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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED MARCH 31, 1998.
COMMISSION FILE NO. 0-17531
OPTICAL SECURITY GROUP, INC.
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
COLORADO 84-1094032
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
535 - 16TH STREET, SUITE 920
DENVER, COLORADO 80202
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
ISSUER'S TELEPHONE NUMBER: (303) 534-4500
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK
(TITLE OF CLASS)
CHECK WHETHER THE ISSUER (1) FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION
13 OR 15(d) OF THE EXCHANGE ACT DURING THE PRECEDING 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 DISCLOSURE OF DELINQUENT FILERS IN RESPONSE TO ITEM 405 OF REGULATION
S-B IS NOT CONTAINED IN THIS FORM, AND NO DISCLOSURE WILL BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-KSB OR ANY AMENDMENT TO
THIS FORM 10-KSB. [X]
THE ISSUER'S REVENUE FOR ITS MOST RECENT FISCAL YEAR WAS $9,798,713.
THE AGGREGATE MARKET VALUE OF THE COMMON STOCK HELD BY NON-AFFILIATES OF THE
ISSUER, 4,403,834 SHARES OF COMMON STOCK, AS OF MAY 29, 1998, WAS APPROXIMATELY
$23,670,608, BASED ON THE CLOSING BID OF THE ISSUER'S COMMON STOCK AS REPORTED
ON THE NASDAQ STOCK MARKETSM. SHARES OF COMMON STOCK HELD BY EACH DIRECTOR,
EACH OFFICER NAMED IN ITEM 9, AND EACH PERSON WHO OWNS 10% OR MORE OF THE
OUTSTANDING COMMON STOCK HAVE BEEN EXCLUDED FROM THIS CALCULATION IN THAT SUCH
PERSONS MAY BE DEEMED TO BE AFFILIATES. THE DETERMINATION OF AFFILIATE STATUS
IS NOT NECESSARILY CONCLUSIVE.
AS OF JUNE 8, 1998, THE ISSUER HAD 5,758,950 SHARES OF COMMON STOCK OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE - NONE
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE): YES [_] NO [X]
EXHIBIT INDEX FOUND AT PAGE 23.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
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Optical Security Group, Inc., together with its subsidiaries (the
"Company"), manufactures and markets highly sophisticated holographic and other
security technologies used in a variety of security, document authentication,
product protection, anti-tampering, and marketing applications. The Company owns
patents and copyrights for several of its technologies, products, and processes,
and holds licenses or other rights for others. The Company was incorporated on
August 4, 1988, as a Colorado corporation under the name TSL Incorporated.
Business Development (Last Three Years)
- ----------------------------------------
Effective November 1, 1996, the Company acquired OpSec Pasternak & Partners
GmbH, a private company organized under the laws of Germany ("OP&P"), engaged in
the distribution of value added packaging and point-of-sale material, including
holographic and lenticular products, in Europe and the Company's European sales
agent.
On April 30, 1997, the Company purchased a manufacturing and office
facility located in Parkton, Maryland (the "Parkton Facility"). The Company
completed its improvements and moved its manufacturing facilities from Sparks,
Maryland to the Parkton Facility by November 30, 1997. The purchase and
improvements on the Parkton Facility were financed through the sale of Economic
Development Revenue Bonds.
In March 1998, the Company announced that it was discontinuing its
lenticular business (Dimensional Printing Industries, Inc.), which was started
in 1996, as it was not central to its security authentication and anti-
counterfeiting business. Discontinuance of the lenticular business will involve
terminating the production of lenticular products in Europe and consolidating
lenticular production in Denver and is expected to improve efficiency and cost-
effectiveness of the Company's buying, manufacturing, and marketing. It will
also reduce the number of employees required in operations. The Company intends
to sell the lenticular business, spin off the lenticular business to existing
shareholders in the form of a dividend, or otherwise dispose of the lenticular
business. Until such time as this occurs, the Company will continue to finance
the lenticular business. For its fiscal year ended March 31, 1998, the Company
will record a one-time charge of $2,460,000 to account for the costs associated
in discontinuing and selling the lenticular business. The Company's discussion
of the business excludes the lenticular business.
On May 29, 1998, the Company, through its newly-formed, wholly-owned
subsidiary, OpSec Advantage, Inc., a Colorado corporation ("OpSec Advantage"),
completed the purchase
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of substantially all of the assets of Advantage Technology, Inc. ("ATI"), a
Pennsylvania corporation, engaged in the business of manufacturing security
products used primarily for government document applications, such as driver's
licenses, passports, ID cards, and for tamper-evident labels. The acquisition
was effective as of May 1, 1998. In the acquisition, OpSec Advantage acquired
AdvantageTM , a chemical coating created through an array of chemical processes
protected by patents that cannot be duplicated by any graphic technology
available today, including color laser copiers or computer digital imaging.
Products
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The Company's products include foils, labels, hang tags, and other security
devices which can be designed to include:
. Holographic imaging and super-resolution Exelgram optically variable
devices (OVD's);
. Microembossed films and threads;
. Self-destructing, tamper-evident holograms;
. Write-resistant laminates or coatings; and
. Specialty coatings.
The Company's micro-embossed "AlphaDot" technology permits the encoding of
certain data in a label or hang tag. In addition, the Company is a sublicensee
of Exelgram, a latest generation holographic technology which is computer-
generated and provides very high resolution.
Markets
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The markets for the Company's security products are growing rapidly due to:
1) increasingly sophisticated technology and low-cost, global manufacturing
making counterfeiting and tampering easier, more widespread, and more difficult
to police; 2) increasing government and corporate awareness and sense of urgency
that steps must be taken soon to protect their products, brands, and documents;
and 3) innovations in optically variable devices ("OVD"), adhesives, and labels,
dramatically lowering the per unit cost and increasing the effectiveness of
using OVDs for product protection and/or document authentication.
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The following chart summarizes the Company's product areas and primary
markets:
Product Area Market Target Group
----------------------------- ------------------- ----------------
(1) Document Authentication Documents of Value Private Industry
Governments
(2) Product Protection/ Brand Protection Private Industry
Authentication Parts Authentication
Pharmaceutical
Distribution Methods. The Company has sales offices in Denver, Colorado;
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Parkton, Maryland; Lancaster, Pennsylvania; Shepshed, England; Willich, Germany;
and Singapore. The Company also distributes its products using independent
marketing agents and distributors in the United States and throughout Western
Europe and in parts of Eastern Europe, South America, and Asia. The Company also
sells its secured temporary registration permits in the United States through
the American Association of Motor Vehicle Administrators ("AAMVA").
Competition
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The Company's competitors fall into the following categories:
1. Holographic Divisions of Large Security Printers. The Company's largest
competitors are the holography divisions of security printers such as
American Bank Note ("ABN") and Thomas DelaRue (U.K.). For these
competitors, OVDs represent a relatively small revenue-generating
opportunity as compared with their main business of printing security
documents (e.g. visas, passports, and bearer bonds) and currencies.
ABN's holography division ("ABNH") derives much of its revenues from
providing holographic security on the Visa, Mastercard, and other
credit cards.
2. Security Divisions of Large Label Manufacturers. Companies such as
Avery-Denison and 3M have only recently begun to explore the potential
to apply OVDs to the products they manufacture. Both companies have
proprietary technologies which are offered as competition to OVD's.
3. Foil Manufacturers. L.G. Kurz (Germany), Markem Astor Universal, a
division of API Group Plc. ("Astor"), Holopak (U.S.A.), and Crown Roll
Leaf (U.S.A.), manufacture hot-stamped foils which also provide
holographic devices primarily for the authentication of documents. The
strategy of these companies is to be the lowest cost manufacturer of
hot-stamped foils. The Company has partnered with Astor in
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certain key holographic applications.
4. Companies Offering Specialized Technologies. Certain companies have
focused on developing applications and markets for specific patented
and proprietary technologies.
5. Holographic Label Suppliers. Certain companies such as Bridgestone, CFC
Applied, Applied Holographics, and Hologram Industries compete directly
with the Company for holographic label and foil security applications.
Bridgestone is privately held; CFC is listed on The Nasdaq Stock
MarketSM; Applied Holographics is listed on the London Stock Exchange;
and Hologram Industries on the Paris Stock Exchange.
6. OVD Brokers and Sales Agents. Literally hundreds of companies
throughout the world act as sales agents or brokers for the competitors
listed above and/or for smaller technology companies. Knowledge of the
local market and appropriate connections within the target industries
are their key competitive advantages.
7. Other Technology Companies. As in any technology industry, particularly
an infant industry, there are numerous new technologies being developed
in optical labs or by individual inventors. Most of the companies with
these technologies have little if any revenues.
Sources of Raw Materials. The Company has numerous sources for raw materials.
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Key suppliers include FLEXcon, Astor, L.G. Kurz, WEB Technologies, Adchem Corp.,
Holopak, Inc.
Significant Customers. With the exception of the licensees (as a group) of the
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National Football League Properties, representing approximately 25% of the
Company's continuing revenue in Fiscal 1998, the Company does not depend on any
single customer, or group of customers, for a significant part of its revenue.
Government Regulation and Approval. No government approval is necessary to
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offer the Company's principal products or services.
Research and Development. The Company has been involved in research and
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development for a number of different technologies and products. The Company
believes that it will continue to expend funds for research and development
activities in order to improve and broaden the Company's technologies.
