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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, 1999
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)
TEXAS 74-2048763
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2210 Denton Drive, Suite 106, Austin, Texas 78758
(Address of principal executive offices) (Zip Code)
Issuer's telephone number .......... (512) 837-4712
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on 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: $2,877,394
The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $3,167,170 as of April 3, 2000, 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 April 3, 2000 is as follows:
Shares Outstanding as of
Title of Class April 3, 2000
-------------- -------------
$0.05 Par Value Common Stock 21,114,468
Transitional Small Business Disclosure Format: Yes [_] No X
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INDEX
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PART I...................................................................................................... 1
RISK FACTORS................................................................................................ 1
ITEM 1. BUSINESS...................................................................................... 1
ITEM 2. PROPERTIES.................................................................................... 12
ITEM 3. LEGAL PROCEEDINGS............................................................................. 12
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........................................................... 14
ITEM 7. FINANCIAL STATEMENTS.......................................................................... 19
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................................................... 43
PART III.................................................................................................... 43
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.................................... 43
ITEM 10. EXECUTIVE COMPENSATION........................................................................ 43
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT................................................................................ 43
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................ 43
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.............................................................. 44
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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 independent accountants opinion, 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, 1999, the Company
incurred a net loss of $695,433 and had a negative cash flow of $30,595 for the
year. In addition, at July 31, 1999, Current Liabilities exceeded Current Assets
by approximately $1,708,000.
Incurrence of Substantial Indebtedness
The Company incurred substantial indebtedness, including amounts owed under
the NIST contract (see Note 12 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 has been dedicated to the payment of interest and principal
on its indebtedness, (ii) the Company's leveraged position has substantially
increased 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 to raise additional financing.
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 (See: Note 13 to Financial Statements).
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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."
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 Company has been granted for a patent dealing with 3D or 3
dimensional metrology, which is scheduled to be issued on or about July 2000.
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 one international patent. But 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
During FY 1999 the Company experienced changes in its senior management,
notably the loss of its Vice President of Sales and Marketing. The Company
appointed the manager for the scanning service division as the new VP of Sales
and Marketing to fill the position.
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 Mr. Howard Burris and Dr. Forrest F. Hopkins. The loss of the
services of certain individuals or the inability of the Company to hire
qualified replacements in an orderly manner could have a material adverse effect
on the Company.
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").
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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 generation equipment and,
extremely rarely, 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").
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
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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 surrounding material(s). Primary applications of the
Company's systems include process and quality control of highly engineered parts
that are to be produced in high volume; are of significant discrete value;
and/or are to be employed in a high physical stress environment, especially
where failure can have catastrophic consequences.
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 nondestructive inspection methodology. That is
especially true where internal features of a complex object must be
characterized with high accuracy.
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
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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 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.
(Radioisotope based systems are very rarely ever used by the company, however).
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 data 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
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
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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 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.
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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 speed, while maintaining very high quality image resolution.
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. Most systems supplied within the past
two years have utilized Sun Ultra(TM) workstations for imaging processing as
well as data acquisition. Moving the Company's proprietary software to these
open platforms has improved speed tenfold on the SMS Smartscan(TM) systems. This
migration has reduced the "build" cost of the computer system, and it has also
made the installed systems easier to support and to upgrade.
Perhaps the most significant developing change in the product offering at
SMS is the CADScan(TM) software, which would be capable of sophisticated
evaluation of complex parts. This product will be able graphically to report
wall thicknesses and wall displacement variances from design data in near real
time. The Company believes that the CADScan(TM) capability 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
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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,
Martin International, Knolls Atomic Power Laboratory, Bridgestone, Continental
Tire, and to Morton International, Inc.
In fiscal year 1999 the Company shipped SmartScan(TM) systems to Picatinny,
the U.S. Army, Toyota Motor Corporation, and Mitsubishi Materials. The Company
also received an upgrade order on CT system from EMPA, the Swiss Federal
Laboratory.
As of August 1, 1999 the Company had orders for the construction of systems
(and one operating lease system) from Rolls Royce Aircraft Engines, Picatinny,
Daimler Chrysler, Bodine Aluminum, and Alliant Technosystems.
Scanning Services
The inspection and measurement capabilities for the Company's products have
been available to both government and industry through the Company's Scanning
Services Department. The services have been 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.
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 provides field services to customers
through the sale of hardware and software upgrades.
Research and Development
Company-sponsored research and development expenses totaled approximately
$89,000 and $304,000 for 1999 and 1998 respectively.
The Company's research in past years has been focused on achieving
increases in the speed of data acquisition and image processing as well as new
three-dimensional metrology tools. These improvements were seen as means to
improve the Company's competitive position in the CT industry. The Company
continues to focus its research and development on increasing speed; ease of
use; and cost reduction. 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. These detectors significantly reduced scan times
compared to previous generation detectors while maintaining performance in terms
of spatial and density resolution. The Company now actively markets the new
detectors as part of a system upgrade package to the installed base of SMS
customers.
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In fiscal 1998, the Company also sold a customized derivative of its new
three-dimensional or 3-D analysis software. CADScan(TM) was first demonstrated
for a complex General Motors casting application, and the Company has continued
to refine this technology for a broad range of potential applications since that
time. In fiscal 1999, a number of new applications for the CADScan(TM)
technology were being explored by the Company.
The Company has also completed the development of a new Graphical User
Interface (GUI) for use in the Company's products as well as a more robust
Object Positioning Unit (OPU) that improved the (weight) capacity and the motion
control of its scanning systems. Both improvements have been key elements in the
sale of upgrade(s) to the Company's installed base of systems.
In February 1996 the Company began work with a joint venture comprised of
the Company, General Electric, General Motors and EG&G. The work was to be
financed in part by a grant from the U.S. Department of Commerce National
Institute of Standards and Technology ("NIST") under their Advanced Technology
Program ("ATP"). The objective of the program was to develop a fast 3-D scanning
capability that would speed up 3D-CT image development one hundred fold. The
Company was appointed as the project leader and was also awarded the sole
commercialization rights for the industrial (read: non-medical) applications of
the technology. Throughout fiscal 1999 the Company was unable to pay for its
cost share of the undertaking. The Company was also unsuccessful during fiscal
1999 in selling additional equity to pay for its cost share to complete this
research 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 SmartScan(TM)
systems are intended to be standardized, customer-oriented commercial products
designed for industrial R&D environments 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.
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. DOD Applications, Munitions. Various forms of ordnance (mortar shells,
tank round components, missiles, rockets) have been evaluated with the
Company's equipment to check for a variety of pre and post production
defects. Such defects can render the subject component inoperable or
hazardous. Computed tomography is perhaps the only way of examining
these items non-destructively.
During fiscal 1999 the Company has been represented in Japan by KBK, a
leading high technology engineering/trading firm, pursuant to an exclusive
marketing agreement covering sales of the Company's products in Japan. KBK acts
as a reseller of the Company's products and services. In Germany the Company was
represented by Promod, based in Stuttgart, during the same period. Domestically,
the Company has been represented by Test Equipment Distributors, located in
Detroit, Michigan, in a five state region including the upper Midwest.
Since 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 has continued to represent the Company for this technology globally.
Eberline is the leading European producer of industrial gauges and is a
significant sales presence in the steel industry worldwide.
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.
