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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
COMMISSION FILE NUMBER 0-20270
SAFLINK CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 95-4346070
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11911 N.E. 1/st/ Street, Suite B-304, Bellevue, Washington 98005
(Address of principal executive offices and zip code)
(425) 278-1100
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
There were 4,502,387 shares of SAFLINK Corporation's common stock
outstanding as of November 19, 2001 after giving effect to the 7 to 1 reverse
stock split as of that date.
SAFLINK Corporation
FORM 10-Q
For the Quarter Ended September 30, 2001
INDEX
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
a. Condensed Consolidated Balance Sheets
as of September 30, 2001 and December 31, 2000................................. 1
b. Condensed Consolidated Statements of Operations
for the three and nine months ended September 30, 2001 and 2000................ 2
c. Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 2001 and 2000.......................... 3
d. Notes to Condensed Consolidated Financial Statements........................... 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................................... 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk................... 22
Part II. Other Information
Item 1. Legal Proceedings............................................................ 23
Item 2. Changes in Securities........................................................ 23
Item 3. Defaults Upon Senior Securities.............................................. 23
Item 4. Submission of Matters to a Vote of Security Holders.......................... 24
Item 6. Exhibits and Reports on Form 8-K............................................. 27
Signature...................................................................................... 28
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PART 1 - FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
SAFLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS September 30, December 31,
2001 2000
(In thousands)
Current assets:
Cash and cash equivalents $ 707 $ 1,108
Accounts receivable, net 64 153
Inventory 23 25
Investments 21 102
Prepaid expenses and other current assets 155 244
-------- --------
Total current assets 970 1,632
Furniture and equipment, net 405 869
Intangible assets, net 178 5,344
Other assets 231 152
-------- --------
$ 1,784 $ 7,997
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 1,108 $ 1,494
Accrued liabilities 479 693
Notes payable 1,135 2,437
Deferred revenue 153 286
-------- --------
Total current liabilities 2,875 4,910
Convertible long-term debt, net of discount 1,506 1,485
Warrants subject to registration 65 -
Stockholders' equity (deficit)
Preferred stock - -
Common stock 316 262
Common stock issuable in asset purchase - 3,228
Deferred stock-based compensation (47) (81)
Additional paid-in capital 69,391 56,865
Accumulated deficit (72,322) (58,672)
-------- --------
(2,662) 1,602
-------- --------
$ 1,784 $ 7,997
======== ========
See accompanying notes to condensed consolidated financial statements.
1
SAFLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except share and per share data)
Three months Ended Nine months ended
September 30, September 30,
-------------------------- --------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
Revenue:
Products and services:
Software $ 22 $ 168 $ 59 $ 637
Hardware 34 10 63 257
Services and other 30 99 258 262
----------- ----------- ----------- -----------
Total revenue 86 277 380 1,156
Cost of revenue:
Software 13 47 38 59
Hardware 26 8 55 207
Services and other 35 24 156 105
Amortization of intangibles 318 - 954 -
Impairment loss on intangible assets 2,811 - 2,811 -
----------- ----------- ----------- -----------
3,203 79 4,014 371
----------- ----------- ----------- -----------
Gross (deficit) profit (3,117) 198 (3,634) 785
Operating expenses:
Product development 474 1,125 2,239 3,193
Amortization of intangible assets 122 - 365 -
Sales and marketing 221 355 610 1,224
Restructuring and relocation - 16 873 216
Impairment loss on intangible assets 998 - 998 -
General and administrative 724 738 3,131 2,132
----------- ----------- ----------- -----------
Total operating expenses 2,539 2,234 8,216 6,765
----------- ----------- ----------- -----------
Loss from operations before interest and extraordinary (5,656) (2,036) (11,850) (5,980)
item
Other income (expense):
Interest and other income 13 - 29 74
Interest expense (35) (30) (704)
----------- ----------- ----------- -----------
Net other income (expense) (22) (30) (675) 74
Loss from operations before extraordinary item (5,678) (2,066) (12,525) (5,906)
Extraordinary Item
Gain from debt restructuring - - 360 -
----------- ----------- ----------- -----------
Net loss (5,678) (2,066) (12,165) (5,906)
Preferred stock dividend - (100) (1,485) (348)
----------- ----------- ----------- -----------
Net loss applicable to common stockholders $ (5,678) $ (2,166) $ (13,650) $ (6,254)
=========== =========== =========== ===========
Basic and diluted loss per share applicable to common
stockholders before extraordinary item $ (1.26) $ (0.73) $ (3.12) $ (2.21)
Extraordinary item - - 0.08 -
----------- ----------- ----------- -----------
Basic and diluted loss per share applicable to common
stockholders $ (1.26) $ (0.73) $ (3.04) $ (2.21)
=========== =========== =========== ===========
Weighted average number of basic and diluted common
shares 4,507,744 2,961,975 4,491,625 2,825,655
See accompanying notes to condensed consolidated financial statements.
2
SAFLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Nine months ended September 30,
2001 2000
--------- ---------
Cash flows from operating activities:
Net loss $(12,165) $ (5,906)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation 67 259
Depreciation and amortization 1,563 136
Impairment loss on intangible assets 3,809 -
Amortization of deferred financing costs 339 -
Beneficial conversion of bridge notes 232 -
Amortization of discount on note payable 21 -
Loss on disposal of fixed assets 387 -
Loss on sale of investments - 42
Changes in assets and liabilities:
Accounts receivable 89 (52)
Inventory 2 22
Prepaid expenses and other current assets 89 (251)
Other assets (79) (346)
Accounts payable (386) 827
Accrued liabilities (213) -
Deferred revenue (133) (127)
-------- --------
Net cash used in operating activities (6,378) (5,396)
Cash flows from investing activities:
Purchases of furniture and equipment (131) (341)
Proceeds from sale of investments 81 132
-------- --------
Net cash used in investing activities (50) (209)
Cash flows from financing activities:
Proceeds from issuance of bridge notes and warrants 854 -
Proceeds from issuance of common stock upon exercise of employee stock
options and investor warrants 156 1,029
Proceeds from issuance of Series E Convertible Preferred Stock 5,207 -
Repayment of bridge notes (190) -
-------- --------
Net cash provided by financing activities 6,027 1,029
-------- --------
Net decrease in cash and cash equivalents (401) (4,576)
Cash and cash equivalents at beginning of period 1,108 5,335
-------- --------
Cash and cash equivalents at end of period $ 707 $ 759
======== ========
Non cash financing and investing activities:
Preferred stock dividend $ 1,485 $ 348
Stock issued for services - 105
Conversion of Series A and Series D Preferred Stock to Common Stock - 65
Warrants issued for product received - 174
See accompanying notes to condensed consolidated financial statements.
3
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The accompanying consolidated financial statements are unaudited and
condensed and, therefore, do not contain certain information included in the
annual consolidated financial statements of SAFLINK Corporation and its wholly-
owned subsidiary, SAFLINK International, Inc., (the "Company" or "SAFLINK"). In
the opinion of management, all adjustments (consisting of normally recurring
items and others) it considers necessary for a fair presentation have been
included in the accompanying condensed consolidated financial statements.
