SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [Fee Required]
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE
ACT OF 1934 [No Fee Required]
For Fiscal Year ended December 31, 1998
Commission file number 0-21738
ON-POINT TECHNOLOGY SYSTEMS, INC.
---------------------------------
(Exact name of registrant as specified in its charter)
NEVADA 33-0423037
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State of incorporation) (I.R.S. Employer Identification)
1370 W. San Marcos Blvd, Ste 100
San Marcos, California 92069
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(Address of registrant's executive offices) (Zip Code)
Former address: 8444 Miralani Drive
San Diego, CA 92126
Registrant's telephone number, including area code (760) 510-4900
Former telephone number: (619) 621-5050
Securities registered pursuant to Section 12 (b) of the Act:
Title of each class Name of each exchange on
which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
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Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15 (d) of the Exchange Act during the past 12 months (or if such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes[X] No[ ]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB [ ].
The Registrant's revenues for fiscal year ended December 31, 1998 were
$16,416,000
The aggregate market value of the registrant's common stock held by
nonaffiliates of the Registrant is $18,271,000 as of March 5, 1999.
The number of shares outstanding of the Registrant's common stock is 10,098,921
as of March 5, 1999.
<PAGE>
1. DESCRIPTION OF BUSINESS
GENERAL On-Point Technology Systems, Inc., (the "Company" or "On-Point"),
is headquartered in San Marcos, California and was incorporated in Nevada in
March of 1990. On-Point designs, manufactures, sells, leases, and services
high-security automated point of sale transaction vending terminals for the
sale of instant-winner lottery tickets (the "Instant Ticket Retailer" or
"ITR?"), pull-tab lottery tickets (the "Pull-Tab Retailer" or "PTR?"),
prepaid phone cards and "smart cards" (the "Debit Card Retailer" or "DCR?")
and vending terminals that dispense high value products such as cell phones
and pagers. The Company's ITR and DCR terminals accept bills of various
denominations, provide a secure means of product distribution and include
software which automatically accounts for product sales and inventories.
The ITR terminals are sold or leased to state and provincial governments
in the United States and Canada and to other foreign governments and their
licensees. The DCR terminals are sold or leased to commercial customers
and to governmental entities and their licensees. The Company has also
developed a patented design for a high-security automated bill-payer terminal
(the "BillPayer?), which allows customers to pay utility and other similar
bills from remote locations. The Company is in the process of evaluating its
strategic plans for the further development and introduction of the BillPayer.
In addition, the Company has introduced certain specially designed dispensing
Technology to South America, Asia, and Europe.
During the last three years, the Company has undergone a process of
"right-sizing" and of redefining its strategic plans. During 1996, The Board
of Directors appointed Frederick Sandvick, the current Chief Executive Officer
and Chairman of the Board of the Company, to oversee the development of the new
strategic plans. Under his leadership, the Company underwent a right sizing
effort during 1996 and 1997 which reduced personnel and overhead costs and
reassigned duties to other personnel to achieve greater efficiencies. The
Company's restructured operations enabled the Company to improve operating
margins and dramatically reduce general and administrative expenses. As a
result, the Company successfully generated net income from its existing
products and services even in the face of lower revenues and increased
competitive pressures during those years.
During 1998, management assessed that, notwithstanding its success
due to right-sizing, if the Company did not advance its current products
increasing competitive pressures and technological advancements would likely
bring lower margins in 1999 and beyond. Based on this assessment, management
chose to begin investing a significantly larger amount of its resources in 1998
into the development of what management believes will be the next generation
lottery products. Management focused on the Company's lottery products first
because they believed the lottery market to be the largest, most stable
industry to deploy its products. Management believes that the overall market
for the Company's next generation products is in excess of $200 million per
year worldwide. However, although management believes its next generation
products will be well positioned to take advantage of this large lottery
market, there can be no assurances as to the amount of revenues the Company's
next generation lottery products will generate.
As a result of its increased development efforts for its next
generation lottery products, the Company's research and development costs
increased from approximately $.6 million in 1997 to $1.4 million in 1998.
Nevertheless, despite those increased development costs, as well as lower
revenues in 1998 due to contract delays, the Company's net income increased
by 9% in 1998 as a result of higher margins and operating efficiencies.
A summary of the net income (loss) and research and development
costs of the Company for the last four years follows:
<TABLE>
<CAPTION>
Research and
Year Net Income Development costs
(In Thousands) (In Thousands)
<S> <C> <C>
1995 $(8,092) $447
1996 $135 $253
1997 $1,572 $582
1998 $1,711 $1,405
</TABLE>
See Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") for a further description of the Company's results of
operations.
The Company intends, as a result of its development efforts, to
introduce in 1999 its next generation lottery products. Its principal
products will be: (i) the Company's next generation automated self-service
instant ticket lottery vending terminal ("PlayPoint"); and (ii) the
Company's first automated instant ticket lottery counter-top dispensing
terminal ("CounterPoint"). PlayPoint will provide advanced electronic,
software, communication and dispensing capabilities as well as new
ergonomically designed features to generate increased impulse purchasing.
Management believes PlayPoint will be far superior to the Company's existing
ITR terminal.
<PAGE>
CounterPoint is designed to be the most flexible, automated
counter-top dispensing system available. Although currently no lottery has
deployed any significant number of automated counter-top dispensing systems,
management believes that many of CounterPoint's proprietary features, which
were not previously available to lotteries, will enhance the Company's ability
to deploy this new product to lotteries worldwide. However, although
management believes the lotteries can receive many new benefits from deploying
this product, there can be no assurances that any lottery will order this new
product.
As a result of its focus on its development efforts in 1998 for
new products for the lottery market, the Company did not aggressively market
in 1998 its DCR or other non lottery products other than to existing customers.
During 1998, the Company continued to strategically provide DCR terminals to a
prepaid phone card company (the "DCR customer") under an exclusive arrangement
in order to assist Solutioneering, Inc. with the achievement of its growth
plans. The Company believed the exclusive arrangement to be an effective means
of increasing its presence in the DCR marketplace. As a result, the Company
has a significant long-term lease receivable from Solutioneering, Inc. which
is currently in dispute. See "Marketing and Sales-DCR Terminals" and "Legal
Proceedings" herein for a further discussion concerning Solutioneering, Inc.
And the lease receivable.
As previously described, during 1998, the Company's development
efforts focused primarily on its lottery market which necessitated, because of
resource constraints, reduced focus on its non lottery markets. Once the
Company's next generation lottery products are introduced, which is anticipated
to occur in the summer of 1999, it is management's intent to reevaluate its
strategic plans for its DCR market as well as other non-lottery markets, such
as its BillPayer market.
INSTANT TICKET RETAILER General In March 1991, the Company received its
first contract to install up to 2,000 ITR terminals from the State of Virginia.
The Company has since signed contracts to provide terminals to numerous state
lottery customers including California, Missouri, Washington, Pennsylvania, New
York, Illinois, Connecticut, the Provinces of Ontario and Quebec, as well as
France and certain other foreign countries. The French Lottery is the largest
instant ticket lottery in the world. Pursuant to these contracts, from its
inception through December 31, 1998, the Company had sold or leased
approximately 14,000 ITR terminals, of which approximately 850 were sold or
leased during 1998. The ITR terminals have been placed in supermarkets,
convenience stores, bowling alleys, restaurants with bars, and other locations.
The Company also may enter into service contracts in connection with sales of
ITR terminals pursuant to which it receives monthly maintenance fees (see
"Customer service, Training and Product Repair" herein).
The Industry Lotteries are operated by state and foreign governmental
authorities and their licensees in over 155 jurisdictions. Governments use
lotteries primarily as a means of generating non-tax revenues. In the United
States, lottery revenues frequently are designated for particular purposes,
such as education, economic development, conservation, transportation and
aid to the elderly. Many states have become increasingly dependent on
lotteries as a significant source of funding for these purposes.
While the specific amounts vary substantially from state to state,
in general it is estimated from industry reports that about 50% of gross
lottery revenues in the United States is returned to the public in the form of
prizes. Approximately 33% is used to support specific public programs or is
contributed to the state's general fund. Typically, 5% to 6% is reserved for
point-of-purchase commissions for the retailer, and the remainder is used to
fund lottery operations, including the cost of advertising and, depending upon
the state and the type of lottery, amounts paid to vendors such as On-Point.
As of December 1998, lotteries were operated in 38 states, the
District of Columbia and five provinces of Canada. Lotteries are also operated
in Europe, Asia, Central America and South America. Government lotteries can
be categorized into three principal groups: the traditional draw-type games,
on-line games and "instant" ticket games. Traditional lotteries, in which
drawings are held once a week, while popular abroad, are rare in the United
States. On-line varieties generally refer to computerized games such as lotto
and daily pick 3/4/5/6 games, in which players make their own selections.
Alternatively, they involve low-stakes video gambling, such as poker,
blackjack, bingo and keno. Instant ticket games consist of preprinted tickets
in which players scratch off a coating or pull off tabs to determine whether
they have purchased a winning ticket.
On-line lotteries generate significantly more revenue than both
the draw-type and instant ticket games. The Company estimates from industry
reports that on-line ticket sales account for approximately 60% of total U.S.
lottery sales and that scratch-off games (the type of instant winner game
predominantly used by state lotteries) hold an approximately 40% market share.
The instant ticket games' market share has increased over the past several
years as lottery organizations have realized that the more instant games being
sold at one time increases sales. Some states currently offer up to 30
different games simultaneously. Notwithstanding the current prevalence of
on-line games, the Company believes that instant ticket games continue to offer
a significant potential for market growth. Of the states conducting instant
ticket lotteries, 29 currently use terminals to dispense instant tickets.
Traditionally, instant winner tickets had been manually dispensed by the
retailer. This distribution method, in addition to being labor intensive,
requires the retailer to maintain rigorous inventory, accounting and security
controls, because the tickets are treated as cash equivalents. The Company's
ITR terminals provide additional security and automate these procedures,
resulting in greater efficiencies and flexibility to offer multiple games
simultaneously.
<PAGE>
Recent advances in print technology have improved the security
of Pull Tab tickets to the levels demanded by the lottery industry. As a
result several U.S lottery jurisdictions have introduced Pull Tab ticket games.
The Company's PTR terminals and Versatile Ticket Retailer ("VTR?") terminals,
which dispense both instant tickets and pull tab tickets, bring the same
benefits of increased security, automated accounting and enhanced promotion at
the point of sales to Pull Tab tickets as the ITR terminals have provided to
instant tickets. During 1998, the Company did not sell its PTR or VTR
terminals and, to date, this market has been limited.
The ITR, PTR & VTR Lottery Terminals In 1990 the Company introduced
the ITR-7000 terminal, which was replaced with the upgraded ITR-7500 in
August 1992. This series of products has been installed at sites throughout
the United States. In 1995 the Company introduced the esthetically updated
ITR-8500 terminal. In 1996 the Company developed the first 12 bin ITR
terminal. During 1996 the Company also developed the 8 bin slim-line terminal
(which dispenses 8 games in a terminal that requires half the retail space of
previous 8 bin models). During 1997, as a result of the average mean time
to failure rate of the Company's dispenser being in excess of nine years,
the Company was able to initiate a program of retrofitting older terminals
to incorporate new technologies. During 1998, the Company introduced its
ITR-8500SL terminal which can vend as many as 15 instant ticket games in a
smaller footprint than its previous 12-game model.
The Company intends to replace all its existing models of ITR,
PTR and VTR terminals with the PlayPoint model in 1999. Management believes
PlayPoint will be far superior to any existing model and, therefore, be the
preferred model of choice by the lotteries in the future. PlayPoint will
provide advanced electronic, software, communication and dispensing
capabilities as well as new ergonomically designed features. PlayPoint
will be capable of dispensing both instant tickets and pull tab tickets.
