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Averstar Inc · IPO:  S-1/A · On 7/16/99

Filed On 7/16/99   ·   Accession Number 940180-99-810   ·   SEC File 333-78517

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  As Of                Filer                Filing    For/On/As Docs:Size              Issuer               Agent

 7/16/99  Averstar Inc                      S-1/A                 13:779K                                   Donnelley RR & So..12/FA

Initial Public Offering (IPO):  Pre-Effective Amendment to Registration Statement (General Form)   —   Form S-1
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: S-1/A       Amendment No. 1 to Form S-1                          134    714K 
 2: EX-1.1      Form of Underwriting Agreement                        27    122K 
 3: EX-3.3      2nd Amended & Restated Cert. of Incorporation         15     57K 
 4: EX-3.5      Amended & Restated Bylaws of Averstar                 10     42K 
 5: EX-5.1      Opinion of Swidler Berlin                              3     14K 
 6: EX-10.1     Business Loan and Security Agreement                  81    314K 
 7: EX-23.2A    Consent of Ernst & Young LLP                           1      7K 
 8: EX-23.2B    Consent of Ernst & Young LLP                           1      6K 
 9: EX-23.2C    Consent of Ernst & Young LLP                           1      6K 
10: EX-23.3     Consent of Grant Thornton LLP                          1      6K 
11: EX-23.4     Consent of Aronson, Fetridge, & Weigle                 1      7K 
12: EX-23.5     Consent of International Date Corp.                    1      7K 
13: EX-27       Financial Data Schedule                                2      7K 


S-1/A   —   Amendment No. 1 to Form S-1
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
4Prospectus Summary
"We provide an integrated offering of services and products in four areas of IT:
5Our goal is to be the leading quality supplier of IT services and software products for mission-critical systems. To achieve our goal, our strategy is to:
6The Offering
7Summary Financial Data
11Risk Factors
14We may require additional financing that we may not be able to secure on favorable terms or at all
19Forward-Looking Statements
20Use of Proceeds
"Dividend Policy
21Capitalization
22Dilution
23Selected Financial Data
26Management's Discussion and Analysis of Financial Condition and Results of Operations
27Revenues
"Cost of revenues
28Selling, general and administrative expense
"Income from continuing operations
29Income from operations
30Backlog
33Business
45Management
47Michael B. Alexander
54Principal Stockholders
56Certain Relationships and Related-Party Transactions
58Description of Securities
"Anti-Takeover Effects of Certain Provisions of Delaware Law and Our Certificate of Incorporation and Bylaws
61Shares Eligible for Future Sale
63Underwriting
64Legal Matters
65Experts
"Where You Can Find Additional Information
67Unaudited Pro Forma Condensed Consolidated Financial Information Overview
70Unaudited Pro Forma Condensed Consolidated Statement of Operations for the three months ended March 31, 1999
73AverStar, Inc. Report of Independent Auditors
78Notes to Consolidated Financial Statements
80Earnings per Share
86Redeemable common stock
93Statements of Operations for the years ended December 31, 1996, 1997 and 1998
94Statements of Other Comprehensive Income for the years ended December 31, 1996, 1997 and 1998
95Statements of Stockholders' Equity for the years ended December 31, 1996, 1997 and 1998
96Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998
109Estimates
115Looking Glass Technologies, Inc. Report of Independent Auditors
117Total
120Accounting for Stock-Based Compensation
121Warrants
127Item 13. Other Expenses of Issuance and Distribution
"Item 14. Indemnification of Directors and Officers
128Item 15. Recent Sales of Unregistered Securities
"Item 16. Exhibits and Financial Statement Schedules
131Item 17. Undertakings
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As filed with the Securities and Exchange Commission on July 16, 1999 Registration No. 333-78517 ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT Under the Securities Act of 1933 ---------------- AVERSTAR, INC. (Exact name of registrant as specified in its charter) Delaware 8711 043411541 (State or other (Primary standard industrial (I.R.S. employer jurisdiction of classification code number) identification number) incorporation or organization) ---------------- 23 Fourth Avenue Burlington, MA 01803 (781) 221-6990 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ---------------- Michael B. Alexander Chief Executive Officer AverStar, Inc. 23 Fourth Avenue Burlington, MA 01803 (781) 221-6990 (Name, address, including zip code, and telephone number, including area code, of agent for service) Copies to: Gerald Adler, Esq. Julie M. Allen, Esq. Swidler Berlin Shereff Friedman, LLP 919 Third Avenue Proskauer Rose LLP New York, New York 10022 (212) 758-9500 1585 Broadway New York, New York 10036 (212) 969-3000 Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement is declared effective. ---------------- If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box: [_] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] . If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier registration statement for the same offering. [_] . If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier registration statement for the same offering. [_] . If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. [_] ---------------- The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. ------------------------------------------------------------------------------- -------------------------------------------------------------------------------
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++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +This information in this prospectus is not complete and may be changed. We + +may not sell these securities until the registration statement filed with the + +Securities and Exchange Commission is effective. This prospectus is not an + +offer to sell these securities and we are not soliciting offers to buy these + +securities in any jurisdiction where the offer or sale is not permitted. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION, DATED JULY 16, 1999 PROSPECTUS 4,000,000 Shares [Logo of AverStar] ________________________ Common Stock ----------- This is an initial public offering of shares of our common stock. We are offering 4,000,000 shares of our common stock. We anticipate that the initial public offering price will be between $7.00 and $9.00 per share. We have applied to have our common stock approved for listing on the Nasdaq National Market under the symbol "ASTR". See "Risk Factors" beginning on page 8 to read about risks that you should consider before buying shares of our common stock. Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. ----------- [Download Table] Per Share Total ----- ----- Public offering price............................................... $ $ Underwriting discounts and commissions.............................. $ $ Total proceeds, before expenses, to us from this offering........... $ $ ----------- The underwriters may purchase up to an additional 600,000 shares of our common stock from us at the initial public offering price less the underwriting discount to cover over-allotments. ----------- Bear, Stearns & Co. Inc. Legg Mason Wood Walker Incorporated The date of this prospectus is , 1999
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Inside Cover: The words AverStar, Assurance, Consulting, Development and Operations, on a background with pictures of the AverStar logo, the American flag, an aircraft carrier, the space shuttle, the front of a government building, a man and woman in conversation, a man walking, a spider web with the earth at its center, and a computer screen with credit cards. Caption: "Customers Trust AverStar to Create and Validate Exceptional Systems and Software for Critical Applications." Back Cover: The customer chart contained on page 36 of the Registration Statement.
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PROSPECTUS SUMMARY This summary highlights information contained elsewhere in this prospectus. You should read the entire prospectus carefully, especially the risks of investing in our common stock discussed under "Risk Factors," before investing in our common stock. Our Business AverStar is a pioneer in providing information technology, or IT, services and software products for the mission-critical systems of a significant number of civilian and defense agencies of the United States government. Our customers include 16 of the 20 government agencies with the largest IT budgets for the government's 1999 fiscal year. We also provide our services to large commercial companies. We have established long-term customer relationships, some of which have extended over 20 years. During our 30-year history, we have maintained a strong record of customer satisfaction based on the quality and reliability of our services and products. We provide an integrated offering of services and products in four areas of IT: . IT Assurance. We provide independent analysis, testing and verification of critical information systems under development or being upgraded. We also provide security for customers' information systems. . IT Development. We offer a full range of software and systems development services for customer-specific applications and Internet applications. . IT Operations. We manage and operate information system networks and data centers at our customers' facilities. . IT Consulting. We serve as consultants with respect to our customers' development of innovative applications or improvements to existing critical systems. We provide IT assurance services for many of the United States government's mission-critical systems. An IT system is mission-critical if the failure of the system would pose a risk to health and safety or cause disruption of a vital service or function. Our key IT assurance contracts include NASA's space shuttle, space station and ground systems, the Health Care Finance Administration's Medicare transactions system and the United States Postal Service's automation systems. Once a customer retains us to perform assurance services, we believe that we can gain expertise about the customer's business and therefore become well positioned to provide additional services and products to that customer. Since June 1994, more than one-half of our customers who originally awarded us IT assurance contracts of more than $1.0 million subsequently awarded us IT development or IT consulting contracts. For example, after first being engaged to provide IT assurance services, we have been awarded contracts to provide IT development and IT consulting services to the United States Postal Service and the Department of Health and Human Services. We serve as the prime contractor on a majority of our contracts. Prime contracts accounted for approximately 78% of our 1998 pro forma revenues. We believe that our position as prime contractor allows us to develop closer relationships with our customers, to control the quality of services and products delivered to the customer and to expand our customer relationships. Our Market The demand for third-party IT services has grown substantially in recent years. Organizations are increasingly using IT to improve the quality of their products and services, to reduce their costs and to improve operating efficiencies. International Data Corporation, or IDC, forecasts that the United States market for IT services will grow from an estimated $139 billion in 1998 to $207 billion in 2002. IDC forecasts that the IT system services segment of the worldwide IT services market will grow at a compound annual growth rate of approximately 12% over this period. 1
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According to Federal Sources, Inc., the United States government is the world's largest single buyer of IT services and products. The Electronics Industry Association, or EIA, reports that the United States government's IT budget for fiscal 1999 is approximately $30 billion, nearly double the budget ten years ago. The EIA also estimates that the outsourced portion of the federal IT budget will be $26 billion in 1999, with approximately 64% allocated to civilian agencies of the government and 36% allocated to the Department of Defense. We believe that the increasing emphasis by the United States government on downsizing and reducing budgets will result in the growing use of IT to enhance productivity and in more testing and upgrading of existing IT systems. In addition, government agencies are increasingly using commercial procurement practices. With our position in IT assurance, reputation for quality and reliability and broad customer base, we believe that we are well positioned to take advantage of these trends. Our Corporate History Our current business and operations result from a series of strategic acquisitions of well established IT companies, executed by our current management team. In February 1998, we combined the businesses of Intermetrics, Inc. and Pacer Infotec, Inc. Previously, Pacer acquired Infotec Development, Inc. in July 1996. Founded in 1969, Intermetrics brought us expertise in IT assurance and IT consulting services for United States civilian and defense agencies and for commercial organizations and IT development services for customer-specific applications. Founded in 1968, Pacer broadened our base of contracts for IT assurance and IT development services for United States defense and civilian agencies. In March 1999, we acquired Computer Based Systems, Inc. Founded in 1978, CBSI strengthened our IT operations services and broadened our customer base among civilian agencies of the federal government. Our acquisitions have provided us with an experienced management team, a broad base of long term contracts, a diverse group of established customers, substantial backlog and strong sales and marketing resources. We believe that these strengths enable us to compete effectively in our industry. Our Strategy Our goal is to be the leading quality supplier of IT services and software products for mission-critical systems. To achieve our goal, our strategy is to: . Leverage our position in IT assurance. We intend to continue to capitalize on our position in IT assurance to attract new customers and to provide additional services and products to our existing customers. . Pursue targeted acquisition opportunities. We seek to acquire companies that operate in defined vertical market niches complementary to our current business or that have well established relationships with key customers. . Expand our commercial business. We intend to leverage our expertise and reputation in the federal IT market to compete for commercial projects. . Continue our investment in sales and marketing. We are continuing to strengthen our sales and marketing efforts to compete effectively for government contracts in a changing procurement environment and to expand our commercial customer base. . Maintain our high level of customer satisfaction. We believe that maintaining our high level of customer satisfaction and the resulting long-term relationships provide a stable customer base from which we can grow our business. We are incorporated in Delaware. Our principal executive offices are located at 23 Fourth Avenue, Burlington, Massachusetts 01803. Our telephone number at that location is (781) 221-6990. Our web site address is www.averstar.com. Information contained on our web site does not constitute part of this prospectus. 2
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The Offering [Download Table] Common Stock Offered ...... 4,000,000 shares Common Stock Outstanding After this Offering....... 10,880,655 shares Use of Proceeds............ To repay a portion of our indebtedness. Please see "Use of Proceeds." Proposed Nasdaq National Market Symbol............. ASTR Additional shares may be issued after this offering. You should be aware that we are permitted, and in some cases obligated, to issue shares of common stock in addition to the common stock to be outstanding after this offering. If and when we issue these shares, the percentage of common stock you own may be diluted. 1,513,433 shares are issuable upon the exercise of outstanding options at a weighted average exercise price of $3.26 per share, of which 757,055 shares are exercisable. Options to purchase an additional 504,180 shares of common stock will become exercisable upon the closing of this offering. In addition, 1,836,014 shares are available for future option grants. Unless otherwise indicated, all information in this prospectus assumes that the underwriters do not exercise their option to purchase additional shares after the closing of this offering to cover over-allotments. ---------------- All pro forma statement of operations information in this prospectus is presented as if our acquisitions of Pacer and of CBSI had occurred as of January 1, 1998, unless otherwise noted. ---------------- AverStar, Inc., Intermetrics, Inc., Pacer Infotec, Inc., JWatch, EWatch, Ada Magic and our logo are our trademarks. Each other trademark, trade name or service mark appearing in this prospectus belongs to its holder. 3
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Summary Financial Data The following tables set forth our summary financial data. These tables do not present all of our financial information. You should read this information together with our financial statements and the notes to those statements beginning on page F-1 of this prospectus and the information under "Selected Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." On March 13, 1995, an investor group led by current management formed a holding company that acquired Intermetrics in August 1995. Substantially all data for the period March 13, 1995 through February 29, 1996 relate to the operations and financial position of Intermetrics. The summary financial data for the 12 months ended February 29, 1996, which are unaudited, combine the two preceding columns which reflect the operations of Intermetrics for the first six months of the period based on Intermetrics' basis of accounting prior to the acquisition, and our operations giving effect to the acquisition of Intermetrics in August 1995. In February 1998, we acquired Pacer, whose results of operations are included from the date of acquisition in our results for the 12 months ended December 31, 1998. In March 1999, we acquired CBSI. The pro forma column below presents our statement of operations data as if the acquisitions of Pacer and CBSI had occurred as of January 1, 1998. The pro forma as adjusted statement of operations data reflect our sale of shares of common stock in this offering, after deducting underwriting discounts and estimated offering expenses, and the application of the proceeds to repay debt as if both these events had occurred as of January 1, 1998. The selected financial data for the 12 months ended February 28, 1997, the 10 months ended December 31, 1997 and the 12 months ended December 31, 1998 are derived from our audited financial statements included elsewhere in this prospectus. The selected financial data for the 12 months ended February 28, 1995 are derived from audited financial statements not included in this prospectus. The consolidated financial data for the three months ended March 31, 1998 and 1999, have been prepared on the same basis as our consolidated financial statements. In our opinion, all necessary adjustments, consisting of normal recurring accruals, have been included. Results of operations for interim periods are not necessarily indicative of results we may achieve in a full year. Historical results are not necessarily indicative of the results we may achieve in the future. Adjusted EBITDA is net income (loss) from continuing operations before taxes, interest expense, interest income, depreciation expense, amortization expense, in process research and development expense and merger-related expense. Depreciation expense is included in cost of revenues in the following tables. In process research and development expenses and merger-related expenses are included in selling, general and administrative expense in the following tables. Adjusted EBITDA is provided because we believe that investors may find it to be a useful tool for analyzing our ability to service debt. Adjusted EBITDA should not be construed: . As an indicator of our operating performance instead of operating income; or . As a measure of liquidity instead of cash flows from operating activities. We may calculate adjusted EBITDA differently than other companies. 4
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[Enlarge/Download Table] Intermetrics ----------------------- Pro Forma Twelve Six March 13, Twelve Twelve Ten Twelve Twelve Months Months 1995 Months Months Months Months Months Ended Ended through Ended Ended Ended Ended Ended FProeFormabruary 28, August 31, February 29, February 29, February 28, December 31, December 31, December 31, As Adjusted1995 1995 1996 1996 1997 1997 1998 1998 ---Twelve--------- ---------- ------------ ------------ ------------ ------------ ------------ ------------ Months Ended December 31, 1998 ------------ (In thousands) Statement of Operations Data: Revenues........ $53,964 $27,103 $27,787 $54,890 $53,274 $53,646 $121,056 $169,039 Cost of revenues....... 37,964 20,470 21,399 41,869 40,704 41,685 93,604 128,520 Selling, general and administrative expense........ 14,139 6,908 5,247 12,155 10,159 10,253 19,531 31,007 Amortization expense........ -- -- 514 514 1,085 150 1,050 4,344 In process research and development expense........ -- -- 8,600 8,600 -- -- -- -- ------- ------- ------- ------- ------- ------- -------- -------- Income (loss) from operations..... 1,861 (275) (7,973) (8,248) 1,326 1,558 6,871 5,168 Interest expense........ 26 13 734 747 1,441 1,302 2,513 4,973 Interest income......... 525 363 149 512 160 96 244 244 ------- ------- ------- ------- ------- ------- -------- -------- Income (loss) from continuing operations before taxes... 2,360 75 (8,558) (8,483) 45 352 4,602 439 Provision for income taxes... 945 40 32 72 18 154 2,168 366 ------- ------- ------- ------- ------- ------- -------- -------- Net income (loss) from continuing operations..... $ 1,415 $ 35 $(8,590) $(8,555) $ 27 $ 198 $ 2,434 $ 73 ======= ======= ======= ======= ======= ======= ======== ======== Statement of Operations Data: Revenues........ $169,039 Cost of revenues....... 128,520 Selling, general and administrative expense........ 31,007 Amortization expense........ 4,344 In process research and development expense........ -- ------------ Income (loss) from operations..... 5,168 Interest expense........ 2,431 Interest income......... 244 ------------ Income (loss) from continuing operations before taxes... 2,981 Provision for income taxes... 1,371 ------------ Net income (loss) from continuing operations..... $ 1,610 ============ Computation of Adjusted EBITDA: Net income (loss) from continuing operations..... $ 1,415 $ 35 $(8,590) $(8,555) $ 27 $ 198 $ 2,434 $ 73 Provision for income taxes... 945 40 32 72 18 154 2,168 366 Interest income......... (525) (363) (149) (512) (160) (96) (244) (244) Interest expense........ 26 13 734 747 1,441 1,302 2,513 4,973 Depreciation expense........ 1,918 709 561 1,270 1,066 785 2,178 2,465 Amortization expense........ -- -- 514 514 1,085 150 1,050 4,344 In process research and development expense........ -- -- 8,600 8,600 -- -- -- -- Merger-related expense........ -- 1,592 -- 1,592 -- 700 560 560 ------- ------- ------- ------- ------- ------- -------- -------- Adjusted EBITDA......... $ 3,779 $ 2,026 $ 1,702 $ 3,728 $ 3,477 $ 3,193 $ 10,659 __12,537$ ======= ======= ======= ======= ======= ======= ======== ======== Adjusted EBITDA as a percentage of revenues.... 7.0% 7.5% 6.1% 6.8% 6.5% 6.0% 8.8% 7.4% ======= ======= ======= ======= ======= ======= ======== ======== Computation of Adjusted EBITDA: Net income (loss) from continuing operations..... $ 1,610 Provision for income taxes... 1,371 Interest income......... (244) Interest expense........ 2,431 Depreciation expense........ 2,465 Amortization expense........ 4,344 In process research and development expense........ -- Merger-related expense........ 560 ------------ Adjusted EBITDA......... __12,537$__ ============ Adjusted EBITDA as a percentage of revenues.... 7.4% ============ Cash Flows: Continuing operating activities..... $ 2,652 $ 3,106 $ 1,147 $ 4,253 $ 433 $ 1,007 $ 1,299 Discontinued operating activities..... -- -- -- -- -- (1,367) (8,951) 2,652 3,106 1,147 4,253 433 (360) (7,652) Investing activities..... (1,537) 7,829 (405) 7,424 (1,297) (2,471) (7,999) Financing activities of continuing operations..... (366) 384 603 987 133 2,348 11,997 Financing activities of discontinued operations..... -- -- -- -- -- -- 3,855 (366) 384 603 987 133 2,348 15,852 ------- ------- ------- ------- ------- ------- -------- Net cash increase (decrease)..... $ 749 $11,319 $ 1,345 $12,664 $ (731) $ (483) $ 201 ======= ======= ======= ======= ======= ======= ======== Cash Flows: Continuing operating activities..... Discontinued operating activities..... Investing activities..... Financing activities of continuing operations..... Financing activities of discontinued operations..... Net cash increase (decrease)..... 5
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[Download Table] Three Months Ended March 31, ---------------------------------------------- Pro Forma As Actual Pro Forma Adjusted ----------------- ---------------- --------- 1998 1999 1998 1999 1999 ------- -------- ------- ------- --------- (In thousands) Statement of Operations Data: Revenues....................... _22,738$ __36,346$ _38,790$ _46,948$ _46,948$ Cost of revenues............... 17,310 28,841 30,177 36,121 36,121 Selling, general and adminis- trative expense............... 4,017 4,940 7,181 7,422 7,422 Amortization expense........... 149 357 1,083 1,056 1,056 ------- -------- ------- ------- ------- Income from operations......... 1,262 2,208 349 2,349 2,349 Interest expense, net.......... 476 760 1,177 1,261 625 Income (loss) from continuing operations before taxes....... 786 1,448 (828) 1,088 1,724 Provision for income taxes..... 370 656 (322) 479 758 ------- -------- ------- ------- ------- Net income (loss) from continu- ing operations................ ____416$ _____792$ ___(506)$____609$ ____966$ ======= ======== ======= ======= ======= Computation of Adjusted EBITDA: Net income (loss) from continu- ing operations................ ____416$ _____792$ ___(506)$____609$ ____966$ Provision for income taxes..... 370 656 (322) 479 758 Interest expense, net.......... 476 760 1,177 1,261 625 Depreciation expense........... 406 452 543 452 452 Amortization expense........... 149 357 1,083 1,056 1,056 Merger-related expense......... 56 -- 56 -- -- ------- -------- ------- ------- ------- Adjusted EBITDA................ __1,873$ ___3,017$ __2,031$ __3,857$ __3,857$ ======= ======== ======= ======= ======= Adjusted EBITDA as a percentage of revenues................... 8.2% 8.3% 5.2% 8.2% 8.2% ======= ======== ======= ======= ======= Cash Flows: Continuing operating activi- ties......................... (706) 927 Discontinued operating activi- ties......................... (2,230) -- ------- -------- (2,936) 927 Investing activities.......... 1,049 (24,167) Financing activities of con- tinuing operations........... 9,877 24,685 Financing activities of dis- continued operations......... -- -- ------- -------- 9,877 24,685 Net cash increase (de- crease)..................... $_7,990 $__1,445 ======= ======== 6
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The following table is a summary of our balance sheet data as of March 31, 1999. The as adjusted column reflects our sale of 4,000,000 shares of common stock in this offering, assuming an initial public offering price of $8.00 per share and after deducting underwriting discounts and estimated offering expenses, and the application of the proceeds to repay debt. [Download Table] March 31, 1999 --------------------- --- As Actual Adjusted ------- --- -------- (In thousands) Balance Sheet Data: Cash and cash equivalents................................. $ 1,777 ___ $1,777 Working capital........................................... 7,653 7,653 Total assets.............................................. 94,212 94,212 Total debt................................................ 58,169 29,914 Redeemable common stock................................... 5,598 0 Stockholders' equity (deficit)............................ (2,048) 31,967 7
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RISK FACTORS Any investment in our common stock involves a high degree of risk. You should consider carefully the following information about these risks, together with the other information contained in this prospectus, before you decide to buy our common stock. If any of the following risks actually occur, our business, results of operations and financial condition would likely suffer. In this case, the market price of our common stock could decline, and you may lose all or part of the money you paid to buy our common stock. Most of our revenues are derived from contracts with agencies of the United States government, and uncertainties in government contracts could adversely affect our business. Our largest customers are agencies of the United States government. In 1998, government contracts, and contracts with prime contractors of the United States government, accounted for approximately 90% of our pro forma revenues. We believe that United States government contracts are likely to continue to account for a significant portion of our revenues for the foreseeable future. Significant changes in the contracting policies or fiscal policies of the United States government could adversely affect our business, results of operations or financial condition. Changes in government contracting policies could directly affect our financial performance. Among the factors that could materially adversely affect our United States government contracting business are: . Budgetary constraints affecting government spending generally, or specific departments or agencies in particular, and changes in fiscal policies or available funding; . Cancellation of government programs; . Curtailment of the government's use of technology services firms; . The adoption of new laws or regulations; . Technological developments; . Governmental shutdowns; . Competition and consolidation in the IT industry; and . General economic conditions. These or other factors could cause governmental agencies to reduce their purchases under contracts, to exercise their right to terminate contracts or not to exercise options to renew contracts, any of which could have a material adverse effect on our business, financial condition or results of operations. Many of our United States government customers are subject to increasingly stringent budgetary constraints. We have substantial contracts in place with many departments and agencies, and our continued performance under these contracts, or award of additional contracts from these agencies, could be materially adversely affected by spending reductions or budget cutbacks at these agencies. Such reductions or cutbacks could have a material adverse effect on our business, financial condition or results of operations. Our government contracts may be terminated prior to their completion, and we may not retain these contracts in any competitive rebidding process. We derive substantially all of our revenues from government contracts that typically span one or more base years and one or more option years and are awarded through formal competitive bidding processes. Many of the option periods cover more than half of the contract's potential duration. United States government agencies generally have the right not to exercise these option periods. In addition, our contracts typically also contain provisions permitting a government customer to terminate the contract on short notice, with or without cause. A decision not to exercise option periods or to terminate contracts would reduce the profitability of these contracts to us. 8
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Upon expiration, if the customer requires further services of the type provided in the contract, there is frequently a competitive rebidding process, and we may not win any particular bid, or be able to replace business lost upon expiration or completion of a contract. Further, all government contracts are subject to protest by competitors. The unexpected termination of one or more of our significant contracts could result in significant revenue shortfalls. The termination or non-renewal of any of our significant contracts, short-term revenue shortfalls, the imposition of fines or damages or our suspension or debarment from bidding on additional contracts could have a material adverse effect on our business, financial condition or results of operations. A negative audit could adversely affect our business, and we could be required to reimburse the government for costs that we have expended on our contracts. Government agencies routinely audit government contracts. These agencies review a contractor's performance on its contract, pricing practices, cost structure and compliance with applicable laws, regulations and standards. Any costs found to be improperly allocated to a specific contract will not be reimbursed, while improper costs already reimbursed must be refunded. Therefore, an audit could result in a substantial adjustment to our revenues. No material adjustments have resulted from any audits of us completed as of December 31, 1994, and we believe that adjustments resulting from subsequent audits will not adversely affect our business. If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeitures of profits, suspension of payments, fines and suspension or debarment from doing business with United States government agencies. In addition, we could suffer serious reputational harm if allegations of impropriety were made against us. Any such government determination of impropriety or illegality, or allegation of impropriety, could have a material adverse effect on our business, financial condition or results of operations. Many of our United States government customers spend their procurement budgets through General Service Administration Schedule contracts and we are required to compete for post-award orders. Budgetary pressures and reforms in the procurement process have caused many United States government agencies to increasingly purchase goods and services through General Service Administration Schedule contracts and other multiple award and/or government-wide acquisition contract vehicles. We must continually persuade government agencies to purchase our IT services and products because government agencies have a larger number of IT service providers from which to choose under these contracts. We may not maintain or increase revenues or otherwise sell successfully under these contracts. Our failure to compete effectively in this procurement environment could have a material adverse effect on our business, financial condition or results of operations. We may be liable for penalties under a variety of procurement rules and regulations, and changes in government regulations could adversely affect our business. Our defense and commercial businesses must comply with and are affected by various government regulations. Among the most significant regulations are the Federal Acquisition Regulations, which comprehensively regulate the formation, administration and performance of government contracts; the Truth in Negotiations Act, which requires certification and disclosure of all cost and pricing data in connection with contract negotiations; the Cost Accounting Standards, which impose accounting requirements that govern our right to reimbursement under certain cost-based government contracts; and laws, regulations and Executive Orders restricting the use and dissemination of information classified for national security purposes and the exportation of certain products and technical data. These regulations affect how our customers and we do business and, in some instances, impose added costs on our businesses. Any changes in applicable laws could adversely affect the financial performance of the business affected by the changed regulations. Any failure to comply with applicable laws could result in contract termination, price or fee reductions or suspension or debarment from contracting with the United States government. 9
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If we fail to recruit, train and retain skilled personnel, our costs could increase and our growth would be limited. Our success depends to a significant extent upon our ability to attract, retain and motivate highly skilled personnel. If we fail to attract, train and retain sufficient numbers of skilled people, our business, results of operations or financial condition would suffer. We must continue to hire skilled people to perform services under our existing contracts and new contracts that we will enter into. Competition for skilled personnel is intense in the IT services industry. Recruiting and training skilled personnel require substantial resources. We also experience significant turnover of skilled employees. We must pay an increasing amount to hire and retain a skilled workforce. These factors may create variations and uncertainties in our compensation expense. In addition, our ability to implement our business strategy and to operate profitably depends largely on the skills, experience and performance of our management team. If several members of our management team become unable or unwilling to serve in their present positions, our business, results of operations or financial condition could suffer. If we fail to maintain our security clearances, we may not be able to perform classified work for the government. Government contracts require us, and some of our employees, to maintain security clearances. The loss of these security clearances could curtail the term and renewal of these government contracts. We maintain facility security clearances complying with the requirements of the Department of Defense and other agencies. In addition, approximately 30% of our employees have security clearances. We may not successfully execute our acquisition strategy. Through acquisitions of companies, we intend to expand our geographic presence and to expand the products and services we offer to new and existing customers. If our acquisition strategy fails, we may not continue to grow at historical rates or at all. We cannot assure you that we will consummate any acquisitions, or that any acquisitions, if consummated, will be advantageous to us. Various risks may prevent us from completing acquisitions. These risks include: . Increased competition for acquisitions; . Fewer suitable acquisition candidates available at acceptable prices; . Insufficient capital resources for acquisitions; and . Inability to enter into definitive agreements for desired acquisitions on acceptable terms. In addition, there are risks that we may not benefit from our acquisitions. These risks include: . Inability to integrate or operate acquired companies successfully or at expected levels of profitability; . Accounting charges that adversely affect our financial results; . Issuance of additional shares of common stock, which could dilute your investment; and . Incurrence of additional debt. If we fail to properly manage our growth, our business could be adversely affected. If we do not manage our growth effectively, our business, results of operations or financial condition could be materially adversely affected. We intend to continue the expansion of our operations in the foreseeable future to pursue existing and potential market opportunities. Our growth places significant demands on our management and operational resources. In order to manage our growth effectively, we must continue to invest in our systems of internal controls and procedures, and continue to expand, train and manage our workforce. 10
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We are highly leveraged. We have a substantial amount of indebtedness. If we default on our debt agreements, our business, financial condition or results of operations would be materially adversely affected. As of March 31, 1999 we had debt with a face amount of approximately $59.0 million outstanding. We will repay approximately $28.7 million of this debt from the proceeds of this offering. We will have approximately $30.0 million of debt outstanding after this offering. We pay interest on this debt at variable rates averaging approximately 8.5% per annum. In addition, we may incur additional debt to finance acquisitions or future growth. Our leverage could have the following important consequences: . Repayment of debt reduces funds available for other purposes; . Our ability to obtain additional debt financing in the future for working capital, general corporate purposes or acquisitions may be constrained; and . We may be more vulnerable to downturns in general economic conditions or our business than our competitors. We may require additional financing that we may not be able to secure on favorable terms or at all. We may need more financing than currently anticipated to support our growth, to develop new or enhanced services, to respond to competitive pressures or unanticipated requirements or to make acquisitions. Any required additional financing may not be available on terms favorable to us, or at all. If adequate funds are not available on acceptable terms, we may be unable to fund our expansion, to develop or enhance services, to respond to competitive pressures or to take advantage of acquisition opportunities, any of which could have a material adverse effect on our business, results of operations or financial condition. If additional funds are raised by our issuing equity securities, stockholders may experience dilution of their ownership interest and the newly issued equity securities may have rights superior to those of the common stock. If additional funds are raised by our issuing debt, we may be subject to limitations on our operations, including limitations on the payment of dividends. Amortization of our intangible assets may have an adverse impact on our operating results. Approximately $35 million, or 37%, of our assets as of March 31, 1999, consisted of intangible assets, including goodwill, arising from our acquisitions. This amount will be amortized over 18 months to 20 years. This non-cash expense, some of which is not tax deductible, will reduce net income or increase net loss in each amortization period. This reduction in our net income or increase in our net loss may have an adverse effect on the market price of our common stock. In addition, we may never realize the value of our intangible assets. We evaluate current events and circumstances to determine whether the remaining balance of our intangible assets will be recoverable. If we deem all or part of our intangible assets to be not recoverable, we would reduce the carrying value of our intangible assets, which could have a material adverse effect on our operating results for the period in which the reduction is recognized. We may not be able to compete successfully. Our business could suffer if we are not able to compete successfully. We experience significant competition in all areas of our business. In general, the markets in which we compete are not dominated by a single company or a small number of companies. Thousands of companies offer services and products that are competitive with our IT service and product offerings. However, we compete regularly with approximately seven different competitors in our IT assurance service offerings, 18 in our IT development service offerings, six in our IT operations service offerings and four in our IT consulting service offerings. 11
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Many of our competitors are significantly larger and have greater financial resources than we do. In addition, many of our competitors have significantly more experience in the commercial IT market than we have. These factors may place us at a disadvantage in responding to competition, technological changes and changes in customer requirements. In addition, some of the contracts on which we have the technical capability to bid are set aside for companies which the United States government classifies as "small businesses" or "minority businesses." After 1999, we will not qualify for any of these classifications. The pricing provisions of our contracts may adversely affect our profits. Some of our contracts are fixed-price contracts which contain pricing provisions that require the payment of a set price by the customer for our services regardless of the costs we incur in performing these services, or provide for penalties in the event we fail to achieve contract requirements. Failure to anticipate technical problems, estimate costs accurately or control costs during our performance of a fixed-price contract may reduce our profit or cause us to suffer a loss. The number of our fixed-price contracts may increase as our commercial business increases. Recently, a growing percentage of our contracts are time-and-materials contracts. Typically, time-and-materials contracts provide for the customer to pay a specified rate per hour of labor dedicated to the project. If market or other conditions require us to increase our employees' salaries or other costs and we cannot convince our customers to pay proportionately higher prices, we would suffer reduced profits or losses under these contracts. Fluctuations in our operating results may negatively impact our stock price. The price of our common stock may fall because of fluctuations in our quarterly operating results and our inability to meet market expectations. Our operating results may fluctuate significantly in the future due to a variety of factors that could affect our revenues or our expenses in any particular quarter. Factors that may affect our quarterly results include, but are not limited to: . The number, size and scope of projects; . Our expenditures; . The accuracy of our estimates of resources required to complete ongoing projects; . The demand for our services and products; and . The adequacy of our reserves for losses. Accordingly, we believe that quarter-to-quarter comparisons of operating results are not necessarily meaningful. You should not rely on the results of any one quarter as an indication of our results for a full year or any other quarter. We may not realize all of the revenues included in our backlog. Although our contract backlog was approximately $450 million as of March 31, 1999, we may not realize all of this backlog as revenue. Backlog represents management's estimate of our realizable revenues on our contracts. Please see "Business--Backlog." Government contracts comprise substantially all of our backlog. The following factors may affect our ability to realize revenues included in our backlog: . The government's failure to fund all of the years of a multi-year contract; . The government's failure to exercise its option to extend the length of a contract; . The government's failure to request any services under contracts that we provide only upon request of the government; and . The government's decision to decrease the size or scope of a contract. 12
