<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED JULY 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM . . . . . . . . . . . . TO. . . . . . . . . . . .
COMMISSION FILE NUMBER 0-14100
SCIENTIFIC MEASUREMENT SYSTEMS, INC.
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
74-2048763
TEXAS (I.R.S. EMPLOYER
(STATE OR OTHER JURISDICTION OF IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
78758
2210 DENTON DRIVE, SUITE 106, AUSTIN, TEXAS (ZIP CODE)
( ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
ISSUER'S TELEPHONE NUMBER . . . . . . . . (512) 837-4712
SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
-------------------- ------------------------
None Not Applicable
SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT:
$0.05 PAR VALUE COMMON STOCK
(TITLE OF CLASS)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes [X] No
[_]
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [_]
State issuer's revenues for its most recent fiscal year: $3,759,765.
The aggregate market value of the voting stock held by nonaffiliates of the
registrant was approximately $2,062,281 as of February 12, 1999, based upon the
bid price at the close of trading on such date as reported by NASDAQ. ($0.15)
The number of shares or units outstanding of each of the registrant's classes
of securities, as of February 12, 1999 is as follows:
SHARES OUTSTANDING AS OF
TITLE OF CLASS FEBRUARY 12, 1999
-------------- ----------------------
$0.05 Par Value Common Stock 21,114,468
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT: Yes [_] No [X]
================================================================================
<PAGE>
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I............................................................................. 1
RISK FACTORS....................................................................... 1
ITEM 1. BUSINESS............................................................. 4
ITEM 2. PROPERTIES........................................................... 13
ITEM 3. LEGAL PROCEEDINGS.................................................... 13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................. 13
PART II............................................................................ 13
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.............................................. 13
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................. 15
ITEM 7. FINANCIAL STATEMENTS................................................. 20
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.............................. 44
PART III........................................................................... 44
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT....... 44
ITEM 10. EXECUTIVE COMPENSATION............................................... 46
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT................................................... 47
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................... 48
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K..................................... 49
</TABLE>
<PAGE>
RISK FACTORS
THE STATEMENTS INCLUDED IN THIS REPORT REGARDING FUTURE FINANCIAL
PERFORMANCE AND RESULTS AND THE OTHER STATEMENTS THAT ARE NOT HISTORICAL FACTS
ARE FORWARD-LOOKING STATEMENTS. THE WORDS "EXPECT," "PROJECT," "ESTIMATE,"
"PREDICT" AND SIMILAR EXPRESSIONS ALSO ARE INTENDED TO IDENTIFY FORWARD-LOOKING
STATEMENTS. SUCH STATEMENTS INVOLVE RISKS, UNCERTAINTIES AND ASSUMPTIONS,
INCLUDING BUT NOT LIMITED TO, INDUSTRY CONDITIONS, FOREIGN EXCHANGE AND CURRENCY
FLUCTUATIONS AND OTHER FACTORS DISCUSSED IN THIS REPORT (INCLUDING THOSE
SPECIFICALLY DISCUSSED BELOW) AND IN THE COMPANY'S OTHER FILINGS WITH THE
SECURITIES AND EXCHANGE COMMISSION. SHOULD ONE OR MORE OF THESE RISKS OR
UNCERTAINTIES MATERIALIZE, OR SHOULD UNDERLYING ASSUMPTIONS PROVE INCORRECT,
ACTUAL OUTCOMES MAY VARY MATERIALLY FROM THOSE INDICATED.
LOW LEVELS OF WORKING CAPITAL
The Company requires additional financing for its operations, including but
not limited to its obligations under the U.S. Department of Commerce National
Institute of Standards and Technology (NIST) Financial Assistance Award dated
January 19, 1996, as amended, and to produce its backlog, and no assurances can
be given that any such financing will be obtainable, adequate or available on
economically favorable terms.
As noted in the report of independent certified public accountants, there
is substantial doubt about the Company's ability to continue as a going concern
without the realization of additional adequate financing. For the year ended
July 31, 1998, the Company incurred a net loss of $848,890. In addition, at July
31, 1998, current liabilities exceeded current assets by $1,050,530.
INCURRENCE OF SUBSTANTIAL INDEBTEDNESS
The Company has incurred substantial indebtedness, including amounts owed
under the NIST contract (see Note 11 to the Financial Statements). The
Company's level of indebtedness has several important effects on its future
operations, including, without limitation, (i) a substantial portion of the
Company's cash flow from operations must be dedicated to the payment of interest
and principal on its indebtedness, (ii) the Company's leveraged position
substantially increases its vulnerability to adverse changes in general economic
and industry conditions, as well as to competitive pressure, and (iii) the
Company's ability to obtain additional financing for working capital, capital
expenditures, general corporate and other purposes may be limited. The
Company's ability to continue its operations, to meet its debt service
obligations and to reduce its total indebtedness will be dependent upon the
Company's ability to restructure its debt and/or raise additional financing.
However, to date, the Company has been unsuccessful in its efforts to raise
additional capital via the equity market, and there is no assurance that the
Company will be successful with its efforts to restructure its current
indebtedness. The Company's future performance will be subject to general
economic conditions, industry cycles and financial, business and other factors,
many of which are beyond its control. There can be no assurance that the
Company's business will continue to generate cash flow at or above current
levels. If the Company is unable to generate sufficient cash flow from
operations in the future to service its debt, it may be required, among other
things, to seek additional financing in the debt or equity markets, to refinance
or restructure all or a portion of its indebtedness, or to sell selected assets
or reduce or delay planned capital expenditures. There can be no assurance that
any such measures would be sufficient to enable the Company to service its debt
or that any such financing, refinancing or sale of assets would be achievable on
economically favorable terms. If these measures cannot be accomplished,
management may seek judicial creditor protection or some other form of
restructure.
<PAGE>
CHANGES IN TECHNOLOGY
There can be no assurances that significant changes will not occur in
tomography or that substantial competition will not develop as a result of
technology changes which may adversely affect the Company's ability to compete.
See "Business - Technology."
Y2K ISSUES
Year 2000 or Y2K concerns stem from the fact that many computer programs
were originally written using two digits rather than four digits to define the
applicable year. Programs written in this manner may recognize a date ending in
00 as the year 1900 rather than the year 2000. Essentially, the Company does not
believe that any of its proprietary software poses a Y2K threat to any of its
customers, although the operating systems for workstations or PC's which are
employed by the Company to operate CT systems may present such issues to
customers. The Company has previously sent instructions to all previous systems
customers advising them of a possible issue with operating system software for
the workstations and/or PC's employed by the Company's customers to operate CT
systems. The Company has provided those customers with procedural
recommendations that could be employed to address any such problems that in the
Company's opinion might arise. The Company does not believe that these issues
represent either a material problem to its customers or a problem that could
have a material financial impact on the Company. Beyond any Y2K issues with the
workstation and/or PC operating systems, in the Company's opinion there may be
other Y2K issues facing the Company in its use of third party software packages
such as financial and cost accounting software. The Company does not believe,
however, that such problems will represent a material financial problem.
BACKLOG
The Company experiences significant fluctuations in its backlog. There is
no assurance that the Company will be able to obtain future orders for its
systems, that the number of future orders will be sufficient to enable the
Company to operate profitably, or that the Company will have sufficient cash
available to fill its backlog.
PATENTS AND OTHER RIGHTS
Effective July 1, 1993, the Company acquired a perpetual, non-exclusive,
royalty-free license from two of the Company's founders to two U. S. patents and
technology know-how relating to its basic system. In addition, the Company co-
owns a patent entitled "Online Tomographic Gauging of Hot Sheet Metal" and has
been awarded a U.S. Patent entitled "Process for Analyzing the Contents of
Containers." The issuance of a patent is not conclusive as to its validity or
enforceability; and there has been no independent study of other patents or
prior art which might be infringed by the Company's systems. Attempts by the
Company to enforce or defend its patent rights could result in substantial
expense. The Company has no patents in any foreign countries. In addition, the
Company's technology may be subject to appropriation without compensation in
some areas of the world and may be subject to use without compensation by the
U.S. government in connection with government contracts. See "Business -
Patents and Other Rights."
RECENT CHANGES IN MANAGEMENT; DEPENDENCE ON KEY PERSONNEL
The Company has experienced changes in its senior management, principally
the loss of its Vice-president of Operations and its Controller. In addition,
the Company believes that its success will depend to a significant extent upon
the continued services of certain other key individuals, including but not
limited to Dr. Forrest F. Hopkins. The loss of the services of any of these
individuals or the inability of the
<PAGE>
Company to hire a Chief Financial Officer could have a material adverse effect
on the Company. The Company's current financial situation inhibits its ability
to attract additional qualified senior management talent.
COMPETITION
The non-destructive evaluation industry is highly competitive, and the
Company faces competition from companies with substantially greater financial
and technological resources and greater production capacity and experience than
the Company. The Company believes that its competitive position is negatively
impacted by its relative lack of financial resources and working capital. For
example, because of its lack of financial resources and working capital, the
Company strives to negotiate contracts with a substantial advance payment
requirement as well as periodic progress payments. There can be no assurance
that the Company's limited resources and capacity will be sufficient to compete
effectively in such industry in the future or that it will be able to negotiate
contracts with favorable payment terms. See "Business - Competition."
PRODUCT LIABILITY INSURANCE
The Company does not carry product liability insurance. There can be no
assurance that suits may not be filed or judgments obtained against the Company
in the future in excess of available funds or any insurance coverage which may
then be in effect. Additionally, should it be determined that product liability
insurance is necessary or desirable, the cost of such insurance could have a
material effect upon the cost of the tomographic systems, thereby having an
adverse effect on the sales price of such systems and the competitiveness of the
Company.
USE OF X-RAY EQUIPMENT AND RADIOACTIVE ISOTOPES
The Company's tomographic systems use x-ray equipment and radioactive
isotope sources. The Company believes that it complies with all current
governmental regulations regarding such equipment and materials. Changes in
safety regulations regarding their use and sale could cause the Company
additional expense and increase the cost of its systems, which could have an
adverse impact upon sales or uses of its systems. See "Business - Governmental
Regulation."
CONFLICTS OF INTEREST AND BENEFITS TO MANAGEMENT AND PRESENT SHAREHOLDERS
Various officers, directors and principal shareholders of the Company have
engaged in or become involved in a variety of business relations with the
Company which confer benefits upon such persons and/or create actual or
potential conflicts of interest.
DIVIDEND POLICY
The Company has never paid cash dividends on the Common Stock and does not
anticipate that cash dividends will be paid in the foreseeable future. The
Company currently intends to retain any future earnings to finance the
operations of the Company's business. The declaration and payment in the future
of any cash dividends will be at the election of the Company's Board of
Directors and will depend upon the earnings, capital requirements and financial
position of the Company, future loan covenants, general economic conditions and
other pertinent factors. Furthermore, certain provisions of the Company's loan
documents may restrict the Company's ability to pay cash dividends on the Common
Stock. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources."
3
<PAGE>
ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS
The Company's Articles of Incorporation and Bylaws include certain
provisions that may have the effect of discouraging potential unsolicited offers
or other efforts to obtain control of the Company that are not approved by the
Board. Such provisions may adversely affect the market price of the Common
Stock and may also deprive the shareholders of opportunities to sell shares of
Common Stock at prices higher than prevailing market prices. Such provisions
include the requirement that all shareholder action must be taken at a duly
called annual or special meeting of shareholders unless a majority of the entire
Board provides its prior approval for shareholder action to be taken by written
consent of shareholders. See "Description of Capital Stock - Provisions Having
Possible Anti-takeover Effect."
The Board has the authority, without further action by the shareholders, to
issue up to 2,000,000 shares of the Company's preferred stock in one or more
series and to fix the rights, preferences, privileges and restrictions thereof,
and to issue over 18,000,000 additional shares of Common Stock. The issuance of
the Company's preferred stock or additional shares of Common Stock could
adversely affect the voting power of the holders of Common Stock and could have
the effect of delaying, deferring or preventing a change in control of the
Company.
PART I
ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
Scientific Measurement Systems, Inc. (the "Company") was incorporated in
Texas in 1979. The Company has pioneered the development of industrial
tomography by using techniques similar to the medical industry's CAT scanner.
The Company is now a significant producer of Computerized Industrial Tomographic
and Digital Radiographic Systems. The Company's systems have a large number of
uses including nondestructive measurement and evaluation, testing and analysis,
and reverse engineering which can produce computer-aided design and computer-
integrated manufacturing models. These functions are utilized by industrial
companies and government agencies involved in research, aerospace, aviation,
automotive, machinery, oil and gas, steel and advanced materials manufacture,
among others.
NARRATIVE DESCRIPTION OF BUSINESS
The Company was organized to develop and market computed tomographic
systems for government and industry. Tomography was pioneered in radio-
astrophysics in 1957 and was later first commercialized in the medical X-ray
industry, where tomographic systems are popularly known as CAT scanners, an
acronym for "computerized axial tomography."
Industrial tomography (commonly called "CT" or "CIT" for "computerized
industrial tomography") was developed by the Company and others to inspect the
internal and external dimensions and structural densities of objects without
harming, modifying or contacting the objects being examined. The Company's
systems can detect internal features approaching 0.001 of an inch in a wide
range of objects, depending upon certain factors including density differences
between the feature and the material surrounding it. Primary applications of
the Company's systems include process and quality control of highly engineering
parts through inspection and metrology.
4
<PAGE>
The Company has also developed a series of specialized proprietary software
programs for the evaluation and analysis of data generated by its systems. CT
provides information consisting of precise dimensional and density information
as well as flaw and defect characteristics. This information is often
unavailable by any other means of nondestructive inspection, especially when
internal features must be characterized.
The Company pioneered industrial tomography and is a leading supplier of
computerized industrial tomography systems and services to the aerospace,
automotive, steel, aviation and defense industries. Principal applications
include non-destructive testing (NDT), dimensional analysis/control and computer
aided design/computer aided manufacturing (CAD/CAM).
