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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2001 or
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission file number 0-2027
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 NE 1st Street, Suite B-304
Bellevue, WA 98005
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (425) 278-1100
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value per share
(Title of Class)
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 [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the last reported sale on the OTC Electronic Bulletin
Board on March 19, 2002, was $1.34. Excludes shares held of record on that date
by directors, executive officers and greater than 10% stockholders of the
registrant. Exclusion of such shares should not be construed to indicate that
any such person directly or indirectly possesses the power to direct or cause
the direction of the management or the policies of the registrant. There were
12,251,337 shares of Common Stock outstanding as of March 19, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Report, to the extent not set
forth herein, is incorporated herein by reference from the registrant's
definitive proxy statement relating to the registrant's 2002 annual meeting of
stockholders, which definitive proxy statement shall be filed with the
Securities and Exchange Commission within 120 days after the end of the fiscal
year to which this Report relates.
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ABOUT FORWARD-LOOKING STATEMENTS
Certain statements in this Annual Report on Form 10-K constitute forward-
looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995, that are not historical facts but rather reflect our
current expectations concerning future results and events. Words such as
"believe," "expect," "intend," "plan," "anticipate," "likely," "will," "may,"
"shall" and similar expressions are intended to identify such forward-looking
statements. Such forward-looking statements involve known and unknown risks,
uncertainties and other important factors that could cause the actual results,
performance or achievements of our company (or entities in which we have
interests), or industry results, to differ materially from historical results
or future results, performance or achievements expressed or implied by such
forward-looking statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements which reflect management's view only as of the date of this Annual
Report on Form 10-K. 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 beliefs regarding trademark and copyright protections, our beliefs and
expectations regarding infringement claims, our beliefs regarding the
development of industry standards, our expectations and beliefs regarding our
ability to hire and retain personnel, our beliefs regarding period to period
results of operations, 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, our expectations regarding defects in products, our expectations
regarding fluctuations in revenues and operating results, our beliefs and
expectations regarding our existing facilities and the availability of
additional space in the future, our intent to use all available funds for the
development and the operation of our business and not to declare or pay any
common stock cash dividends, our expectations regarding software development
costs, our beliefs and expectations regarding our results of operation and
financial position, our beliefs regarding estimates in valuing in-process
research and development, our intentions and expectations regarding deferred
tax assets, our beliefs and expectations regarding liquidity and capital
resources and that cash flow from existing operations, existing cash, cash
equivalents and short-term investments will be sufficient to meet our cash
requirements, and our expectations regarding the impact of recent accounting
pronouncements and revenue recognition matters. These statements are subject to
risks and uncertainties that could cause actual results and events to differ
materially from those anticipated. These risks and uncertainties include
without limitation those identified in the section of this annual report on
Form 10-K entitled "Risk Factors That May Affect Future Results" below. 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.
As used in this annual report on Form 10-K, unless the context otherwise
requires, the terms "we," "us," "the Company," and "Saflink" refer to Saflink
Corporation, a Delaware corporation, and its subsidiaries.
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PART I
Item 1. Business
General
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 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.
The process of identity authentication typically requires that a person
present for comparison one or more of the following factors:
. something known such as a password, PIN, or mother's maiden name;
. something carried such as a token, card, or key; or
. something physical such as fingerprint, iris or voice pattern, signature
motion, facial shape or other biological or behavioral characteristic.
Comparison of biological and behavioral characteristics has historically
been the most reliable and accurate of the three factors, but has also been the
most difficult and costly to implement into a single product that can
automatically verify the identity of a user accessing a computer network or the
Internet. However, recent advances in biometric collection technologies (both
biometric hardware products and their associated processing software) have
increased the speed and accuracy and reduced the cost of implementing
biometrics in commercial environments. We believe that individuals, Web site
operators, government organizations, and businesses will increasingly use this
method of identity authentication.
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 Saflink under contract to 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.
We are positioning and promoting our Secure Authentication Facility, or SAF,
brand in conjunction with selected biometric technologies currently available
in the marketplace including those from:
. AuthenTec, Inc., Billionton Systems, Inc., Lifeview, Inc., Targus Group
International, Startek Engineering, Inc., Zvetco Biometrics, Inc.,
SecuGen Corporation, Veridicom, Inc., and Precise Biometrics A.B. for
fingerprint imaging;
. Lernout & Hauspie Speech Products NV for voice verification;
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. Visionics Corporation for facial recognition; and
. Iridian Technologies, Inc., Panasonic Security and Digital Imaging Co.,
and Oki Electric Industry Co., Ltd. for iris recognition.
Market Overview
As computer use migrates towards a networked environment, individuals and
organizations are becoming more aware and concerned about protecting the
privacy and ensuring the security of information maintained on personal
computers, the Internet, and corporate systems. A number of technologies and
strategies have been developed to address this concern, including new
encryption methods, firewalls, intrusion detection tools, access permission
systems, passwords, identification cards or tokens, digital certificates, and
single sign-on applications. However, the effectiveness of each of these
technologies and strategies is dependent upon the most critical and vulnerable
component of the security process: positive personal identification and
authentication of the individual seeking access.
With the growth of electronic commerce, access points to the Internet and
corporate networks (which we sometimes refer to as enterprise networks) have
increased significantly, and now include corporate desktops, home PCs, mobile
laptops, and hand-held devices. Using passwords as the primary method of
verifying the identity of remote users is subject to a number of security
weaknesses. Passwords are frequently shared.
Passwords are often written down and placed where others can see them. Common
passwords like a user's pet's name or spouse's name can be guessed. More
complex passwords can be broken through sophisticated "dictionary" attacks
based on tools that are easily available from Internet websites. For large
organizations, there is also a measurable cost of managing forgotten and
expired passwords relating to administration overhead and lost employee
productivity.
We believe that a sustainable market is developing for biometric
technologies used in information security and data privacy applications. There
are several factors that we believe will contribute to the growth of this
industry:
. Concern regarding critical infrastructure security which has been
heightened significantly since the terrorist attacks of September 11,
2001. As a result, federal and local government funding is being
increased to help protect critical government network infrastructures.
The private sector is also recognizing the importance of securing
networks against attacks by cyber-terrorists and is seeking more secure
methods of user authentication.
. Recent publicity regarding biometric authentication. According to a
January, 2002 quote from a publication of the International Biometric
Industry Association, "The final one hundred days of 2001 were perhaps
more notable for the degree to which biometrics were elevated in public
consciousness. Surging curiosity about biometrics led to Congressional
hearings and extensive media coverage that vastly broadened knowledge
about how the technologies could serve as an important tool to help
protect facilities, networks, and infrastructure from attack and
disruption."
. Highly publicized security breaches in computer networks and Internet
sites, which have been traced to the vulnerability of password-based
authentication systems.
. The growth of e-commerce as a medium for business and consumer
transactions, which requires the implementation of technologies that
facilitate the positive identification of anonymous parties.
. The cost and inconvenience of using multiple passwords is inconvenient
for users and expensive for businesses to support.
. The information technology industry is beginning to utilize advanced
solutions to protect computer information. The primary means of
protecting computer information is data encryption, which requires
protection of the encryption "keys" used to lock up the data. Today,
these keys are commonly protected by simple PIN numbers or passwords. We
believe biometrics will play an important role in protecting these keys
from unauthorized access.
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. IT industry leaders such as Computer Associates, Novell, Microsoft, IBM,
Intel, and Compaq are supporting the integration of biometrics within
their systems platforms and have publicly announced that information
security is a top corporate focus.
. Rapidly falling prices for biometric collection devices, such as
fingerprint sensors, digital cameras, microphones, etc., and improvements
in the accuracy, performance and user acceptance of the technology have
made integration of biometrics with desktop PCs and portable computers a
cost effective security alternative for the commercial market. The
proliferation of multimedia-ready PCs equipped with microphones and
soundcards makes voice identification an affordable solution for some
potential users.
. New and even more powerful biometric devices, such as silicon chip-based
fingerprint sensors and iris recognition cameras, are also becoming
commercially available from name-brand commercial vendors like Targus and
Panasonic.
. The International Biometric Industry Association (IBIA), the industry's
official trade association, has been effective in helping to shape public
policy in favor of the use of biometrics as a viable security mechanism.
. Finally, the BioAPI Consortium, a group of over 85 organizations from the
biometrics industry, government and information technology vendors, has
succeeded in having Version 1.1 of the BioAPI Specification accepted as
an official standard by the American National Standards Institute (ANSI).
