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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[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
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO _____________.
COMMISSION FILE NO 0-2027
THE NATIONAL REGISTRY INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4346070
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
2502 ROCKY POINT DRIVE, SUITE 100
TAMPA, FLORIDA 33607
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (813) 636-0099
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
(TITLE OF CLASS)
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COMMON STOCK, $.01 PAR VALUE PER SHARE
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 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
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the average bid and asked prices of such stock on
March 26, 1999, was $12,921,485. There were 16,771,480 shares of Common Stock
outstanding as of March 26, 1999.
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PART I
ITEM 1. BUSINESS
GENERAL
The National Registry Inc., a Delaware corporation organized on October
23, 1991, and its wholly-owned subsidiary, SAFLINK Corporation (a Delaware
corporation organized on June 25, 1998), ("NRI" or the "Company"), provides a
suite of data and network security software products that utilize biometric
technologies to replace passwords for more secure and convenient user
authentication when accessing information stored in personal computers and in
networked computing environments. The Company's products also include software
developer kits (SDKs) that allow application developers and enterprises to
easily build custom applications with biometric technologies that will
positively identify persons seeking access to secured data transactions.
Biometric technologies identify and authenticate by electronically capturing
specific biological or behavioral characteristics from an individual, creating
a unique identifier (or template) from that characteristic, and then matching
that identifier against a previously stored identifier or database of
identifiers.
The process of identity authentication typically requires that a person
present for comparison one or more of the following factors: (i) SOMETHING
KNOWN such as a password, PIN, or mother's maiden name; (ii) SOMETHING CARRIED
such as a token, card, or key; or (iii) SOMETHING PHYSICAL such as a finger,
voice, facial shape or other biological or behavioral characteristic.
Comparison of biological and behavioral characteristics, also known as
biometrics, has historically been the most reliable and accurate of the three
factors, but has also been the most difficult and costly to implement in a
fully automated environment. However, recent advances in biometric collection
technologies and processing algorithms have increased the speed and accuracy
and reduced the cost of implementing biometrics in commercial environments. The
Company believes that individuals and enterprises will increasingly use this
method of identity authentication to enhance the security of information
systems, business-to-business and business-to-consumer transactions, reduce the
costs of personal identification of users across geographically dispersed
facilities, remote offices, and mobile computers and support the growth of
electronic commerce and other electronic services because of its level of
reliability and accuracy.
The Company's current products utilize finger imaging biometric service
provider ("BSP") modules and/or algorithms licensed from Cogent Systems, Inc.
and Veridicom, Inc., speaker verification algorithms licensed from Lernout &
Hauspie Speech Products NV and ITT Industries, Inc., facial recognition
algorithms licensed from Visionics Corporation, and biometric collection
hardware manufactured by several suppliers. The Company's software products are
all built upon its proprietary Secure Authentication Facility (SAF)
client/server architecture that supports multiple biometric technologies and
are based on published open systems application program interface standards for
the use of biometric technologies. The Company has tested and determined that
additional biometric technologies are operational with its software products
and intends to either continue such testing or negotiate licenses
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with other leading biometric technology suppliers in the industry. The
Company's goal is to provide its customers with products that offer the highest
level of flexibility, performance, and ease-of-use when compared to solutions
offering either a single biometric technology or password and token-based
identification solutions that can be easily forgotten, lost, or transferred
from person to person. The Company's objective is to make its suite of SAF
application software products the solution of choice for biometric
identification and authentication (I&A) over the Internet, enterprise
information systems, and a broad range of consumer applications.
The Company was started in October 1991 and, through August 1995, was
primarily engaged in research and development utilizing a finger imaging
algorithm license from Cogent Systems, Inc. ("Cogent"). At such time the
Company introduced the first commercially available finger imaging SDK's for
WINDOWS 3.1, WINDOWS 95, WINDOWS NT, and UNIX, that utilized commercially
available (non-proprietary) off-the-shelf computer equipment and finger
scanning peripherals. In order to achieve market affordability and rapid
initial market entry, the Company developed (and patented) a state-of-the-art
proprietary finger image scanner for manufacturing and marketing through
original equipment manufacturer ("OEM"), distributor, and value added reseller
channels.
In late 1996, the Company transitioned out of the developmental stage,
which stage had been characterized by the development of products by the
Company and by the testing and installation of custom applications of its
products for state and local government welfare administrations. In November
1996, the Company announced its Secure Authentication Facility for Microsoft's
Windows NT (SAF/nt) and a line of new, low-cost finger-image scanner hardware
products which provided out-of-box finger imaging functionality for any
workstation running the Company's software. In July 1997, the Company announced
its Secure Authentication Facility for Computer Associates UNICENTER
TNG/trademark/ (SAF/tng) which became available during October 1997 (and won
best new security product at CA World 1998). In November 1997, the Company
announced its Secure Authentication Facility for Microsoft's Internet
Information Server (SAF/iis) for domain based authentication for secure Web
pages.
In December 1997, the Company announced and demonstrated the first
implementation of the Human Authentication -- Application Program Interface
(HA-API) which allowed software developers and technology suppliers to build
their products using a common interface standard. Developed by the Company
under contract to the United States Department of Defense, HA-API has been
released to the public domain and is supported by more than thirty biometric
technology providers and system developers. The Company is also a contributor
to other leading API standards-setting bodies including the Bio-API Consortium,
currently led by Compaq Corporation, and Intel's Common Data Security
Architecture (CDSA) User Authentication Services (UAS) draft standard. It is
the Company's intention to make its products compliant with whatever API
standard is ultimately adopted by the biometrics industry.
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In March 1998, the Company signed its first volume reseller agreement for
$1.5 million in pre-paid software licenses with XL Vision, Inc, a Safeguard
Scientific partnership company ("XL Vision"). In May 1998, the Company
consummated an additional transaction with XL Vision, selling an additional
$2.0 million of pre-paid software licenses to XL Vision and creating the
Company's first Master Reseller of it's products. XL Vision agreed to become
the Company's preferred reseller for the healthcare market and acquired the
Company's end user contracts, resellers, employees, and related assets for
healthcare.
In July 1998, the Company announced a new security software product for
the Internet (SAFsite), the formation of its new operating subsidiary SAFLINK
Corporation, and a new corporate Web site to promote the Company's brand and
better communicate its business focus. In October 1998, the Company introduced
a new Secure Authentication Facility for Novell (SAF/netware) at the
Networld+Interop show with Novell. In November 1998, the Company announced its
first consumer oriented software product (SAFtyLatch) at the Fall Comdex show
in Las Vegas which allows an individual to encrypt/decrypt sensitive files on
his or her PC using biometrics instead of passwords or other technologies.
In an attempt to reach a diverse and worldwide audience, the Company makes
its products and services available through multiple distribution channels. The
Company offers its products and services via a direct sales force to OEMs,
major distributors and resellers, and selected medium to large enterprises. To
leverage its limited sales and marketing resources, the Company has also teamed
with companies like XL Vision, and other strategic partners with greater
resources and complementary technologies, to support their marketing efforts to
end users, computer OEM's, distributors, Independent Software Vendors, network
service providers, system integrators, and Value Added Resellers. The Company
is actively pursuing additional distribution opportunities with retailers,
distributors, PC manufacturers, biometric technology suppliers, and other
resellers.
For the fiscal year ended December 31, 1998, the Company had approximately
$4.9 million in operating revenues, an order backlog of approximately $292,000
and an operating loss of approximately $1.4 million. As of December 31, 1998,
the Company had an accumulated deficit of approximately $45.3 million. The
ability of the Company to achieve profitability and continue as an operating
enterprise depends largely on it's ability to (i) design, sell, and support its
SAF software products and services, (ii) hire and retain key employees as the
business expands and (iii) obtain capital to fund operations and growth. There
is no assurance that the Company will be able to accomplish any of the
foregoing, or to expand its business.
RECENT DEVELOPMENTS
PLAN TO CHANGE COMPANY NAME. The Company's Board of Directors, at a
meeting held on March 19, 1999, decided to defer action on the previously
announced intention to formally change the name of the Company to SAFLINK
Corporation. The Board believes that the Company can realize the benefits of
building the SAF brand identity by continuing
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to market its products through its wholly-owned subsidiary, SAFLINK
Corporation, while retaining The National Registry Inc. name and its
association with past business initiatives.
TRANSFER OF WELFARE CONTRACTS -- As part of its strategy to increasingly
rely on its resellers for marketing and support to end-users in vertical market
segments, the Company transferred its contractual responsibilities for
management of the I&A aspects of the State of Connecticut welfare system to the
prime contractor, Polaroid Corporation ("Polaroid") effective March 1, 1999. In
addition, it has also entered into an agreement, subject to receipt of the
written approval of the State of New Jersey, to transfer its contractual
responsibilities for management of the I&A aspects of the State of New Jersey
welfare system to Image Computing Incorporated ("ICI"). These new resellers for
the government market, like XL Vision in the healthcare market, have the rights
to market the Company's products in those vertical markets and will receive
software support for the remaining term of the transferred contracts.
OEM AGREEMENT -- On March 17, 1999, the Company announced that it had
entered into an OEM agreement with electronic retailer Home Shopping Network, a
USA Networks, Inc. company ("HSN"), pursuant to which HSN has agreed to ship
the Company's SAFtyLatch/trademark/ speaker verification enabled file
encryption software with certain of the personal computers featured on HSN's
televised specialty electronics shows. HSN has not agreed to purchase any
minimum amount of product.
REGISTERED MARKS
All brands and products referenced in this annual report are acknowledged
to be the trademarks or registered trademarks of their respective holders.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Certain of the matters discussed in this annual report are
"forward-looking statements" as defined in Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), which involve certain
risks, uncertainties and other factors which could cause actual results to
differ materially from those discussed herein or implied thereby. For a
discussion of certain risks, uncertainties and other factors associated with
the Company and its operations see MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OPERATION -- FACTORS THAT MAY AFFECT FUTURE
RESULTS as well as other sections of this annual report.
MARKET OVERVIEW
Individuals and organizations are becoming increasingly concerned about
the security of information maintained on personal computers, the Internet, and
enterprise-wide systems. A number of technologies and strategies have been
developed to address the growing concern over information security, including
without limitation, secure identification cards or tokens, digital
certificates, new encryption methods, firewalls and single sign-on
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applications. However, each of these new technologies and strategies are
dependent upon the most critical and vulnerable component of the security
process: positive personal identification and authentication of the individual
seeking access.
As an increasing number of organizations provide their employees with
access to an enterprise network and the Internet from desktops, home offices,
and mobile computing terminals, an opportunity is emerging for companies
providing internal information systems and enterprise applications to utilize
biometric identification technology to secure confidential company information.
Since network expansion exponentially increases the number of endpoints that
may provide access or be accessed, the Company believes the need and demand for
positive personal identification and authentication in the enterprise network
environment is also increasing. According to a 1999 study conducted by the
Computer Security Institute, financial losses due to computer security breaches
grew to over $1 billion in 1998, and 62% of respondents reported computer
security breaches within the last twelve months.
The market for biometric technologies used in information security
applications is largely undeveloped and in its infancy. However, there are
several evolving factors that the Company believes will contribute to the
exponential growth of this industry in the near-term. Falling prices for
biometric collection devices (fingerprint sensors, digital cameras,
microphones, etc.) and significant improvements in the accuracy, performance,
and user acceptance of the technology have made integration of biometrics with
desktop PCs and portable computers a more compelling value proposition for the
commercial market. Major corporations such as IBM, Intel, Microsoft, Compaq,
and Novell are beginning to actively support the integration of biometrics
within their systems architectures as a viable method for identification and
authentication of system users. Enterprise information technology (IT)
priorities are expected to dramatically change with the completion of
preparations for Y2K compliance and the Company believes that enhancing
information security will become the next major focus of IT professionals. The
biometrics industry is working towards adoption of a single application program
interface (API) standard to encourage widespread implementation of the
technology. The Company believes that these factors in combination will create
a growing demand for data and network security products that utilize
biometrics.
BIOMETRIC IDENTIFICATION
A variety of methods are in use today to authenticate an individual's
identity for access privileges. These methods typically require an individual
to present for comparison one or more of the following factors: (i) something
known, such as a password, PIN, or mother's maiden name; (ii) something
carried, such as a token, card, or key; or (iii) something physical, such as a
fingerprint, face, voice, or other biological or behavioral characteristic.
Comparison of biological or behavioral characteristics, also known as biometric
identification, has historically been the most reliable and accurate of the
three factors, but has also been the most difficult and costly to implement in
a fully automated environment. However, recent advances in biometric hardware
technology and processing algorithms have improved the speed and accuracy and
reduced the costs of implementing biometric
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identification solutions in commercial environments. The Company believes that
individuals and organizations will increasingly use this method of identity
authentication to enhance the security of information systems,
business-to-business and business-to-consumer transactions, and enable the
growth of electronic commerce and other electronic services because of its
level of reliability and accuracy.
