<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One) CONFORMED
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Period Ended December 31, 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 6,070,620 December 31, 1998
<PAGE>
Optical Security Group, Inc.
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
December 31
1998 1997
----------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 720,596 $ 360,614
Accounts receivable, less allowance of $50,744 and
$86,265 at the quarter ended December 31, 1998 and
1997, respectively 2,517,783 2,620,651
Inventory 1,657,177 502,953
Prepaid expenses 355,057 195,218
Net current assets of discontinued operations 1,025,850 1,722,196
----------------------------------------
Total current assets 6,276,463 5,401,632
Property and equipment, net 3,371,000 2,150,775
Other assets:
Patents and patent applications, net of accumulated
amortization of $118,802 and $107,610 at the quarter
ended December 31, 1998 and 1997, respectively 274,613 322,365
Goodwill, net of accumulated amortization of $429,815
and $245,760 at the quarter ended December 31, 1998
and 1997, respectively 4,437,955 1,094,744
License and non-compete agreements, net of accumulated
amortization of $300,369 and $221,662 at the quarter
ended December 31, 1998 and 1997, respectively 439,806 517,677
Deposits and other 144,982 252,801
Net long-term assets of discontinued operations 4,541,122 6,464,787
----------------------------------------
Total assets $19,485,941 $16,204,781
========================================
</TABLE>
See accompanying notes
1 of 28
<PAGE>
Optical Security Group, Inc.
Consolidated Balance Sheets (continued)
(Unaudited)
<TABLE>
<CAPTION>
December 31
1998 1997
----------------------------------------
<S> <C> <C>
Liabilities and Stockholders' equity
Current liabilities:
Accounts payable $ 1,162,292 $ 855,110
Accrued expenses 491,305 259,049
Current portion of capital lease obligations 5,814 5,000
Current portion of long-term obligations 479,344 236,600
Allowance for operating losses of discontinued
Operations - -
----------------------------------------
Total current liabilities 2,138,755 1,355,759
Deferred tax liability - 25,840
Capital lease obligations 65,781 2,841
Long-term obligations 1,028,979 1,022,912
Convertible Debentures 3,270,000
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; 6,070,620 and 5,183,949
shares issued and outstanding at December 31, 1998 and
1997, respectively 30,345 25,920
Additional paid-in capital 23,347,239 20,353,181
Foreign currency translation adjustment 109,797 (41,861)
Accumulated deficit (10,504,973) (6,539,829)
----------------------------------------
Total stockholders' equity 12,982,426 13,797,429
----------------------------------------
Total liabilities and stockholders' equity $ 19,485,941 $16,204,781
========================================
</TABLE>
See accompanying notes
2 of 28
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31 December 31
1998 1997 1998 1997
----------------------------------- -----------------------------------
<S> <C> <C> <C> <C>
Revenues $3,670,174 $2,879,032 $10,732,324 $7,507,369
Cost of goods sold 1,916,022 1,751,509 5,958,937 4,438,442
----------------------------------- -----------------------------------
Gross margin 1,754,152 1,127,523 4,773,387 3,068,927
Operating expenses:
Salaries and related costs 853,924 395,307 2,179,630 1,115,396
Depreciation and
amortization 134,366 68,313 367,176 173,978
Other operating expenses 566,190 326,293 1,419,988 835,984
----------------------------------- -----------------------------------
Total operating expenses 1,554,480 789,913 3,966,794 2,125,358
----------------------------------- -----------------------------------
Income (loss) from
operations 199,672 337,610 806,593 943,569
Other income (expense)
Interest income 5,262 24,473 21,845 32,858
Interest expense (78,543) - (195,977) (15,979)
Other income - - 11,399 187
Foreign currency
transaction gain (loss) 5,055 (3,812) 3,892 (134)
----------------------------------- -----------------------------------
