Item 1. Business.
General
The Company is a single-source provider of comprehensive technology-based security solutions for medium and large commercial and government facilities in the United States and abroad. The Company offers a broad range of services, including: (i) consulting and planning; (ii) engineering and design; (iii) systems integration; and (iv) maintenance and technical support. This full range of capabilities enables the Company to provide its clients with any combination of these services or complete turnkey solutions for complex security projects. The solutions provided by the Company include integrated security systems comprised of a command center managing one or more subsystems or components, primarily access control systems, intrusion detection systems, closed circuit television systems, critical condition monitoring systems and fire detection systems. The Company is not aware of any other company providing this comprehensive range of services on a national basis. The Company serves more than 40 clients including airports, hospitals, prisons, corporations, utilities, universities and government facilities. These clients include Washington Dulles International Airport, Hewlett-Packard Company, EDS, Wachovia Bank, MCI WorldCom, Inc. and Alltel Corporation.
The Company began operations in 1987 in association with a large privately held engineering firm. In 1992, the Company became independent from the engineering firm in conjunction with a capital infusion from a private investment group. Since 1992, the Company has devoted a substantial amount of resources and capital to enhancing its technical capability and services offerings, hiring and training key personnel and expanding its client base. In addition to its headquarters office in Sterling, Virginia, which is in the Washington, D.C. metropolitan area, the Company has regional offices in Atlanta, Dallas, and San Francisco.
Integrated Security Systems
Integrated security systems are comprised of one or more subsystems and components that perform a variety of security functions for a facility or group of facilities under the direction of a single command center. The command center consists of a central processor, a common database and software that enable various subsystems and components to communicate with each other and integrate the subsystems and components into a single system. Subsystems and components consist primarily of the following:
Access control systems, which are designed to exclude unauthorized personnel from specified areas and provide access control that is typically card-activated. Entry and exit activity can be monitored or recorded and may be controlled on the basis of time and authority level.
Intrusion detection systems, which incorporate ultrasonic, infrared, microwave and other sensors to detect unauthorized door and window openings, glass breakage, vibration, motion and noise, and alarms and other peripheral equipment.
Closed circuit television systems, which monitor and record entry and exit activity or provide surveillance of designated areas. These systems can deter theft and vandalism and support other access control systems. They can be monitored either by a video recorder or by a monitoring screen.
Critical condition monitoring systems, which provide supervision of various systems and processes such as sprinkler systems, heating and refrigeration systems, power levels, water levels and general manufacturing processes.
Fire detection systems, which incorporate heat, ionization, smoke and flame sensing devices, manual pull stations, evacuation sounders and systems, sprinkler systems and elevator controls.
The Company's Services
The Company offers a full range of security services, consisting of: (i) consulting and planning; (ii) engineering and design; (iii) systems integration; and (iv) maintenance and technical support. At the beginning of each new client relationship, the Company designates one of its professional staff as the client service contact. This individual is the focal point for communications between the Company and the client and often acts as the client's project manager for all of its security needs. The Company's engagement may include one or more of the elements described below.
Consulting and Planning. Security consulting and planning are the initial phases of determining a security solution for a project. The Company has developed a planning process that identifies all systems, policies and procedures that are required for the successful operation of a security system that will both meet a client's current needs and accommodate its projected future requirements. The Company's consulting and planning process includes the following steps:
Identify the client's objectives and security system requirements Review the existing security system plan Survey the site, including inventory of physical components and software and evaluation of client's existing infrastructure and security system Identify and prioritize the client's vulnerabilities Develop and evaluate system alternatives Recommend a conceptual security plan design Estimate the cost of implementing the conceptual plan Develop a preliminary implementation schedule
As a result of this process, the Company provides the client with a master plan for security services which recommends an effective security solution that addresses routine operating needs as well as emergency situations. The Company believes that its comprehensive planning process enables its clients to budget for their security requirements on a long-term basis, identify opportunities for cost reduction and prepare for future risks.
Engineering and Design. The engineering and design process involves preparation of detailed project specifications and working drawings by a team of the Company's engineers, systems designers and computer-aided design system operators. These specifications and drawings detail the instrument sensitivity requirements, layout of the control center, placement of equipment and electrical requirements. Throughout the engineering and design process, the Company utilizes its expertise in advanced technologies and its understanding of its client's operational preferences to design a system that is functional, cost-effective and accommodates the client's present and future requirements. In addition, the Company attempts to incorporate its client's existing personnel, equipment and other physical resources into the system design.
When retained as a single-source provider for turnkey security solutions, the Company also selects the system components required under the specifications and drawings it has prepared. To the extent possible, the Company uses off-the-shelf equipment to minimize the cost of developing custom equipment. The Company has made a strategic decision not to represent any equipment manufacturer exclusively, thereby maintaining objectivity and flexibility in equipment selection. The Company believes that its technical proficiency with the products of a wide range of manufacturers enables it to select components that will best meet a project's requirements.
Systems Integration. Systems integration involves (i) equipment procurement; (ii) custom systems modeling and fabrication; (iii) facility installation; (iv) hardware, software and network integration; and (v) system validation and testing. In addition to these basic integration services, the Company provides engineering services to enhance the compatibility of the client's subsystems. The Company prepares technical documentation of the system and operations manuals and provides on-site training to client personnel.
Under the supervision of a project manager, the Company's technicians conduct hardware installation, hardware and software integration, system validation and testing. The aspects of systems integration that do not require a high level of technical expertise, such as wire installation and basic construction, are typically performed by the Company's subcontractors.
Maintenance and Technical Support. The Company provides maintenance and technical support services on a scheduled, on-call, or emergency basis. These services include developing and implementing maintenance programs both for security systems designed, engineered, or integrated by the Company and for existing systems.
Maintenance services offered by the Company include its EMS, a database used by the Company to effectively manage a security system's components, maintenance planning and scheduling, and costs. The system configuration function monitors system activity and capacity, and identifies the need to reconfigure or expand the system. The system maintenance function schedules and records maintenance activity, and identifies equipment replacement and upgrading requirements.