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We may not be able to replace our Year 2000 testing and assessment contracts with equally profitable business. As demand for Year 2000 services declines, unless we are able to replace our Year 2000 business with equally profitable work, our rate of revenue growth and our profits could suffer. In 1998, approximately 6% of our pro forma revenues related to Year 2000 testing and assessment services. We may not be successful in expanding our commercial business. Only a small portion of our business is currently derived from the commercial IT market. If we are not able to increase the amount of services and products we sell to the commercial market, we may not grow at expected rates and our reliance on federal government agencies may continue. Changes in technology could adversely affect our business. Our business could suffer if we are not successful in adopting and integrating new technologies into our service and product offerings in a timely and cost-effective manner. The markets for our IT services and products change rapidly because of technological innovations, new product introductions, changes in customer requirements, declining prices and evolving industry standards, among other factors. New products and new technology often render existing information services or technology infrastructure obsolete. As a result, our success depends on our ability to integrate new technologies into our service offerings. Further, we cannot be sure that we will be able to continue to commit the resources necessary to refresh our technology infrastructure at the rate demanded by our markets. Advances in technology require us to commit substantial resources to acquire and deploy new technologies for use in our operations. We must continue to commit resources to train our personnel in the use of these new technologies. We must also continue to maintain the compatibility of existing hardware and software systems with these new technologies. We may be unable to protect our intellectual property rights, and we may be liable for infringing the intellectual property rights of others. Third parties may infringe or misappropriate our patents, trademarks or other proprietary rights, which could have a material adverse effect on our business, results of operations or financial condition. The steps we have taken to protect our proprietary rights may not prevent misappropriation. Our suppliers, customers and competitors may have patents and other proprietary rights that cover technology utilized by us. These persons may also seek patents in the future. United States patent applications are confidential until a patent is issued, and most technologies are developed in secret. Accordingly, we are not aware of all patents or other intellectual property rights that our services and products may infringe. We could incur substantial costs to prosecute or defend any litigation against others who allege infringement of intellectual property rights. Intellectual property litigation could force us to do one or more of the following: . Cease selling or using services or products that incorporate infringed intellectual property; . Obtain from the holder of the infringed intellectual property right a license to sell or use the relevant technology; and . Redesign those services or products that incorporate infringed intellectual property. Our shares may experience extreme price and volume fluctuations. Just as the shares of other IT companies have experienced price and volume fluctuations, the market price of our common stock may be volatile. You may not be able to resell your shares at or above the initial public offering price and may suffer a loss of your investment. 13
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The market price of our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control, including: . Quarterly variations in operating results; . Changes in financial estimates by securities analysts; . Changes in market valuations of IT service companies; . Announcements by us of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; . Losses of major contracts; . Additions or departures of key personnel; and . Sales of common stock by our stockholders. In the past, securities class action litigation has often been initiated against a company following periods of volatility in the market price of their securities. If a suit is initiated against us, regardless of the outcome, it could result in substantial costs, diversion of our management's attention and resources, and a material adverse effect on our business, results of operations or financial condition. Future sales of large amounts of our stock, or the perception that such sales could occur, may adversely affect our stock price. The market price of our common stock could drop as a result of sales of a large number of shares of common stock in the market after this offering, or the perception that such sales could occur. Assuming no exercise of the underwriters' over-allotment option, there will be 10,880,655 shares of common stock outstanding immediately after this offering. The 4,000,000 shares of common stock sold in this offering will be freely tradeable without restriction or further registration under the Securities Act of 1933, unless such shares are held by our "affiliates," as that term is defined in Rule 144 under the Securities Act. As of March 1, 2000, holders of approximately 5,254,977 shares of our common stock will be able to sell their shares without limitation under Rule 144(k). After this offering, we will have 3,349,447 shares of common stock reserved for issuance upon the exercise of stock options, of which 1,513,433 shares are subject to currently outstanding options. Following this offering, we intend to file registration statements on Form S-8 to register these shares. Please see "Shares Eligible for Future Sale." Provisions of our certificate of incorporation and bylaws and Delaware law could deter takeover attempts. Some provisions in our certificate of incorporation and bylaws could delay, defer, prevent or make more difficult a merger, tender offer or proxy contest involving our company. However, our stockholders might view such a transaction as being in their best interests because, for example, a change of control might result in a price higher than the market price for shares of our common stock. Among other things, these provisions: . Require an 80% vote of the stockholders to amend certain provisions of our certificate of incorporation and by-laws; . Permit only our chairman, president or a majority of the board of directors to call stockholder meetings; . Authorize our board of directors to issue shares of preferred stock in series with the terms of each series to be fixed by our board of directors without any further action by our stockholders; . Divide our board of directors into three classes so that only approximately one-third of the total number of directors will be elected each year; and . Specify advance notice requirements for stockholder proposals and director nominations to be considered at a meeting of stockholders. 14
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In addition, with certain exceptions, Section 203 of the Delaware General Corporation Law restricts certain mergers and other business combinations between us and any holder of 15% or more of our voting stock. Potential Year 2000 problems could adversely affect our business. We believe that it is not possible to determine with complete certainty that all Year 2000 problems affecting us or our customers have been identified or corrected. As a result, we believe that the following consequences are possible: . Operational inconveniences and inefficiencies for us and our customers may divert management's time and attention and financial and human resources from ordinary business activities; . Routine business disputes and claims for pricing adjustments or penalties due to Year 2000 problems may occur, which will be resolved in the ordinary course of business; . Serious system failures may require significant efforts by us or our customers to prevent or alleviate material business disruptions; and . Serious business disputes alleging that we failed to comply with the terms of contracts or industry standards of performance may result in litigation or contract termination. In addition, any system failures could interfere with our ability to properly manage contracted projects and could adversely affect our business. You will suffer immediate and substantial dilution. Investors purchasing shares in this offering will suffer immediate and substantial dilution of their investment, because the initial public offering price per share will significantly exceed the net tangible book value per share. 15
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FORWARD-LOOKING STATEMENTS Many statements made in this prospectus under the captions "Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" and elsewhere are forward- looking statements. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts" or "continue" or the negative of these terms or other comparable terminology. Forward-looking statements are speculative and uncertain and not based on historical facts. Because forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including those discussed under "Risk Factors." Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these forward-looking statements. We are under no duty to update any of the forward- looking statements after the date of this prospectus to conform such statements to actual results. 16
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USE OF PROCEEDS Our net proceeds from the sale of the shares offered by us in this offering are estimated to be approximately $28.7 million, or approximately $33.1 million if the underwriters' over-allotment option is exercised in full, assuming an initial public offering price of $8.00 per share and after deducting underwriting discounts and estimated offering expenses payable by us. We intend to use these net proceeds as follows: . To repay $23.7 million of the amount outstanding as of March 31, 1999 under our credit agreement with First Union Commercial Corporation, as agent, and the other lenders that are parties to our credit agreement; and . To repay subordinated debt outstanding with a face value of $5.0 million as of March 31, 1999 under our subordinated debt agreement with MassMutual. As of March 31, 1999, approximately $53.4 million was outstanding under our credit agreement with First Union. We used approximately $25.0 million to acquire CBSI, $24.0 million to repay existing debt and $5.0 million to pay transaction fees and expenses and to fund general working capital requirements. Our credit agreement with First Union expires in 2004 and March 2005. Loans outstanding at March 31, 1999 under our credit agreement with First Union bear interest at variable rates averaging approximately 8% per year. In connection with the acquisition of Intermetrics by an investor group led by our current management, we obtained a credit facility with Massachusetts Mutual Life Insurance Company, or MassMutual, and affiliates of MassMutual in August 1995. As of March 31, 1999, subordinated debt with a face value of $5.0 million was outstanding under our credit agreement with MassMutual. The loan outstanding under our credit agreement with MassMutual bears interest at a rate of 13% per year. This credit agreement expires in June 2005. DIVIDEND POLICY We intend to retain all future earnings, if any, to finance the expansion of our business. We have not declared or paid any cash dividends on our common stock since our inception and do not expect to declare or pay any cash dividends in the foreseeable future. In addition, our credit agreement with First Union contains restrictions on our ability to pay dividends. 17
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CAPITALIZATION The following table sets forth, as of March 31, 1999, our capitalization: . On an actual basis; and . On an as adjusted basis to give effect to our sale of 4,000,000 shares in this offering, assuming an initial public offering price of $8.00 per share and after deducting underwriting discounts and the estimated offering costs payable by us, and the application of the proceeds to repay debt. This information should be read together with our financial statements and the notes relating to those statements appearing elsewhere in this prospectus. The table below does not reflect the following changes to our capitalization since March 31, 1999: . We issued 37,500 shares to the AverStar Profit Sharing & Savings Plan; . We redeemed 84,870 shares from stockholders under the terms of existing agreements for an aggregate of approximately $410,000; and . At the closing of this offering, we will issue approximately 911 shares from treasury to stockholders pursuant to obligations incurred in connection with the acquisition of Intermetrics. [Download Table] At March 31, 1999 ------------------------------ As Actual Adjusted ---------- ----- ------------ (In thousands, except share and per share data) Total debt: Term notes...................................... $ 43,125 $ 19,465 Current portion of long-term debt............... 1,704 1,704 Revolver notes.................................. 8,745 8,745 Subordinated notes due June 17, 2005, net of un- amortized original issue discount....................................... 4,595 -- ---------- ----- ---------- Total debt..................................... 58,169 29,914 Redeemable common stock, 2,202,875 shares out- standing........................................ 5,598 -- Stockholder' equity: Preferred stock, $.001 par value, 1,000,000 shares authorized; no shares issued and outstanding actual or as adjusted.............. -- -- Common stock, $.001 par value, 17,000,000 shares authorized, 4,766,344 issued shares actual; 25,000,000 shares authorized, 10,969,219 issued shares as adjusted............................. 5 11 Additional paid in capital...................... 10,189 44,441 Accumulated deficit............................. (12,055) (12,298) Deferred compensation........................... (73) (73) Treasury stock at cost, 42,105 shares........... (114) (114) ---------- Total stockholders' equity (deficit)........... (2,048) 31,967 Total capitalization.......................... $ 61,719 $ 61,881 ========== ===== ========== 18
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DILUTION Our net tangible book value as of March 31, 1999 was $(31,008,000), or $(4.48) per share. Our net tangible book value per share is equal to the amount of our total tangible assets less total liabilities, divided by the number of shares of common stock outstanding as of March 31, 1999. Assuming that we sell the 4,000,000 shares offered by us in this offering at an initial public offering price of $8.00 per share, after deducting the underwriting discounts and the estimated offering expenses payable by us, and apply the proceeds to repay debt, our pro forma net tangible book value as of March 31, 1999 would have been $(2,591,000), or $(0.24) per share. This amount represents an immediate increase in pro forma net tangible book value of $4.24 per share to existing stockholders and an immediate dilution in pro forma net tangible book value of $8.24 per share to investors purchasing shares in this offering. The following table illustrates this per share dilution: [Download Table] Assumed initial public offering price per share................ $8.00 Net tangible book value per share as of March 31, 1999......... $(4.48) Pro forma increase in net tangible book value per share attrib- utable to new investors purchasing shares in this offering.... $ 4.24 Pro forma net tangible book value per share after this offer- ing........................................................... (0.24) Pro forma dilution per share to new investors purchasing shares in this offering.............................................. $8.24 ===== The following table summarizes, as of March 31, 1999, differences between existing stockholders and the new investors purchasing shares in this offering in: . The total number of shares of common stock purchased from us; . The total consideration paid to us; and . The average price per share paid by existing stockholders and by new investors purchasing shares in this offering: [Download Table] Shares Purchased Total Consideration ------------------ ------------------- Average Price Number Percent Amount Percent Per Share ---------- ------- ----------- ------- ------------- Existing stockholders.... 6,927,114 63.4% $15,678,000 32.9% $2.26 New investors purchasing shares in this offer- ing..................... 4,000,000 36.6 32,000,000 67.1 8.00 ---------- ---- ----------- ---- Total.................. 10,927,114 100% $47,678,000 100% ========== ==== =========== ==== None of the foregoing tables or calculations assumes that any options outstanding as of March 31, 1999 will be exercised. If all outstanding options were exercised on the date of the closing of this offering, new investors purchasing shares in this offering would suffer total dilution of $8.16 per share. The above tables do not reflect the following changes to our capitalization since March 31, 1999: . We issued 37,500 shares to the Averstar Profit Sharing & Savings Plan; . We redeemed 84,870 shares from stockholders under the terms of existing agreements for an aggregate of approximately $410,000; and . At the closing of this offering, we will issue approximately 911 shares from treasury to stockholders pursuant to obligations incurred in connection with the acquisition of Intermetrics. 19
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SELECTED FINANCIAL DATA The following tables set forth our selected financial data. These tables do not present all of our financial information. You should read this information together with our financial statements and the notes to those statements beginning on page F-1 of this prospectus and the information under "Management's Discussion and Analysis of Financial Condition and Results of Operations." On March 13, 1995, an investor group formed a holding company which acquired Intermetrics in August 1995. Substantially all data for the period March 13, 1995 through February 29, 1996 relate to the operations and financial position of Intermetrics. The selected financial data for the 12 months ended February 29, 1996, which are unaudited, combine the two preceding columns which reflect the operations of Intermetrics for the first six months of the period based on Intermetrics' basis of accounting prior to the acquisition, and our operations giving effect to the acquisition of Intermetrics in August 1995. In February 1998, we acquired Pacer, whose results of operations are included from the date of acquisition in our results for the 12 months ended December 31, 1998. In March 1999, we acquired CBSI. The pro forma column presents our statement of operations data as if the acquisitions of Pacer and CBSI had occurred as of January 1, 1998. The pro forma as adjusted statement of operations data reflect our sale of shares of common stock in this offering, after deducting underwriting discounts and estimated offering expenses, and the application of the proceeds to repay debt as if both these events had occurred as of January 1, 1998. The selected financial data for the 12 months ended February 28, 1997, the 10 months ended December 31, 1997 and the 12 months ended December 31, 1998 are derived from our audited financial statements included elsewhere in this prospectus. The selected financial data for the 12 months ended February 28, 1995 are derived from audited financial statements not included in this prospectus. The consolidated financial data for the three months ended March 31, 1998 and 1999 have been prepared on the same basis as our consolidated financial statements. In our opinion, all necessary adjustments, consisting of normal recurring accruals, have been included. Results of operations for interim periods are not necessarily indicative of results we may achieve in a full year. 20
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[Enlarge/Download Table] Intermetrics ------------------------ Pro Forma March 13 Twelve Twelve Ten Twelve Twelve Twelve Months Six Months 1995 Months Months Months Months Months Ended Ended Through Ended Ended Ended Ended Ended February 28, August 31, February 29, February 29, February 28, December 31, December 31, December 31, 1995 1995 1996 1996 1997 1997 1998 1998 ------------- ---------- ------------ ------------ ------------ ------------ ------------ ------------ (In thousands, except per share data) Statement of Operations Data: Revenues......... $53,964 $27,103 $27,787 $54,890 $53,274 $53,646 $121,056 $169,039 Cost of revenues........ 37,964 20,470 21,399 41,869 40,704 41,685 93,604 128,520 Selling, general and administrative expense......... 14,139 6,908 5,247 12,155 10,159 10,253 19,531 31,007 Amortization expense......... -- -- 514 514 1,085 150 1,050 4,344 In process research and development expense......... -- -- 8,600 8,600 -- -- -- -- ------- ------- ------- ------- ------- ------- -------- -------- Income (loss) from operations...... 1,861 (275) (7,973) (8,248) 1,326 1,558 6,871 5,168 Interest expense......... 26 13 734 747 1,441 1,302 2,513 4,973 Interest income.. 525 363 149 512 160 96 244 244 ------- ------- ------- ------- ------- ------- -------- -------- Income (loss) from continuing operations before taxes.... 2,360 75 (8,558) (8,483) 45 352 4,602 439 Provision for income taxes.... 945 40 32 72 18 154 2,168 366 ------- ------- ------- ------- ------- ------- -------- -------- Net income (loss) from continuing operations...... $ 1,415 $ 35 $(8,590) $(8,555) $ 27 $ 198 $ 2,434 $ 73 ======= ======= ======= ======= ======= ======= ======== ======== Income (loss) per share from continuing operations: Basic........... $ 0.35 $ 0.01 $ (2.20) $ (2.19) $ 0.01 $ 0.05 $ 0.38 $ 0.01 ======= ======= ======= ======= ======= ======= ======== ======== Diluted......... $ 0.35 $ 0.01 $ (2.20) $ (2.19) $ 0.01 $ 0.04 $ 0.36 $ 0.01 ======= ======= ======= ======= ======= ======= ======== ======== Weighted average common shares and equivalents: Basic........... 4,019 4,151 3,901 3,901 3,878 3,865 6,428 6,428 Diluted......... 4,019 4,151 3,901 3,901 4,523 4,552 6,847 6,847 Pro Forma As Adjusted Twelve Months Ended December 31, 1998 ------------ Statement of Operations Data: Revenues......... $169,039 Cost of revenues........ 128,520 Selling, general and administrative expense......... 31,007 Amortization expense......... 4,344 In process research and development expense......... -- ------------ Income (loss) from operations...... 5,168 Interest expense......... 2,431 Interest income.. 244 ------------ Income (loss) from continuing operations before taxes.... 2,981 Provision for income taxes.... 1,371 ------------ Net income (loss) from continuing operations...... $ 1,610 ============ Income (loss) per share from continuing operations: Basic........... $ 0.15 ============ Diluted......... $ 0.15 ============ Weighted average common shares and equivalents: Basic........... 10,428 Diluted......... 10,847 21
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[Download Table] Three Months Ended March 31, -------------------------------------------- Pro Forma Actual Pro Forma As Adjusted --------------- ---------------- ----------- 1998 1999 1998 1999 1999 ------- ------- ------- ------- ----------- (In thousands, except per share data) Statement of Operations Data: Revenues......................... $22,738 $36,346 $38,790 $46,948 $46,948 Cost of revenues................. 17,310 28,841 30,177 36,121 36,121 Selling, general and administra- tive expense.................... 4,017 4,940 7,181 7,422 7,422 Amortization expense............. 149 357 1,083 1,056 1,056 ------- ------- ------- ------- ------- Income from operations........... 1,262 2,208 349 2,349 2,349 Interest expense, net............ 476 760 1,177 1,261 625 Income (loss) from continuing op- erations before taxes........... 786 1,448 (828) 1,088 1,724 Provision for (benefit from) in- come taxes...................... 370 656 (322) 479 758 ------- ------- ------- ------- ------- Net income (loss) from continued operations...................... $ 416 $ 792 $ (506) $ 609 $ 966 ======= ======= ======= ======= ======= Income (loss) per share from con- tinuing operations: Basic.......................... $ 0.08 $ 0.11 $ (0.10) $ 0.09 $ 0.09 Diluted........................ $ 0.08 $ 0.11 $ (0.10) $ 0.08 $ 0.08 Weighted average common shares and equivalents: Basic.......................... 4,991 6,927 4,991 6,927 10,927 Diluted........................ 5,470 7,440 5,470 7,440 11,440 The following table is a summary of our balance sheet data. [Enlarge/Download Table] As of As of As of As of As of As of February 28, February 29, February 28, December 31, December 31, March 31, 1995 1996 1997 1997 1998 1999 ------------ ------------ ------------ ------------ ------------ --------- (In thousands) Balance Sheet Data: Cash and cash equiva- lents.................. $ 1,304 $ 1,345 $ 614 $ 131 $ 332 $ 1,777 Working capital......... 16,099 6,608 19,850 2,567 9,256 7,653 Total assets............ 30,979 19,192 17,039 23,646 59,663 94,212 Total debt.............. -- 12,710 12,769 15,060 31,610 58,169 Redeemable common stock.................. -- -- -- 1,412 5,598 5,598 Stockholders' equity (deficit).............. 21,192 (3,312) (3,218) (5,795) (3,412) (2,048) 22
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of our financial condition and results of operations should be read together with the financial statements and the notes to those statements included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Please see "Risk Factors" and "Forward-Looking Statements." Overview We provide IT services and products to the United States government and to commercial companies. Through both internal growth and a series of acquisitions, we have increased our revenues from $53.3 million for the fiscal period ended February 28, 1997 to $169 million in pro forma revenues for the fiscal period ended December 31, 1998. Our growth has resulted in a broader base of long-term contracts and a more diverse group of established customers. AverStar is the result of a series of strategic acquisitions executed by our current management. In February 1998, we combined the businesses of Intermetrics and Pacer. In March 1999, we acquired CBSI for $26 million in cash, $25 million of which was paid to the former CBSI stockholders at the closing and $1 million of which will be paid ratably over the next five years. All three transactions were accounted for as purchases. During 1997, we changed our fiscal year to a December 31 year end in anticipation of the merger with Pacer. As a result, the fiscal period ended December 31, 1997 is a ten-month period. A substantial portion of our revenues are derived from contracts with the United States government. Approximately 90% of our pro forma revenues in the fiscal period ended December 31, 1998 were derived from government contracts, either directly with government customers or indirectly through government prime contractors. We enter into three types of contracts: cost-reimbursable, time-and- materials, and fixed-price contracts. Of our total pro forma revenues for 1998, cost-reimbursable contracts represented approximately 46%, time-and-materials contracts approximately 45% and fixed-price contracts approximately 9%. Cost- reimbursable contracts provide for the reimbursement of costs plus the payment of a fixed fee. Under time-and-materials contracts, we are reimbursed for labor hours at negotiated hourly billing rates and reimbursed for travel and other direct expenses at actual cost plus applied indirect, general and administrative expenses. Under fixed-price contracts, we agree to perform certain work for a fixed price and, accordingly, realize a benefit or detriment to the extent that our actual cost of performing the work differs from the negotiated price. We assume greater financial risk on fixed-price contracts than on either time-and-materials or cost-reimbursable contracts. We believe that an increasing percentage of our contracts will be fixed-price as our commercial business increases. Failure to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed-price contract may reduce our profits or cause us to suffer a loss. If we are successful in providing our services at a reduced cost, however, we expect that fixed-price contracts will result in greater profitability. In addition, greater risks are involved under time-and-materials contracts than under cost-reimbursement contracts because we assume the responsibility for the delivery of specified skills at a fixed hourly rate. Our management believes that adequate reserves for our fixed-price and time-and-materials contracts are reflected in our financial statements. We recognize revenues on government and commercial contracts under the percentage-of-completion method. This method involves a periodic assessment of the estimated total cost to complete each contract. The percentage-of- completion method is determined by relating the actual costs incurred to date to the estimated total costs at completion. The cumulative effects resulting from revisions of estimated total costs and revenues are recorded in the period in which the facts requiring revisions become known. When a loss is anticipated on a contract, the full amount of the anticipated loss is provided for at that time. 23
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Revenues from standard software products are recognized upon shipment in accordance with Statement of Position 97-2, "Software Revenue Recognition." Revenues from maintenance agreements are deferred and amortized over the life of the maintenance agreements. Our royalty income is derived from licensing agreements that we have with commercial companies. Typically, the amount of our royalty income is based on a percentage of our customer's revenues for the products that incorporate our technology. Per unit royalties earned from the license of standard software products are recognized when received from the customer. Our royalty income does not represent a significant portion of our revenues. Results of Operations The following table sets forth, for each period indicated, the percentage of items in the consolidated statement of operations in relation to revenues and the percentage increase (decrease) of each item for the periods indicated: [Enlarge/Download Table] Percentage of Revenues Period to Period Increase (Decrease) ---------------------------------------------------------- ------------------------------------- Three Three February 28, December 31, March 31, Twelve Ten Twelve Months Months 1997 1997 1998 Months Ended Months Ended Months Ended Ended Ended Compared to Compared to Compared to February 28, December 31, December 31, March 31, March 31, December 31, December 31, March 31, 1997 1997 1998 1998 1999 1997 1998 1999 ------------ ------------ ------------ --------- --------- ------------ ------------ ----------- Revenues............... 100.0% 100.0% 100.0% 100.0% 100.0% 1% 126% 60% Cost of revenues....... 76.4 77.7 77.3 76.1 79.3 2 125 67 Selling, general & administrative expense............... 21.1 19.4 17.0 18.3 14.6 (7) 98 27 ----- ----- ----- ----- ----- Income from operations............ 2.5 2.9 5.7 5.6 6.1 17 341 75 Interest expense, net.. 2.4 2.2 1.9 2.1 2.1 (6) 88 60 ----- ----- ----- ----- ----- Income from continuing operations before taxes................. 0.1 0.7 3.8 3.5 4.0 682 1,207 84 Provison for income taxes................. -- 0.3 1.8 1.7 1.8 756 1,308 77 ----- ----- ----- ----- ----- Net income from continuing operations............ 0.1 0.4 2.0 1.8 2.2 633 1,129 90 Loss from discontinued operations............ -- (3.2) (4.2) (2.6) -- Net income (loss)...... 0.1 (2.8) (2.2) (0.8) 2.2 Three-Month Periods Ended March 31, 1998 and 1999 The results of operations for the three months ended March 31, 1998 reflect the activity of Intermetrics for the entire three months of the quarter and the activity of Pacer for one month of the quarter. The results of operations for the three months ended March 31, 1999 reflect the activity of Intermetrics and Pacer for the entire three months of the quarter and ten days of activity of CBSI. Revenues. For the three months ended March 31, 1999, our revenues were $36.3 million compared to $22.7 million for the three months ended March 31, 1998. Of the $13.6 million or 60% increase, approximately $8.6 million or 63% related to the acquisition of Pacer and approximately $950,000 or 7% related to the acquisition of CBSI. The remaining 30% of the increase was associated with new task orders and additional work performed under existing contracts, mainly with the United States Postal Service, Government Services Agency Schedule or GSA, National Institutes of Health and NASA. Cost of revenues. For the three months ended March 31, 1999, our cost of revenues was $28.8 million compared to $17.3 million for the three months ended March 31, 1998, an increase of $11.5 million or 67%. As a percentage of revenues, cost of revenues was 79.3% for the period ended March 31, 1999 and 76.1% for 24
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the period ended March 31, 1998. The increase in cost of revenues as a percentage of revenues resulted from higher costs in relation to revenues from acquired contracts and less than full utilization of office facilities acquired to support the increase in the number of contracts and task orders performed. Selling, general and administrative expense. For the three months ended March 31, 1999, our selling, general and administrative, or SG&A, expense, including amortization expense, was $5.3 million compared to $4.2 million for the first quarter of 1998, an increase of $1.1 million or 27%. Amortization expense was $300,000 of the $5.3 million in 1999 and $100,000 of the $4.2 million in 1998. The $200,000 increase in amortization expense reflects three months amortization related to Pacer in 1999 and ten days related to CBSI compared with one month and none, respectively, in the 1998 first quarter results. Of the remaining $900,000 increase in total SG&A expense, approximately 50% was associated with the increased staff from Pacer, approximately 22% related to the growth in the sales and marketing function and the remainder related to acquisition and financing activities. As a percentage of revenues, SG&A expense decreased to 14.6% in the first quarter 1999 from 18.3% in the first quarter 1998, primarily because SG&A expense was spread over a larger revenue base in 1999. Income from continuing operations. For the three months ended March 31, 1999, our income from continuing operations before interest and taxes was $2.2 million compared with $1.3 million for the three months ended March 31, 1998, representing a $900,000 or 75% increase. Approximately $500,000 or 53% of this increase was attributable to the acquisition of Pacer and about 5% was attributable to the acquisition of CBSI. The remainder of the increase resulted from increased profit recorded on new and additional work performed. Net income from continuing operations. For the three months ended March 31, 1999, net income from continuing operations was $800,000 compared to $400,000 in 1998, an increase of 100%. The increase resulted from higher operating income of $900,000 reduced by an increase in interest expense of $300,000 and an increase in income taxes of $200,000. The increase in interest expense resulted from additional borrowings to fund the acquisition of CBSI and to support working capital requirements. The increase in taxes was caused by the increase in taxable income. Net income. For the three months ended March 31, 1999, our net income was $800,000 compared to a net loss of $200,000 for the first quarter of 1998. The net loss for 1998 was the result of income from continuing operations of $400,000 offset by a net loss from discontinued operations of $600,000. Fiscal Periods Ended February 28, 1997, December 31, 1997 and December 31, 1998 Revenues. For the 12 months ended December 31, 1998, our revenues were $121.1 million compared to $53.6 million for the ten months ended December 31, 1997 and $53.3 million for the 12 months ended February 28, 1997, representing a 127% increase over this period. Of the approximately $68 million increase in revenues over this period, approximately $39 million, or 57% of the increase, was the result of the acquisition of Pacer which became effective February 27, 1998. Approximately $12 million, or 18% of the increase, resulted from our winning two contracts with the United States Postal Service in mid-1997. We benefitted from the first full-year effect of these contracts in 1998. The increased work under a contract awarded by NASA in 1996 accounted for approximately $9 million, or 13% of the increase. Revenues were also positively affected by increased business with commercial customers, by new contracts with the National Institute of Health and the United States Navy and by increased royalty income. Cost of revenues. For the 12 months ended December 31, 1998, our cost of revenues was $93.6 million compared to $41.7 million for the ten months ended December 31, 1997 and $40.7 million for the 12 months ended February 28, 1997, representing a 130% increase over this period. The increase primarily resulted from higher labor costs to support a larger number of contracts. As a percentage of revenues, cost of revenues has not changed significantly: 77.3% for the period ended December 31, 1998, 77.7% for the period ended December 31, 1997 and 76.4% for the period ended February 28, 1997. 25
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Selling, general and administrative expense. For the 12 months ended December 31, 1998, our selling, general and administrative expense, including amortization expense, was $20.6 million compared to $10.4 million for the ten months ended December 31, 1997, and $11.2 million for the 12 months ended February 28, 1997, representing an increase of $9.4 million, or 84%, over this period. This increase is attributed to increased staff related to the acquisition of Pacer, increased sales and marketing staff and $1.5 million of expenditures related to the consolidation of Pacer. The decrease of $800,000 from the 12-month period ended February 28, 1997 to the ten-month period ended December 31, 1997 was primarily due to the ten-month reporting period. As a percentage of revenues, SG&A expense decreased to 17% in the 12 months ended December 31, 1998, from 19% in the ten months ended December 31, 1997 and from 21% in the 12 months ended February 28, 1997, primarily because SG&A expense was spread over a larger revenue base in 1998. Income from operations. For the 12 months ended December 31, 1998, our income from operations was $6.9 million compared to $1.6 million for the ten months ended December 31, 1997 and $1.3 million for the 12 months ended February 28, 1997, representing a 431% increase over this period. Of the $5.6 million increase in income from operations over this period, approximately $1.9 million, or 34% of the increase, is attributable to the acquisition of Pacer. Approximately $1.8 million of the increase, or 32%, was the result of higher royalty revenues. Net income from continuing operations. For the 12 months ended December 31, 1998, net income from continuing operations was $2.4 million compared to $198,000 for the ten months ended December 31, 1997 and $27,000 for the 12 months ended February 28, 1997. The increase in net income from continuing operations of $2.4 million over this period resulted from the increase in income from operations of $5.5 million offset by a $1.0 million net increase in interest expense and an increase in taxes of $2.2 million. The increase in interest resulted from additional borrowing to partially fund the acquisition of Pacer and to support working capital needs. The increase in taxes resulted from the increased operating income. Net income. For the 12 months ended December 31, 1998, our net loss was $2.7 million, compared to a net loss of $1.5 million for the ten months ended December 31, 1997 and net income of $27,000 for the 12 months ended February 28, 1997. The net loss for 1998 resulted from income from continuing operations of $2.4 million offset by a net loss from the discontinued operations of $2.5 million and by a net loss on the disposal of discontinued operations of $2.6 million. Similarly, the net loss for the ten months ended December 31, 1997 was the result of income from continuing operations of $198,000 and a net loss from discontinued operations of $1.7 million. There was no loss from discontinued operations for the 12 months ended February 28, 1997. Liquidity and Capital Resources In March 1999, we refinanced our outstanding debt in conjunction with the purchase of CBSI. We obtained a $75.0 million credit facility from a group of lenders led by First Union Commercial Corporation. This facility comprised $45.0 million in senior debt and $30.0 million in revolving credit. In addition, we maintain a $5.0 million subordinated debt agreement, which we obtained in August 1995, with MassMutual. Our total debt capacity has a face value of $80 million. At March 31, 1999, our outstanding debt under these agreements was approximately $58.4 million. The availability of approximately $21.3 million under the revolving credit agreement is subject to certain covenants and collateral limitations. At March 31, 1999, about $10.0 million of additional borrowing under the revolving credit facility was available to us based on the covenants and limitations. Our First Union Credit Facility is secured by the stock of our subsidiaries, our accounts receivable and substantially all our other assets. The agreements expire in March 2004 and March 2005. Loans outstanding under these agreements bear interest at variable rates generally based on LIBOR approximating 8.5% per year. Our current credit agreements require that at least 50% of the proceeds of a sale of equity be used to reduce debt under the agreements. We expect to apply $28.7 million to reduce the senior and subordinated debt under our current agreements thereby increasing the amount of our borrowing capacity. Please see "Use of 26
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Proceeds." As of March 31, 1999, after giving effect to this offering and the application of the proceeds to repay debt, approximately $21.0 million would be outstanding in senior debt, $0 in subordinated debt, and approximately $8.7 million in revolving credit. We intend to seek to increase the borrowing capacity under our revolving credit facility from a group of lenders led by First Union after this offering, primarily to fund acquisitions. We believe the capital resources available to us under our credit agreements and cash from our operations are adequate to fund our ongoing operations and to support the internal growth we expect to achieve for at least the next 12 months. In the longer term, we anticipate financing our internal and external growth from acquisitions through one or a combination of the following: cash from operations; additional borrowing; issuance of equity; use of the existing revolver facility; or a refinancing of our credit facilities. Please see "Risk Factors--We may require additional financing that we may not be able to secure on favorable terms or at all." Backlog Backlog represents management's estimate of our aggregate realizable revenues over the term of all of our contracts, including any option periods. However, backlog is not necessarily indicative of future revenues. Our contract backlog was approximately $450 million as of March 31, 1999. Our backlog is composed of: . Customer authorized contract values for which the customer has set aside, appropriated or committed funds for specifically identified services, products, tasks or delivery orders; and . Management's estimate of the realizable contract values for all expected future services, products, tasks or delivery orders, for which funds have not yet been set aside, appropriated or committed. The actual timing of our receipt of revenues, if any, on projects included in our backlog could change because many factors affect the scheduling of projects. In addition, cancellations or adjustments to contracts may occur. Our backlog is subject to large variations from quarter to quarter as existing contracts are renewed or new contracts are awarded. Additionally, virtually all of our backlog represents contracts with the United States government which may be terminated at any time for any reason. Discontinued Operations In August 1997, we combined our computer and video game business with the operations of Looking Glass Technologies, Inc. to form Intermetrics Entertainment Software, LLC, or IES. After the combination, we owned 66% of IES and consolidated the results of IES' operations with our operations for our financial reporting purposes. In December 1998, we approved a plan of divestiture of IES by means of a distribution of our interest in IES to our stockholders. We effected the distribution in March 1999. Please see note 3 to our consolidated financial statements. As part of our plan of divestiture, we structured financial arrangements with IES that included the conversion of $1.3 million of capital contributed to IES into a term loan, and the establishment of a $2.0 million revolving credit facility for use by IES through December 31, 1999. The term loan is equal to our capital contributed to IES, reduced by the operating losses of IES during our ownership period. We converted the contributed capital to a term loan because the term loan provides us with the possibility to recover some of the advances we made to IES without creating adverse tax consequences. The revolving credit facility obligates us to advance up to $2.0 million to IES through December 31, 1999. These advances must be made available at any time, for any amount up to $2.0 million, as long as IES has not filed for bankruptcy and is not in the process of liquidation or the equivalent. Amounts advanced under the term loan and revolving credit facility and an additional $400,000 in term loans mature on December 31, 2001. If not prepaid, we will pursue collection of all amounts due. However, we presently do not believe that we will be successful in our collection efforts. As a result of the plan of divestiture approved by us in December 1998 and completed in March 1999, we have accounted for our investment in IES as a discontinued operation in 1997 and 1998. For the five months 27
