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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file number 1-13810
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SOCKET COMMUNICATIONS, INC.
(Name of small business issuer in its charter)
Delaware 94-3155066
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
37400 Central Court, Newark, CA 94560
(Address of principal executive offices including zip code)
(510) 744-2700
(Registrant's telephone number, including area code)
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Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
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Common Stock Pacific Exchange
($0.001 par value)
Check whether the issuer (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the preceding
12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained herein, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. YES [X] NO [ ]
Revenue for the fiscal year ended December 31, 1998: $5,477,804
Aggregate market value of Common Stock ($0.001 par value) held by non-
affiliates on March 17, 1999 based on closing price on such date:
$4,169,000. For purposes of this disclosure, shares of Common Stock held
by persons who hold more than 5% of the outstanding shares of Common Stock
and shares held by officers and directors of the registrant have been
excluded because such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily conclusive for other
purposes.
Number of shares of Common Stock ($0.001 par value) outstanding as of
March 17, 1999 is 7,646,584 shares.
Documents Incorporated by Reference:
Document Part of Form 10-KSB
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Proxy Statement for the Annual Meeting of Part III
Stockholders for fiscal year ended December 31, 1998
<PAGE>
PART I
Item 1. Business
This Business section and other parts of this Annual Report on Form
10-KSB contain forward-looking statements (identified with an asterisk
"*") that involve risks and uncertainties. The Company's actual results
may differ materially from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are
not limited to, those discussed in this Business section and in
"Management's Discussion and Analysis of Financial Condition and Results
of Operations." The Company assumes no obligation to update such forward
looking statements or to update the reasons actual results could differ
materially from those anticipated in such forward-looking statements.
General
Socket Communications, Inc. ("Socket" or the "Company") develops and
sells connection solutions for handheld computers that use the Windows CE
operating system from Microsoft Corporation ("Microsoft") and for mobile
computers ("notebooks") that use Microsoft's Windows 9x and NT operating
systems. These connection solutions include a family of low power
"Battery Friendly?" PC Card adapters for serial communications, Ethernet
connectivity, mobile data collection, and wireless communications. Socket
also developed during 1998, and is further developing during 1999, its
family of PC cards in a CompactFlash form factor for use with smaller
handheld computers such as the Windows CE Palm-size PC and other small
devices. The Company's family of serial, Ethernet and data collection
plug-in card products are its principal sources of revenues.
The Company is a leading supplier of connectivity products to the
emerging Windows CE handheld computing market and believes that it is the
world's leading supplier of serial plug-in cards for notebooks and for
Windows computers with PC card slots (See "Industry and Market
Overview"). During 1998, the Company completed a number of steps to
strengthen its leadership position and to improve its financial condition
and operating results. First, the Company expanded its PC Card connection
family of products to add a family of CompactFlash serial, low power
Ethernet and bar code scanning products to support the smallest Windows CE
computer, the Palm-size PC (see "Products"). Second, the Company has
been seeking recurring OEM business for its products. The Company's
serial PC Card was selected by Compaq Computer Corporation for use with
its Remote Insight Board for remote management of Compaq servers.
Shipments began in the fourth quarter of 1998. (See "Strategic Alliances
and Business Relationships"). Third, the Company established several key
strategic relationships with industry leaders for developing products that
are expected to ship in 1999 for use with Windows CE computers including
Symbol Technologies (attaching laser scanners to notebooks and to Windows
CE computers) and Motorola Corporation (developing software for a paging
receiver module for the Palm-size PC). The Company also began working
closely with several North American digital telephone service providers to
develop digital telephone connection products for new digital telephones
designed to transfer voice and data over digital cellular networks. (See
"Strategic Alliances and Business Relationships"). Fourth, the Company
improved its products. Product improvements included enhanced Ethernet
drivers and a cross-over connector to improve Ethernet performance,
extension of the Company's ruggedized form factor to more of Socket's
products, and development of a new high integration serial chip to further
reduce power consumption, increase data transfer speeds and functionality,
and reduce costs (See "Products"). Fifth, distribution channels were
expanded and more closely aligned with those used by the Windows CE
manufacturers. In addition, on-site representation was added in Europe
and Asia to more closely support the Company's international distributors
(see "Sales and Marketing"). Sixth, the Company increased its capital,
raising $2.4 million in new equity financings and converting approximately
$2.1 million of convertible debt and accrued interest into equity. The
Company improved its operating results over 1997 by increasing its
revenues 15% to $5.5 million, improving its gross margins from 42% in 1997
to 59% in 1998, and reducing its operating expenses from $5.4 million in
1997 to $4.2 million in 1998 (see "Management's Discussion and Analysis
of Financial Condition and Results of Operations").
Although the Company believes that its focus on the Windows CE
operating system for handheld computers (see "Industry and Market
Overview"), its expanding family of connection products (see "Products")
and its relationships with key industry strategic partners (see
"Strategic Alliances and Business Relationships") position the Company
for revenue growth in 1999, the Company has incurred significant quarterly
and annual operating losses in every fiscal period since its inception,
and the Company may continue to incur quarterly operating losses at least
through the first half of 1999 and possibly longer (see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations") *. The Company's ability to achieve profitability will be
highly dependent upon: increased market acceptance of the Company's serial
communications, Ethernet connectivity, mobile data collection and paging
products including recently introduced products; growth and acceptance of
handheld computers and devices using the Windows CE operating system; the
ability to raise capital to fund the Company's product development and
sales and marketing efforts; the development of new products for new and
existing markets; the improvement of gross margins through maintaining of
sales prices, higher sales volumes and contract manufacturing
efficiencies; expanding its distribution capability; completing its
software development contracts; and managing its operating expenses.
There can be no assurances that the Company will meet any of these
objectives or ever achieve profitability.
In addition, as of December 31, 1998, the Company had a cash balance of
$971,157, stockholders' equity of $295,977 and working capital of $1,286.
The current cash balance is not sufficient to fund operations through
fiscal 1999. Stockholders' equity is below the minimum equity balance of
$500,000 required for continued listing of the Company's common stock by
the Pacific Exchange. The Company's capital balances were improved during
1998 by two equity financings totaling $2.4 million net of costs and
expenses, and by the conversion into equity of $2.1 million of convertible
subordinated debt plus accrued interest. The Company will require
additional funding in 1999 to strengthen its working capital balances as
well as to meet the minimum capital requirements to retain its listing on
the Pacific Exchange.* See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources," and "-Risk Factors" for a discussion of the Company's need
for additional capital, the uncertainty regarding the Company's continued
listing on the Pacific Exchange and other risks that may affect the
Company's ability to attain profitability.
Products
Low Power Consumption. Since its inception, the Company has developed
low power connection products for use with mobile computing devices.
Socket's products consume less power than the products of its traditional
competitors. Low power consumption is an attractive feature for
connection products for mobile computing devices because it allows
handheld computers and notebooks to operate for longer periods on internal
power without requiring the user to change batteries. Changing handheld
computer batteries frequently is inconvenient and expensive and reduces
the user's productivity. Since the introduction of handheld computers
using the Windows CE operating system at the end of 1996, the Company has
focused on further reducing the power consumption of its products, since
Windows CE computers operate on two AA sized or small rechargeable
batteries.
Connections and Form Factors. The Company today is producing most of
its products with a choice of two connectors, standard or ruggedized, and
two form factors, PC Card or CompactFlash. Standard connectors are
detachable. The ruggedized Card has an integrated fixed cable that
maintains solid contact in high vibration environments such as moving
vehicles. It also has a molded strain relief to protect against lateral
stress and seal out dust and moisture, and a rigid, sonic welded frame to
resist torque that could otherwise crack circuit board traces. PC Card
form factors are credit card size cards that conform to the standards
created for PC Cards by the PCMCIA committee. CompactFlash cards are the
size of a large postage stamp and conform to standards established by the
CompactFlash committee. All notebooks and all Windows CE computers except
for the Palm-size PC have a PC Card slot. The Palm-size PC uses a
CompactFlash slot for input/output connections. In 1997, the Company
worked with Microsoft Corporation and the Windows CE device manufacturers
to adapt the Type I CompactFlash form factor as a 3.3 volt input/output
connector for the Palm-size PC, and a slightly larger Type II form factor
as a 5 volt input/output connector for wireless connectors. Previously,
the CompactFlash form factor had been used primarily for add-on memory
cards. The CompactFlash form factors designed by the Company were
subsequently adopted by all of the Windows CE manufacturers and were
certified in 1998 as standards by the CompactFlash Committee, which is the
recognized standards setting body for CompactFlash devices. Socket is a
member of that committee, and its vice president of engineering is serving
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
as a director during 1999. The Company expects that the CompactFlash I/O
form factor will be adopted for use with future smaller computing and data
collection devices, and that the market for these products will grow*.
Serial connection products. Socket believes that it produces the
world's leading family of serial PC Cards. In December 1996 and during
1997, the Company expanded its standard serial card line, adding a family
of PC card products including a ruggedized serial PC card, dual standard
and ruggedized serial PC cards, and an Ethernet/serial multifunction PC
card. In 1998 the Company added CompactFlash standard and ruggedized
connection serial cards. During 1999, the Company expects to complete a
CompactFlash version of its dual serial PC card and a Quad (4 port) serial
PC card, which are expected to begin shipping in the second half of 1999*.
Socket's serial cards operate as a standard communication port and can
work with conventional serial communications programs. Peripheral devices
that can attach to Socket Serial I/O Cards include stenography machines
for court reporting, medical instruments for monitoring or data
collection, label printers for inventory control, high speed fax/modems
for web browsing, and global positioning systems for tracking location and
time. Adding one or more serial ports to a computer through either the PC
Card or CompactFlash slot provides higher data transfer rates than a
built-in serial port because of the buffered 16550 UART built into the
Company's serial card products. The Company's cards can also transfer
power from the computer to a peripheral device, which cannot be
accomplished through the built-in serial port. Socket's Serial I/O Card
was the first PC Card to receive certification from Microsoft for
operation with Windows CE handheld computers. All of the Company's serial
products use a proprietary high integration serial chip that was first
developed in 1993. The Company expects to complete development of a new
high integration serial chip in the first half of 1999*. The new chip has
been designed to lower power consumption, improve functionality and cost
less to manufacture, and is expected to be incorporated into the Company's
complete serial, data collection and wireless product lines during the
second half of 1999*.
Low Power Ethernet Products. Ethernet cards enable a mobile computer to
communicate with an Ethernet network and are used for higher speed desktop
synchronization, large file transfers, network connections to the Internet
and E-mail. Socket released the first commercially available PC Card
Ethernet adapter in 1992 which was compatible with the popular NE2000
network controller, allowing them to utilize the certified network drivers
included with the major PC-based network operating systems. In December
1997, Socket introduced its Low Power Ethernet PC Card product designed
for use with Windows CE-based computers and Windows notebooks and in 1998,
introduced a CompactFlash version of the Card. Also introduced in 1997 was
an Ethernet/serial multifunction PC Card. The Company believes that its
Low-power Ethernet Card products consume less power than any other
Ethernet adapters on the market and allow data transfers to occur at up to
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
200 times faster than through the RS232 port on the notebook or Windows CE
computer. The Low-power Ethernet card is recognized by Version 2.0 and
higher of the Windows CE operating system. During 1998, the Company also
enhanced its software drivers to add features such as automatic
synchronization and soft status lights which display key network
information on the host computer's screen. During 1999, the Company
expects to complete development of a higher speed 10/100 Low Power
Ethernet Card in both PC and CompactFlash form factors and to further
enhance its Ethernet software drivers.*
Mobile Data Collection Products. Mobile data collection cards are used
in conjunction with data collection devices such as bar code scanners and
magnetic card swipe readers. In October 1997, the Company introduced the
first of its mobile data collection products, an LED bar code scanning
wand manufactured by Welch Allyn, which can be attached to a Windows CE
handheld computer or Windows notebook computer through a serial PC Card
("Data Collection Card"). In 1998, the Company released a CompactFlash
version of its Data Collection Card. The Data Collection Cards can be
configured to deliver power to the scanning device from the computer,
which is an advantage over most built-in serial ports which generally
cannot provide power from the computer, and eliminates the need to carry a
separate scanner power source. The Company also developed keyboard
emulation scanning software that can be configured to route scanned data
to third party data collection programs. During 1998, the Company
connected a Data Collection Card with a laser scanning gun as a special
customer order. In January 1999, Socket released the first of its
standard laser scanning products, connecting two mobile laser scanning
guns from Symbol Technologies to a Data Collection PC card for use with
Windows notebooks and Windows CE handheld devices. The Company expects to
develop additional scanning products during 1999.*
Wireless Products. The Company has three types of wireless connection
products in various stages of development: paging products; digital
telephone connection products; and cordless products.
1) Paging products are products that receive pages and transfer the
paged information into a mobile computer and to a designated application.
The Company is developing, under contract with Motorola Corporation,
receiving software to work with a CompactFlash receiver module being
developed by Motorola for use with the Palm-size PC. The module is
expected to begin shipping in the second half of 1999.* During 1998, the
Company recognized development revenues of $225,000 from its development
contract with Motorola, and expects to earn an additional $175,000 in
development revenues from this contract in 1999, along with software
royalties of $2.00 per unit sold once the product is shipping.* The
product is expected to enable the wireless receipt of email messages and
to facilitate group broadcasting of information by content providers for
updating Internet pages and other files on the Palm-size PC.* The
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
development of paging products for mobile computers is still in its very
early stages. The Company gained considerable experience with paging
during the years 1995 through 1997, and developed a number of the
technology building blocks required for sending and receiving data over
the paging networks, by developing and selling its PageCard Wireless
Messaging System consisting of a PC Card receiver, sending and receiving
software, and paging services. PageCard sales were terminated at the end
of 1997 because of low volume of sales revenues. The Company believes
that the Palm-size PC is an excellent computer platform for receiving
messages and data. The device allows data to be reasonably accessible with
its instant-on features and ability to be carried in a pocket or purse.
The Palm-size PC operating system also includes web browser software
allowing Internet pages to be carried and viewed offline, facilitating
their wireless update, and an email system, which has been designed to
accept paged email messages. During 1998, the Company limited its paging
product development efforts to funded projects. The Company expects to
continue to develop its paging and other wireless messaging technologies
during 1999, primarily on a funded basis, for year 2000 and beyond
products including the application of two-way paging to Windows CE
computers*.
2) Mobile digital telephone connection products have been designed
to transfer data between a new generation of digital mobile CDMA (Code
Division Multiple Access) telephones and Windows or Windows CE mobile
computers. CDMA is the most widely used digital cellular telephone
technology in North America. The Digital Phone Card connected to a new
CDMA digital cellular mobile telephone from Qualcomm Corporation is
undergoing service provider field trials during the first quarter of 1999
and is expected to begin shipping in North America in the second quarter
of 1999.* Other telephone manufacturers are also expected to introduce
similar products during 1999.* The Digital Phone Card directly connects
the telephone and the mobile computer through either the PC Card or
CompactFlash Card slot, and allows the user to use telephone connection
software to dial and connect to others such as corporate networks or to
Internet service providers in the same manner that a user would use a
modem to connect through a land telephone line. The Company believes
that its telephone connection card offers several advantages over a
direct serial cable, including less power drain on the telephone and
interchangeability between mobile computers.
3) Cordless products are products that allow close proximity wireless
connections between a handheld computer or notebook and a peripheral
device such as a scanner or mobile telephone. The Company is in the early
product development stages, evaluating cordless products that are expected
to be developed in the second half of 1999 and to be available beginning
in the first half of 2000*.
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
Industry and Market Overview
Windows CE Operating System. Microsoft Corporation introduced the
Windows CE operating system in November 1996. Windows CE was designed as a
small, real-time, scalable operating system that works in a broad
selection of products, including mobile computers, terminals, and
industrial controllers. The operating system was designed to connect
easily to the Internet and corporate networks as well as to Windows
desktops and other Windows CE-based devices. The system was built in
customizable components to allow its use in embedded system platforms
using the minimum set of software modules and components needed to support
the platform's system requirements, which minimizes memory use and
maximizes performance. Windows CE is built around the Win32 application
programming interface that is consistent with other Windows-based
operating systems, which means that existing third party programming
resources consisting of tools, software examples and documentation are
immediately available to developers. Key features of the Windows CE
operating system are: its ability to synchronize data with desktop or
other companion devices; its support of light versions of many of the
popular Microsoft Office programs including Excel for spreadsheets, Word
for documents, PowerPoint for presentations and Outlook (personal
information management including tasks, calendar, contacts and electronic
mail); low power consumption with extended periods between battery changes
relative to Windows devices; and instant-on features where the computer
screen turns on at the same place where it was previously turned off.
Microsoft has defined its operating system strategy for the next decade as
1) promoting widespread adoption of the Windows CE operating system for
mobile computers, terminals, and industrial controllers; 2) evolving the
Windows NT operating system currently used primarily for servers as the
primary operating system for desktop systems; and 3) gradually phasing out
the current Windows 9x series in favor of the CE and NT operating systems.
The Company's focus on low power PC Card and CompactFlash products for
Windows CE devices are based on the belief that the Windows CE operating
system will attain strong market acceptance for use with mobile computing
devices and embedded control systems devices and will achieve significant
growth over time. The Company believes that early indicators of success
include Microsoft's announced long term commitment to the Windows CE
operating system, early marketing successes of other companion
synchronization devices such as the Palm Pilot from 3Com, the numbers and
strengths of committed device manufacturers, the availability of familiar
development tools and extensive connectivity to corporate information
systems, and attractive price points and features.
Windows CE Handheld Computers - H/PCs. H/PC's were introduced in
November 1996 as black-and-white units. In December 1997, Microsoft
released Version 2.0 of the Windows CE operating system which supported
color, Ethernet connections and the international character set. The units
are designed as the middle size of three handheld computers. It has a
clamshell design with the screen in the upper section and a small
keyboard and PC Card slot for connecting input/output devices in the lower
section. The unit is designed for users who want a small handheld
computer with a keyboard. The device may be connected to a network using
Socket's Ethernet PC Card (see "Products - Low Power Ethernet
Products"). Windows CE Version 2.0 operating system units have color, 8,
16 or 32 MB of memory, a microphone and speaker, optional docking cradle,
and run on two AA or small built-in rechargeable batteries. Major H/PC
computer manufacturers include Casio, Compaq, Hewlett Packard, Hitachi, LG
Electronics and Sharp. International Data Corporation, in their report
dated November 1998, estimated that approximately 500,000 H/PC units were
sold in 1997, 783,000 units were expected to be sold in 1998, increasing
to 911,000 units in 1999. International Data Corporation believes that
H/PC annual sales will then drop moderately each year in favor of the
smaller Palm-size PCs and the larger mini notebooks called H/PC
Professionals*.
Windows CE Handheld Computers - Palm-size PCs. Palm-size PCs are
pocket-sized computers and were introduced in June 1998 as black-and-white
units. During Q1 1999, Microsoft released a Windows CE operating system
software upgrade to support color and CompactFlash paging receivers, and
the first color units began shipping in the first quarter of 1999.
International Data Corporation estimates that 1.2 million units will have
been sold by the end of 1999, increasing to 2.6 million units in the year
2000 and doubling again to 5.4 million units by 2002.* Major Palm-size PC
computer manufacturers include Casio, Compaq, Everex, Hewlett-Packard, LG
Electronics, Palmax, Philips, Samsung Telecommunications and Uniden. The
Palm-size PC units have a CompactFlash slot for input/output connections,
use a pen and handwriting recognition or a software keyboard for data
entry, and have the same desktop data synchronization and instant-on
features as the H/PC. The unit, modeled on the Palm Pilot from 3Com
Corporation, is designed to fit in a pocket or purse. The "wearability"
and instant-on capabilities of the Palm-size PC are designed to make
information more readily accessible to the user. Several of the
manufacturers are working with Motorola and with Socket to insure that the
CompactFlash slot in the new color units will meet the shielding standards
required to operate with the CompactFlash paging module expected to ship
in the second half of 1999.* (see "Products - Wireless Products - Paging
Products").
Windows CE Handheld Computers - H/PC Professionals. H/PC
Professionals are tablet or small notebook-sized computers, and were
introduced in the fourth quarter of 1998. Designed as desktop companions,
the computers have many notebook characteristics including an 8" to 11"
color screen and a full size keyboard. H/PC Professionals have both PC
Card slots and CF+ slots. Many of the units also have built-in modems.
The units typically weigh from 2 to 3 pounds (about 5 pounds lighter than
a notebook) and have the Windows CE features of instant on, long battery
life (10 to 15 hours) and file synchronization. Major H/PC Professionals
computer manufacturers include Hewlett Packard, Hitachi, IBM, NEC, Samsung
Telecommunications, Sharp and Vadem. International Data Corporation
estimates that 300,000 units will be sold in 1999, increasing to 900,000
units in 2000, 1.6 million units in 1001 and 2.7 million units in 2002.*
International Data Corporation predicts that the H/PC Professionals will
redefine the Windows CE computer form factor into large and small devices
(with the Palm-size PC and the H/PC Professional as the Windows CE devices
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
representing these two categories), and will gain corporate acceptance as
a desktop companion or notebook alternative.*
Other developing Windows CE devices and embedded connection
solutions. Windows CE as a real-time, scalable modularized operating
system has been designed to work with a variety of devices. Areas of
significant current market development include automobile control systems,
point-of-sale devices, web-TV set top boxes, real-time industrial
controllers, and home automation and entertainment devices. The Company
has designed an embedded module connection solution prototype and is
seeking opportunities to embed its Windows CE connection, data collection
and wireless solutions in such future devices.
Notebook market support. The Company's products are also designed to
work with Windows notebooks which today is a significantly larger and more
established market than the emerging market for Windows CE computers. All
notebooks today are designed with PC Card slots and over 90% of notebooks
use the Windows operating system. The Company intends to continue to
support the Windows notebook market with its PC Card products*.
Expansion of bar code scanning to Windows and Windows CE computers.
