U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
COMMISSION FILE NUMBER 1-13463
BIO-KEY INTERNATIONAL, INC.
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(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
MINNESOTA 41-1741861
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(State or other jurisdiction of (IRS Employer Identification Number)
Incorporation of organization)
1285 CORPORATE CENTER DRIVE, SUITE #175, EAGAN, MN 55121
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(Address of Principal Executive Offices) (Zip Code)
(651) 687-0414
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ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE.
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
Common Stock, $0.01 par value per share None
SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT
None
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act 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___
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this form 10-KSB. _X_
State issuer's revenues for its most recent fiscal year: $155,399
The aggregate market value of the voting common equity held by
non-affiliates of the registrant based on the closing sale price of the
registrant' common stock as reported on the OTC Bulletin Board on March 26, 2003
was $.37. The information provided shall in no way be construed as an admission
that any person whose holdings are excluded from the figure is an affiliate or
that any person whose holdings are included in the figure is not an affiliate,
and any such admission is hereby disclaimed. The information provided is solely
for the record keeping purposes of the Securities and Exchange Commission.
As of March 26, 2003, 14,377,406 shares of the registrant's common
stock were outstanding.
Transitional Small Business Disclosure Formats (check one):
Yes ___ No _X_
DOCUMENTS INCORPORATED BY REFERENCE
None.
PART I
PRIVATE SECURITIES LITIGATION REFORM ACT
The information contained in this Annual Report on Form 10-KSB
and in other public statements by the Company and Company officers or directors
includes or may contain certain forward-looking statements. The words "may,"
"will," "expect," "anticipate," "believe," "continue," "estimate," "project,"
"intend," and similar expressions used in this Report are intended to identify
forward-looking statements within the meaning of Section 27A of the U.S.
Securities Act of 1933 and Section 21E of the U.S. Securities Exchange Act of
1934. You should not place undue reliance on these forward-looking statements,
which speak only as of the date made. We undertake no obligation to publicly
release the result of any revision of these forward-looking statements to
reflect events or circumstances after the date they are made or to reflect the
occurrence of unanticipated events. You should also know that such statements
are not guarantees of future performance and are subject to risks, uncertainties
and assumptions. Many of these risks and uncertainties are set forth under the
caption "RISK FACTORS" in Item I of this Report. Should any of these risks or
uncertainties materialize, or should any of our assumptions prove incorrect,
actual results may differ materially from those included within the
forward-looking statements.
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL DESCRIPTION OF BUSINESS; MARKET
BIO-key, International, Inc., formerly known as SAC Technologies, Inc.
(the "Company" or "BIO-key"), was formed in 1993 and is in the business of
developing and marketing proprietary biometric technology and software
solutions. Biometric technology, the science of analyzing specific human
characteristics which are unique to each individual in order to identify a
specific person from a broader population, is an emerging technology. Examples
of the unique biological characteristics that can be used to identify an
individual include fingerprints, iris patterns, hand geometry, voice recognition
and facial structure. Fingerprint analysis is an accurate and reliable method to
distinguish one individual from another and is viewed as less intrusive than
many other biometric identification methods. As a result, fingerprint analysis
has gained the most widespread use for biometric identification. Biometric
technology represents a novel approach to identity verification which has only
been used in limited applications and has not gained widespread acceptance in
any commercial or consumer markets.
BIO-key has pioneered the development of high performance automated
finger identification technology that can be used without the aide of
non-automated methods of identification such as a personal identification number
(PIN), password, token, smart card, ID card, credit card, passport, drivers
license or other form of possession based or knowledge based identification.
This advanced BIO-key(TM) identification technology improves both the
accuracy and speed of finger-based biometrics and is the only finger
identification algorithm that has been certified by the International Computer
Security Association (ICSA). The Company's proprietary biometric technology
scans a person's fingerprint and identifies a person, typically within a few
seconds, without the use of any other identifying data. The Company believes
that its fingerprint identification technology will have a broad range of
possible applications relating to information security and access control,
including:
o Securing Internet sites, Web pages and electronic transactions
o Securing access to private networks
o Securing access to building and restricted areas
The Company's initial business plan was to develop an integrated
fingerprint identification product consisting of the Company's core technology
embedded into an optical reader for mass commercialization and distribution. The
Company's current business plan is to:
o License its core technology to OEMs, systems integrators and
application developers to develop products and applications which
utilize the Company's core technology.
o License WEB-key(TM), its web-based biometric authentication solution.
During 2002, the Company began to actively market and sell its
technology and generated minimal sales, principally to biometric system
integrators and value added resellers focused on the security and logical access
markets. The Company competes in a new and evolving market and offers a novel
software solution. For these reasons, the sales cycle is long and the Company
has yet to generate any significant revenue.
MARKET OVERVIEW
Although recent security concerns relating to identification of
individuals has resulted in an increased interest in biometrics generally,
biometric technology has not gained widespread commercial acceptance. Biometric
based solutions compete with more traditional security methods such as keys,
cards, personal identification numbers and security personnel, as well as
competing biometric technologies including voice, face, iris and hand geometry.
The market for business-to-business and business-to-consumer transactions is
substantial and continues to grow. Such transactions are subject to fraud based
on unauthorized persons gaining access to confidential information. The Company
believes that its biometric technology provides a more reliable method for
confirming the identity of persons in remote locations than existing traditional
methods.
Biometric technology is a novel approach to facility and digital
security. Acceptance of biometrics as an alternative to traditional security
methods depends upon a number of factors including:
o The reliability of biometric solutions
o Public perception regarding privacy concerns
o Costs involved in adopting and integrating biometric solutions
Commercial markets have been slow to accept biometrics as a viable alternative
to traditional security methods. Accordingly, the primary competition for
biometric technology has been the traditional security methods described above.
With respect to competing biometrics, each has its strength and weaknesses and
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none has emerged as a market leader. Fingerprint identification is generally
viewed as inexpensive and non-intrusive, but also as less accurate. Iris
scanning is viewed as extremely accurate, but also as inconvenient to use and
expensive. Facial recognition has recently received substantial attention,
however, it suffers from accuracy limitations. In summary, the market for
biometric technology is undeveloped and evolving.
TECHNOLOGY
The Company was formed in 1993 for the purpose of developing an
automated fingerprint identification system. Since that time, the Company has
developed proprietary fingerprint identification technology consisting of the
following:
o VST(TM) (Vector Segment Technology), the patent pending core algorithm
which creates a mathematical representation of a fingerprint based on
its particular characteristics.
o Software which translates and standardizes the image of the
fingerprint for computer analysis ("Biometric Solution").
o SDK (Developers Tool Kit), a biometric application development tool
which facilitates integration of the Company's technology for vertical
market applications.
Utilizing these technologies, the Company is continuing to develop
identification products and software solutions which are designed to assure that
only individuals comprising an approved fingerprint in an online or embedded
database are allowed access to an application through real time authentication
with an emphasis on Web based applications.
Vector Segment Technology. The Company's IT security solutions are
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built around its patent pending VST(TM) (Vector Segment Technology) which
processes features of a live fingerprint. These features are reduced to a
mathematical representation unique to the individual. When a person seeking
access to a computer network or restricted area places his or her finger on a
reader, a new mathematical representation is generated which is compared to an
on-line database to determine whether it matches any mathematical representation
on file. If there is a match, the person is identified and given access to the
application, computer network, Web Site or restricted area. This can be
accomplished without the use of a key, password, user-Id, card, PIN number or
token. The actual fingerprint is not typically stored in the database for
commercial applications. For a more complete description of VST, see "CURRENT
OFFERINGS" below.
De-coupling of Technologies. In order to effectuate the Company's
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evolution from a hardware provider to a licensor of software solutions, the
Company has modified its core Vector Segment Technology to make it easily
adaptable to scanners other than its proprietary readers. In the past, the
Company's identification algorithm had required the use of its own high
resolution reader technology to provide for reliable identification
applications. The further development of the Vector Segment Technology has
allowed for the de-coupling of the core identification algorithm from the reader
technology allowing the algorithm to be utilized with lower resolution and lower
quality readers available from other manufacturers. VST has expanded its
hardware independence capabilities with added scanner communications. The
Company's finger identification technology is now completely hardware
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independent and can be integrated with virtually any finger reading devise.
Enrollments or capture of an individual's biometric ID can be done on one type
of scanner and looked-up or identified for a match on another type of scanner.
This is a very unique capability in the biometric market and allows the
Company's software to be used and integrated with almost any finger scanner
hardware.
Identification Verses Verification Technology. Management believes that
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the Company's Vector Segment Technology is superior to similar technologies
utilized by its competitors. Unlike many of the biometric technologies currently
available, the Company's technology can identify the fingerprint of an unknown
person by searching a database to determine whether the current scanned
mathematical representation matches any previously stored mathematical
representation. Most of the Company's fingerprint competitors simply verify that
the fingerprint image of a known person matches a previously stored copy or
model of that individual's fingerprint. By their very nature, such verification
systems require an additional item of data such as a PIN number or access card
to initially identify the user. Verification systems, therefore, do not
eliminate the need for cumbersome access cards, keys or PIN numbers and the
administrative costs associated with the distribution and replacement of such
data. By contrast, the Company's identification technology typically does not
require any identifying data other than a person's fingerprint. Based on the
foregoing, the Company believes that its identification technology provides it
with a meaningful competitive advantage in the marketplace.
CURRENT OFFERINGS
The following is a description of the status of each of the Company's
current offerings.
VST (Vector Segment Technology) SDK (Systems Developer Kit). The
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Company's SDK is a means of delivering its patent-pending finger identification
algorithm, called Vector Segment Technology (VST), as an integrated software
into existing and new applications. The VST SDK is a software kit licensed to
original equipment manufacturers, systems integrators and application developers
for the purpose of permitting them to develop biometric applications for
distribution to their respective customers.
The VST SDK improves both the accuracy and speed of fingerprint-based
security systems. Traditional fingerprint analysis classifies fingerprints by
mapping their minutiae reference points--distinct features in specific
locations. Most automated fingerprint identification systems create a template
of these minutiae reference points and uses it as the basis for comparison and
verification. However, strictly minutiae-based templates cannot achieve a high
level of differentiation, making them unsuitable for real-time identification
applications. To achieve rapid verification, they often compromise on detail,
supplementing the fingerprint template with a user ID or password. This enables
quick one-to-one matching, but not true identification. VST transcends the
conflict between differentiation and speed by mapping the fingerprint in an
entirely new way. Instead of focusing on minutiae point coordinates, VST also
analyzes the vector segment relationships in the entire fingerprint pattern. The
result is a highly informative representation of the finger packaged as a
mathematical model.
Unlike other algorithms on the market today, VST processes hundreds of
data relationships for each element in the finger model. Because this data is
concisely expressed, VST makes it possible to rapidly identify people based on
their finger alone, without a user ID, password or smart card. This allows for
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the true identification of users, not just verifying the identity of a known
user. No security system can achieve total security as long as a user's
identifying data can be stolen or duplicated. Whereas a user ID, a password or
even a scanned fingerprint image can be stolen, the mathematical model produced
by VST can not. Once a finger is scanned and converted to a VST mathematical
model, the scanned image is destroyed. All that remains is a mathematical model
that cannot be decoded to obtain the original fingerprint image.
WEB-key(TM). WEB-key is a biometric identification/authentication
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software solution designed to secure Web based applications through the use of a
Web based browser plug-in and a server side plug-in. WEB-key is designed to
provide security and identification assuring that a remote user is in fact who
they say they are without the need of a password, PIN, or smart card. WEB-key
protects personal information such as credit card, address, account numbers and
other private data by only disseminating such information upon the authorization
of the owner of such information as determined by such person's fingerprint.
WEB-key is an Internet ready three-tiered Internet application
architecture software security solution. The Company licenses WEB-key(TM) as an
integrated solution of it's VST algorithm for securing e-commerce, e-business,
and web-based transaction applications. All WEB-key communication is
triple-encrypted to prevent secure information from being intercepted over the
Internet. Using WEB-key's browser plug-in, users enroll finger identification at
a WEB-key enabled Web site from their own PC. After enrollment, WEB-key requests
finger identification every time a user begins a secure session. WEB-key's
interface guides users through the few steps necessary to gain an accurate
finger identification. The entire identification process takes less time than
typing a user ID and password.
The Web based server authentication application is an integrated
solution involving the distribution of readers and the licensing of client and
server based software to provide for reliable and cost effective user
authentication in connection with the processing of transactions over the
Internet. This solution is also intended to secure other Internet applications
such as restricting access to specific Web pages, specific information contained
on a Web-site or specific applications. The Company believes it has the
opportunity to be the first supplier of a reliable electronic identification and
authorization solution which operates effectively without the aid of a personal
identification number or password supplied by the user.
Architecture. WEB-key provides an easy-to-use and secure method for
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granting users access via the Internet to proprietary information residing on
remote servers.
WEB-key consists of three basic components:
o a finger print scanner
o Vector Segment Technology processing software tightly and securely
integrated with a web browser
o an identification database residing on a web server.
The user simply logs-on a computer or application residing on a
computer using their fingerprint in lieu of a PIN number, password, user name or
smart card. WEB-key begins by processing a raster scan image which is enhanced
using WEB-key software integrated into the web browser. The image enhancing
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employs a variety of proprietary techniques to improve accuracy and protect
against spoofing. The WEB-key software then converts the enhanced image into a
unique mathematical representation of the fingerprint using Vector Segment
Technology. An encrypted print model is generated for transmission across the
Internet to the central WEB-key registry. The WEB-key web server de-encrypts the
mathematical model which operates as an index key for searching the database for
a match. The web server matches the Vector Segment Technology BIO-key against a
database of registered users to obtain a match. If a match is found, the user is
allowed access to the protected content on a connected web server.
WEB-key provides a reliable and secure user authentication solution.
WEB-key takes advantage of new security features in Microsoft's Internet
Explorer versions 5.5 SP2 and 6.0, in addition to 1024 bit enhanced encryption
capabilities integrated with public/private key pairs. WEB-key has also been
integrated with Oracle9iRAC, which offers advanced speed, scalability, and
reliance to WEB-key's database tier. Additional tools and software based on VST
technology are under development.
The Company does not currently, and does not intend in the future, to
manufacture any hardware. The Company relies on OEMs, or systems integrators and
other licensees of its software to supply the necessary hardware, including
optical readers. The Company has relationships with hardware manufacturers which
enable the Company to supply readers to potential clients as an integrated
solution when necessary. Currently, the Company has integrated its software with
readers manufactured by Polaroid, Authentec, Ethentica, Siemens, and other
independent manufactures. The Company's technology includes proprietary open
architecture communication software which allows virtually any reader to be
integrated with the Company's technology within several weeks.
POTENTIAL MARKET
The growth of electronic fingerprint identification will be driven by
the need for secure access to private applications and proprietary databases
residing on both private and public network infrastructures. The scope of these
opportunities include:
o corporations that increasingly rely upon the exchange and distribution
of proprietary information among staff using intranet or other private
networks
o business-to-business e-commerce among trading partners which share
confidential information on a secure basis
o business-to-consumer e-commerce where the e-commerce service provider
wants to restrict access to paying subscribers
Although electronic commerce has many benefits, the geographical
separation of buyers from sellers creates a significant problem arising from the
opportunity for fraud. Firewall and encryption software address important
aspects of security but do not address the fraud problem inherent in the
potential anonymity of a remote user. Corporate intranets are an equally
attractive and compelling market. Corporations increasingly rely upon intranet
infrastructure for the dissemination of proprietary business data throughout an
organization. Since access rights to different classes of data vary among
employees, password identification and authorization is integral to all
corporate networks.
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The current solution to these issues is the association of passwords
and PIN numbers with individuals. This solution requires employees or users to
remember or retain a growing number of keys cards, passwords and PIN numbers and
employers or Internet companies to periodically change passwords and PIN numbers
to maintain their integrity. Since such information can be stolen or shared,
they provide no assurance that the user is actually who they claim to be.
WEB-key has been designed to address each of these concerns. The Company
believes that replacement of traditional passwords presents a substantial market
opportunity. The Company's technology could virtually replace and eliminate the
need for passwords and the associated administrative costs while providing a
higher assurance of identity security and user convenience. Government,
aviation/transportation and enterprise security present significant additional
opportunities.
MARKETING AND DISTRIBUTION
The Company's marketing and distribution efforts consist of:
o Development of strategic alliances with technology leaders
o General promotion of biometric technology and the Company's offerings
o Direct technology licensing efforts to, among others, OEMs,
application developers and system integrators.
The Company's current marketing efforts are conducted primarily through
direct selling efforts of its Chief Executive Officer, and other marketing
personnel to OEMs, application developers and operators of private networks.
The Company attends and actively participates in various product
conferences and conventions in the technology and security industries to
generate market awareness of biometric technology generally, and the Company's
offerings specifically. In October 2000, the Company began a collaborative
presentation effort with Intel Corporation whereby the Company and Intel created
a proof-of-concept demonstration of the Company's WEB-key product. The
demonstration was created across the Intel IA32 and Itanium family processor
products and was first presented at the Intel Developer Forum (IDF) in February
2001. Intel continues to showcase the Company's biometric IT security solution
as a lead application for Intel's next generation Itanium Internet/e-business
server and as a solution working with Oracle 9i and Oracles database. Although
the Company intends to participate in events and other conferences with Intel,
there can be no assurances that Intel will continue to allow the Company to
participate with it at any such events or conferences. The Company has been
aggressively marketing its WEB-key and SDK technology to leads generated from
these efforts.
The Company has also entered into alliances and/or joint sales and
marketing arrangements with Oracle and Intel, to develop and implement new
security systems utilizing the Company's technology for the Federal Government.
The events of September 11th have heightened the need for securing data
dissemination throughout and between government agencies and automating the
positive identification of personnel. The Company believes that its finger
identification technology coupled with the capabilities of its alliance partners
are the most advanced solutions capable of meeting these needs.
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The Company is targeting both Internet infrastructure companies and
large portal providers as licensees of its WEB-Key solution. On the Internet
infrastructure side, the Company is currently seeking to partner with Internet
server manufacturers, providers of database and data warehouse engine software,
horizontally positioned application engines, firewall solution providers and
peripheral equipment manufacturers. On the portal side, the Company is currently
targeting financial service providers such as credit and debit card
authorization and issuing institutions, Internet retailers, business-to-business
application service providers (ASPs) and corporate intranets.
During 2002, the Company commenced a direct selling effort of WEB-key
and entered into license agreements with OEMs and system integrators to develop
applications for distribution to their respective customers. The Company expects
to continue to generate revenue during the remainder of 2003 from existing and
new customer relationships.
For the following reasons, the Company has yet to generate any
significant revenue. The Company competes in a new and evolving market and
offers a novel software solution. This has resulted in a long sales cycle as
commercial markets continue to evaluate biometrics as a viable alternative to
more traditional security methods such as personal identification numbers,
passwords and the like. In addition, during 2000 and 2001, the Company was
focused on developing and refining its technology and introducing its technology
to the market through participation in technology conferences and trade shows.
The Company did not begin a direct selling effort until 2002. This effort has
resulted in a limited number of sales commencing in the second quarter of 2002.
COMPETITION
The markets for the Company's products and technologies are developing
and are characterized by intense competition and rapid technological change. No
assurance can be given that the Company's competitors will not develop new or
enhanced technologies that will offer superior price, performance or function
features or render the Company's products or technologies obsolete.
In addition to existing commonplace methods of restricting access to
facilities such as pass cards, PIN numbers, passwords, locks and keys, there are
numerous companies involved in the development, manufacture and marketing of
fingerprint biometrics products to government, law enforcement, prison and
consumer markets. These companies include, but are not limited to, PRINTRAK
International, IDENTIX, DigitalPersona, Bioscript and BioLink.
Most current automated fingerprint identification product sales have
been for government and law enforcement applications, which are typically priced
higher than the Company's products and licensing arrangements. Although most of
the companies specifically targeting consumer application markets have completed
the development of their products, biometric products and technologies have not
been widely accepted in the commercial markets.
With current non-biometric technologies, the user must typically
possess a key, card, or bit of information such as a PIN number or password.
These systems are easily defeated by obtaining possession of the key, card, or
password, or by counterfeiting the key or card. The Company's biometric
technology is intended to replace such systems and substantially reduce the
related security breaches. Although biometric based "verification" systems can
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identify a person and prevent unauthorized persons from entering into a
restricted area, such systems do not eliminate the need for PIN numbers, cards,
keys or tokens. By contrast, the Company's identification technology typically
does not require the use of any such additional identifier other than the
person's fingerprint and "identifies" rather than "verifies" the subject. The
Company believes that such end-user convenience creates a meaningful competitive
advantage for the Company. There can be no assurance, however, that the
Company's competitors will not develop similar or superior "identification"
technology, which could have a material adverse effect on the Company's
financial condition and results of operation. The Company will also be competing
for market share with other biometric technologies including hand geometry, iris
scanning, retinal scanning, and signature verification, as well as existing
lock/security/card technology.
Many of the Company's competitors have substantially greater financial
resources and experience in marketing Internet security applications than the
Company. In addition, the Company's WEB-key(TM) offering is a unique approach to
Internet security, requires the distribution and use of additional peripheral
hardware, namely an optical reader, and has not been adopted by any company
conducting business over the Internet. For these and other reasons, there can be
no assurance that the WEB-key(TM) solution will gain any meaningful market
acceptance or that the Company will be able to compete effectively in its chosen
markets.
