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A leading provider of
advanced technology‑based
security solutions
Spectra Systems Corporation
Annual report and accounts 2015
Spectra Systems Corporation
is an established world leader in
providing security technology,
from banknotes and products to
electronic gaming.
Spectra provides an integrated solution of
engineered materials for authentication and
hardware and software systems which verify the
unique signatures of the authentication materials.
WE OPERATE IN
35 COUNTRIES
WE HAVE 29 STAFF
IN OUR OFFICES
FOUR ACQUISITIONS
SINCE 2012
41 CUSTOMERS
Review of the year
IFC Corporate statement
1
2
4 Our strategy
6
Highlights
Spectra at a glance
Chief Executive
Officer’s statement
Corporate governance
Board of Directors and
8
senior management
10 Directors’ report
Independent auditors’ report
Financial statements
15
16 Balance sheets
17
18
Statements of income and
other comprehensive income
Statements of
stockholders’ equity
19 Statements of cash flows
20
Notes to the
financial information
Shareholder and
corporate information
32
Discover more online
www.spsy.com
Our strategy
Page 4
Chief Executive
Officer’s statement
Page 6
Financial highlights
– Revenue exceeded analyst expectations at
US$14.1 million (2014: US$16.9 million)
– Adjusted EBITDA1 at US$1.1 million (2014: US$2.1 million)
– Adjusted earnings1 per share of US$0.02
(2014: US$0.05)
– Strong balance sheet and positive operating cash
flow in 2015 with cash of US$9.8 million
(2014: US$9.8 million) at 31 December
1 Before stock compensation expense and exceptional items.
Operational highlights
– G7 Sensor contract completion resulted in the release
of US$2.0 million of restricted cash
– Reduced operating expenses by US$0.9 million on
completion of G7 Sensor program
– Phosphour sales exceeded last three years’ average
by 20%
– Brand authentication sales exceeded management
forecast by 50%
– Secure Transactions Group performed in line
with expectations
HIGHLIGHTS
Revenue (US$’000)
14,114
(2014: 16,906)
6
0
9
6
1
,
4
1
1
,
4
1
2
7
5
,
1
1
9
7
3
9
,
12
13
14
15
The overall business
continues to create
profits and has
developed a number
of new revenue
sources that will
sustain growth
Review of the year SPECTRA AT A GLANCE
Spectra is a highly responsive
organization that develops customized
solutions for its customers.
Our solutions
Authentication systems
Secure transactions
Spectra’s sophisticated capabilities allow us to invent,
develop and manufacture integrated solutions comprised
of a system of taggant materials and sensor equipment
to authenticate banknotes at high processing speeds.
Our solutions are used by:
– two G8 central banks;
Spectra’s Secure Transactions Group is the leading
supplier of real-time fraud control and risk management
systems to government-sanctioned gaming operators.
Currently deployed in North America, Europe and Asia,
our integrity systems monitor and audit more than
US$20 billion in annual sales for online, internet and
mobile phone-based lotteries and pari-mutuel organizations.
– 18 other central banks for currency authentication; and
Our products have been engineered to provide:
– a major G8 country for passport security.
– fully automated independent real-time monitoring; and
– vendor independence – designed for any gaming system.
Banknote cleaning
Smartphone authentication of product brands
Spectra’s new technology has the potential to substantially
reduce central bank costs and environmental issues in
disposing of soiled banknotes. Two United States patents
on the use of supercritical fluids for cleaning and
decontaminating banknotes in circulation were issued
in 2015.
TruBrand™ and TruNote™
Spectra’s new technology enables end users to verify
products and banknotes with a smartphone. This
technology eliminates the need for costly readers
and allows the consumer to authenticate the
product themselves.
2
Spectra Systems Corporation Annual report and accounts 2015 We believe that we have a number
of transformation opportunities
ahead in all aspects of
our business
Our customers
Acquisition of key specialty
phosphour company
Our customers include a G8 central bank
organization and one of the world’s largest
commercial security printers and papermakers,
which supplies the Company’s technology to
a second G8 central bank and numerous other
central banks.
Our solutions are used by:
– 20 central banks;
– commercial security printers and papermakers;
– Crane & Co;
– national lotteries in six countries;
– suppliers of security threads for world currencies;
– Intralot SA;
– Scientific Games International; and
– GTECH S.p.A.
Overview
Spectra Systems Corporation, a leader in machine-readable
high speed banknote authentication, completed the
acquisition of certain specialty phosphour assets primarily
used in the authentication of world banknotes. Most
importantly, in addition to the assets, Spectra has acquired
long-standing customer relationships related to the assets,
including a major world supplier of banknote inks.
The ability to integrate these assets
and relationships with our existing
phosphour business will further
bolster our stable government-based
business income streams
Nabil M. Lawandy
Chief Executive Officer
3
Spectra Systems Corporation Annual report and accounts 2015Review of the year OUR STRATEGY
The Company’s strategy for increasing
revenue and earnings is based on:
Strategic aim
Development strategy
Progress
Introduce
machine‑readable,
multi‑code security
for polymer banknotes
and existing overt
security features
Upgrade our software
security products with
an outlook to new forms
of gaming
Develop security materials for
polymer substrates.
Co-development with polymer banknote
supplier and printer.
Integrate our machine-readable technologies
into brand product packaging, holograms,
and labels, with a focus on Asia.
Increased sales in brand authentication with
new MultiSureTM codes.
Increase our Secure Transactions Group
revenues by:
First sales of tablet-based dashboard for
real-time monitoring.
– Providing higher value product upgrades to
existing customers.
– Modifying our products to compliment daily
fantasy sports enterprises.
Advanced smartphone
authentication
technology
Increase palette of unique material codes for
smartphone authentication.
First new TruBrandTM customer announced
in China.
– Market TruNoteTM to central banks.
Trials underway for large tobacco opportunity.
– Focus on multiple opportunities in
Asian markets.
Introduction of TruNoteTM for smartphone
authentication of banknotes.
Increase
phosphour sales
Acquire specialty phosphour company.
Actively upsell phosphours in our other
security products.
Acquired specialty phosphour company in
January 2016.
– Increased phosphour sales beyond US
banknotes into Asia and Europe.
4
Spectra Systems Corporation Annual report and accounts 2015 Outlook
New opportunities include G7 and other
central banks.
Executed nine-year contract for
machine-readable authentication of
government certificates in China.
Growing fantasy sports enterprise
opportunities within all professional sports,
in the USA and Europe.
Legislation on the horizon to better police
this gaming area.
Full pipeline for all three areas of
smartphone technology.
– TruNoteTM: Banknotes.
– TruStampTM: Tax Stamps.
– TruBrandTM: Brand goods.
TruNoteTM well received at the 2016
Banknote Conference®.
New opportunities with long-standing
acquisition customers.
Incorporation of phosphours in our
smartphone products.
Our markets
Spectra Systems’ market opportunity has expanded once
more with the introduction of our smartphone authentication
solutions for products, tax stamps, and banknotes. The ability
to empower anyone with a smartphone to authenticate products
and banknotes containing our materials transforms the market
opportunity beyond a reader-constrained model.
With nearly 150 billion banknotes manufactured yearly at a cost approaching
US$10 billion annually along with the increasing demands for governments
to reduce costs, we continue to market our banknote cleaning technology.
AerisTM machines have the potential to generate over US$1 billion of hardware
sales with ongoing service revenue once the long central bank sales cycle
plays out. AerisTM has no competition and, now that patents have been
issued, the market is ours exclusively. Our TruBrandTM, TruStampTM, and
TruNoteTM suite of solutions are the only materials-based smartphone
authentication technologies in the world and rely on our proprietary
materials. This is a powerful combination of new and disruptive technologies
introduced by one company, which, in the span of two years, has gone
from concept to market ready products for sale.
The combination of the banknote authentication market, where we are
one of several competing companies, along with our introduction of highly
innovative technologies, where we will be the sole supplier, dramatically
expands the market potential of this sector and our business within the
coming years. Our high speed, machine-readable banknote authentication
technology is currently utilized by 20 central banks to prevent sophisticated
counterfeiting of their currency and will facilitate our ability to introduce
both AerisTM and the TruNoteTM version of our smartphone
authentication technology.
Spectra’s secure internal control system (ICS) software products have
been augmented with new capabilities since the acquisitions and have
resulted in revenue growth with existing customers as well as with new
ones. Along with expansion in internet-based lotteries, we hope to be
the first supplier of ICS systems to the rapidly growing fantasy sports
gaming industry throughout the world.
Spectra’s suite of portable reader-based solutions can be used for
authenticating and tracking consumer and tax-bearing products, both
locally and through cloud-based internet connections. With the introduction
of TruBrandTM and TruStampTM, our smartphone and consumable
materials-based products for brand and tax stamp authentication,
we expect this segment of our business to grow rapidly and steadily
over the next five years.
5
Spectra Systems Corporation Annual report and accounts 2015Review of the year CHIEF EXECUTIVE OFFICER’S STATEMENT
Through achieving key commercial
milestones, Spectra Systems has out
performed market expectations in 2015.
