<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
CONFORMED
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Period Ended June 30, 1999
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 6,185,514 June 30, 1999
<PAGE>
Optical Security Group, Inc.
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
June 30 March 31
1999 1999
-----------------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 977,226 $ 1,337,128
Accounts receivable, less allowance of $104,194 and
$124,349 at the quarter ended June 30, 1999 and
March 31, 1999, respectively 2,455,507 2,704,189
Inventory 1,369,561 1,443,912
Prepaid expenses 225,306 230,723
-----------------------------------
Total current assets 5,027,600 5,715,952
Property and equipment, net 3,518,383 3,406,972
Other assets:
Patents and patent applications, net of accumulated
amortization of $166,682 and $159,445 at the quarter
ended June 30, 1999 and March 31, 1999, respectively 276,765 281,739
Goodwill, net of accumulated amortization of $551,100
and $490,457 at the quarter ended June 30, 1999 and
March 31, 1999, respectively 4,316,026 4,376,668
License and non-compete agreements, net of accumulated
amortization of $340,779 and $321,067 at the quarter
ended June 30, 1999 and March 31, 1999, respectively 399,296 675,410
Deposits and other 492,779 228,126
Net long-term assets of discontinued operations - 109,318
-----------------------------------
Total assets $14,030,849 $14,794,185
===================================
</TABLE>
See accompanying notes
1 of 27
<PAGE>
Optical Security Group, Inc.
Consolidated Balance Sheets (continued)
(Unaudited)
<TABLE>
<CAPTION>
June 30 March 31
1999 1999
------------------------------------
<S> <C> <C>
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 1,004,367 $ 970,140
Accrued expenses 610,846 511,009
Current portion of capital lease obligations 37,479 37,479
Current portion of long-term obligations 141,344 972,344
Net current liabilities of discontinued operations 396,800 841,363
------------------------------------
Total current liabilities 2,190,836 3,332,335
Capital lease obligations 9,828 11,541
Long-term obligations 1,194,307 1,229,643
Convertible debentures 3,270,000 3,270,000
Commitments
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; 6,185,514 and 6,070,620
shares issued and outstanding at June 30,
1999 and March 31, 1999, respectively 30,603 30,353
Additional paid-in capital 23,859,374 23,662,560
Other comprehensive income 174,354 53,722
Accumulated deficit (16,698,471) (16,795,987)
------------------------------------
Total stockholders' equity 7,365,878 6,950,666
------------------------------------
Total liabilities and stockholders' equity $ 14,030,849 $ 14,794,185
====================================
</TABLE>
See accompanying notes
2 of 27
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
June 30
-------------------------------------
1999 1998
-------------------------------------
<S> <C> <C>
Revenues $3,658,897 $3,083,590
Cost of goods sold 2,058,670 1,754,464
-------------------------------------
Gross margin 1,600,227 1,329,126
Operating expenses:
Salaries and related costs 867,892 595,105
Depreciation 70,994 42,152
Amortization 115,551 63,026
Other operating expenses 456,970 346,755
-------------------------------------
Total operating expenses 1,511,407 1,047,038
-------------------------------------
Income from operations 88,820 282,088
Other income (expense)
Interest income 6,350 7,022
Interest expense (94,991) (35,518)
Other 134,440 (1,254)
Foreign currency transaction income (1,243) (868)
-------------------------------------
Total other income (expense) 44,556 (30,618)
-------------------------------------
Income before income taxes 133,376 251,470
Income tax expense - -
-------------------------------------
Income from continuing operations 133,376 251,470
Discontinued operations:
Loss from operations of discontinued segment - -
-------------------------------------
Net income 133,376 251,470
Dividends on preferred stock 35,860 35,860
-------------------------------------
Net income applicable to common stock $ 97,516 $ 215,610
=====================================
</TABLE>
3 of 27
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
June 30
---------------------------
1999 1998
---------------------------
<S> <C> <C>
Earnings per share:
Basic:
Continuing operations $ 0.02 $ 0.04
Discontinued operations $ - $ -
---------------------------
Net income applicable to common stock $ 0.02 $ 0.04
---------------------------
Diluted:
Continuing operations $ 0.02 $ 0.03
Discontinued operations $ - $ -
---------------------------
Net income applicable to common stock $ 0.02 $ 0.03
===========================
Weighted average number of shares outstanding:
Basic: 6,185,514 5,968,953
===========================
Diluted:
Weighted shares outstanding 6,185,514 5,968,953
Shares attributed to options and warrants 110,642 289,964
---------------------------
6,296,156 6,258,917
===========================
