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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 MARCH 31, 2002
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. 1st 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 12,965,198 shares of SAFLINK Corporation's common stock
outstanding as of May 9, 2002.
SAFLINK Corporation
FORM 10-Q
For the Quarter Ended March 31, 2002
INDEX
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements (Unaudited)
a. Condensed Consolidated Balance Sheets
as of March 31, 2002 and December 31, 2001 ........................ 1
b. Condensed Consolidated Statements of Operations
for the three months ended March 31, 2002 and 2001 ................ 2
c. Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 2002 and 2001 ................ 3
d. Notes to Condensed Consolidated Financial Statements .............. 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Result of Operations ................................ 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk ........ 16
Part II. Other Information
Item 1. Legal Proceedings ................................................. 17
Item 2. Changes in Securities ............................................. 17
Item 6. Exhibits and Reports on Form 8-K .................................. 18
Signature .......................................................................... 19
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PART I - FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
SAFLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
ASSETS March 31, December 31,
2002 2001
-------------- ----------------
Current assets:
Cash and cash equivalents $ 1,965 $ 64
Accounts receivable, net 117 43
Inventory 97 24
Investments 15 15
Other prepaid expenses 158 109
-------------- ----------------
Total current assets 2,352 255
Furniture and equipment, net 286 343
Intangible assets, net 15 27
-------------- ----------------
$ 2,653 $ 625
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LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 928 $ 1,224
Accrued expenses 945 1,030
Notes payable - 1,435
Deferred revenue 156 193
-------------- ----------------
Total current liabilities 2,029 3,882
Convertible long-term debt, net of discounts - 1,506
Warrants and common stock subject to registration 5,024 -
Stockholders' deficit
Common stock 122 46
Deferred stock-based compensation (36) (44)
Additional paid-in capital 76,234 69,530
Accumulated deficit (80,720) (74,295)
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$ 2,653 $ 625
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See accompanying notes to condensed consolidated financial statements.
1
SAFLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
Three months ended March 31,
2002 2001
----------- -----------
Revenue:
Software $ 15 $ 26
Hardware 121 1
Service and other 60 145
----------- -----------
Total revenue 196 172
Cost of revenue:
Software 17 13
Hardware 94 1
Service and other 27 60
Amortization of intangibles - 318
----------- -----------
Total cost of revenue 138 392
----------- -----------
Gross profit 58 (220)
Operating expenses:
Product development 402 984
Sales and marketing 359 176
Amortization of intangibles - 122
General and administrative 961 1,199
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Total operating expenses 1,722 2,481
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Operating loss (1,664) (2,701)
Interest expense (38) (275)
Other income, net 8 2
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Net loss (1,694) (2,974)
Preferred stock dividend (4,731) -
----------- -----------
Net loss attributable to common stockholders $ (6,425) $ (2,974)
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Basic and diluted loss per common share $ (0.61) $ (0.67)
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Weighted average number of common shares outstanding 10,557 4,467
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See accompanying notes to condensed consolidated financial statements.
2
SAFLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Three months ended March 31,
2002 2001
---------------- -----------------
Cash flows from operating activities:
Net loss $(1,694) $(2,974)
Adjustments to reconcile net loss to net cash used in operating
activities:
Stock-based compensation 8 10
Depreciation and amortization 70 544
Amortization of deferred financing costs - 56
Amortization of discount on note payable - 19
Changes in assets and liabilities:
Accounts receivable (74) 44
Inventory (73) (26)
Other prepaid expenses (49) 118
Other assets - 18
Accounts payable (296) 1,031
Accrued liabilities (49) (105)
Deferred revenue (37) (70)
---------------- -----------------
Net cash used in operating activities (2,194) (1,335)
Cash flows from investing activities:
Purchases of furniture and equipment (1) (46)
Increase in investments - (20)
---------------- -----------------
Net cash used in investing activities (1) (66)
Cash flows from financing activities:
Proceeds from issuance of bridge notes and warrants - 389
Payments on notes payable (1,435) -
Proceeds from issuance of common stock and upon exercise of
investor warrants, net of issuance costs 5,531 19
Proceeds upon exercise of employee stock options - 11
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Net cash provided by financing activities 4,096 419
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Net increase (decrease) in cash and cash equivalents 1,901 (982)
Cash and cash equivalents at beginning of period 64 1,108
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Cash and cash equivalents at end of period $ 1,965 $ 126
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Non-cash financing and investing activities:
Preferred stock dividend $ 4,731 $ -
Conversion of note payable to common stock 1,506 -
Conversion of Series E preferred stock 14 -
See accompanying notes to condensed consolidated financial statements.
