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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB/A
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________.
</TABLE>
COMMISSION FILE NUMBER 0-21013
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XYBERNAUT CORPORATION
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
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DELAWARE 54-1799851
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
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<S> <C>
12701 FAIR LAKES CIRCLE,
FAIRFAX, VA 22033
(Address of principal executive offices) (Zip Code)
</TABLE>
(703) 631-6925
(Issuer's telephone number, including area code)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: none
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common stock, $0.01 par value
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 contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB: [ ]
State issuer's revenues for its most recent fiscal year: $3,340,272
The aggregate market value at March 14, 2000 of the Common Stock of the
issuer, its only class of voting stock, was $842,505,431 of which $741,625,710
was held by non-affiliates, calculated on the basis of the closing price of such
stock on the National Association of Securities Dealers Automated Quotation
System Small Cap Market on that date. Such market value of non-affiliates
excludes shares owned by all executive officers and directors (but includes
shares owned by their spouses); this should not be construed as indicating that
all such persons are affiliates.
The number of shares outstanding of the issuer's Common Stock at March 14,
2000 was 36,730,482.
DOCUMENTS INCORPORATED BY REFERENCE: NONE
Transitional Small Business Disclosure Format Yes [ ] No [X]
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PART I
ITEM 1. BUSINESS.
INTRODUCTION
Xybernaut Corporation, a Delaware corporation (the "Company"), is engaged
in the research, development and commercialization of mobile computing and
communication systems along with related software solutions designed to enhance
personal productivity and improve the accuracy, timeliness and utilization of
captured data. The Company's current mobile computing and communications product
is the Mobile Assistant(R) IV (MA IV(R)) model.
The MA IV is a wearable Pentium(R) PC which combines the speed, memory,
processing, multimedia and communications capabilities of a desktop personal
computer ("PC") in a lightweight, user-supported unit with hands-free operation
and simultaneous user mobility. The MA IV is a combination of hardware and
software designed to be worn on the body to perform complex and time consuming
tasks such as remote video teleconferencing, installation, maintenance, repair
and inspection of complex technological and mechanical systems, retrieval and
analysis of medical information from remote locations, and coordination of
remote commercial and industrial activities, or military field operations.
The MA IV incorporates technologically advanced optional features such as
real-time, two-way video and audio communications through radio frequency
transmissions or integrated cellular linkups, global positioning system tracking
capabilities and access to information through the Internet and World Wide Web.
The head-mounted display ("HMD") unit includes a two-way audio system and
optional built-in video camera, weighs approximately l5 ounces and presents a
desk-top quality full VGA color image that is approximately equivalent to that
of a 15" VGA monitor at a distance of two feet. An optional light-weight, 6.4
inch, full VGA color, flat panel display ("FPD"), with integrated digitizer, is
offered for users who either do not desire an HMD, do not need to be hands-free
to perform their job, or need to capture signatures and other forms-related
data. The body-worn computing unit is designed to allow operation in
environmental conditions in which conventional portable computers could not
previously operate, weighs less than two pounds and is designed to run software
applications designed for Microsoft(R) Windows(R) 3.11, Windows 95, 98, Windows
NT(TM), DOS, SCO UNIX(R) and LINUX.
The Company currently offers a multi-media development toolkit and the
linkAssist(TM) software package, which is designed to get user documentation up
and running on the Mobile Assistant(R), or any PC, quickly by providing a
windows-style graphical user interface ("GUI") and the ability to link data
stored in most formats in most locations without disturbing the original data.
This software can also be used on conventional desktop or laptop computers and
features automatic speech enablement of hyperlinks across platforms, formats,
and media. The Company has also established a professional services group to
provide custom solutions development for its customers and to provide needs
assessment and implementation assistance for solutions involving wearable
applications.
The Company's executive and administrative offices are located at 12701
Fair Lakes Circle, Fairfax, Virginia 22033. Its telephone number is (703)
631-6925, and its e-mail address for investor inquiries is
[email protected].
FORWARD-LOOKING STATEMENTS
To keep investors informed of the Company's future plans and objectives,
this Annual Report on Form 10-KSB (and other reports and statements issued by
the Company and its officers from time to time) contain certain statements
concerning the Company's future results, future performance, intentions,
objectives, plans and expectations that are or may be deemed to be
"forward-looking statements." The Company's ability to do this has been fostered
by the Private Securities Litigation Reform Act of 1995 which provides a "safe
harbor" for forward-looking statements to encourage companies to provide
prospective information so long as those statements are accompanied by
meaningful cautionary statements identifying important factors that could cause
actual results to differ materially from those discussed in the statement. Such
forward-
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looking statements are subject to a number of known and unknown risks and
uncertainties that, in addition to general economic and business conditions,
could cause the Company's actual results, performance, and achievements to
differ materially from those described or implied in the forward-looking
statements. Factors that could cause or contribute to such differences include,
but are not limited to, the Company's ability to profit from the Mobile
Assistant(R) as expected (see "Products and Product Development"), the Company's
ability to meet competition (see "Competition"), the Company's ability to
maintain superior technological capability, foreseeing changes and continuing to
identify, develop and commercialize innovative and competitive products and
systems (see "Research and Development"), the Company's ability to penetrate
different markets and successfully expand its market base (see "Marketing and
Sales"), the Company's ability to attract and retain technologically qualified
personnel, particularly in the areas of research and development (see
"Employees"), and the Company's ability to generate cash flows and obtain
financing to support its operations and growth (see "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in Item 7 of this
Annual Report on Form 10-KSB).
INDUSTRY OVERVIEW
There has been an ongoing evolution to personalize the computer by moving
it physically closer to the user, from mainframes, to distributed systems, to
desktops, to notebooks and now to wearable systems. The commercialization of
mobile computing products combined with significant increases in the number and
scope of software applications has resulted in a multi-billion dollar market. In
addition, the rapid growth in the World Wide Web of the Internet has resulted in
computers increasingly being used as communication tools as well as computing
tools. Advances in wireless communications have accelerated this convergence of
computing and communications as cell phones and personal digital assistants
("PDAs") have added computing or wireless communicating capabilities to serve as
such convergence devices for mobile use. Wireless local area networks ("LANs")
now operate at sufficient speeds to allow the Company's MA IV to function as
"just another node on the network" by running existing desktop applications in a
wireless mode on a network with little to no modification.
The Company believes that users looking for mobile computing and
communications capabilities through cellular phones, pagers, PDAs, portable
email devices and portable computers will increasingly demand that one device
provide these capabilities rather than the many devices that are currently
required. The Company believes that its wearable PC products are uniquely suited
to meet this demand, that limited-capability or special-purpose devices will
eventually be replaced by wearable PCs that provide consistent interfaces and
full functionality no matter whether they are used in an office, travel, home or
automobile environment. The Company believes that the potential to develop a
substantial market for its mobile computing and communication hardware and
software products is demonstrated by the substantial historic and projected
growth in all forms of mobile computing and communication devices.
In conjunction with this personalization of hardware has come a
personalization of software to provide the user with the information they need
to perform the task at hand and the expansion of Enterprise Resource Planning
("ERP") systems that extend computing capabilities across an organization, not
just within certain functions of the organization. A recent study by IDC on
wearable computers stated that approximately half of the workers at large U.S.
companies do not work at a fixed location and do not have access to their
company's information technology as they move around. A study by the Gartner
Group concluded that 137 million workers worldwide do not work at a fixed
location. The Company believes that its products and services are ideally
positioned to provide information access to this pool of workers, and allow the
companies in this situation to leverage their existing investment in information
technology to this "other half" of their workforce. Further, the Company
believes that its products and services are also ideally suited to capture the
growing consumer interest in computing and communications devices.
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BUSINESS STRATEGY
The Company's objective is to be the leading provider of hands-free mobile
computing and communication systems, along with related solutions and software
to enhance productivity in a wide variety of applications. To achieve this
objective, the Company intends to pursue the following strategies:
LEVERAGE CORE COMPETENCIES. The Company believes its core competencies,
which have been developed since its inception, are the integration and
adaptation of innovative computer hardware and software technologies into
hands-free, mobile computing and communications solutions that enhance end user
productivity. The Company will seek to expand applications for its technologies
and to capitalize on the breadth of its expertise by developing new hardware and
software products. Consistent with this strategy, the Company will continue to
focus on the integration of hands-free mobile computing hardware with internally
developed, licensed or acquired software applications and hardware products. To
leverage these core competencies, the Company has established a number of
strategic alliances and intends to continue to have its strategic partners play
a significant role in executing the Company's manufacturing, service, sales and
marketing functions, under close coordination with Company management. The
Company intends to remain focused, able to react quickly to market needs and
world economic changes. The Company believes that this structure will allow the
Company to expand its revenues without the need to add internal resources in
direct proportion to increases in revenues.
DEVELOP AND STRENGTHEN STRATEGIC ALLIANCES. The Company has established
and intends to continue to establish strategic alliances with world-class
partners to provide the execution capabilities required by the Company in such
areas as product development, manufacturing, sales, distribution and marketing.
The benefits that the Company receives from these associations include access to
a larger potential customer base, complementary technologies, reduced capital
investment through utilization of outside resources, and access to manufacturing
expertise and efficiencies of world-class manufacturers.
The Company has entered into distribution and support agreements with En
Pointe Technologies, Academic Distributing, PAMAS and D&H Distributing.
Additionally, large systems integrators, such as DynCorp, provide both
implementation support for Xybernaut customers worldwide as well as place our
products within their own client bases. The Company has been pursuing, and will
continue to pursue, additional strategic associations to enhance its product
offerings and expand its marketing activities.
In addition to these marketing and supporting strategic relationships, the
Company has signed agreements and is executing additional relationships with
organizations such as the Softwarezentrum Boeblingen/ Sindelfingen e.V. (SBS) in
Europe with over 30 software companies serving as a development center for
Linux, speech and wearable applications, and companies in the USA and Asia for
development and field testing of application-specific solutions for industry.
STRENGTHEN PATENT AND INTELLECTUAL PROPERTY. The Company has developed a
portfolio of over 470 patent applications granted or pending worldwide as the
base for its intellectual property for wearable computing and communications and
related software solutions (see "Patents"). The Company intends to continue
building and strengthening this portfolio, which it considers to be one of its
most significant assets and potential revenue sources.
PROVIDE CUSTOM SOFTWARE SOLUTIONS FOR DIVERSE CUSTOMER NEEDS. The Company
intends to continue acquiring, developing or licensing software that enables its
customers to more rapidly create customized software applications for use with
the Mobile Assistant Series and on conventional PCs. This software will be
designed to provide prepackaged application expertise that incorporates the end
user's existing programs, procedures and technical documentation to the greatest
extent possible. This will permit the cost-effective development of
productivity-enhancing software applications by customers. To date, revenue from
the sales of software products have not been material, however, the Company
believes that revenue from software will become an important contributor to
operating margins in the future.
PENETRATE TARGET MARKETS USING SELECTED CHANNELS. The Company intends to
continue penetrating its target markets through its direct sales force,
licensing and the effective use of VARs (Value-Added Resellers), ISVs
(Independent Software Vendors) and distributor channels that demonstrate
comprehensive
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market knowledge in their sectors. The objective of the direct sales force is to
establish initial sales and relationships with customers and then turn them over
to the appropriate outside channel for development. The Company believes that by
combining the established customer base of VARs, ISVs, and distributors with the
benefits provided by the Company's products and services, sales can be
accelerated much faster than by using a direct sales force alone. Through the
use of its strategic partners, the Company intends to leverage internal
marketing and sales resources to achieve more rapid foreign and domestic market
penetration. The Company also intends to continue marketing directly to key
national accounts in order to build multiple reference accounts for its
distributors to use to quickly expand their own world wide sales. These
reference accounts will also provide the Company's research and development
organization with valuable direct feedback from customers for future product
development. The Company expects large computer and equipment manufacturers will
desire to enter the wearable or user-supported computing marketplace, and that
it will have numerous opportunities to license its intellectual property. Such
licensing, the Company believes, will yield significant revenue as well as
accelerated market penetration of mobile computing hardware and software.
ACHIEVE AND MAINTAIN TECHNOLOGY LEADERSHIP. The Company is committed to
achieving and maintaining technological superiority of the Mobile Assistant
Series and its other mobile computing hardware and software products through the
continuous reassessment of product performance and the utilization and
integration of state-of-the-art hardware and software technologies. The Company
believes that the substantial time, effort and resources expended in developing
the Mobile Assistant Series has resulted in a set of core competencies which
provides the Company with a solid foundation in the hands-free, mobile computing
industry. The Company intends to maintain this advantage through ongoing
research and development, which will ensure that the Mobile Assistant Series
will continue to provide a full range of computing and communications
capabilities, such as two-way wireless video communication and access to the
Internet, intranets, remote databases and other computerized reference
resources. The Company also intends to pursue joint developments with its
strategic partners and licensing of its intellectual property to build and
market new technology. The current MA IV Series, for example, was the result of
the Company's successful relationships with Fujitsu, Sony Digital Products,
Hitachi, Shimadzu, Toshiba, JAE and NEC, all under the direction of the
Company's staff.
COMMITMENT TO OPEN ARCHITECTURE. The Company utilizes standard PC hardware
and software architectures and designs its products using open systems
technologies, including industry standard operating systems. This open approach
has allowed the Company to readily incorporate state-of-the-art wireless
communications, GPS, sensor and other capabilities as soon as they are available
for use in laptops, especially when these capabilities are provided using
industry-standard PCMCIA cards. In addition, this strategy has allowed the
Company to take advantage of developments in operating systems, such as new
generations of Windows and Linux, and applications software, such as speech.
PRODUCTS AND PRODUCT DEVELOPMENT
In order to address the market for body-worn mobile computing and
communication systems, the Mobile Assistant Series has been designed to provide
hands-free wearable operation of computing and communications capabilities on a
"when-needed, where-needed" basis. The hardware used in the MA IV features:
- Intel Pentium(R) processor with 512 KB Level Two (L2) cache, Synchronous
DRAM (SDRAM) currently ranging from 32 Megabytes (MB) to 192 MB, an
internal hard disk of up to 8.1 Gigabytes (GB) with a complete array of
USB, serial, parallel, monitor, keyboard, power and replicator ports.
- Protected internal dual PCMCIA (PC Card) readers, a sealed enclosure to
allow use in a wide range of environmental conditions,
advanced-technology, hot-swappable lithium-ion battery and charger,
integrated pointing device, built-in sound system for speech recognition
and generation, and a wrist-mounted miniature keyboard.
- Head Mounted and/or Flat Panel Displays with a head-mounted camera to
allow for real-time, two-way audio/video teleconferencing. The MA IV uses
a lightweight HMD with 640 X 480 pixels (VGA
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color). It is anticipated that this display will be offered in color SVGA
800 X 600, and XGA 1280 X 1024 pixel resolutions, and eventually in color
resolutions comparable to those planned for high-definition TV. The
Active Matrix Liquid Crystal Display (AMLCD) used in the head mounted
display is currently approximately one square inch in size and uses
advanced optics to present an image to the user that is equivalent to a
15" desktop monitor at a distance of two feet. The MA IV uses an optional
light-weight, 6.4 inch, full VGA color FPD with integrated digitizer,
which is offered for users who do not desire a HMD or do not need to be
100% hands-free. The FPD can also be speech-activated and contain a
built-in speaker.
- Mini-port replicator for mobile use and a full port replicator for
complete desk-top functionality.
- Compatibility with MS-DOS, Windows 3.11, Windows 95 and 98, Windows NT,
SCD, UNIX and LINUX operating systems.
The Mobile Assistant Series are full-featured PCs that can be readily used
as a desktop PC and can incorporate a wide range of capabilities including
portable CD-ROM readers, bar code readers, battery-operated printers, still and
motion video cameras, global positioning technologies, cellular and radio
frequency communications and interfaces for medical, test and sensor equipment.
HANDS-FREE CONTROL. From the origination of the concept for wearable
computers, the Company has believed that hands-free control of the computer is
essential to realizing the maximum benefits of wearable computing and
communications. The original method of hands-free control was speech
recognition. The Mobile Assistant supports state-of-the-art speech recognition
software and hardware to allow for hands-free operation using spoken commands in
most languages. The combination of voice recognition and body-worn displays
provide the user of the Mobile Assistant with hands-free access to information
and the ability to apply this information to operations and tasks with direct
lines of sight and tactile access. User-independent speech generally requires
little or no training and is ideal for command-and-control applications to
operate the computer from menu-driven software. User-dependent speech systems
generally require some training to provide for a wider usable vocabulary and the
ability to offer dictation. The MA IV currently comes with IBM Via Voice(R) but
can operate most user-dependant and user-independent software systems designed
for PC use. The selection of which speech system to use is generally driven by
the application requirements. In addition to speech control, the Company has
included brain-wave activation, eye tracking and motion tracking in its patents
as alternative approaches to speech for hands-free control.
FLAT PANEL DISPLAY. The MA IV uses an optional light-weight, 6.4 inch,
full VGA color FPD with integrated digitizer. It is offered for users who do not
desire an HMD or do not require full hands-free operation. The FPD can also be
speech-activated and contains a built-in speaker.
