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UNITED STATES 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 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934)
Commission File Number: 0-20376
XXSYS TECHNOLOGIES, INC.
(Name of small business issuer in its charter)
California 33-0161808
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4619 Viewridge Avenue, San Diego, California 92123
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (619) 974-8200
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
Indicate by check mark whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Securities 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 __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not 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. [ ]
Issuer's revenues for its fiscal year ended September 30, 1998: $1,365,955
The market value of voting stock held by non-affiliates of the registrant as of
December 19, 1998, was approximately $6 million.
Shares of Common Stock outstanding at December 29, 1998: 14,074,019
DOCUMENTS INCORPORATED BY REFERENCE
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
XXsys Technologies, Inc. (the "Company") was organized under the laws of
the State of California on November 19, 1985, to develop non-destructive testing
and measurement techniques for advance materials in the defense industry. In
response to the defense cutbacks of the early 1990s and their impact on the
developing markets for advanced materials, the Company initiated efforts in 1993
to develop commercial applications of its technologies and know-how. The initial
results of those efforts is the Company's Robo-Wrapper(TM) machine and
application process, a proprietary technology that produces carbon-based
composite jackets designed to upgrade structurally deficient or corroded
structures that support highway bridges and buildings that could collapse during
seismic activity or from corrosive decay.
The Company's primary business focus is to use its proprietary retrofit
and rehabilitation processes to upgrade aging bridges, buildings and other
structures by wrapping the structural elements with composite materials. The
Company intends to earn revenues from the sale of materials, rental of
Robo-Wrapper(TM) equipment and providing one or more technical assistants to the
contractor directly conducting the column retrofit. The contractor will be
responsible for bidding on public or private retrofit projects, and conducting
the majority of the retrofitting. The Company may also earn fees for providing
the installation services as a specialty subcontractor. The Company may also
license its technology or enter into joint venture arrangements with
construction firms involved in seismic retrofitting or corrosion strengthening
as a specialty subcontractor.
In November 1997 the Company expanded into complimentary products by
acquiring an exclusive license from the Sho-Bond Corporation of Japan for the
sale of Sho-Bond's concrete repair and reinforcement products in the United
States and Canada (See "Licenses and Distribution Agreements").
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENT
The Company's business consists of one business segment, the operations
of which are described below. For detailed financial information with respect to
the revenues, operating loss and assets and liabilities of the Company's
operations, see the consolidated financial statements and notes thereto included
elsewhere in this report.
GENERAL
The Company's technology involves a proprietary column wrapping machine
and process, the Robo-Wrapper(TM), which wraps deficient bridge and building
columns with a precise amount of continuous carbon fiber to produce a composite
jacket that has no seams, joints or potential weak spots. Industry efforts to
commercialize composites for use in the infrastructure have been supported by
both federal and state research and development (R&D) funds totaling about $5.2
million, including $1.2 million in grants directly to the Company. The Company
believes carbon composite jackets match or exceed the performance of steel
jackets at a fraction of the weight, and can be installed in less time. The
Company's carbon jacketing process has been demonstrated to work by structural
testing of 4/10ths-scale and full-scale columns under simulated seismic loads at
the Powell Structural Systems Research Laboratories at the University of
California, San Diego ("UCSD") and 4/10ths-scale tests at the University of
Illinois. In 1998, the Company's composite retrofit technology was further
validated to increase the strength of severely corroded and aging bridges using
a full-scale destructive test on the I-15 Freeway in Salt Lake City, Utah. Since
inception 1985, the Company has been engaged principally in R&D activities and
revenue from operations to date have been insignificant.
On April 10, 1996, the Company was notified by the California Department
of Transportation ("Caltrans") that Caltrans had issued a procurement
specification approving the use of the Company's Robo-Wrapper(TM) technology as
an alternative method of retrofitting publicly-owned highway bridge columns in
the State of California that meet certain criteria in a composite specification
(the "Composite Specification"). In January 1997 the Company completed its first
seismic retrofit of a bridge for Caltrans. Since issuance of the Composite
Specification by Caltrans in 1996, the Company has completed over 10 field
application projects having total value in excess of $1 million in four states
(California, Utah, Washington and New York), and two foreign countries
(Vancouver, British Columbia, Canada and Cornwall, England). XXsys' composite
retrofit technologies is approved in 4 states (California, Nevada, Utah and
Washington) and pending in 3 more During the same period, the Company completed
four private sector building seismic retrofits.
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Prior to issuance of the Composite Specification in April 1996, the only
Caltrans-approved method of retrofitting publicly-owned bridge columns in the
State of California required the use of steel jackets or reinforced concrete.
However, following issuance of the Composite Specification, implementation by
Caltrans of the composite retrofit design for State retrofit work has been much
slower than expected by the Company. To date, only a very limited number of
projects designed for composite retrofits, have been advertised for bid. Given
the lack of implementation of the composite retrofit design in retrofit projects
offered for bid by the State agency, the Company has expressed its concerns to
Caltrans officials over the slow progress.
In response to the slow implementation of the Composite Specification by
Caltrans, the Company expanded into other geographic areas, as well as to add
complimentary products and services (see Licenses and Distribution Agreements).
The Company plans to continue focusing its marketing efforts on the planned
retrofitting of publicly owned bridge and building columns by demonstrating its
Robo-Wrapper(TM) technology in field applications.. There can be no assurance as
to when the Company can get a significant number of retrofit contracts following
these demonstration projects. The Company's strategy and plan of operations over
the next five years is to sell products and services related to its patented
machine wrap systems for columnar forms and the licensed hand-applied woven
fiber reinforcement systems for flat surfaces, and concrete repair products (See
"Licensing and Distribution Agreements").
RETROFIT OF BRIDGE COLUMNS--THE INFRASTRUCTURE PROBLEM
Published reports by the U.S. Department of Transportation have
indicated that approximately $35 billion a year is spent in the United States to
maintain the highway and bridge infrastructure. Conservative estimates indicate
that approximately $53 billion is necessary to maintain the highway and bridge
infrastructure in its current condition. An estimated 107,683(18%) of the
nation's 576,460 bridges are classified as structurally deficient. The primary
concerns are seismic safety and corrosive decay.
Subsequent to the collapse of numerous bridge structures during the 1971
San Fernando earthquake (magnitude 6.4 on the Richter scale) there has been an
increased awareness of the vulnerability of highway bridge support columns to
damage from earthquakes. This vulnerability was again demonstrated by the 1989
San Francisco earthquake with the collapse of the Cypress Viaduct of the Nimitz
Freeway, I-880 in Oakland, and the 1994 Los Angeles earthquake with the collapse
of numerous highways, including portions of the Santa Monica Freeway.
Particularly vulnerable are bridge structures designed and/or built prior to
1971, before the San Fernando earthquake prompted drastic revisions in the
seismic design code (which is still in use today).
While seismic risk is typically associated with California, it is of
concern throughout most of the United States. In 1990 the American Association
of State Highway and Transportation Officials adopted seismic design guide
specifications for the entire United States, recognizing the vulnerability of
the nation's bridge infrastructure to potential seismic activity along the West
Coast, the Midwest (New Madrid fault) and the Northeast. The seismic risk to
bridge structures differs from region to region due to different probable
earthquake magnitudes and recurrence periods as well as geological conditions,
but the unpredictable nature of seismic events and the vulnerability of the
majority of existing bridges necessitates the development and implementation of
innovative, fast, effective and economical retrofitting technologies to ensure
the safe and continued use of the nation's bridge infrastructure.
THE XXSYS TECHNOLOGY
The Company's product is applied using a patented Robo-Wrapper(TM)
machine and application process to wrap prepreg tow (carbon fiber which has been
pre-impregnated with resin) around the bridge column. Upon completion of the
wrapping process, a heat source is used to cure the resin in a controlled
environment. During the heating process, the liquid resin undergoes a chemical
reaction in which molecules crosslink, forming a solid which gives the product
its ultimate mechanical properties. Once the curing is complete, the column will
be painted with a chemical and UV resistant coating to complete the process.
COMMERCIAL OPERATIONS
The Company is transitioning from R & D into commercial operations (see
Management Discussion and Analysis). Technology is defined as a body of
knowledge, and in order for that body of knowledge to be "commercialized,"
technology/knowledge transfer must occur. This process of technology transfer
involves
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teaching, training of the existing customers and the workforce, as well as
problem solving, which are all long-term, ongoing processes necessary for
commercialization to be successful. In order to teach and train, the Company has
to perform initial prototype installations in demonstration projects so as to
package the technology for project delivery. Hence, the Company expects its
sources of retrofit revenues for the next year or two will be a combination of
construction services for prototype installation jobs and technology
demonstration projects in both the public and private sectors, and sales of
composite materials formulated for specific applications. The Company also
intends to pursue the formation of joint ventures and/or license its composite
technologies in overseas markets and earn revenues from such arrangements in the
form of license fees, royalties, sale of materials, equipment sale/lease and
training programs.
In May 1997 the Company announced that it was awarded a $551,000
subcontract to retrofit 176 spandrel columns of the Arroyo Seco Bridge on Route
134 in Pasadena, California. The Arroyo Seco Bridge is the first arch bridge to
be designated by Caltrans for retrofit with composite materials. However,
Caltrans delayed the project until structural tests could be performed at UCSD
to confirm the performance of the retrofit design. The structural tests were
completed, and on December 15, 1997, the Company began column preparation work
on the job site, and work continued into the second quarter of fiscal 1998. In
May 1998, a dispute arose between the Company, its prime contractor and Caltrans
regarding the quality and acceptability of the work performed to date and the
unilateral change order by Caltrans to eliminate the remaining two-thirds of the
columns to be wrapped. The Company had several meetings with Caltrans officials
to resolve these disputes over defects on workmanship versus specification
deficiency issues on the project, which included testimony from independent
professionals knowledgeable of composites used in retrofitting this project and
other bridge structures. Caltrans determined after such review meetings that
some of the work performed to date is acceptable, and some are subject to repair
with additional composite materials. The Company has submitted a repair plan for
Caltrans' approval. As of the date of this filing, there are a number of
technical issues regarding repair submittals that needed to be addressed before
the repair plan is approved by Caltrans. See "Management's Discussion and
Analysis of Plan of Operation" and Note 5 of the "Notes to Consolidated
Financial Statements."
In March 1998, XXsys teamed with British Columbia contracting firm to
complete a seismic retrofit contract in Vancouver, Canada for the Ministry of
Transportation and Highways. In April 1998, The Company demonstrated its bridge
strengthening technologies against truck impact damage to United Kingdom's
Highways Agency. In May 1998, the Company teamed with a California contractor to
complete a seismic retrofit and strengthening project for the columns, ceiling
slab and supporting beams of the City of Redondo Beach Parking Structure. In
July 1998, the Company demonstrated the ability to increase the strength of
severely corroded and aging bridges by over 20% in a full-scale destructive test
on the I-15 corridor in Salt Lake City. In August 1998, the Company completed a
corrosion damage repair demonstration for the New York State Department of
Transportation. The Company was awarded two sole source seismic retrofit
contracts in 1998 - one in the state of Washington announced in September 1998
and the other in Illinois, announced in October 1998. As of the date of filing,
the Company has completed public sector demonstration projects for four
states--California, Utah and Washington and New York, and two foreign countries.
