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, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
For the transition period from ______________ to ______________
Commission file number 010690
____________________
Science Dynamics Corporation
-------------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
Delaware
------------------------------------------------------------
(State or other jurisdiction of incorporation)
22-2011859
-------------------------------
(IRS Employer Identification No.)
1919 Springdale Road, Cherry Hill, New Jersey 08003-1069
----------------------------------------------------------
(Address of principal executive offices)
609-424-0068
--------------------------------------------------
(Registrant's telephone number, including area code)
None
----------------------------------------------------------
(Securities registered pursuant to Section 12(b) of the Act)
Common Stock Par Value $0.01 Per Share
--------------------------------------
Title of Class
----------------------------------------------------------
(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
Form 10-KSB or any amendment to this Form 10-KSB [X]
State issuer's revenues for its most recent fiscal year: $4,352,606.
The number of shares of Common Stock outstanding as of December 31, 1998, was
15,735,649 shares.
The aggregate market value of voting stock of the registrant held by
non-affiliates as of December 31, 1998, was approximately $4,516,747.
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
August 1999, 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
- ----------------
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. In November 1996, the Company acquired the intellectual
property of Innovative Communications Technology (ICT) and under the
direction of the new CEO/President embarked on transforming the Company into
a predominately software design and system integration Company.
Over the past two years, the challenge was to expand the product offerings and
migrate into additional markets within the Computer Telephony Integration
(CTI) industry. The Company believes that communicating via packet networks
such as ATM and Frame Relay, is becoming the preferred strategy for both
public networks and business enterprises. The Company's focus is to address
niche market opportunities in Data Network Companies, Telephone Service
Distributors and Regional Bell Operating Companies (RBOC's), such as
BellSouth, Ameritech, US West, Southwestern Bell and large independent
telephone operating companies, such as GTE, Sprint and Citizens.
The Company's development is driven by user needs for cost effective, easy to
use multiservice products that provide an array of telecommunications
solutions and services to the customers. These opportunities are primarily
in the areas of Voice over Internet Protocol, Inmate Systems, Video over
Frame Relay, 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
- --------------------
Science Dynamics has focused its strategy to be a provider of key enabling
technologies required for the convergence of traditional and new
communications media and infrastructures.
Communications media today must include traditional Telephony (an area for
which Science Dynamics has 21 years experience), Data services (to include
the Internet) and Video services. Current infrastructures based on PDH
(Plesiochronous Digital Hierarchy) technology are quickly being replaced with
SDH (Synchronous Digital Hierarchy) technologies more suited to larger
bandwidth packet data transmissions.
Management believes communicating via packet data networks such as IP
(Internet Protocol), ATM (Asynchronous Transfer Mode), and Frame Relay is
becoming a preferred strategy for both corporate and public network planners.
Predictions have been made that data traffic will soon exceed telephone
traffic. At the same time, more and more companies are seeing the value of
transporting voice and fax over data networks to reduce telephone and
facsimile costs and to set the stage for advanced multimedia applications.
IP's ability to run over any network medium has led to its widespread
adoption around the world. Its popularity, though, goes far beyond the
Internet, to encompass the majority of data networks worldwide.
Providing high quality telephony over IP networks is one of the key steps in
the convergence of voice, fax, video, and data communications services.
- -2-
<PAGE>
Science Dynamics has now proven IP Telephony to be both feasible and cost
effective with several customer trials. New products, such as the
IntegratorC-2400(r) Gatekeeper, will continue to play a very important role in
positioning SDC in this fast growing market.
PRODUCTS
- --------
IP Telephony
Interconnection of the Internet / Intranet to the PSTN or a private PBX, can
be accomplished using a gateway. An IP Telephony based telephone / PC, for
example, would have access to the public network by calling through a gateway
closest to the destination, minimizing long distance charges.
Science Dynamics' IntegratorC-2100(r), IntegratorC-2300(r) and
IntegratorC-2500(r) H.323 compliant IP telephony gateway products provide
the following functions:
- - Interfacing with a PBX, the PSTN, or another telephone connection
- - Basic call processing functions (call setup/tear down, etc.)
- - Real-time voice compression and decompression
- - Packetizing and unpacketizing the compressed voice
- - Interfacing with the IP network
In addition, the IntegratorC-2X00(r) series of IP Telephony gateways also
provides other functions, such as an interactive voice response (IVR)
interface to initiate calls, billing interfaces, etc.
Science Dynamics new IntegratorC-2400(r) H.323 compliant gatekeeper product
will become the intelligent hub for IP telephony networks as well as the
platform for advanced services.