As a result of both customer and Company-sponsored, field-proven
evolutionary product development performed over a period of years, the Company
produces a family of general purpose computerized industrial tomography systems
which provide precise dimensional and density information, as well as flaw and
defect characteristics, for a wide range of industrial applications. The
Company's SmartScan(TM) product line offers the unique combination of
performance, flexibility, and cost-effectiveness needed to meet industry and
government's current and future CT requirements.
TECHNOLOGY
The Company's typical CT system includes a radiation source, a detector
array, an object positioning unit, a computer system with image processing
equipment and a color graphics image display subsystem. At the option of the
customer, the CT system may be integrated into a portable, lead-lined cabinet
for radiation shielding.
The radiation source is either an X-ray tube, X-ray linear accelerator
("Linac") or a gamma-ray emitting radioisotope which emits a flux of photons.
Most recently, radioisotopes are seldom used. The photons are highly collimated
(focused) to form a beam directed at the object under analysis. The source beam
is shaped and filtered to provide application-specific optimization.
High energy photons passing through the object are again highly collimated
upon entering the detector array. Detectors convert the photons into visible
analog light events which are then digitized by the Company's proprietary
electronics, then sent to the computer workstation for processing.
Scanned data values are computer processed to calculate density matrices.
The object's image is then electronically reconstructed using the density
matrices and passed onward to graphics display routines for analysis and video
display. The image information is analyzed using the Company's proprietary
software programs in order to extract precise density and dimensional
information.
Tomographic images (called "tomograms") are developed by rotating the
object in the radiation beam to provide opacity measurements along many interior
axes. A typical scan includes thousands of measurements. Projection data
computed over 360 degrees produce a tomogram which is a cross-sectional two-
dimensional image. Three-dimensional images are generated by making successive
scans along the height of the object.
Digital radiograms are developed by a series of attenuation measurements
along a single axis of an object with the object fixed (not rotating) in angle
with respect to the source and detectors.
SMARTSCAN(TM) CAPABILITIES
5
<PAGE>
The Company's SmartScan(TM) systems can perform a full range of
measurements needed for digital radiography, tomography, and laminography.
Motions and positions in the system are accurately controlled by the computer
system, with positional information preserved throughout the image-formation
process and automatically made available to analysts.
Interactive operation of the SmartScan(TM) is done by a graphical user
interface ("GUI") which can be easily expanded by users to include programmed
procedures that partially or totally automate the scanning and analysis
sequence. The highly developed SmartScan(TM) image analysis software has unique
capabilities in dimensional and density analysis, reverse engineering, and
report generation. Advanced software engineering, including a fourth-generation
user language, an intelligent data base, and an advanced structure for data
files, minimizes learning time for system use.
SMARTSCAN(TM) IMAGE TYPES
The Company's SmartScan(TM) systems can take computerized industrial
tomography opacity measurements in either the second generation (rotate-
translate) mode, which is better for large (over 2 feet in diameter) or highly-
opaque objects, or in the third generation (rotate only) mode, which is more
efficient for objects up to 2 feet in diameter. Adjustable collimator settings,
source-to-object distance, and "subpositioning" to form interlaced sets of data
are available on the Company's systems.
The SmartScan(TM) also produces digital radiograms. These can be used
directly for analysis, to select the cross-sectional planes for tomograms, or in
combination with other radiograms for dual radiography and laminography. In dual
radiography, two radiograms from different angles are used to precisely locate
(in three dimensions) features visible in both images. In addition to its direct
use, this capability permits accurate transfer of coordinates between scans of
the same object in different positions and is also helpful in precision
quantitative analysis using radiograms.
In certain cases, such as the examination of very long objects, the
SmartScan(TM) can take data over a limited angular range. Such data can be
handled by the SmartScan(TM) system to produce tomograms of somewhat reduced
quality, but often still revealing the features of interest.
A related and more powerful technique, laminography, uses several digital
radiograms to resolve internal features throughout the three-dimensional volume
of the object with only limited blurring from overlapping layers. The
radiograms are mathematically filtered by the same methods used for computed
tomography and projected onto a set of surfaces defined by the user. Such
surfaces can be curved to follow interior sections of interest.
Complete resolution of interior detail is possible by stacking a set of
tomograms in parallel cross-sectional planes. The SmartScan(TM) line strongly
supports the acquisition and analysis of such three-dimensional density maps,
from which users can create synthetic tomograms on vertical or oblique flat or
curved surfaces. SmartScan(TM) software can also find the inside and outside
surfaces of the object, and display them from any chosen point of view.
SMARTSCAN(TM) ANALYSIS CAPABILITIES
In addition to a full range of options for visual inspection, SmartScan(TM)
analysis routines include the most advanced set of dimensional analysis routines
available for tomography. This type of analysis permits the easy determination
of wall thickness and position, diameter and radius sizes, and features such as
area, density, and shape. Special options accurately handle cases of edges so
close together that they
6
<PAGE>
cannot be fully resolved. The dimensional analysis routines can also be used on
laminograms and radiograms.
A powerful set of density analysis options makes it easy to find and
characterize flaws in automatic procedures. In addition to histograms and
region-averaging routines, SmartScan(TM) software permits density sampling or
integration based on the features of the particular object, such as samples from
a casting at fixed distance below the surface to detect porosity at the finish
line.
The dimensions, densities and shapes determined by the SmartScan(TM)
can be reported in text files or printouts in multiple formats. This permits
"reverse engineering," in which the dimensions of the parts (after being reduced
to descriptions of lines, arcs and curves) are sent to computer aided design and
computer aided engineering (CAD/CAE) programs in readable format. Both reverse
engineering and the other analysis methods are assisted by the ability to define
points, lines and curves on the images either at fixed positions or fitted to
the edges of the object.
SMARTSCAN (TM) PERFORMANCE
Effective scan times vary depending on object size and radiographic
opacity, source type and energy intensity, slice plane coverage by the detectors
and image quality desired. Image quality is usually represented in terms of the
system's spatial and density resolution.
All of the Company's systems can use a variety of radiation sources. High
energy gamma-ray isotopic and X-ray linear accelerator sources are used for
larger or more opaque objects while lower energy X-ray tubes are used for
smaller or less opaque objects.
PRINCIPAL PRODUCTS AND SERVICES
SMARTSCAN(TM) PRODUCT LINE
The Company's product line is continually evolving as a result of its
research and development efforts. While the products are to a great extent
customized or optimized for a particular customer's application, the Company has
made several significant improvements to its basic systems. The basic systems in
the form of (1) the SMS Model 101, a comparatively low cost scanner capable of
measuring objects measuring up to two feet in diameter, three feet in height and
weighing up to 2,000 pounds and (2) the SMS Model 201 which can measure objects
up to five feet in diameter and weighing up to 5,000 pounds, have both been
substantially improved.
The most recent product improvement has been the employment of a high(er)
speed detection system which has been successfully incorporated into the SMS
SmartScan(TM). The SMS "close-packed" detector has significantly improved data
acquisition rates, while maintaining resolution performance.
An internally funded effort to improve image reconstruction and processing
speed involved replacing the older MicroVax II minicomputers to advanced Sun
Microsystems SPARC(TM) workstations and the newest DEC Alpha(TM) workstations
has improved both basic products as well. Moving the Company's proprietary
software to these open platforms has improved speed tenfold on the SMS
SmartScan(TM) systems. The migration has also reduced the cost of the computer
subsystem, and made the systems easier to support and upgrade.
Perhaps the most significant change in the product offering at SMS is the
CADScan software which is capable of sophisticated evaluation of complex parts.
This product can graphically report wall
7
<PAGE>
thicknesses and wall displacement variances from design data in near real time.
The Company believes that the CADScan capability, which can be employed on all
of its SmartScan systems, will afford the Company access to large existing
markets in product-oriented inspection, reverse engineering and rapid
prototyping.
MANUFACTURE AND PRODUCTION
Manufacture of each of the Company's systems involves assembly of
electronic and mechanical components, system integration with computer hardware
and software, final checkout and diagnostic testing. Major computer subsystems,
electromechanical components and subassemblies are customarily manufactured by
outside vendors.
The Company has produced and delivered industrial CT systems to a variety
of government and commercial customers, both in the United States and abroad. In
previous years, the Company has delivered SMS Model 201 systems to customers
including EG&G Florida, Inc., General Motors Corporation, Rockwell International
Corporation and the U. S. Air Force San Antonio Air Logistics Center at Kelly
Air Force Base, as well as numerous SMS Model 101B+ systems (the predecessor to
the SmartScan(TM) product) to customers such as Martin Marietta Energy Systems,
Pratt & Whitney Canada, the Swiss Federal Laboratories for Materials Testing and
Research (EMPA), BP America (a division of British Petroleum), EG&G Mound
Applied Technologies, Inc. and Allied Signal, Inc. The Company has also sold
SmartScan(TM) systems to a number of customers including Fiat, Toyota, the U.S.
Army, NASA-Lewis Research Center and Morton International, Inc.
In fiscal year 1998, the Company shipped SmartScan(TM) systems to Savit,
the U.S. Army, and Toyota Motor Corporation. In addition, in fiscal year 1998,
the Company delivered a SmartScan system to Fiat (Italy), which had been
returned previously, was modified to meet new specifications, and ultimately
returned to and accepted by Fiat.
In fiscal 1998, the Company received system orders from Toyota Motor
Corporation, Rolls Royce Plc, Chrysler Corporation (now Daimler Chrysler), and
Mitsubishi Materials Corporation. . The Company also received an order for CT
components from Japan Atomic Energy Research Institute (JAERI), and upgrade
orders from Boeing and Ishikawajima-Harima Heavy Industries (Japan.)
SCANNING SERVICES
The inspection and measurement capabilities for the Company's products are
available to both government and industry through the Company's Scanning
Services department. The services are provided by the Company, using Company-
owned systems and software. Quality control of the wall thickness of turbine
blades used in jet aircraft engines and geometry acquisition for reverse
engineering are a significant source of scanning services business. Scanning
services also are playing an increasing role in the development of new composite
and ceramic materials for use in automotive and aerospace industries. The
Company provides these services on a contract, hourly or per part basis. The
Scanning Services department also performs demonstration scans for customers
considering a system purchase.
OPERATIONS AND MAINTENANCE SERVICES
With respect to certain systems previously delivered by the Company, the
Company also provides ongoing services under maintenance contracts with terms of
up to five years. Additionally, the Company
8
<PAGE>
provides field services to customers through the sale of hardware and software
upgrades. Revenues from field services has become an increasingly important
source of revenues as the number of systems in operation continues to grow.
RESEARCH AND DEVELOPMENT
Company-sponsored research and development (R&D) expenses totaled
approximately $304,000 and $6,600 for the years ended July 31, 1998 and 1997,
respectively. During fiscal 1997, the Company received a $229,000 expense
reimbursement from National Institute of Standards and Technology (NIST) which
was recorded as a reduction in R&D expenses. No such reimbursement was received
in fiscal 1998.
The Company's research in past years has been focused on achieving
increases in the speed of data acquisition and image processing. These
improvements were identified as the improvements that would most significantly
expand the implementation of the Company's CT technology in industry. The
Company continues to focus its research and development on increasing speed and
ease of use and reducing costs. In fiscal year 1997, the Company began work on a
prototype development for a solid state detector and state-of-the-art readout
electronics, and delivered the first system based on these new "close-packed"
detectors in fiscal 1998. The new detector system significantly reduces scan
times compared to previous generation detectors while maintaining the
performance in terms of spatial and density resolution. The Company plans to
utilize the close-packed detectors on virtually all new CT system orders, and is
offering the new detectors as an upgrade product for its installed base of CT
systems.
In fiscal 1998, the Company also sold a customized derivation of its new
3-D analysis software in conjunction with a system sale. CADScan(TM) was first
demonstrated as a proof of concept for a General Motors complex casting
application in fiscal 1997, and continues to be refined for a broad range of
potential applications. Additionally, the Company has completed the development
of a new Graphical User Interface (GUI) for use in the Company's products, and
has sold the new GUI as an upgrade to some of its existing CT systems in the
field. The GUI helps provide for user friendly operation of the Company's
systems. In fiscal 1998, the Company completed the design and implementation of
a more robust Object Positioning Unit (OPU) that improved the weight capacity
and precision motion control compared to previous models of its CT scanners.
These change provides a significant advancement towards scanner platform
standardization.
In February 1996 a joint venture comprised of the Company, General Motors,
General Electric, and EG&G, began work on a grant from the U.S. Department of
Commerce National Institute of Standards and Technology ("NIST") under their
Advanced Technology Program. The objective of the program was to develop very
fast CT technology using volumetric scanning techniques. The Company is the
project leader of the consortium and has sole commercializing rights for the new
technology in the industrial market excluding medical applications. However,
project activity was officially suspended in August, 1998 due to the Company's
inability to meet its financial obligations required under the award agreement
(see Note 11 to the Financial Statements), and pending a resolution to the
financial issues, a request for an extension to the program has been denied by
NIST. Efforts by the Company to raise capital to continue to fund its portion of
this research program have been unsuccessful thus far, and the Company has begun
procedures to closeout the program.
MARKETING
The Company markets its products and services through direct sales contacts
with existing customers, responses to inquiries generated by advertising and
articles in trade magazines and technical publications, trade shows and through
equipment demonstrations and scanning services. The Company's
9
<PAGE>
SmartScan(TM) systems are intended to be standardized, customer-oriented
commercial products designed for R&D as well as production environments.
The Company's marketing efforts are distributed across a wide range of
industries. Representative areas are:
. Aviation/Aerospace. The Company believes that tomography offers a
cost-effective method for analysis prior to utilization, as well as
in-service inspection of critical components, including turbine
blades, turbine disks, rotors, fuel valves and structural components.
