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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, 2004
Commission File Number: 000-06377
LASERCARD CORPORATION
(FORMERLY DREXLER TECHNOLOGY CORPORATION)
(Exact name of registrant as specified in its charter)
Delaware 77-0176309
- ------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1875 North Shoreline Boulevard, Mountain View, California 94043-1319
- --------------------------------------------------------- ----------
(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, $0.01 par value, at January 31,
2005: 11,425,389
1
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page Number
Item 1. Condensed Consolidated Financial Statements (Unaudited) 2
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 34
Item 4. Controls and Procedures 34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 35
Item 3. Defaults Upon Senior Securities 35
Item 4. Submission of Matters to a Vote of Security Holders 35
Item 5. Other Information 35
Item 6. Exhibits 35
SIGNATURES 36
- --------------------------------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2
LASERCARD CORPORATION AND SUBSIDIARIES
(FORMERLY DREXLER TECHNOLOGY CORPORATION)
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
DECEMBER 31, MARCH 31,
2004 2004 *
---- ----
ASSETS
Current assets:
Cash and cash equivalents .................................................................... $ 9,213 $ 11,688
Short-term investments -- 981
Accounts receivable, net of allowances of $131 at
December 31, 2004 and $296 at March 31, 2004 .............................................. 3,187 2,550
Inventories .................................................................................. 6,575 6,799
Prepaid and other current assets ............................................................. 1,344 1,276
---------- ----------
Total current assets ...................................................................... 20,319 23,294
---------- ----------
Property and equipment, at cost ................................................................. 29,537 27,609
Less--accumulated depreciation and amortization .............................................. (16,916) (16,079)
---------- ----------
Property and equipment, net ............................................................... 12,621 11,530
Long-term investments ........................................................................... 7,300 8,246
Equipment held for resale ....................................................................... 3,697 2,419
Patents and other intangibles, net of accumulated
amortization of $3,375 at December 31, 2004
and $3,268 at March 31, 2004 .............................................................. 933 978
Goodwill ........................................................................................ 3,321 3,321
Notes receivable ................................................................................ 232 --
Other non-current assets ........................................................................ -- 47
---------- ----------
Total assets ........................................................................... $ 48,423 $ 49,835
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................................. $ 2,236 $ 4,249
Accrued liabilities .......................................................................... 2,139 2,035
Deferred tax liability ....................................................................... 501 608
Advance payments from customers .............................................................. 809 3,102
Deferred revenue ............................................................................. 581 111
Bank borrowings .............................................................................. -- 726
Current portion of long-term debt ............................................................ 2,388 440
---------- ----------
Total current liabilities ................................................................. 8,654 11,271
---------- ----------
Long-term debt, net of current portion .......................................................... -- 2,378
Deferred revenue, net of current portion ........................................................ 2,000 --
Advance payments from customers ................................................................. 8,000 500
---------- ----------
Total liabilities ...................................................................... $ 18,654 $ 14,149
---------- ----------
Commitments and contingencies
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 and outstanding-- 11,425,389 shares
at December 31, 2004 and 11,399,764 shares
at March 31, 2004 ...................................................................... 114 114
Additional paid-in capital ................................................................... 54,071 53,816
Accumulated deficit .......................................................................... (24,150) (18,244)
Accumulated other comprehensive income ....................................................... 390 --
Treasury stock ............................................................................... (656) --
---------- ----------
Total stockholders' equity .......................................................... 29,769 35,686
---------- ----------
Total liabilities and stockholders' equity ....................................... $ 48,423 $ 49,835
========== ==========
* Amounts derived from audited financial statements at the date indicated
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
LASERCARD CORPORATION AND SUBSIDIARIES
(FORMERLY DREXLER TECHNOLOGY CORPORATION)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2004 2003 2004 2003
---- ---- ---- ----
Revenues
Total revenues............................................. $ 6,282 $ 5,467 $ 22,765 $ 10,621
---------- ---------- ---------- ----------
Cost of product sales............................................. 5,477 3,905 17,685 8,987
---------- ---------- ---------- ----------
Gross profit .............................................. 805 1,562 5,080 1,634
---------- ---------- ---------- ----------
Operating expenses:
Selling, general, and administrative expenses................. 3,063 1,560 8,906 4,971
Research and engineering expenses............................. 655 588 2,229 1,941
---------- ---------- ---------- ----------
Total operating expenses................................... 3,718 2,148 11,135 6,912
---------- ---------- ---------- ----------
Operating loss.......................................... (2,913) (586) (6,055) (5,278)
Other income, net................................................. 64 168 149 300
---------- ---------- ---------- ----------
Loss before income taxes................................ (2,849) (418) (5,906) (4,978)
Income tax expense (benefit)...................................... (8) 8,446 -- 7,086
---------- ---------- ---------- ----------
Net loss................................................ $ (2,841) $ (8,864) $ (5,906) $ (12,064)
========== ========== ========== ==========
Net loss per share:
Basic and diluted net loss per share.................... $ (.25) $ (.83) $ (.52) $ (1.14)
========== ========== ========== ==========
Weighted-average shares of common stock used in
computing basic and diluted, net loss per share............... 11,334 10,631 11,370 10,554
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
LASERCARD CORPORATION AND SUBSIDIARIES
(FORMERLY DREXLER TECHNOLOGY CORPORATION)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
NINE MONTHS ENDED
DECEMBER 31,
2004 2003
---- ----
Cash flows from operating activities:
Net loss ............................................................................... $ (5,906) $ (12,064)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization....................................................... 2,021 1,490
Provision for doubtful accounts receivable.......................................... 3 1
Provision for excess and obsolete inventory......................................... 272 --
Provision for product return reserve................................................ 355 --
Stock-based compensation............................................................ 85 49
Loss on disposal of equipment....................................................... 5 --
Deferred tax benefit................................................................ -- 7,086
Gain associated with decrease in fair value of common stock warrants and options.... -- (118)
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable.......................................... (774) 334
Decrease in inventories............................................................. 124 1,942
Increase equipment held for resale.................................................. (1,278) --
Increase in other assets............................................................ (33) (177)
(Decrease) increase in accounts payable and accrued liabilities..................... (2,188) 211
Increase in deferred revenue........................................................ 2,448 226
Decrease in deferred income tax liabilities......................................... (166) --
Increase in advance payments from customers......................................... 5,144 3,037
--------- ----------
Net cash provided by operating activities...................................... 112 2,017
--------- ----------
Cash flows from investing activities:
Purchases of property and equipment..................................................... (2,717) (3,504)
Proceeds from sale of equipment......................................................... 2 --
Investment in patents and other intangibles............................................. (90) (66)
Purchases of investments................................................................ -- (7,513)
Note receivable ........................................................................ (221) --
Proceeds from maturities of investments................................................. 1,927 10,271
--------- ----------
Net cash used in investing activities.......................................... (1,099) (812)
--------- ----------
Cash flows from financing activities:
Proceeds from sale of common stock through stock plans.................................. 255 1,410
Proceeds from sale of common stock, options and warrants through private placement...... -- 9,548
Repayment of bank loan.................................................................. (766) --
Decrease in short-term and long-term debt............................................... (466) --
Stock repurchases....................................................................... (656) --
--------- ----------
Net cash (used in) provided by financing activities............................ (1,633) 10,958
---------- ----------
Effect of exchange rate changes on cash........................................ 145 --
--------- ----------
Net (decrease) increase in cash and cash equivalents......................................... (2,475) 12,163
Cash and cash equivalents:
Beginning of period..................................................................... 11,688 5,754
--------- ----------
End of period........................................................................... $ 9,213 $ 17,917
========= ==========
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
LASERCARD CORPORATION AND SUBSIDIARIES
(FORMERLY DREXLER TECHNOLOGY CORPORATION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
BASIS OF PRESENTATION. The condensed consolidated financial statements
contained herein include the accounts of LaserCard 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, 2004, included in the Company's Annual Report on Form
10-K.
The results of operations for the three and nine-month periods ended
December 31, 2004 are not necessarily indicative of results to be expected for
the entire fiscal year ending March 31, 2005.
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 2004 ended on January 2, 2004, and the
13-week third quarter of fiscal 2005 ended on December 31, 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 realizable value. The components of inventories
are (in thousands):
DECEMBER 31, MARCH 31,
2004 2004
---- ----
Raw materials $ 3,960 $ 3,243
Work-in-process 816 1,651
Finished goods 1,799 1,905
---------- ----------
$ 6,575 $ 6,799
========== ==========
NET LOSS PER SHARE: Basic and diluted net loss per share is computed by
dividing net loss by the weighted average number of shares of common stock
outstanding. As the effect of common stock equivalents would be antidilutive,
stock equivalents (primarily stock options) were excluded from the calculation
of diluted net loss per share for the three and nine-months ended December 31,
2004 and 2003. Accordingly, basic and diluted net loss per share were the same
for the three and nine-months ended December 31, 2004 and 2003.
REVENUE RECOGNITION. Product sales primarily consist of optical card sales,
sales of optical card read/write drives, and sales of specialty cards and
printers. 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
6
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
vault located on Company premises. Shipments are made from the vault on a
shipment schedule provided by the prime contractor, which is subject to
revision, but generally not subject to 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 SEC Staff
Accounting Bulletin No. 104 (SAB 104), 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 deferred and
recognized upon shipment from the vault. In addition, revenue recognition for
future deliveries into the vault would be affected if the U.S. government
cancels the shipment schedule. As a result, the Company's revenues may fluctuate
from period to period if the Company does not continue to obtain shipment
schedules under this subcontract or if the shipment schedules are cancelled.
In May 2003, the Emerging Issues Task Force ("EITF") finalized the terms of
EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables," (EITF
00-21) which provides criteria governing how to identify whether goods or
services that are to be delivered separately in a bundled sales arrangement
should be accounted for separately. Deliverables are accounted for separately if
they meet all of the following criteria: a) the delivered items have stand-alone
value to the customer; b) the fair value of any undelivered items can be
reliably determined; and c) if the arrangement includes a general right of
return, delivery of the undelivered items is probable and substantially
controlled by the seller. In situations where the deliverables fall within
higher-level literature as defined by EITF 00-21, the Company applies the
guidance in that higher-level literature. Deliverables that do not meet these
criteria are combined with one or more other deliverables. The Company adopted
EITF 00-21 for any new arrangements entered into after July 1, 2003 and now
assesses all revenue arrangements against the criteria set forth in EITF 00-21.
The Company applies the provisions of Statement of Position 81-1,
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts" (SOP 81-1) in applicable contracts. Revenues on time and materials
contracts are recognized as services are rendered at contract labor rates plus
material and other direct costs incurred. Revenues on fixed price contracts are
recognized on the percentage of completion method based on the ratio of total
costs incurred to date compared to estimated total costs to complete the
contract. Estimates of costs to complete include material, direct labor,
overhead and allowable general and administrative expenses. In circumstances
where estimates of costs to complete a project cannot be reasonably estimated,
but it is assured that a loss will not be incurred, the percentage-of-completion
method based on a zero profit margin, rather than the completed-contract method,
is used until more precise estimates can be made. The full amount of an
estimated loss is charged to operations in the period it is determined that a
loss will be realized from the performance of a contract. During the three and
nine-months ended December 31, 2004, the Company recognized approximately
$10,000 and $96,000 of revenues based on a zero profit margin related to a
long-term contract.
The Company applies the provisions of Statement of Position (SOP) No. 97-2,
"Software Revenue Recognition," as amended by Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain
Transactions" to 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. Software revenue totaled $28,000 for the three and
nine-months ended December 31, 2004 and $473,000 for the three and nine-months
ended December 31, 2003.
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. There were no license revenues for the three and nine-month periods
ended December 31, 2004 and 2003.
In the fiscal 2005 first quarter, the Company sold a card-manufacturing
license, effective April 3, 2004, to the Global Investments Group (GIG), based
in Auckland, New Zealand, for card manufacturing in Slovenia. This agreement
provides for payments to the Company of $29 million for a five-year training
support package, followed by an ongoing support phase for an additional 15 years
over the 20-year term of the license. Additionally, the Company is
7
to sell approximately $12 million worth of manufacturing equipment including
installation support for new facility to be built by GIG to provide a targeted
initial manufacturing capacity of 10 million optical cards annually. As of
December 31, 2004, the Company had $3.7 million of this equipment classified as
equipment held for resale on its balance sheet. The agreement provides options
to increase capacity to 30 million cards per year. Through December 31, 2004,
the Company has received $10 million of payments called for in the agreements,
consisting of a partial payment for the equipment and installation support of $8
million recorded as advance payments from customers, and $2 million for the
licensing fee recorded as deferred revenue, which are classified as long-term
liabilities within the consolidated balance sheets. In addition to the $41
million discussed above, GIG is to pay the Company royalties for each card
produced under the license. The territories covered by the license include most
of the European Union and eastern European regions. GIG has exclusive marketing
rights in certain territories, with performance goals to maintain these rights.