Marketing
The Company's marketing activities are conducted on both national and regional levels. The Company obtains engagements through direct negotiation with clients, competitive bid processes and referrals. At the national level, the Company conducts analyses of various industries and targets those with significant potential demand for security solutions. At a regional level, under the supervision of senior management, each office develops and implements a marketing plan for its region. The plan identifies prospective clients within the region and sets forth a strategy for developing relationships with them. Each regional office works with the headquarters office in expanding relationships with existing national clients to include facilities within the region.
The Company has identified several key industries or facility types that it believes have substantial and increasing requirements for security services, including telecommunication and technology companies, corporate complexes and industries and facilities for which security systems are required by regulation. The Company has developed expertise in the security regulations applicable to airports, pharmaceutical companies, prisons and nuclear utilities.
The Company's marketing strategy emphasizes developing long-term relationships with clients so that the Company can provide additional services as the clients' security requirements evolve. The Company undertakes significant pre-assessment of a prospective client's needs before an initial contact is made. A long-term relationship typically begins with an engagement to provide consulting and planning or maintenance and technical support services. Consulting and planning assignments place the Company in an advantageous position, often as the client's project manager, to be engaged to implement the plan ultimately adopted by the client. Engagements for maintenance and technical support enable the Company to identify new requirements as they arise and to offer its solutions to such requirements.
The Company employs a variety of pricing strategies for its services. Proposals for consulting services are priced based on an estimate of hours multiplied by standard rates. Systems integration engagements are priced based upon the estimated cost of the components of the engagement, including subcontractors and equipment, plus a profit margin. Pricing for engineering and maintenance services vary widely depending on the scope of the specific project and the length of engagement. All proposals are reviewed by the Company's senior management.
Many projects require that the primary contractor obtain a performance bond in the amount of the contract. The amount of bonding that the Company is able to obtain depends upon the level of its working capital and net worth. The Company believes that prior to the initial public offering of its common stock in October 1997 (the "Offering"), its ability to compete for larger projects as a primary or independent contractor, rather than through a joint venture or subcontract arrangement, was constrained by its inability to obtain adequate bonding. The Company has since secured bonding with a major surety that will enable it to bid as a primary contractor on larger contracts.
The Company is evaluating several opportunities to expand into international operations, which it anticipates that it will initially undertake through joint ventures or partnerships with local and international companies.
Clients
During the past three years the Company has provided services to approximately 50 clients, including airports, hospitals, prisons, corporations, utilities, universities and government facilities. The Company's clients have included the following:
Airports and Aviation Corporations --------------------- ------------ Fresno Airport AT&T United Airlines EDS Washington-Dulles International Airport Gillette Corporation Washington National Airport Hewlett-Packard Company Yuma International Airport Lazard Freres Seattle-Tacoma Airport Lucent Technologies Mary Kay Cosmetics MCI WorldCom, Inc. Mobil Corporation NationsBank US WEST Wachovia Bank Alltel Corporation
Government Other Los Alamos National Laboratory City of Baltimore Central Sandia National Laboratory Booking and Intake Facility Tennessee Valley Authority Moscow Local Telephone System U.S. Department of Energy New York City's World Trade Center U.S. Navy Rostelecom Rowan County (N.C.) Prison
During 1998, the Metropolitan Washington Airport Authority (operator of both Washington National and Washington Dulles airports), MCI WorldCom, Inc. ("MCI") and Wachovia Bank accounted for 22%, 14% and 7% of the Company's earned revenues, respectively. The loss of a significant portion of the revenue from any of these clients would need to be replaced to avoid a material adverse effect upon the Company's business, operating results and financial condition. Although these clients each accounted for a substantial portion of the Company's revenues, work performed for them was comprised of multiple projects and, in the case of MCI, was performed for multiple facilities. Firm contracts are in place for a significant portion of revenue from all three of these clients, although the maintenance contract with the airport authority was awarded to another company in January 1999. Even without the maintenance contract with the airports, Stratesec has firm 1999 backlog with the airport authority for approximately 45% of the entire 1998 revenue from the airport authority. The Company has diversified its client base by winning several new clients regionally and nationally. The revenues from new clients are expected to assist in replacing any reduction in revenues from the existing clients.
Competition
The security industry is highly competitive. The Company competes on a local, regional and national basis with systems integrators, consulting firms and engineering and design firms. The Company believes that it is the only provider offering its comprehensive range of services on a national basis. As a result, the Company competes with different companies depending upon the nature of the project and the services being offered. For example, the Company has competed with Johnson Controls, Science Applications International Corporation and Sensormatic for systems integration work, and Lockwood Greene and Holmes & Narver for consulting and planning and engineering and design work. Many of its competitors have greater name recognition and financial resources than the Company. The Company's competitors also include equipment manufacturers and vendors that also provide security services. The Company may face future competition from potential new entrants into the security industry and increased competition from existing competitors that may attempt to develop the ability to offer the full range of services offered by the Company. The Company believes that competition is based primarily on the ability to deliver solutions that effectively meet a client's requirements and, to a lesser extent and primarily in competitive bid situations, on price. There can be no assurance that the Company will be able to compete successfully in the future against existing or potential competitors.
Backlog
The Company's backlog consists of confirmed orders, including the balance of projects in process. The backlog also includes projects for which the Company has been notified it is the successful bidder even though a binding agreement has not been executed. Projects for which a binding contract has not been executed may be canceled at any time. Binding contracts may also be subject to cancellation or postponement, although cancellation generally obligates the client to pay the costs incurred by the Company. During the last two years none of the Company's contracts were canceled prior to completion.
Long-term maintenance contracts may be canceled without cause. As of December 31, 1997 and 1998, the Company's backlog was approximately $3.8 million and $4.0 million, respectively. Backlog as of December 31, 1998, includes projects having a value of approximately $1.7 million for which binding contracts have not been executed and all backlog is expected to be completed during 1999. Backlog orders as of any particular date may not be indicative of actual operating results for any fiscal period. There can be no assurance that any amount of backlog will be realized.
Employees
As of December 31, 1998, the Company had 50 employees, of which 23 were based in the Company's headquarters located in Sterling, Virginia. The balance work out of the company's regional offices. Six of the Company's employees are engaged exclusively in marketing and sales, 35 employees in engineering, project management, and technical functions, and nine employees in executive management and administration. None of the Company's employees are represented by a labor union and the Company believes its employee relations are good.
