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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
[LOGO OF SSP SOLUTIONS]
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001,
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NO. 000-26227
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SSP SOLUTIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0757190
(STATE OR OTHER JURISDICTION (I.R.S EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
17861 CARTWRIGHT ROAD, IRVINE, CALIFORNIA 92614
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(949) 851-1085
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of November 14, 2001, the registrant had 20,622,654 shares of common
stock outstanding.
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SSP SOLUTIONS, INC.
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements................................................................................... 3
Condensed Consolidated Balance Sheets--December 31, 2000 and September 30, 2001........................ 3
Condensed Consolidated Statements of Operations--Three and nine months ended
September 30, 2000 and 2001............................................................................ 4
Condensed Consolidated Statements of Cash Flows--Nine months ended September 30, 2000 and 2001......... 5
Notes to Condensed Consolidated Financial Statements................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk............................................. 28
PART II OTHER INFORMATION...................................................................................... 29
Item 1. Legal Proceedings...................................................................................... 29
Item 2. Changes in Securities and Use of Proceeds.............................................................. 29
Item 3. Defaults upon Senior Securities........................................................................ 29
Item 4. Submission of Matters to a Vote of Security Holders.................................................... 29
Item 5. Other Information...................................................................................... 30
Item 6. Exhibits and Reports on Form 8-K....................................................................... 30
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SSP SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
DECEMBER 31, SEPTEMBER 30,
2000 2001
----------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 4,120 $ 1,194
Investment in trading securities -- 1,589
Accounts receivable (net of allowance for doubtful accounts
of $268 and $228 as of December 31, 2000 and September 30,
2001, respectively) 4,137 3,009
Inventories 695 992
Prepaid expenses 542 830
Note receivable -- related party -- 49
Other current assets 325 516
--------- ---------
Total current assets 9,819 8,179
Property and equipment, net 823 481
Other assets 343 182
Goodwill and other intangibles, net 783 61,738
--------- ---------
$ 11,768 $ 70,580
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt $ 1,986 $ 159
Accounts payable 1,392 8,106
Accrued liabilities 1,366 1,932
Note payable to related party -- 1,088
Deferred revenue 217 209
--------- ---------
Total current liabilities 4,961 11,494
Long-term debt, less current installments 19 --
Deferred revenue 240 92
--------- ---------
Total liabilities 5,220 11,586
Shareholders' equity:
Preferred stock, $.01 par value; Authorized 5,000,000 shares;
no shares issued or outstanding -- --
Common stock, $.01 par value; Authorized 100,000,000 shares; issued
and outstanding 9,743,573 at December 31,
2000 and 20,622,654 shares at September 30, 2001 97 206
Additional paid-in capital 52,834 118,632
Note receivable from shareholder -- (500)
Deferred compensation -- (1,445)
Accumulated deficit (46,383) (57,899)
--------- ---------
Total shareholders' equity 6,548 58,994
--------- ---------
Commitments and contingencies (notes 9 and 12) $ 11,768 $ 70,580
========= =========
See accompanying notes to condensed consolidated financial statements.
3
SSP SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------- ----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2000 2001 2000 2001
------------- ------------- ------------- -------------
Revenues:
Product $ 14,559 $ 4,693 $ 27,329 $ 14,732
License and service 552 462 1,554 1,251
-------- -------- -------- --------
Total revenues 15,111 5,155 28,883 15,983
-------- -------- -------- --------
Costs and expenses:
Cost of sales--product 12,181 4,007 22,183 11,689
Cost of sales--license and service 170 126 566 376
Selling, general and administrative 2,181 1,775 7,339 5,229
Research and development 1,476 1,903 4,202 5,428
Amortization of goodwill and other intangibles 711 181 2,117 228
In-process research and development -- 3,300 -- 3,300
-------- -------- -------- --------
Operating loss (1,608) (6,137) (7,524) (10,267)
Realized loss on trading securities -- 1,127 -- 1,127
Other expense, net 44 40 3 68
-------- -------- -------- --------
Loss before income taxes (1,652) (7,304) (7,527) (11,462)
Provision for income taxes -- 51 6 54
-------- -------- -------- --------
Net loss $ (1,652) $ (7,355) $ (7,533) $(11,516)
======== ======== ======== ========
Net loss per share--basic and diluted $ (0.17) $ (0.52) $ (0.76) $ (1.02)
======== ======== ======== ========
Shares used in per share computations--basic
and diluted 9,885 14,218 9,878 11,238
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
4
SSP SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
------------------------------
SEPTEMBER 30, SEPTEMBER 30,
2000 2001
------------- -------------
Cash flows from operating activities:
Net loss $ (7,533) $(11,516)
Adjustments to reconcile net loss to net cash
used in operating activities:
Provision for losses on receivables 222 240
Depreciation and amortization 2,610 745
In process research and development -- 3,300
Deferred compensation -- 42
Realized loss on trading securities -- 1,127
Changes in assets and liabilities net of effects
of the Acquisition:
Accounts receivable (4,011) 888
Inventories (660) (297)
Prepaid expenses (222) (288)
Other current assets (135) (699)
Other assets (481) 256
Notes receivable-related party (5) --
Accounts payable 3,267 5,477
Accrued liabilities (266) 333
Deferred revenue 480 (156)
-------- --------
Net cash used in operating activities (6,734) (548)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (837) (52)
Restricted cash related to line of credit 612 --
Proceeds from sale of trading securities -- 107
Net cash paid for merger with BIZ Interactive Zone, Inc. -- (590)
-------- --------
Net cash provided by (used in) investing activities (225) (535)
-------- --------
Cash flows from financing activities:
Stock options exercised 20 3
Borrowings on revolving note payable 10,743 13,988
Proceeds from insurance financing 748 25
Repayment on insurance financing (294) (377)
Principal payments on revolving note payable
and long-term notes payable to bank (6,145) (15,482)
-------- --------
Net cash provided by (used in) financing activities 5,072 (1,843)
-------- --------
Net decrease in cash (1,887) (2,926)
Cash and cash equivalents at beginning of period 6,441 4,120
-------- --------
Cash and cash equivalents at end of period $ 4,554 $ 1,194
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 223 $ 198
Income taxes 6 2
======== ========
Supplemental disclosures of non-cash investing and
financing activities
Merger costs -- (750)
Fair Value of net assets 3,231
Fair Value of net liabilities (331) (3,047)
Goodwill and other intangible assets -- 61,182
In-Process Research and Development -- 3,300
Deferred Compensation -- 29
-------- --------
Market value of common stock issued and options and
warrants assumed related to merger with BIZ (331) 63,945
======== ========
See accompanying notes to condensed consolidated financial statements.
5
SSP SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000 AND 2001
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) GENERAL INFORMATION:
Condensed Consolidated Financial Statements
In the opinion of SSP Solutions, Inc., formerly known as Litronic, Inc.
("the Company"), the accompanying unaudited condensed consolidated financial
statements contain all adjustments (which are normal recurring accruals)
necessary to present fairly the financial position as of September 30, 2001; the
results of operations for the three and nine months ended September 30, 2000 and
2001; and the statements of cash flows for the nine months ended September 30,
2000 and 2001. Interim results for the nine months ended September 30, 2001 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2001. The interim financial statements should be read in
conjunction with the Company's consolidated financial statements for the year
ended December 31, 2000, included in the Company's Form 10-K/A, filed in April
2001.
These condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going concern, which contemplates
the realization of assets and satisfaction of liabilities in the normal course
of business. The Company has incurred significant operating losses, has used
cash in operating activities, has an accumulated deficit, and deficit working
capital. The Company currently anticipates that existing resources will not be
sufficient to satisfy contemplated working capital requirements for the next
twelve months.
We had previously indicated our plan to begin shipping our new
CypherServers in mid-2001. Our operating forecast assumed the CypherServer
product launch would go as planned and that anticipated sales of the
CypherServers would be realized. We have not realized the sales previously
anticipated and have undertaken further market research to clarify customer
requirements. We are currently designing enhancements to the software that
operates the CypherServer to more closely meet customer needs. We will re-launch
the CypherServer family of products during 2002. Since we did not realize the
anticipated sales from the initial launch of our CypherServer products it may be
necessary for us to make additional expense reductions beyond those already
made.
As a result, in 2001 there has been a substantial decrease in sales
versus plan together with a related decrease in gross profit, thereby
substantially contributing to both our accumulated deficit and deficit working
capital. To deal with liquidity issues, the Company plans include the
following:
- Addition of accounts receivable financing through an agreement
with Wells Fargo Business Credit, Inc.
- Sale of trading securities, and
- Pursuit of debt and/or equity financing
Should the above measures not be adequate, the Company will take some
or all of the following actions:
- A reduction in work force to lower expenses
- A Restructuring of the business
- Sell all or portions of the business, and
In a letter to us dated April 17, 2001, our co-chief executive officer,
who is a major shareholder, committed, if necessary, to providing the personal
financial resources required to enable us to meet all of our financial
obligations as they become due through January 1, 2002. Ultimately, the
Company's ability to continue as a going concern is dependent upon its ability
to successfully launch its new products, grow revenue, attain operating
efficiencies, sustain a profitable level of operations and attract new sources
of capital.
Goodwill and Other Intangibles
For all business combinations prior to June 30, 2001, the Company
amortizes goodwill and intangible assets relating to businesses acquired and
costs in excess of the fair value of the net assets of businesses acquired
("goodwill and other intangibles") using the straight-line method over the
estimated useful lives of the intangible assets. The Company recorded an
impairment charge of $31,415 in the fourth quarter of 2000, related to
unamortized goodwill and other intangible assets acquired in the purchase of
Pulsar Data Systems, Inc. ("Pulsar"). Included in the impairment charge was
$10,737 related to goodwill. The goodwill included in the impairment charge
represented all the Company's remaining unamortized goodwill, at December 31,
2000 there was no unamortized goodwill included on the Company's books. No
expense related to the amortization of goodwill has been included in either the
three or nine-month periods ended September 30, 2001. The Company will continue
to amortize the other intangible assets over the remaining useful lives. The
Company has adopted Statements 142 and 141 "Business Combinations" for the
merger with BIZ Interactive Zone, Inc. ("BIZ") that was completed on August 24,
2001 ("Merger"). Accordingly, the Company has not recorded amortization of
goodwill related to the Merger. Amortization of goodwill and other intangibles
was $2,117 and $228 for the nine months ended September 30, 2000 and September
30, 2001, respectively.
New Accounting Standards
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement 141, "Business Combinations", and Statement 142, "Goodwill and Other
Intangible Assets." Statement 141 requires that all business combinations be
accounted for under a single method -- the purchase method. Use of the
pooling-of-interests method is no longer permitted. Statement 141 requires that
the purchase method be used for business combinations initiated after June 30,
2001. Statement 142 requires that goodwill no longer be amortized to earnings,
but instead be reviewed for impairment. Under Statement 142, the amortization of
goodwill ceases upon adoption of the Statement, which is effective for fiscal
years beginning after December 15, 2001, which for calendar year-end companies,
will be January 1, 2002. Early application is permitted for entities with fiscal
years beginning after March 15, 2001, provided that the first interim financial
statements have not been previously issued. In all cases, the provisions of
Statement 142 shall be initially applied at the beginning of a fiscal year.
Goodwill and intangible assets acquired after June 30, 2001, but prior to full
adoption of Statement 142, are to be amortized, or not, in accordance with
Statement 142.
The Company has historically amortized its goodwill and other intangible
assets over their estimated useful lives. Beginning with the adoption of
Statement 142, the Company will cease amortizing goodwill. The Company
anticipates adopting Statement 142 as of the beginning of fiscal year 2002 (i.e.
January 1, 2002).
In June 2001, the FASB issued Statement 143, "Accounting for Asset
Retirement Obligations," which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The standard applies to legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development and (or) normal use of the asset.
Statement 143 requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred if a
reasonable estimate of fair value can be made. The fair
6
value of the liability is added to the carrying value of the associated asset
and this additional carrying amount is depreciated over the life of the asset.
The liability is accreted at the end of each period through charges to operating
expense. If the obligation is settled for other than the carrying amount of the
liability, the Company will recognize a gain or loss on settlement. The Company
is required and plans to adopt the provisions of Statement 143 for the quarter
ending March 31, 2003. Management does not believe adoption of this standard
will have a material adverse effect on the Company's consolidated financial
position, results of operations or liquidity.
In October 2001, the FASB issued Statement 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
While Statement 144 supercedes FASB Statement 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," it
retains many of the fundamental provisions of that Statement. Statement 144
applies to all entities, that is, both business enterprises and not-for-profit
organizations. With the exception of items identified in the Statement, it
applies to all recorded long-lived assets that are held for use, or that will be
disposed of. Long-lived assets include capital lease assets of lessees, assets
of lessors subject to operating leases, proved oil and gas properties that are
accounted for using the successful-efforts method of accounting, long-term
prepaid assets, and intangible assets that are amortized. The Company is
required and plans to adopt the provision of Statement 144 for the fiscal year
beginning January 1, 2002. As Statement 144 was recently released, the Company
has not assessed the impact, if any, Statement 144 may have on its financial
position or results of operations.
(2) BUSINESS COMBINATION
On August 24, 2001, pursuant to an Agreement and Plan of Reorganization
dated July 3, 2001 with BIZ Interactive Zone, Inc., a Delaware Corporation, the
Company completed a merger transaction whereby BIZ became a wholly-owned
subsidiary of the Company. BIZ was a development stage enterprise devoting
substantially all of its efforts to develop, design, and market security
solutions for the financial, government, healthcare, education, and
entertainment industries. Concurrent with the Merger, the Company changed its
name from Litronic Inc., to SSP Solutions, Inc. The Company combined the
businesses of Litronic and BIZ into a single operating unit under the name SSP
Solutions, Inc. The combined company will continue to focus on a complete range
of solutions for physical access, electronic commerce, and communications, from
the Core to the Edge.
In connection with the Merger, the Company issued an aggregate of 10,875
shares of SSP Solutions common stock in exchange for all of the outstanding
shares of BIZ common stock and preferred stock. In addition, the Company
reserved for issuance an aggregate of approximately 860 shares of its common
stock for issuance upon exercise of BIZ options and warrants assumed by the
Company.
