<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One) CONFORMED
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Period Ended September 30, 1998
OR
(_) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File No. 0-17531
OPTICAL SECURITY GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
Colorado 84-1094032
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
535 16th Street, Suite 920
Denver Colorado 80202
(Address of Principal Executive Offices)
(303) 534-4500
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934, during the preceding twelve months and (2) has been subject to the filing
requirements for the past 90 days.
Yes X No.
APPLICABLE ONLY TO CORPORATE ISSUES:
Class of Stock No. of Shares Outstanding Date
Common 6,068,953 September 30, 1998
<PAGE>
Optical Security Group, Inc.
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
September 30
1998 1997
-------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 579,399 $ 976,783
Accounts receivable, less allowance of
$13,555 and $43,228 at the quarter
ended September 30, 1998 and 1997,
respectively 3,136,581 1,895,305
Inventory 1,277,514 776,570
Prepaid expenses 268,447 171,691
Net current assets of discontinued
operations 804,220 2,148,758
-------------------------
Total current assets 6,066,161 5,969,107
Property and equipment, net 3,282,179 1,790,091
Other assets:
Patents and patent applications, net of
accumulated amortization of $111,564
and $101,610 at the quarter ended
September 30, 1998 and 1997,
respectively 279,377 322,315
Goodwill, net of accumulated
amortization of $369,172 and $229,004
at the quarter ended September 30,
1998 and 1997, respectively 4,498,597 1,111,501
License and non-compete agreements, net
of accumulated amortization of
$280,692 and $201,986 at the quarter
ended September 30, 1998 and 1997,
respectively 459,383 536,144
Deposits and other 138,051 240,187
Net long-term assets of discontinued
operations 4,488,959 6,007,286
-------------------------
Total assets $19,212,707 $15,976,631
=========================
</TABLE>
See accompanying notes
1 of 27
<PAGE>
Optical Security Group, Inc.
Consolidated Balance Sheets (continued)
(Unaudited)
<TABLE>
<CAPTION>
September 30
1998 1997
---------------------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,070,622 $ 658,222
Accrued expenses 794,761 317,069
Current portion of capital lease 5,814 5,000
obligations
Current portion of long-term obligations 663,344 441,600
Allowance for operating losses of
discontinued Operations - -
---------------------------
Total current liabilities 2,534,541 1,421,891
Deferred tax liability - 25,840
Capital lease obligations - 3,803
Long-term obligations 1,049,565 834,545
Convertible Debentures 2,770,000 -
Stockholders' equity:
Voting convertible preferred
stock, $0.01 par value:
2,500,000 shares authorized;
1,793 Preferred Series 18 18
B shares issued and outstanding
(preference in
Liquidation $1,954,370)
Common stock, $0.005 par value:
15,000,000 shares authorized;
6,068,953 and 5,019,283 shares issued
and outstanding at September 30, 1998 30,345 25,096
and 1997, respectively
Additional paid-in capital 23,329,209 20,133,204
Foreign currency translation adjustment 99,587 (8,071)
Accumulated deficit (10,600,558) (6,459,695)
---------------------------
Total stockholders' equity 12,858,601 13,690,552
---------------------------
Total liabilities and stockholders' $ 19,212,707 $15,976,631
equity
===========================
</TABLE>
See accompanying notes
2 of 27
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30 September 30
1998 1997 1998 1997
----------------------- -----------------------
<S> <C> <C> <C> <C>
Revenues $3,978,560 $2,499,256 $7,062,150 $4,628,338
Cost of goods sold 2,288,450 1,452,068 4,042,914 2,686,935
----------------------- -----------------------
Gross margin 1,690,110 1,047,188 3,019,236 1,941,403
Operating expenses:
Salaries and related costs 730,601 408,902 1,325,706 720,090
Depreciation 47,884 25,266 90,036 45,718
Amortization 79,747 33,178 142,773 59,947
Other operating expenses 507,164 252,517 853,919 509,690
----------------------- -----------------------
Total operating expenses 1,365,396 719,863 2,412,434 1,355,455
----------------------- -----------------------
Income from operations 324,714 327,325 606,802 605,958
Other income (expense)
Interest income 9,561 9,132 16,583 14,362
Interest expense (81,915) (12,097) (117,433) (21,958)
Other income 12,775 185 11,521 185
Foreign currency transaction gain
(295) 4,758 (1,163) 3,678
