UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[Mark One] FORM 10-K/A
(Amendment No. 1)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from to
----- -----
Commission File Number: 000-6377
DREXLER TECHNOLOGY CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 77-0176309
- ------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1077 Independence Avenue, Mountain View, CA 94043-1601
- ------------------------------------------- -------------------------------
(Address of principal executive offices) (Zip Code)
(650) 969-7277
----------------------------------------------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None None
- ------------------------------- -------------------------------
(Title of each class (Name of each exchange
so registered) on which registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
----------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). [X] Yes [ ] No
Based on the last trade price of the Company's Common Stock on The Nasdaq Stock
Market on June 6, 2003, the aggregate market value of the voting stock held by
non-affiliates of the registrant is approximately $205,378,000.
Number of outstanding shares of Common Stock, $.01 par value, at June 6, 2003:
10,538,608
THE ANNUAL MEETING OF STOCKHOLDERS OF DREXLER TECHNOLOGY CORPORATION
WILL BE HELD ON OCTOBER 10, 2003.
DOCUMENTS INCORPORATED BY REFERENCE: NONE
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business
Forward-Looking Statements................................................................................. 3
General Development of Business............................................................................ 4
Financial Information about Segments....................................................................... 5
Narrative Description of Business.......................................................................... 5
LaserCard(R)Optical Memory Cards........................................................................ 5
Optical Data Storage................................................................................. 5
The Drexon(R)Laser Recording Medium.................................................................. 5
LaserCard Digital Governance Applications............................................................ 6
Reading and Writing the Cards........................................................................ 6
Data Storage Capacity................................................................................ 7
Prerecording......................................................................................... 7
Card Durability...................................................................................... 7
Card Security........................................................................................ 7
International Card Standards......................................................................... 9
Card Manufacturing and Raw Materials................................................................. 10
Product Evolution.................................................................................... 10
Marketing............................................................................................ 10
APIs and Application Software........................................................................ 11
Read/Write Drives; Manufacturing and Parts/Components................................................ 12
LaserCard Biometric ID Verification System........................................................... 12
Peripheral Equipment................................................................................. 12
Licensing............................................................................................... 13
Competition............................................................................................. 13
Other Matters........................................................................................... 15
Research and Engineering Expenses.................................................................... 15
Patents and Trademarks............................................................................... 15
Employees............................................................................................ 16
Dependence on Government Subcontracts through a Sole Contractor...................................... 16
Backlog.............................................................................................. 16
Financial Information about Geographic Areas......................................................... 17
Factors that May Affect Future Operating Results........................................................ 17
Item 2. Properties..................................................................................................... 20
Item 3. Legal Proceedings.............................................................................................. 21
Item 4. Submission of Matters to a Vote of Security Holders............................................................ 21
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters....................................... 21
Item 6. Selected Financial Data........................................................................................ 22
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................... 23
Critical Accounting Policies............................................................................... 24
Restatement of Results for Fiscal 1998-2001 and First Nine Months of Fiscal 2002........................... 25
Results of Operations-Fiscal 2003 Compared with Fiscal 2002 and Fiscal 2001................................ 26
Liquidity and Capital Resources............................................................................ 30
Item 7A. Qualitative and Quantitative Disclosures about Market Risk..................................................... 31
Item 8. Consolidated Financial Statements and Supplementary Data....................................................... 32
Reports of Independent Accountants......................................................................... 32
Consolidated Financial Statements.......................................................................... 34
Notes to Consolidated Financial Statements................................................................. 38
Quarterly Financial Information (Unaudited)................................................................ 47
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................... 48
PART III
Item 10. Directors and Executive Officers of the Registrant............................................................. 49
Item 11. Executive Compensation......................................................................................... 50
Item 12. Security Ownership of Certain Beneficial Owners and Management................................................. 52
Item 13. Certain Relationships and Related Transactions................................................................. 55
PART IV
Item 14. Controls and Procedures........................................................................................ 55
Item 15. Exhibits, Financial Statement Schedule, and Reports on Form 8-K................................................ 56
Signatures ............................................................................................................... 60
2
EXPLANATORY NOTE
This Amendment No. 1 on Form 10-K/A amends Drexler Technology
Corporation's (the Company's) Annual Report on Form 10-K for the fiscal year
ended March 31, 2003, as initially filed with the Securities and Exchange
Commission (SEC) on July 11, 2003. This amendment is being filed in order to
expand the discussion under "Critical Accounting Policies" of the Company's
accounting for income taxes and inventory in response to comments received from
the SEC staff; to add Footnote 9 to the consolidated financial statements which
was inadvertently omitted; to reflect the change in the Company's planned annual
meeting date on the cover page; to make a few other minor corrections in various
places; and to update Item 14 and the certifications of the chief executive and
financial officers in light of intervening SEC rules.
2-A
PART I
------
ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS. All statements contained in this report that
are not historical facts are forward-looking statements. The forward-looking
statements in this report are made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. They are not historical facts
or guarantees of future performance or events. Rather, they are based on current
expectations, estimates, beliefs, assumptions, and goals and objectives and are
subject to uncertainties that are difficult to predict. As a result, the
Company's actual results may differ materially from the statements made. Often
such statements can be identified by their use of words such as "may," "will,"
"intends," "plans," "believes," "anticipates," "visualizes," "expects," and
"estimates." Forward-looking statements made in this report include statements
as to current and potential customers, applications, orders, or market segments
for optical memory card products; statements as to anticipated orders and/or
shipment quantities and schedules under the Company's U.S. government and
Canadian government subcontracts; the Company's expectation that it will be
awarded a contract for approximately 1,000 read/write drives under the U.S.
Department of Homeland Security's Presolicitation Notice and the expectation
that there will be demand for the Company's cards and read/write drives under
Italian government card programs; the Company's belief that the U.S. government
intends to field optical card-based biometric verification systems on the
southern U.S. border and at certain U.S. airports; the objectives of the Company
in its efforts to sell read/write drives; the need for, expected success of, and
potential benefits from the Company's research and engineering efforts,
including developing new or enhanced card capabilities, software products,
production-model read-only drives, or drives with advanced security features or
lower manufacturing costs; whether introduction of new drives will increase
sales, and the effects of read/write drive prices and sales volume on gross
profits or gross margins from read/write drive sales; the Company's estimates
for the level of sales of drives that would be necessary to achieve a gross
profit at current prices inclusive of fixed overhead costs; expectations
regarding the market for read/write drives and read/write drive prices; the
Company's belief that it has an adequate inventory of read/write drives and
components; the Company's efforts to recruit new value-added resellers (VARs) or
licensees; the adequacy of card raw material inventory on hand to meet future
demand; the Company's belief that Kodak will continue to supply sufficient
photographic film and that an alternate supplier could be established if needed;
the Company's ability to expand production capacity; anticipated release orders
and deliveries under the Company's U.S. government subcontract; expectations
regarding revenues, margins, capital resources, capital expenditures and
investments, and the Company's deferred tax asset and related valuation
allowance; anticipated reductions of federal tax cash payments due to current
Company tax benefits; statements as to expected card delivery volumes; estimates
of optical card production capacity, expected card yields therefrom, and the
Company's plans and expectations regarding the growth and associated capital
costs of such capacity; estimate that revenues will be sufficient to generate
cash from operations; the Company's expectation that it will retain any earnings
for use and reinvestment in its business; expectations regarding market growth,
product demand, and foreign business including emerging programs or prospective
applications in China, India, Italy, Macedonia, and Saudi Arabia; and
expectations as to continued, or expanded, or potential U.S. government or other
governmental card programs.
These forward-looking statements are based upon the Company's assumptions
about and assessment of the future, which may or may not prove true, and involve
a number of risks and uncertainties including, but not limited to, customer
concentration and reliance on continued U.S. government business; the
possibility that the U.S. government will not field optical card-based biometric
verification systems on the southern U.S. border and at certain U.S. airports;
lengthy sales cycles; changes in and reliance on government policy-making; the
risks associated with doing business in and with foreign countries, the impact
of litigation or governmental or regulatory proceedings; the ability of the
Company or its customers to initiate and develop new programs utilizing the
Company's card products; the Company's reliance on VARs, licensees, or other
third parties to generate sales, perform customer system integration, develop
application software, or integrate optical card systems with other technologies;
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 and outsourcing manufacturing; ability to produce and sell read/write
drives in volume; reliance on single-source and limited-source suppliers for
certain components and raw materials; 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 schedule,
notification, or plan for shipments out of the government-funded vault located
on the Company's premises, enabling the Company to recognize revenues on cards
delivered to the vault instead of when cards later are shipped from the vault;
the U.S. government's rights to modify or withdraw its reader/writer equipment
Presolicitation Notice or to award any resulting contract, reduce the quantities
released, and extend delivery dates; the impact of technological advances,
general economic trends, and competitive products; and the risks set forth in
the section entitled "Factors That May Affect Future Operating Results" and
elsewhere in this report. Due to these and other risks,
3
the Company's future actual results could differ materially from those discussed
above. 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.
TRADEMARKS. LaserCard(R) and Drexon(R) are the Company's registered
trademarks. Smart/Optical(TM) card, LaserCard(R) ConciergeCard(TM), and
LaserBadge(TM) are the Company's trademarks. The Company may also refer to
trademarks of other corporations and organizations in this document.
GENERAL DEVELOPMENT OF BUSINESS
Headquartered in Mountain View, California, Drexler Technology Corporation
develops, manufactures, and markets optical data storage products and systems
featuring LaserCard(R) optical memory cards and chip-ready Smart/Optical(TM)
cards. Drexler-made LaserCard(R) optical memory cards are used for digital
governance applications such as immigration, border crossing visas, cargo
manifests, motor vehicle registration, multi-biometric identification (ID)
cards, and other digital read/write card applications. LaserCard Systems
Corporation (LSC), a wholly owned subsidiary of Drexler Technology Corporation,
makes optical card read/write drives, develops optical card software, and
markets optical cards, read/write drives, and related systems.
Drexler Technology Corporation was incorporated under the laws of the State
of California on July 23, 1968, and was reincorporated as a Delaware corporation
on June 24, 1987. The Company's mailing address and executive offices are
located at 1077 Independence Avenue, Mountain View, California 94043, and the
telephone number is (650) 969-7277. Throughout this report, the "Company,""we,"
and "us" refer to Drexler Technology Corporation and subsidiaries, unless
otherwise indicated.
The Company's annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those reports can be obtained
free of charge after such material is electronically filed with or furnished to
the Securities and Exchange Commission (SEC). These documents are available as
soon as reasonably practicable on the Company's website,
"www.drexlertechnology.com" via a hypertext link to the SEC's website. They also
may be obtained directly from the SEC's website,
"www.sec.gov/edgar/searchedgar/companysearch.html" under CIK code 30140. In
addition, these documents are posted on the Company's website
"www.drexlertechnology.com" within two business days after being filed with or
furnished to the SEC.
The LaserCard optical memory card is an updatable, laser recordable,
computer readable, credit-card sized, data storage card--invented, patented,
developed, and manufactured by the Company. It contains a reflective stripe of
laser-recording material called Drexon(R), a Company invention. Along with its
ability to record, update, and store up to 4.1 megabytes of digital data (2.86
megabytes of user data), this unique card offers multiple data-security
features, can be carried in a wallet, and is highly resistant to counterfeiting
and data tampering. This makes the LaserCard ideal for portable, recordable,
secure, cumulative data storage.
The Company's LaserCard product line currently consists of optical memory
cards, optical card read/write drives, optical card systems, chip-ready hybrid
Smart/Optical(TM) cards, and related software and peripherals. Target markets
are domestic and foreign government programs; identification cards; and medical,
transportation, pay-per-use, and electronic commerce applications, among others.
The Company's products are sold mainly through value-added reseller (VAR)
companies and card-distribution licensees that develop commercial applications
for LaserCard products. Company revenues also include fees from the occasional
sale of patent licenses.
Originally a supplier of photomasks to the semiconductor industry, the
Company transitioned its business into optical memory cards over a number of
years of research, product development, production engineering, marketing, and
licensing. After several years of moderate-sized orders, the breakthrough order
for LaserCard optical memory cards came in February 1997 in the form of a $7.1
million order for Permanent Resident Cards (Green Cards) under a subcontract
where the United States Immigration and Naturalization Service (INS) was the
ultimate customer. This initial order was followed by a series of additional
multi-million-dollar order releases under subcontracts for INS Green Cards and
U.S. Department of State "Laser Visa" Border Crossing Cards (BCCs). In June
2000, the Company was awarded a U.S. government subcontract for a minimum of 1
million cards and a maximum of 24 million Green Cards and Laser Visa BCCs over a
period of up to five years. Under this five-year subcontract, having an
authorized maximum of $81 million, successive order releases have been received
by the Company, under which 11 million cards have been sold as of March 31,
2003.
Through March 31, 2003, the Company has manufactured and sold over 20
million of its LaserCard optical memory cards for U.S. government programs. In
early 2003, the INS became part of the newly formed U.S. Department of Homeland
Security (DHS), which is now the ultimate customer under the Company's
subcontract for Green Cards and Laser Visa Border Crossing Cards.
4
In addition, the U.S. Department of Defense has employed the LaserCard
since 1993 in its Automated Manifest System, now used for both Army and Marine
military cargo shipments. In mid-2002, the Canadian government began issuing the
Company's optical memory cards as the new Canadian "Maple Leaf" Permanent
Resident Card.
Applications for the LaserCard include the following:
o United States Permanent Resident Card (Green Card)
o United States Department of State Laser Visa Border Crossing Card (BCC)
o United States Department of Defense Automated Manifest System Card
o Government of Canada "Maple Leaf" Permanent Resident Card
o Anticipated Italian national ID card for citizens and permanent
resident card for non-citizens
o Trial programs involving medical record cards, permits, and vehicle
registration cards
For the fiscal year ended March 31, 2003, the Company sold approximately
7.3 million LaserCard optical memory cards. The Company's card manufacturing
facilities, located in Mountain View, California, permit expansion of card
production capacity in steps, using both roll- and sheet-manufacturing
processes. See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations," regarding current card production
capacity.
For a discussion of the risk factors related to the Company's business
operations, see the "Forward-Looking Statements" narrative at the beginning of
this report, the "Factors That May Affect Future Operating Results" at the end
of this section, and the "Management's Discussion and Analysis of Financial
Condition" contained in Item 7.
FINANCIAL INFORMATION ABOUT SEGMENTS
The Company operates in only one industry segment. See "Segment Reporting"
in footnote 2 in Item 8, "Consolidated Financial Statements and Supplementary
Data," for additional industry segment information.
NARRATIVE DESCRIPTION OF BUSINESS
LASERCARD(R)OPTICAL MEMORY CARDS
Optical Data Storage
Optical data storage systems use a beam of laser light to write and read
information. This information is stored digitally in a binary code of "1" or "0"
bits that are represented by either the presence or absence of a physical "spot"
on the recording surface. The difference in reflectivity between the background
surface and the individual spot is measured by a light-sensing device and
converted into an electrical signal. These signals are then translated by a
microprocessor into text, graphics, sound, and pictures (which can include
facial images and other biometric identifiers). Using optical data storage, a
large amount of data can be stored on a relatively small surface area since the
digital data spots are microscopic in size.
The Drexon(R) Laser Recording Medium
The Drexon(R) laser recording medium was invented and patented by the
Company for optical data storage. It consists of a thin, organic film or
colloidal matrix that contains a thin layer of microscopic silver particles.
Using proprietary and patented processes, the Drexon material is produced by
chemical conversion of photographic emulsions, creating a reflective recording
surface. As described under "Prerecording," Drexon allows data to be laser
recorded, prerecorded using photolithography, or both.
The Drexon medium is DRAW (direct-read-after-write). DRAW media permit data
to be read immediately after laser recording--for instantaneous checking of
information. Data can be laser written onto the Drexon material at any time
(over a period of weeks, months, or years) but data can be written in a specific
location on the medium only once (write once). After an area is recorded,
software prevents that same location from being overwritten with new data.
Obsolete data can be ignored by the system but remains permanently stored on the
Drexon optical card as an audit trail of all changes. New or revised information
is recorded in a new location. Through these procedures, the card is easily
updatable.
5
Thus, although the Drexon material is not physically erasable like magnetic
storage media, Drexon can be corrected and updated at any time and has the
important audit trail feature that magnetic media do not have. Data can be read
at any time (read many times), allowing access to newly recorded data and to the
audit trail. The permanent audit trail inhibits data tampering and is of
fundamental importance for high security identification card applications.
To form LaserCard optical memory cards, the Drexon laser recording material
is encapsulated within layers of polycarbonate plastic (laminated using
electron-beam equipment) and then die cut into card shape. The resulting
LaserCard conforms to international card standards for size, thickness, and
flexibility. The average wholesale price to VARs per card is under $5 when the
cards are ordered in hundreds of thousands, and even lower in cost when larger
quantities of basic cards are ordered.
LaserCard(R) Digital Governance Applications
To date, the most widespread use of LaserCard technology has been in
programs involving digital governance, defined as facilitating or expediting the
process of governing by documenting the grant of certain rights to citizens
and/or non-citizen permanent residents. The counterfeit- and tamper-resistant
cards are consumable products because they typically are replaced when the
rights conveyed by the cards expire. The following are examples of digital
governance cards:
o The current U.S. Green Card, or Permanent Resident Card, made by the
Company and issued by the Department of Homeland Security, evidences
that a foreign worker is approved to reside and be employed in the
United States.
o The current Laser Visa Border Crossing Card, made by the Company and
issued by the United States Department of State, permits Mexican
citizens to visit and shop in the United States (within 25 miles of
the U.S. border) for up to 72 hours.
o The current Canadian "Maple Leaf" Permanent Resident Card made by the
Company has been issued by the Government of Canada since mid-2002 to
confirm Canadian permanent resident status and as a safe proof of
status document for permanent residents re-entering Canada by
commercial carrier after international travel
(http://www.cic.gc.ca/english/pr-card/prc-about.html).
o In a planned national ID card application in Italy, the LaserCard
would identify the holder as a citizen and confer upon the holder the
rights and privileges to which a citizen is entitled. Another
potential LaserCard digital governance card program is an Italian
permanent resident card for non-citizens.
o Two of India's 26 states have issued requests for proposals related to
smart optical cards for motor vehicle registration for the purpose of
inhibiting motor vehicle theft and preventing operators of trucks and
buses from making counterfeit licenses.
o The U.S. Department of Defense uses the LaserCard as a paperless cargo
manifest in its Automated Manifest System for governing and
facilitating the shipment of military cargo to Army and Marine
deployments.
Reading and Writing the Cards
The optical card read/write drive contains a low-power, semiconductor diode
laser for writing (10.0 milliwatts) and reading (0.5 milliwatts) of data. The
laser is about the size of a thumbtack. The read/write drive is connected to a
personal computer as an external small computer system interface (SCSI) device
or via SCSI to a universal serial bus (USB) interface cable. Information is
recorded when the read/write drive focuses the laser beam through the upper
clear layer of the card, forming microscopically small spots in linear tracks on
the Drexon material. The recorded spots represent digital data, the language of
computers. Since the read/write drive is connected to a PC, data can be entered
onto the LaserCard via computer keyboard, from the computer's memory, from the
Internet, and from intranet computer networks.
6
Data Storage Capacity
A byte is a unit of computer storage--the amount of memory needed to store
a single number or letter. A kilobyte is 1,024 bytes. A megabyte is 1,024
kilobytes (or 1,024 x 1,024 bytes = 1,048,576 bytes). The data storage capacity
of the standard LaserCard is 4,100 kilobytes, or 4.1 megabytes, explained as
follows. The LaserCard's data storage capacity is determined by the spot size,
track pitch, and width of the Drexon optical stripe used in the card. The
standard spot size is 2.5 microns and the standard track pitch is 12 microns. A
micron is 1/1,000 of a millimeter, or about 1/75 the width of a human hair. (The
smallest size spot the human eye can see is about 20 microns.) Two card products
conforming to international standards are manufactured by the Company: a
16-millimeter stripe LaserCard (1.5 megabyte capacity) and a 35-millimeter
stripe LaserCard (4.1 megabyte capacity). The LaserCard is the size of a
conventional credit card.
A significant portion of the LaserCard's total data capacity is used for an
error detection and correction, or EDAC, algorithm. EDAC is routinely used in
various data storage and transfer methods to compensate for data errors
resulting from transmission errors, surface scratches above the recording
material, or contamination such as dust or fingerprints. EDAC is automatically
added to data written onto the LaserCard, to achieve written data error rates of
less than one in a trillion.
The resulting data storage capacities are 2.86 megabytes of "user" capacity
for the standard 4.1 megabyte LaserCard and 1.1 megabytes of "user" capacity for
the 1.5 megabyte LaserCard. The 16-millimeter stripe LaserCard with 1.1
megabytes of user capacity can be employed in conjunction with a
microcontroller/microprocessor chip to create a hybrid smart card, which the
Company calls a Smart/Optical(TM) card.
The amount of data that can be stored on the LaserCard varies depending
upon the type of digital file, file compression algorithm, formatting
parameters, and data encoding sector size. Typically, a 2.86 megabyte LaserCard
can store more than 1,200 digital text pages or 200 scanned text pages. If the
LaserCard is used in a transaction-based application, more than 35,000
transactions could be recorded. The 2.86 megabyte LaserCard has approximately
one hundred times the storage capacity of a 32 kilobyte integrated circuit (IC)
smart card and over 10,000 times the capacity of a magnetic-stripe card.