INTELLECTUAL PROPERTY RIGHTS
The Company's technology consists of knowledge and information relating
to computer hardware and software which is used to create an automated process
of imaging a fingerprint, formatting the fingerprint for computer analysis, and
identifying and verifying the print relative to an existing database of
fingerprint information. The Optic Technology and the Company's Biometrics
Solution (STBS) and Vector Segment Technology are owned by the Company. The
Company has filed a patent application relating to both the Optic Technology and
Biometrics Solution (STBS) components of its technology wherein several claims
have been allowed. The Company has also filed a patent application with respect
to the Vector Segment Technology. There can be no assurance that any additional
patents will be issued, or that, if issued, the Company will have the resources
to protect any such issued patent infringement. Although the Company believes
that its technology does not infringe upon patents held by others, no assurance
can be given that such infringements do not exist.
Part of the Company's technology consists of software or hardware
implementations of software ("firmware"). The Company intends to take measures
to ensure copyright protection for its software and firmware releases prior to
distribution. Where possible, the firmware/software is serialized in an attempt
to ensure that only matched sets will function together. This provides both a
mechanism to combat cloning of the Company's products and a method for
standardizing products. The Company believes it has developed common law
trademark rights in the terms SACMan(TM), SACcat(TM), SAC_Remote(TM),
BIO_Key(TM), SACSecure(TM), SACcipher__, WEB-key(TM) and SACbook(TM) and has
filed federal trademark applications. The Company does not claim any additional
trademarks.
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RESEARCH AND DEVELOPMENT
During fiscal years ended December 31, 2001 and 2002, the Company spent
approximately $948,000 and $1,085,000, respectively, on research and
development. The Company's limited customer base did not directly bear these
costs, which were principally funded through, outside sources of equity and debt
financing. During 2003, the Company's research and development effort will be
focused on the continued evolution of its Web based authentication solution,
furthering the VST algorithm, SDK and Web-key products.
GOVERNMENT REGULATION
The Company is not currently subject to direct regulation by any
government agency, other than regulations generally applicable to businesses.
However, in the event of any international sales or overseas manufacturing, the
Company would likely be subject to various domestic and foreign laws regulating
such exports and export activities.
ENVIRONMENTAL REGULATION
As of the date of this Report, the Company has not incurred any
material expenses relating to the compliance with federal, state or local
environmental laws and does not expect to incur any material expenses in the
foreseeable future.
EMPLOYEES AND CONSULTANTS
The Company currently employs eleven (11) individuals on a full-time
basis; six (6) in engineering, research and development, three (3) in finance
and administration and two (2) in sales and marketing. The Company also utilizes
three (3) consultants who provide marketing, engineering and management services
to the Company. The Company anticipates retaining additional sales personnel
within the next twelve (12) months to execute its business plan.
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RISK FACTORS
The following material risk factors, among others, may affect the
Company's financial condition and results of operations.
BUSINESS AND FINANCIAL RISKS
BASED ON OUR NEGATIVE WORKING CAPITAL, NEGATIVE NET WORTH AND
SUBSTANTIAL LOSSES, OUR AUDITORS HAVE RAISED SUBSTANTIAL DOUBT ABOUT OUR ABILITY
TO CONTINUE IN BUSINESS.
We have met our working capital requirements through financing
transactions involving the public or private placement of our securities. We do
not expect our current working capital to support our operations beyond December
2003 and we are in need of substantial additional capital to fund operations.
Since our inception, we have not generated any significant revenue and have
experienced substantial losses, including $4,019,974 during 2002. We also have
negative working capital and a negative net worth. As a result of these factors,
our independent auditors have included an explanatory paragraph in their opinion
for the year ended December 31, 2002 as to the substantial doubt about our
ability to continue as a going concern. Our financial statements have been
prepared in accordance with accounting principals generally accepted in the
United States, which contemplate that we will continue to operate as a going
concern. Our financial statements do not contain any adjustments that might
result if we are unable to continue as a going concern.
WE ARE A DEVELOPMENT STAGE COMPANY, HAVE GENERATED MINIMAL REVENUE AND
HAVE SUSTAINED SUBSTANTIAL OPERATING LOSSES. WE EXPECT LOSSES TO CONTINUE WHICH
WILL REQUIRE US TO RAISE ADDITIONAL CAPITAL TO CONTINUE OPERATIONS.
We were formed in 1993 and have yet to generate any significant
revenue. From inception through December 31, 2002, we have accumulated losses of
$22,359,428 and negative cash flow from operations of $16,180,560. As of
December 31, 2002, we had negative working capital of $7,299,038 and a negative
net worth of $7,177,047. Since our inception, we have focused almost exclusively
on developing our core technology and have not had any success marketing our
technology. In order to generate revenue, we will have to retain additional
sales and marketing personnel and incur substantial expenses. We can not assure
you that we will be able to secure these necessary resources, that a significant
market for our technology will develop or that we will be able to generate any
significant revenues. For these reasons we anticipate that net losses will
continue.
WE NEED SUBSTANTIAL ADDITIONAL FINANCING TO EXECUTE OUR BUSINESS PLAN
WHICH MAY NOT BE AVAILABLE. IF WE ARE UNABLE TO RAISE ADDITIONAL CAPITAL, WE MAY
NOT BE ABLE TO CONTINUE OPERATIONS.
We need substantial additional capital to expand our marketing and
sales efforts. Our current resources are insufficient to fund operations beyond
December 31, 2003. We believe we need an additional $3,000,000 to $5,000,000 to
execute our business plan and support operations through 2004. Although The
11
Shaar Fund has committed to provide an additional $1,370,000 in incremental
monthly advances through November, 2003. This obligation is conditioned upon
events outside of our control, including the average trading price of our common
stock exceeding $1.00 per share during the month preceding any advance. For
these reasons, we are currently seeking to obtain additional financing through
the issuance of debt or equity securities on a negotiated private placement
basis with institutional and accredited investors. We have not and can not
assure you that we will ever be able to secure any such financing on terms
acceptable to us. If we can not obtain such financing, we will not be able to
execute our business plan or continue operations.
OUR OUTSTANDING CONVERTIBLE PREFERRED STOCK IS CONVERTIBLE INTO SHARES
OF COMMON STOCK AT A DISCOUNT TO THE TRADING PRICE AT THE TIME OF CONVERSION. IN
ADDITION, CERTAIN OF OUR OUTSTANDING CONVERTIBLE NOTES ARE CONVERTIBLE INTO OUR
OUTSTANDING CONVERTIBLE PREFERRED STOCK. IF THE TRADING PRICE OF OUR COMMON
STOCK DECLINES, THESE SECURITIES WILL BE CONVERTED INTO A GREATER NUMBER OF
SHARES RESULTING IN SUBSTANTIAL DILUTION TO OUR EXISTING SHAREHOLDERS, WHICH
COULD HAVE A SIGNIFICANT NEGATIVE EFFECT ON THE TRADING PRICE OF OUR COMMON
STOCK.
Our preferred stock is convertible into shares of common stock at a per
share conversion price equal to the lesser of $.75 or a 22% discount to the
average of the closing bid prices of our common stock during the five trading
days preceding conversion. In addition, $1,730,000 principal amount of our
outstanding convertible notes and up to $1,370,000 of future potential advances
under such notes are convertible into additional shares of our convertible
preferred stock which, in turn, are convertible into shares of our common stock
on the terms described above. As a result of these provisions, in the event the
trading price of our common stock declines, we will be required to issue a
greater number of shares of common stock upon conversion of the notes and
preferred stock. This could result in the issuance of a substantial number of
additional shares resulting in substantial dilution to our existing
shareholders. For example, if the trading price of our common stock declines
from $.75 to $.40, we would be required to issue 5,344,230 additional shares of
common stock upon conversion of the preferred stock and currently outstanding
principal amount of our notes. The issuance of these additional shares could
have a substantial negative effect on the trading price of our common stock.
The terms of the notes and preferred stock prohibit the holder from
converting these securities into common stock if the conversion would result in
the holder owning in excess of 4.99% of our outstanding shares. Although this
limits the holder's right to convert these securities into more than 4.99% of
our outstanding shares at any one time, it does not prevent the holder from
immediately reselling all shares acquired upon conversion and then converting
additional securities into up to an additional 4.99% of our outstanding shares.
Accordingly, these provisions do not limit the number of shares we may be
required to issue upon conversion of these securities. This will result in
substantial dilution to our existing shareholders and could have a significant
negative effect on the trading price of our common stock.
OUR TECHNOLOGY HAS NOT GAINED MARKET ACCEPTANCE AND WE DO NOT KNOW
WHETHER A MARKET WILL DEVELOP FOR OUR TECHNOLOGY IN THE FORESEEABLE FUTURE TO
GENERATE ANY REVENUE.
Biometric technology has received only limited market acceptance,
particularly in the private sector. Our technology represents a novel security
solution and we have not generated any significant sales. Although recent
security concerns relating to identification of individuals has increased
12
interest in biometrics generally, it remains an undeveloped, evolving market.
Biometric based solutions compete with more traditional security methods
including keys, cards, personal identification numbers and security personnel.
Acceptance of biometrics as an alternative to such traditional methods depends
upon a number of factors including:
o the reliability of biometric solutions
o public perception regarding privacy concerns
o costs involved in adopting and integrating biometric solutions
For these reasons, we are uncertain whether our technology will gain
any acceptance in any commercial markets or that demand will be sufficient to
create a market large enough to produce any meaningful revenue or earnings. Our
future success depends upon business customers adopting biometrics generally,
and our solution specifically.
BIOMETRIC TECHNOLOGY IS A NEW APPROACH TO INTERNET SECURITY WHICH MUST
BE ACCEPTED IN ORDER FOR OUR WEB-KEY(TM) SOLUTION TO GENERATE ANY REVENUE.
Our Web-key(TM) authentication initiative represents a new approach to
Internet security which has not been adopted by any company which distributes
goods, content or software applications over the Internet. The implementation of
our WEB-Key(TM) solution requires the distribution and use of an optical reader
and integration of database and server side software. Although we believe our
solution provides a higher level of security for information transmitted over
the Internet than existing traditional methods, unless business and consumer
markets embrace the use of an optical reader and believe the benefits of
increased accuracy outweigh implementation costs, our solution will not gain
market acceptance.
OUR SOFTWARE MAY CONTAIN DEFECTS WHICH WILL MAKE IT MORE DIFFICULT FOR
US TO ESTABLISH AND MAINTAIN CUSTOMERS WHICH ARE NECESSARY TO GENERATE REVENUE.
Although we have completed the development of our core technology, it
has only been used by a limited number of business customers. Despite extensive
testing during development, our software may contain undetected design faults
and software errors, or "bugs" that are discovered only after it has been
installed and used by customers. Any such default or error in new or existing
software or applications could cause delays in delivering our technology or
require design modifications. These could adversely affect our competitive
position and cause us to lose potential customers or opportunities. Since our
technology is intended to be utilized to secure physical and electronic access,
the effect of any such bugs or delays will likely have a detrimental impact on
us. In addition, given that biometric technology generally, and our technology
specifically, has not gained any meaningful acceptance in the market, any delays
would likely have a more detrimental impact on our business than if we were a
more established company.
13
WE HAVE NOT DEVELOPED ANY EFFECTIVE DISTRIBUTION CHANNELS FOR OUR
TECHNOLOGY.
We market our technology through licensing arrangements with:
o Original equipment manufacturers, system integrators and application
developers which develop and market products and applications which
can then be sold to end users
o companies which distribute goods, services or software applications
over the Internet
Our success will depend upon the ability of these manufacturers to
effectively integrate and market reliable and affordable products which utilize
our technology and upon commercial entities adopting biometric solutions. While
we have commenced a significant marketing effort, we have not developed any
effective distribution channels and may not have the resources or ability to
sustain these efforts or generate any meaningful sales.
IN ORDER TO GENERATE REVENUE, WE ARE DEPENDENT UPON INDEPENDENT
ORIGINAL EQUIPMENT MANUFACTURERS, SYSTEM INTEGRATORS AND APPLICATION DEVELOPERS
WHICH WE DO NOT CONTROL. AS A RESULT, IT MAY BE MORE DIFFICULT TO GENERATE
SALES.
As a technology licensing company, we are dependent upon original
equipment manufacturers, system integrators and application developers to
integrate our technology into products and technologies which they develop and
sell. Licensing revenue from our technology is dependent upon the success of
these third parties in developing and distributing products and applications
which incorporate our technology. We have no control over these licensees and
can not assure you that any of them will have the financial, marketing or
technical resources to successfully develop and distribute products or
applications acceptable to end users or generate any meaningful revenue for us.
These third parties may also offer the products of our competitors to end users.
WE FACE INTENSE COMPETITION AND MAY NOT HAVE THE FINANCIAL AND HUMAN
RESOURCES NECESSARY TO KEEP UP WITH RAPID TECHNOLOGICAL CHANGES WHICH MAY RESULT
IN OUR TECHNOLOGY BECOMING OBSOLETE.
The Internet, facility access control and information security markets
are subject to rapid technological change and intense competition. We compete
with both established biometric companies and a significant number of startup
enterprises as well as providers of more traditional methods of access control.
Most of our competitors have substantially greater financial and marketing
resources than we do and may independently develop superior technologies which
may result in our technology becoming less competitive or obsolete. We may not
be able to keep pace with this change. If we are unable to develop new
applications or enhance our existing technology in a timely manner in response
to technological changes, we will be unable to compete in our chosen markets. In
addition, if one or more other biometric technologies such as voice, face, iris,
hand geometry or blood vessel recognition is widely adopted, it would
significantly reduce the potential market for our fingerprint identification
technology.
14
WE DEPEND ON OUR CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE OFFICER AND CERTAIN
OTHER OFFICERS AND NEED ADDITIONAL MARKETING AND TECHNICAL PERSONNEL TO
SUCCESSFULLY MARKET OUR TECHNOLOGY. WE CAN NOT ASSURE YOU THAT WE WILL BE ABLE
TO RETAIN OR ATTRACT SUCH PERSONS.
A loss of our current Chairman of the Board of Directors, Chief
Executive Officer or certain other officers could severely and negatively impact
our operations. We have employment contracts with Michael W. DePasquale, our
Chief Executive Officer, and other officers of the Company. Although these
employment contracts do not prevent such persons from resigning, they do contain
non-compete clauses which are intended to prevent these persons from working for
a competitor within one year after leaving our Company. During the past 18
months we have also retained additional employees with expertise in developing,
marketing and selling software solutions. In order to successfully market our
technology, we will need to retain additional technology and marketing
personnel. The market for such persons remains highly competitive and our
limited financial resources will make it more difficult for us to recruit and
retain qualified persons.
WE CAN NOT ASSURE YOU THAT THE LIMITED INTELLECTUAL PROPERTY PROTECTION
FOR OUR CORE TECHNOLOGY PROVIDES A MEANINGFUL COMPETITIVE ADVANTAGE OR BARRIER
TO ENTRY AGAINST OUR COMPETITORS.
Our success and ability to compete is dependent in part upon
proprietary rights to our technology. We rely primarily on a combination of
patent, copyright and trademark laws, trade secrets and technical measures to
protect our propriety rights. We have filed a patent application relating to
both the optic technology and biometrics solution components of our technology
wherein several claims have been allowed. More recently, we filed a patent
application with respect to our VST(TM) (Vector Segment Technology), the core
algorithm of our biometric identification solution. We can not assure you that
any additional patents will be issued, or that, if issued, that we will have the
resources to protect any patent from infringement. Although we believe our
technology does not currently infringe upon patents held by others, we can not
assure you that such infringements do not exist or will not exist in the future,
particularly as the number of products and competitors in the biometric industry
segment grows.
RISKS RELATED TO OUR COMMON STOCK
WE HAVE ISSUED A SUBSTANTIAL NUMBER OF SECURITIES CONVERTIBLE INTO
SHARES OF OUR COMMON STOCK WHICH WILL RESULT IN SUBSTANTIAL DILUTION TO THE
OWNERSHIP INTERESTS OF OUR EXISTING SHAREHOLDERS.
As of March 26, 2003, 24,482,240 shares of our common stock were
reserved for issuance upon exercise or conversion of the following securities:
o 11,057,731 upon exercise of outstanding stock options and warrants.
o 429,951 shares upon exercise of options available for future grant under our existing option plans.
o 1,333,333 shares upon conversion of our non interest convertible debenture due September 30, 2003.
o 5,457,226 shares upon conversion of our secured convertible note due September 30, 2003.
o 1,440,000 shares upon conversion of our secured convertible note due September 30, 2003.
15
o 2,457,333 shares or more upon conversion of our outstanding shares of
Series B Convertible Preferred Stock. In the event of a decline in the
market price of our common stock we would be required to issue an
indeterminate number of additional shares upon conversion of these
preferred shares.
o 2,306,666 shares or more upon conversion of our outstanding secured
convertible notes due June 30, 2004 and June 30, 2003. In the event of a
decline in the market price of our common stock we would be required to
issue an indeterminate number of additional shares upon conversion of these
notes.
The exercise or conversion of these securities will result in a
significant increase in the number of outstanding shares and substantially
dilute the ownership interests of our existing shareholders. We have filed a
registration statement covering the public sale of 22,416,139 of these shares
and have agreed to file another registration statement to cover the public
resale of shares issuable upon conversion of our outstanding convertible secured
notes. In addition, The Shaar Fund has agreed to provide an additional
$1,370,000 of financing through November, 2003 in incremental monthly advances
so long as certain conditions are satisfied. In the event that advances are
made, additional secured convertible notes will be issued which will further
dilute the ownership interest of our existing shareholders.
THE TRADING PRICE OF OUR COMMON STOCK AND OUR ABILITY TO RAISE
ADDITIONAL FINANCING MAY BE ADVERSELY EFFECTED BY THE INFLUX INTO THE MARKET OF
A SUBSTANTIAL NUMBER OF SHARES.
We filed a registration statement covering the public sale of
22,416,139 shares of our common stock. This significant increase in the number
of shares available for public sale may have a negative impact on the trading
price of our shares. The Shaar Fund's obligation to provide $1,370,000 in
incremental monthly advances through November, 2003 is conditioned upon the
average trading price of our common stock exceeding $1.00 per share during the
month preceding the advance. To the extent that this influx of shares into the
public market or other factors reduce the trading price of our common stock to
below $1.00, The Shaar Fund would have no obligation to provide this financing
and our ability to raise this necessary financing would be significantly
impaired. In the event that advances are made, additional secured convertible
notes will be issued. We have agreed to register the public resale of the shares
issuable upon conversion of any notes issued which will further increase the
number of share available for public sale.
OUR OUTSTANDING PREFERRED STOCK IS CONVERTIBLE INTO SHARES OF COMMON
STOCK AT A DISCOUNT TO THE TRADING PRICE AT THE TIME OF CONVERSION. THESE
CONVERSION PROVISIONS COULD CAUSE INVESTORS TO SHORT SELL OUR SHARES WHICH MAY
ADVERSELY AFFECT THE TRADING PRICE OF OUR COMMON STOCK.
Our preferred stock is convertible into shares of common stock at a per
share conversion price equal to the lesser of $.75 or a 22% discount to the
average of the closing bid prices of our common stock during the five trading
days preceding conversion. As a result of these provisions, in the event the
trading price of our common stock declines, we will be required to issue a
16
greater number of shares of common stock upon conversion of the debenture and
preferred stock. This could result in the issuance of a substantial number of
additional shares resulting in substantial dilution to our existing
shareholders. To the extent these factors are viewed negatively by the market,
they may provide an incentive for persons to execute short sales of our common
stock which could further adversely affect the trading price of our common
stock. Since the holders of the preferred stock receive additional shares upon
conversion if the trading price of our common stock declines, they may have an
incentive to execute short sales of our common stock. The agreement under which
these securities were issued precludes the holder from executing short sales of
our common stock except in the connection with a conversion of such securities.
APPLICABLE SEC RULES GOVERNING THE TRADING OF "PENNY STOCKS" LIMITS THE
TRADING AND LIQUIDITY OF OUR COMMON STOCK WHICH MAY AFFECT THE TRADING PRICE OF
OUR COMMON STOCK.
Our common stock currently trades on the OTC Bulletin Board. Since our
common stock continues to trade below $5.00 per share, our common stock is
considered a "penny stock" and is subject to SEC rules and regulations which
impose limitations upon the manner in which our shares can be publicly traded.
These regulations require the delivery, prior to any transaction involving a
penny stock, of a disclosure schedule explaining the penny stock market and the
associated risks. Under these regulations, certain brokers who recommend such
securities to persons other than established customers or certain accredited
investors must make a special written suitability determination regarding such a
purchaser and receive such purchaser's written agreement to a transaction prior
to sale. These regulations have the effect of limiting the trading activity of
our common stock and reducing the liquidity of an investment in our common
stock.
WE DO NOT INTEND TO PAY DIVIDENDS IN THE FORESEEABLE FUTURE.
We have never declared or paid a dividend on our common stock. We
intend to retain earnings, if any, for use in the operation and expansion of our
business and, therefore, do not anticipate paying any dividends in the
foreseeable future.
THE TRADING PRICE OF OUR COMMON STOCK MAY BE VOLATILE.
The trading price of our shares has from time to time fluctuated widely
and in the future may be subject to similar fluctuations. The trading price may
be affected by a number of factors including the risk factors set forth in this
Report as well as our operating results, financial condition, announcements of
innovations or new products by us or our competitors, general conditions in the
biometrics and access control industries, and other events or factors. Although
we believe that approximately 15 registered broker dealers currently make a
market in our common stock, we can not assure you that any of these firms will
continue to serve as market makers or have the financial capability to stabilize
or support our common stock. A reduction in the number of market makers or the
financial capability of any of these market makers could also result in a
decrease in the trading volume of and price of our shares. In recent years broad
stock market indices, in general, and the securities of technology companies, in
particular, have experienced substantial price fluctuations. Such broad market
fluctuations may adversely affect the future-trading price of our common stock.