The Company's condensed consolidated interim financial statements are not
necessarily indicative of results to be expected for a full fiscal year and
should be read in conjunction with its consolidated financial statements and the
notes thereto included in the Company's Annual Report on Form 10-K/A for the
fiscal year ended December 31, 2000, as filed with the Securities and Exchange
Commission (the "SEC") on June 22, 2001.
Certain items in the 2000 financial statements and the notes thereto have
been reclassified to conform to the 2001 presentation of such items. Certain
amounts presented in the interim financial statements for 2001 have been
reclassified.
2. Reverse Stock Split
At the Company's recent stockholders' meeting held on September 24, 2001,
the stockholders approved a reverse stock split of between seven-to-one and ten-
to-one with the exact ratio to be determined at the discretion of the Board of
Directors. The Board of Directors met on October 2, 2001 and determined the
ratio for the split to be seven-to-one. The effective date for the reverse stock
split is November 19, 2001. All stockholders of record as of that date will
receive one share of common stock for every seven shares owned of Company common
stock. Fractional interests will be rounded to the next highest share. All share
and per share amounts have been restated in all periods presented to reflect the
effects of the reverse split. In addition, the Company's stock ticker symbol
will be changed to SFLK effective November 19, 2001 as a result of the reverse
stock split.
3. Investments
At September 30, 2001, investments consisted of a $2,000 bank time
certificate of deposit and a $19,000 bank time certificate of deposit pledged to
secure a credit card issued to the Company. These investments are carried at
cost.
4. Note Receivable
The Company has made certain advances totaling approximately $65,000 to
Jotter Technologies, Inc., in return for an unsecured promissory note dated
August 16, 2001 which is included in other current assets. The Company acquired
the assets of Jotter Technologies, Inc. in December 2000. Certain members of the
board of directors of Jotter Technologies, Inc. are either an
4
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
officer or director of the Company. The note is payable in full including
accrued interest on February 12, 2002 and bears interest at 12% per year.
5. Restructuring
In conjunction with a corporate restructuring implemented in June 2001, the
Company initiated a staff reduction. The Company terminated a total of twelve
development staff and two sales staff, in addition to the Chief Executive and
Chief Financial Officers. As part of the staff reduction, the Company paid
approximately $344,000 under severance packages to certain employees.
Additionally, all terminated employees immediately vested in one-third of the
unvested options held by them on the date of their termination. Under their
severance agreements, the former Chief Executive Officer and former Chief
Financial Officer vested in all the remaining options granted to them. The
number of options that remain outstanding upon separation totaled approximately
195,834. The expiration dates of these and any other vested options held by
employees terminated pursuant to the restructuring were extended to June 6,
2002. The total number of options whose expiration dates were extended totaled
approximately 216,310. The Company also incurred approximately $150,000 in lease
termination related costs including the payment of a $100,000 termination fee
and expensed deferred rent related to the lease of their corporate headquarters.
In addition, the Company wrote off approximately $379,000 of certain leasehold
improvements and other furniture and equipment in conjunction with the
restructuring.
6. Impairment loss on intangible assets
During the quarter ended September 30, 2001, the Company performed an
impairment assessment of intangible assets recorded in connection with the
Jotter acquisition. The assessment was performed primarily due to the
fluctuations and declines in the Company's stock price, the continuous decline
in the technology sector and the belief that this trend may continue for an
indefinite period, and finally, a change in the strategic direction of the
Company that limits further integration and development of the Jotter technology
into the Company's current and anticipated product offerings due to current
resource limitations. As a result, present expectations related to the Jotter
technology indicate significant under performance as compared to original plans,
and estimated future cash flows related to this technology have been determined
to be negligible. The Company determined that the carrying value of the
intangible assets were not recoverable and recognized an impairment loss on
intangible assets during the quarter ended September 30, 2001 of approximately
$3.8 million relating to the remaining net carrying value of the intangible
assets acquired. The impairment loss on intangible assets is comprised of
approximately $2.8 million of developed product technology included under the
title of impairment loss on intangible assets in the cost of revenue section of
the accompanying statement of operations for the three and nine months ended
September 30, 2001 and approximately $535,000 of assembled workforce and
approximately $460,000 of sales channel customer relationships included under
the caption impairment loss on intangible assets in the operating expenses
section of the accompanying statement of operations for the three and nine
months ended September 30, 2001. Management determined the amount of the
impairment loss on intangible assets by comparing the carrying value of the
intangible assets to their fair value. Management determined the fair value of
the developed product technology and sales channel customer relationships
intangible assets based on the
5
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
discounted cash flow methodology, which is based upon converting expected future
cash flows to present value using a discount rate reflecting the Company's
average cost of funds. The assembled workforce intangible asset fair value was
determined using a replacement cost approach, which is based on the price a
company would pay to replace the workforce.
7. Commitments and Contingencies
On July 16, 2001 the Company entered into a lease agreement for office space
for its corporate headquarters and on August 6, moved its headquarters from
Redmond, Washington to Bellevue, Washington. The lease term is through March
2003 with payments of approximately $9,300 per month for 17 months beginning in
November 2001 and provides rent concessions for the first two and a half months
of the Company's occupancy.
8. Stockholders' Equity
On March 20, 2001, the Company issued 728,572 shares of Common Stock to
Jotter Technologies Inc. as partial consideration for the intellectual property
and fixed assets acquired from Jotter pursuant to the December 15, 2000 asset
purchase agreement between Jotter and the Company.
For the nine months ended September 30, 2001 the Company has issued 1,429
shares of Common Stock upon exercise of stock options exercised by certain
employees pursuant to provisions of the Company's 1992 Stock Incentive Plan. The
options had an exercise price of $9.38 per share, which equaled fair value of
the common stock on the dates of grant.
On April 10, 2001 the Company announced that Jotter Technologies Inc. will
convert its outstanding remaining balance on the $1.7 million note, plus accrued
interest of $33,635 into Company common stock at $7.00 per share. The note had
been issued to Jotter as partial consideration for the assets acquired by the
Company in December 2000. Upon conversion of the debt, Jotter will own 967,160
shares of the Company's common stock, representing approximately 21.5% of the
Company's currently outstanding common stock after the issuance of the new
shares. The shares issued to Jotter will be held in escrow on behalf of Jotter
and released in monthly distributions after Jotter satisfies certain Canadian
tax obligations related to the asset purchase. The shareholders approved the
conversion of the note at the annual shareholder's meeting on September 24,
2001. As a result of the agreement to convert the note into equity, the Company
has reflected the note as non-current in accordance with SFAS No. 6,
Classification of Short-Term Obligations Expected to Be Refinanced.
6
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Series E Convertible Preferred Stock
On May 21, 2001, the Company authorized the issuance of up to 40,000 shares
of its Series E Convertible preferred stock, $0.01 par value. The Series E
convertible preferred stock has a liquidation preference of $200 per share and
is convertible into common stock at $1.40 per share.
