ITEM 1. BUSINESS
GENERAL
Larson Davis Incorporated ("the Company") is engaged in the design and development of analytical instruments. The Company has been in the business of developing, manufacturing, and marketing precision acoustical and vibration instrumentation since 1981. The Company is currently attempting to commercialize two additional families of products, its mass spectrometry related instruments (the "Sensar Technology"), and its polymer analysis technology (the "CrossCheck Technology"). In late 1996, the Company initiated sales of its time-of-flight mass spectrometer, the TOF 2000, to the semiconductor industry through an exclusive marketing agreement with a major distributor to this market. The Company is currently refining other related technologies to design low-cost, high-speed, mass spectrometry based data acquisition and digital processing products for potential applications in other industries.
The Company has recently entered into an agreement with a leading international vendor of insulation materials for electrical transformers in the utility industry to design and develop products based on its CrossCheck Technology intended to provide predictive maintenance data to the owners and operators of large electrical transformers and related equipment. The Company is also exploring additional applications in other industries for this technology.
The Company is dedicating significant amounts to technological research, product development, and marketing strategies. The Company believes that the patents underlying its technologies represent significant advances on existing technologies in the analytical instrumentation market and that it can design and produce instruments that are technically superior to those available today. However, much of the potential success of the Company depends on the successful development of commercial products, the existence or creation of a market demand for any products that may be developed, the ability of the Company to achieve significant market penetration for any such products in several large markets, and the ability of the Company to produce and market any such products on a profitable basis. Such an effort requires a significant dedication of time, expertise, and money, and there can be no assurance of ultimate success.
The Company is currently comprised of three active, wholly-owned subsidiaries:
LARSON DAVIS LABORATORIES CORPORATION ("LDL") focuses on the design, development, manufacturing, and marketing of acoustics and vibration products and services.
SENSAR CORPORATION ("Sensar") develops, manufactures, and markets sophisticated chemical detection and analysis instrumentation and polymer analysis technology used for quantitative and qualitative analysis.
LARSON DAVIS, LTD. ("LTD"), a European distribution entity located in the United Kingdom.
Unless the context otherwise requires, when used herein, the term "the Company" refers to Larson Davis Incorporated and its operating subsidiaries.
FORWARD LOOKING INFORMATION MAY PROVE INACCURATE
This report on Form 10-K contains certain forward looking statements and information relating to the Company and its business that are based on the beliefs of management of the Company and assumptions made concerning information currently available to management. Such statements reflect the current views of management of the Company and are not intended to be accurate descriptions of the future. The discussion of the future business prospects of the Company is subject to a number of risks and assumptions, including the completion of commercial products within projected time frames, the market acceptance of currently untested products, the ability of the Company to successfully address technical and manufacturing problems in producing new products, entering into strategic alliances, joint ventures, or other collaborative arrangements with established industry partners, the success of the marketing efforts of the Company and the entities with which it has agreements, and the ability of the Company to obtain the necessary financing to successfully complete its goals. Should one or more of these or other risks materialize or if the underlying assumptions of management prove incorrect, actual results of the Company may vary materially from those described. The Company does not intend to update these forward looking statements, except as may occur in the regular course of its periodic reporting obligations.
ACOUSTIC AND VIBRATION BUSINESS
The Company was established to engage in the acoustics and vibration instrumentation industry and this business remains its "core" business. The acoustic and vibration products of the Company are focused on precision measurement instruments for use in a variety of industries. These products combine very sophisticated environmental data collection systems with high-speed data acquisition and processing systems to give users critical information concerning acoustical or vibration based events. The Company's customers for these products include major corporations in a variety of industries, including automobile manufacturers, aircraft manufacturers, defense contractors, and the United States military. Subdivisions of this market in which the Company's instrumentation is currently being utilized are:
Environmental Monitoring provides data used to monitor, control, or avoid noise (unwanted and/or irritable sound which has a detrimental effect on living organisms). It includes such applications as community noise ordinance compliance surveys, vehicle passby surveys, industrial complex perimeter monitoring, environmental impact studies, OSHA (noise in the work place) mandated surveys, military aircraft sonic boom monitoring, and others.
Product Design and Improvement encompasses the use by manufacturers to optimize performance and minimize acoustic output. For example, the auto and aircraft industries determine noise dampening properties of materials used in insulation; a yacht manufacturer studied acoustic spectrums as an aid in selecting efficient hull designs; and other manufacturers of items such as lawn mowers, computer printers, office equipment, and kitchen appliances employ the instruments to collect information on sound emissions to aid in encasement design.
Structural Dynamics is the study of the motion of materials to determine characteristics such as fatigue, resonance, material density, and bonding strengths. For instance, a consultant used the Company's instrumentation to determine the resonant frequency of the vibrations in the Statue of Liberty's arm holding the torch. Braces were designed and installed which resulted in doubling the torch bulb life.
Medical Applications include hardware and software used in automatic calibration systems for medical equipment. The analysis and treatment of both hearing and speech problems can be improved utilizing the Company's instrumentation.
Predictive Maintenance is an emerging industry in which characteristics of rotating or moving machinery are analyzed to predict failure points. Based on information obtained, planned service can be performed. Currently, the Company's instrumentation is being used by helicopter manufacturers, power plant turbine operators, paper producers, and others.
Professional Sound includes both manufacturers and consultants. The Company provides equipment used to certify compliance by sound products (such as amplifiers, mixers, equalizers, speakers, and microphones) with published specifications. Field engineers rely on portable instrumentation to evaluate the acoustic characteristics of a room or building.
Defense and Government applications range from ship/vehicle identification based on spectrum analysis to artillery blast noise studies.
As part of its ongoing research and development efforts, the Company continues to upgrade and refine its existing products in the acoustic and vibration market and develop new products. Over the past year, the Company has introduced a number of new products designed to make its instruments more sensitive and accurate, smaller and lighter weight, and easier to use. The Company believes that its family of products in this industry are competitive on technical sophistication, ease of use, and price.
SENSAR TECHNOLOGY
Sensar currently manufactures an ultra-sensitive, high speed, mass spectrometer known as the TOF-2000 which has been sold to a limited number of producers of semiconductor "chips," including Micron and Atmel. These are highly specialized instruments which currently sell at a retail price of approximately $150,000 to $300,000. The Company entered into a five-year agreement with SAES Getters S.p.A., a major international distributor of scientific instrumentation ("SAES"), for SAES to act as the exclusive distributor to market these instruments to the semiconductor industry. In order to maintain its exclusive rights, SAES is required to meet certain annual minimum sales requirements that escalate over the term of the agreement and that require the sale of a minimum of nine instruments in 1997. Through December 31, 1996, the agreement required SAES to purchase a minimum of eight units. Although only two instruments have been sold through SAES to date, the Company has continued to work with SAES and has not yet sought to terminate the exclusive nature of the agreement.
The TOF-2000 provides fabricators with real-time spectrum analysis of gases used in microchip production. The production process requires ultra-pure gases. Impurities such as hydrogen or oxygen in quantities as small as parts per trillion can reduce production yield and microchip performance. The TOF-2000 has potential applications in other industries, and the Company has recently completed a prototype model that was introduced at PittCon, the analytical instrument industry's largest trade show that was held in March 1997, that is significantly smaller in size, has enhanced capabilities, and can be manufactured at a lower cost.
Mass spectrometers are frequently used as the middle component of systems for high-speed, high sensitivity separation and identification of chemicals and compounds. The first stage is a separation method such as liquid chromatography, gas chromatography, or capillary electrophoresis.
The Company has new products currently in development for the following chemical detection methods based on patented technology:
Capillary Electrophoresis ("CE") and Capillary Chromatography ("CC") are techniques used to separate chemicals. When coupled with the Company's mass spectrometer technology, the user can, more timely and effectively, analyze elements which result from the separation process. Sensitivity is essential because of the small sample size normally involved. These separation techniques are useful in biomedical analysis and have only become feasible with a CE mass spectrometer because of the Company's technology.
Inductively Coupled Plasmas ("ICP") are rapid separation techniques which replace tedious and time-consuming atomic absorption and emission spectroscopies currently used. Current ICP/MS instrumentation is not sensitive enough to detect many trace level elements contained within samples. The instruments currently under development by the Company are designed to do this.
The third stage of the separation and identification system is the high- speed data acquisition system. The Company has significant expertise in this area as a result of its experience in capturing and analyzing acoustical and vibration events. The Company has developed hardware and an algorithm that permits it to capture data from an event as short as 20 milliseconds. Such rapid data acquisition and analysis is critical to the sensitivity and accuracy of the mass spectrometer system. The Company believes that this experience and expertise currently gives it a competitive advantage in high-speed data acquisition and analysis over systems that are currently available. However, the Company's ability to benefit from this advantage will depend on successfully completing the development of the planned products, overcoming any manufacturing difficulties, and gaining the necessary market penetration for any products that may be commercialized. The Company is currently seeking to establish strategic relationships with significant participants in various industries in order to accomplish these goals.
CROSSCHECK TECHNOLOGY
The Company holds the exclusive license to a technology known as "CrossCheck," a proprietary process used to determine, in real time, the in situ characteristics of polymer substances. Polymers are naturally occurring or synthetic substances comprised of long chains of multiple individual molecules and include petrochemicals, paints, adhesives, and composites. The properties and strength of certain polymers are determined by the quality of the bonds linking the individual molecules. These bonds are often formed during a curing process and are affected by heat, friction, oxidation, and contamination. The CrossCheck Technology offers an opportunity to monitor the bonding process and to evaluate the quality and characteristics of the resulting polymer. The Company has been in the process of conducting laboratory research to quantify, categorize, and document results from scientific experimentation, using such research to develop instrumentation. The Company has delivered a limited number of prototype instruments to third-party beta sites for evaluation and comment.