Introduction
Through achieving key commercial milestones, as described
in the Review of operations below, Spectra Systems has again
out performed market expectations in 2015. For the second
year running, Spectra has generated over US$1.0 million EBITDA
and continued to gain traction with its organic and acquired
business lines.
– Continued strong momentum with the evaluation process by a
G7 central bank of a new covert security feature for polymer notes.
– Reduced operating expenses by US$0.9 million on completion
of the G7 sensor program.
– Brand authentication sales of US$1.5 million (2014: US$0.6 million)
exceeded management expectations by 50%.
Revenue for the year was US$14.1 million (2014: US$16.9 million).
EBITDA for the year, before stock compensation expense and
exceptional items, amounted to US$1.1 million, compared to a
prior year of US$2.1 million.
Revenue was partially driven by the completion of a major
hardware sensor program. Although an order for hardware
of this magnitude is unlikely in 2016, we are near the closure
of a significant renewal contract with our major central bank
customer which is in the process of evaluating a significant
five-year contract for materials. The contract is expected to
reimburse the costs incurred in building the manufacturing
facility and would enhance the visibility of future revenues.
Improved margins from both cost-cutting initiatives as well
as lower manufacturing costs from the in-house facility are
long-lived and will contribute to profitability going forward.
Cash at the period end amounted to US$9.8 million
(2014: US$9.8 million). The Company has sufficient resources
to execute on its growth plans with its existing cash reserves.
Review of operations
Authentication Systems
The Authentication Systems business generated revenue of
US$12.8 million (2014: US$15.5 million) and EBITDA of US$1.1 million
(2014: US$1.9 million). The drop-off, which was foreseen, is due
to an exceptional year in 2014 of materials sales and of phosphour
sales, which had reached their highest ever levels.
Particular achievements included:
– Renewed license agreement for covert materials and sensors to
achieve minimum quantities and a 7% price increase.
– Commenced negotiations in 2015 concerning specialty phosphour
assets, which resulted in their acquisition by the Company
in January 2016.
– Executed a new nine-year US$5.5 million contract for
authentication of an Asian government’s documents
commencing in June 2016.
– Initiated several trials of the TruBrandTM smartphone-based
authentication technology, primarily in China.
Although the hardware sales-based earnings in 2015 are not
expected to repeat at this level again in 2016, they should
be compensated by the sale of contracted document
authentication products which will begin in June of 2016.
Secure Transactions Group technologies
The Secure Transactions Group, formed around the various
gaming technology acquisitions made in 2012, performed in
line with management expectations, generating EBITDA of
US$0.5 million (2014: US$0.6 million) on revenue of
US$1.3 million (2014: US$1.4 million).
The Secure Transactions Group has won several new contracts
and has succeeded in introducing new tablet products to
facilitate the tracking and monitoring of gaming transaction
flow by lottery officials. This new "dashboard" product was
recently adopted in Norway, which we hope will validate the
benefits of the product and help promote additional sales of
this and related support options.
Banknote cleaning
While there was no revenue contribution from the business
line in 2015 or 2014, development expenses related to the
product validation and marketing amounted to US$0.5 million
(2014: US$0.4 million). With the completion of the development
phase, the program costs associated with this new technology
will now contract to basic marketing expenses.
The Board continues to be particularly excited by this technology,
which has the potential to substantially reduce central bank
costs and environmental issues in disposing of soiled banknotes.
It was therefore delighted that two US patents on the use of
supercritical fluids for cleaning and decontaminating banknotes
in circulation were issued to the Company in January 2015.
6
Spectra Systems Corporation Annual report and accounts 2015 The Company’s prospects have
dramatically increased with the
growth of the authentication
business outside of banknotes
The near-term opportunities are:
– The rapidly advancing Reserve Bank of India tender in which we
are partnered with our long-time licensee using a new modification
of our current product.
– The potential selection of our new covert technology for
polymer notes by an existing G7 central bank customer
introducing a new denomination in the next two years.
The longer-term opportunities are:
– The joint development and licensing of a multi-code polymer
technology by a major printer of banknotes.
– The sale of our latest smartphone technology, TruNoteTM, for
the authentication of banknotes with a particular focus on its
use by the visually impaired.
We are pleased that we are able to supplement our sustained
and growing profitability with a number of near-term and
longer-term prospects. We are particularly delighted that
the authentication business outside of banknotes is increasing
ahead of expectations and that it can provide a smoothing
of our less predictable, but long term, banknote business,
with its characteristically extended sales cycles and delays.
Furthermore, we believe that we have a number of transformative
opportunities ahead in all aspects of our business and are in a
position to reduce our research efforts once these opportunities
have been fully resolved, replacing them with a less costly
applications support team.
The Board is optimistic about the future of the Company and
its growth through both increased sales, and continued
prudent and properly timed cost-cutting initiatives.
Nabil M. Lawandy
Chief Executive Officer
May 23, 2016
The adoption cycle of the AerisTM product is expected to be
long-term based on the risk average nature of the banknote
industry. The Company is therefore looking to partner with a
credible industry hardware supplier to advance the adoption
of AerisTM. We also expect that, with the costs of development
behind us, we will be in a position to mount a cost effective
and lean marketing effort to attract a central bank to evaluate
the technology, either directly with us, or through a partner
or licensee.
Strategy
The Company’s strategy for increasing revenue and earnings
is based on:
– Focusing on larger central banks with existing technology and
penetrating the polymer banknote authentication market.
– Attracting additional customers for our phosphour product
offerings which have been significantly increased with the
acquisition of related specialty assets in January this year.
– Concentrating our marketing efforts for smartphone authentication
in Asia in all sectors from linens to tobacco and electronics.
– Expanding our Secure Transactions Group contributions by
introducing new hardware options, as well as anticipating new
opportunities in monitoring internet-based gaming and new
betting formats currently in conflict with regulators, such as
daily fantasy sports enterprises.
– Controlling operating costs while maintaining strong capabilities
for delivery of products with a reduced emphasis on research
and development.
Prospects
The Company’s prospects have dramatically increased with
the growth of the authentication business outside of banknotes.
This growth is evidenced by the nearly 50% growth in sales
of the brand, document, and tax stamp authentication products
since the acquisition of that business in 2014. In addition to
continued growth of this business line, we have initiated a
number of customer trials, primarily in China, for our TruBrandTM
smartphone-based authentication technology which we are
confident will lead to sales in 2016. The opportunities for
TruBrandTM are in the tens of billions of units in China and
have the potential to create a high margin revenue stream in
the very near future.
We are targeting four specific opportunities in the banknote
security area, two of which are relatively near term and two
of which are somewhat longer term.
7
Spectra Systems Corporation Annual report and accounts 2015Review of the year BOARD OF DIRECTORS AND SENIOR MANAGEMENT
BOARD OF DIRECTORS
BJ Penn
Non-executive Chairman
Nabil M. Lawandy
President and Chief Executive Officer
Mr. Penn was Acting Secretary of the US Navy from March to
May 2009, having previously been Assistant Secretary of the Navy
(Installations and Environment) from March 2005. He was also Director,
Industrial Base Assessments from October 2001 to March 2005, with
responsibility for the overall health of the US defense industrial base.
He commenced his career as a Naval Aviator, having received his BS
from Purdue University, West Lafayette, and his MS from the George
Washington University, Washington, DC. Mr. Penn has been a member
of the Board since June 2010 and became Chairman of the Board on
7 June 2011.
Dr. Lawandy is the founder, President and Chief Executive Officer
of the Company. From 1981 to 1999, Dr. Lawandy was a tenured
full professor of Engineering and Physics at Brown University in
Providence, Rhode Island. He holds a BA in Physics, and an MSc
and PhD in Chemistry, each from the Johns Hopkins University. He
has authored over 170 reviewed scientific papers and is an inventor
on 52 US and 27 foreign issued patents. He has also received a Presidential
Young Investigator award, an Alfred P. Sloan Fellowship, a Rolex
Award for Enterprise and a Samuel Slater Award for Innovation.
Donald Stanford
Non-executive Director
Martin Jaskel
Non-executive Director
Mr. Stanford, who was until 2001 the Chief Technical Officer of GTECH
Corporation, is an Adjunct Professor of Computer Science and Engineering
at Brown University. He holds a BA in International Relations and an
MS in Computer Science and Applied Mathematics, both from Brown
University. Over 30 years, he has held every technical leadership position,
including Vice President of Advanced Development and Chief Technology
Officer. Mr. Stanford serves on several boards including Spectra Systems,
Times Squared Academy Charter School and the Business Innovation
Factory. Mr. Stanford is a member of the R.I. Science and Technology
Advisory Council. He is also an Adjunct Professor in the School of
Engineering and is an instructor in the Program in Innovation, Management
and Entrepreneurship (PRIME). He serves on the Brown advisory councils
to the President and the School of Engineering. In 1999 Don received
the Black Engineer of the Year Award for Professional Achievement.
In 1999 he also received the Honorable Thurgood Marshall award
for community service from the NAACP. In 2002 he received the
Brown Graduate School’s Distinguished Graduate award and the R.I.