PRODUCTS
COMPREHENSIVE PRODUCT LINE. The Company's Secure Authentication Facility
(SAF) product line includes a suite of packaged network security and data
security applications for Microsoft Windows, Novell and Unix platforms that can
be installed as-is and used immediately. The SAF product family also includes
development tools that allow easy integration of biometric technology into
Windows compatible client/server applications. These products are currently
available with a choice of leading biometric technologies, including finger
image, speaker verification, and facial image recognition, and are sold with
one or more separately packaged "pluggable" BSP modules. The Company's products
are typically shipped with CD-ROMs containing the application software, BSP
module(s) and user documentation. Hardware devices, such as microphones and
fingerprint sensors can also be packaged with the software. The Company's
strategy is to work with the leading technology suppliers to test and evaluate
their products for compatibility and potential licensing for inclusion with its
product offerings in the future.
EASE-OF-USE. The Company's products are easy to install, well documented,
and provide simple and consistent user prompts to enroll an individual's
biometric characteristics into a database and subsequently verify his or her
identity through such biometric characteristics.
SCALABILITY. The Company's distributed client/server architecture is
designed for centralized storage and matching of biometric templates through a
common dedicated authentication server (SAF Server) application running under
the Windows NT operating system. The SAF Server includes a dedicated secure and
encrypted database of biometric templates and is designed to scale to meet the
needs of small, medium and large enterprise networks that are centrally
managed. The Company's network-based security products also provide strong
encryption of authentication messages transmitted between the client
workstation and the SAF Server to further enhance security.
OFF-THE-SHELF HARDWARE. The Company's software applications support
numerous commercial off-the-shelf biometric hardware collection devices
including fingerprint sensor peripherals manufactured by Veridicom, Who?
Vision, Polaroid, Key Tronic, Identix, and Identicator; digital cameras for
facial image recognition from a number of commercial sources; and microphones
and sound cards for speaker authentication that are identical to those widely
sold for PC audio applications.
SUPPORT FOR INDUSTRY STANDARDS. The Company has designed its products
around current industry standards for biometric application program interfaces
(APIs). The Company
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developed in 1997 under contract with the U.S. Department of Defense, and has
been instrumental in promoting, the Human Authentication API (HA-API). HA-API
has been released to the public domain and is currently supported by over
thirty biometric technology providers and system integrators. More recently,
the Company has actively supported the merger and consolidation of HA-API with
another biometrics standards activity known as BioAPI which it believes will
lead to a single common API for biometric implementation across a wide range of
platforms. The Company is also actively supporting an initiative by Intel
Corporation to define a standard for biometric identification and
authentication within extensions to its Common Data Security Architecture
(CDSA) which is already a recognized industry standard security framework
adopted by The Open Group, a recognized standards-setting body. The Company
believes that support of these standards initiatives will enhance its image in
the marketplace and allow it to provide more flexible solutions to its
customers.
"BEST OF BREED -- BEST OF PRICE" PHILOSOPHY. The Company seeks to enter
into license agreements with the biometric technology providers that offer the
leading price/performance solutions available within each biometric category.
The Company wants to establish its SAF brand with only the premier biometric
offerings available and extensively tests each candidate's technology for
accuracy and ease of use before considering it for licensing.
AWARDS AND RECOGNITION. The Company's products have received awards and
recognition from notable organizations including: InfoWorld Magazine (SAF/nt as
the most secure product in a comparison test with two token-based
authentication solutions in June, 1997); Computer Associates (Software
Achievement Award for SAF/tng as the Best Security Agent for Unicenter TNG at
its CA World Conference in New Orleans in April, 1998); Network World Magazine
(SAF/nt for its coveted World Class Award and subsequently named SAF/nt as one
of the top ten network products for 1998); and PC Magazine (SAF/nt for its
Editor's Choice Award as the best biometric solution for network-wide
deployment when compared against ten other biometric software products-February
1999).
PACKAGED SOLUTIONS. The Company's packaged products consist of biometric
based network and Internet security applications and data security applications
that are either domain-based or operate independently of the domain structure.
/bullet/ SECURE AUTHENTICATION FACILITY FOR WINDOWS NT (SAF/NT). SAF/nt
supports Windows 95 and Windows NT Clients and provides both local
Windows NT workstation and domain server-based biometric
authentication of users within both a local area network (LAN)
environment and in a Windows NT Remote Access System (RAS) dial-up
environment. SAF/nt also integrates biometric authentication into
the screen lock/unlock function on Windows NT workstations and
provides a facility to use biometrics for transaction level
authentication within a user application.
/bullet/ SECURE AUTHENTICATION FACILITY FOR MICROSOFT INTERNET INFORMATION
SERVER (SAF/IIS). Provides biometric authentication for intranet
and extranet users who have a registered Windows NT domain
account. SAF/iis integrates with Microsoft's Internet
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Information Server product and popular browser software to allow
proprietary information to be shared across the public Internet
between the enterprise and its employees and/or trusted business
partners.
/bullet/ SECURE AUTHENTICATION FACILITY FOR NOVELL NETWARE (SAF/NETWARE).
Adds biometric authentication with Novell's NetWare operating
system. SAF/netware supports both Windows 95 and Windows NT
clients and provides extensions to Novell Directory Service (NDS)
administrator functions for biometric authentication of system
administrators and end users in Novell Netware environments.
/bullet/ SECURE AUTHENTICATION FACILITY FOR UNICENTER TNG (SAF/TNG).
Supports enterprise level security using biometric authentication
for Computer Associates Unicenter TNG and its Single Sign-on
Option. SAF/tng authenticates system administrators and end-users
allowing secure access to multiple applications in a heterogeneous
multi-vendor, multi-system environment.
/bullet/ SECURE AUTHENTICATION FACILITY FOR WEB SITES (SAFSITE). A packaged
development kit that integrates biometric I&A into custom Internet
web sites. SAFsite secures access to protected transactions and
proprietary information over the public Internet and is ideal for
E-commerce and Internet subscription customers who are not
employees or registered users within a Windows NT domain. SAFsite
integrates with a wide range of Web server application platforms
including Microsoft's InterDev, EveryWare's Tango and other
dynamic Web development tools. "Plug-ins" for both Netscape's
Communicator and Microsoft's Explorer browsers can be downloaded
over the Internet for installation into a client workstation
depending on the desired biometric technology.
/bullet/ SAFTYLATCH. Provides a convenient data security solution for
Windows 95/98 PC users who want to control access to selected file
folders that have been protected through strong military-grade
encryption. SAFtyLatch permits multiple users to share private
file folders and supports network storage of encrypted files.
SAFtyLatch includes voice biometrics and a microphone and is
packaged for the mass distribution channel and retail stores.
SOFTWARE DEVELOPER KITS (SDKS). The Company has created tool kits for
software developers that allow biometrics to be integrated into third-party
products and custom applications.
/bullet/ SAFTYTOOLS FOR WINDOWS -- Contains all of the software components
required to integrate biometric identification into a Windows
application program. Targeted at application developers wanting to
add biometrics with limited involvement or knowledge in the
details of the functionality of biometric technology. SAFtyTools
can be used for both networked and standalone one-to-one matching
applications.
/bullet/ SAFTYMATCH -- Contains all of the software components required to
integrate one-to-many matching against a population of finger
images. Available on several Unix platforms and supports Microsoft
Windows 95/NT and Sun Sparc workstations.
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/bullet/ HA-API DEVELOPMENT KIT --Targeted at technology vendors and
systems programmers who wish to develop HA-API compliant BSP
modules for use with applications designed to use HA-API function
calls.
MARKETING AND DISTRIBUTION
The Company uses a variety of direct and indirect sales and marketing
techniques in an attempt to market its products and services. The Company
markets its products into the horizontal markets for data and network security
primarily through distributors, value-added distributors ("VADs"), resellers,
original equipment manufacturers ("OEMs") and strategic alliance partners. The
Company markets its products into vertical markets (i.e. healthcare, government
and banking) primarily through value-added resellers ("VARs"), independent
software vendors ("ISVs"), integrators, and strategic alliance partners. The
marketing goals of these efforts are to identify potential resellers of the
Company's products, create awareness of the Company's product offerings,
generate leads for follow-on sales, and achieve significant order volume by
rapidly disseminating its products through multiple indirect distribution
channels worldwide.
The Company's direct sales efforts are limited to a web site on the
Internet and pursuit of selected end-user and OEM customers where suitable
channel partners have not yet been identified. The Company's indirect sales
activities provide support to channel partners by geographic region and
vertical markets. The Company has designed its distribution strategy to address
what it believes are the particular requirements of its target customers.
However, there is no assurance that such an objective or material levels of
sales will be achieved or that the Company will be able to successfully market
or distribute, directly or indirectly, any of its products. The following is an
outline of some of the marketing techniques and distribution strategies being
utilized by the Company:
COMPUTER VENDORS/OEMS. The Company is working directly or jointly with
strategic partners to provide the Company's software product line to major
computer and peripheral vendors. The Company believes that certain of its
strategic partners have established relationships with several of these target
organizations.
VARS, ISVS, RESELLERS, DISTRIBUTORS AND SYSTEM INTEGRATORS. The Company
utilizes indirect sales channels such as VARs, ISVs, distributors, system
integrators and other resellers to leverage the market expertise and direct and
indirect sales forces of those companies. The Company is actively engaged in
establishing relationships with major distributors that will carry certain of
its products and make them available to a broad audience of secondary
distributors, resellers and retail stores. In parallel, the Company has already
established agreements with major direct mail resellers including Multiple
Zones International, Inc. and Global DirectMail, Inc. to advertise its
SAFtyLatch product in their catalogs which have mass distribution within North
America. The inability to recruit, manage, and retain important VARs, ISVs,
resellers, distributors and system integrators or their inability to penetrate
their respective market segment could materially adversely affect the Company's
business, operating results, condition (financial or otherwise) or prospects.
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INTERNET MARKETING. The Company operates a Web server home page
(http://www.saflink.com) which provides marketing and corporate information,
news about the Company, and a variety of product and technical support
information. The Company currently intends to expand its Internet operations to
include sales and distribution of products directly to end users through its
World Wide Web Site. The Company's SAFtyLatch product is currently available
for purchase over the Web through Multiple Zones International
(http://www.zones.com) and is expected to be included for sale on other
E-commerce reseller Web sites in the future. The Company is also testing the
effectiveness of banner advertising on various popular Web sites including
Business Week On-Line (http://www.businessweek.com).
STRATEGIC RELATIONSHIPS
As a means to try to accelerate the acceptance of the Company's products
and to facilitate the adoption of biometric identification technology in the
commercial marketplace, the Company has developed and is continuing to develop
strategic relationships with certain leading technology and transaction
providers. The Company intends to rapidly disseminate its products and services
through multiple indirect distribution channels worldwide. However, there is no
assurance that the Company will be able to so market its products and services
or that such objective will be achieved. The Company has either established
strategic relationships or is exploring the possibility of entering into such
relationships with partners in the following categories:
TECHNOLOGY PROVIDERS. The Company has entered into and intends to further
pursue selected technology licenses and partnerships. It is not the Company's
strategy to develop its own biometric technologies but to integrate into its
products the leading technologies available including finger imaging algorithms
licensed from Cogent Systems, Inc. ("Cogent") and Veridicom, Inc.
("Veridicom"), speaker verification algorithms licensed from Lernout & Hauspie
Speech Products NV ("L&H") and ITT Industries, Inc. ("ITT"), facial recognition
algorithms licensed from Visionics Corporation ("Visionics"), and biometric
collection hardware manufactured by several suppliers.
INFRASTRUCTURE PROVIDERS. The Company is pursuing relationships with
computer manufacturers and communications companies that provide connectivity
over virtual private networks, the Internet, and corporate intranets.
FINANCIAL SERVICES PROVIDERS. The Company is pursuing relationships with
leading banks and transaction processing companies interested in providing
enhanced customer service and security in electronic banking. For example,
Unisys Corporation ("Unisys") deploys SAF client/server software in its
Navigator/trademark/ customer service system for banking and has developed
several significant prospects. Most recently, WesternBank in Puerto Rico
contracted with Unisys and NRI to implement 275 finger image scanners and
related software in their new branch automation system. The Company has also
signed a VAR agreement with a leading financial services provider, FIserv, Inc.
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HEALTHCARE PROVIDERS. The Company has entered into a master reseller
agreement with XL Vision which is pursuing relationships with leading
healthcare insurers, providers, and other organizations interested in securing
electronic medical records and transactions, improving customer service, and
auditing attestations in paperless environments. As an example, the Mayo Clinic
began development of a physician identification solution for its clinical
practice management system to provide authentication for physician and nurse
single sign-on to multiple clinical applications. In May, the Company
transferred its interests in the Mayo Clinic system to XL Vision. The Company
believes that XL Vision is, in turn, currently pursing other prospects for this
particular application in the healthcare industry.