Total bookings for the fiscal year 1998 were $915,000.
In the first two quarters of fiscal 1998, the Company, in collaboration
with Sho-Bond, began preparation of technical and sales literature. These
efforts included converting product specifications from JIS (Japan Industrial
Society) standards to ASTM (American Society of Testing and Materials)
standards, translating performance data from Japanese into English, creating
brochures and product labels in English, and obtaining permits and other
regulatory approvals for product importation. The Company began marketing and
sales efforts in the third quarter, and obtained its first sale of Sho-Bond
products in June of 1998. In fiscal 1998, the Company generated approximately
$32,000 of revenues from sales of Sho-Bond's products. In October 1998, the
Company procured its first licensee, distributor and value-added reseller to
use and sell Sho-Bond's concrete repair and restoration products and the
Company's retrofit technologies for the territory of Guam and Micronesia. The
Company intends to further its marketing efforts by direct sales to applicators
(value-added resellers), direct sales via the Internet and the establishment of
a network of distributors in targeted geographical areas. See "Licenses and
Distribution Agreements."
The Company's marketing mission is to educate those engineers,
contractors and government agencies involved in the retrofit industry on the
benefits of the Company's Robo-Wrapper(TM) and other composite retrofit
technology and to obtain a high degree of acceptance of its technology among
them. Since state and local government agencies strictly regulate building and
construction standards, it will be necessary for the Company to obtain
government approval in the various states for its Robo-Wrapper(TM) technology.
Retrofit contractors will also have to accept the technology and incorporate it
into their bid proposals. The Company intends to continue to find the
decision-makers, educate and communicate with them regarding the advantages of
retrofitting with composites, and then convince them to deploy these new
technologies in the rehabilitation of our aging infrastructure. Important
aspects of the Company's marketing strategy will be to develop and disseminate
educational materials for the various target groups through seminars and trade
shows that the Company attends, and to participate in the generation and
improvement of the Composite Specifications.
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The Company can give no predictions as to the amount of time that it
will take to obtain the various approvals of its technologies in each of the
states and their respective approval agencies. There is a substantial risk that
the contractors, engineers and government authorities directly involved in
highway retrofitting may not appreciate the benefits or recognize the potential
applications of the Company's technology. Market acceptance of the Company's
composite technology will depend largely upon the ability of the Company to
demonstrate to the industry the constructability, durability, field quality
assurance, and cost effectiveness of the technology when compared to the current
steel retrofit method, of which there can be no assurance. The Company does not
have the capital, bonding capacity, or expertise necessary to conduct
large-scale bridge column retrofit work. Consequently, the successful
commercialization of the Robo-Wrapper(TM) and other of the Company's composite
technologies may require that the Company enter into collaborative arrangements
with construction and engineering firms who will conduct the retrofit jobs
directly as either the prime or subcontractor. There can be no assurance that
the Company will be able to enter into such collaborative arrangements on terms
acceptable to the Company for such larger scale projects.
MANUFACTURING AND RAW MATERIALS
The Company designed the existing Robo-Wrapper(TM) and its curing system
and uses an original equipment manufacturer for the manufacture of
Robo-Wrapper(TM) and curing systems. To ensure confidentiality of trade secrets
the Company performs a small portion of the final assembly of the machines,
system integration, and quality assurance at the Company's facilities.
The Company believes that all of the raw materials used in the
installation of the Robo-Wrapper(TM) jackets are generally available in adequate
amounts and at competitive prices from multiple sources. The Company believes it
has good relations with these suppliers, including Fortifill Fibers Inc.,
Zoltec Inc., and Hexcel Corporation.
GOVERNMENT REGULATION
Because of use of advanced composite materials in civil engineering
projects is new and has not been extensively tested in many field applications,
the regulatory requirements governing such applications are uncertain and may be
subject to substantial review by various governmental and regulatory authorities
in the U.S. and foreign countries. This regulatory review may result in delays
in regulatory approval. Moreover, as the Company proceeds to market its
technologies for the application of advanced composite materials in civil
engineering projects other than government-owned bridges, state regulatory
bodies, such as the California Building Standards Commission, private regulatory
bodies, such as the International Conference of Building Officials, and other
entities which propose or administer building codes may also undertake
substantial regulatory review of the Company's technologies. Such governmental
or private regulatory review may result in the establishment of requirements,
which could adversely affect the Company's ability to test, manufacture or
market products.
COMPETITION
The principal competition to the Robo-Wrapper(TM) technology is the use
of steel jackets. Additionally, other companies, some of which have
substantially greater resources than the Company, have already been using
composites to retrofit private and publicly owned structures. If other companies
are allowed rely upon the Company's validation testing, the Company could face
additional composite-based competition sooner that expected. Additionally,
should any of the Company's pending patents be rejected, it could lose any
competitive advantage that patent protection affords.
RESEARCH AND DEVELOPMENT
Research and development expenses for the years ended September 30, 1998
and 1997 were $398,984, $485,397, respectively. These amounts represent direct
expenditures by the Company and do not include approximately $4 million of
federal and state grant funds paid directly to third parties, such as UCSD and
Hexcel, Inc. (formerly Hercules, Inc.), for purposes of developing and
validating the Robo-Wrapper(TM) technology.
The Company continues to participate in a $2.7 million program funded in
1995 by the U.S. Department of Commerce, National Institute of Standards and
Technology (NIST), which is scheduled for completion in March 1999. The purpose
of the NIST program has been to accelerate the commercialization of carbon
composite jacketing technology. The NIST program participants include: the
Company, which is responsible for developing the method for installing and
testing carbon based jackets and sensor and non-destructive testing technologies
for quality assurance and performance
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monitoring; Hexcel, Inc., which is responsible for developing a low cost prepreg
tow; and Trans Science Corporation, which is responsible for developing computer
software which will design the length and thickness of the jacked based on the
particular characteristics of the structure to be retrofitted. The Company
utilized its prior expertise in sensor and non-destructive testing ("NDE")
technologies to develop quality assurance and performance monitoring
technologies to increase user confidence in the carbon jacketing process,
thereby accelerating its commercial acceptance. Quality assurance technologies
include the monitoring of the resin impregnation process on the carbon fiber
manufacturing line to control resin content of the prepreg tow and ensure
consistency of the product made, and in situ cure monitoring technologies to
ensure the carbon composite jacket reaches the desired cure state during field
installation. Performance monitoring technologies include the measurement of
strain in the composite jacket over its service life, and particularly after
events like an earthquake, such that an informed decision can be made regarding
maintenance and repair of the jacket. The Company's share of the grant funds
received $661,702 totaled as of September 30, 1998, of which $124,643 relates to
fiscal year 1998.
INTELLECTUAL PROPERTY
On October 28, 1997, the U.S. Patent Office issued Patent Number
5,680,739 for the Company's computer-controlled, fully-automated retrofitting
machine, Robo-Wrapper(TM) and process which provides a fast, cost-effective
solution for seismic retrofit and corrosion rehabilitation of bridge and
building columns. On December 18, 1997, the U.S. Patent Office issued Patent
Number 5,694,734 for the Company's method of curing filament wound columns using
a radiant heater. On September 8, 1998 the U.S. Patent Office issued Patent
Number 5,804,725 for the Company's method of measuring the cure rate of a
curable material using an ultrasonic wire waveguide. In January 1999, the
Company paid the issue fees for its patent application filed on reinforcing a
vertical column with bands of a reinforcement material. The Company holds seven
other U.S. patents on its Ultrasonic Resin Analyzer technology. The Company also
filed two patent applications on a nuclear magnetic resonance technology for
measuring the resin content of a composite material. The Company also licensed
two pending patent applications from the University of California, San Diego,
one on the carbon shell concrete structures and the other on the retrofit and
repair of concrete and masonry walls with carbon overlay. All of these patent
applications are still pending.
The Company's business and future success are dependent on the
confidentiality of the technologies upon which it bases it product and services.
The Company relies upon a combination of patent and trade secrets to protect the
confidentiality of such information. In addition, the Company enters into
confidentiality agreements with all employees, consultants and agents and
restricts access to confidential information on a "need to know" basis. However,
there can be no assurance that if the Company's proprietary rights are violated,
the costs of litigation could be significant and could divert funds that would
otherwise have been available for other purposes. In addition, the Company's
industry is competitive and there can be no assurance that a competitor will not
bring an infringement claim against the Company. Moreover, potential litigation
concerning alleged violations of proprietary rights is inherently uncertain.
LICENSES AND DISTRIBUTION AGREEMENTS
The Company is one of three exclusive licensees able to commercialize
certain proprietary composite strengthening systems. These technologies are the
subject of pending patent applications, include certain minimum annual
royalties, and annual maintenance fees until the last patent expires.
On September 30, 1997, the Company signed an exclusive distribution
agreement with Sho-Bond Corporation of Japan to market and sell its complete
line of concrete repair and reinforcement products and technologies in the
United States and Canada. Sho-Bond is a recognized leader and specialist in the
Japanese repair and maintenance industry, with annual sales in excess of $720
million USD, and a publicly traded corporation on the Tokyo Stock Exchange.
Sho-Bond was the first to introduce epoxy-based adhesives into the civil
engineering and construction industry in Japan, in 1959. XXsys has commenced
marketing for one of the products and a method of concrete crack injection, BICS
(Balloon Injection for Concrete Structures), and its line of graffiti-proof
paint. Some of the Sho-Bond products will require federal and/or state approval
before they can be sold in the United States and Canada, a process that could
take from three to eighteen months (See "Government Regulation"). The
distribution agreement is for a five-year term after obtaining the necessary
approvals.
EMPLOYEES
At December 29, 1998, the Company had 13 full-time employees, of who one
was in construction and manufacturing operations, six in executive or
administrative positions, three engaged in engineering and research, two in
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technical marketing and sales, and one in maintenance. None of the Company's
employees is covered by a collective bargaining agreement. The Company believes
that its relations with its employees are good.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company leases approximately 14,000 square feet of office and
production facilities in San Diego, California. This space is utilized for the
Company's executive offices, research and development, sales and marketing, and
engineering activities, pursuant to two leases that extend to October 31, 1998,
($6,702 per month for 6,927 square feet and $5,600 per month for 7,100 square
feet). In January 1999, the Company renewed one of the leases for three years
and consolidated its facilities. Should additional facilities be required, the
Company believes that adequate space continues to be available in the San Diego
area.