This specification defines a single industry standard software
specification for connecting biometric devices to computer systems that
is expected to encourage implementation of biometrics by facilitating the
interoperability of different biometric technologies.
We believe that all of these factors will create increased demand for
enterprise network security products that use biometrics. We believe that one
of the fastest growing markets for biometrics is the large internal corporate
computer network. Biometrics generally offers a low-cost, simple solution to
ensure the positive identification of employees seeking access to sensitive
data and applications over a corporate computer network.
Products
Our software products use biometric technologies to improve workstation and
internal enterprise network security. Instead of being asked for a password,
users are prompted for their unique biometric characteristic using any one of a
number of biometric technologies. We build software that will work with a
variety of biometric devices, including fingerprint scanners, iris cameras,
facial recognition cameras and microphones using speaker verification
technology. Sales of our products have been limited to date. Our products can
be divided into two groups--enterprise network products, and standalone
workstation products.
Enterprise Products:
Our enterprise products are designed to operate in the computer network
environment of large corporations and include:
. SAF2000 for the Enterprise--SAF2000 replaces passwords for enterprise
users that are accessing a Microsoft Windows NT or Windows 2000 network
server from a computer running Microsoft Windows. Biometric information
is stored and managed on a separate central database using a SAF2000
component called the SAFserver. SAF2000 provides features for the system
administrator that assist in managing the initial enrollment and storage
of biometric information. These features are provided as extensions to
Microsoft's standard administrative tools so that system administrators
do not have to learn how to use a new tool. Communication between an
individual employee's computer and the SAFserver is secure and encrypted.
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. SAFmodule for NMAS--SAFmodule is a companion product to Novell
Corporation's Novell Modular Authentication Service (NMAS) security
product and is fully certified and tested by Novell as an approved NMAS
authentication method. SAFmodule replaces passwords for enterprise users
that are accessing a Novell NetWare server and Novell's e-Directory
central repository from a computer running Novell software components.
SAFmodule extends Novell's administrative tools to assist the
administrator in managing the initial enrollment and storage of biometric
information. Communication between the individual employee's computer and
the Novell server is secure and encrypted. SAFmodule has also been
qualified for use with the single sign-on (SSO) products from both Novell
and from Passlogix, Inc. SSO products provide fast connection to host
computers and applications on a network by supplying a user's password
automatically from a file. We provide the initial user access to the SSO
software product through a secure biometric verification of the user for
enhanced security. SAFmodule also includes a feature that enables
employees on a company network to share account privileges for specific
work-related reasons, e.g., a senior executive who wishes a trusted
assistant to enter and manage the executive's personal email account.
This feature allows an administrator to delegate the logon rights of
employees to authorized assistants or co-workers via SAFmodule's security
control interface. The delegate then uses his or her own biometric ID to
access the other person's account. To ensure accountability, all delegate
logons are automatically audited and logged for later review by security
administrators.
. SAFaccess for eTrust SSO--SAFaccess is a companion product to Computer
Associates' eTrust Single Sign-On (SSO) security product. SAFaccess
provides a secure and positive biometric verification of a user's
identity when they are attempting to access the SSO product provided by
Computer Associates. SAFaccess extends the standard administrative tools
provided by Computer Associates to manage the initial enrollment and
storage of biometric information on the SAFserver database. SAFaccess
also now supports the combination of tokens and biometric authentication.
Tokens can include smart cards or proximity cards. One proximity card
product supported by SAFaccess is capable of automatically capturing a
person's user name from a distance of up to 12 feet.
Standalone Workstation Products:
. SAF2000 for Workstations--SAF2000 for Workstations is a standalone
desktop product that replaces traditional passwords with biometric
verification for anyone using a computer that runs Microsoft Windows.
. SAFsolution: Windows Workstation Edition--SAFsolution is a new product
based on common software components originally developed for SAFmodule
for NMAS and is intended to replace SAF2000 for Workstations.
SAFsolution provides multi-biometric logon and unlocking of Windows
workstations based on Microsoft NT/2000/XP operating systems.
SAFsolution stores the user's biometric information and Windows password
in a hidden encrypted file on the local workstation disk drive. When
properly configured, SAFsolution also logs the user onto the enterprise
network using the cached network profile stored in the local disk drive.
SAFsolution is intended to provide a simple and low-cost method of
deploying biometric authentication in an enterprise environment without
requiring additions or modifications to the network server components.
SAFsolution is also intended to provide a direct upgrade path to later
enterprise versions of SAFsolution that will be fully integrated with
Microsoft's Active Directory Service (ADS) and Microsoft Management
Console (MMC) for central storage and management of biometric
credentials. SAFsolution has also been qualified to directly interface
with the Passlogix, Inc. v-GO Single Sign-On product.
Marketing and Distribution
We use both direct and indirect sales and marketing to market our products
and services. Our sales staff focuses on selling our products to end-user
customers primarily within the sectors of healthcare, education, government,
industry and financial services in North America. Our business development
staff trains and supports our indirect distribution partners, who resell our
products worldwide.
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We market our products to potential customers across a wide range of general
business sectors primarily through:
. direct sales representatives who contact potential end-user customers
through leads generated by our various marketing initiatives;
. distributors who act as middle-men distributing our products to a network
of resellers in a specified region outside the United States;
. resellers who purchase our products directly from us and sell them to
end-user customers in a specified geographic region;
. original equipment manufacturer resellers (hardware manufacturers) who
buy our software to resell to customers with their hardware as a combined
or "bundled" product;
. sales agents who act like "manufacturer's representatives" to introduce
our products into key accounts; and
. strategic alliance partners, such as Novell, Computer Associates and
Passlogix who introduce us into their customer accounts that need
biometric authentication features added to their respective product
platforms.
Our relationships with distributors, resellers, original equipment
manufacturer resellers and sales agents are generally formalized in written
contracts that address the specific products that can be sold, applicable
pricing discounts and the geographic territory within which our products can be
sold. Our strategic alliances are with companies that have formal "partner"
programs. These companies publicize our status as an alliance partner on their
web sites and in other publications and forums. Alliance partnerships provide
us with specific benefits such as:
. access to key alliance partner technical, marketing and sales personnel;
. early access to new versions of the alliance partner's software so that
we can modify ours and release our upgraded product at the same time as
our alliance partner releases its new software version;
. ability to package our products with our alliance partner's product; and
. participation in joint partner marketing programs such as seminars, trade
shows, conferences, and co-op advertising.
Our marketing goals include identifying potential distributors and resellers
of our products, creating awareness of our product offerings, generating leads
for follow-on sales and achieving greater order volume by disseminating our
products through multiple direct and indirect distribution channels worldwide.
Some of our reseller partners combine our enterprise software with their own
biometric technology and sell the combined product through their own sales
channels. We are also engaged in establishing relationships with international
distributors that will carry our products and make them available to a broader
audience of secondary distributors and resellers within their markets.
Our software products are typically priced on the basis of the number of
users that have enrolled their biometric information into the central server
database. As the number of users increases, the software license price per user
decreases. Resellers purchase our products at a favorable discount for resale
at a price that provides an attractive gross margin for the reseller. We
believe that this pricing model is competitive and cost-effective for the end-
user customer and is attractive to our resellers.
Enterprise Products:
We intend to focus our resources on promoting our enterprise network
security products to take advantage of the growing awareness of the importance
of protecting enterprise network infrastructures from unauthorized
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access. We have a team of three business development and three sales
professionals who are located in various regions of the country. They focus
their marketing efforts on high profile end-user customers. They also identify,
recruit, train and support a network of distributors and resellers. Typically,
these resellers are already selling enterprise network products that are based
on Microsoft, Novell or Computer Associates products and our products will
complement these. Our resellers often provide a range of additional services to
their customers, including network component sales, network consulting, systems
installation, technical services and network management services.
We also sell our products alongside the sales organizations of Novell,
Computer Associates and Passlogix. We believe products complement theirs and
fill a customer need that would not otherwise be met. We strive to leverage the
existing sales organizations and reseller networks of these companies to
achieve sales of our products at minimum expense. We work closely with each of
these strategic alliance partners to support these joint sales efforts.