The Merger has been accounted for under the purchase method of accounting
in accordance with generally accepted accounting principles. The Company
recorded a one-time charge for purchased in-process research and development
("IPR&D") expenses of $3,300 related to the acquisition during the three and
nine months ended September 30, 2001.
The Company utilized an independent third-party appraiser to assess and
allocate values to the IPR&D. The preliminary values assigned to these projects
were determined by identifying projects that have economic value but that had
not yet reached technological feasibility and that have no alternative future
use. These products have not been released to the market as of the date of the
Merger, but the features and functionality of the products had been defined.
The preliminary values of these projects were determined using the Income
Forecast Method. In applying the Income Forecast Method, the value of the
acquired technologies was estimated by discounting to present value, the free
cash flows generated by the products with which the technologies are associated.
Adjustments were made to provide for a fair return to fixed assets, working
capital, and other assets that contribute to value. The estimates were based on
the following assumptions:
- The estimated revenues assume average compound annual revenue
growth rates of 44% to 197% during fiscal years 2002 through 2007,
depending on the product line. These projections are based on
management's estimates over the expected remaining economic lives
of the technologies. The preliminary IPR&D value is comprised of
three on-going projects. The estimated cost of revenues as a
percentage of revenues is expected to be 55%. The estimated cost
to complete the three on-going projects is expected to be $5,125.
7
- The discount rates used in the preliminary valuation reflect the
relative risk of the product lines. For IPR&D projects, the
discount rates ranged from 40% to 45%, which was based on the
amount and risk of effort remaining to complete the respective
development projects.
The Company believes that the foregoing assumptions used in determining
the income forecast associated with the IPR&D products are reasonable. No
assurance can be given, however, that the underlying assumptions used to
estimate the income forecast, the ultimate revenues and costs on such projects,
or the events associated with such projects, will transpire as estimated.
The total purchase price and allocation among the fair value of tangible
and intangible assets and liabilities (including purchased in-process research
and development) are summarized as follows:
Tangible assets $ 3,231
Liabilities 3,047
--------
Net tangible assets 184
Identifiable intangible assets:
In-process research and development 3,300
Completed technology 5,900
Strategic relationships 2,800
Goodwill 52,482
Deferred compensation 29
--------
$ 64,695
The other intangible assets will be amortized on a straight-line basis
over the following estimated useful lives, in years:
Completed technology 5
Strategic Relationships 1 to 5
The operating results of BIZ have been included in the condensed
consolidated statements of operations since the acquisition date, August 24,
2001.
Following are the summarized unaudited pro forma combined results of
operations for the nine months ended September 30, 2000 and September 30, 2001,
assuming the acquisition had taken place at the beginning of each of those
fiscal years. The unaudited pro forma combined statement of operations for the
nine months ended September 30, 2000 was prepared based on the statement of
operations of SSP Solutions for the nine months ended September 30, 2000 and the
statement of operations for BIZ from April 30, 2000 (inception) to September 30,
2000. The unaudited pro forma combined statement of operations for the nine
months ended September 30, 2001 was prepared based upon the statement of
operations of SSP Solutions and BIZ for the nine months ended September 30,
2001. The unaudited pro forma results exclude the effects of the IPR&D charge
but include the amortization of other intangibles and deferred compensation. The
unaudited pro forma results are not necessarily indicative of the future
operations or operations that would have been reported had the Merger been
completed when assumed.
Nine Months Ended
------------------------------
September 30, September 30,
2000 2001
------------- -------------
Net revenues $ 28,883 $ 15,983
======== =========
Net loss $ (8,713) $ (27,430)
======== =========
Net loss per share $ (0.42) $ (1.33)
======== =========
8
(3) INVESTMENTS
The Company has an investment that is classified as trading securities.
The securities are comprised of Class A common stock of Wave Systems Corp.
received in the Merger with BIZ. The investment is presented and recorded in
accordance with SFAS No. 115. Management determines the appropriate
classification of its investments in debt and marketable equity securities at
the time of purchase and reevaluates such designation as of each balance sheet
date. Available-for-sale securities are carried at fair value, with the
unrealized gains and losses, net of taxes, reported as a component of
shareholders' equity. Trading securities are carried at fair value with the
unrealized gains and losses, net of applicable taxes, reported in earnings in
the statement of operations. The cost of securities sold is based upon the
specific identification method.
(4) INVENTORIES
A summary of inventories follows:
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ -------------
Raw materials $258 $168
Work-in-process 86 70
Finished goods 351 754
---- ----
$695 $992
==== ====
(5) LONG TERM DEBT
A summary of long-term debt follows:
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ -------------
Revolving note payable to bank with maximum availability of $5,000,
bearing interest at prime plus .625% (10.125% at December 31, 2000 and
6.25% at September 30, 2001) interest payable monthly through maturity
on May 10, 2002; secured by substantially all assets of the Company 1,509 35
Note payable for insurance financing due in nine monthly payments beginning
July 9, 2000 at an annual percentage rate of 7.15% 12 --
Note payable for insurance financing due in eighteen monthly payments beginning
July 9, 2000 at an annual percentage rate of 8.18% 484 124
------ ------
2,005 159
Less current installments 1,986 159
------ ------
$ 19 $ --
====== ======
In June 1999, the Company entered into a three-year lending agreement
with Guaranty Business Credit Corporation ("GBCC") permitting borrowings under a
$20,000 secured revolving line of credit facility that commenced on June 14,
1999. The agreement provided for an annual interest rate of prime plus .625%;
and a pledge of substantially all of the Company's personal and real property as
collateral. Although the credit facility was for borrowings up to $20,000, under
the terms of the agreement the amount of borrowing available to the Company was
subject to a maximum borrowing limitation based on eligible collateral. Eligible
collateral consisted of 85% of eligible accounts receivable plus the lesser of
(a) 50% of the value of eligible on-hand inventory or (b) $1,000. As a result,
the amount that was actually available to the Company at any particular time may
have been significantly less than the full $20,000 credit facility due to the
maximum borrowing limitation calculation. The agreement with the lender included
a number of covenants and restrictions that the Company was required to adhere
to. These covenants and restrictions included maintenance of minimum levels of
working capital, tangible net worth, and profitability. In addition, the
agreement did not allow the Company to pay dividends.
On April 18, 2001, the terms of the Company's revolving line of credit
were amended. Under the terms of the amended agreement the maximum borrowings
were $5,000, eligible collateral excluded inventory, and the advance rate was
35%. In addition, certain of the financial covenants and requirements were
adjusted. The amended $5,000 revolving credit facility also contained various
covenants and restrictions. Under the terms of the amended agreement, the
Company was required to obtain the lender's consent for any merger or
consolidation. The lender was not willing to give its consent to the Merger with
BIZ and discontinued making advances under the terms of the amended agreement
effective with the Merger. The lender applied all collections subsequent to the
Merger to outstanding borrowings until such borrowings and related interest
charges were paid in full. All amounts due to the lender were paid in full on
October 2, 2001. Once all amounts were paid in full the lender released its
security interest in the Company's assets. Borrowings related to this agreement
are included in current installments of long-term debt in the condensed
consolidated financial statements.
On November 2, 2001, the Company's wholly owned subsidiary, Pulsar,
entered into a financing agreement with Wells Fargo Business Credit, Inc.
("WFBC"), which provides for the factoring of accounts receivable. On November
2, 2001, the Company also entered into a financing agreement for SSP Solutions,
Inc. The agreements contain no limit on the dollar volume of receivable
financing, but provides for WFBC's approval of credit limits for non-government
customers. The discount rate charged is 1.25% of the gross receivable, which may
be increased by .0625% per day for accounts that do not pay within thirty days
of the receivable purchase. At the time of purchase, terms call for WFBC to
advance 85% of the gross receivable, with the balance remitted after collection
of the invoice less the discount and any other charges. The agreement contains
no loan covenants or restrictions and requires minimum quarterly fees and
discounts totaling $63. The balances due WFBC are guaranteed by Mr. Kris Shah
and Mr. Marvin Winkler, the Company's co-chairmen and co-chief executive
officers.
The Company previously entered into insurance premium financing
agreements with Cananwill, Inc. for the payment of certain insurance premiums.
The premiums being financed cover policy periods from twelve to twenty four
months. The Merger caused the re-write of some policies carried by the Company.
As a result, the premium financing agreements were re-written to provide for
five monthly installments covering policy periods ending June 30, 2002. These
insurance premium financing agreements are secured by the proceeds of the
policies being financed.
9
(6) BUSINESS SEGMENTS AND PRODUCT LINES
In 1998 and prior to the acquisition of Pulsar in June 1999, the Company
operated in one business segment. Subsequent to the acquisition of Pulsar, the
Company operates in two industry segments, the information security segment and
the network solutions segment. Following are the revenues, cost of sales, and
identifiable assets of these segments as of and for the three and nine months
ended September 30, 2000 and 2001.
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------- ----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2000 2001 2000 2001
------------- ------------- ------------- -------------
Revenue
Information Security Products and Services $ 2,148 $ 2,162 $ 5,706 $ 6,056
Network Solutions Market 12,963 2,993 23,177 9,927
======= ======= ======= =======
Cost of sales
Information Security Products and Services 684 1,212 1,926 2,892
Network Solutions Market 11,667 2,921 20,823 9,173
======= ======= ======= =======
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ -------------
Identifiable assets
Information Security Products and Services $1,373 $62,379
Network Solutions Market 4,370 2,849
====== =======
As the Chief Operating Decision Maker does not review operating expenses
by segment beyond cost of sales or assets, except as identified, additional
segment information is not available.
During the three and nine months ended September 30, 2000, the Company
had four distinct product lines: network deployment products, data security
products, license and service, and electric security systems. During the three
and nine months ended September 30, 2001, the Company had three distinct product
lines: network deployment products, data security products and license and
service. Following is a summary of total revenues by product line.
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------ ------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2000 2001 2000 2001
------------- ------------- ------------- -------------
Network deployment products $12,936 $ 2,993 $22,936 $ 9,927
Data security products 1,623 1,700 4,393 4,806
License and service 525 462 1,313 1,250
Electric security systems 27 -- 241 --
------- ------- ------- -------
Total net product, license and service revenues $15,111 $ 5,155 $28,883 $15,983
======= ======= ======= =======
In July 2000 the Company discontinued the electric security systems product
line. The Company has not and does not anticipate incurring any significant
expense as the result of this decision.
(7) RELATED PARTY TRANSACTIONS
NOTES RECEIVABLE - RELATED PARTY
The notes receivable primarily consists of two promissory notes that were
acquired as part of the Merger with BIZ. As part of a hiring package, an
employee received a $10,000 advance and executed a demand promissory note that
includes interest at 6%. Subsequently, as part of a loan agreement, the same
employee executed a separate promissory note for $37 including interest at 8%
due May 3, 2002. The balance of the related party notes includes accrued
interest.
NOTE PAYABLE TO RELATED PARTY
On July 31, 2001, through our co-chairman, Marvin Winkler, Chase
Manhattan Bank ("Chase") advanced $1,000 for the re-purchase of preferred stock
held by an investor in BIZ. Mr. Winkler executed a $1,000 demand note with Chase
and BIZ executed a $1,000 demand note due September 15, 2001 with J.A.W.
Financial, L.P. ("JAW"), an entity controlled by Mr. Winkler. The demand note
contained an interest charge of prime plus 1% through the maturity date and
prime plus 3% after the maturity date. On October 11, 2001, the Company made a
principal payment of $30, paid accrued interest, and executed a new promissory
note to JAW for $970. The terms of the promissory note call for interest of
prime plus 3% payable monthly, together with five monthly payments of principal
in the amount of $160 and one final payment on April 15, 2002 in the amount of
$170. The promissory note provides Chase a collateral interest in the shares in
Wave Systems Corp. owned by the Company, and subject to Chase's loan security
guidelines the rights to proceeds from any sales of those shares.
NOTE RECEIVABLE FROM SHAREHOLDER
The note receivable from shareholder consists of a note acquired as part
of the Merger with BIZ. The $500,000 note was received by BIZ from our
co-chairman, Kris Shah, in conjunction with the issuance of BIZ common shares
prior to the Merger, and therefore will be shown as a reduction of shareholders'
equity until paid. The note has a stated interest rate of 5% per annum and is
due on July 24, 2005. As the stated interest rate is below the market rate at
the time of issuance, interest was imputed at 9.5% per annum.
(8) CONCENTRATION OF RISK AND SIGNIFICANT CUSTOMERS
Financial instruments that potentially subject the Company to
concentration of credit risk are trade receivables. Credit risk on trade
receivables is limited as a result of the Company's customer base and their
dispersion across different industries and geographic regions. As of December
31, 2000 and September 30, 2001, accounts receivable included $3,732 and $x,xxx
respectively, due from the U.S. Government and related agencies. Sales to
federal government agencies represented 79% and 65% of the Company's revenues
for the nine months ended September 30, 2000 and 2001, respectively.
The Company had sales to one customer that was an agency of the U.S.
Government and represented 42% of the total revenues for the nine months ended
September 30, 2000. The Company had sales to two customers, which were agencies
of the U.S. Government, which represented 17% and 13%, respectively, of total
revenues for the nine months ended September 30, 2001. No other customers
accounted for more than 10% of total revenues during the nine months ended
September 30, 2000 and September 30, 2001. Trade accounts receivable totaled
$1,191 and $1,306 from these major customers as of December 31, 2000 and
September 30, 2001 respectively.
At September 30, 2001, the Company's investment portfolio consisted of
$492 in cash equivalents. The Company does not believe that it has a
concentration of investment risk due to the diversification of the investment
portfolio. All amounts are invested in a money market account with a major
financial services firm.
At September 30, 2001, the Company's trading securities consisted of
Class A common stock of Wave Systems Corp. ("Stock"), which was acquired in the
merger. The Stock is traded on the NASDAQ, and the value of the Stock is subject
to changes in the daily market prices. In accordance with its policy, the
Company adjusts the carrying value of the Stock at the end of each reporting
period.
10
(9) COMMITMENTS
WAVE SYSTEMS CORP.
In May 2001, BIZ signed a development agreement with Wave Systems Corp.
("Wave") for the integration of EMBASSY based systems with set-top box master
reference designs of Broadcom Corporation. Under this agreement, BIZ is required
to pay Wave $278 per month beginning June 1, 2001 through December 1, 2002.