Cost of Compliance With Environmental Laws. The Company's production facilities
- ------------------------------------------
generate minimal non-toxic waste, which is disposed of in the manner prescribed
by applicable law. The Company also uses independent testing laboratories or the
laboratories of its development partners for research and development, and these
laboratories are responsible for environmental compliance.
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Employees. As of March 31, 1998, the Company employed 80 employees full-time,
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and 2 employees part time.
ITEM 2. DESCRIPTION OF PROPERTIES
The Company's principal facilities are as follows:
Location Use
- -------- ---
535 16th Street Optical Security Group, Inc.
Suite 920 Corporate Office
Denver, Colorado 80202
Halskestrasse 3-5 OpSec Pasternak & Partner GmbH
47877 Willich Co. KG/International sales office
GERMANY
1809 Olde Homestead Lane OpSec Advantage
P. O. Box 10155 Manufacturing; sales office
Lancaster, Pennsylvania
17606-155
Unit 4 Gelders Hall Road OpSec International
Shepshed Leicestershire Imaging facilities; international
LE12 9NH sales office
UNITED KINGDOM
21132 Old York Road OpSec U.S.
Parkton, Maryland Manufacturing; sales office
Except for the Parkton Facility, all of the facilities are leased. The
facility located at 535 16th Street, Suite 920, is leased from a corporation of
which Mr. Richard H. Bard is an officer and shareholder. (See Item 12. Certain
Relationships and Related Transactions.)
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending to which the Company is a
party or to which any of its properties are subject.
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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 the solicitation
of proxies or otherwise.
PART II
FORWARD LOOKING STATEMENTS
To the extent that financial information and management's discussion and
analysis of financial condition and results of operations contain forward-
looking statements, such statements involve risks and uncertainties which could
cause the Company's actual results to differ materially from the anticipated
results discussed herein. Factors that might cause such a difference include,
but are not limited to, changes in demand for the Company's products and
services, changes in the level of operating expenses, the Company's inability to
successfully integrate ATI with the Company, competitive conditions, and product
supply. Recipients of this document are cautioned not to place undue reliance on
the forward-looking statements made herein.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market for Common Stock
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The Company's common stock is traded on The Nasdaq SmallCap Stock
Market/SM/ ("NASDAQ") under the symbol "OPSC." The following table sets forth,
on a per share basis, the range of high and low bid information for the common
stock for each quarter within the last two fiscal years, as reported by NASDAQ:
Year Ended March 31, 1998 High Low
First Quarter ended 06/30/97 $7.37 $6.12
Second Quarter ended 09/30/97 8.00 6.00
Third Quarter ended 12/31/97 7.25 5.75
Fourth Quarter ended 03/31/98 7.00 5.25
Year Ended March 31, 1997
First Quarter ended 06/30/96 6.25 5.75
Second Quarter ended 09/30/96 6.12 5.62
Third Quarter ended 12/31/96 6.07 5.62
Fourth Quarter ended 03/31/97 8.00 5.50
The quotations reflect inter-dealer prices without retail markup, markdown or
commission, and may not necessarily represent actual transactions.
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As of June 8, 1998, there were 864 holders of record and approximately
1,263 beneficial holders of the Company's common stock.
The Company has not paid any dividends on its common stock since inception.
Pursuant to the terms of its Series B 8% Cumulative Convertible Exchangeable
Preferred Voting Stock ("Series B Shares"), no dividends or other payments can
be declared and paid on the Company's common stock unless the Company also
declares and pays to the holders of Series B Shares 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. The payment of cash
dividends on common stock is prohibited under the Company's loan agreement with
Mercantile-Safe Deposit and Trust Company and is also restricted under the terms
of the Company's 8% Senior Subordinated Convertible Debentures due May 31, 2005
(the "Debentures").
Recent Sales of Unregistered Securities
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In June 1998, the Company completed its private placement of common stock
and Debentures. The Company raised a total of $4,030,000, of which $2,770,000
was from the sale of Debentures and $1,260,000 was from the sale of 210,000
shares of common stock. In connection with the private placement, the Company
incurred expenses of approximately $400,000, including placement fees of
$303,600 paid to Value Investing Partners, Inc.
The Company raised $2,660,000 from the sale of securities to non-U.S.
persons in reliance on the exemption from registration provided under Regulation
S of the Securities Act of 1933, as amended (the "Act"). The Company raised
$1,370,000 from the sale of securities made to accredited investors or
institutional buyers within the United States in reliance on the exemption from
registration provided under Regulation D of the Act, or alternatively, Section
4(2) of the Act. The offers and sales did not involve any public offering or any
general advertisement or solicitation. The Company also obtained written
representations from the purchasers concerning their status as an accredited
investor, institutional buyer, or non-U.S. person and their investment intent as
a basis for claiming such exemptions.
The Debentures are convertible into shares of common stock commencing from
the date of issuance, at a conversion price of $6.50 per share subject to
certain anti-dilution adjustments. Warrants to purchase a total of 24,000 shares
of common stock at an exercise price of $6.00 per share were issued to
purchasers of the common stock in connection with the placement. The Company has
undertaken to use its best efforts to register the common stock and the common
stock underlying the Debentures sold in the placement with the Securities and
Exchange Commission.
Additionally, between March 31, 1997, and May 31, 1998, the Company issued
a total of 443,834 shares of common stock in connection with (a) the exercise of
stock options granted to former directors of the Company under its Nonqualified
Stock Option Plan and former employees under its Incentive Stock Option Plan,
and (b) the exercise of warrants held by certain
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purchasers of the Company's Series B Shares. The Company received a total of
$613,033 in connection with the issuance of such shares. Such sales were made in
reliance on an exemption from registration provided by Section 4(2) of the Act
and/or Regulation S of the Act. The Company relied on written representations of
the purchasers as the basis of claiming such exemptions.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussions should be read in conjunction with the Financial
Statements and Notes thereto.
Results of Operations
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Fiscal Year Ended March 31, 1998
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Since September 1996, the Company has operated a lenticular printing
business which drew upon the imaging expertise and resources employed in its
security business. In March 1998, the Company announced that it was
discontinuing the lenticular business, as it was consuming critical resources
which will be more effectively utilized in the Company's security authentication
business. Discontinuance of the lenticular business will involve terminating the
production of lenticular products in Europe and consolidating lenticular
administration, imaging and production management in Denver. The Company intends
to sell, spin-off to existing shareholders in the form of a dividend, or
otherwise dispose of the lenticular business.
The Consolidated Statements of Operations of the Company for the fiscal
years ended March 31, 1998 and 1997, reflect the revenues and expenses of the
security business. The lenticular business is reported as discontinued
operations, and includes losses for the periods then ended, and management's
estimate of loss on sale and anticipated operating losses from April 1, 1998, to
the anticipated disposal date.
Revenues increased 61.7% to $9,798,713, and include the full-year impact of
sales of security foils to American Express Travel Services (to be applied to
its travelers' cheques) and the sale of authenticating labels and garment tags
to licensees of the National Football League. Both programs began in the second
half of the prior fiscal year, and are on-going. Expansion of the Company's
authentications program for (U.S.) States' temporary license tags also
contributed to this growth; and new markets in both Eastern Europe and South
America provided new sales opportunities during the period. The document
authentication product line will be further augmented by the purchase of
substantially all of the assets of ATI which was consummated in May 1998. ATI
will provide security coatings for application to labels and over-laminates used
to protect documents such as drivers' licenses and passports from
counterfeiting, alteration, and/or tampering.
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Gross margins declined slightly from 43.26% to 41.52%, as the mix of
business has shifted to include several large base customers at lesser margins
than on standard product lines. Improvements were made in purchasing agreements
throughout the year as volume levels could be ascertained.
Operating expenses increased $879,348 to $3,007,134. Salaries and related
costs increased $395,863, including several executive appointments, and a
significant addition to the Company's security sales and customer support teams.
Depreciation and amortization expenses increased to $301,571 from $186,403. The
increase resulted, in part from the write-off of certain patent costs and the
full-year amortization of license fees for new technology. Other operating
expenses increased $368,317, primarily the result of increased marketing,
travel, and administrative expenses. In addition, the Company increased
expenditures for research and development from $13,396 to $67,067.
The Company had net interest expense of $143 compared to net interest
income of $101,700 in the prior year. This change resulted from the utilization
of cash resources to fund lenticular operations; the addition of debt financing
for plant construction; and working capital financing as the sales and
receivables base increased. Dividends on Series B Shares amounted to $143,440
compared to $431,649 in the prior fiscal year. No income tax liability is
anticipated in either the Company's domestic or international operations.
Revenues for the year ended March 31, 1998, in the lenticular business
increased to $7,129,685, a 1.47% increase over revenues of $7,026,610 for the
year ended March 31, 1997. Gross profit margins decreased to 16.44% compared to
24.51% in the prior fiscal year. Gross profit margins were adversely affected by
inefficiencies in the start-up of lenticular product manufacturing. Operating
expenses increased $2,299,297 to $4,223,841. This increase includes full-year
operations for the lenticular production division and the European sales
division, both of which commenced operations in the third quarter of the prior
fiscal year. In addition, the division recognized bad debt expense of $613,685
due to the bankruptcy of two significant customers. Depreciation and
amortization expense increased $115,168, primarily due to the full-year
amortization of goodwill and the write-off of production tooling that was
initially developed.