Professional Engineer’s Award for Community Service.
Key
Audit Committee
Compensation Committee
Government Security Committee
Nominating Committee
Martin Jaskel has over 40 years of involvement in the financial services
industry. He began in the UK government bond market as a broker
with leading firms, latterly as a Partner in W Greenwell & Co. In 1986
as an element of the deregulation of the UK markets, W Greenwell
was sold to Midland Bank and became the leading Gilt Edged
Market Maker, of which he was a Director. In 1988 he was appointed
Director of Global Sales and Marketing of Midland Montagu Treasury
(the Treasury division of Midland Bank) after chairing a committee
to redesign the distribution of Treasury products. In 1990 he was
appointed Director of Global Sales at NatWest Treasury and rebuilt
the neglected franchise global distribution of Treasury and Capital
Markets products. In 1994 he was promoted to Managing Director
of Global Trade and Banking Services. He sat on the Advisory Board
of ECGD, the UK export-import bank, was responsible for several
years for signing off all the UK exposure to BAE and Airbus and sat on
several government and Bank of England advisory boards. In 1997 he left
NatWest and founded a financial services consultancy, which included a
consultancy at KPMG Corporate Finance and the corporate FX division
of Travelex plc, and an interim appointment as the Managing Director of a
private real estate company with a £500 million portfolio of
commercial and residential property. In 2005 he joined European
American Capital Limited, an FSA authorized and regulated specialized
advisory bank, as Senior Advisor. He has wide experience as a Non-
executive Director of both publicly quoted and private companies.
8
Spectra Systems Corporation Annual report and accounts 2015
SENIOR MANAGEMENT
Douglas A. Anderson
Chief Financial Officer,
Company Secretary and Treasurer
Mr. Anderson joined the Company as Chief Financial Officer in December
2006 and was appointed Company Secretary in June 2011. Prior to joining
the Company, Mr. Anderson was employed by Bluestreak Inc., a global
marketing technology company, where he served as President. Mr. Anderson
also held several financial positions including Director and Secretary
of Bluestreak’s wholly owned UK subsidiary, Bluestreak International
Limited. Prior to Bluestreak, he was responsible for financial and account
operations at Log On America, a publicly traded telecommunication
company. He also spent three years at Ernst & Young advising clients
on financial strategy, accounting and compliance needs. Mr. Anderson
holds an MBA from Boston University and a BA from the University of
Rhode Island.
William Goltsos
Vice President, Engineering
Dr. Goltsos was appointed Vice President, Engineering, in April 2000.
From September 1996 to April 2000, he served as Senior Systems Engineer.
Prior to that, from 1992 to 1996, he served as a staff member of the
MIT/Lincoln Laboratory’s Optical Communications Group. Dr. Goltsos
holds a BSc in Physics from Rensselaer Polytechnic Institute and an
MSc and PhD in Physics from Brown University.
James Cherry
Director of Authentication Systems
Mr. Cherry serves as Director of Authentication Systems. He joined the
Company in 2002 from Auspex Systems, an enterprise network data
storage system business, where he had been involved in marketing
and product management for seven years. Prior to that, he had
worked for five years at DuPont in product management.
Scott Tillotson
Director of Secure Transactions
Mr. Tillotson serves as Director of the Secure Transactions Group.
Mr. Tillotson has held a variety of positions with Spectra for nine years
and GTECH Corporation, a leader in the lottery industry, for eight years
in product marketing and management. Prior to that, he worked for
the IBM Corporation as an Account Executive and Systems Engineer.
Scott holds a BSEE from Purdue University.
Andrei Smuk
Director of Research and Development
Dr. Smuk, who joined the Company in 2000, was appointed
Director of Research and Development in 2006. He is responsible
for the development of advanced materials and innovative sensor
systems. He received a PhD in Physics from Brown University in
2000 and an MS in Applied Physics from the Moscow Institute
of Physics and Technology in 1994.
9
Spectra Systems Corporation Annual report and accounts 2015Corporate governance
DIRECTORS’ REPORT
for the year ended December 31, 2015
The Directors present their report and the audited consolidated financial statements for the year ended December 31, 2015.
Domicile
Spectra Systems Corporation is a C corporation and is registered and domiciled in the United States of America.
Principal activity
The principal activity of the Company is to invent, develop and sell integrated optical systems that provide customers with
increased efficiency, security tracking and product life. The integrated systems combine consumables and engineered optical
materials with software and hardware for use in applications. The Company also provides software tools to the lottery and
gaming industries for fraud, money laundering and match fixing detection, and statistical analysis.
Results and dividends
The Company’s statements of income and other comprehensive income are set out on page 17 and show the result for the year.
There is no federal or state income tax liability on the respective income tax returns due to timing differences arising between
items of income and expenses recorded on the books and those reported on the tax returns. Additionally, the Company has
approximately US$26 million in federal and US$4 million in state net operating loss carryforwards to offset future income
reported on the respective tax returns.
The Directors do not recommend the payment of a dividend (2014 and 2015: US$nil).
Review of business and future developments
A review of the operations of the Group is contained in the Group at a glance review on page 2.
Principal risks and uncertainties and financial risk management
Complex products
Certain of the products produced by the Company are highly complex and are designed to be used in complex systems.
Failure to correct errors or other problems identified after deployment could result in events that may have a negative effect
on the Company’s business and financial conditions.
The Company’s markets may become impacted by technological change
Markets for the Company’s products may become characterized by rapidly changing technology, evolving industry standards
and increasingly sophisticated customer requirements. The introduction of products embodying new technology and the emergence
of new industry standards could render the Company’s existing products obsolete and unmarketable, and may exert price
pressures on existing products. If the Company could not then develop products that remain competitive in terms of technology
and price and that meet customer needs, this could have a negative impact on the business.
Expiry of patents
All patents, have a limited duration of enforceability. United States patents generally have a duration of 20 years from the
filing date. Once a patent expires, the invention disclosed in the patent may be freely used by the public without accounting
to the patent owner, as long as there are no other unexpired patents that embrace an aspect of the invention. There is no
certainty that any improvement, new use, or new formulation will be patented to extend the protection of the underlying
invention, or provide additional coverage to adequately protect the invention. As a result, the public may have the right to
freely use the invention described in and previously protected by an expired patent.
Dependence on key personnel
The success of the Company’s revenues are dependent on a limited number of employees, in particular the Chief Executive Officer
and other managers with technological and development input. The Company has endeavored to ensure its key employees
are incentivized but cannot guarantee the retention of these staff. It also has the benefit of key man insurance.
Forward‑looking statements
All statements, other than statements of historical fact, contained in this document constitute “forward-looking statements”.
In some cases, forward-looking statements can be identified by terms such as “may”, “intend”, “might”, “will”, “should”, “could”,
“would”, “believe”, or the negative of these terms and similar expressions. Such forward-looking statements are based on
assumptions and estimates, and involve risks, uncertainties and other factors which may cause the actual results, financial
condition, performance or achievements of the Company, or industry results, to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking statements. New factors may emerge from time
to time that could cause the Company’s business not to develop as it expects and it is not possible for the Company to predict
all such factors. Given these uncertainties, investors are cautioned not to place any undue reliance on such forward-looking
statements. Except as required by law, the Company disclaims any obligation to update any such forward-looking statements
in this document to reflect future events or developments.
10
Spectra Systems Corporation Annual report and accounts 2015 Key performance indicators
– Revenue of US$14.1 million (2014: US$16.9 million).
– Adjusted EBITDA before taxation of US$1.1 million (2014: US$2.1 million).
– Adjusted earnings per share, in cents, of US$0.02 (2014: US$0.05).
– Basic earnings per share, in cents, of US$0.00 (2014: US$0.02).
Post reporting date events
On January 28, 2016, the Company acquired certain specialty phosphour assets primarily used in the authentication of world
banknotes. The total consideration amounted to US$3.12 million.
Financial instruments
Details of the use of financial instruments by the Company are contained in Note B to the financial statements.
Directors’ responsibilities
The Directors are responsible for preparing the Director’s report and the financial statements on the basis of preparation set
out in Note A to the financial statements and in accordance with United States Generally Accepted Accounting Principles
(US GAAP). The Directors of the Company are responsible for the document in which the financial information is included.
In preparing these financial statements, the Directors are required to:
– select suitable accounting policies and then apply them consistently;
– make judgments and accounting estimates that are reasonable and prudent; and
– state whether they have been prepared in accordance with US GAAP, subject to any material departures disclosed and explained in
the financial statements.
