-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Vp9XvfirhvLow6YG9nVSIHAFS0IyPaUm825L50Wt019RzTmCEmXBRP0aFz8ht3AY v0HUh3PXal/Ry8IJXUlnhw== 0000890566-99-000553.txt : 19990427 0000890566-99-000553.hdr.sgml : 19990427 ACCESSION NUMBER: 0000890566-99-000553 CONFORMED SUBMISSION TYPE: 10KSB40/A PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990426 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DOCUCON INCORPORATED CENTRAL INDEX KEY: 0000843006 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING, DATA PROCESSING, ETC. [7370] IRS NUMBER: 742418590 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB40/A SEC ACT: SEC FILE NUMBER: 001-10185 FILM NUMBER: 99601081 BUSINESS ADDRESS: STREET 1: 7461 CALLAGHAN RD CITY: SAN ANTONIO STATE: TX ZIP: 78229 BUSINESS PHONE: 2105259221 MAIL ADDRESS: STREET 1: 7461 CALLAGHAN ROAD CITY: SAN ANTONIO STATE: TX ZIP: 78229 10KSB40/A 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 AMENDMENT NO. 1 TO FORM 10-KSB/A (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998; OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______ COMMISSION FILE NUMBER 1-10185 DOCUCON, INCORPORATED (Name of Small Business Issuer in its Charter) DELAWARE 74-2418590 (State or Other Jurisdiction (I.R.S. Employer Identification No.) of Incorporation or Organization) 565 E. SWEDESFORD ROAD, SUITE 209 WAYNE, PENNSYLVANIA 19087 (Address of Principal Executive Offices) (Zip Code) Issuer's Telephone Number, Including Area Code: (610) 995-9500 Securities Registered Under Section 12(b) of the Exchange Act: NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED --------------------- ----------------------- COMMON STOCK, PAR VALUE $.01 PER SHARE BOSTON STOCK EXCHANGE Securities Registered Under Section 12(g) of the Exchange Act: NONE Check whether the Issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such Reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B in this form, and no disclosure will be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] State Issuer's revenues for its most recent fiscal year: $2,693,497 State the aggregate market value of the voting stock held by non-affiliates as of March 1, 1999: Common Stock, par value $.01 per share - $2,547,898 State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. CLASS OUTSTANDING AT MARCH 19, 1999 ----------------------- ----------------------------- COMMON STOCK, PAR VALUE 3,304,214 SHARES $.01 PER SHARE DOCUMENTS INCORPORATED BY REFERENCE Certain documents are incorporated by reference into this Annual Report on Form 10-KSB. See Item 13. Transitional Small Business Issuer Format: Yes [ ] No [X] PART I Certain statements contained in this Form 10-KSB, including statements regarding the anticipated development and expansion of the Company's business, expenditures, the intent, belief or current expectations of the Company, its directors or its officers, primarily with respect to the future operating performance of the Company and other statements contained herein regarding matters that are not historical facts, are "forward-looking" statements (as such term is defined in the Private Securities Litigation Reform Act of 1995). Because such statements include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. ITEM. DESCRIPTION OF BUSINESS. GENERAL Docucon, Incorporated ("Docucon" or the "Company") was incorporated under the laws of the State of Delaware in 1988 and is the successor by merger to a Texas corporation organized in 1986. The Company's primary business is document conversion. DOCUMENT CONVERSION SERVICES AND MARKETS Document conversion is an automated process in which source documents are converted into electronic form, including computer accessible images, indices and formats. These source documents may include letters, contracts, manuals, drawings, aperture cards, transcripts, microfilm and microfiche. After conversion, these documents are stored on various optical and magnetic media. These media are then accessed by document management systems which may be based on a wide range of computer systems. The process of document conversion involves the preparation and grading of the documents to be stored, the physical scanning of the documents and the creation of indices to facilitate retrieval of the converted documents. The indexing of the information to be stored is a significant activity in any document conversion system, and because Docucon creates custom indices and formats, the ultimate users can retrieve information from their own documents utilizing their own systems. Additionally, each of Docucon's document conversion systems can customize the format of the converted materials. Throughout all its operations, Docucon maintains a quality control program to ensure the integrity of the indexing, editing and grading processing of the databases which are converted. The Company provides document conversion services primarily at its operations center in San Antonio, Texas. The Company can also process documents at client-site locations. The Company currently markets conversion services to government and commercial customers that have substantial document storage and retrieval needs. Examples of the type of documents which the Company may convert include logistic support documents and technical manuals for the United States Department of Defense ("DOD"), land files for petro-chemical companies and county governments, and personnel, financial and other records and forms for public and private companies and institutions. For the years ended December 31, 1998 and 1997, the Company spent approximayely $281,000, and $98,000, respectively, for research and development activities related to ongoing operations. The Company does not own any patents. The Company uses the word "Docucon" alone and in combination with various designs and logos as a service mark to identify the Company's services. The Company has obtained federal trademark registration for the name "Docucon". 2 The Company has performed conversion services since 1987 under four major contracts awarded by the DOD. A $14.8 million contract was awarded by the DOD in early 1996 and subsequently increased by $5.6 million and extended through February 1998. The Company provided approximately $14.7 million of services under this contract, which expired in February 1998. In December 1997 the DOD awarded an additional, similar contract with a term of one year for approximately $15.5 million. The terms of the contract includes four additional option years so that the entire contract has a potential value of approximately $77.4 million. As of March 1, 1999, the Company had provided approximately $1.2 million of services under this contract. In 1998, 1997, and 1996 approximately 78%, 87%, and 85%, respectively, of the Company's operating revenues were derived from services provided under DOD contracts. The Company has also performed conversion services for various commercial companies including Lucent Technologies, Loral Federal Systems, Westinghouse, QED, Texaco Exploration and Production, Inc., Computer Science Corporation, Amoco, Dowell Schlumberger, and Ericsson GE, DuPont Pharmaceuticals and Johnson & Johnson. COMPETITION The Company's services are sold in highly competitive markets, and its sales and earnings can be affected by changes in competitive prices, fluctuations in the level of activity in major markets or general economic conditions. The Company believes that the document conversion industry is highly fragmented, with numerous relatively small companies seeking to establish market positions. In addition, the Company believes that major hardware, software and service providers may seek to enter the field in the future. Many competitors and potential competitors have larger marketing organizations and greater resources than the Company. In addition, many government and commercial entities have or may develop in-house document conversion capabilities. Due to the rapidly changing technology used in connection with providing such services, competitive positions within the industry are subject to change. JFS TRANSACTION On March 16, 1994, the Company purchased substantially all of the assets, having a book value of approximately $1.0 million, and assumed certain liabilities in the approximate amount of $1.2 million of J. Feuerstein Systems, Inc. ("JFS"), for consideration of approximately $0.2 million. JFS was based in Parsippany, New Jersey and was engaged in the business of providing consulting and support services and software products to the legal market. On November 26, 1997, the Company sold all of the assets of the JFS division to Bowne & Co., Inc., a worldwide financial printing and services company, for approximately $6.5 million. The Company realized a gain of approximately $4.5 million on the sale. Operations relating to the software portion of the JFS division resulted in losses totaling approximately $1.4 million since the date of its purchase. All operations relating to the software portion of the JFS division are considered discontinued operations for this report on Form 10-KSB. 3 GOVERNMENT REGULATION The Company's ability to obtain contracts from the DOD is dependent upon its compliance with rules and regulations promulgated by that department, including regulations related to security and technological standards. Although the Company believes it is currently in compliance, there is no assurance that it will be able to comply with such rules and regulations promulgated in the future or to maintain its current clearances. See this Item, "Description of Business - Document Conversion Services and Markets" and "Description of Business - Competition," Item 3, "Legal Proceedings" and Item 6, "Management's Discussion and Analysis of Financial Condition and Results of Operations". EMPLOYEES At March 19, 1999, the Company had approximately 144 full-time employees and 69 part-time employees. None of the Company's employees is represented by a labor union, and the Company is not aware of any current activities to unionize its employees. Management believes the relationship between the Company and its employees is good. ITEM 2. DESCRIPTION OF PROPERTY. In October 1992, the Company purchased an eight-story, 52,000-square foot office building in San Antonio, Texas. In January 1999, the Company sold this building and is currently leasing it back from the new owner. This facility is utilized for the Company's San Antonio operations center. Approximately 13,000 square feet of this space is sub-leased on a month-to-month basis to Bowne & Co., Inc. to headquarter operations of the JFS division which was sold to Bowne & Co. Inc. in November 1997. The Company leases approximately 2,000 square feet of space in Wayne, Pennsylvania for its corporate headquarters and approximately 1,000 square feet in Vienna, Virginia for its federal government sales office. The Company has signed a new lease for approximately 31,000 square feet of space where the Company will relocate its San Antonio operations center when the lease in the current building expires in November 1999. The new space is currently under construction and is expected to be ready for occupancy in the fourth quarter of 1999. In Management's opinion, the Company's physical properties are adequate for the Company's current needs, and are consistent with the Company's plans described elsewhere in this Annual Report on Form 10-KSB; however, in the event that the Company experiences significant growth, additional space may be required. ITEM 3. LEGAL PROCEEDINGS. In the ordinary course of its business, the Company may be subject, from time to time, to claims and legal actions by clients, suppliers and others. On February 2, 1999 the Company contacted the Department of Defense's Voluntary Disclosure Program Office to request admission into its Voluntary Disclosure Program. The Voluntary Disclosure Program is intended to encourage government contractors to voluntarily disclose potential violations of government contracting policies and procedures. In general, companies who volunteer information and cooperate with the government's investigation are not subject to criminal and administrative sanctions such as suspension and debarment from government contracting activities. Admission into the Voluntary Disclosure Program does not protect companies from any potential civil liability the government may assert. The Department of Defense is currently performing its initial review of the Company's request to determine if the Company satisfies the requirements for inclusion into the Voluntary Disclosure Program. The Company has no reason to believe that it will not be accepted into the Program. 4 The Company's request for admission into the Voluntary Disclosure Program was the result of an internal review by the Company that brought to light a billing practice, with respect to certain invoices submitted during the period from September 1996 through July 1997, that may be perceived by the government as a technical violation of DOD billing procedures. The Company's internal review is ongoing, but based on its investigation to date, the Company believes that the DOD sustained no actual damages as a result of the matter disclosed by the Company. However, the Company expects to incur significant legal and other out-of-pocket costs in connection with presenting the results of its internal review and assisting the government in its investigation, adjudication and resolution of this matter. At December 31, 1998 the Company has established a reserve for estimated legal costs and other expenses, which it believes is adequate for the resolution of this matter. Except as noted above, no material actions are currently pending against the Company. The Company maintains general liability insurance and other insurance coverages which it believes to be adequate and typical in the industry. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of security holders of the Company during the fourth quarter of 1998. 5 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's Common Stock, par value $.01 per share, is traded on The NASDAQ Stock Market'sSM SmallCap Market (Symbol: DOCU), and on the Boston Stock Exchange (Symbol: DOC). In June 1998, the Company's stockholders approved a one-for-four reverse common stock split. All common stock and share information has been adjusted to reflect the reverse stock split. The following table sets forth for the fiscal periods indicated the high and low bid prices per share for the Company's Common Stock in the NASDAQ Stock Market's SmallCap Market, the principal market upon which the Company's Common Stock is traded, as reported to the Company in monthly reports from NASDAQ. REPORTED BID PRICE ------------------ HIGH LOW ------- ------- 1998 ------ First Quarter....................................... $4.00 $2.52 Second Quarter...................................... 3.00 1.13 Third Quarter....................................... 2.06 0.78 Fourth Quarter...................................... 1.31 0.78 1997 ------ First Quarter....................................... $5.36 $2.76 Second Quarter...................................... 4.12 2.52 Third Quarter....................................... 4.88 2.36 Fourth Quarter...................................... 5.24 3.36 The last reported sale price for the Common Stock on The NASDAQ Stock Market on March 19, 1999, was $0.81 per share. Bid and asked prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. There were approximately 228 holders of record of the Common Stock as of March 19, 1999, excluding those shares held by depository companies for certain beneficial owners. The Company has never paid cash dividends on its Common Stock and does not anticipate the payment of cash dividends in the foreseeable future. The Company currently anticipates that any future earnings will be retained to finance the Company's operations. Under the terms of the Company's Series A Convertible Preferred Stock, the Company cannot pay dividends on its Common Stock until all accumulated but unpaid dividends on such Preferred Stock have been paid. At December 31, 1998, cumulative undeclared dividends on the Series A Convertible Preferred Stock were approximately $159,000. 6 On March 10, 1999, the Company received notice that it was subject to delisting on the NASDAQ SmallCap Market System because the Company's average closing bid price per share had not exceeded $1.00 during the prior thirty-day period. The notice provides that the Company's shares are subject to delisting ninety days after receipt of the notice, unless the Company's Common Stock per share bid price is $1.00 or greater for ten consecutive trading days within the ninety day period. In addition, the Company may be subject to delisting due to a failure to meet the NASDAQ's minimum tangible net assets requirement for continued listing. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 1998 COMPARED TO 1997 The Company reported a net loss applicable to common stockholders of approximately $5,113,000 for 1998, as compared to net income applicable to common stockholders of $3,379,000 in 1997. Net income in 1997 included an approximate $4,472,000 gain recognized on the sale of the Company's JFS software division. Revenues were approximately $2,693,000 in 1998 as compared to approximately $6,664,000 in 1997. This decrease is primarily attributable to the loss of funding on a significant DOD project and the completion of several contracts that generated significant revenues in 1997 that were not replaced with a comparable volume of new contracts in 1998. Production costs decreased from approximately $4,636,000 in 1997 to approximately $2,626,000 in 1998. This decrease is primarily attributable to the corresponding reduction in revenues in 1998. Production costs as a percentage of revenues increased from 70% in 1997 to 98% in 1998. This increase is primarily attributable to the Company's decision to retain substantially all of its highly trained engineering and operations management personnel in anticipation of new contracts in 1999, despite the lower revenue volume in 1998. Research and development costs increased to approximately $280,000 in 1998 as compared to approximately $98,000 in 1997. This increase is primarily attributable to a substantial increase in the amount of software engineering devoted to development of the Company's proprietary document conversion processes and controls. General and administrative expenses increased from approximately $1,029,000 in 1997 to approximately $1,916,000 in 1998. This increase is primarily attributable to a charge of approximately $340,000 relating to the buyout of the employment agreement for the Company's former President and COO, costs relating to the transition to new management and the new corporate headquarters office opened in April 1998 and legal and other costs and an accrual relating to the Company's request for admission into the DOD Voluntary Disclosure Program (see Item 3 - "Legal Proceedings"). Marketing costs increased from approximately $633,000 in 1997 to approximately $1,040,000 in 1998. This increase is primarily a result of the development of government and commercial sales forces. 7 Allowance for unbilled receivables was $1,600,000 in 1998 as compared to zero in 1997. The allowance in 1998 relates to certain work performed primarily during 1997 under its contract with the DOD (see "Liquidity and Capital Resources" below). Depreciation and amortization expense decreased from approximately $412,000 in 1997 to approximately $348,000 in 1998. This decrease is primarily attributable to an increase in fully- depreciated assets and the Company's sale of its JFS software division in November 1997. 1997 COMPARED TO 1996 The Company reported net income applicable to common stockholders of approximately $3,379,000 in 1997, as compared to net income applicable to common stockholders of approximately $709,000 in 1996. The improvement in net income was primarily attributable to the approximately $4,472,000 gain recognized on the sale of the Company's JFS software division. Operating results from continuing operations applicable to common stock resulted in a loss for the year ended December 31, 1997, of approximately $324,000 as compared to net income of approximately $812,000 in 1996 due primarily to a decrease in revenues. Revenues from continuing operations were approximately $6,664,000 in 1997 as compared to approximately $10,427,000 in 1996. This decrease was primarily attributable to the discontinuation of funding for a specific project, which the Company had been performing under the DOD contract. Revenues from discontinued operations decreased by 25% to approximately $2,322,000 due to a shorter revenue period in 1997 as well as the receipt of two large nonrecurring orders in 1996. Production costs from continuing operations decreased from approximately $6,813,000 in 1996 to approximately $4,636,000 in 1997. This decrease is primarily attributable to the corresponding reduction in revenues in 1997. Research and development costs decreased from approximately $205,000 in 1996 to approximately $98,000 in 1997. This decrease was primarily the result of the Company employing much of its engineering resources to improving existing production lines, as opposed to research and development relating to new business development and technologies. General and administrative expenses decreased from approximately $1,139,000 in 1996 to approximately $1,029,000 in 1997. This decrease is primarily a result of the Company's decreased operations. Depreciation and amortization expense decreased from approximately $516,000 in 1996 to approximately $412,000 in 1997 primarily due to an increase in fully depreciated equipment. 8 LIQUIDITY AND CAPITAL RESOURCES Since its inception, the Company's operations have been supplemented through bank borrowings, capital contributions, borrowings from affiliated and unaffiliated lenders, an initial public offering of the Company's Common Stock in 1989, the conversion of warrants into Common Stock and private preferred stock placements. The Company has performed conversion services for the DOD through contracts from the Defense Automated Printing Services Office (DAPS). A 1991 award resulted in a contract totaling $16.8 million through April 1996. A 1996 award for $14.8 million was amended and extended by $5.6 million through April 1998. In 1998, approximately $1.4 million, or 51% of the Company's revenues were attributable to work performed under DOD contracts. During 1997, the Company generated approximately $5.8 million, or 87% of operating revenues through DOD contracts. In December 1997 the DOD awarded an additional, similar contract with a term of one year for approximately $15.5 million. The terms of the contract include four additional option years so that the entire contract has a potential value of approximately $77.4 million. As of March 1, 1999, the Company had provided approximately $1.2 million of services under this contract. At December 31, 1998 and 1997, the Company had approximately $0.2 million and $1.5 million, respectively, of unbilled revenues. Substantially all of these unbilled revenues were related to conversion services performed under a delivery order for a customer under the Company's contract with the DOD. The Company was informed in mid-1997 that funding for certain conversion services being performed under this delivery order had been depleted. Management completed work in production on this delivery order at that time. As a result of the loss of funding for this delivery order, the Company has been unable to invoice approximately $1.6 million of conversion services, the substantial majority of which were performed during 1997. A substantial portion of the conversion products associated with the $1.6 million of unbilled revenues has been shipped to the customer and is in various stages of quality control review. There can be no assurances that the customer will accept all of the work product nor are there any assurances that sufficient funding will be made available to enable the Company to invoice the unbilled revenues. Management of the Company, based upon its past operating history and its ongoing discussions with various government personnel regarding the availability of additional funding, believes that all of such unbilled revenues represent valid assets of the Company. However, due to the continued aging of the unbilled revenues, the Company believed it was prudent to provide an allowance on these unbilled revenues for the entire amount during the year ended December 31, 1998. In the event that the Company collects any of the unbilled revenues in the future, such collections would have a favorable impact on the Company's liquidity and capital resources and results of operations in the period of collection. There are no assurances that the Company will ultimately be able to collect any of the fully reserved unbilled revenues. In March 1998, the General Services Administration (GSA) awarded a Federal Supply Schedule to the Company, which is effective until September 30, 2002. Federal Supply Schedules are centralized contracts established by the GSA for the use of all government agencies. There are no limitations to order size or cumulative order value under such contracts. Under the Federal Supply Schedule awarded to Docucon, any government agency can buy a wide variety of document conversion services directly from Docucon. 