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. Those competitors are capable of making competitive
products utilizing tomographic techniques and/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
10
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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 July 31, 1999 the Company employed 20 full time employees, of whom seven
were engaged in research (including software development); two in engineering;
four in scanning services; one in sales and marketing; two in field services;
two 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 generators, linear accelerator equipment, and --very rarely -- radioactive
isotopic 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 that require licensing is the use of isotopic,
X-ray and linear accelerator radiation sources. As required by State of Texas
regulations, the Company has had its SmartScan(TM) product line certified by the
Texas Bureau of Radiation Control as a product for commercial sale. Use of the
systems in-house or at a customer facility requires the operating party to
obtain a license from the appropriate state agency or federal agency (U.S.
Nuclear Regulatory Commission) regulating the use of radiation producing
systems. The 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 that expired 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.
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<PAGE>
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 been granted a patent 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. The patent is scheduled to be issued on or
before July 2000. 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.
During fiscal year 1999, the Company continued development of advanced 3-D
dimensional analysis software specifically designed for quickly identifying
deviations, often for regions of "first article" or part rework and quantifying
the amount of such rework required. 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 the capability of future
systems.
Financial History
The Company completed its initial public offering in March 1985. As of July
31, 1999, the Company had the following equity securities outstanding (exclusive
of employees' and directors' stock options):
Common Stock, $0.05 par value........................... 21,114,468 shares
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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. In fiscal
1998 The Company renewed its building lease to a five (5) year lease, expiring
in November, 2003. The monthly charge for the 13,900 square foot premises is
$9,009 per month -- or an annual charge of $7.78 per square foot. Management
believes that this space should be adequate for all of the Company's activities
through fiscal 1999.
In a transaction subsequent to the end of the FY 1999 reporting period and
with the written consent of the landlord, the Company sublet approximately 40%
of its leasehold to a third party that will operate a scanning services bureau
using the Company's equipment. This will ratably reduce the Company's monthly
leasehold expenditure and utilities for the balance of the lease term. (See:
"Subsequent Events").
ITEM 3. LEGAL PROCEEDINGS
As of July 31, 1999, the Company was made aware by several of its vendors
that continued non-payment of past due accounts would result in legal action
against the Company. Although the amounts were not material, three (3) vendors
had actually filed suit as of that date.
Subsequent to the end of the reporting period all suits filed as of July
31, 1999 were resolved satisfactorily by the Company. (See: "Subsequent
Events").
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, 1999.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
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 de-listed from the NASDAQ "Small Cap"
Market for failure to meet, among other requirements, the minimum bid price
requirement of $1.00 per share. On March 10, 2000 the Company was notified by
NASDAQ that non-compliance with all SEC reporting requirements, including
notably timely filings, would result in the Common Stock being traded on the
NASDAQ "Pink Sheet" Market. Since 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.
Common Stock
------------
Fiscal Year Ended High Low
---- ---
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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
July 31, 1999
First Quarter................................ $0.32 $ 0.12
Second Quarter............................... 0.20 0.07
Third Quarter................................ 0.16 0.06
Fourth Quarter............................... 0.15 0.07
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 July 31, 1999
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.
During the period covered by this report, the Company sold no securities,
registered or unregistered. On or about August 26, 1996, the Company granted
options to acquire 600,000 shares of its Common Stock at an exercise price of
$0.86 per share to eight non-employee directors. These options will expire on
August 25, 2006. To date, all directors have returned their option agreements to
the Company unexercised. Effective December 20, 1996, the Company granted
options to five employees to acquire 700,000 shares of its Common Stock at an
exercise price of $0.89 per share. Those options expire on December 19, 2006. On
or about November 1, 1996, in exchange for certain equipment with an agreed
value of $85,000, the Company issued 500,000 shares of its Common Stock to
Howard L. Burris, Jr. at $0.17 per share, the fair market value of the shares on
the date of the exchange. All of the above grants of options and issuance(s) of
securities were exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
In addition, 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 cash-less 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 $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
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<PAGE>
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 issuance(s) 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 1999.
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,
--------------------------------------------------------------------
1999 1998
------------------------------ ---------------------------------
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................. $ 1,968 68.4% (23.1)% $ 2,560 68.1% (8.6)%
Scanning services........................ 498 17.3% (19.0)% 615 16.4% 25.8%
Field services and upgrades.............. 412 14.3% (29.6)% 585 15.5% 34.2%
--------- ------- ------ ------- ------- -------
Total revenues.......................... 2,877 100.0% (23.5)% 3,760 100.0% 1.0%
Contract costs............................. 2,406 83.6% (16.8)% 2,893 76.9% (20.3)%
--------- ------- ------ ------- ------- -------
Gross profit............................... 471 16.4% (45.7)% 867 23.1% 832.3%
--------- ------- ------ ------- ------- -------
Operating costs:
Marketing................................ 322 11.2% (39.0)% 528 14.0% 49.2%
Research and development................. 89 3.1% (70.8)% 304 8.1% 4243%
General and administrative............... 716 24.9% (11.9)% 812 21.1% 3.7%
--------- ------- ------ ------- ------- -------
Total operating costs................... 1,127 39.2% (31.5)% 1,644 43.7% 43.7%
--------- ------- ------ ------- ------- -------
Income (loss) from operations.............. (656) (22.8)% 15.6% (777) (20.7)% 26.1%
--------- ------- ------ ------- ------- -------
Other (income) expense:
Interest expense......................... (35) (1.2)% 50.9% (72) (1.9)% 1.2%
Interest and other income................ 0 0 0% 0.0% -- 0.0% 0.0%
Loss on sale of asset.................... (9) 0.0% 0.0% 0 0.0% 0.0%
--------- ------- ------ ------- ------- -------
Other - net.............................. (44) (1.5)% 38.8% (72) (1.9)% 2.7%
--------- ------- ------ ------- ------- -------
Net income (loss) before Extraordinary
Item(s)................................... $ (700) (24.3)% 17.5% $ (22.6)% 24.3%
========= ======= ====== ======= ======= =======
Extraordinary Item $ $ (849)
=========
Net Loss $ (695) (24.1)% 18.1% $ (849) (22.6)%
</TABLE>
Fiscal 1999 Results of Operations
Revenues
Total contract revenues for the year ended July 31, 1999 decreased
$883,000, or 23.4% compared to the prior year. Revenues recognized from all
three markets (systems, scanning services, and upgrades) declined due to a
variety of factors including notably production slow downs from cash constraints
for
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<PAGE>
material purchases. Scanning services revenues decreased $117,000, or 19.0%.
Maintenance and upgrades revenues decreased $173,000, or 29.5%. Management
believes that systems sales revenues in particular that declined some 23.1% or
$592,000 could have been substantially higher for the period if there had been
no limitations on the Company's ability to purchase material. Throughout year
the Company found itself in a difficult position with its vendors.
The Company will start the FY 2000 period with a reasonable sales
backlog position, but there will have to be an improvement in that backlog to
improve revenue and bottom line results in the successive period. The Company
will focus its efforts in particular on certain strategic accounts and on
certain new application areas that in the opinion of Management could in time
have a meaningful impact on the Company's position. However, no assurances can
be given that the Company can raise working capital in sufficient amounts; can
successfully produce the existing or prospective backlog; or can improve the
Company's revenues and/or bottom line performance.