The Company will assign a person on site during the license term to assist with
quality, security, and operational procedures, with the mutual goal that the
cards made in their facility conform to the Company's standards. GIG anticipates
start up of the new facility will be late in calendar 2005. Revenue under the
license will be allocated over the remaining term of the agreement beginning
when operation of the factory commences. The Company also retains rights to
utilize up to 20% of the new facility capacity as a backup and capacity buffer
to augment its own card manufacturing facilities in Mountain View, California.
The granting of this license to GIG establishes a potential second source
supplier of optical memory cards for existing and prospective customers who may
request multiple sources for cards. The Company does not expect to record
material license revenues under this agreement prior to the fourth quarter of
fiscal 2006, after which revenue will be recorded over the remainder of the
20-year license term.
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
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 includes 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. The Company recorded a tax benefit of $8,000
for the third quarter and no tax provision for the first nine months of fiscal
2005. The amount of the tax benefit recorded in the third quarter of fiscal 2005
reduced the year to date tax provision to zero due to the operating loss
incurred in the Company's German operation. In December 2003, due to the
Company's recent cumulative tax loss history, income statement loss history over
the previous four quarters, and the continuing difficulty in forecasting the
timing of future revenue as evidenced by the deviations in achieved revenues
from expected revenues during the past few quarters and taking into account the
newness of certain customer relationships, the Company determined that it was
necessary to provide a full valuation allowance under SFAS No.109 of the
deferred tax asset. As a result, for the third quarter of fiscal 2004, the
Company recorded an income tax expense of $8.5 million 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, and the Company recording an income tax
expense for the first nine months of fiscal 2004 of $7.1 million. As of March
31, 2004, the valuation allowance was $14.8 million including a charge to
increase the valuation allowance against the beginning of the year net deferred
tax asset balance of $7.1 million and a charge against its net deferred tax
asset generated during fiscal 2004 in the amount of $2.4 million. As of December
31, 2004, the Company continued to provide for a full valuation allowance of
$16.7 million relating to its U.S. operations consisting of $14.8 million as of
March 31, 2004 and $1.9 million resulting from the net operating loss for the
nine months ended December 31, 2004.
Based upon the fiscal 2005 first nine months taxable loss and booked
orders, the Company cannot determine that any net operating loss carryforward
will be utilized this year, and therefore, has not adjusted its valuation
allowance against the deferred tax asset.
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."
Compensation cost for stock options, if any, is measured by the excess of the
quoted market price of the Company's
8
stock at the date of grant over the amount an employee must pay to acquire the
stock. 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. The following table
illustrates the effect on net loss and loss per share as if the Company had
applied the fair value recognition provisions of SFAS No. 123 (in thousands
except per share amounts):
Three Months Ended Nine Months Ended
December 31, December 31,
2004 2003 2004 2003
---- ---- ---- ----
Net loss, as reported............................................. $ (2,841) $ (8,864) $ (5,906) $ (12,064)
========== ========== ========== ==========
Add: Stock-based employee compensation expense
included in reported net loss, net of related
tax effects in 2003........................................... 32 35 85 83
Deduct: total stock-based employee compensation
determined under fair value based method for all
awards, net of related tax effects in 2003.................... (435) (798) (1,401) (1,904)
---------- ---------- ---------- ----------
Pro forma net loss................................................ $ (3,244) $ (9,627) $ (7,222) $ (13,885)
========== ========== ========== ==========
Loss per common share:
Basic and diluted - as reported............................... $ (.25) $ (.83) $ (.52) $ (1.14)
========== ========== ========== ==========
Basic and diluted - pro forma................................. $ (.29) $ (.91) $ (.64) $ (1.32)
========== ========== ========== ==========
Shares used in computing basic and diluted pro forma loss per share:
Basic and diluted............................................. 11,334 10,631 11,370 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,
2004 2003 2004 2003
---- ---- ---- ----
Risk-free interest rate.................................. N/A 3.75% 4.79% 2.74% to 3.75%
Average expected life of option.......................... N/A 8 years 5 years 5 to 8 years
Dividend yield........................................... N/A 0% 0% 0%
Volatility of common stock............................... N/A 50% 50% 50%
Weighted average fair value of option grants............. N/A $9.36 $4.75 $9.57
There were no options granted during the three-month period and 39,000
options granted during the nine-month period ended December 31, 2004. There were
24,000 options granted during the three-month and 35,000 options granted during
the nine-month period ended December 31, 2003.
ISSUANCE OF STOCK, OPTIONS, AND WARRANTS. In December 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 million in a private placement. The
Company received net proceeds of $9.4 million (net of fees and expenses). The
purchase price of the common stock was $12.76 per share, which was at a 15%
discount from the five-day average price as of December 23, 2003. 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," and were
recorded at those values in short-term and long-term liabilities. The balance of
the net proceeds was accounted for as additional paid-in capital. Under EITF
00-19, the Company marked-to-market the fair value of the options and warrants
at the end of each accounting period. At December 31, 2003, this resulted in
options and
9
warrants valued at $195,000 and $916,000, respectively. The decrease in the
valuation of the options and warrants, between December 23, 2003 and December
31, 2003 due to a decrease in the Company's stock price, of $118,000 was
recorded as other income in the third quarter of fiscal 2004. On February 6,
2004, the Company and the investors entered into an amendment to their original
agreement that resulted in the reclassification of the options and warrants 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 shares 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
options and warrants were reclassified to equity as additional paid-in capital.
As a result of the increase in the value of the options and warrants from
December 31, 2003 to the amendment date due to increases in the Company's stock
price, the Company recognized an expense of $211,000 which is included in other
expense in the consolidated statements of operations for 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
the financing. Morgan Keegan & Company, Inc. acted as the Company's placement
agent for this transaction and was granted warrants to purchase 15,824 shares of
common stock. The options to purchase 122,292 shares of common stock expired on
September 30, 2004.
STOCK REPURCHASES. On August 2, 2004, the Company's Board of Directors
approved a 350,000 share repurchase program pursuant to which the Company can
make open market or privately negotiated repurchase transactions for up to an
aggregate of $3 million for a four-month period beginning August 2, 2004 and
ending December 1, 2004. The Company has repurchased 91,630 shares of common
stock in the open market amounting to $656,000 at an average price of $7.15.
CONCENTRATION OF CREDIT RISK. Two customers comprised 33% and 10% of
accounts receivable as of December 31, 2004 and two customers comprised 26% and
23%, respectively, of accounts receivable as of March 31, 2004.
SEGMENT REPORTING. The Company's three reportable segments are: (1) optical
memory cards, (2) optical memory card drives, maintenance, and related
accessories ("optical card drives"), and (3) specialty cards & printers. The
segments were determined based on the information used by the chief operating
decision maker. The optical memory cards and optical card drives reportable
segments are not strategic business units which offer unrelated products and
services, rather these reportable segments utilize compatible technology and are
marketed jointly. Specialty cards and printers is a strategic business unit
offering at times unrelated products and at times related products with the
other reportable segments.
The accounting policies used to derive reportable segment results is the
same as those described in the "Summary of Significant Accounting Policies."
Resources are allocated to the optical memory card and optical card drive
segments in a manner that optimizes optical memory card revenues and to the
specialty card and printers segment in a manner that optimizes consolidated
income 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. Accounts receivable, cash,
deferred income taxes, prepaid expenses; fixed assets and inventory are not
separately reported by segment to the chief operating decision maker. 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 except for $3.6 million that are attributable to Germany.
The Company's chief operating decision maker is the Company's Chief
Executive Officer. 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, optical card
drives and specialty cards and printers for the three and nine-month periods
ended December 31, 2004 and 2003 (in thousands):
10
THREE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, 2004 DECEMBER 31, 2003
----------------- -----------------
OPTICAL SPECIALTY OPTICAL
MEMORY OPTICAL CARDS & SEGMENT MEMORY OPTICAL SEGMENT
CARDS CARD DRIVES PRINTERS TOTAL CARDS CARD DRIVES TOTAL
----- ----------- -------- ----- ----- ----------- -----
Revenue $ 3,596 $ 279 $ 2,407 $ 6,282 $ 2,942 $ 2,490 $ 5,432
Cost of sales 2,947 716 1,814 5,477 2,231 1,650 3,881
Gross profit (loss) 649 (437) 593 805 711 840 1,551
Depreciation and
amortization expense 391 34 65 490 306 57 363
NINE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, 2004 DECEMBER 31, 2003
----------------- -----------------
OPTICAL SPECIALTY OPTICAL
MEMORY OPTICAL CARDS & SEGMENT MEMORY OPTICAL SEGMENT
CARDS CARD DRIVES PRINTERS TOTAL CARDS CARD DRIVES TOTAL
----- ----------- -------- ----- ----- ----------- -----
Revenue $ 14,345 $ 723 $ 7,685 $22,753 $ 7,422 $ 3,076 $ 10,498
Cost of sales 10,293 1,630 5,738 17,661 6,283 2,628 8,911
Gross profit (loss) 4,052 (907) 1,947 5,092 1,139 448 1,587
Depreciation and
amortization expense 1,125 112 194 1,431 870 110 980
The following is a reconciliation of segment results to amounts included in the
Company's condensed consolidated financial statements:
THREE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, 2004 DECEMBER 31, 2003
----------------- -----------------
SEGMENT SEGMENT
TOTAL OTHER (A) TOTAL TOTAL OTHER (A)(B) TOTAL
----- ------ ----- ----- ------ -----
Revenue $ 6,282 $ -- $ 6,282 $ 5,432 $ 35 $ 5,467
Cost of sales 5,477 -- 5,477 3,881 24 3,905
Gross profit 805 -- 805 1,551 11 1,562
Depreciation and
amortization expense 490 179 669 363 182 545
NINE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, 2004 DECEMBER 31, 2003
----------------- -----------------
SEGMENT SEGMENT
TOTAL OTHER (A) TOTAL TOTAL OTHER (A)(B) TOTAL
----- ------ ----- ----- ------ -----
Revenue $ 22,753 $ 12 $22,765 $10,498 $ 123 $ 10,621
Cost of sales 17,661 24 17,685 8,911 76 8,987
Gross profit (loss) 5,092 (12) 5,080 1,587 47 1,634
Depreciation and
amortization expense 1,431 590 2,021 980 510 1,490
(a) Other revenue consists miscellaneous items not associated with segment
activities. Other cost of sales, depreciation and amortization expense
represents corporate and other costs not directly associated with segment
activities.
(b) The Company did not operate in the specialty card and printers segment for
the three and nine-month periods ended December 31, 2003.
11
OTHER COMPREHENSIVE LOSS. The following are the components of other
comprehensive loss (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------ ------------
2004 2003 2004 2003
---- ---- ---- ----
Net loss $ (2,841) $ (8,864) $ (5,906) $(12,064)
Net change in cumulative
foreign currency translation 296 -- 390 --
--------- --------- --------- ---------
adjustments
Other comprehensive loss $ (2,545) $ (8,864) $ (5,516) $(12,064)
========= ========= ========= =========
The components of accumulated other comprehensive gain consist of
cumulative foreign currency translation adjustments of approximately $390,000 as
of December 31, 2004.
RECENT ACCOUNTING PRONOUNCEMENTS. In March 2004, the Financial Accounting
Standards Board (FASB) approved the consensus reached by the Emerging Issues
Task Force (EITF) Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments" ("EITF 03-1"). The
objective of this Issue was to provide guidance for identifying impaired
investments. EITF 03-1 also provided new disclosure requirements for investments
that are deemed to be temporarily impaired. The accounting provisions of EITF
03-1 were effective for all reporting periods beginning after June 15, 2004,
while the disclosure requirements were effective only for annual periods ending
after June 15, 2004. In September 2004, the FASB deferred the requirement to
record impairment losses caused by the effect of increases in "risk-free"
interest rates and "sector spreads" on debt securities subject to paragraph 16
of EITF 03-1 and excludes minor impairments from the requirement until new
guidance becomes effective. The Company has evaluated the impact of the adoption
of EITF 03-1 and does not believe the impact is significant to the Company's
overall results of operations or financial position.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment" to
revise SFAS No. 123, "Accounting for Stock-Based Compensation", and supersede
APB Opinion No. 25, "Accounting for Stock Issued to Employees" and its related
implementation guidance. It required companies to recognize their compensation
costs related to share-based payment transactions in financial statements. These
costs were measured based on the fair value of the equity or liability
instruments issued. SFAS No. 123R is to be applied to the Company in the second
quarter of fiscal year 2006. The Company has not yet evaluated the impact that
the adoption of SFAS No. 123R will have on its financial statements.
SUBSEQUENT EVENT. On January 6, 2005, a payment of $2.2 million (1.6
million Euro) was made to the Managing Directors of two German subsidiaries to
settle in large part a loan related to the acquisition of these subsidiaries in
March 2004. As of that date, the outstanding balance of $203,000 (150,000 Euro)
is maintained by the Company in case the known contingent claim or other unknown
claims develop into actual claims. The payment was approved on December 2, 2004
by the Company's Board of Directors.