ITEM 3. LEGAL PROCEEDINGS.
There are no pending legal proceedings to which the Company or any of
its officers and directors is a party or to which the property of the Company is
subject, other than routine litigation involving claims of immaterial amounts
arising during the normal course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to the Company's security holders in the
fourth quarter of fiscal 1998.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock has traded on the NASDAQ Small Cap Market
under the symbol XSYS following the Company's initial public offering on July
31, 1992. Effective November 27, 1998, NASDAQ formally notified the Company of
its failure to meet certain requirements to maintain its Small Cap Market
listing and granted the Company a temporary exception from the standards until
February 1, 1998. Effective close of business on January 11, 1999 the Company
ceased trading on the NASDAQ Small Cap Market and commenced trading on the OTC
Bulletin Board under the symbol XSYS. The table below sets forth the quarterly
high and low sales prices as reported on NASDAQ for the two years ended
September 30, 1998 and 1997.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
Year ended September 30, 1998:
First Quarter 1 5/8 9/16
Second Quarter 1 5/16 3/8
Third Quarter 15/16 7/16
Fourth Quarter 23/32 1/4
Year ended September 30, 1997:
First Quarter 4 5/16 2 5/8
Second Quarter 4 1/2 1 7/8
Third Quarter 4 7/32 2 3/8
Fourth Quarter 2 11/16 1 1/4
</TABLE>
On December 29, 1998, the closing price for the Company's Common Stock
was $0.125 per share. As of that date, the Company had 817 stockholders of
record and approximately 4,500 beneficial holders of stock.
The Company has not paid any dividends on its Common Stock and currently
intends to retain any earnings for use in its business; therefore, the Company
does not anticipate paying cash dividends in the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
This discussion contains forms of forward-looking statements that are
based on the Company's beliefs as well as assumptions made by and information
currently available to the Company. Such statements are subject to certain
risks, uncertainties and assumptions, which are identified and described herein
and in other of the Company's registration statements and periodic reports on
file with the Securities and Exchange Commission. Should one or more of these
risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results could vary from those anticipated, estimated, or
projected and the variation may be material.
The Company is engaged in developing and commercializing the use of
composite materials in infrastructure renewal markets and developing
technologies for sensors and quantitative nondestructive evaluation technologies
for quality assurance and performance monitoring of composite materials. Through
September 30, 1998, the Company has generated limited revenues and has incurred
significant losses, due primarily to extensive expenditures in research and
development of various technologies leading to new applications of composite
materials and sales and marketing expense of promoting these new applications.
The Company's independent auditors have included an explanatory
statement in their report to the Company's financial statements at September 30,
1998, that expresses substantial doubt as to the Company's ability to continue
as a going concern. There are several factors that must be considered risks in
that regard and those that are known to management are discussed in
"MD&A--Certain Trends and Uncertainties."
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Arroyo Seco Project
During fiscal 1997, the Company executed a subcontract with McCarthy
Brothers, who was under contract with the California Department of
Transportation (Caltrans), to install carbon composite casings on 174 columns on
the Arroyo Seco bridge in Pasadena, California for $551,000. In compliance with
contract requirements, the Company posted material payment and performance bonds
of $551,000 each underwritten by Great American Insurance Company (Great
American) and secured by a letter of credit and $551,000 of restricted
certificates of deposit. Caltrans issued a number of stop notices and work on
the project was delayed until December 15, 1997. Part of the delay was to allow
for structural tests to be performed at UCSD to confirm the performance of the
retrofit design. Work continued into the second quarter of fiscal 1998.
In May, a dispute arose between the Company, McCarthty Brothers and
Caltrans regarding the quality and acceptability of the work performed to date
and the unilateral change order by Caltrans to eliminate the remaining
two-thirds of the columns to be wrapped. The Company had several meetings with
Caltrans officials to resolve these disputes over defects on workmanship versus
specification deficiency issues on the project, which included testimony from
independent professionals knowledgeable of composites used in retrofitting this
project and other bridge structures. Caltrans determined after such review
meetings that some of the work performed to date is acceptable, and some are
subject to repair with additional composite materials. The Company has submitted
a repair plan for Caltrans' approval. As of the date of this filing, there are a
number of technical issues regarding repair submittals that needed to be
addressed before the repair plan is approved by Caltrans. As a result of the
stop notices and change orders issued by Caltrans, the Company incurred time and
material charges well in excess of the original contract amount. The Company has
filed with Caltrans a number of notices of potential claims for the additional
work and damages caused by Caltrans' delays. It is not possible to predict the
outcome of these claims, and there can be no assurance that the Company will
collect all of its receivables, or recover its claims for damages. Meanwhile,
Great American has paid vendor claims against the material payment bond totaling
$242,476 and has drawn on the letter of credit to recover these costs.
RESULTS OF OPERATIONS
Revenues for the fiscal year ended September 30, 1998, were $1,365,955
compared to $650,520 in the prior fiscal year, an increase of $715,435 or 110%,
principally resulting from several construction contacts, the largest of which,
Arroyo Seco, is discussed above. Other major projects included retrofit of
bridges in Washington state and California and a privately owned parking
structure in Redondo Beach, California. Government funded research in fiscal
1998 represented $124,047 or 9% of revenues for the year.
Total operating expenses decreased by $494,335, or 9% in fiscal 1998 to
$4,796,193. The cost of revenues was $1,359,669, or 99.5% of contract revenues.
In comparison, the cost of services in fiscal 1997 was $730,093, or 112% of
contract revenues. Selling, general and administrative expenses were $3,037,540
in fiscal 1998, a decrease of $1,037,498 or 25% from fiscal 1997. Expense
reductions include salaries, consulting, investor relations, travel,
professional services and business development, all of which were curtailed due
to lack of funds. Research and development costs decreased in fiscal 1998, to
$398,984 from $485,397 in the prior year, or 18%.
Other income of $874,955 includes a receipt of payment in October, 1998
of $500,000 for settlement of the Company's entitlement to receive up to
$350,000 per year of products or services from Cytec Industries, Inc. (Cytec)
over the next three years. This entitlement arose as part of the settlement of
earlier litigation with a composite material company, subsequently acquired by
Cytec, whose liability for this entitlement was assumed by Cytec as part of the
acquisition. Other income also includes receipt of payments as part of a
consulting fee arrangement with a composite materials company. The consulting
fee was higher by $56,529 over the comparable period in 1997 due to final
settlement of a dispute with the former president over rights to the fee and
other matters. Interest income of $57,758 in fiscal 1998 was 1% lower than in
the prior year. The higher interest earned in the prior year was from interest
earned on cash received from a legal settlement and from the sale of common
stock. Interest expense decreased 18% to $8,182 in 1998 as the Company had a
significant reduction in its average borrowings.
The net loss for the year ended September 30, 1998, was $2,505,666
compared to $4,162,131 in the prior year, a decrease of $1,656,465 or 40%. The
loss per share in fiscal 1998 was $0.25, compared to the loss per share of $0.53
in fiscal 1997. The lower losses were primarily the result of lower business
development and marketing expenses as the Company launched its new products and
technology.
9
<PAGE> 10
Liquidity and Capital Resources
The Company operated with modest cash resources in 1998, as it did in
1997. In order to meet all of its operating expenses in 1998, the Company relied
heavily on the sale of common stock for additional funds. Last year, in early
January 1998, the Company had estimated that it would require approximately $5.5
million for the purchase of machines and for working capital. Net cash received
from the sale of common stock in fiscal 1998 was $1,592,101, including $366,000
of stock subscriptions receivable as of September 30, 1997.
The Company had current assets of $2,267,280 as of September 30, 1998,
representing an increase of $601,005 over the prior fiscal year ended September
30, 1997. Funds raised by the Company have been necessary to construct
Robo-Wrapper(TM) equipment, establish collateral for material payment and
performance bonds, and support business development activities intended to help
generate revenues in the future. Net cash used in operating activities of
$1,533,767 and $189,709 in investing activities was funded by $1,689,630 in
financing activities. Financing activities included the receipt of $1,592,101
from the sale of common stock which included $366,000 in stock subscription
receivables as of September 30, 1997. As of September 30, 1998, current assets
were comprised of trade accounts receivable of $1,481,057, restricted cash funds
used for letters of credit totaling $551,000, inventories and work in progress
of $111,735 and other prepaid expenses of $123,488. The Company's current
liabilities as of September 30, 1998, were $2,762,568. The Company had negative
working capital of $495,288 as of the same date, which represents a decline of
$1,051,674 compared with the working capital position at September 30, 1997.
The Company intends to sell additional stock as the primary means to
support critical working capital requirements. On December 30, 1997, the Company
signed agreements for two outside investors to purchase restricted Common Stock
under Regulation D aggregating $3,000,000. The shares were to be purchased from
December 30, 1997, through September 30, 1998. The Company is currently working
to extend these agreements; however, there can be no assurance that these
agreements will in fact be extended. The Company is in the process of finalizing
a private placement offering circular for up to 1,000,000 shares of 7%
Convertible Preferred Series B Stock at $3.00 per share. No shares have been
issued under the offering and there are no commitments to purchase the stock.
Also, the Company intends to pursue licensing technologies, bridge loans and
lease of equipment as a financing alternative, however there can be no
assurances that any such financings can be obtained. Further, there can be no
assurance that the Company will be able to obtain all the capital it needs for
the coming fiscal year.
The Company will need substantial additional funds before it can expect
to realize additional new significant product backlog and revenue. The Company
projects that at its current rate of spending and for its current activities,
its existing cash funds will enable the Company to maintain its present
operations into the second quarter of fiscal 1999. In addition, certain parties
with whom the Company has agreements have claimed default and, should the
Company be obligated to pay these claims or should the Company engage legal
services to defend or negotiate its positions or both, its ability to continue
operations could be significantly reduced or shortened. See "MD&A--Certain
Trends and Uncertainties--Need for Additional Funds; Risk of Insolvency."
Certain Trends and Uncertainties
In addition to the other information contained in this Annual Report on
Form 10-KSB, the following factors should be considered carefully.
Need for Additional Funds; Risk of Insolvency
The Company's operations to date have consumed substantial amounts of
cash. The Company's auditors have included an explanatory paragraph in their
opinion with respect to the Company's ability to continue as a going concern.
See "Report of Feldman Sherb Ehrlich & Co., LLP, Independent Auditors" and
"MD&A--Liquidity and Capital Resources." The Company will need to raise
substantial additional funds to continue operations in order to continue its
efforts to commercialize its technology and create new additional backlog and
sales. The Company intends to seek additional funding through public or private
financings, including equity financings and other financings. Adequate funds for
these purposes, whether obtained through financial markets or other arrangements
with partners or from other sources, may not be available when needed or on
terms acceptable to the Company. Insufficient funds may require the Company: to
delay, scale back or eliminate some or all of its research and product
development programs; to license third parties to commercialize products or
technologies that the Company would otherwise seek to develop itself; to sell
itself to a third party; to cease operations; or to declare bankruptcy.