</TABLE>
See accompanying notes
4 of 27
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
June 30
----------------------------
1999 1998
----------------------------
<S> <C> <C>
Operating activities
Net income $ 133,376 $ 251,470
Adjustments to reconcile net income to net cash provided
(used) in operating activities:
Depreciation and amortization 212,004 239,794
Change in operating assets and liabilities:
Accounts and notes receivable (42,706) 205,192
Inventory 68,147 (56,008)
Prepaid expenses 5,815 136,183
Accounts payable and accrued expenses (13,307) (759,904)
Reserve for discontinued operations - (558,491)
----------------------------
Net cash provided (used) in operating activities 363,329 (541,764)
Investing activities
Patent application costs (2,263) (66)
Acquisition - OpSec Advantage, Inc., net of cash acquired - (2,488,227)
Purchases of property and equipment (97,662) (189,425)
Other deposits and intangible assets (25,993) 67,790
----------------------------
Net cash used in investing activities (125,918) (2,609,928)
</TABLE>
5 of 27
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Cash Flows (continued)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
June 30
------------------------------
1999 1998
------------------------------
<S> <C> <C>
Financing activities
Proceeds from issuance of common stock, net - 1,154,467
Proceeds from exercise of options 197,064 -
Proceeds from issuance of convertible debentures - 2,770,000
Loan proceeds and capital leases - 89,155
Payments on notes and capital lease obligations (879,150) (571,619)
Payments of preferred stock dividends (35,860) (35,860)
------------------------------
Net cash provided (used) by financing activities (717,946) 3,406,143
Effect of exchange rate on cash flows 120,633 8,095
------------------------------
Net increase (decrease) in cash (359,902) 262,546
Cash, beginning of period 1,337,128 797,388
------------------------------
Cash, end of period $ 977,226 $1,059,934
==============================
Supplemental disclosure of cash flow activities:
Interest paid 94,991 35,518
Common stock issued to acquire OpSec Advantage, Inc. - 1,724,000
</TABLE>
See accompanying notes
6 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements
June 30, 1999
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. The Company's principal
markets are the United States and Western Europe. Refer to Note 3 for
discussions regarding the Company's disposal of the lenticular products business
effective March 31, 1999.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All material intercompany accounts
and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Foreign Currency
Foreign currency denominated assets and liabilities are translated into U.S.
dollar equivalents based on exchange rates prevailing at the end of each year.
Revenues and expenses are translated at average exchange rates during the year.
Aggregate foreign exchange gains and losses arising from the translation of
foreign currency denominated assets and liabilities are included in
stockholders' equity, and realized gains and losses are reflected in 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. Annual credit losses have been minimal and have consistently
been within management's expectations. The Company does not depend on any single
customer, or group of customers, for a significant part of its revenue. For the
quarter ended June 30, 1999, the licensees (as a group) of the National Football
League Properties ("NFLP") and 3M represented 20.1% and 12.5%, respectively, of
the Company's revenues. For the year ended March 31, 1999, the NFLP, and
American Express Co., represented approximately 17.7% and 6.2%, respectively, of
the Company's continuing revenue.
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, which
includes amortization of assets acquired through capital leases, is computed
using the straight-line method. The ranges of estimated useful lives are as
follows:
Years
-------------
Buildings 39
Leasehold improvements 2-12
Computer equipment 5
Other equipment and furniture 5-7
Production equipment 5-10
Vehicles 4
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 consist of:
<TABLE>
<CAPTION>
June 30 March 31
1999 1999
------------------------------
<S> <C> <C>
Land $ 316,157 $ 315,026
Buildings 1,368,231 1,342,677
Leasehold improvements 133,729 159,202
Computer equipment 425,793 376,632
Other equipment and furniture 710,473 160,580
Production equipment 1,447,632 1,793,377
Vehicles 18,484 19,347
------------------------------
4,420,499 4,166,841
Less accumulated depreciation (902,116) (759,869)
------------------------------
$ 3,518,383 $ 3,406,972
==============================
</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 June 30, 1999 is associated with the acquisition of
OpSec Advantage in fiscal 1999 and the acquisition of ELEF, Plc during fiscal
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, in its products, technology developed by others.