Bar code scanning is a well established industry used in a wide variety of
industrial/manufacturing, commercial services, retail services and
government applications worldwide including asset management and control,
shipping and receiving, route accounting, warehousing, order processing,
document control and quality assurance. Significant industry trends
identified by Venture Development Corporation, an industry research and
consulting group, include: annual industry sales growth of approximately
20%; upgrading of scanning systems from older DOS-based operating systems
to Windows operating systems, with approximately 50% of the scanning
market using Windows operating systems today, expected to increase
substantially over the next several years; the development of wireless
scanning applications, with approximately 40% of scanning systems
incorporating the wireless transmission of scanning data on local
networks; the increasing use of real-time processing applications so that
scanned data is transmitted and processed when scanned; and the expanding
use of scanning by the mobile professional workforce.* Laser scanning
guns are the most widely user scanners, followed by CCD scanning guns and
LED bar code wands. The Company believes that its family of scanning
products (see "Products - Mobile Data Collection Products") offer
several advantages over existing connection solutions for mobile computers
and stationary scanning devices with built in PC card slots, including the
use of a standard connector form factor so that scanning devices become
easily removable and interchangeable, and the ability to power the scanner
from the mobile computer or data collection device. In addition, the
Company believes that the Windows CE computers are excellent platforms for
use by mobile professionals for route accounting and service applications,
and this area is expected to get increasing attention from third party
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
software application vendors*. The Company is presently working with
third parties creating Windows CE applications for order processing,
package tracking and pharmaceutical delivery tracking which are expected
to be released during the first half of 1999.*
Convergence of Paging and Windows CE. One way paging networks of
the major U.S. paging carriers cover more than 95% of the U.S. population
and transmit information using the FLEX messaging protocols from Motorola
Corporation. Paging carriers have also undertaken building out their two
way paging networks, with two-way messaging currently available from
SkyTel, PageNet and PageMart. Two-way paging is designed with a return
channel for acknowledgement of paging receipt by a mobile paging device
and for picking up and transmitting a paging signal from a portable device
such as a pager or computer operating on batteries. During the years
1995 to 1997, the Company marketed its PageCard receiver designed to
receive data and download it to a notebook computer. Product sales were
terminated at the end of 1997 because of low sales volume. The Company
believes there were a number of reasons for the lack of market acceptance
of the PageCard product, including the high cost of a standalone pager,
the fact that notebooks are generally packed during travel and take
several minutes to start up, so downloading and reading an electronic mail
message while traveling is impractical, and the lack of third party
applications. The introduction of the Windows CE Palm-size PC creates an
instant-on, pocket-sized wearable computer that allows the user to access
messages easily and quickly, and with the Palm-size PC's focus on personal
information management applications (calendar, tasks and contacts), the
devices are expected to be carried and used, thereby making receipt of
pages or email messages on the Palm-size PC practical. The CompactFlash
receiver module under development by Motorola (see "Products - Wireless
Products - Paging Products") is designed to turn the Palm-size PC into a
pager, using the processor, memory, power and screen of the computer,
thereby significantly reducing the cost of the module relative to a stand
alone pager. Each Palm-size PC also has a web viewer that allows the user
to view HTML Internet pages that are subscribed to and reside on the
companion desktop as Mobile Channels. The Company intends to work with
Motorola and the paging carriers to allow the transmission by content
providers of text to wirelessly update the text on Internet pages viewed
on the Palm-size PC, so that such pages when viewed will contain most
recent information.* The color versions of the Palm-size PC which began
shipping in the first quarter of 1999, have been designed to work with the
Motorola pager module. The module is expected to begin shipping in the
second half of 1999 with content update capabilities in place by the end
of 1999.* The Company also believes that multiple paging networks will
support two way paging by the year 2000 and has designed its receiving
software to facilitate incorporating two way paging in anticipation that
the market will be moving in this direction.
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
Convergence of digital telephones and mobile computing. The two most
widely deployed digital cellular telephone networks are the CDMA networks
in North America and the GSM networks covering Europe and other
international countries. Digital telephones are rapidly replacing
earlier analog telephones, with clearer and more reliable phone
connections, longer battery life and lower costs of operation.
Historically, mobile computer users have connected back to their corporate
networks to check electronic mail or through their corporate networks to
access the Internet over telephone land lines connected by modem to the
computer. Often those connections are made at the beginning or end of the
day when the traveling professional returns to his or her room where a
land line phone is available. Several major telephone manufacturers
including Qualcomm and Nokia have recently designed CDMA mobile digital
telephones with a data port on the telephone. The port is designed to
facilitate direct connections between the telephone and data collection
and computing devices. The Company believes that with the improved
clarity and lower cost of operations of digital telephones and with the
new built-in data port, that mobile computer users will now be encouraged
to connect their mobile digital telephone to their computer and to access
their corporate networks and the Internet wirelessly over the digital
cellular networks.* Accordingly, the Company has designed a Digital Phone
PC Card and a Digital Phone CompactFlash Card that will allow the user to
directly connect one of these new mobile digital telephones to either a
notebook or to a Windows CE computer. Service provider field trials are
expected to be completed during the second quarter of 1999 and products
are expected to be available in North America shortly thereafter.*
Strategic Alliances and Business Relationships
The Company has developed a number of strategic relationships that are
important to its product development and marketing programs. The Company
works closely with Microsoft and with Windows CE handheld computer
manufacturers in developing connection solutions for Windows CE devices.
The Company also supports third party software application developers by
providing technical assistance in the porting of their applications to the
Windows CE operating system.
The Company's strategy is to establish strategic alliances in business
relationships with leading participants in various segments of the
communications and mobile computer markets. The Company believes these
alliances enable it to take advantage of the superior financial resources,
technological capabilities, proprietary positions and market presences of
these companies in creating products that utilize these technologies that
are familiar to the marketplace.* See "Management's Discussion and
Analysis of Financial Conditions and Results of Operations - Risk Factors
- - We depend on alliances and other business relationships with a small
number of third parties."
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
The Company has established strategic alliances and business
relationships with the following companies:
Bell Mobility, a leading mobile telephone service provider in Canada,
has signed a Memorandum of Understanding with the Company for the Company
to develop and distribute Digital Phone Plug-in Cards in connection with
the introduction, in 1999, of new CDMA digital telephones.* The
telephones are designed to connect directly to a handheld or notebook
mobile computer for transferring data to and from the computer over the
digital telephone networks. The Company expects to develop similar
relationships with other North American digital telephone service
providers during 1999.*
Compaq Computer Corporation, a leading manufacturer of personal
computers in the U.S., has selected Socket's serial PC card to be offered
as an optional part of Compaq's remote server management product that
began shipping in the fourth quarter of 1998.
Microsoft Corporation, the developer of the Windows CE operating
system, has worked closely with Socket in insuring that the Company's
connection products for Windows CE products work with the Windows CE
operating system. Socket also jointly developed with Microsoft in 1997 the
CompactFlashT form factor for use with smaller Windows CE handheld
computers.
Motorola Corporation, the world's largest manufacturer of paging
receivers, has entered into a contract with the Company for Socket to
develop receiver software for a CompactFlash FLEX receiver module being
developed for use with small Windows CE handheld computers such as the
Palm PC and with other Windows CE embedded systems devices.
Symbol Technologies, Inc., the leading manufacturer of laser scanner
systems and devices, has signed a Memorandum of Understanding and related
supply contracts to allow the Company to create laser scanning products
for Windows and Windows CE mobile and handheld computers.
Welch Allyn, a leading manufacturer of bar code scanning devices, has
signed an Agreement with the Company whereby the Company can create bar
code scanning products for Windows and Windows CE mobile and handheld
computers.
Proprietary Technology
Socket has developed a number of technology building blocks to enhance
its ability to develop new hardware and software products, to offer
products which run on multiple host platforms and to manufacture and
package products efficiently.
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
Socket's most important hardware building block is the universal bus
interface, a highly flexible implementation of the PC Card interface whose
features include programmable bus steering, dual mapping of control and
data registers into both memory and I/O space, an extensive Card
information structure which includes function ID and function extension
tuples, shared-memory arbitration circuitry, support for "execute-in-
place," the ability to support both level and edge triggered interrupts
from multiple sources, host synchronization during initialization and
complete polarity and masking control of interrupts. Socket's universal
bus interface enables Socket's products to work with major PC Card hosts.
Socket's universal bus interface has been incorporated into several
application specific integrated circuits, including Socket's current and
new HIS chips, highly integrated general purpose serial interface chips
used in the family of Serial Connection Plug-in Cards, Data Collection
Plug-in Cards, and Digital Phone Plug-in Cards to control signal
transmission between these products and the mobile or handheld computer's
PC Card slot.
Socket has also developed a library of software drivers and control
applets that allow its products to operate in handheld computers running
Windows CE and in notebooks running Windows 9x and Windows NT.
In connection with its PageCard product (terminated at the end of
1997), Socket developed a suite of PageSoft communications software and
software developers kit which form the basis of an extensive suite of one-
way messaging tools and utilities. These software tools are being utilized
to develop one-way FLEX paging software for use with Motorola's
CompactFlash receiver module for the Palm-size PC.
The Company relies on a combination of copyright, trademark and trade
secret laws and confidentiality procedures to protect its proprietary
rights. As part of its confidentiality procedures, the Company generally
enters into non-disclosure agreements with its employees, distributors and
strategic partners, and limits access to and distribution of its software,
documentation and other proprietary information. Despite these
precautions, it may be possible for a third party to copy or otherwise to
obtain and use the Company's products or technology without authorization,
or to develop similar technology independently. In addition, effective
protection of intellectual property rights may be unavailable or limited
in certain foreign countries.
The Company has received correspondence from General Patent Corporation
claiming possible infringement of certain standard PCMCIA PC Card features
incorporated into the Company's PC Cards. General Patent Corporation
brought suit against a number of companies that manufacture PC Card
products including IBM Corporation, 3Com, Hayes, Xircom and New Media
claiming similar infringement and seeking royalty payments, some of which
have been subsequently settled. No litigation is currently pending against
the Company. There can be no assurance that the Company will not receive
future communications from other third parties asserting that the
Company's products infringe, or may infringe, the proprietary rights of
third parties, and that in connection with such claims or the claims of
General Patent Corporation, that litigation could be brought against the
Company which could result in significant additional expense to the
Company or the discontinuation of use or redesign of infringing products.
Sales and Marketing
The Company markets its products through other equipment manufacturers
("OEMs"), computer platform vendors, vertical market value added
resellers, and a worldwide network of distributors and resellers. The
Company supports its distributors and resellers through education,
training and customer assistance by the Company's sales, marketing and
technical support staff and third party manufacturers' sales
representatives. The Company added third party sales representatives in
Europe and in Asia during the second half of 1998. During 1998, U.S.
distributors Ingram Micro and Tech Data and international distributor PPCP
(U.K.) accounted for 29%, 11% and 10% of the Company's revenues,
respectively. As of December 31, 1998, the Company had 12 people in sales,
marketing and technical support. The Company intends to increase its sales
and marketing effort by adding personnel and increasing promotional
activities.* However, competition for sales and marketing personnel is
intense, and the Company may be unable to recruit qualified sales and
marketing personnel as needed. In addition, the Company had working
capital of $1,286 as of December 31, 1998 and will likely need to obtain
additional equity capital to fund any significant expansion of its sales
and marketing efforts.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources - Future Capital
Needs; Independent Auditor's Report Contained Explanatory Paragraph
Regarding Going Concern."
Consistent with industry practice, the Company provides its
distributors with stock balancing and price protection rights which permit
these distributors to return slow-moving products to the Company for
credit and to receive price adjustments for inventories of the Company's
products held by distributors if the Company lowers the price of those
products. The effect of such returns and adjustments on the Company's
operating results is minimized since the Company recognizes revenues on
products shipped to distributors at the time the merchandise is sold by
the distributor. To date, the Company has not experienced any significant
returns or price protection adjustments.
The Company relies significantly on its OEMs, distributors and
resellers for the marketing and distribution of its products. The
Company's agreements with OEMs, distributors and resellers, in large part,
are nonexclusive and may be terminated on short notice by either party
without cause; furthermore, the Company's OEMs, distributors and resellers
are not within the control of the Company and are not obligated to
purchase products from the Company and may represent other lines of
products. A reduction in sales effort or discontinuance of sales of the
Company's products by its OEMs, distributors and resellers could lead to
reduced sales and could materially adversely affect the Company's
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
operating results. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Risk Factors - We depend on
distributors, resellers and OEMs to sell our products."
Export sales represented approximately 34%, 49% and 40% of the
Company's revenue for the years ended December 31, 1998, 1997 and 1996,
respectively. Export sales are subject to the complications of complying
with laws of various countries and the risk of import/export restrictions
and tariff regulations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Risk Factors - A
significant portion of our revenues are derived from export sales."
Manufacturing
The Company subcontracts the manufacture of substantially all of its
products to independent, third party contract manufacturers. The Company
performs final product testing and packages its products at its Newark,
California facility.
Sole source components include the Company's proprietary HIS chip
manufactured by Lucent Technologies that controls the signal transmission
between the Company's PC and CF+ Serial I/O Products (all products except
Ethernet Cards) and the PC Card or CF+ Card slot on the mobile or handheld
computer; the Company's Ethernet chip manufactured by Tamarack
Corporation, and certain cable and connector components. Although to date
the Company has generally been able to obtain adequate supplies of these
components, certain of these components are purchased on a purchase order
basis under standard commercial terms and conditions in the industry, and
the Company does not have long-term supply contracts for these components.
Although the Company's suppliers are generally large, well-financed
organizations, in the event that a supplier were to experience financial
or operational difficulties that resulted in a reduction or interruption
in supply to the Company, it would materially adversely affect the
Company's results of operations until the Company established sufficient
manufacturing supply through an alternative source which could take a
significant period of time, including qualifying an alternative
subcontractor, redesigning the product as necessary, and commencing
manufacturing.
Research and Development
Since its inception, the Company has made substantial investments in
research and development. The Company believes that its future performance
will depend in large part on its ability to develop significant
enhancements to its existing connection products and to develop successful
new products for emerging and existing markets.* In particular, the
Company believes the timely completion and expected introduction of
Digital Phone Card Plug-in Products, expanding its family of Laser Scanner
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
Plug-in Cards, completing the FLEX receiver software for use with
Motorola's CF+ receiver module, and further expanding its family of serial
and Ethernet connection products are important to maintain a technological
leadership position in wireless and wired connection solutions during 1999
and remain competitive.* As of December 31, 1998, the Company had six
persons on its product development staff and hires engineering consultants
to perform additional engineering services as required. Research and
development expenditures were $1.0 million in 1998 and $1.1 million in
1997 and 1996. The Company anticipates that it will continue to commit
substantial resources to research and development in the future and will
be increasing the size of its research and development staff as a result
of planned or anticipated development projects.* See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Risk Factors - We depend on key employees and we need to hire additional
sales and marketing and product development personnel."
Competition
The overall market for communications products is increasingly
competitive, and the Company expects competition in each of its market
areas to intensify.* The Company anticipates intense competition from a
number of new and established wired and wireless computer, communications
and network equipment companies.* Increased competition, direct and
indirect, could materially adversely affect the Company's revenues and
ability to achieve profitability through pricing pressure and loss of
market share.
Substantially all of the Company's present and potential competitors
have substantially greater financial, marketing, technical and other
resources than the Company and may succeed in establishing technology
standards or strategic alliances in the data communications market, obtain
more rapid market acceptance for their products or otherwise gain a
competitive advantage.
Currently, the Company is not aware of a direct competitor for Motorola
Corporation's CompactFlash receiver module for use with Windows CE devices
for which Socket is developing the receiving software under contract with
Motorola.
The Company faces competition for its Digital Telephone Connection
Plug-in Cards from alternative methods of downloading information into a
mobile computer, primarily over telephone lines through a modem and
connecting through a direct cable connected to a serial port.
The Company competes with Smart Modular Technologies, Quatech and
Silicom, among others, in the serial PC Card market, although the Company
believes that it is the world's leading manufacturer of serial card
products.
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
The market for the Company's Ethernet Cards is highly competitive.
Market leaders for Ethernet Cards include 3Com and Xircom. However, the
Company has established a product leadership position with its Low-power
Ethernet PC and CF+ cards for Windows CE handheld computers and does not
currently face competition from these companies. The Company expects
competitive cards to enter the market during the second half of 1999 from
3Com and Xircom and possibly others including manufacturers of lower
priced cards in Asia. The Company also faces competition from combination
Cards which combine Ethernet and other functions such as fax/modem.
Companies offering combination Cards include 3Com and Xircom.
Personnel
As of December 31, 1998, the Company employed 26 people on a full-time
basis. Of these, twelve were responsible for sales, marketing and customer
technical support, six were in research and development, four were in
finance and administration and four were involved in operations. The
Company's employees are not represented by a union, and the Company
considers its relationship with its employees to be good. The Company's
future success will depend in significant part upon the continued service
of certain key technical and senior management personnel, and the
Company's continuing ability to attract, assimilate and retain highly
qualified technical, managerial and sales and marketing personnel. * The
Company does not have key man life insurance for any of its employees. See
"Management's Discussion and Analysis of Financial Condition and Results
of Operations - Risk Factors - We depend on key employees and we need to
hire additional sales and marketing and product development personnel."
Item 2. Description of Property
The Company leases a 23,000 square foot facility in Newark, California.
The facility is subject to a lease which expires in 2001. The current
monthly rent is approximately $16,325. The Company believes that its
current facilities are sufficient to meet its needs for the foreseeable
future.*
Financial information regarding lease commitments is contained in Note
9 of Notes to Financial Statements.
Item 3. Legal Proceedings
The Company has no material legal actions pending.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted for vote by security holders during the
fourth quarter of 1998.
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results will
meet the Company's current expectations due to factors described in this
Business section, and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including "Risk Factors."
<PAGE>
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
From the effective date of the Company's initial public offering (June
6, 1995) through November 26, 1996, the Company's Common Stock and Common
Stock Warrants were listed on the Nasdaq SmallCap Market under the symbol
SCKT and SCKTW, respectively. The Common Stock and Common Stock Warrants
were delisted from such market effective November 27, 1996 because the
Company's net capital was below that required for continued listing, and
since then have been traded on the OTC Bulletin Board under the symbols
SCKT and SCKTW, respectively. The Company's Common Stock is also quoted on
the Pacific Exchange. The continued listing criteria of the Pacific
Exchange requires the Company to have (i) at least 300,000 publicly held
shares of Common Stock with a market value of at least $500,000, (ii) at
least 250 public beneficial holders of its Common Stock, (iii) total net
tangible assets of at least $500,000 or net worth of at least $2,000,000,
and (iv) a share bid price of at least $1.00 per share of Common Stock.
The Company has not been in compliance with the net tangible asset or net
worth requirements of the Pacific Exchange since December 31, 1996 and
has, therefore, been subject to possible delisting procedures since that
time. The Company is also not in compliance with the share bid price
requirement as of March 17, 1999. In January 1999, the Pacific Exchange
granted the Company an extension to bring itself into compliance with the
continued listing criteria and advised Socket that it would next review
Socket's continued qualification for listing in April 1999. As of December
31, 1998, the Company had total net tangible assets of $295,977.
Accordingly, the Company will need to raise additional equity in 1999
through sale of equity securities or through attaining profitable
operations in order to comply with the Pacific Exchange listing criteria,
and there can be no assurance that the Company will be successful in doing
so. In that case, the Pacific Exchange may decide to initiate delisting
proceedings against Socket. If Socket's Common Stock becomes delisted
from the Pacific Exchange, the Company will become subject to the
Commission's "penny stock" rules and therefore an investor will find it
more difficult to dispose of, or to obtain accurate quotations as to the
price of Socket's securities.
The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain all future
earnings for the expansion and operation of its business and does not
anticipate paying cash dividends in the foreseeable future.
The quarterly high and low sales prices of the Company's Common Stock since
June 6, 1995, the effective date of its initial public offering, are as follows:
QUARTER ENDED High Low
- ---------------------------------------------------- --------- ---------
1996
March 31, 1996.................................. $4.38 $3.00
June 30, 1996................................... $7.38 $2.88
September 30, 1996.............................. $4.38 $2.88
December 31, 1996............................... $3.62 $0.75
1997
March 31, 1997.................................. $1.13 $0.63
June 30, 1997................................... $1.16 $0.50
September 30, 1997.............................. $0.78 $0.50
December 31, 1997............................... $0.75 $0.34
1998
March 31, 1998.................................. $1.13 $0.36
June 30, 1998................................... $1.31 $0.44
September 30, 1998.............................. $1.03 $0.44
December 31, 1998............................... $0.88 $0.27
1999
March 31, 1999 (through March 17)............... $0.78 $0.47
The quarterly high and low sales prices of the Company's Common Stock
warrants during the past three years are as follows:
QUARTER ENDED High Low
- ---------------------------------------------------- --------- ---------
1996
March 31, 1996.................................. $1.50 $1.13
June 30, 1996................................... $2.38 $1.06
September 30, 1996.............................. $1.44 $0.75
December 31, 1996............................... $1.00 $0.25
1997
March 31, 1997.................................. $0.38 $0.13
June 30, 1997................................... $0.44 $0.13
September 30, 1997.............................. $0.44 $0.13
December 31, 1997............................... $0.25 $0.06
1998
March 31, 1998.................................. $0.25 $0.06
June 30, 1998................................... $0.16 $0.13
September 30, 1998.............................. $0.25 $0.03
December 31, 1998............................... $0.13 $0.03
1999
March 31, 1999 (through March 17)............... $0.11 $0.03
These quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not represent actual transactions. As of
March 17, 1999, there were approximately 800 holders of record of the
Company's Common Stock and Warrants.
Recent Sales of Unregistered Securities
In November 1998, the Company sold 174,292 shares of its Series D
Convertible Preferred Stock, $0.001 par value, at $5.7375 per share (total
of $1 million) to two outside investors and to a director of the Company.
Each share of Series D Convertible Preferred Stock is convertible into 10
shares of Common Stock at the option of the holder, in whole or in part,
at any time for a period of three years following the date of sale with a
mandatory conversion date three years from date of issue. The Series D
stock will convert into a total of 1,742,920 shares of Common Stock. The
Series D shares have voting rights equal to the number of common shares
into which the Series D shares will convert, and have a liquidation
preference over common shares in the amount of the investment plus any
accrued but unpaid dividends. Dividends accrue at 8% per annum and are
payable in either cash or common stock at the option of the Company. The
Company also issued three-year warrants to acquire 640,972 shares of
Common Stock at $0.57355 per share.
The issuance of the above referenced securities was deemed to be
exempt from registration under the Securities Act of 1933, as amended (the
"Securities Act"), in reliance on Section 4(2) of the Securities Act as
a transaction by an issuer not involving any public offering. In
addition, the recipients of the securities and the transactions
represented their intention to acquire the securities for investment only
and not with a view for sale in connection with any distribution thereof
and appropriate legends were affixed to the securities issued in such
transactions.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements (identified with
an asterisk "*") that involve risks and uncertainties. The Company's
actual results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a difference
include, but are not limited to, those discussed in this "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
section and in "Business". The Company assumes no obligation to update
such forward-looking statements or to update the reasons actual results
could differ materially from those anticipated in such forward-looking
statements.
Overview
The Company is a leading supplier of connectivity products to the
emerging Windows CE handheld computing market and believes that it is the
world's leading supplier of serial plug-in cards for notebooks and for
Windows computers with PC card slots (See "Industry and Market
Overview"). The Company's family of serial, Ethernet and data collection
plug-in card products are its principal sources of revenues. During 1998,
the Company completed a number of steps to improve its financial condition
and operating results. First, the Company expanded its PC Card connection
family of products to add a family of CompactFlash serial, low power
Ethernet and bar code scanning products to support the smallest Windows CE
computer, the Palm-size PC (see "Products"). Second, the Company has
been seeking recurring OEM business for its products. The Company's
serial PC Card was selected by Compaq Computer Corporation for use with
its Remote Insight Board for remote management of Compaq servers.