17
MINNESOTA ANTI-TAKEOVER LAW AND CERTAIN PROVISIONS OF OUR ARTICLES OF
INCORPORATION MAY DISCOURAGE ATTEMPTS TO EFFECT A CHANGE IN CONTROL OF OUR
COMPANY, WHICH MAY ADVERSELY AFFECT THE VALUE OF OUR COMMON STOCK.
We are governed by the provisions of Section 302A.673 of the Minnesota
Business Corporation Act ("MBCA"). In general, the law prohibits a public
Minnesota corporation from engaging in a "business combination" (with an
"interested shareholder") for a period of four years after the date of the
transaction in which the person became an interested shareholder, unless the
business combination is approved in a prescribed manner. "Business Combination"
includes mergers, share exchanges, asset sales, plan or proposal of liquidation
or dissolution, recapitalization, issuance and transfers of shares in excess of
5% or more of the Company's shares. "Interested Shareholder" means any person
who owns directly or indirectly 10% or more of a public corporation's
outstanding voting stock or an affiliate or associate of a public corporation
which owns, or within four years did own, 10% or more of the public
corporation's outstanding voting stock. These provisions regarding certain
business combinations under the MBCA could have the effect of delaying,
deferring, or preventing a change in control of the company or the removal of
existing management. We have no control over, and therefore cannot predict, what
effect these impediments to the ability of third parties to acquire control of
us might have on the market price of our common stock. In addition, we are
authorized to issue 5,000,000 shares of preferred stock which may be issued by
our Board of Directors on such terms and with such rights, preferences and
designations as the Board may determine. Depending upon the rights, preferences
and designations assigned to it, issuance of shares of preferred stock could
delay, deter or prevent a change in control of our company to the detriment of
our shareholders.
ITEM 2. DESCRIPTION OF PROPERTY
The Company does not own any real estate. The Company conducts its
operations from leased premises in Eagan, Minnesota. The Company leases
approximately 6,000 square feet of space at 1285 Corporate Center Drive, Suite
No. 175 under a five-year lease, which terminates on August 31, 2004 and
currently provides for monthly rent of $3,325 which increases ratably over the
term of the lease to $3,610. The Company believes that its current facility is
adequate for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceeding nor
is it aware of any proceeding contemplated by any governmental authority
involving the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
18
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock currently trades on the OTC Bulletin Board
under the symbol "BKYI". The following table sets forth the range of high and
low bid prices per share of the Company's common stock for each of the calendar
quarters identified below as reported by the OTC Bulletin Board. These
quotations represent inter-dealer prices, without retail mark-up, markdown or
commission, and may not represent actual transactions.
2002: HIGH LOW
---- ---- ---
Quarter ended December 31, 2002 $.74 $.33
Quarter ended September 30, 2002 .50 .26
Quarter ended June 30, 2002 .75 .38
Quarter ended March 31, 2002 1.20 .61
2001: HIGH LOW
---- ---- ---
Quarter ended December 31, 2001 $1.07 $.15
Quarter ended September 30, 2001 .25 .13
Quarter ended June 30, 2001 .4375 .18
Quarter ended March 31, 2001 .4375 .2656
The last price of the Company's common stock as reported on the OTC
Bulletin Board on March 26, 2003 was $.37 per share.
HOLDERS
As of March 26, 2003 the number of stockholders of record of the
Company's common stock was 161. Based on broker inquiry conducted in connection
with the distribution of proxy solicitation materials in connection with the
Company's special meeting of shareholders in 2002, the Company believes that
there are approximately 1,900 beneficial owners of its common stock.
DIVIDENDS
The Company has not paid any cash dividends to date, and has no
intention of paying any cash dividends on our common stock in the foreseeable
future. The declaration and payment of dividends is subject to the discretion of
the Company's Board of Directors and to certain limitations imposed under the
Minnesota Business Corporation Act. The timing, amount and form of dividends, if
any, will depend on, among other things, the Company's results of operations,
financial condition, cash requirements and other factors deemed relevant by the
Company's Board of Directors.
19
RECENT SALES OF UNREGISTERED SECURITIES.
1. On November 13, 2002, the Company issued an aggregate of 82,525 shares
of common stock upon conversion of 300 shares of the Company's Series B 9%
Convertible Preferred Stock and $2,696 of accrued dividends thereon. The shares
were issued in a private placement transaction exempt from the registration
requirements of the Security Act of 1933, as amended, pursuant to Section 4(2)
thereunder without payment of underwriting discounts or commission to any
person.
2. On November 14, 2002, the Company issued an aggregate of 131,343 shares
of common stock upon conversion of 500 shares of the Company's Series B 9%
Convertible Preferred Stock and $4,507 of accrued dividends thereon. The shares
were issued in a private placement transaction exempt from the registration
requirements of the Security Act of 1933, as amended, pursuant to Section 4(2)
thereunder without payment of underwriting discounts or commissions to any
person.
3. Between August and November, 2002, the Company issued $750,000 principal
amount Secured 7% Convertible Promissory Note to The Shaar Fund Ltd. in
consideration of cash proceeds of $750,000. The principal and accrued interest
due under the Note are convertible at the option of the holder into either
common stock at a conversion price of $.75 per share or Series B 9% Convertible
Preferred Stock at a conversion price at $100 per share. The Note is due and
payable on June 30, 2003. The Note was issued to one accredited investor in a
private placement transaction exempt from the registration requirements of the
Securities Act of 1933, as amended, pursuant to Section 4(2) thereunder, without
payment of underwriting discounts or commissions to any person.
4. On January 3, 2003, the Company issued options to purchase 580,000
shares of common stock at an exercise price of $.53 per share, the closing
market price of the Company's common stock on the date of grant, to Michael W.
DePasquale in connection with his retention as the Chief Executive Officer of
the Company. The options vest in quarterly installments over a two (2) year
period commencing on the date of grant. The options terminate on the earlier of
seven (7) years from the date of grant or three (3) months after termination of
service as an employee of the Company, unless termination is for cause, in which
case, the options expire on the date of termination. The options were issued in
a private placement transaction exempt from the registration requirements of the
Securities Act of 1933, as amended, pursuant to Section 4(2) thereunder, without
payment of underwriting discounts or commissions to any person.
20
5. On January 27, 2003, the Company issued a Secured 7% Convertible
Promissory Note in the principal amount of up to $2,350,000 to The Shaar Fund
Ltd. Upon closing, the Company received cash proceeds of $600,000. The Purchase
Agreement provides for incremental monthly advances in the amount of $190,000
conditioned upon the Company satisfying certain covenants. The principal and
accrued interest due under the Notes are convertible at the option of the holder
into either common stock at a conversion price of $.75 per share or Series B 9%
Convertible Preferred Stock at a conversion price at $100 per share. The Notes
are due and payable on June 30, 2004. The Notes were issued to one accredited
investor in a private placement transaction exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2)
thereunder, without payment of underwriting discounts or commissions to any
person.
6. On January 29, 2003, the Company issued options to purchase 200,000
shares of common stock at an exercise price of $.60 per share, the closing
market price of the Company's common stock on the date of grant, to Charles P.
Romeo in connection with his appointment as Director of the Company. Options to
purchase 50,000 shares are immediately exercisable and the remainder vest in
quarterly installments over a three (3) year period commencing on the date of
grant. The options terminate on the earlier of seven (7) years from the date of
grant or three (3) months after cessation of service to the Company, unless
cessation is for cause, in which case, the options expire on the date of
cessation. The options were issued in a private placement transaction exempt
from the registration requirements of the Securities Act of 1933, as amended,
pursuant to Section 4(2) thereunder, without payment of underwriting discounts
or commissions to any person.
7. On February 13, 2003, the Company issued options to purchase 30,000
shares of common stock at an exercise price of $.20 per share to an employee of
the Company. 14,250 of the options vested upon issuance, with the remainder
vesting in equal quarterly installments during the eighteen (18) month period
commencing March 1, 2003. The options terminate on the earlier of August 31,
2008 or three (3) months after termination of employment, unless termination is
for cause, in which case, the options expire on the date of termination. The
options were issued in a private placement transaction exempt from the
registration requirements of the Securities Act of 1933, as amended, pursuant to
Section 4(2) thereunder, without payment of underwriting discounts or
commissions to any person.
8. On February 20, 2003, the Company issued a warrant to purchase
200,000 shares of common stock at an exercise price of $.49 per share, the
closing market price on the date of grant, to CEOCast, Inc., an investor
relations firm. The warrant is immediately exercisable and terminates on
February 19, 2006. The warrant was issued in a private placement transaction
exempt from the registration requirements of the Securities Act of 1933, as
amended, pursuant to Section 4(2) thereunder, without payment of underwriting
discounts or commissions to any person.
21
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS AND PLAN OF OPERATION
This Management's Discussion and Analysis and Plan of Operation and
other parts of this Report contain forward-looking statements that involve risks
and uncertainties. All forward-looking statements included in this Report are
based on information available to the Company on the date hereof, and the
Company assumes no obligation to update any such forward-looking statements. The
Company's actual results could differ materially from those anticipated in these
forward-looking statements as a result of a number of factors, including those
set forth in the Section captioned "RISK FACTORS" in Item 1 and elsewhere in
this Report. The following should be read in conjunction with the audited
financial statements of the Company included elsewhere herein.
OVERVIEW
The Company develops and markets proprietary fingerprint identification
biometric technology and software solutions. These solutions are built around
the advanced capabilities of the Company's proprietary patent pending VST(TM)
(Vector Segment Technology(TM)) algorithm. The Company has pioneered the
development of automated, finger identification technology that can be used
without the aide of non-automated methods of identification such as a personal
identification (PIN), password, token, smart card, ID card, credit card,
passport, drivers license or other form of possession based or knowledge based
identification. This advanced BIO-key(TM) identification technology improves
both the accuracy and speed of finger-based biometrics and is the only finger
identification algorithm that has been certified by the International Computer
Security Association (ICSA).
Over the past three years, recognizing the growth in electronic
commerce, private networks and related security concerns, the Company has
actively positioned its technology for the licensing of a Web based biometric
authentication software solution to e-commerce and other companies conducting
business over the Internet. This integrated solution involves the licensing of
client and server based software to provide for reliable and cost effective user
authentication in connection with the processing of e-commerce transactions or
securing access to private networks.
The Company has completed the development of its core technology, has
commenced the marketing of its technology, and expects to continue to generate
revenue from licensing arrangements during 2003.
Although the Company has developed significant identification
technology, it has not gained any meaningful commercial acceptance and the
Company has only generated minimal revenue since inception. The Company did not
generate any revenue during 2001 and generated minimal revenue during 2002. The
Company's business model, particularly the Web authentication initiative,
represents a novel approach to Internet and network security which as of the
date of this Report has not been adopted by any company conducting business over
the Internet. Although recent security concerns relating to the identification
of individuals has increased interest in biometrics generally, there can be no
assurance that there will be a demand for such a solution or that the Company
will have the financial or other resources necessary to successfully market such
a software solution.
22
The Company believes its existing financial resources will only last
through December 31, 2003. See "LIQUIDITY AND CAPITAL RESOURCES" below. Due to
this and other uncertainties, the Company's independent auditors have included
an explanatory paragraph in their opinion for the year ended December 31, 2002
as to the substantial doubt about the Company's ability to continue as a going
concern. The Company's long-term viability and growth will depend upon the
successful commercialization of its technologies and its ability to obtain
adequate financing, among other matters, as to which there can be no assurances.
PLAN OF OPERATION
The following is a description of the Company's Plan of Operation for
the next twelve (12) months.
BUSINESS STRATEGY
The Company's initial goal was to develop automated fingerprint
identification products which were portable, easily integrated with existing
applications and affordable for mass commercialization and distribution through
OEMs, distributors and to a lesser degree, system integrators in the computer
network, general access control and other markets. This included the development
of readers. During 1998 and 1999 the Company pursued an OEM licensing program,
in 2000 and 2001 the Company developed WEB-key(TM), an integrated Web based
biometric authentication system, and during 2002, the Company continued to
develop its technology, entered into strategic alliances with various third
parties and began to generate revenues primarily from licensing of its core
technology.
The Company's current business plan consists of a threefold strategy
of:
o continued development of technology
o licensing its core technology (SDK and Web-key) to OEMs, system
integrators, Internet service providers and software application
developers addressing industry-specific applications
o licensing its Web-based biometric authentication software solution to
e-commerce and Internet content companies to secure Web based
transactions.
Although the Company has developed significant core finger
identification software technology, it has not gained any meaningful commercial
acceptance, the Company has only generated minimal revenue since inception and
it has not entered into any significant licensing arrangements. In addition, the
Company's business model, particularly the Web authentication initiative,
represents a unique approach to Internet security, requires the distribution and
use of additional peripheral hardware, namely an optical reader, and the
integration of client and server software. It has not been adopted by any
company that conducts business over the Internet. There can be no assurance that
there will be a demand for such a solution or that the Company will have the
financial, marketing and human resources necessary to successfully market such a
software solution.
23
COMPANY PRODUCTS
The Company's primary initiative is the licensing of its Software
Developer's Toolkit (SDK) for integration into other applications and
WEB-key(TM), it's Web-based, Internet ready three tiered Internet application
architecture software security solution. This initiative has involved
transitioning the Company's technology to focus on identification applications
for large databases and Web based server authentication applications, including
porting to multiple platforms and peer group reader technology. These efforts
have resulted in the de-coupling of the core identification algorithm from the
reader technology providing for the algorithm to be utilized with virtually any
reader or scanner. The Company believes that the versatility provided by the
de-coupling of the identification algorithm and reader technology will
facilitate the pursuit of licensing Web based server authentication
applications. Successful execution of this initiative has also required the
development of enhanced software to provide an effective interface between
client and server-based software. The Company continues to refine this software.
The Company's SDK and WEB-key software are available for licensing. During
2002, the Company commenced a direct selling effort and has entered into license
agreements with OEMs and systems integrators and other licensees of its software
to develop applications for distribution to their respective customers. The
Company expects to generate revenue during the remainder of 2003 from existing
and new customer relationships.
CAPITAL REQUIREMENTS
The Company currently requires approximately $190,000 per month to
conduct operations. Based on available cash resources and the existing funding
obligations, the Company believes it can maintain operations at current levels
until December 31, 2003. The Company needs approximately $2,400,000 to continue
to operate at current levels for the next twelve (12) months. Unless the Company
is able to generate in excess of $190,000 of revenue per month, it will be
required to raise additional capital to continue operations beyond December 31,
2003. See "LIQUIDITY AND CAPITAL RESOURCES" below.
RESEARCH AND DEVELOPMENT
Although management believes that the Company's identification
technology is one of the most advanced and discriminating fingerprint
technologies available on the market today, the markets in which the Company
competes are characterized by rapid technological change and evolving standards.
In order to maintain its position in the market, the Company will continue to
upgrade and refine its existing technologies. During the next twelve months, the
Company will continue to focus on enhancing its identification technology for
large databases, Web based server authentication applications, including porting
to multiple platforms, and peer group reader technology. The Company expects
research and development costs to increase during 2003 which will require
additional financing to which there can be no assurance
24
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002 AS COMPARED TO YEAR ENDED DECEMBER 31, 2001:
REVENUES
The Company generated revenues of $155,399 during 2002 consisting of
$128,860 from license fees and $26,539 from sales of products and services. The
Company expects to continue to generate revenue during 2003, primarily from
licensing fees. The Company did not generate any revenue during 2001.
COSTS AND OTHER EXPENSES
Selling, general and administrative expenses. Selling, general and
----------------------------------------------
administrative expenses increased $607,863 to $1,926,328 during 2002 as compared
to $1,318,465 in 2001. Of the increase, $392,425 was related to sales and
marketing costs associated with the implementation of the Company's revised
business plan, $549,773 was related to the engagement of a marketing consultant,
$110,552 was related to the engagement of a investor relations firm, and
$129,755 was related to professional services associated with debt restructuring
and the filing of a registration statement. These amounts were offset by
$536,625 related to a decrease in penalties incurred in 2001 for failing to file
a registration statement covering the public sale of common shares issuable upon
conversion of the Company's Series A Convertible Preferred Stock, $13,435
related to a decrease in costs for administrative personnel, and $24,582 related
to a decrease in general administrative costs. Although the Company continues to
closely monitor expenses to reduce overhead, it expects marketing expenses to
increase as it continues to focus on generating revenue and does not expect to
further materially reduce general and administrative expenses during 2003.
Research and Development. Research, development and engineering
---------------------------
expenses increased $136,581 to $1,084,513 in 2002 as compared to $947,932 in
2001. Of the increase, $227,265 was related to an increase in personnel costs
and $58,846 was related to a increase in general development expense. This was
offset by $149,530 related to a decrease for services of outside programming
sub-contractors. The Company expects research and development costs to increase
during 2003.
Interest Expense. Interest expense increased $845,308 to $1,162,935 in
----------------
2002 as compared to $317,627 in 2001. The increase was due to a net increase in
indebtedness of approximately $1,514,000 during 2002 and the amortization of
discounts applicable to convertible debt issued during 2001 arising from the
warrants issued with such convertible debt and the beneficial conversion
features of such debt.
NET OPERATING LOSS CARRYFORWARDS
As of December 31, 2002, the Company has federal net operating loss
carryforwards of approximately $21,611,000. The carryforwards expire between
2008 and 2022. Such net operating carryforwards may be limited in the future in
the event of a change in ownership of the Company as defined in the Internal
Revenue Code.
25
YEAR ENDED DECEMBER 31, 2001 AS COMPARED TO YEAR ENDED DECEMBER 31, 2000:
REVENUES
The Company had no revenue during 2001 or 2000. This was due to the
Company's decision to deploy substantially all human and capital resources to
executing its new business plan targeted at licensing biometric identification
IT security and identity theft solution software for Internet, intranet and
electronic commerce applications. As a result, the Company's limited resources
were used to refine its technology to develop the applications needed to execute
this plan.
COSTS AND OTHER EXPENSES
Selling, general and administrative expenses. Selling, general and
----------------------------------------------
administrative expenses decreased $534,402 to $1,318,465 during 2001 as compared
to $1,852,867 in 2000. Of the decrease, $117,869 related to a decrease in costs
for administrative personnel, $301,126 related to a decrease in costs associated
with the services of an administrative consultant, $256,212 related to a
decrease in outside professional service charges, $58,909 related to a decrease
in general operating costs, and $94,500 related to a decrease in penalties
incurred for failing to file a registration statement covering the public sale
of common shares issuable upon conversion of the Company's Series A Convertible
Preferred Stock. These amounts were offset by an increase of $294,214 in sales
and marketing costs associated with the implementation of the Company's revised
business plan. In order to preserve its limited resources, the Company has
reduced selling, general and administrative expenses from $2,151,466 to
$1,318,465 during 2000 and 2001. Although the Company continues to closely
monitor expenses to reduce overhead, it expects marketing expenses to increase
as it continues to focus on generating revenue and does not expect to further
materially reduce expenses during 2002.
Research and Development. Research, development and engineering
--------------------------
expenses decreased $188,308 to $947,932 in 2001 as compared to $1,136,240 in
2000. Of the decrease, $137,500 was due to a decrease in personnel costs and
$102,315 was due to a decrease in general operation expenses. These amounts were
offset by an increase of $51,507 for services of outside programming
sub-contractors.
Interest Expense. Interest expense increased $176,286 to $317,627 in
----------------
2001 as compared to $141,341 in 2000. The increase was due to an increase in
interest accrued on additional short term indebtedness of approximately
$1,370,000.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities during 2002 was $2,264,937, and
was principally due to operating losses. The operating losses were primarily
funded by cash on hand at December 31, 2001 and proceeds from the sale of
Company securities and secured short term financing.
26
Net cash provided by financing activities in 2002 was $1,765,100, which
consisted of the issuance of $1,830,000 principal amount of short term notes to
The Shaar Fund Ltd. (the "Investor") between January and November 2002, offset
by deferred offering costs associated with the engagement of an investment
banking firm.
Pursuant to a recapitalization transaction in November, 2001, all then
existing promissory notes payable to the Investor together with all accrued and
unpaid interest due thereon ($3,027,920) were cancelled and converted into a
secured convertible promissory note (the "Secured Note"). The Secured Note is
due September 30, 2003, is secured by substantially all of the Company's assets,
including its intellectual property, accrues interest at the rate of 10% per
annum payable semi-annually in arrears commencing September 30, 2002, may be
prepaid without penalty, and is convertible into shares of common stock at a
conversion price of $.75 per share. The security interest terminates upon the
Company obtaining $5,000,000 of additional equity financing. In this
transaction, the Company received net cash proceeds of $1,024,500 after giving
effect to offering costs of $40,500. Pursuant to the recapitalization
transaction, between March and September 2002, the Investor provided $1,080,000
of additional financing in incremental monthly installments. All such funding
was provided pursuant to secured promissory notes (collectively, the "Advance
Notes") on the terms described above. Accrued interest of $393,250 on the
Secured Note and Advance Notes was due on September 30, 2002. The Investor has
waived the Company's compliance with these payment dates.
