The Company realized a consolidated net loss of $4,920,116 ($.15 per share) and $7,826,205 ($.23 per share) for the three and six months ended December 31, 2004 compared to a consolidated net loss of $7,823,689 ($.32 per share) and $9,523,708 ($.43 per share) for the three and six months ended December 31, 2003.
As reported in Footnote 5 (Segment Information) to the Consolidated Financial Statements appearing in this Form 10-Q, the net loss is the result of losses incurred primarily by the Company’s Authentidate segment. Our Authentidate segment has incurred significant sales, marketing, development and general administrative expenses this year and last in an effort to complete the product development efforts, generate sales and develop a market for its products.
The consolidated net loss for the three months ended December 31, 2004 is approximately $2.9 million less than it was for the same period last year. The Company had approximately $5.6 million in non-cash interest expense related to conversions of debentures and which included approximately $300,000 of amortization expense related to such debt (see Footnote 12) during the three months ended December 31, 2003 (corporate expenses); the Company had no such expense during the same period in 2004. Additionally, there was an increase in the loss in the Authentidate segment of approximately $1.8 million comparing current year second quarter to prior year second quarter. The increase was primarily due to increased personnel costs ($1.0 million) and consultant costs ($1.2 million) in the current year, offset against insignificant decreases in other various categories. The Corporate Division incurred new severance costs of $1.1 million, while incurring none in the prior year. DocStar segment profit increased approximately $5,000, while DJS segment profit decreased approximately $22,000 for the three months ended December 31, 2004, compared to the three months ended December 31, 2003.
The consolidated net loss for the six months ended December 31, 2004 is approximately $1.7 million less than it was for the same period last year. The Company had approximately $5.9 million in non-cash interest expense related to conversions of debentures (see footnote 12) during the six months ended December 31, 2003 (corporate expenses); the Company had no such expense during the same period in 2004. Additionally, there was an increase in the loss in the Authentidate segment of approximately $2.6 million comparing current year to prior year. The increase was primarily due to increased personnel costs ($1.4 million) and consulting expense ($1.5 million) in the current year, offset against insignificant decreases in other various categories. Additionally, the Corporate Division incurred new severance costs of $1.1 million. DocStar segment profit increased approximately $91,000 due to higher sales than prior year, while DJS segment profit remained unchanged for the six months ended December 31, 2004, compared to the six months ended December 31, 2003.
Consolidated sales were $4,761,727 and $8,424,125 for the three and six months ended December 31, 2004, respectively; consolidated sales were $4,029,068 and $7,300,291 for the three and six months ended December 31, 2003, respectively. The increase versus the prior year for both periods is a result of an increase in Authentidate and DocStar segment sales, offset by a decline in DJS low margin hardware sales.
Consolidated gross profit for the three months ended December 31, 2004 and 2003 was $2,268,598 and $1,626,252, respectively, while the consolidated gross profit for the six months ended December 31, 2004 and 2003 was $3,971,211 and $2,852,535, respectively. The consolidated gross profit margin was 47.6% and 40.4% for the three months ended December 31, 2004 and 2003; the consolidated gross profit margin was 47.1% and 39.1% for the six months ended December 31, 2004 and 2003, respectively. Gross profit margin is defined as gross profit as a percentage of sales. The increase for both periods comparing current year to prior year results from increased sales in the Authentidate segment.
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Selling, general and administrative expenses (S,G&A) consist of all other Company expenses except product development costs and interest. S,G&A expenses amounted to $6,962,081 and $3,246,924 for the three months ended December 31, 2004 and 2003, and $11,171,438 and $5,943,997 for the six months ended December 31, 2004 and 2003. The largest increase was in the Authentidate segment which incurred increased personnel costs ($1.0 million and $1.4 million for the three and six months ended December 31, 2004, respectively), along with additional consulting costs ($1.2 million and $1.5 million for the three and six months ended December 31, 2004). The Corporate Division also had new severance costs of $1.1 million during both the three and six months ended December 31, 2004.
As a percentage of net sales, S,G&A costs were 146.2% and 132.6 % for the three and six months ended December 31, 2004, respectively, and 80.6% and 81.4% for the three and six months ended December 31, 2003. This percentage increase is primarily due to the increase in SG&A expenses for the Authentidate segment as discussed above.
Interest expense was $4,615 and $8,813 for the three and six months ended December 31, 2004 and 2003, respectively, compared to $5,724,704 and $6,182,160 for the three and six months ended December 31, 2003, respectively. The decrease is due to non-cash interest expense on convertible debentures which were written off due to conversion to common stock which occurred in fiscal 2004, which is more fully discussed in the footnotes contained herein.
