<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One) CONFORMED
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Period Ended December 31, 1997
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File No. 0-17531
OPTICAL SECURITY GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
Colorado 84-1094032
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
535 16th Street, Suite 920
Denver Colorado 80202
(Address of Principal Executive Offices)
(303) 534-4500
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934, during the preceding twelve months and (2) has been subject to the filing
requirements for the past 90 days.
Yes X No .
APPLICABLE ONLY TO CORPORATE ISSUES:
Class of Stock No. of Shares Outstanding Date
Common 5,183,949 December 31, 1997
<PAGE>
Optical Security Group, Inc.
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
December 31
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 360,614 $ 1,042,734
Accounts receivable, less allowance
of $86,265 and $18,852 at the quarter
ended December 31, 1997 and 1996,
respectively 3,869,014 2,122,457
Inventory 1,424,599 1,176,577
Prepaid expenses 431,552 232,499
------------ ------------
Total current assets 6,085,779 4,574,267
Property and equipment, net 2,828,677 716,447
Other assets:
Patents and patent applications, net of
accumulated amortization of $107,610 and
$79,262 at the quarter ended December 31,
1997 and 1996, respectively 322,365 316,159
Goodwill, net of accumulated amortization of
$719,996 and $234,674 at the quarter ended
December 31, 1997 and 1996, respectively 6,827,570 6,390,723
License and non-compete agreements, net of
accumulated amortization of $229,405 and
$143,100 at the quarter ended December 31,
1997 and 1996, respectively 740,500 624,334
Deposits and other 84,036 780,881
------------ ------------
Total assets 16,888,927 13,402,811
============ ============
</TABLE>
See accompanying notes
1 of 19
<PAGE>
Optical Security Group, Inc.
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
December 31
1997 1996
----------- -----------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,169,415 $ 636,713
Accruals and other liabilities 628,890 979,450
Current portion of capital lease obligations 5,000 13,230
Current portion of long-term obligations 236,600
----------- -----------
Total current liabilities 2,039,905 1,629,393
Deferred tax liability 25,840 32,300
Capital lease obligations 2,841 13,718
Long-term obligations 1,022,912 1,000,000
Commitments
Minority interest in consolidated subsidiary - 75,278
Stockholders' equity:
Voting convertible preferred stock, $0.01 par value
2,500,000 shares authorized; 1,793 and 7,468
Series B shares issued and outstanding at
December 31, 1997 and 1996, respectively
(preference in liquidation $ 1,954,370) 18 75
Common stock $0.05 par value:
15,000,000 shares authorized; 5,183,949 and
3,024,552 shares issued and outstanding at
December 31, 1997 and 1996, respectively 25,920 17,506
Additional paid-in capital 20,353,181 16,992,245
Foreign currency translation adjustment (41,861) 2,491
Accumulated deficit (6,539,829) (6,360,195)
----------- -----------
Total stockholders' equity 13,797,429 10,652,122
----------- -----------
Total liabilities and stockholders' equity $16,888,927 $13,402,811
=========== ===========
</TABLE>
See accompanying notes
2 of 19
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Three Months Ended Nine Months Ended
December 31 December 31
1997 1996 1997 1996
---------- ---------- ----------- ----------
Revenues $3,497,702 $3,180,237 $13,579,114 $8,216,534
Cost of goods sold 2,126,216 2,154,481 9,371,565 5,342,733
---------- ---------- ----------- ----------
Gross margin 1,371,486 1,025,756 4,207,549 2,873,801
Operating expenses:
Salaries and related costs 613,678 484,095 1,954,944 1,376,357
Depreciation and amortization 235,365 131,596 607,537 269,620
Other operating expenses 589,445 333,078 1,649,942 929,390
---------- ---------- ----------- ----------
Total operating expenses 1,438,488 948,769 4,212,423 2,575,367
Income (loss) from operations (67,002) 76,987 (4,874) 298,434
Other income (expense)
Interest expense (3,910) (3,933) (40,168) (8,286)
Interest income 18,599 19,116 37,155 95,750
Other income (expense) - 1,151 - 1,151
Foreign currency transaction
gain (loss) (7,314) 10,999 1,069 7,417
---------- ---------- ----------- ----------
Income (loss) before income
taxes (59,627) 104,320 (6,818) 394,466
Minority interest in net income of
consolidated subsidiary - (15,416) - (22,348)
---------- ---------- ----------- ----------
Income (loss) before income taxes (59,627) 88,904 (6,818) 372,118
Income tax expense (benefit) (15,352) - 3,238 -
---------- ---------- ----------- ----------
Net income (loss) (44,275) 88,904 (10,056) 372,118
========== ========== =========== ==========
Net income (loss) applicable
To common stock $ (80,135) $ (13,256) $ (117,636) $ (24,473)
========== ========== =========== ==========
Net income (loss) per share
