CoreCard Corp — Annual Report 1998

May 21, 1998

1 ================================================================================ - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 Commission file number 1-9330 INTELLIGENT SYSTEMS CORPORATION - -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) GEORGIA 58-1964787 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4355 SHACKLEFORD ROAD, NORCROSS, GEORGIA 30093 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (770) 381-2900 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- COMMON STOCK, $.01 PAR VALUE AMERICAN STOCK EXCHANGE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [x] As of March 20, 1998, 5,104,467 shares of Common Stock were outstanding. The aggregate market value of the Common Stock held by non-affiliates of the registrant was $15,111,949 (computed using the closing price of the Common Stock on March 20, 1998 as reported by the American Stock Exchange). DOCUMENTS INCORPORATED BY REFERENCE: Portions of the registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on June 12, 1998 are incorporated by reference in Part III hereof. - -------------------------------------------------------------------------------- ================================================================================ 2 Consolidated Statements of Cash Flow for the years ended December 31, 1997, 1996 and 1995 Notes to Consolidated Financial Statements 2. Financial Statement Schedules The following financial statement schedules are included in this report. All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because such schedules are not required under the related instructions or are inapplicable or because the information required is included in the consolidated financial statements or notes thereto. See the Index to Financial Statements and Supplemental Schedules on page F-1 hereof. Schedule II - Valuation and Qualifying Accounts and Reserves Report of Independent Auditors for InterQuad Services Limited Report of Independent Auditors for PaySys International, Inc. Consolidated Balance Sheets of PaySys at December 31, 1997 and 1996 Consolidated Statements of Operations of PaySys for the three years ended December 31, 1997 Consolidated Statements of Changes in Stockholders' Equity (Deficit) of PaySys for the three years ended December 31, 1997 Consolidated Statements of Cash Flows of PaySys for the three years ended December 31, 1997 Notes to Consolidated Financial Statements of PaySys Report of Independent Auditors for Visibility Inc. and Subsidiaries Consolidated Balance Sheets of Visibility Inc. and Subsidiaries at December 31, 1997 and 1996 Consolidated Statements of Operations of Visibility Inc. and Subsidiaries for the years ended December 31, 1997 and 1996 Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders' Equity (Deficit) of Visibility Inc. and Subsidiaries for the years ended December 31, 1997 and 1996 Consolidated Statements of Cash Flows of Visibility Inc. and Subsidiaries for the years ended December 31, 1997 and 1996 Notes to Consolidated Financial Statements of Visibility Inc. and Subsidiaries Schedule II - Valuation and Qualifying Accounts of Visibility Inc. and Subsidiaries 3. Exhibits The following exhibits are filed with or incorporated by reference in this report. The Company will furnish any exhibit upon request to Bonnie L. Herron, Secretary, Intelligent Systems Corporation, 4355 Shackleford Road, Norcross, Georgia 30093; telephone (770) 381-2900. There is a charge of $.50 per page to cover expenses of copying and mailing. 