Product development expenses, excluding capitalized costs, primarily relate to software development for the Authentidate segment. For the three month period December 31, 2004, these costs increased to $600,073, as compared to $500,487 the same period last year; for the six month period ended December 31, 2004, these costs were $1,301,347 compared to $1,080,027 for the same period in prior year. We have a policy of capitalizing qualified software development costs after technical feasibility has been established and amortizing those costs over three years as cost of goods sold. The amortization expense of software development costs amounted to approximately $79,000 and $161,000 for the three and six months ended December 31, 2004. Amortization expense of software development costs amounted to approximately $54,000 and $134,000 for the three and six months ended December 31, 2003.
Liquidity and Capital Resources
Overview
Our primary sources of funds to date have been the issuance of equity and the incurrence of third party debt. The principal balance of long-term debt at December 31, 2004 totaled $108,000, which relates to a note payable to the Empire State Development Corporation for the repayment of a grant, as more fully described below. Other long term liabilities relate to severance accruals.
In February 2004, we sold a total of 5,360,370 common shares in private placements pursuant to Section 4(2) of the Securities Act and Rule 506, promulgated thereunder. We realized gross proceeds of approximately $73,700,000 from these transactions and received net proceeds of approximately $69,100,000 after payment of offering expenses and broker commissions.
Our DJS subsidiary has a $2.5 million revolving line of credit with a financial institution collateralized by all assets of DJS and guaranteed by Authentidate Holding Corp. The agreement restricts DJS from making cash advances to AHC, without obtaining a waiver from the financial institution. The interest rate is prime plus 1.75% with a minimum prime rate of 7%. DJS may borrow on this line based on a formula of qualified accounts receivable and inventory. The outstanding balance on this line of credit is $407,696 at December 31, 2004.
Property, plant and equipment expenditures totaled $510,729 and capitalized software development expenditures totaled $161,451 for the six months ended December 31, 2004, respectively. There are no significant purchase commitments outstanding.
In June 1999, the Company completed construction of a new office and production facility in Schenectady, New York for approximately $2,300,000 which was financed with a $1,000,000 grant from the Empire State Development Corporation (ESDC) (an agency of New York state) and a mortgage loan from a local financial institution. The grant stipulated that the Company was obligated to achieve certain annual employment levels between January 1, 2002 and January 1, 2004 or some or all of the grant will have to be repaid. Although we had not achieved the agreed upon employment levels, we reached an agreement with the ESDC in fiscal 2004 to restructure the grant terms relating to this covenant. We agreed to repay $268,000 of the grant amount at the rate of $10,000 per month, interest free, in consideration of the ESDC’s agreement to permanently reduce our employment level requirement to 99. At December 31, 2004 the amount due ESDC was $108,000 and is included in debt on the balance sheet. As a result of this arrangement, we recorded $732,000 as other income in the Corporate Division during fiscal year ended June 30, 2004.
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Cash Flows
Our unrestricted cash and cash equivalents balance at December 31, 2004 was $67,527,016 and total assets were $90,006,073 compared to cash and cash equivalents of $73,989,823 and total assets of $94,236,876 at June 30, 2004. Our unrestricted cash balance at December 31, 2003 was $7,757,986 and our total assets as of such date was $29,004,710. The increase from the six months ended December 31, 2003 to the six months ended December 31, 2004 is due to the completion of private financings during the fiscal year ended June 30, 2004, offset by our operating losses. We used $5,622,599 of cash in operating activities during the six months ended December 31, 2004. This compares to cash used in operating activities of $1,777,840 for the same period last year. Total cash flow used by all activities was $6,462,807 for the six months ended December 31, 2004 compared to net cash provided of $4,297,540 for the six months ended December 31, 2003. This decrease in cash and cash equivalents during the six months ended December 31, 2004 is mainly due to the Company’s operating activities ($5,622,599), primarily the net loss, which was $7,826,205. This was coupled with investing outflows relating to property, plant and equipment ($510,729), software development costs ($161,451), other intangible assets ($403,000), other long term assets ($22,501), and an investment ($750,000). We invested $750,000 in an unaffiliated third party, Health Fusion, Inc. in connection with a strategic relationship we established with this company. We will invest an additional $750,000 in Health Fusion, provided it achieves certain financial and other performance objectives six months from the closing date. This investment occurred on November 23, 2004. The increase in cash during the six months ended December 31, 2003 is mainly due to the sale of convertible debentures of $2,369,622, stock options & warrants exercised of $5,695,178, offset by cash used in operations totaling $1,777,840.