Intellectual Property
The Company has developed its Engineered Maintenance System ("EMS"), a database system used by the Company to effectively manage a security system's components, maintenance planning and scheduling, and costs. In addition to EMS, the Company is developing command center software that permits the integration of multi-vendor security systems into a unified, integrated system.
The Company relies on a combination of various methods to establish and protect its proprietary rights. In addition, it limits access to and distribution of its proprietary information. These measures afford limited protection, and there can be no assurance that the steps the Company takes to protect its proprietary rights will be adequate to prevent misappropriation of its intellectual property or the independent development by others of similar technology.
The Company has decided to convert to a new accounting system in 2nd quarter 1999 in order to be Year 2000 Compliant. The Company does not expect the cost of this system to be material.
Insurance
The Company maintains in force commercial umbrella liability insurance with coverage of $10 million per occurrence and $10 million in the aggregate, with a $10,000 deductible. The Company also maintains a $1.0 million insurance policy to cover any error or omission by the Company that may result in a breach of a security system designed, installed, maintained, or engineered by the Company. There is no assurance that the amount of insurance carried by the Company would be sufficient to protect it fully in the event of a significant liability claim; however the Company believes that the amounts and coverages of its insurance are reasonable and appropriate for its business operations. There is no assurance that such insurance will continue to be available on commercially reasonable terms, and the Company may elect not to retain liability insurance at any time.
Item 2.
Item 2. Properties.
The Company's headquarters office is located in Sterling, Virginia, which is in the Washington, D.C. metropolitan area. In addition, the Company leases between approximately 2,000 and 4,000 square feet of office space in each of the Atlanta, Dallas, and San Francisco metropolitan areas to support its regional operations. The Company believes that its facilities are adequate and suitable for its current operations, and that additional space is readily available if needed to support future growth.
Item 3.
Item 3. Legal Proceedings.
Although the Company is a defendant in certain suits arising from the normal conduct of its business, management does not believe that the resolution of this litigation will have a material adverse effect on the Company's financial position, results of operations, or cash flows. This litigation includes SecuraComm Consulting, Inc. v. Securacom, Incorporated. In this action, filed in the U.S. District Court for the district of New Jersey in October 1995, the plaintiff, a consulting company, sought injunctive relief and damages for alleged confusion in the marketplace and lost business resulting from the Company's alleged infringement of plaintiff's claimed service mark. In November 1997, the court ruled in favor of the plaintiff and enjoined the Company from using the name "Securacom, Incorporated" and awarded the plaintiff damages in the amount of $1,900,000. The Company appealed the decision and it was reversed in January 1999.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of the stockholders of the Company during the fourth quarter of the fiscal year covered by this Report.
Part II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's Common Stock is traded on the American Stock Exchange under the symbol SFT. The following table sets forth the quarterly range of high and low closing sale prices per share for the Common Stock during the period indicated.
The Company has not paid any cash dividends on its Common Stock since its formation. It presently intends to retain its earnings for use in its business and therefore does not anticipate paying any cash dividends in the foreseeable future. The payment of any future dividends will be determined by the Board of Directors in light of conditions then existing, including the Company's earnings, financial condition and requirements, restrictions in financing agreements, business conditions, and other factors. As of March 10, 1999, there were 65 holders of record of common stock.
Item 6.
Item 6. Selected Financial Data.
The selected financial data presented below (in thousands, except for per share data) should be read in conjunction with the consolidated financial statements and notes thereto of the Company and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Overview
The Company is a single-source provider of comprehensive, technology-based security solutions for medium and large commercial and government facilities in the United States and abroad. The Company offers a broad range of services, including: (i) consulting and planning; (ii) engineering and design; (iii) systems integration; and (iv) maintenance and technical support.
The Company began operations in 1987 in association with a large privately held engineering firm. As a start-up, the Company expended significant capital on the development of the Company's business and infrastructure, and it accumulated losses of approximately $2.8 million from 1987 through 1991 on aggregate revenues of approximately $17.2 million. The Company's revenues from 1990 through 1994 were generated primarily by a contract to design and integrate extensive security upgrades at three nuclear facilities for the Tennessee Valley Authority (the "TVA"). In 1992, the Company became independent from the engineering firm in conjunction with a capital infusion from a private investor group. At the same time, the Company hired new management with extensive expertise in the security industry. Since 1992, the Company has devoted a substantial amount of resources and capital to enhancing its technical capability and services offerings, hiring and training key personnel and
expanding its client base. As part of this effort, the Company opened four regional offices in the United States.
The Company derives its revenues primarily from long-term, fixed-price contracts. Earnings are recognized based upon the Company's estimates of the cost and percentage of completion of individual contracts. Earned revenues equal the project's total contract amount multiplied by the proportion that direct project costs incurred on a project bear to estimated total project costs. Project costs include direct labor and benefits, direct material, subcontract costs, project related travel and other direct expenses.
Clients are invoiced based upon negotiated payment terms for each individual contract. Terms usually include a 25% down payment and the balance as stages of the work are completed. Maintenance contracts are billed either in advance, monthly, or quarterly. As a result, the Company records as an asset, costs and estimated earnings in excess of billings and as a liability, billings in excess of costs and estimated earnings.
Results of Operations
The following table sets forth the percentages of earned revenues represented by certain items reflected in the Company's statements of operations.
Year Ended December 31, 1998 Compared with Year Ended December 31, 1997
Revenues decreased by 45% from $12.1 million in 1997 to $6.6 million in 1998. The decrease was due to the closeout of the World Trade Center Project. In addition, revenues from the Metropolitan Washington Airport Authority declined from $2.5 million in 1997 to $2.3 million in 1998.
Cost of earned revenues decreased from $9.8 million in 1997 to $4.8 million in 1998, primarily due to the decrease in revenues. Gross margin decreased from 19.1% in 1997 to (9.9)% in the 1998 period due to the one time charge of $2.5 million taken in the second quarter 1998.
Selling, general and administration expenses increased by 7% from $3.8 million in 1997 to $4.1 million in 1998. Overhead salaries increased by $0.4 million from the previous years as project staff worked less on jobs due to the decreased revenues and as a result at overlap during a transition to new
corporate management. Professional fees increased by $0.1 million for recruiting fees for new corporate officers.
The Company reversed accrued expenses in the amount of $1.7 million due to the January 1999 reversal of a judgment in a lawsuit against the Company.
