<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-KSB
(Mark One)
[X] Annual report under Section 13 of 15(d) of the
Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 1998
[ ] Transition report under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transitional period from ________________ to
________________
Commission File No. 333-52169
AMERICAN CARD TECHNOLOGY, INC.
(Name of Small Business Issuer in Its Charter)
Delaware 06-1403123
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1355 Terrell Mill Road, Building 1462, Suite 200
Marietta, Georgia 30067
(Address of Principal Executive Offices) (Zip Code)
770-951-2284
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Act:
Name of Each Exchange on
Title of Each Class Which Registered
None None
Securities registered under Section 12(g) of the Act:
None
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Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the issuer was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes [X] No [_]
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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 [X]
The registrant has total operating revenues of $253,092 for its most recent
fiscal year ended December 31, 1998.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant as of March 31, 1999, based on the current
offering price of $11.00 per share, was $1,210,957. Shares of Common Stock
held by each officer and director and by each person who owns 5% or more of
the outstanding Common Stock have been excluded in that such persons may be
deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
APPLICABLE ONLY TO CORPORATE REGISTRANTS
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date:
3,901,136 Shares of Common Stock, as of March ___, 1999
DOCUMENTS INCORPORATED BY REFERENCE
See Exhibit Index
Transitional Small Business Issuer Format (check one):
Yes [_] No [X]
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This report contains forward-looking statements which involve certain
risks and uncertainties. See Item 1, "Description of Business-Risk Factors --
Forward-Looking Information" herein. Actual results and events may differ
from those discussed in the forward-looking statements.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
American Card Technology, Inc. (the "Company") is a development stage
company incorporated in June 1994. The Company was organized to design,
develop and market high security, flexible, multiple application smart card
systems. A smart card is a credit card-sized plastic card containing a
microchip that provides the card with memory storage capabilities in a secure
environment and, in advanced versions such as the Company's, enables the card
to perform data processing functions. Smart card systems are typically used by
government agencies or commercial enterprises (the "System Sponsor") to store,
access and modify participant or customer (the "User") information. The
Company's proprietary smart card technology and software enable System
Sponsors to store data on a User's smart card, and enable the System Sponsor,
or a service provider authorized by the System Sponsor (the "Authorized
Service Provider"), to access User information and read, input, delete, modify
and process such data. The Company designs its smart card systems to perform
functions for various target markets, such as employee licensing, animal
health and registration, frequent patron tracking, health care and various
government agency applications and can design each system to perform various
functions in virtually any industry, depending on the System Sponsor's needs.
The Company believes that its smart card systems, which offer the capability
to perform multiple functions on a single card, provide enhanced security and
privacy protection not offered by existing smart cards and position the
Company to capitalize on perceived market opportunities for information
systems incorporating smart card technology. Unless otherwise indicated, all
references to the Company include Canadian Smart Card Technology Inc., its
majority-owned subsidiary incorporated under the laws of Ontario, Canada (the
"Subsidiary"), which was created to exploit the Company's technology in
Canada.
Industry Background
Smart card technology was developed in France in the mid 1970s and is
currently in wide use in Europe, the Pacific Rim, Latin America and the Middle
East. According to the market researcher Dataquest, the microprocessor and
memory based smart card market will grow from 544 million cards in 1995 to 3.4
billion cards by 2001. Most smart cards currently in use are low capacity
memory-only phone cards which provide only data storage, reading and deletion
capabilities. More sophisticated smart cards, including the Company's smart
cards, are microprocessor-based and therefore have the ability not only to
store, read and delete data but also to add, modify and process data. However,
the Company believes that most microprocessor-based smart cards currently in
use were designed to perform functions for single purpose applications only,
such as pay television access control, medical or academic recordkeeping or
insurance claim processing. The Company believes that these smart cards also
generally utilize multiple, alternative technologies such as microchips, bar
codes and magnetic stripes simultaneously, or allow access by any Authorized
Service Provider to all the information included within the card.
Most cards currently used in electronic transactions are magnetic stripe
cards, such as ordinary credit cards. Such cards contain only limited
information such as account numbers and identification information, but cannot
store or update additional information such as current account balances. The
Company believes that the market for smart cards in North America remains
relatively unexploited due to the large capital and infrastructure investments
made by debit and credit card issuers and the significantly lower costs
associated with the use of magnetic stripe cards. However, smart cards have
recently been introduced in the United States in a number of venues. For
example, a stored value card program designed to facilitate purchases from
participating vendors was used during the 1996 Summer Olympics. In addition,
the National Football League's Jacksonville Jaguars and the National Hockey
League's St. Louis Blues have each installed smart card systems to be used for
the purchase of concession items at their respective sports games. Government
Technology Magazine stated in a February 1996 issue that U.S. welfare reform
legislation mandates that every state replace its paper food stamp system with
an Electronic Benefit Transfer (EBT) scheme by the year 2002, consistent with
the government's push towards a paperless society. Pursuant to this mandate,
many states use magnetic stripe cards for their food stamp programs, and the
States of Mississippi, Ohio and Wyoming have each proposed plans to replace
food stamps with a card-based system to improve convenience and efficiency, as
well as to decrease fraud. The Company's smart cards are based on concepts
similar to these applications, but the Company's cards can contain more
information due to the Company's patented method of multiple application
layering. In addition, only the Company can utilize its patented dual card
access technology. The Company believes the enhanced security features and
multiple function capabilities of its cards take existing smart card
technology several steps further.
The Company believes that smart cards offer certain advantages over
magnetic stripe cards including the ability to store pages of information and
update or otherwise utilize data as circumstances require. In addition, while
the data contained on magnetic stripe cards is difficult to secure, smart
cards can be programmed to prevent manipulation of data stored in the card. A
smart card can also be programmed with an unalterable memory, prohibiting the
writing of new data on top of old data, and can be programmed to utilize
public and private key encryption algorithms to lower the risk of theft of
sensitive data. Furthermore, unlike magnetic stripe cards, most smart cards
are extremely difficult and expensive to alter, duplicate or reproduce. The
Company believes that the limitations of magnetic stripe cards will present
significant market opportunities in North America for smart card systems
featuring enhanced security and multiple application layering as electronic
transactions, including government benefits transfers, licensing and frequent
patron tracking, become more complex.
Technology Overview
The Company's proprietary smart card systems incorporate dual card access
technology and multiple application layering. The Company believes that these
components result in certain advantages over magnetic stripe cards and
existing smart card systems, including enhanced security features and multiple
function capabilities. The Company's patented dual card access technology
(analogous to a dual key system for access to a safe deposit box) requires the
simultaneous use of both a "User Card" and an "Access Card" to activate the
system. User Cards are issued by a System Sponsor (such as an HMO, welfare
agency, state motor vehicle department or retail store) to Users such as
patients, benefits recipients, drivers or customers. Access Cards are issued
by the System Sponsor to Authorized Service Providers affiliated with the
particular System Sponsor (such as HMO participating physicians, welfare
administrators, police officers and cashiers). Each User Card issued by the
System Sponsor has stored within it an individualized database containing
User-specific information, which is stored in a "common pool."
By virtue of the dual card access and multiple application layering
features of the Company's technology, a basic set of data carried on a single
smart card can be processed and configured according to the specific
requirements of each application layer of the card. As a result, a vast array
of information and electronic documents and reports can be generated for
various categories of System Sponsors and Authorized Service Providers,
thereby substantially increasing the potential number of uses for each card.
For example, one User's smart card provided by the Company could generate a
medical history when activated by an HMO's participating physician's Access
Card, an insurance claim record when activated by the HMO's benefits
administrator's Access Card, a welfare benefits record when activated by a
welfare administrator's Access Card, and a driver's license when activated by
a police officer's Access Card. By providing a System Sponsor with the ability
to add applications over time and allowing multiple System Sponsors to utilize
different layers of the same smart card, the Company's smart card systems will
enable the cost per smart card to be allocated among separate System Sponsors
or different departments within a single System Sponsor.
The Company's patented method of multiple application layering technology
allows an Access Card to retrieve from this common pool of information only
the data that the Access Card in use is programmed to access. The data stored
on the User Card is then displayed and processed in accordance with the
requirements of the application layer activated by the particular Access Card
in use. This process increases the potential number of uses of the User Card
and enables a single User Card to serve multiple System Sponsors as well as
multiple Authorized Service Providers within a single System Sponsor. The
Company believes that these features position its smart card systems as
secure, cost-effective solutions for electronic transaction and information
processing.
Generally, smart cards can incorporate advanced security features,
ranging in sophistication from a password, photograph or personal
identification number system to a fingerprint, retinal scan or facial geometry
recognition system, which are not found in magnetic stripe cards. The Company
believes that the multiple application layering feature of its smart card
systems provides enhanced security and privacy protection. Each application
layer is separate, with "firewall"-type safeguards to prevent unauthorized
access to data in another application layer. Moreover, each layer can be
programmed with the level of security appropriate to the sensitivity of the
data contained in such layer. In addition, the Company's systems establish an
"audit trail" which will record specific information regarding each instance
in which data is accessed, including the time, the date and the identity of
the person accessing information.
The Company's technology also permits easy adaptation and customization,
allowing the Company to provide a smart card system tailored to the System
Sponsor's needs. The Company's technology provides system scalability by
allowing a System Sponsor, over time, to increase the number of applications
performed by its smart cards, provide additional services or add other System
Sponsors. Furthermore, the Company's technology can support a communication
system in which messages and data updates can be sent between the System
Sponsor and the Authorized Service Provider and/or User, including messages
that render a card inoperable if no longer valid.
Products
The Company was organized to design, develop and market high security,
flexible, multiple application smart card systems, which are comprised of the
following products:
Smart Cards. The Company currently uses commercially available
microchips with varying amounts of memory, depending upon each System
Sponsor's requirements. The Company arranges for initial entry of database
information on the User Cards and authorized access codes on the Access Cards
to the System Sponsor's specifications.
Read/Write Devices. A read/write device is hardware that provides the
data interface between a smart card and the host computer, allowing data to be
transferred between a database and a smart card. Information can be uploaded
and downloaded between the Access Card and the User Card at any read/write
device within the system. The Company's smart card systems utilize basic,
relatively inexpensive read/write devices because certain functions that would
otherwise be performed by the read/write devices are performed by the software
within the Company's smart cards. In addition, because the Company's smart
cards conform to applicable industry standards, the cards are compatible with
various types of read/write devices currently in use.
Printers. The Company utilizes smart card printers for printing images
and other information required to be displayed on the face of the smart cards.
These printers may also include a chip encoder that can write information to
the chip at the same time as the smart card is printed. Numerous such printers
are available in the industry.
Customized Application Software. Each smart card system developed by the
Company, in order to perform the various applications included in that system,
requires customized application software to be written relating to the
specific tasks to be accomplished. Typically, such customized application
software includes software that performs certain basic functions, as well as
software that performs the specific functions required by the particular
system. The Company has developed software that performs the basic functions
required to be performed by all of the Company's smart card systems. By virtue
of having developed such software, the Company is able to create the
customized applications required for a particular system more quickly than if
all of the software necessary to implement the system were required to be
developed for each particular application. The Company's proprietary software
has been developed for use on a workstation personal computer. In addition,
the Company is a member of the Microsoft developer network and participates in
alpha and beta testing of new Microsoft products. The Company's proprietary
software is compatible with Windows 3.x(TM), Windows 95(TM), Windows NT(TM),
and Windows 98(TM).
The Company intends to provide each System Sponsor with a customized
configuration of its products based upon the System Sponsor's specific needs
and constraints, ranging from subsystems comprised of selected components
which may be integrated with products or systems provided by third parties, to
complete "turnkey" systems. Each System Sponsor will utilize system stations
to facilitate initial and ongoing operation of each system installed by the
Company. An issue station will issue personalized smart cards, and will be
comprised of one or more personal computers, video cameras for systems
requiring photographs on User Cards, read/write devices, card printers and
system software. An update station will implement necessary changes to the
Company's smart cards, such as updating of information or modification of an
Authorized Service Provider's ability to access particular User information,
and will be comprised of a personal computer, one or more read/write devices
and system software. One or more display stations will permit a User or
Authorized Service Provider to view information stored on a User Card, and
will be comprised of a personal computer, notebook computer and/or hand-held
display device, read/write devices and system software. One personal computer
may in some cases function as issue station, update station and display
station, depending on the rights encoded in the Access Card used. The Company
anticipates that a System Sponsor may, under certain circumstances, seek to
utilize, or otherwise procure, its own system station hardware. In such cases,
the Company would expect to aid the System Sponsor in integrating such
hardware with the smart card system products provided by the Company.
Pricing. The prices of the Company's products will depend on the System
Sponsor's specifications and requirements relating thereto (including the
number and type of application layers per card) and any applicable volume
discounts. The price of the Company's customized application software will
depend upon various factors, including the nature and complexity of the smart
card products and required system interfaces. The off-the-shelf products
comprising the balance of the components of the smart card systems offered by
the Company (including personal computers, notebook computers and hand-held
display devices) will be offered at then-prevailing market prices.
Warranty and Service. The Company offers a limited warranty covering
both parts and labor, pursuant to which the Company or its authorized service
representatives will make repairs and replace parts that become defective due
to normal use. The Company does not anticipate that the cost of servicing its
smart card systems will be material. Furthermore, substantially all component
parts of the Company's smart card systems will be covered by warranties from
the suppliers thereof. However, there can be no assurance that future warranty
expenses will not have an adverse effect on the Company.
Technical Support. The Company offers technical support to its System
Sponsors at no charge on a limited basis, as described in each individual
System Sponsor contract. Beyond the specified level, the Company charges an
hourly rate for additional technical support. The Company does not anticipate
that the cost of offering such technical support services will be material.
Smart Card Product Development
The Company believes there are numerous potential applications for its
smart card systems, including but not limited to the following:
Employee Licensing-Licensing and identifying employees in certain
regulated industries, including photo identification, time and attendance
records, specific database information required by the employer and access
control to secure areas.
Animal Health and Registration-Tracking of lineage history, medical
information, identification, breed information, nutritional information,
performance data and history of interstate and intrastate movement of
thoroughbred horses and various other racing and show animals and domestic
pets.
Government Applications-Issuing citizen photo identification and
government licenses (such as motor vehicle, professional and weapons licenses)
and maintaining and processing government entitlement information (including
Medicare, Medicaid and welfare information).
Frequent Patron Programs and Tracking-Awarding of points, miles or other
credits for retail purchases and tracking of customer purchases to facilitate
more focused target marketing.
Gaming-Controlling and monitoring loss limits, employee licensing and
frequent player tracking.
Health Care-Simplifying and expediting the verification of patient
insurance coverage and maintaining paperless medical records by medical
service providers.
Soft Trading Desk-Reconfiguring the hardware and software of a securities
trading desk through the use of information embedded in each individual
trader's smart card to accommodate each trader's individual screen and
information preferences.
The Company has installed an employee licensing system for the Birmingham
Racing Commission. The agreement provides for the Company to deliver smart
cards and hardware in connection with the licensing and monitoring of
racetrack personnel and others. Pursuant to the agreement, the Company has
developed a licensing database containing more than 30 categories of
information for each licensee, including name, address, date and place of
birth, height, weight, employer's name, fines, rulings, suspensions and
revocations. To date, the Company has provided the Birmingham Racing
Commission with over 15,000 smart cards, a smart card printer and chip encoder
and two (2) read/write devices. The term of the agreement is five years,
subject to early termination upon 30 days notice to the Company. The Company
may not terminate the license before expiration of the five-year term of the
agreement. The Company has installed a similar system at the Macon County Race
Course in Alabama under a separate contract. See "Certain Relationships and
Related Transactions."
The Company has also installed an employee licensing system at the Oregon
Racing Commission and, to date, the Company has sold approximately 9,500 smart
cards and four (4) read/write devices to the Oregon Racing Commission. The
Company also has two contracts with NAPRA for a national licensing system that
includes a database for nineteen racing jurisdictions, including information
on licensing data, infractions and digital photographs, which contracts NAPRA
and the Company are presently negotiating to amend to include all NAPRA racing
jurisdictions.
In March 1998, the Company installed an employee licensing system at the
Idaho Racing Commission. The system utilizes approximately 1,500 processor
cards for mobile employees who travel between racing facilities, such as
jockeys, owners and trainers, plus over 2,000 memory-only cards for stationary
employees, such as food vendors and ticket takers.
In June, 1998, the Company received contracts or purchase orders from the
Florida, Wyoming and Colorado racing commissions to provide smart card-based
licensing systems.
From June 1 to September 1, 1995, the Company conducted a pilot program
at Atlantic City Raceway and Monmouth Park in New Jersey and Philadelphia Park
in Pennsylvania involving the issuance of equine medical passport smart cards
to track the identity, movement and medical records of thoroughbred
racehorses. To prevent the spread of a deadly disease, the federal government
requires any horse crossing state lines to have a negative Coggins Report
which evidences a negative test result for Equine Infectious Anemia. A Coggins
Report is valid for one year from the issue date. Further, each state requires
a valid health certificate for any horse entering the state. Under the New
Jersey and Pennsylvania program, data on approximately 500 thoroughbred
racehorses that would otherwise have been provided in paper documents was
entered into smart cards provided by the Company and each track gatekeeper in
the program utilized a reader terminal that interfaced with the cards to
determine whether particular horses were eligible for entry on racetrack
grounds. The pilot was co-sponsored by The Jockey Club Racing Services, Inc.
During the pilot program, the Company issued approximately 500 equine medical
passport smart cards. The Company is currently developing enhancements to the
smart card system utilized in the pilot program in order to address certain
operational issues that arose during the program. Although the completed
program successfully tested the equine medical passport smart card system,
such pilot program has not resulted in any system sales to date. There can be
no assurances that any of the Company's pilot programs will result in system
purchases by any potential System Sponsor.
The Florida Department of Agriculture and Consumer Services Bureau of
Disease Control has proposed a similar pilot project anticipated to begin as
soon as possible. The Bureau of Disease Control is responsible for ensuring
the health and marketability of livestock in the state of Florida. The states
of Florida, Georgia and Alabama have formed an alliance whereby a special
ninety (90) day pass authorized by any of the three states can be used to
cross state lines between these states. The proposed Florida pilot program
will involve a test "livestock medical passport" program in which each of 100
animals will be implanted with an "electronic identification transponder" used
in conjunction with smart cards to verify each animal's identity and federal
and state medical certifications. This pilot program will replace the required
paper passports for horses crossing between these states. Although completed
programs in New Jersey and Pennsylvania successfully tested the equine medical
passport smart card system, and similar electronic transponder implants are in
use which are not coordinated with smart card technology, such equine medical
passport pilot programs have not resulted in any system sales to date.
The Company has entered into a Memorandum of Understanding with Traquer
Systems, Inc. ("Traquer") to market the Company's smart card systems to Indian
gaming and wagering facilities in North America. Traquer has significant
expertise with the rules and regulations for Indian gaming environments. In
February 1998, the Company received its first order from Traquer to provide a
smart card-based employee licensing system to an Indian tribe in Arizona. This
system was installed in October 1998. During February, 1999, the Company
received its second purchase order to install a similar system for an Indian
tribe located in Louisiana.
The Company received a request from Foundation Health, a Florida based
HMO, to structure a smart card system to assist and expedite the verification
of patient insurance coverage by hospital employees. The pilot program
involves Palmetto Hospital, one of the largest hospitals in Miami, Florida,
and the Company anticipates the initial phase will be installed during the
second quarter of 1999. Other phases of this proposed project may include
expanding the smart card based verification capability to all Foundation
Health member hospitals and Authorized Service Providers in south Florida. The
final phase may provide all Foundation Health members with enhanced smart card
member identification capabilities.
The Company has also been selected as a subcontractor to Paradigm 4 for
the registered New York City Time Project. The City of New York has
significant problems tracking city employees and verifying the accuracy of
actual hours worked. This project will pilot a number of technologies,
including the use of smart cards, for time and attendance management and
tracking of city employees.
On November 11, 1998, the Company began discussions with Microsoft
regarding its Windows Card Operating System. The Windows Card Operating System
represents Microsoft's foray into the smart card industry. As a result of that
initial meeting in November, and subsequent meetings thereafter, the Company
has been asked to participate in the development and systems integration
component of Microsoft's Windows Card beta program. The exact role of the
Company in this regard has not yet been determined or formalized, and there
can be no assurances in this regard or that meaningful opportunities for the
Company will result.
The Company has formed a new business entity with AVID Identification
Devices, Inc. called Animal Passports, Inc. (API). While final business terms
remain to be negotiated, it is anticipated that API will develop, market, and
sell smart card applications incorporating the Company's patented technology
for all animal owners worldwide. AVID, using PETtrac, a worldwide computerized
tracking system for companion animals, will be responsible for providing its
marketing and sales expertise to the new company and ACTI will be responsible
for providing smart card technology and technological support. Ownership will
be equal between the Company and AVID, however, AVID will be responsible for
funding the initial costs of API. It is anticipated that the Company's smart
card technology will be used in conjunction with AVID's radio frequency
identification devices currently being sold worldwide to veterinarians and
other customers. Owners of animals will carry with them a smart card
containing animal tracking information related to the existing PETtrac
identification systems as well as other AVID related applications, including
animal records. This venture is in its formative stages and there can be no
assurances that the venture will be undertaken as presently anticipated or
that meaningful revenues will result.
