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                    U.S. SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                                 FORM 10-KSB/A
                               ----------------
 
[_]  ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
  OF 1934
 
[X]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
  EXCHANGE ACT OF 1934
 
       For the transition period from June 1, 1998 to December 31, 1998
 
                        Commission file number: 0-22057
 
                         GK INTELLIGENT SYSTEMS, INC.
            (Exact name of registrant as specified in its charter)
 
              Delaware                                 76-0513297
   (State or Other Jurisdiction of                  (I.R.S. Employer
   Incorporation or Organization)                  Identification No.)
 
 
     5555 San Felipe, Suite 625                           77056
   (Address of Principal Executive                     (Zip Code)
               Office)
 
                                 713-292-2300
             (Registrant's Telephone Number, Including Area Code)
 
  Securities registered pursuant to Section 12(b) of the Exchange Act:
 
<TABLE>
<CAPTION>
         Title of class                Name of exchange on which registered
         --------------                ------------------------------------
   <S>                                 <C>
    Common Stock                       American Stock Exchange
 
    Securities registered pursuant to
     Section 12(g)
     of the Exchange Act:              Common Stock
</TABLE>
 
  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-B 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-
KSB or any amendment to this Form 10-KSB. [_]
 
  Issuer's revenues for the 7 months ended December 31, 1998, were
approximately $58,000.
 
  The aggregate market value of the voting stock held by non-affiliates of the
registrant, based on the closing price on the American Stock Exchange on March
22, 1999, was $59,694,650. As of March 22, 1999, registrant had 32,530,335
shares of Common Stock outstanding.
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                               TABLE OF CONTENTS
 
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<CAPTION>
 ITEMS                                                                      PAGE
 <C>      <S>                                                               <C>
                                       PART I
 
 ITEM 1.  DESCRIPTION OF BUSINESS........................................     1
 ITEM 2.  DESCRIPTION OF PROPERTY........................................     6
 ITEM 3.  LEGAL PROCEEDINGS..............................................     6
 ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............     8
 
                                      PART II
 
 ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.......     9
 ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS...........................     9
 ITEM 7.  FINANCIAL STATEMENTS...........................................    17
 ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE...........................................    17
 
                                      PART III
 
 ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS;
          COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT..............    18
 ITEM 10. EXECUTIVE COMPENSATION.........................................    19
 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
          MANAGEMENT.....................................................    24
 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................    24
 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K...............................    25
</TABLE>
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                                    PART I
 
ITEM 1. DESCRIPTION OF BUSINESS
 
  Some of the statements contained in this Form 10-KSB for GK Intelligent
Systems, Inc. ("Company") discuss future expectations, contain projections of
results of operation or financial condition or state other "forward-looking"
information. These statements are subject to known and unknown risks,
uncertainties, and other factors that could cause the actual results to differ
materially from those contemplated by the statements. The forward-looking
information is based on various factors and is derived using numerous
assumptions. Important factors that may cause actual results to differ from
projections include, for example:
 
    . the success or failure of management's efforts to implement their
  business strategy;
 
    . the ability of the Company to raise sufficient capital to meet
  operating requirements;
 
    . the uncertainty of consumer demand for our product;
 
    . the ability of the Company to protect its intellectual property rights;
 
    . the ability of the Company to compete with major established companies;
 
    . the effect of changing economic conditions;
 
    . the ability of the Company to attract and retain quality employees; and
 
    . other risks which may be described in future filings with the SEC.
 
General
 
  The Company is a development-stage enterprise currently developing
"intelligent" computer software training and performance support products and
applications for the consumer, corporate, government, and education markets.
The Company's key differentiating technology to date is its development of
SMART ONE(R), a computer-based training system incorporating artificial
intelligence, multimedia technology, and advanced training techniques to
produce training software that dynamically adapts to the learning styles and
abilities of individual users. In the future, the Company plans to supplement
this technology through the development of a SMART SUPPORT suite of
technologies that includes SMART ONE(R) as well as (i) SMART PERFORM (using
intelligent technology and the access of information in multiple databases
along with multimedia tools to present the information) and (ii) SMART
ENTERPRISE (a strategic resource model manager using intelligent technology
and the capability of SMART PERFORM). The Company's efforts to date have
centered primarily on (i) the acquisition and development of its core software
technologies from which management's goal is to create future products and
applications and (ii) securing the services of competent individuals capable
of implementing the Company's strategy. During the period from inception
(October 4, 1993) through December 31, 1998, the Company had a deficit
accumulated during the development stage of $26,196,000, which includes
$12,704,000 of non-cash compensation expense.
 
  The Company was incorporated in Delaware in February 1988 under the name
Technicraft Financial, Ltd. In October 1991, its name was changed to LBM-US,
Inc. ("LBM"). Pursuant to an agreement effective August 1994, GK Intelligent
Systems, Inc., a Texas corporation ("GK-Texas"), transferred all of its assets
and liabilities to LBM, a Delaware shell corporation with no significant
assets or liabilities, in exchange for 6,758,920 shares of LBM common stock.
The remaining 963,275 shares of LBM common stock out of a total of 7,722,195
shares outstanding were retained by the former owners of LBM in a transaction
treated for accounting purposes as a purchase of the Company by GK-Texas,
referred to as a "reverse merger." Of the LBM shares of common stock issued to
GK-Texas, a total of 6,375,000 shares were issued to Gary F. Kimmons and his
family partnership. Mr. Kimmons had formed GK-Texas, a Texas corporation, in
February 1994 to produce and market multimedia, skill-oriented training and
performance support systems using artificial intelligence. Mr. Kimmons had
formed I-Net Intelligent Systems, Inc., a Delaware corporation ("I-NET
(Delaware)"), prior to forming GK-Texas. In October 1993, I-NET (Delaware) had
contracted with AT&T to develop the SMART ONE(R) training program
 
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template pursuant to an industrial design services agreement ("AT&T
Agreement"). In February 1994, the intellectual property and all rights and
obligations under the AT&T Agreement were assigned by I-NET (Delaware) to GK-
Texas. In August 1994, after acquiring all of the technology of GK-Texas, the
Company changed its name to GK Intelligent Systems, Inc.
 
  In November 1995, the Company acquired from Microelectronics and Computer
Technology Corporation ("MCC") the non-exclusive, worldwide, perpetual right
and license to use various computer software tools and languages (referred to
as CARNOT technology) through the issuance to MCC of 883,333 shares of the
Company's preferred stock, which was subsequently converted into 883,333
shares of Company common stock. MCC is a consortium of corporations, public
and non-profit agencies and universities who are cooperating and sharing
information and technology in order to gain competitive business advantages
for its members. The Company is not a member of MCC. To date, no final
products have been developed using the CARNOT technology, and there can be no
assurance that any products will be developed using the CARNOT technology.
 
  In August 1995, the stockholders of the Company amended and restated its
Certificate of Incorporation in its entirety primarily to increase the number
of shares of capital stock and to adopt more favorable officers and directors
indemnification and limitation of liability provisions available under
Delaware law. In September 1997, after approval by the boards of directors and
majority stockholders of both companies, GK-Texas was merged into the Company.
In May 1998, the stockholders of the Company amended the Certificate of
Incorporation to increase the number of shares of common stock ("Common
Stock"). In August 1998, the Company adopted a calendar year end that became
effective December 31, 1998. The Company's principal place of business is
located at 5555 San Felipe, Suite 625, Houston, Texas 77056 and its telephone
number is (713) 292-2300.
 
SMART ONE(R) TRAINER
 
  The SMART ONE(R) trainer is an advanced technology based on specifications
determined by management and developed for the Company in conjunction with
AT&T Global Information Solutions. SMART ONE(R) is capable of real-time
adaptation and customization of training to the individual and, as a template
or engine, is ready for any content to be added for development of new
consumer products or to meet the specific training needs of institutional
customers. SMART ONE(R) enables training software to function as a highly
personal and sophisticated "learning assistant" which adjusts dynamically
during the training according to the individual knowledge and ideal learning
style of the user.
 
Initial Product: "Around the Web in 80 Minutes"
 
  The Company is currently marketing its first software product titled,
"Around the Web in 80 Minutes," a CD-ROM-based, multimedia Internet tutorial
which is believed to be the first artificial intelligence-based training
software introduced to the consumer market. "Around the Web in 80 Minutes"
teaches computer users to take full advantage of the Internet and uses SMART
ONE(R) technology to determine each user's initial skill level and provide the
appropriate learning experience for that individual. The program adapts
dynamically and adjusts the instructional level and teaching style according
to the performance of the individual user. The first public demonstrations of
the software were held in late November at COMDEX Fall '98, a computer
industry trade show, in Las Vegas.
 
  The initial version of the product provides training based on a Netscape
Navigator Web browser interface. A version of the product based on the
Microsoft Internet Explorer browser interface is expected to be completed
during the second quarter of 1999, and both the Netscape Navigator and
Internet Explorer versions will be packaged together to allow consumers to
load training based on their preferred Internet browser. The Company also
plans to release a Spanish language version of "Around the Web in 80 Minutes"
during the second quarter of 1999.
 
Marketing
 
  The introduction of "Around the Web in 80 Minutes" was hampered by the
resignations in mid-August of a group of key sales and marketing employees
whose responsibilities included the establishment of a retail sales
 
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channel for the Company's consumer products. Management elected to maintain
its original product release schedule and began making "Around the Web in 80
Minutes" available to consumers primarily through direct sales beginning in
late November. During this period, the Company continued to rebuild internal
marketing capabilities and began efforts to establish the necessary external
relationships to support marketing and merchandising, product distribution,
and retail sales.
 
  The introduction of "Around the Web in 80 Minutes" at COMDEX in late
November was intended to build industry awareness of the Company and its
technology and to explore available industry resources prior to the selection
of marketing, merchandising, and distribution partners. The Company's
evaluation of marketing and merchandising firms and initial negotiations with
potential distributors continued through December. In the first quarter of
1999, the Company announced a marketing and merchandising agreement with
HighAltitude Sales and Marketing, Inc., and its affiliate firm, Computer
Generation, and signed distribution agreements with Ingram Micro, Inc., and
Tech Data Corporation.
 
  For the fiscal year, the Company reported revenues of $58,000 from sales of
"Around the Web in 80 Minutes," primarily from orders received through the
Company's direct telephone order lines in response to advertising placements.
Further advertising tests in regional markets in early December indicated the
need for additional refinement of product marketing concepts, and the Company
elected to withdraw future advertising until the marketing program could be
fully staffed and implemented and the retail channel more firmly established.
 
  The Company believes that the primary customer for "Around the Web in 80
Minutes" is a novice computer user with limited Internet experience and that
the product has the greatest likelihood of consumer sales success in
traditional retail stores where PCs are sold. As a result, the Company
intends, based on its financial ability, to accelerate marketing for the
product simultaneous with its retail store availability to consumers and
intends to participate in cooperative advertising programs with major
retailers to encourage product sell-through.
 
  In addition, management will continue to consider potential bundling
opportunities that offer substantial benefit to the Company, including
possible agreements with consumer PC manufacturers, online service providers
and/or complementary software developers. To date, the Company has not entered
into any agreements with any potential bundling partners, and there is no
assurance that the Company will enter any such bundling arrangements in the
future.
 
Distribution
 
  During December 1998, "Around the Web in 80 Minutes" was available to
consumers via a toll-free line for direct orders from the Company and through
three online-oriented retailers, including ComputerLiteracy.com, Amazon.com,
and PC Zone. The agreement with HighAltitude Sales and Marketing, Inc., and
Computer Generation in the first quarter of 1999 accelerated the Company's
efforts to align with established product distribution companies capable of
serving major, national retailers.
 
  The Company's first distribution agreement was announced in February 1999
with Ingram Micro, Inc. Ingram Micro, Inc. distributes products and services
to more than 115,000 resellers in 120 countries. A second distribution
agreement was announced in March 1999 with Tech Data Corporation. Tech Data
serves more than 100,000 value-added resellers and retail dealers in the
United States, Canada, the Caribbean, Latin America, Europe, and the Middle
East. In March 1999, the Company also announced an agreement with Global
Communications Network (GCN) for its Mexico City-based Conexion Mundial
subsidiary to market and distribute the Spanish language version of "Around
the Web in 80 Minutes" when the product is complete. Conexion Mundial provides
Internet services in Mexico and distributes GCN's consumer products and
services to several thousand retail locations within Mexico.
 
  In late February 1999, the Company participated in the annual Retail XChange
conference, a technology trade show for the retail sales channel, organized as
an industry-wide forum for senior executives from channel
 
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<PAGE>
 
organizations, vendors, and distributors to meet in formal sessions and
informal events. The vendors and retailers attending Retail XChange selected
"Around the Web in 80 Minutes" for "Overall Best of Show" and "Best New
Technology" awards and voted the Company's marketing plan as the "Best Retail
Strategy" presented at the conference.
 
  Negotiations that began during this conference led to retail sales
agreements announced in March with CompUSA, Inc. and TigerDirect, Inc.
CompUSA, Inc. placed an order for sales of "Around the Web in 80 Minutes" at
its CompUSA Computer Superstores beginning in early April. Its stores serve
retail, corporate, government, and education customers and include technical
service departments and classroom training facilities. TigerDirect, Inc. is a
catalog, online, and direct business-to-business retailer of "build-to-order"
systems, software, and peripherals with monthly catalog distribution to more
than 2 million customers.
 
  To date, the Company has received a total of 9,061 orders for "Around the
Web in 80 Minutes" from Tech Data Corporation and Ingram Micro, Inc. The
distribution agreements with both Tech Data Corporation and Ingram Micro, Inc.
contain absolute right of return provisions allowing either distributor to
return orders which are not ultimately purchased and retained by consumers. As
a result, the Company will recognize revenue only after its software products
are purchased by the ultimate consumer.
 
Competition
 
  "Around the Web in 80 Minutes" is designed primarily for the consumer
market. It is anticipated that future products could be developed for the
education, government, and corporate markets. There are many alternative
solutions for the consumer seeking information about the Internet, including
CD-ROMs offering training on specific applications or books on the Internet
that include a CD with multimedia content. There are several large, well
capitalized companies that produce educational software, including The
Learning Company, Expert Software, Inc., Broderbund, and Scholastic, which
have established brand names and could introduce and widely distribute an
Internet-oriented educational CD. There are other software companies, most of
which are substantially larger and have far greater resources than the
Company, that could devote substantially greater resources to the development
and marketing of competing products. The market for Internet training programs
is intensely competitive, and there is no assurance that these companies will
not introduce products to compete with the Company's products. The Company's
plan is for its product to compete on a basis of its content, ease of use,
depth, and adaptability to user skills, but there is no assurance that the
Company will be successful in achieving this goal.
 
Additional Future Products: Training and Education Market
 
  Management's strategy is to develop future products for the training and
education market. Development of a Microsoft Internet Explorer version of
"Around the Web in 80 Minutes" is expected to be completed in the second
quarter of 1999 and to be packaged with the current Netscape Navigator
version, providing consumers with a choice of version for loading. A Spanish
language version of "Around the Web in 80 Minutes" is scheduled for completion
in the second quarter of 1999. In addition, the Company has several new
products based on SMART ONE(R) technology in early-stage development.
 
  Additionally, the Company's strategic goal is to develop and deliver
"intelligent" training programs to corporate customers whose employees would
benefit from the quality of learning provided by SMART ONE(R) technology and
whose budgets would be impacted favorably by increased efficiency afforded
through computer-based training. The Company will pursue agreements with
potential corporate partners in 1999 for the co-development of SMART ONE(R)
training courses, which may be adapted and marketed to other corporations with
similar training needs. As the Company has never developed corporate
"intelligent" training programs, there is no assurance that it will be
successful in completing any programs in the future. The initial inability to
successfully complete such program may have an adverse effect on the Company's
reputation, which may impair the Company's ability to enter into future
corporate agreements.
 
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  The Company may deliver SMART ONE(R) training to corporate customers through
a variety of media, including single-user CD-ROM and enterprise software for
deployment on corporate networks; however, management's ultimate goal is to
deliver SMART ONE(R)-based corporate training through an "intelligent
network," incorporating Internet technology to allow employees at customer
companies to access desired courses on a timed, pay-per-use basis. The Company
believes that the inherent efficiency of its SMART ONE(R) technology, which
dynamically adapts to the knowledge level and learning style of users, will
result in cost savings for companies that now rely on traditional training
methods.
 
  The Company believes that the market for training and education is
undergoing a revolutionary change as new technologies reshape the way people
learn. Often, the traditional concept of a classroom setting with one lecturer
and a group of students is replaced or supplemented with interactive
multimedia tools such as video terminals and computers that can provide each
student with more individualized instruction. Even though the costs to produce
a multimedia training program are significant, management believes they
compare favorably to the travel, lost work time, and expenses associated with
traditional training programs. The Company believes that many market segments
exist within select industries and governmental agencies that it believes
would benefit from the implementation of personnel training programs.
 
Long-term Product Strategy
 
  As part of management's long-term strategy, the Company desires to develop a
"suite" of computer programs designed to make sense of data existing across
enterprises of increasingly complex computer systems comprised of different
types of hardware and software. The Company's long-term strategy includes the
development of SMART PERFORM, an intelligent software application expected to
utilize the advanced CARNOT technology licensed from MCC to enable computer
users to seek and obtain specific information in a specific form, such as
text, video, or graphics. SMART PERFORM is being designed as a system for
integrating information located in multiple database systems throughout an
enterprise or multiple enterprises, as well as locating, evaluating,
retrieving, and merging information in environments such as the Internet,
where new information and new sources of information are constantly being
added.
 