On August 28, 2002, the Company entered into a bridge note agreement
with the Investor pursuant to which it provided $750,000 of additional financing
in incremental monthly installments during the four-month period commencing
August 28, 2002 pursuant to the terms of a convertible promissory note (the
"August Note"). The August Note is secured by substantially all of the Company's
assets, including its intellectual property, accrues interest at the rate of 7%
per annum payable on maturity and may be prepaid without penalty. The principal
amount and accrued interest is convertible at the option of the Investor into
either shares of Common Stock at a conversion price of $.75 per share or shares
of Series B Preferred Stock at a conversion price of $100 per share. The August
Note is due June 30, 2003.
On January 27, 2003, the Company entered into a Note Purchase agreement
with the Investor to provide up to $2,350,000 of additional financing pursuant
to the terms of a secured promissory note (the "January Note"). $600,000 of this
amount was advanced at closing, with the balance to be funded in incremental
monthly installments during the nine (9) month period commencing February 1,
2003, provided that certain conditions are satisfied. The January Note is due
June 30, 2004, is secured by substantially all of the Company's assets including
its intellectual property, accrues interest at the rate of 7% per annum payable
on maturity, and may be prepaid without penalty. The principal amount and
accrued interest is convertible at the option of the Investor into either shares
of Common Stock at a conversion price of $.75 per share or shares of Series B
Preferred Stock at a conversion price of $100 share. In the event the Company
completes a private placement of its equity securities resulting in gross
proceeds in excess of $5,000,000 on or before June 30, 2004, the principal and
accrued interest shall at the option of the Investor, be either converted into
such equity securities or repaid in cash.
Under the Note Purchase Agreement, the Investor has agreed to provide
up to $1,750,000 of additional financing in incremental monthly installments
27
during the nine month period commencing February 1, 2003. Any such funding will
be provided pursuant to a secured promissory note on the terms described above.
The Investor's obligation to provide this financing is conditioned upon:
o The Company being in compliance with all material obligations under
the January 27, 2003 funding agreement between the parties and the
January Note.
o The continued truth and accuracy of the representations and warranties
of the Company set forth in the funding agreement.
o The average closing bid price of the Company's common stock during the
calendar month preceding the advance exceeding $1.00 per share.
Provided the forgoing conditions are satisfied, funds are advanced on the first
day of each month upon receipt of written notice from the Company. On or about
February 1, 2003 and March 1, 2003, the Company requested and received advances
in the aggregate amount of $380,000. The Company has agreed to file a
registration statement covering the public resale of the shares of common stock
issuable upon conversion of the Advance Note, August Note and January Note.
Working capital decreased $7,691,571 during 2002 to a deficit of
$7,299,038 on December 31, 2002 as compared to a surplus of $392,533 on December
31, 2001. This decrease is principally due to approximately $4,331,000 of long
term debt becoming current, a net increase in short-term obligations of
approximately $2,176,000, an increase in accrued interest of approximately
$494,000, an increase in other current payables of approximately $104,000, a
decrease in cash of approximately $498,000, and a decrease of approximately
$156,000 in prepaid expenses. These amounts were offset by an increase in
accounts receivable of approximately $68,000.
Since January 7, 1993 (date of inception), the Company's capital needs
have been principally met through proceeds from the sale of equity and debt
securities.
The Company does not currently maintain a line of credit or term loan
with any commercial bank or other financial institution.
28
As of March 26, 2003, the Company had cash resources of approximately
$400,000. Pursuant to its agreement with the Investor, $1,370,000 of additional
financing is available to the Company upon fulfillment of the conditions
described above. Although the Investor has, in the past, provided financing to
the Company notwithstanding that all of the conditions have not been satisfied,
there can be no assurance that it will continue to do so. The Company currently
requires approximately $190,000 per month to conduct operations. Based on
available cash resources and the existing funding obligations, the Company
believes it can maintain operations at current levels through December, 2003.
The Company needs approximately $2,400,000 to continue to operate at current
levels for the next twelve (12) months. Ideally, the Company needs approximately
$3,000,000 to $5,000,000 to execute its business plan and support the growth of
operations through 2004 and to continue product enhancements. The additional
financing is required to conduct the sales and marketing effort necessary to
engage in significant direct selling and marketing activities.
During 2002, the Company entered into license agreements, generated a
small amount of revenue and believes it will continue to generate revenue from
existing and new relationships during 2003. Anticipated revenues are expected to
defray operating expenses and reduce the amount of required additional
financing, but are not expected to be sufficient for the Company to expand
operations.
In addition to generating revenue, the Company is seeking to obtain
additional financing through the issuance of additional debt or equity
securities of the Company on a negotiated private placement basis to
institutional and accredited investors. As of the date of the Report, the
Company has not reached a definitive agreement with any potential investor
regarding the specific terms of an investment in the Company. No assurance can
be given that any form of additional financing will be available on terms
acceptable to the Company, that adequate financing will be obtained to meet its
needs, or that such financing would not be dilutive to existing stockholders. If
available financing is insufficient or unavailable or the Company fails to
generate any meaningful revenue, it may be required to further reduce operating
expenses, suspend operations, seek a merger or acquisition candidate or
ultimately liquidate its assets.
ITEM 7. FINANCIAL STATEMENTS
See Financial Statements beginning on page F-1.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
The following sets forth certain information about each director and
executive officer of the Company.
29
------------------------------------ ----------------- ---------------------------------------------------------------
NAME AGE POSITIONS HELD
------------------------------------ ----------------- ---------------------------------------------------------------
Thomas J. Colatosti 55 Chairman of the Board of Directors
------------------------------------ ----------------- ---------------------------------------------------------------
Michael W. DePasquale 48 Chief Executive Office and Director
------------------------------------ ----------------- ---------------------------------------------------------------
H. Donald Rosacker, II 41 Vice President of Marketing and Director
------------------------------------ ----------------- ---------------------------------------------------------------
Gary E. Wendt 61 Chief Financial Officer, Secretary and Director
------------------------------------ ----------------- ---------------------------------------------------------------
Charles P. Romeo 61 Director
------------------------------------ ----------------- ---------------------------------------------------------------
Jeffrey J. May 43 Director
------------------------------------ ----------------- ---------------------------------------------------------------
Mira K. LaCous 41 Vice President of Technology
------------------------------------ ----------------- ---------------------------------------------------------------
The following is a brief summary of the business experience of each of
the above-named individuals:
THOMAS J. COLATOSTI has served as a Director of the Company since
September 5, 2002 and as Chairman of the Board since January 3, 2003. Mr.
Colatosti currently serves as the Chief Executive Officer of American Security
Ventures, a Lexington, Massachusetts based consulting firm he founded which
specializes in providing strategic management consulting services to emerging
and developing companies in the homeland security industry. From 1997 through
June 2002, Mr. Colatosti served as the Chief Executive Officer of Viisage
Technology, Inc., a publicly traded biometric technology company focusing on
biometric face-recognition technology and delivering highly secure
identification documents and systems. Between 1995 and 1997, Mr. Colatosti
served as President and Chief Executive Officer of CIS Corporation, a higher
education industry leader that designed and implemented integrated and flexible
systems solutions to manage entire university administrative operations. Prior
to CIS, Mr. Colatosti had a 20-year career with Digital Equipment Corporation.
His most recent responsibility was Vice President and General Manager, Northeast
Area, where he was responsible for a business unit with annual revenues of more
than $1.2 billion and 3,000 people. Mr. Colatosti is an active industry security
spokesperson testifying before Congressional Committees and advising the White
House and other Federal security agencies on homeland security issues. Mr.
Colatosti earned a Bachelor of Science degree in Management and Finance as well
as a Masters degree in Business Administration from Suffolk University.
MICHAEL W. DEPASQUALE has served as the Chief Executive Officer and a
Director of the Company since January 3, 2003. Mr. DePasquale brings more than
20 years of executive management, sales and marketing experience to the Company.
Prior to joining the Company, Mr. DePasquale served as the President and Chief
Executive Officer of Prism eSolutions, Inc., a Pennsylvania based provider of
professional consulting services and online solutions for ISO-9001/14000
certification for customers in manufacturing, healthcare and government markets,
since February 2001. From December 1999 through December 2000, Mr. DePasquale
served as Group Vice President for WRC Media, a New York based distributor of
supplemental education products and software. Prior to this position, Mr.
30
DePasquale served as Senior Vice President of Jostens Learning Corp., a
California based provider of multi media curriculum, from January 1996 until
December 1999. Prior to Jostes, Mr. DePasquale held sales and marketing
management positions with McGraw-Hill and Digital Equipment Corporation. Mr.
DePasquale earned a Bachelor of Science degree from the New Jersey Institute of
Technology.
H. DONALD ROSACKER, II currently serves as the Vice President Marketing
and a Director of the Company. From August 2001 until March 2003, Mr. Rosacker
served as the President of the Company. Mr. Rosacker has primary responsibility
for the marketing and promotion functions of the Company. Between 1994 and 2000,
Mr. Rosacker served as the President and Chief Executive Officer of
Tekmerchant.com/FlowersandGifts.com, a Minneapolis, Minnesota based e-commerce
company, where he managed the restructure of that company from a
business-to-consumer Internet company to a business-to-business technology
development company. Between 1992 and 1994, Mr. Rosacker served as President of
Mantech Corporation, a Minneapolis, Minnesota based software developer where he
managed the launch of advanced technology applications for the manufacturing
industry. Mr. Rosacker has in excess of 15 years of financial and marketing
management experience in start-up and emerging growth companies. Mr. Rosacker
earned a Bachelors degree in Computer Science from the University of Minnesota
in 1983.
GARY E. WENDT has served as the Chief Financial Officer and a Director
of the Company since its inception in 1993. Mr. Wendt has primary responsibility
for the Company's financial reports and administers accounting operations. From
1993 to 1994, Mr. Wendt was Treasurer and Chief Financial Officer of Esprit
Technologies, Inc., a computer manufacturer which produced high speed PCs
marketed primarily to government and industry in the Midwestern United States.
Mr. Wendt attended Metropolitan State University, North Hennepin Community
College, and the Academy of Accountancy where he was certified in public
accounting.
JEFFREY J. MAY has served as a Director of the Company since October
29, 2001. Since 1997, Mr. May has served as the President of Gideons Point
Capital, a Tonka Bay Minnesota based financial consulting firm and angel
investor focusing on assisting and investing in start-up technology companies.
In 1983, Mr. May co-founded Advantek, Inc., a manufacturer of equipment and
materials which facilitate the automatic handling of semi-conductors and other
electrical components which was sold in 1993. Mr. May continued to serve as a
director and Vice-President of Operations of Advantek until 1997, at which time
it had over 600 employees and sales in excess of $100 million. Mr. May earned a
Bachelor of Science degree in Electrical Engineering from the University of
Minnesota in 1983.
CHARLES P. ROMEO has served as a director of the Company since January
29, 2003. Since September 2002, Mr. Romeo has served as the President and Chief
Executive Officer of FreedomBridge Technologies, Inc., a Rhode Island based
consulting firm to technology companies in the homeland security industry
specializing in implementing direct and channel selling programs, strategic
alliances and partnerships in the law enforcement market. Prior to founding
FreeedomBridge, Mr. Romeo had a 33 year sales and marketing management career
with Digital Equipment Corporation, Compaq Computer Corporation and Hewlett
Packard. During his career, Mr. Romeo served as Vice President of Service Sales
for a $500 million business unit, and Director of Public Sector Sales, a $275
million division of Hewlett Packard. Mr. Romeo authored "The Sales Manager's
Troubleshooter", Prentice Hall 1998, which was named as one of the "top 10 must
31
reads" by Sales and Marketing Magazine. Mr. Romeo earned a Bachelor of Science
degree in Mathematics and Economics from the University of Massachusetts and an
Executive MBA from Babson College.
MIRA K. LACOUS has served as Vice President of Technology and
Development of the Company since May 15, 2000. On November 20, 2001, Ms. LaCous
was appointed to serve as an executive officer of the Company. Ms. LaCous has
primary responsibility for all engineering and software development functions of
the Company. Ms. LaCous has over 15 years computer software design experience in
the areas of Voice Automation, Commercial Building Control, Information Scanning
and Internet Systems, and Internet Security Training. From 1997 until joining
the Company, she was employed by National Computer Systems, Inc. as Director
Software Development. Between 1997 and March 2000, Ms. LaCous acted as an
independent consultant serving such clients as TEL-line Systems and Security
Analysts. From 1989 to 1997 Ms. LaCous served as a Senior Project Manager with
The Trane Company. Ms. LaCous earned a Bachelors degree in Computer Science for
North Dakota State University.
DIRECTORS' TERMS OF OFFICE
Gary Wendt was elected as a director at the Company's 1998 Annual
Meeting of Shareholders to hold office for a term of one (1) year until his
successor is duly elected and qualified. Michael W. DePasquale, H. Donald
Rosacker, II and Jeffrey J. May were appointed by the Board of Directors to fill
vacancies created by the resignations or death of directors and to serve until
the next annual meeting of shareholders until their successors are duly elected
and qualified. Thomas J. Colatosti and Charles P. Romeo were appointed by the
Board of Directors to serve until the next annual meeting of shareholders until
their successors are duly elected and qualified.
BOARD OF DIRECTORS
All directors hold office until the next annual meeting of shareholders
and the election and qualification of their successors. Officers are elected
annually by the Board of Directors and serve at the discretion of the Board.
DIRECTORS COMPENSATION
Directors who are also officers of the Company receive no additional
compensation for serving on the Board of Directors, other than reimbursement of
reasonable expenses incurred in attending meetings. The Company's 1996 stock
incentive plan provides for the grant of options to purchase 50,000 shares of
common stock to each non-employee director upon first being elected or appointed
to the Board of Directors. Since 2001, the Company has executed a policy of
granting options to purchase 200,000 shares of common stock to each non-employee
director upon first being elected or appointed to the Board of Directors.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the U.S. Securities and Exchange Act of 1934, as
amended (the "Exchange Act"), requires the Company's officers and directors and
persons who own more than ten percent (10%) of the Company's Common Stock to
file with the Securities and Exchange Commission ("SEC") initial reports of
ownership and reports of changes in ownership of the Company's Common Stock.
32
Such officers, directors and ten percent (10%) stockholders are also required by
applicable SEC rules to furnish the Company with copies of all forms filed with
the SEC pursuant to Section 16(a) of the Exchange Act. Based solely on its
review of the copies of such forms received by it, or written representations
from such persons that no other reports were required for such persons, the
Company believes that during the fiscal year ended December 31, 2002, all
Section 16(a) filing requirements applicable to the Company's officers,
directors and ten percent (10%) stockholders were satisfied in a timely fashion
except that Mr. Colatosti did not file a Form 4 in connection with his grant of
options upon being appointed to serve as a director of the Company.
33
ITEM 10. EXECUTIVE COMPENSATION
The following table provides certain summary information
concerning compensation paid to or accrued by the Company's Chief Executive
Officer, and all other executive officers of the Company during the fiscal years
ended December 31, 2000, 2001 and 2002:
SUMMARY COMPENSATION TABLE
SECURITIES
NAME AND PRINCIPAL FISCAL UNDERLYING ALL OTHER
POSITION YEAR SALARY($) OPTIONS (#) COMPENSATION ($)
----------------------- -------- ----------- ----------- ------------------
Jeffry R. Brown, (1) 2002 144,000 -- --
Chief Executive 2001 144,000 400,000 --
Officer 2000 18,000 580,000 24,000(2)
H. Donald Rosacker, II, 2002 108,000 -- --
Vice President 2001 45,400 400,000 --
Marketing(3)
(1) Mr. Brown served as the President of the Company from November 13, 2000
until July 1, 2001. Mr. Brown served as the Chief Executive Officer of
the Company from July 1, 2001 until December 31, 2002.
(2) Represents payment of signing bonus in connection with Mr. Brown
becoming President of the Company in November 2000.
(3) Mr. Rosacker served as the President of the Company during 2002.
OPTION GRANTS IN YEAR ENDED DECEMBER 31, 2002
The Company did not grant any stock options or stock appreciation
rights to any of the named executive officers of the Company during the year
ended December 31, 2002.
34
AGGREGATED OPTION EXERCISES IN THE
2002 FISCAL YEAR AND FISCAL YEAR-END OPTION VALUE
The following table sets forth for each named executive officer,
information regarding stock options exercised by such officer during the 2002
fiscal year, together with the number and value of stock options held at 2002
fiscal year-end, each on an aggregated basis.
======================================================================================================================
NUMBER OF VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
AT FISCAL YEAR-END AT FISCAL YEAR-END
NUMBER OF SHARES VALUE EXERCISABLE/ EXERCISABLE/
NAME ACQUIRED ON REALIZED UNEXERCISABLE(#) UNEXERCISABLE($) (1)
------------------------------------ ------------------ --------------- --------------------- ------------------------
Jeffry R. Brown -- -- 1,010,000/20,000 148,000/0
------------------------------------ ------------------ --------------- --------------------- ------------------------
H. Donald Rosacker, II -- -- 201,660/198,340 74,614/73,385
------------------------------------ ------------------ --------------- --------------------- ------------------------
(1) The last sales price of the Company's Common Stock as reported on the
OTC Bulletin Board on December 31, 2002 was $.57.
EMPLOYMENT AGREEMENTS
MICHAEL W. DEPASQUALE. On January 3, 2003, the Company entered into a
two-year employment agreement with Michael W. DePasquale to serve as the Chief
Executive Officer of the Company at an annual base salary of $150,000. The
employment agreement provides for a quarterly performance bonus during 2003 of
$37,500 per calendar quarter payable upon the Company achieving the following
financial performance targets: $300,000 of gross revenue during the quarter
ending March 31, 2003, $400,000 of gross revenue during the quarter ending June
30, 2003, $650,000 of gross revenue during the quarter ending September 30, 2003
and $900,000 of gross revenue during the quarter ending December 31, 2003. In
the event that the Company does not achieve the financial performance target for
the first calendar quarter, Mr. DePasquale will be entitled to receive the full
$37,500 payable with respect to the first calendar quarter in the event that the
Company's gross revenue for the six months ended June 30, 2003 equals or exceeds
$700,000, or $18,750 of the amount payable with respect to the first calendar
quarter in the event that the Company's gross revenue for the nine months ended
September 30, 2003 equals or exceeds $1,350,000 or the Company's gross revenue
for the twelve months ended December 31, 2003 equals or exceeds $2,250,000. In
the event that the Company does not achieve the financial performance target for
the second calendar quarter, Mr. DePasquale will be entitled to receive $18,750
of the amount payable with respect to the second calendar quarter in the event
that the Company's gross revenue for the nine months ended September 30, 2003
equals or exceeds $1,350,000 or the Company's gross revenue for the twelve
months ended December 31, 2003 equals or exceeds $2,250,000. In the event that
35
the Company does not achieve the financial performance target for the third
calendar quarter, Mr. DePasquale will be entitled to receive $18,750 of the
amount payable with respect to the third calendar quarter in the event that the
Company's gross revenue for the twelve months ended December 31, 2003 equals or
exceeds $2,250,000. The employment agreement also provides for an annual bonus
of options to purchase up to 500,000 shares of Company common stock payable at
the discretion of the Board of Directors.
The employment agreement contains standard and customary
confidentiality, non-solicitation and "work made for hire" provisions as well as
a covenant not to compete which prohibits Mr. DePasquale from doing business
with any current or prospective customer of the Company or engaging in a
business competitive with that of the Company during the term of his employment
and for the one year period thereafter. The agreement may be terminated by the
Company at any time with or without cause. In the event of termination without
cause, Mr. DePasquale shall continue to be paid his then current base salary for
the greater of six months from the date of such termination or the number of
months remaining until the end of the term of the employment agreement.
H. DONALD ROSACKER. On August 1, 2001, the Company entered into a one
year employment agreement with Mr. Rosacker which provided for an annual base
salary of $108,000. The agreement was renewed for an additional one year term
commencing August 1, 2002 and will automatically renew for additional one year
terms unless written notice of termination is received at least one month prior
to the date it would otherwise terminate. The Company recently restructured the
compensation component of the employment agreement. The agreement contains
standard and customary confidentiality, non-solicitation and "work made for
hire" provisions as well as a covenant not to compete which prohibits Mr.
Rosacker from doing business with any current or prospective customer of the
Company or engaging in a business competitive with that of the Company during
the term of his employment and for the one year period thereafter.
The agreement may be terminated by the Company at any time with or
without cause. In the event Mr. Rosacker is terminated without cause, Mr.
Rosacker shall continue to be paid his then current base salary for a period of
nine months from the date of such termination. Mr. Rosacker may terminate the
agreement if his current salary or benefits are reduced by more than 30%, in
which event Mr. Rosacker shall continue to be paid his then current base salary
for a period of two months from the date of such termination.
GARY E. WENDT. On May 10, 1996, the Company entered into a five-year
employment agreement with Gary E. Wendt to serve as the Chief Financial Officer
of the Company. The employment agreement was renewed for a one year term and
renews from year to year for consecutive one year terms unless written notice of
termination is received at least six months prior to the end of the renewal
term. The agreement provides for a base salary subject to an annual increase by
the Board of Directors and a bonus payable at the discretion of the Board of
Directors. Under the agreement, Mr. Wendt may be terminated only for "cause" as
that term is defined in the employment agreement.
The employment agreement contains standard and customary
confidentiality, "work made for hire" and non-solicitation provisions and
incorporates a Non-Competition Letter entered into in connection with his
employment. The Non-Competition Letter prohibits Mr. Wendt from competing with
the Company for a period of three years if the Company terminates employment for
cause and a period of two years if Mr. Wendt voluntarily terminates employment.