Prerecording
Another feature of the LaserCard is its recordability both during and after
the card manufacturing process. Since photographic film is the base material
from which Drexon is made, photolithography is used during the manufacturing
process to prerecord optical digital data, graphics, and formatting such as
tracks and other indicia, while the film is still photosensitive. Later, after
the film is chemically processed to become Drexon media and is made into cards,
data can be laser recorded or updated at any time--even over a period of years.
Card Durability
Unlike most other types of digital storage media, the LaserCard can be
manufactured to withstand temperatures of 100(Degree)C (212(Degree)F) for
extended periods. Additionally, its ability to withstand flexure exceeds that of
conventional credit cards and far surpasses chip cards. Because the Drexon
material is a nonvolatile data storage medium, it is not vulnerable to data loss
or damage when exposed to X rays, static electricity, application of voltage, or
other electromagnetic interference.
Testing has indicated that, when protected by an appropriate envelope, the
LaserCard is not normally damaged by the usual dust particles, grime, and
scratches common to other types of cards carried in a wallet environment. The
ISO/DELA Standard (discussed below) uses a pit center data detection scheme for
the highest reliability in reading and writing, coupled with a powerful EDAC
code to maximize the life of the LaserCard.
The longest running LaserCard programs have been the U.S. Department of
Defense "Automated Manifest" card (since 1993) and the VISX, Incorporated eye
surgery system VisionKey(R) card (since 1992).
Card Security
The level of data security used with the LaserCard would depend upon the
type of application. Very high security features are required for
government-issued ID cards, visas, immigrant work permits, licenses or permits,
and for the protection of confidential information such as medical records and
other personal data. The LaserCard's relatively high storage capacity
accommodates the use of multiple, nonerasable, security safeguards in addition
to holding all of the user data and an audit trail. These security measures
include eye readable and computer readable security features to enhance data
security, confidentiality, and resistance to counterfeiting and data tampering.
7
The LaserCard is a multiple-security-feature, digital identity card
solution that offers customers the capability of utilizing all or any
combination of the following security features on the same card:
o It can be upgraded time and again to deter data tampering and
high-tech counterfeiters.
o It can store PC-readable (digitized) text and multiple
biometrics--face photographs, signatures, fingerprints, hand scans,
iris or retina scans, and other biometrics (simultaneously).
o It can permanently contain an "audit trail" of all digital data
recorded on the card--even data that is thought to be "erased" by the
user.
o It can utilize a patented process of uniquely laser-engraving an
"eye-readable" image of the cardholder's face, biographic data,
signature, document number, and card expiration date.
o It can have a unique, laser-engraved, sequential identification
number.
o It can store precise, high-resolution microimages during the card
manufacturing process--for example, images of all U.S. presidents and
all state flags, which the Company does for Department of State and
Department of Homeland Security cards.
o It can store digital certificates, digital signatures, and public and
private cryptographic keys based upon public key infrastructure for
use with the Internet, intranets, or extranets for verifying identity.
o It can contain an optically variable device for card authentication.
BIOMETRICS, DIGITIZED PHOTOS, PINS, AND DEDICATED SYSTEMS. Various
computer-readable security safeguards that can be used with the LaserCard
optical memory card include multiple biometric identifiers on the same
card--such as digitized iris or retina scans, signatures, fingerprints, and hand
geometries; digitized color photographs; biographic data; and one or more
personal identification numbers (PINs). Combinations of these and other security
features can be recorded onto the card when it is initialized by the card
issuer, for later authentication of the card when it is in actual use. Also, the
Company can factory-prerecord dedicated interface codes onto the cards' embedded
optical memory stripe so that cards without these codes will not function in
dedicated equipment, or vice versa.
With its multi-biometric data capability, the LaserCard's 2.8 megabyte
(2,800 kilobyte) storage capacity exceeds the requirements needed for the
following multi-biometric ID standards:
o U.S. National Institute of Standards and Technology's (NIST) February
11, 2003 requirements for two fingerprints (10 kilobytes each) and a
10-kilobyte facial image (total of 30 kilobytes) of data storage.
o The International Biometrics group recommends the capture of iris,
face, and fingerprint biometrics from visa applicants.
o The International Commercial Aviation Organization (ICAO) recommends
10 fingerprints, face, and iris biometrics, requiring about 250
kilobytes of data storage.
United States Green Cards and Laser Visa BCCs and Canadian "Maple Leaf"
Permanent Resident Cards contain biometrics in the form of machine-readable
fingerprints and/or digitized face photographs stored on the LaserCard's optical
stripe for biometric comparison with the card holders. Target applications such
as the proposed national ID card and permanent resident card for Italy and other
secure ID card applications are also expected to carry biometric identifiers on
the cards.
DATA SEGMENTATION, SECURITY SOFTWARE, AND ENCRYPTION. If desired, data
storage on the LaserCard can be segmented by type of information stored (for
example, patient records separated from insurance information or pharmacy
records) so that access to each type of data can be controlled separately.
Further, for applications that warrant cryptography, all data can be recorded
onto the LaserCard using data encryption algorithms. The Company's hybrid,
chip-ready Smart/ Optical(TM) card--with a microprocessor and over 1 megabyte of
updatable optical memory--could be used to store digital signatures, digital
certificates, and cryptographic keys such as public key infrastructure for
Internet e-commerce, as well as multi-application programs and software
upgrades.
8
AUDIT TRAIL. Because the LaserCard contains an updatable, nonvolatile WORM
memory (write-once, read-many times) that is recorded permanently, the card can
hold a complete audit trail of data, changes, updates, and deletions. This can
be achieved using software--to allow access to previously recorded files and, if
desired, to record all attempts to access data from the LaserCard.
MATCHING, EYE READABLE IMAGES. The LaserCard uniquely offers this key
security feature for maximum counterfeit-resistance. Cardholder-specific
information (typically, the cardholder's face photograph, name, signature,
number, or other identifying information) is laser-engraved onto the card's
reflective stripe (through the card's protective transparent polycarbonate
layer). These laser-engraved visual images provide an ultra-secure, matching
reference to the identical cardholder-specific image thermally printed elsewhere
on the card. These permanent, eye readable images are recorded when the card is
issued, using a specially programmed, standard optical card read/write drive.
The United States Department of Homeland Security and Department of State both
currently use this visual image technology with the Company's cards. For
checking of cards at the United States/Mexico border, the eye-readable,
laser-engraved images facilitate the immigration inspectors' job of visually
verifying cards if automated verification systems are not available.
MICROPRINTING, THERMAL PRINTING, AND OTHER SECURITY ADD-ONS. Using
photolithography, microimages (readable with magnifiers) can be factory
prerecorded onto the LaserCard's optical stripe as further deterrents against
counterfeiting. Examples include complex optical watermarks, emblems, seals, and
logos. Later, using digital identification technology and commercially available
thermal printers, visual data and images can be thermally printed directly onto
the back of the LaserCard at the time the card is initialized (i.e., during card
issuance). Visual data could include the cardholder's name and address, a face
photograph (in full color or black and white), signature, or other information.
Various other security options that can be added to the LaserCard include
conventional holograms, OCR-B (optical character recognition), bar codes, serial
numbers, etc.
International Card Standards
Standardization of optical memory cards allows interchange of the digital
information encoded on the cards and facilitates compatibility among optical
memory card systems. The Company participates in optical card standards
activities in the United States and internationally. The standard format under
which the Company's optical memory cards operate is called the DELA Standard (so
named by the Drexler European Licensees Association). Shown below is the current
status of optical memory card standards under ISO/IEC (the International
Organization for Standardization/International Electrotechnical Committee) and
ANSI (the American National Standards Institute). The LaserCard optical memory
card system, featuring the DELA Standard format, complies with all of the
documents listed.
o ISO/IEC 11693 (2000) describes the general characteristics of optical
memory cards. This approved international standard was first published
in 1994.
o ISO/IEC 11694-1 (2000) describes the physical characteristics of the
card, such as height, width, thickness, etc. This approved
international standard was first published in 1994.
o ISO/IEC 11694-2 (2000) describes the dimensions and location of the
accessible area--the area on the card where data writing/reading
occurs. This approved international standard was first published in
1995.
o ISO/IEC 11694-3 (2001) describes the optical properties and
characteristics of the card and provides the technical specifications
which allow interchange. This approved international standard was
published in 1995.
o ISO/IEC 11694-4 (2001) describes the logical data structure on the
card and defines the method of writing and reading card data. This
approved international standard was published in 1996.
o In the United States, ANSI has adopted all of the above ISO Standards
as ANSI/ISO Standards.
9
Card Manufacturing and Raw Materials
LaserCard optical memory cards are manufactured by the Company in Mountain
View, California. The Company sold approximately 7.3 million cards in fiscal
2003, 5.6 million cards in fiscal 2002, and 5.9 million cards in fiscal 2001.
The optical memory card manufacturing facilities permit incremental expansion of
production capacity. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" regarding card production
capacity.
To maintain adequate raw material supplies for the manufacture of optical
memory cards, the Company attempts to establish ongoing relationships with
principal suppliers and obtains information about alternate suppliers. The
Company maintains raw materials inventory levels that take into account current
expected demand, order-to-delivery lead times, supplier production cycles, and
minimum order quantities. To enable the Company to plan raw material inventory
levels, quotes to potential customers generally provide for certain advance
payments upon placing purchase orders with the Company. If the Company is unable
to buy raw materials in sufficient quantities and on a timely basis, it would
not be able to deliver products to customers on time.
The raw materials used in the manufacture of optical memory cards are
available from one or more qualified suppliers. 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. While the Company believes that
Kodak will continue to supply such photographic films on a satisfactory basis
and in sufficient quantities, no assurances can be made. If Kodak were to
discontinue manufacturing this film, the Company would order the maximum amount
of final-run stock from Kodak for use while the Company endeavored to establish
an alternate supplier, although the purchase price could increase from a new
supplier. Considering that the United States government is a major end-user of
the Company's optical memory cards, the Company anticipates that an alternate
supplier could be established and qualified. The Company has 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, the
Company has on hand what it believes is an adequate supply to meet anticipated
demand.
Product Evolution
The Company continues to add features to its optical memory card products,
making them much more than simple, digital data storage devices. The Company has
enhanced its optical memory card manufacturing capabilities to meet evolving
international standards and, for some applications, to add security printing,
sequential serial numbers, bar coded data, laser-engraved eye-readable images,
signature panels, magnetic stripes, and an optically variable device (a security
diffraction pattern) onto the cards, if specified. In addition, "chip ready"
optical memory cards can be purchased from the Company, for insertion of IC
chips to create hybrid Smart/Optical(TM) cards. The Company intends to continue
its research and development efforts to evolve its products and services to meet
changing market needs or to create new markets for optical cards.
Marketing
CHANNEL MARKETING, CUSTOMER BASE, AND TECHNICAL SUPPORT. LaserCard Systems
Corporation (LSC), a wholly owned subsidiary of Drexler Technology Corporation,
markets the Company's products, primarily through value-added resellers (VARs)
and licensees of the Company in the United States and other countries. To its
VARs and licensees, the Company makes available for sale optical memory cards,
optical card read/write drives and software, and third-party peripherals.
VARs/licensees may add value in the form of services, application-specific
software, personal computers, or other peripherals, and then resell these
products as integrated systems. Sales to the United States government and
foreign governments are made indirectly through VARs and licensees. For example,
products are sold indirectly to ultimate use customers such as the U.S.
Department of State, U.S. Department of Defense, U.S. Department of Homeland
Security, and the government of Canada, through a VAR that is a government
subcontractor.
For fiscal 2003, the Company sold LaserCard products to approximately 30
direct customers in six states and 10 foreign countries. Sales of cards destined
for U.S. government programs represented 82% of total revenues for fiscal year
10
2003 compared with 78% of total revenues for fiscal 2002 and 62% of total
revenues for fiscal 2001. Revenues by geographic region are shown in Note 4 of
the "Notes to Consolidated Financial Statements." Sales of cards and read/write
drives for the Canadian Permanent Resident Card program represented 10.5% of
total revenues for fiscal 2003 and 3% of revenues in fiscal 2002 when shipments
began. Substantially all foreign product sales have been made through VARs and
licensees. The Company believes that international markets will be an important
source of product sales and license revenue in the future.
LaserCard marketing operations are conducted through the Company's offices
in California, New York, and France, and through the LaserCard Systems web site
at www.lasercard.com, which supports worldwide marketing activities. The
Company's marketing staff, general management, and technical personnel work
closely with customers and provide pre-sales technical support to assist VARs
and licensees.
MARKETING OBJECTIVES. In addition to expected continuation of its current
business involving U.S. Green Cards, U.S. Laser Visa BCCs, U.S. military
Automated Manifest System cards, and Canadian Maple Leaf Permanent Resident
Cards, the Company's marketing objectives include card applications in the
United States and abroad, such as:
o U.S. VISIT system (previously called the U.S. Entry-Exit system)
o U.S. Transportation Workers Identification Credential (TWIC)
o Registered /Trusted Traveler card (after TWIC)
o Canadian Citizens' ID card
o Italian national ID card for citizens
o Italian permanent resident card for non-citizens
o Identification cards for Macedonia and Saudi Arabia
o Motor vehicle registration card for several states in India
o Expansion of private/voluntary program in Beijing for a children's
healthcare card
o Multi-application cards, other ID card applications, and pay-per-use
cards
APIs and Application Software
The Company believes that its proprietary optical memory card Application
Programming Interface (API) and software development capabilities play a key
role in developing LaserCard applications and markets. However, API and
application software sales have not been a significant portion of revenues thus
far. To date, the Company's software development has been completed concurrent
with the establishment of technological feasibility and, accordingly, all
software development costs have been charged to research and engineering expense
in the accompanying statements of income.
APIS. As part of its read/write drive and system sales, LSC includes a
comprehensive set of APIs in order for its customers to develop optical card
applications. An API is a set of routines, protocols, and tools used by
programmers for building software applications. LaserCard-related APIs control
or facilitate the basic operations and read/write functions of optical memory
card drives so that they can interface directly with personal computers. LSC
develops LaserCard-related APIs such as device drivers, file system DLLs
(dynamic link libraries), and custom software tools to enhance read/write drive
integration.
CUSTOM APPLICATIONS. LSC also offers contract services for purchase by
customers that require custom programming in the development and integration of
their LaserCard applications. LSC also makes available for purchase by
customers, software for demonstrating data storage, medical, and security
concepts involving the LaserCard, software-development tools for related
peripherals, and a card issuance application software package.
APPLICATION SOFTWARE. End-user application software is an important factor
in developing commercial markets for optical memory cards because it directs
computers to do specific tasks related to the customer's end-user application
for the LaserCard. Typically, the Company's VARs and/or their customers develop
software for specific end-user applications. In this role, VARs may integrate
optical card products into existing software products, write new application
software for specific optical memory card programs, or license software from
other VARs. Several VARs have written optical card software programs for
applications. LSC markets a BadgeMaker card personalization and issuing
application used for card issuance and data management, and a Biometric ID
Verification System application (discussed below).
11
Read/Write Drives; Manufacturing and Parts/Components
Optical memory cards are used in conjunction with a card read/write device
(drive) that connects to a personal computer. The price, performance, and
availability of read/write drives are factors in the commercialization of
optical cards. During fiscal 2000, the Company established in-house capabilities
in read/write drive assembly and design. Previously, the Company purchased
assembled drives from a licensee in Japan, Nippon Conlux Co., Ltd. ("Conlux"),
which was the sole supplier of the drives. The Company completed the acquisition
for cash of Conlux's read/write drive manufacturing operation (manufacturing
tooling, equipment, etc.) and transferred the operation to Mountain View,
California, to produce drives locally. The Company sold approximately 175
read/write drives for fiscal 2003 compared with 450 read/write drives for fiscal
2002 and 1,280 read/write drives for fiscal 2001. The Company has recently
introduced a newer version of a read/write drive, but there is no assurance that
drive sales will increase as a result.
To maintain adequacy of parts and components for the manufacture of
read/write drives, the Company attempts to establish ongoing relationships with
principal suppliers and obtains information about alternate suppliers. If the
Company is unable to buy parts and components in sufficient quantities and on a
timely basis, it would not be able to deliver products to customers on time. The
Company purchases read/write drive parts for its anticipated read/write drive
demand, taking into consideration the order-to-delivery lead times of vendors
and the economic purchase order quantity for such parts. For read/write drives,
the optical recording head for the current drive is a Company-specific part
obtained from one supplier; Audio-Technica Corp., of Japan. No optical heads are
on order at this time because the Company believes that it has adequate
inventory of read/write drives and components. Before reordering, it is
anticipated that the existing optical head will be redesigned; therefore, the
Company is exploring new designs and alternate suppliers.
Prior to fiscal 2002, the Company 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 interface software/device drivers. In fiscal 2002,
the Company reduced the selling price for these read/write drives by 20% for
typical purchase quantities in an effort to develop a broader market and
customer base for LaserCard optical memory cards. Current and target
applications for the Company's LaserCard typically require a small number of
drives relative to the number of cards purchased.
LaserCard Biometric ID Verification System
LSC has developed a LaserCard Biometric ID Verification System that can
quickly confirm validity of optical memory card biometric ID cards, read and
display digitally stored photographs and other digital data from the cards, and
biometrically verify the cardholders' live-scanned fingerprints with the
fingerprint templates stored on the cards at time of card issuance.
The LaserCard Biometric ID Verification System has undergone successful
preliminary testing prior to the U.S. government's consideration of widespread
implementation of the system on the country's southern border. On April 22,
2003, the U.S. Department of Homeland Security issued a Presolicitation Notice
for the purchase of approximately 1,000 optical stripe read/write drives. The
Presolicitation Notice appears to indicate that the government intends to field
optical card-based biometric verification systems on the southern U.S. border
and at 12 international airports in the United States.
The Company believes that this proposed deployment would be an element of
the proposed U.S. VISIT system (previously called the U.S. Entry-Exit system) in
connection with the "U.S. Enhanced Border Security and Visa Entry Reform Act"
when and if granted a contract award. The Company's card also is one of the
technologies under consideration for the U.S. Transportation Workers
Identification Credential (TWIC) program.
LSC also is marketing the LaserCard Biometric ID Verification System as a
"concept" package, meaning that software which performs the same functions (but
not usable with U.S. government cards) is available in customized form to other
customers for government, industrial and commercial applications.
Peripheral Equipment
Through March 31, 2003, the sale of third-party peripheral equipment and
systems has not contributed materially to the Company's revenues. However, to
facilitate application development by its customers, LSC purchases and sells
peripherals including the following:
12
o Fingerprint sensor units to capture fingerprints for storage onto the
LaserCard as a template and as a high-resolution image.
o Digital video cameras for capturing and storing computer readable
photos in color.
LICENSING
The Company has generated a total of approximately $40 million in license
fee revenues since 1983 through nonexclusive patent license agreements related
to optical memory card manufacture, equipment for using the cards, optical data
storage, card distribution, and other aspects of the Company's technologies.
Included in the approximately $40 million of past license revenues, the
Company sold two $10 million, nonexclusive, royalty bearing, patent licenses for
optical memory card manufacture--one in fiscal 1989 to Canon Inc., and one in
fiscal 1991 to Optical Memory Card Business Corporation (OMCBC), a joint venture
formed by four Japanese companies (three of the Company's read/write drive
equipment licensees and Dai Nippon Printing Co., Ltd.). On July 1, 2002, this
license was fully assumed by Dai Nippon Printing.
From time to time, the Company offers nonexclusive, royalty bearing
licenses for optical card read/write drive manufacture, for assembly of
read/write drives from kits, for optical card finishing using Company-supplied
materials, and for card manufacturing. In the past, the Company also offered
card distribution licenses to create distributors, in selected regions of the
world, that can buy cards wholesale from the Company at prices lower than those
charged to VARs.
License revenues for fiscal 2001, 2002, and 2003 are detailed in the
"Management's Discussion and Analysis" section of this report, under the heading
"License Fees and Other Revenues."
The Company conducts its licensing efforts on a selective basis. The
timing, number, type, and magnitude of future license sales, if any, cannot be
predicted or inferred from past events. There is no assurance that any of the
Company's patent licensing efforts will be successful.
COMPETITION
The Company is unaware of other optical memory cards that currently compete
with optical memory cards made by the Company. However, there are other card
technologies that compete with optical memory cards. These alternatives may
include integrated circuit (IC) cards, 2-dimensional bar code cards and
symbology cards, magnetic-stripe cards, CD-read only cards and recordable cards,
PC cards, RF (radio frequency) 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 the
Company's resources. The Company believes that the LaserCard's storage capacity,
read/write capability, price-performance ratio, rugged card construction and
flexibility, optional technology add-ons, ability to store audit trails, and
resistance to counterfeiting and tampering make the LaserCard optical memory
card a viable choice for a variety of digital card applications. As to other
optical memory cards, the Company has licensed its card patents to two Japanese
companies, Canon Inc. and Dai Nippon Printing, which the Company believes are
not manufacturing or selling such cards at this time. A decade ago other
companies had disclosed that they were developing optical memory cards, but now
appear to be inactive in that field. Therefore, the Company's primary
competition is other card products.
Competitive factors among the various card technologies include system/card
portability, interoperability, price-performance ratio of cards and associated
equipment, durability, environmental tolerance, and card security. The Company
believes its cards offer key technological and security advantages. The current
price of optical card read/write drives is a competitive disadvantage to the
Company in some markets because alternative technologies typically have lower
priced drives. However, when the cost of drives and a large number of cards is
factored together, the Company's optical memory card technology can offer
competitive pricing compared with its closest competitor, high capacity IC
cards.
In addition, 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 preclude some potential applications for the
Company's cards but, on the other hand, may create market opportunities in other
areas such as information security and card personalization via the Internet.