  Further, the Company seeks to develop strategic resource management products
utilizing intelligent technology combined with the multi-platform capabilities
of SMART PERFORM. The Company is in the initial stages of developing SMART
ENTERPRISE, a real-time knowledge management tool which summarizes and
presents key management information on a user-defined basis. The software
should allow users to access such vital corporate information as accounting
data, inventory status, sales information, and product margins. Management
believes that its Data Crystal technology, acquired under exclusive worldwide
license from the University of Southern California, may complement SMART
ENTERPRISE. Data Crystal applies advanced technologies to identify useful
patterns and trends from very large data sets.
 
  Management believes that a market may exist for SMART ENTERPRISE with large-
sized enterprises desiring greater timeliness and quality of key enterprise
data. Potential markets include SAP customers, accounting firms, and the
Fortune 10000. To date, the Company has not developed a marketing plan for
SMART ENTERPRISE or SMART PERFORM and has not identified potential markets for
SMART PERFORM.
 
  To date, the Company is in the research and development stage with SMART
PERFORM and SMART ENTERPRISE. It has not developed any products utilizing
SMART PERFORM or SMART ENTERPRISE, it is not expected that any products will
be developed in 1999, and there is no certainty that any products will ever be
developed using SMART PERFORM or SMART ENTERPRISE.
 
Intellectual Property
 
  The Company has applied for trademarks on SMART ENTERPRISE, SMART PERFORM,
PORTAL, SHELLEYVISION, SMARTKIDS, and THINKSMART in the United States. The
Company has also applied for trademark protection for "Around the Web in 80
Minutes" in Argentina, Australia, Canada, Spain, Great Britain,
 
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Mexico, New Zealand, Peru, Venezuela, and the United States. Additionally,
trademark protection for SMART ONE has been applied for in Canada and Mexico.
The Company has applied for servicemarks on SMART SUPPORT, DOORWAYS, and
GLOBAL INTELLIGENT NETWORK, SHELLEYVISION, SMARTKIDS and THINKSMART. There can
be no assurance that any trademarks and/or servicemarks will be issued. The
Company has registered a trademark on SMART ONE(R). The Company has applied
for registration of the copyright for "Around the Web in 80 Minutes" with the
United States Copyright Office, as well as the respective authorities in
Canada, Peru, and Mexico. The Company has not filed for any patent protection
with the United States Government, and relies upon licensed intellectual
property and trade secret protection.
 
  In November 1995, the Company exchanged shares of its capital stock in
return for a non-exclusive, worldwide right and license to use the MCC CARNOT
technology. This license precludes the Company from granting a sub-license
without MCC's prior written approval. The terms for use are perpetual,
provided there is not a material breach by either party which remains uncured
for a period of thirty days after notice from the aggrieved party, or if one
of the parties (i) ceases to carry on its business, (ii) becomes insolvent,
(iii) fails to pay its debts as they become due, or (iv) files for bankruptcy.
 
  In May 1997, the Company acquired from the University of Southern California
the Data Crystal License for a $25,000 license fee and certain royalty
payments of 5%-40% from sales related to the licensed technology, to be not
less than $25,000 nor more than $200,000 per year. The license is perpetual
and exclusive.
 
  In October 1993, the Company entered into a sub-contract agreement with AT&T
GIS wherein AT&T developed for the Company a working prototype computer-based
training system to address skills training for the operation of combustible
gas indicators. The Company acquired the written specifications for the
original architecture for this working prototype and paid AT&T approximately
$445,000. This prototype combined features of the Company's proprietary SMART
ONE(R) program with tools developed by AT&T. This prototype was the logical
precursor to the current SMART ONE(R) training product, and initially served
as the basic architecture for current products.
 
Product Research and Development
 
  As a development stage company, the Company has had minimal revenue to date
and has incurred approximately $12.6 million in development stage cash outlays
since inception, as well as the issuance of capital stock to MCC. For the
former fiscal years ended May 31, 1997 and 1998 and the transition period
ended December 31, 1998, the Company incurred research and development expense
of approximately $1.4 million, $1.8 million and $1.5 million, respectively,
which includes allocated professional services, employee compensation,
depreciation and amortization, and general administrative expenses related to
research and development. It is expected that these expenses will continue,
and likely increase, in the future. Pursuant to contractual agreement, certain
third parties, including possibly customers, may perform research and
development activities in the future.
 
ITEM 2. DESCRIPTION OF PROPERTY
 
  The Company leases approximately 33,975 square feet of office space in
Houston, Texas, at a monthly rental rate of approximately $56,625 expiring
March 2002. The Company leases approximately 1,856 square feet of space for
research and development in Atlanta, Georgia, at a monthly rental rate of
$2,320 until March 2000 after which the monthly rental rate will increase $116
per year, until the lease expires in March 2002. The Company has entered into
a five-year lease commencing May 1999 for a research and development facility
in Houston, Texas. The lease space is approximately 7,671 square feet and the
monthly rental rate is $8,964 for the initial three years and $9,269 for the
final two years. The Company believes its facilities are suitable and adequate
for its present purposes.
 
ITEM 3. LEGAL PROCEEDINGS
 
  In October 1998, the Company, its president and a former officer were named
as defendants in a class-action lawsuit; Griffin v. GK Intelligent Systems,
Inc., et al.; filed in the Texas District Court of Harris County, Texas,
 
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Houston Division, Cause H-98-3847. The plaintiff has alleged violations of the
securities laws, common law fraud, conspiracy, negligence, and negligent
misrepresentation and is seeking unspecified damages. The case was removed to
the United States District Court for the Southern District of Texas in
November 1998. To date, the parties have conducted limited discovery, and the
Company is in the process of evaluating the plaintiff's claims and intends to
vigorously defend the lawsuit.
 
  The Company is a defendant in Cause No. 98-35985; David Michael Sims v. GK
Intelligent Systems, Inc. in the 189th Judicial District Court of Harris
County, Texas. The lawsuit was filed in July 1998, and alleges the Company is
liable to the plaintiff for breach of contract and fraudulent
misrepresentation. The case arises out of services allegedly performed by the
plaintiff for which he did not receive compensation. Although preliminary
discovery has commenced, the precise amount of plaintiff's demand is currently
unknown other than his initial claim for a commission of approximately
$500,000. The Company denies any liability to the plaintiff, and intends to
vigorously defend the lawsuit.
 
  In September 1997, the Company entered into a consulting agreement with
Union Atlantic, LC ("Union Atlantic") for performance of services. The Company
issued Union Atlantic a five year warrant to purchase 200,000 shares of Common
Stock at an exercise price of $.9375 per share, and a five year warrant to
purchase 112,500 shares of Common Stock at an exercise price of $1.25 per
share as compensation for services to be rendered. Each of the warrants
contained demand registration rights. Union Atlantic resigned as a consultant
to the Company in November 1997. As no capital was raised by Union Atlantic,
the Company sent a notice to Union Atlantic in July 1998 canceling the
warrants. In August 1998, the Company received notice from Union Atlantic
demanding registration of the warrants. The Company has contacted Union
Atlantic and is in the process of determining Union Atlantic's legal rights,
if any.
 
  In connection with the Union Atlantic transaction, the Company issued
Catalyst Financial a one year warrant to purchase 66,667 shares of Common
Stock at an exercise price of $.9375 per share, and a one year warrant to
purchase 37,500 shares of Common Stock at an exercise price of $1.25 per share
as a finder's fee for introducing the Company to Union Atlantic. Each of the
warrants contained demand registration rights. Since Union Atlantic did not
raise capital for the Company, the Company contends that no consideration was
received in exchange for the warrants. In August 1998, the Company received a
notice from Catalyst Financial demanding registration of the warrants. The
Company has contacted Catalyst Financial and is in the process of determining
Catalyst Financial's legal rights, if any.
 
  In September 1998, James Cassell, an affiliate of Catalyst Financial,
exercised a portion of the aforementioned warrants to purchase a total of
10,000 shares of Common Stock at an aggregate purchase price of $9375. In
connection with the exercise, Mr. Cassell made a demand registration request
pursuant to a registration rights agreement with the Company. To date, the
Company has not registered the 10,000 shares of Common Stock.
 
  In February 1998, the Company entered into a memorandum of understanding and
confidentiality and non-disclosure agreement with Capella Computers, Ltd.
("Capella") for software interface. The parties never consummated a definitive
agreement, no work was performed under the memorandum of understanding, and
the Company sent Capella a notice of termination in July 1998. In August 1998,
the Company received a demand from Capella for $200,000 asserting that Capella
had invested considerable time and effort in evaluating the effort needed to
fulfill the Company's requirements and working out the details of the server-
to-server architecture. The Company has contacted Capella and is in the
process of determining Capella's legal rights, if any.
 
  In May 1997, the Company entered into a sales purchase/asset recovery
agreement with SGD International Corp. ("SGD") pursuant to which the Company
was to sell SGD certain of the Company's products for marketing purposes. In
exchange for the products, SGD agreed to furnish the Company with merchandise,
service and media credits. The period of exclusivity of the Agreement expired
in May 1998. As the Company had not released any products, none were forwarded
to SGD and the Company did not utilize any of the SGD
 
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credits. In July 1998, the Company sent SGD a notice of termination canceling
the agreement. In August 1998, SGD sent a letter threatening a lawsuit for the
Company's alleged breach of contract. The Company contacted SGD and is in the
process of determining SGD's legal rights, if any.
 
  In August 1998, the Company received a letter from J. David Cabello, the
former general counsel and secretary of the Company, in connection with Mr.
Cabello's separation from employment with the Company. The Company's
contractual obligations to Mr. Cabello turns on whether he resigned from his
employment or whether he was terminated.
 
  Mr. Cabello has demanded $190,000 in total compensation and immediate
vesting of 600,000 shares of Common Stock. The Company contends Mr. Cabello
resigned from his positions with the Company, and as such, Mr. Cabello is
entitled to earned but unpaid salary and vested options to purchase 25,000
shares of Common Stock. In the event the parties are unable to settle this
matter, it is likely Mr. Cabello will file suit for wrongful termination.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  None.
 
                                       8
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
 
  The Common Stock has traded under the symbol "GKI" on the American Stock
Exchange since May 21, 1998. Prior thereto, the Common Stock traded on the OTC
Electronic Bulletin Board. The following table sets forth the high and low
closing price of the Common Stock on the American Stock Exchange since May 21,
1998 and the high and low bid price of the Common Stock on the OTC Electronic
Bulletin Board prior thereto. With respect to the quotes on the OTC Electronic
Bulletin Board, such prices reflect inter-dealer prices, without retail mark-
ups, mark-downs or commissions, and may not necessarily represent actual
transactions.
 
<TABLE>
<CAPTION>
                                                              High     Low
                                                              ----     ---
<S>                                                           <C>      <C>
FISCAL 1997
(represents twelve months ended May 31, 1998)
  First Quarter.............................................. $ 2 1/2     7/8
  Second Quarter.............................................   1 7/16    7/16
  Third Quarter..............................................   1 1/16    3/16
  Fourth Quarter (through May 20,1998).......................   9 1/16    9/32
  Fourth Quarter (from May 21, 1998).........................  10 1/8   6 1/4
FISCAL 1998
(represents seven months ended December 31, 1998)
  First Quarter..............................................  18 3/16  1 5/8
(represents four month transitional quarter ended September
 30, 1998)
  Second Quarter.............................................   8 3/16  2 15/16
</TABLE>
 
  On March 22, 1999, the last sales price of the Common Stock as reported by
the American Stock Exchange was $2.9375. As of March 22, 1999, there were 470
record owners of the Common Stock.
 
  It is the present policy of the Company not to pay cash dividends and to
retain future earnings to support the Company's growth. Any payment of cash
dividends in the future will be dependent upon the amount of funds legally
available therefor, the Company's earnings, financial condition, capital
requirements and other factors that the Board of Directors may deem relevant.
The Company does not anticipate paying any cash dividends in the foreseeable
future.
 
Recent Sales of Unregistered Securities
 
  The following securities issuances occurred between November 20, 1998 (the
filing of the Company's Form 10-QSB for the transitional quarter ended
September 30, 1998) and March 29, 1999. Each transaction was exempt from
registration pursuant to Section 4(2) and/or Regulation D promulgated under
the Act as a transaction by an issuer not involving any public offering. No
underwriter was utilized in such issuances and no commissions were paid.
Between November 1998 and March 1999, the Company issued 1,686,500 shares of
Common Stock to 12 accredited investors at an aggregate purchase price of
$3,373,000 in connection with a private placement. In November 1998, the
Company issued options to purchase 30,500 shares of Common Stock to two
professionals with exercise prices of $2.50 to $4.00 per share and expiration
dates of November 2003 and September 2008. In March 1999, the Company issued a
warrant to purchase 10,000 shares of Common Stock to a former consultant at an
exercise price of $2.00 per share with an expiration date of December 2007 in
connection with a court ordered final judgment.
 
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
 
SELECTED HISTORICAL FINANCIAL DATA
 
  The selected historical financial data set forth below for the seven month
periods ended December 31, 1998 and 1997, the years ended May 31, 1998 and
1997 and the period from inception (October 4, 1993) through December 31, 1998
have been derived from the Company's historical financial statements.
 
                                       9
<PAGE>
 
  The Company is a development stage enterprise engaged in the development of
sophisticated intelligent software products. From inception (October 4, 1993)
to date, the Company has realized minimal revenues as its activities have been
devoted primarily to the (i) acquisition and development of core software
technologies from which future products and applications will be developed and
(ii) securing the services of competent individuals capable of implementing
the Company's product development and marketing strategies. Accordingly,
management does not consider the historical results of operations to be
representative of future results of operations of the Company.
 
<TABLE>
<CAPTION>
                                                                    Inception
                                                                   (October 4,
                            Seven Months Ended     Year Ended         1993)
                               December 31,          May 31,         through
                            -------------------- ----------------  December 31,
                             1998       1997      1998     1997        1998
                            -------  ----------- -------  -------  ------------
                                     (Unaudited)
                                 (In thousands, except per share data)
<S>                         <C>      <C>         <C>      <C>      <C>
STATEMENT OF OPERATIONS
 DATA:
Revenues..................  $    58    $    --   $    --  $    --    $     58
Cost of revenues..........       19         --        --       --          19
Gross margin..............       39         --        --       --          39
                            -------    -------   -------  -------    --------
Costs and Expenses:
  Professional services...    3,801      1,080     2,749    4,964      12,370
  Employee compensation...    1,793        762     1,273      890       3,956
  Depreciation and
   amortization...........      726        502       957      820       3,029
  President's
   compensation...........      140        140       240    2,523       3,688
  Other general and
   administrative.........    1,505        314       663      331       3,005
                            -------    -------   -------  -------    --------
Total costs and expenses..    7,965      2,798     5,882    9,528      26,048
                            -------    -------   -------  -------    --------
Net loss..................   (7,926)    (2,798)   (5,882)  (9,528)    (26,009)
Dividends on preferred
 stock....................      (55)       --       (132)     --         (187)
                            -------    -------   -------  -------    --------
Net loss applicable to
 common shareholders......  $(7,981)   $(2,798)  $(6,014) $(9,528)   $(26,196)
                            =======    =======   =======  =======    ========
Basic net loss per share
 of common stock..........  $  (.27)   $  (.19)  $  (.35) $  (.89)   $  (2.08)
                            =======    =======   =======  =======    ========
Weighted average number of
 shares of common stock
 outstanding..............   30,055     14,766    17,133   10,671      12,600
                            =======    =======   =======  =======    ========
BALANCE SHEET DATA:
Assets:
  Current assets..........  $ 2,030
  Computer software costs,
   net....................    1,629
  Property and equipment,
   net....................    1,421
                            -------
Total assets..............  $ 5,080
                            =======
Liabilities and
 Stockholders' Equity:
  Current liabilities.....  $   883
  Capital lease
   obligations, less
   current maturities.....       70
  Other long term
   liabilities............      204
  Stockholders' equity....    3,923
                            -------
Total liabilities and
 stockholders' equity.....  $ 5,080
                            =======
</TABLE>
 
GENERAL
 
  From inception (October 4, 1993) through May 31, 1998, the Company has
utilized funds obtained primarily through private placements to acquire and
develop core software technologies for the purpose of developing computer-
based training products. The Company's first product, "Around the Web in 80
Minutes," a CD-ROM
 
                                      10
<PAGE>
 
based internet training course, was introduced at the COMDEX Fall '98 trade
show in mid November 1998 and subsequently made available to consumers through
direct sales beginning in late November 1998. Accordingly, the Company has
recorded minimal revenues and has incurred net losses totaling approximately
$26,196,000 from inception through December 31, 1998.
 
  Costs of purchased software used to develop planned software products are
capitalized when acquired and amortized on a straight-line basis over the
expected useful life of the software. Costs incurred to commercially develop
the Company's intelligent software technologies and products are composed
primarily of professional fees, staff salaries, and subcontract costs and are
expensed when incurred until technological feasibility has been established
for an individual product.
 
  The operating losses incurred by the Company since its inception raise
substantial doubt about its ability to meet future expected expenditures
necessary to fully develop its software products and to continue as a going
concern. The Company's independent accountants have issued an explanatory
paragraph in their opinion with respect to the Company's financial statements
for the seven months ended December 31, 1998 regarding the uncertainty
concerning the Company's ability to continue as a going concern. The current
cash forecast indicates that there will be negative cash flow from operations
for at least the first two quarters of the calendar year ended December 31,
1999. The Company is currently seeking short-term and long-term debt or equity
financing sufficient to fund projected working capital and software product
development and marketing needs. However, there can be no assurance that the
Company will be successful in raising funds, that the amount and terms of any
financing will be acceptable to the Company, or that profits, if any, from the
sale of the Company's software product or products in fiscal year 1999 will be
sufficient to fund the Company's working capital, software development, and
marketing expenditure requirements. Failure to obtain sufficient funding will
adversely impact the Company's financial position.
 