PlayPoint will also be capable of dispensing up to 20 instant ticket
games, another industry first for dispensing technology.
The Company believes that the lottery terminals substantially
expand the market for retail sales of instant winner lottery tickets, in that
they are designed to streamline and enhance the operation and marketing of
instant winner tickets by providing greater opportunity for the impulse
purchase. The lottery terminals are designed to provide secure, high
visibility points of presence at the point of sale while using a minimum of
floor space. The terminals are available in several models which house four
to fifteen games. The units are available in counter-top and stand alone models
(the latter incorporating a security storage cabinet). All models accept bills
in $1, $5, $10, and $20 denominations and can be manufactured to accommodate
coins or foreign currency.
The customer inserts a bill in the terminal, receives credit, and
then selects from among any or all of the games offered by pressing the button
located immediately under the appropriate ticket display. The terminals
generally dispense either a single ticket or a string of uncut tickets, which
move past a window, allowing the customer to view the purchase. Based on its
knowledge and experience the Company believes that customers prefer to see the
actual tickets being dispensed. The Company's patented Windows feature is
unique in this regard among similar products available to lottery
jurisdictions. The Company's lottery terminals incorporate other patented
features which in the Company's opinion enhance the likelihood of impulse
purchases of game tickets.
Each lottery terminal includes a display, which shows
instructional and promotional information to the customer. The terminal can
also be equipped with the "Grabber", a multi-color LED sign, which is mounted
on top of the terminal and includes a built-in memory. The Grabber provides the
ability to promote new games or winning jackpots at the point of sale. A
customized message typically is input prior to installation of the terminals.
These messages can be changed on-site using a hand-held remote control or from
remote locations with the Company's optional Shadow communication program
described below.
DEBIT CARD RETAILER General In 1993 the Company recognized the potential
to utilize its lottery technology in the evolving prepaid phone card industry
and developed its DCR-2000 debit card vending machine. Although prepaid phone
cards have only been available in the U.S. since early 1992, their use has been
growing at a steady pace. In 1997, the estimated size of the debit card
market had grown to over $2 billion, with projected growth to $10 billion by
the year 2000. Prepaid phone cards are issued in various denominations by
telephone companies and may be dispensed from as many as four bins in the
Company's machines. The Company expects that the principal markets for its
DCR terminals will be with telephone companies both domestically and in
Europe, Asia, and Latin America. The Company has signed contracts to provide
DCR terminals to a number of customers. Pursuant to these contracts, from
its inception through December 31, 1998, the Company had sold or leased
approximately 6000 DCR terminals, of which approximately 750 were sold or
leased during 1998. To date, these terminals have been placed in many
different types of establishments where there is a market for prepaid phone
or debit cards. The Company also enters into service contracts in connection
with sales of DCR terminals pursuant to which it receives maintenance fees per
month per machine (see "Customer Service, Training and Product Repair" herein)
The Industry Prepaid phone cards are sold by telephone companies
worldwide. These cards contain a pre-programmed amount of credit and can be
inserted into certain pay telephones. The customer can use all or a portion
of the credit on the card to make telephone calls. These card-receptive pay
telephones do not hold cash, thus eliminating security or internal theft
concerns for the owners of the telephones. The cards are either disposable or
reusable and are sold in varying denominations. Since the service is prepaid,
telephone companies often offer discounted rates to card users. Telephone
companies also derive revenue from the sale of advertising space on the cards
which defrays their cost of any discount given. In the United States the
industry is still in the early growth stages and card reader telephones are
not in abundance. Therefore, most of the prepaid calling cards in use in the
United States use an "800" number that is called for verification of the card
by entering a PIN number located on the card.
<PAGE>
Prepaid telephone cards generally allow card purchasers to buy
blocks of calling time at a discount. The cards are more convenient, and the
use of prepaid cards eliminates the need to maintain cash on hand to feed the
pay telephone when making a call. Prepaid cards also reduce the risk of
credit card fraud or theft, since a theft of a prepaid phone card results only
in the loss of the face value of the card less any time already used.
Recent studies indicate that in the United States only a small
percentage of the public have used or are aware of prepaid phone cards.
Therefore, distribution is essential to gaining public awareness. Dispensing
machines are an important element of the distribution network, providing
visual recognition and 24-hour convenient access to the product. An important
aspect of the vending machine is that its design must promote product awareness
to effectively sell cards, not merely dispense them. In 1997 the Company
repackaged its DCR technology into a new cabinet styling. In 1998 the Company
introduced new 3 and 8 bin terminals in response to the specific application
needs of our customers.
In many foreign countries, especially those less developed than
the United States, the majority of residents do not own telephones and rely
on public pay telephones. Management estimates that commercial and government
entities in over 100 countries now use or are in the process of evaluating the
purchase of telephones equipped to accept prepaid phone cards. The Company
believes many of these entities are looking to dispensing machines capable of
handling prepaid phone cards to widen the acceptance and availability of the
prepaid phone cards. The foreign market for prepaid phone card vending
machines is in its infancy, however, and there can be no assurances this
Company will be successful in developing this market.
In addition to prepaid phone cards, there are many other debit
cards which can be dispensed using the DCR terminal, including bus and subway
passes. Several countries have begun using a multi-purpose debit card to
provide easy access to pay telephones, gasoline pumps, subway passes, and bus
passes. The Company is providing terminals to both Hong Kong and Brazil that
dispense such multi-purpose cards, or different types of cards or passes,
including "smart cards".
The DCR Terminal The Company believes that the DCR terminal
substantially expands the distribution potential of prepaid phone cards.
Similar to the lottery terminals, the DCR terminal is designed to provide high
security and high visibility using a minimum of floor or counter-top space
The terminals are available in several models, which house either one, two
or more bins and are able to accept various denominations of foreign and
domestic currency. The terminals can be manufactured to accommodate coins
and to make change. The customer inserts a bill or coin into the DCR terminal,
receives credit, and then selects the denomination of prepaid phone card or
other card/pass by pressing the button located immediately under the
appropriate card display. The terminal dispenses a single card to the buyer.
Each bin in a DCR terminal stores approximately 400 cards,
depending on the thickness of the cards, thus providing a maximum capacity of
about 1,600 cards in the Company's 4-bin terminal. As with the ITR terminal,
the DCR machine includes a display which shows instructional and promotional
messages and can also be equipped with the "Grabber," a multi-color LED sign,
which is mounted on top of the terminal and includes a built in memory.
A customized message typically is input prior to installation of the terminals.
These messages can be changed on site using a hand-held remote control or
loaded from a remote site with the Company's optional "Shadow" communication
program described below.
Management believes that the DCR market, much like the lottery
ITR market, has become extremely competitive. In addition, technological
advances may modify the market over the next few years. Management intends
on reevaluating in 1999 the potential of the DCR market and determine whether
new developments may be necessary to stay competitive and attain a continuing
market share.
ADDITIONAL PRODUCT FEATURES The lottery and DCR terminals are designed
to satisfy the stringently high security demands of state lottery authorities
and commercial customers. The terminals can be bolted to the floor, wall or
counter to prevent removal. Each machine is equipped with an alarm which is
triggered unless the correct password is entered within a specified time
period of opening any of the terminal's doors. The alarm will also sound if
power is interrupted or the terminal is tipped beyond a critical angle.
The terminal's doors are inset to prevent prying or tampering, and the display
windows are made from one-half inch thick lexan. Every terminal has two
unique, serialized keys, one of which opens the bill acceptor door and the
other of which provides access to the terminal ticket or card dispensers,
electronics and base storage cabinet.
Each terminal is controlled by a software system that provides
security and tracks the accounting and inventory of each bin. This software
enables the customer to generate a variety of reports. Every report contains
the date and time, the customer number and terminal serial number, as well as
sales data for each ticket bin and a total for the entire terminal. These
reports generally describe sales by day, week or month, the current inventory
of tickets, and an audit transaction report, which gives a breakdown of the
last three transactions, thus allowing a customer to determine whether reported
malfunctions in fact occurred. Additional functions of the software are the
production of cash management and audit reports.
<PAGE>
The Company produces a Network Monitoring and Reporting System
software package called "Shadow". This optional software allows customers
to monitor sales and inventory remotely by means of a modem using
non-dedicated, regular telephone lines. This feature permits a central
"PC" computer to collect all of the sales and inventory information from
any one locality with a single telephone call. This software facilitates the
preparation of reports, which can be broken down by customer number, bin
number, location category (i.e., convenience stores, bars, nightclubs, etc.),
and geographic location. In addition, informational and promotional messages
may be automatically downloaded to the optional Grabber display during
connection to the terminal. Messages may be sent to a specific machine or
to an entire group of machines within a specific customer, region or state.
The Shadow software can be used to notify customers of the need to replenish
depleted ticket or card stocks, schedule maintenance and assist in trouble
shooting repairs.
The Company also has a remote control unit that allows the
retailer to disable the terminal for any reason. For example, if the retailer
sees that minors are attempting to purchase lottery tickets or that anyone is
attempting to vandalize the equipment, he can turn off the terminal at a
distance of up to one hundred feet.
As described above, the Company continues to work on improving
its products and developing new features (see "Research and Development"
herein).
LOTTERY AND DCR CONTRACTS The Company generally conducts business
primarily under three types of contractual arrangements: (a) Sales Agreements,
(b) Standard Lease Agreements, and (c) Alternate Lease Agreements.
Sales Agreements Under the typical Sales Agreement,
the Company installs and maintains lottery and/or DCR terminals and
provides ancillary support services to customers. These contracts generally
provide for scaled payments, based upon the type of terminal purchased and the
total number of terminals sold under the agreement. In addition, the Sales
Agreements typically provide for the payment of monthly service fees for
product repair, routine maintenance and customer service activities (based upon
the number of terminals installed). In many cases the service portion of the
contract extends beyond the period provided by the contract for the sale of
terminals.
Standard Lease Agreements While the Standard Lease Agreements
are similar to the Sales Agreements with respect to the Company's installation,
maintenance and service obligations, they are distinguishable primarily by the
fact that the Company continues to own the terminals during the lease term and
that monthly lease payments are made, instead of payment in a lump sum.
The lease amount may or may not include the monthly maintenance fee.
Typically, the lessee is given the option to purchase the terminals at the end
of the lease term, either at a set amount or at fair market value at the time
of sale.
Alternate Lease Agreements In addition to the purchasing
and leasing programs described above, the Company offers a unique approach to
the installation, sale and marketing of lottery or DCR terminals. This program
is a modified leasing arrangement. In general, the program relieves the
customer from the day to day details associated with the marketing and sale of
instant tickets or prepaid phone cards from the Company's terminals. Under
these lease agreements, the Company is entitled to a stated percentage of the
revenues generated from terminal sales or a minimum monthly payment, whichever
is greater. Company personnel assume responsibility for servicing the
terminals, maintaining distribution and inventory records, providing repair and
preventative maintenance, collecting money and distributing the collected funds.
MARKETING AND SALES The Company markets its products, both domestically
and internationally, primarily through an in-house marketing and sales staff.
The Company solicits interest in its terminals primarily at trade shows and
through direct contact with customers. The initial marketing package consists
of product brochures and other supportive documentation, e.g., sales analysis
of other customer installations. References from other customers using the
Company's terminals are routinely supplied, along with an offer to demonstrate
and test the terminals. Where possible, print advertising is keyed to feature
articles in trade journals, particularly advertisements targeting the prepaid
phone card market.
