UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-KSB
(Mark One)
[x] ANNUAL REPORT UNDER SECTION 13 0R 13(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the fiscal year ended December 31, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
For the transition period from ______________ to ______________
Commission file number 010690
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Science Dynamics Corporation
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(Exact name of small business issuer as specified in its charter)
Delaware
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(State or other jurisdiction of incorporation)
22-2011859
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(IRS Employer Identification No.)
1919 Springdale Road, Cherry Hill, New Jersey 08003
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(Address of principal executive offices)
609-424-0068
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(Registrant's telephone number, including area code)
None
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(Securities registered pursuant to Section 12(b) of the Act)
Common Stock Par Value $0.01 Per Share
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Title of Class
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(Securities registered pursuant to Section 12(g) of the Act)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes [x] No [ ]
Check if there is no disclosure of delinquent filers in response to item 405
of Regulation S-B contained in this form, and that no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy
or information statements incorporated by reference in part III of this
Form10-KSB or any amendment to this Form10-KSB [ ]
State issuer's revenue for its most recent fiscal year: $4,393,552.
The number of shares of Common Stock outstanding as of December 31, 1997, was
14,535,649 shares.
The aggregate market value of voting stock of the registrant held by
non-affiliates as of December 31, 1997 was approximately $4,521,997.
Documents Incorporated by Reference: Certain portions of the registrant's
definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Securities Exchange Act of 1934, as amended, in connection with the
Annual Meeting of Stockholders of the registrant to be held on or about
June 8, 1998, are incorporated by reference into Part III of this report.
Transitional small business format Yes __ No X
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL OVERVIEW
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Science Dynamics Corporation (the "Company" or "SDC") was incorporated in the
State of Delaware May 1973 and commenced operations in July 1977. During the
past 21 years the Company has developed, designed and marketed a variety of
Telecommunications systems, including intelligent call processing platforms
which provide telecommunications service capabilities to the public switched
telephone network. These platforms are sophisticated software based systems
which satisfy a wide range of computer telephony integration applications.
The Company has utilized this experience complemented with the technology
obtained from the acquisition of the intellectual property of Innovative
Communications Technology (ICT) in November 1996, to address additional
markets in the Computer Telephony Integration (CTI) industry. The Company's
focus is to address niche market opportunities in Regional Bell Operating
Companies (RBOC's), such as BellSouth, Ameritech, US West, and Southwestern
Bell, large independent telephone operating companies, such as GTE, Sprint
and Citizens Data Network Companies and Telephone Service Distributors. The
Company is currently investigating additional market opportunities in the
U.S. and internationally.
The Company's development is driven by user needs for cost effective, easy
to use multiservice products that provide an array of services to the
customers regardless of the geographic diversity. These opportunities are
primarily in the areas of Inmate Systems, Video over Frame Relay, Voice over
Internet Protocol, Voice Announcements, Interactive Communications,
Intelligent Network Control and Administration. The Company's strategy today
is to deliver quality software products and services that empower its
customers to improve their applications and deploy quality services worldwide.
BUSINESS DEVELOPMENT
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Science Dynamics has been evolving its products strategy in concert with the
rapidly expanding Telecommunications market. A key change apparent within
this industry is the wider spread adoption of 'packet based' networks
replacing the original 'circuit switch based' networks. Science Dynamics is
re-positioning itself in order to become a developer of the technology which
enables this advance to take place.
The definition of a 'circuit switched' network, is that of a network which
provides communication channels (such as telephone calls) which can be
opened/closed at any time and, for the duration of that 'call', the channel
being used is dedicated to that particular user. For instance, if a user
makes a connection from New York to London, resources are dedicated, on an
exclusive basis, at every node that the connection may use, regardless of
whether the user actually sends any information or the line is idle. In a
typical telephone call, approximately 60% of the circuit is unused, i.e. 50%
due to the fact that as one person talks, the other generally does not, and
the remaining 10% of free space occurs during natural pauses in conversation.
This is a waste of the world's present communication infrastructure capacity,
when combined with these issues, the network requirement to provide
enough communication capacity for peak demand time, results in 60% over
capacity during the light traffic times.
Packet based networks have a different approach. The concept of a
packet based network is that each user has access to, typically larger,
communication channels, which are shared among other users on a
'statistically multiplexed' basis. This is tantamount to six single lane
roads from A to B, on which only one car can travel at once, or building a
six lane highway with multiple users. The large highway with shared traffic
utilization is much more efficient, but it must be managed more carefully
insuring efficient use of available resources, while providing a flexible
method of carrying new multimedia services.
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PRODUCTS
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IP Telephony
Following the trend of the telecommunications industry toward 'packet based'
networking, Science Dynamics has been closely working on a Telecommunications
level 'Gateway' product which will enable service providers to offer
compressed Voice and Fax services over a packet based network.
One of the earliest introductions of packet based networking was a protocol
called 'IP' (Internet Protocol). From its adoption, the Internet has
flourished and led the industry towards adopting this protocol as the
'defacto' standard for many applications. The natural progression of IP is
to expand this adoption to Telephony and Multimedia services. Advancements
in networks and the development of 'IP Telephony' products enables this
migration. Science Dynamics will draw upon its Telephony and Packet
technologies and the Company's twenty-one years of experience in designing
telephony products, to provide a product highly suited to the Telcos and
Data Carriers worldwide.
Video over Frame Relay
The most common means of videoconferencing is to use a 'circuit switched'
network, typically ISDN. Although this seems an obvious choice, due to
certain technical issues relating to the transmission of continuous data
streams such as, compressed video, it may not be the most cost effective.
Transmission of video over a 'packet based' network, although technically
challenging, provides the same benefits of shared communication
resources/channels as described above. This in turn can lead to significant
cost savings for the user.
Frame Relay is a standardized 'packet based' method (protocol) for
transmission of data.
The advent of Frame Relay Access Devices (FRADs) has enabled users to
integrate LAN-to-LAN (Local Area Network) connectivity, inter-office voice
communications, IBM SNA (System Network Architecture) traffic and much more,
over a single Frame Relay circuit. The advantage of integration is, quite
obviously, cost. Customers of this technology can either build their own
corporate enterprise networks, making best use of available bandwidth for
all their applications, or utilize a Public Service Frame Relay network,
provided by their local Telephone or Network Carrier.
Science Dynamics developed a new FRAD technology with the introduction of
the VFX-250 product range in 1997, a hardware based Frame Relay Access
Device specifically designed for video data streams. The Company intends
to devote resources to further enhance this technology by continuing
development throughout 1998.
Science Dynamics has generated new market opportunities by promoting sales
and OEM relationships for this product within the videoconferencing and
frame relay market places.
Voice Response System
The Company's Voice Response System (VRS) is an automatic intercept product
designed to provide a cost-effective solution for implementing announcement
capabilities at the central office location. The VRS is installed adjunct
to the central office switch eliminating the requirement to purchase
expensive switch software modules for providing call intercept, call
completion and CLASS announcements. The VRS results in a single system
solution that can meet most announcement requirements in most central offices.
The Voice Response System contains a standard library of recorded messages
and phrases that can be used for most telephone company announcement
requirements. These messages can be fixed, concatenated, or recorded by the
user and appended to the phrase and/or announcement library using the digital
encoding feature of the VRS. Several key features of the VRS encompass
interactive Custom Local Area Signal Service (CLASS), changed number
referral announcements with optional call completion, Automatic Number
Announcement (ANA), user recorded custom announcements, service and
emergency announcements.
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<PAGE>
Users can perform custom voice recordings and message construction locally
by using the built-in display and control panel, or remotely using the
administration port. The user recordable memory is expandable to
accommodate larger user recorded message requirements. The VRS has an
internal database for changed number referral or message assignment by
switch designated translation. VRS also supports pooled trunk announcements
to better utilize trunk resources.
Commander Inmate Telephone Control System (ITCS)
Both Commander I and II (ITCS) are based on the Company's new Integrator
C-2000(tm) platform. This open systems platform is a combination of
integrated Computer Telephony (CTI) hardware and software, which can handle
thousands of call transactions per hour and provide correctional facility
officials with effective tools to manage and control inmate telephone calls
utilizing the Commander systems software.