NEW ACCOUNTING PRONOUNCEMENTS
 
  Derivative and Hedging Activities--In June 1998, the FASB issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). SFAS 133 requires companies to recognize all derivatives contracts as
either assets or liabilities in the balance sheet and to measure them at fair
value. If certain conditions are met, a derivative may be specifically
designated as a hedge, the objective of which is to match the timing of gain
or loss recognition on the hedging derivative with the recognition of (i) the
changes in the fair value of the hedged asset or liability that are
attributable to the hedge risk or (ii) the earnings effect of the hedged
forecasted transaction. For a derivative not designated as a hedging
instrument, the gain or loss is recognized in income in the period of change.
SFAS 133 is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. Historically, the Company has not entered into derivatives
contracts either to hedge existing risks or for speculative purposes.
Accordingly, the Company does not expect adoption of the new standard on
January 1, 2000 to affect its financial statements.
 
  Start-up Activities--In June 1998, the Accounting Standards Executive
Committee of the AICPA issued SOP 98-5, Reporting on the Costs of Start-up
Activities. SOP 98-5 requires all start-up and organizational costs to be
expensed as incurred. It also requires all remaining historically capitalized
amounts of these costs existing at the date of adoption to be expensed and
reported as the cumulative effect of a change in accounting principles. SOP
98-5 is effective for all fiscal years beginning after December 31, 1998. The
Company believes that the adoption of SOP 98-5 on January 1, 2000 will not
have a significant effect on its financial statements.
 
  FASB Amendments and Clarifications--In February 1999, the FASB issued SFAS
No. 135, Rescission of Financial Accounting Standards Board No. 75 ("SFAS 75")
and Technical Corrections. SFAS 135 rescinds SFAS 75 and amends SFAS No. 35.
SFAS 135 also amends other existing authoritative literature to make various
technical corrections, clarify meanings, or describe applicability under
changed conditions. SFAS 135 is effective for financial statements issued for
fiscal years ending after February 15, 1999. The Company believes that the
adoption of SFAS 135 will not have a significant effect on its financial
statements.
 
                                      11
<PAGE>
 
RECENT DEVELOPMENTS
 
  In August 1998 the Company changed its fiscal year end to December 31 which
will be its fiscal year end in the future. Prior to August 1998, the Company's
fiscal year ended on May 31. As a result, the financial information discussed
herein includes operations during the (i) transition period from June 1, 1998
through December 31, 1998 ("the transition period") and, for comparative
purposes, operations during the period from June 1, 1997 through December 31,
1997 ("the prior year transition period") and (ii) year ended May 31, 1998
compared to the year ended May 31, 1997.
 
  During the transition period, the Company incurred net operating losses of
approximately $7,926,000 related primarily to the continued development of its
(i) first planned software training product, (ii) systems infrastructure and
(iii) workforce of competent individuals capable of implementing the Company's
product development and marketing strategies. Non-cash expenses for the
transition period included approximately $1,773,000 of compensation expense to
professionals and approximately $726,000 of depreciation and amortization. At
December 31, 1998, current assets were approximately $2 million, total assets
were approximately $5 million, current liabilities were approximately $882,000
and stockholders' equity was approximately $3.9 million.
 
RESULTS OF OPERATIONS
 
TRANSITION PERIOD VERSUS PRIOR YEAR TRANSITION PERIOD
 
  Revenues. The Company's first product, "Around the Web in 80 Minutes," a CD-
ROM based Internet training course, was made available to consumers through
direct sales beginning in late November 1998. Initial revenues of
approximately $58,000 associated with these sales was recognized in the
transition period versus no sales of product during the prior year transition
period.
 
  Cost of Revenues. Cost of revenues associated with the initial product sales
during the transition period amounted to approximately $19,000 versus no such
costs during the prior year transition period. Cost of revenues include the
cost of CD-ROM diskettes, jewel cases, product boxes, and labor required to
assemble product kits.
 
  Costs and Expenses. Costs and expenses for the transition period increased
by approximately $5,167,000, or 185%, from the prior year transition period
levels primarily due to increases in professional services, employee
compensation, depreciation and amortization, and other general and
administrative expenses as more fully described below.
 
  Professional services for the transition period increased by approximately
$2,720,000, or 252%, from the prior year transition period due primarily to a
significant increase in the number of professionals hired during the
transition period to (i) develop and refine the Company's first product, (ii)
develop the Company's internal systems and infrastructure, (iii) provide
marketing and advertising support, (iv) strengthen the Company's Board of
Directors and (v) represent the Company in various legal matters.
 
  Employee compensation for the transition period increased by approximately
$1,031,000, or 135%, from the prior year transition period primarily due to an
increase in the number of employees on staff from seven at December 31, 1997
to 29 at December 31, 1998. In addition, employee compensation during the
transition period includes: (i) compensation paid to several key financial,
sales, marketing, legal, and public relations employees who joined the Company
in May or June 1998 and resigned in August 1998, and (ii) a one-time charge of
approximately $376,000 associated with the resignation of a former officer and
director in September 1998.
 
  Depreciation and amortization for the transition period increased by
approximately $224,000, or 45%, from the prior year transition period due in
large part to the acquisition of additional furniture and equipment to
accommodate the increase in employees, as well as an increase in the
amortization of software development costs associated with the release of the
Company's first product in November 1998.
 
                                      12
<PAGE>
 
  Other general and administrative expenses for the transition period
increased by approximately $1,192,000, or 380%, from the prior year transition
period due primarily to a general increase in the Company's business
activities, an increase in the level of employees, and the infrastructure
needed to support such activities.
 
  As of December 31, 1998, for federal income tax purposes, the Company
reported an aggregate of approximately $20,983,000 of available net operating
loss ("NOL") carry-forwards incurred during the period from inception (October
4, 1993) through December 31, 1998. These NOL carry-forwards may be available
to the Company to offset future taxable income through the year 2019. However,
the conversion of some or all of the outstanding Common Stock warrants or
options, or other future issuances of common or preferred stock could result
in a change in control for federal income tax purposes. Such an event could
significantly limit the amount of the NOL that could be used to offset future
taxable income in any one year. There can be no assurance that the Internal
Revenue Service will not challenge the existence or the amount of such NOL
carry-forwards.
 
YEAR ENDED MAY 31, 1998 VERSUS YEAR ENDED MAY 31, 1997
 
  Revenues. There were no revenues for the years ended May 31, 1998 and 1997.
 
  Costs and Expenses. Costs and expenses for the year ended May 31, 1998
decreased by $3,647,000, or 38%, from 1997 levels primarily due to decreases
in professional services and president's compensation which were partially
offset by increases in employee compensation, general and administrative
expenses and depreciation and amortization as more fully described below.
 
  Professional services for the year ended May 31, 1998 decreased by
$2,215,000, or 45%, from 1997 levels due primarily to a decrease in the value
of Common Stock, options and warrants awarded to professionals in 1998 for
services rendered. Common Stock and warrants valued at $4,731,000 were issued
to professionals in 1997 while the value of such issuances to professionals in
1998 amounted to $1,940,000. The offsetting increase of $576,000 in cash-based
professional fees in 1998 was due primarily to a general increase in the
number of legal and other professionals used by the Company to support an
increased level of business activity.
 
  President's compensation for the year ended May 31, 1998 decreased by
$2,283,000 to $240,000 due primarily to the issuance in 1997 of 1,100,000
shares of Common Stock to the president for services performed valued at
$2,262,500.
 
  Employee compensation for the year ended May 31, 1998 increased by $383,000,
or 43%, from 1997 due to an increase in the number of employees on staff from
four to fourteen offset by a decrease in the value of Common Stock and
warrants granted to employees from $800,000 in 1997 to $621,000 in 1998.
 
  General and administrative expenses for the year ended May 31, 1998
increased by $331,000 from 1997 levels due primarily to a general increase in
the Company's business activities, an increase in the level of employees and
infrastructure needed to support such activities, and the Company's decision
to list its Common Stock on the American Stock Exchange.
 
  Depreciation and amortization for the year ended May 31, 1998 increased by
$137,000, or 17%, from 1997 due in large part to the acquisition of additional
furniture and equipment to accommodate the increase in employees as well as
the accelerated amortization of $60,000 of capitalized software costs not
expected to benefit the Company in the near term.
 
FOREIGN EXCHANGE
 
  The Company currently has no exposure to foreign currency exchange rate
fluctuations. The Company will seek to minimize its exposure to foreign
currency exchange rate fluctuations by requesting that its customers,
distributors, and VARs enter into contracts denominated in United States
dollars or by entering into transactions to attempt to hedge some of the risks
of foreign currency exchange rate fluctuations.
 
                                      13
<PAGE>
 
HISTORICAL CASH FLOWS
 
TRANSITION PERIOD VERSUS PRIOR YEAR TRANSITION PERIOD
 
  Operating Activities--Cash used in operating activities during the
transition period amounted to approximately $5,077,000, an increase of
approximately $4,081,000 over the $996,000 of cash used for operations during
the prior year transition period. The increase relates primarily to
significant expenditures during the transition period to professionals,
employees and vendors required to (i) develop and refine the Company's first
product, (ii) develop the Company's internal systems and infrastructure, (iii)
provide marketing and advertising support, (iv) strengthen the Company's Board
of Directors and (v) represent the Company in various legal matters.
 
  Investing Activities--Investing expenditures during the transition period
amounted to approximately $1,295,000, an increase of $1,105,000 over the
$190,000 of expenditures in the prior year transition period. The increase
relates primarily to the acquisition of furniture and equipment during the
transition period associated with the development of the Company's internal
systems and infrastructure and increased number of employees and
professionals.
 
  Financing Activities--The Company has financed its operating and investing
activities since inception (October 4, 1993) primarily from the proceeds of
private placements. During the transition period, the Company received
approximately $2.2 million from a private placement in November 1998. During
the prior year transition period, the Company received approximately $721,000
from private placements and $150,000 from bank loans.
 
YEAR ENDED MAY 31, 1998 VERSUS YEAR ENDED MAY 31, 1997
 
  Operating Activities--Cash used in operating activities for the year ended
May 31, 1998 amounted to approximately $2,478,000, an increase of
approximately $1,240,000 over the $1,238,000 of cash used for operations
during the year ended May 31, 1997. The increase relates primarily to general
increases in business activity, number of employees, number of consultants and
general and administrative expenses in 1998 as well as the retirement of
$155,000 of prior year president's compensation in 1998.
 
  Investing Activities--During the year ended May 31, 1998, the Company
invested $260,000 for software costs and $177,000 for furniture and equipment,
an increase of $267,000 over combined 1997 fiscal year capital investments.
The increase relates to (i) refinements to the internet trainer course, which
were capitalized and will be amortized when product sales are recognized, and
(ii) furniture and equipment purchases required to accommodate the increase in
employees and consultants.
 
  Financing Activities--The Company has financed its operating and investing
activities since inception (October 4, 1993) primarily from the proceeds of
private placements. During the year ended May 31, 1998, the Company received
approximately $7.8 million from a private placement, including $5.4 million
from the issuance of 4.6 million shares in May 1998 as compared to private
placement proceeds of $1.8 million in 1997. Also during 1998, the Company
received and repaid $150,000 of bank loans.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  The Company has financed its operations to date primarily through private
sales of its equity securities. From inception (October 4, 1993) through
December 31, 1998, the Company has raised a total of approximately $13.4
million in cash. Of this total, approximately $2.2 million, or 19%, was raised
in the transition period while approximately $7.8 million, or 58%, was raised
in the year ended May 31, 1998.
 
  At December 31, 1998, the Company had a cash balance of approximately $1.4
million primarily due to cash remaining from the receipt of approximately $2.2
million of private placement funds received in November 1998. In addition,
working capital at December 31, 1998 amounted to approximately $1.1 million.
 
                                      14
<PAGE>
 
  Based on the Company's current plan of operations, and in the event that no
cash from sales of the Company's products are received, it is anticipated that
its current cash balance of approximately $270,000 will provide sufficient
working capital for approximately one month or until April 1999. As a result,
the Company estimates it will require additional proceeds of approximately
$6.3 million to fund planned operations through fiscal year 1999. The
Company's estimates are based on monthly expenditures of approximately
$700,000, although unexpected expenses may limit the period of time within
which the Company's current cash balance may be utilized. Any required
financing may be raised through additional best efforts equity offerings,
joint ventures or other collaborative relationships, borrowings, and other
sources. To date, the Company has no commitment for any such additional
financing and there can be no assurance that any such financing will be
available or, if it is available, that it will be available on acceptable
terms. Moreover, as the American Stock Exchange has advised the Company that
it does not currently meet the continued listing requirements, and there is no
assurance that the Common Stock will continue to list on the American Stock
Exchange, the Company's ability to raise equity financing may be hampered. If
adequate funds are not available to satisfy either short-term or long-term
capital requirements, the Company may be required to limit its operations
significantly. The Company does not expect that its internal source of
liquidity will improve until adequate net cash is provided by operating
activities and, until such time, the Company will rely upon external sources
for liquidity. In addition, the Company will need additional financing during
this period if demand for its Internet training course or other products is
sufficiently great to require expansion at a rate more rapid than anticipated,
or if research and development expenditures or the extent of service and
customer support that the Company is required to provide are greater than
expected or other opportunities arise which require significant investment.
Additionally, the Company may require significant additional financing to
complete any acquisition.
 
  These conditions and the net operating losses incurred by the Company since
its inception raise substantial doubt about its ability to meet future
expected expenditures necessary to fully develop its software products and to
continue as a going concern. The Company's independent accountants have issued
an explanatory paragraph in their opinion with respect to the uncertainty
concerning the Company's ability to continue as a going concern.
 
YEAR 2000 COMPLIANCE ISSUES
 
  The year 2000 poses certain issues for business and consumer computing,
particularly the functionality of software for two-digit storage of dates and
special meanings for certain dates such as 9/9/99. The year 2000 is also a
leap year, which may also lead to incorrect calculations, functions, or system
failure. The problem exists for many kinds of software, including software for
mainframes, PCs, and embedded systems.
 
  In assessing the effect of the Year 2000 problem on the Company, management
has identified, and is currently evaluating, the following four general areas:
 
    . Software products sold to customers;
 
    . Internal infrastructure;
 
 
    . Supplier/third-party relationships;
 
    . Contingency plans.
 
  A discussion of the four general areas as well as management's ongoing and
planned actions with regard to each is set forth below:
 
  Software Products Sold to Customers. The Company believes its initial
product, "Around the Web in 80 Minutes" is Year 2000 compliant. However, once
purchased, "Around the Web in 80 Minutes" operates on computer systems that
are not under the Company's control. If the computer systems that operate
"Around the Web in 80 Minutes" are not Year 2000 compliant the product may not
function properly. "Around the Web in 80 Minutes" utilizes the operating
computer's date code to log the user's progress, as well as to create
completion certificates. As such, the variability of definitions of
"compliance" with the Year 2000 and of
 
                                      15
<PAGE>
 
different combinations of software, firmware, and hardware may lead to
lawsuits against the Company. The outcomes of any such lawsuits and the impact
on the Company are not estimable at this time. Due to practical constraints,
the Company has not and will not assess the existence of these potential
problems in its customers' various environments. The Company does not believe
that the development of Year 2000 compliant products has created or will
create a significant increase in the development costs of its software
products.
 
  Internal Infrastructure. The Company is in the process of verifying that all
of its personal computers, servers, and software are Year 2000 compliant. The
Company is in the process of replacing or upgrading all items that have been
found not to be Year 2000 compliant. The Company intends to determine if the
software vendors of all its critical applications have represented that their
products are Year 2000 compliant. Although the financial and accounting
software currently used by the Company is not believed to be Year 2000
compliant, the Company's existing infrastructure development plans call for
the purchase and installation of new, integrated systems applications for the
order entry, product support, and financial accounting functions during the
second and third quarters of 1999. The Company will obtain certification from
its vendors that these systems are Year 2000 compliant. The costs related to
these efforts have not been nor are they expected to be material to the
Company's business, financial condition, or results of operations.
 
  Suppliers/Third-Party Relationships. The Company has been gathering
information from vendor Web sites and available compliance statements to
identify and, to the extent possible, resolve issues involving the Year 2000
problem. The Company relies on outside vendors for water, electrical, and
telecommunications services as well as climate control, building access, and
other infrastructure services. The Company does not intend to independently
evaluate the Year 2000 compliance of the systems utilized to supply these
services. The Company has received no assurance of compliance from the
providers of these services. There can be no assurance that these suppliers
will resolve any or all Year 2000 problems with these systems before the
occurrence of a material disruption to the Company's business. Any failure of
these third-parties to resolve Year 2000 problems with their systems in a
timely manner could have a material adverse effect on the Company's business,
financial condition, or results of operation.
 
  Contingency Plans. The Company has not currently developed a formal
contingency plan to be implemented as part of its efforts to identify and
correct Year 2000 problems affecting its internal systems. However, if the
Company deems it necessary, it may take the following actions:
 
    . Accelerated replacement of affected equipment or software;
 
    . Short to medium-term use of backup equipment and software;
 
    . Wholesale backup of existing computerized data prior to January 1,
  2000;
 
    . Increased work hours for Company personnel; and/or
 
    . Other similar approaches.
 
  If the Company is required to implement any of these contingency plans, such
plans could have a material adverse effect on the Company's business,
financial condition, or results of operations.
 
  Based on the actions taken to date as discussed above, the Company is
reasonably certain that it has or will identify and resolve all Year 2000
problems that could materially adversely affect its business and operations.
 
