Non-current liabilities 677,988 1,297,228
Net assets 903,076 226,646
Company's equity in net assets 451,538 113,323
F-20
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
The Company's investment in this unconsolidated subsidiary is reduced by
the elimination of unrealized intercompany profits as of December 31, 1999 and
2000 in the amount of $327,200 and $214,792, respectively. At December 31, 2000
accounts receivable from the unconsolidated subsidiary is also reduced by the
elimination of unrealized intercompany profits in the amount of $192,715.
On January 22, 2001, the Company's ownership interest in the above
unconsolidated subsidiary decreased from 50% to 19.9% after the subsidiary
successfully completed an additional round of financing. The Company did not
participate in the financing.
In October 2000, the Company entered into a sales agreement with an
e-commerce company, whereby the Company has exchanged rights to certain
Web-based licenses for stock in the e-commerce company. The amount of stock
received is approximately 4% of the total stock issued by the e-commerce company
and was valued at $250,000. This investment is carried on the cost basis.
11. Provision for Doubtful Accounts
In September 2000, the Company entered into an agreement for the sale of
nonexclusive licenses of certain of its software to a newly formed Web-based
company. The total sales price for these licenses was $1,925,000, of which
$925,000 was payable in cash and the remainder in stock of the customer with a
fair value of $1,000,000. In December 2000, the customer notified the Company
that unforeseen events unrelated to the Company, which occurred in late November
2000, had negatively impacted the customer's business outlook, placing in doubt
the customer's ability to meet its obligations to the Company. Therefore, the
Company has fully reserved for the collection of this outstanding receivable in
the fourth quarter of 2000.
12. Segment Information
The Company, whose operations consist of a single line of business,
develops, markets and supports "intelligent software robots," software programs
that the Company designs to automate and simplify time-consuming and complex
business-related internet functions.
At December 31, 1998, the Company's operations located outside the United
States were in Switzerland and Russia. The Company's operations in Europe
commenced late in 1998 and generated no revenues as of December 31, 1998. In
1999, the Company commenced operations in Germany.
Other financial data for the years ended December 31, 1998, 1999 and 2000
is as follows:
United Russian
1998 States Switzerland Federation Germany Eliminations Total
------ ---------------------------------------------------------------------------------------------
Loss from operations $(1,991,042) $(184,119) $(16,045) $ -- $ -- $(2,191,206)
Identifiable Assets 13,089,011 538,379 10,922 -- (753,592) 12,884,720
F-21
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
1999
----
Revenues from external
customers $ 3,072,781 $ 1,062,532 $ -- $ 100,963 $ (327,200) $ 3,909,076
Intersegment revenue 343,136 846,013 1,295,577 74,924 (2,559,650) --
Interest income 437,765 872 -- 16,175 (110,774) 344,038
Interest expense 54,471 84,500 -- 28,219 (113,206) 53,984
Depreciation and amortization
Expense 374,924 183,853 55,050 79,270 5,306 698,403
Equity in loss of
unconsolidated subsidiary -- 508,884 -- -- -- 508,884
Income tax expense -- -- 19,502 -- -- 19,502
Net loss (3,808,578) (1,807,578) 282,296 (1,103,040) (321,314) (6,758,214)
Investment in unconsolidated
subsidiary 186,186 -- -- -- -- 186,186
Expenditures for property
and equipment 397,219 664,563 249,330 508,915 -- 1,820,027
Identifiable Assets 10,247,094 1,063,526 320,950 1,792,568 (5,435,827) 7,988,311
2000
------
Revenues from external
customers $ 7,412,597 $ 3,855,427 $ -- $ 1,277,129 $ (80,306) $12,464,847
Intersegment revenue 2,152,747 1,147,573 3,037,526 928,426 (7,266,272) --
Interest income 384,254 513 -- 14,319 (262,750) 136,336
Interest expense 23,191 145,729 -- 123,116 (262,750) 29,286
Depreciation and amortization
Expense 983,132 498,025 138,521 185,264 28,659 1,833,601
Equity in loss of
unconsolidated
subsidiary -- 1,208,494 -- -- -- 1,208,494
Income tax expense -- 1,150 110,809 -- -- 111,959
Net loss (8,173,797) (2,785,086) 735,331 (2,336,084) (28,659) (12,588,295)
Investment in unconsolidated
subsidiary 250,000 -- -- -- -- 250,000
Expenditures for property
and equipment 856,871 784,419 744,963 231,107 -- 2,617,360
Identifiable Assets 8,664,670 2,164,632 890,726 1,092,803 (5,849,826) 6,963,005
13. Selected Quarterly Financial Information (unaudited)
The following table set forth selected quarterly financial information
for the years ended December 31, 1999 and 2000. The operating results for
any given quarter are not necessarily indicative of results for any future
period. The Company's common stock is traded on the Nasdaq National Market
System (NASDAQ/NMS) under the symbol ALIF.
