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To: sibe who wrote (5598)	4/9/1998 11:05:00 PM
From: Jeffrey S. Mitchell	Read Replies (3) \| Respond to of 10786

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.") [continued]

To: sibe who wrote (5598)	4/9/1998 11:10:00 PM
From: Jeffrey S. Mitchell	Read Replies (1) \| Respond to of 10786

Re: ALYD 10-K - Part 2 - Dependence on Acquisitions In order for the Company to sustain its growth and viability after the year 2000, the Company intends to acquire companies which offer a broader range of computer services and products. There can be no assurance that the Company will be able to complete any such acquisitions. Moreover, the Company will require additional capital to finance such acquisitions and there can be no assurance that the Company will be successful in raising additional capital. (See "Business - Future Plans and Strategy.") - Inability to Protect Proprietary Rights The Company regards its software products and solutions as proprietary and attempts to protect them under a combination of copyright, trade secret and trademark laws as well as by contractual restrictions on employees and third parties. Despite these precautions, it may be possible for unauthorized parties to copy the Company's software or to reverse engineer or otherwise obtain and use information the Company regards as proprietary. The Company has no patents, and existing trade secret and copyright laws provide only limited protection. Certain provisions of the client agreements generally used by the Company, including provisions protecting against unauthorized use, copying, transfer and disclosure, may be unenforceable under the laws of certain jurisdictions, and the Company is required to negotiate limits on these provisions from time to time. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that the steps taken by the Company will be adequate to deter misappropriation of proprietary information or that the Company will be able to detect unauthorized use and take appropriate steps to enforce its intellectual property rights. Significant and protracted litigation may be necessary to protect the Company's intellectual property rights, to determine the scope of the proprietary rights of others or to defend against claims for infringement. Although the Company is not currently involved in any litigation with respect to intellectual property rights, infringement claims against software developers are likely to increase as the number of functionally similar products in the market increases. There can be no assurance that third-party claims, with or without merit, alleging infringement will not be asserted against the Company in the future. Such assertions can be time consuming and expensive to defend and could require the Company to cease the use and sale of infringing products and services, to incur significant litigation costs and expenses and to develop or acquire non-infringing technology or to obtain licenses to the alleged infringing technology. If an infringement claim against the Company were successful, there can be no assurance that the Company would be able to develop or acquire alternative technologies or to obtain such licenses on commercially acceptable terms. (See "Business - Patents, Trademarks and Intellectual Property.") - Dependence on Major Customers During fiscal 1997, 3M Corporation, Science Applications International Corporation (SAIC) and GE Capital Global Consumer Finance LTD accounted for 14%, 12% and 9% of the Company's revenues, respectively. The Company believes that these customers may require additional Remediation services for other divisions in the future, but these companies are not obligated to use the Company's services exclusively. As such, the Company may not receive future work orders from those customers, which could affect the Company's future revenues. However, at the present time, the Company's customer base has broadened. Therefore, the dependence on these large customers is decreasing, but the loss of these relationships could affect Alydaar's future strategy after the year 2000. - Risks from International Operations Approximately 32% of the Company's total consolidated revenues for the year ended December 31, 1997 were attributable to international sales. The Company believes that international business will account for a significant portion of its revenues in the future. International operations are subject to a number of risks, including possible exchange rate fluctuations and difficulty in enforcing agreements and collecting accounts receivable. The Company intends to mitigate its exchange rate risk by requiring payment in US dollars. In addition, the laws of certain countries do not protect the Company's products and intellectual property rights to the same extent as do the laws of the United States. There can be no assurance that the factors described above will not have an adverse effect on the Company's future international revenues and, consequently, on the Company's business, results of operations and financial condition. (See "Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations" and "Business - Sales, Marketing and Distribution.") - Dependence on Key Personnel The Company's success will depend, in part, upon the retention of key senior management and technical personnel. At the present time the Company does not have employment agreements with its key personnel, nor does