Standalone Workstation Products:
We intend to offer our new SAFsolution: Windows Workstation Edition product
through biometric technology resellers that want to package this product with
their biometric technology to create a bundled product for their customers. We
intend to market SAFsolution will also be marketed through the direct and
traditional reseller channels as a basic offering. We believe this will provide
a set of biometric authentication functions that can be utilized "out of the
box" as a first step to deploy biometric authentication within an enterprise
setting to create a bundled product for the customer.
Technology Partnerships and Licensed Technology
Nine technology partners supply us with fingerprint-based devices and
algorithms, which are used to capture a fingerprint image. Each fingerprint
scanner, known as "hardware", that we purchase for resale is accompanied by
fingerprint basic software, which is used to recognize the fingerprint image.
The software that we produce allows our customers to use this fingerprint
hardware and software to gain access to a secure computer network or
workstation. Our technology partners' products are packaged with ours into a
single product for sale to our customers. Most of the business relationships
with these companies can be characterized as manufacturer-to-reseller
agreements. The fingerprint vendor suppliers that we support have established
no-cost software licensing arrangements with us. We sell fingerprint scanners
or software provided by the following companies:
. AuthenTec, Inc.--Makes chip-based fingerprint technology components for
standalone and keyboard-integrated fingerprint readers and packaged
software algorithms.
. Billionton Systems, Inc.--Makes chip-based fingerprint reader devices
packaged into a Personal Computer Memory Card (PCMCIA) configuration for
laptop computer applications.
. Lifeview, Inc.--Makes chip-based standalone fingerprint reader devices
that are cable-connected to a desktop computer workstation through a
Universal Serial Bus (USB) port.
. Precise Biometrics AB--Makes packaged software algorithms and chip-based
fingerprint reader devices that are packaged into a computer keyboard for
standalone and keyboard-integrated fingerprint readers that are cable-
connected to a desktop computer workstation through a parallel or USB
port.
. SecuGen Corporation--Makes packaged software algorithms and optics-based
fingerprint reader devices technology for standalone, mouse-integrated,
and keyboard-integrated configurations that are connected to a desktop
computer workstation through a parallel or USB port.
. Startek Engineering, Inc.--Makes chip-based standalone fingerprint reader
devices that are cable-connected to a desktop computer workstation
through a USB port.
. Targus Group International--Makes chip-based standalone fingerprint
reader devices that are cable-connected to a desktop computer workstation
through a USB port.
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. Veridicom, Inc.--Makes chip-based fingerprint technology for standalone
fingerprint readers.
. Zvetco Biometrics, Inc.--Makes chip-based standalone fingerprint reader
devices that are cable-connected to a desktop computer workstation
through a USB port.
We also buy iris recognition, voice verification and facial feature
recognition software from various companies with which we have licensing
arrangements permitting us to resell their software. We bundle our technology
partners' recognition software into our own software products for sale to end-
users. Each licensing agreement requires us to pay the licensor a specified
minimum royalty or a percentage of the revenues we receive from selling the
bundled product. These license agreements are with the following companies:
. Lernout & Hauspie Speech Products NV--Makes speaker verification
technology for text dependent technology modules that work with a Windows
sound card and microphone.
. Visionics Corporation--Makes face recognition technology for modules that
work with a Microsoft Video for Windows compatible desktop
videoconferencing camera.
. Iridian Technologies, Inc.--Makes iris recognition technology.
We are not dependent on any of these licensing arrangements. Additionally,
the bulk of our business relates to fingerprint technology and those
relationships are based on no-cost licensing arrangements.
We buy iris recognition camera hardware from Panasonic Security and Digital
Imaging Company for use with the Iridian Technologies licensed software.
Panasonic makes a dual-function iris recognition camera that provides iris
capture and videoconferencing capability and connects to a desktop computer
workstation through a USB port.
We also license our products to two original equipment manufacturer (OEM)
companies that package our software with their biometric devices and sell them
through their own distribution channel to end-users as a bundled solution.
These OEM companies include the following:
. Oki Electric Industry Co., Ltd.--Makes a hand-held iris recognition
camera that connects to a desktop computer workstation through a USB
port.
. SecuGen Corporation--Makes packaged software algorithms and optics-based
fingerprint reader devices for standalone, mouse-integrated, and
keyboard-integrated configurations that are connected to a desktop
computer workstation through a parallel or USB port.
We are able to provide our customers with a choice of technology by
combining the appropriate biometric "plug-in" software module with our API
standards-based, application software product framework. The customer may also
purchase these plug-in API-compliant modules, and the related biometric device
hardware, that will work with our software from third parties. Our strategy is
to evaluate, qualify, and integrate select biometric technology available from
new and current technology vendors. We are in various stages of qualification
of additional potential technology partners.
Competition
Other companies that have also developed software products that utilize
biometric identification technology and are active in the United States include
BioconX, Inc. BioNetrix, Inc., Digital Persona, Inc., Ankari, Inc., Keyware,
Inc., and I/O Software, Inc. Our strategy is to differentiate our products in
the marketplace by offering products that
. are competitively priced
. meet the requirements for large-scale enterprise network implementation
. are able to use more than one biometric characteristic for
identification,
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. are open-systems-standards compliant
. are scalable as new users are added
We expect to continue to face competition from non-biometric technologies
such as traditional passwords, token cards, smart cards, and digital
certificates. While in some instances we will compete with these technologies,
our strategy is to integrate other factors of authentication into our products.
For example "digital certificates" provide a secure method of encrypting
messages and accessing services. However, only a password or PIN number often
protects the sender's certificate key. We currently offer SAF products that
support smart cards, radio-frequency (RF) proximity badges and digital
certificates, and we intend to continue to enhance these offerings.
As a non-exclusive licensee of biometric technologies, we also expect to
experience competition from other products and services incorporating the
technology that we license.
Patents and Trademarks
We hold five assigned patents covering fingerprint imaging technology which
we believe can be utilized to enhance and create strategic relationships with
fingerprint technology companies, television set-top companies, and hand held
computer companies that will promote or use SAF software products:
. Patent 5,546,471: Ergonomic Fingerprint Reader Apparatus issued August
13, 1996, provides for an ergonomic fingerprint acquisition device. This
device has two displaced surfaces that provide a natural grasping surface
for the hand. The natural grasping surface ensures that a broad
fingerprint surface area is applied with even pressure to the fingerprint
reading device itself. We believe that this invention solves one
significant problem of typical fingerprint capture devices: ensuring that
the same finger is placed in the same position, with consistent
orientation and pressure, to improve overall system performance by
yielding a high quality fingerprint image capture at time of registration
and verification.
. Patent 5,596,454: Uneven Surface Image Transfer Apparatus issued January
21, 1997, provides for a high performance integrated optical system. We
believe that this invention solves one significant problem of typical
fingerprint capture devices: the large size of an optical element
required to acquire a high resolution, distortion-free image of a
fingerprint. Solving this problem dramatically reduces the physical
footprint required for any fingerprint reader or integrated application
of a fingerprint acquisition device. In addition, the invention specifies
a single element multiple lens solution that dramatically reduces
production cost while improving product reliability, durability and
longevity.
. Patent 5,920,642: Ergonomic Fingerprint Reader Apparatus issued July 6,
1999, is directed to improvements in television set-top box technology.
The remote control used with the set-top box captures fingerprint data
and operator account information and transmits them to the set-top box to
be matched with stored fingerprint data. The results are used to adjust
an operator's preferences, modify the provided level of service, or
authorize a transaction against a specific account.
. Patent 6,028,950: Fingerprint Controlled Set-Top Box issued February 22,
2000, discloses a method for securing electronic commerce transactions
initiated via a television set-top box using a fingerprint and is a
continuation of Patent 5,920,642. The fingerprint can be acquired by a
device built into the set top box or by a device built into the remote
control unit. The stored fingerprint data of the customer can be stored
in the set top box, a central server, distributed remote server, smart
card, or other form of "portable data file." We believe that this
invention solves the problem of positively identifying customers making
e-commerce transactions from a home set top access terminal.
. Patent 6,041,134: Ergonomic Fingerprint Reader Housing issued March 21,
2000, provides for an ergonomic fingerprint acquisition device. This
device has two displaced surfaces that provide a natural grasping surface
for the hand. The natural grasping surface ensures that a broad
fingerprint surface area is applied with even pressure to the fingerprint
reading device itself. We believe that this invention
9
solves one significant problem of typical fingerprint capture device:
ensuring that the same finger is placed in the same position, with
consistent orientation and pressure, to improve overall system performance
by yielding a high quality fingerprint image capture at time of
registration and verification.
