INTELLIGENT SYSTEMS CORP (INS)
Annual Report (SEC form 10-K)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
March 30, 2000
All statements, trend analysis and other information contained in the following discussion relative to markets for our products and trends in revenue, gross margins and anticipated expense levels, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," and "intend" and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business and economic risks and uncertainties, and our actual results of operations may differ materially from those contained in the forward-looking statements.
In August 1998, our HumanSoft subsidiary discontinued certain product lines and, in November 1998, filed a petition for relief under Chapter 11 of the federal bankruptcy code. Although HumanSoft emerged from Chapter 11 in November 1999, since the original 1998 filing date, only the QS Technologies subsidiary of HumanSoft has continued to develop and sell software products and services to the public health market. Also, effective February 1, 1999, we sold our InterQuad Services company and thus do not consolidate the results of InterQuad's operations since the sale date. Much of the variance in operating results between 1999 and 1998 can be attributed to these two transactions.
RESULTS OF OPERATIONS
SUMMARY OF OPERATING RESULTS - Our ongoing consolidated subsidiaries are ChemFree Corporation (bio-remediating parts washers), QS Technologies (health and human services software) and PsyCare America (specialty psychiatric treatment programs). The net loss from operations in 1999 was significantly lower than in 1998 principally because we sold or discontinued the HumanSoft and InterQuad businesses, which had sustained large losses in 1998, and because our remaining
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consolidated companies are operating at break even or generating slight profits. Operating losses in 1999 are principally corporate overhead and expenses related to the technology incubator program.
SALES - Net sales in 1999 were $8,479,000, a decline of 54 percent compared to 1998. Almost 80 percent of the decrease is related to the sale of the InterQuad Services business in early 1999 and the discontinuation of certain HumanSoft operations. The QS Technologies subsidiary of HumanSoft continues to generate license and maintenance revenue from software products and services. ChemFree experienced an increase in revenue while PsyCare's revenue declined as the firm closed certain hospital programs and moved to a licensing arrangement with more of its programs. Under the licensing arrangement, although revenue billed declines, expenses associated with the programs also decline.
Net sales in 1998 were $18,253,000, a decline of 14 percent compared to 1997. The decrease is related to the sale of the Intelligent Enclosures business in early 1998 and the continued decline in revenue derived from the PsyCare operations, offset in part by an increased volume of products and services at ChemFree and InterQuad. In the last quarter of 1998, HumanSoft's contribution to our revenue was substantially lower than in prior periods as a result of discontinuing two product lines and the Chapter 11 bankruptcy filing.
Health care services revenues represent 21 percent, 23 percent and 29 percent of the total revenues for 1999, 1998 and 1997, respectively. The decline in the contribution of the health care services is due to fewer inpatient programs, lower reimbursement rates and a shift to licensing arrangements at the PsyCare subsidiary. Revenue derived from international sales was 16 percent in 1999 compared to 39 percent in 1998 and 33 percent in 1997. The decrease in 1999 compared to prior years is a direct result of the sale of the InterQuad Services group, the revenue of which was all international.
COST OF SALES - In 1999, cost of sales was 47 percent of revenue compared to 68 percent in 1998. The change is due to the fact that both InterQuad Services and the discontinued HumanSoft operations had much higher cost of sales than do the continuing operations. Cost of sales for the continuing operations was not significantly different in 1999 compared to 1998.
Cost of sales in 1998 was 68 percent of revenue compared to 62 percent in 1997. Although ChemFree, InterQuad and PsyCare reduced their respective cost of sales as a percentage of revenue in 1998 as compared to 1997, HumanSoft's cost of sales increased dramatically. For much of 1998, HumanSoft's expenses increased significantly for technical personnel to develop, install and support software for which the company was unable to record sufficient new revenue.
