Back to GetFilings.com
1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One) FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the Fiscal Year Ended March 31, 1996
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the Transition Period from to
---- ----
Commission File Number: 0-6377
DREXLER TECHNOLOGY CORPORATION
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 77-0176309
- ------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1077 Independence Avenue, Mountain View, CA 94043-1601
- ------------------------------------------- -----------
(Address of principal executive offices) (Zip Code)
(415) 969-7277
----------------------------------------------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None None
- -------------------- ----------------------
(Title of each class (Name of each exchange
so registered) on which registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
----------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. /X/ Yes / / No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
Based on the last trade price of the Company's Common Stock on The Nasdaq Stock
Market on June 24, 1996, the aggregate market value of the voting stock held by
non-affiliates of the registrant is approximately $113,556,000.
Number of outstanding shares of Common Stock, $.01 par value, at
June 24, 1996: 8,900,624
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Definitive Proxy Statement for the 1996 Annual Meeting of
Stockholders are incorporated by reference into Part III hereof.
2
PART I
ITEM 1. BUSINESS
(a) General Development of Business
Drexler Technology Corporation was incorporated under the laws of the State
of California on July 23, 1968, and was reincorporated as a Delaware corporation
on September 17, 1987. Drexler Technology Corporation and its wholly owned
subsidiary, LaserCard Systems Corporation, (the "Company") develop, manufacture,
and market optical data storage products used with personal computers for
information recording, storage, and retrieval.
The Company's product line consists of LaserCard(R) optical memory cards,
optical card data systems, interface software, demonstration software, and
software development tools. The Company's customers are mainly value-added
reseller (VAR) companies throughout the world that develop commercial
applications for LaserCard products. Target markets include consumer, business,
and government applications for portable, recordable, unitary record cards.
These applications include healthcare, secure access/ID, cargo manifests, and
automobile warranty/maintenance records. The Company's revenues also include
front-end license fee payments from the occasional sale of nonexclusive licenses
and/or royalties under such licenses.
The history of the Company's optical data products business began while the
Company was a supplier of consumable products to the Semiconductor Industry.
Initially and for many years, the Company sold photomasks, photochemicals, and
emulsion-coated glass photoplates used in the production of integrated circuits.
Then in the 1980s, during experiments with glass photoplates as a possible data
storage material, Company personnel made discoveries which led to the
development of "Drexon," a new laser recording medium comprised of pure silver
metal particles suspended in a matrix. Later experiments with Drexon(R) on a
flexible substrate led to the invention and patenting by the Company of a
credit-card sized optical memory card containing a reflective stripe of the
Drexon material. Gradually, the Company's focus shifted to card-related product
development, manufacturing, and licensing, and the Company sold the assets of
two of its semiconductor-related product lines. When the Company discontinued
the production of photoplates in fiscal 1993, its transition from the
Semiconductor Industry to the Information Technology Industry was completed.
Trademarked "LaserCard," the Company's optical memory card is a laser
recordable, nonvolatile, digital-data storage card that can store more than 4
megabytes of information and can be carried in a wallet. The Company's
subsidiary, LaserCard Systems Corporation (LSC) develops optical card systems
and interface software, sells optical card reader/writers and various
peripherals manufactured by other companies, and sells optical memory cards
manufactured by the Company. In mid-1991, LSC launched a value-added reseller
program for worldwide marketing and distribution of optical cards and card
systems, which led to commercial card sales by several VARs by 1993.
Today, Drexler Technology Corporation is the leading manufacturer of
optical memory cards and has 90 VAR companies in 50 countries. Orders from VARs
usually range from 5,000 to 50,000 cards per order, with the largest single-card
order to date being 100,000, but order quantities have not yet reached the
levels required to achieve operating profits. When cards are ordered in the
thousands, the typical wholesale price to VARs is $4 to $5 per card. As
explained under "Management's Discussion and Analysis," the Company's card
manufacturing factory has a designed production capacity of up to 25 million
optical cards per year, depending upon card type and color-printing
requirements.
2
3
Current commercial applications and some of the potential uses for the
LaserCard are:
-- Medical history cards and citizens' health cards
-- Prenatal care records
-- Medical image storage cards
-- Laser eye surgery equipment setup/data storage/key cards
-- Identification cards
-- Military cargo manifests
-- Data logging/recordkeeping
-- Secure entry passes, including soccer-season tickets
-- Student IDs/records
-- Immigration cards
-- Auto repair/warranty records
(b) Financial Information about Industry Segments
Item 8, Consolidated Financial Statements and Supplementary Data, contains
industry segment information.
(c) Narrative Description of Business
OPTICAL MEMORY CARDS
Optical Data Storage
Optical data storage systems use light to write and/or read information.
This information generally is stored digitally in a binary code of "1" or "0"
bits that are represented by either the presence or absence of a physical "spot"
on the recording surface. The difference in reflectivity between the background
surface and the individual spot is measured by a light-sensing device and,
thereby, is converted into an electrical signal. These signals are then
translated by a microprocessor into text, graphics, voice, or pictures. A major
feature of optical data storage systems is that very large amounts of data can
be stored on a relatively small media-surface area since the data spots are
microscopic in size and tightly compacted.
A read/write optical data storage system is comprised of a medium upon
which digital information is recorded using a laser, equipment which writes and
reads the digital information (a "reader/writer"), system software, and
application software. The Company does not manufacture reader/writers but
purchases them from a licensed supplier and resells them to customers. The
Company develops system software, as described later in this report, and
customers develop application-specific software. The Company manufactures and
sells its data storage medium in the form of laser-recordable, optical memory
cards.
The general advantages of optical card storage systems over either magnetic
or semiconductor memories typically include high storage capacity, durability,
low cost per bit stored, and resistance to data degradation or erasure by
exposure to magnetic fields. Magnetic and most semiconductor media are updatable
and erasable. The Company's optical cards are not erasable but are updatable and
correctable. This feature is beneficial for numerous applications--for example,
medical, cargo manifest, access, and identification cards. The Company believes
that updatable, correctable, nonerasable optical cards will constitute an
important segment of the market for portable data storage.
Drexon(R) Laser-Recording Medium
The Drexon laser-recording medium was invented and patented by the Company
for optical data storage. It consists of a thin, organic film or colloidal
matrix containing a thin layer of silver particles. Using proprietary and
patented processes, the Drexon medium is produced by chemical conversion of
photographic emulsions. This creates a gold-colored, mirror-like, reflective
recording surface. The Drexon medium permits data to be recorded by a laser,
prerecorded using photolithography, or both, as described under "Prerecording."
3
4
The Drexon medium is direct-read-after-write (DRAW). DRAW media permit data
to be read immediately after laser recording--for instantaneous checking of
information. The Drexon medium also is classified as WORM (write once, read many
times). This means that data can be laser written and read at any time, but once
an area is recorded, that same area may not be overwritten with new data.
Although data can be corrected or updated through the use of system software,
all previous data remains on the Drexon medium. Since it is nonvolatile, the
Drexon medium is not subject to data loss or degradation by exposure to magnetic
fields or electronic signals.
LaserCard(R) Features and Markets
The LaserCard optical memory card is made of three layers of electron-beam
laminated polycarbonate plastic, with the Drexon laser recording stripe bonded
in the center of the laminate. This card is the size, shape, and thickness of a
standard credit card so that it can be carried in the wallet. Some of the key
features of the Company's optical memory cards are:
-- Permanent, nonvolatile, recordable, updatable, correctable
-- Durable media and card construction suitable for wallet environment
-- High data storage capacity for its credit-card size
-- High difficulty of forgery, tampering, or counterfeiting
-- Audit trail of all data and updates
-- Computer-readable, digital, security options (biometric identifiers,
user codes, photographs)
-- Visible, manufacturer-printed security options (watermarks, security
codes, emblems)
-- Visible, add-on security options (photograph/cardholder data,
holograms, signature panels)
-- Usable in multiple applications
-- Optional add-ons of other data storage technologies (magnetic stripe,
optical character recognition/OCR, bar code, integrated circuit/IC
chip)
The LaserCard is designed primarily for carrying useful, time-saving,
cost-saving, or life-saving data in the wallet and for sequentially recording
and storing information in a secure, permanent mode. It is targeted toward the
following types of information systems:
-- Data recording and transaction systems--for unitary medical records and
citizens' health cards, warranty and service records, cargo manifests,
laser eye surgery systems, and multimedia applications
-- Identification systems--for secure tickets and entry passes,
immigration cards, and other ID cards
-- Image storage systems--for medical images (CT scans, MRIs, X-rays) and
document images (confidential filing systems)
Writing and Reading
A low-power, semiconductor-diode laser is used to write information onto
the LaserCard. The laser is about the size of a thumbtack and is housed inside
an optical card reader/writer. The LaserCard is inserted into a slot in the
reader/writer, which is connected to a personal computer. Information is
recorded by focusing a laser beam through the upper clear layer of the card and
forming microscopically small spots onto the embedded optical stripe, so that
recorded information is protected deep inside the card structure. The recorded
spots represent digital data, the language of computers.
4
5
Since the reader/writer is connected to a personal computer, data can be
entered onto the card from the computer's memory or by using the computer's
keyboard. Equipment such as fax machines, medical imaging devices, document
scanners, or even other data storage media also can transfer data, through a
personal computer, onto the card. Information stored on the optical memory card
is read back using the same reader/writer or a compatible unit. Data read from
the card can be printed, displayed on a computer monitor, or used to operate a
system. LaserCard systems can be used with data communication networks and also
with stand-alone computers.
System software enables the user to write, read, delete, correct, and
update data as if the LaserCard were a floppy disk. However, unlike a floppy
disk, which allows re-recording directly over erased data, the LaserCard
maintains both old and new data, thus providing a permanent, verifiable, audit
trail.
Storage Capacity
The amount of information that can be stored on an optical card is
dependent upon such factors as data density and compression, card reader/writer
design, and spot size. Spot size is measured in microns. (A micron is 1/1,000 of
a millimeter, or about 1/75 the width of a human hair. The smallest size spot
the human eye can see is about 20 microns.) The size of spot used is determined
by the card format and the configuration of the reader/writer. A spot size of
2.25 microns is used for the Conlux LC-305 reader/writer currently sold by the
Company.
A portion of the card's storage capacity is used for the error detection
and correction code (EDAC), a method routinely used throughout the computer
industry to compensate for errors from physical damage to data files.
Data-storage capacity also is determined by data compression and the type of
data encoding technique used. Thus, the storage capacity of the optical memory
card varies based on the type of data stored, EDAC, spot size, data compression,
encoding technique, reader/writer equipment configuration, and format.
The standard LaserCard has a total data capacity of 4.1 megabytes and,
after EDAC, a user data capacity of 2.86 megabytes. This represents about 350
times the storage capacity of an 8 kilobyte IC chip card and over 2,800 times
the capacity of the standard 1 kilobyte IC chip card. (A byte is a unit of
computer storage and is the amount of computer memory needed to store a single
number or letter. A megabyte is one million bytes; a kilobyte is one thousand
bytes.) Magnetic stripes are capable of holding 0.2 to 0.9 kilobytes--which is
less than 0.03% of a standard LaserCard. A special 6.6 megabyte capacity
LaserCard (4.2 megabytes of user data capacity) has been used by one customer
for storing medical images such as MRI (magnetic resonance imaging) scans.
Regardless of its storage capacity, the LaserCard is identical in size to a
conventional credit card and can be carried in the wallet.
Prerecording
Another feature of the LaserCard is its recordability both during the card
manufacturing process and afterward. During card manufacture, since photographic
film is used to make the Drexon medium, photolithography is used to prerecord
optical digital data and formatting while the film is still photosensitive.