All goodwill associated with the lenticular business was written off in fiscal
1999 (See Footnote 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.
9 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Goodwill and License Agreements (continued)
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.
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
Effective April 1, 1998, the Company adopted Financial Accounting Standards
Board ("FASB") Statement No. 130, "Reporting Comprehensive Income" ("Statement
No. 130"). Statement No. 130 establishes standards for reporting and display of
comprehensive income and its components in the financial statements. The
adoption of Statement No. 130 in fiscal year 1999 has no impact on the Company's
Consolidated Statements of Operations. The Company has elected to disclose
comprehensive income in the Consolidated Statements of Stockholders' Equity.
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 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.
The Company conducts business in one operating segment and determined its
operating segment based on the individual operations that the chief operating
decision maker reviews for purposes of assessing performance and making
operating decisions. These individual operations have been aggregated into one
segment because the Company believes doing so helps users understand the
Company's performance and assess its prospects. The combined operations have
similar economic characteristics and each operation has similar products,
services, customers and distribution methods. Accordingly, adoption of this
Statement during fiscal 1999 did not have a significant impact on the Company's
financial reporting related to segments.
Income Per Share of Common Stock
In 1997, the FASB issued Statement No. 128, "Earnings per Share" (SFAS 128).
SFAS 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. Income per share for
the quarters ended June 30, 1999 and 1998, are based on weighted average shares
of common stock outstanding of 6,185,514 and 5,968,953, 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 and convertible debentures have been excluded from the
calculation as the effect, net of related dividend and interest requirements
would be antidilutive.
Research and Development
Research and development costs are expensed in the period incurred. During the
quarter ended June 30, 1999, the Company incurred $5,058 in costs exclusive of
compensation costs. Research and development costs for the quarter ended June
30, 1998 was $38,252, of which $9,330 was for continuing operations and $28,922
was for discontinued operations.
11 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Reclassifications
Certain amounts in the June 30, 1998 financial statements were reclassified to
conform with the June 30, 1999 presentation.
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 of approximately $100,000, was approximately $4.3 million, including an
initial stock payment of 300,000 common shares of the Company valued at $1.7
million, a promissory note of $2.0 million and the assumption of $452,000 in
debt obligations. The initial stock payment was subject to adjustment based
upon the fair market value at March 31, 1999, which resulted in the issuance of
64,897 additional shares effective June 15, 1999. The acquisition resulted in
goodwill of $3.5 million. 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, 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.
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 $5.0 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 $1.0 million. The acquisition
resulted in goodwill of $5.0 million, the balance of which was written off in
fiscal 1999 upon the disposition of DPI (the lenticular products business).
OpSec Pasternak had previously operated as an independent broker selling the
Company's dimensional printed products in Europe.
During fiscal 1997, the Company formed DPI to manufacture dimensional printed
products. DPI was formed in September 1996, with the Company owning a 51%
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. Substantially
all of the assets of DPI were sold on March 31, 1999.
12 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
3. Discontinued Operations
In March 1998, the Company announced that it was discontinuing the lenticular
business of DPI, 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 involved terminating the production of
lenticular products in Europe and consolidating lenticular production in Denver,
and was expected to improve efficiency and cost-effectiveness of the Company's
buying, manufacturing, and marketing. It also reduced the number of employees
required in operations. Until the disposition occurred on March 31, 1999, the
Company continued to operate the lenticular business. The purchasing group
included the Company's CEO among its investors Consideration included cash of
$857,313, a 5-year royalty agreement calling for minimum annual payment of
$250,000, and a contingent interest of 19% of the net consideration received if
the lenticular business is resold within 7 years. The Company retained
ownership over certain assets, primarily the residual assets and liabilities of
the German and UK offices, which were not included in the sale, and certain
other receivables the Company intends to collect. Remaining liabilities include
those payables not assumed by the purchaser, as well as reserves established for
potential obligations and estimated closure costs for the German office. The
royalty interest and the contingent interest have been excluded from the gross
proceeds on the sale in accounting for the loss on disposal of this business
segment due to the uncertainty regarding future collectibility of such amounts.