The Company has entered into a two year Non-Exclusive Representation
Agreement with DTEC/Comprehensive Pharmacy Services, Inc. ("DTEC/CPS"), a
wholly owned subsidiary of Service Master Corporation. DTEC/CPS provides a
full range of services and technologies to the health care industry. The core
of the company's business is in pharmacy consulting and pharmacy management
expertise. DTEC/CPS has the right to market the Company's smart card products
and services to its extensive customer base throughout the world. DTEC/CPS and
the University of Tennessee are currently engaged in several research projects
where smart cards could play a significant role. It is anticipated that the
Company will greatly benefit from these projects, however, there can be no
assurance that the Company's involvement will result in sales to the
University of Tennessee or to any other DTEC/CPS customer.
The Company, either alone or in conjunction with strategic partners, is
currently in discussions and negotiations with certain potential System
Sponsors regarding possible future smart card projects. The Company, through
the Subsidiary, has entered into a Memorandum of Understanding with SHL
Systemhouse, an international systems integrator owned by Worldcom, to form a
joint venture for the purpose of attempting to secure a project to develop a
smart card system for the Province of Ontario, Canada. There can be no
assurance that any such projects will be implemented or, if implemented,
generate meaningful revenues.
Marketing and Sales
The Company's objective is to become a leading provider of smart card
systems to government and commercial System Sponsors requiring increasingly
complex, secure and cost-effective information processing systems. Because the
Company believes there are numerous potential target markets for the Company's
smart card systems, the Company intends to market its products through
multiple channels, including through strategic marketing alliances and
licensing or other arrangements with systems integrators, value added
resellers and other smart card vendors. The Company believes that such
arrangements will enable it to have access to substantial numbers of potential
smart card System Sponsors, and that third-party partners can provide
knowledge, experience and/or financial resources appropriate to a specific
market opportunity and may enhance the Company's ability to achieve
significant penetration in select markets, especially in those involving
government services. The Company anticipates that, under certain
circumstances, its smart card products will be bundled with its strategic
partners' products and services to create a complete integrated system that
can be marketed to potential System Sponsors. The Company will also seek to
provide complete smart card solutions, on a turnkey basis, to System Sponsors
by providing all of the hardware and software elements required to implement
the system.
The Company will seek to identify potential System Sponsors and strategic
partners and attempt to increase the visibility of the Company. It will be the
role of the Director of Sales, under the direction of management, to guide the
Company from the research and development phase to a company with full
marketing and sales strategies for direct and indirect sales. The Company
intends to market its smart card systems directly through its management and
employees and may also retain the services of third parties such as
independent sales representatives and marketing and other consultants. The
Company utilizes independent sales representatives in the United States and
abroad, whose relationships with the Company are generally governed by a
written contract for a specified term, subject to renewal under certain
circumstances, and provides for a limited exclusive territorial or industry
representation, specified fees or commissions and specified sales targets. The
Company may, in the case of potential System Sponsors within certain target
industries, sell its systems through marketing and other consultants with
relationships in such industries.
The Company also plans to market its systems through sales brochures,
direct mailings, advertisements in trade publications and participation in
industry trade shows. The Company intends to utilize a portion of the proceeds
of the Offering to expand its marketing and sales activities.
Research and Development and Technology Purchase
For the years ended December 31, 1997 and December 31, 1998, the Company
incurred costs relating to research and development activities in the
approximate amounts of $260,000 and $656,000, respectively. The Company
intends to utilize a portion of the proceeds of the Offering (as hereinafter
defined) for research and development, including $730,000 (of which $180,000
has been expended through December 31, 1998, $100,000 is expected to be
capitalized and $450,000 is expected to be expensed ratably over approximately
a two year period) payable to SoftChip Israel Ltd. and SoftChip Technologies
(3000) Ltd. in connection with the purchase of the DVK-1 System (as
hereinafter defined) and the further enhancement of the Company's proprietary
technology as well as the development of system applications and pilot
programs for potential System Sponsors. The Company further intends to pursue
additional patents on various aspects of its technology.
Manufacturing
The Company does not manufacture its own microprocessor chips or
associated hardware or assemble its own smart cards. Components for the
Company's smart cards, such as microprocessor chips and plastic cards as well
as associated hardware, may be purchased from a number of qualified electronic
parts manufacturers and distributors. The Company is under no obligation to
purchase any such components from any one particular manufacturer and
therefore may obtain quality components at the best possible prices the
Company can find.
Competition
The market for the Company's smart card systems is characterized by
intense competition. The market is currently dominated by cards utilizing
magnetic stripes, and is expected to be dominated by magnetic stripe cards for
the foreseeable future due to the lower costs of production of such cards and
the substantial capital and infrastructure investments made by debit and
credit card issuers in such cards. The Company also competes with numerous
well-established companies, including Gemplus, Bull PTS (a unit of Groupe
Bull), Schlumberger Electronic Transactions (a business segment of
Schlumberger Limited), Orga Kartensysteme GMBH, Giesecke & Devrient and Mondex
International, which design, manufacture and/or market smart card systems.
Although the Company believes that its dual card access and multiple
application layering technologies will allow the Company to compete on the
basis of enhanced security, flexibility, scalability, cost-effectiveness and
quality, the Company's smart card systems incorporate new concepts and may be
unsuccessful even if they are superior to those of its competitors. In
addition, certain companies may be developing technologies or products of
which the Company is unaware which may be functionally similar or superior to
those developed by the Company. Most of the Company's competitors and
potential competitors possess substantially greater financial, marketing,
personnel and other resources than the Company and have established
reputations relating to the design, development, manufacture, marketing and
service of smart card systems. As the market for smart card systems grows, new
competitors are likely to emerge. Additional competition could adversely
affect the Company's operations. Smart card technology competes with other
electronic transaction and information processing technologies, including
magnetic stripe cards, bar code cards, laser optical cards and radio frequency
contactless cards, as well as traditional methods of transaction and
information processing, whether effected or recorded on paper or otherwise.
Government Regulation and Industry Standards
In the United States, the Company is not currently subject to direct
regulation other than federal and state regulations applicable to businesses
generally. However, changes in the regulatory environment relating to the
smart card industry could have an adverse effect on the Company's business.
Legislative proposals from federal and state government bodies in the area of
privacy rights could impose additional regulations and obligations upon all
smart card providers. The Company cannot predict the likelihood that any such
legislation will pass, nor the financial impact, if any, that any such
legislation may have. Moreover, the applicability to smart card System
Sponsors and Authorized Service Providers of existing laws governing issues
such as personal privacy is uncertain.
The Company believes that its smart card systems are currently in
compliance with the quality assurance standards of ISO-7816, an international
standard promulgated by the International Organization for Standardization, a
worldwide federation of standards bodies from approximately 100 countries. The
European Community and others have adopted these standards as their preferred
quality standards. However, as technological advances occur in the smart card
industry, other emerging standards may gain widespread acceptance. While
compliance with applicable and emerging standards is the responsibility of the
Company's suppliers, any failure on the part of the Company's suppliers to
comply with such standards could materially and adversely affect the Company's
sales to various System Sponsors and prevent the Company's expansion into
certain markets.
As part of its strategy, the Company intends to market its smart card
systems to government agencies in the United States and Canada. If successful,
the Company will become subject to the special risks involving government
contracts, including delays in funding, lengthy review processes for awarding
contracts, non-renewal, delay, termination at the convenience of the
government, reduction or modification of contracts in the event of changes in
the government's policies or as a result of budgetary constraints and
increased or unexpected costs resulting in losses.
The Company will also be required to obtain most potential government
contracts through the competitive bidding process. The competitive bidding
process is typically lengthy and often results in the expenditure of financial
and other resources in connection with bids that are not accepted.
Additionally, inherent in the competitive bidding process is the risk that
actual performance costs may exceed projected costs upon which a submitted bid
or contract price is based. Moreover, in some instances, the Company would be
required to post bid and/or performance bonds in connection with contracts
with government agencies.
To the extent that the Company is able to successfully expand its
operations into foreign markets, the Company may become subject to trade
restrictions (including restrictions on the export of critical technology),
export duties and tariffs and international political and regulatory
developments.
Intellectual Property
The Company's success will depend in part on its ability to enforce its
patents, protect trade secrets and operate without infringing on the
proprietary rights of others. The Company has received United States patent
number 5629508 with respect to its dual card access technology and methods. In
addition, the Company has filed a continuation-in-part on its patent. If
granted, this will significantly expand the Company's intellectual property
rights pertaining to dual card-based data retrieval and access control. The
Company contemplates filing patent applications in selected foreign
jurisdictions where such filings would, in the Company's opinion, provide it
with a competitive advantage. The patent laws of other countries may differ
from those of the United States as to the patentability of the Company's
products or technology and the degree of protection afforded by foreign
patents may be different from that in the United States. The failure by the
Company to obtain any foreign patents could have a material adverse effect on
the Company's ability to successfully commercialize its smart card systems
outside the U.S. Even though the Company has been able to obtain a patent,
there can be no assurance that this patent will afford the Company
commercially significant protection for its technology. Other companies may
independently develop equivalent or superior technologies or products and may
obtain patent or similar rights with respect to them. The Company is not aware
of any infringement by its technology on the proprietary rights of others and
has not received any notice of claimed infringement. However, the Company has
not conducted any investigation as to possible infringement and there can be
no assurance that third parties will not assert infringement claims against
the Company in connection with its products, that any such assertion of
infringement will not result in litigation, or that the Company would prevail
in such litigation. Moreover, in the event that the Company's technology or
proposed products were deemed to infringe upon the rights of others, the
Company would be required to obtain licenses to utilize such technology. There
can be no assurance that the Company would be able to obtain such licenses in
a timely manner on acceptable terms and conditions, or at all, and the failure
to do so could have a material adverse effect on the Company. If the Company
were unable to obtain such licenses, it could encounter significant delays in
product market introductions while it attempted to design around the infringed
upon patents or rights, or could find the development, manufacture or sale of
products requiring such license to be foreclosed. In addition, patent disputes
occur in the smart card and computer industries and there can be no assurance
that the Company will have the financial resources to enforce or defend a
patent infringement or proprietary rights action. In addition, the Company has
received a federal trademark registration for its SMART-ID registered trade
mark and design and has applied for a federal trademark registration for its
Cheeze! mark. SMART-ID registered trademark is a smart card based system that
provides positive identification, transaction tracking and the ability to
layer multiple applications on a single smart card. Cheeze! is a program
currently used by nineteen pari-mutuel licensing jurisdictions to photograph
licensees and transmit the photograph and license data to a central database,
which is currently housed at the Company's offices. The Company's use of its
software, name and marks may be subject to challenge by others, which, if
successful, could have a material adverse effect on the Company.
The Company has entered into agreements with SoftChip Israel Ltd. of
Jerusalem, Israel and SoftChip Technologies (3000) Ltd. to purchase the DVK-1
Chip Mask Operating System and architecture ("DVK-1 System") for a purchase
price of $100,000 from SoftChip Israel Ltd. and with SoftChip Technologies
(3000) Ltd. to provide technical support and development to the Company for a
two-year period for an additional $450,000 plus a maintenance fee ranging from
$.125 to $.25 for each smart card sold by the Company that incorporates the
DVK-1 System. Upon closing, which is scheduled to occur after the earlier of
closing of the minimum Offering or March 15, 1999 (which date was recently
extended to June 15, 1999), these agreements will provide the Company
ownership of its own chip mask and access to the technical resources needed to
develop a completely new and proprietary chip mask and operating system. The
chip mask provides the basic instructions to the microchip and its internal
components and facilitates the orderly utilization of all of the microchip's
components and allows the device to be utilized. The Company had also executed
a purchase order with SoftChip for technical services for a monthly fee of
$18,000, which commenced December 1, 1997 and expired on September 30, 1998.
As of December 31, 1998, the Company owed $30,000 under this purchase order
and such amount is included in the use of proceeds as repayment of certain
outstanding obligations. Under the agreement, ownership of the DVK-1 System
will be transferred to the Company at closing upon payment in full of the
purchase price and technical support fees. If the closing of the minimum
Offering is delayed beyond June 15, 1999, the Company believes it may be able
to reach a mutual agreement with SoftChip to extend the closing date of the
agreement, but there can be no assurance that the Company will be able to
reach such agreement with SoftChip, or that the Company will ultimately secure
ownership of the DVK-1 System if the closing of the minimum offering is
delayed beyond June 15, 1999. Additionally there can be no assurance that
ownership of the DVK-1 System will result in the successful development of new
technology.
The Company also relies on trade secrets and proprietary know-how and
employs various methods to protect the concepts, ideas and documentation
relating to its proprietary technology. However, such methods may not afford
the Company complete protection and there can be no assurance that others will
not independently obtain access to the Company's trade secrets and know-how or
independently develop products or technologies similar to those of the
Company. Furthermore, although the Company has and expects to have
confidentiality and non-competition agreements with its employees and
appropriate suppliers and manufacturers, there can be no assurance that such
arrangements will adequately protect the Company's trade secrets.
The Company purchases many of the hardware and non-proprietary soft-
ware components of its smart card systems through normal electronic and computer
distribution channels. Typically, such components are sold with standardized
license agreements containing non-negotiated terms, conditions and
restrictions established by the manufacturer.
Employees
As of the date of this report, the Company has twelve full-time
employees, consisting of four executive officers and eight employees engaged
in engineering, technical support, product development and marketing and
sales. The Company also uses the resources of independent programmers and
consultants from time to time on an as needed basis. The Company anticipates
that it will hire additional sales and technical personnel to continue to
implement the Company's marketing and product development efforts and may
engage independent sales representatives and industry-specific marketing
consultants to assist the Company in marketing the Company's smart card
systems to potential System Sponsors.
<PAGE>
Risk Factors
The success of the Company's proposed plan of operation could be
affected by a number of risk factors inherent to the business of the Company.
Development Stage Company; Limited Operating History. The Company
was organized in June 1994 and is in the development stage. Since inception, the
Company has been engaged principally in organizational activities, including
developing a business plan, hiring personnel and developing and enhancing its
proprietary smart card technology and software, and it has only recently
commenced the limited marketing of its smart card systems. Therefore, the
Company has a limited operating history upon which an evaluation of its
prospects can be made. The Company's prospects must be considered in light of
the risks, uncertainties, expenses, delays and difficulties associated with
the establishment of a new business in the evolving smart card industry, as
well as those risks encountered in the shift from development to
commercialization of new products based on innovative technologies.
Limited Revenues; Significant and Continuing Losses; Accumulated
Deficit; Explanatory Paragraph in Independent Auditors' Report. The Company has
generated limited revenues to date and does not expect to generate meaningful
revenues in the near future until such time, if ever, as its smart card
systems are successfully commercialized. The Company has incurred significant
losses in each operating period since its inception, resulting in an
accumulated deficit at December 31, 1998 of $8,932,884, and losses are
continuing through the date hereof. Inasmuch as the Company will continue to
have a high level of operating expenses and will be required to make
significant up-front expenditures in connection with both the development of
its business and the commercialization of its smart card systems (including,
without limitation, salaries of executive, technical, marketing and other
personnel), the Company anticipates that it will continue to incur significant
and increasing losses for the foreseeable future until such time, if ever, as
the Company is able to generate sufficient revenues to finance its operations.
Furthermore, the Company has incurred costs related to a possible debt
placement, which costs have to date been deferred. In the event the planned
Offering and financing are not successful, these costs will be subsequently
charged to operations. The Company's independent certified public accountants
have included an explanatory paragraph in their report stating that the
Company's dependence on outside financing, lack of existing commitments from
lenders to provide necessary financing, lack of sufficient working capital and
losses since inception raise substantial doubt about the Company's ability to
continue as a going concern. There can be no assurance that the Company's
smart card systems will gain market acceptance, or that the Company will be
able to successfully implement its business strategy, generate meaningful
revenues or achieve profitable operations.
Uncertainty of Proposed Plan of Operation. The success of the
Company's proposed plan of operation will be largely dependent upon market
acceptance of smart cards generally, as well as on the Company's ability to
successfully market its smart card systems by persuading potential System
Sponsors of the perceived benefits of its dual card access and multiple
application layering concepts (including the benefits to be derived from
allocating total card program costs among individual application layers within a
card) and to develop and commercialize further applications of its proprietary
technology. In addition, the Company's proposed plan of operation and
prospects will be dependent upon, among other things, the Company's ability to
enter into strategic marketing and licensing or other arrangements on a timely
basis and on favorable terms; establish satisfactory arrangements with sales
representatives and marketing consultants; hire and retain skilled management
as well as financial, technical, marketing and other personnel; successfully
manage growth (including monitoring operations, controlling costs and
maintaining effective quality, inventory and service controls); and obtain
adequate financing when and as needed. The Company has limited experience in
developing new products based on innovative technology and there is limited
information available concerning the performance of the Company's technologies
or market acceptance of the Company's products. There can be no assurance that
the Company will be able to successfully implement its plan or that
unanticipated expenses or problems or technical difficulties will not occur
which would result in material delays in its implementation. Moreover, there
can be no assurance that the Company will have sufficient capacity to satisfy
any increased demand for its smart card products and technologies resulting
from the Company's implementation of its plan of operation.
New Concept; Uncertainty of Market Acceptance. The smart card
industry in the United States is an emerging business characterized by an
increasing and substantial number of new market entrants that have introduced or
are developing an array of new products and services relating to electronic
transactions and information processing. Each of these entrants is or may be
seeking to position its products and services as the preferred method of
effectuating highly individualized, easy-to-use electronic transaction and
information processing. The success of the smart card industry depends, in
large part, on the ability of market participants to convince governmental
authorities, commercial enterprises and other potential System Sponsors to
adopt a smart card system in lieu of existing or alternative systems such as
magnetic stripe card and paper-based systems, thereby changing the way certain
transaction and information processing tasks are accomplished. In addition,
due to the large capital and infrastructure investment made by debit and
credit card issuers and significantly lower costs associated with the use of
magnetic stripe cards, many potential System Sponsors may be reluctant to
convert to smart card technology in the near future. Accordingly, there can be
no assurance that there will be significant market opportunities for smart
card systems in the United States or that the acceptance of smart card based
systems in other countries will be sustained. The Company's dual card access
and multiple application layering technologies are new concepts. As such,
demand for and market acceptance of the Company's smart card systems are
subject to a high level of uncertainty. The Company has limited marketing
experience and limited financial, personnel and other resources to undertake
extensive marketing activities. Potential System Sponsors of the Company's
smart card systems, as well as the Company's potential strategic partners,
must be persuaded that the costs of adopting and implementing smart card
systems, in general, and, in particular, of adopting and implementing the
Company's smart card systems, which incorporate dual card access technology
and multiple application layering, are justified by the benefits to be derived
therefrom. Achieving market acceptance for the Company's products and services
will require significant efforts and expenditures by the Company to create
awareness, demand and interest by potential System Sponsors, strategic
partners and others regarding the perceived benefits of the Company's
technologies, including the possible allocation of costs among different
System Sponsors and/or departments of one or more System Sponsors. There can
be no assurance that the Company's smart card technology will prove to be
economically viable for a sufficient number of System Sponsors, that
substantial markets will develop, in the United States or elsewhere, for the
Company's smart card systems or that the Company will be able to meet its
current marketing objectives, succeed in positioning its cards and services as
a preferred method of delivering electronic transaction and information
processing or achieve significant market acceptance of its products. See
"Description of Business-Marketing and Sales."
Significant Capital Requirements; Working Capital Deficit; Dependence
on Proceeds of Initial Public Offering; Possible Future Financing. The
Company's capital requirements have been and will continue to be significant. At
December 31, 1998, the Company had a working capital deficit of $2,439,263 due
to, among other things, costs associated with the development,
commercialization and market testing of the Company's smart card systems,
including the development of the Company's initial pilot programs. The Company
has been dependent on the sales of its securities to private investors, as
well as on capital contributions and loans from affiliates and certain
financial institutions guaranteed by certain stockholders of the Company.
