And more for your overview...
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL
Investors should carefully consider the following information as well as otherinformation contained in this Report before making an investment in the CommonStock. Information contained in this Report contains "forward-lookingstatements" which can be identified by the use of forward-looking terminologysuch as "believes," "expects," "may," "should" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. No assurance can be given that the future results covered by the forward-looking statements will be achieved. The following matters constitute cautionary statements identifying important factors with respect to such forward-looking statements, including certain risks and uncertainties, thatcould cause actual results to vary materially from the future results covered insuch forward-looking statements. Other factors could also cause actual resultsto vary materially from the future results covered in such forward-lookingstatements.The Company is a leading developer and marketer of contactless smart cardsystems ("Smart Card(s)") used primarily in electronic commerce. Generally the size of a credit card, Smart Cards are used in a number of consumer applications including (i) access to restricted areas (replacing keys and identification cards), (ii) public transportation fare collection (replacing bus tokens, taxi cab charge cards, airline or railway tickets and the like), (iii) point of sale purchases (replacing cash or credit cards at cafeterias, newsstands and related point of sale locations where speed of purchase is important), and (iv) miscellaneous small monetary transactions (replacing coins and cash at parking lots, in vending machines and public telephones, etc.). Smart Card technology is also used in industrial applications by attaching a "tag" containing the SmartCard technology to the manufactured product in order to track the product fromthe assembly line through quality control, warehousing, inventory control,distribution and warranty. The Company's Smart Cards are both "contactless" and "batteryless" and thereforedo not require the use of a magnetic stripe or insertion into a terminal as isrequired by contacted cards ("Contacted Card(s)"), such as credit cards and ATM cards. Contacted Cards in use today are typically limited to storing information as opposed to "intelligent" Smart Cards, which have processing capabilitiessimilar to that of a personal computer. The Company's Smart Card Systeminvolves direct wireless radio frequency communications and magnetic inductionbetween a chip in the Smart Card and a terminal. Moreover, the Company'scontactless Smart Card Systems do not require insertion in a terminal or the useof a keypad and therefore may be used by all members of the population regardless of age or physical ability and in both indoor and outdoor locations. Page 7
The Company believes it was the first to successfully develop and introduce contactless Smart Cards using FRAM technology and batteryless, radio frequency ("RF") communications. The Company has primarily relied on its proprietary FRAMtechnology for the memory component of the Smart Cards. Although the FRAMmemory demonstrates quantifiable benefits by improving processing speeds andreliability over competing memory technologies, it is not currently beingproduced in sufficient volumes by a significant number of manufacturers toachieve competitive costs. Complementary to its FRAM technology, the Companynow also utilizes Electronically Erasable Programmable Read-Only Memory("EEPROM") technology in its Smart Card Systems, allowing the Company to offerhigher volume Smart Cards at a more competitive price. The Company principally generates revenues from licensing, fee based customproduct development projects and sale of its Smart Card systems. In the future,the Company anticipates that a substantial portion of its revenues will begenerated from custom product development projects and the sale of its Smart Card systems. If the Company is unable to continually replace larger custom product development projects as these projects are completed, its operationswill be adversely affected. Custom product development projects are billed instages based on certain agreed upon performance milestones. Accordingly,financial results for any calendar quarter may fluctuate widely depending on thestage of a custom product development project or the amount of licensingpayments in a particular quarter.As reflected in the Company's Financial Statements, the Company has generatedsubstantial operating losses since inception and has yet to generate substantialrevenues to fund its operations. To date, the Company has completed a series ofsmaller scale projects; however, the Company has not yet completed a significantnumber of larger projects, and as a result, it is uncertain whether the Companywill be able to successfully market and sell its Smart Card products insufficient quantities and at sufficient prices and volumes to fund itsoperations. During 1997, the Company experienced significant cash flow deficitsand liquidity shortages and funded its operations primarily through licensingtransactions and proceeds from the sale of its Common Stock. During 1998, the Company anticipates that increased operating revenues will be achieved through a combination of product sales, custom product development projects and the sale of non-exclusive licenses. In addition, the Company anticipates incurring increased operating and research and development expenditures in order to further develop and market its Smart Card products. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 1997Revenues. Revenues increased 291.6% to $1,064,505 for First Quarter ended March31, 1998, from $271,834 for the First Quarter ended March 31, 1997. Product Sales. Product sales increased 33.1% to $64,505 for the First Quarter ended March 31, 1998, from $48,469 for the quarter ended March 31, 1997. To date, the Company has completed a series of projects, many of which are small scale "pilot" projects, but may have the potential for implementation on a larger scale. In some cases, these demonstration projects are "rolled out" for full scale implementation, however the demonstration phase often takes six to twelve months or longer. Product Page 8