Primary $(0.02) $0.00 $(0.02) $(.01)
========== ========== =========== ==========
Fully Diluted
Weighted average shares
Primary 5,183,949 3,501,220 5,183,949 3,501,220
========== ========== =========== ==========
Fully diluted
</TABLE>
See accompanying notes
3 of 19
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31 December 31
1997 1996 1997 1996
----------------------- ------------------------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) (44,275) 88,904 (10,057) 372,118
Adjustments to reconcile net
income (loss) to net cash
used in operating activities:
Depreciation and amortization 235,365 131,596 607,537 269,620
Minority interest in consolidated
subsidiary - 15,416 - 22,348
Change in operating assets and liabilities
Accounts receivable 546,463 (123,340) 1,245,062 (934,392)
Inventory 123,825 (582,186) 202,153 (754,817)
Prepaid expenses (125,574) (73,287) (141,181) (110,700)
Accounts payable & accrued liabilities (500,928) 646,316 (1,180,739) 1,166,420
--------- --------- --------- ---------
Net cash provided (used) in
operating activities 234,876 103,419 722,775 30,597
INVESTING ACTIVITIES
Patent application costs (6,050) (20,631) (24,894) (57,304)
Acquisition - OpSec Pasternak &
Partner GmbH (538,474) (1,253,449) (538,474) (1,255,949)
Property and equipment (456,146) (75,481) (2,036,988) (104,250)
Licensing agreements (2,052) - (2,595) (195,414)
Notes receivable 43,800 - (8,110) (100,000)
Organization Costs - (3,788) - (8,439)
Deposits and intangible assets, net (25,869) (694,803) 19,105 (748,920)
-------- ---------- --------- ---------
Net cash provided (used) in
investing activities (984,791) (2,048,152) (2,630,166) (2,470,276)
FINANCING ACTIVITIES
Proceeds from issuance of common
stock, net 220,991 - 241,023 -
Proceeds from issuance of
preferred stock, net - - - 681,500
Change in line of credit facility (211,000) - 155,00 -
Proceeds from bond financing 194,367 - 1,104,512 -
Payments on notes and capital
lease obligations (962) 9,702 (1,014,242) (26,788)
Dividend on preferred stock (35,860) (102,160) (107,580) (396,591)
Cost of financing - (2,413) (81,553) (2,413)
-------- ---------- --------- ---------
Net cash provided (used) by
financing activities 167,536 (94,871) 297,160 255,708
Effect of exchange rate
changes on cash flows (33,790) 2,806 (93,243) (5,119)
------- ---------- --------- ---------
Net increase (decrease) in cash (616,169) (2,036,798) (1,703,474) (2,189,090)
Cash, beginning of period 976,783 3,079,531 2,064,088 3,231,823
-------- ---------- --------- ----------
Cash, end of period $ 360,614 $1,042,733 $ 360,614 $1,042,733
========= ========== ========= ==========
SUPPLEMENTAL DISCLOSURE OF
NON-CASH FLOW ACTIVITIES
Interest paid 3,910 3,933 40,168 8,286
Income tax expense (benefit) (15,352) - 3,238 -
See accompanying notes 4 of 19
</TABLE>
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements
December 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Optical Security Group, Inc. (the "Company"), is a technology company which,
through its principal subsidiaries, Optical Security Industries, Inc; Optical
Security Industries International, Plc ; Dimensional Printing Industries, Inc.
("DPI"), now doing business as OpSec Creative Technologies; and OpSec Pasternak
& Partner GmbH & Co., KG ("OP&P") provides products and solutions to businesses
and governments for the problems of product tampering and counterfeiting,
diversion of goods, and illegal document alteration and copying. In addition,
the Company provides materials and products for use in value-added commercial
applications, including holography and dimensional printing for book
illustrations and trading cards, and for consumer product promotions. The
Company's principal markets are the United States and Western Europe.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All material intercompany accounts
and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
FOREIGN CURRENCY
Foreign currency denominated assets and liabilities are translated into U.S.
dollar equivalents based on exchange rates prevailing at the end of each year.
Revenues and expenses are translated at average exchange rates during the year.
Aggregate foreign exchange gains and losses arising from the translation of
foreign currency denominated assets and liabilities are included in
stockholders' equity, and realized gains and losses are reflected in income.
The Company conducts business with various foreign entities. As such, the
Company's future profitability could be affected in the near term by fluctuating
exchange rates.
5 of 19
[END OF FILE]
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTS RECEIVABLE
The Company grants credit to customers in the ordinary course of business,
primarily in the United States and Western Europe. The Company periodically
performs credit analyses and monitors customers' financial condition in order to
reduce credit risk. Annual credit losses have been minimal and have
consistently been within management's expectations.