9 In March 1994, the Company purchased the assets and assumed certain liabilities of J. Feuerstein Systems for approximately $0.2 million cash. In November 1997, the Company sold the assets of the division to Bowne & Co., Inc., for $6.5 million. A total of $800,000 was placed in an escrow account as security for certain representations and warranties made to the buyer. In accordance with the escrow agreement, approximately $400,000 of the total in escrow was released to the Company on November 25, 1998. The remaining approximately $400,000 is scheduled to be released to the Company on November 25, 1999. Management does not anticipate any material claims to be made against the representations and warranties and expects the funds will be released from escrow on or before November 25, 1999. Including the escrowed funds, net cash proceeds after expenses relating to the sale were approximately $5.7 million. Cash proceeds were used to pay down the Company's line of credit and to fund continuing operations. The Company invested excess proceeds in short-term securities. In October 1996, the Company obtained long-term financing to replace the then existing mortgage note for its office building. The new note bore interest at a fixed rate of 9.5%, payable monthly to a commercial bank, and was being amortized over a 20-year term with a 5-year maturity. The note was secured by the Company's building, other fixed assets, accounts receivable and inventory. Approximately $68,000 of debt issuance costs were incurred in connection with this refinancing. In January 1999, the Company sold its headquarters building. In connection with the sale, the Company paid off its secured indebtedness. The Company's proceeds from the sale, net of debt repayments, approximated $800,000. The gain on the sale of the building was not significant. Net cash and cash equivalents at December 31, 1998 were approximately $1.1 million. Trade accounts receivable, net of allowance for doubtful accounts were approximately $373,000 at December 31, 1998 and unbilled revenues, net of allowance were $194,000. In addition, other receivables included the approximately $400,000 escrow deposit that the Company expects to receive on or before November 25, 1999. Accounts payable and accrued liabilities were approximately $1.4 million at December 31, 1998. Net working capital was approximately $1.4 million at December 31, 1998. The accompanying financial statements of the Company have been prepared on the basis of accounting principles applicable to a going concern. Since its inception, the Company has incurred cumulative net losses of approximately $8.5 million, including a loss of approximately $5.1 million in 1998. For the year ended December 31, 1998, the Company had negative cash flows from operating activities of approximately $2.1 million. A significant portion of the Company's historical revenues has been earned from conversion services performed for agencies of the U.S. Government. The Company experienced significant declines in revenues from these agencies in 1998 and 1997. There can be no assurances that such revenues will be increased in the future. During the year ended December 31, 1997, the Company reported net income of approximately $3.4 million. The 1997 net income amount included a net gain on disposal of the discontinued software division of approximately $4.5 million, a loss from discontinued operations of approximately $0.8 million and a loss from continuing operations of approximately $0.3 million. These matters raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of these uncertainties. The ability of the Company to continue as a going concern is dependent upon the ongoing support of its customers, its ability to obtain capital resources to support operations and its ability to successfully market its services. If the Company is unable to generate positive cash flows from operations or obtain additional capital resources, or if the funds obtained in such efforts are not adequate to support the Company until a successful level of operations is attained, the Company would likely be unable to continue operating as a going concern. 10 The Company has taken steps to improve its operating results including selling its software division in 1997 and focusing on the Company's document conversion business. While the current year's operating loss is significant, management believes that it has taken proper steps to significantly improve the Company's future operating results. Such steps include the sale of its San Antonio office building and repayment of substantially all of the Company's long-term debt in January 1999 and the hiring of experienced management personnel in key senior management positions in late 1998 and early 1999. Expansion of the Company's marketing efforts has been made to include a wide range of vertical markets and formal and informal partnering relationships with systems integrators, file management software developers and others. The Company's management is also seeking suitable financing for working capital, business expansion and other general corporate purposes. The Company's management believes that the Company's results from operations for 1999 will improve and will generate sufficient working capital, along with available cash, to sustain its operations throughout the year. However, there can be no assurances that the Company's efforts in the above areas will improve its operating results. While the Company may consider and evaluate, from time to time, acquisitions and opportunities for future growth, the Company has not entered into any agreements with respect to future acquisitions. Should the Company enter into any such agreements, the Company would, in all likelihood, be required to raise additional outside capital to consummate such transactions. YEAR 2000 COMPLIANCE The efficient operation of the Company's business is dependent on its computer software programs and operating systems (collectively, "Programs and Systems"). These Programs and Systems are used in several key areas of the Company's business, including information management services and financial reporting, as well as in various administrative functions. The Company has been evaluating its Programs and Systems to identify potential year 2000 compliance problems, as well as manual processes, external interfaces with customers, and services supplied by vendors to coordinate year 2000 compliance and conversion. The year 2000 problem refers to the limitations of the programming code in certain existing software programs to recognize data sensitive information for the year 2000 and beyond. Unless modified prior to the year 2000, such systems may not properly recognize such information and could generate erroneous data or cause a system to fail to operate properly. Based on current information, the Company expects to attain year 2000 compliance and institute appropriate testing of its modifications and replacements in a timely fashion and in advance of the year 2000 date change. It is anticipated that modification or replacement of the Company's Programs and Systems will be performed in-house by company personnel. The Company believes that, with modifications to existing software and conversions to new software, the year 2000 problem will not pose a significant operational problem for the Company. However, because most computer systems are, by their very nature, interdependent, it is possible that non-compliant third party computers may not interface properly with the Company's computer systems. The Company could be adversely affected by the year 2000 problem if it or unrelated parties fail to successfully address this issue. Management of the Company currently anticipates that the expenses and capital expenditures associated with its year 2000 compliance project will not have a material effect on its financial position or results of operations. OUTLOOK During much of 1998 and continuing into the first part of 1999, the Company has made several changes in its senior management team and has been focused on initiating a strategy that it believes will more fully capitalize on the Company's core competencies in high volume, automated document conversion services. The Company hired a new President and CEO in April 1998, and added a new Senior Vice President and Chief Financial Officer and Vice President of Technology and Operations in December 1998 and January 1999, respectively. In addition, during 1998 the Company hired a Senior Vice President of 11 Sales and six full-time sales professionals to focus on new business development in both the federal government and commercial markets. With its existing contracts with the Department of Defense and the General Services Administration, the Company believes it is well positioned to service the federal government customers that have historically comprised a majority of the Company's revenues. In addition, the Company believes that its newly developed commercial sales force will significantly enhance its ability to penetrate non-federal government markets. 12 ITEM 7. FINANCIAL STATEMENTS. Financial statements of the Company meeting the requirements of Regulation S-B are filed on the succeeding pages of this Item 7 of this Annual Report on Form 10-KSB, as listed below: PAGE Report of Independent Public Accountants F-1 Balance Sheets as of December 31, 1998 and 1997 F-2 Statements of Operations for the Years Ended December 31, 1998 and 1997 F-4 Statements of Stockholders' Equity for the Years Ended December 31, 1998 and 1997 F-5 Statements of Cash Flows for the Years Ended December 31, 1998 and 1997 F-6 Notes to Financial Statements F-7 13 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Docucon, Incorporated: We have audited the accompanying balance sheets of Docucon, Incorporated, as of December 31, 1998 and 1997, and the related statements of operations, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Docucon, Incorporated, as of December 31, 1998 and 1997, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has experienced recurring operating losses, negative cash flows from operations in 1998, a significant revenue decline and has an accumulated deficit, all of which raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of these uncertainties. /S/ ARTHUR ANDERSEN LLP San Antonio, Texas February 3, 1999 F-1 DOCUCON, INCORPORATED BALANCE SHEETS
DECEMBER 31 ASSETS 1998 1997 ----------- ----------- CURRENT ASSETS: Cash and cash equivalents .............................. $ 1,082,321 $ 4,597,183 Accounts receivable, trade, net of allowance for doubtful accounts of $4,444 ............................................. 373,366 956,234 Unbilled revenues, net of allowance of $1,600,000 and $0 at December 31, 1998 and 1997, respectively ........... 193,722 1,472,075 Other receivables ...................................... 374,379 405,336 Prepaid expenses and other ............................. 123,921 77,044 Asset held for sale, net ............................... 1,668,467 -- ----------- ----------- Total current assets ................. 3,816,176 7,507,872 ----------- ----------- PROPERTY AND EQUIPMENT: Conversion systems ..................................... 4,858,930 4,589,473 Building and improvements .............................. 9,476 1,744,499 Land ................................................... -- 230,000 Furniture and fixtures ................................. 243,167 205,602 ----------- ----------- Total property and equipment ......... 5,111,573 6,769,574 Less- Accumulated depreciation and amortization ........ 4,704,152 4,680,368 ----------- ----------- Net property and equipment ........... 407,421 2,089,206 ----------- ----------- OTHER ASSETS, net ........................................ 48,896 472,490 ----------- ----------- Total assets ......................... $ 4,272,493 $10,069,568 =========== ===========
The accompanying notes are an integral part of these financial statements. F-2 DOCUCON, INCORPORATED BALANCE SHEETS
DECEMBER 31 LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997 ------------ ------------ CURRENT LIABILITIES: Accounts payable ...................................... $ 218,059 $ 482,076 Accrued liabilities ................................... 1,191,351 616,615 Taxes payable ......................................... -- 191,000 Revolving term note ................................... -- 504,000 Deferred revenues ..................................... 40,601 -- Other current liabilities ............................. 44,087 -- Current maturities of long-term debt .................. 927,502 30,722 Current maturities of capital lease obligations ....... 29,537 15,798 ------------ ------------ Total current liabilities ........... 2,451,137 1,840,211 ------------ ------------ LONG-TERM DEBT .......................................... -- 1,485,079 ------------ ------------ CAPITAL LEASE OBLIGATIONS ............................... 76,141 49,547 ------------ ------------ OTHER LONG-TERM OBLIGATIONS ............................. 269,476 -- ------------ ------------ COMMITMENTS AND CONTINGENCIES (Note 5) STOCKHOLDERS' EQUITY: Preferred stock, $1.00 par value, 10,000,000 shares authorized- Series A, 60 shares authorized, 7 and 12 shares issued and outstanding as of December 31, 1998 and 1997, respectively ....................................... 7 12 Common stock, $.01 par value, 25,000,000 shares authorized; 3,306,216 and 3,260,889 shares outstanding as of December 31, 1998 and 1997, respectively ......................................... 33,062 32,609 Additional paid-in capital ............................ 10,027,337 10,069,173 Accumulated deficit ................................... (8,581,573) (3,407,063) Treasury stock, at cost, 2,917 shares and 0 shares as of December 31, 1998 and 1997, respectively .......... (3,094) -- ------------ ------------ Total stockholders' equity .......... 1,475,739 6,694,731 ------------ ------------ Total liabilities and stockholders' equity .................................................. $ 4,272,493 $ 10,069,568 ============ ============
The accompanying notes are an integral part of these financial statements. F-3 DOCUCON, INCORPORATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31 ----------------------------------- 1998 1997 ----------- ----------- OPERATING REVENUES ........................................ $ 2,693,497 $ 6,664,325 ----------- ----------- COSTS AND EXPENSES: Production .............................................. 2,626,315 4,636,087 Research and development ................................ 280,088 97,710 General and administrative .............................. 1,916,489 1,029,073 Allowance for unbilled revenues ......................... 1,600,000 -- Marketing ............................................... 1,039,768 632,632 Depreciation and amortization ........................... 347,556 412,193 ----------- ----------- 7,810,216 6,807,695 ------------ ----------- OPERATING LOSS FROM CONTINUING OPERATIONS ................. (5,116,719) (143,370) OTHER INCOME (EXPENSE): Interest expense ........................................ (193,892) 207,805 Interest income ......................................... 200,037 73,736 ----------- ----------- LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ....... (5,110,574) (277,439) Income tax benefit ........................................ 24,880 -- ----------- ----------- NET LOSS FROM CONTINUING OPERATIONS ....................... (5,085,694) (277,439) Preferred stock dividend requirements ..................... (27,462) (46,420) ----------- ----------- NET LOSS FROM CONTINUING OPERATIONS APPLICABLE TO COMMON STOCKHOLDERS .................................. (5,113,156) (323,859) ----------- ----------- Loss from discontinued operations ......................... -- (769,721) Gain on disposal of discontinued software division, net of income tax expense of $191,000 ......... -- 4,472,409 ----------- ----------- NET INCOME (LOSS) APPLICABLE TO COMMON STOCKHOLDERS ....... $(5,113,156) $ 3,378,829 =========== =========== Basic and diluted loss from continuing operations per common share and common share equivalents ............... $ (1.55) $ (.10) Basic and diluted earnings from discontinued operations per common share and common share equivalents ............... -- 1.18 BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE ........ $ (1.55) $ 1.08 =========== =========== WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING ...... 3,300,056 3,130,371 =========== ===========
The accompanying notes are an integral part of these financial statements. F-4 DOCUCON, INCORPORATED STATEMENTS OF STOCKHOLDERS' EQUITY
PREFERRED STOCK COMMON STOCK ---------------------------- ---------------------------- ADDITIONAL NUMBER NUMBER OF PAID-IN OF SHARES AMOUNT SHARES AMOUNT CAPITAL ------------ ------------ ------------ ------------ ------------ BALANCE, December 31, 1996 ............. 19 $ 19 3,008,139 $ 30,081 $ 9,730,281 Stock option exercises ............... -- -- 85,667 857 202,407 Shares issued pursuant to employee stock plans ............................ -- -- 71,513 715 90,434 Conversion of Series A preferred stock (7) (7) 58,333 583 (576) Shares issued to pay preferred stock dividends .............................. -- -- 37,237 373 (373) Compensation expense ................. -- -- -- -- 47,000 Net income ........................... -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ BALANCE, December 31, 1997 ............. 12 12 3,260,889 32,609 10,069,173 Stock option exercises ............... -- -- 2,500 25 5,475 Shares issued pursuant to employee stock plans ............................ -- -- 26,809 268 (268) Shares issued to pay preferred stock dividends .............................. -- -- 10,318 103 (103) Purchase of treasury stock ........... -- -- (36,250) (362) -- Conversion of Series A preferred stock (5) (5) 41,950 419 (46,940) Accrued dividends on preferred stock . -- -- -- -- -- Net loss ............................. -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ BALANCE, December 31, 1998 ............. 7 $ 7 3,306,216 $ 33,062 $ 10,027,337 ============ ============ ============ ============ ============ TOTAL ACCUMULATED TREASURY STOCKHOLDERS' DEFICIT STOCK EQUITY ------------ ------------ ------------ BALANCE, December 31, 1996 ............. $ (6,832,312) $ -- $ 2,928,069 Stock option exercises ............... -- -- 203,264 Shares issued pursuant to employee stock plans ............................ -- -- 91,149 Conversion of Series A preferred stock -- -- -- Shares issued to pay preferred stock dividends .............................. -- -- -- Compensation expense ................. -- -- 47,000 Net income ........................... 3,425,249 -- 3,425,249 ------------ ------------ ------------ BALANCE, December 31, 1997 ............. (3,407,063) -- 6,694,731 Stock option exercises ............... -- -- 5,500 Shares issued pursuant to employee stock plans ............................ -- -- -- Shares issued to pay preferred stock dividends .............................. -- -- -- Purchase of treasury stock ........... -- (49,620) (49,982) Conversion of Series A preferred stock -- 46,526 -- Accrued dividends on preferred stock . (88,816) -- (88,816) Net loss ............................. (5,085,694) -- (5,085,694) ------------ ------------ ------------ BALANCE, December 31, 1998 ............. $ (8,581,573) $ (3,094) $ 1,475,739 ============ ============ ============
The accompanying notes are an integral part of these financial statements. F-5 DOCUCON, INCORPORATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 ----------------------------------- 1998 1997 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss from continuing operations ................... $(5,085,694) $ (277,439) Adjustments to reconcile net loss to net cash (used in) provided by operating activities- Depreciation and amortization ...................... 347,556 412,193 Allowance for unbilled revenues .................... 1,600,000 -- Noncash compensation accrual ....................... 313,563 -- Changes in current assets and current liabilities- Decrease in net receivables and unbilled revenues . 688,057 1,246,834 (Increase) decrease in prepaid expenses and other . (25,351) 92,751 Increase (decrease) in accounts payable and accrued liabilities ..................................... 221,904 (1,359,040) Increase (decrease) in taxes payable .............. (191,000) 149,761 Increase (decrease) in deferred revenues .......... 40,601 (20,300) ----------- ----------- Net cash (used in) provided by operating activities .............................................. (2,090,364) 244,760 ----------- ----------- NET CASH PROVIDED BY DISCONTINUED OPERATIONS ............ -- 4,369,828 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures .................................. (270,951) (220,146) ----------- ----------- Net cash used in investing activities ....... (270,951) (220,146) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Advances under revolving term note .................... -- 3,395,500 Payments on revolving term note ....................... (504,000) (3,641,500) Principal payments on long-term debt .................. (588,299) (29,898) Principal payments under capital lease obligations .... (16,766) (13,926) Proceeds from employee stock purchase plan ............ -- 91,149 Proceeds from exercise of stock options ............... 5,500 203,264 Purchase of treasury stock ............................ (49,982) -- ----------- ----------- Net cash (used in) provided by financing activities .............................................. (1,153,547) 4,589 ----------- ----------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS .... (3,514,862) 4,399,031 ----------- CASH AND CASH EQUIVALENTS, beginning of year ............ 4,597,183 198,152 ----------- ----------- CASH AND CASH EQUIVALENTS, end of year .................. $ 1,082,321 $ 4,597,183 =========== ===========