Total other income (expense) (68,226) 20,661 (158,841) 16,932
----------------------------------- -----------------------------------
Income before income taxes 131,446 358,271 647,752 960,501
Income tax expense - 7,323 - 7,323
----------------------------------- -----------------------------------
Income from continuing
operations 131,446 350,948 647,752 953,178
----------------------------------- -----------------------------------
Discontinued Operations:
Loss from operations of
discontinued segment - (395,223) - (963,234)
----------------------------------- -----------------------------------
Net income (loss) 131,446 (44,275) 647,752 (10,056)
Dividends on preferred stock 35,860 35,860 107,580 107,580
----------------------------------- -----------------------------------
Net income (loss)
applicable to common stock $ 95,586 $ (80,135) $ 540,172 $ (117,636)
=================================== ===================================
</TABLE>
3 of 28
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Operations (continued)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31 December 31
1998 1997 1998 1997
----------------------------------- ----------------------------------
<S> <C> <C> <C> <C>
Earnings (loss) per share:
Basic:
Continuing operations $ 0.02 $ 0.06 $ 0.09 $ 0.16
Discontinued operations - (0.08) - (0.18)
----------------------------------- ----------------------------------
Net income applicable to
common stock $ 0.02 $ (0.02) $ 0.09 $ (0.02)
=================================== ==================================
Diluted:
Continuing operations $ 0.02 $ 0.05 $ 0.09 $ 0.13
Discontinued operations - (0.06) - (0.15)
----------------------------------- ----------------------------------
Net income applicable to
common stock $ 0.02 $ (0.01) $ 0.09 $ (0.02)
=================================== ==================================
Weighted average number of
shares outstanding:
Basic: 6,070,620 5,183,949 6,027,703 5,183,949
=================================== ==================================
Diluted:
Weighted shares
outstanding 6,070,620 5,183,949 6,027,703 5,183,949
Shares attributed to
options and warrants 209,964 1,167,567 209,964 1,167,567
----------------------------------- ----------------------------------
6,280,584 6,351,516 6,237,667 6,351,516
=================================== ==================================
</TABLE>
See accompanying notes
4 of 28
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31 December 31
1998 1997 1998 1997
--------------------------------- ------------------------------------
<S> <C> <C> <C> <C>
Operating Activities
Income from continuing
operations $ 131,446 $ 350,948 $ 647,756 $ 953,178
Loss from discontinued
operations (66,962) (395,223) (1,172,543) (963,235)
Adjustments to reconcile
net income (loss) to net
cash provided (used) in
operating activities:
Depreciation and
amortization 269,864 235,365 778,081 607,537
Changes in operating assets
and liabilities
Accounts receivable (470,880) 546,463 (1,079,321) 1,245,062
Inventory (314,499) 123,825 (181,106) 202,153
Prepaid expenses (276,466) (125,574) (238,446) (141,181)
Accounts payable and
accrued expenses 819,404 (500,928) 380,410 (1,180,739)
----------------------------------- ------------------------------------
Net cash provided (used) in
operating activities 91,907 234,876 (865,169) 722,775
Investing activities
Patent application costs (6,601) (6,050) (18,930) (24,894)
Acquisition - Advantage
Technology, Inc. - - (2,528,561)
Acquisition - OpSec
Pasternak & Partner GmbH
- (538,474) - (538,474)
Purchase of property and
equipment (249,635) (456,146) (1,077,703) (2,036,988)
Licensing agreements - (2,052) - (2,595)
Notes receivable - 43,800 - (8,110)
Other deposits and
intangible assets (1,880) (25,869) 45,904 (19,105)
----------------------------------- ------------------------------------
Net cash used in investing
activities $(258,116) $(984,791) $(3,579,290) $(2,630,166)
</TABLE>
See accompanying notes
5 of 28
<PAGE>
Optical Security Group, Inc.
