Legal Proceedings
Submission of Matters to a Vote of Security Holders
PART II
Market for Common Equity and Related Stockholder Matters
Management's Discussion and Analysis or Plan of Operation
Financial Statements
Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures
Controls and Procedures
PART III
Directors and Executive Officers of the Registrant
Executive Compensation
Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters
Certain Relationships and Related Transactions
Exhibits
Principal Accountant Fees and Services
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F-1
28
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[/TABLE]
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
The Company is including the following cautionary statement in this Annual Report on Form 10-KSB to make applicable and take advantage of the safe harbor provision of the Private Securities Litigation Reform Act of 1995 for any forward looking statements made by, or on behalf of the Company. Forward looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements which are other than statements of historical facts. Certain statements contained herein are forward looking statements and, accordingly, involve risks and uncertainties which could cause actual results or outcomes to differ materially from those expressed in the forward looking statements. The Company’s expectations, beliefs and projections are expressed in good faith and are believed by the Company to have a reasonable basis, including without limitation, management’s examination of historical operating trends, data contained in the Company’s records and other data available from third parties, but there can be no assurance that management’s expectation, beliefs or projections will result or be achieved or accomplished. Actual events or results may differ materially as a result of risks facing the Company. Such risks include, but are not limited to, changes in business conditions, the general economy, competition, changes in product offerings, as well as regulatory developments that could cause actual results to vary materially from the future anticipated results indicated, expressed or implied, in such forward-looking statements. The Company disclaims any obligation to update any forward-looking statement to reflect events or circumstances after the date hereof.
PART I ITEM 1. DESCRIPTION OF BUSINESS
We were organized as a partnership in September 1999 and subsequently incorporated in Montana in January 2000. In December 2004, we reincorporated in Colorado. Our principal executive offices are located at 489 North Denver Avenue, Loveland, Colorado 80537, and our telephone number is (970) 461-0071. We maintain a website at www.shiftwatch.com. The information on our website is not part of this filing.
Following our formation we initially pursued the development of our technology for use by the United States Air Force. We were engaged by the Air Force to develop digital technology capable of capturing multiple feeds of video, audio and data, including the utilization of Global Positioning Satellite (“GPS”) Time, to provide simultaneous time and location synchronized views of multiple video, audio and data streams of flight and weapons systems. We retained the proprietary commercial rights to our software development, which today is the core technology of our commercial transportation and police evidence video recorder products.
In May 2005, we affected a 1 to 18.4 split of our common stock and changed our name from A4S Technologies, Inc. to A4S Security, Inc. Unless otherwise indicated, all information in this prospectus, including share and per share data, gives effect to this reverse stock split and the name change.
We have a history of net operating losses and an accumulated deficit in excess of $8 million and our Independent Registered Public Accounting Firm has issued an opinion indicating substantial doubt about our ability to continue as a going concern for the year ending December 31, 2006. Our operating losses, accumulated deficit and audit opinion could negatively affect our ability to raise capital.
We completed our initial public offering in July 2005 in which we sold 1,380,000 units of our securities at $6.00 per unit for gross proceeds of $8,280,000. Each unit consisted of one share of our common stock and one warrant. The warrants issued in our IPO are exercisable at $9.00 per share. The common stock and warrants are quoted on The Nasdaq SmallCap Market and the NYSE — ARCA Exchange under the symbols SWAT and SWATW, respectively.
BUSINESS Business Overview
We were formed in 1999 and initially pursued the development of our technology for use by the United States Air Force. We were engaged by the Air Force to develop digital technology capable of capturing multiple feeds of video, audio and data, including the utilization of Global Positioning Satellite (“GPS”) Time, to provide simultaneous time and location synchronized views of multiple different video, audio and data streams of flight and weapons systems. We retained the proprietary commercial rights to our software development, which today is the core technology of our public transportation, high value facility surveillance and in-car digital video police products.
We market our patent pending high resolution mobile digital video recording systems for security and surveillance. ShiftWatch®, our mobile digital recording product line, has been designed for transportation, law enforcement, and general security applications. Tapestream™, our proprietary data capture technology, records high resolution video at broadcast quality in a mobile environment to two different types of recording media, currently to both digital tape and a hard drive. The benefit of recording to two different media types is survivability. In a vehicle or other mobile environment the risks to the survivability of the video recording is at risk due to vehicle collisions, explosions like in the London and Madrid terror bombings, and a variety of incidents that a stationary recording system behind a locked door does not have to contend. The use of dual media recording increases the chance of recovery of the video recording after a catastrophic event such as a crash or a bombing. To demonstrate the efficacy of this approach we completed explosives testing of our Transportation Video System throughout the 4 th quarter of 2005 and January of 2006.
A team of explosive experts from the Larimer County (Colorado) Sheriff’s Department conducted a controlled explosion of a retired city bus at a practice range facility, subjecting the ShiftWatch® Transportation Video Surveillance system to an explosion similar to that used in the London terrorist bombing attack. The ShiftWatch® product withstood a blast using 10 lbs. of explosive material, and provided data and video of the event up to within seconds of the blast. The test, monitored by Underwriters Laboratories, Inc. (UL), was devised to demonstrate that the ShiftWatch® system, designed with two types of storage—an internal hard drive and Sony’s Advanced Intelligent Tape™, AIT, digital tape drive, could withstand such a catastrophic incident and continue to provide video of the event.
We believe the digital tape we use has over 300 times the data reliability, at lower cost compared to a ruggedized removable hard drive used for the same capacity. Furthermore the digital tape can be easily removed and the vehicle can continue in service knowing that critical evidence has been secured. The digital tape has a storage capacity of up to 80 gigabytes, can be maintained as evidence for up to 30 years and can be reliably replayed as we use a standard (MPEG-2 or MPEG-4) which assures the ability to access the information.
In June 2004, the Kansas City Area Transportation Authority, or KCATA chose our ShiftWatch® TVS™ to provide video and audio surveillance with GPS integration on their new buses and to retrofit selected buses currently in use. We were selected by KCATA after a six-month evaluation and testing program. The KCATA accounted for substantially all of our sales in 2005 and in 2004. We also expect additional purchases by KCATA as they purchase new buses or refurbish existing buses. Based on KCATA as a reference customer, we are currently engaged in active discussions with over 100 metropolitan transportation agencies to purchase multiple units of our ShiftWatch® TVS™ product. In the fourth quarter of 2005 we were also awarded sales with the San Joaquin Regional Rail Commission, CityBus of Lafayette, Indiana, and the Greater Cleveland Regional Transit District. We continue to make demonstration installations in vehicles of transportation agencies which are currently evaluating our product. Based on ongoing discussions with other agencies, we expect to continue to make additional demonstration installations over the coming months. As of December 31, 2005 and through the present we have been awarded contracts from new customers and additional orders from existing customers, for an additional 67 units. The fulfillment of these orders will result in total revenue of approximately $425,000.