COMPUTER SOFTWARE FOR MOBILE, BODY-WORN AND DESK-TOP USE. Currently, the
Company offers linkAssist, which is designed to get user documentation up and
running on the Mobile Assistant quickly, and which can also be used on
conventional desktop or laptop computers. The Company's linkAssist software
allows users to quickly and easily link information together regardless of the
format of the data or where it is stored, avoiding the need to change, convert
or re-enter and verify the existing information in any manner, or to use the
detailed HTML tagging process. The linked words or phrases can then be activated
by voice automatically, with no development work required by the author of the
documentation or databases, allowing a subject-matter expert to develop
applications with little training. In addition to linkAssist, the Company offers
a multi-media development (MMD) kit, which allows customers to develop
applications using video, audio, text and graphics.
DEVELOPMENT OF FUTURE PRODUCTS. The Company's approach to development of
future products is to establish functional requirements, specifications and
design criteria internally, then to take those criteria to potential development
partners under non-disclosure agreements to evaluate the ability of that
development partner to meet the Company's needs. The Company is in discussions
with IBM and a number of other world-class technology companies regarding
collaboration on its next-generation of wearable computers. The Company's
selection criteria for partners to develop this next-generation will be based on
pricing, the ability to provide reliable, advanced technology, production
capacity and reputation in the worldwide markets for
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technology products. It is expected that future products will allow the Company
to directly address segments of the consumer market.
MARKETING AND SALES
MARKETS
The Company's current marketing efforts are designed to increase awareness
of, and demand for, its products in the commercial, industrial and military
markets while establishing a base for the Company's plans to enter consumer
interests. The following are examples of selected horizontal and vertical
markets that are being addressed by the Company:
COMMERCIAL MAINTENANCE AND REPAIRS. Information from the United
States Bureau of Labor Statistics and Bureau of Census indicates that as of
1996 there were more than 5,460,000 commercial mechanics and technicians in
the United States, all of which the Company believes are potential users of
the Mobile Assistant Series and its other products. There are many sources
of savings available from use of the Mobile Assistant Series and the
Company's other products in maintenance and repair operations. For example,
less formal training is required for a similar level of performance, the
time required for diagnostic and repair tasks is reduced as "just in time"
refreshers and improved technical information can be provided, and
personnel can address a wider range of complex tasks or products with the
same level of basic training. While these savings can be realized in most
industries, the Company anticipates that these savings will be most
immediate and apparent in those industries that require a large investment
in equipment and machinery, including industries such as manufacturing,
transportation, aerospace, telecommunications, automotive, construction,
power generation, health services, agriculture and the military.
Accordingly, a reduction measured in minutes or hours of downtime in these
industries can, in the Company's view, provide ample cost justification for
a Mobile Assistant. The telecommunications industry is expected to be a
prime candidate for mobile computing systems given the industry's complex
technologies, increased competition and assets spread over a wide
geographic area. The Mobile Assistant can provide needed knowledge to
workers in virtually any location. Locations may include the top of a
telephone pole, a remote relay station or in a conduit tunnel. Crew
locations can be monitored and coordinated in the field with the Mobile
Assistant through optional global positioning system technology and
telecommunication capability. Crews at remote locations can consult with
experts using the Company's two-way audio and/or video communications
products.
HEALTH SERVICES. According to the National Center for Health
Statistics, in 1995 the United States spent approximately 13.6% of the U.S.
Gross Domestic Product, or approximately $1 trillion on healthcare, with an
estimated 25% of such expenses consumed by administrative expenses.
According to the National Center for Health Statistics, United States,
1994, the United States has over 6,000 hospitals and over 540 health
maintenance organizations. According to the United States Department of
Labor, in 1994 there were approximately 4,714,000 healthcare workers in the
United States. The Company believes that many of the current processing and
data systems used in healthcare, both in institutions and in the field, are
not well developed or integrated and that hands-free mobile computing
systems could reduce expenses and increase efficiency in this industry. The
Mobile Assistant is believed to present great potential in field medical
operations by providing on-board and remote diagnostics, audio and/or video
communication with doctors for emergency procedures, and transmission of
locations for helicopter pickup through global positioning systems
integrated into the Mobile Assistant. Another anticipated benefit of the
Company's hands-free mobile computing technologies is that fewer healthcare
personnel will be needed to perform complex tasks. By providing remote
delivery of medical information ("telemedicine"), the Company's hands-free
mobile computing systems can become a key component within both managed
care and telemedicine organizations, which are two key submarkets
developing within the healthcare industry.
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PUBLIC SECTOR. The Company has demonstrated the ability of its
technology to aid in law enforcement, transportation, fire protection,
emergency services, inspection and control of national borders.
EDUCATION. The Company believes that its mobile computing systems are
well suited for educational applications. The Mobile Assistant is
especially suited for distance learning as well as hands-free applications,
such as laboratory work, field research and dissections, and has the
potential to serve as a mobile student workstation. In addition, it can
provide an ideal computing and control platform for special education and
handicapped needs.
MILITARY. There are several current and potential military
applications for the Company's hands-free mobile computing systems,
including intelligence, maintenance and field operations. The military has
long been an early adopter of advanced weapons technologies and as a
result, was one of the first sectors to experience problems with the
ability of personnel to maintain, diagnose and repair the advanced
technology employed in both weapons and equipment. The downsizing of the
United States military and related budget constraints have compounded these
problems. As a result, even greater pressure will be placed upon the
military to maintain its equipment and weapons platforms with fewer
personnel. The Company believes that most of the estimated 700,000 military
maintenance personnel in the United States could be made more efficient and
productive by the Company's hands-free mobile computing systems.
The United States military's increasingly sophisticated weapon systems
require volumes of operational and technical manuals and have dramatically
increased the importance of, and reliance on, maintenance. For example, the
United States Army has purchased the Mobile Assistant and has tested its use in
the maintenance and repair of the AH64 Apache Attack helicopter and M1A1 battle
tank. The Apache can send and receive maintenance data via an industry standard
electrical interface that can be read by an optional interface for the Mobile
Assistant. Operating and performance data can be downloaded directly from the
Apache, and the Mobile Assistant can be used to diagnose existing and potential
maintenance and repair problems. The Company anticipates that manufacturers of
complex military and commercial equipment increasingly will incorporate
integrated data collection and transmission capabilities into their technologies
to reduce downtime, repair and maintenance related costs.
The ability to deliver information to soldiers in combat field operations
is the focus of several development programs sponsored by the United States
Military to simulate combat maneuvers using body-worn computing components,
including those provided by the Company, to determine effectiveness for use in
coordinating troop locations and movements, determining enemy locations, and
using global positioning systems to provide coordinates for artillery,
helicopter pickup and air support.
The Company has already sold systems to the United States Military, and
expects that its sales partners will sell heavily into the armed services both
in the USA and overseas.
MARKETING
Because the Company's products are frequently combined with products and
services from other companies to form integrated information systems, the
Company believes that it is more effective to sell through distributors, systems
integrators, industrial and commercial equipment manufacturers, independent
software vendors and VARs with defined market niche expertise and presence, as
well as directly to end users. In conjunction with the introduction of the MA
IV, the Company established arrangements with specialized distributors for
higher volume distribution of the MA IV. The Company believes that by forming
relationships with these partners the Company can then reach end users more
rapidly in a variety of industries while minimizing the internal resources
required to reach these end users.
The Company has offered detailed in-house training sessions to prepare and
update personnel for field sales and training. In addition, the Company has
developed comprehensive sales and operations manuals to be used by these
channels and end users. The Company's marketing and sales employees are
responsible for implementing direct marketing plans and sales programs, and
coordinating sales activities with sales and
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marketing and service partners. The fulfillment of orders will be accomplished
mainly through distribution partners, regardless of which entity effects the
actual sales.
SALES AND BACKLOG
As of December 31, 1999 the Company had a negligible backlog of orders.
While the Company had several blanket purchase orders from customers outstanding
at that time, it does not include these amounts in backlog until specific orders
are received under these blanket purchase orders. Given the Company's current
inventory position, most orders are filled within a short period after the
receipt of the order and management does not feel that backlog is an appropriate
measure of demand at this time. Customers who have placed orders in the past
include, among others, Boeing, Lucent, Niagara Mohawk, DaimlerChrysler, Dyncorp,
BOC Gas, NTT (Nippon Telegraph and Telephone), Fujitsu, Mitsubishi, Lockheed
Martin and the United States Army. Purchase orders are generally cancelable by
the customers without penalty and are not binding upon the customer.
LICENSE GRANTED TO THE COMPANY BY DATA DISK
During 1997, the Company entered into a series of agreements with Data-Disk
Technology, Inc., a Virginia-based company, that produces a memory product known
as the Data Disk that consists of a non-volatile memory chip encapsulated in a
rugged polymer casing slightly smaller than a soldier's "dogtag" that is highly
resistant to temperature and environmental conditions. The Company's management
believes that the Data Disk provides an ideal storage medium for body-worn
computer applications, especially those that involve a large number of people,
inspection sites or equipment. These tags can be used to store information such
as medical history, repair history or other data unique to an individual or a
piece of equipment and from which information can be read by inserting the tag
into a reader that fits in the existing PC card slots on the Mobile Assistant.
Under the agreement with Data Disk, the Company received an exclusive, perpetual
worldwide license to use and sell present and future Data Disk technology for
user-supported (wearable) computing applications.
KEY SUPPLIERS
The Company has entered into design, production, supply and support
agreements with many companies in the USA and overseas for, and in support of,
its products. They include Fujitsu, Sony Digital Products, Hitachi, Shimadzu,
JAE, Toshiba, NEC, Multicosm, IBM, Hokubu Tsushin, the SBS, and others (See
"Production").
Although the Company believes there are multiple sources for many parts and
components, the Company currently depends heavily on its suppliers. While
management believes that the Company could adapt to any supply interruptions,
such occurrences could necessitate changes in product design or assembly methods
for the Mobile Assistant Series and cause the Company to experience temporary
delays or interruptions in supply while such changes are incorporated. Further,
because the order time for certain components may range up to approximately four
months, the Company also could experience delays or interruptions in supply in
the event the Company is required to find a new supplier for any of these
components. Any disruptions in supply of necessary parts and components from the
Company's key suppliers could have a material adverse effect on the Company's
results of operations. Any future shortage or limited allocation of components
for the Company's products could have a material adverse effect on the Company.
PRODUCTION
The Company commenced fullscale production of the MA IV in the quarter
ended December 31, 1998. The Company has manufacturing agreements with Sony
Digital Products, a subsidiary of Sony Corporation based in Nagano, Japan, and
Hokubu Tsushin for the manufacture of the MA IV. Shimadzu Corporation, a
supplier of head-mounted displays and other commercial technology products based
in Kyoto, Japan, has
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developed and manufactured a color HMD for use with the MA IV. Most of the parts
and components for the Mobile Assistant are existing PC components that are
available in high quantity from multiple vendors.
WARRANTIES
The Company currently provides customers with warranty terms that are
competitive with those of the local market. In the U.S., the warranty is
generally one year for parts and six months for labor. Warranty services for the
MA IV is an integrated offering by several vendors. Our distribution partners
are generally responsible for user and software support. The Company currently
provides call center support internally but intends to outsource its call-center
support to a third party service firm.
COMPETITION
Several other companies are engaged in the manufacture and development of
body-mounted or hand-held computing systems, which can also compete with the
Mobile Assistant Series, including CDI, Teltronics, Inc. (a subsidiary of
Interactive Solutions Inc.), ViA Inc., Texas Microsystems, Telxon, Symbol,
Norand, Raytheon and others. The Company believes that as the markets for mobile
computing and communications converge, that its competitors will consist of
these companies as well as companies that offer mobile computing devices with
wireless communications capabilities and from companies that offer wireless
communications devices with computing capabilities. Companies with mobile
computing devices that are adding wireless communications capabilities include
Palm, Inc., a subsidiary of 3 Com, and manufacturers of notebook and handheld
computers such as Fujitsu, Mitsubishi, Toshiba, Compaq, and Sharp. Companies
with wireless communications devices that offer computing capabilities include
Motorola, Nokia, and Ericsson. Some of these devices are manufactured by major
domestic and foreign computer manufacturers which possess far more resources
than the Company and can be expected to compete vigorously with the Company for
the market in which the Mobile Assistant Series is directed. There can be no
assurance the Company will be able to compete successfully against its
competitors, or competing products, or that the competitive pressures faced by
the Company will not adversely affect its financial performance. However, the
Company believes that the entry into the market for wearable PCs by reputable,
large computer and communications manufacturers will accelerate the validation
of the market for wearable PCs. In addition, the Company believes that its
intellectual property and patent position is such that the Company is in a
strong position to command royalties from such companies.
INTELLECTUAL PROPERTY
The Company relies on a combination of patent, trade secret, copyright and
trademark laws and contractual restrictions to establish and protect its
proprietary rights. The Company has entered into confidentiality and invention
assignment agreements with its employees, and enters into non-disclosure
agreements with its suppliers, VARs, OEMs and actual and potential customers to
limit access to and disclosure of its proprietary information. The Company has
registered a number of trademarks on the Principal Register of the United States
Patent and Trademark Office ("Patent Office"), including its Mobile Assistant
and Xybernaut trademarks, and with the patent and trademark offices in several
other countries.
In addition, the Company has a total of 25 patent applications in the
United States, with thirteen patents granted and twelve patents pending, and
over 450 corresponding applications granted or pending in over 26 countries
outside the United States, for a total of over 470 patent applications granted
or pending worldwide. Of the patents granted in the United States, four are
design patents that cover a specific design of a wearable system or its
components and the remaining nine are utility patents that cover the concepts in
the patents regardless of specific execution or design. The Company believes
that these patents are a valuable asset of the Company and will present
significant opportunities for royalty revenues in the future. The most
significant utility patents for the Company are described below. All inventions
made by employees of the Company, including those described below, are assigned
to the Company by agreement with the employee upon the initiation of employment
with the Company. The Company retains full title to these patents regardless of
the
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inventor's employment status with the Company. The sections in quotations below
are taken directly from the relevant patents. Complete detail on the patents can
be found on the U.S. Patent Office website at http://www.uspto.gov, then
searching by patent number or by "Xybernaut."
U.S. PATENT 5,305,244, "HANDS-FREE, USER-SUPPORTED PORTABLE
COMPUTERS." The application was made on April 6, 1992 and the patent was issued
on April 19, 1994. This patent describes "A compact, self-contained computing
apparatus is provided which is completely supported by a user for hands-free
retrieval and display of information for the user." This patent has been
successfully upheld in two challenges to the validity of the patent
(re-examination) at the Patent Office that were initiated by a competitor of the
Company.
U.S. PATENT 5,844,824, "HANDS-FREE PORTABLE COMPUTER AND SYSTEM." The
original application was made on October 2, 1995 and the patent was issued on
December 1, 1998. This patent describes "a body-worn, hands-free computer
system. The system does not rely upon a keyboard input or activation apparatus
but rather has various activation means all of which are hands-free. The system
can be used with other systems, other system components and communication
apparatus. Also, various components of the present system can be body worn or
placed in a disconnected location if desired." Specifically, this patent covers:
- A NUMBER OF HANDS-FREE ACTIVATION MEANS, including speech, eye-tracking,
head tracking, arm tracking, muscle and brain-wave activation;
- WIRELESS COMMUNICATIONS AND COMPUTING, "wherein said computer apparatus
has means for communicating and interacting with a communication means
selected from the group consisting of cellular telephones, hard line
telephones, infrared transceivers, two-way radio means and mixtures
thereof;"
- A VARIETY OF MODES OF OPERATION, from having the display, computer and
activation means in one housing worn by the user, to having a number of
users with head-mounted displays with a wireless connection to a single
computer to form a local area network for workgroups;
- WIRELESS NETWORKING AND INTERNET ACCESS, "It goes without saying that the
mobile computer of this invention may be interfaced with or used in
connection with any desired computer local networks such as Novel, Banyan
or Arcnet or wide area networks such as "Internet' or the like;"
- INTEGRATED VOICE/DATA OPERATION, "This [feature] allows for the passing
of voice input signals from the apparatus of this invention through to
the telephone system while maintaining voice-activated computer control
of the telephone system. The interface may be integrated within the
computer apparatus of this invention, attached to it during manufacture
or user installed. This approach provides seamless switching between
voice and data transmission and reception between one or more distant
locations without distracting from the task being performed by the
individual using the computer apparatus of the present invention;"
- DIFFERENT TYPES OF PROCESSOR, "It will be appreciated by those of
ordinary skill in the art that while an Intel 80386 or faster processor
is preferred, any other central processor or microprocessor, either
available presently or in the future, could be used;"
- DIFFERENT TYPES OF DISPLAY TECHNOLOGIES, "Those having ordinary skill in
the art will appreciate that the display screen 110 and display screen
driver module 214 can be implemented using any video technology either
available presently or in the future;"
- VIRTUAL REALITY APPLICATIONS, "While the preferred display screen is a
single screen positioned in front of the left or right eye, a binocular,
head-mounted display (HMD) having two or more screens can be used. This
can be immersive (all top and side visions obscured so that the user can
only see the images on the screens) or as part of the user's vision so
that the user can look over or under the displays. Such devices have
utility in the new technology of virtual reality or where stereoscopic
viewing is needed to relate to the displayed information;"
- FULL VIDEO CAPABILITIES, including remote teleconferencing: "Video Camera
273 contains a miniature video camera capable of high resolution output.