Lottery Terminals Once a state lottery has accepted vending
as a distribution tool, the process is opened to competitive bidding. In the
United States, lottery authorities commence the contract award process by
issuing a request for proposal, which constitutes an invitation for bids from
interested vendors. The requests for proposal usually stipulate certain
requirements, such as product specifications, performance capabilities,
delivery and service requirements. The requests also specify various
insurance, bonding, indemnification and liquidated damage provisions. Each
vendor's reply is evaluated on the basis of various criteria, including bid
price, product quality, performance capability (measured in part by demonstrated
experience in performing comparable projects), security, integrity, and
experience. In addition, state lottery authorities consider the applicant's
affirmative action policies and use of minority, handicapped, and women-owned
subcontractors and suppliers. Lottery authorities also show a preference for
vendors that use in-state subcontractors and suppliers. To assist it's
marketing to state lotteries, the Company has employed registered lobbyists and
paid consultants in certain states. Although the Company believes there
remains a substantial market for lottery terminals, no assurances can be given
that lottery authorities will award new contracts or order additional terminals.
<PAGE>
Due to the particularly sensitive nature and high profile of
gambling activities, state lottery authorities are directed by statute to act
in a manner which promotes and ensures the integrity, security, honesty and
fairness of their operations. Thus, applicants typically must provide detailed
financial and historical information concerning their business operations and
principals, and certain employees must consent to background investigations
DCR Terminals Three distinct groups of potential customers
are primarily targeted by the Company for the sale or lease of DCR terminals:
major telephone companies, medium-sized telephone companies and long-distance
resellers. To the Company's knowledge, the major telephone companies, AT&T,
MCI and Sprint, have not yet implemented any significant marketing plans
involving the use of vending terminals to distribute prepaid phone cards on
a large scale basis. However, the medium-sized telephone groups have been
pursuing vending contracts for prepaid phone cards. Similar to the sales
process with state lotteries, many of these companies seek requests for
proposals from vending companies and require testing prior to awarding
contracts. The contract process permits more flexibility and creativity;
however, it requires greater marketing time and energy to win contracts. Long
distance resellers, smaller telephone companies, and pay telephone route
operators are seeking vending contracts. The Company intends to seek out
additional vertical distributorship and joint venture relationships to increase
its presence in the DCR market place; however, there can be no assurance that
the Company will be successful in developing these relationships.
As part of its effort to increase its presence in the DCR
marketplace, the Company entered into an agreement with the DCR customer
to provide, as amended, up to 2000 DCR terminals under long-term lease
arrangements. Under the arrangement, the Company would be the DCR customer's
exclusive DCR provider. Although the Company realized the DCR customer
was under capitalized, the Company believed the deployment of the DCR
terminals to retail locations under relatively long-term lease agreements with
the DCR Customer would create adequate underlying value to support repayment
of the Company's leases should the DCR Customer fail to pay. As of December
31, 1998, the Company's carrying value for its lease obligations due from the
DCR customer was approximately $6.5 million. During 1998, the DCR customer
was unsuccessful in raising the additional capital necessary to continue
paying its current lease obligations to the Company. As result, the Company
is proceeding with legal action to recover all of the lease amounts owed to
the Company, approximately $9 million. The Company believes the underlying
value of the DCR customer's retail base exceeds the amount owed to its secured
creditors and, therefore, the Company is prepared to acquire the DCR customer
should it seek protection from paying its obligations. The Company believes
that right-sizing the DCR customer and reducing its costs can achieve adequate
cash flow to operate and expand the DCR customer's business. However, there can
be no assurances that the Company can acquire the DCR customer or that cash
flows can be achieved to pay its creditors if acquired. The DCR customer
continues to seek additional financing and to sell its business. The failure
of the DCR customer to raise additional capital or sell its business to a
company able to fund the obligations, or the inability of On-Point to acquire
the DCR customer and generate sufficient cash flows from the business could
have a material adverse effect on the Company's financial results in 1999.
FOREIGN OPERATIONS General Internationally, lottery authorities and
foreign telephone companies do not typically use a formal bidding process,
but rather negotiate proposals with one or more potential vendors. In 1998
the Company delivered terminals to various lotteries and telecommunication
service providers for market testing. Nonetheless, the Company's foreign
operations are relatively small, and no assurance can be provided that a
meaningful international market for the Company's terminals will develop.
Pursuant to an agreement with Vanguard Stratagies, Inc.("VSI"), the
Company agreed to form a subsidiary to transact all international business. The
agreement provided that, upon the occurrence of certain events, including the
Company meeting certain pre tax income requirements, VSI and Mr. Robert L. Burr
would each have the right to acquire 40% of such subsidiary the Company had.
However, on March 19, 1998 the Company and VSI entered into an agreement whereby
the original agreement with VSI referred to above was terminated. Pursuant to
the termination agreement, VSI and Mr. Burr have each been granted options
to purchase 50,000 shares of the Company's common stock at $2.88 per share. The
options expire on December 31, 2002 and vest at the earlier of June 30, 2002
(subject to certain conditions) or March 31 following the fiscal year end
during which cumulative gross revenues for fiscal years beginning in 1998 from
Central and South America exceed $5,000,000.
Brazil In June 1995 the Company entered into a distributor
agreement with a Brazilian corporation, to distribute the Company's products
on an exclusive basis in Brazil. The Company can terminate this agreement
at its option.
Europe In December 1997 the Company entered into a
distributor agreement with Editec, a French Corporation, to distribute
the Company's products on an exclusive basis throughout most of Western Europe.
Mexico The Company purchased a 50% interest in LEI Mexico,
S.A de CV., a Mexican corporation ("LEI Mexico"), for $500 thousand in October
1994 and subsequently wrote down the 50% interest to zero value in 1995.
The Company and LEI Mexico entered into an exclusive distributorship agreement
whereby the Company agreed to only sell machines in Mexico to or through LEI
Mexico and LEI Mexico agreed to use only the Company's equipment in its vending
operations. The Company has now terminated its exclusivity with LEI Mexico
and is exploring various alternatives available in the pursuit of business
opportunities in the Mexican market.
<PAGE>
CUSTOMER DEPENDENCY The Company's products are sold or leased to a limited
number of customers worldwide. As a result, the Company has experienced
fluctuations in its financial results and capital expenditures because of the
timing of significant individual contract awards and customer orders as well
as associated product delivery schedules. The Company's sales cycle can, at
times, be relatively long due to the lead time required for business
opportunities to result in signed sales or lease agreements. In 1998, revenues
from four customers individually exceeded 10% of total revenues and in total
comprised 64% of total revenues. Revenues from three customers individually
exceeded 10% of total revenues in 1997 and in total comprised 57% of total
revenues in 1997.
BACKLOG The Company's backlog of orders at December 31, 1998 totaled
approximately 2,000 ITR terminals and 200 DCR terminals. The rate at which
the Company receives orders from its customers is affected from time to time
by the nature of the Company's market. State lottery authorities are
allocated budgets on an annual basis, and their desire and ability to order
products from vendors, including the Company, can be affected by the status
of the budgetary process at any given time. For example, a lottery which
has not spent its budget as the end of a budgetary year approaches may be
encouraged to place orders with vendors, whereas a lottery which has exhausted
its budget may not be able to place orders until the beginning of a new
budgetary year.
MANUFACTURING AND SUPPLY The Company's lottery and DCR terminals are
designed in a modular form to facilitate manufacturing assembly and
serviceability. The Company uses vendors to manufacture and supply some
components and sub-assemblies, including the bill acceptor and electronic
modules. Final assembly and quality control of the terminals is performed by
Company personnel at its San Marcos facility.
CUSTOMER SERVICE, TRAINING AND PRODUCT REPAIR The Company maintains service
facilities at its San Marcos, California headquarters and in the states of
Connecticut, Missouri, New York, Virginia and Washington. These facilities,
and several smaller ones, oversee installations, coordinate repair, and
respond to service calls. The Company maintains toll-free telephone lines
staffed by service personnel to assist retailers and, where possible, resolve
minor service problems over the telephone. If the problem cannot be resolved
easily, a field technician is immediately paged and a service call scheduled.
Each agreement provides for a specified response or service time. A function
of the field service operation is to provide installation and retailer
training on the operation and use of the machine. The Company generally provides
a warranty period of one year on its terminals and provides an option for an
extended warranty period if purchased by the customer.
The modular designs of the terminals promote cost-effective,
timely repair. All three of the major modular components (the currency
acceptor, ticket dispenser, and electronics module) are easily removed from
the terminal. Service technicians are instructed to replace malfunctioning
components if they are unable to repair a machine within 30 minutes. Any
replaced parts are sent to the service center, where they are examined and
repaired in-house or returned to the manufacturer.
The Company has developed a computer program to identify
dispenser malfunctions from remote locations via the optional Shadow software.
This IBM-compatible program enables a customer to interrogate each ITR or DCR
terminal within a given district to identify problems as diverse as a blocked
or damaged sensor or an inoperable gate mechanism. If a malfunction is
detected, a report is automatically generated, giving the machine location
and serial number, and identifying the type of problem. Although this
technology is available from the Company, to date most customers have elected
not to purchase and install such technology.
Company service technicians also perform routine preventative
maintenance of machines. If required, by agreement, each terminal is subject
to on-site cleaning and diagnostic testing of key components. In addition,
on-site modifications or upgrades may be performed.
The Company's administrative staff closely monitor any problems
with terminals in the field. Service reports are forwarded to engineering,
quality control and production on a weekly and monthly basis. The Field
Service Department is also responsible for pre-installation site surveys to
check for space, telephone service and power.
Since its first contract with the Virginia State Lottery in
1991 the Company has provided services to install, train, repair and perform
preventative maintenance of its products. From 1991 to 1997, the service
function of the Company has expanded as new contracts have required.. The
Company currently provides ITR service in the states of: Connecticut, Delaware,
Missouri, New York, Virginia, and Washington. Service revenues decreased in
1997 primarily due to the termination of a significant customer's Alternative
Lease Agreement with regard to DCR's, which involved a nationwide service
program. Services revenues increased in 1998 primarily from increases in fees
from state lottery contracts.
<PAGE>
COMPETITION The Company believes that it possesses a strong competitive
position in the sale of lottery terminals. The Company has established a
reputation for providing quality terminals and service. As a consequence,
the Company has been able to secure contracts in eleven states, in the
Provinces of Ontario and Quebec and in several other foreign countries,
including France, the largest instant ticket lottery in the world. In
addition, the Company generally enjoys repeat or renewal orders from existing
customers and is conducting tests with overseas lottery organizations. However,
as a result of the proposed merger with Interlott Technologies, Inc. ("ILI"), in
1995 the Company's marketing was impacted as the Company terminated bid
protests and no-bid other contracts due to a belief on the part of management
and the Board of Directors that the merger was going to be consummated and
a consequent desire not to hinder the merger process by competitive actions.
ILI has sold or leased machines in twenty two states, while the next largest
current competitor, International Products of America, has sold machines
pursuant to a contract with one state. Nevertheless, a substantial risk of new
market entrants by domestic and foreign competitors exists. While the Company
believes that it possesses a strong competitive position by virtue of
its proprietary position, installed base and reputation, there can be no
assurance that a better capitalized competitor will not successfully establish
itself in the market or develop a machine which renders the Company's
technology obsolete. The instant ticket market may also face competition
from other types of lottery products.
In the United States, the prepaid phone card and, more
generally, the debit card market is relatively new. Consequently, it is
difficult to identify all the competitors in this market. Nonetheless, the
Company believes it possesses a strong competitive position in the sale of
DCR terminals within the United States and overseas. Currently, the Company
believes it has the largest installed base of DCR terminals in the market
place. At present, the Company's principal competitors are Marketing &
Vending Concepts, ILI, VendTek and Opal. There are a number of smaller
vending machine companies in the market which management believes currently
lack the product quality and reliability to significantly impact its sales
efforts. There is also a substantial risk of additional market entry by
domestic and foreign competitors, especially if the United States customer's
response to the use of debit cards and pre-paid phone cards is favorable.