In September 1996, the Company entered into a contract with a marketing subsidiary of Weidmann International Corporation ("Weidmann") to develop and market products targeted at the electrical transmission and distribution market. Weidmann is the world's largest vendor of advanced insulation materials for electrical transformer assemblies and engages in the design of transformer and switching equipment. The Company will provide the diagnostic monitoring technologies like CrossCheck, vibration monitoring, thermography, and chemical analysis, while Weidmann will provide its knowledge of the industry to assist in the identification, design, and development of products intended for this market. On completion of marketable products, the parties anticipate that Weidmann will provide rapid entrance in the industry through established customers and its major industry presence. However, the target products have not yet been developed or fully identified, and there can be no assurance that this market will become a major source of revenues or be profitable for the Company. The Company anticipates that it will spend a significant part of its planned research and development expenses on development of these products during the 1997 calendar year.
The Company has also investigated other potential applications for CrossCheck within a number of industries. To seek to maximize its immediate economic benefit from this technology, the Company has concentrated its efforts in developing products and relationships in the areas of electrical utilities, as described above, and in the composite, coating, and adhesive industries:
Composites Industry - - CrossCheck was developed to monitor cure rates and determine product quality within the composites industry.
Coatings and Adhesives - - Curing characteristics of coatings and adhesives are controlled by additives and different proportions of ingredients and CrossCheck, as a real-time monitor of cure rate and current polymer characteristics, has proven to be effective.
The Company continues to pursue opportunities in other industries, among which are:
Lubrication Industry - - products designed to monitor subtle changes in oils as they age, wear, become contaminated, or change due to environmental exposure.
Environmental Monitoring - - products designed to test and monitor ground water, lakes, streams, or storage containers for contamination.
Chemical Inventory - - products designed to indicate the quality of stored chemicals to assure quality at the time of use.
Concrete Industry - - products designed to monitor rate and current status of concrete cure to allow for intervention, verify quality, and assure strength and hardness.
BUSINESS HISTORY
During the fiscal periods included in this report, the Company has been involved in a number of significant business changes (see Notes to Consolidated financial Statements; Note Q--Discontinued Operations and Note R--Acquisitions):
March 1994 - - The Company purchased all of the outstanding shares of a corporation chartered in England and the corporation was renamed LARSONoDAVIS, LTD. LTD serves as a European distribution point and expanded service and repair center for the Company.
June 1994 - - The Company acquired substantially all of the intangible assets of a privately-held Massachusetts corporation related to the airport noise monitoring industry. Also purchased were the rights to approximately 25 contracts for the installation, maintenance, and support of airport noise monitoring systems. In August 1995, the Company entered into an agreement to transfer this airport noise monitoring operations to an established consulting firm engaged in the transportation industry. The Company also transferred the management of substantially all of its airport contracts to the consulting firm and agreed not to compete within the industry.
June 1994 - - With the return of the minority interest in LarsonoDavis Info, Inc. ("Info"), a subsidiary of the Company, held by Commerce Clearing House, the Company discontinued the operations of two of its software based subsidiaries, Info and Advantage Software, Inc. Management terminated the business of these subsidiaries and reduced the carrying value of the related assets to zero.
October 1995 - - The Company acquired all of the outstanding stock of Sensar Corporation.
PATENTS AND TRADEMARKS
The technology owned by the Company is proprietary in nature. In connection with the design and construction of its precision acoustical and vibration measurement instrumentation and its proprietary software, the Company primarily relies on confidentiality and nondisclosure agreements with its employees, appropriate security measures, copyrights, and the encoding of its software in order to protect the proprietary nature of its technology rather than patents which are difficult to obtain in the computer software area, require public disclosure, and can often be successfully avoided by sophisticated computer programmers.
The CrossCheck technology held by the Company is subject to the protection of United States patents, including several continuations-in-part, and international patent applications. The technology held by Sensar is also protected by patents. The Company currently has technology subject to 14 patents and 5 additional patent applications. The Company also protects its patented technology by confidentiality and nondisclosure procedures similar to those used with its non-patented technology to further ensure the proprietary nature of the technology.
The Company has also registered "NOISEBADGE" to use as a trademark in the marketing of noise level meters with the United States Office of Patents and Trademarks.
MANUFACTURING AND ASSEMBLY
The Company is involved in the manufacture of both its hardware and software products. It utilizes the services of certain subcontractors to manufacture component parts for its products to minimize the amount of its capital investment and increase its flexibility in dealing with changes in the manufacturing processes. Approximately 20% of manufacturing is performed by subcontractors. However, all final assembly is done by the Company's employees as part of its quality control program. Manufacturing activities occupy approximately 17,000 square feet of the Company's facilities. (See "ITEM 2.
ITEM 2. PROPERTIES
The Company owns its own administrative and manufacturing facilities in Provo, Utah, subject to a security lien granted to a commercial financial institution to secure a purchase money loan. The facilities include approximately 12,000 square feet of administrative, engineering, and research and development space and approximately 12,000 square feet of manufacturing, storage, and shipping space.
In addition, the Company rents approximately 10,000 square feet of space on a month-to-month basis that is located immediately across the street from the Company's corporate headquarters in Provo, Utah, and that is being used by the Sensar group. Approximately 5,000 square feet of the space is being used for manufacturing, storage, and shipping and the remaining space is used for development and administrative functions. The monthly payment is approximately $6,500 per month. The Company also rents approximately 1,200 of office space in Red Car, England, to serve as the headquarters of LTD at a monthly rate of approximately $425. This space is leased on a month-to-month basis.
Management considers the existing facilities of the Company to be in good condition and currently sufficient for its operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceedings and, to the best of its knowledge, no such proceedings by or against the Company have been instigated or threatened. To the knowledge of management, there are no material proceedings pending or threatened against any director or executive officer of the Company, whose position in any such proceeding would be adverse to that of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the six months ended December 31, 1996, the Company did not hold an annual meeting and no matters were submitted to a vote of the security holders of the Company, through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is currently listed on the Nasdaq National Market ("NNM"), under the symbol "LDII." Prior to January 30, 1997, the Company's common stock was listed on the Nasdaq SmallCap Market.
The following table sets forth the approximate range of high and low bids for the common stock of the Company during the periods indicated. The quotations presented reflect interdealer prices, without retail markup, markdown, or commissions, and may not necessarily represent actual transactions in the common stock.
On March 25, 1997, the closing quotation for the common stock on NNM was $10.25. As reflected by the high and low bids on the foregoing table, the trading price of the common stock of the Company can be volatile with dramatic changes over short periods. The trading price may reflect market reaction to the perceived applications of the Company's technology, the potential products that may be based on that technology, the direction and results of research and development efforts, and many other factors. Investors are cautioned that the trading price of the common stock can change dramatically based on changing market perceptions that may be unrelated to the Company and its activities.
As of March 25, 1997, there were 11,374,191 shares of common stock issued and outstanding, held by approximately 369 shareholders of record.
The Company has not paid dividends with respect to its common stock. The Company has 200,000 shares of its 1995 preferred stock issued and outstanding which prohibit the payment of dividends on the common stock if the annual dividend of $0.225 per share of preferred stock is in arrears. The Company's line of credit agreement prohibits the payment of dividends if the Company is in violation of its loan covenants or otherwise in default under the agreement. Other than the foregoing, there are no restrictions on the declaration or payment of dividends set forth in the articles of incorporation of the Company or any other agreement with its shareholders or creditors. While the required dividends with respect to the preferred stock have been paid by the Company, management anticipates retaining any potential future earnings for working capital and investment in growth and expansion of the business of the Company and does not anticipate paying dividends on the common stock in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
CERTAIN FINANCIAL DATA
The following statement of operations and balance sheet data were derived from the consolidated financial statements of the Company. The consolidated financial statements of the Company for the six months ended December 31, 1996, and for the fiscal years ended June 30, 1996, 1995, 1994, 1993, and 1992, have been audited by independent certified public accountants. The consolidated financial statements of the Company for the six months ended December 31, 1995, are unaudited; however, in the Company's opinion, such statements reflect all adjustments, consisting only of normal recurring items, necessary for a fair presentation of the financial position and results of operations of the Company for such period. In January 1997, the Company changed its fiscal year end from June 30 to December 31 effective December 31, 1996. The results of operations for any interim period are not necessarily indicative of results of operations for a full year. The selected financial data below should be read in conjunction with the consolidated financial statements of the Company and the notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
[FN] (1) Effective October 27, 1995, the Company acquired Sensar Corporation in a transaction accounted for as a purchase.
(2) During the quarter ended March 31, 1994, the Company acquired Larson Davis, Ltd., in a transaction accounted for as a purchase.
(3) During the years ended June 30, 1995 and 1994, the Company discontinued the operations of its Airport Noise Monitoring Business and its Software Licensing Business, respectively. The results of these operations have been segregated from continuing operations in the Statements of Operations.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW
The following discussion should be read in conjunction with the consolidated financial statements and related notes contained herein.
Over the course of the last three years, the Company has acquired the rights to a number of technologies from Brigham Young University ("BYU"), either directly from BYU or indirectly through its acquisition of Sensar. These technologies have placed the Company in a position to develop a number of sophisticated analytical instruments in addition to its historical acoustical and vibration based business. The Company believes that the patented technology it has acquired will permit it to develop instruments that are technically superior to those currently being offered, that will be on the cutting edge of certain emerging markets, that will address needs in certain industries in a more cost efficient manner, and that can be sold at prices less than alternative solutions currently being offered. In order to accomplish its goals, the Company initiated a research and development plan designed to convert the underlying technologies into commercial products. These efforts are just beginning to lead to products and have not had a significant impact on the revenues of the Company to date. The Company does not anticipate that there will be a significant impact until at least the third or fourth quarter of fiscal 1997. The products currently being worked on by the Company are designed for extremely sophisticated applications, and there can be no assurance that the Company will be successful in its development efforts or that alternative technologies may not be developed by some other entity that provide a more advantageous solution to the needs of the various industries targeted by the Company.