In addition, we have pending applications for our SAF software. There is no
assurance that we will be granted any pending patents, that any patent
previously granted will prove enforceable, or that any competitive advantage
will exist for us because of these patents or patent applications.
We also rely on unpatented know-how, trade secrets and continuing research
and development. We may not have any protection from other parties who
independently develop the same know-how and trade secrets. Protection of our
proprietary products and services may be important to our business, and our
failure or inability to maintain this type of protection could have a material
adverse affect on our business, condition (financial or otherwise), results of
operations and prospects. Moreover, while we do not believe that the production
and sale of our proposed products or services infringe on rights of third
parties, if we are incorrect in this regard, failure to obtain needed licenses
from these third parties could have a material adverse effect on our ability
either to complete the development of certain products or services or to
produce and market these products or services. Failure to obtain any of these
types of licenses could adversely impact our business, condition (financial or
otherwise), results of operations and prospects.
We also license certain patents or other intellectual property (including
biometric hardware or software products) from other companies. The competitive
nature of our industry makes any patents and patent applications of our
licensors important to us. There is no assurance that any of the patent
applications of these licensors will be granted, that patents previously
granted will prove enforceable, or that any of these patents or patent
applications will lead to any competitive advantage for us.
We have registered certain service marks and trademarks with the United
States Patent and Trademark Office. In addition, we have purchased the rights
to certain other service marks and trademarks registered with the Canadian
Trademark Office and the United States Patent and Trademark Office by Jotter.
However, we have not registered certain other trademarks and trade names which
we use with the United States Patent and Trademark Office nor in any foreign
government trademark offices. With respect to unregistered trademarks, we
accompany the use of these trademarks with our name to indicate the origin of
the products to which they are applied, to distinguish them from the products
of competitors and to build goodwill in these trademarks. Certain rights,
however, are protected under the provisions of the Lanham Act and under state
law in respect of unregistered or common law trademarks.
Employees
As of March 25, 2002, we had 32 full-time employees. From time to time, we
also utilize consultants for specific assignments.
We are an employment-at-will employer and none of our employees are
represented by a labor union. We believe that our relationship with our
employees is good. We believe that our future success will depend in part on
our ability to both retain our existing technical and other personnel and to
attract and retain other qualified employees.
Item 2. Properties
We lease our current principal executive offices, consisting of
approximately 5,049 square feet, at 11911 N.E. 1st Street, Suite B-304, in
Bellevue, Washington. We also lease approximately 8,400 square feet of office
space in Edmonton, Alberta, Canada as well as 3,400 square feet of office space
in Reston, Virginia. We believe that our facilities are adequate to satisfy our
projected requirements, and that additional space will be available if needed.
10
Item 3. 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 the Company in the
case brought by IIG, although a final order of the Court has not yet been
entered. The verdict was 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, 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 the Company
intends to vigorously oppose. Payment of a judgment in the amounts
aforementioned could have a material adverse affect on the Company's financial
condition.
Item 4. Submission of Matters to a Vote of Security Holders
None.
11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Prior to August 9, 2001, our common stock was listed on the Nasdaq's
SmallCap Market under the symbol "ESAF"; however, on May 31, 2001, Nasdaq
suspended trading in our stock. On August 9, 2001, our stock was delisted from
the Nasdaq's SmallCap Market for our failure to meet the minimum bid price and
net tangible assets/shareholder equity requirements of the Nasdaq Marketplace
Rules. Our stock, which began trading on the Pink Sheets on August 10, 2001,
is currently quoted both on the Pink Sheets and the OTC Electronic Bulletin
Board. There is no assurance that a viable public market for our shares will
develop in the future or, if one develops, that this type of market will be
sustained. On November 19, 2001, we effected a seven-to-one reverse stock
split and changed our stock symbol to SFLK.
The following table sets forth the range of high and low sales prices for
our common stock as reported on the Nasdaq SmallCap Market (without retail
markup or markdown and without commissions) for each full quarterly period
from January 1, 2000 through August 9, 2001 and the range of high and low bid
prices for our common stock as quoted on the over-the-counter market from
August 10, 2001 through December 31, 2001, as adjusted for our seven-for-one
reverse stock split on November 19, 2001. The over-the-counter market figures
shown below reflect inter-dealer prices, without retail mark-up, mark-down or
commission, and may not necessarily represent actual transactions.
Common Stock
Sales Price
---------------
High Low
------- -------
Fiscal year ended December 31, 2000:
First Quarter................................................ $53.374 $17.500
Second Quarter............................................... 35.328 15.750
Third Quarter................................................ 18.375 9.625
Fourth Quarter............................................... 11.816 2.191
Fiscal year ended December 31, 2001:
First Quarter................................................ 12.467 3.50
Second Quarter............................................... 6.30 1.54
Third Quarter................................................ 2.59 0.56
Fourth Quarter............................................... 2.52 1.25
On March 19, 2002, the last reported sales price of our common stock was
$1.34 per share. As of March 19, 2002 there were approximately 368 record
holders of our common stock. Since our incorporation, we have 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 foreseeable future.
On March 13, 2001, we issued 728,572 shares of our common stock, at $4.41
per share, as consideration to Jotter pursuant to the December 15, 2000 asset
purchase agreement between Jotter Technologies and us. Shares were issued
pursuant to an exemption by reason of Regulation D of the Securities Act of
1933. The issuance was made without general solicitation or advertising. The
investor was a sophisticated investor with access to all relevant information.
The following issuances of warrants from March 13, 2001 to May 17, 2001
were made in connection with our bridge loan transaction. The exercise price
of each of the warrants issued in the transaction of $10.50 per share was
greater than the closing price of the common stock on the date of grant. The
warrants were issued pursuant to an exemption by reason of Section 4(2) of the
Securities Act of 1933. The issuances were made without general solicitation
or advertising. The investors were sophisticated investors with access to all
relevant information.
. On March 13, 2001, we issued a warrant to purchase up to 8,929 shares of
our common stock as partial consideration for a bridge loan in the
amount of $250,000 from SDS Merchant Fund, LP. The warrant was fully
vested on grant and is exercisable until March 31, 2006.
12
. On March 21, 2001, we issued warrants to purchase up to 2,456 shares of
our common stock as partial consideration for two bridge loans. The
loans in the amount of $18,750 and $50,000 were received from Forum
Partners, and Freya Fanning, respectively. The warrants were fully
vested on grant and are exercisable until March 31, 2006.
. On March 29, 2001, we issued a warrant to purchase up to 1,608 shares of
our common stock as partial consideration for a bridge loan in the
amount of $45,000 from Dana Bowler. The warrant was fully vested on
grant and is exercisable until March 31, 2006.
. On April 2, 2001, we issued a warrant to purchase up to 893 shares of
our common stock as partial consideration for a bridge loan in the
amount of $25,000 from Dana Bowler. The warrant was fully vested on
grant and is exercisable until April 20, 2006.
. On April 13, 2001, we issued a warrant to purchase up to 1,072 shares of
our common stock as partial consideration for a bridge loan in the
amount of $30,000 from Dana Bowler. The warrant was fully vested on
grant and is exercisable until April 20, 2006.
. On April 16, 2001, we issued a warrant to purchase up to 715 shares of
our common stock as partial consideration for a bridge loan in the
amount of $20,000 from Dana Bowler. The warrant was fully vested on
grant and is exercisable until April 20, 2006.
. On April 30, 2001, we issued a warrant to purchase up to 358 shares of
our common stock as partial consideration for a bridge loan in the
amount of $10,000 from Anthony Forstmann. The warrant was fully vested
on grant and is exercisable until April 20, 2006.
. On May 14, 2001, we issued a warrant to purchase up to 7,144 shares of
our common stock as partial consideration for two bridge loans in the
amounts of $50,000 and $150,000 from Dana Bowler and Freya Fanning,
respectively. The warrant was fully vested on grant and is exercisable
until May 31, 2006.
. On May 15, 2001, we issued a warrant to purchase up to 536 shares of our
common stock as partial consideration for a bridge loan in the amount of
$15,000 from Dana Bowler. The warrant was fully vested on grant and is
exercisable until May 31, 2006.
. On May 17, 2001, we issued warrants to purchase up to 5,894 shares of
our common stock as partial consideration for three bridge loans in the
amounts of $35,000, $100,000 and $30,000 from Dana Bowler, Freya Fanning
and Peter Brim, respectively. The warrant was fully vested on grant and
is exercisable until May 31, 2006.