The accompanying notes are an integral part of these financial statements. F-6 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION, DESCRIPTION OF THE COMPANY, FUTURE OPERATIONS, LIQUIDITY AND CAPITAL RESOURCES: Docucon, Incorporated (the Company), a Delaware corporation, was incorporated in June 1986. The Company's primary business is the conversion of paper and microform documents to a computer accessible medium for commercial and government customers. Paper or microform documents are scanned by sophisticated computer equipment and stored and indexed on optical disks or magnetic media. Substantially all of the Company's customers are located in the U.S. In March 1994, the Company acquired substantially all of the assets and assumed certain liabilities of J. Feuerstein Systems, Inc. (JFS), a company which provided software products to the legal market. In November 1997, the Company sold this division as disclosed in Note 12. The accompanying financial statements of the Company have been prepared on the basis of accounting principles applicable to a going concern. Since its inception, the Company has incurred cumulative net losses of approximately $8.5 million, including a loss of approximately $5.1 million during 1998. For the year ended December 31, 1998, the Company had negative cash flows from operating activities of approximately $2.1 million. As discussed in Notes 3 and 7, a significant portion of the Company's historical revenues has been earned from conversion services performed for agencies of the U.S. Government. The Company experienced significant declines in revenues from these agencies in 1997 and 1998 and, during 1998, provided an allowance of $1.6 million on certain unbilled revenues. There can be no assurances that the Company will be able to maintain or increase the level of services that it has historically provided to various governmental agencies. During the year ended December 31, 1997, the Company reported net income of approximately $3.4 million. The 1997 net income amount included a net gain on disposal of the discontinued software division of approximately $4.5 million, a loss from discontinued operations of approximately $.8 million and a loss from continuing operations of $.3 million. These matters raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of these uncertainties. The ability of the Company to continue as a going concern is dependent upon the ongoing support of its customers, its ability to obtain capital resources to support operations and its ability to successfully market its services. If the Company is unable to generate positive cash flows from operations or obtain additional capital resources, or if the funds obtained in such efforts are not adequate to support the Company until a successful level of operations is attained, the Company would likely be unable to continue operating as a going concern. The Company has taken steps to improve its operating results including selling its software division in 1997 and focusing on the Company's document conversion business. While the current year's operating loss is significant, management believes that it has taken proper steps to significantly improve the Company's future operating results. Such steps include the sale of its San Antonio office building and repayment of substantially all of the Company's long-term debt in January 1999 and the hiring of experienced management personnel in key senior management positions in late 1998 and early 1999. Expansion of the Company's F-7 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) marketing efforts has been made to include a wide range of vertical markets and formal and informal partnering relationships with systems integrators, file management software developers and others. The Company's management is also seeking suitable financing for working capital, business expansion and other general corporate purposes. The Company's management believes that the Company's results from operations for 1999 will improve and will generate sufficient working capital, along with available cash, to sustain its operations throughout the year. However, there can be no assurances that the Company's efforts in the above areas will improve its operating results. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: PROPERTY AND EQUIPMENT Property and equipment are recorded at original cost. Maintenance and repairs are charged to expense as incurred and betterments which increase the value or extend the useful life of the property are capitalized. Gains or losses on sales or other dispositions of property and equipment are credited or charged to income. Depreciation is provided using the straight-line method over the lesser of the capital lease term or estimated useful lives of the related assets. The Company's conversion system and furniture and fixtures are currently depreciated over periods ranging from two to five years beginning in the month the property is placed in service. The Company's building was being depreciated over 40 years. In January 1999, the Company sold its building as described in Note 13. COMMON STOCK AND PREFERRED STOCK Each share of the Company's preferred stock ($25,000 stated value) is convertible into 8,333 shares of common stock and earns cash dividends of 11 percent per annum. Each share of preferred stock is entitled to vote 8,333 common shares. The Company has never paid cash dividends on its common stock and does not anticipate the payment of cash dividends on its common stock in the foreseeable future. The Company currently anticipates that any future earnings will be retained to finance the Company's operations. Under the terms of the Company's preferred stock, the Company cannot pay dividends on its common stock until all accumulated but unpaid dividends on such preferred stock have been paid. As of December 31, 1998, cumulative undeclared dividends on the preferred stock approximated $159,000. Subsequent to December 31, 1998, the Company paid cash of $88,816 related to cumulative dividends on preferred stock that was converted during the fourth quarter of 1998. This is reflected as a component of accrued liabilities on the accompanying balance sheet at December 31, 1998. As the remainder of these dividends are undeclared, they have not been recorded as a reduction of the Company's equity. Common stock is subordinate to preferred stock in the event of liquidation. TREASURY STOCK On June 18, 1998, the Company announced the board of directors authorized the repurchase of up to 500,000 shares of the Company's common stock in the open market. From June 19, 1998, through December 31, 1998, the Company acquired 36,250 treasury shares for approximately $49,982. Approximately 33,333 of such shares were reissued in connection with the conversion of Series A preferred stock. F-8 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) REVERSE STOCK SPLIT In June 1998, the Company's stockholders approved a one-for-four reverse common stock split. Accordingly, all common stock and share information has been adjusted to reflect the reverse stock split. REVENUE RECOGNITION Revenues from conversion service contracts are recognized at the time services are provided and are based upon the number of documents converted and the conversion rates established in the contracts. The Company maintains an estimated reserve for returns and reconversions based upon an historical analysis. Such amounts have not been significant. Statements of Cash Flows- SUPPLEMENTAL DISCLOSURES The Company considers funds invested in highly liquid investments having original maturities of 90 days or less to be cash equivalents. The following relates to cash interest and income taxes paid by the Company for the periods indicated: YEAR ENDED DECEMBER 31 ------------------- 1998 1997 -------- -------- Cash paid during the year for interest ... $168,892 $220,599 ======== ======== Cash paid during the year for income taxes $157,622 $ 62,478 ======== ======== During the years ended December 31, 1998 and 1997, the Company had noncash investing and financing activities consisting of new capital lease obligations entered into of $57,099 and $16,240, respectively. POST RETIREMENT AND POST EMPLOYMENT BENEFITS The Company does not provide post retirement or post employment benefits to its employees. SELF-INSURANCE RISK The Company self insures under its medical coverage for employees and dependents based upon monthly attachment limits which are calculated based upon the number of participants and monthly participant charges. The Company accrues for known claims and an estimate of claims incurred but not reported up to the maximum anticipated costs to the Company. The Company believes that such accruals are adequate. During 1998 and 1997, the Company recognized approximately $180,000 and $400,000, respectively, in self-insurance expense under the attachment limits. The Company's insurer will pay cumulative claims above the attachment limit up to $1 million lifetime per covered individual. The Company does not believe that claims reported and claims incurred but not reported will exceed the amounts to be covered by the insurer. F-9 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NEW ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." SFAS No. 128 replaced the presentation of Primary Earnings Per Share (EPS) with Basic EPS and requires dual presentation of Basic and Diluted EPS on the face of the statements of operations. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. As the Company had a net loss from continuing operations for the years ended December 31, 1998 and 1997, Diluted EPS equals Basic EPS as potentially dilutive common stock equivalents are antidilutive in loss periods. The average market price per share of the Company's common stock for the years ended December 31, 1998 and 1997, was $2.01 and $3.66, respectively. Note 9 provides a detail of options and warrants outstanding and their corresponding exercise prices. If the Company would have had income from continuing operations for the years ended December 31, 1998 and 1997, the denominator (weighted average number of common shares and common share equivalents outstanding) in the Diluted EPS calculation would have been increased, through application of the treasury stock method, for each class of option or warrant for which the average market price per share of the Company's common stock exceeded the common stock equivalent's exercise price. The following shows the weighted average number of common shares outstanding used to compute Basic and Diluted EPS: YEAR ENDED DECEMBER 31 --------------------- 1998 1997 --------- --------- Weighted average number of common shares outstanding for Basic and Diluted EPS...... 3,300,056 3,130,371 ========= ========= RECLASSIFICATIONS Certain reclassifications have been made to prior period amounts to conform to the 1998 presentation. 3. UNBILLED REVENUES: The majority of the Company's unbilled revenues at December 31, 1998 and 1997, relate to conversion services performed for agencies of the U.S. Government. The Company's ability to invoice these unbilled revenues is dependent upon a number of factors including quality control acceptance and the availability of funding to the respective agencies. The Company was informed by a U.S. Government customer in mid-1997 that funding for certain conversion services being performed had been depleted. Management completed F-10 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) work that had been placed in production at that time. As a result, the Company has been unable to invoice approximately $1.6 million of conversion services that were performed prior to 1998. A significant portion of the conversion products associated with the $1.6 million of unbilled revenues have been shipped to the customer and are in various stages of quality control review. There can be no assurances that the customer will accept all of the work product nor are there any assurances that sufficient funding will be made available to enable the Company to invoice the unbilled revenues. Management of the Company, based upon its past operating history and its ongoing discussions with various government personnel regarding the availability of additional funding, believes that all of such unbilled revenues totaling approximately $1.6 million represent valid assets of the Company. However, due to the continued aging of the unbilled revenues, the Company believed it was prudent to provide an allowance on these unbilled revenues for the entire amount during the year ended December 31, 1998. In the event that the Company collects any of the unbilled revenues in the future, such collections would have a favorable impact on the Company's results of operations in the period of collection. There are no assurances that the Company will ultimately be able to collect any of the fully reserved unbilled revenues. 4. REVOLVING TERM NOTE: In connection with the refinancing of the note payable discussed in Note 6, the Company also obtained a $750,000 revolving term note (the Revolver) which was originally scheduled to mature on October 31, 1997. During 1997, the maturity date was extended to May 31, 1998. At December 31, 1997, $504,000 was outstanding under the Revolver. The Revolver bore interest at the bank's Base Rate (as defined) plus .75 percent (9.25 percent at December 31, 1997). Interest was payable monthly and the Revolver was secured by the same collateral as the note payable. During 1998, the Company repaid the entire balance outstanding under the Revolver and voluntarily terminated the Revolver. 5. COMMITMENTS AND CONTINGENCIES: Certain office equipment and office space is leased under various noncancelable operating leases with lease terms ranging from one to five years. Rent expense under all cancelable and noncancelable operating leases was approximately $59,000 and $175,000 for the years ended December 31, 1998 and 1997, respectively. Future minimum lease payments for all noncancelable operating leases, including the $27,000 monthly operating leaseback described in Note 13, net of noncancelable subleases, as of December 31, 1998, are as follows: Year ending December 31- 1999 $299,534 2000 38,987 2001 2,093 2002 2,093 2003 1,570 -------- Total future minimum lease payments $344,277 ======== In April 1998, the Company appointed a new president and chief executive officer. The Company and the employee have entered into a seven-year employment agreement providing for base compensation of $200,000 per year. The employment agreement is terminable by either party with 30 days' notice. In the event the employee were to be terminated by the Company without cause, the Company would be required to make a severance payment of $300,000. In December 1998, the Company appointed a new senior vice president and chief financial officer. The Company and the employee have entered into a three-year employment agreement providing for base compensation of $140,000 per year. The employment agreement is terminable by either party with 30 days' notice. In the event the employee were to be terminated by the Company without cause, the employee's compensation would continue to be paid for a period of one year from the effective date of termination. In January 1999, the Company appointed a new vice president, operations and technology. The Company have entered into a three-year employment agreement providing for base compensation of $130,000 per year. The employment agreement is terminable by either party with 30 days' notice. In the event the employee were to be terminated by the Company without cause, the employee's compensation would continue to be paid for a period of one year from the effective date of termination. F-11 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) In September 1998, the Company granted early retirement to a member of senior management and terminated the related employment agreement. The employee will be retained as a consultant to the Company for a period of two years following his September 1998 retirement at the rate of $2,500 per month. For the same two-year period during the employee's consultancy, he will receive retirement pay at the rate of $5,500 per month. For a 10-year period following the employee's consultancy, he will receive retirement pay at the rate of $2,500 per month. The consulting payments will be expensed as the services are provided. The present value of the post-retirement payments, discounted at 5 percent, resulted in noncash compensation expense of $341,333 during the year ended December 31, 1998. The present value of the post-retirement obligation is recorded as other long-term obligations on the accompanying balance sheet, with the current portion of $44,087 included as other current liabilities. On February 2, 1999, the Company contacted the Department of Defense's Voluntary Disclosure Program Office to request admission into its Voluntary Disclosure Program. The Voluntary Disclosure Program is intended to encourage government contractors to voluntarily disclose potential violations of government contracting policies and procedures. In general, companies who volunteer information and cooperate with the government's investigation are not subject to criminal and administrative sanctions such as suspension and debarment from government contracting activities. Admission into the Voluntary Disclosure Program does not protect companies from any potential civil liability the government may assert. The Department of Defense is currently performing its initial review of the Company's request to determine if the Company satisfies the requirements for inclusion into the Voluntary Disclosure Program. The Company has no reason to believe that it will not be accepted into the Program. The Company's request for admission into the Voluntary Disclosure Program was the result of an internal review by the Company that brought to light a billing practice, with respect to certain invoices submitted during the period from September 1996 through July 1997, that may be perceived by the government as a technical violation of DOD billing procedures. The Company's internal review is ongoing, but based on its investigation to date, the Company believes that the DOD sustained no actual damages as a result of the matter disclosed by the Company. However, the Company expects to incur significant legal and other out-of-pocket costs in connection with presenting the results of its internal review and assisting the government in its investigation, adjudication and resolution of this matter. At December 31, 1998, the Company has established a reserve for estimated legal costs and other expenses which it believes is adequate for the resolution of this matter. 6. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS: In connection with the purchase of its headquarters building, the Company issued a four-year, 8 percent, $1.5 million promissory note originally due in December 1996. Additionally, the Company issued 225,000 warrants, which expire in December 1999, to purchase an equivalent number of shares of common stock at an exercise price of $8.00 per share. In October 1996, the Company refinanced the $1.5 million note. The new note was payable to a commercial bank, bore interest at a fixed rate of 9.5 percent per annum and required monthly principal and interest payments of $14,448 with the remaining balance maturing in October 2001. The note payable was secured by the Company's building, other fixed assets, accounts receivable and inventory. Debt issuance costs of approximately $68,000 incurred in October 1996 related to this refinancing were capitalized and were being amortized over the five-year term. Subsequent to December 31, 1998, this note was paid in its entirety with proceeds from the sale of the building as discussed below. F-12 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) During 1998, the Company decided to sell its headquarters building. In November 1998, the Company entered into a contract to sell the building for an amount in excess of its net book value. Accordingly, the carrying value of the land, building and associated improvements have been classified as a current asset held for sale at December 31, 1998. In January 1999, the Company sold its headquarters building and paid off the related secured indebtedness. See Note 13 for additional information related to this sale. Equipment held under capital leases and related obligations at December 31, 1998, are as follows: Office equipment requiring monthly principal and interest payments of $2,310, interest at 9.5 percent to 14.56 percent and maturing April 2001 to October 2003 ........................................................... $ 94,710 Telecommunications equipment requiring monthly principal and interest payments of $977, interest at 9.3 percent and maturing July 2001 ......................................... 30,292 -------- Total capital lease payments ..................................... 125,002 Less- Amounts representing interest .............................. 19,324 -------- Capital lease obligations ........................................ $105,678 ======== Maturities of capital lease obligations as of December 31, 1998, are as follows: Year ending December 31- 1999 $29,537 2000 32,834 2001 27,674 2002 8,530 2003 7,103 ------- Total $105,678 ======= 7. MAJOR CUSTOMER: The Company has historically earned a significant portion of its total revenues from conversion services performed for the Department of Defense (DOD). The Company had revenues of approximately $2.1 million and $5.8 million during the years ended December 31, 1998 and 1997, respectively, from services provided to the DOD. The Company had trade receivables of approximately $.3 million and $.6 million from DOD at December 31, 1998 and 1997, respectively. 8. PREFERRED STOCK: In 1990, the Company issued 46 shares of 11 percent Series A preferred stock at $25,000 per share. Each share of preferred stock is convertible into 8,333 shares of common stock. Through December 31, 1998, 39 shares of preferred stock have been converted. Additionally, 92,154 shares of common stock have been issued in lieu of accumulated dividends on the preferred stock which was converted. As of December 31, 1998, cumulative undeclared dividends on the outstanding preferred stock approximated $159,000. F-13 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) 9. STOCK OPTIONS: The Company adopted the 1988 Stock Option Plan (the 1988 Plan) which allows for the granting of stock options at the current market value of the common stock at the date of the grant to key employees. In August 1997, the Company's shareholders authorized a 75,000 share increase in the number of shares of common stock reserved for issuance pursuant to the 1988 Plan. As a result, an aggregate of 415,000 shares of common stock has been reserved for issuance pursuant to the 1988 Plan. The 1988 Plan terminated on October 31, 1998. The 1991 Director Non-Statutory Stock Option Plan (the Director Plan) provides for the granting of options at the common stock's current market value to members of the board of directors of the Company who are not employees of the Company. In June 1998, the Company's shareholders authorized an 85,000 share increase in the number of shares of common stock reserved for issuance under the Director Plan. As a result, the Director Plan authorizes the granting of options to purchase up to 210,000 shares of the Company's common stock. The stock options granted under the 1988 Plan and the Director Plan are exercisable pursuant to the individual agreements between the Company and the grantee and range from a six-month to a three-year vesting period. All options granted under these plans must be exercised within 10 years from the date of grant and expire within three months after termination of employment or service as a director. On April 1, 1998, the Company approved the 1998 Employee Stock Option Plan (the 1998 Employee Plan), covering 187,500 shares of common stock. Unless terminated earlier by the board of directors, the 1998 Plan will terminate on March 31, 2008. The purpose of the plan is to supplement and replace the Company's 1988 Stock Option Plan (the 1988 Plan) which terminated on October 31, 1998. The 1998 Employee Plan provides for the grant to key employees of the Company of incentive stock options (ISOs) intended to qualify under Section 422(b) of the Internal Revenue Code and nonqualified stock options (NQSO). Under the 1998 Employee Plan, which is administered by the Stock Option Committee of the board of directors, key employees may be granted options to purchase shares of the Company's common stock at 100 percent of fair market value on the date of grant (or 110 percent of fair market value in the case of an ISO granted to a 10 percent stockholder/grantee). The 1998 Employee Plan expires on March 31, 2008. Options granted under the 1998 Employee Plan must be exercised within 10 years from the date of grant, vest at varying times, as determined by the Stock Option Committee, are nontransferable except by will or pursuant to the laws of descent and distribution and expire within three months after termination of employment, unless such termination is by reason of death or disability or for cause. All shares purchased upon exercise of any option must be paid in full at the time of purchase, in accordance with the terms set forth on the option. Such payment must be made in cash or through delivery of shares of common stock or a combination of cash and common stock, all as determined by the Stock Option Committee. The Stock Option Committee may determine other terms applicable to particular options. The aggregate fair market value (determined at the time each ISO is granted) of the shares of common stock with respect to which ISOs issued to any one person under the 1998 Employee Plan are exercisable for the first time during any calendar year may not exceed $100,000. F-14 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) The 1998 Employee Plan may be amended at any time by a vote of the board of directors. However, no amendment made without approval of the stockholders of the Company may increase the total number of shares which may be issued under options granted pursuant to the 1998 Employee Plan, reduce the maximum exercise price or extend the latest date upon which options may be granted or change the class of employees eligible to receive the options. In 1998, the Company approved the 1998 Executive Non-Statutory Plan (the 1998 NQSO Plan), covering 375,000 shares of common stock. Unless terminated earlier by the board of directors, the 1998 NQSO Plan will terminate on March 31, 2008. The 1998 NQSO Plan provides for the grant to executives of the Company nonqualified stock options (NQSO) through the added incentive of performance-based compensation and stock ownership. The purpose of the plan is to stimulate the efforts of executive management to increase shareholder wealth by the performance of specific goals designed to increase shareholder wealth in the form of an increased market price of the Company's stock. Under the 1998 NQSO Plan, identified executives may be granted long-term options to purchase shares of the Company's common stock at a price specified on the date of the grant subject to certain acceleration rights upon attainment of specific goals. The 1998 NQSO Plan is administered by the Stock Option Committee. The 1988 NQSO Plan expires on March 31, 2008. Options granted under the 1998 NQSO Plan will expire 10 years from the date of grant, vest at varying times, as determined by the NQSO Committee, are nontransferable except by will or pursuant to the laws of descent and distribution. All shares purchased upon exercise of any option must be paid in full at the time of purchase, in accordance with the terms set forth on the option. Such payment must be made in cash or through delivery of shares of common stock or a combination of cash and common stock, all as determined by the NQSO Committee. The NQSO Committee may determine other terms applicable to particular options. The 1998 NQSO Plan may be amended at any time by a vote of the board of directors. In April 1998, the Company's board of directors granted options to certain members of the Company's senior management to purchase 125,000 shares of the Company's common stock at an exercise price of $4 per share under the 1998 NQSO Plan. Additionally, in April 1998, the Company appointed a new president and chief executive officer. The Company's board of directors granted this employee options to purchase 225,000 shares of the Company's common stock at an exercise price of $4 per share under a time accelerated restricted stock award. In December 1998, the exercise price on these options was reset to $1 per share. The time accelerated restricted stock award options become exercisable in March 2005. Exercisability of the time accelerated restricted stock award options is accelerated, in 20,000 share increments, for each $2 per share incremental increase in the quoted market price per share of the Company's common stock above $4 per share. F-15 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) A summary of activity in the Company's stock option plans is set forth below:
WEIGHTED AVERAGE EXERCISE MARKET PRICE PRICE OPTION PRICE AT DATE OF GRANT SHARES PER SHARE PER SHARE TOTAL PER SHARE TOTAL ----------- ------------- ------------- ----------- ------------- ----------- Outstanding, December 31, 1996 366,188 $ 2.52 $1.64 - $4.88 $ 916,447 $1.64 - $9.76 $ 1,429,553 =========== =========== =========== Exercisable, December 31, 1996 296,068 2.36 1.64 - 4.88 702,410 1.64 - 9.76 1,187,191 =========== =========== =========== Granted ............ 73,363 3.13 2.64 - 5.52 229,341 2.64 - 5.52 229,341 Exercised .......... (85,667) 2.43 2.12 - 4.12 (208,264) 2.24 - 5.76 (289,954) Terminated ......... (80,106) 2.93 1.64 - 5.52 (234,953) 1.64 - 5.52 (269,437) ----------- ----------- ----------- Outstanding, December 31, 1997 273,778 2.57 2.12 - 5.52 $ 702,571 1.64 - 9.76 $ 1,099,503 =========== =========== =========== Exercisable, December 31, 1997 230,157 2.46 2.12 - 5.52 $ 565,547 1.64 - 9.76 $ 933,045 =========== =========== =========== Granted ............ 875,501 2.45 .88 - 4.12 2,147,024 .88 - 4.00 1,697,102 Exercised .......... (2,500) 2.24 2.24 - 2.24 (5,600) 2.24 - 2.24 (5,600) Terminated ......... (329,638) 3.80 2.12 - 4.88 (1,252,540) 2.12 - 4.88 (1,609,052) ----------- ----------- ----------- Outstanding, December 31, 1998 817,141 1.95 .88 - 5.52 $ 1,591,455 .88 - 9.76 $ 1,181,953 =========== =========== =========== Exercisable, December 31, 1998 238,213 2.49 2.00 - 5.52 $ 593,150 1.64 - 9.76 $ 977,481 =========== =========== ===========
The weighted average remaining contractual life of options outstanding at December 31, 1998, is approximately seven years. In October 1995, SFAS No. 123, "Accounting for Stock-Based Compensation," was issued. SFAS No. 123 defines a fair value based method of accounting for employee stock options or similar equity instruments and encourages all entities to adopt that method of accounting for all of their employee stock compensation plans. Under the fair value based method, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period of the award, which is usually the vesting period. However, SFAS No. 123 also allows entities to continue to measure compensation costs for employee stock compensation plans using the intrinsic value method of accounting F-16 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). Entities electing to remain with the accounting prescribed by APB 25, as the Company has, must make pro forma disclosures of net income (loss) and earnings (loss) per share as if the fair value based method recommended by SFAS No. 123 had been applied. The following provides pro forma disclosures of net income (loss) and earnings (loss) per share as if the fair value based method of accounting under SFAS No. 123 had been applied. Had compensation cost for these plans been determined consistent with SFAS No. 123, the Company's net income (loss) applicable to common stockholders and basic and diluted earnings (loss) per share would have been changed to the following pro forma amounts: 1998 1997 ------------- ------------- Net Income (Loss) Applicable to Common Stockholders ............ As Reported $ (5,113,156) $ 3,378,829 Pro Forma $ (5,389,493) $ 3,262,818 Basic and Diluted Earnings (Loss) Per Share ........ As Reported $ (1.55) $ 1.08 Pro Forma $ (1.63) $ 1.04 Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. The weighted average fair values per share of options granted during 1998 and 1997 were $1.51 and $2.40, respectively. 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 in 1998 and 1997, respectively: risk-free interest rates of 6.0 percent and 6.0 percent, expected dividend yields of 0 percent and 0 percent, expected lives of 5 years and 5 years and expected volatility of 110 percent and 125 percent. Included as a component of pro forma expense for 1998 and 1997 is compensation expense of approximately $3,318 and $17,000, respectively, related to the 1993 Employee Stock Purchase Plan described in Note 10. In addition to the above stock option agreements, the Company has warrants outstanding with certain lenders and other parties. As of December 31, 1998, the total number of shares issuable under these warrants was 240,000. Warrants to purchase 225,000 shares of common stock at $8.00 per share expire in December 1999 and warrants to purchase 15,000 shares of common stock at $5.00 per share expire in June 2001. 10. EMPLOYEE BENEFIT PLANS: Effective January 1, 1994, the Company adopted the 1993 Employee Stock Purchase Plan (the Stock Purchase Plan). Under the Stock Purchase Plan, eligible employees may elect to have up to 10 percent of their base pay (as defined) deducted and utilized to purchase common stock of the Company in annual or semiannual offerings. In August 1997 and June 1998, the Company's shareholders authorized an increase in the number of shares of common stock reserved for issuance pursuant to the Stock Purchase Plan by 50,000 shares and 100,000 shares, respectively. The Company has reserved 350,000 shares of common stock for issuance F-17 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) pursuant to the Stock Purchase Plan. In January 1999 and 1998, the Company issued 24,398 and 26,809 shares of common stock at purchase prices of $.77 and $3.40 per share, respectively. The annual purchase price is 85 percent of the lesser of the closing price of the Company's common stock at the beginning or end of each calendar year. The purchase prices represent 85 percent of the closing price on December 31, 1998, and December 30, 1997, respectively. The Stock Purchase Plan is administered by the Compensation Committee of the board of directors. In June 1998, the Company's shareholders amended the Stock Purchase Plan's termination date from December 31, 1998, to December 31, 2001. At December 31, 1998, 184,390 shares remain available for issuance. The Company also maintains a qualified employee benefit plan under Section 401(k) of the Internal Revenue Code. Under this plan, employees meeting certain eligibility requirements may contribute up to 15 percent of their eligible compensation to the plan on a pretax basis. In addition, the Company may make voluntary matching contributions to the plan. At December 31, 1998 and 1997, respectively, the Company had accrued approximately $23,000 and $56,000 as its matching contributions to the plan. 11. INCOME TAXES: The Company follows SFAS No. 109, "Accounting for Income Taxes." This statement establishes financial accounting and reporting standards for deferred income tax assets and liabilities that arise as a result of differences between the reported amounts of assets and liabilities for financial reporting and income tax purposes. As of December 31, 1998, the Company had net operating loss carryforwards of approximately $6.2 million for federal income tax purposes which are available to reduce future taxable income and will expire in 2005 through 2018 if not utilized. Income tax expense (benefit) is included in the financial statements as follows: YEAR ENDED DECEMBER 31 ----------------------- 1998 1997 -------- -------- Continuing operations ............................. $(24,880) $ -- Discontinued operations ........................... -- 191,000 -------- -------- Total income tax expense (benefit) ......... $(24,880) $191,000 ======== ======== The components of income tax expense (benefit) are as follows: YEAR ENDED DECEMBER 31 ----------------------- 1998 1997 -------- -------- Federal ........................................... $(24,880) $ 61,000 State ............................................. -- 130,000 -------- -------- Total income tax expense (benefit) ......... $(24,880) $191,000 ======== ======== F-18 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) Total income tax expense (benefit) from continuing operations differs from the amount computed by applying the statutory federal income tax rate to income (loss) from continuing operations before income taxes. The reasons for these differences are as follows: YEAR ENDED DECEMBER 31 -------------------------- 1998 1997 ----------- ----------- Expected federal income tax expense (benefit) .... $(1,725,000) $ (94,000) Other ............................................ (24,880) -- Tax loss carryforwards generated (utilized) ...... 1,725,000 94,000 ----------- ----------- Total income tax expense (benefit) from continuing operations ........... $ (24,880) $ -- =========== =========== The tax effect of significant temporary differences representing income tax assets (liabilities) is as follows: DECEMBER 31 ----------------------------- 1998 1997 ---------- ---------- Deferred income tax assets (liabilities)- Tax loss carryforwards ................... $2,110,000 $ 885,000 Tax credit carryforwards ................. 81,000 81,000 Depreciation ............................. 94,000 135,000 Accruals ................................. 555,000 41,000 Other .................................... 14,000 20,000 ---------- ---------- $2,854,000 $1,162,000 ========== ========== A valuation reserve of $2,854,000 and $1,162,000 as of December 31, 1998 and 1997, respectively, representing the total of net deferred tax assets has been recognized by the Company as it cannot determine that it is more likely than not that all of the deferred tax assets will be realized. 12. DISCONTINUED OPERATIONS: In November 1997, the Company sold its software division to a third party for $6.5 million, resulting in a pretax gain of approximately $4.7 million. As a result of the sale, the division has been accounted for as a discontinued operation and, accordingly, the Company has restated its financial statements for all periods presented in accordance with APB No. 30. The following table provides certain information related to the discontinued operation for the year ended December 31, 1997: Revenues $2,322,221 ========== Loss from discontinued operations $(769,721) ========== Gain on disposal of discontinued software division, net of income tax expense of $191,000 $4,472,409 ========== F-19 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED) Under the provisions of the Asset Purchase Agreement (Agreement) between the Company and the purchaser (Purchaser) of the software division, the Company sold all of the assets related to this division with the exception of certain office furniture and equipment and the Purchaser agreed to assume all of the liabilities of the division with the exception of trade payables, accrued liabilities and tax liabilities of the Company associated with the operations and disposition of the division. Under the terms of the Agreement, the Purchaser paid $800,000 of the purchase price into an escrow fund for purposes of securing payment for any liability of the Company to the Purchaser under the Agreement, including the Purchaser's right to indemnification for uncollectible purchased receivables. The funds in the escrow account, net of any liabilities of the Company to the Purchaser under the Agreement, were paid to the Company in the amount of $400,000 in November 1998 and the remaining $400,000 is to be released to the Company in November 1999. Management of the Company believes that the remainder held in escrow at December 31, 1998, will be paid to the Company and, accordingly, such amount is reflected as a component of other current receivables on the accompanying balance sheet at December 31, 1998. The Company continued to fund the payroll for the employees of the software division from the date of purchase through December 31, 1997, on behalf of the Purchaser. Such amount is reflected as a component of accounts receivable at December 31, 1997, and was reimbursed by the Purchaser subsequent to December 31, 1997. In connection with the sale of the software division, certain terms of stock options to purchase Company common stock held by employees of the division were modified resulting in compensation expense of $47,000 which has been reflected as a reduction of the gain on disposal of the discontinued software division. 13. SUBSEQUENT EVENTS: In January 1999, the Company sold its headquarters building. In connection with the sale, the Company paid off its secured indebtedness. The Company's net cash proceeds from the sale, net of debt repayments, approximated $800,000. The Company has entered into a noncancelable operating leaseback of the building through October 1999 at a rate of approximately $27,000 per month, before a cancelable month-to-month sublease arrangement of approximately $15,000 per month. The Company intends to locate replacement facilities and believes that suitable facilities will be available. The gain on the sale of the building, which was not significant, was deferred and is being recognized over the term of the operating leaseback. 14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED): The results of operations by quarter for the years ended December 31, 1998 and 1997, were as follows:
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 TOTAL ----------- ----------- ------------ ------------ ----------- 1998 Operating revenues ... $ 612,996 $ 869,982 $ 591,786 $ 618,733 $ 2,693,497 =========== =========== =========== =========== =========== Net loss ............. $ (614,491) $ (455,214) $(1,993,217) $(2,022,772) $(5,085,694) =========== =========== =========== =========== =========== Basic and diluted loss per common share ... $ (0.19) $ (0.14) $ (0.60) $ (0.61) =========== =========== =========== ===========
F-20 DOCUCON, INCORPORATED NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 TOTAL ------------- ------------- ------------- ------------- ----------- 1997 Operating revenues ..... $ 2,489,648 $ 2,096,083 $ 1,317,352 $ 761,242 $ 6,664,325 ============= ============= ============= ============= =========== Net income (loss) from continuing operations $ 98,093 $ 277,797 $ (135,587) $ (517,742) $ (277,439) Net income (loss) from discontinued operations ........... (142,193) (215,698) (281,983) 4,342,562 3,702,688 ------------- ------------- ------------- ------------- ----------- Net income (loss) ...... $ (44,100) $ 62,099 $ (417,570) $ 3,824,820 $ 3,425,249 ============= ============= ============= ============= =========== Basic income (loss) per common share- Continuing operations $ .03 $ .09 $ (.05) $ (.16) Discontinued operations ............. (.05) (.07) (.09) 1.34 ------------- ------------- ------------- ------------- Basic income (loss) per common share ......... $ (.02) $ .02 $ (.14) $ 1.18 ============= ============= ============= ============= Diluted income (loss) per common share- Continuing operations $ .03 $ .08 $ (.05) $ (.16) Discontinued operations ............. (.04) (.06) (.09) 1.34 ------------- ------------- ------------- ------------- Diluted income (loss) per common share ..... $ (.01) $ .02 $ (.14) $ 1.18 ============= ============= ============= =============
F-21 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES. The Company has had no disagreements with its independent accountants within the twenty-four months prior to December 31, 1998 or subsequent to that date. 14 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. DIRECTORS, EXECUTIVE OFFICERS AND KEY TECHNICAL PERSONNEL The following table sets forth certain information with respect to the Company's Directors, executive officers and key technical personnel: NAME AGE POSITION ------ ----- ----------- Edward P. Gistaro 63 Chairman of the Board of Directors Douglas P. Gill 50 President, Chief Executive Officer, and Director Warren D. Barratt 39 Senior Vice President, Chief Financial Officer and Treasurer Michael C. Mooney 60 Senior Vice President - Sales Michael Nunley 54 Vice President - Operations and Technology Ralph Brown 65 Secretary and Director Al R. Ireton 64 Director Chauncey E. Schmidt 66 Director Robert W. Schwartz 54 Director Edward P. Gistaro has served as Chairman of the Board since 1990. He served as Chief Executive Officer of the Company from June 4, 1988 until April 1, 1998, when the Board of Directors accepted his recommendation that he be replaced by Douglas P. Gill as Chief Executive Officer. Pursuant to Mr. Gistaro's retirement, the Board requested that he continue to serve as Chairman, and he accepted. Mr. Gistaro also served as President of the Company from July 10, 1988 until March 18, 1991. Mr. Gistaro was employed by Datapoint Corporation, a company involved in the manufacturing of computer systems, in various managerial positions from 1973 to 1987. From 1982 to 1985 Mr. Gistaro served as the President and Chief Operating Officer of Datapoint Corporation, and he served from 1985 to 1987 as its President and Chief Executive Officer. 15 Douglas P. Gill was elected President and Chief Executive Officer on April 1, 1998. Mr. Gill was a general partner of Foster Management Company, a venture capital firm, from 1994 until 1998. From 1984 to 1994 Mr. Gill served as First Vice President of Janney Montgomery Scott, Inc., a regional investment banking and brokerage firm, and in various management capacities at Scott Paper Company from 1977 to 1984. Mr. Gill also served as a senior auditor at Arthur Andersen & Co. (now LLP) from 1972 to 1975. Warren D. Barratt was named Senior Vice President and Chief Financial Officer in December 1998 and was subsequently appointed Treasurer in March 1999. Mr. Barratt was Senior Vice President and Chief Financial Officer for U.S. Physicians, Inc., a physician practice management company, from 1996 to 1998. From 1994 to 1996, Mr. Barratt was Chief Financial Officer for The Pet Practice, Inc., a veterinary services company. Mr. Barratt was a Senior Manager with Price Waterhouse LLP from 1992 to 1994. Michael C. Mooney was named Senior Vice President, Federal Programs in July 1998. Prior to joining Docucon, Mr. Mooney served Litton-PRC as Vice President, General Manager for Business Development for Outsourcing Systems and Services and as a manager for PRC Logistics Systems. Mr. Mooney was Senior Vice President of Sales and Marketing for Raxco Software from 1989 to 1990 and from 1977 to 1989 held various senior sales positions at Boeing Computer Services, Computer Sciences Corporation, VM Software and Legent Corporation. Prior to his career in the private sector, Mr. Mooney served in the U.S. Marine Corps from 1961-1967 Michael Nunley was named Vice President Operations and Technology in January 1999. From 1985 to 1998 Mr. Nunley served in various positions with Lockheed Martin Corporation, most recently as Program Manager for Citibank Projects. Prior to joining Lockheed Martin, Mr. Nunley spent twenty years with the U.S. Air Force in various roles including the development and testing of automated communications systems and maintaining long radar systems. Ralph Brown, an attorney in private practice since 1968, has served as Secretary of the Company since May 1, 1987. From 1987 to 1989, he served also as Treasurer of the Company. Mr. Brown has also served since 1975 as President of Cherokee Ventures, Inc., a real estate leasing firm, since 1978 as President of East Central Development Corporation and since 1982 as President of Southeast Suburban Properties, Inc. The latter two businesses are real estate development firms. Al R. Ireton was elected as a Director of the Company in May 1993. Mr. Ireton has been Chairman of Manchester Partners, an investment and growth strategy advisory organization providing capital and strategic assistance to growing companies, since October 1988. From 1985 through September 1988, he served as President and Chief Executive Officer of Texet Corporation, a desktop publishing company. Mr. Ireton has 25 years' experience serving as president and chief executive officer of growth-oriented companies, and has served on several corporate boards. Chauncey E. Schmidt was elected to the Board of Directors of the Company in February 1993. He has been Chairman of C. E. Schmidt & Associates, an investment firm, since April 1989. From 1987 to March 1989, he was Vice Chairman of the Board of AMFAC, Inc., a New York Stock Exchange-listed company engaged in diversified businesses. He has previously served as President of The First National Bank of Chicago and Chairman of the Board and Chief Executive Officer of The Bank of California, N.A. Mr. Schmidt is on the Board of Trustees of the U. S. Naval War College Foundation and is active in several civic and charitable organizations. 16 Robert W. Schwartz was elected to the Board of Directors of the Company in April 1998. Mr. Schwartz founded the Schwartz Heslin Group, Inc. ("SHG"), an investment banking firm, in 1985. As Managing Director of SHG, Mr. Schwartz specializes in corporate planning, finance and development. From 1980 to 1985, he was founder, President and Chief Executive Officer of Winsource, Inc., a high tech firm which packaged and marketed integrated telephone and computer systems. Mr. Schwartz served as President, Chief Operating Officer and Director of Coradian Corporation and as Vice President and Chief Financial Officer of Garden Way Manufacturing Corporation from 1975 to 1980 and 1970 to 1975, respectively. SHG has been retained by the Company to provide investment and financial advice. GENERAL Directors of the Company hold office until the next Annual Meeting of Stockholders of the Company and until their successors are elected and qualified. Executive officers of the Company are elected annually by, and serve at the discretion of the Board of Directors. There are no arrangements or understandings known to the Company between any of the Directors, nominees for Director or executive officers of the Company and any other person pursuant to which any of such persons was elected as a Director or an executive officer, except as set forth below under Item 10, "Executive Compensation Employment Agreements". There are no family relationships between any Directors, nominees for Director or executive officers of the Company. Prior to joining the company, Mr. Barratt served as Senior Vice President and Chief Financial Officer of U.S. Physicians, Inc. In October 1998, U.S. Physicians, Inc. filed a bankruptcy case under Chapter 11 of the U.S. Code(the Bankruptcy Code) and such case was subsequently converted to a case under Chapter 7 of the Bankruptcy Code. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and Directors, and persons who beneficially own more than 10% of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission (the "SEC") and the Boston Stock Exchange. Officers, Directors and beneficial owners of more than 10% of the Company's Common Stock are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms that they file. Based solely on review of the copies of such forms furnished to the Company, or written representations that no reports on Form 5 were required, the Company believes that for the period from January 1, 1998 through March 1, 1999, all officers, Directors and greater-than-10% beneficial owners complied with all Section 16(a) filing requirements applicable to them. 17 ITEM 10. EXECUTIVE COMPENSATION. EXECUTIVE COMPENSATION -- GENERAL The following table sets forth compensation paid or awarded to the Chief Executive Officer for all services rendered to the Company in 1998, 1997 and 1996. No other executive officer of the Company had compensation that exceeded $100,000 in 1998. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG-TERM COMPENSATION ------------------------------------------ ----------------------------- ALL BONUS/ANNUAL OTHER SECURITIES LONG-TERM OTHER NAME AND PRINCIPAL INCENTIVE ANNUAL UNDERLYING INCENTIVE COMPEN- POSITION(1) YEAR SALARY AWARD(2) COMPENSATION(3) OPTIONS(4) PAYOUTS SATION(5) - ------------------ ------ --------- ------------- ---------------- ------------- ----------- ----------- Douglas P. Gill 1998 $149,020 $50,000 $ --- 275,000 $ --- $20 President and Chief Executive Officer
(1) Edward P. Gistaro resigned as Chief Executive Officer on April 1, 1998 and is currently Chairman of the Board. Allan H. Hobgood resigned as Vice-Chairman and Chief Operating Officer in September 1998 and Lori A. Turner resigned as Vice President and Chief Financial Officer in December 1998. (2) Mr. Gill is eligible to receive an annual bonus under his employment contract of up to 50% of his annual base salary, to be awarded at the discretion of the Board of Directors. For 1998, Mr. Gill was entitled to a bonus of 25% of his base salary which was accrued at December 31, 1998 but had not been paid as of March 31, 1999. (3) Aggregate perquisites and other personal benefits did not exceed the lesser of either $50,000 or 10% of the total annual salary and bonus reported above. (4) In April 1998, Mr. Gill was awarded options to purchase 225,000 shares of the Company's common stock at an exercise price of $4.00 per share. In December 1998, the exercise price of these options was reset to $1.00 per share. (5) Consists of premiums paid under the Company's group term life insurance program. STOCK OPTION GRANTS IN 1998