Internationally, the Company has sold its DCR terminals into Brazil and Hong
Kong. While the Company believes that it possesses an advantage in obtaining
future customers by virtue of its proprietary position and installed base,
there can be no assurance that a better capitalized competitor will not
successfully establish itself in the market or develop a machine which renders
the Company's technology obsolete. The prepaid phone card and debit card
market may also face competition from other types of products.
Management believes the DCR market has become increasingly
competitive, significantly reducing margins. In addition, technological
advances may modify the market over the next few years. Management intends on
reevaluating in 1999 the potential of the DCR market and determine whether new
developments may be necessary to stay competitive and attain a continuing
market share.
RESEARCH AND DEVELOPMENT Research and Development expenditures totaled
$1,405 thousand and $582 thousand in 1998 and 1997, respectively. The 1998
expenditures were primarily directed towards the development of PlayPoint,
together with the associated development of the Company's first counter top
dispenser, CounterPoint. PlayPoint will provide advanced electronic,
software, communication and dispensing capabilities. The Company believes
that its recently developed dispensing system, which will be incorporated
into PlayPoint and CounterPoint, is the most advanced, space efficient and
cost effective dispenser of instant tickets in the world. Patents have been
filed and/or received for PlayPoint's and CounterPoint's proprietary features.
In addition, the PlayPoint cabinet has been ergonomically designed to not only
generate increased impulse purchasing desires, but to fully comply with all
ADA established guidelines.
None of the Company's research and developments costs were borne
directly by the Company's customers. The Company's research and development
department designs hardware and software for new products, and maintains
hardware and software support for existing products. Software is continually
enhanced to satisfy customer requests. Many new features have evolved from
the sales process (e.g., access code requirements, security features such
as alarm and theft detection, report capabilities, and display features).
Once developed, these features generally are incorporated as standard items
in the product line. Software upgrades have included diagnostics for field
service and memory management and configuration control. Hardware
enhancements included features to provide local control, remote control
and speech functions, and memory upgrades for software and data storage.
Other hardware developments have focused on the physical size, look and
ergonomics of the machines, and conformance with the requirements of the
American Disabilities Act.
GOVERNMENT REGULATION Lotteries are not permitted in the United States
unless expressly authorized by legislation in the subject jurisdiction.
Once authorized, the award of lottery contracts and ongoing state operations
are highly regulated. State rules and regulations specify, among other
things, the qualifications of lottery directors, the prize structure, the
allocation of revenue, the types of games and amounts of wagers permitted,
the manner in which the lottery is marketed, and the procedures for
selecting vendors of equipment and services.
<PAGE>
To ensure the integrity of the contract award and subsequent
contract performance, jurisdictions typically conduct background investigations
of, and require detailed disclosure on a continuous basis from, vendors and
their affiliates, subcontractors, officers, directors, and principal
shareholders (including 5% shareholders of publicly traded corporations).
Background investigations of vendors' employees are also generally conducted,
and most states reserve the right to require the removal of employees they
deem to be unsuitable or whose presence they believe may adversely affect the
operational security or integrity of the lottery.
The Federal Gambling Devices Act of 1962 (the "Federal Act")
makes it unlawful for a person to manufacture, deliver or receive gaming
machines or similar devices across interstate lines unless that person has
first registered with the Attorney General of the United States. The Company
has registered under the Federal Act and must renew its registration annually.
The Federal Act also imposes various record keeping and equipment identification
requirements. Violation of the Federal Act may result in seizure or forfeiture
of equipment, as well as other penalties. As of the date of this filing, the
Company believes that it is in substantial compliance with these provisions.
The international jurisdictions in which the Company operates
or intends to market its products have similar legislation and regulations
governing lottery operations. In addition, restrictions are often imposed
on foreign corporations seeking to do business in such jurisdictions.
Failure to comply with these provisions could result in contract cancellation
or the institution of legal proceedings.
The Company has employed registered lobbyists and retained
paid consultants in certain states. Failure to comply with state
regulatory provisions relating to the activities of the Company's advisors
could adversely affect the Company's ability to bid successfully upon lottery
contracts.
It remains unclear what telecommunication regulations, if any,
relate to the sale of prepaid phone cards or to the dispensing of those cards
using vending machines. There appears to be a strong movement towards
requiring certification as a reseller in states where entities sell prepaid
phone cards. Vermont prohibits the sale of these cards from any venue.
In addition, some states subject DCR terminals and machines to use or
similar taxes.
EMPLOYEES As of March 1, 1999, the Company had 106 full-time employees,
of whom 18 were in executive or administrative positions, 19 in quality control
and production, 3 in research and development, 59 in field service, 6 in the
warehouse and 1 in maintenance. In addition, the Company employed 20 people
on a part-time basis in its field service department. None of the Company's
employees are currently represented by a union, and the Company believes that
its relations with its employees are good.
FACILITIES The Company occupies approximately 32,000 square feet of
space in San Marcos, California. The premises include office, manufacturing
and warehouse space. The Company currently pays monthly rent of $15,663 for
this space. This lease terminates January 31, 2009. The Company believes that
its facilities are adequate to meet its anticipated needs through the term
of the lease.
ITEM 2. DESCRIPTION OF PROPERTIES
At March 1, 1999 the Company had the following properties under lease:
Office, manufacturing, R & D and warehouse space in San Marcos, California
at an annual rent of $187,956 through January 31, 2009.
Office, repair depot and warehouse space in Syracuse, New York on a
month-to-month basis at an annual rent of $13,200.
Office, repair depot and warehouse space in Arnold, Missouri at an annual
rent of $9,903 through October 2001.
Office, repair depot and warehouse space in Richmond, Virginia at an annual
rent of $24,373 through July 2002.
Office, repair depot and warehouse space in Olympia, Washington at an annual
rent of $9,600 through June 1999.
<PAGE>
ITEM 3. LEGAL PROCEEDING
The Company is a party to legal proceedings in the ordinary course
of its business, the most significant of which are described below.
On January 11, 1999, the Company filed an action against
Solutioneering, Inc. in Superior Court of California, County of San Diego.
A first amended complaint of said action was filed on February 9, 1999.
The action arises from the lease to Solutioneering, Inc. of 2,175 prepaid
phone card vending terminals under a March 1, 1995 Master Lease Agreement
and two amendments thereto (the "Agreement"). In the action, the Company
asserts that Solutioneering, Inc. has breached the Agreement and the Company
has claimed damages of approximately $9 million. The Company's net balance
sheet carrying value of the Solutioneering Inc. leased machines at December 31,
1998, is approximately $6.5 million. The Company believes the underlying
value of Solutioneering, Inc.'s retail base exceeds the amount owed to its
secured creditors and, therefore, the Company is prepared to acquire
Solutioneering, Inc. should it seek protection from paying its obligations.
The Company believes that right-sizing Solutioneering, Inc. and reducing its
costs can achieve adequate cash flow to operate and expand Solutioneering,
Inc.'s business. However, there can be no assurances that the Company can
acquire Solutioneering, Inc. or that cash flows can be achieved to pay its
creditors if acquired. Solutioneering, Inc. continues to seek additional
financing and to sell its business. The failure of Solutioneering, Inc. to
raise additional capital or sell its business to a company able to fund the
obligations, or the inability of On-Point to acquire Solutioneering, Inc.
and generate sufficient cash flows from the business could have a material
adverse effect on the Company's financial results in 1999.
On January 23, 1996, the Company's principal competitor, Interlott
Technologies, Inc. ("ILI"), filed a civil action against the Company in the
Common Pleas Court of Hamilton County, Ohio. The action arose from an
agreement in principle between Interlott Technologies, Inc. and the Company
which was signed on March 23, 1995 regarding a proposed merger transaction.
The Company asserted a counterclaim against ILI seeking declaratory judgement
with regard to certain aspects of the agreement, seeking to recover the
Company's own costs and expenses, and seeking compensatory damages from ILI
for certain competition and torturous interference with business relations.
The parties reached a full and complete settlement of this action on March 4,
No liability was admitted by either party pursuant to the settlement
and the settlement had no material adverse effect on the Company's results
of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
None.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
a) The Company's common stock is traded in the over-the-counter
market (NASDAQ symbol: ONPT). The following table sets forth the high and
low bid prices for the Company's common stock, as reported on NASDAQ, for the
quarters presented. The bid prices represent inter-dealer quotations, without
adjustments for retail mark-ups, mark-downs or commissions and may not
necessarily represent actual transactions.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Fiscal 1998 Fiscal 1997
High Low High Low
---- --- ---- ---
First Quarter 3 13/16 1 3/4 2 1/32 5/8
Second Quarter 3 1 3/4 3 1 3/16
Third Quarter 2 1/16 1 9/32 2 13/16 1 5/8
Fourth Quarter 2 9/16 1 3 1/4 1 5/8
</TABLE>
b) The number of stockholders of record of the Company's common
stock, par value $.01 per share, as of March 5, 1999, was 289. The
approximate number of beneficial shareholders is 2400.
c) The Company has never paid any cash dividends on its common
stock and does not anticipate that it will do so in the foreseeable future.
The future payment of dividends, if any, on the common stock is within the
discretion of the Board of Directors and will depend on the Company's
earnings, its capital requirements, financial condition and other relevant
factors.
Following are unregistered sales of securities issued by the
Registrant during the last three years. These securities were issued pursuant
to Section 4(2) of the Securities Act of 1933, as amended. No placement agent
was engaged in connection with such issuances and no commissions or discounts
were paid to any person.
<PAGE>
In January and July 1996, Vanguard Strategies, Inc. received
warrants to purchase 450,000 and 250,000 shares, respectively, of the
Company's Common Stock at $.60 and $.69, respectively, pursuant to a
consulting agreement entered into with the Company. Mr. Sandvick, Chief
Executive Officer of the Company, is the President and principal shareholder
of Vanguard Strategies, Inc. The warrants have a five year term and warrants
to purchase 200,000 shares became exercisable in January 1996 and warrants
to purchase 500,000 shares became exercisable in July 1996.
In August 1996, Metal Masters, Inc. received warrants to purchase
165,000 shares of the Company's Common Stock at $.69 pursuant to a settlement
of a legal action. The warrants became exercisable in August 1996 and 100,000
shares had a one year term and 65,000 shares had a two year term. All of the
warrants have been exercised.
In January 1997, Frederick Sandvick, Chief Executive Officer of
the Company, received a warrant to purchase 500,000 shares of the Company's
Common Stock at $.63 per share pursuant to his personal guaranty and indemnity
in connection with a $2,000,000 performance bond. The warrant has a five year
term and became exercisable in January 1997.
In January 1997, Vanguard Strategies, Inc. received a warrant to
purchase 250,000 shares of the Company's Common Stock at $.72 per share
pursuant to a consulting agreement entered into with the Company. The
warrant has a five year term and became exercisable in January 1997.
In January 1997, S & H Systems, Inc. received a warrant to
purchase 4,000 shares of the Company's Common Stock at $1.00 per share
pursuant to a consulting agreement entered into with the Company. The
warrant has a four year term and became exercisable in January 1997.
In May 1997, GMB Capital Partners received a warrant to
purchase 45,000 shares of the Company's Common Stock at $2.52 per share
in consideration for facilitating financing for the Company. The warrant
as a three year term and became exercisable in May 1997.
In May 1997, Coast Business Credit received a warrant to purchase
50,000 shares of the Company's Common Stock at $2.00 per share pursuant to
a financing agreement entered into with the Company. The warrant has a
three year term and became exercisable in May 1997.