Shipments began in the fourth quarter of 1998. (See "Strategic Alliances
and Business Relationships"). Third, the Company established several key
strategic relationships with industry leaders for developing products that
are expected to ship in 1999 for use with Windows CE computers including
Symbol Technologies (attaching laser scanners to notebooks and to Windows
CE computers) and Motorola Corporation (developing software for a paging
receiver module for the Palm-size PC). The Company also began working
closely with several North American digital telephone service providers
including Bell Mobility to develop digital telephone connection products
for the new CDMA digital telephones designed to transfer voice and data
over digital cellular networks. (See "Strategic Alliances and Business
Relationships"). Fourth, the Company improved its products. Product
improvements included enhanced Ethernet drivers and a cross-over connector
to improve Ethernet performance, extension of the Company's ruggedized
form factor to more of Socket's products, and development of a new high
integration serial chip to further reduce power consumption, increase data
transfer speeds and functionality, and reduce costs (See "Products").
Fifth, distribution channels were expanded and more closely aligned with
those used by the Windows CE manufacturers. In addition, on-site
representation was added in Europe and Asia to more closely support the
Company's international distributors (see "Sales and Marketing").
Sixth, the Company increased its capital, raising $2.4 million in new
equity financings and converting approximately $2.1 million of convertible
debt and accrued interest into equity. The Company improved its operating
results over 1997 by increasing its revenues 15% to $5.5 million,
improving its gross margins from 42% in 1997 to 59% in 1998, and reducing
its operating expenses from $5.4 million in 1997 to $4.2 million in 1998.
Although the Company believes that its focus on the Windows CE
operating system for handheld computers (see "Industry and Market
Overview"), its expanding family of connection products (see "Products")
and its relationships with key industry strategic partners (see
"Strategic Alliances and Business Relationships") position the Company
for revenue growth in 1999, the Company has incurred significant quarterly
and annual operating losses in every fiscal period since its inception,
and the Company may continue to incur quarterly operating losses at least
through the first half of 1999 and possibly longer .* The Company's
ability to achieve profitability will be highly dependent upon: increased
market acceptance of the Company's serial communications, Ethernet
connectivity, mobile data collection and wireless communications products
including recently introduced products; growth and acceptance of handheld
computers and devices using the Windows CE operating system; the ability
to raise capital to fund the Company's product development and sales and
marketing efforts; the development of new products for new and existing
markets; the improvement of gross margins through maintaining of sales
prices, higher sales volumes and contract manufacturing efficiencies;
expanding its distribution capability; completing its software development
contracts; and managing its operating expenses. There can be no
assurances that the Company will meet any of these objectives or ever
achieve profitability.
In addition, as of December 31, 1998, the Company had a cash balance of
$971,157, stockholders' equity of $295,977 and working capital of $1,286.
The current cash balance is not sufficient to fund operations through
fiscal 1999. Stockholders' equity is below the minimum equity balance of
$500,000 required for continued listing of the Company's common stock by
the Pacific Exchange. The Company's capital balances were improved during
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results
will meet the Company's current expectations due to factors described in this
Management's Discussion and Analysis section, and in "Business".
1998 by two equity financings totaling $2.4 million net of costs and
expenses, and by the conversion into equity of $2.1 million of convertible
subordinated debt plus accrued interest. The Company will require
additional funding in 1999 to fund its operations, strengthen its working
capital balances and to meet the minimum capital requirements to retain
its listing on the Pacific Exchange*. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources," and "-Risk Factors" for a discussion of the
Company's need for additional capital, the uncertainty regarding the
Company's continued listing on the Pacific Exchange and other risks that
may affect the Company's ability to attain profitability.
Annual Results of Operations
Revenue
In 1998, revenue was $5,477,804, an increase of 15% from 1997 revenue
of $4,779,200. 1997 revenue increased 5% compared to 1996 revenue of
$4,570,438. Revenue growth in 1998 was primarily due to increases in the
sale of three new products introduced at the end of 1997, a low power
Ethernet PC Card, a dual serial PC Card and a Data Collection PC Card for
attaching bar code scanners. Revenues also increased moderately due to
recurring OEM sales of serial card products to one customer that commenced
in the fourth quarter of 1998 and the introduction of CompactFlash (CF+)
Ethernet, serial and data collection connection products in the second
half of 1998. 1998 revenues included $250,000 in contract engineering
revenues, compared to $100,000 in contract engineering revenues in 1997.
Revenue growth in 1998 was partially offset by reductions in the sale of
standard Ethernet connection products. Revenue growth in 1997 resulted
from new serial card products released at the end of 1996 as the Company
expanded its serial card line to add a ruggedized serial PC card and a
dual port serial PC card and, in the fourth quarter of 1997, a bar code
scanner PC card for Windows CE handheld computers. Ethernet PC Card sales
grew due to significant sales to an international customer for standard
Ethernet PC Cards, and from new products consisting of an Ethernet/serial
multifunction card released at the end of 1996 and a low-power Ethernet
card for Windows CE 2.0 computers released in the fourth quarter of 1997.
Revenue growth in 1997 was partially offset by lower sales of the
Company's PageCard wireless messaging system, which was terminated at the
end of 1997, and the termination of sales of its GPS PC card which was
sold through the first half of 1996.
The Company markets its products primarily through distributors and
other equipment manufacturers "OEMs". Recognition of revenue on
shipments to distributors and the related cost of sales are deferred until
such distributors resell the products to their customers. Recognition of
revenue on shipments to customers other than distributors occurs generally
at the time of shipment. Export sales constituted 34%, 49% and 40% of
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results
will meet the Company's current expectations due to factors described in this
Management's Discussion and Analysis section, and in "Business".
revenue in 1998, 1997, and 1996, respectively. The decline in export
sales in 1998 reflected lower sales of standard Ethernet PC cards to one
international customer in 1998 and concentration of growth in U.S. markets
in 1998 for Windows CE connection products.
Gross Profit
Gross profit for 1998 was $3,239,146, or 59% of revenue compared to
$1,991,092, or 42% of revenue in 1997 and $2,074,410, or 45% of revenue in
1996. Product gross profit in 1997 was impacted by a write-off of
primarily PageCard inventory of $588,572. Gross profit before the
inventory write-off in 1997 was 54%. Gross profit in 1998 compared to 1997
(before 1997 inventory write-off) increased moderately due to a favorable
product mix from higher margin new products and contract engineering
revenues and a reduction in sales of older lower margin products. Gross
profit on 1997 (before inventory write-off) increased over 1996 due to
favorable product mix from a higher percentage of higher margin serial
card sales, higher product gross profit margins on new products, and lower
product manufacturing costs.
Research and Development
Research and development expense in 1998 was $999,362, a decrease of 5%
from 1997 expense of $1,050,411. The decrease reflected moderate
reductions in costs of personnel, equipment and contract engineering
services. 1997 research and development expense was essentially flat with
1996 expense of $1,067,399, reflecting similar levels of staffing and
research and development activities in both years. To date, the Company
has not capitalized any software development costs. The Company expects
to increase its research and development expense in 1999.*
Sales and Marketing
Sales and marketing expense in 1998 was $2,009,003, a decrease of 26%
over 1997 expense of $2,719,050. The decrease reflected lower 1998
staffing levels due to the discontinuation in 1997 of the PageCard selling
and marketing programs including the costs of staff reductions in 1997,
partially offset by increases in sales personnel and marketing activities
for other products in 1998. Marketing expense in 1997 also included the
cost of a new products marketing study. 1997 sales and marketing expense
increased 2% over 1996 sales and marketing expense of $2,666,933. The
moderate increase in 1997 reflected higher sales and marketing staffing
levels in the first half of 1997 and higher costs associated with a
marketing study for new products, offset in the second half of the year
with staffing reductions net of personnel severance costs relating to
discontinued selling activities for the Company's PageCard. The Company
expects to increase its sales and marketing expense in 1999.*
General and Administrative
General and administrative expense in 1998 was $1,192,452, a decrease
of 26% from 1997 expense of $1,613,492. The decrease primarily reflected
professional fees associated with financing and contemplated (subsequently
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results
will meet the Company's current expectations due to factors described in this
Management's Discussion and Analysis section, and in "Business".
discontinued) merger activities during 1997 and one-time severance costs
for the Company's former CEO whose services terminated in April 1997. 1997
expense decreased 2% compared to 1996 expense of $1,647,335, reflected
lower staffing levels in 1997 and lower occupancy costs from a move of the
Company in the fourth quarter of 1996, offset by approximately $450,000 of
expense increase associated with discontinued merger and financing
activities charged to operations during 1997. The Company expects to
increase its general and administrative expense in 1999. *
Interest Income, Interest Expense, Net
Interest income reflects interest earned on cash balances. Interest
expense reflects interest on convertible preferred notes issued on various
dates in 1997 and converting into Series C convertible preferred stock or
common stock in March and May 1998 (see Note 5 to Notes to Financial
Statements), interest expense relating to bank lines (see Note 7 to Notes
to Financial Statements) and equipment lease financing obligations (see
Note 8 to Notes to Financial Statements).
Income Taxes
There was no provision for federal or state income taxes for the years
ended December 31, 1998, 1997 and 1996, as the Company incurred net
operating losses. As of December 31, 1998, the Company has federal and
state net operating loss carryforwards of approximately $13,000,000 and
$5,800,000, respectively. The Company also has federal and state tax
credit carryforwards of approximately $180,000 and $150,000, respectively.
The net operating losses and credit carryforwards will expire at various
dates beginning in 1999 through 2018, if not utilized. The utilization of
approximately $5,200,000 of the federal net operating loss included in the
above amounts will be subject to a cumulative annual limitation of
approximately $600,000 per year pursuant to the stock ownership change
provision of the Tax Reform Act of 1986. Future changes in ownership,
including stock offerings, may result in additional limitations. For
financial reporting purposes, a valuation allowance of $6,702,000 has been
recorded to offset deferred tax assets recognized under Financial
Accounting Standards No. 109, "Accounting for Income Taxes," primarily
related to net operating losses and capitalized research and development
costs. See Note 14 of Notes to Financial Statements.
Preferred Stock Dividend; Accretion of Preferred Stock
Preferred stock dividend in 1998 reflect dividends earned at 8% per
annum on Series B convertible preferred stock, on Series C convertible
preferred stock issued during the first and second quarters of 1998, and
on Series D convertible preferred stock issued during the fourth quarter
of 1998 (see Notes 4, 5 and 6 to Notes to Financial Statements).
Preferred stock dividends in 1997 reflect dividends earned at 6% per annum
on Series A preferred stock issued in November 1996 and converted at the
option of the holder into common stock at various dates through November
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results
will meet the Company's current expectations due to factors described in this
Management's Discussion and Analysis section, and in "Business".
1997 (see Note 3 to Notes to Financial Statements). Accretion of
preferred stock in 1998 reflected a purchase price discount of 20% from
market for $1.0 million of Series B Preferred Stock issued during the
first quarter of 1998. Accretion of preferred stock in 1996 reflected a
purchase discount of 35% from market for $1.55 million of Series A
Convertible Preferred Stock issued in November 1996.
Year 2000 Compliance
The Year 2000 issue is the result of many currently installed computer
programs being written using two digits rather than four to define the
applicable year. As a result, these computer programs are unable to
distinguish between 21st century dates and 20th century dates, and could
cause computer system failures or miscalculations that result in
significant business disruptions.
The Company has evaluated its products and, with the assistance of
third party specialists, its internal systems, and communicated with its
key suppliers and distributors relating to the existence of Year 2000
issues that could adversely affect the supplier's ability to deliver
product to the Company or the distributor's ability to deliver product to
the customer. This project did not impact other information technology
projects. The Company's products do not use or rely on computer date
information and are therefore not affected by the Year 2000 date change.
The Company has made the necessary upgrades to its internal systems to
make its systems Year 2000 compliant at an approximate cost of $15,000,
paid from operating funds. The Company believes that all of its internal
systems are Year 2000 compliant. The Company has also communicated with
its major suppliers and distributors, and is not aware of any compliance
issues. The Company has not assessed its non-information technology
systems to determine whether there are any Year 2000 issues. The Company
believes that its most reasonably likely worst case Year 2000 scenarios
would relate to problems with the systems of third parties rather than
with the Company's internal systems or its products. It is clear that the
Company has the least ability to assess and remedy the Year 2000 problems
of third parties and the Company believes the risks are greatest with
infrastructure (e.g. electricity supply, water and sewer service),
telecommunications, transportation supply chains and critical suppliers of
materials. The Company is of the belief that disruption of services, if
any, are likely to be of limited duration (less than 30 days), and that
inventory balances of the Company's products in its distribution channels
should be sufficient to cover any limited duration interruptions. * In
addition, should such disruptions affect a supplier or a distributor for a
longer time period, the Company believes that it has or can develop
alternative sources of supply and alternative distribution channels, ship
its product directly from its suppliers or directly to its customers, or
employ other contingency steps to minimize any disruption affecting its
business, results of operations, or financial condition.*
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results
will meet the Company's current expectations due to factors described in this
Management's Discussion and Analysis section, and in "Business".
Quarterly Results of Operations
The following table sets forth summary quarterly statements of
operations for each of the quarters in 1998 and 1997. This unaudited
quarterly information has been prepared on the same basis as the annual
information presented elsewhere herein, and, in the Company's opinion,
includes all adjustments (consisting only of normal recurring entries)
necessary for a fair presentation of the information for the quarters
presented. The operating results for any quarter are not necessarily
indicative of results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
---------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998
--------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
SUMMARY QUARTERLY DATA:
Revenue....................... $1,176 $1,486 $1,368 $1,448
Cost of revenue............... 520 564 537 618
--------- --------- --------- ---------
Gross profit.................. 656 922 831 830
OPERATING EXPENSES:
Research and development.... 252 254 248 245
Sales and marketing......... 457 501 500 551
General and administrative.. 299 290 251 353
--------- --------- --------- ---------
Total operating expenses...... 1,008 1,045 999 1,149
Interest expense, net......... (63) (14) (19) (10)
--------- --------- --------- ---------
Net loss...................... (415) (137) (187) (329)
Preferred stock dividends..... (14) (67) (64) (76)
Accretion, preferred stock
issue....................... (250) -- -- --
--------- --------- --------- ---------
Net loss applicable to
common stockholders......... ($679) ($204) ($251) ($405)
========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
Quarter Ended
---------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997
--------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
SUMMARY QUARTERLY DATA:
Revenue....................... $1,071 $1,123 $1,350 $1,235
Cost of revenue............... 540 546 681 1,021
--------- --------- --------- ---------
Gross profit.................. 531 577 669 214
OPERATING EXPENSES:
Research and development.... 272 273 260 245
Sales and marketing......... 757 796 652 514
General and administrative.. 329 537 495 253
--------- --------- --------- ---------
Total operating expenses...... 1,358 1,606 1,407 1,012
Interest expense, net......... (25) (36) (46) (56)
--------- --------- --------- ---------
Net loss...................... (852) (1,065) (784) (854)
Preferred stock dividends..... (31) (8) (5) (1)
--------- --------- --------- ---------
Net loss applicable to
common stockholders......... ($883) ($1,073) ($789) ($855)
</TABLE> ========= ========= ========= =========
The Company's gross profit for the quarter ended December 31, 1997
reflected a write-off of the Company's POCSAG PageCard inventories in the
amount of approximately $500,000 due to low demand and the development,
commencing in 1998, of wireless receivers that utilize the higher speed
FLEX protocols.
The Company has experienced significant quarterly fluctuations in
operating results and anticipates such fluctuations in the future. The
Company generally ships orders as received and as a result typically has
little or no backlog. Quarterly revenues and operating results therefore
depend on the volume and timing of orders received during the quarter,
which are difficult to forecast. Historically, the Company has often
recognized a substantial portion of its revenues in the last month of the
quarter, often in the last week. Operating results may also fluctuate due
to factors such as the demand for the Company's products, the size and
timing of customer orders, the introduction of new products and product
enhancements by the Company or its competitors, changes in the proportion
of revenues attributable to contract engineering, product mix, timing of
software enhancements, changes in the level of operating expenses, and
competitive conditions in the industry. Because the Company's staffing
and other operating expenses are based on anticipated revenue, a
substantial portion of which is not typically generated until the end of
each quarter, delays in the receipt of orders can cause significant
variations in operating results from quarter to quarter.
Liquidity and Capital Resources
Net cash used for operating activities was $1,516,349 in 1998,
resulting primarily from the net loss, increases in inventories and
decreases in accounts payable and accrued expenses. Net cash used for
operating activities was $2,173,687 in 1997, resulting primarily from the
net loss, partially offset by increases in accounts payable and accrued
liabilities. Net cash used for operating activities was $3,050,835 in
1996, resulting primarily from the net loss.
Net cash used for investing activities was $96,714 in 1998, $183,178 in
1997 and $296,048 in 1996, used for the purchase of furniture, computing,
test and manufacturing equipment.
Net cash provided by financing activities was $2,307,320 in 1998,
resulting primarily from the net proceeds from sale of Series B and Series
D convertible preferred stock (see Notes 4 and 6 to Notes to Financial
Statements). Net cash provided by financing activities was $2,015,421 in
1997, resulting primarily from proceeds from the issuance of subordinated
convertible notes of $1,950,000 (see Note 5 to Notes to Financial
Statements) and an increase in borrowings under the bank line of credit
(see Note 7 to Notes to Financial Statements), partially offset by
payments of capital and equipment financing notes leases (see Note 8 to
Notes to Financial Statements) and payment of dividends to Series A
preferred stockholders (see Note 3 to Notes to Financial Statements). Net
cash provided by financing activities was $1,558,572 in 1996, primarily
reflected the sale of Series A Convertible Preferred Stock, increases in
borrowings under a revolving credit line with a bank and proceeds from the
leasing of certain furniture and equipment, partially offset by payments
of capital leases and equipment financing notes.
In 1998, the Company completed two transactions not requiring the use
of cash. Convertible notes payable and related accrued interest at the
end of December 1997 were converted into Series C Convertible Preferred
Stock or into Common Stock at the option of the holder. In addition,
preferred stock dividends paid for Series B and Series D preferred stock
were paid in common stock.
Future Capital Needs; Independent Auditors' Report Contained Explanatory
Paragraph Regarding Going Concern.
The Company has incurred significant quarterly and annual operating
losses in every fiscal period since its inception, and the Company may
continue to incur quarterly operating losses at least through the first
half of 1999 and possibly longer.* The Company's ability to achieve
profitability will be highly dependent upon: increased market acceptance
of the Company's serial communications, Ethernet connectivity, mobile data
collection and paging products including recently introduced products;
growth and acceptance of handheld computers and devices using the Windows
CE operating system; the ability to raise capital to fund the Company's
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results
will meet the Company's current expectations due to factors described in this
Management's Discussion and Analysis section, and in "Business".
product development and sales and marketing efforts; the development of
new products for new and existing markets; the improvement of gross
margins through maintaining of sales prices, higher sales volumes and
contract manufacturing efficiencies; expanding its distribution
capability; completing its software development contracts; and managing
its operating expenses. There can be no assurances that the Company will
meet any of these objectives or ever achieve profitability.
In addition, as of December 31, 1998, the Company had stockholders' equity
of $295,977 and working capital of $1,286. The Company's capital balances
were improved during 1998 by two equity financings totaling $2.4 million
net of costs and expenses, and by the conversion into equity of $2.1
million of convertible subordinated debt plus accrued interest. The
Company will require additional funding in 1999 to fund its operations and
to strengthen its working capital balances, which the Company intends to
accomplish through the issuance of additional equity securities, through
increased borrowings on the Company's bank line as the levels of
receivables permit, and through development funding from development
partners.* The Report of Independent Auditors on the Company's financial
statements for the year ended December 31, 1998 included in Form 10-KSB
contains an explanatory paragraph regarding the Company's need for
additional financing and indicated substantial doubt about the Company's
ability to continue as a going concern. There can be no assurances that
such capital will be available on acceptable terms, if at all, and such
terms may be dilutive to existing stockholders. The Company's inability to
secure the necessary funding would significantly impair the ability of the
Company to carry out its strategy of increasing its sales and marketing
and research and development efforts and otherwise would have a material
adverse affect on the Company's financial condition and results of
operations (see "Risk Factors - The trading market for our common stock
is illiquid.".
Risk Factors
We need to raise additional capital to fund our operations. Our
independent auditors included an explanatory paragraph in their report
expressing doubt about our ability to continue as a going concern.
As of December 31, 1998, we had cash and cash equivalents of $971,157
and continue to utilize our receivables-based bank credit lines to finance
our operations. As of December 31, 1998, we had stockholders' equity of
$295,977 and working capital of $1,286. Our capital balances were improved
during 1998 by two equity financings totaling $2.4 million net of costs
and expenses, and by the conversion into equity of $2.1 million of
convertible subordinated debt plus accrued interest. We believe our
existing capital resources will be sufficient to satisfy our working
capital requirements through at least the first half of 1999. * The Report
of Independent Auditors on our financial statements for the year ended
December 31, 1998 contains an explanatory paragraph regarding our need for
additional financing and indicating substantial doubt about our ability to
continue as a going concern. We intend to raise additional capital to
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results
will meet the Company's current expectations due to factors described in this
Management's Discussion and Analysis section, and in "Business".
fund our working capital requirements in 1999 and beyond. We may not be
able to raise additional capital on acceptable terms, if at all. If we
do, the additional capital may be on terms that are dilutive to existing
stockholders. Our inability to secure any necessary funding would
significantly impair our ability to operate and would adversely affect our
financial condition.
The trading market for our Common Stock is illiquid, and we may be
delisted from the Pacific Exchange
Our Common Stock trades on the OTC Bulletin Board. Our Common Stock is
also quoted on the Pacific Exchange. The continued listing criteria of the
Pacific Exchange requires us to have:
(i) at least 300,000 publicly held shares of Common Stock with a
market value of at least $500,000,
(ii) at least 250 public beneficial holders of our Common Stock,
(iii) total net tangible assets (the same as stockholders' equity
for Socket) of at least $500,000 or net worth of at least
$2,000,000, and
(iv) a share bid price of at least $1.00 per share of Common
Stock.
We have not been in compliance with the net tangible asset
requirements of the Pacific Exchange since December 31, 1996, nor, except
for brief periods of time, with the share bid price requirements of the
Pacific Exchange. Therefore, we have been subject to possible delisting
procedures since December 31, 1996. In January 1999, the Pacific Exchange
granted us a further extension of time to come into compliance with the
continued listing criteria and advised us that it would next review our
qualification for continued listing in April 1999. As of December 31,
1998, stockholders' equity was $295,977. We will need to further increase
our stockholders' equity from $295,977 to $500,000, by raising additional
equity capital or through profitability, in order to comply with the
Pacific Exchange's minimum listing criteria, and we may not be successful
in doing so. In that case, the Pacific Exchange may decide to initiate
delisting proceedings against us.