Should the Company not make the required payments, Wave may request payment in
the form of common stock. As of September 30, 2001, the Company owed $562 to
Wave, but no request for stock payments have been made. Separately, should the
Company or its customers not purchase $5,000 of goods or services from Wave by
June 30, 2003, the Company's exclusivity relative to certain customers will, at
Wave's option, become non-exclusive.
INTERNATIONAL SCHOOLS LICENSING CORP.
In June 2000, the Company executed an agreement with International
Schools Licensing Corp. ("ISLC"), based upon ISLC needs at that time. The
agreement provided for the Company to build and manage, at the Company's cost, a
website to implement a portion of the ISLC business model in exchange for 80% of
the revenues generated from the website. Since that time, ISLC has changed its
business model regarding what business would be conducted through a website, and
the responsibilities of its licensee's. Based upon ISLC changes, the Company
will not build the website. The Company will be the exclusive supplier of
desktop security solutions and other security elements for ISLC services.
EPAY LATINA
Under a joint marketing alliance agreement executed in August 2001 with
ePayLatina ("ePay"), the Company agreed to create the applet to allow ePay's
enhanced security transaction software to communicate with the Company's card
readers. As part of the agreement ePay agreed to purchase and use only the
Company's card readers (or other products with similar functionality sold by the
Company), and granted the Company a world wide, royalty free exclusive license
to use their software. The Company and ePay both agree to bear their own costs.
The Company estimates the cost to complete the applet to be $150. The Company
and ePay both agree to share net revenues from the sales of bundled products on
a 50/50 basis. ePay is currently deploying software and card readers for testing
by its customers.
XSIDES
Under a memorandum of understanding ("MOU") executed in November 2000,
the Company can incorporate xSides technology into its product offerings. The
current form of the technology may require customization for each customer
application. The costs to be incurred for a customization will be determined on
a case-by-case basis. The Company estimates a customized application may cost
$25. However, unless there exists an order for the customized application, the
Company will not incur such costs to complete.
ONENAME
The Company contracted with OneName to produce an XNS applet, which the
Company intends to use in applications as required by customers. The current
form of the base applet may require customization for each customer. The costs
to be incurred for a customization will be determined on a case-by-case basis.
The Company estimates customized application may cost $25. Unless there exists
an order for the customized applet, the Company will not incur such costs.
I.N. CORP.
The Company contracted with I.N. Corp. ("I.N.") for the development of a
universal smart card reader. No further amounts are due for this project and the
Company has not put the product into production. The Company entered into a cost
sharing arrangement with Wave whereby costs of the project will be split 50/50
and both companies will have the right to use the design for the ordering
finished product. Should the Company decide to place the product into
production, the Company estimates it will incur additional costs of
approximately $25 under the cost sharing arrangement.
11
(10) LOSS PER SHARE
The computation of diluted net loss per share for the three months ended
September 30, 2000 and 2001 and the nine months ended September 30, 2000 and
2001 excluded the dilutive effect of 728, and 1,990, respectively, of
incremental common shares attributable to the exercise of outstanding common
stock options and warrants as a result of the antidilutive effect.
(11) SHAREHOLDERS' EQUITY
During the quarter ended September 30, 2001, the Company increased the
authorized number of common shares from 25,000 to 100,000, which was approved by
shareholders on August 23, 2001. In conjunction with the Merger, the Company
issued approximately 10,875 common shares.
BIZ INTERACTIVE ZONE, INC. 2000 STOCK OPTION PLAN -- The BIZ Plan was
assumed as part of the Merger. The BIZ Plan is closed and no additional options
can be granted. As of September 30, 2001, there were options outstanding to
purchase approximately 836 shares under the BIZ Plan at an average purchase
price of $2.11 per share.
2001 EMPLOYEE STOCK PURCHASE PLAN ("ESPP") -- During the quarter ended
September 30, 2001, the Company established the ESPP, which was approved by
shareholders on August 23, 2001. A total of 1,000 shares of our common stock are
currently authorized for issuance under the ESPP. If a right expires or becomes
unexercisable without having been exercised in full, the shares of our common
stock that were subject to that right will again become available for grant
under the ESPP. The number of shares issuable under the ESPP, and the purchase
price per share, is subject to proportional adjustments to reflect stock splits,
stock dividends, mergers, consolidations and similar events. To date, no shares
have been issued under the ESPP.
WARRANTS -- Under the Merger, the Company assumed a warrant to purchase
24 shares of common stock at a price per share of $2.11. The warrant vested
immediately upon grant and has an exercise period of five years.
DEFERRED COMPENSATION -- The deferred compensation consists of amounts
related to stock options and warrants assumed as part of the Merger with BIZ.
Equity instruments issued to nonemployees are measured using the fair
value of the equity instrument using the stock price and other measurement
assumptions as of the earlier of the date at which a performance commitment to
earn the equity instruments is reached or the date at which the performance is
complete.
(12) CONTINGENCIES
As the Company provides engineering and other services to various
government agencies, it is subject to retrospective audits, which may result in
adjustments to amounts recognized as revenues, and the Company may be subject to
investigation by governmental entities. Failure to comply with the terms of any
governmental contracts could result in civil and criminal fines and penalties,
as well as suspension from future government contracts. The Company is not aware
of any adjustments, fines or penalties, which could have a material adverse
effect on its financial position or results of operations.
The Company has cost reimbursable type contracts with the Federal
Government. Consequently, the Company is reimbursed based upon its direct
expenses attributable to the contract, plus a percentage based upon overhead,
material handling, and general and administrative expenses. The overhead,
material handling, and general and administrative rates are estimates.
Accordingly, if the actual rates as determined by the Defense Contract Audit
Agency were below the Company's estimates, a refund for the difference would be
due to the Federal Government. It is management's opinion that no material
liability will result from any contract audits.
On January 16, 1998, G2 Resources Inc. (G2) filed a complaint against
Pulsar in the Circuit Court, Fifteenth Judicial Circuit, Palm Beach County,
Florida. G2 claimed that Pulsar breached a contract under which G2 agreed to
provide services related to the monitoring of government contracts available for
bid and the preparation and submission of bids on behalf of Pulsar. The contract
provided that Pulsar pay G2 $500 in 30 monthly installments of $16 and an
additional fee of 2% of the gross dollar amount generated by awards. In its
complaint, G2 alleged that Pulsar failed to make payments under the contract and
claimed damages in excess of $525 plus interest, costs and attorneys fees. In
the course of discovery G2 asserted that its losses/costs arising out of its
claim amounted to approximately $10,300. Pulsar asserted that G2 failed to
perform the services required under the contract and Pulsar filed a claim for
compensatory damages, interest and attorneys fees against G2. Classical
Financial Services, LLC intervened in the case. Classical claimed that G2
assigned its accounts receivable to Classical under a financing program and that
Pulsar breached its obligations to Classical by failing to make payments under
the contract with G2. Pulsar asserted defenses to Classical's claim. On April
20, 2001, a court hearing was held and G2's complaint against Pulsar was
dismissed without prejudice on the basis of no prosecution activity for more
than 12 months. On May 22,2001, G2 filed a new complaint against Pulsar. The
Company believes that the claims made by G2 against Pulsar are without merit and
intends to vigorously defend against these claims.
The Company recently received a notice from Microsoft pertaining to
alleged sales by the Company of unlicensed copies of Microsoft Office to the
Immigration and Naturalization Service, or INS, as part of a bundle in which
some Company hardware and software was installed onto Dell computers. The
computers were then resold to the INS, along with Microsoft Office software that
the Company received from Dell, as part of a bundled hardware/software package
on the belief that the INS was licensed to use the software. The Company is
currently investigating the matter, but has no way of assessing or quantifying
potential exposure, if any, at this time.
The Company is involved, from time to time, in various other litigation
matters that arise in the ordinary course of business. The Company is not
currently involved in any litigation that it believes will have a material
impact on the results of operations, financial condition or liquidity.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended and Section 21E of the
Securities Exchange Act of 1934, as amended. These statements are based on our
current expectations, estimates and projections about our industry, management's
beliefs and certain assumptions we have made. Words such as "anticipates,"
"expects," "intend," "plans," "believes," "may," "will," or similar expressions
are intended to identify forward-looking statements. In addition, any statements
that refer to expectations, projections, forecasts or other predictions
regarding future events or circumstances, including any underlying assumptions,
are forward-looking statements. These statements may include, but are not
limited to, statements concerning projected revenues, expenses and income or
loss, the need for additional capital, acceptance of our products, growth of the
Internet, our ability to realize the anticipated benefits of the merger with
BIZ, our ability to identify and consummate acquisitions and integrate these
operations successfully, our ability to integrate previously acquired businesses
successfully, the status of evolving technologies and their growth potential,
our production capacity, and the outcome of pending and threatened litigation.
These statements are not guarantees or assurances of future performance and are
subject to various risks, uncertainties, and assumptions that are difficult to
predict. Therefore, our actual results could differ materially and adversely
from those expressed in any forward-looking statements. The section entitled
"Risk Factors" set forth in this Form 10-Q and similar sections in our other
filings with the Securities and Exchange Commission, or SEC, discuss some of the
important risk factors that may affect our business, results of operations and
financial condition. You should carefully consider those risks, in addition to
the other information in this report and in our other SEC filings, before
deciding to buy or sell our common stock. We undertake no obligation to revise
or update publicly any forward-looking statements for any reason.
The information contained in this report is not a complete description of
our business or the risks associated with an investment in our common stock. You
should carefully review and consider the various disclosures made by us in this
report and in our materials filed with the SEC that discuss our business in
greater detail and that also disclose various risks, uncertainties and other
factors that may affect our business, results of operations or financial
condition.
GENERAL
We provide physical access and electronic security solutions and services
for protecting, distributing and monetizing digital content via the Internet and
Internet protocol based networks. Our primary technology offerings use public
key infrastructure ("PKI"), which is the standard technology for securing
Internet-based commerce and communications. SSP, which stands for Secure Service
Provider, also provides real-time solutions for electronic commerce and
communications. By licensing and acquiring best of breed technologies and
combining them with our own leading-edge technologies, SSP is developing the SSP
Solution Suite. This suite provides security from the Core to the Edge of the
Internet, across any digital platform. By moving the transaction location from
the Internet website (Core), to the customer's access device (Edge), SSP has
returned control of security to the customer.
By offering the SSP Solution Suite as well as additional stand-alone
products and services, SSP provides security products and services. We are
uniquely positioned to deliver a complete range of highly customizable data
security solutions across a broad range of industries. It is our intent to
become the Trusted Symbol of the Digital Economy(TM).
On August 24, 2001, pursuant to an Agreement and Plan of Reorganization
dated July 3, 2001 with BIZ Interactive Zone, Inc. a Delaware Corporation
("BIZ"), we completed a merger transaction whereby BIZ became our wholly-owned
subsidiary (the "Merger"). BIZ was a development stage enterprise devoting
substantially all of its efforts to develop, design, and market security
solutions for the financial, government, healthcare, education, and
entertainment industries. Concurrent with the Merger, we changed our name from
Litronic Inc., to SSP Solutions, Inc. We have combined the businesses of
Litronic and BIZ into a single operating unit under the name SSP Solutions, Inc.
The combined company will continue to focus on a complete range of solutions for
physical access, electronic commerce, and communications, from the Core to the
Edge(TM).
Our wholly-owned subsidiary, Pulsar Data Systems, Inc. ("Pulsar"),
operates independently as a network solutions company specializing in solutions
requiring the deployment of large-scale networks and secure PCs. Capitalizing on
18 years of government distribution experience, Pulsar offers unique competitive
advantages selling secure computers using SSP's suite of products. Given
increased public awareness and the increasing demand for security in the
government sector, we intend to re-focus Pulsar sales on products containing our
security offerings. This strategy will decrease Pulsar sales volume.
BUSINESS COMBINATION
On August 24, 2001, pursuant to an Agreement and Plan of Reorganization
dated July 3, 2001 with BIZ Interactive Zone, Inc., a Delaware Corporation, we
completed a merger transaction whereby BIZ became a wholly-owned subsidiary. BIZ
was a development stage enterprise devoting substantially all of its efforts to
develop, design, and market security solutions for the financial, government,
healthcare, education, and entertainment industries. Concurrent with the Merger,
we changed our name from Litronic Inc., to SSP Solutions, Inc. We combined the
businesses of Litronic and BIZ into a single operating unit under the name SSP
Solutions, Inc. The combined company will continue to focus on a complete range
of solutions for physical access, electronic commerce, and communications, from
the Core to the Edge.
In connection with the Merger, we issued an aggregate of 10,875 shares of
SSP Solutions common stock in exchange for all of the outstanding shares of BIZ
common stock and preferred stock. In addition, we reserved for issuance an
aggregate of approximately 860 shares of its common stock for issuance upon
exercise of BIZ options and warrants assumed by us.
The Merger has been accounted for under the purchase method of accounting
in accordance with generally accepted accounting principles. We recorded a
one-time charge for purchased in-process research and development ("IPR&D")
expenses of $3,300 related to the acquisition during the three and nine months
ended September 30, 2001.
We utilized an independent third-party appraiser to assess and allocate
values to the IPR&D. The preliminary values assigned to these projects were
determined by identifying projects that have economic value but that had not yet
reached technological feasibility and that have no alternative future use. These
products have not been released to the market as of the date of the Merger, but
the features and functionality of the products had been defined.
The preliminary values of these projects were determined using the Income
Forecast Method. In applying the Income Forecast Method, the value of the
acquired technologies was estimated by discounting to present value, the free
cash flows generated by the products with which the technologies are associated.
Adjustments were made to provide for a fair return to fixed assets, working
capital, and other assets that contribute to value. The estimates were based on
the following assumptions:
- The estimated revenues assume average compound annual revenue
growth rates of 44% to 197% during fiscal years 2002 through 2007,
depending on the product line. These projections are based on
management's estimates over the expected remaining economic lives
of the technologies. The preliminary IPR&D value is comprised of
three on-going projects. The estimated cost of revenues as a
percentage of revenues is 55%. The estimated cost of complete the
three on-going projects is $5,125.
- The discount rates used in the preliminary valuation reflect the
relative risk of the product lines. For IPR&D projects, the
discount rates ranged from 40% to 45%, which was based on the
amount and risk of effort remaining to complete the respective
development projects.
