Re: ALYD 10K - Part 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
X Annual Report under Section 13 or 15 (d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1997
Transition report under Section 13 or 15 (d) of the Securities
Exchange Act of 1934 (No fee required)
For the transition period from __________ to __________
Commission file number 0-13049
ALYDAAR SOFTWARE CORPORATION
(Name of Small Business Issuer in its Charter)
North Carolina 13-3006788
(State of Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2101 W. Rexford Road, Charlotte, North Carolina 28211
(Address of Principal Executive Offices) (Zip Code)
(704) 365-2324
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12 (g) of the Exchange Act:
Common Stock
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 past 90 days.
Yes X No_____
Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X
State the aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within the past 60 days. $173,952,160 as of March 30, 1998.
Documents Incorporated by Reference: See Footnotes to Exhibits
PART I
Item 1. Business
Background
Alydaar Software Corporation ("Alydaar" or the "Company") is presently engaged in the business of providing software reengineering services specializing in the correction of existing mainframe computer software systems to manage the year 2000 and thereafter.
Alydaar was founded in 1982 as a Utah corporation under the name of Enertronix Corporation ("Enertronix"). In 1992 Enertronix changed its name to Alydaar. Alydaar later changed its corporate domicile to North Carolina through a same day merger with and into a North Carolina corporation, Daar Corporation, established by Alydaar for that express purpose. Alydaar became the surviving corporation.
The Company commenced business in 1992. Initially, the Company focused on research and development of proprietary software known as SmartCode(R) ("SmartCode") to provide automated software re-engineering services specializing in computer language translation and systems migration. SmartCode is computer language and platform independent with the capability of understanding all computer language dialects, including multi-dialect languages such as PL/1, COBOL, Fortran and Natural. In 1994 and 1995, the Company performed software language translation services for such companies as The First Boston Corporation and Stratacom, Inc. In 1995 the Company concluded that SmartCode could be used for more complex tasks than language translation and devoted its efforts, utilizing the basic framework of SmartCode, to develop a proprietary detection and solution process to address the forthcoming year 2000 ("Y2K") problem (the "Y2K Problem").
The Y2K Problem arises from the fact that most software programs automatically assume the first two digits of any year reference are "19," and thus the year 2000 and thereafter will be read as "1900," "1901," and etc. If the software is not converted to correct the Y2K Problem, the two digit field "00" could result in improper calculations and, in many cases, cause programs not to work properly or cease to function. The Gartner Group, Inc., one of the leading technology and consulting firms, estimates that correcting the Y2K Problem ("Remediation") will involve expenditures by corporations and
governments ranging from $300 to $600 billion globally. The standard method employed in estimating the cost for Remediation is to determine the number of lines of code ("LOC") that are contained within each user's programs and multiplying it times a cost per LOC. Industry wide, the costs per LOC generally range from $.30 to $1.50. It is anticipated that such costs will increase significantly as the year 2000 approaches.
Worldwide, large business and governmental organizations rely on large-scale computer applications to help manage their businesses. These applications, many of which are mission-critical, contain the core knowledge and processes that support the major operations of these organizations. Examples of such applications include insurance claims processing systems, on-line banking systems, manufacturing systems and utility and telephone billing systems. These mission-critical applications primarily run on large, mainframe computers using programs written in a variety of mainframe programming languages. Most of these applications must be remediated to become Y2K compliant.
Because most businesses, large or small, and governments rely on "mission-critical" software to operate their core business functions, failure to correct latent Y2K software problems will result in malfunction of these essential processes. The result of these malfunctions can range from incorrect customer billings to complete shutdown of the companies' operations. Therefore, there is no alternative to addressing and eliminating the latent defects.
Between 1995 and the first quarter of 1997, the Company devoted all of its efforts to extensive research in order to perfect SmartCode as a cost effective and fully automated, artificial intelligence-based solution to the Y2K Problem. The goal was to develop SmartCode and a scalable and repeatable methodology which would not be disruptive or interfere with the operations of a client's normal business processes.
As a result of the research and development, the Company has now developed a Remediation solution to the Y2K Problem utilizing SmartCode to automatically identify and remediate a client's Y2K Problem. Most importantly, SmartCode can automatically remediate at least 15 different computer languages and dialects. It is this latter capability which presently distinguishes Alydaar from its competitors, who mainly have automated solutions to remediate the computer language COBOL only. The Company believes that its automated Remediation capabilities for computer languages other than COBOL gives it a competitive advantage.