If our Common Stock becomes delisted from the Pacific Exchange,
trading in our stock will become subject to the Commission's "penny
stock" rules, which will make it more difficult for our stockholders to
dispose of our stock. The "penny stock" rules under the Securities
Exchange Act of 1934, as amended, generally impose additional sales
practices and market making requirements on broker-dealers who sell and/or
make a market in such securities. For transactions covered by the penny
stock rules, a broker-dealer must make special suitability determinations
for purchasers and must have received the purchasers' written consent to
the transactions prior to sale. In addition, for any transaction
involving a penny stock, unless exempt, the rules require delivery prior
to any transaction in a penny stock of a disclosure schedule prepared by
the Commission relating to the penny stock market. Disclosure is also
required to be made about commissions payable to both the broker-dealer
and the registered representative and current quotations for the
securities. Finally, monthly statements are required to be sent
disclosing recent price information for the penny stock held in the
account and information on the limited market in penny stocks.
Consequently, our delisting from the Pacific Exchange and our becoming
subject to the rules on penny stocks would affect the ability or
willingness of broker-dealers to sell and/or make a market in our
securities and therefore would severely adversely affect the market
liquidity for our securities.
Shares eligible for future sale may adversely affect the market price for
our common stock
As of December 31, 1998, there were 1,918,508 shares of Common Stock
issuable upon the exercise of options under our 1995 and 1993 Stock Plans,
as amended, and 4,055,135 shares of our Common Stock issuable upon
exercise of warrants. Certain of these warrants include dilution
adjustments whenever we issue Common Stock or securities converting into
Common Stock at prices below $6.00 per share. In addition, 3,006,500
shares are issuable upon the conversion of Series B Convertible Preferred
Stock, an aggregate of 3,049,106 shares of Common Stock are issuable upon
conversion of Series C Convertible Preferred Stock and accrued dividends
at December 31, 1998, plus additional shares will accrue for dividends
through the date of conversion, and 1,742,920 shares are issuable upon the
conversion of Series D Preferred Stock (See Notes 4, 5 and 6 to Notes to
Financial Statements). All of the Common Stock underlying the Series B
and Series C Convertible Preferred Stock, the Common Stock dividends on
that Preferred Stock, and certain other shares of Common Stock have been
registered on a Form S-3 registration statement. Accordingly, that Common
Stock may be sold into the market under that registration statement
without restriction or the volume limitations of Rule 144 under the
Securities Act of 1933, as amended. The sale of these common shares in
the market, and the appearance that such shares are available for sale,
has in the past and could in the future adversely affect the market price
of our Common Stock and could make it more difficult to sell equity
securities in the future.
We intend to issue additional equity securities in 1999 in order to
increase our working capital and to achieve compliance with the net
tangible asset requirements of the Pacific Exchange. * To the extent we do
so, existing stockholders may experience substantial dilution,
particularly if the terms of such issuance include discounts to market
prices or the issuance of warrants, as we did in connection with the
issuance of $1,500,000 of Series B Convertible Preferred Stock and the
issuance of $1,000,000 of Series D Convertible Preferred Stock. In
addition, the holders of Series D Convertible Preferred Stock have
registration rights and may request us to register at any time the common
shares that will be issued upon conversion. In addition, the holders of
Series D Convertible Preferred Stock also hold warrants to purchase
640,972 shares of Common Stock, and have registration rights under which
we will register the common shares issued upon the exercise of warrants.
Registered shares are immediately eligible to be sold in the public market
without restriction under Rule 144 under the Securities Act of 1933,
which, given the relatively low trading volumes for our Common Stock,
would likely have a significant depressant effect on the per share market
price of our Common Stock.
We have a history of operating losses and we cannot assure you that we
will ever achieve profitability
We were incorporated in March 1992 and we have incurred significant
operating losses in every fiscal period since inception. Although we have
reduced our operating losses during 1998, we are likely to continue to
incur quarterly operating losses at least through the first half of 1999
and possibly longer.* Profitability, if any, will depend upon:
(i) increased market acceptance of products,
(ii) our ability to obtain additional capital to fund our working
capital requirements,
(iii) market acceptance of mobile computers that use Microsoft's
Windows CE operating system,
(iv) the continuation of our development contract with Motorola,
(v) the expansion of development and OEM customer relationships
to increase development and product sales revenues,
(vi) the development of successful new products for new and
existing markets,
(vii) our ability to increase gross margins through higher sales
volumes and contract manufacturing efficiencies,
(viii)our ability to expand our distribution capability,
(ix) our ability to perform on development contracts, and
(x) our ability manage our operating expenses.
There can be no assurance that we will meet any of these objectives or
ever achieve profitability.
We are highly dependent on the market for mobile computers, particularly
those that use the Windows CE operating system
Substantially all of our products are designed for use in mobile
computers, including notebooks, handheld PCs and, beginning in the second
half of 1998, Palm-size PCs and H/PC Professionals (Windows-CE based mini
notebooks). We expect to continue to derive a significant portion of
revenues from the sale of our products for use in mobile computers,
particularly those that use the Windows CE operating system. The market
for mobile computers is characterized by rapidly changing technology,
evolving industry standards, frequent new product introductions and
significant price competition, resulting in short product life cycles and
regular reductions of average selling prices over the life of a specific
product. Although the market for mobile computers has grown substantially
in recent years, and certain industry analysts including International
Data Corporation expect the market to continue to grow, we can give you no
assurance that such growth will in fact continue at the rates predicted by
such industry analyst or at all. A reduction in sales of mobile computers
or a reduction in the growth rate of such sales, would likely reduce
demand for our products. In addition, our ability to compete successfully
will depend on our ability to identify and ensure compliance with evolving
industry standards. Unanticipated changes in industry standards could
render our products incompatible with products developed by major hardware
manufacturers and software developers, including Microsoft and Motorola.
We could be required, as a result, to invest significant time and
resources to redesign our products to ensure compliance with relevant
standards. If our products are not in compliance with prevailing industry
standards for a significant period of time, we would miss opportunities to
have our products specified as standards for new hardware components
designed by mobile computer manufacturers and OEMs. The failure to
achieve any such design win would result in the loss of any potential
sales volume that could be generated by such newly designed hardware
component.
Beginning in 1996, we implemented a strategy of focusing our product
development efforts on mobile computers and other devices that use the
Windows CE operating system of Microsoft. As a result, our success is
substantially dependent on the commercial success of handheld PCs (H/PCs,
Palm-size PCs and H/PC Professionals) and other devices that operate on
the Windows CE operating system. Therefore, our future success depends on
factors outside of our control, including market acceptance of Windows CE
generally and other factors affecting the commercial success of Windows CE
computers and devices, including changes in industry standards or the
introduction of new or competing technologies. Any delays in or failure
of Windows CE to achieve market acceptance would reduce the number of
potential customers of our products, which could adversely affect our
business.
The market for our products changes rapidly, and our success depends upon
our ability to develop new and enhanced products
The market for our products is characterized by rapidly changing
technology, evolving industry standards and short product life cycles.
Accordingly, our success will depend on a number of factors, including:
(i) our ability to identify emerging standards in the field of
mobile computing products,
(ii) our ability to enhance our products by adding additional
features to differentiate our products from those of our
competitors, and
(iii) our ability to maintain superior or competitive performance
in our products and bring products to market quickly.
Given the emerging nature of the mobile computing products market, we can
give you no assurance that our products or technology will not be rendered
obsolete by alternative technologies. Further, short product life cycles
expose our products to the risk of obsolescence and require frequent new
product introductions. If we do develop or obtain access to advanced
mobile communications technologies as they become available, or if we do
not develop and introduce competitive new products on a timely basis, our
future operating results will be adversely affected.
Our products may contain undetected flaws and defects
Although we perform testing prior to new product introductions, our
hardware and software products may contain undetected flaws, which may not
be discovered until the products have been used by customers. From time
to time, we may temporarily suspend or delay shipments or divert
development resources from other projects to correct a particular product
deficiency. Such efforts to identify and correct errors and make design
changes may be expensive and time consuming. Failure to discover product
deficiencies in the future could delay product introductions or shipments,
require us to recall previously shipped products to make design
modifications or cause unfavorable publicity, any of which could adversely
affect our business.
Our quarterly operating results may fluctuate in future periods and our
future results are difficult to predict because we have little order
backlog
We have experienced significant quarterly fluctuations in operating
results and we anticipate such fluctuations in the future. We generally
ship orders as received and as a result typically have little or no
backlog. Quarterly revenues and operating results therefore depend on the
volume and timing of orders received during the quarter, which are
difficult to forecast. Historically, we have often recognized a
substantial portion of our revenues in the last month of the quarter.
This subjects us to the risk that even modest delays in orders adversely
affect our quarterly operating results. Our operating results may also
fluctuate due to factors such as:
(i) the demand for our products,
(ii) the size and timing of customer orders,
(iii) unanticipated delays or problems in the introduction of our
new products and product enhancements,
(iv) the introduction of new products and product enhancements by
our competitors,
(v) changes in the proportion of revenues attributable to
royalties and engineering development services,
(vi) product mix,
(vii) timing of software enhancements,
(viii) changes in the level of operating expenses, and
(ix) competitive conditions in the industry including competitive
pressures resulting in lower average selling prices.
Because we base our staffing and other operating expenses on anticipated
revenue, a substantial portion of which is not typically generated until
the end of each quarter, delays in the receipt of orders can cause
significant variations in operating results from quarter to quarter. As a
result of any of the foregoing factors, our results of operations in any
given quarter may be below the expectations of public market analysts or
investors, in which case the market price of our Common Stock would be
adversely affected.
We depend on alliances and other business relationships with a small
number of third parties
Our strategy is to establish strategic alliances and business
relationships with leading participants in various segments of the
communications and mobile computer markets. * In accordance with this
strategy, we have entered into alliances or relationships with Bell
Mobility, Compaq Computer Corporation, Microsoft, Motorola, Symbol
Technologies and Welch Allyn. Our success will depend not only on our
continued relationships with these parties, but also on our ability to
enter into additional strategic arrangements with new partners on
commercially reasonable terms. We believe that, in particular,
relationships with application software developers are important in
creating commercial uses for our products. Any future relationships may
require us to share control over our development, manufacturing and
marketing programs or to relinquish rights to certain versions of our
technology. Also, our strategic partners may revoke their commitment to
our products or services at any time in the future, or may develop their
own competitive products or services. Also, the hardware or software of
such companies that is integrated into our products may contain defects or
errors. Accordingly, there can be no assurance that our strategic
relationships will result in sustained business alliances, successful
product or service offerings or the generation of significant revenues for
us. Failure of one or more of such alliances could result in delay or
termination of product development projects, reduction in market
penetration, decreased ability to win new customers or loss of confidence
by current or potential customers.
As part of our strategy, we believe that we have developed a close
working relationship with Microsoft to design products for use with the
handheld PCs and other products that use Microsoft's Windows CE operating
system. Beginning in 1997, we have increasingly devoted significant
research and development resources to design activities for Windows CE
based products, diverting financial and personnel resources from other
development projects. These design activities are not undertaken pursuant
to any agreement under which Microsoft is obligated to continue the
collaboration or to support resulting products. Consequently, Microsoft
may terminate its collaborations with us for a variety of reasons
including our failure to meet agreed-upon standards or for reasons beyond
our control, including changing market conditions, increased competition,
discontinued product lines and product obsolescence. Although we believe
that our recent agreements with Motorola to develop software for a FLEX
receiver module for use with the Windows CE Palm-size PC, and with Symbol
Technologies to develop laser scanning handheld products for use with
Windows CE handheld and notebook computers will enhance our collaboration
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results
will meet the Company's current expectations due to factors described in this
Management's Discussion and Analysis section, and in "Business".
with Microsoft, there can be no assurance that Microsoft will not in the
future discontinue collaborating with us on the design of our products.
This would result in our having expended significant research and
development resources without benefit and having lost potential revenues
from the development and sale of alternative products.
We depend on key employees and we need to hire additional sales and
marketing and product development personnel
Our future success will depend upon the continued service of certain
key technical and senior management personnel. Competition for such
personnel is intense, and there can be no assurance that we will be able
to retain our existing key managerial, technical or sales and marketing
personnel. The loss of key personnel in the future has in the past and
could in the future, adversely affect our business.
We believe our ability to achieve increased revenues and to develop
successful new products and product enhancements will depend in part upon
our ability to attract and retain highly skilled sales and marketing and
product development personnel. Competition for such personnel is intense,
and we may not be able to retain such key employees, and there are no
assurances that we will be successful in attracting and retaining such
personnel in the future. In addition, our ability to hire and retain such
personnel will depend upon our ability to raise capital or achieve
increased revenue levels to fund the costs associated with such personnel.
Failure to attract and retain key personnel will adversely affect our
business.
We depend on distributors, resellers and OEMs to sell our products
We sell our products primarily through distributors, resellers and
other equipment manufacturers ("OEMs'). To date we have not achieved
significant OEM sales and there can be no assurance that we will achieve
significant sales through this channel. Our largest distributors, Ingram
Micro and Tech Data in the U.S. and PPCP in the U.K., accounted for
approximately 29%, 11%, and 10% respectively, of our revenue in 1998. Our
agreements with OEMs, distributors and resellers, in large part, are
nonexclusive and may be terminated on short notice by either party without
cause. Our OEMs, distributors and resellers are not within our control,
are not obligated to purchase products from us and may represent other
lines of products. A reduction in sales effort or discontinuance of sales
of our products by our OEMs, distributors and resellers could lead to
reduced sales. Use of distributors also entails the risk that
distributors will build up inventories in anticipation of a growth in
sales. If such growth does not occur as anticipated, these distributors
may substantially decrease the amount of product ordered in subsequent
quarters. Such fluctuations could contribute to significant variations in
our future operating results. The loss or ineffectiveness of any of our
major distributors could adversely affect our operating results.
We allow our distributors to return a portion of our inventory to us
for full credit against other purchases. In addition, in the event we
reduce our prices, we credit our distributors for the difference between
the purchase price of products remaining in their inventory and our
reduced price for such products. Actual returns and price protection may
adversely affect future operating results, particularly since we seek to
continually introduce new and enhanced products and are likely to face
increasing price competition. *
A significant portion of our revenues are derived from export sales
Export sales (sales to customers outside the United States) accounted
for approximately 34% of our revenue in 1998. Accordingly, our operating
results are subject to the risks inherent in export sales, including
longer payment cycles, unexpected changes in regulatory requirements,
import and export restrictions and tariffs, difficulties in managing
foreign operations, the burdens of complying with a variety of foreign
laws, greater difficulty or delay in accounts receivable collection,
potentially adverse tax consequences and political and economic
instability. In addition, our export sales are currently denominated
predominately in United States dollars. Accordingly, an increase in the
value of the United States dollar relative to foreign currencies could
make our products more expensive and therefore potentially less
competitive in foreign markets.
- --------------
* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual results
will meet the Company's current expectations due to factors described in this
Management's Discussion and Analysis section, and in "Business".
<PAGE>
Item 7. Financial Statements
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Socket Communications, Inc.
We have audited the accompanying balance sheets of Socket
Communications, Inc. as of December 31, 1998 and 1997, and the related
statements of operations, stockholders' equity (deficit) and cash flows
for each of the three years in the period ended December 31, 1998. Our
audits also included the financial statement schedule listed in the index
at Item 13(a). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and schedule based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Socket
Communications, Inc. at December 31, 1998 and 1997 and the results of its
operations and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements
taken as a whole, presents fairly in all material respects the information
set forth therein.
The accompanying financial statements have been prepared assuming
Socket Communications, Inc. will continue as a going concern. As discussed
in Note 1 to the financial statements, the Company's recurring operating
losses and stockholders' equity and working capital balances raise
substantial doubt about its ability to continue as a going concern.
Management's plans as to these matters are also discussed in Note 1. The
financial statements do not include any adjustments that might result from
the outcome of this uncertainty.
/s/ ERNST & YOUNG LLP
San Jose, California
February 18, 1999
<PAGE>
SOCKET COMMUNICATIONS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $971,157 $276,900
Accounts receivable, net of allowance for doubtful
accounts of $42,265 in 1998 and $44,691 in 1997.. 874,895 855,925
Accounts receivable from related party............. -- 43,371
Inventories........................................ 479,578 195,127
Prepaid expenses................................... 41,764 9,048
------------ ------------
Total current assets............................. 2,367,394 1,380,371
------------ ------------
Property and equipment:
Machinery and office equipment..................... 595,419 600,851
Computer equipment................................. 480,725 530,239
------------ ------------
1,076,144 1,131,090
Accumulated depreciation........................... (850,056) (807,502)
------------ ------------
226,088 323,588
Other assets......................................... 68,603 66,305
------------ ------------
Total assets..................................... $2,662,085 $1,770,264
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Bank line of credit................................ $520,727 $523,941
Convertible subordinated notes..................... -- 1,950,000
Accounts payable................................... 1,140,445 1,581,008
Accounts payable to related parties................ -- 66,966
Accrued expenses................................... 221,783 314,380
Accrued payroll and related expenses............... 201,952 277,553
Deferred revenue................................... 240,118 178,625
Current portion of capital leases and equipment
financing notes................................. 41,083 61,804
------------ ------------
Total current liabilities........................ 2,366,108 4,954,277
Long-term portion of capital leases and equipment
financing notes................................. -- 40,931
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock, $0.001 par value;
Authorized shares -- 3,000,000
Series B Convertible Preferred Stock:
Designated shares - 37,500; Issued and
outstanding shares -- 30,065 at December 31,
1998 and none at December 31, 1997; Aggregate
liquidation preference -- $1,530,000 at
December 31, 1998............................. 1,565,976 --
Series C Convertible Preferred Stock:
Designated shares - 175,000; Issued and
outstanding shares -- 163,468 at December 31,
1998 and none at December 31, 1997; Aggregate
liquidation preference -- $1,824,320 at
December 31, 1998............................. 1,714,043 --
Series D Convertible Preferred Stock:
Designated shares - 175,000; Issued and
outstanding shares -- 174,292 at December 31,
1998 and none at December 31, 1997; Aggregate
liquidation preference -- $1,010,543 at
December 31, 1998............................. 769,887 --
Common stock, $0.001 par value:
Authorized shares -- 15,000,000
Issued and outstanding shares -- 7,365,914
in 1998 and 6,501,275 in 1997................. 7,366 6,501
Additional paid-in capital......................... 14,217,366 13,208,038
Accumulated deficit................................ (17,978,661) (16,439,483)
------------ ------------
Total stockholders' equity (deficit)............. 295,977 (3,224,944)
------------ ------------
Total liabilities and stockholders' equity
(deficit).................................... $2,662,085 $1,770,264
============ ============
</TABLE>
See accompanying notes.
<PAGE>
SOCKET COMMUNICATIONS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenues................................ $5,477,804 $4,779,200 $4,570,438
Cost of revenue......................... 2,238,658 2,788,108 2,496,028
------------ ------------ ------------
Gross profit............................ 3,239,146 1,991,092 2,074,410
------------ ------------ ------------
Operating expenses:
Research and development.............. 999,362 1,050,411 1,067,399
Sales and marketing................... 2,009,003 2,719,050 2,666,933
General and administrative............ 1,192,452 1,613,492 1,647,335
------------ ------------ ------------
Total operating expenses............ 4,200,817 5,382,953 5,381,667
------------ ------------ ------------
Operating loss.......................... (961,671) (3,391,861) (3,307,257)
Interest income......................... 4 2,544 29,496
Interest expense........................ (105,872) (165,472) (50,609)
------------ ------------ ------------
Net loss................................ (1,067,539) (3,554,789) (3,328,370)
Preferred stock dividend................ (221,639) (45,465) --
Accretion of preferred stock............ (250,000) -- (542,500)
------------ ------------ ------------
Net loss applicable to common
stockholders.......................... ($1,539,178) ($3,600,254) ($3,870,870)
============ ============ ============
Basic and diluted net loss per share
applicable to common stockholders..... ($0.22) ($0.70) ($1.28)
============ ============ ============
Weighted average shares outstanding..... 7,103,395 5,148,729 3,015,263
============ ============ ============
</TABLE>
See accompanying notes.
<PAGE>
SOCKET COMMUNICATIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Series A Series B Series C Series D
Convertible Convertible Convertible Convertible
Preferred Stock Preferred Stock Preferred Stock Preferred Stock
-------------------- ------------------- -------------------- -------------------
Shares Amount Shares Amount Shares Amount Shares Amount
-------- ----------- ------- ----------- -------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995... -- $ -- -- $ -- -- $ -- -- $ --
Issuance of Series A
Convertible Preferred Stock.. 15,500 1,251,313 -- -- -- -- -- --
Exercise of Common Stock
Options...................... -- -- -- -- -- -- -- --
Accretion of Preferred Stock... -- 542,500 -- -- -- -- -- --
Net Loss....................... -- -- -- -- -- -- -- --
-------- ----------- ------- ----------- -------- ----------- --------- ---------
Balance at December 31, 1996... 15,500 1,793,813 -- -- -- -- -- --
Conversion of Series A
Convertible Preferred Stock
to common stock.............. (15,500) (1,793,813) -- -- -- -- -- --
Dividends on Series A
Convertible Preferred Stock.. -- -- -- -- -- -- -- --
Exercise of Common Stock
Options...................... -- -- -- -- -- -- -- --
Net Loss....................... -- -- -- -- -- -- -- --
-------- ----------- ------- ----------- -------- ----------- --------- ---------
Balance at December 31, 1997... -- -- -- -- -- -- -- --
Issuance of Series B
Convertible Preferred Stock.. -- -- 30,065 1,565,976 -- -- -- --
Conversion of Subordinated
Convertible Notes and
Accrued Interest to Series C
Convertible Preferred Stock
and Common Stock............. -- -- -- -- 163,468 1,714,043 -- --
Issuance of Series D
Convertible Preferred Stock.. -- -- -- -- -- -- 174,292 769,887
Accretion of Preferred Stock -- -- -- -- -- -- -- --
Dividends on Convertible
Preferred Stock.............. -- -- -- -- -- -- -- --
Dividends Paid/Payable in
Common Stock................. -- -- -- -- -- -- -- --
Issuance of Common Stock
Warrants in Connection with
Preferred Stock Issuances.... -- -- -- -- -- -- -- --
Charge for Compensatory Stock
Option....................... -- -- -- -- -- -- -- --
Net loss....................... -- -- -- -- -- -- -- --
-------- ----------- ------- ----------- -------- ----------- --------- ---------
Balance at December 31, 1998... -- $ -- 30,065 $1,565,976 163,468 $1,714,043 174,292 $769,887
======== =========== ======= =========== ======== =========== ========= =========
</TABLE>
SOCKET COMMUNICATIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Total
Common Stock Additional Stockholders'
------------------ Paid-in Accumulated Equity
Shares Amount Capital Deficit (Deficit)
---------- ------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995... 2,990,870 $2,991 $11,393,663 ($8,968,359) $2,428,295
Issuance of Series A
Convertible Preferred Stock.. -- -- -- -- 1,251,313
Exercise of Common Stock
Options...................... 38,106 38 20,257 -- 20,295
Accretion of Preferred Stock... -- -- -- (542,500) --
Net Loss....................... -- -- -- (3,328,370) (3,328,370)
---------- ------- ------------ ------------- -------------
Balance at December 31, 1996... 3,028,976 3,029 11,413,920 (12,839,229) 371,533
Conversion of Series A
Convertible Preferred Stock
to common stock.............. 3,466,649 3,466 1,790,347 -- --
Dividends on Series A
Convertible Preferred Stock.. -- -- -- (45,465) (45,465)
Exercise of Common Stock
Options...................... 5,650 6 3,771 -- 3,777
Net Loss....................... -- -- -- (3,554,789) (3,554,789)
---------- ------- ------------ ------------- -------------
Balance at December 31, 1997... 6,501,275 6,501 13,208,038 (16,439,483) (3,224,944)
Issuance of Series B
Convertible Preferred Stock.. -- -- -- -- 1,565,976
Conversion of Subordinated
Convertible Notes and
Accrued Interest to Series C
Convertible Preferred Stock
and Common Stock............. 756,338 757 379,949 -- 2,094,749
Issuance of Series D
Convertible Preferred Stock.. -- -- -- -- 769,887
Accretion of Preferred Stock -- -- -- (250,000) (250,000)
Dividends on Convertible
Preferred Stock.............. -- -- -- (221,639) (221,639)
Dividends Paid/Payable in
Common Stock................. 108,301 108 216,922 -- 217,030
Issuance of Common Stock
Warrants in Connection with
Preferred Stock Issuances.... -- -- 303,396 -- 303,396
Charge for Compensatory Stock
Option....................... -- -- 109,061 -- 109,061
Net loss....................... -- -- -- (1,067,539) (1,067,539)
---------- ------- ------------ ------------- -------------
Balance at December 31, 1998... 7,365,914 $7,366 $14,217,366 ($17,978,661) $295,977
========== ======= ============ ============= =============
</TABLE>
See accompanying notes.
