SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended            June 30, 2004

Commission file number             0-10691

DELPHAX TECHNOLOGIES INC.

(952) 939-9000

Not Applicable

			Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                Yes x    No o
			Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).                Yes o    No x
			Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
			As of August 9, 2004, there were 6,271,047 shares outstanding of Common Stock.

INDEX

DELPHAX TECHNOLOGIES INC. AND SUBSIDIARIES

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

DELPHAX TECHNOLOGIES INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

See notes to condensed consolidated financial statements.

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DELPHAX TECHNOLOGIES INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

See notes to condensed consolidated financial statements.

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DELPHAX TECHNOLOGIES INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See notes to condensed consolidated financial statements.

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DELPHAX TECHNOLOGIES INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See notes to condensed consolidated financial statements.

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DELPHAX TECHNOLOGIES INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE A — Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by the accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended September 30, 2003.

Reclassifications have been made in the prior year to conform to classifications in the current year.

NOTE B — Earnings per Share

The following table sets forth the computation of basic and diluted loss and earnings per share:

a – Excluded because the impact would be antidilutive.

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NOTE C — Comprehensive Income

The components of comprehensive loss and income, net of related tax, for the three and nine months ended June 30, 2004 and 2003 were as follows:

NOTE D — Accounting for Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123) as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure (SFAS 148). Pro forma net loss and income, and loss and earnings per share, determined as if the Company had accounted for its employee stock options under the fair value method of those Statements, for the three and nine months ended June 30, 2004 and 2003 were as follows:

NOTE E — Senior Credit Facilities and Convertible Subordinated Debt

Effective December 20, 2001, the Company entered into a bank credit agreement, secured by substantially all the assets of the Company. The credit facility, under the agreement as amended over its course, expired December 31, 2003, at which time payment was due in full for the balance outstanding of $11.9 million. At that date, the Company had not yet completed its negotiations for replacement financing and, as a result, did not repay the loan when due. On February 5, 2004, the Company refinanced its indebtedness to its prior lender by: (i) issuing at par $3.0 million of convertible subordinated notes that were accompanied by warrants to purchase Company Common Stock, and (ii) entering into new senior credit agreements between the Company and a new senior lender and between the Company’s Canadian subsidiary and a Canadian affiliate of the new lender to the Company.

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The subordinated debt financing consisted of a private placement to an accredited investor of $3.0 million in 7% convertible subordinated notes (the Convertible Notes) and accompanying four-year warrants to purchase 515,625 shares of Company Common Stock at an exercise price of $3.51 per share (the Warrants). The Convertible Notes are immediately convertible to Company Common Stock at a conversion price of $3.20 per share, which would result in 937,500 shares being issued if all $3.0 million in principal of the Convertible Notes were converted at that conversion price. The Convertible Notes are junior to the senior credit facilities described below, bear interest at the rate of 7% per annum, payable quarterly in shares of Common Stock, and principal is due and payable in one lump sum in four years on February 4, 2008, unless earlier paid or converted. The number of shares of Common Stock to be issued in payment of interest is determined by dividing the monetary value of the accrued interest by the initial conversion price of $3.20 per common share, or 16,406 shares per quarter. Interest expense is recorded quarterly based on the fair value of the common shares issued. Accordingly, interest expense may fluctuate from quarter to quarter. The Convertible Notes are unsecured. The Warrants issued in connection with the Convertible Notes are exercisable anytime after August 5, 2004 and expire on February 4, 2008. The conversion price of the Convertible Notes and the exercise price of the Warrants are subject to adjustment in the event of stock splits, dividends and in certain other circumstances affecting the capitalization of the Company. The relative fair value of the Warrants on February 5, 2004 was estimated to be approximately $562,000. Furthermore, the Convertible Notes contained a beneficial conversion feature representing an effective initial conversion price that was less than the fair value of the underlying Common Stock on February 5, 2004. The fair value of the beneficial conversion feature was estimated to be approximately $853,000. Both the relative fair value of the Warrants and the fair value of the beneficial conversion feature were recorded as an increase in additional paid-in capital and as original issue discount on the underlying debt. The total original issue discount of approximately $1.4 million will be amortized to interest expense over the four-year life of the Convertible Notes. Anytime after February 4, 2006, if the average closing price of the Company’s Common Stock has been above $7.00 per share for the preceding 15 trading days and certain other conditions are met, the Company may issue a notice to redeem the Convertible Notes. Holders of the Convertible Notes would then be required to either convert the Convertible Notes to Common Stock or accept payment of 120% of the outstanding unpaid principal.