The Company intends to recognize future amounts related to these contingent
sales proceeds in the period that cash collections become assured.
Assets and liabilities for the lenticular business have been segregated from
those of the continuing operation. The summarized presentation in the balance
sheet is more fully explained below:
<TABLE>
<CAPTION>
June 30 March 31
1999 1999
------------------------------
<S> <C> <C>
Net current assets (liabilities):
Accounts receivable, net $ 400,188 $ 164,745
Other current assets 4,596 4,994
Accounts payable (294,252) (310,053)
Accrued liabilities (507,332) (701,049)
------------------------------
Net current assets (liabilities) $ (396,800) $ (841,363)
==============================
Net long-term assets:
Property and equipment, net - $ 109,318
------------------------------
Net long-term assets $ - $ 109,318
==============================
</TABLE>
13 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
4. Long-term Debt
Total debt outstanding is as follows:
<TABLE>
<CAPTION>
June 30 March 31
1999 1999
------------------------------
<S> <C> <C>
Revolving credit facility $ - $ 831,000
Economic Development Revenue Bonds 1,070,151 1,090,737
Capital expenditure facility 265,500 280,250
Debentures 3,270,000 3,270,000
------------------------------
4,605,651 5,471,987
Less current maturities 141,344 972,344
------------------------------
Long-term obligations $ 4,464,307 $ 4,499,643
==============================
</TABLE>
The Company entered into a $2.0 million revolving credit facility secured by all
the assets of the Company with Mercantile-Safe Deposit and Trust Company on
April 30, 1997. The credit facility was modified on December 18, 1998, at which
time a $500,000 capital expenditure facility was approved. All borrowings under
the original facility are repayable upon demand. Advances on the line are based
on percentage of eligible domestic accounts receivable. The facilities bear
interest at 1% over prime (8.75% at June 30, 1999).
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, were
financed through the issuance of Economic Development Revenue Bonds. The bond
issue amounting to $1,235,000 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, 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 costs of $443,739. Warrants to purchase
24,000 shares at an exercise price of $6.00 per share were issued to purchasers
of common shares and a warrant for 60,982 shares at an exercise price of $7.20
were issued to the
14 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
4. Long-term Debt (continued)
underwriter. In December 1998, an additional $500,000 in Debentures were sold
in a similar transaction, with a warrant for 10,000 shares at an exercise price
of $6.00 issued to the debenture holder. A Registration Statement covering
1,445,733 shares of common stock associated with the Company's Debentures,
Warrants, and certain common stock issued in private placements was filed with
the Securities and Exchange Commission effective December 21, 1998.
The initial Debentures are convertible into common stock at $6.50 per share.
The December 1998 Debenture is convertible into common stock at $6.00 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.
Principal maturities of long-term debt each of the next five fiscal years and
thereafter are:
2000 $ 106,008
2001 141,344
2002 141,344
2003 141,344
2004 and thereafter 4,075,611
---------------
Total principal maturities $ 4,605,651
===============
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.
15 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. Stockholders' Equity (continued)
During fiscal 1996, the Company issued 6,693 shares of Preferred Series B Stock,
including 4,293 issued for cash at $1,000 per share, and 2,400 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. As of March 31, 1999 no shares have yet been redeemed, nor are any
currently redeemable.
<TABLE>
<CAPTION>
Redemption
Date Redeemed Price
---------------------------------------------------------------------------------
<S> <C>
On or after March 30, 1998, but prior to the third
anniversary, $1,090
On or after the third anniversary date but prior to
the fourth anniversary date, 1,075
On or after the fourth anniversary date but prior to
the fifth anniversary date, 1,060
On or after the fifth anniversary date but prior to
the sixth anniversary date, 1,040
On or after the sixth anniversary date but prior to
the seventh anniversary date, 1,020
On or after the seventh anniversary date. 1,000
</TABLE>
16 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. Stockholders' Equity (continued)
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 June 30, 1999, the cumulative unpaid dividend on the Series
B Shares of $35,860 was declared and subsequently paid in July 1999.
On May 14, 1999, the Company's chief executive officer entered into an amendment
to his employment contract with the Company. The chief executive officer is in
the fourth year of his employment contract which expires March 31, 2001. The
employment contract provides for a salary of $240,000 for the fourth and fifth
year, and bonuses in such amount as the board of directors may determine. 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 500,000 shares of common
stock pursuant to an amendment, effective May 14,1999, to the employment
agreement which eliminated an anti-dilution clause. 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.