FAIR VALUE OF FINANCIAL INSTRUMENTS
All of the Company's financial instruments, including cash and notes payable
have fair values which approximate their recorded values as the financial
instruments are either short term in nature or carry interest rates which
approximate market rates.
PROPERTY AND EQUIPMENT
Property and equipment, which are stated at cost, are depreciated over their
estimated useful lives. Leasehold improvements are amortized over the shorter of
their estimated useful lives or the remaining lease term. Depreciation is
computed using the straight-line method. The ranges of estimated useful lives
are as follows:
YEARS
-----------
Leasehold improvements 2-12
Computer equipment 5
Other equipment and furniture 5-7
Production equipment 5-10
Building 40
Vehicles 4
Property and equipment at December 31, 1997 consist of:
Land and building $1,524,142
Leasehold improvements 141,351
Computer equipment 319,077
Other equipment and furniture 215,174
Production equipment 1,060,267
Vehicles 63,449
$3,323,460
----------
Less accumulated depreciation (494,783)
----------
$2,828,677
==========
GOODWILL AND LICENSE AGREEMENTS
Goodwill represents the excess of purchase price over tangible and other
identifiable assets acquired, less liabilities assumed arising from business
combinations. Goodwill at December 31, 1997 is associated with the acquisition
of OP&P and the purchase of the minority interest in DPI in fiscal 1997, and the
acquisition of ELEF, Plc during fiscal year 1995.
6 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Other intangible assets consist primarily of license agreements that provide the
Company with royalties from the use and sale of holographic and diffraction
patterns by various licensees, and a license that allows the Company exclusive
rights to employ technology developed by others in its products.
Goodwill is being amortized on a straight-line basis over lives of 15 to 20
years. License agreements are being amortized over lives of 8 to 10 years.
Goodwill and license agreements are reviewed for impairment whenever events
indicate their carrying amount may not be recoverable. When the Company
believes that those assets may not be recoverable, it estimates the future cash
flows to be generated by the business associated with those assets. In the
event that the sum of the cash flows is less than the carrying amount of those
assets, the assets would be written down to their fair value, which is normally
measured by discounting estimated future cash flows.
INVENTORY
Inventory is stated at the lower of cost or market using the first-in, first-out
(FIFO) method. Inventory on hand consists principally of raw materials used in
embossing polyester films and foils and material used in dimensional printing.
Additionally, at year-end, a portion of the inventory consisted of work-in-
process and finished goods.
PATENTS AND PATENT APPLICATIONS
The Company capitalizes legal costs directly incurred in pursuing patent
applications. When such application results in an issued patent, the related
costs are amortized over the remaining legal life of the patent, using the
straight-line method. On a periodic basis, the Company reviews its issued
patents and pending patent applications, and if it determines to abandon a
patent application, or that an issued patent no longer has economic value, the
unamortized balance in patent costs relating to that patent is expensed.
It is possible the above estimates of future economic life of the Company's
patents, the amount of future revenues, or both, will be reduced significantly
in the near term due to alternative technologies developed by similar entities.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 128, "Earnings Per Share" which is required
to be adopted on March 31, 1998. The Company has adopted the required method to
compute earnings per share and has restated all prior periods. Under the new
requirements for calculating primary earnings per share, the dilutive effect of
stock options will be excluded. The impact of Statement of Financial
Accounting Standard No. 128 on prior periods is not expected to be material.
7 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME OR LOSS PER SHARE OF COMMON STOCK
Primary earnings or loss per share of common stock, after preferred stock
dividend requirements, for the periods ended December 31, 1997 and 1996, are
based on weighted average outstanding shares. Fully diluted loss per share for
the period ended December 31, 1997 and 1996 was not computed as the effect of
common stock equivalents is antidilutive. Earnings and loss per share were
computed for the current and prior period under the Statement of Financial
Accounting Standard No. 128, "Earnings Per Share" adopted by the Financial
Accounting Standards Board in February 1997.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed in the period incurred.
RECLASSIFICATIONS
Certain amounts in the December 31, 1996 financial statements were reclassified
to conform with the December 31, 1997 presentation.
2. BUSINESS COMBINATIONS
On December 10, 1996, the Company acquired 100% of the stock of OpSec Pasternak
& Partner, GmbH, a corporation based in Germany. The purchase price, net of
acquisition costs, was approximately $5 million, including 466,668 common shares
of the Company valued at $2.8 million, cash of $1.2 million, and a promissory
note bearing interest at 6% for $1 million. The acquisition resulted in
goodwill of $5,556,393. This allocation for goodwill increased from $5,017,918
to reflect additional post-closing costs, possible loss of tax benefits due to
changes in German tax law and other contractural commitments. OP&P had
previously operated as an independent broker selling the Company's dimensional
printed products in Europe.