In order to obtain the necessary funding to implement its research and development plan, the Company has sought equity financing, primarily from a small number of private investors. The Company received net proceeds from the issuance of common stock from private placements, and from the exercise of warrants and options of $1,023,688 in the year ended June 30, 1995, $9,269,987 in the year ended June 30, 1996, and $1,493,489 in the six months ended December 31, 1996. Since December 31, 1996, the Company has received gross proceeds of $4,069,393 from the exercise of warrants. This capital has been used for various purposes, including increased research and development activities, the reduction of the Company's operating line of credit, and general operations. Management intends to use only funds available from non-operating and non-debt sources to continue product development in excess of historical research and development levels.
As of March 25, 1997, the Company has issued and outstanding warrants to acquire 1,449,064 shares of common stock which would yield gross proceeds to the Company of $7,426,610 if fully exercised. (See Notes to Consolidated Financial Statements; Note M--Stock Options and Warrants and Note U--Subsequent Events.) The holders of such warrants have no obligation to exercise the warrants and the decision to do so will be largely dependent on the trading price for the Company's common stock in the public market, about which no assurances can be given. However, if the holders do elect to exercise the warrants, management would use the funds to pay for the planned products and to further accelerate development activities.
New product development, prototype manufacture, and first production costs adversely affected the results of operations of the Company in the six months ended December 31, 1996, and the year ended June 30, 1996. These activities generated expenses with no corresponding revenues. It is anticipated the Company will continue to experience operating losses until new products are brought to market and begin to generate significant sales. There can be no assurance as to the timing of these products being brought to market or as to the success of the products. If unsuccessful, the Company would not be able to recover its associated research and development costs, which would have a significant material adverse impact on the business and activities of the Company.
DISCONTINUED OPERATIONS
In a transaction completed August 15, 1995, the Company entered into an agreement to divest its airport noise monitoring business. As a result, the Company is no longer a general contractor for these systems, although it still manufactures and sells acoustic instrumentation used in the systems. Under the terms of the agreement, Harris Miller Miller & Hanson, Inc. ("HMMH"), an established consulting firm with its primary business related to transportation industry acoustic and vibration analysis, purchased essentially all of the Company's assets and contracts related to the airport noise monitoring business and assumed approximately $100,000 of the Company's liabilities. The Company discontinued operations in this area and agreed not to compete with HMMH. HMMH agreed to use its best efforts to utilize the Company's instrumentation in future contracts and receives "most favored nations treatment" from the Company in pricing.
The Company was paid a one-time fee and is entitled to varying royalty payments over the life of the agreement. During the period this agreement has been in effect through December 31, 1996, the Company received or accrued amounts due with respect to this transaction of $494,146. (See Notes to Consolidated Financial Statements; Note Q--Discontinued Operations.) These amounts were offset against the carrying value of associated assets reflected on the balance sheet of the Company under the caption "Long-Term Contractual Arrangement."
RESULTS OF OPERATIONS
Comparison of Six Months ended December 31, 1996, and 1995
Net Sales
Net sales from continuing operations for the six months ended December 31, 1996, and 1995, were $4,889,280 and $4,152,273, respectively. This represents an increase of $737,007, or 17.7%, for 1996 as compared to 1995. The acquisition of Sensar occurred October 27, 1995. As such, the operations of Sensar are included for the entire six month period ended December 31, 1996, while the operations of Sensar were only included for approximately two months of the six-month period ended December 31, 1995. The increase in sales is principally due to increased revenue from Sensar products of approximately $627,000. The remaining increase of approximately $110,000 represented a 3% increase in the sales of acoustical and vibration instrumentation.
During the six months ended December 31, 1996, export sales experienced a significant increase as a percentage of total sales, to 57% of sales. This growth is due to a continuing increase in sales to the Pacific Rim and increases in sales in Europe, compared to the prior period. Domestic sales, on an annualized basis, declined compared to the prior year, but have increased compared to 1995 and 1994.
Cost of Sales and Operating Expenses
Cost of sales and operating expenses for the six months ended December 31, 1996, were $2,177,304, or 44.5% of net sales, compared to $1,182,566, or 28.5% of sales, for the six months ended December 31, 1995. This elevated level of cost compared to historical levels continues principally due to high cost of materials, initial production costs, and development costs associated with production of initial Sensar products. Management expects the cost of sales as a percentage of sales to decline in the future to a level more consistent with historical levels prior to the Sensar acquisition. This should occur when the Sensar products are ready for market, product demand is achieved, and standard production processes are established; although this result cannot yet be assured because the Company continues to have limited production experience with these products to date.
Selling, General, and Administrative
Selling, general, and administrative expenses increased as a percentage of sales from 42.0% for the six months ended December 31, 1995, to 51.8% for the corresponding period of 1996. The increase was due to several factors, including increased audit, legal, and consulting fees, establishment of a new European sales manager, and increased costs related to various corporate and marketing activities. Management believes that some of these costs incurred in the period ended December 31, 1996, were non-recurring in nature, and that selling, general, and administrative expenses should decline in the future to be more consistent with historical levels, although no assurance can be made that the Company will be successful in reducing such expenses.
Research and Development
For the six months ended December 31, 1996, research and development costs were $1,734,911, or 35.5% of net sales, compared to $833,407, or 20.1% of net sales, for the six months ended December 31, 1995. The increase over the prior period, as well as increases above historical levels, is reflective of the Company's continuing commitment to the development of new products. (See "ITEM 1. BUSINESS: Sensar Technology" and "CrossCheck Technology.") It is anticipated that research and development costs will continue to exceed historical levels as a percentage of sales until the development of new products is completed and significant sales levels of the new products are achieved. Historical levels of research and development costs as a percentage of sales for the fiscal years ended June 30, 1991 to 1995 have averaged approximately 11% of sales.
Comparison of Years Ended June 30, 1996, and 1995
Net Sales
Net sales from continuing operations for the fiscal years ended June 30, 1996, and 1995, were $8,255,607 and $6,515,830, respectively. This was the second consecutive year in which the Company posted an approximate 27% increase in its acoustic and vibration instrumentation sales. The increased sales were attributable to a general expansion of the underlying market, and an increase in the unit sales of the Company's products.
The acquisition of Sensar on October 27, 1995, did not materially impact the net sales for the year ended June 30, 1996, with approximately $607,000 in revenue attributable to the Sensar operations during that period.
During 1996, export sales declined from 53% to 33% of total sales. This decline was the result of decreased sales in Europe, but was also due to strong sales increases domestically.
Cost of Sales and Operating Expenses
The Company's cost of sales and operating expenses of $3,407,613 in the year ended June 30, 1996, and $1,916,413 in the year ended June 30, 1995, increased as a percentage of sales from continuing operations to 41.3% from 29.4%. The increase in 1996 is due primarily to the high cost of materials, initial production costs, and development costs associated with production of initial Sensar products. Prior to the Company's acquisition, Sensar purchased major electronics subsystems from a third party. The pricing structure was based on the premise of a high price for a limited number of systems to provide the manufacturer a way to recover development costs. Since the acquisition of Sensar, the Company has designed a replacement subsystem which reduced the cost of the electronics for this component by approximately 90%. Because of the use of the remaining highly priced electronics subsystems in Sensar's inventory in fiscal year June 30, 1996, the entire material and development costs were expensed during the period. Cost of sales and operating expenses in the future for the Sensar products are expected to decrease as production becomes standardized, although this result cannot be assured since the Company has only limited production experience with these products to date.
Selling, General, and Administrative
Selling, general, and administrative expenses remained relatively constant as a percentage of sales for the year ended June 30, 1996, compared to the year ended June 30, 1995. Selling, general, and administrative expenses were $3,922,976, or 47.5% of net sales, for the year ended June 30, 1996. This represents a small decline when compared to the year ended June 30, 1995, when selling, general, and administrative expenses were $3,131,938, or 48.1% of net sales.
Research and Development
The Company is involved in a high-tech industry which demands constant improvements and development of its instrumentation to remain technically viable. Since its inception, the Company has dedicated significant operating funds to research and development. For the five fiscal years June 30, 1991 to 1995, research and development expenses have averaged approximately 11% of net sales and in the year ended June 30, 1995, were $708,679, or approximately 10.9% of net sales. The historical level of research and development commitment was factored into the pricing structure for the Company's products.
For the fiscal year ended June 30, 1996, research and development expenses were $2,149,384, approximately 26.0% of net sales. This level of research and development reflects management's commitment to develop new products to enhance the revenue potential of the Company. (See "ITEM 1. BUSINESS: Sensar Technology and CrossCheck Technology.") Capital obtained from the sale of common stock was used to supplement the Company's operations as a method for funding this accelerated research and development.
Comparison of Years Ended June 30, 1995, and 1994
Net Sales
Net sales from continuing operations for the fiscal years ended June 30, 1995, and 1994, increased to $6,515,830 from $5,137,638, respectively. Sales levels had declined in 1994 related, in part, to a general global recession. The Company was able to maintain its established market share in a then shrinking market. In the fiscal year ended June 30, 1995, sales increased by 27% from 1994 as compared to 1995.
Foreign sales have been an important part of the Company's business plan for many years. For the fiscal years ended June 30, 1995, and 1994, foreign sales as a portion of continuing operations accounted for 53% and 42%, respectively. The increase in 1995 was partially due to the Registrant's operations in the United Kingdom through its subsidiary, LTD.
Cost of Sales and Operating Expenses
The Company's cost of sales and operating expenses as a percentage of sales from continuing operations for the years ended June 30, 1995, and 1994, were 29.4% and 33.5%, respectively. The Company believes its efforts to better track costs and control inventories contributed to the decrease in cost of sales and operating expenses between the fiscal years ended June 30, 1995, and 1994.