As a part of the subordinated debt financing, the Company agreed to file a registration statement with the Securities and Exchange Commission covering the resale from time to time of the shares of Common Stock issuable as interest on the Convertible Notes, or upon the conversion of the Convertible Notes or exercise of the Warrants. The Company also amended its shareholder rights plan to permit the subordinated debt investors to beneficially own up to 25% of the Company’s Common Stock without being considered an “acquiring person” and triggering the distribution and exercisability of the rights afforded under the rights plan.

The Company’s senior debt financing had both a U.S. and Canadian component. The credit facility for the Company consisted of a secured three-year term loan of $114,000 and a secured three-year revolving credit facility of up to $8.5 million, subject to a borrowing base of accounts receivable and inventory and certain financial covenants. The related senior loan to the Company’s Canadian subsidiary consisted of a secured, three-year term loan of $1,042,000 and a secured three-year revolving credit facility of up to $4.0 million, subject to a borrowing base of inventory and certain financial covenants. The senior credit facilities total approximately $13.7 million, of which the Company and its Canadian subsidiary used about $8.1 million at the closing. These proceeds and proceeds from the issuance of the Convertible Notes were used to pay off all indebtedness to the prior lender and to pay expenses related to the new senior and subordinated debt.

Availability under the senior credit facilities is based primarily on the Company’s accounts receivable and inventory levels, but also on compliance with certain covenants, one of which is a tangible net worth covenant requiring improved tangible net worth at specific measurement dates. The Company believes that the tangible net worth covenant is the most restrictive covenant due to its reliance on the improvement in the Company’s net income over the course of the fiscal year. It is the Company’s intent to meet this and all the covenants of the agreements, and the Company monitors prospective compliance with the bank covenants. If the Company determined that revenue shortfalls or other operating results indicate it may not meet the tangible net worth covenant or any other covenant, the Company will initiate expense reduction plans to achieve compliance with the covenants. The Company has developed specific plans to reduce certain expenses in the event of covenant non-compliance, and the plans include, but may not be limited to, reductions in research and development costs and personnel costs. The Company believes

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that its plans to reduce expenses, if required to do so, will be sufficient in order to meet the covenants at all scheduled measurement dates through September 30, 2004. As of June 30, 2004, the Company is in compliance with all the covenants of the credit agreements.

As of June 30, 2004, indebtedness under the bank credit facilities was $8.1 million, outstanding at an estimated average annual interest rate of 4.3%. The weighted average interest rate on all of the Company’s debt was approximately 9% which gives effect to the bank credit facilities and the $3.0 million of 7% Convertible Notes. The interest expense on all debt includes both the amortization of the original issue discount of approximately $1.4 million over the four-year term of the Convertible Notes and the value of the Company’s Common Stock issued at the average market price of the stock over the interest period.

Note F — Restructuring Initiatives

In April 2002, the Company effected a workforce reduction, eliminating approximately 40 positions in the Canadian subsidiary. The total estimated cost of the restructuring of $875,000, comprised entirely of employee severance costs, was accounted for as a cost of acquisition in accordance with SFAS 141. The restructuring was completed by September 30, 2003, at approximately the original cost estimate.

In December 2002, the Company announced plans to consolidate its North American manufacturing and engineering operations at its Canadian subsidiary. The Company incurred approximately $1.1 million in restructuring expenses over the course of the consolidation, originally estimated at $1.2 million. These restructuring expenses were wholly comprised of employee severance costs unrelated to the acquisition of the Canadian subsidiary and, therefore, were properly charged to operating expense in fiscal 2003. As of December 31, 2003, all benefits under the restructuring had been paid.