3
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The accompanying condensed consolidated financial statements present
interim financial information, are unaudited 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 only of normally recurring items) 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 for the
fiscal year ended December 31, 2001, as filed with the Securities and Exchange
Commission (the "SEC") on April 1, 2002.
Certain prior year amounts have been reclassified to conform with the
current year presentation. Such reclassifications had no impact on the results
of operations or stockholders' deficit for any period presented.
2. Investments
At March 31, 2002, investments consist of a $15,000 bank time certificate
of deposit pledged to secure a corporate credit card. This investment is carried
at cost.
3. Stockholders' Deficit
On January 8, 2002, the Company received funds totaling approximately $5.5
million, net of issuance costs, in connection with the issuance of common stock
to certain holders of our Series E preferred stock and the exercise of a portion
of our outstanding Series A and Series B warrants to purchase common stock.
Holders of the Company Series A and Series B warrants exercised warrants to
purchase approximately 4,835,000 shares of our common stock at a price of $1.00
per share. The exercise price of the warrants was reduced from $1.75 to $1.00,
subject to receipt by the Company of the payment in full of such warrant
holders' special exercise price by the close of business on January 8, 2002. In
connection with the exercise, each exercising warrant holder has received a
Series C warrant to purchase that number of shares of our common stock issued to
such holder upon the exercise of the original Series A and Series B warrants.
Due to a restriction in the Series A and Series B warrants held by S.A.C.
Capital Associates, LLC ("SAC") and SDS Merchant Fund, L.P. ("SDS") which
precludes each of them from exercising their respective Series A and Series B
warrants in excess of 4.9% of our outstanding common stock, SAC and SDS were
unable to exercise their warrants in full but agreed to exercise a portion of
their Series A and all of their Series B warrants at a reduced price of $1.00
per share and to purchase approximately 1,200,000 shares of common stock without
exercising their warrants. Each of SAC and SDS agreed to purchase at $1.00
4
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
per share that number of shares of common stock that the Company would have
issued to SAC and SDS above 4.9% if these entities were to fully exercise their
respective Series A and Series B warrants. In connection with their warrant
exercise, SAC and SDS will receive a Series C warrant to purchase that number of
shares of common stock issued to such purchaser upon the exercise of the Series
A and Series B warrants.
In the quarter ended March 31, 2002, the Company accounted for the value
associated with the issuance of common stock in connection with the exercise of
Series A and B warrants, the issuance of Series C warrants and the modifications
made to the Series A and B warrants as an in-substance dividend in the amount of
$4.7 million. The in-substance dividend increases the net loss applicable to
common stockholders. The value allocated to the inducement related to the
shares, Series C warrants and modifications of the Series A and B warrants, was
calculated as the difference between the fair value of modified equity
instruments at the modification date and the fair value of the original equity
instruments immediately before the terms were amended.
The value allocated to the Series C warrants of $3.8 million was calculated
using an option pricing model and is reflected outside of stockholders' deficit,
along with $1.2 million related to the common stock issued directly to SAC and
SDS due to the requirement that the underlying shares of the Series C warrants
and common stock be registered, which is outside the control of the Company.
The Series C warrants have a 5 year term and are initially exercisable at
$2.25 per share, increasing to $3.50 per share six months following the
effectiveness of a registration statement (as declared by the SEC) covering the
shares of common stock underlying the Series C warrants and the shares of common
stock issued to SAC and SDS. In connection with the transaction, the Company
agreed to register for resale under the Securities Act the common stock
underlying the Series C warrants and the common stock issued to SAC and SDS, as
soon as practicable after the filing of the Annual Report on Form 10-K with the
SEC.
In connection with the exercise of the Series A and B warrants, the
anti-dilution provisions of the Series E preferred stock were waived by the
requisite majority of the holders of Series E preferred stock. The exercise
price of the warrants held by those holders of Series E preferred stock that did
not elect to purchase the shares underlying their warrants or otherwise grant a
waiver of the anti-dilution provisions will be adjusted in accordance with the
anti-dilution provisions applicable to such warrants. In connection with the
issuance of common stock to SAC and SDS, the Company received a waiver of the
anti-dilution provisions of the Series E preferred stock and Series A and B
warrants not exercised.