----------------------- -----------------------
Total other expense (59,874) 1,978 (90,492) (3,733)
----------------------- -----------------------
Income before income taxes 264,840 329,303 516,310 602,225
Income tax expense - - - -
----------------------- -----------------------
Income from continuing operations
264,840 329,303 516,310 602,225
Discontinued Operations:
Loss from operations of discontinued
segment - (517,146) - (568,008)
----------------------- -----------------------
Net income (loss) 264,840 (187,843) 516,310 34,217
Dividends on preferred stock 35,860 35,860 71,720 71,720
----------------------- -----------------------
Net income (loss) applicable to common
stock $ 228,980 $ (223,703) $ 444,590 $ (37,503)
======================= =======================
</TABLE>
3 of 27
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Operations (continued)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30 September 30
1998 1997 1998 1997
----------------------- -----------------------
<S> <C> <C> <C> <C>
Earnings (loss) per share:
Basic:
Continuing operations $ 0.04 $ 0.06 $ 0.07 $ 0.11
Discontinued operations - (0.10) - (0.11)
----------------------- -----------------------
Net income applicable to common stock
$ 0.04 $ (0.04) $ 0.07 $ 0.00
======================= =======================
Diluted:
Continuing operations $ 0.04 $ 0.04 $ 0.07 $ 0.09
Discontinued operations - (0.08) - (0.09)
----------------------- -----------------------
Net income applicable to common stock
$ 0.04 $ (0.04) $ 0.07 $ 0.00
======================= =======================
Weighted average number of shares
outstanding:
Basic: 6,068,953 5,019,283 5,985,620 5,019,283
======================= =======================
Diluted:
Weighted shares outstanding
6,068,953 5,019,283 5,985,620 5,019,283
Shares attributed to options and
warrants 209,964 1,167,567 209,964 1,167,567
----------------------- -----------------------
6,278,917 6,186,850 6,195,584 6,186,850
======================= =======================
</TABLE>
See accompanying notes
4 of 27
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30 September 30
1998 1997 1998 1997
---------------------- --------------------------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Income from continuing operations $ 264,840 $ 329,303 $ 516,310 $ 602,225
Loss from discontinued operations (547,090) (517,146) (1,105,581) (568,008)
Adjustments to reconcile net income
(loss) to net cash provided (used) in
operating activities:
Depreciation and amortization
268,423 184,429 508,217 372,172
Changes in operating assets and
liabilities
Accounts receivable (813,633) 188,489 (608,441) 1,737,763
Inventory 189,401 (151,779) 133,393 115,828
Prepaid expenses (98,163) 66,980 38,020 (62,459)
Accounts payable and accrued expenses 320,910 (609,633) (438,994) (1,767,682)
----------------------- --------------------------
Net cash provided (used) in operating
activities (415,312) (509,357) (957,076) 429,839
INVESTING ACTIVITIES
Patent application costs (12,263) (2,860) (12,329) (18,844)
Acquisition - Advantage Technology, Inc. (22,999) - (2,528,561) -
Purchase of property and equipment (638,643) (709,710) (828,068) (1,580,018)
Licensing agreements - - - (432)
Other deposits and intangible assets
15,991 232,277 47,784 11,791
------------------------ --------------------------
Net cash used in investing activities $ (657,914) $(480,293) $ (3,321,174) $(1,587,503)
</TABLE>
See accompanying notes
5 of 27
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Cash Flows (continued)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30 September 30
1998 1997 1998 1997
---------------------- -----------------------
<S> <C> <C> <C> <C>
FINANCING ACTIVITIES
Proceeds from issuance of common stock,
net $ 55,320 $ - $1,263,119 $ 20,222
Proceeds from issuance of convertible
debentures, net - - 2,770,000 -
Change in line of credit facility 581,000 (247,729) 120,155 366,000
Proceeds from bond financing - 910,144 - 910,144
Payments on notes and capital lease
obligations (20,586) (1,267) (42,205) (1,013,280)
Cost of financing - (63,541) - (81,554)
Payments on preferred stock dividends (35,860) (35,860) (71,720) (71,720)
---------------------- -----------------------
Net cash provided (used) by financing
activities 579,874 561,747 4,039,349 129,812
Effect of exchange rate on cash flows 12,817 (107,665) 20,912 (59,453)
---------------------- -----------------------
Net increase (decrease) in cash (480,535) (535,568) (217,989) (1,087,305)
Cash, beginning of period 1,059,934 1,512,351 797,388 2,064,088
