Selected consolidated financial data for the Corporation and its subsidiaries is set forth in the following table. (For additional information, see "Notes to Consolidated Financial Statements").
There were no provisions or benefits from income taxes in 1996 due to taxable net operating loss carry-forwards generated by current operations. The realization of future tax benefits from these items is uncertain at this time.
The Corporation accomplished the acquisitions of TRS and CDS through the issuance of its common stock. Management anticipates to continue using its common stock to acquire additional companies in the technology field. Management believes that its current working capital and anticipated levels of internally generated funds will be sufficient to fund its operating, product development, and capital expenditure requirements. This belief is based on the Corporation's current and planned level of operations. During 1996 the Corporation generated approximately $2,900,000 of cash flow from the sale of its marketable securities. This was a non-recurring transaction. At December 31, 1996, the Corporation had approximately $1,906,000 in cash.
The Corporation must continually update the content of its products and adapt its products to emerging and changing personal computer systems. The Corporation presently delivers its software products in CD-ROM format for use on personal computers. No assurance can be given that CD-ROM technology will not be replaced by other information distribution and access technologies, such as the Internet, or that the Corporation could adapt its products to any such alternative technologies on a timely basis. Furthermore, the Corporation may choose to invest significant resources to explore the feasibility of adopting alternative technologies.
From time to time, operating system and text retrieval system developers will announce substantially modified versions of their systems. Following such proposed announcements, the Corporation may be required to expend substantial financial and personnel resources to achieve compatibility with the Corporation's products, the costs of which will increase as the Corporation offers a greater number of products. Should modifications of computer system requirements occur without the Corporation having the opportunity to develop products compatible with such modifications, the resulting decline in demand for the Corporation's products could have a material adverse effect on the Corporation's results of operations and financial condition.
The electronic information distribution market is characterized by continuously evolving standards and technology. The Corporation's ability to anticipate industry standards, to continue to apply advances in electronic information distribution technology and to develop new complementary products and services will be a significant factor in the Corporation's ability to grow and remain competitive. The Corporation's business and results of operations could be materially and adversely affected if new technologies were introduced or alternative technology developed to displace widespread use of the current systems. There can be no assurance that the Corporation will be able to respond in a timely manner to technological changes or that the ability of competitors to successfully incorporate evolving standards and technologies into new products will not render the Corporation's products noncompetitive. The failure by the Corporation to adapt to or incorporate new standards or technology could have a material adverse effect on the Corporation's business and results of operations.
The Corporation's future success depends to a significant extent on its senior management and other key employees, including key development personnel. The loss of the services of any of these individuals or group of individuals could have a material adverse effect on the Corporation's results of operations. The Corporation also believes that its future success will depend in large part on its ability to attract and retain additional key employees. Competition for such personnel in the computer industry is intense, and there can be no assurance that the Corporation will be successful in attracting and retaining such personnel.
The Corporation relies primarily on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect its proprietary rights. The Corporation currently has no registered trademarks, copyrights, patents or patent applications pending. The Corporation seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection.
The Corporation seeks to protect its brand names under trademark and unfair competition laws. Despite the Corporation's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Corporation's products or to obtain and use information that the Corporation regards as proprietary. Policing unauthorized use of the Corporation's products is difficult, and while the Corporation is unable to determine the extent to which piracy of its software products exists, software piracy can be expected to be a persistent problem. There can be no assurance that the Corporation's means of protecting its proprietary rights will be adequate or that the Corporation's competitors will not independently develop similar technology.
Trading volumes of the Corporation's common stock have been relatively low. Factors such as variations in the Corporation's revenue, earnings and cash flow and announcements of technological innovations or price reductions by the Corporation, its competitors, Folio, or providers of alternative products could cause the market price of the Corporation's common stock to fluctuate
Consolidated statement of operations for the three years ended December 31, 1996, 1995, and 1994
Consolidated statement of cash flows for the three years ended December 31, 1996, 1995, and 1994
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Ethika Corporation and its subsidiaries at December 31, 1996, and the results of their operations and their cash flows for the year ended December 31, 1996, in conformity with generally accepted accounting principles. 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 audit of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above.