In the event of a termination without cause, or a "constructive termination",
which is defined to include an adverse change in Mr. Wendt's status or position
in the Company, a reduction of his base salary other than for austerity
purposes, or breach by the Company of any of its other contractual obligations
36
for other than austerity reasons, Mr. Wendt's non-competition obligations lapse
and he will receive severance in an amount equal to his base salary for two
years.
MIRA LACOUS. On November 20, 2001, the Company entered into a one year
employment agreement with Mira LaCous to serve as the Vice President of
Technology and Development of the Company at an annual base salary of $100,000
and a bonus of up to 50% of her base salary payable at the discretion of the
Board of Directors. The agreement was renewed for a one year term and
automatically renews for additional one year terms unless written notice of
termination is received at least one month prior to the date it would otherwise
terminate. The agreement contains standard and customary confidentiality,
non-solicitation and "work made for hire" provisions as well as a covenant not
to compete which prohibits Ms. LaCous from doing business with any current or
prospective customer of the Company or engaging in a business competitive with
that of the Company during the term of her employment and for the one year
period thereafter.
The agreement may be terminated by the Company at any time with or
without cause. In the event Ms. LaCous is terminated without cause, she shall
continue to be paid her then current base salary for a period of nine (9) months
from the date of such termination. Ms. LaCous may terminate the agreement if her
current salary or benefits are reduced by more than 30%, in which event Ms.
LaCous shall continue to be paid her then current base salary for a period of
two months from the date of such termination.
CHANGE IN CONTROL PROVISIONS
The Company's 1996 Stock Option Plan (as amended to date, the "1996
Plan") and 1999 Stock Option Plan (the "1999 Plan" and together with the 1996
Plan, the "Plans")) provide for the acceleration of the vesting of unvested
options upon a "Change in Control" of the Company. A Change in Control is
defined in the Plans to include (i) a sale or transfer of substantially all of
the Company's assets; (ii) the dissolution or liquidation of the Company; (iii)
a merger or consolidation to which the Company is a party and after which the
prior shareholders of the Company hold less than 50% of the combined voting
power of the surviving corporation's outstanding securities; (iv) the incumbent
directors cease to constitute at least a majority of the Board of Directors; or
(v) a change in control of the Company which would otherwise be reportable under
Section 13 or 15(d) of the Exchange Act.
In the event of a "Change In Control" both Plans provide for the
immediate vesting of all options issued thereunder. The 1999 Plan provides for
the Company to deliver written notice to each optionee under the 1999 Plan
fifteen (15) days prior to the occurrence of a Change In Control during which
all options issued under the 1999 Plan may be exercised. Thereafter, all options
issued under the 1999 Plan which are neither assumed or substituted in
connection with such transaction, automatically expire unless otherwise
determined by the Board. The 1996 Plan provides for all options to remain
exercisable for the remainder of their respective terms and permits the Company
to make a cash payment to any or all optionees equal to the difference between
the exercise price of any or all such options and the fair market value of the
Company's Common Stock immediately prior to the Change In Control.
37
Options issued to executive officers outside of the Plans contain
change in control provisions substantially similar to those contained in the
1999 Plan.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of March 26, 2003, information with
respect to the securities holdings of all persons which the Company, pursuant to
filings with the Securities and Exchange Commission, has reason to believe may
be deemed the beneficial owners of more than five percent (5%) of the Company's
outstanding common stock. The following table also sets forth, as of such date,
the beneficial ownership of the Company's common stock by all officers and
directors, individually and as a group.
AMOUNT AND NATURE
OF BENEFICIAL PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER OWNERSHIP(1) OF CLASS(1)
----------------------------------- ------------------- ----------------
Thomas J. Colatosti
188 East Emerson Road 125,000(2) *
Lexington, MA 02420
Michael W. DePasquale
1285 Corporate Center Drive 72,500 (3) *
Suite No. 175
Eagan, MN 55121
Gary E. Wendt
1285 Corporate Center Drive 578,730(4) 4.0%
Suite No. 175
Eagan, MN 55121
H. Donald Rosacker II
1285 Corporate Center Drive 239,436(5) 1.6%
Suite No. 175
Eagan, MN 55121
Charles P. Romeo
29 Ginger Court 62,500(6) *
North Kingstown, RI 02852
Jeffrey J. May
1285 Corporate Center Drive 125,000(7) *
Suite No. 175
Eagan, MN 55121
38
Mira LaCous
1285 Corporate Center Drive 307,498(8) 2.1%
Suite No. 175
Eagan, MN 55121
Jeffry R. Brown
5710 Northwood Ridge 1,010,000(9) 6.6%
Bloomington, MN 55437
Richard T. Fiskum
28690 660th Avenue 1,237,500 8.6%
Litchfield, MN 55355
N. DeAnne Wittig Qualified Property Marital Trust II,
established under Will dated October 23, 1998 1,237,500 (10) 8.6%
c/o Marshall & Ilsley Trust Company N.A
6625Lyndale Avenue South
Richfield, MN 55423
All officers and directors as a group 1,510,664 9.8%
(7) persons
---------------------
*Less than 1%
(1) The securities "beneficially owned" by an individual are determined in
accordance with the definition of "beneficial ownership" set forth in the
regulations promulgated under the Securities Exchange Act of 1934 and,
accordingly, may include securities owned by or for, among others, the spouse
and/or minor children of an individual and any other relative who has the same
home as such individual, as well as, other securities as to which the individual
has or shares voting or investment power or which each person has the right to
acquire within 60 days through the exercise of options or otherwise. Beneficial
ownership may be disclaimed as to certain of the securities. This table has been
prepared based on 14,377,406 shares of common stock outstanding as of March 26,
2003.
(2) Consists of shares assumable upon exercise of options. Does not include
225,000 shares issuable upon exercise of options subject to vesting.
(3) Consists of shares issuable upon exercise of options. Does not include
507,500 shares issuable upon exercise of options subject to vesting.
(4) Includes 173,380 shares issuable upon exercise of options.
(5) Consists of shares issuable upon exercise of options. Does not include
160,564 shares issuable upon exercise of options subject to vesting.
(6) Consists of shares issuable upon exercise of options. Does not include
137,500 shares issuable upon exercise of options subject to vesting.
39
(7) Consists of shares issuable upon exercise of options. Does not include
75,000 shares issuable upon exercise of options subject to vesting.
(8) Consists of shares issuable upon exercise of options. Does not include
132,502 shares issuable upon exercise of options subject to vesting.
(9) Consists of shares issuable upon exercise of options. Options to purchase
610,00 shares expire on March 31, 2003.
(10) The voting and disposition of these shares are controlled by Nancy DeAnne
Wittig and Marshall & Ilsley Trust Company N.A., as co-trustees.
The following table sets forth, as of December 31, 2002, information
with respect to securities authorized for issuance under equity compensation
plans.
----------------------------------------------------------------------------------------------------------------------
EQUITY COMPENSATION PLAN INFORMATION
NUMBER OF
SECURITIES
REMAINING AVAILABLE
FOR FUTURE ISSUANCE
NUMBER OF WEIGHTED-AVERAGE UNDER EQUITY
SECURITIES TO BE EXERCISE PRICE COMPENSATION PLANS
ISSUED UPON OF OUTSTANDING (EXCLUDING
EXERCISE OF OPTIONS, SECURITIES
OUTSTANDING WARRANTS AND REFLECTED IN COLUMN
OPTIONS, WARRANTS RIGHTS (A))
AND RIGHTS (A) (B) (C)
------------------------------------------------------- --------------------- ------------------ ---------------------
Equity compensation plans approved by security holders 390,380 $.58 266,620
------------------------------------------------------- --------------------- ------------------ ---------------------
Equity compensation plans not approved by security 4,010,919 $.59 163,331
holders
------------------------------------------------------- --------------------- ------------------ ---------------------
Total 4,401,299 $.59 429,951
------------------------------------------------------- --------------------- ------------------ ---------------------
The Company's 1999 Stock Option Plan (the "1999 Plan") was adopted by
the Board of Directors of the Company on or about August 31, 1999. The material
terms of the 1999 Plan are summarized below.
The 1999 Plan is currently administered by the full Board of Directors
of the Company (the "Plan Administrator"). The Plan Administrator is authorized
to construe the 1999 Plan and any option issued under the 1999 Plan, select the
persons to whom options may be granted, and determine the number of shares to be
covered by any option, the exercise price, vesting schedule and other material
terms of such option.
40
The 1999 Plan provides for the issuance of options to purchase up to
2,000,000 shares of common stock to officers, employees, directors and
consultants of the Company at exercise prices not less than 85% of the last sale
price of the Company's common stock as reported on the OTC Bulletin Board on the
date of grant. Options have terms of not more than 10 years from the date of
grant, are subject to vesting as determined by the Plan Administrator and are
not transferable without the permission of the Company except by will or the
laws of descent and distribution or pursuant to a domestic relations order.
Options terminate three (3) months after termination of employment or other
association with the Company or one (1) year after termination due to
disability, death or retirement. In the event that termination of employment or
association is for a cause, as that term is defined in the 1999 Plan, options
terminate immediately upon such termination. The Plan Administrator has the
discretion to extend options for up to three years from the date of termination
or disassociation with the Company.
The 1999 Plan provides for the immediate vesting of all options in the
event of a "Change In Control" of the Company. In the event of a Change In
Control, the Company is required to deliver written notice to each optionee
under the 1999 Plan fifteen (15) days prior to the occurrence of a Change in
Control, during which time all options issued under 1999 Plan may be exercised.
Thereafter, all options issued under the 1999 Plan which are neither assumed or
substituted in connection with such transaction, automatically expire, unless
otherwise determined by the Board. Under the 1999 Plan, a "Change In Control" is
defined to include (i) a sale or transfer of substantially all of the Company's
assets; (ii) the dissolution or liquidation of the Company; (iii) a merger or
consolidation to which the Company is a party and after which the prior
shareholders of the Company hold less than 50% of the combined voting power of
the surviving corporation's outstanding securities; (iv) the incumbent directors
cease to constitute at least a majority of the Board of Directors; or (v) a
change in control of the Company which would otherwise be reportable under
Section 13 or 15(d) of the Exchange Act.
As of December 31, 2002, options to purchase 1,836,669 shares have been
issued under the 1999 Plan and options to purchase an aggregate of 163,331
shares were available for future grants
In addition to options issued under the 1999 Plan, the Company has
issued options to employees, officers, directors and consultants to purchase an
aggregate of 2,174,250 shares of common stock. The terms of these options are
substantially similar to the provisions of the 1999 Plan and options issued
thereunder.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
EMPLOYMENT ARRANGEMENTS
The Company has employment agreements with each of Michael W.
DePasquale, H. Donald Rosacker II, Gary Wendt and Mira LaCous. Prior to January,
2003, the executive officers of the Company comprised a majority of the Board of
Directors. As a result, they determined their own salaries and bonuses. During
the past three fiscal years, with the exception of a signing bonuses to Ms.
LaCous and Mr. Brown, the Company has not paid any bonuses or increased the
compensation of any of its executive officers. See "EXECUTIVE COMPENSATION -
EMPLOYMENT AGREEMENTS."
41
OPTIONS GRANTED TO EXECUTIVE OFFICERS AND DIRECTORS
During 2001, the Company granted non-qualified stock options to
purchase an aggregate of 1,140,000 shares of common stock to its executive
officers, 500,000 of which were issued under the Company's 1999 Stock Incentive
Plan. During 2001, the Company issued options to purchase 200,000 shares of
common stock to Jeffrey J. May upon his appointment as a director of the
Company. During 2002, the Company issued options to purchase 200,000 shares of
common stock to Thomas J. Colatosti upon his appointment as a director of the
Company. All options were issued at exercise prices equal to the last sales
price of the Company's common stock as reported on the OTC Bulletin Board on the
date of grant, have terms of seven (7) years, and vest over a one to three year
period.
CONSULTING ARRANGEMENT WITH THOMAS J. COLATOSTI
In connection with Thomas J. Colatosti's appointment to the Board of
Directors of the Company, the Company agreed to pay Mr. Colatosti $4,000 per
month and issued him options to purchase 150,000 shares of common stock at an
exercise price of $.33 per share, the closing price of the Company's common
stock on the date of grant, to provide consulting services to the Company. Mr.
Colatosti has substantial experience in the biometric industry and in addition
to his role as the Chairman of the Board of Directors of the Company, provides
extensive service to the Company in the areas of strategic planning and
corporate finance.
CONSULTING AGREEMENT WITH JEFFRY R. BROWN
In connection with Jeffry R. Brown's resignation as the Chief Executive
Officer and Chairman of the Board of Directors of the Company on December 31,
2002, the Company and Mr. Brown entered into a consulting agreement effective as
of January 15, 2003. The consulting agreement terminates September 30, 2003,
provides for the payment of monthly consulting fees in the amount of $12,000,
continued participation in the Company's health and benefit plans, and the
reimbursement of out-of-pocket expenses in consideration of Mr. Brown providing
strategic management and consulting services to the Company. During the previous
two fiscal years, Mr. Brown was the chief architect of the Company's strategic
plan and the principal person involved in establishing and developing
relationships with the Company's alliance partners, potential customers and
other industry contacts which are important to the continued execution of the
Company's business plan. In recognition of his continued service to the Company,
the termination date of options to purchase 400,000 shares of common stock at
$.20 per share previously issued to Mr. Brown was extended from March 31, 2003
until December 31, 2003.
CONSULTING AGREEMENT WITH BARRY WENDT
In connection with Barry Wendt's resignation as the Chief Executive
Officer of the Company on July 1, 2001, the Company and Barry Wendt entered into
a consulting agreement pursuant to which Mr. Wendt served as a technology
advisor to the Company until January 31, 2002. Under the Consulting Agreement,
the Company paid consulting fees of $63,000 to Barry Wendt and reimbursed him
42
for out-of-pocket expenses in consideration of approximately 100 hours of
services per month. These services consisted of working with the Company's VP of
Technology and Development on writing and defining certain technologies related
to the Company's Vector Segment Technology and other technology originally
developed by the Company. As a co-founder of the Company, Barry Wendt was the
principal engineer involved in the design and development of the Company's core
technology between 1993 and 2000. The fees paid to Barry Wendt were the result
of negotiation after considering his unique knowledge and expertise of the
Company's technology and on a per hour basis, were approximately equal to the
consulting services obtained by the Company from non-affiliated third parties
over the past two years.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report. Portions
of Item 13 are submitted as separate sections of this Report:
(1) Financial statements filed as part of this Report:
Report of Independent Certified Public Accountants
Balance Sheets at December 31, 2001 and 2002
Statements of Operations - Years ended December 31,
2000, 2001 and 2002 and January 7, 1993 (date of
inception) through December 31, 2002
Statement of Stockholders' Deficit - Years ended
December 31, 2000, 2001 and 2002 and January 7, 1993
(date of inception) through December 31, 2002
Statements of Cash Flows - Years ended December 31,
2000, 2001 and 2002 and January 7, 1993 (date of
inception) through December 31, 2002
Notes to Financial Statements - December 31, 2000,
2001 and 2002
(2) The following exhibits are filed as part of this Report:
-------------------- -------------------------------------------- -----------------------------------------------
Exhibit No. Exhibit Method of Filing
-------------------- -------------------------------------------- -----------------------------------------------
3.1 Amended and Restated Articles of Incorporated by reference to Exhibit 3.1 to
Incorporation the Registrant's Registration Statement on
SB-2, File No. 333-16451 filed February 14,
1997 (the "Registration Statement")
-------------------- -------------------------------------------- -----------------------------------------------
3.2 Amended and Restated Bylaws Incorporated by reference to Exhibit 3.2 to
the Registration Statement
-------------------- -------------------------------------------- -----------------------------------------------
3.3 Certificate of Amendment to Amended and Incorporated by reference to Exhibit 3.3 to
Restated Articles of Incorporation the Registrant's Report on Form 10-QSB for
the quarter ended March 31, 1999
-------------------- -------------------------------------------- -----------------------------------------------
43
-------------------- -------------------------------------------- -----------------------------------------------
3.4 Certificate of Designation of Series A 9% Incorporated by reference to Exhibit 3.4 to
Convertible Preferred Stock the Registrant's Current Report on Form 8-K
dated July 8, 1999
-------------------- -------------------------------------------- -----------------------------------------------
3.5 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.5 to
Designation of Series A 9% Convertible the Registrant's Annual Report on Form 10-KSB
Preferred Stock for the fiscal year ended December 31, 1999
(the "1999 10-KSB")
-------------------- -------------------------------------------- -----------------------------------------------
3.6 Certificate of Designation of Series B 9% Incorporated by reference to Exhibit 3.6 to
Convertible Preferred Stock the Registrants
Current Report on Form 8-K
dated November 26, 2001 (the
"November 20, 2001 8-K")
-------------------- -------------------------------------------- -----------------------------------------------
3.7 Amendment to the Amended and Restated Incorporated by reference to Exhibit 3.7 to
Articles of Incorporation filed February the Registrant's Registration Statement on
28, 2002 Form SB-2 filed March 27, 2002
-------------------- -------------------------------------------- -----------------------------------------------
4.1 Specimen of Common Stock Certificate Incorporated by reference to Exhibit 4.1 to
the Registration Statement
-------------------- -------------------------------------------- -----------------------------------------------
10.1 SAC Technologies, Inc. 1996 Stock Option Incorporated by reference to Exhibit 10.1 to
Plan the Registration Statement
-------------------- -------------------------------------------- -----------------------------------------------
10.2 Employment Agreement by and between Gary Incorporated by reference to Exhibit 10.5 to
E. Wendt and the Company dated as of May the Registration
Statement 10, 1996 (with Non-Competition Letter effective
May 10, 1996 Attached as Exhibit
A)
-------------------- -------------------------------------------- -----------------------------------------------
10.3 Amendment No. 1 to the SAC Technologies, Incorporated by reference to Exhibit 10.23 to
Inc. 1996 Stock Option Plan the 1999 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.4 SAC Technologies, Inc. 1999 Stock Option Incorporated by reference to Exhibit 10.24 to
Plan the 1999 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.5 Employment Agreement dated November 3, Incorporated by reference to Exhibit 10.25 to
2000 by and between the Registrant and the Registrant's Quarterly Report on Form
Jeffry R. Brown 10-QSB for quarter ended September 30, 2000
(the "September 30, 2000 10-QSB")
-------------------- -------------------------------------------- -----------------------------------------------
10.6 Option to Purchase 280,000 shares of Incorporated by reference to Exhibit 10.26 to
Common Stock issued to Jeffry R. Brown the September 30, 2000 10-QSB
-------------------- -------------------------------------------- -----------------------------------------------
10.7 Non-Qualified Stock Option Agreement Under Incorporated by reference to Exhibit 10.27 to
the Registrant's 1999 Stock Option Plan to the September 30, 2000 10-QSB
purchase 300,000 shares of Common Stock
issued to Jeffry Brown
-------------------- -------------------------------------------- -----------------------------------------------
10.8 Consulting Agreement dated July 1, 2001 by Incorporated by reference to Exhibit 10.28 to
and between the Registrant and Barry M. the June 30, 2001 10-QSB
Wendt
-------------------- -------------------------------------------- -----------------------------------------------
44
-------------------- -------------------------------------------- -----------------------------------------------
10.9 Option to purchase 400,000 shares of Incorporated by reference to Exhibit 10.29 to
common stock issued to Jeffrey R. Brown the June 30, 2001 10-QSB
-------------------- -------------------------------------------- -----------------------------------------------
10.10 Employment Agreement dated August 1, 2001 Incorporated by reference to Exhibit 10.30 to
by and between the Registrant and H. the June 30, 2001 10-QSB
Donald Rosacker II
-------------------- -------------------------------------------- -----------------------------------------------
10.11 Funding Agreement by and between the Incorporated by reference to Exhibit 10.31 to
Registrant and The Shaar Fund dated the November 20, 2001 8-K
November 26, 2001
-------------------- -------------------------------------------- -----------------------------------------------
10.12 Registration Rights Agreement by and Incorporated by reference to Exhibit 10.32 to
between The Shaar Fund dated November 26, the November 20, 2001 8-K
2001
-------------------- -------------------------------------------- -----------------------------------------------
10.13 Exchange Agreement by and between the Incorporated by reference to Exhibit 10.33 to
Registrant and The Shaar Fund dated the November 20, 2001 8-K
November 26, 2001
-------------------- -------------------------------------------- -----------------------------------------------
10.14 Secured Note Due September 30, 2003 Incorporated by reference to Exhibit 10.34 to
the November 20, 2001 8-K
-------------------- -------------------------------------------- -----------------------------------------------
10.15 Restated 5% Convertible Debenture Due Incorporated by reference to Exhibit 10.35 to
September 30, 2003 the November 20, 2001 8-K
-------------------- -------------------------------------------- -----------------------------------------------
10.16 No Interest Debenture Due September 30, Incorporated by reference to Exhibit 10.36 to
2003 the November 20, 2001 8-K
-------------------- -------------------------------------------- -----------------------------------------------
10.17 Warrant Incorporated by reference to Exhibit 10.37 to
the November 20, 2001 8-K
-------------------- -------------------------------------------- -----------------------------------------------
10.18 Security Interest Provisions Incorporated by reference to Exhibit 10.38 to
the November 20, 2001 8-K
-------------------- -------------------------------------------- -----------------------------------------------
10.19 Employment Agreement by and between the Incorporated by reference to Exhibit 10.39 to
Registrant and Mira LaCous dated November the November 20, 2001 8-K
20, 2001
-------------------- -------------------------------------------- -----------------------------------------------
10.20 Option to Purchase 140,000 Shares of Incorporated by reference to Exhibit 10.40 to
Common Stock issued to Mira LaCous the November 20, 2001 8-K
-------------------- -------------------------------------------- -----------------------------------------------
10.21 Option to Purchase 150,000 Shares of Filed herewith
Common Stock issued to Thomas J. Colatosti.