The camera may be monochrome or color capable
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producing conventional NTSC television signals or higher resolution scans
as required by a specific application. Video Interface Module 274
contains circuits for video frame or motion capture, enhancement,
compression and output to the computer Bus 253;" and
- MEDICAL AND HANDICAPPED USE, "Medical Device Controller 275 contains any
one of many specialized medical devices designed to perform medical
procedures or patient therapy. Such devices include muscle stimulators,
bed positioning control, emergency call device and any of various medical
units that would perform activities or sense and monitor a patient's
bodily status and function for the patient in a hands-free environment."
U.S. PATENT 5,948,047, "DETACHABLE COMPUTER STRUCTURE." The original
application was made on August 29, 1996 and the patent was issued on September
7, 1999. U.S. PATENT 5,999,952, "CORE COMPUTER UNIT." The original application
was made on January 20, 1998 and the patent was issued on December 7, 1999. U.S.
PATENT 6,029,183, "TRANSFERABLE CORE COMPUTER." The original application was
made on August 15, 1997 and the patent was issued on February 22, 2000.
These three issued patents, and others pending, cover various aspects of
what the Company calls "core computing," or the use of a small device about the
size of a current PDA that contains a processor, non-volatile storage and other
components that docks into various enclosures to function as a notebook,
desktop, home, wearable computing/communicating device, automobile or embedded
computer. This core computer allows the user to always have his or her preferred
operating system, graphical user interface, applications software and data
available in almost any environment without the need to synchronize these items
among multiple computers in multiple locations. For example, whether the user is
answering email at home, in the office, in a car or while walking around, the
same email settings, wireless communication settings, address book, past emails
and email strings would be available in each of these environments. A field
technician would be able to keep technical information, communication settings,
daily work logging, etc., available whether the technician was on top of a
telephone pole, in a service truck, in the office, or at home.
The Company believes that users will increasingly demand a single device to
handle their range of computing, communications, and task needs such as
schedules, telephone numbers, or to-do lists, rather than having separate PDAs,
notebook computers, cellular telephones, pagers, etc., to handle these
functions. By separating the computing functions from the input and output
functions, the core computing concept allows for standard cores to be
mass-produced at a low cost, and allows the functionality of the enclosure to be
tailored to the environment, applications requirements and the desired price
level. The rate of obsolescence is substantially higher for the elements within
the core, namely the processor and the nonvolatile storage, than for the
input/output devices, such as monitors, CD-ROMs, keyboards, and modems. This
approach allows the user to upgrade the processor and storage capabilities of
the computer without having to replace other functions typically integrated
within a desktop or a laptop computer today. In this matter, the core computer
becomes a truly "personal computer" for the user.
The Company believes that initially the core computer will interface with
the enclosures by means of physical contact. Eventually, the Company believes
that the interface with the enclosures and the user's environment will be done
by radio frequency signals, such as those proposed for the Bluetooth wireless
standard developed to connect computing devices. These developments position the
Company with the products and intellectual property to be at the forefront of
the pervasive computing movement, in which the users have the ability to
constantly interact with their environment and represents the complete
convergence of communications and computing capabilities.
For example, travelers could insert their core computer into an enclosure
in the bed stand of their hotel room upon arrival. The core would then interact
with the hotel computer so the room can be set to the preferred temperature
setting, order room service, and arrange for a wake-up call. In addition, the
room computer could ask if the traveler wanted the next day's plane reservations
confirmed, then check the airline's web site to confirm the flight and the
traveler's reservations. The core could then obtain directions to the locations
of scheduled meetings in the area and interact with the hotel computer system to
provide a list of recommended restaurants, entertainment events, or sporting
events for the traveler. The traveler might then take the core in a rented
enclosure with an integrated global positioning system and take a guided tour of
the
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city, directing the traveler to the location of preferred restaurants or
entertainment events, provide history or background, or allow the traveler to
view listings of companies within the city, sorted by various criteria, to
develop potential list of sales prospects.
In this pervasive computing concept, the Company believes that users will
demand a consistent interface regardless of whether the user is computing,
communicating, or interacting with the environment. The various interfaces,
settings, and limits on Web sites or graphical content that can be presented by
the variety of devices on the market today present a hindrance to use as the
user must constantly adjust settings for the different environments, or carry
multiple devices to handle different situations. The Company believes that the
wearable and core concepts alleviate this problem by providing a single device
that can be used to accommodate all of the user's requirements.
The Company has notified several of its competitors of the existence of one
or more of its patents, which the Company's counsel believes may have been
infringed. The Company intends to take any and all appropriate measures,
including legal action, necessary to maintain and enforce its rights under the
patents held by the Company and to recover any damages suffered as a result of
any alleged infringement.
Most of the Company's revenue for the year ended December 31, 1999 and 1998
was derived from the sale of products included within the scope of the patents.
Notwithstanding the foregoing, there can be no assurance that the Company's
pending patent applications will issue as patents, that any issued patent will
provide the Company with significant competitive advantages or that challenges
will not be instituted against the validity or enforceability of any patent held
by the Company. The cost of litigation to uphold the validity and prevent
infringement of patents can be substantial. There also can be no assurance that
others will not independently develop similar or more advanced products, design
patentable alternatives to the Company's products or duplicate the Company's
trade secrets. The Company may in some cases be required to obtain licenses from
third-parties or to redesign its products or processes to avoid infringement.
The Company also relies on trade secrets and proprietary technology and enters
into confidentiality agreements with its employees and consultants. The Company
has implemented a trade secret management program to further protect the
Company's trade secrets and proprietary information. There can be no assurance
that the obligation to maintain the confidentiality of such trade secrets or
proprietary information will not be breached by employees or consultants or that
the Company's trade secrets or proprietary technology will not otherwise become
known or be independently developed by competitors in such a manner that the
Company has no practical recourse.
RESEARCH AND DEVELOPMENT
Research and development expenditures for the years ended December 31, 1999
and 1998 and were $2,462,752 and $2,870,808 respectively. These expenditures
consist primarily of personnel engaged in the research and design of new
hardware products, test components, consulting fees, equipment and purchased
software costs required to conduct the Company's development activities.
The Company expects that as it shifts more of the applied research to its
partners, and focuses instead on basic research to and the establishment of
product requirements and specifications, it will not require increases in
research and development expenditures commensurate with the level of new product
development and introduction. During the second half of fiscal 1999, research
and development expenditures declined over the first half of fiscal 1999 and
last half of fiscal 1998, as the MA IV was finalized during those earlier
periods in design and development activities for the Company's next generation
of products had not yet begun.
EMPLOYEES AND CONSULTANTS
As of December 31, 1999, the Company had 78 full-time and 13 part-time
employees, and had consulting arrangements with eight individuals or firms for
advice and assistance on selected technical and business issues. Of the
Company's full-time employees, 5 are executive officers, 20 are technical and
administrative support employees, 18 are engaged in research and development,
and 35 are engaged in sales, marketing and
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customer service. None of the Company's employees are represented by a labor
organization and management believes that the Company's relations with its
employees are good. Company employees manage the affairs of the Company and
direct the Company's partners for manufacturing, sales and customer support.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company's U.S. office and development facility consists of 18,842
square feet located at 12701 Fair Lakes Circle, Fairfax, Virginia. The Company's
current lease is for a five-year term expiring September 30, 2003 and requires
monthly rent of $26,640.
To minimize lodging expenses for visiting employees and consultants, the
Company leases four apartments in Fairfax, Virginia with aggregate monthly
rental costs of $4,651.
The Company's European facility consists of 856 square feet of office space
located at the SBS Software Center, Otto Lilienthal Strasse 36, D-71034
Boblingen, Germany. The Company's current lease is for a three-year term
expiring on August 31, 2001 with options for up to an additional four years. The
lease requires monthly rent of $944.
The Company's Japanese facility consists of 2,908 square feet of office
space located at Urbansquare, 1-1 Sakae-cho Kanagawa-ka, Yokohama, Japan. The
Company's current lease is for a two-year term expiring September 30, 2001. The
lease requires monthly rent of $10,936.
ITEM 3. LEGAL PROCEEDINGS.
On March 19, 1998, Matrix Corporation ("Matrix") filed a complaint against
the Company in the United States District Court, Eastern District of North
Carolina, alleging that: Matrix has been damaged by a purported breach of an
agreement between the two companies concluded in December 1997 (the "December
Agreement"), and that the Company should return all goods shipped by Matrix
under both the December Agreement and a prior agreement concluded in June 1997
(the "June Agreement"). The Company and its legal counsel filed a counterclaim
against Matrix stating that Matrix failed to perform to the requirements of both
the June Agreement and the December Agreement and that the Company has been
damaged by this failure to perform. The trial for the case was completed in
August 1999 and on September 22, 1999 the District Court rendered a judgment
against the Company. The Company paid approximately $875,000 to Matrix in the
quarter ending December 31, 1999, in full settlement of this legal proceeding
and, as part of the settlement, received approximately 150 systems and
components for its 133P model. At December 31, 1999, the Company accrued
$150,000 in legal fees incurred in connection with this lawsuit. These amounts
are included in the Company's general and administrative expenses in the related
periods.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Company's annual meeting held on December 28, 1999, the following
items were submitted to a vote by the common stockholders and were approved by
the following majority votes:
1. The election of four persons to serve as Class II directors of the
Company for a term of three years and until their successors are duly
elected and qualified. The election of Eugene J. Amobi was approved with
approximate votes of 24,400,000 shares "for," 250,000 shares "against"
or "withheld," and 10,000 shares "abstained." The election of Phillip E.
Pearce was approved with approximate votes of 24,600,000 shares "for,"
75,000 shares "against" or "withheld," and 10,000 shares "abstained."
The election of Lt. Gen. Harry E. Soyster (Ret.) was approved with
approximate votes of 24,600,000 shares "for," 75,000 shares "against" or
"withheld," and 10,000 shares "abstained." The election of Dr. Edwin
Vogt was approved with approximate votes of 24,600,000 shares "for,"
75,000 shares "against" or "withheld," and 10,000 shares "abstained."
2. An amendment to the Company's Certificate of Incorporation to increase
the number of authorized shares of common stock, par value $0.01 per
share, from 40,000,000 to 80,000,000 shares. This item
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was approved with approximate votes of 23,800,000 shares "for," 750,000
shares "against" or "withheld," and 100,000 shares "abstained."
3. The issuance of all shares of common stock which the Company would be
entitled to issue upon conversion of the Company's Series D Convertible
Preferred Stock. This item was approved with approximate votes of
13,100,000 shares "for," 375,000 shares "against" or "withheld," and
300,000 shares "abstained."
4. Approval of the Company's 1999 Stock Incentive Plan, which provides for
up to 3,000,000 shares of common stock to be issued to key employees,
consultants and directors of the Company. This item was approved with
approximate votes of 12,700,000 shares "for," 900,000 shares "against"
or "withheld," and 175,000 shares "abstained."
5. Ratifying the appointment of Grant Thornton LLP as independent auditors
for the 1999 fiscal year. This item was approved with approximate votes
of 24,300,000 shares "for," 75,000 shares "against" or "withheld," and
300,000 shares "abstained."
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
On July 18, 1996, the Company successfully completed its initial public
offering (the "IPO") and sold 2,415,000 Units at a price of $5.50 per Unit. Each
Unit consisted of one share of common stock and one warrant ("Warrant") to
purchase a share of common stock at $9.00 ("Unit"). The common stock currently
trades on the NASDAQ SmallCap Market. The Warrants expired on their own terms on
July 19, 1999.
As of December 31, 1999, there were 399 shareholders of record for the
Company's common stock and over 15,000 holders of common stock in "street name."
There have been no cash dividends paid on the Company's common stock to date and
the Company does not anticipate the payment of dividends in the foreseeable
future.
The table below sets forth by quarter, for the years ended December 31,
1999 and 1998, the high and low market prices of the Company's common stock and
warrants.
<TABLE>
<CAPTION>
COMMON STOCK WARRANTS
----------------- -----------------
HIGH LOW HIGH LOW
----- ----- ----- -----
<S> <C> <C> <C> <C>
1st Quarter 1998......................................... $2.50 $1.38 $0.41 $0.16
2nd Quarter 1998......................................... 8.44 1.41 1.75 0.13
3rd Quarter 1998......................................... 5.94 4.09 2.00 1.06
4th Quarter 1998......................................... 7.88 3.97 2.34 1.19
1st Quarter 1999......................................... 5.63 3.91 1.72 0.50
2nd Quarter 1999......................................... 4.97 3.00 0.94 0.16
3rd Quarter 1999......................................... 3.44 0.97 0.22 0.03
4th Quarter 1999......................................... 6.38 1.31 -- --
</TABLE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company was founded in October 1990 and commenced operations in
November 1992 to develop, manufacture and sell wearable computing and
communications systems solutions and software. In July 1996, the Company
successfully completed the IPO of its common stock and warrants. The Company's
stock is currently traded on the NASDAQ SmallCap Market and the Company intends
to apply for listing on the Nadaq National Market in the near future.
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The first commercial product in the Mobile Assistant series of wearable
PCs, the Mobile Assistant I, was introduced in 1994 and used "486" based
technology. The Mobile Assistant II was introduced in January 1997 and used
"586" based technology. The Mobile Assistant III used a Pentium processor
running at 133 MHz and was introduced during the third quarter of 1997. In the
fourth quarter of 1998, the Company commenced production of the fourth system in
this product development program, the Mobile Assistant IV ("MA IV"), which uses
a Pentium chipset known as the "Tillamook" that runs at 233 MHz.
Additional software products are being developed and are planned for
development for use on the Mobile Assistant and other personal computers. The
Company currently offers linkAssist(TM), a software product which provides a
"windows" style graphical user interface with speech navigation that allows data
stored in almost any format, such as commonly-used word processing, spreadsheet,
data base, graphics or media files, to be linked to virtually any application
without altering the original data.
Since inception, the Company has financed its operations primarily through
private and public sales of equity securities, borrowings under notes and loans,
and to a lesser extent, cash generated from operations. In 1999 and 1998, the
Company received net proceeds of $19,272,368 and $10,426,712, respectively, from
the public and private placements of its equity securities and $3,039,315 and
$1,250,000, respectively, from borrowings under notes and loans.
Historically, the Company has derived its revenues from sales of the Mobile
Assistant Series, consulting services related to the Mobile Assistant, licensing
of its intellectual property and application software for the Mobile Assistant
and other computer platforms. During the years ended December 31, 1999 and 1998,
the Company derived substantially all of its revenues from sales of the Mobile
Assistant. In the future, the Company expects to derive additional revenues from
licensing, services, and the sale of software and additional optional components
of the Mobile Assistant Series. Cost of sales include the cost of components for
the Mobile Assistant Series, inventory obsolescence charges, amortization of
tooling costs and fulfillment and shipping costs.
The Company has incurred operating losses throughout 1999 and expects such
losses to continue in the near term as it expands its product development and
marketing capabilities. At December 31, 1999, the Company had an accumulated
deficit of $48,140,128. The achievement of profitability is primarily dependent
upon the continued development and commercial acceptance of the Company's
products, the successful management of the business and management's ability to
strategically focus the Company. There can be no assurance as to whether or when
profitable operations will occur. In addition, the Company is experiencing
negative cash flow from operations and it is expected that it will continue to
experience negative cash flows through 2000 and potentially thereafter. The
Company will require additional capital to execute its business plan. Management
believes they will be successful in their efforts to obtain such financing. If
the Company is unable to obtain sufficient additional financing, it will be
required to reduce discretionary spending in order to maintain its operations at
a reduced level. Management believes that it will be able to reduce
discretionary spending if required.
The Company intends to continue to make expenditures on research and
development of additional hardware and software products. Research and
development activities consist primarily of personnel engaged in the research
and design of new products and test components, consulting fees and equipment
costs required to conduct the Company's development activities. Software
development costs are expensed as incurred until technological feasibility is
established in accordance with Statement of Financial Accounting Standards No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed," after which any additional costs are capitalized until the
software is ready for release. Through December 31, 1999 the costs eligible for
capitalization under SFAS 86 were immaterial and were not capitalized. Research
and development expenses for the years ended December 31, 1999 and 1998 were
$2,462,752 and $2,870,808, respectively, none of which were capitalized.
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The Company's consolidated financial statements, for all periods presented,
include the results of operations of Tech Virginia, a wholly-owned subsidiary
that supplies software and consulting services to the United States government
and others, Xybernaut K.K., the wholly-owned operating subsidiary in Japan and
Xybernaut GmbH, the wholly-owned operating subsidiary in Germany. The
consolidated financial statements contain eliminations for all material
transactions among the Company and these wholly-owned subsidiaries for all
periods presented.
The Company's consolidated financial statements contain a provision for
income tax expense operations outside the United States. Subject to realization,
the Company has generated net operating losses in the U.S. that can be used to
offset taxable operating income in the future. The Company's future operations,
if profitable, will be subject to income tax expense not previously incurred by
the Company (see Note 9 to Consolidated Financial Statements). At December 31,
1999, the Company had approximately $43,665,000 and $1,100,000 of net operating
loss carry forwards for U.S. federal and foreign income tax purposes,
respectively. The U.S. losses begin to expire in 2010 and the losses from
foreign operations do not expire. The use of the U.S. carryforwards may be
limited in any one year under Internal Revenue Code Section 382 if significant
ownership changes occur.