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ended December 31, 1997, IES recorded revenues of $1.9 million and a net loss from operations of $1.7 million. For the twelve months ended December 31, 1998, IES recorded revenues of $7.2 million and a net loss from operations of $2.5 million. The increase in revenues in 1998 over 1997 was the result of a full year of operations and a higher level of development activities supported by advances of royalties from publishers of the games under development. The increased loss in 1998 over 1997 is primarily attributable to the full year of operations in 1998. The operating losses in both years were the result of the increasing number of game development projects, for some of which the estimated costs to complete the development exceeded the expected advances from publishers, resulting in the recording of losses in current periods. The net losses in both 1997 and 1998 are accounted for in our statement of operations as losses from discontinued operations. In addition, we incurred a net loss from the disposal of IES of $2.6 million, $3.9 million on a pre-tax basis, representing the write-off of $1.7 million of term loans, $200,000 of professional fees, $500,000 of estimated operating losses through the disposal date and the accrual of our remaining estimated funding commitment of $1.5 million described in the preceding paragraph. Quantitative and Qualitative Disclosures About Market Risk Our exposure to market risk relates to changes in interest rates for borrowings under our senior term loans and our revolving credit facility. These borrowings bear interest at variable rates. The unsecured notes bear interest at a fixed rate. Based on our borrowings during 1998, a hypothetical 10% increase in interest rates would have increased our annual interest expense by approximately $250,000 and would have decreased our annual cash flow from operations by approximately $150,000. Impact of the Year 2000 Issue General. Many currently installed computer systems and software products are coded to accept or recognize only two-digit entries in the date code field. These systems may recognize a date using "00" as the year 1900 rather than the year 2000. As a result, computer systems and/or software used by many companies and governmental agencies may need to be upgraded to comply with Year 2000 requirements or risk system failure or miscalculations causing disruptions of normal business activities. We are exposed to the risk that the systems we, our customers and vendors depend on to conduct operations are not Year 2000 compliant. State of Readiness. We have developed a Year 2000 program that was structured to address our Year 2000 exposure. Our Year 2000 program focuses on certain tasks that address critical Year 2000 issues. These tasks include assessing each of the following: . Our computer hardware and software, including data, networks, servers and workstations, human resources systems and financial systems; . Our telephone systems, computer room systems and office equipment; and . Our financial interfaces and leased facilities. We also monitor critical suppliers and vendors for Year 2000 readiness as follows: . We require Year 2000 compliance in all new purchases of hardware and software, both for internal use and for the use by our customers; . We regularly monitor vendor information for additional Year 2000 readiness information and obtain and apply software changes appropriately; . We monitor the readiness of our financial services vendors to provide timely services; . We are conducting a letter survey of landlords requesting information as to the readiness and reliability of building systems including security access, elevators and environmental control systems. 28
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We have substantially completed the process of determining the Year 2000 readiness of our IT systems. We believe that our internal systems, as a whole, are Year 2000 compliant. Our remaining Year 2000 tasks include: . Migrating employee records and data from legacy computer systems; . Reviewing how our systems interface with those of our financial services companies, including payroll functions, direct deposits, health and retirement benefits, and customer electronic interfaces; . Completing our review of Year 2000 compliance by critical suppliers and vendors; . Implementing a strategy for deploying uniform desktop applications across our operations and maintaining desktop systems in a Year 2000 compliant configuration; . Completing upgrades for data and voice communications equipment; and . Working with landlords to assess Year 2000 issues in building systems. We are not currently aware of any Year 2000 problems that would have a material adverse effect on our business, financial condition or results of operations. We intend to complete our assessment, and the replacement or remediation of any non-Year 2000 compliant technologies, by September 1999. Costs. As of March 31, 1999, we have expended approximately $100,000 in connection with Year 2000 compliance efforts. We estimate that the total remaining cost of our Year 2000 compliance efforts will be approximately $500,000. Most of these expenses relate to costs for licensing standardized Year 2000 compliant software, costs for personal computer hardware upgrades and operating costs associated with time spent by employees in Year 2000 compliance matters. If we encounter unexpected difficulties, or if we are unable to obtain compliance information from material third parties, we may need to spend additional amounts to ensure that our systems are Year 2000 complaint. Risks. We provide our IT assurance services for information systems affected by Year 2000 problems. Although we attempt to contractually limit our liability for damages arising from errors, mistakes, omissions or negligent acts in rendering services, our attempts to limit liability may not be successful. Our failure or inability to meet a customer's expectations could cause our customer's operations to suffer and, therefore, could give rise to claims against us or damage our reputation, adversely affecting our business, operating results and financial condition. Although our assessment may be finalized without identifying any material non-compliant systems operated by us or by third parties, a systemic failure beyond our control, such as a prolonged telecommunications or electrical failure, is possible. This type of failure could prevent us from operating our business. We believe that the primary business risks, in the event of such failure, would include, but not be limited to, lost business revenues, increased operating costs or other business interruptions of a material nature, as well as claims of mismanagement, misrepresentation or breach of contract. Presently, we believe we are unable to reasonably estimate the duration and extent of any such interruption, or quantify the effect it may have on our future revenues. Contingency Plan. We have not yet developed a contingency plan to address the worst-case scenario that might occur if our technologies are not Year 2000 compliant. The results of our Year 2000 simulation testing and the responses received from the Year 2000 readiness disclosures obtained from critical providers will be taken into account in determining the need for and nature and extent of any contingency plans. We intend to complete the development of any required contingency plan by September 1999. Effects of Recent Accounting Pronouncements In 1998, the Accounting Standards Executive Committee issued Statement of Position 98-5, "Reporting on the Costs of Start-up Activities," which must be adopted for fiscal years beginning after December 15, 1998, and the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Investments and Hedging Activities," which must be adopted for fiscal years beginning after June 15, 1999. The adoption of these statements is not expected to have a material impact on us. 29
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BUSINESS Overview AverStar is a pioneer in providing IT services and software products for the mission-critical systems of a significant number of civilian and defense agencies of the United States government. We provide an integrated offering of services and products in four areas of IT: . IT Assurance. We provide independent analysis, testing and verification of critical information systems under development or being upgraded. We also provide security for customers' information systems. . IT Development. We offer a full range of software and systems development services for customer-specific applications and Internet applications. . IT Operations. We manage and operate information system networks and data centers at our customers' facilities. . IT Consulting. We serve as consultants with respect to our customers' development of innovative applications or improvements to existing critical systems. Industry Background Growth of IT Industry The demand for third-party IT services has grown substantially in recent years. Organizations are increasingly using IT to improve the quality of their products and services, to reduce their costs and to improve operating efficiencies. IDC forecasts that the United States market for IT services will grow from an estimated $139 billion in 1998 to $207 billion in 2002. IDC forecasts that the IT system services segment of the worldwide IT services market will grow at a compound annual growth rate of approximately 12% over this period. According to Federal Sources, Inc., the United States government is the world's largest single buyer of IT services and products. The EIA reports that the United States government's IT budget for fiscal 1999 is approximately $30 billion, nearly double the budget ten years ago. The EIA also estimates that the outsourced portion of the federal IT budget will be $26 billion in 1999, with approximately 64% allocated to civilian agencies of the government and 36% allocated to the Department of Defense. We believe that the increasing emphasis by the United States government on downsizing and reducing budgets will result in the growing use of IT to enhance productivity and in more testing and upgrading of existing IT systems. Trends in Federal IT Industry Historically, the United States government purchased IT services and products primarily through a protracted, competitive bidding process involving numerous service providers. Recent government procurement reform has streamlined the government's buying practices, resulting in a more commercial approach. These changes have led to the following trends in the federal IT procurement process: . The government now places greater emphasis on an IT service provider's past performance. In evaluating contract bids, the government examines an IT service provider's technical merit, reputation and references, leading to an increasing emphasis on the quality and reliability of IT services and products. . The government increasingly awards government-wide acquisition contracts, or GWACs. GWACs are contracts awarded by a government agency to many IT service contractors to provide IT services and products at pre-negotiated prices, terms and conditions. GWACs streamline the government's 30
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procurement process by allowing any government agency to choose IT services and products from any agency's existing GWAC rather than going through its own protracted contract procurement process. . Government contracts procured by a single agency are increasing in size. Government agencies are consolidating more work under single contracts to reduce the time and effort required to procure IT services and products. These larger contracts favor IT service providers with greater management, financial and technical resources and broader service offerings. In addition, these contracts may lead to preferred contractor relationships for successful IT service providers. . Government agencies have moved toward multiple-award contracts. Multiple-award contracts are awarded by one government agency to several IT service contractors, each with similar service offerings and products. These contracts provide the government agency that awarded the contract a choice among IT service providers. In addition, multiple- award contracts favor IT service contractors with broad technical resources. These trends in the federal procurement process have led to the following responses by IT service providers: . Federal IT service providers are increasing their investments in sales and marketing. As the government adopts a more commercial approach to contract procurement, IT service contractors must increase their sales and marketing efforts. Government-wide acquisition contracts and multiple-award contracts require continued sales and marketing efforts over the life of the contract because a government agency has the freedom to choose among several pre-approved IT service providers. . There is increasing consolidation among federal IT service providers. The trends toward government-wide acquisition contracts, multiple-award contracts and larger single agency contracts requires IT service providers to have greater management, financial, technical and sales resources. As a result, IT service providers increasingly seek to consolidate complementary businesses. The AverStar Solution We provide high-quality and cost-effective IT services and products designed to meet all the needs of mission-critical information systems. Our solution to the challenges presented by the federal IT industry consists of the following components which we believe differentiate us from our competitors. . Emphasis on Quality and Reliability. Over our 30-year history, we believe that we have established a reputation for providing IT services and products of the highest quality and reliability. We have developed a company culture that emphasizes and rewards the delivery of services and products of the highest quality and reliability. As a result, over the last 10 years, we have won over 95% of our government contracts for which we have recompeted. . In-Depth Knowledge of Mission-Critical Systems. Mission-critical systems are complex and perform vital functions in which even a minor failure exposes customers to substantial losses, including potential loss of life. We have developed significant expertise in addressing the needs of these large, complex systems. For 30 years, we have worked on some of the country's most sensitive and critical systems, including NASA's manned flight systems and the Health Care Finance Administration's Medicare transactions system. We also provide services for commercial customers' critical systems. . Highly Developed Project Management Skills. Each of our projects is headed by an experienced project manager. The project manager works closely with our customers' management and IT personnel to ensure that the project is completed on-time and within budget. We currently have approximately 100 project managers with an average of over 20 years experience in the IT industry. . Comprehensive Offering of Services and Products. We offer a comprehensive range of IT services and products. We can support a customer throughout the entire life cycle of an information system from design and development through deployment and operation. 31
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. Expertise in Multiple Technologies. Our IT professionals have experience and expertise in diverse technical environments, legacy platforms, programming languages and software, as well as newer technologies including client/server applications and the Internet. This expertise enables us to assist customers in determining the best solutions for their specific IT needs. We also have extensive knowledge of customers' mission-critical systems and operations, which allows us to design and integrate new systems or applications. Our Business Strategy Our goal is to be the leading quality supplier of IT services and software products for mission-critical systems. To achieve our goal, our strategy is to: . Leverage Our Position in IT Assurance. We intend to continue to leverage our position in IT assurance to attract new customers and to provide additional services and products to our existing customers. We believe that the knowledge we gain concerning our customers' business, processes and technologies while performing IT assurance services allows us to expand our customer relationships over time. . Pursue Targeted Acquisition Opportunities. Strategic acquisitions of IT service providers are an integral part of our growth strategy. We seek to acquire companies that operate in defined vertical market niches complementary to our current business or that have well established relationships with key customers. These acquisitions may allow us to: -- Offer products and services which we do not currently provide; -- Add new markets and customers which we do not currently serve; and -- Compete more effectively for larger contracts with increased technical, financial and sales and marketing resources. Our recent acquisition of CBSI is an example of our targeted acquisition strategy. Through CBSI, we acquired several new customer relationships as well as significantly increased our IT operations capabilities. . Expand Our Commercial Business. We intend to capitalize on our expertise and reputation in the federal IT market to compete for commercial projects. As the size of IT systems of commercial companies has grown in response to the demand for improved product quality, reduced costs and improved operating efficiencies, information systems have become critical to their businesses. As a result, the need for high-quality IT services is likely to grow. We believe that our reputation for high quality and reliability together with our position in IT assurance will enable us to take advantage of this opportunity in the commercial market. . Continue Our Investment in Sales and Marketing. Over the last three years, we have significantly strengthened our sales and marketing efforts and have increased the number of our employees dedicated to sales and marketing from eight to twenty-six as of May 31, 1999. Our investment in sales and marketing enables us to compete effectively for larger government contracts, to provide the continuous sales presence necessary to obtain additional work under government-wide acquisition contracts and multiple-award contracts and to expand our commercial customer base. . Maintain Our High Level of Customer Satisfaction. We remain focused on customer satisfaction which has been a major factor in our past success. Our highly qualified, responsive project teams ensure quick and effective responses to customers' IT concerns. We believe that maintaining our high level of customer satisfaction and the resulting long-term relationships provide a stable customer base from which we can grow our business. Our Services and Products We provide our customers with an integrated offering of services and products in four areas: IT assurance, IT development, IT operations and IT consulting. Through these offerings, we are able to support customers during all or any particular phase of the life cycle of an information system. 32
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IT Assurance Our IT assurance services include the independent analysis, review, testing, verification and validation of information systems under development or being upgraded. Customers increasingly view more of their information systems as being critical to their operations. This growth in the number of critical systems, which must operate correctly and be delivered within schedule and cost constraints, has increased the market demand for our IT assurance services. We provide the following types of IT assurance services: Systems Assurance. Our systems assurance services involve independent assessment of the specification, design, implementation and testing of information systems being developed for our customers. We focus on early detection of problems so that cost-effective corrections can be made early in the development cycle. We also evaluate the processes and tools being used by the systems developer and provide oversight in tracking the customer's schedule and budget. Our systems assurance methodologies, tools and services verify our customers' information systems and provide them with comprehensive technical reports detailing any and all tracking and reporting problems. Information Assurance. Our information assurance services include providing customers with security risk assessments, security policy and architecture design, and certification and accreditation of IT systems. Our solutions help customers automate highly secure transmissions of data across communications networks. With more information systems migrating to Internet and Intranet applications, the potential threat from computer viruses and computer hackers increases the demand for these services. We also offer products that provide customers with the ability to control a user's access to network systems in a multi-level, secure environment. Compliance Assessments. Customers retain us to determine whether a specific component of an information system complies with their specifications. The scope of our compliance assessment services may vary from assessing the readiness of software for operational implementation, to assessing the process, cost and schedule for an information system upgrade. As part of our business strategy, we have begun to apply our expertise in assessing critical information systems to the commercial IT services market. As a result of current market demand, the majority of our recent commercial projects have focused on the Year 2000 problem. We believe that the high demand for these services presents a significant opportunity for us to expand our customer base in the commercial IT market. Already, some of the commercial companies that originally hired us to do Year 2000 work have retained us to provide broader-based IT assurance as well as IT development services such as building web-based applications for legacy systems. IT Development Our IT development services include specification and design, coding and implementation, system integration, testing and verification, training and operational deployment of IT systems. We use both our proprietary and commercially available tools, together with well established procedures, to develop and implement IT systems. Our many years of experience in performing IT assurance services on major systems provide us with a competitive advantage as an IT developer through the use of processes that avoid common development problems and through the utilization of project management disciplines to control the cost, schedule and performance of our projects. Our IT development services specialize in the following: Mission Applications. Mission applications involve developing and maintaining software and systems to support customer-specific programs or operations. Electronic Business. Applications for electronic business involve enabling legacy systems for web-based access and building new Internet and intranet applications for government and commercial customers. 33
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IT Operations Our IT operations include network and desktop operations and complete data center operations at our customers' facilities. We install, maintain and support our customers' network and desktop operations. Our data center operations include software development, data collection and input, database archives, report generation and hardware maintenance. We also support customers in incorporating new technologies and requirements into their operations. As a provider of end-to-end services for these operations, we frequently call upon our expertise in IT assurance, IT development and IT consulting to fulfill particular requirements of an IT operations contract. We recently expanded our IT operations services through the acquisition of CBSI, a company that has significant expertise in providing IT operations services to several civilian agencies of the federal government. IT Consulting Our IT consulting services include supporting customers' innovative applications of new technologies or enhancements to existing critical information systems. Through our IT consulting services, we gain knowledge of customers' systems, providing us with opportunities to capture other IT projects. Our IT consulting services include: Technology Studies. When customers want to investigate the application of a new or developing technology for a particular use, they can engage us to provide our IT consulting services in order to study feasibility of the concept, define the scope of the project, plan the detailed steps involved in phasing in new technology to replace an existing system, or develop a detailed plan, including schedules and budget, for a development project. Prototyping. We develop rapid prototype demonstrations for a variety of systems or applications. Language and Software Tool Development and Services. We deliver custom language and software tool development products and services to support web- based or private network systems and to support electronic design and manufacturing. . Monitoring and Debugging Tools. JWatch, our proprietary software debugging tool, provides users with the ability to analyze Java code execution and to display data and information to isolate problems and repair them within a Java software development environment. We license JWatch to software product companies that incorporate it into their products. Building on our JWatch technology, we have developed a new product, EWatch, which is currently being beta tested. EWatch supports monitoring and debugging in a distributed computing environment. We expect EWatch to enter the marketplace in late 1999 or early 2000. . Computer-Aided Design Automation Tools. We are a leader in developing languages to support the design and simulation of integrated circuits. We lead a group of design automation companies in an effort to develop an industry solution for the exchange of design information for integrated circuits directly between the designer and manufacturer. . Software Languages and Tool Development Services. We have been one of the leaders in creating higher order programming languages for building software-intensive systems for the United States government. We created NASA's HAL/S language, the standard for manned space avionics software, and the latest version of Ada, the standard language of the Department of Defense. These tools and related high-technology capabilities distinguish us and enable us to capture IT services contracts. In addition, our tools have intrinsic value of their own. By licensing some of our tools to third-party distributors, we are able to generate higher margin royalty revenues. 34
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Our Markets and Customers Our primary customers are agencies of the United States government. Our ten largest contracts by revenues are all with United States government agencies and accounted for approximately 45% of our 1998 pro forma revenues. In 1998, the United States Navy accounted for approximately 15% of our pro forma revenues, and NASA accounted for approximately 12% of our pro forma revenues. These revenues are the result of various contracts awarded by several procurement offices within these agencies. Our experience has indicated that particular contracts are subject to the discretion of each procurement office. Of the 20 government agencies with the largest IT budgets for the government's 1999 fiscal year, we have contracts with 16. The breadth of our government contract base and service offerings provides us with less dependence on any one agency and more opportunities to sell additional services to our customers. The following chart illustrates a selected number of our customers across our markets from January 1998 to the date of this prospectus. 35
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[Enlarge/Download Table] SERVICES --------------------------------------------------------------------------------------------------------------------------------- MARKET IT Assurance IT Development IT Operations IT Consulting --------------------------------------------------------------------------------------------------------------------------------- Health Care Department Of TRW/Department National Finance Housing & Urban Of Interior Institute Of Administration Development (Data Center Operations) Standards & (Systems Assurance) (Electronic Business) Technology Federal Deposit (Prototyping, Monitoring NASA SAIC/Department insurance & Debugging Tools) (Systems Assurance) Of Justice Corporation (Mission Applications) (Network & Data Operations) NASA United States (Technology Studies) Postal Service NASA Department Of (Systems Assurance) (Mission Applications) Labor (Data Collection and Department Of Jet Propulsion Reporting) Civilian Labor Laboratory Government (Y2K Compliance Assessment) (Mission Applications) Environmental Protection Securities & Department Of Agency Exchange Health & Human (Data Collection and Commission Services Reporting) (Y2K Compliance Assessment) (Electronic Business & Mission Applications) United States Patent & Trademark Office (Network Operations) ------------------------------------------------------------------------------------------------------------------------------------ United States United States United States Defense Navy Navy Navy Advanced (Systems Assurance) (Mission Applications) (Logistic Operations) Research Projects Agency Lockheed Martin/ Lockheed Martin Lockheed Martin/ United States (Electronic Business) United States (Technology Studies Air Force Air Force & Prototyping) (Information Assurance) Boeing Rockwell (Network Operations) (Mission Applications) Defense Computer Sciences Government Corp/Defense Information Systems Agency (Information Assurance) Lear Siegler/ United States Army (Systems Assurance) ------------------------------------------------------------------------------------------------------------------------------------ AT&T Delphi Automotive Metropolitan Analog Devices (Information Assurance) Systems Washington (Language Tool (Mission Applications) Airports Development) J.P. Morgan & Authority Company Vanguard (Network Operations) Green Hills (Y2K Compliance Assessment) (Mission Applications) Software, Inc. (Language Tool Commercial America Online Development) Prudential (Electronic Business) Insurance Inprise Software (Y2K Compliance Assessment) (Language Tool Development) Deutsche Bank (Y2K Compliance Assessment) Sony Pictures Entertainment Lehman Brothers (Technology Studies) (Y2K Compliance Assessment) Celera Genomics (Technology Studies) ------------------------------------------------------------------------------------------------------------------------------------
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Illustrative Customer Relationships We have long standing relationships with several of our customers. Over time, we have been successful in expanding the range of services that we provide to these customers. National Aeronautics Space Agency The National Aeronautics and Space Administration, or NASA, is currently one of our largest customers. Our contractual relationships with NASA go back nearly 30 years. In the early 1970s, we won a contract to design a programming system for the next generation of manned spacecraft operations, including the space shuttle and space station programs. We designed and developed an advanced programming language called HAL/S which NASA adopted as a standard for avionics software for manned applications. HAL/S was used to program the software for all on-board computers and is still used today for all software updates for each space shuttle flight. Based on the success of HAL/S for the space shuttle, NASA adopted HAL/S for other missions including on-board programming for the Galileo spacecraft that recently visited Jupiter. We continue to maintain HAL/S for NASA today. During the development and initial operational phases of the space shuttle, we played several key contracting roles for NASA. We developed the design requirements for the operating system for the on-board system that is still in use today. We were one of two subcontractors involved, together with one prime contractor, in the development of the backup flight software system that the crew uses in the event of catastrophic failure to the space shuttle's primary on-board flight system. We were also the prime contractor for the validation of the flight navigation system. We invented and implemented the Dynamic Integrated Test Technique, a concept for fully-integrated testing of the software and hardware systems while the shuttle is on the launch pad with the crew in the cockpit, just prior to launch. This test is recognized as the critical end-to-end evaluation of the shuttle's avionics, software, crew and communications prior to an actual flight. Following the Challenger accident in 1986, NASA recommended that we perform a complete audit of all software processes and the key interfaces of software to hardware to determine whether the shuttle was ready to fly again. As a result of our staffing up to perform this high-visibility task, NASA continued our role as the independent verification and validation contractor to assess all changes to the software made for each shuttle flight. Today, we continue to perform this role for NASA and our contract has expanded to include the space station program, ground control systems and robotic spacecraft. Also, within the scope of this contract, we oversee the avionics and software development for the X-33 spacecraft and are supporting NASA in the testing of its software for a ground control system. In 1994, because of our reputation on past work with NASA, we won a contract to perform independent verification and validation for NASA's Earth Observing System and Data Information System, or DIS. Under this contract, we support NASA in the testing and integration of the DIS, which will archive approximately one million megabytes of environmental data per day, collected from satellite-based sensors. The DIS will distribute data over the Internet to scientific and commercial users throughout the world. United States Navy The United States Navy was one of our first and continues to be one of our largest customers. The first contract we received from the Navy over 30 years ago was to define the ground support requirements for the yet-to-be-deployed P- 3C anti-submarine warfare land based aircraft. Since that time, we have been a major contributor to every version of P-3 aircraft that has been delivered to the Navy fleet. Our contributions have included definition of system and software requirements, generation of detailed equipment and software specifications, design and development of system test and integration facilities, validation and verification of system performance in the lab and onboard the aircraft, and development of training media and the training of fleet personnel. 37
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Other major Navy programs we have supported in similar capacities include the S-3A carrier-based anti-submarine warfare aircraft, used to detect and destroy enemy submarines; the executive helicopter, used for transporting the President of the United States and his staff; the Light Airborne Multi-Purpose System Helicopter, used onboard ships for submarine and anti-missile detection and defense; and the Landing Craft Air Cushion vehicle, or LCAC, used to transport personnel and equipment in hostile, shallow water operations. For the LCAC, we also provide the crews used to operate the test craft, and perform all logistics support functions for the United States Navy for all LCACs deployed throughout the world. For over 15 years, we have performed analytical, design, testing and validation efforts associated with the integration of global positioning systems and other navigation systems into a wide range of Navy and joint aircraft and ship programs. We have supported the design, development, testing and operation of the Naval Wargaming System at both the Naval War College and Tactical Training Group Pacific for approximately 20 years. In addition, for approximately 12 years, we have worked closely with the Navy in the design, development, validation and operation of the software used to resolve operational problems and test future avionic upgrades for the EA-6B aircraft. Delphi Automotive Systems Delphi Electronics Systems, a division of Delphi Automotive Systems, a leading manufacturer of automotive control systems, has been one of our largest commercial customers, and we have sustained our relationship with them over a 15-year period. In the mid-1980s, Delphi decided to design and build a proprietary software development system to program the computer chips used in automotive control systems. With over six million vehicles equipped on a yearly basis and a significant increase in the number of individual computers involved to control and monitor various parts of the vehicle, the needs for the programming system were threefold: . To enhance the productivity and lower the time for development to meet manufacturing schedules; . To improve the efficiency of the code generated to reduce memory needs; and . To enhance reliability and maintainability because of the critical nature of the functions performed for the vehicle. At that time, these needs were not met through the use of available programming tools. We won a contract in 1985 to develop this programming system and the related compilers for several of the major microcomputer chips being used in vehicles at that time. Following the initial development of the Delphi system, we designed and developed a complete configuration management system to support the building and control of the software used in Delphi-equipped vehicles and computers. Our role was extended to include building new versions of compilers for the microcomputer chips being planned for future Delphi-equipped vehicles. In addition, Delphi asked us to convert our software from a mainframe to a fully integrated workstation environment. During the 1990s, we built an electronic specification system for distributing and controlling documentation for the vehicle-based electronic systems. This system is used to distribute and control documentation on a worldwide basis. Delphi now uses this system to distribute and control other information beyond the documentation of vehicle-based electronics systems. We have recently added a web-based interface to the system. Sales and Marketing Over the last four years, we have significantly increased the investment in our sales and marketing efforts. As of May 31, 1999, we had 26 employees dedicated to our sales and marketing efforts. These employees all belong to our corporate-wide business development team. The majority of these employees work with project managers and operating teams to pursue new business. Several of our sales and marketing employees work primarily at the corporate level to identify and develop new sales targets and to obtain government awards. 38
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Our management works to foster an environment in which every employee shares the responsibility for our sales and marketing and internal growth. In addition to our dedicated sales and marketing personnel, many other employees spend significant amounts of their time on sales and marketing activities. We seek to ensure that each employee understands how he or she can contribute to our growth, whether by communicating to management opportunities for new business, by building a new customer relationship or by supporting a proposal. As we grow, we will continue to invest our resources in sales and marketing. Our continually growing sales presence is necessary to compete for larger, long-term government contracts, and to develop the ongoing relationships with present and prospective customers demanded by the prevalence of multiple-award government contracts and by our expansion of commercial opportunities. A significant portion of our new business derives from existing customer relationships. We frequently leverage our strong incumbent positions to expand the scope of our customer relationships. In addition, we identify new contract opportunities through the use of industry contacts, attendance at conferences and review of publications that identify new contracting opportunities. While the services and products we provide to commercial customers are the same as or similar to those we offer to government customers, the process of selling to commercial customers is somewhat different. A portion of our sales and marketing staff is, therefore, dedicated to selling services to commercial customers. We expect to continue to expand our commercial sales and marketing staff. We also have a sales effort dedicated to licensing our technology and products to companies that sell our products and pay us royalties. We have an incentive compensation program for sales and marketing personnel. Incentive awards are based on achievement of our goals for profitability and bookings of new business. Contracts Government Contracts We have several multi-year contracts with United States government agencies, typically for three to five years. These contracts require us to provide a broad range of requested services. We receive specific assignments under a given contract through the issuance by the government of task orders. Task orders describe the specific assignment, the number of employees allocated to the assignment and the estimated cost, fee and travel allocated to the assignment. Under our Government Services Agency Schedule, which is a type of GWAC, any government agency may purchase IT services and products at pre-approved prices and without any additional competitive bidding. The term of our current Government Services Agency Schedule contract expires in September 2002. Commercial Contracts Typically, commercial contracts require us to complete a specific task or provide a defined range of services and support. Payments are usually made incrementally during the performance of each specific work assignment. Currently, we are working to expand our customer base and increase the sales of our products and services in the commercial IT market. Most of our existing commercial contracts are fixed-price contracts. Backlog Backlog represents management's estimate of our aggregate realizable revenues over the term of all of our contracts, including any option periods. However, backlog is not necessarily indicative of future revenues. Our contract backlog was approximately $450 million as of March 31, 1999. Our backlog is composed of: . Customer authorized contract values for which the customer has set aside, appropriated or committed funds for specifically identified services, products, tasks or delivery orders; and 39
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. Management's estimate of the realizable contract values for all expected future services, products, tasks or delivery orders, for which funds have not yet been set aside, appropriated or committed. The actual timing of our receipt of revenues, if any, on projects included in our backlog could change because many factors affect the scheduling of projects. In addition, cancellations or adjustments to contracts may occur. Our backlog is subject to large variations from quarter to quarter as existing contracts are renewed or new contracts are awarded. Additionally, virtually all of our backlog represents contracts with the United States government which may be terminated at any time for any reason. Competition We experience significant competition in all areas of our business. In general, the markets in which we compete are not dominated by a single company or a small number of companies. Rather, a large number of companies offer services that overlap and are competitive with our services and products. However, we compete regularly with approximately seven different competitors in our IT assurance service offerings, 18 in our IT development service offerings, six in our IT operation service offerings and four in our IT consulting service offerings. We believe that the principal competitive factors in our business are technical understanding, management capability, past contract performance, personnel qualifications and price. While we have considerable experience, there are many other contractors that have comparable skills. Many of our competitors are significantly larger and have greater financial resources than we do. In addition, many of our competitors have significantly more experience in the commercial IT market than we do. Proprietary Information Although much of our work is performed for the United States government, wherever possible we attempt to retain proprietary rights in our products. We rely on copyright, patent and trade secret laws and internal non-disclosure safeguards, as well as restrictions incorporated into software product license agreements and other contractual provisions to protect our proprietary rights. However, these measures may not prevent the unauthorized disclosure or use of our technical knowledge, practices or procedures, or prevent others from independently developing similar knowledge, practices or procedures. Further, the government may acquire certain proprietary rights to software programs and other products that we develop while performing services under government contracts. The government may disclose this information to others, including our competitors. Disclosure or loss of control over our proprietary information could have a material adverse effect on our business, financial condition and results of operations. Employees As of May 31, 1999, we had a total of 1,765 employees, consisting of 1,643 full-time and 122 part-time or temporary employees. Of our total full-time employees, approximately 1,499 are in engineering, technical and technical support positions, 118 are in general and administrative positions and 26 are in sales and marketing positions. None of our employees are covered by a collective bargaining agreement. We have several full-time employees dedicated to recruiting technical and administrative professionals and managing our human resources. As part of our retention efforts, we seek to minimize turnover by emphasizing our reputation, the nature of our work, our work environment, our encouragement of technical publications, our participation in professional societies and our competitive compensation packages. Certain Regulatory Matters United States government contracts are subject to the Federal Acquisition Regulations, or FAR, and other agency FAR supplements. Major contracts are also subject to the Truth in Negotiations Act, or TIN Act, and Cost Accounting Standards, or CAS. Among other procurement regulations, the FAR contains the cost 40
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principles for setting contract prices while the TIN Act requires us to provide current, accurate and complete cost or pricing data in connection with the negotiation of a contract. CAS requires consistency of accounting practices over time and compliance with specific cost accounting criteria. To the extent that a company fails to comply with procurement requirements, the United States government may adjust contract prices. Additionally, changes in cost accounting practices are subject to a required procedure for negotiation of the cost of the change. The United States government is protected from paying increased costs resulting from accounting changes. Finally, the United States government has the right to audit contractors for three years after final payment. Accordingly, our revenues are subject to adjustment. United States law and regulations restrict and regulate the export of technology as well as goods and commodities provided by United States businesses to controlled foreign subsidiaries and affiliates. We are subject to certain of these regulations with respect to our technology that is sold to non-United States customers. Facilities We currently lease approximately 310,000 square feet of space comprised of 24 facilities. We consider these properties to be modern, well maintained and suitable for their intended purposes. We lease our principal executive and administrative offices and software facility located in 38,800 square feet of space in Burlington, Massachusetts. This lease expires in 2003. We also have offices located in: . Fountain Valley, Huntington Beach, Pasadena, Point Mugu, Sacramento, San Diego and Santa Clara, California; . Colorado Springs, Colorado; . Panama City, Florida; . Baltimore, Greenbelt and Lexington Park, Maryland; . Billerica, Massachusetts; . Kansas City, Missouri; . Eatontown, New Jersey; . Lawton, Oklahoma; . Portland, Oregon; . Warminster, Pennsylvania; . Charleston, South Carolina; . Houston, Texas; and . Arlington, Fairfax and Vienna, Virginia. Legal Proceedings We are not involved in any material litigation. 41