The smaller Commander I (up to 20 lines) and the Commander II (up to 96 lines
per rack, but daisy-chained for multiple racks) both utilize the Windows NT
(tm) operating system for robust, real time administration through the
Commander AdminManager Control Console system.
PRODUCT DEVELOPMENT
The Company's products have primarily been designed and developed by its
internal engineering staff. The Company considers the features and
performance of its products to be generally competitive or superior with
those of other available applications.
The Company believes that continual enhancements of its products will be
required to enable the Company to maintain its competitive position. The
Company intends to focus its principal future product development efforts on
developing new, innovative, technical products and updating existing products
in the communications arena to enable the Company to take advantage of
opportunities resulting from the expected direction of technology.
The Company has completed the development of the next generation of its core
application platform, the Integrator C-2000(tm). This product provides the
foundation for hosting applications for various Telephony and transaction
orientated processes. Currently the C-2000(tm) can host existing Company
products such as the Commander family of inmate products, the Integrator
C-2300 series of IP Telephony Servers, and the IVAP Intelligent Voice
Announcer Platform. Management believes that we have designed our product
strategy to keep us on the cutting edge of the emerging Internet Telephony
market.
INTEGRATION OF PRODUCTS
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Over the past year the Company has transformed into a predominately software
design and system integration company. The purchasing philosophy has been to
establish relationships with industry leaders in the Networking, Telecom and
PC environments providing quality components, prompt delivery and service.
Using an MRP process (Material Requirements Planning) the Company is able to
order on a just in time basis and efficiently integrate systems for prompt
delivery. The key stages in the development cycle of the products consist of
assembling the hardware, installing the software, final system testing and
inspection.
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<PAGE>
The Company's products are primarily produced to order and inventories
consist of raw materials, work in process, and finished goods. The Company
believes it maintains a quantity of inventory adequate to insure a quick turn
around time to meet customers' requirements.
SOURCES AND AVAILABILITY OF MATERIAL
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Although most materials are available from a number of different suppliers on
an off the shelf basis, several suppliers are the sole source of each of
certain components. If a supplier should cease to deliver a component,
another source would have to be developed. The Company believes it would be
able to do so by acquiring a substitute part or module that could require a
hardware or software change in the unit in order to provide satisfactory
performance, although added costs and delays of unknown amount and duration
could be experienced.
SALES AND MARKETING
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The Company sells its products through its direct sales force in the United
States and internationally via the Science Dynamics International sales
office. The Company has also implemented other channels of distribution to
broaden its geographic reach, accelerate its sales expansion and leverage its
sales force. These channels of distribution include value-added resellers,
FRAD and Codec Manufacturers, system integrators and distributors. The
Company's international office is pursuing sales opportunities in South
America, Europe, Middle East, and the Pacific Rim. The Company believes the
international presence allows it to maintain direct contact with and provide
better support to its international customers.
The Company's marketing programs include direct mail, internet presence,
participation in trade shows, advertising and production of corresponding
literature. These programs are designed to raise general awareness of the
Company and its products, generate leads for the sales organization, target
marketable products and promote the Company's various product lines.
RESEARCH & DEVELOPMENT
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The majority of the research and development activities are conducted at the
Company's facility using its array of telephony resources and the technical
expertise of its engineering staff. The Company has fourteen employees
currently engaged in research and development. The Company anticipates that
an increase in future research and development expenditures will be necessary
to remain competitive in the rapidly changing telecommunications industry and
that more development work will be outsourced to accelerate the introduction
of new product offerings.
The Company plans to devote a substantial portion of its resources to
research and development and utilize subcontractors to enhance the
engineering staff. The Company plans to continue to expand its product
offerings to include additional products in Telephony, Voice-Over-IP and Data
Communications.
INTELLECTUAL PROPERTY
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It is the Company's practice to apply for patents as new products or
processes appropriate for patent protection are developed. The Company made
application for a patent on the Three-Way Call Detection System and on
January 21, 1998, received a Notice of Allowance from the U.S. Patent Office.
The formal United States Patent should be received imminently. The Company
holds other patents relating some of its other products. No assurance can be
given as to the scope of the patent protection.
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The Company believes that the rapid technological developments in the
telecommunications industry may limit the protection afforded by patents.
Accordingly, the Company believes that its success will be dependent upon its
engineering competence, service and the quality and economic value of its
products.
The Company also owns trademarks, copyrighted material and intellectual
property relating to proprietary technology utilized in the development of
some of the products.
CUSTOMER SUPPORT
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The Company's technical support staff provides telephone support to our
customers using a computerized call tracking and problem reporting system.
The Company also provides initial installation and training for its products.
The Company is instituting an annual maintenance contract entitling customers
to software updates, technical support and technical bulletins.
INDUSTRY
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According to the Telecommunications Industry Association (TIA) and its
subsidiary, the Multimedia Telecommunications Association (MMTA) the overall
telecommunications market (equipment and services) grew by more than 11
percent in 1997, generating revenues of $406.7 billion. Spending on telecom
equipment grew 13 percent to $106.4 billion, while services, accounting for
about 75 percent of the 1997 revenue total, posted an 11 percent increase to
$300.3 billion.
Spending on emerging technology equipment -- frame relay, ATM and ISDN -- grew
by 60.4 percent to $3.9 billion in 1997. As bandwidth requirements in the
workplace expand, spending on emerging technologies should continue to grow
rapidly. Spending is projected to grow at a 22.1 percent compound Annual rate
through 2001.
U.S. exports of telecommunications equipment rose by an estimated 24 percent
to $21 billion in 1997. This increase is the result of countries throughout
the world recognizing the need to develop a sophisticated telecommunications
infrastructure in order to compete in the global economy.
Management is of the opinion that it is technologically well positioned to
capitalize on these new and emerging technologies and hopes to gain a fair
share of the market.
COMPETITION
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Due to the diversified nature of the products and target markets, Science
Dynamics competition varies greatly by product line. Inmate products division
holds a significant portion of the Inmate market with its Commander system.
The Company competes against three other primary vendors in this area but the
system captures a sizable share of the target market. The data/voice products
division expects to be competitive in the Data, Video and Voice-Over-Frame
Relay markets. Our IP products division is marketing new products designed
by the team that developed the Integrator series. These IP products will
compete in an arena that is predominately dominated by larger companies who
have significantly more resources for development, marketing and deployment.
However, the Company's innovative technology is readily adaptable to
accommodate the fast-paced market changes and the Company has the flexibility
of shifting its resources to respond quickly to customer requests.
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<PAGE>
CUSTOMERS
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The major customers in 1997 were independent and Bell Operating Companies with
three customers accounting for 88.7%, 4.3% and 3% of total revenue. With the
introduction of the new product lines, the Company has expanded its customer
base globally and will be less reliant on any single market or territory.
EMPLOYEES
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As of December 31, 1997, the Company employed 27 persons on a full time basis.
The Company supplements full-time employees with subcontractors and part-time
individuals, consistent with workload requirements. There is at present 28
full time employees.
GOVERNMENT APPROVAL
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The Federal Communications Commission (FCC) requires that some of the
Company's products meet subpart J of Part 15 and Part 68. Part 15 deals with
the suppression of radio frequency and Electro-magnetic radiation to specified
levels. Part 68 deals with protection of the telephone network. Other than
FCC requirements, there is no known Company effect resulting from existing or
probable Government regulations.
COMPLIANCE WITH ENVIRONMENTAL LAWS
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Company operations do not pollute nor involve discharge of material into the
environment. As a result, no expenditure is budgeted or required for
environment protection or restoration. The Company is concerned with
protecting the environment and participates in recycling programs.