On June 5, 2001, the Company issued 40,000 shares of Series E convertible
preferred stock and common stock purchase warrants for an aggregate price of $8
million, including the conversion of certain bridge notes, in a private
placement to accredited investors (the "Financing"). The Series E convertible
preferred stock issued in this transaction is convertible into 5,714,309 shares
of Company common stock at any time until June 5, 2004. In addition, investors
received Series A warrants to purchase 5,714,309 shares of common stock at $1.75
per share exercisable until June 5, 2002, after which the exercise price will
increase to $3.50 per share and will be exercisable until June 5, 2006. Series B
warrants to purchase 639,376 shares of common stock at $1.75 per share until the
later of December 5, 2001 or 120 days after the effective date of the
registration of the common stock underlying such warrants, were issued to
investors purchasing more than $1 million of Series E convertible preferred
stock. After allocation of the proceeds to the warrants based upon the relative
fair values of the preferred stock and the warrants, the Company recorded a
beneficial conversion feature in the form of a dividend on the Series E
convertible preferred stock in the amount of $1,485,000. In accordance with EITF
98-5 and 00-27, the beneficial conversion feature was based on the intrinsic
value and calculated as the difference between the value allocated to the
preferred stock after the consideration of the warrants, and the fair value of
the common stock into which the preferred stock is convertible.
Debt holders representing $2.3 million in bridge notes and accrued interest
at the time of closing exercised their right to participate in the Financing.
RMS Limited Partnership agreed to extend its $1 million bridge note and accrued
interest for an additional 12 months and the Company agreed to apply 50% of any
proceeds received from the exercise of Series A and Series B warrants towards
principal and interest payments during the extension period. The remaining
$203,000 in outstanding bridge notes and accrued interest were repaid from the
proceeds of the Financing.
On July 27, 2001, the Company entered into a modification agreement (the
"Modification Agreement") with certain purchasers of the Series E Preferred
Stock and Series A and B warrants (the "warrants") in order to amend certain
terms of the Securities Purchase Agreement and the Registration Rights Agreement
entered into pursuant to the Financing. Under the Modification Agreement, the
parties agreed to amend, among other things, certain terms of the Certificate of
Designation, Preferences and Rights of the Series E Preferred Stock
("Certificate of Designation"), subject to stockholder approval, which approval
was obtained at the annual stockholders' meeting on September 24, 2001.
In particular, the Company entered into the Modification Agreement to
extend certain dates by which the Company had committed to meet obligations with
respect to the purchasers and to eliminate
7
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
those features of the Preferred Stock and Warrants that would prevent the
proceeds from the Financing to be treated as permanent equity for financial
accounting purposes. These revisions, among other things, modify the penalties
imposed upon the Company in the event the Company fails to register the common
stock underlying the Preferred Stock and Warrants, extend the deadline by which
the Company must register this common stock, and limit the existing rights of
the holders of the Preferred Stock and certain holders of the Warrants by
allowing a cash or stock penalty to be paid only in the event of certain types
of acquisitions. Certain provisions of the Modification Agreement became
effective immediately upon execution by two-thirds of the purchasers of the
Preferred Stock; other provisions, including any amendments to the Certificate
of Designation, became effective upon receipt of stockholder approval of the
Financing, the reverse stock split, and the amendment to the Certificate of
Designation at the Company's stockholder meeting. This approval was obtained on
September 24, 2001. As a result of the approval of the Modification Agreement,
the Financing has been recorded as equity in the accompanying balance sheet as
of September 30, 2001.
In connection with the financing, as modified, the Company agreed to seek
stockholder approval at its next annual stockholders meeting for (i) the
issuance of common stock representing 20% or more of the Company's outstanding
shares of common stock upon conversion of the Series E preferred stock and
warrants issued in the Financing, (ii) a new stock option plan, (iii) a reverse
split of its common stock, and (iv) the issuance of common stock to Jotter
Technologies, Inc. upon conversion of the remaining balance of the $1.7 million
note payable plus accrued interest issued to Jotter as partial consideration for
the intellectual property and fixed assets acquired from Jotter on December 15,
2000 and (v) amendment of the Certificate of Designation. These approvals were
obtained as of September 24, 2001.
Since the Company's stockholders approved the amendments to the Certificate
of Designation, Preferences and Rights of the Series E preferred stock at our
recent stockholders' meeting, the Company amended the terms of the Series E
preferred stock. The revised terms are described below.
Dividends and Voting Rights. The Series E preferred stock will not pay a
dividend and holders of the Series E preferred stock will not have any voting
rights other than the right to elect two members to our board of directors
nominated by Palo Alto Investors, a group of investors that purchased an
aggregate of 10,000 shares of Series E preferred stock, and certain protective
voting rights. For example, the Company may not, without first obtaining the
approval of two-thirds of the Series E Preferred Stock, modify the Certificate
of Designation of the Series E preferred stock, create any senior or parity
securities or change the rights, preferences or privileges of any of the
Company's capital stock so as to affect adversely the Series E preferred stock.
The Series E preferred stockholders have not, to date, nominated any members for
election to the board.
Conversion. The 40,000 shares of Series E preferred stock are convertible,
at the option of the holder, into shares of common stock at an initial
conversion price of $1.40 per share. As of June 5, 2001, and until June 5, 2004,
each share of Series E preferred stock is convertible into 143 shares of common
stock. Any shares of Series E preferred stock outstanding on June 5, 2004 shall
automatically be converted into common stock at the conversion price in effect
on that date, which price will take into account any adjustments in the
conversion price. The Series E preferred stock contains (i) anti-
8
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
dilution provisions with respect to future issuances of our equity securities
and (ii) adjustment provisions upon the occurrence of stock splits, stock
dividends, combinations, reclassifications or similar events of our capital
stock.
Since the Company received the requisite stockholder approval at our recent
stockholders meeting, the Series E preferred stock and Series A and Series B
warrants may now be exercised or converted into more than 19.99% of the common
stock outstanding on June 4, 2001. However, SAC Capital Associates, LLC and SDS
Merchant Fund, LP shall not be issued common stock upon conversion of their
respective Series E preferred stock, if upon that conversion those purchasers
would beneficially own greater than 4.9% of our issued and outstanding shares of
common stock.
Penalties Applicable for Conversion Failure. If a holder of the Series E
preferred stock submits his, her or its shares for conversion and we fail to
convert those shares for any reason, then we will have to pay to the holder
hereof a cash amount equal to $2.00 for each share of Series E preferred stock
we have not converted for each day the failure exists. As a result, assuming all
of the shares of Series E preferred stock outstanding as of June 5, 2001 are
presented to the Company for conversion, and the Company fails to convert those
shares, the Company could have to pay up to $80,000 per day. In addition, if a
holder of Series E preferred stock has not, by the third business day after the
date of surrender of the shares of Series E preferred stock for conversion,
received certificates for all shares of common stock with respect to the shares
of the Series E preferred stock that holder has requested to convert, then the
conversion price will be reduced five percent (5%) per month (pro rated for days
less than a month) during the period beginning on the date of conversion and
ending on the date the Company is no longer in default of the Company's
conversion obligations.