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MANAGEMENT Executive Officers and Directors The following table sets forth, as of the date of this prospectus, the name, age and position of each of our executive officers and directors. [Enlarge/Download Table] Name Age Position ---- --- -------- Michael B. Alexander.... 48 Chief Executive Officer and Chairman of the Board of Directors John C. Rennie.......... 61 Vice Chairman of the Board of Directors Joseph A. Saponaro...... 59 President, Chief Operating Officer and Director Bruce A. Burton......... 44 Executive Vice President Sigmund H. Goldblum..... 61 Executive Vice President and Director Barbara L. Landes....... 49 Executive Vice President and Chief Financial Officer Nicholas A. Pettinella.. 56 Senior Vice President, Treasurer and Secretary Mary Ann Gilleece....... 58 Director Joel N. Levy............ 57 Director Peter M. Schulte........ 41 Director Executive Officers Michael B. Alexander has served as our Chief Executive Officer and Chairman from February 1998 to the present, and as Chief Executive Officer and Chairman of Intermetrics from August 1995 to February 1998. From 1993 to August 1995, Mr. Alexander was the principal of AFH Partners, which invests in public and private computer software companies. From 1990 to 1993, Mr. Alexander served as President and Chief Operating Officer of Pinelands, Inc., a New York Stock Exchange company that was a spin-off from MCA, Inc. From 1981 to 1990, Mr. Alexander worked for MCA/Universal in several capacities, including as President and General Manager of WWOR-TV, Executive Vice President of MCA Broadcasting and Vice President and Chief Financial Officer of USA Network. Mr. Alexander is a member of the Board of Directors of IES Holding, Inc. Mr. Alexander received an AB from Harvard College, cum laude, an MA in Education from Ohio State and completed the course work for a doctorate in education from the Harvard Graduate School of Education. John C. Rennie has served as Vice Chairman of the Board of Directors from February 1998 to the present, and as Chairman of the Board of Directors and Chief Executive Officer of Pacer since he founded Pacer in 1968 until February 1998. Mr. Rennie was Chairman at the time Pacer was named the Overseas Company of the Year in 1987 on the Unlisted Securities Market of the London Stock Exchange. Mr. Rennie has served as a director on a number of private technology companies' boards of directors, and has also served as a director on numerous organizations' boards, including the United States Chamber of Commerce and the National Security Industrial Association. Mr. Rennie has an engineering degree from the United States Naval Academy and a graduate engineering management degree from Northeastern University and is also a graduate of the Harvard Business School, Smaller Company Management Program. Joseph A. Saponaro has served as our President and Chief Operating Officer from March 1999 to the present. From August 1986 to December 1998, Mr. Saponaro served as President of Intermetrics, and from August 1986 to August 1995 served as Chief Executive Officer of Intermetrics. Mr. Saponaro has served as our director from February 1998 to the present and served as a director of Intermetrics from 1986 until February 1998. Mr. Saponaro joined Intermetrics in 1969 and served in a number of management positions before becoming President in August 1986. Mr. Saponaro was a director of Intermetrics from 1979 to 1998. Mr. Saponaro is a member of the Board of Directors of IES Holding, Inc. Mr. Saponaro received a BS in Navigation and Astronomy from Massachusetts Maritime Academy, an MS in Mathematics from Northeastern University and attended Massachusetts Institute of Technology's Aeronautics PhD program. Bruce A. Burton, Ph.D. was appointed as our Executive Vice President in March 1999. Prior to March 1999, Dr. Burton served as Senior Vice President of Intermetrics' Information Systems and Services business 42
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area from 1996 to March 1999. Dr. Burton has been an employee of Intermetrics for 16 years and has held a number of technical and management positions. Dr. Burton received a BS in chemistry from California State University at Bakersfield and an MS degree in computer science and a PhD in chemistry from the University of California in Irvine. Sigmund H. Goldblum has served as our Executive Vice President from March 1999 to the present. From January 1989 to December 1998, Mr. Goldblum served as President and Chief Operating Officer of Pacer. Mr. Goldblum has served as our director from February 1998 to the present and as a director of Pacer from 1989 to February 1998. Mr. Goldblum served as Chief Operating Officer of Pacer from 1983. Previously, Mr. Goldblum served Pacer as Senior Vice President from 1977 to 1983 and Vice President from 1973 to 1977. Mr. Goldblum joined Pacer in December 1969. Mr. Goldblum received a BS in electrical engineering from Drexel University and an MS in electrical engineering from the University of Pennsylvania. Barbara L. Landes has served as our Executive Vice President and Chief Financial Officer since May 1999. From October 1998 to April 1999, Ms. Landes was self-employed. Ms. Landes served as Vice President and Chief Financial Officer of Watson Wyatt & Company from May 1994 until October 1998. From January 1991 through August 1992, Ms. Landes worked as Vice President, Chief Financial Officer and Treasurer of Pinelands, Inc., a New York Stock Exchange company which was a spin-off from MCA, Inc. From November 1989 to December 1993, Ms. Landes was Senior Vice President, Finance and Operations of WWOR-TV. From 1980 to 1989, Ms. Landes worked for NBC in several capacities, including Vice President, Finance and Administration of NBC Radio. Ms. Landes received a BA in political science from Washington University and an MBA from Wharton Graduate School of the University of Pennsylvania. Nicholas A. Pettinella has served as our Senior Vice President and Treasurer from February 1998 to the present, and as Senior Vice President and Chief Financial Officer of Intermetrics from 1983 to December 1998. Mr. Pettinella joined Intermetrics as Director of Finance in November 1981. Mr. Pettinella received a BS in accounting from Bentley College and an MBA from Babson College, and attended the Corporate Finance Management program at Harvard University and the Executive Financial Management Program at Stanford University. He is a licensed Certified Public Accountant in the Commonwealth of Massachusetts. Directors Mary Ann Gilleece has served as our director since September 1998. Ms. Gilleece is a partner of the law firm of Manatt, Phelps and Philips, where she counsels domestic and foreign corporations on issues related to legislative, government contract and regulatory matters. Prior to joining Manatt, Phelps and Philips in June 1997, Ms. Gilleece held several senior positions in the United States government including Deputy Undersecretary of Defense for Research and Engineering, representative for the Department of Defense on the OMB Executive Committee on Procurement Reforms, and Counsel to the United States House of Representatives Committee on Armed Services. Ms. Gilleece sits on the National Board of Trustees of the National Defense Industrial Association, the Board of Advisors of the National Contract Management Association and is vice chair of the Legislative Coordinating Committee of the Section of Public Contract Law of the American Bar Association. Ms. Gilleece received a BA from the University of Connecticut, a JD from Suffolk University Law School, and an LLM in government procurement from George Washington University. Joel N. Levy has served as our director from February 1998 to the present and as a director of Intermetrics from August 1995 to February 1998. Mr. Levy is a managing partner of CMLS Management, L.P. and CM Equity Partners, L.P., and a principal officer of Joel N. Levy/Peter M. Schulte, L.L.C. Joel N. Levy/Peter M. Schulte, L.L.C. supported the management buyout of Intermetrics in August 1995. Mr. Levy managed the buyout group at Arnhold and S. Bleichroeder, Inc., from 1990 to 1992. From 1986 to 1990, Mr. Levy managed Resource Holdings Capital Group, a buyout fund comprised of Swiss investors (Trident II) acquiring United States-based companies. Mr. Levy is a member of the Boards of Directors of ICF Consulting Group, Inc., Tep Fund, Inc., C-3, Inc., Examination Management Services, Inc., Kronos-Central Products, Inc. (Chairman), Beta Brands Incorporated, Evans Consoles, Inc. and Resource Consultants, Inc. Mr. Levy received a BA from American University in Washington, D.C. 43
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Peter M. Schulte has served as our director from February 1998 to the present and as a director of Intermetrics from August 1995 to February 1998. Mr. Schulte is a managing partner of CMLS Management, L.P. and CM Equity Partners, L.P. and is a principal officer of Joel N. Levy/Peter M. Schulte, L.L.C. Joel N. Levy/Peter M. Schulte, L.L.C. supported the management buyout of Intermetrics in August 1995. Mr. Schulte was a member of the buyout group at Arnhold and S. Bleichroeder, Inc. from 1990 to 1992. From 1983 to 1990, Mr. Schulte was a Vice President of Salomon Brothers Inc, where he managed the firm's southeast United States corporate finance relationships and activities with industrial companies. Mr. Schulte is a member of the Boards of Directors of IES Holding, Inc., ICF Consulting Group, Inc., Kronos-Central Products, Inc., Evans Consoles, Inc. and Resource Consultants, Inc. (Chairman). Mr. Schulte received a BA from Harvard University and a Masters in Public and Private Management from Yale University. Executive Compensation The following table sets forth all compensation awarded to, earned by or paid to our Chief Executive Officer and our other four most highly compensated executive officers for services rendered to us during 1998. Summary Compensation Table [Download Table] Annual Compensation ------------------------------ Other Annual All Other Name and Principal Position Salary Bonus Compensation Compensation --------------------------- -------- -------- ------------ ------------ Michael B. Alexander Chief Executive Officer and Chair- man............................... $339,068 $105,000 $ 3,809 $2,801 John C. Rennie Vice Chairman...................... 267,315 70,000 699 6,787 Joseph A. Saponaro President and Chief Operating Offi- cer............................... 266,200 85,000 24,912 7,575 Sigmund H. Goldblum Executive Vice President........... 223,575 60,000 1,910 5,702 Bruce A. Burton Executive Vice President........... 177,011 80,000 9,631 1,703 Other annual compensation consists of the portion of an automobile lease paid by us, and cash payments in lieu of vacation days. All other compensation consists of the imputed income associated with the group term life insurance premium for policy values in excess of $50,000. In accordance with the rules of the SEC, other compensation in the form of perquisites and other personal benefits has been omitted for the named executive officers because the aggregate amount of these perquisites and other personal benefits constituted less than the lesser of $50,000 or 10% of the total of annual salary and bonuses for each of the named executive officers in 1998. Options Granted in Last Year No options were granted to the named executive officers during the year ended December 31, 1998. 44
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The following table sets forth information concerning the value realized upon exercise of options during 1998 and the number and value of unexercised options held by each of the named executive officers at December 31, 1998. There was no public trading market for the common stock as of December 31, 1998. Accordingly, the values set forth below have been calculated on the basis of the assumed initial public offering price of $8.00 per share, less the applicable exercise price per share, multiplied by the number of shares underlying the options. [Enlarge/Download Table] Option Exercises in the Year Ended December 31, 1998 and Year-End Option Values Number of Securities Value of Unexercised Value Realized Underlying Unexercised In- the- Shares (Market Price Options at Money Options at Acquired at Exercise less December 31, 1998 December 31, 1998 on Exercise ------------------------- ------------------------- Name Exercise Price)(/1/) Exercisable Unexercisable Exercisable Unexercisable ---- -------- ---------------- ----------- ------------- ----------- ------------- Michael B. Alexander.... -- -- -- 387,831(/2/) -- $2,571,320 John C. Rennie.......... 17,117 $118,450 24,453 -- $103,192 -- Joseph A. Saponaro...... -- -- -- 116,349(/3/) -- $ 771,394 Sigmund H. Goldblum..... 17,117 $118,450 48,906 -- $206,383 -- Bruce A. Burton......... -- -- -- -- -- -- -------- (1) Solely for purposes of this calculation, the fair market value of the common stock at the time of the exercise was deemed to be the initial public offering price of $8.00 per share. The exercise price of the options was $1.08 per share. (2) All of Mr. Alexander's options to purchase 387,831 shares of common stock will become exercisable when this offering closes and will have a value of $2,571,320 based on an assumed initial public offering price of $8.00 per share and an exercise price of $1.37 per share. (3) All of Mr. Saponaro's options to purchase 116,349 shares of common stock will become exercisable when this offering closes and will have a value of $771,394 based on an assumed initial public offering price of $8.00 per share and an exercise price of $1.37 per share. Classified Board of Directors The board of directors presently consists of seven persons. Our board of directors is divided into three classes. Directors of each class serve for three years and are elected at the annual meeting of stockholders held in the year in which the term for such class expires. Michael B. Alexander, Mary Ann Gilleece and Peter M. Schulte serve as Class 1 directors with their terms expiring at the 2000 annual meeting of stockholders. Joseph A. Saponaro and John C. Rennie serve as Class 2 directors with their terms expiring at the 2001 annual meeting of stockholders. Sigmund H. Goldblum and Joel N. Levy serve as Class 3 directors with their terms expiring at the 2002 annual meeting of stockholders. For further information on the effect of the classification of the Board of Directors, please see "Description of Securities--Anti-Takeover Effects of Certain Provisions of Delaware Law and Our Certificate of Incorporation and Bylaws." Directors Compensation In September 1998, we began compensating our non-employee directors $20,000 per year, paid in arrears in semi-annual increments. In addition, we reimburse each non-employee director for customary and reasonable out-of-pocket expenses for attending each board of directors or committee meeting. At the discretion of the board of directors, non-employee directors may be granted options to purchase common stock at the then prevailing fair market value. We also have a consulting agreement with Messrs. Levy and Schulte. Please see "Certain Relationships and Related-Party Transactions." Prior to September 1998, directors received no cash compensation for their service on our board of directors or any of our committees. 45
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Committees of the Board Audit Committee The audit committee currently consists of Mary Ann Gilleece (chair), Peter M. Schulte and Michael B. Alexander. After this offering, the audit committee will consist of Mary Ann Gilleece (chair) and Peter M. Schulte. The audit committee selects and evaluates our independent auditors, reviews the scope of the annual audit with management and our independent auditors, consults with management and our independent auditors about our systems of internal accounting controls and reviews the non-audit services performed by our independent auditors. Compensation Committee Our compensation committee currently consists of Peter M. Schulte (chair), Joel N. Levy and John C. Rennie. The compensation committee is responsible for approving or recommending salaries and benefits for our employees, consultants, directors and other individuals compensated by us. The compensation committee also reviews our benefit plans. Option Committee Our option committee currently consists of Peter M. Schulte (chair) and Joel N. Levy. The option committee is responsible for approving or recommending option grants, and administering our long-term incentive plan. 1998 Long Term Incentive Plan General. Our 1998 long term incentive plan was approved by our board of directors and our stockholders in June 1998. The purpose of our 1998 long term incentive plan is to enable us to attract, retain and reward employees, officers and directors and to strengthen the mutuality of interests between our employees, officers and directors and our stockholders, by permitting them to participate in our ownership. Pursuant to the plan, we may grant options intended to qualify as "incentive stock options" under Section 422 of the Internal Revenue Code of 1986, non-qualified stock options, stock appreciation rights, restricted stock, deferred stock, stock purchase rights or other stock-based awards. Shares reserved for issuance. A total of 3,349,447 shares of common stock have been reserved for issuance under the plan. Appropriate adjustments in the aggregate number of shares subject to the plan will be made in the event of any recapitalization, dividend of stock or property other than cash, stock split, reclassification or other change in corporate structure affecting the common stock. As of March 31, 1999, we have granted stock options to purchase 1,513,433 shares of common stock. Eligibility. Our employees, officers and directors who are responsible for or contribute to the management, growth and/or profitability of our business are eligible to be granted awards under the plan. However, only our employees are eligible to receive incentive stock options. Administration. Our stock option committee is authorized to administer the plan, including the selection of individuals eligible for grants under the plan and the terms of grants. Generally, the stock option committee has broad authority to amend the plan to take into account changes in applicable securities and tax laws and accounting rules, as well as other developments. We may grant any of the following, or any combination of the following, types of awards under the plan: Stock options. We may grant incentive stock options and non-qualified stock options. A stock option may have a term of not more than ten years. Our option committee determines the price per share, which may be equal to, greater than or less than the fair market value of common stock purchasable under stock options granted under the plan on the date of grant based on the following factors: . The price per share of common stock purchasable under an incentive stock option cannot be less than the fair market value of our common stock on the date of grant; and 46
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. In the case of an incentive stock option granted to an employee who, at the time of grant, owns common stock with more than ten percent (10%) of the total combined voting power of our outstanding common stock, the price per share of common stock cannot be less than one hundred ten percent (110%) of the fair market value of our common stock on the date of grant. The fair market value of our common stock is its closing price on the stock exchange on which it is listed; if it is not listed, the fair market value is determined by the option committee after considering various factors, including our operating results, transactions with third parties involving the exchange of our stock, and independent valuations of our stock which we receive periodically. Stock appreciation rights. A stock appreciation right is the right to surrender to us all or a portion of a stock option in exchange for an amount equal to the difference between: . The fair market value, as of the date any part of a stock option is surrendered, of the shares of common stock covered by any part of a stock option, subject to pricing provisions, and . The aggregate exercise price of any part of a stock option. A stock appreciation right granted with respect to a given stock option shall terminate and no longer be exercisable upon the termination or exercise of the related stock option, subject to provisions specified by the stock option committee. Restricted stock. A restricted stock award entitles the holder to receive shares of common stock at the end of a restricted period determined by the stock option committee. During the restricted period, the holder is not permitted to sell, transfer, pledge or assign shares of restricted stock. The stock option committee may provide for the lapse of such restrictions in installments and may accelerate or waive such restriction in whole or in part, based on service, performance and other criteria as the stock option committee may determine. Deferred stock. A deferred stock award entitles the holder to receive shares of common stock at the end of a specified deferral period. The stock option committee shall determine, among other things, the duration of the period during which, and the conditions under which, receipt of the common stock will be deferred. Stock purchase rights. Stock purchase rights entitle the holder to purchase common stock, including deferred stock and restricted stock: . At its fair market value on the date of grant; . At fifty percent (50%) of the fair market value on the date of grant; . At an amount equal to book value on the date of grant; or . At an amount equal to the par value of the common stock on the date of grant. Other stock-based awards. We may also make other awards of common stock and other awards that are valued in whole or in part by reference to, or are otherwise based on, common stock, including performance shares, convertible preferred stock, convertible debentures, exchangeable securities and stock awards or options valued by reference to book value or our performance. Employment, Severance and Other Agreements with Management Mr. Alexander serves as Chief Executive Officer and Chairman of the Board of Directors pursuant to the terms of a five-year employment agreement dated as of August 21, 1995 between us and Mr. Alexander. Under the terms of his employment agreement, Mr. Alexander receives a base salary of $300,000 per year, which increases by at least 5% each year plus any additional amounts as may be approved from time to time by the board. In addition, commencing April 1, 1997, Mr. Alexander will be paid a tax anticipation payment of $50,000 or a bonus, at the discretion of our board of directors, of not less that $50,000. If Mr. Alexander's employment agreement is terminated by us for any reason other than "cause", as defined in Mr. Alexander's 47
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employment agreement, or long-term disability, then he is entitled to any earned but unpaid salary and bonus and the following severance for the lesser of 36 months following the date of his termination or the remaining term of his employment agreement: . His then current salary; . His tax anticipation payments; and . Continued medical benefits on the same basis as immediately prior to his termination. If Mr. Alexander's employment agreement is terminated for a long-term disability, then he is entitled to the following severance: . $25,000 per month and his tax anticipation payments for 12 months following his termination; . Any earned but unpaid salary and bonus amounts; and . Benefits under our long-term disability policy and medical benefits from the date of termination until his 65th birthday. If Mr. Alexander's employment agreement is terminated by his death, or if Mr. Alexander voluntarily terminates his employment agreement, then he, or his estate in the event of his death, is entitled to receive any earned but unpaid salary and bonus amounts. Under his employment agreement, Mr. Alexander also received options to purchase a maximum of 387,831 shares of common stock, at an exercise price of $1.37 per share. This stock option will vest and become exercisable upon the closing of this offering. Mr. Saponaro serves as President and director pursuant to the terms of an employment agreement, dated as of August 21, 1995, between us and Mr. Saponaro. Under the terms of his employment agreement, Mr. Saponaro receives an annual base salary of $230,000 or such greater amount as may be approved from time to time by our board of directors. Mr. Saponaro's employment agreement provides that he will be eligible to receive a bonus at the discretion of the board of directors. If Mr. Saponaro's employment agreement is terminated by us for any reason other than "cause", as defined in Mr. Saponaro's employment agreement, or long-term disability, or we fail to renew his employment agreement, then he is entitled to the following severance: . One-half of his then current salary, on a monthly basis, and one-half of his bonus, on an annual basis, for four years following the date of his termination; . Any earned but unpaid salary and bonus amounts; and . Continued medical benefits on the same basis as immediately prior to his termination for the greater of the remaining term of his employment agreement or 18 months. If Mr. Saponaro's employment agreement is terminated for a long-term disability, then he is entitled to the following severance: . His then current salary and bonus for 12 months following his termination, and $9,000 per month thereafter or such greater amount as our disability insurance policy permits, less our medical benefits described below; . Any earned but unpaid salary and bonus amounts; . Benefits under our long-term disability policy from the date of termination until his 65th birthday; and . Continued medical benefits to the extent permitted under our policies or plans, at no greater out-of-pocket cost to Mr. Saponaro than incurred prior to termination. 48
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If Mr. Saponaro's employment agreement is terminated by his death, or if Mr. Saponaro voluntarily terminates his employment agreement, then he, or his estate in the event of his death, is entitled to receive any earned but unpaid salary and bonus amounts. In addition, Mr. Saponaro received options to purchase a maximum of 116,349 shares of common stock at an exercise price of $1.37 per share. This stock option will vest and become exercisable upon the closing of this offering. Mr. Rennie serves as Vice Chairman of our board of directors pursuant to the terms of a three-year employment agreement, dated as of February 27, 1998, between us and Mr. Rennie. Mr. Rennie receives a base salary of $275,000 per year, or such greater amount as may be approved from time to time by us. The agreement provides that Mr. Rennie will be eligible to receive a bonus at the discretion of the board of directors. If Mr. Rennie's employment agreement is terminated by us for any reason other than "cause", as defined in Mr. Rennie's employment agreement, or long-term disability or by Mr. Rennie for "good reason", then he is entitled to the following severance: . His base salary, on a monthly basis, and a company car through the term of his employment agreement; . One-half of his then current salary, on a monthly basis, for two years following the expiration of the term of his employment agreement; . Any earned but unpaid vacation, salary and bonus amounts; and . Continued medical benefits on the same basis as immediately prior to his termination for the greater of the remaining term of his employment agreement or 18 months after his date of termination. If Mr. Rennie's employment agreement is terminated for a long-term disability, then he is entitled to the following severance from the date of termination until the earlier of his 65th birthday or the date specified by our long-term disability plan: . His then current salary and bonus for 12 months following his termination, and $10,000 per month thereafter, less our medical benefits described below; . Any earned but unpaid vacation, salary and bonus amounts; . Continued use of a company car; and . Benefits under our long-term disability policy and medical benefits from the date of termination until the earlier of the date specified by our disability policy or his 65th birthday. If Mr. Rennie's employment agreement is terminated by his death, or if Mr. Rennie voluntarily terminates his employment agreement, then he, or his estate in the event of his death, is entitled to receive any earned but unpaid vacation, salary and bonus amounts. Mr. Goldblum serves as Executive Vice President and Director pursuant to the terms of a three-year employment agreement, dated as of February 27, 1998, between us and Mr. Goldblum. Mr. Goldblum receives a base salary of $225,000 per year or such greater amount as may be approved from time to time by our board of directors. The agreement provides that Mr. Goldblum will be eligible to receive a bonus at the discretion of the board of directors. If Mr. Goldblum's employment agreement is terminated by us for any reason other than "cause", as defined in Mr. Goldblum's employment agreement, or long-term disability or by Mr. Goldblum for "good reason", then he is entitled to the following severance: . His base salary, on a monthly basis, and a company car through the term of his employment agreement; . One-half of his then current salary, on a monthly basis, for two years following the expiration of the term of his employment agreement; 49
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. Any earned but unpaid vacation, salary and bonus amounts; and . Continued medical benefits on the same basis as immediately prior to his termination for the greater of the remaining term of his employment agreement or 18 months after his date of termination. If Mr. Goldblum's employment agreement is terminated for a long-term disability, then he is entitled to the following severance from the date of termination until the earlier of his 65th birthday or the date specified by our long-term disability plan: . His then current salary and bonus for 12 months following his termination, and $10,000 per month thereafter, less our medical benefits described below; . Any earned but unpaid vacation, salary and bonus amounts; . Continued use of a company car; and . Benefits under our long-term disability policy and medical benefits from the date of termination until the earlier of the date specified by our disability policy or his 65th birthday. If Mr. Goldblum's employment agreement is terminated by his death, or if Mr. Goldblum voluntarily terminates his employment agreement, then he, or his estate in the event of his death, is entitled to receive any earned but unpaid vacation, salary and bonus amounts. 50
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PRINCIPAL STOCKHOLDERS The following table sets forth information with respect to the beneficial ownership of our common stock as of July 12, 1999, and as adjusted to reflect the sale of the shares of common stock offered by this prospectus, by: . Each of our directors and named executive officers; . All of our directors and executive officers as a group; and . Each person, or group of affiliated persons, who we know beneficially owns 5% or more of the common stock. In accordance with the SEC's rules, the following table gives effect to the shares of common stock that could be issued upon the exercise of outstanding options and warrants within 60 days of July 12, 1999. The following table also gives effect to the shares of common stock that could be issued upon the exercise of outstanding options that will become fully vested upon the closing of this offering. Unless otherwise indicated in the footnotes to the table, the following individuals have sole voting and sole investment control with respect to the shares they beneficially own. [Download Table] Percentage before Percentage Number of this after this Beneficial Owner shares offering offering ---------------- --------- ---------- ---------- Directors and Officers:+ Michael B. Alexander(/1/)............. 1,119,645 15.4% 9.9% John C. Rennie(/2/)................... 330,085 4.8 3.0 Joseph A. Saponaro(/3/)............... 281,052 4.0 2.6 Sigmund H. Goldblum(/4/).............. 138,458 2.0 1.3 Nicholas A. Pettinella(/5/)........... 131,774 1.9 1.2 Peter M. Schulte(/6/)................. 73,176 1.1 0.7 Bruce A. Burton(/7/).................. 73,234 1.1 0.7 Joel N. Levy(/6/)(/8/)................ 54,882 0.8 0.5 Barbara L. Landes(/9/)................ -- * Mary Ann Gilleece..................... -- * All Directors and Executive Officers as a group (10 persons)(/10/) .................. 2,202,306 31.1% 19.9% Other 5% Stockholders: J. Fernando Niebla(/11/).............. 672,315 9.8% 6.2% Richards Capital Fund, L.P.(/12/)..... 548,817 8.0 5.0 AFH Partners(/13/).................... 537,841 7.8 4.9 Massachusetts Mutual Life Insurance Company --Pension Management(/14/)........... 276,695 4.0 2.5 Massachusetts Mutual Life Insurance Company --IMF Traditional(/14/).............. 276,695 4.0 2.5 MassMutual Corporate Investors(/14/).. 147,499 2.1 1.4 MassMutual Corporate Value Partners (Gerlach & Co.)(/14/)................ 147,499 2.1 1.4 MassMutual Participation Invest- ors(/14/)............................ 73,749 1.1% 0.7% -------- * Less than 1% + Unless otherwise indicated, the address of our directors and officers is c/o AverStar, Inc., 23 Fourth Avenue, Burlington, Massachusetts 01803. 51
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(1) Includes options to purchase 387,831 shares of common stock for $1.37 per share. Includes 537,841 shares of common stock held by AFH Partners. Includes 58 shares of common stock held for the benefit of Mr. Alexander in the AverStar Profit Sharing & Savings Plan. (2) Includes options to purchase 24,453 shares of common stock at $3.78 per share. Includes 2,966 shares of common stock held in the Pacer Infotec Employee Stock Bonus Plan, or ESBP, for the benefit of Mr. Rennie. Excludes 155,351 shares held by the ESBP with respect to which Mr. Rennie, as trustee, has voting power but no pecuniary interest. After this offering, Mr. Rennie will not have the right to vote the shares held by the ESBP. (3) Includes options to purchase 116,349 shares of common stock for $1.37 per share. Includes 58 shares of common stock held for the benefit of Mr. Saponaro in the AverStar Profit Sharing & Savings Plan. Excludes 188,367 shares held by the AverStar Profit Sharing & Savings Plan with respect to which Mr. Saponaro has voting power but no pecuniary interest. (4) Includes options to purchase 48,906 shares of common stock at $3.78 per share. Includes 2,932 shares of common stock held for the benefit of Mr. Goldblum in the ESBP. (5) Includes 58 shares of common stock held for the benefit of Mr. Pettinella in the AverStar Profit Sharing & Savings Plan. (6) Excludes shares to be received by Messrs. Levy and Schulte from certain other AverStar stockholders pursuant to agreements between Messrs. Levy and Schulte and such stockholders. In connection with the acquisition of Intermetrics by Apollo Holding, Inc. in 1995, certain stockholders of Apollo who are now stockholders of AverStar agreed to share a percentage of their interest in Intermetrics' profits with Messrs. Levy and Schulte. Each of Mr. Levy and Mr. Schulte will receive (i) approximately 75,551 shares of common stock (assuming an initial public offering price of $8.00) immediately after this offering, approximately 911 of these shares will be issued out of our treasury shares and (ii) an additional number of shares of common stock six months after this offering to be determined based on the market price of the common stock at that time. The address of Messrs. Levy and Schulte is CM Equity Partners, 135 East 57th Street, 27th Floor, New York, New York 10022. (7) Includes 58 shares of common stock held for the benefit of Dr. Burton in the AverStar Profit Sharing & Savings Plan. Does not include options to purchase 15,000 shares of common stock issuable upon exercise of options that do not vest within 60 days of July 12, 1999. (8) Includes 54,882 shares of common stock owned by Levy Family 2/14/96 Limited Partnership, of which Mr. Levy is the general partner. (9) Does not include options to purchase 50,000 shares of common stock issuable upon exercise of options that do not vest within 60 days of July 12, 1999. (10) Includes options to purchase 577,539 shares of common stock. (11) The address of Mr. Niebla is 7524 Saddlehill Trail, Orange, California 92869. (12) The general partner of Richards Capital Fund L.P. is Richards Managers L.P. The general partner of Richards Managers L.P. is Richards LLC. The address of Richards Capital Fund L.P. is c/o James C. Richards, 303 Peachtree Street, N.E., Suite 4100, Atlanta, GA 30308. (13) Mr. Alexander is the President of Bronto, Inc., which is the general partner of AFH Partners. The address of AFH Partners is c/o Bronto, Inc., 127 Farm Road, Sherborn, Massachusetts 01770. (14) The address of these stockholders is c/o Michael P. Hermsen, CFA, MassMutual Life Insurance Co., 1295 State Street, Springfield, Massachusetts 01111. 52
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CERTAIN RELATIONSHIPS AND RELATED-PARTY TRANSACTIONS In connection with the acquisition of Intermetrics by an investor group led by current management, we obtained a $35.0 million credit facility with Massachusetts Mutual Life Insurance Company, or MassMutual, and certain affiliates of MassMutual. This facility comprised $25 million in senior debt, $5 million in subordinated debt and $5 million in revolving credit. In connection with this facility, MassMutual and its affiliates received warrants to purchase shares of common stock. In connection with our acquisition of Pacer in February 1998, these warrants were exchanged for 605,286 shares of our common stock. At December 31, 1998, we owed $23.6 million under the senior term agreement, $5 million under the subordinated debt agreement and $2.5 million under the revolving credit agreement. An additional $2.5 million was available under the revolving credit agreement. We repaid the $2.5 million borrowed under the revolving credit early in 1999 as we collected outstanding receivables. In March 1999, we refinanced our outstanding debt in conjunction with our acquisition of CBSI, and repaid our outstanding debt of $23.2 million under the senior term agreement. Currently, we maintain the $5 million subordinated debt agreement with MassMutual. MassMutual is also one of our lenders under our credit agreement with First Union. In connection with our divestiture of IES, we: . Provided a $2.0 million credit facility to IES; . Received a $1.3 million promissory note from IES; and . Extended the due date of two $200,000 secured notes from IES. Outstanding amounts under the credit facility and the promissory note bear interest at a rate of 8.5% per year. Outstanding amounts under the secured notes bear interest at a rate of 10.5% per year. AfterDecember 31, 1999, we are not required to fund any additional amounts under the credit facility, which matures on December 31, 2001. The promissory note and secured notes mature on December 31, 2001. Mr. Levy and Mr. Schulte, both members of our board, are the principal officers of Joel N. Levy/Peter M. Schulte, LLC, or L&S, which supported the buy out of Intermetrics in August 1995. We have retained L&S to provide financial, strategic and business planning and consulting services, including analysis and advice with respect to programs relating to value of our common stock. The consulting agreement with L&S terminates on the first anniversary of this offering. The total amounts of fees paid to L&S by us in 1996, 1997 and 1998 were $100,000, $200,000 and $263,000, respectively. J. Fernando Niebla was founder, chairman and chief executive officer of Infotec Development Inc. until it was merged into Pacer, and vice-chairman of Pacer until we acquired Pacer. In connection with our formation, Mr. Niebla entered into a repurchase agreement with us. This agreement provides that during 1998, 1999, 2000 and 2001, he can require us to repurchase some of his shares of common stock. Our total cost to repurchase all of the shares of his common stock under this agreement is $1,557,000. However, approximately $1,000,000 of such amount will be paid by cancellation of the outstanding indebtedness owed to us by Mr. Niebla. Mr. Niebla's right to require us to repurchase some of his shares of common stock terminates upon the closing of this offering. Each of our stockholders, including executive officers, who own 3% or more of our common stock calculated on a fully diluted basis have granted us a right of first refusal to purchase their shares at the prevailing market price. For three years following the date of this prospectus, each of these stockholders, other than MassMutual and its affiliates, must offer their shares to us before they may sell their shares on the public market. If we do not buy these shares, then these stockholders may sell their shares on the public market. 53
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The following table sets forth loans made by us to our executive officers and 5% stockholders: [Download Table] Principal Amount Amount of Currently Name and Principal Position Loan Outstanding Interest Rate Due Date --------------------------- --------- ----------- ------------- -------- Michael B. Alexander........ $200,000 $100,000 8.4% August 31, 2000 Chief Executive Officer and $265,000 $ 0 7.0% Paid in Full Chairman of the Board of Directors Bruce A. Burton............. $ 80,000 $ 80,000 7.0% August 31, 2005 Executive Vice President Joseph A. Saponaro.......... $ 75,000 $ 0 Imputed Paid in Full President, Chief Operating interest Officer and Director based on IRS guidelines John C. Rennie.............. $ 94,762 $ 0 6.5% Paid in Full Vice Chairman of the Board of Directors Sigmund H. Goldblum......... $ 27,957 $ 0 6.5% Paid in Full Executive Vice President and Director J. Fernando Niebla.......... $848,730 $848,730 6.36% May 1, 2001 The amounts of the loans set forth above represent the largest principal amounts owed to us at any time during our last three fiscal periods, or since March 1, 1996. The loans set forth above are evidenced by notes, payable to us as indicated. 54
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DESCRIPTION OF SECURITIES The following descriptions of our common stock and preferred stock, and provisions of our certificate of incorporation and bylaws, reflect changes that will occur upon the filing of an amended and restated certificate of incorporation immediately prior to the closing of this offering. Our authorized capital stock consists of 25,000,000 shares of common stock, par value $.001 per share, and 1,000,000 shares of preferred stock, par value $.001 per share. Common Stock As of the date of this prospectus, there are 6,879,744 shares of common stock outstanding and held of record by 111 stockholders. Stockholders do not have cumulative voting with respect to the election of directors. There will be 10,880,655 shares of common stock outstanding upon the closing of this offering. Holders of common stock are entitled to one vote for each share on all matters submitted to a vote of stockholders. Holders of a majority of the shares of common stock entitled to vote in any election of directors may elect all of the directors standing for election. Stockholders will not be liable for any further calls or assessments. Holders of common stock are entitled to receive dividends, if, as and when declared by the board of directors out of funds legally available for such purposes, subject to any dividend preferences of any outstanding preferred stock. Upon our liquidation, dissolution or winding up, the holders of common stock are entitled to share ratably in our assets available for distribution, subject to the preferential rights of any outstanding preferred stock. Holders of the common stock have no preemptive, subscription, redemption or conversion rights. Upon the closing of this offering, there will be no shares of preferred stock outstanding. The rights, preferences and privileges of holders of common stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of preferred stock that we may designate and issue in the future. Preferred Stock As of the date of this prospectus, there are no shares of preferred stock outstanding. Upon the closing of this offering, the board of directors will be authorized, without further stockholder approval, to issue from time to time up to an aggregate of 1,000,000 shares of preferred stock in one or more series. The board of directors may fix or alter the designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each of these series, including the dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption price or prices, liquidation preferences and the number of shares constituting any series or designations of these series. We have no present plans to issue any shares of preferred stock. Stock Options Options to purchase a total of 3,349,447 shares of common stock may be granted under our stock option plan. As of the date of this prospectus, there are outstanding options to purchase a total of 1,513,433 shares of common stock under our stock option plan. Of these, stock options to purchase 757,055 shares are currently exercisable and options to purchase 504,180 shares will become exercisable upon the closing of this offering. As soon as practicable following the closing of this offering, we intend to file a registration statement on Form S-8 which will register the offer and sale of the shares to be issued upon exercise of these options. Upon the filing of the Form S-8, these shares will be immediately available for sale in the public market, subject to the terms of lock-up agreements entered into between certain of these option holders and the underwriters. Anti-Takeover Effects of Certain Provisions of Delaware Law and Our Certificate of Incorporation and Bylaws Delaware Law. We are subject to the provisions of Section 203 of the Delaware General Corporation Law, or the DGCL. Section 203 of the DGCL generally prohibits a publicly-held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the interested stockholder 55