We believes that the foregoing assumptions used in determining the income
forecast associated with the IPR&D products are reasonable. No assurance can be
given, however, that the underlying assumptions used to estimate the income
forecast, the ultimate revenues and costs on such projects, or the events
associated with such projects, will transpire as estimated.
The total purchase price and allocation among the fair value of tangible
and intangible assets and liabilities (including purchased in-process research
and development) are summarized as follows:
Tangible assets $ 3,231
Liabilities 3,047
--------
Net tangible assets 184
Identifiable intangible assets:
In-process research and development 3,300
Completed technology 5,900
Strategic relationships 2,800
Goodwill 52,482
Deferred compensation 29
--------
$ 64,695
The goodwill and other intangibles will be amortized on a straight-line
basis over the following years:
Completed technology 5
Strategic Relationships 1 to 5
The operating results of BIZ have been included in the condensed
consolidated statements of operations since the acquisition date, August 24,
2001.
Following are the summarized unaudited pro forma combined results of
operations for the nine months ended September 30, 2000 and September 30, 2001,
assuming the acquisition had taken place at the beginning of each of those
fiscal years. The unaudited pro forma combined statement of operations for the
nine months ended September 30, 2000 were prepared based on the statement of
operations of SSP Solutions for the nine months ended September 30, 2000 and the
statement of operations for BIZ from April 30, 2000 (inception) to September 30,
2000. The unaudited pro forma combined statement of operations for the nine
months ended September 30, 2001 were prepared based upon the statement of
operations of SSP Solutions and BIZ for the nine months ended September 30,
2001. The unaudited pro forma results exclude the effects of the IPR&D charge
but include the amortization of other intangibles and deferred compensation.
The unaudited pro forma results are not necessarily indicative of the future
operations or operations that would have been reported had the Merger been
completed when assumed.
Nine Months Ended
------------------------------
September 30, September 30,
2000 2001
------------- -------------
Net revenues $ 28,883 $ 15,983
======== =========
Net loss $ (8,713) $ (27,430)
======== =========
Net loss per share $ (0.42) $ (1.33)
======== =========
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues
represented by selected items from the unaudited Condensed Consolidated
Statements of Operations. This table should be read in conjunction with the
Condensed Consolidated Financial Statements included elsewhere herein.
PERCENTAGE OF PERCENTAGE OF
TOTAL REVENUES TOTAL REVENUES
---------------------------------- ----------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------- ----------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2000 2001 2000 2001
------------ ------------ ------------ ------------
Revenues:
Product 96.3% 91.0% 94.6% 92.2%
License and service 3.7 9.0 5.4 7.8
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
----- ----- ----- -----
Costs and expenses:
Cost of sales--product 80.6 77.7 76.8 73.1
Cost of sales--license and service 1.1 2.4 2.0 2.4
Selling, general and administrative 14.4 34.4 25.5 32.7
Research and development 9.8 36.9 14.5 34.0
Amortization of goodwill and other intangibles 4.7 3.5 7.3 1.4
13
In-process research and development 0.0 64.0 0.0 20.6
----- ----- ----- -----
Operating loss (10.6) (118.9) (26.1) (64.2)
Realized loss on trading securities 0.0 21.9 0.0 7.1
Total other expense, net 0.4 0.9 0.0 0.5
----- ----- ----- -----
Loss before income taxes (11.0) (141.7) (26.1) (71.8)
Provision for income taxes 0.0 1.0 0.0 0.3
----- ----- ----- -----
Net loss (11.0)% (142.7)% (26.1)% (72.1)%
===== ===== ===== =====
RESULTS OF OPERATIONS -- COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER
30, 2000 AND 2001
TOTAL REVENUES. Total revenues decreased 66% from $15.1 million during
the three months ended September 30, 2000 to $5.2 million during the three
months ended September 30, 2001. The decrease was primarily attributable to a
decrease in product revenues of $9.9 million related to network deployment
products.
During the three months ended September 30, 2000, we derived 55% of our
revenues from sales to the Immigration and Naturalization Service. During the
three months ended September 30, 2001, we derived 12% and 10%, respectively, of
our revenue from sales to the U.S. Immigration and Naturalization Service and
the Department of State. Sales to government agencies accounted for
approximately 91% and 71% of our sales during the three months ended September
30, 2000 and 2001, respectively.
PRODUCT REVENUE. Product revenue decreased $9.9 million or 68% from $14.6
million during the three months ended September 30, 2000 to $4.7 million during
the three months ended September 30, 2001. The decrease was primarily
attributable to a $10.0 million decrease in revenues related to network
deployment products.
LICENSE AND SERVICE REVENUE. License and service revenue decreased 16%
from $552,000 during the three months ended September 30, 2000 to $462,000
during the three months ended September 30, 2001. The $90,000 decrease was
primarily attributable to a $27,000 decrease in revenues related to electric
security systems and a $63,000 decrease in revenues related to license and
services.
PRODUCT GROSS MARGIN. Product gross margins decreased as a percentage of
net product revenue from 16% during the three months ended September 30, 2000 to
15% during the three months ended September 30, 2001. The decrease was primarily
attributable to a decrease in gross margins related to network deployment
products. Margins on network deployment products decreased from 10% during the
three months ended September 30, 2000 to 2% during the three months ended
September 30, 2001.
LICENSE AND SERVICE GROSS MARGIN. License and service gross margin
increased as a percentage of license and service revenue from 69% during the
three months ended September 30, 2000 to 73% during the three months ended
September 30, 2001. This increase was primarily attributable to the discontinued
electric security systems product line. Gross margins related to the electric
security systems product line were significantly less than those related to
other types of licenses and services that we provide.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative ("S,G&A") expenses decreased 19% from $2.2 million during the
three months ended September 30, 2000 to $1.8 million during the three months
ended September 30, 2001. The decrease was primarily attributable to a reduction
in S,G&A related payroll expenses at Pulsar. The average S,G&A headcount at
Pulsar decreased 6, or 24%, during the three months ended September 30, 2001 as
compared to the three months ended September 30, 2000. As a percentage of
revenue, S,G&A expenses increased from 18% during the three months ended
September 30, 2000 to 34% during the three months ended September 30, 2001. The
percentage increase was primarily attributable to a decrease in S,G&A expenses
combined with a decrease in total revenues.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development ("R&D")
expenses increased 29% from $1.5 million during the three months ended September
30, 2000 to $1.9 million during the three months ended September 30, 2001. The
increase was primarily attributable to increased product development staffing
related to the Merger with BIZ. As a percentage of revenue, R&D expenses
increased from 10% during the three months ended September 30, 2000 to 37%
during the three months ended September 30, 2001. The percentage increase was
primarily attributable to an increase in R&D spending combined with a decrease
in total revenue.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. In September 1999, we
acquired Pulsar. All of the outstanding shares of Pulsar were exchanged for
2,169,938 shares of our common stock. The acquisition was accounted for using
the purchase method of accounting. In the fourth quarter of 2000 we determined
the integration of Pulsar would not be completed as
14
planned and the anticipated operating synergies would not be realized.
Therefore, we are currently re-focusing the strategy for Pulsar operations. As a
result, in accordance with Statement 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", we analyzed the
recoverability of the goodwill and other intangibles relating to the acquisition
of Pulsar. In order to evaluate the recoverability of the remaining goodwill and
other intangible assets, we engaged the services of an independent valuation
firm to perform a valuation. During the fourth quarter of 2000, based on the
results of the independent valuation, we recorded an impairment charge of $31.4
million related to unamortized intangible assets acquired in the purchase of
Pulsar. Based on the independent valuation, management believes that after the
impairment charge of $31.4 million, no further impairment exists. The remaining
unamortized intangible assets acquired in the purchase of Pulsar will be
amortized over the remainder of their 10-year life.
The amortization of goodwill and other intangibles decreased 75% from
$711,000 during the three months ended September 30, 2000 to $181,000 during the
three months ended September 30, 2001. The decrease is primarily attributable to
the reduction of goodwill and other intangibles that occurred as the result of
the impairment charge of $31.4 million that we recorded in the fourth quarter of
2000. The reduction in amortization was slightly offset with an increase in
amortization of other intangible assets acquired in the merger.
IN-PROCESS RESEARCH AND DEVELOPMENT. In-process research and development
("IPR&D") expense was approximately $3.3 million during the three months ended
September 30, 2001. There was no IPR&D expense during the three months ended
September 30, 2000. The increase in IPR&D expense was related to the Merger with
BIZ Interactive Zone.
REALIZED LOSS ON TRADING SECURITIES. Realized loss on trading securities
for the three months ended September 30, 2001 was $1.1 million. There was no
realized loss on trading securities during the three months ended September 30,
2000, as the investment was acquired in connection with the BIZ Merger.
OTHER EXPENSE, NET. Net other expense changed $4,000 from a net $44,000
in other expense during the three months ended September 30, 2000 to a net
$40,000 in net other expense during the three months ended September 30, 2001.
The change was primarily attributable to a reduction in interest expense of
$73,000 and a decrease in interest income of $61,000. The reduction in interest
income was primarily the result of lower cash balances in interest bearing
accounts and the decrease in interest expense was primarily the result of
decreased borrowings.
INCOME TAXES. Tax expense for the three months ended September 30, 2000
was minimal and related to franchise taxes for the State of California as
compared to $51,000 for the three months ended September 30, 2001. The tax
expense for the three months ended September 30, 2001 is attributable to a
$51,000 write-off of prior years R&D income tax credits for the State of
California. We did not recognize any tax benefit from operating losses in the
three months ended September 30, 2000 or 2001.
RESULTS OF OPERATIONS -- COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER
30, 2000 AND 2001
TOTAL REVENUES. Total revenues decreased 45% from $28.9 million during
the nine months ended September 30, 2000 to $16.0 million during the nine months
ended September 30, 2001. The decrease was primarily attributable to a decrease
in product revenue of $13.0 million related to network deployment products.
During the nine months ended September 30, 2000, we derived 42% of our
revenue from sales to U.S. Immigration and Naturalization Service. During the
nine months ended September 30, 2001, we derived 12% and 10% of our revenue from
sales to the U.S. Immigration and Naturalization Service and Department of
State. Sales to government agencies accounted for approximately 79% and 71% of
our sales during the nine months ended September 30, 2000 and 2001,
respectively.
PRODUCT REVENUE. Product revenue decreased $12.6 million or 46% from
$27.3 million during the nine months ended September 30, 2000 to $14.7 million
during the nine months ended September 30, 2001. The decrease was primarily
attributable to a $13.0 million decrease in revenues related to network
deployment products combined with a $413,000 increase in revenues related to
data security products.
LICENSE AND SERVICE REVENUE. License and service revenue decreased 19%
from $1.6 million during the nine months ended September 30, 2000 to $1.3
million during the nine months ended September 30, 2001. The decrease was
primarily attributable to a $241,000 decrease in service revenues related to
network deployment support.
PRODUCT GROSS MARGIN. Product gross margins increased as a percentage of
net product revenue from 19% during the nine months ended September 30, 2000 to
21% during the nine months ended September 30, 2001. The increase is primarily
attributable to
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a change in the mix of data security products as compared to network deployment
products. Data security products have a higher gross margin associated with
them, whereas network deployment products have a higher cost of sales as a
percentage of sales associated with them.
LICENSE AND SERVICE GROSS MARGIN. License and service gross margin
increased as a percentage of license and service revenue from 64% during the
nine months ended September 30, 2000 to 70% during the nine months ended
September 30, 2001. This increase was primarily attributable to the discontinued
electric security systems product line. Gross margins related to the electric
security systems product line were significantly less than those related to
other types of licenses and services that we provide.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased 29% from $7.3 million during the nine months
ended September 30, 2000 to $5.2 million during the nine months ended September
30, 2001. The decrease was primarily attributable to a reduction in S,G&A
related payroll expenses at Pulsar. The average S,G&A headcount at Pulsar
decreased by 19, or 48%, during the nine months ended September 30, 2001 as
compared to the nine months ended September 30, 2000. As a percentage of
revenue, S,G&A expenses increased from 25% during the nine months ended
September 30, 2000 to 33% during the nine months ended September 30, 2001. The
percentage increase was primarily attributable to a decrease in S,G&A expenses
combined with a decrease in total revenues .
RESEARCH AND DEVELOPMENT EXPENSES. R&D expenses increased 29% from $4.2
million during the nine months ended September 30, 2000 to $5.4 million during
the nine months ended September 30, 2001. The increase was primarily
attributable to increased product development staffing related to the merger
with BIZ, including development efforts related to the Forte microprocessor,
Maestro, ProFile Manager, NetSign and token reader/writers. As a percentage of
revenue, R&D expenses increased from 15% during the nine months ended September
30, 2000 to 34% during the nine months ended September 30, 2001. The percentage
increase was primarily attributable to an increase in research and development
spending combined with a decrease in total revenues.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. In September 1999, we
acquired Pulsar. All of the outstanding shares of Pulsar were exchanged for
2,169,938 shares of our common stock. The acquisition was accounted for using
the purchase method of accounting. In the fourth quarter of 2000 we determined
the integration of Pulsar would not be completed as planned and the anticipated
operating synergies would not be realized, therefore, we are currently exploring
various alternatives for the Pulsar operations. As a result, in accordance with
Statement 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of", we analyzed the recoverability of the
goodwill and other intangibles relating to the acquisition of Pulsar. In order
to evaluate the recoverability of the remaining goodwill and other intangible
assets, we engaged the services of an independent valuation firm to perform a
valuation. During the fourth quarter of 2000, based on the results of the
independent valuation, we recorded an impairment charge of $31.4 million related
to unamortized intangible assets acquired in the purchase of Pulsar. Based on
the independent valuation, management believes that after the impairment charge
of $31.4 million, no further impairment exists. The remaining unamortized
intangible assets acquired in the purchase of Pulsar will be amortized over the
remainder of their 10-year life.
The amortization of goodwill and other intangibles decreased 89% from
$2.1 million during the nine months ended September 30, 2000 to $228,000 during
the nine months ended September 30, 2001. The decrease is primarily attributable
to the reduction of goodwill and other intangibles that occurred as the result
of the impairment charge of $31.4 million that we recorded in the fourth quarter
of 2000. The reduction in amortization was slightly offset with an increase in
amortization of other intangible assets acquired in the merger.
