10-K 1 form10k02.txt FORM 10K 2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------- FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal Year Ended December 31, 2001 Commission File No. 0-19301 ----------- Communication Intelligence Corporation (Exact name of registrant as specified in its charter) Delaware 94-2790442 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 275 Shoreline Drive, Suite 500 Redwood Shores, California (650) 802-7888 94065 -------------------------- -------------- ----- (Address of principal (Registrant's telephone (Zip Code) executive offices) number, including area code) Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value ---------------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference into Part III of this Form 10-K or any amendment to this Form 10-K. The aggregate market value of the voting stock (Common Stock) held by non-affiliates of the registrant as of March 25, 2002 was approximately $97,923,618 based on the closing sale price of $1.08 on such date, as reported by the Nasdaq SmallCap Market. The number of shares of Common Stock outstanding as of March 25, 2002 was 91,060,436. A list of Exhibits to this Annual Report on Form 10-K begins on page 25. COMMUNICATION INTELLIGENCE CORPORATION ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2001 TABLE OF CONTENTS Page PART I................................................................ 3 Item 1. Business...................................................... 3 Item 2. Properties.................................................... 14 Item 3. Legal Proceedings............................................. 14 Item 4. Submission of Matters to a Vote of Security Holders........... 14 PART II............................................................... 15 Item 5. Market For Registrant's Common Equity and Related Stockholder Matters........................................... 15 Item 6. Selected Financial Data....................................... 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................... 17 Item 8. Financial Statements and Supplementary Data................... 24 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...................................... 24 PART III.............................................................. 24 Item 10. Directors and Executive Officers of the Registrant........... 24 Item 11. Executive Compensation....................................... 24 Item 12. Security Ownership of Certain Beneficial Owners and Management........................................ 24 Item 13. Certain Relationships and Related Transactions............... 24 PART IV............................................................... 25 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.......................................... 25 ----------- CIC(R) and its logo, Handwriter(R), Jot(R), InkTools(R), Sign-it(R), WordComplete(R) and INKshrINK(R) are registered trademarks of the Company. HRS(TM), InkSnap(TM), PenX(TM), QuickNotes(TM), RecoEcho(TM), Sign-On(TM), Speller(TM) and iSign(TM) are trademarks of the Company. Applications for registration of various trademarks are pending in the United States, Europe and Asia. The Company intends to register its trademarks generally in those jurisdictions where significant marketing of its products will be undertaken in the foreseeable future. Certain statements contained in this Annual Report on Form 10-K, including without limitation, statements containing the words "believes", "anticipates", "hopes", "intends", "expects", and other words of similar import, constitute "forward looking" statements within the meaning of the Private Litigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties and other factors which may cause actual events to differ materially from expectations. Such factors include the following: (1) technological, engineering, quality control or other circumstances which could delay the sale or shipment of products; (2) economic, business, market and competitive conditions in the software industry and technological innovations which could affect the Company's business; (3) the Company's ability to protect its trade secrets or other proprietary rights, operate without infringing upon the proprietary rights of others or prevent others from infringing on the proprietary rights of the Company; and (4) general economic and business conditions and the availability of sufficient financing. -2- PART 1 Item 1. Business General Communication Intelligence Corporation (the "Company" or "CIC") is the global leader in biometric signature verification and a leading supplier of electronic signature and natural input software solutions focused on emerging, fast growth, large potential markets such as document automation, corporate security, handheld computers, smartphones, and the Palm OS aftermarket. CIC is headquartered in Redwood Shores, California and has a joint venture, Communication Intelligence Computer Corporation, Ltd. ("CICC" or the "Joint Venture"), in Nanjing, China. Industry leaders who have chosen to license CIC's technologies include; Charles Schwab, Compaq, EDS, Ericsson, Fujitsu, IBM, Legend, Microsoft, Mitsubishi, National Semiconductor, Prudential, Siebel Systems, and The Tennessee Valley Authority . The Company's core software technologies include multilingual handwriting recognition systems (Jot(R) and the Handwriter(R) Recognition System, referred to as HRS(TM)), electronic signature, biometric signature verification, cryptography, electronic ink capture tools (InkTools(TM), Sign-it(R), iSign(TM) and Sign-on(TM)), and operating system extensions that enable pen input (PenX(TM)). Other consumer and original equipment manufacturer ("OEM") products include electronic notetaking (QuickNotes(TM), and InkSnap(TM)) and predictive text input (WordComplete(R)). CIC's products are designed to increase the ease of use, functionality and security of smart handheld devices with a primary focus on smartphones, handheld computers ("PDAs") and portable web browsers. As a result of the economic slowdown in 2001, which was further exacerbated by the tragic events of September 11th, revenues for the fourth quarter ending December 31, 2001 decreased 35% to $1.5 million as compared to $2.3 million for the corresponding quarter of the prior year and revenue decreased 19% for the year ended December 31, 2001 to $5.9 million as compared to $7.3 million for the prior year. Despite the external factors, which negatively impacted purchasing decisions and expenditures in the company's market segments throughout 2001, fourth quarter 2001 revenues were up over third quarter 2001 revenues by 65%. We believe this reflects the increasing awareness and demand for CIC technologies in our target market segments and applications. Enterprise Revenues Triggered by the signing of the E-Sign Bill in October 2000 and the passage of similar legislation making electronic signatures legally binding, in virtually every major economy in the world, the transition began toward automating transactions in signature dependent industries. CIC's handwritten electronic signature solutions and electronic forms provide the basis for significant expense reduction through document automation by eliminating paper documents and related labor, mailing and storage expense. The billions of signed original documents created in today's global economy demand the utmost in user identification and document integrity. The inherent risks, logistical difficulties and staggering financial costs associated with creating, processing, storing and retrieving paper records are driving the demand for legally binding and, secure electronic documents. The Company's Enterprise related revenue increased 21% over the prior year, to $1.7 million from $1.4 million . This growth, we believe, reflects increasing awareness and demand for our electronic signature technology despite the economic environment that negatively impacted last year's IT expenditures. Countless paper documents were lost or destroyed in the September 11th tragedy and the many resulting business failures and disruptions could have been avoided if electronic documents had been utilized. CIC's biometrics handwritten signature technology provides the benefits of the paperless environment with the social acceptance of a non-intrusive handwritten signature (versus a finger print, iris/facial scan, or DNA) and a much higher level of security than the traditional "wet ink" signature. We believe that combining our technology with electronic documents will reduce dependency on mail and business travel while enabling business transactions at Internet speed. -3- Enterprises that chose to license our technology include the following: Licensee Product(s) licensed Application of Products ------------------- --------------------- ------------------------ Accelio Inktools E-Signature for mobile forms Al-Faris Multiple Reseller and integrator in the Middle East focused on E-Signatures Allergan Sales Sign-it Clinical regulatory applications Ameridial Inktools E-Signature for internal use documents Assurant Group Sign-it Sales force automation, new account openings Audata, Limited Multiple Multiple applications focused on paperless environment and security Baptist Health Inktools E-Signature for patient records BF Goodrich, Aircraft Sign-it E-Signature for internal use Sensor Division documents Canada Customs Sign-it E-Signature for internal use documents Charles Schwab Sign-it New account openings Decade Software PenX & Inktools Windows pen computer upgrades E-Com Asia Pacific Pty Multiple Regional reseller, multiple Ltd. applications EDS InkTools Information assurance for network and application security Federal Reserve Bank Sign-On Biometric mobile device access security FMC Corp. Sign-it E-Signature for internal use documents First American Bank Sign-it E-Signature for various financial and internal documents -4- Licensee Product(s) licensed Application of product ------------------- -------------------- ---------------------- IA Systems Inktools E-Signature for loan organization ILI Technologies(P,Ltd. Inktools & iSign Various E-Signature applications for the vertical markets in Israel Integrate Online InkTools Mortgage closing Naval Surface Warfare Inktools E-Signature for material Center receipts Novabase Sign-it Systems integrator for various vertical market applications Old Republic National Sign-it Title processing applications Title Orange County, CA Sign-it Automate building permit process PHT Corporation Sign-it Clinical trial documents Physician WebLink Sign-it Automate patent enrollment/records/billing Proware Inktools E-Signature for judicial orders PSC Communications Multiple Reseller and OEM Partner in the UK focused on E-Signature PureEdge Sign-it E-Signature for financial documents RecordsCenter.com InkTools Legal contracts and other significant documents Siebel Multiple Sample delivery of regulated drugs Siemens Medical Solutions Multiple E-Signature for healthcare Symbol Technologies Multiple Reseller for all major products Tennessee Valley Multiple E-Signature for approval of Authority internal documents Wisconsin Electric Power Sign-On Biometric mobile device access Company security -5- A 2001 IDC study projects the biometrics handwritten signature verification market, for network authentication alone, will grow from $14 million in 2002 to approximately $32 million by 2005. A 2001 QDI Strategies, Inc market analysis estimated the signature verification software market, in document automation and mobile device security applications, will grow from $15 million in 2002 to over $82 million by 2005. The total market potential reflected in the IDC and QDI studies, for electronic signature software is in excess of $110 million by 2005. IDC further identified CIC as the undisputed global leader in biometric handwritten signature verification with 82% market share. We are optimistic that CIC's installed base and pilot programs which are nearing rollout, some of which are included above, will provide the basis for increasing revenue growth in both the near term and beyond. OEM Revenues OEM revenue for 2001 declined 37% over the prior year, to $1.2 million from $1.9 million reflecting significant cutbacks in planned shipments of smart handheld devices including handheld computers (PDAs) and smartphones. For instance, handheld computer shipments in 2001 were approximately 10% below the prior year and mobile phone shipments have been virtually flat in 2001 after a compound annual growth rate of 60% from 1996 through 2000. In 1999, CIC won a breakthrough order/license agreement from Ericsson for both natural input and electronic signature solutions for its R380 smartphone which began shipment, on a worldwide basis, in the fourth quarter of 2000. R380 shipments, however, have been significantly behind expectations because of the economic environment as well as Ericsson's own market related difficulties which ultimately led to a mobile communications merger last year with Sony. The combined strength of Ericsson's mobile technology and Sony's consumer electronics and retail distribution know-how has resulted in rave reviews for both their potential competitiveness and for their new multi-media smartphone, the P800, (Smartphones combine the function of voice PDA and wireless internet access). The P800 debuted at CeBit in March and we are optimistic that the planned introduction of this new smartphone, together with other Sony-Ericsson related activity, affords CIC the opportunity to participate in Sony-Ericsson smartphone shipments consistent with our initial expectations. Despite the fact that industry forecasts for smartphones have been reduced, by as much as 75% from previous estimates, current IDC projections still provide the Company with solid revenue growth potential of 5 million units in 2002 growing to 23 million units by 2004. In addition to smartphones, CIC's current licensees include PDA, webpad, and digitizer tablet manufacturers. According to IDC, sales of these smart handheld devices are projected to grow to over 47 million units annually by 2004. Market activity since the events of September 11th reflects growing awareness and demand for both CIC's handwriting recognition products and for biometric handwritten signature verification, utilized as a security utility, across the entire smart handheld device market. The Company believes that significant royalty potential exists for 2002 and beyond based on its present and potential OEM agreements. Key OEM Licensees include: Licensee Product(s) licensed Application of product --------------- ------------------------ --------------------------------- AirSpeak Jot Handheld PC Pro Sony Ericsson Jot, QuickNotes, Smart cellular phone Sign-On & WordComplete Fujitsu HRS, PenX, Sign-On Windows and Windows CE pen Plus &InkTools computers GSC Mobile Solutions Inktools Windows pen computers -6- Licensee Product(s) licensed Application of product --------------- ----------------------- -------------------------------- HP Jot Linux based PDA IA Systems Jot Wireless Internet access device IBM Sign-it Windows pen notebook Inteliworxx HRS & PenX Windows pen computers Interlink Sign-it E-Signature retail bundle Intermec/Norand HRS & PenX Windows pen computers Mathsoft Math Recognizer Handwriting recognition for mathematical notation National Semiconductor Jot Wireless Internet access device Pacific Star PenX Windows pen computers Telos Corp. PenX Windows pen computers Topaz InkTools E-Signature bundle Vtech Jot Electronic organizer Wacom Chinese Handwriter Digitizer tablet and & Sign-it E-Signature Walkabout HRS & PenX Windows pen computers Xplore HRS & PenX Ruggedized mobile computers Xybernaut HRS, PenX & Jot Wearable computers Online Revenues Revenue from the Company's software sold through its website, (www.cic.com) was $.9 million in 2001 as compared to $1.2 million in 2000, a decline of 25%. Online sales are generated primarily through direct mail sent to Palm PDA owners whose names and addresses are acquired from Palm. Most of CIC's software products are available for the Palm operating system ("OS") which includes Handspring, IBM, Symbol, Kyocera, Samsung and Sony devices. Exposure is limited to a capture rate of about 25% of new Palm owners. Palm OS shipments in 2001 were 10% less than the prior year as a result of the economic slowdown that affected the entire smart handheld device market. Online revenues for CIC in 2001 reflect both the lower Palm OS shipments as well as a decrease in the direct mail close rate attributed to Palm shipments of lower cost devices such as the m100 and m105. These devices, priced at $99 and $149 respectively, are targeted at children and college students who are not as inclined to purchase/add software upgrades as professional consumers. In the third quarter of 2001, CIC entered into an agreement with Elibrium that positions the company's Palm OS based offerings directly at the retail point of sale next to Palm OS devices. This provides a significant increase in exposure through up to 10,000 retail stores including Comp USA, Staples, Office Max and other leading retailers. This retail distribution will expose CIC's software upgrade products to a much larger base of potential buyers than through direct mail only. 70% of new buyers of Palm OS based handheld computers purchase at retail and CIC software products will also gain exposure to additional potential buyers who already own Palm devices. -7- Palm OS based handheld computers, despite the market decline in 2001, remain the global leader with almost 63% of the handheld computer market worldwide. The 2001 year end installed base is estimated at 13 million in the US alone and is estimated to grow to over 47 million domestically by 2005. The Company believes that positioning its Palm aftermarket products directly at the point of sale, together with CIC's direct mail programs, will optimize Online revenue growth in the near term and generate meaningful sales growth longer term. China Revenue from CICC, the Company's 90% owned Chinese Joint Venture, decreased 10% for the year ended December 31, 2001, from $1,911 in 2000 to $1.7 million. CICC represents a major opportunity for the Company. China is the world's third largest economy and its recent accession into the World Trade Organization ("WTO") is fueling economic growth and individual buying power in this vast nation of 1.3 billion people. The Joint Venture was established almost nine years ago and the Company believes that the 10% ownership position by the Jiangsu Hongtu Electronics Group provides considerable stability and credibility. The company believes that CICC's electronic signature and Chinese handwriting recognition software applications, including automating signature dependent document processes and corporate security, will be in increasing demand as China prepares to compete on a world wide basis through its WTO membership. The China Ministry of Railways, Hu Nan Mobile Communications, Agricultural Bank of China, and the Nanjing Civic Bureau are among the Chinese companies and government agencies who chose and implemented CICC software solutions in 2001. This adds to an installed base including Panda, Neu-Alpine, Hongtu High-Tech, Ministry of Agriculture, and the Ministry of Aviation. Last year, CICC emerged as the leading supplier in Jiangsu Province of a fast growing mobile industry application for regulated goods with an estimated 70% market share. This turn-key offering provides hardware and software systems for the receipt and delivery of taxed, measured and monitored goods using handheld devices from companies including Symbol Technologies, Palm and Handspring. CICC's offering includes the integration of enterprise software solutions for the server side or back-end management of these mobile systems and captured data. This offering further affords CICC the opportunity to integrate electronic signature and Chinese handwriting recognition technology into its turn-key solutions. The Company believes that the emerging markets for electronic signature based applications and handheld receipt/input based systems, acceptance of CICC products by leading Chinese enterprises and government agencies, the legitimacy and credibility afforded CICC by the Joint Venture and the explosive growth potential of the China market, now driven by accession to the World Trade Organization, provide CICC significant growth potential in 2002 and beyond. Segments In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of An Enterprise and Related Information" ("SFAS 131"). SFAS 131 revised information required regarding the reporting of operating segments and was required to be adopted in periods beginning after December 15, 1997. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company adopted SFAS 131 for the year ended December 31, 1998, and the Company's information has been stratified into two segments - handwriting recognition software and systems integration. For further information see Note 9 to the Company's Consolidated Financial Statements. The Company identifies reportable segments by classifying revenues into two categories handwriting recognition and system integration. Handwriting recognition software is an aggregate of three revenue categories, OEM, Enterprise and Online sales. All handwriting recognition software is developed around the Company's core technology. System integration represents the sale and installation of third party computer equipment and systems that utilize the Company's products. -8- Core Technologies The Company offers a wide range of multi-platform software products that enable or enhance pen-based computing. The Company's core technologies are classified into two broad categories: "natural input technologies" and "transaction and communication enabling technologies." Natural Input Technologies. CIC's natural input technologies are designed to allow users to interact with a computer or handheld device by using an electronic pen or "stylus" as the primary input device or in conjunction with a keyboard. CIC's natural input offerings include multilingual handwriting recognition systems, software keyboards, predictive text entry, and electronic ink capture technologies. Many small handheld devices such as electronic organizers, pagers and smart cellular phones do not have a keyboard. For such devices, handwriting recognition and software keyboards offer the most viable solutions for performing text entry and editing. CIC's predictive text entry technology simplifies data entry even further by reducing the number of actual letters required to be entered. The Company's ink capture technologies facilitate the capture of electronic ink for notetaking, drawings or short handwritten messages. Transaction and Communication Enabling Technologies. The Company's transaction and communication enabling technologies are designed to provide a cost-effective means for securing electronic transactions, providing network and device access control, and enabling workflow automation of traditional paper form processing. CIC believes that these technologies offer more efficient methods for conducting electronic transactions while providing more functional user authentication and heightened data security. The Company's transaction and communication enabling technologies have been fundamental in its development of software for electronic signatures, biometric signature verification, data security, and data compression. Products Key CIC products include the following: Handwriter and Jot Handwriting recognition software InkTools A suite of application development tools for electronicsignatures, biometric signature verification and cryptography iSign Web based development tools for electronic signature and biometric signature verification PenX Operating systems extensions for the Windows recognition environment that enables pen based functionality and handwriting QuickNotes and InkSnap Electronic handwritten notetaking software Sign-it and Sign-it Server Electronic signatures for the enterprise market Sign-On Biometric signature verification software for device access WordComplete? Predictive text entry software Products and upgrades that were introduced and first shipped in 2001 include the following: Sign-it for Word 3.2 Sign-it for Acrobat v 3.2 Sign-it Server 2.0 Sign-it EX v 1.14 Sign-On for Windows 1.0 -9- Sign-On for Pocket PC 2.01 WordComplete for Palm v 2.01 WordComplete v 2.0 UK English Dictionary WordComplete v 2.0 Spanish Dictionary WordComplete v 2.0 French Dictionary WordComplete v 2.0 Italian Dictionary WordComplete v 2.0 German Dictionary iSign for Windows v 2.0 iSign for Java v 1.1 PenX v 2.02 Jot for Windows CE v 2.2 Handwriter for CE v2.2 InkTools for CE v 1.6 InkTools for Windows v 2.52 Handwriting recognition software analyzes the individual strokes of characters written with a pen/stylus and converts these stokes into an "ASCII" text character. This software is especially useful for portable electronic devices that are too small to employ a keyboard, and for the input of ideographic script characters such as those used in written Chinese and Japanese. The Company currently has two recognition system offerings, Handwriter and Jot. CIC's Handwriter Recognition System ("HRS(TM)") is an award-winning software solution for recognizing handwritten input on Windows and Windows CE based pen computers and desktop PCs. HRS accurately recognizes handwritten characters with no recognizer training required, so the user can write naturally. HRS is a full-context recognizer that offers some unique features such as automatic spacing between words and automatic capitalization of the first letter of new sentences. HRS is also an integral component of the Companies PenX software that is currently shipping on many of the leading Windows based pen computers. Key vertical market licensees of HRS include such companies as; Fujitsu, Intermec, Xplore, Mitsubishi and Walkabout. Jot is a print-based recognizer that is specifically designed for small form factor devices. Unlike many recognizers that compete in the market for handheld data input solutions, Jot offers a patented user interface that allows for the input of natural upper and lowercase letters, standard punctuation and European languages without requiring the user to memorize unique characters or symbols. This recognizer offers rapid and accurate recognition without requiring the consumer to spend time training the system. Jot has been licensed to such key OEMs as: Microsoft, Ericsson, Symbian, National Semiconductor and Vtech. Jot has been ported to many operating systems including the Palm OS, Windows, Windows CE, VT-OS, EPOC, QNX, Linux and OS/9 and is currently under development for others. The standard version of Jot, which is available through OEM, enterprise and Online product offerings, recognizes and supports input of Roman-based Western European languages. InkTools is an electronic signature and biometric signature verification software developers kit that captures and analyzes the image, speed, stroke sequence and acceleration of a person's handwritten electronic signature. InkTools provides an extremely effective and inexpensive biometric security check for real-time authentication. It also stores certain forensic elements of a signature for use in post signing non-repudiation and authentication. Commercial applications for this type of software include document approval, verification of the identity of users participating in electronic transactions and, securing log-in access to computer systems or protected networks. This software toolkit is used internally by CIC as the underlying technology in its Sign-On and Sign-it products and has been licensed to several key development partners including EDS, Bionetrix, Siebel and Topaz Systems. Sign-On is a product offering that utilizes the Company's biometric signature verification technology to provide access security on portable devices. This provides the additional level of security needed for devices that are increasingly being used in business and generally contain sensitive data. Currently available for the Palm 3.x or later and Windows CE 3.x operating systems, the product is also being ported to EPOC and other platforms to meet the specifications of new licensees and customers. -10- Sign-it is a family of electronic signature products for enabling the real time capture, binding and verification of electronic signatures within standard consumer applications. These products combine the strengths of biometric signatures and cryptography to process, transact and create electronic documents with the same legal standing as a traditional wet signature on paper. Organizations wishing to process electronic forms requiring varying levels of security can reduce the need for paper forms by adding electronic signature technologies to their workflow solution. Currently, Sign-it is available for MS Word and Adobe(R) Acrobat(R) while support for additional application environments are in development. iSign provides functionality similar to InkTools but was specifically designed for web based architectures. The current product supports either a Windows implementation with Internet Information Server and Internet Explorer or Java. The Java implementation was designed to meet the needs of the higher-end server products that support Java 2 and a broad base of client systems, which can range from Windows devices to PDAs. Marketing The Company's products are marketed through three sales approaches: OEM Sales, enterprise and online/retail sales. OEM sales efforts are aimed at license revenues derived from primarily smart handheld device manufacturers. Enterprise sales efforts are directed at both software providers and end-users. Online sales represent revenues generated from the Company's software sold via its website, www.cic.com. OEM Licensed Products. CIC currently licenses software products for Windows(R)3.x, Windows(R)'95, Windows'98, WindowsNT, WindowsCE, EPOC, QNX, VT-OS, Palm and Linux. CIC also ports its products to other platforms to meet the specifications of licensees. The Company's PenX, Sign-it , and Handwriter Recognition System are licensed for portable PCs utilizing the Windows(R)'95, Windows(R)'98, Windows(R)NT, and WindowsCE operating systems and is primarily used for field force automation and in pen-input PC peripherals for desktop use. Jot, QuickNotes, Sign-On, WordComplete and the CIC software keyboard are licensed primarily for the new, smaller classes of Handheld PCs and Pocket PCs such as those that utilize the Windows(R)CE operating systems and handheld communicators such as smartphones and PDAs that use the Palm or Symbian operating system. Enterprise Solution Products. CIC offers several products targeted at the broad enterprise market. This market could benefit from workflow automation solutions using electronic signatures or biometric authentication such as new account openings, regulated document submissions and device/network security. For these markets, CIC offers several products including InkTools, a high performance software developer's kit for implementing systems using electronic ink and electronic signatures which is available for almost all major operating systems, iSign which provides the same functionality as InkTools but is specifically designed for distributed application architectures and Sign-it which is designed to provide this functionality within the framework of the most common word processing applications and electronic form publishing environments. Online Product Offerings. The Company's Online Sales department is charged with the sale of the Company's shrink-wrapped software applications and tools. This currently includes most of CIC's products and everyone from consumers to software developers and corporations are customers. These products are sold through retail outlets and over the Internet on CIC's own website and by other Internet-based electronic resellers. Consumer versions of these products are being sold for users of the Palm connected organizers and Windows(R) CE devices. Much of the growth in Online sales since 1998 was attributable to sales of these products to users of Palm OS devices. History The Company was initially incorporated in Delaware in October 1986 as a wholly owned subsidiary of a predecessor corporation with the same name. In each year since its inception, the Company has incurred losses. The Company has a 90%-owned Joint Venture, Communication Intelligence Computer Corporation, Ltd., with the Jiangsu Hongtu Electronics Group, LTD. The Joint Venture was formed in September 1993. In October, 2000, a wholly-owned subsidiary of the Company, acquired certain assets of PenOp Limited ("PenOp") and its subsidiary PenOp Inc. ("PenOp USA" and together with PenOp, the "Sellers"), pursuant to an asset purchase agreement, dated as of September 29, 2000, by and among the Company and the -11- Sellers (the "Acquisition"), in exchange for 4.7 million shares of common stock of the Company (the "Transaction Shares"). Out of the 4.7 million Transaction Shares issued to the Sellers in connection with the Acquisition, approximately 940,000 shares are being held in escrow to cover potential indemnification claims. Copyrights, Patents and Trademarks The Company relies on a combination of patents, copyrights, trademarks, trade secrecy and contractual provisions to protect its software offerings and technologies. There can be no assurance, however, that these protections will be adequate or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technologies. In addition, the laws of certain countries in which the Company's products are licensed may not protect the Company's products and intellectual property rights to the same extent as the laws of the United States. Because of the rapid evolution of technology and uncertainties in intellectual property law in the United States and internationally, there can be no assurance that the Company's current or future products or technologies will not be subject to infringement by others. The Company's licensees and distributors have access to proprietary information of the Company. In addition a substantial portion of the Company's technology and know-how are maintained as trade secrets, and are not protected by patent, trademark or copyright laws. The Company has a policy of requiring its employees and contractors to respect proprietary information through written agreements. The Company also has a policy of requiring prospective business partners to enter into non-disclosure agreements before any of the Company's proprietary information is revealed to them. There can be no assurance that the measures taken by the Company to protect its technologies, products and other proprietary rights will adequately protect it against improper use. Certain technological processes originally implemented in the Company's software offerings were developed and patented by Stanford Research Institute ("SRI") and SRI assigned those patents, which subsequently expired, to the Company. The Company has made significant improvements to the original technologies and additional patents relating to such technological improvements have been applied for or issued. Therefore, the Company does not believe that the expiration of the SRI patents has had or will have a significant effect on its operations. Other major elements of the Company's software offerings and technologies were developed by the Company and have been patented. As a result of the PenOp transaction, the Company acquired all the intellectual property rights of that company adding that full range of patents, copyrights and trademarks to its portfolio. Certain of the Company's existing patents expire between the years 2002 and 2017. The Company is unable to predict at this time the impact to its business, if any, from such expiration. CIC has an extensive list of registered and unregistered trademarks and applications in the United States and other countries. The Company intends to register its trademarks generally in those jurisdictions where significant marketing of its products will be undertaken in the foreseeable future. The Company may be required or elect to take various forms of legal action from time to time to protect its proprietary rights. Any litigation regarding claims against the Company or claims made by the Company against others could result in significant expense to the Company, divert the efforts of its technical and management personnel and have a material adverse effect on the Company, whether or not such litigation is ultimately resolved in favor of the Company. In the event of an adverse result in any such litigation, the Company may be required to expend significant resources to develop non-infringing technology or obtain licenses from third parties. There can be no assurance that the Company would be successful in such development or that any such licenses would be available on commercially reasonable terms, if at all. Seasonality of Business Historically, the Company has not experienced seasonal trends affecting sales of its products or the development or licensing of its technologies. Material Customers Historically, the Company's handwriting recognition segment revenues have been derived from a limited number of customers. One customer accounted for 16% -12- and one customer accounted for 13% of revenues in 2001. One customer accounted for 16% and two customers accounted for 11% of revenues in 2000. One customer accounted for 27% of the Company's handwriting recognition segment revenues in 1999. The loss of any significant customer or other source of revenue could have a material adverse effect on the Company. Backlog At December 31, 2001, backlog approximated $88,000, representing advanced payments on service maintenance agreements and non recurring engineering projects which are expected to be recognized over the next twelve months. At December 31, 2000, backlog approximated $61,000, representing advanced royalty and service maintenance agreements. At December 31, 1999, backlog approximated $35,000. Competition The markets