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attained that status with the approval of the board of directors or unless the business combination is approved in a prescribed manner. A "business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to exceptions, an "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years did own, fifteen percent (15%) or more of a corporation's voting stock. The provisions of Section 203 of the DGCL are intended to assure that the price that stockholders receive for the common stock in certain transactions is fair in relation to the market value of and the prices paid by the "interested stockholder" in its initial acquisitions of common stock and to allow the board of directors and the stockholders to prevent the consummation of such a transaction because it may not be in our best interest or in the best interest of our stockholders. Under those circumstances in which this statute would apply, minority stockholders may prevent a transaction favored by a majority of stockholders. This statute could prohibit or delay the accomplishment of mergers or other takeover or change in control attempts with respect to us and, accordingly, may discourage attempts to acquire us. Our Certificate of Incorporation and Bylaws. Certain provisions of our certificate of incorporation and bylaws, which will be in effect upon the closing of this offering and which are described in the following paragraphs, may be deemed to have an anti-takeover effect and may delay, defer or prevent a tender offer or takeover attempt that a stockholder might consider in its best interest, including those attempts that might result in a premium over the market price for the shares held by stockholders. However, these provisions are designed to help to ensure that stockholders are treated fairly and equally in a multi-step acquisition, and are intended to encourage persons seeking to acquire control of us to pursue their acquisition in arms-length negotiations with our board of directors. Classified Board of Directors. Our board of directors is divided into three classes of directors serving staggered terms. The terms of our current directors expire at the 2000, 2001 or 2002 annual stockholders meeting. One class of directors will be elected at each annual stockholders meeting for a three-year term. This classification of directors may deter stockholders from changing the composition of our board of directors in a relatively short period of time. At least two annual stockholders meetings, instead of one, generally will be required to change the majority of directors. Because of the additional time required to change the directors, classification of directors also may delay the removal of our current management team. A classified board of directors helps to assure the continuity and stability of our board of directors and our business strategies and policies because generally a majority of directors at any given time will have had prior experience as directors. Board of Directors Vacancies. The certificate authorizes the board of directors to fill vacant directorships or increase the size of the board of directors. In addition, the certificate permits stockholders to remove directors only for cause. This may deter a stockholder from removing incumbent directors or simultaneously gaining control of the board of directors by filling the vacancies created by that removal with its own nominees. Stockholder Action; Special Meeting of Stockholders. The certificate provides that stockholders may only take action at duly called annual or special meetings of stockholders and not by written consent. The certificate further provides that special meetings of stockholders may be called only by the president, the chief executive officer, chairman of the board of directors or a majority of the board of directors. These provisions may delay a stockholders vote for a proposal over the objection of the board of directors. Advance Notice Requirements for Stockholder Proposals and Director Nominations. The bylaws provide that stockholders seeking to bring business before an annual meeting of stockholders, or to nominate candidates for election as directors at an annual meeting of stockholders, must deliver a written notice to our principal executive offices within a prescribed time period. The bylaws also specify requirements as to the form and content of a stockholder's notice. These provisions may preclude stockholders from bringing matters before an annual meeting of stockholders or from making nominations for directors at an annual meeting of stockholders. Advance notice requirements may also delay a contest for the election of directors, and discourage or deter a tender offer or takeover attempt. Authorized But Unissued Shares. The authorized but unissued shares of common stock and preferred stock are available for future issuance without stockholder approval, subject to limitations imposed by the Nasdaq 56
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National Market. These additional shares may be utilized for a variety of corporate purposes, including future public offerings, acquisitions and employee benefit plans. The existence of authorized but unissued and unreserved common stock and preferred stock could complicate or discourage an attempt to obtain control of us by means of a proxy contest, tender offer, merger or otherwise. Restrictions on Certain Business Combinations. The certificate contains provisions which are substantially similar to Section 203 of the DGCL. Such provisions may dely or discourage mergers or other acquisition attempts with respect to us. Vote Required to Amend our Certificate of Incorporation and Bylaws. Subject to certain exceptions, our certificate and bylaws require the vote of 80% of the stockholders to amend, repeal or adopt any provision inconsistent with the anti-takeover and indemnification provisions discussed in this prospectus. This supermajority vote prevents a controlling stockholder from avoiding the requirements of these provisions by simply amending or repealing such provisions. Limitation of Liability and Indemnification Matters To the extent permitted under the DGCL, the certificate limits the personal liability of our directors to us or our stockholders for monetary damages for any breach of fiduciary duty as our directors. Under the DGCL, our directors have a fiduciary duty to us that is not eliminated by this provision of the certificate and, in appropriate circumstances, injunctions and other nonmonetary relief will remain available. This provision also does not affect the directors' responsibilities under any other laws, including the federal securities laws. Section 145 of the DGCL enables a corporation to indemnify its directors and officers and to purchase insurance with respect to liability arising out of their capacity or status as directors and officers. However, this provision does not eliminate or limit the liability of a director: . For any breach of the director's duty of loyalty to the corporation or its stockholders; . For acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law; . For payments of dividends or approval of stock repurchases or redemptions that are prohibited by the DGCL; or . For any transaction from which the director derived an improper personal benefit. Our certificate of incorporation provides that we may fully indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding (whether civil, criminal, administrative or investigative) by reason of the fact that the person is or was one of our directors or officers or is or was serving at our request as a director or officer of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise, against expenses (including attorney's fees), judgments, fine and amount paid in settlement actually and reasonably incurred by that person in connection with any threatened, pending or completed action, suit or proceeding. We believe that the provisions of our certificate and bylaws are necessary to attract and retain qualified directors and executive officers. Our bylaws also permit us to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions, regardless of whether the DGCL would permit indemnification. We have obtained liability insurance for our officers and directors. At present, there is no pending litigation or proceeding involving any director, officer, employee or agent for which indemnification will be required or permitted under the certificate. We are not aware of any threatened litigation or proceeding that may result in a claim for indemnification. Transfer Agent and Registrar The transfer agent and registrar for the common stock will be Chase Mellon Shareholder Services, Ridgefield Park, New Jersey. 57
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SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has not been any public market for our common stock. We cannot predict the effect, if any, that market sales of shares of common stock or the availability of shares of common stock for sale will have on the prevailing market price of our common stock. Nevertheless, sales of substantial amounts of common stock in the public market, or the perception that such sales could occur, could adversely affect the market price of our common stock and could impair our future ability to raise capital through the sale of our equity securities. Upon the closing of this offering, we will have an aggregate of 10,880,655 shares of common stock outstanding, assuming no exercise of the underwriters' over-allotment option and no exercise of outstanding options. Of the outstanding shares, the 4,000,000 shares being sold in this offering will be freely tradable, subject to the lock-up agreements and the right of first refusal described below. Additional shares will be available for sale in the public market as follows: [Download Table] Number of Shares Date ---------------- ----------------------------------------------------------- 21,929 After the date of this prospectus, subject to volume limitations in some cases 6,857,815 After 180 days from the date of this prospectus, subject to volume limitations in some cases 1,513,433 Upon the filing of a registration statement on Form S-8 to register the offer and sale of shares of common stock issuable upon the exercise of options granted under our stock option plan In general, under Rule 144, as currently in effect, a person, or persons whose shares are required to be aggregated, including an affiliate, who has beneficially owned shares for at least one year is entitled to sell, within any three-month period commencing 90 days after the date of this prospectus, a number of shares that does not exceed the greater of: . 1% of the then outstanding shares of common stock, approximately 108,881 shares, immediately after this offering; or . The average weekly trading volume in the common stock during the four calendar weeks preceding the date on which notice of that sale is filed, subject to restrictions. In addition, a person who is not deemed to have been our affiliate at any time during the 90 days preceding a sale and who has beneficially owned the shares proposed to be sold for at least two years is entitled to sell those shares under Rule 144(k) without regard to the requirements described above. To the extent that shares are acquired from our affiliate, the acquiring person's holding period for the purpose of effecting a sale under Rule 144 generally commences on the date of transfer from the affiliate. As of the date of this prospectus, options to purchase a total of 1,513,433 shares of common stock are outstanding, of which options to purchase 757,055 shares are currently exercisable. Of the options to purchase 756,378 shares of common stock that are not currently exercisable, options to purchase 504,180 shares of common stock shall immediately vest and become exercisable upon the closing of this offering. Upon the commencement of this offering, we intend to file a registration statement to register the 1,836,014 shares of common stock reserved for issuance under the stock option plan. That registration statement will automatically become effective upon filing. Accordingly, shares issued upon the exercise of stock options granted under the stock option plan will be eligible for resale in the public market from time to time, subject to vesting restrictions and, in the case of some of the options, the lock-up agreements and the right of first refusal referred to below. Our directors and officers and stockholders who hold 6,871,537 shares in the aggregate, together with the holders of options to purchase 1,513,433 shares of common stock, have agreed that they will not sell, directly or indirectly, any shares of common stock without the prior written consent of Bear, Stearns & Co. Inc. for a period of 180 days from the date of this prospectus. Please see "Underwriting." 58
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Except in limited circumstances, we have agreed not to sell or otherwise dispose of any shares of common stock during the 180-day period following the date of the prospectus. Stockholders who own more than 3% of our common stock calculated on a fully diluted basis, have granted us a right of first refusal to purchase their shares at the prevailing market price. For three years following the date of this prospectus, these stockholders, other than MassMutual and its affiliates, must offer their shares to us before they may sell their shares on the public market. If we do not buy these shares, then these stockholders may sell their shares on the public market. 59
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UNDERWRITING The underwriters of this offering named below, for whom Bear, Stearns & Co. Inc. and Legg Mason Wood Walker, Incorporated are acting as representatives, have severally agreed with us, subject to the terms and conditions of the underwriting agreement, to purchase from us the aggregate number of shares of common stock set forth opposite their respective names below: [Download Table] Underwriter Number of Shares ----------- ---------------- Bear, Stearns & Co. Inc..................................... Legg Mason Wood Walker, Incorporated........................ --------- Total..................................................... 4,000,000 ========= The underwriting agreement provides that the obligations of the several underwriters are subject to approval of certain legal matters by counsel and to various other conditions. We have agreed to indemnify the several underwriters against certain liabilities, including liabilities under the Securities Act, and where such indemnification is unavailable, to contribute to payments that the underwriters may be required to make in respect of such liabilities. The nature of the underwriters' obligations is such that they are committed to purchase and pay for all of the above shares of common stock if any are purchased. If the underwriters sell more than the total number set forth in the table above, the underwriters have an option to buy up to an additional 600,000 shares to cover such sales from us. The underwriters may exercise that option for 30 days. If any shares are purchased pursuant to this option, the underwriters will severally purchase shares in the same proportion as set forth in the table above. The underwriters, at our request, have reserved for sale at the initial public offering price up to 200,000 of the shares of common stock to be sold in this offering for sale to our employees and directors and other persons designated by us. The number of shares available for sale to the general public will be reduced to the extent that any reserved shares are purchased. Any reserved shares not so purchased will be offered by the underwriters on the same basis as the other shares offered hereby. The underwriters do not expect to confirm sales of common stock to any accounts over which they exercise discretionary authority. We, all of our directors and officers and stockholders holding an aggregate of 6,857,815 shares of our common stock have agreed that, subject to certain exceptions, for a period of 180 days from the date of this prospectus, without the prior written consent of Bear, Stearns & Co. Inc., which may be waived, we will not, directly or indirectly, issue, sell, offer or agree to sell, grant any option for the sale of, pledge, make any short sale, establish an open "put equivalent position" within the meaning of Rule 16a-1(h) under the Exchange Act or otherwise dispose of any shares of our common stock or securities convertible into, exercisable for or exchangeable for our common stock. The following table shows the per share and total underwriting discounts and commissions to be paid to the underwriters by us. These amounts are shown assuming both no exercise and full exercise of the underwriters' option to purchase additional shares. [Download Table] No Exercise Full Exercise ----------- ------------- Per Share.......................................... $ $ Total.............................................. $ $ 60
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Shares sold by the underwriters to the public will initially be offered at the public offering price set forth on the cover of this prospectus. Any shares sold by the underwriters to securities dealers may be sold at a discount of up to $ per share from the public offering price. Any such securities dealers may resell any shares purchased from the underwriters to certain other brokers or dealers at a discount of up to $ per share from the public offering price. If all the shares are not sold at the offering price, the representatives may change the offering price and the other selling terms. Prior to this offering, there has been no public market for our common stock. Consequently, the initial public offering price for the common stock will be determined by negotiations among us and the representatives of the underwriters. Among the factors to be considered in those negotiations will be: . Our results of operations in recent periods; . Estimates of our prospects and the industry in which we compete; . An assessment of our management; . The general state of the securities markets at the time of this offering; and . The prices of similar securities of generally comparable companies. We have applied to have our common stock approved for quotation on the Nasdaq National Market under the symbol ASTR. However, there can be no assurance that an active or orderly trading market will develop for the common stock or that the common stock will trade in the public markets subsequent to this offering at or above the initial offering price. In connection with the offering, certain persons participating in this offering may purchase and sell shares of common stock in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve the sale by the underwriters of a greater number of shares than they are required to purchase in this offering. Stabilizing transactions consist of certain bids or purchases made for the purpose of preventing or retarding a decline in the market price of the common stock while this offering is in progress. The underwriters also may impose a penalty bid. This occurs when a particular underwriter repays to the underwriters a portion of the underwriting discount received by it because the representative has repurchased shares sold by or for the account of such underwriter in stabilizing or short covering transactions. These activities by the underwriters may stabilize, maintain or otherwise affect the market price of the common stock. As a result, the price of the common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the underwriters at any time. These transactions may be effected on the Nasdaq National Market, in the over-the-counter market or otherwise. We estimate that the total expenses of the offering, excluding underwriting discounts and commissions, will be approximately $1,100,000. In the ordinary course of business, certain of the underwriters and their affiliates have provided, and may in the future provide, financial advisory and investment banking services for us and our affiliates for customary fees. Legg Mason Wood Walker, Incorporated acted as financial advisor to CBSI in connection with the acquisition of CBSI by us and was paid a fee by CBSI of $625,000 for their services plus expenses and was also given the right to receive up to an additional $25,000 based on the achievement of certain financial thresholds by CBSI. LEGAL MATTERS The validity of the shares of common stock offered by this prospectus will be passed upon for us by Swidler Berlin Shereff Friedman, LLP, New York, New York, and for the underwriters by Proskauer Rose LLP, New York, New York. 61
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EXPERTS The consolidated financial statements and schedule of AverStar, Inc. at December 31, 1997 and 1998, and for the year ended February 27, 1997, the ten- month period ended December 31, 1997 and the year ended December 31, 1998 appearing in this prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing. The consolidated financial statements of Pacer Infotec, Inc. and subsidiaries at December 31, 1996 and 1997, and for the years then ended and for the two months ended December 31, 1998, appearing in this prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing. The financial statements of Looking Glass Technologies, Inc. for the year ended March 31, 1997 and the period from April 1, 1997 through August 8, 1997, appearing in this prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing. The financial statements for CBSI as of December 31, 1997 and 1998 included in this prospectus have been audited by Aronson, Fetridge & Weigle, independent auditors, as stated in their report appearing in this prospectus. These financial statements have been included in reliance upon the report of Aronson, Fetridge & Weigle, upon the authority of said firm as experts in accounting and auditing. The financial statements for CBSI as of December 31, 1996 included in this prospectus have been audited by Grant Thornton LLP, independent auditors, as stated in their report appearing in this prospectus. These financial statements have been included in reliance upon the report of Grant Thornton LLP, upon the authority of said firm as experts in accounting and auditing. WHERE YOU CAN FIND ADDITIONAL INFORMATION We have filed with the SEC a registration statement on Form S-1, including amendments, exhibits, annexes and schedules, under the Securities Act with respect to the shares of common stock to be sold in this offering. This prospectus does not contain all of the information set forth in the registration statement. For further information with respect to us and our common stock to be sold in this offering, reference is made to the registration statement. Statements contained in this prospectus as to the contents of any contract or other documents referred to are not necessarily complete. In each instance, reference is made to the copy of that contract or document filed as an exhibit to the registration statement. You may read and copy all or any portion of the registration statement or any other information we file with the SEC, at the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can request copies of these documents, upon payment of a duplicating fee, by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference rooms. Our SEC filings, including the registration statement, are also available to you on the SEC's web site, www.sec.gov. As a result of this offering, we will become subject to the information and reporting requirements of the Securities Exchange Act, and, in accordance with those requirements, will file periodic reports, proxy statements and other information with the SEC. These reports, proxy and information statements and other information may also be inspected at the offices of Nasdaq Operations, 1735 K Street, N.W., Washington, D.C. 20006. We intend to furnish our stockholders with annual reports containing audited financial statements and with quarterly reports for the first three quarters of each year containing unaudited interim financial information. 62
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AVERSTAR, INC. INDEX TO FINANCIAL STATEMENTS [Download Table] Page ---- Unaudited Pro Forma Condensed Consolidated Financial Information Overview................................................................. F-2 Unaudited Pro Forma Condensed Consolidated Balance Sheet, as of December 31, 1998................................................................ F-3 Unaudited Pro Forma Condensed Consolidated Statement of Operations for the year ended December 31, 1998........................................ F-4 Unaudited Pro Forma Condensed Consolidated Statement of Operations for the three months ended March 31, 1999................................... F-5 Notes to Unaudited Pro Forma Condensed Consolidated Financial Information............................................................. F-6 AverStar, Inc. Report of Independent Auditors........................................... F-8 Consolidated Balance Sheets as of December 31, 1997 and 1998 and March 31, 1999................................................................ F-9 Consolidated Statements of Operations for the year ended February 28, 1997, the ten-month period ended December 31, 1997, the year ended December 31, 1998 three months ended March 31, 1998 and three months ended March 31, 1999.................................................... F-10 Consolidated Statements of Changes in Redeemable Common Stock and Stockholders' Deficit for the year ended February 28, 1997, the ten- month period ended December 31, 1997, the year ended December 31, 1998 and the three months ended March 31, 1999............................... F-11 Consolidated Statements of Cash Flows for the year ended February 28, 1997, the ten-month period ended December 31, 1997, the year ended December 31, 1998 and the three months ended March 31, 1998 and 1999.... F-12 Notes to Consolidated Financial Statements............................... F-13 Computer Based Systems, Inc. Report of Independent Auditors........................................... F-25 Report of Independent, Certified Public Accountants...................... F-26 Balance Sheets as of December 31, 1997 and 1998.......................... F-27 Statements of Operations for the years ended December 31, 1996, 1997 and 1998.................................................................... F-28 Statements of Other Comprehensive Income for the years ended December 31, 1996, 1997 and 1998..................................................... F-29 Statements of Stockholders' Equity for the years ended December 31, 1996, 1997 and 1998........................................................... F-30 Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998.................................................................... F-31 Notes to Financial Statements for the years ended December 31, 1998, 1997 and 1996................................................................ F-32 Pacer Infotec, Inc. and Subsidiaries Report of Independent Auditors........................................... F-38 Consolidated Balance Sheets as of December 31, 1996 and 1997............. F-39 Consolidated Statements of Operations for the years ended December 31, 1996 and 1997 and the period from January 1, 1998 to February 28, 1998.. F-40 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996 and 1997 and the period from January 1, 1998 to February 28, 1998....................................................... F-41 Consolidated Statements of Cash Flows for the years ended December 31, 1996 and 1997 and the period from January 1, 1998 to February 28, 1998.. F-42 Notes to Consolidated Financial Statements............................... F-43 Looking Glass Technologies, Inc. Report of Independent Auditors........................................... F-50 Statements of Operations for the year ended March 31, 1997 and the period from April 1, 1997 through August 8, 1997............................... F-51 Statement of Changes in Stockholders' Equity (Deficit) for the year ended March 31, 1997 and the period from April 1, 1997 through August 8, 1997.................................................................... F-52 Statements of Cash Flows for the year ended March 31, 1997 and the period from April 1, 1997 through August 8, 1997............................... F-53 Notes to Consolidated Financial Statements............................... F-54 F-1
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AVERSTAR, INC. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION Overview On February 27, 1998, we acquired Pacer. The purchase price was approximately $17 million, plus transaction-related expenses of approximately $1.7 million. Of the total purchase price, approximately $7 million was paid in cash to Pacer shareholders, with the balance paid by the issuance of approximately 2,255,000 shares of our common stock. The merger has been accounted for using the purchase method of accounting. On March 18, 1999, we acquired Computer Based Systems, Inc. for $26 million. We did not acquire certain assets of CBSI that we believed were not related to IT operations. $25 million of the purchase price was paid at the closing, with the $1 million balance to be paid equally over five years. The transaction costs are estimated to be $600,000. The purchase price is subject to adjustment, based on CBSI's net worth on the closing date. Simultaneous with the CBSI closing, we entered into a $75 million secured financing agreement comprised of $45 million in senior term loans and a $30 million revolving credit note. Expenses associated with the financing were estimated to be $1.9 million. Proceeds from the financing agreement were used to acquire CBSI and retire debt, and for working capital purposes. The senior term loans are comprised of two tranches: Term A of $15 million with periodic principal payments maturing in five years carrying a variable interest rate of up to LIBOR plus 2.75% and Term B of $30 million with periodic payments maturing in six years carrying a variable interest rate of LIBOR plus 3%. The Unaudited Pro Forma Condensed Consolidated Statement of Operations for the year ended December 31, 1998 gives effect to the acquisitions of Pacer and CBSI, including the financing of these acquisitions, as if they had occurred on January 1, 1998. The Unaudited Pro Forma Condensed Statement of Operations includes the historical results of operations of Pacer for the two months ended February 28, 1998 and CBSI for the year ended December 31, 1998. The Unaudited Pro Forma Condensed Consolidated Balance Sheet gives effect to the acquisition of CBSI as if it had occurred on December 31, 1998. The following pro forma statements and the accompanying notes should be read in conjunction with the historical financial statements of us, Pacer and CBSI and notes thereto. The Unaudited Pro Forma Condensed Consolidated Financial Information is intended for informational purposes only and is not necessarily indicative of the future position or future results of operations of the consolidated company after the acquisitions of Pacer and CBSI or of the financial position or results of operations of the consolidated company that would have actually occurred had the acquisitions of Pacer and CBSI been effected on January 1, 1998. F-2
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AVERSTAR, INC. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET (In thousands) [Download Table] As of December 31, 1998 ------------------- Pro Forma Pro Forma AverStar CBSI Adjustments Balance Sheet ---------- -------- ----------- ------------- Assets Cash and cash equivalents... $ 332 $ 1,305 $ -- $ 1,637 Accounts receivable, net of allowances................. 23,923 12,311 -- 36,234 Unbilled receivable, net of allowances................. 10,261 -- -- 10,261 Other current assets........ 3,496 1,525 (761) 1)e 4,260 -------- -------- ------- ------- Total current assets...... 38,012 15,141 (761) 52,392 Fixed assets, net........... 4,264 2,912 (2,399) 1)e 4,777 Intangible and other assets, net........................ 15,593 -- 21,880 1)a,d 37,473 Other assets................ 1,794 88 -- 1,882 -------- -------- ------- ------- Total assets.............. $ 59,663 __18,141$ _18,720$ $96,524 ======== ======== ======= ======= Liabilities & Stockholders' Equity (Deficit) Revolving credit note payable.................... $ 2,500 $ 1,357 $ 7,520 1)c,e $11,377 Accounts payable & accrued expenses................... 25,302 6,537 (1,137) 1)e 30,702 Due to stockholders......... -- -- 826 1)a 826 Current portion of long-term debt....................... 954 514 (514) 1)e 954 -------- -------- ------- ------- Total current liabilities.............. 28,756 8,408 6,695 43,859 Long-term debt.............. 28,156 1,413 20,004 1)c,e 49,573 Other long-term liabilities................ 565 341 -- 906 Redeemable common stock..... 5,598 -- -- 5,598 Stockholders' equity (deficit).................. (3,412) 7,979 (7,979) 1)b,e (3,412) -------- -------- ------- ------- Total liabilities and stockholders' equity (deficit)................ $ 59,663 __18,141$ _18,720$ $96,524 ======== ======== ======= ======= F-3
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AVERSTAR, INC. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (In thousands, except per share data) [Enlarge/Download Table] For the year ended December 31, 1998 ----------------------------------------- 2 Months of Pro Forma Pro Forma AverStar Pacer CBSI Adjustments Total ------------- --------------------------- ----------- --------- Revenue................. $ 121,056 $ 7,479 $ 40,685 $ (181) 2)f $169,039 Costs and expenses: Cost of revenues...... 93,604 6,230 28,686 -- 128,520 Selling, general and administrative expenses............. 20,581 1,180 10,296 3,294 2)a,b,c 35,351 ------------- ----------- ------------ ------- -------- Income from continuing operations before interest and taxes..... 6,871 69 1,703 (3,475) 5,168 Interest, net......... 2,269 65 236 2,159 2)d,f 4,729 ------------- ----------- ------------ ------- -------- Income from continuing operations before taxes.................. 4,602 4 1,467 (5,634) 439 Provision for income taxes................ 2,168 4 -- (1,806) 2)e 366 ------------- ----------- ------------ ------- -------- Net income from continuing operations.. 2,434 -- 1,467 (3,828) 73 ============= =========== ============ ======= ======== Basic net income per share.................. $ 0.38 $ 0.01 ============= ======== Weighted average shares used in computing net income per share....... 6,428 6,428 ============= ======== Diluted net income per share.................. $ 0.36 $ 0.01 ============= ======== Weighted average shares used in computing diluted net income per share.................. 6,847 6,847 ============= ======== F-4
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AVERSTAR, INC. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS For the three months ended March 31, 1999 (In thousands, except per share data) [Download Table] AverStar CBSI Three Months January 1, 1999 Ended March 31, to March 21, Pro Forma Pro Forma 1999 1999 Adjustments Total --------------- --------------- ----------- --------- Revenue................. $36,346 $10,724 $ (122) 3)e $46,948 Costs and expenses: Cost of revenues...... 28,841 7,280 36,121 Selling, general and administrative expenses............. 5,297 2,482 $ (699 3)a,b 8,478 ------- ------- ------- ------- Income from continuing operations before interest and taxes..... 2,208 962 (821) 2,349 Interest, net......... 760 42 459 3)c,e 1,261 ------- ------- ------- ------- Income from continuing operations before taxes.................. 1,448 920 $(1,280) 1,088 Provision for income taxes................ 656 -- (177) 3)d 479 ------- ------- ------- ------- Net income from continuing operations.. $ 792 $ 920 $(1,103) $ 609 Basic net income per share.................. $ 0.11 $ 0.09 Weighted average shares used in computing net income per share....... 6,927 6,927 Diluted net income per share.................. $ 0.11 $ 0.08 Weighted average shares used in computing diluted net income per share.................. 7,440 7,440 F-5
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AVERSTAR, INC. NOTES TO THE UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION 1. Pro Forma Adjustments and Assumptions--Balance Sheet The pro forma adjustments to the unaudited pro forma condensed consolidated balance sheet, assuming the acquisition occurred on December 31, 1998 are as follows: 1(a) Adjustment to record the purchase price and intangible assets acquired of CBSI as follows: [Download Table] Cash portion of purchase price............................. $25,000,000 Present value for non-competition agreement to be paid over 5 years................................................... 825,830 Estimated transaction costs................................ 600,000 ----------- Purchase price............................................. 26,425,830 Less: estimated fair value of net assets to be acquired as of December 31, 1998...................................... 6,446,000 ----------- Estimated cost in excess of fair value of net assets acquired (goodwill)....................................... $19,979,830 =========== Of the estimated amount of goodwill, the Company expects to allocate this amount and amortize it over estimated useful lives as follows: [Download Table] Contract backlog.................................... $2,300,000 18 Months Assembled workforce................................. 1,000,000 4 Years Non-competition agreement........................... 825,830 5 Years Residual............................................ 15,854,000 20 Years 1(b) Adjustment to eliminate the equity of CBSI in consolidation. 1(c) Adjustment to record the financing from First Union for the acquisition of CBSI as follows: [Download Table] Senior Term Loan A........................................... $15,000,000 Senior Term Loan B........................................... 30,000,000 Revolver loan drawdown....................................... 6,458,000 ----------- Total Amount Borrowed...................................... $51,458,000 Senior Notes repayment....................................... 23,958,000 ----------- Additional Borrowings...................................... $27,500,000 =========== 1(d) Adjustment to record the estimated financing costs of $1,900,000 associated with the refinancing with First Union to be amortized over 6 years. 1(e) Adjustments to eliminate the assets and liabilities of CBSI not acquired, which are as follows: [Download Table] Land and building............................................ 2,455,000 Tenant improvements.......................................... 119,000 Accumulated depreciation..................................... (175,000) Notes and other receivables.................................. 761,000 Long-term debt............................................... (1,927,000) Income taxes................................................. (1,137,000) F-6
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2. Pro Forma Adjustments and Assumptions--Statement of Operations The pro forma adjustments to the unaudited pro forma condensed consolidated statement of operations, assuming the acquisition occurred on January 1, 1998, are as follows: 2(a) Adjustment to record 12 months of amortization associated with the CBSI intangible assets acquired as follows: [Download Table] Contract backlog............................................. $1,533,000 Assembled workforce.......................................... 250,000 Cost in excess of net assets acquired........................ 765,000 Non-competition agreement.................................... 165,000 ---------- Total...................................................... $2,713,000 ========== 2(b) Adjustment to record 2 months of amortization associated with the Pacer intangible assets acquired as follows: [Download Table] Contract backlog............................................... $189,000 Assembled workforce............................................ 25,000 Cost in excess of net assets acquired.......................... 50,000 -------- Total........................................................ $264,000 ======== 2(c) Adjustment to record the amortization of the financing costs associated with the First Union refinancing. 2(d) Adjustment to record the incremental interest costs associated with the First Union Senior and Revolving Credit Notes used to finance the acquisition of CBSI. The interest rate on the Company's new borrowing is comparable to those in prior borrowing arrangements. 2(e) Adjustment to record the federal and state income taxes associated with CBSI operations assumed to be part of a C Corporation in 1998 and with the pro forma adjustments based upon the statutory rates in effect. 2(f) Adjustment to eliminate earnings for real estate and interest expense for real estate property not acquired. The pro forma adjustments to the unaudited pro forma condensed consolidated statement of operations, assuming the acquisition occurred on January 1, 1999, are as follows: 3(a) Adjustment to record amortization from January 1, 1999 to March 21, 1999 associated with the CBSI intangible assets acquired. 3(b) Adjustment to record the amortization of the financing costs from January 1, 1999 to March 18, 1999 associated with the First Union refinancing. 3(c) Adjustment to record the incremental interest costs associated with the First Union Senior and Revolving Credit Notes used to finance the acquisition of CBSI. The interest rate on the Company's new borrowing is comparable to those in prior borrowing arrangements. 3(d) Adjustment to record the federal and state income taxes associated with CBSI operations assumed to be part of a C corporation in 1999 and with the pro forma adjustments based upon the statutory rates in effect. 3(e) Adjustment to eliminate earnings for real estate and interest expense for real estate property not acquired. F-7
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AVERSTAR, INC. REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders of AverStar, Inc. We have audited the accompanying consolidated balance sheets of AverStar, Inc. (the Company), as of December 31, 1997 and 1998, and the related consolidated statements of operations, changes in stockholders' deficit, and cash flows for the year ended February 28, 1997, the ten-month period ended December 31, 1997 and the year ended 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of AverStar, Inc. at December 31, 1997 and 1998, and the consolidated results of its operations and its cash flows for the year ended February 28, 1997, the ten-month period ended December 31, 1997 and the year ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Boston, Massachusetts March 30, 1999 F-8
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AVERSTAR, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts) [Download Table] December 31 ------------------ March 31, 1997 1998 1999 -------- -------- ----------- (Unaudited) ASSETS Current assets: Cash and cash equivalents..................... $ 131 $ 332 $ 1,777 Accounts receivable, net of allowances of $169,000 and $287,000 at December 31, 1997 and 1998 and $293,000 at March 31, 1999 (unaudited).................................. 11,423 23,923 31,857 Unbilled receivables, net of allowances of $265,000 and $310,000 at December 31, 1997 and 1998 and $329,000 at March 31, 1999 (unaudited).................................. 4,927 10,261 13,888 Other current assets.......................... 740 1,100 1,333 Refundable income taxes....................... 1,050 1,662 1,006 Deferred income taxes......................... -- 734 734 -------- -------- ------- Total current assets......................... 18,271 38,012 50,595 Property and equipment: Land.......................................... -- 90 90 Computer, equipment and furniture............. 4,591 9,711 12,183 Building and improvements..................... 832 1,610 1,707 -------- -------- ------- 5,423 11,411 13,980 Less allowances for depreciation.............. 2,337 7,147 8,998 -------- -------- ------- 3,086 4,264 4,982 Other assets: Deferred income taxes......................... -- 1,794 1,794 Intangible and other assets, net.............. 2,289 15,593 36,841 -------- -------- ------- 2,289 17,387 38,635 -------- -------- ------- Total assets................................. $ 23,646 $ 59,663 $94,212 ======== ======== ======= LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable.............................. $ 5,634 $ 7,371 $ 7,432 Accrued payroll and employee benefits......... 2,850 7,109 11,005 Accrued liabilities........................... 3,559 9,909 13,144 Revolving credit notes payable................ 2,000 2,500 8,745 Current portion of long-term debt............. 735 954 1,704 Unearned revenue.............................. 926 913 912 -------- -------- ------- Total current liabilities.................... 15,704 28,756 42,942 Long-term debt: Senior debt................................... 7,833 23,583 43,125 Subordinated debt............................. 4,492 4,573 4,595 -------- -------- ------- 12,325 28,156 47,720 Net liabilities of discontinued operations..... -- 565 -- Redeemable common stock issued and outstanding, 1,179,225, 2,202,875 and 2,202,875 shares at December 31, 1997 and 1998 and March 31, 1999 (unaudited)................................... 1,412 5,598 5,598 Stockholders' deficit: Common Stock, $.001 par value per share- authorized 9,146,950 shares in 1997 and 17,000,000 in 1998 and March 31, 1999 (unaudited); issued 2,850,011, 4,766,344 and 4,766,344 shares at December 31, 1997 and 1998 and March 31, 1999 (unaudited).......... 3 5 5 Additional paid in capital.................... 4,502 9,624 10,189 Accumulated deficit........................... (10,159) (12,847) (12,055) Deferred compensation......................... (106) (80) (73) Treasury stock at cost, 23,306, 42,105 and 42,105 shares at December 31, 1997 and 1998 and March 31, 1999 (unaudited)............... (35) (114) (114) -------- -------- ------- Total stockholders' deficit.................. (5,795) (3,412) (2,048) -------- -------- ------- Total liabilities and stockholders' deficit.................................... $ 23,646 $ 59,663 $94,212 ======== ======== ======= The accompanying notes are an integral part of these consolidated financial statements. F-9
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AVERSTAR, INC. CONSOLIDATED STATEMENT OF OPERATIONS For the year ended February 28, 1997, ten months ended December 31, 1997, year ended December 31, 1998, three months ended March 31, 1998 and three months ended March 31, 1999 (In thousands, except per share amounts) [Download Table] (unaudited) Years Ended Three Months Ended -------------------------------------- ------------------- February 28, December 31, December 31, March 31, March 31, 1997 1997 1998 1998 1999 ------------ ------------ ------------ --------- --------- Revenues................ $53,274 $53,646 $121,056 $22,738 $36,346 Costs and Expenses Cost of revenues...... 40,704 41,685 93,604 17,310 28,841 Selling, general and administrative....... 11,244 10,403 20,581 4,166 5,297 ------- ------- -------- ------- ------- Income from operations.. 1,326 1,558 6,871 1,262 2,208 Interest expense, net... 1,281 1,206 2,269 476 760 ------- ------- -------- ------- ------- Income from continuing operations before income taxes........... 45 352 4,602 786 1,448 Provision for income taxes.................. 18 154 2,168 370 656 ------- ------- -------- ------- ------- Income from continuing operations............. 27 198 2,434 416 792 Loss from discontinued operations, net of income tax benefit of $664,000 for the year ended December 31, 1997, $1,659,000 for the year ended December 31, 1998, and $396,000 for the three months ended March 31, 1998 (unaudited)............ -- (1,727) (2,489) (593) -- Loss on disposal of discontinued operations, net of income tax benefit of $1,267,000............. -- -- (2,633) -- -- ------- ------- -------- ------- ------- Net income (loss)....... $ 27 $(1,529) $ (2,688) $ (177) $ 792 ======= ======= ======== ======= ======= Earnings per share: Basic Income from continuing operations........... $ 0.01 $ 0.05 $ 0.38 $ 0.08 $ 0.11 Discontinued operations........... -- (0.45) (0.80) (0.12) -- ------- ------- -------- ------- ------- Net income (loss)..... $ 0.01 $ (0.40) $ (0.42) $ (0.04) $ 0.11 ======= ======= ======== ======= ======= Diluted Income from continuing operations........... $ 0.01 $ 0.04 $ 0.36 $ 0.08 $ 0.11 Discontinued operations........... -- (0.45) (0.80) (0.12) -- ------- ------- -------- ------- ------- Net income (loss)..... $ 0.01 $ (0.40) $ (0.42) $ (0.04) $ 0.11 ======= ======= ======== ======= ======= Weighted-average shares outstanding: Basic................... 3,878 3,865 6,428 4,991 6,927 Diluted................. 4,523 4,552 6,847 5,470 7,440 The accompanying notes are an integral part of these consolidated financial statements. F-10