Interest expense and financing fees decreased 64.9% from $0.5 million in 1997 to $0.1 million in 1998 due to a decrease in outstanding indebtedness resulting from the repayment of the subordinate debentures in October 1997.
Net loss improved from a net loss of $4.1 million in 1997 to a net loss of $3.5 million in 1998. This improvement was primarily due to the reversal of accrued expenses.
Year Ended December 31, 1997 Compared With Year Ended December 31, 1996
Revenues increased by 108.6% from $5.8 million in 1996 to $12.1 million in 1997. The increase was due to work completed for new clients and an increase in work completed on existing projects. Revenues from the World Trade Center project, which commenced in October 1996, increased from $1.6 million in 1996 to $6.6 million in 1997 In addition, revenues from the Metropolitan Washington Airport Authority increased from $1.2 million in 1996 to $2.5 million in 1997. In addition, $0.1 million of revenue was recognized in 1997 on a project for which all of the costs were accrued during 1996.
Cost of earned revenues increased by 122.0% from $4.4 million in 1996 to $9.8 million in 1997, primarily due to the increase in revenues. Gross margin declined from 24.2% in 1996 to 19.1% in 1997. In 1996 there was a one-time adjustment of $0.2 million to the cost of earned revenues to reflect a reduction in a subcontractor's costs upon the final closeout of the TVA project. Net of this adjustment, gross margin was 20.8% in 1996.
In the fourth quarter of 1997, the Company adjusted its estimate of the cost to complete on several contracts. As a result of this change in estimate, both revenue and gross margins were adjusted downward by $1.3 million for the year. Prior to those adjustments, the Company would have had revenue of $13.4 million with a gross margin of 26.7%.
Selling, general and administrative expenses increased by 2.7% from $3.7 million in 1996 to $3.8 million in 1997, due to a $0.2 million increase in salaries and consulting fees offset by a $0.1 million decrease in professional fees
In November 1997 SecuraComm Consulting, Inc. was awarded a $1.9 million judgment in a lawsuit against the Company. The Company recorded an expense of $2.2 million to cover the judgment, including anticipated legal fees. The judgment was reversed in January 1999. See Item 3 - -Legal Proceedings.
Interest expense and financing fees increased 112.8% from $0.2 million in 1996 to $0.5 million in 1997 due to an increase in outstanding indebtedness resulting from the issuance of $2.1 million of subordinated debentures during 1996 and $0.7 million of subordinated debentures during the first three months of 1997 and the recording of an expense of $0.2 million for amortization of debt discounts upon retirement of subordinated debentures in October 1997.
Net income decreased from a net loss of $2.5 million in 1996 to a net loss of $4.1 million in 1997. This decrease in net income was primarily due to recording a $2.2 million expense for the legal judgment and an adjustment of anticipated margin on several major contracts, offset somewhat by an increase in gross margin due to increased contract revenue.
Year Ended December 31, 1996 Compared With Year Ended December 31, 1995
Revenues increased by 83.4% from $3.2 million in 1995 to $5.8 million in 1996. In October 1996, the Company was awarded an $8.3 million contract as part of the security upgrade at the World Trade Center. Revenues of $1.6 million were recognized from this project in 1996. Work for the Metropolitan Washington Airport Authority increased by $1.0 million from $0.2 million in 1995 to $1.2 million in 1996. Work for MCI Telecommunications Corporation increased by $0.2 million from $0.6 million in 1995 to $0.8 million in 1996.
Cost of earned revenues increased by 102.6% from $2.2 million in 1995 to $4.4 million in 1996 primarily due to the increase in revenues. Gross margin declined from 31.4% in 1995 to 24.2% in 1996 as a result of a change in the mix of work performed. In 1996, a greater proportion of the work performed involved system integration projects, which historically have had lower margins than the other services provided by the Company.
Selling, general and administrative expenses increased by 28.9% from $2.9 million in 1995 to $3.7 million in 1996. The increase was due to increases in legal fees of $0.4 million incurred in the successful defense of certain litigation, increased staffing expense of $0.3 million and increased office expenditures of $0.1 million. The increases in staffing and office expenditures were due to the Company's investment in infrastructure and capabilities to accommodate future growth in revenues.
Interest expense and financing fees increased 137.7% from $0.1 million in 1995 to $0.2 million in 1996 as a result of the issuance of $2.1 million of 10% subordinated debentures during 1996.
The net loss increased 42.2% from $1.8 million in 1995 to $2.5 million in 1996 as a result of lower project margins, higher selling, general and administrative expenses, increased financing fees, and proceeds from a litigation settlement of $0.2 million which was recognized in 1995.
Liquidity and Capital Resources
From 1992 through 1995, members of a private investor group purchased an aggregate of $3.6 million shares of Common Stock at a total purchase price of $8.3 million, generating net proceeds to the Company of $8.0 million, and $0.5 million aggregate principal amount of 10% demand notes, generating an equal amount of net proceeds to the Company. The demand notes were converted in 1995 into 103,000 shares of Common Stock.
In addition, from 1995 through March 31, 1997, members of the same investor group purchased $3.4 million aggregate principal amount of 10% subordinated debentures, together with warrants to purchase 478,580 shares of Common Stock at an exercise price of $7.00 per share, generating net proceeds to the Company of $3.2 million. In 1996, an additional $0.2 million was raised through the exercise of warrants by members of the Board of Directors.
In October 1997, the Company completed the Offering, which resulted in net proceeds to the Company of approximately $9.7 million after payment of offering expenses by the Company. Following the Offering, the Company's interest in a partnership was redeemed at its cost of $0.7 million plus interest of $0.02 million. In the fourth quarter of 1997, the Company received proceeds of approximately $0.7 million upon the exercise of warrants to purchase 269,382 shares of Common Stock by employees. In October 1997, the Company used proceeds of the Offering to repay $3.4 million of outstanding notes payable.
During April 1998, the Board of Directors approved the issuance of up to $2.0 million of convertible subordinated debentures to provide additional working capital. As of May 13, 1998, the Company had issued and sold $1,450,000 of debentures. The Company sold an additional $400,000 of debentures as of August 25, 1998. The debentures have an interest rate of 10%, are due on December 31, 1999 and are convertible into common stock of the Company at $8.50 per share. In addition, the holders were issued 100 warrants for each $1,000 of investment with an exercise price of $2.50 and a term of three years. The value of the warrants of $71,394 was determined based upon the Black Scholes Valuation Model and was recorded as additional paid-in capital. All 185,000 warrants were outstanding at December 30, 1998.