13
IC CARDS. The LaserCard competes in some applications, such as the
identification card market, with cards that contain an integrated circuit (IC)
microprocessor and memory. Invented five years before the LaserCard, these are
known as "smart cards," "IC cards," or "chip cards." The IC card is more
vulnerable to tampering and can be more easily damaged in everyday use, whereas
the Company's card construction and the use of polycarbonate plastic make the
LaserCard more rugged. Also, a 32-kilobyte IC card can store less than 2% of the
amount of data storable on a LaserCard optical memory card. For multi-function
applications, the Company currently offers "chip ready" optical cards to which
an IC can be added to create a hybrid smart card, called a Smart/Optical(TM)
card.
IC card prices and performance vary widely. The IC card uses a much lower
cost read/write drive than is used with an optical card, whereas a typical smart
card containing a 32-kilobyte IC and a microprocessor is roughly double the cost
of the Company's 2,800 kilobyte optical memory card. Because of their low-priced
read/write drive, IC cards containing a 32-kilobyte IC and a microprocessor are
particularly competitive in systems using relatively few cards per read/write
drive. Low-storage capacity IC cards are currently used mainly as telephone
cards, point-of-sale cards, and bank debit/cash card systems. These applications
are not markets for the Company's cards. Companies that manufacture IC cards of
various types and storage capacities include Gemplus, SchlumbergerSema, Sharp,
Orga Card Systems, Oberthur Card Systems, and others.
OTHER CARD PRODUCTS. Read/write magnetic-stripe cards and read-only memory
cards such as 2-dimensional bar code cards and symbology cards are lower priced
and compete with the Company's read/write optical memory cards for certain
markets, such as identification cards. However, the Company's cards have
significantly higher storage capacity and offer unique security features to
deter counterfeiting and data tampering. Commercial magnetic-stripe cards are
relatively easy to duplicate and, because they are erasable and rerecordable,
are highly susceptible to unauthorized erasure and alteration. Two-dimensional
bar codes on cards and other symbology cards store relatively small amounts of
data compared to the LaserCard and are not recordable/updatable after they are
issued. Moreover, alternative technologies--such as magnetic stripes, IC chips,
radio (RF) circuitry, and bar codes/symbology--can be incorporated into the
Company's optical memory cards, thereby adding additional performance features
to the LaserCard. In 2000, a small company announced it was developing a 5
megabyte magnetic card. However, the Company believes that magnetic-based cards
(which are easily erasable) may not have the security and audit trail features
required for government ID cards or medical record cards. Experimental card
technologies probably are under development at other companies.
There also are high capacity, high cost storage cartridges called PCMCIA
(Personal Computer Memory Card Industry Association) cards, or PC cards, that
are used in personal computer applications, for example, data-storage devices
for portable computers. Because they are structurally rigid, thick, and
significantly higher in cost, PC cards are not considered competitive with the
LaserCard for low cost, wallet-card applications. Other small, digital
devices--such as data-storage keys, tokens, finger rings, and small cards and
tags--are viable alternatives for some card-based applications. Competitive
factors include system/card portability, interoperability, price-performance
ratio, and environmental tolerance.
OTHER OPTICAL MEMORY CARDS AND EQUIPMENT. Under royalty-bearing licenses
from the Company, two Japanese companies have the right to manufacture and sell
optical memory cards in competition with the LaserCard, although apparently
neither company is currently selling such products. Licensee Optical Memory Card
Business Corporation (OMCBC)/Dai Nippon Printing Co., Ltd., did not report any
such sales for calendar year 2002, and Canon Inc. has not reported any such
sales for several years. Both Canon and Japan-based Olympus Optical Co. (an
equipment licensee of the Company) have in the past produced their own optical
card drives, although they are not believed to be doing so currently.
The Company's LaserCard utilizes the ISO/DELA card format developed by the
Company in conjunction with a group of its licensees. Canon's optical memory
card used the ISO/SIOC format developed by Canon. Dai Nippon Printing is
believed to be capable of manufacturing both types of cards. Although both card
formats meet the ISO Standard, the Company's ISO/DELA format and the Canon
ISO/SIOC format are not functionally compatible. Olympus Optical has
manufactured and sold ISO/SIOC read/write drives and nonstandard format drives
and is capable of producing an optical card read-only drive. If the production
of ISO/SIOC cards and/or equipment were to resume by Dai Nippon Printing, Canon,
or Olympus, the Company believes that it currently offers competitive advantages
in areas such as system integration, APIs/software, customer support services,
and as the only company that manufactures both optical memory cards and
read/write drives.
14
A decade ago, a number of firms disclosed the development of alternative
optical cards, including Asahi Chemical, Polaroid, Sony, and Toppan Printing.
However, the Company is not aware of any current optical memory card-related
commercial activities by those firms. During the past several years, prerecorded
read-only optical cards functioning with CD players have been used as high-data
capacity, 1.2-millimeter thick, "business cards" containing computer-readable
data such as promotional materials. On June 12, 2000, Philips, Sony, and Taiyo
Yuden announced a customer-recordable version of these thick, rigid data cards
based upon the widely used CD-recordable format; however, they do not meet the
ISO Standards for either credit cards or identification cards. Also in 2000, it
became known that a small company is developing a high-data capacity,
ultraviolet-laser recordable, read-only, optical memory disk and optical memory
card that would be read with a second laser operating in the visible or
near-infrared wavelength. That company's news releases imply a primary focus on
disks.
OTHER MATTERS
Research and Engineering Expenses
Research and engineering expenses were $2,818,000 for fiscal 2003,
$3,045,000 for fiscal 2002, and $2,370,000 for fiscal 2001. The Company is
continuing its efforts to develop new optical memory card features, including
the insertion of contactless chips with radio frequency (RF) capability, optical
memory card read/write drives, read-only drives (readers), and 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 factors are important for the
Company's existing and future optical memory card markets. Also see Item 7,
"Management's Discussion and Analysis."
Patents and Trademarks
OPTICAL DATA STORAGE. As of March 31, 2003, the Company owned approximately
35 U.S. patents relating to optical data storage (including optical storage
media, optical cards, formats, equipment, systems, software, the utilization of
optical storage media, and e-commerce technology), and other U.S. and foreign
patent applications have been filed. Approximately 45 counterpart patents of
certain U.S. patents are issued in various foreign countries. However, the
Company owns certain U.S. patents as to which foreign counterparts have either
not been filed or the examination process has been terminated without issuance
of the foreign patents. From time to time, the Company elects to allow some of
its U.S. or foreign patents to expire when maintenance fees become due, if the
patents are deemed no longer relevant. In addition, the Company protects as
trade secrets some refinements to the Drexon medium and cards and know-how
related to card production. Since the Company's technology is now in the
commercial stage, the Company's know-how and experience in volume card
production, system development and software capabilities, brand-name recognition
within its card markets, and dominant-supplier status for optical-memory cards
are of far greater importance than the Company's patents. Therefore, at this
time, the Company believes that its patent portfolio is helpful but is no longer
essential for maintaining the LaserCard's market position.
The Company's U.S. patents have expiration dates ranging from 2003 to 2020,
with the majority expiring during the first half of this period. Counterpart
patents in foreign countries also expire during this period, usually about two
to three years after the U.S. patent expires. Under the OMCBC/Dai Nippon
Printing license agreement with the Company for manufacture of optical memory
cards, the obligation to pay royalties to the Company for use of the licensed
patents ceases on December 31, 2003. Canon's royalty obligations in connection
with its licenses to manufacture optical memory cards and reading and writing
equipment expire on December 31, 2008. However, Canon and OMCBC/Dai Nippon
Printing apparently are no longer actively selling these products. Other
royalty-bearing licenses sold by the Company, related to equipment for reading
and writing optical memory cards, provide for royalty payments to cease on the
last expiration date of the licensed patents. Royalty payments to the Company
from its licensees have not been significant to date. The Company cannot predict
whether the expiration or invalidation of its patents would result in the
introduction of competitive products which would affect its future revenues
adversely.
The Company presently intends to pursue any infringement of its patents
either by litigation, arbitration, or negotiation. However, there can be no
assurance that any of the Company's patents will be sufficiently broad in scope
to afford protection from products with comparable characteristics that may be
sold by competitors in the future. There
15
also can be no assurance that the validity of any patents actually granted will
not be challenged. In 1992, the claims of three of the Company's issued U.S.
patents successfully passed reexamination proceedings in the U.S. Patent and
Trademark Office (USPTO) after a two-year review by the USPTO's Board of Patent
Appeals and Interferences.
LaserCard(R)and Drexon(R)are federally registered trademarks of Drexler
Technology Corporation. The Company believes that its LaserCard brand name and
trade name are important assets in marketing optical memory card products.
Employees
As of March 31, 2003, the Company and its subsidiaries employed 122 persons
(including four executive officers). This workforce consisted of 110 persons in
administration, marketing/sales, manufacturing, and research and engineering,
plus 12 temporary personnel mainly for quality assurance inspection of cards.
None of the Company's employees is represented by a labor union.
Dependence on Government Subcontracts through a Sole Contractor
For fiscal 2003, one customer represented 94% of the Company's revenues.
This Virginia-based customer is Information Spectrum, Inc., now a unit of Anteon
International Corporation (NYSE:ANT). Information Spectrum is the government
contractor for the following programs: (1) the U.S. Department of Homeland
Security (previously U.S. Immigration and Naturalization Service) Permanent
Resident Green Card, (2) the U.S. Department of State (DOS) Laser Visa Border
Crossing Card, (3) the U.S. Department of Defense/Defense Logistics Agency
(including the U.S. Army and Marines) Automated Manifest Card, and (4) the
Government of Canada Permanent Resident Card. However, since these ultimate
customers are national governments, the Company is not dependent upon the
specific contractor for continued revenues from these programs. Although not
anticipated, if Information Spectrum were to discontinue its participation as
contractor, the Company believes that other qualified contractors could be
utilized by those governments for purchasing the Company's products.
Under the U.S. government's Federal Acquisition 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 orders. The Company's U.S. government card
deliveries depend upon the issuance of corresponding order releases by the
government, and the Company believes that these orders will continue in
accordance with the government subcontracts. Losses would occur if either of the
Company's 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 increases in product revenues or licenses do not keep pace with increased
marketing, research and engineering, and capital equipment expenditures.
Backlog
As of March 31, 2003, the backlog for LaserCard optical memory cards
totaled approximately $1.9 million in firm card orders under card supply
contracts, of which amount 54% is for U.S. government Green Cards or Laser Visas
under a U.S. government subcontract for the purchase of optical memory cards.
Since the Company had a fixed delivery schedule for card shipments out of a
secure, U.S. government-funded vault on Company premises, the Company recognized
revenues on the cards located in the vault, and therefore such cards were not
included in backlog at March 31, 2003. As of March 31, 2002, the backlog for
LaserCard optical memory cards totaled approximately $16.4 million, consisting
of approximately $11.1 million in firm card orders under card supply contracts,
and approximately $5.3 million in cards produced, delivered to, and located in
the government-funded vault. Of the $11.1 million amount, 85% was for U.S.
government Green Cards or Laser Visa BCCs under the Company's U.S. government
subcontract. Of the $5.3 million amount, all were Green Cards or Laser Visa BCCs
produced under this subcontract. The fluctuation in backlog for fiscal 2003
compared with fiscal 2002 is due to the receipt of fixed delivery schedules in
fiscal 2003, in addition to the fact that government release orders arrive at
irregular intervals. Purchase order releases under the Company's five-year U.S.
government subcontract are issued at irregular intervals and for varying card
quantities. At March 31, 2002, the Company had six months remaining on a January
22, 2002 release of 3.25 million cards. At March 31, 2003, the Company had one
month remaining on a September 24, 2002 release of 2.3 million cards.
On May 8, 2003, the Company announced a $1.8 million order for Canadian
"Maple Leaf" Permanent Resident Cards. This order called for deliveries
beginning in May 2003.
On July 14, 2003, the Company announced an optical memory card order valued
at approximately $2 million for Laser Visa BCCs for the Department of Homeland
Security, under the Company's U.S. government subcontract discussed above. The
order calls for card production to start immediately and to be completed within
four months. The Company will recognize the corresponding revenue according to
its revenue-recognition policy, as described under "Critical Accounting
Policies."
16
Financial Information About Geographic Areas
Financial information about geographic areas is described in Note 4 to Item
8, "Consolidated Financial Statements and Supplementary Data."
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
DEPENDENCE ON VARS AND ON A LIMITED NUMBER OF CUSTOMERS - WE DEPEND ON ONE
VAR AND TWO ULTIMATE CUSTOMERS FOR THE BULK OF OUR REVENUE. THE LOSS OF OUR
ULTIMATE CUSTOMERS OR SIGNIFICANT REDUCTIONS IN THEIR ORDERS WOULD CAUSE
REVENUES TO DECLINE, AND HAVING TO REPLACE OUR VAR COULD INTERRUPT OUR
GOVERNMENT BUSINESS. We are heavily dependent on U.S. government subcontract
release orders for DHS Green Cards and DOS Laser Visa BCCs, representing 82% of
our revenues for fiscal year 2003 compared with 78% of total revenues for fiscal
2002 and 62% of total revenues for fiscal 2001. Sales of cards and read/write
drives for the Canadian Permanent Resident Card program represented 10.5% of
total revenues for fiscal 2003 and 3% of revenues in fiscal 2002 when shipments
began. One VAR, Information Spectrum, Inc., based in Virginia (now a unit of
Anteon International Corporation), is the government contractor for the United
States Green Cards, BCCs, and Automated Manifest Cards, and the Canadian
Permanent Resident Cards. However, since the ultimate customers are national
governments, we are not dependent upon the specific contractor for continued
revenues from these programs. Although not anticipated, if Information Spectrum
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 program delays.
LARGEST CUSTOMER IS U.S. GOVERNMENT - OUR LARGEST ULTIMATE CUSTOMER, THE
U.S. GOVERNMENT, HAS THE RIGHT TO DELAY ITS ORDERS OR COULD CHANGE ITS
TECHNOLOGY DECISIONS, WHICH WOULD RESULT IN ORDER DELAYS OR IN LOSSES. Under the
U.S. government's Federal Acquisition 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 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 occur 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 capital equipment expenditures. For example, the latest
release of cards under our U.S. government subcontract (2.3 million cards on
September 24, 2002) called for deliveries through April 2003. We have not
received a follow-on order as of June 23, 2003. Therefore, there is a gap in
production of at least two months. This gap will significantly affect operating
results for the quarter ending June 30, 2003.
FUTURE GROWTH DEPENDENT ON NEW FOREIGN PROGRAMS AND U.S. GOVERNMENT
PROGRAMS - OUR REVENUES WILL NOT CONTINUE TO GROW IF WE DO NOT WIN NEW BUSINESS
IN THE U.S. AND ABROAD. Revenues during fiscal 2003 included sales of 6.6
million U.S. government Green Cards and Laser Visa BCCs. We anticipate that
fiscal 2004 revenues will include sales ranging from 2 million to 3 million
cards for these government programs. In order to maintain card revenues at the
fiscal 2003 level, fiscal 2004 revenues will need to include additional orders
from new and existing programs. Optical memory card digital governance programs
that are emerging programs or prospective applications in various countries
include identification cards for Italy, Saudi Arabia, and Macedonia; motor
vehicle registration cards in India; and several new U.S. government ID card
programs due to the increasing need for enhanced U.S. border security. In the
United States, the U.S. VISIT program and TWIC program are considering the use
of optical memory cards for secure identification. From Italy, we anticipate
receiving orders for two programs--the CIE card (Carta d'Identica Elettronica)
and the PSE card (Permesso di Soggiorno Elettronico). We have been informed by
our Italian VAR that the Italian government plans to issue 1.7 million CIE cards
and 600,000 PSE cards this year through December 2003. However, we have not as
yet received any corresponding card orders. There is no assurance that the
foregoing government programs will be continued or implemented as anticipated or
that the U.S. government will select our cards for its new homeland security
programs.
LENGTHY SALES CYCLES - SINCE THE SALES CYCLE FOR OUR PRODUCTS IS TYPICALLY
LONG AND UNPREDICTABLE, WE HAVE DIFFICULTY PREDICTING FUTURE REVENUE GROWTH.
Initial product sales to value-added resellers 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.
17
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.
TIMING OF REVENUES DEPENDENT ON SHIPMENT SCHEDULE FROM GOVERNMENT. WE DON'T
RECOGNIZE REVENUE UNTIL CARDS ARE SHIPPED OUT OF A VAULT OR WE RECEIVE A FIXED
SHIPMENT SCHEDULE FROM THE GOVERNMENT; THEREFORE, THE TIMING OF OUR REVENUES IS
NOT UNDER OUR CONTROL AND CANNOT BE PREDICTED. We recognize 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. Our U.S. government
subcontract requires delivery of cards to a secure, government-funded vault
built on our premises. Deliveries are made into the vault on a fixed schedule
specified by the prime contractor. At the time the cards are delivered to the
vault, title to the cards transfers to the government, the prime contractor is
invoiced, and payment is due according to normal trade payment terms. However,
revenue is recognized when the cards are shipped from the vault to the
government unless we receive a fixed schedule, notification, or plan for
shipments out of the vault to the government, in which case revenue is
recognized upon the latter of receipt of such fixed shipment schedule or
delivery of the cards into the vault. Our revenues may fluctuate from period to
period if we do not continue to obtain fixed shipment schedules under this
contract.
EXPANSION OF CARD MANUFACTURING CAPACITY - WE COULD EXPERIENCE EQUIPMENT,
RAW MATERIAL, QUALITY CONTROL, OR OTHER PRODUCTION PROBLEMS UNDER VERY
HIGH-VOLUME PRODUCTION . 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.
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.
OPTICAL CARD RAW MATERIALS--SOURCES OF SUPPLY - 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. AS A RESULT, WE COULD LOSE CUSTOMERS, AND
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. While we believe that Kodak will continue to supply such
photographic films on a satisfactory basis and in sufficient quantities, no
assurances can be made. If Kodak were to discontinue manufacturing the film from
which the Drexon optical stripe is made, we would order the maximum amount of
final-run stock from Kodak for use while we endeavored to establish an alternate
supplier for such film, although the purchase price could increase from a new
supplier. Considering that the United States government is a major end-user of
our optical memory cards, we anticipate that an alternate supplier could be
established and qualified. The Company has 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, the Company has on hand
what it believes is an adequate supply to meet anticipated demand.
PRODUCTION OF READ/WRITE DRIVES; PARTS/COMPONENTS; INVENTORY LEVELS - 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, as discussed under Item 7, "Management's Discussion and Analysis."
18
DEVELOPMENT OF READ/WRITE AND READ-ONLY DRIVES - 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. 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 recently introduced a newer version of a
read/write drive and have undertaken a product development program for a
read-only drive, both of 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.
TECHNOLOGICAL CHANGE - 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 products
currently sold or under development will remain competitive or provide sustained
revenue growth.
PATENT PROTECTION - 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.
COMPETITION - 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 two of our licensees (although neither 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; 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. Also see the Competition section appearing
earlier in this report.
19
HISTORICAL LOSSES - WE HAVE INCURRED NET LOSSES IN THE PAST, MAY INCUR
LOSSES IN THE FUTURE, AND MAY NOT BE ABLE TO GENERATE SUFFICIENT NET REVENUE IN
THE FUTURE TO ACHIEVE AND SUSTAIN PROFITABILITY. As of March 31, 2003, we had an
accumulated deficit of $5,817,000. Although we have operated profitably for the
past five years (fiscal 1999 through fiscal 2003), we have incurred significant
losses in the past, including in fiscal 1997 and 1998. We are relying upon our
optical memory card technology to generate future product revenues, earnings,
and cash flow. If alternative technologies emerge or if we are otherwise unable
to compete, we may not be able to achieve and sustain profitability on a
quarterly or annual basis. Annual losses would also occur if either of our two
largest U.S. government programs were to be delayed, canceled, or not extended
and not replaced by other card orders or other sources of income, or if
increases in product revenues or licenses do not keep pace with increased
marketing, research and engineering, and capital expenditures. Quarterly losses
would occur when there are gaps or delays in card orders from either of our two
largest U.S. government programs or if such programs were to be delayed,
canceled, or not extended and not be replaced by other card orders or other
sources of income, or if increases in product revenues or license revenues do
not keep pace with increased marketing and research and engineering, and capital
equipment expenditures.
STOCK PRICE VOLATILITY - THE PRICE OF OUR COMMON STOCK IS SUBJECT TO
SIGNIFICANT VOLATILITY. This volatility 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 10 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.
NATURAL DISASTERS AND OTHER RISKS TO OUR FACILITIES - OUR FACILITIES ARE
LOCATED IN AN EARTHQUAKE ZONE AND THESE OPERATIONS COULD BE INTERRUPTED IN THE
EVENT OF AN EARTHQUAKE, FIRE, OR OTHER DISASTER. Our corporate headquarters,
card manufacturing 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.
UNFORESEEN EVENTS - 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.
ITEM 2. PROPERTIES
As of March 31, 2003, approximately 45,000 square feet of floor space are
leased by the Company for card manufacturing, read/write drive production,
administration, sales, and research and engineering, in three buildings located
in Mountain View, California. These facilities have a current total annualized
rental of approximately $1,170,000 on leases that expire on various dates from
2004 to 2006. The Company also leases a small marketing office in France.
Management believes these leased buildings to be satisfactory for its present
operations. Upon expiration of the leases, management believes that these or
other suitable buildings will be able to be leased on a reasonable basis.
20
ITEM 3. LEGAL PROCEEDINGS
Other than as described below, there are no material pending legal
proceedings to which the Company is a party or of which its property is a
subject.
