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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2003
DREXLER TECHNOLOGY CORPORATION
------------------------------
(Exact name of registrant as specified in its charter)
Delaware 0-6377 77-0176309
-------- ------ ----------
(State or other jurisdiction of (Commission (I.R.S. Employer
incorporation or organization) File Number) Identification No.)
1077 Independence Avenue, Mountain View, California 94043-1601
--------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(650) 969-7277
(Registrant's telephone number, including area code)
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 whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). [x] Yes [ ] No
Number of outstanding shares of common stock, $.01 par value, at February 12,
2004: 11,388,977.
1
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page Number
Item 1. Condensed Consolidated Financial Statements (Unaudited) 3
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Rate Risks 23
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Changes in Securities, Use of Proceeds, and
Issuer Purchases of Equity Securities 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURES 25
- ----------------------------------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands, except share and per share amounts)
March 31, December 31,
2003 2003
---- ----
ASSETS
Current assets:
Cash and cash equivalents .................................................... $ 5,754 $ 17,917
Short-term investments........................................................ 4,363 2,559
Accounts receivable........................................................... 1,659 1,324
Inventories .................................................................. 5,711 3,769
Deferred tax asset, net....................................................... 2,689 --
Prepaid and other current assets.............................................. 1,016 1,193
----------- -----------
Total current assets ...................................................... 21,192 26,762
----------- -----------
Property and equipment, at cost.................................................. 23,204 25,073
Less--accumulated depreciation and amortization ............................... (15,795) (15,482)
----------- -----------
Property and equipment, net................................................ 7,409 9,591
Long-term investments............................................................ 6,898 5,944
Patents and other intangibles, net............................................... 567 465
Deferred tax asset, net.......................................................... 4,397 --
----------- -----------
Total assets.......................................................... $ 40,463 $ 42,762
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................................. $ 1,085 $ 1,441
Accrued liabilities .......................................................... 1,434 1,289
Advance payments from customers............................................... 1,096 4,133
Deferred revenue.............................................................. 5 231
----------- -----------
Total current liabilities.................................................. 3,620 7,094
Long-term liabilities:
Common stock warrants and options redemption liability........................ -- 1,111
----------- -----------
Total liabilities............................................................. 3,620 8,205
----------- -----------
Stockholders' equity:
Preferred stock, $.01 par value:
Authorized--2,000,000 shares
Issued--none................................................................ -- --
Common stock, $.01 par value:
Authorized--30,000,000 shares
Issued--10,443,192 shares at March 31, 2003
and 11,368,777 shares at December 31, 2003............................ 104 114
Additional paid-in capital.................................................... 42,556 52,324
Accumulated deficit........................................................... (5,817) (17,881)
----------- -----------
Total stockholders' equity............................................ 36,843 34,557
----------- -----------
Total liabilities and stockholders' equity........................ $ 40,463 $ 42,762
=========== ===========
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands, except per share amounts)
Three Months Ended Nine Months Ended
December 31, December 31,
2002 2003 2002 2003
---- ---- ---- ----
Revenues
Product sales................................................. $ 4,490 $ 5,467 $ 20,571 $ 10,621
License and royalty revenue................................... 875 -- 875 --
--------- --------- --------- ----------
Total revenues............................................. 5,365 5,467 21,446 $ 10,621
--------- --------- --------- ----------
Cost of product sales............................................. 2,580 3,905 10,960 8,987
--------- --------- --------- ----------
Gross profit .............................................. 2,785 1,562 10,486 1,634
--------- --------- --------- ----------
Operating expenses:
Selling, general, and administrative expenses................. 1,566 1,560 4,574 4,971
Research and engineering expenses............................. 653 588 2,171 1,941
--------- --------- --------- ----------
Total operating expenses................................... 2,219 2,148 6,745 6,912
--------- --------- --------- ----------
Operating income (loss)................................. 566 (586) 3,741 (5,278)
--------- --------- --------- ----------
Other income, net................................................. 96 168 310 300
--------- --------- --------- ----------
Income (loss) before income taxes....................... 662 (418) 4,051 (4,978)
Income tax expense................................................ 265 8,446 1,620 7,086
--------- --------- --------- ----------
Net income (loss)....................................... $ 397 $ (8,864) $ 2,431 $ (12,064)
========= ========= ========= ==========
Net income (loss) per share:
Basic .................................................. $ .04 $ (.83) $ .24 $ (1.14)
========= ========= ========== ==========
Diluted ................................................ $ .04 $ (.83) $ .22 $ (1.14)
========= ========= ========== ==========
Weighted-average shares used in computing
net income (loss) per share:
Basic................................................... 10,376 10,631 10,330 10,554
Diluted................................................. 10,788 10,631 10,915 10,554
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Nine Months Ended
December 31,
2002 2003
---- ----
Cash flows from operating activities:
Net income (loss)....................................................................... $ 2,431 $ (12,064)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization........................................................ 1,355 1,490
Provision for doubtful accounts receivable........................................... 11 1
Stock-based compensation............................................................. 43 49
Deferred tax expense................................................................. 1,417 7,086
Tax benefit relating to the exercise of stock options................................ 202 --
Gain associated with decrease in fair value of
common stock warrants and options................................................. -- (118)
Changes in operating assets and liabilities:
Decrease in accounts receivable...................................................... 181 334
(Increase) decrease in inventories................................................... (1,132) 1,942
Increase in other assets............................................................. (297) (177)
Increase in accounts payable and accrued liabilities................................. 453 211
Increase (decrease) in deferred revenue.............................................. (3,735) 226
Increase (decrease) in advance payments from customers............................... (827) 3,037
--------- ----------
Net cash provided by operating activities......................................... 102 2,017
--------- ----------
Cash flows from investing activities:
Purchases of property and equipment..................................................... (1,436) (3,504)
Acquisition of patents and other intangibles............................................ (270) (66)
Purchases of investments................................................................ (9,379) (7,513)
Proceeds from maturities of investments................................................. 10,075 10,271
--------- ----------
Net cash used in investing activities............................................ (1,010) (812)
--------- ----------
Cash flows from financing activities:
Proceeds from sale of common stock through stock plans.................................. 1,682 1,410
Proceeds from sale of common stock, options, and
warrants through private placement................................................... -- 9,548
--------- ----------
Net cash provided by financing activities......................................... 1,682 10,958
--------- ----------
Net increase in cash and cash equivalents......................................... 774 12,163
Cash and cash equivalents:
Beginning of period..................................................................... 8,193 5,754
--------- ----------
End of period........................................................................... $ 8,967 $ 17,917
========= ==========
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
BASIS OF PRESENTATION. The condensed consolidated financial statements
contained herein 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 accounting
principles generally accepted in the United States of America 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.
The condensed consolidated financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to such rules and regulations, although
the Company believes the disclosures which are made are adequate to make the
information presented not misleading. Further, the condensed consolidated
financial statements reflect, in the opinion of management, all adjustments
(which include only normal recurring adjustments) necessary to present fairly
the financial position and results of operations as of and for the periods
indicated.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and the notes thereto for
the year ended March 31, 2003, included in the Company's Annual Report on Form
10-K/A.
The results of operations for the three and nine-month periods ended
December 31, 2003 are not necessarily indicative of results to be expected for
the entire fiscal year ending March 31, 2004.
FISCAL PERIOD: For purposes of presentation, the Company labels its annual
accounting period end as March 31 and its interim quarterly periods as ending on
the last day of the corresponding month. The Company, in fact, operates and
reports based on quarterly periods ending on the Friday closest to month end.
The 13-week third quarter of fiscal 2003 ended on December 27, 2002, and the
13-week third quarter of fiscal 2004 ended on January 2, 2004.
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 net realizable value. The components of
inventories are (in thousands):
March 31, December 31,
2003 2003
---- -----
Raw materials...................... $ 3,234 $ 2,276
Work-in-process.................... 220 480
Finished goods..................... 2,257 1,013
---------- ----------
$ 5,711 $ 3,769
========== ==========
RECLASSIFICATIONS. Certain items have been reclassified in the prior year
to conform to the current year presentation.
NET INCOME (LOSS) PER SHARE: Basic net income (loss) per share is computed
by dividing net income (loss) by the weighted average number of shares of common
stock outstanding. Diluted net income (loss) per share is computed by dividing
net income (loss) by the weighted average number of shares of common stock and
common stock equivalents outstanding. Common stock equivalents consist of stock
options and warrants using the treasury stock method. As the effect of common
stock equivalents would be antidilutive, stock options and warrants were
excluded from the calculation of diluted net loss per share for the three months
and nine months ended December 31, 2003. As the effect would be antidulutive,
401,200 and 32,000 stock option shares, respectively, were excluded from the
calculation of diluted net earnings per share for the three months and nine
months ended December 31, 2002, respectively. The reconciliation of the
denominators of the basic and diluted net income (loss) per share computation
for the three and
6
nine months ended December 31, 2002 and December 31, 2003 is shown in the
following table (in thousands, except per share data):
Three Months Ended Nine Months Ended
December 31, December 31,
2002 2003 2002 2003
---- ---- ---- ----
Net income (loss)................................................. $ 397 $ (8,864) $ 2,431 $ (12,064)
========= ========= ========= ==========
Basic net income (loss) per share:
Weighted average common shares outstanding.................... 10,376 10,631 10,330 10,554
--------- --------- --------- ----------
Basic net income (loss) per share................................. $ .04 $ (.83) $ .24 $ (1.14)
========= ========= ========= ==========
Diluted net income (loss) per share:
Weighted average common shares outstanding.................... 10,376 10,631 10,330 10,554
Weighted average common shares from
stock option grants........................................ 412 -- 585 --
--------- --------- --------- ----------
Weighted average common shares and common
stock equivalents outstanding.............................. 10,788 10,631 10,915 10,554
--------- --------- --------- ----------
Diluted net income (loss) per share............................... $ .04 $ (.83) $ .22 $ (1.14)
========= ========= ========= ==========
REVENUE RECOGNITION. Product sales primarily consist of card sales and
sales of read/write drives. The Company recognizes revenue from product sales
when the following criteria are met: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the fee is fixed or determinable; and (4)
collectibility is reasonably assured. The Company recognizes revenue on product
sales at the time of shipment when shipping terms are F.O.B. shipping point,
orders are placed pursuant to a pre-existing sales arrangement, and there are no
post-shipment obligations or customer acceptance criteria. Where appropriate,
provision is made at the time of shipment for estimated warranty costs and
estimated returns.