The Company plans to expand its business development and marketing
organization as revenues increase. However, there is no assurance that revenues
will increase, that such internal expansion will be successfully completed,
that the cost of such expansion will not exceed revenues generated, or that the
Company's sales and marketing organization will be able to successfully compete
against its current or potential competitors. The Company's inability to
effectively manage its internal expansion could have a material adverse effect
on the Company's business, operating results, condition (financial or
otherwise) or prospects. There is no assurance that the Company's existing or
future strategic relationships or marketing and distribution strategy will lead
to, or accelerate the acceptance of the Company's products or facilitate the
adoption of biometric identification and authentication technology in the
commercial marketplace, or that the Company will be able to pursue or develop
further relationships with other providers of technology, infrastructure or
transactions.
LICENSED TECHNOLOGY
FUNCTIONALITY. Biometric identification software algorithms and hardware
products typically perform biometric data collection/processing, matching and
search functions. Most of these algorithms represent a software solution that
runs on generally available computer hardware including mainframes, servers,
workstations and a growing list of storage devices including smartcards,
optical cards and bar-code cards. For example, the licensed finger image
identification algorithms provided by Cogent are representative of finger
imaging based biometric algorithms that perform the following functions:
IMAGE PRE-PROCESSING -- Enhances fingerprint images by clearly
differentiating ridges and valleys and locating and extracting ridge endings
and bifurcations (each such ridge ending and bifurcation is called a "point of
interest" or "minutia"). This process accepts gray scale image inputs of finger
images from sensor devices attached to a PC and uses "fuzzy mathematics" to
clearly assign pixels to either ridge lines or valleys. The output of the
process results in an enhanced finger image, consisting of the ridge lines of
the finger that can be evaluated by the extraction and encoding process.
EXTRACTION AND ENCODING -- Locates the finger image and surrounding
minutiae. The automated finger imaging identification technology licensed by
the Company evaluates the image and encodes a pattern description of the
relative positions of the surrounding minutiae. This process evaluates the
quality of the encoded finger image and creates a
11
standard finger image minutiae record ("Finger Image Minutiae Record") output
that can be stored in a database and compared by the pattern matching process
("Pattern Matching Process").
PATTERN MATCHING -- Provides a Pattern Matching Process which will score
the similarity of the Finger Image Minutiae Records against a known record,
providing highly reliable finger image verification.
These essentially stand-alone processes can be integrated with a variety
of computer hardware environments and re-deployed in many different ways to
satisfy the biometric identification requirements of a wide range of potential
products and services. In many ways, the above processes are similar in concept
for speech verification, facial image recognition and other biometric
technologies, although the underlying technologies differ greatly. The Company
refines its use of the Licensed Technology on a continuing basis and explores
and evaluates other biometric technologies, including other finger imaging,
speaker verification, facial recognition, iris scanning and dynamic signature
recognition technologies, with a view towards licensing the most advanced
biometric technologies it deems appropriate and beneficial, although there is
no assurance that such rights will be available on satisfactory terms.
LICENSE AGREEMENTS
COGENT SYSTEMS, INC. In April 1992, the Company was granted a seven and
one-half year world-wide (i) exclusive license to all commercial applications
of Cogent finger imaging identification technology and (ii) a non-exclusive
license for most governmental applications (including control of welfare
fraud), subject to certain rights of earlier termination. Cogent excluded the
law enforcement market from the Company's license and may market and develop
finger imaging identification systems for all governmental applications,
including, among others, control of welfare fraud and law enforcement. In
consideration of the license, the Company has agreed to pay royalties generally
based on the Company's revenues from the licensed technology, subject to
minimum quarterly payments of $125,000. In addition, Cogent has agreed during
the term of the license to provide technical assistance to the Company in its
utilization, enhancement and development of the Cogent finger imaging
identification technology.
12
Pursuant to the License Agreement, certain exclusive rights with respect
to commercial markets which the Company had not entered as of April 1, 1997
became nonexclusive after such date. As of such date, the Company believes that
it has the right of first refusal on any commercial utilization of the Cogent
technology and that it retains exclusive rights in the following commercial
markets and possibly others:
MARKET SIC CODE GROUP
------ --------------
Commercial Bank; Credit Union ...................... 60
Health Services .................................... 80
Business Consulting ................................ 87
Computer & Data Processing Services ................ 73
Computer & Office Equipment Manufacturing .......... 35
Insurance Carrier .................................. 63
In the event it is determined that the Company did not, in fact, enter
into any of the above commercial markets (including any segment thereof) as
required under the terms of the agreement, the Company stands to lose its
exclusivity in those markets.
On March 10, 1994, the Company entered into a ten year extension,
continuing until October 1, 2009, of the term of the license agreement,
provided that the Company makes a $10 million cash payment (the "Extension
Payment") to Cogent on or prior to October 1, 1999, in addition to ongoing
licensing fees. The Company is currently negotiating a modification to the
license which would eliminate the $10 million cash payment. If an acceptable
modification is not achieved, the Company will most likely elect not to make
the $10 million payment and will allow the license to terminate on October 1,
1999. In the event that the license terminates on October 1, 1999, the Company
believes that Cogent will be obligated to provide support for the existing user
base and the Company anticipates that it will use alternate suppliers such as
Verdicom, Inc. for its products that use finger imaging technology.
WHO? VISION SYSTEMS. On March 5, 1998 the Company entered into a five year
marketing agreement with Who? Vision Systems, Inc., an affiliate of XL Vision.
Such agreement grants the Company a world-wide non-exclusive license to Who?
Vision's finger imaging based software algorithms pursuant to a pricing
schedule with no minimum annual royalty. The Company was also granted to right
to re-sell Who? Vision fingerprint sensor hardware with its products.
ITT INDUSTRIES, INC. On April 3, 1998, the Company entered into an
agreement with ITT Industries, Inc. that grants the Company a world-wide
non-exclusive perpetual license to ITT's SpeakerKey speech verification
technology pursuant to a pricing schedule with no minimum annual royalty.
VISIONICS CORPORATION. On April 6, 1998 the Company entered into a three
year agreement with Visionics Corporation that grants the Company a world-wide
non-exclusive license to Visionics FaceIt face recognition BSPs pursuant to a
pricing schedule that includes a minimum annual royalty of $10,000.
13
VERIDICOM. On June 12, 1998 the Company amended its perpetual world-wide
non-exclusive license to Veridicom's finger imaging based BSPs. Pursuant to
such agreement, the Company paid $75,000 for a specified number of prepaid
licenses and has the right to purchase additional licenses pursuant to a
pricing schedule with no minimum annual royalty. The Company was also granted
the right to resell Veridicom's fingerprint sensor hardware with its products.
LERNOUT & HAUSPIE SPEECH PRODUCTS ("L&H"). On September 30, 1998 the
Company entered into a three year agreement with L&H that grants the Company a
world-wide non-exclusive license to L&H's speech recognition and speaker
verification software algorithms for a percentage of the revenues received by
the Company from the sales of specified products. The Company paid $125,000 in
December as a prepaid license for the original three year term which will be
applied toward actual royalties due. The agreement is automatically extended
for one year periods if total royalties paid during the preceding twelve months
exceed $100,000.
COMPETITION
Although the Company believes that the technology it licenses is among the
most advanced available, to the Company's knowledge, the following companies
have also developed software products that utilize biometric identification
technology and are active in the United States: Digital Persona, Inc., Mytec,
Inc., SAC, American Biometric Company, Identix Inc., Identicator Technologies,
Inc., Keyware, Inc., Miros, Inc., Veritel, Inc., and I/O Software, Inc. It is
the Company's strategy to offer products that are competitively priced,
multi-biometrics enabled, open standards based, and scalable to large
enterprise networks to differentiate its products in the marketplace.
In addition, the Company will face competition from non-biometric
technologies such as traditional passwords, token cards, or digital
certificates as forms of user authentication in data and network security
environments. In competing with these non-biometric products, the Company
believes that the most important competitive issue will be the trade-off
between the convenience, additional security and fraud prevention capabilities
provided by biometrics versus the cost of installation. As a non-exclusive
licensee of biometric technologies, the Company expects to experience
competition from other products and services incorporating the technology it
licenses. There is no assurance that the Company will be able to compete
effectively with competitors offering products with similar or identical
biometrics and non-biometric authentication capabilities.
PATENTS AND TRADEMARKS
The Company has no rights to any patents or other intellectual property,
including any biometric software algorithms or BSPs of its licensors, other than
pursuant to its license of rights, and believes the competitive nature of its
industry makes any patents and patent applications of its licensors important to
the Company. There is no assurance that any of the patent
14
applications of such licensors will be granted, that patents previously granted
will prove enforceable, or that any such patents or patent applications will
lead to any competitive advantage for the Company.
The Company has received two patents in connection with the ergonomic
design and optical design used in its finger image-based Microreader systems.
In addition, the Company has received a notice of allowance of all claims in
another patent application which will be issued in due course. Further, the
Company has pending patent rights directed to its SAF software, has identified
further subject matter to include in its patent portfolio, and has filed
additional patent applications for these technologies. There is no assurance
that the Company will be granted any pending patents, that any patent
previously granted will prove enforceable, or that any competitive advantage
will exist for the Company because of such patents or patent applications.
The Company also relies on unpatented know-how, trade secrets and
continuing research and development. As a result, the Company may not have any
protection from other parties who independently develop the same know-how and
trade secrets. Proprietary protection of the Company's products and services
may be important to its business, and the Company's failure or inability to
maintain such protection could have a material adverse affect on the Company's
business, condition (financial or otherwise), results of operations and
prospects. Moreover, while the Company does not believe that the production and
sale of the Company's proposed products or services infringe on rights of third
parties, if such is not the case, failure to obtain needed licenses from such
third parties could have a material adverse effect on the Company's ability
either to complete the development of certain products or services or to
produce and market such products or services. Failure to obtain any such
licenses could adversely impact the Company's business, condition (financial or
otherwise), results of operations and prospects.
The Company has registered certain service marks and trademarks with the
United States Patent and Trademark Office. However, the Company has not
registered certain of the various trademarks and trade names which it uses with
the United States Patent and Trademark Office nor in any foreign government
trademark offices. With respect to unregistered trademarks, the Company intends
to accompany the use of such trademarks with the Company's name to indicate the
origin of the products to which they are applied, to distinguish them from the
products of competitors and to build goodwill in such trademarks. Certain
rights, however, are protected under the provisions of the Lanham Act and under
state law in respect to unregistered or common law trademarks.
EMPLOYEES
As of March 26, 1999, the Company had 22 full-time employees compared to
33 as of March 31, 1998. The reduction in staffing was implemented as part of
the Company's cost reduction program initiated during the third quarter of 1997
to reduce the Company's overhead as it transitioned from a direct sales model
for integration services for governmental and other vertical applications to an
indirect sales model for horizontal
15
packaged software products for commercial applications. From time to time the
Company has also utilized consultants for specific assignments (including the
Company's current contract Chief Financial Officer), and intends to continue
this practice in the future. None of its employees are represented by a labor
union. Management believes that the future success of the Company will depend
in part on its ability to retain its existing technical and other personnel and
to attract and retain other qualified employees. The Company believes that its
relationship with its employees is good.
ITEM 2. PROPERTIES.
The Company leases its current principal executive offices and research
and development facilities consisting of approximately 7,500 square feet
located at 2502 Rocky Point Drive, Tampa, Florida 33607. The Company also
leases office space for its sales and marketing and technical personnel in
Reston, Virginia.
ITEM 3. LEGAL PROCEEDINGS.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
None.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
There is presently a limited public trading market for the Common Stock.
The Common Stock has been listed on the Nasdaq SmallCap Market since April 27,
1993 (NASDAQ: NRID). During 1998, the Company was sent two formal deficiency
notices from The Nasdaq Stock Market, Inc. ("Nasdaq") that the Company's
securities were not in compliance with certain minimum maintenance standards
required by Nasdaq. Nasdaq has notified the Company that it has been deemed to
be in compliance with the net tangible asset, market capitalization, or net
income requirements of Marketplace Rule 4310(c)(2) effective as of December 18,
1998. As of March 26, 1999, the Company believes that it is in compliance with
the minimum bid price requirement of Marketplace Rule 4310(c)(4).
The following table sets forth the range of high and low bid quotations
for the Common Stock as reported on the SmallCap Market for each full quarterly
period from January 1, 1997 through December 31, 1998 and for the period
January 1, 1999 through March 26, 1999. Such quotations have been adjusted for
the May 27, 1998 1 for 6 reverse split of the Common Stock and represent prices
between dealers without adjustment for retail markups, markdowns or
commissions, and may not necessarily represent actual transactions.