ITEM 2. DESCRIPTION OF PROPERTY
The Company has leased for ten years commencing May 1, 1995, a 50,000 square
foot free-standing masonry building in an industrial park in Cherry Hill,
New Jersey, utilized for office space and test of its products and other
corporate activities. Since the Company's restructuring and redirection,
including the outsourcing of product assembly, the facilities are more than
presently required. It is anticipated that a trade-off to a smaller facility
within the vicinity, or in the alternative, a sub lease of the
unused area can be effectuated.
ITEM 3. LEGAL PROCEEDINGS
The Company is not now a party to any litigation and no action against the
Company has been threatened or is known to be contemplated by any governmental
agency or subdivision or any other entity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted, during the Fourth Quarter of the Fiscal Year covered
by this report, to a vote of security holders through solicitation of proxies
for otherwise.
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PART II
ITEM 5. MARKET FOR THE COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Registrant's Common Stock is traded in the NASDAQ Small Cap market system.
The NASDAQ symbol for the Company's Common Stock is "SIDY". The Company's
Common Stock has been traded publicly since April 22, 1981. The "high" and
"low" bid quotations for the Company's Common Stock for each quarterly period
for the fiscal years ended December 31, 1996 and December 31, 1997 were as
follows:
Calendar Quarter High Bid Price Low Bid Price
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1996
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First $ .8125 $ .3750
Second 1.8125 .4062
Third 1.3750 .6250
Fourth 1.1250 .6562
1997
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First $ 1.8750 $ .6875
Second .9687 .5625
Third 1.0937 .7187
Fourth 1.1250 .5000
The above listed quotes reflect inter-dealer prices without retail mark-up,
mark-down, or commissions and are not necessarily representations of actual
transactions or the true value of the Common Stock.
As of December 31, 1997, there were approximately 350 holders of record of
the Common Stock of the Company. However, registrant has reason to believe
that there are more than 850 shareholders because of stock held in street
name by various broker-dealers.
The Company has paid no cash dividends since its inception. The Company
presently intends to retain any future earnings for use in its business and
does not presently intend to pay cash dividends in the foreseeable future.
Holders of the Common stock are entitled to share ratably in dividends when
and as declared by the Board of Directors out of funds legally available
therefor.
The market price of the Company's common stock, like that of other technology
companies, is highly volatile and is subject to fluctuations in response to
variations in operating results, announcements of technological innovations
or new products by the Company, or other events or factors. The Company's
stock price may also be affected by broader market trends unrelated to the
Company's performance.
Starting February 23, 1998 the NASDAQ Stock Market has increased the
quantitative threshold criteria for continued listing on NASDAQ. Among
several changes, a minimum bid price of $1.00 is required for continued
listing on the SmallCap market. At present, SDC meets all of the new
listing standards with the exception of the $1.00 minimum bid. The Company
has been notified of the non-compliance of the minimum bid price and has until
May 28, 1998, to improve its position. There are no assurances that the
Company will be able to increase the bid price and the effect of the
de-listing would have a material adverse effect upon the ability of
shareholders to sell their stock and upon the value of the stock. The
Company is striving to comply with the minimum bid requirement by promoting
interest in its new products as well as the new enhancements to our inmate
product line.
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<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company's net sales for the year ended December 31, 1997 were $4,393,552,
a decrease of $1,168,720 from sales of $5,562,272 for year ended December 31,
1996. The decline was primarily due to the unavoidable delay in the
completion of our Commander II based on the Integrator C-2000(tm) that
incorporates all the functions previously offered in the CCTD and Commander
Plus into one robust system. The design of this system is a key development
effort as it is the foundational platform to be utilized as the basis of a
future line of CTI based products.
During 1997, the Company established an international presence through
agreements with Ci-Tech International Ltd. in the U.K. Science Dynamics
is no longer affiliated with Ci-Tech, however, the Company has subsequently
chartered the name of Science Dynamics International and established an
office in Fleet, U.K under the direction of Ian Glover, formerly sales
director of Ci-Tech. The International Technical Director of Ci-Tech has
also made the transition to Science Dynamics. Together they are aggressively
continuing their efforts to market the VFX product line. The VFX products'
main application is to enable Videoconferencing over Frame Relay. The sales
strategy for this product line is to target Frame Relay Network manufacturers
and providers. Although there was immaterial revenue generated from this
product in 1997, the first OEM distribution agreement has subsequently been
signed.
The promotion and sales of this product line is intended to extend the
awareness of the Company and its products outside of the inmate market.
The Company anticipates a continual revenue base from these products
in 1998 and beyond. The first shipment against the OEM contract has been
shipped in the first quarter of 1998, smaller orders and trial units have
been sold to several additional customers.
The first targeted market for the Integrator C-2000(tm) platform is in the
rapidly expanding Voice-over-IP arena. Advances in public and
private IP-based networks now enable businesses to use the Internet Protocol
to by-pass the Public Switched Telephone Network primarily for international,
long distance voice, fax, and video communications. This provides businesses
with a method to greatly reduce their telecommunication expenses. The
Company has hired a Sales Director, previously with Deutsche Telekom, with
expertise in Voice-over-IP to work out of Science Dynamics International to
market and generate sales for this product line.
During the latter portion of 1997, the Company engaged into an alliance
agreement to develop a forward error detection and correction device based
on a new, highly efficient algorithm. This device can decrease the error
rate on data channels, such as satellite links, while conserving costly
bandwidth. Reducing the error rate increases the speed of data and other
communications and decreases the cost of retransmitting. Management is
actively pursuing other partnerships or joint venture arrangements to
develop additional new products or applications.
To accelerate the Company's growth, management has continually researched,
analyzed and evaluated business opportunities for possible merger or
acquisition. As previously announced, the Company has signed a Memorandum
of Understanding with Worldwave Communications Inc. Under the terms of the
memorandum, Science Dynamics would acquire 100% of Worldwave for
approximately 5.5 million shares of Science Dynamics common stock. This
agreement is contingent upon Worldwave securing contracts for a minimum of
20,000 of its telephone units at a purchase price of approximately
$10,000,000, with a provision for additional shares if Worldwave receives a
purcase order for an additional 10,000 telephone units. There are several
other conditions outlined in the memorandum including a technological
evaluation, the performance of due diligence by Science Dynamics and
shareholder approval. At the end of December, a draft of a definitive
agreement had been generated by the Company and forwarded to Worldwave's
legal advisors. It should be noted that this arrangement has not been
consummated and there is no assurance that the transaction will be concluded.
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RESULTS OF OPERATIONS
The following table sets forth income and certain expense items as a
percentage of total revenue and the change in dollar amounts of such items
compared to the previous fiscal year:
For the Years Ending December 31,
1997 1996
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Sales $4,393,552 $5,562,272
Net Loss $(1,022,030) $(1,618,347)
Net Loss Per Share $(0.08) $(.18)
OPERATING EXPENSES PERCENT OF SALES
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1997 1996 1997 1996
---- ---- ---- ----
Cost of Goods Sold $1,969,837 $3,555,984 44.8% 63.9%
Inventory obsolescence
write off - 449,062 - 8.1%
Research & Development 1,293,608 934,260 29.4% 16.8%
Selling, General & Admin 2,138,408 2,164,784 48.7% 38.9%
Total Operating Costs
and Expenses $5,401,853 $7,104,090 122.9% 127.7%
Sales of $4,393,552 for the year ended 1997 were 21% less than sales of
$5,562,272 in 1996. As previously stated, sales for the latter portion of
the year were delayed by the customer anticipation of the release of the
Commander II based on the Integrator C-2000(tm) platform and the decision by
management to expend substantial time and effort broadening the product line
to reduce dependence on a single product and/or customer. The Company over
the past year has aggressively been expanding its product mix with the
addition of the VFX product line and the Voice-over-IP product lines.
The 1997 Total Operating Costs decreased both as a percentage of sales and
in absolute dollars. This was attributable to two major factors. The
evolution of the Company into a software driven organization and the
elimination of the manufacturing division have positively effected the cost of
sales. The decision to discontinue several of the company's older product
lines resulted in an inventory write-off of $449,062 in 1996.