The Company's U.S. government subcontract requires delivery into a secure,
government-funded vault located on the Company's premises. Shipments are made
from the vault on a shipment schedule provided by the prime contractor, which is
subject to revision, but not cancellation, at the option of the prime
contractor. At the time the cards are delivered into the vault, title to the
cards is transferred to the government and all risks of ownership are
transferred as well. The prime contractor is invoiced, with payment due within
thirty days, and the contract does not contain any return (other than for
warranty) or cancellation provisions. Pursuant to the provisions of Staff
Accounting Bulletin No. 101 (SAB 101), revenue is recognized on delivery into
the vault as the Company has fulfilled its contractual obligations and the
earnings process is complete. If the Company does not receive a shipment
schedule, revenue is recognized upon shipment from the vault.
License revenue, which may consist of up-front license fees and long-term
royalty payments, is recognized as revenue when earned. The cost of license
revenue is not material and is included in selling, general, and administrative
expenses. License revenue in the amount of $875,000 for the fiscal 2003 third
quarter and first nine months represents the unamortized portion of a $1,000,000
nonrefundable distribution license fee received in 2000 from a licensee in Asia
that had committed to purchase a minimum number of optical memory cards for a
program in the licensee's country. The Company recorded this fee as deferred
revenue and had been amortizing it as revenue in proportion to actual card
purchases by the licensee. During the quarter ended December 31, 2002, the
Company determined that, due to the licensee's failure to meet the minimum
contractual purchase commitment, the licensee's distribution rights had become
unenforceable and that the licensee would no longer be acting as the card
supplier for that program.
The Company applies the provisions of Statement of Position (SOP) 97-2,
"Software Revenue Recognition," as amended by SOP 98-9, "Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain Transactions" to all
transactions involving the sale of software products. Revenue from the license
of the Company's software products is recognized when persuasive evidence of an
arrangement exists, the software product has been delivered, the fee is fixed or
determinable, and collectibility is probable, and, if applicable, upon
acceptance when acceptance criteria are specified or upon expiration of the
acceptance period.
7
ACCOUNTING FOR INCOME TAXES. As part of the process of preparing its
consolidated financial statements, the Company is required to estimate income
taxes in each of the jurisdictions in which it operates. This process involves
estimating the actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as deferred
revenue, for tax and accounting purposes. These differences result in deferred
tax assets and liabilities, which are included within the consolidated balance
sheets. The Company must then assess the likelihood that the deferred tax
assets, including net operating loss carryforwards, will be recovered from
future taxable income and to the extent that management believes recovery is not
likely, the Company must establish a valuation allowance. The Company's
methodology for determining the realizability of its deferred tax assets
involves estimates of future taxable income; the estimated impact of future
stock option deductions; and the expiration dates and amounts of net operating
loss carryforwards. To the extent that a valuation allowance is established or
increased in a period, the Company must include an expense within the tax
provision in the statements of operations.
Significant management judgment is required in determining the provision
for income taxes and, in particular, any valuation allowance recorded against
the Company's deferred tax assets. Applying the above methodology, due in part
to the Company's recent cumulative tax loss history and the difficulty in
forecasting the timing of future revenue which could lead to positive income on
its financial statements and taxable income, the Company recorded an income tax
expense of $8,446,000 for the third quarter of fiscal 2004 by increasing the
valuation allowance to be equal to the remaining balance of the Company's
deferred tax asset. This increase resulted in a total valuation allowance of
$13.7 million as of December 31, 2003.
STOCK-BASED COMPENSATION. The Company accounts for its stock-based
compensation plans using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. Compensation cost for stock options, if any, is
measured by the excess of the quoted market price of the Company's stock at the
date of grant over the exercise price. Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," established
accounting and disclosure requirements using a fair-value based method of
accounting for stock-based employee compensation plans. Had compensation expense
been determined consistent with SFAS No. 123, the Company's net income (loss)
and basic and diluted net income (loss) per share would have decreased to the
following pro forma amounts (dollars, in thousands, except per share amounts):
8
Three Months Ended Nine Months Ended
December 31, December 31,
2002 2003 2002 2003
---- ---- ---- ----
Net income (loss), as reported.................................... $ 397 $ (8,864) $ 2,431 $ (12,064)
======== ========== ======== ==========
Add: Stock-based employee compensation expense
included in reported net income (loss), net of related
tax effects................................................... 20 35 46 83
Deduct: total stock-based employee compensation
determined under fair value based method for all
awards, net of related tax effects............................ (396) (798) (977) (1,904)
-------- ---------- -------- ----------
Pro forma net income (loss)....................................... $ 21 $ (9,627) $ 1,500 $ (13,885)
======== ========== ======== ==========
Basic net income (loss) per common share:
As reported................................................... $ .04 $ (.83) $ .24 $ (1.14)
======== ========== ======== ==========
Pro forma..................................................... $ -- $ (.91) $ .15 $ (1.32)
======== ========== ======== ==========
Diluted net income (loss) per common share:
As reported................................................... $ .04 $ (.83) $ .22 $ (1.14)
======== ========== ======== ==========
Pro forma..................................................... $ -- $ (.91) $ .14 $ (1.32)
======== ========== ======== ==========
Shares used in computing basic and diluted pro forma
net income (loss) per share:
Basic ........................................................ 10,376 10,631 10,330 10,554
Diluted....................................................... 10,788 10,631 10,915 10,554
The Company computed the fair value of each option grant on the date of
grant using the Black-Scholes option valuation model with the following
assumptions:
Three Months Ended Nine Months Ended
December 31, December 31,
2002 2003 2002 2003
---- ---- ---- ----
Risk-free interest rate............................ 4.41% to 4.99% 3.75% 4.41% to 4.99% 2.74% to 3.75%
Average expected life of option.................... 5 to 8 years 8 years 5 to 8 years 5 to 8 years
Dividend yield..................................... 0% 0% 0% 0%
Volatility of common stock......................... 50% 50% 50% 50%
Weighted average fair value of option grants....... $10.67 $9.36 $10.67 $9.57
ISSUANCE OF STOCK, OPTIONS, AND WARRANTS. Between December 24 and 30, 2003,
the Company issued and sold 791,172 shares of common stock, options to purchase
122,292 shares of common stock, and warrants to purchase 174,057 shares of
common stock for an aggregate purchase price of $10,095,332 in a private
placement. The Company received net proceeds of $9,548,000 (net of fees and
expenses). The purchase price of the common stock was $12.76 per share, which
was a 15% discount from the five-day average price as of December 23, 2003. The
options have an exercise price of $16.51 per share and a nine-month life. The
warrants have an exercise price of $17.26 per share and a life of five years.
The options and warrants were valued at $245,000 and $984,000, respectively,
based on a Black-Scholes calculation as of December 23, 2003 and pursuant to the
provisions of EITF Issue No. 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock,"
(EITF 00-19) were recorded at those values in long-term liabilities. The balance
of the net proceeds was accounted for as additional paid-in capital. Under EITF
00-19, the Company marks-to-market the fair value of the options and warrants at
the end of each accounting period. At the end of the fiscal 2004 third quarter,
this resulted in options and warrants valued at $195,000 and $916,000,
respectively. The decrease in the valuation of the options and warrants between
December 23, 2003 and the quarter end of $118,000 was recorded as other income
in the accompanying Condensed Consolidated
9
Statement of Operations and resulted from a decrease in the Company's stock
price. On February 6, 2004, the Company and the investors entered into an
amendment to their original agreement, that resulted in the reclassification of
the option and warrant value to equity. The amendment clarified that the options
and warrants granted in the financing may be exercised at a time when a
registration statement covering the resale of the underlying share is not
effective or available and that in such instance the Company would deliver to
the investors shares of common stock whose resale is not currently registered.
On the effective date of the amendment, the option and warrant value was
reclassified to equity as additional paid-in capital. As a result of the
increase in the value of the options and warrants from the closing date to the
amendment date due to increases in the Company's stock price, the Company
recognized an expense of $211,000 which will be included in other expense in the
Condensed Consolidated Statement of Operations in the fourth quarter of fiscal
2004. The Company is subject to certain indemnity provisions included in the
stock purchase agreement entered into as part of the financing in connection
with its registration of the resale of the common stock issued and issuable in
financing. Morgan Keegan & Company, Inc. acted as the Company's exclusive
placement agent for this transaction and was granted warrants to purchase 15,284
shares of common stock.
CONCENTRATION OF CREDIT RISK. One United States customer comprised 99% of
accounts receivable at March 31, 2003 and two customers comprised 88% and 12%,
respectively, of accounts receivable at December 31, 2003.