In May 1997, Capital Structures Corporation and Colliers
Iliff Thorn each received a warrant to purchase 25,000 shares of the
Company's Common Stock at $1.24 per share pursuant to a commission
settlement agreement entered into with the Company. The warrants had
a one year term and have been exercised.
In January 1998, Vanguard Strategies, Inc. and Mr. Robert L.
Burr, former Chairman of the Board and former President and Chief Executive
Officer, were each granted stock options for 50,000 shares of the Company's
Common Stock at $2.88 per share pursuant to an agreement to terminate their
respective rights in the Company's international operations. The options
expire on December 31,2002 and vest the earlier of June 30, 2002 (subject to
certain conditions) or March 31 following the fiscal year end during which
cumulative gross revenues for fiscal years beginning in 1998 from Central and
South America exceed $5,000,000.
In April 1998, Darius Anderson and James Bouskos each received
an option to purchase 10,000 shares of the Company's Common Stock at $2.09
per share pursuant to their appointment as Advisory Directors. The options
vest by April 1999 and expire in April 2001.
In May 1998, Allan Halladay and Brian Roberts each received an
option to purchase 50,000 shares of the Company's Common Stock at $2.09 per
share pursuant to their assignment of certain intellectual property to the
Company. The options vest the earlier of April 1, 2001 or upon the
satisfaction of certain performance conditions. The options expire on
December 31, 2001.
In July 1998, Coast Business Credit received a warrant to
purchase 10,000 shares of the Company's Common Stock at $1.63 per share pursuant
to an amendment to a financing agreement entered into with the Company. The
warrant became exercisable in July 1998 and expires on May 5, 2000.
In September 1998, Elizabeth Williams received an option to
purchase 5,000 shares of the Company's Common Stock at $1.66 per share pursuant
to a consulting agreement entered into with the Company. The option vests
over 2 years and expires on September 30,2003.
In October 1998, Robert Burr received an option to purchase
50,000 shares of the Company's Common Stock at $2.00 per share pursuant to
his consulting agreement with the Company. The option vests on March 31,
2001, or earlier, if certain conditions are met. The option expires on
September 30, 2001.
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General The Company's revenues through 1998 have been generated from
(i) sales of vending terminals (ii) leases of vending terminals (iii)
performance of service on vending terminals, and (iv) sales of associated
parts.
The Company's products are sold or leased to a limited number
of customers worldwide. As a result, the Company has experienced fluctuations
in its financial results and capital expenditures because of the timing
of significant individual contract awards and customer orders as well as
associated product delivery schedules. The Company's sales cycle can, at
times, be relatively long due to the lead time required for business
opportunities to result in signed sales or lease agreements. Operating
results may be affected by such lead time as well as working capital
requirements associated with manufacturing vending terminals pursuant to
new orders, increased competition, and the extended time which may elapse
between the customer's firm order and the receipt of revenue from the sale
or lease of the applicable vending terminals. In addition, there has been
an accelerating trend by customers to lease rather than purchase vending
terminal equipment. Leasing vending terminals requires the Company to
invest capital or otherwise finance the manufacture of the vending terminals.
The Company has obtained the resources necessary to finance its expanding base
of leased terminals over the past two years through its line of credit, as well
as through its existing cash flow and equity financing.
1998 COMPARED TO 1997 1998 revenues declined by approximately $1 million
or 6% from 1997, due to a lower number of vending terminal sales under sales
or sales-type lease arrangements. This reduction occurred because of delays
in certain contract proposals. In total, the Company installed or shipped
approximately 1600 units in 1998 versus approximately 2900 units in 1997,
a decrease of approximately 1300 units. Partially offsetting this decline was
an approximate $700 thousand, or 15%, increase in service revenues. Operating
lease revenue remained constant at a level of approximately $3.5 million.
Cost of revenues, as a percentage of sales, improved by 2
percentage points from 72% in 1997 to 70% in 1998 due to slightly favorable
gross margins combined with favorable manufacturing variances. Management
anticipates that margins will decrease in 1999 as a result of increased
competitive pressures on bid prices. However, the Company anticipates
introducing its next generation lottery products in the summer of 1999 partly
in response to the competitive pressures on its existing products.
Operating expenses, as a percentage of sales, increased by 6
percentage points, due primarily to the $823 thousand increase in research
and development as a result of increased new product development activities.
The Company anticipates continued increased development efforts until the
introduction of its next generation lottery products in 1999. Thereafter,
the extent of its development efforts will depend on management's evaluation
of the positioning of its other products.
As a result of the above factors, 1998 income from operations
of approximately $860 thousand represents a decline of $868 thousand from the
1997 operating income of approximately $1.7 million.
Total other income and expense improved by $764 thousand in
1998 with: interest income up $667 thousand due to greater amortization of
unearned income on sales type leases, lower interest expense by $181 thousand
due primarily to reduced borrowings, and lower "other" costs by $143 thousand
reflecting decreased losses on asset disposals. It is anticipated interest
income will decrease in 1999 as a result of reduced amortization of unearned
income in sales type leases.
As a net result of the above described factors, the Company generated
$1,711 thousand of net income in 1998, an increase of $139 thousand from 1997.
LIQUIDITY AND CAPITAL RESOURCES In 1998 the Company generated approximately
$2.8 million of net cash from operating activities which, when combined with
the approximate $2.2 million of net cash provided by financing activities
and approximately $100 thousand reduction in cash and cash equivalents,
was used for investing activities. In 1997 the Company generated
approximately $300 thousand of net cash from operating activities which,
when combined with the approximate $2.5 million of net cash provided by
financing activities and approximately $200 thousand reduction in cash
and cash equivalents, was used for investing activities. The principal
investing activity in 1998 and 1997 was the net payment of costs associated
with the equipment underlying long term lease agreements, both sales type
and operating, which totaled approximately $4.9 million in 1998 and $2.9
million in 1997. Working capital of approximately $4.1 million at December 31,
1998 represents an increase of approximately $1 million over the approximate
$3.1 million at December 31, 1997.
The Company completed an equity financing and a debt financing
during the second quarter of 1997. The equity financing was a private
placement of $800 thousand of equity Units. The Units consisted of one share
of Common Stock of the Company per $0.75 of equity investment, one-half Class
A Warrants per $1.00 of equity investment and one Class B Warrant per $1.00
of equity investment. Each Class A Warrant was exercisable to purchase one
share of Common Stock at a price of $1.25 per share for a period of one year
while each Class B Warrant is exercisable to purchase one share of Common
Stock at a price of $2.00 per share expiring March 18, 1999. Net proceeds
to the Company from the private placement approximated $673 thousand in 1997.
The Company received $911 thousand in cash in 1998 from the exercise of
warrants from the private placement. On May 5, 1997, the Company entered
into a Loan and Security Agreement for a revolving line of credit whereby
the Company could borrow up to $3 million. Such agreement was amended on
July 7, 1998 to increase the borrowing limit to $5 million. The loan bears
interest at prime plus 2%, which is reduced by .5% annually if the Company
meets certain performance benchmarks, matures on March 31, 2000 and is
secured by virtually all of the Company's assets. At December 31, 1998,
the Company had borrowed approximately $3.9 million under this Agreement.
<PAGE>
Management believes the Company has sufficient liquidity because
of its existing stream of contractual lease payments, its current working
capital, and its available borrowings under its $5 million debt financing
to maintain its current level of operations. However, in order to
accommodate recent contract awards, totaling approximately $27 million,
together with other growth related opportunities in 1999 and beyond, the
Company plans to seek additional financing during 1999.
IMPACT OF INFLATION Inflation has not had any significant effect on the
Company's operating costs. However, the sales price, lease payment and
service fees contained in the Company's agreements with various states are
fixed and the Company will be unable to pass along any increases in
manufacturing and service costs during the term of these agreements.
SEASONALITY OF BUSINESS The Company's operations may be affected by the
fiscal year ends of its state lottery customers, which generally occur on
June 30. States which have a surplus of funds available prior to year-end
may accelerate their purchases of new equipment, while states which experience
a shortage of funds available may delay their purchases until the next fiscal
year.
YEAR 2000 COMPLIANCE As is the case with most other companies using computers
in their operations, the Company is in the process of addressing the year
2000 problem. In 1997 the Company set up a committee to review its computer
software and hardware, fax machines and telephones systems for year 2000
compliance.
The Company's primary accounting and operational software
provider has received year 2000 certification from the Information Technology
Association of America. During 1998 the Company tested its central network
system hardware and software as well as the hardware and software of each
of its computer workstations. As a result, minor expenditures, under $25
thousand total cost, have been made to upgrade certain computer hardware,
PC software and fax equipment to make them year 2000 compliant. The
Company believes that it is now year 2000 compliant with respect to its
existing computer hardware, software and fax equipment and, therefore,
believes that potential risks, including any potential third party risks,
relating to year 2000 issues to be minimal. The Company's telephone system
was not year 2000 compliant at December 31, 1998 and was upgraded in March
1999 at a cost of $13 thousand.
ITEM 7. CONSOLIDATED FINANCIAL STATEMENTS
The Consolidated Financial Statements are filed as part of this
Annual Report on Form 10-KSB.
