November 16, 1998
CUSTOMTRACKS CORP /TX/ (CUST)
Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
At the beginning of 1998, the Company was organized into two market oriented groups.
The Electronic Security Group ("ESG"), which focuses on products and
services for electronic access control applications, includes Cardkey European Holdings
Limited, Cardkey Systems Inc. and related entities. The Transportation
Systems Group ("TSG"), which included Amtech Systems Corporation, Amtech World
Corporation and Amtech International S.A., developed and provided
high-frequency radio frequency identification solutions to the transportation markets.
These markets included electronic toll and traffic management ("ETTM"), rail,
airport, parking and access control, intermodal and motor freight.
The Interactive Data Group ("IDG") business, consisting of WaveNet, Inc. and WaveNet
International, Inc. was sold in November 1997.
On June 11, 1998, the Company sold its Transportation Systems Group to UNOVA, Inc.
("UNOVA"), effective as of May 31, 1998, for approximately
$33,250,000 and recorded a gain of $1,139,000 from the transaction. As consideration for
the sale, the Company received approximately $22,250,000 in cash and
2,2ll,900 unregistered shares of the Company's Common Stock that were previously
purchased by UNOVA in late 1997 valued at approximately $11,000,000.
Included in UNOVA's purchase were the Company's manufacturing and technology
facility in Albuquerque, New Mexico, the Company's radio frequency
identification technologies and other intellectual properties, the brand name Amtech, and
all current operations associated with the transportation business.
On July 7, 1998, the Company sold the net assets of its Cotag International ("Cotag")
business unit (formerly included in the ESG) to Metric Gruppen AB ("Metric")
of Solna, Sweden, effective as of June 30, 1998, for approximately $4,400,000 and
recorded a second quarter 1998 loss of $2,700,000 from the transaction,
including a $2,800,000 write-off of intangible assets. The Company received
approximately $2,700,000 in July 1998 with the remaining $1,700,000 to be received
by January 1999. The Company may receive up to an estimated additional $1,400,000,
depending on the level and mix of Cotag revenues achieved in 1998 and
1999. Included in Metric's purchase is the brand name and intellectual property underlying
Cotag's hands-free proximity technology, Cotag's manufacturing facility in
Cambridge, England, and the ongoing business of the unit.
In November 1998, the Company signed a definitive agreement to sell the balance of the
ESG to Johnson Controls, Inc., in an all-cash transaction valued at
approximately $41,000,000, with the final amount depending on the book value of the
ESG's net assets. The sale of the ESG is estimated to result in a fourth quarter
net gain of approximately $21,000,000 to $23,000,000, after accounting for the net book
value of the assets to be sold, the tax effects of the transaction and the
associated transaction costs. The transaction is scheduled to close by early December,
with an effective date of November 30, 1998, and is subject to the approval
of the companies' boards of directors and normal governmental clearances.
Upon the completion of the sale of the balance of the ESG, the Company will have exited
the electronic identification business, its remaining revenue- generating
business. As previously announced, the Company has entered the digital data distribution
business, with a focus in the music arena. In connection with its entry into
the digital data distribution business, the Company acquired Petabyte Corporation
("Petabyte"), a start-up enterprise founded by Mr. Cook, the Company's current
chairman and chief executive officer. In consideration of the sale of Petabyte, the
Company has paid Mr. Cook $200,000 and has agreed to pay Mr. Cook four
annual payments of $200,000 each. The Company has the right to transfer the Petabyte
enterprise to Mr. Cook in consideration of the cancellation of any annual
payments not yet due. The Company is pursuing digital music content rights and,
additionally, is evaluating other music-related Internet business opportunities.
The sales of TSG, Cotag and IDG impact the comparability of the Company's 1998 results
with those of 1997.
RESULTS OF OPERATIONS
Sales for the three months and nine months ended September 30, 1998 decreased
$14,249,000 or 47% and $7,191,000 or 9%, respectively, from the comparable
periods in 1997 primarily due to the disposition of the TSG and Cotag. Sales for the ESG
decreased from $16,951,000 in the third quarter of 1997 to $15,936,000
for the comparable period in 1998 primarily due to the sale of Cotag, and increased from
$47,652,000 in the first nine months of 1997 to $50,151,000 for the
comparable period in 1998 primarily in its U.S.-based operations. The TSG's sales in the
third quarter of 1997 were $13,122,000, and decreased from
$35,092,000 in the first nine months of 1997 to $25,873,000 for the comparable period in
1998.