INDIVIDUAL GRANTS ---------------------------------------------------------------- NUMBER OF % OF TOTAL SECURITIES OPTIONS GRANTED EXERCISE UNDERLYING TO EMPLOYEES PRICE EXPIRATION NAME OPTIONS GRANTED IN FISCAL YEAR PER SHARE DATE ------ --------------- ----------------- ----------- ----------- Douglas P. Gill....... 50,000 5.7% $2.76 04/01/08 Douglas P. Gill....... 225,000(1) 25.7% 1.00 04/01/05
(1) In April 1998, Mr. Gill was awarded options to purchase 225,000 shares of the Company's common stock at an exercise price of $4.00 per share under the Company's 1998 Non-Statutory Stock Option Plan. These options become exercisable in March 2005. Exercisability of the options is accelerated in 20,000 share increments for each $2.00 per share incremental increase in the quoted market price per share of the Company's common stock above $4.00 per share. In December 1998, the exercise price of these options was reset to $1.00 per share. 18 STOCK OPTION EXERCISES IN 1998 AND OPTION VALUES AT DECEMBER 31, 1998
VALUE OF UNEXERCISED SHARES NUMBER OF UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS ACQUIRED AT DECEMBER 31, 1998 AT DECEMBER 31, 1998 ON VALUE ----------------------------------------------------------------- NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ------------------------------------------------------------------------------------------------------------------ Douglas P. Gill...... -- $ --- 16,667 258,333 $ --- $ ---
TEN-YEAR OPTION REPRICINGS
SECURITIES LENGTH OF UNDERLYING MARKET PRICE EXERCISE PRICE ORIGINAL OPTION NUMBER OF OF STOCK AT OF STOCK AT TERM REMAINING OPTIONS TIME OF TIME OF NEW EXERCISE AT DATE OF NAME DATE REPRICED REPRICING REPRICING PRICE REPRICING -------- -------- -------------- --------------- --------------- ------------- ----------------- Douglas P. Gill..... 12/15/98 225,000 $1.00 $4.00 $1.00 6 years, 5 months
EMPLOYMENT AGREEMENTS The Company entered into an employment agreement with Mr. Gill on April 1, 1998, which carries a seven-year term. Pursuant to the terms of the agreement, Mr. Gill is to be paid $200,000 per annum, an auto allowance, and an annual performance bonus to be determined by the Board of Directors. The Company entered into employment agreements with Messrs. Warren D. Barratt and Michael Nunley in December 1998 and January 1999, respectively. Each of the agreements carries a three-year term and provides for a base salary and an annual performance bonus to be determined by the board of directors. Each of the agreements for Messrs. Gill, Barratt and Nunley are terminable upon 30 days prior written notice by either the Company or the employee, or by the Company "for cause" at any time. Further, each agreement requires that the employee keep Company matters confidential, restricts the employee from being directly or indirectly involved with any entity in a business competitive with that of the Company for specified periods of time following the termination of the agreement, and provides for a severance payment to the employee in the event he is terminated by the Company without cause. 19 STOCK OPTIONS 1988 STOCK OPTION PLAN The Company has a 1988 Stock Option Plan, currently covering an aggregate of 415,000 shares of Common Stock. The 1988 Stock Option Plan provides for the grant to officers, Directors and key employees of the Company of incentive stock options ("ISOs") intended to qualify under Section 422(b) of the Internal Revenue Code of 1986, as amended (the "Code") and non-qualified stock options ("NQSOs"). The 1988 Stock Option Plan was approved by the stockholders of the Company on November 15, 1988. Amendments to the 1988 Stock Option Plan increasing the number of shares covered thereby were approved by the stockholders of the Company on April 21, 1989, May 14, 1991 May 7, 1992, and August 12, 1997. As of March 1, 1999, under the 1988 Stock Option Plan there were outstanding options to purchase 246,066 shares of the Company's Common Stock at prices ranging from $1.00 to $5.52 per share. Under the 1988 Stock Option Plan, which is administered by the Stock Option Committee of the Board of Directors, key employees may be granted options to purchase shares of the Company's Common Stock at 100% of fair market value on the date of grant (or 110% of fair market value in the case of an ISO granted to a 10% stockholder/grantee). The 1988 Stock Option Plan expired on October 31, 1998. Options granted under the 1988 Stock Option Plan must be exercised within ten years from the date of grant, vest at varying times, as determined by the Stock Option Committee, are nontransferable except by will or pursuant to the laws of descent and distribution, and are protected against dilution. All shares purchased upon exercise of any option must be paid in full at the time of purchase, in accordance with the terms set forth in the option. Such payment must be made in cash or through delivery of shares of Common Stock or a combination of cash and Common Stock, all as determined by the Stock Option Committee. The Stock Option Committee may determine other terms applicable to particular options. No one person may receive ISOs for which the aggregate fair market value (determined at the time each ISO is granted) of options exercisable for the first time during any calendar year exceeds $100,000. 1991 DIRECTOR NON-STATUTORY STOCK OPTION PLAN The Company also has a 1991 Director Non-Statutory Stock Option Plan (the "1991 Director Plan"), currently covering an aggregate of 210,000 shares of Common Stock. The 1991 Director Plan was approved by the stockholders of the Company on May 7, 1992 and provides for the grant of NQSOs to non-employee Directors of the Company. An amendment to increase the number of shares offered and reserved for the 1991 Director Plan was approved by the stockholders of the Company on June 9, 1998. As of March 1, 1999, there were outstanding under the 1991 Director Non-Statutory Stock Option Plan options to purchase 96,250 shares of the Company's Common Stock at prices ranging from $2.00 to $5.52 per share. Under the 1991 Director Plan, which is administered by the Board of Directors, non-employee Directors are granted options to purchase 10,000 shares of the Company's Common Stock upon their initial election as Directors and 7,500 shares on the second anniversary date of such election at the then-current market price of such shares. One-third of the initial grant shall vest on each anniversary of the date of grant, and one-third of the second grant shall vest every six months after the date of grant. The 1991 Director Plan expires on February 10, 2001. Under an amendment to the 1991 Director Plan adopted by the Board of Directors in June 1998, each eligible Director will receive an additional annual grant of options covering 6,250 shares of Common Stock, commencing with the fiscal year of the Company immediately following the fiscal year in which all shares of Common Stock covered by the initial grant and the 20 second grant described above are fully vested, and such annual grant will continue each fiscal year thereafter until options covering all shares reserved for issuance under the 1991 Director Plan have been granted. Options granted under the 1991 Director Plan must be exercised within ten years from the date of grant, are nontransferable except by will or pursuant to the laws of descent and distribution, are protected against dilution and expire within three months after termination of service as a Director of the Company, unless such termination is by reason of death or disability or for cause. All shares purchased upon exercise of any option must be paid in full at the time of purchase, in accordance with the terms set forth in the option. Such payment must be made in cash or through delivery of shares of Common Stock or a combination of cash and Common Stock. The 1991 Director Plan may be amended at any time by vote of the Board of Directors. During 1998, Messrs. Ralph Brown, Al Ireton, and Chauncey Schmidt, all Directors of the Company, were granted options covering 6,250 shares each of Common Stock at an exercise price of $2.00 per share. Messrs. Edward Gistaro and Robert Schwartz, both Directors of the Company, were each granted options covering 10,000 shares of Common Stock at an exercise price of $2.76 and $2.00, respectively. The exercise price per share of each such option was not less than the closing bid price of the Common Stock reported on The NASDAQ Stock Market on the date of the grant. 1998 EMPLOYEE STOCK OPTION PLAN On April 1, 1998, the Company approved the 1998 Employee Stock Option Plan (the 1998 Employee Plan), covering 187,500 shares of common stock. Unless terminated earlier by the board of directors, the 1998 Plan will terminate on March 31, 2008. The purpose of the plan is to supplement and replace the Company's 1988 Stock Option Plan (the 1988 Plan) which terminated on October 31, 1998. The 1998 Employee Plan provides for the grant to key employees of the Company of incentive stock options (ISOs) intended to qualify under Section 422(b) of the Internal Revenue Code and nonqualified stock options (NQSOs). Under the 1998 Employee Plan, which is administered by the Stock Option Committee of the board of directors, key employees may be granted options to purchase shares of the Company's common stock at 100 percent of fair market value on the date of grant (or 110 percent of fair market value in the case of an ISO granted to a 10 percent stockholder/grantee). Options granted under the 1998 Employee Plan must be exercised within 10 years from the date of grant, vest at varying time, as determined by the Stock Option Committee, are nontransferable except by will or pursuant to the laws of descent and distribution and expire within three months after termination of employment, unless such termination is by reason of death or disability or for cause. All shares purchased upon exercise of any option must be paid in full at the time of purchase, in accordance with the terms set forth on the option. Such payment must be made in cash or through delivery of shares of common stock or a combination of cash and common stock, all as determined by the Stock Option Committee. The Stock Option Committee may determine other terms applicable to particular options. The aggregate fair market value (determined at the time each ISO is granted) of the shares of common stock with respect to which ISOs issued to any one person under the 1998 Employee Plan are exercisable for the first time during any calendar year may not exceed $100,000. The 1998 Employee Plan may be amended at any time by a vote of the board of directors. However, no amendment made without approval of the stockholders of the Company may increase the total number of shares which may be issued under options granted pursuant to the 1998 Employee Plan, reduce the maximum exercise price or extend the latest date upon which options may be granted or change the class of employees eligible to receive the options. 21 1998 EXECUTIVE NON-STATUTORY PLAN In 1998, the Company approved the 1998 Executive Non-Statutory Plan (the 1998 NQSO Plan), covering 375,000 shares of common stock. Unless terminated earlier by the board of directors, the 1998 NQSO Plan will terminate on March 31, 2008. The 1998 NQSO Plan provides executives of the Company the added incentive of performance-based compensation and stock ownership through the grant of nonqualified stock options. The purpose of the plan is to incentivise executive management to achieve specified goals which are intended to be aligned with the objectives of increasing the market price of the Company's Common Stock and enhancing shareholder wealth. Under the 1998 NQSO Plan, identified executives may be granted long-term options to purchase shares of the Company's common stock at a price specified on the date of the grant subject to certain acceleration rights upon attainment of specific goals. The 1998 NQSO Plan is administered by the Stock Option Committee. Options granted under the 1998 NQSO Plan will expire 10 years from the date of grant, vest at varying times, as determined by the NQSO Committee, are nontransferable except by will or pursuant to the laws of descent and distribution. All shares purchased upon exercise of any option must be paid in full at the time of purchase, in accordance with the terms set forth on the option. Such payment must be made in cash or through delivery of shares of common stock or a combination of cash and common stock, all as determined by the NQSO Committee. The NQSO Committee may determine other terms applicable to particular options. The 1998 NQSO Plan may be amended at any time by a vote of the board of directors. EMPLOYEE STOCK PURCHASE PLAN The Company's 1993 Employee Stock Purchase Plan (the "Stock Purchase Plan") was approved by the stockholders at the 1994 Annual Meeting of Stockholders and amended on August 12, 1997 and June 9, 1998. Under the Stock Purchase Plan, eligible employees may elect to have up to 10% of their Base Pay (as defined) deducted and utilized for the purchase of Common Stock of the Company in annual or semiannual offerings to be made by the Company to eligible employees. The Company has reserved 350,000 shares of Common Stock for issuance pursuant to the Stock Purchase Plan. The Company's stockholders approved an increase of an additional 100,000 shares and an extension of the Stock Purchase Plan until December 31, 2001 in June 1998. The Company issued 24,398, 26,809, and 71,512 shares in January 1999, 1998 and 1997 pursuant to this plan at purchase prices of $.77, $3.40 and $1.28 per share, which represents 85% of the closing price on December 31, 1998, December 30,1997, and January 2, 1996, respectively. At March 1, 1999, 184,390 shares remain available for ISSUANCE. Under the Stock Purchase Plan, the Company will make available in each year from January 1, 1994 through December 31, 2001 up to 50,000 shares of Common Stock. Such shares will be offered to participating employees in annual or semiannual offerings. Participating employees will be deemed to have been granted options to purchase Common Stock in each offering in an amount equal to the amount of their respective payroll deductions divided by 85% of the market value of the Common Stock of the Company on the applicable Offering Commencement Date. The option price shall be the lesser of 85% of the closing price of the Common Stock on the Offering Commencement Date (or the next preceding trading day) or 85% of the closing price of Common Stock on the Offering Termination Date (or the next preceding trading day). Unless a participating employee terminates participation as provided in the Stock Purchase Plan, such employee shall be deemed to have exercised such option on the Offering Termination Date and shall be issued a corresponding number of shares of Common Stock. 22 The Stock Purchase Plan is administered by the Compensation Committee of the Board of Directors and will expire on December 31, 2001, unless sooner terminated or amended by the Board of Directors. 23 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as of March 1, 1999, by all persons known to the Company to own beneficially more than 5% of the Company's Common Stock. NAME AND AMOUNT AND ADDRESS OF NATURE OF PERCENT TITLE OF CLASS BENEFICIAL OWNERS BENEFICIAL OWNERSHIP OF CLASS - -------------------------------------------------------------------------------- Common Stock, Demuth, Folger & Terhune 225,000 (1) 6.26 par value $.01 One Exchange Plaza per share 55 Broadway New York, New York 10006 Edward P. Gistaro 195,385 (2) 5.79 565 E. Swedesford Rd. Suite 209 Wayne, PA 19087 - ---------------------- (1) Consists of 225,000 shares of Common Stock underlying a Warrant to Purchase Common Stock exercisable at an exercise price of $8.00 per share. The percentage of ownership is calculated based on 3,594,393 shares outstanding. (2) Includes 3,333 shares subject to currently exercisable stock options. The percentage of ownership is based on 3,372,726 shares outstanding. The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as of March 1, 1999 (a) by each of the Company's directors, (b) by the Company's Chief Executive Officer (there were no other executive officers whose 1998 compensation exceeded $100,000), and (c) by all Directors and executive officers as a group. NAME AND AMOUNT AND ADDRESS OF NATURE OF PERCENT TITLE OF CLASS BENEFICIAL OWNER (1) BENEFICIAL OWNERSHIP (2) OF CLASS (3) - -------------------------------------------------------------------------------- Common Stock, Edward P. Gistaro 195,385 (4) 5.79 par value $.01 Douglas P. Gill 34,634 (5) 1.02 per share Ralph Brown 75,150 (6) 2.22 Al R. Ireton 23,125 (7) 0.68 Chauncey E. Schmidt 60,625 (7) 1.79 Robert W. Schwartz --- 0.00 All Directors and Executive Officers as a Group (9 persons including the above) 388,919 (8) 11.20 24 - -------------------- (1) The address for all persons named is 565 E. Swedesford Road, Suite 209, Wayne, Pennsylvania 19087. (2) The persons named in the table have sole voting and investment power with respect to all shares of Common Stock shown as beneficially owned by them, except as otherwise indicated. (3) Unless otherwise indicated below, the percentage of ownership is based upon 3,369,393 shares of Common Stock outstanding, which includes 61,838 shares of Common Stock into which outstanding shares of Preferred Stock are convertible and which the holders of the Preferred Stock are entitled to vote. (4) Includes 3,333 shares subject to currently exercisable stock options. The percentage of ownership is based on 3,372,726 shares outstanding. (5) Includes 33,334 shares subject to currently exercisable stock options. The percentage of ownership is based on 3,402,727 shares outstanding. (6) Includes 20,625 shares subject to currently exercisable stock options. The percentage of ownership is based on 3,390,018 shares outstanding. (7) Includes 23,125 shares subject to currently exercisable stock options. The percentage of ownership is based on 3,392,518 shares outstanding. (8) Includes 103,542 shares subject to currently exercisable stock options. The percentage of ownership is based on 3,472,935 shares outstanding. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. In December 1996 the Company's former chief executive officer loaned the Company $100,000 for a period of 5 days. In January 1997 the former chief executive officer loaned the Company up to $420,000 over a period of 20 days. The loans were unsecured and bore interest at 9.5% and were paid in full in December 1996 and February 1997. In September and October 1997, the chief executive officer loaned the Company $45,000 and $150,000. The loan balances were applied to the amount due from the officer when he exercised employee stock options in October 1997. Interest at 9.5% was paid for 11 and 3 days respectively on the unsecured loans, and the balance after the stock option exercise was repaid to the officer. Since January 1, 1996, no officer, executive officer, or affiliate of the Company has entered into any other direct or indirect material transactions, or series of transactions, or had any direct or indirect material interest in any proposed transaction, or series of transactions, to which the Company is to be a party where the amount involved exceeds $60,000. 25 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. The Exhibits required by Regulation S-B are set forth in the following list and are filed either by incorporation by reference from previous filings with the Securities and Exchange Commission or by attachment to this Annual Report on Form 10-KSB, as so indicated in such list. 2.1 Asset Purchase Agreement dated March 15, 1994, between Docucon, Incorporated and J. Feuerstein Systems, Inc., including the related Letter Agreement, dated January 28, 1994, between Jim Feuerstein and Docucon, Incorporated, as filed as Exhibit 2.1 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993, is hereby incorporated herein by reference. 3.1 Certificate of Incorporation of Docucon, Incorporated, filed as Exhibit 3.1 to the Company's Registration Statement on Form S-1 (Registration No. 33-25561), is hereby incorporated herein by reference. 3.2 Certificate of Amendment to Certificate of Incorporation of Docucon, Incorporated, filed as Exhibit 3.2 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1992, is hereby incorporated herein by reference. 3.3 Bylaws of Docucon, Incorporated, filed as Exhibit 3.2 to the Company's Registration Statement on Form S-1 (Registration No. 33-25561), is hereby incorporated herein by reference. 3.4 Certificate of Merger of Docucon, Incorporated, a Delaware corporation, and Docucon, Incorporated, a Texas corporation, October 11, 1988, filed as Exhibit 3.4 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995, is hereby incorporated herein by reference. 3.5 Certificate of Designation Preferences of Series A Convertible Preferred Stock of Docucon, Incorporated, May 29, 1990, filed as Exhibit 3.5 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995, is hereby incorporated herein by reference. 3.6 Certificate of Designation Preferences of Series B Non-Convertible, Cumulative, Non-Voting, Redeemable Preferred Stock of Docucon, Incorporated, June 12, 1991, filed as Exhibit 3.6 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995, is hereby incorporated herein by reference. 3.7 Certificate of Correction of Certificate of Designation Preferences of Series A Convertible Preferred Stock of Docucon, Incorporated, June 1, 1990, filed as Exhibit 3.7 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995, is hereby incorporated herein by reference. 4.1 Warrant to Purchase Common Stock of Docucon, Incorporated, entitling D. H. Blair Investment Banking Corp. to purchase 80,000 shares of Common Stock at an exercise price of $.75 per share, expiring on November 5, 1995, as filed as Exhibit 4.1 to Amendment No. 1 to the Company's Registration Statement on Form SB-2 (Registration No. 33-82018), is hereby incorporated herein by reference. 26 4.2 Warrant to Purchase Common Stock of Docucon, Incorporated, entitling D. H. Blair Investment Banking Corp. to purchase 160,000 shares of Common Stock at an exercise price of $.70 per share, expiring on November 5, 1995, as filed as Exhibit 4.2 to Amendment No. 1 to the Company's Registration Statement on Form SB-2 (Registration No. 33-82018), is hereby incorporated by reference. 4.3 Warrant to Purchase Common Stock of Docucon, Incorporated, entitling James Coleman to purchase 20,000 shares of Common Stock at an exercise price of $.75 per share, expiring on November 5, 1995, as filed as Exhibit 4.5 to Amendment No. 1 to the Company's Registration Statement on Form SB-2 (Registration No. 33-82018), is hereby incorporated herein by reference. 4.4 Warrant to Purchase Common Stock of Docucon, Incorporated, entitling James Coleman to purchase 40,000 shares of Common Stock at an exercise price of $.70 per share, expiring on November 5, 1995, as filed as Exhibit 4.6 to Amendment No. 1 to the Company's Registration Statement on Form SB-2 (Registration No. 33-82018), is hereby incorporated herein by reference. 4.5 Stock Option Agreement, dated August 31, 1992, in which Docucon, Incorporated granted The Wall Street Group, Inc. a stock option to purchase up to 72,727 shares of Common Stock at a price of $1.375 per share, as filed as Exhibit 4.14 to Amendment No. 1 to the Company's Registration Statement on Form SB-2 (Registration No. 33-82018), is hereby incorporated herein by reference. 10.1 Contract, dated as of May 8, 1991, between the Company and the U. S. Department of Defense, filed as Exhibit 10.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, is hereby incorporated herein by reference. 10.2 Employment Agreements between the Company and each of Edward P. Gistaro and Allan H. Hobgood, filed as Exhibit 10.5 to the Company's Registration Statement on Form S-1 (Registration No. 33-25561), are hereby incorporated herein by reference. 10.3 Amendment to Employment Agreement between the Company and Allan H. Hobgood, filed as Exhibit 10.7 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1992, is hereby incorporated herein by reference. 10.5 1988 Stock Option Plan, filed as Exhibit 10.9 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, is hereby incorporated herein by reference. 10.6 1991 Director Non-Statutory Stock Option Plan, filed as Exhibit 10.10 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1992, is hereby incorporated herein by reference. 27 10.8 Note and Warrant Purchase Agreement, dated as of December 15, 1992, between the Company and Demuth, Folger & Terhune, including all Exhibits thereto (which include the form of Promissory Note, the form of Common Stock Purchase Warrant and the form of Deed of Trust executed and delivered in connection with the transaction), filed as Exhibit 5.1 to the Company's Current Report on Form 8-K dated December 16, 1992, is hereby incorporated herein by reference. 10.9 1993 Employee Stock Purchase Plan, filed as Exhibit 10.11 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993, is hereby incorporated herein by reference. 