OPERATING EXPENSES - In 1999, marketing expenses declined in both absolute terms and as a percentage of revenue compared to 1998. Again, much of the year-to-year change is attributed to the sale of the InterQuad Services group and the discontinuation of HumanSoft operations. In addition, PsyCare decreased its marketing expenses in line with lower revenue from hospital based programs although it is likely to increase marketing expenditures slightly in the future as it introduces new services. General and administrative expenses were $3,469,000 compared to $7,346,000 in 1998. Almost 70 percent of the year-to-year change is due to the sale of InterQuad Services and the downsizing of the HumanSoft operation. Included in the 1999 results are non-recurring administrative and legal expenses totaling $156,000 related to the HumanSoft bankruptcy case. In addition, in 1999 PsyCare reduced its facility and personnel expenses and ISC's corporate expenses were lower as well, mainly due to lower personnel expenses. Research and development expense declined in 1999 compared to 1998 principally because of the downsizing of the HumanSoft operation. The QS Technologies and ChemFree subsidiaries continue to invest in new product development efforts.
In 1998, marketing expenses declined in absolute terms but increased as a percentage of revenue compared to 1997. This change represents the net effect of increased expenditures in the technology sector to support more customers and higher revenue levels offset by a decline in marketing spending at PsyCare due to a decline in in-patient hospital programs. Furthermore, in contrast to the prior period, in 1998 we include the operating expenses related to two acquired companies, JK and QS, for the full year. General and administrative expenses were $7.3 million in 1998 compared to $7.6 million in the prior year. PsyCare reduced expenses significantly through lower staffing levels and expense control, as did our corporate group. At the same time, however, general and administrative expenses at HumanSoft increased significantly. The increase includes a third-quarter charge of $955,000 to discontinue two product lines, a $191,000 restructuring charge in the first quarter following the JK acquisition, and increased amortization expense related to the acquisitions. The $955,000 charge includes a goodwill write-off of $558,000. Research and development expense for 1998 includes a one-time expense of $944,000 to allocate a portion of the JK purchase price to in-process research and development as well as increased new
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product development spending in the first 8 months of this year. By comparison,
in 1997, R&D expense includes a one-time charge of $953,000 to allocate a
portion of the QS purchase price to in-process research and development.
INTEREST INCOME - In 1999, we had net interest expense of $88,000 compared to net interest expense of $289,000 in 1998 and net interest income of $350,000 in 1997. In 1999, interest expense associated with InterQuad Services was lower than in 1998 and the domestic operations paid less interest on notes payable to third parties because there was a lower level of debt in 1999 as compared to 1998. In 1998, we had interest expense on notes payable principally to the sellers of QS and JK as well as interest on a higher level of bank debt in 1998 than in 1997. We also earned less interest on interest-bearing notes receivable because some of the notes were repaid early in 1998.
INVESTMENT INCOME - In 1999, we recorded net investment income of $1.2 million compared to net investment income of $5.8 million in 1998 and a net investment loss of $2.6 million in 1997. The main components of investment income in 1999 include gains totaling $1.2 million on the sale of certain equity holdings in three private software companies, a gain of $995,000 on the sale of our holdings in MediaMetrix stock and $948,000 in net losses in the equity of affiliates accounted for by the equity method. Refer to Note 3 for details on the sale transactions mentioned in this section.
The main components of 1998 investment income include a gain of $1.0 million on the sale of IQ Software common stock, a gain of $2.5 million on the sale of PaySys stock, a gain of $457,000 on the sale of Paragon Interface stock, a gain of $1.2 million on the sale of the IE business, and $593,000 in net gains in the equity of affiliates accounted for by the equity method. Refer to Note 3 for details on the sale transactions mentioned in this section.
In 1997, we recorded a net loss of $2.6 million on investments. The principal components of this category include a gain of $1.9 million on the sale of PaySys stock (see Note 3), a gain of $469,000 on the sale of an investment in Astra Communications, a gain of $217,000 on the sale of OrCAD stock (see Note 3), a $3.0 million write-off of a note receivable from DayStar Digital, Inc. and $2.3 million in net losses in the equity of affiliates accounted for by the equity method.
OTHER INCOME - Other income/expense in each of the last three years consists mainly of various minor, non-recurring sources of income and expense. However, in 1999, this category includes a net non-recurring charge of $141,500 related to final settlement of the amounts owed to creditors in the HumanSoft bankruptcy case.
TAXES - We had no income tax expense in 1999 because investment gains were offset by capital loss carryforwards. We recognized a tax benefit in 1998 due to a net operating loss carryback at the JK, Inc. subsidiary. Taxes payable in 1997 relate to the operations of the QS, Inc. subsidiary acquired in 1997.