The IntegratorC-2400(r)'s primary role is to provide call control services for
registered H.323 endpoints.
It performs the following call control functions:
- - Call control and routing
- - Address resolution & dialing plan management
- - Basic telephony services such as directory services and PBX functions
- - Controlling H.323 bandwidth usage to provide a QoS (Quality of Service)
- - Total network usage control
- - Injection of overall system administration and security policies
Science Dynamics will continue to develop this portfolio of IP Telephony
products, adding new features and focusing on new services at each stage.
Video over Frame Relay
The most common means of videoconferencing is to use a "circuit switched"
network, typically ISDN, supplied by the local telco. Although this seems
an obvious choice, it may not be the most cost effective due to certain
technical issues relating to the transmission of continuous data streams
such as, compressed video.
Transmission of video over a "packet based" network (such as the Internet),
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 due to more efficient usage of the
bandwidth. Frame Relay is a standardized "packet based" method (protocol)
for transmission of data.
- -3-
<PAGE>
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 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 VFX-250S product has gone
through much development in 1998, with the current version 2.1, including
many new features.
In addition, 1998 saw the new version of the VFX-240S (soon to be available)
targeted at the 128Kbps ISDN market place with lower delays and lower costs
than its more powerful brother, the VFX-250S.
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.
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.
During the latter part of this year the company received several orders
for its newly engineered VRS Centralized Intelligent Management System (CIMS-
II). The CIMS-II is a WindowsNT host platform that communicates with client
workstations in managing multiple VRS remote locations from a central point.
The CIMS systems were deployed by a large independent telephone company for
managing changed number referral and messaging for over 300 VRS's located in
remote central office locations across the United States.
The VRS and CIMS products are Y2K compliant.
- -4-
<PAGE>
Commander Inmate Telephone Control System (ITCS)
The Commander product lines are based on the Company's new IntegratorC-2000(R)
platform. This open system 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 using the
Commander system software.
The Commander I products are generally wall mounted platforms that have been
designed for the small to mid sized municipal and county correctional
facilities requiring control for up to 40 inmate telephone lines. The
Commander I base system provides telephone control for 4 lines and can be
expanded in 4 line increments. This modular design provides a cost effective
solution with an abundance of inmate phone control features.
Commander II platforms are generally rack mounted and can house up to 96
inmate telephone lines. Multiple platforms can be daisy-chained for systems
requiring control of more than 96 lines. The company has configured and
installed several 432 line Commander ITCS during 1998.
The Commander I and II systems can be configured using one or more
AdminManager workstations. The AdminManager provides real-time administration
of the Commander system through an Ethernet Local Area Network (LAN) or
a Wide Area Network (WAN).
The Commander product lines are Y2K compliant.
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 to
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 IntegratorC-2000(r). This product provides the
foundation for hosting applications for various Telephony and transaction
oriented processes. Currently the IntegratorC-2000(r) can host existing
Company products such as the Commander family of inmate products, the
IntegratorC-2000(r) series of IP Telephony Servers, and the IVAP Intelligent
Voice Announcer Platform. Management believes that the product design
strategy will keep the Company competitive in the emerging Internet Telephony
market.
INTEGRATION OF PRODUCTS
- -----------------------
The Company's primary effort is the software design of products, limited
hardware design and system integration of purchased products. The Company
purchases OEM equipment then integrates its custom software providing quality
solutions for the industry. The purchasing philosophy has been to establish
relationships with industry leaders in the Networking, Telecom and PC
environments providing quality modules and sub-systems and prompt delivery and
service.
Using a material requirement planning process, the Company is generally 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 and performing final system
test and inspection.
- -5-
<PAGE>
The Company's products are primarily produced to order. 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 most customers' requirements.
SOURCES AND AVAILABILITY OF MATERIAL
- ------------------------------------
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
- -------------------
The Company sells its products through its direct sales force in the United
States and internationally through 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
- ----------------------
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 plans to devote a
substantial portion of its resources to research and development and to
continue utilizing subcontractors to enhance the engineering staff.
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
continue to expand its product offerings to include additional products in
Telephony, Voice-Over-IP and Data Communications.
INTELLECTUAL PROPERTY
- ---------------------
It is the Company's practice to apply for patents as new products or
processes appropriate for patent protection as 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 was received in June 1998. The Company
holds other patents related to some of its other products. No assurance can
be given as to the scope of the patent protection.
- -6-
<PAGE>
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
- ----------------
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
- --------
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.