<PAGE>
SOCKET COMMUNICATIONS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss.............................. ($1,067,539) ($3,554,789) ($3,328,370)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation........................ 135,067 108,280 79,095
Amortization........................ 59,147 163,835 150,634
Loss on disposal of property and
equipment......................... -- -- 7,173
Compensatory stock option grant..... 109,061 -- --
Changes in operating assets and
liabilities:
Accounts receivable................. (18,970) (22,666) 67,458
Accounts receivable from related
party............................ 43,371 (43,371) --
Inventories......................... (284,451) 543,681 (228,477)
Prepaid expenses.................... (32,716) 11,475 11,357
Other assets........................ (2,298) (18,070) 24,201
Accounts payable.................... (283,350) 503,611 99,579
Accounts payable to related
parties.......................... (66,966) 48,312 (25,109)
Accrued expenses.................... (92,597) 99,371 92,004
Accrued payroll and related
expenses......................... (75,601) 46,795 (127,013)
Deferred revenue.................... 61,493 (60,151) 126,633
------------ ------------ ------------
Net cash used in operating
activities....................... (1,516,349) (2,173,687) (3,050,835)
INVESTING ACTIVITIES
Purchase of equipment................. (96,714) (183,178) (296,048)
------------ ------------ ------------
Net cash used in investing
activities....................... (96,714) (183,178) (296,048)
FINANCING ACTIVITIES
Payments on capital leases and
equipment financing notes........... (61,652) (109,236) (121,640)
Proceeds from equipment financing..... -- -- 85,861
Net advances(repayments) on
revolving line of credit............ (3,214) 201,198 322,743
Proceeds from issuance of
convertible subordinated notes...... -- 1,950,000 --
Preferred stock dividends paid........ (17,073) (30,318) --
Stock options exercised............... -- 3,777 20,295
Net proceeds from sale of
preferred stock and warrants........ 2,389,259 -- 1,251,313
------------ ------------ ------------
Net cash provided by financing
activities....................... 2,307,320 2,015,421 1,558,572
------------ ------------ ------------
Net increase (decrease) in cash and
cash equivalents...................... 694,257 (341,444) (1,788,311)
Cash and cash equivalents at
beginning of year..................... 276,900 618,344 2,406,655
------------ ------------ ------------
Cash and cash equivalents at end
of year............................... $971,157 $276,900 $618,344
============ ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest.................. $54,734 $63,061 $50,609
Dividends paid/payable in cash.......... $4,609 $15,147 $ --
Dividends paid in common stock.......... $217,030 $ -- $ --
Notes payable and accrued interest
converted to preferred stock.......... $1,714,043 $ -- $ --
Notes payable and accrued interest
converted to common stock............. $380,706 $ -- $ --
Conversion of preferred stock to
common stock.......................... $ -- $1,793,813 $ --
Accretion of preferred stock............ $250,000 $ -- $542,500
Warrants issued in conjunction
with preferred stock financing........ $303,396 $ -- $ --
</TABLE>
See accompanying notes.
<PAGE>
SOCKET COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - Organization and Basis of Presentation
Socket Communications, Inc. ("Socket" or the "Company") develops and
sells connection solutions for handheld computers that use the Windows CE
operating system from Microsoft Corporation ("Microsoft") and for mobile
computers that use Microsoft's Windows 9x and NT operating systems. These
connection solutions include a family of low power PC Card adapters for
serial communications, Ethernet connectivity, mobile data collection, and
wireless communications. Socket also developed during 1998, and is further
developing during 1999, its family of PC cards in a CompactFlash form
factor for use with smaller handheld computers such as the Windows CE
Palm-size PC and other small devices. The Company's family of serial,
Ethernet and data collection plug-in card products are its principal
sources of revenues. The Company is incorporated in the state of
Delaware.
Basis of Presentation
The financial statements have been prepared on a going concern basis.
As of December 31, 1998, the Company had working capital of $1,286 and an
accumulated deficit of $17,978,661, used cash in operating activities of
$1,516,349 in 1998, and had recurring losses. The Company will require
additional funding in 1999 to finance and strengthen its working capital
balances, which the Company intends to accomplish through the issuance of
additional equity securities, through increased borrowings on the
Company's bank line as the levels of receivables permit, and through
development funding from development partners. The Report of Independent
Auditors on the Company's financial statements for the year ended December
31, 1998 included in Form 10-KSB contains an explanatory paragraph
regarding the Company's need for additional financing and indicated
substantial doubt about the Company's ability to continue as a going
concern. There can be no assurances that such capital will be available
on acceptable terms, if at all, and such terms may be dilutive to existing
stockholders. The Company's inability to secure the necessary funding
would have a material adverse affect on the Company's financial condition
and results of operations. The financial statements do not include any
adjustments to reflect the possible future effects on the recoverability
and classification of assets or the amounts and classification of assets
and liabilities that may result from the outcome of this uncertainty.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
NOTE 2 - Summary of Significant Accounting Policies
Cash Equivalents
The Company considers all highly liquid investments purchased with a
maturity date of three months or less at date of purchase to be cash
equivalents as of December 31, 1998 and 1997. All of the Company's cash
and cash equivalents consisted of monies held in demand deposits.
Inventories
Inventories consist principally of raw materials and sub-assemblies,
which are stated at the lower of cost (first-in, first-out) or market.
December 31,
-------------------------
1998 1997
------------ ------------
Raw materials and sub-assemblies....... $454,836 $179,267
Finished goods......................... 24,742 15,860
------------ ------------
$479,578 $195,127
============ ============
Property and Equipment
Property and equipment are stated at cost. Depreciation and
amortization are computed using the straight-line method, over the
estimated useful lives of the assets which range from one to five years.
Assets under capital leases are amortized over the shorter of the asset
life or the remaining lease term.
Concentration of Credit Risk
The Company uses financial instruments that potentially subject it to
concentrations of credit risk. Such instruments include cash equivalents
and accounts receivable. The Company invests its cash in cash demand
deposits. The Company places its investments with high-credit-quality
financial institutions and limits the credit exposure to any one financial
institution or instrument. To date, the Company has not experienced losses
on these investments. The Company sells primarily to distributors and
original equipment manufacturers. The Company performs ongoing credit
evaluations of its customers' financial condition but generally requires
no collateral. Reserves are maintained for potential credit losses, and
such losses have been within management's expectations.
Revenue Recognition
Product revenue to customers other than distributors is recognized at
the time of shipment. Revenue on shipments to distributors, which are
subject to certain rights of return and price protection, is deferred
until the merchandise is sold by the distributors. Contract engineering
revenue is recognized as earned based on contract milestones.
Sales Returns and Warranties
The Company accrues for estimated sales returns/exchanges for end user
sales and warranty costs upon recognition of sales. The Company has not
experienced significant warranty claims to date.
Research and Development
Research and development expenditures are generally charged to
operations as incurred. Statement of Financial Accounting Standards No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed," requires the capitalization of certain software
development costs subsequent to the establishment of technological
feasibility. Based on the Company's product development process,
technological feasibility is established upon the completion of a working
model. Costs incurred by the Company between the completion of the working
model and the point at which the product is ready for general release have
been insignificant. Accordingly, the Company has charged all such costs to
research and development expenses in the accompanying statements of
operations.
Advertising Expense
The cost of advertising is expensed as incurred. The Company incurred
$373,054, $343,910, and $370,945 in advertising costs during 1998, 1997,
and 1996 respectively.
Net Loss Per Share
The Company calculates earnings per share in accordance with Financial
Accounting Standards Board Statement No. 128, "Earnings per Share".
The following table sets forth the computation of basic net loss per
share (amounts in thousands except per share):
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Numerator for basic:
Net loss.............................. ($1,067) ($3,555) ($3,328)
Preferred stock dividends............. (222) (45) --
Accretion of preferred stock.......... (250) -- (543)
------------ ------------ ------------
Net loss applicable to common
stockholders.......................... ($1,539) ($3,600) ($3,871)
============ ============ ============
Denominator:
Weighted average common shares
outstanding used in computing
basic net loss per share............ 7,103 5,149 3,015
============ ============ ============
Basic and diluted net loss per share
applicable to common stockholders..... ($0.22) ($0.70) ($1.28)
============ ============ ============
</TABLE>
The diluted net loss per share is equivalent to the basic net loss per
share because the Company has experienced losses since inception and thus
no potential common shares from stock options, convertible preferred stock
or convertible notes have been included in the net loss per share
calculation.
Comprehensive Earnings
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Statement No. 130, "Reporting Comprehensive Income." This
Statement requires that all items recognized under accounting standards as
components of comprehensive earnings be reported in an annual financial
statement that is displayed with the same prominence as other annual
financial statements. This Statement also requires that an entity classify
items of other comprehensive earnings by their nature in an annual
financial statement. For example, other comprehensive earnings may include
foreign currency translation adjustments, minimum pension liability
adjustments, and unrealized gains and losses on marketable securities
classified as available-for-sale. As the Company has no components of
other comprehensive earnings, there are no disclosure requirements
involved in the Company's adoption of this Statement.
Impact of New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement
133, "Accounting for Derivative Instruments and Hedging Activities", which
is required to be adopted in years beginning after June 15, 1999. Because
of the Company's minimal use of derivatives, management does not
anticipate that the adoption of the new Statement will have a significant
effect on earnings or the financial position of the Company.
Segment Information
The Company adopted Statement No. 131, "Disclosures about Segments of
an Enterprise and Related Information," in fiscal 1998. Statement No.
131 supersedes Statement No. 14, "Financial Reporting for Segments of a
Business Enterprise," and establishes standards for reporting information
about operating segments. Operating segments are defined as components of
an enterprise about which separate financial information is available that
is evaluated regularly by the chief operating decision maker, or group, in
deciding how to allocate resources and in assessing performance. The
Company operates in one segment, connection solutions for mobile
computers. The Company markets its products in the United States and
foreign countries through its sales personnel and distributors.
Information regarding geographic areas for the years ended December 31,
1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenues: (in thousands)
United States........................ $3,598 $2,424 $2,749
Europe............................... 1,490 2,011 1,145
Asia and rest of world............... 390 344 676
------------ ------------ ------------
$5,478 $4,779 $4,570
============ ============ ============
</TABLE>
Export revenues are attributable to countries based on the location of the
customers. The Company does not hold long lived assets in foreign
locations.
Major Customers
Customers who accounted for at least 10% of total revenues were as
follows:
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Ingram Micro......................... 29% 21% 17%
Tech Data............................ 11% 15% 12%
PPCP Ltd (UK)........................ 10% 21% --
</TABLE>
NOTE 3 - Series A Convertible Preferred Stock
The Board of Directors may issue 3,000,000 shares of preferred stock in
one or more series and may fix the rights, privileges and restrictions
granted to or imposed upon any wholly unissued series of preferred stock,
as well as to fix the number of shares constituting any series and
designations of such series, without any further vote or action by the
stockholders. In October 1996, the Company designated 1,000,000 shares of
the 3,000,000 Preferred Stock as Series A Convertible Preferred Stock.
On November 1, 1996 (the "Closing"), the Company sold 15,500 shares
of its Series A Convertible Preferred Stock, $0.001 par value, at $100 per
share pursuant to Regulation D of the Securities Act of 1933, as amended
(the "Series A Transaction"). The Series A Transaction was effected
pursuant to a Private Offering Memorandum. Each share of Series A
Convertible Preferred Stock was convertible at the option of the holder,
in whole or in part, at any time on or after the 60th day following the
Closing, into shares of Common Stock of the Company equal to $100 divided
by the lower of: (i) the closing bid price of the Company's Common Stock,
as reported on the Nasdaq OTC Bulletin Board Market, on the date of
Closing; and (ii) 65% of the average bid price of the Company's Common
Stock, as reported on the OTC bulletin board, for the five business days
prior to the business day on which notice of conversion is transmitted by
the holder of such share of Series A Convertible Preferred Stock, subject
to adjustment in certain events. Each share of Series A Convertible
Preferred Stock converted automatically into shares of Common Stock on the
first anniversary of the Closing. In connection with the Series A
Transaction, the placement agent received a warrant to purchase 43,539
shares of common stock at an exercise price of $3.56 per share. The
warrant is immediately exercisable and has a five year term. No warrants
were exercised as of December 31, 1998. The holders of the Series A
Convertible Preferred Stock were entitled to receive dividends at an
annual rate of 6% (adjusted ratably if a holder converts Series A
Convertible Preferred Stock into Common Stock prior to a Dividend Payment
Date, as defined hereafter), payable on April 1,1997 and November 1, 1997
(each a "Dividend Payment Date"), and otherwise when, and as and if
declared by the Board of Directors at the same rate as to which any
dividend is declared and paid on shares of Common Stock. During 1997 and
1998, the Company accrued dividends of $50,074 ($0.01 per share) of which
$30,318 was paid in cash in 1997 and $17,073 was paid in cash in 1998.
During 1997, all Series A Convertible Preferred shares converted into
3,466,649 shares of common stock. The Company recorded accretion of
$542,500 for the 35% discount given to the Series A convertible preferred
stockholders in the fourth quarter of 1996.
NOTE 4 - Series B Convertible Preferred Stock
In January 1998, the Board of Directors designated 37,500 shares of
Preferred Stock as Series B Convertible Preferred Stock ("Series B
Preferred Stock). Series B Preferred Stock is convertible into Common
Stock anytime at the option of the Holder prior to the mandatory
conversion date of two years after issue and automatically converts
earlier in the event of a merger or consolidation of the Company if, as a
result of such transaction, the holders of Common Stock immediately prior
to such merger or consolidation would hold less than 50% of the voting
securities of the surviving entity immediately following such merger or
consolidation. The holders of Series B Preferred Stock have voting rights
equal to the number of common shares issuable upon conversion. In the
event of liquidation, holders of Series B Preferred Stock are entitled to
liquidation preferences over common stockholders equal to their initial
investment plus all accrued but unpaid dividends. Dividends accrue at the
rate of 8% per annum and are payable quarterly in cash or in Common Stock,
at the option of the Company. Dividends for the first three quarters of
1998 of $74,795 were paid by the issuance of 108,301 shares of Common
Stock during 1998. Accrued dividends at December 31, 1998 were $30,000,
which were paid through the issuance of 62,139 shares of Common Stock in
January 1999.
Series B Closing
On January 21, 1998 (the "Series B Closing"), the Company sold 12,500
shares of its Series B Convertible Preferred Stock, $0.001 par value, at
$40 per share (total of $500,000) pursuant to Section 4(2) of the
Securities Act of 1933, as amended (the "Series B Transaction"). The
Series B stock will convert into a total of 1,250,000 shares of Common
Stock. The conversion ratio for the Series B Transaction was based upon
the average bid price of the Company's Common Stock for the ten days prior
to the Series B Closing. The Company also issued five-year warrants to
acquire 187,500 shares of Common Stock at $0.40 per share and granted two
options to invest an additional $500,000 on similar terms, with the first
option expiring on February 15, 1998 and the second option expiring on
March 15, 1998.
Series B-1 Closing
On February 6, 1998, (the "Series B-1 Closing"), the Company sold
8,850 shares of Series B Convertible Preferred Stock, $0.001 par value, at
$56.50 per share, pursuant to exercise of the option to invest an
additional $500,000 expiring on February 15, 1998. On March 18, 1998,
such 8,850 shares of Series B were exchanged for a like number of Series
B-1 Convertible Preferred Stock, $.001 par value (the "Series B-1
Transaction"). The Series B-1 stock will convert into a total of 885,000
shares of Common Stock. The conversion ratio for the Series B-1
Transaction was based upon 80% of the average high and low sales price of
the Company's Common Stock for the ten days prior to the Series B-1
Closing. The Company also issued five-year warrants to acquire 132,750
shares of Common Stock at $0.565 per share. The Company recorded Accretion
of Preferred Stock of $125,000 in 1998 for the 20% discount given to the
Series B-1 holders.
Series B-2 Closing
On March 18, 1998, (the "Series B-2 Closing"), the Company sold 8,715
shares of Series B-2 Convertible Preferred Stock, $0.001 par value, at
$57.375 per share, pursuant to exercise of the option to invest an
additional $500,000 (the "Series B-2 Transaction"). The Series B-2
stock will convert into a total of 871,500 shares of Common Stock. The
conversion ratio for the Series B-2 Transaction was based upon 80% of the
average high and low sales price of the Company's Common Stock for the ten
days prior to the Series B-2 Closing. The Company also issued five-year
warrants to acquire 130,725 shares of Common Stock at $0.57375 per share.
The Company recorded Accretion of Preferred Stock of $125,000 in 1998 for
the 20% discount to market price given to the Series B-2 holders.
These transactions resulted in the valuation of warrants of $153,378
which was recorded as additional paid in capital in 1998.
NOTE 5 - Conversion of Convertible Subordinated Notes into Series C
Convertible Preferred Shares and Common Stock
On March 31, 1998, $1,750,000 of convertible subordinated notes and
$140,076 of accrued interest were converted into 95,037 shares of Series C
Preferred Stock at $10.60 per share, 51,574 shares of Series C-1 Preferred
Stock at $10.60 per share and 671,803 shares of Common Stock. On May 15,
1998, $200,000 of convertible subordinated notes and $13,353 of accrued
interest were converted into 16,857 shares of Series C-2 Preferred Stock
at $10.00 per share and 84,535 shares of Common Stock. Series C, C-1, and
C-2 Preferred Stock plus accrued dividends at 8% per annum are convertible
into Common Stock at the option of the holder, with a mandatory conversion
date of March 31, 2000 for Series C and C-1 and May 15, 2000 for Series C-
2. The per share conversion rates are based upon the conversion rates of
the underlying notes which are Series C: $1.00; Series C-1: $0.50; Series
C-2: $0.53. Series C Preferred Stockholders do not have voting rights.
Accrued dividends in 1998 were $101,692 payable through the issuance of
169,588 shares of Common Stock at the time of conversion. At December 31,
1998, Series C, C-1, and C-2 shares plus accrued dividends, if converted,
would have converted into 3,049,106 shares of Common Stock. In the event
of liquidation, holders of Series C Preferred Stock are entitled to
liquidation preferences over common stockholders equal to their initial
investment plus all accrued but unpaid dividends.
NOTE 6 - Series D Convertible Preferred Stock
In November 1998, the Board of Directors designated 175,000 shares of
Preferred Stock as Series D Convertible Preferred Stock ("Series D
Preferred Stock"). Series D Preferred Stock is convertible into Common
Stock anytime at the option of the Holder prior to the mandatory
conversion date of three years after issue and automatically converts
earlier in the event of a merger or consolidation of the Company if, as a
result of such transaction, the holders of Common Stock immediately prior
to such merger or consolidation would hold less than 50% of the voting
securities of the surviving entity immediately following such merger or
consolidation. The holders of Series D Preferred Stock have voting rights
equal to the number of common shares issuable upon conversion. In the
event of liquidation, holders of Series D Preferred Stock are entitled to
liquidation preferences over common stockholders equal to their initial
investment plus all accrued but unpaid dividends. Dividends accrue at the
rate of 8% per annum and are payable quarterly in cash or in Common Stock,
at the option of the Company.
In November 1998 the Company sold 174,292 shares of its Series D
Convertible Preferred Stock, $0.001 par value, at $5.7375 per share (total
of $1,000,000) pursuant to Section 4(2) of the Securities Act of 1933, as
amended. Each share of Series D Convertible Preferred Stock is convertible
into 10 shares of Common Stock at the option of the holder, in whole or in
part, at any time for a period of three years following the date of sale
with a mandatory conversion date three years from date of issue. The
Series D stock will convert into a total of 1,742,920 shares of Common
Stock. The Company also issued three-year warrants to acquire 640,972
shares of Common Stock at $0.57375 per share. Accrued dividends at
December 31, 1998 were $10,543, which were paid through the issuance of
23,431 shares of Common Stock in January 1999.
These transactions resulted in the valuation of warrants of $150,018
which was recorded as additional paid in capital in 1998.
NOTE 7 - Bank Financing Arrangements
The Company entered into a credit agreement with a bank ("Original
Agreement"), which commenced in July 1995 and expired on March 15, 1998.
In March 1998, the Company entered into a new credit agreement ("New
Agreement") which expires on April 15, 1999 (together, the
"Agreements"). The Agreements are secured by the Company's current and
future assets. The credit facility under the Agreements allows the company
to borrow up to $500,000 based on the level of qualified receivables at an
interest rate of the lender's index rate, which is based on prime plus
1.5% (9.25% at December 31, 1998). The Agreements contain covenants that
require the Company to maintain certain financial ratios including current
ratio and tangible net worth. As of December 31, 1998 and 1997 the Company
was not in compliance with the covenants and had obtained a waiver from
the bank. The waiver as of December 31, 1998 was effective through the
expiration date of the New Agreement. As of December 31, 1998 and
December 31, 1997, outstanding borrowings under the Agreements were
$419,727 and $268,908 respectively, which were the amounts available under
the line.
In 1998 and 1997, the Company entered into an international credit
agreement ("International Agreement") with a commercial lending
institution which expires on August 31, 1999. The International Agreement
is secured by the Company's international receivables and by the Company's
current and future assets. The credit facility under the International
Agreement allows the Company to borrow up to $500,000 based on the level
of qualified international receivables at the lender's index rate, which
is based on prime plus 2.75% (10.5% at December 31, 1998). As of December
31, 1998 and 1997 outstanding borrowings under the International Agreement
were $101,000 and $255,033 respectively, which were the amounts available
under the line.