On January 15, 2002, we issued 238,588 shares to Jotter Technologies Inc.
pursuant to our recent agreement to issue these shares in exchange for
cancellation of the convertible long-term note payable issued to Jotter as
partial consideration for the intellectual property and fixed assets acquired
from Jotter in December 2000, for which we received stockholder approval. The
shares were placed in escrow on behalf of Jotter to be released in monthly
distributions after Jotter satisfies certain Canadian tax obligations related to
the asset purchase.
5
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
During the three months ended March 31, 2002, the Company issued
approximately 3.4 million options to purchase common stock to employees under
the 2000 Stock Incentive Plan. As of March 31, 2002, approximately 1.5 million
shares of common stock are reserved for future grants under the plan.
4. Notes Payable
At December 31, 2001, the Company carried a total balance in notes payable
of $1.4 million, which included a $1 million dollar note to RMS Limited
Partnership, a major shareholder of the Company, a note for $135,000 to a
vendor, and bridge financing notes totaling $300,000 originated in December of
2001. All of these notes, related accrued interest, and early termination fees
of approximately $28,000, were paid off. Thus, there is no balance in notes
payable as of March 31, 2002.
5. Concentration of Credit Risk and Significant Customers
Three customers accounted for approximately 31%, 28% and 27% of the
Company's revenues and three customers accounted for 48%, 16%, and 15%,
respectively, of accounts receivable for the quarter ended March 31, 2002. Two
customers accounted for approximately 56% and 31% of the Company's revenues for
the quarter ended March 31, 2001.
6. Comprehensive Loss
For the quarter ended March 31, 2002, total comprehensive loss was
$1,694,000 which equaled the net loss for the quarter. For the quarter ended
March 31, 2001, total comprehensive loss was $2,974,000, which equaled the net
loss for that quarter.
7. 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 and convertible
preferred stock. 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 10.8 million and 629,000 common shares at March 31, 2002 and 2001,
respectively, and preferred stock convertible into approximately 4.3 million
common shares at March 31, 2002.
6
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. 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, as a single segment.
9. 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. The lawsuit alleged that the Company failed to perform under the
terms of a settlement agreement relating to a prior lawsuit filed by IIG.
After the Superior Court dismissed certain IIG causes of action, the
California Court of Appeals reinstated IIG's fraud cause of action in August
2000. The case was then sent back to the Superior Court for adjudication of
IIG's breach of contract and fraud causes of action.
On January 28, 2002, a jury rendered a verdict against us in the case
brought by IIG. The verdict was for $150,000 in compensatory damages and $1.5
million in punitive damages. On February 15, 2002, we filed a motion for a new
trial on the punitive damages award and a motion for a judgment notwithstanding
the verdict. We also filed motions to stay entry and/or enforcement of a
judgment pending the outcome of the hearing on these motions.
On March 19, 2002, the Court conditionally granted a new trial on the issue
of punitive damages and reduced the amount of punitive damages from $1.5 million
to $300,000, to which the plaintiff has consented. Accordingly, judgment has
been entered in the amount of $450,000 subject to the parties' rights to appeal
and the parties' claims in post-trial proceedings to fees, costs and interest.
The plaintiff has filed a motion for attorneys' fees and costs in the total
amount of approximately $190,000 which the Company intends to vigorously oppose.
The Company accrued $450,000 related to this litigation as a charge to general
and administrative expenses in 2001. Payment of a judgment in the amount of
$450,000 could have a material adverse effect on the Company's financial
condition.
10. Recently Issued Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards (SFAS) No. 141, "Business
Combinations", which requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. The adoption of SFAS No. 141 has not had a
significant impact on our financial statements.
7
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In July 2001, FASB issued Statement of Financial Accounting Standards SFAS
No. 142, "Goodwill and Other Intangible Assets," which is effective for fiscal
years beginning after December 15, 2001. SFAS No. 142 requires, among other
things, the discontinuance of goodwill amortization. In addition, the standard
includes provisions upon adoption for the reclassification of certain existing
recognized intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the testing for impairment of existing goodwill
and other intangibles. The Company adopted the provisions of SFAS No. 142 on
January 1, 2002. The adoption of SFAS No. 142 did not have a material effect on
our financial statements because of the insignificant value of our intangible
assets as of that date.