After the film is processed to become Drexon and made into cards, data can be
laser recorded at any time-- over a period of years (for example, a health
history) or over a period of minutes (for example, a set of MRI studies).
To perform card prerecording or preformatting, the data pattern is printed
repeatedly, end to end, onto a strip of photographic film. This film is spliced
into a master loop, then inserted into a photolithographic machine. There, a
light source accomplishes "printing with light" by exposing the loop's images
onto long lengths of film at the rate of about 300 feet per minute. These
lengths of film, after chemical conversion and physical development into Drexon,
are laminated between polycarbonate sheets and cut into cards. On the finished
cards, the data pattern has low reflectivity and the background is more
reflective. The Drexon material's ability to be prerecorded is utilized not only
for preformatting the LaserCard but also to add
5
6
security features such as special codes, micro-line printing of text or
graphics, and the like. If desired, a LaserCard could be fully prerecorded with
data during manufacture.
Card Security
The level of data security used with the LaserCard will depend on the
application. Storing automobile maintenance records requires little or no data
security, whereas very high security features can be employed to protect
confidential information such as medical records and other personal data.
The optical recording stripe has enough memory to hold multiple,
nonerasable security safeguards in addition to all of the application data and
an audit trail as described below. Computer-readable security features that can
be stored on the optical stripe include digitized color photographs; biometric
identifiers such as digitized signatures, fingerprints, and hand geometries;
extensive biographic data; and multiple PINs (personal identification numbers).
Combinations of these and other identifiers can be recorded on the card when it
is initialized by the card issuer, for later verification that the person using
the card is authorized to do so.
In addition to computer-readable identifiers on the optical stripe,
individualized eye-readable information such as the cardholder's name and
address, a photograph (in full color or black-and-white), description, or other
information can be printed directly onto the back of the LaserCard for visual
identity verification.
Using software, data on the optical memory card can be segmented according
to confidentiality level (for example, patient records separated from insurance
information or pharmacy records) so that access to each area of the card can be
controlled separately. For applications that warrant cryptography, all data can
be recorded using data encryption algorithms--for example, the U.S. government's
Data Encryption Standard (DES). In addition, during the card manufacturing
process, the Company can prerecord a dedicated card/equipment digital interface
code to the cards' recording surface so that unauthorized cards will not
function in dedicated equipment, or vice versa.
Because the LaserCard is a nonvolatile, WORM memory card that cannot be
erased, it can hold a complete audit trail of all data, changes, and deletions.
This can be accomplished through software--to allow access to previously
recorded files and, if desired, to record each attempt to access data from the
card. Competitive card technologies such as magnetic-stripe cards and IC cards
cannot store enough data to provide this audit trail or other high-security
features that are storage-capacity dependent. They also are susceptible to
counterfeiting and contain volatile (erasable) memory that can be destroyed by
static electricity, the intentional application of voltage, or other
electromagnetic interference. (For additional comparisons, see "Storage
Capacity" and "Competition.")
Licensing
The Company has developed a portfolio of United States and foreign patents
which have generated significant revenues in the form of license agreements
related to optical memory cards and equipment for using optical cards. The
Company's patent licensing program is directed primarily toward licensing the
manufacture of optical memory card reader/writers and, in a few special cases,
manufacture of optical memory cards themselves. The Company presently offers
nonexclusive, royalty-bearing licenses for optical card reader/writer
manufacture and for card manufacture. Also offered are nonexclusive licenses for
optical memory card distribution, thereby creating licensed card distributors in
regions of the world, who can purchase cards wholesale from the Company at
prices lower than the prices charged to VARs. The royalty-bearing, reader/writer
manufacturing licenses include card distribution rights and, in some cases,
license upgrades for rights to additional patents. The Company estimates that
approximately ten licensees currently
6
7
are involved in some aspect of the optical card industry, such as card
reader/writer manufacture, card manufacture, market development, standards,
system integration, or software development.
The initial fees charged by the Company for its licenses vary based on the
rights and benefits of each license. License fees are unconditional and
nonrefundable and no significant obligations remain unfulfilled by the Company
under any of the licenses. The Company will continue its licensing efforts on a
selective basis, although the timing, number, type of license, and magnitude of
future license sales, if any, cannot be predicted.
Basic Licenses and Upgrades
The Company has sold limited-term, nonexclusive, basic licenses to over 25
companies worldwide. Each such license involved a one-time license payment and
no royalties. The basic license included certain technical know-how,
information, and nonexclusive licenses under certain patents owned by the
Company, involving equipment for reading and writing optical memory cards. Some
of these licenses include card distribution rights for the purchase of optical
memory cards, for use or resale, at the Company's most favorable pricing. The
Company also has sold five nonexclusive, royalty-bearing license upgrades
related to equipment for reading and writing optical memory cards. The upgrade
extends the term of the basic license and covers equipment patents issued to the
Company after the date limits of the original basic license agreements. No basic
licenses or upgrades have been sold since 1989.
Card Distribution Licenses
In fiscal 1995, the Company sold a nonexclusive, royalty-free, card
distribution license for a one-time payment of $1 million to a Korean firm that
initially was a VAR of the Company. A card distribution license entitles the
licensee to purchase optical memory cards from the Company at the most favorable
pricing, for use or resale. Card prices to licensed distributors are typically
10% to 15% below VAR pricing for cards having similar data capacity, printing
complexity, formatting complexity, specifications, tolerances, quality,
quantity, and delivery times. In fiscal 1996, no similar licenses were sold,
although a $200,000 payment was received toward the purchase of a card
distribution license in conjunction with a trademark license.
Card Manufacturing Licenses
Two nonexclusive, royalty-bearing, patent licenses have been sold by the
Company for optical card manufacture--one in fiscal 1989 and one in fiscal 1991.
The license fee for each was $10 million plus long-term, periodic royalty
payments to the Company. The 1989 license sale was to Canon Inc., which
previously also had purchased a basic license from the Company. In 1991, the
card licensee was Optical Memory Card Business Corporation ("OMCBC"), a Japanese
company formed by Dai Nippon Printing Co. and three of the equipment licensees
of the Company--Nippon Conlux Co., Ltd., Olympus Optical Co., Ltd., and Omron
Corporation. As described under "Competition," OMCBC is a second source
(alternative) supplier for optical cards compatible with the Company's cards.
The Company may consider the sale of additional such licenses, but the future
sale or timing of such licenses cannot be predicted or inferred from past
events.
OPERATIONS
Card Production Volumes
Optical cards are produced at the Company's card manufacturing facility in
Mountain View, California. As explained under "Management's Discussion and
Analysis," the card manufacturing facility is designed for a production capacity
of 25 million optical cards per year, depending upon card type and
color-printing requirements. In fiscal 1996, the Company manufactured and sold
about 420,000 optical memory cards, primarily for commercial card orders, and
made an additional quantity of marketing sample cards.
7
8
The optical memory card is in its early commercial stage. The Company
currently makes and sells optical cards in order quantities typically ranging
from 5,000 to 50,000 cards per order, with the largest single-card order to date
totaling 100,000 cards. This volume is expected to increase as the market
expands and/or when one or more major customer programs require a very large
initial quantity of cards. The Company believes there are prospects for such
programs and market expansion, but cannot predict if or when larger orders will
occur.
Systems
LaserCard Systems Corporation (LSC), a wholly owned subsidiary of Drexler
Technology Corporation, markets the Company's products primarily through an
international VAR (value-added reseller) network. The VARs may add value in the
form of services, application software, personal computers, or other
peripherals, and then resell these products, integrated into data systems, for
end-user customers in their geographic regions.
Under nonexclusive distribution agreements with LSC, the VARs purchase the
Company's optical memory cards, LSC's system software, optical card
reader/writers made by a licensee of the Company, and other peripherals. LSC
purchases and re-sells the following application-specific peripherals, adding
LSC- developed software that interfaces these peripherals to the LaserCard
reader/writer:
-- Electronic digital camera with video capture board for storing
computer-readable photographs in color
-- Thermal card printers for recording eye-readable photographs, logos,
text, and other data in black and white or color
-- Digital biometric identity verification systems (fingerprint, hand
geometry, and signature verification systems) that compare the unique
biometric identifier stored on the LaserCard with that of the person
attempting to use the card
LSC also provides customer support related to system integration, software,
sales, and maintenance. These activities are performed by a staff of software,
engineering, and administrative professionals. The Company's plans include
increased marketing and customer support activity, which will be implemented
when certain financial goals are achieved.
System Software (Company-Developed Software)
System software controls or facilitates the basic operations and read/write
functions of optical card reader/writers so that they can interface directly
with personal computers and various peripheral devices. For use with
IBM-compatible personal computers, LSC develops LaserCard-related system
software such as device drivers, file systems, and DLLs (Dynamic Link
Libraries). LSC also develops software-development tools for related peripherals
and software for demonstrating archival, medical, and security concepts
involving the LaserCard. LSC does not develop application software. (See "The
Role of VARs in Application Software.")
"Windows/DOS" Device Driver. A device driver is system software that
translates operating system commands so that the reader/writer emulates a floppy
disk drive. LaserCard device drivers save VARs and their customers considerable
custom software development time because existing application software can be
modified easily to work with the LaserCard. LSC's initial device driver
development was a LaserCard DOS (Disk Operating System) device driver for use
with LaserCard-equipped personal computer systems under the DOS platform and
with "Windows."
"Windows NT" Device Driver. During fiscal 1996, the LSC software staff
completed development of a "Windows NT" device driver, which is being evaluated
by customers. This device driver
8
9
allows the LaserCard to be used with computer networks under "Windows NT," a
widely used network operating system. Listed below are the features of LSC's
"Windows NT" device driver:
-- Enables use of LaserCard with network software sold by Microsoft,
Novell, and others
-- Supports multi-tasking applications and background reader/writer
operation
-- Facilitates the first-ever connectivity of optical card reader/writers
to multiple hardware platforms (such as Intel x86, DEC Alpha, IBM Power
PC)
-- Functions with application software programs designed to work with
"Windows 95" or "Windows NT"
O-CON-OL(TM) Driver/Adapter. Interface software developed by LSC also
includes a Small Computer Systems Interface (SCSI) host adapter and DOS device
driver that LSC developed for the interchange of data among different types of
ISO/DELA Standard optical memory card reader/writers. Called the O-CON-OL(TM)
driver/adapter, it is a software data format (driver) and a hardware add-on
(adapter).
LaserCard File System (LCFS) Software. LaserCard applications can be
developed using the LaserCard File System for additional security and to
optimize the LaserCard's WORM recording medium without the constraints of a DOS
or "Windows" file structure. The LCFS is not part of any operating system (as
are device drivers) so access to the LaserCard is available only from the
application that created the card or a related application. In fiscal 1996, LSC
completed development of an LCFS for "Windows 3.1" and has provided this LCFS to
customers for evaluation. Versions of LCFS for use with "Windows NT" and
"Windows 95" are under development. The following are features of the LaserCard
File System:
-- Enables use of the LaserCard with database management systems from
Microsoft, Oracle, Sybase, etc.
-- Permits writing of LaserCard application programs under software
languages such as Visual Basic, C++, and others
-- Generates highly secure, password-protected, multiple-application cards
-- Enables LaserCard file format to be operating-system independent
Marketing
LaserCard marketing offices are located in Mountain View, California;
Birmingham, England; and Zurich, Switzerland. In addition, general management
and technical personnel work closely with the Company's marketing staff. The
objective of the LaserCard marketing organization is to attract and qualify new
VARs, provide customer support and products to VARs, and thereby generate income
through the sale of LaserCard products both domestically and internationally.