To date we have been largely dependent on our ability to sell additional shares of our common stock or other securities to obtain financing to fund our operating deficits. Under our current operating plan to introduce the Authentidate technology, our ability to improve operating cash flow has been highly dependent on the market acceptance of our products. We believe we have enough cash and cash equivalents to support our operations for at least the next twelve months.
Our future capital requirements may vary materially from those now planned. The amount of capital that we will need in the future will depend on many factors, including:
| • | our relationships with suppliers and customers; |
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| • | the market acceptance of our products; |
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| • | the levels of promotion and advertising that will be required to launch our new products and achieve and maintain a competitive position in the marketplace; |
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| • | price discounts on our products to our customers; |
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| • | our pursuit of strategic transactions; |
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| • | our business, product, capital expenditure and research and development plans and product and technology roadmaps; |
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| • | the levels of inventory and accounts receivable that we maintain; |
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| • | capital improvements to new and existing facilities; |
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| • | technological advances; and |
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| • | our competitors’ response to our products. |
Financing Activities
During the 2004 fiscal year we completed the private financings described below in order to address our working capital needs.
On September 12, 2003, we completed the sale of $2,470,000 of our securities to certain accredited investors pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Regulation D, promulgated thereunder. We received net proceeds of approximately $2,300,000, after paying all fees and expenses. We have applied these proceeds to working capital and general corporate purposes. In the transaction, we sold $2,470,000 of convertible debentures to the investors and warrants to purchase an aggregate of 247,000 shares of common stock. The debentures are convertible into shares of our common stock at an initial conversion price of $3.00 per share and the warrants are exercisable into shares of common stock at an initial price of $3.00 per share. The other terms and conditions of the debentures and warrants are the same as set forth in the debentures and warrants issued in the first tranche of this transaction in October 2002. As previously discussed, the convertible debentures issued in this transaction were converted into shares of common stock during the fiscal quarter ended December 31, 2003.
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We also issued warrants to purchase an aggregate of 49,400 shares of common stock to certain consultants for services rendered in connection with this transaction which are exercisable at $3.00 per share. The consultants also received a cash fee equal to 6% of the gross proceeds we received.
Further, on September 22, 2003, we completed the sale of 166,667 shares of common stock to an additional accredited investor pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Regulation D, promulgated thereunder for $500,000. We have applied these proceeds to working capital and general corporate purposes. In addition, we also issued warrants to purchase an aggregate of 50,000 shares of common stock to the investor in this transaction. The per share purchase price of the common stock and the per share exercise price of the warrants is $3.00. The investor also agreed to a twelve-month “lock-up” provision restricting the resale of the securities, which expired in September 2004. We also issued warrants to purchase an aggregate of 10,000 shares of our common stock to a consultant for services rendered in connection with this transaction which are exercisable at $3.00 per share. The consultants also received a cash fee equal to 6% of the gross proceeds we received.
In February 2004, we completed private offerings of our common stock to certain accredited investors pursuant to Section 4(2) of the Securities Act of 1933, as amended and Regulation D, promulgated thereunder. We sold a total of 5,360,370 common shares at a price of $13.75 per share and realized gross proceeds of $73,705,000. After payment of offering expenses and broker commissions we realized approximately $69.1 million in net proceeds. We have been and will continue to use the proceeds to strengthen our balance sheet as well as for sales and marketing activities and general corporate purposes.
The securities sold in each of the foregoing transactions were restricted securities under the terms of Regulation D and may not be transferred or resold for a period of one year, except pursuant to registration under the Securities Act or an exemption thereunder. Pursuant to registration rights agreements entered into with the investors in these financings, registration statements were filed with and declared effective by the Securities and Exchange Commission registering the shares of common stock sold in or issuable pursuant to these transactions.
Other Matters
The events and contingencies described below have or may have impacted our liquidity and capital resources.
