Syscan Imaging--Who's Watching Management?

Syscan Imaging (SYII.OB-$1.25), a leader in USB powered portable image scanners, is a prime example of the lack of corporate accountability that the 10Q Detective has been working to expose since our founding last year.
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On April 26, 2005, the Company entered into employment agreements with each of Darwin Hu, the Chief Executive Officer, William Hawkins, the Chief Operating Officer and Acting Chief Financial Officer, and David Clark, Senior Vice President of Business Development. In connection therewith the Board of Directors granted options to each of Messrs. Hu, Hawkins, and Clark to purchase 1,500,000, 1,000,000 and 800,000 shares of our common stock, respectively, at an exercise price of $0.01 per share. The options vest one-third on the execution date of the employment agreement, one-third on April 3, 2006 and one-third on April 2, 2007.

In addition to the aforementioned stock options, the terms and conditions of each employment agreement—including base salary and annual bonus—were approved by the "independent members"--all two of them-- of the Company's Board of Directors.

During the fiscal year ended December 31, 2005, the Board of Directors held one meeting [ed. note. Why bother to even have a Board?] The Board of Directors totals five: Messrs. Hu, Hawkins, Clark, and the two “independent” directors, Peter Mor and Lawrence Liang.

Syscan is materially dependent upon the performance of its executive officers and we agree that these key employees should be compensated accordingly, but the Board issued these option awards well below fair market value—approximately 99.5% below fair value. In February 2005, when the option contracts were first drawn up as part of the comprehensive employee agreements, the Common Stock traded between $2.00 to $3.00 per share.

By the way, on December 8, 2005, OTHER employees were granted options under the Plan to purchase 230,000 shares of the Company's common stock at $0.65 per share—the fair market value of the stock on the grant date.

Talk about the fox watching the henhouse, although Peter Mor and Lawrence Liang approved the employment agreements for Hu, Hawkins, and Clark, the entire Board of Directors was active in the aforementioned compensation process.

The lack of corporate governance extends to other activities beyond executive compensation, too. For example, the Company purchases significantly its entire finished scanner imaging products from the parent company of its majority stockholder, Syscan Technology Holdings Limited (STH). Chairman and CEO, Darwin Hu, was formerly the CEO of STH, and beneficially still owns approximately 5.33% of the issued and outstanding capital stock of STH (shares are listed on The Growth Enterprise Market of The Stock Exchange of Hong Kong Limited). The Company purchased $4.91 million and $4.34 million in equipment during the years ended December 31, 2005 and 2004, respectively.

Despite the lack of corporate accountability, the 10Q Detective believes that the Company’s technology holds promise: While Syscan continues to grow its presence in image capture technology, it has begun creating, through acquisition and research and development, new technology solutions for the substantially larger, image display market. More specifically Syscan is creating products and technologies to accent and enhance the HDTV television market. Its image display product is expected to be available for delivery during the first quarter of 2007.

To reflect its new business’, the Company will be changing its name at the end of June 2006 to Sysview, Inc.

Unfortunately, in addition to weak corporate oversight, there are other red flags for potential investors to consider:

• During the year ended December 31, 2005 three of Syscan’s customers accounted for approximately 66% of total revenues. The loss of any of these clients would have a material adverse effect on business.
• The law firm of Richardson & Patel LLP, of New York, New York, refused to pass validity on Syscan’s Common Stock. A partner of the firm beneficially owns 16,667 shares of Common Stock, which shares were issued to the partner in exchange for legal services rendered when the partner was employed by a prior law firm.
• In connection with investor relations services rendered for Common Stock issued, the Company overpaid the consultant $30,000. The Company also has ended its relationship with the consultant due to non-performance. The consultant has agreed to repay the $30,000 overpayment by December 1, 2006 and return 75,000 shares. As of July 11, 2006, both remain outstanding. [ed note. How come in financial statements the going concern always refers to the object of the declaration in the third person?] Doing some digging, the 10Q Detective unearthed that Syscan had signed The Investor Relations Group, Inc. (IRG), based in New York City, to serve as its money relations and corporate public-relations agency of record.

On March 15, 2005, the Company sold $1.865 million of a Convertible Preferred Stock (par value--$100). The Series A Preferred Stock is convertible into shares of Common Stock at a conversion price of $1.00 per share and is entitled to receive interest at a rate of 5.0% per annum. (The Company also issued to the selling stockholders warrants to purchase up to 932,500 shares of Common Stock at a price equal to $2.00 per share.) The problem for existing shareholders, however, is that the Preferred Stock Conversion Price is subject to anti-dilution protection adjustments, on a full ratchet basis. What this means is if Syscan issues even one share of stock in a future financing deal at a price below the conversion price of $1.00 (Series A Preferred Stock Conversion Price), then the new conversion price drops downward fully to that new price—dilution that ultimately proves to be punitive to existing shareholders.

As the Company has no Audit Committee, it should surprise none that on June 1, 2006, as the result of review by the SEC of Syscan’s accounting for its non-cash, stock-based, employee compensation, that its consolidated financial statements for the year ended December 31, 2005 and for the quarter ended March 31, 2006 may have to be amended. In the event that the Company may need to make any accounting adjustments, reclassifications and/or write-downs of a material amount of its assets, investors ought note that there might be a risk that Syscan could be in violation of certain financial covenants under its credit facility, which would adversely affected the financial health of the Company.

“Sunlight is said to be the best of disinfectants; electric light the most efficient policeman." – Supreme Court Justice, Louis Dembitz Brandeis (1856-1941)