During fiscal 1996, the Company sold LaserCard products to approximately 50
customers located in 8 states and 28 foreign countries. For the 1996, 1995, and
1994 fiscal years, sales of the Company's LaserCard products and licenses
outside the United States were 42%, 71%, and 52%, respectively, of the Company's
net sales. The Company believes that international markets will continue to be
an important source of license revenue and product sales. Substantially all of
the foreign product sales were made through the Company's VAR network, whereas
licensing activities are conducted directly by the Company. The Company does not
believe that there are substantial risks inherent in its international business
as compared to its domestic business.
Standards
Standardization of optical memory cards allows interchange of the digital
information encoded on the cards and facilitates compatibility among card
systems. The Company is actively involved in optical card standards in the
United States and internationally. The standard format under which the Company's
optical memory cards operate is called the "DELA Standard" format. The following
list gives the current status of optical memory card standards under ISO/IEC
(the International
9
10
Organization for Standardization/International Electrotechnical Committee) and
ANSI (the American National Standards Institute):
-- ISO/IEC 11693 describes the general characteristics of optical memory
cards. This approved international standard was published in 1994.
-- ISO/IEC 11694-1 describes the physical characteristics of the card,
such as height, width, thickness, durability, etc. This approved
international standard was published in 1994.
-- ISO/IEC 11694-2 describes the dimensions and location of the accessible
optical area; that is, the area on the card where data writing and
reading occurs. This approved international standard was published in
1995.
-- ISO/IEC 11694-3 describes the OPTICAL PROPERTIES AND CHARACTERISTICS of
the card and provides technical specifications which allow interchange.
This approved international standard was published in 1996.
-- ISO/IEC 11694-4 describes the LOGICAL DATA STRUCTURE on the card and
defines the method of writing and reading card data. This approved
international standard was published in 1996.
-- In the United States, ANSI Standards Committee X3B10, has voted to
recommend the adoption of ISO/IEC 11693 and ISO/IEC 11694 parts 1 - 3
as ANSI/ISO Standards.
The LaserCard optical memory card system, featuring the DELA Standard
format, complies with all documents listed above. (For additional information,
see "Competition.") To date, the majority of optical memory cards sold in the
world marketplace have been DELA Standard format cards.
The Company believes that it could qualify for certification under ISO 9000
but has not applied to do so. The ISO 9000 Standard Series is a set of voluntary
international standards related to quality control procedures, documentation,
and other details of quality assurance management.
BUSINESS DEVELOPMENT FACTORS
Early Commercial Stage
Considerable resources have been invested by the Company in the development
of optical memory cards, card manufacturing capability, equipment development
programs, and system software. Although software and product/manufacturing
engineering are ongoing activities, the Company believes that it has
successfully completed the development stage of the business. LaserCard products
have entered the early commercial stage through the Company's VAR network and
have comprised the Company's sole product line since 1993.
LaserCard-related product sales are occurring at modest levels; however,
the Company has not yet entered into any long-term supply agreements with its
customers and does not have a consistent, large backlog of orders. Therefore,
during the present commercial stage, statistics concerning market growth are not
necessarily indicative of future results. High-volume orders for optical memory
cards cannot be achieved until the VAR companies develop customers and
applications or obtain significant follow-on orders from customers whose
programs are already underway. There is no assurance that volume orders will be
received or, if received, that they will satisfy the Company's profit and
cash-flow requirements.
The Company is relying upon its optical card technology to generate future
revenues, earnings, and cash flow when order volumes reach material levels. The
Company has operated at a loss for the last five years. Until such time as
increased commercialization occurs, with material sales levels of optical cards
and
10
11
equipment resulting in profitability and positive cash flows, the Company is
dependent upon license fees or equity financing. License sales are sporadic
events and are difficult to predict. If there is slow progress by customers in
the development and implementation of LaserCard-based programs, this could
extend the period during which the Company would need additional financing.
(Further comments are provided under "Management's Discussion and Analysis.")
Raw Material Sources
The ability to produce optical memory cards in high volume in the Company's
optical card manufacturing facility will be dependent upon maintaining sources
of supply of certain materials meeting the requirements for quality, quantity,
and price. Such materials include special photographic films which are
commercially available solely from the Eastman Kodak Company, of the United
States. The Company believes that Kodak will continue to supply such
photographic films to the Company on a satisfactory basis. Plastic films used in
optical card production are available from one supplier in the United States and
from multiple foreign suppliers. Processing chemicals, inks, bonding adhesives,
and packaging materials are obtained from various U.S. and foreign suppliers.
To ensure the adequacy of raw material supplies, the Company attempts to
establish ongoing relationships with its principal suppliers and maintains
information about alternative suppliers. The Company maintains reasonable
inventory levels of raw materials that are consistent with current expected
demand, order-to-shipment lead times, and minimum order quantities. To enable
the Company to plan its raw material inventory levels, the Company's quotations
to potential customers specify certain advance payments to the Company and
realistic delivery dates for the optical memory cards.
Reader/Writer Availability
Optical memory card reader/writer availability is essential for industry
viability and volume pricing is important for market growth. As discussed under
"Standards" and "Competition," the Company's optical cards are compatible with
the ISO/DELA Standard format. Several types of reader/writers have been
developed by Japanese companies under royalty-bearing licenses purchased from
the Company, and commercial quantities of ISO/DELA Standard reader/writers are
available from Nippon Conlux Co., Ltd. ("Conlux"). This supplier, whose stock is
traded on the First Section of the Tokyo Stock Exchange, sells its card
reader/writers to the Company under a nonexclusive distribution agreement.
The Company incorporates the Conlux reader/writer into LaserCard systems
for sale to customers. The Company's inventory level for reader/writers
fluctuates based on the timing of purchases and sales. The Company cannot
guarantee that Conlux, as the Company's sole source supplier, will be able to
produce and sell an adequate quantity and quality of reader/writers to meet
market demands. If market demand increases sharply over a short period of time,
an initial shortage of reader/writers could result. An interruption or change in
the supply of reader/writers could cause a delay in product shipments and a
possible loss of sales, which would have an adverse effect on the Company's
operating results. If Conlux were to curtail manufacture of reader/writers, the
Company would allocate its incoming shipments of the devices among incoming
orders from established customers during such period.
The Company sells reader/writers for a few thousand dollars per unit, and
these units generally include the Company's interface software and device
drivers. In principle, price reductions due to production economies of scale,
volume price breaks on components, and other volume manufacturing cost savings
can be achieved when production shifts from small-scale to large-scale volumes.
Upon request, Conlux provides quotations to the Company for various volume
quantities of reader/writers for potential customer programs and recently has
quoted substantially lower prices for a very high volume potential application.
The Company can give no assurance that any such quotations will result in
high-volume orders for Conlux reader/writers, that a cumulative increase in
orders would result in larger-scale production, or that correspondingly lower
11
12
prices would result. However, a significant decrease in the price of
reader/writers would have a positive impact on the development of the market for
optical memory cards.
Although Conlux has developed reader/writers, it has not developed its own
optical memory card and is not believed to be doing so. Users of its
reader/writers continue to rely on cards manufactured by the Company or by
OMCBC. As explained under "Licensing," Conlux also is a minority owner of OMCBC,
a card manufacturer licensed by the Company. Due to this affiliation, it is
believed likely that Conlux would purchase its cards from OMCBC for use in
Japan, in which case the Company would expect to receive a royalty payment per
card.
The Role of VARs in Application Software
Software is an important factor in developing the commercial markets for
optical cards. As described under "System Software (Company-Developed)," the
Company's software consists of optical card interface software/device drivers,
file systems, software development tools, and demonstration programs. The
Company does not develop application software but relies on VARs or their
customers to do so. Application software directs the computer to do specific
tasks related to the customer's end-user application for the LaserCard (for
example, to store a person's medical record). In this role, VARs may integrate
optical card products into existing software, write new application software for
specific optical card programs, or license software available from other VARs of
the Company. VARs have written optical card software programs for applications,
and other application software development is underway by VARs and their
customers.
Card Durability
The LaserCard optical card is a nonvolatile storage medium; therefore,
information stored on the card is not affected by exposure to magnetic or
electrostatic fields. The LaserCard's ability to withstand flexure exceeds that
of conventional credit cards; and, unlike other types of storage media, the
LaserCard can be manufactured to withstand temperatures of 100 degrees C (212
degrees F) for extended periods.
Commercial LaserCard applications are underway, a number of field trials/
pilot programs have been started, and extensive product evaluations have been
successfully completed. However, the LaserCard has not yet undergone widespread
commercial use over an extended period of years. The longest running program of
LaserCard use has been in London, England, over a period of more than six years.
In this prenatal records program, optical memory cards produced by the Company
for British Telecom have been issued to maternity patients at two hospitals.
The Company has conducted a program of accelerated life testing to
demonstrate the LaserCard's durability when exposed to the heat and moisture of
various world climates. Additional testing has indicated that, when protected by
an appropriate envelope, the LaserCard is not normally damaged by the usual
dust, grime, and scratches that are common to any type of card in a wallet
environment. Further, the ISO/DELA Standard uses a pit center data-detection
scheme for highest reliability in reading/writing, coupled with a powerful EDAC
code to maximize the life of the LaserCard when used under adverse conditions.
Product Obsolescence
The Company continues to upgrade its card products and software and has
been able to adjust optical card production to meet evolving international
standards and to add signature panels, sequential serial numbers, or magnetic
stripes to optical cards for specific applications. Bar codes, IC chips, and
holograms are further examples of add-ons that may be of interest to some
customers or potential customers. The Company expects its card products to
continue to evolve over time to meet changing market needs or to create new
markets for optical memory cards.
12
13
COMPETITION
Manufacturers of data storage media and devices continually strive for
optimal form factors, larger data storage capacities, durability, higher
performance, and lower cost. The Company believes that optical memory cards
excel in certain of these categories--most notably as a combination of a small,
portable, durable form factor with a large storage capacity relative to its size
and price.
Competitive Technologies
Depending on the application, optical memory cards and systems compete with
other data storage cards in addition to other established products that are
commonly used for the storage and transfer of digital information. Because the
optical memory card is not widely commercialized, some potential customers may
choose to employ the use of these other cards or technologies that have been on
the market longer. For some applications, these alternate technologies can be
added to the LaserCard for compatibility with customers' existing systems (for
example, ICs, bar codes, and magnetic stripes).
IC Cards
The Company's LaserCard competes in certain applications with other
portable, recordable, data storage cards known as "IC cards" or "chip cards."
These plastic, electronic cards contain volatile memory--an integrated circuit
and/or a microprocessor chip. Volatile memory can be damaged or destroyed by
electrical surges, magnetic fields, and intentional tampering. ICs also are more
vulnerable to unauthorized access and duplication. The IC card can be more
easily damaged in everyday use, whereas the LaserCard's construction and
manufacturing processes make it highly counterfeit-resistant and rugged. (Also
see "Card Security.")
The LaserCard, with data compression, can store between six and 12 copies
of a 436-page book such as "The Pelican Brief." An 8 kilobyte IC card stores
less than 1% of the amount of data that can be stored on a standard LaserCard.