10
<PAGE> 11
Loss History; Uncertainty of Future Profitability
The Company has been unprofitable to date and continues to be
unprofitable, incurring substantial operating losses associated with research
and development activities. The Company had no significant revenues in its first
fiscal quarter of 1999. From the period since its inception to September 30,
1998, the Company has incurred a cumulative net loss of $19.6 million. The
Company has experienced significant quarterly fluctuations in operating results
and expects that these fluctuations in revenues, expenses and losses will
continue. The Company's independent auditors have included an explanatory
paragraph in their report to the Company's financial statements at September 30,
1998, which paragraph expresses substantial doubt as to the Company's ability to
continue as a going concern. See "Report of Feldman Sherb Ehrlich & Co., LLP,
Independent Auditors" and "MD&A--Certain Trends and Uncertainties--Need for
Additional Funds; Risk of Insolvency."
Limited Availability of Net Operating Loss Carry Forwards
At September 30, 1998, the Company has federal and state net operating
loss carryforwards of approximately $18,700,000 and $9,400,000, respectively.
These tax loss carryforwards will begin expiring in 2001 unless previously
utilized. Certain restrictions imposed by Section 382 of the Internal Revenue
Code may limit the utilization of the loss carryforwards. In addition, because
of the decrease in value of the Company's stock, present and future ownership
changes may have a material adverse impact on the Company's ability to utilize
these carryforwards.
Dividends
The Company has never paid cash dividends on its Common Stock and does
not anticipate paying any such dividends in the foreseeable future. The Company
currently intends to retain its earnings, if any, after payment of dividends on
outstanding shares of Preferred Stock, for the development of its business.
Impact of Year 2000
Some older computer programs were written using two digits rather than
four to define the applicable year. As a result, those computer programs have
time sensitive software that recognizes a date using 00 as the year 1900 rather
than the year 2000 (the "Year 2000 Issue"). This could cause a system failure or
miscalculations causing disruption of operations, including a temporary
inability to process transactions or engage in similar normal business
activities.
The Company is assessing whether it will have to modify or replace
portions of its software so that its computer systems will function properly
with respect to dates in the year 2000 and thereafter. The total year 2000
project cost to the Company is not expected to be material. The year 2000
project is expected to be completed not later than June 30, 1999, which is prior
to any anticipated impact on its operating systems. The Company believes the
Year 2000 Issue will not pose significant operational problems for its computer
systems.
The Company intends to initiate formal communications with all of its
significant suppliers to determine the extent to which the Company's interface
systems are vulnerable to those third parties' failure to remediate their own
Year 2000 Issues. There is no assurance that the systems of other companies on
which the Company's systems rely will be timely converted and will not have a
material adverse effect on the Company's systems. The costs of the project and
the date on which the Company believes it will complete the year 2000
modifications are based on management's best estimates, which were derived using
numerous assumptions of future events, including the continued availability of
certain resources and other factors. However, there can be no assurance that
these estimates will be achieved and actual results could differ materially from
those anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, and
similar uncertainties.
Impact of Inflation
Inflation has not had any significant effect on the Company's operating
costs.
11
<PAGE> 12
ITEM 7. FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report 13
Consolidated Balance Sheet at September 30, 1998 14
Consolidated Statements of Operations for the years ended 15
September 30, 1998 and 1997
Consolidated Statements of Stockholders' Equity for the two 16
years ended September 30, 1998
Consolidated Statements of Cash Flows for the years ended 17
September 30, 1998 and 1997
Notes to Consolidated Financial Statements 18
</TABLE>
12
<PAGE> 13
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
XXsys Technologies, Inc.
We have audited the accompanying consolidated balance sheet of XXsys
Technologies, Inc. and subsidiaries as of September 30, 1998 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the two years ended September 30, 1998. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of XXsys
Technologies, Inc. and subsidiaries as of September 30, 1998, and the
consolidated results of its operations and cash flows for each of the two years
ended September 30, 1998, 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 discussed in Note 1 to the
consolidated financial statements, the Company has incurred substantial losses
since inception. Additionally, the Company has a working capital deficiency of
approximately $495,000 at September 30, 1998. These conditions raise substantial
doubt about the Company's ability to continue as a going concern. Management's
plans with respect to these matters are also described on Note 1 to the
financial statements. The accompanying financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ Feldman Sherb Ehrlich & Co., P.C.
----------------------------------------
Feldman Sherb Ehrlich & Co., P.C.
Certified Public Accountants
New York, New York
January 8, 1999
13
<PAGE> 14
XXSYS TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEET
AS OF SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
ASSETS
<S> <C>
Current Assets:
Restricted certificates of deposit $ 551,000
Accounts receivable 1,481,057
Inventories 111,735
Prepaid expenses and other 123,488
------------
Total current assets 2,267,280
Machinery, equipment and furniture, net of
accumulated depreciation of $1,077,378 1,429,497
Deferred costs 4,219
Licenses and patents, net of amortization of $169,949 279,605
------------
Total assets $ 3,980,601
============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,861,376
Accrued compensation 63,857
Accrued liabilities 557,103
Related party accrued expenses and notes payables 182,192
Current portion, long-term debt 98,040
------------
Total current liabilities 2,762,568
------------
Long-term debt, less current portion 40,858
------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, par value $100; Shares authorized -- 2,000,000;
Issued and outstanding - 500; (liquidation preference -- $50,000) 50,000
Common stock, no par value; Shares authorized -- 20,000,000;
Issued and outstanding -- 12,640,351 21,205,253
Accumulated deficit (19,653,914)
Note receivable for preferred stock (272,925)
Deferred compensation (151,239)
------------
Total stockholders' equity 1,177,175
------------
Total liabilities and shareholders' equity $ 3,980,601
============
</TABLE>
See accompanying notes.
14
<PAGE> 15
XXSYS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
1998 1999
------------ ----------
<S> <C> <C>
Contract revenues $ 1,365,955 $ 650,520
Operating expenses:
Cost of services 1,359,669 730,093
Selling, general and administrative 3,037,540 4,075,038
Research and development 398,984 485,397
------------ -----------
Total operating expenses 4,796,193 5,290,528
============ ===========
Operating loss
(3,430,238) (4,640,008)
Interest income 57,759 58,457
Other income 874,995 429,349
Interest expense (8,182) (9,929)
------------ -----------
Net loss $ (2,505,666) $(4,162,131)
============ ===========
Basic net loss per share $ (0.25) $ (0.53)
============ ===========
Weighted average number of shares outstanding 10,099,818 7,815,522
============ ===========
</TABLE>
See accompanying notes.
15
<PAGE> 16
XXSYS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
TWO YEARS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
NOTES TOTAL
PREFERRED COMMON STOCK RECEIVABLE ACCUMULATED DEFERRED STOCKHOLDERS'
STOCK SHARES AMOUNT FOR STOCK DEFICIT COMPENSATION EQUITY
----- ------ ------ --------- ------- ------------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at October 1, 1996 $ 450,000 7,270,101 $15,099,537 $(499,888) $(12,986,117) $ -- $ 2,063,532
Decrease in interest receivable on 164,048 164,048
notes
Exercise of warrants 31,250 25,000 25,000
Sale of common stock 2,054,759 4,116,000 4,116,000
Stock issued for services 3,261 9,725 9,725
Stock issued for guarantee 3,000 11,790 11,790
Net loss (4,162,131) (4,162,131)
----------- ---------- ----------- --------- ------------ --------- -----------
Balances at September 30, 1997 $ 450,000 9,362,371 $19,262,052 $(335,840) $(17,148,248) $ -- $ 2,227,964
Sale of common stock 2,607,980 1,226,101 1,226,101
Stock issued for services and licenses 350,000 317,100 (196,800) 120,300
Increase in interest receivable on (27,766) (27,766)
notes
Reduction of note 90,681 90,681
Conversion of preferred to common (400,000) 320,000 400,000 --
Amortization of deferred compensation 45,561 45,561
Net loss (2,505,666) (2,505,666)
----------- ---------- ----------- --------- ------------ ---------- -----------
Balances at September 30, 1998 $ 50,000 12,640,351 $21,205,253 $(272,925) $(19,653,914) $(151,239) $ 1,177,175
=========== ========== ============ ========= ============ ========= ===========
</TABLE>
See accompanying notes
16
<PAGE> 17
XXSYS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss $(2,505,666) $(4,162,131)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization 338,935 385,038
Non-cash compensation 45,561 9,725
Accrued interest income -- (47,104)
Changes in assets and liabilities:
Restricted certificates of deposit -- (551,000)
Accounts receivable (976,413) (411,490)
Cash in escrow -- 175,000
Inventories (31,239) (61,016)
Prepaid expenses 6,801 (40,322)
Accounts payable 1,247,564 288,988
Accrued liabilities and other 268,892 220,531
Related party accrued expenses 71,798 28,683
----------- -----------
Net cash used in operating activities (1,533,767) (4,165,098)
Cash flows from investing activities:
Purchase of machinery and equipment (131,751) (933,779)
Deferred acquisition costs -- (80,563)
Other assets (57,958) (105,706)
----------- -----------
Net cash used in investing activities (189,709) (1,120,048)
Cash flows from financing activities:
Sales of common stock 1,592,101 5,075,933
Exercise of warrants and stock options -- 25,000
Stock issued for guarantee -- 11,290
Issuance of other notes payable 124,062 117,852
Repayment of notes payable (26,533) (96,072)
----------- -----------
Net cash from financing activities 1,689,630 5,134,503
Net decrease in cash (33,846) (150,643)
Cash and cash equivalents at beginning of year 33,846 184,489
----------- -----------
Cash and cash equivalents at end of year $ -- $ 33,846
=========== ===========
Supplemental information:
Cash interest paid $ 7,862 $ 9,929
Stock issued for services $ 196,800 $ 9,725
Stock issued for licenses $ 120,300 $ --
Reduction of notes receivable for preferred stock $ 90,681 $ --
</TABLE>
See accompanying notes.
17
<PAGE> 18
XXSYS TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Business. XXsys Technologies, Inc. (the "Company") was organized under the
laws of the State of California on November 19, 1985, to develop non-destructive
testing and measurement techniques for advance materials in the defense
industry. The Company's primary business focus is to use its proprietary
retrofit and rehabilitation processes to upgrade aging bridges, buildings and
other structures by wrapping the structural elements with composite materials.