. Automotive. Tomography can be used for design verification, quality
control and reliability analysis of automotive components, such as
engine parts, gears, shafts and supports and can assist in computer
integrated manufacturing ("CIM"). The Company believes that its
technology is capable of being used in on-line automotive production
applications to detect structural flaws and provide dimensional
analysis.
. Castings. Numerous industries other than Aviation/Aerospace and
Automotive utilize castings composed of various metals, alloys and
ceramics. In many of these cases, dimensional accuracy and porosity
are critical. The Company believes that tomography is particularly
suited to accurate dimensional measurement and detection of flaws in
such products.
. Oil and Gas. Tomography is widely used in the oil industry to measure
fluid flow properties in rock samples from oil and gas reservoirs.
The Company has independent representatives in Japan, Germany, and the
upper Midwest, which represent particularly attractive geographic markets. These
representatives provide sales and technical support for the Company's systems
and services in their respective geographic regions. Sales and technical
assistance for customers outside of these territories is supported directly by
the Company from its Austin facilities.
In fiscal 1995, the Company appointed Eberline Radiometrie Group of Thermo
Electron Instruments, Inc. (Eberline) as its exclusive worldwide representative
for the Company's patented Tomographic Sheet Profile Gauge. Eberline is the
leading European producer of industrial gauges.
PAYMENT TERMS
The Company utilizes several different types of billing arrangements and
payment terms, depending upon the type of product or service sold, and upon
whether the customer is a private or a governmental entity. With respect to
system sales, the Company typically obtains a substantial payment from the
customer at the time the order is placed, with subsequent receipt of progress
payments as certain milestones on the contract are met. This type of payment
structure is not uncommon in the capital equipment and government markets. The
Company is of the opinion that future sales contracts will have similar terms
although there is no assurance that the Company will be able to secure such
terms on future contracts.
As described elsewhere herein, the Company's pricing and payment terms with
respect to scanning services are to enter into open purchase orders to perform
tomographic analysis of a specified number and class of objects for a unit
price, turnkey fixed fee or hourly rate.
10
<PAGE>
SUBSTANTIAL COMPETITION AND TECHNOLOGY CHANGES
The non-destructive evaluation and test industry is highly competitive, and
the Company faces competition from companies with substantially greater
financial and technological resources and greater production capacity and
experience than the Company. Such other companies include but are not limited
to, ARACOR, Inc., and Bio-Imaging Research, Inc., each of which makes or is
capable of making competitive products utilizing tomographic or other
technology. The principal elements of competition in the tomographic industry,
in the opinion of management, are the ability: (i) to produce high quality
images of a variety of target objects; (ii) to manipulate and analyze collected
data; (iii) to demonstrate to customers that the costs of using the technology
are reasonable compared to the benefits realized from alternative non-
destructive methods; and (iv) comparative cost.
The Company believes that its competitive position is negatively impacted
by its relative lack of financial resources and working capital. The Company
seeks to negotiate contracts with a view toward obtaining a significant advance
payment and periodic progress payments, as described above. The Company
believes, however, that its competitive position is benefited by the quality of
the Company's technology, and the Company's ability through its products to
perform tests with speed, accuracy and minute precision not generally available
through competing products. Accordingly, many of the Company's customers and
prospective customers are faced with a decision of whether to obtain products
that are less precise and less sophisticated than those of the Company, or to
obtain the Company's products with potentially more stringent payment terms than
are available through the Company's competition.
EMPLOYEES
At December 31, 1998, the Company employed 21 full-time employees, of whom
two were engaged in research, four in software development, two in engineering,
three in scanning services, two in sales and marketing, two in field services,
four in administrative, clerical and support services, and two in manufacturing.
When necessary, temporary labor in the form of part-time employment or contract
labor is utilized to meet increased demand for the production of the Company's
systems.
None of the Company's employees are represented by a union or covered by a
collective bargaining agreement. The Company has not experienced a strike or
work stoppage and believes that its relations with its employees are adequate.
GOVERNMENTAL REGULATION
The detector systems incorporated within the Company's products utilize X-
ray and linear accelerator equipment and radioactive isotope sources. Various
governmental agencies, such as the U.S. Nuclear Regulatory Commission, the
Federal Aviation Administration, the U.S. Department of Transportation and state
health departments regulate the sale, use, disposal, labeling and shipment of
radioactive material and the use of X-ray and linear accelerator equipment.
There are also federal, state and local regulations covering the occupational
safety and health of the Company's employees. The Company believes that it is in
compliance with all applicable governmental requirements.
The primary aspect of the equipment or protocol associated with the
Company's products or activities which require licensing is the use of isotopic,
X-ray and linear accelerator radiation sources. Use of the systems in-house or
at a customer facility requires the operating party to obtain a license from the
appropriate state agency and/or federal agency regulating the use of radiation
producing systems. The
11
<PAGE>
Company and all of its customers operating its systems in the field have been
able to obtain such licenses in a timely and efficient manner.
PATENTS AND OTHER RIGHTS
Pursuant to a 1981 assignment agreement (the "Assignment"), the Company
received an assignment of and exclusive rights to use certain technical and
proprietary know-how and two patents expiring in 1998. The Assignment to the
Company was made by Lon Morgan and E. C. George Sudarshan (the "Assignors"),
both of whom were founders or former affiliates of the Company. The Assignment
was for a term continuing through the patent expiration dates, but was subject
to early termination under certain circumstances described below. The Assignment
required the Company to make royalty payments to the Assignors of an aggregate
of one percent of the Company's sales that were related to products or
technology based on the rights subject to the Assignment, subject to a $10,000
annual minimum royalty. On July 1, 1993, the Company reassigned ownership of the
technical and proprietary know-how and the patents to the Assignors in return
for a payment of money by the Company, a mutual release and the cancellation of
the royalty commitment described above and the grant to the Company of a
perpetual, non-exclusive royalty-free license to the patents and the technical
and proprietary know-how.
On September 27, 1994, SMS, and co-owner Bethlehem Steel were awarded U.S.
Patent No. 5,351,703, entitled "Online Tomographic Gauging of Hot Sheet Metal."
The patent was filed in August 1992. The sheet steel gauge was developed by the
Company in collaboration with Bethlehem Steel and the National Science
Foundation's Small Business Innovation Research program, and has been in
operation at Bethlehem Steel for approximately four years. The steel gauge
provides the steel manufacturing industry, for the first time, with the ability
to inspect fully certain steel products as the products are being produced and,
thus, provides the manufacturers with automated feedback for process control.
PCT and EP foreign patent applications have been filed and are pending.
Corresponding Canadian, Taiwanese, and Korean patent applications also are
pending for this invention.
On March 21, 1995, the Company was awarded U.S. Patent No. 5,400,381
entitled, "Process for Analyzing the Contents of Containers." This very broad
patent covers a highly cost effective method for determining free liquid content
in radioactive waste drums. There are approximately 2,000,000 drums within the
Department of Energy (DOE) complex which require inspection per DOE and Nuclear
Regulatory Commission regulations. The Company is working with the DOE to
modernize its inspection procedures to include the patented technology. A second
specialized use for the same method is being considered by major auto companies
for production-line characterization of fluid distribution within sealed
systems.
The Company has applied for patent protection for an "Apparatus and Method
for Comparison" for use by manufacturers in determining how close a manufactured
part comes to parts that have previously been determined to be acceptable or to
the design of an acceptable part. Historically, it has not been possible to
measure parts completely once manufactured so as to determine such important
measurements as shape and wall thickness without destroying the part to be
measured. Prior art devices have utilized computerized tomography to create
scans of slices of a part. These prior art scans, however, result only in
individual slices of a part which then are analyzed by an engineer. Because of
the time consuming nature of the prior art scanning devices and the necessity
for an engineer to review the scans, only a limited number of predetermined
"critical" specific locations have been analyzed in the past. The Company's
innovative, proprietary technology provides an apparatus and method wherein the
whole part may be analyzed to determine the shape and wall thickness of the
device throughout and compare it to design specifications or an acceptable
manufactured part.
12
<PAGE>
The Company has also completed work on a new patent application for a CT
system designed especially for oil core scanning. The new design provides more
capabilities than the medical CT systems that the oil industry has widely
adopted for measuring fluid flow properties in rock cores. The new design
provides higher energy and higher resolution scanning on cores that can be
horizontally or vertically mounted to provide information on the effects of
gravity on the fluid flow process. The same imaging capabilities of the new
system have been sold by the Company for "vertical-only" core scanners in China,
Canada, and the U.S.
During fiscal year 1998, the Company continued development of advanced 3D
dimensional analysis software specifically designed for quickly identifying
regions of rework and quantifying the amount of rework required. The Company
intends on delivering a customized version of this software in fiscal 1999 to
fulfill an order received in fiscal 1998. The Company believes that this
software is a significant improvement in dimensional analysis and the Company
anticipates that this new software may be an important component in future
system sales.
FINANCIAL HISTORY
The Company completed its initial public offering in March 1985. As of
December 31, 1998, the Company had the following equity securities outstanding
(exclusive of employees' and directors' stock options):
<TABLE>
<CAPTION>
<S> <C>
Common Stock, $0.05 par value .............................. 21,114,468 shares
</TABLE>
ITEM 2. PROPERTIES
The Company currently leases approximately 13,900 square feet of office and
manufacturing space in an industrial park located in Austin, Texas. The Company
has recently renewed its building lease to a new 5-year term expiring in
October, 2003 at $9009 per month. Management believes that this space should be
adequate for all of the Company's activities through fiscal 1999.
ITEM 3. LEGAL PROCEEDINGS
The Company is currently involved in litigation arising from its normal
course of business and believes that such litigation will not adversely impact
the Company's financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of the Company's fiscal year ended July 31, 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
13
<PAGE>
Prior to May 13, 1993, the Company's Common Stock was traded in the over-
the-counter "Small Cap" Market and was quoted on the automated quotation system
of the National Association of Securities Dealers ("NASDAQ") under the symbol
SCMS. On May 13, 1993 the Common Stock was delisted from the NASDAQ "Small Cap"
Market for failure to meet, among other requirements, the minimum bid price
requirement of $1.00 per share. After May 13, 1993 the Common Stock has been
traded over-the-counter on the OTC Bulletin Board under the symbol "SCMS."
The following table shows the quarterly range of high and low bid
quotations for the Common Stock for the past two fiscal years, as reported by
the OTC Bulletin Board.
<TABLE>
<CAPTION>
Common Stock
------------
Fiscal Year Ended High Low
------ -----
<S> <C> <C>
July 31, 1997
First Quarter $0.90 $0.68
Second Quarter................ 1.41 0.67
Third Quarter................. 1.07 0.51
Fourth Quarter................ 0.65 0.35
July 31, 1998
First Quarter................. $0.98 $0.35
Second Quarter................ 0.60 0.29
Third Quarter................. 0.71 0.35
Fourth Quarter................ 0.53 0.28
</TABLE>
The above quotations are over-the-counter market quotations and thus
reflect inter-dealer prices, without retail mark-up, mark-down or commission and
may not represent actual transactions.
The total number of shares of Common Stock outstanding as of December 31,
1998 was 21,114,468 and the total number of holders of Common Stock of record as
of such date was approximately 605.
The holders of the Company's Common Stock are entitled to receive dividends from
funds legally available therefor, when and as declared by the Board of
Directors. No cash dividends have been paid or are anticipated in the
foreseeable future, since the Company intends to retain earnings, if any, for
use in its business.
The Company issued the following restricted shares of its Common Stock in
connection with the exercise of options. All options were exercised pursuant to
the cashless exercise provisions of the option agreements. In August 1996, the
Company issued to an employees 22,387 shares for $0.08 per share, and to a
former officer 39,570 shares for $0.15 per share and 60,878 shares for $0.24 per
share. In September 1996, the Company issued to the same employee 28,207 shares
for $0.1406 per share, 28,946 shares for $0.15 per share, 79,296 shares for
$0.15 per share and 33,437 shares for $0.24 per share. In October 1996, the
Company issued to an officer, 196,978 shares for $0.1406 per share and to an
employee, 125,730 shares for $0.1406 per share and 77,579 shares for $0.225 per
share. In November 1996, the Company issued to an officer 461,585 shares for
$.1406 per share and 252,468 shares for $0.225 per share. In December 1996, the
Company issued 258,141 shares for $0.15 per share and 90,584 shares for
14
<PAGE>
$0.225 per share to two separate officers of the Company. In January 1997 the
Company issued 34,810 shares for $0.24 per share to an officer of the Company
and 123,472 shares for $0.1406 per share to an employee. In April 1997, the
Company issued 155,521 shares to a former director of the Company for $0.15 per
share. All such issuances were made in connection with the exercise of employee
or director options and were exempt from registration pursuant to Section 4(2)
of the Securities Act of 1933.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward looking statements which involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward looking statements. In addition, the
Management's Discussion and Analysis should be read in conjunction with, and is
qualified in its entirety by reference to, the financial statements of the
Company and the notes thereto included elsewhere in this Annual Report. This
discussion and analysis of operations compares the two years ended July 31, 1998
and 1997.
