UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2005
LASERCARD CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 0-6377 77-0176309
-------- ------ ----------
(State or other jurisdiction of (Commission (I.R.S. Employer
incorporation or organization) File Number) Identification No.)
1875 North Shoreline Boulevard, Mountain View, California 94043-1319
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(Address of principal executive offices) (Zip Code)
(650) 969-4428
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). [X] Yes [ ] No
Number of outstanding shares of common stock, $.01 par value, at August 1, 2005:
11,436,794
Exhibit Index is on Page 34
Total number of pages is 38
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page Number
Item 1. Condensed Consolidated Financial Statements (Unaudited) 2
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures about Market Rate Risks 30
Item 4. Controls and Procedures 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 31
Item 3. Defaults Upon Senior Securities 31
Item 4. Submission of Matters to a Vote of Security Holders 31
Item 5. Other Information 31
Item 6. Exhibits 31
SIGNATURES 33
EXHIBIT INDEX 34
- ----------------------------------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2
LASERCARD CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
JUNE 30, MARCH 31,
2005 2005 *
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 1,674 $ 3,965
Short-term investments 11,950 6,150
Accounts receivable, net 2,490 1,934
Inventories 8,408 7,909
Prepaid and other current assets 824 1,352
---------- ----------
Total current assets 25,346 21,310
---------- ----------
Property and equipment, net 12,240 12,532
Long-term investments 2,500 6,300
Equipment held for resale 5,173 4,061
Patents and other intangibles, net 925 923
Goodwill 3,321 3,321
Note receivable 206 220
Other non-current assets 158 101
---------- ----------
Total assets $ 49,869 $ 48,768
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,110 $ 2,105
Accrued liabilities 1,943 2,312
Deferred tax liability 599 641
Advance payments from customers 1,944 1,167
Deferred revenue 609 539
---------- ----------
Total current liabilities 7,205 6,764
---------- ----------
Advance payments from customers 15,500 13,000
Deferred revenue, net of current portion 2,000 2,000
Deferred rent 384 326
---------- ----------
Total liabilities 25,089 22,090
---------- ----------
Commitments and contingencies
Stockholders' equity:
Common stock 114 114
Additional paid-in capital 54,155 54,155
Accumulated deficit (28,839) (27,145)
Accumulated other comprehensive income 5 209
Treasury stock at cost (655) (655)
---------- ----------
Total stockholders' equity 24,780 26,678
---------- ----------
Total liabilities and stockholders' equity $ 49,869 $ 48,768
========== ==========
* Amounts derived from audited financial statements at the date indicated.
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
LASERCARD CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
JUNE 30,
2005 2004
---- ----
Revenues:
Total revenues $ 6,994 $ 8,710
------------ -----------
Cost of product sales 5,154 6,366
------------ -----------
Gross profit 1,840 2,344
------------ -----------
Operating expenses:
Selling, general, and administrative expenses 3,131 3,034
Research and engineering expenses 499 851
------------ -----------
Total operating expenses 3,630 3,885
------------ -----------
Operating loss (1,790) (1,541)
Other income, net 96 23
------------ -----------
Loss before income taxes (1,694) (1,518)
Income tax expense -- 26
------------ -----------
Net loss $ (1,694) $ (1,544)
============ ===========
Net loss per share:
Basic and diluted net loss per share $ (.15) $ (.14)
============ ===========
Weighted-average shares of common stock used in
computing basic and diluted, net loss per share 11,345 11,407
============ ===========
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
LASERCARD CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
JUNE 30,
2005 2004
---- ----
Cash flows from operating activities:
Net loss $ (1,694) $ (1,544)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization 633 709
Loss on disposal of fixed assets 8 8
Provision for excess and obsolete inventory 55 16
Provision for product return reserve (11) 115
Expenses related to employee stock purchase plan 32 22
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (654) 158
(Increase) decrease in inventories (638) 33
Decrease in other assets 496 5
Increase in equipment for resale (1,113) --
Increase in other non-current assets (57) --
Decrease in accounts payable and accrued liabilities (297) (2,125)
Decrease in deferred income taxes -- (72)
Increase in deferred revenue 104 2,151
Increase in deferred rent 58 --
Increase in advance payments from customers 3,286 3,033
------------ -----------
Net cash provided by operating activities 208 2,520
------------ -----------
Cash flows from investing activities:
Purchases of property and equipment (454) (1,520)
Investment in patents and other intangibles (35) (30)
Purchases of investments, net (2,000) --
Proceeds from maturities of investments -- 689
------------ -----------
Net cash used in investing activities (2,489) (861)
------------ -----------
Cash flows from financing activities:
Proceeds from sale of common stock through stock plans -- 110
Repayment of bank loan -- (662)
Repayment of long-term debt -- (650)
------------ -----------
Net cash used in financing activities -- (1,202)
------------ -----------
Effect of exchange rate changes on cash (10) 20
------------ -----------
Net (decrease) increase in cash and cash equivalents (2,291) 477
Cash and cash equivalents:
Beginning of period 3,965 2,288
------------ -----------
End of period $ 1,674 $ 2,765
============ ===========
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
LASERCARD CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION.
The condensed consolidated financial statements contained herein include
the accounts of LaserCard Corporation and its wholly owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The condensed consolidated financial statements included herein have
been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been condensed or omitted pursuant to such rules and regulations,
although the Company believes the disclosures which are made are adequate to
make the information presented not misleading. Further, the condensed
consolidated financial statements reflect, in the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position and results of operations as of and for
the periods indicated.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and the notes thereto for
the year ended March 31, 2005, included in the Company's Annual Report on Form
10-K.
The results of operations for the three-month period ended June 30, 2005
are not necessarily indicative of results to be expected for the entire fiscal
year ending March 31, 2006.
FISCAL PERIOD: For purposes of presentation, the Company labels its
annual accounting period end as March 31 and its interim quarterly periods as
ending on the last day of the corresponding month. The Company, in fact,
operates and reports based on quarterly periods ending on the Friday closest to
month end. The 13-week first quarter of fiscal 2006 ended on July 1, 2005 and
the 13-week first quarter of fiscal 2005 ended on July 2, 2004.
RECLASSIFICATIONS. Certain items have been reclassified in the prior
year to conform to the current year presentation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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.
FOREIGN CURRENCY TRANSACTIONS. The functional currency of the Company's
foreign subsidiaries is generally the local currency. The financial statements
of these subsidiaries are translated to United States dollars using period-end
rates of exchange for assets and liabilities and average rates of exchange for
the year for revenues and expenses. Translation gains (losses) are recorded in
accumulated other comprehensive income as a component of stockholders' equity.
Net gains and losses resulting from foreign exchange transactions are included
in other income, net and were not significant during the periods presented.
CONCENTRATION OF CREDIT RISK. One customer accounted for 33% of accounts
receivable at June 30, 2005. One customer accounted for 27% of accounts
receivable at March 31, 2005.
6
MAJOR CUSTOMERS. One customer accounted for 43% and 22% of revenues for
the three-month periods ended June 30, 2005 and 2004, respectively. Another
customer accounted for 42% of revenues for the three-month period ended June 30,
2004. The revenue from these customers was attributable to both the optical
memory card and the optical card drive segments. No other customer accounted for
more than 10% of revenues during the periods.
CASH AND CASH EQUIVALENTS, SHORT-TERM INVESTMENTS AND LONG-TERM
INVESTMENTS. The Company considers all highly liquid investments, consisting
primarily of commercial paper, discount notes and U.S. government bonds, with
maturities of three months or less at the date of purchase, to be cash
equivalents. Cash equivalents at June 30, 2005 and March 31, 2005 were $1.7
million and $4 million, respectively. As of June 30, 2005 and March 31, 2005,
the Company held auction rate securities which have been accounted for as
available-for-sale and classified as short-term investments. The fair values of
the auction rate securities, based on quoted market prices, were substantially
equal to their carrying costs due to the frequency of the reset dates.
Short-term investments also include investments with maturities at date of
purchase of more than three months and up to one year. All investments with
maturities at date of purchase greater than one year are classified as long-term
investments. Management determines the appropriate classification of debt
securities at the time of purchase and reevaluates the classification of
investments as of each balance sheet date.
All short-term investments, except for auction rate securities which are
recorded at fair value, and long-term investments are classified as held to
maturity and are stated in the balance sheet at amortized cost. As such
investments are classified as held to maturity, no unrealized gains or losses
are recorded. The carrying amounts of individual held to maturity securities are
reviewed at the balance sheet date for potential impairment. As of June 30, 2005
and March 31, 2005, the Company has determined that an impairment which was
"other than temporary" has not occurred.
INVENTORIES: Inventories are stated at the lower of cost or market, with
cost determined on a first-in, first-out basis and market based on the lower of
replacement cost or estimated net realizable value. The components of
inventories are (in thousands):
JUNE 30, MARCH 31,
2005 2005
---- ----
Raw materials $ 5,195 $ 4,891
Work-in-process 820 739
Finished goods 2,393 2,279
---------- ----------
$ 8,408 $ 7,909
========== ==========
NET LOSS PER SHARE: Basic and diluted net loss per share is computed by
dividing net loss by the weighted average number of shares of common stock
outstanding. As the effect of common stock equivalents would be antidilutive,
stock options and warrants were excluded from the calculation of diluted net
loss per share for the three-month periods ended June 30, 2005 and 2004.
Accordingly, basic and diluted net loss per share were the same for the three
months ended June 30, 2005 and 2004.
REVENUE RECOGNITION. Product sales primarily consist of optical card
sales, sales of optical card read/write drives and sales of specialty cards and
card printers. The Company recognizes revenue from product sales when the
following criteria are met: (1) persuasive evidence of an arrangement exists;
(2) delivery has occurred; (3) the fee is fixed or determinable; and (4)
collectibility is reasonably assured. The Company recognizes revenue on product
sales at the time of shipment when shipping terms are F.O.B. shipping point,
orders are placed pursuant to a pre-existing sales arrangement and there are no
post-shipment obligations other than warehousing under a U.S. government
subcontract or customer acceptance criteria. Where appropriate, provision is
made at the time of shipment for estimated warranty costs and estimated returns.
The total amount of actual warranty costs and returns activity were $57,000 and
$121,000 for the three month periods ended June 30, 2005 and 2004, respectively.
The Company's U.S. government subcontract requires delivery into a
secure vault located on Company premises. Shipments are made from the vault on a
shipment schedule provided by the prime contractor, which is subject to
revision, but generally not subject to cancellation, at the option of the prime
contractor. At the time the cards are
7
delivered into the vault, title to the cards is transferred to the government
and all risks of ownership are transferred as well. The prime contractor is
invoiced, with payment due within thirty days and the contract does not contain
any return (other than for warranty) or cancellation provisions. Pursuant to the
provisions of SEC Staff Accounting Bulletin No. 104 (SAB 104), revenue is
recognized on delivery into the vault as the Company has fulfilled its
contractual obligations and the earnings process is complete. If the Company
does not receive a shipment schedule for shipment of cards from the vault,
revenue is deferred and recognized upon shipment from the vault. In addition,
revenue recognition for future deliveries into the vault would be affected if
the U.S. government cancels the shipment schedule. As a result, the Company's
revenues may fluctuate from period to period if the Company does not continue to
obtain shipment schedules under this subcontract or if the shipment schedules
are cancelled.
In May 2003, the Emerging Issues Task Force ("EITF") finalized the terms
of EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables,"
(EITF 00-21) which provides criteria governing how to identify whether goods or
services that are to be delivered separately in a bundled sales arrangement
should be accounted for separately. Deliverables are accounted for separately if
they meet all of the following criteria: a) the delivered items have stand-alone
value to the customer; b) the fair value of any undelivered items can be
reliably determined; and c) if the arrangement includes a general right of
return, delivery of the undelivered items is probable and substantially
controlled by the seller. In situations where the deliverables fall within
higher-level literature as defined by EITF 00-21, the Company applies the
guidance in that higher-level literature. Deliverables that do not meet these
criteria are combined with one or more other deliverables. The Company adopted
EITF 00-21 for any new arrangements entered into after July 1, 2003 and now
assesses all revenue arrangements against the criteria set forth in EITF 00-21.
The Company applies the provisions of Statement of Position 81-1,
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts" (SOP 81-1) in applicable contracts. Revenues on time and materials
contracts are recognized as services are rendered at contract labor rates plus
material and other direct costs incurred. Revenues on fixed price contracts are
recognized on the percentage of completion method based on the ratio of total
costs incurred to date compared to estimated total costs to complete the
contract. Estimates of costs to complete include material, direct labor,
overhead and allowable general and administrative expenses. In circumstances
where estimates of costs to complete a project cannot be reasonably estimated,
but it is assured that a loss will not be incurred, the percentage-of-completion
method based on a zero profit margin, rather than the completed-contract method,
is used until more precise estimates can be made. The full amount of an
estimated loss is charged to operations in the period it is determined that a
loss will be realized from the performance of a contract. During the first
quarters ended June 30, 2005 and 2004, the Company recognized approximately
$42,000 and $65,000 of revenues based on a zero profit margin, respectively.