YEAR 2000 ISSUE
The year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, a
temporary inability to process transactions, send invoices, or engage in similar
normal business activities.
The Company utilized both internal and external resources to test,
reprogram or replace, as needed, the computing and communications hardware and
software for year 2000 modifications. Based on this evaluation, modifications
were made to the Company's computer system and it was determined that these
systems will properly utilize dates beyond December 31, 1999. As such, the
Company is compliant with the year 2000 issue. As a result of the testing, the
old phone system was determined not to be year 2000 compliant. In December 1999
the existing phone system was replaced with one that provides enhanced
capabilities and is year 2000 compliant. The cost to purchase and install the
new phone system was approximately $75,000. Outside of the phone system, the
cost of testing and modifying the Company's computer systems to obtain year 2000
compliance was less than $10,000 in the aggregate.
The Company has contacted all of its significant suppliers and large
customers to determine the possible effect on our operations of their inability
or failure to remediate their own year 2000 issues. While the Company does not
believe that our significant suppliers and customers have potential problems
with the year 2000 issue, there can be no guarantee that the systems of our
customers and suppliers were timely converted successfully to avoid the year
2000 issue, or that any failure to successfully avoid the year 2000 issue by
another company, or a conversion that is incompatible with our systems, would
not have material adverse effect on our operations. The Company does not believe
that it has exposure to contingencies related to the year 2000 issue for the
Company's products. The Company did not experience any significant product or
system failures or miscalculations related to the year 2000 issue on or since
January 1, 2000.
The estimates of the date of completion and the cost of the Company's year
2000 project are based on the best available estimates, which were derived
utilizing numerous assumptions of future events, including the continued
availability of certain resources, third party modification plans and other
factors. The final costs and results of the Company's year 2000 project could
differ materially from estimates due to the lack of availability and cost of
personnel trained in this area, the ability to locate and correct all relevant
computer codes, and similar uncertainties.
17
<PAGE> 18
RESULTS OF OPERATIONS
The following table sets forth certain consolidated financial data as a
percentage of revenues for the years ended December 31, 1999 and 1998.
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------
<S> <C> <C>
Revenues.................................................... 100.0% 100.0%
Cost of sales............................................... 85.5 259.8
------ --------
Gross margin........................................... 14.5 (159.8)
------ --------
Operating expenses:
Sales and marketing.................................... 250.8 512.6
General and administrative............................. 193.7 501.0
Research and development............................... 73.7 327.9
------ --------
Total operating expenses.................................... 518.2 1,341.5
------ --------
Interest and other income, net.............................. 2.3 3.8
------ --------
Loss before provision for income taxes...................... (501.4) (1,497.5)
------ --------
Provision for income taxes.................................. 0.9 --
------ --------
Net loss.................................................... (502.2) (1,497.5)
------ --------
Provision for preferred stock............................... 54.5 110.4
------ --------
Net loss applicable to holders of common stock.............. (556.7)% (1,607.9)%
====== ========
</TABLE>
YEARS ENDED DECEMBER 31, 1999 AND DECEMBER 31, 1998
REVENUES. Revenues for the year ended December 31, 1999 were $3,340,272,
an increase of $2,464,712, or 281.5%, compared to $875,560 for the year ended
December 31, 1998. Product revenues for the year ended December 31, 1999 were
$3,301,899, an increase of $2,428,313 or 278.0%, compared to $873,586 for the
corresponding period in 1998. This increase was related to the higher unit sales
of the MA IV in 1999 relative to the unit sales of predecessor models in the
prior year. Consulting, licensing and other revenues for the year ended December
31, 1999 were $38,373, an increase of $36,399, or 1,843.9%, compared to $1,974
for the corresponding period in 1998, resulting from consulting revenues
realized by the Company's Professional Services Group, which was formed during
fiscal 1999.
COST OF SALES. The cost of sales for the year ended December 31, 1999 was
$2,854,456, an increase of $580,001 or 25.5%, compared to $2,274,455 for the
year ended December 31, 1998. In 1999, the Company recognized charges of
approximately $304,000 related to the amortization of capitalized tooling costs
for products sold. Additionally, in 1998, the Company recognized charges of
approximately $455,000 related to the write-off of certain capitalized tooling
costs related to the 133P Systems. In 1999 and 1998, the Company recognized
charges to decrease the carrying value of inventory by $120,000 and $770,557,
respectively, to reflect the loss of value of older products and technologies.
The cost of sales as a percentage of revenues for the year ended December 31,
1999 was 72.8% before related charges and was 85.5% after related charges,
compared to 119.8% before related charges and 259.8% after related charges for
the year ended December 31, 1999.
SALES AND MARKETING EXPENSES. Sales and marketing expenses for the year
ended December 31, 1999 was $8,377,811, an increase of $3,889,315 or 86.7%,
compared to $4,488,496 for the year ended December 31, 1998. The increase
resulted primarily from increases in consulting expenses related to additional
marketing programs to support the launch of the MA IV, personnel and
infrastructure costs related to support sales, marketing and customer service,
and expenses related to sales activities at the Company's subsidiaries in Japan
and Germany.
18
<PAGE> 19
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
for the year ended December 31, 1999 were $6,469,922, an increase of $2,083,023
or 47.5%, compared to $4,386,899 for the year ended December 31, 1998. This
increase was related to legal settlements and related fees in 1999 of
$1,700,463, an increase of $1,215,651, compared to $484,813 in 1998, as well as
administrative expenses related to the increased development and sales activity
related to the MA IV and the establishment and staffing of operations in Japan
and Germany.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses for
the year ended December 31, 1999 were $2,462,752, a decrease of $408,056, or
14.2%, compared to $2,870,808 for the year ended December 31, 1998. This
decrease was related to the higher level of development expenditures during 1998
related to the MA IV and the substantial completion of these development
activities by the first quarter of fiscal 1999.
INTEREST AND OTHER INCOME, NET. Other income for the year ended December
31, 1999 was $78,095, an increase of $44,485, or 132.4%, compared to $33,610 for
the year ended December 31, 1998. This increase is primarily the result of
interest and other miscellaneous income from the Company's subsidiaries, which
were formed in 1999.
PROVISION FOR INCOME TAXES. The Company has accrued $29,223 for an income
tax provision in 1999 related to income earned by the Company's foreign
subsidiaries. The Company's U.S. operations had a net loss in 1999 and,
therefore, no provision for U.S. income taxes was made.
DIVIDEND ON CONVERTIBLE PREFERRED STOCK, DEEMED DIVIDEND ACCRETION ON
CONVERTIBLE PREFERRED STOCK. For the year ended December 31, 1999, the amount of
dividends on preferred stock was $311,714, an increase of $252,411 or 425.6%,
compared to $59,303 in 1998. In accordance with the Emerging Issues Task Force
report from the Securities and Exchange Commission titled "Accounting for the
Issuance of Convertible Preferred Stock and Debt Securities with a Nondetachable
Conversion Feature," the value of the beneficial conversion feature on the
Company's convertible preferred stock issuances was recognized during the
appropriate periods. Additional paid-in capital is reduced by the amount of
accretion and preferred stock is increased by the amount of accretion, resulting
in no impact on the overall amount of stockholders' equity. The amount of this
accretion for the year ended December 31, 1999 was $1,507,376, an increase of
$599,887 or 66.1%, compared to $907,489 in 1998. The dividends and accretion for
the year ended December 31, 1999 related to the Series C, Series D and Series E
Convertible Preferred Stock and for the year ended December 31, 1998 related to
the Series A, Series B and Series C Convertible Preferred Stock.
NET LOSS ATTRIBUTABLE TO HOLDERS OF COMMON STOCK. As a result of the
factors described above, the net loss attributable to holders of common stock
for the year ended December 31, 1999 was $18,594,887 an increase of $4,516,607
or 32.1% compared to $14,078,280 for the year ended December 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
From its inception until the completion of the IPO, the Company financed
its operations through the private sale of its securities, vendor credit,
short-term loans received from management, stockholders and others. During and
subsequent to the IPO, the Company has financed its operations from public and
private sales of its common and preferred stock, borrowings from financial
institutions and management, proceeds from the exercise of warrants and sales of
its products and services.
On July 18, 1996, the Company completed its IPO and sold 2,415,000 Units at
a price of $5.50 per Unit. Each Unit consisted of one share of common stock and
one warrant to purchase a share of common stock at $9.00 (the "Unit"). Gross
proceeds from the sale of the Units were $13,282,500 and net proceeds after
expenses were $10,842,487.
On June 30, 1997, the Company issued 3,000 shares of Series A Convertible
Preferred Stock (the "Series A Preferred Stock") for gross proceeds of
$3,000,000. As of December 31, 1998, all Series A Preferred Stock had been
converted into 1,958,981 shares of common stock, which included payment of all
accrued dividends.
19
<PAGE> 20
On November 12, 1997, the Company issued 3,180 shares of Series B
Convertible Preferred Stock (the "Series B Preferred Stock") for gross proceeds
of $3,180,000. In 1998, the Company issued an additional 1,000 shares of Series
B Preferred Stock with identical terms for additional gross proceeds of
$1,000,000. In connection with these issuances, the Company granted to the
underwriter warrants to purchase a total of 100,000 shares of common stock at
prices that ranging from $2.13 to $3.03. As of December 31, 1998, all Series B
Preferred Stock had been converted into 3,172,239 shares of common stock, which
included payment of all accrued dividends. Subsequent to year-end, all warrants
had been exercised and converted into common stock.
On April 13, 1998, the Company entered into an Equity Line of Credit
Agreement (the "Equity Line Agreement") with a private investor. Under the terms
of the Equity Line Agreement, the Company issued 840,124 shares of common stock
at a price per share of $1.27 per share and obtained the right to require the
investor to purchase an additional $10,000,000 worth of common stock at 90% of
the Company's common stock market price (the "Put Rights"). Pursuant to the
terms of the Equity Line Agreement, the Company issued warrants to purchase a
total of 60,000 shares of common stock at a price per share ranging from $1.76
to $2.81, issued 50,000 shares of common stock which could not be traded prior
to April 13, 1999 and paid $60,000 in cash. Upon exercise of a Put Right, the
Company was required to pay issuance costs of approximately 5.5% of the gross
proceeds in cash and issue shares of common stock equal to 5% of the number of
shares issued in the transaction.
On May 22, 1998, the Company issued 375 shares of Series C Convertible
Preferred Stock (the "Series C Preferred Stock") for gross proceeds of $375,000
and 110,294 shares of common stock for additional gross proceeds of $375,000. As
of December 31, 1999, all Series C Preferred Stock had been converted into
165,230 shares of common stock, which included payment of all accrued dividends.
In June 1998, the Company completed a $1,000,000 private placement of
common stock in which 153,846 restricted shares, as defined in Rule 144
promulgated under the Securities Act, were issued at a price of $6.50 per share.
In June 1998, the Company amended the Equity Line Agreement and exercised a
Put Right in the aggregate principal amount of $3,000,000. In connection with
such action, the Company issued 545,454 shares of common stock which were
subject to restrictions on resale during a nine-month period which has
subsequently lapsed. In addition, the Company issued five-year warrants to
purchase up to 300,000 shares of common stock at a price of $5.25 per share. The
amendment contained certain repricing features which, as a result of market
fluctuations in the Company's common stock, required the Company to issue an
additional 94,004 shares of its common stock without receiving additional
compensation. The Company has no further obligation to issue additional shares
related to these repricing features.
In October 1998, the Company entered into a financing agreement with an
investor pursuant to which the Company sold $2,600,000 of common stock to the
investor during the period from October 8, 1998 to November 12, 1998. The
Company issued 593,201 shares of common stock at prices ranging from $4.04 to
$5.72 under this financing agreement. In addition, the Company issued three
warrants to purchase up to 12,500 shares of common stock each, at prices of
$9.09, $9.58 and $13.05 per share, respectively. These warrants are exercisable
at any time starting six months after the closing and ending five years after
closing. The placement agent for this transaction received a cash fee of 6%.
In November 1998, the Company entered into a financing agreement with an
investor pursuant to which the Company sold $1,595,000 of common stock to the
investor. The Company issued 290,000 shares of common stock at $5.50 per share
under this financing agreement. Such shares were subject to repricing under
certain circumstances. Subsequently the Company issued an additional 150,000
shares upon the occurrence of certain repricing events.
On December 17, 1998, the Company borrowed $1,250,000 from two financial
institutions. The maturity date of the debt was January 29, 1999 and interest
was at 12% per annum. On January 29, 1999, the Company
20
<PAGE> 21
exercised separate Put Rights under the Equity Line Agreement. In connection
with such Put Rights, the Company issued 841,356 shares of common stock at
prices ranging from $4.08 to $4.46, repaid the $1,250,000 borrowed from the two
financial institutions and received proceeds of $2,110,000. In addition, the
Company issued a warrant to purchase 100,000 shares of common stock at an
exercise price of $6.00 per share and a warrant to purchase 100,000 shares of
common stock at an exercise price of $5.50 per share.
On March 10, 1999, the Company issued the first tranche of 5,000 shares of
its Series D Convertible Preferred Stock (the "Series D Preferred Stock") for
gross proceeds of $5,000,000. The Company issued an additional 5,000 shares of
Series D Preferred Stock for gross proceeds of $5,000,000 following the
effectiveness of a registration statement covering the resale of the common
stock issuable upon conversion of the Series D Preferred Stock. In connection
with these issuances, the investors received warrants to purchase 20 shares of
common stock for each share of Series D Preferred Stock purchased. The warrants
have an exercise price of $6.09 per share and a term of three years. The Series
D Preferred Stock had a 5% cumulative dividend which is payable, in cash or
through the issuance of common stock, upon the conversion of the Series D
Preferred Stock into common stock. The Series D Preferred Stock may be converted
into shares of common stock by dividing the dollar amount of Series D Preferred
Stock outstanding by the lesser of 100% of the average of the three lowest
closing bids for the common stock during the twenty trading days prior to
conversion or $4.88, the closing bid price of the common stock on the trading
day immediately preceding the closing date of this private placement. The
Company may redeem the Series D Preferred Stock at any time for a premium to
face value that varies depending on the timing of redemption. In connection with
this private placement, the Company issued an additional 500 shares of Series D
Preferred Stock to a finder. As of December 31, 1999, holders of the Series D
Preferred Stock had converted 6,000 shares into 4,059,399 shares of common
stock, which included payment of all accrued dividends on these 6,000 shares of
Series D Preferred Stock. Additionally, during the fourth quarter of 1999, the
Company received notices from the investors to convert 4,000 shares of Series D
Preferred Stock into common stock. In January 2000, the Company converted these
4,000 shares of Series D Preferred Stock, along with related dividends, into
4,039,033 shares of common stock. Subsequent to these conversions, 500 shares of
Series D Preferred Stock were issued and outstanding.
On May 12, 1999, the Company issued 2,000 shares of Series E Convertible
Preferred Stock (the "Series E Preferred Stock") for gross proceeds of
$2,000,000. In connection with this issuance, the investor received warrants to
purchase a total of 50,000 shares of common stock. The warrants have an exercise
price of $4.65 per share and a term of three years. The Series E Preferred Stock
has a 5% cumulative dividend which is payable, in cash or through the issuance
of common stock, upon the conversion of the Series E Preferred Stock. The
Company may redeem the Series E Preferred Stock at any time at a premium to face
value that varies depending on the timing of the redemption, as long as the
price of the common stock is above certain levels. Holders of the Series E
Preferred Stock may convert these securities into shares of common stock at the
lesser of 94% of the average of the three lowest closing bids for the common
stock during the twenty trading days prior to conversion, or $3.72, the closing
bid price of the common stock on the trading day immediately preceding the
closing date of this private placement. In connection with this private
placement, the Company issued an additional 100 shares of Series E Preferred
Stock were issued to a finder. As of December 31, 1999, the Series E Preferred
Stock investor had converted all of its 2,000 shares of Series E Preferred
Stock, along with related dividends, into 1,627,481 shares of common stock.
On various dates during 1999, the Company borrowed $583,500 from several
officers of the Company pursuant to non-interest bearing promissory notes or
agreements. All of these borrowings had been repaid at December 31, 1999 except
for $10,000, which was repaid in February 2000.
In August 1999, the Company entered into a financing agreement with a
lender under which the Company receives 80% of an identified accounts receivable
balance upon presentation to the lender of certain documentation supporting the
underlying sale. The Company receives the remaining 20%, net of a fee paid to
the lender, upon collection by the lender of the original accounts receivable
balance. The lender has recourse to the Company for any uncollected accounts
receivable balances. The Company paid $60,000 in initial placement fees
associated with this facility, all of which was amortized during 1999. During
the year ended
21
<PAGE> 22
December 31, 1999, the Company received $456,315 in proceeds and incurred $9,698
in interest expense related to this facility. The Company owed $24,254 on this
facility at December 31, 1999.
On September 21, 1999, the Company completed a $100,000 private placement
of common stock in which 135,000 restricted shares, as defined in Rule 144
promulgated under the Securities Act, were issued.
During October 1999 through December 1999, the Company borrowed $1,000,000
from an investor pursuant to a secured promissory note. In connection with this
borrowing, the Company issued warrants to purchase 1,000,000 shares of its
common stock at $1.00 per share. On December 31, 1999, the cashless conversion
of these warrants into 1,000,000 shares of the Company's common stock was used
as consideration to fully repay the loan.