it maintain key man life insurance on any of these persons. Further, the Company's success will also depend in part on its ability to hire and retain skilled technical personnel. Although the Company believes it will be able to hire such skilled technical personnel, an inability to do so could materially adversely affect the Company's ability to deliver and enhance its services. - Ability to Manage Change and Rapid Growth The Company expects its business to continue to undergo rapid growth and expansion. If the Company experiences such rapid growth and expansion, the Company's profitability will depend on, among other things, its ability to manage a larger number of personnel and to handle those problems normally associated with rapid growth. - Possible Volatility of Stock Price The Company's stock price has been highly volatile since it first started trading. The Company believes that factors such as awareness of the Y2K Problem, quarterly fluctuations in results of operations, announcements of new acquisitions by competitors, change in revenue or earnings estimates by securities analysts or other factors may cause the market price of the Company's stock to continue to fluctuate, perhaps substantially. In addition, stock prices for many technology companies fluctuate widely for reasons that may be unrelated to operating results. Due to market and securities analysts' expectations of continued growth and the higher price/earnings ratio at which the Company's stock may trade, any shortfall in meeting such expectations may have a rapid and significant adverse effect on the trading price of the Company's stock. Fluctuations in the market price of the Company's stock may, in turn, adversely affect the Company's ability to complete any targeted acquisitions, its access to capital and financing and its ability to attract and retain qualified personnel. (See "Market for the Company's Common Stock.") - Influence by Existing Shareholder Mr. Gruder, the Chief Executive Officer and President, is presently the beneficial owner of approximately 40% of the outstanding shares of the Company's Common Stock. As such, Mr. Gruder is in a position to influence the election of directors and generally to direct the affairs of the Company. - Unlikely to Declare Dividends The Company has never declared or paid cash dividends on its capital stock and does not anticipate paying any cash dividends in the foreseeable future. The Company currently anticipates that it will retain future earnings, if any, to fund the development and growth of its business. - Forward-Looking Statements and Associated Risks This Annual Report on Form 10-K contains certain forward-looking statements, including (i) the potential size of and anticipated growth in the Y2K compliance market; (ii) anticipated trends in the Company's financial condition and results of operations (including expected changes in the Company's gross margin and general, administrative and selling expenses); (iii) the Company's business strategy for growth in its business for Y2K compliance, and (iv) the Company's ability to distinguish itself from its current and future competitors. These forward-looking statements are based largely on the Company's current expectations and are subject to a number of risks and uncertainties. In addition to the other risks described elsewhere in the "Risk Factors" discussion, important factors to consider in evaluating such forward-looking statements include (i) the shortage of reliable market data regarding the market for Y2K solutions; (ii) changes in external competitive market factors which might impact trends in the Company's results of operations; (iii) unanticipated working capital or other cash requirements; (iv) changes in the computer hardware and software industries and the Y2K solutions market; and (v) various competitive factors that may prevent the Company from competing successfully in the marketplace. In light of these risks and uncertainties, many of which are described in greater detail elsewhere in this "Risk Factors" discussion, actual results could differ materially from the forward-looking statements contained in this Annual Report on Form 10-K. Item 2. Properties The Company presently leases office space to house its operations under four different leases in two office complexes, one located at 2101 Rexford Road, Charlotte, North Carolina and the other located at 2201 Water Ridge Parkway, Charlotte, North Carolina. The leases at 2101 Rexford Road all expire between August 31, 1998 and November 15, 1998. The Company has made arrangements to extend these leases through January 31, 1999. The lease at 2201 Water Ridge Parkway expires October 31, 2000. The Company intends to relocate to one central location by January 31, 1999 and is currently in negotiations to sublet the 2201 Water Ridge Parkway facilities after February 1, 1999. The Company is currently paying a total annual rent under all of these leases of $799,276.00. In addition, the Company leases space for twelve sales offices located throughout the United States and in England. The following is a description of the leases and annual rent: Location Expires 1 Annual Rent -------- ------- ----------- 1. Atlanta, GA 6-30-98 $ 7,800.00 2. Denver, CO 7-31-98 $ 16,800.00 3. Detroit, MI 9-14-98 $ 10,908.00 4. Los Angeles, CA Month to Month $ 11,340.00 5. Minneapolis, MN 8-30-98 $ 13,800.00 6. Oakbrook Terrace, IL 7-31-98 $ 14,376.00 7. Reston, VA 