SEGMENT REPORTING. The Company has two reportable segments: (1) optical
memory cards and (2) optical memory card drives, drive service, and related
accessories ("optical card drives"). The segments were determined based on the
information used by the chief operating decision maker. The segments reported
though are not strategic business units which offer unrelated products and
services, but utilize compatible technology and are marketed jointly.
The accounting policies used to derive reportable segment results are the
same as those described in the "Summary of Significant Accounting Policies"
included in the Company's fiscal 2003 Annual Report on Form 10-K/A. Resources
are allocated to the segments in a manner that optimizes optical memory card
revenues as determined by the chief operating decision maker. Segment revenues
are comprised of sales to external customers. Segment gross profit (loss)
includes all segment revenues less the related cost of sales. Fixed assets and
inventory are not separately reported by segment to the chief operating decision
maker. Accounts receivable, cash, deferred income taxes, prepaid expenses,
certain fixed assets, and other assets are not separately identifiable to
segments. Therefore, the amount of assets by segment is not meaningful. There
are no inter-segment sales or transfers; all of the Company's long-lived assets
are attributable to the United States.
The Company's chief operating decision maker is currently the Company's
Co-Chief Executive Officers, prior to which the Company's Chairman and Chief
Executive Officer was considered to be the chief operating decision maker. The
chief operating decision maker reviews financial information presented on a
consolidated basis that is accompanied by disaggregated information about
revenues and gross profit (loss) by segment.
The tables below present information for optical memory cards and optical
card drives for the three- and nine-month periods ended December 31, 2002 and
December 31, 2003 (in thousands):
Three Months Ended December 31, 2002 Three Months Ended December 31, 2003
------------------------------------ ------------------------------------
Optical Optical
Memory Optical Card Segment Memory Optical Card Segment
Cards Drives Total Cards Drives Total
----- ------ ----- ----- ------ -----
Revenue......................... $ 4,166 $ 280 $ 4,446 $ 2,942 $ 2,490 $ 5,432
Cost of sales................... 2,111 400 2,511 2,231 1,650 3,881
Gross profit (loss)............. 2,055 (120) 1,935 711 840 1,551
Depreciation and
amortization expense............ 272 21 293 306 57 363
10
Nine Months Ended December 31, 2002 Nine Months Ended December 31, 2003
----------------------------------- -----------------------------------
Optical Optical
Memory Optical Card Segment Memory Optical Card Segment
Cards Drives Total Cards Drives Total
----- ------ ----- ----- ------ -----
Revenue......................... $ 19,698 $ 616 $20,314 $ 7,422 $ 3,076 $10,498
Cost of sales................... 9,399 1,328 10,727 6,283 2,628 8,911
Gross profit (loss)............. 10,299 (712) 9,587 1,139 448 1,587
Depreciation and
amortization expense............ 756 60 816 870 110 980
The following is a reconciliation of segment results to amounts included in
the Company's condensed consolidated financial statements (in thousands):
Three Months Ended December 31, 2002 Three Months Ended December 31, 2003
------------------------------------ ------------------------------------
Segment Segment
Total Other Total Total Other Total
----- ----- ----- ----- ----- -----
Revenue......................... $ 4,446 $ 919 $ 5,365 $ 5,432 $ 35 $ 5,467
Cost of sales................... 2,511 69 2,580 3,881 24 3,905
Gross profit.................... 1,935 850 2,785 1,551 11 1,562
Depreciation and
amortization expense............ 293 181 474 363 182 545
Nine Months Ended December 31, 2002 Nine Months Ended December 31, 2003
----------------------------------- -----------------------------------
Segment Segment
Total Other Total Total Other Total
----- ----- ----- ----- ----- -----
Revenue......................... $ 20,314 $ 1,132 (a) $21,446 $10,498 $ 123 $10,621
Cost of sales................... 10,727 233 10,960 8,911 76 8,987
Gross profit.................... 9,587 899 10,486 1,587 47 1,634
Depreciation and
amortization expense............ 816 539 1,355 980 510 1,490
(a) Other revenue for fiscal year 2003 consists primarily of license revenue.
Other cost of sales and depreciation and amortization expense represents
corporate and other costs not directly associated with segment activities.
POTENTIAL ACQUISITION. On November 13, 2003, the Company announced that it
had entered into a Letter of Intent to acquire two card companies related
through common ownership, Challenge Card Design Plastikkarten GmbH of Rastede,
Germany (CCD), and cards & more GmbH of Ratingen, Germany (C&M), including their
sales operations in the USA and Korea. The Letter of Intent calls for
acquisition of substantially all of the assets of the two companies in exchange
for assumption of approximately $600,000 of debt and payment of approximately
$6.1 million cash, consisting of approximately $3.5 million payable at closing
and approximately $2.6 million payable in four equal annual installments. CCD
and C&M provide advanced contactless card solutions, primarily in the consumer,
event, and access control sectors of the European market. The final acquisition
agreement is expected to be signed and announced during the first calendar
quarter of 2004, after (1) a due diligence period is completed, including
preparing financial statements for CCD and C&M in accordance with accounting
principles generally accepted in the United States; (2) the terms and conditions
of the definitive agreement are negotiated; and (3) any required approvals are
obtained. CCD and C&M will continue serving their existing customer base for
card-related products. The addition of the CCD card manufacturing plant in
Rastede is expected to add significant capacity and product flexibility to the
Company's product line. The Company believes that the combined companies will
not require additional operating cash for their base businesses. Included in the
capital equipment plans discussed under "Liquidity and Capital Resources" are
amounts for optical memory card production equipment to be installed in Germany
at CCD.
LEGAL MATTERS. The Company was informed on July 10, 2003, that its
subsidiary, LaserCard Systems Corporation, had been named as one of several
defendants in a lawsuit. The plaintiff alleged in the lawsuit that he was
injured in
11
laser eye surgery performed using a VISX, Incorporated laser system that may
have incorporated a LaserCard and read/write drive as components. The plaintiff
also is suing the physicians involved for malpractice and VISX, Incorporated,
the Company, and various unnamed defendants for product liability, alleging
their products were defective. The lawsuit was filed in California Superior
Court for San Joaquin County, case number CV020962 and seeks unspecified
damages. The Company has tendered defense of the lawsuit to its product
liability insurance carrier, which has agreed to provide a defense. The Company
believes that settlement costs, if any, will be covered by its insurance policy.
Discovery is in the early stages.
RECENT ACCOUNTING PRONOUNCEMENTS. In November 2002, the Emerging Issues
Task Force (EITF) reached a consensus on Issue No. 00-21, "Revenue Arrangements
with Multiple Deliverables" (EITF 00-21). EITF 00-21 provides guidance on how to
account for arrangements that involve the delivery or performance of multiple
products, services and/or rights to use assets. The provisions of EITF 00-21
apply to revenue arrangements entered into in fiscal periods beginning after
June 15, 2003. The adoption of this standard did not have a material impact on
the Company's financial position and results of operations.
In January 2003, the FASB issued Financial Interpretation No. 46,
"Consolidation of Variable Interest Entities" (FIN 46). FIN 46 addresses
consolidation by business enterprises of variable interest entities. Under that
interpretation, certain entities known as Variable Interest Entities (VIEs) must
be consolidated by the primary beneficiary of the entity. The primary
beneficiary is generally defined as having the majority of the risks and rewards
arising from the VIE. For VIEs in which a significant (but not majority)
variable interest is held, certain disclosures are required. In December 2003,
the FASB revised FIN 46, delaying the effective dates for certain entities
created before February 1, 2003, and making other amendments to clarify
application of the guidance. For potential variable interest entities other than
any Special Purpose Entities (SPEs), the revised FIN 46 (FIN 46R) is now
required to be applied no later than the end of the first fiscal year or interim
reporting period ending after March 15, 2004. The original guidance under FIN 46
is still applicable, however, for all SPEs created prior to February 1, 2003 at
the end of the first interim or annual reporting period ending after December
15, 2003. FIN 46R may be applied prospectively with a cumulative effect
adjustment as of the date it is first applied, or by restating previously issued
financial statements with a cumulative-effect adjustment as of the beginning of
the first year restated. FIN 46R also requires certain disclosures of an
entity's relationship with variable interest entities. The Company will adopt
FIN 46R for non-SPE entities as of March 31, 2004.
In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003 and for hedging relationships designated after June 30, 2003. The
adoption of SFAS No. 149 did not have an impact on the Company's financial
position and results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS
No. 150 establishes standards for how companies classify and measure certain
financial instruments with characteristics of both liabilities and equity. It
requires companies to classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS No. 150 is effective
beginning with the third quarter of fiscal 2004. The adoption of SFAS No. 150
did not have an impact on the Company's financial position and results of
operations.
In July 2003, the EITF reached a consensus on Issue No. 03-5,
"Applicability of AICPA Statement of Position 97-2 (SOP 97-2) to Non-Software
Deliverables" (EITF 03-5). The consensus was reached that SOP 97-2 is applicable
to non-software deliverables if they are included in an arrangement that
contains software that is essential to the non-software deliverables'
functionality. This consensus is to be applied to Company's financial year
beginning after October 1, 2003. The Company has not yet evaluated the impact
that EITF 03-5 will have on its financial position and results of operations.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the condensed
consolidated financial statements and related notes included elsewhere in this
Form 10-Q Report and the consolidated financial statements and notes thereto for
the year ended March 31, 2003, included in the Company's fiscal 2003 Annual
Report on Form 10-K/A.