Frost & Sullivan predicts that the total IP telephony equipment market will
have a compound annual growth rate of nearly 150% for the next few years,
reaching $1.89 billion by the year 2001. It is also expected that IP
Telephony will be deployed by 70% of the Fortune 1000 companies by the year
2000.
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
- -----------
Due to the diversified nature of the products and target markets, Science
Dynamics competition varies greatly by product line. Inmate products division
holds a respectable 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. The Company has limited competition in
the Video-Over-Frame market. This includes an integrated Frame Relay
Codec, an ISDN over Frame Relay product which is very expensive and the use of
H.323 packetized LAN Video, a different concept which crosses into our
market.
- -7-
<PAGE>
The IP products division is marketing and conducting international trials
supported by the team that developed the IntegratorC2000(r) series. These IP
products will compete in a marketplace that is populated by larger companies
who have significantly more resources for development, marketing and
deployment. The number of companies involved with IP Telephony Gateways has
risen from about twenty last summer to nearly one hundred currently. The
Company's IP product is a more intelligent offering than some of the
competitors but the industry outlook could rapidly become a cost per port
arena.
CUSTOMERS
- ---------
The major customers in 1998 were independent and Bell Operating Companies
with three customers accounting for 82.95%, 4.69% and 3.45% 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
- ---------
As of December 31, 1998, the Company employed 26 persons on a full time
basis. The Company supplements full-time employees with subcontractors and
part-time individuals, consistent with workload requirements.
GOVERNMENT APPROVAL
- -------------------
The Federal Communications Commission (FCC) requires that some of the
Company's products meet Part 15 and Part 68 of the code of Federal Regulations
(CFR). Part 15 (subpart B) 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
requiring approval.
COMPLIANCE WITH ENVIRONMENTAL LAWS
- ----------------------------------
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 about
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 freestanding masonry building in an industrial park in Cherry Hill, New
Jersey, utilized for office space and test of its products and other corporate
activities. In the latter part of 1998, the Company subleased 25,645 square
feet of the building to a printed circuit board manufacturer. It is
anticipated that the leasee will eventually require the entire area and SDC
will relocate to a smaller suitable office facility.
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
or otherwise.
- -8-
<PAGE>
PART II
ITEM 5. MARKET FOR THE COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Registrant's Common Stock is traded on the Over the Counter Bulletin Board
(BBOTC:SIDY) effective February 18, 1999. The 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,
1997 and December 31, 1998 were as follows:
Calendar Quarter High Bid Price Low Bid Price
---------------- -------------- -------------
1997
----
First $1.8750 $.6875
Second .9687 .5625
Third 1.0937 .7187
Fourth 1.1250 .5000
1998
----
First $.8437 $.5312
Second 1.1562 .6875
Third .9687 .5000
Fourth .6562 .4062
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, 1998, 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.
Effective February 23, 1998, the NASDAQ Stock Market 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. The Company was notified by The Nasdaq
Stock Market that effective with the close of business Feb. 18, 1999, the
company's securities were delisted from the Nasdaq SmallCap Market. The
company's securities are trading on the Over the Counter Bulletin Board.
Although the management of the company was disappointed in the decision, the
move from the Nasdaq SmallCap market has not had a significant impact on the
trading of the stock. The Company will continue to implement the business
strategy and focus on the growth of the Company to enhance stockholder value.
- -9-
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL BUSINESS OVERVIEW
The Company's net sales for the year ended December 31, 1998 were $4,352,606
a decrease of $40,947 from sales of $4,393,553 for the year ended December 31,
1997. The Company's revenue in 1998 was principally derived from the
Commander Product Line and a portion from the VFX-250S product line. The
modestly weaker results were primarily due to the delayed recognition of the
VFX-250S product line resulting in lower than anticipated sales results. The
strategy for 1998 was to generate sales from the Commander Product as well as
the VFX-250S Products while continuing the development effort in the IP
Telephony Product line. Although the sales of the VFX-250S did not reach the
anticipated level, the market awareness of the functionality and quality of
the product has been recognized. In an independent evaluation of
videoconferencing via frame relay technology equipment, Network Computing
Magazine's Editor's Choice was awarded to the Memotec CX900e system which
uses the Science Dynamics VFX-250S device. This recognition in the
marketplace, the continuing sales and marketing efforts expended by the sales
team and the further development of the new version VFX-240S to be released
shortly is expected to result in a base line source of revenue in the coming
years.