                                      16
<PAGE>
 
ITEM 7. FINANCIAL STATEMENTS
 
  The financial statements filed as a part of this report include:
 
<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
Index to Financial Statements............................................  F-1
Report of Independent Certified Public Accountants.......................  F-2
Balance Sheet as of December 31, 1998....................................  F-3
Statements of Loss for the seven months ended December 31, 1998, the
 years ended May 31, 1998 and 1997 and the period from inception (October
 4, 1993) through December 31, 1998......................................  F-4
Statements of Stockholders' Equity (Capital Deficit) for the period from
 inception (October 4, 1993) through December 31, 1998...................  F-5
Statements of Cash Flows for the seven months ended December 31, 1998,
 the years ended May 31, 1998 and 1997 and the period from inception
 (October 4, 1993) through December 31, 1998.............................  F-7
Notes to Financial Statements............................................  F-8
</TABLE>
 
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
    FINANCIAL DISCLOSURE
 
  Alonzo & Wells, LLP, the Company's former independent accountants, resigned
in August 1997 and did not audit the fiscal year ended May 31, 1997. Alonzo &
Wells, LLP audited the Company's financial statements for the fiscal years
ended May 31, 1995 and 1996 and their reports did not contain an adverse
opinion or disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principle except it was modified as to
uncertainty as follows, "[t]he Company has suffered recurring losses from
operations, which raise substantial doubt about its ability to continue as a
going concern."
 
  In August 1997, upon recommendation by the Board of Directors, the Company
engaged BDO Seidman LLP as its principal accountant to audit the Company's
financial statements for the fiscal years ending May 31, 1996 and 1997 and for
the period from inception (October 4, 1993) through May 31, 1997.
 
                                      17
<PAGE>
 
                                   PART III
 
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
    COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
 
  The Company's directors and executive officers are:
 
<TABLE>
<CAPTION>
 Name                          Position
 ----                          -----------------------------------------
 <C>                           <S>
 Gary F. Kimmons.............  Chairman of the Board of Directors, Chief
                               Executive Officer,
                               Chief Financial Officer, Secretary, and
                               President
 
 Gerald Allen................  Director
 
 John Paul DeJoria...........  Director
 
 Marcus F. Wray..............  Director
 
 Cynthina Heinsohn...........  Vice President, Enterprise Computing
</TABLE>
 
  GARY F. KIMMONS, Age 48, has served as chairman of the board of the Company
since August 1998, and from 1993 until April 1998. Mr. Kimmons has also served
as president and chief executive officer of the Company since 1993 and
secretary since September 1998. Mr. Kimmons has extensive experience in the
design, development and implementation of business management and technical
training systems. Mr. Kimmons received a bachelor of science degree in
psychology, anthropology, and behavioral science from Rice University in 1973
and a masters degree in applied industrial psychology and management science
from Stevens Institute of Technology in 1975.
 
  GERALD C. ALLEN, Age 54, has served as a director of the Company since May
1998. Mr. Allen has served as chairman of the board of International
Industrial Services, Inc., owners of Cooper Heat and MQS Inspection, for over
five years. For the past twenty years, Mr. Allen has been involved in all
aspects of venture capital financing in the energy sector.
 
  JOHN PAUL DEJORIA, Age 55, has served as a director of the Company since
August 1998. Mr DeJoria is the chairman of the board and chief executive
officer of John Paul Mitchell Systems, a privately held cosmetic company
serving the United States and twenty-three other countries and has held this
position for over five years. Mr. DeJoria also serves as a director for MQS
Inspection, Cooper Heat, Skidmore Energy, and N.R.G. Resources. Mr. DeJoria is
co-founder of Solar Utility Company and St. Marten Spirits.
 
  MARCUS F. WRAY, has served as a director of the Company since November 1998.
From 1989 until his retirement in November 1994, Mr. Wray was chairman of the
board and chief executive officer of Joy Technologies, Inc. Since November
1994, Mr. Wray has been a private investor.
 
  CYNTHINA HEINSOHN, Age 38, has served as vice president, enterprise
computing for the Company since May 1997. From June 1994 to May 1998, Ms.
Heinsohn was the chief executive officer and president of Esoteric Essences
Corporation. From 1981 to February 1997, Ms. Heinsohn performed strategic
planning for Exxon Corporation.
 
  The directors of the Company hold office until the next annual meeting of
stockholders of the Company and until their successors in office are elected
and qualified. In September 1998, the Company established an audit committee
which is comprised of Messrs. Allen and DeJoria, and a compensation committee
comprised of Messrs. Kimmons and Allen. The Company has not established and
does not maintain any executive or nominating committees. All officers serve
at the discretion of the board of directors.
 
Compliance with Section 16(a) of the Securities Exchange Act of 1934
 
  Section 16(a) of the Securities Exchange Act of 1934 ("Exchange Act")
requires the Company's directors and executive officers, and persons who own
beneficially more than ten percent of the common stock of the Company, to file
reports of ownership and changes of ownership with the Securities and Exchange
Commission.
 
                                      18
<PAGE>
 
Copies of all filed reports are required to be furnished to the Company
pursuant to Rule 16a-3 promulgated under the Exchange Act. Based solely on the
reports received by the Company and on written representations from certain
reporting persons, the Company believes that the directors, executive
officers, and greater than ten percent beneficial owners complied with all
applicable filing requirements during the transitional period from May 31,
1998 to the fiscal year ended December 31, 1998, except the following. Mr.
DeJoria did not timely file a Form 3 in August 1998, the date the Mr. DeJoria
joined the Board, which Form 3 was subsequently filed in September 1998, and
Mr. DeJoria did not timely file a Form 4 in December 1998, reporting the
acquisition of Common Stock, which Form 4 was subsequently filed in February
1999 and amended in April 1999. Mr. Wray did not timely file a Form 3 in
November 1998, the date the Mr. Wray joined the Board, which Form 3 was
subsequently filed in December 1998.
 
ITEM 10. EXECUTIVE COMPENSATION
 
  The following tables contain compensation data for the Chief Executive
Officer and other named executive officers of the Company for the fiscal year
(of seven months) ended December 31, 1998:
 
<TABLE>
<CAPTION>
                              Annual Compensation          Long Term Compensation
                          ------------------------------   ---------------------------
                                                           Restricted      Securities
Name and Principal        Fiscal            Other Annual     Stock         Underlying
Positions                  Year     Salary  Compensation    Award(1)      Options/SARs
------------------        ------   -------- ------------   ----------     ------------
<S>                       <C>      <C>      <C>            <C>            <C>
Gary F. Kimmons, CEO....   1998(2) $140,000          --            --             --
                           1997(3) $240,000          --            --      4,000,000(5)
                           1996(4) $240,000          --    $2,262,500(6)   2,000,000(7)
Gerald Allen, Director..   1998(2)       --    $192,000(8)         --             --
                           1997(3)       --          --    $4,250,000(9)          --
                           1996(4)       --          --            --             --
John Paul DeJoria,
 Director...............   1998(2)       --  $1,575,000    $1,625,000(10)         --
                           1997(3)       --          --            --             --
                           1996(4)       --          --            --             --
Marcus F. Wray,
 Director...............   1998(2)       --          --            --      1,000,000(11)
                           1997(3)       --          --            --             --
                           1996(4)       --          --            --             --
Cynthina Heinsohn.......   1998(2) $ 75,000          --            --             --
                           1997(3) $ 84,000          --    $  143,750(12)    100,000(13)
                           1996(4) $  3,500          --    $   36,060(14)         --
Shelley Duvall,
 Consultant.............   1998(2)       --  $  200,000            --        120,000(15)
                           1997(3)       --          --            --             --
                           1996(4)       --          --            --             --
</TABLE>
--------
  * Does not include perquisites and other personal benefits in amounts less
    than 10% of the total annual salary and other compensation.
 (1) These issuances of Common Stock were awarded for services rendered,
     valued at the closing market price as of date of grant.
 (2) Represents transitional fiscal year 1998 consisting of seven months ended
     December 31, 1998.
 (3) Represents former fiscal year 1998 consisting of twelve months ended May
     31, 1998.
 (4) Represents former fiscal year 1997 consisting of twelve months ended May
     31, 1997.
 (5) Consists of a warrant granted in March 1998 to purchase 4,000,000 shares
     of Common Stock at an exercise price of $0.3125 per share, vesting over a
     period of four years at a rate of 1,000,000 shares per year, beginning in
     March 1999.
 (6) Consists of: (a) 1,000,000 shares of Common Stock granted April 18, 1997,
     (b) 50,000 shares of Common Stock granted January 31, 1997, and (c)
     50,000 shares of Common Stock granted May 27, 1997.
 (7) In September 1996, Mr. Kimmons was granted a warrant to purchase
     2,000,000 shares of Common Stock at a price of $1.00 per share. In March
     1998, the warrant was re-issued as a result of a decrease in the
 
                                      19
<PAGE>
 
    price of the Common Stock as follows: (a) options to purchase 290,909
    shares of Common Stock, currently exercisable at $0.34375 per share, and
    (b) a warrant to purchase 1,709,091 shares of Company Common Stock,
    currently exercisable at $0.3125 per share.
 (8) Pursuant to an agreement with the Company, Mr. Allen is compensated at a
     rate of $1,500 per day.
 (9) Consists of 1,000,000 shares of Common Stock granted March 31, 1998.
(10) Includes of 1,000,000 shares of Common Stock purchased August 20, 1998,
     at an aggregate purchase price of $50,000.
(11) Consists of an option to purchase 1,000,000 shares of Common Stock
     granted November 1998 at an exercise price of $0.05 per share vesting
     monthly over a period of one year, beginning November 30, 1998.
(12) Consists of: (a) 80,000 shares of Common Stock granted March 13, 1998,
     (b) 50,000 shares of Common Stock granted February 9, 1998, and (c)
     50,000 shares of Common Stock granted August 29, 1997.
(13) Consists of an option granted in March 1998 to purchase 100,000 shares of
     Common Stock at an exercise price of $0.3125 per share vesting over a
     period of four years at a rate of 25,000 per year beginning March 1999.
(14) Consists of 20,000 shares purchased May 18, 1997 at a purchase price of
     $0.01 per share.
(15) Consists of an option to purchase 120,000 shares of Common Stock granted
     September 1998, at an exercise price of $2.50 per share vesting at a rate
     of 3,333 per month.
 
                                      20
<PAGE>
 
                     EMPLOYMENT AND CONSULTING AGREEMENTS
 
  In March 1998, the Company amended and restated its employment agreement
with Mr. Kimmons. The amended agreement provides for a three-year term that
automatically renews at the end of the term for consecutive one-year terms,
and which provides for an annual base compensation of $240,000 and a warrant
to purchase 4,000,000 shares of Company Common Stock exercisable at a purchase
price of $.3125 per share (closing market price on the date of grant) which
vest at the rate of one-quarter per year over four years. Upon Mr. Kimmon's
death, disability or involuntary termination (other than for cause), all
unvested warrants will become immediately vested and exercisable. The Company
may terminate the agreement for cause, or upon the extended disability or
death of Mr. Kimmons. Mr. Kimmons may terminate the agreement for good reason,
which is defined as (1) diminution of duties, (2) failure by the Company to
comply with the agreement, (3) a requirement by the Company for Mr. Kimmons to
move locations, (4) any purported termination other than as permitted in the
agreement, (5) a change of control, or (6) failure to have a successor
corporation assume the agreement. If the agreement is terminated in connection
with a change of control, (1) the Company must pay Mr. Kimmons an amount equal
to approximately three times the sum of his annual base salary and the average
of the last annual incentive bonuses actually paid, (2) all outstanding
warrants immediately vest, (3) welfare and fringe benefits are provided for
one year, (4) the Company must pay the sum of any earned salary not yet paid,
deferred compensation and an amount equal to 150% of the value of Mr. Kimmons
accrued benefits in any Company long term incentive plan times a fraction
equal to the months worked in the performance period before termination
divided by the total performance period. If the agreement is terminated for
cause or Mr. Kimmons terminates for other than good reason, the Company shall
pay earned but unpaid salary and any vested benefits payable to him under a
plan or policy. In the event of a change of control, Mr. Kimmons will remain
with the Company until the later of: (1) 15 days after the one year
anniversary of the change of control, (2) 15 days after the anniversary date
of any merger, or (3) March 15, 2001. The agreement defines a change of
control as: (1) any person acquiring 30% of the Company or if Mr. Kimmons'
voting rights are reduced to less than 30% of the outstanding shares, (2) if
during a two year period, individuals who were on the board of directors (and
any new directors elected by two-thirds of directors in office at the
beginning of the period or whose election or nomination was so approved) cease
to be a majority of the board of directors, (3) if the shareholders approve a
merger or consolidation (other than a merger in which company shareholders own
at least 50% of surviving entity), or (4) a complete liquidation. Mr. Kimmons
holds voting rights for 5.1 million shares of Company Common Stock held by
other individuals pursuant to voting rights agreements. The voting rights
agreements expire May 31, 2000; however, upon the sale of the shares by record
holders pursuant to Rule 144 of the Act after May 31, 1999, the voting rights
terminate as to the sold shares. Upon the expiration of the voting rights
agreements or the sale of a significant number of shares of Common Stock by
the Company, it is possible that Mr. Kimmons percentage of voting rights would
fall below 30% triggering the change of control provisions in his employment
agreement.
 
  In August 1998, the Company entered into a one year consulting agreement
with John Paul DeJoria whereby, the Company agreed to compensate Mr. DeJoria
in the amount of $50,000, and Mr. DeJoria purchased 1,000,000 shares of
Company Common Stock at $.05 per share. The shares are subject to repurchase
by the Company at $.05 per share in the event of Mr. DeJoria's failure to
perform or early termination of the agreement. Under the agreement, the shares
vest at a rate of one-twelfth per month, and the vested shares are no longer
subject to repurchase by the Company. The entire amount of the shares vests
immediately and automatically without notice from DeJoria upon material breach
of the agreement by the Company or breach of any of the representations or
warranties. Mr. DeJoria may terminate the agreement at any time upon thirty
days notice. The Company may terminate the agreement if the Board determines
that DeJoria failed to perform his duties under the agreement for a period of
six months, and such failure was not due to illness or disability.
 
  In November 1998, the Company entered into a one year consulting agreement
with Marcus F. Wray whereby, the Company agreed to issue Mr. Wray an option to
purchase 1,000,000 shares of Company Common Stock at an exercise price of $.05
per share, and agreed to compensate Mr. Wray in the amount of $50,000, which
is deferred until the exercise of Mr. Wray's option at a rate of $0.05 per
option share exercised. Under the
 
                                      21
<PAGE>
 
agreement, the option vests at a rate of one-twelfth per month. The entire
amount of the shares vests immediately and automatically upon termination of
the Agreement by the Company without cause or upon the death of Mr. Wray. Mr.
Wray may terminate the agreement at any time upon ten days notice, at which
time the vesting of the options shares ceases.
 
  In March 1998, the Company entered into an employment agreement with Ms.
Heinsohn, pursuant to which Ms. Heinsohn received: (i) 80,000 shares of Common
Stock, (ii) options to purchase 100,000 shares of Common Stock at an exercise
price of $0.3125 per share vesting over a four year period beginning March
1999, (iii) a salary of $8,333 per month which has been subsequently raised to
$11,667 per month. The Company may terminate the agreement immediately for
cause, and either party may terminate the agreement with 30 days notice. The
agreement includes a standard non-disclosure provision and a three-year non-
compete provision following termination of the agreement.
 
  In September 1998, the Company entered into a memorandum of understanding
with Shelley Duvall, pursuant to which Ms. Duvall will serve as an independent
consultant to the Company for an initial term of three years. Ms. Duvall will
assist the Company in the creation, development, and distribution of
children's and family-oriented intelligent learning products. Additionally,
Ms. Duvall granted to the Company the non-exclusive right for the Company to
use her name for products which she helps to produce, and for mutually
approved public relations activities. In exchange for her services, the
Company agreed to compensate Ms. Duvall as follows: (i) $500,000 for use of
the name rights, payable $150,000 on September 8, 1998, $50,000 no later than
30 days thereafter, and $50,000 per month commencing January 1, 1999, (ii) 10%
of sales revenues (less distribution fees) from products produced by or
bearing the Duvall name, (iii) 5% of sales revenues (less distribution fees)
from products produced by third parties introduced by Ms. Duvall to the
Company, (iv) a minimum of 8% of the total production cost of each product,
and (v) options to purchase 120,000 shares of Company Common Stock which vest
on a schedule of 3,300 shares per month at an exercise price of $2.50 per
share (the closing market price on the date of grant). Upon any termination of
the agreement, the Company will retain the right to use the name "Shelley
Duvall" in connection with any then existing product produced by or bearing
the Duvall name until September 8, 2008. Ms. Duvall will continue to receive
the compensation based on sales revenues (but not production costs) of such
products until such time as those products are no longer marketed under the
Duvall name, and any stock options granted but not exercised will be canceled
upon the termination of the agreement. Ms. Duvall is currently working with
the Company in the development of children's and family-oriented software
applications incorporating Smart One technology.
 
Stock Options And Warrants
 
  During 1996 the Company adopted, and the board of directors approved, the
1995 Incentive Stock Option Plan ("Plan"). Pursuant to the Plan, options to
purchase shares of Common Stock may be granted to employees, officers, and
directors of the Company. In June 1998, the board of directors approved an
increase in the number of authorized options from 1,000,000 shares to
5,000,000 shares. Options granted under the Plan generally expire five to ten
years after the date of grant. As of December 31, 1998, options to purchase
453,464 shares were currently exercisable, options to purchase 700,645 shares
were outstanding but unexercisable, and 3,845,891 shares were available for
future grants under the Plan. For the fiscal year ended December 31, 1998, the
Company did not maintain any long-term retirement or other benefit plan.
 