During the quarter ended December 31, 2003, we exercised our right to require the holders of an aggregate amount of $8,895,300 of convertible debentures to convert the entire outstanding principal amount of their debentures into shares of our common stock. The conversion of these debentures has resulted in our issuance of an aggregate amount of 3,351,527 shares of our common stock to the holders of the debentures. The specific debentures subject to this conversion requirement are an aggregate principal amount of $3,700,000 of convertible debentures issued in October 2002, an aggregate principal amount of $2,725,300 of convertible debentures issued in May 2003 and an aggregate principal amount of $2,470,000 of convertible debentures issued in September 2003. We expensed the debt discount as interest expense related to these debenture issues during the quarter ended December 31, 2003. During the year ended June 30, 2004 and prior to the conversions, we recognized approximately $300,000 of amortization expense related to the beneficial conversion feature and debt discount. During the year ended June 30, 2004, upon conversion, we expensed the entire balance of unamortized beneficial conversion feature and debt discount and charged approximately $5.1 million to interest expense, all of which is a non cash interest charge. In addition, we expensed all unamortized deferred financing costs related to these three debenture issues during the year ended June 30, 2004, in the amount of approximately $500,000 as interest expense. We will save approximately $623,000 in interest payments annually as a result of these conversions.
Presently, 28,000 shares of our Series B Preferred Stock, originally issued in a private financing in October 1999, remain outstanding. As of October 1, 2004, our right to redeem the outstanding 28,000 shares of Series B Preferred Stock is vested. Accordingly, we have the right to repurchase such shares at a redemption price equal to $25.00 per share, plus accrued and unpaid dividends. The holder, however, has the right to convert these shares of preferred stock into an aggregate of 500,000 shares of our common stock at a conversion rate of $1.40. In the event we elect to redeem these securities, the holder will be able to exercise its conversion right subsequent to the date that we issue a notice of redemption but prior to the deemed redemption date as would be set forth in such notice.
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We are the defendant in a third party complaint filed by Shore Venture Group, LLC in Federal District Court in Pennsylvania. The third party complaint was filed against us on May 7, 2001. Shore Venture is the defendant to an action commenced by Berwyn Capital. The third party complaint alleges a claim for breach of contract and seeks indemnification. A trial was held in October, 2002 and we are currently awaiting the verdict of the judge. Management believes that the claim will not have a material adverse impact on our financial condition, results of operations or cash flows.
We have also been advised of a claim by Shore Venture Group concerning additional shares of the common stock of our subsidiary, Authentidate, Inc. and one of our patent applications. We are continuing to conduct settlement negotiations with Shore Venture in an effort to resolve all claims between the parties. If the settlement results in our purchase of Shore Venture’s interest in Authentidate in excess of the then fair value of the Authentidate shares, such excess may be recorded as a charge to operations. Based on the settlement negotiations held between the parties to date, management believes that the resolution of all of our claims with Shore Venture will not have a materially adverse effect on our financial condition.
As we previously announced, effective November 15, 2004, John T. Botti no longer serves as our President and Chief Executive Officer. In connection with an employment agreement we entered into with Mr. Botti, effective July 1, 2003, we are obligated to pay Mr. Botti certain severance benefits (unless he is terminated for cause or resigns for other than “good reason”), including (a) all compensation accrued but not paid as of the termination date; (b) the greater of (i) his base salary to the termination date or (ii) a severance payment equal twenty-four months of his base salary, including any regularly scheduled increases in the base salary; (c) continued participation in our benefit plans; (d) accelerated vesting of all options granted to him; and (e) continuation of the exercise period in which he may exercise such options up to the duration of the original term of the option. Further, as reported on our Current Report on Form 8-K for December 7, 2004, John T. Botti informed the Board of Directors that he will retire from his position as Chairman of the Board at our annual meeting of stockholders, which was held on January 20, 2005. On February 7, 2005, we entered into an Agreement and Release (the “Agreement”) with Mr. Botti. Pursuant to the Agreement, we will pay him the severance payments as described above and agreed to retain Mr. Botti to provide consulting services to us for a period of one year. Under this consulting arrangement and in accordance with the terms of a separate consulting agreement, we agreed to pay Mr. Botti a monthly retainer of $10,000 in consideration of his provision of such services as may be requested by our Chief Executive Officer. The foregoing description of the Agreement and consulting agreement is qualified in its entirety by reference to the provisions of the Agreement and consulting agreement attached as Exhibits 10.2 and 10.3, respectively, to this Quarterly Report on Form 10-Q. The severance benefits have been accrued and are expected to be paid over the next two years.
In addition, as we previously announced on our Current Report on Form 8-K for December 20, 2004, effective December 31, 2004, Mr. Peter Smith is no longer serving as our Executive Vice President – Chief Operating Officer. In connection with our employment arrangement with Mr. Smith, we are obligated to pay him a severance benefit of up to twelve months of his base salary unless he is terminated for cause. On February 8, 2005 we entered into an Agreement and Release with Mr. Smith in order to more specifically describe our severance obligations. Pursuant to this agreement, we will pay Mr. Smith a severance payment equal to his base salary for a period of up to twelve months. If Mr. Smith commences new full-time employment on or before June 30, 2005, our severance obligation will expire on June 30, 2005. If he commences full-time employment thereafter, our severance obligation will cease on the date he commences such new employment. However, our obligation will expire on December 31, 2005 in the event Mr. Smith does not secure new full-time employment prior to such date. The benefits have been accrued for in the current period and are expected to be paid over the next six to twelve months. The foregoing description of this severance agreement is qualified in its entirety by reference to the provisions of the severance agreement attached as Exhibit 10.4 to this Quarterly Report on Form 10-Q.