---------------------- -----------------------
Cash, end of period $ 579,399 $ 976,783 $ 579,399 $ 976,783
====================== =======================
SUPPLEMENTAL DISCLOSURE OF NON-CASH
FLOW ACTIVITIES
Interest paid $ 81,915 $ 22,827 $ 117,433 $ 36,258
Common stock issued to acquire
Advantage Technology, Inc. - - 1,724,000 -
Income taxes expense - 15,401 - 18,590
</TABLE>
See accompanying notes
6 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements
September 30, 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"),
OpSec Advantage, Inc. ("OpSec Advantage"), and Optical Security International
GmbH & Co., KG ("OSI") 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 inter-company accounts
and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
FOREIGN CURRENCY
Foreign currency denominated assets and liabilities are translated into U.S.
dollar equivalents based on exchange rates prevailing at the end of each year.
Revenues and expenses are translated at average exchange rates during the year.
Aggregate foreign exchange gains and losses arising from the translation of
foreign currency denominated assets and liabilities are included in
stockholders' equity, and realized gains and losses are reflected in 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.
7 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTS RECEIVABLE
The Company grants credit to customers in the ordinary course of business
primarily in the United States and Western Europe. The Company periodically
performs credit analyses and monitors customers' financial condition in order to
reduce credit risk. 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>
8 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT (CONTINUED)
Property and equipment at quarter end was as follows:
<TABLE>
<CAPTION>
Quarter ended September 30
1998 1997
--------------------------
<S> <C> <C>
Land $ 304,066 $ 304,066
Buildings 1,387,140 891,516
Leasehold improvements 128,271 126,863
Computer equipment 309,454 276,504
Other equipment and furniture 102,091 54,314
Production equipment 1,538,223 437,544
Vehicles 18,401 61,176
--------------------------
3,787,646 2,151,983
Less accumulated depreciation (505,467) (361,892)
--------------------------
$3,282,179 $1,790,091
==========================
</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 September 30, 1998 is associated with the acquisition
of OpSec Advantage in May 1998, 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 business associated with those assets, the assets
would be written down to their fair value, which is normally measured by
discounting estimated future cash flows.
9 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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.
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.
10 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
EARNINGS 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. Earnings per share for
the quarters ended September 30, 1998 and 1997 is based on weighted average
shares of common stock outstanding of 6,068,953 and 5,019,283, 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.
RESEARCH AND DEVELOPMENt
Research and development costs are expensed in the period incurred. During the
quarter ended September 30, 1998, the Company incurred $14,818 in costs, of
which $7,608 was for continuing operations and $7,210 was for discontinued
operations. Research and development costs for the quarter ended September 30,
1997 were immaterial.
RECLASSIFICATIONS
Certain amounts in the September 30, 1997 financial statements were reclassified
to conform with the September 30, 1998 presentation.
11 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
2. BUSINESS COMBINATIONS
Effective May 1, 1998, the Company, through its subsidiary, OpSec Advantage,
purchased substantially all of the assets of Advantage Technology, Inc. ("ATI"),
based in Lancaster Pennsylvania. The purchase price, including acquisition
costs, was approximately $4.3 million, including common shares of the Company
valued at $1.7 million and a promissory note of $2 million. The acquisition
resulted in goodwill of $3,527,265. The Company used funds raised in a private
placement to pay off the $2 million note and $452,000 in debt obligations
assumed in the purchase. The purchase price is subject to certain adjustments
based on achieving certain revenue and earning targets. ATI has as its
principal technology, Advantage/TM/, 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.