The Company learned on July 10, 2003, that its subsidiary, LaserCard
Systems Corporation, had been named as one of several defendants in a lawsuit
brought by George Rawe. Mr. Rawe alleged in the lawsuit that he was injured in
laser eye surgery performed using a VISX, Incorporated laser that incorporated a
LaserCard as a component. Mr. Rawe is suing the physicians involved for
malpractice and VISX, Incorporated, the Company, and various unnamed defendants
for product liability, alleging their products were defective. The lawsuit was
filed in California Superior Court for San Joaquin County, case number CV020962
and seeks an amount of damages which are not quantified. The Company is just
beginning to evaluate the complaint and the Company's defenses, including the
availability of insurance coverage and any rights or obligations of
indemnification involving VISX, Incorporated.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of fiscal 2003.
PART II
-------
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK
AND RELATED STOCKHOLDER MATTERS
The Company's only class of common stock, $.01 par value, is traded on The
Nasdaq Stock Market(R) under the symbol DRXR and is quoted in THE WALL STREET
JOURNAL and other newspapers. The table below sets forth the high and low trade
prices for the Company's common stock (rounded to two decimal points) as
reported by Nasdaq during the fiscal periods indicated.
Quarterly Stock Prices (Unaudited)
----------------------------------
Fiscal 2002 Fiscal 2003
--------------- ----------------
High Trade Low Trade High Trade Low Trade
---------- --------- ---------- ---------
First Quarter................ $ 14.94 $ 10.40 $ 30.30 $ 16.61
Second Quarter............... 17.00 8.80 22.00 12.03
Third Quarter................ 24.50 14.25 21.50 12.01
Fourth Quarter............... 25.90 18.10 15.95 11.61
As of March 31, 2003, there were approximately 970 holders of record of the
Company's common stock. The total number of stockholders is believed by the
Company to be several thousand higher since many holders' shares are listed
under their brokerage firms' names.
The Company has never paid cash dividends on its common stock. The Company
anticipates that for the foreseeable future, it will retain any earnings for use
and reinvestment in its business.
21
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information as of and for
each of the five years in the period ended March 31 is derived from the
consolidated financial statements of the Company. This financial data should be
read in conjunction with the consolidated financial statements and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing in Item 7 of this report.
DREXLER TECHNOLOGY CORPORATION
FIVE-YEAR SUMMARY OF FINANCIAL INFORMATION
Fiscal Years Ended March 31, 1999 - 2003
(In thousands, except per share amounts)
(Unaudited)
OPERATIONS DATA 1999(1) 2000(1) 2001(1) 2002 2003
---- ---- ---- ---- ----
Revenues............................................. $ 12,577 $ 15,443 $ 24,906 $ 20,889 $ 26,331
Cost of product sales................................ 6,087 8,668 12,199 10,652 13,906
Selling, general, and administrative expenses........ 3,698 3,996 4,134 5,165 6,202
Research and engineering expenses.................... 456 1,299 2,370 3,045 2,818
Other income (expense), net.......................... (44) 6 -- -- --
Interest income, net................................. 312 382 612 386 397
--------- ---------- ---------- ---------- ----------
Income before income taxes........................... 2,604 1,868 6,815 2,413 3,802
Income tax provision (benefit)....................... 128 (2,919) (1,097) (2,786) 1,520
--------- ---------- ---------- ---------- ----------
Net income........................................... $ 2,476 $ 4,787 $ 7,912 $ 5,199 $ 2,282
========= ========== ========== ========== ==========
Net income per share:
Basic............................................ $ .25 $ .49 $ .80 $ .52 $ .22
========= ========== ========== ========== ==========
Diluted.......................................... $ .25 $ .48 $ .76 $ .50 $ .21
========= ========== ========== ========== ==========
Weighted average number of common and common
equivalent shares:
Basic............................................ 9,748 9,812 9,897 9,961 10,356
Diluted.......................................... 10,007 9,935 10,446 10,468 10,842
BALANCE SHEET DATA
Current assets....................................... $ 11,485 $ 14,489 $ 18,333 $ 28,118 $ 21,192
Current liabilities.................................. 5,973 8,305 7,324 7,501 3,620
Total assets......................................... 16,566 24,362 30,137 40,713 40,463
Long-term obligations................................ -- -- -- -- --
Stockholders' equity................................. 10,593 16,057 22,813 32,337 36,843
(1) As more fully described in the Company's Report on Form 8-K dated May 15,
2002, the financial statements for fiscal 1999, 2000, and 2001 were
restated due to changes in the timing of revenue recognition of LaserCard
optical memory cards that have been delivered into a secure,
government-funded vault built for the government on Company premises to
comply with security regulations under the subcontract.
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
All statements contained in this report that are not historical facts are
forward-looking statements. The forward-looking statements in this report are
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. They are not historical facts or guarantees of future
performance or events. Rather, they are based on current expectations,
estimates, beliefs, assumptions, and goals and objectives and are subject to
uncertainties that are difficult to predict. As a result, the Company's actual
results may differ materially from the statements made. Often such statements
can be identified by their use of words such as "may," "will," "intends,"
"plans," "believes," "anticipates," "visualizes," "expects," and "estimates."
Forward-looking statements made in this report include statements as to current
and potential customers, applications, orders, or market segments for optical
memory card products; statements as to anticipated orders and/or shipment
quantities and schedules under the Company's U.S. government and Canadian
government subcontracts; the Company's expectation that it will be awarded a
contract for approximately 1,000 read/write drives under the U.S. Department of
Homeland Security's Presolicitation Notice and the expectation that there will
be demand for the Company's cards and read/write drives under Italian government
card programs; the Company's belief that the U.S. government intends to field
optical card-based biometric verification systems on the southern U.S. border
and at certain U.S. airports; the objectives of the Company in its efforts to
sell read/write drives; the need for, expected success of, and potential
benefits from the Company's research and engineering efforts, including
developing new or enhanced card capabilities, software products,
production-model read-only drives, or drives with advanced security features or
lower manufacturing costs; whether introduction of new drives will increase
sales, and the effects of read/write drive prices and sales volume on gross
profits or gross margins from read/write drive sales; the Company's estimates
for the level of sales of drives that would be necessary to achieve a gross
profit at current prices inclusive of fixed overhead costs; expectations
regarding the market for read/write drives and read/write drive prices; the
Company's belief that it has an adequate inventory of read/write drives and
components; the Company's efforts to recruit new value-added resellers (VARs) or
licensees; the adequacy of card raw material inventory on hand to meet future
demand; the Company's belief that Kodak will continue to supply sufficient
photographic film and that an alternate supplier could be established if needed;
the Company's ability to expand production capacity; anticipated release orders
and deliveries under the Company's U.S. government subcontract; expectations
regarding revenues, margins, capital resources, capital expenditures and
investments, and the Company's deferred tax asset and related valuation
allowance; anticipated reductions of federal tax cash payments due to current
Company tax benefits; statements as to expected card delivery volumes; estimates
of optical card production capacity, expected card yields therefrom, and the
Company's plans and expectations regarding the growth and associated capital
costs of such capacity; estimate that revenues will be sufficient to generate
cash from operations; the Company's expectation that it will retain any earnings
for use and reinvestment in its business; expectations regarding market growth,
product demand, and foreign business including emerging programs or prospective
applications in China, India, Italy, Macedonia, and Saudi Arabia; and
expectations as to continued, or expanded, or potential U.S. government or other
governmental card programs.
These forward-looking statements are based upon the Company's assumptions
about and assessment of the future, which may or may not prove true, and involve
a number of risks and uncertainties including, but not limited to, customer
concentration and reliance on continued U.S. government business; the
possibility that the U.S. government will not field optical card-based biometric
verification systems on the southern U.S. border and at certain U.S. airports;
lengthy sales cycles; changes in and reliance on government policy-making; the
risks associated with doing business in and with foreign countries, the impact
of litigation or governmental or regulatory proceedings; the ability of the
Company or its customers to initiate and develop new programs utilizing the
Company's card products; the Company's reliance on VARs, licensees, or other
third parties to generate sales, perform customer system integration, develop
application software, or integrate optical card systems with other technologies;
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 and outsourcing manufacturing; ability to produce and sell read/write
drives in volume; reliance on single-source and limited-source suppliers for
certain components and raw materials; 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 schedule,
notification, or plan for shipments out of the government-funded vault located
on the Company's premises, enabling the Company to recognize revenues on cards
delivered to the vault instead of when cards later are shipped from the vault;
the U.S. government's rights to modify or withdraw its reader/writer equipment
Presolicitation Notice or to award any resulting contract, reduce the quantities
released, and extend delivery dates; the impact of technological advances,
general economic trends, and competitive products; and the risks set forth in
the section entitled "Factors That May Affect Future Operating Results" and
elsewhere in this report. Due to these and other risks,
23
the Company's future actual results could differ materially from those discussed
above. These forward-looking statements speak only as to the date of this
report, and, except as required by law, the Company undertakes no obligation to
publicly release updates or revisions to these statements whether as a result of
new information, future events, or otherwise.
CRITICAL ACCOUNTING POLICIES
REVENUE RECOGNITION. Product sales primarily consist of card sales and
sales of read/write drives. The Company recognizes revenue from product sales
when the following criteria are met: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the fee is fixed or determinable; and (4)
collectibility is reasonably assured. The Company recognizes revenue on product
sales at the time of shipment when shipping terms are F.O.B. shipping point,
orders are placed pursuant to a pre-existing sales arrangement and there are no
post-shipment obligations or customer acceptance criteria. Where appropriate,
provision is made at the time of shipment for estimated warranty costs and
estimated returns.
The Company's U.S. government subcontract requires delivery to a secure,
government-funded vault built on Company premises. Deliveries are made into the
vault on a fixed schedule specified by the prime contractor. At the time the
cards are delivered to the vault, title to the cards transfers to the
government, the prime contractor is invoiced, and payment is due according to
normal trade payment terms. However, revenue is recognized when the cards are
shipped from the vault to the government unless the Company receives a fixed
schedule, notification, or plan for shipments out of the vault to the
government, in which case revenue is recognized upon the latter of receipt of
such fixed shipment schedule or delivery of the cards into the vault.
License revenue, which may consist of up-front license fees and long-term
royalty payments, is recognized as revenue when realized. The cost of license
revenue, unless patent litigation is involved, is not material and is included
in selling, general, and administrative expenses.
The Company applies the provisions of Statement of Position (SOP) 97-2,
"Software Revenue Recognition," as amended by SOP 98-9 "Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain Transactions" to all
transactions involving the sale of software products. Revenue from the license
of the Company's software products is recognized when persuasive evidence of an
arrangement exists, the software product has been delivered, the fee is fixed or
determinable, and collectibility is reasonably assured, and, if applicable, upon
acceptance when acceptance criteria are specified or upon expiration of the
acceptance period. To date, software sales have not been significant to the
Company's business.
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 must include an expense within the tax provision in the
statements of income.
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 has recorded a valuation
allowance of $5.3 million as of March 31, 2003, due to uncertainties related to
its ability to utilize some of the deferred tax assets, primarily consisting of
certain net operating losses attributable to stock option deductions carried
forward, before they expire. The amount of the valuation allowance has been
determined based on management's estimates of taxable income by jurisdiction in
which the Company operates over the periods in which the related deferred tax
assets will be recoverable.
The Company's net operating losses available to reduce future taxable
income expire on various dates from fiscal 2005 through fiscal 2023. The
Company's methodology for determining the realizability of its deferred tax
assets involves estimates of future taxable income from its core business, which
assume ongoing business under the U.S. government subcontract for Permanent
Resident Cards and Laser Visa Border Crossing Cards and the Canadian
government's
24
Permanent Resident Card program, as well as estimated operating expenses to
support that anticipated level of business; the estimated impact of future stock
option deductions; and the expiration dates and amounts of net operating loss
carryforwards. These estimates are projected through the life of the related
deferred tax assets based on assumptions which management believes to be
reasonable and consistent with current operating results. In concluding that a
valuation allowance was required as of March 31, 2003, the Company considered
both the positive and negative evidence regarding its ability to generate
sufficient future taxable income to realize its deferred tax assets. Positive
evidence included having achieved taxable income in recent periods and having
achieved profitability for financial reporting purposes since 1999, which the
Company concluded provided evidence regarding its ability to generate a
sustained level of future profits through the expiration periods of the net
operating loss carryforwards. Other positive evidence included (1) the level of
sales and business experienced under the contract with the U.S. government for
Permanent Resident Cards and Laser Visa Border Crossing Cards and the Canadian
government's Permanent Resident Card program; (2) prospects in Italy and Saudi
Arabia for national identification card programs; and (3) the heightened
interest in border security initiatives following the events of September 11,
2001. 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. In weighing the positive and negative
evidence above, the Company considered the "more likely than not" criteria
pursuant to Statement of Financial Accounting Standards (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." Based upon the
above analysis, the Company concluded that of the $12.3 million of total
deferred tax assets as of March 31, 2003, a valuation allowance of $5.3 million
was required since it could not be concluded that it was more likely than not
that those deferred tax assets would be realized. The Company also concluded
that it was more likely than not that the resultant net deferred tax assets in
the amount of $7.1 million would be realized based upon the analysis described
above. As of March 31, 2003, the Company would require approximately $17 million
in cumulative future taxable income to be generated at various times over the
next approximately ten years to realize the related net deferred tax assets
recognized as of March 31, 2003.
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 the estimated forecast of product demand. Demand for read/write
drives can fluctuate significantly. LaserCard market growth could be limited and
operating results could be harmed if the Company is unable to produce and sell
read/write drives in volume. In order to obtain favorable pricing, purchases of
read/write drive parts are made in quantities that exceed the historical annual
sales rate of drives. The Company purchases read/write drive parts for its
anticipated read/write drive demand and takes into consideration the
order-to-delivery lead times of vendors and the economic purchase order quantity
for such parts.
Management's analysis of the carrying value of card and read/write drive
inventory is performed on a quarterly basis. At March 31, 2003, read/write drive
parts, work in process, and finished goods inventory totaled $2.8 million
compared with $3.1 million at March 31, 2002. During fiscal 2003, the Company
sold approximately 175 read/write drives. The Company believes that the
read/write drive inventory as of March 31, 2003 is reflected at its net
realizable value. During fiscal 2003, the Company neared production-ready status
for a newer version of a read/write drive. The design change resulted in a lower
cost model with enhanced functionality that is expected to fulfill the needs of
a number of prospective customers. This newer version, however, does not have a
major function offered by the older drive model, which is therefore not
obsolete. Many of the component parts of the previous read/write drive model are
also used in the new model. However, the Company determined that a write-down of
the other component parts not used by the new model was necessary since there
are no current plans to manufacture additional units of the old model. The
Company recorded a $300,000 charge in fiscal 2003 to write off these parts.
There are 680 drives of the previous model in finished goods inventory that are
available for purchase for the primary use as encoders in personalization
systems. In addition, there are 260 drives of the new design in finished goods
inventory. During the first six months of fiscal 2004, the Company
25
expects to purchase approximately $250,000 in read/write drive parts and
complete the assembly of an additional 650 drives of the new design. The Company
believes there is a market for both designs of its read/write drives to support
and expand optical card sales and, based on current proposals in process, that
the read/write drive inventory on hand at March 31, 2003, including parts to be
received, will be ordered by customers. For example, on April 22, 2003, the U.S.
Department of Homeland Security issued a Presolicitation Notice for the purchase
of approximately 1,000 optical stripe read/write drives, which the Company
expects will be ordered this calendar year. The Company is the only manufacturer
of read/write drives that function with the cards to be read under this program.
The Company is also working, through a VAR, with the Italian government
regarding a national identification card program; in addition to supplying the
Company's optical memory cards for the program, the Company expects that there
will be demand for its previous model read/write drives necessary for encoding
and initialization needs and for the new model for other read/write requirements
under the program. The Company is the only manufacturer of read/write drives
that function with the cards to be read under this program. The Company believes
that demand for such drives could be significantly more than its current
inventory, but will ultimately depend on the nature and scope of deployment of
the program. In particular, drives will be required if and as the program is
rolled out to new towns and cities over the next several years at a pace which
will be determined based upon the acceptance and success of the program and
cannot be predicted at this time. The status of this program is described in the
"Overview" section on page 26. If these anticipated drive orders do not
materialize, the Company may need to write-down the value of its inventory for
any potential excess quantities. However, the Company concluded that as of March
31, 2003, there was no need to write down the value of its read/write drive
inventory on hand. In reaching this conclusion, the Company considered (1) the
potential market demand, (2) that the Company is the only provider of read/write
drives that function with the Company's cards, (3) that the 680 drives of the
previous model provide a function not offered by the new model, and (4) that the
new model provides a solution for applications not requiring the encoding or
initialization function.
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 (Staff
Accounting Bulletin 100) as it relates to determining the appropriate cost basis
of inventory and determining whether firm, noncancelable purchase commitments
should be accrued as a loss if forecasted demand is not sufficient to utilize
all such committed inventory purchases. As part of the Company's quarterly
excess/obsolete analysis, management also determines whether lower of cost or
market adjustments (i.e., where selling prices less certain costs are not
sufficient to recover inventory carrying values) are warranted; to date, the
Company has not recorded any significant lower of cost or market adjustments. In
those instances where the Company has recorded charges for excess and obsolete
inventory, management ensures that such new cost basis is reflected in the
statement of operations if that inventory is subsequently sold.
RESTATEMENT OF RESULTS FOR FISCAL 1998-2001 AND FIRST NINE MONTHS OF FISCAL 2002
In connection with the Company's audit for the fiscal year ended March 31,
2002, the Company and its newly appointed independent accountants conducted an
internal review of revenue recognition practices that were being followed as
they related to a government subcontract. This review, as more fully described
in the Company's Report on Form 8-K dated May 15, 2002, resulted in accounting
adjustments arising from changes in the timing of revenue recognition of
LaserCard optical memory card shipments into and out of a secure,
government-funded vault built for the government on Company premises to comply
with security regulations under the subcontract. In the past, the Company had
recognized revenue upon deliveries to the vault since the customer takes title
to the cards, assumes all risks of ownership, is obligated to remit payment for
the cards at that time, and has no rights of return except for product defects.
However, the Company's newly appointed independent accountants advised the
Company that under the terms and conditions of the Company's U.S. government
supply subcontract, the transfer of title and the imminent cash payment pursuant
to the contract payment terms upon delivery of the cards to the vault are
necessary but not necessarily sufficient to recognize revenue upon delivery of
cards to the vault, under the SEC's Staff Accounting Bulletin 101, "Revenue
Recognition," and under the prior criteria set forth in the SEC's Accounting and
Auditing Enforcement Release No. 108. In the restated financial statements,
revenue was recognized upon shipment of cards from the vault to the customer
since the Company had not been provided with a fixed schedule, notification, or
plan for shipments out of the vault to the government. The Company restated
previously issued results for fiscal years 1998 through 2001 and the first nine
months of fiscal 2002 to reflect these adjustments in the timing of revenue
recognition. As a result of the restatement, revenue for fiscal 1998, fiscal
1999, and fiscal 2000 declined, while revenue for fiscal 2001 and the first nine
months of fiscal 2002 increased.
25-A
RESULTS OF OPERATIONS--FISCAL 2003 COMPARED WITH FISCAL 2002 AND FISCAL 2001
Overview
The Company's principal LaserCard market today involves high-security,
counterfeit-resistant, tamper-resistant cards for digital governance. In this
regard, the Company provides governments with high security LaserCard optical
memory cards and read/write drives to facilitate or expedite the process of
governing by documenting the grant of certain rights to citizens and/or
non-citizen permanent residents. These counterfeit- and tamper-resistant cards
are consumable products because they typically are replaced when the rights
documented by the cards expire. Within this market, the Company's largest
customer for LaserCard products is the United States government (through a
government prime contractor, Information Spectrum, Inc., a unit of Anteon
International Corporation), representing 82% of total revenues for fiscal year
2003 compared with 78% of total revenues for fiscal 2002 and 62% of total
revenues for fiscal 2001. These revenues are predominantly the result of two
U.S. Department of Homeland Security card programs-U.S. Permanent Resident Cards
(Green Cards), formerly for the U.S. Immigration and Naturalization Service
(INS); and "Laser Visa" Border Crossing Cards (BCCs) for the U.S. Department of
State (DOS). Sales of cards and read/write drives for the Canadian Permanent
Resident Card program represented 10.5% of total revenues for fiscal 2003 and 3%
of revenues in fiscal 2002 when shipments began. VISX, Incorporated, a
non-government customer since 1992, represented 7% of the Company's fiscal 2002
revenues and near zero in fiscal 2003. The Company anticipates orders for two
programs in Italy-the CIE card (Carta d'Identica Elettronica), and the PSE card
(Permesso di Soggiorno Elettronico). The Company has been informed by its
Italian VAR that the Italian government plans to issue 1.7 million CIE cards and
600,000 PSE cards this year through December 2003. However, the Company has not
as yet received any corresponding card orders.
Potential applications for optical memory card digital governance programs
in various countries include identification cards for Saudi Arabia and
Macedonia; motor vehicle registration cards in India; children's healthcare
cards in the People's Republic of China; and the expansion of current U.S.
government ID card programs due to the increasing need for enhanced U.S. border
security. Since governmental card programs typically rely on government
policy-making, which in turn is subject to technical requirements, budget
approvals, and political considerations, there is no assurance that these
programs will be implemented as expected.
In addition to using its own marketing staff, the Company utilizes
value-added reseller (VAR) companies and card distribution licensees for the
development of commercial 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 (PCs), and other peripherals, and then resell these
products integrated into data systems. The Company is continuing its efforts to
recruit new VARs and card distribution licensees and eliminate nonproductive
VARs.