10.10 Form of Promissory Note, Revolving, dated as of September 30, 1996, between Docucon, Incorporated and Bank One, Texas, N.A., filed as Exhibit 10.12 to the Company's Quarterly Report on Form 10-QSB for the quarter ended September 30, 1996, is hereby incorporated herein by reference. 10.11 Form of Promissory Note, dated as of September 30, 1996, between Docucon, Incorporated and Bank One, Texas, N.A., filed as Exhibit 10.13 to the Company's Quarterly Report on Form 10-QSB for the quarter ended September 30, 1996, is hereby incorporated herein by reference. 10.12 Deed of Trust, Security Agreement and Financing Statement, dated as of September 30, 1996, executed in connection with the issuance of Promissory Notes in Exhibits 10.12 and 10.13, filed as Exhibit 10.14 to the Company's Quarterly Report on Form 10-QSB for the quarter ended September 30, 1996 is hereby incorporated herein by reference. 10.13 Asset Sale and Purchase agreement, November 26, 1997, between Docucon, Incorporated and Bowne of Dallas, Inc., and Bowne Litigation Solutions, L.P., filed as Exhibit 10.13 to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1997 is herein incorporated by reference. 10.14 Employment Agreement, January 5, 1998, between Docucon, Incorporated and Lori Turner, filed as Exhibit 10.14 to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1997 is herein incorporated by reference. 10.15 Employment Agreement, April 1, 1998, between Docucon, Incorporated and Douglas P. Gill, filed as Exhibit 10.15 to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1997 is herein incorporated by reference. 10.16 Employment Agreement, December 20, 1998, between Docucon, Incorporated and Warren D. Barratt. 10.7 Employment Agreement, January 4, 1999, between Docucon, Incorporated and Michael Nunley. 11 Computation of Earnings (Loss) Per Share. 23 Consent of Arthur Andersen LLP 28 27 Financial Data Schedule (b) Reports on Form 8-K. none 29 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. DOCUCON, INCORPORATED By DOUGLAS P. GILL /S/ Douglas P. Gill President, Chief Executive Officer, and Director Date: April 26, 1999 In accordance with the Exchange Act, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. SIGNATURE CAPACITY DATE ---------- ---------- ------ DOUGLAS P. GILL President, Chief Executive April 26, 1999 /S/ Douglas P. Gill Officer and Director (Principal Executive Officer) WARREN D. BARRATT Senior Vice President April 26, 1999 /S/ Warren D. Barratt Chief Financial Officer and Treasurer (Principal Financial Officer) EDWARD P. GISTARO Chairman of the Board of Directors April 26, 1999 /S/ Edward P. Gistaro RALPH BROWN Director April 26, 1999 /S/ Ralph Brown AL R. IRETON Director April 26, 1999 /S/ Al R. Ireton CHAUNCEY E. SCHMIDT Director April 26, 1999 /S/ Chauncey E. Schmidt ROBERT W. SCWARTZ Director April 26, 1999 /S/ Robert W. Schwartz 30 EX-10.16 2 EXHIBIT 10.16 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT ("Agreement") is made and entered as of the 20th day of December, 1998 by and between Docucon, Incorporated, a corporation organized and existing under the laws of the State of Delaware ("Company"), and Warren D. Barratt, an individual residing in Westtown, Chester County, Pennsylvania ("Employee"). FOR AND IN CONSIDERATION of the mutual covenants herein contained and the mutual benefits to be gained by the performance thereof and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. INTRODUCTION. It is the intent and purpose of Company and Employee to specify in this Agreement the terms and conditions of Employee's employment with Company. 2. EMPLOYMENT. Company hereby employs Employee and Employee hereby accepts employment with Company on the terms and conditions herein set forth. In consideration of Employee's employment by Company, Employee agrees to the terms, conditions and covenants of this Agreement. 3. TERM OF EMPLOYMENT. This Agreement shall be effective as of December 20, 1998 and shall continue through the third anniversary of such date. 4. DUTIES AND RESPONSIBILITIES. Employee is hereby employed as, and shall serve in the capacity of, Senior Vice President and Chief Financial Officer of Company. Employee shall have the duties and responsibilities normally performed by an executive officer in such position, and shall perform services commensurate with such position for Company as may be determined from time to time by the Board of Directors of Company. Employee shall report to the President/Chief Executive Officer of Company and shall perform services hereunder as directed by the President/Chief Executive Officer of Company. During the term of this Agreement Employee's primary business interest shall be the Company, and Employee shall devote such of his time, attention, skills and energies as may be necessary to discharge his duties and responsibilities hereunder. Employee shall, in the performance of services hereunder, use his best efforts to serve and advance the interest of Company well and faithfully. 5. COMPENSATION AND BENEFITS. The compensation and other benefits payable to or accruing to Employee under this Agreement shall constitute the full consideration to be paid to Employee for all services to be rendered by Employee to Company and all other agreements of Employee hereunder. 1 5.01 SALARY. As compensation for all services of whatever type rendered by Employee in the performance of these duties under this Agreement and for all other agreements and undertakings of Employee hereunder, Company shall pay to Employee a minimum annual salary as set forth in this Section 5.01. Employee's annual salary ("Base Salary") shall initially be One Hundred Forty Thousand Dollars ($140,000.00). Such Base Salary shall be payable in equal regular installments in accordance with Company's customary payroll payment policy. Employee's Base Salary will be reviewed annually by the Compensation Committee of the Board of Directors of the Company for adjustment based on performance in accordance with Company's normal compensation policies and practices. Employee's Base Salary shall never be decreased below its then current level. It is specifically understood and agreed that a portion of Employee's Base Salary hereunder is attributable to Employee's agreement, pursuant to Section 10 hereof, to maintain the confidentiality of "Confidential Information" (as herein defined), both during and after the term of this Agreement, and that Employee's Base Salary would be reduced significantly if Employee did not agree to be bound by the terms of Section 10. It is further understood and agreed that a portion of Employee's annual salary is attributable to Employee's agreement, pursuant to Section 11 hereof, not to compete with Company either during or for a specified period of time after the expiration or termination of this Agreement and that Employee's Base Salary would be reduced significantly if Employee did not agree to be bound by the terms of Section 11 hereof. Employee agrees that he is being fairly and reasonable compensated for the agreements undertaken by Employee pursuant to Sections 10 and 11 hereof. 5.02 BONUS. In addition to the Base Salary set forth above, Employee shall be eligible for a targeted annual bonus of 50% of Employee's Base Salary, the amount of such annual bonus to be determined by the Compensation Committee of the Board of Directors. Such annual bonus will be paid not later than one hundred twenty (120) days after the end of the Company's fiscal year. 5.03 BENEFITS. Employee shall be entitled to a paid vacation each year of not less than four (4) weeks, the times for such vacation to be mutually agreed upon by Employee and Company. As an executive officer of Company, Employee shall be entitled to participate in the Company benefit programs designed for Company employees with similar salaries, duties and/or responsibilities. 5.04 EXPENSES. Company shall pay or reimburse Employee for all reasonable and necessary expenses actually incurred or paid by Employee during the term of this Agreement in the performance of Employee's services under this Agreement, upon presentation of expense statements or vouchers or such other supporting documents as Company may reasonably require. 5.05 STOCK OPTIONS. Upon the Effective Date, Company shall award to Employee stock options to purchase (i) up to 25,000 shares of common stock of the Company under the 1998 Employee Stock Option Plan and (ii) up to 75,000 shares of common stock of the Company under 2 the 1998 Executive Non-Statutory Plan. The terms and conditions of the foregoing stock options and awards shall be governed exclusively by the applicable plan and related stock option agreements. Acceptance by Employee of the form and terms (including but not limited to option price and exercise and vesting rights) of agreements to be executed with respect to the award of stock options specified above is a condition precedent to effectiveness of this Agreement. 6. INSURANCE. Company may, in its sole and absolute discretion, at any time after the Effective Date, apply for and procure, as owner and for its own benefit, insurance on the life of Employee, in such amounts and in such forms as Company may choose. Employee shall have no interest whatsoever in any insurance policy or policies obtained by Company, but Employee shall, at Company's request, submit to such medical examinations, supply such information and execute and deliver such documents as may be required or reasonably requested by Company or the insurance company or companies to which Company has applied for such insurance. 7. REPRESENTATIONS, WARRANTIES AND AGREEMENTS. Employee represents, warrants and agrees that: (i) Employee is not currently bound by any employment agreement, restriction or other obligation of any kind which would in any way materially interfere with or be inconsistent with the services to be provided by Employee to Company hereunder, (ii) Employee will not, during the term of this Agreement, become engaged as an employee, consultant, independent contractor or representative or in any other capacity or otherwise perform services of any kind for any person or entity or assume any such obligations or restrictions, in whatever capacity, which would in any way materially interfere with or be inconsistent with the services to be provided by Employee to Company hereunder; and, (iii) Employee is free to enter into this Agreement and the services and work product provided by Employee to Company hereunder will be original works of Employee and no portion of such services or work product, or the use or distribution thereof by Company, violates or will violate, or is or will be protected by, the right, title or interest of any patent, copyright, license or other similar property or proprietary right of any third person or entity. The representations contained in this Section shall survive the expiration or termination of this Agreement. 8. REGULATIONS AND POLICIES. Employee shall, during the term of this Agreement, comply with all Company regulations and policies, including, without limitation, security regulations. 9. CONFIDENTIAL INFORMATION. The term "Confidential Information", as used herein, shall mean and include any and all documents, knowledge, data or information (in whatever medium) know, communicated, provided or made available to Employee, whether before or after the execution of this Agreement, which are marked with a confidentiality legend by Company or which Employee knows or reasonably should know constitute trade secrets of Company or information belonging to third parties to whom Company may have an obligation of confidentiality or which embody, comprise, relate to, are incorporated in or constitute 3 "Intellectual Property" (as herein defined) in any stage of development; including, in each case, all trade secrets and other proprietary ideas, concepts, know-how, methodologies and information incorporated therein; PROVIDED, HOWEVER, that Confidential Information shall not include any information or materials which are or become generally available to the public other than as a result of any breach of the provisions of this Agreement or any other agreement between Employee and Company (or their respective successors, assigns or affiliates). The term "Intellectual Property", as used herein, shall include any and all information or materials, in any medium, of a technical or a business nature relating to the actual or reasonably anticipated business of Company, such as ideas, discoveries, designs, inventions, improvements, trade secrets, know-how, manufacturing processes, product formulae, design specifications, writings and other works of authorship, computer software, financial figures, marketing plans, customer lists and data, business plans or methods and any other material relating to the actual or reasonably anticipated business of the Company. In connection with computer software, the term "Intellectual Property" shall include, without limitation, the data bases, data processing and communications networking systems, practices and procedures and other internal systems, logic and controls, and the object code, source code, source listings, programming systems, programming or systems documentation and specifications, and user, operations or systems manuals or documentation related thereto or incorporated therein, firmware, models, sketches, writings, flow charts, diagrams, graphs or data related thereto, together with all modifications, enhancements, improvements, accessions, amendments, supplements or other additions to any of the foregoing. 10. CONFIDENTIALITY. Employee acknowledges and agrees that in his employment by Company he occupies a position of trust and confidence and that during the term of his employment under this Agreement he will have access to and will become familiar with Company's Confidential Information. Employee further acknowledges and agrees that the Confidential Information, including any and all copies thereof, constitutes trade secrets of Company and is confidential and proprietary information of Company. Employee further acknowledges and agrees that he has no right, title, interest or claim in or to any of the Confidential Information or any copies thereof. Employee agrees to maintain the confidentiality of the Confidential Information and agrees that he will not take, or permit to be taken, any action with respect to the Confidential Information (or any portion thereof) which is inconsistent with the confidential and proprietary nature of such information. Without limiting the generality of the foregoing, Employee agrees that he will not, directly or indirectly, without the prior specific written consent of Company, except as specifically required in the course of his employment, (i) communicate, divulge, transmit or otherwise disclose any Confidential Information to any person, firm, partnership, corporation or other entity, or (ii) use any confidential Information in any manner except as specifically required in connection with the performance of services hereunder, or 4 (iii) copy, reproduce or otherwise duplicate any Confidential Information in any fashion, in whole or in part. Employee agrees to take any and all steps reasonably necessary to protect the confidentiality of the Confidential Information. Employee shall, upon termination of this Agreement, immediately return to Company all Confidential Information in Employee's control or possession, including, without limitation, any and all copies thereof. This Section shall survive the expiration or termination of this Agreement. 11. RESTRICTIVE COVENANT AND NONCOMPETITION. 11.01 NONCOMPETE. During the term of this Agreement, Employee shall not, directly or indirectly, own, manage, operate, join, control or participate in, or be connected with, directly or indirectly, as an officer, director, stockholder, employee, advisor, consultant, partner, owner, agent, representative or in any other capacity, any "Competitive Business"; PROVIDED, HOWEVER, that the foregoing shall not prohibit Employee from becoming a shareholder owning less than five percent (5%) of the shares of a corporation whose shares are publicly traded. As used herein, the term "Competitive Business" shall mean and include any person, firm, corporation or other entity which offers services relating to the conversion or transferring of information from paper or microform to computer accessible media or which engages in document conversion, storage and/or retrieval services or which otherwise competes in any fashion with any products or services offered by Company or which it is reasonably anticipated will be offered by Company or which it is reasonably anticipated will be offered by Company in the foreseeable future. 11.02 UPON TERMINATION. As an independent covenant, Employee agrees that, for a period of one (1) year commencing upon the termination or expiration of this Agreement for any reason, he will not, unless granted express written permission by the Board of Directors of Company, directly or indirectly, own, manage, operate, join, control or participate in, or be connected with, directly or indirectly, as an officer, director, stockholder, employee, advisor, consultant, partner, owner, agent, representative or in any other capacity, any Competitive Business; PROVIDED, HOWEVER, that the foregoing shall not prohibit Employee from becoming a shareholder owning less than five percent (5%) of the shares of a corporation whose shares are publicly traded. 11.03 NO USURPATION. As an independent covenant, Employee agrees, during the term of this Agreement and, upon termination or expiration of this Agreement for any reason, for a period of one (1) year thereafter, unless granted express written permission by the Board of Directors of Company, not to divert, take, solicit and/or accept on his own behalf or on behalf of any other person, firm, company or other entity, any business of any customer or client of Company whose identity became known to Employee through his employment by or involvement with Company which constitutes business relating to the actual or reasonably anticipated business of Company. 5 11.04 COMPANY EMPLOYEES. As an independent covenant, Employee agrees, during the term of this Agreement and, upon termination or expiration of this Agreement for any reason, for a period of one (1) year thereafter, not to induce or attempt to influence any employee of Company to terminate his or her employment with Company. 11.05 REASONABLENESS. Employee acknowledges and agrees that the covenants and agreements set forth in this Section are made to protect the legitimate business interests of Company, including Company's interest in Confidential Information, and not to restrict his mobility or to prevent him from utilizing his skills. Employee recognizes and acknowledges the necessarily national and international scope of the market served by Company and agrees that the restrictions set forth in this Section are reasonable. 11.06 SURVIVAL. This Section 11 shall survive the expiration or termination of this Agreement. 12. OWNERSHIP OF DEVELOPMENTS AND WORK PRODUCTS. 12.01 DEVELOPMENT. Employee agrees that any and all Intellectual Property and any and all other material relating to the actual or reasonably anticipated business or services of Company, developed, prepared, conceived, made, discovered or suggested by Employee, solely or jointly with others, during the term of this Agreement, whether on or off the premises of Company (collectively "Developments"), including all such Developments as are originated or conceived during the term of this Agreement but which are completed or reduced to practice thereafter, shall be deemed to be "works made for hire" within the meaning of Title 17, U.S.C. 101, and shall be and remain the sole and exclusive property of Company. To the extent that any such Developments may not, by operation of law, be "works made for hire", Employee hereby assigns, transfers and conveys to Company the ownership of all right, title and interest in and to such Developments, including, without limitation, all copyrights, patents and other proprietary and property rights applicable thereto, and Company shall have the right to obtain and hold in its own name such copyrights, patents or other proprietary protection which may be available or become available in such Developments. Employee agrees that Company shall have the right to keep such Developments as trade secrets, if Company chooses. 12.02 COOPERATION. Employee agrees, at any time during the term of this Agreement and thereafter, to execute such documents and provide such additional cooperation as Company may reasonably request or require in order to perfect, evidence, protect or secure Company's right, title and interest in and to any and all such Developments. Without limiting the generality of the foregoing, either during or subsequent to Employee's employment, upon the request and at the expense of Company, and for no remuneration in addition to that due Employee hereunder pursuant to his employment by Company, Employee agrees to execute, acknowledge and deliver to Company or its attorneys any and all instruments which in the judgment of 6 Company or its attorneys may be necessary or desirable to secure or maintain for the benefit of Company adequate patent, copyright and/or other property or proprietary rights protection in the United States and/or foreign countries with respect to any Developments, including, but not limited to: (i) domestic and foreign patents, trademarks, service marks and copyright applications, (ii) any other applications for securing, protecting or registering any property or proprietary right, and (iii) powers of attorney, assignments, oaths, affirmations, supplemental oaths and sworn statements. 12.03 DISCLOSURE TO COMPANY. Employee shall, during the term of this Agreement and for a period of one (1) year thereafter, disclose promptly in writing to Company all Developments, whether copyrightable, patentable or not, made, discovered, written, conceived, first reduced to practice or developed by Employee, either alone or in conjunction with any other person or entity while employed by Company. 12.04 SURVIVAL. This Section 12 shall survive the expiration or termination of this Agreement. 13. PERFORMANCE BY EMPLOYEE. Employee acknowledges and agrees that the value of the Confidential Information and the success and long-term viability of Company depends largely upon Employee's performance of his obligation under Sections 10, 11 and 12 of this Agreement. 14. INJUNCTIVE RELIEF. Employee acknowledges and agrees that in the event of any unauthorized use or disclosure of Confidential Information in violation of the terms and conditions of Section 10 of this Agreement by Employee, or any breach of any of the terms and conditions of Sections 11 or 12 of this Agreement by Employee, Company will suffer irreparable injury not compensable by money damages and therefore will not have an adequate remedy available at law. Accordingly, if Company institutes an action or proceeding to enforce the provisions of Sections 10, 11 or 12 of this Agreement, Company shall be entitled to obtain such injunctive relief or other equitable remedy from a court of competent jurisdiction as may be necessary or appropriate to prevent or curtail any such breach, threatened or actual. The foregoing shall be in addition to and without prejudice to such other rights as Company may have at law or in equity. 15. TERMINATION. 