The following unaudited pro forma combined results of operations for the six
months ended September 30, 1997 has been prepared assuming that the acquisition
of ATI occurred at the beginning of the period. In preparing the proforma data,
adjustments have been made for: (i) the amortization of goodwill, and (ii) the
interest expense related to debentures issued to complete the purchase. The
proforma results for the six-month period ended September 30, 1998 would not
have been materially different than those shown in the accompanying statement of
operations.
<TABLE>
<CAPTION>
<S> <C>
Sales and royalty income $6,694,129
Net income 570,187
Net income applicable to common stock 498,467
Earnings per share of common stock:
Basic $ 0.09
Diluted $ 0.07
</TABLE>
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.
12 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
2. BUSINESS COMBINATIONS (CONTINUED)
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 OpSec Pasternak and DPI are part of the lenticular segment, which is being
discontinued (see Note 3).
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 included the termination of the
production of lenticular products in Europe and consolidating lenticular
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. 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. Management believes the original reserve established for operating
losses through the anticipated disposal date are still adequate.
<TABLE>
<CAPTION>
<S> <C>
Estimated loss on sale and related costs $ 1,560,000
Operating losses from April 1, 1998 to 900,000
Anticipated disposal date
Reserve used year to date (1,105,581)
-----------
Remaining reserve $ 1,354,419
===========
</TABLE>
Sales of the lenticular business were $436,707 and $2,161,272 in the quarters
ended September 30, 1998 and 1997, respectively. The net operating loss for the
same periods were $547,090 and $517,146 in 1998 and 1997, respectively.
13 of 27
<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 the quarter ended September 30, 1998 have been restated to
reflect the discontinued operations. The summarized presentation in the balance
sheet is more fully explained below:
<TABLE>
<CAPTION>
Quarter ended September 30
1998 1997
-------------------------------
<S> <C> <C>
Net current assets:
Accounts receivable, net $ 958,019 $ 2,563,972
Inventory 519,903 771,854
Other current assets 33,492 134,287
Accounts payable (628,064) (1,200,397)
Accrued expenses (79,130) (120,958)
-------------------------------
Net current assets $ 804,220 $ 2,148,758
===============================
Net long-term assets:
Property and equipment, net 714,060 632,591
Goodwill and other intangible assets 5,129,318 5,374,695
Less estimated loss on sale
and related costs (1,354,419) -
-------------------------------
Net long-term assets $ 4,488,959 $ 6,007,286
===============================
</TABLE>
4. LONG-TERM DEBT
Total debt at quarter end was as follows:
<TABLE>
<CAPTION>
Quarter ended September 30
1998 1997
-------------------------------
<S> <C> <C>
Revolving credit facility $ 581,000 $ 366,000
Economic Development Revenue Bonds 1,131,909 910,145
-------------------------------
1,712,909 1,276,145
Less current maturities 663,344 441,600
-------------------------------
Long-term obligations $1,049,565 $ 834,545
===============================
</TABLE>
14 of 27
<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 (9.25% at September 30,
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:
1999 (remaining 6 months) $ 41,172
2000 82,344
2001 82,344
2002 82,344
2003 and thereafter 843,705
----------
Total principal maturities $1,131,909
==========
5. STOCKHOLDERS' EQUITY
In May, 1998, 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 $476,047. Warrants
to purchase 24,000 shares at an exercise price of $6.00 per share were issued to
purchasers of common shares.
15 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. STOCKHOLDERS' EQUITY (CONTINUED)
The Debentures are convertible into common stock at $6.50 per share. The
Company may redeem the Debentures in whole or part commencing September 1, 1999
at 109% of face value, with the premium declining 1.8% per year until July 1,
2004, at which time redemptions may be made at face value. If not converted
earlier, the debentures mature May 31, 2005.
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 if the common
stock trades at 150% of the conversion price for at least 30 consecutive trading
days.
16 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
<TABLE>
<CAPTION>
5. STOCKHOLDERS' EQUITY (CONTINUED)
Redemption
Date Redeemed Price
----------------------------------------------------------
<S> <C>
On or after March 30, 1998,
but prior to the
third anniversary, $1,090
On or after the third
anniversary date but
prior to the fourth 1,075
anniversary date,
On or after the fourth
anniversary date but
prior to the fifth 1,060
anniversary date,
On or after the fifth
anniversary date but
prior to the sixth 1,040
anniversary date,
On or after the sixth
anniversary date but
prior to the seventh 1,020
anniversary date,
On or after the seventh 1,000
anniversary date.