Contractual Commitments
Following is a summary of the contractual commitments associated with our debt and lease obligations, as well as our accrued severance as of December 31, 2004:
| | | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years | |
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| Long term debt obligations | | $ | 108,000 | | $ | 108,000 | | | — | | | — | | | — | |
| Operating leases | | | 839,206 | | | 266,499 | | | 572,707 | | | — | | | — | |
| Capital leases | | | 59,310 | | | 43,233 | | | 16,077 | | | — | | | — | |
| Accrued severance | | | 1,221,114 | | | 724,189 | | | 496,925 | | | — | | | — | |
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| Total | | $ | 2,227,630 | | $ | 1,141,921 | | $ | 1,085,709 | | $ | 0 | | $ | 0 | |
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We invested $750,000 in an unaffiliated third party, Health Fusion, Inc. in connection with a strategic relationship we established with this company. We will invest an additional $750,000 in Health Fusion, contingent on Health Fusion achieving certain financial and other performance objectives six months from the closing date. This investment occurred on November 23, 2004.
On December 6, 2004, we assumed certain assets and liabilities of Cryptcom Securities Inc. for a purchase price of $125,000. We will be obligated to pay an additional $425,000 to former shareholders of Cryptcom Securities Inc. in the event our operation of the acquired assets generate certain financial measures by December 31, 2006. Additionally, we will be required to pay an “earn out” equal to a percentage of net income based on the performance of the Division commencing on the earlier of December 6, 2007 or the fiscal year immediately following the fiscal year during which the additional purchase price (referenced above), has been earned, and following for a term of five years from either date.
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Off-Balance Sheet Arrangements
We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating parts of our business that are not consolidated into our financial statements. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of our capital resources. We have entered into various agreements by which we may be obligated to indemnify the other party with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business under which we customarily agree to hold the indemnified party harmless against losses arising from a breach of representations related to such matters as intellectual property rights. Payments by us under such indemnification clauses are generally conditioned on the other party making a claim. Such claims are generally subject to challenge by us and to dispute resolution procedures specified in the particular contract. Further, our obligations under these arrangements may be limited in terms of time and/or amount and, in some instances, we may have recourse against third parties for certain payments made by us. It is not possible to predict the maximum potential amount of future payments under these indemnification agreements due to the conditional nature of our obligations and the unique facts of each particular agreement. Historically, we have not made any payments under these agreements that have been material individually or in the aggregate. As of December 31, 2004, we were not aware of any obligations under such indemnification agreements that would require material payments.
Effects of Inflation and Changing Prices
The impact of general inflation on our operations has not been significant to date and we believe inflation will continue to have an insignificant impact on us. However, price deflation in the major categories of components we purchase for DocStar has been substantial and is anticipated to continue through fiscal 2005. Typically, new components such as new generations of microprocessors and new optical disk drive technologies etc. are introduced at premium prices, by its vendors. During this period, we earn lower margins on our products. As the life cycle progresses competitive pressures could force vendor prices down and thus improve our profit margins. We do not believe that competitive pressures will require us to lower our DocStar selling price. Because much of DJS's business is service-related, price deflation has less of an impact on DJS's profits. We do not believe that the impact of inflation will have a significant impact on our Authentidate business lines.
Present Accounting Standards Not Yet Adopted
In November 2004, the Financial Accounting Standards Board (FASB) issued FAS No. 151, Inventory Costs–an amendment of ARB No. 43, Chapter 4. This Statement revises the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. This standard becomes effective for inventory costs incurred during fiscal years beginning on or after June 15, 2005. We do not expect the adoption of FAS No. 151 to have a material effect on our financial statements.
In December 2004, the FASB issued FAS No. 153, Exchanges of Nonmonetary Assets – an amendment of APB Opinion No. 29 Accounting for Nonmonetary transactions. This Statement revises Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. The provisions of this Statement shall be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not expect the adoption of FAS No. 151 to have a material effect on our financial statements.