The Company applies the provisions of Statement of Position (SOP) No.
97-2, "Software Revenue Recognition," as amended by Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions" to all transactions involving the sale of software products.
Revenue from the license of the Company's software products is recognized when
persuasive evidence of an arrangement exists, the software product has been
delivered, the fee is fixed or determinable and collectibility is probable, and,
if applicable, upon acceptance when acceptance criteria are specified or upon
expiration of the acceptance period. Software revenue was immaterial for fiscal
period ended June 30, 2005 and 2004.
License revenue, which may consist of up-front license fees and
long-term royalty payments, is recognized as revenue when earned. There were no
license revenue and cost of license revenue recorded for fiscal periods ended
June 30, 2005 or 2004.
In the fiscal 2005 first quarter, the Company sold a card-manufacturing
license, effective April 3, 2004, to Global Investments Group (GIG), based in
Auckland, New Zealand, for card manufacturing in Slovenia. This agreement
provides for payments to the Company of $14 million for a 20-year license and
five-year training support package, followed by $15 million paid $1 million
annually for ongoing support for an additional 15 years. Additionally, the
Company is to sell approximately $12 million worth of the required manufacturing
equipment and installation support for the new facility to be built by GIG to
provide a targeted initial manufacturing capacity of 10 million optical cards
annually. The agreement provides options to increase capacity to 30 million
cards per year. As of June 30, 2005 the Company had $5.2 million of this
equipment classified as equipment held for resale on its balance sheet. The
Company has received $17.5 million of payments called for in the agreements,
consisting of a partial payment for the
8
equipment of $3.5 million and $14 million for the license fee and support. For
the $17.5 million the Company received, $15.5 million was recorded as advance
payments from customers and $2 million for the licensing fee was recorded as
deferred revenue, which were both classified as long term liabilities within the
consolidated balance sheets. In addition to the $41 million discussed above, GIG
is to pay the Company royalties for each card produced under the license. The
territories covered by the license include most of the European Union and
eastern European regions. GIG has exclusive marketing rights in certain
territories, with performance goals to maintain these rights. The Company will
assign a person on site during the license term to assist with quality, security
and operational procedures, with the mutual goal that the facility and the cards
made in the facility conform to the Company's standards. The Company also
retains rights to utilize up to 20% of the new facility capacity as backup and
capacity buffer to augment its own card manufacturing facilities in Mountain
View, California. The granting of this license to GIG establishes a potential
second source supplier of optical memory cards for existing and prospective
customers who may request multiple sources for cards. Revenue will be recognized
over the remaining term of the agreement beginning when operation of the factory
commences.
ACCOUNTING FOR INCOME TAXES. As part of the process of preparing its
consolidated financial statements, the Company is required to estimate income
taxes in each of the jurisdictions in which it operates. This process involves
estimating the actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as deferred
revenue, for tax and accounting purposes. These differences result in deferred
tax assets and liabilities, which are included within the consolidated balance
sheets. The Company must then assess the likelihood that the deferred tax assets
will be recovered from future taxable income and to the extent that management
believes recovery is not likely; the Company must establish a valuation
allowance. To the extent that a valuation allowance is established or increased
in a period, the Company includes an expense within the tax provision in the
statements of operations.
Significant management judgment is required in determining the provision
for income taxes and, in particular, any valuation allowance recorded against
the Company's deferred tax assets. Due to the Company's recent cumulative tax
loss history for the three-year period ended March 31, 2004, income statement
loss history over the previous five quarters and the difficulty in forecasting
the timing of future revenue as evidenced by the deviations in achieved revenues
from expected revenues during the previous few quarters and taking into account
the newness of certain customer relationships, the Company determined as of
March 31, 2004, that it was necessary to increase the valuation allowance under
SFAS No. 109 to the full amount of the deferred tax asset. As a result, the
Company determined that a full valuation allowance was required. As of June 30,
2005, the Company continues to provide for a full valuation allowance of $18.5
million relating to its U.S. operations.
STOCK-BASED COMPENSATION. The Company accounts for its stock-based
compensation plans using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
Compensation cost for stock options, if any, is measured by the excess of the
quoted market price of the Company's stock at the date of grant over the amount
an employee must pay to acquire the stock. SFAS No. 123, "Accounting for
Stock-Based Compensation," established accounting and disclosure requirements
using a fair-value based method of accounting for stock-based employee
compensation plans. The following table illustrates the effect on net loss and
loss per share as if the Company had applied the fair value recognition
provisions of SFAS No. 123 (in thousands except per share amounts):
9
THREE MONTHS ENDED JUNE 30,
2005 2004
---- ----
Net loss, as reported $ (1,694) $ (1,544)
========== ==========
Add: Stock-based employee compensation expense included 32 33
in reported net loss
Deduct: Total stock-based employee compensation
determined under fair value based method for all
awards (326) (432)
---------- ----------
Pro forma net loss $ (1,988) $ (1,943)
========== ==========
Loss per common share:
Basic and diluted - as reported $ (.15) $ (.14)
========== ==========
Basic and diluted - as pro forma $ (.18) $ (.17)
========== ==========
Common shares used in computing basic and diluted pro forma
Net loss per share:
Basic and diluted 11,345 11,407
========== ==========
The Company computed the fair value of each option grant on the date of
grant using the Black-Scholes option valuation model with the following
assumptions:
THREE MONTHS ENDED
JUNE 30, 2005
-------------
Risk-free interest rate 3.81%
Average expected life of option.. 5 years
Dividend yield 0%
Volatility of common stock 55%
Weighted average fair value of option grants $3.15
During the three-month ended June 30, 2005, 404,800 options were
granted. During the three month period ended June 30, 2004, there were no
options granted.
3. SEGMENT REPORTING.
The Company's three reportable segments are: (1) optical memory cards,
(2) optical memory card drives, maintenance and related accessories ("optical
card drives") and (3) specialty cards and card printers. The segments were
determined based on the information used by the chief operating decision maker.
The optical memory cards and optical card drives reportable segments are not
strategic business units which offer unrelated products and services; rather
these reportable segments utilize compatible technology and are marketed
jointly. Specialty cards and card printers is a strategic business unit offering
at times unrelated products and at times related products with the other
reportable segments.
The accounting policies used to derive reportable segment results are
the same as those described in the "Summary of Significant Accounting Policies."
Resources are allocated to the optical memory card and optical card drive
segments in a manner that optimizes optical memory card revenues and to the
specialty card and card printers segment in a manner that optimizes consolidated
income as determined by the chief operating decision maker. Segment revenues are
comprised of sales to external customers. Segment gross profit (loss) includes
all segment revenues less the related cost of sales. Accounts receivable, cash,
deferred income taxes, prepaid expenses, fixed assets and inventory are not
separately reported by segment to the chief operating decision maker. Therefore,
the amount of assets by segment is not meaningful. There are no inter-segment
sales or transfers. All of the Company's long-lived assets are attributable to
the United States except for $3.3 million as of June 30, 2005 and $3.4 million
as of March 31, 2005 that are attributable to Germany.
10
The Company's chief operating decision maker is currently the Company's
Chief Executive Officer. The chief operating decision maker reviews financial
information presented on a consolidated basis that is accompanied by
disaggregated information about revenues and gross profit (loss) by segment.
The table below presents information for optical memory cards, optical
card drives and specialty cards and card printers for the three-month periods
ended June 30, 2005 and 2004 (in thousands):
THREE MONTHS ENDED JUNE 30, 2005 THREE MONTHS ENDED JUNE 30, 2004
-------------------------------- --------------------------------
OPTICAL OPTICAL SPECIALTY OPTICAL OPTICAL SPECIALTY
MEMORY CARD CARDS & SEGMENT MEMORY CARD CARDS & SEGMENT
CARDS DRIVES PRINTERS TOTAL CARDS DRIVES PRINTERS TOTAL
----- ------ -------- ----- ----- ------ -------- -----
Revenue $ 3,865 $ 309 $ 2,820 $ 6,994 $ 5,634 $ 289 $ 2,780 $ 8,703
Cost of sales 2,752 419 1,983 5,154 3,880 527 1,943 6,350
Gross profit (loss) 1,113 (110) 837 1,840 1,754 (238) 837 2,353
Depreciation and
Amortization expense 380 31 67 478 358 60 63 481
The following is a reconciliation of segment results to amounts included in
the Company's condensed consolidated financial statements:
THREE MONTHS ENDED JUNE 30, 2005 THREE MONTHS ENDED JUNE 30, 2004
-------------------------------- --------------------------------
SEGMENT SEGMENT
TOTAL OTHER (A) TOTAL TOTAL OTHER (A) TOTAL
----- ------ ----- ----- ------ -----
Revenue $ 6,994 $ 0 $ 6,994 $ 8,703 $ 7 $ 8,710
Cost of sales 5,154 0 5,154 6,350 16 6,366
Gross profit (loss) 1,840 0 1,840 2,353 (9) 2,344
Depreciation and
amortization expense 478 155 633 481 228 709
(a) Other revenue consists miscellaneous items not associated with
segment activities. Other cost of sales, depreciation and amortization expense
represents corporate and other costs not directly associated with segment
activities.
5. OTHER COMPREHENSIVE LOSS
The following are the components of other comprehensive loss (in
thousands):
THREE MONTHS ENDED JUNE 30,
2005 2004
---- ----
Net loss $ (1,694) $ (1,544)
Net change in cumulative foreign
currency translation adjustments (204) (35)
-------- --------
Other comprehensive loss $ (1,898) $ (1,579)
======== ========
The components of accumulated other comprehensive loss mainly consist of
cumulative foreign currency translation adjustments of approximately $204,000
and $35,000 for the three-month period ended June 30, 2005 and 2004,
respectively.
6. RECENT ACCOUNTING PRONOUNCEMENTS.
On June 1, 2005, the Financial Accounting Standards Board (FASB) issued
Statement No. 154, Accounting
11
Changes and Error Corrections (FAS 154), a replacement of APB No. 20, Accounting
Changes and FASB Statement No. 3, Reporting Accounting Changes in Interim
Financial Statements. FAS 154 applies to all voluntary changes in accounting
principle and changes the requirements for accounting for and reporting of a
change in accounting principle. This statement establishes, that unless
impracticable, retrospective application is the required method for reporting a
change in accounting principle in the absence of explicit transition
requirements specific to the newly adopted accounting principle. It also
requires the reporting of an error correction which involves adjustments to
previously issued financial statements similar to those generally applicable to
reporting an accounting change retrospectively. FAS 154 is effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The Company does not expect the adoption of FAS 154
will have a material impact on its results of operations or financial condition.
In March 2005, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 47, "Accounting for Conditional Asset Retirement
Obligations." Interpretation No. 47 clarifies that an entity must record a
liability for a "conditional" asset retirement obligation if the fair value of
the obligation can be reasonably estimated. Interpretation No. 47 also clarifies
when an entity would have sufficient information to reasonably estimate the fair
value of an asset retirement obligation. Interpretation No. 47 is effective no
later than the end of the fiscal year ending after December 15, 2005. The
Company is currently evaluating the provision and does not expect the adoption
in the fourth quarter of fiscal 2006 will have a material impact on our results
of operations or financial condition.
On October 22, 2004, the American Jobs Creation Act of 2004 (the "Act")
was signed into law. The Act contains numerous changes to U.S. tax law, both
temporary and permanent in nature, including a potential tax deduction with
respect to certain qualified domestic manufacturing activities, changes in the
carryback and carryforward utilization periods for foreign tax credits and a
dividend received deduction with respect to accumulated income earned abroad.
The new law could potentially have an impact on the Company's effective tax
rate, future taxable income and cash and tax planning strategies, amongst other
affects. In December 2004, the FASB issued Staff Position No. 109-1 ("FSP
109-1"), Application of FASB Statement No. 109, Accounting for Income Taxes, to
the Tax Deduction on Qualified Production Activities Provided by the American
Jobs Creation Act of 2004 and Staff Position No. 109-2 ("FSP 109-2"), Accounting
and Disclosure Guidance for the Foreign Earnings Repatriation Provision within
the American Jobs Creation Act of 2004. FSP 109-1 clarifies that the
manufacturer's tax deduction provided for under the Act should be accounted for
as a special deduction in accordance with SFAS No. 109 and not as a tax rate
reduction. FSP 109-2 provides accounting and disclosure guidance for the
repatriation of certain foreign earnings to a U.S. taxpayer as provided for in
the Act. The Company is currently studying the impact of the one-time favorable
foreign dividend provision. Accordingly, the Company has not adjusted its income
tax expense or deferred tax liability to reflect the tax impact of any
repatriation of non-U.S. earnings it may make.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment"
to revise SFAS No. 123, "Accounting for Stock-Based Compensation" and supersede
APB Opinion No. 25, "Accounting for Stock Issued to Employees" and its related
implementation guidance. It requires companies to recognize their compensation
costs related to share-based payment transactions in financial statements. These
costs are to be measured based on the fair value of the equity or liability
instruments issued. The Company will apply SFAS No. 123(R) in the first quarter
of the fiscal year ending March 31, 2007. The Company has not yet evaluated the
impact that the adoption of SFAS No. 123R will have on its financial statements.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets -- an Amendment of APB Opinion No. 29," which eliminates the
exception for nonmonetary exchanges of similar productive assets and replaces it
with a general exception for exchanges of nonmonetary assets that do not have
commercial substance. A nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. SFAS No. 153 will be effective for nonmonetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. The Company is
currently evaluating SFAS No. 153 and does not expect the adoption will have a
material impact on its results of operations or financial condition.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs -- an
Amendment of ARB No. 43, Chapter 4," which clarifies the accounting for abnormal
amounts of idle facility expense, freight, handling costs and
12
wasted material (spoilage) be recognized as current period charges. In addition,
SFAS No. 151 requires that allocation of fixed production overheads to the costs
of conversion be based on the normal capacity of the production facilities. SFAS
No. 151 will be effective for inventory costs incurred in fiscal years beginning
after June 15, 2005. The Company has not evaluated the impact of SFAS No. 151 to
its overall result of operations or financial condition.