</TABLE>
The Company is restricted from paying dividends on its common shares pursuant to
the terms of its Preferred Series B shares. No dividends or other payments can
be declared and paid on the common stock unless the Company also declares and
pays dividends on the shares of common stock issuable upon conversion of the
Series B shares and unless there are no accrued and unpaid dividends on the
Series B shares. On September 30, 1998, the cumulative unpaid dividend on the
Series B Shares of $35,860 was declared and subsequently paid in October 1998.
On July 16, 1998, the Company's chief executive officer entered into an
amendment to his employment contract with the Company extending his employment
for an additional two years. The chief executive officer is in the third year
of his employment contract which expires March 31, 2001. The employment contract
provides for a salary of $200,000 for the third year, $240,000 for the fourth
and fifth year, and bonuses in such amount as the board of directors may
determine. As additional compensation, the chief executive officer 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, 2003, the chief executive officer is entitled to a stock bonus of
250,000 shares of common stock. In addition to benefits available generally to
other Company employees, the chief executive officer is entitled to a $500 per
month automobile allowance and reimbursement of expenses incurred on behalf of
the Company. If the Company terminates the chief executive officer's employment
prior to the expiration of the contract, he is entitled to a buyout at 150% of
the value of the contract at the time of termination.
17 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. STOCKHOLDERS' EQUITY (CONTINUED)
Below is a summary of common stock reserved by the Company at September 30, 1998
for issuance upon the conversion of preferred stock and the exercise of the
various options and warrants:
<TABLE>
<CAPTION>
<S> <C>
Series B preferred stock 298,833
Stock option plans 2,105,912
Warrants 1,081,765
---------
3,486,510
=========
</TABLE>
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 September 30, 1998. All ISOP and NSOP options granted in the
quarter ended September 30, 1998 and 1997 were granted at an exercise price
equal to or greater than fair market value at the date of grant.
A Registration Statement covering the underlying common stock associated with
the Company's ISOP, NSOP and Stock Bonus Plans was filed with the Securities and
Exchange Commission effective July 23, 1998.
The following is a summary of stock options granted, exercised and outstanding
for the six-month period ending September 30, 1998 and fiscal years ended March
31, 1998 and 1997:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OTHER EXERCISE EXERCISE EXPIRATION
NUMBER OF SHARES OPTIONS PRICE PRICE DATE
---------------------------
ISOP NSOP
-------------------------------------------------------------------------------------------------------
<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 $ 0.25-$7.64 $1.11
Options canceled 234,001 - 8,834 $ 0.20-$6.00 $5.71
Options granted 227,500 50,000 - $6.00-$6.624 $6.16
--------------------------------------------------------------------------------------
Outstanding, March 31, 1998 1,064,033 1,136,212 13,334 $ 0.25-$7.63 $4.92
Options exercised 100,000 203,334 - $ 0.25-$1.10 $0.91
Options canceled 1,333 - - $ 5.75 $5.75
Options granted 70,000 127,000 - $ 6.00 $6.00 6/03-9/03
--------------------------------------------------------------------------------------
Outstanding, September 30,
1998 1,032,700 1,059,878 13,334 $ 2.85-$7.63 $5.59
======================================================================================
</TABLE>
18 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
The following is a summary of warrants granted, exercised and as of September
30, 1998 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 100,000 $4.05 10/2001
acquisition
Exercised 12,346 $4.05
--------------------------------------
Outstanding, March 31, 1995 512,655
Issued in conjunction with the Series B 85,860 $7.13 1/2003
financing
------------
Outstanding, March 31, 1996 598,515
Issued in conjunction with the Series B 15,500 $7.13 1/2003
financing
Issued upon conversion of Series B 472,917 $6.00 3/2002
shares
------------
Outstanding, March 31, 1997 1,086,932
Exercised 4,167 $6.00
------------
Outstanding, March 31, 1998 1,082,765
Issued in conjunction with private
placement 24,000 $6.00 6/2008
Exercised 25,000 $6.00
------------
Outstanding, September 30, 1998 1,081,765
============
</TABLE>
An additional 60,692 warrants at a $7.20 exercise price are to be issued in
conjunction with the May 1998 private placement of common shares and convertible
debentures.