Rights Upon Occurrence of Major Transactions. Holders of the Series E
preferred stock will be entitled to receive from the Company 125% of the
liquidation preference of their Series E preferred stock in cash only in
connection with an acquisition involving the issuance of more than 40% of
Company common stock, where the acquisition does not constitute a change of
control.
Adjustment to Conversion Price for Registration Failure. In the event that
the registration statement registering the shares of common stock underlying the
Series E preferred stock and warrants is not declared effective by the SEC by
December 31, 2001, the conversion price in respect of any shares of Series E
preferred stock held by any affected holder, will be reduced by 20% and by 1.5%
for each month thereafter during which such failure continues (pro rated for
partial months).
Rank; Liquidation Preference. The holders of Series E preferred stock rank
prior to the holders of common stock and prior to all other classes of capital
stock hereafter established with respect to the distribution of the Company's
assets upon a bankruptcy, liquidation or other similar event. The liquidation
preference for the Series E preferred stock is an amount equal to the purchase
price of the Series E preferred stock of $200 per share.
9
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Warrants
Warrants issued in connection with the recent Financing. Since our
stockholders approved certain proposals at our recent stockholders' meeting, the
Company has issued to holders of the Series A and Series B warrants amended
warrants, the terms of which are described below, which will replace the
warrants issued on June 5, 2001.
Series A warrants have an initial exercise price of $1.75 per share, which
exercise price will be in effect until June 5, 2002 and are exerciseable for
common stock. After this date, the exercise price will increase to $3.50 per
share until the warrant expires on June 5, 2006. If, however, the registration
statement which was filed August 31, 2001 and amended on November 7, 2001 is not
declared effective by the SEC by December 31, 2001, the expiration date of these
warrants will be extended 120 days from the effective date of the registration
statement as declared by the SEC.
The Series B warrants have an initial exercise price of $1.75 per share and
are exercisable for common stock at any time until the later of December 5, 2001
or 120 days from the effective date of the registration statement as declared by
the SEC.
The terms of the warrants issued to the placement agent are substantially
similar to the Series A warrants other than with regard to their respective
initial exercise prices and expiration dates. The Series A and Series B warrants
contain (i) anti-dilution provisions with respect to future issuances of the
Company's equity securities and (ii) adjustment provisions upon the occurrence
of stock splits, stock dividends, combinations, reclassification or similar
events of our capital stock. SAC Capital Associates, LLC and SDS Merchant Fund,
LP will only be issued common stock upon exercise of these warrants to the
extent their respective holdings do not exceed 4.9% of the Company's issued and
outstanding shares of common stock. In addition, if the Company's common stock
closing bid price is at least 200% of the then effective exercise price of the
warrants for a specified period of time and subject to certain other conditions,
50% of the warrants are redeemable by the Company for cash before March 5, 2002.
After this date, all warrants are redeemable by the Company for cash.
10
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In addition, in the event of certain major transactions and subject to
certain conditions, the warrant holders are entitled to receive cash
consideration in exchange for their warrants. For example, if in connection with
an acquisition involving the issuance of more than 40% of the Company's common
stock, where such acquisition does not constitute a change of control, then each
warrant holder shall be entitled to receive a cash amount equal to the "Black
Scholes Amount" times the number of shares of common stock for which the warrant
was exercisable on the date before the transaction. For purposes of the warrant,
the term "Black Scholes Amount" is an amount determined by calculating the
"Black Scholes" value of an option to purchase one share of common stock using
the applicable Bloomberg online page, using the following variable values:
. current market price of common stock equal to the closing trade price
on the last trading day before notice of the major transaction;
. volatility of the common stock equal to the volatility of the common
stock during the 100 trading day period preceding notice of the major
transaction;
. a risk free rate equal to the interest rate on the U.S. treasury bill
or note with a maturity corresponding to the remaining term of the
warrant on the date of the notice of the major transaction; and
. an exercise price equal to the exercise price on the date of notice of
the major transaction.
If this calculation function is no longer available using the Bloomberg
online page, the holder shall calculate this amount in its sole discretion using
the closest available alternative mechanism and variable values to those
available on the Bloomberg online page.
2000 Stock Incentive Plan
On September 6, 2000, the Company's board of directors adopted, and on
June 29, 2001, amended, the SAFLINK Corporation 2000 Stock Incentive Plan ("the
2000 Plan"). The 2000 Plan was approved by the Company's shareholders on
September 24, 2001. Prior to the approval, shareholders representing
approximately 54% of the outstanding common shares had indicated their intent to
vote in favor of the proposal at the shareholders meeting. Through September 30,
2001 the Company has granted and outstanding a total of 517,881 options to
employees and 11,429 options to directors under the 2000 Plan which were still
outstanding. A total of 12,858 options have been granted to a consultant with
terms similar to those granted to employees and directors. The Black Scholes
value of these options granted to the consultant of approximately $17,000 has
been charged to general and administrative expenses for the three months ended
September 30, 2001. Additional options to purchase 62,018 shares were granted to
employees through November 12, 2001. The options were granted with an exercise
price of ranging between $1.68 and $2.10, which equaled or exceeded the fair
value of the stock on the date of the grant. The options expire 10 years from
the date of the grant.
11
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. Significant Customers
One customer accounted for approximately 60% of the Company's revenues
for the three months ended September 30, 2001. Three customers accounted for
approximately 73%, 13% and 10% of the Company's revenues for the three months
ended September 30, 2000. Two customers accounted for approximately 29% and 16%
of the Company's revenues for the nine months ended September 30, 2001. Two
customers accounted for approximately 44% and 26% of the Company's revenues for
the nine months ended September 30, 2000.
10. Comprehensive Loss
For the three and nine months ended September 30, 2001, total
comprehensive loss was $5,678,000 and $12,165,000, respectively, which equaled
the net loss for the respective periods. For the three and nine months ended
September 30, 2000, total comprehensive loss was $1,981,000 and $6,172,000,
respectively which consisted of a net loss of $2,066,000 and $5,906,000 and
unrealized holding gains (losses) on investments of $85,000 and ($266,000),
respectively.
11. Net Loss Per Share
In accordance with Statement of Financial Accounting Standard No. 128,
"Earnings Per Share", the Company has reported both basic and diluted net loss
per common share for each period presented. Basic net loss per common share is
computed on the basis of the weighted-average number of common shares
outstanding for the period. Diluted net loss per common share is computed on the
basis of the weighted-average number of common shares plus dilutive potential
common shares outstanding. Dilutive potential common shares are calculated under
the treasury stock method. Securities that could potentially dilute basic income
per share consist of outstanding stock options and warrants, convertible
preferred stock and convertible debt. Net loss available to common stockholders
includes net loss and preferred stock dividends. As the Company had a net loss
available to common stockholders in each of the periods presented, basic and
diluted net loss per common share are the same. All outstanding warrants and
stock options to purchase common shares were excluded because their effect was
anti-dilutive. Potential common shares consisted of options and warrants to
purchase approximately 7.9 million and 0.5 million common shares at September
30, 2001 and 2000, respectively, and preferred stock and long-term debt
convertible into approximately 6.0 million common shares at September 30, 2001.