Consolidated Statements of Cash Flows (continued)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31 December 31
1998 1997 1998 1997
---------------------------------- ---------------------------------
<S> <C> <C> <C> <C>
Financing Activities
Proceeds from issuance of
common stock, net $ (20,470) $ 220,991 $1,242,649 $ 241,023
Proceeds from issuance of
convertible debentures, net 500,000 - 3,270,000 -
Change in line of credit (184,000) (211,000) (63,845) 155,000
facility
Proceeds from bond financing - 194,367 - 1,104,512
Proceeds from capital leases 65,781 - 65,781 -
Payments on notes and
capital lease obligations (20,586) (962) (62,791) (1,014,242)
Cost of financing (7,670) - (7,670) (81,553)
Payments on preferred stock
dividends (35,860) (35,860) (107,580) (107,580)
-------------------------------- -----------------------------------
Net cash provided (used) by
financing activities 297,195 167,536 4,336,544 297,160
Effect of exchange rate on
cash flows 10,211 (33,790) 31,123 (93,243)
-------------------------------- -----------------------------------
Net increase (decrease) in 141,197 (616,169) (76,792) (1,703,474)
cash
Cash, beginning of period 579,399 976,783 797,388 2,064,088
-------------------------------- -----------------------------------
Cash, end of period $ 720,596 $ 360,614 $ 720,596 $ 360,614
================================ ===================================
Supplemental disclosure of
non-cash flow activities
Interest paid $ 78,543 $ - $ 195,977 $ 15,979
Common stock issued to
acquire Advantage
Technology, Inc. - 1,724,000
Income taxes expense - 7,323 - 7,323
</TABLE>
See accompanying notes
6 of 28
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements
December 31, 1998
1. Summary of Significant Accounting Policies
Organization
Optical Security Group, Inc. (the "Company") is a technology company which,
through its principal subsidiaries, Optical Security Industries, Inc. ("OpSec
U.S."), Optical Security Industries International, Plc ("OpSec International"),
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 28
<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 28
<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 December 31
1998 1997
----------------------------------------
<S> <C> <C>
Land $ 304,066 $ 304,066
Buildings 1,368,231 1,220,076
Leasehold improvements 129,346 129,337
Computer equipment 324,035 298,470
Other equipment and furniture 134,652 55,227
Production equipment 1,665,462 471,582
Vehicles 18,400 63,449
----------------------------------------
3,944,192 2,542,207
Less accumulated depreciation (573,192) (391,432)
$3,371,000 $2,150,775
========================================
</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 December 31, 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 28
<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 28
<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 December 31, 1998, the Company incurred $18,574 in costs,
excluding staff costs, of which $8,136 was for continuing operations and $10,438
was for discontinued operations. Research and development costs for the quarter
ended December 31, 1997 were immaterial.
Reclassifications
Certain amounts in the December 31, 1997 financial statements were reclassified
to conform with the December 31, 1998 presentation.
11 of 28
<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, 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.
The following unaudited pro forma combined results of operations for the nine
months ended December 31, 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 nine-month period ended December 31, 1998 would not
have been materially different than those shown in the accompanying statement of
operations.
<TABLE>
<S> <C>
Sales and royalty income $10,832,184
Net income 954,206
Net income applicable to common stock 846,626
Earnings per share of common stock:
Basic $ 0.15
Diluted $ 0.12
</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 28
<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 (see
further discussion on this matter in Item 2: Management's Discussion and
Analysis of Financial Condition and Results of Operations).
<TABLE>
<S> <C>
Estimated loss on sale and related costs $ 1,560,000
Operating losses from April 1, 1998 to Anticipated
disposal date 900,000
Reserve used year to date (1,172,543)
-----------------
Remaining reserve $ 1,287,457
=================
</TABLE>
Sales of the lenticular business were $1,659,691 and $618,671 in the quarters
ended December 31, 1998 and 1997, respectively. The net operating loss for the
same periods were $66,962 and $395,223 in 1998 and 1997, respectively.
13 of 28
<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 December 31, 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 December 31
1998 1997
-----------------------------------------
<S> <C> <C>
Net current assets:
Accounts receivable, net $ 1,615,049 $1,248,363
Inventory 453,422 921,646
Other current assets 223,347 236,334
Accounts payable (1,140,282) (314,305)
Accrued expenses (125,686) (369,842)
-----------------------------------------
Net current assets $ 1,025,850 $1,722,196
=========================================
Net long-term assets:
Property and equipment, net 758,241 677,902
Goodwill and other intangible assets 5,070,338 5,786,885
Less estimated loss on sale and related costs (1,287,457) -
-----------------------------------------
Net long-term assets $ 4,541,122 $6,464,787
=========================================
</TABLE>
4. Long-Term Debt
Total debt at quarter end was as follows:
<TABLE>
<CAPTION>
Quarter ended December 31
1998 1997
----------------------------------------
<S> <C> <C>
Revolving credit facility $ 397,000 $ 155,000
Economic Development Revenue Bonds 1,111,323 1,104,512
1,508,323 1,259,512
Less current maturities 479,344 236,600
----------------------------------------
Long-term obligations $1,028,979 $1,022,912
========================================
</TABLE>
14 of 28
<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 December 31,
1998).
On April 30, 1997, the Company purchased a manufacturing and office facility in
Baltimore County, Maryland. The property, consisting of an existing building
with approximately 14,500 square feet on a nine-acre site and a newly
constructed 10,000 square-foot addition completed on November 30, 1997, was
financed through the issuance of Economic Development Revenue Bonds. The bond
issue was finalized on July 10, 1997 with Mercantile-Safe Deposit and Trust
Company acting as bondholder and trustee. The term of the bond issue is for 15
years. Principal in the amount of $6,862 is paid monthly plus interest at the
current rate of 7.14%. The rate is subject to adjustment to 84% of the prime
rate periodically announced by Mercantile-Safe Deposit and Trust Company.