During fiscal 1997, the Company formed Dimensional Printing Industries, LLC to
manufacture dimensional printed products. DPI was formed in September 1996,
with the Company owning a 51% membership interest. The Company purchased the
other 49% minority interest in two transactions before year end for a total cost
of $650,668, including all related acquisition costs, which have been recorded
as goodwill. DPI was converted to a corporation subsequent to year-end.
3. CONVERTIBLE SUBORDINATED NOTES
During fiscal 1995, the Company issued $1.25 million of Convertible Subordinated
Secured Notes to related parties. These notes, which bore interest at 12% per
annum, paid quarterly, were convertible into the Company's common stock at the
rate of $4.05 per common share. For the first two years, the noteholders were
entitled to receive 60% of the interest payment in the form of the Company's
common
8 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
3. CONVERTIBLE SUBORDINATED NOTES (CONTINUED)
stock, valued at 70% of the average public trading price on the 30 days
preceding the interest due date, and 40% in cash. In the interest of preserving
the Company's working capital position, the noteholders waived the cash portion
of the quarterly interest, and accepted 100% of the payment in the Company's
common stock through June 30, 1995. Effective July 1, 1995, the Company issued
400,000 shares of Preferred Series A shares in exchange for the cancellation of
$1.25 million of Convertible Subordinated Secured Notes.
4. STOCKHOLDERS' EQUITY
Effective March 27, 1997, the Company completed a financing arrangement with a
group of individual investors, including officers and directors, and with
various institutional investors in which 526,899 common shares were issued at
$6.00 per share. The private placement resulted in total proceeds, net of
offering costs, of $3,128,268.
The Company also completed by March 15, 1997, the conversion of 5,675 shares of
Series B 8% Cumulative Convertible Exchangeable Preferred Voting Stock ("Series
B Shares") into common stock. The Company issued a total of 945,833 common
shares in the conversion. Warrants for 472,916 common shares exercisable at
$6.00 per share were also issued to those Series B shareholders electing to
convert early. The conversion included Series B Shares held by officers and
directors of the Company. A total of 400,000 common shares and 200,000 warrants
were issued to these related parties.
During fiscal 1996, the Company issued 6,693 shares of Preferred Series B
Stock, including 4,293 issued for cash at $1,000 per share, and 2,400 issued in
exchange and full cancellation for the previously outstanding Preferred Series A
shares. In conjunction with the issuance of the Preferred Series B, the Company
granted a warrant to purchase 85,860 shares of the Company's common stock at an
exercise price of $7.13 per share. Subsequent to year end March 31, 1996, the
Company completed its Preferred Series B stock offering, issuing 775 shares at
$1,000 per share, resulting in total proceeds of $4,491,036, net of issuance
costs.
The Series B shareholders have voting rights equal to the number of common
shares that would be held if converted. The Series B shares are convertible
into shares of the Company's common stock at a conversion price of $6.00 per
common share. Each Series B share can be converted into 166.67 common shares.
The Series B shares are entitled to receive an 8% per annum cumulative dividend
payable out of legally available funds. At the option of the Company, upon 30
days prior written notice, the Series B shares are redeemable, in whole or in
part, from time to time, commencing on or after March 30, 1998 at the redemption
price set forth in the following table. The shares are redeemable if the common
stock trades at 150% of the conversion price for at least 30 consecutive trading
days.
9 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
4. STOCKHOLDERS' EQUITY (CONTINUED)
<TABLE>
<CAPTION>
Redemption
Date Redeemed Price
- --------------------------------------------------------------------
<S> <C>
On or after March 30, 1998, but prior to the third
anniversary, $1,090
On or after the third anniversary date but
prior to the fourth anniversary date, 1,075
On or after the fourth anniversary date but
prior to the fifth anniversary date, 1,060
On or after the fifth anniversary date but
prior to the sixth anniversary date, 1,040
On or after the sixth anniversary date but
prior to the seventh anniversary date, 1,020
On or after the seventh anniversary date. 1,000
</TABLE>
The Company is restricted from paying dividends on its common shares pursuant to
the terms of its Preferred Series B shares. No dividends or other payments can
be declared and paid on the common stock unless the Company also declares and
pays dividends on the shares of common stock issuable upon conversion of the
Series B shares and unless there are no accrued and unpaid dividends on the
Series B shares. On December 31, 1997, the cumulative unpaid dividend on the
Series B Shares of $35,860 was declared and subsequently paid on July 2, 1997.
The preferred dividend scheduled for fiscal 1998 on the reduced number of
outstanding Series B Shares will be $143,440, or $35,860 per quarter.