FORWARD-LOOKING STATEMENTS
All statements contained in this report that are not historical facts are
forward-looking statements. The forward-looking statements in this report are
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. They are not historical facts or guarantees of future
performance or events. Rather, they are based on current expectations,
estimates, beliefs, assumptions, and goals and objectives and are subject to
uncertainties that are difficult to predict. As a result, the Company's actual
results may differ materially from the statements made. Often such statements
can be identified by their use of words such as "may," "will," "intends,"
"plans," "believes," "anticipates," "visualizes," "expects," and "estimates."
Forward-looking statements made in this report include statements as to current
and potential market segments, customers, and applications for and deployment of
the products of the Company; the Company's expectation that it will complete the
acquisition of CCD-C&M during the first calendar quarter of 2004; statements as
to the business benefits to the Company as a result of the private placement
and/or the acquisitions--including increased revenue potential, card production
capacity and product flexibility; production quantities, delivery rates and
expected delivery schedule, backlog, and revenue recognition for Company
products for U.S. or foreign government programs; statements as to potential
deployment and use of the Company's products in the Department of Homeland
Security (DHS) U.S. Visitor and Immigration Status Indication Technology
(US-VISIT) program, expectations as to the establishment of new sheet-lamination
production facilities and the short-term effect on gross margins; uncertainties
associated with achieving adequate production capacity for sheet-lamination
process cards to meet order requirements and delivery schedules; anticipated
continued use of the Company's cards by the governments of the United States,
Canada, and Italy, and an anticipated order for citizen ID cards for an
undisclosed country; reliance on value-added resellers and system integrators to
generate sales, perform customer system integration, develop application
software, test products, and work with governments to implement card programs;
the Company's efforts to recruit new value-added resellers (VARs); the Company's
expectations regarding current and future orders and deliveries of cards and
read/write drives under Italian government card programs; the need for, expected
success of, and potential benefits from the Company's research and engineering
efforts, including developing new or enhanced card capabilities, software
products, production-model read-only drives, or drives with advanced security
features or lower manufacturing costs; whether introduction of new drives will
increase sales, and the effects of read/write drive prices and sales volume on
gross profits or gross margins from read/write drive sales; the Company's belief
that the read/write drive inventory at December 31, 2003 is reflected at its net
realizable value; belief that there is a market for both designs of its
read/write drives to support and expand optical card sales and that the
read/write drive inventory on hand will be ordered by customers; expectations
regarding revenues, margins, capital resources, and capital expenditures and
investments, and the Company's deferred tax asset and related valuation
allowance; anticipated reductions of federal tax cash payments due to current
Company tax benefits; statements as to expected card delivery volumes, estimates
of optical card production capacity, expected card yields therefrom, the
Company's ability to expand production capacity, and the Company's plans and
expectations regarding the growth and associated capital costs of such capacity;
estimates that revenues will be sufficient to generate cash from operating
activities over the next 12 months despite expected quarterly fluctuations;
expectations regarding market growth, product demand, and foreign business
including emerging programs or prospective applications in India, Italy, and
several other countries; and expectations as to continued, expanded, or
potential U.S. government or other governmental card programs.
These forward-looking statements are based upon the Company's assumptions
about and assessment of the future, which may or may not prove true, and involve
a number of risks and uncertainties including, but not limited to, whether there
is a market for cards for homeland security and if so whether such market will
utilize optical memory cards as opposed to other technology; customer
concentration and reliance on continued U.S. government business; risks
associated with doing business in and with foreign countries; whether the
results of the CCD-C&M due diligence will support the Company proceeding with
the acquisition and whether the Company and CCD-C&M can timely
13
negotiate and execute an acquisition agreement; lengthy sales cycles and changes
in and dependence on government policy-making; reliance on value-added resellers
and system integrators to generate sales, perform customer system integration,
develop application software, integrate optical card systems with other
technologies, test products, and work with governments to implement card
programs; risks and difficulties associated with development, manufacture, and
deployment of optical cards, drives, and systems; the possibility that optical
memory cards will not be selected for the full implementation of the US-VISIT
program or for new government programs abroad; the impact of litigation or
governmental or regulatory proceedings; the ability of the Company or its
customers to initiate and develop new programs utilizing the Company's card
products; risks and difficulties associated with development, manufacture, and
deployment of optical cards, drives, and systems; potential manufacturing
difficulties and complications associated with increasing manufacturing capacity
of cards and drives, implementing new manufacturing processes, and outsourcing
manufacturing; the Company's ability to produce and sell read/write drives in
volume; the unpredictability of customer demand for products and customer
issuance and release of corresponding orders; government rights to withhold
order releases, reduce the quantities released, and extend shipment dates;
whether the Company receives a fixed payment schedule and/or a schedule,
notification, or plan for shipments out of the government-funded vault located
on the Company's premises, enabling the Company to recognize revenues on cards
delivered to the vault instead of when cards later are shipped from the vault;
whether the Company conducts its planned production capacity expansion and
acquisition of CCD-C&M, the impact of technological advances, general economic
trends, and competitive products; and other risks detailed from time to time in
the Company's SEC filings, including its Annual Report on Form 10-K/A for the
fiscal year ended March 31, 2003. These forward-looking statements speak only as
to the date of this report, and, except as required by law, the Company
undertakes no obligation to publicly release updates or revisions to these
statements whether as a result of new information, future events, or otherwise.
CRITICAL ACCOUNTING POLICIES
REVENUE RECOGNITION. Product sales primarily consist of card sales and
sales of read/write drives. The Company recognizes revenue from product sales
when the following criteria are met: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the fee is fixed or determinable; and (4)
collectibility is reasonably assured. The Company recognizes revenue on product
sales at the time of shipment when shipping terms are F.O.B. shipping point,
orders are placed pursuant to a pre-existing sales arrangement, and there are no
post-shipment obligations or customer acceptance criteria. Where appropriate,
provision is made at the time of shipment for estimated warranty costs and
estimated returns.
The Company's U.S. government subcontract requires delivery into a secure,
government-funded vault located on the Company's premises. Shipments are made
from the vault on a shipment schedule provided by the prime contractor, which is
subject to revision, but not cancellation, at the option of the prime
contractor. At the time the cards are delivered into the vault, title to the
cards is transferred to the government and all risks of ownership are
transferred as well. The prime contractor is invoiced, with payment due within
thirty days, and the contract does not contain any return (other than for
warranty) or cancellation provisions. Pursuant to the provisions of SAB 101,
revenue is recognized on delivery into the vault as the Company has fulfilled
its contractual obligations and the earnings process is complete. If the Company
does not receive a shipment schedule for shipment of cards from the vault,
revenue is recognized upon shipment from the vault.
License revenue, which may consist of up-front license fees and long-term
royalty payments, is recognized as revenue when earned. The cost of license
revenue is not material and is included in selling, general, and administrative
expenses.
The Company applies the provisions of Statement of Position (SOP) 97-2,
"Software Revenue Recognition," as amended by SOP 98-9, "Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain Transactions" to all
transactions involving the sale of software products. Revenue from the license
of the Company's software products is recognized when persuasive evidence of an
arrangement exists, the software product has been delivered, the fee is fixed or
determinable, and collectibility is probable, and, if applicable, upon
acceptance when acceptance criteria are specified or upon expiration of the
acceptance period.
ACCOUNTING FOR INCOME TAXES. As part of the process of preparing its
consolidated financial statements, the Company is required to estimate income
taxes in each of the jurisdictions in which it operates. This process involves
14
estimating the actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as deferred
revenue, for tax and accounting purposes. These differences result in deferred
tax assets and liabilities, which are included within the consolidated balance
sheets. The Company must then assess the likelihood that the deferred tax assets
will be recovered from future taxable income and to the extent that management
believes recovery is not likely, the Company must establish a valuation
allowance. To the extent that a valuation allowance is established or increased
in a period, the Company must include an expense within the tax provision in the
statements of operations.
Significant management judgment is required in determining the provision
for income taxes and, in particular, any valuation allowance recorded against
the Company's deferred tax assets. Due in part to the Company's recent
cumulative tax loss history, income statement loss history over the past four
quarters, and the difficulty in forecasting the timing of future revenue which
could lead to positive income on its financial statements and taxable income,
the Company determined it was necessary to increase the valuation allowance
under SFAS No. 109. As a result, the Company has recorded a valuation allowance
of $13.7 million as of December 31, 2003, including $8,446,000 in the third
quarter of fiscal 2004, due to uncertainties related to its ability to utilize
its deferred tax assets before they expire.
The Company's methodology for determining the realizability of its deferred
tax assets involves estimates of future taxable income; the estimated impact of
future stock option deductions; and the expiration dates and amounts of net
operating loss carryforwards. These estimates are based on near-term projections
and assumptions which management believes to be reasonable. In concluding that a
valuation allowance was required as of December 31, 2003, the Company considered
both the positive and negative evidence regarding its ability to generate
sufficient future taxable income to realize its deferred tax assets. Positive
evidence included having achieved profitability for financial reporting purposes
from fiscal 1999 through fiscal year 2003. Other positive evidence included (1)
the level of sales and business experienced under the contract with the Canadian
government's Permanent Resident Card program; (2) prospects in Italy and an
unnamed eastern hemisphere country for national identification card programs;
(3) the heightened interest in border security initiatives following the events
of September 11, 2001;, and (4) expected future orders. Negative evidence
included (1) the Company's reliance on a limited number of customers for a
substantial portion of its business; (2) the uncertainty in timing of
anticipated orders from customers; (3) the impact of future stock option
deductions on taxable income; and (4) recent experience of net operating loss
carryforwards expiring unused; (5) the loss for the fourth quarter of fiscal
2003 and the first, second, and third quarters of fiscal 2004; and (6) the
prospect of three years' cumulative tax net operating losses. In weighing the
positive and negative evidence above, the Company considered the "more likely
than not" criteria pursuant to SFAS No. 109 as well as the risk factors related
to its future business described under the subheadings: "Dependence on VARs and
on a Limited Number of Customers," "Lengthy Sales Cycles," "Technological
Change," and "Competition" as noted in the section entitled "Factors That May
Affect Future Operating Results" in the Company's Report on Form 10-K/A for the
fiscal year ended March 31, 2003.