Selling, General, and Administrative
Selling, general, and administrative expenses declined as a percentage of sales for the year ended June 30, 1995, compared to the year ended June 30, 1994. Selling, general, and administrative expenses were $3,131,938, or 48.1% of net sales, for the year ended June 30, 1995, compared to $2,863,074, or 55.7% of net sales, for the year ended June 30, 1994. The decline was largely related to the fact that in 1994, significant general and administrative expenses were incurred related to two acquisitions. Similar expenses were not incurred in 1995.
Research and Development
Since its inception, the Company dedicated significant operating funds to research and development. For the years ended June 30, 1995, and 1994, this commitment represented 10.9% and 16.2%, respectively, of the Company's net sales from continuing operations. The Company introduced a number of new products in 1995 which caused the increased spending reflected in the fiscal year ended June 30, 1994 (the development period for products introduced in 1995).
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, the Company had total current assets of $9,521,665 and total current liabilities of $2,951,754, resulting in working capital of $6,569,911 and a working capital ratio of 3.2:1. Included in total current liabilities is the Company's revolving line of credit with a balance of $1,033,018. During the six months ended December 31, 1996, the Company's principal line of credit was placed with a new financial institution. The maximum limit on this line of credit has been increased to $3,000,000, but is adjusted from time to time based on the amount of inventories and accounts receivable that secure the line of credit. The Company is in the first year of a three-year agreement. The Company anticipates the line of credit will continue to remain available to it.
The Company has relied on the sale of common stock as a method to fund increases in accounts receivable and inventories, operational losses, and research and development efforts. During the six months ended December 31, 1996, and the year ended June 30, 1996, the Company used $1,944,738 and $2,019,944, respectively, in operating activities. The Company anticipates it will continue to rely on equity funding in the future. The Company received net proceeds from the issuance of common stock on the exercise of warrants and options in the net amount of $1,493,489 during the six months ended December 31, 1996, and $9,269,987 during the fiscal year ended June 30, 1996. Subsequent to December 31, 1996, the Company has received gross proceeds from the exercise of warrants for 651,103 shares of common stock in the amount of $4,069,393. There are currently issued and outstanding warrants with respect to 1,449,064 shares of common stock. If all of these warrants were exercised, the Company would receive gross proceeds of $7,426,610 in additional funding. On the satisfaction of certain conditions, the Company has agreed to issue additional warrants to acquire up to an aggregate of 1,715,832 shares of common stock at an exercise price of $10.75 per share. There is no obligation of the holders of these rights to exercise them and the exercise will largely depend on the price of the Company's common stock in the public trading market, as to which no assurance can be given.
In the opinion of management, current cash balances, funds available under the line of credit, and anticipated proceeds from exercise of warrants will provide the Company with sufficient capital to fund its operations and development plans for the 1997 calendar year.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data are set forth immediately following the signature page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
In January 1996, the Company changed its accountants from Peterson, Siler & Stevenson (currently known as Pritchett Siler & Hardy, P.C.) to Grant Thornton LLP. This change was approved by the board of directors of the Company.
The report of Peterson, Siler & Stevenson on the Company's financial statements as of June 30, 1995, and the two years then ended did not contain an adverse opinion, or a disclaimer of opinion, nor was its report qualified or modified as to uncertainty, audit scope, or accounting principles, other than a limitation as to the representation of the financials on a going concern basis. During the engagement of Peterson, Siler & Stevenson, there were no disagreements on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which disagreements, if not resolved to the satisfaction of Peterson, Siler & Stevenson, would have caused it to make reference to the subject matter of the disagreements in connection with its reports.
The Company was not advised by Peterson, Siler & Stevenson that internal controls necessary for the Company to develop reliable financial statements did not exist nor that information came to its attention that led it to no longer be able to rely on management's representations or that made it unwilling to be associated with the financial statements prepared by management. The Company was not advised by Peterson, Siler & Stevenson of the need to expand significantly the scope of the Company's audit, nor was the Company advised that any information came to the attention of Peterson, Siler & Stevenson that on further investigation may (i) materially impact the fairness or reliability of either a previously issued audit report or the underlying financial statements, or the financial statements issued or to be issued covering the fiscal period subsequent to the date of the most recent financial statements covered by an audit report, or (ii) cause Peterson, Siler & Stevenson to be unwilling to rely on management's representations or be associated with the Company's financial statements. The Company provided its former auditors, Peterson, Siler & Stevenson with a copy of the foregoing disclosures. The Company has filed a concurrence of the former auditors with the foregoing statements as an exhibit to its reports filed with the Securities and Exchange Commission.
The Company did not consult Grant Thornton LLP prior to its appointment regarding the application of accounting principles to a specific completed or contemplated transaction, the type of audit opinion, or other accounting advice that was considered by the Company in reaching a decision as to an accounting, auditing, or financial reporting issue.
The Company and its current auditors have not disagreed on any items of accounting treatment or financial disclosure.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is the name and age of each executive officer and director of the Company, together with all positions and offices of the Company held by each and the term of office and the period during which each has served:
A director's regular term is for a period of three years or until his successor is duly elected and qualified. The terms of the board are staggered so that one-third of the board is subject to election at each annual shareholders' meeting. The current term of Brian G. Larson expires at the 1996 annual meeting; the current term of Larry J. Davis expires at the 1997 annual meeting; Dan J. Johnson's term would have expired at the 1995 annual meeting, but he is continuing to serve until the next election; and William E. Hosker and Gerald L. Seelig were appointed in 1996 to serve until the next annual meeting and election of directors.
There is no family relationship among the current directors and executive officers. The following sets forth brief biographical information for each director and executive officer of the Company.
Brian G. Larson, was a founder of the Company's predecessor and has been an executive officer and director of the Company and its predecessor since 1981. Mr. Larson earned his masters of business administration from Brigham Young University in 1972 and a bachelor's degree in electrical engineering from the same institution in 1971. During the time he was attending Brigham Young University, Mr. Larson worked as a design engineer in the medical research laboratory of Brigham Young University.
Larry J. Davis, was a founder of the Company's predecessor and has been an officer and director of the Company and its predecessor since 1981. Mr. Davis earned his electrical engineering degree from Brigham Young University in 1974, where he graduated Magna Cum Laude.
Dan J. Johnson, has served as the vice-president in charge of administration and financial strategy, asset control, and fiscal operations of the Company and its predecessor since 1984 and a director since 1987. Prior to that time, he was a director of finance for Fiber Technology Corporation. Mr. Johnson has also been previously employed with a public accounting firm.
William E. Hosker, was appointed as a director of the Company in March 1996. Mr. Hosker was formerly employed by Hercules, Inc., from 1960 to 1995. Mr. Hosker served in various capacities with Hercules, Inc., culminating in his positions as corporate vice-president of International Operations, Subsidiaries, and Ventures from 1987 to 1990 and vice-president and general manager of the Resins Group from 1990 to 1995. Mr. Hosker is the president and owner of STAT Associates, Inc., a business consulting firm. Mr. Hosker attended the Amos Tuck Business School at Dartmouth University studying strategic planning and financial analysis and the Darden Business School of the University of Virginia studying executive marketing. He obtained a bachelor of arts degree in biochemistry from Bowdoin College in 1960.
Gerard L. Seelig, was appointed as a director of the Company in June 1996. Mr. Seelig currently serves on the board of directors of a number of privately- held companies and has taught as a visiting professor at Columbia Graduate School of Business and Rutgers Graduate School of Management. Prior to his retirement, Mr. Seelig served as executive vice-president of Allied-Signal, Inc., and as president of its Electronics and Instrumentation Sector from 1983 to 1988. Prior to joining Allied-Signal, Inc., Mr. Seelig spent 12 years at ITT in senior executive positions, including president of ITT's Industrial and Commercial Products Company and as executive vice-president of the parent corporation. Prior to that, Mr. Seelig worked for ten years at Lockhead Corporation where he was corporate vice-president and president of Lockhead Electronics Company. Mr. Seelig is a member of the Dean's Advisory Council of the Rutgers Graduate School of Management and was designated as the school's first Distinguished Executive Lecturer in 1987. He was invited to become a Visiting Professor and Executive-In-Residence at the Columbia Graduate School of Business in 1988 and served for three years as a member of its board of overseers. Mr. Seelig received a masters degree in industrial management from New York University in 1954 and a bachelors degree in electrical engineering form Ohio State University in 1948.
Craig E. Allen, was appointed chief financial officer of the Company in December 1996. Mr. Allen was formerly controller of CUSA Technologies, Inc., from September 1994 to December 1996. Prior to that, Mr. Allen was a senior audit manager with the accounting firm of Grant Thornton LLP where he had been employed since 1978. Mr. Allen is a certified public accountant and received a masters degree in accounting from Brigham Young University in 1978.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Craig E. Allen, who became the chief financial officer of the Company on December 9, 1996, filed his initial report on Form 3 February 10, 1997. Larry J. Davis filed a report on Form 4 for the month of December 1996 on January 14, 1997. Dan J. Johnson filed a report on Form 4 for the month of October 1996 on February 24, 1997. The report of Nathan West on Form 4 for the month of January 1997 was filed late.
Other than the foregoing, the Company believes that all reports required by section 16(a) for transactions in the six months ended December 31, 1996, were timely filed.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Company and its subsidiaries for the six months ended December 31, 1996, and the fiscal years ended June 30, 1996, 1995, and 1994, to the chief executive officer of the Company and the other executive officers of the Company who received compensation in excess of $100,000.
[FN]
(1) These amounts reflect the benefit to the named executive officers of automobiles provided to such officers by the Company and amounts paid by the Company for health, disability, and life insurance.
(2) This reflects amounts paid, awarded, or accrued for the six month transition period ended December 31, 1996.
The named executive officers were not granted any options during the six months ended December 31, 1996.
The following table sets forth the information concerning the options exercised by the named executive officers during the six months ended December 31, 1996, and the value of unexercised options as of December 31, 1996.