IN-PROCESS RESEARCH AND DEVELOPMENT. IPR&D expense was $3.3 million
during the nine months ended September 30, 2001. There was no IPR&D expense
during the nine months ended September 30, 2000. The increase in IPR&D expense
was related to the merger with BIZ.
REALIZED LOSS ON TRADING SECURITIES. Realized loss on trading securities
for the nine months ended September 30, 2001 was $1.1 million. There was no
realized loss on trading securities during the nine months ended September 30,
2000 as the investment was acquired in connection with the BIZ Merger.
OTHER EXPENSE, NET. Net other expense changed $65,000 from a net $3,000
in other expense during the three months ended September 30, 2000 to a net
$68,000 in net other expense during the three months ended September 30, 2001.
The change was primarily attributable to a reduction in interest income of
$142,000 and a decrease in interest expense of $85,000. The reduction in
interest income was primarily the result of lower cash balances in interest
bearing accounts and the increase in interest expense was primarily the result
of increased borrowings.
16
INCOME TAXES. Tax expense of $6,000 was recognized during the nine months
ended September 30, 2000 and was primarily related to minimum franchise taxes
for the state of California. We did not recognize any tax benefit from operating
losses in the nine months ended September 30, 2000. Tax expense of $54,000 was
recognized during the nine months ended September 30, 2001 and was primarily
related to a $51,000 write-off of prior years R&D income tax credits for the
State of California and to $2,000 for minimum franchise taxes for the state of
California. We did not recognize any tax benefit from operating losses in the
nine months ended September 30, 2001.
LIQUIDITY AND CAPITAL RESOURCES
In June 1999, we entered into a three-year lending agreement with
Guaranty Business Credit Corporation ("GBCC") permitting borrowings under a
$20.0 million secured revolving line of credit facility that commenced on June
14, 1999. The agreement provided for an annual interest rate of prime plus
.625%; and a pledge of substantially all of our personal and real property as
collateral. Although the credit facility was for borrowings up to $20.0 million,
under the terms of the agreement the amount of borrowing available to us was
subject to a maximum borrowing limitation based on eligible collateral. Eligible
collateral consisted of 85% of eligible accounts receivable plus the lesser of
(a) 50% of the value of eligible on-hand inventory or (b) $1.0 million. As a
result, the amount that was actually available to us at any particular time may
have been significantly less than the full $20.0 million credit facility due to
the maximum borrowing limitation calculation. The agreement with the lender
included a number of covenants and restrictions that we were required to adhere
to. These covenants and restrictions included maintenance of minimum levels of
working capital, tangible net worth, and profitability. In addition, the
agreement did not allow us to pay dividends.
On April 18, 2001, the terms of our revolving line of credit were
amended. Under the terms of the amended agreement the maximum borrowings were
$5.0 million, eligible collateral excluded inventory, and the advance rate was
35%. In addition, certain of the financial covenants and requirements were
adjusted. The amended $5.0 million revolving credit facility also contained
various covenants and restrictions. Under the terms of the amended agreement, we
were required to obtain the lender's consent for any merger or consolidation.
The lender was not willing to give its consent to our Merger with BIZ and
discontinued making advances under the terms of the amended agreement effective
with the Merger. The lender applied all collections subsequent to the Merger to
outstanding borrowings until such borrowings and related interest charges were
paid in full. All amounts due to the lender were paid in full on October 2,
2001. Once all amounts were paid in full the lender released its security
interest in our assets. Borrowings related to this agreement are included in
current installments of long-term debt in the condensed consolidated financial
statements.
On July 31, 2001 our co-chairman, Marvin Winkler, Chase Manhattan Bank
("Chase") advanced $1.0 million for the re-purchase of preferred stock held by
an investor in BIZ. Mr. Winkler executed a $1.0 million demand note with Chase
and BIZ executed a $1 million demand note due September 15, 2001 with J.A.W.
Financial, L.P. ("JAW"), an entity controlled by Mr. Winkler. The demand note
contained an interest charge of prime plus 1% through the maturity date and
prime plus 3% after the maturity date. On October 11, 2001, we made a principal
payment of $30,000, paid accrued interest, and executed a new promissory note to
JAW for $970,000. The terms of the promissory note call for interest of prime
plus 3% payable monthly, together with five monthly payments of principal in the
amount of $160,000 and one final payment on April 15, 2002 in the amount of
$170,000. The promissory note provides Chase a collateral interest in the shares
in Wave Systems Corp. owned by us, and subject to Chase's loan security
guidelines the rights to proceeds from any sales of those shares.
On October 19, 2001, our wholly owned subsidiary, Pulsar, entered into a
financing agreement with Wells Fargo Business Credit, Inc. ("WFBC"), which
provides for the factoring of accounts receivable. On November 2, 2001, the
financing arrangement was expanded to include SSP Solutions, Inc. The agreements
contain no limit on the dollar volume of receivable financing, but do provide
for WFBC's approval of credit limits for non-government customers. The discount
rate charged is 1.25% of the gross receivable, which may be increased by .0625%
per day for accounts that do not pay within thirty days of the receivable
purchase. At the time of purchase, terms call for WFBC to advance 85% of the
gross receivable, with the balance remitted after collection of the invoice less
the discount and any other charges. The agreement contains no loan covenants or
restrictions. The balances due WFBC are guaranteed by Mr. Kris Shah and Mr.
Marvin Winkler, our co-chairmen and co-chief executive officers.
Cash used in operations decreased $5.6 million during the nine months
ended September 30, 2001 as compared to the nine months ended September 30,
2000. The decrease in cash used in operations was primarily attributable to a
decrease of $4.9 million in accounts receivable during the nine months ended
September 30, 2001 as compared to the nine months ended September 30, 2000, and
to an increase of $1.0 million in accounts payable during the nine months ended
September 30, 2001 as compared to the nine months ended September 30, 2000.
17
Cash provided by investing activities decreased $310,000 during the nine
months ended September 30, 2001 as compared to the nine months ended September
30, 2000. The decrease in cash provided by investing activities was attributable
to the net cash paid for the merger of $590,000 offset by a decrease of $785,000
in the amount of property and equipment purchased during the nine months ended
September 30, 2001 as compared to the nine months ended September 30, 2000.
However, during the nine months ended September 30, 2000, the decrease in the
amount of property and equipment purchased was partially offset by $612,000 of
previously restricted cash related to our revolving credit line that was
reclassified as unrestricted during the nine months ended September 30, 2000. In
addition, during the nine months ended September 30, 2001, we received proceeds
of $107,000 from the sale of trading securities.
Cash used in financing activities increased $6.9 million during the nine
months ended September 30, 2001 as compared to the nine months ended September
30, 2000. The increase was primarily attributable to a net increase in debt
repayments combined with a reduction in proceeds from insurance financing during
the nine months ended September 30, 2001 as compared the nine months ended
September 30, 2000.
Based upon current sales and expense levels, we currently anticipate that
existing cash, cash equivalents, investments and the current availability under
our WFBC factoring agreement will not be sufficient to satisfy our contemplated
cash requirements for the next twelve months. Without a substantial increase in
sales or a reduction in expenses, we will continue to incur operating losses. As
a remedy, we are currently in discussion with several sources of financing.
At the time of the Merger, BIZ was a development stage enterprise
devoting substantially all of its efforts towards conducting research and
development, advertising and brand promotion, raising capital and building
infrastructure.
The effects of the events on September 11, 2001 throughout the economy
may have an affect on our commercial customers and their ability to make
payments. The events may also affect potential investors and related terms of
investment capital.
Over the past three years and through September 30, 2001, we have spent
substantial sums on research and development ("R&D") activities. During that
time period, we incurred substantial losses from continuing operations. As a
result, we currently have a deficit in working capital. While we believe the R&D
expenditures created significant future revenue producing opportunities, some of
the related products are just entering production. We are currently involved in
sales pursuits relative to these products that, if successful, will generate
significant revenues. However, unless we receive orders for these new products
and receive significant financing, we can no longer support the current level of
research and development activity. If sales fail to materialize, we will need to
reduce expenses through reductions in staff.
Reduced accounts receivable financing availability caused us to
re-evaluate the operations of our networking business. We made the decision to
reduce low margin sales made through our networking business. This caused a
substantial reduction in the sales and related cost of sales during the quarter,
which in turn reduced cashflow. The reduced cashflow will impair our ability to
meet vendor commitments as they become due.
In May 2001, BIZ signed a development agreement with Wave Systems Corp.
("Wave") for the integration of EMBASSY based systems with set-top box master
reference designs of Broadcom Corporation. Under this agreement, BIZ is required
to pay Wave $278,000 per month beginning June 1, 2001 through December 1, 2002.
Should we not make the required payments, Wave may request payment in the form
of common stock. As of September 30, 2001, we owed $561,551 to Wave, but no
request for stock payments have been made.
In October 2001, the Company executed a memorandum of understanding
("MOU") regarding the integration of Valence Semiconductor ("Valence") GPS chip
technologies, and Homeplug and Gateway technologies with Company products,
together with Valence providing certain modules for inclusion in the Company's
products. The MOU also provides for Valence to license various technologies to
the Company for the integration of Valence Homeplug, Gateway and other
technologies into our products. The Company currently estimates such integration
costs will be $100. Under the MOU, the Company may purchase GPS chips from
Valence at cost, plus payment of a percentage of the actual selling price of
products containing the GPS chip.
In planning for future growth, in October 2001 we arranged for the future
lease of two buildings approximating 62,600 square feet. The buildings are under
construction and we anticipate completion in December 2001, at which time the
leases will commence. Kris Shah, our Co-Chairman, has a minority interest in the
entity that owns the two buildings. The leases would have a monthly triple net
rental totaling approximately $114,600 per month, plus common area costs for
seven years. On one building totaling 22,500 square feet, we have sublet one
half of the building and are in negotiations to sub-lease the other half of that
building, both on terms and conditions matching the underlying lease. The
executed sublease is with a related party company owned by our co-chairman,
Marvin Winkler. Whether we occupy the second building will depend upon the
receipt of sales orders prior to December 31, 2001 and our ability to raise
additional capital. Should we decide to do so, we currently anticipate being
able to sub-lease the second building on terms substantially the same as those
contained in the underlying lease.
With our deficit working capital position, we will not be able to meet
existing obligations as they become due. We will use receivables and investments
to generate liquidity, and have solicited the cooperation of vendors for
extended terms on current obligations. To remedy the working capital deficiency,
we are in discussions with various financing sources.
To satisfy our contemplated cash requirements for the next twelve months
it will be necessary to obtain additional capital from one or more of the
following sources:
Additional equity capital -- We will seek additional equity capital.
Equity capital, if available, will most likely be issued at a discount to
market, or require the issuance of warrants causing a dilution to current
stockholders. In addition, providers of new equity capital may require
additional concessions in order for them to provide needed capital to the
Company.
18
- Convertible debt -- We plan to raise capital through equity
securities. However, depending upon the market and costs for
equity, we may issue a debt instrument. The types of instruments
available in the market would likely contain a provision for the
issuance of warrants and may also be convertible into equity. For
convertible instruments, the anticipated stated interest rates
would be in the mid to low single digits and be payable in cash or
by the issuance of common shares.
- Off balance sheet financing -- our operations are not relatively
capital intensive. However, should we need to add equipment or
decide to expand our facilities, we may use an operating lease
transaction to acquire the use of capital assets. An operating
lease would not appear on our balance sheet and would be charged
as an expense as payments accrue.
- We will finance receivables in conjunction with the WFBC agreement
to generate cash.
- We will sell investments to generate cash. The market value of
trading securities was approximately $1.6 million at September 30,
2001.
- Additional commitment - In a letter to us dated April 17, 2001,
our co-chief executive officer, who is a major shareholder,
committed, if necessary, to providing the personal financial
resources required to enable us to meet all of our financial
obligations as they become due through January 1, 2002.
We had previously indicated our plan to begin shipping our new
CypherServers in mid-2001. Our operating forecast assumed the CypherServer
product launch would go as planned and that anticipated sales of the
CypherServers would be realized. We have not realized the sales previously
anticipated and have undertaken further market research to clarify customer
requirements. We are currently designing enhancements to the software that
operates the CypherServer to more closely meet customer needs. We will re-launch
the CypherServer family of products during 2002. Since we did not realize the
anticipated sales from the initial launch of our CypherServer products it may be
necessary for us to make additional expense reductions beyond those already
made.
We currently have a need for a substantial amount of capital to meet our
liquidity requirements. The amount of capital that we will need in the future
will depend on many factors including, but not limited, to:
- the market acceptance of our products and services
- the levels of promotion and advertising that will be required to
launch new products and services and attain a competitive position
in the market place
- research and development plans
- levels of inventory and accounts receivable
- technological advances
- competitors' responses to our products and services
- relationships with partners, suppliers and customers
- our projected capital expenditures
- merger related costs.
In addition, we may require additional capital to accommodate planned
growth, hiring, infrastructure and facility needs or to consummate acquisitions
of other businesses, products or technologies.
RISK FACTORS
RISKS RELATED TO OUR BUSINESS
19
WE HAVE A HISTORY OF LOSSES AND MAY INCUR FUTURE LOSSES
We may not become profitable or significantly increase our revenue. We
incurred net operating losses of $7.5 million and net losses of $7.5 million for
the nine month period ended September 30, 2000 and net operating losses of $10.3
million and net losses of $11.5 million for the nine month period ended
September 30, 2001. To achieve profitability, we will need to generate and
sustain sufficient revenues while maintaining reasonable cost and expense
levels. We expect to continue to incur significant operating expenses primarily
to support research and development and expansion of our sales and marketing
efforts. These expenditures may not result in increased revenues or customer
growth. We do not know when or if we will become profitable. We may not be able
to sustain or increase profitability on a quarterly or annual basis.
WE HAVE NOT GENERATED ANY SALES TO DATE OF OUR SSP(TM) SOLUTION SUITE, WHICH
MAKES IT DIFFICULT TO EVALUATE OUR CURRENT BUSINESS PERFORMANCE AND FUTURE
PROSPECTS
To date, we have not had any sales of our SSP(TM) Solution Suite and have
not established a sales and marketing force to promote this product. We may be
unable to establish sales and marketing operations to levels necessary for us to
grow this portion of our business, especially if we are unsuccessful at selling
this product into vertical markets. We may not be able to support the
promotional programs required by selling simultaneously into several markets. If
we are unable to develop an efficient sales system, our operating results will
suffer.