As of December 30, 1998, the Company had $0.4 million in unrestricted cash and working capital. During February 1999, the $1.9 million the Company was required to post as collateral for a bond pending its appeal of a lawsuit was released when the trial court's judgment was reversed.
Based upon new contract awards and backlog in early 1999, the Company believes that it will be able to fund its cash requirements for the remainder of the year from operating cash flow.
Forward-Looking Statements
This Form 10-K includes certain statements that may be deemed to be "forward-looking statements" within the meaning of Section 27A of the Securities Act. All statements, other than statements of historical fact, included in this Form 10-K that addresses activities, events, or developments that the Company expects, projects, believes, or anticipates will or may occur in the future, including matters having to do with existing or future contracts, the Company's ability to fund its operations and repay debt, business strategies, expansion and growth of operations and other such matters, are forward-looking statements. These statements are based on certain assumptions and analyses made by our management in light of its experience and its perception of historical trends, current conditions, expected future developments, and other factors it believes are appropriate in the circumstances. These statements are subject to a number of assumptions, risks and uncertainties, including general economic and business conditions, the business opportunities (or lack thereof) that may be presented to and pursued by the Company, the Company's performance on its current contracts and its success in obtaining new contracts, the Company's ability to attract and retain qualified employees, and other factors, many of which are beyond the Company's control. You are cautioned that these forward-looking statements are not guarantees of future performance and that actual results or developments may differ materially from those projected in such statements.
Year 2000 Update
The Company evaluated its internal operating systems and software for Year 2000 compliance. Based on this analysis, the Company replaced its accounting system to ensure Year 2000 compliance.
The cost of this replacement was $25,000. The Company replaced several obsolete computers and upgraded the software on its remaining computers at an estimated cost of $20,000. The Company has reviewed its computers and remaining systems and does not foresee incurring any additional costs to make them Year 2000 compliant.
The Company has installed and maintained an assortment of security systems for its customers. To address the issue of Year 2000 compliance, the Company has surveyed its suppliers for a status of all software and hardware purchased on behalf of its customers. The Company has communicated the results to its customers and based on the status reports, it has made recommendations on how to resolve any Year 2000 problems and issues. The Company has evaluated the cost required to upgrade security systems installed by the Company for Year 2000 compliance and has proposed solutions for its customers. Based on these evaluations and solutions, the Company has begun to upgrade several of its customers' systems as they have requested. The Company expects to complete the upgrades for its existing customers by the fourth quarter of 1999. It should be noted that the Company does not manufacture its own system components, but uses components by other vendors; therefore, there is no internal software development cost associated with the upgrades for its customers' security systems.
Since the Company has tested its internal systems for Year 2000 compliance, the Company does not feel that a contingency plan is necessary for internal operations. The risk associated with the Company's customers' upgrade is contingent upon its completing their Year 2000 compliance and providing the Company with the documentation and equipment necessary to complete Year 2000 upgrades for its customers prior to the end of 1999. The Company has identified alternative vendors to allow it to meet any customer requirements that are deemed critical. In addition, the Company's customers can supplement their automated systems with guard services if the security system upgrades are not complete by the end of 1999.
If the Company's suppliers were unable to provide the Company with the equipment and information necessary to upgrade the security systems, it could result in the Company's inability to provide electronic security to customers in accord with current contract terms. This could lead to termination of the contract which would result in significant loss of revenue for the Company. Based upon the responses of our vendors on the surveys, the Company does not expect this to occur and does not have a contingency plan for this responsibility.
Item 7a.
Item 7a. Quantive and Qualitative Disclosures About Market Risk.
Not Applicable.
Item 8.
Item 8. Financial Statements.
The Financial Statements of the Company, together with the report thereon of Grant Thornton LLP dated March 3, 1999 are listed in Item 14(a)(1) and are included at the end of this Report on Form 10-K, beginning on page, and are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
The information required by Item 10 is contained in the Company's Proxy Statement for the 1999 Annual Meeting of Stockholders under the captions "Directors and Nominees" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934."
Item 11.
Item 11. Executive Compensation.
The information required by Item 11 is contained in the Company's Proxy Statement for the 1999 Annual Meeting of Stockholders under the caption "Executive Compensation," and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by Item 12 is contained in the Company's Proxy Statement for the 1999 Annual Meeting of Stockholders under the caption "Common Stock Ownership of Certain Beneficial Owners and Management," and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The information required by Item 13 is contained in the Company's Proxy Statement for the 1999 Annual Meeting of Stockholders under the caption "Compensation Committee Interlocks and Insider Participation and Certain Transactions," and is incorporated herein by reference.
Part IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) (1) List of Financial Statements. The following is a list of the financial statements included at the end of this Report of Form 10-K beginning on page:
Report of Independent Certified Public Accountants Balance Sheets as of December 31, 1997 and 1998 Statements of Operations for the Years Ended December 31, 1996, 1997 and 1998 Statement of Stockholders' Equity (Deficiency)for the Years Ended December 31, 1996, 1997 and 1998 Statements of Cash Flows for the Years Ended December 31, 1996, 1997 and 1998 Notes to Financial Statements
(2) List of Financial Statement Schedules.
Schedule II - Valuation and Qualifying Accounts
All other schedules have been omitted because they are not applicable or not required, or the required information is provided in the financial statements or notes thereto.
(b) Reports on Form 8-K.
None
(c) List of Exhibits. The following is a list of exhibits furnished. Copies of exhibits will be furnished upon written request of any stockholder at a charge of $.25 per page plus postage.
Exhibit Number Exhibit
3.1 Form of Restated Certificate of Incorporation1 3.2 Form of Bylaws(1) 4 Form of Rights Agreement(1) 10.1 Stock Option Plan(1) 10.2 Employment Agreement with Ronald C. Thomas(1) 10.4 Consulting Agreement with Wirt D. Walker, III(1) 11 Computation of Net Income (Loss) Per Share 23.1 Consent of Grant Thornton LLP 27 Financial Data Schedule
(1) Filed as an exhibit of the same number to the Company's registration statement on Form S-1 (File No. 333-26439) and incorporated by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
STRATESEC INCORPORATED
By: /s/BARRY W. MCDANIEL Barry W. McDaniel President and Chief Operating Officer
Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the dates indicated.