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

Overview

The Company’s business is the design, manufacture, sale and servicing of advanced digital print production equipment based on its patented electron beam imaging (EBI) technology. The Company’s digital printing equipment includes both: (i) “roll-fed” or “web” equipment (the CR Series and RS Series) where the paper input is on rolls, and (ii) “cut-sheet” or “sheet-fed” printers and presses (the state-of-the art Imaggia II system and the Checktronic legacy system) that use pre-cut sheets of paper or base stock. The Company’s EBI technology allows extremely high speed production at high print quality.

The Company’s business has improved in fiscal 2004 compared with fiscal 2003. Although the Company was not profitable in the third quarter of fiscal 2004 (the three months ended June 30, 2004), it was profitable for the first nine months of the fiscal year. The third quarter loss was primarily driven by lower equipment sales, down by approximately 75% from equipment sales for each of the first and second quarters of the fiscal year. The Company attributes weak third quarter equipment sales to postponed purchase decisions, due in part to the Company’s introduction of its new CR2000 digital press at the Drupa 2004 trade show in Germany in May of this year. The CR2000 runs 50% faster than the CR1300 model, with superior print quality, and will be available for sale in the latter part of fourth quarter, fiscal 2004. Although the Company’s CR1300 and CR900 are fully field upgradeable to a CR2000, with respect to both speed and print quality, the Company believes that prospects deferred their purchase decisions until the new model is available.

Critical Accounting Policies

Management’s Discussion and Analysis of Results of Operations and Financial Condition discusses the Condensed Consolidated Financial Statements of the Company, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the

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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. On an ongoing basis, management evaluates its estimates and assumptions, including those related to inventory, income taxes, revenue recognition and restructuring initiatives. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its Condensed Consolidated Financial Statements.

Inventory

The Company reduces the stated value of its inventory for obsolescence or impairment in an amount equal to the difference between the cost of the inventory and the estimated market value, based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional reductions in stated value may be required.

Income Taxes

In determining the carrying value of the Company’s net deferred tax assets, the Company must assess the likelihood of sufficient future taxable income in certain tax jurisdictions, based on estimates and assumptions, to realize the benefit of these assets. The Company has fully reserved its net deferred tax assets, totaling $2.9 million and $3.0 million as of June 30, 2004 and September 30, 2003, respectively, recognizing that the Company has incurred losses in four of the last five fiscal years, and there is no assurance that future years will be profitable. If these estimates and assumptions change in the future, the Company may record a reduction in the valuation allowance, resulting in an income tax benefit in the Company’s Consolidated Statements of Operations. Management evaluates the realizability of the deferred tax assets and assesses the valuation allowance quarterly.

Revenue Recognition

Systems are tested at the Company’s facility prior to shipment, and revenue related to orders shipped under standard performance conditions is recognized when systems are shipped. Systems shipped subject to non-standard contractual performance conditions, such as financing approval, are recognized as revenue upon completion or attainment of the specified condition. Service revenue is recognized as services are rendered. For spare parts, supplies and consumable items stored at customer sites, revenue is recognized when the customer uses the inventory. Amounts billed to customers under maintenance contracts are recorded as deferred revenue and recognized in income over the term of the maintenance agreement. Revenue on equipment manufactured by others is recorded on a gross basis. Freight revenue is recorded on a gross basis and recognized upon shipment. The related freight costs are recorded as a cost of sales.

Restructuring Initiatives

In April 2002, the Company effected a workforce reduction, eliminating approximately 40 positions in the Canadian subsidiary. In December 2002, the Company announced plans to consolidate its North American manufacturing and engineering operations at its Canadian subsidiary. As of December 31, 2003, the Company’s restructuring initiatives had been completed. See Note F to the Condensed Consolidated Financial Statements.

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Results of Operations

The following table sets forth the Company’s Statements of Operations as a percentage of net sales and should be read in connection with the Condensed Consolidated Financial Statements and notes thereto presented elsewhere in this report.

Net Sales. The Company’s net sales consist of revenues from: (i) maintenance contracts, spare parts, supplies and consumable items, and (ii) sales of printing systems and related equipment. For the three-month period ended June 30, 2004 (third quarter of fiscal 2004), net sales were $12.6 million, down 15% from $14.8 million for the three-month period ended June 30, 2003 (third quarter of fiscal 2003). For the nine months ended June 30, 2004, net sales were $41.5 million, down 7% from $44.5 million for the same period a year ago. The reduction in net sales for both the three- and nine-month periods was primarily due to lower sales of printing equipment in the third fiscal quarter.