Below is a summary of common stock issuable by the Company at June 30, 1999 for
issuance upon the conversion of preferred stock and the exercise of the various
options and warrants:
Series B preferred stock 298,883
Debentures 509,486
Stock option plans 1,994,287
Stock Bonus Plan 60,000
Warrants 1,152,457
------------
4,015,113
============
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 June 30, 1999. All ISOP and NSOP options granted in the quarter
ended June 30, 1999 were granted at an exercise price equal to or greater than
fair market value at the date of grant.
17 of 27
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
6. Stock Option Plans and Stock Warrants (continued)
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 quarter ended June 30, 1999 and fiscal year ended March 31, 1999:
<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, 1998 1,064,033 1,136,212 13,334 $ .25-$7.63 $4.92
Options exercised 100,000 203,334 - $ .25-$1.10 $0.91
Options canceled 1,833 - - $ 5.75 $5.75
Options granted 90,000 127,000 - $ 6.00 $6.00 06/03-03/04
--------------------------------------------------------------------------------------
Outstanding, March 31, 1999 1,052,200 1,059,878 13,334 $2.85-$7.63 $5.58
--------------------------------------------------------------------------------------
Options exercised - 50,000 - $ 3.95 $3.95
Options canceled 81,125 - - - -
Options granted - - - - -
--------------------------------------------------------------------------------------
Outstanding, June 30, 1999 971,075 1,009,878 13,334 $2.85-$7.63 $5.85
======================================================================================
</TABLE>
The following is a summary of warrants granted, exercised and outstanding and as
of June 30, 1999:
<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 06/01
Issued in ELEF, Plc acquisition 12,346 $4.05 05/04
Issued in ELEF, Plc acquisition 57,655 $5.00 05/04
Issued in The Diffraction Company acquisition 100,000 $4.05 10/01
Exercised 12,346 $4.05
----------------------------------------------------
Outstanding, March 31, 1995 512,655
Issued in conjunction with the Series B financing 85,860 $7.13 01/03
----------------------------------------------------
Outstanding, March 31, 1996 598,515
Issued in conjunction with the Series B financing 15,500 $7.13 01/03
Issued upon conversion of Series B shares 472,917 $6.00 03/02
----------------------------------------------------
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 94,692 $6.00 - $7.20 06/08 - 12/08
Exercised 25,000 $6.00
----------------------------------------------------
Outstanding, March 31, 1999 and June 30, 1999 1,152,457
=============
</TABLE>
18 of 27
<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 has authorized the grant of options to management
personnel and directors for up to 4,000,000 shares of the Company's common
stock. All options granted have 1-4 year terms and vest and become fully
exercisable at the end of 1-4 years of continued employment.
Pro forma information regarding net income and earnings per share is required by
Statement No. 123 which also requires that the information be determined as if
the Company has accounted for its employee stock options granted subsequent to
March 31, 1995 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 1999
and 1998, 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 .436 and .431 for 1999 and 1998 respectively; and a weighted-
average life of the option of 2.3 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.
19 of 27
<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:
<TABLE>
<CAPTION>
Three Months Ended
June 30
----------------------------
1999 1998
----------------------------
<S> <C> <C>
Pro forma net income $ 40,376 $ 146,563
Pro forma net income applicable to
common stock 4,516 110,703
Pro forma income per share:
Basic $ 0.00 $ 0.02
Diluted $ 0.00 $ 0.02
</TABLE>
Exercise prices for options outstanding as of June 30, 1999 ranged from $2.85 to
$7.63. The weighted-average remaining contractual life of those options is 2.3
years. At June 30, 1999, there were 465,534 options outstanding, exercisable at
a range of $2.85 to $4.45 per share, 503,500 options exercisable between $5.00
to $5.75 per share and 1,025,253 options exercisable between $6.00 to $7.63 per
share.
8. Segments of Business
The following table sets forth financial information for the Company's foreign
and domestic operations for the quarter ended June 30, 1999. The revenues are
to external customers and are reported by geographic destination.