COMMON SHARES - In 1999, the exercise of a stock option to acquire 10,000 shares increased the number of shares outstanding at year-end to 5,114,467.
YEAR 2000 READINESS - In preparation for potential problems arising from the inability of certain computer programs to correctly interpret dates designated as "00" as the year 2000 rather than the year 1900, we reviewed our internal computer-based systems, inquired of our key vendors and suppliers as to their Year 2000 readiness and upgraded all non-compliant internal systems. Our QS Technologies subsidiary licenses software to its customers and either migrated its customers to software versions that we believe are Year 2000 compliant or had previously informed customers that certain older software versions would no longer be supported. Our cost to address internal compliance updates was well under the anticipated level of $100,000. To date, we have not experienced any impact on our operations or financial position as a result of the Year 2000 issue nor are we aware of any problems that might arise. However, we have investments in a number of companies over which we do not exercise control. To the extent that any company in which we have a significant investment experiences a material negative impact on its business, the long-term value of our investment could be reduced.
LIQUIDITY AND CAPITAL RESOURCES
With respect to continuing operations, in 1999 we derived $902,000 cash from the sale of our remaining holdings in Information Advantage (formerly IQ Software), $416,000 cash from sales of part of our holdings in two privately held software companies and $1.1 million cash from the sale of our holdings in MediaMetrix, Inc. During the year, we drew down a total of $1.25 million under a bank line of credit which was paid down subsequently to $100,000 at year-end 1999.
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We used approximately $1.1 million cash in 1999 to pay down short-term notes payable to third parties (not including banks), $845,000, net, for investments in new businesses or follow-on funding for prior investments, and $310,000 for payments for legal expenses and creditor settlements under the confirmed Plan of Reorganization of HumanSoft. Significant changes year-to-year in accounts receivable, property plant and equipment, notes payable, accounts payable, and other current assets and liabilities are due principally to the sale of InterQuad Services in February 1999 and the de-consolidation of assets and liabilities of the former subsidiary.
In 1998, we derived most of our cash from the sale of common stock of IQ Software (now Information Advantage) for $1.2 million, the sale of our interest in Paragon Software and payment of a Paragon note for a total of $989,000, the sale of shares of common stock of PaySys for $2.5 million, advances of $750,000 under a bank loan at the InterQuad subsidiary, and a net cash return of $589,000 on another minority investment. Details on these sales are found in Note 3. We used approximately $5.3 million cash in 1998 to fund operating losses at certain subsidiaries (the majority of which relates to the HumanSoft operation), $200,000 for the initial payment related to the acquisition of JK, $700,000 to repay a domestic bank line, and $500,000 for a principal payment on a note related to the acquisition of QS. Accounts receivable are lower at December 31, 1998 than at December 31, 1997 mainly because of improved collection activity, lower revenue levels at the PsyCare subsidiary and reserves taken at the HumanSoft subsidiary related to the decision to discontinue certain product lines.
We believe we have adequate funding for anticipated cash needs for the foreseeable future. Subsequent to year end, on March 21, 2000, we sold the majority of our holdings in Risk Laboratories for $8.8 million in cash. In addition, we have the right to require the purchaser to acquire our remaining 7% interest in Risk Laboratories from us at various time periods in the next two years for approximately $2.4 million cash. Refer to Note 19 for further details. Furthermore, as a result of the acquisitions by public companies of two of our investments, 2order.com and VerticalOne, we now hold common stock of the two public companies. These holdings represent additional sources of liquidity either through borrowings secured by a pledge of the stock or by selling the stock in the public market, subject to certain short-term holding period restrictions. As explained in Note 1 to the Consolidated Financial Statements, a substantial deterioration in the financial condition of companies in which we have significant long-term investments could have an adverse effect on the company. Conversely, developments at one or more of these companies which result in a liquidity event, such as an initial public offering or acquisition, could impact our financial condition in a positive manner.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section of this report. See page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
No independent public accountant of the company has resigned, indicated any intent to resign or been dismissed as the independent public accountant of the company during the two years ended December 31, 1999 or at any time afterward. |