During the period from inception through December 31, 1998, the Company has
raised capital in the estimated aggregate amount of $6,355,000. On February
12, 1999, the Securities and Exchange Commission declared effective the
Company's registration statement on Form SB-2 relating to the offering of a
minimum of 454,600 shares (and a maximum of 648,900 shares) of Common Stock,
at a price of $11.00 per share (the "Offering"). The Offering is being
conducted by the Company's underwriter, Rockcrest Securities L.L.C. (the
"Underwriter"), on a "best efforts" basis. As of the date hereof, the
Offering has not been completed (and the Company has not received any proceeds
thereof). There can be no assurance that the Offering will be completed. The
Company is nonetheless dependent on and intends to use the proceeds of the
Offering to continue the implementation of its proposed plan of operation. The
Company anticipates, based on assumptions relating to its operations
(including assumptions regarding the Company's ability to meet its current
marketing objectives and the timing and costs associated therewith), that the
net proceeds of the Offering, together with projected cash flow from
operations, will be sufficient to fund the Company's operations and capital
requirements for at least twelve months following the consummation of the
Offering. In the event the Company's plans change, its assumptions change or
prove to be inaccurate or if the proceeds of the Offering prove to be
insufficient to fund operations (due to unanticipated expenses, technical
difficulties, problems or otherwise), the Company would be required to seek
additional financing sooner than currently anticipated. There can be no
assurance that the proceeds of the minimum Offering will be sufficient to
permit the Company to successfully further develop and commercialize the
Company's smart card technology or that any assumptions relating to the
Company's operations will prove to be accurate. In addition, any
implementation of the Company's business plans subsequent to the twelve month
period following the Offering may require proceeds greater than the proceeds
of the Offering or otherwise currently available to the Company. Further, if
the minimum closing of the Offering is delayed, the Company may not have
sufficient capital to fund operations and the anticipated expenses of the
Offering. There can be no assurance that additional financing will be
available to the Company on commercially reasonable terms, or at all. Although
the Company believes it may be able to raise at least a portion of its future
financing requirements for such period among its officers, directors and/or
stockholders, no officer, director or stockholder of the Company has made any
further commitment to the Company to provide any portion of the Company's
future financing requirements and there are no assurances that any officer,
director or stockholder will do so. At some future date, the Company intends
to offer up to approximately $30 million in debt financing, to be negotiated
by Lilly Beter Capital Group, Ltd. ("Beter"). The Company has no written
agreement with Beter with regard to such possible future financing. There can
be no assurance that such additional financing, or any other additional
financing, will be available to the Company on reasonable terms, or at all.
Further, if such additional financing is attempted, there can be no assurance
that such additional financing, or any other additional financing, will be
successful. Any inability to obtain additional financing when needed may have
a material adverse effect on the Company, including requiring the Company to
curtail its activities and possibly causing the Company to cease its
operations. To the extent that the Company finances its operations through the
issuance of additional equity securities, any such issuance may involve
substantial dilution to the Company's then-existing stockholders.
Additionally, to the extent that the Company incurs indebtedness or issues
debt securities, the Company will be subject to all of the risks associated
with incurring substantial indebtedness, including the risks that interest
rates may fluctuate and cash flow may be insufficient to pay principal and
interest on any such indebtedness.
Limited Marketing Capabilities and Experience; Dependence on Third
- -Party Marketing Arrangements. The Company has limited marketing capabilities,
experience and resources. To date, the Company has conducted only limited
marketing activities and has relied primarily on the efforts of its executive
officers in connection with such activities. It will be the role of the
Company's management and its Director of Sales to guide the Company from the
research and development phase to a company with full marketing and sales
strategies for direct and indirect sales. Although the Company expects to
continue to market smart card systems directly through the Company's
management and employees, the Company intends to establish strategic marketing
alliances and licensing or other arrangements with systems integrators,
value-added resellers and other smart card vendors and may also retain the
services of sales representatives and marketing and other consultants. The
Company's success will depend in part on its ability to enter into agreements
with such third parties, and on the ability and efforts of such third parties
to successfully market the Company's smart card systems. Moreover, marketing
arrangements with third parties may require financial or other commitments by
the Company. There can be no assurance that the Company will be able, for
financial or other reasons, to enter into third-party marketing arrangements
on commercially acceptable terms, or at all. The failure of the Company to
complete its third-party marketing strategy or the failure of any such party
to develop and sustain a market for the Company's smart cards could have a
material adverse effect on the Company. Although the Company views third-party
marketing arrangements as a major factor in the commercialization of its smart
card systems, there can be no assurance that any strategic partners, licensees
or others would view an arrangement with the Company as significant to their
businesses. See "Description of Business-Marketing and Sales."
Competition; Technological Obsolescence. The market for the
Company's smart card systems is characterized by intense competition. The market
is currently dominated by cards utilizing magnetic stripes, and is expected to
be dominated by magnetic stripe cards for the foreseeable future due to the
lower costs of production of such cards and the substantial capital and
infrastructure investments made by debit and credit card issuers in such
cards. The Company also competes with numerous well-established companies,
including Gemplus, Bull PTS (a unit of Groupe Bull), Schlumberger Electronic
Transactions (a business segment of Schlumberger Limited), Orga Kartensysteme
GMBH, Giesecke & Devrient and Mondex International, which design, manufacture
and/or market smart card systems. Although the Company believes its
proprietary dual card access and multiple application layering technologies
will allow the Company to compete on the basis of enhanced security,
flexibility, scalability, cost-effectiveness and quality, the Company's smart
card systems incorporate new concepts and may be unsuccessful even if they are
superior to those of its competitors. In addition, certain companies may be
developing technologies or products of which the Company may be unaware which
may be functionally similar or superior to those developed by the Company.
Most of the Company's competitors and potential competitors possess
substantially greater financial, marketing, personnel and other resources than
the Company and have established reputations relating to the design,
development, manufacture, marketing and service of smart card systems. As the
market for smart card systems grows, new competitors are likely to emerge.
Additional competition could adversely affect the Company's operations. There
can be no assurance that the Company will be able to compete successfully,
that competitors will not develop technologies or products that render the
Company's systems obsolete or less marketable or that the Company will be able
to successfully enhance its products or develop new products when necessary.
See "Description of Business-Competition."
Technological Factors. The Company's research and development
efforts are subject to all of the risks inherent in the development of new
products and technology (including unanticipated delays, expenses and
difficulties). There can be no assurance that the Company's products will
satisfactorily perform the functions for which they are designed, that they will
meet applicable price or performance objectives or that unanticipated technical
or other problems will not occur which would result in increased costs or
material delays in the development thereof. Furthermore, software products as
complex as those developed by the Company and incorporated into its smart card
products may contain errors or failures when installed, updated or enhanced.
There can be no assurance that, despite testing by the Company and by current
and potential end users, errors will not be found in new products after the
delivery by the Company, resulting in loss of or delay in market acceptance.
See "Description of Business-Technology Overview" and "-Products."
The Company has entered into agreements with SoftChip Israel Ltd. of
Jerusalem, Israel and SoftChip Technologies (3000) Ltd. to purchase from
SoftChip Israel, Ltd., the DVK-1 Chip Mask Operating System and architecture
("DVK-1 System") for a purchase price of $100,000 and with SoftChip
Technologies (3000) Ltd. to provide technical support and development to the
Company for a two-year period for an additional $450,000 plus a maintenance
fee ranging from $.125 to $.25 for each smart card sold by the Company that
incorporates the DVK-1 System. Upon closing, which is scheduled to occur after
the earlier of closing of the minimum Offering or March 15, 1999 (which date
was recently extended to June 15, 1999), these agreements will provide the
Company ownership of its own chip mask and access to the technical resources
needed to develop a completely new and proprietary chip mask and operating
system. The chip mask provides the basic instructions to the microchip and its
internal components and facilitates the orderly utilization of all of the
microchip's components and allows the device to be utilized. The Company had
also executed a purchase order with SoftChip Israel Ltd. for technical
services for a monthly fee of $18,000, which commenced December 1, 1997 and
expired on September 30, 1998. As of December 31, 1998 the Company owed
$30,000 under this purchase order and such amount is included in the use of
proceeds as repayment of certain outstanding obligations. Under the agreement,
ownership of the DVK-1 System will be transferred to the Company at closing
upon payment in full of the purchase price and technical support fees. If the
closing of the minimum Offering is delayed beyond June 15, 1999, the Company
believes it may be able to reach a mutual agreement with both companies to
extend the closing date of the agreement, but there can be no assurance that
the Company will be able to reach such agreement, or that the Company will
ultimately secure ownership of the DVK-1 System if the closing of the minimum
offering is delayed beyond June 15, 1999. Additionally there can be no
assurance that ownership of the DVK-1 System will result in the successful
development of new technology.
Proprietary Rights. The Company's success will depend in part on its
ability to enforce its patents, protect trade secrets and operate without
infringing on the proprietary rights of others. The Company has received
United States patent number 5629508 with respect to its dual card access
technology and methods. The Company contemplates filing patent applications in
selected foreign jurisdictions where such filings would, in the Company's
opinion, provide it with a competitive advantage. The patent laws of other
countries may differ from those of the United States as to the patentability
of the Company's products or technology and the degree of protection afforded
by foreign patents may be different from that in the United States. The
failure by the Company to obtain any foreign patents could have a material
adverse effect on the Company's ability to successfully commercialize its
smart card systems outside the U.S. Even though the Company has been able to
obtain a U.S. patent, there can be no assurance that this patent will afford
the Company commercially significant protection for its technology. Other
companies may independently develop equivalent or superior technologies or
products and may obtain patent or similar rights with respect to them. The
Company is not aware of any infringement by its technology on the proprietary
rights of others and has not received any notice of claimed infringement.
However, the Company has not conducted any investigation as to possible
infringement and there can be no assurance that third parties will not assert
infringement claims against the Company in connection with its products, that
any such assertion of infringement will not result in litigation, or that the
Company would prevail in such litigation. Moreover, in the event that the
Company's technology or proposed products were deemed to infringe upon the
rights of others, the Company would be required to obtain licenses to utilize
such technology. There can be no assurance that the Company would be able to
obtain such licenses in a timely manner on acceptable terms and conditions,
and the failure to do so could have a material adverse effect on the Company.
If the Company were unable to obtain such licenses, it could encounter
significant delays in product market introductions while it attempted to
design around the infringed upon patents or rights, or could find the
development, manufacture or sale of products requiring such license to be
foreclosed. In addition, patent disputes occur in the smart card and computer
industries and there can be no assurance that the Company will have the
financial resources to enforce or defend a patent infringement or proprietary
rights action. The Company has received a federal trademark registration for
its SMART-ID registered trademark and design and has applied for a federal
trademark registration for its Cheeze! mark. SMART-ID registered trademark
is a smart card based system that provides positive identification,
transaction tracking and the ability to layer multiple applications on a single
smart card. Cheeze! is a program currently used by nineteen pari-mutuel
licensing jurisdictions to photograph licensees and transmit the photograph and
license data to a central database, which is currently housed at the Company's
offices. The Company's use of its software, name and mark may be subject to
challenge by others, which, if successful, could have a material adverse effect
on the Company.
The Company also relies on trade secrets and proprietary know-how and
employs various methods to protect the concepts, ideas and documentation
relating to its proprietary technology. However, such methods may not afford
the Company complete protection and there can be no assurance that others will
not independently obtain access to the Company's trade secrets and know-how or
independently develop products or technologies similar to those of the
Company. Furthermore, although the Company has and expects to have
confidentiality and non-competition agreements with its employees and
appropriate suppliers and manufacturers, there can be no assurance that such
arrangements will adequately protect the Company's trade secrets. See
"Description of Business-Intellectual Property."
Lengthy Sales Cycle; Possible Fluctuations in Operating Results. The
Company's sales cycle is expected to commence at the time a prospective System
Sponsor demonstrates an interest in purchasing a smart card system from the
Company or issues a request for a proposal or information or takes similar
action and ends upon the installation of a smart card system for the System
Sponsor. The sales cycle will vary by System Sponsor and could extend for
periods of up to twelve months or more, depending upon, among other things,
the time required by the System Sponsor to complete a pilot test of the
Company's smart card system, make a determination regarding an acquisition
thereof and negotiate payment terms with the Company. The Company's operating
results could vary from period to period as a result of this fluctuation in
the length of the Company's sales cycle and as a result of fluctuations in the
purchasing patterns of potential System Sponsors, technological factors,
variations in marketing strategies for different target markets and
non-recurring smart card system sales.
Possible Dependence on Government Contracts. As part of its
strategy, the Company intends to market its smart card systems to government
agencies in the United States and Canada. If successful, the Company will become
subject to the special risks involving government contracts, including delays in
funding, lengthy review processes for awarding contracts, non-renewal, delay,
termination at the convenience of the government, reduction or modification of
contracts in the event of changes in the government's policies or as a result
of budgetary constraints and increased or unexpected costs resulting in
losses, any or all of which could have a material adverse effect on the
Company.
The Company will also be required to obtain most potential government
contracts through the competitive bidding process. There can be no assurance
that the Company will be successful in having its bids accepted or, if
accepted, that awarded contracts will generate sufficient revenues to result
in profitable operations. The competitive bidding process is typically lengthy
and often results in the expenditure of financial and other resources in
connection with bids that are not accepted. Additionally, inherent in the
competitive bidding process is the risk that actual performance costs may
exceed projected costs upon which a submitted bid or contract price is based.
To the extent that actual costs exceed projected costs, the Company could
incur losses, which could adversely affect the Company's operating margins and
results of operations. Moreover, in most instances, the Company may be
required to post bid and/or performance bonds in connection with contracts
with government agencies. Any inability by the Company to obtain bonding
coverage in sufficient amounts could have a material adverse effect on the
Company. See "Description of Business-Government Regulation and Industry
Standards."
Dependence on Management and Key Personnel. The success of the
Company will be largely dependent on the personal efforts of Lawrence O. Perl,
its Chairman of the Board and Chief Executive Officer, Raymond Findley, Jr., its
President and Chief Operating Officer, Frank Fuino Jr., its Chief Financial
Officer and Vice President of Finance, Robert H. Dixon, its Vice President of
Technical Operations, Robert Cartagine, its Director of Sales, and other key
personnel. Although the Company has entered into an employment agreement with
each of the above gentlemen, the loss of services of any of these key
personnel would have a material adverse effect on the Company's business and
prospects. The Company has obtained "key man" insurance on the lives of
Messrs. Perl and Findley in the amount of $2,000,000 each. In order to
successfully implement and manage its proposed expansion, the Company will be
dependent upon, among other things, its ability to attract and retain
qualified managerial, technical and marketing personnel with experience in
business activities such as those contemplated by the Company. Competition for
qualified personnel is intense and there can be no assurance that the Company
will be able to hire or retain additional personnel. Any inability to attract
and retain qualified personnel would have a material adverse effect on the
Company.
Control by Management. After the closing of the Offering, the
Company's directors and executive officers (or trusts created by or for such
individuals or their families) will beneficially own, in the aggregate, no less
than approximately 79.1 percent of the outstanding shares of Common Stock
(assuming no exercise of any warrants or other options) issued in the minimum
Offering, or no less than approximately 75.7 percent of the outstanding shares
of Common Stock (assuming no exercise of any warrants or other options) issued
in the maximum Offering. Accordingly, such persons, acting together, will be in
a position to elect the directors, adopt amendments to the Company's Certificate
of Incorporation (the "Certificate") and By-Laws (the "By-Laws"), approve
mergers and other significant corporate transactions, including a sale of
substantially all of the Company's assets, and otherwise control the Company's
affairs. Purchasers of the shares of Common Stock offered pursuant to the
Offering will be minority stockholders, and, although entitled to vote on
matters submitted for a vote of the stockholders, will not control the outcome
of such a vote.
Year 2000. The Company believes that software developed and utilized
by the Company is Year 2000 compliant. However, hardware, software, embedded
microchips and other material provided by others may not be compliant, and
there can be no assurances that the hardware, software, embedded microchips
and other material provided by others will not have a negative effect on the
software developed by the Company.
No Dividends. The Company has never paid any cash or other dividends
on its Common Stock. Payment of dividends on the Common Stock is within the
discretion of the Board of Directors of the Company and will depend upon the
Company's earnings, capital requirements and financial condition, and on any
other relevant factors. For the foreseeable future, the Board of Directors
intends to retain future earnings, if any, to finance its business operations
and does not anticipate paying any cash dividends with respect to the Common
Stock. In addition, the payment of cash dividends may be limited or prohibited
by the terms of any future loan agreements or any Preferred Stock that may be
issued by the Company.
Limitations on Liability of Directors and Officers. The Certificate
includes provisions to eliminate, to the full extent permitted by the Delaware
General Corporation Law (the "DGCL") as in effect from time to time, the
personal liability of directors of the Company for monetary damages under
certain circumstances. The Certificate and By-Laws also include provisions to
the effect that (subject to certain exceptions) the Company shall, to the
maximum extent permitted from time to time under the law of the State of
Delaware, indemnify, and upon request shall advance expenses to, any director
or officer to the extent that such indemnification and advancement of expenses
is permitted under such law, as it may from time to time be in effect. As a
result of such provisions, stockholders may be unable to recover damages
against the directors and officers of the Company for actions taken by them
that constitute negligence, gross negligence or a violation of their fiduciary
duties. In anticipation of the Offering, the Board has authorized and directed
the Company to enter into indemnification agreements with each director of the
Company, pursuant to which the Company would, in general, (i) agree to
indemnify and hold harmless each director to the full extent permitted or
authorized by the DGCL as in effect from time to time and (ii) specify the
various terms and conditions relating to the advancement of expenses in
connection with indemnifiable claims. Each of the provisions described above
may reduce the likelihood of stockholders instituting derivative litigation
against directors and may discourage or deter stockholders from suing
directors, officers, employees and agents of the Company for (among other
things) breaches of their duty of care, even though such an action, if
successful, might otherwise benefit the Company and its stockholders.
Adoption of Certain Charter and By-Law Provisions Having Anti-
Takeover Effects. The Certificate and By-Laws contain various provisions which,
under certain circumstances, could make it more difficult for a third party to
gain control of the Company (e.g., by means of a tender offer), prevent or
substantially delay such a change of control, discourage bids for the Common
Stock at a premium, or otherwise adversely affect the market price of the
Common Stock. The Certificate provides that the Board will be classified into
three classes of directors, with each class serving a staggered three-year
term. This provision, together with the provision authorizing the Board to
issue one or more series of Preferred Stock, could make it more difficult for
stockholders to effect certain corporate actions that might facilitate a
proposed acquisition of the Company and could have the effect of delaying or
preventing a change of control of the Company.
Forward-Looking Information. Certain statements made in this report
and in oral statements which may be made by representatives of the Company
relating to plans, strategies, economic performance and trends and other
statements that are not descriptions of historical facts may be forward-
looking statements within the meaning of the Private Securities Litigation
Reform Act, Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Such information includes information
relating to the Company which is based upon the beliefs of the Company's
management as well as assumptions made by and information currently available
to the Company's management. When used in this report, words such as
"anticipate," "believe," "estimate," "expect," "intend," and similar
expressions, as they relate to the Company's management, identify forward-
looking statements. Such statements reflect the current views of management
with respect to future events and are subject to certain inherent risks,
uncertainties and assumptions relating to the operations and results of
operations of the Company, competitive factors, shifts in customer demand,
government spending, economic cycles, availability of financing as well as the
factors described in this report. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results or outcomes may vary materially from those described herein as
anticipated, believed, estimated, expected or intended.
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases, pursuant to a sublease, approximately 2,750
square feet of office space at 1355 Terrell Mill Road, Marietta, Georgia. The
sublease commenced on January 1, 1997 and will continue through January 31,
2000. Pursuant to the sublease, the Company is required to pay rent of
approximately $3,005 per month, increasing through the term of the sublease to
approximately $3,100 per month. The Company is currently negotiating with the
landlord for a revised three-year lease which will commence on May 1, 1999 for
approximately 5,500 square feet of office space at a rental of approximately
$6,200 per month.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any pending legal proceeding (and none
of its property is the subject of any pending legal proceeding).
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
Pursuant to written consent adopted by a majority of the security
holders of the Company on December 30, 1998, Raymond W. Roncari and Gordon W.
Walker were re-elected to the board of directors of the Company. See
"Directors, Executive Officers, Promoters and Control Persons." No other
matters were submitted during the fourth quarter of the fiscal year covered by
this report to a vote of security holders, whether through the solicitation of
proxies or otherwise.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is presently no public trading market for the common equity of
the Company.
As of March 31, 1999, there were approximately twenty (20) holders of
record of the Company's Common Stock.
The Company has never declared dividends on its Common Stock and does
not anticipate paying dividends in the foreseeable future. See "Dividends of
the Business -- Risk Factors -- No Dividends."
The Company issued certain equity securities during the fiscal year
ended December 31, 1998 that were not registered under the Securities Act of
1933. In March 1998, the Company completed the sale to fourteen private
investors (including certain officers and directors of the Company) (the "1998
Private Placement") of 30 Units, each Unit consisting of (i) an unsecured non-
negotiable promissory note in the principal amount of $50,000 (the "Bridge
Notes"), (A) bearing interest at the rate of ten percent (10%) per annum,
payable annually in arrears, and (B) providing for a loan fee payable upon
payoff of the Bridge Note in an amount equal to $5,000 less interest accrued
under the Bridge Note during the first year through the date of payoff; (ii)
3,863 shares of Common Stock (the "Bridge Shares"); and (iii) 3,863 Bridge
Warrants. The purchase price per Unit was $50,000. The Company received gross
proceeds of $1,500,000 from the sale of such Units. After payment of
approximately $10,000 in costs associated with the 1998 Private Placement, the
Company received net proceeds of approximately $1,490,000 in connection with
the 1998 Private Placement. A total of $900,000 of the 1998 Private Placement
funds was assigned to the value of the common stock and warrants.