Intensive development efforts have been expended this past year in the IP
Telephony product based on the IntegratorC-2000(r) platform. Advances in
public and private IP-based networks now enable businesses to use the
Internet Protocol to by-pass the Public Switched Telephone Network for
national and international long distance voice, fax, and video
communications. This provides businesses with a method to reduce
their telecommunication expenses. The IntegratorC-2000(r) platform for IP
telephony takes voice and fax communication and converts them into data
packets, allowing international phone calls and faxes to be transported over
IP networks at very high quality and low cost.
During the past year the company has gained considerable knowledge and
experience in enhancing the development of the system for IP Telephony. The
Company has installed several trial systems and revised its understandings
and implementations of the products accordingly. The latest H.323 standards
have been added to these systems. This will lead to interoperability testing
with other vendors during 1999. The Company experienced technical success in
the trial systems installed during the latter part of the year. Management
believes that the penetration of the IP Telephony will provide significant
growth potential
The Company is continuously exploring new niche opportunities, introducing
new products and marketing and sales initiatives to increase market share and
share of customer; and actively pursuing business alliance candidates that
complement or support the Company's core competencies.
YEAR 2000 PROBLEM
The Year 2000 issue arises because many computerized systems use two digits
rather than four to identify a year. Date-sensitive systems may recognize the
Year 2000 as 1900 or some other date, resulting in errors when information
using Year 2000 dates is processed. In addition, similar problems may arise
in some systems, which use certain dates in 1999 to represent something other
than a date. The effects of the Year 2000 issue may be experienced before,
on, or after January 1, 2000, and financial reporting may range from minor
errors to significant systems failure, which could affect an entity's ability
to conduct normal business operations. It is not possible to be certain that
all aspects of the Year 2000 issue affecting the Company, including those
relating to the efforts of Customers, Suppliers, or other third parties will
be fully resolved
- -10-
<PAGE>
The Company's investigation of the Year 2000 problem has been ongoing for
sometime. Employees have accomplished all present efforts, therefore no out
of pocket costs have been expended with exception of minimal telephone
charges, stationary, stamps, etc. It is estimated that various employees
have expended on the order of 250 man-hours through 1998 Fiscal Year. No
attempt has been made to capture those expended hours since the Year 2000
effort is considered an overhead function and entails no added employees or
facilities.
The evaluation of the company's products to date has found only one installed
product that is not compliant due to a purchased integrated circuit (I.C.).
This IC has been discontinued and the manufacturer will not provide a
replacement. The discontinued I.C. is designed into multiple circuits and
the cost of retrofit to the older systems is cost prohibitive. Efforts to
date have entailed working with customers to determine if older installations
are still in service. At this juncture the problem appears to be of minor
significance, since the systems are years old and outdated by today's
technology.
The next orderly step presently ongoing is additional attention to:
1. Suppliers. There are only six major suppliers that could cause
significant problems for the Company. Three certificates of
compliance have been obtained with the other three in process.
Selective involved electronic component suppliers consisting
primarily of integrated circuits have been contacted for
certificates of compliance (COC) to Y2K. Notification on selective
purchase orders has been included stating that items will not be
accepted without a COC.
2. Utilities. Primarily electric, gas, water, and telephone services
are being monitored to insure that no interruption of services will
be experienced. The backup plan is to replace, if possible, those
suppliers not supplying a COC for Y2K.
3. Office equipment, etc. While these providers do not directly
affect the Company's products, they do affect the ability to
operate in an efficient manner. Certificates have been received
from suppliers such as postage meter, carriers, duplicator, etc.
4. Company Software. A Compliance Test Plan for the Company's new
system has been defined with testing in process with completion
scheduled by June 1999. Should any suppliers from Item 1. above
not prove to meet Y2K, a replacement will be selected.
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,
1998 1997
---- ----
Sales $4,352,606 $4,393,553
Net Loss $(1,036,306) $(1,022,029)
Net Loss Per Share $(0.07) $(.08)
- -11-
<PAGE>
OPERATING EXPENSES PERCENT OF SALES
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
Cost of Goods Sold $1,694,557 $1,969,837 38.9% 44.8%
Research & Development 1,219,687 1,293,608 28.0% 29.4%
Selling, General & Admin 2,470,534 2,138,408 56.8% 48.7%
Total Operating Costs
and Expenses $5,384,778 $5,401,853 123.7% 122.9%
Sales for the fiscal year ended December 31, 1998 were $4,352,606 compared to
sales of $4,393,553 in the 1997 fiscal year.. The primary factor that
affected the sales performance was the slower than anticipated ramp up of
interest in the VFX-250S product. Over the past year, the Company has devoted
substantial time and effort researching and developing the Voice over IP
product line, the new version VFX-240S and enhancements to the inmate system
to reduce the dependence on a single product and/or customer.