Stratesec, Incorporated
Contents
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Report of Independent Certified Public Accountants 3
Financial Statements
Balance Sheets 4
Statements of Operations 5
Statements of Shareholders' Equity (Deficit) 6
Statements of Cash Flows 7-8
Notes to Financial Statements 9-20
Supplemental Information
Schedule II--Valuation and Qualifying Accounts 22
Report of Independent Certified Public Accountants
Board of Directors and Shareholders Stratesec, Incorporated
We have audited the accompanying balance sheets of Stratesec, Incorporated (formerly known as Securacom, Incorporated), as of December 31, 1997 and 1998, and the related statements of operations, shareholders' equity (deficit), and cash flows for the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Stratesec, Incorporated, as of December 31, 1997 and 1998, and the results of its operations and its cash flows for the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
We have also audited Schedule II of Stratesec, Incorporated, for the years ended December 31, 1996, 1997 and 1998. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein.
GRANT THORNTON LLP
Vienna, Virginia March 3, 1999
Stratesec, Incorporated
Balance Sheets
The accompanying notes are an integral part of these statements.
Stratesec, Incorporated
Statements of Operations
The accompanying notes are an integral part of these statements.
Stratesec, Incorporated
Statements of Cash Flows
Stratesec, Incorporated
Statements of Cash Flows--Continued
During 1997 and 1998, the Company acquired equipment totaling approximately $144,000 and $50,000, respectively, through capital lease transactions.
The accompanying notes are an integral part of these statements.
Stratesec, Incorporated
Notes to Financial Statements - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE A--BUSINESS AND SUMMARY OF ACCOUNTING POLICIES
Stratesec, Incorporated (the Company), formerly known as Securacom, Incorporated, is a provider of comprehensive security solutions for large commercial and government facilities worldwide. At December 31, 1996, the Company was approximately 91 percent owned by KuwAm Corporation: two private investment partnerships of which KuwAm serves as general partner, Special Situations Investment Holdings, Ltd., and Special Situations Investment Holdings L.P. II; and certain individual limited partners of the investment partnerships (the KuwAm Group). On October 1, 1997, the Company completed an initial public offering and sold 1,400,000 shares of common stock and the KuwAm Group sold 808,000 shares of stock. At December 31, 1997 and 1998, the KuwAm Group owns approximately 53 percent and 31 percent of the Company, respectively.
A summary of the significant accounting policies applied in the preparation of the accompanying financial statements follows:
Revenue Recognition
The Company derives its revenue principally from long-term contracts which are generally on a fixed-price basis. Earnings are recognized on the basis of the Company's estimates of the percentage of completion of individual contracts, whereby total estimated income is earned based upon the proportion that costs incurred bear to the Company's estimate of total contract costs.
The percentage of completion of individual contracts includes management's best estimates of the amounts expected to be realized on the contracts. It is at least reasonably possible that the amounts the Company will ultimately realize could differ materially in the near term from the amounts estimated in arriving at the earned revenue and costs and earnings in excess of billings on uncompleted contracts.
Contract costs include all direct material, direct labor and subcontract costs. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability, including those arising from contract revisions and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined.
The asset "costs and estimated earnings in excess of billings on uncompleted contracts" represents revenue recognized in excess of amounts billed to clients. The liability "billings in excess of costs and estimated earnings on uncompleted contracts" represents billings in excess of revenue recognized.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
Inventory
Inventory consisting of equipment held for sale is stated at the lower of cost or market, with cost being determined by the first-in, first-out method.
Stratesec, Incorporated
Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE A--BUSINESS AND SUMMARY OF ACCOUNTING POLICIES--Continued
Plant and Equipment
Plant and equipment are stated at cost. Depreciation is provided using the straight-line method based on the estimated useful lives of the related assets. Leasehold improvements are amortized over the shorter of the economic life of the improvements or the lease term.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." SFAS No. 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.
Use of Estimates
In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. In addition, the Company estimates an allowance for doubtful accounts based on the creditworthiness of its clients, as well as general economic conditions. Consequently, an adverse change in those factors could affect the Company's estimate.
Concentrations of Credit Risk and Fair Value of Financial Instruments
The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash, money market funds and trade accounts receivable. The Company places its cash and money market funds with high credit quality institutions. In general, such investments exceed the FDIC insurance limit.
The Company provides credit to its clients in the normal course of business. The Company routinely assesses the financial strength of its clients and, as a consequence, believes its trade accounts receivable exposure is limited.
The carrying value of financial instruments potentially subject to valuation risk (principally consisting of cash, accounts receivable and accounts payable) approximates fair market value.
Stratesec, Incorporated
Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE A--BUSINESS AND SUMMARY OF ACCOUNTING POLICIES--Continued
Loss Per Share
The Company has adopted SFAS No. 128, "Earnings Per Share" (EPS), which requires public companies to present basic earnings per share and, if applicable, diluted earnings per share. Basic EPS is based on the weighted-average number of common shares outstanding without consideration of common stock equivalents. Diluted earnings per share is based on the weighted-average number of common and common equivalent shares outstanding. When dilutive, the calculation takes into account the shares that may be issued upon exercise of stock options and warrants, reduced by the shares that may be repurchased with the funds received from the exercise, based on the average price during the year.
Stock options and warrants have not been included in the calculation of diluted earnings per share as their inclusion would be antidilutive.
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NOTE B--OPERATIONS
As shown in the accompanying financial statements, the Company has incurred recurring operating losses and has an accumulated deficit of $19,800,705 at December 31, 1998. In such circumstances, the Company's continued existence is dependent upon its ability to generate profitable operations and, if necessary, secure financing to fund future operations. Management is addressing these matters by cutting overhead expenses and reorganizing the Company's management structure. The Company anticipates that existing cash and cash equivalents generated from 1999 operations will be sufficient to meet its working capital needs. The Company has, in the past, been able to secure additional financing to meet its operating requirements, although there can be no assurance that it will be able to continue doing so.