9-14-98 $ 17,160.00 8. Salem, NH 9-30-98 $ 6,000.00 9. San Francisco, CA 8-31-98 $ 16,800.00 10. Tampa, FL 7-31-98 $ 9,276.00 11. Surrey, UK 7-6-2000 $ 87,244.00 ----------- Total $211,504.00 ------------------- 1 All of these leases, with the exception of the Surrey, UK, lease, expire in 1998. It is the Company's intention to renew these leases for a fixed period or continue the leases on a month-to-month basis. Item 3. Litigation During the year ended December 31, 1997, there were two lawsuits pending against the Company's Chief Executive Officer, Robert F. Gruder ("Gruder") and the Company: Robert Colby v. Robert Gruder et al., Index No. CV 96 02542045, Superior Court (Conn.), Judicial District of New Haven at Meriden (the "Colby Lawsuit") and Andrew Kaplan et al. v. Robert F. Gruder et al., Index No. CV 96 03343085, Superior Court (Conn.), Judicial District of Fairfield at Bridgeport (the "Kaplan Lawsuit").Thomas J. Dudchik, Senior Vice President of the Company, is also named as a defendant in the Kaplan lawsuit. The Colby Lawsuit involved allegations that Mr. Gruder promised to provide Colby with shares of stock in Alydaar as reimbursement for a prior investment in GEM Technologies, Inc. ("GEM"), a company founded by Mr. Gruder and of which he was the principal shareholder. This matter was settled by Mr. Gruder on July 25, 1997, and the Company was released from any further liability. In connection with this lawsuit, Mr. Gruder had entered into an agreement to indemnify and hold harmless the Company from any liability. The agreement also provided that the Company would bear Mr. Gruder's and its own legal expenses, which the Company paid. (See "Certain Relationships and Related Transactions.") The Kaplan Lawsuit involves allegations by a group of former creditors of GEM of breach of contract and misrepresentations. The plaintiffs claim they were fraudulently induced to invest in GEM; that GEM wrongfully transferred assets to Alydaar and Alydaar promoted products based on technology misappropriated from GEM. The plaintiffs are seeking unspecified damages, but claim they are entitled to damages equal to a nine percent interest in GEM, and as such, some interest in Alydaar. This matter is expected to go to trial in April 1998. Both Mr. Gruder and the Company intend to vigorously defend this action and believe they have meritorious defenses to the action. Mr. Gruder has agreed to indemnify and hold harmless the Company in the event of a judgement against the Company. The Company has agreed to bear all costs of the litigation for itself and Mr. Gruder. Company's litigation counsel is of the opinion that in view of Mr. Gruder's agreement to indemnify the Company, the likelihood of a materially adverse outcome against the Company is remote. (See "Certain Relationships and Related Transactions.") Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to shareholders during the year ended December 31, 1997. [continued]

To: sibe who wrote (5598)	4/9/1998 11:18:00 PM
From: Jeffrey S. Mitchell	Read Replies (1) \| Respond to of 10786

Re: ALYD 10K - Part 3 PART II Item 5. Market for Registrant's Common Equity and Related Stock Matters The Company's Common Stock trades on the NASDAQ National Market ("National Market") under the symbol "ALYD." The Common Stock was admitted to trading on the National Market on December 3, 1997. Prior to that and from 1982 through December 2, 1997, the Common Stock traded on the Bulletin Board first as Enertronix and then as Alydaar. The following tables set forth the high and low bid prices for the Common Stock on the Bulletin Board and the high and low sales price on the National Market for the years ended December 31, 1996 and 1997. For Year Ended December 31, 1996 High Bid Low Bid 1st Quarter Ended March 31, 1996 $13.75 $ 1.125 2nd Quarter Ended June 30, 1996 $31.50 $10.375 3rd Quarter Ended September 30, 1996 $19.75 $10.25 4th Quarter Ended December 31, 1996 $16.125 $10.375 For Year Ended December 31, 1997 High Bid Low Bid 1st Quarter Ended March 31, 1997 $12.187 $ 9.25 2nd Quarter Ended June 30, 1997 $22.125 $ 8.00 3rd Quarter Ended September 30, 1997 $32.125 $19.00 Period Ended November 30, 1997 $22.50 $11.437 Period Ended December 31, 1997 1 $19.25 $14.125 --------------------- 1 The Company's Common Stock was admitted to trading on the National Market on December 3, 1997, and as such, the price reflects the high and low sales for the month of December, 1997. The tables set forth above were for periods as reported by the National Association of Securities Dealers Corporate composite feed and NASDAQ. The figures represent inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions. As of December 15, 1997, the approximate number of beneficial holders of the Common Stock of the Company was approximately 6,300, based on information received from the Company's transfer agent and those brokerage firms who hold securities for customers in "street name." The Company has not paid any cash dividends since its inception. By reason of its present financial status and contemplated future financial requirements, the Company does not anticipate paying any cash dividends in the foreseeable future. It is anticipated that earnings will be used to finance the Company's growth. (See "Risk Factors - Unlikely to Declare Dividends.") Item 6. Selected Financial Data Years Ending December 31st --------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Net