Alydaar's approach to Y2K services consists of a step-by-step process starting with a methodology for extraction of the clients' software programs which the clients deem necessary to correct and delivery of this code to Alydaar. Once Alydaar receives the programs, they are processed and corrected and then sent back to the clients for testing and reintroduction back into the clients' production system. Since all Remediation is performed at the Company's facilities, the Company believes that it is saving its clients time and money by not using the clients' valuable computer resources and personnel during Remediation. Each step of Alydaar's factory process is controlled by procedures and checks to insure the most accurate results possible. In addition, extensive use of Alydaar's proprietary SmartCode software reduces manual corrections to the minimum extent practicable resulting in a low defect rate on code returned to the client. Because of Alydaar's approach, a minimum amount of client software must be changed.
Present Operations
Since the second quarter of 1997, the Company has been engaged full time in performing Remediation services pursuant to contracts with various corporations as well as state governments. Prior to the Company actually providing its services, the client is required to package its software in accordance with Alydaar's Guide to Packaging. Once the client's software is received at Alydaar and properly compiled, there are five phases involved in the Remediation process. In Phase One, SmartCode scans a client's code and automatically identifies the areas for Remediation. Once this is completed, Phase Two is triggered, which involves the manual verification of the Phase One results. Phase Three involves an automatic process that inserts code that corrects the Y2K Problem. Phase Four involves another manual verification of the output of Phase Three. Finally, Phase Five involves an automated quality check to insure that the client's modified code is syntactically correct. The entire process, depending upon the size of the client's applications and the computer language(s) present, can take from three to eight weeks for completion.
Once the Company has completed its Remediation, the remediated software is returned to the client. The client generally has sixty (60) days to test the code to identify any Y2K issues, which the Company will then correct free of charge. The Company prides itself on the fact that its error rate at the current time is approximately 2.7 errors per 1,000,000 lines of code, which the Company believes is substantially lower than the prevailing market average. The Company's low error rate serves to attract customers because they believe Alydaar's process reduces testing time and costs. The Company believes that it can further improve on its error rate through additional stringent quality controls.
The standard contract employed by the Company generally requires payment of an initial percentage of the contract price after receipt and count of the client's code, a further percentage upon delivery of the code back to the client and a remaining small percentage at the end of the testing period. At the inception, the Client is quoted a price for each LOC which can vary as a result of the number of LOC and the complexity of the undertaking.
In addition to normal Remediation services, the Company also provides auditing services. The auditing services involve a review by the Company, through SmartCode, of a client's software which has been remediated either internally or by a third party. Many companies that have performed internal Remediation are beginning to question the accuracy of their own Remediation and are now looking for third-party validation. The Company believes that confirming the accuracy of already remediated software will become a significant source of revenues in the future.
For the year ended December 31, 1997, the Company performed services under 41 contracts, many with major corporations. Some of Alydaar's clients included E.I. Dupont DeNemours & Co., 3M Corporation, British Airways PLC, AER Lingus, Ltd., Nabisco, Inc., R.J. Reynolds Tobacco Company, and Smith Barney, Inc.
Marketing
Over the last few years, computer-dependent companies and the government have generally been slow to address the Y2K Problem for a variety of reasons. To date there has been a general lack of awareness of the pending problem, an unwillingness to admit that a potential problem exists or an unwillingness to immediately address the problem because of the high costs that must be taken as an expense in the year in which the costs are incurred, which could materially affect a company's earnings. As a result, many companies and governments have failed to budget for an expenditure that could be substantial. Many companies and governments are just now beginning to address the Y2K
Problem.
The Company currently conducts direct sales through sales offices located throughout the United States and Europe with a staff of 25 salespeople. The salespeople receive both a base salary and a commission. Names of potential corporate clients are obtained through a variety of sources, including master databases which the Company has purchased from various sources. The Company also markets its services through advertising in major trade magazines, attendance at various trade shows and telemarketing.
The Company has recently introduced a sales promotion whereby the Company demonstrates SmartCode's Remediation capabilities by remediating 10,000 LOC at no charge to a prospective client. In this way, the Company introduces its services to prospective clients to determine if their software requires Remediation or to provide a free check on the accuracy of any previous Remediation performed by the prospective client or a third party. This new program has generated interest in Alydaar's services and resulted in new contracts.
The scalability of the Company's Remediation process enables it to service clients with as little as 1,000,000 LOC or clients with 100 million or more LOC within the same time period. The Company currently targets companies with more than $500 million or more in revenues or companies or governmental agencies which have a Y2K budget of $1,000,000 or more. While the Company has been successful in obtaining contracts following this marketing strategy, there can be no assurance that the Company will be successful in the future. (See "Risk Factors - Uncertainty of Current and Future Demand for Y2K Solutions".)
In addition to direct marketing, the Company has entered into business arrangements with several other computer software service providers under which those providers recommend Alydaar for code Remediation services. In return the providers receive either a discount to Alydaar's list prices or a commission.