The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s
transactions, disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure
that the financial statements comply with all legal requirements. They are also responsible for safeguarding the assets of the
Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
Directors’ interests
The Directors’ beneficial interests in the common stock of the Company were as follows:
Ordinary shares
O. Salam
N.M. Lawandy
R. Puton
M. Jaskel
December 31,
2015
2014
3,594,464
1,833,570
314,514
9,960
3,594,464
1,833,570
314,514
9,960
5,802,508
5,802,508
Substantial shareholdings
The following shareholders held 3% or more of the issued common stock of the Company at December 31, 2015:
Worsley Investors Fund
O. Salam
N.M. Lawandy
H. Heye
N. Slater
Ordinary
shares
6,870,000
3,594,464
1,883,570
1,813,850
1,415,000
% of issued
15.18
7.94
4.16
4.01
3.13
15,576,884
34.42
11
Spectra Systems Corporation Annual report and accounts 2015Corporate governance DIRECTORS’ REPORT continued
for the year ended December 31, 2015
Directors’ compensation
The following table details the Directors’ earned compensation for the year ended December 31, 2015:
Executive Directors
N.M. Lawandy
Non‑executive Directors
B. Penn
O. Salam
M. Jaskel
R. Puton
D. Stanford
J. Donohue
Total
Salary
and bonus
Benefits
Board fees
Total
compensation
$
475,000 $
31,268
$
— $
506,268
—
—
—
—
—
—
—
—
—
—
—
—
12,000
12,000
12,000
12,000
12,000
12,000
12,000
12,000
12,000
12,000
12,000
12,000
$
475,000 $
31,268
$
72,000 $
578,268
Directors’ share options
At December 31, 2015, Directors had options or warrants to purchase ordinary shares under the Company’s stock option plan
as follows:
N.M. Lawandy
B. Penn
O. Salam
M. Jaskel
R. Puton
D. Stanford
Options held at
December 31,
2015
Weighted
average
exercise price
Options vested
at December 31,
2015
2,449,229
$
120,000
125,000
120,000
128,000
120,000
3,062,229
$
0.69
0.60
0.62
0.60
0.62
0.60
0.67
2,374,229
120,000
125,000
120,000
128,000
120,000
2,987,229
Corporate governance
At December 31, 2015, the Board comprised one Executive Director, Nabil M. Lawandy, and six Non-executive Directors, BJ Penn,
as Chairman, Martin Jaskel, Donald Stanford, Oussama Salam, Roland Puton, and Jeffrey Donohue. On April 12, 2016, the Board
contracted to four members in response to a G7 central bank customer security requirement relating to the composition of
the Board.
At the date of the report, the Board comprised one Executive Director, Nabil M. Lawandy, and three independent Non-executive
Directors, BJ Penn, as Chairman, Martin Jaskel, and Donald Stanford. The Board usually meets at least every three months to
closely monitor the progress of the Company towards the achievement of budgets, targets, and strategic objectives.
The Board also operates four Committees: the Audit Committee, the Compensation Committee, the Nominating Committee,
and the Government Security Committee.
The Audit Committee comprises Martin Jaskel, Nabil M. Lawandy, and Donald Stanford. It has primary responsibility for monitoring
the quality of internal controls and ensuring that the financial performance of the Company is properly measured and reported
on. It will receive and review reports from the Company’s management and auditors relating to the interim and annual accounts,
and the accounting and internal control systems in use throughout the Company. The Audit Committee intends to meet no
less than three times each financial year and will have unrestricted access to the Company’s auditors.
The Compensation Committee comprises Martin Jaskel, BJ Penn, and Donald Stanford. It reviews the performance of the
Executive Director and makes recommendations to the Board on matters relating to their remuneration and terms of employment.
The Committee also makes recommendations to the Board on proposals for the granting of share options and other equity
incentives pursuant to any share options scheme or equity incentive scheme in operation from time to time.
The Nominating Committee comprises Martin Jaskel, as Chairman, BJ Penn, and Donald Stanford. The Committee seeks and
nominates qualified candidates for election or appointment to Spectra’s Board of Directors.
12
Spectra Systems Corporation Annual report and accounts 2015 The Government Security Committee comprises BJ Penn, as chairman, and Nabil M. Lawandy. It is responsible for ensuring the
implementation within the Company of all procedures, organizational matters and other aspects pertaining to the security
and safeguarding of information, including the exercise of appropriate oversight and the monitoring of operations to ensure
that protective measures are effectively maintained and implemented.
The Board intends to comply with Rule 21 of the AIM Rules relating to directors’ dealings and will also take all reasonable steps
to ensure compliance by the Company’s applicable employees; the Company has adopted a share dealing code for this purpose
on substantially the same terms as the Model Code.
Website publication
The Directors are responsible for ensuring the annual report and the financial statements are made available on a website.
Financial statements are published on the Company’s website in accordance with legislation in the United Kingdom governing
the preparation and dissemination of financial statements, which may vary from legislation in other jurisdictions. The maintenance
and integrity of the Company’s website is the responsibility of the Directors. The Directors’ responsibility also extends to the
ongoing integrity of the financial statements contained therein.
Auditors
All of the current Directors have made themselves aware of any information needed by the Company’s auditors for the purposes
of its audit and to establish that the auditors are aware of that information. The Directors are not aware of any relevant information
of which the auditors are unaware.
Miller Wachman LLP has expressed its willingness to continue as the Company’s auditors and a resolution to re-appoint
Miller Wachman LLP will be proposed at the Annual General Meeting.
By order of the Board
Douglas A. Anderson
Company Secretary
May 23, 2016
13
Spectra Systems Corporation Annual report and accounts 2015Corporate governance FINANCIAL STATEMENTS
Independent auditors’ report
15
16 Balance sheets
17 Statements of income and other comprehensive income
18 Statements of stockholders’ equity
19 Statements of cash flows
20 Notes to the financial information
32 Shareholder and corporate information
INDEPENDENT AUDITORS’ REPORT
To the Board of Directors and Stockholders of Spectra Systems Corporation Providence, Rhode Island
We have audited the accompanying financial statements of Spectra Systems Corporation, which comprise the balance
sheets as of December 31, 2015 and 2014, and the related statements of income and other comprehensive income,
stockholders’ equity and cash flows for the year then ended, and the related notes to the financial statements.
Management’s responsibility for the financial statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with
accounting principles generally accepted in the United States of America; this includes the design, implementation, and
maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from
material misstatement, whether due to fraud or error.
Auditors’ responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in
accordance with auditing standards generally accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from
material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial
statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material
misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditors
consider internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to
design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the
appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management,
as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of
Spectra Systems Corporation as of December 31, 2015 and 2014, and the results of its operations and its cash flows for
the years then ended in accordance with accounting principles generally accepted in the United States of America.
Miller Wachman LLP
Boston, Massachusetts
May 17, 2016
15
Spectra Systems Corporation Annual report and accounts 2015Financial statements BALANCE SHEETS
December 31, 2015 and 2014
Assets
Current assets
Cash and cash equivalents
Accounts receivable, net of allowance for doubtful accounts
of $12,650 and $20,000 at December 31, 2015 and 2014
Other receivables
Inventory
Prepaid expenses
Deferred tax assets
Total current assets
Property, plant and equipment, net
Other assets
Intangible assets, net
Restricted cash and investments
Deferred tax assets
Other assets
Total other assets
Total assets
Liabilities and stockholders’ equity
Current liabilities
Accounts payable
Accrued expenses and other liabilities
Deferred revenue
Total current liabilities
Non-current liabilities
Deferred revenue
Total non-current liabilities
Total liabilities
Stockholders’ equity
Common stock, $0.01 par value, 125,000,000 shares authorized
45,251,370 shares issued and outstanding
Additional paid in capital – common stock
Accumulated other comprehensive loss
Accumulated deficit
Total stockholders’ equity
2015
2014
$
9,808,487
$
9,772,846
4,198,356
52,705
2,824,195
124,975
170,000
17,178,718
2,867,526
4,627,355
1,073,558
819,000
19,285
6,539,198
1,702,438
50,653
4,195,180
111,319
215,000
16,047,436
2,824,282
4,092,210
2,500,000
774,000
183,941
7,550,151
$
26,585,442
$
26,421,869
$
1,463,698
$
1,564,641
1,247,273
4,275,612
277,222
277,222
738,878
1,223,676
2,165,744
4,128,298
292,653
292,653
4,552,834
4,420,951
452,514
54,936,776
(86,291)
452,514
54,913,613
(60,063)
(33,270,391)
(33,305,146)
22,032,608
22,000,918
Total liabilities and stockholders’ equity
$
26,585,442
$
26,421,869
The accompanying notes are an integral part of these financial statements.
16
Spectra Systems Corporation Annual report and accounts 2015 STATEMENTS OF INCOME AND OTHER
COMPREHENSIVE INCOME
for the years ended December 31, 2015 and 2014
Revenues
Product
Service
Royalty
Total revenues
Cost of sales
Gross profit
Operating expenses
Research and development
General and administrative
Sales and marketing
Total operating expenses
(Loss)/income from operations
Other income/(expense)
Interest income
Other income
Foreign currency (loss)/gain
Total other income
Income before provision for income taxes
Provision for income taxes
Net income
Earnings per share
Earnings per share, basic and diluted
Weighted average number of common shares
Other comprehensive (loss)/income
Unrealized loss on currency exchange
Reclassification for realized loss/(gain) in net income
Total other comprehensive loss
Comprehensive income
The accompanying notes are an integral part of these financial statements.