Gross Margin
Gross margin (revenue less direct contract costs) as a percentage of
revenue decreased from 23.1% in FY 1998 to 16.3% in FY 1999. This decrease is
due to several factors including most notably a decision to allocate the
Research & Development associated with three specific contracts to the (direct)
cost of sales. During fiscal 1999 the Company engaged in extensive research
and/or development efforts for three customers: (a) Daimler-Chrysler, (b) Rolls
Royce Aircraft Engines, and (c) the Picatinny Arsenal. While the Company
believes that in time these research and development efforts may well lead to
other systems sales to these customers and/or to other new customers seeking the
same technical capability and know how, Management felt it appropriate to
allocate the costs to the three systems under construction at the Company.
Management anticipates that margins on subsequent systems using these
developments may well improve in future sales of similar systems, however no
assurances of any such improvement can be given.
Operating Costs
Fiscal year 1999 total operating costs as a percentage of revenues
decreased to 31.4% -- from 43.7% in FY 1998 to 39.1% in FY 1999. Marketing
expenses dropped 36% and General & Administrative expenses were reduced 11.8%.
In all the non-research and development expenditures were reduced 23% or some
$302,000.
Also during FY 1999 most research and development expenses were either
charged to underlying the contracts (Daimler-Chrysler, Rolls Royce Aircraft
Engines, and Picatinny Arsenal) that made extensive use of the R&D group.
Management believes that it must recover R&D expenditures to the extent possible
from such systems contracts. Not every system contract has R&D involved in its
design and manufacture, but for those that do, it seemed appropriate to
Management to record the R&D cost in this manner. This of course has the effect
of increasing Operating Costs, while reducing the Company's unallocated R&D
budget by 70.7%.
Net Deferred Tax Asset
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" requires the recording of a valuation allowance when it is "more likely
than not that some portion or all of the deferred tax assets will not be
realized." It further states that "forming a conclusion that a valuation
allowance is not needed is difficult when there is negative evidence such as
cumulative losses in recent years." The ultimate realization of this deferred
income tax asset depends upon the ability to generate
16
<PAGE>
sufficient taxable income in the future. There was a 100% valuation allowance
for the years ended July 31, 1999 and 1998.
Other Expenses
Interest expense dropped 51.3% from $72,000 in fiscal year 1998 to $35,000
in fiscal year 1999. This was largely due to a consistent reduction during the
fiscal year in the principal balance of the Company's outstanding loans, notably
the borrowings from a bank employing an U.S. Export-Import Bank guarantee on a
system construction credit line -- as well as a revolving line of credit. (See:
"Subsequent Events").
LIQUIDITY AND CAPITAL RESOURCES
Working Capital
As of July 31, 1999, the Company had negative working capital of
approximately $1,315,400 compared to negative net working capital of
approximately $1,050,530 at July 31, 1998.
Cash Flows
The Company's operating activities provided net cash of approximately
$140,700 in fiscal year 1999 compared to net cash provided by operations of
approximately $8,400 in fiscal year 1998.
During fiscal 1999 and 1998, the Company used $80,700 and $342,600,
respectively, for financing activities. The use of cash for financing activities
in both fiscal years was mainly to repay borrowings under two bank lines of
credit.
Capital Expenditures
Capital expenditures in fiscal year 1999 and 1998 were approximately
$90,547 and $15,000, respectively. Fiscal year 1999 capital expenditures were
for office and warehouse equipment and, most significantly, for the upgrade of
in house computer equipment. Except for computer equipment upgrades, the fiscal
year 1999 capital expenditures are nonrecurring in nature.
Liquidity
Sources of liquidity as of July 31, 1999 include cash on hand of $10,100
and accounts receivable from the Company's customers of $274,200. Based on these
sources of liquidity as well as revenues generated by current backlog, and
assuming that the Company does not lose any contracts, and that none of its
customers cancel their contracts or otherwise fail to pay their debts to the
Company, management believes that the Company has the ability to meet its cash
requirements during the fiscal year ending July 31, 1999, provided, however,
that the Company's backlog is heavily concentrated with a small number of
customers. 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. This would require the Company to either obtain
additional capital from external sources or to curtail its working capital
expenditures, provided however, that 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.
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<PAGE>
Over the past two years, the Company has sought 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 10 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
July 31, 1999 the Company owed a total of $1,591,000 to General Electric
($871,000 of which is currently due to General Electric and $720,000 of which
will be due to General Electric upon the Company's receipt of the detector
panels) in contract expenses to consortium members. If the Company were to
proceed with this project, this amount would increase over future periods, the
timing of which would be dependent upon the project's progress. The Company had
been seeking to obtain such financing from additional borrowing arrangements
and/or the offering of debt or equity securities. However, to date the Company
has been unsuccessful in this regard, and there can be no assurance that in the
future funds will be available on terms satisfactory to the Company or at all.
Given those circumstances in January and February of 1999, the Company
initiated formal procedures to terminate its participation in the National
Institute of Standards and Technology (NIST) Advanced Technology Program. Since
the fall, the Company had concluded that financing for the NIST program to
develop a high speed volumetric CT or 3D CT capability along with General
Electric and other consortium partners was simply not going to be available. The
Company continues nonetheless with its own internal development effort to
enhance its own volumetric CT capability.
As of November 7, 1997 the Company was in default with one of its
commercial bank lenders with respect to its Export Import Bank of the U.S.
("EXIMBANK") guaranteed line of credit. As more fully described in Note 4 to the
financial statements, the Company owed approximately $144,000 and approximately
$227,000, for a total of $371,000, to two different commercial lenders.
(Subsequent to the end of the FY 1999 reporting period on December 22, 1999 both
commercial bank loans were paid off in full along with all accrued interest.
See: "Subsequent Events").
As noted in the independent accountant's opinion for the reporting
period ending July 31, 1999, 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, 1999, the Company incurred a net loss of
$695,400 and negative cash flows from operations in 1999 and 1998 of $140,700
and $8,414 respectively. In addition, at July 31, 1999, Current Liabilities
exceeded Current Assets by approximately $1,709,000.
Management had expected a return to profitable operations for the
period ending July 31, 1999, but the lack of available working capital severely
constrained the rate at which the work in process could be handled. While the
magnitude of the loss for the period was reduced by 18.1% over the FY 1998 net
income result, 1999 could have been at least a breakeven year with a speedier
processing of the committed book of business. As revenues are recognized on a
percent of completion basis, a slow down in the completion of systems due to
working capital constraints had a severe impact on the amount of revenue
recognized in a given period. The Company will seek alternative sources of
financing to provide additional working capital in the future. Should the
Company be unable to achieve the anticipated level of revenues in 1998,
management would anticipate reducing expenditures even further to preserve
positive cash flows. No assurance can be given, however, that management will be
successful in its endeavors.
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<PAGE>
Backlog
Total contract backlog as of July 31, 1999 was approximately $881,000,
down from $1,571,000 at July 31, 1998. Of the current net backlog, virtually all
is for systems sales. Accounts receivable or billing backlog for the analogous
periods were $1,282,700 and $1,237,000 respectively. All of the Company's order
backlog is scheduled for completion of production in fiscal year 2000, however
no assurances can be given that all such backlog will in fact be completed.
New Accounting Pronouncements
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.