Research and Development expenses in 1997 increased 38.5% to $1,293,608
compared to $934,260 in 1996, an increase of $359,348. Several factors
contributed to this increase including the utilization of subcontractors to
augment the design effort of the engineering staff, increases in the
compensation of the Engineering staff and the amortization expense associated
with the intellectual property.
The Company believes that the research and development activities are crucial
to maintaining a competitive edge in the rapid growth of the
telecommunications marketplace. The Company intends to increase its
investment in the research and development team to maintain a highly skilled
force of design engineers for new product development, the key to the future.
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<PAGE>
The selling, general and administration expenses increased 9.8% as a
percentage of sales but decreased in absolute dollars to $2,138,408 in 1997,
from $2,164,784 in 1996. The general and administrative expenses include the
costs associated with accounting, human resource, MIS, purchasing, corporate
and the administrative functions within the Company, including the
establishment of Science Dynamics International.
The 1997 net loss of $1,022,030, compared to the loss of $1,618,347
experienced in 1996, resulted in a decrease both as a percentage of total
revenue from 29% in 1996 to 23% in 1997 and decreased $596,317 in absolute
dollars. This decrease reflects the overall strategy to improve our profit
margins by maximizing purchasing power and the cost cutting measures
instituted as part of the transition to a Software Company.
LIQUIDITY & CAPITAL RESOURCES
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Net cash used for operating activities for the years ended December 31, 1997,
1996, and 1995 were $728,791, $587,380 and $1,270,280 respectively. The use
of cash in operating activities in 1997 resulted primarily from the net loss,
the significant increase in accounts receivable and the significant decrease
in accounts payable and accrued expenses, offset by the decrease in inventory
and the collection of the $200,000 receivable that was a constituent of the
acquisition of ICT consummated in November 1996.
Net cash used in investing activities was $80,257 in 1997, $24,379 in 1996
and $225,247 in 1995. The increase in cash used by investing activities in
1997 was primarily attributable to capital expenditures for the purchase of
test equipment used to establish a testing environment to be utilized in the
test and evolvement of the Company's current and new products. Additional
expenditures were also made in 1997, as well as in 1996 and 1995 for other
computer related equipment to advance the development activity. The Company
expects to increase its capital expenditures as necessary to maximize
development efforts of new products and applications.
There was no net cash provided by financing activities in 1997, compared to
$1,419,362 in 1996 and $1,599,110 in 1995, respectively. The net cash in
1996 and 1995 was generated by the net proceeds from the sale of the Company's
common stock and funds generated from a convertible note payable reduced by
the payments made on the bank note. The funds were utilized for working
capital.
At December 31, 1997, the Company had $21,181 in cash and cash equivalents
and $633,593 in working capital. Current assets as of December 31, 1997 were
$1,009,827 compared to $1,741,327 in 1996. The decrease in cash and cash
equivalents was mainly attributable to the substantial collection of the
accounts receivable in the fourth quarter of 1996 resulting in the increase
of cash and cash equivalents. The factors contributing to the decrease in
current assets at December 31, 1997 compared to December 31, 1996, was the
increase in accounts receivable and current assets offset by the collection
of the other receivable, which was a component of the ICT acquisition, and
the reduction in inventory attributable to the improved purchasing process
implemented to accommodate the transition of the Company from a hardware
developer to a software design operation.
Current liabilities at December 31, 1997 were $376,234, 32.5% less than
current liabilities of $557,615 at December 31, 1996. There were two major
factors that attributed to this decrease. By establishing a partnership
arrangement with OEM vendors and instituting a material requirements planning
process the Company has the ability to order materials on a just in time
basis reducing the payment of accounts to vendors resulting in the reduction
of accounts payable. The elimination of the manufacturing operation has
resulted in the consequential decline in the payroll and related expenses.
Total Liabilities at December 31, 1997 were $376,234 compared to $1,057,615
at December 31, 1996. This decrease was the result of converting the
long-term debt of $500,000 and accrued interest of $77,294 into 2,605,588
restricted shares of the Company's common stock. The elimination of the
long-term debt has strengthened the Company's ability to raise additional
financing to consummate a potential merger or acquisition, strategic
alliances or other possible ventures to intensify the Company's growth
strategy.
- -11-
<PAGE>
The Company believes that the forecasted sales generating cash flow from
operations, together with its current cash balances, will be sufficient to
finance the Company's operations and meet its foreseeable cash requirements
including planned capital expenditures, through the next twelve months.
To promote future growth, the Company may require the utilization of some
form of financing instrument.
Statements in this Annual Report on Form 10KSB concerning the Company's
business outlook on future economic performance and statements concerning
assumptions made or expectations as to any future events, conditions or other
matters are "forward-looking statements" as that term is defined under the
Federal Securities Laws. Forward-looking statements are subject to risks,
uncertainties and other factors, which cause actual results to differ
materially from those set forth above and elsewhere in the Annual Report.
The Company may encounter competitive, technological, financial and business
challenges making it more difficult to market its products and services, the
impact of which may in turn affect the Company's results of operations and
financial position.
ITEM 7. FINANCIAL STATEMENTS
The Financial Statements are listed at "Index to Consolidated Financial
Statements".
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no disputes or disagreements of any nature between the Company
or its management and its public auditors with respect to any aspect of
accounting or financial disclosure.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The directors and executive officers of the registrant were:
Name Age Position with the Company
Lyndon A. Keele 69 Chairman of the Board of Directors.
President from June 1973, until
November 7, 1996. CFO and Treasurer from
December 1980 until November 7, 1996
Alan C. Bashforth 47 President and Director since November 7, 1996
Kenneth P. Ray 64 Director since May, 1990
Joy C. Hartman 49 Executive Vice President, since December 1994,
Corporate Secretary since June 1, 1993, CFO and
Treasurer since November 7, 1996, and Director
since May 7, 1991
Sheldon Hofferman 53 Director since September 17, 1997
Michael L. Hershey 59 Director from March 1997 to December 1997
Russell R. Angely 59 Vice President, Sales and Marketing since
May 2, 1994
- -12-
<PAGE>
There were six board meetings during 1997. All the members participated in
these meetings. There was one audit committee meeting held on
November 20, 1997.
None of the above persons is related to any other of the above-named persons
by blood or marriage.
Mr. Hofferman previously served as a member of the Board from June 1995 to
June 1, 1996, but acted as advisor to the Board for the period June 1, 1996
to September 1997.
Based upon a review of filings with the Securities and Exchange Commission
and written representations that no other reports were required, the Company
believes that all of the Company's directors and executive officers complied
during fiscal 1997 with the reporting requirements of Section 16(a) of the
Securities Exchange Acts of 1934.
BIOGRAPHIES
- -----------
LYNDON A. KEELE is the founder of the Company and has been active as Chairman
of its Board of Directors and President from June of 1973 until November 1996.
From April of 1973 to August of 1977 Mr. Keele managed his own investments and
served as a consultant to a number of companies involved in the electronics
industry. Prior to 1973, Mr. Keele served for five years as a founder and
Executive Vice President of TeleSciences, Incorporated, a company engaged in
design and manufacture of telephone support equipment. From 1962 to 1968 he
served as a Program Manager for multimillion-dollar programs involving data
and circuit switching systems at ITT Federal Laboratories. From 1958 to
1962, he was employed by GTE's Sylvania Electronics Systems Division in
various management positions, including Program Manager of data processing
and cryptographic communications Projects and Programs. The University of
Texas awarded him a B.B.A. in 1951.
ALAN C. BASHFORTH, President, was the President of Innovative Communications
Technology, LTD. (ICT), a data communications company, located in Jersey,
Channel Islands, until the acquisition of the intellectual property of ICT by
SDC in November, 1996. Prior experience included ownership of the CSL Group
of companies from its inception in 1975. CSL is a Communications and Computer
engineering group and employed over 100 people in 1992 when Mr. Bashforth
sold the company. From 1970 to 1975, Mr. Bashforth was employed by Automaten
CI, LTD., an office equipment and telecommunications company, in various
engineering and sales positions leading to the position of General Manager.