for CIC's offerings are competitive, and have attracted a number of competitors within certain product markets. The Company intends to be responsive to emerging market demands as well as competitive threats. While competitors may pose a threat to the Company's efforts to gain market share within certain markets, the Company believes these competitors also help bring attention to and build awareness for pen-input solutions. Certain competitors of the Company have substantially greater financial and other resources than that of the Company. The Company faces competition at different levels. Certain competitors have developed or are developing software offerings, which may compete directly with the Company's offerings. Most of the direct competitors of CIC have focused only on one element of such offerings, such as handwriting recognition technology, signature capture/verification or pen-based operating environments or other pen-based applications. While the Company believes that it has a competitive advantage in some cases due to its range of product offerings, there can be no assurance that competitors will not succeed in developing products or technologies that are more effective, easier to use or less expensive than the Company's products or technologies or that would render the Company's products or technologies obsolete or non-competitive. Competitors of the Company include certain of the Company's current and potential strategic partners and customers who are developing or acquiring alternative products and technologies to those offered by the Company. There can be no assurance that companies with which the Company has established or will establish distribution, license, product development or other strategic relationships will not choose to market competitive technologies or products developed internally or acquired from third parties. Joint Venture in the People's Republic of China The Company currently owns 90% of the Joint Venture with the Jiangsu Hongtu Electronics Group LTD, formerly the Information Industries Bureau of the Jiangsu Province, a provincial agency of the People's Republic of China (the "Agency"). As of December 31, 2001, the Company had contributed an aggregate of $1.8 million in cash to the Joint Venture and provided it with non-exclusive licenses to technologies and certain distribution rights, and the Agency had contributed certain land use rights. In 1998, the registered capital of the Joint Venture was reduced, and as a result, pursuant to the terms and provisions of the Joint Venture agreement, neither party is required to make further contributions. For further information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Joint Venture in the People's Republic of China". Employees As of March 25, 2002, the Company and the Joint Venture employed an aggregate of 60 full-time employees, 23 of which are in the United States and 37 of which are in China. From time to time, the Company also engages additional personnel on an as needed basis. The Company believes it has good relations with its employees. None of the Company's employees is a party to a collective bargaining agreement. Geographic Areas For the years ended December 31, 2001, 2000, and 1999, the Company's export sales as a percentage of total revenues were approximately 17%, 24%, and 36%, respectively. The decrease in export sales in 2001, is due to the reduction in -13- licensing revenues from Ericsson compared to the prior year period. The decrease in export sales in 2000, is due to the reduction in licensing revenues from Ericsson compared to the prior year period. The increase in export sales in 1999, is due to the recognition of licensing revenues from Ericsson. The Company maintains certain agreements with Japanese customers; however the revenues are derived from the Company's U.S. operations. Due to the volume of the Company's sales on its website, and the selling price of the products offered, it is not economically feasible to track product sales by individual country. The Company is subject to various risks in connection with the Joint Venture in the People's Republic of China, including the risks commonly associated with doing business abroad. For further information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Notes 2 and 9 to the Company's Consolidated Financial Statements. Forward Looking Statements Certain statements contained in this Annual Report on Form 10-K, including without limitation, statements containing the words "believes", "anticipates", "hopes", "intends", "expects", and other words of similar import, constitute "forward looking" statements within the meaning of the Private Litigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties and other factors which may cause actual events to differ materially from expectations. Such factors include the following: (1) technological, engineering, quality control or other circumstances which could delay the sale or shipment of products; (2) economic, business, market and competitive conditions in the software industry and technological innovations which could affect the Company's business; (3) the Company's ability to protect its trade secrets or other proprietary rights, operate without infringing upon the proprietary rights of others or prevent others from infringing on the proprietary rights of the Company; and (4) general economic and business conditions and the availability of sufficient financing. Item 2. Properties The Company currently leases its principal facilities (the "Principal Offices"), consisting of approximately 9,634 square feet, in Redwood Shores, California, pursuant to a sub-lease that expires in 2006. The Joint Venture leases approximately 1,500 square feet in Nanjing, China. The Company also believes that its current facilities will be suitable for it to continue operations in the foreseeable future. Item 3. Legal Proceedings As of March 25, 2002, the Company was not a party to any legal proceeding, which, if adversely determined, would have a material adverse effect on its business. Item 4. Submission of Matters to a Vote of Security Holders None -14- PART II Item 5. Market For Registrant's Common Equity and Related Stockholder Matters The Company's Common Stock is currently listed on the Nasdaq SmallCap Market under the trading symbol CICI. The following table sets forth the high and low sale prices of the Common Stock for the periods noted. Sale Price Per Share Year Period High Low 2000 First Quarter............................... $12.03 $ 5.31 Second Quarter.............................. $ 5.22 $ 1.84 Third Quarter............................... $ 4.25 $ 2.25 Fourth Quarter.............................. $ 3.06 $ 1.00 2001 First Quarter............................... $ 2.28 $ 0.97 Second Quarter.............................. $ 1.63 $ 0.76 Third Quarter............................... $ 1.13 $ 0.64 Fourth Quarter.............................. $ 0.91 $ 0.60 2002 First Quarter (through March 25, 2001)...... $ 1.18 $ 0.56 As of March 25, 2002, the closing sale price of the Common Stock on the Nasdaq SmallCap Market was $1.08 per share and there were approximately 660 registered holders of the Common Stock. To date, the Company has not paid any dividends on its Common Stock and does not anticipate paying dividends in the foreseeable future. The declaration and payment of dividends on the Common Stock is at the discretion of the Board of Directors and will depend on, among other things, the Company's operating results, financial condition, capital requirements, contractual restrictions or such other factors as the Board of Directors may deem relevant. During the three months ended December 31, 2001, the Company granted stock options to employees and directors for services rendered as follows: Grant Number of Option Vesting Expiration Grantees Date Options Price Period Date ------------------------------------------------------------------------------ 1 employee 10/01/2001 25,000 $0.69 3 year quarterly 10/01/2012 1 Consultant 12/06/2001 29,421 $0.68 immediately 12/06/2012 1 employee 12/07/2001 95,000 $0.66 25% immediately, 12/07/2012 balance 3 year quarterly -15- Item 6. Selected Financial Data The selected consolidated financial data presented below as of December 31, 2001, 2000, 1999, 1998, and 1997 and for each of the years in the five-year period ended December 31, 2001 are derived from the audited consolidated financial statements of the Company. The consolidated financial statements as of December 31, 2001 and 2000, and for each of the years in the three-year period ended December 31, 2001, are included in Item 8 of this Form 10-K. The selected consolidated financial data should be read in conjunction with the Company's audited financial statements and the notes thereto and other portions of this Form 10-K including "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Year Ended December 31, ------------------------------------------------- 2001 2000 1999 1998 1997 ------------------------------------------------- (In thousands, except per share amounts) Statement of Operations Data: Revenues..................... $5,947 $7,312 $6,518 $4,581 $5,516 Research and development expenses(1)................. 1,808 1,603 1,363 1,989 2,360 Sales and marketing expenses. 2,054 2,239 1,877 2,015 6,257 General and administrative expenses.................... 2,791 2,181 1,683 1,889 2,663 Loss from operations........ (2,946) (1,607) (1,722) (3,285) (11,627) Net loss available to common stockholders(2)..... (3,215) (1,799) (1,740) (3,592) (16,940) Basic and diluted loss per common share................ (0.04) ( 0.02) ( 0.02) ( 0.06) ( 0.37) As of December 31, -------------------------------------------------- 2001 2000 1999 1998 1997 -------------------------------------------------- (In thousands) Balance Sheet Data: Cash, cash equivalents and restricted cash........... $2,588 $2,349 $2,374 $1,045 $5,485 Working capital(3)........... 3,017 3,109 3,054 346 2,721 Total assets................. 10,072 11,302 4,963 3,354 7,491 Deferred revenue............. 88 61 35 651 440 Long-term obligations........ 3,000 1,427 1,338 - 8 Stockholders' equity (4)..... 6,060 8,307 2,349 1,332 3,989 ----------- (1) Excludes software development costs capitalized in accordance with Statement of Financial Accounting Standards No. 86 of $20, $20, $9 and $17, for the years ended December 31, 2001, 2000, 1999, and 1998 respectively. No software development costs were capitalized in the year ended December 31, 1997. (2) The Company's 1997 net loss applicable to common stockholders includes a one-time, non-cash charge of $4.9 million related to the embedded yield on the Company's Series A Preferred Stock issued in December 1996 due to the discounted conversion provisions of such stock and the cumulative dividends of $1.25 per share, per annum on Series A Preferred Stock. Includes dividends on Series A Preferred Stock and Series B Preferred Stock of $435 and $564 for the years ended December 31, 1998 and 1997, respectively. (3) Current liabilities used to calculate working capital at December 31, 2001, 2000, 1999, 1998, and 1997 include deferred revenue of $88, $61, $35, $651, and $440, respectively. (4) The Company has never paid dividends to the holders of its common stock. -16- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview History. The Company was initially incorporated in Delaware in October 1986. In each year since its inception, the Company has incurred losses. For the five-year period ended December 31, 2001, operating losses aggregated approximately $21 million and at December 31, 2001, the Company's accumulated deficit was approximately $76 million. Revenue Recognition. In October 1997, the American Institute of Certified Public Accountants (the "AICPA") issued Statement of Position No. 97-2, "Software Revenue Recognition" ("SOP 97-2"), which the Company has adopted for transactions entered into during the fiscal year beginning January 1, 1998. SOP 97-2 provides guidance for recognizing revenue on software transactions and supersedes Statement of Position No. 91-1, "Software Revenue Recognition". In March 1998, the AICPA issued Statement of Position No. 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition" ("SOP 98-4"). SOP 98-4 defers, for one year, the application of certain passages in SOP 97-2 which limit what is considered vendor-specific objective evidence ("VSOE") necessary to recognize revenue for software licenses in multiple-element arrangements when undelivered elements exist. In December 1998, the AICPA issued Statement of Position No. 98-9 ("SOP 98-9") Modifications of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions." SOP 98-9 extends the effective date of SOP 98-4 and provides additional interpretative guidance. SOP 98-9 is effective for fiscal years beginning after March 15, 2000. The Company also follows the interpretive guidance of SAB 101 issued by The Securities and Exchange Commission and EITF issue 00-21 of the AICPA Emerging Issues Task Force. Revenue from retail product sales is recognized upon sell through, while revenue from other product sales is recognized upon shipment, provided that no significant obligations remain and that collection of the resulting receivable is likely. The Company provides for estimated sales returns at the time of shipment. License revenues are recognized when the software has been delivered and all significant obligations have been met. Royalty revenues are recognized as products are licensed and sold by licensees. Revenues from development contracts are primarily generated from non-recurring engineering fees and research grants. Revenue is recognized in accordance with the terms of the grants and agreements, generally when collection is probable and related costs have been incurred. Sources of Revenues. To date, the Company's revenues have been derived principally from end-users, manufacturers, retailers and distributors of computer products in North America, Europe and the Pacific Rim. The Company performs periodic credit evaluations of its customers and does not require collateral. The Company maintains reserves for potential credit losses. Historically, such losses have been insignificant and within management's expectations. Software Development Costs. Software development costs are accounted for in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed" ("SFAS 86"). Under SFAS 86, capitalization of software development costs begins upon the establishment of technological feasibility, subject to net realizable value considerations. In the Company's case, capitalization commences upon the completion of a working model, and generally ends upon the release of the product. As of December 31, 2001, 2000, and 1999, such costs were insignificant. Significant Customers. Two customers accounted for 16% and 13%, respectively, of revenues in 2001. One customers accounted for 16% of revenues in 2000. One customer accounted for 27% of the Company's revenues in 1999. Research and Development. Research and development costs are charged to expense as incurred. Foreign Currency Translation. The Company considers the functional currency of the Joint Venture to be the respective local currency and, accordingly, gains and losses from the translation of the local foreign currency financial statements are included as a component of "accumulated other comprehensive loss" in the Company's consolidated balance sheets included in this Annual Report on -17- Form 10-K. Foreign currency assets and liabilities are translated into U.S. dollars at exchange rates prevailing at the end of the period except for non-monetary assets and liabilities which are translated at historical exchange rates. Revenues and expenses are translated at the average exchange rates in effect during each period, except for those expenses included in balance sheet accounts which are translated at historical exchange rates. Net foreign currency transaction gains and losses are included as components of "interest income and other income (expense), net" in the Company's consolidated statements of operations included in this Annual Report on Form 10-K. Due to the stability of the currency in China, net foreign currency transaction gains and losses were not material for the year ended December 31, 2001 and 2000, respectively. The Company recorded a net foreign currency transaction gain of $59,000 for the year ended December 31, 1999. Net Operating Loss Carryforwards. Utilization of the Company's net operating losses may be subject to an annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986 and similar state provisions. As a result, a portion of the Company's net operating loss carryforwards may not be available to offset future taxable income. The Company has provided a full valuation allowance for deferred tax assets at December 31, 2001 of $22 million based upon the Company's history of losses. The Company reports in two segments, handwriting recognition and systems integration. For purposes of Management Discussion and Analysis, handwriting recognition includes Online/Retail revenues and Corporate sales, including OEM and Enterprise revenues, and systems integration is referred to as China sales. Results of Operations Years Ended December 31, 2001 and December 31, 2000 Revenues. Revenues decreased $1,365,000, or 19%, to $5,947,000 for the year ended December 31, 2001, as compared to $7,312,000 in the prior year. Online revenues declined $285,000, or 24%, to 913,000 in 2001, as compared to $1,198,000 in the prior year period. The number of names available for use in the Company's direct mail campaign has been reduced to newly registered palm users, and was the primary reason for the decline in revenues. In the prior years the Company's direct mail campaigns also targeted the installed base of Palm users. Corporate sales, which includes Enterprise and OEM revenue decreased $893,000, or 21%, to $3,310,000 (including the nonrecurring maintenance fees from M10, previously PenOp) for the year ended December 31, 2001, compared to $4,203,000 in the prior year period. Sales of the Company's software solutions and maintenance to end users increased $155,000 to $2,076,000 in 2001 compared to $1,921,000 in the prior year period. The decrease was due primarily to a $524,000 decrease in the nonrecurring maintenance fees, from M10 in 2001 compared to the prior year. This decrease was offset by sales to Prudential and TVA. During the fourth quarter of 2000, the Company engaged in a transaction with PenOp to provide nonrecurring maintenance services from pre-existing PenOp contracts in the aggregate amount of $1.5 million, of which $352,000 and $877,000 was recorded (net) in 2001 and 2000, respectively. The Company previously entered into a separate transaction, to acquire the intellectual property rights from PenOp (see note 1). OEM revenues included in corporate sales decreased $989,000 or 48% to $1,078,000 from $2,067,000 in the prior year period. This decrease was due to a reduction in the amount of revenues recognized from Ericsson and other