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NOTE C--COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
Costs and estimated earnings on uncompleted contracts are as follows at December 31:
1997 1998 ------------- ------------- Costs incurred on contracts $ 14,229,410 $ 18,988,832 Estimated earnings 3,473,560 5,289,572 ------------- ------------- 17,702,970 24,278,404 Less billings to date 15,664,570 22,940,051 ------------- ------------- $ 2,038,400 $ 1,338,353 ============= =============
Stratesec, Incorporated
Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE C--COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS --Continued
In addition, included in accounts receivable at December 31, 1997 and 1998, were retainages of approximately $648,000 and $45,000, respectively, which are anticipated to be collected within one year. Included in accounts payable at December 31, 1997 and 1998, were retainages of approximately $111,000 and $-0-, respectively.
During the third quarter of 1998, the Company negotiated a final settlement on a major contract. As a result of the adjustments, revenue and gross margin for 1998 were reduced by $2,491,000.
During the fourth quarter of 1997, the Company revised its estimate of cost to complete on several contracts. As a result of the adjustments, revenue and gross margin for 1997 were reduced by $1,248,000.
In February 1996, the Company negotiated a final settlement on a major contract with the Tennessee Valley Authority. As a result, the Company wrote off approximately $238,000 of amounts owed to a subcontractor and reduced cost of earned revenues.
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NOTE D--PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows at December 31:
Stratesec, Incorporated
Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE E--NOTES PAYABLE
During the years ended December 31, 1996 and 1997, the Company issued subordinated debentures to the KuwAm Group totaling $3,250,000, with 478,580 of warrants to purchase common stock of the Company at $7.00 per share. The debentures bore interest at 10 percent and were repaid in full from the proceeds of the initial public offering. The value of the warrants of $176,000 was determined based upon an appraisal of the securities by an independent firm and was recorded as additional paid-in capital. All 478,580 warrants are outstanding at December 31, 1998.
During April 1998, the Company's board of directors approved issuance of up to $2 million in convertible subordinated debentures in an effort to provide additional working capital. As of December 31, 1998, the Company had sold $1,850,000 of these debentures to related parties with 185,000 warrants attached to purchase common stock of the Company at $2.50 per share. The debentures bear interest at 10 percent semiannually. The value of the warrants was $71,393 at issuance and was determined by the Company, using the Black-Scholes valuation model and was recorded as additional paid-in capital. All 185,000 warrants are outstanding at December 31, 1998. In addition, the debentures are convertible into the Company stock at $8.50 per share.
Interest expense on the notes amounted to approximately $125,000, $413,000 and $136,000 (including $5,000, $171,000 and $24,000 of amortization of debt discount) for the years ended December 31, 1996, 1997 and 1998, respectively. During February 1999, the Company paid $920,000 of the outstanding $1,850,000 debt at December 31, 1998.
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NOTE F--ACCRUED EXPENSES
Accrued expenses and other are summarized as follows for the year ended December 31:
1997 1998 ------------ ------------ Legal judgment $ 2,200,000 $ 262,290 Payroll 273,877 78,419 Employee expense reimbursements 62,607 - Professional fees 45,745 34,796 Deferred rent obligation 56,515 54,504 Sales tax 54,618 90,221 Interest and foreign tax 140,423 227,656 Other 105,004 261,069 ------------ ------------ $ 2,938,789 $ 1,008,955 ============ ============
Stratesec, Incorporated
Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE G--OBLIGATIONS UNDER CAPITAL LEASE AGREEMENTS
The Company has entered into various capital lease agreements for equipment with a cost of approximately $293,000 and $342,000 at December 31, 1997 and 1998, respectively. The leases expire at various times through 2002. The related future minimum lease payments, as of December 31, 1998, are as follows:
Year ending December 31,
1999 $ 103,325 2000 106,048 2001 70,399 2002 25,813 2003 - ------------- 305,585
Amount representing interest (69,483) ------------- $ 236,102 ============= The net book value of assets held under capitalized leases at December 31, 1998, was $209,505.
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NOTE H--RELATED PARTY TRANSACTIONS
The Company had agreements (the Agreements) with KuwAm Corporation (KuwAm) whereby the Company paid a fee of 5 percent of the capital raised from the private sale of common stock and subordinated debentures under the Agreements. The Company incurred approximately $103,000, $35,000 and $-0- of investment banking fees under the Agreements during 1996, 1997 and 1998, respectively, which have been recorded as a reduction of proceeds from sales of equity securities and interest and financing fees for sales of subordinated debentures.
The Company issued subordinated debentures in the amount of $1,850,000 with 185,000 warrants attached and incurred related interest to the KuwAm Corporation and other related parties of $180,992 as of December 31, 1998.
During 1998, the Company sold its aircraft, which had a book value of $335,000 and accumulated depreciation of approximately $50,000, to a related party for $240,000 in cash. The Company recorded a loss of approximately $45,000 on the sale.
During 1997, of the total $3,350,000 proceeds received from the issuance of notes payable, the Company invested $700,000 in a limited partnership interest of Special Situations Investment Holdings, Ltd. (SSIH) recorded at cost which was deemed to be equivalent to fair market value. At the conclusion of the initial public offering, SSIH redeemed the limited partnership interest at $700,000 plus interest.
Stratesec, Incorporated
Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE I--INITIAL PUBLIC OFFERING
On October 1, 1997, the Company completed an initial public offering of 1,400,000 shares of its common stock, par value $.01 per share (common stock), at an initial offering price of $8.50 per share. In addition, the majority shareholder sold 808,000 shares at $8.50 per share. The net proceeds from the offering to the Company were approximately $9,735,000. On October 7, 1997, the Company issued to the underwriter, at a purchase price of $0.001 per warrant, warrants to purchase up to an aggregate of 140,000 shares of common stock at an exercise price of $13.18 per share, all of which are outstanding at December 31, 1998.
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NOTE J--EMPLOYEE STOCK WARRANTS AND OPTIONS
In 1997, the board of directors approved the adoption of the 1997 Stock Option Plan. The 1997 Stock Option Plan provides for the grant of nonqualified options to purchase up to 500,000 shares of the Company's common stock. Options may be granted to employees, officers, directors and consultants of the Company for the purchase of common stock of the Company at a price not less than the fair market value of the common stock on the date of the grant. In December 1997, 15,000 options were issued to a new director at $8.625 per share. In February 1998, the Company issued to employees and directors an additional 180,000 options at $2.375 per share. In June and September 1998, 145,000 and 20,000 additional options, respectively, were issued to employees and directors at $1.50 per share.