In March 2004, the Financial Accounting Standards Board (FASB) approved
the consensus reached by the Emerging Issues Task Force (EITF) Issue No. 03-1,
"The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments" ("EITF 03-1"). The objective of this Issue was to provide guidance
for identifying impaired investments. EITF 03-1 also provided new disclosure
requirements for investments that are deemed to be temporarily impaired. The
accounting provisions of EITF 03-1 were effective for all reporting periods
beginning after June 15, 2004, while the disclosure requirements were effective
only for annual periods ending after June 15, 2004. In September 2004, the FASB
deferred the requirement to record impairment losses caused by the effect of
increases in "risk-free" interest rates and "sector spreads" on debt securities
subject to paragraph 16 of EITF 03-1 and excluded minor impairments from the
requirement until new guidance becomes effective. The Company has evaluated the
impact of EITF 03-1 and does not believe the impact is significant to its
overall results of operations or financial condition.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following discussion and analysis of the Company's financial
condition and results of operations should be read in conjunction with the
condensed consolidated financial statements and related notes included elsewhere
in this Form 10-Q Report and the consolidated financial statements and notes
thereto for the year ended March 31, 2005, included in the Company's fiscal 2005
Annual Report on Form 10-K.
FORWARD-LOOKING STATEMENTS
ALL STATEMENTS CONTAINED IN THIS REPORT THAT ARE NOT HISTORICAL FACTS
ARE FORWARD-LOOKING STATEMENTS. THE FORWARD-LOOKING STATEMENTS IN THIS REPORT
ARE MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995. THEY ARE NOT HISTORICAL FACTS OR GUARANTEES OF
FUTURE PERFORMANCE OR EVENTS. RATHER, THEY ARE BASED ON CURRENT EXPECTATIONS,
ESTIMATES, BELIEFS, ASSUMPTIONS, AND GOALS AND OBJECTIVES AND ARE SUBJECT TO
UNCERTAINTIES THAT ARE DIFFICULT TO PREDICT. AS A RESULT, THE COMPANY'S ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THE STATEMENTS MADE. OFTEN SUCH STATEMENTS
CAN BE IDENTIFIED BY THEIR USE OF WORDS SUCH AS "MAY," "WILL," "INTENDS,"
"PLANS," "BELIEVES," "ANTICIPATES," "VISUALIZES," "EXPECTS," AND "ESTIMATES."
FORWARD-LOOKING STATEMENTS MADE IN THIS REPORT INCLUDE STATEMENTS AS TO THE
COMPANY'S PLANS TO MERGE ONE OF ITS GERMAN SUBSIDIARIES INTO THE OTHER DURING
FISCAL 2006; THAT THE GERMAN SUBSIDIARIES WILL COMPLETE A CONTRACT FOR A
CONVENTIONAL NON-OPTICAL CARD PRODUCTION FACILITY ON OR ABOUT DECEMBER 2006; THE
COMPANY'S BELIEF THAT ITS U.S. GOVERNMENT CONTRACT WILL BE EXTENDED OR REPLACED
PRIOR TO EXPIRATION IN NOVEMBER 2005; THE COMPANY'S BELIEFS AS TO CARD
PERSONALIZATION RATES TO CURRENT AND POTENTIAL MARKET SEGMENTS, CUSTOMERS, AND
APPLICATIONS FOR AND DEPLOYMENT OF THE PRODUCTS OF THE COMPANY; THE ADVANTAGES
OF, POTENTIAL INCOME FROM, AND DUTIES TO BE PERFORMED UNDER THE SALE OF A
SECOND-SOURCE CARD MANUFACTURING LICENSE TO GLOBAL INVESTMENTS GROUP (GIG); THE
GIG LICENSE FOR SECOND-SOURCE CARD PRODUCTION IN SLOVENIA, INCLUDING FUTURE
SCHEDULED PAYMENTS AND ROYALTIES, GIG'S TARGETED STARTUP DATE AND PRODUCTION
CAPACITY, AND THAT THE COMPANY WILL SELL EQUIPMENT TO GIG, PROVIDE GIG WITH
INSTALLATION SUPPORT, AND HAVE ON-SITE PERSONNEL; PRODUCTION QUANTITIES,
DELIVERY RATES AND EXPECTED DELIVERY SCHEDULE, BACKLOG, AND REVENUE RECOGNITION
FOR COMPANY PRODUCTS FOR U.S. OR FOREIGN GOVERNMENT PROGRAMS; STATEMENTS AS TO
POTENTIAL DEPLOYMENT AND USE OF THE COMPANY'S PRODUCTS BY THE DEPARTMENT OF
HOMELAND SECURITY (DHS); PLANS TO INCREASE CARD PRODUCTION CAPACITY FOR
ANTICIPATED INCREASES IN ORDERS FROM PROGRAMS FROM THE ITALIAN GOVERNMENT AND
OTHER POTENTIAL PROGRAMS INCLUDING $7 MILLION IN CAPITAL EQUIPMENT AND LEASEHOLD
IMPROVEMENTS DURING FISCAL 2006; ANTICIPATED CONTINUED USE OF THE COMPANY'S
PRODUCTS BY THE GOVERNMENTS OF THE UNITED STATES, CANADA, A MIDDLE EASTERN
COUNTRY, AND ITALY; 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, THE EFFECTS OF
READ/WRITE DRIVE PRICES AND SALES VOLUME ON GROSS PROFITS OR GROSS MARGINS FROM
READ/WRITE DRIVE SALES; BELIEF THAT THERE IS A MARKET FOR BOTH DESIGNS OF ITS
READ/WRITE DRIVES TO SUPPORT AND EXPAND OPTICAL CARD SALES AND THAT THE
READ/WRITE DRIVE INVENTORY ON HAND WILL BE ORDERED BY CUSTOMERS AND THAT A 10%
INCREASE OR DECREASE IN SALES WILL NOT MATERIALLY AFFECT INVENTORY RESERVES;
EXPECTATIONS REGARDING REVENUES, MARGINS, SG&A AND R&D EXPENSES, CAPITAL
RESOURCES, AND CAPITAL EXPENDITURES AND INVESTMENTS, AND THE COMPANY'S DEFERRED
TAX ASSET AND RELATED VALUATION ALLOWANCE; EXPECTED CARD DELIVERY VOLUMES,
ESTIMATES OF OPTICAL CARD PRODUCTION CAPACITY, EXPECTED CARD YIELDS THERE FROM,
THE COMPANY'S ABILITY TO EXPAND PRODUCTION CAPACITY, AND THE COMPANY'S PLANS AND
EXPECTATIONS REGARDING THE GROWTH AND ASSOCIATED CAPITAL COSTS OF SUCH CAPACITY;
ESTIMATES THAT REVENUES AND ADVANCE PAYMENTS WILL BE SUFFICIENT TO GENERATE CASH
FROM OPERATING ACTIVITIES OVER THE NEXT 12 MONTHS DESPITE EXPECTED QUARTERLY
FLUCTUATIONS; EXPECTATIONS REGARDING MARKET GROWTH, PRODUCT DEMAND, AND THE
CONTINUATION OF CURRENT PROGRAMS; POTENTIAL EXPANSION OR IMPLEMENTATION OF
GOVERNMENT PROGRAMS UTILIZING OPTICAL MEMORY CARDS, INCLUDING WITHOUT
LIMITATION, THOSE IN ITALY, INDIA, AND A MIDDLE EASTERN COUNTRY, AND THE TIMING
OF THE AWARD OF ANY PRIME CONTRACTS FOR SUCH PROGRAMS AND THE AMOUNT OF CARD
ORDERS IN SUCH PROGRAMS, AND IN PARTICULAR THAT THE GAP IN SALES TO ITALY
REPRESENTS A TEMPORARY LULL; AND THE COMPANY'S PLANS, OBJECTIVES, AND EXPECTED
FUTURE ECONOMIC PERFORMANCE INCLUDING WITHOUT LIMITATION, ITS MARKETING
OBJECTIVES AND DRIVE PRICING STRATEGY.
THESE FORWARD-LOOKING STATEMENTS ARE BASED UPON THE COMPANY'S
ASSUMPTIONS ABOUT AND ASSESSMENT OF THE FUTURE, WHICH MAY OR MAY NOT PROVE TRUE,
AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES INCLUDING, BUT NOT LIMITED TO,
WHETHER THERE IS A MARKET FOR CARDS FOR HOMELAND SECURITY IN THE U.S. AND
ABROAD, AND IF SO WHETHER SUCH MARKET WILL UTILIZE OPTICAL MEMORY CARDS AS
OPPOSED TO OTHER TECHNOLOGY; CUSTOMER CONCENTRATION AND RELIANCE ON CONTINUED
U.S. AND ITALIAN GOVERNMENT BUSINESS; RISKS ASSOCIATED WITH DOING BUSINESS IN
AND WITH FOREIGN COUNTRIES; WHETHER THE COMPANY CAN SUCCESSFULLY INTEGRATE AND
OPERATE ITS RECENTLY ACQUIRED GERMAN SUBSIDIARIES; WHETHER THE COMPANY WILL BE
SUCCESSFUL IN ASSISTING GIG WITH FACTORY STARTUP AND TRAINING; WHETHER GIG WILL
HAVE THE FINANCIAL WHEREWITHAL TO MAKE ITS REQUIRED PAYMENTS TO THE COMPANY AND
TO OPERATE THE FACILITY; WHETHER THE FACILITY WILL EFFICIENTLY PRODUCE HIGH
QUALITY OPTICAL MEMORY CARDS IN VOLUME AND THAT MEETS OUR STANDARDS; LENGTHY
SALES CYCLES AND CHANGES IN AND DEPENDENCE ON GOVERNMENT POLICY-MAKING; RELIANCE
ON VALUE-ADDED RESELLERS AND SYSTEM INTEGRATORS TO GENERATE SALES, PERFORM
CUSTOMER SYSTEM INTEGRATION, DEVELOP APPLICATION SOFTWARE, INTEGRATE OPTICAL
CARD SYSTEMS WITH OTHER TECHNOLOGIES, TEST PRODUCTS, AND WORK WITH GOVERNMENTS
TO IMPLEMENT CARD PROGRAMS; RISKS AND DIFFICULTIES ASSOCIATED WITH DEVELOPMENT,
MANUFACTURE, AND DEPLOYMENT OF OPTICAL CARDS, DRIVES, AND SYSTEMS; THE IMPACT OF
LITIGATION; THE ABILITY OF THE COMPANY OR ITS CUSTOMERS TO INITIATE AND DEVELOP
NEW PROGRAMS UTILIZING THE COMPANY'S CARD PRODUCTS; RISKS AND DIFFICULTIES
ASSOCIATED WITH
14
DEVELOPMENT, MANUFACTURE, AND DEPLOYMENT OF OPTICAL CARDS, DRIVES, AND SYSTEMS;
POTENTIAL MANUFACTURING DIFFICULTIES AND COMPLICATIONS ASSOCIATED WITH
INCREASING MANUFACTURING CAPACITY OF CARDS AND DRIVES, IMPLEMENTING NEW
MANUFACTURING PROCESSES, AND OUTSOURCING MANUFACTURING; THE COMPANY'S ABILITY TO
PRODUCE AND SELL READ/WRITE DRIVES IN VOLUME; THE UNPREDICTABILITY OF CUSTOMER
DEMAND FOR PRODUCTS AND CUSTOMER ISSUANCE AND RELEASE OF CORRESPONDING ORDERS;
GOVERNMENT RIGHTS TO WITHHOLD ORDER RELEASES, REDUCE THE QUANTITIES RELEASED,
AND EXTEND SHIPMENT DATES; WHETHER THE COMPANY RECEIVES A FIXED SHIPMENT
SCHEDULE, ENABLING THE COMPANY TO RECOGNIZE REVENUES ON CARDS DELIVERED TO THE
VAULT INSTEAD OF WHEN CARDS LATER ARE SHIPPED FROM THE VAULT; THE IMPACT OF
TECHNOLOGICAL ADVANCES, GENERAL ECONOMIC TRENDS, AND COMPETITIVE PRODUCTS; THE
IMPACT OF CHANGES IN THE DESIGN OF THE CARDS; AND THE POSSIBILITY THAT OPTICAL
MEMORY CARDS WILL NOT BE PURCHASED FOR THE FULL IMPLEMENTATION OF CARD PROGRAMS
IN ITALY, A MIDDLE EASTERN COUNTRY AND INDIA, OR FOR DHS PROGRAMS IN THE U.S.,
OR WILL NOT BE SELECTED FOR OTHER GOVERNMENT PROGRAMS IN THE U.S. AND ABROAD;
UNANTICIPATED DELAYS IN OBTAINING US GOVERNMENT APPROVALS TO EXTEND OR REPLACE
ITS EXPIRING CONTRACT; THE RISKS SET FORTH IN THE SECTION ENTITLED "RISKS
FACTORS AND FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS" AND ELSEWHERE IN
THIS REPORT; AND OTHER RISKS DETAILED FROM TIME TO TIME IN THE COMPANY'S SEC
FILINGS. THESE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS TO THE DATE OF THIS
REPORT, AND, EXCEPT AS REQUIRED BY LAW, THE COMPANY UNDERTAKES NO OBLIGATION TO
PUBLICLY RELEASE UPDATES OR REVISIONS TO THESE STATEMENTS WHETHER AS A RESULT OF
NEW INFORMATION, FUTURE EVENTS, OR OTHERWISE.