Basis of Presentation. The accompanying financial statements have been
prepared assuming that the Company will continue as a going concern. However,
the Company has had substantial losses since inception and management expects
that they will continue for the foreseeable future. Additionally, the Company
has a working capital deficiency of approximately $495,000 at September 30,
1998. These conditions raise substantial doubt about the Company's ability to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
The Company is actively seeking additional equity financing and other
financing arrangements with potential partners and other sources. The Company is
in the process of finalizing an offering circular for up to 1,000,000 shares of
7% Convertible Preferred Series B Stock at $3.00 per share. No shares have been
issued under the offering and there are no commitments to purchase the stock.
There can be no assurance that any such financing arrangements or other sources
of funding will be available on favorable terms, if at all.
Consolidation. The consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries, Composite Retrofit Corporation
and TransRez Technologies Inc. All intercompany accounts have been eliminated in
consolidation.
Cash and Cash Equivalents. Cash and cash equivalents consist of investments
with an original maturity of three months or less.
Inventory. Inventory is stated at the lower of cost or market using the
first-in, first-out method of inventory valuation
Machinery, Equipment and Furniture. Machinery, equipment and furniture are
stated at cost and are being depreciated on a straight-line basis over estimated
useful lives of three to five years.
Licenses and patents. Costs incurred in obtaining technology licenses and
patents are amortized over 5 years.
Revenue Recognition. The Company's revenues from construction contracts
have been recognized on the basis of completion milestones under terms of the
contracts. Revenues from research contracts are based on cost reimbursement
and/or shipment of deliverables as specified under the terms of the contracts.
Research and Development. Research and development costs are expensed as
incurred.
Income Taxes. The Company recognizes deferred tax assets and liabilities
based on the difference between the financial statements carrying amount and the
tax basis of assets and liabilities. Net operating losses may be carried forward
to offset future taxable income of the Company.
Major Customers. In 1998, four major customers accounted for 47%, 12% 11%
and 10% of 1998 revenues. In 1997, three major customers accounted for 40%, 22%,
and 15% of revenues.
Net Loss Per Share. The Company has adopted Statement of Financial
Accounting Standard No. 128, "Earnings Per Share;" specifying the computation,
presentation, and disclosure requirements of earnings per share information.
Basic earnings per share has been calculated based upon the weighted average
number of shares of common
18
<PAGE> 19
stock outstanding. Conversion of preferred stock and exercise of stock options
have been excluded, as the effect of their inclusion would be anti-dilutive.
There is no effect on loss per share information for the year ended September
30, 1997 related to the adoption of this standard.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the 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.
Fair Value of Financial Instruments. The carrying amounts reported in the
balance sheet for cash, trade receivables, accounts payable and accrued expenses
approximate fair value based on the short-term maturity of these instruments.
Impairment of Long-lived Assets. The Company reviews long-lived assets for
impairment whenever the circumstances and situations change such that there is
an indication that the carrying amounts may not be recovered. At September 30,
1998, the Company believes that there has been no impairment of its long-lived
assets.
Accounting for Stock Options and Stock Based Compensation. The Company
accounts for its stock option plans under APB Opinion No. 25, "Accounting for
Stock Issued to Employees," under which no compensation expense is recognized.
In accordance with Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," the Company has adopted the pro forma
disclosure requirements of Statement No. 123.
For disclosure purposes the fair value of each stock option grant is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted average assumptions used for stock options granted during
both years ended September 30, 1998 and 1997: annual dividends of $0.00,
expected volatility of 50%, risk-free interest rate of 5.7%, and expected life
of five years. The weighted-average fair value of the stock options granted
during the year ended September 30, 1997 was $1.49. No options were granted
during the year ended September 30, 1998. If the Company recognized compensation
cost for these plans in accordance with SFAS No. 123, the Company's pro forma
net loss and loss per share would have been $2.66 million and $.26 in 1998 and
$4.27 million $0.55 in 1997.
2. FINANCING ARRANGEMENTS
Long-term debt at September 30, 1998 consists of the following:
<TABLE>
<S> <C>
Equipment financing -- computers, printers $ 10,668
Equipment financing -- copiers 55,737
Financing of truck 28,770
Pre-paid insurance financing 43,723
--------
138,898
Less current portion 98,040
--------
$ 40,858
========
</TABLE>
4. RELATED PARTY TRANSACTIONS
Related party accrued expenses consist of salaries, severance and vacation
pay due to the Company's Chairman. See also, Preferred Stock, Note 7, for
additional transactions with the Chairman.
In September 1998, two family members of the Chairman advanced $124,062 to
the Company. These amounts have been recorded as current liabilities. These
advances are to be consummated into formalized notes payable on demand with
market interest rates.
5. COMMITMENTS AND CONTINGENCIES
Arroyo Seco Project
During fiscal 1997, the Company executed a subcontract with McCarthy
Brothers, who was under contract with the California Department of
Transportation (Caltrans), to install carbon composite casings on
19
<PAGE> 20
174 columns on the Arroyo Seco bridge in Pasadena, California for $551,000. In
compliance with contract requirements, the Company posted material payment and
performance bonds of $551,000 each underwritten by Great American Insurance
Company (Great American) and secured by a letter of credit and $551,000 of
restricted certificates of deposit. Caltrans issued a number of stop notices and
work on the project was delayed until December 15, 1997. Part of the delay was
to allow for structural tests to be performed at UCSD to confirm the performance
of the retrofit design. Work continued into the second quarter of fiscal 1998.
In May, a dispute arose between the Company, McCarthty Brothers and
Caltrans regarding the quality and acceptability of the work performed to date
and the unilateral change order by Caltrans to eliminate the remaining
two-thirds of the columns to be wrapped. The Company had several meetings with
Caltrans officials to resolve these disputes over defects on workmanship versus
specification deficiency issues on the project, which included testimony from
independent professionals knowledgeable of composites used in retrofitting this
project and other bridge structures. Caltrans determined after such review
meetings that some of the work performed to date is acceptable, and some are
subject to repair with additional composite materials. The Company has submitted
a repair plan for Caltrans' approval. As of the date of this filing, there are a
number of technical issues regarding repair submittals that needed to be
addressed before the repair plan is approved by Caltrans. As a result of the
stop notices and change orders issued by Caltrans, the Company incurred time and
material charges well in excess of the original contract amount. The Company has
filed with Caltrans a number of notices of potential claims for the additional
work and damages caused by Caltrans' delays. It is not possible to predict the
outcome of these claims, and there can be no assurance that the Company will
collect all of its receivables, or recover its claims for damages. Meanwhile,
Great American has paid vendor claims against the material payment bond totaling
$242,476 and has drawn on the letter of credit to recover these costs.
Consulting Agreements
On April 15, 1998, the Company entered into a two-year consulting agreement
with Continental Capital & Equity Corporation (CCEC), a public relations and
direct marketing advertising firm located in Longwood, Florida, specializing in
the dissemination of information about publicly traded companies. As part of the
agreement, CCEC would publicize the Company to brokers, prospective investors
and shareholders, including preparation and mailing of corporate information
about the Company and field calls from firms, investors and brokers inquiring
about the Company. In consideration of the services to be performed by CCEC,
300,000 shares of freely trading Common Stock were issued and placed into
escrow, subject to certain repurchase options by the Company which have expired
at the time of this filing. Additionally, the Company will issue CCEC an option
to purchase an additional 50,000 shares at $2.00 per share and 50,000 shares at
$3.00 per share upon meeting certain market trading price per share performance
milestones. (See Note 6 "Shareholders' Equity").
Leases
The Company leases its office facilities pursuant to two leases that extend
to October 31, 1998. The remaining rent commitment at September 30, 1998 is
$12,300. Rent expense was $194,209 in fiscal year 1998 and $141,654 in 1997. On
March 1, 1997, the Company signed a lease for an apartment in San Diego for use
by its employees and consultants, for the purposes of reducing hotel bills for
employees and consultants who have residences outside of the San Diego area and
who travel extensively to San Diego. This lease terminated in fiscal 1998. In
September 1998, the Company entered into another San Diego apartment rental
agreement for $800 a month on a month-to-month basis. On April 18, 1997, the
Company signed a lease for an apartment in Washington, D.C. The Washington
apartment rents for $1,175 a month and expires in January 1999, for a remaining
rent commitment at September 30, 1998, of $4,700.
Capital Equipment
On April 14, 1997, the Company signed a construction contract for $501,138
to design and build a second-generation Robo-Wrapper(TM). As of September 30,
1998, the Company still owed $140,500 on the contract The machine successfully
passed performance tests in the third fiscal quarter of 1998. Delivery is
contingent on the Company's ability to secure funding to make the remaining
payments to the machine manufacturer.
6. STOCKHOLDERS' EQUITY
Preferred Stock:
20
<PAGE> 21
In May 1994 the Company sold to the brother of Gloria C. L. Ma, an officer
and director of the Company, in a private transaction 4,500 shares of Series A
Preferred Stock in exchange for the assignment of a non-recourse promissory note
made by Dr. Ma in the principal amount of $450,000, plus $198,750 of accrued
interest, secured by a second deed of trust on real property. The non-recourse
promissory note has an interest rate of 10% per annum and is due in January
1999, including accrued interest. Each preferred share has a liquidation
preference of $100, is redeemable at the Company's option at a price of $120 per
share, and is convertible at any time into 80 shares of the Company's common
stock. On March 19, 1998 the holder of the Company's $100 par value Series A
preferred stock exercised his right to convert 4,000 shares into 320,000 shares
of common stock at $1.25 per share.
On May 12, 1998 Dr. Ma reduced a note and accrued interest payable to the
Company by $90,681 by relinquishing her rights to certain deferred salaries and
accrued vacation. The remaining balance due under the note of $272,925 at
September 30, 1998 and is reported as a contra-equity account. Of the amount
paid on the note by Dr. Ma in May 1998, $55,056 was first applied to accrued
interest payable and the remaining amount of $35,625 was applied to reduction in
principal on the note.
Warrants:
During fiscal 1998, warrants to purchase 220,000 shares of common stock
were issued, and warrants to purchase 203,750 shares expired. On June 1, 1998
the Company issued a three-year warrant to a law firm to purchase 20,000 shares
of common stock at fair market value on date of grant. On July 10, 1998, the
Company issued a two-year warrant for a consultant to assist in debt financing
to purchase 200,000 shares or the pro-rata share at 10% of the dollar amount of
financing raised at $1.00 a share or the bid price on July 10, 1998. The
agreement had a performance period of 60 days from July 10, 1998 and has
expired.
Total warrants issued in connection with services, stock sales and debt
extensions, as well as warrants exercised, are shown in the following table. The
balance of warrants outstanding at September 30, 1998 expire on various dates
ranging from September 11, 2000 to June 23, 2002.