In October 1997, Alydaar entered into a one-year agreement with Compuware Corporation ("Compuware"). The agreement calls for Alydaar to perform Remediation services as a subcontractor for Compuware's customers. Compuware is a major provider of Y2K testing products and services with at least 11,000 customers worldwide. Under the arrangement, Alydaar will receive a percentage of its normally quoted list prices for such services. The Company has already received several significant contracts through Compuware's recommendation and believes that this relationship will produce significant revenues in the future.
The Company also markets its services internationally through its wholly owned subsidiary, Alydaar International Ltd. ("Alydaar International"), which the Company acquired in July 1997. Prior to the acquisition, Alydaar International marketed the Company's services through an exclusive arrangement which permitted the use of the name "Alydaar" for the United Kingdom and certain other designated European countries. The subsidiary was acquired by an exchange of stock and the issuance of warrants and was accounted for as a purchase transaction. (See "Financial Information - Footnotes to Audited Financial Statements").
To further expand its international business, the Company has also entered into marketing alliances with computer services organizations to market Alydaar's services in countries not covered by the Company's direct sales. These countries include South Africa, Australia, New Zealand, Monaco (for Poland), Switzerland, Norway, Sweden and Denmark. These alliances generally provide for the companies to market Alydaar's Y2K services to their customers and receive a commission or discount to list prices.
The Company also intends to target European financial institutions and other affected businesses for an automated solution to the conversion of software for the change of the various European currencies to the "Euro" which is anticipated to begin by January 1, 1999. The Gartner Group Inc. estimates that the changeover to the "Euro" will cost $150 Billion to $400 Billion to upgrade existing computer systems for financial institutions, other businesses and governments. There can be no assurance that the Company will be able to effectively penetrate this market since at the present time the Company is still in the process of developing a SmartCode tool for the conversions and as such may not be successful. In addition, competitors may be much further advanced in their development of an effective solution and may be able to introduce their solution earlier than Alydaar can.
Competition
The Company is confronted with two distinct levels of competition: other companies that compete directly with Alydaar by offering other types of Remediation and software services and those companies which use their internal technical staff to complete Remediation.
On the first level, the Company presently competes with companies which are much better established, more widely known, have been offering computer software services for a much longer period and have far greater resources than the Company. Some of the Companies are International Business Machine, Inc., Computer Associates International Inc., Computer Horizons, Inc. and Keane, Inc. In addition, within the last six months, there has been a proliferation of new companies claiming to have Remediation capabilities. The Company does not believe that these new emerging companies pose a significant competitive threat to the Company's success because they appear inadequately staffed, and, as yet, have no proven track record. However, there is always the possibility that some of these companies could be successful and therefore could pose competition for the Company.
The second level of competition arises from the fact that many large businesses plan to do their own Remediation by using their own personnel and licensing of Remediation "tools" which are marketed by certain vendors such as Viasoft, Inc. and Peritus Software Services, Inc. While this poses significant competition, the Company believes that as its services and reputation become better known in the marketplace, companies that are now considering in-house Remediation may decide to use the Company's services. In addition, the Company believes that companies using internal staff who are not familiar with the Y2K Problem might fail in their efforts, which might create opportunities for the Company to provide its services. The Company believes that it can successfully demonstrate that its Y2K approach is a more cost-efficient and time expedient solution, especially when the Company's error rate demonstrates that the customer could possibly eliminate or minimize unit testing.
Personnel
As of December 31, 1997 the Company had 260 employees. Additionally, the Company had 43 contract programmers working at its site. The contract programmers were supplied by independent agencies and Alydaar has the option to hire these programmers as full-time Alydaar employees after a six-month period of time. Of the workforce, 178 individuals are engaged in production, 62 in research and development, 25 in sales, and the balance of 38 in administration and systems support.
The Company recognizes that it may require more employees as business increases. To date, the Company has been successful in recruiting qualified personnel principally within the Southeastern United States and, as such, the Company believes for the near future it will be able to satisfy its requirements from this labor pool. (See "Risk Factors - Dependence on Key Personnel.")
Patents, Trademarks and Intellectual Property
The Company holds registered trademarks in the United States for Alydaar(R) and SmartCode(R) and has filed for protection of these trademarks in Europe.
In addition, Alydaar relies on a combination of copyright, trade secret and trademark laws, and contractual provisions to establish and protect its rights to its proprietary technology. The Company protects the source code version of its products as a trade secret and as an unpublished copyrighted work. In addition, the Company has adopted stringent internal security measures. Despite these precautions, it may be possible for unauthorized parties to copy certain portions of the Company's software or reverse engineer or obtain and use information that the Company regards as proprietary. The Company has no patents and existing copyright and trade secret laws offer only limited protection. (See "Risk Factors - Inability to Protect Proprietary Rights".)