The following table sets forth items from the Company's statement of
operations as a percentage of total revenues and as a percentage change from the
prior year:
<TABLE>
<CAPTION>
Year Ended July 31,
-----------------------------------------------------------------
1998 1997
------------------------------- --------------------------------
Dollar % of % Change Dollar % of % Change
Amount Total from Prior Amount Total from Prior
(000s) Revenue Year (000s) Revenue Year
-------- -------- ----------- --------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
Contract revenues:
Tomographic system sales.......................... $2,560 68.1% (8.6)% $ 2,800 75.2% 45.6%
Scanning services................................. 614 16.3% 25.8% 488 13.1% (13.5)%
Field services and upgrades....................... 585 15.6% 34.2% 436 11.7% (35.7)%
Total revenues.................................. 3,760 100.0% 1.0% 3,724 100.0% 17.7%
Contract costs...................................... 2,893 76.9% (20.3)% 3,631 97.5% 65.9%
Gross profit........................................ 867 23.1% 832.3% 93 2.5% (90.5)%
Operating costs:
Marketing......................................... 528 14.2% 49.2% 354 9.5% 36.7%
Research and development.......................... 304 8.1% 4243% 7 0.2% 40.0%
General and administrative........................ 812 21.8% 3.7% 783 21.0% 84.7%
Total operating costs............................ 1,644 43.7% 43.7% 1,144 30.7% 66.3%
Loss from operations................................ (777) (21.6)% 26.1% (1,051) (28.2)% (464.9)%
Other (income) expense:
Interest expense.................................. 72 1.9% 1.2% 71 1.9% 208.7%
Interest and other income......................... 0 0.0% 0.0% (1) 0.0% (91.7)%
Loss on sale of asset............................. 0 0.0% 0.0% 0 0.0% 0.0%
Other - net..................................... 72 1.9% 2.7% 70 1.9% 536.4%
------ ------ ------ ------- ------ -------
Net Loss............................................ $ (849) (22.6)% 24.3% $(1,121) (30.1)% (504.7)%
------ ------ ------ ------- ------ -------
</TABLE>
NM- Not meaningful
FISCAL 1998 RESULTS OF OPERATIONS
Total contract revenues for the year ended July 31, 1998 was basically flat
compared to the previous year, increasing about 1% or $36,175. A $239,554, or
8.6% decrease in revenues from systems sales was offset by increases in upgrade
and scanning services revenue. Scanning services revenues increased $126,470, or
26% and maintenance and upgrades revenues increased $149,259, or 34%. The
Company's systems revenue was adversely affected by its continued cash flow
limitations, and the delay
15
<PAGE>
in completion of its new "close-packed" detector system. To date, the Company
has been unsuccessful in its efforts to raise additional capital via the equity
market, and no assurances can be given that the Company can raise working
capital in sufficient amounts or otherwise successfully produce all such backlog
or that any of the Company's revenues will increase.
GROSS MARGIN
Gross margin (revenue less direct contract costs) as a percentage of
revenue increased from 2.5% in fiscal year 1997 to 23% in fiscal year 1998.
This increase is due to several factors including improvement in managing cost
over-runs on system projects, as well as a more favorable product mix (i.e.,
higher margin scanning services, maintenance, and upgrade revenue, contributed
to 32% of the total revenue in fiscal 1998, compared to 25% of the total revenue
in fiscal 1997.)
OPERATING COSTS
Fiscal year 1998 total operating costs as a percentage of revenues
increased to 44% from 31% in fiscal year 1997. Marketing and sales expenses
grew by 49% mostly due to the hiring of a VP of Sales and Marketing, as well as
expenditures for new company collateral and web site development. The dramatic
increase in R&D expenses is primarily due to the fact that the Company received
an expense reimbursement of $229,000 from National Institute of Standards and
Technology (NIST) in fiscal 1997, which was recorded as a reduction in R&D
expenses. No such reimbursement was received in fiscal 1998. (see Note 11 to
the Financial Statements.) General and administrative expenses were basically
flat year over year.
NET DEFERRED TAX ASSET
At July 31, 1998 and 1997, the Company provided a 100% valuation allowance
for the deferred tax asset because it could not determine whether it was more
likely than not that the deferred tax asset would be realized.
OTHER EXPENSES
Interest expense was basically flat between fiscal 1998 and fiscal 1997.
LIQUIDITY AND CAPITAL RESOURCES
WORKING CAPITAL
As of July 31, 1998, the Company had negative working capital of $1,050,530
compared to negative net working capital of approximately $164,000 at July 31,
1997.
CASH FLOWS
The Company's operating activities provided net cash of approximately
$8,400 in fiscal year 1998 compared to net cash utilized in operations of
approximately $845,000 in fiscal year 1997. Cash utilized in operations is less
than net losses in fiscal year 1997 primarily because of non-cash charges for
depreciation and amortization and a net increase in current liabilities.
During fiscal 1998 and 1997, the Company used $342,600 and generated $1,303,600,
respectively, from financing activities. The generation of cash from financing
activities in fiscal 1997 was due mainly to the
16
<PAGE>
issuance of the Company's common stock and borrowings under a bank line of
credit. The net use of cash from financing activities in fiscal 1998 was due
mainly to payments on borrowings.
CAPITAL EXPENDITURES
Capital expenditures in fiscal year 1998 and 1997 were approximately
$15,000 and $114,000, respectively. Fiscal year 1998 capital expenditures were
for scanning services equipment, leasehold improvements to accommodate
production requirements, and for the upgrade of internally utilized computer
equipment. Except for computer equipment upgrades, the fiscal year 1997 capital
expenditures are nonrecurring in nature.
LIQUIDITY
Sources of liquidity as of December 31, 1998 include cash on hand of
approximately $8,500 and accounts receivable of approximately $75,000. Based
on these sources of liquidity as well as revenues generated by current backlog,
management believes that the Company has the ability to manage its cash
requirements during the fiscal year ending July 31, 1999 provided that the
--------
Company does not lose any contracts; that none of its customers cancel their
contracts or otherwise fail to pay their debts to the Company; or that among the
company's creditors GE CR&D in particular does not initiate an aggressive
collection effort. The Company's heavy concentration on a small number of
customers makes it particularly vulnerable to the loss of any account.
If a customer of the Company cancels a contract or becomes unable to pay
its debts to the Company pursuant to its purchase contract, liquidity would be
adversely affected. If a creditor(s) of the Company aggressively pursues a
collection effort, liquidity would also be adversely affected. This would
require the Company to either obtain additional capital from external sources or
to curtail its working capital expenditures. No assurances can be given of the
Company's ability to obtain such additional capital and any such curtailment
could adversely affect the Company's operations and competitive position. To
date, the Company has been unsuccessful in its efforts to raise additional
capital via the equity market, and there is no assurance that the Company will
be successful with its efforts to restructure its current indebtedness. If these
measures cannot be accomplished, management may seek judicial creditor
protection. During fiscal 1998, the Company was unable to pay vendors in
accordance with the terms of purchases. Also, subsequent to fiscal 1998, the
Company has been unable to meet all of its payroll obligations in a timely
fashion. At this time, the Company remains in arrears of its payroll
obligations.
For the past several years, the Company has been aware that it needed
significant additional financing for its participation, with consortium members,
in a research grant from the U.S. Department of Commerce National Institute of
Standards and Technology ("NIST") under the Advanced Technology Program. As
more fully described in Note 11 to the financial statements, pursuit of this
project has required funding for the Company's portion of the project in the
approximate amount of $2,745,000. As of December 31, 1998 the Company owed a
total of $871,500 to General Electric and may contingently owe an additional
$718,200. Since October 1997 the Company has been seeking diligently to obtain
such financing from additional borrowing arrangements and/or the offering of
debt or equity securities. However, with the end of, first, the Tucker Anthony
investment banking engagement on October 1, 1998 and, subsequently, that of the
Company's co-advisor, Mitsubishi Trust and Banking Corporation, Management has
concluded that prospects for such new financing are remote.
NIST officially suspended project activity in August, 1998 due to the
Company's inability to meet its financial obligations required under the award
agreement (see Note 11), and pending a resolution to the financial issues, a
request for an extension to the program has been denied by NIST. Efforts by the
17
<PAGE>
Company to raise capital to continue to fund its portion of this research
program have been unsuccessful thus far, and consequently the Company has begun
procedures to closeout the program.
As of November 7, 1997 the Company was in default with a local bank with
respect to its Export Import Bank of the U.S. ("EXIMBANK") guaranteed line of
credit, originally in the amount of $1,250,000. As of July 1998 the Company owed
approximately a net $167,000 to its commercial bank on this credit which was
made in connection with the production of one of the Company's systems for
delivery to a foreign customer. The associated receivable from the export
customer was to serve as the bank's collateral.
In February of 1998, the customer accepted the system after the Company
discounted the price of the system somewhat and resolved certain technical and
performance issues. Management negotiated and executed a series of modifications
to the note with the bank. These modifications extended the maturity due date
successively to July 31, 1998 and then to December 31, 1998. The $630,000
principal balance, which had been owing as of July 31, 1997, was reduced to
approximately $138,000 as of December 31, 1998.
Management has negotiated with the bank to extend the note for an
additional ninety (90) day period beyond the December 31, 1998 maturity date.
While no assurance can be given, management anticipates that on or before the
maturity date of this latest extension to the note the principal balance and
interest obligations will have been retired in their entirety.
As noted in the report of independent certified public accountants, there
is substantial doubt about the Company's ability to continue as a going concern
without the realization of additional adequate financing. As of July 31, 1998,
the Company incurred a net loss of $848,890. In addition, at July 31, 1998,
current liabilities exceeded current assets by $1,050,530.
The Company has incurred substantial indebtedness, including amounts owed
under the NIST contract (see Note 11 to the Financial Statements). The Company's
level of indebtedness has several important effects on its future operations,
including, without limitation, (i) a substantial portion of the Company's cash
flow from operations must be dedicated to the payment of interest and principal
on its indebtedness, (ii) the Company's leveraged position substantially
increases its vulnerability to adverse changes in general economic and industry
conditions, as well as to competitive pressure, and (iii) the Company's ability
to obtain additional financing for working capital, capital expenditures,
general corporate and other purposes may be limited. The Company's ability to
continue its operations, to meet its debt service obligations and to reduce its
total indebtedness will be dependent upon the Company's ability to restructure
its debt and/or raise additional financing. However, to date, the Company has
been unsuccessful in its efforts to raise additional capital via the equity
market, and there is no assurance that the Company will be successful with its
efforts to restructure its current indebtedness. The Company's future
performance will be subject to general economic conditions, industry cycles and
financial, business and other factors, many of which are beyond its control.
There can be no assurance that the Company's business will continue to generate
cash flow at or above current levels. If the Company is unable to generate
sufficient cash flow from operations in the future to service its debt, it may
be required, among other things, to seek additional financing in the debt or
equity markets, to refinance or restructure all or a portion of its
indebtedness, or to sell selected assets or to reduce or to delay planned
capital expenditures. There can be no assurance that any such measures would be
sufficient to enable the Company to service its debt or that any such financing,
refinancing or sale of assets would be achievable on economically favorable
terms. If these measures cannot be accomplished, management may seek judicial
creditor protection or some other form of restructure.
18
<PAGE>
BACKLOG
Total contract backlog as of December 31, 1998 was approximately
$1,636,000, down from $2,700,000 one year earlier. Of the current backlog,
approximately $1,571,000 is for systems sales. All backlog is scheduled for
production in fiscal year 1999, provided, however that no assurances can be
given that all such backlog will be produced.
Y2K ISSUES
Year 2000 or Y2K concerns stem from the fact that many computer programs
were originally written using two digits rather than four digits to define the
applicable year. Programs written in this manner may recognize a date ending in
00 as the year 1900 rather than the year 2000. Essentially, the Company does not
believe that any of its proprietary software poses a Y2K threat to any of its
customers, although the operating systems for workstations or PC's which are
employed by the Company to operate CT systems may present such issues to
customers. The Company has previously sent instructions to all previous systems
customers advising them of a possible issue with operating system software for
the workstations and/or PC's employed by the Company's customers to operate CT
systems. The Company has provided those customers with procedural
recommendations that could be employed to address any such problems that in the
Company's opinion might arise. The Company does not believe that these issues
represent either a material problem to its customers or a problem that could
have a material financial impact on the Company. Beyond any Y2K issues with the
workstation and/or PC operating systems, in the Company's opinion there may be
other Y2K issues facing the Company in its use of third party software packages
such as financial and cost accounting software. The Company does not believe,
however, that such problems will represent a material financial problem.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"), which establishes standards for reporting and display of comprehensive
income, its components and accumulated balances. Comprehensive income is
defined to include all changes in equity except those resulting from investments
by owners and distributions to owners. Among other disclosures, SFAS 130
requires that all items that are required to be recognized under current
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 June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"), which supersedes SFAS No. 14, "Financial Reporting for Segments of a
Business Enterprise." SFAS 131 establishes standards for the way that public
companies report information about operating segments in annual financial
statements and requires reporting of selected information about operating
segments in interim financial statements issued to the public. It also
establishes standards for disclosures regarding products and services,
geographic areas and major customers. SFAS 131 defines operating segments as
components of a company about which separate financial information is available
that is evaluated regularly by the chief operating decision maker in deciding
how to allocate resources and in assessing performance.
SFAS 130 and 131 are effective for financial statements for periods
beginning after December 15, 1997 and require comparative information for
earlier years to be restated. Because of the recent issuance of these
standards, management has been unable to fully evaluate the impact, if any, it
may have on future financial statement disclosures. Results of operations and
financial position, however, will be unaffected by implementation of these
standards.
19
<PAGE>
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). This statement standardizes the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, by requiring that an entity recognize those items
as assets or liabilities in the statement of financial position and measure them
at fair value. The statement generally provides for matching the timing of gain
or loss recognition on the hedging instrument with the recognition of (a) the
changes in fair value of hedged asset or liabilities that are attributable to
the hedged risk or (b) the earnings effect of the hedged forecasted transaction.
The statement is effective for all fiscal quarters for all fiscal years
beginning after June 15, 1999, with early application encouraged, and shall not
be applied retroactively to financial statements of prior periods. Adoption of
SFAS 133 is expected to have no effect on the Company's financial statements.
ITEM 7. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Report of Independent Certified Public Accountants.............................................. 21
Financial Statements:
Balance Sheets, July 31, 1998 and 1997..................................................... 22
Statements of Loss, Years Ended July 31, 1998 and 1997..................................... 24
Statements of Stockholders' Equity (Capital Deficit), Years Ended July 31, 1998 and 1997... 25
Statements of Cash Flows, Years Ended July 31, 1998 and 1997............................... 26
Summary of Significant Accounting Policies................................................. 28
Notes to Financial Statements.............................................................. 33
</TABLE>
20
<PAGE>
Report of Independent Certified Public Accountants
Scientific Measurement Systems, Inc.