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AVERSTAR, INC. CONSOLIDATED STATEMENTS OF CHANGES IN REDEEMABLE COMMON STOCK AND STOCKHOLDERS' DEFICIT (In thousands) [Enlarge/Download Table] Stockholders' Deficit ----------------------------------------------------------------------------- Redeemable Treasury Common Stock Common Stock Additional Stock -------------- ------------- Paid-In Accumulated Deferred ------------ Stockholders' Shares Amount Shares Amount Capital Deficit Compensation Shares Cost Deficit ------ ------ ------ ------ ---------- ----------- ------------ ------ ----- ------------- Balance, February 29, 1996.................. 1,179 $1,147 2,699 $ 3 $ 4,129 $ (8,657) $(4,525) Payment of promissory notes................ 133 -- Net income............ 27 27 ----- ------ ----- ---- ------- -------- ----- --- ----- ------- Balance, February 28, 1997.................. 1,179 $1,280 2,699 $ 3 $ 4,129 $ (8,630) -- -- -- $(4,498) Payment of promissory notes................ 132 -- Purchase of treasury stock................ (23) (35) (35) Deferred compensation......... 133 (133) -- Stock option vesting.. 27 27 Stock contribution to Profit Sharing Plan.. -- 151 240 240 Net loss.............. (1,529) (1,529) ----- ------ ----- ---- ------- -------- ----- --- ----- ------- Balance, December 31, 1997.................. 1,179 $1,412 2,850 $ 3 $ 4,502 $(10,159) $(106) (23) $ (35) $(5,795) Issuance of shares in connection with acquisition.......... 1,030 4,211 1,831 2 5,010 5,012 Options Exercised..... -- -- 79 -- 87 87 Purchased treasury stock................ -- (13) (54) (54) Redeemed stock........ (6) (25) 6 -- 25 (6) (25) -- Deferred compensation......... 26 26 Net loss.............. (2,688) (2,688) ----- ------ ----- ---- ------- -------- ----- --- ----- ------- Balance, December 31, 1998.................. 2,203 $5,598 4,766 $ 5 $ 9,624 $(12,847) $ (80) (42) $(114) $(3,412) Distribution to shareholders of net liabilities of discontinued operation (unaudited).......... 565 565 Deferred compensation (unaudited).......... 7 7 Net income (unaudited).......... 792 792 ----- ------ ----- ---- ------- -------- ----- --- ----- ------- Balance, March 31, 1999.................. 2,203 $5,598 4,766 $ 5 $10,189 $(12,055) $ (73) (42) $(114) $(2,048) ===== ====== ===== ==== ======= ======== ===== === ===== ======= The accompanying notes are an integral part of these consolidated financial statements. F-11
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AVERSTAR, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the year ended February 28, 1997, ten months ended December 31, 1997, year ended December 31, 1998 and three months ended March 31, 1998 and 1999 (In thousands) [Download Table] (Unaudited) ------------------- February 28, December 31, December 31, March 31, March 31, 1997 1997 1998 1998 1999 ------------ ------------ ------------ --------- --------- Cash Flows from Operating Activities Income from continuing operations............. $ 27 $ 198 $ 2,434 $ 416 $ 792 Adjustments to derive cash flows from continuing operating activities: Depreciation and amortization.......... 2,151 935 3,228 568 838 Changes in deferred income taxes.......... (78) 29 (2,384) -- -- Loss on disposal of fixed assets.......... 22 5 315 95 -- Change in assets and liabilities Accounts receivable.... (1,034) (839) (7,987) (1,835) (1,535) Unbilled receivables... 706 (1,322) 209 592 (253) Other current assets... 143 (110) 861 103 1 Accounts payable....... (223) 2,323 (3,451) (723) (1,639) Accrued payroll and employee benefits..... (519) 487 1,491 (936) 985 Accrued liabilities.... (902) 422 6,817 636 1,082 Unearned revenue....... (272) (71) 378 378 -- Refundable income taxes................. 412 (1,050) (612) -- 656 ------- ------- ------- ------- ------- Net cash provided by (used in) continuing operating activities... 433 1,007 1,299 (706) 927 Net cash used by discontinued operating activities............. (1,367) (8,951) (2,230) -- ------- ------- ------- ------- ------- Net cash provided by (used in) operating activities............. 433 (360) (7,652) (2,936) 927 Cash flows from investing activities: Acquisitions net of cash acquired............... -- (400) (6,749) 202 (23,260) Proceeds from sale of division............... 300 100 1,000 1,000 -- Purchase of equipment and leaseholds......... (1,376) (1,866) (2,615) (372) (693) Deposits and investment in other assets........ (221) (305) 365 219 (214) ------- ------- ------- ------- ------- Net cash provided by (used in) investing activities............. (1,297) (2,471) (7,999) 1,049 (24,167) Cash flows from financing activities: Issuance of common Stock.................. -- 240 87 -- -- Purchase of redeemable and treasury stock..... -- (35) (79) -- -- Net borrowings (repayments) of revolving credit....... -- 2,000 500 (2,000) 6,245 Repayments of long term debt................... -- (1) (5,011) (4,623) (24,658) Proceeds from issuance of long term debt...... 16,500 16,500 43,098 Repayment of loan from shareholder............ 133 144 -- -- -- ------- ------- ------- ------- ------- Net cash provided by financing activities of continuing operations.. 133 2,348 11,997 9,877 24,685 Net cash provided by financing activities of discontinued operations............. 3,855 -- -- ------- ------- ------- ------- ------- 133 2,348 15,852 9,877 24,685 Net increase (decrease) in cash and cash equivalents............ (731) (483) 201 7,990 1,445 Cash and cash equivalents at beginning of year...... 1,345 614 131 131 332 ------- ------- ------- ------- ------- Cash and cash equivalents at end of period................. $ 614 $ 131 $ 332 $ 8,121 $ 1,777 ======= ======= ======= ======= ======= The accompanying notes are an integral part of these consolidated financial statements. F-12
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies and Basis of Presentation Nature of Operations AverStar provides information technology, or IT, services and software products for the mission-critical systems of civilian and defense agencies of the United States government, as well as, large commercial companies. Basis of Presentation These consolidated financial statements include the accounts of AverStar, Inc. (the Company) and its wholly owned subsidiaries, Apollo Holding, Inc., (Apollo), and Pacer Infotec, Inc. (Pacer). The Company was incorporated in Delaware on February 4, 1998 for the purpose of combining the businesses of Apollo and Pacer (see Note 2). All material intercompany balances and transactions have been eliminated. Prior to February 4, 1998, the Company operated as Apollo, and the financial statements included herein reflect the operations of Apollo for those periods presented. On February 4, 1998 Averstar, Inc. (the Company) was formed by the Apollo shareholders to acquire the business of Pacer (see Note 2) and to combine the businesses of Apollo and Pacer. In connection with these activities, the Company effected exchanges of stock with both Apollo and Pacer shareholders at the time of the acquisition of Pacer. As described in Note 2, the acquisition of Pacer has been accounted for as a purchase. The exchange by Apollo shareholders of their shares in Apollo for their shares in Averstar was accounted for as an exchange of shares by entities under common control in accordance with paragraph 5 of APB #16. Accordingly, the Apollo operations retained their historical cost basis. All share and per share data in these financial statements and related footnotes have been adjusted to reflect such exchanges. In 1997, the Board of Directors changed Apollo's fiscal year from the last day of February to the last day of December. For the year ended December 31, 1998, the financial statements include twelve months of operations for Apollo and ten months of operations for Pacer. For the period ended December 31, 1997, the financial statements include ten months of operations for Apollo. Revenue Recognition Contracts with the Federal Government, or prime contractors of the Federal Government, are cost reimbursable with a fee that is fixed or awarded based on performance. Contracts with commercial enterprises and some Government contracts are time and materials. Overhead and general and administrative costs charged on U.S. Government contracts are generally subject to audit by the Federal Government for allowability and proper charging under the contracts. These contracts provide for periodic payments as the services are performed and generally do not represent any unusual burden on the Company's liquidity. All contracts with the Federal Government are subject to termination by the customer. The Company has not suffered any adverse effects from the termination of Government contracts in the past. The Company recognizes revenue on government and commercial contracts under the percentage-of-completion method in accordance with Statement of Position 81-1, "Accounting for Performance of Construction-Type and Certain Production- Type contracts." The percentage of completion is determined by relating the costs incurred to date to the estimated total costs at completion. The cumulative effects resulting from revisions of estimated total contract costs and revenues are recorded in the period in which the facts requiring revision become known. When a loss is anticipated on a contract, the full amount of the anticipated loss is provided for when it becomes probable. The Company sometimes recognizes revenue that is not billable to the customer at a given balance sheet date. Such amounts are included in unbilled receivables. Revenues from standard software products are recognized upon shipment in accordance with Statement of Position 97-2, "Software Revenue Recognition." Revenues from maintenance agreements are deferred and amortized over the life of the maintenance agreement. Per unit royalties earned from the license of standard software products are recognized when received from the customer. F-13
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Cash Equivalents The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Unbilled Receivables Unbilled receivables represent amounts earned on contracts in process and retainage that are not billable at the balance sheet date. Such amounts generally become billable upon completion of a specific phase of the contract, documentation of approved contract modifications, completion of government audit or upon customer acceptance, if the Company believes the acceptance criteria present no risk to the Company. The Company estimates that all billed receivables and 80% of unbilled receivables will be collected within one year. The Company has not recognized significant revenue relating to customer claims for amounts in excess of agreed upon contract prices. To the extent that billings exceed costs incurred, plus fees or less losses, the difference is recorded as unearned revenue. Property, Plant and Equipment Property, plant and equipment are stated at cost. The Company provides for depreciation and amortization over estimated useful lives using the straight- line method as follows: [Download Table] Asset Classification Estimated Useful Life -------------------- --------------------- Building & improvements........ 30 years, lesser of remaining life of lease or estimated life of improvement Computer, equipment and furniture..................... 2-7 years Stock Compensation The Company accounts for grants of stock options in accordance with the provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees." The Company has adopted the disclosure-only provision of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." See Note 9. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates. Impairment Evaluation The Company examines the carrying value of its long lived assets, identifiable intangibles, and goodwill to determine whether there are any impairment losses. If indicators of impairment were present in those assets, and future undiscounted cash flows were not expected to be sufficient to recover the assets' carrying amounts, an impairment loss would be charged to expense in the period identified. No event has been identified that would indicate an impairment of the value of long-lived assets, identifiable intangibles, and goodwill recorded in the accompanying consolidated financial statements. F-14
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Concentration of Credit Risk Financial instruments which subject the Company to credit risk consist of cash equivalents and accounts receivable. The risk with respect to cash equivalents is minimized by the Company's policies in which investments are placed with highly rated issuers with relatively short maturities. The risk with respect to accounts receivable is minimized due to the fact that customer accounts and unbilled receivables represent amounts earned under the Company's contracts, which are principally with U.S. Government agencies. Fair Value of Financial Instruments The Company's cash equivalents, accounts receivable, long-term debt and redeemable common stock are carried at cost, which approximates fair value. Reclassifications Certain reclassifications have been made to the 1997 financial statements to conform to the 1998 basis of presentation. Earnings Per Share In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings Per Share," of SFAS 128, which was required to be adopted for fiscal years ending after December 15, 1997. Earnings per share amounts for all periods presented conform to the SFAS 128 requirements. See Note 11 for the computation of basic and diluted earnings per share. Comprehensive Income In 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income," or SFAS 130, which was required to be adopted for fiscal years beginning after December 15, 1997. This statement established new rules for reporting and display of comprehensive income and its components. The adoption of this Statement had no impact on the Company's financial statements. Segments of an Enterprise In 1997, the Financial Accounting Standards Board issued statement No. 131, "Disclosures About Segments of an Enterprise and Related Information," or SFAS 131, which was required to be adopted for fiscal years beginning after December 15, 1997. SFAS 131, superseded SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise." This statement changes the way public companies report segment information in annual financial statements. SFAS 131 requires public companies to report financial and descriptive information about their operating segments in interim financial reports to shareholders as well. The adoption of this Statement had no impact on the disclosures in the Company's financial statements as the Company has one reportable segment from continuing operations: the development and delivery of information technology products and services. The U.S. Government and its prime aerospace, civil and defense contractors accounted for approximately 88%, 80% and 90% of the Company's revenues for the year ended February 28, 1997, the ten-month period ended December 31, 1997 and the year ended December 31, 1998. Pending Accounting Pronouncements In 1998, the Accounting Standard Executive Committee issued Statement of Position 98-5, "Reporting on the Costs of Start-up Activities," which must be adopted for fiscal years beginning after December 15, 1998, and the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative F-15
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Investments and Hedging Activities," which must be adopted for fiscal years beginning after June 15, 1999. The adoption of these statements is not expected to have a material impact on AverStar. Note 2. Acquisition On February 27, 1998, Pacer, a company providing software engineering services primarily to government customers, was acquired for a purchase price of approximately $17,000,000, plus transaction related expenses of approximately $1,700,000. Of the total purchase price, approximately $7,000,000 was paid in cash to Pacer shareholders, with the balance paid by the issuance of approximately 2,255,000 shares of Class F common stock issued by AverStar and the fair value of options exchanged in the transaction; said shares and options having a value of approximately $10,000,000. The acquisition has been accounted for using the purchase method of accounting, whereby assets and liabilities have been allocated based upon their respective fair values, resulting in goodwill and other intangible assets of approximately $12 million. Unaudited pro forma revenue, net loss and loss per share shown below for the ten month period ended December 31, 1997 and the year ended December 31, 1998 assumes the acquisition of Pacer occurred on March 1, 1997: [Download Table] 1997 1998 ------- -------- (In thousands, except per share data) ----------------- Revenue................................................ $95,519 $128,530 Income (loss) from continuing operations............... $ (403) $ 2,109 Net loss............................................... $(2,130) $ (3,013) Net loss per share..................................... $ (0.55) $ (0.47) On March 18, 1999, the Company acquired all of the outstanding shares of Computer Based Systems, Inc. (CBSI) for $26,000,000. CBSI provides software engineering services primarily to government customers. Of the total purchase price, $25,000,000 was paid to the shareholders at the closing, with the balance paid equally over five years. The transaction costs are estimated to be $600,000. The acquisition was accounted for using the purchase method of accounting, whereby assets and liabilities have been allocated based upon their respective fair value, resulting in goodwill and other intangibles assets of approximately $19,400,000 which will be amortized for periods not to exceed 20 years. Unaudited pro forma revenue, and income per share (basic) shown below for the three-month periods ended March 31, 1998 and March 31, 1999 assumes the acquisition of CBSI occurred on January 1, 1998: [Download Table] March 31, ---------------- 1998 1999 ------- ------- (In thousands, except per share data) ---------------- Revenue................................................... $38,790 $46,948 Income from continuing operations......................... 349 2,349 Net income (loss)......................................... (506) 609 Net income (loss) per share............................... (0.10) 0.09 Note 3. Discontinued Operations In December 1998, the Board of Directors of AverStar, Inc. adopted a plan to divest of its 66% interest in Intermetrics Entertainment Software, Inc.'s (IES) operations, which developed software games, by distributing such interest to AverStar shareholders. As part of the plan to dispose of IES, the Company converted $1.3 million of contributed capital (representing capital contributed by the Company reduced by cumulative operating losses) into an 8.5% term loan due on December 31, 2001. In connection with this conversion, the Company recorded the term loan and fully reserved the amount and also fully reserved a pre-existing term loan of $400,000 because, F-16
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) based upon forecasted operating results for IES, the Company believes it is uncollectible. This write-off is part of the loss on disposal of discontinued operations described below. In addition, AverStar is obligated to provide on demand financing of up to $2 million pursuant to an 8.5% revolving credit agreement, unless IES has filed for bankruptcy, is in the process of liquidation or the equivalent. Under the terms of the revolving credit agreement, no new borrowings may occur subsequent to December 31, 1999 and amounts borrowed are due on December 31, 2001. Based upon forecasted operating results for IES, AverStar management believes it is probable that the full amount available will be drawn by IES and, further, management does not believe such amounts which will become due under the revolving credit agreement will be recoverable and, therefore, has assigned no value to it in the accompanying financial statements. The Company will, however, pursue collection efforts. Any subsequent recovery of such amounts due under the term loans or the revolving credit agreement all of which are due not later than December 31, 2001, and currently represent a deferred gain of $3,700,000, will be reflected as a gain from discontinued operations at the time of such recovery. The major components of the $3,900,000 loss from disposal of discontinued operations are estimated operating losses through the disposal date of $500,000, estimated remaining funding commitment of $1,500,000 pursuant to a $2,000,000 revolving credit agreement estimated professional fees of $200,000 and write-offs of estimated non-recoverable term loans of $1,700,000. As of December 31, 1998, the liabilities of IES exceeded its assets by $565,000, which is comprised of billed and unbilled receivables of $4,200,000, other assets and equipment of $2,300,000, bank debt of $3,900,000, accrued expenses of $1,500,000, and obligations to AverStar of approximately $1,700,000. Included in the loss on disposal in 1998 is approximately $500,000 of operating losses from the date the Plan was adopted through the date of divestiture, which occurred on March 18, 1999. In addition, interest of $293,000 was allocated to the loss from discontinued operations based on the financing that was specifically attributed to those operations. Revenues from discontinued operations were $7,232,000 for the year ended December 31, 1998 and $1,928,000 for the period from August 9 through December 31, 1997. Note 4. Intangible Assets The following represents the components of net intangible assets at December 31, 1997 and 1998 and their estimated useful lives: [Download Table] December 31, Estimated Useful December 31, ------------ Life 1997 1998 ---------------- ------------ ------------ Cost in excess of fair value of net assets acquired........... 15-20 years $488 $12,458 Contract backlog............... 18 months -- 256 Assembled workforce............ 7 years -- 875 ---- ------- $488 $13,589 ==== ======= Accumulated amortization relating to these intangible assets is $62,000 and $1,005,000 at December 31, 1997 and 1998. F-17
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Note 5. Income Taxes The provision for (benefit from) income taxes from continuing operations for the year ended February 28, 1997 and the ten-month period ended December 31, 1997 and the year ended December 31, 1998 consists of the following: [Download Table] February 28, 1997 December 31, 1997 December 31, 1998 ----------------- ----------------- ----------------- ($ in thousands) Current: Federal............. $ 75 $117 $2,507 State............... 21 8 502 ---- ---- ------ 96 125 3,009 Deferred: Federal............. (60) 63 (715) State............... (18) (34) (126) ---- ---- ------ (78) 29 (841) ---- ---- ------ Total................. $ 18 $154 $2,168 ==== ==== ====== The following table reconciles the provision (benefit) for income taxes to the amount computed by applying the statutory federal income tax rate to income from continuing operations before the provision for (benefit from) income taxes for the year ended February 28, 1997, the ten-month period ended December 31, 1997 and the year ended December 31, 1998: [Enlarge/Download Table] February 28, 1997 % December 31, 1997 % December 31, 1998 % ----------------- ---- ----------------- ---- ----------------- ---- ($ in thousands) Income tax expense/(benefit) at statutory rate......... $ 15 34.0 % $120 34.0% $1,564 34.0% State income tax (net).. 6 13.0 21 6.0 276 6.0 Non-deductible items.... (3) (7.0) 13 4.0 328 7.1 ----- ---- ---- ---- ------ ---- Total................. $ 18 40.0 % $154 44.0% $2,168 47.1% ===== ==== ====== Income taxes paid (refunded)............. $(799) $418 $1,481 ===== ==== ====== Deferred income taxes arise from temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. The significant temporary differences included in net deferred tax assets at December 31, 1997 and 1998 are as follows: [Download Table] December 31, 1997 December 31, 1998 ----------------- ----------------- ($ in thousands) Accrued liabilities................... $ 530 $ 3,195 Accounts and unbilled receivables..... (1,874) (1,511) Depreciation and amortization......... 370 766 Net operating loss.................... 312 -- Other................................. 662 78 ------- ------- Deferred income tax asset............. $ -- $ 2,528 ======= ======= F-18
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Note 6. Benefit Plans The Company has a 401(k) profit-sharing plan that covers substantially all employees and provides for a company matching contribution. As defined under the Plan, employees are allowed to contribute the maximum established by law, and the Company may match up to 4% of the employee's contribution. Expenses relating to this Plan amounted to $402,000 for the year ended February 28, 1997, $784,000 for the ten-month period ended December 31, 1997 and $1,405,000 for the year ended December 31, 1998. The Company has a noncontributory defined contribution plan that covered substantially all employees of Pacer prior to the acquisition described in Note 2. Substantially all of the contributions have been invested in the Company's common stock. At December 31, 1998, the Plan is dormant and the Company did not incur any expense related to the Plan in 1998. Note 7. Borrowings At December 31, 1998, the Company had $24,333,000 of secured Senior Notes, secured by substantially all of the Company's tangible and intangible assets, and $5,000,000 of unsecured Subordinated Notes. The interest rate on the Senior Notes of $7,833,000 was a variable rate based on the three-month London Interbank Offered Rate (LIBOR) plus 3% (8.065% at December 31, 1998). The interest rate on the Senior Bridge Notes of $16,500,000 was LIBOR plus 3% and increased 0.5% each six months during the term. The interest rate on the Subordinated Notes is fixed at 13% per annum. The Senior Notes contain covenants and restrictions involving consolidated net worth, ratio of current assets to current liabilities, fixed charge and interest coverage, limitations on liens, restricted payments and investments, transactions with affiliates, sale of assets, sale and leaseback transactions, and mergers and consolidations. At December 31, 1998 the Company also had a secured Senior Revolving Credit Agreement that provided for aggregate borrowings of $5,000,000 maturing on August 31, 2001. The revolving credit facility was available to finance general operating requirements. The outstanding borrowings under this facility were $2,000,000 as of December 31, 1997 and $2,500,000 as of December 31, 1998. On March 18, 1999, simultaneous with the CBSI closing described in Note 2, the Company entered into an agreement to provide up to $75,000,000 of secured financing, based upon availability, comprised of $45,000,000 in Senior Term Loans and a $30,000,000 revolving credit facility note. Expenses associated with the financing are estimated to be $1,900,000. Proceeds from the financing agreement were used to pay CBSI shareholders, retire existing debt, and provide for working capital requirements. The Senior Term Loans comprise two tranches. The Term A Note of $15,000,000 matures March 17, 2004 and carries a variable interest rate of up to LIBOR plus 2.75%. The Term B Note of $30,000,000 matures March 17, 2005 and carries a variable interest rate of LIBOR plus 3%. The revolving facility note matures on March 17, 2004 and carries a variable interest rate of LIBOR plus 2.75%. These agreements contain covenants and restrictions pertaining to the maintenance of net worth and certain ratios relating to operating results. At March 31, 1999, the Company had $44.8 million, $8.7 million and $5.0 million outstanding under the senior term loans, revolving credit facility note and subordinated notes respectively. The interest paid on all borrowings was $1,255,000 for the ten-month period ended December 31, 1997, $2,809,000 for the year ended December 31, 1998 and $764,000 for the three months ended March 31, 1999. F-19
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following represents aggregate maturities of long term debt pursuant to these borrowing arrangements: [Download Table] 1999......................................................... $ 1,500,000 2000......................................................... 2,700,000 2001......................................................... 3,600,000 2002......................................................... 4,200,000 2003......................................................... 4,500,000 Thereafter................................................... 33,500,000 ----------- $50,000,000 =========== Note 8. Capital Stock The following summarizes the classes of stock the Company has authorized and issued as of December 31, 1997 and 1998: [Download Table] Shares Authorized Shares Issued ------------------------- ------------------------- Class of December 31, December 31, December 31, December 31, Common Stock 1997 1998 1997 1998 ------------ ------------ ------------ ------------ ------------ A--Voting............... 1,943,727 2,280,471 1,847,687 1,847,687 A--Non-Voting........... 91,470 105,190 84,152 84,152 B--Voting............... 1,737,921 1,867,808 1,494,246 1,494,246 B--Non-Voting........... 233,247 290,873 232,698 232,698 C--Voting............... 146,350 182,939 146,352 146,352 D--Voting............... 3,388,945 2,924,643 150,925 150,925 D--Non-Voting........... 617,419 -- -- -- E--Voting............... 73,176 91,470 73,176 73,176 F--Voting............... -- 6,000,000 -- 2,334,697 G--Voting............... -- 756,608 -- -- G--Non-Voting........... -- 756,608 -- 605,286 Not designated.......... 914,695 1,743,390 -- -- --------- ---------- --------- --------- Total Shares.......... 9,146,950 17,000,000 4,029,236 6,969,219 ========= ========== ========= ========= In connection with the merger of Apollo and Pacer as described in Note 2, the Apollo stockholders agreed to exchange their shares of Class A, B, C, D, E, and G into shares of AverStar at a ratio of approximately 4.6:1. Pacer stockholders were given the choice of receiving $2.00 per share in cash or exchanging their shares of Pacer into Class F shares of AverStar at a ratio of approximately 0.5:1. Such issuance and exchanges are reflected in the table. Certain classes of common stock noted above have provisions which require the holders, in certain circumstances, to share a portion of proceeds received upon the sale of such shares with holders of other classes of common stock. F-20
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Redeemable Common Stock In connection with the acquisition described in Note 2, the Company granted certain shareholders rights that require the company to purchase up to a maximum number of shares of Class F--Voting common stock held by the shareholders at $4.09 per share over a four year period. Shares that are not redeemed in a year convert to shareholders' equity and the shareholders' rights to redeem these shares expire. The 1998 activity and schedule of Class F-- Voting redeemable shares are as follows: [Download Table] Beginning balance at February 28, 1998............................ 484,597 Lapsed in 1998.................................................... (24,450) Redeemed in 1998.................................................. (6,112) ------- Balance at December 31, 1998...................................... 454,035 ======= Class F--Voting redeemable shares and related maximum amounts redeemable annually as of December 31, 1998 are as follows: [Download Table] Year Shares Amount ---- ------- ---------- 1999.................................................... 122,249 $ 500,000 2000.................................................... 137,531 562,500 2001.................................................... 194,255 794,500 ------- ---------- Total................................................. 454,035 $1,857,000 ======= ========== Certain Class F voting, redeemable shares serve as collateral on a note receivable of approximately $850,000 issued to the Company by a former employee. The note bears interest at 6.36% per annum with scheduled repayments through May 2001. In the event the Class F shareholder presents certain shares to the Company for redemption, the proceeds from such redemption are required to be remitted to the Company in satisfaction of this note, which is included in other assets in the accompanying balance sheet. In addition to the redemption features of the Class F--Voting shares, the Company has also granted to certain management shareholders the right to have the Company redeem approximately 1,749,000 shares of Class A-F stock at certain amounts, as defined. The estimated fair value of such redemption at December 31, 1998 was $3,941,225. The redemption of such shares is limited in the first five years by amounts stipulated in the Stockholder Agreements. The shares are subject to redemption at a price and upon terms as defined in the Stockholder Agreements. Upon the occurrence of certain events, including an initial public offering, the redemption features for all classes of stock lapse. The Company holds Promissory Notes of $200,000 issued by certain employees for the purchase of Class A Common Stock. The Notes, which are fully recourse to the issuers and have been classified as a reduction of redeemable common stock, bear interest at 7% per annum. Interest is payable semiannually or annually, and the principal is scheduled for payment from March 2000 through August 2005. Note 9. Stock Options The Company has a Long Term Incentive Plan (the Plan) pursuant to which the Company may grant Incentive Stock Options, Non-qualified Stock Options, Stock Appreciation Rights, Restricted Stock, Deferred Stock, Stock Purchase Rights or Other Stock-Based Awards. F-21
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The maximum aggregate number of shares of Stock reserved and available for distribution under the Plan shall be 3,349,447 shares of Stock, reduced by the number of shares of Stock subject to being issued from time to time upon the exercise of outstanding awards granted under the Plan. At December 31, 1998 there were 3,349,447 shares of stock reserved and available for distribution. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," and will continue to account for option grants to employees under the Plan in accordance with APB No. 25, "Accounting for Stock Issued to Employees." Adoption of SFAS No. 123 did not have a material impact on the Company's financial statements and, accordingly, no pro forma net income has been disclosed for the year ended February 28, 1997, the ten-month period ended December 31, 1997 and the year ended December 31, 1998, for the compensation expense of options grants which otherwise would be required under the disclosure requirements of SFAS No. 123. The fair market value of each option grant is estimated on the date using the Minimum Value option-pricing model with the following weighted-average assumptions used for grants issued in the year ended February 28, 1997, the ten-month period ended December 31, 1997 and the year ended December 31, 1998: [Download Table] February 28, 1997 December 31, 1997 December 31, 1998 ----------------- ----------------- ----------------- Dividend yield.......... 0% 0% 0% Expected lives (years).. 5 5 5 Range of risk-free interest rates......... 5.70-6.29 5.70-6.37 6.22-6.36 A summary of the status of AverStar's stock compensation plan as of February 28, 1997, December 31, 1997 and December 31, 1998 and changes during the years ending on those dates is presented below: [Download Table] February 28, 1997 December 31, 1997 December 31, 1998 ----------------- ----------------- -------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------- --------- ------- --------- --------- --------- Fixed Options Outstanding at beginning of year................ 504,180 $1.37 533,908 $1.37 588,789 $1.37 Granted................. 29,728 1.37 54,881 1.37 -- -- Exchanged............... 845,086 3.29 Exercised............... -- -- -- -- (79,473) 1.10 Forfeited............... -- -- -- -- (30,969) 2.70 ------- ------- --------- Outstanding at end of year................... 533,908 1.37 588,789 1.37 1,323,433 2.58 ======= ======= ========= Options exercisable at year-end............... -- 100,836 757,055 Weighted-average fair market value of options granted/exchanged during the year........ $ 0.37 $ 0.34 $ 0.94 F-22
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table summarizes information about stock options at December 31, 1998: [Download Table] Options Options Outstanding Exercisable ------------------------------- ----------------- Weighted- Average Weighted- Weighted- Remaining Average Average Range of Contractual Exercise Exercise Exercise Prices Number Life Price Number Price --------------- --------- ----------- --------- ------- --------- $1.37 to $2.11................ 615,917 8.8 years $1.41 49,538 $1.88 2.44 to 2.99................ 98,828 7.6 2.50 98,828 2.50 3.15 to 3.91................ 591,571 8.3 3.78 591,572 3.78 $4.05 to $4.25................ 17,117 7.5 4.08 17,117 4.08 --------- ------- 1,323,433 8.5 $2.58 757,055 $3.49 ========= ======= Note 10. Commitments and Contingencies The Company leases certain equipment and operating facilities under non- cancelable operating leases expiring at various dates through November 2004. Most facilities have leases with renewable options of between three and five years. Facilities and equipment rental expense charged to operations was approximately $3,273,000 for the year ended December 31, 1998 and $1,766,000 for the ten-month period ended December 31, 1997 and $1,528,000 for the twelve-month period ended February 28, 1997. As of December 31, 1998, future minimum rental commitments under operating leases were as follows: [Download Table] Fiscal Year Facilities Equipment Total ----------- ---------- --------- ------- (In thousands) 1999........................................... $ 3,110 $496 $ 3,606 2000........................................... 2,469 154 2,623 2001........................................... 2,168 27 2,195 2002........................................... 1,715 -- 1,715 2003........................................... 961 -- 961 Thereafter..................................... 198 -- 198 ------- ---- ------- Total........................................ $10,621 $677 $11,298 ======= ==== ======= In connection with improvements made to leased office facilities, the Company has issued standby letters of credit for $435,000 in favor of the landlord. Certain shareholders are entitled to receive fees for ongoing business planning and consulting services under the terms of consulting agreements between such shareholders and the Company, up to an aggregate annual amount of $300,000. These consulting agreements terminate on August 31, 2002. Such fees totaled $200,000 for the year ended February 28, 1997, $106,000 in the ten- month period ended December 31, 1997 and $263,000 for the twelve-month period ended December 31, 1998. F-23
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AVERSTAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Note 11. Earnings Per Share The calculations of earnings per share are as follows: [Download Table] February 28, December 31, December 31, March 31, March 31, 1997 1997 1998 1998 1999 ------------ ------------ ------------ --------- --------- (unaudited) (In thousands, except per share amounts) Numerator: Income from continuing operations.......... $ 27 $ 198 $2,434 $ 416 $ 792 Denominator: Denominator for basic earnings per share: Weighted-average shares outstanding....... 3,878 3,865 6,428 4,991 6,927 Effect of dilutive securities: Employee stock options............. 40 82 419 479 513 Warrants............. 605 605 -- -- -- ------ ------ ------ ------ ------ 645 687 419 479 513 Dilutive potential common shares: Denominator for diluted earnings per share: Adjusted weighted- average shares outstanding and assumed conversions....... 4,523 4,552 6,847 5,470 7,440 ====== ====== ====== ====== ====== Basic earnings per share................. $ 0.01 $ 0.05 $ 0.38 $ 0.08 $ 0.11 ====== ====== ====== ====== ====== Diluted earnings per share................. $ 0.01 $ 0.04 $ 0.36 $ 0.08 $ 0.11 ====== ====== ====== ====== ====== Options to purchase 24,494 and 46,391 shares of common stock at December 31, 1998 and March 31, 1999 were outstanding but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares and, therefore, the effect would be anti-dilutive. There were no shares of common stock excluded in the computation of diluted earnings per share at February 28, 1997 and December 31, 1997. F-24
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INDEPENDENT AUDITOR'S REPORT Board of Directors Computer Based Systems, Inc. Fairfax, Virginia We have audited the accompanying Balance Sheets of COMPUTER BASED SYSTEMS, INC. (An S Corporation) as of December 31, 1997 and 1998, and the related Statements of Operations, Other Comprehensive Income, Stockholders' Equity and Cash Flows for the years then ended. 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. The financial statements of COMPUTER BASED SYSTEMS, INC. as of December 31, 1996, were audited by other auditors whose report dated April 18, 1997, expressed an unqualified opinion on those statements. 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 COMPUTER BASED SYSTEMS, INC. as of December 31, 1997 and 1998, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. /s/ Aronson, Fetridge & Weigle Rockville, Maryland March 12, 1999 F-25
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Report of Independent Certified Public Accountants Board of Directors Computer Based Systems, Inc. We have audited the accompanying statements of operations, changes in stockholders' equity and cash flows of Computer Based Systems, Inc. (a Virginia corporation), for the year ended December 31, 1996. 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 audit. We conducted our audit 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations equity and cash flows of Computer Based Systems, Inc., for the year ended December 31, 1996, in conformity with generally accepted accounting principles. /s/ Grant Thornton LLP Vienna, Virginia April 18, 1997 F-26
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COMPUTER BASED SYSTEMS, INC. BALANCE SHEETS December 31, 1997 and 1998 [Download Table] 1997 1998 ----------- ----------- ASSETS Current Assets Cash and cash equivalents (Note 1).................. $ 215,120 $ 1,304,849 Marketable securities (Note 3)...................... 1,142,495 -- Accounts receivable--contracts (Notes 2 and 5)...... 11,184,784 12,310,839 Prepaid expenses.................................... 631,374 612,302 Current portion of notes and other receivables (Note 4)........................................... 608,902 912,755 ----------- ----------- Total current assets.............................. 13,782,675 15,140,745 ----------- ----------- Property and Equipment, Net (Notes 1 and 5) Office equipment and software....................... 1,315,634 1,378,002 Furniture and fixtures.............................. 409,589 410,868 Vehicles............................................ 138,954 71,135 Land and building................................... 2,455,184 2,455,184 Tenant improvements................................. 76,010 131,304 ----------- ----------- Total............................................. 4,395,371 4,446,493 Less: Accumulated depreciation and amortization..... (1,437,934) (1,534,139) ----------- ----------- Net property and equipment.......................... 2,957,437 2,912,354 ----------- ----------- Other Assets Deposits............................................ 52,374 62,831 Notes receivable, net of current portion (Note 4)... 88,851 25,831 ----------- ----------- Total other assets................................ 141,225 88,662 ----------- ----------- Total Assets...................................... $16,881,337 $18,141,761 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities ZBA account balance (Note 1)........................ $ -- $ 2,758,759 Note payable--line of credit (Note 5)............... 4,510,000 1,357,313 Current portion of long-term notes payable (Note 5)................................................. 592,681 514,588 Accounts payable.................................... 442,676 284,332 Accrued expenses and wages.......................... 1,805,577 2,310,533 Distributions payable............................... 128,131 -- Current portion of accrued rent payable (Note 9).... 55,725 46,208 Deferred income taxes (Note 1)...................... 1,136,881 1,136,881 ----------- ----------- Total current liabilities......................... 8,671,671 8,408,614 ----------- ----------- Long-term Liabilities, Net of Current Portion Accrued rent payable (Note 9)....................... 334,600 341,002 Long-term notes payable (Note 5).................... 1,437,689 1,412,717 Total long-term liabilities....................... 1,772,289 1,753,719 ----------- ----------- Total liabilities................................. 10,443,960 10,162,333 ----------- ----------- Commitments and Contingencies (Notes 7, 8, 9, 10 and 11) -- -- Stockholders' Equity (Note 12) Common stock--$1 par value per share, Voting--500,000 shares authorized, issued and outstanding...................................... 500,000 500,000 Nonvoting--1,500,000 shares authorized, issued and outstanding...................................... 1,500,000 1,500,000 Accumulated other comprehensive income Unrealized losses on investments held as available for sale (Note 3)................................ (74,918) -- Retained earnings................................... 4,512,295 5,979,428 ----------- ----------- Total stockholders' equity........................ 6,437,377 7,979,428 ----------- ----------- Total Liabilities and Stockholders' Equity....... $16,881,337 $18,141,761 =========== =========== The accompanying Notes to Financial Statements are an integral part of these financial statements. F-27
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COMPUTER BASED SYSTEMS, INC. STATEMENTS OF OPERATIONS For the Years Ended December 31, 1996, 1997 and 1998 [Download Table] 1996 1997 1998 ----------- ----------- ----------- Contract Revenue and Other Income......... $23,052,976 $30,035,802 $40,685,426 ----------- ----------- ----------- Costs and Expenses Cost of contract service and sales...... 15,265,645 20,560,682 28,685,685 Selling, general and administrative..... 7,899,435 8,175,058 10,295,156 Interest................................ 226,422 195,332 237,452 ----------- ----------- ----------- Total costs and expenses.............. 23,391,502 28,931,072 39,218,293 ----------- ----------- ----------- Income (Loss) Before Income Taxes......... (338,526) 1,104,730 1,467,133 Federal and State Income Taxes (Note 1)... -- -- -- ----------- ----------- ----------- Net Income (Loss)......................... $ (338,526) $ 1,104,730 $ 1,467,133 =========== =========== =========== The accompanying Notes to Financial Statements are an integral part of these financial statements. F-28
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COMPUTER BASED SYSTEMS, INC. STATEMENTS OF OTHER COMPREHENSIVE INCOME For the Years Ended December 31, 1996, 1997 and 1998 [Download Table] 1996 1997 1998 --------- ---------- ---------- Net Income (loss)............................. $(338,526) $1,104,730 $1,467,133 Other Comprehensive Income Unrealized losses on investments held as available for sale......................... -- (74,918) -- Adjustment for realized losses on investments held as available for sale..... -- -- 74,918 --------- ---------- ---------- Comprehensive Income (loss)................... $(338,526) $1,029,812 $1,542,051 ========= ========== ========== The accompanying Notes to Financial Statements are an integral part of these financial statements. F-29
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COMPUTER BASED SYSTEMS, INC. STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 1996, 1997 and 1998 [Download Table] Voting Nonvoting Unrealized Common Common Retained Loss on Stock Stock Earnings Investment Total -------- ---------- ---------- ---------- ---------- Balance, January 1, 1996, as Restated (Note 12).............. $500,000 $1,500,000 $3,831,241 $ -- $5,831,241 Distribution of Retained Earnings Paid or Accrued................ -- -- (85,150) -- (85,150) Net Loss................ -- -- (338,526) -- (338,526) -------- ---------- ---------- ------- ---------- Balance, December 31, 1996, as Restated (Note 12).............. 500,000 1,500,000 3,407,565 -- 5,407,565 Unrealized Loss on Investment (Note 3).... -- -- -- (74,918) (74,918) Net Income.............. -- -- 1,104,730 -- 1,104,730 -------- ---------- ---------- ------- ---------- Balance, December 31, 1997................... 500,000 1,500,000 4,512,295 (74,918) 6,437,377 Adjustment for Realized Gain on Investment (Note 3)............... -- -- -- 74,918 74,918 Net Income.............. -- -- 1,467,133 -- 1,467,133 -------- ---------- ---------- ------- ---------- Balance, December 31, 1998................... $500,000 $1,500,000 $5,979,428 $ -- $7,979,428 ======== ========== ========== ======= ========== The accompanying Notes to Financial Statements are an integral part of these financial statements. F-30