<TABLE>
<CAPTION>
North Western All
America Europe Other Total
------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $2,438,908 $ 853,030 $366,959 $3,658,897
======================================================
Long-lived assets $7,330,958 $1,672,293 $ - $9,003,251
======================================================
</TABLE>
20 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
Results of Operations
Quarter Ended June 30, 1999
- ---------------------------
The Consolidated Statements of Operations of the Company for the quarters ended
June 30, 1999 and 1998, reflect the revenues and expenses of its security
business. The lenticular business is reported as discontinued operations,
following the announcement in March 1998 of the Company's intent to sell, and
its subsequent sale completed in March 1999.
Revenues increased 18.7% to $3,658,897, an increase of $575,307. OpSec
Advantage, acquired May 1, 1998 accounted for $474,216 of the increased revenues
for the current quarter. Sales with two major and continuing customers are
continuing at a lower rate than in the first quarter of the prior fiscal year,
but these lesser sales rates have been augmented by sales growth, primarily in
the European market.
Gross margins improved slightly to 43.74% from 43.1%. Management has initiated
some programs intended to maintain or improve margins. Business volume
improvements will also favorably impact margins.
Operating expenses including depreciation and amortization increased $464,369 to
$1,511,407. OpSec Advantage, reporting for a full three months, accounted for
$140,364 of the increase, with the original core business growing $324,005 over
the first quarter of the prior year. Compensation and related costs increased
$272,787, or 58.7% of the total increase. Staffing increases, which occurred
after the first quarter of the prior year included additions to the security
sales and customer support teams, a new office in Germany, the mid-year addition
of a senior vice president of manufacturing, and a manufacturing controller.
Wages increases, board fees, and the addition of a 401(k) plan comprised the
balance of the increase. In addition, certain employment costs shared with the
now-disposed lenticular products division are being fully absorbed by the core
business. A cost removal program, initiated during the quarter, will affect
future periods.
Depreciation and amortization increased $81,367. Full quarter amortization of
goodwill on the Advantage purchase added $15,834, amortization of financing
costs increased $11,500, with the balance resulting from increases in capital
expenditures for production equipment.
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 June 30, 1999 (continued)
- ---------------------------------------
Other operating expenses increased $110,215, including an increase in
Advantage's operating expenses of $76,512. The new German office contributed
$49,627 to the increase. The company also recognized a bad debt recovery in the
amount of $18,486 during the quarter. Among categories of expenses, marketing
increased the most at $61,000, followed by travel at $25,000 and professional
fees at $21,000.
The Company had net interest expense of $88,641, an increase of $60,145. The
Company issued 8% Senior Debentures starting in May, 1998, which contributed
$47,000 to the increase. The capital expenditure line of credit added $7,600
over the prior year. The remaining interest was recognized on the revolving
credit facility and capital leases. Dividends on Series B Shares amounted to
$35,860, and remain unchanged from the first quarter of the prior year. No
income tax liability is anticipated in either the Company's domestic or
international operations for the near term due to the carry forward effect of
recent net operating losses.
Other income includes the accrual of royalty income from the purchaser of the
lenticular products division of $62,500 and partial recovery of $76,500 of trade
receivables previously reserved in the lenticular products division.
Quarter Ended June 30, 1998
- ---------------------------
Revenues increased 44.8% to $3,083,590, and include two months of operations for
OpSec Advantage, acquired effective May 1, 1998, which contributed $702,996 of
sales to total sales 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. Sales of authenticating label and garment tags to licensees of the
National Hockey league commenced in the quarter, as the Company's licensed
product business continues to expand.
Gross margins increased slightly from 42% to 43.1%. Margins will vary with the
mix of business. Increased business with large base customers with lower margins
than on standard product lines have been offset with improved supplier
purchasing agreements.
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 June 30, 1998 (continued)
- ---------------------------------------
Operating expenses increased $431,456 to $1,047,038, with OpSec Advantage
comprising $221,438 of the increase. Excluding OpSec Advantage, salaries and
related costs increased $158,055 to reflect staff additions to the Company's
security sales and customer support teams, as well as wage increases.
Depreciation and amortization increased $57,957, including $31,756 in OpSec
Advantage (mostly goodwill), and additional depreciation associated with
production equipment and the Parkton manufacturing facility. Other operating
expenses increased $89,582, including $63,820 in OpSec Advantage, and $25,762
from all other locations.