In the event that actual results differ from these estimates or that these
estimates are adjusted in future periods, the Company may need to adjust the
amount of the valuation allowance based on future determinations of whether it
is more likely than not that some or all of its deferred tax assets will be
realized. A decrease in the valuation allowance would be recorded as an income
tax benefit or a reduction of income tax expense or a credit to stockholders'
equity. The Company's net operating losses available to reduce future taxable
income expire on various dates from fiscal 2005 through fiscal 2024.
INVENTORIES. The Company values its inventory at the lower of the actual
cost to purchase and/or manufacture the inventory or the current estimated
market value of the inventory. Management regularly reviews inventory quantities
on hand and records a provision for excess and obsolete inventory based
primarily on forecasts of product demand. Demand for read/write drives can
fluctuate significantly. In order to obtain favorable pricing, purchases of
certain read/write drive parts are made in quantities that exceed the historical
annual sales rate of drives. The Company purchases read/write drive parts for
its anticipated read/write drive demand and takes into consideration the
order-to-delivery lead times of vendors and the economic purchase order quantity
for such parts.
Management's analysis of the carrying value of card and read/write drive
inventory is performed on a quarterly basis. With respect to inventory carrying
values, the Company follows the principles articulated in Accounting Research
Bulletin 43, Chapter 4, "Inventory Pricing," paragraphs 5 through 7 and 10 and
other authoritative guidance
15
(SAB 100) as it relates to determining the appropriate cost basis of inventory
and determining whether firm, noncancelable purchase commitments should be
accrued as a loss if forecasted demand is not sufficient to utilize all such
committed inventory purchases. As part of the Company's quarterly
excess/obsolete analysis, management also determines whether lower of cost or
market adjustments (i.e., where selling prices less certain costs are not
sufficient to recover inventory carrying values) are warranted; during the first
nine months of fiscal 2004, the Company has not recorded any significant lower
of cost or market adjustments. In those instances where the Company has recorded
charges for excess and obsolete inventory, management ensures that such new cost
basis is reflected in the statement of operations if that inventory is
subsequently sold. The Company's inventory reserves are based upon the lower of
cost or market for slow moving or obsolete items. As a result, the Company
believes a 10% increase or decrease of sales would not have a material impact on
such reserves.
RESULTS OF OPERATIONS--FISCAL 2004 THIRD QUARTER AND FIRST NINE MONTHS
COMPARED WITH FISCAL 2003 THIRD QUARTER AND FIRST NINE MONTHS
Overview
Drexler Technology Corporation is located in Mountain View, California. The
Company makes and markets high-security, durable plastic optical memory cards
and associated computerized read/write drives primarily for use in digital
governance programs by the US and foreign governments. The counterfeit- and
tamper-resistant cards are consumable products because they typically are
replaced when the rights documented by the cards expire. The largest user of
LaserCard products is the U.S. government, which purchases the Company's
products through a value-added reseller (VAR), Information Spectrum, Inc. (ISI),
a unit of Anteon International Corporation. ISI is the government contractor for
LaserCard product sales to the U.S. Department of Homeland Security (DHS), U.S.
Department of State (DOS), U.S. Department of Defense (DOD), and the government
of Canada. Under government contracts with ISI, the DHS purchases U.S. Permanent
Resident Cards (Green Cards) and DOS "Laser Visa" Border Crossing Cards (BCCs);
the DOD purchases Automated Manifest System cards; and the Canadian government
purchases Permanent Resident Cards. Encompassing all of these programs, the
Company's product sales to ISI represented 89% of total revenues for the fiscal
2004 third quarter ended December 31, 2003, 81% of total revenues for the fiscal
2003 third quarter ended December 31, 2002, 86% of total revenues for the fiscal
2004 first nine months, and 94% of total revenues for the fiscal 2003 first nine
months.
Revenues for the major government programs are shown below as a percentage
of total Company revenues:
Three Months Ended Nine Months Ended
December 31, December 31,
2002 2003 2002 2003
---- ---- ---- ----
United States Green Cards and Laser Visa BCCs............ 65% 60% 87% 53%
Canadian Permanent Resident Cards........................ 16% 22% 7% 29%
Italian Carta d'Identica Elettronica (CIE) Cards......... 1% 10% 1% 6%
For the government of Italy, the Company has received orders for CIE cards
(Carta d'Identica Elettronica) and anticipates orders for a new program for the
PSE cards (Permesso di Soggiorno Elettronico). The Company currently has a
backlog in the amount of $5.7 million for CIE cards scheduled for delivery from
January 2004 through May 2004 for Phase 2 of this program. According to program
descriptions released by the Italian government, CIE card orders could
potentially reach 8 to 10 million cards per year if Phase 3 is fully
implemented.
Optical memory card revenues for the quarter ended December 31, 2003 mainly
included sales of Green Cards manufactured for the U.S. government, and sales of
Permanent Resident Cards made for the Canadian government, and CIE cards for the
Italian government for its planned national ID card program.
Production of U.S. Laser Visa Border Crossing Cards (BCCs) and Permanent
Resident Cards (Green Cards) for the U.S. Department of Homeland Security (DHS)
was delayed at the beginning of fiscal 2004 while new artwork for the cards was
being designed by DHS. The artwork change for Laser Visa BCCs was completed in
July 2003, and on July 14, 2003, the Company announced receipt of an optical
memory card order valued at approximately $2 million for
16
Laser Visa BCCs. The new order called for card production to start immediately
and to be completed within four months. The artwork change for Green Cards
resulted in an order announced by the Company on December 19, 2003, valued at
approximately $2.6 million, calling for deliveries through May 2004.
Optical memory card revenues during fiscal year 2003 included about $21.2
million on sales of Green Cards and Laser Visa BCCs. The Company anticipates
that fiscal 2004 optical memory card revenues for these two programs will not
exceed $4.8 million to $5.6 million. The U.S. Government is currently
personalizing cards at an $8.9 million annualized run rate. The value is based
upon the Company's selling price of cards to ISI. The Company believes that
annual revenues will approximate the U.S. Government personalization rate over
time subject to fluctuations in the level of inventory deemed appropriate by the
U.S. Government. Optical memory card revenues through the first nine months of
fiscal 2004 for these two programs were approximately $3.2 million.
The Company has established sheet-lamination production facilities to make
Canadian Permanent Resident Cards, Italian National ID cards, and cards for
other potential programs. This process is currently more labor intensive than
its roll-lamination process but allows the use of high security offset printing
and other special features, resulting in a premium card. To date, gross margins
on the Canadian sheet-process cards have been less than 40%. The Company
believes that over time it will be able to improve margins on cards made by the
sheet-lamination process through automation and yield improvements. In addition,
roll-lamination card gross margins have been hampered by low sales and
production volume.
Potential applications for LaserCard optical memory card digital governance
programs include identification cards in several countries, motor vehicle
registration cards in India, and the expansion of current U.S. government ID
card programs due to the perceived increasing need for enhanced U.S. border
security. U.S. government ID programs include the U.S. Visitor and Immigration
Status Indication Technology (US-VISIT) program. During the fiscal 2004 third
quarter, the Company received an order for and delivered 1,000 optical memory
card read/write drives and biometric verification systems software for a
Department of Homeland Security program. Revenue was recognized for the 900
systems accepted during the quarter. These 1,000 drives and software systems
will be deployed by the DHS to air, land, and sea ports of entry around the
United States, enabling the DHS to read the encoded data on more than 13 million
Permanent Resident Cards and Border Crossing Cards previously manufactured by
the Company and issued by the U.S. government since 1998. Since governmental
card programs typically rely on government policy-making, which in turn is
subject to technical requirements, budget approvals, and political
considerations, there is no assurance that the US-VISIT program will be
implemented as expected or that the Company will be chosen as a vendor for the
full implementation of this program.
In addition to using its own marketing staff, the Company utilizes VAR
companies and card distribution licensees for the development of markets and
applications for LaserCard products. Product sales to VARs and licensees consist
primarily of the Company's optical memory cards and optical card read/write
drives. The Company also offers for sale, its customized software applications
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/licensees may add application software, personal computers, and other
peripherals, and then resell these products integrated into data systems. The
Company is continuing its efforts to recruit new VARs and eliminate
nonproductive VARs.
The Company's current five-year U.S. government subcontract for Green Cards
and Laser Visa BCCs was announced in June 2000. This subcontract was received by
the Company through LaserCard VAR ISI, that is a U.S. government prime
contractor, under a competitively bid, government procurement contract. The
subcontract provides for an initial one-year contract period and four additional
one-year contract options. This contract was most recently extended in June 2003
for the one-year period through May 25, 2004. This subcontract has one remaining
extension, and there is no assurance that a follow-on contract will be issued by
the DHS.