OEM's compared to the prior year. Revenues from development contracts included in corporate sales decreased $59,000 or 27% to $156,000 from $215,000 for the prior year due primarily to decreases in non-recurring engineering revenues. Revenues from development contracts in 2001 and 2000 were primarily attributable to porting of the Company's software to third party products such as smartphones and web browsers. China sales decreased $187,000, or 10%, to $1,724,000 for the year ended December 31, 2001, as compared to $1,911,000 in the prior year. The decrease was due to a decrease in system integration sales of $202,000, or 13%, to $1,401,000 in 2001, as compared to $1,603,000 in the prior year. The decrease in system -18- integration sales was offset by an increase in software sales of $15,000, or 5%, to $323,000 in 2001 as compared to $308,000 in the prior year. The changes in revenues are not related to any single customer. Cost of Sales. Cost of sales decreased $656,000, or 23%, to $2,240,000 for the year ended December 31, 2001, as compared to $2,896,000 in the prior year period. Online cost of sales decreased $282,000, or 26%, to $805,000 in 2001, as compared to $1,087,000 in the prior year. This decrease was due to lower mailing costs brought about by the reduced number of new names available in 2001 as compared to 2000. Corporate sales costs decreased $126,000, or 30%, to $290,000 from $416,000 in the prior year. Costs associated with the Company's signature software solutions decreased $36,000, or 21%, to $135,000, compared to $171,000 in the prior year period. The decrease in the cost of software solutions was due to a decrease in amount of third party hardware costs sold with the Company's corporate signature software products during 2001 as compared to 2000. Amortization of capitalized software costs was approximately $12,000 in 2001 and 2000, respectively. Costs of development contract revenues included in corporate sales decreased $85,000, or 45%, to $105,000 in 2001, as compared to $190,000 in the prior year. The decrease in development contract cost was due to the reduction in non-recurring engineering projects during 2001 as compared to the prior year period. OEM costs decreased $5,000, or 37%, to $38,000 as compared to $43,000 in the prior year. The decrease was due to a decrease in revenues and the associated technology import tax from the Company's Japanese OEM customers. China cost of sales decreased $247,000, or 18%, to $1,145,000 in 2001 as compared to $1,393,000 in the prior year period. The decrease was due to the decrease in systems integration sales in 2001 as compared to the prior year. Gross Margin. Gross margin decreased $709,000, or 16%, to $3,707,000 in 2001, as compared to $4,416,000 in the prior year. Online gross margin decreased $3,000, or 3%, to $108,000 in 2001, as compared to gross margins of $111,000 in the prior year period. The decrease was due to the lower sales volumes as compared to the prior year offset by the elimination of the follow-up mailer costs, which were primarily used to convert long-time users of PDA's to the Company's more natural input products. Online gross margins were 12% of sales for the year ended December 31, 2001. Corporate sales gross margin decreased $767,000, or 20%, to $3,020,000 in 2001, from $3,787,000 in the prior year period. This decrease was primarily due to the 21% decrease in Corporate sales as discussed above. Corporate sales gross margin as a percentage of sales was 91% and 90% of revenues for the years ended December 31, 2001 and 2000, respectively. China sales gross margin increased $61,000, or 12%, to $579,000 in 2001, from $518,000 in the prior year. This increase was primarily due to the increase in software sales in 2001 as discussed above. China sales gross margin as a percentage of sales increased 7% to 34% as compared to 27% in the prior year. Research and Development Expenses. Research and development expenses increased $205,000, or 11%, to $1,808,000 for the twelve months ended December 31, 2001, as compared to $1,603,000 for the prior year. Salaries and related costs decreased $104,000, or 9%, to $1,077,000 in 2001, compared to $1,181,000 in 2000. This decrease was due to reductions in headcount during 2001 as compared to 2000. Other costs, including shared development costs with the Joint Venture, facility and other costs increased $255,000 to $342,000 in 2001, compared to $87,000 in the prior year. The increase was due primarily to outside engineering costs associated with the assimilation of the PenOp intellectual property into the Company's products and continued support for new engineering projects. Other expenses including travel and related expenses and depreciation decreased 6%, or $30,000, as compared to the prior year period. In addition costs, associated with development contracts and charged to cost of sales decreased $84,000 or 44% to $106,000 from $190,000 in the comparable prior year period. This decrease was due to a lower number of revenue generating nonrecurring engineering projects in 2001 compared to the prior year. Sales and Marketing Expenses. Sales and marketing expenses for the year ended December 31, 2001 decreased $185,000, or 10%, to $2,054,000, as compared to $2,239,000 in the prior year. Payroll and related costs decreased 12%, or -19- $93,000, to $2,054,000 in 2001 from $2,239,000 due primarily to a decrease in headcount during the year. Travel and related expenses decreased $58,000, or 29%, to $140,000 in 2001, compared to $198,000 in the prior year. The decrease was due to decreases in travel related to the reduction in headcount from the comparable prior year. Advertising and promotion expense decreased $195,000, or 49%, to $203,000 in 2001, from $398,000 in the prior year. The decrease was due primarily to the one-time cost of the development of a media campaign in the prior year related to the Company's Online sales via CIC's website. Professional services expense increases $128,000, or 129%, to $227,000 from $99,000 in the comparable prior year period. The increase was due to marketing studies undertaken by the Company to assess the markets with the greatest potential for the Company's products. Other costs, such as facilities and miscellaneous expenses, increased $33,000, or 5%, in 2001 as compared to the prior year. General and Administrative Expenses. General and administrative expenses increased 34%, or $610,000, to $2,791,000 for the year ended December 31, 2001, from $2,181,000 for the prior year. The increase was primarily due to a increase in patent amortization expense of $393,000, or 914%, to $436,000 in 2001 from $43,000 in the prior year. In addition professional fees increased $274,000, or 105%, to $535,000 from $261,000 in the comparable prior year period.Investor relations expenses decreased $66,000, or 15%, to $366,000 in 2001, as compared to $432,000 in the comparable prior year. The decrease was due primarily to a reduction in costs associated with information disseminated through the wire services. Other expenses including travel, facilities cost and provision for uncollectable accounts increased $9,000 in 2001 as compared to the prior year. Interest Income and Other Income (Expense), Net. Interest income and other income (expense) net, decreased $60,000, or 79%, to $16,000 in 2001, from $76,000 in the prior year. This decrease resulted from a decrease in cash balances and interest rates during the year. The interest income was offset by fees associated with credit card sales from the Company's website of approximately $37,000 in 2001, compared to $49,000 in the prior year. Interest Expense. Interest expense increased $16,000, or 6%, in 2001, to $282,000 from $266,000 in the prior year. This increase was due to the increase in long-term debt outstanding since June of 2001. Years Ended December 31, 2000 and December 31, 1999 Revenues. Revenues increased $794,000, or 12%, to $7,312,000 for the year ended December 31, 2000, as compared to $6,518,000 in the prior year. Online revenues declined $477,000, or 28%, to 1,198,000 in 2000, as compared to $1,675,000 in the prior year period. In 1999, the Company was able to draw on a large number of previously unsolicited names during the first year of the direct mail campaign. In 2000, the number of names was reduced to newly registered Palm users, and was the primary reason for the decline in revenues. Sales of the Company's Handwriter products for the years ended December 31, 2000 and 1999, respectively, were insignificant. The Company discontinued the Handwriter products in 1998, and sold the remaining inventory over the web through the second quarter of 1999. Corporate sales, which includes Enterprise and OEM revenue increased $980,000, or 30%, to $4,203,000 (including the nonrecurring maintenance fees from M10, previously PenOp) for the year ended December 31, 2000 compared to $3,223,000 in the prior year period. Sales of the Company's software solutions and maintenance to end users increased $1,805,000 to $1,921,000 in 2000, compared to $116,000 in the prior year period. The increase was due primarily to nonrecurring maintenance fees, from M10, and the sale of software solutions and maintenance revenues to Charles Schwab, Assurant, Orange County, E-Com, and others in 2000. During the fourth quarter of 2000, the Company engaged in a transaction with PenOp to provide nonrecurring maintenance services from pre-existing PenOp contracts in the aggregate amount of $1.5 million, of which $877,000 was recorded (net). The Company previously entered into a separate transaction, to acquire the intellectual property rights from PenOp (see note 1). OEM revenues included in corporate sales decreased $574,000, or 22%, to $2,067,000, from $2,641,000 in the prior year period. This decrease was due to a reduction in the amount of revenues recognized from Ericsson and other OEM's compared to the prior year. Revenues from development contracts included in corporate sales decreased $251,000, or 54%, to $215,000, from $466,000 for the prior year due primarily to decreases in non-recurring engineering ("NRE") -20- revenues. Revenues from development contracts in 2000 and 1999 were primarily attributable to porting of the Company's software to third party products such as smartphones and web browsers. China sales increased $291,000, or 18%, to $1,911,000 for the year ended December 31, 2000, as compared to $1,620,000 in the prior year. The increase is due to increased sales activity in 2000, and not related to any one-time large sale to a single customer. Cost of Sales. Cost of sales decreased $421,000, or 13%, to $2,896,000 for the year ended December 31, 2000, as compared to $3,317,000 in the prior year period. Online cost of sales decreased $745,000, or 41%, to $1,087,000 in 2000, as compared to $1,832,000 in the prior year. This decrease is due to the reduced number of new names available in 2000, as compared to 1999, and the elimination of mailing costs associated with follow-up mailers sent after initial contact. Corporate sales costs increased $91,000, or 28%, to $416,000 from $325,000 in the prior year. Costs associated with the Company's signature software solutions increased to $167,000, and was due to $155,000 in third party hardware costs sold with the Company's corporate signature software solution products, and $12,000 in amortization of capitalized software costs. The Company had no significant costs associated with its off-the-shelf signature solution products sold in 1999, due to the low volume of revenues generated compared to 2000. Costs of development contract revenues included in corporate sales decreased $71,000, or 27%, to $190,000 in 2000, as compared to $261,000 in the prior year. The decrease in development contract cost is due to the reduction in non-recurring engineering projects during 2000 as compared to the prior year period. OEM costs decreased $5,000, or 8%, to $59,000, as compared to $64,000 in the prior year. The decrease is due to a decrease in revenues and the associated technology import tax from the Company's Japanese OEM customers. China cost of sales increased $233,000, or 20%, to $1,393,000 in 2000, as compared to $1,160,000 in the prior year period. The increase was due to the increase in sales activity in 2000 as compared to the prior year. Gross Margin. Gross margin increased $1,215,000, or 38%, to $4,416,000 in 2000, as compared to $3,201,000 in the prior year. Online gross margin increased $268,000 to $111,000 in 2000, as compared to a gross margin loss of $157,000 in the prior year period. The increase was due to the change in the mix of names from new and long time users of Palm products to newly registered Palm users. The change in the mix of names has allowed the Company to eliminate the follow-up mailers, primarily used to attempt to convert long time users of PDA's to the Company's more natural input products. Online gross margins were 91% of sales for the year ended December 31, 2000. Corporate sales gross margin increased $889,000, or 31%, to $3,787,000 in 2000, from $2,898,000 in the prior year period. This increase is primarily due to the 30% increase in Corporate sales discussed above. Corporate sales gross margin as a percentage of sales was 90% for the years ended 2000 and 1999, respectively. China sales gross margin increased $58,000, or 13%, to $518,000 in 2000, from $460,000 in the prior year. This increase is primarily due to the 18% increase in sales in 2000 as discussed above. China gross margin as a percentage of sales declined 1% to 27% as compared to 28% in the prior year. Research and Development Expenses. Research and development expenses increased $240,000, or 18%, to $1,603,000 for the twelve months ended December 31, 2000, as compared to $1,363,000 for the prior year. Salaries and related costs increased $46,000, or 4%, to $1,181,000 in 2000, compared to $1,135,000 in 1999. This increase is due to additional headcount during 2000 compared 1999. Other costs, including shared development costs with the Joint Venture, facility and other costs increased $122,000 in 2000 compared to the prior year. In addition costs, associated with development contracts and charged to cost of sales decreased $72,000. This decrease was due to reduced revenue from non-recurring engineering projects in 2000 as compared to the prior year. Sales and Marketing Expenses. Sales and marketing expenses for the year ended December 31, 2000, increased $362,000, or 19%, compared to the prior year. -21- Payroll and related costs in 2000 increased 16%, or $110,000, due primarily to increased headcount during the year. Travel and related expenses increased $77,000, or 64%, in 2000 compared to the prior year. The increase was due to increases in travel related to sales and marketing activities compared to the prior year. Advertising and promotion expense increased $210,000, or 112%, to $398,000 in 2000, from $188,000 in the prior year. The increase was due to a $76,000, or 90%, increase in media placement costs and $134,000 or 107% increase in trade show and printed marketing materials expenses compared to the prior year. Other costs, such as facilities and miscellaneous expenses, decreased $35,000, or 4%, in 2000 to $866,000 from $901,000 in the prior year. General and Administrative Expenses. General and administrative expenses increased 30%, or $498,000, to $2,181,000 for the year ended December 31, 2000, from $1,683,000 for the prior year. Payroll and related costs in 2000 increased 13%, or $132,000, due to the addition of key management in late 1999 and the third quarter of 2000. Investor relations expenses increased $218,000, or 102%, to $432,000 in 2000, as compared to $214,000 in the prior year. This increase was due to additional NASDAQ listing fees, and the increased costs of disseminating information due to the increased interest in the Company in the fourth quarter of 1999 and the first quarter of 2000. Director and officers insurance expense increased $44,000 in 2000, due to the increased activity in the Company's stock. Patent amortization due to the capitalization of the intellectual property from the PenOp acquisition increased $28,000 over the prior year. Other expenses including travel, professional services, facilities cost and provision for uncollectable accounts increased $76,000 in 2000 as compared to the prior year. Interest Income and Other Income (Expense), Net. Interest income and other income (expense) net, increased $21,000, or 38%, to $76,000 in 2000, from $55,000 in the prior year. This increase resulted from an increase in interest income due to higher cash balances during the year. The increase in interest income was offset by fees associated with credit card sales from the Company's website of approximately $49,000 in 2000, compared to $59,000 in the prior year. Interest Expense. Interest expense increased $193,000, or 264%, in 2000, to $266,000 compared to $73,000 in the prior year. This increase is due to long-term debt outstanding for the full year and the amortization of the loan discount associated with warrants issued in connection with the long term debt. Liquidity and Capital Resources Cash and cash equivalents at December 31, 2001 totaled $2,588,000, compared to cash and cash equivalents of $2,349,000 at December 31, 2000. This increase was primarily attributable to $2,456,000 of cash provided by financing activities, offset by $2,159,000 used in operations and $58,000 of cash used in investing activities in 2001. In 2001, the effect of exchange rate changes on cash was immaterial. At December 31, 2001, current liabilities, which include deferred revenue, were $882,000. Deferred revenue, totaling $88,000 at December 31, 2001, primarily reflects advance service contract fees received from the Company's licensees which are generally recognized as revenue by the Company in the period in which the service work is completed. As of December 31, 2001, the Company's principal source of liquidity was its cash and cash equivalents of $2,588,000. In each year since its inception, the Company has incurred losses. Although there can be no assurance, the Company believes that its current cash and resources, together with the expected revenue levels, will provide sufficient funds for planned operations for at least the next twelve months. However, if the Company is unable to generate adequate cash flow from sales, or if expenditures required to achieve the Company's plans are greater than expected, the Company may need to obtain additional funds or reduce discretionary spending. There can be no assurance that additional funds will be available when needed, or if available will be on favorable terms or in the amounts required by the Company. If adequate funds are not available when needed, the Company may be required to delay, scale back or eliminate some or all of its marketing and development efforts or other operations, which could have a material adverse effect on the Company's business, results of operations and prospects. -22- Financing.On August 23, 2001, the Company's 90% owned Joint