Austin, Texas
We have audited the accompanying balance sheets of Scientific Measurement
Systems, Inc. (the "Company") as of July 31, 1998 and 1997, and the related
statements of loss, stockholders' equity (capital deficit) and cash flows for
each of the years then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Scientific Measurement Systems,
Inc. at July 31, 1998 and 1997, and the results of its operations and its cash
flows for each of the years then ended in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As disclosed in Note 1 to the
Financial Statements, the Company has suffered recurring losses from operations,
has a capital deficit, and a working capital deficit that raise substantial
doubt about its ability to continue as a going concern. In addition, the Company
is in default in connection with its line of credit agreement and on one other
note payable as disclosed in Note 3 to the Financial Statements. Management's
plans in regard to these matters are described in Note 1. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ BDO SIEDMAN, LLP
Houston, Texas
September 22, 1998, except for Note 3
which is as of January 15, 1999
21
<PAGE>
<TABLE>
<CAPTION>
====================================================================================================
July 31, 1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets (Note 1)
Current
Cash and cash equivalents $ 40,710 $ 390,213
Trade accounts receivable, less allowance for
doubtful accounts of $48,950 in 1998 (Note 3) 610,550 293,523
Research grant receivable (Note 11) - 450,090
Costs and earned profits on long-term contracts
in excess of related billings (Note 6) 232,799 903,148
Inventories (Note 3) 202,131 19,900
Prepaid expenses and other 53,190 27,667
- ----------------------------------------------------------------------------------------------------
Total current assets 1,139,380 2,084,541
- ----------------------------------------------------------------------------------------------------
Property and equipment less accumulated
depreciation (Notes 2 and 3) 56,826 87,171
- ----------------------------------------------------------------------------------------------------
Other assets
Scanning equipment, less accumulated depreciation
of $269,762 and $229,810 (Notes 3 and 8) 278,844 211,323
Other assets, less accumulated amortization
of $27,725 and $24,591 (Note 8) 87,675 87,164
- ----------------------------------------------------------------------------------------------------
Total other assets 366,519 298,487
- ----------------------------------------------------------------------------------------------------
$ 1,562,725 $ 2,470,199
====================================================================================================
</TABLE>
22
<PAGE>
Scientific Measurement Systems, Inc.
Balance Sheets
<TABLE>
<CAPTION>
====================================================================================================
July 31, 1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Liabilities and Stockholders' Equity (Capital Deficit)
Current liabilities
Accounts payable and accrued liabilities $ 481,191 $ 507,568
Payable to research consortium members (Note 11) 871,469 773,186
Billings in excess of related costs and earned
profits on long-term contracts (Note 6) 480,106 267,964
Notes payable, in default (Note 3) 357,144 699,775
- ----------------------------------------------------------------------------------------------------
Total current liabilities 2,189,910 2,248,493
- ----------------------------------------------------------------------------------------------------
Commitments and contingencies (See Notes 1, 9, 10 and 11)
- ----------------------------------------------------------------------------------------------------
Stockholders' equity (capital deficit) (Notes 4 and 5)
Preferred stock, 2,000,000 shares authorized,
no shares issued or outstanding - -
Common stock, $.05 par value; 40,000,000 shares
authorized; 21,114,468 shares issued
and outstanding 1,055,723 1,055,723
Additional paid-in capital 9,253,622 9,253,622
Deficit (10,936,530) (10,087,639)
- ----------------------------------------------------------------------------------------------------
Total stockholders' equity (capital deficit) (627,185) 221,706
- ----------------------------------------------------------------------------------------------------
$ 1,562,725 $ 2,470,199
====================================================================================================
</TABLE>
See accompanying summary of significant accounting policies and notes to
financial statements.
23
<PAGE>
Scientific Measurement Systems, Inc.
Statements of Loss
<TABLE>
<CAPTION>
====================================================================================================
Years ended July 31, 1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Contract revenues (Note 6)
Tomographic system sales $ 2,560,500 $ 2,800,054
Scanning services 614,116 487,646
Field services and upgrades 585,149 435,890
- ----------------------------------------------------------------------------------------------------
Total revenues 3,759,765 3,723,590
Direct contract costs 2,893,127 3,630,976
- ----------------------------------------------------------------------------------------------------
Gross profit 866,638 92,614
- ----------------------------------------------------------------------------------------------------
Operating costs:
Marketing 528,105 353,679
Research and development 303,831 6,606
General and administrative 811,754 783,497
- ----------------------------------------------------------------------------------------------------
Total operating costs 1,643,690 1,143,782
- ----------------------------------------------------------------------------------------------------
Loss from operations (777,052) (1,051,168)
- ----------------------------------------------------------------------------------------------------
Other (income) expense:
Interest expense 71,838 70,973
Interest and other income - (1,051)
- ----------------------------------------------------------------------------------------------------
Total other expense, net 71,838 69,922
- ----------------------------------------------------------------------------------------------------
Net loss $ (848,890) $ (1,121,090)
- ----------------------------------------------------------------------------------------------------
Basic net loss per common share(1) $ (0.04) $ (0.05)
- ----------------------------------------------------------------------------------------------------
Weighted average number of shares outstanding(1) 21,114,468 19,795,663
====================================================================================================
</TABLE>
See accompanying summary of significant accounting policies and notes to
financial statements.
(1)Diluted per share amounts not presented due to anti-dilutive effect of
additional shares.
24
<PAGE>
Scientific Measurement Systems, Inc.
Statements of Stockholders' Equity (Capital Deficit)
<TABLE>
<CAPTION>
===================================================================================================
Common Stock Additional
-------------------- Paid-In
Shares Amount Capital Deficit Total
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at July 31, 1996 16,584,007 $ 829,200 $ 8,339,675 $ (8,966,549) $ 202,326
Issuance of common stock
and stock options exercised 4,530,461 226,523 913,947 - 1,140,470
Net loss - - - (1,121,090) (1,121,090)
- ---------------------------------------------------------------------------------------------------
Balance at July 31, 1997 21,114,468 1,055,723 9,253,622 (10,087,639) 221,706
Net loss - - - (848,890) (848,890)
- ---------------------------------------------------------------------------------------------------
Balance at July 31, 1998 21,114,468 $1,055,723 $ 9,253,622 $ (10,936,530) $ (627,185)
===================================================================================================
</TABLE>
See accompanying summary of significant accounting policies and notes to
financial statements.
25
<PAGE>
Scientific Measurement Systems, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
===================================================================================================
Increase (decrease) in cash and cash equivalents
Years ended July 31, 1998 1997
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
Operating activities:
Net loss $ (848,890) $ (1,121,090)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 88,715 78,623
Changes in assets and liabilities:
Trade accounts receivable (317,027) 12,664
Other receivables 450,090 (203,018)
Costs and earned profits on long-term contracts
in excess of related billings 670,349 (94,323)
Inventories (182,231) (5,775)
Prepaid expenses and other current assets (25,523) 55,614
Other assets (111,116) (1,674)
Billings in excess of related costs and earned
profits on long-term contracts 212,142 (24,848)
Accounts payable and accrued expenses 71,905 459,198
- ----------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 8,414 (844,629)
- ----------------------------------------------------------------------------------------------------
Net cash used in investing activities:
Capital expenditures (15,286) (113,763)
- ----------------------------------------------------------------------------------------------------
</TABLE>
26
<PAGE>
Scientific Measurement Systems, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
====================================================================================================
Years ended July 31, 1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Financing activities:
Proceeds from issuance of common stock - 1,075,470
Borrowings under notes payable 140,019 537,702
Repayments on notes payable (482,650) (309,609)
- ----------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (342,631) 1,303,563
- ----------------------------------------------------------------------------------------------------
(Decrease) increase in cash and cash equivalents (349,503) 345,171
Cash and cash equivalents at beginning of year 390,213 45,042
- ----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 40,710 $ 390,213
====================================================================================================
</TABLE>
Supplemental disclosures of cash flow information:
Cash payments for interest were $74,593 and $71,077 in 1998 and 1997,
respectively. No taxes were paid in 1998 and 1997.
================================================================================
Supplemental disclosure of non-cash investing and financing activities:
Assets acquired through issuance of common stock were valued at $65,000 in 1997.
================================================================================
See accompanying summary of significant accounting policies and notes to
financial statements.
27
<PAGE>
Scientific Measurement Systems, Inc.
Summary of Significant Accounting Policies
================================================================================
Nature of Business
Scientific Measurement Systems, Inc. (the "Company") was incorporated in Texas
in 1979. The Company is a research, manufacturing and service company and is
primarily engaged in the design, development, assembly and marketing of
radiographic/ tomographic scanning systems used for nondestructive examination
of the surface and interior structure of various materials, and in providing
contract services with respect thereto. All operations of the Company are
domestically based; however the Company has significant foreign sales.
Accounting Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Inventories
Inventories are stated at the lower of cost (specific identification) or market
and consist primarily of parts to be used in the manufacture of tomographic
scanning systems.
Financial Instruments
The carrying amount of the Company's financial instruments, consisting of cash,
receivables, accounts payable, payable to research consortium members, and notes
payable approximates their fair value due to the short term nature of these
items.
Property and Equipment
Property and equipment is stated at cost. Depreciation and amortization for
financial statement purposes are provided by the straight-line method over
estimated useful lives of two to five years for equipment and furniture and
fixtures. Improvements to building are depreciated by the straight-line method
over the shorter of the estimated life or the remaining term of the building
lease. Maintenance and repairs are charged to expense as incurred.
28
<PAGE>
Scientific Measurement Systems, Inc.
Summary of Significant Accounting Policies
================================================================================
Scanning Equipment
Scanning equipment is stated at cost. Depreciation for financial statement
purposes is provided by the straight-line method over estimated useful lives of
five to ten years.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to a concentration
of credit risk consist primarily of cash deposits and accounts receivable. The
Company maintains cash balances at financial institutions which may at times be
in excess of federally insured levels. The Company has not incurred losses
related to these balances to date. Concentrations of credit risk with respect to
trade accounts receivable are limited due to the number of customers and their
dispersion across many geographic areas. Although, the Company does not
currently foresee a credit risk associated with these receivables, repayment is
dependent upon the financial stability of the national economies of the various
countries in which the Company does business (see Note 6). The Company performs
periodic credit evaluations of its customers and generally does not require
collateral. The Company monitors its exposure for credit losses and maintains an
allowance for doubtful accounts.
Patent Rights
The Company holds patent rights related to procedures for tomographic
examinations which are being amortized using the straight-line method over their
remaining lives of 15 years.
Research and Development
Expenditures for Company-sponsored research and development are expensed as
incurred. Reimbursements by third parties for research and development are
offset against the Company's research and development expenses as incurred.
Loss Per Share
The Company adopted Statement of Financial Accounting Standard (SFAS) No. 128,
"Earnings Per Share" which replaces the presentation of primary EPS with a
presentation of basic EPS. SFAS 128 was applied to July 31, 1997 calculations
but resulted in no change to previously reported EPS.
29
<PAGE>
Scientific Measurement Systems, Inc.
Summary of Significant Accounting Policies
================================================================================
Net loss per common share amounts are computed based on the weighted average
number of shares outstanding. Diluted earnings per share amounts are based on an
increased number of shares that would be outstanding assuming conversion of the
common stock options. Stock options for 2,422,678 shares and warrants for
150,000 shares are not included in the computation of loss per share for 1998
and 1997 since their effect would be anti-dilutive.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash and
interest bearing deposits with original maturities of three months or less.
Income Taxes
The Company follows the liability method of accounting for income taxes. This
method provides for deferred income taxes to be recorded based on enacted income
tax rates in effect on the dates on which temporary differences between the
financial reporting and tax bases of assets and liabilities are expected to
reverse. The effect on deferred tax assets and liabilities of a change in income
tax rates is recognized in the period in which the change is determined.
Deferred tax assets are reduced by a valuation allowance to amounts that are
more likely than not to be realized.
Contract Revenues
Revenues for tomographic system sales are accounted for under the percentage-of-
completion method of accounting in which revenues and gross profits are
recognized as work is performed based on the relationship between actual costs
incurred and total estimated costs at completion. Revenues and gross profit are
adjusted for revisions in estimated total contract costs and contract value in
the accounting period in which the revisions are made. Estimated losses are
recorded in the period such losses are identified. The Company recognizes
revenue and costs under research and development and scanning services contracts
as the related services are performed and costs are incurred. Revenues under
field services maintenance contracts are recognized on a straight-line basis
over the term of the contract; related costs are expensed when incurred.
Contract costs include all direct labor, material, subcontract costs and
allocations of indirect overhead.
30
<PAGE>
Scientific Measurement Systems, Inc.
Summary of Significant Accounting Policies
================================================================================
Impairment of Long-Lived Assets
Management reviews long-lived assets and intangible assets for impairment
whenever events or changes in circumstances indicate the carrying amount of an
asset may not be fully recoverable. As part of this assessment, management
prepares an analysis of the undiscounted cash flows for each product that has
significant long-lived or intangible asset values associated with it. This
analysis for the asset values as of July 31, 1998 and 1997 indicated there was
no impairment to these assets' carrying values.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"), which establishes standards for reporting and display of comprehensive
income, its components and accumulated balances. Comprehensive income is defined
to include all changes in equity except those resulting from investments by
owners and distributions to owners. Among other disclosures, SFAS 130 requires
that all items that are required to be recognized under current 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 June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information", ("SFAS
131") which supersedes SFAS No. 14, "Financial Reporting for Segments of a
Business Enterprise". SFAS 131 establishes standards for the way that public
companies report information about operating segments in annual financial
statements and requires reporting of selected information about operating
segments in interim financial statements issued to the public. It also
establishes standards for disclosures regarding products and services,
geographic areas and major customers. SFAS 131 defines operating segments as
components of a company about which separate financial information is available
that is evaluated regularly by the chief operating decision maker in deciding
how to allocate resources and in assessing performance.