<PAGE>
INDEPENDENT AUDITORS' REPORT
----------------------------
To the Board of Directors and Shareholders of On-Point Technology Systems,
Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of On-Point
Technology Systems, Inc. and subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the two years in the period ended
December 31, 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, such financial statements present fairly, in all material
respects, the financial position of On-Point Technology Systems, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the two years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
Deloitte & Touche LLP
San Diego, California
March 25, 1999
<PAGE>
<TABLE>
<CAPTION>
On-Point Technology Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31,
-----------------
Assets Thousands of dollars, except share amounts 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $129 $273
Accounts receivable, net 2,744 1,961
Inventories 3,143 2,704
Net investment in sales-type leases 1,586 1,638
Other current assets 122 88
- -------------------------------------------------------------------------------
Total current assets 7,724 6,664
- -------------------------------------------------------------------------------
Plant, property and equipment, net 422 582
Net investment in sales-type leases 8,911 5,364
Property held for operating leases, net 2,013 2,657
Other assets 502 768
- -------------------------------------------------------------------------------
Total assets $19,572 $16,035
===============================================================================
Liabilities and shareholders' equity
- -------------------------------------------------------------------------------
Current liabilities:
Accounts payable $1,190 $1,118
Current portion of long term debt 104 277
Accrued expenses 2,301 2,134
- -------------------------------------------------------------------------------
Total current liabilities 3,595 3,529
- -------------------------------------------------------------------------------
Other liabilities 100 757
- -------------------------------------------------------------------------------
Long-term debt 3,872 2,371
- -------------------------------------------------------------------------------
Shareholders' Equity:
Preferred stock, no par value, 2,000,000 shares
authorized, no shares issued or outstanding - -
Common stock, $.01 par value, 20,000,000 shares
authorized, 10,094,826 and 9,421,255 shares issued and
outstanding, respectively 101 94
Additional paid-in capital 30,939 30,030
Accumulated deficit (19,035) (20,746)
- --------------------------------------------------------------------------------
Total shareholders' equity 12,005 9,378
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity $19,572 $16,035
================================================================================
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
On-Point Technology Systems, Inc. and Subsidiaries
Consolidated Statements of Operations
Years ended December 31,
Thousands of dollars/shares, except per share amounts 1998
1997
- --------------------------------------------------------------------------------
- ------------
<S> <C>
<C>
Revenues $16,416
$17,439
Cost of revenues 11,538
12,566
- --------------------------------------------------------------------------------
- ------------
Gross profit 4,878
4,873
- --------------------------------------------------------------------------------
- ------------
Operating expenses:
Selling, general and administrative 2,613
2,563
Research and development 1,405
582
- --------------------------------------------------------------------------------
- ------------
Total operating expenses 4,018
3,145
- --------------------------------------------------------------------------------
- ------------
Income from operations 860
1,728
- --------------------------------------------------------------------------------
- ------------
Other income (expense):
Interest income 1,125
458
Interest expense (237)
(418)
Other (17)
(160)
- --------------------------------------------------------------------------------
- ------------
Total other income (expense) 871
(120)
- --------------------------------------------------------------------------------
- ------------
Income before provision for income taxes 1,731
1,608
Provision for income taxes 20
36
- --------------------------------------------------------------------------------
- ------------
Net income $1,711
$1,572
================================================================================
============
Earnings per share:
Basic:
Earnings per share $0.17
$0.17
================================================================================
============
Weighted average shares 9,882
9,011
================================================================================
============
Diluted:
Earnings per share $0.15
$0.15
================================================================================
============
Weighted average shares 11,672
10,839
================================================================================
============
See accompanying notes to consolidated financial statements
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
On-Point Technology Systems, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
Common Stock Additional
----------- Paid-in
Accumulated
Thousands shares/dollars Shares Amount Capital
Deficit Total
- --------------------------------------------------------------------------------
- ---------------------------
<S> <C> <C> <C>
<C> <C>
Balance, January 1,1997 8,187 $82 $29,157
($22,318) 6,921
- --------------------------------------------------------------------------------
- ---------------------------
Warrants issued in compensation
for services - - 75
- - 75
Issuance of common stock, net of
$116 issuance costs 1,067 11 673
- - 684
Exercise of stock warrants 142 1 100
- - 101
Exercise of stock options 25 - 25
- - 25
Net income - - -
1,572 1,572
- --------------------------------------------------------------------------------
- ---------------------------
Balance, December 31, 1997 9,421 94 30,030
(20,746) 9,378
- --------------------------------------------------------------------------------
- ---------------------------
Exercise of stock warrants 669 7 904
- - 911
Exercise of stock options 5 0 5
- - 5
Net income - - -
1,711 1,711
- --------------------------------------------------------------------------------
- ---------------------------
Balance, December 31, 1998 10,095 $101 $30,939
($19,035) $12,005
================================================================================
==========================
See accompanying notes to consolidated financial statements
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
On-Point Technology Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended December 31,
- -------------------------
Thousands of dollars
1998 1997
- --------------------------------------------------------------------------------
- -------------------------
<S> <C>
<C>
Cash flows from operating activities
Net income
$1,711 $1,572
Adjustments to reconcile net income to net cash provided
by (used for) operating activities:
Depreciation and amortization
1,376 1,489
Non-cash charges, primarily changes in reserves
1,135 (45)
Changes in assets and liabilities:
Accounts receivable
(642) (627)
Inventories
(439) (247)
Accounts payable
72 (1,563)
Accrued expenses
(625) (275)
Deferred income
- - (518)
Other
165 551
- --------------------------------------------------------------------------------
- --------------------------
Net cash provided by operating activities
2,753 337
- --------------------------------------------------------------------------------
- --------------------------
Cash flows from investing activities:
Purchases of plant, property and equipment
(283) (176)
Net investment in sales-type leases
(4,636) (1,607)
Investment in property held for operating leases
(303) (1,305)
Fixed asset disposals
81 99
- --------------------------------------------------------------------------------
- -------------------------
Net cash used for investing activities:
(5,141) (2,989)
- --------------------------------------------------------------------------------
- --------------------------
Cash flows from financing activities:
Proceeds from exercise of stock warrants and options
916 810
Proceeds from debt financing
- - 655
Proceeds from line of credit, net
1,605 2,267
Repayment of notes payable
(277) (1,311)
- --------------------------------------------------------------------------------
- --------------------------
Net cash provided by financing activities
2,244 2,421
- --------------------------------------------------------------------------------
- --------------------------
Decrease in cash and cash equivalents
(144) (231)
- --------------------------------------------------------------------------------
- --------------------------
Cash and cash equivalents at beginning of period
273 504
- --------------------------------------------------------------------------------
- --------------------------
Cash and cash equivalents at end of period
$129 $273
================================================================================
=========================
Supplemental cash flow information;
Cash paid during the period for interest
$306 $281
Cash paid during the period for income taxes
$117 $27
================================================================================
==========================
See accompanying notes to consolidated financial statements
</TABLE>
<PAGE>
ON-POINT TECHNOLOGY SYSTEMS, INC. AND SUBSIDIARIES
--------------------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
YEARS ENDED DECEMBER 31, 1998 AND 1997
--------------------------------------
1. Summary of Significant Accounting Policies
Organization On-Point Technology Systems, Inc. and subsidiaries,
formerly Lottery Enterprises, Inc. (collectively, the "Company" or "On-Point")
designs, manufactures, and services vending terminals for the retail sale and
leasing of instant-winner lottery tickets (the "Instant Ticket Retailer" or
"ITR*") and for the retail sale and leasing of prepaid telephone calling cards
(the "Debit Card Retailer" or "DCR*"). The ITR terminals are sold or leased
to state and provincial governments in the United States and Canada and to
foreign governments and their licensees. DCR terminals are generally sold
or leased to commercial customers.
Liquidity The Company completed an equity financing and a debt
financing in 1997. The equity financing was a private placement of $800
thousand of equity Units. The Units consist of one share of Common stock of
the Company per $0.75 of equity investment, one-half Class A Warrant per $1.00
of equity investment and one Class B Warrant per $1.00 of equity investment.
Each Class A Warrant is exercisable to purchase one share of Common Stock at
a price of $1.25 per share for a period of one year while each Class B Warrant
was exercisable to purchase one share of Common Stock at a price of $2.00 per
share expiring March 18, 1999. Net proceeds to the Company in 1997 from the
private placement approximated $673 thousand. The Company received $911
thousand in cash in 1998 from the exercise of warrants from the private
placement. On May 5, 1997, the Company entered into a Loan and Security
Agreement for a revolving line of credit whereby the Company could borrow up
to $3,000,000. Such agreement was amended on July 7, 1998 to increase the
borrowing limit to $5,000,000. The loan bears interest at Prime plus 2%
which is reduced by .5% annually if the Company meets certain performance
benchmarks, matures on March 31, 2000 and is secured by virtually all of the
Company's assets. At December 31, 1998, the Company had borrowed approximately
$3.9 million under this Agreement.
Management believes the Company has sufficient liquidity because
of its existing stream of contractual lease payments, its current working
capital, and its available borrowings under its $5 million debt financing
to maintain its current level of operations. However, in order to accommodate
recent contract awards, totaling approximately $27 million, together with
other growth related opportunities in 1999 and beyond, the Company plans to
seek additional financing during 1999.
Principles of Consolidation The consolidated financial
statements include the accounts of the Company and all majority owned
subsidiaries after elimination of all significant inter-company balances
and transactions. Investments of 50 percent or less in affiliated companies
are accounted for on the equity method.
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.
Cash and Cash Equivalents Cash equivalents consist of highly
liquid investments purchased with original maturities of three months or
less and which are readily convertible into cash.
Accounts Receivable Accounts receivable consists of amounts due
to the Company from its normal business activities. The Company maintains an
allowance for doubtful accounts to reflect the expected uncollectibility of
accounts receivable based on collection history. The Company's concentration
of credit risk related to accounts receivable balances is limited due to the
geographical diversity of customers making up the Company's customer base,
thus spreading the credit risk. Bad debt expense was $(1) thousand and $62
thousand in 1998 and 1997, respectively.
Included in accounts receivable are unbilled receivables
representing amounts billable in accordance with specific contract terms.
Substantially all unbilled receivables at December 31, 1998 are expected
to be collected within one year.
Inventories Inventories include the cost of material, direct
labor, manufacturing overhead, parts and supplies, and terminals assembled
or in the process of assembly. Inventories are stated at the lower of cost,
on a first-in, first-out basis or market.
Property, Plant and Equipment Property, plant and equipment are
stated at cost. Depreciation is provided using the straight-line method, over
estimated useful lives of 2 to 10 years. Maintenance and repairs are expensed
as incurred.
<PAGE>
Revenue Recognition and Significant Customers Revenues from
terminal sales are recognized when terminals are shipped or installed in
accordance with the terms of specific contracts.
Revenues from sales-type leases are recognized at the present
value of the future minimum payments for terminals, when such terminals are
shipped or installed. The difference between the total future minimum
payments plus the residual value of the equipment and the present value of
such amounts is recorded as unearned income and amortized over the term of
the lease so as to produce a constant rate of return. Any unearned income
is recognized immediately upon the sale of the associated lease receivable.
The Company also leases products under leases accounted for as
operating leases. Terminals under operating leases are recorded net of
accumulated depreciation. Assets under operating leases are depreciated to
their residual value over four years. Income from operating leases is
recognized as rentals become receivable according to provisions of the leases.
Revenues arising from the sale of service and maintenance
contracts are recognized ratably over the terms of the individual contracts.
Any estimated losses on such contracts are charged to operations when
identified.
The Company's 1998 revenues include ITR sales and service to
the state lottery of Virginia, to the state lottery of Illinois, to the
State Lottery of Washington and to a DCR customer, Solutioneering
Inc., a telecommunications industry company that markets prepaid phone cards.
Revenues from each of these customers individually exceeded 10% of total
revenues in 1998 and in total comprised 64% of total revenues in 1998.
Amounts receivable from these customers represented 73% of accounts
receivable as of December 31, 1998. One DCR customer, Solutioneering
Inc., represents 59% of the net investment in sales-type leases at December 31,
1998. The Company's 1997 revenues include ITR sales and service to the state
lottery of Virginia, to the state lottery of Illinois, and to a DCR customer,
Solutioneering. Revenues from each of these customers individually
exceeded 10% of total revenues in 1997 and in total comprised 56% of total
revenues in 1997. Amounts receivable from these customers represented 44% of
accounts receivable as of December 31, 1997.
Research and Development Research and development costs are
expensed as incurred.
Income Taxes Deferred income taxes are recorded to reflect
the tax consequences on future years of differences between the tax basis
of assets and liabilities and their financial reporting amounts at each
year-end. If it is more likely than not that some portion or all of a
deferred income tax asset will not be realized, a valuation allowance is
recognized.
Per Share Information In February 1997, the Financial
Accounting Standards Board issued Statement of Financial Accounting
Standards ("SFAS") No. 128 "Earnings per Share" establishing standards
for computing and presenting Basic Earnings Per Share ("Basic EPS") and
Diluted Earnings Per Share ("Diluted EPS"). Basic EPS is computed on the
basis of the weighted average shares of common stock outstanding plus
contingently issuable shares. Diluted EPS is computed on the basis of
weighted average shares outstanding plus contingently issuable shares
and the additional common shares that would have been outstanding if
dilutive potential common shares had been issued, using the treasury stock
method.
Statement of Financial Accounting Standards No. 123 In October
1995, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards ("SFAS") No. 123 "Accounting for Stock-Based
Compensation." SFAS No. 123 requires expanded disclosures for the stock-based
compensation arrangements with employees and encourages (but does not require)
compensation cost to be measured based on the fair value of the equity
instrument awarded. Companies are permitted, however, to continue to
apply APB Opinion No. 25, "Accounting for Stock Issued to Employees,"
which recognizes compensation cost based on the intrinsic value of equity
instrument awarded. The Company elected to continue to apply APB Opinion No.
25 to its stock based compensation awards to employees and has disclosed
the pro forma effect on net income and earnings per share.