(See "Storage Capacity" for a comparison of memory capacities.) IC card prices
and performance vary widely. A typical 8 kilobyte IC card is higher priced than
the Company's 4.1 megabyte LaserCard but the IC card uses a lower cost
reader/writer. However, 8 kilobyte IC cards are believed to be competitive in
some of the Company's markets. IC cards can be used as identification cards
provided the application does not require a verifiable audit trail,
counterfeit-resistant card construction, or any significant amount of data
accumulation on the card. The IC card has a greater installed base worldwide
because it was invented five years before the LaserCard, and low-capacity IC
cards are used as payphone cards and point-of-sale cards, particularly in
Europe. Low-capacity cards for payphones and for prepaid debit/cash cards (which
recently have been introduced to the U.S. banking industry) are not markets for
the Company's cards.
The Company believes that the LaserCard's high storage capacity,
performance/cost ratio, rugged card construction, ability to store an audit
trail, counterfeit-resistance, and other competitive advantages make it the
superior choice for a number of potentially sizable card applications. Examples
include health history cards, high-security ID/access card systems,
warranty/maintenance cards, military cargo manifest cards, and medical image
storage cards.
Other Products
While not functionally similar to optical memory cards, there are other
commercial data storage products that are sometimes thought of as competitive to
the Company's products. They include floppy disks, magnetic-stripe cards, cards
with two-dimensional bar codes or other visual patterns, magneto-optical laser
recording media, read/write optical disks, and CD-ROM disks. Magnetic-stripe
cards are highly susceptible to unauthorized use, duplication, erasure, and
alteration. Cards that store data using two-dimensional bar codes or other
visual patterns can be utilized as identification cards; however, data cannot be
added to these types of cards once they are initialized. There also are high
capacity, high cost storage cards called PCMCIA (Personal Computer Memory Card
Industry Association) cards that are used with personal computers as a
substitute for magnetic disk drives. These PCMCIA cards are very
13
14
high cost relative to the Company's optical memory cards and generally are not
considered directly competitive.
Competitive Optical Memory Cards
Two Japanese companies, Optical Memory Card Business Corporation (OMCBC)
and Canon Inc., are selling optical memory cards. OMCBC is affiliated with Dai
Nippon Printing Co., Ltd., and produces ISO/DELA format cards and Canon format
cards, called the SIOC format. The Company manufactures ISO/DELA format cards.
The DELA and SIOC formats are not functionally compatible with one another.
Both DELA and SIOC format cards meet the ISO Standard but differ from each other
with respect to recording modulation method, error correction code, and
efficiency of sector sizes. The Company believes that the ISO/DELA format offers
performance advantages over the ISO/SIOC format, particularly when the card is
subjected to dirt and becomes scratched. In addition, the Company believes that,
through its systems subsidiary, it currently offers competitive advantages in
areas such as system integration, interface software, and customer support for a
variety of applications and markets.
Optical card reader/writers made by Nippon Conlux Co., Ltd., use the
ISO/DELA format. Canon- produced reader/writers use the ISO/SIOC format. Olympus
Optical Co., Ltd., of Japan, is capable of producing reader/writers compatible
with DELA, SIOC, or its own proprietary format but is not known to be selling
ISO/DELA format reader/writers at this time.
The Company's production-plant-made ISO/DELA format cards have had the
benefit of approximately six years of successful customer use, including
commercial applications, whereas Canon's current ISO/SIOC format cards have been
in field trials for two years or less. Nevertheless, ISO/SIOC cards and
associated reader/writers have been sold in competition with the Company's
products, although in small quantities thus far. The Company expects that if
Canon and Olympus Optical continue their marketing and product improvement
programs for optical card systems, they should be able to obtain materially
sizable orders for cards and equipment.
The Company anticipates that many optical card programs will be dedicated
applications for defined groups of users and that various types of optical cards
will co-exist. Although the Company's current worldwide market share for optical
memory cards exceeds that of its competitors, singly and collectively, it is
possible that the Company's market share could decrease over time. This is
because the size, tradename recognition, and resources for marketing of Canon,
Olympus Optical, and Dai Nippon Printing Co. (the principal owner of OMCBC) are
considerably greater than the Company's.
Additional entrants into the optical card industry could expand the overall
size of the market and also could result in further licensing opportunities for
the Company. In the past, a number of companies have disclosed the development
of alternative optical memory cards, including Toppan Printing, Sony, Optical
Recording Corporation, Polaroid, and Asahi Chemical. However, the Company is not
expressly aware of any current optical card related development activities by
these companies.
GENERAL MATTERS
Research and Engineering
In the 1996, 1995, and 1994 fiscal years, research and engineering expenses
approximated $1,092,000, $1,860,000, and $2,202,000, respectively. Research and
engineering expenses primarily consist of the majority of operating costs and
depreciation and amortization expenses on the optical card facility. The optical
card manufacturing facility is used both for engineering and manufacturing.
Therefore, the facility costs (depreciation expense, building
14
15
lease payments, and other costs) are allocated between manufacturing and
engineering based upon the level of manufacturing activity.
Patents and Trademarks
As of March 31, 1996, the Company owned over 55 U.S. patents relating to
optical data storage (including media, optical memory cards, formats, equipment,
systems, and the utilization of optical storage media).
Counterparts of certain U.S. patents have been issued as patents in a
number of foreign countries, and the Company has applied for additional foreign
patents corresponding to patent applications filed in the United States.
However, the Company owns certain U.S. patents as to which foreign counterparts
have either not been filed or the prosecution has been terminated without
issuance of the foreign patents. Also, from time to time, the Company elects to
allow some of its U.S. or foreign patents to expire when maintenance fees become
due, if the patents are deemed no longer relevant. In addition to its patents,
the Company has chosen to protect through trade secrets rather than by patents
some refinements to the Drexon medium and optical memory cards and know-how
related to their manufacture.
There can be no assurance that the validity of any patents actually granted
will not be challenged. In 1992, the claims of three of the Company's issued
U.S. patents successfully passed re-examination proceedings in the U.S. Patent
and Trademark Office ("USPTO"), after a two-year review by the USPTO's Board of
Patent Appeals and Interferences.
The Company's United States patents and counterpart foreign patents in
foreign countries have expiration dates ranging from 2002 to 2012, with a
majority expiring in the first half of this period. Under its license agreement
with the Company for the manufacture of optical memory cards, OMCBC has no
obligation to pay royalties to the Company after December 31, 2003 for use of
the licensed patents. Canon's royalty obligations similarly expire on December
31, 2008, in connection with its separate licenses to manufacture optical memory
cards and equipment for reading and writing such cards. Other royalty-bearing
licenses sold by the Company, related to equipment for reading and writing
optical cards, contain provisions for royalty payments until the last expiration
date of the licensed patents.
Since the Company's royalty revenues are not significant at this time and
the Company does not know whether royalties will increase in the future, the
Company is unable to determine whether there would be a material adverse effect
on royalties in the event of patent expiration or unenforceability. With respect
to its pocket-sized, digital optical memory cards, the Company is not aware of
any otherwise infringing products in countries where the Company has no patent
protection or where the Company may have difficulty enforcing its patents.
Furthermore, the Company does not know whether the expiration or invalidation of
its patents would result in the introduction of competitive products that would
have an adverse effect on future revenues.
The Company presently intends to prosecute diligently any infringement of
its patents. However, there can be no assurance that any such patents will be
sufficiently broad in scope to afford protection from products with comparable
characteristics that may be sold by competitors in the future.
The Company believes that several of its optical data storage patents also
apply to the motion picture industry in connection with reading optical digital
sound signals from motion picture film. The Company has been attempting to
license the patents or to sell two U.S. patents for this purpose; however, there
is no assurance that such efforts will be successful.
"Drexon" and "LaserCard" are federally registered trademarks of Drexler
Technology Corporation.
15
16
Environment
Compliance with federal, state, and local laws and regulations involving
the protection of the environment did not have and is not expected to have a
material effect on the Company's capital expenditures, earnings, or competitive
position. The Company is a voluntary participant in the "Green Lights" program
of the U.S. Environmental Protection Agency. Under this program, most of the
Company's lighting systems have been upgraded to energy efficient lighting. The
Company endorses and recommends participation in EPA Green Lights.
Employees
As of March 31, 1996, the Company and its subsidiaries employed 44 persons,
consisting of approximately 37 persons in administration, marketing/sales,
manufacturing, and research and engineering, plus approximately seven temporary
personnel mainly for quality assurance inspection of cards. None of the
Company's employees is represented by a labor union.
Forward-Looking Statements
Certain statements made above relating to plans, objectives, and economic
performance go beyond historical information and may provide an indication of
future results. To that extent, they are forward- looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and
each is subject to factors that could cause actual results to differ from those
in the forward-looking statement. Such factors are described above and in the
documents filed by the Company from time to time with the Securities and
Exchange Commission, including Form S-3 Registration Statement 33-88588.
ITEM 2. PROPERTIES
As of March 31, 1996, approximately 32,000 square feet of floor space are
leased by the Company for production, administration, sales, and research and
engineering, in two buildings located in Mountain View, California. These
facilities have a current total annualized rental of approximately $369,000. The
Company also leases a small marketing office in the United Kingdom. Management
believes these leased facilities to be satisfactory for its present operations.
Upon expiration of the leases, management believes that these or other suitable
facilities will be able to be leased on a reasonable basis.
ITEM 3. LEGAL PROCEEDINGS
On September 28, 1995, the Company filed a complaint against LeRoy A.
Pesch, Genus Technology Corporation, LAPESCH & Company, and Genus Technology,
N.V. ("Genus"), in Santa Clara County California Superior Court, to collect an
$800,000 balance due under an upgrade license agreement entered into between the
Company and Genus. The other defendants are guarantors and/or co-obligors.
On November 29, 1995, the defendants answered by denying the allegations of
the complaint and asserting as a cross-complaint that defendant Genus was
wrongly denied the right to purchase 400,000 shares of the Company's common
stock at a purchase price of $5.75 per share. The Company believes this
cross-complaint to be meritless.
On January 16, 1996, the parties entered into a stipulation to submit all
issues raised in this litigation to binding arbitration before the American
Arbitration Association. The Company intends to vigorously pursue the complaint
and vigorously defend the cross-complaint.
ITEM 4. RESULTS OF VOTES OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of fiscal 1996.
16
17
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Officer or
Director Position with Company and, If Different,
Name Age Since Principal Occupation
---- --- ----- ----------------------------------------
Jerome Drexler 68 1968 Chairman of the Board of Directors and President
Christopher J. Dyball 45 1992 Executive Vice President and General Manager,
Card Manufacturing
Steven G. Larson 46 1987 Vice President of Finance and Treasurer
Arthur H. Hausman 72 1981 Director; private investor; retired Chairman, President,
and Chief Executive Officer of Ampex Corporation
(manufacturer of professional audio-video systems,
data/memory products, and magnetic tape). Director of
California Amplifier, Inc. (low-noise amplifiers),
California Microwave, Inc. (commercial telecommunications
and defense electronics), and Director Emeritus of
Technology for Communications International (high-frequency
antenna systems and electronic reconnaissance systems).
William E. McKenna 76 1970 Director; private investor. Director of California
Amplifier, Inc. (low-noise amplifiers), Safeguard Health
Enterprises, Inc. (health-care services), WMS Industries,
Inc. (amusement games), Williams Hospitality Management
Group, Inc. (resort hotels), and Calprop Corporation (real
estate).
There are no family relationships among directors or executive officers
of the Company.
It is anticipated that each of the directors and executive officers
will continue in his position, although there is no understanding or arrangement
to that effect. Each director holds office until the next annual meeting of
stockholders and until such director's successor is elected and qualified.
However, any of the above directors or executive officers could resign, and any
of the officers could be replaced or removed by the Board of Directors at any
time.