15.01 TERMINATION. Employee's employment hereunder is terminable, with or without cause, at the will of either Company or Employee upon the giving of 30 days' prior written notice by either party. If Employee's termination is voluntary or "for cause," Company shall discontinue Employee's compensation as of the effective date of the termination of Employee's employment. If Employee's termination is involuntary and/or without cause or good reason, including, without limitation, termination resulting from the death or mental or physical 7 disability of Employee, Employee's compensation hereunder shall continue to be paid for a period of twelve (12) months from the effective date of termination of employment. For purposes of this Agreement, "for cause" shall mean: (a) Any willful or intentional act of Employee which has or will have the effect of injuring the reputation or business relationships of Company or its affiliates; (b) Employee's conviction of or entering a plea of nolo contendere to a charge of felony or a misdemeanor involving dishonesty or fraud; (c) Employee's material breach of any of the terms, covenants or conditions contained in this Agreement; PROVIDED, HOWEVER, that with respect to any breach which can be effectively cured by some act of Employee, such termination of this Agreement shall be revoked if, within fourteen (14) days after receipt of notice of such breach from Company, Employee cures such breach to the reasonable satisfaction of Company or, if such cure cannot reasonably be accomplished within such fourteen (14) day period, if Employee initiates efforts to cure such breach within such fourteen (14) day period and diligently pursues such cure efforts thereafter until such cure is accomplished; or (d) Employee's repeated or continuous failure, neglect or refusal to perform his duties under this Agreement. For purposes of this Agreement, "good reason" shall mean: (a) The assignment to Employee of a job position or title that is junior or inferior to that of Senior Vice President and Chief Financial Officer; (b) The assignment to Employee of duties that are materially different from the duties of Senior Vice President and Chief Financial Officer; (c) Any reduction in Employee's Base Salary or bonus opportunity (such bonus opportunity as defined in paragraph 5.02 above); (d) Any breach by Company of any stock option agreement to which employee is a party; (e) The Company's material breach of its obligations under this Agreement or any other plan or agreement relating to Employee's employment or compensation; (f) Any request or directive by the Company or its Board of Directors calling for Employee to commit, implement or participate in actions that are dishonest, 8 unlawful or a material violation of Company policy; (g) Any change in control (defined below); or (h) Any failure by Company to obtain the assumption of this Agreement by an assignee or successor, as required in Section 18.02 below. For purposes of this Agreement, "change in control" shall mean: A transaction or series of transactions (including any cash tender or securities exchange offer, merger, sale of asset, or other business combinations or contested election of directors, or any combination thereof) as the result of which (a) any person (other than the Company, a subsidiary of the Company, an employee benefit plan of the Company or of a subsidiary of the Company) together with all affiliates and associates of such persons (within the meaning of Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended), shall become the Beneficial Owner of 40% or more of the aggregate combined Voting Power of all Voting Securities of the Company then outstanding, or (b) during any period of two consecutive calendar years there is a change of 50% or more in the composition of the Board of Directors of the Company in office at the beginning of such two-year period except for changes approved by at least two-thirds of the directors then in office who were directors at the beginning of the period. For purposes of this Agreement, a Change of Control shall be deemed to have occurred on the date upon which either of the foregoing results is consummated or becomes effective. For purposes of this Agreement, "Voting Power" means with respect to any Voting Security the maximum number of votes that such security is or would be entitled to cast generally for the election of directors, and in the case of a convertible, exercisable, or exchangeable Voting Security, considering such security both on an unconverted, unexercised, or unexchanged basis, as the case may be. "Voting Securities" means to the common stock and any other securities of the Company entitled to vote generally for the election of directors, any security convertible into or exchangeable for or exercisable for the purchase of common stock of the Company (other than employee stock options or other employee stock purchase rights), and other securities of the Company entitled to vote generally for the election of directors. Until the effective date of termination, Employee, if requested to do so by Company, shall continue to render services to Company. 15.02 EXCESS PARACHUTE PAYMENTS. Notwithstanding the foregoing provisions of this Section 15, if Employee will be considered (as determined in the sole opinion of a national accounting firm employed by Employee) as receiving payments, any part of which constitutes excess parachute payments, such payments shall be reduced by or, if already paid, refunded to Company in the minimum amount (such minimum amount shall be determined by the national accounting firm employed by Employee, who shall interpret and apply all applicable law and regulations in the way which results in the most favorable results for Employee and who shall 9 so instruct Company of its determination) required to result in there being no excess parachute payments; PROVIDED, HOWEVER, (i) the payments to be made to Employee pursuant to this Section 15 shall be reduced first and in the manner requested by Employee, and (ii) if the compensation to be paid to Employee after the termination of his employment is reduced to $0.00 as a result of the operation of this subparagraph, no further reduction of any kind in any other payments to Employee shall be made, notwithstanding that any part of such remaining payments may constitute excess parachute payments. As used herein, the terms excess parachute payment and parachute payment shall have the same definition as such terms are given in Section 280G of the Internal Revenue Code of 1986, as amended and as may be amended after the date hereof ("IRC"), or as defined in any section of the IRC hereafter enacted to succeed Section 280G. 15.03 NO DUTY TO MITIGATE. Employee shall not be required to mitigate the amount of any post employment payment or benefit paid or provided to Employee under this Agreement by seeking other employment or otherwise, nor shall the amount of any such payment or benefit paid or provided to Employee under this Agreement be reduced or offset by any compensation earned by Employee as the result of employment by another employer or otherwise. 16. EFFECT OF TERMINATION. Upon the termination or expiration of this Agreement: (i) Employee shall immediately return to Company and all Confidential Information in his possession or control (including, without limitation, all copies thereof and all materials incorporating such Confidential Information), (ii) Employee shall have no further obligation to perform services for Company hereunder, PROVIDED, HOWEVER, that Employee shall continue to be bound by the terms of Sections 10, 11 and 12 hereof, and (iii) except to the extent specifically provided in Section 15 above, Company shall have no further obligation to compensate or provide benefits to Employee hereunder. 17. BUSINESS KNOWLEDGE AND EXPERIENCE. Notwithstanding anything to the contrary contained in this Agreement, it is specifically understood and agreed that Employee has, prior to entering into this Agreement, developed significant business expertise, ideas and experience (collectively "Business Experience") and that such Business Experience, to the extent it applies to business operations generally and not to the specific operations, technologies or trade secrets of Company, shall not be deemed to constitute Confidential Information, and nothing contained in Section 10 of this Agreement shall be deemed to prevent Employee from using such general Business Experience in such a manner as does not violate any of the other terms and conditions of this Agreement. 18. GENERAL. 18.01 SURVIVAL OF REPRESENTATIONS, WARRANTIES AND Covenants. All representations, warranties and covenants contained herein shall survive the execution of this Agreement and the consummation of the transactions contemplated hereby. 10 18.02 SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, successors, assigns and legal representatives, but shall not be assignable by Employee. Any purported assignment in violation of the foregoing shall be invalid and of no force and effect. No assignment of this Agreement shall relieve the assigning party of any obligation or liability hereunder. In the event the Company wishes to assign this Agreement, it must require the assignee expressly to assume this Agreement and agree to perform under it in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. Such assumption, however, shall not constitute a release or novation with respect to the Company's obligations hereunder. 18.03 NOTICES. Any notice, demand, payment, request, response or other communication provided for herein or given hereunder to a party hereto shall be in writing and shall be deemed to have been duly given if signed by the party giving it. Notice shall be deemed effective upon delivery by hand, or on the third business day after it is deposited in the United States mail, postage prepaid (registered or certified mail) or on the business day after it is sent by federal express or similar overnight service to the address of the parties listed below: if to Company: 565 East Swedesford Road, Suite 209 Wayne, PA 19087 if to Employee: Warren D. Barratt 1419 Evie Lane Westtown, PA 19382 or to such other address as the party to receive such communication has last designated by notice delivered to the other party in accordance with the foregoing provisions. 18.04 WAIVER. Failure or delay in insisting upon strict compliance with any provision hereof shall not be deemed a waiver of such provision or any other provision hereof with respect to prior, such provision or any other provision hereof with respect to prior, contemporaneous or subsequent occurrences. No waiver by either party of any right hereunder or of any default shall be binding upon such party unless such waiver is in writing and signed by Employee (in the case of Employee) or a duly authorized officer or partner of Company in the case of Company. 18.05 GOVERNING LAW; VENUE. This Agreement shall be governed by and construed in accordance with the laws of the state in which the corporate headquarters is located as of the date when the course of action arose or the events in question occurred. 18.06 ENTIRE AGREEMENT. Any and all previous employment agreements, 11 whether written or oral, existing between Company and Employee shall be deemed to be revoked and cancelled for all purposes on the Effective Date. This Agreement, as may be amended from time to time, shall represent the sole and entire agreement between Employee and Company respecting the employment relationship between Company and Employee. There are no representations, agreements, arrangements or understandings, oral or written, between or among the parties hereto relating to the employment relationship between Company and Employee which are not fully expressed in this Agreement. 18.07 SEVERABILITY. The provisions of this Agreement are severable and the invalidity or unenforceability of any provision hereof shall not affect the validity or enforceability of any other provision. In addition, in the event that any provision of this Agreement (or portion thereof) is determined by a court to be unenforceable as drafted by virtue of the scope, duration, extent or character of any obligation contained therein, the parties acknowledge that it is their intention that such provision (or portion thereof) shall be construed in a manner designed to effectuate the purposes of such provision to the maximum extent enforceable under applicable law. 18.08 ATTORNEY'S FEES. If any legal action or other proceeding is brought for the enforcement of this Agreement, or because of an alleged dispute, breach, default or misrepresentation in connection with any of the provisions of this Agreement, the prevailing party shall be entitled to recover reasonable attorneys' fees and other costs incurred in that action or proceeding, in addition to any other relief to which it may be entitled. 18.09 REMEDIES CUMULATIVE. All remedies provided for in this Agreement shall be cumulative and in addition to and not in lieu of any other remedies available to either party under this or any other agreement between the parties or at law, in equity or otherwise. 18.10 LANGUAGE. The language used in this Agreement shall be deemed to be language chosen by the parties hereto to express their mutual intent, and no rule of strict construction against any party shall apply to any term or condition of this Agreement. 18.11 AMENDMENT. This Agreement may not be modified or amended except by written agreement executed by all of the parties to this Agreement at the time of such amendment. 18.12 HEADINGS. The descriptive headings of the sections, paragraphs and subparagraphs hereof are inserted for convenience only and do not constitute a part of this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. DOCUCON, INCORPORATED ("Company") 12 _______________________________ By: /s/ DOUGLAS P. GILL Warren D. Barratt ("Employee") Its: PRESIDENT AND CHIEF EXECUTIVE OFFICER 13 EX-10.17 3 EXHIBIT 10.17 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT ("Agreement") is made and entered as of the 4th day of January, 1999 by and between Docucon, Incorporated, a corporation organized and existing under the laws of the State of Delaware ("Company"), and Paul M. Nunley, an individual residing in Glenmore, Pennsylvania ("Employee"). FOR AND IN CONSIDERATION of the mutual covenants herein contained and the mutual benefits to be gained by the performance thereof and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. INTRODUCTION. It is the intent and purpose of Company and Employee to specify in this Agreement the terms and conditions of Employee's employment with Company. 2. EMPLOYMENT. Company hereby employs Employee and Employee hereby accepts employment with Company on the terms and conditions herein set forth. In consideration of Employee's employment by Company, Employee agrees to the terms, conditions and covenants of this Agreement. 3. TERM OF EMPLOYMENT. This Agreement shall be effective as of January 4, 1999 and shall continue through the third anniversary of such date. 4. DUTIES AND RESPONSIBILITIES. Employee is hereby employed as, and shall serve in the capacity of, Vice President, Operations and Technology of Company. Employee shall have the duties and responsibilities normally performed by an executive officer in such position, and shall perform services commensurate with such position for Company as may be determined from time to time by the Board of Directors of Company. Employee shall report to the President/Chief Executive Officer of Company and shall perform services hereunder as directed by the President/Chief Executive Officer of Company. During the term of this Agreement Employee's primary business interest shall be the Company, and Employee shall devote such of his time, attention, skills and energies as may be necessary to discharge his duties and responsibilities hereunder. Employee shall, in the performance of services hereunder, use his best efforts to serve and advance the interest of Company well and faithfully. 5. COMPENSATION AND BENEFITS. The compensation and other benefits payable to or accruing to Employee under this Agreement shall constitute the full consideration to be paid to Employee for all services to be rendered by Employee to Company and all other agreements of Employee hereunder. 1 5.01 SALARY. As compensation for all services of whatever type rendered by Employee in the performance of these duties under this Agreement and for all other agreements and undertakings of Employee hereunder, Company shall pay to Employee a minimum annual salary as set forth in this Section 5.01. Employee's annual salary ("Base Salary") shall initially be One Hundred Thirty Thousand Dollars ($130,000.00). Such Base Salary shall be payable in equal regular installments in accordance with Company's customary payroll payment policy. Employee's Base Salary will be reviewed annually by the Compensation Committee of the Board of Directors of the Company for adjustment based on performance in accordance with Company's normal compensation policies and practices. Employee's Base Salary shall never be decreased below its then current level. It is specifically understood and agreed that a portion of Employee's Base Salary hereunder is attributable to Employee's agreement, pursuant to Section 10 hereof, to maintain the confidentiality of "Confidential Information" (as herein defined), both during and after the term of this Agreement, and that Employee's Base Salary would be reduced significantly if Employee did not agree to be bound by the terms of Section 10. It is further understood and agreed that a portion of Employee's annual salary is attributable to Employee's agreement, pursuant to Section 11 hereof, not to compete with Company either during or for a specified period of time after the expiration or termination of this Agreement and that Employee's Base Salary would be reduced significantly if Employee did not agree to be bound by the terms of Section 11 hereof. Employee agrees that he is being fairly and reasonable compensated for the agreements undertaken by Employee pursuant to Sections 10 and 11 hereof. 5.02 BONUS. In addition to the Base Salary set forth above, Employee shall be eligible for a targeted annual bonus of 50% of Employee's Base Salary, the amount of such annual bonus to be determined by the Compensation Committee of the Board of Directors. Such annual bonus will be paid not later than one hundred twenty (120) days after the end of the Company's fiscal year. 5.03 BENEFITS. Employee shall be entitled to a paid vacation each year of not less than four (4) weeks, the times for such vacation to be mutually agreed upon by Employee and Company. As an executive officer of Company, Employee shall be entitled to participate in the Company benefit programs designed for Company employees with similar salaries, duties and/or responsibilities. 5.04 EXPENSES. Company shall pay or reimburse Employee for all reasonable and necessary expenses actually incurred or paid by Employee during the term of this Agreement in the performance of Employee's services under this Agreement, upon presentation of expense statements or vouchers or such other supporting documents as Company may reasonably require. 5.05 STOCK OPTIONS. On January 11, 1999, Company shall award to Employee stock options to purchase (i) up to 25,000 shares of common stock of the Company under the 1998 Employee Stock Option Plan and (ii) up to 75,000 shares of common stock of the Company under 2 the 1998 Executive Non-Statutory Plan. The terms and conditions of the foregoing stock options and awards shall be governed exclusively by the applicable plan and related stock option agreements. Acceptance by Employee of the form and terms (including but not limited to option price and exercise and vesting rights) of agreements to be executed with respect to the award of stock options specified above is a condition precedent to effectiveness of this Agreement. 6. INSURANCE. Company may, in its sole and absolute discretion, at any time after the Effective Date, apply for and procure, as owner and for its own benefit, insurance on the life of Employee, in such amounts and in such forms as Company may choose. Employee shall have no interest whatsoever in any insurance policy or policies obtained by Company, but Employee shall, at Company's request, submit to such medical examinations, supply such information and execute and deliver such documents as may be required or reasonably requested by Company or the insurance company or companies to which Company has applied for such insurance. 7. REPRESENTATIONS, WARRANTIES AND AGREEMENTS. Employee represents, warrants and agrees that: (i) Employee is not currently bound by any employment agreement, restriction or other obligation of any kind which would in any way materially interfere with or be inconsistent with the services to be provided by Employee to Company hereunder, (ii) Employee will not, during the term of this Agreement, become engaged as an employee, consultant, independent contractor or representative or in any other capacity or otherwise perform services of any kind for any person or entity or assume any such obligations or restrictions, in whatever capacity, which would in any way materially interfere with or be inconsistent with the services to be provided by Employee to Company hereunder; and, (iii) Employee is free to enter into this Agreement and the services and work product provided by Employee to Company hereunder will be original works of Employee and no portion of such services or work product, or the use or distribution thereof by Company, violates or will violate, or is or will be protected by, the right, title or interest of any patent, copyright, license or other similar property or proprietary right of any third person or entity. The representations contained in this Section shall survive the expiration or termination of this Agreement. 8. REGULATIONS AND POLICIES. Employee shall, during the term of this Agreement, comply with all Company regulations and policies, including, without limitation, security regulations. 9. CONFIDENTIAL INFORMATION. The term "Confidential Information", as used herein, shall mean and include any and all documents, knowledge, data or information (in whatever medium) know, communicated, provided or made available to Employee, whether before or after the execution of this Agreement, which are marked with a confidentiality legend by Company or which Employee knows or reasonably should know constitute trade secrets of Company or information belonging to third parties to whom Company may have an obligation of confidentiality or which embody, comprise, relate to, are incorporated in or constitute 3 "Intellectual Property" (as herein defined) in any stage of development; including, in each case, all trade secrets and other proprietary ideas, concepts, know-how, methodologies and information incorporated therein; PROVIDED, HOWEVER, that Confidential Information shall not include any information or materials which are or become generally available to the public other than as a result of any breach of the provisions of this Agreement or any other agreement between Employee and Company (or their respective successors, assigns or affiliates). The term "Intellectual Property", as used herein, shall include any and all information or materials, in any medium, of a technical or a business nature relating to the actual or reasonably anticipated business of Company, such as ideas, discoveries, designs, inventions, improvements, trade secrets, know-how, manufacturing processes, product formulae, design specifications, writings and other works of authorship, computer software, financial figures, marketing plans, customer lists and data, business plans or methods and any other material relating to the actual or reasonably anticipated business of the Company. In connection with computer software, the term "Intellectual Property" shall include, without limitation, the data bases, data processing and communications networking systems, practices and procedures and other internal systems, logic and controls, and the object code, source code, source listings, programming systems, programming or systems documentation and specifications, and user, operations or systems manuals or documentation related thereto or incorporated therein, firmware, models, sketches, writings, flow charts, diagrams, graphs or data related thereto, together with all modifications, enhancements, improvements, accessions, amendments, supplements or other additions to any of the foregoing. 10. CONFIDENTIALITY. Employee acknowledges and agrees that in his employment by Company he occupies a position of trust and confidence and that during the term of his employment under this Agreement he will have access to and will become familiar with Company's Confidential Information. Employee further acknowledges and agrees that the Confidential Information, including any and all copies thereof, constitutes trade secrets of Company and is confidential and proprietary information of Company. Employee further acknowledges and agrees that he has no right, title, interest or claim in or to any of the Confidential Information or any copies thereof. Employee agrees to maintain the confidentiality of the Confidential Information and agrees that he will not take, or permit to be taken, any action with respect to the Confidential Information (or any portion thereof) which is inconsistent with the confidential and proprietary nature of such information. Without limiting the generality of the foregoing, Employee agrees that he will not, directly or indirectly, without the prior specific written consent of Company, except as specifically required in the course of his employment, (i) communicate, divulge, transmit or otherwise disclose any Confidential Information to any person, firm, partnership, corporation or other entity, or (ii) use any confidential Information in any manner except as specifically required in connection with the performance of services hereunder, or 4 (iii) copy, reproduce or otherwise duplicate any Confidential Information in any fashion, in whole or in part. Employee agrees to take any and all steps reasonably necessary to protect the confidentiality of the Confidential Information. Employee shall, upon termination of this Agreement, immediately return to Company all Confidential Information in Employee's control or possession, including, without limitation, any and all copies thereof. This Section shall survive the expiration or termination of this Agreement. 11. RESTRICTIVE COVENANT AND NONCOMPETITION. 11.01 NONCOMPETE. During the term of this Agreement, Employee shall not, directly or indirectly, own, manage, operate, join, control or participate in, or be connected with, directly or indirectly, as an officer, director, stockholder, employee, advisor, consultant, partner, owner, agent, representative or in any other capacity, any "Competitive Business"; PROVIDED, HOWEVER, that the foregoing shall not prohibit Employee from becoming a shareholder owning less than five percent (5%) of the shares of a corporation whose shares are publicly traded. As used herein, the term "Competitive Business" shall mean and include any person, firm, corporation or other entity which offers services relating to the conversion or transferring of information from paper or microform to computer accessible media or which engages in document conversion, storage and/or retrieval services or which otherwise competes in any fashion with any products or services offered by Company or which it is reasonably anticipated will be offered by Company or which it is reasonably anticipated will be offered by Company in the foreseeable future. 