COMMON STOCK BID PRICE
--------------------------
HIGH LOW
------------ -----------
1997
First Quarter .................................. $ 15.937 $ 8.062
Second Quarter ................................. 14.625 7.125
Third Quarter .................................. 9.375 5.250
Fourth Quarter ................................. 5.812 1.500
1998
First Quarter .................................. 6.187 1.687
Second Quarter ................................. 4.875 1.250
Third Quarter .................................. 3.813 0.875
Fourth Quarter ................................. 2.125 0.250
1999
First Quarter (through March 26, 1999) ......... 4.500 0.875
As indicated in the preceding paragraph, there has been only a limited
public market for the outstanding Common Stock and the market price for the
Common Stock does not necessarily reflect the value of the Company. There is no
assurance that a viable public market for such shares will develop in the
future or, if one develops, that such a public market will continue to exist.
On March 26, 1999, the closing bid price of the Common Stock as reported
on the SmallCap Market was $2.188. As of March 26, 1999 there were
approximately 281 record holders of Common Stock.
17
Since its incorporation, the Company has not paid or declared dividends on
the Common Stock, nor does it intend to pay or declare cash dividends on its
Common Stock in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
SUMMARY OPERATING DATA
Revenue .......................................... $ 4,920 $ 1,585 $ 2,305 $ 401 $ --
Net loss ......................................... (1,384) (7,424) (7,340) (5,070) (7,006)
Preferred stock deemed dividend .................. -- 1,470 1,412 -- --
Preferred stock dividend ......................... 278 350 303 -- --
Net loss attributable to common stockholders ..... (1,662) (9,244) (9,055) (5,070) (7,006)
Net loss per common share ........................ (0.23) (1.57) (1.93) (1.31) (2.20)
Weighted average number of common shares ......... 7,216 5,875 4,680 3,873 3,182
AS OF DECEMBER 31,
---------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(IN THOUSANDS)
SUMMARY BALANCE SHEET DATA
Total assets ................. $2,685 $2,578 $2,832 $1,600 $1,701
Total liabilities ............ 716 1,807 1,348 510 273
Stockholders' equity ......... 1,969 771 1,484 1,090 1,428
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATING ACTIVITIES
The Company incurred net operating losses for the fiscal years 1998, 1997
and 1996 of approximately $1.4 million, $7.4 million and $7.3 million,
respectively, primarily due to its efforts in developing and marketing its
biometric I&A software products. During 1998, the Company increased its
strategic focus on commercial software development and sales.
The following discussion presents certain changes in revenue and operating
expenses of the Company which have occurred between fiscal years 1998 and 1997,
and between fiscal years 1997 and 1996 and should be read in conjunction with
the Company's Consolidated Financial Statements, including the notes thereto,
and Selected Financial Data included elsewhere herein.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUE AND COST OF REVENUE
Revenue for the year ended December 31, 1998 increased by approximately
$3.3 million over revenue for the year ended December 31, 1997. This increase
was primarily due to the sale of approximately $4.0 million of software
licenses and related services to XL Vision in 1998, partially offset by
decreases in software sales and services to miscellaneous other customers.
Approximately $3.4 million or 69% of total revenue was from commercial software
sales during 1998 compared to $294,000 or 19% in 1997 resulting from the
Company's shift to focusing on software based solutions during 1998.
Government related project revenue, including both PCS and product revenue,
associated with the States of New Jersey and Connecticut welfare control systems
increased to approximately $627,000 in 1998 from approximately $535,000 in 1997
as the result of a system expansion installed for the State of New Jersey in
1998. As part of its increased focus on commercial software development and
sales, the Company entered into agreements during the first quarter of 1999 to
(i) transfer its contractual responsibilities for the management of the I&A
aspects of the Connecticut welfare system to the prime contractor, Polaroid
Corporation, and (ii) sell its software and transfer its contractual
responsibilities for the management of the I&A aspects of the New Jersey welfare
system to a third party contractor, Image Computing Incorporated ("ICI"). These
new resellers have agreed to purchase software support through the balance of
1999.
The approximately $378,000 increase in cost of revenue was primarily
attributable to the sale of approximately $335,000 of hardware to XL Vision, at
cost, as part of the agreement making XL Vision the Company's master reseller
to the healthcare market.
19
Gross profit increased to $3.8 million or 77% of revenue during 1998 from
$841,000 or 53% of revenue in 1997 primarily due to the change in product mix
to primarily software sales in 1998.
OPERATING EXPENSES
Operating expenses for 1998 decreased by approximately $3.2 million from
1997 primarily due to (i) the expense reduction plan implemented by the Company
in late 1997, (ii) the sale of the Company's healthcare line of business to XL
Vision in 1998, and (iii) the elimination of expenses outside the Company's
current strategic focus on indirect sales and marketing of software products.
The following table provides a breakdown of the dollar and percentage changes
in operating expenses:
CHANGES IN OPERATING
EXPENSES
------------------------
(000s) % CHANGE
------------ ---------
Product development ................ $ (939) (42)%
Sales and marketing ................ (1,252) (45)
General and administrative ......... (973) (33)
-------- ---
$ (3,164) (37)%
======== ===
PRODUCT DEVELOPMENT
The decrease in product development expenses was primarily due to
reductions in employee expense, travel and professional consulting services
related to hardware and the elimination of expenditures outside of the
Company's current strategic focus. The Company expects to continue to incur
product development costs as it develops additional products and enhances
existing products.
SALES AND MARKETING
The decrease in sales and marketing expenses was primarily due to
reductions in employee expense, travel, professional consulting services and
advertising, partially offset by a one-time commission paid in connection with
the XL Vision transactions. As part of the current strategic focus, the Company
sold its healthcare line of business, eliminated a portion of its other sales
and marketing staff and closed certain offices shifting such sales and
marketing efforts and costs to certain of the Company's strategic partners.
GENERAL AND ADMINISTRATIVE
The decrease in general and administrative expense was primarily due to
the accrual of $450,000 of settlement costs related to the IIG lawsuit in 1997
compared to $157,000 of such costs in 1998 as well as decreases in employee
expense, travel, outside consulting, telephone and legal and professional
expense. The Company expects certain general and administrative costs to
increase if sales of the Company's products increase.
20
INTEREST AND OTHER INCOME
This decrease in interest and other income was primarily due to a $150,000
write-off of obsolete assets and a $136,000 reduction in interest income due to
lower cash balances, partially offset by a $200,000 gain on sale of assets
transferred to XL Vision during 1998.
OPERATING EXPENSE ANALYSIS BY FUNCTIONAL ACTIVITY
The following table provides an analysis of total operating expense change
by functional category:
CHANGES IN OPERATING
EXPENSES
--------------------------
(000s) % CHANGE
------------ -----------
Compensation and related benefits ......... $ (1,688) (48)%
Legal and professional services ........... (506) (64)
Consulting ................................ (441) (55)
Travel and entertainment .................. (443) (64)
Advertising and promotion ................. (218) (48)
Telephone and Internet .................... (80) (29)
Commission ................................ 351 *
Other ..................................... (139) (7)
-------- ------
$ (3,164) (37)%
======== =====
- ----------------
* Not meaningful
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUE AND COST OF REVENUE
Revenue for the year ended December 31, 1997 decreased by approximately
$720,000 from revenue for the year ended December 31, 1996 due to the decrease
in revenue associated with the welfare fraud control systems for the states of
Connecticut and New Jersey. 1996 revenue included revenue from the installation
of the welfare fraud control systems in Connecticut and New Jersey, while the
only revenue associated with these contracts during 1997 was for on-going
maintenance of the systems. The Connecticut installation, where the Company was
a subcontractor to a direct service provider, included a service commitment
through 2000.
Cost of revenue for the year ended December 31, 1997 decreased by
approximately $550,000 compared to cost of revenue for the same period in 1996
primarily as a result of the lack of installation costs related to the
Connecticut and New Jersey contracts. Cost of revenue associated with sales of
the Company's software and hardware include media costs and direct hardware
costs. Cost of revenue associated with on-going maintenance
21
contracts and service includes labor and overhead associated with software
customization, ongoing technical support and amortization of hardware acquired
by the Company on behalf of its customers.
OPERATING EXPENSES
Operating expenses for the year ended December 31, 1997 decreased by
approximately $76,000 compared to operating expenses for the same period in
1996. The following table provides a breakdown of the dollar and percentage
changes in operating expenses:
CHANGES IN OPERATING
EXPENSES
-------------------------
(000s) % CHANGE
---------- ------------
Product development ................ $ (109) (5)%
Sales and marketing ................ (550) (16)
General and administrative ......... 583 25
------ ---
$ (76) (1)%
====== ===
PRODUCT DEVELOPMENT
Product development costs decreased by $109,000 or 5% during 1997. The
Company expects to continue to incur product development costs as it continues
to develop additional products and enhance existing products.
SALES AND MARKETING
The decrease in sales and marketing expenses was due to a decrease in
employee and consulting expenses. The decrease resulted from the Company's
decision to curtail its efforts in Canada and eliminate expenditures in areas
identified as being outside of the Company's current strategic focus on
indirect selling and marketing of commercial software products. As part of such
efforts, the Company eliminated a portion of its sales and marketing staff
shifting such efforts to certain of the Company's strategic partners. The
Company expects that sales and marketing expenses will increase if sales of the
Company's products increase.
GENERAL AND ADMINISTRATIVE
The increase of approximately $583,000 in general and administrative
expenses was primarily due to the accrual of settlement costs of approximately
$450,000 related to the IIG lawsuit in 1997 with no such costs in 1996 as well
as increases in occupancy costs. See discussion in Liquidity and Capital
Resources below.
YEAR 2000 EXPOSURE
The Company recognizes the need to ensure that its operations will not be
adversely impacted by Year 2000 software failures. The Year 2000 problem is the
result of computer
22
programs being written using two digits (rather than four) to define the
applicable year. Programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than 2000, which could result in
miscalculations or system failures. The Company is currently working to address
the potential impact of the Year 2000 problem. It's processes for evaluating
and managing the risks and costs associated with this potential problem are
being managed by internal staff members.
The Company has, to date, determined that (i) all of the software that it
has developed for sale to others is Y2K compliant and (ii) all of the developers
of other software that it has acquired for use in its business have publicly
stated that their products are also Y2K compliant. The Company is still
evaluating the possible effects of its Year 2000 exposure relative to certain
equipment utilized by it. The Company has not yet determined the impact that a
Y2K failure suffered by vendors, customers, suppliers or other third party
service providers would have on the Company, but believes such a failure could
have a material adverse impact on the Company's business, condition (financial
or otherwise), results of operations and prospects.
The Company will continue to evaluate the status of its Year 2000
compliance to determine whether a contingency plan for dealing with any such
failures is necessary, but no such plan has yet been adopted by the Company. The
Company is still evaluating the possible effects of its Year 2000 exposure
relative to certain equipment utilized by it. The Company has not yet determined
what the nature and timing of any such contingency plan would be. Based on the
information the Company has developed to date, the Company estimates that costs
of addressing potential problems will not have a material adverse impact on the
Company's business, condition (financial or otherwise), results of operations,
prospects and cash flows. However, there can be no assurance that these
estimates will be achieved and actual results could differ materially from those
anticipated. Specific factors that might cause such material differences
include, but are not limited to, the extent to which the Company might be
adversely impacted by vendors, customers, suppliers and other third party
service providers' failure to remediate their own Year 2000 issues.
NEW ACCOUNTING STANDARDS
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 ("SFAS 130"), Reporting Comprehensive Income,
issued by the Financial Accounting Standards Board. SFAS 130 establishes new
rules for the reporting and display of comprehensive income and its components.
Adoption of this Statement has not had, and is not expected to have, a material
impact on the Company's net income or stockholders' equity.
As of January 1, 1998 the Company adopted Statement of Financial
Accounting Standards No. 131 ("SFAS 131"), Disclosures about Segments of an
Enterprise and Related Information, issued by the Financial Accounting
Standards Board. SFAS 131 requires the use of a management approach to report
financial and descriptive information about a company's operating segments.
Operating segments are revenue-producing components of the enterprise for which
separate financial information is produced internally for company management.
Under this definition, the Company operated, for all periods presented, as a
single segment.
23
As of January 1, 1998, the Company adopted Statement of Position 97-2
("SOP 97-2"), SOFTWARE REVENUE RECOGNITION, issued by the American Institute of
Certified Public Accountants. SOP 97-2 changes the requirements for revenue
recognition relating to software sales. Adoption of this Statement has not had,
and is not expected to have, a material impact on the Company's net income or
stockholders' equity.