Fiscal Year ended March 31, 1997
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Operations for the year ended March 31, 1997, have been restated to reflect
the discontinuance of the lenticular business, announced in March 1998.
Revenues in the Company's security business increased 60.9% to $6,059,154.
Significant growth in sales started in the late third quarter as the Company
began delivering security foils to the American Express Travel Services to be
applied to its travelers' cheques; and the sale of authenticating labels and
garment tags to licensees of the National Football League.
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Gross margins declined from 52.94% to 43.26%, as the mix of business has
shifted to include several large base customers at lesser margins than on
standard product lines. In addition, holographic originations and patterns,
generally sold at higher margin levels, became a relatively small proportion of
the sales mix.
Operating expenses increased $176,223 to $2,127,786. Salaries and related
costs increased $42,777. Depreciation and amortization expenses increased
$61,079, with the remaining cost increases spread between increased marketing,
travel and administrative expenses.
The Company had net interest income of $101,700 compared to net interest
expense of $34,341 in the prior year. The change resulted from the conversion of
subordinated debt to convertible preferred stock during the fiscal year, and the
liquidity resulting from the issuance of preferred stock during the year.
Dividends for the year on the preferred stock were $431,649.
Revenues in the Company's lenticular business grew 35.4% to $7,026,610. The
Company started the internal production of dimensional printing products during
the third quarter. Previously, the Company was an agent with a limited license
to sell similar products in Western Europe. As a result of the Company's
production capabilities, significant new accounts were added in the third and
fourth quarters in North America.
Operating expenses in the lenticular business increased $957,988 to
$1,924,544. This increase resulted in establishing a manufacturing function
based in the United States, and the purchase of the Company's agent in Germany.
Both events occurred in the third quarter of the year, and added to the cost of
operations for what was previously a United Kingdom-based sales function.
Compensation increased $174,840, depreciation and amortization increased
$361,324, and other operating expenses increased $421,824.
Liquidity and Capital Resources
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Fiscal Year Ended March 31, 1998
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The Company utilized a strong liquidity position at the beginning of the
fiscal year to fund the purchase and development of a new manufacturing plant
necessary for production for new security label customers; paid off $1 million
in seller financing on its German acquisition; and enabled the Company to obtain
favorable bond financing of $1,235,000 and a $2 million bank credit facility.
The Company's working capital position at March 31, 1998, was $1,736,803,
and its current ratio was 1.575-to-1. Included in the working capital surplus
was a cash position of $797,388. Included in current liabilities was a reserve
of $900,000 for anticipated losses in the next fiscal year in the lenticular
business. The Company's long-term debt consisted of $1,001,582 in bond financing
and $2,462 in capital lease obligations.
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The Company reported operating income of $1,060,925 and net income of
$1,032,867 from its continuing (security) business. Excluding non-cash expenses
of $301,571, earnings before interest, taxes, depreciation and amortization were
$1,362,496. The lenticular business operated at a loss of $3,052,382. A reserve
of $2,460,000 was also recorded to include an estimated loss on sale and a
reserve for losses prior to disposal. The total loss from discontinued
operations was $5,512,382. When combined with the net income from the continuing
(security) business, the Company reported a net loss of $4,479,515.
Subsequent to year end, during its fiscal quarter ending June 30, 1998, the
Company sold $4,030,000 of securities in a private placement. Of that amount,
$2,770,000 was from the sale of Debentures, and $1,260,000 was from the sale of
210,000 shares of common stock. (See Item 5. MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS - Recent Sales of Unregistered Securities.) Funds
from the private placement were used, in part, to fund the purchase of
substantially all of the assets of ATI. ATI was effectively purchased on May 1,
1998, for a short-term note of $2 million, common shares of the Company valued
at $2,000,000, and the pay-off of approximately $455,000 in debt obligations
assumed in the purchase. Remaining funds from the placement will be used to
supplement the Company's working capital position.
Fiscal Year Ended March 31, 1997
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Operations for the year ended March 31, 1997, have been restated to reflect
the discontinuance of the lenticular business announced in March 1998.
During the year ended March 31,1997, the Company raised $3,128,268, net of
offering costs from the issuance of common stock, and $679,086, net of offering
costs from the issuance of 775 Series B Shares. The funds were used to rebuild
working capital used to finance the German acquisition and the start-up of
Dimensional Printing Industries, Inc. Remaining funds were used for working
capital. Total stockholders' equity increased 91.1% to $13,767,285, up from
$7,202,659.
The Company's working capital position at March 31, 1997, was $5,092,557,
resulting in a current ratio of 3.58-to-1. Included in this working capital
surplus was a cash position of $2,064,088. The Company's long-term debt
consisted of $6,507 of capital lease obligations.
The Company reported operating income of $493,644 and net income of
$606,932 from its security business for the year ended March 31, 1997. Excluding
non-cash expenses of $186,403, earnings before interest, taxes, depreciation,
and amortization were $680,047 and net income was $793,335. Discontinued
operations contributed a net loss of $261,752 which reduced combined net income
to $345,180.
Subsequent to the year ended March 31, 1997, the Company negotiated a $2
million revolving line of credit with Mercantile-Safe Deposit and Trust Company.
The credit facility is secured by the assets of the Company. The Company uses
such credit facility to finance
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inventories and trade supplies. The credit facility was also used to bridge
financing to purchase the Parkton Facility. The Company replaced such financing
in July 1, 1997, with $1,235,000 of Economic Development Revenue Bond ("EDRB")
financing. The revolving line and EDRB are cross collateralized and cross
defaulted.
Computerized Operations and the Year 2000
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Based on an internal review of its data processing, operating,
manufacturing and other computer-based systems, the Company does not currently
believe that it will experience any significant adverse effects or material
unbudgeted costs resulting from the inability of current technology to process
properly the change from the year 1999 to 2000. However, if the Company's
suppliers and customers cannot process properly the change from the year 1999 to
2000, the Company may be adversely affected.
ITEM 7. FINANCIAL STATEMENTS
The financial statements required by this item are included herein starting
at page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
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PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Directors and Executive Officers
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Directors, executive officers, and significant employees of the Company, as
of June 15, 1998, are as follows:
Name Age Position
---- --- --------
Richard H. Bard 50 Chairman of the Board, and Chief
Executive Officer
Mark T. Turnage 37 President and Chief Operating Officer
Edward Dietrich 45 President of OpSec U.S., and
Senior Vice President Sales.
Catherine M. Gotwalt 42 Secretary
Martin T. Hart 62 Director
J. R. Holland, Jr. 54 Director
Richard D. Lamm 63 Director
Gerald A. Melfi 47 Chief Accounting Officer and Treasurer
Bruce I. Raben 44 Director
RICHARD H. BARD has been a director and chief executive officer of the Company
since September 1993. He was elected chairman of the board in April 1994. Mr.
Bard served as president from April 1994 to July 1997, and treasurer from
September 1993 to December 1994. Mr. Bard is also the chief executive officer of
Bard & Co., Inc., a diversified investment management company, and chairman of
Security Technology Group, Inc., a private company involved in electronic
security system integration. From 1989 to 1991, Mr. Bard was vice-chairman of
ComputerLand Corporation and chief executive officer of ComputerLand
International, Inc (since renamed Vanstar Corporation). From 1986 to 1988, Mr.
Bard was chairman and chief executive officer of Coast America Corporation, the
franchisor of Coast-to-Coast Hardware stores. From 1978 to 1986, Mr. Bard was
the president and chief operating
13
<PAGE>
officer of FoxMeyer Corporation, a large pharmaceutical distributor and
franchisor of drug stores. Mr. Bard is also a director of Vanstar Corporation.
EDWARD DIETRICH has been president of OpSec U.S. since July 1997, and senior
vice president sales since October 1996. Mr. Dietrich served as vice president
sales of OpSec U.S. from August 1994 to October 1996. Mr. Dietrich was employed
by American Bank Note Holographics, Inc. from February 1992 until August 1994 as
the director of sales and marketing. From June 1989 to February 1992, he was
vice-president of United States business development for Business Vision
Management Systems, Inc., a computer software company.
MARTIN T. HART has been a director since December 1993 and serves as the
chairman of the Compensation Committee, and as a member of the Audit Committee
and Nominating Committee. Mr. Hart has been a Denver-based businessman and
investor for the past twenty-eight years. He is also a director of Schuler
Homes, Inc., T. Netiks, P.J. America, Inc. and PNB Financial Group, the holding
company for Pacific National Bank, and a trustee of MassMutual Corporate
Investors and MassMutual Participation Investors.
J. R. HOLLAND, JR. has been a director since July 1994 and serves as chairman of
the Audit Committee, and as a member of the Nominating Committee. Since 1991, he
has been the managing director of Hunt Capital Group, L.L.C. and president and
chief executive officer of Unity Hunt, Inc., diversified investment
companies based in Dallas, Texas. He is also a director of Placid Refining
Company, Heartland Wireless Communications, Inc., and TNP Enterprises, Inc.
RICHARD D. LAMM has been a director since December 1993 and serves on the Audit
Committee. He previously served as a director from 1989 through 1992. Since
1987, Mr. Lamm has been a professor and director of the Center for Public Policy
and Contemporary Issues at the University of Denver. He was a law partner at
Berliner, Boyle, Pablan, Zisser and Walter P.C. and O'Connor and Hannan, from
1987 until 1992. Mr. Lamm served as the governor of the state of Colorado from
1975 to 1987.