Venture borrowed the aggregate equivalent of $181,000 denominated in Chinese currency, from a Chinese bank. The loan bears interest at 5.37% per annum and is due August 23, 2002. The borrowing did not require the Joint Venture to deposit a compensating balance. On September 1, and September 19, 2000, respectively, the Company's 90% owned Joint Venture borrowed, in two transactions the aggregate equivalent of $120,000, denominated in Chinese currency, from a Chinese bank. The loans bore interest at 5.12% and were due on March 2, and March 19, 2001, respectively. The borrowings did not require a compensating balance. The notes were paid in March 2001. On June 19, 2001, the Company consummated a three-year $3 million financing (the "Loan") with a charitable remainder annuity trust of which the trustee was a former director and officer of the Company (the "Trust"). The proceeds of the Loan were used to refinance $1,500,000 of indebtedness outstanding to the Trust pursuant to a loan made by the Trust to the Company in October 1999(see below), and for working capital purposes. The Loan bears interest at the rate of 2% over the prime rate publicly announced by Citibank N. A. from time to time, which was 8.00% per annum at September 30, 2001, and is due June 18, 2004. The Loan may be pre-paid by the Company in whole or in part at any time without penalty, subject to the right of the Trust to convert the outstanding principal amount of the Loan into shares of common stock. Pursuant to the terms of the Loan, the Trust has the option, at any time prior to maturity, to convert all or any portion of the outstanding principal amount of the Loan into shares of common stock of the Company at a conversion price of $2.00 per share, subject to adjustment upon the occurrence of certain events. If, prior to maturity of the Loan, the Company consummates one or more financings providing $5 million or more in gross proceeds, the Company is required to apply 50% of the proceeds in excess of $5 million to the then outstanding principal amount of the Loan. The Loan is secured by a first priority security interest in and lien on all of the Company's assets as now owned or hereafter acquired by the Company. In connection with the Loan, the Company entered into a registration rights agreement with the Trust which obligates the Company to file a registration statement with the Securities and Exchange Commission covering the sale of the shares of the Company's common stock issuable upon conversion of the Loan if it receives a demand by the holder of the Loan to do so, and to use its reasonable best efforts to cause such registration statement to become effective. In June 1999, the Company obtained a bridge loan (the "Bridge Loan") in the amount of $500,000 from a charitable remainder annuity trust, of which a director and officer of the Company is a trustee. The Bridge Loan was increased by $150,000 and $100,000 in August and September 1999, respectively. Amounts outstanding under the Bridge Loan bore interest at the prime rate plus 2%. The loan was secured by the Company's cash, accounts receivable and other receivables as then owned or thereafter acquired by the Company. The Bridge Loan plus accrued interest was due December 31, 1999. In October 1999, the Company entered into a loan agreement with the same charitable remainder annuity trust, whereby the then existing Bridge Loan of $750,000 was converted into a long-term loan in the amount of $1,500,000 (the "1999 Loan"). The 1999 Loan was secured by a first priority security interest in all of the Company's assets as now owned or hereafter acquired by the Company. The 1999 Loan bore interest at the rate of 2% over the prime rate as published by Citibank from time to time. In , in connection with the 1999 Loan, the Company issued to the charitable remainder annuity trust warrants to purchase 300,000 shares of the Company's common stock. The Company ascribed a value of $179,000 to these warrants, which was amortized to the Company's results of operations over the life of the warrant. The fair value ascribed to the warrants was estimated on the date of issuance using the Black-Scholes pricing model with the following assumptions: risk-free interest rate of 5.50%; expected life of 2 years; expected volatility of 99%; and expected dividend yield of 0%. The warrants had an exercise price of $1.09 per share. On January 20, 2000, the charitable remainder trust, of which a director and officer of the Company is a trustee, exercised all 300,000 warrants issued in connection with the $1,500,000 long-term debt. The warrants were exercised under the cashless exercise provision in the warrant agreement. The Company issued approximately 255,000 shares of common stock in exchange for the 300,000 warrants. Operating Lease Commitments. The Company leases facilities in the United States and China. The Company's rental expense for the years ended December 31, 2001, and 2000 was approximately $443,000 and $390,000, respectively. Sublease -23- income was approximately $35,000 and $105,000 for the years ended December 31, 2001 and 2000, respectively. Future minimum lease payments under non-cancelable operating leases are expected to be approximately $397,000 for the years ending December 31, 2002. On October 2, 2001 the Company entered a new five year lease for its existing principal offices at 275 Shoreline Drive, Suite 500, Redwood Shores California for approximately 9,634 square feet. The lease commenced on November 1, 2001, with first year lease costs of approximately $347,000. The cost of the lease will increase approximately 3% per annum over the term of the lease which expires on October 31, 2006. In addition to the base rent the Company will pay a percentage of the increase, if any, in operating cost incurred by the landlord in such year over the operating expenses incurred by the landlord in the base year. The Company believes the offices will be adequate for its needs over the term of the lease. Volatility of Stock Price The Company's stock price may be subject to significant volatility. The public stock markets have experienced significant volatility in stock prices in recent years. The stock prices of technology companies have experienced particularly high volatility, including, at times, severe price changes that are unrelated or disproportionate to the operating performance of such companies. The trading price of the Company's Common Stock could be subject to wide fluctuations in response to, among other factors, quarter to quarter variations in operating results, announcements of technological innovations or new products by the Company or its competitors, announcements of new strategic relationships by the Company or its competitors, general conditions in the computer industry or the global economy generally, or market volatility unrelated to the Company's business and operating results. Item 8. Financial Statements and Supplementary Data The Company's audited consolidated financial statements for the years ended December 31, 2001, 2000, and 1999 begin on page F-1 of this Annual Report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None PART III Item 10. Directors and Executive Officers of the Registrant Information with respect to this Item is incorporated by reference to the Company's definitive proxy statement with respect to its Annual Meeting of Stockholders expected to be held on June 24, 2002. Item 11. Executive Compensation Information with respect to this Item is incorporated by reference to the Company's definitive proxy statement with respect to its Annual Meeting of Stockholders expected to be held on June 24, 2002. Item 12. Security Ownership of Certain Beneficial Owners and Management Information with respect to this Item is incorporated by reference to the Company's definitive proxy statement with respect to its Annual Meeting of Stockholders expected to be held on June 24, 2002. Item 13. Certain Relationships and Related Transactions Information with respect to this Item is incorporated by reference to the Company's definitive proxy statement with respect to its Annual Meeting of Stockholders expected to be held on June 24, 2002. -24- PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K Index to Financial Statements Page (a)(1) Financial Statements Report of Stonefield Josephson, Inc., Independent Auditors.......... F-1 Consolidated Balance Sheets at December 31, 2001 and 2000........... F-2 Consolidated Statements of Operations for the years ended December 31, 2001, 2000, and 1999................................. F-3 Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the years ended December 31, 2000, 1999 and 1998..... F-4 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998............................ F-5 Notes to Consolidated Financial Statements.......................... F-6 (a)(2) Financial Statement Schedule Schedule II Valuation and Qualifying Accounts and Reserves.......... S-1 (b) Reports on Form 8-K None (c) Exhibits Exhibit Document Number 2.0 Second Amended Plan of Reorganization of the Company, incorporated herein by reference to the Company's Form 8-K filed October 24, 1994. 2.1 Orderly Liquidation Valuation, Exhibit F to the Second Amended Plan of Reorganization, incorporated herein by reference to the Company's Form 8-K filed October 19, 1994. 2.2 Order Confirming Plan of Reorganization, incorporated herein by reference to the Company's Form 8-K filed November 14, 1994. 3.1 Certificate of Incorporation of the Company, as amended, incorporated herein by reference to Exhibits 3.1, 3.2, 3.3 and 3.4 to the Company's Registration Statement on Form 10 (File No. 0-19301). 3.2 Certificate of Amendment to the Company's Certificate of Incorporation (authorizing the reclassification of the Class A Common Stock and Class B Common Stock into one class of Common Stock) as filed with the Delaware Secretary of State's office on November 1, 1991, incorporated herein by reference to Exhibit 3 to Amendment 1 on Form 8 to the Company's Form 8-A (File No. 0-19301). 3.3 By-laws of the Company adopted on October 6, 1986, incorporated herein by reference to Exhibit 3.5 to the Company's Registration Statement on Form 10 (File No. 0-19301). 4.1 1984 Stock Option Plan of the Company, as amended and restated as of October 15, 1987 and as amended by resolutions of the stockholders of the Company passed on August 15, 1989 and October 8, 1990 to increase the aggregate shares covered thereby to 1,000,000, incorporated herein by reference to Exhibit 4.4 to the Company's Registration Statement on Form 10 (File No. 0-19301). 4.2 Form of Stock Option Grant under 1984 Stock Option Plan, incorporated herein by reference to Exhibit 4.5 to the Company's Registration Statement on Form 10 (File No. 0-19301). 4.3 1991 Stock Option Plan of the Company, incorporated herein by reference to Exhibit 4.5 of the Company's Form S-1 dated December 23, 1991 (Registration No. 33-43879). 4.4 1991 Non-Discretionary Stock Option Plan, incorporated herein by reference to Exhibit 4.6 of the Company's Form S-1 dated December 23, 1991 (Registration No. 33-43879). -25- 4.5 Form of Incentive Stock Option Grant under 1991 Stock Option Plan, incorporated herein by reference to Exhibit 4.7 of the Company's Form S-1 dated December 23, 1991 (Registration No. 33-43879). 4.6 Form of Non-Qualified Stock Option Grant under 1991 Stock Option Plan, incorporated herein by reference to Exhibit 4.8 of the Company's Form S-1 dated December 23, 1991 (Registration No. 33-43879). 4.7 Form of Stock Option Grant under 1991 Non-Discretionary Stock Option Plan, incorporated herein by reference to Exhibit 4.9 of the Company's Form S-1 dated December 23, 1991 (Registration No. 33-43879). 4.8 1994 Stock Option Plan, incorporated herein by reference to Exhibit G of the Company's Second Amended Disclosure Statement filed on Form 8-K dated October 19, 1994 and approved by shareholders on November 14, 1994. 4.9 Form of Warrant of the Company dated March 28, 1997 issued in connection with the Waiver by and among the Company and the signatories thereto, incorporated herein by reference to Exhibit 4.9 of the Company's 1996 Form 10-K (File No. 0-19301). 4.10 1999 Stock Option Plan, incorporated herein by reference to Exhibit A of the Company's Definitive Proxy Statement filed on May 4, 1999 and approved by shareholders on June 7, 1999. . +10.1Licensing and Development Agreement for Use and Marketing of Program Materials dated September 25, 1992 between the Company and International Business Machines Corporation, incorporated herein by reference to Exhibit 10.13 of the Company's 1992 Form 10-K (File No. 0-19301) 10.2 Standby Stock Purchase Agreement between the Company and Philip Sassower dated October 3, 1994, incorporated herein by reference to Exhibit 10.13 of the Company's 1994 Form 10-K (File No. 0-19301) 10.3 Form of Subscription Agreement between the Company and the Purchasers, dated November 28, 1995, incorporated herein by reference to Exhibit 1 of the Company's Form 8-K dated November 28, 1995. 10.4 Form of Registration Rights Agreement between the Company and the Purchasers, dated November 28, 1995, incorporated herein by reference to Exhibit 1 of the Company's Form 8-K dated November 28, 1995. 10.5 Form of Warrant of the Company issued to Libra Investments, Inc. on November 28, 1995, incorporated herein by reference to Exhibit 1 of the Company's Form 8-K dated November 28, 1995. 10.6 Form of Registration Rights Agreement between the Company and Libra Investments, Inc., dated November 28, 1995, incorporated herein by reference to Exhibit 1 of the Company's Form 8-K dated November 28, 1995. 10.7 Form of Subscription Agreement between the Company and various investors, dated June 13, 1996, incorporated herein by reference to Exhibit 1 of the Company's Form 8-K dated June 27, 1996. 10.8 Form of Registration Rights Agreement between the Company and various investors, dated June 13, 1996, incorporated herein by reference to Exhibit 2 of the Company's Form 8-K dated June 27, 1996. 10.9 Form of Preferred Stock Investment Agreement, dated as of December 31, 1996, between the Company and the investors listed on Schedule 1 thereto, incorporated herein by reference to Exhibit 1 of the Company's Form 8-K dated December 31, 1996. 10.10Form of Registration Rights Agreement between the Company and the Investors Listed on Schedule 1 thereto, incorporated herein by reference to Exhibit 2 of the Company's Form 8-K dated December 31, 1996. 10.11Form of Certificate of Designation of the Company with respect to the 5% Cumulative Convertible Preferred Stock, incorporated herein by reference to Exhibit 3 of the Company's Form 8-K dated December 31, 1996. 10.12Waiver, dated March 26, 1997, effective December 31, 1996, by and among the Company and the signatories thereto, incorporated herein by reference to Exhibit 10.19 of the Company's 1996 Form 10-K (File No. 0-19301). -26- 10.13Form of Subscription Agreement between the Company and each subscriber, dated as of November 25, 1997, incorporated herein by reference to Exhibit 10.1 of the Company's Form 8-K dated December 3, 1997. 10.14Certificate of Designations of the Company with respect to the Series B 5% Cumulative Convertible Preferred Stock, incorporated herein by reference to Exhibit 10.2 of the Company's Form 8-K dated November 13, 1997. 10.15Form of Registration Rights Agreement, by and among the Company and the signatories thereto, dated as of November 25, 1997, incorporated herein by reference to Exhibit 10.3 to the Company's Form 8-K dated November 13, 1997. 10.16Amendment to the Company's Certificate of Designation with respect to the 5% Cumulative Convertible Preferred Stock dated June 12, 1998, incorporated herein by reference to Exhibit 10.23 of the Company's 1998 Form 10-K (File No. 0-19301). 10.17Amendment to the Company's Amended and Restated Certificate of Incorporation dated June 12, 1998, incorporated herein by reference to Exhibit 10.24 of the Company's 1998 Form 10-K (File No. 0-19301). 10.18Employment Agreement dated August 14, 1998 between James Dao and the Company, incorporated herein by reference to Exhibit 10.25 of the Company's 1998 Form 10-K (File No. 0-19301). ++10.19 Software Development and License Agreement dated December 4, 1998 between Ericsson Mobile Communications AB and the Company, incorporated herein by reference to Exhibit 10.26 of the Company's 1998 Form 10-K (File No. 0-19301). 10.20Loan and Warrant Agreement dated October 20, 1999 between the Company and the Philip S. Sassower 1996 Charitable Remainder Annuity Trust. 10-21Asset Purchase Agreement between the Company and PenOp Ltd and PenOp Inc., incorporated herein by reference to the Company's Form 8-K dated October 6, 2000. 10-22Loan dated June 19, 2001 between the Company and the Philip S. Sassower 1996 Charitable Remainder Annuity Trust. *21.1 Schedule of Subsidiaries. *23.1Consent of Stonefield Josephson, Accountancy Corporation, Independent Accountants. + Confidential treatment of certain portions of this exhibit have been previously granted pursuant to a request for confidentiality dated March 29, 1993, filed pursuant to the Securities Exchange Act of 1934. * Filed herewith. ++ Confidential treatment of certain portions of this exhibit have been requested from the SEC pursuant to a request for confidentiality dated March 30, 1999, filed pursuant to the Securities and Exchange Act of 1934. -27- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Redwood Shores, State of California, on March 28, 2001. COMMUNICATION INTELLIGENCE CORP. By: /s/ Guido DiGregorio _____________________________ Guido DiGregorio President and Chief Executive Officer and Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Registrant and in the capacities indicated on March 28, 2001. Signature Title /s/ Guido DiGregorio Chairman, President and Chief Executive Officer ___________________________ (Principal Executive Officer) Guido DiGregorio /s/ Francis V. Dane Chief Legal Officer and Acting Chief Financial ___________________________ Officer(Principal Financial and Accounting Officer) Francis V. Dane /s/ Michael Farese Director ___________________________ Michael Farese /s/ Louis Panetta Director ___________________________ Louis Panetta /s/ Chien Bor Sung Director ___________________________ Chien Bor Sung -28- Independent Auditors Report Board of Directors and Stockholders of Communication Intelligence Corporation Redwood Shores, California We have audited the accompanying consolidated balance sheets of Communication Intelligence Corporation and its subsidiary as of December 31, 2001 and 2000 and the related consolidated statements of operations, changes in stockholders' equity (deficit), cash flows and financial statement schedule for each of the three years in the period ended December 31, 2001, as listed in the index appearing under Item 14(a)(1) and (2) of this Annual Report on Form 10-K. 