In August 2001, FASB issued SFAS No.143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 requires an enterprise to record the fair value of
an asset retirement obligation as a liability in the period in which it incurs a
legal obligation associated with the retirement of a tangible long-lived asset.
Since the requirement is to recognize the obligation when incurred, approaches
that have been used in the past to accrue the asset retirement obligation over
the life of the asset are no longer acceptable. Statement No. 143 also requires
the enterprise to record the contra to the initial obligation as an increase to
the carrying amount of the related long-lived asset (i.e., the associated asset
retirement costs) and to depreciate that cost over the remaining useful life of
the asset. The liability is changed at the end of each period to reflect the
passage of time (i.e., accretion expense) and changes in the estimated future
cash flows underlying the initial fair value measurement. The provision of SFAS
No. 143 is effective for fiscal years beginning after June 15, 2002. We do not
expect the adoption of SFAS No. 143 to have a material effect on our results of
operations or financial position.
In October 2001, FASB issued SFAS No.144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 addresses the financial accounting
and reporting for the impairment or disposal of long-lived assets. This
statement supersedes SFAS No. 121 "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 144 also
supersedes the accounting and reporting provisions of APB Opinion No.30,
"Reporting the Results of Operations--Reporting the Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of business. The provision is
effective for fiscal years beginning after December 15, 2001 and interim periods
within those fiscal periods. The Company adopted the provisions of SFAS No. 144
on January 1, 2002. The adoption of SFAS No. 144 did not have a material effect
on our financial statements.
11. Going Concern
The condensed consolidated financial statements have been prepared assuming that
the Company will continue as a going concern.
The Company incurred net losses of $14.1 million, $9.0 million and $3.9
million and used cash of $7.2 million, $7.1 million and $3.6 million in
operating activities in 2001, 2000 and 1999, respectively. The Company incurred
an additional net loss of $1.7 million and used cash of $2.2 million in
operating activities for the quarter ended March 31, 2002. At March 31, 2002,
the Company had net working capital of $323,000 and an accumulated deficit of
$80.7 million. These factors raise substantial doubt about the Company's ability
to continue as a going concern.
8
SAFLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
While the Company raised approximately $5.5 million, net of issuance
costs, of additional working capital in January 2002 through the exercise of
warrants connected to the Series E preferred stock placement discussed in Note
3, the Company will require significant additional funds to continue its
operations beyond the middle of 2002. Alternatives the Company is reviewing to
obtain such additional financing include, but are not limited to, the sale and
issuance of additional stock, issuance of debt, the sale of certain assets and
entering into an additional strategic relationship or relationships to either
obtain the needed funding or to create what the Company believes would be a
better opportunity to obtain such funds. The failure to obtain such additional
funds could cause the Company to curtail or cease operations.
There can be no assurance that the Company will be able to sell
additional securities, achieve profitability, generate cash from operations or
obtain additional financing when required. 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.
12. Subsequent Events
In April 2002, 4,275 shares of our Series E preferred stock were
converted into 610,715 shares of our common stock.
9
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion and analysis should be read in conjunction with our
unaudited condensed consolidated financial statements and accompanying notes
included in this document and the 2001 audited consolidated financial statements
and notes thereto included in our Annual Report on Form 10-K, which was filed
with the Securities and Exchange Commission on April 1, 2002.
This quarterly report on Form 10-Q contains statements and
information about management's view of the Company's future expectations, plans
and prospects that constitute forward-looking statements for purposes of the
safe harbor pro visions under the Private Securities Litigation Reform Act of
1995. These forward-looking statements include without limitation statements
regarding our expectations and beliefs about our ability to obtain the
substantial financing we will need for our operations, our expectations and
beliefs about the market and industry, our goals, plans, and expectations
regarding our products and services and product development, our intentions and
strategies regarding customers and customer relationships, our relationships
with the software development community, our intent to continue to invest
resources in research and development, our intent to develop relationships and
strategic alliances, our beliefs regarding the future success of our products
and services, our expectations and beliefs regarding competition, competitors,
the basis of competition and our ability to compete, our expectations regarding
future growth and financial performance, our expectations regarding licensing
arrangements and our revenues, our expectations and beliefs regarding revenue
and revenue growth, our expectations regarding our strategies and long-term
strategic relationships, and our beliefs and expectations regarding our results
of operation and financial position. These statements are subject to risks and
uncertainties that could cause actual results and events to differ materially
from those anticipated, including the factors described below under the caption
"Additional Factors that May Affect Our Business, Future Operating Results and
Financial Condition," and the sections of our annual report on Form 10-K for the
year ended December 31, 2001, entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Risk Factors That May Affect
Future Results." We undertake no obligation to publicly release the result of
any revisions to these forward-looking statements which may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events, conditions or circumstances.