Research and Development expenses in 1998 decreased 5.71% to $1,219,687
compared to $1,293,608 in 1997, a decrease of $73,921. The decrease is
attributable to the reduced overhead expenses as a result of the leasing of a
portion of the facility and the natural attrition of human resources.
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.
The selling, general and administration expenses increased 15.5% as a
percentage of sales and increased in absolute dollars to $2,470,534 in 1998,
from $2,138,408 in 1997. The increase in selling, general, and
administrative was primarily due to the costs of operating the international
sales office, increased advertising costs to promote the company and its
products in the marketplace and the overall increase of personnel related
costs.
The 1998 net loss increased $14,277 to $1,036,306 from $1,022,029. The
increase in the loss was the result of weaker than expected sales
performance of the VFX-250S.
LIQUIDITY & CAPITAL RESOURCES
Net cash used for operating activities for the years ended December 31,
1998 and 1997 was 578,177 and $728,791 respectively. The use of cash in
operating activities in 1998 resulted primarily from the net loss, the
increase in receivables offset by the increase in accounts payable and
accrued expenses.
Net cash used in investing activities was $85,755 in 1998 and $80,257 in
1997. The increase in cash used for investing activities in 1998 was
primarily attributable to capital expenditures for the purchase of
software tools and computer related equipment for development of the
Company's current and new products. The Company expects to increase its
capital expenditures incrementally to maximize development efforts of new
products and applications. The Company had no significant commitments as
of December 31, 1998 for capital expenditures.
Net cash provided by financing activities in 1998 was $675,000. The
first financing arrangement was the accounts receivable purchase
agreement in which CIT Group/Commercial Services will advance 60% funding
of the accounts receivable balance at an interest rate equal to the
greater of the sum of one percent plus the Chase Prime Rate or six
percent per annum. The factoring fee for this service is six-tenths of
one percent of the gross face amount of all accounts factored with CIT up
to $4,000,000 and thirty hundreds of one percent of the accounts in
excess of $4,000,000. This financing vehicle will assist in providing
consistent cash flow.
- -12-
<PAGE>
During December 1998, the Company initiated a private placement offering
for the issuance of two million shares of Common Stock, pursuant to which
one million two hundred thousand shares were sold. The Company received
net proceeds of $575,000 dollars. The Company is in the process of
placing the remaining 800,000 shares. All such proceeds have and will be
used to fund product development, sales, and the Company's general
operating expenses.
At December 31, 1998, the Company had $32,249 in cash and cash
equivalents and $563,327 in working capital, compared with $21,181 in
cash and cash equivalents and $633,593 in working capital at December 31,
1997. Current liabilities at December 31, 1998 were $919,985, 245% more
than current liabilities of $376,234 at December 31, 1997. The $543,741
increase is attributable to the increase in accounts payable in material
purchased for projected orders that were delayed, the outstanding balance
owed to CIT on the accounts receivable purchase agreement and the accrued
payroll which was paid subsequent to the year end.
The Company believes that the forecasted sales generating cash flow from
operations, together with funds generated in the private placements will
be sufficient to finance the Company's operations and meet its
foreseeable cash requirements including planned capital expenditures,
through the next twelve months.
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 70 Chairman of the Board of Directors.
President from June 1973, until
November 7, 1996. CFO and Treasurer from
December 1980 until November 7, 1996
- -13-
<PAGE>
Alan C. Bashforth 48 President and Director since November 7, 1996
Kenneth P. Ray 65 Director since May, 1990
Joy C. Hartman 50 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 54 Director since September 17, 1997
Russell R. Angely 60 Vice President, Sales and Marketing since
May 2, 1994
There were three board meetings during 1998. All the members participated in
these meetings.
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 1998 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.
- -14-
<PAGE>
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.
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.
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 attended 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.
- -15-
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth certain information as of February 5, 1999 with
respect to the beneficial ownership of the common stock by each beneficial
owner of more than 5% of the outstanding shares thereof, by each director, each
nominee to become a director and each executive officer named in the Summary
Compensation Table and by all executive officers, directors and nominees to
become directors of the Company as a group. Under the rules of the Commission,
a person is deemed to be the beneficial owner of a security if such person has
or shares the power to vote or direct the voting of such security or the power
to dispose or direct the disposition of such security. A person is also deemed
to be a beneficial owner of any securities if that person has the right to
acquire beneficial ownership within 60 days. Accordingly, more than one person
may be deemed to be a beneficial owner of the same securities. Unless
otherwise indicated by footnote, the named entities or individuals have sole
voting and investment power with respect to the shares of common stock
beneficially owned. 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.