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, 2004, included in the Company's fiscal 2004 Annual
Report on Form 10-K.
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 the
Company's plan to merge LaserCard Systems Corporation into LaserCard Corporation
prior to calendar year end; the Company's belief that its U.S. government
contract will be extended and as to card personalization rates to current and
potential market segments, customers, and applications for and deployment of the
products of the Company; statements as to the advantages of, potential income
from, and duties to be performed under the sale of a second-source card
manufacturing license to Global Investments Group (GIG); statements as to the
GIG license for second-source card production in Slovenia, including future
scheduled payments and royalties, targeted startup date and production capacity,
and that the Company will sell equipment to GIG, provide GIG with installation
support, and have on-site personnel; 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 by the Department of Homeland
Security (DHS); expectations as to the new sheet-lamination production
facilities and the short-term effect on gross margins; plans to increase card
production capacity for anticipated increases in orders from programs from the
Italian government and other potential programs; anticipated continued use of
the Company's products by the governments of the United States, Canada, and
Italy; 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 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; 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
there from, 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 the continuation of current programs; potential expansion or implementation
of government programs utilizing optical memory cards, including without
limitation, those in Senegal, India and Saudi Arabia, and the timing of the and
award of any prime contracts for such programs; and the Company's plans,
objectives, and expected future economic performance.
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 in the U.S. and abroad, and if so
whether such market will utilize optical memory cards as opposed to other
technology; customer concentration and reliance on continued U.S. and Italian
government business; risks associated with doing business in and with foreign
countries; whether the
13
Company can successfully integrate and operate its recently acquired German
subsidiaries; whether the Company will be successful in assisting GIG with
factory startup and training; whether GIG will have the financial wherewithal to
make its required payments to the Company and to operate the facility; whether
the facility will efficiently produce high quality optical memory cards in
volume and that meets our standards; 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 impact of litigation; 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 shipment
schedule, enabling the Company to recognize revenues on cards delivered to the
vault instead of when cards later are shipped from the vault; the impact of
technological advances, general economic trends, and competitive products; the
impact of changes in the design of the cards; and the possibility that optical
memory cards will not be purchased for the full implementation of card programs
in Italy, Saudi Arabia, India, and Senegal or for DHS programs in the U.S., or
will not be selected for other government programs in the U.S. and abroad; the
risks set forth in the section entitled "Risks and Other Factors That May Affect
Future Operating Results" and elsewhere in this report; and other risks detailed
from time to time in the Company's SEC filings. 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 optical card sales,
sales of optical card read/write drives and sales of specialty cards and
printers. 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.
For the nine month period ended December 31, 2004, the provisions for sales
returns and warranty costs were $311,000 and $152,000, respectively.
The Company's U.S. government subcontract requires delivery into a secure
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 generally not subject to 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 SEC Staff
Accounting Bulletin (SAB) No. 104, 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 deferred and recognized upon
shipment from the vault. In addition, revenue recognition for future deliveries
into the vault would be affected if the U.S. government cancels the shipment
schedule. As a result, the Company's revenues may fluctuate from period to
period if the Company does not continue to obtain shipment schedules under this
subcontract or if the shipment schedules are cancelled.
In May 2003, the Emerging Issues Task Force ("EITF") finalized the terms of
EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables," (EITF
00-21) which provides criteria governing how to identify whether goods or
services that are to be delivered separately in a bundled sales arrangement
should be accounted for separately. Deliverables are accounted for separately if
they meet all of the following criteria: a) the delivered items have stand-
alone value to the customer; b) the fair value of any undelivered items can be
reliably determined; and c) if the
14
arrangement includes a general right of return, delivery of the undelivered
items is probable and substantially controlled by the seller. In situations
where the deliverables fall within higher-level literature as defined by EITF
00-21, the Company applies the guidance in that higher-level literature.
Deliverables that do not meet these criteria are combined with one or more other
deliverables. The Company adopted EITF 00-21 for any new arrangements entered
into after July 1, 2003 and now assesses all revenue arrangements against the
criteria set forth in EITF 00-21.
The Company applies the provisions of Statement of Position 81-1,
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts" (SOP 81-1) in applicable contracts. Revenues on time and materials
contracts are recognized as services are rendered at contract labor rates plus
material and other direct costs incurred. Revenues on fixed price contracts are
recognized on the percentage of completion method based on the ratio of total
costs incurred to date compared to the estimated total costs to complete the
contract. Estimates of costs to complete include material, direct labor,
overhead and allowable general and administrative expenses. In circumstances
where estimates of costs to complete a project cannot be reasonably estimated,
but it is assured that a loss will not be incurred, the percentage-of-completion
method based on a zero profit margin, rather than the completed-contract method,
is used until more precise estimates can be made. The full amount of an
estimated loss is charged to operations in the period it is determined that a
loss will be realized from the performance of a contract. During the three and
nine-month periods ended December 31, 2004, the Company recognized approximately
$10,000 and $96,000 of revenues based on a zero profit margin related to a
long-term contract.
License revenue, which may consist of up-front license fees and long-term
royalty payments, is recognized as revenue when earned. The second-source
card-manufacturing license sold in April 2004 to GIG provides for license fees,
training charges, and royalty payments to the Company for each card produced
during the 20-year term of the license agreement. This is a multi-element
arrangement as described in Emerging Issues Task Force (EITF) Issue No. 00-21;
revenue derived from the up-front payments will be recognized ratably over the
remainder of the 20-year license term once the plant has begun production. There
were no license revenues for the three and nine-month periods ended December 31,
2004 and 2003.
The Company applies the provisions of Statement of Position (SOP) No. 97-2,
"Software Revenue Recognition," as amended by SOP No. 98-9, "Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain Transactions" to 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. Software
revenue totaled $28,000 for the three and nine-months ended December 31, 2004
and $473,000 for the three and nine-month period ended December 31, 2003.
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
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 includes 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. The Company recorded a tax benefit of $8,000
for the third quarter and no tax provision for the first nine months of fiscal
2005. The amount of the tax benefit recorded in the third quarter of fiscal 2005
reduced the year to date tax provision to zero due to the operating loss
incurred in the Company's German operation. In December 2003, due to the
Company's recent cumulative tax loss history, income statement loss history over
the previous four quarters, and the continuing difficulty in forecasting the
timing of future revenue as evidenced by the deviations in achieved revenues
from expected revenues during the past few quarters and taking into account the
newness of certain customer relationships, the Company determined that it was
necessary to provide a full valuation allowance under SFAS No.109 of the
deferred tax asset. As a result, for the third quarter of fiscal 2004, the
Company recorded an income tax expense of $8.5 million by increasing the
valuation
15
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, and the Company recording an income tax expense for the
first nine months of fiscal 2004 of $7.1 million. As of March 31, 2004, the
valuation allowance was $14.8 million including a charge to increase the
valuation allowance against the beginning of the year net deferred tax asset
balance of $7.1 million and a charge against its net deferred tax asset
generated during fiscal 2004 in the amount of $2.4 million. As of December 31,
2004, the Company continued to provide for a full valuation allowance of $16.7
million relating to its U.S. operations consisting of $14.8 million as of March
31, 2004 and $1.9 million resulting from the net operating loss for the nine
months ended December 31, 2004.
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. For recent prior
periods, the Company had been estimating future taxable income from its core
business, which assumed on-going business under the U.S. government subcontract
for Green Cards and LaserVisa BCCs and the Canadian government's Permanent
Resident Card program, as well as estimated operating expenses to support that
level of business, as offset by the estimated impact of future stock option
deductions. The Company went back to estimating future taxable income based upon
its expectations for the current and next three years because this past core
business has not proven to be as stable as the Company had believed it to be and
because this past core business is expected to represent an increasingly smaller
part of the business. This is because the Company expects revenues from these
U.S. programs to stabilize at revenue levels lower than had been expected in the
past and because the Company expects new foreign business, which has fluctuated
considerably quarter to quarter, to comprise a larger portion of the core
business. The Company has had difficulty in the past, and expects to have
continued difficulty in the future, in reliably forecasting its foreign business
and the revenue to be received from it. This, in combination with the three-year
cumulative tax loss for the period ended March 31, 2004, has resulted in the
Company basing its estimates of future income for these purposes to booked
orders only. As circumstances change, the Company may in the future be able to
revert back to estimating future revenue based upon its forecast revenues rather
than only using booked orders, although the Company cannot say when this will
occur.
In concluding that a valuation allowance was required, 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 Saudi Arabia 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 first nine months of fiscal 2005 and the losses in
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." As described above,
the Company concluded that the negative evidence outweighed the positive
evidence and has continued to record a valuation allowance to be equal to the
full amount of the deferred tax asset as of December 31, 2004 relating to its
U.S. operations.
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. To the
extent that the Company generates taxable income in jurisdictions where the
deferred tax asset relates to net operating losses that have been offset by a
full valuation allowance, the utilization of these net operating losses would
result in the reversal of the related valuation allowance in the Company's
results of operations. The Company would need $8.2 million of income on its
federal income tax return to avoid the expiration of $8.2
16
million of the deferred tax asset now set to expire in fiscal 2005. In these
regards, it should be noted that certain payments from GIG might be treated as
income on the Company's tax return even though they are being deferred for
financial reporting purposes. This could result in the utilization of net
operating losses that otherwise might have expired which would result in a tax
benefit for financial reporting purposes as the valuation allowance would be
correspondingly reduced. However, based upon first nine months taxable income
taking into account these payments and booked orders, the Company cannot
determine that any net operating loss will be utilized this year, and therefore,
has not adjusted its valuation allowance against the deferred tax asset.
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 booked
orders. 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. In
addition, the Company keeps a supply of card raw materials it deems necessary
for anticipated demand. Therefore, the calculation of inventory turnover for
actual demand will differ from the calculation considering anticipated demand.
Management's analysis of the carrying value of 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 (SAB 100) as it relates to determining the appropriate cost basis of
inventory and determining whether firm, non-cancelable 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 2005, the Company recorded a lower of cost or market
adjustment in the amount of $67,000. 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 2005 THIRD QUARTER AND FIRST NINE MONTHS COMPARED
WITH FISCAL 2004 THIRD QUARTER AND FIRST NINE MONTHS
Overview
Headquartered in Mountain View, California, LaserCard Corporation (formerly
known as Drexler Technology Corporation, until October 1, 2004) manufactures
LaserCard(R) optical memory cards, chip-ready OpticalSmart(TM) cards, and other
advanced-technology cards. In addition, the Company operates three wholly owned
subsidiaries. LaserCard Systems Corporation, of Mountain View, manufactures
optical card read/write drives; develops optical card system software; and
markets cards, card-related data systems, and peripherals. Challenge Card Design
Plastikkarten GmbH, of Rastede, Germany, manufactures advanced-technology cards;
and cards & more GmbH, of Ratingen, Germany, markets cards, system solutions,
and thermal card printers. The Company will transfer its U.S. operating assets
and liabilities and operations from LaserCard Corporation into its wholly owned
subsidiary, LaserCard Systems Corporation during the fourth quarter of fiscal
2005 making LaserCard Corporation primarily a holding company. The Company is
reviewing the viability of merging cards & more GmbH into Challenge Card Design
Plastikkarten GmbH during the next twelve months.
During nine-month period ended December 31, 2004, the Company was in
process of the integration of the two related German card companies acquired on
March 31, 2004, Challenge Card Design Plastikkarten GmbH of Rastede, Germany,
and cards & more GmbH of Ratingen, Germany. These acquisitions provide the
Company with a optical card manufacturing base to serve the European, Middle
Eastern, African, and Asian markets, supplementing the Company's newly expanded
manufacturing operations in California. The German operations accounted for 36%
of
17
total Company revenues for the three months period ended December 31, 2004 and
32% of total Company revenues for the nine-month period ended December 31, 2004.
This is the third quarter that the German operations are included in the
Company's Statement of Operations. The German operations had net loss of
$347,000 for the third quarter and $202,000 for the first nine months of fiscal
2005. Low production volumes for Italian CIE cards had a negative impact on the
third quarter results.
In addition to using its own marketing staff in California, New York, and
Germany, the Company utilizes value added resellers (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.
Application areas with major growth potential for LaserCard optical memory
cards include government-sponsored identification programs in several countries,
motor vehicle registration in India, and the possible expansion of U.S.
government ID programs due to the need for enhanced border security. Since
governmental card programs typically rely on policy-making, which in turn is
subject to technical requirements, budget approvals, and political
considerations, there is no assurance that these programs will be implemented as
expected or that they will include optical cards.
During the three months ended December 31, 2004, the Company incurred the
following unusual expenses; 1) a $291,000 Cost of Goods Sold expense for the
conversion of our model 780 RW drive to model Q-600 including our remaining
inventory, 2) a $150,000 Cost of Goods Sold expense associated with a card
inventory reserve, and 3) a $202,000 SG&A expense for the foreign exchange loss
on debt denominated in Euros that was subsequently extinguished.