<TABLE>
<CAPTION>
COMMON PRICE PER
SHARES SHARE
------ ---------
<S> <C> <C> <C>
Balance -- September 30, 1996 1,949,353 $0.25 - $6.00
Warrants issued for services 25,000 $4.19
Warrants issued with debt 45,000 $2.63 - $3.93
Warrants expired (280,000) $3.00 - $5.40
Warrants exercised (31,250) $0.80
---------
Balance -- September 30, 1997 1,708,103 $0.25 - $6.00
Warrants issued for services 220,000 $0.46
Warrants expired (203,750) $0.46 - 2.50
---------
Balance -- September 30, 1998 1,724,353 $0.25 - $6.00
========= =============
</TABLE>
Common Stock:
During the fiscal year ended September 30, 1998, the Company received cash
in the amount of $559,067 from an individual for 1,091,130 shares of restricted
common stock in private placements under Regulation S, for an average price of
$0.55. Of the total received, $190,000 was reported as a subscription receivable
at September 30, 1997. Also during the year, $667,034 was received from two
individuals for 1,516,850 shares of restricted common stock under private
placements under regulation D, for an average common stock share price of $0.44.
On March 19, 1998 the holder of the Company's $100 par value Series A
preferred stock exercised his right to convert 4,000 shares into 320,000 shares
of common stock at $1.25 per share.
On June 1, 1998 the Company issued 50,000 shares of common stock as partial
payment of license issue costs for two licenses. The shares have been valued at
$120,300 or $2.406 per share, based on the negotiated number of shares of common
stock of the Company at the share price on the date of signing the agreement in
June 1997.
21
<PAGE> 22
On June 24, 1998 the Company issued 300,000 shares of common stock in
connection with a consulting agreement. The 300,000 shares have been valued at
$196,800 or $0.656 per share, which was the price of the stock on April 15,
1998, the effective date of the agreement. Additionally, the Company will issue
CCEC an option to purchase an additional 50,000 shares at $2.00 per share and
50,000 shares at $3.00 per share upon meeting certain market trading price per
share performance milestones. All common stock issued is to be held in escrow
for a specific period of time and is subject to repurchase by the Company at
designated prices for a limited period after issuance.
On October 13, 1998 the Company filed a registration statement under Form
S-8 for purposes of registering 1,433,422 shares of common stock issuable upon
exercise of outstanding options or in consideration of services rendered. In
October 1998, the Company issued 1,433,422 shares of common stock in
consideration of services rendered at the deemed average value of $0.40 per
share.
7. STOCK OPTIONS
A total of 550,000 shares of common stock are reserved for issuance upon
the exercise of options to be granted pursuant to the Company's 1991 Stock
Option Plan and 1,000,000 shares for issuance under the 1996 Stock Option Plan.
Options may be granted to officers, directors and employees. Transactions in the
various plans are summarized below:
<TABLE>
<CAPTION>
OPTIONS
AVAILABLE GRANTED PRICE
FOR GRANT OPTIONS PER SHARE
--------- ------- -----------
<S> <C> <C> <C>
1991 STOCK OPTION PLAN
Balance at September 30, 1996 -- 550,000 $0.75-$5.18
Granted (20,000) 20,000 $2.44
Canceled 99,000 (99,000) $3.75-$5.18
------- -------
Balance at September 30, 1997 79,000 471,000 $0.75-$5.00
Granted -- -- --
Canceled 135,000 (135,000) $3.50-$5.18
------- -------
Balance at September 30, 1998 214,000 336,000 $0.75-$5.00
1996 STOCK OPTION PLAN
Balance at September 30, 1996 970,000 30,000 $3.63
Granted (583,500) 583,500 $1.56-$4.31
Canceled 196,000 (196,000) $2.50-$5.38
------- -------
Balance at September 30, 1997 582,500 417,500 $1.56-$4.19
Granted -- -- --
Canceled 187,500 (187,500) $1.31-$5.38
------- -------
Balance at September 30, 1998 770,000 230,000 $1.56-$4.13
======= ======= ===========
</TABLE>
22
<PAGE> 23
8. INCOME TAXES
A reconciliation between the federal statutory rate and the effective
income tax rate for the years ended September 30, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Tax rate 34% 34%
Losses for which no benefit is provided (34%) (34%)
---- ----
Effective income tax rate 0% 0%
==== ====
</TABLE>
As of September 30, 1998 the Company had net operating loss carryforwards of
approximately $18,800,000 for federal income tax purposes expiring from 2001
through 2018. The resulting deferred tax asset of approximately $6,400,000 has
been offset by a corresponding valuation allowance.
9. OTHER INCOME
Other income of $874,955 represents the net effect of the Company's receipt
of payment of $374,995 of a final consulting fee from a composite materials
company through June 1998, and a $500,000 payment received in October, 1998 for
final settlement of the Company's entitlement to receive up to $350,000 per year
of products or services from Cytec Industries, Inc. (Cytec) over the next three
years. This entitlement arose as part of the settlement of earlier litigation
with a company, subsequently acquired by Cytec, whose liability for this
entitlement was assumed by Cytec as part of the acquisition.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
23
<PAGE> 24
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT.
<TABLE>
<CAPTION>
NAME AGE POSITION
<S> <C> <C>
Gloria C. L. Ma, Ph.D. 50 Chairman, Chief Executive Officer and Chief Financial
Officer (Chief Accounting Officer)
Lawrence D. Cercone, Ph.D. 54 Vice President Engineering
William J. Dale 65 Director of the Company
David B. Abrams 33 Director of the Company
</TABLE>
DR. MA is co-founder of the Company and served as President or Chairman
from its inception in 1985 to September 1991, Executive Vice President from
September 1991 to July 1994, and thereafter as Chairman. She resumed the
position of Chief Executive Officer in April 1995. Before founding the Company,
Dr. Ma was President of Zealot & Company, Ltd., a privately held investment
company in Hong Kong. She received undergraduate and masters degrees in genetics
from McGill University (Montreal) and a Ph.D. degree in molecular biology from
the University of California, San Diego. She is a member of the Board of
Directors for the American Road and Transportation Builders Association (ARTBA),
International Road Federation (IRF), Civil Engineering Research Foundation
(CERF), California Chamber of Commerce and the San Diego Economic Development
Corporation. Other memberships include the President's Council on
Competitiveness, the Board of Overseers to the Chancellor of the University of
California, San Diego, and the San Diego Technology Council.
DR. CERCONE was appointed Vice President of Engineering in August 1994. In
April 1997, Dr. Cercone was named a finalist for Technical Innovator of the
Year, Transportation and Automotive category, by Discover Magazine. From 1989 to
1994 he was an adjunct professor at the University of Wyoming. From 1984 to 1989
Dr. Cercone owned an engineering firm specializing in the design and manufacture
of machinery used in the manufacture and treatment of composites. Prior to that,
Ciba Composite, Celanese Corp. and Stauffer Chemical employed him. Dr. Cercone
has a Ph.D. in Chemical Engineering from Massachusetts Institute of Technology.
MR. DALE is President of Silverado Capital, Inc., a San Diego-based company
engaged in arranging the exchange of international currencies and in the
international marketing of biorational plant growth enhancers. From 1980 to
1989, Mr. Dale was a partner in a San Diego law firm dealing with corporate and
securities law matters. Prior to that, he was a sole practitioner for two years
and for eight years was general counsel for an agricultural management company.
Mr. Dale received a B.A. degree in Economics from Allegheny College and a LL.B.
degree from the University of Pennsylvania.
MR. ABRAMS is President and CEO of Cape Composites, Inc. in San Diego, a
leading producer of uni-directional prepreg composite materials for the
recreational, medical and industrial markets. Mr. Abrams purchased Cape
Composites in 1996, and successfully turned it into a profitable business. From
1993 to 1995, Mr. Abrams was Manager of Business Development and Contracts
Administration for WesTech Geer Corporation, a subsidiary of Zimmerman Holdings
Inc. (ZHI) of Pasadena, and spearheaded the commercialization of its defense
oriented business to bring in over $30 million in new commercial programs in one
year. From 1992 to 1996, Mr. Abrams directed ZHI's technology transfer
activities from Government and academic institutions for its eight subsidiary
companies.
All directors serve for a term of one year and until their successors are
duly elected and qualified. All officers serve at the discretion of the Board of
Directors.
24
<PAGE> 25
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Directors, officers and each beneficial owner of more than 10% of the
Common Stock of the Company are required by Section 16(a) of the Securities
Exchange Act of 1934 to file reports periodically disclosing their transactions
in the Company's securities. Based on a review of such reports, the Company has
noted that Form 4 was not filed on the specified due dates by its former CFO
Gregory Hanson.
ITEM 10. EXECUTIVE COMPENSATION.
Item 10 is incorporated by reference to the proxy statement to be filed on
or about January 30, 1999.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Item 11 is incorporated by reference to the proxy statement to be filed on
or about January 30, 1999.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Item 12 is incorporated by reference to the proxy statement to be filed on
or about January 30, 1999.
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
The exhibits listed in the accompanying index to exhibits are filed as part
of this annual report.
(b) Reports on Form 8-K
None.
25
<PAGE> 26
XXSYS TECHNOLOGIES, INC.
INDEX TO EXHIBITS
(Item 13(a))
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C> <C>
3.1 (1) Restated Articles of Incorporation.
3.1.1 (3) Certificate of Amendment to Articles of Incorporation.
3.2 (1) Restated Bylaws.
4.0 (4) Certificate of Determination for Registrant's Series A Preferred Stock.
10.1 (1) Employment Agreement dated September 7, 1991 between Registrant and Gloria C.L. Ma.
10.2 (13) Lease Agreement dated October 26, 1995 between Registrant and Viewridge Business Park.
10.3 (1) Form of Indemnification Agreement between Registrant and its officers and directors.
10.4 (13) 1991 Stock Option Plan dated December 14, 1991, as amended.
10.5 (2) Warrant dated August 12, 1992 issued to H. J. Meyers & Co., Inc.
10.6 (2) Stock Escrow Agreement among Registrant, American Stock Transfer and Trust Company and certain stockholders of
Registrant.
10.7 (2) Agreement between certain of Registrant's stockholders and H. J. Meyers & Co., Inc. with respect to
transferability of shares.
10.8 (2) Letter agreement between Registrant and H. J. Meyers & Co., Inc. pertaining to mergers and acquisitions.
10.9 (1) Form of Warrant issued in 1992 bridge financing.
10.10 (3) Memorandum of Understanding dated February 12, 1993 among the members of the Advanced Composite Technology
Transfer (ACTT) Consortium.
10.11 (3) Cooperation Agreement dated July 21, 1993 among Composite Retrofit Corporation, Hercules Incorporated, FCI
Constructors, and Ciba Composites Division, Ciba-Geigy Corporation.
10.12 (5) Warrant Agreement dated December 30, 1993 between the Company and Mr. S. Georgiev.
10.13 (6) Registrant's Promissory Note dated May 10, 1994 in the amount of $35,000.
10.14 (6) Registrant's Promissory Note dated May 10, 1994 in the amount of $20,000.
10.15 (6) Registrant's Promissory Note dated May 10, 1994 in the amount of $10,000.