Revenues $10,736,237 $37,500 $229,400 $160,400 $30,000 Payroll & Related $13,800,797 $3,598,307 $443,741 $235,593 $92,990 Net (Loss) from Opers ($7,797,167) ($5,132,845) ($580,148) ($304,466) ($196,730) Net (Loss) from Opers Per Common Share ($.51) ($.41) ($.05) ($.03) ($.02) Total Assets $18,866,474 $2,869,292 $133,195 $160,011 $24,723 Long Term Oblig $101,230 -0- -0- -0- -0- Cash Dividends -0- -0- -0- -0- -0- Prior to 1994, the operations of the Company were primarily related to research and development of computer language translation services: converting one computer language to another. Between 1994 and 1996, the Company directed its efforts to adapting SmartCode as an automated solution to the Y2K Problem. As such, the financial data is not truly indicative of future operating results. The Company only began to generate revenues from its Y2K Problem solution commencing with the second quarter of calendar 1997. Item 7. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations The following discussion should be read in conjunction with the "Selected Financial Data" and the other financial data appearing elsewhere in this Report. This 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 contained in Management's Discussion and Analysis and elsewhere in this Annual Report. Results of Operations - Revenues Net revenues earned for the year ended December 31, 1997 ("1997") and December 31, 1996 ("1996") approximated $10,736,000 and $38,000, respectively. The Company was essentially a research and development company during 1996 and through the first quarter, 1997. The Company began to generate revenues in the second quarter, 1997, from its proprietary, internally developed software solution for the Y2K Problem. During 1996, the Company's revenues decreased from $229,000 in 1995 to $38,000, because the Company's strategy changed during 1995, from marketing its language translation services to focusing all available resources on research and development of an automated factory solution for the Y2K Problem. Revenues earned during 1995 were from the completion of contracts awarded during 1994 for computer language translation projects. - Operating Expenses Operating expenses also experienced major increases from $5,199,000 in 1996 to over $19,218,000 in 1997, a 270% increase. The change from a research and development company in 1996 to an operating company in 1997 caused this dramatic increase in operating expenses. Also, Alydaar International, Ltd. ("Alydaar International"), as a result of the Company's acquisition, added $1,161,000 to operating expenses during 1997 for its cost of operations during the last half of 1997. Payroll and related benefit costs increased from $3,598,000 in 1996 to $13,800,000 in 1997, a 284% increase, as the Company added new personnel (from 194 people at December 31, 1996 to over 300 people at December 31, 1997) to meet the increase in sales volume. As such, the Company absorbed a full-year cost of the 1996 increase in personnel from 30 people at June 30, 1996 to 194 at December 31, 1996. Occupancy costs also increased by approximately $781,000 from 1996 to 1997, as the Company expanded its operating facilities (or "factory") capacity and opened over a dozen regional sales offices in the USA and UK during 1997. Advertising and promotion expenditures increased from approximately $215,000 in 1996 to $832,000 in 1997. This increase was due to increased marketing efforts by the Company's sales force via print, direct mail and telemarketing efforts and over $208,000 worth of demonstrations in 1997. Depreciation and amortization expense increased by $488,000, due in large part to the amortization of $6,719,000 of goodwill, which was recorded at the time of acquisition of Alydaar International, and the increase in the amount of property and equipment of $1,839,000. Bad debt expense was $311,000 in 1997, compared to no bad debt write-off or provision for losses in 1996. Other operating expenses increased $1,619,000 in 1997, due mostly to the significant increase in personnel, marketing and selling activities and expanded square footage occupied in 1997 versus 1996. Categories showing significant increases included travel, meals and entertainment expenses, which increased from $219,000 in 1996 to $747,000 in 1997; telephone expenses increased by $138,000 in 1997 from 1996 due to a significant increase in sales and marketing efforts during 1997 and increase in sales force from one person in 1996 to 22 people from August 1997 through the end of the year; office supplies and related expenses increased to $122,000 from $31,000 in 1996 due to increased personnel; professional fees, which increased $348,000 primarily due to legal fees incurred by the Company to defend against two civil actions filed against the Company in late 1996; computer supplies and related expenses increased $79,000; sales office expenses, including telephone, copying and similar expenses increased $57,000; and other administrative and operating expenses, including postage and employee training costs, increased by $378,000. Operating expenses increased from December 31, 1995 ("1995") to December 31, 1996 ("1996") by $4,396,000. Substantially all of this increase was caused by the Company's change in its business focus to provide a Y2K automated factory solution. Payroll and related costs increased by $3,154,000 in 1996, a 710% increase, as the Company added new personnel (from 