Also during the quarter, the $980,000 included in backlog since the March
31, 2004 acquisition of our German operations for a partially completed contract
for an amusement park gate system has been canceled due to the insolvency of the
customer. This does not affect the financial position of the Company since we
did not anticipate any gross profit or loss from the contract because it was
substantially completed prior to the March 31, 2004 acquisition and all profit
accrued to the prior entity. In addition to cancellation of the backlog, we
removed the $1.2 million of deferred costs from inventory, $824,000 from
deferred revenue, and $330,000 from accounts payable and accrued liabilities
since the contract will not be completed and the Company has been indemnified
for potential losses.
Prior to fiscal 2005, the largest purchaser of LaserCard products was
Anteon International Corporation (Anteon), a value-added reseller (VAR) of the
Company. Anteon 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 Anteon, the DHS purchases Green Cards and DOS LaserVisa 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 Anteon represented 45% and 27% for the three and
nine-month periods ended December 31, 2004 and 89% and 86% for the same periods
a year ago. Another unaffiliated Company VAR, Laser Memory Card SPA of Italy,
accounted for 4% and 33% of the Company's total revenues for the three and
nine-month periods ended December 31, 2004 for programs in Italy and Senegal.
Revenues for the major programs are shown below as a percentage of total
Company revenues
Three Months Ended Nine Months Ended
December 31, December 31,
2004 2003 2004 2003
---- ---- ---- ----
United States Green Cards and LaserVisa BCCs 32% 60% 16% 53%
Canadian Permanent Resident Cards 6% 22% 8% 29%
Italian Carta d'Identica Elettronica (CIE) Cards 4% 10% 32% 6%
18
Optical memory card revenues for the three and nine-month periods ended
December 31, 2004 mainly included sales of CIE cards for the Italian government
for its national ID card program; Green Cards, National ID cards for the Saudi
Arabian government, Automated Manifest System cards for the U.S. government; and
sales of Permanent Resident Cards made for the Canadian government. Optical
memory card revenues for the three and nine month periods ended December 31,
2003 mainly included sales of Green Cards, DOS LaserVisa BCCs, Automated
Manifest System cards for the U.S. government; Permanent Resident Cards for the
Canadian government and CIE cards for the Italian government for its national ID
card program.
For the government of Italy, the Company has received orders for CIE cards
(Carta d'Identita Elettronica) and anticipates orders for a new program for the
PSE cards (Permesso di Soggiorno Elettronico). As of December 31, 2004, the
Company did not have a backlog for CIE or PSE cards. According to program
descriptions released by the Italian government, CIE card orders could
potentially reach more than $32 million per year if Phase 3 is fully funded and
implemented. While the Company anticipates additional CIE orders to be placed
during the fourth quarter of this fiscal year with volume shipments to begin
during fiscal 2006, there can be no assurance that such orders will be placed,
or that if placed, such orders will have the volume and delivery schedule
contemplated by the Company.
For the Department of Homeland Security (DHS), the Company delivered $2
million in the three-month period and $3.5 million in the nine-month period
ended December 31, 2004 of Green Cards and no LaserVisa BCCs during those
periods. As of December 31, 2004, between the U.S. government's own on-site
inventory and the inventory the U.S. government owns and maintains in its vault
on Company premises, the U.S. government has inventories of LaserVisa BCCs which
would last approximately nine months and Green Cards which would last
approximately seven months at the U.S. government's card-personalization rates.
The Company believes that the U.S. government wants to maintain an inventory
which would last approximately 6 months at the U.S. government's card
personalization rates. The Company received an order of Green Cards in September
2004 for delivery through March 2005 in the amount of $4.9. The Company
delivered $2.5 million of this order during the second and third quarters of
fiscal 2005. This order called for delivery to the DHS vault on Company premises
and included a schedule for shipment of the cards from the vault.
Over the past year, the U.S. government personalized Green Cards valued at
$7.4 million and LaserVisa BCCs valued at $2.6 million. This value is based upon
the Company's selling price of cards to Anteon the prime contractor. The Company
believes that annual revenues under these two programs 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. The Company's current
order of Green Cards calls for deliveries at a $8.5 million annualized rate and
the Company currently does not have any orders for LaserVisa BCCs.
The Company's current five-year U.S. government subcontract for Green Cards
and LaserVisa BCCs was announced in June 2000 and will expire on May 25, 2005.
The Company believes the government will issue a new competitively bid contract
or issue sole-source purchase orders prior to, or shortly after expiration.
There is no assurance that a follow-on contract or sole-source purchase orders
will be issued by the DHS upon expiration of the current contract. This
subcontract was received by the Company through Anteon, a LaserCard VAR that is
a U.S. government prime contractor, under a competitively bid, government
procurement contract.
The Company has established sheet-lamination production facilities to make
Canadian Permanent Resident Cards, Italian National ID cards, Saudi Arabia
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.
In 2002, the Company was awarded a subcontract for production of Canada's
Permanent Resident Cards. Shipments began in fiscal 2003 and have totaled $6.5
million as of December 31, 2004. The Company's non-cancelable backlog at
December 31, 2004 relating to this contract of $449,000 calls for deliveries at
about $45,000 monthly or the next five months with increases thereafter.
In March 2004, the Company quoted on a Phase 2 tender issued by the Kingdom
of Saudi Arabia for three million optical memory cards, one million secure
non-optical polycarbonate ID cards, and 220 read/write drives for a secure
19
personal identification card program. Since that time, according to Saudi
officials, the start of Phase II has been delayed due to the need to re-engineer
parts of the central issuing system and to create a card management system. To
maintain continuity of the Phase I card issuance program, the government of
Saudi issued a new Request for Proposal in December 2004, calling for a full
range of consumable items, including up to five million optical memory cards and
up to five million secure non-optical polycarbonate ID cards. The Company has
submitted proposals to a number of authorized resellers. The Request for
Proposal states that deliveries of both cards must start within two months of
contract signing and must be completed within twelve months thereafter. However,
there is no assurance that the contract will be issued, that the Company would
be the selected vendor, or that the Company will receive additional orders for
this program under any contract that may ultimately be issued by the Saudi
Arabian government. The Company previously sold 120 read/write drives for this
program, most of which were shipped in the fiscal 2004 second quarter, for
installation of the infrastructure required for card issuance. The Company
shipped $440,000 of Phase 1 optical memory cards in the third quarter of fiscal
2005 and $614,000 for the first nine months of fiscal 2005. At December 31,
2004, the Company had backlog of $527,000 Phase 1 optical memory cards for
delivery this fiscal year. In addition, the Company received a separate purchase
order of $288,400 to ship secure non-optical polycarbonate ID cards for use in
Saudi Arabia government family identity program. The non-optical polycarbonate
ID cards are manufactured by the Company's wholly owned subsidiary, Challenge
Card Design of Rastede, Germany and about half were delivered during the quarter
ended December 31, 2004.
Effective April 3, 2004, the Company sold a second-source
card-manufacturing license to the Global Investments Group (GIG), based in
Auckland, New Zealand, for card manufacturing in Slovenia. This agreement
provides for payments to the Company of $29 million for the license over the
20-year term of the license (including a five-year training support package,
followed by an ongoing support phase for an additional 15 years). Additionally,
the Company is to sell approximately $12 million worth of the required
manufacturing equipment and installation support for the to-be-built new
facility to provide a targeted initial manufacturing capacity of 10 million
optical cards annually. The Company has received $10 million of payments called
for in the agreements as of December 31, 2004, consisting of a partial payment
for the equipment and installation support of $8 million, recorded as advance
payments from customers, and $2 million for the license fee, recorded as
deferred revenue, which are classified as long-term liabilities within the
consolidated balance sheets. An additional $5 million was received after
December 31, 2004 bringing the total payments to $15 million. GIG is to pay the
Company royalties for each card produced during the 20-year term of the license
agreement. GIG anticipates that start up of the GIG facility will be late in
calendar 2005. Revenue will be recognized over the remaining term of the
agreement beginning when operation of the factory commences. Subsequent to
December 31, 2004 the Company received an additional $2 million under this
agreement.
Kodak is the Company's sole-source supplier of raw material for its optical
memory card media. The Company currently has an order which Kodak has accepted
with deliveries scheduled through December 2005. Kodak announced in the
Company's prior fiscal year that it is reducing its emphasis on emulsion based
films in general. Subsequently, however, Kodak has reassured us that it has no
plans to discontinue the fine-grained monochrome emulsion used in our optical
memory card since it is similar to those used in military and commercial
high-resolution products for which Kodak continues to maintain production. If
Kodak were nonetheless 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 uses a second photographic emulsion for the preparation of
mastering loops. The Company has purchased a long-term supply of this emulsion
and believes it has on hand an adequate supply to meet anticipated demand.
The Company plans to invest approximately $10 million in additional capital
equipment and leasehold improvement expenditures as customer orders justify the
investment. These expenditures could occur during the next twelve months, as
more fully discussed under "Liquidity and Capital Resources."
Revenues
PRODUCT REVENUES. The Company's total revenues for the fiscal 2005 third
quarter ended December 31, 2004 consisted of sales of optical memory cards,
optical card read/write drives, drive accessories, specialty cards and
20
printers, maintenance, and other miscellaneous items. The Company's total
revenues were $6.3 million for the fiscal 2005 third quarter and $22.8 million
for the fiscal 2005 first nine months, compared with $5.5 million for the fiscal
2004 third quarter and $10.6 million for the fiscal 2004 first nine months. Net
sales to external customers from the German companies acquired on March 31, 2004
were $2.3 million and $7.4 million respectively for the three and nine-month
periods ended December 31, 2004.
Revenue on optical memory cards totaled $3.6 million for the fiscal 2005
third quarter compared with $2.9 million for the fiscal 2004 third quarter.
Revenue on optical memory cards totaled $14.3 million for the first nine months
of fiscal 2005 compared with $7.4 million for the first nine months of fiscal
2004. The increase in optical memory card revenue was mainly due to the sale of
optical memory cards for the Italian National ID card program of $7.2 million
for the fiscal 2005 first nine months versus $0.5 million in last year's first
nine months.
Revenue on read/write drives, drive service, and related accessories
totaled $279,000 for the fiscal 2005 third quarter compared with $2.5 million,
inclusive of $473,000 for biometric system software, for the fiscal 2004 third
quarter. Revenue on read/write drives, drive service, and related accessories
totaled $723,000 for the fiscal 2005 first nine months compared with $3.1
million, inclusive of $473,000 for biometric systems software, for the fiscal
2004 first nine months. These decreases were primarily due to a spike in unit
sales volume for read/write drives resulting from an approximately 1,000 drive
order from the U.S. government during the third quarter of fiscal 2004.
LICENSE FEES AND OTHER REVENUES. There were no license revenues for the
three and nine-month periods ended December 31, 2004.
In the fiscal 2005 first quarter, the Company announced the sale of a
royalty-bearing, optical memory card manufacturing license to GIG for card
manufacturing in Slovenia. The license agreement provides for payments to the
Company of $29 million for the license (including a five-year training support
package, followed by an ongoing support phase for an additional 15 years).
Additionally, the Company agreed to sell approximately $12 million worth of
manufacturing equipment and installation support for the new facility to provide
a targeted initial manufacturing capacity of 10 million optical cards annually,
with options to increase capacity to 30 million cards per year. As of December
31, 2004, the Company has received $10 million of payments called for in the
agreements, consisting of a partial payment for the equipment and support of $8
million, recorded as advance payments, and $2 million toward the license fee,
recorded as deferred revenue. The payments of $41 million called for in the
agreements will be recognized as revenue over the remaining term of the
arrangement beginning when operation of the factory commences, presently
targeted by GIG for late in 2005. Direct and incremental costs will also be
deferred and recorded as cost of sales along with the revenue. In addition, the
agreement calls for royalty payments based upon unit sales and for purchases of
certain raw materials for card manufacture from the Company.
Backlog
As of December 31, 2004, the backlog for LaserCard optical memory cards
totaled $3.6 million mostly scheduled for delivery in fiscal 2005. Order backlog
as of December 31, 2004 mainly includes orders for the U.S. Permanent Resident
Cards, Saudi Arabian government Nation ID cards, and Canadian government
Permanent Resident Cards. 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 in fiscal 2004. Order backlog as of
December 31, 2003 included 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. The decrease of
$6 million in backlog at December 31, 2003 compared to December 31, 2004 was
mainly due to the Company not having received an order for CIE cards for the
Italian national ID card program. The Company has only a few customers who
generally place orders for a several month period so that variations in order
placement from a single customer can materially affect backlog.
The Company has no significant backlog for read/write drives.
In addition, the backlog for Challenge Card Design Plastikkarten GmbH and
cards & more GmbH as of December 31, 2004 for specialty cards and printers
totaled 321,000 euros (approximately $437,000); for a contract to develop a
conventional non-optical card production facility totaled 782,000 euros
($1,067,000). Revenue on the contract for a
21
conventional non-optical card production facility contract is being booked on a
zero profit margin basis. Therefore, the total profit under this contract will
be booked at completion on or about December 2006.