1999 Quarter ended 2000 Quarter ended
-------------------------------------------- ------------------------------------------------
Mar. 31 June 30* Sep. 30 Dec. 31 Mar. 31 June 30 Sep. 30 Dec. 31
-------------------------------------------- ------------------------------------------------
Net Revenue $439,423 $ 885,128 $1,211,488 $1,373,037 $1,521,204 $2,822,114 $4,650,348 $3,471,181
General and administrative 677,408 1,008,486 1,136,399 1,233,588 1,416,207 2,000,357 2,336,979 2,104,262
F-22
ARTIFICIAL LIFE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Years Ended December 31, 1998, 1999 and 2000
Engineering and cost
of sales 280,244 661,431 772,659 1,851,858 1,723,412 2,284,762 2,292,016 3,024,798
Research and development 154,851 131,673 205,170 174,352 210,008 302,545 390,172 270,250
Sales and marketing 100,663 259,573 481,632 1,140,826 796,009 930,174 679,970 906,409
Provision for doubtful
accounts -- -- -- -- -- -- -- 2,162,194
--------- ----------- ----------- ----------- ----------- ----------- ------------ -----------
Operating Loss (773,743) (1 ,176,035) (1,384,372) (3,027,587) (2,624,432) (2,695,724) (1,048,789) (4,996,732)
Interest income
(expense), net 95,558 59,487 85,507 49,502 13,590 48,095 32,252 13,113
Foreign exchange
gain (loss) (29,124) (15,596) 2,201 (69,661) (40,350) (1,186) 15,415 16,906
Equity in loss of
unconsolidated subsidiary -- (31,020) (111,169) (366,695) (240,143) (325,426) (188,499) (454,426)
Writedown of investment in
unconsolidated subsidiary -- (45,965) -- -- -- -- -- --
Provision for income taxes -- -- (9,896) (9,606) -- -- -- (111,959)
Net Loss $(707,309) $(1,209,129) $(1,417,729) $(3,424,047) $(2,891,335) $(2,974,241) $(1,189,621) $(5,533,098)
Basic and diluted net
loss per share $ (0.08) $ (0.13) $ (0.14) $ (0.35) $ (0.29) $ (0.20) $ (0.12) $ (0.54)
Market Price
High $ 17.50 $ 23.00 $ 15.00 $ 19.75 $ 38.938 $ 31.50 $ 20.25 $ 14.25
Low 9.50 12.875 9.00 12.875 15.875 15.125 11.938 3.625
* In November 1999, the Company amended its Quarterly Report on Form 10-Q for
the Quarter ended June 30, 1999, to reduce revenue and engineering expenses by
$251,849 representing an intercompany sales elimination not previously
recorded. The above information reflects the corrected amounts.
F-23
Schedule 2
Artificial Life, Inc.
Valuation and Qualifying Accounts
Additions
--------------------
Balance at Charged to Charged
beginning of costs and to other Balance at
Description period expenses accounts Deductions and of period
----------- ------------ ----------- --------- ---------- -------------
1999
----
Allowance for Doubtful Accounts $ - $ - $ - $ - $ -
========= ========== ========= ========= ==========
2000
----
Allowance for Doubtful Accounts $ - $2,152,070 - $ - $2,152,070
========= ========== ========= ========= ==========
S-1