12
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
12. Segment Information
Operating segments are revenue-producing components of the enterprise for
which separate financial information is produced internally for the Company's
management. Under this definition, the Company operated, for all periods
presented, in a single segment.
13. Legal Proceedings
On June 16, 1999, International Interest Group, Inc. ("IIG") filed suit
against the Company and Mr. J. Anthony Forstmann, a former director and chairman
of the Company, in the Superior Court of the State of California for the County
of Los Angeles (Civil Action No. BC 212033). The lawsuit alleged that the
Company failed to perform under the terms of a settlement agreement relating to
a prior lawsuit filed by IIG. The original complaint alleged three causes of
action:
. the Company's breach of contract with IIG causing IIG to sustain damages;
. fraud; and
. rescission by IIG against the Company and Mr. Forstmann.
IIG's causes of action for rescission and fraud were dismissed with
prejudice by the trial court during the first quarter of 2000. However, the
Appellate Court reinstated IIG's fraud cause of action in August 2000. On
November 7, 2000, IIG filed a third amended complaint adding causes of action
for fraud by concealment, negligent misrepresentation and breach of fiduciary
duties.
The company, Mr. Forstmann and IIG all filed motions for summary
adjudication with the court on March 29, 2001. On May 31, 2001, the trial court
ruled on the motions as follows:
. IIG's motion was denied in its entirety;
. Mr. Forstmann was granted summary judgment; and
. trial court dismissed the causes of action for fraud by concealment,
negligent misrepresentation and breach of fiduciary duty as to the
Company and Mr. Forstmann.
The court further limited the issues in the case as they related to the
remaining causes of action (breach of contract and fraud) to the narrow issues
of whether the Company breached the contract or made a false promise, by failing
to use reasonable best efforts to file the Form S-3 Registration Statement, for
the purpose of registering the shares given to IIG in settlement, within 30 days
of execution of the settlement agreement, and by failing to use reasonable best
efforts to have the registration statement declared effective. The trial court
implicitly ruled that the reverse stock split which occurred on or about May 27,
1998 was not a material fact.
Thereafter, IIG filed two additional petitions for writ of mandate with
the Court of Appeal. In response to the first petition, the Court of Appeal
reinstated the breach of contract cause of action against Mr. Forstmann, but
left the remainder of the trial court's ruling intact. The Court of Appeal
denied IIG's second petition in its entirety.
13
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Trial is set to commence on the remaining issues in this case on January
9, 2002. As a result of the trial court's rulings on the motions for summary
adjudication, the remaining factual basis for IIG's alleged fraud claim is
whether the Company made a false promise in the underlying settlement agreement
by not allegedly intending to use reasonable best efforts to file the Form S-3
registration statement or to use reasonable best efforts to have the
registration statement declared effective. IIG is seeking actual and
consequential damages and attorneys' fees in connection with its cause of action
for breach of contract and actual, consequential and punitive damages in
connection with its fraud cause of action against the Company. Although in its
original complaint, IIG claimed damages for $1,000,000, the Company believes
that damages awarded, if any, would be de minimus. The Company believes that
these damages, if any, would be calculated as the difference between the market
value of the shares given to IIG at the time IIG was allegedly supposed to
receive the shares and the market value of the shares at the time that IIG
actually received the registered stock. The Company believes the remaining
claims have little merit and intend to vigorously defend ourselves at trial.
14. Recently Issued Accounting Pronouncements
The Financial Accounting Standards Board (FASB) issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, in June 1998. This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. If certain conditions are met, a derivative may
be specifically designated as a hedge. The accounting for changes in the fair
value of a derivative depends on the intended use of the derivative and the
resulting designation. SFAS No. 133, as amended, is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. The adoption of this
statement on January 1, 2001 did not have an impact on the consolidated
financial statements.
In July 2001, the FASB issued Statement No. 141, Business Combinations,
and Statement No. 142, Goodwill and Other Intangible Assets. Statement No. 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and is applicable to all purchase
method business combinations completed after June 30, 2001. Statement No. 142
will require that goodwill and intangible assets with indefinite useful lives no
longer be amortized, but instead tested for impairment at least annually in
accordance with the provisions of Statement No. 142. Statement No. 142 will be
adopted by the Company on January 1, 2002 and is not expected to have a material
impact on the Company's consolidated financial statements.
15. NASDAQ Proceedings
On April 20, 2001 the Company announced that it received a Nasdaq Staff
Determination on April 16, 2001 indicating that the Company failed to comply
with the minimum bid price requirement for continued listing set forth in
Marketplace Rule 4310(c)(4), and that its securities were, therefore, subject to
delisting from The Nasdaq SmallCap Market. On May 31, 2001 the Nasdaq Stock
Market
14
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
suspended trading in the Company's common stock due to the inclusion of a
disclaimer opinion with respect to financial statements required to be certified
by the Company's independent accountants in the Company's Form 10-K. On June 7,
2001, the Company appeared at a hearing before a Nasdaq Listing Qualifications
Panel to appeal the Staff Determination. The Hearing Panel requested additional
information, which the Company provided. On August 8, 2001, the Hearing Panel
notified the Company that the Company had not met the minimum bid price and net
tangible asset/shareholder equity requirements of the Nasdaq Marketplace Rules
and that the Company's securities were delisted effective with the open of the
market on August 9, 2001. The stock is presently being quoted on the Over The
Counter Bulletin Board ("OTCBB") and the Pink Sheets inter dealer quotation
service under the symbol ESAF. Effective with the Company's reverse stock split
on November 19, 2001, the Company's common stock is being quoted under the
symbol SFLK.
16. Going Concern
The Company incurred net losses of $9.0 million, $3.9 million and $1.4
million and used cash of $7.2 million, $3.6 million and $723,000 in operating
activities in 2000, 1999, and 1998, respectively. The Company incurred
additional net losses applicable to common stockholders of approximately $5.7
million and $13.7 million for the three and nine months ended September 30,
2001, respectively, and used cash of $6.4 million in operating activities for
nine months ended September 30, 2001 compared to losses of approximately $2.2
million and $6.3 million and used cash of $5.4 million for the prior year
comparable periods. At September 30, 2001, the Company has a net working capital
deficiency of $1,905,000 and has an accumulated deficit of $72.3 million.
Although the Company has obtained proceeds from the Financing, additional
funding of at least $9.0 million is needed to maintain its current level of
operations through December 31, 2002. The Company must seek additional funding
available to it through the exercise of the Series A and B Warrants issued in
the Financing. The exercise of these warrants will be dependant upon the price
of our Common stock being at sufficient levels to induce the Series A and B
Warrant holders to exercise.
There can be no assurance that the Company will be able to raise
additional capital, achieve profitability, or generate cash from operations. If
the Company is unable to obtain additional financing in the near term, it will
be forced to severely curtail or possibly discontinue operations. The
accompanying financial statements have been prepared on the basis that the
Company will be able to meet its obligations as they become due and continue as
a going concern.