. On April 20, 2001, in conjunction with extending the payment terms of a
Development and Distribution Agreement entered into between Anovea, Inc.
and us effective September 18, 2000, we issued a warrant to purchase up
to 2,858 shares of our common stock at an exercise price of $7.00 per
share to Anovea. The warrant was fully vested upon grant and is
exercisable until April 20, 2003. On April 30, 2001, we also issued a
warrant to purchase up to 2,858 shares of our common stock at an
exercise price of $7.00 per share to Anovea, Inc. The warrant was fully
vested upon grant and is exercisable until April 30, 2003. In addition,
we issued a warrant to purchase up to 1,429 shares of our common stock
at an exercise price of $3.50 per share to Anovea. The warrant was fully
vested upon grant and is exercisable until May 31, 2003. These warrants
were issued pursuant to an exemption by reason of Section 4(2) of the
Securities Act of 1933. The issuances were made without general
solicitation or advertising. Anovea had an existing business
relationship with us prior to the grant of the warrants. On May 31,
2001, the 5,716 warrants issued to Anovea on April 20 and April 30 were
repriced at $3.50 per share.
On June 5, 2001, we 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 approximately $2.2 million in bridge notes and
accrued interest, in a private placement to 66 accredited investors. The shares
were issued pursuant to an exemption by reason of Regulation D of the
Securities Act of 1933. The issuance was made
13
without general solicitation or advertising. The Series E convertible preferred
stock issued in this transaction is convertible into 5,714,309 shares of our
common stock at any time until June 5, 2004. The preferred stock will not pay a
dividend and holders of the stock will have no voting rights other than the
right to elect two members of the Board of Directors. 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 purchase price
will increase to $3.50 per share and will be exercisable until June 5, 2006.
Series B warrants to purchase approximately 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.
In connection with the Series E financing, on June 5, 2001, we issued
placement agent warrants to 10 accredited investors to purchase 428,575 shares
of common stock at $1.40 per share exercisable until June 5, 2006. The warrants
were issued pursuant to an exemption by reason of Section 4(2) of the
Securities Act of 1933. The issuance was made without a general solicitation or
advertising. The investors were sophisticated investors with access to all
relevant information.
On July 27, 2001, we entered into a Modification Agreement with certain
purchasers in the Series E 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 and the Series A and
Series B warrants were amended. In particular, we entered into the Modification
Agreement to extend certain dates by which we had committed to meet obligations
with respect to the purchasers and to eliminate 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 us in the event we fail
to register the common stock underlying the preferred stock and Series A and B
warrants, extend the deadline by which we 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 our stockholder meeting. This
approval was obtained on September 24, 2001.
A one-for-seven reverse stock split of our common stock became effective on
November 19, 2001, for stockholders of record on that date.
On January 8, 2002, we issued approximately 4,835,000 shares of our common
stock to accredited investors upon the exercise of Series A and Series B
warrants resulting in the issuance of a like number of 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 us of the payment in full of
such warrant holders' special exercise price by the close of business on
January 8, 2002. We received funds totaling approximately $6 million in
connection with this exercise of a portion of our outstanding Series A and
Series B warrants together with a sale of approximately 1,200,000 shares of our
common stock. In connection with the exercise, we issued Series C warrants to
the exercising warrant holders and certain investors discussed below to
purchase approximately 4,835,000 shares of our common stock.
Due to a restriction in the Series A and Series B warrants held by SAC
Capital Associates, LLC and SDS Merchant Fund, LP 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
additional shares of common stock from us without exercising their warrants.
Each of SAC and SDS agreed to purchase at $1.00 per share that number of shares
of our common
14
stock that we 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, each of SAC and SDS will receive a
Series C warrant to purchase that number of shares of our common stock issued
by us to such purchaser upon the exercise of the original Series A and Series B
warrants.
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 certain accredited investors. In connection with the
transaction, we agreed to register for resale under the Securities Act of 1933
the common stock underlying the Series C warrants and the common stock to be
issued to those certain accredited investors, as soon as practicable after the
filing of this Annual Report on Form 10-K with the SEC. In addition, in
connection with this transaction, each purchaser agreed not to sell any common
stock issuable upon conversion of its Series E preferred stock or upon exercise
of its Series A or Series B warrants prior to January 12, 2002.
In connection with the exercise of the Series A and B warrants and the
purchase of common stock by certain accredited investors, 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.
The shares of common stock issued upon the exercise of the Series A and
Series B warrants, the Series C warrants, and the shares of common stock issued
in the special warrant offer were issued pursuant to an exemption by reason of
Section 4(2) of the Securities Act of 1933. The issuances were made without a
general solicitation or advertising. The investors were sophisticated investors
with access to all relevant information.
On January 15, 2002, we issued 238,588 shares of our common stock, valued at
approximately $7.00 per share, to Jotter Technologies, Inc pursuant to our
agreement to issue these shares in exchange for cancellation of a note payable
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. Shares were issued pursuant to exemption by reason of Section 4(2)
of the Securities Act of 1933. The issuance was made without general
solicitation or advertising. The investor was a sophisticated investor with
access to all relevant information.
On November 16, 2001, 375 shares of our Series E preferred stock were
converted into 53,572 shares of our common stock pursuant to a notice of
conversion submitted to us by H.C. Wainwright & Co., Inc. as a holder of the
Series E preferred stock. The original consideration paid for the Series E
preferred stock under the terms of the Series E financing was $75,000. The
issuance was made pursuant to an exemption by reason of Section 4(2) of the
Securities Act of 1933. The issuance was made without general solicitation or
advertising. H.C. Wainwright & Co., Inc. was a sophisticated investor with
access to all of the relevant information.
On December 27, 2001, 50 shares of our Series E preferred stock were
converted into 7,143 shares of our common stock pursuant to a notice of
conversion submitted to us by William Gitow as a holder of the Series E
preferred stock. The original consideration paid for the Series E preferred
stock under the terms of the Series E financing was $10,000. The issuance was
made pursuant to an exemption by reason of Section 4(2) of the Securities Act
of 1933. The issuance was made without general solicitation or advertising.
William Gitow was a sophisticated investor with access to all of the relevant
information.
15
Item 6. Selected Financial Data
Year Ended December 31,
---------------------------------------------
2001 2000 1999 1998 1997
--------- ------- ------- ------- -------
(in thousands except per share data)
Summary Operating Data
Revenue........................ $ 402 $ 1,523 $ 1,303 $ 4,920 $ 1,585
Net loss....................... (14,138) (8,956) (3,927) (1,384) (7,424)
Preferred stock deemed
dividend...................... -- -- -- -- 1,470
Preferred stock dividend and
accretion..................... 1,485 348 104 278 350
Net loss attributable to common
stockholders.................. (15,623) (9,304) (4,031) (1,662) (9,244)
Basic and diluted loss per
common share.................. (3.47) (3.12) (1.61) (1.61) (11.02)
Weighted average number of
common shares................. 4,499 2,983 2,506 1,031 839
As of December 31,
---------------------------------------------
2001 2000 1999 1998 1997
--------- ------- ------- ------- -------
(in thousands except per share data)
Summary Balance Sheet Data
Total assets................... $ 625 $ 7,997 $ 6,782 $ 2,685 $ 2,578
Total liabilities.............. 5,388 6,395 1,184 716 1,807
Long-term debt, net of
discounts..................... 1,506 1,485 -- -- --
Stockholders' equity
(deficit)..................... (4,763) 1,602 5,598 1,969 771
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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 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 to 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.
16
Critical Accounting Policies and Estimates
Saflink's discussion and analysis of its financial condition and results of
operations are based upon our 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 consolidated
financial statements:
. Revenue Recognition. The Company derives 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.
The Company recognizes 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 the Company's 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.
The Company also acts 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.
The Company recognized $46,000, $149,000, and $593,000 of software revenue
from a related party for the years ended December 31, 2001, 2000 and 1999,
respectively. A founder of the related party is a shareholder of the
Company and a director of the Company is an officer of the related party.
Total amounts owing to the Company are zero as of December 31, 2001.