EXECUTIVE EMPLOYMENT AGREEMENTS
The Company has employment agreements with each of its named executive officers. These employment agreements were entered into as of January 3, 1996, and have a term of five years. The employment agreements require devotion of the full business time of the executive to the Company, prohibit the executive from competing in any fashion with the Company during the term of the agreement and for one year subsequent to termination, and prohibit disclosure or use by the executive of trade secrets or other confidential information of the Company.
The employment agreements provided for initial compensation ranging from $150,000 to $200,000 per annum. These base salaries were increased approximately 9% in August 1996. Under the terms of the employment agreements, the salaries are subject to an annual increase as may be determined by the board of directors or the compensation committee of the Company; provided that, such increase shall not be less than a percentage equal to the sum of the increase in the consumer price index, plus 6%. Bonuses may be paid at the discretion of the board of directors or compensation committee.
In connection with the execution of the employment agreements, options were granted to acquire a combined total of 825,000 shares of common stock with an exercise price of $4.25 per share. The right to exercise such options vest in the executive with respect to 20% of the shares as of the date of grant and an additional 20% on each following anniversary of the date of grant. The options expire if not previously exercised on January 3, 2006.
Under the terms of the agreements, the Company maintains key-man life insurance policies on the lives of the executives in the amount of $2,000,000 each, but is not obliged to pay annual premiums in excess of 8% of the executives base salary. The Company furnishes the executives with automobiles, and with health, medical, and disability insurance.
In the event that the executive is disabled during the term of his employment agreement, he is entitled to the better of (i) the benefits under any disability policy maintained by the Company; (ii) 50% of his base salary for the unexpired employment term; or (iii) his base salary for the initial six months of disability, one-half of his base salary during the next three months of disability, and one-fourth of his base salary during the next three months of disability. The executive is also entitled to receive incentive compensation during the initial six months of any disability based on the incentive compensation paid to the executive during the preceding fiscal year.
The employment agreements can be terminated by the Company for cause by showing that the executive has materially breached the terms of the employment agreement, that the executive, in the reasonable determination of the board of directors, has been grossly negligent or engaged in material willful or gross misconduct in the performance of his duties, or that the executive has committed or been convicted of fraud, embezzlement, theft, dishonesty, or other criminal conduct against the Company. On the sale or transfer of all or substantially all of the assets of the Company, the merger of the Company into another entity, the termination of the business of the Company, a change in control of the Company, or the continued breach by the Company of the employment agreement after 20 days written notice, the executive has the right to terminate the employment agreement. In the event of a termination of the employment agreement other than by the Company for cause, the executive will receive an amount equal to the greater of two times the then current annual salary or the amount of salary that would otherwise accrue during the remaining employment period. In addition, the right to exercise the options granted pursuant to the employment agreements shall immediately vest with respect to all shares of common stock subject to such option and the Company shall maintain all employee benefit plans for a period equal to the greater of two years or the remaining employment period.
If the employment agreements are terminated as a result of the death of the executive, the right to exercise the option with respect to all shares shall immediately vest in the estate or heirs of the executive, the Company shall maintain the employee benefits for the family of the executive for a period equal to the greater of two years or the remaining employment period, and the Company shall pay an amount equal to 90% of the proceeds of the life insurance policy maintained by the Company on the executive or, if no policy is then in effect, an amount equal to the then current annual salary plus a pro rata portion of the incentive compensation based on the number of full months of employment during the year of the executive's death, payable in six equal monthly installments.
The Company agrees to indemnify the executives and hold them harmless from liability for acts or decisions made by the executive in connection with providing services to the Company to the greatest extent permitted by law. The Company has an obligation to use its best efforts to obtain officer's and director's insurance covering the executive. Each of the executives agree to indemnify the Company and hold it harmless from liabilities arising from their acts or omissions in violation of their duties under the employment agreements that constitute fraud, gross negligence, or willful and knowing violations.
COMPENSATION OF DIRECTORS
The Company compensates its outside directors for service on the board of directors by payment of a monthly fee of $1,000, payment of $2,000 for each board meeting attended, and reimbursement of expenses incurred in attending board meetings. The Company does not separately compensate its board members who are also employees of the Company for their service on the board. The Company has adopted its 1996 Director Stock Option Plan pursuant to which each of the five current directors received an option to acquire 200,000 shares of common stock of the Company at an exercise price of $7.00 per share. The right to exercise this option vests with respect to 25% of the shares as of the date of grant and an additional 25% of the shares on each succeeding anniversary of the grant provided that the individual holder is then a director of the Company. The exercise price of these options was fixed at the closing price of the Company's common stock of $7.00 per share on May 8, 1996, the day immediately preceding the adoption of the plan by the board of directors of the Company. The options granted to Brian G. Larson, Larry J. Davis, and Dan J. Johnson are subject to the approval of the plan by the shareholders of the Company. The Company anticipates submitting the plan to the shareholders at its next annual meeting. Because of a consulting agreement with STAT Associates, Inc., Mr. Hosker waived his monthly fee of $1,000 through September 30, 1996. (See "ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.")
By action dated February 21, 1997, the board of directors appointed Mr. Hosker to act on behalf of the board in pursuing potential strategic relationships with companies in the petrochemical and chemical industries. Mr. Hosker has 35 years of experience in these industries and it is the judgment of the board that his participation will facilitate the initial discussions concerning a possible alliance. It is anticipated that Mr. Hosker will dedicate essentially full-time to this effort over a few months. The board anticipates compensating Mr. Hosker for his time by delivering shares of the Company's common stock with a value of $100,000.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of March 25, 1997, the number of shares of the Company's common stock, par value $0.001, held of record or beneficially by each person who held of record or was known by the Company to own beneficially, more than 5% of the Company's common stock, and the name and shareholdings of each officer and director and of all officers and directors as a group.
[FN]
(1) Except as otherwise indicated, to the best knowledge of the Company, all stock is owned beneficially and of record, and each shareholder has sole voting and investment power.
(2) These options have been issued to the executive officers and directors pursuant to the 1987 Employee Stock Option Plan, the 1991 Director Stock Option Plan and the 1996 Director Stock Option Plan. The options have exercise prices ranging from $2.0625 to $7.00 per share with a weighted average price of $4.84 per share. Of the 750,000 shares subject to options shown for Messrs. Larson and Davis, options with respect to 330,000 shares are not currently vested or exercisable. Of the 701,365 shares subject to options shown for Mr. Johnson, options with respect to 285,000 shares are not currently vested or exercisable. Of the 200,000 shares subject to options shown for Messrs. Hosker and Seelig, options with respect to 150,000 shares are not currently vested or exercisable.
(3) The percentages shown are based on 11,374,191 shares of common stock of the Company issued and outstanding as of March 25, 1997.
(4) The percentage ownership for the options held by the indicated individuals is based on an adjusted total of issued and outstanding shares giving effect only to the exercise of each individual's options.
(5) The number of shares indicated for Mr. Larson includes 25,000 shares held by his wife and 46,300 shares held of record by Mr. Larson or his spouse for the benefit of minor children and in which he disclaims direct economic interest.
(6) The number of shares owned by Mr. Davis includes 696,362 shares held jointly with his wife over which he exercises joint investment and voting control and 64,000 shares which are held of record by Mr. Davis for the benefit of his minor children and in which he disclaims direct economic interest.
(7) Summit Enterprises, Inc., of Virginia holds all of the issued and outstanding preferred stock of the Company. The preferred stock is convertible into common stock at a rate determined by dividing $3.00 by the 20 day average of the trading price of the common stock. Based on the trading price of $10.25 as of March 25, 1997, the 200,000 shares of preferred stock is convertible into 58,537 shares. The total amount reflects the voting rights held by Summit of one vote for each share of preferred stock. If the preferred stock was converted to common stock at the market price as of March 25, 1997, Summit would hold 69,297 shares of common stock, or 0.6% of the issued and outstanding common stock.
(8) These shares are held by two subsidiaries of Mellon Bank Corporation, The Dreyfus Corporation and Dreyfus Investment Advisors, Inc. The number of shares owned reflects the holdings of these entities as of February 28, 1997, the latest date for which the Company has information.
(9) The number of shares indicated for Mr. Hosker includes 2,500 shares held by his wife.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In the course of the business of the Company, the two founders and principal shareholders of the Company have been required to guarantee certain obligations, including its principal line of credit. The Company's principal line of credit was placed with another financial institution subsequent to June 30, 1996, which did not require personal guarantees.
The Company entered into a Consulting Agreement dated March 19, 1996, with STAT Associates, Inc., a Delaware corporation owned and controlled by William E. Hosker, a director of the Company. The Agreement called for payments of $100,000 and the reimbursement of third-party expenses incurred on behalf of the Company. The Agreement contains confidentiality and noncompete provisions protecting the technology and business of the Company. In accordance with the terms of the Agreement, the consulting arrangement ended in September 1996.
Under the terms of various contractual arrangements with Brigham Young University ("BYU"), the Company owed BYU approximately $215,500 for royalties, license fees, and reimbursement of patent expenses, had additional upcoming expenses of approximately $109,000, and had an obligation to issue it 6,000 shares. BYU agreed to accept shares of the Company's restricted common stock in satisfaction of the cash obligations valued at the closing price of the Company's common stock on July 17, 1996, of $9.00 per share discounted by 20% to recognize the restricted nature of the securities. The Company purchased an aggregate of 49,272 shares of common stock from two of its executive officers and directors, at a price equal to the obligations to BYU, in order to deliver the shares to BYU. A portion of the purchase price was paid by offsetting the amounts due to the Company for advances made to the officers during the fiscal year ended June 30, 1996, in the aggregate principal amount of $105,000, plus accrued interest of approximately $5,300.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS AND SCHEDULES
The financial statements, including the index to the financial statements, are included immediately following the signatures to this report.