LIQUIDITY AND CAPITAL RESOURCES
Cash and working capital as of December 31, 1998 were approximately $1.7
million and $1.5 million, respectively, as compared to a cash and working
capital (deficit) of $298,000 and ($386,000), respectively, as of December 31,
1997. The increase was primarily the result of the December 30, 1998 $2.0
million capital contribution made to the Company by the purchasers of all of
the then outstanding Series C Preferred Stock of the Company without the
issuance of any securities, see "Factors that May Affect Future Results --
Control of the Company" below. The Company expended net cash at a rate of
approximately $117,000 per month during the last three months of 1998.
Cash as of March 26, 1999 was approximately $847,000. Cash and working
capital as of February 28, 1999 were approximately $1.2 million and $1.1
million, respectively. The decrease from December 31, 1998 was primarily due to
net operating expenses.
In an effort to reduce the Company's net cash expenditure rate, the
Company began implementing a plan to reduce operating expenses in September
1997. This plan included, among other things, closing certain corporate
facilities outside its Tampa headquarters and reducing the number of employees.
Additionally, during 1998, the Company completed the sale of prepaid software
licenses to one customer that generated approximately $4.0 million in cash.
These two items reduced the net cash used in operating activities for fiscal
1998 to approximately $723,000 from approximately $6.5 million used during
1997.
During 1998, the Company settled a lawsuit filed by IIG on February 13,
1997. The final settlement consisted of a $300,000 cash payment and the
issuance of 41,667 shares of Common Stock in addition to warrants to purchase
75,000 shares of Common Stock at an exercise price of $3.375. Expense
recognized for this settlement was $157,000 and $450,000 for 1998 and 1997,
respectively. On July 7, 1998, the Company filed a registration statement with
the SEC to register the shares of Common Stock issued to IIG and the shares of
Common Stock issuable upon the exercise of the warrants issued to IIG. This
registration statement was declared effective by the SEC on September 11, 1998.
The Company expended net cash at a rate of approximately $278,000 per
month during the first two months of 1999. The Company believes that its
existing working capital, together with anticipated cash flows from sales under
current contracts and continuation of the Company's operating expense reduction
plan will be insufficient to meet its expected working capital needs beyond May
31, 1999. Accordingly, the audit opinion issued in connection with the
Company's 1998 financial statements (included in this annual report) contains a
going concern qualification.
24
Absent a significant increase in sales, which itself may require a
significant increase in working capital, the Company will require significant
additional funds during 1999 to continue its operations. The options the
Company is reviewing to obtain additional financing include, but are not
limited to, the sale and issuance of stock, the sale and issuance of debt, the
sale of certain assets of the Company and entering into an additional strategic
relationship or relationships to either obtain the needed funding or to create
what the Company believes would be a better opportunity to obtain such funds.
It is possible that any such additional infusion of capital would be in the
form of the sale and issuance of additional shares of Common Stock or
securities that are convertible into Common Stock, which would substantially
increase the number of shares of Common Stock outstanding on a fully-diluted
basis. However, there is a significant likelihood that additional funding or
strategic relationships will not be available on terms acceptable to the
Company, if at all. The failure to obtain such additional funds would cause the
Company to cease or curtail operations. Even if such additional funding is
obtained, there is no assurance that the Company will be able to generate
significant sales of its products or services, or, if the Company is able to
consummate significant sales, that any such sales would be profitable.
FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to other information contained in this annual report, the
following factors, among others, sometimes have affected, and in the future
could affect the Company's actual results and could cause future results to
differ materially from those in any forward looking statements made by or on
behalf of the Company. Factors that could cause future results to differ from
expectations include, but are not limited to the following: the Company's need
for additional funds, the Company's limited operating history and substantial
accumulated net losses, control of the Company, the SmallCap Market eligibility
and maintenance requirements, the possible delisting of the Company's Common
Stock from the SmallCap Market, technological and market uncertainty,
competition, and the Company's dependence upon software licensors.
NEED FOR ADDITIONAL FUNDS
The Company believes that its existing working capital, together with
anticipated cash flows from sales from current contracts, continuation of the
Company's operating expense reduction plan and the reduction of capital
expenditures will be insufficient to meet its expected working capital needs
after May 31, 1999. Accordingly, the Company is reviewing the options available
to it to obtain additional funding. There is a significant likelihood that such
additional funding will not be available on terms acceptable to the Company. It
is possible that any such funding would be obtained through the sale and
issuance of additional shares of Common Stock or securities that are
convertible into Common Stock, which would substantially increase the number of
shares of Common Stock outstanding on a fully-diluted basis.
25
LIMITED OPERATING HISTORY, SUBSTANTIAL ACCUMULATED NET LOSSES
From its commencement of business in October 1991, the Company has been
principally engaged in organizational, development and marketing activities.
Through December 31, 1998, the Company has reported an accumulated net loss of
approximately $45.3 million and has had only limited revenues. The Company has
incurred additional losses from December 31, 1998 to date. There is no
assurance that the Company will be able to achieve significant revenues or any
net income in the future.
CONTROL OF THE COMPANY
On December 17, 1998, RMS Limited Partnership ("RMS"), Francis R.
Santangelo ("Santangelo") and Clearwater Fund III ("Clearwater") entered into a
stock purchase agreement pursuant to which RMS and Santangelo agreed to
purchase 195,500 and 34,500 shares, respectively, of the Series C Convertible
Preferred Stock (the "Series C Preferred") of the Company from Clearwater in
exchange for $1.0 million cash and 1.0 million shares of the Common shares
received upon conversion. Upon consummation of the purchase of the Series C
Preferred, RMS and Santangelo converted all of their respective shares of
Series C Preferred into 8,264,138 and 1,458,377 shares, respectively, of Common
Stock (representing approximately 49.6% and 8.7% of the then issued and
outstanding shares of Common Stock). After the issuance of such shares of
Common Stock and the delivery of the applicable shares of Common Stock to
Clearwater, RMS and Santangelo were the beneficial owners of 8,080,805 and
1,308,377 shares of Common Stock, respectively, representing approximately
48.5% and 7.8%, respectively, of the then issued and outstanding shares of
Common Stock. As a result of the foregoing transactions, RMS and Santangelo
effectively acquired control of the Company through the ability to control the
vote on most if not all matters to be determined by the stockholders of the
Company, including, without limitation, the election of the directors of the
Company. Also as a part of this transaction, RMS and Santangelo agreed to
contribute $2.0 million to the Company's working capital without the issuance
of any additional securities. The Company received these funds on December 30,
1998.
As of March 26, 1999, RMS Limited Partnership, a Nevada limited
partnership controlled by Roy M. Speer ("RMS"), Francis R. Santangelo and J.
Anthony Forstmann beneficially own approximately 47.8%, 7.8% and 4.1% of the
Common Stock, respectively. Mr. Forstmann, Mr. Santangelo and RMS are parties
to a certain stockholders' voting agreement pursuant to which they agreed to
vote certain shares for directors nominated by Mr. Forstmann or RMS, and not to
vote in favor of certain specified actions unless mutually agreed to by Mr.
Forstmann and RMS. Accordingly, such persons, acting together, are in a
position immediately to exercise significant control over the general affairs
of the Company, to control the vote on any matters presented to stockholders
and direct the business and policies of the Company.
26
NASDAQ SMALLCAP MARKET ELIGIBILITY AND MAINTENANCE REQUIREMENTS; POSSIBLE
DELISTING OF SECURITIES FROM THE NASDAQ SMALLCAP MARKET
In 1998, the Company received notices from Nasdaq notifying the Company
that its Common Stock was not in compliance with Nasdaq Marketplace Rule
4310(c)(4) ("Rule 4310(c)(4)") which requires the Company to maintain a $1.00
minimum bid price for its Common Stock. The Company believes that as of March
26, 1999, it is in compliance with the minimum bid price requirement set forth
in Rule 4310(c)(4).
Also in 1998, the Company received notices from Nasdaq notifying the
Company that the Common Stock was not in compliance with Nasdaq Marketplace
Rule 4310(c)(2) ("Rule 4310(c)(2)"), which requires the Company to (i) maintain
net tangible assets of $2 million; (ii) maintain a market capitalization of $35
million; or (iii) have recorded net income of $500,000 in the most recently
completed fiscal year or in two of the three most recently completed fiscal
years. The Company has been notified by Nasdaq that effective December 18,
1999, it was in compliance with Rule 4310(c)(2).
There is no assurance that the Company will be in compliance with Rule
4310(c)(4) or Rule 4310(c)(2) at any time in the future or that the Common
Stock will not be delisted from the SmallCap Market. If the Common Stock was
delisted from the SmallCap Market, it would adversly affect (i) the prices of
such securities, (ii) the ability of holders to sell them and (iii) the
Company's ability to raise additional funds, especially in the public markets.
TECHNOLOGICAL AND MARKET UNCERTAINTY
The development, production, distribution and marketing of the Company's
products and services may be impeded by various possible problems, which
problems may be beyond the financial and technical abilities of the Company to
solve. Technology employed in I&A is subject to rapid change, and more advanced
or alternate technology employed by competitors, currently or in the future,
and not available to the Company could give such competitors a significant
advantage over the Company. In addition, concerns about unauthorized (including
government) access to private information may impede market acceptance of I&A
systems. Further, there is no assurance that products and services developed by
competitors of the Company will not significantly limit the potential market
for the Company's products and services or render the Company's products and
services obsolete. Finally, there is no assurance that laws, rules or
regulations will not be adopted in such a manner as will materially adversely
affect the Company.
COMPETITION
The Company is attempting to compete in the highly competitive market for
network and data security which is dominated by more traditional I&A techniques
(such as cards, keys, passwords and personal information). A number of other
companies also have biometric I&A technology and have sold systems
incorporating such technology in the United States. The Company is aware of
several other companies that produce or are
27
developing other biometric I&A technologies which may compete with the Licensed
Technology (as defined below) or may be integrated into I&A products and
services that are competitive with those offered by the Company. Such
technologies include, among others, identification by eye retina blood vessel
patterns, hand geometry and signature analysis. The Company's products and
services compete with companies that have substantially greater resources than
the Company and are better equipped than the Company. There is no assurance
that the Company will be able to compete successfully against these companies
or technologies. Announcements and advances by the Company's competitors
concerning new products or features, governmental or other contracts and
developments or disputes relative to patents or proprietary rights may have an
adverse material impact on the Company's business, condition (financial or
otherwise), results of operations and prospects.
DEPENDENCE UPON SOFTWARE LICENSORS
The Company has acquired certain rights to biometric I&A software (the
"Licensed Technology") under agreements with software algorithm suppliers
including Cogent Systems, Inc., ITT Industries, Inc., L&H, Veridicom, Inc.,
Visionics Corporation and Who? Vision that may be terminated in the event the
Company fails to pay license fees (including minimum specified payments) or
commits any other material breach of any covenant of such agreements. Although
the Company is not in default of such agreements as of the date hereof, there
is no assurance that such defaults will not occur in the future or that the
Company will make the minimum royalty payments required under such agreements.
Although the Company's products can be sold without the Licensed Technology,
loss of the Company's license rights could substantially impair (if not
entirely preclude) the Company's ability to compete with products including
similar or identical technology.
28
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to market risk from changes in interest rates. The
Company does not use any hedging transactions or any financial instruments for
trading purposes and is not a party to any leveraged derivatives.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.
See Index to Financial Statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information concerning directors and officers of the Company is included
in the definitive Proxy Statement for the Company's 1999 Annual Meeting of
Stockholders, which is incorporated herein by reference. It is expected that
such Proxy Statement will be filed with the SEC no later than April 30, 1999.
ITEM 11. EXECUTIVE COMPENSATION.
Information concerning directors and officers of the Company is included in
the definitive Proxy Statement for the Company's 1999 Annual Meeting of
Stockholders, which is incorporated herein by reference. It is expected that
such Proxy Statement will be filed with the SEC no later than April 30, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information concerning directors and officers and certain beneficial owners
of the Company is included in the definitive Proxy Statement for the Company's
1999 Annual Meeting of Stockholders, which is incorporated herein by reference.
It is expected that such Proxy Statement will be filed with the SEC no later
than April 30, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information concerning directors and officers and certain beneficial
owners of the Company is included in the definitive Proxy Statement for the
Company's Annual Meeting of Stockholders, which is incorporated herein by
reference. It is expected that such Proxy Statement will be filed with the SEC
no later than April 30, 1999.
29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K.
(a) The following documents are filed as a part of this Annual Report on
Form 10-K:
(1) Consolidated Financial Statements
The financial statements filed as a part of this report are listed in the
"Index to Financial Statements" at Item 8.
(2) Financial Statement Schedules
All schedules have been omitted because they are either not applicable,
not material or the required information has been given in the financial
statements or in notes to the financial statements.