Revenues
For the 2003 fiscal year ended March 31, 2003, the Company's total
revenues were $26,331,000 compared with $20,889,000 for fiscal 2002 and
$24,906,000 for fiscal 2001.
PRODUCT REVENUES. Sales of LaserCard(R) optical memory cards and related
products totaled $25,221,000 for fiscal 2003 compared with $19,562,000 for
fiscal 2002 and $22,690,000 for fiscal 2001. The changes in product revenues
over these periods were due primarily to the sale of optical memory cards for
two U.S. government card programs, as described below. For fiscal 2003, the
Company sold LaserCard products to approximately 30 customers in six states and
10 foreign countries. The Company sold 7.3 million optical memory cards and
approximately 175 read/write drives for fiscal 2003 compared with 5.6 million
optical cards and 450 read/write drives for fiscal 2002 and 5.9 million cards
and 1,280 read/write drives for fiscal 2001. Read/write drive revenues decreased
by $0.7 million for fiscal 2003 compared with fiscal 2002 and by approximately
$2.6 million for fiscal 2002 as compared with fiscal 2001. Read/write drives
comprised less than approximately 5% of total revenues during both fiscal 2003
and fiscal 2002 and approximately 15% of total revenues during fiscal 2001. Of
the 1,280 read/write drives sold during fiscal 2001, approximately 600 drives
were delivered mainly for the U.S. Department of Defense Automated Manifest
System as compared with approximately 60 read/write drives for fiscal 2002 and
approximately 15 drives for fiscal 2003. Orders for this program have
historically been sporadic. The remaining decrease in read/write drive
deliveries was due to a reduction in sales to VISX, Incorporated, a VAR. Sales
of cards and drives to VISX were
26
negligible in fiscal 2003, but represented 7% of the Company's fiscal 2002
revenues and 22% in fiscal 2001. Although some of VISX's LaserCard-equipped
surgery systems that are already installed at laser eye-surgery clinics continue
to use the Company's optical memory cards, VISX does not employ LaserCard drives
for system activation of its currently produced laser eye-surgery equipment. In
addition to sales to other customers, the Company anticipates delivery of
approximately 1,000 read/write drives for the Department of Homeland Security
during fiscal 2004.
Revenues during fiscal 2003 included sales of 6.6 million Green Cards and
Laser Visa BCCs. The Company anticipates that fiscal 2004 revenues will include
sales ranging from 2 million to 3 million cards for these programs. In order to
maintain card revenues at the fiscal 2003 level, fiscal 2004 revenues will need
to include additional orders from new and existing programs. Such programs could
include those in Italy, Macedonia, Saudi Arabia, and the United States
government's U.S. VISIT and TWIC programs.
LICENSE FEES AND OTHER REVENUES. The Company entered into a read/write
drive kits assembly license with a customer in Italy which generated license
revenue of $712,000 during fiscal 2001 and $119,000 during fiscal 2002. The
arrangement was structured whereby the customer agreed to pay a contractually
agreed upon fee in exchange for the transfer of technical knowledge and know-how
and training in the assembly of read/write drives. The training period extended
over 16 months, which is the period over which the Company recognized the fee as
revenue. The Company recorded revenue of $1,465,000 during fiscal 2001 and
$1,206,000 in fiscal 2002 realized on digital sound patent licenses sold to Sony
Corporation and Dolby Laboratories, Inc. The revenues were net of legal costs
and third party contingency (success) fees. There are no ongoing royalty
payments. Fiscal 2003 license and other revenue included $875,000 representing
the unamortized portion of a $1,000,000 nonrefundable distribution license fee
received in 2000 from a licensee in Asia that had committed to purchase a
minimum number of optical memory cards for a program in the licensee's country.
The Company recorded this fee as deferred revenue and has been amortizing it as
revenue in proportion to the actual card purchases by the licensee. During
December 2002, the Company determined that, due to the licensee's failure to
meet the minimum contractual purchase commitment, the licensee's distribution
rights had become unenforceable and that the licensee would no longer be acting
as the card supplier for that program. In addition, at that time the Company
decided it would no longer work with the licensee under the terms of the license
agreement. Since there were no further obligations, the Company recognized the
remaining $875,000 of revenue in the quarter ended December 31, 2002. Fiscal
2003 license and other revenue also included $235,000 relating to a payment
received in January 2002 from a third party that was considering entering into a
license agreement with the Company; the Company originally recorded this payment
as deferred revenue. The third party had subsequently foregone its rights under
this agreement due to non-performance and accordingly, the Company recognized
revenue on this arrangement in the fourth quarter of fiscal 2003.
Backlog
As of March 31, 2003, the backlog for LaserCard optical memory cards
totaled approximately $1.9 million in firm card orders under card supply
contracts, of which amount 54% is for U.S. government Green Cards or Laser Visas
under a U.S. government subcontract for the purchase of optical memory cards.
Since the Company had a fixed delivery schedule for card shipments out of a
secure, U.S. government-funded vault on Company premises, the Company recognized
revenues on the cards located in the vault, and therefore such cards were not
included in backlog at March 31, 2003. As of March 31, 2002, the backlog for
LaserCard optical memory cards totaled approximately $16.4 million, consisting
of approximately $11.1 million in firm card orders under card supply contracts,
and approximately $5.3 million in cards produced, delivered to, and located in
the government-funded vault. Of the $11.1 million amount, 85% was for U.S.
government Green Cards or Laser Visa BCCs under the Company's U.S. government
subcontract. Of the $5.3 million amount, all were Green Cards or Laser Visa BCCs
produced under this subcontract. The fluctuation in backlog for fiscal 2003
compared with fiscal 2002 is due to the receipt of fixed delivery schedules in
fiscal 2003, in addition to the fact that government release orders arrive at
irregular intervals. Purchase order releases under the Company's five-year U.S.
government subcontract are issued at irregular intervals and for varying card
quantities. At March 31, 2002, the Company had six months remaining on a January
22, 2002 release of 3.25 million cards.
On May 8, 2003, the Company announced a $1.8 million order for Canadian
"Maple Leaf" Permanent Resident Cards. This order called for deliveries
beginning in May 2003.
27
Gross Profit
Excluding license and other revenue, the gross margin on product sales was
45% for fiscal 2003, 46% for fiscal 2002, and 46% for fiscal 2001.
Historically, optical memory card gross margins have approximated 50%.
Optical memory card gross profit and margins can vary significantly based on
average selling price, sales and production volume, mix of card types,
production efficiency and yields, and changes in fixed costs. As discussed
below, read/write drive gross margins are currently negative, inclusive of fixed
overhead costs. Even if read/write drive sales volume achieves profitable
levels, the Company believes that read/write drive gross margins will remain
below 10% for the foreseeable future. The decrease in gross margin on product
sales for fiscal 2003 as compared to fiscal 2002 and fiscal 2001 was due largely
to (1) the initial production of cards for the Canadian program under a new
manufacturing process initiated by the Company during fiscal 2003, and (2) the
larger negative gross margin on read/write drive sales discussed below.
OPTICAL MEMORY CARDS. The Company depends on gross profit generated from
optical memory card sales. Gross profit on optical memory card sales was about
$12.1 million for fiscal 2003, $9.5 million for fiscal 2002, and $9.9 million
for fiscal 2001. The change in gross profit from year to year was mainly due to
changes in sales volume.
READ/WRITE DRIVES. For fiscal 2003, gross profit on read/write drive sales
decreased by about $250,000, to a negative gross profit of about $890,000. The
negative gross margin for fiscal 2003 includes inventory write-offs of about
$300,000 and unabsorbed overhead costs that were charged to cost of product
sales due to manufacturing volume being well below capacity during the year. For
fiscal 2002, gross profit on read/write drive sales decreased by about $1
million, to a negative gross profit of about $640,000 compared with a gross
profit of about $430,000 for fiscal 2001. The decrease for fiscal 2002 was due
to lower selling prices for drives and lower sales volume to a level that does
not fully absorb fixed manufacturing expenditures. Prior to fiscal 2002, the
Company had been selling read/write drives for less than three thousand dollars
per unit in quantities of six or more, and these units generally included
interface software. In fiscal 2002, the Company 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.
This reduced gross profit on read/write drive sales in fiscal 2002, and
increased the level of sales required to achieve gross profits on read/write
drive sales, inclusive of fixed overhead costs. The Company believes that
assembly and sales of approximately 400 read/write drives per quarter would be
necessary to achieve a gross profit on read/write drive sales at current selling
prices and costs. Currently, in an effort to stimulate optical memory card
sales, the Company's priority is to increase the number of read/write drives in
the marketplace rather than maximizing per-unit gross profit on read/write
drives. The Company has no plans to further lower read/write drive prices for
the current model. The margin on the new drive model recently introduced by the
Company is expected to be similar to that of the current drive model.
The Company believes that potential markets for read/write drives include
the U.S. Department of Homeland Security, the U.S. Department of State, the U.S.
armed forces, and the governments of Canada, Italy, and several other countries.
On April 22, 2003, the U.S. Department of Homeland Security issued a
Presolicitation Notice for the purchase of approximately 1,000 optical stripe
read/write drives for delivery over a five-month period beginning thirty days
after contract award. The Company anticipates winning such award when granted.
The Company maintains an inventory of read/write drive parts and finished drives
that it believes is adequate to meet customer demand. However, 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
the Company's operating results.
Income and Expenses
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES (SG&A). SG&A expenses were
$6,202,000 for fiscal 2003, $5,165,000 for fiscal 2002, and $4,134,000 for
fiscal 2001. The increase for fiscal 2003 compared with fiscal 2002 included
approximately $507,000 for increased marketing and selling expenditures, an
increase of $273,000 in general and administrative expenditures, an increase of
$177,000 for insurance expenditures, and an increase of $132,000 for legal and
accounting services. The increase for fiscal 2002 compared with fiscal 2001
included approximately $575,000 for increased marketing and selling
expenditures, an increase of $365,000 in general and administrative
expenditures, and
28
an increase of $80,000 in Company 401(k) matching and Company contribution to
the Employee Stock Purchase Plan. The Company believes that SG&A expenses for
fiscal 2004 will be higher than fiscal 2003 levels, mainly due to increases in
marketing and selling expenses, increases in insurance premiums and accounting
and audit fees, and other general increases.
RESEARCH AND ENGINEERING EXPENSES (R&E). The Company is continuing its
efforts to develop new optical memory card features, including the insertion of
contactless chips with radio frequency (RF) capability, optical memory card
read/write drives, read-only drives (readers), and 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 factors are important for the
Company's existing and future optical memory card markets. Total R&E expenses
were $2,818,000 for fiscal 2003, $3,045,000 for fiscal 2002, and $2,370,000 for
fiscal 2001. The decrease for fiscal 2003 compared with 2002 is mainly due to a
reduction in purchased services and prototype expenditures. The increase in R&E
spending for fiscal 2002 was due to the increase in read/write and read-only
drive manufacturing engineering and product development. The Company anticipates
that R&E expenses will increase during fiscal 2004, primarily due to optical
memory card read/write drive development efforts.
OTHER INCOME. Total other income for fiscal 2003 consisted of $397,000 of
interest income compared with $386,000 of interest income for fiscal 2002 and
$612,000 of interest income for fiscal 2001. The difference for fiscal 2002
compared with fiscal 2001 is due to interest rate declines.
PRETAX PROFIT. For fiscal 2003, pretax profit increased by $1.4 million
compared with fiscal 2002 due to the $2.2 million increase in gross profit
partially offset by the $0.8 million increase in operating expenses. Pretax
profit for fiscal 2002 decreased by $4.4 million compared with fiscal 2001 due
primarily to the $1.6 million reduction in product gross profit, a $1.7 million
increase in expenses, and a $0.9 million decrease in license revenue.
INCOME TAXES. The Company recorded an income tax expense of $1,520,000 for
fiscal 2003 as compared with the income tax benefits of $2,786,000 for fiscal
2002 and $1,097,000 for fiscal 2001. As of March 31, 2002, the Company had
recognized all prior tax benefits for income statement purposes. The income tax
benefit for fiscal 2002 included a credit of $2,999,000 due to the change in the
valuation allowance relating to the federal deferred tax asset, net of federal
alternative minimum taxes, partially offset by $213,000 for state tax expense.
The income tax benefit for fiscal 2001 included a credit of $1,671,000 due to
the change in the valuation allowance relating to the federal deferred tax
asset, net of federal alternative minimum taxes, partially offset by $220,000
for state tax expense and $354,000 for foreign income taxes.
The Company analyzes its deferred tax assets with regard to potential
realization, as described above under Critical Accounting Policies - Accounting
for Income Taxes. The Company has established a valuation allowance on a
significant portion of the deferred tax assets attributable to stock option
deductions based upon the uncertainty of their realization. Any release of the
remaining valuation allowance would be recorded as a credit to equity and would
have no impact on net income. The Company has considered estimated future
taxable income and ongoing prudent and feasible tax planning strategies in
assessing the amount of the valuation allowance. All or some portion of the
deferred tax asset that has been recognized would be reversed if it is
determined that it is more likely than not that such portion would not be
realized on the Company's tax return.
There are timing differences between when certain items are included in
book income and when the same items are included on income tax returns.
Therefore, tax payments or credits often occur in different periods than when an
income tax expense or benefit is included in the statements of income. For
income tax purposes, the Company estimates that if these timing differences are
fully realized on the tax return, future federal tax cash payments could be
reduced by approximately $10 million.
29
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2003, the Company had cash, cash equivalents, and
short-term investments of $10,117,000, a current ratio of 5.9 to 1, and no
long-term debt. The Company also had $6,898,000 in long-term investments with
original maturities from 1 to 2.5 years.
Net cash used in operating activities was $64,000 for fiscal 2003 compared
with net cash provided by operating activities of $4,369,000 for fiscal 2002,
and $7,080,000 for fiscal 2001. The major categories comprising cash provided by
(used in) operating activities are (in thousands):
Fiscal Year
-----------
2001 2002 2003
---- ---- ----
Net income ............................................. $ 7,912 $ 5,199 $ 2,282
Depreciation and amortization .......................... 2,449 1,556 1,829
(Increase) decrease in deferred tax asset .............. (1,903) (3,484) 1,326
Increase in inventory .................................. (461) (368) (1,163)
Decrease (increase) in deferred revenue and
advance payments from customers ..................... 754 1,392 (2,560)
Decrease in deferred gross profit ...................... (2,161) (295) (2,860)
Other .................................................. 490 369 1,082
------- ------- -------
Cash provided by (used in) operating activities ..... $ 7,080 $ 4,369 $ (64)
======= ======= =======
The $1,163,000 increase in inventory during fiscal 2003 was largely due to
a $900,000 increase in raw materials inventory for optical memory card
manufacture, and a $460,000 increase in optical memory card finished goods
inventory partially offset by a $160,000 decrease in optical memory card
work-in-process inventory. The advance payments from customers amount fluctuates
with the amount of Company backlog on which advance payments are received.
Deferred revenue increases when cash is received for items on which revenue has
not yet been recognized. Deferred revenue decreases when revenue is recognized
on these items.
The Company believes that the estimated level of revenues over the next 12
months will be sufficient to generate cash from operating activities over the
same periods. However, quarterly fluctuations are probable. Operating cash flow
could be negatively impacted to a significant degree if either of the Company's
largest U.S. government programs were to be delayed, canceled, or not extended
and not be replaced by other card orders or other sources of income, or if
increases in product revenues or licenses do not keep pace with increased
marketing and R&E expenditures.
The Company has not established a line of credit and has no current plans
to do so. The Company may negotiate a line of credit if and when it becomes
appropriate, although no assurance can be made that such financing would be
available on favorable terms or at all, if needed.
As a result of the $2,282,000 net income recorded for fiscal 2003, the
Company's accumulated deficit was reduced to $5,817,000. Stockholders' equity
increased to $36,843,000 as a result of the net income recorded and $2,224,000
in additions to equity, mainly due to stock option exercises.
Net cash used for investing activities was $4,151,000 for fiscal 2003,
$6,319,000 for fiscal 2002, and $2,350,000 for fiscal 2001. These amounts
include changes in the maturity of liquid investments, purchases of property and
equipment of $2,468,000 for fiscal 2003, $1,723,000 for fiscal 2002, and
$2,202,000 for fiscal 2001, and increases in patents and other intangibles of
$307,000 for fiscal 2003, $98,000 for fiscal 2002, and $164,000 for fiscal 2001.
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 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 date of purchase, are classified as
short-term. The Company determines the length of its investments after
considering its cash requirements and yields available for the type of
investment considered by the Company. Management also determines the appropriate
classification of debt and equity securities at the time of purchase and
reevaluates the
30
classification of investments as of each balance sheet date. As of March 31,
2003, the Company had $11,261,000 classified as short-term and long-term
investments, compared with $9,885,000 at March 31, 2002. All marketable
securities were classified as held-to-maturity. Cash plus short-term and
long-term investments were $17,015,000 at March 31, 2003 and $18,078,000 at
March 31, 2002.
The Company added capital equipment and leasehold improvements of
approximately $2.5 million during fiscal 2003 compared with approximately $1.7
million during fiscal 2002 and $2.2 million during fiscal 2001. Depending on
card type, the Company's card production capacity currently is approximately 13
million cards per year. The Company plans to purchase additional production
equipment in a series of steps when deemed appropriate by the Company. In
addition to investment used for expansion, the Company expects to make
additional capital expenditures for cost savings, quality improvements, and
other purposes. The Company plans to use cash on hand and cash generated from
operations to fund capital expenditures of about $7 million during fiscal 2004
for equipment and leasehold improvements for card production, read/write drive
tooling and assembly, and general support items. The majority of this proposed
expenditure is slated for new card manufacturing equipment.
Net cash provided by financing activities was $1,776,000 for fiscal 2003
and $3,922,000 for fiscal 2002 compared with $1,327,000 used for financing
activities for fiscal 2001. Financing activities consisted of proceeds on sales
of common stock through the Company's stock-option and stock-purchase plans and
cash used for purchases of common stock under a stock repurchase program,
discussed below. Net cash provided by sales of common stock through stock plans
were in the amounts of $1,776,000 for fiscal 2003, $4,097,000 for fiscal 2002,
and $1,486,000 for fiscal 2001.
During fiscal 2001, the Company commenced a share repurchase program under
which up to 200,000 shares of common stock could be purchased by the Company
from time to time in Nasdaq Stock Market transactions in an aggregate amount not
exceeding $3 million. During fiscal 2001 and the first quarter of fiscal 2002,
the Company used cash of $2,813,000 and $175,000 for this purpose and has since
terminated this program without further activity.
There were no debt financing activities for fiscal 2003, 2002, or 2001.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET 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:
o Commercial paper rated A1/P1 or debt instruments rated AAA, as rated
by the major rating services
o Can readily be sold for cash
FOREIGN CURRENCY EXCHANGE RATE RISK. The Company sells products in various
international markets. All of these sales are denominated in U.S. Dollars. As of
March 31, 2003, the Company had no outstanding foreign currency hedge contracts.
Accordingly, the Company had no material foreign currency exchange risk as of
March 31, 2003. During fiscal 2003, there were no material changes to the
Company's exposure to market risk for changes in interest rates.
31
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders
of Drexler Technology Corporation:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, of stockholders' equity and of cash
flows present fairly, in all material respects, the financial position of
Drexler Technology Corporation and its subsidiaries at March 31, 2003 and March
31, 2002, and the results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally accepted in the
United States of America. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. The financial statements of
the Company as of March 31, 2001 and for the year then ended were audited by
other independent accountants who have ceased operations. Those independent
accountants expressed an unqualified opinion on those financial statements in
their report dated May 13, 2002.