15
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Factors That May Affect Future Results
Except for the historical information contained herein, certain of the
matters discussed in this quarterly report are "forward-looking statements" as
defined in Section 21E of the Securities Exchange Act of 1934, as amended, which
involve certain risks and uncertainties which could cause actual results to
differ materially from those discussed herein. In addition to other information
contained in this quarterly report, the following factors, among others, may
have affected, and in the future could affect the Company's actual results and
could cause future results to differ materially from those in any forward
looking statements made by or on behalf of the Company. Factors that could cause
future results to differ from expectations include, but are not limited to, the
following:
. the Company's need for additional funds to continue operations;
. the Company's substantial accumulated net losses;
. that the Company's independent auditors have stated that there is
doubt about our ability to continue as a going concern;
. the Company's dependence on significant growth in the biometrics
market which is a developing market;
. that because 65% of the Company is owned by a few stockholders, they
can significantly influence the Company's affairs;
. the Company's ability to compete against competitors with greater
financial and technical resources and greater ability to respond to
market changes;
. the Company's workforce reductions may cause the Company to be unable
to take advantage of sales opportunities;
. the Company's ability to retain key employees and to attract high
quality new employees;
. the Company's key executive officers have not held their positions for
very long;
. the Company's common stock has been delisted from the Nasdaq SmallCap
Market and there is a limited public market for the Company's common
stock;
. the Over the Counter Electronic Bulletin Board and Pink Sheets on
which the Company's common stock trades can be volatile markets;
. the classification of the Company's stock as a "penny stock" and the
additional rules that apply to sales of penny stocks;
. volatility of the Company's common stock;
. dilution resulting from the issuance of common stock for the Company's
stock option plans and the exercise of warrants;
. the Company's partial dependence on third parties for product
distribution;
. the Company's revenues have historically been derived from a limited
number of customers;
. the Company's ability to keep up with rapid technological change in
the software industry;
. the Company's lack of experience doing business outside the United
States;
. provisions of the Company's certificate of incorporation may prevent
or impact the value of a takeover;
16
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
. the significant number of shares available for future sale could drive
down the price of the Company's common stock, making it difficult to
raise capital;
. the Company's failure to register the shares underlying the Financing
by December 31, 2001 will result in additional shares of common stock
being issued which could depress the price of the Company's common
stock
These factors are discussed in greater detail in the Company's Annual
Report on Form 10-K/A filed with the SEC on June 22, 2001 and in the Company's
registration statement on Form S-1/A filed on November 7, 2001.
A. Recent Events
On July 27, 2001 the Company entered into a Modification Agreement with
certain purchasers of the Series E Preferred Stock. See Note 8 to the Company's
condensed consolidated financial statements for a description of the terms of
the Modification Agreement.
On September 24, 2001 the Company held its annual stockholders' meeting.
See Item 4 for a description of each matter voted upon and the results of such
voting.
On October 9, 2001, pursuant to stockholder approval obtained at the annual
meeting of stockholders held on September 24, 2001, the Company filed with the
Secretary of State of Delaware a Certificate of Amendment to the Certificate of
Incorporation for the purpose of amending the Certificate of Designation,
Preferences and Rights of the Series E preferred stock. This Certificate of
Amendment is included as Exhibit 3(i) to this Quarterly Report.
On October 31, 2001, the Company announced the public availability of
SAFmodule 2.1 for Novell Modular Authentication Service (NMAS). The Company has
filed an application for patent protection with the United States Patent and
Trademark Office.
On November 7, the Company announced that it had been awarded a three year
contract by a major financial services institution for delivery of its biometric
enterprise security products. The three-year contract provides for the
deployment of up to 5,000 seats in the next 12 months, with potential to deploy
up to 22,000 seats over the life of the agreement. The number of seats will be
determined in the sole discretion of the financial services institution, which
will have no obligation to purchase any of the Company's products or services.
At the Company's recent stockholders' meeting held on September 24, 2001,
the stockholders approved a reverse stock split of between seven-to-one and ten-
to-one, the exact ratio to be determined at the discretion of the Board of
Directors. The Board of Directors met on October 2, 2001 and determined the
ratio for the split to be seven-to-one. The Company will effect the Reverse
Stock Split on November 19, 2001. All stockholders of record on November 19,
2001, will receive one share for every seven shares of SAFLINK common stock held
by them. Fractional interests will be rounded to the next highest share. All
share and per share amounts have been restated in all periods presented to
reflect the effects of the reverse split unless otherwise noted. In addition,
the Company's stock ticker symbol will be changed to SFLK effective November 19,
2001.
17
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
The Company has made certain advances totaling approximately $65,000 to
Jotter Technologies, Inc. in return for an unsecured promissory note dated
August 16, 2001. The Company acquired the assets of Jotter Technologies, Inc. in
December 2000. Certain members of the board of directors of Jotter Technologies,
Inc. are either an officer or director of the Company. The note is payable in
full including accrued interest on February 12, 2002 and bears interest at 12%
per year.
B. Results of Operating Activities
We incurred net losses attributable to common stockholders of approximately
$5.7 million and $13.7 million for the three-month and nine-month periods ended
September 30, 2001, respectively as compared to losses of approximately $2.2
million and $6.3 million for the prior year comparable periods. Excluding the
impairment charge for the intangible assets relating to the Jotter acquisition
in the aggregate amount of $3,809,000, losses for the three months ended
September 30, 2001 decreased by $297,000 compared to the same period in 2000.
This is primarily due to decreases in personnel costs ($549,000), decreases in
advertising ($118,000) and decreases in professional services ($136,000)
somewhat offset by increases in amortization expense ($440,000) for which no
prior year comparable expense exists.
Excluding the impairment charge for the intangible assets relating to the
Jotter acquisition of $3,809,000 the net loss attributable to common
stockholders for the nine months ended September 30, 2001 increased by
$3,587,000 compared to the same period in 2000. This increase is primarily due
to increases in professional services ($550,000) and amortization of intangible
assets relating to the acquisition of Jotter in December 2000 ($1,293,000),
increases in restructuring and relocation expenses ($657,000), and increases in
preferred stock dividends ($1,137,000), partially offset by decreases in
personnel expense ($1,148,000). We incurred net interest expense of $675,000 on
bridge loans and the loan payable to Jotter for the nine months ended September
30, 2001 compared to interest and other income of $74,000 for the nine months
ended September 30, 2000.
Revenue and Cost of Revenue
Revenue of $86,000 for the three months ended September 30, 2001 decreased
approximately $191,000 (69%) from revenue of approximately $277,000 for the
three months ended September 30, 2000 while revenue of $380,000 for the nine
months ended September 30, 2001 decreased approximately $776,000 (67%) from
revenue of $1,156,000 for the nine months ended September 30, 2000. The decrease
for the nine month period ended September 30, 2001 versus 2000 was due to the
shortage of funds to pursue sales opportunities during the first six months of
the year. During the three months ended September 30, 2001, the Company
refocused its efforts on the enterprise biometric market and concentrated on
closing sales to potential customers currently evaluating the Company's product
offerings.
The $3,124,000 increase in cost of revenue for the three months ended
September 30, 2001 versus the comparable period in 2000 was primarily
attributable to the impairment charge and amortization of the intangible assets
from the Jotter acquisition and an increase in hardware sales, which have a
lower margin. For the nine months ended September 30, 2001 the $3,643,000
increase in cost of revenue over the 2000 period is primarily due to the
impairment charge and amortization of intangible assets from the Jotter
acquisition.