During 1996, the Company granted nonqualified options to purchase shares of the Company's stock. The options were granted on a discretionary basis. In January 1996, 50,000 options were granted, and in June 1996, 75,000 options were granted. All 1996 options expire in 1999.
The Company has elected to follow Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in measuring compensation expense for its stock warrants and options. Under APB No. 25, because the exercise price of the Company's employee stock warrants and options is not less than the fair market value of the underlying stock on the date of grant, no compensation expense is recognized. However, SFAS No. 123, "Accounting for Stock-Based Compensation," requires presentation of pro forma net income and earnings per share as if the Company had accounted for its employee stock warrants and options, granted subsequent to December 31, 1994, under the fair value method of that statement. For purposes of pro forma disclosure, the estimated fair value of the warrants and options is amortized to expense over the vesting period. Under the fair value method, the Company's net loss in 1998 would have increased by $109,000 or $.01 per share on a basic and diluted basis. Under the fair value method, the Company's net loss in 1997 would have increased by $60,000 or $.01 per share on a basic and diluted basis. Under the fair value method, in 1996, the Company's net loss would not have had a material change.
The weighted-average fair value of the individual warrants and options granted during 1996, 1997 and 1998 is estimated as $.04, $1.13 and $.29, respectively, on the date of grant. The fair values were determined using a Black-Scholes option-pricing model with the following assumptions:
Stratesec, Incorporated
Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE J--EMPLOYEE STOCK WARRANTS AND OPTIONS--Continued
Stock warrant and option activity during 1996-1998 is summarized below:
Stratesec, Incorporated
Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE J--EMPLOYEE STOCK WARRANTS AND OPTIONS--Continued
The following table summarizes information concerning outstanding and exercisable warrants and options at December 31, 1998:
During the year ended December 31, 1996, the president of the Company exercised warrants for the purchase of 53,320 shares of common stock at an exercise price of $.53 per share. Since no amount was paid upon exercise of the warrants, the Company recorded compensation expense of $28,000.
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NOTE K--INCOME TAXES
Deferred tax attributes resulting from differences between financial accounting amounts and tax bases of assets and liabilities at December 31, 1997 and 1998, follow:
Stratesec, Incorporated
Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE K--INCOME TAXES--Continued
The valuation allowance has been established for those loss carryforwards and temporary differences which are not presently considered likely to be realized.
The provision for income taxes differs from the effective tax rate used in the financial statements as a result of current year net operating losses, the benefit of which has not been recognized in the current year.
As of December 31, 1998, the Company has net operating loss carryforwards of approximately $18,700,000, which expire in 2002 through 2018.
In 1992, a major stockholder of the Company significantly increased his ownership of the Company. As a result of a complex set of rules limiting the utilization of net operating loss carryforwards in tax years following a corporate ownership change (enacted in the Tax Reform Act of 1986), the ability of the Company to utilize net operating losses of approximately $3.5 million may be limited.
Also, the shares issued in connection with the Company's initial public offering are expected to create an ownership change. However, based on the expected value of the Company immediately before such ownership change and the resulting limitation as defined, the Company expects to be able to utilize its net operating losses of approximately $8.7 million incurred after August 1992 through the date of the initial public offering. Losses incurred after the initial public offering may be limited by future ownership changes.
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NOTE L--EMPLOYEE BENEFIT ARRANGEMENTS
The Company established a contributory employee savings plan under Section 401(k) of the Internal Revenue Code. The Company contributes amounts to individual participant accounts based on specific provisions of the plan. The cost to the Company for the employer match under the plan was approximately $13,000, $17,000 and $16,000 for the years ended December 31, 1996, 1997 and 1998, respectively.
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NOTE M--COMMITMENTS AND CONTINGENCIES
Leases
The Company conducts all its operations from leased facilities consisting of its corporate headquarters and branch office locations. All facility leases are classified as operating leases with terms ranging from one to five years.
Stratesec, Incorporated
Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE M--COMMITMENTS AND CONTINGENCIES--Continued
The following is a schedule by years of approximate future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1998:
Year ending December 31,
1999 $ 226,000 2000 159,000 2001 118,000 2002 88,000 2003 12,000 -------------- $ 603,000 ==============
Rent expense for the years ended December 31, 1996, 1997 and 1998 was approximately $286,000, $248,000 and $345,000, respectively.
Employment and Consulting Agreements
In 1998, the Company entered into employment agreements with its executive vice president which provides for annual base salaries of $150,000. The agreements provide for an additional payment equal to three times the annual base salary if the executive is terminated due to a change in control as defined in the agreement. The Company also entered into a consulting agreement with its chairman (who is also managing partner of KuwAm Corporation) which provides for an annual consulting fee of $145,000 through March 31, 2002. As of February 1998, the annual base salaries under these agreements were reduced by 10 percent.
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NOTE N--SUBSEQUENT EVENT
In January 1999, the Company received a favorable judgment in its appeal regarding litigation arising from its trademark case in 1997. This subsequent event resulted in the reversal of its accrued expenses of $1,655,000, net of $245,000 in previously awarded attorney fees which have been remanded to the state court. The Company had restricted cash of $1,900,000 related to this judgment at December 31, 1998, which was released in February 1999.
Subsequent to year-end, the Company purchased 95,000 shares of common stock worth approximately $200,000.
Stratesec, Incorporated Notes to Financial Statements--Continued - -------------------------------------------------------------------------------- December 31, 1997 and 1998 - --------------------------------------------------------------------------------
NOTE O--SIGNIFICANT CLIENTS
During the year ended December 31, 1996, contracts with four clients accounted for approximately 22 percent, 14 percent and 11 percent of earned revenue. For the year ended December 31, 1997, two clients accounted for approximately 55 percent and 20 percent of earned revenue. During the year ended December 31, 1998, contracts with three clients accounted for approximately 35 percent, 20 percent and 9 percent of earned revenue.
STRATESEC Incorporated
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
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(A) Uncollectible accounts written off.