The Company realized a consolidated net loss of $2,960,055 ($.09 per share) and $10,786,260 ($.32 per share) for the three and nine months ended March 31, 2005 compared to a consolidated net loss of $2,565,345 ($.09 per share) and $12,089,053 ($.49 per share) for the three and nine months ended March 31, 2004.
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 Security Software Solutions Segment. Our Security Software Solutions Segment has incurred significant sales, marketing, development and general and administrative expenses this year and last in an effort to complete the product development efforts, to generate sales, and to develop a market for its products. Additionally, the Company incurred significant consulting costs related to the documentation and testing of the internal control environment as required by the Sarbanes-Oxley Act of 2002.
The consolidated net loss for the three months ended March 31, 2005 is approximately $395,000 more than it was for the same period last year. There was an increase in the loss in the Security Software Solutions Segment of approximately $521,000 comparing current year third quarter to prior year third quarter. The increase was primarily due to increased personnel costs of approximately $600,000 and consultant costs of approximately $230,000 in the third quarter, offset against insignificant decreases in various other categories. The Document Management Solutions Segment profit increased approximately $26,000, while the Systems Integration Segment profit decreased approximately $67,000 for the three months ended March 31, 2005, compared to the three months ended March 31, 2004.
The consolidated net loss for the nine months ended March 31, 2005 is approximately $1.3 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 13) during the nine months ended March 31, 2004 (corporate expenses); the Company had no such expense during the same period in fiscal year 2005. Additionally, there was an increase in the loss in the Security Software Solutions Segment of approximately $3.1 million comparing current year to the corresponding period for the prior year. The increase was primarily due to increased personnel costs ($2.0 million) and consulting expense ($1.7 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 in the nine months ended March 31, 2005, while incurring none in the corresponding period for the prior year. The Document Management Solutions Segment profit increased approximately $117,000 due to higher sales than in the corresponding period for the prior year, while the Systems Integration Segment profit decreased approximately $67,000 for the nine months ended March 31, 2005, compared to the nine months ended March 31, 2004 due to a decrease in sales.
Consolidated sales were $4,359,981 and $12,784,106 for the three and nine months ended March 31, 2005, respectively; consolidated sales were $6,790,398 and $14,090,689 for the three and nine months ended March 31, 2004, respectively. The decrease versus the prior year for both periods is primarily a result of a decrease in the Systems Integration Segment of $3.2 million and $3.4 million, mainly as a result of a one-time large sale of $3.0 million in 2004, offset by an increase in Security Software Solutions Segment sales of approximately $488,000 and $1.6 million comparing current year to prior year. Sales for the Document Management Solutions Segment increased approximately $252,000 and $548,000 for the three and nine months ended March 31, 2005, respectively, compared to the corresponding period for the prior year.
Consolidated gross profit for the three months ended March 31, 2005 and 2004 was $2,059,087 and $1,695,035, respectively, while the consolidated gross profit for the nine months ended March 31, 2005 and 2004 was $6,030,298 and $4,547,570, respectively. The consolidated gross profit margin was 47.2% and 25.0% for the three months ended March 31, 2005 and 2004; the consolidated gross profit margin was 47.1% and 32.3% for the nine months ended March 31, 2005 and 2004, 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 gross profit in the Security Software Solutions Segment with a slight increase to the Document Management Solutions Segment.
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 $4,633,871 and $3,783,166 for the three months ended March 31, 2005 and 2004, and $15,805,309 and $9,727,163 for the nine months ended March 31, 2005 and 2004. The largest increase was in the Security Software Solutions Segment which incurred increased personnel costs ($.6 million and $1.7 million for the three and nine months ended March 31, 2005, respectively), along with additional consulting costs ($.2 million and $1.7 million for the three and nine months ended March 31, 2005). The Corporate Division also had new severance costs of $1.1 million during the nine months ended March 31, 2005.
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As a percentage of net sales, S,G&A costs were 106.3% and 123.6 % for the three and nine months ended March 31, 2005, respectively, and 55.7% and 69.0% for the three and nine months ended March 31, 2004. This percentage increase is primarily due to the increase in SG&A expenses for the Security Software Solutions Segment as discussed above.
Interest expense was $4,326 and $13,139 for the three and nine months ended March 31, 2005 and 2004, respectively, compared to $42,134 and $6,224,294 for the three and nine months ended March 31, 2004, 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 and due to interest expense from the building mortgage which was paid off in the third quarter of fiscal 2004.