Furthermore, the $980,000 included in the September 30, 2004 backlog of the
Company's German operations for a partially completed contract for an amusement
park gate system has been canceled due to the insolvency of the customer. This
does not effect the financial position of the Company since we did not
anticipate any gross profit or loss from the contract because it was
substantially completed prior to the March 31, 2004 acquisition and all profit
accrued to the prior entity. In addition to cancellation of the backlog, we
removed the $1,154,000 of deferred costs from inventory, $824,000 from deferred
revenue, and $330,000 from accounts payable and accrued liabilities since the
contract will not be completed and the Company has been indemnified for
potential losses.
Gross Margin
Gross margin on product sales was 13% for the fiscal 2005 third quarter and
22% for the fiscal 2005 first nine months compared with 29% for the fiscal 2004
third quarter and 15% for the fiscal 2004 first nine months. The change from
fiscal 2004 to fiscal 2005 was due to changes in product mix and the various
items discussed below.
OPTICAL MEMORY CARDS. Optical memory card gross profit and margins can vary
significantly based on sales and production volume, yields, average selling
price, mix of card types, production efficiency, and changes in fixed costs. The
gross margin on optical memory cards was 18% for the third quarter of fiscal
2005 and 28% for the first nine months of fiscal 2005 versus 24% for the third
quarter of fiscal 2004 and 15% for the first nine months of fiscal 2004. In
comparing the third quarter ended December 31, 2004 to the same quarter a year
ago, the increase in production and sales volumes, net of increase in fixed
costs, had a positive effect on margins of about four points. However, this was
offset by a $107,000 expense due to increased inventory and warranty reserves,
by $180,000 due to lower yields than last year, and by $102,000 due to sales
returns.
READ/WRITE DRIVES. 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. Read/write drive gross profits are generally negative, inclusive of fixed
overhead costs, due to low sales volume. For the fiscal 2005 third quarter, the
Company had a negative gross profit on read/write drive sales of approximately
$437,000 compared with a gross profit of approximately $840,000 for the fiscal
2004 third quarter. For the fiscal 2005 first nine months, gross profit on
read/write drive sales was a negative gross profit of approximately $907,000
compared with a gross profit of approximately $448,000 for the fiscal 2004 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. The Company believes that margins will
remain below 10% when sales volume is sufficient to generate positive gross
profit. During the third quarter ended December 31, 2004, the Company reserved
about $291,000 for the conversion of model 780 to model Q-600 including the
Company's remaining inventory. The Company will no longer sell model 780
read/write drives.
SPECIALTY CARDS AND PRINTERS. Gross margin on specialty cards and printers
was 25% for both the three-months and the nine-months ended December 31, 2004.
The Company anticipates that gross margins on these projects will fluctuate a
few percentage points above or below 25% each quarter. The operation of this
segment was started in the first quarter of fiscal 2005.
Expenses
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES (SG&A). SG&A expenses were
$3.1 million and $8.9 million for the three and nine-month periods ended
December 31, 2004, compared with $1.6 million and $5 million the same periods a
year ago. For the three-month period end December 31, 2004, the increase of $1.5
million was due primarily to $768,000 in SG&A expenses recorded by the acquired
German entities, $456,000 for legal, accounting, salaries and consulting mainly
related to the integration of the acquired German companies and Sarbanes-Oxley
Act compliances, $72,000 for occupancy and $202,000 for foreign currency
exchange loss. For the nine-month period ended December 31, 2004, the increase
of $3.9 million was due primarily to $2.2 million in SG&A expenses recorded by
the acquired German entities, $166,000 for occupancy, $140,000 for investor
relations, $1.1 million for legal, accounting, salaries and consulting mainly
related to the integration of the acquired German companies and Sarbanes-Oxley
Act
22
compliance, and $228,000 for foreign currency exchange loss. The Company
believes that SG&A expenses for fiscal 2005 fourth quarter will be higher than
fiscal 2004 levels, as represented by the quarter ended December 31, 2004,
mainly due to the inclusion of SG&A of the acquired German companies,
integration of the acquired companies, increases in marketing and selling
expenses, and the cost of compliance with internal control auditing mandated by
Section 404 of the Sarbanes-Oxley Act.
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 chips
with radio frequency (RF) capability, Optichip(TM), OVD (optically variable
device) products, and associated media development including new media
manufacturing methods; 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 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 $655,000 and $2.2 million
for the three and nine-month periods ended December 31, 2004, compared with
$588,000 and $1.9 million the same periods a year ago. The increase was due
primarily to R&E expenses of $74,000 and $198,000 recorded by the acquired
German entities for the three and nine-month periods ended December 31, 2004.
The Company believes that R&E expenses will increase in the fourth quarter
fiscal 2005 due to expenses for preproduction prototypes of a hand-held
read-only drive, optical memory card media development, and other card and
hardware related programs.
OTHER INCOME AND EXPENSE. The net other income for the third quarter of
fiscal 2005 was $64,000 consisting mainly of $97,000 in interest income offset
by $32,000 in interest expense, compared with $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. Total net other
income for the first nine months of fiscal 2005 was $149,000 mainly consisting
of $283,000 of interest income partially offset by $128,000 in interest
expenses, compared with $300,000 consisting of the $178,000 of 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. The increase in interest
income was mainly due to the increase in invested funds and higher interest
rates. Interest expense of $32,000 was recorded in the December fiscal 2005
quarter on long-term debt. The Company made a one-time payment of $2.2 million
(1.6 million Euro) in January 2005 for this debt and therefore the interest
expense will significantly decrease starting the fourth quarter of fiscal year
2005. The Company retained an outstanding loan balance of $203,000 (150,000
Euro) in case the known contingent claim or other unknown claims develop into
actual claims.
INCOME TAXES. The Company recorded an income tax benefit of $8,000 for the
third quarter of fiscal 2005 compared with an income tax expense of $8.5 million
for the third quarter of fiscal 2004. The Company recorded a tax benefit of
$8,000 for the third quarter and no tax provision for the first nine months of
fiscal 2005. The amount of the tax benefit recorded in the third quarter of
fiscal 2005 reduced the year to date tax provision to zero due to the operating
loss incurred in the Company's German operation. In December 2003, due to the
Company's recent cumulative tax loss history, income statement loss history over
the previous four quarters, and the continuing difficulty in forecasting the
timing of future revenue as evidenced by the deviations in achieved revenues
from expected revenues during the past few quarters and taking into account the
newness of certain customer relationships, the Company determined that it was
necessary to provide a full valuation allowance under SFAS No.109 of the
deferred tax asset. As a result, for the third quarter of fiscal 2004, the
Company recorded an income tax expense of $8.5 million 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, and the Company recording an income tax
expense for the first nine months of fiscal 2004 of $7.1 million. As of March
31, 2004, the valuation allowance was $14.8 million including a charge to
increase the valuation allowance against the beginning of the year net deferred
tax asset balance of $7.1 million and a charge against its net deferred tax
asset generated during fiscal 2004 in the amount of $2.4 million. As of December
31, 2004, the Company continued to provide for a full valuation allowance of
$16.7 million relating to its U.S. operations consisting of $14.8 million as of
March 31, 2004 and $1.9 million resulting from the net operating loss for the
nine months ended December 31, 2004.
23
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2004, the Company had cash and cash equivalents of $9.2
million and a current ratio of 2.4 to 1. The Company also had $7.3 million in
long-term investments with original maturities from one year to two and one-half
years. Cash and cash equivalents, short-term investments, and long-term
investments were $16.5 million at December 31, 2004 and $20.9 million at March
31, 2004.
Net cash provided by operating activities was $112,000 for the first nine
months of fiscal 2005 compared with $2 million for the first nine months of
fiscal 2004. The decrease of $1.9 million is due primarily to increase in
accounts receivable, inventories and equipment held for resale, and decrease in
accounts payable offset by increase in advance payments from customers and
deferred revenue. The accounts receivable increase at December 31, 2004 as
compared with March 31, 2004 is mostly due to the $521,000 increase at our
subsidiaries in Germany. This was partially due to strong sales in December and
the effect of the exchange rate converting euros to U.S. dollars. The increase
in inventories as compared to the same period a year ago, was due primarily to
the $2.5 million in sale of read/write drives, drive service and related
accessories for the first nine months of fiscal 2004 which resulted in a
decrease in inventories for that period. The $1.3 million increase in equipment
held for resale is related to the GIG contract. The decrease in accounts payable
and accrued liabilities was due mainly to $1 million of leasehold improvements
accrued in the fourth quarter of fiscal 2004 but paid in the first quarter of
fiscal 2005 and $568,000 of accounts payable paid down by the Company's
subsidiaries in Germany. The increase of $2.1 million in advance payments and $2
million in deferred revenue as compared to the same period a year ago were
mainly due to receipts from GIG related to the contract for a card-manufacturing
license, sale of required equipment and for support services.
The Company believes that the estimated level of revenues and advance
payments over the next 12 months will be sufficient to generate cash from
operating activities, including payments due from GIG over the same period.
However, quarterly fluctuations are expected. Operating cash flow could be
negatively impacted to a significant degree if GIG does not make the required
payments as scheduled, or if either of the Company's largest U.S. government
programs were to be further delayed, reduced, 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.
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 $5.9 million net loss recorded for the first nine months
of fiscal 2005, the Company's accumulated deficit increased to $24.2 million.
Stockholders' equity decreased to $29.8 million mainly due to the net loss
recorded and $656,000 of treasury stock resulting from stock repurchases in open
market or privately negotiated transactions.
Net cash used in investing activities was $1.1 million for the first nine
months of fiscal 2005 compared with $812,000 used in investing activities in the
first nine months of fiscal 2004. These amounts include maturities of liquid
investments; purchases of property and equipment of $2.7 million in the first
nine months of fiscal 2005 versus $3.5 million in the first nine months of
fiscal 2004; acquisitions of patents and other intangibles of $90,000 in the
third quarter of fiscal 2005 and $66,000 in the third quarter of fiscal 2004 and
$221,000 for a loan from one of our German subsidiaries to a vendor in the third
quarter of fiscal 2005 to partially fund a business acquisition by the vendor.
The Company made this loan to increase its specialty card business in Germany as
the vendor committed to exclusively purchase cards from the Company's German
subsidiaries for a minimum of three years.
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
24
purchase and reevaluates the classification of investments as of each balance
sheet date. As of December 31, 2004 the Company had $7.3 million classified as
long-term investment, compared with $981,000 and $8.2 million as short-term and
long-term investments at March 31, 2004. All marketable securities are accounted
for as held-to-maturity.
The Company made capital equipment and leasehold improvement purchases of
approximately $2.7 million during first nine months of fiscal 2005 compared with
approximately $3.5 million during the first nine months of fiscal 2004. As of
December 31, 2004, the Company has non-cancelable purchase orders of $110,000
for equipment and $3.1 million for raw materials which will be delivered over 12
months. The Company's current card capacity, assuming optimal card type mix, is
estimated at approximately 16 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 approximately $10 million in additional capital equipment and
leasehold improvement expenditures for card production, read/write drive tooling
and assembly, and general support items as customer orders justify the
investment. These expenditures could occur during the next twelve months. The
Company plans to increase card production capacity for anticipated increases in
orders for Italian National ID Cards and other potential programs.
Net cash used in financing activities was $1.6 million for the first nine
months of fiscal 2005 compared with net cash provided by financing activities of
$11 million for the first nine months of fiscal 2004. Financing activities
consisted of repayments of bank loans and long-term debt in the amount of $1.2
million in the first nine months of fiscal 2005, proceeds of $255,000 on sales
of common stock through the Company's stock plan in the first nine months of
fiscal 2005 compared with $1.4 million in the same period a year ago. In
addition, the Company used $656,000 of cash to repurchase its common stock in
open market or privately negotiated transactions. For the nine-month period
ended December 31, 2003, the Company received $9.5 million of proceeds from sale
of common stock, options and warrants through private placement.
On August 2, 2004, the Company's Board of Directors approved a 350,000
share repurchase program pursuant to which we can make open market or privately
negotiated repurchase transactions for up to an aggregate of $3 million for a
four-month period beginning August 2, 2004. As of December 31, 2004, the Company
has repurchased 91,630 shares of common stock in open market amounting to
$656,000 at an average price of $7.15.
After the quarter ended, on January 6, 2005, a payment of $2.2 million (1.6
million Euro) was made to the Managing Directors of two German subsidiaries to
settle in large part a loan related to the acquisition of these subsidiaries in
March 2004. As of that date, the outstanding balance of $203,000 (150,000 Euro)
is maintained by the Company in case the known contingent claim or other unknown
claims develop into actual claims. The payment was approved on December 2, 2004
by the Company's Board of Directors.
There were no new debt financing activities for the fiscal 2005 third
quarter ended December 31, 2004.
