Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[Mark One]
[ x ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended March 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to _____
Commission File Number: 000-6377
LASERCARD CORPORATION
(FORMERLY DREXLER TECHNOLOGY CORPORATION)
Delaware 77-0176309
- -------------------------------- -----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1875 North Shoreline Boulevard, Mountain View, CA 94043-1601
- ------------------------------------------------- -----------------------
(Address of principal executive offices) (Zip Code)
(650) 969-7277
--------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
NONE NONE
- ----------------------- -----------------------
(Title of each class (Name of each exchange
so registered) on which registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
----------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. [x] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). [x] Yes [ ] No
Based on the last trade price of the Company's Common Stock on The Nasdaq Stock
Market on the last business day of the registrant's most recently completed
second fiscal quarter (September 30, 2004), the aggregate market value of the
voting stock held by non-affiliates of the registrant is approximately
$104,000,000. Shares of common stock held by officers, directors and other
persons who may be "affiliates" of the Registrant have been excluded from this
computation. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
Number of outstanding shares of Common Stock, $.01 par value,
at June 10, 2005: 11,436,794
1
DOCUMENTS INCORPORATED BY REFERENCE: NONE
Exhibit Index is on Page 86
Total number of pages is 113
2
PART I
Page
----
Item 1. Business.............................................................................................. 4
Forward-Looking Statements........................................................................ 4
General Development of Business................................................................... 5
Financial Information about Segments.............................................................. 6
Narrative Description of Business................................................................. 6
Risk Factors and Factors that May Affect Future Operating Results................................. 17
Item 2. Properties............................................................................................ 23
Item 3. Legal Proceedings..................................................................................... 24
Item 4. Submission of Matters to a Vote of Security Holders................................................... 24
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities............................................................................. 25
Item 6. Selected Financial Data............................................................................... 26
Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition................. 27
Critical Accounting Policies...................................................................... 27
Results of Operations--Fiscal 2005 Compared with Fiscal 2004 and Fiscal 2003...................... 30
Liquidity and Capital Resources................................................................... 36
Item 7A. Quantitative and Qualitative Disclosures about Market Risk............................................ 39
Item 8. Financial Statements and Supplementary Data........................................................... 40
Reports of Independent Registered Public Accounting Firms......................................... 40
Consolidated Financial Statements................................................................. 44
Notes to Consolidated Financial Statements........................................................ 48
Quarterly Financial Information (Unaudited)....................................................... 68
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................. 69
Item 9A. Controls and Procedures............................................................................... 69
Item 9B. Other Information..................................................................................... 69
PART III
Item 10. Directors and Executive Officers of the Registrant.................................................... 70
Item 11. Executive Compensation................................................................................ 72
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters........ 74
Item 13. Certain Relationships and Related Transactions........................................................ 76
Item 14. Principal Accountant Fees and Services................................................................ 77
PART IV
Item 15. Exhibits and Financial Statement Schedules............................................................ 78
Signatures ...................................................................................................... 85
3
PART I
ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS. All statements contained in this report that
are not historical facts are forward-looking statements. The forward-looking
statements in this report are made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. They are not historical facts
or guarantees of future performance or events. Rather, they are based on current
expectations, estimates, beliefs, assumptions, and goals and objectives and are
subject to uncertainties that are difficult to predict. As a result, the
Company's actual results may differ materially from the statements made. Often
such statements can be identified by their use of words such as "may," "will,"
"intends," "plans," "believes," "anticipates," "visualizes," "expects," and
"estimates." Forward-looking statements made in this report include statements
as to the Company's belief that its U.S. government contract will be extended
and as to card personalization rates to current and potential market segments,
customers, and applications for and deployment of the products of the Company;
statements as to the advantages of, potential income from, and duties to be
performed under the sale of a second-source card manufacturing license to Global
Investments Group (GIG); statements as to the GIG license for second-source card
production in Slovenia, including future scheduled payments and royalties, 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); belief that the
European marketing base provided by the German operations will accelerate
European acceptance of OMCs; belief that the Company's supply of film is
adequate to bring up a second source without interruption should Kodak cease as
a supplier; intent to pursue infringers of its patents; plans to increase card
production capacity for anticipated increases in orders from programs from the
Italian government and other potential programs; anticipated continued use of
the Company's products by the governments of the United States, Canada, and
Italy, including that Italy will be the largest customer for the next few years
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; 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; anticipated reductions of federal tax cash payments due to current
Company tax benefits; statements as to expected card delivery volumes, estimates
of optical card production capacity, expected card yields there from, the
Company's ability to expand production capacity, and the Company's plans and
expectations regarding the growth and associated capital costs of such capacity;
estimates that revenues 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 Company's plans,
objectives, and expected future economic performance including without
limitation, its marketing objectives.