Revenues from maintenance contracts, spare parts, supplies and consumable items were $12.0 million for the third quarter of fiscal 2004, compared with $12.2 million for the same quarter in fiscal 2003, down 2%. For the nine months ended June 30, 2004, revenues from maintenance contracts, spare parts, supplies and consumable items were $36.4 million, down 1% from $36.6 million for the year earlier period. Quarterly revenues from maintenance contracts, spare parts, supplies and consumable items for fiscal 2004 have ranged between $12.3 million and $12.0 million. The Company does not anticipate that fourth quarter revenues from maintenance contracts, spare parts, supplies and consumable will diverge significantly from previous levels.

The Company’s printing systems primarily consist of the CR Series, the RS Series, the Imaggia, the Checktronic and the Foliotronic product lines. The CR Series and RS Series products are the Company’s roll-fed duplex digital presses. The Imaggia is the Company’s cut-sheet simplex digital press. The Checktronic and Foliotronic are the Company’s legacy products. The Checktronic is now sold principally as a system upgrade or refurbished product in

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Latin America, Asia and Africa. The Foliotronic is still actively marketed to customers with folio production applications.

Revenues from the sale of printing equipment were $600,000 for the third quarter of fiscal 2004, down 77% from $2.6 million for the third quarter of fiscal 2003. For the first nine months of fiscal 2004, revenues from the sale of printing equipment were $5.1 million, down 35% from printing equipment revenues of $7.9 million for the same period in fiscal 2003. The decrease in revenues from printing equipment for the third quarter of fiscal 2004, compared with the third quarter of fiscal 2003, was due to lower sales of all products. For the nine months ended June 30, 2004, compared with the nine months ended June 30, 2003, significantly lower sales of legacy products and Imaggia, were partially offset by higher sales of roll-fed products.

Gross Margin. The Company’s gross margin percentages for the three and nine months ended June 30, 2004 were 58% and 56%, respectively, compared with 52% for the three and nine months ended June 30, 2003. The gross margins for the three- and nine-month periods ended June 30, 2004 were higher than for the year earlier periods primarily due to lower sales of printing equipment. In addition, margins for the three and nine months ended June 30, 2003 were negatively affected by costs associated with discontinuing the manufacturing operation in Minnetonka and consolidation of the manufacturing functions in Mississauga. Partially offsetting these shutdown costs, the Company sold certain inventory acquired in the December 2001 Canadian acquisition at values in excess of those originally assigned in the final purchase accounting for the acquisition. As noted above under Critical Accounting Policies — Inventory, actual future demand or market conditions for inventory may be more or less favorable than projected by management, resulting in more or less favorable margins than projected. The sale of acquired inventory also favorably affected margins in fiscal 2004, but to a much lesser extent than in fiscal 2003. The higher margins in the fiscal 2004 periods were achieved more from improved pricing and cost reduction efforts than from the sale of acquired inventory. In general, the Company anticipates that its gross margin percentage for fiscal 2004 as a whole will be higher than in fiscal 2003 but lower than for the nine months ended June 30, 2004, as the Company expects fourth quarter fiscal 2004 revenues to be derived from a higher proportion of printing equipment revenues at lower margins.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for the third quarter were $6.3 million in fiscal 2004 and fiscal 2003, and as a percentage of net sales were 50% and 42%, respectively. For the first nine months of fiscal 2004, selling, general and administrative expenses of $18.6 million were 1% lower than for the first nine months of fiscal 2003 when selling, general and administrative expenses were $18.8 million. This decrease was primarily due to the effects of the restructuring initiatives and cost control measures, partially offset by higher selling, general and administrative expenses in the second quarter of fiscal 2004 as a result of costs incurred to refinance the Company’s debt.

Research and Development Expenses. Research and development expenses for the third quarters of fiscal 2004 and fiscal 2003 were flat at $1.2 million, 10% and 8% of net sales for the quarters, respectively. For the first nine months of fiscal 2004, research and development expenses were $3.7 million, up slightly from $3.5 million for the first nine months of fiscal 2003, 9% and 8% of net sales, respectively. These expenses for the nine months ended June 30, 2004, compared with the same period in 2003, though only slightly higher were the result of project costs for product speed and print quality improvements, partially offset by cost savings from the restructuring initiatives.