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.
19 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
7. STOCK-BASED COMPENSATION (CONTINUED)
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.
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:
<TABLE>
<CAPTION>
Quarter ended September 30
1998 1997
---------------------------
<S> <C> <C>
Pro forma net income (loss) $159,933 $(805,892)
Pro forma net loss applicable to common 124,073 (841,752)
stock
Pro forma loss per share:
Basic $ 0.02 $ (0.17)
Diluted $ 0.02 $ (0.14)
</TABLE>
Exercise prices for options outstanding as of September 30, 1998 ranged from
$2.85 to $7.63. The weighted-average remaining contractual life of those
options is 2.56 years. At September 30, 1998, there were 585,534 options
exercisable between $2.85 to $5.00 per share and 1,520,378 options exercisable
between $5.75 to $7.63 per share.
20 of 27
<PAGE>
Optical Security Group, Inc.
----------------------------
Notes to Consolidated Financial Statements (continued)
8. SEGMENTS OF BUSINESS
The following table sets forth-financial information for the Company's foreign
and domestic segments for the quarter ended September 30, 1998:
<TABLE>
<CAPTION>
NORTH WESTERN ALL
AMERICA EUROPE OTHER TOTAL
----------------------------------------------
Revenues:
<S> <C> <C> <C> <C>
Continuing operations $ 2,549,266 $ 636,025 $793,269 $ 3,978,560
Discontinued operations 119,168 317,539 - 436,707
----------------------------------------------
$ 2,668,434 $ 953,564 $793,269 $ 4,415,267
==============================================
Identifiable assets:
Continuing operations $12,278,188 $2,586,180 - $14,864,368
Discontinued operations 2,828,333 1,518,985 - 4,347,318
----------------------------------------------
$15,106,521 $4,105,165 - $19,211,686
==============================================
</TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Quarter Ended September 30, 1998
- --------------------------------
The Consolidated Statements of Operations of the Company for the quarters ended
September 30, 1998 and 1997, reflect the revenues and expenses of its continuing
security products business. Its specialty printing (lenticular business) is
reported as discontinued operations, following the Company's decision and intent
in March 1998 to sell, spin-off to existing shareholders in the form of a
dividend, or otherwise dispose of the lenticular business during the current
fiscal year. The quarter ended September 30, 1997 has been restated to reflect
the discontinuance of the lenticular business.
Revenues increased 59.2% to $3,978,560, and include five months of operations
for OpSec Advantage, acquired effective May 1, 1998, which contributed
$1,000,172 to total revenues for the quarter. OpSec Advantage provides 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. In addition, net revenue growth for the quarter was attibutable to
the sale of authenticating label and garment tags to licensees of the National
Hockey league, which commenced in the first quarter, sales relating to new
relationships with certain pharmaceutical manufacturers, and strong government
product sales.
21 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
Quarter Ended September 30, 1998 (continued)
- --------------------------------------------
Gross margins increased slightly from 41.9% to 42.48%. While margins will vary
with the mix of business, overall margin attainment reflects improved supplier
purchasing economics and manufacturing efficiencies.
Operating expenses increased $645,533 to $1,365,396, with OpSec Advantage
comprising $355,048 of the increase. Excluding OpSec Advantage, salaries and
related costs increased $126,126 to reflect staff additions to the Company's
security sales and customer support teams, the addition of a Vice President of
Manufacturing, a Divisional Controller, as well as wage increases. Depreciation
and amortization increased $69,187, including $48,779 in OpSec Advantage (mostly
goodwill amortization), and additional depreciation associated with production
equipment and the new Parkton manufacturing facility. Other operating expenses
increased $254,647, including $110,696 in OpSec Advantage, and $143,951 from all
other locations.
Net interest expense increased $69,389. The Company issued $2,770,000 in 8%
convertible debentures near the end of the first quarter for funding the
purchase of OpSec Advantage. In addition, net interest expense reflects the
addition of debt financing for plant construction completed in the third quarter
of the prior year. Dividends on Series B shares of $35,860 remained unchanged
compared to the same quarter of the prior year. No income tax liability is
anticipated in either of the Company's domestic or international operations.