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
4
with development, manufacture, and deployment of optical cards, drives, and
systems; the impact of litigation; the ability of the Company or its customers
to initiate and develop new programs utilizing the Company's card products;
risks and difficulties associated with development, manufacture, and deployment
of optical cards, drives, and systems; potential manufacturing difficulties and
complications associated with increasing manufacturing capacity of cards and
drives, implementing new manufacturing processes, and outsourcing manufacturing;
the Company's ability to produce and sell read/write drives in volume; the
unpredictability of customer demand for products and customer issuance and
release of corresponding orders; government rights to withhold order releases,
reduce the quantities released, and extend shipment dates; whether the Company
receives a fixed shipment schedule, enabling the Company to recognize revenues
on cards delivered to the vault instead of when cards later are shipped from the
vault; the impact of technological advances, general economic trends, and
competitive products; the impact of changes in the design of the cards; and the
possibility that optical memory cards will not be purchased for the full
implementation of card programs in Italy, 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; 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.
TRADEMARKS. LaserCard(R) and Drexon(R) are the Company's registered
trademarks. OpticalSmartTM card, OpticalProximityTM caRD, LaserCard(R)
ConciergeCardTM, OptiChipTM, and LaserBadgeTM are the Company's trademarks. The
Company may also refer to trademarks of other corporations and organizations in
this document.
GENERAL DEVELOPMENT OF BUSINESS
Headquartered in Mountain View, California, LaserCard Corporation, a
Delaware corporation, (formerly known as Drexler Technology Corporation, until
October 1, 2004) is primarily a holding company that operates all its operations
through its three wholly owned subsidiaries. LaserCard Corporation, a California
corporation, of Mountain View, develops, manufactures and sells optical memory
cards, read/write drives; and system software; card-related systems, and markets
peripherals, specialty cards and card printers. Challenge Card Design
Plastikkarten GmbH, of Rastede, Germany, manufactures specialty cards; and cards
& more GmbH, of Ratingen, Germany, markets cards, system solutions, and card
printers. The Company is reviewing the viability of merging cards & more GmbH
into Challenge Card Design Plastikkarten GmbH during the next twelve months.
LaserCard Corporation was incorporated under the laws of the State of
California on July 23, 1968, and was reincorporated as a Delaware corporation on
June 24, 1987. The Company's mailing address and executive offices are located
at 1875 North Shoreline Boulevard, Mountain View, California 94043, and the
telephone number is (650) 969-7277. Throughout this report, the "Company," "we,"
and "us" refer to LaserCard Corporation and subsidiaries, unless otherwise
indicated.
The Company's annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and all amendments to those reports can be
obtained free of charge after such material is electronically filed with or
furnished to the Securities and Exchange Commission (SEC). These documents are
available as soon as reasonably practicable using the hypertext link to the
SEC's website via the Company's website, www.lasercard.com. They also may be
obtained directly from the SEC's website,
www.sec.gov/edgar/searchedgar/companysearch.html under CIK code 30140. In
addition, these documents and the Company's "Code of Ethics and Business Conduct
for Employees, Officers, and Directors" are posted on the Company's website.
The Company's primary product is the LaserCard optical memory card which
is a credit-card sized, data storage card--invented, patented, developed, and
manufactured by the Company. Along with its ability to record, update, and store
up to 2.86 megabytes of user data, this unique card offers multiple
data-security features, can be carried in a wallet, and is highly resistant to
counterfeiting and data tampering. This makes the LaserCard ideal for portable
and secure data storage and for cardholder identification.