Net Interest Expense. Net interest expenses for the three months ended June 30, 2004 and 2003 were $236,000 and $145,000, respectively. For the first nine months of fiscal 2004, net interest expense was $623,000, compared with $581,000 for the same period in fiscal 2003. The increase during both the three- and nine-month periods was primarily due to non-cash interest expense related to the Convertible Notes issued by the Company in February 2004, which was partially offset by lower average levels of bank debt in the fiscal 2004 periods compared with the fiscal 2003 periods.

Foreign Exchange Gains and Losses. The Company incurs realized and unrealized transactional foreign exchange gains and losses on currency conversion transactions that are reflected on the Company’s Statements of Operations. Realized and unrealized transactional exchange gains and losses reflect actual and anticipated, respectively, gains or losses recognized as the result of transactions between entities with different functional currencies. The net

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transactional exchange gain or loss for the three and nine months ended June 30, 2004 was a gain of $50,000 for the quarter and a loss of $25,000 for the first nine months of fiscal 2004. For the three and nine months ended June 30, 2003, net transactional exchange losses were $160,000 and $371,000, respectively. The Company experiences translational foreign currency gains and losses, which are reflected in the Company’s equity, with gains due to the weakening, and losses due to the strengthening, of the U.S. dollar against the currencies of the Company’s foreign subsidiaries and the resulting effect of currency translation on the valuation of the intercompany accounts and certain assets of the subsidiaries, which are denominated in U.S. dollars. The functional currency of the Company’s Canadian subsidiary is the U.S. dollar. The Company anticipates that it will continue to have transactional and translational foreign currency gains and losses from foreign operations in the future, although strategies to reduce the magnitude of the gains and losses will be reviewed and implemented whenever economical and practical.

Income Taxes. For the three and nine months ended June 30, 2004, income tax expenses of $19,000 and $170,000, respectively, were recognized based on projected profitable European operations for the fiscal year. For the first nine months of fiscal 2003, no income tax benefit was recognized on the loss before income taxes. As of June 30, 2004 and September 30, 2003 the Company had fully reserved deferred tax assets of $2.9 million and $3.0 million, respectively, arising primarily from net operating loss carryforwards. The deferred tax assets have been reserved because the Company has incurred losses in four of the last five fiscal years and there is no assurance that future years will be profitable.

Loss or Earnings per Share. For the third quarter of fiscal 2004, the Company’s basic and diluted loss per share was $0.07, compared with basic and diluted loss per share of $0.02 per share for the third quarter of fiscal 2003. The decrease in earnings between periods was primarily attributable to lower equipment sales. For the first nine months of fiscal 2004, basic and diluted earnings per share were $0.05, compared with basic and diluted loss per share of $0.20 for the first nine months of fiscal 2003. The increase in earnings per share between periods was primarily due to higher gross margins in the first nine months of fiscal 2004 compared with the first nine months of fiscal 2003, and lower expenses in fiscal 2004 because a $1.2 million charge for the North American restructuring initiative was recognized in the first quarter of fiscal 2003.

Restructuring Initiatives. On April 23, 2002, the Company effected a workforce reduction, eliminating approximately 40 positions in the Canadian subsidiary. The cost of terminating the employees in these positions, estimated at approximately $875,000, was included in the cost of the acquisition in accordance with SFAS 141 and included in accrued expenses in the consolidated balance sheets This initiative was completed by September 30, 2003 at approximately the original cost estimate. By taking this action, the Company estimated resulting annual operating expense reductions of approximately $1.3 million without affecting its ability to fulfill current or future orders.

On December 4, 2002, the Company announced plans to consolidate its North American manufacturing and engineering operations at its Canadian subsidiary. The Company expected to incur approximately $1.2 million in restructuring expenses over the course of the consolidation, but paid out the last of the benefits payable for the restructuring in the first quarter of fiscal 2004, completing the restructuring at the slightly lower cost of $1.1 million. By taking this action, the Company estimated resulting annual operating expense reductions of $1.6 million while improving the Company’s ability to provide customer service and fulfill current and future orders.