<TABLE>
<CAPTION>
Shares of
Common
Stock
Beneficially Percent of
Name and Address Title of Shares Outstanding Shares(1)
---------------- ----- --------- ------------------
<S> <C> <C> <C>
Golden Phoenix, LTD 5% Owner
P.O. Box 350, Fairfax Station, 2,969,121 18.72%
VA 22039 Director
Sheldon C. Hofferman, General Partner
of Golden Phoenix
Innovative Communications
Technology, LTD. (ICT)
Le Clos D'Avranche 5% Owner
La Rue Bel-Aire 1,500,000 9.46%
St. Mary, Jersey C.I. President, CEO and
(Alan C. Bashforth, President of Director
the Company controls ICT)
Lyndon A. Keele Chairman of the 775,534(2) 4.89%
701 Garwood Road Board
Moorestown, NJ 08057
Russell R. Angely Vice President 41,000 .258%
107 Hardwood Court
Chalfont, PA 18914
Joy C. Hartman Exec. Vice President, 86,000(2) .539%
27 Hogan Way CFO, Treasurer,
Moorestown, NJ 08057 Secretary, Director
- -2-
<PAGE>
Kenneth P. Ray Director 40,000(3) .041%
909 Darfield Drive
Raleigh, NC 27615
All Directors and
Officers as a Group(3) 5,411,655 34.39%
- ---------------
(1) Based upon a total number of 15,735,649 shares outstanding as of February
5, 1999.
(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) In addition to the 10,000 shares owned by Mr. 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
and 20,000 warrants.
</TABLE>
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
There have been no 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).
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 March 9,1999..........Page 21
Consolidated Balance Sheets as of
December 31, 1998 and 1997....................................Page 22
Consolidated Statements of Operations,
two years ended December 31, 1998.............................Page 23
Consolidated Statements of Changes in
Shareholders' Equity, two years ended December 31, 1998.......Page 24
Consolidated Statements of Cash Flows,
two years ended December 31, 1998.............................Page 25
Notes to Consolidated Financial Statements....................Page 26
- -17-
<PAGE>
2. INDEX OF EXHIBITS
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 1998 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.
- -18-
<PAGE>
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, 1999
---------------------------------
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on
the date indicated.
Signature Title Date
--------- ----- ----
BY: /s/ Lyndon A. Keele Chairman of the Board of March 31, 1999
--------------------- Directors --------------
Lyndon A. Keele
BY: /s/ Alan C. Bashforth President, CEO and Director March 31, 1999
--------------------- since Nov. 7, 1996 --------------
Alan C. Bashforth
BY: /s/ Joy C. Hartman Exec. Vice President, CFO, March 31, 1999
--------------------- Treasurer, Secretary and --------------
Joy C. Hartman Director
- -19-
<PAGE>
SCIENCE DYNAMICS CORPORATION
------------
Index to Consolidated Financial Statements
Report of Independent Accountants dated 19, 1999..................Page 21
Consolidated Balance Sheets as of December 31, 1998 and 1997......Page 22
Consolidated Statements of Operations, two years ended
December 31, 1998.................................................Page 23
Consolidated Statements of Changes in Shareholders' Equity,
two years ended December 31, 1998.................................Page 24
Consolidated Statements of Cash Flows, two years ended
December 31, 1998.................................................Page 25
Notes to Consolidated Financial Statements........................Page 26
- -20-
<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, 1998 and 1997 and the
related consolidated statements of operations, shareholders' equity and cash
flows for the years ended December 31, 1998 and 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, 1998 and
1997 and the consolidated results of their operations and their cash flows
for the years then ended in conformity with generally accepted accounting
principles.