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COMPUTER BASED SYSTEMS, INC. STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1996, 1997 and 1998 [Download Table] 1996 1997 1998 ---------- ----------- ------------ Cash Flows from Operating Activities Net income (loss)....................... $ (338,526) $ 1,104,730 $ 1,467,133 Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities Depreciation and amortization......... 190,306 209,915 232,172 Gain on sale of fixed assets.......... -- -- (5,542) Gain on sale of marketable securities........................... -- -- (712) (Increase) decrease in Accounts receivable--contracts....... 1,162,836 (3,026,280) (1,126,055) Prepaid expenses..................... (473,810) 389,640 19,072 Other receivables.................... (114,228) -- -- Deposits............................. (37,182) (6,996) (10,457) Increase (decrease) ZBA account balance.................. -- -- 2,758,759 Accounts payable..................... (88,625) 370,732 (158,344) Accrued expenses and wages........... (140,779) 729,977 504,956 Accrued rent payable................. 23,361 2,034 (3,115) ---------- ----------- ------------ Net cash provided (used) by operating activities............... 183,353 (226,248) 3,677,867 ---------- ----------- ------------ Cash Flows from Investing Activities Purchase of fixed assets................ (66,816) (446,221) (188,547) Proceeds from sales of fixed assets..... -- -- 7,000 Advances under notes and other receivables............................ (32,389) (368,610) (984,408) Repayment of notes and other receivables............................ -- 5,717 743,575 Purchase of marketable securities....... -- (1,217,413) (480,429) Cash proceeds from sale of marketable securities............................. -- -- 1,698,554 ---------- ----------- ------------ Net cash provided (used) by investing activities............................. (99,205) (2,026,527) 795,745 ---------- ----------- ------------ Cash Flows from Financing Activities Proceeds from line of credit............ -- 2,920,000 17,898,093 Curtailments of line of credit.......... 125,000 (485,000) (21,050,780) Shareholder distributions paid.......... (52,378) (25,221) (128,131) Payments of long-term debt.............. (25,116) (180,989) (203,065) Proceeds on long-term debt.............. -- 30,000 100,000 ---------- ----------- ------------ Net cash provided (used) by financing activities............................ 47,506 2,258,790 (3,383,883) ---------- ----------- ------------ Net Increase in Cash.................... $ 131,654 $ 6,015 $ 1,089,729 Cash and Cash Equivalents, Beginning of Year................................... 77,451 209,105 215,120 ---------- ----------- ------------ Cash and Cash Equivalents, End of Year.. $ 209,105 $ 215,120 $ 1,304,849 ========== =========== ============ Supplemental Cash Flow Information Actual cash payments for: Interest................................ $ 226,422 $ 195,332 $ 237,452 ========== =========== ============ The accompanying Notes to Financial Statements are an integral part of these financial statements. F-31
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COMPUTER BASED SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS December 31, 1996, 1997 and 1998 NOTE 1--Organization And Significant Accounting Policies (A) Organization Computer Based Systems, Inc. (CBSI) was incorporated in 1978 under the laws of the Commonwealth of Virginia. The Company's primary business is providing engineering, management and analytical services to principally civilian agencies of the U.S. Government. (B) Revenue recognition Revenue from cost-type contracts is recognized as costs are incurred on the basis of direct costs plus allowable indirect costs and an allocable portion of a fixed fee. Revenue from fixed-price type contracts is recognized under the percentage- of-completion method of accounting with costs and estimated profits included in contract revenue as work is performed. If actual and estimated costs to complete a contract indicate a loss, provision is made currently for the loss anticipated on the contract. Revenue from time and materials contracts is recognized as costs are incurred at amounts represented by the agreed-upon billing amounts. Revenue recognized on contracts for which billings have not been presented to customers at year end, is included in the Accounts receivable--contracts classification on the Balance Sheets as detailed in Note 2. (C) Property and equipment Property and equipment are recorded at cost. Depreciation and amortization is provided using the straight-line method over the estimated useful lives of the assets. The estimated lives used in determining depreciation and amortization are: [Download Table] Office equipment and software...... 5 years Furniture and fixtures............. 7 years Vehicles........................... 5 years Tenant improvements................ shorter of term of lease or useful life Building........................... 39 years (D) Income taxes Effective January 1, 1990, the Company elected S-Corporation status whereby the taxable income of the Company, subject to certain restrictions and elections, is taxed directly to the Company's shareholders. The Company continues to be liable for tax on built-in gains existing at the date of the election which are primarily deferred taxable income from the Company's use of the cash basis of accounting for income tax purposes, net of available net operating loss and investment tax credit carryforwards. Such tax is payable to the extent the Company would have otherwise paid income taxes on a C Corporation basis during the ten-year period following the election. A deferred tax liability has been provided in the accompanying financial statements for this liability. The liability is classified as current due to the uncertainty as to when this liability might be required to be paid. F-32
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COMPUTER BASED SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 NOTE 1--Organization And Significant Accounting Policies--(continued) (E) Cash and cash equivalents The Company maintains cash balances which may exceed Federally insured limits. The Company does not believe that this results in any significant credit risk. For purposes of the financial statement presentation, the Company considers all highly liquid debt instruments with initial maturities of ninety days or less to be cash equivalents. Beginning in 1998, the Company has a Money Management Zero Balance Account (ZBA) arrangement for its checking account activity. Under this arrangement, the bank automatically draws/repays the line of credit based upon the net daily activity in the checking accounts and invests any excess cash balance overnight. Therefore, checks not yet presented for payment are reflected on the Balance Sheet as ZBA account balance which at December 31, 1998 was $2,758,759. (F) Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (G) Comprehensive income In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. This statement established standards for the reporting and display of comprehensive income and its components in the financial statements. In accordance with the provisions of this statement, the Company has included a separate Statement of Other Comprehensive Income in the accompanying financial statements. Comprehensive income for the years ended December 31, 1996 and 1997 has been presented for comparative purposes. (H) Reclassifications Certain 1996 amounts have been reclassified to conform to the 1997 and 1998 presentation. NOTE 2--Accounts Receivable--Contracts The accounts receivable consist mainly of billed and unbilled recoverable amounts under contracts in progress with governmental units, principally with four agencies of the Federal Government. Unbilled receivables consist primarily of award fees earned on cost-reimbursement contracts earned during the year. The components of accounts receivable at December 31, 1997 and 1998 are as follows: [Download Table] 1997 1998 ----------- ----------- Billed............................................... $10,896,170 $12,196,691 Unbilled............................................. 288,614 114,148 ----------- ----------- Total.............................................. $11,184,784 $12,310,839 =========== =========== All billed and unbilled amounts are expected to be collected during the next fiscal year. The accounts receivable are pledged to Crestar Bank as collateral on the line of credit arrangement described in Note 5. F-33
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COMPUTER BASED SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 NOTE 3--Marketable Securities The Company held marketable equity securities which are considered to be available for sale as of December 31, 1997, as follows: [Download Table] Fair market value............................................... $ 1,142,495 Cost of securities.............................................. $(1,217,413) ----------- Net unrealized loss............................................. $ (74,918) =========== During 1998, the Company sold the securities and realized a gain of $712. As of December 31, 1997, the aggregate unrealized loss on marketable securities was $101,386 and the aggregate unrealized gain was $26,468 which resulted in the net unrealized loss of $74,918 which has been reflected as a separate component of stockholders' equity in the accompanying financial statements. Realized gains and losses are determined using the specific identification method to determine cost. NOTE 4--Notes and Other Receivables [Download Table] 1997 1998 --------- --------- Note receivable from two stockholders, bearing interest at 7%, due on demand, paid in 1998.......... $ 67,770 $ -- Note receivable from affiliated company (Note 6), bearing interest at 8%, payable in monthly installments of $649, including interest, final payment due May 2001................................. 22,715 22,715 Due from affiliate (Note 6)........................... 457,345 681,003 Advances and other receivables........................ 149,923 234,868 --------- --------- Total............................................... 697,753 938,586 Less: Current portion................................. (608,902) (912,755) --------- --------- Long-term portion................................... $ 88,851 $ 25,831 ========= ========= NOTE 5--Notes Payable (A) Line of Credit At December 31, 1997 and 1998, the Company had a line of credit with Crestar Bank which had a maximum amount available of $5,000,000. Under the terms of the line of credit, interest is payable monthly at the bank's prime rate. The line is secured by all accounts receivable and equipment. In addition, the agreement requires the Company to maintain a minimum taxable net worth, which the Company was in compliance with at December 31, 1997 and 1998. The outstanding balance at December 31, 1997 and 1998 was $4,510,000 and $1,357,313, respectively. F-34
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COMPUTER BASED SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 NOTE 5--Notes Payable--(continued) (B) Long-term debt At December 31, 1997 and 1998, long-term debt was as follows. [Download Table] 1997 1998 ---------- ---------- Notes payable to shareholders, due upon demand with interest ranging from 7% to 10%, uncollateralized.. $ 490,000 $ 490,000 Notes payable to relatives of the shareholders due upon demand; with interest ranging from 7.5% to 10%; uncollateralized, paid off in 1998............ 80,000 -- Note payable to bank; balloon payment due in 2002 with interest at 8.10%; monthly principal and interest payments of $11,677; collateralized by a building and land.................................. 1,460,370 1,437,305 ---------- ---------- Total............................................. 2,030,370 1,927,305 Less: Current portion............................... (592,681) (514,588) ---------- ---------- Long-term debt.................................... $1,437,689 $1,412,717 ========== ========== The aggregate amount of principal payments due as of December 31, 1998 is as follows: [Download Table] Year Ending December 31 Amount ----------- ---------- 1999............................................................. $ 514,588 2000............................................................. 26,320 2001............................................................. 28,868 2002............................................................. 1,357,529 ---------- Total.......................................................... $1,927,305 ========== (C) Letters of Credit The Company is contingently liable under irrevocable letters of credit aggregating approximately $56,000 at December 31, 1998. The letters of credit expire in March 1999. NOTE 6--Related Party Transactions CBSI owns a rental real estate property which is managed, at no cost, by a Company which is owned by the shareholders of CBSI. The 1996, 1997 and 1998 net earnings of approximately $181,000, $203,000 and $181,000, respectively, are included in other income on the statements of operations. As of December 31, 1997 and 1998, the Company had a net intercompany receivable of $457,345 and $681,003, respectively, due from the management company. There are no specific repayment terms on these amounts due from the management company. During 1996 and 1997, the Company paid $34,000 and $22,000, respectively, in consulting fees to a Company owned by an officer/shareholder. The Company paid no such consulting fees during 1998. In addition, at December 31, 1996 and 1997, the Company had interest bearing notes receivable (Note 4) with stockholders of the Company in the amount of $53,500 and $67,770, respectively. The notes were due on demand or on a specific future date and were repaid during 1998. F-35
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COMPUTER BASED SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 NOTE 7--Retirement Plan The Company maintains a qualified profit sharing plan with a 401(k) deferred contribution option for all present and future employees that have reached 21 years of age and are employed on the first day of any calendar quarter with the Company. The annual contribution to the profit sharing plan is determined by the Board of Directors with the maximum contributions equal to the maximum allowed by Internal Revenue Service regulations, which at the present time is 15% of gross salaries. There was no profit sharing contribution for 1996, 1997 and 1998. The participants in the 401(k) deferred contribution option may elect to contribute from 1% to 17.5% of their gross annual earnings up to $7,000, as indexed for inflation. The Company may, at its discretion, make a matching contribution of each participants' contributions. Employees become fully vested in the Company's contributions at the rate of 20% per year after three years and are fully vested after seven years. Participants are fully vested in their voluntary contributions. For the years ended December 31, 1996, 1997 and 1998, the Company's matching contribution was $53,000, $12,112 and $94,620 net of forfeitures of $69,933, $86,810 and $54,351, respectively. NOTE 8--Self Insurance The Company maintains a self-insurance program for certain health care costs of its employees. The Company is liable for claims of up to $75,000 for the year ended December 31, 1996 and $50,000 per employee annually for the years ended December 31, 1997 and 1998, and aggregate claims up to $1,500,000 annually. Self-insurance costs are accrued based upon the aggregate of the liability for reported claims and an actuarially determined estimated liability for claims incurred but not reported. Total expense under the program for the years ended December 31, 1996, 1997 and 1998, was approximately $814,000, $597,000 and $730,000, respectively. NOTE 9--Leases The Company is obligated under certain noncancelable operating leases for facilities and equipment. The following is a schedule by years of the approximate future minimum rental payments required under operating leases that have an initial and remaining noncancelable lease term of one year or more as of December 31, 1998: [Download Table] Year Ending Office Office December 31 Space Subleases Furniture Total ----------- ---------- ----------- --------- ---------- 1999......................... 1,365,890 (279,290) (60,417) 1,026,183 2000......................... 1,387,622 (221,329) (60,417) 1,105,876 2001......................... 1,407,018 (180,138) (60,417) 1,166,463 2002......................... 1,316,122 (180,138) (60,417) 1,075,567 2003......................... 964,802 (142,609) (60,417) 761,776 Thereafter................... 18,218 (15,012) (5,035) (1,829) ---------- ----------- --------- ---------- Total...................... $6,459,672 $(1,018,516) $(307,120) $5,134,036 ========== =========== ========= ========== Total rental expense under all leases, net of sublease income, charged to operations for the years ended December 31, 1996, 1997 and 1998, was approximately $1,285,000, $1,133,000 and $1,220,000, respectively. In addition, the Company received approximately $140,000, $286,000 and $349,000 in rental income during the years ended December 31, 1996, 1997 and 1998, respectively, from sublease agreements. During 1997, the F-36
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COMPUTER BASED SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 NOTE 9--Leases--(continued) Company entered into an agreement to lease office furniture to one of its tenants which resulted in income from furniture rental of $66,417 and $60,417 for the years ended December 31, 1997 and 1998, respectively. Certain leases have escalation clauses and rent for certain office space was abated by a lessor for approximately four months. The Company has recorded rent on a straight-line basis based upon the total of lease payments to be paid over the life of the leases. The straight-line recognition of rent expense has created a deferred rent payable which will be paid over the remaining life of these leases. NOTE 10--Contracts Billings under cost-based government contracts are calculated using provisional rates that permit recovery of indirect costs. These rates are subject to audit on an annual basis by the government agencies' cognizant audit agency. The cost audit will result in the negotiation and determination of the final indirect cost rates that the Company may use for the period(s) audited. The final rates, if different from the provisionals, may create an additional receivable or liability. As of December 31, 1998, the Company has final settlements on indirect rates through December 31, 1995. The Company periodically reviews its cost estimates and experience rates, and adjustments, if needed, are made and reflected in the period in which the estimates are revised. In the opinion of management, redetermination of any cost-based contracts will not have a material effect on the Company's financial position or results of operations. NOTE 11--Subsequent Event As of December 31, 1998, the Company had entered into a letter of intent for the sale of the Company. On January 31, 1999, the Company signed an agreement and Plan of Merger with the acquiring company. NOTE 12--Restatement Of Stockholders' Equity During 1998, the Company corrected an error to the par value of its voting and non-voting common stock. During 1996, the financial statements reflected a par value of $.01 per share for voting and non-voting common stock. The error has been corrected by restating the components of stockholders' equity as of January 1, 1996 to reflect $1 par value of voting and non-voting common stock. F-37
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REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders of Pacer Infotec, Inc. We have audited the accompanying consolidated balance sheets of Pacer Infotec, Inc. and subsidiaries (the Company) as of December 31, 1996 and 1997 and the related consolidated statements of operations, stockholders equity, and cash flows for the years ended December 31, 1996 and 1997 and the period from January 1, 1998 to February 28, 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 consolidated financial position of Pacer Infotec, Inc. and subsidiaries at December 31, 1996 and 1997, and the consolidated results of their operations and their cash flows for the years ended December 31, 1996 and 1997 and the period from January 1, 1998 to February 28, 1998 in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Boston, Massachusetts April 17, 1998 F-38
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PACER INFOTEC, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS [Download Table] December 31, ------------------------ 1996 1997 ----------- ----------- ASSETS Current assets: Cash and cash equivalents.......................... $ 140,224 $ 48,234 Customer accounts receivable....................... 10,449,685 5,556,779 Unbilled amounts on contracts in process........... 6,837,843 5,443,807 Inventory.......................................... 159,055 172,566 Prepaid expenses and other current assets.......... 915,186 472,024 Deferred income taxes.............................. -- 573,800 Refundable income taxes............................ 681,002 -- ----------- ----------- Total current assets............................. 19,182,995 12,267,210 Property, equipment and leasehold improvements: Land............................................... 89,800 89,800 Building and improvements.......................... 884,872 751,827 Furniture and equipment............................ 3,613,619 4,181,279 ----------- ----------- 4,588,291 5,022,906 Less allowance for depreciation.................... (2,671,392) (3,248,496) ----------- ----------- 1,916,899 1,774,410 Other assets: Deferred income taxes.............................. 339,000 1,094,500 Cost in excess of net assets acquired of business acquired, net of amortization of $87,795 and $413,970 at December 31, 1996 and 1997............ 4,246,477 5,430,303 Notes receivable from stockholders................. 1,238,102 1,160,960 Deposits, notes receivable and other assets........ 1,021,036 1,072,467 ----------- ----------- 6,844,615 8,758,230 ----------- ----------- Total assets..................................... $27,944,509 $22,799,850 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses.............. $ 7,699,526 $ 7,011,660 Notes payable to bank.............................. 7,500,000 4,300,000 Compensation and related payroll taxes............. 2,739,476 2,433,342 Federal and state income taxes..................... -- 161,317 Deferred income taxes.............................. 111,000 -- Current portion of long-term debt.................. 210,282 207,749 ----------- ----------- Total current liabilities........................ 18,260,284 14,114,068 Long-term debt:...................................... 400,000 200,000 Stockholders' equity: Common stock, $.01 par value per share--authorized 15,000,000 shares at December 31, 1996 and 1997, issued and outstanding 7,962,339 shares at December 31, 1996, and 8,086,716 at December 31, 1997 respectively............................... 79,623 80,867 Additional paid-in capital......................... 5,997,196 6,120,065 Retained earnings.................................. 3,207,406 2,284,850 ----------- ----------- Total stockholders' equity....................... 9,284,225 8,485,782 ----------- ----------- Total liabilities and stockholders' equity....... $27,944,509 $22,799,850 =========== =========== See accompanying notes. F-39
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PACER INFOTEC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS [Download Table] Period from January 1, Year ended December 31, 1998 to ----------------------- February 28, 1996 1997 1998 ----------- ----------- ------------ Contract revenues and other income...... $41,337,214 $51,708,445 $7,478,506 Costs and expenses: Cost of contract service and product sales................................ 33,794,564 42,874,426 6,229,752 Selling, general and administrative... 5,685,093 7,976,362 1,179,496 Interest.............................. 381,056 636,026 65,252 ----------- ----------- ---------- 39,860,713 51,486,814 7,474,500 ----------- ----------- ---------- Earnings before income taxes............ 1,476,501 221,631 4,006 Federal and state income taxes.......... 622,000 384,000 4,000 ----------- ----------- ---------- Net earnings (loss)..................... $ 854,501 $ (162,369) $ 6 =========== =========== ========== Net earnings (loss) per share: Basic................................. $ .13 $ (.02) $ .00 =========== =========== ========== Diluted............................... $ .13 $ (.02) $ .00 =========== =========== ========== Shares used in computing net earnings (loss) per share: Basic................................. 6,392,566 8,013,599 8,086,716 =========== =========== ========== Diluted............................... 6,687,051 8,013,599 8,343,953 =========== =========== ========== See accompanying notes. F-40
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PACER INFOTEC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY [Download Table] Common Stock Additional ----------------- Paid-in Retained Shares Amount Capital Earnings Total --------- ------- ---------- ---------- ---------- Balance at December 31, 1995..................... 5,267,588 $52,676 $2,283,400 $2,537,498 $4,873,574 Exercise of option...... 6,500 65 4,010 -- 4,075 Issuance of shares in connection with acquisition............ 2,688,251 26,882 3,709,786 -- 3,736,668 Cash dividends.......... -- -- -- (184,593) (184,593) Net earnings............ -- -- -- 854,501 854,501 --------- ------- ---------- ---------- ---------- Balance at December 31, 1996..................... 7,962,339 79,623 5,997,196 3,207,406 9,284,225 Exercise of options..... 124,377 1,244 122,869 -- 124,113 Cash dividends.......... -- -- -- (760,187) (760,187) Net loss................ -- -- -- (162,369) (162,369) --------- ------- ---------- ---------- ---------- Balance at December 31, 1997..................... 8,086,716 $80,867 $6,120,065 $2,284,850 $8,485,782 Net earnings............ -- -- -- 6 6 --------- ------- ---------- ---------- ---------- Balance at February 28, 1998..................... 8,086,716 $80,867 $6,120,065 $2,284,856 $8,485,788 ========= ======= ========== ========== ========== See accompanying notes. F-41
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PACER INFOTEC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS [Download Table] Period from January 1, Year ended December 31, 1998 to ------------------------ February 28, 1996 1997 1998 ----------- ----------- ------------ Operating activities Net earnings (loss)..................... $ 854,501 $ (162,369) $ 6 Adjustments to reconcile net earnings (loss) to net cash flows provided by operations: Depreciation and amortization......... 602,927 948,617 135,966 Deferred income tax benefit........... (764,000) (653,100) -- Changes in operating assets and liabilities, net of effect of acquisition: Customer accounts receivable and unbilled amounts on contracts in process.............................. 1,600,068 5,786,942 591,299 Inventory............................. 155,441 (13,511) (107,313) Accounts payable and accrued expenses............................. (1,715,131) (2,374,020) (920,616) Compensation and related payroll taxes................................ -- (306,135) 428,886 Income taxes.......................... 899,972 731,319 4,000 Prepaid expenses and other assets..... 18,601 443,087 30,017 ----------- ----------- ----------- Net cash provided by operating activities............................. 1,652,379 4,400,830 162,245 Investing activities Costs incurred in connection with acquisition, including reduction of notes payable of acquired business, less cash acquired of $354,435......... (4,032,713) -- -- Acquisition of equipment and leaseholds............................. (276,466) (455,520) (20,398) Deposits and investment in other assets, net.................................... 53,096 1,307 3,380 ----------- ----------- ----------- Net cash used in investing activities... (4,256,083) (454,213) (17,018) Financing activities Cash received in connection with merger................................. -- -- 16,500,000 Issuance of common stock................ 4,075 124,113 -- Notes payable to bank repayments........ -- (3,200,000) (4,300,000) Net repayment of long-term debt......... (180,714) (202,533) -- Cash dividends.......................... (184,593) (760,187) -- ----------- ----------- ----------- Net cash provided by (used in) financing activities............................. (361,232) (4,038,607) 12,200,000 ----------- ----------- ----------- Net increase in cash and cash equivalents............................ (2,964,936) (91,990) 12,345,227 Cash and cash equivalents at beginning of period.............................. 3,105,160 140,224 48,234 ----------- ----------- ----------- Cash and cash equivalents at end of period................................. $ 140,224 $ 48,234 $12,393,461 =========== =========== =========== See accompanying notes. F-42
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PACER INFOTEC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Significant Accounting Policies Principles of Consolidation The consolidated financial statements of Pacer Infotec, Inc. (formerly Pacer Systems, Inc.) and subsidiaries (collectively, the Company) include the accounts of the Company and its wholly-owned subsidiaries, Computing Applications Software Technology, Inc. (CAST), acquired in 1992, and Infotec Development, Inc. (IDI), which was merged with Pacer Systems, Inc. in 1996 by way of acquisition. In connection with this merger, the Company's name was changed to Pacer Infotec, Inc. All significant intercompany transactions have been eliminated in consolidation. On February 27, 1998, the Company merged with Apollo Holding, Inc. (see Note 2). Cash Equivalents The Company considers all highly liquid investments with maturities of three months or less from the date acquired to be cash equivalents. Inventory Inventory, principally electrical and mechanical components and assemblies, is stated at the lower of cost or market. Cost is determined using the first- in, first-out (FIFO) method. Property and Equipment Property and equipment are valued at historical cost or fair value if obtained in connection with an acquisition. Depreciation of office building, furniture and equipment is provided for over the estimated useful lives of the assets, which range from five to thirty years. Amortization of leasehold improvements is provided for over the term of the lease or their estimated useful lives, whichever is shorter. Depreciation and amortization are calculated on the straight-line basis for financial reporting purposes. Cost in Excess of Net Assets of Business Acquired This balance represents the excess of the value of shares issued and other costs incurred over the fair value of the net assets acquired of IDI. The excess cost is being amortized using the straight-line method over 20 years. Impairment of Long-Lived Assets In 1996, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 121, "Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of." SFAS No. 121 requires recognition of impairment losses on long- lived assets when indicators of impairment losses on long-lived assets are present and future undiscounted cash flows are insufficient to support the assets' recovery. Adoption of SFAS No. 121 had no material impact on the Company's financial statements. Revenue Recognition A major portion of the Company's sales consists of revenues earned from long-term professional engineering service and other contracts, principally with U.S. Government agencies. The Company recognizes revenue as services are performed or the percentage-of-completion method based upon the terms of the contracts. Sales of air data systems are recognized as revenue at the time of shipment. F-43
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PACER INFOTEC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 1. Significant Accounting Policies--(continued) Risks and Uncertainties Concentration of Credit Risk Financial instruments which subject the Company to credit risk consist of cash equivalents and accounts receivable. The risk with respect to cash equivalents is minimized by the Company's policies in which investments are only placed with highly rated issuers with relatively short maturities. The risk with respect to accounts receivable is minimized due to the fact that customer accounts and unbilled receivables represent amounts earned under the Company's contracts, which are principally with U.S. Government agencies. Estimates The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are required by management in the area of determining contract completion. Significant estimates and assumptions have also been made by management in connection with the merger discussed in Note 2. Actual results could differ from those estimates. Income Taxes The Company accounts for income taxes in accordance with Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes." This method requires income taxes to be recognized based on income taxes currently payable and the change in deferred taxes during the year. Deferred taxes are recognized based on the temporary differences between the financial statement and tax bases of assets and liabilities at enacted tax rates as of the dates the differences are expected to reverse. Earnings per Share In 1997, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share." SFAS No. 128 establishes criteria for calculating basic earnings per share in which the dilutive effect of stock options is excluded, and requires restatement of all prior period earnings per share data presented. Adoption of SFAS No. 128 did not have a material impact on the Company's financial statements. Basic earnings per share is computed using the weighted-average number of common shares outstanding during the year. Diluted earnings per share includes the effect of all potentially dilutive securities. Reclassification Certain amounts at December 31, 1996 have been reclassified to permit comparison with December 31, 1997. Stock-Based Compensation The Company accounts for stock option grants to employees in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees." Accounting Pronouncements Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income", which is effective for all financial statements beginning after December 15, 1997. Under SFAS No. 130, the F-44
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PACER INFOTEC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 1. Significant Accounting Policies--(continued) Company is required to report and display comprehensive income and its components in a full set of general purpose financial statements and to reclassify earlier periods provided for comparative purposes. For the period from January 1, 1998 to February 28, 1998, net earnings and comprehensive income are the same. In 1997, the Financial Accounting Standards Board issued statement No. 131, "Disclosures About Segments of an Enterprise and Related Information," or SFAS 131, which was required to be adopted for fiscal years beginning after December 15, 1997, SFAS 131, superseded SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise." This statement changes the way public companies report segment information in annual financial statements. SFAS 131 requires public companies to report financial and descriptive information about their operating segments in interim financial reports to shareholders as well. The adoption of this Statement had no impact on the disclosures in the Company's financial statements as the Company has once reportable segment. 2. Business Combination On June 28, 1996, Pacer Systems, Inc. (Pacer) and IDI entered into an Agreement of Merger and Plan of Reorganization (Merger Agreement) in which each share of IDI common stock was exchanged for 4.1856 shares of Pacer. In accordance with the Merger Agreement, and subsequent modifications, 2,688,251 shares of stock were issued by Pacer and exchanged for all the outstanding common stock of IDI. In connection with the merger, Pacer changed its name to Pacer Infotec, Inc. The merger has been accounted for under the purchase method and, accordingly, the fair value of the shares and costs including professional fees and certain liabilities, principally related to severance arrangements, incurred in connection with the merger have been allocated to the net assets of IDI based upon their fair value. The excess of the cost over fair value of net assets is being amortized over 20 years on a straight-line basis. The operating results of IDI have been included in the Company's consolidated financial statements from July 25, 1996, the effective date of the merger. As previously discussed, management allocated the cost of the acquisition to the net assets of IDI based on its estimate of their fair value. Significant estimates were made with respect to the fair value of unbilled receivables recoverable under certain contracts which are subject to final settlement with the U.S. Government agencies. Although at the date of the merger, management believed its estimates to be appropriate, the final resolution of actual amounts due in connection with these contract settlements differed from the estimates. As a result, the Company increased costs in excess of net assets during the year by $857,651 to reflect the final resolution of these estimates. In connection with the merger, certain stockholders of IDI executed new promissory notes representing principal and accrued interest owed to IDI on notes entered into in previous years in exchange for cash. The promissory notes bear interest at 6.3 6%, mature at various dates ranging from 1997 to 2001 and are collateralized by shares of the Company owned by these stockholders. On February 27, 1998, Pacer Infotec, Inc. and Apollo Holding, Inc. merged to form AverStar, Inc. (AverStar), a newly formed corporation. The merger was consummated by the contribution of approximately 4.6 million shares of common stock of Pacer Infotec, Inc. and all of the outstanding shares of Apollo Holding, Inc. As a result, the Company's business and operations will be combined into AverStar, Inc. In connection with the merger, AverStar provided cash to the Company to reduce its bank debt (see Note 3). In addition, AverStar will pay approximately $7 million to redeem the remaining 3.5 million outstanding shares of Pacer Infotec, Inc. publicly registered common stock on the London Stock Exchange. The Company terminated its listing on the London Stock Exchange on February 27, 1998. 3. Financing Arrangements In July 1996, in connection with the acquisition discussed in Note 2, the Company entered into a revolving credit agreement (Agreement) with its bank which permits borrowings up to $12,000,000 based on specified F-45
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PACER INFOTEC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 3. Financing Arrangements--(continued) levels of billed and unbilled accounts receivable on contracts in process. At the date of the merger, approximately $11,000,000 of IDI debt was repaid from $7,500,000 of proceeds from borrowings under the Agreement and the Company's existing cash balances. Borrowings are due on demand and bear interest at the bank's prime lending rate plus 1.75% (10% at December 31, 1997). Substantially all of the Company's assets are secured as collateral under the Agreement. The Agreement as amended in January 1997, includes certain quarterly and annual operating and net worth covenants. The Agreement expires on June 30, 1998. At December 31, 1996 and 1997, $7,500,000 and $4,300,000 were outstanding under the Agreement. On February 27, 1998, the Company, in connection with its acquisition disclosed in Note 2, canceled the Agreement by paying its outstanding line of credit balance. Long-term debt consists of the following: [Download Table] December 31 -------------------- 1996 1997 --------- --------- Obligation under settlement agreement, payable in annual installments of $200,000 bearing interest at 8%............................................. $ 600,000 $ 400,000 Other.............................................. 10,282 7,749 --------- --------- 610,282 407,749 Less current portion............................... (210,282) (207,749) --------- --------- $ 400,000 $ 200,000 ========= ========= Future maturities of long-term debt are as follows: 1998--$207,240 and 1999--$200,000. The carrying value of the Company's debt approximates fair value. Interest paid for the years ended December 31, 1996 and 1997 and the period from January 1, 1998 to February 28, 1998 approximates interest expense. 4. Stock Options The Company has an Incentive Stock Option Plan (the Plan). Under terms of the Plan, as amended, options may be granted to key employees to purchase up to 3,000,000 shares of common stock at prices not less than fair market value at date of grant. The options expire up to ten years from date of grant, or upon termination of employment, and are exercisable in installments based on vesting schedules approved by the Board of Directors. The Company has adopted the disclosure provisions only of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock Based- Compensation," and will continue to account for option grants to employees under the Plan in accordance with APB No. 25, "Accounting for Stock Issued to Employees." Adoption of SFAS No. 123 would not have a material impact on the Company's financial statements and, accordingly, no pro forma net income has been disclosed for the years ended December 31, 1997 and for the period from January 1, 1998 to February 28, 1998 and for the compensation expense of option grants which otherwise would be required under the disclosure requirements of SFAS No. 123. F-46
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PACER INFOTEC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 4. Stock Options--(continued) Information regarding options under the Plan is summarized below: [Download Table] Weighted- Average Number of Exercise Shares Price --------- --------- Balance at December 31, 1995.......................... 351,200 $0.74 Granted............................................. 35,000 2.08 Exercised........................................... (6,500) 0.63 Canceled............................................ (7,500) 0.96 Exchanged for options of IDI........................ 740,849 1.67 --------- Balance at December 31, 1996.......................... 1,113,049 1.37 Granted............................................. 785,000 1.85 Exercised........................................... (124,377) 1.00 Canceled............................................ (45,700) .95 --------- Balance at December 31, 1997.......................... 1,727,972 1.61 --------- Granted............................................. -- Canceled............................................ -- Balance at February 28, 1998.......................... 1,727,972 $1.61 ========= The options for 740,849 shares of the Company's common stock were issued in exchange for all of the outstanding options of IDI at the merger date. The number of shares and exercise prices were adjusted based upon the exchange ratio of 4.1856 described in Note 2. At December 31, 1996, December 31, 1997 and February 28, 1998, options for the purchase of 947,482, 1,722,972 and 1,727,972 shares, respectively, were exercisable with weighted average exercise prices of $.93, $1.61 and $1.45, respectively. Exercise prices for options outstanding as of February 28, 1998 ranged from $0.53 to $2.08. The weighted average remaining contractual life of options outstanding at February 28, 1998 is 6.67. 5. Retirement Plans Defined Contribution Plan The Company has a 401(k) profit-sharing plan which covers substantially all employees and provides for a Company matching contribution. As defined under the plan, employees are allowed to contribute the maximum established by law, and the Company may match up to 4% of the employee's compensation. The Company's expense relating to this plan amounted to $289,975 for the year ended December 31, 1996, $499,983 for the year ended December 31, 1997 and $96,679 for the period January 1, 1998 to February 28, 1998. Employee Stock Bonus Plan The Company has a noncontributory defined contribution plan which covers substantially all employees and provides for an annual discretionary contribution by the Company as determined by the Board of Directors based on the Company's performance. The contribution is allocated among participating employees in proportion to each participant's basic annual salary, as defined in the plan. Substantially all of the Company's contributions will be invested in the Company's common stock. The Company recognized $132,000 for the year ended December 31, 1996 and $157,004 of expense for the year ended December 31, 1997 and did not recognize any expense for the period from January 1, 1998 to February 28, 1998 related to the plan. F-47
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PACER INFOTEC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 6. Leases The Company leases office space, office equipment and automobiles which have been accounted for as operating leases. The base agreements expire at various times through 2003. Total rent expense amounted to $996,019 for the year ended December 31, 1996, $1,504,925 for the year ended December 31, 1997 and $230,592 for the period from January 1, 1998 to February 28, 1998, respectively. The future minimum annual rental commitments under these long-term noncancelable leases are as follows: [Download Table] Year ending December 31, 1998.............. $1,460,856 1999.............. 1,275,082 2000.............. 854,963 2001.............. 617,114 2002.............. 288,655 Thereafter........ 188,264 ---------- $4,684,934 ========== 7. Income Taxes Significant components of the Company's deferred tax liabilities and assets as of December 31, 1996 and 1997 are as follows: [Download Table] December 31 ----------------------- 1996 1997 ----------- ---------- Deferred tax asset (liability): Cash to accrual method.......................... $(1,018,000) $ -- Depreciation and amortization................... 339,000 243,100 Contracts in progress........................... 92,000 925,600 Compensation.................................... 605,000 399,700 Other........................................... 210,000 99,900 ----------- ---------- Net deferred tax asset............................ 228,000 1,668,300 Net current deferred asset (liability)............ 111,000 (573,800) ----------- ---------- Noncurrent net deferred tax asset................. $ 339,000 $1,094,500 =========== ========== In connection with the merger described in Note 2, the Company assumed a net deferred tax liability, the most significant component of which related to the change in 1993 by IDI from the cash to the accrual method of reporting taxable income. The effect of this change has been included in taxable income ratably over tax reporting periods beginning in 1993 and ending February 28, 1998. In addition, due to significant losses of IDI incurred prior to the merger, the Company was entitled to refundable income taxes of approximately $1,533,000 as of December 31, 1996. F-48