                                      22
<PAGE>
 
  The following table provides information on the warrants and options granted
to the indicated officer and director during the fiscal year (of seven months)
ended December 31, 1998 and during the former fiscal year (of twelve months)
ended May 31, 1998:
 
                               INDIVIDUAL GRANTS
 
<TABLE>
<CAPTION>
                                       Shares        Percent of
                                     Underlying         Total
                         Fiscal   Warrants/Options Warrant/Options Exercise Expiration Market
Name                      Year        Granted       to Employees    Price      Date     Price
----                     ------   ---------------- --------------- -------- ---------- -------
<S>                      <C>      <C>              <C>             <C>      <C>        <C>
Gary Kimmons............  1998(1)           --            --             --        --
                          1997(2)      290,909(3)       12.5%      $0.34375  03/13/03  $0.3125
                                     1,709,091(4)       24.1%        0.3125  03/13/03  $0.3125
                                     4,000,000(5)       56.4%        0.3125  03/13/03  $0.3125
Gerald Allen............  1998(1)           --            --             --        --
                          1997(2)           --            --             --        --
John Paul DeJoria.......  1998(1)           --            --             --        --
                          1997(2)           --            --             --        --
Marcus F. Wray..........  1998(1)    1,000,000(6)       79.6%(7)   $   0.05  11/10/08  $4.9375
                          1997(2)           --            --             --        --
Cynthina Heinsohn.......  1998(1)           --            --             --        --
                          1997(2)      100,000(8)        4.3%      $ 0.3125  03/13/08  $0.3125
Shelley Duvall..........  1998(1)      120,000(9)        9.6%(7)   $   2.50  09/08/08  $  2.50
                          1997(2)           --            --             --        --
</TABLE>
--------
(1) Represents transitional fiscal year 1998 consisting of seven months ended
    December 31, 1998.
(2) Represents former fiscal year 1998 consisting of twelve months ended May
    31, 1998. Consists of a currently exercisable option.
(3) Consists of a currently exercisable option.
(4) Consists of a currently exercisable warrant.
(5) Consist of a warrant vesting over four years at a rate of 1,000,000 per
    year, beginning in March 1999.
(6) Consist of a warrant vesting monthly over a twelve month period at a rate
    of 83,333 per month, beginning in November 1998.
(7) Represents percent the grant represents of total warrants granted to non-
    employee consultants.
(8) Consists of an option vesting over four years at a rate of 25,000 per
    year, beginning March 1999.
(9) Consists of a warrant vesting monthly over a three-year period at a rate
    of 3,333 per month, beginning in September 1998.
 
           AGGREGATED WARRANT/OPTIONS EXERCISES IN FISCAL YEAR 1998
            (REPRESENTING THE 7 MONTHS ENDED DECEMBER 31, 1998) AND
                    FISCAL YEAR-END WARRANT/OPTIONS VALUES
 
<TABLE>
<CAPTION>
                           Shares               Number of Securities      Value of Unexercised
                          Acquired    Value    Underlying Unexercised         In-the Money
Name                     on Exercise Realized     Warrants/Options         Warrants/options(1)
----                     ----------- -------- ------------------------- -------------------------
                                              Exercisable Unexercisable Exercisable Unexercisable
                                              ----------- ------------- ----------- -------------
<S>                      <C>         <C>      <C>         <C>           <C>         <C>
Gary Kimmons............      --        --     1,709,091           --   $5,127,273            --
                              --        --       290,909           --   $  863,636            --
                              --        --            --    4,000,000           --   $12,000,000
Gerald Allen............      --        --            --           --           --            --
John Paul DeJoria.......      --        --            --           --           --            --
Marcus F. Wray..........      --        --       166,666      833,337   $  543,748   $ 2,718,762
Cynthina Heinsohn.......      --        --            --      100,000           --   $   300,000
Shelley Duvall..........      --        --        10,000      110,000   $    8,125   $    89,375
</TABLE>
--------
(1) Computed based on the differences between the closing market price and
    aggregate exercise prices as of Thursday, December 31, 1998.
 
                                      23
<PAGE>
 
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  The following table sets forth, as of March 15, 1999, the number and
percentage of outstanding shares of Company Common Stock owned by (i) each
person known to the Company to beneficially own more than 5% of its
outstanding Common Stock, (ii) each director, (iii) each named executive
officer, and (iv) all executive officers and directors as a group.
 
<TABLE>
<CAPTION>
                                                     Number of
                                                     Shares of
                                                    Common Stock    Percentage
                                                    Beneficially        of
Name and Address of Beneficial Owner(1)                Owned        Ownership
---------------------------------------             ------------    ----------
<S>                                                 <C>             <C>
Kimmons Family Partnership, Ltd.(2)................   4,955,000        15.4%
Gary F. Kimmons....................................  15,802,752(3)     44.9%
Gerald Allen.......................................   2,026,860(4)      6.3%
John Paul DeJoria..................................   1,130,000(5)      3.4%
Marcus F. Wray.....................................     600,000(6)      1.8%
Cynthina Heinsohn..................................     225,000(7)        *
Shelley Duvall.....................................      26,664(8)        *
All executive officers and directors as a group (5
 persons)(9).......................................  18,757,752(10)    52.4%
</TABLE>
--------
  * Less than 1%.
 (1) The business address of each principal stockholder is the same as the
     address of the Company's principal executive offices.
 (2) Mr. Kimmons is a general partner of a family limited partnership, and as
     such has the sole voting, investment and disposition power over the
     4,955,000 shares of Common Stock owned by the partnership.
 (3) Includes: (i) 4,955,000 shares owned of record by the Kimmons Family
     Partnership, Ltd., (ii) a warrant to purchase 1,709,091 shares, and (iii)
     options to purchase 290,909 shares of Common Stock. Includes 1,000,000
     shares of Company Common Stock representing a portion of a warrant to
     purchase 4,000,000 shares of Common Stock which have vested or will vest
     within 60 days of March 15, 1999. Includes 5,100,000 shares of Common
     Stock held by other individuals that have granted Mr. Kimmons voting
     rights with respect to these shares. The voting rights agreements expire
     May 31, 2000; however, if the shares are sold by the record holder
     pursuant to Rule 144 of the Act, after May 31, 1999, the voting rights
     terminate as to the sold shares.
 (4) Includes 28,860 shares owned by LK Resources, L.C., of which Mr. Allen is
     a member and 900,000 shares owned by Mr. Allen as trustee.
 (5) See "Executive Compensation--Employment and Consulting Agreements," for a
     discussion of the purchase terms of 1,000,000 shares of Common Stock.
 (6) Includes a portion of an option to purchase 1,000,000 shares of Common
     Stock which have vested or will vest within 60 days of March 15, 1999.
 (7) Includes a portion of an option to purchase 100,000 shares of Common
     Stock which have vested or will vest within 60 days of March 15, 1999.
 (8) Consists of a portion of an option to purchase 120,000 shares of Common
     Stock which have vested or will vest within 60 days of March 15, 1999.
 (9) Includes Messrs. Kimmons, Allen, DeJoria, Wray and Ms. Heinsohn.
(10) Includes options and warrants to purchase 3,525,000 shares of Common
     Stock.
 
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  In September 1996, Mr. Kimmons was issued a five-year warrant to purchase
2,000,000 shares of Common Stock at an exercise price of $1 per share, which
was re-issued in March 1998 as an option to purchase 290,909 shares of Common
Stock at $0.34375 per share and a warrant to purchase 1,709,091 shares of
Common Stock at $0.3125 per share. Mr. Kimmons was granted an additional
1,100,000 shares of Common Stock, of which 50,000 shares were issued in
January 1997, 50,000 shares were issued in May 1997, and 1,000,000 shares were
granted
 
                                      24
<PAGE>
 
in April 1997 and issued in August 1997. In March 1998, Mr. Kimmons received a
warrant to purchase 4,000,000 shares of Common Stock vesting over a period of
four years at a rate of 1,000,000 shares per year, beginning in March 1999.
All grants were for services rendered and at exercise prices of no less than
the closing market price on the date of grant.
 
  In September 1997, the Board of Directors voted to pay Kathryn Kimmons, the
wife of Mr. Kimmons, an annual salary of $60,000 for her services as corporate
secretary (a non-executive office) for the fiscal year ended May 31, 1998.
Mrs. Kimmons began serving as secretary in June 1997 and resigned as secretary
in May 1998.
 
  Between March and May 1998, Gerald Allen assisted the Company in connection
with a private placement of Common Stock for which Mr. Allen was issued
1,000,000 shares of Common Stock. Mr. Allen, individually and as trustee,
purchased an aggregate of 1,050,000 shares of Company Common Stock in May 1998
at a purchase price of $1.50 per share. This purchase was part of a private
placement offering subscribed to by additional unrelated third parties, which
offering price was at or about market.
 
  In November 1998, Mr. DeJoria's family purchased an aggregate of 270,000
shares of Common Stock at a purchase price of $2.50 per share. This purchase
was part of a private placement offering subscribed to by additional unrelated
third parties, which offering price was at or about market.
 
  See "Executive Compensation--Employment and Consulting Agreements" for a
discussion of shares of Common Stock purchased by Mr. DeJoria, and for a
discussion of the option granted to Mr. Wray.
 
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
 
  (a) The following exhibits are to be filed as part of this report:
 
<TABLE>
<CAPTION>
    EXHIBIT NO.                   IDENTIFICATION OF EXHIBIT
    ----------- ------------------------------------------------------------
 <C>            <S>
     2.1(1)     Certificate of Merger
 
     3.1(1)     Certificate of Incorporation of the Company, and Amendments
                thereto.
 
     3.2(1)     By-laws of the Company
 
     3.3(2)     Amendment to Certificate of Incorporation
 
     4.1(1)     Common Stock Certificate
 
     4.2(1)     Form of Warrant
 
     9.1(2)     Form of Voting Agreement granted to Mr. Kimmons
 
    10.1(1)     Agreement with Microelectronics Computer Corporation
 
    10.2(1)     Agreement with AT&T
 
    10.3(a)(2)  Gary Kimmons Amended and Restated Employment Agreement
 
    10.3(b)(2)  Gary Kimmons Addendum to the Amended and Restated Employment
                Agreement
 
    10.4(1)     Employee Stock Option Plan
 
    10.5(1)     Data Crystal Agreement
 
    10.6(2)     John Paul DeJoria Consulting Agreement
 
    10.7(2)     Shelley Duvall Memorandum of Understanding
 
    10.8(2)     Rodney L. Norville Severance Agreement and General Release
 
    10.9(3)     Marcus F. Wray Consulting Agreement
 
    10.10(4)    Cynthina Heinsohn Employment Agreement
 
    23.1(5)     Consent of BDO Seidman, LLP
 
    27.1(6)     Financial Data Schedule
</TABLE>
--------
(1) Filed as an exhibit to the Company's registration statement on Form 10-SB
    SEC File No. 000-22057 and incorporated by reference herein.
 
                                      25
<PAGE>
 
(2) Filed as an exhibit to the Company's Annual Report for fiscal year ended
    May 31, 1998 on Form 10-KSB SEC File No. 000-22057 and incorporated by
    reference herein.
 
(3) Filed as an exhibit to the Company's Quarterly Report for transitional
    quarter from June 1, 1998 to September 30, 1998 on Form 10-QSB SEC File
    No. 000-22057 and incorporated by reference herein.
 
(4) Filed as an exhibit to the Company's registration statement on Form S-8
    SEC File No. 333-65835 and incorporated by reference herein.
 
(5) Filed herewith.
 
(6) Filed as an exhibit to the Company's Annual Report for fiscal year ended
    December 31, 1998 on Form 10-KSB SEC File No. 000-22057 and incorporated
    by reference herein.
 
  (b) There have been no reports filed on Form 8-K for the quarter ended
December 31, 1998.
 
 
                                      26
<PAGE>
 
                                  SIGNATURES
 
  In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
 
                                          GK Intelligent Systems, Inc.
 
                                                  /s/Gary F. Kimmons
                                          By:__________________________________
                                                    Gary F. Kimmons,
                                           President, Chief Executive Officer,
                                              Chief Financial Officer, and
                                                        Director
 
  In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
 
 
<TABLE>
<S>  <C> <C>
              Signature                      Title                   Date
 
   /s/    Gary F. Kimmons            President, Chief          April 30, 1999
                                      Executive Officer and
-----------------------------------   Director
          Gary F. Kimmons
 
   /s/    Gerald C. Allen            Director                  April 30, 1999
-----------------------------------
          Gerald C. Allen
 
   /s/    Marcus F. Wray             Director                  April 30, 1999
-----------------------------------
          Marcus F. Wray
 
</TABLE>
 
                                      27
<PAGE>
 
                          GK INTELLIGENT SYSTEMS, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
 
                         INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
Report of Independent Certified Public Accountants.......................  F-2
Balance Sheet as of December 31, 1998....................................  F-3
Statements of Loss for the seven months ended December 31, 1998, the
 years ended May 31, 1998 and 1997 and the period from inception (October
 4, 1993) through December 31, 1998......................................  F-4
Statements of Stockholders' Equity (Capital Deficit) for the period from
 inception (October 4, 1993) through December 31, 1998...................  F-5
Statements of Cash Flows for the seven months ended December 31, 1998,
 the years ended May 31, 1998 and 1997 and the period from inception
 (October 4, 1993) through December 31, 1998.............................  F-7
Notes to Financial Statements............................................  F-8
</TABLE>
 
                                      F-1
<PAGE>
 
              REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
 
To the Stockholders
GK Intelligent Systems, Inc.
 
We have audited the balance sheet of GK Intelligent Systems, Inc. (a
development stage enterprise) as of December 31, 1998, and the related
statements of loss, stockholders' equity (capital deficit) and cash flows for
the seven months ended December 31, 1998, the years ended May 31, 1998 and
1997 and for the period from inception (October 4, 1993) through December 31,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements 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 GK Intelligent Systems, Inc.
(a development stage enterprise) as of December 31, 1998 and the results of
its operations and its cash flows for the seven months ended December 31,
1998, the years ended May 31, 1998 and 1997 and for the period from inception
(October 4, 1993) through December 31, 1998, in conformity with generally
accepted accounting principles.
 
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has suffered recurring operating losses
which raise substantial doubt about its ability to continue as a going
concern. Management's plans in regard to these matters are also discussed in
Note 2. The financial statements do not include any adjustments that might
result from the outcome of these uncertainties.
 
                                          BDO SEIDMAN, LLP
 
Houston, Texas
March 5, 1999
 
                                      F-2
<PAGE>
 
                          GK INTELLIGENT SYSTEMS, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
 
                                 BALANCE SHEET
                               DECEMBER 31, 1998
 
                                     ASSETS
<TABLE>
<S>                                                                  <C>
Current:
  Cash and cash equivalents......................................... $1,440,822
  Deposits..........................................................    313,838
  Prepaid expenses..................................................    249,531
  Other.............................................................     26,121
                                                                     ----------
Total Current Assets................................................  2,030,312
Computer software costs, net (Notes 4 and 8)........................  1,629,072
Property and equipment, net (Note 5)................................  1,420,822
                                                                     ----------
Total Assets........................................................ $5,080,206
                                                                     ==========
</TABLE>
                      LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<S>                                                                 <C>
Current Liabilities:
  Accounts payable and accrued liabilities Note 8)................. $   855,539
  Capital lease obligations, current maturities (Note 6)...........      26,879
                                                                    -----------
Total Current Liabilities..........................................     882,418
                                                                    -----------
Capital lease obligations, less current maturities (Note 6)........      70,461
Other long term liabilities (Note 8)...............................     203,844
Commitments and Contingencies (Notes 2, 6, 8 and 10)
Stockholders' Equity (Notes 1, 4, 8, 9, 10, 11 and 12):
  Common stock.....................................................      32,530
  Additional paid-in capital.......................................  36,351,876
  Subscriptions receivable.........................................   (779,900)
  Unearned compensation (Note 10).................................. (5,484,531)
  Deficit accumulated during the development stage................. (26,196,492)
                                                                    -----------
Total Stockholders' Equity.........................................   3,923,483
Total Liabilities and Stockholders' Equity......................... $ 5,080,206
                                                                    ===========
</TABLE>
 
                                      F-3
<PAGE>
 
                          GK INTELLIGENT SYSTEMS, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
 
                               STATEMENTS OF LOSS
 
<TABLE>
<CAPTION>
                                                                    Inception
                          Seven Months                             (October 4,
                             Ended        Year Ended May 31,      1993) through
                          December 31,  ------------------------  December 31,
                              1998         1998         1997          1998
                          ------------  -----------  -----------  -------------
<S>                       <C>           <C>          <C>          <C>
Revenues, less returns
 and allowances
 of $1,691..............  $    58,255   $        --  $        --  $      58,255
Cost of revenues........       19,349            --           --         19,349
                          -----------   -----------  -----------  -------------
Gross margin............       38,906            --           --         38,906
                          -----------   -----------  -----------  -------------
Costs and expenses:
  Professional services
   (Note 10)............    3,800,446     2,748,628    4,963,686     12,370,116
  Employee
   compensation.........    1,793,323     1,272,876      889,527      3,955,726
  Depreciation and
   amortization.........      726,235       957,475      820,497      3,029,259
  President's
   compensation (Note
   11)..................      140,000       240,000    2,523,443      3,688,457
  Other general and
   administrative.......    1,504,902       662,819      331,320      3,004,525
                          -----------   -----------  -----------  -------------
Total costs and
 expenses...............    7,964,906     5,881,798    9,528,473     26,048,083
                          -----------   -----------  -----------  -------------
Net loss................   (7,926,000)   (5,881,798)  (9,528,473)   (26,009,177)
Dividends on preferred
 stock (Note 9).........      (54,815)     (132,500)         --        (187,315)
                          -----------   -----------  -----------  -------------
Net Loss Applicable to
 Common Shareholders....  $(7,980,815)  $(6,014,298) $(9,528,473) $ (26,196,492)
                          ===========   ===========  ===========  =============
Basic Net Loss Per Share
 of Common Stock........        $(.27)        $(.35)       $(.89)        $(2.08)
                          ===========   ===========  ===========  =============
Weighted Average Number
 of Shares of Common
 Stock Outstanding......   30,055,000    17,133,102   10,671,092     12,599,734
                          ===========   ===========  ===========  =============
</TABLE>
 