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 the 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 consolidated financial statements and financial statements schedule listed in the index appearing under Item 14(a)(1) and (2) of this Annual Report on Form 10-K present fairly, in all material respects, the financial position of Communication Intelligence Corporation and its subsidiaries ("the Company") as of December 31, 2001, and 2000 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. STONEFIELD JOSEPHSON INC. Certified Public Accountants San Francisco, California February 18, 2002 F-1 Communication Intelligence Corporation Consolidated Balance Sheets (In thousands, except par value amounts) December 31, --------------------------------- 2001 2000 --------------------------------- Assets Current assets: Cash and cash equivalents.................. $ 2,588 $ 2,349 Accounts receivable, including $350 from M10 (Previously PenOp) at December31, 2000 net of allowances of $278 and $118 at December 31, 2001 and 2000,respectively.......................... 1,043 1,760 Inventories................................ 129 171 Prepaid expenses and other current assets.. 139 270 --------------- --------------- Total current assets................. 3,899 4,550 Note receivable from officer................. - 46 Property and equipment, net.................. 161 262 Patents and trademarks....................... 5,799 6,234 Other assets................................. 213 210 --------------- --------------- Total assets......................... $ 10,072 $ 11,302 =============== =============== Liabilities and Stockholders' Equity Current liabilities: Accounts payable........................... $ 206 $ 679 Short-term debt............................ 181 120 Accrued compensation....................... 208 263 Other accrued liabilities.................. 199 318 Deferred revenue........................... 88 61 --------------- --------------- Total current liabilities............ 882 1,441 Long-term debt - related party............... 3,000 1,427 Minority interest............................ 130 127 Commitments Stockholders' equity: Common stock, $.01 par value; 100,000 shares authorized; 90,912 and 89,668 shares issued and outstanding at December 31, 2001 and 2000, respectively..................... 909 897 Additional paid-in capital................. 81,605 80,656 Accumulated deficit........................ (76,258) (73,043) Accumulated other comprehensive loss....... (196) (203) --------------- --------------- Total stockholders' equity................... 6,060 8,307 --------------- --------------- Total liabilities and stockholders' equity.. $ 10,072 $ 11,302 =============== =============== See accompanying Notes to Consolidated Financial Statements F-2 Communication Intelligence Corporation Consolidated Statements of Operations (In thousands, except per share amounts) Years ended December 31, ------------------------------------------- 2001 2000 1999 ------------------------------------------- Revenues: Online.......................... $ 913 $ 1,198 $ 1,675 Corporate....................... 2,958 3,326 3,223 Nonrecurring maintenance fees - M10 (Previously PenOp).. 352 877 - China........................... 1,724 1,911 1,620 -------------- ---------------------------- 5,947 7,312 6,518 -------------- ---------------------------- Operating costs and expenses: Cost of sales: Online........................ 805 1,087 1,832 Corporate..................... 290 416 325 China......................... 1,145 1,393 1,160 Research and development........ 1,808 1,603 1,363 Sales and marketing............. 2,054 2,239 1,877 General and administrative...... 2,791 2,181 1,683 -------------- ---------------------------- 8,893 8,919 8,240 -------------- ---------------------------- Loss from operations.............. (2,946) (1,607) (1,722) Interest income and other income (expense), net.................... 16 76 55 Interest expense.................. (282) (266) (73) Minority interest................. (3) (2) - -------------- ---------------------------- Net loss......................... $ (3,215) $ (1,799) $ (1,740) ============== ============================ Basic and diluted loss per share............................ $ (0.04) $ (0.02) $ (0.02) ============== ============================ Weighted average shares.......... 90,571 85,324 79,625 ============== ============================ See accompanying Notes to Consolidated Financial Statements F-3 Communication Intelligence Corporation Consolidated Statements of Changes in Stockholders' Equity (Deficit) (In thousands) Accumulated Additional Other Common Paid-In Accumulated Comprehensive Stock Capital Deficit Loss Total -------------------------------------------------------------------- Balances as of December 31, 1998.... $785 $70,205 $(69,504) $(154) $1,332 Issuance of 300 warrants in connection with Long-term debt....................... - 179 - - 179 Exercise of options for 3,421 shares of Common Stock...................... 34 1,802 - - 1,836 Exercise of 329 warrants for 329 shares of Common Stock. 3 797 - - 800 Foreign currency translation adjustment................. - - - (58) (58) Net loss..................... - - (1,740) - (1,740) -------------------------------------------------- Balances as of December 31, 1999....................... $822 $72,983 $(71,244) $(212) $2,349 -------------------------------------------------- Exercise of 2,352 options for 2,352 shares of Common Stock...................... $24 $1,559 - - $1,583 Exercise of 406 warrants for 361 shares of Common Stock. 4 433 - - 437 Issuance of 4,700 shares of Common Stock in exchange for intellectual property of PenOp Ltd............... 47 5,681 - - 5,728 Foreign currency translation adjustment................. - - - 9 9 Net loss..................... - - (1,799) - (1,799) -------------------------------------------------- Balances as of December 31, 2000....................... $897 $80,656 $(73,043) $(203) $8,307 -------------------------------------------------- Exercise of options for 1,176 shares of Common Stock...................... $11 $892 - - $903 Issuance of 68 shares of Common Stock in exchange for services............... 1 57 - - 58 Foreign currency translation adjustment................. - - - 7 7 Net loss..................... - - (3,215) - (3,215) -------------------------------------------------- Balances as of December 31, 2001....................... $909 $81,605 $(76,258) $(196) $6,060 --------------------------------------------------- See accompanying Notes to Consolidated Financial Statements F-4 Communication Intelligence Corporation Consolidated Statements of Cash Flows (In thousands) Years ended December 31, ----------------------------------------- 2001 2000 1999 ----------------------------------------- Cash flows from operating activities Net loss............................ $ (3,215) $ (1,799) $ (1,740) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization..... 687 328 334 Equity securities issued for services.......................... 58 - - Non-cash compensation............. 46 89 - (Gain) loss on disposal of property and equipment................. - - (1) Changes in operating assets and liabilities Accounts receivable, net......... 717 (185) (429) Inventories...................... 42 (90) (7) Prepaid expenses and other current assets........................... 135 (95) (72) Other assets..................... (14) 48 (49) Accounts payable................. (469) 390 (184) Accrued compensation............. (55) (3) 38 Other accrued liabilities........ (117) (176) 70 Deferred revenue................. 26 26 (616) ------------- ------------- ------------- Net cash used in operating activities. (2,159) (1,467) (2,656) ------------- ------------- ------------- Cash flows from investing activities Acquisition of property and equipment. (58) (636) (78) Acquisition of property through capital leases...................... - 2 17 ------------- ------------- ------------- Net cash used in investing activities. (58) (634) (61) ------------- ------------- ------------- Cash flows from financing activities Proceeds from issuance of short-term debt................................. 181 120 96 Proceeds from issuance of long-term debt - related party................. 3,000 - 1,500 Restricted cash related to short-term debt................................. - - 250 Principal payments on short-term debt (120) (60) (181) Principal payments on short-term debt (1,500) - - Principal payments on capital lease obligations......................... (8) (4) (5) Proceeds from exercise of warrants... - 437 800 Proceeds from exercise of stock options 903 1,583 1,836 ------------- ------------- ------------- Net cash provided by (used in) financing activities................. 2,456 2,076 4,296 ------------- ------------- ------------- Effect of exchange rate changes on cash............................. - - - Net increase (decrease) in cash and cash equivalents.................... 239 (25) 1,579 Cash and cash equivalents at beginning of year................... 2,349 2,374 795 ------------- ------------- ------------- Cash and cash equivalents at end of year............................ $ 2,588 $ 2,349 $ 2,374 ============= ============= ============= See accompanying Notes to Consolidated Financial Statements F-5 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies The Company Communication Intelligence Corporation (the "Company" or "CIC") develops and markets natural input and biometric electronic signature solutions aimed at the emerging markets such as, e-commerce, wireless Internet/information devices, and corporate security. These emerging markets for CIC's products include all areas of personal computing, as well as electronic commerce and communications. The Company's research and development activities have given rise to numerous technologies and products. The Company's core technologies are classified into two broad categories: "natural input technologies" and "transaction and communication enabling technologies". CIC's natural input technologies are designed to allow users to interact with a computer or handheld device through the use of an electronic pen or "stylus". Such products include the Company's multi-lingual Handwriter(R) Recognition System, and its Handwriter(R) for Windows(R) family of desktop computing products. CIC's transaction and communication enabling technologies provide a means for protecting electronic transactions and discretionary communications. CIC has developed products for dynamic signature verification, electronic ink data compression and encryption and a suite of development tools and applications which the Company believes could increase the functionality of its core products and facilitate their integration into original equipment manufacturers' ("OEM") hardware products and computer systems and networks. Through its 90% owned joint venture in China (the "Joint Venture"), the Company provides system integration services and markets its pen-based business computer systems to Chinese businesses, government users and other joint ventures. For the five-year period ended December 31, 2001, the Company incurred aggregate losses of $27,286, and, at December 31, 2001, the Company's accumulated deficit was approximately $76,258. The Company has primarily funded these losses through the sale of debt and equity securities. As of December 31, 2001, the Company's principal source of liquidity was its cash and cash equivalents of $2,588. Although there can be no assurance, the Company believes that its current resources, together with expected revenues, will provide sufficient funds for planned operations for at least the next twelve months. However, if the Company is unable to generate adequate cash flow from sales, or if expenditures required to achieve the Company's plans are greater than expected, the Company may need to obtain additional funds or reduce discretionary spending. Management believes that it will be able to reduce discretionary spending if required. Basis of Consolidation The accompanying consolidated financial statements are prepared in accordance with generally accepted accounting principles, and include the accounts of CIC and its 90% owned Joint Venture in the People's Republic of China. All inter-company accounts and transactions have been eliminated. All amounts shown in the accompanying financial statement are in thousands of dollars except per share amounts. 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, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Reclassification The revenues have been reclassified to conform with the current year presentation. F-6 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 1. Nature of Business, Basis of Presentation and Summary of SignificantAccounting Policies (continued) Fair Value of Financial Instruments The carrying amounts of the Company's financial instruments, including cash and cash equivalents, restricted cash, and short-term debt, approximate fair value due to their short maturities. Cash and Cash Equivalents The Company considers all highly liquid investments with maturity at the date of purchase of three months or less to be cash equivalents. Short-term investments are classified as "available-for-sale." For all periods presented, cost of investments approximated fair market value. The cost of securities sold is based on the specific identification method. The Company had no short-term investments as of December 31, 2001 or 2000. The Company's cash and cash equivalents, at December 31, consisted of the following: 2001 2000 ----------- ------------ Cash in bank.............................. ......... $ 1,621 $ 1,332 Commercial paper.................................... 26 687 Money markets....................................... 941 330 ----------- ------------ Cash and cash equivalents........................ $ 2,588 $ 2,349 =========== ============ Concentrations of Credit Risk Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, short-term investments and accounts receivable. The Company maintains its cash, cash equivalents and short-term investments with various financial institutions. This diversification of risk is consistent with Company policy to maintain liquidity, and mitigate against risk of loss as to principal. Although such amounts may exceed the F. D. I. C. limits, the Company limits the amount of credit exposure with any one financial institution and believes that no significant concentration of credit risk exists with respect to cash and cash equivalents. At December 31, 2001, the Joint Venture had approximately $802 in cash accounts held by a financial institution in the People's Republic of China. The Joint Venture deposits are not covered by any federal deposit insurance program that is comparable to the programs applicable to U.S. deposits. To date, accounts receivable have been derived principally from revenues earned from end users, manufacturers, retailers and distributors of computer products in North America, Europe and the Pacific Rim. The Company performs periodic credit evaluations of its customers, and does not require collateral. The Company maintains reserves for potential credit losses; historically, such losses have been insignificant and within management's expectations. Six customers accounted for approximately 62% of gross accounts receivable at December 31, 2001. Eleven customers accounted for approximately 72% of gross accounts receivable at December 31, 2000. Inventories Inventories are stated at the lower of cost or market, cost being determined using the first-in first-out ("FIFO") method. Cost principally includes direct materials. At December 31, 2001 and 2000, inventories consisted of finished goods. F-7 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued) Property and Equipment, Net Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, ranging from three to five years. Leasehold improvements are amortized over their estimated useful lives, not to exceed the term of the related lease. The cost of additions and improvements is capitalized, while maintenance and repairs are charged to expense as incurred. Depreciation expense was $140, $166 and $190 for the year ended December 31, 2001, 2000 and 1999, respectively. Property and equipment, net at December 31, consists of the following: 2001 2000 ------------ ------------ Machinery and equipment............................... $1,224 $1,191 Office furniture and fixtures......................... 448 448 Leasehold improvements................................ 84 84 Purchased software.................................... 206 174 ------------ ------------ 1,962 1,897 Less accumulated depreciation and amortization........ (1,801) (1,635) ------------ ------------ $ 161 $ 262 ============ ============ Included in property and equipment as of December 31, 2001, and 2000 is $42 and $42, respectively, of assets acquired under capital leases. Accumulated depreciation on such assets totaled $38 and $32 at December 31, 2001 and 2000, respectively. Patents On October 6, 2000, a wholly-owned subsidiary of the Company, acquired certain assets of PenOp Limited (PenOp) and its subsidiary PenOp Inc. pursuant to an asset purchase agreement dated as of September 29, 2000. Patents are stated at cost less accumulated amortization which in Managements opinion is less than fair value. Amortization is computed using the straight-line method over the estimated lives of the related assets, ranging from five to seventeen years. Amortization expense was $436, $43 and $15 for the years ended December 31, 2001, 2000 and 1999, respectively. Patents, net at December 31, consists of the following: Expiration Life 2001 2000 ---------- ---- ------------ ------------ Patent...................... Various 5 $ 9 $ 9 Patent...................... Various 7 476 476 Patent...................... 2013 13 93 93 Patent...................... 2014 14 187 187 Patent...................... 2015 15 373 373 Patent...................... 2017 17 5607 5,607 ------------ ------------ 6745 6,745 Less accumulated amortization.......... (946) (511) ------------ ------------ $ 5,799 $ 6,234 ============ ============ F-8 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued) Long-Lived Assets The Company evaluates the recoverability of its long-lived assets whenever circumstances or events indicate such assets might be impaired. The Company would recognize an impairment reserve in the event the net book value of such assets exceeded the future undiscounted cash flows attributable to such assets. No such reserves have been recorded in the three years ended December 31, 2001. Software Development Costs The Company capitalizes software development costs upon the establishment of technological feasibility, subject to net realizable value considerations. Capitalization commences upon the completion of a working model and ends on general product release. As of December 31, 2001 and 2000, such costs were insignificant and are included as a component of "other assets" in the accompanying consolidated balance sheets. Amortization expense related to capitalized software development costs in 2001, 2000 and 1999 amounted to $12, $12 and $1, respectively. Stock-Based Compensation Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). The Company has elected to continue to use the intrinsic value based method of Accounting Principles Board Opinion No. 25, as allowed under SFAS 123, to account for its employee stock-based compensation plans. The Company complies with the disclosure provisions of SFAS 123. Revenue Recognition In October 1997, the American Institute of Certified Public Accountants (the "AICPA") issued Statement of Position No. 97-2, "Software Revenue Recognition" ("SOP 97-2"), which the Company has adopted for transactions entered into during the fiscal year beginning January 1, 1998. SOP 97-2 provides guidance for recognizing revenue on software transactions and supersedes Statement of Position No. 91-1, "Software Revenue Recognition". In March 1998, the AICPA issued Statement of Position No. 