During October 1999 through December 1999, the Company issued 545,000
shares of its common stock to investors who exercised warrants granted in
connection with previous financings for proceeds of $838,513.
On November 19, 1999, the Company completed a $3,000,000 private placement
of common stock in which 1,000,000 shares were issued.
On December 2, 1999, the Company entered into a financing facility with IBM
Global Finance (the "IBM Facility"). Borrowings under the IBM Facility are
secured by the Company's equipment, inventory and accounts receivable balances.
The Company paid $60,000 in initial placement fees, which are being amortized
over the six-month period ending May 31, 2000. Under the terms of the facility,
the Company borrowed $1,000,000 under a term loan and was extended a $3,000,000
credit line to finance customer purchases upon presentation to the lender of
certain documentation supporting the underlying sales. The borrowing under the
term loan accrues interest at the prime rate (8.5% at December 31, 1999) plus
2.5% per annum and is to be repaid in three equal installments in February,
April and June, 2000. Borrowings under the credit line accrue interest at up to
the prime rate plus 2.75%, depending on certain characteristics of the
underlying Company sales being financed such as the type of customer and the age
of the accounts receivable balance. The Company owed $1,000,000 at December 31,
1999 and incurred $9,167 in interest expense during 1999 associated with the IBM
Facility.
Subsequent to December 31, 1999, the Company has raised approximately
$18,600,000 through the issuance of common stock, borrowings, and the exercise
of warrants granted in connection with previous financings.
For the year ended December 31, 1999, the Company's operating activities
used cash of $15,803,023. This was primarily the result of a $16,775,797 net
loss and cash used by inventory of $3,989,991, offset by a net increase in
accounts payable and accrued expenses of $4,028,612 and depreciation and
amortization of $1,409,249. Cash used in investing activities for the year ended
December 31, 1999 was $2,236,684 which included $959,073 for the acquisition of
property and equipment, $349,250 related to obtaining and maintaining patents,
$120,000 in capitalized loan costs and $808,545 in capitalized tooling costs.
Proceeds from the Company's financing activities for the year ended December 31,
1999 were $19,056,622, which primarily consisted of $11,418,621 from the
issuance of the Company's Series D and Series E Preferred Stock, net of related
fees, $6,009,834 from the issuance of the Company's common stock, $1,838,513
from the exercise of warrants, and $3,039,315 of proceeds from notes and loans,
offset by payments on notes and loans totaling $3,255,061. As a result of the
above, cash and cash equivalents on hand as of December 31, 1999 was $2,031,143,
an increase of $1,106,494 from the $924,629 of cash on hand as of December 31,
1998.
For the year ended December 31, 1998, the Company's operating activities
used cash of $10,699,000. This was primarily the result of a $13,111,488 net
loss and a net increase in inventories of $835,795. These were offset by a net
increase in accounts payable and accrued expenses of $1,242,766, a non-cash
obsolescence inventory charge of $770,557, depreciation and amortization of
$503,143 and a non-cash charge for tooling costs of $455,449. Cash used in
investing activities for the year ended December 31, 1998 was $985,899, which
included $448,744 in capitalized tooling costs, $313,109 related to obtaining
and maintaining patents and $256,358 for the acquisition of property and
equipment. Proceeds from the Company's financing activities for the year ended
December 31, 1998 were $11,657,182 which primarily consisted of $9,186,659 from
the issuance of common stock, $1,240,053 from the issuance of the Company's
Series B and Series C Preferred Stock, net of related fees, and $1,250,000 of
proceeds from notes and loans. As a result of the above, cash and
22
<PAGE> 23
cash equivalents on hand as of December 31, 1998 was $924,649, a decrease of
$27,717 from the $952,366 of cash on hand as of December 31, 1997.
At December 31, 1999, the Company had informal agreements with several of
its suppliers to take shipments of additional inventory of parts and components
during the first half of 2000. While the timing and amount of these shipments
may be adjusted, the total amount of inventory and related payment under these
agreements could be approximately as much as $1,500,000 to $2,000,000.
The Company anticipates that its working capital requirements and operating
expenses will increase as the Company expands production and sales of the Mobile
Assistant Series, develops and sells new models in the Mobile Assistant Series,
expands its full sales, service and marketing functions, and develops the
support structure for these activities. The timing of increases in personnel and
other expenses, the amount of working capital consumed by operations, marketing
and rollout expenses for the Mobile Assistant Series, and competitive pressures
on gross margins will impact the magnitude and timing of the Company's cash
requirements. Management is currently exploring financing alternatives to
supplement the Company's cash position. Potential sources of additional
financing include private equity financings, mergers, strategic investments,
strategic partnerships or various forms of debt financings. If additional funds
are raised by the Company through the issuance of equity securities, the
percentage of ownership of the then current stockholders of the Company will be
reduced. The Company's management believes that the combination of cash on hand,
operating cash flow, and outside funding will provide sufficient liquidity to
meet the Company's cash requirements until at least March 2001. However, there
can be no assurance that the Company can or will obtain sufficient funds from
operations or from closing additional financings on terms acceptable to the
Company.
23
<PAGE> 24
ITEM 7. FINANCIAL STATEMENTS.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Accountants........................... F-1
Consolidated Balance Sheets -- December 31, 1999 and 1998... F-2
Consolidated Statements of Operations -- Years ended
December 31, 1999 and 1998................................ F-3
Consolidated Statements of Stockholders' Equity -- Years
ended December 31, 1999 and 1998.......................... F-4
Consolidated Statements of Cash Flows -- Years ended
December 31, 1999 and 1998................................ F-5
Notes to Consolidated Financial Statements.................. F-6
</TABLE>
24
<PAGE> 25
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Xybernaut Corporation
We have audited the accompanying consolidated balance sheets of Xybernaut
Corporation as of December 31, 1999 and 1998, and the related consolidated
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 Xybernaut Corporation as of
December 31, 1999 and 1998, and the results of its operations and its cash flows
for the years then ended in conformity with generally accepted accounting
principles.
/s/ Grant Thornton, LLP
Vienna, VA
February 25, 2000 (Except for Notes 1 and 13, as to which the date is July 5,
2000)
F-1
<PAGE> 26
XYBERNAUT CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $ 2,031,143 $ 924,649
Accounts receivable, net of allowances of $140,968 and
$91,131............................................. 706,850 229,120
Inventory, net of reserves of $120,000 and $770,557... 6,060,455 1,347,668
Prepaid and other current assets...................... 556,042 374,243
------------ ------------
Total current assets.............................. 9,354,490 2,875,680
------------ ------------
Property and equipment, net................................. 695,440 462,384
------------ ------------
Other assets:
Patent costs, net of accumulated amortization of
$520,683 and $313,982............................... 703,174 560,625
Tooling costs, net of accumulated amortization of
$630,890 and $326,752............................... 286,456 370,285
Other................................................. 283,864 142,614
------------ ------------
Total other assets................................ 1,273,494 1,073,524
------------ ------------
Total assets...................................... $ 11,323,424 $ 4,411,588
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes and loans payable............................... $ 1,034,254 $ 1,250,000
Accounts payable...................................... 4,601,631 1,626,897
Accrued expenses and other............................ 2,284,390 786,980
------------ ------------
Total current liabilities......................... 7,920,275 3,663,877
------------ ------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value, 6,000,000 shares
authorized:
600 and 188 shares of convertible preferred stock
issued and outstanding at December 31, 1999 and
1998; (liquidation preference $600,000 and
$188,000 at December 31, 1999 and 1998)........... 543,751 182,378
4,000 shares of convertible preferred stock converted
into common stock subsequent to December 31, 1999;
(liquidation preference $4,000,000)............... 3,452,837 --
Common stock, $0.01 par value, 80,000,000 shares
authorized:
29,944,407 and 21,359,751 shares issued and
outstanding....................................... 299,444 213,597
Additional paid-in capital............................ 47,188,704 31,716,067
Foreign currency translation.......................... 58,541 --
Accumulated deficit................................... (48,140,128) (31,364,331)
------------ ------------
Total stockholders' equity........................ 3,403,149 747,711
------------ ------------
Total liabilities and stockholders' equity........ $ 11,323,424 $ 4,411,588
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-2
<PAGE> 27
XYBERNAUT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
Revenue:
Product sales......................................... $ 3,301,899 $ 873,586
Consulting, licensing and other....................... 38,373 1,974
------------ ------------
Total revenue..................................... 3,340,272 875,560
Cost of sales............................................... 2,854,456 2,274,455
------------ ------------
Gross income (loss)............................... 485,816 (1,398,895)
Operating expenses:
Sales and marketing................................... 8,377,811 4,488,496
General and administrative............................ 6,469,922 4,386,899
Research and development.............................. 2,462,752 2,870,808
------------ ------------
Total operating expenses.......................... 17,310,485 11,746,203
------------ ------------
Operating loss.................................... (16,824,669) (13,145,098)
Interest and other income, net.............................. 78,095 33,610
------------ ------------
Loss before provision for income taxes................ (16,746,574) (13,111,488)
Provision for income taxes.................................. 29,223 --
------------ ------------
Net loss.............................................. (16,775,797) (13,111,488)
Provision for preferred stock dividends..................... 311,714 59,303
Provision for accretion on preferred stock beneficial
conversion feature........................................ 1,507,376 907,489
------------ ------------
Net loss applicable to holders of common stock........ $(18,594,887) $(14,078,280)
============ ============
Net loss per common share applicable to holders of
common stock (basic and diluted).................... $ (0.78) $ (0.80)
============ ============
Weighted average number of common shares Outstanding (basic
and diluted).............................................. 23,842,403 17,670,318
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
<PAGE> 28
XYBERNAUT CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
NUMBER OF SHARES VALUE OF SHARES ADDITIONAL ACCUMULATED
---------------------- ------------------------------------- PAID-IN COMPREHENSIVE
PREFERRED COMMON PREFERRED PREFERRED(1) COMMON CAPITAL INCOME
--------- ---------- ----------- ------------ -------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997......... 5,430 14,360,515 $ 4,193,355 $ -- $143,605 $17,181,329 $ --
Issuance of common stock........... -- 2,776,923 -- -- 27,770 9,158,889 --
Issuance of preferred stock........ 1,375 -- 1,240,053 -- -- -- --
Issuance of common stock in
connection with issuance of Series
B Preferred Stock................. -- 50,000 -- 500 97,938 --
Conversion of preferred stock into
common stock...................... (6,617) 4,827,570 (5,982,049) 48,275 5,933,774 --
Value of beneficial conversion
feature on preferred stock........ -- -- (176,470) -- -- 176,470 --
Accretion of deemed dividend of
preferred stock................... -- -- 907,489 -- -- (907,489) --
Preferred stock dividend
requirements...................... -- -- -- -- -- (59,303) --
Amortization of deferred
compensation...................... -- -- -- -- -- -- --
Cancellation of escrow shares of
common stock...................... -- (750,000) -- -- (7,500) 7,500 --
Dividends on preferred stock paid
with common stock................. -- 94,743 -- -- 947 126,959 --
Net loss........................... -- -- -- -- -- -- --
------ ---------- ----------- ---------- -------- ----------- -------
BALANCE, DECEMBER 31, 1998......... 188 21,359,751 $ 182,378 $ -- $213,597 $31,716,067 $ --
Issuance of common stock........... -- 1,976,356 -- -- 19,764 5,990,070 --
Issuance of preferred stock........ 12,600 -- 11,418,621 -- -- -- --
Conversion of preferred stock into
common stock...................... (8,188) 5,666,514 (7,604,411) 56,665 7,547,746 --
Conversion of preferred stock into
common stock subsequent to
December 31, 1999................. -- -- (3,452,837) 3,452,837 -- -- --
Exercise of warrants............... -- 1,545,000 -- -- 15,450 1,823,063 --
Exercise of stock options.......... -- 1,800 -- -- 18 5,382 --
Shares and stock options issued for
services and incentives........... -- 2,500 -- -- 25 223,522 --
Cancellation of escrow shares of
common stock...................... -- (750,000) -- -- (7,500) 7,500 --
Value of beneficial conversion
feature on preferred stock........ -- -- (1,507,376) -- -- 1,507,376 --
Accretion of deemed dividend of
preferred stock................... -- -- 1,507,376 -- -- (1,507,376) --
Dividends on preferred stock paid
with common stock................. -- 142,486 -- -- 1,425 187,068 --
Preferred stock dividend
requirements...................... -- -- -- -- -- (311,714) --
Foreign currency translation....... -- -- -- -- -- -- 58,541
Net loss........................... -- -- -- -- -- -- --
------ ---------- ----------- ---------- -------- ----------- -------
Total comprehensive income
(loss)............................ -- -- -- -- -- -- --
------ ---------- ----------- ---------- -------- ----------- -------
BALANCE, DECEMBER 31, 1999......... 4,600 29,944,407 $ 543,751 $3,452,837 $299,444 $47,188,704 $58,541
====== ========== =========== ========== ======== =========== =======
<CAPTION>
TOTAL
ACCUMULATED DEFERRED STOCKHOLDERS'
DEFICIT COMPENSATION EQUITY
------------ ------------ -------------
<S> <C> <C> <C>
BALANCE, DECEMBER 31, 1997......... $(18,252,843) $(91,511) $ 3,173,935
Issuance of common stock........... -- -- 9,186,659
Issuance of preferred stock........ -- -- 1,240,053
Issuance of common stock in
connection with issuance of Series
B Preferred Stock................. -- -- 98,438
Conversion of preferred stock into
common stock...................... -- -- --
Value of beneficial conversion
feature on preferred stock........ -- -- --
Accretion of deemed dividend of
preferred stock................... -- -- --
Preferred stock dividend
requirements...................... -- -- (59,303)
Amortization of deferred
compensation...................... -- 91,511 91,511
Cancellation of escrow shares of
common stock...................... -- -- --
Dividends on preferred stock paid
with common stock................. -- -- 127,906
Net loss........................... (13,111,488) -- (13,111,488)
------------ -------- ------------
BALANCE, DECEMBER 31, 1998......... $(31,364,331) $ -- $ 747,711
Issuance of common stock........... -- -- 6,009,834
Issuance of preferred stock........ -- -- 11,418,621
Conversion of preferred stock into
common stock...................... -- -- --
Conversion of preferred stock into
common stock subsequent to
December 31, 1999................. -- -- --
Exercise of warrants............... -- -- 1,838,513
Exercise of stock options.......... -- -- 5,400
Shares and stock options issued for
services and incentives........... -- -- 223,547
Cancellation of escrow shares of
common stock...................... -- -- --
Value of beneficial conversion
feature on preferred stock........ -- -- --
Accretion of deemed dividend of
preferred stock................... -- -- --
Dividends on preferred stock paid
with common stock................. -- -- 188,493
Preferred stock dividend
requirements...................... -- -- (311,714)
Foreign currency translation....... -- -- 58,541
Net loss........................... (16,775,797) -- ( 16,775,797)
------------ -------- ------------
Total comprehensive income
(loss)............................ -- -- (16,717,256)
------------ -------- ------------
BALANCE, DECEMBER 31, 1999......... $(48,140,128) $ -- $ 3,403,149
============ ======== ============
</TABLE>
---------------
(1) Represents preferred stock converted into common stock subsequent to
December 31, 1999.
The accompanying notes are an integral part of these
consolidated financial statements
F-4
<PAGE> 29
XYBERNAUT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(16,775,797) $(13,111,488)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.......................... 1,409,249 503,143
Gain on disposal of assets............................. (26,562) (6,626)
Provision for inventory................................ 120,000 770,557
Provision for bad debts................................ 49,837 37,920
Non-cash charges for equity securities issued for
services............................................. 223,547 91,511
Reduction of carrying value for equipment and tooling
costs................................................ -- 688,546
Changes in assets and liabilities:
Inventory............................................ (3,989,991) (835,795)
Accounts receivable.................................. (547,097) (50,273)
Prepaid and other current assets..................... (178,951) (39,998)
Other assets......................................... (115,870) 10,737
Accounts payable..................................... 2,505,775 1,364,158
Accrued expenses and other........................... 1,522,837 (121,392)
------------ ------------
Net cash used in operating activities.................. (15,803,023) (10,699,000)
------------ ------------
Cash flows from investing activities:
Proceeds from sale of property and equipment.............. 834 32,312
Acquisition of property and equipment..................... (959,073) (256,358)
Acquisition of patents, trademarks and related costs...... (349,900) (313,109)
Acquisition of trademarks................................. (650) --
Capitalization of tooling costs........................... (808,545) (448,744)
Capitalization of loan costs.............................. (120,000) --
------------ ------------
Net cash used in investing activities.................. (2,236,684) (985,899)
------------ ------------
Cash flows from financing activities:
Proceeds from:
Preferred stock offerings, net......................... 11,418,621 1,240,053
Common stock offerings, net............................ 6,009,834 9,186,659
Exercise of warrants................................... 1,838,513 --
Exercise of stock options.............................. 5,400 --
Notes and loans........................................ 3,039,815 1,250,000
Payments for:
Notes and loans........................................ (3,255,561) (19,530)
------------ ------------
Net cash provided by financing activities.............. 19,056,622 11,657,182
------------ ------------
Effect of exchange rate changes on cash and cash
equivalents............................................... 89,579 --
Net increase (decrease) in cash and cash equivalents........ 1,106,494 (27,717)
Cash and cash equivalents, beginning of period.............. 924,649 952,366
------------ ------------
Cash and cash equivalents, end of period.................... $ 2,031,143 $ 924,649
============ ============
Supplemental disclosure of cash flow information:
Cash paid for interest................................. $ 18,367 $ 5,032
============ ============
Cash paid for taxes.................................... $ 9,419 $ --
============ ============
Supplemental disclosure of non-cash financing activities:
Equity securities issued for payment of services
provided............................................. $ 223,547 $ 91,511
============ ============
Provision for preferred stock dividend requirements.... $ 311,714 $ 59,303
============ ============
Common stock issued for preferred stock dividend
requirements......................................... $ 188,493 $ 134,833
============ ============
Exercise of warrants in consideration of loan
repayment............................................ $ 1,000,000 $ --
============ ============
Issuance of common stock in consideration of loan
repayment............................................ $ 1,250,000 $ --
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
<PAGE> 30
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND FINANCING
THE COMPANY
Xybernaut Corporation (the "Company") was incorporated in Virginia as
Contemporary Products & Services, Inc. in October 1990 and changed its name to
Computer Products & Services, Inc. in November 1992. In April 1996, the Company
merged with Xybernaut Corporation, a Delaware corporation, in order to change
its name and reincorporate in Delaware. On July 18, 1996, the Company completed
its Initial Public Offering ("IPO"). Since the commencement of operations in
November 1992, the Company has engaged in the research, development and
commercialization of hardware and software products for wearable computing and
communications. The Company's current mobile computing product is the Mobile
Assistant IV model (the "MA IV(R)"), which is a full-function, body-worn,
voice-controlled computer with a body-worn video display. Additional hardware
and software products are planned for development and use on the Mobile
Assistant series and subsequent proprietary products.