On April 1, 1996, the Company's chief executive officer and president, entered
into a new employment contract with the Company effective through March 31,
1999. The chief executive officer's previous employment agreement was to
terminate on September 17, 1996. Under the terms of the new contract, all
options granted to the chief executive officer through March 31, 1996 remain in
full force and effect. The chief executive officer's salary is $150,000 for the
first year, $175,000 for the second year and $200,000 for the third year. As
additional compensation, the chief executive officer will be granted additional
options during the term of the contract in sufficient amounts to maintain the
chief executive officer's percentage beneficial ownership of the Company's
common stock as of December 31, 1995, less common stock the chief executive
officer sells or otherwise disposes of after that date. The chief executive
officer also is entitled to discretionary bonuses in such amount as the board of
directors may determine. The new employment contract also provides that, if the
Company is sold or merged into another Company prior to March 31, 2000, the
chief executive officer will receive a stock bonus of 250,000 shares. If the
Company terminates the chief executive officer's employment prior to the
expiration of the contract, the chief executive officer is entitled to a buyout
at 150% of the value of the contract at the time of termination.
Below is a summary of common stock reserved by the Company at December 31, 1997
for issuance upon the conversion of preferred stock and the exercise of the
various options and warrants:
Series B preferred stock 298,833
Stock option plans 2,255,913
Warrants 1,082,765
---------
3,637,511
=========
10 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. STOCK OPTION PLANS AND STOCK WARRANTS
The Company has an Incentive Stock Option Plan ("ISOP") under which 2,000,000
shares of common stock are reserved for issuance. Under the ISOP plan, options
may be granted to key employees at prices not less than fair market value of the
Company's stock at date of grant. The Company also has a Nonqualified Stock
Option Plan ("NSOP") under which 2,000,000 shares of common stock are reserved
for issuance at December 31, 1997. All ISOP and NSOP options were at an exercise
price equal to or greater than fair market value at the date of grant.
The following is a summary of stock options granted, exercised and outstanding
for the quarter ended December 31, 1997 and the two prior fiscal years:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF SHARES AVERAGE
---------------- OTHER EXERCISE EXERCISE EXPIRATION
ISOP NSOP OPTIONS PRICE PRICE DATE
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, March 31, 1995 724,800 440,001 63,335 $ .20-$5.00 $2.65
Options exercised 10,000 - - $ 4.38 $4.38
Options canceled 123,400 - - $4.05-$5.00 $4.28
Options granted 220,000 310,000 - $4.05-$5.75 $5.67 7/96-3/01
----------------------------------------------------
Outstanding, March 31, 1996 811,400 750,001 63,335 $ .20-$5.75 $3.50
Options exercised - - - - -
Options canceled 45,200 5,000 - $4.05-$6.00 $5.64
Options granted 469,000 387,878 - $6.00-$7.63 $6.34 6/01-3/02
----------------------------------------------------
Outstanding, March 31, 1997 1,235,200 1,132,879 63,335 $ .20-$7.63 $4.46
====================================================
Options exercised 164,666 - 41,167 $ .20-$5.75 -
Options canceled 228,334 - 8,834 $ .20-$6.00 -
Options granted 217,500 50,000 - $6.00-$6.37 $6.37 6/02-7/02
----------------------------------------------------
Outstanding, Dec. 31, 1997 1,059,700 1,182,879 13,334 $ .20-$7.63 $4.47
====================================================
</TABLE>
The following is a summary of warrants granted, exercised and outstanding for
the quarter ended December 31, 1997, and the three prior fiscal years:
<TABLE>
<CAPTION>
WARRANTS
---------------------------------------
NUMBER OF EXERCISE EXPIRATION
SHARES PRICE DATE
---------------------------------------
<S> <C> <C> <C>
Outstanding, March 31, 1994 -
Issued for June 1994 financing 355,000 $5.00 6/2001
Issued in ELEF, Plc acquisition 12,346 $4.05 5/2004
Issued in ELEF, Plc acquisition 57,655 $5.00 5/2004
Issued in The Diffraction Company acquisition 100,000 $4.05 10/2001
Exercised 12,346 $4.05
---------------------------------------
Outstanding, March 31, 1995 512,655
Issued in conjunction with the Series B financing 85,860 $7.13 1/2003
---------------
Outstanding, March 31, 1996 598,515
Issued in conjunction with the Series B financing 15,500 $7.13 1/2003
Issued upon conversion of Series B shares 472,917 $6.00 3/2002
---------------
Outstanding, March 31, 1997 1,086,932
Exercised 4,167 $6.00
---------------
Outstanding, December 31, 1997 1,082,765
===============
</TABLE>
11 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCK BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25) and related Interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
"Accounting for Stock-Based Compensation," requires use of option valuation
models that were not developed for use in valuing employee stock options. Under
APB 25, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
The Company's ISOP and NSOP has authorized the grant of options to management
personnel and directors for up to 4,000,000 shares of the Company's common
stock. All options granted have 1-4 year terms and vest and become fully
exercisable at the end of 1-4 years of continued employment.