Revenues for the quarter ended September 30, 1998 in the lenticular business
decreased to $436,707 from revenues of $2,161,272 for the quarter ended
September 30, 1997. Operating expenses decreased $44,439 to $635,162. A loss
reserve was established during the fiscal year ending March 31, 1998. The
current quarter loss of $547,090 was offset against that reserve.
Quarter Ended September 30, 1997
- --------------------------------
Operations for the quarter ended September 30, 1997 have been restated to
reflect the discontinuance of the lenticular business announced in March, 1998.
Revenues for the quarter ended September 30, 1997 were $2,499,256, a 65.7%
increase when compared to the revenues of $1,508,005 for the quarter ended
September 30, 1996. Significant increases in revenues resulting from
authenticating label and tag sales for the NFL licensing program and Exelgram(R)
embossed foil sales to American Express for application on travelers' cheques.
22 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
Quarter Ended September 30, 1997 (continued)
- --------------------------------------------
Gross profits for the quarter ended September 30, 1997 increased 55.5% to
$1,047,188 compared to $673,286 for the quarter ended September 30, 1996. The
gross profit margin of 41.9% decreased from the 44.65% for the comparable
quarter of the prior year, reflecting product mix and the outsourcing of certain
products.
Operating expenses of $719,863 grew 28.5% compared to the same quarter of the
prior fiscal year, an increase of $159,820.
The Company reported net income (before lenticular operations) for the quarter
ended September 30, 1997 of $329,303, as compared to net income of $147,862 for
the quarter ended September 30, 1996. With the conversion of 76% of the Series
B Shares into common stock during the fourth quarter of the prior fiscal year,
the dividend payment decreased $113,500 to $35,860. No significant tax
liabilities were reported for the quarter. The Company carries significant net
operating losses for U.S. tax reporting purposes.
Revenues for the quarter ended September 30, 1997, in the lenticular business
increased to $2,161,272 from revenues of $1,201,782 for the quarter ended
September 30, 1996. Operating expenses increased to $679,601 from $313,257
primarily as a result of the acquisition of OpSec Pasternak and the formation of
DPI subsequent to September 30, 1996. The loss for the current quarter of
$517,146 compares to net income of $32,520 for the same quarter of the prior
fiscal year.
LIQUIDITY AND CAPITAL RESOURCES
Quarter Ended September 30, 1998
- --------------------------------
In September 1998, the Company completed the sale $4,030,000 of securities in a
private placement. Of that amount, $2,770,000 was from the sale of 8% senior
convertible subordinated debentures, and $1,260,000 was from the sale of 210,000
shares of common stock, before anticipated costs of $476,047. The Company used
approximately $2.5 million to complete the purchase of OpSec Advantage during
the quarter, with remaining proceeds used to reduce outstanding bank lines of
credit.
23 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Quarter Ended September 30, 1998 (continued)
- --------------------------------------------
The Company's working capital position at September 30, 1998, was $3,531,620,
and its current ratio was 2.39-to-1.00. Included in the working capital surplus
was a cash position of $579,399. The Company's long-term debt consisted of
$1,049,565 in bond financing and $2,770,000 in the newly issued convertible
debentures.
The Company reported operating income of $324,714 and net income of $264,840
from its security business. Excluding non-cash expenses of $127,631, earnings
before interest, taxes, depreciation and amortization were $452,345.
QUARTER ENDED SEPTEMBER 30, 1997
- --------------------------------
The Company's working capital position at September 30, 1997 was $4,547,216.
Current assets were 4.198-to-1.00 over current liabilities. Included in this
working capital surplus was a cash position of $976,783. The Company's long-
term debt consisted of $834,545 in bond financing.
The Company's purchase of the new manufacturing facility occurred in April 1997
for a cash purchase price of $700,000. Improvements and additions increased the
overall cost to approximately $1.5 million, with completion and occupancy in
November 1997.
The Company paid off $1,000,000 in short-term debt that financed a portion of
the OpSec Pasternak purchase. The payoff was funded substantially through
working capital of the Company.