Mr. Bashforth was educated in electronic engineering at Mid Herts Polytechnic
College in England and holds a Higher National Diploma in Electronic
Engineering. Mr. Bashforth also serves as a Director of Satellite Media
Services Ltd.
KENNETH P. RAY is President of DelRay, Inc., an active telecommunications
consulting firm. From 1964 to 1987 he was associated with ITT in various
responsible positions and in 1976 became Vice President of ITT
Telecommunications, with responsibility for engineering, marketing and
sales departments. In 1981 he became Vice President and Director of
Operations for the Transmission Division of ITT Space Communications. In
January 1987, ITT's telecommunications group was acquired by Alcatel and
Mr. Ray became Vice President of Marketing and Development for Alcatel
Network Systems. From 1988 to 1991, he was Vice President for Technology and
Business Development for Alcatel North America, a telecommunications company.
Mr. Ray received a BSEE from Polytechnic Institute of New York in 1954 and a
Masters in Economics from North Carolina State University in 1970.
JOY C. HARTMAN, Executive Vice President, was employed by the Company in
January 1982, and is responsible for General Corporate Administration
including the functions inherent in comptrollership, personnel, employee
benefits, and insurance activities. Her prior experiences included MSA, a
marketing Research Company, TeleSciences, Incorporated, and Peat
Marwick-Mitchell. Ms. Hartman is a graduate of the Wharton School of
Business of the University of Pennsylvania.
- -13-
<PAGE>
SHELDON C. HOFFERMAN, has been an Attorney and Private Investor since 1971.
Mr. Hofferman graduated from the University of Pennsylvania in 1966 and
Temple University Law School in 1971. He was in private law practice in
Washington, D.C., specializing in communications law, from 1971 to 1974.
He served as Senior Trial Attorney for the Federal Trade Commission from 1974
to 1983, and re-entered private law practice thereafter. Mr. Hofferman has
also served as General Partner of Golden Phoenix Limited Partnership, an
investment concern, since 1983.
MICHAEL L. HERSHEY is founder and principal of Landis Associates, Inc. and
has actively managed the Company since its founding in 1975. Landis
Associates, an investment advisory business, serves high net worth
individuals in asset management. Prior to 1975, Mr. Hershey was employed in
the securities industry as an institutional salesman with Laird & Co. and
with Wertheim. He is presently on the Board of Directors of Nematron
Corporation, Atlantic Aviation, Tremont Medical, Inc. as well as many
charitable organizations. Mr. Hershey attended Princeton University.
The Company regrettably accepted the resignation of Mr. Hershey on
December 9, 1997. There was no dispute or problem with the Company or any
Board member. Mr. Hershey relinquished his seat on the board due to limited
time to devote to interests outside his direct business operations.
RUSSELL R. ANGELY, Vice President of Sales and Marketing, was employed by
the Company in May, 1994. Prior to joining the Company, Mr. Angely was the
National Sales Manager for CXR Corporation, where he managed the direct sales
organization and an extensive network of domestic and international
distributors, VAR's, and Manufacture Representative sales organizations.
Mr. Angely has served in executive level assignments with Xerox Corporation,
Racal Milgo, Delta Data Systems, Develcon Electronics, and Racal DataCom.
These assignments have provided Mr. Angely with over 25 years experience in
sales and marketing management in the data and telecommunication industry.
Mr. Angely received a degree in Business Administration from Penn
State University and has participated in Executive Management programs at the
University of Pennsylvania, NYU, and Michigan State University.
ITEM 10. MANAGEMENT REMUNERATION AND TRANSACTIONS
EXECUTIVE COMPENSATION
- ----------------------
Reference is made to the information to be set forth in Item 1, the sections
entitled "Director and Executive Compensation" in the Proxy Statement, which
section is incorporated herein by reference.
The outside Directors receive $250.00 per meeting as standard compensation
for service as directors. Should there be a change in control or ownership
of the Company by acquisition or merger, the Board of Directors on
January 25, 1996, adopted a resolution whereby the then present officers of
the Corporation are protected from termination without cause. The
compensation amount is limited to compensation for three years of salary.
Such compensation can be either a lump sum payment or payment over a three
year period.
- -14-
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of December 31, 1997,
with respect to the ownership of the Company's Common Stock by each person
known to the Company to own beneficially more than 5% of the outstanding
shares of the Company's Common Stock, which is its only voting security.
Name and Address of Beneficial Owner Number of Percent of
Shares Outstanding Shares(1)
------ ------------------
Lyndon A. Keele
701 Garwood Road, Moorestown, NJ 08057 775,534(2) 5.34%
Reynolds E. Moulton, Jr.
54 Washington Street, Marblehead,
MA 01945 761,000(3) 5.24%
Sheldon C. Hofferman
P.O. Box 350, Fairfax Station,
VA 22039 2,969,121(5) 20.43%
Innovative Communications Technology,
LTD. (ICT) Le Clos D'Avranche
La Rue Bel-Aire St. Mary, Jersey C.I.
(Alan C. Bashforth, President of the
Company controls ICT) 1,500,000(4) 10.32%
The following table sets forth certain information as of December 31, 1997,
with respect to the ownership of the Company's Common Stock by each director
of the Company, and all directors and officers of the Company as a group.
Number Percent of
Name and Address Title of Shares Outstanding
---------------- ----- --------- -----------
Shares(1)
------
Lyndon A. Keele Chairman of the Board. 775,534(2) 5.34%
701 Garwood Road
Moorestown, NJ 08057
Russell R. Angely Vice President 11,000 .076%
107 Hardwood Court
Chalfont, PA 18914
Joy C. Hartman Exec. Vice President, 1,000(2) .001%
504 Bartram Road CFO, Treasurer,
Moorestown, NJ 08057 Secretary, Director
Kenneth P. Ray Director 6,000(3) .041%
909 Darfield Drive
Raleigh, NC 27615
Alan C. Bashforth President, CEO and 1,500,000(4) 10.32%
Le Clos D'Avranche Director
La Rue Bel-Aire
St. Mary, Jersey C.I.
- -15-
<PAGE>
Sheldon C. Hofferman Director 2,969,121(5) 20.43%
P.O. Box 350, Fairfax
Station, VA 22039
All Directors and
Officers as a Group(6) 5,262,655 36.21%
1 Based upon a total number of 14,535,649 shares outstanding as of
December 31, 1997.
2 Includes 1,700 shares owned by Mr. Keele's daughter, and 300 shares
owned by Ms. Hartman's children. The daughter of Mr. Keele has sole
voting and investment power with respect to her shares and Mr. Keele
has sole voting and investment power with respect to all other shares
in this total.
3 Has sole voting power and sole investment power with respect to the
shares owned by such person.
4 Shares in the name of Innovative Communications Technology, LTD., a
corporation, controlled by Mr. Bashforth.
5 The total includes 2,831,721 shares owned by Golden Phoenix, LTD., of
which Mr. Hofferman is General Partner.
6 In addition to the 6,000 shares owned by K. Ray, an outside Company
Director, Mr. Ray holds incentive options to acquire 30,000 shares.
Mr. Angely holds incentive options to acquire 30,000 shares in
addition to the 11,000 shares owned. In addition to the 1,000 shares
owned, Ms. Hartman holds incentive options to acquire 65,000 shares.
Mr. Hofferman, an outside Director, holds 2,000,000 warrants based
upon exercise prices of 50% of the market value of the Company's
stock on the day preceding the exercise, but in no event to exceed
$1.00 per share.
There are no arrangements known to the Company including pledges of securities,
which might, at a subsequent date, result in any change of control of the
Company.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During 1995 there were three transactions with certain related parties.
Mr. Reynolds Moulton, Jr., an owner in excess of 5% of the Company's stock,
and Mr. Sheldon Hofferman, a Company Director, purchased additional restricted
stock each in the amount of $100,000 and $25,000 respectively.
Mr. Lyndon A. Keele, then President and a Director converted the Company's
$188,600 indebtedness to him into common stock (See Note 6.B. of the 1995
10-KSB). During 1996, Golden Phoenix, L. P. of which a former member of the
Company's Board of Directors made a convertible loan in the amount of
$500,000 with warrants to later acquire company stock.