In May 1997, the Company paid off the $1 million in short-term seller financing
of a portion of the OpSec Pasternak purchase. The payoff was funded through a
combination of working capital and the revolving credit facility.
Principal maturities of long-term debt for each of the next five fiscal years
and thereafter are:
<TABLE>
<S> <C>
1999 (remaining 3 months) $ 20,586
2000 82,344
2001 82,344
2002 82,344
2003 and thereafter 843,705
----------
Total principal maturities $1,111,323
==========
</TABLE>
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 $512,000. Warrants
to purchase 24,000 shares at an exercise price of $6.00 per share were issued to
purchasers of common shares. In December 1998, an additional $500,000 in
Debentures were sold to complete the private placement.
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.
15 of 28
<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 28
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. Stockholders' Equity (continued)
Redemption
Date Redeemed Price
------------------------------------------------------------------------
On or after March 30, 1998, but prior to the
third anniversary, $1,090
On or after the third anniversary date but
prior to the fourth anniversary date, 1,075
On or after the fourth anniversary date but
prior to the fifth anniversary date, 1,060
On or after the fifth anniversary date but
prior to the sixth anniversary date, 1,040
On or after the sixth anniversary date but
prior to the seventh anniversary date, 1,020
On or after the seventh anniversary date. 1,000
The Company is restricted from paying dividends on its common shares pursuant to
the terms of its Preferred Series B shares. No dividends or other payments can
be declared and paid on the common stock unless the Company also declares and
pays dividends on the shares of common stock issuable upon conversion of the
Series B shares and unless there are no accrued and unpaid dividends on the
Series B shares. On December 31, 1998, the cumulative unpaid dividend on the
Series B Shares of $35,860 was declared and subsequently paid in January 1999.
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 28
<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 December 31, 1998
for issuance upon the conversion of preferred stock and the exercise of the
various options and warrants:
Series B preferred stock 298,833
Stock option plans 2,105,412
Warrants 1,081,765
-----------------
3,486,010
=================
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 December 31, 1998. All ISOP and NSOP options granted in the
quarter ended December 31, 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 nine-month period ending December 31, 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 1,833 - - $ 5.75 $5.75
Options granted 70,000 127,000 - $ 6.00 $6.00 6/03-9/03
Outstanding, December 31,
1998 1,032,200 1,059,878 13,334 $ 2.85-$7.63 $5.59
============================================================================
</TABLE>
18 of 28
<PAGE>
Optical Security Group, Inc.
Notes to Consolidated Financial Statements (continued)
The following is a summary of warrants granted, exercised and as of December 31,
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 acquisition 100,000 $4.05 10/2001
Exercised 12,346 $4.05
----------------------------------------------
Outstanding, March 31, 1995 512,655
Issued in conjunction with the Series B financing 85,860 $7.13 1/2003
------------
Outstanding, March 31, 1996 598,515
Issued in conjunction with the Series B financing 15,500 $7.13 1/2003
Issued upon conversion of Series B shares 472,917 $6.00 3/2002
------------
Outstanding, March 31, 1997 1,086,932
Exercised 4,167 $6.00
------------
Outstanding, March 31, 1998 1,082,765 $6.00 6/2008
Issued in conjunction with private placement 24,000 $6.00
Exercised 25,000
------------
Outstanding, December 31, 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 28
<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 December 31
1998 1997
---------------------------
<S> <C> <C>
Pro forma net income (loss) $26,539 $(168,456)
Pro forma net loss applicable to common stock (9,321) (204,316)
Pro forma loss per share:
Basic $ - $ (0.04)
Diluted $ - $ (0.03)
</TABLE>
Exercise prices for options outstanding as of December 31, 1998 ranged from
$2.85 to $7.63. The weighted-average remaining contractual life of those
options is 2.56 years. At December 31, 1998, there were 585,034 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 28
<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 December 31, 1998:
<TABLE>
<CAPTION>
North Western All
America Europe Other Total
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Continuing operations $ 2,197,340 $ 834,533 $638,301 $ 3,670,174
Discontinued operations 1,555,940 103,751 - 1,659,691
---------------------------------------------------------------
$ 3,753,280 $ 938,284 $638,301 $ 5,329,865
===============================================================
Identifiable assets:
Continuing operations $12,577,704 $2,355,639 $ - $14,933,343
Discontinued operations 3,150,387 1,402,211 - 4,552,598
---------------------------------------------------------------
$15,728,091 $3,757,850 $ - $19,485,941
===============================================================
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Quarter Ended December 31, 1998
- -------------------------------
The Consolidated Statements of Operations of the Company for the quarters ended
December 31, 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 December 31, 1997 has been restated to reflect
the discontinuance of the lenticular business.