                                      F-4
<PAGE>
 
                          GK INTELLIGENT SYSTEMS, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
 
              STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIT)
<TABLE>
<CAPTION>
                                                                                                         Deficit
                             Preferred Stock                                                           Accumulated
                                   (a)        Common Stock (b)  Additional                             During the
                            ----------------- -----------------  Paid-in    Subscriptions   Unearned   Development
                            Shares   Amount     Shares   Amount  Capital     Receivable   Compensation    Stage
                            ------- --------- ---------- ------ ----------  ------------- ------------ -----------
<S>                         <C>     <C>       <C>        <C>    <C>         <C>           <C>          <C>
Initial capitalization by
 president................       -- $      --  6,375,000 $6,375 $       --     $   --        $   --    $        --
Shares issued in
 connection with reverse
 merger...................       --        --    963,275    963       (963)        --            --             --
Series A preferred shares
 issued in connection with
 acquisition of software
 (Notes 4 and 9)..........  883,333 3,389,432         --     --         --         --            --             --
Shares issued in private
 placements at prices
 ranging from $.50 to
 $3.00 per share (net of
 commissions of $95,180)..       --        --    908,803    908  1,123,687         --            --             --
Shares issued to president
 for services.............       --        --    332,580    333    236,421         --            --             --
Shares issued for
 professional services....       --        --    283,956    284    338,990         --            --             --
Shares issued in
 settlement of debt.......       --        --    250,000    250    471,007         --            --             --
Net loss..................       --        --         --     --         --         --                   (2,672,906)
                            ------- --------- ---------- ------ ----------     ------        ------    -----------
BALANCE, May 31, 1996.....  883,333 3,389,432  9,113,614  9,113  2,169,142         --            --     (2,672,906)
Shares issued in private
 placements at $.875 and
 $1.00 per share (net of
 commissions of $61,306).....    --        --  2,371,653  2,372  1,802,134         --            --             --
Shares issued to president
 and employees for
 services.................       --        --    296,110    296    706,716         --            --             --
Shares issued for
 professional services and
 expenses.................       --        --    508,652    509    940,665         --                           --
Warrants issued to
 employees................       --        --         --     --     56,040         --            --             --
Warrants issued for
 professional services....       --        --         --     --    290,596         --            --             --
Net loss..................       --        --         --     --         --         --            --     (9,528,473)
                            ------- --------- ---------- ------ ----------     ------        ------    -----------
BALANCE, May 31, 1997.....  883,333 3,389,432 12,290,029 12,290  5,965,293         --            --    (12,201,379)
Shares issued in private
 placements at $.40, $.47,
 $.48, $.50, $1.00, $1.36
 and $1.50 per share......       --        --  8,136,290  8,136  7,528,866         --            --             --
Shares issued for exercise
 of warrants at $1.00 per
 share....................       --        --    158,500    159    158,341         --            --             --
Shares issued to president
 and employees for
 services.................       --        --  1,976,140  1,976  2,817,120         --            --             --
Shares issued for
 professional services....       --        --  5,618,360  5,618  4,994,186         --            --             --
Warrants and options
 issued to president and
 employees for services...       --        --         --     --    102,349         --            --             --
Warrants and options
 issued for professional
 services.................       --        --         --     --    576,313         --            --
Net loss..................       --        --         --     --         --         --            --     (5,881,798)
Dividends on Series A
 preferred stock..........       --   132,500         --     --         --         --            --       (132,500)
                            ------- --------- ---------- ------ ----------     ------        ------    -----------
BALANCE, May 31, 1998.....  883,333 3,521,932 28,179,319 28,179 22,142,468         --            --    (18,215,677)
</TABLE>
 
                See accompanying notes to financial statements.
 
                                      F-5
<PAGE>
 
                          GK INTELLIGENT SYSTEMS, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
 
              STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIT)
 
<TABLE>
<CAPTION>
                                                                                                               Deficit
                                                                                                             Accumulated
                           Preferred Stock (a)    Common Stock (b)  Additional                               During ther
                           --------------------  ------------------   Paid-in   Subscriptions   Unearned     Development
                            Shares     Amount      Shares   Amount    Capital    Receivable   Compensation      Stage
                           --------  ----------  ---------- ------- ----------- ------------- ------------  -------------
<S>                        <C>       <C>         <C>        <C>     <C>         <C>           <C>           <C>
Balance, May 31, 1998....   883,333   3,521,932  28,179,319  28,179  22,142,468          --            --     (18,215,677)
Shares issued in private
 placement at $2.00 per
 share (net of
 commissions of $93,090)....     --          --   1,551,504   1,551   3,008,364    (779,900)           --              --
Shares issued for
 exercise of warrants and
 options at $-0-, $.31,
 $.94 and $1.00 per
 share...................        --          --     884,960     885     318,213          --            --              --
Shares issued to director
 for professional
 services................        --          --   1,000,000   1,000   1,624,000          --    (1,001,096)             --
Warrants and options
 issued for professional
 services................        --          --          --      --   5,682,999          --    (4,483,435)             --
Dividends on Series A
 preferred stock.........        --      54,815          --      --          --          --            --         (54,815)
Shares issued to convert
 preferred stock.........  (883,333) (3,576,747)    914,552     915   3,575,832          --            --              --
Net loss.................        --          --          --      --          --          --            --      (7,926,000)
                           --------  ----------  ---------- ------- -----------   ---------   -----------   -------------
BALANCE, December 31,
 1998....................        --  $       --  32,530,335 $32,530 $36,351,876   $(779,900)  $(5,484,531)  $ (26,196,492)
                           ========  ==========  ========== ======= ===========   =========   ===========   =============
</TABLE>
 
NOTES:
-------
(a) $.001 par; 10,000,000 shares authorized
(b) $.001 par; 250,000,000 shares authorized
 
 
                See accompanying notes to financial statements.
 
                                      F-6
<PAGE>
 
                          GK INTELLIGENT SYSTEMS, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
 
                            STATEMENTS OF CASH FLOWS
 
                Increase (Decrease) in Cash and Cash Equivalents
 
<TABLE>
<CAPTION>
                                                                    Inception
                                                                   (October 4,
                           Seven Months                               1993)
                              Ended        Year Ended May 31,        through
                           December 31,  ------------------------  December 31,
                               1998         1998         1997          1998
                           ------------  -----------  -----------  ------------
<S>                        <C>           <C>          <C>          <C>
Operating activities:
  Net loss...............  $(7,926,000)  $(5,881,798) $(9,528,473) $(26,009,177)
  Adjustments to recon-
   cile net loss to net
   cash used in operating
   activities:
  Depreciation and amor-
   tization..............      726,235       957,475      820,497     3,029,259
  Issuance of common
   stock, warrants and
   options for various
   expenses..............    1,773,468     2,560,853    7,681,831    12,703,682
Changes in assets and li-
 abilities:
  Current assets.........     (491,410)      (39,557)     (58,523)     (589,490)
  Accounts payable.......      840,669       (74,789)    (153,621)    1,073,446
                           -----------   -----------  -----------  ------------
    Net cash used in
     operating
     activities..........   (5,077,038)   (2,477,816)  (1,238,289)   (9,792,280)
                           -----------   -----------  -----------  ------------
Investing activities:
  Purchased and developed
   software..............           --      (259,771)    (131,143)     (915,742)
  Organization costs.....           --            --           --       (78,745)
  Other capital expendi-
   tures.................   (1,295,100)     (177,520)     (39,215)   (1,536,270)
                           -----------   -----------  -----------  ------------
    Net cash used in
     investing
     activities..........   (1,295,100)     (437,291)    (170,358)   (2,530,757)
                           -----------   -----------  -----------  ------------
Financing activities:
  Proceeds from private
   placements and other
   share issuances.......    2,585,051     7,832,211    1,806,156    13,354,227
  Proceeds from
   borrowings............           --       150,000           --       716,269
  Repayment of
   borrowings............      (13,540)     (174,120)     (68,327)     (306,637)
                           -----------   -----------  -----------  ------------
    Net cash provided by
     financing
     activities..........    2,571,511     7,808,091    1,737,829    13,763,859
                           -----------   -----------  -----------  ------------
  Net increase (decrease)
   in cash and cash
   equivalents...........   (3,800,627)    4,892,984      329,182     1,440,822
  Cash and cash
   equivalents at
   beginning of period...    5,241,449       348,465       19,283            --
                           -----------   -----------  -----------  ------------
  Cash and cash equiva-
   lents at end of peri-
   od....................  $ 1,440,822   $ 5,241,449  $   348,465  $  1,440,822
                           ===========   ===========  ===========  ============
</TABLE>
 
 
                                      F-7
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                         NOTES TO FINANCIAL STATEMENTS
 
1. BUSINESS, ORGANIZATION AND PRESENTATION
 
Business
 
  GK Intelligent Systems, Inc. (the "Company"), is a development stage
enterprise incorporated in Delaware in 1988. The Company is principally
engaged in the development and marketing of software products capable of
interaction with, and adaptation to, the needs of software users (referred to
as "intelligent" software) and sophisticated real-time access to and
interpretation of data. To date, the Company has realized minimal revenues and
its activities have been limited primarily to the acquisition of software
assets used to develop future products and applications, research and
development of software products and initial marketing activities. All
revenues to-date are derived from sales of the Company's first product, Around
the Web in 80 Minutes. The Company has adopted a calendar year end to be
effective December 31, 1998.
 
  The Company's software technology is capable of evaluating a users'
competence level and adapting training programs to the user's specific
learning styles and abilities, and is referred to as Smart One technology. The
Company is using this technology to develop specific training software
products (e.g., Internet training).
 
  The Company's proprietary Carnot technology is capable of accessing and
evaluating large amounts of data on network systems, such as the Internet. The
Company is currently developing specific business applications utilizing this
technology called Smart Enterprise.
 
Reverse Merger
 
  Pursuant to an agreement effective August 15, 1994, LBM-US, Inc. (LBM)
issued 6,758,920 shares of its common stock in exchange for all of the assets
and liabilities of GK Intelligent Systems, Inc., a Texas corporation (GKIS-
Texas). The remaining 963,275 common shares out of a total of 7,722,195 common
shares were retained by the former owners of LBM. Prior to, and in conjunction
with the transaction, LBM authorized a stock split of three and one-half
shares to one for its existing shareholders. On August 18, 1994, LBM changed
its name to GK Intelligent Systems, Inc.
 
  This transaction resulted in the former stockholders of GKIS-Texas acquiring
approximately 88% of the Company. Accordingly, the transaction has been
treated for accounting purposes as a purchase of the Company by GKIS-Texas,
referred to as a "reverse merger". As GKIS-Texas is deemed to be the acquirer
for accounting purposes, (i) its assets and liabilities are included in the
financial statements of the continuing entity at their carrying values, (ii)
its operations are presented for all periods prior to August 15, 1994 and
(iii) its outstanding shares for periods prior to August 15, 1994 have been
retroactively restated giving effect to the reverse merger transaction.
 
Transition Period
 
  In August 1998, the Company changed its fiscal year-end to December 31 which
will be its fiscal year-end in the future. Prior to August 1998, the Company's
fiscal year ended on May 31. As a result, the accompanying financial
statements include (1) results of operations and cash flows for the seven-
month period from June 1, 1998 through December 31, 1998, referred to as the
transition period and (2) the historically reported twelve-month periods ended
May 31, 1998 and 1997. For comparative purposes, unaudited results of
operations and cash flows for the comparable seven-month period ended December
31, 1997 have been presented in Note 13.
 
 
                                      F-8
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
2. GOING CONCERN UNCERTAINTY AND MANAGEMENT PLANS
 
  The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has suffered recurring
operating losses since its inception that raise substantial doubt about its
ability to meet future expected expenditures necessary to fully develop its
software products and applications and to continue as a going concern. The
financial statements do not reflect any adjustments that might result from the
outcome of this uncertainty. In this regard, the Company is contemplating
short and long term debt or equity financing sufficient to fund projected
working capital and software product development needs. The Company continues
to obtain distribution partners for its current internet training product and
expects to release two follow-up software products during the second quarter
of 1999. However, there can be no assurance that the Company will be
successful in raising funds, that the amount and terms of such financing will
be acceptable to the Company, or that the profits from the sale of software
products in fiscal year 1999 will be sufficient to fund the Company's working
capital needs and software development expenditure requirements. Accordingly,
the Company will continue to seek additional sources of financing as may be
necessary.
 
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Revenue Recognition
 
  Revenues from the sale of software products to retail customers are
recognized upon shipment, provided that no significant obligations remain
outstanding and collection of the receivable is probable. Revenues from the
sale of software products to distributors or other resellers where right of
return exists are deferred until shipped products are sold to retail
consumers. Allowances for estimated returns are provided at the time of sale
and charged against revenues.
 
Cost of Revenues
 
  Cost of revenues include materials such as diskettes, packaging and
documentation as well as labor required to assemble the product.
 
Inventories
 
  Inventories are stated at the lower of cost (average cost) or net realizable
value and consist principally of CD-ROM diskettes, jewel cases and product
boxes. Net realizable value is the estimated selling price less all applicable
selling costs. Inventory on hand at December 31, 1998 amounted to $12,623 and
is included in other current assets in the accompanying balance sheet.
 
Computer Software Costs
 
  Costs of purchased software having alternative future uses in developing
other software products are (i) capitalized when acquired, (ii) amortized on a
straight-line basis over their expected useful life of five years and (iii)
reported at the lower of unamortized cost or net realizable value.
 
  Costs of internally created computer software products are charged to
expense when incurred as research and development until technological
feasibility has been established for the product. Technological feasibility is
considered established upon completion of a detailed program design or, in its
absence, completion of a working model. Thereafter, all software production
costs are capitalized and subsequently reported at the lower of unamortized
cost or net realizable value. Capitalized costs are amortized based on the
ratio of current revenue to current and future revenue for each product with
an annual minimum equal to the straight-line amortization over the remaining
estimated economic life of the product. During the seven months ended December
31, 1998, the years ended May 31, 1998 and 1997 and from inception (October 4,
1993) through December 31, 1998 the Company charged approximately $1,458,000,
$1,808,000, $1,409,000 and $5,270,000 to costs and expenses for research and
development.
 
                                      F-9
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
Property and Equipment
 
  Property and equipment consists primarily of furniture, equipment and
leasehold improvements, and are carried at cost. Depreciation and amortization
is computed principally on a straight-line basis over the estimated useful
lives of the various assets ranging from 3 to 5 years or, in the case of
certain property under capital lease, over the lesser of the useful life or
the lease term. Leasehold improvements are amortized over the length of the
related leases. Expenditures for maintenance and repairs are expensed as
incurred while improvements and major replacements are capitalized.
 
Income Taxes
 
  The Company uses the asset and liability method of accounting for income
taxes. Under this method, the Company recognizes deferred tax assets and
liabilities for the expected future tax consequences of temporary differences
between the carrying amounts and the tax bases of assets and liabilities and
are measured using the enacted tax rate and laws that will be in effect when
the differences are expected to reverse. Deferred tax assets are reduced by a
valuation allowance to amounts expected to be realized.
 
Loss Per Common Share
 
  In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 128, "Earnings Per
Share". SFAS 128 is effective for the seven months ended December 31, 1998 and
the year ended May 31, 1998. SFAS 128 simplifies the standards required under
previously existing accounting rules for computing earning per share and
replaces the presentation of primary earnings per share and fully diluted
earnings per share with a presentation of basic earnings per share ("basic
EPS") and diluted earnings per share ("diluted EPS"). Diluted EPS for the
periods presented was not disclosed on the Statements of Loss as the effect is
anti-dilutive.
 
  Basic net loss per share has been calculated using the weighted average
number of common shares outstanding and any common stock equivalents, if
dilutive, during the period presented. For the period from inception (October
4, 1993) through December 31, 1998, the weighted average number of common
shares outstanding gives retroactive recognition to the reverse merger
transaction described in Note 1.
 
Accounting Estimates
 
  The accompanying financial statements are prepared in conformity with
generally accepted accounting principles which requires management to make
estimates and assumptions that effect 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. The actual results could differ from those
estimates.
 
Statements of Cash Flows
 
  For purposes of the statement of cash flows, the Company considers cash and
cash equivalents to be cash on hand or deposited in demand deposit accounts
with financial institutions and highly liquid investments purchased with an
original maturity of three months or less.
 
Fair Value of Financial Instruments
 
  The carrying amounts of the Company's financial instruments, including cash
and cash equivalents, accounts payable, and accrued liabilities, approximate
fair value due to their short maturities.
 
                                     F-10
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
Stock-Based Compensation
 
  The Company has chosen to continue to account for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
Interpretations and to elect the disclosure option of SFAS No. 123,
"Accounting for Stock-Based Compensation". Accordingly, compensation cost for
stock options issued to employees is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of the grant over the
amount an employee must pay to acquire the stock.
 