In 2002, the Company was awarded a subcontract for production of Canada's
new Permanent Resident Cards. Orders to date under this subcontract now total $7
million, including a $1.4 million backlog as of December 31, 2003. The
subcontract provides for a minimum purchase of cards valued at approximately
$10.3 million over the five-year term of the subcontract. Also in 2002, the
Canadian government purchased 220 read/write drives from the Company to read and
verify Canadian Permanent Resident Cards and to authenticate U.S. Green Cards
and Laser Visa BCCs.
17
On August 13, 2003, the Company announced that an undisclosed country has
selected the Company's optical memory cards for secure personal identification,
and orders for optical memory cards are anticipated. The Company sold 120 drives
for this program, most of which were shipped in the fiscal 2004 second quarter,
for installation of the infrastructure required for card issuance.
As more fully described below, in December 2003, the Company raised
approximately $9.5 million in an equity private placement. The Company sold
791,172 shares of common stock, nine-month options to purchase 122,292 shares of
common stock at $16.51, and five-year warrants to purchase 174,057 shares of
common stock at $17.26.
Kodak, the Company's sole-source supplier of raw material for its optical
memory card media, announced that it is reducing its emphasis on emulsion based
films. If Kodak were to discontinue manufacturing the raw material from which
the Company's optical memory card media is made, the Company would order the
maximum amount of final-run stock for use while endeavoring to establish an
alternate supplier for such raw material, although the purchase price could
increase from a new supplier. The Company has purchased a long-term supply of
the raw material to make mastering loops and believes it has on hand an adequate
supply of media raw material on hand and on order to meet anticipated demand.
The Company plans to invest approximately $11 million in the acquisition of
CCD and C&M, and additional capital equipment and leasehold improvement
expenditures over the next six to nine months as more fully discussed under
Liquidity. In this regard, the Company has entered into ten-year leases for two
buildings in Mountain View, California, totaling 69,000 square feet, with
average annual lease payments totaling $1,106,000 combined. One lease is a
renegotiation of the lease for an existing leased building and the other lease,
signed on January 29, 2004, is for additional space. The Company anticipates it
will occupy the newly leased building by the end of May 2004. The Company will
move out of a smaller building at that time. This has resulted in the
acceleration of certain leasehold improvement amortization costs for the period
from November 2003 through May 2004, resulting in recognition of $280,000 of
additional leasehold amortization expense through that period.
Revenues
The Company's total revenues for the fiscal 2004 third quarter ended
December 31, 2003 consisted of sales of optical memory cards, optical card
read/write drives, drive accessories, maintenance, peripherals, and other
miscellaneous items. The Company's total revenues were $5,467,000 for the fiscal
2004 third quarter and $10,621,000 for the fiscal 2004 first nine months,
compared with $5,365,000 for the fiscal 2003 third quarter and $21,446,000 for
the fiscal 2003 first nine months. The increase in revenues for the three months
ended December 31, 2003 was due to the sale of read/write drives to the
Department of Homeland Security, discussed below, partially offset by the
decrease in license revenues and the decrease in optical memory card revenues.
The decrease in total revenues for the nine-month periods was due to
significantly lower sales of optical memory cards for the U.S. government's
Laser Visa BCC and Green Card programs, as described above.
Revenue on optical memory cards totaled $2,942,000 for the fiscal 2004
third quarter compared with $4,166,000 for the fiscal 2003 third quarter.
Revenue on optical memory cards totaled $7,422,000 for the first nine months of
fiscal 2004 compared with $19,698,000 for the first nine months of fiscal 2003.
These decreases were due to lower unit volume of card sales.
During the fiscal 2004 third quarter, the Company received an order for and
delivered 1,000 optical memory card read/write drives and biometric verification
systems software for a Department of Homeland Security program. Revenue was
recognized for the 900 systems accepted during the fiscal 2004 third quarter.
One hundred systems were delivered near the end of the third quarter and will be
recorded as revenue in the quarter ending March 31, 2004 when acceptance
occurred. Revenue on read/write drives, drive service, and related accessories
totaled $2,490,000, inclusive of $473,000 for biometric systems software, for
the fiscal 2004 third quarter compared with $280,000 for the fiscal 2003 third
quarter. Revenue on read/write drives, drive service, and related accessories
totaled $3,076,000, inclusive of $473,000 for biometric systems software, for
the fiscal 2004 first nine months compared with $616,000 for the fiscal 2003
first nine months. These increases were due to an increase in unit sales volume
for read/write drives and higher selling prices due to the inclusion of
biometric systems software.
18
Backlog
As of December 31, 2003, the backlog for LaserCard optical memory cards
totaled $9.6 million, with approximately $5.6 million in firm card orders
scheduled for delivery this fiscal year. Order backlog as of December 31, 2003
includes orders for the following programs: Green Cards for the U.S. Department
of Homeland Security, Italian government national ID cards (CIE cards), and
Canadian government Permanent Resident Cards. Backlog is subject to fluctuation
due to having few customers and the timing of orders. As of December 31, 2003,
the backlog for LaserCard optical memory cards totaled $6.3 million. The Company
has no backlog for read/write drives.
Gross Margin
Gross margin on overall product sales was 29% for the fiscal 2004 third
quarter and 15% for the fiscal 2004 first nine months compared with 43% for the
fiscal 2003 third quarter and 47% for the fiscal 2003 first nine months. The
overall gross profit declined $1,223,000, to $1,562,000 for the third quarter of
fiscal 2004 from $2,785,000 for the third quarter of fiscal 2003. This decline
was due primarily to lower volume of optical memory card sales and the shift in
revenue mix for the quarter from optical memory cards to read/write drives. For
the fiscal 2004 first nine months, overall gross profit declined $8,852,000 to
$1,634,000 from $10,486,000 for the fiscal 2003 first nine months, due
principally to the decline in optical memory card revenue.
OPTICAL MEMORY CARDS. Prior to fiscal 2004, optical memory card gross
margins have approximated 50%. Optical memory card gross profit and margins can
vary significantly based on average selling price, sales and production volume,
mix of card types, production efficiency and yields, and changes in fixed costs.
The gross margin on optical memory cards declined to 24% for the third quarter
of fiscal 2004 and 15% for the first nine months of fiscal 2004 as compared to
49% for the third quarter of fiscal 2003 and 52% for the first nine months of
fiscal 2003. The declines in both periods were primarily due to low revenues and
production volume and the corresponding underabsorption of fixed costs and the
introduction of cards made by a sheet-lamination process that currently have
lower margins than cards made by the roll-lamination process.
READ/WRITE DRIVES. For the fiscal 2004 third quarter, the Company had a
gross profit on read/write drive sales, including biometric systems software, of
approximately $840,000 and a gross margin of 34% compared with a negative gross
profit on read/write drive sales of approximately $120,000 for the fiscal 2003
third quarter. For the fiscal 2004 first nine months, gross profit on read/write
drive sales, including biometric systems software, was approximately $448,000
and a gross margin of l5% compared with a negative gross profit of approximately
$712,000 for the fiscal 2003 first nine months. The inclusion of biometric
systems software on a per-drive basis increased read/write drive gross profits
by $473,000 in both the third quarter and first nine months of fiscal 2004.
During the fiscal 2003 first nine months, the Company wrote off read/write drive
inventory totaling approximately $300,000. Read/write drive gross profit and
margins can vary significantly based upon sales and production volume, changes
in fixed costs, and the inclusion of optional features and software licenses on
a per-drive basis. Prior to the third quarter of fiscal 2004, read/write drive
gross profits have been negative, inclusive of fixed overhead costs, due to low
sales volume. The Company anticipates that quarterly negative gross profits will
recur in the future unless sales volume is sufficient to cover fixed costs.
Also, unless per drive systems software licenses are included in future orders,
the Company believes that margins will be below 10% when sales volume is
sufficient to result in positive gross profit.
Income and Expenses
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES (SG&A). SG&A expenses were
$1,560,000 for the fiscal 2004 third quarter compared with $1,566,000 for the
fiscal 2003 third quarter. For the fiscal 2004 first nine months, SG&A expenses
were $4,971,000 compared with $4,574,000 for the fiscal 2003 first nine months.
The increase of $397,000 for the fiscal 2004 first nine months compared with the
fiscal 2003 first nine months was primarily due to a $245,000 increase in
insurance premiums and an increase of $194,000 in legal and accounting fees. The
Company believes that SG&A expenses for the remainder of fiscal 2004 will be
higher than fiscal 2003 levels, mainly due to increases in accounting and legal
fees primarily related to due diligence for the potential acquisition of two
companies in Germany.
RESEARCH AND ENGINEERING EXPENSES (R&E). The Company is continuing its
efforts to develop new optical memory card features and structures, including
various sheet-lamination card structures, the insertion of contactless
19
chips with radio frequency (RF) capability, Optichip(TM), OVD (optically
variable device) products and associated media development; enhanced optical
memory card read/write drives and read-only drives (readers); and new software
products in an effort to provide new products that can stimulate optical memory
card sales growth. For example, the Company recently has developed a prototype
of a LaserCard handheld reader. The Company anticipates that these ongoing
research and engineering efforts will result in new or enhanced card
capabilities, production-model read-only drives, or drives with advanced
security features and lower manufacturing costs; however, there is no assurance
that such product development efforts will be successful. These features are
important for the Company's existing and future optical memory card markets.