Fair Value of Financial Instruments and Concentration of Credit
Risk The following disclosure of estimated fair value was determined by
available market information and appropriate valuation methodologies;
however, considerable judgment is necessary to interpret market data and
develop the related estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts that could
be realized upon disposition of the financial instruments. The use of
market assumptions and or estimation methodologies may have a material
effect on estimated fair value amounts.
Cash and cash equivalents, accounts receivable, inventories,
investment in sales type leases, accounts payable and accrued expenses
carrying cost reasonably approximates their fair value because of the short
maturities of these investments.
Other assets are carried at cost or net amortized cost, which,
in management's opinion, is less than fair value.
The Company believes that the carrying amount of its outstanding
notes payable at December 31, 1998 and 1997 is a reasonable estimate of their
fair value. This was determined based on a review of borrowing rates available
to the Company at December 31, 1998 and 1997 for loans with similar terms and
average maturities.
<PAGE>
The Company periodically assesses its ability to recover the
carrying value of its long-lived assets. If management concludes that the
carrying value will not be recovered, an impairment write down is recorded
to reduce the asset to its estimated fair value.
2. Other Financial Data Following are details concerning certain
balance sheet accounts as of December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998
1997
----
- ----
<S> <C>
<C>
Accounts receivable:
Trade billed $2,605
$1,861
Trade unbilled 291
394
------
- ------
2,896
2,255
Less allowance for doubtful accounts (152)
(294)
-------
- -------
Total $2,744
$1,961
=======
======
Inventories:
Materials $2,299
$1,844
Work-in-process 274
220
Finished goods 570
640
------
- ------
Total $3,143
$2,704
======
======
Property, plant and equipment:
Computers and equipment $1,236
$1,162
Furniture and fixtures 325
332
Tooling 248
324
Building and improvements 51
37
------
- ------
1,860
1,855
Less accumulated depreciation (1,438)
(1,273)
-------
- -------
Total $422
$582
======
======
Other assets:
Patents $715
$677
Software development costs 268
268
Deposits 134
628
Other 332
136
------
- ------
1,449
1,709
Less accumulated amortization (947)
(941)
=======
======
Total $502
$768
</TABLE>
3. Notes Payable Notes payable at December 31, 1998 and 1997
consists of notes aggregating $3,976,000 and $2,648,000, respectively.
The notes bear interest at rates ranging from 9% to 10%. Included in
notes payable is a Loan and Security Agreement entered into by the
Company on May 5, 1997 for a revolving line of credit whereby the Company
could borrow up to $3,000,000. Such agreement was amended on July 7, 1998
to increase the borrowing limit to $5,000,000. The loan bears interest
at prime plus 2%, or 9.75% at December 31, 1998, which is reduced by .5%
annually if the Company meets certain performance benchmarks, matures
on March 31, 2000 and is secured by virtually all of the Company's assets.
At December 31, 1998, the Company had borrowed approximately $3.9 million
under this Agreement.
<PAGE>
Future principal payments on notes payable as of December 31,
1998, are as follows (in thousands):
<TABLE>
<CAPTION>
Year ending December 31,
<S> <C>
1999 $104
2000 3,872
-----
$3,976
======
</TABLE>
4. Other Liabilities Other liabilities at December 31, 1998 and
1997 included $100 thousand and $757 thousand, respectively, of various
accrued expenses payable at dates beyond December 31, 1999 and 1998,
respectively.
5. Operating Leases The Company leases certain of its vending
terminals to customers under agreements accounted for as operating leases.
The net investment in vending terminals held under operating leases at December
31, 1998 and 1997 consisted of approximately $5.3 million and $5.1 million,
respectively, less accumulated depreciation and reserves of approximately
$3.3 million and $2.4 million at December 31, 1998 and 1997, respectively.
Approximate future minimum lease payments receivable by the
Company under operating leases as of December 31, 1998, are as follows
(in thousands):
<TABLE>
<CAPTION>
Year ending December 31,
<S> <C>
1999 $1,803
2000 54
------
$1,857
======
</TABLE>
6. Sales-Type Leases The Company leases certain of its vending
terminals under agreements accounted for as sales-type leases. Included
in product sales are approximately $4 million and $5 million of revenues
related to sales-type leases for the years ended December 31, 1998 and
1997, respectively. These non-cancelable leases expire over the next
one to five years.
The following lists the components of the net investment
in sales-type leases as of December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
1998 1997
---- ----
Total minimum lease including service payments to
be received $13,308 $9,453
Less amounts representing estimated executory
costs, including profit (828) (830)
-------- ------
Net minimum lease payments receivable 12,480 8,623
Estimated unguaranteed residual value 1,278 1,071
Less unearned interest income (2,054) (2,418)
Less reserves for sales-type leases (1,207) (274)
------- -------
Net investment in sales-type leases $10,497 $7,002
======= =======
</TABLE>
<PAGE>
Future minimum lease including service payments due from customers
under sales-type leases as of December 31, 1998, are as follows (in thousands):
<TABLE>
<CAPTION>
Year ending December 31,
<S> <C>
1999 $3,100
2000 6,711
2001 2,136
2002 1,152
2003 209
-------
$13,308
=======
</TABLE>
The amortization of unearned income for sales-type leases
amounted to approximately $1,029 thousand and $458 thousand for the years
ended December 31, 1998 and 1997, respectively, which is included in
interest income.
7. Income Taxes Following is a reconciliation of the income
tax benefit expected (based on the statutory federal income tax rate)
to the actual income tax provision recorded (in thousands):
<TABLE>
<CAPTION>
1998
1997
------
- ------
<S> <C>
<C>
Tax benefit (expense) computed at the statutory federal
rate of 34% $(589)
$(547)
State income tax benefit, net of federal income tax effect (103)
(95)
Expenses not deductible for income tax
purposes (6)
(9)
Change in valuation allowance for
deferred income tax assets 678
615
------
- ------
Provision for income taxes $(20)
$(36)
======
</TABLE>
Deferred income tax assets and the related valuation allowance as of December
31, 1998 and 1997, result from the
following temporary differences:
<TABLE>
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
Net operating loss carryforwards $3,157 $2,411
Inventory and other reserves 2,092 3,516
Valuation allowance (5,249) (5,927)
------
Net deferred income tax assets $- $-
======
</TABLE>
Management believes future taxable income of the Company may
be adequate to utilize a portion of the Company's net operating loss
carryforwards and realize a portion of the related deferred income tax
asset. However, due to significant losses for income tax reporting
purposes prior to 1998 as well as the other issues currently being
addressed by the Company, management has concluded that a valuation
allowance is needed to reduce the carrying value of deferred income
tax assets to zero.
At December 31, 1998, the Company has $14.2 million of
operating loss carryforwards and net deferred income tax assets consisting
of current federal income tax loss carryforwards of approximately $9
million available to offset future federal taxable income which expire
during the years 2011 through 2018 and net deferred income tax assets
of approximately $5.2 million.
8. Shareholders' Equity
Preferred Stock The Company is authorized to issue up to
two million shares of preferred stock without further shareholder approval;
the rights, preferences and privileges of which would be determined at the
time of issuance.
Stock Option Plans The Company has employee option plans
whereby options to purchase 1,972,500 shares of the Company's common
stock may be granted to certain employees, and an option plan for directors
under which options for 525,000 shares of the Company's common stock may be
issued to directors of the Company.
<PAGE>
The Company has three fixed option plans which reserve shares
of common stock for issuance to executives, key employees and directors.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Accordingly, no compensation
cost has been recognized for the stock option plans. Had compensation for
the Company's three stock option plans been determined based on the fair
value at the grant date for awards in 1998 and 1997 consistent with the
provisions of SFAS No. 123, the Company's net earnings and earnings per
share would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997
Net Per Share Net Per Share
Earnings Basic Diluted Earnings Basic Diluted
------- ----- ------- -------- ----- -------
<S> <C> <C> <C> <C> <C> <C>
As Reported $1,711 $0.17 $0.15 $1,572 $0.17 $0.15
====== ===== ===== ====== ===== =====
Pro Forma $1,443 $0.15 $0.12 $1,321 $0.15 $0.12
====== ===== ===== ====== ===== =====
</TABLE>
In 1998 the fair value of options granted is estimated as
approximately $685 thousand on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions used
for the grants; dividend yield of 0% forfeiture rate of 14%; expected
volatility of 51%; risk free interest rate of 4.65%; and expected lives
of 4.09 years. In 1997 the fair value of options granted is estimated
s approximately $391 thousand on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions used
for the grants; dividend yield of 0%; forfeiture rate of 26%; expected
volatility of 70%; risk free interest rate of 5.69%; and expected lives
of 1.77 years.
In October 1998, Robert Burr, a former Chairman of the Board,
President and CEO of the Company, received a three year option to purchase
50,000 shares of the Company's Common Stock at $2.00 per share pursuant to
his consulting agreement with the Company. The option vests on March 31, 2001,
or earlier, if certain conditions are met. In September 1998, a consultant
received an option to purchase 5,000 shares of the Company' Common Stock at
$1.66 per share pursuant to a consulting agreement entered into with the
Company. The option vests over 2 years. In May 1998, two individuals,
one of which is an officer of the Company, each received an option to
purchase 50,000 shares of the Company's Common Stock at $2.09 per share
pursuant to their assignment of certain intellectual property to the Company.
The options vest the earlier of April 1, 2001, or upon the satisfaction of
certain performance conditions. In April 1998, two advisory board members of
the Company each received three year options to purchase 10,000 shares of the
Company's Common Stock at $2.09 per share pursuant to their appointment as
Advisory Directors. The options vest by April 1999. In January 1998,
Vanguard Strategies, Inc. and Mr. Robert L. Burr, were each granted five
year stock options for 50,000 shares of the Company's Common Stock at
$2.88 per share pursuant to an agreement to terminate their respective
rights in the Company's international operations. The options vest at
the earlier of June 30, 2002 (subject to certain conditions) or March
31 following the fiscal year end during which cumulative gross revenues
for fiscal years beginning in 1998 from Central and South America exceed
$5,000,000. In January 1997, three consultants were granted options to
purchase a total of 30,000 shares of the Company's common stock at $.90
per share. 25,000 shares vested in 1997 and the remaining 5,000 shares
vested in 1998. In October 1994, pursuant to an agreement, an officer
of the Company was granted an option to purchase 100,000 shares of the
Company's common stock at $7.45 per share. This option vested on the d
date of the grant. The fair value of the options granted during 1998 and
1997 was not material.
<PAGE>
Information regarding these option plans for 1998 and 1997
follows:
Options granted in 1996 included 870,000 shares issued at $.80 per share
to Frederick Sandvick, the Company's Chief Executive Officer and Chairman
of the Board of Directors, pursuant to a three year employment agreement.