Revenues for the quarter increased 27.5% to $3,670,174, and have increased 42.9%
on a year to date basis, which include eight months of operations for OpSec
Advantage, acquired effective May 1, 1998. OpSec Advantage contributed
$1,193,634 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. Remaining net revenues decreased $402,492 over the same quarter of
the prior year, primarily as a result of government product sales, which are low
for the quarter, but on a year to date basis, are in line with sales in the
prior year.
21 of 28
<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 December 31, 1998 (continued)
- -------------------------------------------
Gross margins increased from 39.16% to 47.79%. While margins will vary with the
mix of business, overall margin attainment reflects improved supplier purchasing
economies and manufacturing efficiencies.
Operating expenses increased $764,567 to $1,554,480, with OpSec Advantage,
acquired in May, 1998, comprising $353,955 of the increase. Excluding OpSec
Advantage, salaries and related costs increased $260,107 to reflect staff
additions to the Company's security sales and customer support teams, including
a new office in Germany, full quarter effects from the addition of a Vice
President of Manufacturing, a Divisional Controller, as well as wage increases.
Depreciation and amortization increased $66,053, including $48,953 in OpSec
Advantage (mostly goodwill amortization), and additional depreciation associated
with production equipment and the new Parkton, Maryland manufacturing facility.
Other operating expenses increased $239,897, including $106,492 in OpSec
Advantage, and $133,405 from all other locations. These cost increases have
occurred in several areas, with the most pronounced increases in marketing
expenditures ($35,000) as the Company has committed more resources to the
creation of product brochures, agent support services, and cooperative marketing
programs with major customers; professional fees ($31,000) as the Company is
implementing improvements in information systems and communication facilities
and, in addition, the Company added $21,000 to its reserves for bad debts.
Net interest expense increased $97,754. The Company issued $3,270,000 in 8%
convertible debentures primarily 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 December 31, 1998 in the lenticular business
increased to $1,659,651 from revenues of $618,671 for the quarter ended December
31, 1997. Operating expenses increased $58,406 to $706,980. A loss reserve was
established during the fiscal year ending March 31, 1998. The current quarter
loss of $66,962 was offset against that reserve.
22 of 28
<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 December 31, 1998 (continued)
- -------------------------------------------
At March 31, 1998 the company announced the discontinuation of the specialty
printing business (aka `lenticular') which is conducted through a wholly-owned
subsidiary, Dimensional Printing Industries, Inc. (`DPI'). The lenticular
business for accounting and financial reporting purposes was, therefore, treated
as a discontinued operation in the fiscal year then ended and in the subsequent
fiscal quarters including the current quarter ended December 31, 1998. If a
sale of DPI is not consummated or substantially completed on or before March 31,
1999, the accounting treatment referenced herein above will not be allowed and
the company will restate these reporting periods and include the lenticular
business as part of the continuing operations.
During the first quarter of this fiscal year, the company engaged investment
bankers to assist the company in the timely disposal of DPI. That effort has
not to date resulted in an offer for the business at an adequate value. DPI has
incurred operating losses over this period, yet has continued the development of
new and proprietary products. These products show commercial promise but have
not yet proven to produce significant revenues in the future.
Management believes that it is in the best interests of shareholders for the
company to accomplish the disposition of DPI and, at the same time, retain an
interest in the potential value of these developments. Therefore, we have begun
negotiating with a group of private investors to join certain members of
management in the purchase of at least 81% of DPI. If such a transaction is
consummated, it will occur as of March 31, 1999. However, given the uncertainty
of the future value of the company's continuing investment in DPI, it is
anticipated that such a sale could result in a one time, non-cash charge of up
to $3 million.
Quarter Ended December 31, 1997
- -------------------------------
Operations for the quarter ended December 31, 1997 have been restated to reflect
the discontinuance of the lenticular business announced in March, 1998.
Revenues for the quarter ended December 31, 1997 were $2,879,032, a 130%
increase when compared to the revenues of $1,248,415 for the quarter ended
December 31, 1996. Significant increases in revenues resulting from
authenticating label and tag sales for the NFL licensing program and Exelgram
embossed foil sales to American Express for application on travelers' cheques.