Subsequent Events
On December 22, 1999 the Company sold its scanning service bureau to an
unrelated third party for $600,000 in cash and a contract for the purchase for a
new scanning system at full price. The proceeds of sale were used to satisfy all
of the Company's commercial lenders; a large number of the Company's material
vendors; and, most notably, General Electric Corporate Research & Development.
While the Company had been incrementally paying down its loans to
commercial lenders during FY 1998 and 1999 and while certain vendors had
exercised patience on aging credits, Management concluded that it was in the
best interest of the Company to proceed to satisfy as many obligations as
possible. Sale of the Company's service bureau was deemed to be the best course
available.
Additional terms of the sale provided for the purchaser to place an
order for the purchase of a CT Scanner on or before February 29, 2000, however
such an order has not been placed to date. Additional provisions provide for the
repurchase of these assets under certain circumstances, including the failure of
the purchaser to place the order for the CT Scanner, with a specific repurchase
formula. The Company has not initiated efforts to avail itself of the options
under this agreement to date.
Concurrently with the negotiations to sell these service bureau assets,
the Company entered into negotiations with various vendors to settle outstanding
balances owed to these vendors at year-end. The Company offered a fixed amount
of cash plus a set amount of common stock of the Company in exchange for a
complete settlement of its debt with these vendors. Specifically, the Company
entered into an
19
<PAGE>
agreement to settle the long outstanding balance due to a member of the
consortium formed to participate in a grant from the U.S. Department of Commerce
National Institute of Standards and Technology ("NIST") under their Advanced
Technology Program. This vendor agreed to accept a settlement of $175,000 in
cash, plus 92,105 shares of common stock of the Company to settle a debt in the
amount of $871,469, plus any and all other potential claims up to an additional
$718,200, related to its participation in the consortium. All other vendors who
accepted the negotiated offer were paid a total of $94,111 plus 7,895 shares of
common stock, to settle trade payable liabilities in the amount of $153,810.
The Company is permitted without restriction to engage in certain kinds
of key scanning service activities worldwide, and it retains all rights to
employ its systems for scanning services outside the US for its own account. The
Company also would collect a royalty on sales for any operating lease
arrangements with customers wishing to purchase medium and long term scanning
services. Such operating lease arrangements are to be negotiated on a case by
case basis.
20
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
Table of Contents
<TABLE>
<CAPTION>
Page
<S> <C>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 22
FINANCIAL STATEMENTS
Balance Sheets, July 31, 1998 and 1999 23-24
Statements of Loss, July 31, 1998 and 1999 25
Statements of Shareholders' Equity (Capital Deficit), July 31, 1998 and 1999 26
Statements of Cash Flows, July 31, 1998 and 1999 27-28
Notes to Financial Statements 29-41
</TABLE>
21
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders
Scientific Measurement Systems, Inc.
Austin, Texas
We have audited the accompanying balance sheet of Scientific Measurement
Systems, Inc. (the "Company") as of July 31, 1999, and the related statements of
loss, stockholders' equity (capital deficit) and cash flows for of the year 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 audit. The financial statements of Scientific
Measurement Systems, Inc. as of July 31, 1998, were audited by other auditors
whose report dated September 22, 1998, except for Note 4 which is as of January
15, 1999, on those statements included an explanatory paragraph describing
conditions that raised substantial doubt about the Company's ability to continue
as a going concern.
We conducted our audit 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 audit provides 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, 1999, and the results of its operations and its cash flows for
the year 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 2 to the
Financial Statements, the Company has suffered recurring losses from operations,
has a capital deficit, and a working capital deficit that raises substantial
doubt about its ability to continue as a going concern. Management's plan in
regard to these matters are described in Note 2. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
/s/ Dickey, Rush, Duncan, Scott & Co., P.C.
Houston, Texas
March 17, 2000
22
<PAGE>
Scientific Measurement Systems, Inc.
Balance Sheets
================================================================================
Balance Sheets
July 31
<TABLE>
<CAPTION>
1999 1998
---------------- ---------------
<S> <C> <C>
CURRENT ASSETS
Cash $ 10,115 $ 40,710
Trade accounts receivable, less allowance for
Doubtful accounts of $15,501 and $48,950 274,161 610,550
Costs and earned profits on long-term contracts in
Excess of related billings 559,005 232,799
Inventories 140,963 202,131
Prepaid expenses and other current assets 20,613 53,190
---------------- ---------------
TOTAL CURRENT ASSETS 1,004,857 1,139,380
---------------- ---------------
Property and equipment, net of accumulated
Depreciation 110,287 56,826
Scanning and compent equipment, net of
Accumulated depreciation of $302,482 and 269,762 217,957 278,844
Other assets, net of accumulated amortization of
$33,451 and $27,725 65,294 87,675
---------------- ---------------
Total other assets 283,251 366,519
---------------- ---------------
TOTAL ASSETS $ 1,398,395 $ 1,562,725
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
(CAPITAL DEFICIT)
CURRENT LIABILITIES
</TABLE>
23
<PAGE>
Scientific Measurement Systems, Inc.
Balance Sheets
================================================================================
<TABLE>
<S> <C> <C>
Trade payables and accrued liabilities $ 1,231,344 $ 481,191
Payable to research consortium members 871,469 871,469
Billings in excess of related costs and
earned profits on long-term contracts 341,757 480,106
Current portion of capital leases obligations 29,068 -
Notes payable 240,165 357,144
---------------- --------------
TOTAL CURRENT LIABILITIES 2,713,803 2,189,910
---------------- --------------
LONG-TERM LIABILITIES
Capital leases obligations 7,210 -
COMMITMENTS AND CONTINGENCIES - -
---------------- --------------
TOTAL LIABILITIES 2,721,013 2,189,910
STOCKHOLDERS' EQUITY (CAPITAL DEFICIT)
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 Issued and Outstanding 1,055,723 1,055,723
Additional Paid In Capital 9,253,622 9,253,622
Deficit (11,631,963) (10,936,530)
---------------- --------------
TOTAL STOCKHOLDERS' EQUITY (CAPITAL DEFICIT) (1,322,618) (627,185)
---------------- --------------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY
(CAPITAL DEFICIT) $ 1,398,395 $ 1,562,725
================ ==============
</TABLE>
See accompanying summary of significant accounting policies and notes
to financial statements.
24
<PAGE>
Scientific Measurement Systems, Inc.
Statements of Operations
================================================================================
Statements of Loss
For the years ended July 31
<TABLE>
<CAPTION>
1999 1998
------------------ ---------------
<S> <C> <C>
REVENUES
Tomographic systems sales $ 1,967,683 $ 2,560,500
Scanning services 497,929 614,116
Field services and systems upgrades 411,782 585,149
------------------ ----------------
Total Revenues 2,877,394 3,759,765
DIRECT CONTRACT COSTS 2,406,371 2,893,127
------------------ ----------------
GROSS PROFIT 471,023 866,638
OPERATING EXPENSES
Marketing and sales 322,347 528,105
Research and development 88,799 303,831
General and administrative 715,760 811,754
------------------ ----------------
Total Operating Expenses 1,126,906 1,643,690
------------------ ----------------
LOSS FROM OPERATIONS (655,883) (777,052)
OTHER INCOME (EXPENSE)
Loss on impairment of assets (8,916) -
Interest expense, net (35,341) (71,838)
------------------ ----------------
Total Other Income (Expense) (44,257) (71,838)
------------------ ----------------
NET LOSS BEFORE EXTRAORDINARY ITEMS (700,140) (848,890)
Extraordinary item - gain on extinguishment of debt (no
applicable income taxes) 4,707
------------------ ----------------
</TABLE>
25
<PAGE>
Scientific Measurement Systems, Inc.