17
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The Company's only class of common stock, $.01 par value, is traded on the
Nasdaq National Market tier of The Nasdaq Stock MarketSM under the symbol DRXR
and is quoted in The Wall Street Journal and other newspapers. The table below
sets forth the high and low trade prices (rounded to the nearest one-eighth) for
the Company's common stock as reported by Nasdaq during the fiscal periods
indicated.
HIGH AND LOW TRADE PRICES BY QUARTER
- ---------------------------------------------------------------------------------------------------------------------------------
1ST 2ND 3RD 4TH
--- --- --- ---
FISCAL 1995:
High....................................................... 8 6 1/4 6 7/8 6 1/4
Low........................................................ 5 1/2 4 1/4 4 1/4 4 7/8
FISCAL 1996:
High....................................................... 8 1/4 13 3/4 16 15 3/4
Low........................................................ 5 6 1/4 10 11
On March 31, 1996, there were approximately 1,443 holders of record of the
Company's common stock. The Company has never paid cash dividends on its common
stock. The Company expects that for the foreseeable future it will continue to
retain its earnings for use and reinvestment in its business.
18
19
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data for, and as of the end
of, each of the years in the five-year period ended March 31, 1996, are derived
from the consolidated financial statements of the Company. The data should be
read in conjunction with the "Consolidated Financial Statements" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere herein.
FIVE-YEAR SUMMARY OF FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FISCAL YEAR ENDED MARCH 31,
- -------------------------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
OPERATIONS DATA
Revenues:
Product sales ............................ $ 1,010 $ 1,197 $ 1,819 $ 2,141 $ 5,059
License fees and royalties ............... 19 21 19 1,025 236
------- ------- ------- ------- -------
Total revenues ........................... 1,029 1,218 1,838 3,166 5,295
------- ------- ------- ------- -------
Cost of product sales ....................... 569 831 1,180 1,511 3,659
Selling, general, and administrative expenses 2,190 1,836 1,925 2,023 2,400
Research and engineering expenses ........... 2,298 2,284 2,202 1,860 1,092
Other income ................................ -- -- 713 4 202
Interest income ............................. 302 83 24 35 78
Interest expense ............................ (34) (4) (4) (7) (8)
------- ------- ------- ------- -------
Loss from continuing operations ............. (3,760) (3,654) (2,736) (2,196) (1,584)
Income (loss) from
discontinued operations .................. (3) (76) (90) 22 --
------- ------- ------- -------
Net loss .................................... $(3,763) $(3,730) $(2,826) $(2,174) $(1,584)
======= ======= ======= ======= =======
Loss per share:
Continuing operations .................... $ (.52) $ (.50) $ (.36) $ (.27) $ (.18)
Discontinued operations .................. -- (.01) (.01) -- --
------- ------- ------- ------- -------
Net loss per share .......................... $ (.52) $ (.51) $ (.37) $ (.27) $ (.18)
======= ======= ======= ======= =======
Weighted average common shares .............. 7,184 7,264 7,581 8,161 8,692
BALANCE SHEET DATA
Current assets .............................. $ 4,458 $ 1,549 $ 2,733 $ 1,873 $ 3,782
Current liabilities ......................... 1,061 639 1,154 995 2,044
Total assets ................................ 9,113 5,403 5,856 4,531 6,371
Long-term obligations ....................... -- -- -- -- --
Stockholders' equity ........................ 8,052 4,764 4,702 3,536 4,327
19
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS--FISCAL 1996 AS COMPARED WITH FISCAL 1995 AND 1994
Revenues
The Company's total revenues for fiscal 1996 were $5,295,000 as compared
with $3,166,000 for fiscal 1995 and $1,838,000 for fiscal 1994.
Optical Memory Card Products
Sales of optical memory cards and related products to value-added reseller
(VARs), licensees, and end-user customers increased to $5,059,000 for fiscal
1996 as compared with $2,141,000 for fiscal 1995 and $1,819,000 for fiscal 1994,
mainly due to increases in unit shipments for commercial applications.
For the development of commercial market applications for its products, the
Company utilizes VAR companies as part of its marketing and distribution program
for LaserCard(R) products. Sales to VARs include the Company's optical memory
cards, the Company's system software, optical card reader/writers made by a
licensee of the Company, and add-on peripherals made by other companies (such as
equipment for adding a digitized photo, fingerprint, hand template, or signature
to the cards). The VARs may add application software, personal computers, and
other peripherals, and then resell these products, integrated into data systems,
for end-user customers in their geographic regions.
For fiscal year 1996, the Company commercially sold approximately 420,000
LaserCard(R) optical memory cards and 879 reader/writers versus 150,000 cards
and 313 reader/writers for fiscal 1995 and 143,000 cards and 242 reader/writers
for fiscal 1994.
The Company sold LaserCard products in fiscal 1996 to approximately 50
customers in 8 states and 28 foreign countries, including products for American
medical data applications; U.S. government-related programs; several programs in
Italy, including a secure soccer-season ticket; and two programs in the
Philippines--an admission pass/retail purchase log at a duty-free shopping zone
and a vehicle warranty/maintenance records card. In addition, these sales
included products for medical card field trials/pilot programs in the United
States, South Korea, Brazil, Saudi Arabia, and other countries.
There can be no assurances that any VAR company in any country will be
successful in its markets or field trials or that it will place follow-on orders
with the Company for additional quantities of cards and systems. In order to
upgrade its VAR customer base to increase the probability of success, the
Company will continue its efforts to recruit new VARs and eliminate
nonproductive ones. The Company provides marketing leads, customer support, and
system software to assist VARs. Seventeen newly recruited VARs purchased initial
systems including optical cards and equipment during fiscal 1996.
Software is an important factor in developing the commercial markets for
optical cards. The Company's system software consists of optical card interface
software and device drivers, file systems, software development tools, and
demonstration software. The Company does not provide software for specific
applications, but instead depends on its VARs to integrate optical card products
into existing software products, write new application software for specific
optical card programs, or license software from other VARs. Several VARs have
written optical card software programs for applications such as automobile
warranty/maintenance, cargo manifesting, digital optical key systems,
admissions/ID, data logging systems,
20
21
and various medical-related applications such as medical image storage and
health history cards. Other application software development is underway by VARs
and their customers.
Optical memory cards are used in conjunction with card reader/writer
equipment connected to personal computers and accessed in the same manner as
floppy disk drives. Such reader/writers are incorporated into LaserCard systems
sold to VARs and other customers of the Company. The price, performance, and
availability of such reader/writers are factors in the commercialization of
optical cards. The Company sells reader/writers for a few thousand dollars per
unit, and these units generally include the Company's interface software and
device drivers.
The Company does not manufacture card reader/writers but instead continues
to purchase such equipment from a Japanese licensee, Nippon Conlux Co., Ltd.,
currently the Company's sole supplier of reader/writers. The Company's inventory
level for reader/writers fluctuates based on the timing of purchases and sales.
The Company can give no assurance that increased production of card
reader/writers will occur in the near term or that high-volume sales and
correspondingly lower prices will result. If market demand increases sharply
over a short period of time, an initial shortage of reader/writers could result.
Also, an interruption or change in the supply of reader/writers could cause a
delay in product shipments and a possible loss of sales, which would affect
operating results adversely.
Licensing
The Company sold one license in fiscal 1996 for $200,000, one license for
$1,000,000 in fiscal 1995, and no licenses in fiscal 1994. Payment of the
license fees were received in the respective fiscal periods. The fiscal 1996
license agreement included a trademark license and an installment payment toward
the purchase of a LaserCard distribution license. The fiscal 1995 license
agreement was for a LaserCard distribution license sold to a Korean VAR of the
Company. License fees received by the Company are unconditional and
nonrefundable, and no significant obligations remain unfulfilled by the Company
under any of its licenses. The Company is actively pursuing its efforts to
generate additional license revenues; however, license sales by the Company are
sporadic and unpredictable as to timing and type of license. The magnitude of
future license revenues, if any, cannot be predicted or inferred from past
events.
Royalties
Royalty revenues were $36,000 for fiscal 1996, $25,000 for fiscal 1995, and
$19,000 for fiscal 1994. Although royalty revenues have not reached material
amounts, the Company does anticipate future royalty income on a long-term,
continuing basis from among two royalty-bearing optical memory card
manufacturing licenses and several royalty-bearing, equipment-license upgrades
previously sold. The Company cannot predict whether or when equipment or card
sales by its licensees will result in material royalties to the Company, since
the optical memory card industry is in the early commercial stage. Therefore,
the Company is not relying on royalty income and does not expect it to be a
significant factor in the near term.
Backlog
The Company generally fills most orders within 30 to 120 days of receipt of
purchase order or release order. Therefore, to date there has not been a
consistent, large order backlog. The Company's quarterly sales are generally
dependent upon new orders placed each quarter. Until a large order backlog is
established, the Company's quarterly sales will be subject to material
fluctuation.
Margins
Gross margin on product sales for fiscal 1996 was 28% as compared with 29%
for fiscal 1995 and 35% for fiscal 1994, respectively. The decrease in fiscal
1996 as compared with 1995 is due mainly to a decrease in the average selling
price of optical memory cards, partially offset by a lower per-card cost. This
is a result of a greater portion of fiscal 1996 card sales being lower-priced
cards with fewer features than cards sold
21
22
the previous fiscal year. The decrease in fiscal 1995 as compared with fiscal
1994 is due mainly to an increase in optical memory card facility costs charged
to cost of product sales and a decrease in the markup on optical memory card
reader/writers.
Gross margins on optical memory card sales will fluctuate based upon type
and volume of cards sold. As card manufacturing for commercial orders increases,
the Company's optical memory card manufacturing facility is used less for the
purposes of research and engineering. Therefore, an increasing amount of the
manufacturing facility costs (depreciation expense, building lease payments, and
other costs) are allocated to cost of product sales and a decreasing amount of
these costs are charged to research and engineering. This allocation has no
effect on pretax profits. For fiscal 1996, 1995, and 1994, respectively, the
Company allocated 47%, 17%, and 11% of the facility expenses to card
manufacturing for commercial orders and marketing samples. When the Company
reaches a production level of approximately 1.5 million cards per year for
commercial orders, the cost allocation percentages should become relatively
fixed, with essentially all of the card manufacturing facility costs allocated
to cost of product sales. The facility expenses will then become a fixed cost
component of product sales and should decrease on a per-card basis as volumes
increase.
Income and Expenses
Selling, General, and Administrative Expenses (SG&A)
For fiscal 1996, SG&A expenses were $2,400,000 as compared with $2,023,000
and $1,925,000, respectively, for fiscal 1995 and 1994. SG&A spending is
expected to continue at current levels for the short term. The $377,000 increase
for fiscal 1996 is due mainly to a $100,000 increase in payroll expenses, a
$112,000 increase in marketing expenses, including trade shows and travel, and a
$73,000 increase in legal expenses. The Company's plans include increased
marketing and customer support activity, which will be implemented when certain
financial goals are achieved.
Research and Engineering Expenses
Research and engineering expenses were $1,092,000 for fiscal 1996 as
compared with $1,860,000 for fiscal 1995 and $2,202,000 for fiscal 1994. The
optical memory card facility is used both for engineering and manufacturing.
Therefore, the facility costs (depreciation expense, building lease payments,
and other costs) are allocated between manufacturing and engineering based upon
the level of manufacturing activity. Depreciation and amortization expenses
charged to research and engineering decreased to $238,000 for fiscal 1996 as
compared with $603,000 for fiscal 1995 and $947,000 for fiscal 1994. This was
due mainly to a change on October 1, 1994 in the estimated useful lives of the
optical memory card manufacturing equipment. (See Note 2 of "Notes to
Consolidated Financial Statements.")