Future Plans and Strategy
The Company recognizes that the life cycle of the Y2K business is limited. While computer industry experts, such as the Gartner Group, Inc., estimate that the Y2K business will continue at least through the year 2003 because the limited amount of time remaining before January 1, 2000 is forcing companies and governmental authorities to focus their immediate efforts on remediating only their "mission critical" systems, the Company anticipates that there will be a decline in the volume of Y2K business after the year 2000. Therefore, in view of the short life-cycle, the Company has developed an agressive acquisition strategy to acquire companies which are engaged in the business of providing a broad range of computer services and products to position the Company for continued growth after the year 2000. At the present time, the Company is engaged in preliminary discussions with several acquisition
candidates. The Company believes that the current general trend is for large companies to retain independent contractors to manage and to take responsibility for day-to-day operations of their Information Technology departments, which is known as "Outsourcing" or "Systems Integration." The Company intends to position itself as an outsourcer or systems integrator through its acquisition strategy
and also by leveraging existing client relationships. Utilizing SmartCode, the Company believes that it can automate many of the outsourcing processes and tasks, and, as a result, achieve a significant competitive advantage and increased profit margins from outsourcing. However, there can be no assurance that the Company will be successful in its acquisition strategy or penetrating other markets. Moreover, such acquisition strategy will be dependent upon the ability of the Company to raise sufficient additional capital through internal cash flow or debt or equity offerings. There can be no assurance that the Company will be successful in raising such additional capital. (See "Risk Factors - Future Acquisitions" and "Risk Factors - Technological Changes" and "Dependence on Acquisitions.")
In addition, the Company currently has approximately 60 of its employees engaged in research and development activities, including the further adaptation of SmartCode to offer additional software re-engineering services, such as conversion of the European currencies into the "Euro" as described above; conversion of financial institutions' software for the mandated conversions from fractions to decimals for stock transactions; and to offer sophisticated language translation services such as converting software code from COBOL 68 to COBOL 370.
Risk Factors
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth below and elsewhere in this Annual Report on Form 10-K. In evaluating the Company's business, prospective investors should carefully consider the following factors in addition to the other information presented in this Annual Report.
- Continuing Losses
For each year from December 31, 1994 to December 31, 1997, the Company's financial statements have reflected operating losses, and as of December 31, 1997, the Company has an accumulated deficit of $14,094,107. There can be no assurance that the Company will ever achieve an operating profitability on a quarterly basis, or if achieved, whether the Company will be able to sustain an operating profitability in the future.
- Possible Fluctuation of Operating Results
The Company has experienced fluctuations in revenues. These fluctuations are due, in part, to the fact that the Company only began to generate significant revenues in the second quarter of 1997, when it began to receive deliveries of LOC for Y2K Remediation services. The timing of completion of customer engagements, especially at or near the end of any accounting period, could cause variations in operating results from period to period and could result in quarterly losses. In addition, the Company has experienced, and expects to experience in the future, delays arising from the inability of clients to extract and correctly package software from their mainframe systems. These delays could result in variations in operating results during quarterly and year-end periods. Finally, variations in operating results may occur as a result of a number of other factors such as employee hiring, demand for the
Company's services, competitive conditions in the industry, foreign currency exchange rates, changes in pricing policies by the Company or its competitors, and the amount expended for research and development.
- Intense Competition
The market for the Company's Y2K services is intensely competitive at two different levels: Remediation performed in-house and Y2K Remediation software and services offered by direct competitors of the Company, many of whom are better established and have far greater resources than the Company. Likewise, the solutions for Y2K Remediation are characterized by rapid change in technology and user needs and the frequent introduction of new products. (See "Description of Business - Competition.")
- Uncertainty of Current and Future Demand for Y2K Solutions
The Company is currently focusing all of its efforts on the marketing and sale of its Y2K services. Although the Company believes that the market for solutions to the Y2K Problem will grow significantly as the year 2000 approaches, there can be no assurance that this market will develop to the extent anticipated by the Company. In addition, organizations affected by the Y2K Problem may not be willing or able to allocate the financial or other resources required to address the problem in a timely manner. Many organizations may attempt to resolve the problem internally rather than purchase tools and services from outside firms such as the Company. Due to these factors, development of the market for the Y2K Problem is uncertain and unpredictable. If the market fails to increase, or increases more slowly than anticipated, the Company's business, operating results and financial condition could be materially and adversely affected. Furthermore, the demand for Y2K products and solutions is likely to diminish rapidly after the year 2000. As a result, the Company could experience a significant decline in revenues, unless it is able to leverage customer relationships and knowledge of customer systems derived from Y2K services to market other products and services beyond the year 2000. There can be no assurance that the Company will be able to replace revenues related to Y2K services and solutions after the year 2000. (See "Business - Future Plans and Strategy.")
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