Statements of Stockholders' Equity
================================================================================
<TABLE>
<S> <C> <C>
NET LOSS $ (695,433) $ (848,890)
============ ================
Basic net loss per common share (1) ($0.03) ($0.04)
Weighted average number of shares outstanding (1) 21,114,468 21,114,468
</TABLE>
(1) Diluted per share amounts not presented due to anti-dilutive effect of
additional shares.
See accompanying summary of significant accounting policies and notes to
financial statements.
26
<PAGE>
Scientific Measurement Systems, Inc.
Statements of Stockholders' Equity
================================================================================
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
Statements of Stockholders' Equity (Capital Deficit)
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
Additional
- ----------------------------------------------------------------------------------------------------------------------------
Common Stock Paid In
- ----------------------------------------------------------------------------------------------------------------------------
Shares Amount Capital Deficit Total
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at July 31, 1997 21,114,468 $ 1,055,723 $ 9,253,622 $ (10,087,640) $ 221,705
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
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)
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
Net Loss - - - (695,433) (695,433)
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 1999 21,114,468 $ 1,055,723 $ 9,253,622 $ (11,631,963) $ (1,322,618)
============= ============ ============ ============= ============
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying summary of significant accounting policies
and notes to financial statements.
27
<PAGE>
Scientific Measurement Systems, Inc.
Statements of Cash Flows
Increase (decrease) in cash and cash equivalents
================================================================================
Statements of Cash Flows
For the years ended July 31
<TABLE>
<CAPTION>
1999 1998
--------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
NET LOSS $ (695,433) $ (848,890)
Adjustments to Reconcile Net Loss to Net Cash
Provided (Used) by Operating Activities
Depreciation and amortization 94,782 88,715
Loss on impairment of property and equipment 8,916 -
(Increase)/Decrease in Assets:
Trade accounts receivable 336,389 (317,027)
Other receivables 450,090
Costs and earned profits in excess of billings on contracts (326,206) 670,349
Inventories 61,168 (182,231)
Prepaid expenses and other current assets 32,577 (25,523)
Other assets 16,655 (111,116)
Increase/(Decrease) in Liabilities:
Accounts payable and accrued liabilities 750,153 71,905
Billings in excess of costs and earned profits on contracts (138,349) 212,142
--------------- --------------
Total Adjustments 836,085 857,304
--------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 140,652 8,414
--------------- --------------
</TABLE>
28
<PAGE>
Scientific Measurement Systems, Inc.
Statements of Cash Flows
Increase (decrease) in cash and cash equivalents
================================================================================
<TABLE>
<S> <C> <C>
CASH FLOWS USED BY INVESTING ACTIVITIES
Acquisitions of property and equipment (90,547) (15,286)
--------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under notes payable - 140,019
Borrowings under capital leases 68,131 -
Repayments of notes payable (116,979) (482,650)
Repayments of capital leases (31,852) -
--------------- --------------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES $ (80,700) $ (342,631)
--------------- --------------
NET INCREASE (DECREASE) IN CASH $ (30,595) $ (349,503)
CASH AT BEGINNING OF YEAR 40,710 390,213
--------------- --------------
CASH AT END OF YEAR $ 10,115 40,710
=============== ==============
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION
Cash Paid During the Period:
Interest $ 33,156 $ 74593
Taxes - -
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
None
See accompanying summary of significant accounting policies
and notes to financial statements.
29
<PAGE>
Scientific Measurement Systems, Inc.
Statements of Cash Flows
Increase (decrease) in cash and cash equivalents
================================================================================
NOTE 1 - 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.
30
<PAGE>
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 that 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 7). 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 that are being amortized using the straight-line method over their
remaining lives ranging from 10 to 13 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 has 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.
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 and warrants. At July 31, 1999 and 1998 respectively,
vested stock options for 1,399,639 and 2,422,678 shares and warrants for 360,940
and 360,940 shares are not included in the computation of loss per share 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.
31
<PAGE>
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.
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, 1999 identified assets with a cost
of $924,642, accumulated depreciation of $915,726 and a net book value of
$8,916, were impaired and an adjustment was made to reduce the carry value of
these assets to their net realizable value. This adjustment resulted in a charge
of $8,916 in the accompanying financial statements and is included in the
caption "loss on impartment of assets". This analysis at July 31, 1998 indicated
there was no impairment to these assets' carrying values.
New Accounting Pronouncements
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.
32
<PAGE>
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.
NOTE 2 - GOING CONCERN UNCERTAINTY
The Company continued to incur substantial losses from operations and incurred a
net loss from operations of $695,433 for the fiscal year ended 1999 and has a
capital deficit of $1,322,618. In addition, the Company incurred substantial
indebtedness resulting in current liabilities exceeding current assets by
approximately $1,708,946 at July 31, 1999 and was in default with its line of
credit agreement and on one other note payable (see Note 4). 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, the Company has
been unsuccessful in its efforts to raise additional capital. 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 (See Note 13
regarding events subsequent to July 31, 1999) 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 1999 and 1998, the Company was unable to pay vendors in accordance with
the terms of its purchase agreements. Also, subsequent to July 31, 1999 and
1998, the Company was, at times, unable to meet its payroll obligations in a
timely fashion.
Subsequent to July 31, 1999 the Company successfully completed a restructuring
of its current indebtedness with its vendors, most notably its indebtedness to
General Electric-Corporate Research and Development (see Note 13). Integral to
this restructuring was the sale of certain service bureau assets that resulted
in net cash proceeds of $600,000. Those cash proceeds and cash from operations
were used to pay off the delinquent bank loans and substantially reduce the
Company's outstanding vendor accounts payable. Management's plans include the
continued pursuit to raise additional capital and outside financing in order to
continue to fund operations and to take advantage of other related business
opportunities. 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 obtain debt with favorable terms.
NOTE 3 - PROPERTY, EQUIPMENT AND DEPRECIATION
The major classes of property and equipment as of July 31 are as follows:
1999 1998
----------------------
Equipment $ 337,368 $1,124,383
Furniture and Fixtures $ 85,372 $ 104,285
Improvements to Building $ 62,180 $ 62,180
----------------------
Total $ 484,920 $1,290,848
33
<PAGE>
Less Accumulated Depreciation (374,633) (1,234,022)
Total $ 110,287 $ 56,826
NOTE 4 - NOTES PAYABLE
Notes payable at July 31 consisted of the following:
1999 1998
---------------------
Exim Bank guaranteed note payable in default
secured by certain accounts receivable,
inventories, property and equipment; interest
payable monthly at prime plus 5%
(13.25% at July 31, 1999) $ 93,961 $167,125
Note payable to bank, in default and payable on
demand with interest at 8% $ 50,000 $ 60,000
Note payable to a law firm, in default, and
payable on demand with interest at 8% $ 96,204 $130,019
Total $240,165 $357,144
At July 30, 1999, the Company was in default on numerous debt covenants under
the Eximbank guaranteed note payable. The debt covenant violations have not been
waived; however, the due date has been extended by the bank to December 31,
1999. (Subsequent to year-end the all bank notes were paid in full. See Note
13).