Applications for the LaserCard include the following:
5
o United States Permanent Resident Card ("Green Card")
o United States Department of State Laser Visa Border Crossing
Card (BCC)
o United States Department of Defense Automated Manifest System
Card
o Government of Canada "Maple Leaf" Permanent Resident Card
o Italian citizens' ID card
o Middle Eastern country national ID card
o Other developing programs involving banking, medical records,
and vehicle registration
On March 31, 2004, the Company successfully completed the acquisition of
two related German card companies, Challenge Card Design Plastikkarten GmbH of
Rastede, Germany, and cards & more GmbH of Ratingen, Germany, including their
sales operations in the USA and Korea. These acquisitions provide the Company
with a strong card manufacturing base to serve the European, Middle Eastern,
African, and Asian markets, supplementing the Company's newly expanded
manufacturing operations in California. While operating results of these German
companies are consolidated into the Company's financial statements for fiscal
2005, the historic operating results of CCD and C&M have not been included in
the financial statements for fiscal 2004 and prior periods although the
consolidated balance sheets as of March 31, 2005 and March 31, 2004 reflect the
acquisition of these two companies.
Effective April 3, 2004, the Company sold a royalty-bearing,
second-source card-manufacturing license to Global Investments Group, for
optical memory card manufacturing in Slovenia. This agreement provides for
payments to the Company of $41 million over the 20-year term of the license
(consisting of the sale of equipment for approximately $12 million, a five-year
training support package, followed by an ongoing support phase for an additional
15 years). The required manufacturing equipment and installation support for the
licensee's new facility are targeted to achieve an initial manufacturing
capacity of 10 million optical cards annually. The Company has received the
initial $15 million of payments called for in the agreements as of March 31,
2005. We have been informed that Global Investments Group is planning to start
manufacturing operations in their new facility early in 2006.
For a discussion of the risk factors related to the Company's business
operations, see the "Forward-Looking Statements" narrative at the beginning of
this report, the "Risk Factors and Factors That May Affect Future Operating
Results" at the end of this section, and the "Management's Discussion and
Analysis of Results of Operations and Financial Condition" contained in Item 7.
FINANCIAL INFORMATION ABOUT SEGMENTS
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 printers. The segments were
determined based on the information used by the chief operating decision maker.
The optical memory cards and optical card drives reportable segments are not
strategic business units which offer unrelated products and services; rather
these reportable segments utilize compatible technology and are marketed
jointly. Specialty cards and printers is a strategic business unit offering at
times unrelated products and at times related products with the other reportable
segments. See "Segment Reporting" in Note 4 in Item 8, "Consolidated Financial
Statements and Supplementary Data," for additional industry segment information.
NARRATIVE DESCRIPTION OF BUSINESS
LaserCard Corporation develops, manufactures and sells optical memory
cards, read/write drives, system software and card-related systems, and markets
peripherals, specialty cards and card printers. The primary product of the
Company is the LaserCard optical memory card (OMC).
LASERCARD; A SECURE COUNTERFEIT-RESISTANT CREDENTIAL
The Company's LaserCard optical memory card is a secure,
counterfeit-resistant credential whose current primary use is by national
governments in identification applications.
Digital data is recorded in an irreversible process so that ID
information on a legitimate card cannot be
6
fraudulently altered for criminal purposes. Each implementation for secure ID is
customized to the issuers' own specifications. Key characteristics of the card's
memory and the issuing and inspection hardware are matched. To date, the
Company's users have concluded that the hurdle for would-be card counterfeiters
is so high that such persons instead would seek some other vulnerability in the
issuance process.
Another security benefit of optical memory is its ability to create
visible, high-resolution micro images and security patterns in the optical media
itself at resolutions up to 12,000 dots per inch. These features, which cannot
be accurately simulated, are used by inspectors and forensic specialists for
both overt and aided visual card authentication.
It is also possible to create a "laser-etched," eye visible image in the
media, irreversibly marking the digital memory with the visible identity of the
card holder, a unique security feature among all machine readable card
technologies.