10 to 194 people) required to staff its operating facility in Charlotte, North Carolina. Occupancy costs increased by $287,000 in 1996, a 859% increase, as additional space was obtained as the Company began its facility expansion efforts. Advertising expenses increased by $127,000, a 44% increase, as the Company embarked upon its print advertising campaign for Y2K solution. Other operating expenses increased $500,000, a 232% increase, due principally to the increase in number of square feet occupied and number of personnel. - Net Loss Net loss increased to $7,797,000 from $5,132,000 in 1996, a 52% increase, from 1996 to 1997, due to the Company's increased expenditures to increase its capacity during 1997. The Company experienced significantly slower flow of code from its customers than had been anticipated, particularly during the first three quarters of 1997, resulting in the loss from operations due to significant idle "factory" capacity. The increase in net loss from $580,000 in 1995 to $5,132,000 in 1996, a 785% increase, was due primarily to the Company's decision to add approximately 150 people during the last half of 1996 and to increase space occupied from 3,100 square feet to approximately 30,000 square feet during the first half of 1996. Liquidity and Capital Resources At December 31, 1997, the Company had working capital of $6,466,000 as compared to negative working capital of ($1,727,000) at December 31, 1996. The change from 1996 to 1997 was due primarily to an increase in accounts receivable of approximately $4,963,000 and an increase in costs and estimated earnings in excess of billings of approximately $1,298,000, which resulted from revenues primarily generated during the second half of 1997 of approximately $8,500,000. Cash increased to $1,527,000 from $379,000 at the end of 1996. The sources of cash were primarily sales of stocks and exercises of warrants and options, which provided $16,985,000, and loans from shareholders, net of repayments of $900,000, of $463,000. The uses of cash were primarily to fund net cash operating requirements of $14,291,000, purchase of equipment of $1,664,000 and a loan to Alydaar International of $300,000, which was made prior to acquisition. As of March 31, 1998, the Company is negotiating with a major financial institution to obtain a $5,000,000 revolving line of credit facility, which would be secured by its accounts receivable. The Company expects to complete the negotiations and to sign an agreement for the facility by the end of April 1998. Borrowings under the facility would be used for working capital requirements. Based on its current operating plan, the Company believes that its cash on hand and its cash flow from operations will be sufficient to meet its working capital requirements at least during the next twelve months. Foreign Operations On July 1, 1997 (the third quarter), the Company acquired 100% of the outstanding shares of Alydaar International, Ltd. ("Alydaar International") in exchange for 791,652 shares of the Company's Common Stock and the issuance of 207,152 Warrants plus the forgiveness of debt. This acquisition was accounted for as a purchase transaction. Accordingly, 100% of the revenues earned and expenses incurred by Alydaar International since the acquisition date, are included in the Consolidated Statement of Operations. From July through December 31, 1997, Alydaar International contracted sales accounted for approximately 30% of the total consolidated revenues recorded for the full year of 1997. The amount of sales made during the period which were subject to currency exchange rate adjustment was not significant. It is anticipated that the amount of future contracts generated by Alydaar requiring payment in foreign currencies will be immaterial in amount. Therefore, the currency exchange rate adjustment risk is expected to be insignificant. The Company does not view other risks inherent in international operations, such as political and regulatory, contractual enforceability, economic instability, etc., to have a material effect upon its foreign operations because its target customers are large, established companies which are domiciled in European Union countries or other countries which have stable governments and economies. Impact of Inflation The Company believes that inflation will not have a material impact upon its future operating results. Item 8. Financial Statements and Supplementary Data The financial statements and supplementary data commence on page F-1. Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable [continued]

To: sibe who wrote (5598)	4/9/1998 11:37:00 PM
From: Jeffrey S. Mitchell	Read Replies (1) \| Respond to of 10786