On November 7, 1996, the stockholders approved the acquisition of the
intellectual property of Innovative Communications Technology, LTD.
This acquisition entailed the issuance of 1,500,000 shares of the Company's
common stock to a Corporation controlled by Mr. Alan C. Bashforth the
President, CEO and Director of the Company. There have been no other
transactions during the last two years or any currently proposed with any
executive officers, directors, nominees for election as director or any
security holder or beneficial owner of more than five percent of the Company's
voting securities or any immediate family member of any such owner and to the
Company within the terms of 17. C.F.R. Section 228.404 (Item 404 of
Regulation S-B).
- -16-
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. FINANCIAL STATEMENTS
Report of Independent Accountants dated Feb 25, 1998........Page 20
Consolidated Balance Sheets as of December 31, 1997
and 1996....................................................Page 21
Consolidated Statements of Operations, three years ended
December 31, 1997...........................................Page 22
Consolidated Statements of Changes in Shareholders'
Equity, three years ended December 31, 1997.................Page 23
Consolidated Statements of Cash Flows, three years
ended December 31, 1997.....................................Page 24
Notes to Consolidated Financial Statements..................Page 25-32
<TABLE>
<CAPTION>
2. INDEX OF EXHIBITS
<C> <C>
Exhibit No. Description of Exhibit
----------- ----------------------
3.1(1) The Articles of Incorporation
3.2(1) By-Laws
4 Not Applicable. All relevant rights are described in Exhibit 3.1.
9 Not Applicable.
10 Not Applicable.
11 Computation of per share earnings - see Note 11 to the Financial Statements.
13 No Annual Report has yet been sent to Security Holders. The Company will send
stockholders copies of the present 10-KSB in lieu of a separate Annual Report.
18 Not Applicable.
24.1 Consent to incorporation by reference of the accountant's report dated April 11,
1995 in the S-8 Registration Statements, File Numbers 33-20687, 2-85878,
2-93126, and 2-70685.
25 Not Applicable.
28 1997 Proxy Statement
29 Not Applicable.
(1) Filed as like numbered exhibits to Registration Statement, Form S-18, File Number 33-20687, effective
April 21, 1981, incorporated by reference.
- -17-
<PAGE>
</TABLE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
SCIENCE DYNAMICS CORPORATION
BY: /s/Alan C. Bashforth
---------------------------------
Alan C. Bashforth, President, CEO
DATED: March 31, 1998
---------------------------------
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on
the date indicated.
Signature Title Date
--------- ----- ----
BY: /s/ Lyndon A. Keele Chairman of the Board of March 31, 1997
--------------------- Directors --------------
Lyndon A. Keele
BY: /s/ Alan C. Bashforth President, CEO and Director March 31, 1997
--------------------- since Nov. 7, 1996 --------------
Alan C. Bashforth
BY: /s/ Joy C. Hartman Exec. Vice President, CFO, March 31, 1997
--------------------- Treasurer, Secretary and --------------
Joy C. Hartman Director
- -18-
<PAGE>
SCIENCE DYNAMICS CORPORATION
------------
Index to Consolidated Financial Statements
Report of Independent Accountants dated Feb 25, 1998..............Page 20
Consolidated Balance Sheets as of December 31, 1997 and 1996......Page 21
Consolidated Statements of Operations, three years ended
December 31, 1997.................................................Page 22
Consolidated Statements of Changes in Shareholders' Equity,
three years ended December 31, 1997...............................Page 23
Consolidated Statements of Cash Flows, three years ended
December 31, 1997.................................................Page 24
Notes to Consolidated Financial Statements........................Page 25-32
- -19-
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Science Dynamics Corporation
We have audited the accompanying consolidated balance sheets of Science
Dynamics Corporation and Subsidiary as of December 31, 1997 and 1996 and
the related consolidated statements of operations, shareholders' equity
and cash flows for each of the three years in the period ended
December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Science Dynamics Corporation and Subsidiary as of December 31, 1997 and
1996 and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1997 in
conformity with generally accepted accounting principles.
Peter C. Cosmas Co., CPA's
400 Madison Avenue
New York, N. Y. 10017
February 25, 1998
- -20-
<PAGE>
<TABLE>
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements:
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1996
<CAPTION>
DECEMBER 31,
1997 1996
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 21,181 $ 830,229
Accounts receivable - trade 613,916 87,726
- other - 200,000
Inventories 322,530 581,277
Other current assets 52,200 42,095
----------- -----------
Total current assets 1,009,827 1,741,327
----------- -----------
Property and equipment, net 220,060 208,376
Software development costs, net of
accumulated amortization of $277,992
in 1997 and $173,745 in 1996 243,243 347,489
Deferred income taxes 308,000 308,000
Intellectual Property, net of accumulated 1,200,000 1,500,000
amortization of 300,000 in 1997
and -0- in 1996
Other assets 39,239 41,294
----------- -----------
Total assets $ 3,020,369 $ 4,146,486
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 289,188 $ 372,913
Accrued expenses, principally
payroll related 87,046 184,702
----------- -----------
Total current liabilities 376,234 557,615
Long term debt:
Long term debt payable - 500,000
----------- -----------
Total liabilities 376,234 1,057,615
Commitments:
Shareholders' equity -
Common stock - .01 par value,
25,000,000 shares authorized,
in 1997 and 1996 respectively 14,661,449 and
12,055,861 issued, 14,535,649 and 11,930,061
outstanding in 1997 and 1996 respectively 146,614 120,558
Additional paid-in capital 10,166,429 9,615,191
(Deficit) (7,271,075) (6,249,045)
----------- -----------
3,041,968 3,486,704
Common stock held in treasury,
at cost (397,833) (397,833)
----------- -----------
Total shareholders' equity 2,644,135 3,088,871
----------- -----------
Total liabilities and shareholders' Equity $ 3,020,369 $ 4,146,486
=========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
</TABLE>
- -21-
<PAGE>
<TABLE>
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements (Continued):
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
NET SALES $ 4,393,552 $ 5,562,272 $ 6,722,592
Operating costs and expenses:
Cost of sales 1,969,837 3,555,984 3,712,683
Inventory obsolescence write off - 449,062 -
Research and development 1,293,608 934,260 984,567
Selling, general
and administrative 2,138,408 2,164,784 2,891,487
----------- ---------- -----------
5,401,853 7,104,090 7,588,737
----------- ---------- -----------
Operating (loss) (1,008,301) (1,541,818) (866,145)
Other income (expenses):
Interest and other
investment income 15,673 12,441 -
Interest expense (29,402) (88,970) (68,811)
----------- ---------- -----------
Net (loss) $(1,022,030) $(1,618,347) $ (934,956)
============ ============ ============
Net (loss) per common share $ (0.08) $ (0.18) $ (0.16)
The accompanying notes are an integral part of
these consolidated financial statements.
</TABLE>
- -22-
<PAGE>
<TABLE>
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements (Continued):
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating
activities:
Net (loss) $ (1,022,030) $ (1,618,347) $ (934,956)
------------ ------------ ----------
Adjustments to reconcile
net (loss) to net cash
(used for) operating activities:
Depreciation 68,573 59,041 102,287
Amortization of
capitalized software 104,246 171,456 148,114
Amortization of
intellectual property 300,000 - -
Other non-cash expense 29,402 - -
Changes in operating assets
and liabilities:
(Increase) decrease in:
Accounts receivable (526,190) 395,916 182,803
Other Receivables 200,000 - -
Inventories 258,747 645,319 (90,862)
Other current assets (10,105) 144,721 (128,938)
Other assets 2,055 (2,238) (12,566)
(Decrease) in:
Accounts payable and
accrued expenses (133,489) (383,248) (536,162)
------------ ------------ ----------
Total adjustments 293,239 1,030,967 (335,324)
Net cash (used for)
operating activities: (728,791) (587,380) (1,270,280)
------------ ------------ ----------
Cash flows from investing
activities:
Capitalized software - - (83,219)
Purchase of property and
equipment - net (80,257) (24,379) (225,247)
------------ ------------ ----------
Net cash (used) in
investing activities (80,257) (24,379) (308,466)
------------ ------------ ----------
Cash flows from financing
activities:
Increase (decrease) in
notes payable - 455,873 (290,300)
Issuance of common stock
and warrants - 963,489 1,889,410
------------ ------------ ----------
Net cash provided
by financing activities - 1,419,362 1,599,110
------------ ------------ ----------
Net increase (decrease) in
cash and cash equivalents (809,048) 807,603 20,364
Cash and cash equivalents -
beginning of period 830,229 22,626 2,262
------------ ------------ ----------
Cash and cash equivalents -
end of period $ 21,181 $ 830,229 $ 22,626
============ ============ ==========
The accompanying notes are an integral part of these
consolidated financial statements.