The expense reductions realized and anticipated from the restructuring actions taken are not directly accretive to results of operations, as reductions in certain expenses may be reinvested in other endeavors, such as marketing or research and development.

Market Risk

The Company has foreign subsidiaries located in Canada, the United Kingdom and France, does business in more than 60 countries and generates approximately 28% of its revenues from outside North America. The Company’s ability to sell its products in foreign markets may be affected by changes in economic, political or market conditions in the foreign markets in which it does business.

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The Company’s net investment in its foreign subsidiaries was $7.9 million and $7.2 million at June 30, 2004 and September 30, 2003, respectively, translated into U.S. dollars at the closing exchange rates. The potential loss based on end-of-period balances and prevailing exchange rates resulting from a hypothetical 10% strengthening of the U.S. dollar against foreign currencies was not material in the quarter ended June 30, 2004. The functional currency of the Canadian subsidiary is the U.S. dollar.

From time to time, the Company has entered into foreign exchange contracts as a hedge against specific foreign currency receivables. In the first nine months of fiscal 2004 and fiscal 2003, the Company did not enter into any foreign exchange contracts and does not anticipate entering into any such contracts in the near future, although strategies to reduce the magnitude of the Company’s foreign exchange gains and losses will be reviewed and implemented whenever economical and practical.

Interest Rate Risk

Substantially all of the Company’s bank debt and the associated interest expense are sensitive to changes in the level of interest rates. A hypothetical 100 basis point increase in interest rates would result in incremental interest expense for the three-month periods ended June 30, 2004 and 2003 of approximately $19,000 and $33,000, respectively, and for the nine-month periods then ended of approximately $76,000 and $103,000, respectively.

Interest on the convertible notes is determined by dividing the monetary value of the accrued interest at a fixed 7% rate by the initial conversion price of $3.20 per common share, or 16,406 shares per quarter. Interest expense on the convertible notes is recorded quarterly based on the fair value of the common shares issued measured as the average closing price of the common stock over the period multiplied times the number of common shares issued. Accordingly, interest expense on the Convertible Notes may fluctuate from quarter to quarter but is not subject to interest rate risk.

Factors Affecting Results of Operations

The Company’s revenues are subject to fluctuations, which may be material. The Company’s net sales and operating results may fluctuate from quarter to quarter because: (i) the Company’s sales cycle is relatively long, (ii) the size of orders may vary significantly, (iii) the availability of financing for customers in some countries is variable, (iv) customers may postpone or cancel orders, and (v) economic, political and market conditions in some markets change with minimal notice and affect the timing and size of orders. Because the Company’s operating expenses are based on anticipated revenue levels and a high percentage of the Company’s operating costs are relatively fixed, variations in the timing of revenue recognition will result in significant fluctuations in operating results from period to period.

The Company has two significant customers that accounted for 23% and 21% of net sales in the third quarter of fiscal 2004 and 17% and 26% of net sales in the third quarter of fiscal 2003. For the nine-month period ended June 30, 2004, net sales from these customers were 20% and 19% of net sales, and 11% and 21% of net sales for the nine months ended June 30, 2003. The Company anticipates, but cannot assure, that these customers will continue to be significant in the fourth quarter of fiscal 2004 and beyond. However, the loss of, or significant decrease in sales to, either of these customers could have a material adverse effect on the Company.

The Company is dependent on its credit facilities to fund its operations. The Company’s ability to maintain working capital depends on its compliance with the credit agreements. The Company’s credit facilities are discussed below under the heading “Liquidity and Capital Resources.”

Liquidity and Capital Resources

Working capital was $22.2 million at June 30, 2004, compared with $11.4 million at September 30, 2003. This increase in working capital was primarily the result of refinancing the Company’s debt, whereby $13.9 million of current debt as of September 30, 2003 was refinanced over three to four years. Accounts receivable were down from $11.0 million at September 30, 2003, to $9.8 million at June 30, 2004, primarily due to lower sales in the third quarter of fiscal 2004 than in the fourth quarter of fiscal 2003. Inventory increased from $17.9 million at September

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30, 2003, to $20.9 million at June 30, 2004, due to replenishment of printing equipment and other inventory. A long-term note receivable from a customer of approximately $650,000 was foreclosed during the third quarter of fiscal 2004 resulting in notes receivable from customers and deferred revenue lower at June 30, 2004 compared with September 30, 2003 Accounts payable and accrued expenses increased $2.2 million from $6.8 million at September 30, 2003, to $9.0 million at June 30, 2004. The increase was primarily due to increased inventory purchases and timing of payments.