Re: ALYD 10-K - Part 4 PART III Item 10. Directors and Executive Officers of the Registrant and Compliance with Section 16(a) Directors and Executive Officers Age Position Robert F. Gruder 39 Chief Executive Officer, President and Chairman of the Board V. Hollis Scott 51 Chief Financial Officer, Secretary and Director Frank G. Milligan 57 Chief Operating Officer Thomas J. Dudchik 38 Senior Vice President and Director James F. Helm 56 Chief Information Officer J. Alex McMillan 65 Director John McCarthy 58 Director Directors are elected to serve until the next annual meeting of shareholders of the Company or until their successors are elected and qualified. The Board of Directors held three meetings during the calendar year 1997 and also met informally and acted by written consent during the year. Officers serve at the discretion of the Board of Directors subject to any contracts of employment. At the present time there are no contracts. Robert F. Gruder has served as Chief Executive Officer, President and Chairman of the Board of Directors since 1989, when the Company was first acquired. Prior to his association with the Company and for three years, Mr. Gruder served as president of GEM Technologies, Inc. ("GEM"), a company which was engaged in developing a computer language compiler. GEM filed for bankruptcy in 1992 pursuant to Chapter 7 of the Bankruptcy Code. Mr. Gruder was the principal stockholder of GEM. Prior to Mr. Gruder's association with GEM, he was employed at three different banks. Mr. Gruder is a graduate of American University and holds a BS degree in finance. V. Hollis Scott has served as Chief Financial Officer, Secretary and Director since January 1996. Prior to January 1996 and from November 1988, Mr. Scott served as Senior Vice President and Treasurer of the Cato Corporation, a publicly held 600-store ladies' apparel retailer. Before 1988, he held senior financial management positions with a cable television operator and with a department store chain. Prior to that, he was employed with Ernst & Young. Mr. Scott is a graduate of the University of Virginia and is a licensed certified public accountant. Frank G. Milligan joined the Company as Chief Operating Officer in December 1996. Between 1963 and December 1996, Mr. Milligan was employed by IBM. He served as a senior manager with various management responsibilities in development and systems integration and general business management. Mr. Milligan attended the University of Tennessee, where he received BS and MS degrees in electrical engineering. Thomas J. Dudchik joined the Company as Senior Vice President in February 1996. He is responsible for all national and international marketing and investor relations. Prior to joining the Company, Mr. Dudchik served as Deputy Chief of Staff for Connecticut Governor Lowell P. Weicker, Jr. from January 1993 through January 1995. As part of his responsibilities, Mr. Dudchik administered the State of Connecticut's $10 billion annual budget for the 26 major state agencies, covering 50,000 state employees. From February 1991 through December 1992, Mr. Dudchik served as Deputy Commissioner of the Connecticut Department of Environmental Protection. From February 1995 through January 1996 he operated an advertising and sales promotion business. Mr. Dudchik received a BA degree from Trinity College. James F. Helm joined the Company in April 1996. Mr. Helm serves as Chief Information Officer for Information Technology. Prior to joining the Company, Mr. Helm acted as an independent consultant to various companies between 1994 and 1996. Prior to that, he was employed by Formula Consultants, Inc. from June 1992 to May 1994 in various management positions and acted as consultant to that company from February through May of 1992. From 1969 to October 1991, Mr. Helm held various management positions with Unisys Corporation ("Unisys"). His last position with Unisys was Vice President of Customer Services. J. Alex McMillan was elected a Director of the Company effective March 19, 1997. Mr. McMillan is currently employed with The McMillan Group, merchant bankers and consultants. Between April 1, 1997 through December 31, 1997, Mr. McMillan was retained by the Company to act as an independent consultant to assist the Company in developing government contracts. (See "Certain Relationships and Related Transactions".) From 1985 through 1994 Mr. McMillan served in the US House of Representatives, representing the 9th Congressional District for the State of North Carolina. While a member of Congress, Mr. McMillan served on various committees, including Energy and Commerce, Budget, Bank and Small Business. From 1976 through 1983, Mr. McMillan was President and Chief Executive Officer of Harris Teeter Supermarkets, Inc., a regional chain of supermarkets owned by the Ruddick Corporation. Mr. McMillan currently serves as a Director of Interstate/Johnson Lane, Inc., and Scottish Bank of Charlotte, North Carolina, both publicly held companies. Mr. McMillan holds an MBA from the Darden School, University of Virginia. John McCarthy was appointed to serve as a Director in August 1997. For approximately 31 years, Mr. McCarthy has been employed in the brokerage business in the data processing area. He has held management positions in various brokerage firms. From 1993 until December 1997, he was employed with Smith Barney & Co. as Senior Vice President and Year 2000 Project Director. Messrs. McMillan, McCarthy and Scott currently serve on the Company's Audit Committee, which committee is charged with, among other things, the review with the Company's auditors of the general scope of the Company's annual audit; a review of the annual audit and the auditor's report on the adequacy of internal controls and other findings; review of the auditor's management letter; and the implementation of any corrective measures, if so required. Messrs. McMillan, McCarthy and Gruder currently serve on the Company's Compensation Committee, which committee is charged with the review of officers' compensation, bonuses and the granting of stock options. The Company's outside directors, upon their appointment to the Board, were given an award of 