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PACER INFOTEC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 7. Income Taxes--(continued) These refundable income taxes have been included in the accompanying 1996 balance sheet net of federal and state taxes otherwise payable by the Company. In addition, in 1997, as a result of the final resolution of amounts due under certain IDI contracts assumed as of the acquisition, the Company recognized a deferred tax asset of $787,200 in connection with the final adjustment of costs in excess of net assets of IDI acquired. Significant components of the provision for income taxes are as follows: [Download Table] 1996 1997 ---------- ---------- Current: Federal........................................ $1,113,000 $ 787,000 State.......................................... 273,000 250,100 ---------- ---------- 1,386,000 1,037,100 Deferred benefit, principally federal............ (764,000) (653,100) ---------- ---------- $ 622,000 $ 384,000 ========== ========== The Company's tax provision for the period from January 1, 1998 to February 28, 1998 exceeds the statutory rate due to the amortization of the excess of costs over net assets acquired, which are not deductible for income tax purposes. The 1997 effective income tax rate is higher than the expected statutory rate due to amortization of the excess of costs over net assets acquired and merger-related costs (see Note 8) which are not deductible for income tax reporting purposes. The Company made payments of approximately $571,000 for the year ended December 31, 1996, $1,295,000 for the year ended December 31, 1997 and did not make any income tax payments from January 1, 1998 to February 28, 1998 F-49
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LOOKING GLASS TECHNOLOGIES, INC. REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders Looking Glass Technologies, Inc. We have audited the accompanying statements of operations, changes in stockholders' equity (deficit) and cash flows of Looking Glass Technologies, Inc. for the year ended March 31, 1997 and the period from April 1, 1997 through August 8, 1997. 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 results of operations and cash flows of Looking Glass Technologies, Inc. for the year ended March 31, 1997 and the period from April 1, 1997 through August 8, 1997 in conformity with generally accepted accounting principles. Ernst & Young LLP April 30, 1999 F-50
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LOOKING GLASS TECHNOLOGIES, INC. STATEMENTS OF OPERATIONS Year ended March 31, 1997 and the period from April 1, 1997 through August 8, 1997 [Download Table] March 31, August 8, 1997 1997 --------- --------- Revenues: Product Sales....................................... $ 3,579,879 $ 1,356,867 Software Development................................ 555,555 933,333 Other royalties and licenses........................ 270,172 31,730 ----------- ----------- 4,405,606 2,321,930 Cost and expenses: Cost of revenues.................................... 661,675 445,766 Research and development............................ 4,459,537 1,327,451 Selling, general and administrative................. 4,059,154 1,752,838 ----------- ----------- Total costs and expenses.......................... 9,180,366 3,526,055 ----------- ----------- Loss from operations................................. (4,774,760) (1,204,125) Interest expense..................................... 3,934 33,144 ----------- ----------- Net loss............................................. $(4,778,694) $(1,237,269) =========== =========== See accompanying notes. F-51
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LOOKING GLASS TECHNOLOGIES, INC. STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICITS) Year ended March 31, 1997 and the period ended August 8, 1997 [Enlarge/Download Table] Series A Series B Series C preferred stock preferred stock preferred stock Common Stock ----------------- -------------------- ------------------ ---------------- Additional Par paid in Accumulated Shares Amount Shares Amount Shares Amount Shares value capital deficit --------- ------- --------- ---------- ------- ---------- --------- ------ ---------- ------------ Balance at March 31, 1996........ 1,650,000 $73,540 2,280,000 $3,749,893 995,139 $3,901,990 3,735,600 $3,735 $10,140 $ (5,657,991) Issuance of common stock pursuant to exercise of options...... 503,000 503 45,068 Net (loss)...... (4,778,694) --------- ------- --------- ---------- ------- ---------- --------- ------ ------- ------------ Balance at March 31, 1997........ 1,650,000 73,540 2,280,000 3,749,893 995,139 3,901,990 4,238,600 4,238 55,208 (10,436,685) Issuance of common stock pursuant to exercise of options...... 28,100 28 4,656 Net (loss)...... (1,237,269) --------- ------- --------- ---------- ------- ---------- --------- ------ ------- ------------ Balance at August 8, 1997.. 1,650,000 $73,540 2,280,000 $3,749,893 995,139 $3,901,990 4,266,700 $4,266 $59,864 $(11,673,954) ========= ======= ========= ========== ======= ========== ========= ====== ======= ============ Total stockholders' equity (deficit) ---------------- Balance at March 31, 1996........ $ 2,081,307 Issuance of common stock pursuant to exercise of options...... 45,571 Net (loss)...... (4,778,694) ---------------- Balance at March 31, 1997........ (2,651,816) Issuance of common stock pursuant to exercise of options...... 4,684 Net (loss)...... (1,237,269) ---------------- Balance at August 8, 1997.. $(3,884,401) ================ F-52
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LOOKING GLASS TECHNOLOGIES, INC. STATEMENTS OF CASH FLOWS Year ended March 31, 1997 and period from April 1, 1997 through August 8, 1997 [Download Table] Period Year ended ended March 31, August 8, 1997 1997 ----------- ----------- Cash flows from operating activities: Net loss.......................................... $(4,778,694) $(1,237,269) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization..................... 465,200 118,800 Changes in assets and liabilities: Accounts receivable............................. 327,914 327,881 Inventories..................................... 33,193 -- Prepaid expenses................................ (38,475) 56,334 Other assets.................................... 779 (99) Accounts payable................................ (129,855) 670,337 Accrued expenses................................ 28,142 903,866 Deferred revenue................................ (453,964) 70,267 ----------- ----------- Net cash (used) provided by operating activities.... (4,545,760) 910,117 Cash flows from investing activities: Purchases of fixed assets......................... (184,881) (9,474) Cash flows from financing activities: Proceeds (repayment) from revolving line of credit........................................... 2,000,000 (2,000,000) Proceeds (repayment) from secured note payable.... -- 400,000 Repayment of capital lease obligations............ (189,454) (97,531) Proceeds from issuance of common stock............ 45,571 4,684 ----------- ----------- Net cash (used) provided by financing activities.... 1,856,117 (1,692,847) ----------- ----------- Net decrease in cash and cash equivalents........... (2,874,524) (792,204) ----------- ----------- Cash and cash equivalents, beginning of year........ 3,692,830 818,306 Cash and cash equivalents, end of year.............. $ 818,306 $ 26,102 =========== =========== Supplemental disclosure of cash flow information: Cash paid for interest during the period from April 1, 1997 through August 8, 1997 and the year ended March 31, 1997 was $13,000 and $51,000, respectively. See accompanying notes. F-53
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LOOKING GLASS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 1. Nature of Business and Summary of Significant Accounting Policies Looking Glass Technologies, Inc. (the Company) was incorporated in Delaware on June 29, 1992. The Company designs, develops and publishes interactive entertainment software. The Company sells its products to distributors primarily in North America and the United Kingdom and its principal market is the consumer market. The Company also licenses to other leading industry publishers the right to publish and distribute the Company's software in exchange for product development fees and future royalties. Effective August 9, 1997 the company contributed all its assets, liabilities and operations to a newly formed entity, Intermetrics Entertainment Software LLC (IES), and the shareholders of the Company received approximately a 34% interest in IES. A summary of the Company's significant accounting policies follows: Fixed Assets Fixed assets are stated at cost and depreciated using the straight-line method over the related estimated useful lives. Maintenance and repair costs are expensed as incurred. Revenue Recognition Revenues from product sales are recognized upon shipment, net of allowances for estimated returns and price protection, provided that no significant vendor obligations remain and collection of the related receivable is probable. Nonrefundable advances on future royalties pursuant to software development agreements with publishers are recognized as revenue as work is performed and milestones defined in the related agreements are attained. The publishers are entitled to set off all payments made to the Company during development of the software against initial royalty payments due to the Company. Such right of set off is conditioned upon the successful development and commercialization of the software. Royalties in excess of payments made to the Company during development of the software are recognized as revenue when earned based upon product shipments from the publisher, net of allowances for returns and price protection, as and when reported to the Company by the respective publishers. Payments received under licensing agreements are initially recorded as deferred revenue and recognized as revenue when earned based upon product shipments to licensees. Research and Development and Software Development Costs Costs incurred in the research and development of the Company's products through the establishment of technological feasibility, as defined by Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leases, or Otherwise Marketed, are expensed as incurred. Development costs incurred thereafter and until the products are first available for release have not been material and have therefore been expensed as incurred. Advertising Advertising costs are expensed as incurred. Advertising expense for the year ended March 31, 1997 and for the period from April 1, 1997 through August 8, 1997 were $420,000 and $225,000, respectively. Concentration of Credit Risk and Significant Customers At March 31, 1997 and August 8, 1997 the Company maintained cash balances in certain bank accounts in excess of federally insured limits. All such accounts are maintained in a highly rated financial institution. Accordingly, these accounts bear minimal credit and market risk. F-54
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LOOKING GLASS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) At March 31, 1997 $295,000 of the Company's accounts receivable was due from one customer. Two customers accounted for 57% of the Company's total revenues during the year ended March 31, 1997. During the period from April 1, 1997 through August 8, 1997, one customer accounted for 60% of the Company's total revenues. Accounting Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Accounting for Stock-Based Compensation In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. The Company has adopted this standard through disclosure only in the accompanying financial statements. 2. Income Taxes The Company has gross deferred tax assets of approximately $868,000 at March 31, 1997 and August 8, 1997. Gross deferred tax assets consist of federal and state net operating loss carryforwards, research and development credit carryforwards and temporary differences resulting from certain transactions recognized in different periods for financial reporting and income tax purposes. The Company has no deferred tax liabilities at March 31, 1997 and August 8, 1997. The Company has provided a valuation allowance for the full amount of the deferred tax assets at March 31, 1997 and August 8, 1997 since realization of these future benefits is not sufficiently assured. At March 31, 1997, the Company has federal and state net operating loss carryforwards of approximately $8,336,000 and $7,832,000, respectively, which expire at various dates through 2011. At March 31, 1997, the Company also has federal and state research and development tax credit carryforwards of approximately $144,000 and $199,000, respectively, which expire at various dates through 2011. Under the Internal Revenue Code, certain substantial changes in the Company's ownership may limit the amount of net operating loss and tax credit carryforwards that can be utilized to offset future taxable income or tax liability. 3. Stockholders' Equity Issuance of Preferred Stock Series A preferred stock consists of 825,000 shares of Series A-1 preferred stock, issued for net proceeds of $36,770, and 825,000 shares of Series A-2 preferred stock, issued for net proceeds of $36,770. The Series A-1 preferred stock and the Series A-2 preferred stock differ only as to voting rights, as defined in the amended and restated certificate of incorporation. The 2,280,000 shares of Series B preferred stock were issued at a price of $1.67 per share for aggregate consideration of $3,800,000. On August 10, 1995, the Company issued 995,139 shares of Series C preferred stock at a price of $4.01 per share for gross proceeds of $3,990,000. F-55
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LOOKING GLASS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Each share of Series A, Series B and Series C preferred stock is convertible into common stock at the option of the holder as a conversion price per share defined in the amended and restated certificate of incorporation, or automatically upon the earlier of (I) a vote of the holders of a least two- thirds of each series of the outstanding preferred shares or (ii) the closing of a public offering of the Company's common stock at a price of at least $4.33 per share and with aggregate net proceeds to the Company in excess of $15,000,000. At March 31, 1997 and August 8, 1997, the Company has reserved a total of 4,925,139 shares of common stock for the conversion of the outstanding Series A, Series B and Series C preferred stock. Stockholders of Series A, Series B, and Series C preferred stock are entitled to one vote for each share of common stock into which the Series A, Series B and Series C preferred stock is convertible. The holders of the Series A, Series B and Series C preferred stock are entitled to receive dividends when and if declared by the Board of Directors and are noncumulative. Through August 8, 1997, no dividends have been declared or paid. Warrants In connection with the issuance of Series C preferred stock in August 1995, the Company issued a warrant for the purchase of up to 150,000 shares of Series C preferred stock (Preferred Stock Warrant). The Preferred Stock Warrant is exercisable at a price of $4.01 per share and expired on December 31, 1996. The Company also issued a warrant for the purchase of up to 150,000 shares of common stock (Common Stock Warrant), exercisable upon the effective date of an initial public offering (IPO) at the IPO price per common share. The Common Stock Warrant expires twenty four months after the IPO date. The values ascribed to the preferred and common stock warrants were not significant. The Company has reserved 150,000 shares of preferred stock and 150,000 shares of common stock for issuance upon exercise of the warrants. 4. 1992 Stock Plan At August 8, 1997 Looking Glass Technologies, Inc. had a stock compensation plan which is described below. Looking Glass Technologies, Inc. applies APB Opinion 25 related Interpretations in accounting for its plan. Looking Glass Technologies, Inc. has adopted the disclosure-only provision of SFAS 123. Accordingly, no compensation cost has been recognized for its stock compensation plans. Adoption of SFAS 123 would not have a material impact on the Company's financial statements and accordingly no pro forma net income has been disclosed for the year ended March 31, 1997 and the period from April 1, 1997 through August 8, 1997. The weighted-average grant date fair value of options granted is not material. The effects on pro forma net income of expensing the estimated fair market value of stock options are not necessarily representative of effects on reported net income for future years due to such factors as the vesting period of the stock options and the potential issuance of additional stock options in future years. Additionally, because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 1999 or 2000. Fixed stock compensation plans: The 1992 Stock Plan (the "1992 Plan") provides for the grant of incentive stock options, nonqualified stock options and stock purchase rights for the purchase of up to an aggregate of 2,700,000 shares of the Company's common stock by employees, consultants and directors. The Board of Directors is responsible for administration of the 1992 Plan and, accordingly, determines the term, exercise price, number of shares and vesting period of each option. Options granted under the 1992 Plan generally expire ten years from the date of the grant. F-56
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LOOKING GLASS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Incentive stock options may be granted to an employee at an exercise price per share of not less fair value per common share on the date of grant (not less than 110% of the fair value in the case of holders of more than 10% of Company's voting stock). Non qualified stock options may be granted to employees, consultants and directors at an exercise price per share not less than 85% of the fair value per common share on the date of the grant (110% of the fair value in the case of holders of more than 10% of the Company's voting stock). The fair market value of each option grant is estimated on the date of the grant using the Minimum Value option-pricing model with the following weighted average assumptions used for grants in the year ended March 31, 1997 and the period April 1, 1997 through August 8, 1997: [Download Table] March 31, August 8, 1997 1997 --------- --------- Expected life (years)....................................... 5 5 Range of risk-free interest rates........................... 6.73% 6.76% A summary of the status of Looking Glass Technologies, Inc. 1992 Plan compensation plan at March 31, 1997 and August 8, 1997 is presented below: The following table summarizes stock option activity under the 1992 Plan: [Download Table] Year ended April 1, 1997 March 31, through August 1997 8, 1997 ---------------- ---------------- Weighted Weighted Average Average Shares Exercise Shares Exercise (000) Price (000) Price ------ -------- ------ -------- Outstanding at beginning of year.............. 1,772 $.18 1,431 $.25 Granted....................................... 444 .40 147 .40 Exercised..................................... (501) .09 (28) .16 Canceled...................................... (284) .26 (76) .20 ----- ----- Outstanding at end of year.................... 1,431 .25 1,474 .25 ===== ===== Options exercisable at year end............... 634 614 The following table summarizes information about the 1992 Plan at August 8, 1997: [Download Table] Options Outstanding Options Exercisable ----------------------------- -------------------------- Weighted Average Weighted Weighted Number Remaining Average Number Average Exercise Outstanding Contractual Exercise Outstanding Exercise Prices at 8/8/97 Life Price at 8/8/97 Price -------- ----------- ----------- -------- ----------- -------- $.08 338,600 6.2 $.08 225,726 $.08 .17 498,900 7.6 .17 249,209 .17 .40 636,500 8.9 .40 139,050 .40 --------- ------- 1,474,000 613,985 --------- ------- F-57
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LOOKING GLASS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 5. Related-Party Transactions In connection with the Series C preferred stock issuance in August 1995 (Note 4), the Company entered into a technology licensing and product development agreement with the sole Series C preferred stockholder whereby the Company granted to the stockholder the exclusive right to distribute and license certain of the Company's products. Under the terms of the agreement, the Company is entitled to receive royalty payments based on sales of the Company's products. During the year ended March 31, 1997, the Company received and recognized as revenue nonrefundable fees for software development pursuant to this agreement totaling $400,000. In January 1994, the Company and its two founders entered into an agreement which provides that, upon termination of a founder's employment with the Company prior to an initial public offering of the Company's common stock, such founder's stock shall be subject to a right of repurchase by the other founder. 6. Commitments The Company leases its facilities and certain computer equipment and furniture under noncancellable lease agreements. Future minimum lease obligations are approximately as follows: [Download Table] Period ending August 8 Capital Lease Operating Leases ---------------------- ------------- ---------------- 1997....................................... $100,000 $ 150,000 1998....................................... 218,000 523,000 1999....................................... 42,000 537,000 2000....................................... 537,000 2001....................................... 45,000 -------- ---------- Thereafter................................. $1,792,000 Less amount representing interest.......... (22,000) -------- $338,000 ======== Rental expense under operating leases for the year ended March 31, 1997 and the period from April 1, 1997 through August 8, 1997 was approximately $349,000 and $120,000, respectively. 7. Licensing and Distribution Agreements In August 1995, the Company entered into a distribution agreement with a publisher of interactive entertainment software (the Publisher). Under the terms of the agreement, the Company granted the Publisher the exclusive right to distribute and license certain of the Company's products in North America and the United Kingdom. The agreement is effective through August 1996 and is thereafter renewable for two-year periods by mutual agreement of the Company and the Publisher. On June 25, 1997, the Company exercised its right to terminate the agreement effective August 31, 1997. During the year ended March 31, 1997 and for the period from April 1, 1997 through August 8, 1997, the Company entered into licensing and distribution agreements whereby the Company is entitled to receive royalty payments based on sales of the Company's products. Advances on future royalties pursuant to these agreements aggregating $233,000 and $300,000 have been included in deferred revenue at March 31, 1997 and August 8, 1997, respectively. F-58
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LOOKING GLASS TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 8. Debt Under the licensing and distribution agreements disclosed in Note 8, the Company has an available line of credit facility of $3,000,000. Any outstanding balance is to be repaid not later than 12 months following general release of the relevant product. Borrowings bear interest at prime. The line of credit facility is secured by the Company's intellectual property rights in products and revenues from them. At March 31, 1997, the Company had an outstanding line of credit balance of $2,000,000 relating to this agreement. The company also has outstanding as of August 8, 1997, $400,000 of 10.5% secured convertible promissory notes. $200,000 of the notes mature on August 22, 1997 and $200,000 mature in December 1997. Amounts outstanding under these promissory notes are payable to the stockholders of IES-please see Note 1. 9. 401(k) Plan In January 1996, the Company adopted a retirement savings plan (the Plan) under section 401(k) of the Internal Revenue Code. The Plan covers substantially all employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre- tax basis. Company contributions to the Plan may be made at the discretion of the Board of Directors. There were no contributions by the Company to the Plan for the period from April 1, 1997 through August 8, 1997 or the year ended March 31, 1997. F-59
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[Enlarge/Download Table] SERVICES --------------------------------------------------------------------------------------------------------------------------------- MARKET IT Assurance IT Development IT Operations IT Consulting --------------------------------------------------------------------------------------------------------------------------------- Health Care Department Of TRW/Department National Finance Housing & Urban Of Interior Institute Of Administration Development (Data Center Operations) Standards & (Systems Assurance) (Electronic Business) Technology Federal Deposit (Prototyping, Monitoring NASA SAIC/Department insurance & Debugging Tools) (Systems Assurance) Of Justice Corporation (Mission Applications) (Network & Data Operations) NASA United States (Technology Studies) Postal Service NASA Department Of (Systems Assurance) (Mission Applications) Labor (Data Collection and Department Of Jet Propulsion Reporting) Civilian Labor Laboratory Government (Y2K Compliance Assessment) (Mission Applications) Environmental Protection Securities & Department Of Agency Exchange Health & Human (Data Collection and Commission Services Reporting) (Y2K Compliance Assessment) (Electronic Business & Mission Applications) United States Patent & Trademark Office (Network Operations) ------------------------------------------------------------------------------------------------------------------------------------ United States United States United States Defense Navy Navy Navy Advanced (Systems Assurance) (Mission Applications) (Logistic Operations) Research Projects Agency Lockheed Martin/ Lockheed Martin Lockheed Martin/ United States (Electronic Business) United States (Technology Studies Air Force Air Force & Prototyping) (Information Assurance) Boeing Rockwell (Network Operations) (Mission Applications) Defense Computer Sciences Government Corp/Defense Information Systems Agency (Information Assurance) Lear Siegler/ United States Army (Systems Assurance) ------------------------------------------------------------------------------------------------------------------------------------ AT&T Delphi Automotive Metropolitan Analog Devices (Information Assurance) Systems Washington (Language Tool (Mission Applications) Airports Development) J.P. Morgan & Authority Company Vanguard (Network Operations) Green Hills (Y2K Compliance Assessment) (Mission Applications) Software, Inc. (Language Tool Commercial America Online Development) Prudential (Electronic Business) Insurance Inprise Software (Y2K Compliance Assessment) (Language Tool Development) Deutsche Bank (Y2K Compliance Assessment) Sony Pictures Entertainment Lehman Brothers (Technology Studies) (Y2K Compliance Assessment) Celera Genomics (Technology Studies) ------------------------------------------------------------------------------------------------------------------------------------
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------------------------------------------------------------------------------- ------------------------------------------------------------------------------- You should rely only on the information contained in this prospectus. Nei- ther AverStar, any selling stockholder nor any underwriter has authorized any- one to provide prospective investors with different or additional information. This prospectus is not an offer to sell nor is it seeking an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. The information contained in this prospectus is correct only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of these securities. ------------------- TABLE OF CONTENTS ------------------- [Download Table] Page ---- Prospectus Summary....................................................... 1 The Offering............................................................. 3 Summary Financial Data................................................... 4 Risk Factors............................................................. 8 Forward-Looking Statements............................................... 16 Use of Proceeds.......................................................... 17 Dividend Policy.......................................................... 17 Capitalization........................................................... 18 Dilution................................................................. 19 Selected Financial Data.................................................. 20 Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................... 23 Business................................................................. 30 Management............................................................... 42 Principal Stockholders................................................... 51 Certain Relationships and Related-Party Transactions..................... 53 Description of Securities................................................ 55 Shares Eligible For Future Sale.......................................... 58 Underwriting............................................................. 60 Legal Matters............................................................ 61 Experts.................................................................. 62 Where You Can Find Additional Information................................ 62 ------------------- Until , 1999 (25 days after the date of this prospectus), all dealers effecting transactions in the common stock, whether or not participating in this distribution, may be required to deliver a prospectus. This delivery re- quirement is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- 4,000,000 Shares [LOGO OF AVERSTAR] _________________________________________________________________________ Common Stock ----------------------------------- PROSPECTUS ----------------------------------- Bear, Stearns & Co. Inc. Legg Mason Wood Walker Incorporated , 1999 ------------------------------------------------------------------------------- -------------------------------------------------------------------------------
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PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 13. Other Expenses of Issuance and Distribution. The following table sets forth the costs and expenses, other than the underwriting discount and commissions, payable by the registrant in connection with the sale of the common stock being registered hereby. All amounts shown are estimates, except the Securities and Exchange Commission registration fee, the NASD filing fee and the Nasdaq National Market listing fee. [Download Table] Securities and Exchange Commission registration fee................. $ 12,788 NASD filing fee..................................................... 5,100 Nasdaq National Market listing application fee...................... 85,000 Blue Sky fees and expenses.......................................... 10,000 Printing and engraving expenses..................................... 200,000 Legal fees and expenses............................................. 350,000 Accounting fees and expenses........................................ 350,000 Transfer agent and registrar fees................................... 25,000 Miscellaneous expenses.............................................. 62,112 ---------- TOTAL............................................................. $1,100,000 ========== Item 14. Indemnification of Directors and Officers. Our amended and restated bylaws that will become effective upon the closing of this offering provide that we will indemnify our directors and executive officers to the fullest extent permitted by Delaware law and may indemnify our other officers, employees and other agents to the fullest extent permitted by Delaware law. In addition, our second amended restated certificate of incorporation that will become effective upon the closing of this offering provides that, to the fullest extent permitted by Delaware law, our directors will not be personally liable to us or our stockholders for monetary damages for any breach of fiduciary duty as directors. This provision of the restated certificate of incorporation does not eliminate the directors' duty of care. In appropriate circumstances, equitable remedies such as an injunction or other forms of non- monetary relief are available under Delaware law. This provision also does not affect the directors' responsibilities under any other laws, such as the federal securities laws. Each director will continue to be subject to liability for: . Breach of a director's duty of loyalty to us and our stockholders; . Acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law; . Unlawful payments of dividends or unlawful stock repurchases or redemptions; and . Any transaction from which a director derived an improper personal benefit. We have purchased liability insurance for our directors and executive officers. There is no pending litigation or proceeding involving any of our directors or officers as to which indemnification is being sought. We are not aware of any pending or threatened litigation that may result in a claim for indemnification. II-1
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Item 15. Recent Sales of Unregistered Securities. Common Stock. In connection with the combination of the businesses of Intermetrics and Pacer and our acquisition of Pacer on February 27, 1998, we issued an aggregate of: . 4,611,211 shares of common stock in exchange for all of the issued and outstanding capital stock of Apollo Holding, Inc., the parent of Intermetrics; and . 2,255,224 shares of common stock, and paid $7 million in exchange for all of the issued and outstanding capital stock of Pacer Infotec, Inc. The issuance and sale of these shares of common stock was exempt from registration pursuant to Section 4(2) of the Securities Act. Options. In connection with the combination of the business of Intermetrics and Pacer and our acquisition of Pacer, we assumed all outstanding stock options of each of Intermetrics and Pacer in reliance upon exemptions from registration pursuant to either Section 4(2) of the Securities Act, or (ii) Rule 701 under the Securities Act. In addition, we have granted and may grant stock options to employees in reliance upon exemptions from registration pursuant to Rule 701 under the Securities Act. From March 1, 1998 to March 31, 1999, we have granted options under our 1998 Long Term Incentive Plan to purchase 190,000 shares of common stock at an exercise price per share of $8.00. Underwriters. No underwriters were involved in the transactions referred to in this Item 15. Item 16. Exhibits and Financial Statement Schedules. (a) Exhibits [Download Table] Exhibit Description ------- ----------- 1.1 Form of Underwriting Agreement. 3.1+ Amended and Restated Certificate of Incorporation of AverStar. 3.2* Certificate of Amendment of Amended and Restated Certificate of Incorporation of AverStar. 3.3 Form of Second Amended and Restated Certificate of Incorporation of AverStar, to become effective upon the closing of this offering. 3.4+ Bylaws of AverStar. 3.5 Form of Amended and Restated Bylaws of AverStar, to become effective upon the closing of this offering. 4.1 Reference is made to exhibits 3.1 through 3.5. 4.2* Specimen of stock certificate representing shares of our common stock. 5.1 Opinion of Swidler Berlin Shereff Friedman, LLP regarding the legality of the common stock being registered in this registration statement. 10.1 Business Loan and Security Agreement, dated as of March 18, 1999, by and among AverStar, Inc., Computer Based Systems, Inc., and other borrower parties thereto from time to time, First Union Commercial Corporation, and other lender parties hereto from time to time, and First Union Commercial Corporation, as the Agent. 10.2(a)+ Amended and Restated Securities Purchase Agreement, dated February 27, 1998, by and among AverStar, Inc., Apollo Holding, Inc., Intermetrics, Inc. and Pacer Infotec, Inc., and each of Massachusetts Mutual Life Insurance Company, MassMutual Corporate Investors, MassMutual Participation Investors and MassMutual Corporate Value Partners Limited. 10.2(b)+ Amendment to Amended and Restated Securities Purchase Agreement, dated March 18, 1999. 10.3+ Lease, dated July 31, 1996, by and between Trustees of Maryland Building's Trust and Intermetrics, Inc. II-2
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[Download Table] Exhibit Description ------- ----------- 10.4+ Lease Agreement, dated as of May 23, 1997, between The Equitable Life Assurance Society of the United States and Intermetrics, Inc. 10.5+ Lease Amendment, dated October 31, 1997, between The Equitable Life Assurance Society of the United States and Intermetrics, 10.6+ Second Lease Amendment, dated March 16, 1999, between The Equitable Life Assurance Society of the United States and AverStar, Inc. 10.7+ Consulting Agreement, dated August 31, 1995, between Joel N. Levy/Peter M. Schulte, LLC and Intermetrics, Inc. 10.8+ Assignment Agreement and Amendment to Consulting Agreement, dated as of February 27, 1998, by and among Joel L. Levy/Peter M. Schulte, LLC, Intermetrics, Inc. and AverStar, Inc. 10.9+ AverStar, Inc. 1998 Long Term Incentive Plan. 10.10+ Employment Agreement, dated as of August 21, 1995, by and among IMT Acquisition Corp., Apollo Holding, Inc. and Michael B. Alexander. 10.11+ Amendment to Employment Agreement, dated as of March 1998, among Apollo Holding Inc., AverStar, Inc. and Michael B. Alexander. 10.12 Intentionally omitted. 10.13+ Employment Agreement, dated as of August 21, 1995, by and among IMT Acquisition Corp., Apollo Holding, Inc. and Joseph A. Saponaro. 10.14+ Amendment to Employment Agreement, dated as of March 1998, among Apollo Holding, Inc., AverStar, Inc. and Joseph A. Saponaro. 10.15 Intentionally omitted. 10.16+ Assignment and Assumption Agreement, dated as of February 27, 1998 among Apollo Holding Inc., Intermetrics, Inc. and IP Technologies, Inc. 10.17+ Employment Agreement, dated as of February 27, 1998 by and among Pacer Infotec, Inc., AverStar, Inc. and John C. Rennie. 10.18+ Non-Competition Agreement, dated as of February 27, 1998, by and between AverStar, Inc. and John C. Rennie. 10.19+ Employment Agreement, dated as of February 27, 1998, by and among Pacer Infotec, Inc., AverStar, Inc. and Sigmund H. Goldblum. 10.20+ Non-Competition Agreement, dated as of February 27, 1998, by and between AverStar, Inc. and Sigmund Goldblum. 10.21+ Employment Agreement, dated as of April 22, 1999, between AverStar, Inc. and Barbara Landes. 10.22+ Termination Benefit Agreement, dated as of February 27, 1998, among Pacer Infotec, Inc., AverStar, Inc. and Rudolph R. Koczera. 21+ List of Subsidiaries of AverStar, Inc. 23.1 Consent of Swidler Berlin Shereff Friedman, LLP (included in exhibit 5.1). 23.2(a) Consent of Ernst & Young LLP. 23.2(b) Consent of Ernst & Young LLP. 23.2(c) Consent of Ernst & Young LLP. 23.3 Consent of Grant Thornton LLP. 23.4 Consent of Aronson, Fetridge & Weigle. 23.5 Consent of International Data Corporation. 24.1+ Powers of Attorney. 27.1 Financial Data Schedule. + Previously filed as an Exhibit to Registration Statement on Form S-1 (Registration No. 333-78517) filed with the Securities and Exchange Commission on May 14, 1999. * To be filed by Amendment. II-3
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(b) Financial Statement Schedules. The following financial statement schedules are filed herewith, accompanied by reports of independent accountants for such schedules. Year Ended February 28, 1997, Ten Months Ended December 31, 1997 and Year Ended December 31, 1998 Schedule II--Valuation and Qualifying Accounts [Enlarge/Download Table] Balance at Additions Additions beginning due to charged to costs Amounts Balance at of year acquisitions and expenses written off end of year ---------- ------------ ---------------- ----------- ----------- (In thousands) February 28, 1997 Allowance for doubtful accounts............. $ 73 $-- $-- $(27) $ 46 Allowance for unbilled receivables.......... 192 -- 10 -- 202 ---- ---- ---- ---- ---- Total............... $265 $-- $ 10 $(27) $248 December 31, 1997 Allowance for doubtful accounts............. $ 46 $ 15 $108 $-- $169 Allowance for unbilled receivables.......... 202 -- 63 -- 265 ---- ---- ---- ---- ---- Total............... $248 $ 15 $171 $-- $434 December 31, 1998 Allowance for doubtful accounts............. $169 $ 93 $ 25 $-- $287 Allowance for unbilled receivables.......... 265 -- 45 -- 310 ---- ---- ---- ---- ---- Total............... $434 $ 93 $ 70 $-- $597 ==== ==== ==== ==== ==== Financial statement schedules other than those listed above have been omitted because they are inapplicable, are not required under applicable provisions of Regulation S-X, or the information that would otherwise be included in such schedules is contained in the registrant's financial statements or accompanying notes. II-4
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Item 17. Undertakings. The undersigned registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreement certificates in those denominations and registered in those names as required by the underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to provisions described in Item 14 or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission this indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against those liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether this indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of that issue. The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and this offering of these securities at that time shall be deemed to be the initial bona fide offering thereof. II-5
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SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Burlington, Commonwealth of Massachusetts on July 16, 1999. Averstar, Inc. /s/ Michael B. Alexander By: _________________________________ Michael B. Alexander Chief Executive Officer and Chairman of the Board of Directors Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities and on the dates indicated. [Download Table] Signature Title Date /s/ Michael B. Alexander Chief Executive Officer July 16, 1999 ______________________________________ and Chairman of the Board Michael B. Alexander of Directors * Vice Chairman of the Board July 16, 1999 ______________________________________ of Directors John C. Rennie * President, Chief Operating July 16, 1999 ______________________________________ Officer and Director Joseph A. Saponaro * Executive Vice President July 16, 1999 ______________________________________ and Director Sigmund H. Goldblum * Executive Vice President July 16, 1999 ______________________________________ and Chief Financial Barbara L. Landes Officer * Director July 16, 1999 ______________________________________ Mary Anne Gilleece * Director July 16, 1999 ______________________________________ Joel N. Levy * Director July 16, 1999 ______________________________________ Peter M. Schulte /s/ Michael B. Alexander *By: _________________________________ Michael B. Alexander Attorney-in-fact II-6
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EXHIBIT INDEX (a) Exhibits [Download Table] Exhibit Description ------- ----------- 1.1 Form of Underwriting Agreement. 3.1+ Amended and Restated Certificate of Incorporation of AverStar. 3.2* Certificate of Amendment of Amended and Restated Certificate of Incorporation of AverStar. 3.3 Form of Second Amended and Restated Certificate of Incorporation of AverStar, to become effective upon the closing of this offering. 3.4+ Bylaws of AverStar. 3.5 Form of Amended and Restated Bylaws of AverStar, to become effective upon the closing of this offering. 4.1 Reference is made to exhibits 3.1 through 3.5. 4.2* Specimen of stock certificate representing shares of our common stock. 5.1 Opinion of Swidler Berlin Shereff Friedman, LLP regarding the legality of the common stock being registered in this registration statement. 10.1 Business Loan and Security Agreement, dated as of March 18, 1999, by and among AverStar, Inc., Computer Based Systems, Inc., and other borrowers parties thereto from time to time, First Union Commercial Corporation, and other lenders parties hereto from time to time, and First Union Commercial Corporation, as the Agent. 10.2(a)+ Amended and Restated Securities Purchase Agreement, dated February 27, 1998, by and among AverStar, Inc., Apollo Holding, Inc., Intermetrics, Inc. and Pacer Infotec, Inc., and each of Massachusetts Mutual Life Insurance Company, MassMutual Corporate Investors, MassMutual Participation Investors and MassMutual Corporate Value Partners Limited. 10.2(b)+ Amendment to Amended and Restated Securities Purchase Agreement, dated March 18, 1999. 10.3+ Lease, dated July 31, 1996, by and between Trustees of Maryland Building's Trust and Intermetrics, Inc. 10.4+ Lease Agreement, dated as of May 23, 1997, between The Equitable Life Assurance Society of the United States and Intermetrics, Inc. 10.5+ Lease Amendment, dated October 31, 1997, between The Equitable Life Assurance Society of the United States and Intermetrics, Inc. 10.6+ Second Lease Amendment, dated March 16, 1999, between The Equitable Life Assurance Society of the United States and AverStar, Inc. 10.7+ Consulting Agreement, dated August 31, 1995, between Joel N. Levy/Peter M. Schulte, LLC and Intermetrics, Inc. 10.8+ Assignment Agreement and Amendment to Consulting Agreement, dated as of February 27, 1998, by and among Joel L. Levy/Peter M. Schulte, LLC, Intermetrics, Inc. and AverStar, Inc. 10.9+ AverStar, Inc. 1998 Long Term Incentive Plan. 10.10+ Employment Agreement, dated as of August 21, 1995, by and among IMT Acquisition Corp., Apollo Holding, Inc. and Michael B. Alexander. 10.11+ Amendment to Employment Agreement, dated as of March 1998, among Apollo Holding Inc., AverStar, Inc. and Michael B. Alexander. 10.12 Intentionally omitted. 10.13+ Employment Agreement, dated as of August 21, 1995, by and among IMT Acquisition Corp., Apollo Holding, Inc. and Joseph A. Saponaro. 10.14+ Amendment to Employment Agreement, dated as of March 1998, among Apollo Holding, Inc., AverStar, Inc. and Joseph A. Saponaro. 10.15 Intentionally omitted. 10.16+ Assignment and Assumption Agreement, dated as of February 27, 1998 among Apollo Holding Inc., Intermetrics, Inc. and IP Technologies, Inc.
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[Download Table] Exhibit Description ------- ----------- 10.17+ Employment Agreement, dated as of February 27, 1998 by and among Pacer Infotec, Inc., AverStar, Inc. and John C. Rennie. 10.18+ Non-Competition Agreement, dated as of February 27, 1998, by and between AverStar, Inc. and John C. Rennie. 10.19+ Employment Agreement, dated as of February 27, 1998, by and among Pacer Infotec, Inc., AverStar, Inc. and Sigmund H. Goldblum. 10.20+ Non-Competition Agreement, dated as of February 27, 1998, by and between AverStar, Inc. and Sigmund Goldblum. 10.21+ Employment Agreement, dated as of April 22, 1999, between AverStar, Inc. and Barbara Landes. 10.22+ Termination Benefit Agreement, dated as of February 27, 1998, among Pacer Infotec, Inc., AverStar, Inc. and Rudolph R. Koczera. 21+ List of Subsidiaries of AverStar, Inc. 23.1 Consent of Swidler Berlin Shereff Friedman, LLP (included in exhibit 5.1). 23.2(a) Consent of Ernst & Young LLP. 23.2(b) Consent of Ernst & Young LLP. 23.2(c) Consent of Ernst & Young LLP. 23.3 Consent of Grant Thornton LLP. 23.4 Consent of Aronson, Fetridge & Weigle. 23.5 Consent of International Data Corporation. 24.1+ Powers of Attorney. 27.1 Financial Data Schedule. -------- + Previously filed as an Exhibit to Registration Statement on Form S-1 (Registration No. 333-78517) filed with the Securities and Exchange Commission on May 14, 1999. *To be filed by amendment.

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