NOTE 8 - Capital Lease Obligations and Equipment Financings
The Company leases certain of its equipment under capital leases. The
leases are collateralized by the underlying assets. At December 31, 1998
and 1997, property and equipment with a cost of $233,757, were subject to
such financing arrangements. Related accumulated amortization at December
31, 1998 and 1997, amounted to $225,143 and $165,996, respectively.
Future minimum payments under capital lease and equipment financing
arrangements as of December 31, 1998 were $43,110 in 1999, of which $2,027
represents interest and $41,083 as the present value of net minimum
payments.
NOTE 9 - Commitments
In November 1996, the Company moved into new facilities under a five-year
noncancelable operating lease which expires in October 2001. Future minimum
lease payments under operating leases are as follows:
1999........................................... $195,905
2000........................................... 195,905
2001........................................... 163,254
------------
$555,064
============
Rental expense under all operating leases was $195,905, $194,122 and
$330,097 for the years ended December 31, 1998, 1997 and 1996, respectively.
NOTE 10 - Stock Option/Stock Issuance Plan
The Company's 1993 Stock Option/Stock Issuance Plan (the 1993 Plan)
provides for the grant of incentive stock options and nonstatutory stock
options or the immediate issuance of the Company's common stock to
employees, directors, and consultants of the Company at prices not less
than 85% of the fair market value of the common stock on the date of
grant, as determined by the Board of Directors. The vesting and exercise
provisions are determined by the Board of Directors, with a maximum term
of ten years. Options granted and shares issued under the 1993 Plan
generally vest over a four-year period, with 25% vesting after one year
and 2.08% each month afterwards. Unvested shares which have been purchased
are subject to repurchase by the Company.
Information with respect to the 1993 Plan is summarized as follows:
<TABLE>
<CAPTION>
Outstanding Options
-------------------------
Options Weighted
Available Number Average
for of Exercise
Grant Shares Price
------------ ------------ ------------
<S> <C> <C> <C>
Balance at December 31, 1995............ 83,505 143,759 $0.61
Canceled.............................. 13,386 (13,386) $0.62
Exercised............................. -- (38,106) $0.56
------------ ------------
Balance at December 31, 1996............ 96,891 92,267 $0.63
Canceled.............................. 8,846 (8,846) $0.65
Exercised............................. -- (5,650) $0.67
------------ ------------
Balance at December 31, 1997............ 105,737 77,771 $0.63
Canceled.............................. 6,359 (6,359) $0.63
------------ ------------
Balance at December 31, 1998............ 112,096 71,412 $0.63
============ ============
</TABLE>
As of December 31, 1998, 1997 and 1996, 71,119, 68,474 and 67,286
options were exercisable at a weighted average exercise price of $0.63,
$0.63 and $0.64, respectively. The exercise price of the options at
December 31, 1998 ranged from $0.59 to $0.67. The Company has not
granted options from the 1993 Plan since February 1995 and does not intend
to make any future grants from the 1993 Plan. The weighted average
contractual life for options outstanding under the 1993 Plan at December
31, 1998 is approximately 5.5 years.
The Company's 1995 Stock Plan (the 1995 Plan) provides for the grant of
incentive stock options and nonstatutory stock options to employees,
directors, and consultants of the Company. The exercise price per share of
all incentive stock options granted must be at least equal to the fair
market value per share of Common Stock on the date of grant. The exercise
price per share of all nonstatutory stock options shall be not less than
85% of the fair market value of the common stock on the date of grant. The
vesting and exercise provisions are determined by the Board of Directors,
with a maximum term of ten years.
Information with respect to the 1995 Plan is summarized as follows:
<TABLE>
<CAPTION>
Outstanding Options
-------------------------
Shares Weighted
Available Number Average
for of Exercise
Grant Shares Price
------------ ------------ ------------
<S> <C> <C> <C>
Balance at December 31, 1995............ 157,298 127,702 $5.00
Increase in shares authorized......... 150,000 --
Granted............................... (360,650) 360,650 $2.98
Canceled.............................. 91,254 (91,254) $4.60
Repriced options canceled............. 260,192 (260,192) $4.12
Repriced options granted.............. (260,192) 260,192 $1.55
------------ ------------
Balance at December 31, 1996............ 37,902 397,098 $1.57
Increase in shares authorized......... 300,000 --
Granted............................... (381,620) 381,620 $0.61
Canceled.............................. 285,189 (285,189) $1.40
------------ ------------
Balance at December 31, 1997............ 241,471 493,529 $0.93
Increase in shares authorized......... 1,000,000 --
Granted............................... (1,192,148) 1,192,148 $0.63
Canceled.............................. 55,867 (55,867) $0.55
Repriced options canceled............. 167,789 (167,789) $1.55
Repriced options granted.............. (167,789) 167,789 $0.46
------------ ------------
Balance at December 31, 1998............ 105,190 1,629,810 $0.60
============ ============
</TABLE>
In 1998, the Company granted employees, including executives, the
option to exchange 167,789 options with an aggregate exercise price of
$260,073 for new options with an exercise price of $0.46 per share, the
fair value of the stock on the day of exchange. All vested options that
are repriced will vest monthly over an additional one year period and the
unvested repriced options will vest under the original terms of the option
grant. As of December 31, 1998, 1997 and 1996, 667,197, 223,891 and zero
options were exercisable at a weighted average exercise price of $0.58,
$1.28 and zero, respectively. The exercise price of options at December
31, 1998 ranged from $0.4375 to $0.6875. The weighted average fair value
of options granted during the years ended December 31, 1998, 1997, and
1996 was $0.49, $0.42, and $0.99 respectively. The weighted average
contractual life for options outstanding under the 1995 Plan at December
31, 1998, is approximately 9.1 years.
The Company has elected to follow Accounting Principle Board Opinion
No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under
FASB Statement No. 123, "Accounting for Stock-Based Compensation,"
requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, because the exercise price
of the Company's employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is
recognized.
Pro forma information regarding net loss and loss per share is required
by Statement 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of that
Statement. The fair value of these options was estimated at the date of
grant using the Black-Scholes option pricing model with the following
weighted average assumptions for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Risk-free interest rate (%)............. 5.52% 6.28% 8.00%
Dividend yield.......................... -- -- --
Volatility factor....................... 0.921 0.808 0.600
Expected remaining option life (years).. 6.5 5.5 5.5
</TABLE>
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility and expected option life. Because the
Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
Had compensation cost for the Company's stock-based compensation plans
been determined based on the fair value at the grant dates for awards
under those plans consistent with the method of Statement 123, the
Company's net loss per share would have increased to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Pro forma net loss...................... ($1,731,291) ($3,703,075) ($3,921,363)
Pro forma net loss per share............ ($0.24) ($0.72) ($1.30)
</TABLE>
The effects of applying FAS 123 pro forma disclosures are not likely to
be representative of effects on pro forma disclosures of future years.
NOTE 11 - Warrants
The Company issued warrants to purchase common stock in connection with
its initial public offering and periodically granted warrants in
connection with certain financing agreements and certain lease agreements.
The Company has the following warrants outstanding to purchase common
stock at December 31, 1998:
<TABLE>
<CAPTION>
Number Price
of Per Issue Expiration
Reason Shares Share Date Date
- -------------------------------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Initial public offering......... 550,275 $8.40 * Jun 1995 Jun 2000
IPO underwriting................ 150,000 $8.40 * Jun 1995 Jun 2000
Series A Pfd underwriting....... 43,539 $3.56 Nov 1996 Nov 2001
Equipment leasing............... 8,791 $5.6875 Dec 1996 Dec 2001
Bank line financing............. 50,000 $0.50 Dec 1997 Dec 2002
Series B financing.............. 187,500 $0.40 Jan 1998 Jan 2003
Series B-1 financing............ 132,750 $0.565 Feb 1998 Feb 2003
Series B-2 financing............ 130,725 $0.57375 Mar 1998 Mar 2003
Series D financing.............. 640,972 $0.57375 Nov 1998 Nov 2001
</TABLE>
_______________
* The common warrants expiring in June 2000 are subject to certain
dilution adjustments resulting from the subsequent issuance of common
stock or securities converting into common stock at prices below the
initial offering price for the Company's common stock. At December 31,
1998, the effects of the dilution adjustments relating to these warrants
were to increase the number of shares exercisable from 550,275 shares to
2,248,058 shares and from 150,000 to 612,800 and to correspondingly
reduce the exercise price of these warrants from $8.40 per share to
$2.06 per share.
NOTE 12 - Shares Reserved
Common stock reserved for future issuance was as follows at December 31,
1998:
<TABLE>
<S> <C>
Stock option plans outstanding (see Note 10)................ 1,701,222
Reserved for future stock option grants (see Note 10)....... 217,286
Common stock warrants (see Note 11)......................... 4,055,135
Series B conversion (see Note 4)............................ 3,006,500
Series C conversion (see Note 5)............................ 2,879,518
Series D conversion (see Note 6)............................ 1,742,920
Preferred Stock dividends .................................. 255,158
-----------
Total common stock reserved for future issuance............. 13,857,739
===========
</TABLE>
NOTE 13 - Retirement Plan
During fiscal year 1996, the Company adopted a tax-deferred savings
plan, the Socket Communications, Inc. 401(k) Plan ("The Plan"), for the
benefit of qualified employees. The Plan is designed to provide
employees with an accumulation of funds at retirement. Qualified
employees may elect to make contributions to The Plan on a quarterly
basis. No contributions are made by the Company. Administrative expenses
relating to The Plan are not significant.
NOTE 14 - Income Taxes
Due to the Company's loss position, there was no provision for income
taxes for the years ended December 31, 1998, 1997 and 1996.
As of December 31, 1998, the Company had federal and state net
operating loss carryforwards of approximately $13,000,000 and $5,800,000,
respectively. The Company also has federal and state tax credit
carryforwards of approximately $180,000 and $150,000, respectively. The
net operating loss and credit carryforwards will expire at various dates
beginning in 1999 through 2018, if not utilized.
The utilization of approximately $5,200,000 of the federal net
operating loss included in the above amounts will be subject to a
cumulative annual limitation of approximately $600,000 per year pursuant
to the stock ownership change provision of the Tax Reform Act of 1986.
Future changes in ownership, including stock offerings, may result in
additional limitations.
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amount of assets and liabilities for
financial reporting purposes and the amount used for income tax purposes.
Significant components of deferred tax assets are as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------
1998 1997
----------- -----------
<S> <C> <C>
Net operating loss carryforwards................... $4,800,000 $4,407,000
Credits............................................ 284,000 283,000
Capitalized research and development costs......... 806,000 837,000
Reserves........................................... 369,000 371,000
Other.............................................. 443,000 412,000
----------- -----------
Total deferred tax assets........................ 6,702,000 6,310,000
Valuation allowance for deferred tax assets........ (6,702,000) (6,310,000)
----------- -----------
Net deferred tax assets.......................... $ -- $ --
=========== ===========
</TABLE>
NOTE 15 - Related Parties
The Company in 1997 jointly developed products with Cetronic AB, a
Swedish company which converted $1.1 million in convertible subordinated
notes held at December 31, 1997 into preferred and common stock during
1998. The Company completed its development obligations during 1997 and
had insignificant related expenses in 1998. The Company had outstanding
accounts payable to Cetronic of $1,288 and $45,681 at December 31, 1998
and 1997 respectively. The Company had an outstanding accounts receivable
balance from Cetronic of $43,371 at December 31, 1997.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not Applicable.
PART III
The information required in Items 9-12 is hereby incorporated by
reference from the Company's definitive proxy statement for the Annual
Meeting of Stockholders to be held on June 16, 1999.
PART IV
Item 13. Exhibits and Reports on Form 8-K.
(a) Documents filed as part of this report:
1. All financial statements.
INDEX TO FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors
Balance Sheets
Statements of Operations
Statements of Stockholders' Equity (Deficit)
Statements of Cash Flows
Notes to Financial Statements
2. Financial statement schedules.
II. Valuation and Qualifying Accounts
3. Exhibits.
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
- ------------ ----------------------------------------------------------------
<C> <S>
3.1 (1) Certificate of Incorporation.
3.2 (1) Bylaws.
3.3 (3) Certificate of Designations of Preferences and Rights of Series B
Convertible Preferred Stock.
3.4 (3) Certificate of Designations of Preferences and Rights of Series
B-1 Convertible Preferred Stock.
3.5 (3) Certificate of Designations of Preferences and Rights of Series
B-2 Convertible Preferred Stock.
3.6 (4) Certificate of Designations of Preferences and Rights of Series C
convertible Preferred Stock
3.7 (4) Certificate of Designations of Preferences and Rights of Series
C-1 Convertible Preferred Stock
3.8 (5) Certificate of Designations of Preferences and Rights of Series
C-2 Convertible Preferred Stock
3.9 (6) Certificate of Designations of Preferences and Rights of Series
D Convertible Preferred Stock
10.1 (1) Form of Indemnification Agreement entered into between the
Company and its directors and officers.
10.2 (1) 1993 Stock Option/Stock Issuance Plan and forms of agreement
thereunder.
10.3 (1) 1995 Stock Plan and forms of agreement thereunder.
10.4 (2) Standard Lease Agreement by and between Central Court, LLC and
the Company dated September 15, 1996.
10.5 (3) Form of Employment Agreement dated October 15, 1997 with:
Micheal Gifford, Executive Vice President Business Development
and General Manager, Wireless Products Division; Kevin Mills,
Vice President of Engineering and Operations and General
Manager, Wired Products Division,; and David Dunlap, Vice
President Finance and Administration, Chief Financial Officer
and Corporate Secretary.
10.6 (3) Series B Preferred Stock Purchase Agreement dated January 21,
1998 by and between the Company and Explorer Partners, L.L.C.,
a Delaware limited liability company and Explorer Fund
Management, L.L.C., an Illinois limited liability company and
Amendment No. 1 thereto dated March 18, 1998.
10.7 (3) Bonus Plan dated February 18, 1998 between the Company and
certain eligible participants.
10.8 (3) Form of Amendment No.1 to Stock Option Agreement between the
Company and certain Option Holders under the 1995 Stock Option
Plan.
10.9 (6) Series D Convertible Preferred Stock Purchase Agreement
10.10 (6) Common Stock Purchase Warrant dated November 9, 1998 to The
Harmat Organization
10.11 (6) Common Stock Purchase Warrant dated November 9, 1998 to Global
Holdings, LP
10.12 Series D Convertible Stock Purchase Agreement for Bass Trust
23.1 Consent of Ernst & Young LLP, Independent Auditors.
27.1 Financial Data Schedule.
</TABLE>
- ------------------------
(1) Incorporated by reference to exhibits filed with Company's
Registration Statement on Form SB-2 (File No. 33-91210-LA)
filed on June 2, 1995 and declared effective on June 6, 1995.
(2) Incorporated by reference to Exhibit 10.5 of the Company's
Registration Statement on Form SB-2 (File No. 333-22273) filed
on February 24, 1997.
(3) Incorporated by reference to exhibits filed with the Company's
Form 10-KSB (File No. 001-13810) for the year ended December
31, 1997 filed on March 30, 1998.
(4) Incorporated by reference to exhibits filed with the Company's
Form 10-QSB (File No. 001-13810) filed on May 13, 1998.
(5) Incorporated by reference to exhibits filed with the Company's
Form 10-QSB (File No. 001-13810) filed on August 14, 1998.
(6) Incorporated by reference to exhibits filed with the Company's
Form 10-QSB (File No. 001-13810) filed on November 13, 1998.
b. Reports on Form 8-K
None
<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 report to be signed on
its behalf by the undersigned, hereunto duly authorized.
SOCKET COMMUNICATIONS, INC.
REGISTRANT
Date: March 26, 1999 By: /s/ CHARLIE BASS
-----------------------------------------
Charlie Bass
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints, jointly and severally, Charlie Bass and David
Dunlap as his attorneys-in-fact, each with the power of substitution, for him in
any and all capacities, to sign any and all amendments to this Report on Form
10-KSB and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorney-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
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 on the dates indicated.
Signature Title Date
- ---------------------------- --------------------------------- -------------
By /s/ Charlie Bass Chairman and Chief March 26, 1999
- ---------------------------- Executive Officer
Charlie Bass
By /s/ David W. Dunlap Vice President of Finance March 26, 1999
- ---------------------------- and Administration and
David W. Dunlap Chief Financial Officer
By /s/ Micheal L. Gifford Executive Vice President March 26, 1999
- ---------------------------- and Director
Micheal L. Gifford
By /s/ Jack C. Carsten Director March 26, 1999
- ----------------------------
Jack C. Carsten
By /s/ Edward M. Esber, Jr. Director March 26, 1999
- ----------------------------
Edward M. Esber, Jr.
By /s/ Gianluca Rattazzi Director March 26, 1999
- ----------------------------
Gianluca Rattazzi
By /s/ Lars Lindgren Director March 26, 1999
- ----------------------------
Lars Lindgren
<PAGE>
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
SOCKET COMMUNICATIONS, INC.
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
Additions
-------------------
Balance Charged
at to Charged Amounts Balance
Beginning Costs and to Written at end
Description of Period Expenses Other Off of Period
- ----------------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Accounts Receivable Allowance
for Doubtful Accounts:
1998....................... $44,691 $9,752 -- $12,178 $42,265
1997....................... $35,330 $11,106 -- $1,745 $44,691
1996....................... $47,790 $4,830 -- $17,290 $35,330
</TABLE>
Exhibit 10.12
SOCKET COMMUNICATIONS, INC.
SERIES D CONVERTIBLE PREFERRED STOCK PURCHASE AGREEMENT
November __, 1998
TABLE OF CONTENTS
Page
1. Purchase and Sale of Stock and Warrant 1
1.1 Issuance of Series D Convertible Preferred Stock and Warrant 1
1.2 Closing Date 1
1.3 Delivery 1
2. Representations and Warranties of the Company 2
2.1 Organization, Good Standing and Qualification 2
2.2 Capitalization 2
2.3 Subsidiaries 2
2.4 Authorization 2
2.5 Valid Issuance of Preferred and Common Stock 3
2.6 Governmental Consents 3
2.7 Litigation 4
2.8 Patents and Trademarks 4
2.9 Compliance with Other Instruments 4
2.10 Permits 5
2.11 Disclosure 5
2.12 Title to Property and Assets 5
2.13 Company Financial Statements 5
2.14 Taxes and Tax Returns 5
2.15 Brokers or Finders 6
3. Representations and Warranties of the Investor 6
3.1 Experience 6
3.2 Investment 6
3.3 Rule 144 6
3.4 Access to Data 6
3.5 Authorization 7
3.6 Accreditted Investor 7
3.7 High Degree of Risk 7
4. Conditions of Investor's Obligations at Closing 7
4.1 Representations and Warranties 7
4.2 Performance 7
4.3 Blue Sky 8
4.4 Issuance of Warrant 8
5. Conditions of the Company's Obligations at Closing 8
5.1 Representations and Warranties 8
5.2 Payment of Purchase Price 8
5.3 Blue Sky 8
5.4 Proceedings and Documents 8
6. Registration Rights; Restrictions on Transfer 8
6.1 Certain Definitions 8
6.2 Restrictions on Transferability 10
6.3 Restrictive Legend 10
6.4 Notice of Proposed Transfers 10
6.5 Company Registration 11
6.6 Registration on Form S-3 12
6.7 Expenses of Registration 13
6.8 Indemnification 13
6.9 Information by Holder 15
6.10 Transfer or Assignment of Rights 15
6.11 "Lock-Up" Agreement 16
7. Preemptive Rights 16
10. Miscellaneous 18
10.1 Governing Law 18
10.2 Survival 18
10.3 Successors and Assigns 18
10.4 Entire Agreement; Amendment 18
10.5 Notices, etc 18
10.6 Delays or Omissions 18
10.7 California Corporate Securities Law 19
10.8 Expenses 19
10.9 Finder's Fee 19
10.10 Counterparts 19
10.11 Severability 19
<PAGE>
SOCKET COMMUNICATIONS, INC.
SERIES D CONVERTIBLE PREFERRED STOCK PURCHASE AGREEMENT
This Series D Convertible Preferred Stock Purchase Agreement is made
as of November 23, 1998, by and between Socket Communications, Inc., a
Delaware corporation (the "Company") and the Bass Trust (the
"Investor").
The parties hereby agree as follows:
1. Purchase and Sale of Stock and Warrant.
1.1 Issuance of Series D Convertible Preferred Stock and Warrant.
(a) Subject to the terms and conditions of this
Agreement, the Investor agrees to purchase from the Company at the
Closing, and the Company agrees to sell and issue to the Investor at the
Closing, 17,429 shares of Series D Convertible Preferred Stock (the
"Shares") and a warrant to purchase 58,097 shares of Common Stock in the
form attached hereto as Exhibit B (the "Warrant") for an aggregate
purchase price of $100,000.
1.2 Closing Date. The closing of the purchase
and sale of the Shares hereunder (the "Closing") shall be held at 10:00
a.m. (California time) on such date that the Company and the Investor
mutually agree but no later than November 23, 1998 (the date of such
Closing being referred to as the "Closing Date"). The place of the
Closing (including the place of delivery to the Investor by the Company of
the certificate evidencing the Shares and the Warrant being purchased and
the place of payment to the Company by the Investor of the purchase price
therefor) shall be at the offices of Wilson Sonsini Goodrich & Rosati, 650
Page Mill Road, Palo Alto, California 94304-1050, or at such other
location as the Company and the Investor may agree.
1.3 Delivery . At the Closing, the
Company will deliver to the Investor a certificate representing the Shares
and the Warrant against payment of the purchase price therefor, by check
or wire transfer in immediately available funds, in the amount of
$100,000.
2. Representations and Warranties of the Company. Except as set
forth in (i) the Company's Form 10-K for the year ended December 31, 1997
and Form 10-Q for the quarter ended September 30, 1998, copies of which have
been provided to the Investor, or (ii) the Schedule of Exceptions attached
hereto as Exhibit B, the Company hereby represents and warrants to the
Investor as follows:
2.1 Organization, Good Standing and Qualification. The Company
is a corporation duly organized, validly existing and in good standing under
the laws of the State of Delaware and has all requisite corporate power and
authority to carry on its business as currently conducted. The Company is
duly qualified to transact business and is in good standing in each
jurisdiction in which the failure to so qualify would have a material
adverse effect on its business or properties. True and accurate copies of
the Company's Amended and Restated Certificate of Incorporation and Bylaws,
each as amended and in effect at the Closing, have been delivered to the
Investor.
2.2 Capitalization. The authorized capital stock of the
Company consists of 15,000,000 shares of Common Stock, $0.001 par value
("Common Stock"), of which 7,365,914 shares are issued and outstanding
as of November 18, 1998, and 3,000,000 shares of Preferred Stock
("Preferred Stock"), of which 37,500 shares are designated Series B
Convertible Preferred Stock, 12,500 of which are issued and outstanding,
8,850 shares are designated Series B-1 Convertible Preferred Stock, all of
which are issued and outstanding, 8,715 shares are designated Series B-2
Convertible Preferred Stock, all of which are issued and outstanding,
95,037 shares are designated Series C Convertible Preferred Stock, all of
which are issued and outstanding, 51,574 shares are designated Series C-1
Convertible Preferred Stock, all of which are issued and outstanding, and
16,857 shares are designated Series C-2 Convertible Preferred Stock, all
of which are issued and outstanding. All such issued and outstanding
shares have been duly authorized and validly issued and are fully paid and
nonassessable. An aggregate of 1,918,508 shares of Common Stock are
reserved for issuance under the Company's 1993 Stock Option Plan/Stock
Issuance Plan and the Company's 1995 Stock Plan. Except as set forth on
Schedule 2.2 of Exhibit B, there are no outstanding rights, options,
warrants, preemptive rights, rights of first refusal or similar rights for
the purchase or acquisition from the Company of any securities of the
Company.