-------------------- -------------------------------------------- -----------------------------------------------
10.22 Non-Qualified Stock Option Agreement under Filed herewith
the Registrant's 1999 Stock Incentive Plan
to Purchase 200,000 Shares of Common Stock
issued to Thomas J. Colatosti
-------------------- -------------------------------------------- -----------------------------------------------
10.23 Employment Agreement by and between the Filed herewith
Registrant and Michael W. DePasquale dated
January 3, 2003
-------------------- -------------------------------------------- -----------------------------------------------
45
-------------------- -------------------------------------------- -----------------------------------------------
10.24 Option to Purchase 580,000 Shares of Filed herewith
Common Stock issued to Michael W.
DePasquale
-------------------- -------------------------------------------- -----------------------------------------------
10.25 Note Purchase Agreement dated January 27, Filed herewith
2003
-------------------- -------------------------------------------- -----------------------------------------------
10.26 Secured Convertible Promissory Due June Filed herewith
30,2004
-------------------- -------------------------------------------- -----------------------------------------------
10.27 Option to Purchase 200,000 Shares of Filed herewith
Common Stock issued to Charles P. Romeo
-------------------- -------------------------------------------- -----------------------------------------------
23.1 Consent of Divine, Scherzer & Brody, Ltd. Filed herewith
-------------------- -------------------------------------------- -----------------------------------------------
25.1 Power of Attorney (included in the Filed herewith
signature page to this Annual Report on
Form 10-KSB)
-------------------- -------------------------------------------- -----------------------------------------------
99.1 Certificate of CEO of Registrant Pursuant Filed herewith
to 18 USC Section 1350, as Adopted
Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
-------------------- -------------------------------------------- -----------------------------------------------
99.2 Certificate of CFO of Registrant Pursuant Filed herewith
to 18 USC Section 1350, as Adopted
Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
-------------------- -------------------------------------------- -----------------------------------------------
(b) Reports on Form 8-K.
None
ITEM 14. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an
evaluation was carried out under the supervision and with the participation of
the Company's management, including the Chief Executive officer ("CEO") and
Chief Financial Officer ("CFO"), of the effectiveness of the Company's
disclosure controls and procedures. Based on that evaluation, the CEO and CFO
have concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company in
reports that it files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms. There have been no
significant changes in our internal controls or in other factors that could
significantly affect internal controls subsequent to the date we carried out
this evaluation.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
BIO-KEY INTERNATIONAL, INC.
Date: March 28, 2003 /s/ Michael W. DePasquale
----------------------------
Michael W. DePasquale
CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities on the dates indicated.
Signature Title Date
/s/ Thomas J. Colatosti March 28, 2003
--------------------------------------
Thomas J. Colatosti Chairman of the Board of Directors
/s/ H. Donald Rosacker, II March 28, 2003
--------------------------------------
H. Donald Rosacker, II Vice President Marketing, Director
/s/ Gary E. Wendt Chief Financial Officer, Principal March 28, 2003
--------------------------------------- Accounting Officer and Director
Gary E. Wendt
/s/ Jeffrey J. May March 28, 2003
---------------------------------------
Jeffrey J. May Director
/s/ Charles P. Romeo March 28, 2003
--------------------------------------
Charles P. Romeo Director
47
CERTIFICATION
I, Michael W. DePasquale, certify that:
1. I have reviewed this annual report on Form 10-KSB of Bio-key International,
Inc. (the "Registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
48
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003 /s/ Michael W. DePasquale
---------------------------------
Michael W. DePasquale
Chief Executive Officer
49
CERTIFICATION
I, Gary E. Wendt, certify that:
1. I have reviewed this annual report on Form 10-KSB of Bio-key International,
Inc. (the "Registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
50
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003 /s/ Gary E. Wendt
---------------------------------------
Gary E. Wendt
Chief Financial Officer
51
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION
10.21 Option to Purchase 150,000 Shares of Common Stock
issued to Thomas J. Colatosti.
10.22 Non-Qualified Stock Option Agreement under the
Registrant's 1999 Stock Incentive Plan to Purchase
200,000 Shares of Common Stock issued to Thomas J. Colatosti
10.23 Employment Agreement by and between the Registrant and Michael
W. DePasquale dated January 3, 2003
10.24 Option to Purchase 580,000 Shares of Common Stock issued to Michael
W. DePasquale
10.25 Note Purchase Agreement dated January 27, 2003
10.26 Secured Convertible Promissory Due June 30,2004
10.27 Option to Purchase 200,000 Shares of Common Stock
issued to Charles P. Romeo
23.1 Consent of Divine, Scherzer & Brody, Ltd.
25.1 Power of Attorney (included in the signature page to the Report)
99.1 Certificate of CEO of Registrant Pursuant to 18 USC Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certificate of CFO of Registrant Pursuant to 18 USC Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
52
ITEM 7 - FINANCIAL STATEMENTS
The following financial statements of BIO-key International, Inc. are included herein at the indicated page
numbers:
Page No.
------------
Report of Independent Certified Public Accountants F-2
Balance Sheets at December 31, 2001 and 2002 F-3
Statements of Operations - Years ended December 31, 2000, 2001 and 2002, and January 7, 1993 (date of
inception) through December 31, 2002 F-4
Statement of Stockholders' Deficit - Years ended December 31, 2000, 2001 and 2002, and January 7, 1993
(date of inception) through December 31, 2002 F-5
Statements of Cash Flows - Years ended December 31, 2000, 2001 and 2002, and January 7, 1993 (date of
inception) through December 31, 2002 F-6
Notes to the Financial Statements - December 31, 2000, 2001 and 2002 F-7
F-1
Report of Independent Certified Public Accountants
-------------------------------------------------
Board of Directors and Stockholders
BIO-key International, Inc.
We have audited the accompanying balance sheets of BIO-key International, Inc.
(a Minnesota corporation in the development stage) as of December 31, 2001 and
2002 and the related statements of operations, stockholders' deficit and cash
flows for each of the three years in the period ended December 31, 2002, and the
period January 7, 1993 (date of inception) through December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of BIO-key International, Inc. as
of December 31, 2001 and 2002, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2002, and the
period January 7, 1993 (date of inception) through December 31, 2002 in
conformity with accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared in conformity with
accounting principles generally accepted in the United States, which contemplate
continuation of the Company as a going concern. However, as discussed in Note A
to the financial statements, the Company is in the development stage and has not
generated significant revenues since inception, has suffered recurring losses
from operations and has a stockholders' deficit. These aforementioned issues,
among others, raise substantial doubt about the Company's ability to continue as
a going concern. The financial statements do not include any adjustments that
might result from this uncertainty. Management's plans in regard to these
matters are also discussed in Note A.
/s/ Divine, Scherzer & Brody, Ltd.
Minneapolis, Minnesota
March 14, 2003 (except for note F, as to
which the date is March 27, 2003)
F-2
BIO-key International, Inc.
(a Corporation in the Development Stage)
BALANCE SHEETS
ASSETS
December 31,
----------------------------------
2001 2002
-------------- ---------------
CURRENT ASSETS
Cash and cash equivalents $ 514,970 $ 16,748
Accounts receivable - 67,998
Prepaid expenses 206,634 50,897
-------------- ---------------
Total current assets 721,604 135,643
OTHER ASSETS 41,706 121,991
-------------- ---------------
$ 763,310 $ 257,634
============== ===============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Current maturities of long-term obligations $ - $ 6,507,286
Accounts payable 238,496 354,694
Accrued liabilities 90,575 572,701
-------------- ---------------
Total current liabilities 329,071 7,434,681
LONG-TERM OBLIGATIONS, net of discount, less current maturities 4,331,238 -
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT
Preferred stock - authorized, 5,000,000 shares of $.01 par value
(liquidation preference of $100 per share)
Series B 9% convertible issued and outstanding, 21,430
and 18,430 shares, respectively 214 184
Common stock - authorized, 60,000,000 shares of $.01 par value; issued
and outstanding 12,528,469 and 14,377,406 shares, respectively 125,285 143,774
Additional contributed capital 15,538,025 16,284,399
Deficit accumulated during the development stage (19,560,523) (23,605,404)
-------------- ---------------
(3,896,999) (7,177,047)
-------------- ---------------
$ 763,310 $ 257,634
============== ===============
The accompanying notes are an integral part of these statements.
F-3
BIO-key International, Inc.
(a Corporation in the Development Stage)
STATEMENTS OF OPERATIONS
January 7,
1993 (date of
inception)
Years ended December 31, through
----------------------------------------------- December 31,
2000 2001 2002 2002
------------ ------------ ------------- -------------
Revenues
Product sales $ - $ - $ 5,754 $ 583,138
License fees - - 128,860 228,860
Reimbursed research and development - - - 284,506
Technical support and other services - - 20,785 450,670
------------ ------------ ------------- -------------
- - 155,399 1,547,174
Costs and other expenses
Cost of product sales - - 2,720 1,739,615
Cost of technical support and other
services - - - 237,317
Selling, general and administrative 1,852,867 1,318,465 1,926,328 13,357,462
Research, development and engineering 1,136,245 947,932 1,084,513 6,890,638
------------ ------------ ------------- -------------
2,989,112 2,266,397 3,013,561 22,225,032
------------ ------------ ------------- -------------
Operating loss (2,989,112) (2,266,397) (2,858,162) (20,677,858)
Other income (deductions)
Interest expense (141,341) (317,627) (1,162,935) (2,492,080)
Sundry - - 1,123 510,260
------------ ------------ ------------- -------------
(141,341) (317,627) (1,161,812) (1,981,820)
------------ ------------ ------------- -------------
Loss before extraordinary gain (3,130,453) (2,584,024) (4,019,974) (22,659,678)
Extraordinary gain - troubled payable
reduction - 300,250 - 300,250
------------ ------------ ------------- -------------
NET LOSS $ (3,130,453) $ (2,283,774) $ (4,019,974) $ (22,359,428)
============ ============ ============= =============
Net loss $ (3,130,453) $ (2,283,774) $ (4,019,974) $ (22,359,428)
Convertible preferred stock dividends and
accretion (307,225) (550,478) (164,965) (1,364,268)
------------ ------------ ------------- -------------
Loss applicable to common stockholders $ (3,437,678) $ (2,834,252) $ (4,184,939) $ (23,723,696)
============ ============ ============= =============
Basic and diluted loss per share
Net loss before extraordinary gain $ (.33) $ (.24) $ (.31) $ (3.04)
Extraordinary gain - .03 - .04
------------ ------------ ------------- -------------
Net loss (.33) (.21) (.31) (3.00)
Convertible preferred stock dividend and
accretion (.03) (.05) (.01) (.18)
------------ ------------ ------------- -------------
Loss applicable per common share $ (.36) $ (.26) $ (.32) $ (3.18)
============ ============ ============= =============
Weighted average number of shares used 9,589,304 10,928,311 13,106,483 7,460,408
============ ============ ============= =============
The accompanying notes are an integral part of these statements.
F-4
BIO-key International, Inc.
(a Corporation in the Development Stage)
STATEMENT OF STOCKHOLDERS' DEFICIT
Series A 9% Convertible
Preferred Stock
---------------------------
Shares Amount
------------ ------------
Sale of common stock January 1993 -- $ --
Sale of common stock January 1993 at $.02 per share -- --
Redemption of director and officers common stock August 1995 at
$0 per share -- --
Sales of common stock August 1995 through December 1995 at $.17 through
$.24 per share -- --
Redemption of common stock August 1995 through December 1995 at $.22 through
$.24 per share -- --
Issuance of detachable warrants May 1996, in connection with bridge
financing arrangements, valued at $25,000, to purchase 100,000 shares of
common stock at $1.00 per share -- --
Sales of common stock during June and July, 1996 at $1.00 per share,
less offering costs of $124,663 -- --
Conversion of bridge notes plus accrued interest of $1,841 to common
stock June 1996 at $1.00 per share -- --
Exercise of stock options and warrants -- --
Sales of common stock in February and March 1997 at $3.00 per share, less
offering costs of $1,039,668 -- --
Issuance of warrants March 1997 to purchase 25,000 shares of common
stock at $3.00 per share -- --
Issuance of stock options April 1998 to purchase 100,000 shares of
common stock at $8.46 per share -- --
Fair market value of conversion feature on debenture issued June 1998 -- --
Issuance of warrant June 1998 to purchase 350,000 shares of common stock
at $7.29 and $7.50 per share -- --
Issuance of stock options April 1998 and September 1998 to purchase
423,000 shares of common stock at $3.00 to $6.42 per share -- --
Sale of stock warrants September 1999 to purchase 320,000 shares of
common stock at $.84 - $1.00 per Share -- --
Issuance of preferred stock and warrant, less offering costs of $74,461
during July 1999 13,125 131
Accretion of preferred stock beneficial conversion feature during 1999 -- --
Conversion of debentures during 1999 -- --
Unearned compensation grant -- --
Unearned compensation amortization -- --
Unearned compensation reversal related to employee terminations -- --
Other -- --
Net loss -- --
------------ ------------
Balance as of December 31, 1999 13,125 131
Issuance of preferred stock and warrant, less offering costs of $16,481 6,750 68
Accretion of preferred stock beneficial conversion feature -- --
Conversion of debentures -- --
Options and warrants issued for services and other -- --
Net loss -- --
------------ ------------
Balance as of December 31, 2000 19,875 199
Conversion of Series A preferred stock and cumulative dividends in
arrears to common stock (1,431) (14)
Issuance of Series B preferred stock in exchange for Series
A preferred stock and dividends in arrears, less offering
costs of $40,500 (18,444) (185)
Accretion of preferred stock beneficial conversion feature -- --
Conversion of debentures and accrued interest to common stock -- --
Fair value of beneficial conversion feature on debenture -- --
Options and warrants issued for services and other -- --
Net loss -- --
------------ ------------
Balance as of December 31, 2001 -- --
Conversion of series B preferred stock and cumulative dividends in
arrears to common stock -- --
Conversion of debentures and accrued interest to common stock -- --
Options and warrants issued for services and other -- --
Net loss -- --
------------ ------------
Balance as of December 31, 2002 -- $ --
============ ============
F-5a
Series A 9% Convertible
Preferred Stock
---------------------------
Shares Amount
------------ ------------
Sale of common stock January 1993 -- $ --
Sale of common stock January 1993 at $.02 per share -- --
Redemption of director and officers common stock August 1995 at
$0 per share -- --
Sales of common stock August 1995 through December 1995 at $.17 through
$.24 per share -- --
Redemption of common stock August 1995 through December 1995 at $.22 through
$.24 per share -- --
Issuance of detachable warrants May 1996, in connection with bridge
financing arrangements, valued at $25,000, to purchase 100,000 shares of
common stock at $1.00 per share -- --
Sales of common stock during June and July, 1996 at $1.00 per share,
less offering costs of $124,663 -- --
Conversion of bridge notes plus accrued interest of $1,841 to common
stock June 1996 at $1.00 per share -- --
Exercise of stock options and warrants -- --
Sales of common stock in February and March 1997 at $3.00 per share, less
offering costs of $1,039,668 -- --
Issuance of warrants March 1997 to purchase 25,000 shares of common
stock at $3.00 per share -- --
Issuance of stock options April 1998 to purchase 100,000 shares of
common stock at $8.46 per share -- --
Fair market value of conversion feature on debenture issued June 1998 -- --
Issuance of warrant June 1998 to purchase 350,000 shares of common stock
at $7.29 and $7.50 per share -- --
Issuance of stock options April 1998 and September 1998 to purchase
423,000 shares of common stock at $3.00 to $6.42 per share -- --
Sale of stock warrants September 1999 to purchase 320,000 shares of
common stock at $.84 - $1.00 per Share -- --
Issuance of preferred stock and warrant, less offering costs of $74,461
during July 1999 -- --
Accretion of preferred stock beneficial conversion feature during 1999 -- --
Conversion of debentures during 1999 -- --
Unearned compensation grant -- --
Unearned compensation amortization -- --
Unearned compensation reversal related to employee terminations -- --
Other -- --
Net loss -- --
------------ ------------
Balance as of December 31, 1999 -- --
Issuance of preferred stock and warrant, less offering costs of $16,481 -- --
Accretion of preferred stock beneficial conversion feature -- --
Conversion of debentures -- --
Options and warrants issued for services and other -- --
Net loss -- --
------------ ------------
Balance as of December 31, 2000 -- --
Conversion of Series A preferred stock and cumulative dividends in
arrears to common stock -- --
Issuance of Series B preferred stock in exchange for Series
A preferred stock and dividends in arrears, less offering
costs of $40,500 21,430 214
Accretion of preferred stock beneficial conversion feature -- --
Conversion of debentures and accrued interest to common stock -- --
Fair value of beneficial conversion feature on debenture -- --
Options and warrants issued for services and other -- --
Net loss -- --
------------ ------------
Balance as of December 31, 2001 21,430 214
Conversion of series B preferred stock and cumulative dividends in
arrears to common stock (3,000) (30)
Conversion of debentures and accrued interest to common stock -- --
Options and warrants issued for services and other -- --
Net loss -- --
------------ ------------
Balance as of December 31, 2002 18,430 $ 184
============ ============
F-5b
Common Stock Additional
---------------------------- Contributed
Shares Amount Capital
------------- ------------ ------------
Sale of common stock January 1993 3,150,000 $ 31,500 $ (22,750)
Sale of common stock January 1993 at $.02 per share 1,350,000 13,500 11,500
Redemption of director and officers common stock August 1995 at
$0 per share (270,000) (2,700) 2,700
Sales of common stock August 1995 through December 1995 at $.17 through
$.24 per share 1,237,500 12,376 262,624
Redemption of common stock August 1995 through December 1995 at $.22 through
$.24 per share (1,350,000) (13,500) (265,324)
Issuance of detachable warrants May 1996, in connection with bridge
financing arrangements, valued at $25,000, to purchase 100,000 shares of
common stock at $1.00 per share -- -- 25,000
Sales of common stock during June and July, 1996 at $1.00 per share,
less offering costs of $124,663 698,160 6,982 566,515
Conversion of bridge notes plus accrued interest of $1,841 to common
stock June 1996 at $1.00 per share 201,840 2,018 178,990
Exercise of stock options and warrants 99,367 993 211,399
Sales of common stock in February and March 1997 at $3.00 per share, less
offering costs of $1,039,668 2,420,000 24,200 6,196,132
Issuance of warrants March 1997 to purchase 25,000 shares of common
stock at $3.00 per share -- -- 27,500
Issuance of stock options April 1998 to purchase 100,000 shares of
common stock at $8.46 per share -- -- 352,650
Fair market value of conversion feature on debenture issued June 1998 -- -- 525,000
Issuance of warrant June 1998 to purchase 350,000 shares of common stock
at $7.29 and $7.50 per share -- -- 432,000
Issuance of stock options April 1998 and September 1998 to purchase
423,000 shares of common stock at $3.00 to $6.42 per share -- -- 237,500
Sale of stock warrants September 1999 to purchase 320,000 shares of
common stock at $.84 - $1.00 per Share -- -- 80,000
Issuance of preferred stock and warrant, less offering costs of $74,461
during July 1999 -- -- 800,408
Accretion of preferred stock beneficial conversion feature during 1999 -- -- 285,000
Conversion of debentures during 1999 1,569,390 15,694 1,326,306
Unearned compensation grant -- -- 408,920
Unearned compensation amortization -- -- --
Unearned compensation reversal related to employee terminations -- -- (227,111)
Other -- -- 58,310
Net loss -- -- --
------------- ------------ ------------
Balance as of December 31, 1999 9,106,257 91,063 11,473,269
Issuance of preferred stock and warrant, less offering costs of $16,481 -- -- 433,451
Accretion of preferred stock beneficial conversion feature -- -- 141,000
Conversion of debentures 860,467 8,604 541,396
Options and warrants issued for services and other -- -- 544,484
Net loss -- -- --
------------- ------------ ------------
Balance as of December 31, 2000 9,966,724 99,667 13,133,600
Conversion of Series A preferred stock and cumulative dividends in
arrears to common stock 670,445 6,704 18,232
Issuance of Series B preferred stock in exchange for Series
A preferred stock and dividends in arrears, less offering
costs of $40,500 -- -- 240,520
Accretion of preferred stock beneficial conversion feature -- -- 451,000
Conversion of debentures and accrued interest to common stock 1,891,300 18,914 494,887
Fair value of beneficial conversion feature on debenture -- -- 113,000
Options and warrants issued for services and other -- -- 1,086,786
Net loss -- -- --
------------- ------------ ------------
Balance as of December 31, 2001 12,528,469 125,285 15,538,025
Conversion of series B preferred stock and cumulative dividends in
arrears to common stock 1,045,739 10,457 14,480
Conversion of debentures and accrued interest to common stock 803,198 8,032 314,360
Options and warrants issued for services and other -- -- 417,534
Net loss -- -- --
------------- ------------ ------------
Balance as of December 31, 2002 14,377,406 $ 143,774 $ 16,284,399
============= ============ ============
F-5c
Deficit
accumulated Deferred
during the compensation
development related to
stage stock options Total
------------ ------------ ------------
Sale of common stock January 1993 $ (8,747) $ -- $ 3
Sale of common stock January 1993 at $.02 per share -- -- 25,000
Redemption of director and officers common stock August 1995 at
$0 per share -- -- --
Sales of common stock August 1995 through December 1995 at $.17 through
$.24 per share -- -- 275,000
Redemption of common stock August 1995 through December 1995 at $.22 through
$.24 per share (29,350) -- (308,174)
Issuance of detachable warrants May 1996, in connection with bridge
financing arrangements, valued at $25,000, to purchase 100,000 shares of
common stock at $1.00 per share -- -- 25,000
Sales of common stock during June and July, 1996 at $1.00 per share,
less offering costs of $124,663 -- -- 573,497
Conversion of bridge notes plus accrued interest of $1,841 to common
stock June 1996 at $1.00 per share -- -- 181,008
Exercise of stock options and warrants -- -- 212,392
Sales of common stock in February and March 1997 at $3.00 per share, less
offering costs of $1,039,668 -- -- 6,220,332
Issuance of warrants March 1997 to purchase 25,000 shares of common
stock at $3.00 per share -- -- 27,500
Issuance of stock options April 1998 to purchase 100,000 shares of
common stock at $8.46 per share -- -- 352,650
Fair market value of conversion feature on debenture issued June 1998 -- -- 525,000
Issuance of warrant June 1998 to purchase 350,000 shares of common stock
at $7.29 and $7.50 per share -- -- 432,000
Issuance of stock options April 1998 and September 1998 to purchase
423,000 shares of common stock at $3.00 to $6.42 per share -- -- 237,500
Sale of stock warrants September 1999 to purchase 320,000 shares of
common stock at $.84 - $1.00 per Share -- -- 80,000
Issuance of preferred stock and warrant, less offering costs of $74,461
during July 1999 -- -- 800,539
Accretion of preferred stock beneficial conversion feature during 1999 (285,000) -- --
Conversion of debentures during 1999 -- -- 1,342,000
Unearned compensation grant -- (408,920) --
Unearned compensation amortization -- 181,809 181,809
Unearned compensation reversal related to employee terminations -- 227,111 --
Other -- -- 58,310
Net loss (12,925,228) -- (12,925,228)
------------ ------------ ------------
Balance as of December 31, 1999 (13,248,325) -- (1,683,862)
Issuance of preferred stock and warrant, less offering costs of $16,481 -- -- 433,519
Accretion of preferred stock beneficial conversion feature (141,000) -- --
Conversion of debentures -- -- 550,000
Options and warrants issued for services and other -- -- 544,484
Net loss (3,130,453) -- (3,130,453)
------------ ------------ ------------
Balance as of December 31, 2000 (16,519,778) -- (3,286,312)
Conversion of Series A preferred stock and cumulative dividends in
arrears to common stock (24,922) -- --
Issuance of Series B preferred stock in exchange for Series
A preferred stock and dividends in arrears, less offering
costs of $40,500 (281,049) -- (40,500)
Accretion of preferred stock beneficial conversion feature (451,000) -- --
Conversion of debentures and accrued interest to common stock -- -- 513,801
Fair value of beneficial conversion feature on debenture -- -- 113,000
Options and warrants issued for services and other -- -- 1,086,786
Net loss (2,283,774) -- (2,283,774)
------------ ------------ ------------
Balance as of December 31, 2001 (19,560,523) -- (3,896,999)
Conversion of series B preferred stock and cumulative dividends in
arrears to common stock (24,907) -- --
Conversion of debentures and accrued interest to common stock -- -- 322,392
Options and warrants issued for services and other -- -- 417,534
Net loss (4,019,974) -- (4,019,974)
------------ ------------ ------------
Balance as of December 31, 2002 $(23,605,404) $ -- $ (7,177,047)
============ ============ ============
The accompanying notes are an integral part of this statement.