10.16 (6) Registrant's Promissory Note dated May 10, 1994 in the amount of $35,000.
10.17 (6) Form of Warrant Agreement issued to holders of Registrant's Promissory Note dated May 10, 1994.
10.18 (7) Registrant's November 30, 1994 Amendment to Note and Warrant Agreement dated May 10, 1994,
in the amount of $35,000.
10.19 (7) Registrant's November 30, 1994 Amendment to Note and Warrant Agreement
dated May 10, 1994, in the amount of $20,000.
10.20 (7) Registrant's November 30, 1994 Amendment to Note and Warrant Agreement
dated May 10, 1994, in the amount of $10,000.
10.21 (7) Registrant's November 30, 1994 Amendment to Note and Warrant Agreement
dated May 10, 1994, in the amount of $35,000.
10.22 (7) Form of Warrant Agreement issued to holders of Registrant's Promissory Notes, Amended November 30, 1994.
10.23 (7) Letter Agreement between Company and Steven Georgiev dated January 4, 1995.
10.24 (8) Agreement regarding separation of employment of Paul W. Pendorf and William J. Timmerman dated March 25, 1995.
10.25 (9) Registrant's Promissory Note dated March 25, 1995 in the amount of $200,000 and related Warrant Agreement.
10.26 (9) Registrant's Promissory Note dated March 26, 1995 in the amount of $100,000 and related Warrant Agreement.
10.27 (9) Registrant's Promissory Note dated May 10, 1995 in the amount of $110,000 and related Warrant Agreement.
10.28 (10) Registrant's Promissory Note dated July 28, 1995 in the amount of $93,000 and related Warrant Agreement.
</TABLE>
26
<PAGE> 27
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C> <C>
10.29 (10) Registrant's Promissory Note in the amount of $247,202, effective September 12, 1995, together with related
Warrant Agreement and rescission of agreement to accept common stock in lieu of loan.
10.30 (10) Registrant's Promissory Note in the amount of $123,601, effective September 12, 1995, together with related
Warrant Agreement and rescission of agreement to accept common stock in lieu of loan.
10.31 (10) Registrant's Promissory Note in the amount of $131,749, effective September 12, 1995, together with related
Warrant Agreement and rescission of agreement to accept common stock in lieu of loan.
10.32 (10) Common stock purchase agreement between Biu Bui Law and the Company dated August 30, 1995.
10.33 (11) Current report on Form 8-K, giving evidence of compliance with the minimum listing requirements
for Nasdaq.
10.34 (13) Common stock purchase agreements between the Company and Tung Bik Lin and Li Sau Foon,
dated September 15, 1996.
10.35 (12) Common stock purchase agreements between the Company and Tung Bik Lin and Li Sau Foon,
dated August 29, 1997.
10.36 (13) License Agreement between the Regents of the University of California and the Company, dated June
27, 1997.
10.37 (13) Distributorship Agreement between the Sho-Bond Corporation and the Company, dated June 27, 1997.
10.38 (13) Common stock purchase agreements between the Company and Tung Bik Lin and Li Sau Foon,
dated December 30, 1997.
10.39 (14) Consulting Services Agreement between the Company and Continental Capital & Equity
Corporation dated April 15, 1998
10.40 Engagement Agreement between the Company and Muir Management Group, Inc. Dated July 6, 1998 and as
amended on September 15, 1998
</TABLE>
<TABLE>
<CAPTION>
Notes:
- ------
<S> <C>
(1) Incorporated by reference to Form S-1 dated July 16, 1992, File No. 33-47018.
(2) Incorporated by reference to Form 10-K for the year ended September 30, 1992.
(3) Incorporated by reference to Form 10-K for the year ended September 30, 1993.
(4) Incorporated by reference to Form 8-K dated May 12, 1994.
(5) Incorporated by reference to Form 10-QSB for the quarter ended December 31, 1993.
(6) Incorporated by reference to Form 10-QSB for the quarter ended June 30, 1994.
(7) Incorporated by reference to Form 10-QSB for the quarter ended December 31, 1994.
(8) Incorporated by reference to Form 8-K dated April 10, 1995.
(9) Incorporated by reference to Form 10-QSB for the quarter ended June 30, 1995.
(10) Incorporated by reference to the original Form 10-KSB for the year ended September 30, 1995, filed on
January 15, 1996.
(11) Incorporated by reference to Form 8-K dated October 31, 1996.
(12) Incorporated by reference to Form 8-K dated August 29, 1997
(13) Incorporated by reference to Form 10-KSB for the year ended September 30,
1997.
(14) Incorporated by reference to Form S-8 filed as of October 13, 1998
</TABLE>
27
<PAGE> 28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
XXSYS TECHNOLOGIES, INC.
January 12, 1999 By: /s/ Gloria C. L. Ma
------------------------------------
Gloria C. L. Ma
Chairman, Chief Executive Officer
and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the date indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ GLORIA C. L. MA Chairman, Chief Executive January 12, 1999
- ------------------------------------------ Officer, Chief Financial Officer and Director
Gloria C. L. Ma
/s/ WILLIAM J. DALE Director January 12, 1999
- ------------------------------------------
William J. Dale
/s/ DAVID B. ABRAMS Director January 12, 1999
- ------------------------------------------
David B. Abrams
</TABLE>
28
<PAGE> 1
EXHIBIT 10.40
MUIR MANAGEMENT GROUP, INC.
ENGAGEMENT AGREEMENT
AGREEMENT NUMBER M004-001
MUIR Management Group, Inc., 491B Carlisle Dr., Herndon, VA.,
22070, (MMG), is entering into this Agreement with the following
organization or individual ("Customer") for performance of the
work described below:
CUSTOMER: XXsys Technologies, Inc. CUSTOMER ID NO.: M004
Address: 4619 Viewridge Avenue Purchase Order No.:
San Diego, CA 92123 Purchase Order Date:
Services:
Deliverables: PROVIDE MANAGEMENT CONSULTING SERVICES TO ASSIST XXsys IN
IMPROVING THE BOTTOM LINE PROFITABILITY. SEE ATTACHED PROPOSAL DATED 5/8/98 and
7/20/98.
Performance Schedule: EFFORT TO COMMENCE ON OR ABOUT JULY 6, 1998 AND CONTINUE
UNTIL XXsys DETERMINES THAT MMG SERVICES ARE NO LONGER REQUIRED. XXsys WILL
PROVIDE MMG WITH A 30 DAY NOTICE OF TERMINATION.
MUIR Management Fees: SEE "PROJECTED COSTS" SECTION IN ATTACHED PROPOSAL DATED
July 20, 1998
================================================================================
Representatives:
Muir Management Group Administrator:
Name: JOSEPH NeSMITH Name: Dr. GLORIA MA
Address: 491-B CARLISLE DRIVE Address: 4619 VIEWRIDGE AVENUE
HERNDON, VA 20170 SAN DIEGO, CA 92123
Phone: 703-478-3331 Phone: 619-974-8200
Fax: 703-478-3332 Fax: 619-974-8208
Customer Technical Contact: SPECIAL NOTES:
Name:
Address:
Customer Billing Contact:
Location of Work: VARIOUS
Additional Customer Obligations:
--------------------------
================================================================================
For Muir Management Group: For Customer:
Signature: [SIG] Signature: [SIG]
Name: Name:
Title: Title:
Date: July 6, 1998 Date: July 6, 1998
EXECUTION PROCEDURE: Customer signs both copies and returns them to Muir
Management Group. Muir Management Group signs both copies and returns one fully
signed copy to Customer. This Agreement becomes effective upon execution by
Customer and acceptance and execution by Muir Management Group at Muir
Management Group's home offices. BY SIGNING THIS AGREEMENT, CUSTOMER AGREES TO
ALL OF THE TERMS AND CONDITIONS SET FORTH HEREIN, INCLUDING THE WARRANTY
EXCLUSIONS AND LIMITATIONS ON LIABILITY CONTAINED ON THE REVERSE SIDE HEREOF.
<PAGE> 2
MUIR MANAGEMENT GROUP, INC.
TERMS AND CONDITIONS
1. MMG FEES. Customer shall pay MMG the fee identified ("MMG Fees") within
thirty (30) days of invoicing. Customer also agrees to pay the reasonable travel
expenses of MMG's personnel in the course of MMG's performance hereunder. MMG,
in incurring any such expenses, shall conform to XXsys's then-current standard
travel policies for employee travel expenses. Payments due and unpaid shall,
upon written notice to Customer by MMG, bear interest from the date payment is
due at the lesser of the maximum rate permitted by law or one and one-half
percent (1-1/2%) per month.
2. CUSTOMER OBLIGATIONS. It is understood that MMG may be required to perform
Services based, in part, on materials, information, equipment, facilities and/or
services furnished by Customer, agents of Customer or other contractors for
Customer, and MMG shall be entitled to rely on the accuracy and completeness of
such information and materials and to assume that all equipment and facilities
shall be in good working order and that all services provided by Customer shall
be provided in a timely and professional manner. Additional duties of Customer
shall be set forth in the Additional Obligations of Customer Section on the
reverse side hereof. When MMG performs any services at Customer's facility,
Customer shall supply sufficient work space, terminals, materials and related
resources which may be needed by MMG for timely performance of the Project.
3. PERFORMANCE OF MMG. The Deliverables of MMG shall be upon delivery in
substantial conformance with any applicable specifications set forth or
referenced on the reverse side hereof. CUSTOMER UNDERSTANDS AND ACKNOWLEDGES
THAT MMG DOES NOT AND CANNOT WARRANT THAT THE DELIVERABLES ARE FREE OF ALL
DEFECTS OR ERRORS. Customer shall have ten (10) days after delivery of the
Deliverables, or portion thereof, to review the Deliverables and determine
whether or not such are in substantial conformance with any specifications set
forth or referenced on the reverse side hereof. Failure to notify MMG in writing
within the ten (10) day period shall be deemed to be acceptance hereunder.
Customer agrees that MMG shall have satisfied its warranty obligation upon
Customer acceptance of the Deliverables. If any portion of the Deliverables
supplied by MMG hereunder fails to comply with the foregoing warranty and MMG is
so notified in writing within the ten (10) day acceptance period, MMG shall
correctly perform such portion of the Deliverables at MMG's own expense. Should
MMG fail to so cure the performance within a reasonable period of time or should
MMG determine that the Deliverables cannot be corrected with a commercially
reasonable effort, MMG shall refund the amount of the MMG Fees as relate to such
portion of the Deliverables not satisfactorily completed.