Total R&E expenses were $588,000 for the third quarter of fiscal 2004 compared
with $653,000 for the third quarter of fiscal 2003. For the first nine months of
fiscal 2004, R&E expenses were $1,941,000 compared with $2,171,000 for the first
nine months of fiscal 2003. The $230,000 decrease for the fiscal 2004 first nine
months is mainly due to the completion of the design for a new read/write drive
model and a $98,000 reduction related to the completion last year of the
amortization of design technology transfer costs. Increases in R&E expenses are
anticipated for development of production-model read-only drives and optical
memory card media development.
OTHER INCOME AND EXPENSE. Total net other income for the third quarter of
fiscal 2004 was $168,000 consisting of $50,000 in interest income and a $118,000
gain recorded to mark-to-market the fair value of the common stock options and
warrants issued in December 2003, compared with $96,000 of interest income for
the third quarter of fiscal 2003. Other income for the first nine months of
fiscal 2004 was $300,000 consisting of the $118,000 gain on these options and
warrants, and $178,000 of interest income compared with $310,000 of interest
income for the first nine months of fiscal 2003. The decrease in interest income
was primarily due to decline in interest rates.
INCOME TAXES. The Company recorded an income tax expense of $8,446,000 for
the third quarter due to increasing the valuation allowance to be equal to the
remaining balance of the Company's deferred tax asset. This income tax expense
is not a cash item and does not mean that the Company owes income taxes, but
rather that it no longer can demonstrate that in the future it will likely be
able to utilize the tax benefits of previously generated net operating losses.
The methodology for determining the realizability of its deferred tax asset is a
critical accounting policy as described under the heading "Critical Accounting
Policies" and in the Company's SEC filings. In summary, this methodology
considers positive and negative evidence regarding the Company's ability to
generate sufficient future taxable income to realize its deferred tax assets.
Due in part to the Company's recent cumulative tax loss history, income
statement loss history over the past four quarters, and the difficulty in
forecasting the timing of future revenue which could lead to positive income on
its financial statements and taxable income, the Company determined it was
necessary to increase the valuation allowance under SFAS No. 109. If the Company
has taxable income in the future, any unexpired net operating loss income tax
carry-forward amounts will be utilized to reduce otherwise required income tax
payments, and future tax expense, up to the full amount of the deferred tax
asset which is currently $13.7 million. For the nine-month period ended December
31,2004, the Company recorded an income tax expense of $7,086,000. The Company
recorded income tax expense of $265,000 for the three months ended December 31,
2002 and $1,620,000 for the nine months ended December 31, 2002, both at an
effective tax rate of 40%.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2003, the Company had cash, cash equivalents, and
short-term investments of $20,476,000 and a current ratio of 3.8 to 1. The
Company also had $5,944,000 in long-term investments with original maturities
from 1 year to 2 1/2 years. Cash, short-term investments, and long-term
investments were $26,420,000 at December 31, 2003 and $17,015,000 at March 31,
2003.
Net cash provided by operating activities was $2,017,000 for the first nine
months of fiscal 2004 compared with $102,000 for the first nine months of fiscal
2003. The primary components of the increase in operating cash flow were
$3,864,000 from the increase in advance payments from customers during the first
nine months of fiscal 2004 compared with the decrease for the first nine months
of fiscal 2003; $3,074,000 from the decrease in inventories for the first nine
months of fiscal 2004 compared with the decrease for the first nine months of
fiscal 2003; and $3,961,000 from the increase in deferred revenue for the first
nine months of fiscal 2004 compared with the decrease for the first nine months
of fiscal 2003, all of which were partially offset by the $8,852,000 decrease in
gross profit. At December 31, 2003, the Company had received advance payments
from customers in the amount of $4.1 million for partial payment for the optical
memory card orders described in the Backlog section above. Cash also increased
during the
20
quarter due to partial payment received for the 1,000 read/write drives shipped
during the quarter, which accounted for most of the inventory decrease for the
first nine-months of fiscal 2004. Cash will fluctuate based upon the timing of
advance payments from customers relative to shipments and the timing of
inventory purchases and subsequent manufacture and sale of products.
The Company believes that the estimated level of revenues over the next 12
months will be sufficient to generate cash from operating activities over the
same period. However, quarterly fluctuations are expected. Operating cash flow
could be negatively impacted to a significant degree if either of the Company's
largest U.S. government programs were to be further delayed, canceled, or not
extended, if the Italian CIE card program does not grow as planned internally,
and if these programs are not replaced by other card orders or other sources of
income, or if increases in product revenues or licenses do not keep pace with
increased marketing and R&E expenditures.
The Company has not established a line of credit and has no current plans
to do so. The Company may negotiate a line of credit if and when it becomes
appropriate, although no assurance can be made that such financing would be
available on favorable terms or at all, if needed.
As a result of the $8,964,000 net loss recorded for the fiscal 2004 third
quarter, the Company's accumulated deficit increased to $17,881,000.
Stockholders' equity decreased to $34,557,000 as a result of the net loss
recorded that was offset by $9,872,000 in additions to equity due to the sale of
stock through stock plans during the fiscal 2004 third quarter and the proceeds
of a private placement of common stock, as described below.
Net cash used in investing activities was $812,000 for the first nine
months of fiscal 2004 compared with $1,010,000 used in investing activities for
the first nine months of fiscal 2003. These amounts include purchases and
maturities of liquid investments, purchases of property and equipment of
$3,504,000 for the first nine months of fiscal 2004, and $1,436,000 for the
first nine months of fiscal 2003, and increases in patents and other intangibles
of $66,000 for the first nine months of fiscal 2004 and $270,000 for the first
nine months of fiscal 2003.
The Company considers all highly liquid investments, consisting primarily
of commercial paper, taxable notes, and U.S. government bonds, with original or
remaining maturities of three months or less at the date of purchase, to be cash
equivalents. All investments with original or remaining maturities of more than
three months but not more than one year at the date of purchase, are classified
as short-term. Investments with original or remaining maturities of more than
one year at the date of purchase are classified as long-term. The Company
determines the length of its investments after considering its cash requirements
and yields available for the type of investment considered by the Company.
Management also determines the appropriate classification of debt and equity
securities at the time of purchase and reevaluates the classification of
investments as of each balance sheet date. As of December 31, 2003, the Company
had $8,503,000 classified as short-term and long-term investments, compared with
$11,261,000 at March 31, 2003. All marketable securities were accounted for as
held-to-maturity.
The Company made capital equipment and leasehold improvement purchases of
approximately $3.5 million during the first nine months of fiscal 2004 compared
with approximately $1.4 million during the first nine months of fiscal 2003. The
Company's current card capacity, assuming optimal card type mix, is estimated at
approximately 13 million cards per year. The Company plans to purchase
additional production equipment in a series of steps when deemed appropriate by
the Company. The Company is also increasing production capacity for cards with
new structures used by the Canadian and Italian programs. In addition to
investment used for expansion, the Company expects to make additional capital
expenditures for cost savings, quality improvements, and other purposes. The
Company plans to use cash on hand and cash generated from operations to fund
capital expenditures of approximately $8 million during the next six to nine
months for equipment and leasehold improvements for card production, read/write
drive tooling and assembly, and general support items. Approximately $5 million
of this proposed expenditure is slated for new card manufacturing equipment.
On November 13, 2003, the Company announced that it had entered into a
Letter of Intent to acquire two German card companies related through common
control, CCD and C&M, including their sales operations in the USA and Korea. The
Letter of Intent calls for acquisition of substantially all of the assets in
exchange for assumption of approximately $600,000 of debt and payment of
approximately $6.1 million cash, consisting of approximately $3.5 million
payable at closing, and approximately $2.6 million payable in four equal annual
installments. CCD and C&M
21
provide advanced contactless card solutions, primarily in the consumer, event,
and access control sectors of the European market. The final acquisition
agreement is expected to be signed and announced during the first calendar
quarter of 2004, after (1) a due diligence period is completed, including
preparing financial statements for CCD and C&M in accordance with accounting
principles generally accepted in the United States; (2) the terms and conditions
of the definitive agreement are negotiated; and (3) any required approvals are
obtained. CCD and C&M will continue serving their existing customer base for
card-related products. The addition of the CCD card manufacturing plant in
Rastede is expected to add significant capacity and product flexibility to the
Company's product line. The Company believes that the combined companies will
not require additional operating cash for their base businesses. Included in the
capital equipment plans outlined above are amounts for optical memory card
production equipment to be installed in Germany at CCD.
Net cash provided by financing activities was $10,958,000 for the first
nine months of fiscal 2004 compared with net cash provided by financing
activities of $1,682,000 for the first nine months of fiscal 2003. Financing
activities consisted of proceeds from an equity private placement described
below and proceeds on sales of common stock through the Company's stock-option
and stock-purchase plans of $1,410,000 in the first nine months of fiscal 2004
and $1,682,000 in the first nine months of fiscal 2003.