15,000 warrants each. The warrants are only exercisable one year from the date of the grant at the fair market price of the Company's Common Stock on the date of grant. The options will expire in 2007. The outside directors do not receive any compensation for their attendance at meetings. Based solely on review of the copies of such forms furnished to the Company or written representations that no forms 5 were required, the Company believes that during the year ended December 31, 1997 all Section 16(a) filing requirements applicable to its officers, directors and greater than ten-percent beneficial owners were complied with. Item 11. Executive Compensation The following tables set forth information with respect to compensation paid by the Company for the services to the Company during the three years ended December 31, 1997 by the Company's Chief Executive Officer. No other officer receives compensation in excess of $100,000. SUMMARY COMPENSATION TABLE Long Term Compensation Annual Compensation Awards Payouts (a) (b) (c) (d) (e) (f) (g) (h) (i) Re- Other stricted Securities Annual Stock Underlying LTIP All Other Compen- Awarded Options/ Payouts Compen- Name and Principal Position Year Salary($) Bonus($) sation ($) ($) SARs (#) ($) sation ($) --------------------------- ---- --------- -------- ---------- ----- -------- ----- ---------- Robert F. Gruder 1997 60,000 -0- -0- -0- 2,000 1 -0- -0- Chief Executive Officer 1996 60,000 -0- -0- -0- -0- -0- -0- 1995 60,000 -0- -0- -0- -0- -0- -0- ------------------- 1 Mr. Gruder was granted 2,000 incentive stock options under the 1994 Plan on April 24, 1997. The options are exercisable at $8.80 per share. 1,000 options vest on April 24, 1998 and 1,000 options vest on October 24, 1998. The options expire on April 24, 2002. The senior executive officers do not currently receive any other personal benefits. The Company offers health insurance to all of its employees. The Company also has a 401(k) program, but during the year 1997, the Company made no contributions. OPTION/SAR GRANTS IN LAST FISCAL YEAR ----------------------------------------------------------------------------------------------------------------------------------- Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Individual Grants Option Term (a) (b) (c) (d) (e) (f) (g) Number of % of Total Securities Options/ Underlying SARs Options/ Granted to SARs Employees in Exercise Name Granted (#) Fiscal Year Price ($/Sh) Expiration Date 5% ($) 10% ($) ---- ----------- ----------- ------------ --------------- ------ ------- Robert F. Gruder 2,000 1 0.2% 8.80 4/24/02 2,820 8,160 ------------------- 1 The exercise price for the options granted to Mr. Gruder was established at 110% of fair market value on date of grant. 1,000 of these options will vest on April 24, 1998, and 1,000 will vest on October 24, 1999. AGGREGATED OPTION/SAR EXERCISE IN LAST FISCAL YEAR AND FY-ENDED OPTION/SAR VALUES Value of Number of Unexercised Unexercised In-the-Money Options/SARs Options/SARs Shares at FY-End (#) at FY-End ($) Acquired on Value Realized Exercisable/ Exercisable/ Name Exercise (#) ($) Unexercisable Unexercisable ---- ------------ ----- ------------- ------------- Not Applicable Employment Agreements At the present time none of the Company's senior executive officers have employment agreements with the Company. Once the Company is in a sounder financial condition to pay salaries actually commensurate with each officer's position and the services he renders to the Company, employment agreements will be negotiated. Stock Option Plans In 1994, the Company adopted the Omnibus Stock Plan (the "1994 Plan") for the benefit of its employees. The 1994 Plan covered the issuance of 375,000 options to purchase shares of the Company's Common Stock. The 1994 Plan was subsequently amended in December 1996 by the Board of Directors to increase the number of options from 375,000 to 1,000,000. This increase requires ratification by shareholders, which the Company intends to present to shareholders at its forthcoming annual meeting now scheduled for May 22, 1998. On October 20, 1997, the Board of Directors also approved an increase of the number of shares subject to the 1994 Plan to 2,000,000, which the Company also intends to present to shareholders for their approval at the next annual meeting. The award of options in excess of 375,000 under the Plan are therefore subject to shareholder approval. The 1994 Plan provides for the issuance of options and/or stock appreciation rights. The 1994 Plan permits the issuance of either incentive stock options or non-qualified stock options. In case of incentive stock options (as defined under Section 422 of the Internal Revenue Code), the exercise price can be no less than fair market value on the date of grant. In the case of non-qualified stock options, the exercise price may be less than then fair market value. To date no options have been granted at less than fair market value at date of grant. The 1994 Plan is administered by the Compensation Committee. All employees and directors are entitled to participate in the 1994 Plan, except that no members of the Committee may participate. As of December 31, 1997, there were 977,400 options outstanding. The Company has adopted a policy of offering options to all full-time employees, which enables the Company to attract and retain skilled and dedicated personnel. All of the outstanding options expire at various