18
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Operating Expenses
Excluding the impairment loss on intangible assets of $998,000 related to
the Jotter acquisition, total operating expenses for the three months ended
September 30, 2001 decreased approximately $693,000 (31%) to approximately $1.5
million from approximately $2.2 million for the same period in 2000. The
decrease is primarily due to the reduction in staffing made in June 2001
resulting in savings of approximately $549,000 from the prior year partially
offset by increases in amortization of intangibles ($122,000) for which no prior
year comparable expense exists.
Excluding the above mentioned impairment loss on intangible assets of
$998,000, operating expenses for the nine months ended September 30, 2001
increased approximately $453,000 versus the same period in 2000. The increase is
primarily due to increases in restructuring and relocation costs ($657,000),
increases in professional services ($550,000) and amortization of intangible
assets ($365,000), which had no prior year comparable expense partially offset
by decreases in personnel costs ($1.1 million) and decreases in advertising
($280,000).
The following table provides a breakdown of the dollar and percentage
changes in operating expenses for the three and nine months ended September 30,
2001, as compared to the same periods in 2000:
Three Months Nine Months
(Dollars in thousands) Increase Increase Increase Increase
(Decrease) (Decrease) (Decrease) (Decrease)
---------- ---------- ---------- ----------
Product development $ (651) (58%) $ (954) (30)%
Amortization of intangible assets 122 * 365 *
Sales and marketing (134) (38) (614) (50)
Restructuring and relocation (16) (100) 657 304
Impairment loss on intangible assets 998 * 998 *
General and administrative (14) (2) 999 47
--------- ------- -------- -------
$ 305 14% $ 1,451 21%
========= ======= ======== =======
*N/M - Not meaningful
Product Development - The decrease in product development costs for both the
three and nine months ended September 30, 2001 compared to the same periods in
2000 is primarily due to decreased personnel costs. The Company reduced its
staffing levels by approximately 13 staff members in product development during
June of 2001. We expect to continue to incur product development expenses as we
continue to release new products and enhancements for the enterprise network
market.
Amortization of Intangible assets - The amortization of intangible assets
increased for the three and nine month periods due to the amortization of
intangible assets relating to the acquisition of Jotter in December 2000 for
which no prior year comparable expense exists.
19
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Sales and Marketing - The decrease in sales and marketing expenses for three
months ended September 30, 2001 versus the same period in 2000 was primarily due
to decreases in travel ($77,000) and advertising expenses ($40,000). The
decrease for the nine months ended September 30, 2001 versus the same period in
2000 was primarily due to decreases in personnel costs ($125,000) decreases in
travel ($149,000) and advertising expenses ($284,000). We believe that the
increase in awareness of biometrics as a security solution in light of the
events of September 11, 2001 will lead to greater market acceptance of biometric
security solutions. While we intend to maintain tight control over sales and
marketing expenses in the near term as we focus our efforts to consummate sales
to currently identified prospects, we expect our sales and marketing expenses to
increase over the longer term as the market for our products and services
develops.
Restructuring and Relocation - The decrease of $16,000 for the three months
ended September 30, 2001 versus the same period in 2000 pertains to the move of
the corporate offices in fiscal 2000 for which no current year comparable
expense exists. The increase in the nine months ended September 30, 2001
compared to the comparable period in 2000 is due to the restructuring charges
taken in June 2001.
Impairment loss on intangible assets - During the three months ended September
30, 2001, the Company determined that the carrying value of the remaining Jotter
intangible assets was not recoverable and recognized an impairment loss during
the quarter ended September 30, 2001, of approximately $998,000 relating to the
remaining net carrying value of the intangible assets acquired. The impairment
charge is comprised of approximately $535,000 of assembled workforce and
approximately $460,000 of sales channel customer relationships. As previously
mentioned, the Company also recognized an impairment of intangible assets of
approximately 2.8 million as part of cost of revenue.
General and Administrative - General and administrative expenses for the three
months ended September 30, 2001 were comparable to the prior year period. For
the nine months ended September 30, 2001 the increase was primarily due to
increases in professional services ($550,000) and increases in shareholder
expenses ($128,000) related to our recent annual meeting.
B. Liquidity and Capital Resources
Working Capital
Cash and working capital (deficiency) as of September 30, 2001 were
approximately $707,000 and ($1.9 million), respectively, compared to
approximately $1.1 million and ($3.3 million), respectively, as of December 31,
2000. The decrease in the Company's cash as of September 30, 2001 compared to
December 31, 2000 was primarily due to net operating losses and payments and
settlements to vendors offset by the receipt of proceeds from the Series E
Preferred Stock Financing and approximately $125,000 from the exercise of
warrants and approximately $31,000 upon the exercise of employee stock options
during the nine months ended September 30, 2001. The increase in the Company's
working capital is primarily due to the conversion of bridge loans in the recent
Financing.
We expended cash in our operations, including capital expenditures and debt
repayments during the nine months ended September 30, 2001 at the rate of
approximately $750,000 per month, excluding financing activities. For the three
months ended September 30, 2001 we expended cash at the rate of approximately
$550,000 per month due to reductions in staffing levels and curtailing of
overhead. Our anticipated cash needs to fund our working capital and debt
service requirements are anticipated to be
20
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
approximately $9.0 million through December 31, 2002. To date, we have had no
success in raising these funds. Additionally, the terms of our recent financing
prohibit the Company from raising additional capital by selling discounted,
variable priced equity securities until 180 days after the date the Company's
registration statement on Form S-1 is declared effective by the SEC. After
December 31, 2002, our need for additional liquidity will be primarily to fund
our working capital requirements. In the next three to six months, we anticipate
that additional financing will be available through the exercise of the
outstanding warrants issued in the Financing. The exercise of the warrants will
depend upon the price of our common stock being at a sufficient level to induce
the Series A and Series B warrant holders to exercise. We are also exploring the
possibility of a business combination with a partner with adequate resources to
sustain our operations. In the longer term, a combination of additional warrant
exercises and revenue growth will be required to sustain our operations. If we
are unable to obtain sufficient additional funding through the exercise of
warrants or execution of a business combination, we will need to significantly
curtail or discontinue our operations.
Even though our recent financing is completed, we will require significant
additional funds to continue our operations into the year 2002. We do not
believe that our existing working capital, together with anticipated cash flows
from sales under current contracts will be sufficient to meet our working
capital needs for the next twelve months. Options we are reviewing to obtain
such additional financing include, but are not limited to the receipt of
proceeds from outstanding warrants, the sale and issuance of additional stock,
the sale and issuance of debt, the sale of certain of our assets and entering
into an additional strategic relationship or relationships to either obtain the
needed funding or to create what we believe would be a better opportunity to
obtain such funds. The failure to obtain such additional funds could cause us to
cease or curtail operations. Even if such additional funding is obtained, there
is no assurance that we will be able to generate significant sales of our
products or services, or if we are able to consummate significant sales, that
any such sales would be profitable.