FINANCING
The Company has incurred significant recurring losses from operations since
inception and will require additional capital to fund its business plan and meet
its ongoing obligations for 2000 and potentially beyond. Management believes
they will be successful in their efforts to obtain such financing and subsequent
to year-end has raised approximately $18,600,000 (see Note 13). There can be no
assurance that the Company will not incur additional losses or will not require
significant amounts of additional capital. If the Company is unable to obtain
sufficient additional financing, it will be required to reduce discretionary
spending in order to maintain its operations at a reduced level. Management
believes that it will be able to reduce discretionary spending if required.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries: Xybernaut GmbH (Boblingen, Germany),
Xybernaut K.K. (Yokohoma, Japan) and Tech Virginia (Fairfax, Virginia). All
significant intercompany accounts and transactions have been eliminated in the
consolidation. Net gains and losses resulting from foreign exchange transactions
have not been material.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
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.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
INVENTORY
Inventory consists primarily of component parts held for resale and
allocated tooling costs and is comprised principally of finished goods.
Inventory is stated at the lower of cost or market, cost being
F-6
<PAGE> 31
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
determined on a first-in, first-out basis. Management periodically assesses the
need to provide for obsolescence of inventory and adjusts carrying values to
their net realizable value when required. As of December 31, 1999 and 1998, the
allowance to reduce inventory balances to net realizable value was $120,000 and
$770,557, respectively. The reserve at December 31, 1999 represents the
Company's estimate of the loss of value of certain of the older peripherals and
components of the MA IV. In the event that sales do not materialize, an
adjustment may be necessary to write down the carrying value of inventory. The
reserve at December 31, 1998 represents the full reduction of all inventory
amounts related to the Company's products prior generations of products.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are depreciated on a
straight-line basis over the estimated useful lives of the assets, as follows:
<TABLE>
<S> <C>
Furniture and fixtures...................................... 5 years
Equipment................................................... 3-5 years
Leasehold improvements...................................... 3 years
Demonstration units......................................... 1 year
</TABLE>
Expenditures for maintenance and repairs are expensed directly to the
appropriate operating account as incurred. Expenditures determined to represent
additions and betterments are capitalized.
TOOLING COSTS
Capitalized tooling costs consist of payments made to third-party vendors
for reimbursement of their products and services that are used in the design and
manufacturing of the Company's proprietary products. Tooling costs are amortized
into cost of sales expense based upon the ratio of units sold in a given period
to total units expected to be produced and sold. In 1998, the Company recognized
charges of approximately $455,000 related to the write-off of certain
capitalized tooling costs related to the Company's products prior to the MA IV.
SOFTWARE DEVELOPMENT COSTS
Software development costs are included in research and development and are
expensed as incurred. Statement of Financial Accounting Standards No. 86
requires the capitalization of certain software development costs once
technological feasibility is established, which the Company defines as the
completion of a working model. The capitalized cost is then amortized on a
straight-line basis over the estimated product life, or on the ratio of current
revenues to total projected product revenues, whichever is greater. To date, the
period between achieving technological feasibility and the general availability
of such software has been short and software development costs qualifying for
capitalization have not been significant. Accordingly, the Company has not
capitalized any software development costs. Since the Company is currently in
the planning and development phase for software toolkits, no costs have been
capitalized to date.
PATENT COSTS
Patent costs consist of legal fees, filing fees and other direct costs
incurred in obtaining patents and are amortized on a straight-line basis over a
five-year period and are presented as general and administrative expenses in the
accompanying consolidated statements of operations. Amortization expense related
to the patents was $206,701 and $136,906 during 1999 and 1998, respectively.
Costs associated with the upkeep and maintenance of existing patents are
expensed as incurred.
F-7
<PAGE> 32
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
START-UP COSTS
The Company expenses start-up and organization costs as incurred in
accordance with Statement of Position 98-5, "Reporting on Costs of Start-Up
Activities."
IMPAIRMENT OF LONG-LIVED ASSETS
Management of the Company monitors the carrying value of long-lived assets
for potential impairment on an on-going basis. Potential impairment would be
determined by comparing the carrying value of these assets with their related,
expected future net cash flows. Should the sum of the related, expected future
net cash flows be less than the carrying value, management would determine
whether an impairment loss should be recognized. An impairment loss would be
measured by the amount by which the carrying value of the asset exceeds the
future discounted cash flows. No such impairment losses were recorded during
1999 or 1998.
REVENUE RECOGNITION AND WARRANTIES
The Company recognizes revenues upon shipment to end-users pursuant to a
valid purchase order ("sell-to accounting"). Shipments to distributors are
accounted for using "sell-through accounting," under which revenue is recognized
when the distributor ships to an end-user, until such time as an adequate
history of shipments and returns from distributors can be developed to allow for
revenue to be recognized upon shipment offset by an allowance for returns.
Shipments to distributors are treated as revenue upon shipment only if shipped
pursuant to a separate purchase order that stipulates that the products are for
demonstration or testing by the distributor and that the obligation to pay is
binding and not subject to contingencies.
The Company generally provides a one-year warranty on parts and a six-month
warranty on labor. A provision for estimated future warranty costs is recorded
at the time of shipment. However, the Company's suppliers for the significant
components of the MA IV, including the computing unit, flat panel display, head
mounted display, and batteries, provide the Company with similar warranties. The
Company recorded warranty expense of $36,204 and $59,678 during 1999 and 1998,
respectively, and had a warranty reserve of $100,781 and $64,577 at December 31,
1999 and 1998, respectively.
RESEARCH AND DEVELOPMENT PROGRAMS
Research and development costs are charged to operations as incurred,
including the cost of components purchased for testing and product development
that are saleable but are intended for development work only.
INCOME TAXES
Deferred income tax assets and liabilities are computed annually for
differences between the financial statement and income tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future.
Such deferred income tax asset and liability computations are based on enacted
tax laws and rates applicable to periods in which the differences are expected
to affect taxable income. Income tax expense is the tax payable or refundable
for the period plus or minus the change during the period in deferred income tax
assets and liabilities. The provision for income taxes in 1999 results from the
operations of the Company's international subsidiaries.
NET LOSS PER SHARE
Basic earnings (or loss) per share is based on the weighted average number
of outstanding shares of common stock. Diluted earnings per share adjusts the
weighted average for the potential dilution that could occur if stock options,
warrants or other convertible securities were exercised or converted into common
stock.
F-8
<PAGE> 33
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
For all periods presented herein, diluted earnings per share is the same as
basic earnings per share for the Company because the effects of such items were
anti-dilutive given the losses incurred in such periods.
ISSUANCE OF EQUITY SECURITIES FOR SERVICES
Periodically, the Company issues shares of common stock and options to
purchase shares of common stock to vendors and consultants in return for goods
or services. These transactions are recorded at either the fair value of the
securities issued or at the fair value of goods received or services performed,
whichever is more reliably measured.
ESCROWED SHARES
Escrowed shares are considered issued and outstanding and reported as such
on the combined balance sheets until their cancellation. At December 31, 1999,
all escrowed shares had been cancelled. Since the Company has reported losses,
the loss per share for the Company is calculated using outstanding shares less
shares held in escrow to avoid antidilution. Therefore, the cancellation of
shares from escrow does not affect the reported losses per share.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments including cash and cash
equivalents, accounts receivable and accounts payable approximated fair value as
of December 31, 1999 and 1998, because of the relatively short maturity of these
instruments. The carrying value of the notes and loans payable approximated fair
value as of December 31, 1999 and 1998, based upon market prices for the same or
similar debt issues.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of the Company's foreign subsidiaries are translated
at the exchange rate on the balance sheet date. Translation adjustments
resulting from this process are charged or credited to equity. Revenues and
expenses are translated at average exchange rates prevailing during the year.
Gains and losses on foreign currency transactions are included in nonoperating
revenues and expenses.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." In 1999, the
required implementation date of SFAS No. 133 was delayed to fiscal years
beginning after June 15, 2000. SFAS 133 requires that all derivative instruments
be recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. Currently the
Company does not utilize derivative instruments, but may elect to do so to hedge
foreign currency exposure if such exposure becomes significant. The adoption of
SFAS 133 is not expected to have a significant effect on the Company's results
of operations or its financial position. The Company will adopt SFAS 133 for the
year ending December 31, 2001.
RECLASSIFICATIONS
Certain 1998 balances and disclosures have been reclassified to conform to
the 1999 presentation.
F-9
<PAGE> 34
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1999 1998
----------- ----------
<S> <C> <C>
Furniture and fixtures................................... $ 195,896 74,872
Equipment................................................ 695,393 $ 516,669
Leasehold improvements................................... 257,868 153,159
Demonstration units...................................... 922,604 327,872
----------- ----------
2,071,761 1,072,572
Less accumulated depreciation and amortization........... (1,376,321) (610,188)
----------- ----------
$ 695,440 $ 462,384
=========== ==========
</TABLE>
Depreciation expense for the years ended December 31, 1999 and 1998 was
$703,158 and $364,472, respectively.
4. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1999 1998
---------- --------
<S> <C> <C>
Accrued salaries and benefits............................... $ 863,233 $541,427
Professional fees........................................... 565,496 70,418
Warranty reserve............................................ 100,781 64,577
Dividends on preferred stock................................ 143,466 5,794
Other....................................................... 611,414 104,764
---------- --------
$2,284,390 $786,980
========== ========
</TABLE>
Other accruals consist of amounts related to expenses incurred in the
normal course of business, such as employee travel costs, sales and other taxes,
royalty costs for software sales, and deferred revenues.
5. NOTES PAYABLE
On December 17, 1998, the Company borrowed $1,250,000 from two financial
institutions. The maturity date of the debt was January 29, 1999 and interest
was at 12% per annum. On January 29, 1999, the Company repaid the principal and
accrued interest through the issuance of common stock.
On various dates during 1999, the Company borrowed a total of $583,000 from
several officers of the Company pursuant to non-interest bearing promissory
notes or agreements. All of these borrowings had been repaid at December 31,
1999 except for $10,000, which was repaid in February 2000.
In August 1999, the Company entered into a financing agreement with a
lender under which the Company receives 80% of an accounts receivable balance
upon presentation to the lender of certain documentation supporting the
underlying sale. The Company receives the remaining 20%, net of a fee paid to
the lender, upon collection by the lender of the original accounts receivable
balance. The lender has recourse to the Company for any uncollected accounts
receivable balance. The Company paid $60,000 in initial placement fees
associated with this facility, all of which was amortized during 1999. During
the year ended December 31, 1999, the Company received $456,315 in proceeds and
incurred $9,698 in interest expense related to this facility. The Company owed
$24,254 on this facility at December 31, 1999.
F-10
<PAGE> 35
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. NOTES PAYABLE, CONTINUED:
Between October 1999 and December 1999, the Company borrowed $1,000,000
from an investor pursuant to a secured promissory note. On December 31, 1999,
the cashless conversion of warrants issued in connection with this borrowing was
used as consideration to fully repay the loan.
On December 2, 1999, the Company entered into a financing facility with IBM
Global Finance (the "IBM Facility"). Borrowings under the IBM Facility are
secured by the Company's equipment, inventory and accounts receivable balances.
The Company paid $60,000 in initial placement fees, which are being amortized
over the six-month period ending May 31, 2000. Under the terms of the facility,
the Company borrowed $1,000,000 under a term loan and was extended a $3,000,000
credit line to finance customer purchases upon presentation to the lender of
certain documentation supporting the underlying sales. The borrowing under the
term loan accrues interest at up to the prime rate (8.5% at December 31, 1999)
plus 2.5% per annum and is to be repaid in three equal installments in February,
April and June, 2000. Borrowings under the credit line accrue interest up to the
prime rate plus 2.75%, depending on certain specifics of the underlying Company
sales being financed, such as the type of customer and the age of the accounts
receivable balance. The Company owed $1,000,000 at December 31, 1999 and
incurred $9,167 in interest expense during 1999 associated with the IBM
Facility.
6. STOCKHOLDERS' EQUITY
PREFERRED STOCK
As of December 31, 1999, the Company had 6,000,000 shares of authorized
Preferred Stock of which 3,000, 4,180, 375, 10,500, and 2,100 shares had been
designated as Convertible Preferred Stock Series A, B, C, D, and E, respectively
("Series A, B, C, D or E Preferred Stock", respectively). Under the terms of the
Company's Certificate of Incorporation, the Board of Directors may determine the
rights, preferences, and terms of the Company's authorized but unissued shares
of Preferred Stock.
On June 30, 1997, the Company issued 3,000 shares of Series A Preferred
Stock for gross proceeds of $3,000,000. As of December 31, 1998, all Series A
Preferred Stock had been converted into 1,958,981 shares of common stock, which
included payment of all accrued dividends.
On November 12, 1997, the Company issued 3,180 shares of Series B Preferred
Stock for gross proceeds of $3,180,000. In 1998, the Company issued an
additional 1,000 shares of Series B Preferred Stock with identical terms for
additional gross proceeds of $1,000,000. In connection with this issuance, the
Company granted to the underwriter warrants to purchase a total of 100,000
shares of common stock at prices ranging from $2.13 to $3.03. As of December 31,
1998, all Series B Preferred Stock had been converted into 3,172,239 shares of
common stock, which included payment of all accrued dividends.
On May 22, 1998, the Company issued 375 shares of Series C Preferred Stock
for gross proceeds of $375,000. As of December 31, 1999, all Series C Preferred
Stock had been converted into 165,230 shares of common stock, which included
payment of all accrued dividends.
On March 10, 1999, the Company issued the first tranche of 5,000 shares of
Series D Preferred Stock for gross proceeds of $5,000,000. Following the
effectiveness of a registration statement covering the resale of the common
stock issuable upon conversion of the Series D Preferred Stock, the Company
issued an additional 5,000 shares of Series D Preferred Stock for gross proceeds
of $5,000,000. In connection with these issuances, the investors received
warrants to purchase 20 shares of common stock for each share of Series D
Preferred Stock purchased. The warrants have an exercise price of $6.09 per
share and a term of three years. The Series D Preferred Stock has a 5%
cumulative dividend which is payable, in cash or through the issuance of
F-11
<PAGE> 36
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. STOCKHOLDERS' EQUITY, CONTINUED:
common stock, upon the conversion of the Series D Preferred Stock into common
stock. The Series D Preferred Stock may be converted into shares of common stock
by dividing the dollar amount of Series D Preferred Stock outstanding by the
lesser of 100% of the average of the three lowest closing bids for the common
stock during the twenty trading days prior to conversion or $4.88, the closing
bid price of the common stock on the trading day immediately preceding the
closing date of this private placement. The Company may redeem the Series D
Preferred Stock at any time for a premium to face value that varies depending on
the timing of redemption. In connection with this private placement, the Company
issued an additional 500 shares of Series D Preferred Stock to a finder. As of
December 31, 1999, holders of the Series D Preferred Stock had converted 6,000
shares into 4,059,399 shares of common stock, which included payment of all
accrued dividends on these 6,000 shares of Series D Preferred Stock.
Additionally, during the fourth quarter of 1999, the Company received notices
from the investors to convert 4,000 shares of Series D Preferred Stock into
common stock. In January 2000, the Company converted these 4,000 shares of
Series D Preferred Stock, along with related dividends, into 4,039,033 shares of
common stock. Subsequent to these conversions, 500 shares of Series D Preferred
Stock remain issued and outstanding.
On May 12, 1999, the Company issued 2,000 shares of Series E Preferred
Stock for gross proceeds of $2,000,000. In connection with this issuance, the
investor received warrants to purchase a total of 50,000 shares of common stock.
The warrants had an exercise price of $4.65 per share and a term of three years.