31
<PAGE>
Scientific Measurement Systems, Inc.
Summary of Significant Accounting Policies
================================================================================
SFAS 130 and 131 are effective for financial statements for periods beginning
after December 15, 1997 and require comparative information for earlier years to
be restated. Adoption of these statements is not expected to have a material
effect on the Company's financial statements disclosures.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). This statement standardizes the accounting
for derivative instruments, including certain derivative instruments embedded in
other contracts, by requiring that an entity recognize those items as assets or
liabilities in the statement of financial position and measure them at fair
value. The statement generally provides for matching the timing of gain or loss
recognition on the hedging instrument with the recognition of (a) the changes in
fair value of hedged asset or liabilities that are attributable to the hedged
risk or (b) the earnings effect of the hedged forecasted transaction. The
statement is effective for all fiscal quarters for all fiscal years beginning
after June 15, 1999, with early application encouraged, and shall not be applied
retroactively to financial statements of prior periods. Adoption of SFAS 133 is
expected to have no effect on the Company's financial statements.
Stock Options and Warrants
The Company accounts for stock options and warrants issued to employees in
accordance with APB 25, "Accounting for Stock Issued to Employees". The Company
follows FASB Statement 123, "Accounting for Stock-Based Compensation" ("SFAS No.
123") for financial statement disclosure purposes and for the issuance of
options and warrants to non-employees for services rendered.
Reclassification
Certain amounts previously reported have been reclassified to conform to current
year presentation.
32
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
1. Going Concern Uncertainty
The Company has continued to incur substantial losses from operations and
incurred a net loss from operations of $848,890 for the fiscal year ended 1998
and has a capital deficit of $627,185. In addition, the Company has incurred
substantial indebtedness resulting in current liabilities exceeding current
assets by approximately $1,050,500 at July 31, 1998 and is presently in default
with its line of credit agreement and on one other note payable (see Note 3).
The Company's ability to continue its operations, to meet its debt service
obligations and to reduce its total indebtedness will be dependent upon the
Company's ability to restructure its debt and/or raise additional financing.
However, to date, the Company has been unsuccessful in its efforts to raise
additional capital, and there is no assurance that the Company will be
successful with its efforts to restructure its current indebtedness. There can
be no assurance that the Company's business will continue to generate cash flow
at or above current levels. If the Company is unable to generate sufficient cash
flow from operations in the future to service its debt, it may be required to
seek additional financing in the debt or equity markets, to refinance or
restructure all or a portion of its indebtedness, or to sell selected assets or
reduce or delay planned capital expenditures. There can be no assurance that any
such measures would be sufficient to enable the Company to service its debt or
that any such financing, refinancing or sale of assets would be achievable on
economically favorable terms. If these measures cannot be accomplished,
management may seek judicial creditor protection. The financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
During 1998, the Company was unable to pay vendors in accordance with the terms
of its purchase agreements. Also, subsequent to July 31, 1998, the Company has
been unable to meet its payroll obligations in a timely fashion and is
delinquent in meeting its payroll tax obligations.
33
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
Management's plans include restructuring of the Company's debt and/or the
raising of additional financing. However, to date the Company has been
unsuccessful in its efforts to raise additional capital, and there is no
assurance that the Company will be successful with its efforts to restructure
its current indebtedness.
2. Property, Equipment and Depreciation
The major classes of property and equipment as of July 31 are as follows:
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
Equipment $ 1,124,383 $ 1,116,886
Furniture and fixtures 104,285 104,285
Improvements to building 62,180 54,391
- ---------------------------------------------------------------------------------------------------
1,290,848 1,275,562
Less accumulated depreciation (1,234,022) (1,188,391)
- ---------------------------------------------------------------------------------------------------
$ 56,826 $ 87,171
===================================================================================================
</TABLE>
3. Notes Payable
Notes payable at July 31 consisted of the following:
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
Eximbank note payable, in default
secured by certain accounts
receivable, inventories, and
property and equipment; interest
payable monthly at prime plus 5%
(13.5% at July 31, 1998). $ 167,125 $ 629,775
Note payable to a bank, due
July 18, 1999; interest at 11%. 60,000 70,000
Note payable to a law firm, in
default, and payable on demand
with interest at 8% 130,019 -
- ---------------------------------------------------------------------------------------------------
$ 357,144 $ 699,775
===================================================================================================
</TABLE>
34
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
At July 30, 1998, the Company is in default on numerous debt covenants under the
Eximbank note payable. The debt covenant violations have not been waived;
however, due date has been extended by the bank to March 31, 1999.
4. Stockholders' Equity
The Company has authorized 40,000,000 shares of common stock, $0.05 par value.
Additionally, the Company has authorized 2,000,000 shares of preferred stock,
$0.15 par value. As of July 31, 1998, no preferred stock has been issued or is
outstanding.
In November 1996, the Company completed limited offerings of 1,960,732 shares of
common stock pursuant to Regulation S of the Securities Act of 1933. Net
proceeds of approximately $1,080,000 were primarily used for general corporate
needs.
The Company agreed to compensate a sales agent of the limited offering 10% of
the gross dollars raised as a fee. In addition, the Company has granted the
sales agent 150,000 stock purchase warrants exercisable at $0.875 per share.
These warrants may be exercised through November 2001, with no call provisions
and piggyback registration rights and a one-time demand registration after
twelve months.
5. Stock Options
On February 16, 1990, the Board of Directors approved the 1990 Stock Option Plan
("1990 Plan"). The 1990 Plan is administered by a Stock Option Committee which
consists of not less than three members of the Board of Directors. The 1990 Plan
reserves 2,500,000 shares of the Company's common stock and provides for the
grant of incentive stock options, non-qualifying stock options and stock
appreciation rights ("SARs") to certain key employees of the Company, and to
certain other individuals. Options and SARs will be awarded at the discretion of
the Stock Option Committee.
The 1990 Plan prohibits the grant of options thereunder after February 16, 2000.
The Stock Option Committee also determines the expiration dates of options
granted provided that all options must be exercised within 7 years of the date
of grant (5 years to any optionee who is the owner of 10% of the Company). The
price at which options
35
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
may be exercised is determined by the Stock Option Committee but in no event may
the price be less than the fair market value of the underlying common stock on
the date of grant. In the case of an optionee who is the owner of 10% or more of
the total combined voting power of all classes of stock of the Company, the
option price must be at least 110% of the fair value of the underlying common
stock on the date of grant.
On December 12, 1996, the Board of Directors approved the 1996
Incentive Plan (the "1996 Plan"). The 1996 Plan is administered by a
Stock Option Committee which consists of not less than two non-
employee directors. The 1996 Plan reserves 3,000,000 shares of the
Company's common stock and provides for the grant of incentive stock
options, nonstatutory options, restricted stock awards, and SARs to
certain key employees of the Company, and to certain other
individuals. Options, stock awards, and SARs will be awarded at the
discretion of the Stock Option Committee.
The 1996 Plan prohibits the grant of options thereunder after December 12, 2006.
The Stock Option Committee also determines the expiration dates of options
granted provided that all options must be exercised within 10 years of the date
of grant. The price at which options may be exercised is determined by the Stock
Option Committee but in no event may the price be less than the fair market
value of the underlying common stock on the date of grant.
During fiscal 1997, the Board of Directors approved awards of 700,000 options to
employees which were awarded under the 1996 Plan. All options were granted at
fair market value at date of issuance. The options will vest over a period of
three years and will expire December 19, 2006.
During fiscal 1997, the Board of Directors also approved awards of 600,000
options to eight non-employee directors. These options were not awarded pursuant
to any formal plan. All options were granted at fair market value at date of
issuance. The options vested immediately and will expire August 25, 2006. Two
directors chose to return their option agreements to the Company unexercised
during fiscal 1997.
36
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
During fiscal 1998, the Board of Directors approved awards of 500,000 options to
two employees which were awarded under the 1996 plan. All options were granted
at fair market value at date of issuance. The options vest over various periods
and expire over various periods.
As of July 31, 1998, 2,923,681 shares of common stock were under option, with
exercise prices ranging from $0.1406 to $0.8900; 2,422,678 of these options were
exercisable at July 31, 1998.
A summary of the status of the Company's stock options as of July 31 is
presented below:
<TABLE>
<CAPTION>
1998 1997
----------------- ------------------
Weighted Weighted
Number Average Number Average
of Exercise of Exercise
Options Shares Price Shares Price
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding and
exercisable at
beginning of year 2,423,681 $ 0.43 4,119,352 $ 0.17
Granted 500,000 0.38 1,050,000 0.87
Exercised - - (2,510,671) 0.17
Forfeited - - (235,000) 0.64
- ---------------------------------------------------------------------------------------------------
Outstanding at
end of year 2,923,681 $ 0.42 2,423,681 $ 0.43
===================================================================================================
</TABLE>
37
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
The following table summarizes the information about the stock options as of
July 31, 1998.
<TABLE>
<CAPTION>
Weighted
Average
Number Weighted Remaining Number Weighted
Range of Outstand- Average Contractual Exercisable Average
Exercise ing at Exercise Life at Exercise
Price July 31 Price (Years) July 31 Price
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 0.1406 32,000 $ 0.1406 1 32,000 $ 0.1406
$ 0.1500 1,050,641 $ 0.1500 3 1,049,641 $ 0.1500
$ 0.2250 141,040 $ 0.2250 1 141,040 $ 0.2250
$ 0.2400 300,000 $ 0.2400 3 300,000 $ 0.2400
$ 0.3700 100,000 $ 0.3700 10 100,000 $ 0.3700
$ 0.3800 400,000 $ 0.3800 3.5 100,000 $ 0.3800
$ 0.8600 450,000 $ 0.8600 5 450,000 $ 0.8600
$ 0.8900 450,000 $ 0.8900 9 249,997 $ 0.8900
------------------------------------------------------------------------
$ 0.1406
$ 0.8900 2,923,681 $ 0.4249 4 2,422,678 $ 0.3922
</TABLE>
SFAS No. 123 requires the Company to provide pro forma information regarding net
loss applicable to common stockholders and loss per share as if compensation
cost for the Company's stock options granted had been determined in accordance
with the fair value based method prescribed in that Statement.
The Company estimates the fair value of each stock option at the grant date by
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1998 and 1997 as follows: dividend yield of 0%;
expected volatility of 100%; risk-free interest rates ranging from 5.44% to
6.50%; and expected lives ranging from 2 to 3 years. The weighted fair value of
options granted in 1998 ranged from $0.24 to $0.25 and 1997 ranged from $0.47 to
$0.58.
38
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
Under the accounting provisions of SFAS No. 123, the Company's net loss
applicable to common stockholders and loss per share for the year ended July 31,
would have been increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
Net loss applicable to
common stockholders:
As reported $ (848,890) $ (1,121,090)
Pro forma (993,889) (1,382,090)
Loss per share:
As reported $ (0.04) $ (.05)
Pro forma (0.05) (0.07)
===================================================================================================
</TABLE>
6. Contract Revenues and Contracts in Progress
The Company's revenues have been derived from certain major customers (greater
than 10% of total revenues) as follows:
<TABLE>
<CAPTION>
Customer 1998 1997
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
A - 31%
B - 24%
C - 14%
D 33% -
E 15% -
===================================================================================================
</TABLE>
The Company had export revenues of approximately $1,069,000 and $910,000 to
Japan, $103,000 and $1,156,000 to Germany, $21,000 and $117,000 to Switzerland,
and none and $531,000 to Italy during fiscal 1998 and 1997, respectively.
Contracts in progress consist of the following:
<TABLE>
<CAPTION>
July 31, 1998 1997
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Costs and estimated earnings $ 2,591,095 $ 3,526,572
Billings 2,838,402 2,891,388
- --------------------------------------------------------------------------------------------------
$ (247,307) $ 635,184
==================================================================================================
Included in the balance sheet:
Costs and earned profits on
</TABLE>
39
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
<TABLE>
<CAPTION>
<S> <C> <C>
long-term contracts in excess
of related billings $ 232,799 $ 903,148
Billings in excess of related
costs and earned profits on
long-term contracts (480,106) (267,964)
- --------------------------------------------------------------------------------------------------
$ (247,307) $ 635,184
==================================================================================================
</TABLE>
Requirements for progress billings are negotiated on an individual contract
basis and, accordingly, vary between contracts.
7. Income Taxes
Deferred taxes are determined based on the temporary differences between the
financial statement and income tax bases of assets and liabilities as measured
by the enacted tax rates which will be in effect when these differences reverse.
The components of deferred income tax assets were as follows:
<TABLE>
<CAPTION>
July 31, 1998 1997
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Accrued expenses $ 12,384 $ 15,000
- --------------------------------------------------------------------------------------------------
Total current deferred income tax asset 12,384 15,000
- --------------------------------------------------------------------------------------------------
Depreciation (14,756) (17,000)
Operating loss carryforward 3,634,052 3,396,000
Tax credit carryforward 144,157 137,000
- --------------------------------------------------------------------------------------------------
3,775,837 3,531,000
Valuation allowance (3,775,837) (3,531,000)
- --------------------------------------------------------------------------------------------------
Total net deferred income tax asset $ - $ -
==================================================================================================
</TABLE>
At July 31, 1998 the Company has available for federal income tax reporting
purposes approximately $10,688,000 of net operating loss carryforwards of which
approximately $32,000 expires in 1999, $483,000 expires in 2000 with the balance
expiring in varying amounts in 2001 through 2018. Also, the Company has
approximately $424,000 of tax credit carryforwards expiring from 1999 to 2002.