11.02 UPON TERMINATION. As an independent covenant, Employee agrees that, for a period of one (1) year commencing upon the termination or expiration of this Agreement for any reason, he will not, unless granted express written permission by the Board of Directors of Company, directly or indirectly, own, manage, operate, join, control or participate in, or be connected with, directly or indirectly, as an officer, director, stockholder, employee, advisor, consultant, partner, owner, agent, representative or in any other capacity, any Competitive Business; PROVIDED, HOWEVER, that the foregoing shall not prohibit Employee from becoming a shareholder owning less than five percent (5%) of the shares of a corporation whose shares are publicly traded. 11.03 NO USURPATION. As an independent covenant, Employee agrees, during the term of this Agreement and, upon termination or expiration of this Agreement for any reason, for a period of one (1) year thereafter, unless granted express written permission by the Board of Directors of Company, not to divert, take, solicit and/or accept on his own behalf or on behalf of any other person, firm, company or other entity, any business of any customer or client of Company whose identity became known to Employee through his employment by or involvement with Company which constitutes business relating to the actual or reasonably anticipated business of Company. 5 11.04 COMPANY EMPLOYEES. As an independent covenant, Employee agrees, during the term of this Agreement and, upon termination or expiration of this Agreement for any reason, for a period of one (1) year thereafter, not to induce or attempt to influence any employee of Company to terminate his or her employment with Company. 11.05 REASONABLENESS. Employee acknowledges and agrees that the covenants and agreements set forth in this Section are made to protect the legitimate business interests of Company, including Company's interest in Confidential Information, and not to restrict his mobility or to prevent him from utilizing his skills. Employee recognizes and acknowledges the necessarily national and international scope of the market served by Company and agrees that the restrictions set forth in this Section are reasonable. 11.06 SURVIVAL. This Section 11 shall survive the expiration or termination of this Agreement. 12. OWNERSHIP OF DEVELOPMENTS AND WORK PRODUCTS. 12.01 DEVELOPMENT. Employee agrees that any and all Intellectual Property and any and all other material relating to the actual or reasonably anticipated business or services of Company, developed, prepared, conceived, made, discovered or suggested by Employee, solely or jointly with others, during the term of this Agreement, whether on or off the premises of Company (collectively "Developments"), including all such Developments as are originated or conceived during the term of this Agreement but which are completed or reduced to practice thereafter, shall be deemed to be "works made for hire" within the meaning of Title 17, U.S.C. 101, and shall be and remain the sole and exclusive property of Company. To the extent that any such Developments may not, by operation of law, be "works made for hire", Employee hereby assigns, transfers and conveys to Company the ownership of all right, title and interest in and to such Developments, including, without limitation, all copyrights, patents and other proprietary and property rights applicable thereto, and Company shall have the right to obtain and hold in its own name such copyrights, patents or other proprietary protection which may be available or become available in such Developments. Employee agrees that Company shall have the right to keep such Developments as trade secrets, if Company chooses. 12.02 COOPERATION. Employee agrees, at any time during the term of this Agreement and thereafter, to execute such documents and provide such additional cooperation as Company may reasonably request or require in order to perfect, evidence, protect or secure Company's right, title and interest in and to any and all such Developments. Without limiting the generality of the foregoing, either during or subsequent to Employee's employment, upon the request and at the expense of Company, and for no remuneration in addition to that due Employee hereunder pursuant to his employment by Company, Employee agrees to execute, acknowledge and deliver to Company or its attorneys any and all instruments which in the judgment of 6 Company or its attorneys may be necessary or desirable to secure or maintain for the benefit of Company adequate patent, copyright and/or other property or proprietary rights protection in the United States and/or foreign countries with respect to any Developments, including, but not limited to: (i) domestic and foreign patents, trademarks, service marks and copyright applications, (ii) any other applications for securing, protecting or registering any property or proprietary right, and (iii) powers of attorney, assignments, oaths, affirmations, supplemental oaths and sworn statements. 12.03 DISCLOSURE TO COMPANY. Employee shall, during the term of this Agreement and for a period of one (1) year thereafter, disclose promptly in writing to Company all Developments, whether copyrightable, patentable or not, made, discovered, written, conceived, first reduced to practice or developed by Employee, either alone or in conjunction with any other person or entity while employed by Company. 12.04 SURVIVAL. This Section 12 shall survive the expiration or termination of this Agreement. 13. PERFORMANCE BY EMPLOYEE. Employee acknowledges and agrees that the value of the Confidential Information and the success and long-term viability of Company depends largely upon Employee's performance of his obligation under Sections 10, 11 and 12 of this Agreement. 14. INJUNCTIVE RELIEF. Employee acknowledges and agrees that in the event of any unauthorized use or disclosure of Confidential Information in violation of the terms and conditions of Section 10 of this Agreement by Employee, or any breach of any of the terms and conditions of Sections 11 or 12 of this Agreement by Employee, Company will suffer irreparable injury not compensable by money damages and therefore will not have an adequate remedy available at law. Accordingly, if Company institutes an action or proceeding to enforce the provisions of Sections 10, 11 or 12 of this Agreement, Company shall be entitled to obtain such injunctive relief or other equitable remedy from a court of competent jurisdiction as may be necessary or appropriate to prevent or curtail any such breach, threatened or actual. The foregoing shall be in addition to and without prejudice to such other rights as Company may have at law or in equity. 15. TERMINATION. 15.01 TERMINATION. Employee's employment hereunder is terminable, with or without cause, at the will of either Company or Employee upon the giving of 30 days' prior written notice by either party. If Employee's termination is voluntary or "for cause," Company shall discontinue Employee's compensation as of the effective date of the termination of Employee's employment. If Employee's termination is involuntary and/or without cause or good reason, including, without limitation, termination resulting from the death or mental or physical 7 disability of Employee, Employee's compensation hereunder shall continue to be paid for a period of twelve (12) months from the effective date of termination of employment. For purposes of this Agreement, "for cause" shall mean: (a) Any willful or intentional act of Employee which has or will have the effect of injuring the reputation or business relationships of Company or its affiliates; (b) Employee's conviction of or entering a plea of nolo contendere to a charge of felony or a misdemeanor involving dishonesty or fraud; (c) Employee's material breach of any of the terms, covenants or conditions contained in this Agreement; PROVIDED, HOWEVER, that with respect to any breach which can be effectively cured by some act of Employee, such termination of this Agreement shall be revoked if, within fourteen (14) days after receipt of notice of such breach from Company, Employee cures such breach to the reasonable satisfaction of Company or, if such cure cannot reasonably be accomplished within such fourteen (14) day period, if Employee initiates efforts to cure such breach within such fourteen (14) day period and diligently pursues such cure efforts thereafter until such cure is accomplished; or (d) Employee's repeated or continuous failure, neglect or refusal to perform his duties under this Agreement. For purposes of this Agreement, "good reason" shall mean: (a) The assignment to Employee of a job position or title that is junior or inferior to that of Vice President Operations and Technology; (b) The assignment to Employee of duties that are materially different from the duties of Vice President Operations and Technology; (c) Any reduction in Employee's Base Salary or bonus opportunity (such bonus opportunity as defined in paragraph 5.02 above); (d) Any breach by Company of any stock option agreement to which employee is a party; (e) The Company's material breach of its obligations under this Agreement or any other plan or agreement relating to Employee's employment or compensation; (f) Any request or directive by the Company or its Board of Directors calling for Employee to commit, implement or participate in actions that are dishonest, 8 unlawful or a material violation of Company policy; (g) Any change in control (defined below); or (h) Any failure by Company to obtain the assumption of this Agreement by an assignee or successor, as required in Section 18.02 below. For purposes of this Agreement, "change in control" shall mean: A transaction or series of transactions (including any cash tender or securities exchange offer, merger, sale of asset, or other business combinations or contested election of directors, or any combination thereof) as the result of which (a) any person (other than the Company, a subsidiary of the Company, an employee benefit plan of the Company or of a subsidiary of the Company) together with all affiliates and associates of such persons (within the meaning of Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended), shall become the Beneficial Owner of 40% or more of the aggregate combined Voting Power of all Voting Securities of the Company then outstanding, or (b) during any period of two consecutive calendar years there is a change of 50% or more in the composition of the Board of Directors of the Company in office at the beginning of such two-year period except for changes approved by at least two-thirds of the directors then in office who were directors at the beginning of the period. For purposes of this Agreement, a Change of Control shall be deemed to have occurred on the date upon which either of the foregoing results is consummated or becomes effective. For purposes of this Agreement, "Voting Power" means with respect to any Voting Security the maximum number of votes that such security is or would be entitled to cast generally for the election of directors, and in the case of a convertible, exercisable, or exchangeable Voting Security, considering such security both on an unconverted, unexercised, or unexchanged basis, as the case may be. "Voting Securities" means to the common stock and any other securities of the Company entitled to vote generally for the election of directors, any security convertible into or exchangeable for or exercisable for the purchase of common stock of the Company (other than employee stock options or other employee stock purchase rights), and other securities of the Company entitled to vote generally for the election of directors. Until the effective date of termination, Employee, if requested to do so by Company, shall continue to render services to Company. 15.02 EXCESS PARACHUTE PAYMENTS. Notwithstanding the foregoing provisions of this Section 15, if Employee will be considered (as determined in the sole opinion of a national accounting firm employed by Employee) as receiving payments, any part of which constitutes excess parachute payments, such payments shall be reduced by or, if already paid, refunded to Company in the minimum amount (such minimum amount shall be determined by the national accounting firm employed by Employee, who shall interpret and apply all applicable law and regulations in the way which results in the most favorable results for Employee and who shall 9 so instruct Company of its determination) required to result in there being no excess parachute payments; PROVIDED, HOWEVER, (i) the payments to be made to Employee pursuant to this Section 15 shall be reduced first and in the manner requested by Employee, and (ii) if the compensation to be paid to Employee after the termination of his employment is reduced to $0.00 as a result of the operation of this subparagraph, no further reduction of any kind in any other payments to Employee shall be made, notwithstanding that any part of such remaining payments may constitute excess parachute payments. As used herein, the terms excess parachute payment and parachute payment shall have the same definition as such terms are given in Section 280G of the Internal Revenue Code of 1986, as amended and as may be amended after the date hereof ("IRC"), or as defined in any section of the IRC hereafter enacted to succeed Section 280G. 15.03 NO DUTY TO MITIGATE. Employee shall not be required to mitigate the amount of any post employment payment or benefit paid or provided to Employee under this Agreement by seeking other employment or otherwise, nor shall the amount of any such payment or benefit paid or provided to Employee under this Agreement be reduced or offset by any compensation earned by Employee as the result of employment by another employer or otherwise. 16. EFFECT OF TERMINATION. Upon the termination or expiration of this Agreement: (i) Employee shall immediately return to Company and all Confidential Information in his possession or control (including, without limitation, all copies thereof and all materials incorporating such Confidential Information), (ii) Employee shall have no further obligation to perform services for Company hereunder, PROVIDED, HOWEVER, that Employee shall continue to be bound by the terms of Sections 10, 11 and 12 hereof, and (iii) except to the extent specifically provided in Section 15 above, Company shall have no further obligation to compensate or provide benefits to Employee hereunder. 17. BUSINESS KNOWLEDGE AND EXPERIENCE. Notwithstanding anything to the contrary contained in this Agreement, it is specifically understood and agreed that Employee has, prior to entering into this Agreement, developed significant business expertise, ideas and experience (collectively "Business Experience") and that such Business Experience, to the extent it applies to business operations generally and not to the specific operations, technologies or trade secrets of Company, shall not be deemed to constitute Confidential Information, and nothing contained in Section 10 of this Agreement shall be deemed to prevent Employee from using such general Business Experience in such a manner as does not violate any of the other terms and conditions of this Agreement. 18. GENERAL. 18.01 SURVIVAL OF REPRESENTATIONS, WARRANTIES AND Covenants. All representations, warranties and covenants contained herein shall survive the execution of this Agreement and the consummation of the transactions contemplated hereby. 10 18.02 SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, successors, assigns and legal representatives, but shall not be assignable by Employee. Any purported assignment in violation of the foregoing shall be invalid and of no force and effect. No assignment of this Agreement shall relieve the assigning party of any obligation or liability hereunder. In the event the Company wishes to assign this Agreement, it must require the assignee expressly to assume this Agreement and agree to perform under it in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. Such assumption, however, shall not constitute a release or novation with respect to the Company's obligations hereunder. 18.03 NOTICES. Any notice, demand, payment, request, response or other communication provided for herein or given hereunder to a party hereto shall be in writing and shall be deemed to have been duly given if signed by the party giving it. Notice shall be deemed effective upon delivery by hand, or on the third business day after it is deposited in the United States mail, postage prepaid (registered or certified mail) or on the business day after it is sent by federal express or similar overnight service to the address of the parties listed below: if to Company: 565 East Swedesford Road, Suite 209 Wayne, PA 19087 if to Employee: Paul M. Nunley 110 Waterview Drive Glenmore, Pa. 19343 or to such other address as the party to receive such communication has last designated by notice delivered to the other party in accordance with the foregoing provisions. 18.04 WAIVER. Failure or delay in insisting upon strict compliance with any provision hereof shall not be deemed a waiver of such provision or any other provision hereof with respect to prior, such provision or any other provision hereof with respect to prior, contemporaneous or subsequent occurrences. No waiver by either party of any right hereunder or of any default shall be binding upon such party unless such waiver is in writing and signed by Employee (in the case of Employee) or a duly authorized officer or partner of Company in the case of Company. 18.05 GOVERNING LAW; VENUE. This Agreement shall be governed by and construed in accordance with the laws of the state in which the corporate headquarters is located as of the date when the course of action arose or the events in question occurred. 18.06 ENTIRE AGREEMENT. Any and all previous employment agreements, 11 whether written or oral, existing between Company and Employee shall be deemed to be revoked and cancelled for all purposes on the Effective Date. This Agreement, as may be amended from time to time, shall represent the sole and entire agreement between Employee and Company respecting the employment relationship between Company and Employee. There are no representations, agreements, arrangements or understandings, oral or written, between or among the parties hereto relating to the employment relationship between Company and Employee which are not fully expressed in this Agreement. 18.07 SEVERABILITY. The provisions of this Agreement are severable and the invalidity or unenforceability of any provision hereof shall not affect the validity or enforceability of any other provision. In addition, in the event that any provision of this Agreement (or portion thereof) is determined by a court to be unenforceable as drafted by virtue of the scope, duration, extent or character of any obligation contained therein, the parties acknowledge that it is their intention that such provision (or portion thereof) shall be construed in a manner designed to effectuate the purposes of such provision to the maximum extent enforceable under applicable law. 18.08 ATTORNEY'S FEES. If any legal action or other proceeding is brought for the enforcement of this Agreement, or because of an alleged dispute, breach, default or misrepresentation in connection with any of the provisions of this Agreement, the prevailing party shall be entitled to recover reasonable attorneys' fees and other costs incurred in that action or proceeding, in addition to any other relief to which it may be entitled. 18.09 REMEDIES CUMULATIVE. All remedies provided for in this Agreement shall be cumulative and in addition to and not in lieu of any other remedies available to either party under this or any other agreement between the parties or at law, in equity or otherwise. 18.10 LANGUAGE. The language used in this Agreement shall be deemed to be language chosen by the parties hereto to express their mutual intent, and no rule of strict construction against any party shall apply to any term or condition of this Agreement. 18.11 AMENDMENT. This Agreement may not be modified or amended except by written agreement executed by all of the parties to this Agreement at the time of such amendment. 18.12 HEADINGS. The descriptive headings of the sections, paragraphs and subparagraphs hereof are inserted for convenience only and do not constitute a part of this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. DOCUCON, INCORPORATED ("Company") 12 _______________________________ By: DOUGLAS P. GILL Paul M. Nunley ("Employee") Its: PRESIDENT AND CHIEF EXECUTIVE OFFICER EX-11 4 EXHIBIT 11 DOCUCON, INCORPORATED COMPUTATION OF EARNINGS (LOSS) PER SHARE
YEAR ENDED DECEMBER 31 -------------------------- 1998 1997 ----------- ----------- COMPUTATION OF BASIC EARNINGS (LOSS) PER SHARE: Net loss from continuing operations ...................... $(5,085,694) $ (277,439) Less- Preferred stock dividend requirements ............. (27,462) (46,420) ----------- ----------- Net loss from continuing operations applicable to common stockholders ............................................ (5,113,156) (323,859) Net income from discontinued operations applicable to common stockholders ..................................... -- 3,702,688 ----------- ----------- Net income (loss) applicable to common stockholders used for computation .............. $(5,113,156) $ 3,378,829 =========== =========== WEIGHTED AVERAGE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING USED FOR COMPUTATION ......................... 3,300,056 3,130,371 =========== =========== Basic loss from continuing operations per common share ... $ (1.55) $ (.10) Basic earnings from discontinued operations per common share ................................................... -- 1.18 ----------- ----------- BASIC EARNINGS (LOSS) PER COMMON SHARE ..................... $ (1.55) $ 1.08 =========== =========== COMPUTATION OF DILUTED EARNINGS (LOSS) PER SHARE: Net loss from continuing operations ...................... $(5,085,694) $ (277,439) Preferred stock dividend requirements .................... (27,462) (46,420) Decrease in net loss applicable to common stock for preferred stock dividends not incurred upon assumed conversion of preferred stock ........................... 27,462 46,420 ----------- ----------- Net loss from continuing operations applicable to common stockholders used for computation ....... (5,085,694) (277,439) Net income from discontinued operations applicable to common stockholders ..................................... -- 3,702,688 ----------- ----------- Net income (loss) applicable to common stockholders used for computation .............. $(5,085,694) $ 3,425,249 =========== =========== Weighted average number of shares of common stock outstanding ............................................. 3,300,056 3,130,371 Weighted average incremental shares outstanding upon assumed conversion of options and warrants .............. 91,073 127,983 Weighted average incremental shares outstanding upon assumed conversion of the preferred stock ............... 82,975 140,683 ----------- ----------- WEIGHTED AVERAGE NUMBER OF SHARES OF COMMON STOCK AND COMMON STOCK EQUIVALENTS OUTSTANDING USED FOR COMPUTATION .............................................. 3,474,104 3,399,037 =========== ===========
EXHIBIT 11 (Continued) -2- YEAR ENDED DECEMBER 31 ---------------------- 1998 1997 ----- ----- Diluted loss from continuing operations per common share and common share equivalents ......... $(1.46)(a) $(.08)(a) Diluted earnings from discontinued operations per common share and common share equivalents ..... -- 1.09 ----- ----- DILUTED EARNINGS (LOSS) PER COMMON SHARE AND COMMON SHARE EQUIVALENTS ........................... $(1.46)(a) $1.01 ===== ===== (a) This calculation is submitted in accordance with Item 601(b)(11) of Regulation S-K although it is not required by SFAS No. 128 because it is antidilutive. EX-23 5 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report, included in this Form 10-KSB, into the Company's previously filed Registration Statement on Form S-8 (File No. 1-10185). /S/ ARTHUR ANDERSEN LLP San Antonio, Texas March 25, 1999 EX-27 6
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM DOCUCON, INCORPORATED'S BALANCE SHEET AS OF DECEMBER 31, 1998, AND ITS STATEMENT OF OPERATIONS FOR THE YEAR THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 1,082,321 0 2,545,911 1,604,444 0 3,816,176 5,111,573 4,704,152 4,272,493 2,451,137 345,617 0 7 33,062 1,442,670 4,272,493 2,693,497 2,693,497 2,626,315 2,626,315 1,667,412 1,600,000 193,892 (5,110,574) (24,880) (5,085,694) 0 0 0 (5,113,156) 0 0
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