Net interest expense increased $23,865. The Company issued $2,770,000 in 8%
convertible debentures near the end of the 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 June 30, 1998 in the lenticular business
decreased to $1,275,997 from revenues of $3,291,799 for the quarter ended June
30, 1997. Operating expenses decreased $54,323 to $704,991. A loss reserve for
the current year was established at March 31, 1998. The current quarter loss of
$558,491 was offset against that reserve.
Liquidity and Capital Resources
Quarter Ended June 30, 1999
- ---------------------------
The Company's working capital position at June 30, 1999, was $2,836,764, and its
current ratio was 2.295-to-1. Included in the working capital surplus was a
cash position of $977,226.
The Company's long-term debt includes $1,070,151 in bond financing, $3,270,000
in 8% Senior Debentures, a revolving credit facility (no balance outstanding at
quarter end), and a capital expenditure line of credit of $265,500. During the
quarter, the Company reduced outstanding debt and capital leases by $879,150,
including a reduction in the revolving credit facility of $831,000. The balance
of the reduction resulted from normally scheduled principal payments.
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 June 30, 1999 (continued)
- ---------------------------------------
The Company reported operating income of $88,820 and net income of $133,376.
Excluding non-cash expenses of $186,545 and net interest expense of $88,641,
earnings before interest, taxes, depreciation and amortization were $408,562.
Quarter Ended June 30, 1998
- ---------------------------
In June 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 $421,367. 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.
The Company's working capital position at June 30, 1998, was $3,851,590, and its
current ratio was 2.836-to-1. Included in the working capital surplus was a cash
position of $1,059,934. Included in current liabilities was a reserve of
$341,509 for anticipated losses in the current fiscal year in the lenticular
business. The Company's long-term debt consisted of $1,059,934 in bond
financing and $2,770,000 in the newly issued convertible debentures.
The Company reported operating income of $282,088 and net income of $251,470
from its security business. Excluding non-cash expenses of $105,178 and net
interest expense of $28,496, earnings before interest, taxes, depreciation and
amortization were $385,144.
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
informational technology ("IT") systems related to its business. The Company is
completing an internal IT evaluation and expects satisfactory results and is
currently reviewing external and third
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 June 30, 1999 (continued)
- ---------------------------------------
Computerized Operations and the Year 2000 (continued)
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 compliant. An interruption may lead to
missed deadlines or delays in research, development and FDA filings. The
Company's contingency plan includes the following:
. Regular back-up of all scientific and business related electronic data;
. Archival of critical business paperwork;
. Scheduling manufacturing campaigns not to extend or overlap the year 2000
time change; and,
. 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>
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 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: August 18, 1999 By: /s/ Richard H. Bard
----------------------------
Richard H. Bard,
Chief Executive Officer and
Director
Date: August 18, 1999 By: /s/ Gerald A. Melfi
----------------------------
Gerald A. Melfi, Principal
Financial Officer
27 of 27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> MAR-31-2000 MAR-31-1999
<PERIOD-START> APR-01-1999 APR-01-1998
<PERIOD-END> JUN-30-1999 JUN-30-1998
<CASH> 977,226 1,059,934
<SECURITIES> 0 0
<RECEIVABLES> 2,559,701 2,617,973
<ALLOWANCES> 104,194 21,353
<INVENTORY> 1,369,561 1,510,695
<CURRENT-ASSETS> 5,027,600 5,949,000
<PP&E> 4,420,499 3,280,100
<DEPRECIATION> 902,116 465,711
<TOTAL-ASSETS> 14,030,849 18,500,476
<CURRENT-LIABILITIES> 2,190,836 2,097,410
<BONDS> 0 0
0 0
18 18
<COMMON> 30,603 29,845
<OTHER-SE> 7,335,257 12,531,623
<TOTAL-LIABILITY-AND-EQUITY> 14,030,849 18,500,476
<SALES> 3,658,897 3,083,590
<TOTAL-REVENUES> 3,658,897 3,083,590
<CGS> 2,058,670 1,754,464
<TOTAL-COSTS> 1,511,407 1,047,038
<OTHER-EXPENSES> (139,547) (4,900)
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 94,991 35,518
<INCOME-PRETAX> 133,376 251,470
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 133,376 251,470
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 133,376 251,470
<EPS-BASIC> .02 0
<EPS-DILUTED> .02 0
</TABLE>