2.3 Subsidiaries . The Company does not presently own or
control, directly or indirectly, any interest in any other corporation,
association, or other business entity. The Company is not a participant in
any joint venture, partnership, or similar arrangement.
2.4 Authorization . Except as set forth in Schedule 2.4 of
Exhibit B, all corporate action on the part of the Company, its officers,
directors and shareholders necessary for the authorization, execution and
delivery of this Agreement, the performance of all obligations of the
Company hereunder and thereunder, and the authorization, issuance (or
reservation for issuance), sale and delivery of the Shares, the Warrant
being sold hereunder, and the Common Stock issuable upon conversion of the
Shares and upon exercise of the Warrant, has been taken or will be taken
prior to the Closing, and this Agreement constitutes a valid and legally
binding obligation of the Company, enforceable in accordance with its
terms, subject to: (i) judicial principles limiting the availability of
specific performance, injunctive relief, and other equitable remedies; and
(ii) bankruptcy, insolvency, reorganization, moratorium or other similar
laws now or hereafter in effect generally relating to or affecting
creditors' rights.
2.5 Valid Issuance of Preferred and Common Stock. The Shares
and the Warrant being purchased by the Investor hereunder, when issued,
sold and delivered in accordance with the terms of this Agreement for the
consideration expressed herein, will be duly and validly issued, fully
paid, and nonassessable, and will be free of restrictions on transfer other
than restrictions on transfer under this Agreement, such Warrant and
applicable state and federal securities laws. Except as set forth in
Schedule 2.5 of Exhibit B, the Common Stock issuable upon conversion of the
Series D Convertible Preferred Stock and the Common Stock issuable upon
exercise of the Warrant has been duly and validly reserved for issuance
and, upon issuance in accordance with the terms of the Certificate of
Designations of Preferences and Rights of Series D Convertible Preferred
Stock attached hereto as Exhibit C (the "Certificate of Designations") and
the Amended and Restated Certificate of Incorporation (the "Certificate of
Incorporation") or upon issuance in accordance with the terms of such
Warrant, as the case may be, will be duly and validly issued, fully paid,
and nonassessable and will be free of restrictions on transfer other than
restrictions on transfer under this Agreement, such Warrant and applicable
state and federal securities laws. So long as the number of shares of
Common Stock of the Company outstanding on a fully-diluted, as-converted
basis exceeds the number of authorized Common Stock of the Company, at the
1999 Annual Meeting of Stockholders (which shall be held prior to June 30,
1999) the Company shall seek stockholder approval of an amendment to its
Certificate of Incorporation to increase its authorized Common Stock so
that the number of authorized shares of Common Stock will thereafter exceed
the number of shares outstanding on a fully-diluted, as-converted basis,
and the Company shall use its reasonable best efforts to obtain such
stockholder approval.
2.6 Governmental Consents. No consent, approval, order or
authorization of, or registration, qualification, designation, declaration
or filing with, any federal, state or local governmental authority on the
part of the Company is required in connection with the offer, sale or
issuance of the Shares (and the Common Stock issuable upon conversion of
the Shares) or the Warrant (and the Common Stock issuable upon exercise of
the Warrant) (together with the Shares and the Common Stock issuable upon
conversion thereof, the "Securities") or the consummation of any other
transaction contemplated hereby, except for the following: (i) the filing
of such notices as may be required under the Securities Act of 1933, as
amended (the "Securities Act"); and (ii) the filing of any notices required
under applicable state securities laws (the "Applicable Blue Sky Law").
Based in part on the representations of the Investor set forth in Section 3
below, the offer, sale and issuance of the Shares and the Warrant in
conformity with the terms of this Agreement are exempt from the
registration requirements of Section 5 of the Securities Act and from the
qualification requirements of Applicable Blue Sky Law.
2.7 Litigation. There is no action, suit, proceeding or
investigation pending or, to the best of the Company's knowledge, currently
threatened before any court, administrative agency or other governmental
body against the Company which questions the validity of this Agreement and
the Investor Rights Agreement or the right of the Company to enter into it,
or to consummate the transactions contemplated hereby or thereby, or which
could result, either individually or in the aggregate, in any material
adverse change in the condition (financial or otherwise), business,
property, assets or liabilities of the Company. The foregoing includes,
without limitation, actions, suits, proceedings or investigations pending
or threatened (or any basis therefor known to the Company) involving the
prior employment of any of the Company's employees, their use in connection
with the Company's business of any information or techniques allegedly
proprietary to any of their former employers, or their obligations under
any agreements with prior employers. The Company is not a party or subject
to, and none of its assets is bound by, the provisions of any order, writ,
injunction, judgment or decree of any court or government agency or
instrumentality.
2.8 Patents and Trademarks. The Company has sufficient title
and ownership of all patents, trademarks, service marks, trade names,
copyrights, trade secrets, information, proprietary rights and processes
(collectively, "Intellectual Property") necessary for its business as now
conducted without any conflict with or infringement of the rights of
others. There are no outstanding options, licenses, or agreements of any
kind relating to the foregoing, nor is the Company bound by or a party to
any options, licenses or agreements of any kind with respect to the
Intellectual Property of any other person or entity. Except as set forth
in Schedule 2.8 of Exhibit B, the Company has not received any
communications alleging that any material Intellectual Property of the
Company has violated or would violate any of the Intellectual Property of
any other person or entity.
2.9 Compliance with Other Instruments. Except as set forth in
Schedule 2.9 of Exhibit B, the Company is not in violation or default of
any provision of its Certificate of Incorporation or Bylaws, each as
amended and in effect on and as of the Closing. Except as set forth in
Schedule 2.9 of Exhibit B, the Company is not in violation or default of
any material provision of any instrument, mortgage, deed of trust, loan,
contract, commitment, judgment, decree, order or obligation to which it is
a party or by which it or any of its properties or assets are bound or, to
the best of its knowledge, of any provision of any federal, state or local
statute, rule or governmental regulation, except for such violations or
defaults which would not materially adversely affect the Company's business
or properties. The execution, delivery and performance of and compliance
with this Agreement, and the issuance and sale of the Shares and the
Warrant, will not result in any such violation, be in conflict with or
constitute, with or without the passage of time or giving of notice, a
default under any such provision, require any consent or waiver under any
such provision (other than any consents or waivers that have been
obtained), or result in the creation of any mortgage, pledge, lien,
encumbrance or charge upon any of the properties or assets of the Company
pursuant to any such provision.
2.10 Permits. The Company has all franchises, permits,
licenses, and any similar authority necessary for the conduct of its
business as now being conducted by it, the lack of which could materially
and adversely affect the Company's business or properties, and the Company
believes it can obtain, without undue burden or expense, any similar
authority for the conduct of its business as planned to be conducted. The
Company is not in default in any material respect under any of such
franchises, permits, licenses, or other similar authority.
2.11 Disclosure. No representation, warranty or statement by
the Company in this Agreement, or in any written statement or certificate
furnished to the Investor pursuant to this Agreement or the transactions
contemplated hereby, contains any untrue statement of a material fact or,
when taken together, omits to state a material fact necessary to make the
statements made herein or therein, in light of the circumstances under
which they were made, not misleading.
2.12 Title to Property and Assets. Except as set forth in
Schedule 2.12 of Exhibit B, the Company has good and marketable title to
all of its properties and assets free and clear of all mortgages, liens and
encumbrances, except liens for current taxes and assessments not yet due
and possible minor liens and encumbrances which do not, in any case, in the
aggregate, materially detract from the value of the property subject
thereto or materially impair the operations of the Company. With respect
to the property and assets it leases, the Company is in compliance with
such leases and, to the best of its knowledge, holds a valid leasehold
interest free of all liens, claims or encumbrances.
2.13 Company Financial Statements. The Company's audited
balance sheets as of December 31, 1997, and the related audited statements
of income and cash flow for the twelve-month period ended December 31,
1997, included in the Company's Form 10-K for the year ended December 31,
1997, and the Company's unaudited balance sheets as of September 30, 1998
and the related unaudited statements of income and cash flow for the
nine-month period ended September 30, 1998 included in the Company's Form
10-Q for the quarter ended September 30, 1998 (collectively the "Company
Financials"), are correct in all material respects and have been prepared
in accordance with U.S. generally accepted accounting principles consistent
with the reporting practices and principles ("GAAP"), applied on a basis
consistent throughout the periods indicated and consistent with each other.
The Company Financials present fairly the financial condition, operating
results and cash flows of the Company as of the dates and during the
periods indicated therein.
2.14 Taxes and Tax Returns. The Company has accurately
prepared all United States income tax returns and all state and municipal
tax returns required to be filed by it, if any, has paid all taxes,
assessments, fees and charges when and as due under such returns and has
made adequate provision for the payment of all other taxes, assessments,
fees and charges shown on such returns or on assessments received by the
Company. To the best of the Company's knowledge, no deficiency assessment
or proposed adjustment of the Company's United States income tax or state
or municipal taxes is pending. The Company has withheld or collected from
each payment made to each of its employees, the amount of all taxes,
including, but not limited to, federal income taxes, Federal Insurance
Contribution Act taxes and Federal Unemployment Tax Act taxes, required to
be withheld or collected therefrom, and have paid the same to the proper
tax receiving officers or authorized depositaries.
2.15 Brokers or Finders. Except as specifically provided in
this Agreement, the Company has not agreed to incur, directly or
indirectly, any liability for brokerage or finders' fees, agents'
commissions or other similar charges in connection with this Agreement or
any of the transactions contemplated hereby.
30 Representations and Warranties of the Investor. The Investor
hereby represents and warrants that:
3.1 Experience. Such Investor is experienced in evaluating
companies such as the Company, is able to fend for itself in transactions
such as the one contemplated by this Agreement, has such knowledge and
experience in financial and business matters that Investor is capable of
evaluating the merits and risks of Investor's prospective investment in the
Company, and has the ability to bear the economic risks of the investment.
3.2 Investment. Such Investor is acquiring the Securities
for investment for such Investor's own account and not with the view to, or
for resale in connection with, any distribution thereof. Such Investor
understands that the Securities have not been registered under the
Securities Act by reason of a specific exemption from the registration
provisions of the Securities Act which depends upon, among other things,
the bona fide nature of the investment intent as expressed herein. Such
Investor further represents that it does not have any contract,
undertaking, agreement or arrangement with any person to sell, transfer or
grant participation to any third person with respect to any of the
Securities. Such Investor understands and acknowledges that the offering
of the Securities pursuant to this Agreement will not, and any issuance of
Common Stock on conversion may not, be registered under the Securities Act
on the ground that the sale provided for in this Agreement and the issuance
of securities hereunder is exempt from the registration requirements of the
Securities Act.
3.3 Rule 144. Such Investor acknowledges that the Securities
must be held for at least one (1) year pursuant to Rule 144 promulgated
under the Securities Act unless subsequently registered under the
Securities Act or an exemption from such registration is available. Such
Investor is aware of the provisions of Rule 144, which permit limited
resale of shares purchased in a private placement subject to the
satisfaction of certain conditions. Such Investor covenants that, in the
absence of an effective registration statement covering the stock in
question, such Investor will sell, transfer, or otherwise dispose of the
Securities only in a manner consistent with such Investor's representations
and covenants set forth in this Section 3. In connection therewith, such
Investor acknowledges that the Company will make a notation on its stock
books regarding the restrictions on transfers set forth in this Section 3
and will transfer securities on the books of the Company only to the extent
not inconsistent therewith.
3.4 Access to Data. Such Investor has received and reviewed
information about the Company and has had an opportunity to discuss the
Company's business, management and financial affairs with its management
and to review the Company's facilities. Such Investor understands that
such discussions, as well as any written information issued by the Company,
were intended to describe the aspects of the Company's business and
prospects which the Company believes to be material, but were not
necessarily a thorough or exhaustive description. The foregoing, however,
does not limit or modify the representations and warranties of the Company
in Section 2 of this Agreement or the right of the Investor to rely thereon.
3.5 Authorization. This Agreement when executed and
delivered by such Investor will constitute a valid and legally binding
obligation of such Investor, enforceable in accordance with its terms,
subject to: (i) judicial principles respecting election of remedies or
limiting the availability of specific performance, injunctive relief, and
other equitable remedies; and (ii) bankruptcy, insolvency, reorganization,
moratorium or other similar laws now or hereafter in effect generally
relating to or affecting creditors' rights.
3.6 Accredited Investor. Such Investor acknowledges that it
is an "accredited investor" as defined in Rule 501 of Regulation D as
promulgated by the Securities and Exchange Commission under the Securities
Act and shall submit to the Company such further assurances of such status
as may be reasonably requested by the Company. For state securities law
purposes, the principal address of such Investor is 401 S. LaSalle Street
Suite 1500, Chicago, IL 60605.
3.7 High Degree of Risk. Such Investor is aware that the
securities offered hereby involve a high degree of risk and that Investor
may suffer a total loss of its investment. The Investor has been provided
with, among other things, the Company's periodic reports filed with the
Securities and Exchange Commission under the Securities Exchange Act of
1934, as amended, including the Company's most recently filed Annual Report
on Form 10-K and Quarterly Report on Form 10-Q. Such Investor has read the
information in such reports, including the information under the caption
"Risk Factors" included in the "Management's Discussion and Analysis of
Financial Condition and Results of Operations" section. Such Investor is
further aware that following the investment contemplated herein, the
Company may need to raise additional capital to maintain continued listing
of its Common Stock on the Pacific Exchange. Should the Company's Common
Stock be delisted from the Pacific Exchange, such Investor understands that
it would find it more difficult to dispose of, or obtain accurate
quotations as to the price of, the Company's securities, and that the
ability or willingness of broker-dealers to sell or make a market in the
Company's Common Stock, and therefore such Investor understands that its
ability to sell the Company's Common Stock in the secondary market would be
materially adversely affected.
40 Conditions of Investor's Obligations at Closing. The
obligations of the Investor under subsection 1.1(b) of this Agreement are
subject to the fulfillment on or before each Closing of each of the
following conditions, the waiver of which shall not be effective against
any Investor who does not consent in writing thereto:
4.1 Representations and Warranties. The representations and
warranties of the Company contained in Section 2 shall be true on and as of
the Closing with the same effect as though such representations and
warranties had been made on and as of the date of such Closing.
4.2 Performance. The Company shall have performed and
complied with all agreements, obligations and conditions contained in this
Agreement that are required to be performed or complied with by it on or
before the Closing.
4.3 Blue Sky. The Company shall have obtained all necessary
permits and qualifications, if any, or secured an exemption therefrom,
required by any state or country prior to the offer and sale of the Shares.
4.4 Issuance of Warrant. Upon the Closing, the Company shall
have delivered to the Investor the Warrant.
50 Conditions of the Company's Obligations at Closing. The
obligations of the Company to the Investor under this Agreement are subject
to the fulfillment on or before each Closing of each of the following
conditions by that Investor:
5.1 Representations and Warranties. The representations and
warranties of the Investor contained in Section 3 shall be true on and as
of the Closing with the same effect as though such representations and
warranties had been made on and as of the Closing.
5.2 Payment of Purchase Price. The Investor shall have
delivered the purchase price specified in Section 1.1 against delivery of
the Shares.
5.3 Blue Sky . The Company shall have obtained all necessary
permits and qualifications, if any, or secured an exemption therefrom,
required by any state or country for the offer and sale of the Shares.
5.4 Proceedings and Documents. All corporate and other
proceedings in connection with the transactions contemplated at the Closing
hereby, and all documents and instruments incident to these transactions,
shall be reasonably satisfactory in substance to the Company and its
counsel.
60 Registration Rights; Restrictions on Transfer.
6.1 Certain Definitions. As used in Sections 6 and 7 hereof,
the following terms shall have the following respective meanings:
"Commission" shall mean the Securities and Exchange Commission or
any other Federal agency at the time administering the Securities Act
"Common Stock" shall mean all shares of Common Stock of the
Company.
"Conversion Stock" shall mean the Common Stock issued or
issuable upon conversion of shares of Series D Preferred.
"Exchange Act" shall mean the Securities Exchange Act of 1934,
as amended, or any similar successor federal statute and the rules and
regulations thereunder, all as the same shall be in effect from time to time.
"Holder" shall mean the Investor and any holder of Registrable
Securities to whom the registration rights conferred by this Agreement have
been transferred in compliance with Sections 6.2 and 6.10 hereof.
"Preferred Stock" shall mean all shares of all Series of
Preferred Stock of the Company.
"Registrable Securities" shall mean (i) Common Stock held by
the Investor or issued or issuable upon conversion of the Series D Preferred,
(ii) the Warrant Stock or (iii) any Common Stock issued as a dividend or
other distribution with respect to or in exchange for or in replacement of
the stock referenced in (i) or (ii) above.
The terms "register", "registered" and "registration" shall
refer to a registration effected by preparing and filing a registration
statement in compliance with the Securities Act and applicable rules and
regulations thereunder, and the declaration or ordering of the effectiveness
of such registration statement.
"Registration Expenses" shall mean all expenses incurred by the
Company in compliance with Sections 6.5 and 6.6 hereof, including, without
limitation, all registration and filing fees, printing expenses, fees and
disbursements of counsel for the Company which shall include any fees and
disbursements for legal services provided by counsel for the Company on
behalf of the Holders up to a maximum of $10,000 of fees and disbursements,
blue sky fees and expenses for state qualifications or registrations.
"Restricted Securities" shall mean the securities of the
Company required to bear or bearing the legend set forth in Section 3 hereof.
"Securities Act" shall mean the Securities Act of 1933, as
amended, or any similar successor federal statute and the rules and
regulations thereunder, all as the same shall be in effect from time to time.
"Selling Expenses" shall mean all underwriting discounts,
selling commissions and expense allowances applicable to the sale of
Registrable Securities and all fees and disbursements of counsel for any
Holder (other than the fees and disbursements of the Company's counsel
included in Registration Expenses).
"Warrant Stock" shall mean the Common Stock issued or issuable
upon exercise of the Warrant.
6.2 Restrictions on Transferability. The Series D Preferred,
the Conversion Stock, the Warrant Stock and any other securities issued in
respect of the foregoing upon any stock split, stock dividend,
recapitalization, merger, consolidation, or similar event, shall not be
transferred except upon the conditions specified in this Agreement, which
conditions are intended to ensure compliance with the provisions of the
Securities Act. Any transferee of such securities shall take and hold such
securities subject to the provisions and upon the conditions specified in
this Agreement.
6.3 Restrictive Legend. Each certificate representing the
Series D Preferred, the Conversion Stock, the Warrant Stock and any other
securities issued in respect of the foregoing upon any stock split, stock
dividend, recapitalization, merger, consolidation or similar event, shall
(unless otherwise permitted or unless the securities evidenced by such
certificate shall have been registered under the Securities Act) be stamped
or otherwise imprinted with a legend substantially in the following form
(in addition to any legend required under applicable state securities laws):
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED
FOR INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES
ACT OF 1933, AS AMENDED (THE "ACT") OR ANY STATE SECURITIES
LAWS. SUCH SHARES MAY NOT BE SOLD OR OFFERED FOR SALE IN THE
ABSENCE OF SUCH REGISTRATION OR AN OPINION OF COUNSEL
SATISFACTORY TO THE COMPANY AND ITS COUNSEL THAT SUCH
REGISTRATION IS NOT REQUIRED UNDER THE ACT.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO,
AND MAY BE TRANSFERRED ONLY IN COMPLIANCE WITH, THAT CERTAIN
STOCK PURCHASE AGREEMENT AMONG THE HOLDER OF THESE SECURITIES
AND CERTAIN OTHER HOLDERS OF THE COMPANY'S STOCK, A COPY OF
WHICH IS ON FILE AT THE PRINCIPAL OFFICE OF THE ISSUER.
Upon request of a holder of such a certificate, the Company
shall remove the foregoing legend from the certificate or issue to such
holder a new certificate therefor free of any transfer legend, if, with such
request, the Company shall have received either the opinion referred to in
Section 6.4(i) or the "no-action" letter referred to in Section 6.4(ii) to
the effect that any transfer by such holder of the securities evidenced by
such certificate will not violate the Securities Act and applicable state
securities laws, unless any such transfer legend may be removed pursuant to
Rule 144(k) or any successor rule, in which case no such opinion or "no-
action" letter shall be required.
6.4 Notice of Proposed Transfers. The holder of each
certificate representing Restricted Securities by acceptance thereof agrees
to comply in all respects with the provisions of this Section 6.4. Prior
to any proposed transfer of any Restricted Securities (other than under
circumstances described in Section 6.5 and 6.6 hereof), the holder thereof
shall give written notice to the Company of such holder's intention to
effect such transfer. Each such notice shall describe the manner and
circumstances of the proposed transfer in sufficient detail, and shall be
accompanied by either (i) if required, a written opinion of legal counsel
to the holder who shall be reasonably satisfactory to the Company,
addressed to the Company, to the effect that the proposed transfer of the
Restricted Securities may be effected without registration under the
Securities Act or (ii) a "no-action" letter from the Commission to the
effect that the distribution of such securities without registration will
not result in a recommendation by the staff of the Commission that action
be taken with respect thereto, whereupon the holder of such Restricted
Securities shall be entitled to transfer such Restricted Securities in
accordance with the terms of the notice delivered by such holder to the
Company. The Company will not require such a legal opinion or "no action"
letter (i) in any transaction in compliance with Rule 144 promulgated under
the Securities Act, (ii) in any transaction in which the Investor
distributes Restricted Securities solely to its stockholders on a pro rata
basis for no consideration, or (iii) in any transaction in which a holder
which is a partnership distributes Restricted Securities solely to partners
thereof on a pro rata basis for no consideration; provided that each
transferee agrees in writing to be subject to the terms of the section 4.
Each certificate evidencing the Restricted Securities transferred as above
provided shall bear the restrictive legend set forth in Section 3 above.
6.5 Company Registration.
(i) If at any time, the Company shall determine to
register any of its securities either for its own account or the account
of a holder or holders of its securities (other than Holders of
Registrable Securities) exercising their respective demand registration
rights, other than (i) a registration relating solely to employee benefit
plans, (ii) a registration relating solely to a Commission Rule 145
transaction, the Company will:
(1) promptly give to each Holder written notice
thereof; and
(2) include in such registration (and any
related qualification under blue sky laws or other compliance), and in any
underwriting involved therein, all of the Registrable Securities specified
in a written request or requests made by any Holder within 30 days after
receipt of the written notice from the Company, except as set forth in
Section 6.5(ii) below. Such written request may specify all or a part of
a Holder's Registrable Securities. tc \l4 "(2) include in such
registration (and any related qualification under blue sky laws or other
compliance), and in any underwriting involved therein, all of the
Registrable Securities specified in a written request or requests made by
any Holder within 30 days after receipt of the written notice from the
Company, except as set forth in Section 6.5(ii) below. Such written
request may specify all or a part of a Holder's Registrable Securities.