Approximately $1,345,000 of the net proceeds was used to exercise (as
hereinafter defined) certain options to repurchase securities sold in a
private placement completed in 1997. Some holders of the 1997 Units (as
hereinafter defined) chose to invest in the 1998 Private Placement and defer
all interest due them from the 1997 Units; such holders included Lawrence O.
Perl, the Company's Chairman of the Board, Chief Executive Officer and Chief
Financial Officer, Raymond A. Roncari, a director of the Company, Harold
Rothstein, a director of the Company and Bruce R. Bonadies, a director of the
Company, Richard Shelton, Susan Shelton and Ronald Seplowitz. These holders
deferred a total of $26,764 in interest, to be repaid in two parts: $12,157
from the proceeds of the minimum offering and $14,607 from the proceeds of the
maximum offering. The balance of the net proceeds are being used for working
capital and general corporate purposes, as well as to fund some expenses of
the Offering. $575,000 of the Bridge Notes were converted to equity by two
directors of the Company as of September 30, 1998 and the remaining $925,000
are to be repaid from the proceeds of the minimum Offering.
In conjunction with the closing of the 1998 Private Placement, the
Company issued 38,625 shares of Common Stock, valued at $7.77 per share for a
total of $300,116, and an option to purchase 77,250 shares of Common Stock,
exercisable at 85% of the per share market price of the Common Stock on the
exercise date, subject to adjustment (the "Chapman Option") to Chapman Group
LLC, a company affiliated with Cohn Birnbaum & Shea P.C., general counsel to
the Company. These shares and options were issued in partial consideration for
services rendered by Cohn Birnbaum & Shea P.C. from the date of the Company's
inception through the closing of an initial public offering by the Company and
in consideration of deferral of fees at different times during such same time
period.
In conjunction with the closing of the 1998 Private Placement, the
Company entered into Director Loan Agreements with each of Harold Rothstein
and Raymond A. Roncari pursuant to which Messrs. Rothstein and Roncari each
committed to loan $450,000 (for a total of $900,000) to the Company to be used
for working capital and certain costs of the anticipated initial public
offering. These amounts, together with approximately $155,000 of the proceeds
of the 1998 Private Placement, were used to fund certain costs of the
Offering, and provide required working capital. In consideration for this
commitment, Messrs. Rothstein and Roncari were each granted 19,313 shares of
Common Stock of the Company, valued at $7.77 per share for a total of
$300,116, and 19,313 Commitment Warrants. Pursuant to each Director Loan
Agreement, the Company has the right to draw down advances from each of
Messrs. Rothstein and Roncari (each a "Director Lender") as funds are required
and the Director Lender is obligated to so advance funds within three
(3) business days of any such request. Any amounts advanced will bear interest
at a rate of ten percent (10%) per annum. The entire $900,000 principal
outstanding was converted to equity as of September 30, 1998. All accrued
interest thereon, will be due and payable in full on the earlier of
(i) January 1, 2001, or (ii) the closing of subsequent debt financing.
In September, 1998, the 1994 Perl Trust Indenture and Messrs.
Findley, and Basch contributed shares of Common Stock to the Company by way of a
capital contribution in the respective amounts of 44,920, 44,920 and 22,460.
Contemporaneously, Messrs. Rothstein and Roncari converted $1,235,000 and
$1,235,594, respectively, of Company debt to equity in exchange for 56,150
shares of Common Stock each. The converted debt consisted of a portion of
their respective loans to the Company and some of the Bridge Notes each
acquired in connection with the 1998 Private Placement.
In January 1997, the Company completed the sale to 23 private
investors (including Lawrence O. Perl, an officer and director of the Company,
and Mr. Roncari, Mr. Rothstein and Bruce Bonadies, all directors of the Company)
(the "1997 Private Placement") of 25 units (the "1997 Units"); each 1997 Unit
consisted of (i) an unsecured 9% non-negotiable bridge note in the principal
amount of $50,000 due on the earlier of the consummation of an initial public
offering or January 16, 1998 (the "1997 Bridge Notes"); (ii) 7,725 bridge
shares (the "1997 Bridge Shares"); and (iii) 38,625 bridge warrants, each
bridge warrant representing the right to purchase one share of Common Stock at
an exercise price of $2.59 per share, subject to adjustment in certain
circumstances (the "1997 Bridge Warrants"). The purchase price per 1997 Unit
was $50,000. The Company received gross proceeds of $1,250,000 from the sale
of the 1997 Private Placement. After payment of $125,000 in placement fees to
the underwriting firm (not the Underwriter in the Offering), which acted as
placement agent for the Company with respect to the 1997 Private Placement,
and other offering expenses of approximately $105,000, the Company received
net proceeds of approximately $1,020,000 in connection with the 1997 Private
Placement. The net proceeds from the 1997 Private Placement were used in
connection with the Company's operations, including to fund the Company's
research and development efforts, to fund its sales and marketing activities,
to repay certain outstanding obligations, and for working capital and general
corporate purposes.
From July 1997 through January 1998, three directors, Raymond A.
Roncari, Harold Rothstein and Lawrence O. Perl, provided the Stockholder Loans
to the Company in the amounts of $320,000, $460,000 and $15,000, respectively,
each bearing interest at an annual rate of ten percent (10%). These Loans
provided the Company working capital and covered some costs associated with this
Offering and except for the $15,000 payable to Mr. Perl, have been previously
converted to equity and are part of the aforementioned Stockholder Loans.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
The Company was organized in June 1994 and is in the development
stage. Since inception, the Company has been engaged principally in
organizational activities, including developing a business plan, hiring
personnel and developing and enhancing its proprietary smart card technology and
software, and has only recently commenced the limited marketing of its smart
card systems.
To date, the Company has developed and installed, on a limited basis,
employee identification and licensing smart card systems for the thoroughbred
racing industry. To date, the Company has executed two contracts with the
North American Pari-Mutuel Regulators Association ("NAPRA") to provide and
maintain an internet-based regulatory tracking system that includes a database
with licensing information, infractions records and digital photographs of the
licensees in its jurisdictions. NAPRA is an organization comprised of nineteen
pari-mutuel wagering jurisdictions located in North America, including horse
and dog racing, jai alai and card rooms. In addition to the contracts with
NAPRA, the Company has developed and installed smart card based employee
identification and licensing systems in five NAPRA jurisdictions: the
Birmingham Racing Commission and the Macon County Race Course, both in
Alabama, the Oregon Racing Commission, the Idaho State Racing Commission, and
the Wyoming Pari-Mutuel Commission. In addition, the Company has a similar
contract with the Colorado Racing Commission. The Company recently submitted a
proposal to two additional NAPRA jurisdictions, the Arizona Racing Commission
and the Kentucky Racing Commission, to provide a smart card-based employee
identification and licensing system.
The Company has also entered into a contract with the Florida
Department of Pari-Mutuel Wagering to develop and maintain an internet
accessible smart card based employee identification and licensing database
system for their 27 pari-mutuel wagering facilities around the state. The
licensing system the Company is developing for the State of Florida will be a
database maintained by ACTI and will be accessible by the Internet. The smart
card licenses of the employees will be utilized to provide secure access to the
web site and the database through the Internet. This system was installed in
March 1999 and will commence operation in April, 1999.
In addition, the Company has completed a pilot program in New
Jersey and Pennsylvania for the issuance of "equine medical passport" smart
cards for monitoring the identity, interstate and intrastate movement and
medical records of thoroughbred horses. The Florida Department of Agriculture
and Consumer Services Bureau of Disease Control has proposed a similar pilot
project anticipated to begin as soon as possible. The Bureau of Disease
Control is responsible for ensuring the health and marketability of livestock
in the state of Florida. To prevent the spread of a deadly disease, the
federal government requires any horse crossing state lines to have a negative
Coggins Report which evidences a negative test result for Equine Infectious
Anemia. A Coggins Report is valid for one year from the issue date. Further,
each state requires a valid health certificate for any horse entering the
state. The states of Florida, Georgia and Alabama have formed an alliance
whereby a special ninety (90) day pass authorized by any of the three states
can be used to cross state lines between these states. The proposed Florida
pilot program will involve a test "livestock medical passport" program in
which each of 100 animals will be implanted with an "electronic identification
transponder" used in conjunction with smart cards to verify each animal's
identity and federal and state medical certifications. This pilot program will
replace the required paper passports for horses crossing between these states.
Although completed programs in New Jersey and Pennsylvania successfully tested
the equine medical passport smart card system and similar electronic
transponder implants are in use which are not coordinated with smart card
technology, such equine medical passport pilot programs have not resulted in
any system sales to date. There can be no assurance that any of the Company's
pilot programs will result in system purchases by any potential System
Sponsor.
The Company has entered into a Memorandum of Understanding with
Traquer to market the Company's smart card systems to Indian gaming and wagering
facilities in North America. Traquer has significant expertise with the
rules and regulations for Indian gaming environments. In February 1998, the
Company received its first order from Traquer to provide a smart card based
employee licensing system to an Indian tribe in Arizona. This system was
installed in October 1998. During February, 1999, the Company received its
second purchase order to install a similar system for an Indian tribe located
in Louisiana.
The Company received a request from Foundation Health, a Florida
based HMO, to structure a smart card system to assist and expedite the
verification of patient insurance coverage by hospital employees. The pilot
program involves Palmetto Hospital, one of the largest hospitals in Miami,
Florida, and the Company anticipates the initial phase will be installed during
the second quarter of 1999. Other phases of this proposed project may include
expanding the smart card based verification capability to all Foundation
Health member hospitals and Authorized Service Providers in south Florida. The
final phase may provide all Foundation Health members with enhanced smart card
member identification capabilities.
The Company has also been selected as a subcontractor to Paradigm
4 for the registered New York City Time Project. The City of New York has
significant problems tracking city employees and verifying the accuracy of
actual hours worked. This project will pilot a number of technologies,
including the use of smart cards, for time and attendance management and
tracking of city employees.
On November 11, 1998, the Company began discussions with Microsoft
regarding its Windows Card Operating System. The Windows Card Operating System
represents Microsoft's foray into the smart card industry. As a result of that
initial meeting in November, and subsequent meetings thereafter, the Company
has been asked to participate in the development and systems integration
component of Microsoft's Windows Card beta program. The exact role of the
Company in this regard has not yet been finally determined or formalized.
Further, notwithstanding the Company's participation in the beta program, the
Company does not have any agreement with Microsoft concerning any business
opportunities for the Company, and there can be no assurances that any such
agreement will be obtained or that meaningful opportunities for the Company
will result.
The Company has formed a new business entity with AVID Identification
Devices, Inc. called Animal Passports, Inc. (API). While final business terms
remain to be negotiated, it is anticipated that API will develop, market, and
sell smart card applications incorporating the Company's patented technology
for all animal owners worldwide. AVID, using PETtrac, a worldwide computerized
tracking system for companion animals, will be responsible for providing its
marketing and sales expertise to the new company and ACTI will be responsible
for providing smart card technology and technological support. Ownership will
be equal between the Company and AVID, however, AVID will be responsible for
funding the initial costs of API. It is anticipated that the Company's smart
card technology will be used in conjunction with AVID's radio frequency
identification devices currently being sold worldwide to veterinarians and
other customers. Owners of animals will carry with them a smart card
containing animal tracking information related to the existing PETtrac
identification systems as well as other AVID related applications, including
animal records. This venture is in its formative stages and there can be no
assurances that the venture will be undertaken as presently anticipated or
that meaningful revenues will result.
The Company has entered into a two year Non-Exclusive Representation
Agreement to DTEC/CPS. DTEC/CPS provides a full range of services and
technologies to the health care industry. The core of the company's business
is in pharmacy consulting and pharmacy management expertise. DTEC/CPS has the
right to market the Company's smart card products and services to its
extensive customer base throughout the world. DTEC/CPS and the University of
Tennessee are currently engaged in several research projects where smart cards
could play a significant role. It is anticipated that the Company will greatly
benefit from these projects, however, there can be no assurance that the
Company's involvement will result in sales to the University of Tennessee or
to any other DTEC/CPS customer.
The Company's objective is to become a leading provider of smart card
systems to government and commercial System Sponsors requiring increasingly
complex, secure and cost-effective information processing systems. The Company
intends to market its products through strategic marketing alliances and
licensing or other arrangements with systems integrators, value added
resellers and other smart card vendors. The Company anticipates that, under
certain circumstances, its smart card products will be bundled with its
strategic partners' products and services to create a complete integrated
system that can be marketed to potential System Sponsors. The Company will
also seek to provide complete smart card solutions, on a turnkey basis, to
System Sponsors by providing all of the hardware and software elements
required to implement the system.
The Company has generated limited revenues to date and does not
expect to generate meaningful revenues in the near future until such time, if
ever, as its smart card systems are successfully commercialized. The Company has
incurred significant losses in each operating period since its inception,
resulting in an accumulated deficit at December 31, 1998 of $8,932,884, and
losses are continuing through the date of this report. Inasmuch as the Company
will continue to have a high level of operating expenses and will be required
to make significant up-front expenditures in connection with both the
development of its business and the commercialization of its smart card
systems (including, without limitation, salaries of executive, technical,
marketing and other personnel), the Company anticipates that it will continue
to incur significant and increasing losses for the foreseeable future until
such time, if ever, as the Company is able to generate sufficient revenues to
finance its operations. Furthermore, the Company has incurred costs related to
a possible debt placement, which costs have to date been deferred. In the
event the planned Offering and financings are not successful, these costs will
be subsequently charged to operations. The Company's independent certified
public accountants have included an explanatory paragraph in their report
stating that the Company's dependence on outside financing, lack of existing
commitments from lenders to provide necessary financing, lack of sufficient
working capital and losses since inception raise substantial doubt about the
Company's ability to continue as a going concern.
The success of the Company's proposed plan of operation will be
largely dependent upon market acceptance of smart cards generally, as well as on
the Company's ability to successfully market its smart card systems by
persuading potential System Sponsors of the perceived benefits of its dual card
access and multiple application layering concepts (including the benefits to be
derived from allocating total card program costs among individual application
layers within a card) and to develop and commercialize further applications of
its proprietary technology. In addition, the Company's proposed plan of
operation and prospects will be dependent upon, among other things, the
Company's ability to enter into strategic marketing and licensing or other
arrangements on a timely basis and on favorable terms; establish satisfactory
arrangements with sales representatives and marketing consultants; hire and
retain skilled management as well as financial, technical, marketing and other
personnel; successfully manage growth (including monitoring operations,
controlling costs and maintaining effective quality, inventory and service
controls); and obtain adequate financing when and as needed. The Company has
limited experience in developing new products based on innovative technology
and there is limited information available concerning the performance of the
Company's technologies or market acceptance of the Company's products. There
can be no assurance that the Company will be able to successfully implement
its plan or that unanticipated expenses or problems or technical difficulties
will not occur which would result in material delays in its implementation.
Moreover, there can be no assurance that the Company will have sufficient
capacity to satisfy any increased demand for its smart card products and
technologies resulting from the Company's implementation of its plan of
operation.
The Company believes that software developed and utilized by the
Company is Year 2000 complaint. However, hardware, software, embedded
microchips and other material provided by others may not be compliant, and there
can be no assurances that the hardware, software, embedded microchips and other
material provided by others will not have a negative effect on the software
developed by the Company.
As of the date of this report, the Company has twelve full-time
employees, consisting of four executive officers and eight employees engaged
in engineering, technical support, product development, marketing and sales,
and administration. The Company also uses the resources of independent
programmers and consultants from time to time on an as needed basis. The
Company anticipates that it will hire additional sales and technical personnel
to continue to implement the Company's marketing and product development
efforts and may engage independent sales representatives and industry-specific
marketing consultants to assist the Company in marketing the Company's smart
card systems to potential System Sponsors.
Liquidity and Capital Resources
At December 31, 1998, the Company had cash on hand of $137,130,
working capital deficit of $2,439,263 and a stockholders' deficit of $3,576,058.
The Company's primary capital requirements will be to fund the Company's
continuing smart card system development and enhancement efforts, its sales
and marketing activities and the Company's working capital. The Company has
historically financed its capital requirements through the issuance of equity
and debt securities, contributions to capital and bank borrowings.
Since the inception of the Company, Lawrence O. Perl, the Chairman of
the Board and Chief Executive Officer of the Company (both individually and
through The 1994 Perl Trust Indenture, a trust for the benefit of the family
of Lawrence O. Perl (the "Perl Trust")), Raymond Findley, the Chief Operating
Officer of the Company, Raymond A. Roncari, a director of the Company, and
Harold Rothstein, a director of the Company (both individually and through The
Rothstein Family Trust, a trust for the benefit of the family of Harold
Rothstein (the "Rothstein Trust")) (each of the foregoing being referred to
individually as an "Original Stockholder"), have made the loans to the Company
in amounts aggregating $30,177, $15,177, $1,008,854 and $1,300,747,
respectively (the "Stockholder Loans"). The Stockholder Loans bear interest at
ten percent (10%) per annum. Of this total of $2,354,955, $1,050,000 had
previously been converted to equity and an additional $995,594 was converted
to equity as of September 30, 1998. The remaining balance of the loans,
together with accrued interest, are to be repaid with the proceeds of a
subsequent debt financing, but in no event later than January 1, 2001. These
loans were to provide the Company working capital and cover costs associated
with the Offering.
In March 1995, $250,000 of the then-outstanding principal amount of
the Stockholder Loans of each of Messrs. Rothstein and Roncari was
recharacterized as paid-in capital of the Company (the "Capital Contribution").
Pursuant to an agreement among the Original Stockholders, the Capital
Contribution was allocated equally among the Original Stockholders, in
consideration for which Mr. Findley issued to Mr. Roncari and the Perl Trust
issued to the Rothstein Trust a promissory note in the amount of $125,000 (each,
a "Capital Contribution Note"). Mr. Findley and the Perl Trust subsequently
trans-ferred 25,000 shares of Common Stock to Mr. Roncari and the Rothstein
Trust, respectively, in satisfaction of the indebtedness represented by the
Capital Contribution Notes. Upon the consummation of the 1997 Private Placement,
$12,675 of the Perl Trust's Stockholder Loans, $12,675 of Mr. Findley's
Stockholder Loans, $223,260 of Mr. Roncari's Stockholder Loans and $301,390 of
Mr. Rothstein's Stockholder Loans were converted into 2,535, 2,535, 44,652 and
60,278 shares of Common Stock, respectively.
From March through June of 1995, Joseph D. Basch, the President,
Chief Executive Officer and sole director of the Subsidiary, loaned the Company
an aggregate of $300,000. The loans accrued interest at ten percent (10%) per
annum and were payable on demand. In July 1996, the Company and Mr. Basch
entered into an agreement pursuant to which the then-outstanding principal
amount of the loans, together with accrued interest thereon of approximately
$30,000, was converted into an aggregate of 370,800 shares of Common Stock,
for a per share value of $.89. In September, 1998, Mr. Basch made a capital
contribution to the Company of 22,460 of these shares.
In July, September and November 1996, the Company borrowed an
aggregate of $300,000 from The First National Bank of Suffield ("First
Suffield"). Interest accrues on such borrowings at the prime lending rate
established by First Suffield from time to time, which was 8.25% as of December
31, 1998, and is payable monthly. The aggregate outstanding principal amount
owed by the Company to First Suffield, together with accrued interest thereon,
is payable on July 1, 1999. Mr. Roncari has personally guaranteed all of the
Company's indebtedness to First Suffield. The loan agreements prohibit the
Company, except with the prior consent of First Suffield, from paying dividends
on its stock (other than dividends payable in stock), merging or consolidating
with another company or purchasing or retiring any of its outstanding stock. The
loan agreements also provide that it shall constitute an event of default
thereunder if, among other events, either the Company or Mr. Roncari shall
become insolvent or if First Suffield, in good faith, deems that it has
insufficient security with respect to the loans. This debt is to be repaid
from the proceeds of the maximum offering.
From July through October 1996, the Company borrowed $150,000 from
Fleet National Bank ("Fleet"). Such amount is payable on demand. Interest
accrues on such borrowings at the prime lending rate established by Fleet from
time to time, which was 7.75% as of December 31, 1998, and is payable monthly.
The Company's indebtedness to Fleet (the "Fleet Loan") is personally guaranteed
by Mr. Rothstein, and is secured by personal assets pledged by Mr. Rothstein in
the form of a certificate of deposit in the amount of $150,000. This debt is
to be repaid from the proceeds of the maximum offering.