Under the Tax Reform Act of 1986, as amended, an annual limitation will be
placed on the amount of net operating loss and tax credit carryforwards
40
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
which may be utilized if there are substantial changes in the ownership of the
Company.
At July 31, 1998 and 1997, the Company provided a 100% valuation allowance for
the deferred tax asset because it could not determine whether it was more likely
than not that the deferred tax asset would be realized.
8. Related Party Transactions
In 1981 the Company purchased from various stockholders certain technology and
patent rights related to the procedures for tomographic examinations. The cost
of such rights, net of accumulated amortization, of $7,703 and $10,157 are
included in other assets at July 31, 1998 and 1997. During fiscal 1993, the
Company reassigned ownership of the patents to the stockholders in return for
cancellation of the Company's royalty commitment and issuance to the Company of
a perpetual, non-exclusive, royalty free license to the patents.
During fiscal year 1997, the Company purchased a scanner from a Director of the
Company. The Company issued 500,000 shares of common stock valued at $65,000 to
the Director in exchange for the scanner.
9. Commitments and Contingencies
Product Liability Insurance
The Company does not carry product liability insurance. Management does not
believe that the lack of such insurance has a material adverse effect on the
Company's financial position or results of operations.
Legal Proceedings
The Company is involved in legal actions arising in the ordinary course of
business. Management does not believe that the outcome of such legal actions
will have a material adverse effect on the Company's financial position or
results of operations.
10. Leases
The Company entered into a lease agreement for office and manufacturing space.
The lease was for an initial three year period, with two three year options to
renew the lease at then market prices. These options have been exercised. Lease
expense for 1998 and 1997 was $92,738 and $91,175, respectively.
Future minimum payments, by fiscal year and in the aggregate for leases of
office and manufacturing space and equipment consist of the following:
41
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
<TABLE>
<CAPTION>
July 31, Amount
- ----------------------------------------------------------------------------------------------------
<S> <C>
1999 $ 150,030
2000 137,114
2001 108,205
2002 108,205
2003 108,205
Thereafter 18,034
- ----------------------------------------------------------------------------------------------------
Total minimum lease payments $ 629,793
====================================================================================================
</TABLE>
11. Research and Development Consortium and Grant
In 1996, the Company formed a consortium with General Motors, General Electric
and EG&G to develop scanning technology that is capable of tomographical
scanning 100 times faster than current systems. The Company is the project
leader of the consortium and has sole commercialization rights, except for
medical applications, for the new technology.
Under the terms of the consortium agreement, approximately 30 advanced detector
panels would be produced by the consortium which will require aggregate funding
of $7,660,000. In February 1996, the consortium was awarded a grant from the
U.S. Department of Commerce National Institute of Standards and Technology
("NIST") under their Advanced Technology Program. The terms of the grant provide
that NIST will contribute 49% of the consortium's funding requirement or
$3,753,000 as a grant to the consortium. Further, the Company will invest a
total of $1,218,000 into the project. During 1998 and 1997, the Company incurred
approximately $53,600 and $194,600, respectively, under the project net of
reimbursement from NIST.
Through July 31, 1998, the Company, acting as project leader, has collected
grants approximating $1,409,000 from NIST as reimbursement for costs incurred by
other consortium members, of which $582,500 has been repaid to such members.
Accordingly, at July 31, 1998 the Company had amounts payable to consortium
members, (primarily General Electric) of $871,469. In addition, under the
consortium agreement the Company may be contingently liable for an additional
$718,200 to General Electric.
42
<PAGE>
Scientific Measurement Systems, Inc.
Notes to Financial Statements
================================================================================
Project activity was suspended in August 1998 due to the Company's inability to
meet its financial obligations under the award agreement, and a request for an
extension to the program has been denied by NIST. The Company has begun to
closeout its participation under this arrangement since efforts by the Company
to raise capital to continue to fund its portion of these research program have
been unsuccessful thus far, and there is substantial doubt that the required
funding will be available to the Company to complete this research program.
43
<PAGE>
SCIENTIFIC MEASUREMENT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
The current members of the Board of Directors are as follows:
<TABLE>
<CAPTION>
Year
Became
Directors Position with the Company Age Director
- --------- --------------------------- --- --------
<S> <C> <C> <C>
Howard L. Burris, Jr. Director, President, Chief Executive Officer,
Chief Financial Officer 49 1996
Dr. Larry Secrest Chairman of the Board 57 1986
Burton W. Kanter Director 68 1985
James W. Kenney Director 57 1986
Phillips A. Moore Director 52 1987
Dr. Thomas Prud'homme Director 68 1990
</TABLE>
BACKGROUND OF DIRECTORS
Howard L. Burris, Jr. has served as President and Chief Executive Officer
of the Company since October 1997. Since 1989 he has also served as the
Chairman of the Board of Applied-Machine Tool Technology, Inc., a Texas
corporation ("AMTT") and is currently its principal stockholder. He purchased
the assets of AMTT's predecessor company in 1989 and has been actively involved
in the turnaround of AMTT since that time. Prior to his involvement with AMTT,
Mr. Burris worked successfully in real estate and oil and gas investments. Mr.
Burris developed and sold over 480 single family homesites at Jester Estates in
Austin, Texas; purchased and arranged permanent, fixed rate financing for a
201,500 square foot office building in California; was a working interest
partner in over 180 oil and gas properties located in Texas, Louisiana, and West
Virginia; and was a co-partner and investor in a local cable television
business. Prior to his real estate and oil and gas activities, Mr. Burris was a
director and stockholder in Bandargaz Chemical Company, Inc., which was the
Joint Venture Partner of Dow Chemical Company in Iran from 1976 until 1979. Mr.
Burris holds a Master of Business Administration Degree from the University of
Texas at Austin and a Bachelor of Arts degree in History from Princeton
University.
Dr. Larry Secrest currently serves as Chairman of the Board of the Company.
He joined the Company in January 1986 and served as its President and Chief
Executive Officer from 1986 through July 1997. Since the latter part of 1994,
Dr. Secrest also has served as Chairman of the Board of Hydrolab Corporation and
since July 1997 also serves as its President and Chief Executive Officer.
During the period from 1982 through 1985 he served as an advisor and consultant
for strategic planning and venture management; first, as owner of Secrest &
Associates from September 1982 through September 1984; and subsequently, as a
member of Ozark Research Group, from October 1984 through December 1985. Dr.
Secrest holds a B.A. from Tulane University and an M.B.A. from the Wharton
School of Business. He received an interdisciplinary Ph.D. in Management,
Business and Public Affairs from The University of
44
<PAGE>
SCIENTIFIC MEASUREMENT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Texas at Austin in 1971. During 1971-72 he served as visiting Fulbright Research
Professor at Keio University in Tokyo, Japan.
Burton W. Kanter was elected to the Board in August 1985. Mr. Kanter is a
lawyer specializing in federal income tax matters, formerly attorney-advisor to
the Tax Court of the United States, author of numerous articles in the field of
federal income taxation and a member of the faculty of the University of Chicago
Law School. He was a partner in the Chicago law firm of Kanter & Eisenberg from
May 1979 to January 1986. Since that time, he has served as counsel to the
successor firm of Neal Gerber & Eisenberg. He is a Director of Logic Devices,
Inc., HealthCare COMPARE Corp., Walnut Financial Services, Inc., Channel America
LPTV Holdings, Inc, and Power-Cell, Inc., plus many private companies. He is
also Chairman of Chicago Holding, Inc., a private investment company. Mr.
Kanter is formerly a member of the Board of Directors of the University of
Chicago School of Biological Sciences and the Pritzker Medical School. He is a
member of the visiting Committee of the Art School of the University of Chicago,
and is presently a member of the Board of Directors of a number of public
charitable organizations, including the Museum of Contemporary Art of Chicago,
the Chicago International Film Festival, and the Film Department of the Art
Institute of Chicago.
James W. Kenney was elected to the Board of Directors in March 1986. He
currently is associated with San Jacinto Securities, Inc. as Executive Vice
President and owner. From February 1992 until September 1993, he was Vice
President of Investments for Renaissance Capital, a fund manager, and from
October 1989 until February 1992, he was Executive Vice President of Capital
Institutional Services, Inc. In addition, he once served as an Executive Vice
President for a full-service securities brokerage firm that was the managing
underwriter for the initial public offering of the Company in March 1985. Mr.
Kenney also serves as a member of the Board of Directors of Consolidated Health
Care Associates, Inc., Industrial Holdings, Inc., Tecnol Medical Products, Inc.
and Tricom Corporation. Mr. Kenney received a B.B.A. in Economics from the
University of Colorado in 1964.
Phillips A. Moore was elected to the Board in January 1987, and is
currently a consultant to PRESBYNET/ECUNET, a project to develop a global
telecommunication system for churches. Until June 1991, Mr. Moore was Chairman
of PSN Corporation, Avon, Connecticut, a firm that develops and sells
comprehensive electronic communications systems to industry. Prior to that
position, Mr. Moore served as President of NWI, Inc., and as Vice President,
Product Development, for Sony Corporation. He has extensive experience in high
technology product development and marketing.
Dr. Tom Prud'homme has been Vice President for Technology of Thermo
Instrument Systems since 1994. In addition, he currently serves on the Board of
Directors of Austin American Technology. From 1990 until March 1994, Dr.
Prud'homme was Vice President for Technology of a division of Baker, Hughes,
Inc. Dr. Prud'homme co-founded a research company 34 years ago and led the firm
through three changes in ownership to become a highly successful instrumentation
company. After teaching mathematics and physics at The University of Texas at
Austin, he was employed as Research Scientist in applied nucleonic techniques by
Magnolia Petroleum Co. (now Mobil Oil Co.). Dr. Prud'homme is the author of 22
publications and is very active in professional and community affairs. He
serves on a number of Boards of Directors and Advisory Committees and is an
officer of a family-owned business, Amal Oil Company. Dr. Prud'homme holds a
B.S. degree in Physics/Mathematics from Spring Hill College and M.A. and Ph.D.
degrees from The University of Texas at Austin.
EXECUTIVE OFFICERS
The following information relates to executive officers of the Company who
are not directors:
45
<PAGE>
<TABLE>
<CAPTION>
Officer Position with the Company Age Year Became Officer
<S> <C> <C> <C>
Dr. Forrest F. Hopkins Vice President of Research and Development 52 1979
and Secretary
Matthew R. Gutierrez Vice President of Marketing and Sales 34 1997
</TABLE>
BACKGROUND OF OFFICERS
Forrest F. Hopkins, Ph.D., Vice President of Research and Development has
been a Director or a Vice President of the Company since July 1979. He chose
not to stand for reelection to the Board in 1986 to permit the addition of other
outside participants. Dr. Hopkins has extensive experience in the development
of tomographic hardware and image reconstruction algorithms. He received a B.S.
in Physics in 1969 and a Ph.D. in Physics in 1972, both from The University of
Texas at Austin.
Matthew R. Gutierrez, Vice President of Marketing and Sales, joined the
Company in 1997. Mr. Gutierrez oversees the Company's worldwide marketing and
sales efforts, including management of its sales representatives. Before
joining the Company, Mr. Gutierrez most recently served as Vice President of
Marketing at Ross Technologies, Inc. a subsidiary of Fujitsu Ltd., which
designs, manufactures and markets high-performance semiconductors and computer
workstation/server products. Prior to joining Ross Technologies, Mr. Gutierrez
worked in a variety of engineering capacities at General Motors Corporation's
Tech Center, including test and design. Mr. Gutierrez holds a B.S. in
Electrical Engineering from GMI Engineering and Management Institute and an M.S.
in Electrical Engineering from the University of Texas at Austin.
TIMELINESS OF CERTAIN SEC FILINGS
Based on information available to it, the Company is not aware that any
officer, director or beneficial owner of 10% or more of the Company's Common
Stock failed during fiscal 1998 to file, on a timely basis, reports required by
Section 16(a) of the Securities Exchange Act of 1934.
ITEM 10. EXECUTIVE COMPENSATION
EXECUTIVE OFFICERS' COMPENSATION
The following table shows the cash compensation paid by the Company, as
well as certain other compensation, for the Company's Chief Executive Officer
for fiscal years 1998, 1997 and 1996 and for Matthew R. Gutierrez, the Company's
Vice President of Sales and Marketing for fiscal year 1998. No other officers
were paid compensation in fiscal 1998 in excess of $100,000.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation
---------------------------------------------------
LONG TERM
COMPENSATION
OTHER ANNUAL AWARDS
Name and Principal Position Year Salary ($) Bonus ($) COMPENSATION OPTIONS/SARS (#)
<S> <C> <C> <C> <C> <C>
Howard L. Burris, President, 1998 $98,917 -0- -0- 100,000
Chief Executive Officer, and
Chief Financial Officer
</TABLE>
46
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C>
Matthew R. Gutierrez, Vice President 1998 $109,807 -0- $10,000 400,000
of Sales and Marketing
</TABLE>
OPTIONS
The following table sets forth certain information concerning options
granted in fiscal 1998 and held at July 31, 1998 to Howard Burris and Matthew
Gutierrez.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES PERCENT OF TOTAL
UNDERLYING OPTIONS/SARS OPTIONS/SARS GRANTED TO EXERCISE EXPIRATION
NAME GRANTED EMPLOYEES IN FISCAL 1998 PRICE DATE
- ---- ------- ------------------------ ----- ----
<S> <C> <C> <C> <C>
Howard L. Burris 100,000 20% $0.31 Jan. 29, 2008
Matthew R. Gutierrez 400,000 80% $0.38 Sept. 1, 2007
</TABLE>
DIRECTORS' COMPENSATION
Outside directors receive stock options under the Company's 1996 Incentive
Plan.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table presents, as of December 1, 1998, beneficial Common
Stock ownership of (1) each of the directors and nominees owning shares Of
Common Stock of the Company; and (2) all directors, officers and nominees for
director of the Company as a group. The Company knows of no individuals who are
not directors of the Company who are beneficial owners of more than 5% of the
Company's Common Stock.