sales in the current quarter included approximately $37,000 of sales of product to Racom Japan ("RJ"), of which the Company owns 19.9%, as compared to approximately $6,000 for the First Quarter in 1997. License Revenues. License revenues increased 347.7% to $1,000,000 for the First Quarter ended March 31, 1998, from $223,365 for the First Quarter ended March 31, 1997. In First Quarter of 1997, license revenues included the recognition of deferred revenues on a license from RJ for the manufacture and sale of FRAM based radio frequency products in Japan of $23,349. The amount received for the license in 1996 was $933,968. In 1996, pursuant to the technology license discussed above, RJ entered into a custom product development project with Fujitsu, Ltd. under which the Company is entitled to 50% of all sublicense revenue earned by RJ. This sublicense resulted in the Company recording and receiving the balance of the sublicense revenue of $200,016 during the First Quarter 1997. The increase in license revenues reflects the execution of the licensing contract with Hitachi, Ltd. which closed in January 1998, and under which the Company received the initial payment in January 1998.COST OF REVENUES AND GROSS MARGIN. As a percentage of revenues, gross marginincreased to 96.6% in the First Quarter ended March 31, 1998, from 57.6% for thesame period in 1997. Product Costs. The Company has not generated significant margin on product sales in part because of competition with Contacted Cards which typically are sold at a lower price than the Company's Smart Cards. Currently, production volumes of the Company's products are not sufficient to cover manufacturing costs which are included in Cost of Revenues. Due to an increase in availability of FRAM memory chips resulting in lower component costs, and the use of EEPROM memory chips which are already available at lower component costs, the Company expects to be able to lower its prices while improving gross margin. The Company anticipates that cost efficiencies will allow the Company to compete more effectively with Contacted Card products and to build sales volume for its Smart Cards. License revenues. In both periods presented, gross margin is primarily a result of license revenues which have no direct cost of revenues.Research and Development Expenses ("R&D"). R&D increased $10,339 from $256,409in First Quarter 1997 to $266,748 in First Quarter 1998. The increase isprimarily due to changes in the personnel responsible for the productdevelopment. In November 1997, a group of engineers responsible for a specificproject left the Company upon completion of the project. Additional engineerswith skills necessary to complete new product development were hired. In FirstQuarter 1997, approximately $38,000 of research and development costs wereallocated to cost of revenues as they were incurred in direct relation to acustom product development contract. Page 9
General and Administrative Expenses ("G&A"). G&A increased $138,427 from$177,179 in First Quarter 1997 to $315,606 in First Quarter 1998. First Quarter1998 includes increasing expenditures approximating $30,000 relating to investorrelations consulting, securities legal and Nasdaq filing expenses incurred afterthe Company's initial public offering ("IPO") which was completed on March 12,1997. The Company also recognized approximately $26,000 relating to theDirectors and Officers Liability Insurance policy which was not effective inFirst Quarter 1997 and was renewed in March 1998. First Quarter 1998 alsoincludes an increase in consulting and office expenses of approximately $57,000due to increased audit fees, mergers & acquisitions research consulting andlegal consulting expenses. G&A also includes approximately $10,000 in increasedpersonnel costs.Sales and marketing expenses. Sales and marketing expenses increased $34,769from $211,204 in First Quarter 1997 to $245,973 in First Quarter 1998. Travelexpenses increased approximately $11,000 between the First Quarter periods.Personnel expenses also increased between First Quarter periods by approximately$17,000 due to the internal transfer of an applications support engineer andoverall salary increases for the department. First Quarter 1998 includesapproximately $12,000 for alliance marketing consulting for the Japanese market.1997 Sales & Marketing expenses for the First Quarter included a $20,000recruiting fee for the hiring of a new Product Manager. In First Quarter 1997,approximately $10,000 of Sales and Marketing related expenses were in directsupport of a custom product development project and accordingly charged to costof revenues.Equity in Loss of Joint Venture. The Company currently owns 19.9% of RJ. RJwas formed in 1993 for the purpose of marketing, distributing and supporting theCompany's Smart Card products to be sold in Japan. The Company accounts for itsinvestment on the cost method. In First Quarter 1997, the Company owned 22.8%of RJ and accounted for its investment under the equity method, recognizing itsproportionate share of RJ's losses. Amortization Expense. The Company's primary asset is a technology licenserelated to the design and manufacture of its Smart card products. The asset isamortized over its estimated useful life on a straight line basis.Other Income (Expense). During First Quarter 1997, the Company incurred $57,121in interest expense on various notes payable to Intag International Limited("Intag"), Ramtron and a group of lenders. The notes carried interest at 10%and prime plus 2%, respectively. The notes and accrued interest were paidduring First Quarter 1997 upon completion of the IPO. Interest expense for FirstQuarter 1997 also includes $97,799 related to the amortization of debt issuancecosts associated with a bridge financing completed prior to the IPO. FirstQuarter 1997 also included approximately $26,000 in currency exchange losses onthe sub-licensing transaction completed with RJ. During First Quarter 1998 theCompany earned $17,722 in interest income on its cash balances held primarily ina government obligations fund with an average maturity of less than 90 days. Net Income (Loss). The Company is a C Corporation under the Internal RevenueCode and for income tax reporting purposes as of December 31, 1997, hasapproximately $13,700,000 of net operating loss carryforwards that expire atvarious dates through 2012. The Tax Reform Act of 1986 contains provisionswhich may limit the net operating loss carryforwards available to the Company inany given year if certain events occur, including significant changes inownership interests. Page 10
LIQUIDITY AND CAPITAL RESOURCESThe Company's primary need for capital has been to finance expansion of researchand development of new Smart Card products, sales and marketing of its productsand operations. Annual product revenues growth has been limited due to limitedfinancial resources and an inability to expand receivables, build inventory andeffectively sell and market Smart Card products. CASH FLOWThe Company had cash and cash equivalents of $1,198,567 and $1,356,667 as ofDecember 31, 1997 and March 31, 1998, respectively. During the first quarter of1998, the Company's primary source of cash was from the initial payment underthe Hitachi license agreement, and the sale of 60,000 shares of common stock toa former employee upon the exercise of employee stock options at $1.00 pershare. CAPITALIZATIONThe Company's capitalization of $2,775,235 as of December 31, 1997 was comprisedentirely of stockholders' equity, as compared to $3,013,793 of stockholders'equity as of March 31, 1998. Again, the increase is primarily attributable tothe net income of the quarter of $178,558 and the sale of 60,000 shares ofcommon stock to a former employee upon the exercise of employee stock options at$1.00 per share. Management of the Company intends to fund its 1998 operations through acombination of product sales, technology sublicensing and possible offerings ofits common stock. There is no assurance that sales of common stock will occuror that additional proceeds will be received from such offerings.
Hope this helps,
Marty
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