Gross profits for the quarter ended December 31, 1997 increased 120.8% to
$1,127,523 compared to $510,558 for the quarter ended December 31, 1996. The
gross profit margin of 39.2% decreased from the 40.9% for the comparable quarter
of the prior year.
23 of 28
<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 December 31, 1997 (continued)
- -------------------------------------------
Operating expenses of $789,913 grew 54.9% compared to the same quarter of the
prior fiscal year, an increase of $279,828.
The Company reported net income (before lenticular operations) for the quarter
ended December 31, 1997 of $350,948, as compared to net income of $43,560 for
the quarter ended December 31, 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 December 31, 1997, in the lenticular business
decreased to $618,671 from revenues of $1,931,822 for the quarter ended December
31, 1996. Operating expenses increased to $648,574 from $438,684 primarily as a
result of the acquisition of OpSec Pasternak and the formation of DPI during the
quarter ending December 31, 1996. The loss for the current quarter of $395,224
compares to net income of $45,345 for the same quarter of the prior fiscal year.
Liquidity and Capital Resources
Quarter Ended December 31, 1998
- -------------------------------
In December 31, 1998, the Company completed the sale $4,530,000 of securities in
a private placement. Of that amount, $3,270,000 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 $512,000. 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 December 31, 1998, was $4,137,708, and
its current ratio was 2.94-to-1.00. Included in the working capital surplus was
a cash position of $720,596. The Company's long-term debt consisted of
$1,111,323 in bond financing and $3,270,000 in the newly issued convertible
debentures.
The Company reported operating income of $199,672 and net income of $131,446
from its security business. Excluding non-cash expenses of $134,366, earnings
before interest, taxes, depreciation and amortization were $334,038.
24 of 28
<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 December 31, 1997
- -------------------------------
The Company's working capital position at December 31, 1997 was $4,045,873.
Current assets were 3.98-to-1.00 over current liabilities. Included in this
working capital surplus was a cash position of $360,614. The Company's long-
term debt consisted of $1,104,512 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.
The security business generated earnings before interest, taxes, depreciation
and amortization (EBITDA) of $405,923 and net income was $350,948. This
compares to EBITDA and net income of $42,557 and $43,560, respectively, in the
prior year third quarter. The discontinued lenticular business operated at a
loss of $395,224, compared to net income of $45,345 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
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 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
25 of 28
<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 December 31, 1997 (continued)
- -------------------------------------------
Computerized Operations and the Year 2000 (continued)
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.
26 of 28
<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
27 of 28
<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: February 19, 1999 By: /s/ Richard H. Bard
--------------------------------
Richard H. Bard, Chief Executive Officer
and Director
Date: February 19, 1999 By: /s/ Gerald A. Melfi
--------------------------------
Gerald A. Melfi, Principal Financial
Officer
28 of 28
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> MAR-31-1999 MAR-31-1998
<PERIOD-START> OCT-01-1998 OCT-01-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<CASH> 720,596 360,614
<SECURITIES> 0 0
<RECEIVABLES> 50,744 86,265
<ALLOWANCES> 2,568,527 2,706,916
<INVENTORY> 1,657,177 502,953
<CURRENT-ASSETS> 6,276,463 5,401,632
<PP&E> 3,944,192 2,542,207
<DEPRECIATION> 573,192 391,432
<TOTAL-ASSETS> 19,485,941 16,204,781
<CURRENT-LIABILITIES> 2,138,755 1,355,759
<BONDS> 4,364,760 1,025,753
0 0
18 18
<COMMON> 30,345 25,920
<OTHER-SE> 12,952,063 13,771,491
<TOTAL-LIABILITY-AND-EQUITY> 19,485,941 16,204,781
<SALES> 3,670,174 2,879,032
<TOTAL-REVENUES> 3,670,174 2,879,032
<CGS> 1,916,022 1,751,509
<TOTAL-COSTS> 1,916,022 1,751,509
<OTHER-EXPENSES> 1,554,480 789,913
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 73,281 (24,473)
<INCOME-PRETAX> 0 0
<INCOME-TAX> 0 7,323
<INCOME-CONTINUING> 131,446 350,948
<DISCONTINUED> 0 (395,223)
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 131,446 (44,275)
<EPS-PRIMARY> 0.02 (0.02)
<EPS-DILUTED> 0.02 (0.01)
</TABLE>