(b) Reports on Form 8-K
During the fourth quarter of 1998, the Company filed one report on Form
8-K on December 17, 1998.
(c) Exhibits
EXHIBIT
NO. DESCRIPTION
- -------- -----------
3.1 Articles of Incorporation, as amended to date, of the Company (incorporated by reference to
Exhibit 3.1 of the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1992).
3.2 By-laws of the Company (incorporated by reference to Exhibit 3.3 of the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1991).
3.3 Certificate of Amendment to Certificate of Incorporation of the Company, dated as of July 2,
1996. (incorporated by reference to Exhibit 3.3 of the Companys' Annual Report on Form 10-K for
the fiscal year ended December 31, 1996.)
3.4 Certificate of Amendment to Certificate of Incorporation of the Company, dated as of May 26, 1998.
4.1 Certificate of the Voting Powers, Designations, Preferences, Rights, Qualifications,
Limitations and Restrictions of the Series A Preferred Stock of the Company (incorporated by
reference to Exhibit 4.1 of the Company's Quarterly Report on Form 10-Q for the period
ended March 31,1997).
10.1 Agreement and Plan of Merger dated as of December 24, 1991 between the Company,
Topsearch and Top Search Merging Corp. (incorporated by reference to the Company's
Report on Form 8-K, dated December 24, 1991).
10.4 License Agreement, dated as of April 1, 1992, by and between Cogent Systems, Inc. and the
Company (confidential treatment requested) (incorporated by reference to Exhibit 10.1 of the
Company's Quarterly Report on Form 10-Q for the period ended March 31, 1992).
10.5 Stock Purchase Agreement, dated as of April 28, 1992, by and between Home Shopping
Network and the Company (incorporated by reference to Exhibit 10.2 of the Company's
Quarterly Report on Form 10-Q for the period ended March 31, 1992).
10.6 Stock Incentive Plan (incorporated by reference to Exhibit 10.6 of the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1992).
30
EXHIBIT
NO. DESCRIPTION
- -------- -----------
10.10 Letter of Intent, dated as of March 9, 1995 (incorporated by reference from the Exhibits to
the Company's Report on Form 8-K, dated March 1,1995).
10.11 Stock Purchase Agreement, dated as of March 14, 1995, by and among the Company, RMS
Limited Partnership ("RMS") and Francis R. Santangelo (incorporated by reference from the
Exhibits to the Company's Report on Form 8-K, dated March 14, 1995).
10.14 Stockholders' Voting Agreement, dated as of March 14, 1995, by and between J. Anthony
Forstmann and RMS (incorporated by reference from the Exhibits to the Company's Report
on Form 8-K, dated March 14, 1995).
10.18 Form of Warrant, dated February 5, 1997 (incorporated by reference to Exhibit 10.2 of the
Company's Report on Form 8-K, dated February 6, 1997).
11 Computation of Earnings per Share
23 Consent of Ernst & Young LLP
27 Financial Data Schedule
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE NATIONAL REGISTRY INC.
(REGISTRANT)
By: /s/ JEFFREY P. ANTHONY
-----------------------------------------------
Jeffrey P. Anthony
President, Chief Executive Officer and Director
Dated: March 30, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of registrant
and on the dates indicated.
NAME AND SIGNATURE TITLE DATE
------------------ ----- ----
/s/ JEFFREY P. ANTHONY President, Chief Executive Officer March 30, 1999
------------------------------ and Director (Principal
Jeffrey P. Anthony Executive Officer)
/s/ JAMES W. SHEPPERD Chief Financial Officer (Principal March 30, 1999
------------------------------ Financial Officer and
James W. Shepperd Principal Accounting Officer)
/s/ HECTOR J. ALCALDE Director
------------------------------ March 30, 1999
Hector J. Alcalde
/s/ FRANK M. DEVINE Director March 30, 1999
------------------------------
Frank M. Devine
/s/ J. ANTHONY FORSTMANN Director March 30, 1999
------------------------------
J. Anthony Forstmann
/s/ O.G. GREENE Director March 30, 1999
------------------------------
O. G. Greene
/s/ DONALD C. KLOSTERMAN Director March 30, 1999
------------------------------
Donald C. Klosterman
/s/ ROBERT ROSENBLATT Director March 30, 1999
------------------------------
Robert J. Rosenblatt
/s/ FRANCIS R. SANTANGELO Director March 30, 1999
------------------------------
Francis R. Santangelo
32
INDEX TO FINANCIAL STATEMENTS
PAGE
NUMBER
------
Report of Independent Certified Public Accountants ....................... F-1
Consolidated Balance Sheets as of December 31, 1998 and December 31, 1997 F-2
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 1998 ......................................... F-3
Consolidated Statements of Stockholders' Equity for each of the
three years in the period ended December 31, 1998 ...................... F-4
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1998 ......................................... F-5
Notes to Consolidated Financial Statements ............................... F-6
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Stockholders and Board of Directors
The National Registry Inc.
We have audited the accompanying consolidated balance sheets of The
National Registry Inc. and subsidiary as of December 31, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of The
National Registry Inc. and subsidiary at December 31, 1998 and 1997, and the
results of their operations and cash flows for each of the three years in the
period ended December 31, 1998 in conformity with generally accepted accounting
principles.
The accompanying consolidated financial statements have been prepared
assuming that The National Registry Inc. will continue as a going concern. As
more fully described in Note 3, the Company has incurred operating losses in
each year since inception and has no sources of financing available at December
31, 1998. These conditions raise substantial doubt about the Company's ability
to continue as a going concern. The consolidated 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 liabilities that may result from the outcome of this uncertainty.
/s/ ERNST & YOUNG LLP
Tampa, Florida
March 19, 1999
F-1
THE NATIONAL REGISTRY INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------------
1998 1997
------------ ------------
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents .................................... $ 1,736 $ 298
Accounts receivable, net of allowance for doubtful accounts of
$27,000 and $30,000 respectively ........................... 149 450
Inventory .................................................... 37 362
Prepaid royalties ............................................ 200 125
Prepaid other ................................................ 70 147
Other ........................................................ 27 39
--------- ---------
Total current assets ....................................... 2,219 1,421
Furniture and equipment -- net ................................ 361 1,052
Investment .................................................... 105 105
--------- ---------
$ 2,685 $ 2,578
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................. $ 189 $ 677
Accrued legal settlement ..................................... -- 450
Accrued professional fees .................................... 105 216
Accrued other ................................................ 117 290
Deferred revenue ............................................. 305 174
--------- ---------
Total current liabilities .................................. 716 1,807
Commitments and contingencies .................................
Stockholders' equity:
Preferred stock, $.01 par value convertible:
Authorized -- 1,000,000 shares ..............................
Series A -- Liquidation preference $100 per share,
100,000 shares issued and outstanding as of
December 31, 1998 and 1997, respectively .................. 1 1
Series C -- Liquidation preference $20 per share,
0 and 259,750 shares issued and outstanding as of
December 31, 1998 and 1997, respectively .................. -- 3
Common stock, $.01 par value:
Authorized -- 25,000,000 and 75,000,000 shares as of
December 31, 1998 and 1997, respectively ..................
Issued and outstanding--16,677,005 and 6,355,776 as of
December 31, 1998 and 1997, respectively .................. 167 64
Additional paid-in-capital ................................... 47,138 44,378
Accumulated deficit .......................................... (45,337) (43,675)
--------- ---------
Total stockholders' equity ................................. 1,969 771
--------- ---------
$ 2,685 $ 2,578
========= =========
See accompanying notes.
F-2
THE NATIONAL REGISTRY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Post contract services revenue .......................... $ 538 $ 535 $ --
Net product and service revenue ......................... 4,382 1,050 2,305
-------- -------- --------
Total revenue ........................................ 4,920 1,585 2,305
Cost of post contract services revenue .................. 312 356 --
Cost of product and service revenue ..................... 810 388 1,292
-------- -------- --------
Total cost of revenue ................................ 1,122 744 1,292
-------- -------- --------
Gross profit ......................................... 3,798 841 1,013
Operating expenses:
Product development .................................... 1,282 2,221 2,330
Sales and marketing .................................... 1,558 2,810 3,360
Minimum royalty payments ............................... 500 500 500
General and administrative ............................. 1,950 2,923 2,340
-------- -------- --------
5,290 8,454 8,530
Interest and other income ............................... 108 189 177
-------- -------- --------
Net loss ............................................. (1,384) (7,424) (7,340)
-------- -------- --------
Preferred stock deemed dividend ......................... -- 1,470 1,412
Preferred stock dividend ................................ 278 350 303
-------- -------- --------
Net loss attributable to common stockholders ......... $ (1,662) $ (9,244) $ (9,055)
======== ======== ========
Basic and diluted loss per common share ................. $ (0.23) $ (1.57) $ (1.93)
Weighted average number of
common shares outstanding ............................. 7,216 5,875 4,680
See accompanying notes.
F-3
THE NATIONAL REGISTRY INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
COMMON STOCK PREFERRED STOCK ADDITIONAL
----------------- ---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
-------- -------- ----------- ---------- ------------- ------------ -----------
Balance at December 31, 1995 ..................... 4,041 $ 40 100 $ 1 $26,425 $ (25,376) $ 1,090
Issuance of Series B preferred
stock, net of offering costs, at
$10,000 per share ............................. -- -- 1 -- 7,280 -- 7,280
Series B preferred stock dividend at 8% ......... -- -- -- -- 303 (303) --
Series B preferred stock deemed dividend ........ -- -- -- -- 1,412 (1,412) --
Conversion of Series B preferred stock .......... 1,655 17 (1) -- (17) -- --
Expense related to stock option plans ........... -- -- -- -- 109 -- 109
Issuance of common stock upon exercise of
stock options at $1.50 per share .............. 38 -- -- -- 345 -- 345
Net loss ........................................ -- -- -- -- -- (7,340) (7,340)
----- ---- ----- ---- ------- --------- ---------
Balance at December 31, 1996 ..................... 5,734 57 100 1 35,857 (34,431) 1,484
Issuance of Series C preferred stock, at
$20 per share, net of offering costs .......... -- -- 350 4 5,723 -- 5,727
Issuance of Common Stock warrants ............... -- -- -- -- 660 -- 660
Series C preferred stock dividend at 6% ......... -- -- -- -- 350 (350) --
Series C preferred stock deemed dividend ........ -- -- -- -- 1,470 (1,470) --
Conversion of Series C preferred stock .......... 560 6 (90) (1) (5) -- --
Expense related to stock option plans ........... -- -- -- -- 94 -- 94
Cancellation of compensatory stock options ...... -- -- -- -- (105) -- (105)
Issuance of common stock upon exercise of
stock options at various prices ............... 14 -- -- -- 11 -- 11
Issuance of common stock for services ........... 48 1 -- -- 323 -- 324
Net loss ........................................ -- -- -- -- -- (7,424) (7,424)
----- ---- ----- ------ -------- --------- ---------
Balance at December 31, 1997 ..................... 6,356 64 360 4 44,378 (43,675) 771
Conversion of Series C preferred stock .......... 10,280 103 (260) (3) (100) -- --
Common stock and warrants issued for legal
settlement .................................... 41 -- -- -- 307 -- 307
Series C preferred stock dividend at 6% ......... -- -- -- -- 278 (278) --
Issuance of warrants for services ............... -- -- -- -- 168 -- 168
Issuance of stock options for services .......... -- -- -- -- 78 -- 78
Expense related to stock option plans ........... -- -- -- -- 29 -- 29
Capital contribution ............................ -- -- -- -- 2,000 -- 2,000
Net loss ........................................ -- -- -- -- -- (1,384) (1,384)
------ ---- ------ ------ -------- --------- ---------
Balance at December 31, 1998 ..................... 16,677 $167 100 $ 1 $47,138 $ (45,337) $ 1,969
====== ==== ====== ====== ======== ========= =========
See accompanying notes.
F-4
THE NATIONAL REGISTRY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
------------------------------------------
1998 1997 1996
------------ ------------ ------------
(IN THOUSANDS)
CASH USED IN OPERATING ACTIVITIES
Net loss ........................................................... $ (1,384) $ (7,424) $ (7,340)
Adjustments to reconcile net loss to net cash used
in operating activities: ........................................