Between December 24 and 30, 2003, the Company received net proceeds of
$9,548,000 (net of fees and expenses) from the issuance and sale of 791,172
shares of common stock, options to purchase 122,292 shares of common stock, and
warrants to purchase 174,057 shares of common stock for an aggregate purchase
price of $10,095,332 in a private placement. The purchase price of the common
stock was $12.76 per share, which was a 15% discount from the five-day average
price as of December 23, 2003. The options have an exercise price of $16.51 per
share and a nine-month life. The warrants have an exercise price of $17.26 per
share and a life of five years. The options and warrants were valued at $245,000
and $984,000, respectively, based on a Black-Scholes calculation as of December
23, 2003 and pursuant to the provisions of EITF Issue No. 00-19, "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock," (EITF 00-19) were recorded at those values in long-term
liabilities. The balance of the net proceeds was accounted for as additional
paid in capital. Under EITF 00-19, the Company marks-to-market the fair value of
the options and warrants at the end of each accounting period. At the end of the
fiscal 2004 third quarter, this resulted in options and warrants valued at
$195,000 and $916,000, respectively. The decrease in valuation of the options
and warrants between December 23, 2003 and the quarter end of $118,000 was
recorded as other income in the accompanying Condensed Consolidated Statement of
Operations and resulted from a decrease in the Company's stock price. On
February 6, 2004, the Company and the investors entered into an amendment to
their original agreement that resulted in the reclassification of the option and
warrant value to equity. The amendment clarified that the options and warrants
granted in the financing may be exercised at a time when a registration
statement covering the resale of the underlying share is not effective or
available and that in such instance the Company would deliver to the investors
shares of common stock whose resale is not currently registered. On the
effective date of the amendment, the option and warrant value was reclassified
to equity as additional paid-in-capital. As a result of the increase in value of
the options and warrants from the closing date to the amendment date, due to
increases in the Company's stock price, the Company recognized an expense of
$211,000, which will be included in other expense in the Condensed Consolidated
Statement of Operations in the fourth quarter of fiscal 2004.
On January 23, 2004, the Company filed an S-3 Registration Statement with
the Securities and Exchange Commission covering the resale of the common stock
issued and issuable in such financing. There can be no assurance that the
Securities and Exchange Commission will declare the registration statement
effective. The Company is subject to certain indemnity provisions included in
the stock purchase agreement entered into as part of the financing associated
with this registration. Morgan Keegan & Company, Inc. acted as the Company's
exclusive placement agent for this transaction. The Company presently intends to
use the net proceeds from this private placement (1) to purchase capital
equipment and make leasehold improvements to further expand Drexler's LaserCard
optical memory card production capacity, (2) for the planned cash purchase of
CCD and C&M, and (3) for general corporate purposes.
There were no debt financing activities for the fiscal 2004 first nine
months ended December 31, 2003.
The following table provides the effect on liquidity and cash flows for the
Company's leased buildings as of December 31, 2003 (in thousands). There are no
other contractual obligations or commercial commitments as of that date:
22
Fiscal Year
-----------
2004..................... $ 241
2005..................... 616
2006..................... 528
2007..................... 459
2008..................... 407
2009..................... 424
Thereafter............... 2,322
--------
Total................. $ 4,997
========
Subsequent to December 31, 2003, on January 29, 2004, the Company entered
into a ten-year building lease for approximately 43,000 square feet with annual
lease payments beginning April 1, 2004 of $386,000 for the first five years and
$890,000 for the final five years, for a total amount of $6.4 million.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RATE RISKS
INTEREST RATE RISK. The Company invests its cash, beyond that needed for
daily operations, in high quality debt securities. In doing so, the Company
seeks primarily to preserve the value and liquidity of its capital and,
secondarily, to safely earn income from these investments. To accomplish these
goals, the Company invests only in debt securities issued by (a) the U.S.
Treasury and U.S. government agencies and corporations and (b) debt instruments
that meet the following criteria:
-- Commercial paper rated A1/P1 or debt instruments rated AAA, as rated
by the major rating services
-- Can readily be sold for cash
There were no material changes during the third quarter of fiscal 2004 to
the Company's exposure to market risk for changes in interest rates.
FOREIGN CURRENCY EXCHANGE RATE RISK. The Company sells products in various
international markets. All of these sales are denominated in U.S. Dollars.
However, some raw material and purchased services are denominated in euros.
Accordingly, the Company is subject to exposure if the exchange rate for euros
increases in relation to the exchange rate for United States dollars. As of
December 31, 2003, the Company had not entered into a forward exchange contract
to hedge against or potentially minimize the foreign currency exchange risk.
Therefore, there were no material changes during the third quarter of fiscal
2004 to the Company's foreign currency exchange rate risk.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company's principal
executive officers and principal financial officer have evaluated the Company's
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c)
and 15d-14(c)) as of the end of the period covered by this Form 10-Q and have
determined that they are reasonable taking into account the totality of the
circumstances.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There were no
significant changes in the Company's internal control over financial reporting
that occurred during the period covered by this Form 10-Q that have materially
affected, or are reasonably likely to materially affect, such control.
23
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There have been no material developments this past quarter to the
litigation described in the Company's Annual Report on Form 10-K for the fiscal
year ended March 31, 2003, as supplemented by the Company's Quarterly Report on
Form 10-Q for the quarterly period ended June 30, 2003.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS, AND
ISSUER PURCHASES OF EQUITY SECURITIES
On December 26-30, 2003, the Company closed a private placement of its
common stock and raised $10.1 million, with net proceeds of $9.5 million. The
Company sold 791,172 shares of our $0.01 par value common stock to 17 investors
at $12.76 per share and granted them five-year warrants to purchase 174,057
shares of common stock at an exercise price of $17.26 per share and nine-month
options to purchase 122,292 shares of common stock at an exercise price of
$16.51 per share, all of which are immediately exercisable for cash only.
The private placement was conducted without registration under the Federal
Securities Act of 1933, as amended, in reliance upon the exemption provided by
Section 4(2) of such Act and Rule 506 promulgated under such Section. The
Company filed a Registration Statement on Form S-3 on January 23, 2004 to
register the resale of these shares and the shares issuable upon exercise of the
warrants, and options with the Securities Exchange Commission. In addition to
cash fees, on December 30, 2003, the Company issued Morgan Keegan & Co., Inc.,
which served as the placement agent, three-year warrants to purchase 15,284
shares of the Company's $0.01 par value common stock at an exercise price of
$17.26 per share, which are immediately exercisable for cash only. These
warrants were sold in reliance upon similar exemptions from registration and the
shares underlying these warrants were included in the registration statement
described above.
ITEM 5. OTHER INFORMATION
NON-AUDIT SERVICES. The Company's Audit Committee has approved certain
non-audit services provided or to be provided by KPMG LLP, the Company's
independent accountants. These services relate to consultation, advice, and
other services in connection with tax planning and compliance and due diligence
matters in connection with the proposed acquisition of two German companies.
NEXT ANNUAL MEETING OF STOCKHOLDERS. The Company's 2004 Annual Meeting of
Stockholders is scheduled to be held on Friday, October 1, 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit No. Exhibit Description
----------- -------------------
10.1 Building lease agreement (as amended)
31.1 Rule 13a-14(a) Certification of Christopher J. Dyball,
co-principal executive officer
31.2 Rule 13a-14(a) Certification of Richard M. Haddock,
co-principal executive officer
31.3 Rule 13a-14(a) Certification of Steven G. Larson,
principal financial officer
32.1 Section 1350 Certification of Christopher J. Dyball
and Richard M. Haddock, co-chief executive officers
32.2 Section 1350 Certification of Steven G. Larson,
chief financial officer
24
99.1 Engagement Letter with Morgan Keegan & Co., Inc.
(as amended)
99.2 Stock and Warrant Purchase Agreement (as amended)
The above-listed exhibits are filed herewith. No other exhibits are
included in this report as the contents of the required exhibits are either not
applicable to Registrant, to be provided only if Registrant desires, or
contained elsewhere in this report.
(b) Reports on Form 8-K
On October 22, 2003, the Company filed a Report on Form 8-K dated October
15, 2003, which reported under Item 4 that the Company engaged KPMG LLP to be
its new independent accountant.
On November 4, 2003, the Company filed a Report on Form 8-K dated October
30, 2003, which reported under Item 12 the issuance of a press release
containing financial results for the fiscal 2004 second quarter ended September
30, 2003.
On November 19, 2003, the Company filed a Report on Form 8-K dated November
13, 2003, which reported under Item 9 the issuance of a press release announcing
that the Company entered into a Letter of Intent to acquire two German card
companies.
On December 31, 2003, the Company filed a Report on Form 8-K dated December
23, 2003, which reported under Item 5 that it that it had entered into an
agreement to conduct an equity private placement to institutional investors,
with gross proceeds to the Company of approximately $10.1 million.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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:
DREXLER TECHNOLOGY CORPORATION
(Registrant)
Signature Title Date
--------- ----- ----
/s/ Christopher J. Dyball Co-Chief Executive Officer February 17, 2004
- --------------------------------- (Co-Principal Executive Officer)
Christopher J. Dyball
/s/ Richard M. Haddock Co-Chief Executive Officer February 17, 2004
- --------------------------------- (Co-Principal Executive Officer)
Richard M. Haddock
/s/ Steven G. Larson Vice President of Finance and Treasurer February 17, 2004
- --------------------------------- (Principal Financial Officer and
Steven G. Larson Principal Accounting Officer)
25
INDEX TO EXHIBITS
[ITEM 14(c)]
Exhibit
Number Description
- ------ -----------
10.1 Building lease agreement (as amended)
31.1 Rule 13a-14(a) Certification of Christopher J. Dyball,
co-principal executive officer
31.2 Rule 13a-14(a) Certification of Richard M. Haddock,
co-principal executive officer
31.3 Rule 13a-14(a) Certification of Steven G. Larson,
principal financial officer
32.1 Section 1350 Certification of Christopher J. Dyball and
Richard M. Haddock, co-chief executive officers
32.2 Section 1350 Certification of Steven G. Larson,
chief financial officer
99.1 Engagement Letter with Morgan Keegan & Co., Inc. (as amended)
99.2 Stock and Warrant Purchase Agreement (as amended)