Dividends
Since our incorporation, the Company has not paid or declared dividends on
our common stock, nor do we intend to pay or declare cash dividends on our
common stock in the forseeable future.
21
SAFLINK CORPORATION
QUANTITIVE AND QUALITATIVE DISCLOSURES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market rate risk for changes in interest rates relates
primarily to the $21,000 time certificates of deposit included in our investment
portfolio. Investments in fixed rate earning instruments carry a degree of
interest rate risk as their fair market value may be adversely impacted due to a
rise in interest rates. As a result, our future investment income may fall short
of expectations due to changes in interest rates. The Company does not use any
hedging transactions or any financial instruments for trading purposes and we
are not a party to any leveraged derivatives.
The Company maintains an office and currently has 8 employees located in
Canada. Expenses related to this office are incurred in its local currency. As
exchange rates vary, transaction gains or losses will be incurred and may vary
from expectations and adversely impact overall profitability. If in 2001, the US
dollar uniformly changes in strength by 10% relative to the currency of the
foreign operations, our operating results would likely not be significantly
affected.
22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Trial has been set for January 9, 2002 for the suit filed by International
Interest Group, Inc. against the Company and Mr. J. Anthony Forstmann, a former
director and chairman of the Company. For a full discussion of the suit filed
against the Company by International Interest Group, Inc. in June 1999, please
refer to Note 13 to the Company's condensed consolidated financial statements.
Item 2. Changes in Securities and Use of Proceeds
On July 27, 2001, the Company entered into a Modification Agreement with
certain purchasers of the Series E Preferred Stock in the Financing to amend
certain terms of the Securities Purchase Agreement and Registration Rights
Agreement entered into pursuant to the Financing. Pursuant to the Modification
Agreement, and subsequent to obtaining stockholder approval at the annual
meeting of stockholders held on September 24, 2001, certain terms of the
Certificate of Designation, Preferences and Rights of the Series E Preferred
Stock were amended. The amended terms of the Series E Preferred Stock are
discussed in Note 8 of the condensed consolidated financial statements filed as
part of this Form 10-Q.
Item 3. Defaults Upon Senior Securities
None
23
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its 2000 annual meeting on September 24, 2001. All seven
proposals made by the Company were approved at the Company's stockholders
meeting. In particular, the Company's stockholders
. elected four directors (Glenn Argenbright, Frank Devine, Bradley Galinson,
and Robert Smibert) for a term of one year or until their successors are duly
elected and qualified;
. approved the SAFLINK Corporation 2000 Stock Incentive Plan;
. approved the issuance of common stock representing 20% or more of the
Company's outstanding shares of common stock upon conversion of the Series E
preferred stock and the exercise of the Series A warrants and Series B
warrants issued to the Company in its recent Financing and upon the exercise
of warrants issued to the placement agent in the Financing;
. approved an amendment to the Company's Certificate of Incorporation to effect
a reverse stock split of the Company's outstanding common stock of at least
seven-to-one but no more than ten-to-one as determined in the Company's sole
discretion by its board of directors;
. approved the conversion into shares of common stock of the $1.64 million
remaining balance of the $1.7 million promissory note issued to Jotter
Technologies, Inc. ("Jotter") as partial consideration in the asset purchase
transaction between the Company and Jotter;
. approved an amendment to the Certificate of Designation, Preferences and
Rights for the Series E preferred stock; and
. ratified the appointment by the Company's board of directors of KPMG LLP as
the Company's independent auditors.
The vote counts reflect the actual shares voted at the Company's
stockholder meeting and have not been adjusted to reflect the seven-for-one
reverse split effected by the Company on November 19, 2001.
Proposal 1. Election of Directors
---------------------
VOTES VOTES BROKER
----- ----- ------
NAME VOTES FOR AGAINST WITHHELD NON-VOTES
--------- ------- -------- ---------
Glenn L. Argenbright 29,747,058 0 28,722 0
Frank M. Devine 29,747,058 0 28,722 0
Bradley D. Galinson 29,747,058 0 28,722 0
Robert M. Smibert 29,747,058 0 28,722 0
24
Proposal 2. 2000 Stock Incentive Plan
-------------------------
BROKER
------
VOTES FOR VOTES AGAINST VOTES WITHHELD NON-VOTES
--------- ------------- -------------- ---------
20,276,745 67,834 2,628 9,428,573
Proposal 3. Series E Financing
------------------
BROKER
------
VOTES FOR VOTES AGAINST VOTES WITHHELD NON-VOTES
--------- ------------- -------------- ---------
20,322,215 22,699 2,293 9,428,573
Proposal 4. Reverse Stock Split
-------------------
BROKER
------
VOTES FOR VOTES AGAINST VOTES WITHHELD NON-VOTES
--------- ------------- -------------- ---------
29,729,173 43,931 2,676 0
Proposal 5. Jotter Note Conversion
----------------------
BROKER
------
VOTES FOR VOTES AGAINST VOTES WITHHELD NON-VOTES
--------- ------------- -------------- ---------
20,293,767 47,054 6,386 9,428,573
Proposal 6. Amendment to the Certificate of Designation of the Series E
-----------------------------------------------------------
Preferred Stock
---------------
BROKER
------
VOTES FOR VOTES AGAINST VOTES WITHHELD NON-VOTES
--------- ------------- -------------- ---------
20,315,403 27,653 4,151 9,428,573
25
In addition, shareholders of the Series E Preferred Stock approved the
proposal to amend the Certificate of Designation of the Series E Preferred
Stock. The following table sets for information regarding voting on the
proposal.
BROKER
------
VOTES FOR VOTES AGAINST VOTES WITHHELD NON-VOTES
--------- ------------- -------------- ---------
32,696 0 65 0
Proposal 7. Ratify KPMG LLP as the Company's independent auditors
-----------------------------------------------------
BROKER
------
VOTES FOR VOTES AGAINST VOTES WITHHELD NON-VOTES
--------- ------------- -------------- ---------
29,750,806 2,215 22,759 0
26
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3(i) Certificate of Amendment to Certificate of Incorporation for purposes of
amending the Certificate of Designation, Preferences and Rights of the
Series E Preferred Stock (incorporated by reference to Exhibit 3.1.8 of
the Company's registration statement on Form S-1/A (#333-68642), filed
with the SEC on November 7, 2001).
10.1 Form of Modification Agreement, dated July 27, 2001, between SAFLINK and
certain purchasers (incorporated by reference to Exhibit 10.1 of Form 8-K
filed with the SEC on August 20, 2001.
10.2 Sublease agreement, dated July 16, 2001, between SAFLINK and Motorola,
Inc. (Incorporated by reference to exhibit 10.9 of Form 10Q filed with
the SEC on August 20, 2001).
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on July 2, 2001 regarding
the consent of KPMG LLP.
The Company filed a Current Report on Form 8-K on August 20, 2001
regarding the Modification Agreement and notification of delisting.
27
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.
SAFLINK CORPORATION
DATE: November 19, 2001 BY: /s/ STEVEN OYER
----------------------
Steven Oyer
Interim Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
28