RISK FACTORS AND FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
OUR CURRENT AND FUTURE EXPECTED REVENUES ARE DERIVED FROM A SMALL NUMBER OF
ULTIMATE CUSTOMERS SO THAT THE LOSS OF OR REDUCTIONS IN PURCHASES BY ANY ONE
ULTIMATE CUSTOMER COULD MATERIALLY REDUCE OUR REVENUES AND LEAD TO LOSSES.
During fiscal 2004 and each of the previous two fiscal years, we have derived
more than 90% of our optical memory card and drive-related revenues from four
programs-two U.S. government programs and two foreign government programs. Due
to the lengthy sales cycles, we believe that these programs, with perhaps the
addition of one or two other foreign programs, will be the basis for a
substantial majority of our revenues in the near-term. The loss of or reductions
in purchases by any one customer due to program cutbacks, competition, or other
reasons would materially reduce our revenue base. Our U.S. government
subcontract expires on May 25, 2005. The Company believes this contract will be
extended prior to expiration. There is no assurance that the contract will be
extended or a follow-on contract will be issued by the U.S. government upon
expiration of the current contract. Annual or quarterly losses occur when there
are material reductions, gaps or delays in card orders from our largest U.S. or
foreign government programs or if such programs were to be reduced in scope,
delayed, canceled, or not extended and not replaced by other card orders or
other sources of income.
25
WE HAVE INCURRED NET LOSSES DURING THE PAST EIGHT QUARTERS AND MAY NOT BE ABLE
TO GENERATE SUFFICIENT REVENUE IN THE FUTURE TO ACHIEVE OR SUSTAIN
PROFITABILITY. As of December 31, 2004, we had an accumulated deficit of $24.2
million and we incurred losses of $5.9 million during the first nine months of
fiscal 2005. Although we operated profitably for fiscal 1999 through fiscal
2003, we have incurred significant losses in the past, including in fiscal 1997
and 1998, and we incurred losses in fiscal 2004 and in the first nine months of
fiscal 2005 due primarily to delays in orders for our cards, and additionally in
the third fiscal quarter of fiscal 2004, by the increase in the valuation
allowance we recorded against our deferred tax assets. There can be no assurance
that we will generate enough card revenues in the near term or ever to become
profitable. We are relying upon our optical memory card technology to generate
future product revenues, earnings, and cash flows. If alternative technologies
emerge or if we are otherwise unable to compete, we may not be able to achieve
or sustain profitability on a quarterly or annual basis. Annual or quarterly
losses would also continue if increases in product revenues or license revenues
do not keep pace with increased selling, general, administrative, research and
engineering expenses and the depreciation and amortization expenses associated
with capital expenditures.
OUR PRODUCT REVENUES WILL NOT GROW IF WE DO NOT WIN NEW BUSINESS IN THE U.S. AND
ABROAD. Fiscal 2004 revenues included sales of approximately $5 million of Green
Cards and LaserVisa BCCs, and we expect revenues of $6 million for these
programs in fiscal 2005. The Company expects these revenues could grow to up to
$10 million annually thereafter if the government continues to personalize cards
at that rate and continues to maintain an inventory level equal to six-months of
usage. Other optical memory card programs that are emerging programs or
prospective applications in various countries include identification cards for
Italy and Saudi Arabia; motor vehicle registration cards in India.
For Italy, we delivered cards valued at $7.1 million in the first nine months of
fiscal 2005 for Phase 2 of the Italian CIE card program. We anticipate receiving
orders during fiscal 2005 for one of Italy's new programs, the Permesso di
Soggiorno Elettronico (PSE) card and further orders for the CIE card program. We
do not current have orders for either of these programs and we understand that
there is currently an inventory of CIE cards in Italy waiting to be issued.
There is no assurance that the foregoing government programs will be continued
or implemented as anticipated.
OUR PROGRAM WITH ITALY, WHICH WE BELIEVE WILL BE OUR LARGEST CUSTOMER FOR THE
NEXT FEW YEARS, IS IN AN EXPERIMENTAL STAGE AND MAY BE DELAYED OR CANCELLED FOR
REASONS OUTSIDE OUR CONTROL WHICH WOULD CAUSE US TO HAVE LESS REVENUE THAN
PLANNED AND WOULD LEAD TO CONTINUED LOSSES. The Company believes that the
Italian CIE card program will be our largest customer for the next few years,
comprising a significant portion of future revenues. We are increasing capacity
to meet the anticipated demand. However, since the program is in Phase 2, which
is its second experimental phase, there can be no assurance that demand will
increase as anticipated by the Company. Losses would continue if Phase 3 of this
program, which is full implementation, was to be delayed, canceled, or not
extended and not be replaced by other card orders or other sources of income, or
if the government were to change its technology decisions. During Phase 2,
selected Italian cities have been issuing cards and testing the card issuing
process. The knowledge gained during Phase 2 has resulted in initiatives to
improve the issuing system and to improve the overall performance of the
program. Overcoming some of these issues may be difficult and complex and
involve third parties, which could be time consuming and expensive and lead to
delays for implementation of Phase 3.
ONE VALUE ADDED RESELLER IS THE CONTRACTOR FOR OUR U.S. AND CANADIAN GOVERNMENT
CUSTOMERS AND ANOTHER VALUE ADDED RESELLER PURCHASES CARDS FROM US FOR THE
ITALIAN NATIONAL ID CARD PROGRAM. HAVING TO REPLACE EITHER OF THESE VALUE ADDED
RESELLERS COULD INTERRUPT OUR U.S., CANADIAN, OR ITALIAN GOVERNMENT BUSINESS.
The largest purchaser of LaserCard products has been Anteon International
Corporation, one of our value-added resellers (VARs). Anteon is the government
contractor for LaserCard product sales to the U.S. Department of Homeland
Security, U.S. Department of State, U.S. Department of Defense, and the
government of Canada. Under government contracts with Anteon, the U.S.
Department of Homeland Security purchases Green Cards and U.S. Department of
State purchases LaserVisa BCCs; the U.S. Department of Defense purchases
Automated Manifest System cards; and the Canadian government purchases Permanent
Resident Cards. Encompassing all of these programs, our product
26
sales to Anteon represented 27% of total revenues for the nine-month period
ended December 31, 2004, 72% of total revenues for fiscal 2004 ended March 31,
2004; and 94% of total revenues for fiscal 2003 ended March 31, 2003. However,
since our customers are national governments, we are not dependent upon any one
specific contractor for continued revenues from these programs. Although not
anticipated, if Anteon were to discontinue its participation as contractor,
other qualified contractors could be utilized by those governments for
purchasing our products, although the process of doing so could cause the U.S.
program delays. Concerning Italy, during fiscal 2004, 22% and for the first nine
months of fiscal 2005 33% of the Company's revenues were derived from sales of
cards and read/write drives for the government of Italy for its CIE card
program. Card orders under this program are channeled to the Company through a
VAR, Laser Memory Card SPA, of Rome, Italy. According to Italian government
sources, the distribution of this new national ID card has started in a number
of the 56 Italian communities that were scheduled to be activated under the
program during 2004. If this program were to be discontinued or interrupted by
the Italian government, the Company would lose one of its significant sources of
optical memory card revenues.
ONE OF OUR LARGER ULTIMATE CUSTOMERS, THE U.S. GOVERNMENT, HAS THE RIGHT TO
DELAY ITS ORDERS OR COULD CHANGE ITS TECHNOLOGY DECISIONS, WHICH WOULD RESULT IN
ORDER DELAYS OR LOSSES. Under U.S. government procurement regulations, the
government reserves certain rights, such as the right to withhold releases, to
reduce the quantities released, extend delivery dates, reduce the rate at which
cards are issued, and cancel all or part of its unfulfilled purchase orders. Our
U.S. government card deliveries depend upon the issuance of corresponding order
releases by the government to its prime contractor and, in turn, to us, and we
believe that these orders will continue in accordance with our government
subcontract. Losses would continue if either of our largest U.S. government
programs were to be delayed, canceled, or not extended and not be replaced by
other card orders or other sources of income, or if the government were to
change its technology decisions, or if increases in product revenues or licenses
do not keep pace with increased marketing, research and engineering, and
depreciation on capital equipment. For example, the U.S. government acting
through its prime contractor delayed shipments on its order of Green Cards
earlier this year because of excess inventory, which resulted in a gap in
production of several months, and which in turn significantly affected our
operating results for the first half of fiscal 2005. Any future excess inventory
held by the U.S. government for example due to delayed funding or a slower than
anticipated program volume, or any future changes to the design of the cards may
result in future gaps in orders or production which may negatively impact our
operating results.
U.S. government subcontract release orders for Green Cards and LaserVisa BCCs
represented approximately 16% of the Company's revenue during the first nine
months of fiscal 2005; 44% of the Company's revenue for the entire fiscal 2004;
and 82% of revenues for fiscal year 2003. The percentage declined during the
first half of fiscal 2005 as U.S. government orders decreased due to the U.S.
government's desire to reduce inventory levels, while at the same time orders of
cards from foreign governments increased as planned over prior years' levels and
the Company received revenue from its new German operations. The U.S.
government's agreement with Anteon our VAR expires on May 25, 2005. There can be
no assurance that the U.S. government will enter into a new contract with Anteon
or renew its current contract to purchase our cards, in which case one of our
major sources of revenues would be eliminated.
There is no assurance of continuing read/write drive orders from the U.S.
government. The fiscal 2004 sale of 1,000 drive units for use by the U.S.
government with our Biometric Verification System application software may not
result in similar sales in the future. The system performance, including
biometric verification speed, accuracy, and card reading performance may not
meet government objectives for further system expansion. There is no assurance
that the government will have budgeted sufficient funds to expand the system to
its full potential or that the Company will be successful in winning any new
U.S. government procurements for similar systems or application software.
SINCE THE SALES CYCLE FOR OUR PRODUCTS IS TYPICALLY LONG AND UNPREDICTABLE, WE
HAVE DIFFICULTY PREDICTING FUTURE REVENUE GROWTH. Initial product sales to VARs
for their use or use by their ultimate customers are generally in small
quantities, for evaluation purposes and trial programs. Obtaining substantial,
follow-on orders from these customers usually involves a lengthy sales cycle,
requiring marketing and technical time and expense with no guarantee that
substantial orders will result. This long sales cycle results in uncertainties
in predicting operating results, particularly on a quarterly basis. In addition,
since our major marketing programs involve the U.S. government and various
foreign governments and quasi-governmental organizations, additional
uncertainties and extended sales cycles can result. Factors which increase the
length of the sales cycle include government regulations, bidding procedures,
budget cycles, and other government procurement procedures, as well as changes
in governmental policy-making.
27
THE TIMING OF OUR U.S. GOVERNMENT REVENUES IS NOT UNDER OUR CONTROL AND CANNOT
BE PREDICTED BECAUSE WE REQUIRE A FIXED SHIPMENT SCHEDULE IN ORDER TO RECORD
REVENUE WHEN WE DELIVER CARDS TO A VAULT, OTHERWISE WE RECOGNIZE REVENUE WHEN
THE CARDS ARE SHIPPED OUT OF A VAULT OR WE RECEIVE A FIXED SHIPMENT SCHEDULE
FROM THE GOVERNMENT. We recognize revenue from product sales when the following
criteria are met: (a) persuasive evidence of an arrangement exists; (b) delivery
has occurred; (c) the fee is fixed or determinable; and (d) collectibility is
reasonably assured.
Our U.S. government subcontract requires delivery of cards to a secure vault
built on our premises. Deliveries are made into the vault on a fixed schedule
specified by the government or one of its specified agents. When the cards are
delivered to the vault, all title and risk of ownership are transferred to the
government. At the time of delivery, the prime contractor is invoiced, with
payment due within thirty days. The contract does not provide for any return
provisions other than for warranty. We recognize revenue when the cards are
delivered into the vault because we have fulfilled our contractual obligations
and the earnings process is complete. However, if we do not receive a shipment
schedule for shipment from the vault, revenue is not recognized until the cards
are shipped from the vault. In addition, revenue recognition for future
deliveries into the vault would be affected if the U.S. government cancels the
shipment schedule. As a result, our revenues may fluctuate from period to period
if we do not continue to obtain shipment schedules under this subcontract or if
the shipment schedules are cancelled. We would no longer recognize revenue when
cards are delivered to the vault, but instead such revenue recognition would be
delayed until the cards are shipped from the vault to the U.S. government.
WE COULD EXPERIENCE EQUIPMENT, RAW MATERIAL, QUALITY CONTROL, OR OTHER
PRODUCTION PROBLEMS ESPECIALLY IN PERIODS OF INCREASING VOLUME. There can be no
assurance that we will be able to meet our projected card manufacturing capacity
if and when customer orders reach higher levels. We have made and intend to
continue to make significant capital expenditures to expand our card
manufacturing capacity. However, since customer demand is difficult to predict,
we may be unable to ramp up our production quickly enough to timely fill new
customer orders. This could cause us to lose new business and possibly existing
business. In addition, if we overestimate customer demand, we could incur
significant costs from creating excess capacity. We may experience manufacturing
complications associated with increasing our manufacturing capacity of cards and
drives, including the adequate production capacity for sheet-lamination process
cards to meet order requirements and delivery schedules. We may also experience
difficulties implementing new manufacturing processes or outsourcing some of our
manufacturing. The addition of fixed overhead costs results in lower profit
margins unless compensated for by increased product sales. When purchasing raw
materials for our anticipated optical card demand, we take into consideration
the order-to-delivery lead times of vendors and the economic purchase order
quantity for such raw materials. If we over-estimate customer demand, excess raw
material inventory can result.