/s/PricewaterhouseCoopers LLP
San Jose, California
April 28, 2003
32
THIS REPORT IS A CONFORMED COPY OF THE REPORT PREVIOUSLY ISSUED BY
ARTHUR ANDERSEN LLP AND HAS NOT BEEN REISSUED BY THAT FIRM.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of Drexler Technology Corporation:
We have audited the accompanying consolidated balance sheet of Drexler
Technology Corporation (a Delaware corporation) and subsidiaries as of March 31,
2001, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the two years in the period ended March 31, 2001 (as
restated). These consolidated financial statements and the schedule referred to
below are the responsibility of the Company's management. Our responsibility is
to express an opinion on these consolidated financial statements and schedule
based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Drexler
Technology Corporation and subsidiaries as of March 31, 2001, and the results of
their operations and their cash flows for each of the two years in the period
ended March 31, 2001 in conformity with accounting principles generally accepted
in the United States of America.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The Schedule II included in this Form
10-K is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not a part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in our audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
/s/Arthur Andersen LLP
San Jose, California
May 13, 2002
33
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, 2002 and 2003
(In thousands, except share and par value amounts)
2002 2003
---- ----
ASSETS
Current assets:
Cash and cash equivalents ............................................................... $ 8,193 $ 5,754
Short-term investments .................................................................. 8,883 4,363
Accounts receivable, net of product return reserve of $100 in 2002 and $90 in 2003 ...... 1,659 1,659
Inventories ............................................................................. 4,973 5,711
Deferred tax asset ...................................................................... 3,849 2,689
Prepaid and other current assets ........................................................ 561 1,016
-------- --------
Total current assets ................................................................. 28,118 21,192
-------- --------
Property and equipment, at cost ............................................................ 20,979 23,204
Less--accumulated depreciation and amortization ......................................... (14,561) (15,795)
-------- --------
Property and equipment, net .......................................................... 6,418 7,409
Long-term investments ...................................................................... 1,002 6,898
Patents and other intangibles, net ......................................................... 612 567
Deferred tax asset, net .................................................................... 4,563 4,397
-------- --------
Total assets .................................................................... $ 40,713 $ 40,463
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................................ $ 738 $ 1,085
Accrued liabilities ..................................................................... 1,117 1,434
Advance payments from customers ......................................................... 2,551 1,096
Deferred revenue ........................................................................ 235 5
Deferred gross profit ................................................................... 2,860 --
-------- --------
Total current liabilities ............................................................ 7,501 3,620
Deferred revenue, long-term ............................................................. 875 --
-------- --------
Total liabilities ............................................................... $ 8,376 $ 3,620
-------- --------
Commitments and contingencies (Note 6)
Stockholders' equity:
Preferred stock, $.01 par value:
Authorized--2,000,000 shares
Issued--none ......................................................................... -- --
Common stock, $.01 par value:
Authorized--30,000,000 shares
Issued--10,240,687 shares at March 31, 2002 and 10,443,192 shares at March 31, 2003 .. 102 104
Additional paid-in capital .............................................................. 40,334 42,556
Accumulated deficit ..................................................................... (8,099) (5,817)
-------- --------
Total stockholders' equity ........................................................... 32,337 36,843
-------- --------
Total liabilities and stockholders' equity ...................................... $ 40,713 $ 40,463
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
34
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Fiscal Years Ended March 31, 2001, 2002, and 2003
(In thousands, except per share amounts)
2001 2002 2003
---- ---- ----
Revenues:
Product sales ............................................. $ 22,690 $ 19,562 $ 25,221
License and other revenue ................................. 2,216 1,327 1,110
-------- -------- --------
Total revenues ....................................... 24,906 20,889 26,331
-------- -------- --------
Cost of product sales ......................................... 12,199 10,652 13,906
-------- -------- --------
Gross profit .............................................. 12,707 10,237 12,425
-------- -------- --------
Operating expenses:
Selling, general, and administrative expenses ............. 4,134 5,165 6,202
Research and engineering expenses ......................... 2,370 3,045 2,818
-------- -------- --------
Total operating expenses ............................. 6,504 8,210 9,020
-------- -------- --------
Operating income ................................. 6,203 2,027 3,405
Other income:
Interest income ........................................... 612 386 397
-------- -------- --------
Total other income, net .......................... 612 386 397
-------- -------- --------
Income before income taxes ....................... 6,815 2,413 3,802
Income tax expense (benefit) .................................. (1,097) (2,786) 1,520
-------- -------- --------
Net income ....................................... $ 7,912 $ 5,199 $ 2,282
======== ======== ========
Net income per share:
Basic ............................................ $ .80 $ .52 $ .22
Diluted .......................................... $ .76 $ .50 $ .21
Weighted average number of common and common
equivalent shares:
Basic ............................................ 9,897 9,961 10,356
Diluted .......................................... 10,446 10,468 10,842
The accompanying notes are an integral part of these consolidated financial statements.
35
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Fiscal Years Ended March 31, 2001, 2002, and 2003
(In thousands)
Common Stock Additional Treasury Accumulated
Shares Amount Paid-In Capital Stock Deficit Total
------ ------ --------------- ----- ------- -----
Balance, March 31, 2000....................... 9,864 $ 99 $ 37,168 $ -- $ (21,210) $ 16,057
Shares purchased through an
open market repurchase program......... -- -- -- (2,813) -- (2,813)
Shares issued under stock option
and stock purchase plans............... 87 -- 513 973 -- 1,486
Income tax benefit arising from
stock options.......................... -- -- 100 -- -- 100
Compensation related to
stock plan activity.................... -- -- 71 -- -- 71
Net income................................ -- -- -- -- 7,912 7,912
------- ------- ---------- -------- ----------- ---------
Balance, March 31, 2001....................... 9,951 99 37,852 (1,840) (13,298) 22,813
Shares purchased through an
open market repurchase program......... -- -- -- (175) -- (175)
Shares issued under stock option
and stock purchase plans............... 290 3 2,079 2,015 -- 4,097
Income tax benefit arising from
stock options.......................... -- -- 307 -- -- 307
Compensation related to
stock plan activity.................... -- -- 96 -- -- 96
Net income................................ -- -- -- -- 5,199 5,199
------- ------- ---------- -------- ----------- ---------
Balance, March 31, 2002....................... 10,241 102 40,334 -- (8,099) 32,337
Shares issued under stock option
and stock purchase plans............... 202 2 1,774 -- -- 1,776
Income tax benefit arising from
stock options.......................... -- -- 356 -- -- 356
Compensation related to
stock plan activity.................... -- -- 92 -- -- 92
Net income................................ -- -- -- -- 2,282 2,282
------- ------- ---------- -------- ----------- ---------
Balance, March 31, 2003....................... 10,443 $ 104 $ 42,556 $ -- $ (5,817) $ 36,843
======= ======= ========== ======== =========== =========
The accompanying notes are an integral part of these consolidated financial statements.
36
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Years Ended March 31, 2001, 2002, and 2003
(In thousands)
2001 2002 2003
---- ---- ----
Cash flows from operating activities:
Net income..................................................................... $ 7,912 $ 5,199 $ 2,282
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization.............................................. 2,449 1,556 1,829
Provision for doubtful accounts receivable................................. (15) (14) 11
Provision for product return reserve....................................... -- (127) --
Provision for excess and obsolete inventory................................ (1) 276 425
Decrease (increase) in deferred tax asset.................................. (1,903) (3,484) 1,326
Compensation from stock plan activity...................................... 71 96 92
Tax benefit for stock options.............................................. 100 307 356
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable................................. 172 (240) (11)
Decrease in notes receivable............................................... 150 -- --
Increase in inventories.................................................... (461) (368) (1,163)
(Increase) decrease in other assets........................................ (413) 116 (455)
Increase (decrease) in accounts payable and accrued liabilities............ 426 (45) 664
Increase (decrease) in deferred revenue.................................... 597 116 (1,105)
Increase (decrease) in advance payments from customers..................... 157 1,276 (1,455)
Decrease in deferred gross profit.......................................... (2,161) (295) (2,860)
--------- --------- ---------
Net cash provided by (used in) operating activities.................... 7,080 4,369 (64)
--------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment............................................ (2,202) (1,723) (2,468)
Investments in patents and other intangibles................................... (164) (98) (307)
Purchases of investments....................................................... (18,938) (13,964) (16,453)
Maturities of investments...................................................... 18,954 9,466 15,077
--------- --------- ---------
Net cash used in investing activities.................................. (2,350) (6,319) (4,151)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from sale of common stock through stock plans......................... 1,486 4,097 1,776
Cash used to purchase common stock through an open market
repurchase program......................................................... (2,813) (175) --
--------- --------- ---------
Net cash provided by (used in) financing activities.................... (1,327) 3,922 1,776
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents................... 3,403 1,972 (2,439)
Cash and cash equivalents:
Beginning of year.............................................................. 2,818 6,221 8,193
--------- --------- ---------
End of year ................................................................... $ 6,221 $ 8,193 $ 5,754
========= ========= =========
Supplemental disclosures--cash payments for:
Income taxes................................................................... $ 320 $ 182 $ --
========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
37
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS
Drexler Technology Corporation and its wholly owned subsidiary, LaserCard
Systems Corporation, (the "Company") develop and manufacture optical data
storage products featuring LaserCard(R) optical memory cards and chip-ready
Smart/Optical(TM) cards used with personal computers for information recording,
storage, and retrieval. These optical data storage products include optical
memory cards, optical card read/write drives, and related systems and
peripherals. The Company's customers are mainly value-added reseller (VAR)
companies and licensees, in the United States and other countries, that develop
commercial applications for LaserCard products. Target markets for these
products include government and commercial applications for portable,
recordable, secure, identification cards and other unitary-record cards.
Applications include U.S. immigration Green Cards and Laser Visa Border Crossing
Cards, U.S. military cargo manifests, Canadian Permanent Resident Cards,
biometric IDs, access cards, and other wallet-card applications.
The Company is subject to certain risks including, but not limited to,
competition from substitute products and larger companies and dependence on
certain suppliers and customers.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION. The consolidated
financial statements include the accounts of Drexler Technology Corporation and
its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
USE OF ESTIMATES. 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.
FISCAL PERIOD. For purposes of presentation, the Company labels its annual
accounting period end as March 31. The Company, in fact, operates and reports
based on quarterly periods ending on the Friday closest to month end. Fiscal
2001 ended on March 30, 2001; fiscal 2002 ended on March 29, 2002; and fiscal
2003 ended on March 28, 2003.
CASH AND CASH EQUIVALENTS, SHORT-TERM INVESTMENTS, AND LONG-TERM
INVESTMENTS. The Company considers all highly liquid investments, consisting
primarily of commercial paper, taxable notes, and U.S. government bonds, with
maturities of three months or less at the date of purchase, to be cash
equivalents. All investments with original or remaining maturities at date of
purchase of more than three months and up to one year, are classified as
short-term investments. All investments with original maturities greater than
one year are classified as long-term investments. Management determines the
appropriate classification of debt and equity securities at the time of purchase
and reevaluates the classification of investments as of each balance sheet date.
All short-term investments are classified as held to maturity. The carrying
amounts of short-term investments at March 31, 2002 and 2003 are (in thousands):
2002 2003
---- ----
Corporate bonds................................ $ 5,199 $ --
U.S. government and agency obligations......... 1,900 401
Certificates of deposit........................ 1,784 3,962
---------- ---------
$ 8,883 $ 4,363
========== =========
At March 31, 2003, scheduled maturities of held-to-maturity investments are
(in thousands):
Up to one year................................. $ 4,363
After one year through five years ............ 6,898
---------
$ 11,261
=========
38
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying amounts of the Company's
financial instruments including cash and cash equivalents, accounts receivable,
accounts payable and accrued liabilities, approximate their fair values due to
their short maturities.
INVENTORIES. Inventories are stated at the lower of cost or market, with
cost determined on a first-in, first-out basis and market based on the lower of
replacement cost or estimated realizable value. The components of inventories as
of March 31 are (in thousands):
2002 2003
---- ----
Raw materials..................... $ 3,063 $ 3,209
Work-in-process................... 479 220
Finished goods.................... 1,338 2,257
Systems and components
held for resale................ 93 25
--------- ---------
$ 4,973 $ 5,711
========= =========
During fiscal 2003, the Company recorded a $425,000 charge to write down
excess inventory.
PROPERTY AND EQUIPMENT, NET. The components of property and equipment as of
March 31 are (in thousands):
2002 2003
---- ----
Equipment and furniture........... $ 18,425 $ 20,523
Leasehold improvements............ 2,554 2,681
--------- ---------
$ 20,979 $ 23,204
========= =========
Property and equipment are recorded at cost. Depreciation is provided over
the estimated useful lives (four to seven years) of equipment and furniture
using the double-declining balance and straight-line methods. Leasehold
improvements are amortized over the shorter of the life of the asset or the life
of the lease using the straight-line method. Depreciation and leasehold
amortization expense for fiscal 2001, 2002, and 2003 was $974,000, $1,082,000,
and $1,477,000, respectively.
PATENT COSTS. Legal expenses incurred in connection with patents are
capitalized and amortized over the estimated remaining useful lives of the
patents of six to seventeen years. Costs incurred in connection with other
intangibles are amortized using the straight-line method over three to five
years.
Gross patent expenditures capitalized and accumulated amortization as of
March 31 are as follows (in thousands):
2002 2003
---- ----
Gross patent and other
intangible expenditures........ $ 3,327 $ 3,634
Accumulated amortization.......... (2,715) (3,067)
--------- ---------
$ 612 $ 567
========= =========
ASSESSMENT OF IMPAIRMENT OF LONG-LIVED ASSETS. The Company periodically
evaluates whether events and circumstances have occurred which indicate that the
carrying value of its long-lived assets may not be recoverable. If the Company
determines an asset has been impaired, the impairment charge is recorded based
on the excess of the carrying value over the fair value of the impaired asset,
with the reduction in value charged to expense. To date, the Company has not
needed to record any impairment losses on long-lived assets.
ACCRUED LIABILITIES. The components of accrued liabilities as of March 31
are (in thousands):
2002 2003
---- ----
Accrued payroll and fringe benefits...... $ 525 $ 605
Other accrued liabilities................ 592 829
--------- ---------
$ 1,117 $ 1,434
========= =========
39
SOFTWARE DEVELOPMENT COSTS. Development costs incurred in the research and
development of new software products are expensed as incurred until
technological feasibility in the form of a working model has been established.
To date, the Company's software development has been completed concurrent with
the establishment of technological feasibility and, accordingly, all software
development costs have been charged to research and engineering expenses in the
accompanying statements of income.
ADVANCE PAYMENTS FROM CUSTOMERS. The Company customarily receives advance
payments on orders placed by its customers. The advance payments are recorded as
a liability on the balance sheet until the related orders are shipped.
REVENUE RECOGNITION. Product sales primarily consist of card sales and
sales of read/write drives. The Company recognizes revenue from product sales
when the following criteria are met: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the fee is fixed or determinable; and (4)
collectibility is reasonably assured. The Company recognizes revenue on product
sales at the time of shipment when shipping terms are F.O.B. shipping point,
orders are placed pursuant to a pre-existing sales arrangement, and there are no
post-shipment obligations or customer acceptance criteria. Where appropriate,
provision is made at the time of shipment for estimated warranty costs and
estimated returns. Product sales primarily consist of card sales and sales of
read/write drives.
The Company's U.S. government subcontract requires delivery to a secure,
government-funded vault built on Company premises. Deliveries are made into the
vault on a fixed schedule specified by the prime contractor. At the time the
cards are delivered to the vault, title to the cards transfers to the
government, the prime contractor is invoiced, and payment is due according to
normal trade payment terms. However, revenue is recognized when the cards are
shipped from the vault to the government unless the Company receives a fixed
schedule, notification, or plan for shipments out of the vault to the
government, in which case revenue is recognized upon the latter of receipt of
such fixed shipment schedule or delivery of the cards into the vault.
The Company applies the provisions of Statement of Position SOP 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 all transactions involving the sale of software products.
Revenue from the license of the Company's software products is recognized when
persuasive evidence of an arrangement exists, the software product has been
delivered, the fee is fixed or determinable, and collectibility is reasonably
assured, and, if applicable, upon acceptance when acceptance criteria are
specified or upon expiration of the acceptance period. Software sales have not
been significant to the Company's business for all periods presented.
License revenue, which may consist of up-front license fees and long-term
royalty payments, is recognized as revenue when realized. The cost of license
revenue, unless patent litigation was involved, is not material and is included
in selling, general, and administrative expenses.
The Company entered into a read/write drive kits assembly license with a
customer in Italy which generated license revenue of $712,000 during fiscal 2001
and $119,000 during fiscal 2002. The arrangement was structured whereby the
customer agreed to pay the Company a contractually agreed upon fee in exchange
for the transfer of technical knowledge and know-how and training in the
assembly of read/write drives. The training period extended over 16 months,
which is the period over which the Company recognized the fee as revenue. The
Company recorded revenue of $1,465,000 during fiscal 2001 and $1,206,000 in
fiscal 2002 relating to digital sound patent licenses sold to Sony Corporation
and Dolby Laboratories, Inc. The revenues were net of legal costs and third
party contingency (success) fees. There are no ongoing royalty payments.
RESEARCH AND ENGINEERING EXPENSES. Costs related to research, design, and
development of products are charged to research and development expense as
incurred.
STOCK-BASED COMPENSATION. On December 31, 2002, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 148, "Accounting for Stock Based Compensation - Transition and Disclosure,"
which amends SFAS No. 123. SFAS No. 148 requires more prominent and frequent
disclosures about the effects of stock-based compensation, which the Company
adopted for the year ended March 31, 2003. 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 stock at the date of grant
over the amount an
40
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. Had compensation expense for the Plans been determined
consistent with SFAS No. 123, the Company's net income and basic and diluted net
income per share would have decreased to the following pro forma amounts
(dollars, in thousands, except per share amounts):
Fiscal Year
-----------
2001 2002 2003
---- ---- ----
Net income, as reported............................................................ $ 7,912 $ 5,199 $ 2,282
========= ========= =========
Deduct: Total stock-based employee compensation determined under
fair value based method for all awards, net of related tax effects.............. (1,823) (2,245) (1,353)
--------- --------- ---------
Pro forma net income............................................................... $ 6,089 $ 2,954 $ 929
========= ========= =========
Basic net income per common share:
As reported..................................................................... $ .80 $ .52 $ .22
========= ========= =========
Pro forma ...................................................................... $ .62 $ .30 $ .09
========= ========= =========
Diluted net income per common share:
As reported..................................................................... $ .76 $ .50 $ .21
========= ========= =========
Pro forma ...................................................................... $ .58 $ .28 $ .09
========= ========= =========
Shares used in computing basic and diluted and pro forma net income per share:
Basic. ...................................................................... 9,897 9,961 10,356
Diluted ...................................................................... 10,446 10,468 10,842
Stock-based employee compensation expense included
in reported net income, net of related tax effects.............................. 78 91 55
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:
Fiscal Year
-----------
2001 2002 2003
---- ---- ----
Risk-free interest rate........................ 5% 5% 2.67% to 4.99%
Average expected years life of option.......... 6 to 8years 6 to 8 years 5 to 8 years
Dividend yield................................. 0% 0% 0%
Volatility of common stock..................... 50% 50% 50%
Weighted average fair
values of option grants..................... $8.58 $7.54 $8.59
COMPREHENSIVE INCOME (LOSS). Under SFAS No. 130, "Reporting Comprehensive
Income," comprehensive income (loss) is defined as the changes in equity of an
enterprise except those resulting from stockholders' transactions. For the
fiscal years ended March 31, 2000, 2001, and 2002, comprehensive income equaled
net income.
SEGMENT REPORTING. In accordance with SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," the Company is required to
disclose information about operating segments. The Company operates in one
segment--the development, manufacture, and sale of optical data products used
for information storage and retrieval.
41
RECENT ACCOUNTING PRONOUNCEMENTS.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statement
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" which eliminates inconsistencies between the required accounting
for sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. SFAS No. 145 also amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings, or
describe their applicability under changed conditions. The provisions of SFAS
No. 145 are effective for fiscal years beginning after May 15, 2002 and for
transactions occurring after May 15, 2002. The Company does not expect adoption
of SFAS No. 145 to have a material impact on its financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or
Disposal Activities" which addresses the recognition, measurement, and reporting
of costs that are associated with exit and disposal activities, including
restructuring activities that are currently accounted for pursuant to the
guidance that the Emerging Issues Task Force (EITF) has set forth in EITF Issue
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 will be effective for exit or disposal activities
that are initiated after December 31, 2002. The Company does not expect adoption
of SFAS No. 146 to have a material impact on its financial statements.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 requires that a liability
be recorded in the guarantor's balance sheet upon issuance of a guarantee. In
addition, FIN 45 requires disclosures about the guarantees that an entity has
issued, including a reconciliation of changes in the entity's product warranty
liabilities. The initial recognition and initial measurement provisions of FIN
45 are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002, irrespective of the guarantor's fiscal year-end. The
disclosure requirements of FIN 45 are effective for financial statements of
interim or annual periods ending after December 15, 2002. The adoption of this
standard had no material impact on the Company's financial statements, although
the Company has complied with the disclosure requirements of this standard.
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables."
EITF Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or rights
to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
Company believes that the adoption of this standard will have no material impact
on its consolidated financial statements.
In January 2003, the FASB issued Financial Interpretation No. 46,
"Consolidation of Variable Interest Entities" (FIN 46). FIN 46 addresses
consolidation by business enterprises of variable interest entities. Under that
interpretation, certain entities known as Variable Interest Entities (VIEs) must
be consolidated by the primary beneficiary of the entity. The primary
beneficiary is generally defined as having the majority of the risks and rewards
arising from the VIE. For VIEs in which a significant (but not majority)
variable interest is held, certain disclosures are required. It applies
immediately to variable interest entities created after January 31, 2003, and
applies in the first year or interim period beginning after June 15, 2003 to
variable interest entities in which an enterprise holds a variable interest that
it acquired before February 1, 2003. The Company does not believe that the
adoption of this interpretation will have a material effect on its consolidated
financial position, results of operations, or cash flows.
In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003 and for hedging relationships designated after June 30, 2003. The
Company is currently analyzing the provisions of SFAS No. 149 to determine if
there will be any impact of adoption, but does not believe that there will be
any material impact on its consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for how companies classify and measure certain
financial instruments with characteristics of both liabilities and equity. It
requires companies to classify a financial
42
instrument that is within its scope as a liability (or an asset in some
circumstances). SFAS No. 150 is effective beginning with the second quarter of
fiscal 2004; the Company is currently analyzing the provisions of SFAS No. 150
to determine its impact, but does not believe that there will be any material
impact on its consolidated financial statements.
RECLASSIFICATIONS. Certain reclassifications were made to the prior year
financial data to conform with the current year presentation.
INDEMNIFICATION. The Company's major sales agreements provide remedies to
customers, such as defense, settlement, or payment of judgment for intellectual
property claims related to the use of the Company's products. The Company has
also entered into indemnification agreements with its directors and officers and
the Company's bylaws contain similar indemnification obligations. Claims made
under such indemnifications are rare and the associated estimated fair value of
the liability is not material.
3. NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the
weighted average number of shares of common stock outstanding. Diluted net
income per share is computed by dividing net income by the weighted average
number of shares of common stock and common stock equivalents outstanding.
Common stock equivalents consist of stock options using the treasury stock
method.