THE AVERAGE SELLING PRICE OF OUR PRODUCTS MAY DECREASE, WHICH MAY REDUCE GROSS
MARGINS
The average selling prices for our products may decline as a result of
competitive pricing pressures, promotional programs and customers who negotiate
price reductions in exchange for longer term purchase commitments. The pricing
of products depends on the specific features and functions of the products,
purchase volumes and the level of sales and service support required. We expect
competition to increase in the future. As we experience pricing pressure, we
anticipate that the average selling prices and gross margins for our products
will decrease over product life cycles. These same competitive pressures may
require us to write down the carrying value of inventory on hand, if any.
WE DERIVE A SUBSTANTIAL PORTION OF OUR REVENUE FROM A SMALL NUMBER OF CUSTOMERS
AND, THEREFORE, THE LOSS OF EVEN ONE OF THESE CUSTOMERS COULD SIGNIFICANTLY AND
NEGATIVELY IMPACT OUR OPERATING RESULTS
We depend on a limited number of customers for a substantial portion of
our revenue and many of our contracts with our significant customers are
short-term contracts. The non-renewal of any significant contract upon
expiration, or a substantial reduction in sales to any of our significant
customers, would adversely affect our business unless we were able to replace
the revenue we received from these customers. During the nine month period ended
September 30, 2000, we derived 42% of our consolidated revenue from one customer
and during the nine month period ended September 30, 2001, we derived 12% of our
consolidated net revenue from one customer.
IF THE SSP(TM) SOLUTION SUITE IS NOT COMMERCIALLY SUCCESSFUL, OUR OPERATING
RESULTS WILL SUFFER
Although we have had some success selling our security solutions to
government agencies, we are just beginning to enter the complex and competitive
commercial market for digital commerce and communication security solutions. We
believe that many potential customers in our target markets are not fully aware
of the need for security products and services in the digital economy.
Historically, only enterprises having substantial resources developed or
purchased security solutions for Internet or other means of delivering digital
content. Also, there is a perception that security in delivering digital content
is costly and difficult to implement. Therefore, we will not succeed unless we
can educate our target markets about the need for security in delivering digital
content and convince potential customers of our ability to provide this security
in a cost-effective and easy-to-use manner.
Even if we convince our target markets about the importance of and need
for such security, we do not know if this will result in the sale of our
products. To date, we have not entered into any commitments or contractual
agreements for the delivery of the SSP(TM) Solution Suite products or
components. Commercial customers may not select our products over those of our
competitors. If our SSP(TM) Solution Suite products or components do not achieve
wide market acceptance and/or if our pricing system is not competitive, our
ability to earn revenues will be negatively impacted and our operating results
will suffer.
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OUR RELIANCE ON THIRD PARTY TECHNOLOGIES FOR THE DEVELOPMENT OF THE SSP(TM)
SOLUTION SUITE PRODUCTS AND OUR RELIANCE ON THIRD PARTIES FOR MANUFACTURING MAY
DELAY PRODUCT LAUNCH, IMPAIR OUR ABILITY TO DEVELOP AND DELIVER PRODUCTS OR HURT
OUR ABILITY TO COMPETE IN THE MARKET
We have licensed the rights to use a broad array of technology components
from third parties to develop the SSP(TM) Solution Suite and we face many risks
associated with our reliance on third parties as follows:
- a third party may develop or enable others to develop a similar
solution to digital communication security issues as the SSP(TM)
Solution Suite thereby eroding our market share;
- Our dependence on the patent protection of third parties may not
afford us any control over the protection of the technologies we
rely on, and, thus, if the patent protection of any of these third
parties were compromised, our ability to compete in the market
would also be impaired.
OUR INABILITY TO MAINTAIN AND DEVELOP NEW RELATIONSHIPS WITH PARTNERS AND
SUPPLIERS COULD IMPACT OUR ABILITY TO OBTAIN OR SELL OUR PRODUCTS INCLUDING THE
SSP(TM) SOLUTION SUITE AND RESULT IN A FAILURE TO GENERATE REVENUES
We plan to obtain certain of our products, have products built to
specifications and sell products through alliance and supplier agreements. While
we will have direct sales channels, we currently anticipate that many of our
products will be sold through alliance and supplier partners. While we have
entered into such agreements, none of these agreements include commitments to
purchase any of our products. If alliance or supplier agreements are cancelled,
modified or delayed, if alliance or supplier partners decide not to purchase our
products or purchase only limited quantities of our products, or if we are
unable to enter into additional alliance or supplier agreements, our ability to
produce and sell our products and, therefore, our ability to generate revenues,
could be adversely affected.
FAILURE TO LICENSE NEW TECHNOLOGIES COULD IMPAIR OUR NEW PRODUCT DEVELOPMENT
Our SSP(TM) Solution Suite is a collection of technologies, some of which
are licensed from our alliance and supplier partners. As a result, our ability
to license new technologies from third parties is and will continue to be
critical to our ability to offer a complete suite of products that meets
customer needs and technological requirements. Some of our licenses do not run
for the length of the patent for the technology. We may not be able to renew our
existing licenses on favorable terms, or at all. If we lose the rights to a
patented technology, we may need to stop selling certain of our products or
redesign our products or lose a competitive advantage. Potential competitors
could license technologies that we fail to license and potentially erode our
market share for certain products.
IF PUBLIC KEY INFRASTRUCTURE, OR PKI, TECHNOLOGY IS COMPROMISED, OUR BUSINESS
WOULD BE ADVERSELY AFFECTED
Many of our products are based on PKI technology. The security afforded
by this technology depends on the integrity of a user's private key, which
depends in part, on the application of algorithms, or advanced mathematical
factoring equations. The occurrence of any of the following could result in a
decline in demand for our data security products:
- Any significant advance in techniques for attacking PKI systems,
including the development of an easy factoring method or faster,
more powerful computers;
- publicity of the successful decoding of cryptographic messages or
the misappropriation of private keys; and
- government regulation limiting the use, scope or strength of PKI.
IF USE OF THE INTERNET AND OTHER COMMUNICATION NETWORKS BASED ON INTERNET
PROTOCOLS DOES NOT CONTINUE TO GROW, DEMAND FOR OUR PRODUCTS MAY NOT INCREASE
Increased demand for our products depends in large part on the continued
growth of the Internet and Internet protocol-based networks and the widespread
acceptance and use of these mediums for electronic commerce and communications.
Because electronic
21
commerce and communications over these networks are evolving, we cannot predict
the size of the market and its sustainable growth rate. A number of factors may
affect market size and growth rate, including:
- the use of electronic commerce and communications may not
increase, or may increase more slowly than we expect;
- the Internet infrastructure and communications services to support
electronic commerce may not be able to continue to support the
demands placed on it by continued growth; and
- the growth and reliability of electronic commerce and
communications could be harmed by delays in development or
adoption of new standards and protocols to handle increased levels
of activity or by increased governmental regulation.
WE FACE INTENSE COMPETITION FROM A NUMBER OF SOURCES
The markets for our products and services are intensely competitive and,
as a result, we face significant competition from a number of different sources.
We may be unable to compete successfully as many of our competitors are more
established, benefit from greater name recognition and have substantially
greater financial, technical and marketing resources than we have. In addition,
there are several smaller and start-up companies with which we compete from time
to time. We also expect that competition will increase as a result of
consolidation in the information security technology and product reseller
industries.
THIRD PARTIES COULD OBTAIN ACCESS TO OUR PROPRIETARY INFORMATION OR
INDEPENDENTLY DEVELOP SIMILAR TECHNOLOGIES BECAUSE OF THE LIMITED PROTECTION FOR
OUR INTELLECTUAL PROPERTY
Our business, financial condition and operating results could be
adversely affected if we are unable to protect our intellectual property rights.
Notwithstanding the precautions we take, third parties may copy or obtain and
use our proprietary technologies, ideas, know-how and other proprietary
information without authorization or independently develop technologies similar
or superior to our technologies. In addition, the confidentiality and
non-competition agreements between us and our employees, distributors, and
clients may not provide meaningful protection of our proprietary technologies or
other intellectual property in the event of unauthorized use or disclosure.
Policing unauthorized use of our technologies and other intellectual property is
difficult, particularly because the global nature of the Internet makes it
difficult to control the ultimate destination or security of software or other
data transmitted. Furthermore, the laws of other jurisdictions may afford little
or no effective protection of our intellectual property rights.
IF WE ARE UNABLE TO RAISE ADDITIONAL CAPITAL TO FUND OUR FUTURE OPERATIONS, OUR
BUSINESS WILL BE HARMED
If we are unable to obtain additional capital to fund operations when
needed, our product development efforts would be adversely affected, causing our
business, operating results, financial condition and prospects to be materially
harmed. If we undertake or accelerate significant research and development
projects for new products, we may require additional outside financing. We
expect that, to meet our long-term needs, we will need to raise substantial
additional funds through the sale of equity securities or the incurrence of
additional debt or through collaborative arrangements. Any additional equity
financing may be dilutive to stockholders, and debt financing, if available, may
involve restrictive covenants. Collaborative arrangements, if necessary to raise
additional funds, may require us to relinquish rights to certain technologies,
products or marketing territories. Our failure to raise capital when needed
could have a significant negative effect on our business, operating results,
financial condition and prospects.
IF WE DO NOT RESPOND TO RAPID TECHNOLOGICAL CHANGES, OUR PRODUCTS AND SERVICE
OFFERINGS COULD BECOME OBSOLETE
If we are unable to modify existing products and develop new products
that are responsive to changing technology and standards and meet customer needs
in a timely and cost effective manner, our business could be adversely affected.
The markets we serve are characterized by rapidly changing technology, emerging
industry standards and frequent introduction of new products. The introduction
of products embodying new technologies and the emergence of new industry
standards may render our products obsolete or less marketable. The process of
developing our products and services is extremely complex and requires
significant continuing development efforts.
22
IF WE FAIL TO ESTABLISH AND MAINTAIN STRATEGIC RELATIONSHIPS, OUR ABILITY TO
DEVELOP AND MARKET OUR PRODUCTS WOULD BE ADVERSELY AFFECTED
The loss of any of our existing strategic relationships, or the inability
to create new strategic relationships in the future, could adversely affect our
ability to develop and market our products. We depend upon our partners to
develop and market products and to fund and perform their obligations as
contemplated by our agreements with them. We do not control the time and
resources devoted by our partners to these activities. These relationships may
not continue or may require us to spend significant financial, personnel and
administrative resources from time to time. We may not have the resources
available to satisfy our commitments, which may adversely affect our strategic
relationships. Further, our products and services may compete with the products
and services of our strategic partners. This competition may adversely affect
our relationships with our strategic partners, which could adversely affect our
business.
WE MAY FACE CLAIMS OF INFRINGEMENT OF PROPRIETARY RIGHTS
There is a risk that our products infringe the proprietary rights of
third parties. In addition, whether or not our products infringe on proprietary
rights of third parties, infringement or invalidity claims may be asserted or
prosecuted against us and we could incur significant expense in defending them.
If any claims or actions are asserted against us, we may be required to modify
our products or seek licenses for these intellectual property rights. We may not
be able to modify our products or obtain licenses on commercially reasonable
terms, in a timely manner or at all. Our failure to do so could adversely affect
our business.
A SECURITY BREACH OF OUR INTERNAL SYSTEMS OR THOSE OF OUR CUSTOMERS COULD HARM
OUR BUSINESS
Since we will provide security for Internet and other digital
communication networks, we may become a greater target for attacks by computer
hackers. We will not succeed unless the marketplace is confident that we provide
effective security protection for Internet and other digital communication
networks. Networks protected by our products may be vulnerable to electronic
break-ins. Because the techniques used by computer hackers to access or sabotage
networks change frequently and generally are not recognized until launched
against a target, we may be unable to anticipate these techniques. Although we
have not experienced any act of sabotage or unauthorized access by a third party
of our internal network to date, if an actual or perceived breach of security
for Internet and other digital communication networks occurs in our internal
systems or those of our end-user customers, regardless of whether we caused the
breach, it could adversely affect the market perception of our products and
services. This could cause us to lose customers, resellers, alliance partners or
other business partners.
DOING BUSINESS WITH THE U.S. GOVERNMENT ENTAILS MANY RISKS, WHICH COULD
ADVERSELY AFFECT US
Sales to U.S. government agencies accounted for 71% of our consolidated
revenue for the nine month period ended September, 2001. Our sales to these
agencies are subject to risks, including:
- early termination of our contracts;
- disallowance of costs upon audit; and
- the necessity to participate in competitive bidding and proposal
processes, which is costly, time consuming and may result in
unprofitable contracts.
In addition, the government may be in a position to obtain greater rights
with respect to our intellectual property than we would grant to other entities.
Government agencies also have the power, based on financial difficulties or
investigations of its contractors, to deem contractors unsuitable for new
contract awards. Because we engage in the government contracting business, we
have been and will be subject to audits and may be subject to investigation by
governmental entities. Failure to comply with the terms of any of our
governmental contracts could result in substantial civil and criminal fines and
penalties, as well as our suspension from future government contracts for a
significant period of time, any of which could adversely affect our business.
OUR BUSINESS MAY BE THE TARGET OF TERRORIST ACTIVITIES, OR OUR REVENUES MAY BE
AFFECTED BY THE AFFECT OF TERRORIST ACTIVITIES ON OUR CUSTOMERS AND/OR EMPLOYEES
The full effects of the events on September 11, 2001 have not been
determined. The ripple effects throughout the economy may have an affect on our
potential commercial customers, or their ability to purchase our products and
services. Additionally, because we
23
offer security products, we may be targeted by terrorist groups for the
follow-up activities threatened against the United States based targets.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY
Our quarterly operating results may fluctuate significantly as a result
of a variety of factors, many of which are outside our control. These factors
include:
- the length of our customer commitments;
- patterns of information technology spending by customers;
- the timing, size, mix and customer acceptance of our product and
service offerings and those of our competitors;
- the timing and magnitude of required capital expenditures; and
- the need to use outside contractors to complete some assignments.