. Intangible Assets. We assess the impairment of identifiable intangible
assets whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors we consider important
which could trigger an impairment review include the following:
. significant underperformance relative to expected historical or
projected future operating results;
17
. significant changes in the manner of our use of the acquired
assets or the strategy for our overall business;
. significant negative industry or economic trends;
. significant decline in our stock price for a sustained period;
and
. our market capitalization relative to net book value.
When we determine that the carrying value of intangibles may not be
recoverable based upon the existence of one or more of the above
indicators of impairment, we measure any impairment based on a projected
discounted cash flow method using a discount rate determined by our
management to be commensurate with the risk inherent in our current
business model.
. 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.
Results of Operating Activities
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.
We incurred a net loss attributable to common stockholders of approximately
$15.6 million for the year ended December 31, 2001, as compared to a net loss
of approximately $9.3 million for the year ended December 31, 2000. Excluding
the amortization of and impairment charge for the intangible assets relating to
the Jotter acquisition in the aggregate amount of $3.8 million, the loss for
the year ended December 31, 2001 was $11.8 million.
The following discussion presents certain changes in our revenue and
operating expenses which have occurred between fiscal years 2001 and 2000 and
between fiscal years 2000 and 1999 and should be read in conjunction with our
Consolidated Financial Statements, including the notes thereto, included
elsewhere in this Form 10-K.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Revenue and Cost of Revenue
Revenue of $402,000 for the year ended December 31, 2001 decreased
approximately $1.1 million from revenue of approximately $1.5 million for the
year ended December 31, 2000. The decrease was primarily due to reduced
promotional activities caused by a shortage of funds during the first six
months of the year. During the last six months of 2001, the Company refocused
its efforts on the enterprise biometric market and concentrated on closing
sales to potential customers who are continuing to evaluate the Company's
product offerings.
Four customers--Triton Resources, Kaiser Permanente, Nufocus and Home
Shopping Network, a related party, accounted for 36%, 29%, 16% and 11% of the
Company's 2001 revenue, respectively.
Cost of revenue consists of software materials, computer hardware, and
services costs, amortization of intangibles and impairment of intangible
assets. The cost of revenue increased from $481,000 in 2000 to $4.0
18
million in 2001. The increase is primarily due to nine months of amortization
of purchased technology totaling $955,000, and an impairment loss of $2.8
million related to the acquisition of substantially all of the assets of
Jotter Technologies in December 2000.
Late in 2001, the Company changed its strategic direction in reaction to
resource limitations and decided not to pursue opportunities related to
technologies acquired in the Jotter acquisition. Accordingly, the Company
determined that the carrying value of the purchased technology was not
recoverable and recognized the impairment loss.
The increase in cost of revenue due to amortization of purchased technology
and the impairment charge were offset by decreases in software, hardware and
services costs of approximately $289,000, combined. This decrease is primarily
the result of lower revenues.
We anticipate that cost of revenue will be more in line with prior year
trends, as a percentage of sales, since we do not anticipate continued
expenses related to amortization of purchased technology or impairment
charges.
Operating Expenses
Excluding amortization of intangibles and one-time charges related to
impairments, restructuring and purchased in-process research and development,
operating expenses for the year ended December 31, 2001 decreased
approximately $2.2 million as compared to the year ended December 31, 2000.
The decrease is primarily due to lower personnel costs as a result of
restructuring as well as decreased travel, entertainment, advertising and
promotion costs.
The following table provides a breakdown of the dollar and percentage
changes in operating expenses:
Changes in
Operating
Expenses
----------------
(000s) Percent
------- -------
Product development............................................ $(1,615) (39)
Amortization of intangibles.................................... 374 *
Impairment loss on intangible assets........................... 1,127 *
Sales and marketing............................................ (827) (47)
Restructuring and relocation................................... 562 251
Purchased in-process research and development.................. (208) (100)
General and administrative..................................... 825 24
------- ----
$ 238 2
======= ====
* Not meaningful
Product Development
Product development expenses consist primarily of salaries, benefits and
equipment for software developers and quality assurance personnel. Product
development expenses decreased from $4.2 million in 2000 to $2.6 million in
2001. The decrease in product development costs is primarily due to decreased
personnel costs of $1.3 million. We reduced our staffing levels by
approximately 13 staff members in product development during June of 2001. 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.
Amortization of Intangible Assets
Amortization of intangible assets reflects the amortization of certain
identifiable intangible assets resulting from the acquisition of Jotter in
December of 2000 and other licensed technology acquired from Anovea, Inc. We
incurred amortization of intangible expenses of $374,000 during 2001. There
was no significant amortization of intangible assets for the year 2000 as the
acquisition occurred in late December. These intangible assets were being
amortized over periods between 2 to 3 years.
19
Impairment loss on intangible assets
In 2001, we 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 our 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 decision by management of
the Company to limit further integration and development of the Jotter
technology into the Company's current and anticipated product offering due to
current resource limitations. We 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
$3.9 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 statements of operations, and approximately $535,000 of
assembled workforce, $460,000 of sales channel customer relationships and
$132,000 related to development and distribution agreements included under the
caption impairment loss on intangible assets in the operating expenses section
of the accompanying statements of operations.
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 decreased from $1.8 million
in 2000 to $929,000 in 2001. The decrease in sales and marketing costs is
primarily due to decreases in personnel costs of $143,000 and decreases in
travel of $185,000 and advertising expenses of $331,000. While we intend to
maintain tight control over sales and marketing expenses in the near term as we
focus our efforts on closing sales with currently identified prospects, we
expect our sales and marketing expenses to increase over the longer term as we
continue to focus on creating demand for our products.
Restructuring and Relocation
Restructuring and relocation expenses consist of costs resulting from the
termination or relocation of employees and other expenses associated with a
corporate restructuring program aimed at streamlining our underlying cost
structure. During 2001, there were no relocation costs. The 2001 expense of
$786,000 is primarily comprised of $304,000 in severance packages to certain
employees, approximately $139,000 in lease termination costs and the write off
of $328,000 in leasehold improvements and other furniture and equipment in
conjunction with the restructuring.
In fiscal year 2000, we incurred $224,000 as a result of the Company's
relocation from Tampa, Florida to Redmond, Washington.
Purchased In-Process Research and Development
In connection with our purchase of the intellectual property and fixed
assets of Jotter in December 2000, we recorded a non-recurring charge of
$208,000 for in-process research and development that had not yet reached
technological feasibility and had no alternative future use. Among the factors
we considered in determining the amount of the allocation of the purchase price
to in-process research and development were the estimated stage of development
of each module of the technology, including the complexity and technical
obstacles to overcome, the estimated expected life of each module, the
estimated cash flows resulting from the revenues, margins, and operating
expenses generated from each module, and the discounted present value of the
cash flows associated with the in-process technologies. There was no similar
expense in 2001, and we do not expect such an expense to recur in the near
term.
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
20
bad debt. General and administrative expenses increased from approximately $3.5
million in 2000 to approximately $4.3 million in 2001. Two large components of
the increase in general and administrative costs were an increase in
professional service fees of approximately $200,000 and the accrual of $450,000
related to the IIG lawsuit. 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.
Interest Expense
Interest expense, net consists of interest expense and bank fees associated
with debt obligations and credit facilities. Interest expense increased from
approximately $141,000 in 2000 to approximately $783,000 in 2001. The increase
in interest expense was primarily attributable to the beneficial conversion
feature on the bridge notes valued at $232,000 with the remaining increase
relating primarily to interest on the bridge notes.
Other Income, Net
Other income, net consists of earnings on our cash and cash equivalent and
short-term investment balances, offset by any miscellaneous charges. Other
income, net increased from approximately $11,000 in 2000 to approximately
$26,000 in 2001. The increase was primarily due to an increase in earnings on
our cash and cash equivalent balances, which carried a higher average balance
than in 2000.
Operating Expense Analysis by Functional Activity
The following table provides an analysis of the 2001 over 2000 change in
total operating expense by functional category:
Changes In
Operating
Expenses
----------------
(000s) Percent
------- -------
Compensation and related benefits.............................. $(1,437) (30)
Legal and professional services................................ 201 15
Travel and entertainment....................................... (204) (43)
Advertising and promotion...................................... (407) (76)
Telephone and Internet......................................... 70 29
Occupancy...................................................... (61) (15)
Restructuring and relocation................................... 562 251
Purchased in process-research and development.................. (208) (100)
Impairment loss on intangible assets........................... 1,127 *
Amortization................................................... 292 357
Depreciation................................................... 104 51
Other.......................................................... 199 10
------- ----
$ 238 2
======= ====
* Not meaningful
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Results of Operating Activities
We incurred net losses of approximately $9.0 million for fiscal year 2000
and $3.9 million for fiscal year 1999, primarily due to our efforts in
developing and marketing our biometric software products. Approximately $1.2
million or 82% of total revenue was from sales of commercial software and
services during 2000 compared to $895,000 or 69% in 1999. The following
discussion presents certain changes in our revenue and
21
operating expenses which have occurred between fiscal years 2000 and 1999, and
should be read in conjunction with our Consolidated Financial Statements,
including the notes thereto, included elsewhere in this Form 10-K.