<TABLE>
<CAPTION>
1998
1997
Weighted Average
Weighted Average
Shares Exercise Price Shares
Exercise Price
---------------------------- -----------
- -------------------
<S> <C> <C> <C>
<C>
Outstanding at January 1 1,280,380 $1.44 1,171,577
$2.21
Granted 882,000 1.88 367,080
1.13
Exercised 5,085 .90 (25,000)
1.00
Expired 50,000 2.00 0
- -
Forfeited 23,460 2.21 (233,277)
4.83
-------- ----------
Outstanding at December 31 2,083,835 1.61 1,280,380
1.44
========= =========
Option price range, December 31 $.80 - $7.54
$.80 - $7.54
Options available for grant, December 31 792,580
1,372,120
</TABLE>
The following table summarizes information about fixed-price
stock options outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Shares Options Exercise Remaining
Outstanding Exercisable Price Life
(Years)
------------ ----------- --------- ------------
- -
<S> <C> <C> <C>
80,000 65,000 .90 - 2.09 0 - 2
371,835 110,563 .90 - 2.88 2 - 3
662,000 0 1.41 - 2.88 4 - 5
100,000 100,000 7.54 5 - 6
870,000 580,000 .80 7
Weighted Average 1.61 5.2
</TABLE>
Stock Warrants In January 1997, the Chairman and Chief
Executive Officer of the Company, received a warrant to purchase 500,000
shares of the Company's Common Stock at $.63 per share pursuant to his
personal guaranty and indemnity in connection with a $2,000,000 performance
bond. The warrant has a five year term and became exercisable in January
1997. In January 1997, Vanguard Strategies, Inc. ("VSI") received a warrant
to purchase 250,000 shares of the Company's Common Stock at $.72 per share
pursuant to a consulting agreement entered into with the Company. The warrant
has a five year term and became exercisable in January 1997. In 1996, solely
as compensation and not with respect to any recapitalization, the Company
issued warrants to purchase 865,000 shares of the Company's common stock
at prices ranging from $.60 - $.69 for terms of one to five years. VSI
received 700,000 of these warrants pursuant to an agreement with the Company
under which VSI, as exclusive consultant, assisted the Company in negotiating
financing arrangements. The Company's Chief Executive Officer and Chairman of
the Board of Directors, is the president and principal stockholder of VSI.
The Company recognized $80 thousand of compensation expense related to the
1996 VSI warrants.
9. Commitments and Contingencies
Purchase and Lease Commitments As of December 31, 1998 and
1997, the Company had no purchase commitments for production materials.
No purchases against such commitments were made in 1997 and $600 thousand
were made in 1997 (for purchase commitments at December 31, 1996).
<PAGE>
The Company leases facilities under operating leases expiring
at various dates through January 2009. Rent expense for such facilities
totaled $244 thousand and $264 thousand for the years ended December 31,
1998 and 1997, respectively. Future minimum rentals under noncancelable
operating leases as of December 31, 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
1999 $254
2000 283
2001 279
2002 253
2003 215
2004-2008 211
2009 18
-------
$2,357
=======
</TABLE>
Legal Proceedings The Company is a party to legal proceedings
in the ordinary course of its business, the most significant of which is
described below.
On January 11, 1999, the Company filed an action against
Solutioneering, Inc. in Superior Court of California, County of
San Diego. A first amended complaint of said action was filed on February
9, 1999. The action arises from the lease to Solutioneering, Inc.
of 2,175 prepaid phone card vending terminals under a March 1, 1995 Master
Lease Agreement and two amendments thereto (the "Agreement"). In the
action, the Company asserts that Solutioneering, Inc. has breached
the Agreement and has claimed damages of approximately $9 million. The
Company's net balance sheet carrying value of the Solutioneering, Inc.
leased machines at December 31, 1998, is approximately $6.5 million.
The Company believes the underlying value of Solutioneering, Inc. retail
base exceeds the amount owed to its secured creditors and, therefore, the
Company is prepared to acquire Solutioneering, Inc. should it seek
protection from paying its obligations. The Company believes that
right-sizing Solutioneering, Inc. and reducing its costs can achieve
adequate cash flow to operate and expand Solutioneering, Inc.'s business.
However, there can be no assurances that the Company can acquire
Solutioneering, Inc. or that cash flows can be achieved to pay its creditors
if acquired. Solutioneering, Inc. continues to seek additional financing
and to sell its business. The failure of Solutioneering, Inc. to raise
additional capital or sell its business to a company able to fund the
obligations, or the inability of On-Point to acquire Solutioneering, Inc.
and generate sufficient cash flows from the business could have a material
adverse effect on the Company's financial results in 1999.
10. Subsequent Event On January 23, 1996, the Company's principal
competitor, Interlott Technologies, Inc. ("ILI"), filed a civil action against
the Company in the Common Pleas Court of Hamilton County, Ohio. The action
arose from an agreement in principle between Interlott Technologies, Inc.
and the Company which was signed on March 23, 1995 regarding a proposed
merger transaction. The Company asserted a counterclaim against ILI seeking
declaratory judgement with regard to certain aspects of the agreement,
seeking to recover the Company's own costs and expenses, and seeking
compensatory damages from ILI for certain competition and torturous
interference with business relations. The parties reached a full and
complete settlement of this action on March 4, 1999. No liability was
admitted by either party pursuant to the settlement and the settlement
had no material adverse effect on the Company's results of operations.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None
<PAGE>
PART III.
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required is incorporated herein by reference
to the Registrant's definitive Proxy Statement for the 1999 Annual Meeting
of Shareholders.
ITEM 10. EXECUTIVE COMPENSATION
The information required in incorporated herein by reference
to the Registrant's definitive Proxy Statement for the 1999 Annual Meeting
of Shareholders.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required is incorporated herein by reference
to the Registrant's definitive Proxy Statement for the 1999 Annual Meeting
of Shareholders.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required is incorporated herein by reference
to the Registrant's definitive Proxy Statement for the 1999 Annual Meeting
of Shareholders.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K AND 8-K/A
a) Exhibits
--------
Exhibit Numbers Description of Documents
--------------- ------------------------
3.1 Amended and Restated Articles of Incorporation
of Registrant (B)
3.1.1 Amended and Restated Articles of Incorporation
dated March 1, 1993 (D)
3.1.2 Certificate of Amendment to Articles of
Incorporation dated August 6, 1996 (H)
3.2 Restated By-Laws of Registrant (C)
3.2.1 Restated By-Laws dated March 1, 1993 and
Amendment thereto dated May 27, 1993 (D)
3.3 Certificate of corporate status dated August 3,
1993 (D)
4.1 Specimen Stock Certificate (C)
4.2 Form of Representative's Warrant (C)
10.1 Employment Agreement dated July 1, 1991, between
Registrant and Robert L. Burr, and the January 11
and April 21, 1993, amendments thereto (A)
10.2 Employment Agreement dated July 1, 1991, between
Registrant and John F. Winchester, and the April
21, 1993, amendment thereto (A)
10.3 ITR Sale and Lease Agreement, dated as of January
12, 1993, between Registrant and the State of
Missouri (C)
10.3.1 Amendment No.1 to ITR Sale and Lease Agreement
between Registrant and the State of Missouri (C)
10.4 ITR Sales and Service Agreements dated March 21,
1991 between Registrant and the Commonwealth of
Virginia, as amended (C)
10.5 ITR Sales Agreement dated August 13, 1992
between Registrant and the California State
Lottery, as amended (A)
10.5.1 Extension of ITR Sales Agreement between
Registrant and the California Lottery (C)
10.6 ITR Sale and Lease Agreement, dated as of April
9, 1993, between Registrant and the State of
Washington (A)
10.7 Form of Indemnification Agreement between
Registrant and its officers and directors (C)
10.8 1993 Stock Option Plan (A)
10.8.1 First Amendment to 1993 Stock Option Plan (C)
10.9 Line of Credit Agreement between Registrant and
the Bank of America (A)
10.10 Technology Transfer Agreement, dated as of
April 9, 1993, between Registrant and certain of
its shareholders (confidential treatment
requested as to certain portions) (B)
<APGE>
10.11 Agreement to Purchase and Sale of Assets, dated
February 9, 1993, between Registrant, CVS and
Michael C. Brown (confidential treatment
requested as to certain portions) (B)
10.12 Documents relating to purchase of ITR terminals
by the Province of Ontario (B)
10.13 Stock Option Agreement between Robert L. Burr and
the Trust, as amended (C)
10.14 Lease with regard to 9190 Activity Road, San
Diego, CA premises (D)
10.15 1993 Stock Option Plan (D)
10.16 1994 Stock Option Plan (E)
10.17 1994 Stock Option Plan for Directors (E)
10.18 Agreement to acquire 50% of LEI Mexico (E)
10.19 Agreement to sell machines to LEI Mexico (E)
10.20 John Robinson Note (F)
10.21 Employment agreement with Frederick Sandvick (G)
10.22 Loan Agreement between Registrant and U.S.
Mortgage Bankers Corporation (I)
10.23 Employment Agreement with Michael Wright (I)
10.24 Loan and Security Agreement between Registrant
and Coast Business Credit (J)
10.25 Termination of Agreement between Registrant and
Vanguard Strategies, Inc. (K)
10.26 Amendment Number One to Loan and Security
Agreement between Registrant and Coast Business
Credit (L)
24.1 Power of attorney (reference is made to Page II-5
of the Registration Statement as originally
filed.) (A)
(A) Incorporated by reference to Registrant's Registration
Statement on Form S-2 dated April 23,1993 (Registration No.
33-61442)
(B) Incorporated by reference to Registrant's Amendment No. 1 to
the Registration Statement on Form S 2 filed on June 1, 1993.
(C) Incorporated by reference to Registrant's Amendment No. 2 to
the Registration Statement on Form S- 2 filed on June 21,
1993.
(D) Incorporated by reference to Registrant's Annual Report
on Form 10-KSB for the year ended December 31, 1993.
(E) Incorporated by reference to Registrant's Annual Report on
Form 10-KSB for the year ended December 31, 1994.
(F) Incorporated by reference to Registrant's Quarterly Report on
Form 10-QSB for the quarter ended June 30, 1995.
(G) Incorporated by reference to Registrant's Quarterly Report on
Form 10-QSB for the quarter ended March 31, 1996
(H) Incorporated by reference to Registrant's Quarterly Report on
Form 10-QSB for the quarter ended September 30, 1996
(I) Incorporated by reference to Registrant's Annual Report on
Form 10-KSB for the year ended December 31, 1996.
(J) Incorporated by reference to Registrant's Quarterly Report on
Form 10-QSB for the quarter ended June 30, 1997.
(K) Incorporated by reference to Registrant's Annual Report on
Form 10-KSB for the year ended December 31, 1997.
(L) Incorporated by reference to Registrant's Quarterly Report on
Form 10-QSB for the quarter ended June 30, 1998
(M) (b) Reports on Form 8-K: The Registrant did not file any
reports on Form 8-K during the last quarter for the
year for which this report is filed.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to
annual report to be signed on its behalf by the undersigned, thereunto
duly authorized.
ON-POINT TECHNOLOGY SYSTEMS, INC.
Dated: March 30, 1999 By: /s/Frederick Sandvick
------------------------------
Frederick Sandvick
Chief Executive Officer and
Chairman of the Board of Directors
Dated: March 30, 1999 By: /s/Kenneth Hoitt
------------------------------
Kenneth Hoitt
Chief Financial and
Accounting 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 and in the capacities and dates indicated.
Dated: March 30, 1999 By: /s/John H. Olbrich
------------------------------
John H. Olbrich, Director
Dated: March 30, 1999 By: /s/Ed M. Bacani
------------------------------
Ed M. Bacani, Director
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 129
<SECURITIES> 0
<RECEIVABLES> 2,896
<ALLOWANCES> 152
<INVENTORY> 3,143
<CURRENT-ASSETS> 7,724
<PP&E> 1,860
<DEPRECIATION> 1,438
<TOTAL-ASSETS> 19,572
<CURRENT-LIABILITIES> 3,595
<BONDS> 0
0
0
<COMMON> 101
<OTHER-SE> 11,904
<TOTAL-LIABILITY-AND-EQUITY> 19,572
<SALES> 16,416
<TOTAL-REVENUES> 16,416
<CGS> 11,538
<TOTAL-COSTS> 11,538
<OTHER-EXPENSES> 2,910
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 237
<INCOME-PRETAX> 1,731
<INCOME-TAX> 20
<INCOME-CONTINUING> 1,711
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,711
<EPS-PRIMARY> .017
<EPS-DILUTED> .015
</TABLE>