In October 1996, the Company borrowed $100,000 from The Chase Manhat-
tan Bank. The loan was subsequently acquired by The Mechanics Savings Bank
("Mechanics"). Such loan matured on March 1, 1999. The Company is currently
negotiating for an extension of the maturity date of such loan. Interest
accrues at the prime lending rate established by Mechanics from time to time,
which was 7.75% as of December 31, 1998, and is payable monthly. The Company's
indebtedness to Mechanics (the "Mechanics Loan") is secured by personal assets
pledged by Mr. Rothstein in the form of a certificate of deposit in the amount
of $105,000. This debt is to be repaid from the proceeds of the maximum
Offering.
Mr. Rothstein has agreed with the Company that, in the event a demand
is made by Fleet with respect to the Fleet Loan and/or a demand is made by
Mechanics with respect to the Mechanics Loan prior to the earlier of the
closing of the maximum Offering, subsequent debt financing or March 3, 2001,
he shall either (i) secure replacement financing to pay the amount so demanded
or (ii) personally satisfy the amount demanded, either through surrender of
the collateral previously pledged by him or through other means satisfactory
to Fleet and/or Mechanics, as the case may be. In the event Mr. Rothstein
elects to personally satisfy the demanded amount, the Company has agreed to
reimburse Mr. Rothstein for the full amount of such payment on the earlier of
the closing of the maximum offering, subsequent debt financing or March 3,
2001.
In December 1996, the Company borrowed $50,000 from First Southern
Bank ("FSB"). Such amount is payable on April 9, 1999 and bears interest at a
rate of 7.25% payable annually. The Company is currently negotiating for an
extension of the maturity date of such loan. The Company's indebtedness to
FSB is secured by personal assets pledged by Mr. Rothstein in the form of a
certificate of deposit in the amount of $50,000. This debt is to be repaid
from the proceeds of the maximum offering.
The Company also maintains $1,000,000 unsecured lines of credit with
both International Caribbean Trust Ltd., a Turks and Caicos Islands trust, and
Prometheus Trust, a Gibraltar trust, and a $250,000 unsecured line of credit
with the Butterfly Trust, a Turks and Caicos Islands trust. These trusts are
lending institutions on their respective islands, but are not banks. All
lines of credit are personally guaranteed by Messrs. Roncari and Rothstein.
The line of credit from the Butterly Trust is additionally guaranteed by
Messrs. Perl and Findley. As of December 31, 1998 the Company had drawn down
$455,000 from International Caribbean Trust Ltd. and $325,000 from Prometheus
Trust. All three lines of credit carry a 10% interest rate and are due no
later than June 30, 2001. Principal and interest under the line of credit from
the Butterfly Trust are payable earlier to the extent of the Company's gross
profits (gross receipts less cost of goods sold), as determined on a monthly
basis. Advances are at the discretion of the lenders.
The Company's capital requirements have been and will continue to be
significant. The Company has been dependent on the sales of its securities to
private investors, as well as on capital contributions and loans from
affiliates and certain financial institutions guaranteed by certain
stockholders of the Company. During the period from inception through December
31, 1998, the Company raised capital through such means in the estimated
aggregate amount of $6,135,000.
The Company is dependent on and intends to use the proceeds of the
Offering to continue the implementation of its proposed plan of operation.
The Company anticipates, based on assumptions relating to its current
operations (including assumptions regarding the Company's ability to meet its
current marketing objectives and the timing and costs associated therewith),
that the proceeds of the Offering, together with projected cash flow from
operations, will be sufficient to fund the Company's operations and capital
requirements for at least twelve months following the closing of the minimum
offering. In the event that the Company's plans change, its assumptions
change or prove to be inaccurate of the proceeds of the Offering prove to be
insufficient to fund operations (due to unanticipated expenses, technical
difficulties, problems or otherwise), the Company would be required to seek
additional financing sooner than currently anticipated. There can be no
assurance that the proceeds of the Offering will be sufficient to permit the
Company to successfully further develop and commercialize the Company's smart
card technology or that any assumptions relating to the Company's operations
will prove to be accurate. In addition, any implementation of the Company's
business plans subsequent to the twelve month period following the Offering
may require proceeds greater than the proceeds of the Offering or otherwise
currently available to the Company. There can be no assurance that additional
financing will be available to the Company on commercially reasonable terms,
or at all. Further, if the closing of the Offering is delayed, the Company
may not have sufficient capital to fund operations and the anticipated
expenses of the Offering. Although the Company believes it may be able to
raise at least a portion of the Company's future financing requirements for
such period among the officers, directors and/or stockholders of the Company,
no officer, director or stockholder of the Company has made any further
commitment to the Company to provide any portion of the Company's future
financing requirements and there are no assurances that any officer, director
or stockholder will do so. Any inability to obtain additional financing when
needed may have a material adverse effect on the Company, including requiring
the Company to curtail its activities and possibly causing the Company to
cease its operations. To the extent that the Company finances its operations
through the issuance of additional equity securities, any such issuance would
result in dilution of the interests of the Company's then-existing
stockholders. At some future date, the Company intends to offer up to
approximately $30 million in debt financing, to be negotiated by Beter. There
can be no assurance that such additional financing, or any other additional
financing, will be available to the Company on commercially reasonable terms,
or at all. Further, if such additional financing is attempted, there can be
no assurance that such additional financing, or any other additional
financing, will be successful. To the extent that the Company incurs
indebtedness or issues debt securities, the Company will be subject to all of
the risks associated with incurring substantial indebtedness, including the
risks that interest rates may fluctuate and cash flow may be insufficient to
pay principal and interest on any such indebtedness.
Possible Fluctuations in Operating Results
The sales cycle for a prospective System Sponsor is expected to
commence at the time the prospective System Sponsor demonstrates an interest in
purchasing a smart card system from the Company or issues a request for a
proposal or information or takes similar action and ends upon the installation
of a smart card system for the System Sponsor. The sales cycle will vary by
System Sponsor and could extend for periods of up to twelve months or more,
depending upon, among other things, the time required by the System Sponsor to
complete a pilot test of the Company's smart card system, make a determination
regarding an acquisition thereof and negotiate payment terms with the Company.
The Company's operating results could vary from period to period as a result
of this fluctuation in the length of the Company's sales cycle and as a result
of fluctuations in the purchasing patterns of potential System Sponsors,
technological factors, variations in marketing strategies for different target
markets and non-recurring smart card system sales.
ITEM 7. FINANCIAL STATEMENTS
The information required by this item is incorporated by reference to
the Financial Statements set forth on pages F-1 through F-20 hereof.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
<TABLE>
The current directors and executive officers of the Company are as
follows:
<CAPTION>
Name Age Position
<S> <C> <C>
Lawrence O. Perl 56 Chief Executive Officer, Chairman of the Board &
Director
Raymond Findley, Jr. 50 President, Chief Operating Officer & Director
Frank S. Fuino, Jr. 52 Chief Financial Officer & Vice President of
Finance
Robert H. Dixon 38 Vice President of Technical Operations
Lilly Beter 64 Secretary & Director
Harold Rothstein 76 Director
Raymond A. Roncari 74 Director
Bruce R. Bonadies 56 Director
Gordon W. Walker 57 Director
</TABLE>
Lawrence O. Perl, a co-founder of the Company, has served as Chairman
of the Board and Chief Executive Officer and a director of the Company since its
inception. From April 1993 to June 1994, Mr. Perl served as Chief Executive
Officer and a director of McKinnie Systems, Inc. ("McKinnie"), a privately
held supplier of computerized management information systems to the
pari-mutuel industry. From September 1984 through March 1993, Mr. Perl served
as a financial consultant for Roncari Industries, Inc., a privately held
producer of quarry, asphalt and concrete products. In addition, since
August 1977, Mr. Perl has served as President of Lawrence Owen
Associates, Inc., a privately held hotel and financial consulting firm, and,
since 1978, has been affiliated with other privately held entities engaged in
hotel ownership and management.
Raymond Findley, Jr., a co-founder of the Company, has been
President, Chief Operating Officer and a director of the Company since its
inception. From June 1990 to May 1994, Mr. Findley served as President and
Chief Executive Officer of Phoenix DataCrypt Systems, Inc., a privately held
designer and developer of smart card-based technology and business
applications. From September 1988 to April 1990, Mr. Findley was President and
Chief Executive Officer of British Telecom CBP, Inc., a developer and marketer
of financial telecommunications and trading systems.
Frank S. Fuino, Jr. was appointed as the Company's Chief Financial
Officer and Vice President of Finance on August 4, 1998. From January 1996 to
July 1998, Mr. Fuino was Senior Vice President and Chief Financial Officer of
Mayor's Jewelers, Inc. From June 1988 to December 1995, Mr. Fuino was both an
independent consultant providing financial services and a reorganization and
management specialist for various corporations, most recently as Executive
Vice President of Finance and Chief Financial Officer of Jan Bell
Marketing, Inc., a position he held from May 1993 to May 1995. In prior years,
Mr. Fuino served in various capacities, including Vice President and Treasurer
for Allied Stores Corporation from May 1977 to September 1987.
Robert H. Dixon has been Vice President of Technical Operations of
the Company since July 1994. From September 1987 to July 1994, Mr. Dixon was
employed as software manager of McKinnie and from April 1984 to August 1987
Mr. Dixon was employed as computer programmer by Tri-State Lighting, Inc., a
privately held lighting fixture manufacturer.
Harold Rothstein, a co-founder of the Company, has been a director of
the Company since January 1996. In 1967, Mr. Rothstein founded Utility
Development Corporation, a Connecticut-based privately held general contracting
firm which is primarily engaged in building federally insured multi-family and
low-income housing. Mr. Rothstein has served as the Chief Executive Officer of
Utility Development Corporation since its inception.
Raymond A. Roncari, a co-founder of the Company, has been a director
of the Company since January 1996. From 1979 to July 1995, Mr. Roncari served as
the President and Chief Executive Officer of Roncari Industries, Inc.,
thereafter serving as President and Chief Executive Officer of
Tilcon-Roncari, Inc., a partial successor-in-interest to Roncari
Industries, Inc. until January 1997, at which time he retired. Mr. Roncari
continues to serve as President and Chief Executive Officer of Roncari
Industries, Inc. Mr. Roncari has also served as Chairman, President and Chief
Executive Officer of Roncari Development Co., a real estate development
company, since 1970 and of Roncari Associates, Inc., a cargo facilities
company, since 1980. In addition, from 1965 to 1985, Mr. Roncari served as a
director and Chairman of the Executive Committee of the Northern Connecticut
National Bank-Windsor Locks.
Lilly Beter, Secretary and member of the Board since December 31,
1997, is President of Lilly Beter Capital Group, Ltd., with offices in
Washington, D.C., Minneapolis, Minnesota and Century City, California. She co-
founded the firm over thirty years ago with her late husband, with whom she was
also associated in his law practice, providing government representation to
clients. Ms. Beter represents companies doing business in the Pacific Rim,
South America, Europe and the Caribbean. She is a member of the American
League of Lobbyists and the American Arbitration Association.
Bruce R. Bonadies, a member of the Board since December 31, 1997,
retired in March 1998 from his position as Vice President, Business Development
of Marriott Health Care Services, a division of Marriott International.
Mr. Bonadies has held numerous positions with various Marriott companies since
1977, including Senior Vice President of National Food Services and
Facilities, Vice President of Sales and Vice President of Area Sales, and
Director of Sales, and is currently president of Brandon Scott Associates,
LLC, a recently formed sales training and consulting company.
Gordon W. Walker became a director of the Company in February 1997.
Mr. Walker served as counsel to Miller Thomson, a Toronto, Ontario law firm.
From 1978 to 1985, Mr. Walker held various government cabinet positions for
the Province of Ontario, including Minister of Correctional Services,
Provincial Secretary for Justice, Minister of Industry and Trade, and Minster
of Consumer and Commercial Relations. Between 1971 and 1985, Mr. Walker served
three terms as a member of the Ontario legislature.
Executive officers serve at the discretion of the Board. Directors of
the Company hold office until the expiration of the term for which they are
elected and until their respective successors have been elected and qualified,
or until their prior death, resignation or removal. The Board is classified
into three classes of directors, with each class serving a staggered
three-year term. Messrs. Bonadies and Findley and Ms. Beter are Class I
directors, Messrs. Roncari and Walker are Class II directors, and Messrs. Perl
and Rothstein are Class III directors. The terms of the Class I, Class II and
Class III directors will expire at the annual meetings of stockholders to be
held in 2000, 2001, and 1999, respectively. The Company reimburses the
directors for reasonable travel expenses incurred in connection with their
activities on behalf of the Company, but does not pay its directors any fees
for Board participation (although it may do so in the future). Pursuant to the
Nonemployee Directors' Stock Option Plan, non-employee directors will
automatically be granted each year, on the date of the Company's annual
meeting of stockholders, Non-incentive Options (as hereinafter defined) to
purchase 3,863 shares of Common Stock of the Company at an exercise price
equal to the fair market value thereof on the date of grant.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth certain information regarding the
compensation in each of the last three fiscal years paid to the person who
served as the Company's Chief Executive Officer and to the other officers of
the Company who earned $100,000 or more during such periods.
<PAGE>
<TABLE>
Summary Compensation Table
<CAPTION>
Long-Term Compensation
Annual Compensation Awards Payouts
Name & Year Salary Bonus Other Restricted Securities LTP All Other
Principal $ ($) Annual Stock Underlying Payouts Comp.
Position Comp. Award(s) Options ($) ($)
($) SARs
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Lawrence
O. Perl
Chief
Executive
Officer 1998 112,500(1) - - - - - -
1997 156,000(2) - - - - - -
1996 200,000(3) - - - - - -
1995 192,308 - - - - - -
Raymond
Findley,
Jr.
President
and Chief
Operating
Officer 1998 176,000(1) - - - - - -
1997 189,955(2) - - - - - -
1996 200,000(3) - - - - - -
1995 192,308 - - - - - -
Frank S.
Fuino Jr.
Vice
President
and Chief
Financial
Officer 1998 160,000(4) - - - 92,700(5) - -
___________
<FN>
<F1>
(1) Does not include $137,500 and $74,000 in accrued but unpaid salary
payable to each of Messrs. Perl and Findley, respectively.
<F2>
(2) Does not include $94,000 and $60,045 in accrued but unpaid salary
to each of Messrs. Perl and Findley, respectively.
<F3>
(3) Does not include $50,000 in accrued but unpaid salary payable to
each of Messrs. Perl and Findley.
<F4>
(4) Mr. Fuino's employment with the Company commenced August 4, 1998.
The salary actually paid to him by the Company for 1998 equals
$60,000.
<F5>
(5) Although 92,700 options were granted to Mr. Fuino during 1998,
only 23,175 of stock options are exercisable during 1998.
</FN>
</TABLE>
<TABLE>
OPTION/SAR GRANTS IN LAST FISCAL YEAR
(Individual Grants)
<CAPTION>
Percent of Total
Options/SARs
Number of Securities Granted to
Underlying Options/ Employees Exercise or Base
SARs Granted (#) in Fiscal Year Price ($/Sh) Exp. Date
Name
<S> <C> <C> <C> <C>
Frank 92,700 34.6% $11.00 August 4, 2008
S.
Fuino
Jr.
</TABLE>
<PAGE>
Employment Agreements
Each of the Company's officers, with the exception of Ms. Beter,
has executed a five-year employment agreement to be effective upon closing of
the Offering. The agreements provide for base annual salaries of $250,000 for
each of Messrs. Perl and Findley, $200,000 for Mr. Dixon, and $160,000
(increasing to $175,000 during the fourth and fifth years of the term) for Mr.
Fuino, plus the right to participate in any incentive bonus plan which may be
established in the future. Each such officer can be terminated by the Company
for cause with notice and an opportunity to be heard, or without cause, upon
ninety days notice and payment of severance equal to the greater of one year's
base annual salary or the total salary payable for the balance of the term,
plus a pro-rata portion of any bonus due such officer for such year. Each of
the agreements contain prohibitions on the disclosure of confidential
information and covenants not to compete with the Company which survive any
such termination.
Advisor to the Board
The Company has secured the services of Dr. Mary Mundinger as
advisor to the Board. Dr. Mundinger currently holds the position of Dean and
Professor at the School of Nursing, as well as an Associate Dean in the Faculty
of Medicine, at Columbia University in New York. She sits as a consultant and
advisor to various state and federal commissions including: The Federally
Commissioned Committee to advise the Department of Veteran Affairs on
Innovations in Nursing, 1997; The White House Steering Committee on Health,
1996; Co-Chair of the International Society of Technology Assessment in Health
Care, Nursing and Technology Assessment Panel, 1993; and the Health
Professions Review Group, appointed by President Clinton to review proposals
of the Health Reform Task Force, 1993. She has authored two books on nursing
and healthcare, as well as numerous articles in various nursing journals and
magazines. Dr. Mundinger is also on the Boards of Directors of Cell
Therapeutics, Inc., and United Healthcare. Her contacts and experience are
expected to be instrumental in promoting smart card technology in the
healthcare industry.
Other Key Employee
Robert J. Cartagine, a 1984 graduate of New York University with a
Business Administration degree and a 1985 graduate of the New York Institute
of Technology with a Sales Management degree, brings several years of sales
experience to the Company as its Director of Sales. He has developed training
syllabuses for the Regional Bell Operating Companies and was employed for
several years with Nynex, New York Telephone, Bell Atlantic and New Jersey
Bell as Northeast Regional Sales Director. Mr. Cartagine performed sales
services for the Company on a contract basis beginning in February 1998 and
became a regular employee in April 1998.
1996 Stock Option Plan
In order to attract, retain and motivate employees (including
officers), directors, consultants and other persons who perform substantial
services for or on behalf of the Company, the Company has adopted the 1996 Stock
Option Plan (the "Stock Option Plan"). Pursuant to the Stock Option Plan, stock
options covering an aggregate of 417,150 shares of the Company's Common Stock
may be granted to the foregoing persons. Under the Stock Option Plan,
"incentive stock options" ("Incentive Options") within the meaning of Section
422 of the Internal Revenue Code of 1986, as amended (the "Code"), may be
granted to employees (including officers), and non-incentive stock options
("Non-incentive Options") may be granted to any such employee and to other
persons (including directors) who perform substantial services for or on
behalf of the Company. Incentive Options and Non-incentive Options are
collectively referred to herein as "1996 Options."
The Stock Option Plan is administered by the Board or, at its
discretion, by the Compensation Committee. The Board or the Compensation
Committee have complete authority to administer and interpret the Stock Option
Plan, to determine the terms upon which 1996 Options may be granted, to
prescribe, amend and rescind such interpretations and determinations and to
grant 1996 Options. The Board or the Compensation Committee has the power to
terminate or amend the Stock Option Plan from time to time in such respects as
it deems advisable, except that no termination or amendment shall materially
adversely affect any outstanding Option without the consent of the grantee,
and the approval of the Company's stockholders will be required in respect of
any amendment which would (i) change the total number of shares subject to the
Stock Option Plan or (ii) change the designation or class of employees or
other persons eligible to receive Incentive Options or Non-incentive Options.
The price at which shares covered by a 1996 Option may be
purchased pursuant thereto shall be no less than the par value of such shares
and no less than the fair market value of such shares on the date of grant (the
"Fair Market Value"); provided, however, that in the case of Incentive Options,
if the optionee directly or indirectly beneficially owns more than ten percent
(10%) of the total combined voting power of all of the outstanding voting
stock of the Company (a "10% Holder"), the purchase price shall not be less
than one hundred ten percent (110%) of the Fair Market Value on the date of
grant. The Fair Market Value will generally be equal to the last sale price
quoted for shares of Common Stock on Nasdaq on the date of grant. The purchase
price of shares issuable upon exercise of an option may be paid in cash or by
delivery of shares with a value equal to the exercise price of the option. The
Company may also loan the purchase price to the optionee, or guarantee
third-party loans to the optionee, on terms and conditions acceptable to the
Board or the Compensation Committee.
In the event the aggregate fair market value of the shares of
Common Stock (determined at the time the option is granted) with respect to
which Incentive Options are exercisable for the first time by the optionee
during any calendar year (under all such option plans maintained by the Company)
exceeds $100,000, then only the first $100,000 of such shares so purchased
will be treated as Incentive Options and any excess over $100,000 so purchased
shall be treated as Non-incentive Options (the "$100,000 Limitation"). This
rule shall be applied by taking 1996 Options into account in the order or
sequence in which they were granted.
The number of shares covered by an option is subject to adjustment
for stock splits, mergers, consolidations, combinations of shares, reorganiz-
ations and recapitalizations. The 1996 Options are generally non-transferable
except by will or by the laws of descent and distribution, and in the case of
employees, with certain exceptions, may be exercised only so long as the
optionee continues to be employed by the Company. If the employee dies or
becomes disabled, the right to exercise the Option, to the extent then vested,
continues for specified periods. 1996 Options may be exercised within a period
not exceeding ten years from the date of grant, except that the term of any
Incentive Options granted to a 10% Holder may not exceed five years from the
date of grant. The terms of Incentive Options are subject to additional
restrictions provided by the Stock Option Plan.