</TABLE>
- -23-
<PAGE>
<TABLE>
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements (Continued):
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE THREE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<CAPTION>
Common Stock Additional Retained
------------ Paid-In Earnings
Shares Amount Capital (Deficit) Shares Amount
------ ------ ------- --------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Balance
December
31, 1994 $ 4,443,274 $ 44,433 $ 5,102,544 $ (3,695,742) 125,800 $ 397,833
Common stock
issued 3,605,504 36,055 1,853,355 - - -
Net loss - - - (934,956) - -
----------- ---------- ----------- ------------ ------- ---------
Balance
December
31, 1995 8,048,778 80,488 6,955,899 (4,630,698) 125,800 397,833
Issuance of common
stock and warrants 2,047,083 20,470 943,019 - - -
Issuance of common
stock for acquisition of
intellectual property 1,500,000 15,000 1,485,000 - - -
Issuance of common
stock to pay note
payable to investment
company 460,000 4,600 231,273 - - -
Net loss - - - (1,618,347) - -
----------- ---------- ----------- ------------ ------- ---------
Balance
December
31, 1996 12,055,861 120,558 9,615,191 (6,249,045) 125,800 397,833
Issuance of common
stock to pay long term
debt and related interest 2,605,588 26,056 551,238 - - -
Net loss - - - (1,022,030) - -
----------- ---------- ----------- ------------ ------- ---------
Balance
December
31, 1997 14,661,449 $ 146,614 $10,166,429 $ (7,271,075) 125,800 $ 397,833
The Company issued 2,047,083 and 3,605,504 shares of its common stock in 1996 and 1995 respectively.
Proceeds to the Company totaled $963,489 and $1,889,410 net of expenses associated with the offering
in 1996 and 1995 respectively. The proceeds were used to improve the Company's cash condition and to
fund its operating deficit.
The accompanying notes are an integral part of
these consolidated financial statements.
</TABLE>
- -24-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1) Summary of Significant Accounting Policies:
a) Principles of Consolidation:
The consolidated financial statements include the Company's
wholly-owned subsidiary. All intercompany transactions have been
eliminated in consolidation.
b) Organization and Description of Business:
The Company, which was incorporated in May, 1973 and commenced
operations in July 1977, is engaged in the design, development,
integration and marketing of advanced telecommunications products and
applications. All the Company's operations are considered to be in
one industry.
c) Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles require management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting periods. Actual results
could differ from those estimated.
d) Inventories:
Inventories are stated at the lower of cost or market, with cost
determined on a first-in, first-out basis.
e) Property and Equipment:
Property and equipment are stated at cost. Depreciation of property
and equipment is computed generally using the straight-line method
based on estimated useful lives of five years for machinery and
equipment and seven years for furniture and fixtures. Leasehold
improvements are amortized over the life of the related lease or
their estimated useful lives, whichever is shorter, using the
straight-line method. Costs of major additions and betterment's are
capitalized; maintenance and repairs which do not improve or extend
the life of respective assets are charged to expense as incurred.
When an asset is sold or otherwise disposed of, the cost of the
property and the related accumulated depreciation is removed from
the respective accounts and any resulting gains or losses are
reflected in income.
f) Cash and Cash Equivalents:
The Company considers all highly liquid debt instruments purchased
with a maturity of three months or less to be cash equivalents.
The Company did not pay income taxes in 1997, 1996 and 1995. Cash
paid for interest was $68,811 in 1995, 88,970 in 1996 and $ 0 in 1997.
- -25-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
g) Software Development Costs:
Software development costs are capitalized in accordance with
Statement of Financial Accounting Standards (SFAS) No. 86. As of
December 31, 1997, capitalized software development costs, net of
amortization were $243,243. The capitalization of these costs
begins when a product's technological feasibility has been
established and ends when the product is available for general
release to customers. Amortization is computed on an individual
product basis and is the greater of: (a) the ratio of current gross
revenues for a product to the total current and anticipated future
gross revenues for that product or (b) the straight-line method over
the estimated economic life of the product. Currently the Company is
using an estimated economic life of five years for all capitalized
software costs. The amount of software development costs capitalized
was $ 0 in 1997 and 1996 and $83,219 in 1995. The amortization was
$104,246 in 1997, $171,456 in 1996, and $148,114 in 1995.
h) Income Taxes:
The Company elected to adopt the provisions of Statement of Financial
Accounting Standards No. 109 "Accounting for Income Taxes", (SFAS 109)
in 1992. Under SFAS 109, deferred income taxes are recognized for the
tax consequences in future years of differences between the tax basis
of assets and liabilities and their financial reporting amounts at each
year end based on enacted tax laws and statutory tax rates applicable
to the periods in which the differences are expected to affect taxable
income. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount expected to be realized. Income tax
expense (credit) is the tax payable (receivable) for the period and the
change during the period in deferred tax assets and liabilities.
Prior years' financial statements have not been restated for the
accounting change (see Note 6).
i) Revenue Recognition:
Sales and related cost of sales are recognized upon shipment.
j) Impairment of Long-Lived Assets:
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 121, Accounting for the impairment of
Long-Lived Assets and for Long-Lived Assets to be disposed of. SFAS
No. 121 requires the Company to review the recoverability of the
carrying amount of its long-lived assets whenever events or changes
in circumstances indicate that the carrying amount of an asset might
not be recoverable.
In the event that facts and circumstances indicate that the carrying
amount of long-lived assets may be impaired, an evaluation of
recoverability would be performed. If an evaluation is required, the
estimated future undiscounted cash flows associated with the asset
would be compared to the assets' carrying amount to determine if a
write-down to fair value is required. Fair value may be determined
by reference to discounted future cash flows over the remaining useful
life of the related asset. Such adoption did not have a material
effect on the Company's consolidated financial position or results of
operations.
- -26-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
k) Fair Value Disclosures:
The carrying amounts reported in the Consolidated Balance Sheets for
cash and cash equivalents, accounts receivable, accounts payable and
accrued expenses, approximate fair value because of the immediate or
short-term maturity of these financial instruments.
l) Stock Options:
The Company accounts for its stock options in accordance with the
provisions of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations.
As such, compensation expense would be recorded on the date of grant
only if the current market price of the underlying stock exceeded the
exercise price. On January 1, 1996, the Company adopted the
disclosure requirements of Statement of Financial Accounting Standards
(SFAS) No. 123, Accounting for Stock-Based Compensation. Had the
Company determined Compensation Cost based on fair value at the grant
date for stock options under SFAS No. 123 the effect would have been
immaterial.
m) Effect of New Accounting Pronouncements:
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information." SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components in a
full set of general-purpose financial statements. The Company will be
required to comply with the requirements of SFAS No. 130 for the year
ending December 31, 1998. SFAS No. 131 establishes revised guidelines
for determining an entity's operating segments and the type and level
of financial information to be disclosed. It requires entities to
report segment information in quarterly reports issued to shareholders.
The Company will be required to comply with the requirements of SFAS
No. 131 for the year ending December 31, 1998. The Company believes
that the implementation of these statements will not have a significant
impact on the nature of information disclosed in the financial
statements.
2) Accounts Receivable:
The Company evaluates its accounts receivable on a customer by customer
basis and has determined that no allowance for doubtful accounts is
necessary at December 31, 1997 and 1996.