NOTE 5 - 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, 1999, 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 sales agents of the limited offering 10%
of the gross dollars raised as a fee. In addition, the Company has granted the
sales agents 360,940 stock purchase warrants exercisable at prices ranging from
$0.61 to $0.875 per share. These warrants expire at various times beginning
December 15, 2001 through December 15, 2003, with no call provisions and
piggyback registration rights and a one-time demand registration after twelve
months.
NOTE 6 - 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 that
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.
34
<PAGE>
The 1990 Plan prohibits the grant of options there under 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 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
that 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 prohibited the grant of options there under 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 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. The remaining six directors returned their option agreements
to the Company unexercised during fiscal 1999.
During fiscal 1998, the Board of Directors approved awards of 500,000 options to
two employees that 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, 1999 and 1998, 1,449,641 and 2,923,681 shares of common stock
were under option, with exercise prices ranging from $0.1406 to $0.8900;
1,399,639 and 2,422,678 of these options were exercisable at July 31, 1999 and
1998, respectively.
A summary of the status of the Company's stock options as of July 31 is
presented below:
1999 1998
---- ----
Weighted Weighted
Number Average Number Average
of Exercise of Exercise
Options Shares Price Shares Price
-------------------------------------------
Outstanding and
exercisable at
beginning of year 2,923,681 $ 0.42 2,423,681 $ 0.43
Granted - - 500,000 0.38
Exercised - - - -
35
<PAGE>
Forfeited 1,474,040 0.59 - -
Outstanding at
end of year 1,449,641 $ 0.26 2,923,681 $ 0.42
===========================================
The following table summarizes the information about the stock options as of
July 31, 1999.
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
-----------------------------------------------------------------------
$ 0.1500 849,641 $ 0.1500 1 849,641 $ 0.1500
$ 0.1600 50,000 $ 0.1600 1 50,000 $ 0.2250
$ 0.2400 300,000 $ 0.2400 1 300,000 $ 0.2400
$ 0.3700 100,000 $ 0.3700 9 100,000 $ 0.3700
$ 0.8900 150,000 $ 0.8900 7 99,998 $ 0.8900
-----------------------------------------------------------------------
1,449,641 $ 0.2607 2 1,399,639 $ 0.2382
============================================================
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 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.
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:
1999 1998
------------------------
Net loss applicable to common shareholders:
As reported: $(695,433) $(848,890)
Pro forma: (724,432) (993,889)
Loss per share:
As reported: $ (0.03) $ (0.03)
Pro forma: (0.03) (0.04)
NOTE 7 - CONTRACT REVENUES AND CONTRACTS IN PROGRESS
The Company's revenues have been derived from certain major customers (greater
than 10% of total
36
<PAGE>
revenues) as follows:
Customer 1999 1998
------------ ---- ----
A 14% -
B 13% -
C 15% -
D - 33%
E - 15%
The Company had export revenues of approximately $472,304 and $1,069,000 to
Japan, $24,600 and $103,000 to Germany, none and $21,000 to Switzerland,
$185,278 and none to Canada, $262,001 and none to Norway, and $618,863 and none
to the United Kingdom during fiscal 1999 and 1998, respectively.
Contracts in progress consist of the following: 1999 1998
---------------------
Costs and estimated earnings $4,050,366 $2,591,095
Billings $3,833,118 $2,838,402
Included in the Balance Sheet:
Costs and earned profits on long term
contracts in excess of related billings $ 559,005 $ 232,799
Billings in excess of related costs and
earned profits on long term contracts (341,757) (480,106)
$ 217,248 $ (247,307)
Requirements for progress billings are negotiated on an individual contract
basis and, accordingly, vary between contracts.
37
<PAGE>
NOTE 8 - 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 that will be in effect when these differences reverse.
The components of deferred income tax assets at July 31 were as follows:
1999 1998
---------------------
Accrued expenses $ 20,215 $ 12,384
Total current deferred income tax asset $ 20,215 $ 12,384
Depreciation $ - (14,756)
Operating loss carryforward $ 3,864,649 $ 3,775,837
Tax credit carryforward $ 3,844,434 $ 3,634,052
Valuation allowance $ 3,864,649 $ 3,775,837
Total net deferred income tax asset $ - $ -
At July 31, 1999 the Company has available for federal income tax reporting
purposes approximately $11,307,160 of net operating loss carryforwards of which
approximately $483,000 expires in 2000, with the balance expiring in varying
amounts in 2001 through 2019. Also, the Company had approximately $144,157 of
tax credit carryforwards, all expired during 1999. 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 that may be utilized if there are
substantial changes in the ownership of the Company.
At July 31, 1999 and 1998, 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.
NOTE 9 - 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, 1999 and 1998. 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.
NOTE 10 - 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.
38
<PAGE>
NOTE 11 - LEASES
Operating 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 1999 and 1998 was $129,676 and $92,738,
respectively.
Future minimum payments, by fiscal year and in the aggregate for leases
of office and manufacturing space and equipment consist of the following:
Future minimum lease payments under these leases for years ending July
31, are as follows:
1999 1998
---- ----
1999 $ - $150,030
2000 105,399 137,114
2001 104,784 108,205
2002 104,784 108,205
2003 104,784 108,205
2004 26,196 -
-------- --------
Total $445,947 $611,759
======== ========
Capital Leases
The Company acquired various equipment under the provisions of a long-
term lease. For financial reporting purposes, minimum lease payments relating to
the equipment have been capitalized. The leases run through January 2001. The
leased equipment under capital lease as of July 31, 1999 has a cost of $68,130,
accumulated depreciation of $16,809 and a net book value of $51,321.
The future minimum lease payments under capital lease and the net
present value of the future minimum lease payments for years ending July 31, are
as follows:
1999
----
2000 30,750
2001 5,210
2002 2,449
-------
Total minimum lease payments $ 38,409
Amount representing interest (2,131)
Present Value on Net Minimum Lease Payments $ 36,278
Current Portion (29,068)
Long-Term Capital Lease Obligation $ 7,210
39
<PAGE>
NOTE 12 - 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 was designated 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 1999 and 1998, the Company incurred
approximately $0 and $53,600, 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, 1999 the Company had amounts payable to consortium
members, (primarily General Electric) of $871,469. In addition, under the
consortium agreement the Company may be liable for an additional $718,200 to
General Electric.
Subsequent to July 31, 1999, this liability has been settled (See Note 13).
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 this 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.
NOTE 13 - SUBSEQUENT EVENTS
On December 12, 1999 the Company completed the sale of its scanning service
bureau assets, for a cash sales price of $600,000. The proceeds from this sale
were used to reduce the Company's debt. The cost of the service bureau assets
sold amounted to $493,532, with related accumulated depreciation of $272,278 and
a net book value of $221,254. The Company will recognize a one-time gain on the
sale of these assets in the amount of $324,460, which includes a charge for the
forfeiture to the right of future cash flows on a system and scanning contract,
in the approximate amount of $54,286. Terms of the sale provided for the
purchaser to place an order for the purchase of a CT Scanner on or before
February 29, 2000, however such an order has not been placed to date. Additional
provisions provide for the repurchase of these assets under certain
circumstances, including the failure of the purchaser to place the order for the
CT Scanner, with a specific repurchase formula. The Company has not initiated
efforts to avail itself of the options under this agreement to date.