IF WE ARE UNABLE TO BUY RAW MATERIALS IN SUFFICIENT QUANTITIES AND ON A TIMELY
BASIS, WE WILL NOT BE ABLE TO DELIVER PRODUCTS TO CUSTOMERS ON TIME WHICH COULD
CAUSE US TO LOSE CUSTOMERS, AND OUR REVENUES COULD DECLINE. We depend on sole
source and limited source suppliers for optical card raw materials. Such
materials include plastic films used in optical memory card production, which
are available from one supplier in the U.S. and from multiple foreign suppliers.
Processing chemicals, inks, and bonding adhesives are obtained from various U.S.
and foreign suppliers. Certain photographic films are commercially available
solely from Eastman Kodak Company, of the United States. No assurance can be
given that Kodak will continue to supply such photographic films on a
satisfactory basis and in sufficient quantities. If Kodak were to discontinue
manufacturing the film from which the Drexon optical stripe is made, we would
endeavor to establish an alternate supplier for such film, although the purchase
price could increase and reliability and quality could decrease from a new
supplier. Considering that the U.S. government is a major end-user of our
optical memory cards, we anticipate that an alternate supplier of these films
could be established and qualified; however, no assurance can be given that
there will be adequate demand to attract a second source. In addition, an
alternate supplier could encounter technical issues in producing the film as
there may be know-how and manufacturing expertise which Kodak has developed over
the years which an alternate supplier may have difficulty to replicate. We have
pre-purchased a long-term supply of the film used to produce mastering loops for
prerecording cards. With regard to the film from which the Drexon optical stripe
is made, we currently have an order which Kodak has accepted with deliveries
28
scheduled through December 2005. If Kodak announced that it was no longer going
to sell film, we would request that Kodak provide us with a last-buy opportunity
which we would plan to take maximum advantage of, although no assurance can be
given that Kodak would provide us with such an opportunity. We have film on hand
plus on order that we believe would provide us with an adequate supply to meet
anticipated demand until we could locate and begin volume purchases from a
second source.
AN INTERRUPTION IN THE SUPPLY OF READ/WRITE DRIVE PARTS OR DIFFICULTIES
ENCOUNTERED IN READ/WRITE DRIVE ASSEMBLY COULD CAUSE A DELAY IN DELIVERIES OF
DRIVES AND OPTICAL MEMORY CARDS AND A POSSIBLE LOSS OF SALES, WHICH WOULD
ADVERSELY AFFECT OUR OPERATING RESULTS. Several major components of our
read/write drives are designed specifically for our read/write drive. For
example, the optical recording head for the current drive is a part obtained
from one supplier; and at current production volumes, it is not economical to
have more than one supplier for this custom component. The ability to produce
read/write drives in high-volume production, if required, will be dependent upon
maintaining or developing sources of supply of components that meet our
requirements for high volume, quality, and cost. In addition, we could encounter
quality control or other production problems at high-volume production of
read/write drives. We are also investing in research and engineering in an
effort to develop new drive products.
IF WE ARE UNABLE TO DEVELOP UPGRADED READ/WRITE DRIVES THAT COST LESS TO
MANUFACTURE AND ALSO A READ-ONLY DRIVE, WE COULD LOSE POTENTIAL NEW BUSINESS.
Prior to fiscal 2002, we had been selling read/write drives for less than three
thousand dollars per unit in quantities of six or more, and these units
generally include our interface software/device drivers. In fiscal 2002, we
reduced the selling price by 20% for these read/write drives for typical
purchase quantities in an effort to develop a broader market and customer base
for LaserCard optical memory cards. Since fiscal 2002, there has not been a
further reduced selling price for these read/write drives. However, in fiscal
2004, we introduced a new drive with a 25% reduction in price for typical
quantities as compared with the previous model. We believe the price of our
drives is competitive in applications requiring a large number of cards per each
drive, because the relatively low cost for our cards offsets the high cost per
drive when compared with our major competition, IC card systems. In addition, we
have undertaken a product development program for a hand-held read-only drive,
which we believe would increase our prospects for winning future business.
However, there can be no assurance that our development program will be
successful, that production of any new design will occur in the near term, or
that significantly lower manufacturing costs or increased sales will result.
IF WE ARE UNABLE TO ADAPT TO TECHNOLOGICAL CHANGES IN THE DATA CARD INDUSTRY AND
IN THE INFORMATION TECHNOLOGY INDUSTRY GENERALLY, WE MAY NOT BE ABLE TO
EFFECTIVELY COMPETE FOR FUTURE BUSINESS. The information technology industry is
characterized by rapidly changing technology and continuing product evolution.
The future success and growth of our business will require the ability to
maintain and enhance the technological capabilities of the LaserCard product
line. There can be no assurance that the Company's products currently sold or
under development will remain competitive or provide sustained revenue growth.
SEVERAL OF OUR FOREIGN PROGRAMS INVOLVE OUR CARDS AS PART OF A SOLUTION WHICH
INCLUDES TECHNOLOGIES OF THIRD PARTIES THAT ARE INTEGRATED BY OUR SYSTEMS
INTEGRATOR CUSTOMER. WE THEREFORE DO NOT HAVE CONTROL OVER THE OVERALL SYSTEM
WHICH COULD LEAD TO TECHNICAL AND COMPATIBILITY ISSUES WHICH ARE DIFFICULT,
EXPENSIVE, AND TIME CONSUMING TO SOLVE. THIS COULD CAUSE OUR GOVERNMENT ULTIMATE
CUSTOMERS TO FIND FAULT IN OPTICAL CARDS AND SWITCH TO OTHER SOLUTIONS EVEN
THOUGH OUR OPTICAL TECHNOLOGY IS NOT THE ROOT CAUSE. In certain of our current
foreign programs such as Italy and Saudi Arabia, and possibly in future other
programs, various third party technologies such as smart chips, RFID chips, and
biometrics will be added to our cards. Our cards are complex environments which
embedding other technologies can disturb which can lead to technical,
compatibility and other issues. The addition of other technologies makes it
difficult to determine whether an error originated with our technology or that
of a co-supplier. These errors, if they occur could be difficult, expensive, and
time-consuming to solve. Such difficulties could lead to our ultimate customers,
the foreign governments, finding fault with optical cards and switching to other
technologies even though optical technology is not the root cause. The resulting
loss of customers would adversely affect our revenues.
29
IF WE FAIL TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, COMPETITORS MAY BE ABLE
TO USE OUR TECHNOLOGIES, WHICH COULD WEAKEN OUR COMPETITIVE POSITION, REDUCE
REVENUES, OR INCREASE COSTS. We use a combination of patent, trademark, and
trade secret laws, confidentiality procedures, and licensing arrangements to
establish and protect our proprietary rights. Our existing and future patents
may not be sufficiently broad to protect our proprietary technologies. Despite
our efforts to protect proprietary rights, we cannot be certain that the steps
we have taken will prevent the misappropriation or unauthorized use of our
technologies, particularly in foreign countries where the laws may not protect
proprietary rights as fully as U.S. law. Any patents we may obtain may not be
adequate to protect our proprietary rights. Our competitors may independently
develop similar technology, duplicate our products, or design around any of our
issued patents or other intellectual property rights. Litigation may be
necessary to enforce our intellectual property rights or to determine the
validity or scope of the proprietary rights of others. This litigation could
result in substantial costs and diversion of resources and may not ultimately be
successful. We cannot predict whether the expiration or invalidation of our
patents would result in the introduction of competitive products that would
affect our future revenues adversely. However, since our technology is now in
the commercial stage, our know-how and experience in volume card production,
system development and software capabilities, brand-name recognition within our
card markets, and dominant-supplier status for optical memory cards are of far
greater importance than our patents. At this time, we believe that our existing
patent portfolio is helpful but is no longer essential for maintaining the
LaserCard's market position.
THE MARKETS FOR OUR PRODUCTS ARE COMPETITIVE, AND IF WE ARE UNABLE TO COMPETE
SUCCESSFULLY, REVENUES COULD DECLINE OR FAIL TO GROW. Our optical memory cards
may compete with optical memory cards that can be manufactured and sold by three
of our licensees (although none is currently doing so) and with other types of
portable data storage cards and technologies used for the storage and transfer
of digital information. These may include integrated circuit/chip cards;
2-dimensional bar code cards and symbology cards; magnetic-stripe cards; thick,
rigid CD-read only cards or recordable cards; PC cards; radio frequency, or RF,
chip cards; and small, digital devices such as data-storage keys, tokens, finger
rings, and small cards and tags. The financial and marketing resources of some
of the competing companies are greater than our resources. Competitive product
factors include system/card portability, interoperability, price-performance
ratio of cards and associated equipment, durability, environmental tolerance,
and card security. Although we believe our cards offer key technological and
security advantages for certain applications, the current price of optical card
read/write drives is a competitive disadvantage in some of our targeted markets.
However, we believe the price of our drives is competitive in applications
requiring a large number of cards per each drive, because the relatively low
cost for our cards offsets the high cost per drive when compared with our major
competition, IC card systems. In countries where the telecommunications
infrastructure is extensive and low cost, centralized databases and wide-area
networks may limit the penetration of optical memory cards. These trends toward
Internet, intranet, and remote wireless networks will in some cases preclude
potential applications for our cards.
THE PRICE OF OUR COMMON STOCK IS SUBJECT TO SIGNIFICANT VOLATILITY. The price of
our common stock is subject to significant volatility, which may be due to
fluctuations in revenues, earnings, liquidity, press coverage, financial market
interest, low trading volume, and stock market conditions, as well as changes in
technology and customer demand and preferences. As a result, our stock price
might be low at the time a stockholder wants to sell the stock. Also, since we
have a relatively low number of shares outstanding, approximately 11 million
shares, there will be more volatility in our stock if one or two major holders,
for example, large institutional holders, attempt to sell a large number of
shares in the open market. There also is a large short position in our stock,
which can create volatility when borrowed shares are sold short and later if
shares are purchased to cover the short position. Furthermore, our trading
volume is often small, meaning that a few trades may have disproportionate
influence on our stock price. In addition, someone seeking to liquidate a
sizeable position in our stock may have difficulty doing so except over an
extended period or privately at a discount. Thus, if one or more stockholders
were to sell or attempt to sell a large number of its shares within a short
period of time, such sale or attempt could cause our stock price to decline.
There can be no guarantee that stockholders will be able to sell the shares that
they acquired at a price per share equal to the price they paid for the stock.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH CHANGES IN FOREIGN CURRENCY EXCHANGE
RATES. Part of the manufacturing process of the LaserCard products that we sell
in Italy takes place in our operations in Germany. Also, some of the raw
materials we use to manufacture optical memory cards are sourced in Europe.
30
These costs are denominated in euros, the currency used in much of Europe.
However, when we sell our finished products the prices that we charge are
denominated in United States dollars. Accordingly, we are subject to exposure if
the exchange rate for euros increases in relation to the United States dollar.
As of December 31, 2004, we had not entered into a forward exchange contract to
hedge against or potentially minimize the foreign currency exchange risk. The
debt in the amount of 1.8 million euros as of December 31, 2004 relating to the
acquisition of Challenge Card Design Plastikkarten GmbH and cards & more GmbH,
of Germany was paid on January 5, 2005.
WE ACQUIRED TWO CARD COMPANIES LOCATED IN GERMANY ON MARCH 31, 2004 AND MAY
ENCOUNTER DIFFICULTIES IN INTEGRATING THEM INTO OUR BUSINESS. We may encounter
unforeseen difficulties in managing Challenge Card Design GmbH and cards & more
GmbH, in which case we may not obtain some of the hoped-for benefits of these
acquisitions, such as expanded manufacturing capacity and establishment of a
significant European presence. Integration of these acquired companies may
result in problems related to integration of technology, management, personnel,
or products. If we fail to successfully integrate these acquisitions or if they
fail to perform as we anticipated, our operations and business could be harmed.
Likewise, if the due diligence and audit of these operations performed by third
parties on our behalf was inadequate or flawed, we could later discover
unforeseen financial or business liabilities. Additionally, in the future we may
evaluate other acquisition opportunities that could provide additional product
or services offerings or technologies. Any recent or future acquisition could
result in difficulties assimilating acquired operations and products, diversion
of capital and management's attention away from other business issues and
opportunities and may result in an expense if goodwill is impaired or other
intangible assets acquired are subsequently determined to be impaired. Goodwill
may become impaired if the acquired German companies cannot demonstrate
sufficient profitability over a reasonable forecast period.