Pro forma information regarding net income and earnings per share is required by
Statement No. 123 which also requires that the information be determined as if
the Company has accounted for its employee stock options granted subsequent to
March 31, 1995 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 1997
and 1996, respectively: risk-free interest rates of 5.52% to 6.49%; a dividend
yield of 0%; volatility factors of the expected market price of the Company's
common stock of .212; and a weighted-average expected life of the option of 3.5
years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options being neither transferable nor
unrestricted, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The effects of
applying Statement 123 in the year of adoption are not likely to be
representative of the effects on pro forma net income for future years. The
Company's pro forma information follows (in thousands except for earnings per
share information):
<TABLE>
<CAPTION>
QUARTER ENDED DECEMBER 31
1997 1996
-------------------------
<S> <C> <C>
Pro forma net income (loss) $(122,664) $ 276,765
Pro forma net loss applicable (158,524) (378,925)
to common stock
Pro forma earnings per share
Primary $(0.03) $(0.11)
</TABLE>
12 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCK BASED COMPENSATION (CONTINUED)
Exercise prices for options outstanding as of December 31, 1997 ranged from $.20
to $7.63 The weighted-average remaining contractual life of those options is
3.28 years.
7. NOTES PAYABLE
During the quarter ended June 30, 1997, the Company opened a revolving credit
line with Mercantile-Safe Deposit and Trust Company in Baltimore, Maryland. The
$2 million facility is secured by the assets of the Company. At December 31,
1997, the Company had a balance outstanding of $155,000.
On July 22, 1997, the Company closed on the issuance of $1,235,000 in Economic
Development Revenue Bonds to finance the purchase and improvements to the
manufacturing facility acquired in Baltimore County, with Mercantile-Safe
Deposit and Trust Company funding the bond issue. The bridge loan provided by
the line-of-credit was paid off upon closing of the bond issue. At December 31,
1997, the outstanding balance on the loan was $1,104,512.
As of May 6, 1997, the Company had paid off, in full, the $1 million in short-
term debt that financed a portion of the OP&P purchase. The payoff was funded
substantially through working capital of the Company.
13 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
QUARTER ENDED DECEMBER 31, 1997
- -------------------------------
Revenues for the quarter ended December 31, 1997 were $3,497,702 a 10% increase
when compared to the revenues of $3,180,237 for the quarter ended December 31,
1996. Sales grew 95% in the security products division with significant
increases in revenues resulting in part from authenticating label and tag sales
for the NFL over-all licensing program and Exelgram(R) embossed foil sales for
American Express travelers' cheques. Revenue in OpSec's dimensional printing
division declined 62% during the quarter compared to the same quarter in the
prior year. Year-to-date, revenues in security and dimensional printing have
grown 73% and 56% respectively.
Commercial sales of OP&P peaked soon after the acquisition, but decreased
$1,220,000 this quarter over the same quarter of the prior year. Management is
reviewing the loss in revenue, and results to date, so as to make a
determination if the revenue trend to date is of a temporary nature in the
booking of jobs and the timing of revenue, or if it is an indicator of
continuing subpar results. If the ability to generate revenues is found to be
impaired, Management will review the amount of goodwill recorded in the purchase
transaction and determine if an adjustment is needed. Total goodwill recorded
for this purchase, net of amortization, is $5,123,312.
Gross profits for the quarter ended December 31, 1997 increased 33.3% to
$1,371,406 compared to $1,025,756 for the quarter ended December 31, 1996. The
gross profit margin of 39.2% increased from the 32.2% for the comparable quarter
of the prior year. Margins were higher in security sales which comprised a
significant proportion of the current quarter sales, but were less than half of
the total in the same quarter of the prior year. Margins on security product
sales remained steady, while margins on dimensional printing sales are below
historical performance levels. Improvements and controls in our dimensional
printing operation were begun in our first fiscal quarter, and will continue to
be phased in.
Operating expenses of $1,438,488 grew 51.6% compared to the prior fiscal year,
an increase of $489,719 of which $363,000 resulted from the addition of the
dimensional printing division and the operating expenses of OP&P which was
acquired during the third quarter of the prior fiscal year. Compensation and
related costs increased 26.8% or $129,583; depreciation and amortization
increased 78.9% or $103,769; and, all other operating expenses increased 76.9%
or $256,367.
The Company incurred a net loss for the quarter ended December 31, 1997 of
$44,275, as compared to net income of $88,904 for the quarter ended December 31,
1996. The Company paid a dividend on the Series B shares of $35,860 for the
quarter ended December 31, 1997, a decrease of $66,300 as compared to dividends
paid in the quarter ended December 31, 996. No significant tax liabilities were
reported for the quarter. The Company carries significant net operating losses
for U.S. tax reporting purposes.