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition" ("SOP 98-4"). SOP 98-4 defers, for one year, the application of certain passages in SOP 97-2 which limit what is considered vendor-specific objective evidence ("VSOE") necessary to recognize revenue for software licenses in multiple-element arrangements when undelivered elements exist. In December 1998, the AICPA issued Statement of Position No. 98-9 ("SOP 98-9") Modifications of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions." SOP 98-9 extends the effective date of SOP 98-4 and provides additional interpretative guidance. SOP 98-9 is effective for fiscal years beginning after March 15, 2000. The Company also follows the interpretive guidance of SAB 101 issued by The Securities and Exchange Commission and EITF issue 00-21 of the AICPA Emerging Issues Task Force. Online Revenue Revenue from retail product sales is recognized upon sell through, while revenue from other product sales is recognized upon shipment provided that no significant obligations remain and the collection of the resulting receivable is probable. The Company provides for estimated sales returns at the time of shipment. Corporate Revenue License revenues are recognized when the software has been delivered and when all significant obligations have been met. Royalty revenues are recognized as products are licensed/sold by licensees. Deferred revenue in the accompanying balance sheets reflects service contract fees received from the Company's licensees in advance of revenue being earned. F-9 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued) Corporate Revenue (continued) Development contracts revenue is generated primarily from non-recurring engineering activities and research grants from licensees and government agencies. Revenue is recognized in accordance with the terms of the grants and agreements, generally when collection is probable and related costs have been incurred. China Joint Venture Revenue Revenue from system integration activities and product sales are recognized upon shipment provided that no significant obligations remain and the collection of the resulting receivable is probable. Three customers accounted for 13%, 9% and 7%, respectively, of revenues in 2001. Three customers accounted for 16%, 6% and 5%, respectively, of revenues in 2000. One customer accounted for 27% of revenues in 1999. No other customers accounted for greater than 10% of revenues in 2001, 2000 and 1999. Research and Development Research and development costs are charged to expense as incurred. Advertising The Company expenses advertising costs as incurred. Advertising expense for the year ended December 31, 2001, 2000, and 1999 was $203, $399 and $140, respectively. Net Loss Per Share The Company calculates earnings per share under the provisions of Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 requires the disclosure of both basic earnings per share, which is based on the weighted average number of shares outstanding, and diluted earnings per share, which is based on the weighted average number of shares and dilutive potential shares outstanding. For the year ended December 31, 2001, 2000 and 1999 potential equivalent shares excluded from the calculation of diluted earnings per share, as their effect is not dilutive, include stock options of 7,027, 8,145 and 9,956 of equivalent shares and of warrants of 237, 237 and 876 equivalent shares, respectively. Foreign Currency Translation The Company considers the functional currency of the Chinese Joint Venture to be the local currency and, accordingly, gains and losses from the translation of the local foreign currency financial statements are included as a component of "accumulated other comprehensive loss" in the accompanying consolidated balance sheets. Foreign currency assets and liabilities are translated into U.S. dollars at the end-of-period exchange rates except for non-monetary assets and liabilities, which are translated at historical exchange rates. Revenues and expenses are translated at the average exchange rates in effect during each period except for those expenses related to balance sheet amounts which are translated at historical exchange rates. Net foreign currency transaction gains and losses are included in "interest income and other income (expense), net" in the accompanying consolidated statements of operations. The Company recorded a net foreign currency transaction gain of $59 for the year ended December 31, 1999. Foreign currency transaction gains in 2001 and 2000 were insignificant. F-10 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued) Income Taxes Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their financial statement reported amounts and for tax loss and credit carryforwards. A valuation allowance is provided against deferred tax assets when it is determined to be more likely than not that the asset will not be realized. Acquisition of Assets From PenOp On October 6, 2000, a wholly-owned subsidiary of the Company, (the "Buyer"), acquired certain assets of PenOp Limited ("PenOp") and its subsidiary PenOp Inc., (collectively, the "Sellers") pursuant to an asset purchase agreement dated as of September 29, 2000, by and among Buyer and the Sellers for 4.7 million shares of common stock of the Company (the "Acquisition"). Out of the 4.7 million shares issued to Sellers in connection with the Acquisition, approximately 940,000 shares are being held in escrow to cover indemnification of Buyer. The Company ascribed a value of $5,728 to the assets which will be charged to income over the estimated lives of the assets, five to seventeen years. Pursuant to the asset purchase agreement, the Company agreed to use reasonable efforts to file a Registration Statement under the Securities Act of 1933, as amended (the "Act"), covering the sale of the Transaction Shares no later than thirty (30) days from closing and to use reasonable efforts to have the Registration Statement declared effective as soon as practicable thereafter. The registration statement was declared effective on November 22, 2000. Subsequent to the closing, an officer and Chairman of the Board of the Company at that time, and his designees, purchased in a private transaction an aggregate of 1,713,728 shares of common stock received by Sellers in connection with the Acquisition for $3.3 million. New Accounting Pronouncements In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations." SFAS No. 141 supersedes Accounting Principles Board ("APB") No. 16 and requires that business combinations entered into after June 20, 2001 be accounted for as using the purchase method, eliminating the pooling-of-interest method defined in APB 16. The statement is effective for business combinations initiated after June 30, 2001 and shall apply to all business combinations accounted for by the purchase method for which the date of acquisition is July 1, 2001 or later. The Company believes that adoption of FASB No. 141 will not have a material impact on its current financial position or results of operations. In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangibles". SFAS No. 142 addresses the initial recognition, measurement and amortization of intangible assets acquired individually or in a group of other assets (not acquired in a business combination) and addresses the amortization provisions for excess cost over fair value of net assets or intangibles assets acquired in a business combination. The statement is effective for fiscal years beginning after December 15, 2001, and is effective July 1, 2001 for any intangibles acquired in a business combination initiated after June 30, 2001. The Company is evaluating the effect, if any, on its financial position and results of operations arising from the issuance of SFAS No. 142, "Goodwill and Other Intangibles." In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets. " SFAS No. 144 addresses the accounting and reporting for the impairment or disposal of long-lived assets. The statement provides a single accounting model for long-lived assets to be disposed of. New criteria must be met to classify the asset as an asset held-for-sale. SFAS No. 144 also focuses on reporting the effects of a disposal of a segment of a business. Statement SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not expect SFAS No. 144 will have a material impact on the Company's financial position or results of operations at this time. In January 2001, the Financial Accounting Standards Board's Emerging Issues Task Force (EITF) issued EITF Issue No. 00-27 effective for convertible debt F-11 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued) instruments issued after November 16, 2000. This pronouncement requires the use of the intrinsic value method for recognition of the detachable and imbedded equity features included with indebtedness, and requires amortization of the amount associated with the convertibility feature over the life of the debt instrument rather than the period for which the instrument first became convertible. The Company does not expect EITF Issue No. 00-27 will have a material impact on the Company's financial position or results of operations at this time. 2. Chinese Joint Venture The Company currently owns 90% of a joint venture with the Information Industry Bureau of the Jiangsu Province, a provincial agency of the People's Republic of China (the "Agency"). In June 1998, the registered capital of the Joint Venture was reduced from $10,000 to $2,550. As of December 31, 2001, the Company had contributed an aggregate of $1,800 in cash to the Joint Venture and provided it with non-exclusive licenses to technologies and certain distribution rights and the Agency had contributed certain land use rights. Following the reduction in registered capital of the Joint Venture, neither the Company nor the Agency are required to make further contributions to the Joint Venture. Prior to the reduction in the amount of registered capital, the Joint Venture was subject to the annual licensing requirements of the Chinese government. Concurrent with the reduction in registered capital, the Joint Venture's business license has been renewed through October 18, 2043. 3. Comprehensive Income In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). The Company adopted SFAS 130 effective January 1, 1998. SFAS 130 requires that all items recognized under accounting standards as components of comprehensive earnings be reported in an annual statement that is displayed with the same prominence as other annual financial statements. SFAS 130 also requires that an entity classify items as other comprehensive earnings by their nature in an annual financial statement. For example, other comprehensive earnings may include foreign currency translation adjustments, minimum pension liability adjustments, and unrealized gains and losses on marketable securities classified as available-for-sale. Annual financial statements for prior periods have been reclassified, as required. The accumulated other comprehensive loss at December 31, 2001 and 2000 consisted of cumulative foreign currency translation adjustments. 4. Short-term Debt On August 23, 2001, the Company's 90% owned Joint Venture borrowed the aggregate equivalent of $181, denominated in Chinese currency, from a Chinese bank. The loan bears interest at 5.37% per annum and is due August 23, 2002. The borrowing did not require the Joint Venture to deposit a compensating balance. On September 1, and September 19, 2000, respectively, the Company's 90% owned Joint Venture borrowed, in two transactions, the aggregate equivalent of $121, denominated in Chinese currency, from a Chinese bank. The loans bear interest at 5.12%. The borrowings did not require a compensating balance. The loans were paid in March 2001. Interest expense for the years ending December 31, 2001, 2000, and 1999 was $281, $266, and $53, respectively. Interest expense associated with related party debt was $274, $258 and $53 for the years ended December 31, 2001, 2000 and 1999, respectively. 5. Related Party Transactions In April 1994, the Company loaned $210 to the Company's then Chief Executive Officer in exchange for a note, secured by shares of the Company's Common Stock, bearing interest at the lesser of the highest marginal rate per annum applicable to the Company's borrowings or the highest rate allowable by law (10% per annum at December 31, 1997). On August 14, 1998, the Company entered into an employment agreement (the "Employment Agreement") with the F-12 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 5. Related Party Transactions (continued) aforementioned former officer. Under the Employment Agreement, the former officer provided consulting services to the Company through December 15, 2001. In exchange for these services, $110 of the note receivable from the officer was forgiven on a monthly basis over the period commencing August 15, 1998 and ending December 15, 2001. Per the terms of the employment agreement, the remaining $100 of the note receivable from the officer was forgiven on December 15, 2001. On June 16, 1999, the Company obtained a bridge loan (the "Bridge Loan") in the amount of $500 from a charitable remainder annuity trust, a trustee of which was then a director and officer of the Company. The Bridge Loan was increased by $150 and $100 in August and September 1999, respectively. Amounts outstanding under the Bridge Loan bore interest at the prime rate plus 2%. The loan was secured by the Company's cash, accounts receivable and other receivables as then owned or thereafter acquired by the Company. The Bridge Loan plus accrued interest was due December 31, 1999. In October 1999, the Bridge Loan was converted to long-term debt as discussed below. On October 20, 1999, the Company entered into a loan agreement with the same charitable remainder annuity trust, whereby the then existing Bridge Loan of $750 was converted into a long term loan in the amount of $1,500 (the "1999 Loan"). The 1999 Loan is secured by a first priority security interest in all of the Company's assets as now owned or hereafter acquired by the Company. The 1999 Loan bore interest at the rate of 2% over the prime rate as published by Citibank from time to time. The note had a due date of January 31, 2002. In connection with the 1999 Loan the Company issued to the charitable remainder annuity trust warrants to purchase 300 shares of the Company's common stock. The warrants had an exercise price of $1.09 per share. The Company ascribed a value of $179 to these warrants, which was amortized to the Company's results of operations over the life of the debt. The fair value ascribed to the warrants was estimated on the date of issuance using the Black-Scholes pricing model with the following assumptions: risk-free interest rate of 5.50%; expected life of 2 years; expected volatility of 99%; and expected dividend yield of 0%. On January 20, 2000, the charitable remainder trust exercised all 300 warrants issued in connection with the $1,500 long-term debt. The warrants were exercised under the cashless exercise provision in the warrant agreement. The Company issued 255 shares of common stock in exchange for the 300 warrants. The 1999 Loan was paid off June 19, 2001 as discussed below. On June 19, 2001, the Company consummated a three-year $3 million financing (the "Loan") with the charitable remainder annuity trust, a trustee of which was then a director and officer of the Company (the "Trust"). The proceeds of the Loan were used to refinance $1,500 of indebtedness outstanding to the Trust pursuant to a loan made by the Trust to the Company in October 1999 and for working capital purposes. The Loan is secured by a first priority security interest in all of the Company's assets as now owned or hereafter acquired by the Company. The Loan bears interest at the rate of 2% over the prime rate publicly announced by Citibank N. A. from time to time, which was 8.00% per annum at September 30, 2001, and is due June 18, 2004. The Loan may be pre-paid by the Company in whole or in part at any time without penalty, subject to the right of the Trust to convert the outstanding principal amount of the Loan into shares of common stock. Pursuant to the terms of the Loan, the Trust has the option, at any time prior to maturity, to convert all or any portion of the outstanding principal amount of the Loan into shares of common stock of the Company at a conversion price of $2.00 per share, subject to adjustment upon the occurrence of certain events. If, prior to maturity of the Loan, the Company consummates one or more financings providing $5 million or more in gross proceeds, the Company is required to apply 50% of the proceeds in excess of $5 million to the then outstanding principal amount of the Loan. In connection with the Loan, the Company entered into a registration rights agreement with the Trust which obligates the Company to file a registration statement with the Securities and Exchange Commission covering the sale of the shares of the Company's common stock issuable upon conversion of the Loan if it receives a demand by the holder of the Loan to do so, and to use its reasonable best efforts to cause such registration statement to become effective. In 2001, 2000, and 1999, $150 in consulting fees, including office expenses, were paid to a party who, at that time, was a director of the Company. F-13 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 5. Related Party Transactions (continued) During the fourth quarter of 2000 the Company engaged in a transaction with PenOp (See Note 1) to provide nonrecurring maintenance services from pre-existing PenOp contracts in the aggregate amount of $1.5 million. The Company recorded $877 and $352 in nonrecurring maintenance services during the fourth quarter of 2000 and the first quarter of 2001, respectively, (net). The Company previously entered into a separate transaction, to acquire the intellectual property rights from PenOp. Subsequent to the closing of the Acquisition (See Note 1), an officer and Chairman of the Board of the Company at that time, and his designees, purchased in a private transaction an aggregate of 1,713,728 shares of common stock received by Sellers in connection with the Acquisition for $3.3 million. 