The following management's discussion and analysis of financial
condition and results of operations should be read in conjunction with
management's discussion and analysis of financial condition and results of
operations included in our Form 10-K for the year ended December 31, 2001.
As used in this quarterly report on Form 10-Q, unless the context
otherwise requires, the terms "we," "us," "our," "the Company," and "SAFLINK"
refer to SAFLINK Corporation, a Delaware corporation, and its subsidiaries.
Overview
We provide cost-effective software that may be combined with a variety
of biometric hardware products to verify the identity of a user accessing a
computer and related network resources. Our products may be used to protect
business and personal information and to replace passwords and
10
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
personal identification numbers, known as PINs, in order to safeguard and
simplify access to electronic systems. Biometric technologies identify computer
users by electronically capturing a specific biological or behavioral
characteristic of that individual, such as a fingerprint or voice or facial
feature, and creating a unique digital identifier from that characteristic.
Because this process relies on largely unalterable human characteristics,
positive identification can be achieved independent of any information possessed
by the individual seeking authorization.
Our software products are designed for large-scale and complex computer
networks and allow computer users to be identified using a choice of biometric
technologies. Our products comply with a published industry standard that allows
the use of multiple biometric technologies. In December 1997, we introduced and
demonstrated the first example of this industry standard called the Human
Authentication Application Programming Interface, or HA-API. HA-API was the
first definition of a standard way to allow software developers and biometric
technology suppliers to build their products using a uniform method for
connecting many different biometric devices to computer systems. HA-API was
developed by us under contract with the United States Department of Defense and
was subsequently released into the public domain. We are also a leading
contributor to a new standard that is intended to replace HA-API called BioAPI.
One of our employees serves as the elected Chair of the BioAPI Consortium that
represents over 85 organizations that have collaborated to develop this new
standard. We also support other related standards efforts, including the Common
Biometric Exchange File Format (CBEFF) specification, and we intend to make our
products compliant with these standards as they continue to evolve.
Given the tragic events of September 11th of last year, and the
resulting increased emphasis and focus on security issues, our industry and
company is receiving more attention than in prior periods. However, we cannot
predict whether this increased focus and attention will result in greater access
to capital or improvement in sales results for us in the foreseeable future.
Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of
operations are based upon our unaudited condensed consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses and related disclosure of
commitments and contingencies. On an on-going basis, we evaluate our critical
accounting policies and estimates. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our unaudited
condensed consolidated financial statements:
. Revenue Recognition. We derive revenue from license fees for software
products, reselling of hardware and fees for services relating to the software
products including maintenance services, technology and programming consulting
services.
11
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
We recognize revenue in accordance with the provisions of Statement of
Position 97-2, "Software Revenue Recognition" (SOP 97-2), which provides
specific guidance and stipulates that revenue recognized from software
arrangements is to be allocated to each element of the arrangement based on the
relative fair values of the elements, such as software products, upgrades,
enhancements, post contract customer support, installation or training. Under
SOP 97-2, the determination of fair value is based on objective evidence that is
specific to the vendor. If such evidence of fair value for each element of the
arrangement does not exist, all revenue from the arrangement is deferred until
such time that evidence of fair value does exist or until all elements of the
arrangement are delivered.
Revenue from software license fees is recognized upon delivery, net of
an allowance for estimated returns, provided persuasive evidence of an
arrangement exists, collection is probable, the fee is fixed or determinable,
and vendor-specific objective evidence exists to allocate the total fee to
elements of the arrangement. If customers receive pilot or test versions of
products, revenue from these arrangements are recognized upon customer
acceptance. If our software is sold through a reseller, revenue is recognized
when the reseller delivers its product to the end-user or if there are
non-refundable minimum guaranteed fees upon delivery to the reseller. We also
act as a reseller of hardware. Such revenues are recognized upon delivery of the
hardware.