In December 2004, the FASB revised FAS No. 123 and issued FAS No. 123R, Share Based Payment. The new statement requires companies to measure and recognize compensation expense associated with share-based payments to employees and directors to be recognized in the financial statements based on their fair values. Stock based payments include employee and director stock option grants. We grant options to purchase common stock to our employees under stock option plans at prices equal to the value of the stock the date the options were granted. We currently account for the options to purchase shares of common stock issued to our employees under the recognition and measurement principles of APB 25, and related interpretations using the fair value method. Accordingly, no compensation expense has been recognized for the options in our consolidated statements of operations. Upon the adoption of SFAS 123R, we will be required to apply the provisions of the statement prospectively for any newly issued, modified or settled award after the date of initial adoption. This Statement is effective for all interim or annual periods beginning after June 15, 2005. We have not yet adopted this pronouncement and are currently evaluating the expected impact that the adoption of SFAS 123R will have on our consolidated financial position, results of operations and cash flows, which is expected to be material.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
We have approximately $66 million invested in high quality, short term investments as of December 31, 2004. We do not believe that any of our financial instruments have significant risk associated with market sensitivity. We are not exposed to significant financial market risks from changes in foreign currency exchange rates and are only minimally impacted by changes in interest rates. However, in the future, we may enter into transactions denominated in non-U.S. currencies or increase the level of our borrowings, which could increase our exposure to these market risks. We have not used, and currently do not contemplate using, any derivative financial instruments.
Interest Rate Risk
At any time, fluctuations in interest rates could affect interest earnings on our cash and cash equivalents. We believe that the effect, if any, of reasonably possible near term changes in interest rates on our financial position, results of operations, and cash flows would not be material. Currently, we do not hedge these interest rate exposures. The primary objective of our investment activities is to preserve capital. We have not used derivative financial instruments in our investment portfolio.
At December 31, 2004, our unrestricted cash and cash equivalents totaled $67,527,016, most of which was invested in asset backed short term investments and money market accounts. The remainder of our cash was in non-interest bearing checking accounts used to pay operating expenses.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, under the supervision and with the participation of our chief executive officer and chief financial officer, conducted an evaluation of our “disclosure controls and procedures” (as defined in Securities Exchange Act of 1934 (the “Exchange Act”) Rules 13a-14(c)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on their evaluation, the chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are effective to ensure that all material information required to be filed in this Quarterly Report on Form 10-Q has been made known to them in a timely fashion.
Changes in Internal Controls Over Financial Reporting
We are currently undergoing a comprehensive effort in preparation for compliance with Section 404 of the Sarbanes-Oxley Act of 2002. This effort includes the documentation, testing and review of our internal controls under the direction of senior management. During the course of these activities, senior management has not identified any weaknesses that it believes are material, but management has identified certain aspects of its internal control over financial reporting that can be improved. As a result, we have made enhancements to our internal control over financial reporting and will continue to do so if appropriate. These enhancements include further formalization of our policies and procedures, improving the segregation of duties, controls over the authorization of transactions and the addition of an internal auditor and other personnel. No changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended December 31, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.
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Part II Other Information
Item 1. Legal Proceedings:
As described in our report on Form 10-K for the fiscal year ended June 30, 2004, we are involved in the following pending and threatened legal proceedings. We are the defendant in a third party complaint filed by Shore Venture Group, LLC (Shore Venture) in Federal District Court in Pennsylvania. The third party complaint was filed against us on May 7, 2001. Shore Venture is the defendant to an action commenced by Berwyn Capital. The third party complaint alleges a claim for breach of contract and seeks indemnification. A trial was held in October, 2002 and we are currently awaiting the verdict of the judge. Management believes that the claim will not have a material adverse impact on our financial condition, results of operations or cash flows.
We have also been advised of a claim by Shore Venture concerning additional shares of the common stock of our subsidiary, Authentidate, Inc. and one of our patent applications.We have been conducting settlement negotiations with Shore Venture in an effort to resolve all claims between the parties and believed we had reached an agreement in principle. However, we have been unable to agree with Shore Venture on the specific terms of a settlement agreement and negotiations have not yet resulted in a final agreement. If we reach a settlement with Shore Venture that results in our purchase of Shore Venture’s interest in Authentidate in excess of the then fair value of the Authentidate shares, such excess may be recorded as a charge to operations. Based on the settlement negotiations held between the parties to date, management believes that the resolution of all of Shore Venture’s claims will not have a material adverse effect on the Company’s financial condition.
We are engaged in no other litigation which would be anticipated to have a material adverse effect on our financial condition, results of operations or cash flows.