The law enforcement market has been slow to advance in the area of digital video due to digital video file format variations in the marketplace and related confusion concerning purchasing, and lack of feature guidelines and standard setting for police agencies to base a purchase decision. The law enforcement market is progressing as the International Association of Chiefs of Police, or IACP, which is developing minimum performance specifications for law enforcement digital in-car camera video systems, has established an Advisory Panel to determine minimum specifications for In-Car Digital Video Systems for law enforcement. Michael Siemens, our President and a retired police officer, was asked to sit on the Executive Committee and chair the Interoperability Task Group for the Advisory Panel. In addition, our representatives sit on two other Advisory Panel Task Groups. We believe that our current ShiftWatch® architecture can support the high resolution digital video that could become the specification recommended for law enforcement by a standards body such as the IACP. That specification is expected to be published later this year by the IACP for use by law enforcement agencies. We expect this to have significant impact on the future purchases by police agencies throughout the United States.
As an industry technology provider, we were asked by the IACP to participate on the Advisory Panel developing minimum performance specification for law enforcement digital in-car camera video systems. In addition, Sony Electronics Product Manager, Cynthia Greaux, as our guest at the Advisory Panel, was asked to participate on the Quality Task Group Subcommittee on Digital Video.
Our dual media recording of video, audio, and data to multiple media including, a hard drive and Sony digital tape is well suited for additional products and application development, including possible recording of high definition television video. Our systems are currently designed to perform their assigned recording tasks while leaving up to 60% of the CPU capacity unused. This design feature enables the system to perform many other tasks simultaneously while recording video, audio and data streams. Examples of other applications include – wireless access to our device, network capability, display of video advertising and entertainment, audio announcements and more.
We believe that our patent pending system offers competitive advantages due to the high capacity of the recording medium we use and relative low cost. Our products provide high quality, full motion video and digital tape storage. We believe we will have the ability to rapidly evolve as technology and the product markets develop as our products are software based and designed to use cameras and other components, which are commercially available. Our technology is upgradeable and software driven which should be more advantageous than a hardware driven solution that can require substantial engineering changes, extended time periods and expense.
Our digital tape recording media is well suited as one part of our multiple media recording solutions. In addition to a hard disk drive (internal or removable) we use Sony’s innovative Advanced Intelligent Tape™, or AIT, platform as the removable digital tape storage technology used within our ShiftWatch® solutions because the AIT platform provides ease of use and flexibility, minimal downtime and multi-partitioning. AIT technology is also an economical solution with a low cost-per-gigabyte, while delivering superior performance, density and reliability. We believe that our collaboration with Sony will be a significant step in advancing our digital video surveillance technology to meet the storage capacity and reliability needs required for video surveillance in high profile facilities.
The nature of our business includes sales and marketing, engineering, customer support, manufacturing, administration and finance. We maintain facilities and/or personnel to support these efforts in Loveland, Colorado, St. Louis, Missouri, Kansas City, Missouri and Sacramento, California. Our Loveland facility, which houses engineering and operations, is our largest. Our St. Louis, Kansas City and Sacramento offices perform sales functions.
Our ShiftWatch® product line is generating revenue in the public transportation market. In June 2004, KCATA chose our ShiftWatch® TVS™ to provide video and audio surveillance with GPS integration on their new buses and to retrofit selected buses currently in use. Cumulatively, we have fulfilled orders for 82 units to be used in buses operated by KCATA. We were selected by KCATA after a six-month evaluation and testing program. Based on KCATA as a reference customer, we are currently engaged in discussions with over 100 metropolitan transportation agencies to purchase multiple units of our ShiftWatch® TVS™ product and four agencies are currently engaged in product evaluations.
The architecture of our software, in which the technology is integrated, has many capabilities that we believe could be leveraged into other market spaces with only incremental integration development by either a licensed third party or ourselves. Accordingly, we believe the potential market for our technology is substantially greater than our current product market space.
Products and Marketing
Overview
According to the American Public Transportation Association, in 2003 there were approximately 77,328 passenger buses, 5,959 commuter rail vehicles, 1,482 light rail vehicles and 10,754 heavy rail vehicles in use in the United States. Additionally, the School Bus Information Council estimates that there are approximately 450,000 school buses transporting children to school daily and the Bureau of Transportation Statistics estimates there are approximately 511,000 interstate freight motor carriers in the United States. There were approximately 420,000 law enforcement vehicles in the United States as of 2001. According to a 2005 market study prepared by Frost & Sullivan, the digital video recorder segment of the video surveillance equipment market should be the fastest growing segment through 2010. Frost & Sullivan estimates that the digital video recorder market should grow at a compound annual growth rate of 21.4% through 2010. We believe the transportation and law enforcement authorities and carriers that maintain and procure these vehicles represent potential markets for our digital video recording systems.
Our marketing efforts with respect to our mobile products primarily target metropolitan transportation authorities and local law enforcement agencies. We believe commercial airlines and freight carriers are potential future markets for our mobile products. Our stationary system has broad potential market coverage including retail establishments, financial centers, government installations, military sites, casinos, and installations designed to compliment our mobile product placement in mass transit and law enforcement vehicles.
In October 2005, we were awarded a five-year General Services Administration, or GSA, contract, with options to extend up to an additional 15 years. The contract will enable us to sell our products to federal government agencies and we believe it will help us to increase our customer base. The contract qualified us to make sales to law enforcement and security systems and also allows for sales under the s size standard exemption. By virtue of the contract, we may participate in the GSA’s Federal 1122 Program and multiple state award schedules program. These programs allow state and local law enforcement agencies to directly receive the purchasing benefits of the procurement procedures and channels that the GSA has developed.
In November 2005 we were awarded Multiple Award Schedule (MAS) contracts from Texas and California. These contracts will enable the Company to sell its products to state and local government agencies directly.
These MAS contracts rely on the Federal General Services Administration (GSA) contract awarded to the Company in October for pricing, terms and conditions. They allow state and local law enforcement and transportation agencies to procure products and services from the Company directly and receive the pre-negotiated purchasing benefits of the Company’s GSA contract.
As old buses and police cruisers are retired, due to age or accidents, new units are procured. As a result, additional revenues could be created after the product is embedded in an agency. Another aspect of our marketing approach is augmentation of repeated sales of video units with sales of digital tapes and software upgrades. Furthermore due to the nature of our design where we maintain availability of up to 60% of the computer’s CPU capacity we are in a position to offer additional functionality as technology changes and market demands new and enhanced capability.
While our marketing efforts are currently focused in the United States, our patent pending technology has been designed to allow us to pursue global markets.