CRITICAL ACCOUNTING POLICIES
REVENUE RECOGNITION. Product sales primarily consist of optical card
sales, sales of optical card read/write drives and sales of specialty cards and
card printers. The Company recognizes revenue from product sales when the
following criteria are met: (1) persuasive evidence of an arrangement exists;
(2) delivery has occurred; (3) the fee is fixed or determinable; and (4)
collectibility is reasonably assured. The Company recognizes revenue on product
sales at the time of shipment when shipping terms are F.O.B. shipping point,
orders are placed pursuant to a pre-existing sales arrangement and there are no
post-shipment obligations other than warehousing under a U.S. government
subcontract or customer acceptance criteria. Where appropriate, provision is
made at the time of shipment for estimated warranty costs and estimated returns.
The total amounts of actual warranty costs and returns activity were $57,000 and
$121,000 for the three-month periods ended June 30, 2005 and 2004, respectively.
The Company's U.S. government subcontract requires delivery into a
secure vault located on Company premises. Shipments are made from the vault on a
shipment schedule provided by the prime contractor, which is subject to
revision, but generally not subject to cancellation, at the option of the prime
contractor. At the time the cards are delivered into the vault, title to the
cards is transferred to the government and all risks of ownership are
transferred as well. The prime contractor is invoiced, with payment due within
thirty days, and the contract does not contain any return (other than for
warranty) or cancellation provisions. Pursuant to the provisions of SEC Staff
Accounting Bulletin No. 104 (SAB 104), revenue is recognized on delivery into
the vault as the Company has fulfilled its contractual obligations and the
earnings process is complete. If the Company does not receive a shipment
schedule for shipment of cards from the vault, revenue is deferred and
recognized upon shipment from the vault. In addition, revenue recognition for
future deliveries into the vault would be affected if the U.S. government
cancels the shipment schedule through the prime contractor. As a result, the
Company's revenues may fluctuate from period to period if the Company does not
continue to obtain shipment schedules under this subcontract or if the shipment
schedules are cancelled.
In May 2003, the Emerging Issues Task Force ("EITF") finalized the terms
of EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables,"
(EITF 00-21) which provides criteria governing how to identify whether goods or
services that are to be delivered separately in a bundled sales arrangement
should be accounted for separately. Deliverables are accounted for separately if
they meet all of the following criteria: a) the delivered items have stand-alone
value to the customer; b) the fair value of any undelivered items can be
reliably determined; and c) if the arrangement includes a general right of
return, delivery of the undelivered items is probable and substantially
controlled by the seller. In situations where the deliverables fall within
higher-level literature as defined by EITF 00-21, the Company applies the
guidance in that higher-level literature. Deliverables that do not meet these
criteria are combined with one or more other deliverables. The Company adopted
EITF 00-21 for any new arrangements entered into after July 1, 2003 and now
assesses all revenue arrangements against the criteria set forth in EITF 00-21.
The Company applies the provisions of Statement of Position 81-1,
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts" (SOP 81-1) in applicable contracts. Revenues on time and materials
contracts are recognized as services are rendered at contract labor rates plus
material and other direct costs incurred. Revenues on fixed price contracts are
recognized on the percentage of completion method based on the ratio of total
15
costs incurred to date compared to estimated total costs to complete the
contract. Estimates of costs to complete include material, direct labor,
overhead and allowable general and administrative expenses. In circumstances
where estimates of costs to complete a project cannot be reasonably estimated,
but it is assured that a loss will not be incurred, the percentage-of-completion
method based on a zero profit margin, rather than the completed-contract method,
is used until more precise estimates can be made. The full amount of an
estimated loss is charged to operations in the period it is determined that a
loss will be realized from the performance of a contract. During the first
quarters ended June 30, 2005 and 2004, the Company recognized approximately
$42,000 and $65,000 of revenues based on a zero profit margin, respectively.
The Company applies the provisions of Statement of Position (SOP) No.
97-2, "Software Revenue Recognition," as amended by Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions" to all transactions involving the sale of software products.
Revenue from the license of the Company's software products is recognized when
persuasive evidence of an arrangement exists, the software product has been
delivered, the fee is fixed or determinable, and collectibility is probable,
and, if applicable, upon acceptance when acceptance criteria are specified or
upon expiration of the acceptance period. Software revenue was immaterial for
three-month periods ended June 30, 2005 and 2004.
License revenue, which may consist of up-front license fees and royalty
payments, is recognized as revenue when earned. The second-source
card-manufacturing license sold in April 2004 to Global Investments Group
provides for royalty payments to the Company for each card produced during the
20-year term of the license agreement. This is a multi-element arrangement as
described in Emerging Issues Task Force (EITF) Issue No. 00-21; revenue derived
from the payments will be recognized from time to time over the term of the
license. Revenue will be recognized over the remaining term of the agreement
beginning when operation of the factory commences. There was no cost of license
revenue recorded for three-month periods ended June 30, 2005 and 2004,
respectively.
ACCOUNTING FOR INCOME TAXES. As part of the process of preparing its
consolidated financial statements, the Company is required to estimate income
taxes in each of the jurisdictions in which it operates. This process involves
estimating the actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as deferred
revenue, for tax and accounting purposes. These differences result in deferred
tax assets and liabilities, which are included within the consolidated balance
sheets. The Company must then assess the likelihood that the deferred tax assets
will be recovered from future taxable income and to the extent that management
believes recovery is not likely; the Company must establish a valuation
allowance. To the extent that a valuation allowance is established or increased
in a period, the Company includes an expense within the tax provision in the
statements of operations.
Significant management judgment is required in determining the provision
for income taxes and, in particular, any valuation allowance recorded against
the Company's deferred tax assets. As of June 30, 2005, the Company continues to
provide for a full valuation allowance of $18.5 million relating to its U.S.
operations.
In the event that actual results differ from Company estimates or that
Company estimates are adjusted in future periods, the Company may need to adjust
the amount of the valuation allowance based on future determinations of whether
it is more likely than not that some or all of its deferred tax assets will be
realized. A decrease in the valuation allowance would be recorded as an income
tax benefit or a reduction of income tax expense or a credit to stockholders'
equity. The Company's net operating losses available to reduce future taxable
income expires on various dates from fiscal 2007 through fiscal 2024. To the
extent that the Company generates taxable income in jurisdictions where the
deferred tax asset relates to net operating losses that have been offset by a
full valuation allowance, the utilization of these net operating losses would
result in the reversal of the related valuation allowance.
INVENTORIES. The Company values its inventory at the lower of the actual
cost to purchase and/or manufacture the inventory or the current estimated
market value of the inventory. Management regularly reviews inventory quantities
on hand and records a provision for excess and obsolete inventory based
primarily on forecasts of product demand. Demand for read/write drives can
fluctuate significantly. In order to obtain favorable pricing, purchases of
certain read/write drive parts are made in quantities that exceed the booked
orders. The Company purchases read/write drive parts for its anticipated
read/write drive demand and takes into consideration the order-to-delivery lead
times of vendors and the economic purchase order quantity for such parts. In
addition, the Company keeps a supply of card raw materials it deems necessary
for anticipated demand.
16
Management's analysis of the carrying value of card and read/write drive
inventory is performed on a quarterly basis. With respect to inventory carrying
values, the Company follows the principles articulated in Accounting Research
Bulletin 43, Chapter 4, "Inventory Pricing," paragraphs 5 through 7 and 10 and
other authoritative guidance (SAB 100) as it relates to determining the
appropriate cost basis of inventory and determining whether firm, noncancelable
purchase commitments should be accrued as a loss if forecasted demand is not
sufficient to utilize all such committed inventory purchases. As part of the
Company's quarterly excess/obsolete analysis, management also determines whether
lower of cost or market adjustments (i.e., where selling prices less certain
costs are not sufficient to recover inventory carrying values) are warranted;
during the three-month periods ended June 30, 2005 and 2004, the Company has not
recorded any significant lower of cost or market adjustments. In those instances
where the Company has recorded charges for excess and obsolete inventory,
management ensures that such new cost basis is reflected in the statement of
operations if that inventory is subsequently sold. The Company's inventory
reserves are based upon the lower of cost or market for slow moving or obsolete
items. As a result, the Company believes a 10% increase or decrease of sales
would not have a material impact on such reserves. The Company is currently
evaluating SFAS No. 151 "Inventory Costs - Amendment of ARB No. 43, Chapter 4"
and does not expect the adoption will have a material impact on its results of
operations or financial condition.
RESULTS OF OPERATIONS--FISCAL 2006 FIRST QUARTER
COMPARED WITH FISCAL 2005 FIRST QUARTER
OVERVIEW
Headquartered in Mountain View, California, LaserCard Corporation
manufactures LaserCard(R) optical memory cards, chip-ready OpticalSmart(TM)
cards, and other advanced-technology cards. In addition, the Company operates
two wholly owned subsidiaries acquired on March 31, 2004, Challenge Card Design
Plastikkarten GmbH, of Rastede, Germany, manufactures advanced-technology cards;
and cards & more GmbH, of Ratingen, Germany, markets cards, system solutions,
and thermal card printers.
The Company is in the process of merging cards & more GmbH into
Challenge Card Design Plastikkarten GmbH before our fiscal year ends.
In addition to using its own marketing staff in California, New York,
and Germany, the Company utilizes value added reseller (VAR) companies and card
distribution licensees for the development of markets and applications for
LaserCard products. Product sales to VARs and licensees consist primarily of the
Company's optical memory cards and optical card read/write drives. The Company
also offers for sale, its customized software applications and add-on
peripherals made by other companies (such as equipment for adding a digitized
photo, fingerprint, hand template, or signature to the cards). These peripherals
have not generated material revenue for the Company but have demonstrated
various system options. The VARs/licensees may add application software,
personal computers, and other peripherals, and then resell these products
integrated into data systems. The Company is continuing its efforts to recruit
new VARs and eliminate nonproductive VARs.
Major near term growth potential for LaserCard optical memory cards are
in government-sponsored identification programs in several countries. Since
governmental card programs typically rely on policy-making, which in turn is
subject to technical requirements, budget approvals, and political
considerations, there is no assurance that these programs will be implemented as
expected or that they will include optical cards. Objectives for long-term
revenue growth include: (1) broaden the "Optical Memory" ("OM") products range
to address lower end applications characterized by higher price sensitivity, (2)
diversify OM products into, and effectively penetrate, industrial and commercial
markets, (3) expand hardware product offering to address new markets and add
value to current offering, (4) increase OM product revenues by selling more
application software and integrated solutions, such as personalization and kiosk
systems.
Consolidated revenue recorded by the U.S. operations totaled
approximately $4.2 million for the fiscal 2006 first quarter and $5.9 million
for the fiscal 2005 first quarter. Consolidated revenue recorded by the German
operations
17
totaled approximately $2.8 million in both the first quarter of
fiscal 2006 and 2005. Revenues recorded by the U.S. operations are generally to
a small number of government customers located throughout the world. Revenues
recorded by the German operations are mainly for a relatively large number of
commercial customers.
The largest purchaser of LaserCard products is Anteon International
Corporation (Anteon), a value-added reseller (VAR) of the Company. Anteon is the
government contractor for LaserCard product sales to the U.S. Department of
Homeland Security (DHS), U.S. Department of State (DOS), U.S. Department of
Defense (DOD), and the government of Canada. Under government contracts with
Anteon, the DHS purchases Green Cards and DOS Laser Visa BCCs; the DOD purchases
Automated Manifest System cards; and the Canadian government purchases Permanent
Resident Cards. Encompassing all of these programs, the Company's product sales
to Anteon represented 43% for fiscal 2006 first quarter and 22% for fiscal 2005
first quarter. Another unaffiliated VAR, Laser Memory Card SPA of Italy,
accounted for 42% of the Company's total revenues for the fiscal 2005 first
quarter mainly for the program in Italy.