- -27-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3) Inventories:
Inventories consist of the following:
1997 1996
---- ----
Raw materials $ 88,242 $ 156,012
Work in process 61,999 36,438
Finished goods 172,289 388,827
------- -------
Totals $322,530 $ 581,277
4) Property and Equipment:
A summary of the major components of property and equipment is as follows:
1997 1996
---- ----
Computers, fixtures and equipment $ 1,256,652 $ 1,229,210
Leasehold improvements - 1,245
--------- ---------
1,256,652 1,230,455
Less accumulated depreciation and
amortization (1,036,592) (1,022,079)
Totals $ 220,060 $ 208,376
5) Long - Term Debt:
The $500,000 15% secured convertible note, along with accrued interest
of $77,294, was converted into 2,605,588 restricted shares of the
Company's Common Stock.
6) Income Taxes:
In 1992, the Company adopted Statement of Financial Accounting Standards
No. 109, Accounting for Income Taxes. Under the provision of SFAS No. 109,
the Company elected not to restate prior years due to immateriality.
In 1992, the effect of the change was to decrease the net loss by $308,000
(.10 per share). The deferred tax asset recognized in the accompanying
balance sheet at December 31, 1997 and 1996 is $308,000.
At this time, the Company does not believe it can reliably predict
profitability for the long-term. Accordingly, the deferred tax asset
applicable to 1997 and 1996 operations has been reduced in its entirety by
the valuation allowance. However, the Company believes it is more likely
than not that it will realize the net deferred tax asset based upon the
Company's future profitability and therefore not necessary to reduce the
deferred tax asset of $308,000 that resulted from the 1992 operations.
- -28-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As a result of the operating losses for the years ended December 31, 1990
and 1992 - 1997 the Company has available to offset future taxable income
a net operating loss of $8,361,058 expiring 2005 - 2012. In addition,
research credits expiring 2005 - 2012 are available to offset future taxes.
The components of the provision (credit) for income taxes from continuing
operations is as follows:
1997 1996 1995
---- ---- ----
Deferred
Federal $ - $ - $ -
Current
Federal - - -
State - - -
------- ------- -------
$ - $ - $ -
------- ------- -------
Differences between the tax provision computed using the statutory federal
income tax rate and the effective income tax rate on operations are as
follows:
1997 1996 1995
---- ---- ----
Federal statutory rate $(347,490) $(550,238) $(317,885)
Research tax credits - - -
Tax benefit not provided due
to valuation allowance 347,490 550,238 317,885
Surtax exemptions, net - - -
Other - - -
------- ------- -------
$ - $ - $ -
------- ------- -------
Components of the Company's deferred tax assets and liabilities are as
follows:
December 31,
1997 1996
Deferred tax assets:
Tax benefits related to net operating
loss carryforwards and research
tax credits $2,792,281 $2,444,791
---------- ----------
Total deferred tax assets 2,792,281 2,444,791
Valuation allowance for
deferred tax assets 2,484,281 2,136,791
---------- ----------
Net deferred tax assets $ 308,000 $ 308,000
- -29-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7) COMMITMENTS
a) Leases
The company leases their office, sales and manufacturing facilities and
certain vehicles under non-cancelable operating leases with varying
terms. The leases generally provide that the Company pay the taxes,
maintenance and insurance expenses related to the leased assets.
Future minimum lease payments required under operating leases that have
initial or remaining non-cancelable lease terms in excess of one year,
as of December 31, 1997 are as follows:
1998 $ 211,116
1999 195,093
2000 191,941
2001 195,295
2002 197,760
After 2002 461,440
-------
Total minimum lease payments $1,452,645
----------
Rent expense for the years ended December 31, 1997, 1996 and 1995 was
$197,769, $190,365 and $181,899 respectively.
b) Employment Agreements:
The Company maintains employment agreements with three officers, two of
whom are also directors of the Company. The employment agreements
contain change in control provisions that would entitle each of the
three to receive up to 2.99 times their annual salary if there is a
change in control in the Company (as defined) and a termination of
their employment. The maximum contingent liability under these
agreements in such event is approximately $ 980,000.
8) Intangible Assets:
On November 7, 1996, the Company acquired "Intellectual Property", issuing
1,500,000 shares of its common stock. Based on technical reviews of the
property and the business potential of the technology, the Company valued
the "Intellectual Property" at $1,500,000. The Company began amortizing
the property on January 1, 1997 over a period of five years. The
amortization for 1997 amounted to $300,000.
Subsequent to the transaction on November 7, 1996 the seller's President
Alan C. Bashforth became President and Chief Executive Officer at a
management fee of $160,000 per year. In addition, there are warrants to
be earned over the next five years on a formula based on profits.
- -30-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9) Stock Options and Warrants:
On April 27, 1992, the shareholders approved the adoption of a successor
Incentive Stock Option Plan encompassing 200,000 shares, excluding 90,950
that had not been subject to grants under the initial Plan. To date, net
option grants with respect to 184,500 have been awarded, with 299,075
shares remaining available for future awards.
During 1997 a total of 62,000 shares were awarded, sixteen individuals
participated in the Plan as a result of grant of options awarded. The
share price of options on award ranged from $0.81 to $0.88 utilizing
the market price of shares on date of award. To date, 78,425 shares
have been exercised. No options have been awarded nor can be awarded
at less than market value at the time of grant.
As allowed by FASB 123, the Company has elected to continue to follow
Accounting Principles Board Opinion No. 25, "Accounting For Stock Issued
to Employees" (APB25) in accounting for its stock option plans. Under
APB 25, the Company does not recognize compensation expense on the
issuance of its stock options because the option terms are fixed and the
exercise price equals the market price of the underlying stock on the
grant date.
As required by FASB 123, the Company has determined the pro-forma
information as if the Company had accounted for stock options granted
since January 1, 1996, under the fair value method of FASB 123. An
option pricing model similar to the Black-Scholes was used with the
following weighted average assumptions used for grants in the year 1997
and 1996, respectively: expected volatility of 80 percent; risk free
interest rate of 6% and 5.5% respectively and expected lives of 5 years.
The pro-forma effect of these options on net earnings was not material.
These pro-forma calculations only include the effects of 1996 and 1997
grants. As such, the impacts are not necessarily indicative of the
effects on reported net income of future years.
Warrants to acquire 270,000 shares are exercisable at $0.78. In
addition, there are warrants to acquire 2,000,000 shares exercisable
through April 30, 2002 at an exercise price based on 50% of the market
value of the Company's stock on the day preceding the exercise date, but
in no event to exceed an exercise price of $1.00 per share.
10) Major Customers:
During 1997, three customers and their operating subsidiaries accounted
for 88.7%, 4.3% and 3% of total sales. During 1996, three customers and
their operating subsidiaries accounted for 84.3%, 9.7% and 3% of total
sales. During 1995, three customers and their operating subsidiaries
accounted for 54.5%, 19.4& and 12.3% of total shares.
- -31-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11) Earnings (Loss) Per Share:
In February 1997, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards ("SFAS") No. 128.
"Earnings Per Share" applicable for financial statements issued for
periods ending after December 15, 1997. As required the Company adopted
"SFAS" No. 128 for the year ended December 31, 1997 and restated all
prior period earnings per share figures. The Company has presented
basic earnings per share. Basic earnings per share excludes potential
dilution and is calculated by dividing income available to common
stockholders by the weighted average number of outstanding common shares.
Diluted earnings per share incorporates the potential dilutions from all
potentially dilutive securities that would have reduced earnings per
share. Since the potential issuance of additional shares would reduce
loss per share they are considered anti-dilutive and are excluded from
the calculation. The potential common stock that was excluded from the
calculation because it was antidilutive amounted to 1,000,000 shares.
The weighted average number of shares used to compute basic earnings
(loss) per share was 13,590,656 in 1997, 8,937,044 in 1996 and 5,756,183
in 1995.
- -32-
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<PERIOD-END> DEC-31-1997
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0
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