New Accounting Pronouncements
 
  Derivative and Hedging Activities--In June 1998, the FASB issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). SFAS 133 requires companies to recognize all derivatives contracts as
either assets or liabilities in the balance sheet and to measure them at fair
value. If certain conditions are met, a derivative may be specifically
designated as a hedge, the objective of which is to match the timing of gain
or loss recognition on the hedging derivative with the recognition of (i) the
changes in the fair value of the hedged asset or liability that are
attributable to the hedge risk or (ii) the earnings effect of the hedged
forecasted transaction. For a derivative not designated as a hedging
instrument, the gain or loss is recognized in income in the period of change.
SFAS 133 is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. Historically, the Company has not entered into derivatives
contracts either to hedge existing risks or for speculative purposes.
Accordingly, the Company does not expect adoption of the new standard on
January 1, 2000 to affect its financial statements.
 
  Start-up Activities--In June 1998 the Accounting Standards Executive
Committee of the AICPA issued SOP 98-5, Reporting on the Costs of Start-up
Activities. SOP 98-5 requires all start-up and organizational costs to be
expensed as incurred. It also requires all remaining historically capitalized
amounts of these costs existing at the date of adoption to be expensed and
reported as the cumulative effect of a change in accounting principles. SOP
98-5 is effective for all fiscal years beginning after December 31, 1998. The
Company believes that the adoption of SOP 98-5 will not have a significant
effect on its financial statements.
 
  FASB Amendments and Clarifications--In February 1999 the FASB issued SFAS
No. 135, Rescission of Financial Accounting Standards Board No. 75 ("SFAS 75")
and Technical Corrections. SFAS 135 rescinds SFAS 75 and amends Statement of
Financial Accounting Standards Board No. 35. SFAS 135 also amends other
existing authoritative literature to make various technical corrections,
clarify meanings, or describe applicability under changed conditions. SFAS 135
is effective for financial statements issued for fiscal years ending after
February 15, 1999. The Company believes that the adoption of SFAS 135 will not
have a significant effect on its financial statements.
 
4. COMPUTER SOFTWARE COSTS
 
  Computer software costs were comprised of the following at December 31,
1998:
 
<TABLE>
<S>                                                                 <C>
  Cost of purchased software used to develop other software
   products:
    Training software technology................................... $  444,833
    Carnot software tools and languages............................  3,389,432
    Other tools and product costs..................................    470,909
                                                                    ----------
                                                                     4,305,174
  Less accumulated amortization.................................... (2,676,102)
                                                                    ----------
                                                                    $1,629,072
                                                                    ==========
</TABLE>
 
                                     F-11
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
  The Carnot software tools and languages were acquired on November 2, 1995 in
exchange for the issuance of 883,333 shares of the Company's Series A
preferred stock (see Note 9). The cost basis of the software was determined
using the estimated fair market value of the preferred shares at the date the
agreement was signed. Amortization of software costs during the seven months
ended December 31, 1998 and the years ended May 31, 1998 and 1997 amounted to
$525,597, $862,348 and $794,016, respectively. Amortization of software costs
from inception (October 4, 1993) through December 31, 1998 amounted to
$2,676,102.
 
5. PROPERTY AND EQUIPMENT
 
  Property and equipment were comprised of the following at December 31, 1998:
 
<TABLE>
<S>                                                                   <C>
Furniture and equipment.............................................. $1,432,246
Furniture and equipment under capital leases.........................    159,592
Leasehold improvements...............................................     91,516
                                                                      ----------
                                                                       1,683,354
Less accumulated depreciation and amortization.......................  (262,532)
                                                                      ----------
                                                                      $1,420,822
                                                                      ==========
</TABLE>
 
6. LEASES
 
  The Company leases office furniture and equipment under capital lease
agreements and office space and equipment under operating leases expiring
through 2004.
 
  A schedule by years of future minimum lease payments under the capital
leases together with the present value of the net minimum lease payments as of
December 31, 1998, and future minimum rental payments required under the long-
term operating leases as of December 31, 1998 are as follows:
 
<TABLE>
<CAPTION>
                                                            Capital  Operating
Year ending December 31,                                    Leases     Leases
------------------------                                    -------  ----------
<S>                                                         <C>      <C>
  1999..................................................... $41,773  $  831,746
  2000.....................................................  40,688     858,594
  2001.....................................................  32,250     868,271
  2002.....................................................  11,625     307,530
  2003.....................................................      --     111,228
  Thereafter...............................................      --      37,076
Total minimum lease payments............................... 126,336  $3,014,445
                                                                     ==========
Less--amount representing interest......................... (28,996)
                                                            -------
Present value of net minimum lease payments................  97,340
Less--current maturities...................................  26,879
                                                            -------
Long-term portion.......................................... $70,461
                                                            =======
</TABLE>
 
  Rent expense under operating leases for the seven months ended December 31,
1998 and the years ended May 31, 1998 and 1997 was $304,000, $180,900 and
$32,400, respectively. Rent expense for the period from inception (October 4,
1993) through December 31, 1998 was $592,500.
 
                                     F-12
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
7. INCOME TAXES
 
  The Company uses the liability method to record deferred income taxes. Under
the liability method, a deferred tax asset or liability is determined based on
the difference between the financial statement and tax bases of assets and
liabilities as measured by the enacted tax rates which will be in effect when
these differences reverse. Net deferred income tax assets are comprised of the
following at December 31, 1998:
 
<TABLE>
<S>                                                               <C>
Net operating loss carryforwards................................. $  5,954,000
Differences between the financial reporting and income tax bases
 of:
  Property, plant and equipment..................................        9,000
  Accrued compensation...........................................      105,000
  Issuances of stock, options and warrants for services..........      327,000
  Other..........................................................       28,000
                                                                  ------------
Gross deferred tax assets........................................    6,423,000
                                                                  ------------
Difference between the financial reporting and income tax bases
 of:
  Computer software costs........................................      503,000
                                                                  ------------
Gross deferred tax liability.....................................      503,000
                                                                  ------------
                                                                     5,920,000
Valuation allowance..............................................  (5,920,000)
                                                                  ------------
Net deferred tax asset........................................... $        -0-
                                                                  ============
</TABLE>
 
  The Company has recorded a 100% valuation allowance on its deferred tax
asset because it believes that it is more likely than not that it will be
unable to utilize the deferred tax benefits in the foreseeable future.
 
  The income tax benefit differs from the amount of income tax determined by
applying the applicable statutory federal income tax rate to pretax loss from
operations due to the effect of net operating losses that are not currently
utilizable.
 
  The Company has generated approximately $17,512,000 of tax loss
carryforwards through December 31, 1998. The carryforwards expire in the
following years:
 
<TABLE>
<CAPTION>
      Year
      ----
      <S>                                                            <C>
      2008.......................................................... $   129,000
      2009..........................................................     612,000
      2010..........................................................   1,732,000
      2011..........................................................   3,287,000
      2012..........................................................   5,306,000
      2013..........................................................   6,446,000
                                                                     -----------
                                                                     $17,512,000
                                                                     ===========
</TABLE>
 
  Section 382 of the Internal Revenue Code of 1986, as amended, limits the
availability of the net operating loss ("NOL") carryforwards if there is a
change of ownership of more than 50% of the Company within a retroactive three
year period. This limitation, if applied, would limit the utilization of the
NOL carryforwards in each taxable year to an amount equal to the product of
the federal long-term tax-exempt bond rate prescribed by the Internal Revenue
Service and the fair market value of the Company immediately prior to the time
of the ownership change. The Company anticipates, however, that should a
cumulative change in ownership of the Company in excess of 50% be deemed to
occur within a retroactive three year period in connection with the exercise
of outstanding common stock warrants and options or other securities
transaction, the resulting limitation would not have a material impact on the
Company's financial position as a 100% valuation allowance has been
established against the expected future benefit of the Company's net operating
loss carryforwards.
 
                                     F-13
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
8. COMMITMENTS AND CONTINGENCIES
 
Litigation
 
  In October 1998, the Company, its president and a former officer were named
as defendants in a class-action lawsuit; Griffin v., GK Intelligent Systems,
Inc., et al.; filed in Texas District Court. The plaintiff has alleged
violations of the securities laws, common law fraud, conspiracy, negligence,
and negligent misrepresentation and is seeking unspecified damages. The case
was removed to the United States District Court for the Southern District of
Texas in November 1998. To-date, the parties have conducted limited discovery,
and the Company is in the process of evaluating the plaintiff's claims and
intends to vigorously defend the lawsuit.
 
  The Company is defendant in a lawsuit; David Michael Sims v. GK Intelligent
Systems, Inc. The lawsuit was filed in July 1998, and alleges the Company is
liable to the plaintiff for breach of contract and fraudulent
misrepresentation. The case arises out of services allegedly performed by the
plaintiff for which he did not receive compensation. Although preliminary
discovery has commenced, the precise amount of the plaintiff's demand is
currently unknown other than his initial claim for a commission of
approximately $500,000. The Company denies any liability to the plaintiff,and
intends to vigorously defend the lawsuit.
 
  In September 1997, the Company entered into a consulting agreement with
Union Atlantic, LC for performance of services. The Company issued Union
Atlantic a five year warrant to purchase 200,000 shares of common stock at an
exercise price of $.9375 per share, and a five year warrant to purchase
112,500 shares of common stock at an exercise price of $1.25 per share as
compensation for services to be rendered. Each of the warrants contained
demand registration rights. Union Atlantic resigned as a consultant to the
Company in November 1997. As no capital was raised by Union Atlantic, the
Company sent a notice to Union Atlantic in July 1998 canceling the warrants.
In August 1998, the Company received notice from Union Atlantic demanding
registration of the warrants. The Company has contacted Union Atlantic and is
in the process of determining Union Atlantic's legal rights, if any.
 
  In connection with the Union Atlantic transaction, the Company issued
Catalyst Financial a one year warrant to purchase 66,667 shares of common
stock at an exercise price of $.9375 per share, and a one-year warrant to
purchase 37,500 shares of common stock at an exercise price of $1.25 per share
as a finder's fee for introducing the Company to Union Atlantic. Each of the
warrants contained demand registration rights. Since Union Atlantic did not
raise capital for the Company, the Company contends that no consideration was
received in exchange for the warrants. In August 1998, the Company received a
notice from Catalyst Financial demanding registration of the warrants. The
Company has contacted Catalyst Financial and is in the process of determining
Catalyst Financial's legal rights, if any.
 
  In September 1998, James Cassell, an affiliate of Catalyst Financial,
exercised a portion of the aforementioned warrants to purchase a total of
10,000 shares of common stock at an aggregate purchase price of $9,375. In
connection with the exercise, Mr. Cassell made a demand registration request
pursuant to a registration rights agreement with the Company. To-date, the
Company has not registered the 10,000 shares of common stock.
 
  In August 1998, the Company received a letter from its former general
counsel and secretary of the Company, in connection with the former general
counsel's separation from employment with the Company. The Company's
contractual obligations to the former general counsel turns on whether he
resigned from his employment or whether he was terminated. The former general
counsel has demanded $190,000 in total compensation and immediate vesting of
600,000 shares of common stock. The Company contends the former general
counsel resigned from his positions with the Company, and as such, the former
general counsel is entitled
 
                                     F-14
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
to earned but unpaid salary and vested options to purchase 25,000 shares of
common stock. In the event the parties are unable to settle this matter, it is
likely the former general counsel will file suit for wrongful termination.
 
  The Company is involved in various other legal actions arising in the normal
course of business. Management is of the opinion that their outcome will not
have a material adverse effect on the Company's financial position or results
of operations.
 
Employment and Consulting Agreements
 
  In March 1998, the Company amended and restated its employment agreement
with the president. The agreement provides for a three year term with
automatic one year renewals at the end of its initial term and for annual base
compensation of $240,000. Upon the president's death, disability or
involuntary termination (other than for cause), all unvested warrants or
options will become immediately vested and exercisable. If the Company has a
change of control, and subsequently the employment agreement is terminated by
the Company, other than for cause or disability, the agreement generally
provides that the Company must pay an amount equal to approximately three
times the sum of the annual base salary and the average of the last three
annual incentive bonuses actually paid.
 
  In March 1998, the Company amended and restated an employment agreement with
a former officer and director of the Company. That agreement contained
identical terms to the employment agreement of the president except for an
annual base compensation of $180,000. In September 1998, by mutual agreement
between the Company and the individual, the individual resigned as a director
and officer of the Company and his employment agreement was terminated.
Concurrently therewith, his professional corporation entered into a one-year
consulting agreement with the Company. The consulting agreement provides for
monthly consulting fees of $7,500 for a period of twelve months ending
September 15, 1999. A severance agreement was also entered into providing for
severance compensation of $360,000 payable in installments of $7,500 for a
period of twelve months, and thereafter $15,000 per month for a period of
eighteen months. The severance agreement also affirmed a warrant to purchase
1,200,000 shares of the Company's common stock which vests one-quarter per
year over a four year period beginning March 1999. Severance expense totaling
$375,951 was charged to employee compensation during the seven months ended
December 31, 1998 as a result of this transaction.
 
  At December 31, 1998, $134,013 of amounts currently due under the severance
agreement are included in accounts payable and accrued liabilities while
$203,844 of amounts due after December 31, 1999 represent other long term
liabilities in the accompanying balance sheet.
 
  In September 1998, the Company entered into a memorandum of understanding
with Shelley Duvall, pursuant to which Ms. Duvall will serve as an independent
consultant to the Company for an initial term of three years. Ms. Duvall will
assist the Company in the creation, development, and distribution of
children's and family-oriented intelligent learning products. Additionally,
Ms. Duvall granted to the Company the non-exclusive right for the Company to
use her name for products which she helps to produce, and for mutually
approved public relations activities. In exchange for her services, the
Company agreed to compensate Ms. Duvall as follows: (i) $500,000 for use of
the name rights, payable $150,000 on September 8, 1998, $50,000 no later than
30 days thereafter, and $50,000 per month commencing January 1, 1999, (ii) 10%
of sales revenues (less distribution fees) from products produced by or
bearing the Duvall name, (iii) 5% of sales revenues (less distribution fees)
from products produced by third parties introduced by Ms. Duvall to the
Company, (iv) a minimum of 8% of the total production cost of each product,
and (v) options to purchase 120,000 shares of Company common stock which vest
on a schedule of 3,300 shares per month at an exercise price of $2.50 per
 
                                     F-15
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
share (the closing market price on the date of grant). Upon any termination of
the agreement, the Company will retain the right to use the name "Shelley
Duvall" in connection with any then existing product produced by or bearing
the Duvall name until September 8, 2008. Ms. Duvall will continue to receive
the compensation based on sales revenues (but not production costs) of such
products until such time as those products are no longer marketed under the
Duvall name, and any stock options granted but not exercised will be canceled
upon the termination of the agreement. Ms. Duvall is currently working with
the Company in the development of children's and family-oriented software
applications incorporating Smart One technology.
 
Business Risk
 
  The Company has filed for trademark and servicemark protection for certain
proposed products and applications. However, not all trademarks or
servicemarks have been awarded to the Company to date. In the event that the
trademark and servicemark rights are not ultimately granted to the Company,
and the Company is not able to otherwise protect its proprietary information,
there could be a material adverse effect on the Company's business, operating
results and financial condition.
 
9. SERIES A PREFERRED STOCK
 
  Effective November 2, 1995, the Company issued 883,333 shares of Series A
convertible, redeemable preferred stock to Microelectronics and Computer
Technology Corporation ("MCC") in exchange for a perpetual non-exclusive
worldwide right and license to use and commercialize certain computer software
technology developed by MCC under its Carnot Project (see Note 4). The Series
A preferred stock had a stated value of $6.00 per share, a par value of $.001
per share, accrued dividends at 6% per annum beginning January 1, 1998 and
along with unpaid dividends were convertible into shares of the Company's
common stock beginning January 1, 1998 at the rate of $6.00 per common share
as adjusted for certain events. Also beginning January 1, 1998, the Company
had the right to redeem the shares at their stated value of $6.00 per share,
plus any accrued and unpaid dividends. However, once notified of the Company's
intention to redeem, MCC had the option to convert the preferred shares to
common prior to the Company exercising its redemption rights. In addition, the
preferred shares were entitled to vote beginning January 1, 1998 even if not
converted. No redemption rights were held by the Series A preferred
stockholders.
 
  During the seven months ended December 31, 1998 and the years ended May 31,
1998 and 1997, the Company accrued cumulative dividends on the Series A
preferred stock totalling $54,815, $132,500 and $-0-, respectively.
 
  During the seven months ended December 31, 1998, MCC converted the preferred
stock and accrued dividends into 883,333 and 31,219 shares of the Company's
common stock, respectively.
 
  The preferred shares have not been included in the calculation of net loss
per share for all periods presented as their effect, if converted, would be
anti-dilutive.
 