Our Products
Our existing and in-development products consist of the ShiftWatch® product line which includes:
• ShiftWatch®TVS™- designed for the needs of the mass transit industry • ShiftWatch®LE - our police surveillance product (to be relaunched in late 2006 based on expected published law enforcement digital video specification recommendations by IACP) • ShiftWatch®FS - a ruggedized stationary system designed for facility surveillance • ShiftWatch®VCC - a video command center that allows simultaneous viewing of multiple audio and video streams • Tapestream™- software allowing streaming media to be written to removable digital tape
ShiftWatch® products record to both an internal hard drive that is not removable, and a removable digital tape cartridge or removable hard drive. Recording redundant mirrored data to both an internal hard drive and the removable tape or storage device makes our digital video recorder very robust. End users will have two sources from which to recover video, instead of the single source competitive systems available in the market today.
All of our products record to a dual media system, which includes digital tape and removable HDD media. Digital tape is easy to transport and comes in a variety of sizes. Originally, digital tape was used for backing up computer files and was not designed to write real time video data. Our software creates the ability to write multiple simultaneous video, audio, GPS and other information to digital tape in real time — in effect synchronizing the data to the video image.
Digital technology provides numerous advantages over analog technology. Unlike analog videotape, digital tapes can be indexed and searched rapidly. Rather than sitting through hours of recorded video to view a recorded event, the use of digital technology allows the user to search for specific events. Recording on digital tape is accomplished at a higher resolution, allowing for better quality pictures and easier identification of images captured on tape, an important consideration when videos are used for suspect identification or introduced as evidence. Digital media can be recorded over many times without image degradation, allowing the same digital tape to be used many times without losing image quality. Finally, digital media can be stored for long periods of time without degradation to the original picture.
The use of a dual media storage solution also provides numerous advantages over the use of a hard drive only based storage system. For example, while using digital tape as the removable recording medium, it can be removed and replaced without losing any video or other information even while the cartridge is being extracted and replaced due to the use of the secondary storage of the hard disk drive. The last frame recorded on one tape will follow to the first frame on the next tape. No hard disk only based system has this feature implemented.
Key Features of the ShiftWatch® Product Line:
Pre- and Post-Event Recording — When an event is triggered or after the vehicle is turned off the recorder is running.
Time Synchronized Replay — Because GPS information is stored on all of the recorders, each unit is time locked to every other unit in the system. This allows for the user to replay and view video from two or more vehicles or locations and synchronize the images to attempt to recreate the event from a variety of angles.
Post-Production Capabilities — The user can leave the video on tape, or transfer it seamlessly to a storage area network, local area network, HDD, DVD or CD.
Industry Standard Video Format — The user can replay and view the video on any DVD player or any PC with DVD software installed or Windows® MediaPlayer or like standards based video player.
Interoperability — ShiftWatch® products are designed to be interoperable between transportation, law enforcement and stationary surveillance applications. All ShiftWatch®systems record to standards-based video formats that can be replayed on any standard PC.
Independent Power System — All of our ShiftWatch® units include an option for an independent power system. This allows for the user to turn off their vehicle and have our unit run off of separate battery power. This feature is particularly useful in law enforcement vehicles, as many demands are placed upon the electrical system in a police cruiser. Any additional electrical equipment can swamp an alternator and battery on these vehicles — our power subsystem solves this problem.
Redundant Video Storage — All ShiftWatch® products have dual redundant storage enabled. This is useful if an agency is concerned about the ability to retrieve video after different types of catastrophic incidents. We duplicate all data going to the digital tape cartridge on an internal hard drive accessible via a network connection. This feature allows the end user to retrieve data from one source where the other may have been damaged such as explosion, high impact, fire, flooding, or chemical or biological contamination.
Intellectual Property
The ShiftWatch® product line currently has pending patent applications with claims covering over 30 features of the product, including the base Tapestream(tm) technology, video that is authenticated for court use, and the implementation of MPEG2 video compression in a mobile environment. We continuously review our technology and patent applications to expand and broaden our protection. For example, one of our provisional applications includes fundamental claims to a mobile video advertising display system (VADS) that displays ads for commercial establishments as a vehicle, such as a bus or train, approaches them.
Key Claims
MPEG2 Video Recording to existing Digital Tape formats — High resolution recording to a robust removable medium. More capacity than DVD, higher resolution than competing formats, and lower cost to store long term makes these claims important to maintain market position.
MPEG2 Recording in a Vehicle for Law Enforcement and Recording in a Mobile Environment — Includes frame-by-frame location and time identification and a video surveillance system with at least eight hours of recording capacity. These claims are specific to our application of the technology for Law Enforcement purposes. Our efforts and work to integrate into the operational environment of law enforcement is protected. We believe this is important to our initial market position, as it appears that MPEG2 is becoming the format of choice by Law Enforcement technology selection committees.
Redundant storage to two types of Media — Our solution allows for simultaneous mirrored recording to both hard disk and removable tape. We believe this is a critical differentiator between our system and others as the data stored on two types of media is protected from damaging forces (fire, impact, water) that may destroy one or the other media but is unlikely to destroy both
Storing MPEG compressed video in a plurality of partitions on a digital medium, with directory information distributed in redundant locations. Storing the directory information in a plurality of media, which can be hard disk, semiconductor memory, or tape. These claims provide additional protection for our fail-safe system capable of surviving worst-case disaster scenarios.
Storing mobile security video on a tape cassette with built-in solid state memory, and storing directory information in the memory. These claims cover our application of the Sony Advanced Intelligent Tape (AIT) system.
Streaming security video over a plurality of channels, with each channel having a different transfer rate, each stream including timing information that permits synchronization on playback. The transfer rate can be variable in each channel, and of either conventional density or high density. These claims focus on the flexibility of the Shiftwatch system, which will allow us to continue to meet future needs of our customers.
Patent Filing Summary
We have filed patents for our products and processes in the United States and Europe. We have filed provisional and non-provisional patent applications covering our principal products as well as future products. There are currently over one-hundred ninety pending patent claims in our United States patent applications. The most fundamental of these claims have been filed in our European application and additional foreign claims based on our US provisional applications will be filed within the next six months. As of March 21, 2006, thirty-two claims have been examined in the US Patent and Trademark Office.
Manufacturing and Supply
We currently have a manufacturing and supply arrangements with qualified suppliers for the development, procurement and assembly of our key products. Our suppliers, ISO 9001 certified manufacturers, specialize in providing outsourced manufacturing and assembly services for companies such as A4S. Our software design and implementation, which is the enabling factor in our product, is performed at our headquarters in Colorado. We ensure that our products qualify for the “Buy America” standard.
Public Transportation — ShiftWatch® TVS™
More than 14 million people in the United States use public transportation daily. Threats and attacks around the world, including bombings in Madrid, Spain, in 2004 and London, England, in 2005, have heightened the security focus on public transportation.