Product development expenses, excluding capitalized costs, primarily relate to software development for the Security Software Solutions Segment. For the three month period March 31, 2005, these costs increased to $855,049, as compared to $679,027 the same period last year; for the nine month period ended March 31, 2005, these costs were $2,156,396 compared to $1,759,054 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 $133,498 and $294,949 for the three and nine months ended March 31, 2005. Amortization expense of software development costs amounted to $135,610 and $170,122 for the three and nine months ended March 31, 2004.
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 March 31, 2005 totaled $78,000, which relates to a note payable to the Empire State Development Corporation for the repayment of a grant, as more fully described below
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 $420,696 at March 31, 2005.
Property, plant and equipment expenditures totaled $865,207 and capitalized software development expenditures totaled $434,209 for the nine months ended March 31, 2005, 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 did 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 March 31, 2005 the amount due ESDC was $78,000 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 March 31, 2005 was $27,800,076 and total assets were $87,630,139 compared to cash and cash equivalents of $42,689,823 and total assets of $94,236,876 at June 30, 2004. Our unrestricted cash balance at March 31, 2004 was $75,369,779 and our total assets as of such date were $98,856,573. We invested our excess cash in marketable securities, which totaled $31,300,000 at June 30, 2004 and $37,750,000 at March 31, 2005. The decrease from the nine months ended March 31, 2004 to the nine months ended March 31, 2005 is due primarily to cash used in operating activities. We used $8,049,839 of cash in operating activities during the nine months ended March 31, 2005. This compares to cash used in operating activities of $6,233,658 for the same period last year. Total cash flow used by all activities was $14,889,747 for the nine months ended March 31, 2005, compared to net cash provided of $71,909,333 for the nine months ended March 31, 2004. This decrease in cash and cash equivalents during the nine months ended March 31, 2005 is mainly due to the Company’s operating activities ($8,049,839), primarily the net loss, which was $10,786,260. This was coupled with investing outflows relating to the purchase of marketable securities ($6,450,000), property, plant and equipment ($865,207), software development costs ($434,209), other intangible assets ($422,219), and an investment ($750,000), offset by inflow of cash off restriction $223,810. 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 nine months ended March 31, 2004 is mainly due to the net proceeds of $69,561,882 derived from the sale of common stock, the sale of convertible debentures of $2,369,622, and $8,334,321 resulting from the exercise of stock options and warrants, offset by cash used in operations totaling $6,233,658 and principal payments on long-term debt $1,486,700.
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, cash equivalents and marketable securities 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. |
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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 there under. 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 were 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.
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 there under. 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 are applying the proceeds to strengthen our balance sheet, develop a back-up data center for Authentidate Inc. 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 there under. 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.
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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.
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 are also the defendant in a claim filed against by Shore Venture Group in the federal District Court for the District of New Jersey, under the caption Shore Venture Group, LLC, et al v. Authentidate Holding Corp., Authentidate, Inc. and John T. Botti. This complaint was filed on March 2, 2005. The plaintiffs seek additional shares of the common stock of our subsidiary, Authentidate, Inc. and rights under one of our patent applications. We had conducted extensive settlement negotiations with Shore Venture in an effort to resolve all claims between the parties. However, negotiations were unable to result in a mutually agreeable settlement. We are currently preparing an answer to the complaint. 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 addition, Mr. Botti subsequently retired from his position as Chairman of the Board. 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. On February 7, 2005, we entered into an Agreement and Release with Mr. Botti. Pursuant to this agreement, we will pay Mr. Botti the severance payments as described above and agreed to retain him 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 severance benefits have been accrued and are expected to be paid over the next two years.
In addition, as we previously announced effective December 31, 2004, Mr. Peter Smith no longer serves 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 second quarter and are expected to be paid over the next three to nine months.
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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., a privately-held technology consulting company, 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 generates 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 this division, commencing on the earlier of December 6, 2007 or the fiscal year immediately following the fiscal year during which the additional purchase price, $425,000, has been earned, and following for a term of five years from either date.
As previously reported, on March 23, 2005 we entered into a new employment agreement with Jan C. E. Wendenburg, who currently serves as the Chief Executive Officer of our German subsidiary, Authentidate International, A.G. The agreement, which is effective as of March 15, 2005 and expires on March 31, 2007, sets forth the terms and conditions of Mr. Wendenburg’s continued employment as the Chief Executive Officer of Authentidate International. Under the agreement, Mr. Wendenburg’s annual base salary will be €200,000 for the period commencing April 1, 2005 through March 31, 2006 and will be €210,000 from April 1, 2007 until expiration. A description of the material terms and conditions of Mr. Wendenburg’s employment agreement were described in a Current Report on Form 8-K filed on March 25, 2005.