As of December 31, 1998, Employee Incentive Options to purchase an
aggregate of 248,745 shares of Common Stock were outstanding under the Stock
Option Plan, including 77,250 shares to Robert Dixon and 92,700 shares to
Frank S. Fuino, Jr., both officers of the Company; plus 15,450 shares to
Robert Cartagine and 1,545 shares to Phyllis Burke, both employees of the
Company. All of such Incentive Options will be exercisable at a per share
price equal to $7.77, with the exception of the Incentive Options granted to
Mr. Fuino, Mr. Cartagine and Ms. Burke, all of whose Incentive Options will be
exercisable at a per share price equal to $11.00, and will vest in annual
installments of twenty-five percent (25%) beginning on the date of grant.
Shares subject to 139,050 of the 1996 Options, including the 1996
Options held by Mr. Dixon, are exercisable at a price of $7.77 per share.
Shares subject to the remaining 109,695 1996 Options, including the 1996
Options held by Mr. Fuino, are exercisable at a per share price equal to
$11.00. The right to exercise all 1996 Options vests in annual installments of
twenty-five percent (25%) commencing on the date of grant. All 1996 Options
are Incentive Options except for 25,772 of the 1996 Options held by Mr. Dixon
and 56,340 of the 1996 Options held by Mr. Fuino, which are Non-Incentive
Options. The Non-Incentive Options held by Mr. Dixon and Mr. Fuino are
Non-Incentive Options due to the $100,000 Limitation.
Nonemployee Directors' Stock Option Plan
In order to attract and retain the services of non-employee
members of the Board of Directors and to provide them with increased motivation
and incentive to exert their best efforts on behalf of the Company by enlarging
their personal stake in the Company, the Company has adopted the Nonemployee
Directors' Stock Option Plan (the "Directors' Plan"). Pursuant to the
Directors' Plan, stock options covering an aggregate of 46,350 shares of the
Company's Common Stock may be granted to such non-employee directors.
Pursuant to the Directors' Plan, each member of the Board of
Directors of the Company who is not an employee of the Company (or a subsidiary)
(a "Nonemployee Director") and who is elected or re-elected as a director of the
Company by the stockholders at any annual meeting of stockholders commencing
with the first annual meeting in 1999 will receive, as of the date of each
such election or re-election, options to purchase 3,863 shares of the
Company's Common Stock at the fair market value thereof on the date of grant.
In addition, each Nonemployee Director shall be granted options to purchase
3,863 shares of Common Stock at each annual meeting of the Board during the
term of such Nonemployee Director's directorship. All options granted under
the Directors' Plan are to be Non-incentive Options.
On February 2, 1998, each Nonemployee Director was issued an
option to purchase 3,863 shares of Common Stock (aggregating 19,315 shares) at
an exercise price of $7.77 per share, pursuant to the Directors' Plan.
Limitation of Liability and Indemnification
Section 145 of the DGCL contains provisions entitling the
Company's directors and officers to indemnification from judgments, fines,
amounts paid in settlement, and reasonable expenses (including attorney's fees)
as the result of an action or proceeding in which they may be involved by reason
of having been a director or officer of the Company. In the Certificate, the
Company has included a provision that limits, to the fullest extent now or
hereafter permitted by the DGCL, the personal liability of its directors to
the Company or its stockholders for monetary damages arising from a breach of
their fiduciary duties as directors. Under the DGCL as currently in effect,
this provision limits a director's liability except where such director
(i) breaches his duty of loyalty to the Company or its stockholders,
(ii) fails to act in good faith or engages in intentional misconduct or a
knowing violation of law, (iii) authorizes payment of an unlawful dividend or
stock purchase or redemption as provided in Section 174 of the DGCL, or
(iv) obtains an improper personal benefit. This provision does not prevent the
Company or its stockholders from seeking equitable remedies, such as
injunctive relief or rescission. If equitable remedies are found not be to
available to stockholders in any particular case, stockholders may not have
any effective remedy against actions taken by directors that constitute
negligence or gross negligence.
The Certificate and By-Laws also include provisions to the effect
that (subject to certain exceptions) the Company shall, to the maximum extent
permitted from time to time under the law of the State of Delaware, indemnify,
and upon request shall advance expenses to, any director or officer to the
extent that such indemnification and advancement of expenses is permitted
under such law, as it may from time to time be in effect. At present, the DGCL
provides that, in order to be entitled to indemnification, an individual must
have acted in good faith and in a manner he or she reasonably believed to be
in or not opposed to the Company's best interests.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of the date of this
report and as adjusted to reflect the sale by the Company of a minimum of
454,600 and a maximum of 648,900 shares of Common Stock offered pursuant to the
Offering (assuming the completion of the Offering in either the minimum or the
maximum number of shares of Common Stock) and the exercise of the options, based
on information obtained from the persons named below, with respect to the
beneficial ownership of shares of Common Stock by (i) each person who is known
by the Company to beneficially own more than five percent (5%) of the
outstanding shares of Common Stock, (ii) each director of the Company and
(iii) all of the Company's officers and directors as a group.
<TABLE>
<CAPTION>
Shares Beneficially Shares Beneficially Shares Beneficially
Owned Before Owned After Owned After
Offering (2) Minimum Offering Maximum Offering
Number of Number of Number of
Name Shares Percent Shares Percent Shares Percent
and
Address
of
Beneficial
Owner(1)
<S> <C> <C> <C> <C> <C> <C>
Lawrence O.
Perl (3) 698,667 17.9% 698,667 16.0% 698,667 15.4%
Raymond
Findley 696,735 17.9% 696,735 16.0% 696,735 15.3%
Harold
Rothstein(4) 1,024,138 26.3% 1,024,138 23.5% 1,024,138 22.5%
Raymond A.
Roncari(5) 999,995 25.6% 999,995 23% 999,995 22.0%
Lilly
Beter(6) 3,863 0.1% 3,863 0.1% 3,863 0.1%
Bruce
Bonadies(7) 5,795 0.2% 5,795 0.1% 5,795 0.1%
Gordon
Walker(8) 3,863 0.1% 3,863 0.1% 3,863 0.1%
Joseph Basch 348,340 8.9% 348,340 8.0% 348,340 7.7%
All officers
and directors
as a group
(nine persons) 3,506,444 89.9% 3,506,444 80.5% 3,506,444 77.1%
Lawrence O. Perl, Raymond Findley, Harold Rothstein and Raymond A.
Roncari may be deemed "promoters" of the Company, as such term is defined under
the federal securities laws.
___________
<FN>
<F1>
(1) The address for each such person is c/o American Card Technology,
Inc., 1355 Terrell Mill Road, Building 1462, Suite 200, Marietta,
Georgia 30067.
<F2>
(2) Unless otherwise indicated, the Company believes that all persons
named in the table have sole voting and investment power with
respect to all shares of Common Stock beneficially owned by them.
A person is deemed to be the beneficial owner of securities that
can be acquired by such person within 60 days from the date of
this report upon the exercise of options, warrants or convertible
securities. Each beneficial owner's percentage ownership is
determined by assuming that options, warrants or convertible
securities that are held by such person (but not those held
by any other person) and which are exercisable within 60 days of
the date of this report have been exercised. Assumes 3,901,136
shares of Common Stock outstanding prior to the Offering,
4,355,736 shares of Common Stock outstanding immediately after the
minimum offering and 4,550,036 shares of Common Stock outstanding
immediately after the maximum offering, before any consideration
is given to outstanding options, warrants or convertible
securities.
<F3>
(3) Includes 696,735 shares held by the Perl Trust, a family trust for
the benefit of the family of Lawrence O. Perl, of which Mr. Perl
is a beneficiary. As of May 1, 1998, the Perl Trust entered into a
voting trust agreement with respect to the 696,735 shares held by
the Perl Trust. As of July 8, 1998 Lilly Beter has been appointed
the voting trustee of such shares; such appointment shall expire
April 30, 1999. Does not include 1,932 shares issuable upon
exercise of warrants received in connection with the 1998 Private
Placement.
<F4>
(4) Includes 908,118 shares held by the Rothstein Trust, a family
trust for the benefit of the family of Harold Rothstein, and 3,863
shares issuable upon exercise of the option issued pursuant to the
Directors' Plan. As of May 1, 1998, the Rothstein Trust entered
into a voting trust agreement with Lilly Beter pursuant to which
Ms. Beter was appointed the voting trustee with respect to the
908,118 shares held by the Rothstein Trust; such appointment shall
expire April 30, 1999. Does not include 36,694 shares issuable
upon exercise of warrants received in connection with the 1998
Private Placement or the 19,313 shares issuable upon exercise of
his Commitment Warrants.
<F5>
(5) Includes 3,863 shares issuable upon exercise of the option issued
pursuant to the Directors' Plan. Does not include 36,694 shares
issuable upon exercise of warrants received in connection with the
1998 Private Placement or 19,313 shares issuable upon exercise of
his Commitment Warrants. Does not include shares issuable upon
exercise of an option to purchase 154,500 shares granted to
Shreveport, pursuant to the Shreveport Option, which has since
been assigned to Mr. Roncari.
<F6>
(6) Includes 3,863 shares issuable upon exercise of the option issued
pursuant to the Directors' Plan.
<F7>
(7) Includes 3,863 shares issuable upon exercise of the option issued
pursuant to the Directors' Plan. Does not include 1,931 shares
issuable upon exercise of warrants received in connection with the
1998 Private Placement.
<F8>
(8) Includes 3,863 shares issuable upon exercise of the option issued
pursuant to the Directors' Plan.
</FN>
</TABLE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to an agreement dated as of January 1, 1993, Shreveport
Acquisition Corp. ("Shreveport"), a corporation which was founded by Lawrence
O. Perl, the Chairman of the Board and Chief Executive Officer and Raymond A.
Roncari, a director of the Company, and which was owned by Mr. Perl,
Mr. Roncari and Harold Rothstein, a director of the Company, but was dissolved
on December 31, 1997, acquired all of the outstanding stock of McKinnie, a
supplier of computerized management information systems to the pari-mutuel
industry, for a purchase price of $2 million, which was paid $75,000 in cash
and $1,925,000 by delivery of a one-year promissory note which was guaranteed
by Mr. Roncari. Concurrently with such acquisition, McKinnie entered into an
agreement (the "McKinnie License Agreement") with Amazing Controls!, Inc. and
Phoenix DataCrypt Systems, Inc. ("Phoenix"), a company of which Raymond
Findley, Jr., the Company's President, Chief Operating Officer and a director,
was co-founder, President and Chief Executive Officer. Pursuant to the
McKinnie License Agreement, Phoenix granted to McKinnie an exclusive license
to use, in connection with McKinnie's management information systems, the
smart card technology and computer software owned or licensed by Phoenix
(including technology then licensed by Phoenix) for use in the pari-mutuel
industry and McKinnie agreed to purchase all of its smart card requirements
from Phoenix, a distributor of Amazing Controls!, Inc.'s smart cards.
In May 1994, Mr. Findley severed his relationship with Phoenix in
order to pursue smart card-related business opportunities with Messrs. Perl,
Roncari and Rothstein. In June 1994, Messrs. Findley, Perl, Roncari and
Rothstein formed the Company to develop and market smart card technology and
applications. In order to pursue their business plan, Messrs. Perl, Roncari
and Rothstein elected to divest themselves of control of McKinnie. In
July 1994, Shreveport sold a 51% equity interest in McKinnie to The Jockey
Club Racing Services, Inc. ("The Jockey Club"). In connection therewith, The
Jockey Club agreed to cause McKinnie to transfer to the Company all of
McKinnie's rights to any smart card technology, including certain software
technology and all rights under the McKinnie License Agreement. The Jockey
Club purchased the balance of the McKinnie stock from Shreveport effective
December 31, 1997.
In December 1996, the Company issued to Shreveport the Shreveport
Option to purchase 154,500 shares of Common Stock at an exercise price of $3.24
per share, which has since been increased to $7.77 per share and assigned to
Mr. Roncari. The Shreveport Option is exercisable at any time during the
five-year period commencing the earlier of January 1, 1999 or 90 days
following the closing of the minimum offering. The Shreveport Option provides
that upon exercise, in lieu of a cash payment, the option may be exchanged for
a number of shares of Common Stock equal to (a) the total number of shares
issuable upon exercise of such option for cash, minus (b) a number of shares
equal to the quotient of (i) the aggregate exercise price of the exercised
portion of the option, divided by (ii) the then current market price of a
share of Common Stock.
In connection with the formation of the Company in June 1994, each
of the Perl Trust, Mr. Roncari, the Rothstein Trust and Mr. Findley
(collectively, the "Original Stockholders") purchased 784,088 shares of Common
Stock for a purchase price of $250. In January 1995, each of the Original
Stockholders sold to Robert Dixon, the Company's Vice President of Technical
Operations, 7,725 shares of Common Stock for a purchase price of $1,250.
Since the inception of the Company, the Perl Trust and Messrs.
Findley, Roncari and Rothstein (either individually or through the Rothstein
Trust) have made the Stockholder Loans to the Company in amounts aggregating
$30,177, $15,177, $1,008,854 and $1,300,747, respectively. The Stockholder Loans
bear interest at ten percent (10%) per annum. Of this total amount of
$2,354,955, $1,050,000 had previously been converted to equity and an additional
$995,595 was converted to equity as of September 30, 1998. The remaining
principal balance of the loans, together with accrued interest, are to be repaid
from the proceeds of subsequent debt financing, but in no event later than
January 1, 2001. In March 1995, $250,000 of the then-outstanding principal
amount of the Stockholder Loans of each of Messrs. Rothstein and Roncari was
recharacterized as paid-in capital of the Company. Pursuant to an agreement
among the Original Stockholders, the aggregate $500,000 Capital Contribution
was allocated equally among the Original Stockholders, in consideration for
which Mr. Findley issued to Mr. Roncari, and the Perl Trust issued to the
Rothstein Trust, Capital Contribution Notes, each in the amount of $125,000.
Pursuant to the Debt Conversion which occurred upon the consummation of the
1997 Private Placement in January 1997, $12,675 of the Perl Trust's
Stockholder Loans, $12,675 of Mr. Findley's Stockholder Loans, $223,260 of
Mr. Roncari's Stockholder Loans and $301,390 of Mr. Rothstein's Stockholder
Loans were converted into 3,917, 3,917, 68,988 and 93,130 shares of Common
Stock, respectively. Mr. Findley and the Perl Trust subsequently transferred
38,625 shares of Common Stock to Mr. Roncari and the Rothstein Trust,
respectively, in satisfaction of the indebtedness represented by the Capital
Contribution Notes.
Pursuant to an agreement dated as of July 1, 1994, the Company
agreed to pay Lawrence Owen Associates, a corporation wholly owned by Mr. Perl,
a monthly fee of $1,000 in consideration for the use of office space in West
Hartford, Connecticut and for accounting and other general and administrative
services. The Company extended this arrangement until December 31, 1997, after
which time the agreement expired. Upon expiration $42,000 was due to Lawrence
Owen Associates from the Company.
From March through June 1995, Joseph D. Basch, the President,
Chief Executive Officer and sole director of the Subsidiary, loaned the Company
an aggregate of $300,000. The loans accrued interest at ten percent (10%) per
annum and were payable on demand. In July 1996, the Company and Mr. Basch
entered into an agreement pursuant to which the then-outstanding principal
amount of the loans, together with accrued interest thereon of approximately
$30,000, was converted into an aggregate of 370,800 shares of Common Stock.
In January 1996, the Company sold 154,500 shares of Common Stock
to Stephen S. Weisglass at a price of $.16 per share. Mr. Weisglass became a
director of the Company in November 1996. In July 1997, Mr. Weisglass resigned
from the Board and transferred his shares to Lilly Beter Capital Group, Ltd.
Mr. Weisglass introduced the Company to Whale Securities Corp L.P. ("Whale").
Whale was thereafter retained by the Company to act as placement agent for a
private placement to be followed by an initial public offering. The private
placement was effected, but Whale subsequently refused to underwrite the
public offering. Because of Mr. Weisglass' relationship with Whale, and the
Company's dispute with Whale over Whale's failure to underwrite the public
offering, the Company asked Mr. Weisglass to resign from the Board and to
divest himself of his shares of Common Stock in the Company at his cost.
Mr. Weisglass did as requested.
Mr. Rothstein has personally guaranteed all of the Company's
indebtedness to Fleet and has pledged personal assets in the form of a
certificate of deposit in the amount of $150,000 to secure such indebtedness;
Mr. Roncari has personally guaranteed all of the Company's indebtedness to
First Suffield; and Mr. Rothstein has pledged to Mechanics a certificate of
deposit in the amount of $105,000 to secure the Company's indebtedness to
Mechanics. In addition, Mr. Rothstein has agreed with the Company that, in the
event a demand is made by Fleet with respect to the Fleet Loan and/or a demand
is made by Mechanics with respect to the Mechanics Loan prior to the earlier
of the closing of the maximum Offering, subsequent debt financing or March 3,
2001, he shall either (i) secure replacement financing to pay the amount so
demanded or (ii) personally satisfy the amount demanded, either through
surrender of the collateral previously pledged by him or through other means
satisfactory to Fleet and/or Mechanics, as the case may be. In the event
Mr. Rothstein elects to personally satisfy the demanded amount, the Company
has agreed to reimburse Mr. Rothstein for the full amount of such payment on
the earlier of the closing of the maximum offering, subsequent debt financing
or March 3, 2001. See "Management's Discussion and Analysis-Liquidity and
Capital Resources."
In December 1996, the Company borrowed $50,000 from FSB. Such
amount is payable on April 9, 1999 and bears interest at a rate of 7.25% payable
annually. The Company's indebtedness to FSB is secured by personal assets
pledged by Mr. Rothstein in the form of a certificate of deposit in the amount
of $50,000. This debt is to be repaid from the proceeds of the maximum
Offering. See "Management's Discussion and Analysis-Liquidity and Capital
Resources."
The Company also maintains $1,000,000 unsecured lines of credit
with both International Caribbean Trust Ltd., a Turks and Caicos Islands trust,
and Prometheus Trust, a Gibraltar trust, and a $250,000 unsecured line of credit
with the Butterfly Trust, a Turks and Caicos Islands trust. These trusts are
lending institutions on their respective islands, but are not banks. All
lines of credit are personally guaranteed by Messrs. Roncari and Rothstein.
The line of credit from the Butterly Trust is additionally guaranteed by
Messrs. Perl and Findley. As of December 31, 1998 the Company had drawn down
$455,000 from International Caribbean Trust Ltd. and $325,000 from Prometheus
Trust. All three lines of credit carry a 10% interest rate and are due no
later than June 30, 2001. Principal and interest under the line of credit from
the Butterfly Trust are payable earlier to the extent of the Company's gross
profits (gross receipts less cost of goods sold), as determined on a monthly
basis. Advances are at the discretion of the lenders. See "Management's
Discussion and Analysis-Liquidity and Capital Resources."
In January 1997, pursuant to the 1997 Private Placement, the
Company completed the sale to 23 private investors (including Lawrence O. Perl,
an officer and director of the Company, and Mr. Roncari, Mr. Rothstein and Bruce
Bonadies, all directors of the Company) of 25 1997 Units. Each 1997 Unit
consisted of (i) one 1997 Bridge Note; (ii) 7,725 1997 Bridge Shares; and
(iii) 38,625 1997 Bridge Warrants. The purchase price per 1997 Unit was
$50,000. The Company received gross proceeds of $1,250,000 from the sale of
the 1997 Private Placement. A total of $262,500 of the 1997 Private Placement
funds was assigned to the value of the common stock and warrants, which
resulted in an effective interest rate of 30% on the 1997 Bridge Notes. After
payment of $125,000 in placement fees to Whale, which acted as placement agent
for the Company with respect to the 1997 Private Placement, and other offering
expenses of approximately $105,000, the Company received net proceeds of
approximately $1,020,000 in connection with the 1997 Private Placement. The
net proceeds from the 1997 Private Placement were used in connection with the
Company's operations, including to fund the Company's research and development
efforts, to fund its sales and marketing activities, to repay certain
outstanding obligations, and for working capital and general corporate
purposes. It was anticipated that the Company would shortly thereafter
undertake an initial public offering underwritten by Whale pursuant to a
letter of intent between the Company and Whale. However, Whale eventually
declined to underwrite the initial public offering, and in July of 1997, the
Company commenced exploration of alternative financing arrangements. In
connection with that initiative, the Company retained Beter as a consultant to
work with the Company to obtain new financing. During the course of the
Company's discussions with Beter and a number of the prospective underwriters,
it became evident that the structure of the 1997 Private Placement was an
impediment to additional financing. In order to meet the requirements for the
Company to undertake a best efforts initial public offering to be underwritten
by the Underwriter, it was necessary for the Company to redeem the 1997 Units.
The Company entered into a series of option agreements dated November 19, 1997
to purchase the 1997 Units sold to investors for an aggregate of $1,250,000 in
the 1997 Private Placement. The 1997 Units were redeemed with a portion of the
net proceeds from the 1998 Private Placement.