4. INFRINGEMENT. MMG warrants, except as to material or information
incorporated into the Deliverables that Customer, its agents or other
contractors have supplied to MMG, that the Deliverables will not infringe on the
copyright, patent or trade secret of any third party. If any portion of the
Deliverables supplied hereunder fails to comply with the warranty against
infringement, MMG hereby agrees to indemnify, protect, defend, and hold Customer
harmless from all claims, suits, actions, and judgments which may be sustained
by Customer as a result of such failure; provided, however, that (i) Customer
gives prompt written notice to any suit to MMG, and (ii) MMG shall have sole
control of the defense of any action or claim and all negotiations for
settlement or compromise thereof. Customer may elect to participate in any such
action with an attorney of its own choice and at its own expense. In the event
Customer is precluded by a court of competent jurisdiction from using any
Deliverables as a result of such an infringement, MMG may, in its sole and
absolute discretion, (i) obtain the right to use the Deliverables for the
Customer, or (ii) replace or modify the Deliverables so that they no longer
infringe or (ii) if neither (i) nor (ii) above is commercially reasonable, in
MMG's sole and absolute discretion, then MMG may terminate this Agreement with a
pro-rata refund of the MMG Fees paid by Customer based on a useful life of five
(5) years for the Deliverables. If Customer does not notify MMG, as required
herein, Customer's rights under this Section shall terminate.
5. LIMITATIONS. THE FOREGOING REMEDIES AND WARRANTIES ARE EXCLUSIVE AND IN
LIEU OF ALL OTHER REMEDIES AND WARRANTIES, INCLUDING BUT NOT LIMITED TO ANY
IMPLIED OR OTHER WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR
PURPOSE. MMG SHALL NOT BE LIABLE TO CUSTOMER OR ANY OTHER PERSON, FIRM OR
CORPORATION FOR ANY LOSS OR SPECIAL, INDIRECT, INCIDENTAL OR CONSEQUENTIAL
DAMAGES, INCLUDING WITHOUT LIMITATION LOST PROFITS, LOSS OF TIME, MONEY, DATA OR
GOODWILL, OR ANY OTHER CLAIM OR DEMAND BY OR AGAINST CUSTOMER WHICH MAY ARISE
OUT OF THE FURNISHING, PERFORMANCE OR USE OF ANY ITEM OF SERVICE PROVIDED FOR
UNDER THIS AGREEMENT.
6. CONFIDENTIAL INFORMATION. "Confidential Information" shall mean information
or material proprietary to either MMG or Customer and provided by one party
hereunder to the other, provided that such is designated in writing as
confidential or proprietary. Any information relating directly or indirectly to
any software product of MMG and any Deliverables delivered hereunder shall be
confidential and proprietary to MMG and written notice of its confidential
nature shall not be required. "Owner" means the party delivering Confidential
Information to the other. "Recipient" means the party receiving Confidential
Information. Recipient shall use reasonable efforts not to disclose or otherwise
make available any part of the Confidential Information to any other person or
entity. Recipient agrees to use all Confidential Information solely for the
purpose of performing its obligations contemplated hereunder, or as otherwise
expressly permitted under this Agreement. Unless otherwise expressly
contemplated under this Agreement, Recipient shall not incorporate any portion
of the Confidential Information into any other work or product, and shall not
have any proprietary interest in any of the Confidential Information as a result
of Recipient's access to such by virtue of this Agreement. Recipient's
obligation to maintain the confidentially or Confidential Information shall not
apply where such: (i) was already in Recipient's possession prior to disclosure
by Owner, and such was received by Recipient without obligation of confidence;
(ii) is independently developed by Recipient; (iii) is or becomes publicly
available without breach of this Agreement; (iv) is rightfully received by
Recipient from a third party without obligation of confidence; or (v) is
released in accordance with a valid order of a court or governmental agency.
7. CHANGES. Customer and MMG may, at any time, upon mutual agreement, execute
a written document ("Change Order") providing for changes in the Scope of Work,
in any one or more of the following: (i) tasks or sub-tasks to be performed;
(ii) time or place of deliver, and (iii) period of performance. If any such
change causes an increase in the cost of, or the time required for, the
performance of Services, such Change Order shall include an equitable adjustment
in the MMG Fees or Schedule of Performance, or both. In no event shall MMG be
responsible or obligated to perform any change unless the parties have agreed
upon an increase in the Project Fees and revision in the Performance Schedule in
the event MMG determines such is necessary.
8. DELAYS AND EXTENSIONS OF TIME. If MMG is delayed at any time in the
progress of the Services by any act or neglect of Customer, or by any employee
of Customer, or by any separate contractor or agent employed by Customer, or
changes ordered in the Scope of Work, or by labor disputes, fire, unusual delay
in transportation, adverse weather conditions not reasonably anticipated,
unavoidable casualties, or any causes beyond MMG's control, or by any other
cause which justifies the delay, then the performance Schedule, upon request by
MMG, shall be extended by Change Order for such reasonable time as MMG and
customer mutually may determine to be necessary. MMG shall provide an estimate
of the probable effect of such delay on the progress of the Services. If no
agreement is made stating the reasonable effects of the delay, then MMG shall
unilaterally determine the effect of the delay upon MMG's Performance Schedule
and the MMG Fees, which unilateral determination shall be binding upon Customer,
provided that such is supported by proper documentation. There shall be no
adjustment to the Project Fees unless the delay is caused by Customer, an
employee of Customer or an agent or other contractor of Customer. In the case of
a continuing Customer delay in excess of thirty (30) days after written notice
from MMG, or in the case of persistent Customer delays which continue to persist
after written notice from MMG, MMG may terminate its Services and shall be
entitled to all MMG Fees for Services performed prior to termination and all
extra expenses caused by the delay(s), as well as MMG's anticipated profit for
Services not performed.
9. MISCELLANEOUS. The parties are independent contractors with respect to the
services contemplated hereunder. This Agreement shall be binding upon and inure
to the benefit of the respective successors and assigns of Customer and MMG.
However, neither Customer nor MMG shall have the right to assign this Agrement
or any obligations or responsibilities hereunder without the prior written
consent of the other party. The terms, conditions, representation, and
warranties contained in this Agreement shall survive the termination or
expiration of the time for completion of Services, delivery of any Deliverables
and the time for meeting any final payment of Project Fees. No amendment or
modification of any provision of this Agreement shall be effective unless in
writing and signed by both parties hereto. The failure of either party at any
time to demand strict performance by the other party of any of the terms,
covenants or conditions set forth herein shall not be construed as a continuing
waiver or relinquishment of any such term, covenant or condition, and either
party may at any time subsequent demand strict and complete performance by the
other party of said term, covenant or condition. If any provision of this
Agreement is held by a court of competent jurisdiction to be contrary to law,
the remaining provisions of this Agreement will remain in full force and effect
to the extent that such does not operate to create an absurdity. This Agreement
constitutes the entire agreement between Customer and MMG concerning the subject
matter governed by this Agreement. This Agreement shall be construed in
accordance with the plain meaning of the language employed herein, and it shall
not be construed either for or against the drafting party. The headings used
herein are for the sole sake of convenience and shall not be used to interpret,
limit or add to the language of any section contained herein. Any notice, to be
effective hereunder, shall be made in writing and sent to the address of the
appropriate party first appearing herein, unless such party shall have notified
the other party, in accordance with the provisions of this Section, of a new
mailing address. This Agreement shall be governed by and construed in accordance
with the laws of the Commonwealth of Virginia.
Muir Management Group, Inc. Proprietary
Form TS0696
<PAGE> 3
TO: XXsys Board of Directors
FROM: MUIR Management Group
DATE: September 16, 1998
SUBJECT: Addendum to MUIR Agreement
This addendum memorializes the ratified actions for MUIR Management Group
made by the XXsys Board of Directors at the Board meeting held on Monday
September 14, 1998.
The following actions were agreed to:
1. MUIR (Tom and Joe) will take full time responsibility for the finance,
administration and operational aspects of the company as Tom -- COO and
Joe -- CFO. Both of these positions will be on an interim basis until the
Company is back on its feet and can attract replacements for both
positions. They will report to the Board of Directors. Both Tom Shea and
Joe NeSmith will be covered by D&O Insurance that will be paid in advance
to ensure coverage.
2. All XXsys personnel with the exception of Dr. Ma and her administrative
assistant will report to MUIR.
3. MUIR will continue fulfilling its existing agreement and tasks (over &
above this new responsibility) with some overlap in performance.
4. MUIR will make personnel adjustments as necessary in the XXsys team. Any
action taken regarding the employment of the current management team will
require board concurrence.
5. MUIR will adjust XXsys personnel functional responsibilities as necessary.
6. John Rosicky will report to MUIR.
7. MUIR will keep the Board appraised at least monthly through a written
progress report.
8. Joe & Tom will be granted signature authority consistent with current
XXsys guidelines and will be responsible for authorizing all external
agreements and alliances.
9. MUIR will take whatever other actions are required to ensure XXsys operates
as a cost conscious, focused business operation.
10. The existing agreement remains in force. A separate addendum to that
agreement will be executed to add these additional responsibilities.
11. MUIR will provide one full time equivalent (FTE) in either Tom or Joe's
time, as needed, to fulfill the new responsibilities for 818,000 monthly
paid bi-monthly with the same priority and at the same time as XXsys
internal salaries. MUIR will be responsible for its own taxes, benefits,
etc.
12. Additionally, MUIR will be granted 50,000 shares of XXsys free trading
stock in lieu of a cash bonus for accepting this additional assignment.
13. Expenses associated with the new assignment are paid in the same manner as
those under the existing agreement.
[SIG]
MUIR Management Group, Inc.
COMPANY CONFIDENTIAL
1
<PAGE> 4
14. Activities above the FTE are compensated according to the original
agreement.
15. The Board of Directors has granted Wally Geer with the authority to review
and approve this addendum to the MUIR Agreement.
Therefore in addition to the supporting items shown above, the addendum to the
existing MUIR Management Agreement, M004-001 will be as follows:
Muir will provide one full time equivalent (FTE) in either Tom or Joe's time,
as needed, to fulfill the new responsibilities for the sum of $18,000 monthly
paid bi-monthly with the same priority and at the same time as XXsys internal
salaries. MUIR will be responsible for its own taxes, benefit, etc.
Additionally, MUIR will be granted 50,000 shares of XXsys free trading stock in
lieu of a cash bonus for accepting the additional assignment.
XXsys agrees to cover the members of the XXsys Board of Directors and both Tom
Shea and Joe NeSmith by prepaid D&O insurance payable in advance to ensure
sufficient coverage.
XXsys Technologies, Inc. MUIR Management Group, Inc.
/s/ WALTER GEER /s/ TOM J. SHEA
- ------------------------------- --------------------------------
XXsys Board of Director MUIR Management Group
Walter Geer Tom J. Shea
- ------------------------------- --------------------------------
Name Name
Director Managing Partner
- ------------------------------- --------------------------------
September 15, 1998 9/15/98
- ------------------------------- --------------------------------
Date Date
MUIR Management Group, Inc.
COMPANY CONFIDENTIAL
2
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<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
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