Item 2. Changes in Securities
(a) Sales of Unregistered Securities.
As previously reported on our Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, effective October 4, 2004 we issued an aggregate of 250,000 common stock purchase warrants to a consultant in partial consideration for services to be provided by such person under a consulting agreement entered into with such consultant as of such date. The warrants are exercisable as follows:
| Warrant No. | | Number of Shares | | Exercise Price | | Exercisable as of | | Expiration Date | |
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| 1 | | 100,000 | | $15.00 | | October 4, 2004 | | October 4, 2008 | |
| 2 | | 30,000 | | $16.00 | | November 4, 2004 | | October 4, 2008 | |
| 3 | | 30,000 | | $17.00 | | December 4, 2004 | | October 4, 2008 | |
| 4 | | 30,000 | | $18.00 | | January 4, 2005 | | October 4, 2008 | |
| 5 | | 30,000 | | $19.00 | | February 4, 2005 | | October 4, 2008 | |
| 6 | | 30,000 | | $20.00 | | March 4, 2005 | | October 4, 2008 | |
The holder was also granted demand and piggyback registration rights for the shares of common stock issuable upon exercise of the warrants. The issuance of these warrants was exempt from registration under the Securities Act of 1933, as amended, under Section 4(2) thereof.
(b) Not applicable.
(c) Repurchase of Equity Securities.
We did not repurchase any of our equity securities during the fiscal quarter ended December 31, 2004.
Item 3. Defaults Upon Senior Securities:
None
Item 4. Submission of Matters to a Vote of Securities Holders:
None
Item 5. Other Information:
On October 27, 2004, we issued a press release announcing that Mr. Surendra Pai has been named as our President and Chief Executive Officer, effective November 15, 2004. Effective October 27, 2004, Mr. Pai was also appointed to our Board of Directors. We entered into a two-year employment agreement with Mr. Pai, dated October 27, 2004 and effective November 15, 2004, pursuant to which Mr. Pai will serve as our Chief Executive Officer and President. The terms and conditions of Mr. Pai’s employment agreement were disclosed in our Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 1, 2004.
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As reported in our Current Report on Form 8-K for October 27, 2004, our Board of Directors also determined to change our fiscal year from December 31 back to June 30 commencing with the fiscal year ending June 30, 2005. In light of the fact that we have historically reported our financial statements on the basis of a June 30 fiscal year and filed an Annual Report on Form 10-K for the fiscal year ended June 30, 2004 on September 13, 2004, we will continue to file all periodic reports under the Securities and Exchange Act of 1934, as amended, on the basis of a June 30 fiscal year end.
As we previously announced, effective November 15, 2004, John T. Botti no longer serves as our President and Chief Executive Officer. In connection with an employment agreement we entered into with Mr. Botti, effective July 1, 2003, we are obligated to pay Mr. Botti certain severance benefits (unless he is terminated for cause or resigns for other than “good reason”), including (a) all compensation accrued but not paid as of the termination date; (b) the greater of (i) his base salary to the termination date or (ii) a severance payment equal twenty-four months of his base salary, including any regularly scheduled increases in the base salary; (c) continued participation in our benefit plans; (d) accelerated vesting of all options granted to him and (e) continuation of the exercise period in which he may exercise such options up to the duration of the original term of the options. Further, as reported on our Current Report on Form 8-K for December 7, 2004, John T. Botti informed the Board of Directors that he will retire from his position as Chairman of the Board at our annual meeting of stockholders, which was held on January 20, 2005. On February 7, 2005, we entered into an Agreement and Release (the “Agreement”) with Mr. Botti. Pursuant to the Agreement, we will pay him the severance payments as described above and agreed to retain Mr. Botti to provide consulting services to us for a period of one year. Under this consulting arrangement and in accordance with the terms of a separate consulting agreement, we agreed to pay Mr. Botti a monthly retainer of $10,000 in consideration of his provision of such services as may be requested by our Chief Executive Officer. The foregoing description of the Agreement and consulting agreement is qualified in its entirety by reference to the provisions of the Agreement and consulting agreement attached as Exhibits 10.2 and 10.3, respectively, to this Quarterly Report on Form 10-Q.
On December 13, 2004, we issued a press release announcing that the Nominating and Corporate Governance Committee of our Board of Directors nominated Mr. Roger O. Goldman and Mr. Ranjit C. Singh to stand for election to the Board at our annual meeting of stockholders, which was held on January 20th, 2005. As announced in our Current Report on Form 8-K filed on January 28th , 2005, Messrs. Goldman and Singh were elected to our Board of Directors along with the six additional nominees which our shareholders were asked to approve.