In January 1997, in connection with the 1997 Private Placement,
the Company borrowed from Messrs. Perl, Rothstein and Roncari $175,000 and
issued to them 1997 Bridge Notes in such aggregate principal amount, an
aggregate of 27,038 1997 Bridge Shares, at the same price per share as that paid
by purchasers of the 1997 Private Placement, and 135,188 1997 Bridge Warrants.
Such 1997 Bridge Notes, 1997 Bridge Shares and 1997 Bridge Warrants were
repurchased by the Company as part of the 1998 Private Placement.
Between July 1997 and January 1998, Messrs. Rothstein, Roncari,
and Perl provided a portion of the Stockholder Loans to the Company in the
amounts of $460,000, $320,000, and $15,000, respectively. These loans were to
provide the Company working capital and cover costs associated with the
Offering, and except for the $15,000 payable to Mr. Perl, have been previously
converted to equity and are part of the aforementioned Stockholder Loans. In
addition, various employees of the Company have deferred salary totaling
approximately $668,208 as of December 31, 1998. Such employees continue to defer
salaries and such deferred salary amounts are to be paid, together with interest
at ten percent (10%), in two parts, $50,000 at the closing of the minimum
Offering and the remainder, estimated to be $748,113 as of March 31, 1999, from
the proceeds of the maximum Offering, but in no event later than January 1,
2001.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The financial statements described in
the Index to Financial Statements contained on pages F-1 through F-20 hereof are
filed herewith as a part of this report.
(b) The exhibits set forth in the Exhibit
Index on the page immediately preceding the exhibits are filed herewith as a
part of this report.
(c) No reports on Form 8-K were filed by the
Company during the last quarter of the fiscal year covered by this report.
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
American Card Technology, Inc.
By: ______________________________
Lawrence O. Perl,
Chief Executive Officer
<PAGE>
In accordance with the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates stated.
<TABLE>
Name Title Date
<CAPTION>
<S> <C> <C>
/s/ Lawrence O. Perl Chief Executive Officer,
Lawrence O. Perl Chairman of Board April 12, 1999
/s/ Raymond Findley, Jr. President, Chief Operating
Raymond Findley, Jr. Officer, Director April 12, 1999
/s/ Frank S. Fuino, Jr.
Frank S. Fuino, Jr. Chief Financial Officer April 12, 1999
/s/ Harold Rothstein
Harold Rothstein Director April 12, 1999
/s/ Raymond Roncari
Raymond Roncari Director April 12, 1999
/s/ Lilly Beter Corporate Secretary,
Lilly Beter Director April 12, 1999
/s/ Bruce R. Bonadies
Bruce R. Bonadies Director April 12, 1999
/s/ Gordon W. Walker
Gordon W. Walker Director April 12, 1999
</TABLE>
<PAGE>
<TABLE>
EXHIBIT INDEX
<CAPTION>
Exhibit
Number Description of Document
<S> <C>
3.1 Articles of Incorporation. (1)
3.2 By-Laws. (1)
3.2.1 Amended By-laws. (1)
4.1 Sample Certificate for Common Stock. (1)
9.1 Voting Trust Agreement for Lawrence O. Perl. (1)
9.1.1 Amended, Voting Trust Agreement for Lawrence O. Perl. (1)
9.2 Voting Trust Agreement for Harold Rothstein. (1)
10.1 Amended Employment Agreement between the Company and
Lawrence O. Perl. (1)
10.2 Employment Agreement between the Company and Raymond
Findley, Jr. (1)
10.3 Amended Employment Agreement between the Company and Robert H.
Dixon. (1)
10.3.1 Employment Agreement between the Company and Frank S.
Fuino, Jr. (1)
10.4 Escrow Agreement, Bank of New York. (1)
10.4.1 Amended Escrow Agreement, Bank of New York, Dated August 24,
1999. (1)
10.4.2 Amended Escrow Agreement, Bank of New York, Dated
February 5, 1999. (1)
10.7.1 Subscription Agreement. (1)
10.7.2 Stock Option Agreement (warrant), Chapman Group, LLC. (1)
10.7.2.1 Amended, Stock Option Agreement (warrant), Chapman Group, LLC. (1)
10.7.3 Stock Option Agreement (warrant), Harold Rothstein. (1)
10.7.3.1 Amended, Stock Option Agreement (warrant), Harold Rothstein. (1)
10.7.4 Stock Option Agreement (warrant), Raymond Roncari. (1)
10.7.4.1 Amended, Stock Option Agreement (warrant), Raymond Roncari. (1)
10.8.1 Stock Option Agreement for non-employees and Amendment,
Lilly Beter. (1)
10.8.2 Stock Option Agreement/non-employees and Amendment, Harold
Rothstein. (1)
10.8.3 Stock Option Agreement/non-employees and Amendment, Raymond
Roncari. (1)
10.8.4 Stock Option Agreement for non-employees and Amendment,
Bruce Bonadies. (1)
10.8.5 Stock Option Agreement for non-employees and Amendment,
Gordon Walker. (1)
10.8.6 1996 Nonemployee Director's Stock Option Plan. (1)
10.8.6.1 Amended, 1996 Nonemployee Director's Stock Option Plan. (1)
10.8.7 1996 Stock Option Plan for Employees. (1)
10.8.7.1 Amended, 1996 Stock Option Plan for Employees. (1)
10.8.8 Amended Director Loan Agreement, Harold Rothstein. (1)
10.8.9 Amended Director Loan Agreement, Raymond Roncari. (1)
10.9.1 Amended Agreement with SoftChip Israel Ltd. and the
Company.(1)
10.9.1.1 Amended, Agreement with SoftChip Israel Ltd. and the Company. (1)
10.9.1.2 Amended Technology Purchase Agreement.
10.9.2 Agreement with SoftChip Technology (3000) Ltd. and the
Company. (1)
10.9.2.1 Agreement with SoftChip Technology (3000) Ltd. and the
Company. (1)
10.9.3 Stock Option Agreement and Amendment, Shreveport Acquisition
Corp. (1)
10.9.3.1 Amended, Stock Option Agreement, Amendment and Second Amendment,
Shreveport Acquisition Corp. (1)
10.9.4 Amended, Stock Option Agreement for employee, Robert
Dixon.(1)
10.9.5 Amended, Stock Option Agreement for employee, Michael
Pate.(1)
10.9.6 Amended, Stock Option Agreement for employee, Robert
Patten.(1)
10.9.7.1 Amended, Stock Option Agreement for employee, Shawn Nixon. (1)
10.9.7.2 Amended, Stock Option Agreement for employee, Jeremy Zela. (1)
10.9.7.3 Stock Option Agreement for employee, Phyllis Burke. (1)
10.9.8 Stock Option Agreement for employee, Robert Cartagine. (1)
10.9.9 Stock Option Agreement for employee, Frank S. Fuino, Jr. (1)
10.10.1 Loan Agreement between the Company and Prometheus Trust. (1)
10.10.2 Promissory Note between the Company and Prometheus Trust. (1)
10.10.3 Loan Agreement between the Company and International Caribbean
Trust, Ltd. (1)
10.10.4 Promissory Note between the Company and International Caribbean
Trust, Ltd. (1)
10.10.5 Articles of Incorporation of Animal Passports, Inc. (1)
10.10.6 Bylaws of Animal Passports, Inc. (1)
10.10.7 Consent of BOD, of Animal Passports Inc., acting in lieu of first
meeting. (1)
27.0 Financial Data Schedule.
99.1 Dual Smart Card Access, Patent Number # TX 3-639-032 for the
Company. (1)
99.2 Amended Rothstein personal guarantee. (1)
99.3 Database Services Agreement and Addendum (Florida). (1)
99.4 Falcetta, Wachtel & Knochenhauer, LLC regarding the Company. (1)
<FN>
<F1>
(1) Previously filed as an Exhibit to the Company's
Registration Statement on Form SB-2 (File No. 333-52169).
</FN>
/TABLE
<PAGE>
<PAGE>
INDEX TO FINANCIAL STATEMENTS
PAGE
Report of Independent Certified Public Accountants F-2
Consolidated Balance Sheets as of December 31, 1998 F-3
Statements of Operations for the Years Ended December 31, 1998 and 1997 F-4
Statements of Stockholders' Deficit for the Years Ended December 31, 1998,
1997, 1996, 1995 and 1994 F-5
Statements of Cash Flows for the Years Ended December 31, 1998 and 1997 F-6
Summary of Significant Accounting Policies F-8
Notes to Financial Statements F-12
<PAGE>
American Card Technology, Inc.
Financial Statements
Years Ended December 31, 1997 and 1998
Period from June 21, 1994 (inception) to December 31, 1998
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors
American Card Technology, Inc.
We have audited the accompanying balance sheet of American Card Technology,
Inc. (a development stage company) as of December 31, 1998, and the related
statements of operations and cash flows for the years ended December 31, 1997
and 1998 and for the period from June 21, 1994 (inception) to December 31,
1998, and the statements of stockholders' deficit for each of the years
(period) from June 21, 1994 (inception) to December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of American Card Technology,
Inc. as of December 31, 1998, and the results of its operations and its cash
flows for the years ended December 31, 1997 and 1998 and for the period from
June 21, 1994 (inception) to December 31, 1998 in conformity with generally
accepted accounting principles.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company's dependence on outside financing, lack of existing
commitments from lenders to provide necessary financing, lack of sufficient
working capital, and losses since inception raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans
concerning these matters are also described in Note 1. The financial
statements do not include any adjustments that might result from the outcome
of this uncertainty.
BDO Seidman, LLP
Atlanta, Georgia
March 5, 1999
F-2
<PAGE>
American Card Technology, Inc.
(a development stage company)
<TABLE>
Balance Sheet
December 31, 1998
<CAPTION>
Assets
<S> <C>
Current
Cash $ 137,130
Accounts receivable 169,505
Inventory 151,703
Prepaid expenses and other current assets 10,533
Total current assets 468,871
Equipment, net of accumulated depreciation of $108,934 93,681
Other assets:
Software development costs, net 113,348
Deferred registration and debt costs 662,717
Other 7,820
$ 1,346,437
Liabilities and Stockholders' Deficit
Current:
Accounts payable $ 806,439
Accrued interest expense 525,984
Accrued salary and benefits 727,164
Other accrued expenses 52,000
Deferred revenue 196,547
Notes payable to banks (Note 2) 600,000
Total current liabilities 2,908,134
Notes payable to stockholders (Note 3) 309,361
Bridge financing notes payable (Note 4(b)) 925,000
Notes payable (Note 2) 780,000
Total liabilities 4,922,495
Commitments and contingencies (Notes 1, 5 and 7)
Stockholders' deficit (Note 8):
Preferred stock, $.001 par value - shares authorized 1,000,000; none issued
Common stock, $.001 par value - shares authorized 20,000,000;
issued and outstanding 3,901,136 3,901
Additional paid-in capital 5,352,925
Accumulated deficit during the development stage (8,932,884)
Total stockholders' deficit (3,576,058)
$ 1,346,437
See accompanying summary of significant accounting policies and notes to
financial statements.
</TABLE>
F-3
<PAGE>
American Card Technology, Inc.
(a development stage company)
<TABLE>
Statements of Operations
<CAPTION
Period from
June 21, 1994
December 31, (inception) to
December 31,
- -------------------------------------
1997 1998 1998
<S> <C> <C> <C>
Revenues $ 76,912 $ 253,092 $ 430,510
Costs of sales 86,995 263,200 435,094
Gross profit (loss) (10,083) (10,108) (4,584)
Expenses
General and administrative 1,176,885 1,622,264 4,807,893
Research development 260,000 655,718 1,262,295
Write-off of license fee (Note 5) - - 168,000
Interest and financing costs,
net (Notes 2 and 3) 1,065,240 1,714,014 2,952,612
2,502,125 3,991,996 9,190,800
Net loss $(2,512,208) $(4,002,104) $(9,195,384)
Basic loss per share $ (.62) $ (1.02)
Weighted average number
of shares outstanding 4,040,705 3,915,709
See accompanying summary of significant accounting policies and notes to
financial statements.
</TABLE>
F-4
<PAGE>
American Card Technology, Inc.
(a development stage company)
<TABLE>
Statements of Stockholders' Deficit
Period from June 21, 1998 (inception) to December 31, 1998
<CAPTION>
Accumulated
deficit
Common stock Additional Stock during the
paid-in subscriptions development
Shares Amount capital receivable stage Total
<S> <C> <C> <C> <C> <C> <C>
Issuance
of
shares
to
founders 3,136,350 $ 3,136 $ (2,136) $ (250) $ - $ 750
Net loss - - - - (434,545) (434,545)
Balance,
December
31,
1994 3,136,350 3,136 (2,136) (250) (434,545) (433,795)
Capital
contribution
(conversion
of loan) - - 500,000 - - 500,000
Net loss - - - - (1,021,610) (1,021,610)
Balance,
December
31,
1995 3,136,350 3,136 497,864 (250) (1,456,155) (955,405)
Issuance
of
shares 185,400 186 29,814 (30,000) - -
Issuance
of
shares
for debt 370,800 371 329,629 - - 330,000
Net loss - - - - (1,224,917) (1,224,917)
Receipt
of stock
subscrip-
tions - - - 250 - 250
Balance,
December
31,
1996 3,692,550 3,693 857,307 (30,000) (2,681,072) (1,850,072)
Shares
and
warrants
issued
in
connection
with the
first
bridge
financing
(Note
4(a)) 193,125 193 262,307 - - 262,500
Issuance
of
shares
for debt 169,950 170 549,830 - - 550,000
Net loss - - - - (2,512,208) (2,512,208)
Balance,
December
31,
1997 4,055,625 4,056 1,669,444 (30,000) (5,193,280) (3,549,780)
For-
feiture
of
shares (154,500) (154) (24,846) 25,000 - -
Receipt
of
stock
sub-
scriptions - - - 5,000 - 5,000
Shares
and
warrants
redeemed
in
connection
with
the first
bridge
financing
(Note
4(a)) (193,125) (193) (262,307) - 262,500 -
Shares
and
warrants
issued
in con-
nection
with
second
bridge
financing
(Note
4(b)) 115,886 116 899,884 - - 900,000
Issuance
of
shares
for
services
rendered 38,625 38 300,078 - - 300,116
Issuance
of
shares
for
loan
commit-
ment 38,625 38 300,078 - - 300,116
Contri-
buted
sha-
res (112,300) (112) 112 - - -
Is-
suance
of
shares
for
debt 112,300 112 1,235,188 - - 1,235,300
Capital
con-
tribution
(con-
version
of loan) - - 1,235,294 - - 1,235,294
Net loss - - - - (4,002,104) (4,002,104)
Balance,
December
31,
1998 3,901,136 $3,901 $5,352,925 $ - $(8,932,884) $(3,576,058)
See accompanying summary of significant accounting policies and notes to
financial statements.
</TABLE>
F-5
<PAGE>
American Card Technology, Inc.
(a development stage company)
<TABLE>
Statements of Cash Flows
<CAPTION>
Period from
June 31, 1994
(inception) to
December 31, December 31,
1997 1998 1998
Cash flows from operating activities:
<S> <C> <C> <C>
Net loss $(2,512,208) $(4,002,104) $(9,195,384)
Adjustments
to reconcile
net loss to
net cash used in
operating activities:
Depreciation and
amortization 71,726 115,206 222,281
Amortization of
deferred financing
costs 220,417 91,703 312,120
Issuance of debt
for services
rendered - - 72,774
Issuance of stock
for services rendered - 300,116 300,116
Issuance of stock for
loan commitment - 300,116 300,116
Notes receivable
exchange for services - 5,000 5,000
Deferred registration
costs written off 352,966 - 352,966
Amortization of
bridge financing
discount 251,563 910,937 1,162,500
Changes in assets and
liabilities:
(Increase) decrease
in assets:
Accounts receivable (6,730) (162,775) (169,505)
Inventory (855) (147,785) (151,703)
Prepaid expenses and
other current assets (6,558) 1,124 (10,533)
Other assets 1,390 (249) (7,820)
Increase (decrease)
in liabilities:
Accounts payable 942 408,042 806,439
Deferred revenue - 196,547 196,547
Accrued expenses 458,850 583,247 1,335,148
Total adjustments 1,343,711 2,601,229 4,726,446
Net cash used in
operating activities (1,168,497) (1,400,875) (4,468,938)
Cash flows from
investing activities:
Capital expenditures (78,231) (41,917) (202,613)
Software development
costs (21,936) - (226,696)
Net cash used in
investing activities (100,167) (41,917) (429,309)
Cash flows from
financing activities:
Issuance of common stock - - 1,000
Deferred registration
costs-original (152,255) - (352,966)
Deferred registration
costs-current (228,912) (433,806) (662,718)
Deferred financing costs (248,644) (63,475) (312,120)
Borrowings on line
of credit 780,000 1,380,000
Proceeds from the
issuance of notes to
stockholders 685,000 1,042,500 3,514,681
Payments on notes to
stockholders (10,000) (22,500) (32,500)
Payments on bridge
financing - (1,250,000) (1,250,000)
Proceeds from the
issuance of bridge
financing 1,250,000 1,500,000 2,750,000
Net cash provided
by financing activities 1,295,189 1,552,719 5,035,377
Net increase (decrease)
in cash 26,525 109,927 137,130
Cash, beginning of period 678 27,203 -
Cash, end of period $ 27,203 $ 137,130 $ 137,130
Supplemental disclosures
of cash flow information:
Cash paid during
the period for:
Interest $ 53,076 $ 174,320 $ 251,864
Income taxes $ - $ - $ -
</TABLE>
F-6<PAGE>
American Card Technology, Inc.
(a development stage company)
Statements of Cash Flows
(concluded)
Supplemental noncash investing and financing information:
Loans totaling $500,000 were converted into capital contributions in 1995.
Notes receivable for $30,000 were obtained in 1996 in connection with the
issuance of common stock.
Loans payable of $300,000 and accrued interest of $30,000 were extinguished
in 1996 with the issuance of common stock.
Loans payable of $550,000 were extinguished in 1997 with the issuance of
common stock.
Notes receivable of $25,000 were cancelled in 1998 upon forfeiture of
common stock.
Loans payable of $2,470,594 were converted into equity in 1998.
See accompanying summary of significant accounting policies and notes to
financial statements.
F-7
<PAGE>
American Card Technology, Inc.
(a development stage company)
Summary of Significant Accounting Policies
December 31, 1998
Organization and Business
The financial statements include the accounts of American Card Technology,
Inc. (a development stage company) (the "Company") and its majority-owned
Canadian subsidiary, which was formed in June 1996 and whose results of
operations have been immaterial through December 31, 1998. All significant
intercompany accounts and transactions have been eliminated in consolidation.
The Company, a Delaware corporation, was incorporated on June 21, 1994 to
design, develop and market high security, flexible multiple application smart
card systems.
The Company is in the development stage and its activities to date have been
limited to organizational activities including developing a business plan,
hiring personnel and developing and enhancing its proprietary smart card
technology and software, and it has only recently commenced the limited
marketing of its smart card systems. Revenues to date, which have been
received from few customers, have been limited.
Certain stock splits were effected in 1996 and 1998 (see Note 8) and reflected
retroactively in these financial statements.
Revenue Recognition
The Company generally recognizes revenue upon the shipment of products or the
performance of services. Revenue recognition is deferred on shipments in
which customer acceptance of the product is pending final testing and approval
by the customer.
Use of Estimates
In preparing the financial statements in conformity with generally accepted
accounting principles, management is required 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
reported period. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The carrying amounts of cash, accounts payable, accrued expenses, short-term
notes payable to banks and the bridge financings approximate fair value
because of the short-term nature of these items. It was not considered
practical to determine the current fair value of the notes payable to
stockholders and affiliates.
Inventory
Inventory consists primarily of peripheral computer equipment and supplies and
is valued at the lower of cost or market. Cost is determined by the average
cost method.
F-8
<PAGE>
American Card Technology, Inc.
(a development stage company)
Summary of Significant Accounting Policies
December 31, 1998
Equipment
Equipment is stated at cost, less accumulated depreciation. Depreciation is
computed over the estimated useful lives (3 to 5 years) of the assets using
declining balance methods.
Income Taxes
The Company originally elected to be treated for income tax purposes as an S
corporation and, accordingly, income or losses were not subject to corporate
income taxes, rather the amounts of taxable income or loss were passed through
to its stockholders.
In June 1996, the Company became a C corporation. No deferred taxes resulted
from this change in tax status. Deferred tax assets and/or liabilities are
recorded for the expected future tax consequences of temporary differences
between the tax basis and financial reporting basis of assets and liabilities.
At December 31, 1998, deferred tax assets of approximately $2,850,000 relating
primarily to net operating losses of approximately $6,412,000 (and which
expire through 2013), have been offset by a valuation reserve since the
utilization of this asset cannot be determined.