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 March 31, 2005:
| | | Total | | | Less than 1 year | | | 1-3 years | | | 3-5 years | | | More than 5 years | |
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| Long term debt obligations | $ | 78,000 | | $ | 78,000 | | | — | | | — | | | — | |
| Operating leases | | 712,960 | | | 502,504 | | | 210,456 | | | — | | | — | |
| Capital leases | | 43,998 | | | 34,072 | | | 9,926 | | | — | | | — | |
| Long term severance liabilities | | 991,371 | | | 647,500 | | | 343,871 | | | — | | | — | |
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| Total | $ | 1,826,329 | | $ | 1,262,076 | | $ | 564,253 | | $ | 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 this division commencing on the earlier of December 6, 2007 or the fiscal year immediately following the fiscal year during which the additional purchase price, $425,000, 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 March 31, 2005, 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 the Document Management Solutions Segment 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. Competitive pressures from an evolving document imaging industry have required us to adjust our marketing model for selling DocStar to accommodate a lower entry point. Because much of the Systems Integration Segment business is service-related, price deflation has less of an impact on the Systems Integration Segment profits. We do not believe that the impact of inflation will have a significant impact on our Security Software Solutions Segment 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 Non-monetary Assets—an amendment of APB Opinion No. 29 Accounting for Non-monetary transactions. This Statement revises Opinion 29 to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. The provisions of this Statement shall be effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not expect the adoption of FAS No. 153 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 FAS 123R, we will incur additional expenses related to unvested option grants and newly awarded grants as of and after the effective date. 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 FAS 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 $62 million invested in high quality, short term investments as of March 31, 2005. 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 marketable securities. 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 March 31, 2005, our unrestricted cash and marketable securities totaled $65,550,076, most of which was invested in asset backed short term investments, commercial paper, 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 previously reported, on April 15, 2005, our Chief Financial Officer advised certain members of our Board of Directors of the existence of corporate governance issues, which he believes if not corrected, may lead to significant problems in the future. In response to the letter of the Chief Financial Officer, and to assist in the determination of whether the issues raised warrant any changes to our internal controls and/or Corporate Governance Principles, our Audit Committee engaged the services of a special counsel to review the letter and report its findings to the Audit Committee. This investigation is currently in progress. We do not believe that the issues raised by the Chief Financial Officer will have a material impact on any of our preceding financial reports.
As previously reported and in connection with the foregoing, 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 March 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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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.
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 are the defendant in a case filed by Shore Venture Group, LLC in the United States District Court for the District of New Jersey, under the caption Shore Venture Group, LLC, et al v. Authentidate Holding Corp., Authentidate, Inc. and John T. Botti. This complaint was filed on March 2, 2005, and an amended complaint was filed on or about April 26, 2005. The plaintiffs in this case seek additional shares of the common stock of our subsidiary, Authentidate, Inc., the right to exchange its stock in Authentidate, Inc., for publicly traded stock and securities in us, rights under one of our patent applications and damages in connection with an alleged copyright infringement. Prior to the commencement of this case, we had conducted extensive settlement negotiations with Shore Venture in an effort to resolve all claims between the parties. However, negotiations did not result in a mutually agreeable settlement. The lawsuit requests damages, injunctive relief, costs and attorneys’ fees. We intend to defend the action vigorously. Based on the facts of which we are currently aware, management believes that the resolution of all of our claims with Shore Venture will not have a materially adverse effect on our financial condition. However, no assurances can be given that such belief will ultimately prove to be accurate or that other facts adverse to our position currently not known to management will not be uncovered, in which case the ultimate resolution of this claim could potentially have a material adverse effect on our 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. |
| | None. |
| | |
| (b) | Not applicable. |
| | |
| (c) | Repurchase of Equity Securities. |
We did not repurchase any of our equity securities during the fiscal quarter ended March 31, 2005.