/s/Price Waterhouse, LLP - ------------------------ PRICE WATERHOUSE, LLP Atlanta, Georgia March 27, 1997
To The Shareholders Ethika Corporation (formerly Dixie National Corporation) Hilton Head Island, SC
We have audited the accompanying consolidated balance sheet of Ethika Corporation (formerly Dixie National Corporation) and subsidiaries as of December 31, 1995 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to report on these financial statements based on our audits.
In our opinion, the consolidated financial statements, as restated, referred to above present fairly, in all material respects, the financial position of Ethika Corporation and subsidiaries as of December 31, 1995 and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.
Jackson, Mississippi March 7, 1996, except as to the restatement as described in Note 1 which is as of March 27, 1997.
Nature of operations: Ethika corporation (the Corporation) operates as an applied technology company through two of its wholly-owned subsidiaries, Text Retrieval Systems, Inc. (TRS) and Compass Data Systems (CDS). See business combination information in Note 4. TRS and CDS are engaged in publishing electronic libraries that link related data sources for convenient access by personal computers. Certain products of TRS and CDS are sold nationally, while others are specific to states such as Florida, Missouri, and Kansas.
Principles of Consolidation: The consolidated financial statements include the financial statements of the Corporation and its wholly-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated.
Cash and Cash Equivalents: Cash and cash equivalents include cash in banks and money-market investments which carry no withdrawal restrictions.
Revenue Recognition: The Corporation recognizes revenue for software sales ratably over the period of each product's subscription life. The Corporation's various products are updated annually, quarterly and monthly based on content availability and/or specific customer agreements. Revenue associated with certain sales of TRS' primary product are not recognized until cash is collected due to the customers' right of return and limited history of returns for the product.
Inventory: Inventory consists primarily of software product manuals and promotional materials. Inventory is valued based on an average cost method.
Intangible assets: Intangible assets consist primarily of assets acquired through the acquisitions of TRS and CDS. Acquired goodwill and software products are amortized over three years. Non-compete agreements are amortized over the life of the related agreement (2-3 years). The Corporation regularly reviews its ability to realize future economic benefit from software products and goodwill based upon the expected future cash flows of the related subsidiary or product.
Use of estimates: The preparation of financial statements in accordance with generally accepted accounting principles requires the use of certain estimates. Actual results may differ from those estimates.
Earnings Per Share: Primary and fully diluted earnings per share are based on the weighted average number of common shares of 10,900,000; 9,471,000; and 6,551,000 outstanding for the years ended December 31, 1996, 1995, and 1994 respectively. Earnings per share calculations include contingently returnable shares only if their impact is dilutive. Previously reported earnings per share of ($.65) have been restated to ($0.72) in the accompanying financial statements due to an error in the prior calculations.
Certain of the assets above are being held for disposal. These assets consist primarily of the Corporation's former home office in Jackson, Miss., which has a net book value of approximately $381,000. The Corporation has operating lease agreements for office space, and certain office equipment. Ethika's corporate office space is leased from a member of the Board of Directors at the rate of approximately $1,400 per month. For the year ended December 31, 1996 payments on all operating leases were $107,000.
During 1995 and the first quarter of 1996, the Corporation accounted for its initial investment in TRS by the equity method under which the Corporation's share of the net loss of the affiliate was recognized in the Corporation's operations and included as an adjustment to the investment balance. The losses recorded by the Corporation were $265,643 and $48,687 for the quarter ended March 31, 1996 and the year ended December 31, 1995, respectively.
Amortization expense of approximately $567,000 related to the TRS acquisition includes a write-off of $171,000 for one of the two products being developed by TRS at the time of acquisition (a real estate library product). During the fourth quarter of 1996, the Corporation elected to abandon the product because Management subsequently determined it had limited marketability.
Effective October 1, 1996, the Corporation revised estimates used in determining the lives of intangible assets acquired through its acquisition of TRS and CDS from five years to three years.
The information below summarizes the unaudited proforma results of the Corporation assuming that the acquisitions of TRS and CDS had taken place at January 1, 1995:
Net deferred tax liabilities (assets) from continuing operations consist of the following components as of December 31:
The Corporation has net operating loss carry-forwards at December 31, 1996 of approximately $1,543,000 which expire in 2010 and 2011.