WE ARE CONTINUING TO IMPLEMENT DISCLOSURE CONTROLS AND PROCEDURES AND TO EXTEND
OUR INTERNAL CONTROL OVER FINANCIAL REPORTING TO OUR NEWLY ACQUIRED GERMAN
OPERATIONS. IN ADDITION, WE ARE BEGINNING TO PREPARE FOR OUR ASSESSMENT OF OUR
INTERNAL CONTROL OVER FINANCIAL REPORTING AS OF MARCH 31, 2005, AND THAT OF OUR
INDEPENDENT AUDITORS, BOTH OF WHICH WILL BE CONTAINED IN OUR FISCAL 2005 REPORT
ON FORM 10-K. THESE ASSESSMENTS MAY INDICATE SIGNIFICANT DEFICIENCIES OR
MATERIAL WEAKNESSES IN SUCH INTERNAL CONTROL. SIGNIFICANT DEFICIENCIES OR
MATERIAL WEAKNESSES, IF ANY, IDENTIFIED THROUGH THIS PROCESS WOULD NEED TO BE
CORRECTED BY MANAGEMENT AND COMPENSATING PROCEDURES WOULD NEED TO BE IMPLEMENTED
BY OUR INDEPENDENT AUDITORS IN ORDER FOR THEM TO ISSUE AN UNQUALIFED AUDIT
REPORT. We are continuing to implement disclosure controls and procedures and to
extend our internal control over financial reporting to our newly acquired
German operations. These two private German companies previously had accounted
only to their six shareholders who were also Managing Directors and to German
tax authorities. Other than in connection with their acquisition by the Company,
these companies had not previously prepared financial statements in accordance
with accounting principles generally accepted in the United States of America.
As a result, we have added an experienced Controller, and are continuing the
process of implementing disclosure controls and internal control procedures. The
disclosure controls and internal control procedures used in our German
operations are tailored to their business circumstances and we anticipate that
it will take several months until they are strengthened and made more robust in
order to be comparable to those used in our U.S. operations. We are currently
preparing for our and our auditors' assessment of our internal controls over
financial reporting. This continued implementation in Germany, any changes
required in the U.S., and the overall assessment is a costly and complex task
requiring large amounts of internal personnel resources as well as consultants,
significant management time and attention, and material amounts of training.
Ultimately, we or our outside independent auditors may assess our internal
control over financial reporting as having significant deficiencies, especially
relative to our German operations, which could lead to a determination that our
internal control over financial reporting has a material weakness. Any such
significant deficiency or material weakness, if any, would need to be corrected
by management and our auditors would need to design and utilize compensating
procedures in order to be able to issue an audit report with an unqualified
opinion. Should they be unable to do so, then investor confidence and our stock
price may be adversely impacted as well as our ability to raise future
financing.
WE ARE REQUIRED TO EVALUATE OUR INTERNAL CONTROL OVER FINANCIAL REPORTING UNDER
SECTION 404 OF THE SARBANES-OXLEY ACT OF 2002 AND ANY ADVERSE RESULTS FROM SUCH
31
EVALUATION COULD RESULT IN A LOSS OF INVESTOR CONFIDENCE IN OUR FINANCIAL
REPORTS AND HAVE AN ADVERSE EFFECT ON OUR STOCK PRICE. REPLACING OUR AUDITORS
DURING DECEMBER COMPRESSED THE TIMEFRAME AVAILABLE TO TEST AND REMEDIATE ANY
SO-FOUND DEFICIENCIES IN OUR INTERNAL CONTROLS INCREASING THE PROBABILITY OF
FINDING ISSUES WITH OUR INTERNAL CONTROL WHEN THEY ARE FINALLY EVALUATED.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404),
beginning with our Annual Report on Form 10-K for the fiscal year ending March
31, 2005, we will be required to furnish a report by our management on our
internal control over financial reporting as of our fiscal year end of March 31,
2005. Such report will contain, among other matters, an assessment of the
effectiveness of our internal control over financial reporting as of the end of
our fiscal year, including a statement as to whether or not our internal control
over financial reporting is effective. This assessment must include disclosure
of any material weaknesses in our internal control over financial reporting
identified by management. Such report must also contain a statement that our
auditors have issued an attestation report on management's assessment of such
internal controls.
The Committee of Sponsoring Organizations of the Treadway Commission (COSO)
provides a framework for us to assess and improve our internal control systems.
Auditing Standard No. 2 provides the professional standards and related
performance guidance for auditors to attest to, and report on, management's
assessment of the effectiveness of internal control over financial reporting
under Section 404. Management's assessment of internal controls over financial
reporting requires management to make subjective judgments and, particularly
because Section 404 and Auditing Standard No. 2 are newly effective, some of the
judgments will be in areas that may be open to interpretation and therefore the
report may be uniquely difficult to prepare and our auditors may not agree with
our assessments.
We are still performing the system and process documentation and evaluation
needed to comply with Section 404, which is both costly and challenging. We
recently changed audit firms when our former firm was unable to staff our
account, engaging our new firm in early January 2005. Our internal control
documentation preparation and its evaluation and testing to comply with Section
404 have been delayed, in part due to the staffing issues of our prior auditor.
If we and our new auditors are unable to adequately test our internal controls
prior to March 31, 2005, or if during this process we identify one or more
significant deficiencies or material weaknesses in our internal control over
financial reporting which we are unable to remediate prior to March 31, 2005, we
may be unable to assert such internal control is effective. If we are unable to
assert that our internal control over financial reporting is effective as of
March 31, 2005 (or if our auditors are unable to attest that our management's
report is fairly stated or they are unable to express an opinion on the
effectiveness of our internal controls), we could lose investor confidence in
the accuracy and completeness of our financial reports, which could have an
adverse effect on our stock price.
WE RECENTLY SOLD A SECOND-SOURCE CARD MANUFACTURING LICENSE TO GLOBAL
INVESTMENTS GROUP (GIG), UNDER WHICH WE WILL PROVIDE CERTAIN FACTORY SET-UP AND
TRAINING SERVICES. IF WE ARE NOT SUCCESSFUL OR IF GIG IS UNABLE TO FINANCE THIS
OPERATION, THE SECOND-SOURCE SUPPLY OF OPTICAL CARDS WILL NOT MATERIALIZE. IF WE
AND GIG ARE SUCCESSFUL, THE SECOND-SOURCE WILL COMPETE WITH US FOR BUSINESS. If
GIG is not successful, but current and potential customers require a second
source of optical memory cards (which is a common business practice) they could
decide to use alternate technology cards, such as chip cards, that have
multiple-source suppliers. We are planning to sell to GIG approximately $12
million worth of the required manufacturing equipment and installation support
for its to-be-built new card manufacturing facility in Slovenia, to provide a
targeted initial manufacturing capacity of 10 million optical cards annually. If
successful, this will supply a second source for optical memory cards. We will
also be assigning personnel to be on site during the license term to assist with
quality, security, and operational procedures, with a mutual goal that the
facility and the cards made in Slovenia conform to our standards. If cards are
not produced in conformance with our quality standards, the reputation and
marketability of optical memory card technology could be damaged. If the factory
does not become operational and produce quality cards in high volume, or if GIG
is unable to raise sufficient capital to build, equip and operate this facility,
we would not obtain the hoped-for benefits--including ongoing royalties, sales
of raw materials to GIG, expansion of the European market, and a bona fide
second source for optical memory cards. On the other hand, if and when the
factory is successfully manufacturing the cards in high volume, it will compete
against us for business in certain territories, which could reduce our potential
card revenues if the market does not expand.
WE MAY NOT BE ABLE TO ATTRACT, RETAIN OR INTEGRATE KEY PERSONNEL, WHICH MAY
32
PREVENT US FROM SUCCEEDING. We may not be able to retain our key personnel or
attract other qualified personnel in the future. Our success will depend upon
the continued service of key management personnel. The loss of services of any
of the key members of our management team, including either of our chief
executive officer, president, the managing directors of our German operations,
or our vice president of finance and treasurer, or our failure to attract and
retain other key personnel could disrupt operations and have a negative effect
on employee productivity and morale, thus decreasing production and harming our
financial results. In addition, the competition to attract, retain and motivate
qualified personnel is intense.
OUR CALIFORNIA FACILITIES ARE LOCATED IN AN EARTHQUAKE ZONE AND THESE OPERATIONS
COULD BE INTERRUPTED IN THE EVENT OF AN EARTHQUAKE, FIRE, OR OTHER DISASTER. Our
card manufacturing, corporate headquarters, and drive assembly operations,
administrative, and product development activities are located near major
earthquake fault lines. In the event of a major earthquake, we could experience
business interruptions, destruction of facilities and/or loss of life, all of
which could materially adversely affect us. Likewise, fires, floods, or other
events could similarly disrupt our operations and interrupt our business.
ACTS OF TERRORISM OR WAR MAY ADVERSELY AFFECT OUR BUSINESS. Acts of terrorism,
acts of war, and other events may cause damage or disruption to our properties,
business, employees, suppliers, distributors, resellers, and customers, which
could have an adverse effect on our business, financial condition, and operating
results. Such events may also result in an economic slowdown in the United
States or elsewhere, which could adversely affect our business, financial
condition, and operating results.
33
ITEM 3. QUANTITATIVE AND QUALITATIVE 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 second quarter of fiscal 2005 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. As
of December 31, 2004, the Company had debt relating to the acquisition of
Challenge Card Design Plastikkarten GmbH and cards & more GmbH, of Germany, in
the amount of approximately 1.8 million euros. Accordingly, the Company is
subject to exposure if the exchange rate for euros increases in relation to U.S.
dollars.
On December 2, 2004, the Company's Board of Directors approved a one-time
payment of $2.4 million (Euro 1.8 million) for this debt. A payment of $2.2
million (1.6 million Euro) was made on January 6, 2005. To date, the outstanding
balance of this debt is $203,000 (150,000 Euro). The exchange rate risk related
to this debt is minimal.
As of December 31, 2004, the Company had not entered into a forward
exchange contract to hedge against or potentially minimize the foreign currency
exchange risk. We will continue to evaluate our exposure to foreign currency
exchange rate risk on a regular basis.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. We are continuing to
implement disclosure controls and procedures and to extend our internal control
over financial reporting to our newly acquired German operations. These two
private German companies previously had accounted only to their six shareholders
who were also Managing Directors and to German tax authorities. Other than in
connection with their acquisition by the Company, these companies had not
previously prepared financial statements in accordance with accounting
principles generally accepted in the United States of America. As a result, we
have added an experienced Controller and we have instituted disclosure controls
and internal control procedures in an environment where few existed previously
and in which the existing personnel have no experience in operating a business
using the newly instituted controls and procedures. Therefore, the disclosure
controls and procedures used in our German operations are tailored to their
business circumstances and we anticipate that it will take several months until
they are strengthened and made more robust in order to be comparable to those
used in our U. S. operations. 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-15(e) and 15d-15(e)) as of the
end of the period covered by this Form 10-Q and have determined that they are
reasonably effective taking into account the totality of the circumstances,
including those described as to our German operations.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. As described above,
the Company is in the process of extending its internal controls from the U.S.
to its newly acquired German operations. Otherwise, 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.
34
PART II. OTHER INFORMATION
Item 1. - Legal Proceedings
None
Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. - Defaults Upon Senior Securities
None
Item 4. - Submission of Matters to a Vote of Security Holders
None
Item 5. - Other Information
None
Item 6. - Exhibits
Exhibit No. Exhibit Description
----------- -------------------
3.1 Amended and Restated By-Laws as of November 30, 2004.
The amendments affected Article IV, Officers
resulting from the elimination of co-chief executive
officers.
31.1 Rule 13a-14(a) Certification of Richard M. Haddock,
chief executive officer
31.2 Rule 13a-14(a) Certification of Steven G. Larson,
chief financial officer
32.1 Section 1350 Certification of Richard M. Haddock,
chief executive officer
32.2 Section 1350 Certification of Steven G. Larson, chief
financial officer
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.
35
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:
LASERCARD CORPORATION
(Registrant)
Signature Title Date
--------- ----- ----
/s/ Richard M. Haddock Chief Executive Officer February 8, 2005
- ----------------------------
Richard M. Haddock
/s/ Steven G. Larson Chief Financial Officer February 8, 2005
- ----------------------------
Steven G. Larson
36
INDEX TO EXHIBITS
[ITEM 14(c)]
Exhibit
Number Description
- ------ -----------
3.1 Amended and Restated By-Laws as of November 30, 2004. The amendments
affected Article IV, Officers resulting from the elimination of
co-chief executive officers.
31.1 Rule 13a-14(a) Certification of Richard M. Haddock, chief executive
officer
31.2 Rule 13a-14(a) Certification of Steven G. Larson, chief financial
officer
32.1 Section 1350 Certification of Richard M. Haddock, chief executive
officer
32.2 Section 1350 Certification of Steven G. Larson, chief financial
officer
37