(ii) If the registration of which the Company gives
notice is for a registered public offering involving an underwriting, the
Company shall so advise the Holders as a part of the written notice given
pursuant to Section 6.5(i)(1). In such event the right of any Holder
registration pursuant to this Section 6.5 shall be conditioned upon such
Holder's participation in such underwriting and the inclusion of such
Holder's Registrable Securities in the underwriting to the extent provided
herein. All Holders proposing to distribute their securities through such
underwriting shall (together with the Company) enter into an underwriting
agreement in customary form with the underwriter or underwriters selected
by the Company. Notwithstanding any other provision of this Section 6.5,
if the managing underwriters of the offering advise the Company in writing
that marketing factors require a limitation on the number of shares to be
underwritten, the Company may limit the number of Registrable Securities
to be included in the registration and underwriting. In such event, the
Company shall so advise all Holders requesting registration and the number
of Registrable Securities that are entitled to be included in the
registration and underwriting shall be reduced to the extent required by
the underwriters' limitation, in proportion, as nearly as practicable, to
the number of Registrable Securities held by each Holder. If any Holder
disapproves of the terms of any such underwriting, such Holder may elect
to withdraw therefrom by written notice to the Company and the
underwriter. Any Registrable Securities or other securities excluded or
withdrawn from such underwriting shall be withdrawn from such
registration.
6.6 Registration on Form S-3.
(i) The Company shall file a Registration Statement on
Form S-3 or other appropriate registration document under the Securities
Act of 1933, as amended, for resale of the Registrable Securities and
shall maintain the shelf registration effective for as long as a
registration statement is required for resale of the Common Stock (it
being agreed that such a registration statement shall be required so long
as a Holder is subject to the volume limitations of Rule 144(e) under the
Securities Act). The Company shall use reasonable efforts to file such
Registration Statement within ninety (90) days of a request by a Holder.
(ii) Notwithstanding the foregoing, the Company shall
not be obligated to take any action pursuant to this Section 6.6:
(1) in any particular jurisdiction in which the
Company would be required to execute a general consent to service of
process in effecting such registration, qualification or compliance unless
the Company is already subject to service in such jurisdiction and except
as may be required by the Securities Act;
(2) if the Company, within ten (10) days of the
receipt of the request of a Holder, gives notice of its bona fide
intention to effect the filing of a registration statement with the
Commission within sixty (60) days of receipt of such request (other than a
registration of securities in a Rule 145 transaction or with respect to an
employee benefit plan);
(3) during the period starting with the date of
filing of, and ending on the date 90 days immediately following the
effective date of, any registration statement pertaining to securities of
the Company (other than a registration of securities in a Rule 145
transaction or with respect to an employee benefit plan), provided that
the Company is actively employing in good faith all reasonable efforts to
cause such registration statement to become effective; or
(4) if the Company shall furnish to each Holder
a certificate signed by the President of the Company stating that in the
good faith judgment of the Board of Directors it would be seriously
detrimental to the Company or its stockholders for registration statements
to be filed in the near future, in which case the Company's obligation to
use its best efforts to file a registration statement shall be deferred
for a period not to exceed ninety (90) days from the receipt of the
request to file such registration by such Holder, provided that the
Company may not exercise this deferral right more than once per
twelve-month period.
(iii) In the event that the Company fails to perform any
of its obligations under this Section 6.6 and such failure to perform
remains uncured, the Company shall not have the right to call the Warrant,
notwithstanding any provision in such warrant to the contrary, for so long
as such failure to perform remains uncured.
6.7 Expenses of Registration. The Company shall bear all
Registration Expenses incurred in connection with any registration,
qualification or compliance pursuant to this Agreement and all underwriting
discounts, selling commissions and expense allowances applicable to the
sale of any securities by the Company for its own account in any
registration. All Selling Expenses shall be borne by the Holders, if any,
whose securities are included in such registration pro rata on the basis of
the number of their Registrable Securities so registered.
6.8 Indemnification.
(i) The Company will indemnify each Holder, each of
its officers, directors, agents, employees and partners, and each person
controlling such Holder, with respect to each registration, qualification
or compliance effected pursuant to this Agreement, and each underwriter,
if any, and each person who controls any underwriter, and their respective
counsel against all claims, losses, damages and liabilities (or actions,
proceedings or settlements in respect thereof) arising out of or based on
any untrue statement (or alleged untrue statement) of a material fact
contained in any prospectus, offering circular or other document prepared
by the Company (including any related registration statement, notification
or the like) incident to any such registration, qualification or
compliance, or based on any omission (or alleged omission) to state
therein a material fact required to be stated therein or necessary to make
the statements therein not misleading, or any violation by the Company of
the Securities Act or any rule or regulation thereunder applicable to the
Company and relating to action or inaction required of the Company in
connection with any such registration, qualification or compliance, and
will reimburse each such Holder, each of its officers, directors, agents,
employees and partners, and each person controlling such Holder, each such
underwriter and each person who controls any such underwriter, for any
legal and any other expenses as they are reasonably incurred in connection
with investigating and defending any such claim, loss, damage, liability
or action, provided that the Company will not be liable in any such case
to the extent that any such claim, loss, damage, liability or expense
arises out of or is based on any untrue statement (or alleged untrue
statement) or omission (or alleged omissions) based upon written
information furnished to the Company by such Holder or underwriter and
stated to be specifically for use therein.
(ii) Each Holder whose Registrable Securities are
included in any registration, qualification or compliance effected
pursuant to this Agreement will indemnify the Company, each of its
directors and officers and each underwriter, if any, of the Company's
securities covered by such a registration statement, each person who
controls the Company or such underwriter within the meaning of the
Securities Act and the rules and regulations thereunder, each other such
Holder and each of their officers, directors and partners, and each person
controlling such Holder, and their respective counsel against all claims,
losses, damages and liabilities (or actions in respect thereof) arising
out of or based on any untrue statement (or alleged untrue statement) of a
material fact contained in any such registration statement, prospectus,
offering circular or other document, or any omission (or alleged omission)
to state therein a material fact required to be stated therein or
necessary to make the statements therein not misleading, and will
reimburse the Company and such Holders, directors, officers, partners,
persons, underwriters or control persons for any legal or any other
expenses as they are reasonably incurred in connection with investigating
or defending any such claim, loss, damage, liability or action, in each
case to the extent, but only to the extent, that such untrue statement (or
alleged untrue statement) or omission (or alleged omission) is made in
such registration statement, prospectus, offering circular or other
document in reliance upon and in conformity with written information
furnished to the Company by such Holder and stated to be specifically for
use therein; provided, however, that the obligations of such Holders
hereunder shall be limited to an amount equal to the net proceeds to each
such Holder sold under such registration statement, prospectus, offering
circular or other document as contemplated herein.
(iii) Each party entitled to indemnification under this
Section 6.8 (the "Indemnified Party") shall give notice to the party
required to provide indemnification (the "Indemnifying Party") promptly
after such Indemnified Party has actual knowledge of any claim as to which
indemnity may be sought, and shall permit the Indemnifying Party to assume
the defense of any such claim or any litigation resulting therefrom,
provided that counsel for the Indemnifying Party, who shall conduct the
defense of such claim or any litigation resulting therefrom, shall be
approved by the Indemnified Party (whose approval shall not unreasonably
be withheld), and the Indemnified Party may participate in such defense at
such party's expense; and provided further that if any Indemnified Party
reasonably concludes that there may be one or more legal defenses
available to it that are not available to the Indemnifying Party, or that
such claim or litigation involves or could have an effect on matters
beyond the scope of this Agreement, then the Indemnified Party may retain
its own counsel at the expense of the Indemnifying Party; and provided
further that the failure of any Indemnified Party to give notice as
provided herein shall not relieve the Indemnifying Party of its
obligations under this Agreement unless and only to the extent that such
failure to give notice results in material prejudice to the Indemnifying
Party. No Indemnifying Party, in the defense of any such claim or
litigation, shall, except with the consent of each Indemnified Party,
consent to entry of any judgment or enter into any settlement which does
not include as an unconditional term thereof the giving by the claimant or
plaintiff to such Indemnified Party of a release from all liability in
respect to such claim or litigation. Each Indemnified Party shall furnish
such information regarding itself or the claim in question as an
Indemnifying Party may reasonably request in writing and as shall be
reasonably required in connection with defense of such claim and
litigation resulting therefrom.
(iv) If the indemnification provided for in this
Section 6.8 is held by a court of competent jurisdiction to be unavailable
to an Indemnified Party with respect to any loss, liability, claim, damage
or expense referred to herein, then the Indemnifying Party, in lieu of
indemnifying such Indemnified Party hereunder, shall contribute to the
amount paid or payable by such Indemnified Party as a result of such loss,
liability, claim, damage or expense in such proportion as is appropriate
to reflect the relative fault of the Indemnifying Party on the one hand
and of the Indemnified Party on the other in connection with the
statements or omissions which resulted in such loss, liability, claim,
damage or expense as well as any other relevant equitable considerations.
The relative fault of the Indemnifying Party and of the Indemnified Party
shall be determined by reference to, among other things, whether the
untrue or alleged untrue statement of a material fact or the omission to
state a material fact relates to information supplied by the Indemnifying
Party or by the Indemnified Party and the parties' relative intent,
knowledge, access to information and opportunity to correct or prevent
such statement or omission.
6.9 Information by Holder. Each Holder of Registrable
Securities to be included in a registration referred to in this agreement
shall furnish to the Company such information regarding such Holder, the
securities to be offered and sold and the intended plan of distribution of
the securities by such Holder as the Company may reasonably request in
writing and as shall be reasonably required in connection with any
registration, qualification or compliance referred to in this Agreement and
shall promptly advise the Company in writing of any material changes to
such information while the registration is in effect.
6.10 Transfer or Assignment. The rights to cause the Company
to register a Holder's securities granted by the Company under this
Agreement may be transferred or assigned by a Holder to a transferee or
assignee of any of the Restricted Securities, provided that the Company is
given written notice prior to the time that such right is exercised,
stating the name and address of said transferee or assignee and identifying
the securities with respect to which such registration rights are being
transferred or assigned; provided further that the transferee or assignee
of such rights assumes in writing the obligations of the Holder under this
Agreement.
6.11 Registration Procedures. In the case of each
registration effected by the Company pursuant to this Section 6, the
Company will keep each Holder who is entitled to registration rights
hereunder advised in writing as to the initiation of each registration and
as to the completion thereof. At its expense, the Company will:
(a Prepare and file with the Commission such
amendments and supplements to such registration statement and the
prospectus used in connection with such registration statement as may be
necessary to comply with the provisions of the Securities Act with respect
to the disposition of securities covered by such registration statement;
(b Furnish such number of prospectuses and other
documents incident thereto, including supplements and amendments, as a
Holder may reasonably request; and
(c Furnish to each selling Holder a copy of all
documents filed with and all correspondence from or to the Commission in
connection with any such offering other than nonsubstantive cover letters
and the like.
6.12 Rule 144 Reporting. With a view to making available the
benefits of certain rules and regulations of the Commission which may
permit the sale of the Restricted Securities to the public without
registration, the Company agrees to:
(a Make and keep public information available, as
those terms are understood and defined in Rule 144 under the Securities
Act; and
(b Use its reasonable best efforts to file with
the Commission in a timely manner all reports and other documents required
of the Company under the Securities Act and the Exchange Act.
6.13 "Lock-Up" Agreement. Each Holder agrees, if requested by
the Company in connection with a public offering of the company's
securities, not to sell or otherwise transfer or dispose of any securities
of the Company held by such Holder during a period of time determined by
the Company and its underwriters (not to exceed 90 days) following the
effective date of the registration statement of the Company filed under the
Securities Act relating to such public offering.
Such agreement shall be in writing in a form reasonably
satisfactory to the Company and such underwriter. The Company may impose
stop-transfer instructions with respect to the Shares (or securities)
subject to the foregoing restriction until the end of said period.
7. Preemptive Rights. The Company hereby grants to the
Investor a right (the "Preemptive Right") to purchase all or any part of
the Investor's pro rata share of any "New Securities" (as defined in this
section 7) that the Company may, from time to time, propose to sell and
issue solely for cash. Such pro rata share, for purposes of this
Preemptive Right, is the ratio of (x) the sum of the number of shares of
Common Stock then held by the Investor immediately prior to the issuance of
the New Securities, assuming the full conversion of any Series D Preferred
and full exercise of the Warrant, to (y) the total number of shares of
Common Stock held by all stockholders of the Company immediately prior to
the issuance of the New Securities (after giving effect to the exercise
and/or conversion, as the case may be, of all shares of Preferred Stock and
of all outstanding options and warrants to purchase Common Stock or any
other securities convertible into Common Stock). This Preemptive Right
shall be subject to the following provisions:
(1) "New Securities" shall mean any Common Stock
or Preferred Stock of the Company, whether or not authorized on the date
hereof, and rights, options or warrants to purchase Common Stock or Preferred
Stock and securities of any type whatsoever that are, or may become,
convertible into Common Stock or Preferred Stock; provided, however, that
"New Securities" does not include the following:
(a) shares of capital stock of the Company
issuable upon conversion or exercise of any currently outstanding securities
or any New Securities issued in accordance with this Agreement;
(b) shares, options or warrants granted to
officers, directors and employees of, and consultants to, the Company which
are approved by the Board of Directors; or
(c) shares of Common Stock or Preferred
Stock issued in connection with any pro rata stock split, stock dividend or
recapitalization by the Company (in which case, all numbers of shares and per
share amounts referenced in this Section 7(1) will be adjusted accordingly);
or
(d) shares issued in a registered public
offering.
(2) In the event that the Company proposes to
undertake an issuance of New Securities for cash, it shall give the Investor
written notice (the "Notice") of its intention, describing the type of New
Securities, the price, and the general terms upon which the Company proposes
to issue the same. The Investor shall have twenty (20) business days after
receipt of such notice to agree to purchase all or any portion of their
respective pro rata shares of such New Securities at the price and upon the
terms specified in the notice by giving written notice to the Company and
stating therein the quantity of New Securities to be purchased.
(3) In the event that any New Securities subject
to the Preemptive Right are not purchased by the Investor within the twenty
(20) business day period specified above, the Company shall have ninety (90)
days thereafter to sell (or enter into an agreement pursuant to which the
sale of New Securities that had been subject to the Preemptive Right shall
be closed, if at all, within sixty (60) days from the date of said agreement)
the New Securities with respect to which the rights of the Investor were not
exercised at a price and upon terms, including manner of payment, no more
favorable to the purchasers thereof than specified in the Notice. In the
event the Company has not sold all offered New Securities within such ninety
(90) day period (or sold and issued New Securities in accordance with the
foregoing within sixty (60) days from the date of such agreement), the
Company shall not thereafter issue or sell any New Securities, without first
again offering such New Securities to the Investor in the manner provided
above.
(4) This Preemptive Right is nonassignable by the
Investor.
(5) This Preemptive Right shall terminate as to
the Investor at such time as such Investor ceases to own any Series D
Preferred, Registrable Securities or the Warrant.
(6) This Preemptive Right shall terminate, in any
case, after three years from the date hereof.
8. Confidentiality. Each party hereto agrees that, except
with the prior written permission of the other parties or as required by
applicable law, it shall at all times keep confidential and not divulge,
furnish or make accessible to anyone any confidential information, knowledge
or data concerning or relating to the business or financial affairs of the
other parties to which such party has been or shall become privy by reason
of this Agreement. The parties hereto further agree that there shall be no
press release or other public statement issued by either party relating to
this Agreement or the transactions contemplated hereby, unless the parties
otherwise agree in writing the applicable law requires.
9. Miscellaneous.
9.1 Governing Law. This Agreement shall be governed in all
respects by the laws of the State of Delaware, without regard to any
provisions thereof relating to conflicts of laws among different
jurisdictions.
9.2 Survival. The representations, warranties, covenants and
agreements made herein shall survive any investigation made by the Investor
and the closing of the transactions contemplated hereby. All statements as
to factual matters contained in any certificate or exhibit delivered by or
on behalf of the Company pursuant hereto shall be deemed to be the
representations and warranties of the Company hereunder as of such date of
such certificate or exhibit.
9.3 Successors and Assigns. Except as otherwise provided
herein, the provisions hereof shall inure to the benefit of, and be binding
upon, the successors, assigns, heirs, executors and administrators of the
parties hereto.
9.4 Entire Agreement; Amendment. This Agreement and the other
documents delivered pursuant hereto constitute the full and entire
understanding and agreement among the parties with regard to the subjects
hereof and thereof. Neither this Agreement nor any term hereof may be
amended, waived, discharged or terminated other than by a written
instrument signed by the party against whom enforcement of any such
amendment, waiver, discharge or termination is sought.
9.5 Notices. All notices and other communications required
or permitted hereunder shall be in writing and shall be deemed effectively
given upon delivery to the party to be notified in person or by courier
service or five days after deposit with the United States mail, by First
Class mail, postage prepaid, addressed (a) if to the Investor, at the
Investor's address or (b) if to any other holder of any securities, at such
address as such holder shall have furnished the other parties hereto in
writing, or, until any such holder so furnishes an address to the Company,
then to and at the address of the last holder of such Shares who has so
furnished an address to the Company, or (c) if to the Company, to Socket
Communications, Inc. 37400 Central Court Newark, CA 94560, and addressed
to the attention of the President, or at such other address as the Company
shall have furnished to the Investor. If notice is provided by mail,
notice shall be deemed to be given three (3) business days after proper
deposit in the U.S. Mail.
9.6 Delays or Omissions. No delay or omission to exercise
any right, power or remedy accruing to any holder of any Shares upon any
breach or default of the Company under this Agreement shall impair any such
right, power or remedy of such holder, nor shall it be construed to be a
waiver of any such breach or default, or an acquiescence therein, or of or
in any similar breach or default thereafter occurring; nor shall any waiver
of any single breach or default be deemed a waiver of any other breach or
default theretofore or thereafter occurring. Any waiver, permit, consent
or approval of any kind or character on the part of any holder of any
breach or default under this Agreement, or any waiver on the part of any
holder of any provisions or conditions of this Agreement, must be in
writing and shall be effective only to the extent specifically set forth in
such writing or as provided in this Agreement. All remedies, either under
this Agreement or by law or otherwise afforded to any holder, shall be
cumulative and not alternative.
9.7 California Corporate Securities Law. THE SALE OF THE
SECURITIES WHICH ARE THE SUBJECT OF THIS AGREEMENT HAS NOT BEEN QUALIFIED
WITH THE COMMISSIONER OF CORPORATIONS OF THE STATE OF CALIFORNIA AND THE
ISSUANCE OF SUCH SECURITIES OR THE PAYMENT OR RECEIPT OF ANY PART OF THE
CONSIDERATION THEREFOR PRIOR TO SUCH QUALIFICATION IS UNLAWFUL, UNLESS THE
SALE OF SECURITIES IS EXEMPT FROM THE QUALIFICATION BY SECTION 25100,
25102, OR 25105 OF THE CALIFORNIA CORPORATIONS CODE. THE RIGHTS OF ALL
PARTIES TO THIS AGREEMENT ARE EXPRESSLY CONDITIONED UPON SUCH QUALIFICATION
BEING OBTAINED, UNLESS THE SALE IS SO EXEMPT.
9.8 Expenses. The Company and the Investor shall bear their
own expenses and legal fees incurred on its behalf with respect to this
Agreement and the transactions contemplated hereby.
9.9 Finder's Fee. The Company and the Investor shall each
indemnify and hold the other harmless from any liability for any commission
or compensation in the nature of a finder's fee (including the costs,
expenses and legal fees of defending against such liability) for which the
Company or the Investor, or any of their respective partners, employees, or
representatives, as the case may be, is responsible.
9.10 Counterparts. This Agreement may be executed in any
number of counterparts, each of which shall be enforceable against the
parties actually executing such counterparts, and all of which together
shall constitute one instrument.
9.11 Severability. In the event that any provision of this
Agreement becomes or is declared by a court of competent jurisdiction to be
illegal, unenforceable or void, this Agreement shall continue in full force
and effect without said provision; provided that no such severability shall
be effective if it materially changes the economic benefit of this
Agreement to any party.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
first above written.
SOCKET COMMUNICATIONS, INC. BASS TRUST
By: /s/ David Dunlap By: /s/ Charlie Bass
- -------------------------------- -----------------------------
Name: David Dunlap, Name: Charlie Bass
Title: Vice President, Finance Title: Trustee
and Administration, and
Chief Financial Officer
<PAGE>
EXHIBIT A
WARRANT
<PAGE>
EXHIBIT B
SCHEDULE OF EXCEPTIONS
<PAGE>
EXHIBIT C
CERTIFICATE OF DESIGNATIONS, PREFERENCES AND RIGHTS
OF SERIES D CONVERTIBLE PREFERRED STOCK
<PAGE>
Exhibit 23.1
Consent of Ernst & Young LLP, Independent Auditors
We consent to the incorporation by reference in the Registration Statement
(Form S-3 No. 333-49001) for the registration of 2,135,000 shares of
common stock related to conversion of Series B Convertible Preferred Stock
and the Registration Statement (Form S-8 No. 333-68347) pertaining to
Socket Communications, Inc. 1995 Stock Plan of our report dated February
18, 1999, with respect to the financial statements and schedules of Socket
Communications, Inc. included in this Annual Report (Form 10-KSB) for the
year ended December 31, 1998.
/s/ ERNST & YOUNG LLP
San Jose, California
March 26, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION
EXTRACTED FROM THE BALANCE SHEETS AND STATEMENTS OF
OPERATIONS OF THE COMPANY'S FORM 10-KSB FOR THE YEAR ENDED
DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jan-01-1998
<PERIOD-END> Dec-31-1998
<PERIOD-TYPE> 12-MOS
<CASH> 971,157
<SECURITIES> 0
<RECEIVABLES> 917,160
<ALLOWANCES> 42,265
<INVENTORY> 479,578
<CURRENT-ASSETS> 2,367,394
<PP&E> 1,076,144
<DEPRECIATION> 850,056
<TOTAL-ASSETS> 2,662,085
<CURRENT-LIABILITIES> 2,366,108
<BONDS> 0
0
4,049,906
<COMMON> 7,366
<OTHER-SE> (3,761,295)
<TOTAL-LIABILITY-AND-EQUITY> 2,662,085
<SALES> 5,477,804
<TOTAL-REVENUES> 5,477,804
<CGS> 2,238,658
<TOTAL-COSTS> 2,238,658
<OTHER-EXPENSES> 4,200,817
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 105,872
<INCOME-PRETAX> (1,067,539)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,067,539)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,539,178)
<EPS-PRIMARY> ($0.22)
<EPS-DILUTED> ($0.22)
</TABLE>