Service revenues include payments under support and upgrade contracts
and fees from consulting. Support and upgrade revenues are recognized ratably
over the term of the contract, which typically is less than twelve months.
Consulting revenues are primarily related to technology, programming and
training services performed on a time-and-materials basis under separate service
arrangements. Fees from consulting are recognized as services are performed.
Revenue results are difficult to predict, and any shortfall in revenue
or delay in recognizing revenue could cause our operating results to vary
significantly from quarter to quarter and could result in future operating
losses.
. Litigation. We are subject to proceedings, lawsuits and other claims.
We are required to assess the likelihood of any adverse judgments or outcomes to
these matters as well as potential ranges of probable losses. A determination of
the amount of loss accrual required, if any, for these contingencies are made
after careful analysis of each individual issue. The required accruals may
change in the future due to new developments in each matter or changes in
approach such as a change in settlement strategy in dealing with these matters.
It is possible that future results of operations for any particular quarterly or
annual period could be materially affected by changes in our assumptions or the
effectiveness of our strategies related to these proceedings.
Results of Operations
We believe that period-to-period comparisons of our operating results
may not be a meaningful basis to predict our future performance. You should
consider our prospects in light of the risks, expenses and difficulties
frequently encountered by companies in new and rapidly evolving markets. We may
not be able to successfully address these risks and difficulties.
12
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
We incurred a net loss attributable to common stockholders of
approximately $6.4 million for the quarter ended March 31, 2002, as compared to
a net loss of approximately $3.0 million for the quarter ended March 31, 2001.
The net loss attributable to common stockholders for the three months ended
March 31, 2002 included an in-substance dividend, of approximately $4.7 million
resulting from the modification of our Series A and B warrants, sale of common
stock, and issuance of Series C warrants during the quarter.
The following discussion presents certain changes in our revenue and
operating expenses which have occurred in the quarter ended March 31, 2002 as
compared to the quarter ended March 31, 2001.
Revenue and Cost of Revenue
Revenue of approximately $196,000 for the three months ended March 31,
2002 increased approximately $24,000, or 14%, from revenue of approximately
$172,000 for the three months ended March 31, 2001.
Cost of revenue decreased significantly to approximately $138,000 for
the three months ended March 31, 2002 from approximately $392,000 for the three
months ended March 31, 2001. The decrease was primarily attributable to the
cessation of the amortization of intangibles. During the three months ended
March 31, 2001, the Company recorded approximately $318,000 to cost of revenue
for amortization of intangibles acquired in the acquisition of Jotter
Technologies, Inc. There were no comparable costs during the three months ended
March 31, 2002, due to the write-down of Jotter intangibles in the second half
of fiscal 2001.
Our gross margins for the three months ended March 31, 2002 and 2001
were approximately 30% and (128%), respectively. The changes from 2001 to 2002
were primarily due to discontinued amortization of Jotter intangibles, offset by
a change in product mix. Hardware sales, which have higher costs, significantly
increased during the three months ended March 31, 2002.
Operating Expenses
Total operating expenses for the three months ended March 31, 2002
decreased approximately $759,000, or 31%, to approximately $1.7 million from
approximately $2.5 million for the comparable period in 2001. This decrease was
primarily due to decreases in personnel costs ($282,000), professional services
($109,000), communication costs ($74,000) and the cessation of amortization of
Jotter intangibles ($122,000). The reduced operating expenses reflect the
corporate restructuring activities effected in June of 2001. The following table
provides a breakdown of the dollar and percentage changes in operating expenses
for the three months ended March 31, 2002, as compared to the comparable period
in 2001:
Changes in Operating
Expenses
(000's) Percent
----------- ----------
Product development $ (582) (59)
Sales and marketing 183 104
Amortization of intangible assets (122) *
General and administrative (238) (20)
------------- ----------
$ (759) (31)
============= ==========
* Not meaningful
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SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Product Development - Product development expenses consist primarily of
salaries, benefits and equipment for software developers and quality assurance
personnel. Product development expenses decreased significantly, in the first
quarter of 2002 as compared to the first quarter of 2001, as a result of the
reduction in headcount of 13 staff members in June of 2001 and the termination
of contract labor. We expect to continue to incur product development expenses
at a relatively constant rate as we continue to release new products and
enhancements for the enterprise network market.