14 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
RESULTS OF OPERATIONS (CONTINUED)
QUARTER ENDED SEPTEMBER 30, 1997
- --------------------------------
Revenues for the quarter ended September 30, 1997 were $4,660,530, a 72%
increase when compared to the revenues of $2,709,787 for the quarter ended
September 30, 1996. Sales grew 66% in the holographic division with continuing
significant increases in revenues resulting from authenticating label and tag
sales for the NFL over-all licensing program and Exelgram/R/ embossed foil sales
for American Express travelers' cheques. Revenue growth of 79% also occurred in
OpSec's dimensional printing division, as sales expanded based on the addition
of internally controlled manufacturing capabilities, both in the U.S. and
Europe, and the purchase of the Company's previously independent German sales
agent.
Gross profits for the quarter ended September 30, 1997 increased 19.4% to
$1,224,705 compared to $1,025,995 for the quarter ended September 30, 1996. The
gross profit margin of 26.28% decreased from the 37.86% for the comparable
quarter of the prior year. Margins on holographic sales remained steady, while
margins on lenticular sales are below historical performance levels.
Improvements and controls in our dimensional printing operation were begun in
our first fiscal quarter, and will continue to be phased in. The Company
believes these improvements will result in a gradual improvement in overall
profit margins over the ensuing quarters.
Operating expenses of $1,399,463 grew 60.3% compared to the prior fiscal year,
an increase of $526,163, of which $435,000 results from the addition of the
dimensional printing division in the second half of the last fiscal year and the
purchase of our German agent during the third quarter of the prior fiscal year.
Compensation and related costs increased 48.2%, or $227,533, depreciation and
amortization increased 55.3% or $112,198, and all other operating expenses
increased 56.6% or $186,432.
The Company incurred a net loss for the quarter ended September 30, 1997 of
$187,843, as compared to net income of $180,382 for the quarter ended September
30, 1996. Interest increased $22,214 as the Company has utilized a line of
credit to finance its growing working capital needs. The Company paid a
dividend on the Series B shares of $35,860 for the quarter ended September 30,
1997, a decrease of $113,500 as compared to dividends paid in the quarter ended
September 30, 1996. No significant tax liabilities were reported for the
quarter. The Company carries significant net operating losses for U.S. tax
reporting purposes.
QUARTER ENDED JUNE 30, 1997
- ---------------------------
Revenues for the quarter ended June 30, 1997 were $5,420,881, a 133% increase
when compared to the revenues of $2,326,574 for the quarter ended June 30, 1996.
Sales grew in the holographic division with significant increases in revenues
resulting from authenticating label and tag sales for the NFL over-all licensing
program and Exelgram/R/ embossed foil sales for American Express travelers'
cheques. Strong revenue growth also occurred in OpSec's dimensional printing
division, as sales expanded based on the addition of internally controlled
manufacturing capabilities, both in the U.S. and Europe, and the purchase of the
Company's previously independent German sales agent.
15 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
RESULTS OF OPERATIONS (CONTINUED)
QUARTER ENDED JUNE 30, 1997 (CONTINUED)
- ---------------------------------------
Gross profits for the quarter ended June 30, 1997 increased 96% to $1,611,357
compared to $822,113 for the quarter ended June 30, 1996. The gross profit
margin of 29.7% decreased from the 35.3% for the comparable quarter of the prior
year. The gross profit margins are below historical performance levels, as
difficulties in our dimensional printing operations, (the processes and controls
of which were brought in-house in the second half of last year) produced a less
than optimal profit contribution. Improvements and controls that are being
implemented are expected to produce a gradual improvement in the overall profit
margin.
Operating expenses of $1,374,895 grew 82.5% compared to the prior fiscal year,
an increase of $621,598. All costs categories increased as a result of the
addition of the dimensional printing division to operations since the second
half of the last fiscal year, and the purchase of our German agent during the
third quarter of the prior fiscal year. Compensation and related costs
increased 52.7% or $221,473, depreciation and amortization increased 185.4% or
$121,950, and all other operating expenses increased 104.2% or $278,175.
Net income for the quarter ended June 30, 1997 improved $119,164 to $222,060, as
compared to $102,896 for the quarter ended June 30, 1996. Interest expense
increased $9,691 as the Company added a revolving credit line. With the
conversion of 76% of the Series B Shares into common stock during the fourth
quarter of the prior fiscal year, the dividend payment decreased $109,211 to
$35,860. No significant tax liabilities were reported for the quarter. The
Company carries significant net operating losses for U.S. tax reporting
purposes.
LIQUIDITY AND CAPITAL RESOURCES
QUARTER ENDED DECEMBER 31, 1997
- -------------------------------
The Company's working capital position at December 31, 1997 was $4,045,874.