EXHIBITS
[FN] *Incorporated by reference
REPORTS ON FORM 8-K
The Company did not file a report on Form 8-K during the last quarter of the transition period ended December 31, 1996.
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Company has caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.
LARSON DAVIS INCORPORATED
Dated: March 28, 1997 By /s/ Brian G. Larson --------------------------------------- Brian G. Larson, President (Principal Executive Officer)
Dated: March 28, 1997 By /s/ Craig E. Allen --------------------------------------- Craig E. Allen. Chief Financial Officer (Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated:
Dated: March 28, 1997 By /s/ Brian G. Larson ---------------------------- Brian G. Larson, Director
Dated: March 28, 1997 By /s/ Larry J. Davis ---------------------------- Larry J. Davis, Director
Dated: March 28, 1997 By /s/ Dan J. Johnson ---------------------------- Dan J. Johnson, Director
Dated: March 25, 1997 By /s/ William E. Hosker ---------------------------- William E. Hosker, Director
Dated: March 24, 1997 By /s/ Gerard L. Seelig ---------------------------- Gerard L. Seelig, Director
Larson Davis Incorporated and Subsidiaries
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
All Financial Statement Schedules are omitted because they are not applicable or because the required information is contained in the Consolidated Financial Statements or the Notes thereto.
REPORT OF INDEPENDENT ---------------------
CERTIFIED PUBLIC ACCOUNTANTS ----------------------------
Board of Directors Larson Davis Incorporated and Subsidiaries
We have audited the accompanying consolidated balance sheets of Larson Davis Incorporated and Subsidiaries as of December 31, 1996 and June 30, 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows listed in the accompanying index for the six months ended December 31, 1996 and for the year ended June 30, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Larson Davis Incorporated and Subsidiaries as of December 31, 1996 and June 30, 1996, and the consolidated results of their operations and their consolidated cash flows for the six months ended December 31, 1996 and for the year ended June 30, 1996, in conformity with generally accepted accounting principles.
/s/ GRANT THORNTON LLP
Provo, Utah March 12, 1997
INDEPENDENT AUDITORS' REPORT ----------------------------
Board of Directors Larson Davis Incorporated and Subsidiaries Provo, Utah
We have audited the accompanying consolidated balance sheet of Larson Davis Incorporated and Subsidiaries at June 30, 1995, and the related consolidated statements of operations, stockholders' equity and cash flows listed in the accompanying index for the years ended June 30, 1995 and 1994. 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 did not audit the financial statements of Larson Davis, Ltd., a wholly-owned subsidiary, which statements constitute approximately 4% of total assets and 14% of total revenues of the related 1995 consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Larson Davis, Ltd., is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Larson Davis Incorporated and Subsidiaries as of June 30, 1995 and the results of their operations and their cash flows for the years ended June 30, 1995 and 1994 in conformity with generally accepted accounting principles.
/s/ PRITCHETT, SILER & HARDY, P.C.
Salt Lake City, Utah August 4, 1995
Larson Davis Incorporated and Subsidiaries
The accompanying notes are an integral part of these financial statements.
Larson Davis Incorporated and Subsidiaries
The accompanying notes are an integral part of these financial statements.
Larson Davis Incorporated and Subsidiaries
The accompanying notes are an integral part of these financial statements.
Larson Davis Incorporated and Subsidiaries
The accompanying notes are an integral part of these financial statements.
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows.
1. Business activity and principles of consolidation -------------------------------------------------
Larson Davis Incorporated (the Company) is primarily engaged in the design, development, manufacture, and marketing of analytical instruments related to the environmental sciences, and accompanying computer hardware and software technology. The Company sells its measurement instruments to private industries and governmental agencies for both industrial and military applications. The accompanying consolidated financial statements of the Company include the accounts of the Company and its wholly-owned subsidiaries; Larson Davis Laboratories Corporation, Sensar Corporation, and Larson Davis Ltd. (a UK Corporation). All significant intercompany transactions and accounts have been eliminated in consolidation.
2. Revenue recognition -------------------
The Company recognizes revenues on the majority of its product sales and services at the time of product delivery or the rendering of services. Occasionally, the Company enters into long-term contracts under which products are sold and services delivered over the term of the contract. Revenue under long-term contracts is recognized on the percentage-of- completion method.
3. Depreciation and amortization -----------------------------
Property and equipment are stated at cost. Depreciation and amortization are provided in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives. Leased property under capital leases and leasehold improvements are amortized over the shorter of the lives of the respective leases or over the service lives of the asset. The straight-line method of depreciation is followed for financial reporting purposes and accelerated methods are used for income tax purposes.
4. Income taxes ------------
The Company utilizes the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. An allowance against deferred tax assets is recorded when it is more likely than not that such tax benefits will not be realized. Research tax credits are recognized as utilized.
5. Cash and cash equivalents -------------------------
For purposes of the financial statements, the Company considers all highly liquid debt instruments with an original maturity of three months or less when purchased to be cash equivalents.
6. Inventories -----------
Inventories consisting of raw materials, work-in process, and finished goods are stated at the lower of cost or market using the average cost method, which approximates the first-in-first-out method.
7. Earnings (loss) per common share --------------------------------
Earnings (loss) per common share are computed by dividing net income (loss) by the weighted average common and dilutive common equivalent shares outstanding during each period. Common stock equivalents represent the dilutive effect of the exercise of stock options and warrants, and the conversion of preferred stock. Earnings used in the calculation are reduced (loss is increased) by the dividends paid to preferred stockholders. Fully diluted earnings (loss) per share is not materially different from primary earnings (loss) per share.
The weighted average shares outstanding were 10,410,820 for the six months ended December 31, 1996 and 9,317,297, 6,227,707 and 5,824,345 for the years ended June 30, 1996, 1995 and 1994, respectively.
8. Research and development costs ------------------------------
The Company conducts research and development to develop new products or product improvements not directly related to a specific project. Research and development costs have been charged to expense as incurred.
9. Concentrations of credit risk -----------------------------
The Company's financial instruments that are exposed to concentration of credit risk consist primarily of cash equivalents and trade receivables. The Company provides credit according to the terms of individual contracts, in the normal course of business.
10. Intangible assets -----------------
The Company capitalizes costs incurred to acquire product technology and patents. The amounts are amortized on the straight-line method over the estimated useful life or the terms of the respective technology or patent, whichever is shorter. The amortization periods range from 5 to 15 years.
The Company capitalizes all costs incurred to develop software after technological feasibility has been established. Amortization of these costs is calculated using the greater of the amount computed using (a) the ratio of current gross sales to the total current and anticipated future gross sales or (b) the straight-line method over estimated useful lives of 5 to 10 years.
The Company capitalized as goodwill, the excess acquisition costs over the fair value of the net assets acquired, in connection with the purchase of a subsidiary, which costs are being amortized on the straight-line method over 10 years.
On an ongoing basis, management reviews the valuation and amortization of intangible assets to determine possible impairment by comparing the carrying value to the undiscounted estimated future cash flows of the related assets and necessary adjustments, if any, are recorded.
11. Translation of foreign currencies ---------------------------------
The foreign subsidiary's asset and liability accounts, which are originally recorded in the appropriate local currency, are translated, for consolidated financial reporting purposes, into U.S. dollar amounts at period-end exchange rates. Revenue and expense accounts are translated at the average rates for the period. Transaction gains and losses, the amounts of which are not material, are included in general and administrative expenses. Gains and losses on intercompany foreign currency transactions, where settlement is not planned or anticipated in the foreseeable future, are not included in determining net earnings or loss but are reported in the same manner as translation adjustments. Foreign currency translation adjustments are accumulated as a separate component of stockholders' equity.
12. Use of estimates ----------------
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues and expenses during the reporting period. Estimates also affect the disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from these estimates. Such estimates of significant accounting sensitivity are the allowance for doubtful accounts and the allowance for inventory overstock or obsolescence. Additionally, certain estimates which are affected by expected future gross revenues or royalty receipts are capitalized software costs, long-term contractual arrangement and patents on proprietary technology. Management believes the estimates used in determining carrying values of assets as of the respective balance sheet dates are reasonable.
13. Fair value of financial instruments -----------------------------------
Calculation of estimated fair value of financial instruments is not presented because, in management's opinion, this calculation would not result in a material difference between carrying amounts and estimated fair values of financial instruments as presented on the accompanying consolidated balance sheets, with the exception of the long-term contractual arrangement. It is not practicable to estimate the fair value of this asset, since its value is dependent on the future revenues of an unrelated entity, which is not readily determinable by the Company.
14. Reclassifications - not material --------------------------------
Certain reclassifications have been made to the June 30, 1996, 1995 and 1994 financial statements to conform with the December 31, 1996 presentation.
NOTE B - CHANGE IN FISCAL YEAR END
On January 23, 1997, the Board of Directors of the Company approved a change of its fiscal year end from June 30, to December 31, effective December 31, 1996. The following is selected financial data for the six month transition period ended December 31, 1996 and the comparable prior year period.
NOTE C - CASH AND CASH EQUIVALENTS
Included in cash and cash equivalents at December 31, 1996 and June 30, 1996 are approximately $2,300,000 and $2,600,000, respectively of securities purchased through a daily repurchase agreement with a bank. The agreement provides for the balance of available funds to be invested in an undivided interest in one or more direct obligations of, or obligations that are fully guaranteed as to principal and interest by, the United States government, or an agency thereof. These securities are not a deposit and are not insured by the Federal Deposit Insurance Corporation.
In addition, the Company maintains a certificate of deposit in the amount of $400,000 to secure a letter of credit related to a performance bond for a third party. Accordingly, this cash amount is currently restricted.