Revenues for the major programs are shown below as a percentage of total
Company revenues:
THREE MONTHS ENDED JUNE 30,
2005 2004
---- ----
United States Green Cards and Laser Visa BCCs 35% 12%
Canadian Permanent Resident Cards 3% 8%
Italian Carta d'Identica Elettronica (CIE) Cards 3% 40%
For the government of Italy, the Company has received orders for CIE
cards (Carta d'Identita Elettronica) and anticipates orders for a new program
for the PSE cards (Permesso di Soggiorno Elettronico); however, the Company
currently has no backlog for these programs. The Italian parliament has enacted
a law that moves this program into full implementation requiring the issuance of
CIE cards instead of paper cards beginning January 2006. The PSE card program
was also included in the legislation. The Company anticipates orders for these
programs this calendar year in preparation for the full implementation.
According to program descriptions released by the Italian government, CIE card
orders could potentially reach 8 to 10 million cards per year when fully
implemented.
The Company's current five-year U.S. government subcontract, as extended
in May 2005, for Green Cards and Laser Visa BCCs was announced in June 2000 and
will expire on November 26, 2005 but the Company expects that it will be
extended or replaced with a new contract prior to expiration. This subcontract
was received by the Company through Anteon, a LaserCard VAR that is a U.S.
government prime contractor. U.S. Laser Visa Border Crossing Cards (BCCs) and
U.S. Permanent Resident Cards (Green Cards) for the U.S. Department of Homeland
Security (DHS) are an important part of the Company's revenue base. Therefore,
when orders were delayed at the beginning of fiscal 2004 while new artwork for
the cards was being designed by DHS and when the U.S. government decided to
decrease the number of cards they hold in their safety stock, the Company's
revenues and profits suffered. For these programs, the Company recorded card
revenues of $2.5 million for fiscal 2006 first quarter and $1 million for fiscal
2005 first quarter. The Company believes that inventory levels have declined to
the level desired by the government and revenue levels will increase to the
governments' rate of card personalization. During fiscal 2006 first quarter, the
Company received orders totaling $7.3 million comprised of $5 million for Green
Cards with deliveries from April 2005 through January 2006 and $2.3 million for
BCCs with deliveries from May 2005 through October 2005. This represents an $8.7
million annualized run rate for the two programs assuming subsequent orders are
continuous and at the same delivery rate.
In 2003, the Company began shipments under a subcontract for Canada's
new Permanent Resident Cards. The backlog at June 30, 2005 was $1.9 million
deliverable through July 2006 at the rate of approximately $135,000 per month.
For a secure personal identification card program in the Middle East,
the Company has sold 120 read/write drives, most of which were shipped in the
fiscal 2004 second quarter, for installation of the infrastructure required for
card issuance, and also has shipped about 350,000 optical memory cards over the
past two years for testing and sample purposes. During the fiscal 2006 first
quarter, the Company shipped optical memory cards valued at of $0.5 million for
this program.
18
Effective April 3, 2004, the Company sold a license to Global
Investments Group (GIG), based in Auckland, New Zealand, for card manufacturing
in Slovenia. This agreement provides for payments to the Company of $14 million
for a 20-year license and five-year training support package, followed by $15
million paid $1 million annually for ongoing support for an additional 15 years.
Additionally, the Company is to sell approximately $12 million worth of the
required manufacturing equipment and installation support for the new facility
to be built by GIG to provide a targeted initial manufacturing capacity of 10
million optical cards annually. The agreement provides options to increase
capacity to 30 million cards per year. As of June 30, 2005 the Company had
acquired $5.2 million of this equipment classified as equipment held for resale
on its balance sheet. The Company has received $17.5 million of payments called
for in the agreements, consisting of a partial payment for the equipment of $3.5
million and $14 million for the license fee and support. For the $17.5 million
the Company received, $15.5 million was recorded as advance payments from
customers and $2 million for the licensing fee was recorded as deferred revenue,
which were both classified as long term liabilities within the consolidated
balance sheets. In addition to the $41 million discussed above, GIG is to pay
the Company royalties for each card produced under the license. The territories
covered by the license include most of the European Union and eastern European
regions. The GIG has exclusive marketing rights in certain territories, with
performance goals to maintain these rights. The Company will assign a person on
site during the license term to assist with quality, security and operational
procedures, with the mutual goal that the facility and the cards made in the
facility conform to the Company's standards. The Company also retains rights to
utilize up to 20% of the new facility capacity as backup and capacity buffer to
augment its own card manufacturing facilities in Mountain View, California. The
granting of this license to GIG establishes a potential second source supplier
of optical memory cards for existing and prospective customers who may request
multiple sources for cards. Revenue will be recognized over the remaining term
of the agreement beginning when operation of the factory commences, which GIG
has targeted for calendar 2006.
The Company plans to invest up to $7 million in additional capital
equipment and leasehold improvement expenditures when forecasts justify the
investment. These expenditures could occur throughout the next nine to twelve
months, as more fully discussed under "Liquidity and Capital Resources."
REVENUES
THREE MONTHS ENDED
JUNE 30,
(IN THOUSANDS, EXCEPT PERCENTAGES)
2005 2004 CHANGE
---- ---- ------
Optical memory cards $ 3,865 $ 5,634 $ (1,769)
Percentage of total revenues 55% 65%
Optical card read/write drives $ 309 $ 289 $ 20
Percentage of total revenues 4% 3%
Specialty cards and card printers $ 2,820 $ 2,780 $ 40
Percentage of total revenues 40% 32%
Other $ -- $ 7 $ (7)
Percentage of total revenues --% --%
Total revenues $ 6,994 $ 8,710 $ (1,716)
PRODUCT REVENUES. The Company's total revenues for fiscal 2006 first
quarter and fiscal 2005 first quarter consisted of sales of optical memory
cards, optical card read/write drives, drive accessories, maintenance, specialty
cards, card printers, and other miscellaneous items. The decrease in total
revenues for the three months ended June 30, 2006 was compared with the same
period last year occurred mainly in the optical memory card segment.
The decrease in optical memory card revenue was mainly due to there
being no significant sales of cards for the Italian national ID card program
versus $3.4 million of revenue in last year's first quarter. The Company
believes that
19
this gap in sales represents a temporary lull and that orders will resume in
even higher volumes than before later this year as the program enters the full
implementation phase.
Optical card reader/write derive revenues consisted of revenue on
read/write drives, drive service, and related accessories.
Specialty cards and card printers revenues were essentially flat year to
year.
LICENSE FEES AND OTHER REVENUES. There were no license revenues for the
fiscal 2006 first quarter ended June 30, 2005 or the fiscal 2005 first quarter
ended June 30, 2004. Effective April 3, 2004, the Company sold a second-source
card-manufacturing license to the Global Investments Group, based in Auckland,
New Zealand, for card manufacturing in Slovenia discussed above in "Overview."
Revenue will begin to be recorded when operation of their factory commences.
BACKLOG
As of June 30, 2005, the backlog for LaserCard optical memory cards
totaled $6.8 million mostly scheduled for delivery in fiscal 2006, compared with
$4.1 million at June 30, 2004. The Company has only a few customers who
generally place orders for a several-month period so that variations in order
placement from a single customer can materially affect backlog. As a result, the
relative size of our backlog has not been a reliable indicator of future sales
revenue trends.
The Company has no significant backlog for read/write drives.
In addition, the backlog for Challenge Card Design Plastikkarten GmbH
and cards & more GmbH as of June 30, 2005 for specialty cards and card printers
totaled 0.5 million euros (approximately $0.6 million) and for a contract to
develop a conventional non-optical card production facility totaled 0.7 million
euros (approximately $0.9 million). Revenue on the contract for a conventional
non-optical card production facility is being booked on a zero profit margin
basis. Therefore, the total profit under this contract will be booked at
completion on or about December 2006. The backlog for Challenge Card Design
Plastikkarten GmbH and cards & more GmbH products and services totaled 0.8
million euros (approximately $0.9 million) as of June 30, 2004. That backlog
excludes about $1.1 million for a partially completed contract that was canceled
due to the insolvency of the customer.
GROSS MARGIN
THREE MONTHS ENDED
JUNE 30,
(IN THOUSANDS, EXCEPT PERCENTAGES)
2005 2004 CHANGE
---- ---- ------
Optical memory cards $ 1,113 $ 1,754 $ (641)
Percentage of optical memory cards revenue 29% 31% (2)%
Optical card read/write drives $ (110) $ (238) $ 128
Percentage of optical card read/write drive revenue NM NM NM
Specialty cards and card printers $ 837 $ 837 -
Percentage of specialty cards and card printers revenue 30% 31% (1)%
Other -- $ (9) $ 9
Percentage of other revenue NM NM NM
Total gross margin $ 1,840 $ 2,344 $ (504)
Percentage of total revenues 26% 27% (1)%
20
The overall gross profit decreased $0.5 million, to $1.8 million for the
first quarter of fiscal 2006 from $2.3 million for the first quarter of fiscal
2005. This decrease was due primarily to lower volume of optical memory card
sales
OPTICAL MEMORY CARDS. Optical memory card gross profit and margins can
vary significantly based on average selling price, sales and production volume,
mix of card types, production efficiency and yields, and changes in fixed costs.
The declines for fiscal 2006 first quarter as compared with fiscal 2005 first
quarter were primarily due to lower sales and production volume and the
corresponding lower absorption of fixed costs.
READ/WRITE DRIVES. Read/write drive gross profit and margins can vary
significantly based upon sales and production volume, changes in fixed costs,
and the inclusion of optional features and software licenses on a per-drive
basis. Read/write drive gross profits are generally negative, inclusive of fixed
overhead costs, due to low sales volume. Read/write drive gross margin increased
by $0.1 million in fiscal 2006 first quarter due to the absorption of costs on
previously accrued warranty items. The Company anticipates that quarterly
negative gross profits will continue in the future unless sales volume is
sufficient to cover fixed costs. Also, unless per drive system software licenses
are included in future orders, the Company believes that margins will be below
10% when sales volume is sufficient to result in positive gross profit due to
the Company's strategy to price drives at close to the cost in order to help
promote optical memory card sales.
SPECIALTY CARDS AND CARD PRINTERS. Specialty cards and card printers
gross margins have fluctuated between 21% and 31% depending upon product mix.
OPERATING EXPENSES
THREE MONTHS ENDED
JUNE 30,
(IN THOUSANDS)
2005 2004 CHANGE
---- ---- ------
Selling, general and administrative expenses $ 3,131 $ 3,034 $ 97
Research and engineering expenses $ 499 $ 851 $ (352)
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES (SG&A). The increase in
SG&A for the first quarter of fiscal 2006 as compared with the same period last
year was primarily due to $0.2 million in advertising cost. The Company believes
that SG&A expenses for fiscal 2006 will be higher than fiscal 2005 levels,
mainly due to increases in marketing and selling expenses.
RESEARCH AND ENGINEERING EXPENSES (R&E). The Company is continuing its
efforts to develop new optical memory card features and structures, including
various sheet-lamination card structures, the insertion of contactless chips
with radio frequency (RF) capability, OptiChip(TM), OVD (optically variable
device) products, and associated media development; enhanced optical memory card
read/write drives and read-only drives (readers); and new software products in
an effort to provide new products that can stimulate optical memory card sales
growth. For example, the Company recently has developed a prototype of a
LaserCard handheld reader. The Company anticipates that these ongoing research
and engineering efforts will result in new or enhanced card capabilities,
production-model read-only drives, or drives with advanced security features and
lower manufacturing costs; however, there is no assurance that such product
development efforts will be successful. These features are important for the
Company's existing and future optical memory card markets. The decrease in R&E
spending for the fiscal 2006 first quarter compared with the fiscal 2005 first
quarter was mainly due to (1) about $200,000 due to the completion of major
spending for the portable read-only drive and the reaching of decision
milestones on other projects, (2) about $55,000 due to a reduction in occupancy
costs resulting from the move last year, and (3) about $72,000 in direct cost
transferred to the Global Investments Group equipment project and therefore
shown under equipment held for resale. The Company anticipates the R&E spending
will increase throughout the remainder of fiscal 2006.
OTHER INCOME, NET
Other income, net for the first quarter of fiscal 2006 was $96,000
consisting of $105,000 in interest income, partially offset by a $9,000 loss on
the sale of capital equipment. Other income, net for the first quarter of fiscal
2005 was $23,000 consisting of $90,000 in interest income, partially offset by
$61,000 in interest expense, and an $8,000
21
loss on the sale of capital equipment. The increase in interest income was
mainly due to an increase in interest rates. The decrease of interest expense
was due primarily to the elimination of the long-term debt in fiscal 2005.
INCOME TAXES
The Company recorded an income tax expense of $26,000 in the fiscal 2005
first quarter. The Company's income tax expense for fiscal 2005 first quarter
was recorded on profit generated in Germany. The amount of income tax expense
recorded in Germany was based upon the Company's anticipated tax rate for the
full fiscal year. No income tax benefit was recognized during the fiscal 2006
first quarter on operating losses generated in the U.S.