2015
2014
$
11,672,565 $
14,163,982
1,747,474
693,824
14,113,863
7,402,407
6,711,456
2,549,341
3,525,747
655,395
6,730,483
(19,027)
86,648
769
(33,635)
53,782
34,755
—
1,928,431
813,936
16,906,349
8,208,984
8,697,365
3,033,934
3,775,627
659,322
7,468,883
1,228,482
69,727
250
2,349
72,326
1,300,808
257,000
$
$
34,755
$
1,043,808
— $
0.02
45,251,370
45,251,370
$
(59,863) $
33,635
(26,228)
(52,817)
(2,349)
(55,166)
$
8,527 $
988,642
17
Spectra Systems Corporation Annual report and accounts 2015Financial statements STATEMENTS OF STOCKHOLDERS’ EQUITY
for the years ended December 31, 2015 and 2014
Common stock
Shares
Amounts
Additional
paid in capital
Accumulated
deficit
Other
comprehensive
loss
Total
stockholders’
equity
Balance at December 31, 2013
45,251,370 $
452,514 $ 54,855,662 $ (34,348,954) $
(4,897) $ 20,954,325
Compensation cost related to
amortization of stock options
Reclassification for realized
gain in net income
Unrealized loss on
currency exchange
Net income
57,951
57,951
(2,349)
(2,349)
(52,817)
(52,817)
1,043,808
1,043,808
Balance at December 31, 2014
45,251,370 $
452,514 $ 54,913,613 $ (33,305,146) $
(60,063) $ 22,000,918
Compensation cost related to
amortization of stock options
Reclassification for realized
loss in net income
Unrealized loss on
currency exchange
Net income
23,163
23,163
33,635
33,635
34,755
(59,863)
(59,863)
34,755
Balance at December 31, 2015
45,251,370 $
452,514 $ 54,936,776 $ (33,270,391) $
(86,291) $ 22,032,608
The accompanying notes are an integral part of these financial statements.
18
Spectra Systems Corporation Annual report and accounts 2015 STATEMENTS OF CASH FLOWS
for the years ended December 31, 2015 and 2014
Cash flows from operating activities
Net income
Adjustments to reconcile net income/(loss) to net cash from operating activities:
2015
2014
$
34,755
$
1,043,808
Depreciation and amortization
Stock based compensation expense
Allowance for doubtful accounts
Inventory obsolescence
Provision for income taxes
Changes in operating assets and liabilities:
Accounts receivable
Other receivable
Deferred contract costs
Inventory
Prepaid expenses
Other assets
Accounts payable
Accrued expenses and other liabilities
Deferred revenue
Contingent liability
Net cash used in operating activities
Cash flows from investing activities
Decrease in restricted cash and investments
Deposits for property, plant, and equipment
Payment of patent and trademark costs
Asset acquisitions
Purchases of property, plant, and equipment
Net cash provided by/(used in) investing activities
Effect of exchange rate changes on cash and cash equivalents
Net increase/(decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of the year
866,673
23,163
75,671
—
(2,499,512)
(2,052)
—
1,295,314
(17,853)
1,989
453,617
160,922
(921,685)
801,889
57,951
20,000
—
257,000
539,244
(45,706)
9,892
(1,226,462)
45,542
49,014
(894,010)
264,732
(668,455)
—
(2,000,000)
(528,998)
(1,745,561)
1,426,442
—
(326,192)
(213,917)
(288,584)
—
(162,000)
(308,863)
(1,042,441)
(354,859)
597,749
(1,868,163)
(33,110)
35,641
9,772,846
(48,167)
(3,661,891)
13,434,737
Cash and cash equivalents at end of the year
$
9,808,487 $
9,772,846
Supplemental disclosure of cash flow information
Income taxes paid
Non-cash investing activities
Acquisition of patents through accounts payable
Acquisition of property, plant and equipment through accounts payable
The accompanying notes are an integral part of these financial statements.
$
$
$
500 $
500
228,536
$
44,000 $
—
—
19
Spectra Systems Corporation Annual report and accounts 2015Financial statements NOTES TO THE FINANCIAL INFORMATION
for the years ended December 31, 2015 and 2014
Note A – Corporate information
Spectra Systems Corporation (the “Company”), develops and sells integrated optical systems that provide customers with
increased efficiency, security tracking and product life. The integrated systems combine consumables and engineered
optical materials with software and hardware for use in applications. The Company develops and sells its integrated
solutions across a spectrum of markets, including currency manufacturing and cleaning, branded products, industrial
logistics, and other highly sensitive documents. The Company also provides software tools to the lottery and gaming
industries for fraud, money laundering and match fixing detection.
The Company was incorporated on July 3, 1996 in Delaware as Spectra Acquisition Corp. On August 26, 1996, the Company
purchased substantially all of the assets of SSC Science Corporation (SSCSC) and changed its name to Spectra Science
Corporation. The assets were purchased for US$1,6 million in cash plus common stock warrants. The acquisition was accounted
for using the purchase method of accounting.
On June 8, 2001, the Company changed its name to Spectra Systems Corporation.
On July 25, 2011, the Company raised $20,241,179, net of offering costs, on the London Stock Exchange in a placing of 18,592,320
common shares at a placing price of £0.753 per new common share, representing 41.09% of the enlarged common share
capital of the Company. As a result of the offering, anti-dilution provisions found in the Company’s Amended and Restated
Certificate of Incorporation converted all of the issued and outstanding preferred shares into 17,185,052 common shares,
giving 26,659,050 common shares in issue at the time of the placing.
On June 6, 2012, the Company acquired, all of the assets of ESI Integrity, Inc., including its proprietary source codes, multi-year
contracts, long-standing customer relationships, and assumed liabilities. $1,425,000 was paid in consideration for the assets.
On September 14, 2012, the Company acquired certain assets of Lapis Software Associates LLC including, their proprietary
source codes, multi-year and long-standing customer relationships, and assumed liabilities. $726,000 was paid in
consideration for the assets.
On February 28, 2014, the Company acquired certain assets of Inksure Technologies, Inc., including their long-standing
customer relationships and authentication technology. $1,356,000 was paid in consideration for the assets (see Note O).
On September 30, 2015, the Company acquired certain assets of Solaris Nanosciences, Inc. including technology and customer
relationships, in exchange for $213,917 in cash. The Company also recorded $184,000 in contingent payments based on a
royalty payment arrangement for anticipated continuing business.
On January 28, 2016, the Company acquired certain specialty phosphour assets primarily used in the authentication of world
banknotes. The total consideration amounted to $3,120,000 (see Note O).
Note B – Significant accounting policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and judgments that affect the amounts reported in the financial statements
and accompanying notes. The accounting estimates that require management’s most difficult and subjective judgments
include the assessment of recoverability of property, plant, and equipment; the valuation of inventory; intangible assets;
and the recognition and measurement of income tax assets and liabilities. The actual results may differ materially from
management’s estimates.
Cash and Cash Equivalents
The Company considers highly liquid investment purchases with a maturity of 90 days or less at date of acquisition to be
cash equivalents.
Restricted Cash and Investments
Restricted cash and investments represents money market investments held as collateral for certain performance agreements
entered into by the Company in 2015 and 2014 as required in accordance with terms of a services contract. At December 31,
2015 and 2014, the agreement required $500,000 and $2,500,000 respectively be maintained as collateral. The collateral
will be released as the Company meets contractual milestones. Restricted cash and investments of $1,073,558 as of
December 31, 2015 is a certificate of deposit, of which $500,000 is restricted.
20
Spectra Systems Corporation Annual report and accounts 2015 Note B – Significant accounting policies continued
Concentration of Credit Risk and Significant Customers
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash
and cash equivalents and trade accounts receivable. The Company’s cash management policies restrict investments to
low-risk highly liquid securities, and the Company restricts its transactions to financial institutions with a good credit
standing. The Company has cash, including restricted cash, on deposit with two financial institutions which are insured by
the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per institution. As of December 31, 2015, the amount in
excess of the FDIC limit was $9,332,000. Also included in cash at December 31, 2015 is $34,338 of cash in bank accounts in
the United Kingdom and Canada. Both accounts are not FDIC insured.
Concentrations of credit risk with respect to trade accounts receivable are limited due to the concentration of business
with government entities.
The following table summarizes the number of customers that individually comprise greater than 10% of total revenues and
their aggregate percentage of the Company’s total revenues:
Year ended
December 31,
2015
2014
Number of
significant
customers
3
3
Percentage
of total
revenues
72%
78%
The following table summarizes the number of customers that individually comprise greater than 10% of total accounts
receivable and their aggregate percentage of the Company’s total accounts receivable:
Year ended
December 31,
2015
2014
Number of
significant
customers
2
2
Percentage
of total
receivables
80%
59%
Fair Value of Financial Instruments
The carrying amounts of the Company’s financial instruments, which include cash and cash equivalents, accounts
receivable and accounts payable, are carried in the financial statements at amounts that approximate their fair market
values at December 31, 2015 and 2014.
Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. Fair value is estimated by applying the following hierarchy, which
prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon
the lowest level of input that is available and significant to the fair value measurement:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for
identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable
market data for substantially the full term of the assets or liabilities.
Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market
participants would use in pricing the asset or liability.
As of December 31, 2015 and 2014, the Company had certificates of deposit of $1,073,558 and $1,055,053, respectively,
which is included in restricted cash and investments of $1,073,558 and $2,500,000, respectively. The Company considers
this certificate of deposit as a Level 2 investment.
Foreign Currency Translation
The functional currency of the Company’s foreign operations is the applicable local currency, the Canadian dollar. The
functional currency is translated into US dollars for balance sheet accounts using currency exchange rates in effect as of
the balance sheet date and for revenue and expense accounts using an average exchange in effect during the applicable
period. The translation adjustments are deferred as a separate component of stockholders’ equity in accumulated other
comprehensive loss.
Accounts Receivable
Accounts receivable are stated at the amount management expects to collect from outstanding customer accounts.
Management provides for uncollectible accounts through a provision for bad debt expense. At December 31, 2015 and 2014,
the Company had allowances for doubtful accounts of $12,650 and $20,000 respectively.
21
Spectra Systems Corporation Annual report and accounts 2015Financial statements Note B – Significant accounting policies continued
Inventory
Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method. The Company
regularly reviews inventory quantities on hand and records a provision to write down excess and obsolete inventory to its
estimated net realizable value if less than cost.
Intangible Assets
Intangible assets including goodwill are recorded at the purchase price. Amortization is calculated using the straight-line
method over the estimated useful lives of assets ranging from seven to 15 years. Amortization is not recorded on goodwill
items. The Company evaluates the possible impairment of long-term assets annually and/or whenever events or
circumstances indicate the carrying value of the asset may not be recoverable.
Property and Equipment
Property and equipment is stated on the basis of purchase price. Depreciation is calculated using the straight-line method
over the following estimated useful lives:
Laboratory equipment
Computer and office equipment
Furniture and fixtures
3–7 years
3–5 years
7 years
Leasehold improvements
Shorter of lease term or estimated useful life
Software
Manufacturing equipment
3–5 years
5–7 years
Maintenance and repairs are charged to expense as incurred. When assets are retired or otherwise disposed of, the assets
and related allowances for depreciation and amortization are eliminated from accounts and any resulting gain or loss is
reflected in net income.
Investment in Affiliates
The Company accounts for investments in affiliates under the cost method of accounting if the Company owns less than
20% of the affiliates’ outstanding capital. As of December 31, 2015, the Company held a 19% ownership in an affiliate (SpectraMed),
and a 10% ownership in an affiliate (Solaris). These affiliates have had significant losses in prior years and the Company had
previously reduced its investments in these affiliates to $0.
Accounting for Stock-Based Compensation
In accounting for the Employee Stock Option Plan (the Plan), the Company uses the Black-Scholes option pricing model to
calculate compensation costs associated with options granted to employees. Total compensation costs are recorded over
the option vesting period, generally three years. The Company recorded compensation costs of $23,163 and $57,951 for
2015 and 2014, respectively, under the Plan.
Revenue Recognition
Product revenue includes sales of pigments and security taggants, delivery of prototypes, and contracts with multiple elements
including nonrecurring engineering and follow-on manufacturing. Service revenue includes research and development
services provided for a fixed price or provided for a specific period.
Revenues related to sales of pigments and security taggants, and research and development services provided for a
specific period are generally recognized when products are shipped or services are provided, the risk of loss has passed to
the customer, the sales price is fixed or determinable, and collectibility is reasonably assured.
Revenue from multiple element arrangements is deferred until all elements of the contract are delivered, unless all of the
following criteria have been met: (1) the product or service has been delivered; (2) the fee for the delivered element is not
subject to forfeiture, refund or concession based on performance or delivery of the undelivered element; and (3) the fair
value of the delivered element is determined based upon the price charged by the Company or the price charged by
competitors when similar services or products are sold separately, in which case the revenues for each element will be
recognized independently in accordance with the Company’s policy.
The Company enters into arrangements that can include various combinations of software, services and hardware. Where
elements are delivered over different periods of time, and when allowed under US GAAP, revenue is allocated to the respective
elements based on their relative selling prices at the inception of the arrangement, and revenue is recognized as each
element is delivered.
22
Spectra Systems Corporation Annual report and accounts 2015NOTES TO THE FINANCIAL INFORMATION continuedfor the years ended December 31, 2015 and 2014
Note B – Significant accounting policies continued
Revenue Recognition continued
Revenue from fixed-price development contracts is recognized on the percentage-of-completion method, measured by the
percentage of effort incurred to date to estimated total effort for each contract. That method is used because
management considers total effort to be the best available measure of progress on the contracts. Because of inherent
uncertainties in estimating effort, it is at least reasonably possible that the estimates used will change within the near term.
Royalties are recognized when they are earned based on sales or use of technologies by third parties, except where future
income is not anticipated to cover nonrefundable advances received when the excess royalty is taken to income.
Research and Development
Internal research and development costs are expensed as incurred. Certain third party research and development costs are
capitalized in connection with contracted work. These costs are expensed as certain milestones are achieved. Overhead,
general and administrative, and training costs are expensed as incurred.
Advertising Costs
Advertising costs are charged to expense when incurred. No advertising expense was incurred in 2015 or 2014.
Income Tax
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income taxes. The benefits from net operating losses
carried forward may be impaired or limited in certain circumstances. In addition, a valuation allowance can be provided for
deferred tax assets when it is more likely than not that all or some portion of the deferred tax asset will not be realized. The
Company had a deferred tax asset of $989,000 at December 31, 2015 and 2014. For 2015, there is no federal or state
income tax liability on those respective income tax returns.
Shipping and Handling
The Company reports the cost of shipping and handling as an operating expense. Shipping and handling expense was
$245,019 and $231,356 for 2015 and 2014, respectively.
Subsequent Events
On January 28, 2016, the Company completed the acquisition of certain specialty phosphour assets primarily used in the
authentication of world banknotes. The total consideration amounted to US$3.1 million of which US$2.8 million was paid in
cash on closing with US$0.3 million held in escrow for twelve months. See Note O.
Note C – Related party transactions
100% of the sales of the Company’s phosphour products, which amounted to approximately $1,211,000 and $1,650,000 for
the years ended December 31, 2015 and 2014, respectively, were to a company owned by a shareholder.
On September 30, 2015, the Company purchased certain assets, including technology and customer relationships, from
Solaris Nanosciences, Inc. (Solaris) in exchange for $213,917 in cash. The Company also recorded $184,000 in contingent
payments based on a royalty payment arrangement for anticipated continuing business. The agreement requires the Company
to pay Solaris 10% of any revenues hereafter received by the Company from the commercial exploitation of the assets. The
Chief Executive Officer of Solaris is also the Chief Executive Officer of Spectra.
Note D – Inventories
Inventories consist of the following:
Raw materials
Finished goods
December 31,
2015
2014
$
2,111,413
$
3,952,203
712,782
242,977
$
2,824,195 $
4,195,180
23
Spectra Systems Corporation Annual report and accounts 2015Financial statements Note E – Property and equipment
Property and equipment consists of the following:
Laboratory equipment
Computer and office equipment
Furniture and fixtures
Leasehold improvements
Software
Manufacturing equipment
Total
Less: accumulated depreciation
December 31,
2015
2014
$
981,343
$
963,950
629,544
136,850
1,802,635
348,483
2,604,386
6,503,241
611,911
136,850
1,802,635
361,621
2,151,154
6,028,121
(3,635,715)
(3,203,839)
$
2,867,526
$
2,824,282
Depreciation expense amounted to $449,173 and $429,290 for the years ended December 31, 2015 and 2014, respectively.
Note F – Intangible assets
Intangible assets consist of the following:
Patents
Customer relationships
Non-compete agreements
Developed technology
Tradename
Trademarks
Goodwill
Total
Less: accumulated amortization
December 31,
2015
2014
$
2,120,741
$
1,531,013
1,943,000
1,730,000
177,440
632,000
30,000
17,739
1,564,863
6,485,783
177,440
510,000
30,000
17,739
1,536,946
5,533,138
(1,858,428)
(1,440,928)
$
4,627,355
$
4,092,210
Amortization expense amounted to $417,500 and $369,175 for the years ended December 31, 2015 and 2014, respectively.