In addition, as we previously announced on our Current Report on Form 8-K for December 20, 2004, effective December 31, 2004, Mr. Peter Smith is no longer serving as our Executive Vice President – Chief Operating Officer. In connection with our employment arrangement with Mr. Smith, we are obligated to pay him a severance benefit of up to twelve months of his base salary unless he is terminated for cause. On February 8, 2005 we entered into an Agreement and Release with Mr. Smith in order to more specifically describe our severance obligations. Pursuant to this agreement, we will pay Mr. Smith a severance payment equal to his base salary for a period of up to twelve months. If Mr. Smith commences new full-time employment on or before June 30, 2005, our severance obligation will expire on June 30, 2005. If he commences full-time employment thereafter, our severance obligation will cease on the date he commences such new employment. However, our obligation will expire on December 31, 2005 in the event Mr. Smith does not secure new full-time employment prior to such date. The foregoing description of this severance agreement is qualified in its entirety by reference to the provisions of the severance agreement attached as Exhibit 10.4 to this Quarterly Report on Form 10-Q.
Pursuant to Section 10A(i)(2) of the Securities Exchange Act of 1934, we are responsible for listing the non-audit services approved in the first quarter of 2004 by our Audit Committee to be performed by PricewaterhouseCoopers LLP, our external auditor. Each of the permitted non-audit services has been pre-approved by the Audit Committee or the Audit Committee's Chairman pursuant to delegated authority by the Audit Committee. During the first quarter of 2004, the Audit Committee pre-approved the following non-audit services anticipated to be performed by PricewaterhouseCoopers LLP: tax consulting in connection with certain corporate initiatives, including structuring a joint venture and in determining state and local tax treatments for revenues derived from electronic postmark and CareCert transactions.
Item 6. Exhibits:
(a) Exhibits
The exhibits designated with an asterisk (*) are filed herewith. All other exhibits have been previously filed with the Commission and, pursuant 17 C.F.R. § 230.411, are incorporated by reference to the document referenced in brackets following the description of such exhibits.
| Exhibit No. | | | |
| | | | |
| 10.1 | | Employment Agreement between Authentidate Holding Corp. and Surendra Pai (Filed as Exhibit 10.1 to Current Report on Form 8-K dated October 27, 2004) | |
| | | | |
| *10.2 | | Agreement and Release between Authentidate Holding Corp. and John T. Botti, dated February 7, 2005. | |
| | | | |
| *10.3 | | Consulting Agreement between Authentidate Holding Corp. and John T. Botti dated as of February 1, 2005 | |
| | | | |
| *10.4 | | Agreement and Release between Authentidate Holding Corp. and Peter R. Smith, dated February 8, 2005 | |
| | | | |
| *31.1 | | Certification of Chief Executive Officer | |
| | | | |
| *31.2 | | Certification of Chief Financial Officer | |
| | | | |
| *32.1 | | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
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SAFE HARBOR STATEMENT
Certain statements in this Form 10-Q, including information set forth under Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the Act). We desire to avail ourself of certain “safe harbor” provisions of the Act and is therefore including this special note to enable us to do so. Forward-looking statements in this Form 10-Q or hereafter included in other publicly available documents filed with the Securities and Exchange Commission, reports to our stockholders and other publicly available statements issued or released by us involving known and unknown risks, uncertainties and other factors which could cause our actual results, performance (financial or operating) or achievements to differ from the future results, performance (financial or operating) or achievements expressed or implied by such forward-looking statements. Such future results are based upon our management’s best estimates based upon current conditions and the most recent results of operations. These risks include, but are not limited to risks associated with the market acceptance of the DocStar, Authentidate and related product lines, competition, pricing, technological changes, technological implementation of the Authentidate business plan and other risks as discussed in our filings with the Securities and Exchange Commission, in particular our Annual Report on Form 10-K for the year ended June 30, 2004 and registration statements we have filed and which have been declared effective by the Securities and Exchange Commission pursuant to the Securities Act of 1933, as amended, all of which risk factors could adversely affect our business and the accuracy of the forward-looking statements contained herein.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | AUTHENTIDATE HOLDING CORP. |
| | |
| February 9, 2005 | /s/ Surendra Pai |
| DATE | SURENDRA PAI |
| | PRESIDENT & CHIEF EXECUTIVE OFFICER |
| | |
| | /s/ Dennis H. Bunt |
| | DENNIS H. BUNT |
| | CHIEF FINANCIAL OFFICER |