Sales and Marketing - Sales and marketing expenses consist primarily of
salaries and commissions earned by sales and marketing personnel, promotional
expenses and travel and entertainment costs. Sales and marketing expenses
increased substantially, in the first quarter of 2002 as compared to the first
quarter of 2001, as a result of increased headcount and sales and marketing
activities, such as trade shows and sales conferences, during the three months
ended March 31, 2002. This increased activity reflects new sales initiatives
carried out by new sales management, added in the fourth quarter of 2001.
Additionally, the Company was very low on funds during the three months ended
March 31, 2001, and therefore maintained tight control over discretionary
expenses, such as trade shows and conferences, during that period. We anticipate
that sales and marketing expenses will remain relatively constant in the near
term, while the Company pursues additional funding, but increase in the longer
term as we continue to focus on creating demand for our products.
General and Administrative - General and administrative expenses consist
primarily of salaries, benefits and related costs for our executive, finance,
human resource and administrative personnel, professional services fees and
allowances for bad debt. General and administrative expenses decreased, in the
first quarter of 2002 as compared to the first quarter of 2001, primarily due to
reduced personnel and rent expenses, reflecting the corporate restructuring
activities in June of 2001. We anticipate that general and administrative
expenses will continue to be the largest component of operating expenses for the
foreseeable future as we continue to incur significant professional service
expenses associated with our ongoing SEC filings and reliance on outside
personnel for certain key financial positions.
Liquidity and Capital Resources
Cash and working capital (deficit) as of March 31, 2002 were approximately
$2 million and $323,000, respectively, compared to approximately $64,000 and
$(3.6 million), respectively, as of December 31, 2001. The increase in the
Company's cash and working capital as of March 31, 2002 compared to December 31,
2001 was primarily due to the proceeds of approximately $5.5 million, net of
issuance costs, from the issuance of common stock and Series C warrants to
certain holders of our Series E preferred stock and the exercise of a portion of
our outstanding Series A and Series B warrants to purchase common stock. This
increase was offset by the repayment of notes payable of approximately $1.4
million, and cash used in operations of approximately $2.2 million.
14
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
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 immediate working capital needs.
As a result of the recent exercises of Series A and Series B warrants and
the purchases of our common stock, we have sufficient funds to continue our
operations through July of 2002. We will be seeking to raise additional funds
for our short- and long-term operational needs by means of further bridge
financing and the exercise of our outstanding warrants, but there can be no
assurance that we will be able to obtain such funds.
If we cannot raise additional financing prior to July 31, 2002 on
acceptable terms, or at all, we would experience severe financial and operating
difficulties, including the probable discontinuance of operations. If we
discontinue operations our company will likely liquidate and our stock will
become worthless. In order to raise additional working capital, we may need to
issue additional shares of common stock or securities that are convertible into
common stock. Additional financing may be unavailable to us or only available on
terms unacceptable to us.
15
SAFLINK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market rate risk for changes in interest rates relates
primarily to money market funds 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. We do not use any hedging
transactions or any financial instruments for trading purposes and we are not a
party to any leveraged derivatives.
We have certain foreign operations whose expenses 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 the remainder of fiscal 2002, 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.
16
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
On June 16, 1999, International Interest Group, Inc. (IIG) filed suit
against our company and Mr. J. Anthony Forstmann, a former director and chairman
of our company, in the Superior Court of the State of California for the County
of Los Angeles. The lawsuit alleged that we failed to perform under the terms of
a settlement agreement relating to a prior lawsuit filed by IIG.
After the Superior Court dismissed certain IIG causes of action, the
California Court of Appeals reinstated IIG's fraud cause of action in August
2000. The case was then sent back to the Superior Court for adjudication of
IIG's breach of contract and fraud causes of action.