2.1 Stock Exchange Agreement between OrCAD, Inc., Intelligent Systems Corporation, Stuart A. Harrington, Michel A. Burton, and various ISJ minority shareholders dated December 2, 1995. (Incorporated by reference to Exhibit 2.1 to the Registrant's Form 10-K for the year ended December 31, 1995.) 2.2 Piggyback Registration Rights Agreement regarding stock of OrCAD, Inc. dated December 1, 1995. (Incorporated by reference to Exhibit 2.2 to the Registrant's Form 10-K for the year ended December 31, 1995.) 2.3 Stock Purchase Agreement between Intelligent Systems Corporation and Francis Crowder, Sr., Marion S. Crowder, Kevin W. Davidson and Charles S. Verdin III dated July 1, 1997. 2.4 Stock Purchase Agreement between Intelligent Systems Corporation and Oak Investment Partners V, L.P. and Oak V Affiliate Fund, L.P. dated March 31, 1997. 3(i) Articles of Amendment of Articles of Incorporation dated November 25, 1997. (Incorporated by reference to Exhibit 3.1 to the Registrant's Report on Form 8-K dated November 25, 1996.) 3(ii) Bylaws of the Registrant dated June 6, 1997. 4.1 See Exhibits 3(i) and 3(ii) for instruments defining rights of holders of Common Stock and Preferred Stock of Registrant. INTELLIGENT SYSTEMS CORPORATION - 13 - 3 4.2 Rights Agreement dated as of November 25, 1997 between the Registrant and American Stock Transfer & Trust Company as Rights Agent. (Incorporated by reference to Exhibit 4.1 of the Registrant's Report on Form 8-K dated November 25, 1997.) 4.3 Form of Rights Certificate. (Incorporated by reference to Exhibit 4.2 of the Registrant's Report on Form 8-K dated November 25, 1997.) 10.1 Lease Agreement dated March 11, 1985, between a subsidiary of the Registrant and A.R. Weeks. (Incorporated by reference to Exhibit 10.1 to Intelligent Systems Corporation Annual Report on Form 10-K for the fiscal year ended March 31, 1986.) 10.2 Second Amendment to Lease Agreement dated June 19, 1997 between a subsidiary of the Registrant and A.R. Weeks. 10.3 Promissory Note of Registrant in favor of NationsBank dated September 29, 1995 and related Security Agreement. (Incorporated by reference to Exhibit 10.5 to the Registrant's Form 10-K for the year ended December 31, 1995.) 10.4 Management Compensation Plans and Arrangements: (a) Intelligent Systems Corporation 1991 Stock Incentive Plan, amended June 6, 1997. (b) Intelligent Systems Corporation Change in Control Plan for Officers. (c) Intelligent Systems Corporation Outside Director's Retirement Plan. Item 10.6 (a) is incorporated by reference to Exhibit 4.1 of the Registrant's Form S-8 dated July 25, 1997. Items 10.6 (b) and (c) are incorporated by reference to Exhibit 10.4 to Registrant's Form 10-K for the year ended December 31, 1993. 10.5 Form of Promissory Note of Registrant in favor of sellers of QS, Inc. dated as of July 1, 1997. 10.6 Loan Agreement dated February 17, 1998 between Registrant and NationsBank, N.A. 10.7 Pledge Agreement dated February 17, 1998 between Registrant and NationsBank, N.A. 21.0 List of subsidiaries of Registrant. 23.1 Consent of Arthur Andersen LLP. 23.2 Consent of Morley and Scott. 23.3 Consent of Ernst and Young LLP. 23.4 Consent of Arthur Andersen LLP. (b) REPORTS ON FORM 8-K. The Registrant filed a report on Form 8-K dated November 25, 1997. (c) SEE ITEM 14(a)(3) ABOVE. (d) SEE ITEM 14(a)(2) ABOVE. * Filed herewithin. INTELLIGENT SYSTEMS CORPORATION - 14 - 4 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. INTELLIGENT SYSTEMS CORPORATION Registrant By: /s/ J. LELAND STRANGE ----------------------------------- J. Leland Strange Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:

INTELLIGENT SYSTEMS CORPORATION - 15 - 5 INTELLIGENT SYSTEMS CORPORATION INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULES The following consolidated financial statements and schedules of the Registrant and its subsidiaries are submitted herewith in response to Item 8:

INTELLIGENT SYSTEMS CORPORATION F-1 6 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Visibility Inc. and Subsidiaries: We have audited the accompanying consolidated balance sheets of Visibility Inc. (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, redeemable convertible preferred stock and stockholders' equity (deficit) and cash flows for the years then ended. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Visibility Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule of Visibility Inc. and subsidiaries listed in Item 14(a) (2) is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. The schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. Arthur Andersen LLP Boston, Massachusetts April 23, 1998 S-26 7 VISIBILITY INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1996 ASSETS

The accompanying notes are an integral part of these consolidated financial statements. S-27 8 VISIBILITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996

The accompanying notes are an integral part of these consolidated financial statements. S-28 9 VISIBILITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996

The accompanying notes are an integral part of these consolidated financial statements. S-29 10 VISIBILITY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996

The accompanying notes are an integral part of these consolidated financial statements. S-30 11 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (1) NATURE OF THE BUSINESS Visibility Inc., a Delaware corporation, and subsidiaries (the Company), develops, markets, sells and supports an integrated line of business application software for manufacturers. The Company is subject to a number of risks similar to those of other companies in a similar stage of development. Principal among these risks are the ability to obtain adequate financing, dependence on key individuals, successful development and marketing of services and products, and competition from other companies. Management believes that its current cash reserves and available borrowings under the Company's bank line of credit will provide sufficient working capital to finance the Company through December 31, 1998. The Company may attempt to raise additional capital during 1998 in order to fund operations, product marketing and development, and working capital requirements. There can be no assurance that additional financing will be available or on terms favorable to the Company. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A summary of the Company's significant accounting policies follows: Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassification Certain prior-year balances have been reclassified in order to conform with current year presentation. Principles of Consolidation The accompanying financial statements include the accounts of the Company and its wholly owned subsidiaries after elimination of intercompany accounts and transactions. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. The Company invests in a money market account and believes the investment is subject to minimal credit and market risk. The carrying amounts of cash and cash equivalents approximate their fair value due to the short-term maturities of these investments. S-31 12 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) Foreign Currency Translation The functional currency for the Company's United Kingdom subsidiary is the British pound sterling. Gains (losses) from foreign currency translations of the United Kingdom Subsidiary are credited or charged to foreign currency translation adjustment, which is included as a component of stockholders' equity in the accompanying consolidated balance sheets. The functional currency of the Company's other foreign operations is the U.S. dollar. Gains and losses resulting from the remeasurement of foreign currencies into U.S. dollars for these subsidiaries are included in the results of operations and the amounts are insignificant. Fair Value of Financial Instruments The Company's financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable and long-term debt. The carrying amounts of the Company's cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to their short-term nature. See Note 6 for fair value information pertaining to the Company's long-term debt. Revenue Recognition The Company recognizes revenue from noncancelable software licenses upon product shipment, provided collection is probable and no significant vendor and postcontract customer obligations remain at the time of shipment. The Company accounts for insignificant vendor obligations by deferring a portion of the revenue and recognizing it when the related services are performed. Postcontract support (maintenance) service fees are typically billed separately and are recognized on a straight-line basis over the life of the applicable agreement. The Company recognizes service revenues from consulting and implementation services, including training, provided by both its own personnel and by third parties, upon performance of the services. Long-term service contracts are recognized using the percentage of completion method. Revenue from equipment sales is recognized upon shipment of the equipment. In October 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 97-2, Software Revenue Recognition. The statement provides specific industry guidance and stipulates that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post contract customer support, installation or training. Under SOP 97-2, the determination of fair value is based on objective evidence that is specific to the vendor. If such evidence of fair value for each element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered. Revenue allocated to software products, specified upgrades and enhancements is generally recognized upon delivery of the related products, upgrades and S-32 13 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) enhancements. Revenue allocated to postcontract customer support is generally recognized ratably over the term of the support, and revenue allocated to service elements is generally recognized as the services are performed. SOP 97-2 will be adopted by the Company effective January 1, 1998 and is not expected to have a material effect on revenue recognition. Impairment of Long-Lived Assets In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This statement addresses the accounting for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. This statement requires that long-lived assets, including intangibles, be reviewed for impairment whenever events or changes in circumstances, such as a change in market value, indicates that the asset's carrying amounts may not be recoverable. In performing the review for recoverability, if future undiscounted cash flows (without interest charges) from the use and ultimate dispositions of the assets are less than their carrying value, an impairment loss is recognized. Impairment losses are to be measured based on the fair value of the asset. To date, the Company has not experienced any such impairments. Capitalized Software Development Costs The Company capitalizes certain software development costs after technological feasibility of the product has been established. Costs incurred prior to the establishment of technological feasibility are charged to research and development expense. The Company capitalized no software developments costs during 1997 and 1996, as the costs incurred after technological feasibility was established were deemed to be immaterial. Capitalized software costs are amortized ratably over the useful life of the product, generally two years, and are charged to cost of revenues. Amortization expense for the years ended December 31, 1997 and 1996 relating to capitalized software amounted to approximately $0 and $201,000, respectively. In 1996, the Company also charged approximately $111,000 of previously capitalized software costs to cost of revenues because their future realizability was uncertain. Income Taxes The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences, utilizing current tax rates, of temporary differences between the carrying amounts and the tax bases of assets and liabilities. S-33 14 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) (3) ACQUISITION On May 15, 1997, the Company established a wholly owned UK subsidiary, Visibility Europe Ltd. (the Subsidiary), which acquired certain equipment and intangible assets of the Company's then European distributor, whose parent company was formerly also a minority stockholder of the Company, for $250,000. The purchase price was allocated $109,135 to equipment and $140,865 to goodwill and other intangibles, which are being amortized on a straight line basis over three years. This acquisition was accounted for as a purchase. Additional purchase price is contingent on the Subsidiary achieving certain pretax income levels for 1997 and 1998, which the Company did not meet in 1997. The purchase price will be increased by 30% of the Subsidiary's 1998 pretax income in excess of $500,000. Any future contingent payments will be accounted for as an addition to goodwill. Pro forma information for this acquisition has not been presented as the impact was not material. (4) PROPERTY AND EQUIPMENT Property, plant and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Maintenance and repair costs are charged to expense as incurred. Fixed assets consist of the following at December 31, 1997 and 1996:

Included above is equipment held under capital leases with a cost of $1,683,114 and $1,683,114, and accumulated amortization of $1,358,397 and $1,051,233 at December 31, 1997 and 1996, respectively. S-34 15 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) (5) LINE OF CREDIT At December 31, 1997, the Company had a line of credit with a bank which allowed for borrowings of up to $2,500,000. Borrowings were limited to the lesser of a borrowing base calculation based on certain percentages of accounts receivable, as defined, or $2,500,000. The available borrowing base at December 31, 1997 was approximately $2,500,000. Borrowings under the line were due on April 5, 1998. Interest accrued at the bank's prime lending rate (8.5% at December 31, 1997) plus 2.5%. Borrowings were secured by substantially all assets of the Company. At December 31, 1997, the Company had borrowed $1,500,000 under the line of credit. In connection with the November 1997 amendment of this agreement, the Company issued the bank a warrant to purchase 71,685 shares of common stock at an exercise price of $2.79 per share. The fair value of this warrant was immaterial. The warrant expires on June 30, 2004. The agreement also requires the Company to achieve minimum levels of profitability, quick ratio and tangible net worth. The bank also requires the Company to cause the line to not exceed $1,500,000 for at least five consecutive days per quarter. The Company was in compliance with its covenants as of December 31, 1997. Effective April 5, 1998, the Bank renewed the line of credit through April 4, 1999 under similar terms and conditions, except that the interest rate was reduced to prime plus 2%. In addition, the Company will be required to issue the Bank another warrant to purchase 10,526 shares of common stock at an exercise price of $4.75 per share in the event the Company defaults under this agreement, as defined. (6) LONG-TERM DEBT In conjunction with the acquisition of the Company in February 1993, the Company entered into term note agreements aggregating $500,000 with certain stockholders, of which approximately $173,000 was repaid in 1996. The notes accrue interest at the prime rate (8.5% at December 31, 1997) plus 3% per annum. During 1997, the maturity date was extended to March 31, 1999 and, accordingly, is reflected as long-term in the accompanying balance sheet. The notes are secured by the Company's accounts receivable. During November 1996, the Company entered into several stockholder note agreements, totaling $800,000. During 1997, the Company entered into several additional stockholder note agreements, totaling $1,200,000, of which $250,000 was repaid during 1997. All of these notes were due upon demand, carried a rate of 10% per annum and were unsecured. All of the outstanding notes were converted into Series A Preferred Stock in 1997 (see Note 12). On January 2, 1997, the Company borrowed $250,000 from the parent company of its then European distributor pursuant to a demand note. On May 15, 1997, the Company secured the replacement of the demand note and the right to borrow up to an additional $750,000 from the parent company of its then European distributor pursuant to a $1,000,000 senior subordinated note due May 15, 2000. The S-35 16 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) Company received an additional $250,000 on May 15, 1997, June 30, 1997 and September 30, 1997, respectively. The note accrues interest at 8% per annum, payable upon maturity, and is unsecured. As part of the financing, the Company also issued a warrant for the purchase of up to 50,000 shares of common stock at $6.67 per share. The fair value of the warrant was not material. The warrant expires upon repayment of the senior subordinated note. The following summarizes the debt outstanding as of December 31, 1997 and 1996, including accrued interest:

The fair value of the Company's debt approximates its carrying value based on the current rate offered to the Company for obligations of the same remaining maturities. (7) RELATED PARTY TRANSACTIONS During 1996 and the beginning of 1997, the Company had a distribution agreement that provided a stockholder with exclusive distribution rights in certain European markets in exchange for royalties which management believes represented fair value as negotiated on an arms-length basis. Royalty income received during the years ended December 31, 1997 and 1996 amounted to approximately $0 and $592,000, respectively. Related maintenance and service revenue for the years ended December 31, 1997 and 1996 amounted to approximately $48,000 and $44,000, respectively. At December 31, 1996, accounts receivable included approximately $292,000, and accounts payable included approximately $139,000, respectively, related to this stockholder. The Company reimbursed this stockholder approximately $188,000 and $323,000 in 1997 and 1996, respectively, for expenses incurred by the Company but paid by this stockholder. (8) BENEFIT PLAN The Company has a defined contribution plan, which is qualified under Section 401(k) of the Internal Revenue Code. The plan covers substantially all employees who meet minimum age and service requirements and allows participants to defer a portion of their salary. After one year of employment, the Company contributes 25% of the employee's contribution, up to a maximum of 6% of the employee's salary. Employer contributions may be suspended at the option of the Board of Directors. The Company's contributions to the plan for the years ended December 31, 1997 and 1996 amounted to approximately $86,000 and $21,000, respectively. S-36 17 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) (9) INCOME TAXES The provision for income taxes consists of state taxes at December 31, 1996. A reconciliation of the federal statutory rate to the Company's effective tax rate is as follows:

The Company has approximately $5,600,000 of U.S. federal net operating loss carryforwards available to reduce future taxable income, if any. These net operating loss carryforwards expire in varying amounts through 2012 and are subject to the review and possible adjustment by the Internal Revenue Service. The Company has approximately $2,860,000 of foreign net operating loss carryforwards available to reduce future taxable income in the foreign jurisdictions, if any. Section 382 of the Internal Revenue Code also contains provisions that could place annual limitations on the utilization of these net operating loss carryforwards in the event of a change in ownership, as defined. Significant components of deferred income taxes are as follows:

S-37 18 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) The valuation allowance at December 31, 1997 and 1996 relates to the uncertainty of realizing the tax benefits of the deferred tax assets. (10) COMMITMENTS AND CONTINGENCIES The Company leases facilities under various operating leases. The Company also leases certain equipment under noncancelable capital and operating leases. Future minimum lease commitments under all noncancelable operating and capital leases at December 31, 1997 are as follows:

Total rent expense under noncancelable operating leases was approximately $491,000 and $389,000 for the years ended December 31, 1997 and 1996, respectively. (11) CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially expose the Company to concentrations of credit risk include trade accounts receivable. To minimize this risk, ongoing credit evaluations of customers' financial condition are performed, although collateral is not required. The Company maintains reserves for potential credit losses. At December 31, 1997, no customer represented 10% of gross accounts receivable. At December 31, 1996, accounts receivable from one customer accounted for 13% of gross accounts receivable. No customer accounted for greater than 10% of revenues in 1997 and 1996. s-38 19 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) (12) REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) (a) Redeemable Convertible Preferred Stock On October 6, 1997, the Company amended and restated its Certification of Incorporation, whereby the Company's authorized shares of $.001 par value common stock was increased to 15,000,000. The Company also authorized the issuance of 3,847,752 shares of $.001 par value preferred stock, of which 1,881,721 shares are designated as Series A Preferred Stock, 1,628,700 shares are designated as Series B Preferred Stock and 337,331 shares are designated as Series C Preferred Stock. The Company issued 1,881,721 shares of Series A Redeemable Convertible Preferred Stock in exchange for $3,500,000 plus the conversion of the $1,750,000 notes payable issued in 1997 and 1996. The Company also allowed common stockholders to convert 1,966,031 shares of common stock into 1,628,700 shares of Series B Redeemable Convertible Preferred Stock and 337,331 shares of Series C Redeemable Convertible Preferred Stock. The Series A, Series B and Series C Redeemable Convertible Preferred Stock have the following rights and preferences: VOTING Preferred stockholders are entitled to vote on an as-converted basis together with common stockholders as one class. DIVIDENDS The preferred stockholders are entitled to receive dividends or other distributions equal to the dividend or distribution that would be received had the preferred stockholders converted their shares into common stock. LIQUIDATION In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company, the holders of Series A, B and C Redeemable Convertible Preferred Stock are entitled to receive a $2.79, $.54 and $6.67 per share liquidation preference, respectively, plus accrued or unpaid dividends. If the assets available for distribution are insufficient to permit payment of the liquidation preference amount, then the holders of the preferred stock shall share ratably in any distribution, as defined. After distribution to the preferred stockholders of the full liquidation preference amount, any remaining assets available for distribution are distributed both to holders of common stock and preferred stock on a pro rata basis, assuming the preferred stock is converted into common stock. Any dissolution or liquidation resulting S-39 20 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) from an event of sale, as defined, with proceeds of greater than or equal to $15.00 per share on an as-converted basis, will not result in distributions in accordance with the foregoing, but rather all preferred stock will be converted into common and share in the proceeds on a pro rata basis. CONVERSION Each share of preferred stock is convertible, at the option of the holder, into one share of common stock, adjusted for certain dilutive events, as defined. In the event of an initial public offering with a per share price of less than $15.00, each holder of the preferred stock will receive a cash payment equal to the liquidation preference (the IPO Preference Amount) and all shares shall convert automatically into common stock. The shares automatically convert upon the occurrence of a qualified offering with a per share price greater than or equal to $15.00 without any IPO Preference Amount. REDEMPTION As of March 31, 2003, the holders of the preferred stock may require the Company, with 30 days' written notice, to redeem outstanding preferred stock. The redemption price equals the liquidation preference plus all accrued but unpaid dividends. OTHER RESTRICTIONS The Corporation is restricted, without the approval of 51% of the holders of preferred stock, from issuing additional shares of preferred stock, common stock or convertible debt, altering the terms of outstanding preferred stock, amending its articles of incorporation, selling or otherwise disposing of all or substantially all of its assets or voluntary dissolving or otherwise liquidating the Company. (b) Stock Option Plans In 1994, the Company adopted the Visibility Inc. and Subsidiaries Stock Option Plan (the 1994 Plan), which is administered by the Board of Directors. The 1994 Plan provides for the issuance to key employees and directors of the Company options to purchase shares of common stock. The maximum number of shares of common stock that may be issued under the 1994 Plan is 300,000 shares. Options are granted under the 1994 Plan at exercise prices not less than the fair value of the stock on the date of grant. The options are exercisable over periods determined by the Board of Directors and expire after 10 years from the date of grant. Subsequent to December 31, 1997, the Board of Directors reduced the maximum number of shares available under this plan to 202,500. The Company is currently evaluating using the 97,500 shares from the 1994 Plan to establish a separate stock option plan for the Company's foreign employees. S-40 21 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) On February 2, 1996, the Company adopted the Visibility Inc. and Subsidiaries 1996 Stock Plan (the Plan), which is administered by the Board of Directors. The Plan provides for the issuance of incentive and nonqualified options to purchase shares of common stock to key employees and directors of the Company. The maximum number of shares of common stock that may be issued under the Plan is 1,050,000 shares. Incentive stock options may be granted under the Plan at exercise prices not less than the fair value of the stock on the date of grant. The options are exercisable over periods determined by the Board of Directors and expire 10 years from the date of grant. The following summarizes the stock option activity under the Company's stock option plans:

At December 31, 1997, options to purchase 364,600 shares were exercisable, and 197,450 shares were available for future option grants. The options exercisable at December 31, 1997 had a weighted average exercise price of $0.55. Options generally vest over three to four years. During 1995, the Financial Accounting Standards Board issued SFAS No. 123, Accounting for Stock-Based Compensation, which defines a fair value-based method of accounting for employee stock options or similar equity instruments and encourages all entities to adopt that method of accounting for all their employee stock compensation plans. However, it also allows an entity to continue to measure compensation costs for those plans using the intrinsic method of accounting prescribed by APB Opinion 25. Entities electing to remain with the accounting in APB Opinion 25 must make pro forma disclosures of net income as if the fair-value-based method of accounting defined in SFAS No. 123 has been applied. The Company has elected to account for its stock-based compensation plans under APB Opinion 25. S-41 22 VISIBILITY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Continued) Had compensation costs for the stock option plan been determined using the fair value-based method as prescribed by SFAS No. 123, the Company's 1997 and 1996 net losses would have been increased to the following pro forma amounts:

Consistent with SFAS No. 123, pro forma compensation cost has not been calculated for options granted prior to January 1, 1995. Pro forma compensation cost may not be representative of that to be expected in future years. The weighted average fair values of options granted during 1997 and 1996 were $0.05 and $0.33, respectively. The values were estimated on the date of grant using the minimum value method with the following weighted average assumptions used for grants in 1997 and 1996: risk-free interest rate of 6.15% and 5.99%, respectively, expected life of five years, expected dividend yield of 0% and volatility factor of 0%. The weighted average remaining contractual life of outstanding options was 9.32 years and the range of exercise prices was $0.20 to $1.67 at December 31, 1997. (13) FOREIGN OPERATIONS The following table summarizes the Company's operations by geographic area:

Export sales were not material in 1997 or 1996, respectively. S-42 23 Schedule II VISIBILITY INC. AND SUBSIDIARIES "Valuation and Qualifying Accounts" For The Years Ended December 31, 1997 and December 1996 (In Thousands) Allowance for Doubtful Accounts

• -------- (1) Accounts deemed uncollectible, net of recoveries. S-43