Revenue and Cost of Revenue
Revenue for the year ended December 31, 2000 increased by approximately
$220,000, from approximately $1.3 million for the year ended December 31, 1999
to approximately $1.5 million for the year ended December 31, 2000. This
increase was primarily due to an increase in services and other revenue of
approximately $419,000, partially offset by decreases in commercial software
sales of approximately $69,000, hardware sales of approximately $35,000, and
post-contract services revenue of approximately $95,000. Payments from each of
Home Shopping Network, Kaiser Permanente, SecuGen Corporation and Triton
Secure, Ltd. accounted for 10% or more of revenue for 2000, and payments from
each of Home Shopping Network and Triton Secure, Ltd. accounted for 10% or
more of revenue for 1999.
The approximately $122,000 increase in cost of revenue was primarily
attributable to the increase in revenue.
Gross profit increased to approximately $1.0 million or 68% of revenue
during 2000 from approximately $944,000 or 72% of revenue in 1999 primarily
due to the change in the mix of product revenues.
Operating Expenses
Operating expenses for 2000 increased by approximately $5.0 million, from
approximately $4.9 million for the year ended December 31, 1999, to
approximately $9.9 million for the year ended December 31, 2000. This increase
was primarily due to the addition of new staff to enhance existing products,
develop new products and market our products to both commercial and
governmental organizations and, to a lesser degree, the relocation of our
headquarters to Redmond, Washington during the first half of 2000 and the
acquisition of purchased in-process research and development costs associated
with the purchase of the intellectual property and fixed assets of Jotter in
December 2000. These increased expenses were partially offset by the
expiration of our obligation to make minimum royalty payments of $125,000 per
quarter to Cogent Systems, Inc. as of October 1, 1999.
The following table provides a breakdown of the dollar and percentage
changes in operating expenses:
Changes In
Operating Expenses
---------------------
(000s) Percent
---------- ---------
Product development................................... $ 2,811 204
Sales and marketing................................... 424 32
Minimum royalties..................................... (375) (100)
Relocation expense.................................... 224 *
Purchased in-process research and development......... 208 *
General and administrative............................ 1,679 93
---------- -------
$ 4,971 102
========== =======
* Not meaningful
Product Development
The increase in product development expenses was primarily due to increased
personnel costs of approximately $2.6 million, including the addition, through
the acquisition of Jotter on December 15, 2001, of 21 staff members to enhance
current products and develop new products to meet anticipated demand for our
products. In addition, we expensed $208,000 of in process technology related
to the Jotter acquisition for which no prior period comparable expense exists.
While we expect product development expenses to decrease in the
22
near-term as a result of our recently implemented cost reduction initiative, if
we obtain additional funding, we expect to sustain or increase product
development expenses as we expand our product development efforts in the
longer-term. If we do not obtain this type of additional funding, we expect
that it will be necessary to curtail or discontinue product development
efforts.
Sales and Marketing
The increase in sales and marketing expenses was primarily due to increases
in employee expenses related to the addition of five staff members ($247,000)
to market our products, related travel ($98,000) and advertising expenses
($130,000). The sales cycle for our products has taken longer to develop than
management anticipated due to, among other things, the lack of industry
standards and acceptance by the commercial market, the cost of hardware
associated with the technology, and the extended period of time potential
customers require to test, evaluate and pilot applications. However, we believe
that a convergence of factors, including decreases in hardware costs as well as
the development of industry standards, will lead to greater market acceptance
of biometric security solutions. While we expect sales and marketing expenses
to decrease in the near-term as a result of our recently implemented cost
reduction initiative, if we obtain additional funding, we expect to sustain or
increase our sales and marketing expenses as we expand our sales and marketing
efforts in the longer-term. If we do not obtain this type of additional
funding, we expect that it will be necessary to curtail or discontinue sales
and marketing efforts.
Relocation Expense
We incurred $224,000 of non-recurring costs to relocate our executive
offices from Tampa, Florida to Redmond, Washington during the first half of
2000.
Purchased In-Process Research and Development
In connection with our purchase of the intellectual property and fixed
assets of Jotter in December 2000, we recorded a non-recurring charge of
$208,000 for in-process research and development that had not yet reached
technological feasibility and had no alternative future use. Among the factors
we considered in determining the amount of the allocation of the purchase price
to in-process research and development were the estimated stage of development
of each module of the technology, including the complexity and technical
obstacles to overcome, the estimated expected life of each module, the
estimated cash flows resulting from the revenues, margins, and operating
expenses generated from each module, and the discounted present value of the
cash flows associated with the in-process technologies.
General and Administrative
The increase in general and administrative expenses was the result of
increased spending on six additional staff ($188,000), occupancy ($282,000) and
professional services ($210,000) primarily due to additions to infrastructure
to support our increased product development and sales and marketing activities
and recognition of an impairment loss on prepaid royalties of approximately
$438,000 in 2000, with no such loss in 1999. While we expect general and
administrative expenses to decrease in the near-term as a result of our
recently implemented cost reduction initiative, if we obtain additional
funding, we expect significant additional increases in general and
administrative expenses as we add infrastructure to support increased product
development and sales and marketing activities in the longer-term.
Interest Expense
The change in interest expense from approximately $5,000 in 1999 to
approximately $141,000 in 2000 was primarily due to the issuance of $2.5
million of 12% bridge notes in November 2000 to fund operations while we
continued to seek equity financing and the issuance of a $1.7 million, 7% note
payable issued to Jotter in December 2000 as partial consideration for the
intellectual property and fixed assets acquired from Jotter pursuant to an
asset purchase agreement entered into on December 15, 2000.
23
Other Income, Net
The change in other income from approximately $31,000 in 1999 to
approximately $11,000 in 2000 was primarily due to the loss on sale of
investment securities of approximately $121,000 incurred in 2000, with no such
loss in 1999, partially offset by an increase in interest income of
approximately $67,000 and a reduction in loss on disposal of fixed assets of
approximately $17,000.
Operating Expense Analysis by Functional Activity
The following table provides an analysis of the 2000 over 1999 change in
total operating expense by functional category:
Changes In
Operating
Expenses
---------------
(000s) Percent
------ -------
Compensation and related benefits............................ $2,778 129
Legal and professional services.............................. 821 152
Travel and entertainment..................................... 184 63
Advertising and promotion.................................... 245 134
Telephone and Internet....................................... 88 56
Occupancy.................................................... 195 88
Relocation................................................... 224 *
In process-research and development.......................... 208 *
Minimum royalty payments..................................... (375) (100)
Impairment of prepaid royalties.............................. 438 *
Amortization................................................. 105 *
Depreciation................................................. (31) (13)
Other........................................................ 91 2
------ ----
$4,971 102
====== ====
* Not meaningful
Liquidity and Capital Resources
As of December 31, 2001, we had cash and cash equivalents of $64,000, a
decrease of $1.04 million from cash and cash equivalents held as of December
31, 2000. We invest our cash in excess of current operating requirements in a
money market fund with a commercial bank. We had a working capital deficit of
$3.6 at December 31, 2001 compared to a working capital deficit of $3.3 million
at December 31, 2000.
As of December 31, 2001, our principal cash obligations consisted of
facility operating leases totaling $185,000, notes payable of $1.4 million and
license fee commitments of $104,000. In January of 2002, we paid off the entire
balance of notes payable.
The following table reflects our contractual commitments as of December 31,
2001:
2002 2003 2004 2005 2006 Thereafter Total
----- ---- ---- ---- ---- ---------- -----
(in thousands)
Operating leases..................... 150 31 3 1 -- -- 185
Notes payable........................ 1,435 -- -- -- -- -- 1,435
License fee commitments.............. 80 24 -- -- -- -- 104
----- --- --- --- --- --- -----
1,665 55 3 1 -- -- 1,724
===== === === === === === =====
On January 8, 2002, we received funds totaling approximately $6 million 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.