Our ShiftWatch® TVS™is a product specifically designed for the transportation industry. We are currently targeting metropolitan transportation authorities,. Our system incorporates up to 16 cameras for use in a bus, light rail vehicle, or train. It records continuously and incorporates broadcast quality video resolution using MPEG2 file format (the same as on a DVD). This system incorporates our patent pending Tapestream™ technology that writes digital video to digital tape, versus competing systems that write to analog video tape or hard disk. We designed our system to be priced approximately 10 percent less than the competition while providing significantly more functionality.
In addition to the security benefits, our system may be used to review customer complaints and/or liability, risk management issues and training. Transportation authorities can use the system to discipline bus operators or catch criminal activity. Cutting short normally long labor arbitration hearings can result in substantial costs savings. Bob Kohler, Director of Transportation, KCATA, in discussing our ShiftWatch® TVS™ product stated that, “It’s the best full motion digital video we’ve ever seen in a mobile security surveillance application; it has already paid for itself.”
Marketing
The public transportation market requires, in most instances, direct contact from the manufacturer to sell products to the agency. Due to the nature of new technology and the nature of competitors in the marketplace, it is often necessary to provide complete demonstrations of our equipment at the agency’s site for its evaluation. While this is an expensive process, we think the need for this activity will be reduced as the product gains exposure and acceptance in the marketplace. After an initial evaluation period, the potential exists for multiple unit orders.
Public transportation authorities generally rely, in part, on funding provided by the Federal Transportation Administration (“FTA”). The federal procurement process governs all purchases to which federal funds will be applied. ShiftWatch® TVS™ sales for public buses are made either to outfit new buses coming off the line, or to retrofit existing buses. If the system is purchased for installation on a new bus to be manufactured, the public transportation authority can specify the video system for use on the new buses in its Request for Proposal (“RFP”). Following approval of the RFP, the bus manufacturer then purchases the system on behalf of the agency. Occasionally, a customer can specify a video system without a full bid process. If units are to be installed in existing buses the agency can purchase them directly. Sales to regional transportation agencies have a longer sales cycle, as they often require a bid process.
Product Features
We believe that our ShiftWatch ® TVS™ units provide technological advancements that place us on par or above our competitors including:
• Full Motion Video – 30 frames per second per camera video capability providing full motion video from multiple angles utilizing up to 16 cameras. • Higher resolution per frame – up to 720x480 pixels allowing for crisp, high-resolution images. • Digital Tape Recording – allowing for decreased media replacement costs. By comparison, the use of a hard drive recording system causes a vehicle to be without recording capability when a video is being reviewed. The use of digital tape allows low cost recording and allows for video review without requiring removal of the system from the vehicle. • GPS Time/Location – providing time and location coordinates specifically in reviewing videos.
We believe ShiftWatch® TVS™ has these key competitive advantages over our competitors while maintaining a lower cost per unit to the end user and a lower total cost of ownership over the product life.
Competition
We believe that our chief competitors with regard to public transportation are:
• GE Security. The GE Interlogix MobileView ® product allows for the simultaneous capture of video and audio images from up to 8 onboard cameras with distributed video. The system is primarily designed for use on buses, light-rail, delivery vehicles and armored cars.
• SafetyVision ® . Through its RoadRecorder ® 6000 Pro Series, Safety Vision provides an onboard surveillance product, which utilizes digital video. Designed for use on mass transit, rail, law enforcement and other vehicles, the system can utilize up to 10 color or black and white cameras. The company’s Observer ® series is designed specifically for use on school buses and captures up to 24 hours of footage on a VHS tape. • Integrian. Integrian’s TransitCam™ products offer digital video and information solutions for bus and rail applications. The TransitCam solution can support up to 16 cameras on distributed video channels. • March Networks. The 5308 MDVR from March Networks supports up to eight cameras and is used in bus and rail transit systems, first response vehicles and other fleet operations. • Radio Engineering Industries. Digital Bus-Watch®, the Radio Engineering Industries product, is designed for most transit applications. In addition to capturing audio and video images, the system can monitor and record vehicle functions on a hard drive.
The following table is a comparison of our product with products offered by our principal public transportation competitors and is based on their publicly available product information:
| Company |
A4S Security, Inc. |
GE Interlogix |
SafetyVision |
Integrian |
March Networks |
Radio Engineering Industries (REI) | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Products as of 3/27/06 |
ShiftWatch ® TVS ™ |
MobileView ® III |
RoadRecorder ® 6000 PRO |
TransitCam ™ TC-100 |
5308 MDVR |
Digital Bus-Watch ® II | ||||||||||||||
| Functionality | ||||||||||||||||||||
| Full Motion Video | 240 fps(1) | 30 pps(2) | 300 fps | 60 fps | 60 fps distributed | 60 fps distributed | ||||||||||||||
| Redundant Storage | Yes | No | No | No | No | No | ||||||||||||||
| to Two Types of | ||||||||||||||||||||
| Media | ||||||||||||||||||||
| Recording medium | Redundant Hard Disc Drive and Digital Tape | Hard Disc Drive | Hard Disc Drive | Hard Disc Drive | Hard Disc Drive | Hard Disc Drive | ||||||||||||||
| Recording Time at | 140 hrs (3) MPEG-4 | 33 hours (120 GB) |
54 hours | 24 hours | No mention (100 GB) |
22 hours (100 GB) |
||||||||||||||
| 30fps | ||||||||||||||||||||
| Number of Cameras(4) | Up to 32 | Up to 6 | Up to 10 | Up to 16 | Up to 8 | Up to 4 | ||||||||||||||
| Audio Inputs | Up to 4 | 1 | 2 | 1 | 2 | 1 (only at 60 fps) | ||||||||||||||
| Battery Backup | Yes | No | No | No | Yes | No | ||||||||||||||
| Video Channel | 720 x 480 | 720 x 243 | 720 x 480 | 720 x 480 | 720 x 288 | 720 x 486 | ||||||||||||||
| Resolution | ||||||||||||||||||||
| Video Compression | MPEG-2 or 4 | Wavelet | Wavelet | MPEG-4 | H.263 | Proprietary Wavelet | ||||||||||||||
| Event Marking | Yes | Yes | No mention | Yes | Yes | Yes | ||||||||||||||
| GPS | 1Yes | No mention | Yes | Yes | Yes | No mention | ||||||||||||||
| Wireless | Q2 2006 | Cell | Yes | 802.11g | 802.x | No mention | ||||||||||||||
| Operating System | XP Pro | No | No | XP embedded | Linux embedded | No | ||||||||||||||
Specifications subject to change.
NOTE: the ShiftWatch TVS can partner/compete with systems integrators like Siemens, Parsons Brinckerhoff, etc. to provide a total integrated transit solution.
(1) fps = frames per second per video channel available.
(2) pps = pictures per second
(3) Assumes 160 GB media recording two 720x480 video channels. Recording time subject to change and assumes largest size of internal and/or removable media. Number of competitor's cameras for listed record times unknown.