Estimated amortization expense for the next five years is as follows:
Year ending
December 31,
2016
2017
2018
2019
2020
Thereafter
24
$
432,813
413,389
378,715
339,643
259,837
1,238,095
$
3,062,492
Spectra Systems Corporation Annual report and accounts 2015NOTES TO THE FINANCIAL INFORMATION continuedfor the years ended December 31, 2015 and 2014
Note G – Other assets
Other assets consist of the following:
Rental deposits
License agreements
Equipment deposits
Note H – Accrued expenses and other liabilities
Accrued expenses and other liabilities consist of the following:
Royalties
Employee compensation
Contingent costs
Professional fees
Property and franchise taxes
Product warranty
Other
Note I – Income taxes
The approximate components of the income tax provision are as follows:
Income tax benefit computed at:
Federal statutory rate – current
State statutory rate – current
Federal deferred
State deferred
Change in valuation allowance
Provision for income taxes
December 31,
2015
2014
$
18,786
$
499
—
19,453
2,488
162,000
$
19,285
$
183,941
December 31,
2015
2014
$
808,510 $
303,441
184,000
82,830
90,629
25,000
70,231
668,019
269,723
—
64,793
101,086
25,000
95,055
$
1,564,641
$
1,223,676
December 31,
2015
2014
$
(54,000) $
(10,000)
89,000
16,000
(50,000)
(9,000)
726,000
128,000
(41,000)
(538,000)
$
— $
257,000
A reconciliation of the statutory federal income tax rate with our effective income tax rate was as follows:
Statutory federal rate
State income taxes, net of income tax benefit
Non-deductible expenses and other
Change in valuation allowance
Effective tax rate
December 31,
2015
34.0%
1.2%
(44.8%)
9.6%
0%
2014
34.0%
3.0%
1.0%
(18.2%)
19.8%
25
Spectra Systems Corporation Annual report and accounts 2015Financial statements Note I – Income taxes continued
Approximate deferred income tax assets are as follows:
Depreciation and amortization
Deferred revenue
Deferred rent
Federal and state tax credits
Inventory
Bad debts
Contingent liability
Net operating loss carryforward
Valuation allowance
Total deferred income tax assets
December 31,
2015
2014
$
(138,000) $
(94,000)
(492,000)
7,000
(471,000)
8,000
1,054,000
1,039,000
189,000
5,000
—
240,000
8,000
—
9,048,000
8,985,000
(8,684,000)
(8,726,000)
$
989,000 $
989,000
The Company uses an effective tax rate of 40% consisting of a federal rate of 34% and a state rate of 6%, net of federal effect.
At December 31, 2015, the Company had net operating loss carryforwards expiring between 2018 and 2036 for United States
federal income tax purposes of approximately $26,000,000 and $4,000,000 expiring between 2018 and 2019 for state
income tax purposes. A valuation allowance has been established for $8,684,000 and $8,726,000 as of December 31, 2015
and 2014, respectively, for the deferred tax benefit related to those loss carryforwards and other deferred tax assets.
At December 31, 2015, the Company also had approximately $740,000 and $313,000 of tax credit carryforwards that are
available to offset federal and state liabilities, respectively. The credits will begin to expire between 2016 and 2030 for
federal liabilities and between 2017 and 2020 for state liabilities.
The utilization of the tax carryforwards described above are dependent upon future profitability prior to any expiration
dates. Additionally, alternative minimum taxes, if any, and substantial changes in ownership, tax laws and regulations may
substantially limit their realization.
Note J – Accounting for uncertainty in income taxes
The Company accounts for the effect of any uncertain tax positions based on a “more likely than not” threshold to the
recognition of the tax positions being sustained, based on the technical merits of the position under scrutiny by the
applicable taxing authority. If a tax position or positions are deemed to result in uncertainties of those positions, the
unrecognized tax benefit is estimated based on a “cumulative probability assessment” that aggregates the estimated
tax liability for all uncertain tax positions. The Company is not currently under examination by any taxing jurisdiction.
The Company’s federal and state income tax returns are generally open for examination for three years following the
date filed.
Note K – Commitments
Lease Commitments
The Company holds four real estate leases. The Company’s lease agreement for corporate office space expired September
30, 2012 and is now in a month-to-month arrangement. The Company signed a five-year lease agreement for a new space
in East Providence beginning in November 2013 and expiring in October 2017. To support our “ICS” business, the Company
signed a two-year lease from February 2013 through January 2015. In 2014, the Company renewed the lease for another
two years from February 2015 through January 2017. The Company’s lease for laboratory space in East Providence was
extended through May 31, 2017. Rent expense was $419,990 and $434,592 for the years ended December 31, 2015 and
2014, respectively.
26
Spectra Systems Corporation Annual report and accounts 2015NOTES TO THE FINANCIAL INFORMATION continuedfor the years ended December 31, 2015 and 2014 Note K – Commitments continued
Lease Commitments continued
Future minimum lease payments are as follows:
Year ending
December 31,
2016
2017
$
$
337,615
198,559
536,173
License and Supply Agreements
In 1996, and subsequently amended in 1999 and 2002, the Company entered into a license agreement under which the
Company obtained a nonexclusive right to use certain technology through the term of the licensor’s patents on such
technology. The license agreement contains provisions for royalties to be paid on sales of products developed under
the agreement. For the years ended December 31, 2015 and 2014, the Company recorded $224,904 and $461,095,
respectively, in royalty expenses.
Note L – Stockholders’ equity
Common and Preferred Stock
On July 25, 2011, the Company raised $20,241,179, net of offering costs, on the London Stock Exchange in a placing of 18,592,320
common shares at a placing price of £0.753 per new common share, representing 41.09% of the enlarged common share
capital of the Company. As a result of the offering, anti-dilution provisions found in the Company’s Amended and Restated
Certificate of Incorporation converted all of the issued and outstanding preferred shares into 17,185,052 common shares
giving 26,659,050 common shares in issue at the time of the placing. At December 31, 2015, there were 45,251,370 common
shares issued and outstanding and no preferred shares in issue.
Warrants
– WH Ireland Warrant Agreement
Pursuant to a warrant agreement dated July 19, 2011, the Company created and issued warrants to WH Ireland under
Regulation D under the US Securities Act, which entitles the holder to subscribe for up to 452,514 common shares at an
exercise price of £0.753 per share. The warrants expired on July 25, 2014. Under the Black-Scholes pricing model, the
Company estimated the fair value of the warrants to be $273,318. These costs have been included as part of the 2011
offering costs.
Stock Option Plan
In December 1996, the Company’s Board of Directors, who control a majority of the shares of the Company, approved the
1997 Stock Option Plan (the “1997 Plan”).
The 1997 Plan provided that key employees, non-employee Directors, and certain consultants and advisors may be granted
either nonqualified or incentive stock options for the purchase of the Company’s common stock at the fair market value, on
the date of the grant. Stock options generally vest over three years. The options would be exercisable over a period up to
ten years from the date of grant.
In February 2002, the Company adopted the 2002 Stock Plan (the “2002 Plan”) which provided for the grant of incentive
stock options and nonqualified stock options, stock awards, and stock purchase rights for the purchase of up to 1,500,000
shares of the Company’s common stock to officers, employees, consultants and Directors of the Company. The Board of
Directors is responsible for the administration of the 2002 Plan. The Board determines the term of each option, the option
exercise price, the number of shares for which each option is granted and the rate at which each option is exercisable. Incentive
stock options may be granted to an officer or employee at an exercise price per share of not less than the fair value per common
share on the date of the grant (not less than 110% of fair value in the case of holders of more than 10% of the Company’s voting
stock) and with a term not to exceed ten years from the date of the grant (five years for incentive stock options granted
to holders of more than 10% of the Company’s voting stock). Nonqualified stock options may be granted to consultants
or Directors at an exercise price per share of not less than 85% of the fair value of the common stock.
Upon the effective date of the 2002 Plan, the 1997 Plan was terminated. The termination did not affect the previously issued options.
27
Spectra Systems Corporation Annual report and accounts 2015Financial statements
Note L – Stockholders’ equity continued
Stock Option Plan continued
In 2007, the number of shares available for grant under the 2002 Plan increased from 1,500,000 to 3,500,000.
In May 2007, the Company adopted the 2007 Stock Plan (the”2007 Plan”) which provided for the grant of incentive stock
options and nonqualified stock options, stock awards, and stock purchase rights for the purchase of up to 14,100,000
shares of the Company’s common stock to officers, employees, consultants and Directors of the Company. The Board
of Directors is responsible for administration of the 2007 Plan. The Board determines the term of each option, the option
exercise price, the number of shares for which each option is granted and the rate at which each option is exercisable.
The 2007 plan and the 2002 Plan existed at December 31, 2015.
At December 31, 2015, 2,176,464 options were issued under the 2002 Plan and 3,491,476 options were issued under the
2007 Plan. 344,451 options were issued without a plan. 8,087,609 options were available for grant under the 2007 Plan.
Information related to stock options granted by the Company is summarized as follows (including certain options granted
outside of the Plans):
December 31, 2015
December 31, 2014
Number of shares
under option
Weighted average
exercise price
Number of shares
under option
Weighted average
exercise price
Outstanding at beginning of year
6,141,491
$
Granted
Exercised
Forfeited/canceled
Outstanding at end of year
—
—
(129,100) $
6,012,391
$
0.74
—
—
0.73
0.74
6,533,103
$
45,000 $
—
(436,412) $
6,141,491
$
0.74
0.36
—
0.58
0.74
The following table summarizes information about stock options outstanding at December 31, 2015:
Exercise price range
$0.30–$0.84
$0.85–$1.23
Options outstanding
Options exercisable
Number of
outstanding
shares
3,511,725
2,500,666
6,012,391
Weighted
average
contractual life
(years)
Weighted
average
exercise price
3.79
$
1.30 $
0.57
0.99
Number of
shares
3,421,169
2,500,666
$
$
5,921,835
Weighted
average
exercise price
0.57
1.00
The Company currently uses the Black-Scholes option pricing model to determine the fair value of its stock options. The
valuations determined using this model are affected by assumptions regarding a number of complex and various subjective
variables including stock price, volatility, expected life of options, risk free interest rates, and expected dividends, if any.