DELAYS IN DELIVERIES FROM OUR SUPPLIERS OR DEFECTS IN GOODS OR COMPONENTS
SUPPLIED BY OUR VENDORS COULD CAUSE REVENUES TO DECLINE AND ADVERSELY AFFECT OUR
OPERATING RESULTS
We rely on a limited number of vendors for certain components for the
products we are developing that will comprise the SSP(TM) Solution Suite. If we
are unable to purchase these components, this may delay or prevent product
shipments and result in a loss of sales. In addition, if any components have
undetected flaws, this could lead to unanticipated costs to repair or replace
these parts. This could cause a loss of revenue, which would adversely affect
our results of operations. We may not be able to replace any of our supply
sources on economically advantageous terms. Further, if we experience price
increases for the components for our products, we will experience declines in
our gross margins.
A DEFAULT UNDER OUR SECURED CREDIT ARRANGEMENTS COULD RESULT IN A FORECLOSURE OF
OUR ACCOUNTS RECEIVABLE BY OUR CREDITOR
All of accounts receivable are pledged as collateral to secure portions
of our debt. This means that if we default on our secured debt obligations, our
indebtedness could become immediately due and payable and the lenders could
foreclose on our assets.
OUR INABILITY TO FIND ALTERNATIVE SUPPLIERS OF COMPONENTS MAY ADVERSELY AFFECT
OUR BUSINESS
Some of the components incorporated into our products are produced by
other vendors. We currently purchase some of these components from a single
supplier, thus presenting a risk that they may not be available on commercially
reasonable terms in the
24
future or at all. Our inability to develop alternative sources, if necessary,
may require us to re-design certain products, which could result in delays or
reductions in product shipments that could adversely affect our business.
WE DEPEND ON KEY MANAGEMENT PERSONNEL
Our success will depend largely on the continuing efforts of our
executive officers and senior management. Our business may be adversely affected
if the services of any of our key personnel become unavailable to us. There is a
risk that these individuals will not continue to serve for any particular period
of time. While we have obtained a key person life insurance policy on the life
of Kris Shah, our co-chairman, co-chief executive officer and secretary in the
amount of $3 million, this amount may not be sufficient to offset the loss of
his service. We have not yet obtained any such policies on the lives of our
other key executives.
THERE IS SIGNIFICANT COMPETITION IN OUR INDUSTRY FOR HIGHLY SKILLED EMPLOYEES
AND OUR FAILURE TO ATTRACT AND RETAIN TECHNICAL PERSONNEL WOULD ADVERSELY AFFECT
OUR BUSINESS
We may not be able to attract or retain highly skilled employees. Our
inability to hire or retain highly qualified individuals may impede our ability
to develop, install, implement and service our software and hardware systems,
customers and potential customers or efficiently conduct our operations, all of
which may adversely affect our business. The data security and networking
solution industries are characterized by a high level of employee mobility, and
the market for highly qualified individuals in the computer-related fields is
intense. This competition means there are fewer highly qualified employees
available to hire and the costs of hiring and retaining these individuals are
high. Even if we are able to hire these individuals, we may be unable to retain
them. Furthermore, there is increasing pressure to provide technical employees
with stock options and other equity interests, which may dilute earnings per
share.
POTENTIAL PRODUCT DEFECTS COULD SUBJECT US TO CLAIMS FROM CUSTOMERS
Products as complex as those we offer may contain undetected errors or
result in failures when first introduced or when new versions are released.
Despite our product testing efforts and testing by current and potential
customers, it is possible that errors will be found in new products or
enhancements after commencement of commercial shipments. The occurrence of
product defects or errors could result in adverse publicity, delay in product
introduction, diversion of resources to remedy defects, loss of or a delay in
market acceptance, claims by customers against us, or could cause us to incur
additional costs, any of which could adversely affect our business.
WE MAY BE EXPOSED TO POTENTIAL LIABILITY FOR ACTUAL OR PERCEIVED FAILURE TO
PROVIDE REQUIRED PRODUCTS OR SERVICES
Because our customers rely on our products for critical security
applications, we may be exposed to potential liability claims for damage caused
to an enterprise as a result of an actual or perceived failure of our products.
An actual or perceived breach of enterprise network or data security systems of
one of our customers, regardless of whether the breach is attributable to our
products or solutions, could adversely affect our business reputation.
Furthermore, our failure or inability to meet a customer's expectations
in the performance of our services, or to do so in the time frame required by
the customer, regardless of our responsibility for the failure, could:
- result in a claim for substantial damages against us by the
customer;
- discourage customers from engaging us for these services; and
- damage our business reputation.
In addition, as a professional services provider, a portion of our
business involves employing people and placing them in the workplace of other
businesses. Therefore, we are also exposed to liability for actions taken by our
employees while on assignment.
OUR EFFORTS TO EXPAND INTERNATIONAL OPERATIONS ARE SUBJECT TO A NUMBER OF RISKS
We are currently seeking to increase our international sales. Our
inability to maintain or to obtain federal or foreign regulatory approvals
relating to the import or export of our products on a timely basis could
adversely affect our ability to expand our
25
international business. Additionally, our international operations could be
subject to a number of risks, any of which could adversely affect our future
international sales, including:
- increased collection risks;
- trade restrictions;
- export duties and tariffs;
- uncertain political, regulatory and economic developments; and
- inability to protect our intellectual property rights.
OUR ABILITY TO PRODUCE THE FORTE PKI CARD ON A TIMELY AND COST-EFFECTIVE BASIS
DEPENDS ON THE AVAILABILITY OF A COMPUTER CHIP FROM A THIRD-PARTY SUPPLIER, WITH
WHOM WE DO NOT EXPECT TO MAINTAIN A SUPPLY AGREEMENT
Any inability to receive adequate supplies of Atmel Corporation's
specially designed Forte microprocessor would adversely affect our ability to
complete and sell the Forte PKI card. We do not anticipate maintaining a supply
agreement with Atmel Corporation for the Forte microprocessor. If Atmel were
unable to deliver the Forte microprocessor for a lengthy period of time or
terminated its relationship with us, we would be unable to produce the Forte PKI
card until we could design a replacement computer chip for the Forte
microprocessor. We anticipate this would take substantial time and resources to
complete.
THERE ARE LAWSUITS PENDING AGAINST US AND OUR WHOLLY-OWNED SUBSIDIARY, PULSAR,
WHICH, IF RESOLVED AGAINST EITHER US OR PULSAR, COULD ADVERSELY AFFECT OUR
BUSINESS
We recently received a notice from Microsoft pertaining to alleged sales
by us of unlicensed copies of Microsoft Office to the Immigration and
Naturalization Service, or INS, as part of a bundle in which some of our
hardware and software was installed onto Dell computers. The computers were then
resold to the INS, along with Microsoft Office software that we received from
Dell, as part of a bundled hardware/software package on the belief that the INS
was licensed to use the software. We are currently investigating the matter, but
have no way of assessing or quantifying potential exposure, if any, at this
point.
In addition, there is a lawsuit pending against Pulsar which, if resolved
against Pulsar, could materially and adversely affect our financial condition.
This suit was brought by G2 Resources, Inc. alleging breach of contract by
Pulsar. This suit was dismissed but G2 Resources has refiled the suit.
OUR STOCK PRICE IS EXTREMELY VOLATILE
The trading price of our common stock is highly volatile as a result of
factors specific to us or applicable to our market and industry in general.
These factors, include:
- variations in our annual or quarterly financial results or those
of our competitors;
- company issued earnings announcements that vary from consensus
analyst estimates;
- changes by financial research analysts in their recommendations or
estimates of our earnings;
- conditions in the economy in general or in the information
technology service sector in particular;
- announcements of technological innovations or new products or
services by us or our competitors; and
- unfavorable publicity or changes in applicable laws and
regulations, or their judicial or administrative interpretations,
affecting us or the information technology service sectors.
In addition, the stock market has recently been subject to extreme price
and volume fluctuations. This volatility has significantly affected the market
prices of securities issued by many companies for reasons unrelated to the
operating performance of these
26
companies. In the past, following periods of volatility in the market price of a
company's securities, some companies have been sued by their stockholders. If we
were sued, it could result in substantial costs and a diversion of management's
attention and resources, which could adversely affect our business.
WE HAVE ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN ACQUISITION AND
COULD ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK
Our certificate of incorporation and bylaws contain provisions that may
deter a takeover or a change in control or prevent an acquisition not approved
by our board of directors, or that may adversely affect the price of our common
stock.
GOVERNMENTAL REGULATIONS AFFECTING SECURITY OF INTERNET AND OTHER DIGITAL
COMMUNICATION NETWORKS COULD LIMIT THE MARKET FOR OUR PRODUCTS AND SERVICES
The United States and other foreign governments have imposed controls,
export license requirements and restrictions on the import or export of some
technologies, including encryption technology. Any additional governmental
regulation of imports or exports or failure to obtain required export approval
of our encryption technologies could delay or prevent the acceptance and use of
encryption products and public networks for secure communications and could
limit the market for our products and services. In addition, some foreign
competitors are subject to less rigorous controls on exporting their encryption
technologies and, as a result, they may be able to compete more effectively than
us in the United States and in international security markets for Internet and
other digital communication networks. In addition, certain governmental
agencies, such as the Federal Communications Commission, periodically issue
regulations governing the conduct of business in telecommunications markets that
may negatively affect the telecommunications industry and us.
A SMALL NUMBER OF STOCKHOLDERS, WHO INCLUDE CERTAIN OF OUR OFFICERS AND
DIRECTORS, HAVE THE ABILITY TO CONTROL STOCKHOLDER VOTES
Kris Shah, Marvin Winkler, their affiliates and certain family members
own, in the aggregate, approximately [63.8%] of our outstanding common stock.
These stockholders, if acting together, have the ability to elect our directors
and to determine the outcome of corporate actions requiring stockholder
approval, irrespective of how our other stockholders may vote. This
concentration of ownership may also have the effect of delaying or preventing a
change in control of our company.
RISKS RELATED TO THE RECENT MERGER
THE ANTICIPATED BENEFITS OF THE MERGER MAY NOT BE REALIZED
The anticipated benefits of the Merger may not be realized due to a
number of factors. For example:
- The anticipated management synergies and operational efficiencies
of the Merger may not be realized.
- The anticipated increase in sales resulting from the combined
efforts and combined distribution channels may not be realized.
WE MAY NOT SUCCESSFULLY INTEGRATE OUR BUSINESS WITH BIZ, WHICH COULD HARM FUTURE
EARNINGS
As a result of the Merger, we face challenges in integrating our products
and services with those of BIZ and this may continue for some time. The
integration might not be smooth or successful. The integration of certain
operations requires the dedication of management resources, which may
temporarily distract management's attention from the day-to-day business of the
combined company. The business of the combined company may also be disrupted by
employee uncertainty and lack of focus during the integration. If this occurs,
the anticipated advantages from the Merger could be undermined and our business,
financial condition and results of operations could be adversely impacted.
OUR INABILITY TO INTEGRATE OUR MANAGEMENT TEAM WITH BIZ'S MANAGEMENT TEAM MAY
ADVERSELY AFFECT OUR ABILITY TO REALIZE THE EXPECTED BENEFITS OF THE MERGER
The success of the recent Merger depends, in part, on our ability to
unite the members of our respective management teams. Combining management from
BIZ and our company has resulted in changes that affect all employees and
operations. Differences in
27
corporate cultures, strategies and management philosophies may strain employee
relations. Additionally, if we encounter difficulties in integrating our
management teams, our ability to realize the expected benefits from the Merger,
including management synergies, operational efficiencies and increased sales,
could be adversely affected.
UNANTICIPATED COSTS RELATING TO THE RECENT MERGER COULD REDUCE OUR FUTURE
EARNINGS
We believe that we reasonably estimated the likely costs of integrating
our operations with the operations of BIZ and the incremental costs of operating
as a combined company. It is possible, however, that unexpected transaction
costs, such as taxes, fees or professional expenses, or unexpected future
operating expenses, such as increased personnel costs, as well as other types of
unanticipated developments, could adversely impact our business and
profitability.
THE UNCERTAINTIES ASSOCIATED WITH THE RECENT MERGER MAY CAUSE OUR CUSTOMERS TO
DELAY OR DEFER DECISIONS, WHICH MAY RESULT IN THE LOSS OF CUSTOMERS AND REVENUES
Our customers may, in response to the announcement of the Merger, delay
or defer decisions concerning business with us. Any delay or deferral in those
decisions by our customers could adversely affect our business. For example, we
could experience a decrease in expected revenue as a consequence of such delays
or deferrals.
THE UNCERTAINTIES ASSOCIATED WITH THE RECENT MERGER MAY CAUSE US TO LOSE KEY
PERSONNEL
Current and prospective employees may perceive uncertainty about their
future role with us until strategies with regard to the combined company are
announced or executed. Any uncertainty may adversely affect our ability to
attract and retain key management, sales, marketing and technical personnel.
MERGER-RELATED ACCOUNTING CHARGES MAY DELAY OR REDUCE OUR PROFITABILITY
We have accounted for the acquisition of BIZ as a purchase. Under the
purchase method of accounting, the purchase price of BIZ is allocated to the
fair value of the identifiable tangible and intangible assets and liabilities
that we acquired from BIZ. The excess of the purchase price over BIZ's tangible
net assets results in intangible assets for us that will have to be amortized
over their useful lives with the exception of goodwill based on the adoption of
Statement 142. In addition, we incurred an in-process research and development
charge of $3.3 million in connection with our recent acquisition of BIZ. As a
result, we will incur accounting charges from the Merger that may delay and
reduce our profitability.
RECENTLY ISSUED FASB STATEMENTS REQUIRE US TO EVALUATE THE FAIR VALUES OF
INTANGIBLE ASSETS AND GOODWILL THAT WE ACQUIRED IN THE MERGER THAT COULD RESULT
IN SIGNIFICANT CHARGES TO OUR EARNINGS AND MAY ADVERSELY AFFECT THE MARKET PRICE
OF OUR COMMON STOCK
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement 141, "Business Combinations", and Statement 142, "Goodwill and Other
Intangible Assets." The changes included in these statements require companies
to perform impairment tests on goodwill and certain intangibles using a fair
value approach rather than allowing companies to amortize goodwill and certain
intangibles over their estimated useful lives. We are now required to evaluate
periodically whether intangible assets and goodwill that we acquired in the
Merger have fair values that meet or exceed the amounts recorded on our balance
sheet. We cannot predict whether or when there will be an impairment charge, or
the amount of such charge, if any. However, if the charge is significant, it
could cause the market price of our common stock to decline. In addition,
adoption of the Statement 142 will eliminate recurring amortization charges that
would remove certain intangible assets and goodwill from our balance sheet, and
such amounts will remain permanently on our balance sheet unless future
evaluations require us to record impairment charges.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
In June 1999 we entered into an agreement with GBCC permitting us to
borrow under a $20 million secured revolving line of credit facility. As of
September 30, 2001, there was $35,000 outstanding under the line, which was paid
off on October 2, 2001.