LIQUIDITY AND CAPITAL RESOURCES
JUNE 30 MARCH 31
2005 2005
---- ----
(IN THOUSANDS)
Cash, cash equivalents and short-term $ 13,624 $ 10,115
investments
Cash, cash equivalents, short-term and $ 16,124 $ 16,415
long-term investments
THREE MONTHS ENDED
JUNE 30,
2005 2004 CHANGE
---- ---- ------
(IN THOUSANDS)
Net cash provided by operating activities $ 208 $ 2,520 $ (2,312)
Net cash used in investing activities $ (2,489) $ (861) $ 1,628
Net cash used in financing activities - $ (1,202) $ (1,202)
The Company's primary sources of liquidity consisted of approximately
$13.6 million in cash, cash equivalents and short-term investments and
approximately $2.5 million in long-term investments for a total of approximately
$16.1 million as of June 30, 2005 compared to approximately $10.1 million in
cash, cash equivalents and short-term investments and approximately $6.3 million
in long-term investments for a total of approximately $16.4 million as of March
31, 2005. During the three-month period ended June 30, 2005, the decrease of
$2.3 million in cash and cash equivalents was primarily related to approximately
$0.4 million of capital expenditure and $2 million of net purchase of short and
long-term investments. The current ratio was 3.5 to 1 as of June 30, 2005.
The decrease in cash provided by operating activities was mainly due to
the acquisition of $1.1 million of equipment for the GIG contract recorded as
equipment held for resale, the $0.6 million increase in inventories, and the
$0.7 million increase in accounts receivable this year. Also, last year in the
first quarter, the Company received $2 million license fee payment from GIG
recorded as deferred revenue, and paid down approximately $1.7 million in
accounts payable mainly for leasehold improvements for the Company's new
facility. During the three months period ended June 30, 2005, the amount of $2.5
million in advance payment was received from GIG related to the contract for
card-manufacturing license, sales of required equipment and support services.
Cash and investments will fluctuate based upon the timing of advance
payments from customers relative to shipments and the timing of inventory
purchases and subsequent manufacture and sale of products.
The Company believes that the estimated level of revenues and advance
payments over the next 12 months will be sufficient to generate cash from
operating activities over the same period. However, quarterly fluctuations are
expected. Operating cash flow could be negatively impacted to a significant
degree if GIG does not make the required payments as scheduled, or if either of
the Company's largest U.S. government programs were to be delayed, reduced,
canceled, or not extended, if the Italian CIE card program does not grow as
planned internally, and if these programs are not replaced by other card orders
or other sources of income.
22
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 $1.7 million net loss recorded for the fiscal 2006
first quarter, the Company's accumulated deficit increased to $28.8 million.
Stockholders' equity decreased to $24.8 million mainly due to the net loss
recorded.
The increase in net cash used for investing activities in the fiscal
2006 first quarter as compared to the fiscal 2005 first quarter was due
primarily to $2 million of net purchase of liquid investments in the first
quarter of fiscal 2006 versus $0.7 million of net proceeds from maturities of
investments in the first quarter of fiscal 2005 and purchases of property and
equipment of $0.5 million in the first quarter of fiscal 2006 versus $1.5
million in the first quarter of fiscal 2005.
The Company considers all highly liquid investments, consisting
primarily of commercial paper, discount notes, and U.S. government bonds, with
original or remaining maturities of three months or less at the date of
purchase, to be cash equivalents. All investments with original or remaining
maturities of more than three months but not more than one year at the date of
purchase are classified as short-term. Investments with original or remaining
maturities of more than one year at the date of purchase are classified as
long-term. The Company determines the length of its investments after
considering its cash requirements and yields available for the type of
investment considered by the Company. Management also determines the appropriate
classification of debt and equity securities at the time of purchase and
reevaluates the classification of investments as of each balance sheet date. As
of June 30, 2005 the Company had $14.4 million classified as short-term and
long-term investments, compared with $12.4 million at March 31, 2005. All
auction rate securities are accounted for as available-for-sale and all other
interest-bearing securities are accounted for as held-to-maturity.
The Company made capital equipment and leasehold improvement purchases
of approximately $0.5 million during fiscal 2006 first quarter compared with
approximately $1.5 million during the fiscal 2005 first quarter. As of June 30,
2005, the Company has non-cancelable purchase orders of $1.8 million primarily
for raw materials. The Company's current card capacity, assuming optimal card
type mix, is estimated at approximately 16 million cards per year. The Company
plans to purchase additional production equipment in a series of steps when
deemed appropriate by the Company. The Company is also increasing production
capacity for cards with new structures used by the programs in Canada, Italy,
and a Middle Eastern country. In addition to investment used for expansion, the
Company expects to make additional capital expenditures for cost savings,
quality improvements, and other purposes. The Company plans to use cash on hand
and cash generated from operations to fund capital expenditures of approximately
$7 million for equipment and leasehold improvements for card production,
read/write drive tooling and assembly, and general support items as customer
orders justify the investment.
The decrease in net cash used for financing activities in the fiscal
2006 first quarter as compared to the fiscal 2005 first quarter was due
primarily to the repayment in full of bank loans and long-term debt during
fiscal 2005.
There were no new debts in financing activities for the fiscal 2006
first quarter ended June 30, 2005.
RISK FACTORS AND FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
OUR CURRENT AND FUTURE EXPECTED REVENUES ARE DERIVED FROM A SMALL NUMBER
OF ULTIMATE CUSTOMERS SO THAT THE LOSS OF OR REDUCTIONS IN PURCHASES BY ANY ONE
ULTIMATE CUSTOMER COULD MATERIALLY REDUCE OUR REVENUES AND LEAD TO LOSSES.
During fiscal 2005 and each of the previous two fiscal years, we have derived
more than 84% of our optical memory card and drive-related revenues from four
programs - two U.S. government programs and two foreign government programs. Due
to the lengthy sales cycles, we believe that these programs, with perhaps the
addition of one or two other foreign programs, will be the basis for a
substantial majority of our revenues in the near-term. The loss of or reductions
in purchases by any one customer due to program cutbacks, competition, or other
reasons would materially reduce our revenue base. Annual or quarterly losses
occur when there are material reductions, gaps or delays in card orders from our
largest U.S. or foreign government programs or if such programs were to be
reduced in scope, delayed, canceled, or not extended and not replaced by other
card orders or other sources of income.
23
WE HAVE INCURRED NET LOSSES DURING THE PAST TEN QUARTERS AND MAY NOT BE
ABLE TO GENERATE SUFFICIENT REVENUE IN THE FUTURE TO ACHIEVE OR SUSTAIN
PROFITABILITY. As of June 30, 2005, we had an accumulated deficit of $28.8
million and we incurred a loss of $1.7 million for the first quarter of fiscal
2006, $8.9 million in fiscal 2005 and $12.4 million in fiscal 2004. Although we
operated profitably for fiscal 1999 through fiscal 2003, we have incurred
significant losses in the past, including in fiscal 1997 and 1998, and we
incurred losses in fiscal 2004 and in fiscal 2005 due primarily to gaps in
orders for our cards while we increased our manufacturing capacity for expected
future orders. Also, during fiscal 2005 we incurred approximately $660,000 of
incremental consulting and auditing expenses for implementation of
Sarbanes-Oxley Section 404. There can be no assurance that we will generate
enough card revenues in the near term or ever to become profitable. We are
relying upon our optical memory card technology to generate future product
revenues, earnings, and cash flows. If alternative technologies emerge or if we
are otherwise unable to compete, we may not be able to achieve or sustain
profitability on a quarterly or annual basis. Annual or quarterly losses would
also continue if increases in product revenues or license revenues do not keep
pace with increased selling, general, administrative, research and engineering
expenses and the depreciation and amortization expenses associated with capital
expenditures.
OUR PRODUCT REVENUES WILL NOT GROW IF WE DO NOT WIN NEW BUSINESS IN THE
U.S. AND ABROAD. Fiscal 2005 revenues included sales of approximately $6 million
of Green Cards and Laser Visa BCCs, and we expect revenues of at least $8.5
million for these programs in fiscal 2006. The Company expects these revenues
could grow to up to $10 million annually thereafter ($7.5 million for Green
Cards and $2.5 million for Laser Visa BCCs) if the government continues to
personalize cards at that rate and continues to maintain an inventory level
equal to six-months of usage. Other optical memory card programs that are
emerging programs or prospective applications in various countries include
identification cards for Italy and a Middle Eastern country; and motor vehicle
registration cards in India.
For Italy, we delivered cards valued at $7.3 million in fiscal 2005 for
Phase 2 of the Italian CIE card program. We anticipate receiving orders during
fiscal 2006 for one of Italy's new programs, the Permesso di Soggiorno
Elettronico (PSE) card and further orders for the CIE card program. We do not
currently have orders for either of these programs. There is no assurance that
the foregoing government programs will be continued or implemented as
anticipated.
For the ID program in a Middle Eastern country, we shipped $0.6 million
of cards during fiscal 2005 and $0.5 million in the first quarter of fiscal 2006
during the experimental phase of the program. Negotiations are in process for
follow-on orders. There can be no assurance that we will be able to successfully
conclude such negotiations or that sizable orders will follow even if we are
successful.
OUR PROGRAM WITH ITALY, WHICH WE BELIEVE WILL BE OUR LARGEST CUSTOMER
FOR THE NEXT FEW YEARS, MAY BE DELAYED OR CANCELLED FOR REASONS OUTSIDE OUR
CONTROL WHICH WOULD CAUSE US TO HAVE LESS REVENUE THAN PLANNED AND WOULD LEAD TO
CONTINUED LOSSES. The Company believes that the Italian CIE card program will be
our largest customer for the next few years, comprising a significant portion of
future revenues. We are increasing capacity to meet the anticipated demand.
However, there can be no assurance that demand will increase as anticipated by
the Company. Losses would continue if Phase 3 of this program, which is full
implementation, was to be delayed, canceled, not extended, or not implemented at
the level foreseen and not be replaced by other card orders or other sources of
income, or if the government were to change its technology decisions. During
Phase 2, selected Italian cities have been issuing cards and testing the card
issuing process. The knowledge gained during Phase 2 has resulted in initiatives
to improve the issuing system and to improve the overall performance of the
program. Overcoming some of these issues may be difficult and complex and
involve third parties, which could be time consuming and expensive and lead to
delays for implementation of Phase 3.
ONE VALUE ADDED RESELLER IS THE CONTRACTOR FOR OUR U.S. AND CANADIAN
GOVERNMENT CUSTOMERS AND ANOTHER VALUE ADDED RESELLER PURCHASES CARDS FROM US
FOR THE ITALIAN NATIONAL ID CARD PROGRAM. HAVING TO REPLACE EITHER OF THESE
VALUE ADDED RESELLERS COULD INTERRUPT OUR U.S., CANADIAN, OR ITALIAN GOVERNMENT
BUSINESS. The largest purchaser of LaserCard products has been Anteon
International Corporation, one of our value-added resellers (VARs). Anteon is
the government contractor for LaserCard product sales to the U.S. Department of
Homeland Security, U.S. Department of State, U.S. Department of
24
Defense, and the government of Canada. Under government contracts with Anteon,
the U.S. Department of Homeland Security purchases Green Cards and U.S.
Department of State purchases Laser Visa BCCs; the U.S. Department of Defense
purchases Automated Manifest System cards; and the Canadian government purchases
Permanent Resident Cards. Encompassing all of these programs, our product sales
to Anteon represented 31% of total revenues for fiscal 2005, 72% of total
revenues for fiscal 2004 and 94% of total revenues for fiscal 2003. However,
since our customers are national governments, we are not dependent upon any one
specific contractor for continued revenues from these programs. Although not
anticipated, if Anteon were to discontinue its participation as contractor,
other qualified contractors could be utilized by those governments for
purchasing our products, although the process of doing so could cause the U.S.
program delays. Concerning Italy, during fiscal 2005 and 2004, 26% and 22% of
the Company's revenues were derived from sales of cards and read/write drives
for the government of Italy for its CIE card program, respectively. The revenues
generated from this program were immaterial in fiscal 2003. Card orders under
this program are placed with the Company through a VAR, Laser Memory Card SPA of
Italy. According to Italian government sources, the distribution of this new
national ID card has started in a number of the 56 Italian communities that were
scheduled to be activated under the program during 2004. If this program were to
be discontinued or interrupted by the Italian government, the Company would lose
one of its significant sources of optical memory card revenues.
OUR CONTRACT WITH THE U.S. GOVERNMENT, ONE OF OUR LARGER ULTIMATE
CUSTOMERS MAY EXPIRE IN NOVEMBER 2005. EVEN IF RENEWED, THE U.S. GOVERNMENT HAS
THE RIGHT TO DELAY ITS ORDERS OR COULD CHANGE ITS TECHNOLOGY DECISIONS, WHICH
WOULD RESULT IN ORDER DELAYS OR LOSSES. Our U.S. government subcontract expires
on November 26, 2005. While we have received orders for $7.3 million in optical
memory cards deliverable through January 2006, further orders may require a new
contract. Based on events to date, the Company believes another extension to the
current contract or a follow-on contract will be issued prior to January 2006;
however, there is no assurance that the contract will be extended or a follow-on
contract will be issued by the U.S. government. Under U.S. government
procurement regulations, the government reserves certain rights, such as the
right to withhold releases, to reduce the quantities released, extend delivery
dates, reduce the rate at which cards are issued, and cancel all or part of its
unfulfilled purchase orders. Our U.S. government card deliveries depend upon the
issuance of corresponding order releases by the government to its prime
contractor and, in turn, to us, and we believe that these orders will continue.