The Corporation's effective income tax (provision) benefit from continuing operations differs from amounts applying the statutory federal income tax rate of 34% as follows:
On May 26, 1995, the Corporation created the 1995 Stock Option Plan (the Plan) with a maximum amount of 500,000 common stock shares reserved for options eligible to be granted under the Plan during its ten-year life. The Corporation granted various stock options to Employees and Directors during 1996 and 1995. As of December 31, 1996, there are 230,000 remaining common stock shares reserved for granting and there are 250,000 options outstanding from the Plan. Employees vest in stock options granted at the rate of 20% each year on a cumulative basis commencing one year after the date of grant.
As permitted by SFAS 123, "Accounting for Stock-Based Compensation", the Corporation has elected not to record compensation cost for stock options in the accompanying statement of operations. The compensation cost for the Corporation's stock options have been determined based on the fair value at the grant dates consistent with the methodology prescribed by SFAS 123. The Corporation's net income and income per share would have been reduced to the pro forma amounts indicated below if these amounts had been recorded in the financial statements:
The following table summarized the changes in the number of options included under the Plan:
The composition of the net investment in direct financing leases at December 31 as follows:
The minimum future lease payments receivable under the direct financing leases are as follows:
A lawsuit was filed in the United States District Court for the Southern District of Mississippi, Jackson Division, styled EURAM B.V., Peeper, et al. vs. Ethika by certain plaintiffs against Ethika and its Chairman, S.L. Reed, Jr. This suit alleges breach of fiduciary duties, fraud, conspiracy to breach fiduciary duty of loyalty and care, breach of contract, misrepresentation, and conversion. These allegations arise from the transactions surrounding the Corporation's issuance of 2,000,000 shares of its stock in exchange for 16% interest in PMM (See Note 12 for further information), and the sale by the Corporation of $2,000,000 of its stock in exchange for shares of Alanco stock valued at $2,000,000 (See Note 11 for additional information). On October 30,1996 Ethika filed answers to the suit and instituted a counterclaim against the individuals named in the above suit and other defendants not named in the original suit. The Corporation, on advice of outside legal counsel, believes the plaintiffs' suit is without merit, and that its resolution will not have a material effect on the Corporation, however, it is too early in the proceedings to assure the outcome.
The Corporation entered into an agreement with Universal Management Services, a Nevada corporation (UMS), as of October 27, 1994 (UMS Agreement). The UMS Agreement provided that UMS would use its best efforts to assist the Corporation in locating potential investors for its common stock. On November 29, 1994 the Corporation sold 2,000,000 shares of its common stock for which it received shares of Alanco Environmental Resources, Inc. ("Alanco") common stock (November transaction), with an aggregate market value of $2,000,000. Under the terms of the UMS Agreement as amended (See Note 12), any market appreciation prior to closing of the sale of Dixie Life to Standard could not be realized because the purchasers of the Corporation's common stock had the right to repurchase the Alanco shares for cash equal to the $2,000,000 fair value of such shares on November 29, 1994. The purchasers had the obligation to cover any market depreciation, as defined which might have occurred prior to closing of the sale of Dixie Life to Standard. Therefore, the Alanco shares were carried at cost until October 2, 1995, the closing date of the Dixie Life sale to Standard. At December 31, 1995, market value of the Alanco shares based on the average of the closing bid and asked price was $2,227,904.
In December 1995 the Corporation sold 75,000 shares of Alanco stock on the open market generating a $10,020 profit. The Corporation also recorded on its December 31, 1995 Financial Statements an unrealized gain on its remaining Alanco stock of $347,859. During the first quarter of 1996, the Corporation sold the remaining Alanco shares resulting in the recognition of a $672,785 gain.
As a result of the unaudited stockholders deficit of PMM as of December 31, 1995 and other factors, the Corporation wrote off its entire remaining investment in PMM which resulted in a loss of $1,051,217 during the year ended December 31, 1995.
The publishing, distribution, and future development rights of the CodeManager Reference Library were purchased from American Practice Management, Inc. ("APM") and Consulting Concepts, Inc. on January 31, 1997 in exchange for 180,000 shares of Ethika common stock having a fair market value of approximately $101,250 at January 31, 1997.