NOTE D - INVENTORIES
Inventories consist of the following:
NOTE E - PROPERTY AND EQUIPMENT
Property and equipment and estimated useful lives are as follows:
NOTE F - INTANGIBLE ASSETS
Intangible assets consist of acquired technology, capitalized software development costs, goodwill, and patents which are being amortized using the straight line method over useful lives ranging from 5 to 15 years.
The long-term value of these assets is connected to the application of technologies and software costs to viable products which can be successfully marketed by the Company. Management believes current and projected sales levels of its existing and planned products will support the carrying costs of the assets.
The following is a summary of intangible assets and estimated useful lives:
NOTE G - INCOME TAXES
Effective July 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". The cumulative effect of this change in accounting principle was $486,992 in the year ended June 30, 1994.
The income tax expense on continuing operations reconciled to the tax computed at the statutory federal rate of 34% is as follows:
Deferred income tax assets and liabilities are as follows:
The Company has sustained net operating losses in each of the periods presented. There were no deferred tax assets or income tax benefits recorded in the financial statements for net deductible temporary differences or net operating loss carryforwards because the likelihood of realization of the related tax benefits cannot be established. Accordingly, a valuation allowance has been recorded to reduce the net deferred tax asset to zero and consequently, there is no income tax provision or benefit for any of the periods presented. The increase (decrease) in the valuation allowance was $577,126, $1,454,363, ($381,591), and $840,698 for the six months ended December 31, 1996 and for the years ended June 30, 1996, 1995 and 1994, respectively.
As of December 31, 1996, the Company had a net operating loss carryforward for tax reporting purposes of approximately $8,300,000 expiring in various years through 2011. Utilization of approximately $3,100,000 of the total net operating loss is dependent on the profitable operation of Sensar Corporation in the future under the separate return limitation rules and Internal Revenue Code Section 382 limitations on the carryforward of net operating losses after a change in ownership. The valuation allowance associated with the preacquisition Sensar net operating losses is approximately $1,160,000, and if realized, will be recognized by reducing costs allocated to acquired technology in the purchase of Sensar.
NOTE H - LINES OF CREDIT
Lines of credit are as follows:
(A) At December 31, 1996, the outstanding line of credit contains certain covenants including, but not limited to, provisions that the Company maintain certain levels of net worth, achieve certain results of operations, meet certain financial ratios, and restrict the amount of capital expenditures. At times, the Company has been in violation of certain of these covenants. The lender monitors the Company's compliance with these covenants. Under the line of credit agreement, the lender is required to notify the Company when it considers an event of default to have occurred. Through December 31, 1996, and subsequent thereto, the Company has not been notified by the lender of any event of default.
NOTE I - LONG-TERM OBLIGATIONS
1. Debt ----
Long-term debt consists of the following:
Aggregate maturities of long-term debt are as follows:
2. Capital leases --------------
The Company leases certain equipment on 36 to 60 month capital leases. The leases contain provisions for the Company to acquire the equipment at the end of the lease term through either payment of a nominal amount or, in other cases, the greater of fair market value or 10% of the original equipment cost. Assets under capital lease obligations are as follows:
Total amortization on equipment under capital lease obligations was $82,434 for the six months ended December 31, 1996 and $158,693, $111,496 and $68,755 for the years ended June 30, 1996, 1995 and 1994, respectively.
Total future minimum lease payments, under capital lease obligations are as follows:
3. Operating leases ----------------
The Company leases certain office and manufacturing space and equipment under operating leases. The lease on a portion of the Company's office space terminated in November 1996, and is currently leased on a month-to- month basis. The Company is currently negotiating the renewal of this lease. Leases of equipment expire through 1998. Minimum future payments under non-cancelable operating leases are as follows:
Total rent expense under operating leases was $75,408 for the six months ended December 31, 1996 and $83,857, $62,932, and zero for the years ended June 30, 1996, 1995 and 1994, respectively.
NOTE J - 401(K) PROFIT SHARING PLAN
In February 1995, the Company adopted a 401(k) profit sharing plan under which eligible employees may choose to contribute up to 6% of their wages on a pre-tax basis, subject to IRS limitations. Employees who have completed six months of qualified service with the Company are eligible to enroll in the plan. The Company will match 50% of the employee's contribution to the plan up to a maximum of 1.5% of the employee's eligible annual salary. The Company's contributions vest at a rate of 20% per year beginning with the second year of service and participants are fully vested after six years of service. The Company contributed $38,581 for the six months ended December 31, 1996, and $34,594 and $15,282 for the years ended June 30, 1996 and 1995, respectively.
NOTE K - PREFERRED STOCK
During the year ended June 30, 1995, the Company issued 200,000 shares of preferred stock in payment of $500,000 of short-term debt. The preferred stock has a liquidation preference equal to $2.50 per share, plus unpaid dividends. This preferred stock pays cumulative dividends at a rate of $0.225 per share per annum, payable monthly. The preferred stock is convertible into common stock at the option of the holder or the option of the Company at the rate of $3.00 per share divided by an amount equal to the average of the closing bid prices for the common stock for the twenty consecutive trading days immediately prior to the date that the holder provides notice of such conversion. The Company may redeem the preferred stock for $2.50 per share plus unpaid dividends. The preferred stockholders are entitled to one vote for each share of preferred stock held.
NOTE L - COMMON STOCK
During the six months ended December 31, 1996 and the year ended June 30, 1996, the Company issued 548 shares and 34,940 shares respectively, of common stock valued at prices ranging from $4.75 to $9.13 per share, for services rendered. During the year ended June 30, 1996 the Company also issued 16,483 shares of common stock, at prices ranging from $2.19 to $2.88 per share, as payment of interest on the Company's long-term debt. The Company also issued 98,905 shares of common stock during the year ended June 30, 1995 valued at prices ranging from $1.25 to $2.50 per share for services rendered and for reimbursement of certain research, development and other costs.
During the years ended June 30, 1995 and 1994, the Company issued 614,000 and 381,122 shares of common stock in various private placements at prices ranging from $1.63 to $1.75 and $2.15 to $3.32 per share, respectively. Proceeds to the Company, less expenses of $34,767 and $175,000, respectively, were $991,343 and $895,000, respectively.
NOTE M - STOCK OPTIONS AND WARRANTS
1. Stock-based compensation plans ------------------------------
During the periods presented in the accompanying financial statements, the Company has granted stock options under three stock option plans; the 1991 Director Stock Option Plan (the 1991 Director Plan), the 1996 Director Stock Option Plan (the 1996 Director Plan), and the 1987 Employee Stock Option Plan (the 1987 Employee Plan). The Company has also granted options under executive employment agreements.
Under the 1991 Director Plan, the Company granted 30,000 options to each director for each year of service, up to an aggregate of 450,000 options. Options granted under this plan vested immediately and expire five years after the grant. The 1991 Director Plan terminated July 1, 1996.
Under the 1996 Director Plan, the Company granted options to each director to acquire 200,000 shares of common stock (for a total of 1,000,000 options) at $7.00 per share. Options under the 1996 Director Plan vested 25% on the grant date and 25% for each year of service thereafter and expire five years after their vesting date.
Under the 1987 Employee Plan, as amended in 1994, the Company may grant options to acquire up to 750,000 shares of common stock, of which 728,453 have been granted as of December 31, 1996. Options granted under the 1987 Employee Plan vest at varying dates from zero to five years after the grant date and expire five years after the vesting date.
In January 1996, the Company granted options to three executives under newly executed employment agreements. The agreements granted options to acquire an aggregate of 825,000 shares of common stock at an exercise price of $4.25 per share. The options under the employment agreements vest 20% on the grant date and 20% on each year of service thereafter, and expire in January 2006.
A summary of the status of the options granted under the Company's stock option plans and employment agreements at December 31, 1996, and June 30, 1996, 1995, and 1994 and changes during the periods then ended is presented in the table below:
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants during the periods ended December 31, 1996 and June 30, 1996, 1995 and 1994, respectively: risk-free interest rates of 5.9%, 6.1%, 7.4% and 6.7%, expected dividend yields of zero for all periods, expected lives of 5.0, 6.4, 4.0 and 4.1 years, and expected volatility of 50%, 47%, 59% and 60%.
A summary of the status of the options outstanding under the Company's stock option plans and employment agreements at December 31, 1996 is presented below:
1. Stock-based compensation plans - continued ------------------------------------------
The Company accounts for these plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Accordingly, since all options granted under these plans were granted at fair market value of the stock on the date of the grant no compensation cost has been recognized in the accompanying financial statements for options granted under these plans. Had compensation cost for these plans been determined based on the fair value of the options at the grant dates for awards under these plans consistent with the method prescribed by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation", the Company's net loss and loss per common share would have been increased to the pro forma amounts indicated below:
2. Stock warrants --------------
In conjunction with a private placement in May 1995, the Company issued warrants to acquire additional common stock of the Company to a group of investors. Since that time, the Company has issued additional warrants to this group as the previously outstanding warrants were exercised. A summary of the status of common stock underlying the warrants issued at December 31, 1996, and June 30, 1996, 1995, and 1994 and changes during the periods then ended is presented in the table below:
2. Stock warrants - continued --------------------------
The warrants outstanding at December 31, 1996 expire on November 1, 1998 (Note U).
NOTE N - COMMITMENTS AND CONTINGENCIES
The Company is from time to time involved in litigation as a normal part of its ongoing operations. At December 31, 1996, there was no litigation which would have a material impact on the financial condition of the Company.
During January 1996, the Company entered into employment agreements with three officers. The agreements provide, among other things, for terms of annual salary, minimum annual salary increases equal to the increase in the consumer price index plus 6%, the granting of 825,000 options at $4.25 per share, and an automobile allowance. Total annual salaries payable under these agreements are approximately $550,000 plus specified increases in each calendar year 1997 through 2000. The employment agreements may be terminated under certain circumstances. In the event of a termination of the employment agreement other than by the Company for cause, the officer will receive severance pay in an amount equal to the greater of two times the then current annual salary or the amount of salary that would otherwise accrue during the remaining employment period. In addition, the right to exercise the options granted shall immediately vest with respect to all shares of common stock subject to such option. Additionally, in the event of disability or death of the officer, certain benefits are payable to the officer or his family.