| Item 3 | Defaults Upon Senior Securities: |
| | |
| | None. |
| Item 4 | Submission of Matters to a Vote of Securities Holders: |
We held our Annual Meeting of shareholders on January 20, 2005. As of the record date of December 13, 2004, there were 33,826,621 shares outstanding and eligible to vote at the Annual Meeting. At the Annual Meeting, shareholders were requested to vote on the election of the following eight directors, each of whom was elected by the shareholders as follows:
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| Name of Nominee | | Votes Cast In Favor | | Votes Withheld | | % In Favor | |
| |
| |
| |
| |
| Surendra Pai | | 27,965,815 | | 956,585 | | 82.7% | |
| John J. Waters | | 27,514,260 | | 1,408,140 | | 81.3% | |
| J. Edward Sheridan | | 27,426,748 | | 1,495,652 | | 81.1% | |
| Charles J. Johnston | | 27,740,380 | | 1,182,020 | | 82.0% | |
| J. David Luce | | 27,494,603 | | 1,427,797 | | 81.3% | |
| F. Ross Johnson | | 27,440,335 | | 1,482,065 | | 81.1% | |
| Ranjit C. Singh | | 28,194,886 | | 727,514 | | 83.4% | |
| Roger O. Goldman | | 28,195,302 | | 727,098 | | 83.4% | |
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. On February 7, 2005, we entered into an Agreement and Release 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.
In addition, as we previously announced, effective December 31, 2004, Mr. Peter Smith no longer serves 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.
On April 13, 2005, we announced that we entered into an agreement with Liberty Healthcare Group Inc., a national medical products company for the use of a new authentication service to enable clients and other authorized parties to verify Doctor Orders that are received via fax. Authentidate’s service enables the faxed records to be verified online for compliance and audit purposes by utilizing the United States Postal Service Electronic Postmark Service (USPS® EPM®). It is anticipated that the Liberty implementation will utilize 1.5 to 2 million EPMs annually. A Doctor Order supports the medical need for issuance of supplies and services that are reimbursed under the Medicare Program.
As previously reported, on March 23, 2005 we entered into a new employment agreement with Jan C. E. Wendenburg, who currently serves as the Chief Executive Officer of our German subsidiary, Authentidate International, A.G. The agreement, which is effective as of March 15, 2005 and expires on March 31, 2007, sets forth the terms and conditions of Mr. Wendenburg’s continued employment as the Chief Executive Officer of Authentidate International. Under the agreement, Mr. Wendenburg’s annual base salary will be €200,000 for the period commencing April 1, 2005 through March 31, 2006 and will be €210,000 from April 1, 2006 until expiration. A description of the material terms and conditions of Mr. Wendenburg’s employment agreement were described in a Current Report on Form 8-K filed on March 25, 2005.
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Pursuant to Section 10A (i) (2) of the Securities Exchange Act of 1934, we are responsible for listing the non-audit services approved by our Audit Committee to be performed by our independent registered public accounting firm. During the first quarter of fiscal 2005, the Audit Committee pre-approved the following non-audit services 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, and revenue recognition consulting for the electronic postmark and CareCert transactions. 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. These services were performed prior to close of the second quarter of fiscal 2005. The Audit Committee has not authorized our independent registered public accounting firm to provide any additional non-audit services. As previously reported, subsequent to the end of our third quarter for our 2005 fiscal year, our Audit Committee dismissed PricewaterhouseCoopers, LLP as our independent registered public accounting firm and engaged Eisner LLP as our new independent registered public accounting firm.
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. | | Description | |
| | | | |
| 10.1 | | Agreement and Release between Authentidate Holding Corp. and John T. Botti dated February 7, 2005 (Filed as Exhibit 10.2 to our Quarterly Report on Form 10-Q for the quarter ended December 31, 2004). | |
| 10.2 | | Consulting Agreement between Authentidate Holding Corp. and John T. Botti dated as of February 1, 2005(Filed as Exhibit 10.3 to our Quarterly Report on Form 10-Q for the quarter ended December 31, 2004). | |
| 10.3 | | Agreement and Release between Authentidate Holding Corp. and Peter R. Smith, dated February 8, 2005 (Filed as Exhibit 10.4 to our Quarterly Report on Form 10-Q for the quarter ended December 31, 2004). | |
| 10.4 | | Employment Agreement between Authentidate Holding Corp., Authentidate International A.G. and Jan C. E. Wendenburg (Filed as Exhibit 10.1 to our Current Report on Form 8-K filed March 25 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 ourselves of certain “safe harbor” provisions of the Act and are 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. |
| | |
| May 16, 2005 | /s/ Surendra Pai |
| DATE |
|
| | SURENDRA PAI |
| | PRESIDENT & CHIEF EXECUTIVE OFFICER |
| | |
| | /s/ Dennis H. Bunt |
|
|
| | DENNIS H. BUNT |
| | CHIEF FINANCIAL OFFICER |
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