(4) Up to eight (8) 720x480 D1 Video channels supporting up to 32 320x240 video channels using four (4) quad multiplexers.
In late 2005, we announced that our new ShiftWatch® Video Advertising Delivery System (VADS) is to be installed through a partnership with the Kansas City Area Transportation Authority in a pilot program to provide an up-to-the-minute advertising and entertainment solution in its buses. The addition of the video playback solution to the TVS product provides transit agencies with a revenue-generating opportunity to help offset the cost of their video security systems. VADS uses broadcast quality, full-motion video to provide transit agencies the ability to deliver advertising and entertainment content to transit commuters. We expect to implement this new program during 2006.
We are continually engaged in research and development efforts to improve our products and released an updated version of the ShiftWatch® TVS product at the end of 2005. This upgrade from the previous version is physically more compact and provides significant customer requested software enhancements. We expect the newest version of our product will provide for consistent stable operation in varying environmental and hostile situations and resolve some problematic issues noted in prior versions. As we continue developing and enhancing product capabilities, as well as responding to market forces, our products are in a constant process of progress and improvement.
Law Enforcement — ShiftWatch® LE
The federal government and 29 states have enacted legislation designed to combat racial profiling. In many instances, governments or law enforcement agencies have entered into voluntary consent decrees to implement anti-racial and ethnic profiling programs, many of which specifically include videotaping traffic stops and arrests. Law enforcement agencies and decision makers have not only come to accept the concept of recording their “public contacts” primarily in the form of “traffic stops” but they have also begun to aggressively pursue the concept of having video and audio records from the time of arrest through the release process in order to reduce liability and retain video and audio evidence in the judicial process. Based on this, we believe there will be increased demand for mobile video recoding systems in law enforcement.
Product Features
Our law enforcement ShiftWatch® product was designed by our founding team, which has over 30 years of law enforcement operational experience. It includes a forward facing high resolution zoom camera, an interior rear seat camera, and an optional externally facing rear camera. It also includes two wireless microphones for the officer to wear to catch all of the critical audio of a situation. Our solution was designed to pass the “baggy” test. Where competing systems may not be able to see a baggy thrown out the window of a car in a high-speed chase, ShiftWatch® is designed to catch the action and encode the GPS information, identifying where the item was tossed. This feature allows the video in patrol cars to be used for more than reviewing police pursuits: it brings feature-rich, high resolution video into the patrol car. ShiftWatch® LE will be offering the latest in wireless upload of captured video and real time viewing of the action as it happens in the field coming this summer. Our next generation LE product will meet or exceed the IACP minimum operational specification due out in the fall of 2006.
The system activates when a light or siren is activated or when the officer turns it on and places a mark on the video. Usually the probable cause to turn on the light and siren has already occurred, but our product is designed to continually record; therefore, it can capture events or probable cause data prior to receiving an indication to start and a police department or agency can determine the amount of time (30 seconds to 30 minutes) to place onto the digital tape before the light or siren activation.
The IACP is engaged in efforts to establish recommended standards for the use of digital video in law enforcement. We believe that with minor changes to our hardware configuration, our current ShiftWatch® LE architecture can support the standards we expect will be established. We are currently developing a new version of our ShiftWatch® LE product. We expect the next generation LE product to include or offer features such as; high resolution/high definition digital video capabilities, wireless transfer and upload of recorded video to main server, real time viewing of events as they are occurring in the field. The market can expect to see a Good, Better, Best approach from ShiftWatch® to better serve the over 85% of the police and sheriff’s departments that have less than 25 officers here in the United States. By offering a scalable ShiftWatch® LE product both for the mobile recording and the back end video server we believe will enable a broad market acceptance.
Marketing
Law enforcement sales are engaged by direct sales as most local agencies deal with makers of technical police equipment. We believe that sales of the ShiftWatch® product will be most effective when conducted personally as opposed to other techniques such as catalog, mass mailings, telemarketing or sales brokers. A demonstration of the product’s features is most effective when it is visual and interactive. Direct sales allow us to highlight the benefits of our products compared to other products on the market.
Additionally, the price point of our products makes these direct sales more effective. Leads are generated through a number of sources including; trade shows, referrals from participating IACP members and limited advertising. Management believes that the LE market will begin to increase once the minimum specifications are published through the IACP, anticipated to occur in the fall of 2006.
Competitors
We believe that our chief competitors with regard to sales to law enforcement agencies are:
• Kustom Signals, Inc. Kustom is headquartered in Lenexa, Kansas, and has been selling law enforcement products since 1965. It is a wholly owned subsidiary of Public Safety Equipment, Inc., which also sells to law enforcement under the Code 3®name. It sells a full line of products including radar, laser, video products, and speed monitoring trailers;
• Mobile Vision, Inc. Mobile Vision, founded in 1987, is headquartered in Boonton, New Jersey. Its product is sold under the "System 7" name. In 2003, Mobile Vision formed a partnership with JVC to incorporate the JVC VCRs in its products;
• International Police Technologies, Inc. IPT was founded in 1994 and is based out of Tulsa, Oklahoma. It sells both analog and digital mobile audio\video recoding systems. Its products use Sony cameras;
• Prosecutor of Texas, LLC. Prosecutor of Texas is based in Humble, Texas. The company offers systems with both video and digital recording options. Both systems can be set to begin recording either manually or automatically with lights, siren and body remote triggers;
• ICOP Digital, Inc. ICOP, a Kansas corporation, produces the ICOP Model 20/20™, a digital video in-car recording system. It provides up to 60 seconds of pre-event recording simultaneously on two cameras and stores data on a removable hard drive; and
• Verint Systems, Inc. Verint is based in Melville, New York and was incorporated in 1994. Verint, through its SmartSight™ product line, focuses primarily on facility security devices and allows for networking video across multiple locations. The company focuses on providing "actionable intelligence" and its products allow for the capture and analysis of video images in a variety of locations.
Stationary/Facility Surveillance — ShiftWatch® FS
Currently designed to fit ruggedized requirements of remote transit related stationary applications, our ShiftWatch® FS takes all of the video quality and low cost of ownership features from the TVS™ and LE and puts them in a stationary system for facility surveillance.
ShiftWatch®FS is designed for use in facilities where surveillance and recording of activities is required. Video surveillance of critical business and government facilities is growing rapidly. From a $1.58 billion North American market in 2003, Frost and Sullivan, projects a compound annual growth rate of 13.7% through 2010 for the video surveillance equipment market.
We believe that the desire for increased quality in surveillance systems will require digital DVD-quality recordings. Systems exist today to provide digital recordings onto hard disk drives with long recording times and high quality. However, these systems do not allow for easy extraction of information at affordable costs. High quality video generates three megabits of data per second or higher. This high rate of speed does not allow for efficient or secure storage in most installations. Our system enables a very low cost method of archiving massive amounts of data in a true 24/7/365 capability with easy accessibility.