The Series E Preferred Stock has a 5% cumulative dividend which is payable, in
cash or through the issuance of common stock, upon the conversion of the Series
E Preferred Stock. The Company may redeem the Series E Preferred Stock at any
time at a premium to face value that varies depending on the timing of the
redemption, as long as the price of the common stock is above certain levels.
Holders of the Series E Preferred Stock may convert these securities into shares
of common stock at the lesser of 94% of the average of the three lowest closing
bids for the common stock during the twenty trading days prior to conversion, or
$3.72, the closing bid price of the common stock on the trading day immediately
preceding the closing date of this private placement. In connection with this
private placement, the Company issued an additional 100 shares of Series E
Preferred Stock to a finder. As of December 31, 1999, the Series E Preferred
Stock investor had converted all of its 2,000 shares of Series E Preferred
Stock, along with related dividends, into 1,627,481 shares of common stock.
Subsequent to these conversions, 100 shares of Series E Preferred Stock remain
issued and outstanding.
The Company filed registration statements with the SEC to register the
common stock into which its various convertible preferred stock issuances can be
converted except for the 500 shares of Series D Preferred Stock and the 100
shares of Series E Preferred Stock which were issued to finders in connection
with the respective private placements. As of January 2000, the SEC has declared
effective all such registration statements.
The Company's preferred stock issues have included nondetachable conversion
features that are considered to be "in the money" at the date of issuance (a
"beneficial conversion feature"). The beneficial conversion was recognized as a
return to the preferred stockholders over the minimum period in which the
preferred stockholders could realize the maximum beneficial conversion. As a
result of the accumulated deficit, the value of the preferred stock was not
allocated between par value and additional paid-in capital and the accretion of
the value allocated to the beneficial conversion on the preferred stock and the
related dividends is recorded against additional paid-in capital. At December
31, 1999, all of the value associated with the beneficial conversion features
has been fully accreted against additional paid-in capital.
F-12
<PAGE> 37
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. STOCKHOLDERS' EQUITY, CONTINUED:
The Company's preferred stock activity is summarized in the following
table:
<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C SERIES D
-------------------- -------------------- ------------------ --------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------ ----------- ------ ----------- ------ --------- ------ -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997.......... 2,250 $ 1,741,983 3,180 $ 2,451,372 -- -- -- --
Issuance of shares, net............. -- -- 1,000 875,299 375 364,754 -- --
Value of beneficial conversion
feature............................ -- -- -- (176,470) -- -- -- --
Accretion of deemed dividend........ -- 329,269 -- 578,220 -- -- -- --
Conversion into common stock........ (2,250) (2,071,252) (4,180) (3,728,421) (187) (182,376) -- --
------ ----------- ------ ----------- ---- --------- ------ -----------
Balance, December 31, 1998.......... -- $ -- -- $ -- 188 $ 182,378 -- $ --
====== =========== ====== =========== ==== ========= ====== ===========
Issuance of shares, net............. -- -- -- -- -- -- 10,500 $ 9,442,390
Value of beneficial conversion
feature............................ -- -- -- -- -- -- -- (1,173,024)
Accretion of deemed dividend........ -- -- -- -- -- -- -- 1,173,024
Conversion into common stock........ -- -- -- -- (188) (182,378) (6,000) (5,539,913)
------ ----------- ------ ----------- ---- --------- ------ -----------
Balance, December 31, 1999.......... -- $ -- -- $ -- -- $ -- 4,500 $ 3,902,477
====== =========== ====== =========== ==== ========= ====== ===========
<CAPTION>
SERIES E
--------------------
SHARES AMOUNT
------ -----------
<S> <C> <C>
Balance, December 31, 1997.......... -- --
Issuance of shares, net............. -- --
Value of beneficial conversion
feature............................ -- --
Accretion of deemed dividend........ -- --
Conversion into common stock........ -- --
------ -----------
Balance, December 31, 1998.......... -- $ --
====== ===========
Issuance of shares, net............. 2,100 $ 1,976,231
Value of beneficial conversion
feature............................ -- (334,352)
Accretion of deemed dividend........ -- 334,352
Conversion into common stock........ (2,000) (1,882,120)
------ -----------
Balance, December 31, 1999.......... 100 $ 94,111
====== ===========
</TABLE>
COMMON STOCK
On April 13, 1998, the Company entered into an Equity Line of Credit
Agreement (the "Equity Line Agreement") with a private investor. Under the terms
of the Equity Line Agreement, the Company issued 840,124 shares of common stock
at $1.27 per share and obtained the right to require the investor to purchase an
additional $10,000,000 worth of common stock at 90% of the Company's common
stock market price (the "Put Rights"). Upon exercise of a Put Right, the Company
was required to pay issuance costs of approximately 5.5% of the gross proceeds
in cash and issue shares of common stock equal to 5% of the number of shares
issued in the transaction. Pursuant to the terms of the agreement, the Company
issued warrants to purchase a total of 60,000 shares of common stock at a price
per share ranging from $1.76 to $2.81, issued 50,000 shares of common stock
which could not be traded prior to April 13, 1999 and paid $60,000 in cash.
In July 1998, the Company amended the Equity Line Agreement to allow for
the sale of 545,454 shares of common stock for $5.50 per share and issued
five-year warrants to purchase up to 300,000 shares of common stock at a price
of $5.25 per share. The amendment contained certain repricing features which, as
a result of market fluctuations in the Company's common stock, required the
Company to issue an additional 94,004 shares of common stock without receiving
additional compensation. The Company has no further obligation to issue
additional shares related to these repricing features.
On May 22, 1998, concurrent with the sale of the Company's Series C
Preferred Stock, the Company issued 110,294 shares of common stock for $3.40 per
share.
In January 1999, the Company exercised additional Put Rights in which it
issued 841,356 shares of common stock at prices ranging from $4.08 to $4.46 for
cash proceeds of $2,110,000 and for use as consideration for the repayment of
certain notes payable. In addition, the Company issued a warrant to purchase
100,000 shares of common stock at an exercise price of $5.50 per share and a
warrant to purchase 100,000 shares of common stock at an exercise price of $6.00
per share.
In November 1998, the Company sold 290,000 shares of common stock for $5.50
per share to a private investor. The terms of the purchase agreement allowed for
an adjustment to the purchase price per share based on market fluctuations in
the Company's common stock. Based on events in December 1998, the Company was
required to issue an additional 150,000 shares of common stock to this investor
without receiving additional compensation. The Company has no further obligation
to issue additional shares related to these repricing features.
F-13
<PAGE> 38
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. STOCKHOLDERS' EQUITY, CONTINUED:
On various dates in 1998, the Company received gross proceeds of $3,600,000
pursuant to the terms of several investment agreements whereby the Company
issued 747,047 shares of common stock at prices ranging from $4.04 to $5.72 and
issued warrants to purchase 37,500 shares of common stock at prices of $9.09,
$9.58, and $13.05 per share. These agreements restricted the transfer of the
shares of common stock issued for certain periods, all of which have expired at
December 31, 1999.
During 1999, the Company issued 2,500 shares of common stock and 161,750
options to purchase common stock to certain consultants and vendors as
consideration related to services provided to the Company. The Company recorded
expenses related to these services of $223,547 during 1999 based upon the value
of the services received.
On September 21, 1999, the Company completed a $100,000 private placement
of common stock in which 135,000 restricted shares, as defined in Rule 144
promulgated under the Securities Act, were issued.
On November 19, 1999, the Company completed a $3,000,000 private placement
of common stock in which 1,000,000 shares were issued.
COMMON STOCK WARRANTS
In connection with the Company's IPO and the conversion of debentures
during 1996 and 1997, a total of 3,846,427 warrants to purchase common stock
were issued and outstanding at December 31, 1998. These warrants expired on
their own terms on July 19, 1999 and no warrants were exercised prior to this
date.
During October through December 1999, the Company borrowed $1,000,000 from
an investor pursuant to a secured promissory note. In connection with this
borrowing, the Company issued warrants to purchase 1,000,000 shares of its
common stock at $1.00 per share. On December 31, 1999, the cashless conversion
of these warrants into 1,000,000 shares of the Company's common stock was used
as consideration to fully repay the loan.
In the quarter ended December 1999, the Company issued 545,000 shares of
its common stock to investors who exercised warrants granted in connection with
previous financings for proceeds of $838,513.
Exclusive of the expired warrants issued in connection with the Company's
IPO and the conversion of debentures during 1996 and 1997 discussed above, the
Company has issued warrants to purchase 3,510,560 shares of its common stock in
connection with the Company's various financings at prices that range from $1.00
to $18.00 per share. At December 31, 1999, the Company had warrants outstanding
to purchase 1,842,700 shares of its common stock at prices that range from $1.50
to $18.00 per share. Subsequent to year-end, certain of these warrants were
exercised at an average price of $4.51 per share, resulting in the issuance of
1,565,200 shares of common stock.
ESCROWED SHARES
As a condition to the Company's IPO, a representative of the several
underwriters required certain of the Company's stockholders to deposit a total
of 1,800,000 shares of common stock (the "Escrowed Shares") in escrow pursuant
to an escrow agreement.
The Escrowed Shares were to be released over a three-year period in the
event the Company's gross revenues and earnings (loss) per share for the
12-month periods ending September 30, 1997, 1998 and 1999 equaled or exceeded
certain per share targets or if the Company's stock price exceeded a certain per
share target price. If such targets were not met, certain amounts of the
Escrowed Shares were to be returned to the Company for each period and canceled.
F-14
<PAGE> 39
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. STOCKHOLDERS' EQUITY, CONTINUED:
The Company did not meet the targets for escrow release for the periods
ending September 30, 1997, 1998 or 1999. As a result, 300,000, 750,000 and
750,000 shares, respectively, were canceled from the escrow pool and returned to
the Company, resulting in a reduction of 2.1%, 3.6% and 3.1% of the outstanding
shares of common stock on each of the cancellations, respectively.
Since the Company has reported losses, the loss per share for the Company
is calculated using outstanding shares less shares held in escrow to avoid
anti-dilution. Therefore, the cancellation of shares from escrow does not affect
the reported loss per share.
7. STOCK OPTIONS
On April 18, 1996, the Board of Directors approved, effective January 1,
1996, the Company's 1996 Omnibus Stock Incentive Plan (the "1996 Plan"). At the
annual meeting of stockholders on August 28, 1997, the Company's stockholders
approved the 1997 Stock Incentive Plan (the "1997 Plan"). At the annual meeting
of stockholders on December 28, 1999, the Company's stockholders approved the
1999 Stock Incentive Plan (the "1999 Plan").
Under these plans, the Company may grant incentive stock options,
non-qualified stock options, stock appreciation rights and shares of common
stock to officers, directors, employees and others. The Company's stock options
are generally exercisable in five equal annual installments beginning one year
after the date of grant. Under the terms of these plans, no stock option may be
granted at less than the fair market value of the Company's common stock on the
date of grant.
The 1996 Plan, the 1997 Plan and the 1999 Plan authorize the issuance of
650,000, 1,650,000 and 3,000,000 shares of the Company's common stock,
respectively. At December 31, 1999, 650,000, 1,573,466, and 2,537,845 of the
shares authorized under the 1996 Plan, the 1997 Plan and the 1999 Plan,
respectively, are outstanding.
The following table summarizes information on the Company's stock options:
<TABLE>
<CAPTION>
FISCAL 1999 FISCAL 1998
------------------------- -------------------------
WEIGHTED WEIGHTED
NUMBER AVERAGE PRICE NUMBER AVERAGE PRICE
OF SHARES PER SHARE OF SHARES PER SHARE
--------- ------------- --------- -------------
<S> <C> <C> <C> <C>
Beginning balance...................... 1,795,000 $3.59 1,738,430 $3.04
Granted................................ 3,309,278 $3.06 802,550 $4.61
Exercised.............................. (1,800) $3.00 -- --
Cancelled.............................. (341,167) $4.54 (745,980) $3.29
--------- ----- --------- -----
Ending balance......................... 4,761,311 $3.17 1,795,000 $3.59
========= ===== ========= =====
</TABLE>
The following table summarizes information about fixed stock options
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------ OPTIONS EXERCISABLE
RANGE OF WEIGHTED-AVERAGE ------------------------------
EXERCISE NUMBER REMAINING WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
----------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$1.37-$2.50 1,640,061 10 years $1.61 322,971 $1.95
$2.51-$4.00 1,277,250 8 years $3.14 832,680 $2.94
$4.01-$7.31 1,844,000 10 years $4.58 265,700 $5.12
--------- -------- ----- --------- -----
4,761,311 9 years $3.17 1,421,351 $3.12
========= ======== ===== ========= =====
</TABLE>
F-15
<PAGE> 40
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. STOCK OPTIONS, CONTINUED:
The Company complies with the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation." In accordance with the provisions of SFAS No. 123, the Company
applies APB Opinion 25 and related interpretations in accounting for its plans
and, accordingly, does not recognize compensation expense.
Had compensation expense for the Company's plan been determined based on
the fair value at the grant date for plan awards consistent with the provisions
of SFAS No. 123, the Company's net loss and net loss per common and common
equivalent shares outstanding would have been the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Net loss -- as reported................................. $(16,775,797) $(13,111,488)
Net loss -- pro forma................................... $(21,844,935) $(13,647,074)
Net loss per share -- as reported....................... $ (0.70) $ (0.74)
Net loss per share -- pro forma......................... $ (0.92) $ (0.77)
</TABLE>
The weighted-average fair values of each option at the date of grant for
1999 and 1998 was $1.53 and $0.67, respectively, and were estimated on the date
of grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions used in 1999 and 1998: dividend yield of 0%;
expected volatility of 70% in 1999 and 60% in 1998; risk-free interest rate of
5.49% in 1999 and 5.20% in 1998; and expected lives of 3 years.
8. SEGMENT AND ENTERPRISE WIDE REPORTING
The Company has adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information," in the fiscal year ended December 31, 1999.
SFAS No. 131 requires certain financial and supplementary information to be
disclosed on an annual and interim basis of each reportable segment of an
enterprise. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. Operating
segments are defined as components of an enterprise about which separate
discrete financial information is evaluated regularly by the chief operating
decision maker or decision making group, in deciding how to allocate resources
and assess performance. The financial information disclosed herein, materially
represents all of the financial information related to the Company's principal
operating segments as a provider of wearable computers. The Company established
foreign subsidiaries in both Germany and Japan in January 1999.
Revenues by geographical destination as a percentage of total revenues for
the year ended December 31, 1999 are as follows:
<TABLE>
<S> <C>
United States............................................... 55%
European countries, principally Germany..................... 18%
Far East countries, principally Japan....................... 20%
Other....................................................... 7%
</TABLE>
F-16
<PAGE> 41
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. SEGMENT AND ENTERPRISE WIDE REPORTING, CONTINUED:
Operations in various geographical areas, since the inception of those
entities, are summarized as follows:
<TABLE>
<CAPTION>
UNITED STATES EUROPE FAR EAST CONSOLIDATED
------------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Year Ended December 31, 1999:
Total revenues.................. $ 2,085,058 $ 591,314 $ 663,900 $ 3,340,272
============ =========== =========== ============
Net income (loss)............... $(14,482,993) $(1,203,968) $(1,088,836) $(16,775,797)
============ =========== =========== ============
Identifiable assets............. $ 7,125,523 $ 300,422 $ 3,897,479 $ 11,323,424
============ =========== =========== ============
</TABLE>
The following table summarizes the number of customers that individually
comprise greater than 10% of total revenue and/or total accounts receivable and
their aggregate percentage of the Company's total revenues and accounts
receivable.
<TABLE>
<CAPTION>
REVENUE ACCOUNTS RECEIVABLE
------------------------- ----------------------------
PERCENT OF TOTAL
NUMBER OF PERCENT OF NUMBER OF ACCOUNTS
CUSTOMERS TOTAL REVENUE CUSTOMERS RECEIVABLE
--------- ------------- --------- ----------------
<S> <C> <C> <C> <C>
For the Year Ended December 31,
1999.......................................... -- --% 2 22%
1998.......................................... 2 23% 4 62%
</TABLE>
9. SIGNIFICANT VENDOR
One manufacturer currently supplies a significant portion of the Company's
production parts and components. Management believes other manufacturers could
provide the parts and components on similar terms. However, a delay in supply of
the necessary parts and components, as a result of a change in supplier, could
have a material adverse effect on the Company's results of operations.
10. INCOME TAXES
For the years ended December 31, 1999 and 1998 no income tax benefit has
been provided because the losses could not be carried back and realization of
the benefit of the net operating losses carried forward was not assured. In
1999, the Company recognized approximately $29,000 in income tax expense related
to foreign operations.
At December 31, 1999, the Company had approximately $43,665,000 and
$1,100,000 of net operating loss carryforwards for U.S. federal and foreign
income tax purposes, respectively. The U.S. losses begin to expire in 2010 and
the losses from foreign operations do not expire. The use of the U.S.
carryforwards may be limited in any one year under Internal Revenue Code Section
382 if significant ownership changes occur.