Included in this working capital surplus was a cash position of $360,614.
Current assets were 3-to-l over current liabilities. Included in this working
capital surplus was a cash position of $360,614.
Permanent long-term financing through Economic Development Revenue Bonds of
$1,235,000 was arranged in July 1997. This facility is being used to finance
the purchase of the Company's new manufacturing facility and the improvements
and additions therein. The property was occupied on September 30, 1997, with
construction of the addition completed during the third quarter. The total
amount advanced on the bond issued at December 31, 1997 was $1,104,512.
The Company has a $2 million revolving line of credit to finance working capital
needs. The balance outstanding at December 31, 1997 was $155,000.
Earnings before interest, taxes, depreciation and amortization (EBITDA) was
$179,648 and the net loss was $44,275. This compares to EBITDA and net income
of $284,433 and $88,904, respectively.
16 of 19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
QUARTER ENDED SEPTEMBER 30, 1997
- --------------------------------
The Company's working capital position at September 30, 1997 was $4,547,216.
Current assets were 2.658-to-1 over current liabilities. Included in this
working capital surplus was a cash position of $976,783.
Permanent long-term financing through Economic Development Revenue Bonds of
$1,235,000 was secured in July 1997. This facility is being used to finance the
purchase of the Company's new manufacturing facility and the improvements and
additions being made. The property was occupied on September 30, 1997, with
construction of the addition to be completed during the third quarter. The
total amount advanced on the bond issue at September 30, 1997 was $910,145.
The Company has a $2 million revolving line of credit to finance working capital
needs. The balance outstanding at September 30, 1997 was $366,000.
Earnings before interest, taxes, depreciation and amortization (EBITDA) was
$34,814 and the net loss was $187,843. This compares to EBITDA and net income
of $260,158 and $180,832.
QUARTER ENDED JUNE 30, 1997
- ---------------------------
The Company's working capital position at June 30, 1997 was $4,407,273. Current
assets were 2.24-to-1 over current liabilities. Included in this working
capital surplus was a cash position of $1,512,351. The Company had no
significant long-term liabilities. The balance of the line of credit of
$613,729 is serving as a bridge loan for the purchase of a new manufacturing
facility located in Maryland. Permanent long-term financing through Economic
Development Revenue Bonds of $1,235,000 was secured in July 1997 which retired
the then existing line of credit balance.
The Company's purchase of the new manufacturing facility occurred in April 1997
for a purchase price of $700,000. Improvements and additions will increase the
overall cost to approximately $1.5 million, with completion and occupancy
expected to occur by October 1997.
The Company paid off $1,000,000 in short-term debt that financed a portion of
the OpSec Pasternak purchase. The payoff was funded substantially through
working capital of the Company.
Earnings before interest, taxes, depreciation and amortization (EBITDA) were
$426,423 and net income was $222,060. This compares to EBITDA and net income of
$172,429 and $102,896, respectively, in the prior year first quarter.
17 of 19
<PAGE>
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) List of Exhibits required by Item 601 of Regulation S-B:
Exhibit Exhibit Page
Number Name Reference
- ----------------------------------------------------------------
None
Date of Report Items Reported
-------------- --------------
None
18 of 19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> MAR-31-1998 MAR-31-1997
<PERIOD-START> OCT-01-1997 OCT-01-1996
<PERIOD-END> DEC-31-1997 DEC-31-1996
<CASH> 360,614 1,042,734
<SECURITIES> 0 0
<RECEIVABLES> 3,869,014 2,122,457
<ALLOWANCES> 0 0
<INVENTORY> 1,424,599 1,176,577
<CURRENT-ASSETS> 6,085,779 4,574,267
<PP&E> 3,323,460 1,010,374
<DEPRECIATION> 494,783 293,927
<TOTAL-ASSETS> 16,888,927 13,402,811
<CURRENT-LIABILITIES> 2,039,905 1,629,393
<BONDS> 0 0
0 0
18 75
<COMMON> 25,920 17,506
<OTHER-SE> 13,771,491 10,634,541
<TOTAL-LIABILITY-AND-EQUITY> 16,888,927 13,402,811
<SALES> 3,497,702 3,180,237
<TOTAL-REVENUES> 3,497,702 3,180,237
<CGS> 2,126,216 2,154,481
<TOTAL-COSTS> 1,434,488 948,769
<OTHER-EXPENSES> (11,285) (15,850)
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 3,910 3,933
<INCOME-PRETAX> (59,627) 88,904
<INCOME-TAX> (15,352) 0
<INCOME-CONTINUING> (44,275) 88,904
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (44,275) 88,904
<EPS-PRIMARY> (.02) .00
<EPS-DILUTED> 0 0
</TABLE>