The Command Center – ShiftWatch® VCC
The ShiftWatch® Video Command Center is a flexible digital video management tool. The VCC allows the user to replay single or multiple video feeds simultaneously using GPS time synchronization, thereby allowing the user to view a single incident from multiple angles with GPS synchronized replay of all audio and video streams. The VCC can combine, view or archive files from any ShiftWatch® surveillance system.
First Responders – ShiftWatch® ERV
ShiftWatch® ERV is currently in the development stage. Designed specifically for Emergency Response Vehicle Installations, ShiftWatch® ERV is designed to allow first responders to capture an incident on video. The “always on” feature deployed by the system requires no manual intervention by the operator of the vehicle. The system’s recording options can be customized to meet specific requirements of individual departments.
Tapestream™
Tapestream™ is a software development project that had its genesis in the MIL-4000 project developed by us for the United States Air Force and is the core of each of our products today.
Tapestream™ was developed to provide the technology to write streaming media, such as video, audio, and other digital signals, in real time to removable digital tape. The technology we developed enables the time-synchronized writing of multiple streams of video, audio, and other digital data to removable digital tape. The underlying technology can be ported to, or used with, any other kind of removable media such as DVD-ROM, CD-ROM, or other static digital storage medium. This technology is the unique differentiator between our digital recorders and competitors’ recorders on the market.
Tapestream™ is simply the technology that makes the tape drive act, in essence, like a VCR on a digital basis. As demonstrated by the existence of our ShiftWatch® line of products that use Tapestream™, we enable recording of multiple simultaneous DVD quality videos. Tapestream™ changes the place in the computer food chain for digital tape drives and other back-up technologies. The fact that we now can write and read directly from a digital tape drive in real time instead of waiting hours to write the data and hours to read the data makes the digital tape drive available for new applications –like ShiftWatch®. Due to this flexibility, our current software can be used in over 87% of the market of digital tape drives.
Facilities and Employees
We do not own any of our facilities. Each of our facilities is leased from a non-affiliate. We have 29 full time employees who devote their full business time to our activities and four employees who devote some of their business time to our activities.
RISK FACTORS Risks Related to Our Business and Industry
We have a limited history of product sales and have incurred substantial losses since inception, which makes it difficult to evaluate our prospects and the merits of investing in our securities.
We were incorporated in December 1999. For approximately four years, we were primarily engaged in the research and development of our initial product the MIL-4000, under a contract with the United States Air Force, which was our only product until 2003, when we commercially released ShiftWatch® TVSTM, which has only minimal sales to date. As a result of our limited operating history, we have a limited amount of sales and financial data that you can use to evaluate our business. You must consider our prospects in light of the risks, expenses and challenges of attempting to introduce new products in new and developing markets. We may not address these risks, and our business strategy may not prove successful.
In 2004 we had revenues of $268,500 and incurred a net loss of $1,326,000. In 2005 we had revenues of $108,500 and incurred a net loss of $4,193,000. We expect to continue to incur significant sales, marketing, general and administrative and product development expenses in connection with the development of our business. Although we believe our sales will begin to increase and currently we have open orders of approximately $425,000 in process, we expect to incur a net loss for the most if not all of 2006.
Historically our revenues have been generated by only one principal customer, and we will be unable to operate profitably unless we expand our customer base.
Our success depends on our ability to market and enhance our products to meet and maintain our current customers’ and potential customers’ needs. We have successfully produced products which have been installed in buses operated by KCATA. KCATA accounted for substantially all of our sales in 2005 and 2004, and is our current principal customer. We believe our ability to substantially increase our revenues and generate net income is contingent on successfully expanding our sales and marketing efforts and our consummation of additional sales orders and contracts. We have encountered in the past, and may again encounter in the future, delays on the part of customers in making purchase decisions and issuing purchase orders as they evaluate our products and technology. If we are unable to expand our customer base, we will be unable to operate profitably.
Our marketing efforts are focused primarily on municipalities or quasi governmental agencies, such as mass transit authorities, which can have prolonged buying cycles and operate under voter mandated budget constraints. As a result, sales to these potential customers could be delayed or not achieved.
We anticipate that our primary customers in the near future will be municipalities or quasi governmental agencies, such as mass transit authorities. Municipalities generally have prolonged purchase and buying cycles and generally require compliance with specified proposal and Request for Proposal conditions. They typically have budget considerations and buying patterns frequently tied to fiscal year considerations. In order to do business with certain customers we may also be subject to a number of public policies covering procurement procedures. As a result of these prolonged buying cycles and particular procurement procedures as well as voter mandated budgetary constraints, our sales to these potential customers could be delayed or not achieved.
We may not achieve substantial business from governmental agencies because of our brief operating history and absence of a prior relationship.
We expect to derive a significant amount of our future revenues from sales made to municipalities and other governmental agencies. Governmental agencies or quasi governmental agencies are more likely than private sector clients to provide business based on our reputation and our relationship with the agency. We have a brief operating history and only one principal customer, the KCATA. Accordingly, it may be more difficult for us to establish substantial business with agencies. Also, if for any reason our reputation or relationship with a governmental agency is impaired, or if levels of government expenditures and authorizations for security related programs do not increase or shift to programs in areas where we do not provide products, our business generated from governmental sources may be materially and adversely affected.
Our growth plans will be hindered if the markets for our products do not develop as anticipated.
The markets for our security and surveillance products are still emerging. Our growth is dependent on, among other things, the size and pace at which the markets for our products develop. If the markets do not grow as we anticipate, our growth plans will not be realized. Continued growth may be hindered, for many reasons, including products deemed to be superior to ours that are offered by our competitors, our customers experiencing technical difficulty in utilizing our products, or our customers achieving their security objectives by using alternative solutions.
Product modifications, upgrades and enhancements may affect our ability to successfully market our products.
Our software, like any software product, will require modifications. We are also continually engaged in seeking product upgrades and enhancements. As we move forward with these changes, we may experience delays due to programming or product development. Such delays may impact our ability to meet delivery schedules or other commitments to customers or prospective customers and may ultimately result in our inability to successfully market our products.
Our products, exclusive of the software, are currently produced and assembled with generally available off-the-shelf components. Should technological changes in the product be necessary that would make such off-the-shelf components no longer workable, it could have an impact on our ability to deliver finished products, as well as our costs to have such products manufactured.
Changes in technology, product features required by customers and product features offered by our competitors may affect our ability to successfully market our products.
Technological and software based products continue to evolve and change in the marketplace and will require modifications to our products. We are also continually engaged in seeking product upgrades and enhancements and future product development requirements may involve delays in product advancement and additional costs. Such changes and additional costs may impact our ability to successfully market our products.