The assumptions used to value stock option grants for the year ended December 31, 2015 are as follows:
Risk free rate
Expected life
0.09% – 0.10%
5 years
Assumed volatility
52.80% – 53.63%
Expected dividends
Expected forfeitures
None
75.0%
Unrecognized Compensation costs
As of December 31, 2015, there was approximately $3,000 of unrecognized compensation costs, adjusted for estimated
forfeitures, related to unvested stock-based payments granted to our employees, Directors and consultants. Total unrecognized
compensation costs will be adjusted for future changes in estimated forfeitures and recognized over the remaining vesting
periods of the stock grants.
28
Spectra Systems Corporation Annual report and accounts 2015NOTES TO THE FINANCIAL INFORMATION continuedfor the years ended December 31, 2015 and 2014
Note M – Employee retirement plan
In 1999, the Company adopted a defined contribution plan (the Plan), established under the guidelines of Section 401(k) of
the Internal Revenue Code (IRC), which covers all employees. Employees are eligible to participate in the Plan at the beginning
of the first month following the date of hire. Employees may contribute up to the maximum, allowed by the IRC of eligible
pay on a pretax basis. The Company made a matching contribution of 50% of employee contributions up to 4% of eligible
salary. Company matching contributions vest at 25% after one year of service, 50% at the end of two years of service and
100% at the end of three years of service. For the years ended December 31, 2015 and 2014, the Company’s matching
contribution was $41,419 and $53,792, respectively.
Note N – Contingent liability
In December 2011, the Company was notified by a corporate shareholder regarding a license agreement between the
Company and the shareholder dated March 8, 1999. The shareholder had stated that the Company owed the shareholder
approximately $2,100,000 in total for the years 2004 through 2010 based on their interpretation of the license agreement.
The Company disagreed with the shareholder’s interpretation of the license agreement.
In 2014, the Company and the shareholder reached a settlement which terminated the agreement and liabilities that would
otherwise have continued through the remainder of the agreement. To settle the dispute for all past amounts due and all
future amounts that may be due, the Company agreed to pay the shareholder $2,000,000 along with relieving a receivable
owed to the Company from the shareholder in the amount of approximately $129,000. Accordingly, the Company recorded
a contingent liability expense of $1,789,040 in 2013 after offsetting accruals.
Note O – Business combinations
Acquisition of certain assets from Inksure Technologies, Inc.
On February 28, 2014, the Company acquired certain assets from Inksure Technologies, Inc., a leader in brand protection
and tax stamp authentication headquartered in New York City, NY. The acquisition was strategic for the Company allowing
us to extend our reach into tax stamps and the authentication of commercial product brands. The Company will support
the customers with resources existing in its banknote authentication division. The total purchase price was $1,356,000 in
cash with deferred consideration of $35,000, dependent upon achieving a commercial milestone. The purchase price included
Inksure’s long-standing customer relationships and authentication technology. We report Inksure as part of our
authentication systems.
Acquisition of certain specialty phosphour assets
On January 29, 2016, the Company acquired certain specialty phosphour assets primarily used in the authentication of world
banknotes. The total consideration amounted to $3,120,000, of which $2,805,000 million was paid in cash on closing with
$315,000 held in escrow for twelve months.
Most importantly, in addition to the assets, Spectra has acquired long-standing customer relationships related to the assets
including a major world supplier of banknote inks. Spectra will incorporate the company’s assets within its existing phosphour
business and is not making any incremental hires to support the increased revenue. We report this acquisition as part of
our authentication systems.
The following tables provide further detail of these acquisitions:
Date of acquisition
Reporting business segment
Cash consideration paid to former owners
Allocation of purchase price:
Accounts receivable
Inventories
Property, plant, and equipment
Goodwill
Identifiable intangible assets
Total assets acquired
Specialty phosphour
January 1, 2016
Authentication
systems
$
3,120,000
—
235,000
—
904,000
1,981,000
$
3,120,000
29
Spectra Systems Corporation Annual report and accounts 2015Financial statements
Specialty phosphour
Weighted
average
amortization
period
years
Total
15.00 $
1,100,000
10.00
3.00
870,000
11,000
12.74
$
1,981,000
Inksure
February 28, 2014
Authentication
systems
$
1,356,000
136,000
246,000
—
260,000
817,000
1,459,000
—
(103,000)
(103,000)
$
1,356,000
Inksure
Weighted
average
amortization
period
years
Total
10.00 $
600,000
10.00
5.00
3.00
120,000
30,000
67,000
9.06
$
817,000
Note O – Business combinations continued
Acquisition of certain specialty phosphour assets continued
Identifiable intangible assets
Customer relationships
Developed technology
Non-compete agreements
Weighted average amortization period and total
Date of acquisition
Reporting business segment
Cash consideration paid to former owners
Allocation of purchase price:
Accounts receivable
Inventories
Property, plant, and equipment
Goodwill
Identifiable intangible assets
Total assets acquired
Deferred revenue
Other liabilities
Total liabilities acquired
Net assets assumed
Identifiable intangible assets
Customer relationships
Developed technology
Trade name
Non-compete agreements
Weighted average amortization period and total
30
Spectra Systems Corporation Annual report and accounts 2015NOTES TO THE FINANCIAL INFORMATION continuedfor the years ended December 31, 2015 and 2014
Note P – Segment reporting
In accordance with ASC 280, management has identified three operating segments. The first is the Authentication Systems
Group, which captures the hardware, software, and materials related to banknote, tax stamp, and other high value goods.
The second segment is the Secure Software Transactions Group. This group is characterized as providing an Internal Control
System (ICS) software offering to the lottery and gaming industries. ICS provides tools for fraud, money laundering and
match fixing detection, and statistical analysis. The third group is the Banknote Cleaning Group. This group captures the
technology related to cleaning soiled banknotes. Overall development expense across all divisions was approximately
$955,000 for the year 2015.
Information for each reportable segment as of December 31, 2015 and 2014 is as follows:
Gross
sales
Income/(loss)
from operations
Depreciation and
amortization
Capital
expense
Segment
assets
2014
Secure Software Transactions
$
1,378,849 $
106,471 $
188,075 $
4,152 $ 3,663,548
Authentication Systems
15,527,500
Banknote Cleaning
—
1,455,180
(333,169)
600,156
13,668
186,688
164,019
22,359,111
399,210
Total segments
$ 16,906,349 $
1,228,482 $
801,899 $
354,859 $ 26,421,869
2015
Secure Software Transactions
$
1,321,822 $
162,058 $
202,957 $
18,517 $
3,147,070
Authentication Systems
12,792,041
357,509
Banknote Cleaning
—
(538,594)
626,843
36,873
22,690
247,377
22,633,632
804,740
Total segments
$
14,113,863 $
(19,027) $
866,673 $
288,584 $ 26,585,442
Note Q – Income per share
The calculation of income per share figures for the years ended December 31, 2015 and 2014 is based on the profit attributable
to ordinary shareholders of $34,755 and $1,043,808, respectively, divided by the weighted average number of shares in
issue, shown in the table. For 2015 and 2014, the exercise price of all options exceeded the average market price of the
shares in issue and therefore are not considered in the calculations.
31
Spectra Systems Corporation Annual report and accounts 2015Financial statements SHAREHOLDER AND CORPORATE INFORMATION
English Law Legal Counsel
Covington & Burling LLP
265 Strand
London WC2R 1BH
United Kingdom
+44 (0) 207 067 2000
US Based Legal Counsel
Adler, Pollock & Sheehan, PC
One Citizens Plaza, 8th Floor
Providence, RI 02903
United States of America
+1 401 274 7200
Registrar
Computershare Investor Services PLC
2nd Floor
Vintners’ Place
68 Upper Thames Street
London EC4V 3BJ
+44 (0) 870 703 0300
Registered office
Spectra Systems Corporation
321 South Main Street, Suite 102
Providence, RI 02903
United States of America
+1 401 274 4700
Nominated Advisor
WH Ireland Limited
24 Martin Lane
London EC4R 0DR
United Kingdom
+44 (0) 207 220 1666
Broker
WH Ireland Limited
24 Martin Lane
London EC4R 0DR
United Kingdom
+44 (0) 207 220 1666
Auditors and Reporting Accountants
Miller Wachman LLP
100 Cambridge Street, 13th Floor
Boston, MA 02114
United States of America
+1 617 338 6800
RSM Tenon Audit Limited
66 Chiltern Street
London W1U 4JT
United Kingdom
+44 (0) 207 535 1400
32
Spectra Systems Corporation Annual report and accounts 2015 Design Portfolio is committed to planting
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Spectra Systems Corporation
321 South Main Street
Providence, RI 02903 USA
tel: 401.274.4700 fax: 401.274.3127
email: info@spsy.com
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