10. COMMON STOCK, OPTIONS AND WARRANTS
 
Options and Warrants Issued for Professional Services
 
  The Company periodically grants common stock warrants or options to
consultants for services rendered or to be rendered. Certain of such grants
may be issued at prices less than fair market value and contain vesting
 
                                     F-16
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
terms ranging from zero to five years. The following table summarizes activity
associated with such grants for the period from inception (October 4, 1993)
through December 31, 1998:
 
<TABLE>
<CAPTION>
                                                            Price per Share
                                                         ----------------------
                                                                       Weighted
                                               Shares        Range     Average
                                             ----------  ------------- --------
<S>                                          <C>         <C>  <C> <C>  <C>
Inception through May 31, 1996..............         --  $ --  -- $ --   $ --
  Granted...................................  1,046,429   .88  -- 2.00    .51
                                             ----------
Balance, May 31, 1997.......................  1,046,429   .88  -- 2.00    .51
  Granted...................................    887,238   .22  -- 5.00   1.35
  Exercised.................................    (75,000)  .22  --  .22   2.19
  Cancelled or lapsed....................... (1,183,500)  .22  -- 2.00    .70
                                             ----------
Balance, May 31, 1998.......................    675,167   .40  -- 5.00   1.57
  Granted...................................  1,256,500   .05  -- 4.00    .65
  Reclassified from warrants issued to
   officers.................................  1,380,000   .31  --  .31    .31
  Exercised.................................   (217,500)  .40  -- 1.08    .76
  Cancelled or lapsed.......................   (289,167)  .88  -- 2.31   1.76
                                             ----------
Balance, December 31, 1998..................  2,805,000   .05  -- 5.00    .57
                                             ==========
</TABLE>
 
  The following is additional information relating to outstanding warrants and
options issued for professional services at December 31, 1998:
 
<TABLE>
<CAPTION>
                                Options          Options
                              Outstanding      Exercisable
                           ----------------- ----------------
                           Weighted Weighted         Weighted
                           Average  Average  Number  Average
     Exercise    Number of Exercise   Life     of    Exercise
   Price Range    Shares    Price   (Years)  Shares   Price
   -----------   --------- -------- -------- ------- --------
   <S>           <C>       <C>      <C>      <C>     <C>
   $ .01--$ .99  2,380,000  $ .20     6.1    346,666  $ .19
    1.00--3.99     359,000   2.40     6.1    249,000   2.35
    4.00--5.00      66,000   4.09     4.8     56,000   4.11
                 ---------                   -------
                 2,805,000                   651,666
                 =========                   =======
</TABLE>
 
  In accordance with the provisions of SFAS No. 123, "Accounting for Stock
Based Compensation", combined compensation expense for the above warrants and
options is recognized over the period of vesting. Compensation expense
recognized during the seven months ended December 31, 1998, the years ended
May 31, 1998 and 1997 and the period from inception (October 4, 1993) through
December 31, 1998 amounted to $1,199,564, $456,713, $290,596 and $1,946,873,
respectively, and is included in professional services in the accompanying
financial statements.
 
  During the seven months ended December 31, 1998, the Company issued options
to a director and two consultants to purchase an aggregate 1,150,000 shares of
its common stock. The options vest over periods ranging from three months to
three years. Non-cash compensation expense of $5,278,900 associated with these
grants will be recognized over the vesting periods. Included in the
compensation expense recognized during the seven months ended December 31,
1998 is $795,465 of non-cash professional services relating to these grants.
 
  The basic net loss per share of common stock for all periods presented does
not reflect the weighted average number of shares that would be outstanding
assuming exercise of these warrants and options as the effect of such exercise
would be anti-dilutive.
 
                                     F-17
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
Stock Issued for Professional Services
 
  In August 1998, the Company issued 1,000,000 shares of common stock to a
director at $.05 per share. The shares vest ratably over a one-year period
from the date issued. Non-cash compensation expense of $1,575,000 associated
with this transaction will be recognized over the vesting period. During the
seven months ended December 31, 1998, the Company recognized $573,904 of non-
cash professional services relating to this transaction.
 
Options and Warrants Issued to President, Officers and Employees
 
 Common Stock Warrants
 
  From September 1996 through March 1998, the Company granted the president,
an officer and certain employees warrants to purchase shares of the Company's
common stock at exercise prices equal to or less than the fair market value at
the date of grant and containing vesting terms ranging from zero to four
years. The following table summarizes activity associated with such warrants
for the period from inception (October 4, 1993) through December 31, 1998:
 
<TABLE>
<CAPTION>
                                                                         Price
                                                             Shares    Per Share
                                                           ----------  ---------
<S>                                                        <C>         <C>
Inception through May 31, 1996............................         --    $  --
  Granted.................................................  2,300,000     1.00
                                                           ----------
Balance, May 31, 1997.....................................  2,300,000     1.00
  Granted.................................................  7,089,091      .31
  Cancelled............................................... (2,300,000)    1.00
                                                           ----------
Balance, May 31, 1998.....................................  7,089,091      .31
Reclassified to warrants for professional services........ (1,380,000)     .31
                                                           ----------
Balance, December 31, 1998................................  5,709,091      .31
                                                           ==========
Vested as of December 31, 1998............................  1,709,091      .31
                                                           ==========
</TABLE>
 
  During March 1998, the Company cancelled warrants to purchase 2,000,000
shares exercisable at $1.00 per share held by the president and issued new
warrants to purchase 1,709,091 shares exercisable at $.3125 and common stock
options to purchase 290,909 shares exercisable at $.34375 per share pursuant
to the Company's 1995 Incentive Stock Option Plan.
 
  In September 1998, an officer holding warrants to purchase 1,380,000 shares
of common stock at $.3125 per share resigned from the Company. Accordingly,
these warrants were reclassified to the section detailing warrants and options
issued for professional services.
 
 Common Stock Option Plans
 
  During the year ended May 31, 1996, the Company adopted, and the board of
directors approved, the 1995 Incentive Stock Option Plan ("the Plan").
Pursuant to the Plan, as amended on March 1, 1998, options to purchase up to
5,000,000 shares of common stock may be granted to directors, officers and
employees of the Company. Options are granted at 100% to 110% of the fair
market value of the common stock at the date of grant and generally vest over
three to four years. In certain circumstances, options may vest immediately or
within two years from the date of grant. Options granted under the Plan
generally expire five to ten years after
 
                                     F-18
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
the date of grant. As of December 31, 1998, options to purchase 453,464 shares
were exercisable and 3,845,891 shares were available for future grants under
the Plan. The following table summarizes activity under the Plan for the
period from inception (October 4, 1993) through December 31, 1998:
 
<TABLE>
<CAPTION>
                                                             Price per Share
                                                         -----------------------
                                                                        Weighted
                                               Shares        Range      Average
                                             ----------  -------------- --------
<S>                                          <C>         <C>            <C>
Balance, May 31, 1997.......................         --  $  -- - $   --  $ --
  Granted...................................  2,328,909     -- -   6.44   1.44
  Cancelled.................................   (300,000)    -- -   1.00    .50
Balance, May 31, 1998.......................  2,028,909     .31 -  6.44   1.58
  Granted...................................  1,870,700    1.63 - 13.38   6.81
  Exercised.................................   (393,000)    .31 -   .31    .31
  Cancelled................................. (2,352,500)    .31 -  8.75   6.06
Balance, December 31, 1998..................  1,154,109     .31 - 13.38   1.35
</TABLE>
 
  The following is additional information relating to options outstanding
under the Plan at December 31, 1998:
 
<TABLE>
<CAPTION>
                           Options Outstanding           Options Exercisable
                  ------------------------------------- ----------------------
                               Weighted      Weighted   Number     Weighted
   Exercise       Number of    Average       Average      of       Average
   Price Range     Shares   Exercise Price Life (Years) Shares  Exercise Price
   -----------    --------- -------------- ------------ ------- --------------
   <S>            <C>       <C>            <C>          <C>     <C>
   $ .01--$  .99    880,909     $ .38          4.9      415,909     $ .34
    1.00--  3.99     91,500      2.95          9.8        2,605      2.51
    4.00--  5.99    143,200      4.70          9.1       21,908      4.29
    6.00-- 13.38     38,500      7.38          8.5       13,042      7.17
                  ---------                             -------
                  1,154,109                             453,464
                  =========                             =======
</TABLE>
 
 Pro Forma Information
 
  The Company follows Accounting Principles Board Opinion 25 "Accounting for
Stock Issued to Employees ("APB Opinion 25")" to account for warrants and
options issued to the president, officers and employees. Compensation cost is
recognized only when the option exercise price is less than the estimated
market value of the underlying stock on the date of the grant. Amortization of
compensation expense under APB Opinion 25 for the seven months ended December
31, 1998, the years ended May 31, 1998 and 1997 and the period from inception
(October 4, 1993) through December 31, 1998 amounted to $-0-, $102,349,
$56,040 and $158,389, respectively.
 
  Effective for the seven months ended December 31, 1998 and the years ended
May 31, 1998 and 1997, the Company was required to adopt the disclosure
provisions of SFAS No. 123. This statement requires the Company to provide pro
forma information regarding net income or loss applicable to common
shareholders and net income or loss per share as if compensation cost for the
Company's common stock warrants and options had been determined in accordance
with certain fair value assumptions used for grants during the seven months
ended December 31, 1998 and the years ended May 31, 1998 and 1997, as follows:
no expected dividend yield for all years, expected volatility of 149%, 90% and
110%; an average risk free interest rate of 5.1%, 5.5% and 5.9% and an average
expected life of 4.8, 4.0 and 2.5 years, respectively.
 
                                     F-19
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
  Had compensation cost for the warrants and options issued during the periods
presented been determined based on fair value at the grant date, consistent
with the provisions of SFAS No. 123, the Company's net loss and net loss per
share would have increased to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                                    Inception
                                                                   (October 4,
                             Seven Months                             1993)
                                Ended       Year Ended May 31,       Through
                             December 31, -----------------------   December
                                 1998        1998        1997       31, 1998
                             ------------ ----------  -----------  -----------
<S>                          <C>          <C>         <C>          <C>
Net loss applicable to
 common stock:
  As reported..............   $7,980,815  $6,014,298  $ 9,528,473  $26,196,492
                              ----------  ----------  -----------  -----------
  Pro forma................   $8,835,593  $6,127,976  $10,630,229  $28,266,704
                              ----------  ----------  -----------  -----------
Basic net loss per share of
 common stock:
  As reported..............   $     (.27) $     (.35) $      (.89) $     (2.08)
                              ----------  ----------  -----------  -----------
  Pro forma................   $     (.29) $     (.36) $     (1.00) $     (2.24)
                              ----------  ----------  -----------  -----------
</TABLE>
 
Warrants Issued in Private Placements
 
  During the year ended May 31, 1996, the Company issued warrants to purchase
869,003 shares of common stock in connection with three separate private
placements. As no warrants were exercised during the year ended May 31, 1997,
the following table summarizes activity associated with these warrants from
that date through December 31, 1998:
 
<TABLE>
<CAPTION>
                                                        Exercise Price
                                                       ----------------
                                                                        Weighted
                                              Shares        Range       Average
                                             --------  ---------------- --------
<S>                                          <C>       <C>   <C>        <C>
Balance, May 31, 1997.......................  869,003  $1.00 -- - $2.00  $1.48
  Exercised................................. (158,500)  1.00 -- -  1.00   1.00
                                             --------
Balance, May 31, 1998.......................  710,503   1.00 -- -  2.00   1.58
  Exercised................................. (166,000)  1.00 -- -  1.00   1.00
  Expired...................................  (79,503)  1.00 -- -  1.00   1.00
                                             --------
Balance, December 31, 1998..................  465,000   1.50 -- -  2.00   1.89
                                             ========
</TABLE>
 
  Outstanding warrants issued in private placements at December 31, 1998 were
comprised of the following:
 
<TABLE>
<CAPTION>
      Date          Exercise           Expiration
     Granted         Price                Date              Outstanding           Vested
     -------        --------           ----------           -----------           ------
     <S>            <C>                <C>                  <C>                   <C>
     7/31/95         $2.00              7/31/00               365,000             365,000
     7/31/95         1.50               7/31/00               100,000             100,000
                                                              -------             -------
                                                              465,000             465,000
                                                              =======             =======
</TABLE>
 
  The basic net loss per share of common stock for all years presented in the
accompanying financial statements does not reflect the weighted average number
of shares that would be outstanding assuming exercise of these warrants as the
effect of such exercise would be anti-dilutive.
 
11. RELATED PARTIES
 
  During the year ended May 31, 1998, the Company issued 1,000,000 shares of
its common stock to a director as compensation for capital raising efforts on
behalf of the Company.
 
                                     F-20
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
  In March 1998, the Company granted warrants to the president to purchase
4,000,000 shares of the Company's common stock at $.3125 per share. The
warrants vest annually on a ratable basis over a four year period and expire
in March 2003. At December 31, 1998, none of the warrants were vested or
exercisable.
 
  On September 1, 1996, the Company granted common stock warrants to the
president to purchase 2,000,000 shares of the Company's common stock. In March
1998, the Company cancelled these warrants and issued new warrants to purchase
1,709,091 shares and options to purchase 290,909 shares. All of the warrants
and options are immediately exercisable (see Note 10).
 
  The Company incurred non-cash compensation expense via the issuance of
common stock to the president during the period from inception (October 4,
1993) through December 31, 1998 as more fully described in Note 12.
 
  The president provided working capital loans to the Company during 1996 and
1995 on an as needed basis. As of December 31, 1998, no loans were
outstanding.
 
12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
 
  Non-cash compensation expense incurred during the period from inception
(October 4, 1993) through December 31, 1998 was determined using the estimated
fair market value of the Company's common stock, common stock warrants, or
common stock options on the date such instruments were granted.
 
  During the seven months ended December 31, 1998, the Company recognized
$573,904 of non-cash professional services associated with the issuance of
1,000,000 shares of common stock to a director which vest over a one-year
period.
 
  During the seven months ended December 31, 1998, the Company recognized non-
cash compensation expense associated with the issuance of warrants and options
for professional services valued at $1,199,564.
 
  During the year ended May 31, 1998, the Company incurred non-cash
compensation expense associated with the issuance of (i) 3,000,000 shares of
common stock to the ex-chairman of the board valued at $787,500, (ii) 889,940
shares of common stock for professional services valued at $576,094, (iii)
826,140 shares of common stock to key employees valued at $518,596, (iv)
warrants and options for professional services valued at $576,313, and (v)
warrants to key employees valued at $102,349.
 
  During the year ended May 31, 1997, the Company incurred non-cash
compensation expense associated with the issuance, or the accrual to issue (i)
1,100,000 shares of common stock to the president valued at $2,262,500, (ii)
2,258,652 shares of common stock for professional services and expenses valued
at $4,440,425, (iii) 346,110 shares of common stock to key employees valued at
$743,612, (iv) warrants for professional services valued at $290,596, and (v)
warrants to key employees valued at $56,040.
 
  For the period from inception (October 4, 1993) through December 31, 1998,
the Company incurred non-cash compensation expense via the issuance of (i)
1,432,580 shares of common stock to the president valued at $2,499,415, (ii)
3,000,000 shares of common stock to the ex-chairman of the board valued at
$787,500, (iii) 4,432,548 shares of common stock for professional services and
expenses valued at $5,929,697, (iv) 1,172,250 shares of common stock to key
employees valued at $1,262,208, (v) warrants and options for professional
services valued at $2,066,473, and (vi) warrants to key employees valued at
$158,389.
 
  Accounts payable and accrued liabilities totalling $111,341 for professional
services and expenses were converted to common stock during the year ended May
31, 1997.
 
                                     F-21
<PAGE>
 
                         GK INTELLIGENT SYSTEMS, INC.
                       (A DEVELOPMENT STAGE ENTERPRISE)
 
                  NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
  The Company issued 883,333 shares of Series A preferred stock in exchange
for computer software technology during the year ended May 31, 1996 (see Notes
4 and 9). During the seven months ended December 31, 1998, the preferred stock
and accrued dividends of $187,315 were converted to 883,333 and 31,219 shares
of the Company's common stock, respectively.
 
  The Company issued 250,000 shares of its common stock in settlement of a
note payable in the amount of $471,257 during the year ended May 31, 1996.
 
13. TRANSITION PERIOD COMPARABLE INFORMATION (UNAUDITED)
 
  In August 1998, the Company changed its fiscal year end from May 31 to
December 31. Therefore, the transition period ended December 31, 1998 includes
seven months of operations. Unaudited information for the comparable seven
month period of June 1, 1997 through December 31, 1997 is included below:
 
STATEMENT OF LOSS
 
<TABLE>
<CAPTION>
                                                                  Seven Months
                                                                     Ended
                                                                  December 31,
                                                                      1997
                                                                  ------------
<S>                                                               <C>
Revenues......................................................... $        --
Costs and expenses:
  Professional services..........................................   1,080,113
  Employee compensation..........................................     762,320
  Depreciation and amortization..................................     502,449
  President's compensation.......................................     140,000
  Other general and administrative...............................     313,393
                                                                  -----------
Net loss......................................................... $(2,798,275)
                                                                  ===========
Basic Net Loss Per Share of Common Stock......................... $      (.19)
                                                                  ===========
Weighted Average Number of Shares of Common Stock Outstanding....  14,766,045
                                                                  ===========
</TABLE>
 
                                     F-22
<PAGE>
 
                          GK INTELLIGENT SYSTEMS, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
 
                   NOTES TO FINANCIAL STATEMENTS--(Continued)
 
 
STATEMENT OF CASH FLOWS
 
                Increase (Decrease) in Cash and Cash Equivalents
 
<TABLE>
<S>                                                               <C>
Operating activities:
Net loss......................................................... $(2,798,275)
Adjustments to reconcile net loss to net cash used in operating
 activities:
  Depreciation and amortization..................................      502,449
  Issuance of common stock, warrants and options for various
   expenses......................................................    1,117,115
  Changes in assets and liabilities:
    Other current assets.........................................       34,818
    Accounts payable.............................................      147,428
                                                                  ------------
      Net cash used in operating activities......................    (996,465)
                                                                  ------------
Investing activities:
  Purchased and developed software...............................    (175,384)
  Other capital expenditures.....................................     (14,520)
                                                                  ------------
      Net cash used in investing activities......................    (189,904)
                                                                  ------------
Financing activities:
  Proceeds from private placements and other share issuances.....      720,814
  Proceeds from borrowings.......................................      150,000
                                                                  ------------
      Net cash provided by financing activities..................      870,814
                                                                  ------------
Net decrease in cash and cash equivalents........................    (315,555)
Cash and cash equivalents at beginning of period.................      348,465
                                                                  ------------
Cash and cash equivalents at end of period....................... $     32,910
                                                                  ============
</TABLE>
 
                                      F-23