Because of our limited resources, for the foreseeable future, we will be dependent on our officers and key personnel for sales and marketing and on a third party for manufacturing our products. As a result, our sales may not increase rapidly and we may have less ability to control the manufacturing and delivery of our products.
Our ability to achieve revenue growth will depend to a large extent on our ability to bolster the sales and marketing efforts of our existing sales personnel. Because of our limited resources, we will rely primarily upon efforts of our officers and key personnel and we will not have available to us a fully developed internal sales force. Accordingly, we may be unable to achieve revenue growth. We also do not anticipate acquiring the substantial facilities, equipment and personnel necessary to manufacture our products, but will rely on third parties for these efforts. We do not have a written contract with our contract manufacturer. Our reliance on a third party for manufacturing may limit our ability to control the quality of the manufacturing and timing of the completion and delivery of our products. Also, because of our limited sales, we have no experience with our manufacturer in producing substantial quantities of products, and there may be production difficulties or delays in the future.
We rely upon patents, trademarks, and trade secrets to protect our proprietary rights that we believe give us a competitive advantage; however, such intellectual property protections may not be broad enough, could be successfully challenged or may become useless as competitors independently develop similar technologies. Enforcement of intellectual property rights is expensive and involves a significant amount of management resources, which could decrease our revenues, and, if we lose, defeat our competitive advantage.
Our ability to compete depends to a significant degree upon the protection of our software and other proprietary technology rights. We may not be able to protect our proprietary technology, and our proprietary rights may not provide us with a meaningful competitive advantage. To protect our proprietary technology, we rely on a combination of patents, trademarks, trade secrets and non-disclosure agreements, each of which affords only limited protection. Any inability to protect our intellectual property rights could seriously harm our business, operating results and financial condition. It is possible that:
• our pending patent applications may not result in the issuance of patents; • any patents issued to us may not be broad enough to protect our proprietary rights; • any issued patent could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in those patents; • current and future competitors may independently develop similar technologies, duplicate our products or design around any of our patents; and • former employees, consultants or contractors may violate their confidentiality or non-compete agreements with us leading to a loss of proprietary intellectual property.
In an effort to protect our unpatented proprietary technology, processes and know-how, we require our employees and consultants to execute confidentiality agreements. However, these agreements may not provide us with adequate protection against improper use or disclosure of confidential information. These agreements may be breached, and we may not have adequate remedies for any such breach. In addition, in some situations, these agreements may conflict with, or be subject to, the rights of third parties with whom our employees or consultants have previous employment or consulting relationships. Also, other companies may independently develop substantial proprietary information and techniques or otherwise gain access to our trade secrets. We intend to market our products in many different countries, some of which we will not have patents in or applied for. Different countries have different patent rules and we may sell in countries that do not honor patents and in which the risk that our products could be copied and we would not be protected would be greater.
Claims that we infringe upon third parties’ intellectual property rights could be costly to defend or settle, and thus could reduce our income or increase our net loss.
We may from time to time encounter disputes over rights and obligations concerning intellectual property. Although we believe that our intellectual property rights are sufficient to allow us to market our products without incurring liability to third parties, third parties may bring claims of infringement against us. Such claims may be with or without merit. Any litigation to defend against claims of infringement or invalidity could result in substantial costs and diversion of resources. Furthermore, a party making such a claim could secure a judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent us from selling our products. Our business, operating results and financial condition could be harmed by a reduction in income or an increase in our net loss if any of these events occurred.
In addition, we may indemnify certain of our customers against certain claims that our software infringes upon the intellectual property rights of others. We could incur substantial costs in defending ourselves and such customers against infringement claims. In the event of a claim of infringement, our customers and we may be required to obtain one or more licenses from third parties. We, or our customers, may be unable to obtain necessary licenses from third parties at a reasonable cost, if at all. An adverse decision in a lawsuit or failure to obtain any such required licenses could limit our ability to market our products resulting in a loss of revenues and could require us to restructure our operations.
We have limited human resources; we need to attract and retain highly skilled personnel; and we may be unable to manage our growth effectively with our limited resources.
We expect that the expansion of our business may place a strain on our limited managerial, operational and financial resources. We will be required to expand our operational and financial systems significantly and to expand, train and manage our work force in order to manage the expansion of our operations. Our future success will depend in large part on our ability to attract, train and retain additional highly skilled executive level management, logistics and sales personnel. We may not be successful in attracting and retaining qualified personnel on a timely basis, on competitive terms or at all. If we are not successful in attracting and retaining these personnel, our business, prospects, financial condition and operating results would be materially adversely affected. Further, our ability to manage our growth effectively will require us to continue to improve our operational, financial and management controls, reporting systems and procedures, to install new management information and control systems and to train, motivate and manage employees. If we are unable to manage growth effectively and new employees are unable to achieve adequate performance levels, our operating results will suffer.
Our competitors may have greater resources or sales and marketing capabilities than we have, and we may not have the resources necessary to successfully compete with them.
Our business strategy has been to create a niche in the digital recording system for mobile and stationary security applications, specifically focused near-term in law enforcement, mass transit and security/surveillance markets. The security business is highly competitive, and we may face increasing competition. We expect that many of our competitors will have greater financial and human resources, more experience in research and development, and more established sales, marketing and distribution capabilities than we have. Therefore, our efforts to increase sales may be unsuccessful. In addition, the security market we are focused in is characterized by rapid technological change. New product introductions or other technological advancements could make some or all of our products obsolete.
Our operating results may fluctuate, which makes results difficult to predict and could cause our results to fall short of expectations.
Our operating results may fluctuate as a result of a number of factors, many of which are outside of our control. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly and annual expenses as a percentage of our revenues may be significantly different from our historical or projected rates. Our operating results in future quarters may fall below expectations. Any of these events could cause our stock price to fall. Each of the risk factors listed in this Risk Factors section, and the following factors, may affect our operating results:
• Our ability to expand our customer base in the mass transit market; • Our ability to penetrate the law enforcement and the general security applications markets; • Our plans to increase our marketing personnel and other marketing costs to further our growth strategy; • Our plans to continue to develop new and improved product offerings; • Our intent to focus on long-term goals over short-term results; • General economic conditions and those economic conditions which could specifically affect purchasing by our target customers; and • Geo-political events such as war, threat of war or terrorist actions.
Our auditors have added an emphasis paragraph to their opinion raising a question of our ability to continue as a going concern.
Due to our continued losses and limited capital resources our Independent Registered public Accounting Firm has issued an opinion that questions our ability to continue as a going concern. The auditors’ report discloses that we did not generate significant revenues in 2005, we incurred a net loss of approximately $4,193,000 and consumed net cash in operations of approximately $3,346,000 in 2005. These conditions raise substantial doubt about our ability to continue as a going concern and may make it difficult for us to raise capital. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Our financial results could be adversely affected by changes in accounting rules governing the recognition of stock-based compensation expense, which would reduce our income or increase our losses.