24 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Quarter Ended September 30, 1997 (continued)
- --------------------------------------------
The security business generated earnings before interest, taxes, depreciation
and amortization (EBITDA) of $385,769 and net income was $329,303. This
compares to EBITDA and net income of $155,444 and $147,862, respectively, in the
prior year second quarter. The discontinued lenticular business operated at a
loss of $517,146, compared to net income of $32,520 in the prior year second
quarter.
COMPUTERIZED OPERATIONS AND THE YEAR 2000
Until recently most computer programs were written to store only two digits of
date-related information in order to more efficiently handle and store data.
Thus the programs were unable to properly distinguish between the year 1900 and
the year 2000. This is referred to as the "Year 2000 Issue" ("Y2K"). Since 1997,
the Company has been reviewing all internal, external and third party IT systems
for Y2K compliance. External and third party evaluations include requiring
compliance certificates from vendors, suppliers and significant businesses
related to the Company. The Company estimates it will complete external and
third party evaluations by the second quarter of 1999. To date, all evaluations
have uncovered minimum exposure to Y2K problems. The Company currently estimates
the internal Y2K cost at approximately $60,000, which would include replacing
hardware systems and upgrading software. Estimates of external or third party
Y2K expenses available at this time are immaterial, however, the Company
continues to review compliance. Management does not believe the Company will
have to modify or replace any significant portions of its computer applications
in order for the computer systems to function properly with respect to the dates
in the year 2000 and thereafter. However, a "worst case" scenario may include
the temporary interruption of research, development and business due to the
necessity of upgrading or replacing systems which are not Y2K complaint. An
interruption may lead to missed deadlines or delays in research, development and
FDA filings. The Company's contingency plan includes the following:
o Regular back-up of all scientific and business related electronic data;
o Archival of critical business paperwork;
o Scheduling manufacturing campaigns not to extend or overlap the year 2000 time
change; and,
o Upgrading security systems to be Y2K compliant (included in above dollar
amount).
Currently, the Company has determined that there is no significant exposure to
the Y2K issue, however, the Company will continue to evaluate all IT systems for
Y2K compliance throughout 1999.
25 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) List of Exhibits required by Item 601 of Regulation S-B:
Exhibit Exhibit Page
Number Name Reference
- --------------------------------------------------------
27.1 Financial Data Schedule -
(b) Reports on Form 8-K:
None
26 of 27
<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.
(Registrant)
Date: November 18, 1998 By: /s/ Richard H. Bard
--------------------------------
Richard H. Bard, Chief Executive
Officer and Director
Date: November 18, 1998 By: /s/ Gerald A. Melfi
--------------------------------
Gerald A. Melfi, Principal Financial
Officer
27 of 27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM OPTICAL
SECURITY GROUP INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> MAR-31-1999 MAR-31-1998
<PERIOD-START> JUL-01-1998 JUL-01-1997
<PERIOD-END> SEP-30-1998 SEP-30-1997
<CASH> 579,349 976,783
<SECURITIES> 0 0
<RECEIVABLES> 3,150,136 1,938,533
<ALLOWANCES> (13,555) 43,228
<INVENTORY> 1,277,514 776,570
<CURRENT-ASSETS> 1,072,667 2,320,449
<PP&E> 3,787,646 2,151,983
<DEPRECIATION> (505,467) (361,892)
<TOTAL-ASSETS> 19,212,707 15,976,631
<CURRENT-LIABILITIES> 2,534,541 1,421,891
<BONDS> 0 0
0 0
18 18
<COMMON> 30,345 25,096
<OTHER-SE> 12,828,238 13,665,438
<TOTAL-LIABILITY-AND-EQUITY> 19,212,707 15,976,631
<SALES> 3,978,560 2,499,256
<TOTAL-REVENUES> 3,978,560 2,499,256
<CGS> 2,288,450 1,452,068
<TOTAL-COSTS> 1,365,396 719,863
<OTHER-EXPENSES> (22,041) (14,075)
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 81,915 12,097
<INCOME-PRETAX> 264,840 329,303
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 264,840 329,303
<DISCONTINUED> 0 (517,146)
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 264,840 (187,843)
<EPS-PRIMARY> 0 0
<EPS-DILUTED> 0 0
</TABLE>