BRUCE I. RABEN has been a director since February 1995. He serves as chairman of
the Nominating Committee and is a member of the Compensation Committee. Since
February 1996, Mr. Raben has been the managing director of CIBC Oppenheimer
Securities Corp. in Los Angeles. From March 1990 until January 1996, he served
as the executive vice president and director of corporate finance at Jefferies &
Company, Inc., an investment banking firm. He is also a director of Equity
Marketing, Inc. and Terex Corporation.
MARK T. TURNAGE has been president and chief operating officer of the Company
since July 1, 1997. Mr. Turnage served as managing director of OpSec
International from November 1995 to July 1997 and prior to that as vice
president from July 1994 to July 1997. From 1991 to 1994, Mr. Turnage practiced
law with Davis, Graham & Stubbs in Denver, Colorado. From 1986 to 1989, Mr.
Turnage served as a management consultant with McKinsey & Co.
14
<PAGE>
There are no family relationships among the Company's directors or
executive officers. The directors of the Company serve in such capacity until
the next annual meeting of the Company's shareholders. Committee members are
appointed by the board of directors to serve a one year term or until their
successors have been elected. Mr. Bard has an employment agreement with the
Company. The Company's other officers serve at the discretion of the Company's
board of directors.
To the Company's knowledge, none of the above listed individuals has been
involved in legal proceedings during the last five years that are material to an
evaluation of the ability or integrity of any director, executive officer,
promoter or control person.
Compliance with Section 16(a) of the Exchange Act
- -------------------------------------------------
The Company believes that during the fiscal year ended March 31, 1998, its
directors, officers and greater than 10% beneficial owners complied with all
filing requirements under Section 16(a) of the Exchange Act.
15
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth in summary form the compensation received
during each of the Company's last three completed fiscal years by the chief
executive officer ("CEO") of the Company and each of the Company's other
executive officers (two officers) whose total annual salary and bonus exceeded
$100,000 (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
Annual Compensation Long-Term
------------------- Compensation
Awards
------------
Securities
Underlying All Other
Name Year Salary Options Compensation
- ---- ---- ------ ------------ ------------
Richard H. Bard 1998 $175,000 50,000 --
Chief Executive 1997 $150,000 342,878 --
Officer 1996 $125,000 300,000 --
since 9/17/93 and
President 4/1/94-7/1/97
Mark T. Turnage 1998 $120,505 50,000 $11,519(1)
President since 1997 $ 77,600 80,000 $41,984(1)
7/1/97; 1996 $ 67,629 20,000 --
Managing Director
of OpSec
International
11/95-7/97
Edward Dietrich 1998 $111,667 50,000 --
President OpSec 1997 $ 80,625 50,000 --
U.S. since 7/1/97; 1996 $ 77,500 10,000 --
Sr.VP Sales 10/96
to present; VP Sales
OpSec U.S. 8/94 to
10/96
_____________________
(1) Fiscal 1998 and Fiscal 1997 housing allowance paid on behalf of Mr. Turnage
relating to his overseas assignment in the United Kingdom.
16
<PAGE>
Stock Options
- -------------
The following table sets forth information concerning stock options granted
during the fiscal year ended March 31, 1998, to the Named Executive Officers.
Each option represents the right to purchase one share of the Company's common
stock.
OPTIONS GRANTED IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
% OF TOTAL
# SECURITIES OPTIONS GRANTED
UNDERLYING TO EMPLOYEES IN EXERCISE EXPIRATION
NAME OPTIONS FISCAL YEAR PRICE DATE
- ---- ------- ----------- ----- ----
Richard H. Bard 50,000 (1) 18% $6.00 July 16, 2002
Mark Turnage 50,000 (2) 18% $6.37 June 15, 2002
Edward Dietrich 50,000 (2) 18% $6.37 June 15, 2002
_______________________________________
(1) Issued under the Company's Nonqualified Stock Option Plan.
(2) Issued under the Company's Incentive Stock Option Plan. Vesting ratably
over four years beginning June 16, 1998.
17
<PAGE>
Stock Options
- -------------
The following table sets forth information concerning each exercise of
stock options during the fiscal year ended March 31, 1998, for the Named
Executive Officer and the fiscal year-end value of all unexercised in-the-money
options (regardless of when granted) held by such person.
AGGREGATED OPTION/EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION/VALUES
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs at Options/SARs
FY-End(#) at FY-End($)
Shares Acquired Value Exercisable/ Exercisable/
Name on Exercise(#) Exercised Unexercisable Unexercisable(1)
- --------------- --------------- --------- ------------- ---------------
Richard H. Bard - - 1,092,878/0 $632,000/$.0
Mark T. Turnage - - 73,333/ $ 45,700/
126,667 $ 10,600
Edward Dietrich - - 65,833/ $ 45,700/
104,167 $ 10,600
_______________
(1) Market value of underlying securities based on the average of the high and
low bid of the Company's common stock on March 31, 1998, on NASDAQ of $5.44 per
share minus the exercise price.
Long-Term Incentive Plans - Awards in Last Fiscal Year
- ------------------------------------------------------
There were no awards made to any Named Executive Officer under any long-
term incentive plans.
Repriced Options
- ----------------
In the fiscal year ended March 31, 1998, there were no actions taken
regarding the repricing of options relating to Executive Officer Compensation.
18
<PAGE>
Employee Pension, Profit Sharing or Other Retirement Plans
- ----------------------------------------------------------
The Company does not have a defined benefit, pension plan, profit sharing
or other retirement plan.
Compensation of Directors
- -------------------------
Standard Arrangements. Beginning July 1, 1997, outside directors received
---------------------
a director's fee of $1,000 per attendance at all regular meetings on the board
of directors. Additionally, directors serving as committee members received a
fee of $500 per attendance at each regularly scheduled committee meeting.
Other Arrangements. During the year ended March 31, 1998, the Company did
------------------
not grant stock options to any non-officer directors.
Employment Contracts
- --------------------
Mr. Richard H. Bard, the Company's chief executive officer, is in the third
and last year of his employment contract, which terminates March 31, 1999. The
employment contract provides for a salary of $200,000 for the third year and
bonuses in such amount as the board of directors may determine. Additionally,
Mr. Bard, under his employment agreement, is entitled to grants of stock options
during the term of the contract in an amount sufficient to maintain a 20%
beneficial ownership of the common stock, his beneficial ownership of the common
stock as of December 31, 1995 ("Base Ownership"). If the Company is sold or
merged into another company prior to March 31, 2000, Mr. Bard is entitled to a
stock bonus of 250,000 shares of common stock. In addition to benefits available
generally to other Company employees, Mr. Bard is entitled to a $500 per month
automobile allowance and reimbursement of expenses incurred on behalf of the
Company. If the Company terminates Mr. Bard's employment prior to the expiration
of the contract, Mr. Bard is entitled to a buyout at 150% of the value of the
contract at the time of termination. During the fiscal year ended March 31,
1998, no bonus was granted to Mr. Bard; however, to maintain his Base Ownership,
Mr. Bard was issued options from the Nonqualified Stock Option Plan to purchase
50,000 shares of common stock. (See "Item 10. Executive Compensation.")
No other executive officers have written employment contracts with the
Company or any termination or change of control benefits.
19
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security Ownership of Certain Beneficial Owners and Management.
- --------------------------------------------------------------
The following table sets forth, as of June 8, 1998, the number of and
percentage of outstanding shares of the Company's common stock, beneficially
owned by (a) all directors and nominees, naming them, (b) the Named Executive
Officers, (c) the directors and executive officers of the Company as a group,
without naming them, and (d) persons or groups known by the Company to own
beneficially 5% or more of the common stock:
Name and Address of Amount and Nature of Title Percent
Beneficial Owner Beneficial Ownership of Class of Class
- ---------------------------- -------------------- -------- ---------
Richard H. Bard 1,808,343(1) Common 25.93%
535 16th Street, Suite 920
Denver, CO 80202
Yoram Curiel 337,135(2) Common 5.65%
9400 E. Iliff Ave., #303
Denver, CO 80231
Edward Dietrich 89,568(3) Common 1.53%
535 16th Street, #920
Denver, CO 80206
Martin T. Hart 242,148(4) Common 4.15%
875 Race Street
Denver, CO 80206
J.R. Holland, Jr. 15,000(5)(6) Common 00.26%
4000 Thanksgiving Tower
1601 Elm Street
Dallas, TX 75201
Hunt Capital Group, L.L.C. 838,929(6)(7) Common 13.80%
4000 Thanksgiving Tower
1601 Elm Street
Dallas, TX 75201
20
<PAGE>
Richard D. Lamm 71,583(8) Common 1.24%
c/o University of Denver
2050 East Iliff, #224
Denver, CO 80208
Gudrun Pasternak/ 466,668(9) Common 8.10%
Hans M. Andresen
Halskestrasse 3-5
47877 Willich
Germany
Philena Enterprises, Inc./ 403,635(10) Common 7.01%
Mark Bar
P. O. Box 6246
Denver, CO 80206
Bruce I. Raben 66,679(11) Common 1.15%
Suite 2340
1999 Avenue of the Stars
Los Angeles, CA 90067
Mark T. Turnage 102,006(12) Common 1.74%
535 16th Street, #920
Denver, CO 80202
Advantage Technology, Inc. 300,000 Common 5.20%
676 Patriot Lane
Lancaster, PA 17601
All executive officers 2,437,397(13) Common 33.12%
and directors as a group
(9 persons)
_______________________
(1) Includes 170,000 shares held in an IRA, and shares held as custodian for a
family member. In addition, includes the right to acquire, currently or
within 60 days, 1,215,878 shares of common stock.