Our financial results could be affected by changes in the accounting rules governing the recognition of stock-based compensation expense. We measure compensation expense for our employee stock options under the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Because we have granted all stock-based compensation at the estimated fair value on the date of grant, no compensation expense has been recognized. As permitted, we have elected to adopt only the disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123) and we do not account for our compensation expense under the fair value method of accounting prescribed by SFAS No. 123. Had we accounted for our compensation expense under the fair value method of accounting prescribed by SFAS No. 123, we would have had to record a charge of $409,000 for the year ended December 31, 2005. In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment”, which addresses the accounting for share-based payment transactions. SFAS No. 123(R) eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25, and generally requires instead that such transactions be accounted and recognized in the statement of operations based on their fair value. SFAS No. 123(R) will be effective for public companies that file as s issuers as of the first interim or annual reporting period that begins after December 15, 2005. We continue to evaluate the provisions of the standard and based upon initial computations of options granted to date, we anticipate a non-cash expense of approximately $480,000 in 2006 being recorded under the standard. Depending upon the amount of and terms for options that are granted in future periods, the implementation of this standard could have a significant non-cash impact on results of operations in future periods.
We substantially increased executive compensation and other expenses in 2005 following the completion of our public offering. As a result, our historical financial statements are not indicative of future results and we must substantially increase revenues in order to become profitable.
During the year ended December 31, 2004, our officers received total compensation of $186,000. We have bolstered our executive team and increased our officers’ compensation in mid 2005. Many of our officers previously worked at reduced levels of compensation. The aggregate annual compensation of our officers in 2005 approximated $500,000. We also substantially increased our sales and marketing activities in an effort to increase sales. Accordingly, our historical financial statements are not indicative of future results. We will need to substantially increase revenues to become profitable. In addition, because of our plans to substantially increase executive compensation and sales and marketing activities as well as incur other expenditures, our business and operating results will be materially adversely affected if our sales do not increase substantially.
Compliance with the new corporate governance requirements to which we will be subject as a public company will cause us to incur significant costs, and the failure to comply with such requirements will expose us to investigations and sanctions by regulatory authorities.
We face new corporate governance requirements under the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), as well as new rules and regulations subsequently adopted by the SEC, the Public Company Accounting Oversight Board, The Nasdaq Stock Market and NYSE — ARCA. These laws, rules and regulations continue to evolve and may become increasingly stringent in the future.
In particular, we will be required to include the management and auditor reports on internal control as part of our annual report for the year ending December 31, 2007 pursuant to Section 404 of Sarbanes-Oxley. We are in the process of evaluating our internal control systems in order (i) to allow management to report on, and our independent auditors to attest to our internal controls, as required by these laws, rules and regulations, (ii) to provide reasonable assurance that our public disclosure will be accurate and complete, and (iii) to comply with the other provisions of Section 404 of Sarbanes-Oxley. We cannot be certain as to the timing of the completion of our evaluation, testing and remediation actions or the impact these may have on our operations. Furthermore, there is no precedent available by which to measure compliance adequacy. If we are not able to implement the requirements relating to internal controls and all other provisions of Section 404 in a timely fashion or achieve adequate compliance with these requirements or other requirements of Sarbanes-Oxley, we might become subject to sanctions or investigation by regulatory authorities such as the SEC, The Nasdaq Stock Market or NYSE — ARCA. Any such action may materially adversely affect our reputation, financial condition and the value of our securities, including our common stock. We expect that Sarbanes-Oxley and these other laws, rules and regulations will increase legal and financial compliance costs and will make our corporate governance activities more difficult, time-consuming and costly. We also expect that these new requirements will make it more difficult and expensive for us to obtain director and officer liability insurance.
If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential shareholders could lose confidence in our financial reporting, which could harm our business and the trading price of our stock.
Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. If we cannot provide financial reports or prevent fraud, our business reputation and operating results could be harmed. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.
Our articles of incorporation and bylaws contain provisions that could delay or prevent a change in control even if the change in control would be beneficial to our shareholders.
Our articles of incorporation and bylaws contain provisions that could delay or prevent a change in control of our company, even if it were beneficial to our shareholders to do so. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Among other things, these provisions:
• authorize the issuance of preferred stock that can be created and issued by the board of directors without prior shareholder approval and deter or prevent a takeover attempt; • authorize shareholder action only by unanimous written consent, thereby effectively requiring all shareholder actions to be taken at a meeting of our shareholders; and • prohibit cumulative voting in the election of directors, which would otherwise allow less than a majority of shareholders to elect director candidates.
Risks Related to our Securities.
The public market for our securities was recently established, and our stock price could be volatile and could decline, resulting in a substantial loss in your investment.
We completed our public offering in July 2005, so a trading market was only established recently. An active trading market for our securities may not be sustained, which could affect your ability to sell your securities and could depress the market price of your securities. The stock market in general and the market for technology-related stocks in particular, has been highly volatile. As a result, the market price of our common stock is likely to be similarly volatile, and investors in our common stock may experience a decrease in the value of their stock, including decreases unrelated to our operating performance or prospects. The price of our common stock could be subject to wide fluctuations in response to a number of factors, including those listed in this “Risk Factors” section of this prospectus. In the past securities class action litigation has often been instituted against companies following periods of volatility in their stock price. This type of litigation against us could result in substantial costs and divert our management’s attention and resources.
Shares of common stock that are issuable pursuant to our stock option plans and our outstanding warrants when issued, could result in dilution to existing shareholders and could cause the market price of our common stock to fall.
We have reserved shares of common stock that may be issuable pursuant to our stock option plans and our outstanding warrants outside those plans. These securities when issued and outstanding, may reduce earnings per share under accounting principles generally accepted in the U.S., and, to the extent they are exercised and shares of our common stock are issued, dilute percentage ownership to existing shareholders which could have an adverse effect on the market price of our common stock.
We have authorized, but unissued, shares of preferred stock available for issuance, which could negatively affect the value of our common shares.
Our articles of incorporation currently authorize the issuance of 5,000,000 shares of our preferred stock. Our board of directors has the power to issue any or all of these additional shares without shareholder approval, and such shares can be issued with such rights, preferences, and limitations as may be determined by our board of directors. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of any holders of preferred stock that may be issued in the future. We presently have no commitments or contracts to issue any shares of preferred stock. Authorized and unissued preferred stock could delay, discourage, hinder or preclude an unsolicited acquisition of our company, could make it less likely that shareholders receive a premium for their shares as a result of any such attempt, and could adversely affect the market prices of, and the voting and other rights, of the holders of outstanding shares of common stock.
We do not intend to pay dividends on our common stock.
We have never declared or paid any cash dividends on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future.