Compensation (benefit) applicable to stock option grants ......... 29 (11) 109
Depreciation ..................................................... 587 649 536
Issuance of common stock, stock options, and warrants
for services ................................................... 246 324 --
Issuance of stock and warrants for legal settlement .............. 307 -- --
Gain on sale of fixed assets ..................................... (57) (41) --
Changes in operating assets and liabilities:
Accounts receivable ............................................. 301 (12) (378)
Inventory ....................................................... 325 (362) 143
Prepaid expenses ................................................ 2 (73) (17)
Other assets .................................................... 12 12 141
Accounts payable ................................................ (488) 309 148
Accrued expenses ................................................ (734) (24) 690
Deferred revenue ................................................ 131 174 --
-------- -------- --------
Net cash used in operating activities .............................. (723) (6,479) (5,968)
CASH PROVIDED BY (USED) IN INVESTING ACTIVITIES
Purchase of equipment .............................................. (52) (610) (921)
Proceeds from the sale of assets ................................... 213 75 --
-------- -------- --------
Net cash provided by (used) in investing activities ................ 161 (535) (921)
CASH PROVIDED BY FINANCING ACTIVITIES
Proceeds from capital contribution ................................. 2,000 -- --
Proceeds from issuance of preferred stock .......................... -- 6,387 7,280
Proceeds from issuance of common stock ............................. -- 11 345
-------- -------- --------
Net cash provided by financing activities .......................... 2,000 6,398 7,625
-------- -------- --------
Net increase (decrease) in cash and cash equivalents ............... 1,438 (616) 736
Cash and cash equivalents at beginning of period ................... 298 914 178
-------- -------- --------
Cash and cash equivalents at end of period ......................... $ 1,736 $ 298 $ 914
======== ======== ========
See accompanying notes.
F-5
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
The National Registry Inc., a Delaware corporation organized on October 23,
1991, and its wholly-owned subsidiary, SAFLINK Corporation (a Delaware
corporation organized on June 25, 1998), ("NRI" or the "Company"), provides a
suite of data and network security software products that utilize biometric
technologies to replace passwords or other technologies for user authentication
when accessing information stored in personal computers and in networked
computing environments. The Company's products also include software developer
kits (SDKs) that allow application developers and enterprises to build custom
applications with biometric technologies that identify persons seeking access to
secured data transactions.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of The National
Registry Inc. and its wholly-owned subsidiary, SAFLINK Corporation. All
intercompany accounts and transactions have been eliminated.
REVENUE RECOGNITION
During 1998 and 1997, operating revenue was derived from the sale of the
Company's software and hardware products, the performance of programming and
integration services and post contract customer support (PCS). During 1996
operating revenue was derived from the installation and lease of Company
installed welfare fraud systems in the states of Connecticut, New Jersey and
New York. Effective January 1, 1998, the Company adopted American Institute of
Certified Public Accountants' Statement of Position No. 97-2, SOFTWARE REVENUE
RECOGNITION (SOP 97-2). SOP 97-2 provides for the recognition of revenue when
product is shipped and programming and integration services are performed,
provided no significant obligations remain and collection of the receivable is
deemed probable. Revenue for elements not delivered, including PCS revenue, is
deferred and recognized as delivered or ratably over the life of the service
period of the related contract. Adoption of this Statement did not have a
significant impact on the Company's results of operations.
MAJOR CUSTOMERS
Approximately 80% of the Company's 1998 revenue was from the sale of
software licenses and related services to one customer. No other individual
customer accounted for significant sales. Three customers accounted for
approximately 21%, 18% and 12%, respectively, of 1997 revenue. In fiscal 1996,
the same three customers specified in 1997 accounted for 39%, 0% and 48%,
respectively, of total revenue.
F-6
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash in bank and overnight
investments in repurchase agreements collateralized by United States Government
or United States Government Agency obligations.
MANAGEMENT OF CREDIT RISK
The Company is subject to concentrations of credit risk from its cash
investments. The Company's credit risk is managed through monitoring the
stability of the financial institutions utilized and diversification of its
financial resources. The Company's financial instruments consist of cash,
overnight investments in repurchase agreements, accounts receivable, an
investment in a bank time certificate of deposit and accounts payable. The fair
value of these instruments approximates their carrying value based on the
current rate offered to the Company for similar instruments.
INVENTORY
Inventory is comprised of computer hardware purchased in connection with
the installation of the Company's biometric products. Inventories are stated at
the lower of cost, on a first-in - first-out basis, or market.
SOFTWARE DEVELOPMENT COSTS
The Company expenses costs associated with the development of software as
incurred until technological feasibility is established.
IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with Statement of Financial Accounting Standards No. 121,
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO
BE DISPOSED OF (SFAS 121), the Company reviews its long-lived assets for
impairment when events or changes in circumstances indicate that the carrying
value of such assets may not be
F-7
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
recoverable. This review consists of a comparison of the carrying value of the
asset with the asset's expected future undiscounted cash flows without interest
costs. Estimates of expected future cash flows represent management's best
estimate based on reasonable and supportable assumptions and projections. If
the expected future cash flow exceeds the carrying value of the asset, no
impairment is recognized. If the carrying value of the asset exceeds the
expected future cash flows, an impairment exists and is measured by the excess
of the carrying value over the fair value of the asset. Any impairment
provisions recognized are permanent and may not be restored in the future. No
impairments have been recorded.
FURNITURE AND EQUIPMENT
Furniture and equipment are recorded at cost. Depreciation is provided
using the straight-line method over the following estimated useful lives of the
assets:
YEARS
--------
Computer equipment and software ................ 1 to 3
Office furniture, equipment and other .......... 3 to 10
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Advertising expense
was approximately $228,000, $443,000 and $428,000 in 1998, 1997 and 1996,
respectively.
INCOME TAXES
Income taxes have been provided for using the liability method in
accordance with the provisions of Statement of Financial Accounting Standards
No. 109, ACCOUNTING FOR INCOME TAXES.
STOCK BASED COMPENSATION
The Company accounts for employee stock-based compensation in accordance
with the provisions of Accounting Principles Board Opinion No. 25, ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES and related Interpretations, because the Company
believes the alternative fair value accounting provided under Statement of
Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION
(SFAS 123), requires the use of option valuation models that were not developed
for use in valuing employee stock options. Accordingly, in cases where exercise
prices equal or exceed fair market value, the Company recognizes no
F-8
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
compensation expense for stock option grants. In cases where exercise prices
are less than fair market value, compensation expense is recognized over the
period of performance or the vesting period.
The Company accounts for non-employee stock-based compensation in
accordance with SFAS 123. Pro forma financial information, assuming that the
Company had adopted the measurement standards of SFAS 123 for all stock-based
compensation, is included in Note 6.
NET LOSS PER COMMON SHARE
Net loss per common share was computed by dividing the net loss
attributable to common stockholders by the weighted average number of common
shares outstanding during the period. Common stock equivalents, relating to
convertible Series A preferred stock, convertible Series C preferred stock and
exercise of certain stock options and warrants were not included in this
calculation due to their anti-dilutive effect.
REVERSE STOCK SPLIT
All share and per share information presented herein, and in the Company's
consolidated financial statements, has been retroactively restated to reflect a
one-for-six reverse split of the Company's Common Stock, par value $.01 per
share, which occurred on May 27, 1998.
SEGMENT REPORTING
Statement of Financial Accounting Standards No. 131, DISCLOSURES ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, issued in June 1997,
requires the use of a management approach to report financial and descriptive
information about a Company's operating segments. Operating segments are
revenue-producing components of the enterprise for which separate financial
information is produced internally for the Company's management. Under this
definition, the Company operated, for all periods presented, as a single
segment.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, REPORTING COMPREHENSIVE INCOME, which requires
that total comprehensive income and comprehensive income per share be disclosed
with equal prominence as net income and earnings per share. Comprehensive
income is defined as
F-9
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
changes in stockholders' equity exclusive of transactions with owners such as
capital contributions and dividends. The Company did not have any comprehensive
income items in any of the years presented.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the 1998
presentation.
3. GOING CONCERN
The accompanying financial statements have been prepared on a going
concern basis which contemplates the realization of assets and liquidation of
liabilities in the ordinary course of business. The Company incurred net
operating losses of $1.4 million, $7.4 million and $7.3 million in 1998, 1997
and 1996 respectively, and used approximately $723,000, $6.5 million and $6.0
million of cash in operations in 1998, 1997 and 1996, respectively.
The Company is attempting to obtain additional working capital through
various means, which may include the issuance of equity and the development of
strategic relationships, to support its operations but, there is no assurance
that sufficient capital will be available to the Company.
Based on the foregoing factors, it is uncertain whether or not the Company
can generate adequate cash flows from operations, or from financing
transactions, to meet its obligations as they become due. In that event, the
Company would be required to seek other alternatives including sale, merger or
discontinuance of operations.
4. FURNITURE AND EQUIPMENT
Furniture and equipment consists of the following (in thousands):
DECEMBER 31,
-------------------------
1998 1997
----------- -----------
Computer equipment and software ............... $ 1,259 $ 3,031
Office furniture, equipment and other ......... 208 415
-------- --------
1,467 3,446
Less: accumulated depreciation ................ (1,106) (2,394)
-------- --------
$ 361 $ 1,052
======== ========
Depreciation expense amounted to $587,000 in 1998, $649,000 in 1997 and
$536,000 in 1996.
F-10
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. FURNITURE AND EQUIPMENT--(CONTINUED)
During 1998, the Company disposed of various fixed assets that were no
longer in use. The net book value of these assets at the time of disposal, of
approximately $156,000, is reflected as a component of interest and other
income in the Consolidated Statements of Operations.
5. TECHNOLOGY LICENSES
The Company has acquired certain rights to biometric identification and
authentication software (the "Licensed Technology") under agreements with
software algorithm suppliers including Cogent Systems, Inc., ITT Industries,
Inc., L&H, Veridicom, Inc., Visionics Corporation and Who? Vision Systems that
may be terminated in the event the Company fails to pay license fees (including
minimum specified payments) or commits any other material breach of any covenant
of such agreements. Under the terms of the agreement with Cogent, the Company is
obligated to make a $10 million cash payment (the "Extension Payment") to Cogent
on or prior to October 1, 1999, in addition to ongoing license fees, to continue
the agreement until October 1, 2009. The Company is currently negotiating a
modification to the license to eliminate the Extension Payment. If an acceptable
modification is not achieved, the Company will most likely elect not to make the
Extension Payment and will allow the license to terminate. If the license
terminates on October 1, 1999, the Company anticipates that it will use
alternate suppliers such as Veridicaom, Inc. for its products that use finger
image technology. The Company made prepayments totaling $75,000 and $125,000 to
Veridicom and L&H, respectively, during 1998.
6. INCOME TAXES
As of December 31, 1998, the Company had net operating loss carryforwards
of approximately $29.4 million for federal income tax purposes which expire at
various dates through 2018. The difference between the net operating loss
carryforward for federal income tax purposes and the deficit accumulated for
financial reporting arises primarily from temporary differences associated with
the Company's start-up expenses which were capitalized for income tax purposes
and, beginning January 1995, are being ratably amortized to expense over a
60-month period.
These temporary differences and net operating loss carryforwards give rise
to a deferred tax asset of approximately $12.4 million and $11.9 million as of
December 31, 1998 and 1997, respectively, based on a combined federal and state
statutory rate of 37.7%. Due to the uncertainty of achieving taxable income
sufficient to realize the deferred tax asset, a valuation allowance of $12.4
million and $11.9 million was recorded as of December 31, 1998 and 1997,
respectively, which fully offsets the deferred tax asset.
The future utilization of the tax benefit carryforward items is subject to
an annual limitation when a cumulative change in stock ownership of more than
50% occurs over a three year period. The Company believes that such a change
has occurred, and that it is possible that taxable income and income taxes in
future years, which would otherwise be offset by net operating losses and
reduced by tax credits, will not be offset or reduced and, therefore, income
tax liabilities will be incurred. The potential tax benefits of these
carryforwards at December 31, 1998 and 1997 of approximately $11.1 million and
$9.3
F-11
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. INCOME TAXES--(CONTINUED)
million, respectively, have been fully reserved in the financial statements due
to the uncertainty of realization. Tax benefits will be recognized in future
years if and when such benefits are judged to be realizable.
An analysis of the reasons for the variations from the expected federal
corporate income tax rate of 34% and the effective rates provided is as follows:
1998 1997 1996
---- ---- ----
Tax benefit computed at U.S. statutory rate (34.0)% (34.0)% (34.0)%
State tax, net of federal benefit (3.6)% (3.7)% (3.7)%
Nondeductible items (meals and entertainment) 0.5 0.1 0.2
Change in valuation allowance 37.1 37.6 37.5
------- ------ ------
Effective tax rate 0.0% 0.0% 0.0%
======= ====== ======
7. STOCKHOLDERS' EQUITY
COMMON STOCK
The holders of Common Stock are entitled to receive ratably such
dividends, if any, as may be declared by the Board of Directors from funds
legally available for the payment of dividends. In the event of liquidation or
dissolution of the Company, the holders of Common Stock are entitled to share
ratably in all assets of the Company remaining after provision for payment of
liabilities and after holders of the convertible Series A preferred stock
receive a liquidation preference of $100 per share or an aggregate liquidation
preference of $10 million.