(2) Includes 15,534 shares held by a family member and 10,000 shares held by
entities controlled by Mr. Curiel.
(3) Includes the right to acquire, currently or within 60 days, 88,333 shares
of common stock.
21
<PAGE>
(4) Includes the right to acquire, currently or within 60 days, 79,000 shares
of common stock.
(5) Includes the right to acquire, currently or within 60 days, 15,000 shares
of common stock.
(6) Mr. Holland is the manager and president of Hunt Capital Group, L.L.C. Mr.
Holland has no ownership interest in Hunt Capital Group, L.L.C. and
disclaims beneficial ownership of the shares held by Hunt Capital Group,
L.L.C.
(7) Includes the right to acquire, currently or within 60 days, 320,000 shares
of common stock.
(8) Includes 9,470 shares held as trustee for family members and 10,200 shares
held by his spouse. In addition, includes the right to acquire, currently
or within 60 days, 25,000 shares of common stock.
(9) Gudrun Pasternak and Hans M. Andresen are husband and wife and each own
233,334 shares of common stock. Ms. Pasternak disclaims beneficial
ownership of the shares held by Ms. Andresen. Mr. Andresen disclaims
beneficial ownership of the shares held by Ms. Pasternak.
(10) Mr. Mark Bar is the president of Philena Enterprises, Inc. and, for
purposes of calculating the percentage of beneficial owner, the shares held
by Philena Enterprises, Inc., Mr. Bar, and Mr. Bar's spouse have been
aggregated.
(11) Includes 6,000 shares held by Mr. Raben's spouse. Mr. Raben disclaims
beneficial ownership of these shares. In addition, includes the right to
acquire, currently or within 60 days, 48,333 shares of common stock.
(12) Includes 6,173 shares held as trustee for family members, and the right to
acquire, currently or within 60 days, 95,833 shares of common stock.
(13) Includes the right to acquire, currently or within 60 days, 1,601,210
shares of common stock.
As of June 8, 1998, the Company also had outstanding 1,738 Series B Shares.
The holders of the Series B Shares are entitled to one vote for each share of
common stock issuable upon conversion of the Series B Shares (166.67 common
shares for each Series B Share) on all matters to which holders of the common
stock are entitled to vote. In addition, under Colorado law, the holders are
entitled to vote on certain matters, including matters effecting the rights of
the Series B Shares, as a class. No director or executive officer owns
beneficially any Series B Shares.
22
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following outlines certain relationships and related transactions
during the fiscal years ended March 31, 1997, and March 31, 1998.
Effective March 27, 1997, the Company completed a private offering of
526,899 shares of common stock. The purchase price of such shares was $6.00 per
share. The purchasers of the shares were granted certain registration rights. In
the offering, Mr. Bard and Mr. Lamm and his spouse purchased 16,866 and 12,000
shares of common stock for a purchase price of $101,200 and $72,000,
respectively.
The Company leases its Denver office space from 16th & Welton Investment,
Inc., a corporation owned by Mr. Bard and members of his immediate family. In
the fiscal year ended March 31, 1998, the Company paid a total of $88,158 under
such leases. Unless renewed or extended, the leases expire in 2000.
Mr. Bard has an employment agreement with the Company. (See Item 10.
EXECUTIVE COMPENSATION - Employment Contracts.)
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
Financial Statements:
- --------------------
For a list of financial statements, see INDEX TO FINANCIAL STATEMENTS, page
26.
(a) List of Exhibits required by Item 601 of Regulation S-B:
Exhibits filed herewith:
------------------------
Exhibit Exhibit Page
Number Name Reference
------ ---- ---------
21.1 List of Subsidiaries Filed herewith at 21.1.1
27.1 Financial Data Schedule Filed herewith at 27.1
23
<PAGE>
Exhibits incorporated by reference:
----------------------------------
Number Exhibit Date
of Exhibit Name Form Filed Number
---------- ---- ---- -------- ------
3(i) Amended and S-3/A 10/16/96 3.24
Restated Articles
of Incorporation
3(ii) Amended and 10-KSB 06/28/95 3.22
Restated Bylaws
4.1 Form of Debentures 8-K 06/15/98 4.1
10.1 Purchase of Parkton 10-QSB 08/08/97 10.1.1
Facility
10.2 Employment Agreement 10-KSB 06/25/96 10.1.1
between the Company
and Richard H. Bard
(b) Reports on Form 8-K during the Company's fourth fiscal quarter ending March
31, 1998.
Date of Report Items Reported
-------------- --------------
None
24
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
OPTICAL SECURITY GROUP, INC.
Date: June 26, 1998 By: /s/ Richard H. Bard
--------------------------------
Richard H. Bard, Chief Executive
Officer and Director
Date: June 26, 1998 By: /s/ Gerald A. Melfi
--------------------------------
Gerald A. Melfi, Principal
Financial Officer
Date: June 26, 1998 By: /s/ Martin T. Hart
--------------------------------
Martin T. Hart, Director
Date: June 26, 1998 By: /s/ J.R. Holland, Jr.
--------------------------------
J. R. Holland, Jr., Director
Date: June 26, 1998 By: /s/ Richard D. Lamm
--------------------------------
Richard D. Lamm, Director
Date: June 26, 1998 By: /s/ Bruce I. Raben
--------------------------------
Bruce I. Raben, Director
25
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULES
Table of Contents
- -----------------
Financial Statements: Page
----
Report of Independent Auditors F-1
Balance Sheets F-2
Statements of Operations F-4
Statement of Stockholders' Equity F-6
Statements of Cash Flow F-7
Notes to Financial Statements F-9
26
<PAGE>
Optical Security Group, Inc.
Consolidated Financial Statements
Years ended March 31, 1998 and 1997
CONTENTS
Report of Independent Auditors..........................................F-1
Audited Consolidated Financial Statements
Consolidated Balance Sheets.............................................F-2
Consolidated Statements of Operations...................................F-4
Consolidated Statements of Stockholders' Equity.........................F-6
Consolidated Statements of Cash Flows...................................F-7
Notes to Consolidated Financial Statements..............................F-8
<PAGE>
Report of Independent Auditors
Board of Directors and Stockholders
Optical Security Group, Inc.
We have audited the accompanying consolidated balance sheets of Optical Security
Group, Inc. as of March 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Optical Security
Group, Inc. as of March 31, 1998 and 1997, and the consolidated results of its
operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
ERNST & YOUNG LLP
Denver, Colorado
May 29, 1998
F-1
<PAGE>
Optical Security Group, Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
MARCH 31
1998 1997
------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 797,388 $ 2,064,088
Accounts receivable, less allowance of $19,353 and
$11,287 in 1998 and 1997, respectively 2,143,303 2,001,777
Inventory 906,747 650,338
Prepaid expenses 262,956 280,171
Net current assets of discontinued operations 647,685 2,068,194
-------------------------------
Total current assets 4,758,079 7,064,568
Property and equipment, net 2,392,676 572,141
Other assets:
Patents and patent applications, net of accumulated
amortization of $98,327 and $89,610 in 1998
and 1997, respectively 259,475 315,471
Goodwill, net of accumulated amortization of
$262,516 and $195,490 in 1998 and 1997,
respectively 1,077,989 1,145,015
License and noncompete agreements, net of
accumulated amortization of $241,332 and
$162,634 in 1998 and 1997, respectively 498,737 660,239
Deposits and other assets 207,895 113,383
Net long-term assets of discontinued operations 4,289,781 5,900,826
-------------------------------
Total assets $13,484,632 $15,771,643
===============================
</TABLE>
F-2
<PAGE>
Optical Security Group, Inc.
Consolidated Balance Sheets (continued)
<TABLE>
<CAPTION>
MARCH 31
1998 1997
----------------------------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,146,312 $ 552,156
Accrued expenses 338,235 404,279
Current portion of capital lease obligations 4,385 15,576
Current portion of long-term debt 632,344 1,000,000
Allowance for operating losses of discontinued
operations 900,000 -
----------------------------------
Total current liabilities 3,021,276 1,972,011
Deferred tax liability - 25,840
Capital lease obligations 2,462 6,507
Long-term debt 1,001,582 -
Stockholders' equity:
Voting convertible preferred stock, $0.01 par value:
2,500,000 shares authorized; 1,793 Preferred
Series B shares issued and outstanding
(preference in liquidation $1,954,370) 18 18
Common stock, $0.005 par value:
15,000,000 shares authorized; 5,230,619 and
4,973,952 shares issued and outstanding in 1998
and 1997, respectively 26,153 24,870
Additional paid-in capital 20,399,614 20,113,208
Foreign currency translation adjustment 78,675 51,382
Accumulated deficit (11,045,148) (6,422,193)
----------------------------------
Total stockholders' equity 9,459,312 13,767,285
----------------------------------
Total liabilities and stockholders' equity $ 13,484,632 $15,771,643
==================================
</TABLE>
Commitments (See Note 9)
See accompanying notes.