The Company has also entered into licensing agreements for the use of certain patented technology, a substantial portion of which is owned by a university, which is also a stockholder of the Company. The licensing agreements require royalty payments through the ends of the lives of the underlying patents which expire at various dates through 2013. Royalty payments are equal to specified percentages of the sales amounts of certain products, but not less than minimum annual royalty requirements of up to $146,000 per year.
Royalty expenses included in the statements of operations were $82,000 for the six months ended December 31, 1996 and $92,919, $73,937 and 69,536 for the years ended June 30, 1996, 1995 and 1994, respectively.
NOTE O - SALES
Sales by geographical area are as follows:
During the six months ended December 31, 1996, one customer accounted for 13% of net sales. During the years ended June 30, 1996, 1995, and 1994, no customers accounted for more than 10% of net sales.
NOTE P - RELATED PARTY TRANSACTIONS
In the ordinary course of business of the Company, the two founders and principal stockholders of the Company have been required to guarantee certain obligations, including its principal line of credit. The personal guarantees of the principal line of credit of the Company were eliminated when it was placed with another financial institution in October 1996.
The Company entered into a consulting agreement in March 1996, with a corporation owned and controlled by a director of the Company. Under the terms of the agreement, the corporation agreed to provide the Company with advisory and consulting services concerning the commercialization of the technology held by Sensar Corporation, the identification of markets for such products, the establishment of marketing contacts, and the development of an operational plan for the development and marketing of products based on the Sensar technology. The agreement called for compensation of $100,000 and the reimbursement of third-party expenses incurred on behalf of the Company. In accordance with the terms of the agreement, the consulting arrangement ended in September, 1996.
Under the terms of various contractual arrangements with a university, the Company owed approximately $215,500 for royalties, license fees, and reimbursement of patent expenses, had additional upcoming expenses of approximately $109,000, and had an obligation to issue it 6,000 shares. The university agreed to accept shares of the Company's restricted common stock in satisfaction of the cash obligations. The stock was valued at the closing price of the Company's common stock on July 17, 1996, of $9.00 per share discounted by 20% to recognize the restricted nature of the securities. The Company purchased an aggregate of 49,272 shares of common stock from two of its executive officers and directors, at a price equal to the obligations to the university, in order to deliver the shares to the university. A portion of the purchase price was paid by offsetting amounts due to the Company for advances made to the officers during the fiscal year ended June 30, 1996 in the aggregate principal amount of $105,000, plus accrued interest of approximately $5,300.
NOTE Q - DISCONTINUED OPERATIONS
Airport Noise Monitoring Business ---------------------------------
In connection with a decision by the Company in fiscal 1995, the Company entered into an agreement, completed in August 1995, to divest its airport noise monitoring business. Under the terms of this agreement Harris Miller Miller and Hanson, Inc. (HMMH), an established consulting firm with its primary business related to transportation industry acoustic and vibration analysis, purchased all of the Company's tangible assets and contracts related to the airport noise monitoring business and assumed approximately $100,000 of the Company's liabilities. HMMH also entered into a licensing agreement with the Company, which transfers the ownership of the Company's related software for application in the airport noise monitoring industry. Also included in the agreement is a covenant for the Company to discontinue operations in and to not compete with HMMH within the airport noise monitoring industry. In return HMMH agreed to use its best efforts to utilize the Company's instrumentation in future contracts and will receive "most favored nations treatment" from the Company in pricing.
The Company was paid a one-time fee of $125,000 and is guaranteed installment payments of $150,000 annually for the lesser of ten years or the term of the contract. The Company will also receive a varying royalty of 2 1/2% to 4% on gross revenues of HMMH resulting from the sale, installation, upgrade, and maintenance of airport noise and operations monitoring systems. The royalty is not dependent on HMMH's revenues being directly related to the acquired technology. HMMH has the right to buy out the installment nature of its obligation to the Company by making a balloon payment at the end of year 3, 5, 7, or 10 in the amount of $3,000,000, $2,200,000, $1,700,000 or $875,000, respectively, as a prepayment of all guaranteed and anticipated royalties due. If at the end of year 10 a balloon payment has not been made, HMMH will continue to make royalty payments of 3% for an additional five years. At the point of prepayment or the end of year 15, the technology portion of the assets licensed by HMMH will be transferred to them without lien or other encumbrance. Until then, the Company has placed in escrow the source codes related to pertinent computer software and allows, through an exclusive license agreement, HMMH full access and use of the technology.
The Company's consolidated financial statements as of and for the year ended June 30, 1995 reflect the transaction with the carrying value of the long- term contractual arrangement being assigned the basis of the net assets sold and no gain or loss being recognized. Management estimates the proceeds from the contractual arrangement will equal or exceed the carrying value of the respective asset and currently is applying such proceeds received on a "cost recovery" method whereby the carrying cost of the asset is reduced accordingly.
During the six months ended December 31, 1996 and the year ended June 30, 1996, the Company recognized royalty payments from HMMH in the amounts of $106,000 and $388,146, respectively.
Software Licensing Business ---------------------------
During the year ended June 30, 1994, with the return of the minority interest shares in Larson Davis Info, Inc. ("Info"), the Board of Directors decided, pursuant to a plan effective June 30, 1993, to discontinue the operations and pursue the sale or licensing of the software technologies then owned by Info and Advantage Software, Inc. In as much as the Company was unable to locate a buyer for the technologies, management elected to reduce the carrying value of the related assets to zero as of June 30, 1994, resulting in a loss of $2,156,987.
The airport noise monitoring and software licensing businesses have been accounted for as discontinued operations, and accordingly, the results of their operations are segregated from continuing operations in the accompanying statements of operations. Net sales, costs and operating expenses, other income and expense, and income taxes of these businesses for the fiscal years ended June 30, 1995 and 1994, have been reclassified as discontinued operations.
Summary operating results of discontinued operations for the fiscal years ended June 30, 1995 and 1994, excluding the loss on disposal, are as follows:
NOTE R - ACQUISITIONS
Sensar Corporation ------------------
Effective October 27, 1995, the Company acquired 100% of the stock of Sensar Corporation (Sensar). Sensar holds manufacturing and distribution rights to patented technology developed at Brigham Young University related to time- of-flight mass spectrometers. The Company issued 586,387 shares and 31,336 shares of common stock during the year ended June 30, 1996 and the six months ended December 31, 1996, respectively (valued at an aggregate of $1,590,636), assumed an outstanding obligation of Sensar with regard to a line of credit in the amount of $535,823 at October 27, 1995, and paid $280,000 to Sensar to be used by Sensar to redeem 1,400,000 shares of its common stock. This transaction was accounted for using the purchase method of accounting; accordingly the purchased assets and liabilities have been recorded at their estimated fair value at the date of acquisition, with the excess purchase price of $2,774,707 being allocated to acquired technology. A useful life of 15 years has been determined with amortization being calculated using the straight-line method. The results of operations of the acquired business have been included in the financial statements since the date of acquisition.
Larson Davis, Ltd. ------------------
During the quarter ended March 31, 1994, the Company purchased all of the outstanding common shares of Industrial & Marine Acoustics, Ltd, (IMA), a corporation chartered in England, for a cash payment of 6,000 British pounds (approximately $9,300). IMA was formerly an independent sales representative of the Company for Great Britain. The acquisition was accounted for using the purchase method of accounting, with the excess purchase price allocated to goodwill. Goodwill is being amortized over 10 years. Results of operations of IMA subsequent to March 1994 have been reflected in the consolidated statements of operations. Subsequently, management renamed the British subsidiary Larson Davis, Ltd. and has developed an expanded service and repair center to serve the European Community.
Airport Noise Monitoring Business ---------------------------------
On June 30, 1994, the Company completed the acquisition of substantially all of the intangible assets of Technology Integration Incorporated, a privately-held Massachusetts Corporation ("TII") for a total cost of $2,508,541. The Company acquired TII's rights and obligations to approximately 25 contracts for the installation, maintenance, and support of airport noise monitoring systems. In addition, the Company acquired all rights to the ANOMS software developed by TII for use in airport noise monitoring systems, a principal competitor of the Company's own proprietary software. The Company also hired 10 former employees of TII who were an integral part of TII's airport noise monitoring business. The Company intended to complete existing contracts with ANOMS and then combine ANOMS and its own proprietary software to produce an enhanced product. However, effective June 30, 1995, the Company decided to discontinue its selling, installation and maintenance of airport noise and operations monitoring systems (Note Q).
The following unaudited pro forma summary represents the combined results of operations as if the acquisitions had occurred as of the beginning of each year presented and do not purport to be indicative of what would have occurred had the acquisitions been made as of the dates set forth, or of results which may occur in the future.
NOTE S - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Supplemental disclosure of cash flow information:
Significant non-cash investing and financing activities are as follows:
NOTE T - ACCRUED LIABILITIES
Accrued liabilities are composed of the following:
NOTE U - SUBSEQUENT EVENTS
In January 1997, the Board of Directors approved a reduction in the exercise price of 1,715,832 of the outstanding warrants from an exercise price of $6.25 to $5.30 per share. In consideration of this reduction, the holders of the warrants have agreed to the early exercise of these warrants which were otherwise permitted to be exercised until November 1, 1998. The holders agreed to exercise a portion of the warrants on or before January 31, 1997 (which exercise has occurred and resulted in gross proceeds to the Company of approximately $4,069,000) and the remaining portion of the warrants on or before April 16, 1997 (which exercise, if it occurs, will result in additional proceeds to the Company of approximately $5,025,000). On the satisfaction of certain conditions, the Company has agreed to issue replacement warrants at an exercise price of $10.75 per share equal in number to those exercised.