<TABLE>
<CAPTION>
Amount and Nature Percent of
Name and Address of Beneficial Owner of Beneficial Ownership(1) Class
----------------------------- -----
<S> <C> <C>
Howard L. Burris,Jr........................................ 1,944,341/(2)/ 9.18%
Scientific Measurement Systems, Inc.
2210 Denton Drive, Suite 106
Austin, Texas 78758
Larry Secrest.............................................. 1,203,160/(3)/ 5.59%
Scientific Measurement Systems, Inc.
2210 Denton Drive, Suite 106
Austin, Texas 78758
Burton W. Kanter........................................... 190,000/(4)/ *
Neal, Gerber & Eisenberg
Two North LaSalle Street
Chicago, Illinois 60602
James W. Kenney............................................ 75,000/(5)/ *
Brittany Associates
3030 Canton
Dallas, Texas 75226
</TABLE>
47
<PAGE>
<TABLE>
<S> <C>
Phillips A. Moore.......................................... 75,000/(5)/ *
61 Sunnybrook
Avon, Connecticut 06001
Thomas Prud'homme.......................................... 75,000/(5)/ *
Envirotech
5914 West Courtyard Drive, Suite 300
Austin, Texas 78730-5024
Forrest Hopkins............................................ 564,186/(6)/ 2.64%
Scientific Measurement Systems, Inc.
2210 Denton Drive, Suite 106
Austin, Texas 78758
Matt Gutierrez............................................. -- *
Scientific Measurement Systems, Inc.
2210 Denton Drive, Suite 106
Austin, Texas 78758
All Directors, Officers and Nominees as a.................. 4,126,687 18.5%
Group (10 persons)
</TABLE>
______________
*Less than 1%.
(1) Shares of Common Stock that are not outstanding but that can be acquired by
a person within 60 days upon exercise of an option or similar right are
included in the number of shares beneficially owned and in computing the
percentage for such person but are not included in the number of shares
beneficially owned and in computing the percentage for any other person.
(2) Includes shares underlying options to purchase 75,000 shares of Common
Stock, all of which are immediately exercisable.
(3) Includes shares underlying options to purchase 421,607 shares of Common
Stock, 354,940 of which are immediately exercisable, and 66,667 of which
are exercisable within the next 60 days.
(4) Includes 65,000 shares of Common Stock which are held solely as Trustee for
Hi-Chicago Trust, an irrevocable trust, as to which Mr. Kanter disclaims
any beneficial interest, and includes shares underlying options to purchase
125,000 shares of Common Stock, all of which are immediately exercisable.
(5) Includes shares underlying options to purchase 75,000 shares of Common
Stock, all of which are immediately exercisable.
(6) Includes shares underlying options to purchase 254,138 shares of Common
Stock, 220,804 of which are immediately exercisable, and 33,334 of which
are exercisable within the next 60 days.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In fiscal 1997, Mr. Howard Burris transferred scanning equipment, with a value
of $85,000, to the Company in exchange for 500,000 shares of Common Stock at
$.17 per share, the fair market value of the shares on the date of the exchange.
48
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report. Page
1. Financial Statements:
<TABLE>
<S> <C>
Independent Certified Public Accountants' Report.............. 20
Balance Sheets, July 31, 1997................................. 21
Statements of Operations, Years Ended July 31, 1997 and 1996.. 23
Statements of Stockholders' Equity, Years Ended July 31, 1997
and 1996.................................................... 24
Statements of Cash Flows, Years Ended July 31, 1997 and 1996.. 25
Summary of Significant Accounting Policies.................... 27
Notes to Financial Statements................................. 32
</TABLE>
49
<PAGE>
2. Exhibits:
<TABLE>
<CAPTION>
Incorporated by
Number Description Reference to
------ ----------- ------------
<C> <S> <C>
3.1 Restated Articles of Incorporation Exhibit 3.1 to the Registration
Statement on Form S-18 effective
March 5, 1985
(File No. 2-94269-FW)
3.1A Amendment to Articles of Incorporation Exhibit 3.1A to the Annual Report
on Form 10-K for the Fiscal Year
Ended July 31, 1991
3.2 By-laws Exhibit 3.2 to the Registration
Statement on Form S-18 effective
March 5, 1985
(File No. 2-94269-FW)
3.2A Amendment to By-laws Exhibit 3.2A to the Annual Report
on Form 10-K for the Fiscal Year
Ended July 31, 1991
4.1 Form of Common Stock Certificate Exhibit 4.1 to the Registration
Statement on Form S-18 effective
March 5, 1985
(File No. 2-94269-FW)
10.8 Form of Employee Agreement (Non-Disclosure) Exhibit 10.10 to the Registration
Statement on Form S-1 effective
September 9, 1986
(File No. 33-6220)
10.9 1983 Incentive Stock Option Plan Exhibit 10.18 to the Registration
Statement on Form S-18 effective
March 5, 1985
(File No. 2-94269-FW)
10.10 Letter agreements dated November 20, 1987 and Exhibit 10.14 to the Company's
October 7, 1988 between the Registrant and Annual Report on Form 10-K for the
Bethlehem Steel Corporation for the fiscal year ended July 31, 1988
development and sale of a tomographic system.
Portions of these
</TABLE>
50
<PAGE>
<TABLE>
<CAPTION>
Incorporated by
Number Description Reference to
------ ----------- ------------
<C> <S> <C>
letter contracts have been
omitted and filed separately with the
Commission together with an application for
confidential treatment
10.11 1990 Incentive Stock Option Plan Exhibit A to Proxy Statement for
1990 Annual Meeting of
Shareholders filed October 29, 1990
10.12 Mutual License Agreement dated May 5, 1993 Exhibit 10.12 to the Company's
between the Registrant and Bethlehem Steel Annual Report on Form 10-KSB for
Corporation the fiscal year ended July 31, 1995
10.13 Frost National Bank letter dated October 25, Exhibit 10.13 to the Company's
1995 regarding Term Note Annual Report on Form 10-KSB for
the fiscal year ended July 31, 1995
10.14 Notes dated May 8, 1995, May 31, 1995 and June Exhibit 10.14 to the Company's
16, 1995 in the principal amounts of $50,000, Annual Report on Form 10-KSB for
$30,000 and $10,000 respectively, all payable the fiscal year ended July 31, 1995
by Registrant to Mr. Howard L. Burris, Jr.
10.15 Note dated June 5, 1996, in the principal Exhibit 10.15 to the Company's
amount of $25,000 payable to Thomas Prud'homme Annual Report on Form 10-KSB for
the fiscal year ended July 31, 1996
10.16 Note dated July 12, 1996, in the principal Exhibit 10.16 to the Company's
amount of $233,608.70 payable to Ulster Annual Report on Form 10-KSB for
Investments, Ltd. and related loan documents the fiscal year ended July 31, 1996
10.17 Volumetric Computed Tomography Consortium Exhibit 10.17 to the Company's
Collaboration Agreement dated December 1995 Annual Report on Form 10-KSB for
the fiscal year ended July 31, 1996
10.18 Volumetric Computed Tomography Consortium Exhibit 10.18 to the Company's
Commercialization Agreement dated December 1995 Annual Report on Form 10-KSB for
the fiscal year ended July 31, 1996
10.19 Amendment to U.S. Department of Commerce Exhibit 10.19 to the Company's
National Institute of Standards and Technology Annual Report on Form 10-KSB for
Financial Assistance Award dated January 19, the fiscal year ended July 31, 1996
1996
10.20 Promissory Note dated June 15, 1996 to Wells Exhibit 10.20 to the Company's
Fargo HSBC Trade Bank, N.A. in the principal Annual Report on Form 10-KSB for
amount of $1,250,000.00; Security Agreement the fiscal year ended July 31, 1996
dated June 15, 1996 between the Company and
</TABLE>
51
<PAGE>
<TABLE>
<CAPTION>
Incorporated by
Number Description Reference to
------ ----------- ------------
<C> <S> <C>
Wells Fargo HSBC Trade Bank, N.A.
10.21 Note dated January 25, 1996 to Jenkens & Exhibit 10.21 to the Company's
Gilchrist, P.C. in the principal amount of Annual Report on Form 10-KSB for
$52,000 the fiscal year ended July 31, 1996
10.22 U. S. Department of Commerce National N/A
Institute of Standards and Technology
Financial Assistance Award dated September 26,
1995
10.23 1996 Incentive Stock Option Plan N/A
10.24 Amendment to U.S. Department of Commerce N/A
National Institute of Standards and Technology
(NIST) Financial Assistance Award dated
effective September 1, 1997
10.25 Letter from Frost National Bank dated August N/A
5, 1997 and Promissory Note dated July 21, 1997
10.26 EXIM Guaranteed Loan Agreement dated June 15, N/A
1996
10.27 First Amendment to EXIM Guaranteed Loan N/A
Agreement dated as of August 1, 1996 between
the Company and Wells Fargo HSBC Trade Bank,
N.A. and Promissory Note dated August 1, 1996
payable to Wells Fargo HSBC Trade Bank, N.A.
10.28 Second Amendment to EXIM Guaranteed Loan N/A
Agreement dated as of June 15, 1997 between
the Company and Wells Fargo HSBC Trade Bank,
N.A. and Promissory Noted dated June 15, 1997
payable to Wells Fargo HSBC Trade Bank, N.A.
10.29 First Amendment to Security Agreement dated N/A
June 15, 1997 between the Company and Wells
Fargo HSBC Trade Bank, N.A.
10.30 Registration Rights Agreement dated May 8, N/A
1995 between the Company and Howard L. Burris,
Jr.
10.31 Third Amendment to EXIM Guaranteed Loan
Agreement dated as of July 31, 1997 between
the Company and Wells Fargo HSBC Trade Bank,
N.A. and Promissory Note dated July 31, 1997,
</TABLE>
52
<PAGE>
<TABLE>
<CAPTION>
Incorporated by
Number Description Reference to
------ ----------- ------------
<C> <S> <C>
payable to Wells Fargo HSBC Trade Bank, N.A.
10.32 Second Amendment to Security Agreement dated
July 31, 1997 between the Company and Wells
Fargo HSBC Trade Bank, N.A.
24.1 Consent of Independent Accountants N/A
25.1 Power of Attorney N/A
</TABLE>
(b) Reports on Form 8-K.
None filed during the last quarter of the period.
(c) Exhibits.
The exhibits described in Item 13(a)(2), above, and identified as being
filed herewith, are filed as a part of this report.
53
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d), the Securities Act of
1934, the Registrant has duly caused this Form 10-KSB, Annual Report, for the
year ending July 31, 1997, to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Austin and State of Texas, on the 19th
day of December, 1997.
SCIENTIFIC MEASUREMENT SYSTEMS, INC.
By: /s/ Howard L. Burris, Jr.
- --------------------------------------------------------------------------------
By: /s/ Howard L. Burris, Jr.
- --------------------------------------------------------------------------------
Howard L. Burris, Jr. Howard L. Burris, Jr.
President and Chief Executive Officer
Acting Principal Financial and Accounting Officer
POWER OF ATTORNEY TO SIGN AMENDMENTS
KNOW ALL BY THESE PRESENTS, that each person whose signature appears below
does hereby constitute and appoint Howard L. Burris, Jr. his true and lawful
attorney-in-fact and agent for him and in his name, place and stead, in any and
all capacities, to sign any or all amendments to the Scientific Measurements
Systems, Inc. Form 10-KSB, Annual Report, for year ending July 31, 1997, and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorney-in-fact and agents full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the premises
in order to effectuate the same as fully, to all intents and purposes, as they
or he might or could do in person, hereby ratifying and confirming all that said
attorney-in-fact and agents, or any of them, may lawfully do or cause to be done
by virtue hereof. This Power of Attorney been signed below by the following
persons in the capacities and on the dates indicated.
Pursuant to the requirements of the Securities Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant in
the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Howard L. Burris President, December 19, 1997
- -------------------- Chief Executive
Howard L. Burris, Jr. Officer and
Director
/s/ Howard L. Burris Acting Principal December 19, 1997
- -------------------- Financial and
Howard L. Burris, Jr. Accounting
Officer
/s/ Larry Secrest Director December 19, 1997
- -----------------
Larry Secrest
/s/ Burton W. Kanter Director December 19, 1997
- --------------------
Burton W. Kanter
/s/James W. Kenney Director December 19, 1997
- ------------------
James W. Kenney
/s/ Phillips A. Moore Director December 19, 1997
- ---------------------
Phillips A. Moore
54
<PAGE>
/s/ Thomas Prud'homme Director December 19, 1997
- ---------------------
Dr. Thomas Prud'homme
Director December, 1997
Nancy R. Woodward
55
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> JUL-31-1998 JUL-31-1997
<PERIOD-START> AUG-01-1997 AUG-01-1996
<PERIOD-END> JUL-31-1998 JUL-31-1997
<CASH> 41 390
<SECURITIES> 0 0
<RECEIVABLES> 843 1,647
<ALLOWANCES> 49 0
<INVENTORY> 202 20
<CURRENT-ASSETS> 1,139 2,085
<PP&E> 1,291 1,276
<DEPRECIATION> 1,234 1,188
<TOTAL-ASSETS> 1,139 2,470
<CURRENT-LIABILITIES> 2,190 2,248
<BONDS> 0 0
0 0
0 0
<COMMON> 1,056 1,056
<OTHER-SE> 9,254 9,254
<TOTAL-LIABILITY-AND-EQUITY> 1,563 2,470
<SALES> 3,760 3,724
<TOTAL-REVENUES> 3,760 3,724
<CGS> 2,893 3,631
<TOTAL-COSTS> 4,537 4,775
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 72 71
<INCOME-PRETAX> (849) (1,121)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (849) (1,121)
<EPS-PRIMARY> (.04) (.05)
<EPS-DILUTED> (.04) (.05)
</TABLE>