F-3
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31
1998 1997
-----------------------------------
<S> <C> <C>
Revenues $ 9,798,713 $ 6,059,154
Cost of goods sold 5,730,654 3,437,724
-----------------------------------
Gross margin 4,068,059 2,621,430
Operating expenses:
Salaries and related costs 1,548,604 1,152,741
Depreciation 113,720 70,161
Amortization 187,851 116,242
Other operating expenses 1,156,959 788,642
-----------------------------------
Total operating expenses 3,007,134 2,127,786
-----------------------------------
Income from operations 1,060,925 493,644
Other income (expense):
Interest income 36,929 101,700
Interest expense (37,072) -
Other (48,188) (384)
Foreign currency transaction income 1,756 1,303
-----------------------------------
Total other income (expense) (46,575) 102,619
-----------------------------------
Income before income taxes 1,014,350 596,263
Income tax benefit 18,517 10,669
-----------------------------------
Income from continuing operations 1,032,867 606,932
Discontinued operations:
Loss from operations of discontinued segment (3,052,382) (261,752)
Loss on disposal of business segment, including
provision of $900,000 for operating losses during
phase-out period (2,460,000) -
-----------------------------------
Total loss from discontinued operations (5,512,382) (261,752)
-----------------------------------
Net income (loss) (4,479,515) 345,180
Dividends on preferred stock 143,440 431,649
Net loss applicable to common stock $(4,622,955) $ (86,469)
===================================
</TABLE>
F-4
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Operations (continued)
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31
1998 1997
---------------------------------
<S> <C> <C>
Earnings (loss) per share:
Basic:
Continuing operations $ 0.18 $ 0.05
Discontinued operations (1.09) (0.08)
---------------------------------
Net loss applicable to common stock $ (0.91) $ (0.03)
=================================
Diluted:
Continuing operations $ 0.15 $ 0.04
Discontinued operations (0.94) (0.06)
---------------------------------
Net loss applicable to common stock $ (0.79) $ (0.02)
=================================
Weighted average number of shares outstanding:
Basic: 5,056,039 3,381,037
=================================
Diluted:
Weighted shares outstanding 5,056,039 3,381,037
Shares attributed to options and warrants 800,418 957,423
---------------------------------
5,856,457 4,338,460
=================================
</TABLE>
See accompanying notes.
F-5
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
FOREIGN
ADDITIONAL CURRENCY TOTAL
PREFERRED SERIES B COMMON STOCK PAID-IN TRANSLATION ACCUMULATED STOCKHOLDERS'
------------------ -----------------
SHARES AMOUNT SHARES AMOUNT CAPITAL ADJUSTMENT DEFiCIT EQUITY
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at March 31, 1996 6,693 $ 67 3,034,552 $15,173 $13,515,502 $ 7,641 $ (6,335,724) $ 7,202,659
Stock issued for cash:
Preferred Series B, net of
issuance costs of $95,914 775 8 - - 679,078 - - 679,086
Common stock, net of issuance
costs of $33,114 - - 526,899 2,635 3,125,633 - - 3,128,268
Stock issued upon conversion:
Conversion of Preferred Series
A into common stock, net of
issuance costs of $4,672 (5,675) (57) 945,833 4,729 (4,672) - - -
Common stock issued in business
combination - - 466,668 2,333 2,797,667 - - 2,800,000
Dividend declared on Preferred
Series B - - - - - - (431,649) (431,649)
Foreign currency translation
adjustment - - - - - 43,741 - 43,741
Net income - - - - - - 345,180 345,180
---------------------------------------------------------------------------------------------------
Balance at March 31, 1997 1,793 18 4,973,952 24,870 20,113,208 51,382 (6,422,193) 13,767,285
Warrants exercised - - 4,167 21 24,981 - - 25,002
Options exercised - - 252,500 1,262 279,167 - - 280,429
Issuance costs on prior year
stock issue - - - - (17,742) - - (17,742)
Dividend declared on Preferred
Series B - - - - - - (143,440) (143,440)
Foreign currency translation
adjustment - - - - - 27,293 - 27,293
Net loss - - - - - - (4,479,515) (4,479,515)
---------------------------------------------------------------------------------------------------
Balance at March 31, 1998 1,793 $ 18 5,230,619 $26,153 $20,399,614 $78,675 $(11,045,148) $ 9,459,312
===================================================================================================
</TABLE>
See accompanying notes.
F-6
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31
1998 1997
----------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $(4,479,515) $ 345,180
Adjustments to reconcile net income (loss) to net
cash provided (used) in operating activities:
Depreciation and amortization 945,064 519,109
Deferred tax benefit (25,840) (6,460)
Changes in operating assets and liabilities:
Accounts receivable 1,952,812 (3,302,620)
Inventory (18,465) (1,204,992)
Prepaid expenses (39,485) (204,701)
Accounts payable and accrued expenses (326,964) 1,934,211
Reserve for discontinued operations 2,460,000 -
----------------------------------
Net cash provided (used) in operating activities 467,607 (1,920,273)
INVESTING ACTIVITIES
Patent application costs (33,189) (66,964)
Acquisition--OpSec Pasternak & Partner GmbH (3,321) (1,183,756)
Acquisition--Dimensional Printing Industries, Inc. - (650,668)
Purchases of property and equipment (2,440,333) (418,352)
Licensing agreements (2,641) (195,414)
Other deposits and intangible assets 42,391 (107,832)
----------------------------------
Net cash used in investing activities (2,437,093) (2,622,986)
FINANCING ACTIVITIES
Proceeds from issuance of common stock, net 287,689 3,128,268
Proceeds from issuance of preferred stock, net - 679,086
Loan proceeds 1,695,845 -
Payments on notes and capital lease obligations (1,077,155) (43,922)
Cost of financing (87,446) -
Payments of preferred stock dividends (143,440) (431,649)
----------------------------------
Net cash provided by financing activities 675,493 3,331,783
Effect of exchange rate changes on cash flows 27,293 43,741
----------------------------------
Net decrease in cash (1,266,700) (1,167,735)
Cash, beginning of year 2,064,088 3,231,823
----------------------------------
Cash, end of year $ 797,388 $ 2,064,088
==================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW ACTIVITIES
Interest paid $ 37,072 $ 24,808
Common stock issued to acquire OpSec Pasternak &
Partner GmbH - 2,800,000
Promissory note issued to acquire OpSec Pasternak &
Partner GmbH - 1,000,000
Conversion of Preferred Series B shares into common
stock - 3,908,294
Equipment acquired through capital lease transactions - 12,268
</TABLE>
See accompanying notes.
F-7
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements
March 31, 1998
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. ("OpSec
U.S."), Optical Security Industries International, Plc ("OpSec International"),
Dimensional Printing Industries, Inc. ("DPI") and OpSec Pasternak & Partner GmbH
& Co., KG ("OpSec Pasternak") 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 other commercial applications,
including holography and dimensional printing ("lenticular products") for book
illustrations and for consumer product promotions. The Company's principal
markets are the United States and Western Europe. Refer to Note 3 for
discussions regarding the Company's intent to dispose of the lenticular products
business.
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
F-8
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
are reflected in the consolidated statements of operations. 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.
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. With the exception of two unusual bad debt losses
aggregating $613,685 in the lenticular business, for fiscal year 1998, 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, accounts receivable,
accounts payable and long-term debt, 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:
<TABLE>
<CAPTION>
YEARS
-------------
<S> <C>
Buildings 39
Leasehold improvements 2-12
Computer equipment 5
Other equipment and furniture 5-7
Production equipment 5-10
Vehicles 4
</TABLE>
F-9
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statement (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Property and equipment at March 31 consist of:
<TABLE>
<CAPTION>
1998 1997
-------------------------------
<S> <C> <C>
Land $ 304,066 $ -
Buildings 1,342,677 -
Leasehold improvements 124,535 107,698
Computer equipment 292,653 229,308
Other equipment and furniture 57,616 54,239
Production equipment 622,543 433,466
Vehicles 46,040 75,647
-------------------------------
2,790,130 900,358
Less accumulated depreciation (397,454) (328,217)
-------------------------------
$2,392,676 $ 572,141
===============================
</TABLE>
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 March 31, 1998 is associated with the acquisition of
OpSec Pasternak and the purchase of a minority interest in DPI in fiscal 1997,
and the acquisition of ELEF, Plc during fiscal year 1995.
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.
All goodwill associated with the lenticular business has been reclassified as
discontinued operations (see Note 3).
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
F-10
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 consisted principally of raw materials,
including polyester films and foils used in holographic label production and
lens material used in dimensional printing. A portion of the inventory
consisted of work-in-process and finished goods.
PATENTS AND PATENT APPLICATIONS
The Company capitalizes legal costs and other fees 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.
Amortization expense in 1998 includes the $68,080 write-off of patents that were
considered to have no future benefit.
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
due to alternative technologies developed by similar entities.
NEW ACCOUNTING PRONOUNCEMENTS
During 1997, the FASB issued Statement No. 130, Reporting Comprehensive Income,
which establishes standards for reporting and display of comprehensive income
and its components (revenues, expenses, gains, and losses) in a full set of
general-purpose financial statements. This Statement requires that all items
that are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. In addition, this Statement
requires that an enterprise classify items of other comprehensive income by
their nature in a financial statement and display the accumulated balance of
other comprehensive income separately from retained earnings and additional
paid-in capital in the equity section of a statement of financial position.
F-11
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Statement is effective for fiscal years beginning after December 15, 1997.