As optical card production increases and card manufacturing resources are
allocated to card production to a greater degree than at present, reported
research and engineering expenses are expected to decrease. The Company believes
that the reduction in card manufacturing facility expenses allocated to research
and engineering will not have any negative effect on its optical card business
since research and engineering projects are continuing. It also is possible that
future projects may require increased spending as the optical card industry
grows.
Other Income and Expense
Other income for fiscal 1996 was $272,000 as compared with $32,000 for
fiscal 1995 and $733,000 for fiscal 1994. During the first quarter of fiscal
1996, the Company received a $200,000 nonrefundable deposit toward a license
agreement. The license agreement was not consummated and the deposit was
forfeited by the licensee. The income from the forfeiture of the deposit is
recorded as other income in fiscal 1996. See Part I, Item 3, "Legal
Proceedings." There was no income of this type for fiscal 1995 or fiscal 1994.
Other income for fiscal 1994 included $713,000, net of expenses, resulting from
22
23
full and final settlement of a claim filed in December 1992 by the Company
against a third party for possible future business loss. There was no income of
this type for fiscal 1996 or fiscal 1995.
Interest income for fiscal 1996 was $78,000 as compared with $35,000 for
fiscal 1995 and $24,000 for fiscal 1994. The increase in interest income for
fiscal 1996 versus fiscal 1995 was due to an increase in average invested funds.
The increase for fiscal 1995 versus fiscal 1994 was due to an increase in
average invested funds and higher interest rates. The Company's interest expense
on short-term loans was $8,000 for fiscal 1996, $7,000 for fiscal 1995, and
$4,000 for fiscal 1994.
Discontinued Operations
During fiscal 1993, the Company discontinued its emulsion photoplate
operation because of the limited market for these products, which was long
anticipated by the Company. During fiscal 1995, the Company completed settlement
of its remaining commitments related to its discontinued emulsion photoplate
operation, at an amount lower than its accruals for these items. Therefore,
discontinued operations had income of $22,000 for fiscal 1995 as compared with a
loss of $90,000 for fiscal 1994. There was no income or loss of this type for
fiscal 1996.
LIQUIDITY
As of March 31, 1996, the Company had cash and cash equivalents of
$2,094,000 and a current ratio of 1.9 to 1. Net cash used for operating
activities was $940,000 during fiscal year 1996 as compared with $1,729,000 for
fiscal 1995 and $1,200,000 for fiscal 1994. The Company had no long-term debt as
of March 31, 1996.
The Company has not established a line of credit. Generally, the Company's
customers make advance payments, in whole or in part, at time of order placement
because the Company's optical memory cards are usually made to custom
specifications that are specific to each customer, end user, or application. The
Company believes that although working capital requirements should grow in
proportion to product shipment levels, the advance payments will reduce the need
for working capital financing. The Company may negotiate a line of credit if and
when it becomes appropriate.
At the current level of product sales, the Company does not generate cash
or profits from operations. To fund its operations, the Company requires either
a substantial increase in order levels of optical cards, sales of additional
licenses, or additional financing. Based on current raw material costs and other
expense calculations, the Company estimates that it will break even on
operations at annual sales of approximately 1.5 million optical memory cards
along with sales of related hardware. If there is slow progress by customers in
the development and implementation of LaserCard-based programs, this could
extend the period during which the Company would need additional financing.
The Company has updated its plan to increase card production capacity,
which calls for the addition over several years of $4.3 million in capital
equipment to the card manufacturing facility and additional production employees
when customer orders are of sufficient magnitude to justify each incremental
step. Previously, in its Report on Form 10-K for the year ended March 31, 1995,
the Company estimated a requirement for $3 million in capital additions to
attain a 25 million card production level. The updated plan provides for a
greater variety of optical memory card versions based upon presently known
customer requirements. The added $1.3 million investment in a high-throughput,
color-printing press would further expand the Company's color ink printing
capacity. This would permit color printing of all of the 25 million cards per
year that the Company estimates it could produce in an updated manufacturing
facility. The $4.3 million investment in capital equipment would be implemented
incrementally, as follows: to increase the current production equipment
capabilities from 3 million to 6 million cards annually, $500,000; for producing
up to 10 million
23
24
cards annually, $2.4 million more; for producing up to 25 million cards
annually, $1.4 million more. The Company may make additional capital investments
for cost savings and other purposes.
At March 31, 1996, the Company had an accumulated deficit of $25,213,000.
The Company anticipates that the size of its losses will decrease due to
anticipated increases in sales of optical memory cards and related products,
except for possible quarterly fluctuations. However, if increased
commercialization is delayed and the Company does not realize such increased
sales, its losses will continue, except in the event of sporadic sales of
licenses which in the past have ranged in price from approximately $1 million
for a card distribution license to $10 million plus royalties for a card
manufacturing license.
During fiscal 1996, the Company had cash receipts, net of expenses, of
$446,000 from the private placement of 115,000 shares of its common stock. These
shares have not been registered under the Securities Act of 1933 and cannot be
offered or sold in the United States absent registration or an applicable
exemption from registration requirements. The Company has agreed to file an S-3
registration statement covering certain of the shares sold by the Company under
private placements in fiscal years 1995 and 1996. At such time as the SEC
approves the registration, the shareholders may resell the shares.
During fiscal 1996, Company employees and consultants purchased from the
Company 355,350 shares of registered common stock, at an average price of $5.33
per share, through the exercise of stock options under the Company's 1991 Stock
Option Plan, which resulted in additional cash receipts to the Company of
$1,894,000. As of March 31, 1996, Company employees and consultants held
unexercised, vested options to purchase 860,333 shares of common stock at
exercise prices ranging from $4.25 to $9.06 per share, for an average of $6.51
per share. These stock options, if exercised, would provide the Company cash in
the amount of $5,603,000.
The Company will continue its product marketing activities and its
licensing efforts and will consider opportunities for additional equity
financing in order to strengthen its cash position, to accelerate its marketing
and sales activities, and to add software and manufacturing capabilities to more
rapidly build sales of optical memory cards. The Company is not aware of any
materially adverse trends that would limit its ability to finance operations
through additional equity financings, if required. However, the Company cannot
guarantee that such equity financing would be available, if needed.
STOCK PRICE VOLATILITY
The Company's common stock price is subject to significant volatility due
to fluctuations in revenues, earnings, capitalization, liquidity, press
coverage, and financial market interest. Some of these factors may be
exacerbated because the Company operates solely in the optical memory card
products industry, which is in the early stage of commercialization.
FORWARD-LOOKING STATEMENTS
Certain statements made above relating to plans, objectives, and economic
performance go beyond historical information and may provide an indication of
future results. To that extent, they are forward- looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and
each is subject to factors that could cause actual results to differ from those
in the forward-looking statement. Such factors are described above and in the
documents filed by the Company from time to time with the Securities and
Exchange Commission, including Form S-3 Registration Statement 33-88588.
24
25
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Drexler Technology Corporation:
We have audited the accompanying consolidated balance sheets of Drexler
Technology Corporation (a Delaware corporation) and subsidiaries as of March 31,
1995 and 1996, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended March 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Drexler Technology Corporation
and subsidiaries as of March 31, 1995 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
March 31, 1996, in conformity with generally accepted accounting principles.
/s/Arthur Andersen LLP
ARTHUR ANDERSEN LLP
San Jose, California
April 26, 1996
25
26
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1995 AND 1996
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS
1995 1996
-------- --------
Current assets:
Cash and cash equivalents ........................................... $ 1,050 $ 2,094
Accounts receivable ................................................. 98 667
Inventories ......................................................... 586 864
Other current assets ................................................ 139 157
-------- --------
Total current assets ............................................. 1,873 3,782
-------- --------
Property and equipment, at cost ......................................... 12,773 13,067
Less--accumulated depreciation and amortization ..................... (11,189) (11,460)
-------- --------
Property and equipment, net ...................................... 1,584 1,607
Patents, net ............................................................ 1,074 982
-------- --------
Total assets .................................................. $ 4,531 $ 6,371
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................................... $ 420 $ 1,498
Accrued payroll costs ............................................... 222 233
Advance payments from customers ..................................... 216 177
Other accrued liabilities ........................................... 123 136
Current liabilities related to discontinued operations .............. 14 --
-------- --------
Total current liabilities ........................................ 995 2,044
-------- --------
Commitments (Note 7)
Stockholders' equity:
Preferred stock, $.01 par value:
Authorized--2,000,000 shares
Outstanding--none ................................................ -- --
Common stock, $.01 par value:
Authorized--15,000,000 shares
Outstanding--8,358,029 shares in 1995 and 8,831,674 shares in 1996 83 88
Additional paid-in capital .......................................... 27,082 29,452
Accumulated deficit ................................................. (23,629) (25,213)
-------- --------
Total stockholders' equity ....................................... 3,536 4,327
-------- --------
Total liabilities and stockholders' equity .................... $ 4,531 $ 6,371
======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
BALANCE SHEETS.