Concurrently with the negotiations to sell these service bureau assets, the
Company entered into negotiations with various vendors to settle outstanding
balances owed to these vendors at year-end. The Company offered a fixed amount
of cash plus a set amount of common stock of the Company in exchange for a
complete settlement of its debt with these vendors. Specifically, the Company
entered into an
40
<PAGE>
agreement to settle the long outstanding balance due to a member of the
consortium formed to participate in a grant from the U.S. Department of Commerce
National Institute of Standards and Technology ("NIST") under their Advanced
Technology Program. This vendor agreed to accept a settlement of $175,000 in
cash, plus 92,105 shares of common stock of the Company to settle a debt in the
amount of $871,469, plus any and all other potential claims up to an additional
$718,200, related to its participation in the consortium. All other vendors who
accepted the negotiated offer were paid a total of $94,111 plus 7,895 shares of
common stock, to settle trade payable liabilities in the amount of $153,810.
These settlements will be recorded as an extraordinary gain, less the value of
the common stock issued based upon a trading price of $0.06 per share on the
date of settlement, and amounts to $ 750,168.
Additionally, on September 15, 1999, the Company's board of directors approved a
grant of up to 555,000 of options to purchase common stock to it employees in
consideration of the sacrifices made to assist the Company through difficult
financial times. The options will be issued with a grant price of $0.06 per
share.
41
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not applicable.
<PAGE>
PART III
INDEX
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
ITEM 10 EXECUTIVE COMPENSATION
ITEM 11 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 12 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
<PAGE>
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 50 1996
Dr. Larry Secrest Chairman of the Board 58 1986
Burton W. Kanter Director 69 1985
James W. Kenney Director 58 1986
Phillips A. Moore Director 53 1987
Dr. Thomas Prud'homme Director 69 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 Texas at Austin
in 1971. During 1971-72 he served as visiting Fulbright Research Professor at
Keio
<PAGE>
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:
<PAGE>
<TABLE>
<CAPTION>
Year Became
Officer Position with the Company Age Officer
- ------- ------------------------- --- -----------
<S> <C> <C> <C>
Dr. Forrest F. Vice President of Research and 52 1979
Hopkins Development and
Secretary
Joe Llamas Vice President of Marketing and Sales 31 1999
</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.
Joe E. Llamas, Vice President of Marketing and Sales, joined the
Company in February 1997. Mr. Llamas oversees the Company's worldwide marketing
and sales efforts, including management of its sales representatives. Mr. Llamas
most recently served as Director of Scanning Services at SMS. Prior to joining
the Company, Mr. Llamas served as the General Manager for Accelerated
Technologies, Inc., a rapid prototyping service company. Mr. Llamas holds a BS
in Mechanical 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 1999, 1998 and 1997 and for Joe Llamas, the Company's Vice
President of Sales and Marketing for fiscal year 1999. No other officers were
paid compensation in fiscal 1999 in excess of $150,000.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation
-------------------
Long Term
Compensation
Other Annual Awards
Name and Principal Position Year Salary ($) Bonus ($) Compensation Options/SARs (#)
--------------------------- ---- ---------- --------- ------------ ----------------
<S> <C> <C> <C> <C> <C>
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C>
Howard L. Burris, President and Chief 1999 -0- -0- -0-
Executive Officer 1998 -0- -0- 100,000
1997 $120,000 -0- $8,273 -0-
Loe E. Llamas, Vice President of Sales and 1999 $ 53,500 -0- -0- -0-
Marketing
</TABLE>
Options
The following table sets forth certain information concerning options
granted in fiscal 1998 to Howard Burris.
<TABLE>
<CAPTION>
Number of Securities Percent of total Options/SARs
Underlying Options/SARs Granted to Employees in Exercise Expiration
Name Granted Fiscal 1998 Price Date
---- ------- ----------- ----- ----
<S> <C> <C> <C> <C>
Howard L. Burris 100,000 20% $0.31 Jan. 29, 2008
</TABLE>
Directors' Compensation
Outside directors receive stock options under the Company's 1996 Incentive
Plan.
47
<PAGE>
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. 1,784,341/(2)/ 8.45%
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 50,000/(4)/ *
BK Consultants
Two North LaSalle Street
Chicago, Illinois 60602
James W. Kenney 75,000/(5)/ *
San Jacinto Securities
5949 Sherry Lane, Suite 960
Dallas, Texas 75225
Phillips A. Moore 75,000/(5)/ *
61 Sunnybrook
Avon, Connecticut 06001
Thomas Prud'homme 75,000/(5)/ *
Process Sciences
3585 CR 272, Suite 400
Leander, Texas 78641
Forrest Hopkins
Scientific Measurement Systems, Inc. 278,627/(6)/ 1.31%
2210 Denton Drive, Suite 106
Austin, Texas 78758
</TABLE>
48
<PAGE>
<TABLE>
<CAPTION>
Amount and Nature Percent of
Name and Address of Beneficial Owner Of Beneficial Ownership(1) Class
- ------------------------------------ -------------------------- -----
<S> <C> <C>
All Directors, Officers and Nominees as a 3,541,128 16.8%
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 100,000 shares of Common
Stock, all of which are immediately exercisable.
(3) Includes shares underlying options to purchase 421,607 shares of Common
Stock, all of which are exercisable within the next 60 days.
(4) Includes shares underlying options to purchase 50,000 shares of Common
Stock, all of which are all immediately exercisable.
(5) Includes shares underlying options to purchase 75,000 shares of Common
Stock, all of which are immediately exercisable.
(6) Includes 24,489 share of Common Stock and underlying options to
purchase 254,138 shares of Common Stock, all of are immediately
exercisable.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
49
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
Documents filed as part of this report
50
<PAGE>
Exhibits:
<TABLE>
<CAPTION>
Incorporated by
Number Description Reference to
------ ----------- ------------
<S> <C> <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 Annual
October 7,1988 between the Registrant and Report on Form 10-K for the fiscal year
Bethlehem Steel Corporation for the ended July 31, 1988
development and sale of a tomographic
system.
</TABLE>
51
<PAGE>
<TABLE>
<CAPTION>
Incorporated by
Number Description Reference to
------ ----------- ------------
<S> <C> <C>
Portions of these 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 between Exhibit 10.12 to the Company's Annual
the Registrant and Bethlehem Steel Report on Form 10-KSB for the fiscal year
Corporation ended July 31, 1995
10.13 Frost National Bank letter dated October 25, 1995 Exhibit 10.13 to the Company's Annual
regarding Term Note 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 16, Exhibit 10.14 to the Company's Annual
1995 in the principal amounts of $50,000, Report on Form 10-KSB for the fiscal year
$30,000 and $10,000 respectively, all payable ended July 31, 1995
by Registrant to Mr. Howard L. Burris, Jr.