Management believes there will be no significant impact on the Company's
financial reporting as a result of adopting this Statement.
During 1997, the FASB issued Statement No. 131, Disclosures about Segment
Reporting of an Enterprise and Related Information, which establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosure about products and services, geographic areas, and major customers.
This Statement is effective for fiscal years beginning after December 15, 1997.
Management does not expect any significant changes as a result of adopting this
Statement.
LOSS PER SHARE OF COMMON STOCK
In 1997, the FASB issued Statement No. 128, Earnings per Share ("SFAS No. 128").
SFAS No. 128 replaced the calculation of primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. Diluted earnings per share is very similar
to the previously reported fully diluted earnings per share. The Company has
reported its income or loss per share for both continuing and discontinued
operations, after preferred stock dividend requirements. Loss per share for the
years ended March 31, 1998 and 1997 is based on weighted average shares of
common stock outstanding of 5,056,039 and 3,381,037, respectively. Common
equivalent shares from stock options and warrants have been included in the
computation of income per share from continuing and discontinued operations for
diluted earnings per share in accordance with SFAS 128. The convertible
preferred stock has been excluded from the calculation as the effect, net of
related dividend requirements, would be antidilutive.
F-12
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESEARCH AND DEVELOPMENT
Research and development costs are expensed in the period incurred. During the
year ended March 31, 1998, the Company incurred $330,150 in costs, of which
$67,067 was for continuing operations and $263,083 was for discontinued
operations. Research and development costs for the fiscal year ended March 31,
1997 were immaterial.
RECLASSIFICATIONS
Certain amounts in the March 31, 1997 financial statements were reclassified to
conform with the March 31, 1998 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 $5,021,239. OpSec Pasternak 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, Inc. 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 during the fiscal year for a
total cost of $650,668, including all related acquisition costs, which have been
recorded as goodwill.
Both of the businesses are part of the lenticular segment, which is being
discontinued (see Note 3).
F-13
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
3. DISCONTINUED OPERATIONS
Since September 1996, the Company has operated a lenticular printing business
which drew upon the imaging expertise and resources employed in its security
business. In March 1998, the Company announced that it was discontinuing the
lenticular business, as it was not central to its core competency or strategy of
dominating the security authentication and anti-counterfeiting business.
Discontinuance of the lenticular business will involve terminating the
production of lenticular products in Europe and consolidating lenticular
production in Denver, and is expected to improve efficiency and cost-
effectiveness of the Company's buying, manufacturing, and marketing. It will
also reduce the number of employees required in operations. The Company intends
to sell, spin off to existing shareholders in the form of a dividend, or
otherwise dispose of the lenticular business. Until such time as this occurs,
the Company will continue to finance the lenticular business. The Company's
ability to spin off the lenticular business may be limited due to restrictions
in the Debentures issued in the first quarter of fiscal 1999, which limit the
Company's right to provide start-up funding to a spun-off entity. The Company
has estimated a loss on disposal. As the utilization of prior and future losses
for tax purposes is uncertain, the loss on disposal, shown below, has not been
reduced for possible tax benefits.
<TABLE>
<S> <C>
Estimated loss on sale and related costs $1,560,000
Operating losses from April 1, 1998 to
anticipated disposal date 900,000
----------
$2,460,000
==========
</TABLE>
Sales of the lenticular business were $7,129,686 and $7,026,610 in the years
ended March 31, 1998 and 1997, respectively. The net operating loss for the
same periods was $3,051,587 and $202,135 in 1998 and 1997, respectively.
F-14
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
3. DISCONTINUED OPERATIONS (CONTINUED)
Assets and liabilities for the lenticular business have been segregated from
those of the continuing operation. The consolidated balance sheet and statement
of operations for fiscal 1997 have been restated to reflect the discontinued
operations. The summarized presentation in the balance sheet is more fully
explained below:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31
1998 1997
-------------------------------------
<S> <C> <C>
Net current assets:
Accounts receivable, net $ 1,009,851 $ 3,104,189
Inventory 738,470 976,414
Other current assets 66,899 10,199
Accounts payable (947,790) (1,495,191)
Accrued expenses (219,745) (527,417)
-------------------------------------
Net current assets $ 647,685 $ 2,068,194
=====================================
Net long-term assets:
Property and equipment, net $ 581,095 $ 368,818
Goodwill and other intangible assets 5,268,686 5,532,008
Less estimated loss on sale (1,560,000) -
-------------------------------------
Net long-term assets $ 4,289,781 $ 5,900,826
=====================================
4. LONG-TERM DEBT
Total debt at year end was as follows:
YEAR ENDED MARCH 31
1998 1997
-------------------------------------
Revolving credit facility $ 550,000 $ -
Economic Development Revenue Bonds 1,083,926 -
Purchase notes - 1,000,000
-------------------------------------
1,633,926 1,000,000
Less current maturities 632,344 1,000,000
-------------------------------------
Long-term obligations $ 1,001,582 $ -
=====================================
</TABLE>
F-15
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
4. LONG-TERM DEBT (CONTINUED)
The Company entered into a $2 million revolving credit facility secured by all
the assets of the Company with Mercantile-Safe Deposit and Trust Company on
April 30, 1997. The agreement is for a three-year term, at which time all
borrowings are due in full. However, the loan is repayable upon demand.
Advances on the line are based on a percentage of eligible domestic accounts
receivable. The facility bears interest at 1% over prime (9.5% at March 31,
1998).
On April 30, 1997, the Company purchased a manufacturing and office facility in
Baltimore County, Maryland. The property, consisting of an existing building
with approximately 14,500 square feet on a nine-acre site and a newly
constructed 10,000- square-foot addition completed on November 30, 1997, was
financed through the issuance of Economic Development Revenue Bonds. The bond
issue was finalized on July 10, 1997 with Mercantile-Safe Deposit and Trust
Company acting as bondholder and trustee. The term of the bond issue is for 15
years. Principal in the amount of $6,862 is paid monthly plus interest at the
current rate of 7.14%. The rate is subject to adjustment to 84% of the prime
rate periodically announced by Mercantile-Safe Deposit and Trust Company.
In May 1997, the Company paid off the $1 million in short-term seller financing
of a portion of the OpSec Pasternak purchase. The payoff was funded through a
combination of working capital and the revolving credit facility.
Principal maturities of long-term debt for each of the next five fiscal years
and thereafter are:
<TABLE>
<S> <C>
1999 $ 82,344
2000 82,344
2001 82,344
2002 82,344
2003 and thereafter 672,206
----------
Total principal maturities $1,001,582
==========
</TABLE>
F-16
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. 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 shares issued for cash at $1,000 per share and 2,400 shares
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
F-17
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. STOCKHOLDERS' EQUITY (CONTINUED)
if the common stock trades at 150% of the conversion price for at least 30
consecutive trading days.
Redemption
Date Redeemed Price
----------------------------------------------------------------
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
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 March 31, 1998, the cumulative unpaid dividend on the
Series B Shares of $35,860 was declared and subsequently paid in April 1998.
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
F-18
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. STOCKHOLDERS' EQUITY (CONTINUED)
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 March 31, 1998 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 2,213,579
Warrants 1,082,765
--------------
$3,595,177
==============
6. 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 March 31, 1998. All ISOP and NSOP options granted in fiscal 1998
and 1997 were granted at an exercise price equal to or greater than fair market
value at the date of grant.
F-19
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCK OPTION PLANS AND STOCK WARRANTS (CONTINUED)
The following is a summary of stock options granted, exercised and outstanding
for the years ended March 31, 1998 and 1997:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF SHARES OTHER EXERCISE EXERCISE EXPIRATION
------------------------
ISOP NSOP OPTIONS PRICE PRICE DATE
------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, March 31, 1996 811,400 750,001 63,335 $0.20-$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 $0.20-$7.63 $4.46
Options exercised 164,666 46,667 41,167 $0.20-$5.75 $1.11
Options canceled 234,001 - 8,834 $0.20-$6.00 $5.71
Options granted 227,500 50,000 - $6.00-$6.625 $6.16 6/02-1/03
------------------------------------------------------------------------------
Outstanding, March 31, 1998 1,064,033 1,136,212 13,334 $0.25-$7.63 $4.92
==============================================================================
</TABLE>
The following is a summary of warrants granted, exercised and outstanding for
the fiscal years ended March 31, 1995 through 1998:
<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, March 31, 1998 1,082,765
==============
</TABLE>
F-20
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
7. 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 have 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 1998
and 1997, 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 .431 and .212 in 1998 and 1997, respectively; and a weighted-
average life of the option of 2.6 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.
F-21
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
7. STOCK-BASED COMPENSATION (CONTINUED)
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 No. 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):
Year ended March 31
1998 1997
-------------------------------
Pro forma net loss $(5,405,285) $ (758,695)
Pro forma net loss applicable to common stock (5,548,725) (1,190,344)
Pro forma loss per share:
Basic (1.10) (0.35)
Diluted (0.95) (0.27)
Exercise prices for options outstanding as of March 31, 1998 ranged from $0.25
to $7.63. The weighted-average remaining contractual life of those options is
2.56 years. At March 31, 1998, there were 303,334 options outstanding,
exercisable at a range of $0.25 to $1.10 per share, 585,534 options exercisable
between $2.85 to $5.00 per share and 1,324,711 options exercisable between $5.75
to $7.63 per share.