Software Development Costs
Software development costs for products and certain product enhancements are
capitalized subsequent to the establishment of their technological feasibility
(as defined in Statement of Financial Accounting Standards ("SFAS") No. 86)
based upon the existence of working models of the products which are ready for
initial customer testing. Costs incurred prior to such technological
feasibility or subsequent to a product's general release to customers are
expensed as incurred. During 1995, the technological feasibility of the
Company's basic products was established and the Company incurred and
capitalized costs totaling $226,696 through June 30, 1997. Amortization of
these costs commenced on July 1, 1997 and these costs are being amortized over
3 years. Amortization expense is included in cost of sales and for the years
ended December 31, 1997 and 1998 and approximated $38,000 and $76,000,
respectively.
Deferred Costs
Costs associated with the first bridge financing described in Note 4(a) were
deferred and were amortized, commencing in January 1997, over the life of the
debt (one year).
Costs associated with the second bridge financing described in Note 4(b) were
deferred and amortized, commencing in February 1998, over the anticipated life
of the debt (six months).
Costs associated with an earlier planned initial public offering (totaling
$352,996) were written off in 1997 when the offering did not occur and are
included in interest and financing costs, net.
F-9
<PAGE>
American Card Technology, Inc.
(a development stage company)
Summary of Significant Accounting Policies
December 31, 1998
Costs associated with the Company's currently planned initial public offering
have been deferred and will be charged to equity upon the successful closing
of the offering or written off to expense if the offering is not successful.
Costs associated with the Company's planned debt offering have been deferred
and will be amortized over the life of the debt upon closing or written-off to
expense if the offering is not successful.
Loss Per Common Share
Effective for the year ended December 31, 1997, the Company adopted SFAS No.
128, "Earnings Per Share" ("SFAS 128"). In accordance with SFAS 128, the
Company is required to provide basic and dilutive loss per common share
information.
The basic loss per common share is computed by dividing the net loss available
to common shareholders by the weighted average number of common shares
outstanding.
Diluted loss per common share is computed by dividing the net loss available
to common shareholders, adjusted on an as-if-converted basis, by the weighted
average number of common shares outstanding plus potential dilutive
securities.
For the years ended December 31, 1997 and 1998, potential dilutive securities
had an anti-dilutive effect and, accordingly, were not included in the
calculation of diluted loss per common share. The assumed exercise of options
and warrants may impact diluted earnings per common share in future periods.
Long-Lived Assets
Long-lived assets are evaluated for impairment when events or changes in
circumstances indicate that the carrying amounts of the assets may not be
recoverable through the estimated undiscounted future cash flows from the use
of these assets. When any such impairment exists, the related assets will be
written down to their fair value. This policy is in accordance with SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets
to be Disposed Of," which became effective for fiscal 1996. No write-downs
have been necessary December 31, 1998.
F-10
<PAGE>
American Card Technology, Inc.
(a development stage company)
Summary of Significant Accounting Policies
December 31, 1998
Stock-Based Compensation
The Company accounts for its stock option awards under the intrinsic value
based method of accounting prescribed by Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees". Under the intrinsic value
based method, compensation cost is the excess, if any, of the quoted market
price of the stock at grant date or other measurement date over the amount the
employee must pay to acquire the stock. The Company adopted the disclosure
provision of SFAS 123,"Accounting for Stock-Based Compensation" and discloses
the pro forma amounts of net income and earnings per share as if the fair
value based method of accounting had been applied.
F-11
<PAGE>
American Card Technology, Inc.
(a development stage company)
Notes to Financial Statements
December 31, 1998
1. Basis of Presentation
The accompanying financial statements have been prepare assuming the Company
will continue as a going concern. This basis of accounting contemplates the
recovery of the Company's assets and the satisfaction of its liabilities in
the normal course of operations. Since inception the Company has been involved
in organizational activities. The Company's ultimate ability to attain
profitable operations is dependent upon obtaining additional financing
adequate to complete its development activities, and to achieve a level of
sales adequate to support its cost structure. Through December 31, 1998, the
Company has incurred losses totalling $9,195,384 and at December 31, 1998, has
deficiencies in working capital and equity of $2,439,263 and $3,576,058,
respectively. These circumstances raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.
In 1996, the Company entered into a letter of intent with an underwriter for a
private placement of debt and equity securities and a subsequent initial
public offering of equity securities. In January 1997, a private placement was
consummated (see Note 4(a)) and the Company received gross proceeds of
$1,250,000. Certain debt was converted to equity upon consummation of this
private placement (see Note 8). The initial public offering did not occur as
originally planned, and all costs previously deferred in connection with that
offering were written off
In February 1998, a second private placement was consummated (see Note 4(b))
and the Company utilized substantially all of the gross proceeds of $1,500,000
to redeem the debt incurred and accrued interest thereon from the January 1997
private placement. The Company is currently attempting to raise capital from
various sources including an anticipated initial public offering ("IPO") and a
debt offering. In 1997, the Company entered into a letter of intent with
another underwriter for an initial public offering of equity securities. The
Company filed a Registration Statement on Form SB-2 with the Securities and
Exchange Commission that was declared effective on February 12, 1999. The
public offering is being made on a "best efforts" basis with the minimum and
maximum estimated net proceeds to the Company of $4,500,000 and $6,424,000,
respectively. However, there can be no assurance that the Company will be
successful in consummating its plans, including closing the IPO, or that such
plans, if consummated, will enable the Company to attain profitable operations
or continue as a going concern. In 1998, certain shareholders contributed to
the Company 112,300 shares of the Company's common stock by way of a capital
contribution. As of the same date, a total of $2,470,594 of debt was converted
to equity and a total of 112,300 shares of the Company's common stock was
issued in exchange for this debt.
F-12
<PAGE>
American Card Technology, Inc.
(a development stage company)
Notes to Financial Statements
December 31, 1998
2. Notes Payable
At December 31, 1998 and 1997, the Company had lines of credit with certain
banks. Loans totaling $600,000 bear interest at the respective banks' prime
interest rates and are due on demand or through March 1999. The Company is
currently in discussions with its lenders to obtain extensions of the due
dates on these loans. Borrowings of $300,000 under these lines of credit are
secured by certificates of deposit of one of the Company's stockholders held
by the banks. Another stockholder has guaranteed the balance of these loans.
In September 1998, the Company entered into additional unsecured lines of
credit with two different Offshore Trusts for $1,000,000 each. As of December
31, 1998, loans under each of these credit lines bear interest at 10% per
annum and are due June 30, 2001. The Company has drawn down an aggregate of
$780,000 from these lines of credit as of December 31, 1998. Certain
stockholders have guaranteed this debt.
3. Notes Payable to Stockholders
Notes payable to stockholders' including the Director Loan Agreements
mentioned below, totaling $309,361 at December 31, 1998, bear interest at 10%
per annum and were originally payable on demand. The due dates of these notes
have been extended to the earlier of January 1, 2001 or the closing of a
subsequent debt financing. These notes have been used to finance operations.
Notes totaling $500,000 were converted to equity in 1995, notes totaling
$550,000 were converted to equity in January 1997 and notes totaling
$1,895,594 were converted to equity in September 1998. (See "Note 8").
In February 1998, in connection with the bridge financing (see Note 4(b)), the
Company entered into Director Loan Agreements with two shareholders pursuant
to which each of the shareholders committed to loan $450,000 ($900,000 in
total) to the Company to be used for working capital and certain costs of the
anticipated IPO. In consideration for this commitment, each of the
shareholders were granted 19,313 shares of common stock of the Company and
warrants to purchase 19,313 shares of common stock at an exercise price of 85%
of the market price of the common stock on the exercise date. The Company
included $300,116 in financing costs in the year ended December 31, 1998 for
these securities. Pursuant to each Director Loan Agreement, the Company shall
have the right to draw down advances from each of the shareholders as funds
are required. The Director Loans were converted to equity as of September 30,
1998 and accrued interests on such loans, which was at a rate of ten percent
(10%) per annum, will be due and payable in full on the earlier of (i) January
1, 2001, and (ii) the closing of a debt offering by the Company.
Interest expense to stockholders totaled approximately $74,000 and $134,000
for the years ended December 31, 1997 and 1998, respectively.
F-13
<PAGE>
American Card Technology, Inc.
(a development stage company)
Notes to Financial Statements
December 31, 1998
4. Bridge Financing
(a) In January 1997, the Company received $1,020,000, net of costs of
$230,000, through a private placement of 25 units (the "1997 Units"), at a
cost of $50,000 per 1997 Unit. Each 1997 Unit consisted of:(i)an unsecured
nonnegotiable promissory note in the principal amount of $50,000, bearing
interest at the rate of 9% per annum, payable semi-annually in arrears, and
maturing on the earlier date to occur of: (a)the first anniversary of the
initial closing (the "Initial Bridge Closing") of such bridge financing; and
(b) the consummation of an IPO of the Company's securities registered with the
Securities and Exchange Commission pursuant to the Securities Act of 1933, as
amended; (ii) 7,725 shares of common stock of the Company, and (iii) warrants
exercisable until the fifth anniversary of the Initial Bridge Closing to
purchase 38,625 shares of common stock (the "Bridge Warrant Shares") at an
exercise price of $2.59 per Bridge Warrant Share, subject to adjustment in
certain circumstances. A total of $262,500 of the private placement funds was
assigned to the value of the common stock and warrants, which resulted in an
effective interest rate of 30% on the notes.
In February 1998, the Company repurchased all of the 1997 Units and paid
related accrued interest with proceeds obtained from a second private
placement bridge financing (see Note 4(b)).
(b) In February 1998 the Company received $1,490,000, net of costs of $10,000,
through a private placement of 30 units (the "1998 Units"), at a cost of
$50,000 per 1998 Unit (each a "Bridge Note"). Substantially all of the
proceeds were utilized to repurchase the 1997 Units and related accrued
interest (see Note 4(a)). Each 1998 Unit consists of: (i) an unsecured
nonnegotiable promissory note in the principal amount of $50,000, bearing
interest at the rate of 10% per annum, payable annually in arrears, and
providing for a loan fee payable upon payoff of the Bridge Note in an amount
equal to $5,000 less interest accrued during the first year through the date
of payoff The Bridge Note shall mature on the earlier date to occur of: (a)
the third anniversary of the final closing (the "Bridge Closing") of such
bridge financing; and (b) the consummation of an IPO of the Company's
securities registered with the Securities and Exchange Commission pursuant to
the Securities Act of 1933, as amended; (ii) 3,863 shares of common stock of
the Company and (iii) warrants exercisable until the sixth anniversary of the
Bridge Closing to purchase 3,863 shares of common stock (the "Bridge Warrant
Shares") at an exercise price of 80% (subsequently amended to 85%) of the
market price of the Company's common stock on the exercise date per Bridge
Warrant Share. A total of $900,000 of the private placement funds was assigned
to the value of the common stock and warrants, resulting in a 160% effective
rate on the debt. This $900,000 was reflected as interest and financing cost
during the year ended December 31, 1998.
Directors (one employee and two non-employees) of the Company held $1,000,000
of the $1,500,000 Bridge Notes. In September 1998, $575,000 of the Bridge
Notes were converted to equity.
F-14
<PAGE>
American Card Technology, Inc.
(a development stage company)
Notes to Financial Statements
December 31, 1998
5. License Agreements
(a) In 1995, the Company acquired a license for certain technology rights. The
total cost was $296,000; $148,000 of which was paid upon signing the agreement
and $148,000 which was payable in various amounts through December 31, 1996.
Subsequent to June 30, 1996, the Company paid $20,000 under the agreement. The
recoverability of this fee was in question and, in 1996, the Company
determined that it would not utilize the technology acquired in this license
and terminated the agreement and future obligations thereunder. The licensor
agreed on December 2,1996 to waive all future obligations, including the
$128,000 remaining balance of the license fee.
In 1995, the Company wrote off the portion of the license fee paid in cash
($148,000) and recorded an asset and liability for the remaining balance due
under the agreement. In 1996, the asset was written off and the liability was
reduced by $128,000. The balance ($20,000) was expensed.
(b) In March 1998, the Company entered into an agreement with a company
located in Israel to purchase an operating system to be utilized with its
smart card systems upon completion of an anticipated. initial public offering.
The operating system will cost $100,000 and provides for two years of
technical support and development costs of an additional $450,000 plus
royalties ranging from $.125 to $.25 for each smart card sold by the Company
that incorporates the operating system. In addition, commencing December 1997,
the Company agreed to pay $18,000 per month for technical services related to
the development of the operating system. This agreement expired on September
30, 1998. Through September 30, 1998, the Company has incurred $180,000
relating to these technical services which are included in research and
development expense.
6. Related Party Transactions
In addition to the notes payable to stockholders (see Note 3), the Company had
an agreement to pay a fee of $1,000 per month to a company owned by the
Company's chief executive officer (who is a major stockholder). The agreement
commenced July 1, 1994 and concluded December 31, 1997, and covered accounting
and various other general and administrative services performed for the
Company. At December 31, 1998, $42,000, is payable to this affiliate for
these services.
F-15
<PAGE>
American Card Technology, Inc.
(a development stage company)
Notes to Financial Statements
December 31, 1998
7. Commitments
Lease
The Company rents office space in Atlanta, Georgia. Commencing December 1996,
the Company entered into a new lease which provides for annual rent of
approximately $36,000 through January 31, 2000.
Rent charged to operations was approximately $36,000 and $40,000 for the years
ended December 31, 1997 and 1998, respectively.
Employment Contracts
As of December 31, 1998, the Company had entered into employment agreements
with four of its executive officers. The agreements become effective upon the
closing of the Company's IPO and provide for aggregate salaries up to $860,000
per year for a term of five years.
8. Stockholders' Deficit
The Company's founders capitalized the Company in 1994 with $1,000. Certain
stockholders either individually or through trusts have loaned funds to the
Company since its incorporation. In 1995, loans totaling $500,000 were
converted to capital. In connection with the consummation in January 1997 of
the private placement for the financing, loans totaling $550,000 were
converted to 169,950 shares of common stock ($3.24 per share) (see Note 3). As
of September 30, 1998, certain shareholders contributed to the Company 112,300
shares of the Company's common stock by way of a capital contribution. As of
the same date, a total of $2,470,594 of debt was converted to equity and a
total of 112,300 shares of the Company's common stock was issued in exchange
for this debt.
In January 1996, the Company sold 185,400 shares of stock for notes totaling
$30,000. The notes bear interest at 8% per annum and were payable on July 1,
1997. In 1998, 154,500 shares of stock were returned to the Company and the
related note, totaling $25,000, was forgiven. In addition, the remaining note,
totaling $5,000, was exchanged with the payee for certain services, the value
of which equaled the note receivable.
In July 1996, the Company issued 370,800 shares of common stock to retire the
$300,000 note payable to an affiliate and related accrued interest of $30,000
($.89 per share).
On January 2, 1996, the Company effected a split of its common stock of 4.06-
for-1. On December 11, 1996, the Company (i) increased its authorized shares
of common stock from 1,500 to 20,000,000; (ii) authorized 1,000,000 shares of
preferred stock to be issued at the discretion of the Board of Directors;
(iii) changed the common stock from no par value to $.001 par value;
F-16
<PAGE>
American Card Technology, Inc.
(a development stage company)
Notes to Financial Statements
December 31, 1998
and (iv) effected a split of its common stock of 2,500-for-1. On July 9, 1998,
the Company effected a split of its common stock of 1.545-for-1. All share
amounts have been retroactively adjusted to reflect the stock splits.
Stock Options
In December 1996, the Company granted options to acquire 154,500 shares of its
common stock to an affiliate. The options had an exercise price of $3.24 per
share (subsequently increased to $7.77 per share), are immediately exercisable
and have a term of 10 years. The estimated fair value of these options at
their date of grant was immaterial.
In December 1996, the Company adopted the 1996 Stock Option Plan, pursuant to
which 417,150 shares of the Company's common stock may be granted to its
employees, directors and consultants. The option exercise price will be no
less than the fair value of the common stock at the date of grant. The options
will include vesting provisions and generally have ten year maturity periods.
The Company also adopted the 1996 Non-employee Director Stock Option Plan for
its non-employee directors pursuant to which 46,350 shares of common stock may
be granted.
In 1998, the Company issued, under the 1996 Stock Option Plan, 216,300 options
at an exercise price of $7.77 per share and 109,695 options at an exercise
price of $11.00 per share, all of which vest over four years and 19,315
options under the 1996 Non-employee Director Stock Option Plan at an exercise
price of $7.77, which vested upon issuance. The fair value of the non-employee
director options were immaterial.
The following summarizes stock option activity:
<TABLE>
<CAPTION>
Number of Weighted Average
Options Exercise Price
<S> <C> <C>
Outstanding, December 31, 1996 154,500 $7.77
Granted - -
Exercised - -
Forfeited - -
Outstanding, December 31, 1997 154,500 $7.77
Outstanding, December 31, 1997 154,500 $7.77
Granted 345,310 9.00
Exercised -
Forfeited (77,250) 7.77
Outstanding, December 31, 1998 422,560 $8.61
</TABLE>
F-17
<PAGE>
American Card Technology, Inc.
(a development stage company)
Notes to Financial Statements
December 31, 1998
Options exercisable at December 31, 1998 were as follows:
Weighted
Average
Number of Exercise Option
Options Price Price
208,577 $ 7.77 $ 7.77
27,424 11.00 11.00
236,001 $ 8.15
Options outstanding at December 31, 1998 were as follows:
Weighted Weighted
Average Remaining Average
Number of Contractual Option Exercise
Options Life in Years Price Price
312,865 8.6 $ 7.77 $ 7.77
109,695 9.3 11.00 11.00
422,560 $ 8.61
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 123 Accounting for Stock-Based Compensation ("SFAS 123")
effective August 1, 1996. As permitted by SFAS 123, the Company continues to
measure compensation expense for stock options issued to employees using the
intrinsic-value only provisions of Accounting Principles Board Opinion No. 25.
Expense for stock options granted to non-employees is measured at fair value
using methods consistent with the requirements of SFAS 123.
If the Company had elected to recognize compensation costs based on the fair
value at the grant date of all options, including employee awards, issued
under the plan described above, consistent with the method prescribed by SFAS
123, net loss and net loss per share would have been changed to the pro forma
amounts indicated below.
F-18
<PAGE>
American Card Technology, Inc.
(a development stage company)
Notes to Financial Statements
December 31, 1998
December 31,
1997 1998
Net loss
As reported $(2,512,000) $(4,002,000)
Pro forma (2,537,000) (4,107,000)
Net loss per share (basic and diluted)
As reported $ (.62) $ (1.02)
Pro forma (.63) (1.05)
The weighted average grant date fair value of options, calculated using the
Black-Scholes options pricing model, was as follows:
December 31,
1997 1998
Options granted at market price -0- $442,000
Options granted at above market price -0- -0-
The significant weighted average assumptions used to estimate the fair value
of stock options for the year ended December 31, 1998 were: a risk-free
interest rate of 5.4%, an expected option life of four years and no dividend
yield. A trading market for the Company's common stock had not developed as
of December 31, 1998, therefore, the minimum value method was used in
estimating fair value.
Stock Warrants
At December 31, 1998, the Company had an aggregate of 231,758 common stock
warrants outstanding as described below.
In February 1998, the Company issued 38,625 shares of common stock and
warrants to purchase 77,250 shares of common stock, at an exercise price of
80% (subsequently amended to 85%) of the market price of the common stock on
the date of exercise, to an affiliated company of the Company's general
counsel in consideration for corporate legal services rendered. The Company
expensed $300,116 in connection with this transaction which has been included
in general and administrative expenses.
In February 1998, the Company issued 115,882 common stock warrants in
connection with obtaining the bridge financing, as described more fully in
Note 4(b).
In February 1998, the Company issued an aggregate of 38,626 common stock
warrants in connection with entering into the Director Loan Agreements, as
described more fully in Note 3.
F-19
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998
<PERIOD-START> JAN-01-1997 JAN-01-1998
<PERIOD-END> DEC-31-1997 DEC-31-1998
<CASH> 27,203 137,130
<SECURITIES> 0 0
<RECEIVABLES> 6,730 169,505
<ALLOWANCES> 0 0
<INVENTORY> 3,918 151,703
<CURRENT-ASSETS> 77,736 468,871
<PP&E> 161,097 202,615
<DEPRECIATION> (69,692) (108,934)
<TOTAL-ASSETS> 594,536 1,346,437
<CURRENT-LIABILITIES> 4,144,316 2,908,134
<BONDS> 0 0
0 0
0 0
<COMMON> 4,056 3,901
<OTHER-SE> (3,553,836) (3,579,959)
<TOTAL-LIABILITY-AND-EQUITY> 594,536 1,346,437
<SALES> 76,912 253,092
<TOTAL-REVENUES> 76,912 253,092
<CGS> 86,995 263,200
<TOTAL-COSTS> 1,436,885 2,277,982
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 1,065,240 1,714,014
<INCOME-PRETAX> (2,512,208) (4,002,104)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (2,512,208) (4,002,104)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (2,512,208) (4,002,104)
<EPS-PRIMARY> (.62) (1.02)
<EPS-DILUTED> (.62) (1.02)
</TABLE>