The Company has undertaken no significant investing activities. No significant capital investment has been undertaken or is planned, and at June 30, 2004, the Company had no material commitments for capital expenditures. Short-term investments are purchased as cash is available and sold as they mature.

On February 5, 2004, the Company refinanced its debt by: (i) issuing at par $3.0 million of 7% convertible subordinated notes that were accompanied by warrants to purchase Company Common Stock, and (ii) entering into new senior credit agreements between the Company and a new senior lender and between the Company’s Canadian subsidiary and a Canadian affiliate of the new lender to the Company. (See Note E to the Condensed Consolidated Financial Statements for details.) The Company believes that its current financial arrangements and anticipated level of internally generated funds will be sufficient to fund its working capital requirements throughout fiscal 2004.

Cautionary Statement

Statements included in this Management’s Discussion and Analysis of Results of Operations and Financial Condition, the Company’s Annual Report, the Company’s Form 10-K, in other filings with the Securities and Exchange Commission, in the Company’s press releases and in oral statements made to securities market analysts and shareholders, which are not historical or current facts, are “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties that could cause the Company’s actual results to differ materially from historical earnings and those presently anticipated or projected.

The factors mentioned under the subheading “Factors Affecting Results of Operations” are among those that in some cases have affected, and in the future could affect, the Company’s actual results, and could cause the Company’s actual financial performance to differ materially from that expressed in any forward-looking statement.

Item 3. Quantitative and Qualitative Disclosure of Market Risk

The information called for by this item is provided under the caption “Market Risk” under Item 2. — Management’s Discussion and Analysis of Results of Operations and Financial Condition.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures.

     The Company’s Chairman and Chief Executive Officer, Jay A. Herman, and Vice President and Chief Financial Officer, Jeffrey S. Mathiesen, have reviewed the Company’s disclosure controls and procedures at the end of the quarter. Based upon this review, these officers believe that the Company’s disclosure controls and procedures are effective in ensuring that material information related to the Company is made known to them by others within the Company.

(b) Changes in Internal Controls.

     There were no significant changes in the Company’s internal controls over financial reporting that occurred during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 2. Recent Sales of Unregistered Securities

On April 1, 2004, the Company issued 10,068 shares of Company Common Stock in payment of $44,000 of accrued interest as of March 31, 2004 on the Company’s Convertible Notes. As of June 30, 2004, interest of $81,000 on the Convertible Notes was accrued related to the 16,406 shares issued on July 1, 2004. The Convertible Notes provide for 7% interest in the form of shares of Company Common Stock, issued on the first business day of each calendar quarter, computed based on the initial conversion price of $3.20 per share. The Convertible Notes and accompanying warrants issued on February 5, and the shares issued on April 1 and July 1, were issued in reliance on the exemption afforded by Section 4(2) of the Securities Act of 1933, as amended. No underwriting discounts or commissions were paid.

Item 5. Other Information

Effective March 25, 2004, Robert Barniskis resigned as the Company’s Chief Financial Officer to take a position with another company. Throughout the quarter ended June 30, 2004, the Company’s Chief Executive Officer and Controller performed the functions typically performed by the Chief Financial Officer. Effective July 12, 2004, Jeffrey Mathiesen joined the Company as Vice President and Chief Financial Officer.

Item 6. Exhibits and Reports on Form 8-K

(a) The following exhibits are included herein:

     31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act).

     31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act).

     32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).

     32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).

(b) The following report on Form 8-K was filed during the three months ended June 30, 2004:

     May 5, 2004 — Form 8-K: Item 12. Disclosure of Results of Operations and Financial Condition — Earnings release issued May 5, 2004 for the quarter ended March 31, 2004.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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