8. LEASES AND COMMITMENTS
The Company has leased several vehicles and computer equipment under long-term
leases classified as capital leases. The Company has the option to purchase the
equipment for a nominal cost at the termination of the lease. The assets
classified as capital leases are amortized over the estimated useful life of the
property. Amortization related to these assets is included in depreciation for
financial reporting purposes.
F-22
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financail Statements (continued)
8. LEASES AND COMMITMENTS (CONTINUED)
Property and equipment include the following amounts for existing leases that
have been capitalized:
Year ended March 31
1998 1997
---------------------------------
Computer/production equipment $12,268 $ 24,654
Vehicles - 79,035
---------------------------------
12,268 103,689
Less accumulated amortization 1,738 60,529
---------------------------------
$10,530 $ 43,160
=================================
Future minimum payments for capitalized leases were as follows at March 31,1998:
1999 $5,153
2000 2,576
--------
Total minimum lease payments 7,729
Less amounts representing interest 882
--------
Present value of net minimum
lease payments 6,847
Less current maturities 4,385
--------
Long-term obligation $2,462
========
The Company leases various facilities and equipment under noncancelable
operating lease arrangements. The major facilities leases are for terms of 1 to
10 years. Rent expense under all operating leases was $329,156 and $321,225 in
1998 and 1997, respectively.
F-23
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
8. LEASES AND COMMITMENTS (CONTINUED)
Future minimum lease payments under these noncancelable operating leases as of
March 31, 1998 are as follows:
1999 $259,491
2000 220,599
2001 117,457
2002 54,091
2003 and thereafter 50,298
----------------
Total minimum lease payments $701,936
================
The Company's corporate offices and DPI's operating office are located in an
office building owned in part by an officer/director/shareholder. Total rents
paid to the affiliate of the officer/director/shareholder during the years ended
March 31, 1998 and 1997 were $88,142 and $48,955, respectively.
9. INCOME TAXES
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standard No. 109, Accounting for Income Taxes ("SFAS No. 109").
Under the provisions of SFAS No. 109, a deferred tax liability or asset (net of
a valuation allowance) is provided in the financial statements by applying the
provisions of applicable tax laws to measure the deferred tax consequences of
temporary differences that will result in net taxable or deductible amounts in
future years as a result of events recognized in the financial statements in the
current or preceding years.
F-24
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
9. INCOME TAXES (CONTINUED)
The provision (benefit) for income taxes is comprised of the following:
<TABLE>
<CAPTION>
<S> <C> <C>
1998 1997
---------------------------
Current:
Federal and state $ 7,323 $ -
Foreign (12,332) 42,649
---------------------------
(5,009) 42,649
Deferred:
Federal and state - -
Foreign (25,840) (6,460)
---------------------------
(25,840) (6,460)
---------------------------
Total provision (benefit) (30,849) 36,189
Less the net tax expense
(benefit) applicable to
discontinued operations (12,332) 46,858
---------------------------
Income tax benefit $(18,517) $(10,669)
===========================
</TABLE>
A reconciliation between the actual income tax expense (benefit) and income
taxes computed by applying the statutory tax rates for the years ended March 31
is as follows:
<TABLE>
<CAPTION>
Year ended March 31
1998 1997
----------------------------------
<S> <C> <C>
Computed expected tax expense (benefit) $(1,522,000) $ 130,000
State income tax expense (benefit) (10,000) 28,000
Use of net operating loss carryforward (287,000)
Nondeductible foreign losses 1,507,000 135,000
Other (5,849) 30,189
-----------------------------------
$ (30,849) $ 36,189
===================================
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
F-25
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
9. INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax liabilities and assets are
as follows:
YEAR ENDED MARCH 31
1998 1997
----------------------------------
Deferred tax liabilities:
Amortization $ 113,183 $ 122,929
Depreciation (1,106) 4,309
----------------------------------
Total deferred tax liabilities 112,077 127,238
Deffered tax assets:
Tax net operating loss carryforwards 1,934,632 1,828,280
Deferred wages/option grants 89,911 92,715
----------------------------------
Total deferred tax assets 2,024,543 1,920,995
Valuation allowance for deferred tax assets (1,912,466) (1,819,597)
----------------------------------
Net deferred tax assets 112,077 101,398
----------------------------------
$ - $ 25,840
==================================
At March 31, 1998, the Company has aggregate net operating loss carryforwards of
approximately $5,228,000 for federal tax reporting purposes, which expire
beginning 2004 through 2013, if not utilized. Annual utilization of the net
operating loss carryforward could be limited by certain prior, as well as
subsequent sales of securities by the Company or its stockholders.
The Company does not provide for income taxes on the unremitted earnings of
foreign subsidiaries as the Company intends to reinvest these undistributed
earnings. There were no undistributed earnings of foreign subsidiaries at
March 31, 1998.
F-26
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
10. SEGMENTS OF BUSINESS
The following table, sets forth financial information for the Company's foreign
and domestic segments for the year ended March 31, 1998:
NORTH WESTERN ALL
AMERICA EUROPE OTHER TOTAL
------------------------------------------------------
Revenues:
Continuing operations $ 7,128,881 $ 1,679,870 $ 989,962 $ 9,798,713
Discontinued operations 1,959,795 4,413,208 756,683 7,129,686
------------------------------------------------------
$ 9,088,676 $ 6,093,078 $ 1,746,645 $ 16,928,399
======================================================
Identifiable assets:
Continuing operations $ 5,592,747 $ 2,954,419 $ - $ 8,547,166
Discontinued operations 2,078,904 2,858,562 - 4,937,466
------------------------------------------------------
$ 7,671,651 $ 5,812,981 $ - $ 13,484,632
======================================================
11. SUBSEQUENT EVENTS
Business Combinations
Effective May 1, 1998, the Company purchased substantially all assets of
Advantage Technology, Inc. ("ATI"), based in Lancaster, Pennsylvania. The
purchase price, including acquisition costs, was approximately $4.5 million,
including common shares of the Company valued at $2 million and a promissory
note of $2 million. The Company will use funds raised in the private placement,
described below, to pay off the $2 million note. Approximately $455,000 in debt
obligations was assumed in the purchase. The purchase price is subject to
certain adjustments based on achieving certain revenue and earnings targets. ATI
has as its principal technology AdvantageTM, a patented and proprietary
optically variable security coating that is applied to labels and over-laminates
to protect documents and products against counterfeiting, alteration and/or
tampering.
F-27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
11. SUBSEQUENT EVENTS (CONTINUED)
Private Placement (Unaudited)
During the first quarter of fiscal year 1999 the Company sold $4,030,000 of
securities in a private placement. Of that amount, $2,770,000 was from the sale
of 8% Senior Subordinated Convertible Debentures (the "Debentures") and
$1,260,000 was from the sale of 210,000 shares of common stock before
anticipated costs of $410,000. Warrants to purchase 2,000 shares at an exercise
price of $6.00 per share were issued to individual purchasers of $100,000 or
more of common shares. The Debentures are convertible into common stock at $6.50
per share.
F-28
<PAGE>
Exhibit 21.1.1
--------------
<TABLE>
<CAPTION>
State of Country Assumed
Name of Organization Names/DBA
- ---- ------------------ ----------
<S> <C> <C>
Optical Security Industries, Inc. Colorado OpSec U.S.
Optical Security Industries United Kingdom OpSec
International, Plc International, Plc
OpSec Pasternak & Partner Holding GmbH Germany -
OpSec Pasternak & Partner GmbH & Co., K.G. Germany -
Dimensional Printing Industries, Inc. Colorado OpSec
Creative
Technologies
TSL Incorporated Colorado -
OpSec Advantage, Inc. Colorado -
OpSec International GmbH & Co. KG Germany -
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> MAR-31-1998 MAR-31-1997
<PERIOD-START> APR-01-1997 APR-01-1996
<PERIOD-END> MAR-31-1998 MAR-31-1997
<CASH> 797,388 2,064,088
<SECURITIES> 0 0
<RECEIVABLES> 2,162,656 2,013,064
<ALLOWANCES> 19,353 11,287
<INVENTORY> 906,747 650,338
<CURRENT-ASSETS> 4,758,079 7,064,568
<PP&E> 2,790,130 900,358
<DEPRECIATION> (397,454) (328,217)
<TOTAL-ASSETS> 13,484,632 15,771,643
<CURRENT-LIABILITIES> (3,021,276) (1,972,011)
<BONDS> (1,004,044) (6,507)
0 0
(18) (18)
<COMMON> (26,153) (24,870)
<OTHER-SE> (9,433,141) (13,742,397)
<TOTAL-LIABILITY-AND-EQUITY> (13,484,632) (15,771,643)
<SALES> 9,798,713 6,059,154
<TOTAL-REVENUES> 9,798,713 6,059,154
<CGS> 5,730,654 3,437,724
<TOTAL-COSTS> 3,007,134 2,127,786
<OTHER-EXPENSES> 46,432 (919)
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 143 (101,700)
<INCOME-PRETAX> 1,014,350 596,263
<INCOME-TAX> 18,517 10,669
<INCOME-CONTINUING> 1,032,867 606,932
<DISCONTINUED> (5,512,382) (261,752)
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (4,622,955) (86,469)
<EPS-PRIMARY> (0.91) (0.03)
<EPS-DILUTED> (0.79) (0.02)
</TABLE>