On January 28, 2002, after a nine-day trial in California Superior Court
for the County of Los Angeles, a jury rendered a verdict against us in the case
for $150,000 in compensatory damages and $1.5 million in punitive damages. On
March 19, 2002, the Court conditionally granted a new trial on the issue of
punitive damages and reduced the amount of punitive damages from $1.5 million to
$300,000, to which the plaintiff has consented. Accordingly, we have been
informed that judgment will be entered in the amount of $450,000 subject to the
parties' rights to appeal and the parties' claims in post-trial proceedings to
fees, costs and interest. The plaintiff has filed a motion for attorneys' fees
and costs in the total amount of approximately $190,000 which we intend to
vigorously oppose. Payment of a judgment in the amount of $450,000 could have a
material adverse effect on our results of operations and financial condition.
Item 2. Changes in Securities.
In January 2002, we issued an aggregate of 4,811,233 shares of our common
stock to certain holders of our Series E Preferred stock upon the exercise of
outstanding Series A and Series B warrants. The aggregate consideration received
in connection with the exercise of such warrants was $4,811,233. In connection
with the exercise of the Series A and Series B warrants, we issued Series C
warrants to purchase up to an aggregate of 4,811,233 shares of our common stock
to those holders of our Series E Preferred stock who exercised Series A or
Series B warrants. The initial exercise price of the Series C warrants is $2.25
per share, increasing to $3.50 per share six months following the effectiveness
of a registration statement covering the shares of common stock underlying such
warrants. No consideration was received in connection with the issuance of the
Series C warrants. On March 7, 2002, we issued 17,858 shares of our common
stock, and a Series C warrant to an accredited investor upon the exercise of a
Series A warrant, pursuant to a notice given to us on January 7, 2002. The
consideration received in connection with the exercise of such warrant was
$17,858. The issuances were exempt from registration under Section 4(2) of the
Securities Act of 1933, were made without general solicitation or advertising,
and each holder was a sophisticated investor with access to all relevant
information.
During the quarter ended March 31, 2002, we issued an aggregate of
1,401,869 shares of our common stock to certain holders of our Series E
Preferred stock upon the conversion of shares of our Series E Preferred stock.
No consideration was received in connection with the issuance of such shares.
The issuances of the shares of our common stock upon exchange of our Series E
17
Preferred stock were exempt from registration under Section 4(2) of the
Securities Act of 1933, were made without general solicitation or advertising,
and each holder was a sophisticated investor with access to all relevant
information.
On January 10, 2002, we sold 395,788 shares of our common stock to S.A.C.
Capital Associates, LLC for aggregate consideration of $395,788. On January 11,
2002, we sold 803,444 shares of our common stock to SDS Merchant Fund, L.P. for
aggregate consideration of $803,444. The sales were exempt from registration
under Section 4(2) of the Securities Act of 1933, were made without general
solicitation or advertising, and each purchaser was a sophisticated investor
with access to all relevant information.
On January 17, 2002, we issued 238,588 shares of our common stock to Jotter
Technologies, Inc. in exchange for the cancellation of a promissory note made to
Jotter in the amount of $1,506,000, which included both principal and interest,
offset by a debt discount. The issuance was exempt from registration under
Section 4(2) of the Securities Act of 1933, was made without general
solicitation or advertising, and the purchaser was a sophisticated investor with
access to all relevant information.
On February 25, 2002, we issued 36,429 shares of our common stock to H.C.
Wainwright as compensation for placement agent services in connection with the
Special Warrant Offering in January 2002, as well as certain placement agent
services provided in April 2001. The issuance was exempt from registration under
Section 4(2) of the Securities Act of 1933, was made without general
solicitation or advertising, and the purchaser was a sophisticated investor with
access to all relevant information.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
None.
(b) Reports on Form 8-K.
On January 23, 2002, we filed a report on Form 8-K regarding the
Special Warrant Offering to our Series E Preferred stockholders.
On February 4, 2002, we filed a report on Form 8-K regarding a jury
verdict in the case brought against us by International Interest Group, Inc.
On February 22, 2002, we filed a report on Form 8-K regarding a motion
filed by us in the case brought by International Interest Group, Inc. as well as
an update on the results of the Special Warrant Offering to our Series E
Preferred stockholders.
On April 10, 2002, we filed a report on Form 8-K regarding reporting
judgment in the case brought against us by International Interest Group, Inc.
On May 7, 2002, we furnished, but did not file, on a report on Form
8-K information to be distributed or discussed at an investors' conference.
18
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: May 15, 2002 BY: /s/ Jon C. Engman
-----------------------------
Jon C. Engman
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
19