Peter C. Cosmas Co., CPAs
400 Madison Avenue
New York, NY 10017
March 9, 1999
- -21-
<PAGE>
<TABLE>
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements:
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997
<CAPTION>
ASSETS
December 31,
1998 1997
---- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 32,249 $ 21,181
Accounts receivable - trade 266,403 613,916
- other 659,900 -
Inventories 478,494 322,530
Other current assets 46,266 52,200
-------------- -------------
Total current assets 1,483,312 1,009,827
-------------- -------------
Property and equipment, net 231,088 220,060
Software development costs, net of
accumulated amortization of $382,239
in 1998 and $277,992 in 1997 138,996 243,243
Deferred income taxes 308,000 308,000
Intangible Assets, net of accumulated
amortization of $600,000 in 1998 and
$300,000 in 1997. 900,000 1,200,000
Other assets 41,418 39,239
-------------- -------------
Total assets $ 3,102,814 $ 3,020,369
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Loan payable $ 100,000 $ -
Accounts payable 638,493 289,188
Accrued expenses, principally
payroll related 181,492 87,046
-------------- -------------
Total current liabilities 919,985 376,234
-------------- -------------
Commitments
Shareholders' equity -
Common stock - .01 par value,
45,000,000 shares authorized,
15,861,449 and 14,661,449 issued
15,735,649 and 14,535,649 outstanding
in 1998 and 1997 respectively. 158,614 146,614
Additional paid-in capital 10,729,429 10,166,429
(Deficit) (8,307,381) (7,271,075)
-------------- -------------
2,580,662 3,041,968
Common stock held in treasury,
at cost (397,833) (397,833)
-------------- -------------
Total shareholders' equity 2,182,829 2,644,135
-------------- -------------
Total liabilities and shareholders' equity $ 3,102,814 $ 3,020,369
============== =============
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 STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
NET SALES $ 4,352,606 $ 4,393,553
------------- ---------------
Operating costs and expenses:
Cost of sales 1,694,557 1,969,837
Research and development 1,219,687 1,293,608
Selling, general
and administrative 2,470,534 2,138,408
------------- ---------------
5,384,778 5,401,853
------------- ---------------
Operating (loss) (1,032,172) (1,008,300)
Other income (expenses):
Interest and other
investment income - 15,673
Interest expense (4,134) (29,402)
------------- ---------------
Net (Loss) $ (1,036,306) $ (1,022,029)
============= ===============
Net (Loss) per common share
basic and diluted $ (0.07) $ (0.08)
============= ===============
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 CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 and 1997
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating
activities:
Net (loss) $ (1,036,306) $ (1,022,029)
------------ ------------
Adjustments to reconcile net (loss) to net cash
provided by (used for) operating activities:
Depreciation 74,727 68,573
Amortization of capitalized software 104,247 104,246
Amortization of Intangible assets 300,000 300,000
Other non-cash expense 29,402
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable 347,513 (526,190)
Other receivable (659,900) 200,000
Inventories (155,964) 258,747
Other current assets 5,934 (10,105)
Other assets (2,179) 2,054
Increase (decrease) in:
Accounts payable and accrued expenses 443,751 (133,489)
------------ ------------
Total adjustments 458,129 293,238
------------ ------------
Net cash provided by (used for)
operating activities (578,177) (728,791)
------------ ------------
Cash flows from investing activities:
Purchase of property and
equipment - net (85,755) (80,257)
------------ ------------
Net cash (used) in
investing activities (85,755) (80,257)
------------ ------------
Cash flows from financing activities:
Increase (decrease) in Loan Payable 100,000
Issuance of Common Stock 575,000 -
------------ ------------
Net cash (used in) provided
by financing activities 675,000 -
------------ ------------
Net increase (decrease) in
cash and cash equivalents 11,068 (809,048)
Cash and cash equivalents -
beginning of period 21,181 830,229
------------ ------------
Cash and cash equivalents -
end of period $ 32,249 $ 21,181
============ ============
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
- -24-
<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 TWO YEARS ENDED DECEMBER 31, 1998 AND 1997
<CAPTION>
Common Stock Additional Treasury
Paid-In
Shares Amount Capital (Deficit) Shares Amount
------ ------ ------- ------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Balance
December 31, 1996 12,055,861 $120,558 $9,615,191 $(6,249,046) 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 - - - (1,022,029) - -
---------- -------- ---------- --------- ------- -------
Balance
December 31, 1997 14,661,449 146,614 10,166,429 (7,271,075) 125,800 397,833
---------- -------- ---------- --------- ------- -------
Issuance of common stock
net of related expenses 1,200,000 12,000 563,000 - - -
Net loss - - - $ (1,036,306) - -
---------- -------- ---------- --------- ------- -------
Balance
December 31, 1998 15,861,449 $ 158,614 $10,729,429 $ (8,307,381) 125,800 $ 397,833
========== ======== ========== ========= ======= =======
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
- -25-
<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 1998 and 1997. Cash paid for
interest was $ 0 in 1997 and $4,134 in 1998.
- -26-
<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, 1998, capitalized software development costs, net of
amortization were $138,996. 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 $521,234 in 1998
and 1997. The amortization was $104,247 in 1998, and $104,246 in
1997.
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 5).
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.