6. Stockholders' Equity Common Stock Options The Company adopted two stock option plans in 1991 (the 1991 Stock Option Plan and the 1991 Non-discretionary Plan, collectively, the "1991 Plans"). Incentive and non-qualified options under the 1991 Plans may be granted to employees, officers, and consultants of the Company. As amended, there are 2,050 shares of Common Stock authorized for issuance under the 1991 Plans. At December 31, 2001, 63 options are available for grant. In late 1994 the Company adopted the 1994 Stock Option Plan (the "1994 Plan"). The 1994 Plan allows directors, officers and employees to be eligible for grants of incentive and non-qualified stock options. In May 1997, the stockholders approved an increase of 1,000 shares to the number of shares authorized for issuance under the 1994 Plan. Accordingly, a total of 6,000 shares of Common Stock are authorized for issuance under the 1994 Plan. The exercise prices of options under the 1994 Plan are determined by a committee of the Board of Directors, but, in the case of an incentive stock option, the exercise price may not be less than 100% of the fair market value of the underlying Common Stock on the date of grant. Non-qualified options may not have an exercise price of less than 85% of the fair market value of the underlying Common Stock on the date of grant. Options under the 1994 Plan generally vest over four years. For those options which vest over four years, 20% of the total options granted vest on the first anniversary of the date of grant, and an additional 20%, 20%, and 40% of the total options granted vest on the second, third, and fourth anniversaries of the date of grant, respectively. Options under the 1994 Plan are generally exercisable over a period not to exceed seven years. At December 31, 2001, there were 433 options available for grant under the 1994 Plan. In December 1994, for services rendered options to purchase 180 shares of Common Stock at $0.50 per share were granted to three directors of the Company under non-plan option agreements. In addition, a non-plan option to purchase 100 shares of Common Stock at $0.50 per share was granted on December 28, 1994 to a newly elected director. The newly elected director also received an option, vesting one year from date of grant, to purchase 50 shares of Common Stock at an exercise price of $0.50 per share pursuant to the Company's 1991 Non-discretionary Plan. The non-plan options generally vest over four years. For those non-plan options which vest over four years, 20% of the total non-plan options granted vest on the first anniversary of the date of grant and an additional 20%, 20%, and 40% of the total non-plan options granted vest on the second, third, and fourth anniversaries of the date of grant, respectively. Non-plan options are generally exercisable over a period not to exceed seven years. As of December 31, 2001, 3,585 non-plan options were outstanding with a weighted average exercise price of $0.88 per share. Of such non-plan options, 3,167 were exercisable at December 31, 2001 with a weighted average exercise price of $0.89 per share. In June 1999, the Company adopted and the shareholders approved a stock option plan (the "1999 Plan"). Incentive and non-qualified options under the 1999 Plan may be granted to employees, officers, and consultants of the Company. There are 2,000 shares of Common Stock authorized for issuance under the 1999 Plan. The options have a ten year lifeand generally vest quarterly over three years. At December 31, 2001, there were 1,035 shares available for future grants. F-14 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 6. Stockholders' Equity (continued) Common Stock Options Information with respect to the Company's 1991 Plans the 1994 Plan and the 1999 Plan is summarized below: Year Ended December 31, ------------------------------------------------------ 2001 2000 ------------------------------------------------------ Weighted Weighted Average Average Shares Exercise Price Shares Exercise Price ------------------------------------------------------ Outstanding at beginning of period.. 3,257 $1.54 3,544 $1.02 Granted.............. 1,367 $1.21 947 $3.19 Exercised............ (384) $0.90 (757) $0.85 Forfeited............ (798) $1.53 (477) $2.07 ------- ------- Outstanding at period end.. 3,442 $1.48 3,257 $1.54 ======= ======= Options exercisable at period end....... 2,208 $1.35 1,150 $1.27 ======= ======= Weighted average grant-date fair value of options granted during the period... $0.98 $1.54 ======= ======= The following table summarizes information about stock options outstanding under the 1991 Plans, the 1994 Plan and the 1999 Plan at December 31, 2001: Weighted Average ------------------------------------- Remaining Options Contractual Life (Years) Range of Exercise Prices Outstanding Exercise Price -------------------------------------------------------------------------------- $0.00 - $0.50............... 24 3.8 $0.47 $0.51 - $2.00............... 2,812 6.2 $1.11 $2.01 - $2.99............... 58 7.8 $2.32 $3.00 - $7.50............... 548 8.3 $3.35 -------------- 3,442 ============== The following table summarizes information about stock options exercisable under the 1991 Plans, the 1994 Plan and the 1999 Plan at December 31, 2001: Weighted Options Average Range of Exercise Prices Exercisable Exercise Price ------------------------------------------ $0.00 - $0.50..................... 12 $0.47 $0.51 - $2.00..................... 1,862 $1.03 $2.01 - $2.99..................... 56 $2.30 $3.00 - $7.50..................... 278 $3.35 ------------------- 2,208 =================== Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). The Company has elected to continue to use the intrinsic value based method of Accounting Principles Board Opinion No. 25, as allowed under SFAS 123, to account for its employee stock-based compensation plans. The Company complies with the disclosure provisions of SFAS 123. F-15 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 6. Stockholders' Equity (continued) Common Stock Options Had compensation cost for the Company's option plans been determined based on the fair value of the options at the date of grant, as prescribed by SFAS 123, the Company's net loss available to stockholders and basic and diluted net loss per share available to stockholders would have been as follows for the year ended December 31: 2001 2000 1999 ------------------------------------------- Net loss available to stockholders: As reported........................ $ (3,215) $ (1,799) $ (1,740) Pro forma.......................... $ (4,743) $ (3,937) $ (3,316) Basic and diluted net loss per share available to stockholders: As reported........................ $ (0.04) $ (0.02) $ (0.02) Pro forma.......................... $ (0.05) $ (0.05) $ (0.04) The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants during the applicable periods: risk-free interest rate of 4.1% for 2001, 4.7% for 2000, and 5.4% for 1999, an expected life of 6 years for 2001, 3.5 years for 2000, and 4 years for 1999, respectively; expected volatility of 100% all periods and dividend yield of 0% for all periods. The Company expects to make additional option grants each year. The Company believes the above pro forma disclosures are not representative of the pro forma effects on reported results of operations to be expected in future periods. Warrants On March 28, 1997, and effective as of December 31, 1996, holders constituting 100% of the then issued and outstanding shares of Series A Preferred Stock executed a waiver to certain provisions of the registration rights agreement (the "Agreement") entered into in connection with the December Private Placement. Under the waiver, these holders irrevocably waived any redemption obligation of the Company with respect to its Series A Preferred Stock in exchange for the issuance to the holders of warrants to purchase the 300 shares of the Company's Common Stock, allocated amongst the holders on a pro-rata basis. The warrants expire five years from the date of issuance and have an exercise price of $2.00 per share, subject to adjustment for anti-dilution. The Company has ascribed a value of $484 to these warrants, which was recorded as an expense in the Company's statement of operations during the first quarter of 1997. The fair value ascribed to the warrants was estimated on the date of issuance using the Black-Scholes pricing model with the following assumptions: risk-free interest rate of 6.60%; expected life of 5 years; expected volatility of 104%; and expected dividend yield of 0%. On October 20, 1999, in connection with the 1999 Loan (as defined below in Note 6) the Company issued to a charitable remainder annuity trust warrants to purchase 300 shares of the Company's common stock. The warrants expire two years from the effective date of issuance and have an exercise price of $1.09 per share. The Company ascribed a value of $179 to these warrants, which were amortized to the Company's results of operations over the life of the warrant. The fair value ascribed to the warrants was estimated on the date of issuance using the Black-Scholes pricing model with the following assumptions: risk-free interest rate of 5.50%; expected life of 2 years; expected volatility of 99%; and expected dividend yield of 0%. Warrants to purchase a total of 237 shares of Common Stock were outstanding as of December 31, 2001, and have a weighted average remaining contractual life of 3 months and a weighted average exercise price of $2.00 per share. As of December 31, 2001, 7,264 shares of Common Stock were reserved for issuance upon exercise of outstanding options and warrants. F-16 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 7. Commitments Operating Lease Commitments The Company currently leases its principal facilities (the "Principal Offices) in Redwood Shores, California, pursuant to a sublease that expires in 2006. In addition, the Company subleased to third parties certain space adjacent to the Principal Offices through August 2001. The Joint Venture leases approximately 1,000 square feet in Nanjing, China. In addition to monthly rent, the U.S. facilities are subject to additional rental payments for utilities and other costs above the base amount. Facilities rent expense was approximately $443, $390, and $376 in 2001, 2000, and 1999, respectively. Sublease income was approximately $35, $104, and $209 for the years ended December 31, 2001, 2000, and 1999, respectively. Future minimum lease payments under noncancelable operating leases are approximately, $397,$408 ,$419, $430, and $407 for the years ending December 31, 2002, 2003, 2004, 2005 and 2006, respectively. The Company's rent expense was reduced by approximately $35 in 2001 in connection with the subleases described above. Future minimum payments required under capital leases, which expire in 2002, were insignificant at December 31, 2001. 8. Income Taxes As of December 31, 2001, the Company had federal net operating loss carryforwards available to reduce taxable income through 2012 of approximately $53,179. The Company also had federal research and investment tax credit carryforwards of approximately $315 which expire at various dates through 2010. Deferred tax assets and liabilities at December 31, consist of the following: 2001 2000 ---------------------------- Deferred tax assets: Net operating loss carryforwards................ $ 21,272 $20,192 Credit carryforwards............................ 315 315 Deferred income................................. 13 13 Other, net...................................... 775 782 ---------------------------- Total deferred tax assets....................... 22,375 21,602 ---------------------------- Valuation allowance.............................. (22,375) (21,602) ---------------------------- Net deferred tax assets......................... $ - $ - ============================ A full valuation allowance has been established for the Company's net deferred tax assets since the realization of such assets through the generation of future taxable income is uncertain. Under the Tax Reform Act of 1986, the amounts of, and the benefit from, net operating losses and tax credit carryforwards may be impaired or limited in certain circumstances. These circumstances include, but are not limited to, a cumulative stock ownership change of greater than 50%, as defined, over a three year period. During 1997, the Company experienced stock ownership changes which could limit the utilization of its net operating loss and research and investment tax credit carryforwards in future periods. 9. Segment Information In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of An Enterprise and Related Information" ("SFAS 131"). SFAS 131 revises information regarding the reporting of operating segments and was required to be adopted in periods beginning after December 15, 1997. It also establishes standards for related disclosures about products and services, geographic areas and major F-17 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 9. Segment Information (continued) customers. The Company adopted SFAS 131 for the year ended December 31, 1998 and the Company's information has been stratified into two Segments - Handwriting recognition software and Systems integration. The accounting policies followed by the segments are the same as those described in the "Summary of Significant Accounting Policies." Segment data includes revenues, as well as allocated corporate-headquarters costs charged to each of the operating segments. The Company identifies reportable segments by classifying revenues into two categories Handwriting recognition and system integration. Handwriting recognition software is an aggregate of three revenue categories, OEM, Enterprise and Online sales. All Handwriting recognition software is developed around the Company's core technology. System integration represents the sale and installation of third party computer equipment and systems that utilize the Company's products. All sales above represent sales to external customers. The table below presents information about reporting segments for the years ended December 31,: Handwriting Systems Recognition Integration Total ----------------- ---------------- ----------------- 2001 (Unaudited) Revenues $ 4,546 $ 1,401 $ 5,947 Loss from Operations $(2,842) $ (104) $ (2,946) Total assets $ 8,662 $ 1,410 $ 10,072 Depreciation and amortization $ 662 $ 25 $ 687 2000 (Unaudited) Revenues $ 5,401 $ 1,911 $ 7,312 Loss from Operations $(1,594) $ (13) $ (1,607) Total assets $ 9,896 $ 1,405 $ 11,301 Depreciation and amortization $ 310 $ 18 $ 328 1999 (Unaudited) Revenues $ 4,898 $ 1,620 $ 6,518 Loss from Operations $(1,078) $ (44) $ (1,722) Total assets $ 3,523 $ 1,440 $ 4,963 Depreciation and amortization $ 289 $ 45 $ 334 The following table represents revenues and long-lived asset information by geographic location for the period ended December 31: Revenues Long Lived Assets ------------------------------------------------------------------ 2001 2000 1999 2001 2000 1999 ------------------------------------------------------------------ U.S. $ 4,223 $ 5,401 $ 4,898 $ 6,113 $ 6,430 $ 261 China 1,724 1,911 1,620 44 66 83 ------------------------------------------------------------------ Total $ 5,947 $ 7,312 $ 6,518 $ 6,157 $ 6,496 $ 344 ===================================================================== The Company's export sales from U.S. operations were 16%, 36%, and 16%, of total revenues in 2001, 2000, and 1999, respectively. F-18 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 10. Statement of Cash Flows Data December 31, ----------------------------------------- 2001 2000 1999 Schedule of non-cash transactions: Non-cash compensation................ $ 46 $ 89 $ - Equity securities issued for services............................. $ 58 $ - $ - Intellectual property acquired in exchange for 4,700 shares of the Company's common stock............... $ - $ 5,728 $ - Fair market value of warrants in connection with long-term debt - related party........................ $ - $ - $ 176 10. Statement of Cash Flows Data (continued) Supplemental disclosure of cash flow information: Interest paid in 2001, 2000, and 1999 was $196, $187, and $4, respectively. 11. Employee Benefit Plans The Company sponsors a 401(k) defined contribution plan covering all employees meeting certain eligibility requirements. Contributions made by the Company are determined annually by the Board of Directors. To date, the Company has made no contributions to this plan. 12. Quarterly information (Unaudited) The summarized quarterly financial data presented below, in the opinion of Management, reflects all adjustments which are of a normal and recurring nature necessary to present fairly the results of operations for the periods presented. First Second Third Fourth Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- ------- 2001 Unaudited Net Sales $ 1,618 $1,903 $ 915 $1,511 $ 5,947 Gross profit $ 996 $1,201 $ 459 $1,051 $ 3,707 Income (loss) before income taxes, and minority interest $ (741) $ (691) $(1,228) $ (552) $(3,212) Net income (loss) $ (741) $ (693) $(1,229) $ (552) $(3,215) Basic and diluted income (loss) per share $ (0.01) $(0.01) $ (0.01) $(0.01) $ (0.04) F-19 Communication Intelligence Corporation Notes to Consolidated Financial Statements (In thousands) 12. Quarterly information (Unaudited)(continued) First Second Third Fourth Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- ------ 2000 Unaudited Net Sales $ 1,377 $ 1,250 $2,346 $2,339 $ 7,312 Gross profit $ 648 $ 442 $1,649 $1,677 $ 4,416 Income (loss) before income taxes, and minority interest $ (889) $(1,127) $ 107 $ 112 $(1,797) Net income (loss) $ (888) $(1,127) $ 106 $ 110 $(1,799) Basic and diluted income (loss) per share $ (0.01) $ (0.01) $(0.00) $(0.00) $ (0.02) 1999 Unaudited Net Sales $ 1,247 $1,436 $1,966 $1,869 $ 6,518 Gross profit $ 617 $ 903 $ 831 $ 850 $ 3,201 Income (loss) before income taxes, and minority interest $ (448) $ (380) $ (430) $ (482) $(1,740) Net income (loss) $ (448) $ (380) $ (430) $ (482) $(1,740) Basic and diluted income (loss) per share $ (0.01) $(0.01) $(0.01) $(0.01) $ (0.02) 13. Subsequent event In February 2002, Mr. Guido DiGregorio, President & CEO was appointed Chairman, President & CEO. Prior to Mr. DiGregorio's appointment, Mr. Philip Sassower resigned his Chairmanship and board position and Mr. Jeffrey Steiner also resigned from the board. F-20 SCHEDULE II Communication Intelligence Corporation Valuation and Qualifying Accounts and Reserves (In thousands) Years Ended December 31, 1999, 2000, 2001 Balance Charged to Balance At Beginning Costs and At End Of Period Expense Deductions Of Period Year ended December 31, 1999: Accounts receivable reserves.......$174 $ 39 $(200) $ 13 Year ended December 31, 2000: Accounts receivable reserves.......$ 13 $108 $ (3) $118 Year ended December 31, 2001: Accounts receivable reserves.......$118 $ 78 $ - $196 S-1