Losses would continue if either of our largest U.S. government programs were to
be delayed, canceled, or not extended and not be replaced by other card orders
or other sources of income, or if the government were to change its technology
decisions, or if increases in product revenues or licenses do not keep pace with
increased marketing, research and engineering, and depreciation on capital
equipment. For example, the U.S. government acting through its prime contractor
delayed orders for Green Cards during fiscal 2004 due to a design change and
again in the first part of fiscal 2005 because of excess inventory, which
resulted in a gap in production of several months, and which in turn
significantly affected our operating results for the first half of fiscal 2005.
Any future excess inventory held by the U.S. government for example due to
delayed funding or a slower than anticipated program volume, or any future
changes to the design of the cards may result in future gaps in orders or
production which may negatively impact our operating results.
SINCE THE SALES CYCLE FOR OUR PRODUCTS IS TYPICALLY LONG AND
UNPREDICTABLE, WE HAVE DIFFICULTY PREDICTING FUTURE REVENUE GROWTH. Obtaining
substantial orders usually involves a lengthy sales cycle, requiring marketing
and technical time and expense with no guarantee that substantial orders will
result. This long sales cycle results in uncertainties in predicting operating
results, particularly on a quarterly basis. In addition, since our major
marketing programs involve the U.S. government and various foreign governments
and quasi-governmental organizations, additional uncertainties and extended
sales cycles can result. Factors which increase the length of the sales cycle
include government regulations, bidding procedures, budget cycles, and other
government procurement procedures, as well as changes in governmental
policy-making.
THE TIMING OF OUR U.S. GOVERNMENT REVENUES IS NOT UNDER OUR CONTROL AND
CANNOT BE PREDICTED BECAUSE WE REQUIRE A FIXED SHIPMENT SCHEDULE IN ORDER TO
RECORD REVENUE WHEN WE DELIVER CARDS TO A VAULT, OTHERWISE WE RECOGNIZE REVENUE
WHEN THE CARDS ARE SHIPPED OUT OF A VAULT OR WE RECEIVE A FIXED SHIPMENT
SCHEDULE FROM THE GOVERNMENT. We recognize revenue from product sales when the
following criteria are met: (a) persuasive evidence of an arrangement exists;
(b) delivery has occurred; (c) the fee is fixed or determinable; and (d)
collectibility is reasonably assured.
25
Our U.S. government subcontract requires delivery of cards to a secure
vault built on our premises. Deliveries are made into the vault on a production
schedule specified by the government or one of its specified agents. When the
cards are delivered to the vault, all title and risk of ownership are
transferred to the government. At the time of delivery, the prime contractor is
invoiced, with payment due within thirty days. The contract does not provide for
any return provisions other than for warranty. We recognize revenue when the
cards are delivered into the vault because we have fulfilled our contractual
obligations and the earnings process is complete. However, if we do not receive
a shipment schedule for shipment from the vault, revenue is not recognized until
the cards are shipped from the vault. In addition, revenue recognition for
future deliveries into the vault would be affected if the U.S. government
cancels the shipment schedule. As a result, our revenues may fluctuate from
period to period if we do not continue to obtain shipment schedules under this
subcontract or if the shipment schedules are cancelled. In this case, we would
no longer recognize revenue when cards are delivered to the vault, but instead
such revenue recognition would be delayed until the cards are shipped from the
vault to the U.S. government.
WE COULD EXPERIENCE EQUIPMENT, RAW MATERIAL, QUALITY CONTROL, OR OTHER
PRODUCTION PROBLEMS ESPECIALLY IN PERIODS OF INCREASING VOLUME. There can be no
assurance that we will be able to meet our projected card manufacturing capacity
if and when customer orders reach higher levels. We have made and intend to
continue to make significant capital expenditures to expand our card
manufacturing capacity. However, since customer demand is difficult to predict,
we may be unable to ramp up our production quickly enough to timely fill new
customer orders. This could cause us to lose new business and possibly existing
business. In addition, if we overestimate customer demand, we could incur
significant costs from creating excess capacity which was the case during fiscal
2005. We may experience manufacturing complications associated with increasing
our manufacturing capacity of cards and drives, including the adequate
production capacity for sheet-lamination process cards to meet order
requirements and delivery schedules. We may also experience difficulties
implementing new manufacturing processes or outsourcing some of our
manufacturing. The addition of fixed overhead costs increases our breakeven
point and results in lower profit margins unless compensated for by increased
product sales. When purchasing raw materials for our anticipated optical card
demand, we take into consideration the order-to-delivery lead times of vendors
and the economic purchase order quantity for such raw materials. If we
over-estimate customer demand, excess raw material inventory can result.
IF WE ARE UNABLE TO BUY RAW MATERIALS IN SUFFICIENT QUANTITIES AND ON A
TIMELY BASIS, WE WILL NOT BE ABLE TO DELIVER PRODUCTS TO CUSTOMERS ON TIME WHICH
COULD CAUSE US TO LOSE CUSTOMERS, AND OUR REVENUES COULD DECLINE. We depend on
sole source and limited source suppliers for optical card raw materials. Such
materials include plastic films used in optical memory card production, which
are available from one supplier in the U.S. and from multiple foreign suppliers.
Processing chemicals, inks, and bonding adhesives are obtained from various U.S.
and foreign suppliers. Certain photographic films are commercially available
solely from Eastman Kodak Company, of the United States. No assurance can be
given that Kodak will continue to supply such photographic films on a
satisfactory basis and in sufficient quantities. If Kodak were to discontinue
manufacturing the film from which our optical media is made, we would endeavor
to establish an alternate supplier for such film, although the purchase price
could increase and reliability and quality could decrease from a new supplier.
No assurance can be given that there will be adequate demand to attract a second
source. In addition, an alternate supplier could encounter technical issues in
producing the film as there may be know-how and manufacturing expertise which
Kodak has developed over the years which an alternate supplier may have
difficulty to replicate. We have pre-purchased a long-term supply of the film
used to produce mastering loops for prerecording cards. With regard to the film
from which our optical media is made, we currently have an order which Kodak has
accepted with deliveries scheduled through December 2006. If Kodak announced
that it was no longer going to sell film, we would request that Kodak provide us
with a last-buy opportunity which we would plan to take maximum advantage of,
although no assurance can be given that Kodak would provide us with such an
opportunity. We have film on hand plus on order that we believe would provide us
with an adequate supply to meet anticipated demand until we could locate and
begin volume purchases from a second source.
AN INTERRUPTION IN THE SUPPLY OF READ/WRITE DRIVE PARTS OR DIFFICULTIES
ENCOUNTERED IN READ/WRITE DRIVE ASSEMBLY COULD CAUSE A DELAY IN DELIVERIES OF
DRIVES AND OPTICAL MEMORY CARDS AND A POSSIBLE LOSS OF SALES, WHICH WOULD
ADVERSELY AFFECT OUR OPERATING RESULTS. Several major components of our
read/write drives are
26
designed specifically for our read/write drive. For example, the optical
recording head for the current drive is a part obtained from one supplier; and
at current production volumes, it is not economical to have more than one
supplier for this custom component. The ability to produce read/write drives in
high-volume production, if required, will be dependent upon maintaining or
developing sources of supply of components that meet our requirements for high
volume, quality, and cost. In addition, we could encounter quality control or
other production problems at high-volume production of read/write drives. We are
also investing in research and engineering in an effort to develop new drive
products.
IF WE ARE UNABLE TO DEVELOP UPGRADED READ/WRITE DRIVES THAT COST LESS TO
MANUFACTURE AND ALSO A READ-ONLY DRIVE, WE COULD LOSE POTENTIAL NEW BUSINESS.
The price of our standard read/write drive ranges from $1,800 to just under
$2,000 depending on quantity purchased. We believe the price of our drives is
competitive in applications requiring a large number of cards per each drive,
because the relatively low cost for our cards offsets the high cost per drive
when compared with our major competition, IC card systems. In addition, we have
undertaken a product development program for a portable read-only drive now
available in prototype, 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.
WE MAY NOT BE ABLE TO ADAPT OUR TECHNOLOGY AND PRODUCTS TO COMMERCIAL
APPLICATIONS WHICH GENERATE MATERIAL AMOUNTS OF REVENUE AND PROFIT. THIS WOULD
LIMIT THE FUTURE GROWTH OF OUR BUSINESS TO THE GOVERNMENT SECTOR AND THE LACK OF
DIVERSIFICATION EXPOSES US TO ENHANCED RISK OF COMPETITION. We are seeking
commercial applications for our optical memory products in order to lessen our
dependence upon the government sector. Our efforts to develop OpticalProximity
with HID Corporation are but one example. We may be unsuccessful in these
efforts in which case we would not obtain the diversity of revenues we are
seeking for the future. If the use of our technology remains limited to secure
ID card applications for government use, then we are more susceptible to other
technologies and products making in-roads or to political pressures or changing
laws
IF WE ARE UNABLE TO ADAPT TO TECHNOLOGICAL CHANGES IN THE DATA CARD
INDUSTRY AND IN THE INFORMATION TECHNOLOGY INDUSTRY GENERALLY, WE MAY NOT BE
ABLE TO EFFECTIVELY COMPETE FOR FUTURE BUSINESS. The information technology
industry is characterized by rapidly changing technology and continuing product
evolution. The future success and growth of our business will require the
ability to maintain and enhance the technological capabilities of the LaserCard
product line. There can be no assurance that the Company's products currently
sold or under development will remain competitive or provide sustained revenue
growth.
SEVERAL OF OUR FOREIGN PROGRAMS INVOLVE OUR CARDS AS PART OF A SOLUTION
WHICH INCLUDES TECHNOLOGIES OF THIRD PARTIES THAT ARE INTEGRATED BY OUR SYSTEMS
INTEGRATOR CUSTOMER OR SUBCONTRACTOR. WE THEREFORE DO NOT HAVE CONTROL OVER THE
OVERALL SYSTEM WHICH COULD LEAD TO TECHNICAL AND COMPATIBILITY ISSUES WHICH ARE
DIFFICULT, EXPENSIVE, AND TIME CONSUMING TO SOLVE. THIS COULD CAUSE OUR
GOVERNMENT ULTIMATE CUSTOMERS TO FIND FAULT IN OPTICAL CARDS AND SWITCH TO OTHER
SOLUTIONS EVEN THOUGH OUR OPTICAL TECHNOLOGY IS NOT THE ROOT CAUSE. In certain
of our current foreign programs such as Italy and a Middle Eastern country, and
possibly in future other programs, various third party technologies such as
contact or contactless chips will be added to our cards. The embedding or
addition of other technologies to the LaserCard OMC, especially when contracted
to independent third parties, could potentially lead to technical, compatibility
and other issues. In such circumstances, it may be difficult to determine
whether a fault originated with the Company's technology or that of a
co-supplier. If such faults occur, they could be difficult, expensive, and
time-consuming to resolve. Such difficulties could lead to our ultimate
customers, the foreign governments, switching to other technologies even though
optical technology is not the root cause. The resulting loss of customers would
adversely affect our revenues.
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,
27
confidentiality procedures, and licensing arrangements to establish and protect
our proprietary rights. Our existing and future patents may not be sufficiently
broad to protect our proprietary technologies. Despite our efforts to protect
proprietary rights, we cannot be certain that the steps we have taken will
prevent the misappropriation or unauthorized use of our technologies,
particularly in foreign countries where the laws may not protect proprietary
rights as fully as U.S. law. Any patents we may obtain may not be adequate to
protect our proprietary rights. Our competitors may independently develop
similar technology, duplicate our products, or design around any of our issued
patents or other intellectual property rights. Litigation may be necessary to
enforce our intellectual property rights or to determine the validity or scope
of the proprietary rights of others. This litigation could result in substantial
costs and diversion of resources and may not ultimately be successful. We cannot
predict whether the expiration or invalidation of our patents would result in
the introduction of competitive products that would affect our future revenues
adversely. However, since our technology is now in the commercial stage, our
know-how and experience in volume card production, system development and
software capabilities, brand-name recognition within our card markets, and
dominant-supplier status for optical memory cards are of far greater importance
than our patents. At this time, we believe that our existing patent portfolio is
helpful but is no longer essential for maintaining the LaserCard's market
position.