- -27-
<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) Comprehensive Income
During the year ended December 31, 1998 the Company adopted Statement
of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income." SFAS 130 requires the reporting of
Comprehensive income in addition to net income from operations.
Comprehensive income is a more inclusive financial reporting
methodology that includes disclosure of certain financial information
in the calculation of net income. The Company does not have any
Comprehensive income as determined by SFAS 130.
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, 1998 and 1997.
3) Inventories:
Inventories consist of the following:
1998 1997
---- ----
Raw materials $ 197,643 $ 88,242
Work in process - 61,999
Finished goods 280,851 172,289
------- -------
Totals $478,494 $ 322,530
======= =======
- -28-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4) Property and Equipment:
A summary of the major components of property and equipment is as follows:
1998 1997
---- ----
Computers, fixtures and equipment $ 1,342,408 $ 1,256,652
Leasehold improvements - -
--------- ---------
1,342,408 1,256,652
Less accumulated depreciation and
amortization (1,111,320) (1,036,592)
--------- ---------
Totals $ 231,088 $ 220,060
========= =========
5) 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, 1998 and 1997 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 1998 and 1997 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.
As a result of the operating losses for the years ended December 31, 1990
and 1992 - 1998 the Company has available to offset future taxable income
a net operating loss of $9,397,364 expiring 2005 - 2018. In addition,
research credits expiring 2005 - 2013 are available to offset future
taxes.
The components of the provision (credit) for income taxes from continuing
operations is as follows:
1998 1997
---- ----
Deferred
Federal $ - $ -
Current
Federal - -
State - -
------- -------
$ - $ -
------- -------
- -29-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Differences between the tax provision computed using the statutory federal
income tax rate and the effective income tax rate on operations are as
follows:
1998 1997
---- ----
Federal statutory rate $(352,344) $(347,490)
Research tax credits - -
Tax benefit not provided due
to valuation allowance 352,344 347,490
Surtax exemptions, net - -
Other - -
------- -------
$ - $ -
------- -------
Components of the Company's deferred tax assets and liabilities are as
follows:
December 31,
1998 1997
---- ----
Deferred tax assets:
Tax benefits related to net operating
loss carryforwards and research
tax credits $3,144,625 $2,792,281
---------- ----------
Total deferred tax assets 3,144,625 2,792,281
Valuation allowance for
deferred tax assets 2,836,625 2,484,281
---------- ----------
Net deferred tax assets $ 308,000 $ 308,000
6) 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, 1998 are as follows:
1999 $ 214,717
2000 201,322
2001 193,622
2002 185,483
2003 185,483
After 2003 243,644
-------
Total minimum lease payments $1,224,291
Rent expense for the years ended December 31, 1998 and 1997 was
$150,037,and $197,769 respectively.
- -30-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 $ 1,016,600.
7) 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 1998 and 1997 amounted to $300,000 for each
year.
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.
8) 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 178,500 have been awarded, with 305,075
shares remaining available for future awards.
During 1998, no shares were awarded. In 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. Warrants to acquire 20,000 shares exercisable at $0.78 are
outstanding at December 31, 1998.
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 1998
and 1997, 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 1997 and 1998
grants. As such, the impacts are not necessarily indicative of the
effects on reported net income of future years.
- -31-
<PAGE>
SCIENCE DYNAMICS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9) Major Customers:
During 1998, three customers and their operating subsidiaries accounted
for 82.95%, 4.69% and 3.45% of total sales. During 1997, three customers
and their operating subsidiaries accounted for 88.7%, 4.3% and 3% of
total sales.
10) 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 weighted average number of shares used to compute basic earnings
(loss) per share was 14,535,649 in 1998 and 13,590,656 in 1997.
- -32-
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 32
<SECURITIES> 0
<RECEIVABLES> 926
<ALLOWANCES> 0
<INVENTORY> 478
<CURRENT-ASSETS> 1,483
<PP&E> 1,342
<DEPRECIATION> 1,111
<TOTAL-ASSETS> 3,103
<CURRENT-LIABILITIES> 920
<BONDS> 0
0
0
<COMMON> 159
<OTHER-SE> 2,183
<TOTAL-LIABILITY-AND-EQUITY> 3,103
<SALES> 4,353
<TOTAL-REVENUES> 4,353
<CGS> 1,695
<TOTAL-COSTS> 1,695
<OTHER-EXPENSES> 3,690
<LOSS-PROVISION> 1,032
<INTEREST-EXPENSE> 4
<INCOME-PRETAX> (1,036)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,036)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,036)
<EPS-PRIMARY> (.07)
<EPS-DILUTED> (.07)
</TABLE>