24
We intend to use the proceeds of the warrant exercises and common stock
purchases for working capital and general corporate purposes, including
repaying our short- and long-term debt. We have applied a portion of the
proceeds received from the exercise of the Series A and Series B warrants to
pay off the principal and interest on the $1.0 million note issued to RMS
Limited Partnership, which was due in May 2002. We have also applied a portion
of proceeds to repay the principal and interest payments of the notes in
aggregate principal amount of $300,000 issued to SDS Merchant Fund, LP and
Freya Fanning & Company in the December 2001 bridge financing.
We used cash of approximately $7.2 million for operating activities in 2001
which was approximately consistent with the amount used in 2000. The increased
use of cash was primarily due to decreased revenue as a result of reduced
promotional activities brought on by limited sources of capital, while
operating expenses remained relatively constant.
We expended cash in our operations, including capital expenditures and debt
repayments during the year ended December 31, 2001 at the rate of approximately
$630,000 per month, excluding financing activities. Beyond our short-term
capital needs, our anticipated cash needs to fund our working capital and debt
service requirements are anticipated to be approximately $2 million through
December 31, 2002. To date, we have not attempted to raise these funds.
Additionally, the terms of our recent financing prohibit us from raising
additional capital by selling discounted, variable priced equity securities
until June 12, 2002 (180 days after the effective date (as declared by the SEC)
of our registration statement on Form S-1).
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 December 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.
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 Company believes that the adoption of SFAS No. 141 will
not have a significant impact on its financial statements.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other
Intangible Assets", which is effective for fiscal year 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 will adopt the provisions of SFAS No. 142 beginning January 1, 2002.
The adoption of SFAS No. 142 will not have a material effect on our financial
statements because of the insignificant value of our intangible assets--$27,000
as of December 31, 2001.
25
In August 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (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 Saflink's consolidated results of operations
or financial position.
In October 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (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 will be
effective for fiscal years beginning after December 15, 2001 and interim
periods within those fiscal periods. The Company plans to adopt the provision
on January 1, 2002. We do not expect the adoption of SFAS No. 144 to have a
material effect on Saflink's consolidated results of operations or financial
position.
Factors That May Affect Future Results
In addition to other information contained in this Annual Report on Form 10-
K, the following factors, among others, sometimes have affected, and in the
future could affect our actual results and could cause future results to differ
materially from those in any forward looking statements made by us or on our
behalf. Factors that could cause future results to differ from expectations
include, but are not limited to the following:
Our failure to obtain the substantial financing we will need for our operations
on acceptable terms, or at all, would severely impact our ability to run our
business which could result in a loss in stockholder value and possibly
termination of our operations.
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 are 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.
Subsequent to the January 2002 financing in which we received funds totaling
approximately $6 million, in order to sustain our operations at the current
level through December 31, 2002, we need to raise more than $2 million in
additional funds. A portion of these funds may come from the exercise of the
outstanding Series A warrants issued in the Series E preferred stock financing
and the Series C warrants issued under the Special Warrant Offer. If all of the
outstanding Series A warrants and Series C warrants were to be exercised, we
would have proceeds of approximately $13.5 million of additional capital.
26
If we cannot raise additional financing prior to that time 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. Our issuances of additional securities could dilute the interests
of stockholders. Additional financing may be unavailable to us or only
available on terms unacceptable to us.
We have, to date, not attempted to raise this $2 million. There can be no
assurance when we do attempt to raise this money that we will be successful.
Additionally, the terms of our Series E financing prohibit us from raising
additional capital by selling equity securities that are discounted or that
have a variable conversion price until June 12, 2002.
We have accumulated significant losses since we started doing business and may
not be able to generate significant revenues or any net income in the future,
which would negatively impact our ability to run our business.
We may continue to accumulate losses. We have accumulated net losses of
approximately $74.3 million from our inception through December 31, 2001. We
have continued to accumulate losses after December 31, 2001 to date and we may
be unable to generate significant revenues or any net income in the future. We
have funded our operations through issuances of debt and equity securities to
investors and may not be able to generate a positive cash flow.
Our independent auditors have stated that there is doubt about our ability to
continue as a going concern and in the event of a liquidation of our assets the
value received may be less than the value of our assets as presented in our
financial statements.
As a result of our recurring losses from operations and our working capital
deficit, our independent auditors, in their audit opinion covering our 2001
financial statements, stated there was substantial doubt about our ability to
continue as a going concern. We are exploring options that would provide
additional capital for our objectives and operating needs, such as:
. the sale and issuance of additional stock;
. the sale and issuance of debt;
. the sale of certain assets; and
. entering into an additional strategic relationship or relationships to
obtain the needed funding or create what we believe would be a better
opportunity to obtain such funds.
Our failure to obtain additional capital could cause us to cease or curtail
operations. The accompanying financial statements assume that we will be able
to meet our obligations as they become due and that we will continue as a going
concern. We may, in fact, not be able to meet our obligations or we may be
forced to curtail or shut down our business. Our financial statements do not
take into account any adjustments that might result from the outcome of this
uncertainty, which means that if we had to liquidate, the funds received may be
less than the value of our assets as presently recorded in our financial
statements.
An opinion by our independent auditors which expresses doubt about our
ability to continue as a going concern may impact our dealings with third
parties, including customers, suppliers and creditors, because of their
concerns about our financial condition. Any such impact could harm our business
and results of operation.
We are currently a defendant in a lawsuit brought by International Interest
Group, Inc., whose outcome is uncertain and whose economic impact on the
company cannot be predicted with any certainty.
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 the Company in a
case brought by International Interest Group, Inc., although a
27
final order of the Court has not yet been entered. The verdict was 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, 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 the Company intends to vigorously oppose.
Payment of a judgment in the amounts aforementioned could have a material
adverse affect on the Company's financial condition.
Our success depends on significant growth in the biometrics market and on broad
acceptance of products in this market.
Because almost all of our revenues will come from the sale of products that
use biometric technologies, our success will depend largely on the expansion of
markets for biometric products domestically and internationally. Even if use of
biometric technology gains market acceptance, our products may not achieve
sufficient market acceptance to ensure our viability. We cannot accurately
predict the future growth rate of this industry or the ultimate size of the
biometric technology market.
Because they own approximately 30% of our company, a small group of
stockholders will be able to significantly influence our affairs which may
preclude other stockholders from being able to influence stockholder votes.
Given that five investors, combined, own in excess of 30% of our currently
outstanding common stock, they are able to significantly influence the vote on
those corporate matters to be decided by our stockholders. In addition, as of
March 19, 2002, the holders of the Series E preferred stock will be able to
convert their shares into 4,468,000 shares of common stock, which would equal
27% of the then outstanding common stock. If the holders of the Series E
preferred stock were to convert their preferred stock into common stock and
exercise their Series A and Series C warrants held by them for an additional
10,890,000 shares, they would own 16,590,000 shares, or 72%, of the then
outstanding common stock.
We may not be able to compete with our competitors with greater financial and
technical resources and greater ability to respond to market changes, which
would affect our ability to promote and sell our technology and services.
We may not be able to compete successfully in our markets against our
competitors. We will face intense competition in both the biometric software
and Internet toolbar markets. Many of our competitors, such as BioNetrix, Inc.,
Digital Persona, Inc., Ankari, Inc., Precise Biometrics, A.B., Keyware, Inc.,
and I/O Software, Inc. have greater resources than we do. In addition, there
are smaller competitors that may be able to respond more rapidly to changes in
the market. Our competitors may also be able to adapt more quickly to new or
emerging technologies and standards or changes in customer requirements or
devote greater resources to the promotion and sale of their products.
We may not be able to take advantage of sales opportunities in the future given
the reduction in our workforce of sales and marketing personnel, which could
cause our business to suffer.
Given the reduced number of our sales and marketing personnel as a result of
our recent restructuring, we may not be able to meet demand for our products
and/or take advantage of sales opportunities, if this type of demand or these
types of opportunities arise. If we cannot meet demand for our products, we may
not be able to compete with our competitors and our business may suffer.
We depend on attracting and retaining skilled employees, which may be difficult
due to the competitive employment market.
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If we lose any of our key, highly skilled technical, managerial and
marketing personnel due to the intense competition in the technology industry,
our operations may suffer. The success of our com