F-17
<PAGE> 42
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. INCOME TAXES, CONTINUED:
Net deferred tax assets are comprised of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
Excess of book over tax depreciation..................... $ 214,000 $ 65,000
Net operating loss carryforwards......................... 16,575,000 10,557,000
Adjustment to accrual basis of accounting................ 148,000 244,000
Accrued expenses and reserves............................ 280,000 517,000
Tax credit carryforwards................................. 63,000 63,000
Foreign tax credits...................................... 28,000 --
Foreign net operating loss carryforwards................. 510,000 --
Foreign other............................................ 9,000 --
Less valuation allowance................................. (17,827,000) (11,446,000)
------------ ------------
Net deferred tax asset................................... -- --
============ ============
</TABLE>
The following table is a reconciliation of the effective income tax rate at
December 31, 9999:
<TABLE>
<CAPTION>
AMOUNT PERCENT
------------ -------
<S> <C> <C>
Pretax book income (loss)................................... $(16,746,573) --
============ ======
Federal, U.S. statutory rate................................ (5,693,835) 34.00%
State, net of federal tax benefit........................... (687,165) 4.10%
Valuation allowance......................................... 6,381,000 (38.10%)
Foreign..................................................... 29,000 (0.17%)
</TABLE>
11. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
The Company leases operating facilities and certain equipment under various
operating leases expiring on various dates through 2004. Future minimum payments
under noncancelable operating leases at December 31, 1999 are:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
2000........................................................ $ 361,838
2001........................................................ 354,123
2002........................................................ 364,070
2003........................................................ 279,798
2004........................................................ 4,268
----------
$1,364,097
==========
</TABLE>
Total rental expense charged to operations for the year ended December 31,
1999 and 1998 was $321,987 and $292,957, respectively.
LEGAL PROCEEDINGS
On March 19, 1998, Matrix Corporation ("Matrix") filed a complaint against
the Company in the United States District Court, Eastern District of North
Carolina, alleging that: Matrix has been damaged by a purported breach of an
agreement between the two companies concluded in December 1997 (the "December
F-18
<PAGE> 43
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. COMMITMENTS AND CONTINGENCIES, CONTINUED:
Agreement"), and that the Company should return all goods shipped by Matrix
under both the December Agreement and a prior agreement concluded in June 1997
(the "June Agreement"). The Company and its legal counsel filed a counterclaim
against Matrix stating that Matrix failed to perform to the requirements of both
the June Agreement and the December Agreement and that the Company has been
damaged by this failure to perform. The trial for the case was completed in
August 1999 and on September 22, 1999 the District Court rendered a judgment
against the Company. The Company paid approximately $875,000 to Matrix in the
quarter ending December 31, 1999, in full settlement of this legal proceeding
and, as part of the settlement, received approximately 150 systems and
components for its 133P model. At December 31, 1999, the Company accrued
$150,000 in legal fees incurred in connection with this lawsuit. These amounts
are included in the Company's general and administrative expenses in the related
periods.
12. RELATED PARTY TRANSACTIONS
The Company uses a Director of the Company as its patent counsel. The
Company incurred expenses for this Director of $239,598 and $164,956 during 1999
and 1998, respectively, in fees and disbursements for legal services rendered on
the behalf of the Company. In addition, this Director served as processing agent
for payments of $224,377 and $148,231 during 1999 and 1998, respectively, made
to domestic and international law firms for fees and expenses related to the
filing and maintenance of the Company's patents and trademarks.
The Company uses a law firm, in which a Director of the Company is a
partner, as its general counsel and for other legal services related to the
Company's financings and litigation. The Company incurred $663,075 and $345,207
in legal expenses during 1999 and 1998, respectively, payable to the Director's
law firm.
The Company uses a law firm, in which a Director of the Company is a
partner, for the Company's litigation and for other general legal services. The
Company incurred $218,687 and $97,238 in legal expenses during 1999 and 1998,
respectively, payable to the Director's law firm.
The Company incurred $94,425 and $97,800 in 1999 and 1998, respectively,
for salaries and automobile allowances payable to a Director of the Company for
services provided to Tech Virginia, and for which $95,000 and $65,000 in 1999
and 1998, respectively, were paid.
The Company incurred expenses of $211,621 and $234,745 in 1999 and 1998,
respectively, for salaries, automobile allowances and travel costs payable to a
Director and Executive Vice President of the Company who is the brother of the
President and Chief Executive Officer and served as a consultant to the Company
during 1999 and 1998. The Company incurred expenses of approximately $50,000
related to salary in 1999 and 1998 for the wife of the Chief Executive Officer.
In 1998, the Company incurred $219,433 for sales and marketing consulting
fees and expenses to two members of the SBS Software Center in Germany who
became employees of the Company when a GmbH Company owned by one of these
members was purchased by the Company at fair market value and renamed Xybernaut
GmbH to establish the Company's operations in Europe.
Xybernaut GmbH has engaged Bit-Solutions and Call-In, members of the SBS,
to serve as the Company's distributors and to provide installation, repair and
services for Company products sold in German-speaking countries. The executive
officers of Bit-Solutions and Call-In are the son and daughter-in-law of one of
the Company's Executive Vice Presidents and Directors. During 1999, the Company
incurred expenses from Bit-Solutions and Call-In of $294,315 for service and
support. During 1999 and 1998, the Company sold approximately $14,500 and
$35,000, respectively, of products to Call-In.
On various dates during 1999, the Company borrowed $583,000 from several
officers of the Company pursuant to non-interest bearing promissory notes or
agreements. All of these borrowings had been repaid at December 31, 1999 except
for $10,000, which was repaid in February 2000.
F-19
<PAGE> 44
XYBERNAUT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. SUBSEQUENT EVENTS
In January 2000, the Company borrowed approximately $3,025,000 from several
lenders pursuant to promissory notes that require the Company to repay the
borrowings by January 2001 unless repaid earlier upon a public or private
placement of common stock in excess of $10,000,000. Interest accrues at 10% per
annum. In connection with these borrowings, the Company issued warrants to
purchase approximately 302,500 shares of unregistered common stock at $0.10 per
share.
On January 3, 2000, the Company was party to a private placement
transaction in which it received $2,460,500 in proceeds through the issuance of
647,500 shares of common stock to an investor. The shares of common stock were
sold for $4.00 per share, representing an approximate 17% discount to the
average closing price of the Company's common stock for the month preceding this
private placement.
Between January and June 2000, all remaining 4,500 shares of Series D
Preferred Stock and all remaining 100 shares of Series E Preferred Stock were
converted by the investors, along with related dividends, into 4,173,430 shares
of common stock. At June 30, 2000, all shares of preferred stock had been fully
converted into shares of common stock.
Between January and June 2000, the Company issued 2,077,700 shares of its
common stock to investors who exercised warrants granted in connection with
financings for gross proceeds of $8,274,975.
In January and February of 2000, certain of the Company's employees and
consultants exercised stock options that had been issued pursuant to the
Company's various stock incentive plans. The Company issued 529,334 shares of
its common stock and received gross proceeds of $1,336,109 related to these
exercises.
On April 7, 2000, the Company acquired Selfware, Inc. ("Selfware"), a
provider of enterprise management services and software for projects,
maintenance and work flow (the "Merger"). Pursuant to the terms of the Agreement
and Plan of Merger, the value of Selfware was determined at approximately
$8,100,000. Based on a ratio established by the 30-day average closing price for
the Company's common stock prior to closing, the Company exchanged 429,327
shares of its common sock for the stock of Selfware, for an effective price of
$18.97 per share of the Company's common stock. It is intended that the Merger
will be accounted for as a pooling of interests. The terms of the Merger were
determined in arms-length negotiations between the Company and Selfware and a
fairness opinion for the acquisition was provided to the Company's board of
directors by Merrill Lynch. This opinion covered only the fairness of the
exchange ratio for the Merger from a financial point of view and did not address
the merits of the decision to merge with Selfware or the financial impact of
such Merger. Mr. Jacques Rebibo, chairman and CEO of Selfware, served on the
Company's board of directors from January 1996 to August 1997. The Company and
Selfware estimate that they incurred direct transaction costs of approximately
$400,000 associated with the Merger. These expenditures consist of fees for
investment banking, legal, accounting and other related costs and will be
charged to operations in the second quarter of 2000, which is the quarter in
which the Merger was consummated.
On June 23, 2000, the Company was party to a private placement transaction
in which it received $3,500,000 in gross proceeds through the issuance of
437,500 shares of its common stock to an investor. The shares of common stock
were sold for $8.00 per share, representing a 12% discount to the closing bid
price of the Company's common stock on June 22, 2000. The Company also issued
warrants to purchase 87,500 shares of common stock, representing an amount equal
to 20% of the number of shares sold, at $10.00 per share, representing 125% of
the price for which our common stock was sold in this financing.
F-20
<PAGE> 45
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On September 13, 1999, the Company engaged Grant Thornton LLP as its new
independent accountant and dismissed PricewaterhouseCoopers LLP, its previous
independent accountant. On September 17, 1999, the Company filed a Form 8-K
(file #000-21013) in connection with the change in accounting firms.
PART III
Items 9 through 12 were included in a Form 10-KSB/A filed with the Securities
and Exchange Commission on April 21, 2000 and are incorporated herein by
reference.
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K.
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<C> <C> <S> <C>
1.1 -- Form of Financial Consulting Agreement between the Company (1)
And the Representative.
3.1 -- Certificate of Incorporation of the Company, as Amended. (5)
3.2 -- Bylaws of the Company (as Amended on September 24, 1998). (5)
3.3 -- Certificate of Designation of the Series D Preferred Stock. (6)
3.4 -- Certificate of Designation of the Series E Preferred Stock. (7)
4.1 -- Warrant Exercise Fee Agreement. (1)
4.2 -- Form of Forfeiture Escrow. (1)
4.3 -- Form of specimen certificate for Units. (1)
4.4 -- Form of specimen certificate for Common Stock. (1)
4.6 -- Form of Warrant. (2)
4.7 -- Form of Securities Purchase Agreement for Series D Preferred (6)
Stock.
4.8 -- Form of Warrant in connection with the placement of Series D (6)
Preferred Stock.
4.9 -- Form of Securities Purchase Agreement for Series E Preferred (7)
Stock.
4.10 -- Form of Warrant in connection with the placement of Series E (7)
Preferred Stock.
4.11 -- Warrant issued in connection with the October 1999 Bridge (10)
Loan Financing.
10.1 -- December 31, 1994 Acquisition Agreement between the Company (1)
and Tech Virginia.
10.2 -- Form of Indemnification Agreement to be entered into between (1)
the Company and each officer and director of the Company.
10.3 -- Form of Employment Agreement between the Company and Edward (10)
G. Newman.
10.4 -- Form of Employment Agreement between the Company and Steven (10)
A. Newman.
10.5 -- November 30, 1994 Lease Agreement between Hyatt Plaza (1)
Limited Partnership and the Company.
10.6 -- March 22, 1996 Month-to-Month Tenancy Agreement between the (1)
Company and The Original Tollhouse Historical Preservation
Company.
10.7 -- October 27, 1994 Residential Deed of Lease between the (1)
Company and Frank E. and Heather H. Moxley.
10.8 -- June 10, 1994 Rockwell International Corporation contract. (1)
10.9 -- January 5, 1996 Kopin Corporation contract. (1)
10.10 -- June 19, 1996 License Agreement for Mobile Inspector (1)
Software.
10.11 -- 1996 Omnibus Stock Incentive Plan. (1)
10.12 -- 1997 Omnibus Stock Incentive Plan. (2)
10.13 -- November 20, 1995 Consulting Agreement with CMC Services. (1)
10.14 -- Form of Consulting Agreement with Victor J. Lombardi. (1)
10.15 -- March 29, 1996 License Agreement with Rockwell International (1)
Corporation.
10.16 -- Interim 90-Day Agreement with Kopin Corporation. (1)
10.17 -- Multicosm Ltd. Software Licensing Agreement. (1)
10.18 -- April 4, 1996 Electronic Surveillance Technologies (1)
Corporation VAR Agreement.
10.19 -- January 22, 1996 FC Imaging, Inc. VAR Agreement. (1)
10.20 -- June 18, 1996 NeuroSystems Europe Limited VAR Agreement. (1)
10.21 -- Business Loan Agreement, Promissory Note and Commercial (1)
Security Agreement By and Between Fairfax Bank & Trust
Company and the Company.
</TABLE>
25
<PAGE> 46
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
------- -----------
<C> <C> <S> <C>
10.22 -- December 10, 1996 Lease Agreement between Autumnwood (3)
Apartments and the Company.
10.23 -- September 10, 1996 Lease Agreement between the Company and (3)
South Beach Warehouse, LLC.
10.24 -- First Amendment to Office Lease Agreement between Hyatt (4)
Plaza Limited Ptr. and the Company.
10.25 -- Form of Agreement between Ed Nixon Davis and the Company. (4)
10.26 -- Form of Exclusive Licensing Agreement between Data Disk (4)
Technology, Inc. and the Company.
10.27 -- Form of Exclusive Licensing Agreement between SBS Vertrieb (4)
GmbH and the Company.
10.28 -- Form of Software Distribution Agreement between Multicosm (4)
LTD and the Company.
10.29 -- First Amendment to Office Lease Agreement between Hyatt (4)
Plaza Limited Partnership and Tech International of
Virginia, L.L.C.
10.30 -- Second Amendment to Storage Space Lease Agreement between (5)
Hyatt Plaza Limited Ptr. and the Company.
10.31 -- Second Amendment to Office Lease Agreement between Hyatt (5)
Plaza Limited Ptr. and the Company.
10.32 -- Third Amendment to Office Lease Agreement between Hyatt (5)
Plaza Limited Ptr. and the Company.
10.33 -- Form of Registration Rights Agreement in connection with the (6)
placement of Series D Preferred Stock.
10.34 -- Form of Escrow Agreement in connection with the placement of (6)
Series D Preferred Stock.
10.35 -- Form of finder's agreement in connection with the placement (6)
of Series D Preferred Stock.
10.36 -- Form of Registration Rights Agreement in connection with the (7)
placement of Series E Preferred Stock.
10.37 -- Form of Escrow Agreement in connection with the placement of (7)
Series E Preferred Stock.
10.38 -- Form of finder's agreement in connection with the placement (7)
of Series E Preferred Stock.
10.39 -- Purchase Agreement dated as of November 19, 1999 (10)
10.40 -- Registration Rights Agreement dated November 19, 1999 (10)
10.41 -- Escrow Agreement dated as of November 19, 1999 (10)
10.42 -- 1999 Stock Incentive Plan (8)
10.43 -- Form of Restated Bridge Loan Financing Agreement dated (10)
October 18, 1999
10.44 -- Form of Employment Agreement between the Company and John F. (10)
Moynahan.
16 -- Letter on Change in Certifying Accountant (9)
23.1 -- Consent of Grant Thornton LLP *
27.1 -- Financial Data Schedule (10)
</TABLE>
---------------
(1) Incorporated by reference in the initial filing of the Company's
Registration Statement on Form SB-2, No. 333-4156.
(2) Incorporated by reference in an amendment to the Company's Registration
Statement on Form SB-2, No. 333-65123.
(3) Incorporated by reference in the filing of the Company's 1996 Annual Report
on Form 10KSB, No. 0-15086.
(4) Incorporated by reference in the filing of the Company's 1997 Annual Report
on Form 10KSB, No. 0-15086.
(5) Incorporated by reference in the filing of the Company's 1998 Annual Report
on Form 10KSB, No. 0-15086.
26
<PAGE> 47
(6) Incorporated by reference to the registration statement on Form S-3, as
amended, file No. 333-77769.
(7) Incorporated by reference to the registration statement on Form S-3, as
amended, file No. 333-80837.
(8) Incorporated by reference to the registration statement on Form S-8, file
No. 333-94463.
(9) Incorporated by reference to the report on Form 8-K, file No. 000-21013.
(10) Incorporated by reference to the report on Form 10-KSB, file No. 000-21013.
* Filed herewith.
REPORTS ON FORM 8-K
The Company has not filed any Report on Form 8-K during the last quarter of
fiscal year 1999.
27
<PAGE> 48
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
XYBERNAUT CORPORATION
By: /s/ EDWARD G. NEWMAN
------------------------------------
Edward G. Newman
President, Chief Executive Officer
and Chairman of the Board of
Directors
Date: July 7, 2000
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Company and the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ EDWARD G. NEWMAN President, Chief Executive July 7, 2000
----------------------------------------------------- Officer and Chairman of the
Edward G. Newman Board of Directors
* Senior Vice President, Chief July 7, 2000
----------------------------------------------------- Financial Officer and
John F. Moynahan Treasurer
* Senior Vice President and July 7, 2000
----------------------------------------------------- Director
Edwin Vogt
* Executive Vice President and July 7, 2000
----------------------------------------------------- Vice Chairman of the Board
Steven A. Newman of Directors
* Executive Vice President and July 7, 2000
----------------------------------------------------- Director
Kaz Toyosato
* Secretary and Director July 7, 2000
-----------------------------------------------------
Martin Eric Weisberg
* Director July 7, 2000
-----------------------------------------------------
George Allen
* Director July 7, 2000
-----------------------------------------------------
Eugene J. Amobi
* Director July 7, 2000
-----------------------------------------------------
Keith P. Hicks
* Director July 7, 2000
-----------------------------------------------------
Phillip E. Pearce
</TABLE>
28
<PAGE> 49
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
* Director July 7, 2000
-----------------------------------------------------
James J. Ralabate
* Director July 7, 2000
-----------------------------------------------------
Lt. Gen. Harry E. Soyster
</TABLE>
* By Edward G. Newman
Attorney-in-fact
29