F-5d
BIO-key International, Inc.
(a Corporation in the Development Stage)
STATEMENTS OF CASH FLOWS
January 7,
1993 (date of
inception)
through
Years ended December 31, December
----------------------------------------- 31,
2000 2001 2002 2002
----------------------------------------- -----------
Cash flows from operating activities
Net loss $ (3,130,453) $ (2,283,774) (4,019,974) $(22,359,429)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 47,315 31,942 - 242,913
Amortization
Unearned compensation - - - 193,333
Deferred financing costs 53,287 11,524 - 426,397
Discounts on convertible debt related to warrants
and beneficial conversion features 36,701 60,863 662,048 1,284,612
Write-down of inventory 32,500 - - 916,015
Write-down of deferred financing costs - - - 132,977
Gain on sale of Inter-Con/PC, Inc. stock - - - (190,000)
Revenues realized due to offset of billings against a
stock repurchase - - - (170,174)
Acquired research and development - - - 117,000
Options and warrants issued for services and other 544,484 70,786 385,534 1,786,554
Other - - - 34,684
Change in assets and liabilities:
Accounts receivable 4,213 9,118 (67,998) (67,998)
Inventories - - - (916,015)
Prepaid expenses and other 21,375 (184,889) 155,737 (50,897)
Accounts payable (12,637) (89,902) 116,198 354,694
Accrued liabilities 679,892 448,607 503,518 2,084,774
----------- ----------- ----------- -----------
Net cash used in operating activities (1,723,323) (1,925,725) (2,264,937) (16,180,560)
Cash flows from investing activities
Capital expenditures - - - (242,913)
Proceeds from sale of Inter-Con/PC, Inc. stock - - - 190,000
Other (12,518) (2,635) 1,615 (40,091)
----------- ----------- ----------- -----------
Net cash provided by (used in) investing activities (12,518) (2,635) 1,615 (93,004)
Cash flows from financing activities
Net borrowings under short-term borrowing agreements 1,500,000 1,370,000 - 3,003,000
Issuance of convertible bridge notes - - 1,830,000 2,005,000
Issuance of convertible debentures and long-term notes - 1,065,000 - 2,840,000
Issuance of warrants and discount on convertible debentures - - - 830,000
Financing costs - (40,500) (64,900) (418,377)
Exercise of stock options and warrants - - - 190,799
Sale of common stock - - - 7,093,832
Sale of preferred stock and assigned value of warrant 183,519 - - 884,058
Redemption of common stock - - - (138,000)
----------- ----------- ----------- ------------
Net cash provided by financing activities 1,683,519 2,394,500 1,765,100 16,290,312
----------- ----------- ----------- ------------
NET INCREASE (DECREASE) IN CASH (52,322) 466,140 (498,222) 16,748
Cash and cash equivalents, beginning of period 101,152 48,830 514,970 -
----------- ----------- ----------- -----------
Cash and cash equivalents, end of period $ 48,830 $ 514,970 $ 16,748 $ 16,748
=========== =========== =========== ===========
The accompanying notes are an integral part of these statements.
F-6
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE A - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Change in name of Company
-------------------------
In February 2002, the Company's shareholders approved the change in the
Company's name from SAC Technologies, Inc. to BIO-key International,
Inc.
Nature of Business
------------------
BIO-key International, Inc. (the Company) is a development stage
company incorporated on January 7, 1993 with operations in Minneapolis,
Minnesota. The Company's goal is to develop and market advanced
biometric fingerprint technology solutions that provide fast, easy and
highly secure personal identification for online access to computers
and networks. The Company's fingerprint identification techniques can
be used without the aid of a personal identification number. The
Company's target market includes Internet application service
providers, Internet based retailers and other operators of private
networks, and entities where security and identification applications
are required, including the aviation industry.
Basis of Presentation
---------------------
Broad commercial acceptance of the Company's technology is critical to
the Company's success and ability to generate revenues. The Company has
had no significant revenues to date, and has accumulated losses since
inception of approximately $22,359,000, of which approximately
$4,020,000 was incurred during 2002. As of December 31, 2002, there was
a stockholders' deficit of approximately $7,177,000.
The Company is in need of substantial additional capital. The Company
is currently considering various alternatives related to raising
additional capital including continued funding from an investment group
and new funding from other sources. No assurance can be given that any
form of additional funding will be available on terms acceptable to the
Company, that adequate funding will be obtained to meet its needs, or
that such funding would not be dilutive to existing stockholders.
The accompanying financial statements have been prepared in conformity
with accounting principles generally accepted in the United States,
which contemplate continuation of the Company as a going concern. The
matters described in the preceding paragraphs raise substantial doubt
about the Company's ability to continue as a going concern.
Recoverability of a major portion of the recorded asset amounts shown
in the accompanying balance sheet is dependent upon the Company
advancing beyond the development stage, which in turn is dependent upon
the Company's ability to obtain additional funding, meet its funding
requirements on a continuing basis, and succeed in its future
operations. The accompanying financial statements do not include any
adjustments that might be necessary should the Company be unable to
continue in existence.
F-7
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE A - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Summary of Significant Accounting Policies
------------------------------------------
A summary of the significant accounting policies consistently applied
in the preparation of the accompanying financial statements follows:
1. Revenue Recognition
-------------------
Revenues from software licensing is recognized in accordance with
Statement of Position (SOP) No. 97-2, Software Revenue Recognition, as
amended by SOP No. 98-9. Accordingly, revenue from software licensing
is recognized when all of the following criteria are met: persuasive
evidence of an arrangement exists, delivery has occurred, the fee is
fixed or determinable, and collectibility is probable.
The Company intends to enter into arrangements with end users for items
which may include software license fees, usage fees and services or
various combinations thereof. For each arrangement, revenues will be
recognized when evidence of an agreement has been documented, the fees
are fixed or determinable, collection of fees is probable, delivery of
the product has occurred and no other significant obligations remain.
Multiple-Element Arrangements: For multiple-element arrangements, each
element of the arrangement will be analyzed and the Company will
allocate a portion of the total fee under the arrangement to the
elements using vendor specific objective evidence of fair value of the
element, regardless of any separate prices stated within the contract
for each element. Vendor specific objective evidence is based on the
price the customer is required to pay when the element is sold
separately (i.e., software license fees charged when consulting or
other services are not provided, hourly rates charged for consulting
services when sold separately from a software license or usage fees).
If vendor specific objective evidence of fair value does not exist for
any undelivered elements, all revenue is deferred and recognized
ratably over the service period if the undelivered element is services,
or until sufficient objective evidence of fair value exists or all
elements have been delivered.
License revenues: Amounts allocated to license revenues are recognized
at the time of delivery of the software and all other revenue
recognition criteria discussed above have been met.
Service revenues: Revenues from services are comprised of consulting
and implementation services. Consulting services are generally sold on
a time-and-materials basis and include a range of services including
installation of software and assisting in the design of interfaces to
allow the software to operate in customized environments. Services are
generally separable from other elements under the arrangement since
performance of the services are not essential to the functionality of
any other element of the transaction and are described in the contract
such that the total price of the arrangement would be expected to vary
as the result of the inclusion or exclusion of the services. Revenues
from services are generally recognized as the services are performed.
F-8
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE A - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
1. Revenue Recognition - Continued
-------------------------------
Usage fees: Usage fees are charged on certain applications based on the
customer's volume of use. Usage revenue is recognized based on the
actual level of activity used by the customer or, in the case of
fixed-fee arrangements, ratably over the arranged time period.
Although each sale will be separately negotiated, the Company does not
anticipate offering customers any extended payment terms.
The Company provides customers, free of charge or at a minimal cost,
testing kits which potential licensing customers may use to test
compatibility/acceptance of the Company's technology with the
customer's intended applications.
2. Cash and Cash Equivalents
-------------------------
Cash equivalents consist of certificates of deposit and all other
liquid investments with original maturities of three months or less.
The Company maintains its cash balances in a financial institution in
Nevada. These balances are insured by the Federal Deposit Insurance
Corporation up to $100,000.
3. Equipment, Furniture and Fixtures
--------------------------------
Equipment, furniture and fixtures are stated at cost. Depreciation is
provided for in amounts sufficient to relate the cost of depreciable
assets to operations over their estimated services lives of three and
five years using the straight-line method. Equipment, furniture and
fixtures consisted of the following as of December 31:
2001 2002
-------------- ---------------
Equipment $ 206,363 $ 206,363
Furniture and fixtures 36,550 36,550
-------------- ---------------
242,913 242,913
Less accumulated depreciation 242,913 242,913
-------------- ---------------
$ - $ -
============== ===============
4. Advertising Expense
-------------------
The Company expenses the costs of advertising as incurred. Advertising
expenses for the years ended December 31, 2000, 2001, 2002, and the
period January 7, 1993 (date of inception) through December 31, 2002
were approximately $6,000, $1,000, $6,000 and $222,000, respectively.
F-9
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE A - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
5. Research and Development Expenditures
-------------------------------------
All costs related to development of new products are charged to expense
as incurred. Such costs are required to be expensed until technological
feasibility and proven marketability of the product are established.
6. Basic and Diluted Loss per Common Share
---------------------------------------
Basic and diluted loss per share for all periods presented is computed
using the weighted average number of common shares outstanding. Basic
weighted average shares outstanding include only outstanding common
shares. Shares reserved for outstanding warrants, stock options or
convertible preferred stock are not considered because the impact of
the incremental shares is antidilutive.
7. Income Taxes
------------
The Company provides for income taxes based on income reported for
financial reporting purposes. Certain charges to earnings differ as to
timing from those deducted for tax purposes; these relate primarily to
net operating loss carryforwards. The tax effect of these differences
are recorded as deferred income taxes.
8. Accounting for Stock-Based Compensation
---------------------------------------
The Company uses the intrinsic value method prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25) in accounting for employee stock options. Under the
intrinsic value method, compensation expense is recognized only to the
extent the market price of the common stock exceeds the exercise price
of the stock option at the date of the grant.
In the future, if employees exercise certain nonstatutory stock
options, the Company may realize a tax benefit equal to the tax effect
on the difference between the strike price of the option and the fair
market value of the stock on the day of exercise. Tax benefits
realized, if any, by the Company will be credited to additional paid-in
capital. Similar accounting treatment is also given to any tax benefits
the Company may realize arising from employees making disqualifying
dispositions of incentive stock options.
9. Use of Estimates
----------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management
to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements, the
reported amounts of receivables and expenses during the reporting
period, and disclosure of contingent
F-10
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE A - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
9. Use of Estimates - Continued
-----------------------------
assets and liabilities. Actual results could differ from those
estimates. Estimates are used for such items as valuation of deferred
income taxes, conversion features of convertible debentures and
preferred stock, and stock options and warrants outstanding.
NOTE B - PREPAID EXPENSES
Prepaid expenses consisted of the following:
2001 2002
-------------- ---------------
Consulting fees $ 188,275 $ 24,274
Insurance 18,359 26,623
-------------- ---------------
$ 206,634 $ 50,897
============== ===============
In November 2001, the Company entered into agreements with consultants
under which the consultants will arrange to make introductions of
senior executives of entities which may become business partners of the
Company. The terms of the consulting agreements required an initial
cash payment of approximately $332,000. The prepaid fees were amortized
to expense over the ten-month term of the agreements, which expired in
August 2002.
NOTE C - OTHER ASSETS
Other assets consisted of the following as of December 31:
2001 2002
-------------- ---------------
Patents pending $ 26,706 $ 40,091
Security deposits 15,000 -
Offering costs - 81,900
-------------- ---------------
$ 41,706 $ 121,991
============== ===============
In March 2002, the Company engaged an investment banking firm to advise
the Company regarding raising additional capital through the potential
future issuance of the Company's equity, debt or convertible
securities. The firm received a nonrefundable retainer fee of $50,000,
out of pocket costs of $14,900 and has been granted a warrant to
purchase 25,000 shares of the Company's common stock at an exercise
price of $1.00 per share through the next four years. The estimated
value of the warrant is $17,000.
F-11
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE D - ACCRUED LIABILITIES
Accrued liabilities consisted of the following as of December 31:
2001 2002
-------------- ---------------
Interest $ 42,509 $ 537,004
Compensation 36,699 35,555
Other 11,367 142
-------------- ---------------
$ 90,575 $ 572,701
============== ===============
NOTE E - RECAPITALIZATION TRANSACTION
On November 26, 2001, the Company completed a recapitalization
transaction (the Transaction) with an investment group (the Investor).
As a result of the Transaction, the Company converted approximately
$4.6 million of short-term debt and accruals into long-term convertible
notes and debentures, obtained $1.065 million of additional funding and
issued shares of its newly designated Series B 9% convertible preferred
stock in exchange for all of the issued and outstanding shares of its
Series A 9% convertible preferred stock and the cumulative dividends in
arrears due thereon. Additionally, the Investor forgave $300,250 of
previously accrued penalties which has been treated as an extraordinary
gain in 2001 in the accompanying financial statements. Under the terms
of the Transaction, the Investor agreed to provide $1.08 million of
additional funding in incremental monthly installments during the
six-month period commencing March 1, 2002.
NOTE F - LONG-TERM OBLIGATIONS
Long-term obligations consisted of the following as of December 31:
2001 2002
-------------- ---------------
10% secured convertible note issued in 2001 $ 4,092,920 $ 4,092,920
Zero interest convertible debenture 1,000,000 1,000,000
5% convertible note 316,000 -
10% secured convertible notes issued in 2002 - 1,080,000
7% convertible notes - 750,000
Discounts assigned to fair values of conversion feature and
warrants (1,077,682) (415,634)
-------------- ---------------
4,331,238 6,507,286
Less current maturities - 6,507,286
-------------- ---------------
$ 4,331,238 $ -
============== ===============
F-12
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE F - LONG-TERM OBLIGATIONS - CONTINUED
A summary of the Company's long-term notes and debentures are as
follows:
o 10% SECURED CONVERTIBLE NOTE ISSUED IN 2001: Prior to the
Transaction, the Company had unsecured short-term notes from the
Investor in the aggregate principal amount of $2,770,000. The
Investor converted this amount and associated accrued interest of
$257,920 together with additional financing of $1,065,000 into a
convertible note in the principal amount of $4,092,920 (the
Convertible Note). The Convertible Note is due September 30, 2003
and accrues interest at 10%, payable semi-annually on April 30
and September 30 commencing September 2002. The note is
convertible into shares of the Company's common stock at a
conversion price of $0.75 per share. The note is collateralized
by substantially all of the Company's assets. The Company has not
made the scheduled semi-annual interest payment due September 30,
2002. On March 27, 2003, the Investor waived this interest
non-payment as a default item through April 30, 2003.
In conjunction with the issuance of the Convertible Note, the
Company issued a warrant to the Investor to purchase 4,000,000
shares of common stock at $1.00 per share through November 26,
2006. The Convertible Note was recorded net of a $1,016,000
discount assigned to the fair value or the warrant. The value
assigned to the warrant is being amortized as interest expense
over the twenty-two month life of the Convertible Note. The fair
value assigned to the warrant was estimated on the grant date
using the Black-Scholes pricing model. The assumptions used to
determine the fair value of the grant included the following
assumptions: risk-free interest rate of 3.5%, expected life of
three years, stock price volatility of 175%, and expected
dividends of zero.
o ZERO INTEREST CONVERTIBLE DEBENTURE: During 2000 and 2001, the
Company had accrued penalties under a previous registration
rights agreement with the Investor in the amount of $1,300,250.
In 2001, the Investor agreed to reduce the penalty by $300,250
and converted the balance into a convertible debenture in the
principal amount of $1,000,000. The debenture is due September
30, 2003 and bears a stated interest rate of zero. The debenture
is convertible into shares of the Company's common stock at a
conversion price of $0.75 per share. The $300,250 reduction in
previously accrued penalties has been treated as an extraordinary
gain for 2001 in the accompanying financial statements.
o 5% CONVERTIBLE NOTE: During 2001, a convertible debenture in the
principal amount of $539,625 was issued in exchange for the
cancellation of an outstanding 5% debenture in the principal
amount of $418,000 plus accrued interest of $121,625. During 2001
and 2002 this debenture was converted into shares of the
Company's common stock at the stipulated per share conversion
price equal a 22% discount to the average of the closing price of
the common stock for the five days preceding conversion. This
convertible debenture was recorded net of a $113,000 discount
assigned to the fair value of the beneficial conversion feature.
This discount was amortized as interest expense when the debt was
converted to common stock.
F-13
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE F - LONG-TERM OBLIGATIONS - CONTINUED
o 10% SECURED CONVERTIBLE NOTES ISSUED IN 2002: As part of the
Company's November 2001 recapitalization transaction, the
Investor agreed to provide additional financing in incremental
monthly installments during the six-month period commencing March
1, 2002, subject to certain conditions. As of December 31, 2002,
the Company has received $1,080,000 and issued notes payable to
the Investor. The terms of the notes require the principal to be
repaid on September 30, 2003, and accrues interest at 10%,
payable semi-annually on April 30 and September 30 commencing
September 2002. The notes are convertible into shares of the
Company's common stock at a conversion price of $0.75 per share.
The notes are collateralized by substantially all of the
Company's assets. The Company has not made the schedule
semi-annual interest payment due September 30, 2002. On March 27,
2003, the Investor waived this interest non-payment as a default
item through April 30, 2003.
o 7% CONVERTIBLE NOTES: As part of an August 2002 bridge note
agreement with the Investor, the Investor has provided a total of
$750,000 of additional financing in incremental monthly
installments during the four-month period commencing August 2002,
and issued the corresponding notes payable to the Investor. The
terms of the notes, as amended and restated on March 27, 2003,
require the principal and accrued 7% per annum interest to be
repaid by June 30, 2003. The bridge notes are convertible at the
option of the Investor into shares of the Company's common stock
at a conversion price of $0.75 per share or into shares of the
Company's series B preferred stock at a conversion price of $100
per share. The note is collateralized by substantially all of the
Company's assets.