Gross profit as a percentage of sales increased from 36% in 1997 to 44% in 1998 for the
three month periods and from 37% in 1997 to 42% in 1998 for the nine
month periods. The increase in the three month and nine month periods is primarily due to
provisions in 1997 of $800,000 and $1,800,000, respectively, to adjust
certain IDG assets to their estimated net realizable values. Also effecting the increase in
the nine month period is an increase in TSG's gross profit margin from 32%
in 1997 to 39% in 1998. This increase is due in part to improved gross profit margins on
systems integration services work in the first half of 1998, although
revenues of $3,000,000 from the Florida Department of Transportation electronic toll
collection contract had no gross profit margin as expected. Additionally, the
TSG gross profit margin in 1998 increased as a result of lower manufacturing costs due to
higher sales volumes of Company- manufactured products. The ESG's
gross profit margin was 44% and 42% for the three month and nine month periods in
1998, respectively, as compared to 42% in both of the 1997 periods.
Research and development for the three months and nine months ended September 30,
1998 decreased $2,562,000 or 85% and $3,962,000 or 45% from the
comparable periods in 1997, primarily due to the dispositions of the IDG in November
1997, the TSG effective May 1998 and the Cotag business unit effective
June 1998. IDG expenditures were $194,000 and $899,000 for the three month and nine
month periods in 1997. The TSG expenditures were $2,018,000 in 1997
for the three month period and decreased from $5,193,000 in 1997 to $2,688,000 in 1998
for the nine month periods. The ESG expenditures decreased from
$796,000 in 1997 to $446,000 in 1998 for the three month periods and from $2,688,000 in
1997 to $2,130,000 in 1998 for the nine month periods.
Marketing, general and administrative expenses for the three months and nine months
ended September 30, 1998 decreased $3,827,000 or 40% and $6,834,000
or 22% from the comparable periods in 1997, primarily due to the dispositions of the IDG
in November 1997, the TSG effective May 1998 and the Cotag business
unit effective June 1998. IDG expenditures were $786,000 and $3,143,000 for the three
month and nine month periods in 1997, including provisions of $750,000
and $1,725,000, respectively, for employee severance costs, winding-up of operating
activities and adjusting certain assets to their estimated net realizable values.
TSG expenditures were $2,746,000 in 1997 for the three month period and decreased from
$9,420,000 in 1997 to $4,938,000 in 1998 for the nine month periods.
These expenditure reductions were partially offset during the nine month period in 1998 by
an expense charge of approximately $1,000,000 pursuant to the
provisions of the Company's former chairman, president and chief executive officer's
severance agreement and various stock options.
Investment income for the three months and nine months ended September 30, 1998
increased from $159,000 to $582,000 and increased from $894,000 to
$1,154,000, respectively. The increase for both periods is attributable to the increase in
invested cash and short-term marketable securities resulting from the sale of
the TSG and Cotag.
The income tax provision of $76,000 and $280,000 for the three months and nine months
ended September 30, 1998 consists primarily of state and foreign income
taxes. The Company has net operating loss carryforwards available in the U.S. to offset a
portion of its current tax expense. In the second quarter of 1997, in light of
continued operating losses, the Company determined that future taxable income in the
U.S. was uncertain. As a result, the provision for income taxes in the nine
months ended September 30, 1997 includes $4,680,000, representing the effect of
establishing a valuation allowance for U.S. deferred tax assets, in accordance
with the requirements of Statement of Financial Accounting Standards No. 109
"Accounting for Income Taxes."
As a result of the foregoing, the Company experienced net income of $1,267,000 and
$1,853,000 for the three months and nine months ended September 30, 1998
as compared to a net loss of $1,667,000 and $11,686,000 for the same periods in 1997.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company's principal source of liquidity is its net working
capital position of $48,730,000 including cash and short-term marketable
securities of $39,410,000. After the sale of the ESG, as currently anticipated, the
Company should have approximately $80,000,000 in cash or equivalents. Pending
the utilization of funds in new businesses, the Company plans to invest its cash in
short-term high-grade commercial paper and U.S. government and agency
securities.
THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written using two digits
rather than four to define the applicable year. Upon completion of the sale of
the balance of its Electronic Security Group, the Company will have exited its remaining
revenue-generating business. Management believes that the Year 2000 Issue
will not have a material impact on the Company.
BUSINESS CONSIDERATIONS
Successful development of a start-up enterprise, particularly Internet related businesses,
can be difficult and costly; there are no assurances of ultimate success and a
start-up enterprise involves risks and uncertainties, including the following: (1) There are
no assurances that the Company will be able to successfully develop its
targeted businesses, that it will be able to compete effectively against similar or alternative
digital data distribution businesses, that it will gain market acceptance, that
it will not be made obsolete by further technological development, that it will be able to
provide or attract the necessary capital, or that it will not encounter other,
and even unanticipated, risks. (2) Use of the Internet by consumers, while growing, is still
at an early stage of development, and market acceptance of the Internet as
a medium for entertainment, commerce and information is still subject to a high level of
uncertainty. (3) The Company may decide to exit the digital data distribution
business at any time. |