26
27
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FISCAL YEARS ENDED MARCH 31, 1994, 1995, AND 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1994 1995 1996
------- ------- -------
Revenues:
Product sales .................................. $ 1,819 $ 2,141 $ 5,059
License fees and royalties ..................... 19 1,025 236
------- ------- -------
Total revenues .............................. 1,838 3,166 5,295
------- ------- -------
Costs and expenses:
Cost of product sales .......................... 1,180 1,511 3,659
Selling, general, and administrative expenses .. 1,925 2,023 2,400
Research and engineering expenses .............. 2,202 1,860 1,092
------- ------- -------
Total costs and expenses .................... 5,307 5,394 7,151
------- ------- -------
Operating loss from continuing operations (3,469) (2,228) (1,856)
Other income and expense:
Income from settlement of claim, net of expenses 713 -- --
Other income ................................... -- 4 202
Interest income ................................ 24 35 78
Interest expense ............................... (4) (7) (8)
------- ------- -------
Total other income, net ..................... 733 32 272
------- ------- -------
Loss from continuing operations .......... (2,736) (2,196) (1,584)
Income (loss) from discontinued operations ......... (90) 22 --
------- ------- -------
Net loss ................................. $(2,826) $(2,174) $(1,584)
======= ======= =======
Loss per share:
Continuing operations .......................... $ (.36) $ (.27) $ (.18)
Discontinued operations ........................ (.01) -- --
------- ------- -------
Net loss ................................. $ (.37) $ (.27) $ (.18)
======= ======= =======
Weighted average common shares ..................... 7,581 8,161 8,692
======= ======= =======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
27
28
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE FISCAL YEARS ENDED MARCH 31, 1994, 1995, AND 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ADDITIONAL
COMMON STOCK PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------ ------ ------- ------- -----
Balance, March 31, 1993 ....................................... 7,351 $ 73 $ 23,320 $(18,629) $ 4,764
Shares issued under stock option
and stock purchase plans ............................... 343 4 1,394 -- 1,398
Compensation related to
stock plan activity .................................... -- -- 5 -- 5
Shares issued under private placement
at $3.34 per share, net of issuance
costs of $9 ............................................ 410 4 1,357 -- 1,361
Net loss .................................................. -- -- -- (2,826) (2,826)
-------- -------- -------- -------- -------
Balance, March 31, 1994 ....................................... 8,104 81 26,076 (21,455) 4,702
Shares issued under stock option
and stock purchase plans ............................... 17 -- 78 -- 78
Compensation related to
stock plan activity .................................... -- -- 8 -- 8
Shares issued under private placement
at $4.00 per share, net of issuance
costs of $28 ........................................... 237 2 920 -- 922
Net loss .................................................. -- -- -- (2,174) (2,174)
-------- -------- -------- -------- --------
Balance, March 31, 1995 ....................................... 8,358 83 27,082 (23,629) 3,536
Shares issued under stock option
and stock purchase plans ............................... 359 4 1,914 -- 1,918
Compensation related to
stock plan activity .................................... -- -- 11 -- 11
Shares issued under private placement
at $4.00 per share, net of issuance
costs of $14 ........................................... 115 1 445 -- 446
Net loss .................................................. -- -- -- (1,584) (1,584)
-------- -------- -------- -------- --------
Balance, March 31, 1996 ....................................... 8,832 $ 88 $ 29,452 $(25,213) $ 4,327
======== ======== ======== ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
28
29
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED MARCH 31, 1994, 1995, AND 1996
(IN THOUSANDS)
1994 1995 1996
------- ------- -------
Cash flows from operating activities:
Net loss from continuing operations ............................. $(2,736) $(2,196) $(1,584)
Adjustments to reconcile net loss to net cash used
for operating activities:
Income (loss) from discontinued operations .................. (90) 22 --
Depreciation and amortization ............................... 1,117 800 449
Provision for doubtful accounts receivable .................. (1) 1 1
Compensation on stock plan activity ......................... 5 8 11
Changes in operating assets and liabilities:
Increase in accounts receivable ............................. (78) (6) (570)
(Increase) decrease in inventories .......................... 49 (191) (278)
Increase in other assets .................................... (19) (8) (18)
Increase in accounts payable and accrued liabilities ........ 287 35 1,102
(Decrease) increase in advance payments from customers ...... 218 (121) (39)
Decrease in net assets (liabilities) related to
discontinued operations .................................. 48 (73) (14)
------- ------- -------
Net cash used for operating activities ................... (1,200) (1,729) (940)
------- ------- -------
Cash flows from investing activities:
Purchase of property and equipment .............................. (293) (252) (313)
Increase in patents ............................................. (93) (83) (67)
------- ------- -------
Net cash used for investing activities ................... (386) (335) (380)
------- ------- -------
Cash flows from financing activities:
Proceeds from sale of common stock, net of issuance costs ....... 2,759 1,000 2,364
------- ------- -------
Net cash provided by financing activities ................ 2,759 1,000 2,364
------- ------- -------
Net increase (decrease) in cash and cash equivalents ..... 1,173 (1,064) 1,044
Cash and cash equivalents:
Beginning of year ............................................... 941 2,114 1,050
------- ------- -------
End of year ..................................................... $ 2,114 $ 1,050 $ 2,094
======= ======= =======
Supplemental disclosures--cash payments for the following items are:
Income taxes .................................................... $ 5 $ 5 $ 6
======= ======= =======
Interest ........................................................ $ 4 $ 7 $ 8
======= ======= =======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
29
30
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1996
1. Organization and Operations
Drexler Technology Corporation and its wholly owned subsidiary, LaserCard
Systems Corporation, (the "Company") develop, manufacture, and market optical
data storage products used with personal computers for information recording,
storage, and retrieval. The Company's customers are mainly value-added reseller
(VAR) companies throughout the world that develop commercial applications for
LaserCard(R) products. The Company's target markets include consumer, business,
and government applications for portable, recordable, unitary record cards.
These applications include healthcare, secure access/ID, and automobile
maintenance cards.
The Company is subject to certain risks including competition from
substitute products and larger companies, and the need for additional financing
through profitable operations or external financing, or both.
2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of Drexler
Technology Corporation and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Fiscal Period
For purposes of presentation, the Company has indicated its accounting
period as ending on March 31 and its interim quarterly periods as ending on the
corresponding month end. The Company, in fact, operates and reports quarterly
periods ending on the Friday closest to month end. Fiscal 1994, 1995, and 1996
were 52-week years.
Cash and Cash Equivalents
The Company considers all highly liquid investments, consisting primarily
of commercial paper, with original maturities of three months or less to be cash
equivalents.
Inventories
Inventories are stated at the lower of cost or market, with cost determined
on a first-in, first-out basis and market based on the lower of replacement cost
or estimated realizable value. The components of inventories as of March 31 are
(in thousands):
1995 1996
---- ----
Raw materials ................................ $296 $443
Work-in-process .............................. 23 79
Finished goods ............................... 110 164
Systems and components
held for resale ........................... 157 178
---- ----
$586 $864
==== ====
The Company currently buys all of its reader/writers, an important
component of its systems, from one supplier. An interruption or change in the
supply of reader/writers could cause a delay in product shipments and a possible
loss of sales, which would affect operating results adversely.
30
31
Property and Equipment
The components of property and equipment as of March 31 are (in thousands):
1995 1996
---- ----
Equipment and furniture .................. $11,021 $11,285
Leasehold improvements ................... 1,752 1,782
------- -------
$12,773 $13,067
======= =======
Depreciation is provided over the estimated useful lives (five to seven
years) of equipment and furniture using the double-declining balance and
straight-line methods. During fiscal 1995, the Company completed a review of its
fixed asset lives and determined that the actual lives for manufacturing
equipment, with a net book value of $1,320,000, were generally longer than the
estimated useful lives for depreciation purposes. Therefore, the Company
extended the estimated useful lives of its manufacturing equipment by five
years, effective October 1, 1994. In addition, the Company established a salvage
value of approximately $315,000 on this equipment. For the year ended March 31,
1995, this change in estimated lives reduced depreciation expense by
approximately $375,000 and decreased the net loss by approximately $375,000
($0.05 per share); and for the year ended March 31, 1996, the change reduced
depreciation expense by approximately $658,000 and decreased the net loss by
approximately $658,000 ($0.08 per share). Leasehold improvements are amortized
over the shorter of the life of the asset or life of the lease using the
straight-line method.
Patent Costs
Costs incurred in connection with patents are capitalized and amortized
over the estimated useful lives of the patents of 9 to 17 years.
Gross patent expenditures capitalized and accumulated amortization as of
March 31 are as follows (in thousands):
1995 1996
------- -------
Gross patent expenditures ............................ $ 2,245 $ 2,312
Accumulated amortization ............................. (1,171) (1,330)
------- -------
$ 1,074 $ 982
======= =======
Software Development Costs
Under the criteria set forth in SFAS No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed," capitalization of
software development costs begins upon the establishment of technological
feasibility of the product, which the Company defines as a beta version of the
software. The period of time commencing when a product achieves beta status and
ending when a product is available for general release is typically very short.
Accordingly, amounts that could have been capitalized under SFAS No. 86 after
consideration of the above factors were immaterial and, therefore, no software
development costs have been capitalized by the Company to date.
Revenue Recognition
Product sales primarily consist of card sales and sales of reader/writers.
The Company generally recognizes revenue from product sales at the time of
shipment. Where appropriate, provision is made at that time for estimated
warranty costs.
31
32
License revenues include front-end license fees and long-term royalty
payments. License fees are generally recognized as revenues when the license
agreement is signed. Long-term royalty payments are recognized as revenue when
realized.
No licenses were sold in fiscal 1994; fiscal 1995 license revenue included
$1 million from the sale of an optical memory card distribution license; and
fiscal 1996 license revenue included $200,000 from an agreement comprised of a
trademark license and an installment payment toward a possible future license
for optical memory card distribution. Optical memory card distribution licenses
grant the right to purchase such cards at the Company's most favorable pricing.
The cost of license revenue is not material and is included in selling,
general, and administrative expenses.
Reclassifications
Certain reclassifications were made to the prior year presentation to
conform with the current year presentation.
New Accounting Standards
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation," which will be effective for the
Company's 1997 fiscal year. SFAS No. 123 allows companies which have stock-based
compensation arrangements with employees to adopt a new fair-value basis of
accounting for stock options and other equity instruments, or to continue to
apply the existing accounting rules under Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees," but with additional
financial statement disclosure. The Company plans to continue to account for
stock-based compensation arrangements under APB Opinion No. 25 and, therefore,
does not anticipate SFAS No. 123 will have a material impact on its financial
position, results of operations, or cash flows.
In March 1995, the Financial Accounting Standards Board issued SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." SFAS No. 121 requires that long-lived assets be
reviewed for impairment and, if necessary, an impairment loss be recorded
whenever events or changes in circumstances indicate that the carrying amount of
the asset may not be recoverable. SFAS No. 121 is effective for fiscal year
1997. Management does not believe the adoption of SFAS No. 121 will have a
material effect on the financial position or results of operations of the
Company.
3. Loss Per Share
Loss per share has been computed based upon the weighted average number of
common shares outstanding.
4. Major Customers and Export Sales
The Company operates in one industry segment--the development, manufacture,
and sale of optical data products used for computer data storage. Five customers
each accounted for more than 10% of revenues for one or more years during fiscal
1994, 1995, and 1996, as follows:
Fiscal Year
-----------
1994 1995 1996
---- ---- ----
Customer A ..................... 15% NA 39%
Customer B ..................... NA NA 18%
Customer C ..................... 19% 16% 13%
Customer D ..................... 18% 13% NA
Customer E ..................... NA 32% NA
(NA = Not applicable, less than 10% of revenues.)
32
33
At March 31, 1996, two substantial U.S. customers comprised 96% of total
accounts receivable, primarily for products sold under a U.S. government
subcontract.
Revenues by region are as follows (in thousands):
Fiscal Year
-----------
1994 1995 1996
------ ------ --------
United States ....................................... $ 885 $ 917 $ 3,083
Asia ................................................ 233 1,427 1,263
Europe .............................................. 601 698 684
Rest of world ....................................... 119 124 265
------ ------ --------
$1,838 $3,166 $ 5,295
====== ====== ========
Three foreign countries each accounted for more than 10% of revenues for
one or more years during fiscal 1994, 1995, and 1996, as follows: fiscal 1994 -
Czech Republic (18%); fiscal 1995 - South Korea (34%), Czech Republic (14%);
fiscal 1996 - Philippine Islands (19%).
5. Discontinued Operations
In the fourth quarter of fiscal 1993, the Company closed its Precision
Photoglass, Inc. subsidiary, which was a manufacturer of photoplates for the
semiconductor industry.
The components of the income (loss) from discontinued operations included
in the consolidated statements of operations contained herein for the fiscal
years ended March 31 are (in thousands):
Fiscal Year
-----------
1994 1995
---- ----
Revenues ..................................... $ 29 $--
Cost of product sales ........................ 93 --
Operating loss reserve ....................... (64) --
Shutdown expense reserve ..................... 90 (22)
---- ----
Income (loss) from
discontinued operations ................... $(90) $ 22
==== ====
Liabilities related to discontinued operations as of March 31, 1995
consisted of accounts payable.
6. Common Stock
As of March 31, 1996, the Company has reserved 1,465,520 shares and 69,412
shares of common stock under its stock option and stock purchase plans,
respectively.
The Company's 1991 Stock Option Plan provides that stock options may be
granted to employees, officers, and consultants of the Company and that option
prices may be no less than 100% of the fair market value of the shares at the
date of grant. Options are exercisable, as determined by the Board of Directors,
during the term of the option, which cannot exceed ten years (except that the
option term cannot exceed five years in the case of incentive stock options
granted to a principal shareholder).