Primarily all of the Company's interest expense was related to
obligations due the Investor. The conversion and exercise prices of
the Company's convertible instruments, options and warrants discussed
here and elsewhere were determined by individual negotiation between
the Company and the individual security holder or grantee.
NOTE G - COMMITMENTS AND CONTINGENCIES
Operating Leases
----------------
The Company operates a leased facility in Minnesota under a
non-cancelable operating lease that expires in August 2004. In addition
to base rent, the Company pays for property taxes, maintenance,
insurance, and other occupancy expense applicable to the leased
premises.
Minimum rental commitments of non-cancelable operating leases are
approximately as follows:
Year ending December 31, 2003 $ 42,000
Year ending December 31, 2004 29,000
---------------
$ 71,000
===============
F-14
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE G - COMMITMENTS AND CONTINGENCIES -CONTINUED
Operating Leases - Continued
-----------------------------
Rental expense was approximately $89,000, $70,000, $63,000 and $552,000
during 2000, 2001, 2002 and for the period January 7, 1993 (date of
inception) through December 31, 2002, respectively.
Contingent Consultant Fees
--------------------------
In November 2001, the Company entered into an agreement with a
consultant and an associate. In addition to fixed fees, the agreement
requires contingent future consulting fees to be paid based on future
sales, if any, generated by introductions, as defined, made by the
consultant. The contingent fee is to be 2.19% of such sales, including
product sales, sale or licensing of technology, or sale of an equity
interest in the Company. The consultant and the associate have the
option to convert the contingent fees, if any, into shares of the
Company's common stock (but no more than 525,000 shares) at a
conversion price of $0.38 per share. The agreement expired in August
2002.
Employment Agreements
---------------------
The Company has employment agreements with three individuals. The
employment agreements contain non-compete clauses that restrict the
employees from competing with the Company following a termination of
employment from the Company. In the event of termination without
cause, as defined, the agreements provide each employee with severance
payments. As of December 31, 2002, the aggregate commitment is
approximately $328,800.
Litigation Settlements
-----------------------
During 1999, a former licensor of technology to the Company commenced
litigation claiming breach of contract. The Company filed a
counter-claim. In August 2001, the Company and the plaintiff reached a
settlement whereby both parties release each other from all claims, the
plaintiff agreed to deliver copies of certain software to the Company,
and the Company agreed to pay $50,000 to the plaintiff in various
installments through April 2002. The entire settlement amount was
charged to expense in 2001. The plaintiff has not delivered all of the
specified software. Accordingly, the Company has suspended making its
scheduled payments. The remaining unpaid balance was $25,000 as of
December 31, 2002.
In July 2000, litigation was commenced against the Company alleging
breach of a licensing agreement and conversion of certain proprietary
technology. In August 2000, the Company and plaintiff reached a
settlement and entered into a new agreement whereby: a) ownership of
each of the parties' technologies was clarified; b) previously existing
contracts between the two parties were terminated; c) royalties or
payables due between the two parties were discharged; d) the Company
granted the plaintiff certain royalty-free rights and licenses to
manufacture and sell certain hardware devices; and e) the Company
granted the plaintiff certain other rights, including
F-15
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE G - COMMITMENTS AND CONTINGENCIES -CONTINUED
Litigation Settlements - Continued
----------------------------------
the right to purchase certain inventory items at terms and prices
similar to those offered to other customers.
Future Public Offering Costs
-----------------------------
In June 1998, the Company entered into an agreement with its
underwriter, whereby the underwriter agreed to waive all future rights
of first refusal to sell the Company's securities. In exchange for
this, the Company agreed to pay the underwriter $100,000, of which
$34,000 was paid at the closing of the sale of certain debentures and
$66,000 is due upon completion of a future public offering, if one
occurs.
NOTE H - STOCKHOLDERS' EQUITY
Increase in Authorized Shares of Common Stock
--------------------------------------------
In February 2002, the Company's shareholders approved amendments to its
articles of incorporation which increased the number of authorized
shares of common stock from 20,000,000 to 60,000,000.
Issuance of Series B 9% Convertible Preferred Stock
---------------------------------------------------
In November 2001, the Company issued 21,430 shares of its newly
authorized Series B 9% convertible preferred stock (the Series B
Preferred Stock) in exchange for all 18,444 outstanding shares of its
Series A 9% convertible preferred stock (the Series A Preferred Stock)
and cumulative dividends in arrears of $281,049 due thereon. In
conjunction with the issuance of the Series B Preferred Stock, all
previously issued shares of Series A Preferred Stock were retired and
canceled and became authorized but unissued shares of preferred stock.
The Series B Preferred Stock accrues dividends of 9% payable
semi-annually on June 15 and December 15 in cash, or at the option of
the Company, in additional shares of its common stock. As of December
31, 2002, cumulative dividends in arrears were approximately $165,000.
The Series B shares are redeemable at the option of the Company, so
long as the Company's common stock is eligible for quotation on the
OTC Bulletin Board and the shares issuable upon conversion are subject
to an effective registration statement. The Series B shares are
convertible into shares of the Company's common stock at a per share
conversion price equal to the lesser of $0.75 or a 22% discount to the
average closing price of the common stock during the five trading days
preceding conversion. The Series B shares have no voting rights.
The fair value assigned to the beneficial conversion feature of the
Series B shares was $451,000. The $451,000 is analogous to a dividend
and was immediately recognized as a return to the preferred stockholder
since the Series B shares are immediately convertible into common
stock.
F-16
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2001
NOTE H - STOCKHOLDERS' EQUITY - CONTINUED
Warrants
--------
The Company has issued warrants to certain creditors, investors,
underwriters and consultants. A summary of warrant activity is as
follows:
Exercisable at
Price per Expiration December 31,
Outstanding share date 2002
-------------- -------------- ------------- --------------
Balance, December 31, 1999 998,466 $1.20-$7.50 2003-2004 864,466
Granted in connection with
issuance of Series A
preferred stock 67,500 1.31 2005 67,500
Granted to acquire software 400,000 1.00 2004 400,000
Granted to consultants 50,000 1.00 2005 50,000
-------------- --------------
Balance, December 31, 2000 1,515,966 1,381,966
Granted in connection with 10%
secured convertible note
payable 4,000,000 1.00 2006 4,000,000
Granted to consultants 295,932 0.38- 1.00 2004-2006 295,932
-------------- --------------
Balance, December 31, 2001 5,811,898 5,677,898
Granted to consultants 218,000 1.00- 1.25 2003-2006 218,000
Expired (372,216) 0.84- 3.60 - (372,216)
-------------- --------------
Balance, December 31, 2002 5,657,682 5,523,682
============== ==============
Exercised through December
31, 2002 7,500
==============
The estimated fair value of the warrants granted during 2000, 2001 and
2002 was $220,500, $1,171,000, and $32,000, respectively. The estimated
fair value of the 295,932 warrants granted to consultants in 2001 was
$150,000 of the $1,171,000 total for the year. The fair value of
warrants is estimated as of the grant date using the Black-Scholes
pricing model utilizing the same assumptions described in Note J. The
estimated fair value of warrants granted for goods and services is
being amortized to expense over the terms of the consulting agreements.
F-17
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE I - STOCK-BASED COMPENSATION
1996 Stock Option Plan
----------------------
During 1996, the Board of Directors and stockholders of the Company
adopted the 1996 Stock Option Plan (the 1996 Plan). Under the 1996
Plan, 750,000 shares of common stock are reserved for issuance to
employees, officers, directors, and consultants of the Company at
exercise prices which may not be below 100% of fair market value for
incentive stock options and 50% for all others. The term of stock
options granted may not exceed ten years. Options issued under the Plan
vest pursuant to the terms of stock option agreements with the
recipients. In the event of a change in control, as defined, all
options outstanding vest immediately. The Plan terminates in May 2006.
1999 Stock Option Plan
----------------------
During 1999, the Board of Directors of the Company adopted the 1999
Stock Option Plan (the 1999 Plan). The 1999 Plan was not presented to
stockholders for approval and thus incentive stock options are not
available under the plan. Under the 1999 Plan, 2,000,000 shares of
common stock are reserved for issuance to employees, officers,
directors, and consultants of the Company at exercise prices which may
not be below 85% of fair market value. The term of nonstatutory stock
options granted may not exceed ten years. Options issued under the
Plan vest pursuant to the terms of stock option agreements with the
recipients. In the event of a change in control, as defined, all
options outstanding vest immediately. The 1999 Plan terminates in
August 2009.
Non-Plan Stock Options
---------------------
Periodically, the Company has granted options outside of the 1996 and
1999 Plans to various employees and consultants. In the event of change
in control, as defined, certain of the non-plan options outstanding
vest immediately.
F-18
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE I - STOCK-BASED COMPENSATION - CONTINUED
Summary of Option Information
------------------------------
Information summarizing option activity is as follows:
Number of shares Weighted
--------------------------------------------------- Range of average
1996 1999 Non- exercise exercise
plan plan Plan Total prices prices
--------- ---------- --------- ---------- ---------- --------
Balance, December 31, 1999 470,325 885,548 1,038,000 2,393,873 $ .50 -10.75 $ 1.73
Granted - 400,000 850,000 1,250,000 .27 - 1.22 .74
Relinquished (185,610) (222,000) - (407,610) .88 - .91 .89
Expired or cancelled (170,335) (446,879) (407,000) (1,024,214) .88 -10.75 1.80
--------- ---------- --------- ----------
Balance, December 31, 2000 114,380 616,669 1,481,000 2,212,049 .27 - 6.42 1.28
Granted 276,000 840,000 730,000 1,846,000 .19 - .46 .40
Expired or canceled - - (230,000) (230,000) .27 - .91 .54
--------- ---------- --------- ----------
Balance, December 31, 2001 390,380 1,456,669 1,981,000 3,828,049 .19 - 6.42 .86
Granted - 380,000 350,000 730,000 .31 - .45 .35
Expired or canceled - - (168,000) (168,000) 1.00 1.00
--------- ---------- --------- ----------
Balance, December 31, 2002 390,380 1,836,669 2,163,000 4,390,049 .19 - 6.42 .77
========= ========== ========= ==========
Available for future
grants, December 31,
2002 266,620 163,331 NA 429,951
========= ========== ========= ==========
Additional information regarding outstanding options as of December 31, 2002 is
as follows:
Shares exercisable under
Shares under outstanding options outstanding options
---------------------------------------------------------------------- ------------------------------
Weighted
Weighted average Weighted
average remaining average
Range of Number of exercise life Number exercise
exercise prices shares price (in years) exercisable price
---------------- ------------ ------------ -------------- ------------- -----------
$ .19 - .50 2,566,000 $ .32 5.4 1,841,800 $ .33
.63 - .97 1,313,049 .76 3.6 1,279,709 .76
1.00 - 3.00 458,000 2.66 0.9 458,000 2.66
3.22 - 6.42 53,000 6.12 4.7 53,000 6.12
F-19
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE I - STOCK-BASED COMPENSATION - CONTINUED
Summary Option Information - Continued
--------------------------------------
The weighted average fair value of options granted to employees and
directors during 2000, 2001 and 2002 were $0.69, $0.15 and $0.17 per
share, respectively. The fair value of each option grant is estimated
as of the date of the grant using the Black-Scholes option-pricing
model utilizing the same assumptions presented in the proforma
compensation disclosure section below.
During 1997 and 1998, options for 360,000 and 40,000 shares,
respectively, were granted to employees at per share exercise prices
less than the fair market value of the common stock at the date of
issuance. The difference between the option exercise price and
estimated fair value of common stock at the date of grant for these
options was $225,400 and $58,520, respectively, and has been reflected
as unearned compensation in the accompanying balance sheets and is
being recognized as expense over the vesting period of the grants. In
connection with certain employee terminations, $184,191 and $42,920 of
unearned compensation was reversed during 1997 and 1999, respectively,
with no resulting impact to the statement of operations.
Options were granted to consultants and strategic partners during 2000,
2001 and 2002 totaling 570,000, 276,000 and 350,000 shares,
respectively. The estimated fair value of the options granted to
consultants and strategic partners which vested in 2000, 2001 and 2002
were $323,984, $1,387,000 and $100,000, respectively.
Proforma Compensation Disclosure
--------------------------------
The Company has adopted Statement of Financial Accounting Standards No.
123 "Accounting for Stock-Based Compensation" (SFAS No. 123) which
encourages, but does not require, a fair-value based method of
accounting for employee stock options. As permitted under SFAS 123, the
Company has continued to account for employee stock options using the
intrinsic value method outlined in APB 25, "Accounting for Stock Issued
to Employees." Accordingly, no compensation expense has been recognized
by the Company for its stock options granted to employees or directors.
F-20
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE I - STOCK-BASED COMPENSATION - CONTINUED
Proforma Compensation Disclosure - Continued
---------------------------------------------
If compensation expense for the stock options granted had been
determined based on the fair value at the grant dates consistent with
the method of SFAS No. 123, the Company's proforma net loss and
proforma loss per share would have been as follows:
January 7,
1993 (date of
inception)
Years ended December 31, through
---------------------------------------------------- December 31,
2000 2001 2002 2002
--------------- --------------- -------------- ---------------
Net loss
As reported $ (3,130,453) $ (2,283,774) $ (4,019,974) $ (22,359,428)
Proforma (3,313,453) (2,480,774) (4,166,974) (23,438,428)
Loss applicable to
common stockholders
As reported $ (3,437,678) $ (2,834,252) $ (4,184,939) $ (23,723,696)
Proforma (3,620,678) (3,031,252) (4,331,939) (24,802,696)
Basic and diluted loss per
common share
As reported $ (.36) $ (.26) $ (.32) $ (3.18)
Proforma (.38) (.28) (.33) (3.33)
In determining the proforma compensation cost of the options granted,
the fair value of each grant was estimated on the date of grant using
the Black-Scholes option pricing model. The assumptions used to
determine the fair value of each grant included the following weighted
average assumptions:
2000 2001 2002
------------ -------------- ---------------
Risk free interest rate 5.00 % 3.50 % 2.54 %
Expected life of options (in years) 4.00 3.00 5.00
Expected dividends - - -
Volatility of stock price 1,655 % 175 % 154 %
F-21
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE J - INCOME TAXES
Deferred taxes are due to income tax credits and net operating loss
carryforwards, and to the temporary differences between the carrying
values of certain assets and liabilities for financial reporting and
income tax purposes. Significant components of deferred taxes are as
follows at December 31:
2001 2002
------------- --------------
Short-term items:
Accrued compensation $ 13,000 $ 38,000
Long-term items:
Accrued interest $ 15,000 $ 193,000
Income tax credits 112,000 112,000
Net operating loss carryforwards 6,726,000 7,985,000
------------- --------------
Less valuation allowances (6,866,000) (8,328,000)
------------- --------------
$ - $ -
============= ==============
A valuation allowance equal to the full amount of the deferred tax
asset has been recorded due to the uncertainty of realization of the
deferred tax assets due to the development stage nature and operating
loss history of the Company. The valuation allowance could be reduced
or eliminated based on future earnings and future estimates of taxable
income. Similarly, income tax benefits related to stock options
exercised have not been recognized in the financial statements.
The Company has federal and Minnesota net operating loss carryforwards
of approximately $21,611,000 and $10,229,000, respectively, as of
December 31, 2002. These operating losses expire between 2008 and 2022.
Net operating loss carryforwards may be subject to the limitations
under Section 382 of the Internal Revenue Code due to changes in the
equity ownership of the Company.
F-22
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE K - RELATED PARTY TRANSACTIONS
In addition to the transactions with the Investor discussed in Notes E,
F and H, a summary of significant related party transactions is as
follows:
January 7, 1993
(date of
inception)
Years ended December 31, through
---------------------------------------------- December 31,
2000 2001 2002 2002
------------ ------------- ------------- ---------------
Sales to:
Stockholder $ - $ - $ - $ 629,000
Entity partially owned by
Company - - - 209,000
Entity related to underwriter
and holder of options - - - 244,900
Purchase of optics technology from
stockholder - - - 117,000
Purchase of component parts from
entity owned by stockholder and
director - - - 308,800
Rent, assembly, and design
services purchased from affiliate - - - 77,000
Equipment purchased from stockholder - - - 5,000
Payment for development services and
other from entity related to
underwriter and holder of options - - - 138,600
Sale of investment to director - - - 190,000
NOTE L - FAIR VALUES OF FINANCIAL INSTRUMENTS
The Statement of Financial Accounting Standards Board No. 107
"Disclosures about Fair Value of Financial Instruments" (SFAS 107)
requires disclosure of the estimated fair value of an entity's
financial instruments. Such disclosures, which pertain to the Company's
financial instruments, do not purport to represent the aggregate net
fair value of the Company. At December 31, 2001 and 2002, the carrying
value of all material financial instruments, for which it is
practicable to estimate the fair value, approximated fair value because
of the short maturity of those instruments.
F-23
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE M - SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION
January 7,
1993 (date of
inception)
Years ended December 31, through
--------------------------------------------- December 31,
2000 2001 2002 2002
------------ ------------- ------------ --------------
Cash paid for:
Interest $ - $ - $ - $ 28,544
Noncash Financing Activities:
Conversion of short-term notes,
accrued interest and
penalties into long-term
notes and debentures - 4,567,546 - 4,567,546
Conversion of convertible
debentures, bridge notes, and
accrued interest into common
stock 550,000 513,801 322,392 2,907,360
Accretion of preferred stock
beneficial conversion
feature 141,000 451,000 - 877,000
Issuance of Series B preferred
stock in exchange for Series
A preferred stock and
cumulative dividends in
arrears, thereon - 281,049 - 281,049
Issuance of common stock in
exchange for Series A and Series B
preferred stock and
cumulative dividends in
arrears, thereon - 31,626 24,937 56,563
Issuance of preferred stock
effected through reduction
of debt 250,000 - - 350,000
Unearned compensation
reversal related to
employee terminations - - - 227,111
Common stock repurchases
effected through a reduction
in receivable - - - 170,174
Offset deferred offering costs
against proceeds of
initial public offering,
and other - - - 159,021
Issuance of warrants for
Reduction in payables - - 32,000 32,000
F-24
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE N - RECLASSIFICATIONS
Certain amounts in the 2001 financial statements have been reclassified
to conform to the 2002 presentation. These reclassifications had no
effect on the previously reported net loss or stockholders' deficit.
NOTE O - EVENTS OCCURRING SUBSEQUENT TO DECEMBER 31, 2002
In January 2003, the Investor agreed to provide up to $2,350,000 of new
debt financing. The agreement provides for $600,000 of immediate
borrowings plus periodic additional monthly borrowings through November
2003, subject to certain conditions. The terms of the notes require the
principal and accrued interest at 7% to be repaid on June 30, 2004. In
the event that Company completes a private placement of equity
securities resulting in gross proceeds of at least $5,000,000 on or
before June 30, 2004, the principal amount and accrued interest due
under the note is convertible, at the option of the Investor, into the
securities sold in such transaction at a conversion price equal to the
sale price of such securities. Upon completion of such an equity
transaction, the Investor also has the right to request repayment of
the note. The Investor may, at any time, elect to convert some or all
of the notes into shares of the Company's common stock at a conversion
of $0.75 per share or into shares of the Company's series B preferred
stock at a conversion price of $100 per share. The note is
collateralized by substantially all of the Company's assets. The terms
of a Registration Rights Agreement with the Investor require the
Company to file a registration statement with the SEC by June 30, 2003
covering the resale of any shares of common stock issuable upon any
conversion of these notes.
In January 2003, the Company entered into a two-year employment
agreement with their new CEO. The agreement provides for an annual base
salary of $150,000, a bonus during 2003 of up to $150,000 based on the
Company achieving certain financial goals, as defined, and an annual
bonus at the sole discretion of the Board of Directors in the form of
options to purchase up to 500,000 shares of the Company's common stock
at an exercise price equal to the closing market price on the date of
grant. In addition, the new CEO was appointed to the Board of Directors
and was granted a seven-year option to purchase 580,000 shares of the
Company's common stock at an exercise price of $0.53 per share. The
option vests in quarterly installments over a two-year period
commencing on the date of grant. If the employee is terminated without
cause, the employee is entitled to severance of up to $375,000.
In January 2003, the Company extended the expiration date from March
31, 2003 to December 31, 2004 of a previously granted option to
purchase 400,000 shares of the Company's stock at $0.20 per share to
the Company's former Chief Executive Officer (CEO). The estimated fair
value of this extended option granted in 2003 is $89,000.
In January 2003, the Company provided a new outside director of the
Company a seven-year option to purchase 200,000 shares of the
Company's common stock at an exercise price of $.60 per share. The
option is immediately exercisable for 50,000 shares and the remainder
vests quarterly in equal amounts over a three-year period commencing
on the date of grant.
F-25
BIO-key International, Inc.
(a Corporation in the Development Stage)
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002
NOTE O - EVENTS OCCURRING SUBSEQUENT TO DECEMBER 31, 2002 - CONTINUED
In February 2003, the Company issued a warrant to purchase 200,000
shares of common stock at an exercise price of $.49 per share to an
investor relations firm. The warrant is immediately exercisable and
terminates on February 19, 2006. The estimated value of this option
granted in 2003 is $67,000.
In February 2003, the Company provided an employee of the Company a
five and one half-year option to purchase 30,000 shares of the
Company's common stock as an exercise price of $.20 per share. The
option is immediately exercisable for 14,250 shares and the remainder
vests in equal quarterly installments during the eighteen month period
commencing March 1, 2003.
F-26