THE MARKETS FOR OUR PRODUCTS ARE COMPETITIVE, AND IF WE ARE UNABLE TO
COMPETE SUCCESSFULLY, REVENUES COULD DECLINE OR FAIL TO GROW. Our optical memory
cards may compete with optical memory cards that can be manufactured and sold by
three of our licensees (although none is currently doing so) and with other
types of portable data storage cards and technologies used for the storage and
transfer of digital information. These may include integrated circuit/chip
cards; 2-dimensional bar code cards and symbology cards; magnetic-stripe cards;
thick, rigid CD-read only cards or recordable cards; PC cards; radio frequency,
or RF, chip cards; and small, digital devices such as data-storage keys, tokens,
finger rings, and small cards and tags. The financial and marketing resources of
some of the competing companies are greater than our resources. Competitive
product factors include system/card portability, interoperability,
price-performance ratio of cards and associated equipment, durability,
environmental tolerance, and card security. Although we believe our cards offer
key technological and security advantages for certain applications, the current
price of optical card read/write drives is a competitive disadvantage in some of
our targeted markets. However, we believe the price of our drives is competitive
in applications requiring a large number of cards per each drive, because the
relatively low cost for our cards offsets the high cost per drive when compared
with our major competition, IC card systems. In countries where the
telecommunications infrastructure is extensive and low cost, centralized
databases and wide-area networks may limit the penetration of optical memory
cards. These trends toward Internet, intranet, and remote wireless networks will
in some cases preclude potential applications for our cards.
THE PRICE OF OUR COMMON STOCK IS SUBJECT TO SIGNIFICANT VOLATILITY. The
price of our common stock is subject to significant volatility, which may be due
to fluctuations in revenues, earnings, liquidity, press coverage, financial
market interest, low trading volume, and stock market conditions, as well as
changes in technology and customer demand and preferences. As a result, our
stock price might be low at the time a stockholder wants to sell the stock.
Also, since we have a relatively low number of shares outstanding (approximately
11 million shares) there will be more volatility in our stock if one or two
major holders, for example, large institutional holders, attempt to sell a large
number of shares in the open market. There also is a large short position in our
stock, which can create volatility when borrowed shares are sold short and later
if shares are purchased to cover the short position. Furthermore, our trading
volume is often small, meaning that a few trades may have disproportionate
influence on our stock price. In addition, someone seeking to liquidate a
sizeable position in our stock may have difficulty doing so except over an
extended period or privately at a discount. Thus, if one or more stockholders
were to sell or attempt to sell a large number of its shares within a short
period of time, such sale or attempt could cause our stock price to decline.
There can be no guarantee that stockholders will be able to sell the shares that
they acquired at a price per share equal to the price they paid for the stock.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH CHANGES IN FOREIGN CURRENCY
EXCHANGE RATES. Part of the manufacturing process of the LaserCard products that
we sell in Italy takes place in our operations in Germany. Also, some of the raw
materials we use to manufacture optical memory cards are sourced in Europe.
These costs are denominated in euros, the currency used in much of Europe.
However, when we sell our finished products the prices that we charge are
denominated in United States dollars. Accordingly, we are subject to exposure if
the exchange rate for euros increases in relation to the United States dollar.
During fiscal 2005, we experienced a $0.2 million loss on foreign currency
exchange. As of June 30, 2005, we had not entered into a forward exchange
contract to hedge against or potentially minimize the foreign currency exchange
risk.
28
WE SOLD A SECOND-SOURCE CARD MANUFACTURING LICENSE TO GLOBAL INVESTMENTS
GROUP (GIG), UNDER WHICH WE WILL PROVIDE CERTAIN FACTORY SET-UP AND TRAINING
SERVICES. IF WE ARE NOT SUCCESSFUL OR IF GIG IS UNABLE TO FINANCE THIS
OPERATION, THE SECOND-SOURCE SUPPLY OF OPTICAL CARDS WILL NOT MATERIALIZE. IF WE
AND GIG ARE SUCCESSFUL, THE SECOND-SOURCE WILL COMPETE WITH US FOR BUSINESS. If
GIG is not successful, but current and potential customers require a second
source of optical memory cards (which is a common business practice) they could
decide to use alternate technology cards, such as chip cards, that have
multiple-source suppliers. We are obligated to deliver approximately $12 million
worth of the required manufacturing equipment and installation support to GIG
for its to-be-built new card manufacturing facility in Slovenia, to provide a
targeted initial manufacturing capacity of 10 million optical cards annually. If
GIG is successful, this will supply a second source for optical memory cards. We
will also be assigning personnel to be on site during the license term to assist
with quality, security, and operational procedures, with a mutual goal that the
facility and the cards made in Slovenia conform to our standards. If cards are
not produced in conformance with our quality standards, the reputation and
marketability of optical memory card technology could be damaged. If the factory
does not become operational and produce quality cards in high volume, or if GIG
is unable to raise sufficient capital to build, equip and operate this facility,
we would not obtain the hoped-for benefits--including ongoing royalties, sales
of raw materials to GIG, expansion of the European market, and a bona fide
second source for optical memory cards. On the other hand, if and when the
factory is successfully manufacturing the cards in high volume, it will compete
against us for business in certain territories, which could reduce our potential
card revenues if the market does not expand. Revenue will be recognized over the
remaining term of the agreement beginning when operation of the factory
commences. The Company could incur greater expenses than it anticipates for the
purchase and installation of the required manufacturing equipment thereby
reducing cash and anticipated profits.
WE MAY NOT BE ABLE TO ATTRACT, RETAIN OR INTEGRATE KEY PERSONNEL, WHICH
MAY PREVENT US FROM SUCCEEDING. We may not be able to retain our key personnel
or attract other qualified personnel in the future. Our success will depend upon
the continued service of key management personnel. The loss of services of any
of the key members of our management team, including our chief executive
officer, president, the managing directors of our German operations, vice
president of business development or our vice president of finance and
treasurer, or our failure to attract and retain other key personnel could
disrupt operations and have a negative effect on employee productivity and
morale, thus decreasing production and harming our financial results. In
addition, the competition to attract, retain and motivate qualified personnel is
intense.
OUR CALIFORNIA FACILITIES ARE LOCATED IN AN EARTHQUAKE ZONE AND THESE
OPERATIONS COULD BE INTERRUPTED IN THE EVENT OF AN EARTHQUAKE, FIRE, OR OTHER
DISASTER. Our card manufacturing, corporate headquarters, and drive assembly
operations, administrative, and product development activities are located near
major earthquake fault lines. In the event of a major earthquake, we could
experience business interruptions, destruction of facilities and/or loss of
life, all of which could materially adversely affect us. Likewise, fires,
floods, or other events could similarly disrupt our operations and interrupt our
business.
ACTS OF TERRORISM OR WAR MAY ADVERSELY AFFECT OUR BUSINESS. Acts of
terrorism, acts of war, and other events may cause damage or disruption to our
properties, business, employees, suppliers, distributors, resellers, and
customers, which could have an adverse effect on our business, financial
condition, and operating results. Such events may also result in an economic
slowdown in the United States or elsewhere, which could adversely affect our
business, financial condition, and operating results.
29
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RATE RISKS
INTEREST RATE RISK. The Company invests its cash, beyond that needed for
daily operations, in high quality debt securities. In doing so, the Company
seeks primarily to preserve the value and liquidity of its capital and,
secondarily, to safely earn income from these investments. To accomplish these
goals, the Company invests only in debt securities issued by (a) the U.S.
Treasury and U.S. government agencies, state 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
Investments in both fixed rate and floating rate interest earning
instruments carry a degree of interest rate risk. Fixed rate securities may have
their fair market value adversely impacted because of a rise in interest rates,
while floating rate securities may produce less income than expected if interest
rates fall. Due in part to these factors, the Company's future investment income
may fall short of expectations because of changes in interest rates or we may
suffer losses in principal if forced to sell securities that have seen a decline
in market value because of changes in interest rates.
There were no material changes during the first quarter of fiscal 2006
in the Company's exposure to market risk for changes in interest rates.
The following summarizes short-term and long-term investments at fair
value, weighted average yields and expected maturity dates as of June 30, 2005
(in thousands):
2006 2007 TOTAL
---- ---- -----
Auction rate securities $ 7,150 $ -- $ 7,150
Weighted Average Yield 3.26% -- 3.26%
U.S. Government and Agency Obligations 4,754 2,474 7,228
Weighted Average Yield 2.04% 2.80% 2.30%
-------- -------- --------
Total Investments $ 11,904 $ 2,474 $ 14,378
======== ======== ========
FOREIGN CURRENCY EXCHANGE RATE RISK. The Company's U.S. Operations sell
products in various international markets. To date an immaterial amount of sales
have been denominated in euros. In addition, some raw material purchases and
purchased services are denominated in euros. As of June 30, 2005, the
outstanding balance of a debt relating to the acquisition of Challenge Card
Design Plastikkarten GmbH and cards & more GmbH, of Germany was immaterial.
Accordingly, the exchange rate risk related to this debt is minimal. The Company
had not entered into a forward exchange contract to hedge against or potentially
minimize the foreign currency exchange risk. We will continue to evaluate our
exposure to foreign currency exchange rate risk on a regular basis.
The income statements of the Company's non-U.S. operations are
translated into U.S. dollars at the average exchange rate in each applicable
period. To the extent the U.S. dollar weakens against euro, the translation of
euro denominated transactions results in increased revenues, operating expenses
and net income for the non-U.S. operations. Similarly, the Company's revenues,
operating expenses and net income will decrease for the non-U.S. operations if
the U.S. dollar strengthens against euro. For the three-month period ended June
30, 2005, the fluctuation of the average exchange rate as compared to the
average exchange rate from fiscal 2005 was immaterial. Additionally, the assets
and liabilities of the non-U.S. operations are translated into U.S. dollars at
exchange rates in effect as of the applicable balance sheet dates, and revenue
and expense accounts of these operations are translated at average exchange
rates during the applicable period the transactions occur. Translation gains and
losses are included as an adjustment to stockholders' equity.
30
ITEM 4. CONTROLS AND PROCEDURES
(A) 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-14(c) and 15d-14(c)) as of the end of the
period covered by this Form 10Q and have determined that they are
reasonable taking into account the totality of the circumstances.
(B) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There were no
significant changes in the Company's internal control over financial
reporting that occurred during the first quarter of fiscal 2006 that
have materially affected, or are reasonably likely to materially
affect, such control.
PART II. OTHER INFORMATION
Item 1. - Legal Proceedings
None
Item 2. - Changes in Securities and Use of Proceeds
None
Item 3. - Defaults Upon Senior Securities
None
Item 4. - Submission of Matters to a Vote of Security Holders
None
Item 5. - Other Information
None
Item 6. - Exhibits
(a) Exhibit No. Exhibit Description
----------- -------------------
3(I) Certificate of Incorporation: Exhibit 3.1 of the
registrant's annual report on Form 10-K for the
fiscal year ended March 31, 2005, filed with the
SEC on June 15, 2005, is hereby incorporated by
reference
3(II) Bylaws: Exhibit 3.2 of the registrant's annual
report on Form 10-K for the fiscal year ended
March 31, 2005, filed with the SEC on June 15,
2005, is hereby incorporated by reference
10.1-10.8 Material Contracts: Exhibits 10.1 through 10.8
listed in registrant's annual report on Form 10-K
for the fiscal year ended March 31, 2005, filed
with the SEC on June 15, 2005, are hereby
incorporated by reference.
31.1 Rule 13a-14(a) Certification of Richard M.
Haddock, principal executive officer is filed
herewith.
31.2 Rule 13a-14(a) Certification of Steven G. Larson,
principal financial officer is filed herewith.
31
32.1 Section 1350 Certification of Richard M. Haddock,
chief executive officers is filed herewith.
32.2 Section 1350 Certification of Steven G. Larson,
chief financial officer is filed herewith.
The above-listed exhibits are filed herewith. No other exhibits are
included in this report as the contents of the required exhibits are either not
applicable to Registrant, to be provided only if Registrant desires, or
contained elsewhere in this report.
32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized:
LASERCARD CORPORATION
(Registrant)
Signature Title Date
--------- ----- ----
/s/ Richard M. Haddock Chief Executive Officer August 8, 2005
- -------------------------------- (Principal Executive Officer)
Richard M. Haddock
/s/ Steven G. Larson Vice President of Finance and Treasurer August 8, 2005
- -------------------------------- (Principal Financial Officer and
Steven G. Larson Principal Accounting Officer)
33
INDEX TO EXHIBITS
[Part II, ITEM 6]
Exhibit
Number Description
- ------ -----------
3(I) Certificate of Incorporation: Exhibit 3.1 of the registrant's
annual report on Form 10-K for the fiscal year ended March 31,
2005, filed with the SEC on June 15, 2005, is hereby incorporated
by reference
3(II) Bylaws: Exhibit 3.2 of the registrant's annual report on Form
10-K for the fiscal year ended March 31, 2005, filed with the SEC
on June 15, 2005, is hereby incorporated by reference
10.1-10.8 Material Contracts: Exhibits 10.1 through 10.8 listed in
registrant's annual report on Form 10-K for the fiscal year ended
March 31, 2005, filed with the SEC on June 15, 2005, are hereby
incorporated by reference.
31.1 Rule 13a-14(a) Certification of Richard M. Haddock, principal
executive officer, follows on page 35
31.2 Rule 13a-14(a) Certification of Steven G. Larson, principal
financial officer follows on page 36
32.1 Section 1350 Certification of Richard M. Haddock, chief executive
officers follows on page 37
32.2 Section 1350 Certification of Steven G. Larson, chief financial
officer follows on page 38
34