The reconciliation of the numerators and denominators of the basic and
diluted net income per share computation for fiscal years 2001, 2002, and 2003
is shown below (in thousands, except per share data):
Fiscal Year
-----------
2001 2002 2003
---- ---- ----
Net income ................................................................................. $ 7,912 $ 5,199 $ 2,282
======== ========= =========
Basic net income per share:
Weighted average common shares outstanding................................................. 9,897 9,961 10,356
-------- --------- ---------
Basic net income per share.................................................................... $ .80 $ .52 $ .22
======== ========= =========
Diluted net income per share:
Weighted average common shares outstanding................................................. 9,897 9,961 10,356
Weighted average common shares from stock option grants.................................... 549 507 486
-------- --------- ---------
Weighted average common shares and common stock equivalents outstanding.................... 10,446 10,468 10,842
-------- --------- ---------
Diluted net income per share.................................................................. $ .76 $ .50 $ .21
======== ========= =========
Stock options having an exercise price greater than the average market
value for the periods are excluded from the calculation of diluted net income
per share, as their effect would be antidilutive. Stock options to purchase
321,400, 280,950, and 168,000 shares were excluded from the calculation of
diluted net income per share for the years ended March 31, 2001, 2002, and 2003,
respectively.
4. MAJOR CUSTOMERS AND EXPORT SALES
Two customers each accounted for more than 10% of revenues during fiscal
2001 and 2002, and one customer accounted for more than 10% of revenues in
fiscal 2003, as follows:
Fiscal Year
-----------
2001 2002 2003
---- ---- ----
Customer A...................... 62% 81% 94%
Customer B...................... 22% 7% --
One United States customer comprised 98% of accounts receivable at March
31, 2002 and 99% of accounts receivable at March 31, 2003.
43
Sales by geographic region are generally determined based upon the ship to
address on the invoice. Revenues by geographic region are as follows (in
thousands):
Fiscal Year
-----------
2001 2002 2003
---- ---- ----
United States................ $ 21,140 $ 18,832 $ 22,205
Other North America.......... 10 622 2,780
Europe....................... 1,408 835 426
Asia ........................ 2,299 580 887
Rest of world................ 49 20 33
---------- --------- ---------
$ 24,906 $ 20,889 $ 26,331
========== ========= =========
5. RELATED-PARTY TRANSACTIONS
On October 21, 2001, the Company entered into a one-year agreement with
Wexler & Walker Public Policy Associates, a unit of Hill and Knowlton, Inc.,
("Wexler") to be lobbyists on behalf of the Company. The Chairman of Wexler is
Robert S. Walker, a brother of director Walter F. Walker. In October 2002, the
agreement was extended for the period October 1, 2002 through September 2003, or
until terminated upon seven days' notice. The extended agreement provides for a
monthly retainer of $10,000. During the 2003 fiscal year, the Company paid
$96,985 to Wexler. There were no significant amounts due to Wexler as of March
31, 2002 or 2003.
6. COMMON STOCK
STOCK OPTION PLAN. The Company has one stock option plan (the Stock Option
Plan) under which 2,278,602 shares of common stock have been reserved as of
March 31, 2003, consisting of 2,059,798 shares for stock options already granted
and 218,804 shares for stock options not yet granted.
The Company's Stock Option Plan provides that stock options may be granted
to employees, officers, directors, and consultants of the Company and that
option prices may be no less than 100% of the fair market value of the shares at
the date of grant. No options were granted to consultants during fiscal 2001,
2002, or 2003. The Board of Directors specifies the term of options and the
vesting schedule for exercise of options. The option term cannot exceed ten
years (except that incentive stock options granted to a principal shareholder
cannot exceed five years). The following table lists Stock Option Plan activity
from March 31, 2000 through March 31, 2003:
Options Weighted
Available Outstanding Average
for Grant Options Exercise Price
--------- ------- --------------
Balance March 31, 2000..................... 237,920 1,908,210 $ 10.54
Authorized.............................. 300,000 --
Granted ................................ (364,800) 364,800 $ 15.73
Exercised............................... -- (141,810) $ 9.62
Expired ................................ 103,100 (103,100) $ 11.54
------- ---------
Balance March 31, 2001..................... 276,220 2,028,100 $ 11.49
------- ---------
Authorized.............................. 300,000 --
Granted ................................ (345,500) 345,500 $ 13.82
Exercised............................... -- (416,618) $ 9.52
Expired ................................ 83,251 (83,251) $ 13.86
------- ---------
Balance March 31, 2002..................... 313,971 1,873,731 $ 12.25
------- ---------
Authorized.............................. 275,000 --
Granted ................................ (394,000) 394,000 $ 16.03
Exercised............................... -- (184,100) $ 8.67
Expired ................................ 23,833 (23,833) $ 16.11
------- ---------
Balance March 31, 2003..................... 218,804 2,059,798 $ 13.25
======= =========
44
The following table summarizes information about stock options outstanding
at March 31, 2003:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------- ----------------------------------
Number Weighted-Average Weighted- Number Weighted-
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices At 3/31/03 Contractual Life Exercise Price At 3/31/03 Exercise Price
--------------- ---------- ---------------- -------------- ---------- --------------
$ 6.97 - $10.75 334,515 5.2 years $ 9.11 258,598 $ 9.43
$10.91 - $12.69 593,308 5.1 years $ 11.76 542,794 $ 11.74
$13.06 - $15.56 730,775 7.7 years $ 14.05 324,775 $ 13.94
$16.47 - $22.75 401,200 8.2 years $ 17.43 124,000 $ 17.02
--------- ---------
Totals 2,059,798 1,250,167
========= =========
EMPLOYEE STOCK PURCHASE PLAN. The Company has an Employee Stock Purchase
Plan (Stock Purchase Plan), under which 84,461 shares are reserved as of March
31, 2003 for future purchases by employees. Under the Stock Purchase Plan,
eligible employees may designate from 2% to 6% of their compensation to be
withheld for the purchase of shares of common stock at 67% of a trailing average
price. The differential between fair market value and the average price of the
shares sold under the Stock Purchase Plan is charged to operations as a
compensation expense and is taxed to the employee as income. Under the Stock
Purchase Plan, employees purchased 12,964 shares for fiscal 2001, 12,942 shares
for fiscal 2002, and 18,405 shares for fiscal 2003. The average purchase price
per share was $9.51 for fiscal 2001, $10.52 for fiscal 2002, and $9.74 for
fiscal 2003. The weighted average market price per share for shares purchased
was $15.05 for fiscal 2001, $17.97 for fiscal 2002, and $14.76 for fiscal 2003.
7. COMMITMENTS AND CONTINGENCIES
The Company occupies its buildings under various operating leases. Rent
expense relating to these buildings was approximately $1,077,000 for fiscal
2001, $1,169,000 for fiscal 2002, and $1,186,000 for fiscal 2003. As of March
31, 2003, future minimum rental payments relating to these leases are (in
thousands):
Fiscal Year
-----------
2004..................... 1,221
2005..................... 911
2006..................... 856
2007..................... 139
Thereafter............... --
-------
$ 3,127
In the normal course of business, the Company is subject to various claims
and assertions. In the opinion of management, the ultimate disposition of such
claims and assertions will not have a material adverse impact on the financial
position of the Company.
8. INCOME TAXES
The provision for income taxes for fiscal 2001, 2002, and 2003 consists of
the following (in thousands):
Fiscal Year
-----------
2001 2002 2003
---- ---- ----
Current provision:
Federal...................... $ 136 $ 49 $ 261
State........................ 220 213 98
Foreign...................... 354 -- --
--------- --------- ---------
710 262 359
--------- --------- ---------
Deferred provision:
Federal...................... (1,807) (3,048) 1,161
--------- --------- ---------
Income tax expense (benefit).... $ (1,097) $ (2,786) $ 1,520
========= ========= =========
45
The Company's effective tax rate differs from the statutory rate as
follows:
FISCAL YEAR
-----------
2001 2002 2003
---- ---- ----
Tax rate reconciliation:
Federal statutory rate................. 34% 34% 34%
State tax, net of federal benefit..... 6% 6% 6%
Change in valuation allowance............. (58%) (159%) --
Alternative minimum taxes................. 2% -- --
------- ------ ------
(16%) (119%) 40%
======= ====== ======
The major components of the net deferred tax asset as of March 31 are as
follows (in thousands):
2002 2003
---- ----
Net operating loss carryforwards:
Federal................................ $ 10,420 $ 10,311
Tax credits............................... 440 537
Reserves and accruals not
currently deductible for tax purposes.. 2,373 964
Depreciation.............................. 461 574
Capitalized patent costs.................. (175) (153)
Other ................................... 211 107
-------- --------
Total deferred tax asset............... 13,730 12,340
Valuation allowance, equity............... (5,318) (5,254)
-------- --------
Net deferred tax asset.................... $ 8,412 $ 7,086
======== ========
The Company analyzes its deferred tax assets with regard to potential
realization. The Company has established a valuation allowance on a portion of
the deferred tax assets as management could not conclude that it was more likely
than not that those deferred tax assets would be realized. The Company's
determination of the realizability of its deferred tax assets involves
considering all available evidence, both positive and negative, regarding the
likelihood of sufficient future income. The methodology used involves estimates
of future income which assumes ongoing profitability of its core business and
includes the estimated impact of future stock option deductions and the
expiration dates and amounts of net operating loss carryforwards. These
estimates of future income are projected through the life of the related
deferred tax assets using assumptions which management believes to be
reasonable. As of March 31, 2003, the Company would require approximately $17
million of future taxable income to realize the related deferred tax assets
recognized as of March 31, 2003.
There are timing differences between when certain items are included in
book income and when the same items are included on income tax returns.
Therefore, tax payments or credits often occur in different periods than when an
income tax expense or benefit is included in the statements of income.
The Company's federal net operating loss carryforwards as of March 31, 2003
of $30,326,000 will expire at various dates from 2005 through 2023, if not
utilized. The tax effect of this amount is reflected above in the $10,311,000
amount. Of this amount, $5,254,000 will be credited to stockholders' equity to
the extent the Company concludes that it is more likely than not that this
amount will be realized. Tax credits in the amount of $300,000 for alternative
minimum taxes have no expiration. Other tax credits in the amount of $237,000
will expire on various dates from 2013 through 2018 if not utilized.
9. SUBSEQUENT EVENT (Unaudited)
The Company learned on July 10, 2003, that its subsidiary, LaserCard
Systems Corporation, had been named as one of several defendants in a lawsuit
brought by George Rawe. Mr. Rawe alleged in the lawsuit that he was injured in
laser eye surgery performed using a VISX, Incorporated laser that incorporated a
LaserCard as a component. Mr. Rawe is suing the physicians involved for
malpractice and VISX, Incorporated, the Company, and various unnamed defendants
for product liability, alleging their products were defective. The lawsuit was
filed in California Superior Court for San Joaquin County, case number CV020962
and seeks an amount of damages which are not quantified. The Company is just
beginning to evaluate the complaint and the Company's defenses, including the
availability of insurance coverage and any rights or obligations of
indemnification involving VISX, Incorporated.
46
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
(In thousands, except per share amounts)
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Fiscal 2002
Product sales...................................... $ 3,972 $ 3,909 $ 7,030 $ 4,651
License and other revenue.......................... 311 765 -- 251
Total revenues..................................... 4,283 4,674 7,030 4,902
Cost of product sales.............................. 2,273 2,063 3,734 2,582
Net income......................................... 1,134 1,418 1,659 988
Net income per share:
Basic.......................................... $ .12 $ .14 $ .17 $ .10
Diluted........................................ $ .11 $ .14 $ .15 $ .09
Weighted average number of common
and common equivalent shares:
Basic.......................................... 9,820 9,813 10,015 10,194
Diluted........................................ 10,135 10,039 10,847 10,975
Fiscal 2003
Product sales...................................... $ 6,588 $ 9,493 (1) $ 4,490 $ 4,650
License and other revenue.......................... -- -- 875 235
Total revenues..................................... 6,588 9,493 (1) 5,365 4,885
Cost of product sales.............................. 3,285 5,095 2,580 2,946
Net income (loss).................................. 659 1,375 397 (149)
Net income (loss) per share:
Basic.......................................... $ .06 $ .13 $ .04 $ (.01)
Diluted........................................ $ .06 $ .13 $ .04 $ (.01)
Weighted average number of common and
common equivalent shares:
Basic.......................................... 10,300 10,314 10,376 10,433
Diluted........................................ 11,117 10,764 10,788 10,433
(1) During the second quarter of fiscal 2003, for the first time, the Company received a fixed schedule for shipments
out of a secure, government-funded vault built on Company premises. Revenue on all of the 2.17 million cards
located in the vault was recognized upon the receipt of such fixed shipment schedule. Had the Company not received
this fixed schedule, revenues for the fiscal 2003 second quarter would have been based only on shipment of cards
out of the vault, as in the past, which would have reduced revenue by approximately $6.9 million for the three
months ended September 30, 2002.
47
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On April 8, 2002, the Board of Directors of Drexler Technology Corporation
(the "Company"), upon recommendation of the Audit Committee, dismissed Arthur
Andersen LLP ("Arthur Andersen") as the Company's independent public accountants
and engaged PricewaterhouseCoopers LLP ("PWC") to serve as the Company's
independent public accountants for the fiscal year ended March 31, 2002.
Arthur Andersen's report on the Company's consolidated financial statements
for the fiscal year ended March 31, 2001 did not contain an adverse opinion or
disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit
scope or accounting principles.
During the fiscal year ended March 31, 2001 and through the date of their
dismissal, there were no disagreements with Arthur Andersen on any matter of
accounting principle or practice, financial statement disclosure, or auditing
scope or procedure which, if not resolved to Arthur Andersen's satisfaction,
would have caused them to make reference to the subject matter in connection
with their report on the Company's consolidated financial statements for such
year; and there were no reportable events as defined in Item 304(a)(1)(v) of
Regulation S-K.
The Company provided Arthur Andersen with a copy of the foregoing
disclosures. A copy of Arthur Andersen's letter dated April 10, 2002, stating
its agreement with such statements, is contained in Exhibit 16 to the Company's
Report on Form 8-K dated April 8, 2002, filed by the Company on April 12, 2002.
During the fiscal year ended March 31, 2001 and through the date of
engagement of PWC, the Company did not consult PWC with respect to the
application of accounting principles to a specified transaction, either
completed or proposed, or the type of audit opinion that might be rendered on
the Company's consolidated financial statements, or any other matters or
reportable events as set forth in Items 304(a)(2)(i) and (ii) of Regulation S-K.
48
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
A. DIRECTORS AND EXECUTIVE OFFICERS*
Officer or
Director
Name Age Since Position with Registrant and, If Different, Principal Occupation
---- --- ----- ----------------------------------------------------------------
Jerome Drexler 75 1968 Chairman of the Board of Directors and Chief Executive Officer of Drexler
Technology Corporation and its wholly owned subsidiary, LaserCard Systems
Corporation.
Richard M. Haddock 51 1997 Director; President and Chief Operating Officer (since 1997) of Drexler
Technology Corporation and President and Chief Operating Officer (since 1989)
of its wholl owned subsidiary, LaserCard Systems Corporation.
Christopher J. Dyball 52 1992 Director; Executive Vice President and General Manager, Card Manufacturing,
Drexler Technology Corporation.
Steven G. Larson 53 1987 Vice President of Finance and Treasurer of Drexler Technology Corporation and
its wholly owned subsidiary, LaserCard Systems Corporation.
Arthur H. Hausman 79 1981 Director. Private investor. Retired Chairman, President, and Chief Executive
Officer of Ampex Corporation (manufacturer of professional audio-video systems,
data/memory products, and magnetic tape). Director of California Amplifier,
Inc. (low-noise amplifiers).
Dan Maydan 67 1998 Director. President Emeritus (since May 2003), President (1993 to May 2003) and
Director (since 1992) of Applied Materials, Inc. (semiconductor manufacturing
equipment). Director of Electronics for Imaging, Inc. (software). Member of the
National Academy of Engineering.
William E. McKenna 83 1970 Director. Private investor. Director of Midway Games, Inc. (interactive
entertainment software for the home market) and WMS Industries, Inc.
(coin-operated video and other games). Certified Public Accountant (New York
and California).
Walter F. Walker 48 1999 Director. President, CEO, and Director (since 2001) of The Basketball Club of
Seattle, LLC, which owns the Seattle Sonics & Storm Basketball teams (NBA and
WNBA basketball); formerly President (since 1994) of Seattle SuperSonics NBA
basketball team. Previously, was President (in 1994) of Walker Capital, Inc.
(money management firm) and Vice President (from 1987 to 1994) of Goldman Sachs
& Co. (investment banking firm). Director of Advanced Digital Information
Corporation (archival and backup data-storage peripherals). National Trustee of
Boys & Girls Clubs of America. Member of the Institute of Chartered Financial
Analysts (CFAs).
There are no family relationships among any directors or executive officers
of the Company.
It is anticipated that each of the directors and executive officers will
continue in his position, although there is no understanding or arrangement to
that effect. Each director holds office until the next annual meeting of
stockholders and until such director's successor is elected and qualified.
However, any of the above directors or executive officers could resign, and any
of the officers could be replaced or removed by the Board of Directors at any
time.
- ----------------------
* As of July 11, 2003. See September 11, 2003 Proxy Statement for subsequent
changes.
49
B. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's directors, executive officers, and beneficial owners of more than
10% of the Company's common stock to file with the Commission initial reports of
ownership and reports of changes in ownership of common stock and other equity
securities of the Company. The Company typically files these reports on behalf
of its directors and officers, based on information provided by them. A Form 5
was filed in May 2003 on behalf of director Walter F. Walker, whose spouse sold
500 shares in March 2002; Mr. Walker disclaims beneficial ownership of the 1,000
shares currently owned by his spouse. With the exception of this late filing,
the Company believes, based on its review of Forms 3, 4, 5, if any, and periodic
written representations from reporting persons, that all other officers,
directors, and holders of more than 10% of the Company's common stock complied
with all Section 16(a) filing requirements for the 2003 fiscal year. The SEC
website address
"www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=30140&owner=only"
contains the electronic filings of Forms 3, 4, and 5 related to beneficial
ownership by the Company's directors and executive officers.
ITEM 11. EXECUTIVE COMPENSATION
A. COMPENSATION OF EXECUTIVE OFFICERS
The Summary Compensation table below discloses the total compensation paid
to each of the Company's four executive officers for the three fiscal years
ended March 31, 2003, for services rendered in all capacities to the Company and
its subsidiaries.
SUMMARY COMPENSATION TABLE
Annual Compensation Long-term Compensation
------------------- ----------------------
Fiscal Securities Underlying All Other
Name and Principal Position Year Salary ($) Bonus ($) Option Grants (#) Compensation(1)
- --------------------------- ---- ---------- --------- ----------------- ---------------
Jerome Drexler 2003 $ 245,405 -- -- --
Chairman of the Board and 2002 237,972 -- -- --
Chief Executive Officer 2001 235,622 $ 50,000 -- --
Richard M. Haddock 2003 $ 282,158 -- 50,000 $6,250
President and 2002 263,645 -- 30,000 5,437
Chief Operating Officer 2001 255,029 $ 50,000 30,000 2,625
Christopher J. Dyball 2003 $ 263,109 -- 50,000 $6,250
Executive Vice President; General 2002 256,763 -- 30,000 5,437
Manager, Card Manufacturing 2001 237,227 $ 50,000 30,000 2,625
Steven G. Larson 2003 $ 217,217 -- 35,000 $6,123
Vice President of Finance 2002 207,810 -- 12,000 5,437
and Treasurer 2001 207,234 $ 30,000 20,000 2,625
- -----------------------
(1) Represents the Company's matching contribution on behalf of these
individuals in the Company's 401(k) Plan.
Stock Option Grants to Executive Officers
The following table sets forth the stock options granted to each of the
Company's four executive officers under the Company's Stock Option Plan during
the 2003 fiscal year ended March 31, 2003. The options become exercisable in
installments of one-fourth (1/4) each after one, two, three, and four years from
the date of grant.
50
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
Potential Realizable Value at
Number of Percent of Assumed Annual Rates of
Securities Total Options Exercise Stock Price Appreciation
Underlying Granted to Price Expiration For Option Term (3)
Options Employees ($/Share) Date -------------------
Name Granted(#) in Fiscal Year (1) (2) 5% ($) 10% ($)
---- ---------- -------------- --------- ---------- ------ -------
Jerome Drexler -- -- -- -- -- --
Richard Haddock 50,000 12.69% $17.675 6/6/12 $555,786 $1,408,470
Christopher Dyball 50,000 12.69% $17.675 6/6/12 555,786 1,408,470
Steven Larson 35,000 8.88% $17.675 6/6/12 389,050 985,929
- ---------------------
(1) At the discretion of the Board of Directors and/or Stock Option Committee,
the optionee may pay the exercise price to the Company in cash or by
delivering already owned shares, subject to certain conditions.
(2) Options have ten-year terms but are subject to earlier termination in
certain events.
(3) The 5% and 10% assumed rates of appreciation are mandated by the rules of
the Securities and Exchange Commission and do not represent the Company's
estimate or projection of the future common stock price.