The Company owns Class A common stock of Wave Systems Corp., which is
classified as trading securities. The Stock is traded on the NASDAQ exchange and
the increase or decrease in value of the stock is included in the Company's
statement of operations, together with the gain or loss on sales of Stock.
28
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved from time to time in routine litigation that arises in
the ordinary course of business.
On January 16, 1998, G2 Resources Inc. (G2) filed a complaint against
Pulsar in the Circuit Court, Fifteenth Judicial Circuit, Palm Beach County,
Florida. G2 claimed that Pulsar breached a contract under which G2 agreed to
provide services related to the monitoring of government contracts available for
bid and the preparation and submission of bids on behalf of Pulsar. The contract
provided that Pulsar pay G2 $500,000 in 30 monthly installments of $16,666 and
an additional fee of 2% of the gross dollar amount generated by awards. In its
complaint, G2 alleged that Pulsar failed to make payments under the contract and
claimed damages in excess of $525,000 plus interest, costs and attorneys fees.
In the course of discovery G2 asserted that its losses/costs arising out of its
claim amounted to approximately $10.3 million. Pulsar asserted that G2 failed to
perform the services required under the contract and Pulsar filed a claim for
compensatory damages, interest and attorneys fees against G2. Classical
Financial Services, LLC intervened in the case. Classical claims that G2
assigned its accounts receivable to Classical under a financing program and that
Pulsar breached its obligations to Classical by failing to make payments under
the contract with G2. Pulsar asserted defenses to Classical's claim. On April
20, 2001, a court hearing was held and G2's complaint against Pulsar was
dismissed without prejudice on the basis of no prosecution activity for more
than 12 months. On May 22, 2001, G2 filed a new complaint against Pulsar. We
believe that the claims made by G2 against Pulsar are without merit and intend
to vigorously defend against these claims.
We recently received a notice from Microsoft pertaining to alleged sales
by us of unlicensed copies of Microsoft Office to the Immigration and
Naturalization Service, or INS, as part of a bundle in which some of our
hardware and software was installed onto Dell computers. The computers were then
resold to the INS, along with Microsoft Office software that we received from
Dell, as part of a bundled hardware/software package on the belief that the INS
was licensed to use the software. We are currently investigating the matter, but
have no way of assessing or quantifying potential exposure, if any, at this
point.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 23, 2001, we adopted an amendment to our amended and restated
certificate of incorporation to change our name from Litronic Inc. to SSP
Solutions, Inc. and to increase the number of authorized shares of common stock
from 25,000,000 shares to 100,000,000 shares.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On August 23, 2001, we held our annual meeting of stockholders. At this meeting,
our stockholders were asked to vote on the following seven matters:
the approval of the merger of our wholly-owned subsidiary Litronic Merger Corp.
with and into BIZ Interactive Zone, Inc. pursuant to an Agreement and Plan of
Reorganization dated July 3, 2001 by and among us, Litronic Merger Corp and BIZ;
the approval of our amended and restated 1999 stock option plan;
the election of four directors;
the approval of amendments to our amended and restated certificate of
incorporation to change our name to SSP Solutions, Inc. and to increase the
number of authorized shares of common stock from 25,000,000 shares to
100,000,000 shares;
the ratification of KPMG LLP as our independent auditors for fiscal 2001;
the approval of the issuance of our securities in future financing transactions;
and
the approval of our 2001 employee stock purchase plan.
29
As of June 29, 2001, or the record date for the determination of
stockholders entitled to notice of and to vote at the meeting, there were
9,747,526 shares of our common stock outstanding. Of these, 8,478,837 shares
were represented either in person or by proxy at the meeting, representing 86.9%
of our total outstanding shares as of the record date.
The first item presented for a vote before our stockholders was the
approval of the merger of Litronic Merger Corp. with and into BIZ. Of the votes
received, 6,194,191 shares were in favor of the proposal, 30,281 were against
and 3,400 abstained from voting on the matter. There were 2,250,965 broker
non-votes in connection with this proposal.
The second item presented for a vote before our stockholders was the
approval of our amended and restated 1999 stock option plan. Of the votes
received, 6,070,089 shares were in favor of the proposal, 151,283 were against
and 6,500 abstained from voting on the matter. There were 2,250,965 broker
non-votes in connection with this proposal.
The third item presented for a vote before our stockholders was the
election of four directors to our board of directors. Set forth below is
information with respect to the nominees elected as directors at the annual
meeting and the votes cast for, against and/or withheld with respect to each
such nominee. The terms of two of our directors, Kris Shah and Frank Cilluffo,
were not yet up and as such, they were not up for re-election at the meeting but
continue to serve on our board of directors.
Nominee For Against Withheld
------- --- ------- --------
Gregg Amber 8,437,698 41,139 0
Bruce Block 8,448,548 30,289 0
Matthew Medeiros 8,437,698 41,139 0
Marvin Winkler 8,434,498 44,339 0
There were no broker non-votes in connection with this proposal.
The fourth item presented for a vote before our stockholders was the
approval of the amendments to our amended and restated certificate of
incorporation. Of the votes received, 6,116,781 shares were in favor of the
proposal, 99,603 were against and 11,488 abstained from voting on the matter.
There were 2,250,965 broker non-votes in connection with this proposal.
The fifth item presented for a vote before our stockholders was the
ratification of the appointment of KPMG LLP as our independent auditors for
fiscal 2001. Of the votes received, 8,447,528 shares were in favor of the
proposal, 22,059 were against and 9,250 abstained from voting on the matter.
There were no broker non-votes in connection with this proposal.
The sixth item presented for a vote before our stockholders was the
approval of the issuance of our securities in future financing transactions. Of
the votes received, 6,132,367 shares were in favor of the proposal, 83,720 were
against and 11,785 abstained from voting on the matter. There were 2,250,965
broker non-votes in connection with this proposal.
The final item presented for a vote before our stockholders was the
approval of our 2001 employee stock purchase plan. Of the votes received,
6,170,074 shares were in favor of the proposal, 45,908 were against and 11,890
abstained from voting on the matter. There were 2,250,965 broker non-votes in
connection with this proposal.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit No. Description
----------- -----------
2.1 Agreement and Plan of Reorganization dated as of
July 3, 2001 by and among Litronic Inc., Litronic
Merger Corp., and BIZ Interactive Zone, Inc. (1)
30
2.2 Agreement of Merger dated as of August 24, 2001 by
and among Litronic Inc., Litronic Merger Corp.,
and BIZ Interactive Zone, Inc. (2)
4.1 Termination Agreement dated as of August 24, 2001,
by and among BIZ Interactive Zone, Inc., certain
BIZ Interactive Zone, Inc. stockholders, certain
Litronic Inc. stockholders, and Litronic Inc. (now
"SSP Solutions")
10.1 Microsoft Letter Agreement with the SSP Solutions,
Inc. dated as of October 11, 2001
10.2 Grid Demand Promissory Note dated as of July 31,
2001 by and between JAW Financial, L.P. and BIZ
Interactive Zone, Inc.
10.3 Cross-Receipt dated as of July 26, 2001 by and
between BIZ Interactive Zone, Inc. and e-celerator
fund, L.P.
10.4 SSP Solutions, Inc. Amended and Restated 1999
Stock Option Plan (#) (3)
10.5 SSP Solutions, Inc. 2001 Employee Stock Purchase
Plan (#) (4)
10.6 Account Purchase Agreement dated as of November 2,
2001 by and between Pulsar Data Systems,
Incorporated and Wells Fargo Business Credit, Inc.
for the sale and assignment of Accounts Receivable
10.7 Account Purchase Agreement dated as of November 2,
2001 by and between SSP Solutions, Inc. and Wells
Fargo Business Credit, Inc. for the sale and
assignment of Accounts Receivable
10.8 Guaranty dated as of November 2, 2001 by Kris
Shah for the benefit of Wells Fargo Business
Credit Inc. relative Pulsar Data Systems, Inc.
Purchase Agreement dated November 2, 2001
10.9 Guaranty dated as of November 2, 2001 by Kris
Shah for the benefit of Wells Fargo Business
Credit Inc. relative to SSP Solutions, Inc.
Purchase Agreement dated November 2, 2001
10.10 Guaranty dated as of November 2, 2001 by Marvin
Winkler for the benefit of Wells Fargo Business
Credit Inc. relative Pulsar Data Systems, Inc.
Purchase Agreement dated November 2, 2001
10.11 Guaranty dated as of November 2, 2001 by Marvin
Winkler for the benefit of Wells Fargo Business
Credit Inc. relative to SSP Solutions, Inc.
Purchase Agreement dated November 2, 2001
(b) Reports on Form 8-K.
We filed a Form 8-K for August 22, 2001 on August 23, 2001 in connection
with the dissemination of a press release announcing changes in management,
chairman of the board positions, and the name of the Company, following the
Merger. The filing included "Item 5 -- Other Events" and "Item 7 -- Financial
Statements and Exhibits."
We filed a Form 8-K for September 7, 2001 on September 7, 2001 in
connection with the completion of the Merger, change of listing symbol and
potential Nadsaq delisting. The filing included "Item 2 -- Acquisition of
Disposition of Assets", "Item 5 -- Other Events", and "Item 7 -- Financial
Statements, Pro Forma Financial Information and Exhibits".
We filed a Form 8-K/A for August 24, 2001 on November 6, 2001 in
connection with the completion of the Merger. The filing included "Item 2 --
Acquisition or Disposition of Assets", "Item 5 -- Other Events", and "Item 7 --
Financial Statements, Pro Forma Financial Information and Exhibits".
----------
(#) Management contract or compensatory plan, contract or arrangement
required to be filed as an exhibit.
(1) Filed on November 13, 2001 as an exhibit to the registrant's registration
statement on Form S-8 and incorporated herein by reference.
(2) Filed on November 13, 2001 as an exhibit to the registrant's registration
statement on Form S-8 and incorporated herein by reference.
(3) Filed as an exhibit to the registrant's definitive proxy statement filed
pursuant to Section 14(a) of the Securities Exchange Act of 1934 on July
25, 2001 and incorporated herein by reference.
(4) Filed as an exhibit to the registrant's definitive proxy statement filed
pursuant to Section 14(a) of the Securities Exchange Act of 1934 on July
25, 2001 and incorporated herein by reference.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 19, 2001 SSP SOLUTIONS, INC.
By /s/ MARVIN J. WINKLER
-------------------------------------
Marvin J. Winkler
Director, Co-Chairman of the Board
and Co-Chief Executive Officer
By /s/ KRIS SHAH
-------------------------------------
Kris Shah
Director, Co-Chairman of the Board
and Co-Chief Executive Officer
By /s/ THOMAS E. SCHIFF
-------------------------------------
Thomas E. Schiff
Chief Financial Officer
32
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
2.1 Agreement and Plan of Reorganization dated as of
July 3, 2001 by and among Litronic Inc., Litronic
Merger Corp., and BIZ Interactive Zone, Inc. (1)
2.2 Agreement of Merger dated as of August 24, 2001 by
and among Litronic Inc., Litronic Merger Corp.,
and BIZ Interactive Zone, Inc. (2)
4.1 Termination Agreement dated as of August 24, 2001,
by and among BIZ Interactive Zone, Inc., certain
BIZ Interactive Zone, Inc. stockholders, certain
Litronic Inc. stockholders, and Litronic Inc. (now
"SSP Solutions")
10.1 Microsoft Letter Agreement with the SSP Solutions,
Inc. dated as of October 11, 2001
10.2 Grid Demand Promissory Note dated as of July 31,
2001 by and between JAW Financial, L.P. and BIZ
Interactive Zone, Inc.
10.3 Cross-Receipt dated as of July 26, 2001 by and
between BIZ Interactive Zone, Inc. and e-celerator
fund, L.P.
10.4 SSP Solutions, Inc. Amended and Restated 1999
Stock Option Plan (#) (3)
10.5 SSP Solutions, Inc. 2001 Employee Stock Purchase
Plan (#) (4)
10.6 Account Purchase Agreement dated as of November 2,
2001 by and between Pulsar Data Systems,
Incorporated and Wells Fargo Business Credit, Inc.
for the sale and assignment of Accounts Receivable
10.7 Account Purchase Agreement dated as of November 2,
2001 by and between SSP Solutions, Inc. and Wells
Fargo Business Credit, Inc. for the sale and
assignment of Accounts Receivable
10.8 Guaranty dated as of November 2, 2001 by Kris
Shah for the benefit of Wells Fargo Business
Credit Inc. relative Pulsar Data Systems, Inc.
Purchase Agreement dated November 2, 2001
10.9 Guaranty dated as of November 2, 2001 by Kris
Shah for the benefit of Wells Fargo Business
Credit Inc. relative to SSP Solutions, Inc.
Purchase Agreement dated November 2, 2001
10.10 Guaranty dated as of November 2, 2001 by Marvin
Winkler for the benefit of Wells Fargo Business
Credit Inc. relative Pulsar Data Systems, Inc.
Purchase Agreement dated November 2, 2001
10.11 Guaranty dated as of November 2, 2001 by Marvin
Winkler for the benefit of Wells Fargo Business
Credit Inc. relative to SSP Solutions, Inc.
Purchase Agreement dated November 2, 2001
----------
(#) Management contract or compensatory plan, contract or arrangement
required to be filed as an exhibit.
(1) Filed on November 13, 2001 as an exhibit to the registrant's registration
statement on Form S-8 and incorporated herein by reference.
(2) Filed on November 13, 2001 as an exhibit to the registrant's registration
statement on Form S-8 and incorporated herein by reference.
(3) Filed as an exhibit to the registrant's definitive proxy statement filed
pursuant to Section 14(a) of the Securities Exchange Act of 1934 on July
25, 2001 and incorporated herein by reference.
(4) Filed as an exhibit to the registrant's definitive proxy statement filed
pursuant to Section 14(a) of the Securities Exchange Act of 1934 on July
25, 2001 and incorporated herein by reference.
33