times between December 2005 and 2007 with exercise prices ranging from 1.19 per share to $27.88 per share. During the year ended December 31, 1997 the Board of Directors approved the adoption of the 1997 Employee Stock Purchase Plan (the "Purchase Plan"). Shareholders of the Company will be requested to ratify the adoption of the Purchase Plan at the Company's Annual Meeting of Shareholders. The Purchase Plan would permit employees of the Company to purchase shares of the Company's Common Stock through payroll deductions at six-month intervals as specified in the Purchase Plan at a 15% discount from market. The Purchase Plan is to be administered by members of the Board who are ineligible to participate in the Purchase Plan. An employee electing to participate can have up to 10% of his weekly salary withheld for the purchase of stock. A participant who is not subject to Section 16(b) of the Exchange Act may withdraw shares at any time after the shares have been purchased and credited to the participant's account. The Purchase Plan is intended to qualify under Section 423 of the Internal Revenue Code of 1986, as amended (the "Code"), and as such, the Purchase Plan requires approval of the stockholders. If participants wish to avoid a tax on the purchase of Common Stock under the Purchase Plan, the participant must meet certain holding period requirements as required by the Code. The aggregate amount of purchases by any employee may not exceed $25,000 per year. A total of 200,000 shares have been reserved by the Company under the Purchase Plan. Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth information regarding the beneficial ownership of the Company's Common Stock as of December 31, 1997 by (i) each person who is known by the Company to own beneficially more than 5% of the Company's outstanding Common Stock; (ii) each of the Company's officers and directors and (iii) all officers and directors of the Company as a group: Name and Address Amount and Nature Percent of Class Robert F. Gruder 7,030,325 38.8% c/o Alydaar Software Corporation 2101 West Rexford Road Charlotte, NC 28211 V. Hollis Scott 186,667 1 1.0% c/o Alydaar Software Corporation 2101 West Rexford Road Charlotte, NC 28211 Thomas J. Dudchik 226,166 2 1.3% c/o Alydaar Software Corporation 2101 West Rexford Road Charlotte, NC 28211 Frank G. Milligan 30,000 3 * c/o Alydaar Software Corporation 2101 West Rexford Road Charlotte, NC 28211 James F. Helm 20,250 4 * c/o Alydaar Software Corporation 2101 West Rexford Road Charlotte, NC 28211 J. Alex McMillan (Director) 27,840 5 * 3801 Barnwood Drive Charlotte, NC 28211 John McCarthy (Director) -0- * 4 Glenwood Circle East Windsor, NJ 08520-2304 All officers and directors as a group (9 persons) 7,576,248 42.5% -------- 1 Includes 100,000 shares issuable upon exercise of options which vest on April 24, 1998. 2 Includes 200,000 shares issuable upon exercise of options. Of these, 50,000 options vest on April 24, 1998. 3 Includes 10,000 shares issuable upon exercise of options and an additional 20,000 shares issuable upon exercise of options, which options vest on April 24, 1998. 4 Includes 10,000 shares issuable upon exercise of options and an additional 10,000 shares issuable upon exercise of options, which options vest on April 24, 1998. 5 Includes 15,000 shares issuable upon exercise of warrants and warrants to purchase 7,840 shares owned by a company which Mr. McMillan controls. * Represents less than 1% ownership. Item 13. Certain Relationships and Related Transactions In connection with the litigation referred to in Item 3, "Legal Proceedings," Mr. Robert Gruder, President and Chief Executive Officer of the Company, entered into agreements with the Company to indemnify the Company against any liability resulting from a final unappealable judgment. The Colby Lawsuit was settled by Mr. Gruder in 1997, and the Company was released from all liability. Pursuant to the agreement with Mr. Gruder, the Company paid all his legal expenses. Mr. Gruder has also entered into an agreement to indemnify the Company from all liability in connection with the Kaplan Lawsuit, which is now scheduled for trial in April 1998. In consideration of the agreement to indemnify the Company, the Company agreed to pay Mr. Gruder's legal fees and expenses in defending the Kaplan Lawsuit. Between April 1, 1997 and December 31, 1997, The McMillan Group, owned by Mr. Alex McMillan, who is a Director of the Company, was retained by the Company to act as an independent consultant to assist the Company in developing government contracts. (See "Directors and Executive Officers of the Registrant.") Robert F. Gruder, Chairman and Chief Executive Officer, has made advances to the Company from time to time to assist the Company in its working capital requirements. As of January 1, 1997, $500,000 of principal and $3,550 of interest were owed by the Company to Mr. Gruder. During 1997, Mr. Gruder advanced an additional $1,100,000 to the Company, and during the year the Company repaid Mr. Gruder $800,000, leaving a balance due Mr. Gruder at year end of $800,000 of principal and accrued interest at 10.5% per annum of $27,868. The advances are evidenced by promissory notes payable on demand. Just before December 31, 1997, V. Hollis Scott, Chief Financial Officer of the Company, advanced the Company $166,700 with interest at 10.5% per annum. The loan is evidenced by a promissory note payable on demand.