During 1998, the Company issued 41,667 shares of Common Stock, as well as
warrants to purchase 75,000 shares of Common Stock for $3.38 per share, to
International Interest Group, Inc. ("IIG") as part of the settlement of a
lawsuit filed by IIG on February 13, 1997.
PREFERRED STOCK
The Series A preferred stock is convertible at the option of the holder
and will automatically be converted into 1,056,026 shares of common stock, or
approximately 6% of the common stock of the Company (after giving effect to
such conversion), upon the satisfaction of certain conditions.
On January 29, 1996, the Company completed an equity financing pursuant to
which certain investors purchased from the Company 800 shares of Series B
preferred stock for an aggregate purchase price of $8 million before
commissions and expenses (the Series B Preferred Stock Private Placement).
Shares of Series B preferred stock were convertible at the option of the holder
into shares of common stock, based upon a defined conversion formula. Until
conversion, the Series B preferred stock accreted dividends at a rate of 8% per
year. Prior to conversion, the Company accreted dividends of $303,000. All
holders of Series B preferred stock had converted their shares into an
aggregate of 1,654,500 shares of the Company's common stock by December 31,
1996.
On February 6, 1997, the Company completed an equity financing (the
"Series C Preferred Stock Private Placement") pursuant to which two accredited
investment funds
F-12
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' EQUITY--(CONTINUED)
purchased an aggregate of 350,000 shares of the Company's Series C Preferred
Stock, $.01 par value per share (the "Series C Preferred Stock"), for an
aggregate purchase price of $7 million before commissions and expenses which
totaled approximately $613,000. Shares of Series C Preferred Stock were
convertible at the option of the holder into shares of common stock, based upon
a defined conversion formula. The Series C Preferred Stock carried a six
percent per annum accretion which the Company treated as a dividend resulting
in a charge to accumulated deficit and a credit to additional paid-in capital.
The Company recorded accretion of $278,000 and $350,000 during 1998 and 1997,
respectively. It also recorded, during 1997, a deemed dividend of $1.5 million
attributable to the recognition of the market discount that the holders
received upon conversion into Common Stock. 90,250 shares of Series C Preferred
Stock were converted into 560,653 shares of Common Stock, including 23,442
shares attributable to accrued dividends, during 1997. The remaining 259,750
shares of Series C Preferred Stock were converted into 10,279,513 shares of
Common Stock, including 1,010,743 shares attributable to accrued dividends,
during 1998.
STOCK OPTIONS
The Company maintains an employee stock incentive plan (the "Plan") for
officers, directors and key employees under which 2,282,500 shares were
reserved for issuance as of December 31, 1998. In addition, the Company has
granted, outside of the Plan, options to purchase an aggregate of 645,000
shares to certain employees. Options currently granted by the Company generally
vest over a three to five-year period. Additionally, from time to time, the
Company will grant stock options to non-employees in exchange for services
rendered. During 1998, a total of 80,000 options were issued to contractors at
an average exercise price of $1.29. Expense recorded related to these
non-employee grants during 1998 was estimated using the Black-Scholes valuation
model and amounted to $77,500. A total of 82,917 options were outstanding to
non-employees at December 31, 1998.
Certain options granted prior to 1998 were granted with exercise prices
less than the market price of the underlying stock on grant date and the
Company has recorded compensation expense for these options. Compensation
related to stock options is measured at the grant date. The difference between
market value of the options, at time of issuance, and their exercise price is
charged to stockholders' equity, as unamortized deferred compensation, and
amortized to expense over the options' vesting periods. The Company recognized
$29,000, $94,000, and $109,000 as compensation expense in 1998, 1997 and 1996
respectively, relating to compensatory options.
F-13
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' EQUITY--(CONTINUED)
Disclosure of pro forma information regarding net loss and loss per share
is required by SFAS No. 123. If compensation expense related to employee stock
options issued under the Plan had been determined based on the fair values at
the grant dates consistent with the method of accounting prescribed by SFAS No.
123, the Company's net loss attributable to common stockholders and loss per
common share would been as follows:
1998 1997 1996
------------ ------------ ------------
(IN THOUSANDS EXCEPT PER SHARE DATA)
Pro forma net loss attributable to
common stockholders ................... $ (4,558) $ (9,840) $ (9,594)
Pro forma loss per common share ......... (0.63) (1.68) (2.05)
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model based on the following weighted average
assumptions: risk-free interest rates of 5.0% for 1998 and 6.5% for 1997 and
1996; no dividends; volatility factors of the expected market price of the
Company's Common Stock of 1.273 for 1998, 1.063 for 1997 and 1.098 for 1996; and
a weighted-average expected life 3.0 years for 1998 and 4.5 years for 1997 and
1996.
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. 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.
F-14
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' EQUITY--(CONTINUED)
A summary of the Company's stock option activity, and related information
for the years ended December 31 follows:
1998 1997 1996
--------------------- --------------------- --------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
OPTIONS EXERCISE OPTIONS EXERCISE OPTIONS EXERCISE
(000) PRICE (000) PRICE (000) PRICE
--------- ----------- --------- ----------- --------- ----------
Outstanding -- beginning of year .......... 757 $ 8.34 816 $ 8.52 723 $ 8.88
Granted .................................. 1,993 1.82 41 7.08 132 6.66
Exercised ................................ -- -- (14) .84 (38) 9.00
Canceled/expired ......................... (442) 8.11 (86) 10.32 (1) 13.50
----- --- ---
Outstanding-end of year ................... 2,308 2.24 757 8.34 816 8.52
===== === ===
Exercisable at end of year ................ 1,348 3.12 608 8.34 546 12.84
===== === ===
Weighted-average fair value of
options granted during the year ......... 1.38 7.08 5.22
Exercise prices for options outstanding as of December 31, 1998 ranged
from $.64 to $4.68. The weighted-average remaining contractual life of those
options is seven years.
On March 11, 1998, the exercise price of all outstanding stock options
held by employees and directors of the Company was reduced to $4.68 per share,
the closing bid price of the Common Stock on the SmallCap Market on such date.
In addition, all options outstanding on December 31, 1998 were immediately
exercisable to the extent that they were granted at least six months prior to
December 17, 1998 due to the occurrence of a "change in control" of the
Company, as defined in the Plan. Options granted within the six month period
preceding December 17, 1998 will become exercisable six months following their
grant date.
WARRANTS
During 1998, the Company recognized $335,000 of expense related to the
issuance of 121,875 new Warrants using the Black-Scholes pricing model and
assumptions discussed under options above. These warrants were issued in
connection with the IIG settlement (75,000 warrants) and to consultants in
exchange for services (46,875 warrants).
In connection with the 1996 Series B Preferred Stock Private Placement,
the Company issued warrants to purchase 47,431 shares of common stock at an
exercise price of $15.18 per share. Such warrants are exercisable at any time
and expire in January 2001. The Company has also agreed to certain registration
rights with respect to such warrants.
F-15
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' EQUITY--(CONTINUED)
In connection with the 1997 Series C Preferred Stock Private Placement,
the Company issued warrants to purchase up to 90,000 shares of Common Stock at
an exercise price of $15.68 per share, subject to certain adjustments from time
to time. Such warrants are exercisable at any time and expire in February 2002.
In connection with the December 1998 conversion of the outstanding Series C
Preferred Stock and related $2 million capital contribution, the Company agreed
to issue 100,000 new Warrants at an exercise price of $0.63 upon the surrender
and cancellation of warrants to purchase 47,619 shares of Common Stock at an
exercise price of $15.68 per share. The estimated fair value of these warrants
was $46,000 and was included as a component of additional paid-in capital. The
expiration date and all terms other than the exercise price of the new warrants
are the same as the old warrants. The Company has also agreed to certain
registration rights with respect to these warrants.
CAPITAL CONTRIBUTION
On December 17, 1998, RMS Limited Partnership ("RMS"), Francis R.
Santangelo ("Santangelo") and Clearwater Fund III, L.P. ("Clearwater") entered
into a stock purchase agreement pursuant to which RMS and Santangelo agreed to
purchase 195,500 and 34,500 shares, respectively, of the Series C Convertible
Preferred Stock (the "Series C Preferred") of the Company from Clearwater in
exchange for $1.0 million cash and 1million shares of the Common shares
received upon conversion of the Series C Preferred. Upon consummation of the
purchase of the Preferred Stock, RMS and Santangelo converted all of their
respective shares of Series C Preferred into 8,264,138 and 1,458,377 shares,
respectively, of Common Stock (representing approximately 49.6% and 8.7% of the
then issued and outstanding shares of Common Stock). After the issuance of such
shares of Common Stock and the delivery of the applicable shares of Common
Stock to Clearwater, RMS and Santangelo were the beneficial owners of 8,080,805
and 1,308,377 shares of Common Stock, respectively, representing approximately
48.5% and 7.8%, respectively, of the then issued and outstanding shares of
Common Stock. As a result of the foregoing transactions, RMS and Santangelo
effectively acquired control of the Company through the ability to control the
vote on most if not all matters to be determined by the stockholders of the
Company, including, without limitation, the election of the directors of the
Company. Also as a part of this transaction, RMS and Santangelo agreed to
contribute $2.0 million to the Company to fund working capital needs without
the issuance of any additional securities. The Company received these funds on
December 30, 1998.
Options to purchase 250,000 shares of Common Stock issued to RMS Limited
Partnership in connection with its March 14, 1995 stock purchase, expired
unexercised on March 13, 1998. In addition, an option to purchase up to 166,667
shares of Common Stock
F-16
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' EQUITY--(CONTINUED)
granted by the Company to Santangelo in connection with this transaction
expired unexercised on March 14, 1999. As part of the stock purchase
transaction, J. Anthony Forstmann, RMS and Santangelo entered into a
stockholders' voting agreement, dated as of March 14, 1995, pursuant to which
they agreed to vote for a director nominated by Mr. Forstmann or RMS and not to
vote certain shares of common stock beneficially owned in favor of certain
specified stockholder actions unless mutually agreed to by Mr. Forstmann and
RMS.
8. COMMITMENTS AND CONTINGENCIES
The Company leases office space and equipment under various non cancelable
operating leases. The lease obligation related to office space is secured by a
pledged bank time certificate of deposit. Future minimum payments under these
lease commitments are as follows:
YEARS ENDING
DECEMBER 31,
- ------------ (IN THOUSANDS)
1999 ............. $225
2000 ............. 130
2001 ............. 92
2002 ............. 32
2003 ............. --
----
$479
====
Rent expense was $266,000, $272,000 and, $222,000 for 1998, 1997 and 1996,
respectively.
9. DEFINED CONTRIBUTION RETIREMENT PLAN
The Company offers an employee benefit plan pursuant to Section 401(k) of
the Internal Revenue Code covering substantially all employees. Matching
employer contributions are set at the discretion of the Board of Directors.
There were no employer contributions made for 1998, 1997 or 1996.
F-17
THE NATIONAL REGISTRY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted loss
per common share:
1998 1997 1997
------------ ------------ ------------
(IN THOUSANDS)
Numerator:
Net loss ............................................. $ (1,384) $ (7,424) $ (7,340)
Preferred Stock deemed dividend ...................... -- 1,470 1,412
Preferred Stock dividend ............................. 278 350 303
-------- -------- --------
Net loss attributable to common stockholders ......... $ (1,662) $ (9,244) $ (9,055)
======== ======== ========
Denominator:
Weighted average number of shares outstanding
of Common Stock .................................... 7,216 5,875 4,680
-------- -------- --------
Net loss per common share ............................ $ (0.23) $ (1.57) $ (1.93)
======== ======== ========
Net loss per common share was compiled by dividing net loss attributable
to common stockholders by the weighted average number of common shares
outstanding during the period.
Common stock equivalents, relating to convertible Series A Preferred
Stock, convertible Series C Preferred stock, stock options and warrants are not
included in this calculation due to their anti-dilutive effect.
11. LITIGATION
On May 15, 1998, the Company and International Interest Group (IIG)
reached a final settlement of a lawsuit filed against the Company by IIG on
February 13, 1997. The settlement included a $300,000 cash payment made by the
Company on May 15, 1998, the issuance to IIG of 41,667 shares of Common Stock,
and the granting to IIG of an option to purchase 75,000 shares of Common Stock
at an exercise price of $3.375 per share, the closing bid price of the Common
Stock on the SmallCap Market on April 3, 1998. Expense recognized for this
settlement was $157,000 and $450,000 for 1998 and 1997, respectively. The
lawsuit was dismissed with prejudice.
F-18
EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.4 Certificate of Amendment to Certificate of Incorporation of the
Company, dated as of May 26, 1998.
21 List of Subsidiaries
23 Consent of Ernst & Young LLP
27 Financial Data Schedule