Aggregated Option Exercises and Options Held by Executive Officers
The following table sets forth the value of options exercised by the
Company's executive officers during the fiscal year ended March 31, 2003, and
remaining options held at fiscal year end.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
Number of Securities
Shares Underlying Unexercised Value of Unexercised
Acquired Options at In-the-Money Options at
on Value Fiscal Year-End (#) Fiscal Year-End ($)(2)
Exercise Realized ------------------- ----------------------
Name (#) ($)(1) Exercisable Unexercisable Exercisable Unexercisable
---- -------- -------- ----------- ------------- ----------- -------------
Jerome Drexler 85,600 $989,047 155,000 -- $386,548 --
Richard Haddock -- -- 192,000 87,500 $484,894 $25,763
Christopher Dyball -- -- 160,200 87,500 $351,114 $25,763
Steven Larson -- -- 115,667 54,000 $196,604 $10,305
- ---------------------
(1) Market value of underlying securities (based on the fair market value of
the Company's common stock on The Nasdaq Stock Market) at the time of their
exercise, minus the exercise price.
(2) Market value of securities underlying in-the-money options at fiscal year
end (based on $14.27 per share, the average market price of the Company's
common stock on The Nasdaq Stock Market on the last day of the Company's
fiscal year) minus the exercise price.
B. COMPENSATION OF DIRECTORS
Each director receives a fee of $1,200 per month for serving as a director,
the standard fee in effect since July 1995. The Company also reimburses
reasonable out-of-pocket expenses incurred by directors performing services for
the Company.
51
The Company's Stock Option Plan provides for the automatic grant of an
option to purchase 15,000 shares of the Company's common stock on the date any
person first becomes a director. These grants to newly elected directors have
become exercisable in cumulative increments of one-fourth (1/4) each at the end
of 12 months, 24 months, 36 months, and 48 months from the date of grant. The
Stock Option Plan further provides that on the date of the Company's annual
meeting, each non-employee director who has been a director of the Company for
the preceding six-month period and who is re-elected at the annual meeting, is
automatically granted an option to purchase 6,000 shares of the Company's common
stock. The option share grants to the re-elected directors are exercisable in
full at the time of grant. The exercise price for options granted to newly
elected directors and re-elected directors is the fair market value of the
Company's common stock on the date of grant.
C. EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT, AND CHANGE OF CONTROL
ARRANGEMENTS
None of the Company's executive officers has employment or severance
arrangements with the Company. Under the terms of the Stock Option Plan, the
Board of Directors and/or Stock Option Committee retains discretion, subject to
certain limits, to modify the terms of outstanding options. In the event of a
merger or sale of assets or like event, the Board of Directors is empowered to
make appropriate adjustments to options under the Stock Option Plan. The Board
of Directors has adopted guidelines specifying the following as adjustments that
it would consider appropriate upon the occurrence of such an event:
o permitting optionees no less than 30 days to exercise the vested
portion of their options;
o having the successor corporation either (a) issue to optionees
replacement options for the unvested portions of options, or else (b)
pay deferred compensation on the spread between the value of Company
stock upon the occurrence of such event and the option exercise price
at the time such unvested portion would have vested; and
o providing for vesting of 100% of the unvested portion for optionees
employed by the Company for at least two years prior to such event if
their employment is terminated within one year of such event by the
successor corporation other than by resignation or for acts of moral
turpitude.
D. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During fiscal 2003, none of the Company's executive officers served on the
board of directors of any entities whose directors or officers serve on the
Company's Compensation Committee. During fiscal 2003, Mr. McKenna and Dr. Maydan
served as members of the Compensation Committee, which is currently composed
entirely of two outside directors who are not officers or employees of the
Company. As presently established, the Compensation Committee approves the
salary of executive officers, including the Chief Executive Officer, and certain
other employees.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The table below, based upon information supplied by the principal
stockholders, shows the name, address, number of shares held, nature of
ownership, and percentage of shares held as of March 31, 2003 by the persons or
entities known to the Company to own beneficially more than 5% of the
outstanding common stock. Applicable percentages are based on 10,443,192 shares
outstanding on March 31, 2003.
BENEFICIAL OWNERSHIP BY PRINCIPAL STOCKHOLDERS
Common Percent of
Name and Address of Beneficial Owner Shares (1) Class (2)
------------------------------------ ---------- --------
Jerome Drexler, c/o Drexler Technology Corporation, 1077 Independence Avenue,
Mountain View, CA 94043 898,445 (3) 8.5%
FMR Corp., 82 Devonshire Street, Boston, MA 02109 1,205,745 (4) 11.5%
William D. Witter, Inc., 51st Floor, 153 E. 53rd Street, New York, NY 10022 1,023,560 (5) 9.8%
- ---------------------
52
(1) Each of the stockholders named in this table has sole voting and investment
power with respect to the shares indicated as beneficially owned, subject
to community property laws, where applicable, and the information contained
in the footnotes to this table.
(2) For purposes of computing the percentage of outstanding shares held by each
person or group of persons named above on a given date, shares which such
person or group has the right to acquire within 60 days after such date are
deemed to be outstanding, but are not deemed to be outstanding for the
purposes of computing the percentage ownership of any other person.
(3) Includes 155,000 shares purchasable by exercise of option within 60 days.
Does not include 7,700 shares owned by Mr. Drexler's wife, as to which
shares Mr. Drexler disclaims any beneficial ownership. Includes 10,000
shares held by The Drexler Foundation, the assets of which are perpetually
dedicated to charity. The power to vote and to dispose of the shares held
by The Drexler Foundation is shared by the Foundation's directors,
consisting of Mr. Drexler and his wife. Mr. Drexler disclaims beneficial
ownership with respect to these shares.
(4) This information is based on a Schedule 13F-HR filing with the SEC for the
quarter ended March 31, 2003 by FMR Corp.("FMR") on behalf of Edward C.
Johnson 3d and Abigail P. Johnson: Fidelity Management & Research Company,
a registered investment adviser and wholly owned subsidiary of FMR, is the
beneficial owner of 1,043,326 shares over which Mr. Johnson and FMR each
have sole dispositive power and the Funds' Boards of Trustees have sole
voting power; Fidelity Management Trust Company, a wholly owned subsidiary
of FMR, is the beneficial owner of 521,645 shares over which Mr. Johnson
and FMR each have sole voting and sole dispositive power.
(5) This information is based on a Schedule 13F-HR filing with the SEC for the
quarter ended March 31, 2003 by William D. Witter, Inc. Of the 1,023,560
shares attributed to William D. Witter, Inc., it has sole voting power over
903,082 of these shares and sole dispositive power over all 1,023,560
shares.
The following table contains information as of March 31, 2003, respecting
the number of shares and percentage of the Company's common stock beneficially
owned by each of the Company's seven directors, by each executive officer of the
Company, and by all executive officers and directors as a group. The address of
each beneficial owner listed in the table is c/o Drexler Technology Corporation,
1077 Independence Avenue, Mountain View, California 94043. Applicable
percentages are based on 10,443,192 shares outstanding on March 31, 2003.
STOCK OWNERSHIP BY DIRECTORS AND EXECUTIVE OFFICERS
Common Percent
Name Shares (1) of Class (2)
---- ---------- ------------
Jerome Drexler 898,445 (3) 8.5%
Arthur H. Hausman 56,392 (4) .5%
Dan Maydan 33,000 (5) .3%
William E. McKenna 83,483 (6) .8%
Walter F. Walker 48,250 (7) .5%
Richard M. Haddock 199,214 (8) 1.9%
Christopher J. Dyball 167,088 (9) 1.6%
Steven G. Larson 118,822 (10) 1.1%
All executive officers and directors as a group (8 persons) 1,604,694 (11) 14.3%
----------------------------------------
(1) To the Company's knowledge, the persons named in the table have sole voting
and investment power with respect to all shares of common stock shown as
beneficially owned by them, subject to community property laws, where
applicable, and the information contained in the footnotes to this table.
53
(2) For purposes of computing the percentage of outstanding shares held by each
person or group of persons named above on a given date, shares which such
person or group has the right to acquire within 60 days after such date are
deemed to be outstanding, but are not deemed to be outstanding for the
purposes of computing the percentage ownership of any other person.
(3) Includes 155,000 shares purchasable by exercise of option within 60 days.
Does not include 7,700 shares owned by Mr. Drexler's wife, as to which
shares Mr. Drexler disclaims any beneficial ownership. Includes 10,000
shares held by The Drexler Foundation, the assets of which are perpetually
dedicated to charity. The power to vote and to dispose of the shares held
by The Drexler Foundation is shared by the Foundation's directors,
consisting of Mr. Drexler and his wife. Mr. Drexler disclaims beneficial
ownership with respect to these shares.
(4) Includes 36,000 shares purchasable by exercise of option within 60 days.
(5) Includes 33,000 shares purchasable by exercise of option within 60 days.
(6) Includes 48,000 shares purchasable by exercise of option within 60 days.
(7) Includes 31,000 shares purchasable by exercise of option within 60 days.
Does not include 1,000 shares owned by Mr. Walker's wife, as to which
shares Mr. Walker disclaims any beneficial ownership.
(8) Includes 192,000 shares purchasable by exercise of option within 60 days.
(9) Includes 160,000 shares purchasable by exercise of option within 60 days.
(10) Includes 115,667 shares purchasable by exercise of option within 60 days.
(11) Includes 770,867 shares purchasable by exercise of option within 60 days.
EQUITY COMPENSATION PLAN INFORMATION
The table below shows information as of March 31, 2003, with respect to
equity compensation plans under which equity securities of the Company are
authorized for issuance. The Company's equity compensation plans, consisting of
the Stock Option Plan and Employee Stock Purchase Plan, are approved by security
holders.
Number of Securities to Be Weighted-Average Number of Securities Remaining
Issued upon Exercise of Exercise Price of Available for Future Issuance under
Outstanding Options, Outstanding Options, Equity Compensation Plans (Excluding
Plan Category Warrants, and Rights Warrants, and Rights Securities Reflected in Column (A))
------------- -------------------- -------------------- ------------------------------------
(a) (b) (c)
Equity compensation plans
approved by security holders 2,059,798 $13.25 303,265 (1)
Equity compensation plans not
approved by security holders 0 0 0
- ---------------------
(1) Includes 84,461 shares reserved as of March 31, 2003 for future purchases
by employees through payroll deductions under the Company's Employee Stock
Purchase Plan, which is available to all regular employees who work a
minimum of 30 hours per week and who have completed six months of
employment with the Company.
54
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On October 21, 2001, the Company entered into a one-year agreement with
Wexler & Walker Public Policy Associates, a unit of Hill and Knowlton, Inc.,
("Wexler") to be lobbyists on behalf of the Company. The Chairman of Wexler is
Robert S. Walker, a brother of director Walter F. Walker. In October 2002, the
agreement was extended for the period October 1, 2002 through September 2003, or
until terminated upon seven days' notice. The extended agreement provides for a
monthly retainer of $10,000. During the 2003 fiscal year, the Company paid
$96,985 to Wexler. There were no significant amounts due to Wexler as of March
31, 2002 or 2003.
ITEM 14. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company's principal
executive officer 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-K/A and have
determined that they are reasonable taking into account the totality of the
circumstances.
CHANGES IN INTERNAL CONTROLS. There were no significant changes in the
Company's internal control over financial reporting that occurred during the
period covered by this Form 10-K/A that have materially affected, or are
reasonably likely to materially affect, such control.
55
PART IV
-------
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) List of Documents Filed as Part of this Report
1. The consolidated financial statements of the Company, filed herewith
under Item 8, as follows:
Page Number
-----------
(1) Reports of Independent Accountants and Independent Public
Accountants 32
(2) Consolidated Balance Sheets at March 31, 2002 and March 31, 2003 34
(3) Consolidated Statements of Income for Fiscal Years 2001, 2002,
and 2003 35
(4) Consolidated Statements of Stockholders' Equity for Fiscal Years
2001, 2002, and 2003 36
(5) Consolidated Statements of Cash Flows for Fiscal Years 2001,
2002, and 2003 37
(6) Notes to Consolidated Financial Statements 38
2. Financial Statement Schedules:
The schedule supporting the Company's Consolidated Financial
Statements, filed herewith under Item 14(d), as follows:
Schedule
Number Description Page Number
------ ----------- -----------
-- Report of Independent Accountants on Financial
Statement Schedule 58
II Valuation and Qualifying Accounts 59
Schedules not listed above are not applicable or not required, or the
information required to be set forth therein is included in the
consolidated financial statements or the notes thereto.
3. Exhibits:
The Exhibits to this Report, filed herewith under Item 14(c) or
incorporated by reference from other documents previously filed with
the Securities and Exchange Commission, as follows:
Exhibit Filed Herewith or Incorporated
Number Description Herein by Reference to
------ ----------- ----------------------
3.1 Amended and Restated Certificate of Incorporation Exhibit 3.1.1 to Report on Form 10-Q
for period ended September 30, 2000
3.2 Amended and Restated By-Laws as of July 24, 2001 Exhibit 3.2. to Report on Form 10-K
filed June 21, 2002
10.1 Building lease agreement with The Milla and Exhibit 10.1.6 to Report on Form 10-K
Raymond Handley 1992 Trust (Marine Way) for fiscal year ended March 31, 2000
56
Exhibit Filed Herewith or Incorporated
Number Description Herein by Reference to
------ ----------- ----------------------
10.1.1 Building lease agreement with Renault & Handley Exhibit 10.1 to Report on Form 10-Q
Employees Investment Co. (Bayshore Parkway) for period ended September 30, 2000
10.2 Optical memory card manufacturing license with Exhibit 4 to Report on Form 8-K
Canon Inc. dated January 10, 1989
10.3 Optical memory card manufacturing license with Exhibit 10.8 to Report on Form 10-K
Optical Memory Card Business Corporation for fiscal year ended March 31, 1991
10.4* Stock Option Plan Exhibit 10.1 to Report on Form 10-Q
for period ended September 30, 2000
10.4.1* Amendment to Stock Option Plan Exhibit 10.4.1 to Report on Form 10-K
filed June 28, 2001
10.4.2* Amended and Restated Stock Option Plan Exhibit 10.4.1 to Report on Form 10-K
filed November7, 2002
10.5 Patent License Agreement with Nippon Conlux Co., Ltd. Exhibit 10.6 to Report on Form 10-K
for fiscal year ended March 31, 1999
10.6 Subcontract with Information Spectrum Inc. dated Exhibit 10.6 to Report on Form 10-K
June 2, 2000 (INS/DOS) filed June 28, 2001
16 Letter re Change in Certifying Accountants Exhibit 16 to Report on Form 8-K
dated April 8, 2002
21 Subsidiaries of the Registrant Exhibit 21 to Report on Form 10-K
filed June 28, 2001
23 Consent of Independent Accountants Filed herewith as page 62
24 Power of Attorney Filed previously as page 60
31.1 Rule 13a-14(a) Certification of Christopher J.
Dyball, co-principal executive officer Filed herewith as page 63
31.2 Rule 13a-14(a) Certification of Richard M. Haddock,
co-principal executive officer Filed herewith as page 64
31.3 Rule 13a-14(a) Certification of Steven G. Larson,
principal financial officer Filed herewith as page 65
32.1 Section 1350 Certification of Christopher J. Dyball
and Richard M. Haddock, co-chief executive officers Filed herewith as page 66
32.2 Section 1350 Certification of Steven G. Larson,
chief financial officer Filed herewith as page 67
------------------------
*Indicates management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
None.
(c) Exhibits
Exhibits 23, 31.1, 31.2,31.3, 32.1, and 32.2 are filed herewith.
(d) Financial Statement Schedule
Schedule II to the Company's consolidated financial statements follows on
page 59.
57
REPORT OF INDEPENDENT AUDITORS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders
of Drexler Technology Corporation:
Our audit of the consolidated financial statements of Drexler Technology
Corporation referred to in our report dated April 28, 2003, which report and
consolidated financial statements are included in this Annual Report on Form
10-K/A, also included an audit of the financial statement schedule for Fiscal
2003 and Fiscal 2002 listed in Item 15(a)(2) of this Form 10-K/A. In our
opinion, this financial statement schedule presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements.
/s/PricewaterhouseCoopers LLP
San Jose, CA
April 28, 2003
58
SCHEDULE II
DREXLER TECHNOLOGY CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
For the Fiscal Years Ended March 31, 2001, 2002, and 2003
Balance at Additions (Deletions) Additions
Beginning Charged to Charged to Balance at
Description of Period Profit and Loss Other Accounts Deductions End of Period
----------- --------- --------------- -------------- ---------- -------------
Fiscal 2001:
Product return reserve $ 500,000 $ -- $ -- $ 266,000 $ 234,000
============= =============== ============== =============== =============
Deferred tax asset
valuation allowance $ 12,201,000 $ (1,807,000) $ 373,000 $ (2,359,000) $ 8,408,000
============= =============== ============== =============== =============
Fiscal 2002:
Product return reserve $ 234,000 $ (127,000) $ -- $ 7,000 $ 100,000
============= =============== ============== =============== =============
Deferred tax asset
valuation allowance $ 8,408,000 $ (3,048,000) $ 1,499,000 $ (1,541,000) $ 5,318,000
============= =============== ============== =============== =============
Fiscal 2003:
Product return reserve $ 100,000 $ -- $ -- $ 10,000 $ 90,000
============= =============== ============== =============== =============
Deferred tax asset
valuation allowance $ 5,318,000 $ -- $ -- $ 64,000 $ 5,254,000
============= =============== ============== =============== =============
59
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:
Dated: September 29, 2003
D R E X L E R T E C H N O L O G Y C O R P O R A T I O N
By: /s/ Christopher J. Dyball By: /s/ Richard M. Haddock
------------------------------------------------- ----------------------------------------------
Christopher J. Dyball, Co-Chief Executive Officer Richard M. Haddock, Co-Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
/s/ Christopher J. Dyball Co-Chief Executive Officer September 29, 2003
- ------------------------------------ (Co-Principal Executive Officer)
Christopher J. Dyball
/s/ Richard M. Haddock Co-Chief Executive Officer September 29, 2003
- ------------------------------------ (Co-Principal Executive Officer)
Richard M. Haddock
/s/ Steven G. Larson Vice President of Finance and Treasurer September 29, 2003
- ------------------------------------ (Principal Financial Officer and
Steven G. Larson Principal Accounting Officer)
/s/ Jerome Drexler Chairman of the Board of Directors September 29, 2003
- ------------------------------------
Jerome Drexler
/s/ Arthur H. Hausman* Director September 29, 2003
- ------------------------------------
Arthur H. Hausman
/s/ Dan Maydan* Director September 29, 2003
- ------------------------------------
Dan Maydan
/s/ William E. Mckenna* Director September 29, 2003
- ------------------------------------
William E. McKenna
/s/ Walter F. Walker* Director September 29, 2003
- ------------------------------------
Walter F. Walker
*By: /s/ Jerome Drexler
- ---------------------------------
Jerome Drexler, attorney-in-fact
60
EXHIBIT INDEX
INDEX TO EXHIBITS
[ITEM 14(c)]
Exhibit
Number Description
- ------ -----------
3.1 Amended and Restated Certificate of Incorporation; previously filed
as Exhibit 3.1.1 to Report on Form 10-Q for period ended September
30, 2000, and incorporated herein by reference
3.2 Amended and Restated By-Laws as of July 24, 2001; previously filed
as Exhibit 3.2. to Report on Form 10-K filed June 21, 2002 and
incorporated herein by reference
10.1 Building lease agreement with The Milla and Raymond Handley 1992
Trust (Marine Way); previously filed as Exhibit 10.1.6 to Report on
Form 10-K for fiscal year ended March 31, 2000, and incorporated
herein by reference
10.1.1 Building lease agreement with Renault & Handley Employees Investment
Co. (Bayshore Parkway); previously filed as Exhibit 10.1 to Report
on Form 10-Q for period ended September 30, 2000, and incorporated
herein by reference
10.2 Optical memory card manufacturing license with Canon Inc.;
previously filed as Exhibit 4 to Report on Form 8-K dated January
10, 1989, and incorporated herein by reference
10.3 Optical memory card manufacturing license with Optical Memory Card
Business Corporation; previously filed as Exhibit 10.8 to Report on
Form 10-K for fiscal year ended March 31, 1991, and incorporated
herein by reference
10.4 Stock Option Plan; previously filed as Exhibit 10.1 to Report on
Form 10-Q for period ended September 30, 2000, and incorporated
herein by reference
10.4.1 Amendment to Stock Option Plan; previously filed as Exhibit 10.4.1
to Report on Form 10-K filed June 28, 2001, and incorporated herein
by reference
10.5 Patent License Agreement with Nippon Conlux Co., Ltd.; previously
filed as Exhibit 10.6 to Report on Form 10-K for fiscal year ended
March 31, 1999, and incorporated herein by reference
10.6 Subcontract with Information Spectrum Inc. dated June 2, 2000;
(INS/DOS) previously filed as Exhibit 10.6 to Report on Form 10-K
filed June 28, 2001, and incorporated herein by reference
16 Letter re Change in Certifying Accountant; previously filed as
Exhibit 16 to Report on Form 8-K dated April 8, 2002
21 Subsidiaries of the Registrant; previously filed as Exhibit 21 to
Report on Form 10-K filed June 28, 2001, and incorporated herein by
reference
23 Consent of Independent Accountants; filed herewith as page 62
24 Power of Attorney; filed previously as page 60
31.1 Rule 13a-14(a) Certification of Christopher J. Dyball, co-principal
executive officer; filed herewith as page 63
31.2 Rule 13a-14(a) Certification of Richard M. Haddock, co-principal
executive officer; filed herewith as page 64
31.3 Rule 13a-14(a) Certification of Steven G. Larson, principal
financial officer; filed herewith as page 65
32.1 Section 1350 Certification of Christopher J. Dyball and Richard M.
Haddock, co-chief executive officers; filed herewith as page 66
32.2 Section 1350 Certification of Steven G. Larson, chief financial
officer; filed herewith as page 67
61