10.15 Note dated June 5, 1996, in the principal amount of Exhibit 10.15 to the Company's Annual
$25,000 payable to Thomas Prud'homme Report on Form 10-KSB for the fiscal year
ended July 31, 1996
10.16 Note dated July 12, 1996, in the principal amount of Exhibit 10.16 to the Company's Annual
$233,608.70 payable to Ulster Investments, Ltd. and Report on Form 10-KSB for the fiscal year
related loan documents ended July 31, 1996
10.17 Volumetric Computed Tomography Consortium Collaboration Exhibit 10.17 to the Company's Annual
Agreement dated December 1995 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 Annual
Commercialization Agreement dated December 1995 Report on Form 10-KSB for the fiscal year
ended July 31, 1996
</TABLE>
52
<PAGE>
<TABLE>
<CAPTION>
Incorporated by
Number Description Reference to
------ ----------- ------------
<S> <C> <C>
10.19 Amendment to U.S. Department of Commerce National Exhibit 10.19 to the Company's Annual
Institute of Standards and Technology Financial Report on Form 10-KSB for the fiscal year
Assistance Award dated January 19, 1996 ended July 31, 1996
10.20 Promissory Note dated June 15, 1996 to Wells Fargo Exhibit 10.20 to the Company's Annual
HSBC Trade Bank, N.A. in the principal amount of Report on Form 10-KSB for the fiscal year
$1,250,000.00; Security Agreement dated June 15, 1996 ended July 31, 1996
between the Company and Wells Fargo HSBC Trade Bank,
N.A.
10.21 Note dated January 25, 1996 to Jenkens & Gilchrist, Exhibit 10.21 to the Company's Annual
P.C. in the principal amount of $52,000 Report on Form 10-KSB for the fiscal year
ended July 31, 1996
10.22 U.S. Department of Commerce National Institute of Exhibit 10.22 to the Company's Annual
Standards and Technology Financial Assistance Award Report on Form 10-KSB for the fiscal year
dated September 26, 1995 ended July 31, 1997.
10.23 1996 Incentive Stock Option Plan Exhibit 10.23 to the Company's Annual
Report on Form 10-KSB for the fiscal year
ended July 31, 1997.
10.24 Amendment to U.S. Department of Commerce National Exhibit 10.24 to the Company's Annual
Institute of Standards and Technology (NIST) Report on Form 10-KSB for the fiscal year
Financial Assistance Award dated effective ended July 31, 1997.
September 1, 1997
10.25 Letter from Frost National Bank dated August 5, Exhibit 10.25 to the Company's Annual
1997 and Promissory Note dated July 21, 1997 Report on Form 10-KSB for the fiscal year
ended July 31, 1997.
10.26 EXIM Guaranteed Loan Agreement dated June 15, 1996 Exhibit 10.26 to the Company's Annual
Report on Form 10-KSB for the fiscal year
ended July 31, 1997.
10.27 First Amendment to EXIM Guaranteed Loan Agreement Exhibit 10.27 to the Company's Annual
dated as of August 1, 1996 between the Company Report on Form 10-KSB for the fiscal year
and Wells Fargo HSBC Trade ended July 31, 1997.
</TABLE>
53
<PAGE>
<TABLE>
<CAPTION>
Incorporated by
Number Description Reference to
------ ----------- ------------
<S> <C> <C>
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 Agreement Exhibit 10.28 to the Company's Annual
dated as of June 15, 1997 between the Company and Report on Form 10-KSB for the fiscal year
Wells Fargo HSBC Trade Bank, N.A. and Promissory ended July 31, 1997.
Noted dated June 15, 1997 payable to Wells Fargo
HSBC Trade Bank, N.A.
10.29 First Amendment to Security Agreement dated June 15, Exhibit 10.29 to the Company's Annual
1997 between the Company and Wells Fargo HSBC Trade Report on Form 10-KSB for the fiscal year
Bank, N.A. ended July 31, 1997.
10.30 Registration Rights Agreement dated May 8, 1995 between Exhibit 10.30 to the Company's Annual
the Company and Howard L. Burris, Jr. Report on Form 10-KSB for the fiscal year
ended July 31, 1997.
10.31 Third Amendment to EXIM Guaranteed Loan Agreement Exhibit 10.31 to the Company's Annual
dated as of July 31, 1997 between the Company and Report on Form 10-KSB for the fiscal year
Wells Fargo HSBC Trade Bank, N.A. and Promissory ended July 31, 1997.
Note dated July 31, 1997, payable to Wells Fargo
HSBC Trade Bank, N.A.
10.32 Second Amendment to Security Agreement dated July 31, Exhibit 10.32 to the Company's Annual
1997 between the Company and Wells Fargo HSBC Trade Report on Form 10-KSB for the fiscal year
Bank, N.A. ended July 31, 1997.
23.1 Consent of Independent Accountants N/A
24.1 Power of Attorney (see page 55) 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.
54
<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, 1999 to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Austin and State of Texas, on the 4th
day of April, 2000.
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,
1999, 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.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Howard L. Burris President, CEO, Director
- --------------------------------------
April 4, 2000
/s/ Howard L. Burris, Jr.
/s/ Larry Secrest Director April 4, 2000
- --------------------------------------
Larry Secrest
/s/ Burton W. Kanter Director April 4, 2000
- --------------------------------------
Burton W. Kanter
/s/ James W. Kenney Director April 4, 2000
- --------------------------------------
James W. Kenney
/s/ Phillips A. Moore Director April 4, 2000
- --------------------------------------
Phillips A. Moore
/s/ Thomas Prud'homme Director April 4, 2000
- --------------------------------------
Dr. Thomas Prud'homme
</TABLE>
55
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Company's Annual
Report pertaining to Scientific Measurement Systems, Inc. of our report dated as
of March 17, 2000, with respect to the consolidated financial statements of
Scientific Measurement Systems, Inc. included in the Form 10-KSB for the year
ended July 31, 1999, which contains an explanatory paragraph regarding the
company's ability to continue as a going concern.
/s/ Dickey, Rush, Duncan, Scott & Co.
- -----------------------------------------
Dickey, Rush, Duncan, Scott & Co., P.C.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Balance
Sheet at July 31, 1999 and the Statement of Loss for the year then ended, and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> JUL-31-1999 JUL-31-1998
<PERIOD-START> AUG-01-1998 AUG-01-1997
<PERIOD-END> JUL-31-1999 JUL-31-1998
<CASH> 10 41
<SECURITIES> 0 0
<RECEIVABLES> 290 843
<ALLOWANCES> 16 49
<INVENTORY> 141 202
<CURRENT-ASSETS> 1,005 1,139
<PP&E> 1,005 1,291
<DEPRECIATION> 677 1,234
<TOTAL-ASSETS> 1,398 1,139
<CURRENT-LIABILITIES> 2,714 2,190
<BONDS> 0 0
0 0
0 0
<COMMON> 1,056 1,056
<OTHER-SE> 9,254 9,254
<TOTAL-LIABILITY-AND-EQUITY> 1,398 1,563
<SALES> 2,877 3,760
<TOTAL-REVENUES> 2,877 3,760
<CGS> 2,406 2,893
<TOTAL-COSTS> 3,533 4,537
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 35 72
<INCOME-PRETAX> (700) (849)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (700) (849)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 5 0
<CHANGES> 0 0
<NET-INCOME> (695) (849)
<EPS-BASIC> 0.03 0.04
<EPS-DILUTED> 0.03 0.04
</TABLE>