33
34
The following option activity in the Plan has occurred since March 31,
1993:
Stock Option Table
Options
Available Outstanding
for Grant Options Per Share Price
--------- ------- ---------------
Balance March 31, 1993............................... 402,020 970,547 $ 3.375 -- $ 6.60
Granted........................................... (293,700) 293,700 $ 5.812 -- $ 8.125
Exercised......................................... -- (339,797) $ 3.375 -- $ 6.50
Expired........................................... 1,500 (1,500) $ 8.125
-------- --------
Balance March 31, 1994............................... 109,820 922,950 $ 3.375 -- $ 8.125
Authorized........................................ 400,000 --
Granted........................................... (93,100) 93,100 $ 4.563 -- $ 6.813
Exercised......................................... -- (11,900) $ 4.94 -- $ 5.94
Expired........................................... 1,500 (1,500) $ 6.50
-------- ---------
Balance March 31, 1995............................... 418,220 1,002,650 $ 3.375 -- $ 8.125
Authorized........................................ 400,000 --
Granted........................................... (530,400) 530,400 $ 5.57 -- $12.313
Exercised......................................... -- (355,350) $ 3.375 -- $ 8.125
Expired........................................... 2,100 (2,100) $ 6.813
-------- ---------
Balance March 31, 1996............................... 289,920 1,175,600 $ 4.25 -- $12.313
======== =========
As of March 31, 1996, a total of 860,333 option shares were fully vested
and exercisable under the Plan. The total option price paid on options exercised
during fiscal 1994, 1995, and 1996 was $1,386,348, $62,278, and $1,893,609,
respectively.
Under the Company's Employee Stock Purchase Plan, eligible employees may
designate from 2% to 6% of their compensation to be withheld for the purchase of
shares of common stock at 67% of fair market value. The 33% differential in the
price of shares sold under the Plan is charged to operations as compensation.
Under the Plan, employees purchased 2,762 shares in fiscal 1994; 4,673 shares in
fiscal 1995; and 3,295 shares in fiscal 1996, at an average purchase price per
share of $4.00, $3.35, and $7.00, respectively.
7. Commitments
The Company occupies its facilities under various operating leases. The
rent expense relating to these facilities was approximately $380,000 in fiscal
1994, $363,000 in fiscal 1995, and $369,000 in fiscal 1996.
As of March 31, 1996, future minimum rental payments relating to these
leases are (in thousands):
Fiscal Year
-----------
1997.................................. $ 367
1998.................................. 366
1999.................................. 367
2000.................................. 336
2001.................................. 53
---------
$ 1,489
=========
34
35
8. Income Taxes
The major components of the net deferred tax asset as of March 31 are as
follows (in thousands):
1995 1996
-------- --------
Net operating losses:
Federal .............................. $ 12,248 $ 13,065
State ................................ 1,013 1,089
Tax credits .............................. 1,109 1,109
Reserves and accruals not
currently deductible
for tax purposes ..................... 136 144
Depreciation ............................. (122) (86)
Capitalized patent costs ................. (398) (364)
Other .................................... (18) (4)
-------- --------
Total deferred tax asset ............. 13,968 14,953
Valuation allowance ...................... (13,968) (14,953)
-------- --------
Net deferred tax asset ............... $ -- $ --
======== ========
The Company has established a valuation allowance for the total deferred
tax asset, as it is uncertain that the deferred tax asset will be realized.
The Company's federal net operating losses will expire at various dates
from 2001 through the year 2011. The Company's state net operating losses will
expire at various dates from 1997 through the year 2001. The tax credit
carryforwards will expire at various dates from 2000 through the year 2004.
9. Other Income
In December 1992, the Company filed a claim against a third party for
possible future business loss. In June 1993, the Company and the third party
reached an agreement whereby the third party agreed to pay the Company $744,000
in full and final settlement of the claim. The income from the settlement was
recorded in fiscal 1994 as other income, net of expenses of $31,000. There was
no income of this type in fiscal 1995 or 1996.
During the first quarter of fiscal 1996, the Company received a $200,000
nonrefundable deposit toward a license agreement. The license agreement was not
consummated and the deposit was forfeited by the licensee. The income from the
forfeiture of the deposit is recorded as other income in fiscal 1996.
35
36
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The unaudited quarterly results of operations of the Company for fiscal
1995 and fiscal 1996 are as follows (in thousands, except per share amounts):
QUARTERLY FINANCIAL RESULTS (UNAUDITED)
- ----------------------------------------------------------------------------------------------
1ST 2ND 3RD 4TH
--- --- --- ---
FISCAL 1995:
Product sales .......................... $ 795 $ 545 $ 232 $ 569
License fees ........................... 10 3 1,003 9
Income (loss) from continuing operations (817) (759) 162 (782)
Gain from discontinued operations ...... 22 -- -- --
Net income (loss) ...................... (795) (759) 162 (782)
Income (loss) per share:
Continuing operations ............... $ (.10) $ (.09) $ .02 $ (.09)
Discontinued operations ............. -- -- -- --
Net loss ............................ (.10) (.09) .02 (.09)
FISCAL 1996:
Product sales .......................... $ 762 $ 785 $ 1,582 $ 1,930
License fees ........................... 207 10 7 12
Net loss ............................... (453) (441) (364) (326)
Loss per share ......................... $ (.05) $ (.05) $ (.04) $ (.04)
36
37
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
Pursuant to Paragraph G(3) of the General Instructions for Form 10-K,
portions of the information required by Part III of Form 10-K are incorporated
by reference from the Company's Proxy Statement to be filed with the Commission
in connection with the Company's 1996 Annual Meeting of Stockholders (the "Proxy
Statement").
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning directors and executive officers of the Company is
set forth under the caption "Directors and Executive Officers of the Registrant"
at the end of Part I of this Report on Form 10-K.
Information concerning compliance with Section 16(a) of the Securities
Exchange Act of 1934, as amended, is set forth in the Proxy Statement under the
caption "Compliance with Section 16(a) of the Securities Exchange Act of 1934"
and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation appears in the Company's
Proxy Statement, under the captions "Director Compensation," "Executive
Compensation," and "Compensation Committee Interlocks and Insider Participation"
and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning the security ownership of certain beneficial owners
and management appears in the Company's Proxy Statement under the captions
"Stock Ownership Table" and "Principal Stockholder" and is incorporated herein
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
37
38
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
1. The Consolidated Financial Statements of the Company, filed herewith
under Item 8, as follows:
Page
Number
------
(1) Report of Independent Public Accountants 25
(2) Consolidated Balance Sheets at March 31, 1995
and March 31, 1996 26
(3) Consolidated Statements of Operations for
Fiscal Years 1994, 1995, and 1996 27
(4) Consolidated Statements of Stockholders' Equity
for Fiscal Years 1994, 1995, and 1996 28
(5) Consolidated Statements of Cash Flows for Fiscal
Years 1994, 1995, and 1996 29
(6) Notes to Consolidated Financial Statements 30
2. Financial Statement Schedules: None
Schedules not listed above are not applicable or not required, or the
information required to be set forth therein is included in the
Consolidated Financial Statements or the notes thereto.
3. Exhibits
The Exhibits to this Report, filed herewith under Item 14(c) or
incorporated by reference from other documents previously filed with
the Securities and Exchange Commission, as follows:
Exhibit Page Number or Incorporated
Number Description By Reference to
------- ----------- ---------------------------
(1) Exhibits 3.1, 3.2, 3.2.1, 3.2.2, and 3.2.3, Articles of
Incorporation and By-Laws of the Company, as follows:
3.1 Articles of Incorporation Exhibit 3.1 to Report on
Form 10-Q for period
ended September 25, 1987
38
39
Exhibit Page Number or Incorporated
Number Description By Reference to
------- ----------- ---------------------------
3.2 By-Laws Exhibit 3.2 to Report on
Form 10-Q for period
ended September 25, 1987
3.2.1 By-Law Amendment Adopted Exhibit 3.2.1 to Report on
during Fiscal 1991 Form 10-K for period
ended March 31, 1992
3.2.2 By-Law Amendments Adopted Exhibit 3.2.2 to Report on
during Fiscal 1992 Form 10-K for period
ended March 31, 1992
3.2.3 By-Law Amendment Adopted Exhibit 3.2.3 to Report on
during Fiscal 1994 Form 10-Q for period
ended September 30, 1993
(2) Exhibits 10.1 through 10.6.2, Material Contracts, as follows:
10.1 Building Lease with Exhibit 10.1 to Report on
Kimes Properties Form 10-K for fiscal year
ended March 31, 1993
10.1.2 Building Lease Extension Page 42
with Kimes Properties
10.2 Building Lease with Exhibit 10.8 to Report on
Renault & Handley Form 10-K for fiscal year
Employees Investment Co. ended April 2, 1982
10.2.1 Building Lease Extensions Exhibit 10.10 to Report
with Renault & Handley on Form 10-K for fiscal
Employees Investment Co. year ended March 31, 1987
10.2.2 Building Lease Extensions Exhibit 10.3.2 to Report
with Renault & Handley on Form 10-K for fiscal
Employees Investment Co. year ended March 31, 1989
10.2.3 Building Lease Extensions Exhibit 10.2.3 to Report on
with Renault & Handley Form 10-K for fiscal year
Employees Investment Co. ended March 31, 1992
10.2.4 Building Lease Extensions Exhibit 10.2.4 to Report on
with Renault & Handley Form 10-Q for period ended
Employees Investment Co. September 30, 1994
10.3 Optical Memory Card Exhibit 4 to Report on
Manufacturing License Form 8-K dated
with Canon Inc. January 10, 1989
39
40
Exhibit Page Number or Incorporated
Number Description By Reference to
------- ----------- ---------------------------
10.4 Optical Memory Card Manufacturing Exhibit 10.8 to Report on
License with Optical Memory Card Form 10-K for fiscal year
Business Corporation ended March 31, 1991
10.5 Management Bonus Plan Exhibit 10.9 to Report on
Form 10-K for fiscal year
ended April 1, 1983
10.6 1991 Stock Option Plan Exhibit 10.10 to Report
on Form 10-K for fiscal
year ended March 31, 1991
10.6.1 Amended 1991 Stock Option Plan Exhibit 10.10.1 to Report
Approved by Stockholders during on Form 10-Q for period
Fiscal 1994 ended September 30, 1993
10.6.2 Amended 1991 Stock Option Plan Exhibit 10.6.2 to Report
Approved by Stockholders during on Form 10-K for period
Fiscal 1995 ended March 31, 1995
10.6.3 Amended 1991 Stock Option Plan Exhibit 10.1 to Report
Approved by Stockholders during on Form 10-Q for period
Fiscal 1996 ended September 30, 1995
(3) 22.0 Subsidiaries Page 43
(4) 24.0 Consent of Experts and Counsel Page 44
Exhibits not listed above are not applicable to registrant.
(B) REPORTS ON FORM 8-K
The Company did not file any Reports on Form 8-K during the quarter ended
March 31, 1996.
(C) EXHIBITS
Exhibits 10.1.2, 22.0, and 24.0 are contained herein.
(D) FINANCIAL STATEMENT SCHEDULES
None.
40
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized:
Dated: June 27, 1996
DREXLER TECHNOLOGY CORPORATION
By /s/Jerome Drexler
---------------------------------
Jerome Drexler, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
/s/Jerome Drexler Chairman of the Board of Directors June 27, 1996
- ----------------------------- and President
Jerome Drexler (Principal Executive Officer)
/s/Steven G. Larson Vice President of Finance and Treasurer June 27, 1996
- ----------------------------- (Principal Financial Officer and
Steven G. Larson Principal Accounting Officer)
/s/Arthur H. Hausman Director June 27, 1996
- -----------------------------
Arthur H. Hausman
/s/William E. McKenna Director June 27, 1996
- -----------------------------
William E. McKenna
41