These images are recorded during card personalization using a secure
optical memory card (OMC) encoder unit: the diffraction pattern created results
in a highly visible image on the optical media. This image cannot be altered,
since the media is not erasable, and the permanent laser etching can be visually
compared to more readily changeable colored photographic images of the
cardholder that may also be printed on the card's surface.
LaserCard OMC also offers a hologram under overlay where a custom
hologram is laminated into the structure of the card and is visible through a
transparent outer layer of the card. The hologram will never be subject to wear
and attempts at cannibalization of the feature are rendered useless.
LASERCARD NATIONAL GOVERNMENT APPLICATIONS
The predominant present application is secure identity in government
programs, covering both immigration and border entry along with citizenship. The
counterfeit-resistant cards are typically replaced every five or ten years. The
following are examples of these national government applications:
o The current U.S. Permanent Resident Card (or "Green Card"), made
by the Company and issued by the Department of Homeland
Security, evidences that a non-US citizen is approved to reside
and be employed in the United States.
o The current Laser Visa Border Crossing Card, made by the Company
and issued by the United States Department of State, permits
Mexican citizens to visit the United States (close to the U.S.
border) for up to 30 days.
o The current Canadian "Maple Leaf" Permanent Resident Card, made
by the Company, has been issued by the Government of Canada
since mid-2002 to confirm Canadian permanent resident status.
o The electronic citizen ID card of Italy, approved for full
implementation, identifies the holder as a citizen and confers
upon the holder the rights and privileges to which a citizen is
entitled. According to recent legislation an Italian resident
permit card for non-EU citizens will also be implemented.
o In a program for a Middle Eastern country, the LaserCard would
be used as a national identification card. The Company has sold
read/write drives for installation of the infrastructure
required for card issuance, and also has shipped about 300,000
optical memory cards for testing and sample purposes.
o A motor vehicle registration program in the States of Delhi and
Gujarat, India, in which the OpticalSmart LaserCard is used for
storing the payment of road tax, vehicle registration,
insurance, violations, and vehicle fitness. We have been
informed that the two states have issued more than 300,000 such
optical card-based registrations to date, and other Indian
states have planned OpticalSmart card vehicle registration
programs as well.
7
o The U.S. Department of Defense uses the LaserCard as a paperless
cargo manifest in its Automated Manifest System for governing
and facilitating the shipment of military cargo to Army and
Marine deployments.
DATA STORAGE CAPACITY
The gross data storage capacity of the standard LaserCard is 4.1
megabytes on the 35mm optical stripe and 1.5 megabytes on the 16mm stripe. The
LaserCard itself is the size of a conventional credit card.
A significant portion of the LaserCard's total data capacity is used for
an error detection and correction, or EDAC, algorithm. EDAC is routinely used in
various data storage and transfer methods to compensate for data errors
resulting from transmission errors, surface scratches above the recording
material, or contamination such as dust or fingerprints. EDAC is automatically
added to data written onto the LaserCard, to achieve written data error rates of
less than one in a trillion.
The resulting data storage capacities are 2.86 megabytes of "user"
capacity for the standard 4.1 megabyte LaserCard and 1.1 megabytes of "user"
capacity for the 1.5 megabyte LaserCard. The 16-millimeter stripe LaserCard with
1.1 megabytes of user capacity can be employed in conjunction with an IC chip to
create a hybrid smart card, which the Company calls an OpticalSmart(TM) card.
Durability
Durability is another important feature, primarily in industrial
applications. The U.S. Defense Logistics Agency's (DLA) Automated Manifest
System (AMS) uses optical memory cards to resolve the problem of in-transit
identification for critical supplies. The AMS card solution provides in-transit
visibility, expedited receipt processing, prioritizes container processing,
facilitates discrepancy reporting, minimizes impact on existing systems and
achieves a portable permanent record of transactions. Since 1993 more than
750,000 LaserCard optical memory cards and approximately 2,000 LaserCard OMC
drives have been installed for use in shipping goods all over the world, often
in the most hazardous environments. Environmental testing done by the U.S. Army
showed high durability with the optical memory card.
The AMS program has won several government awards, including the
Vice-Presidential Golden Hammer for cutting logistics costs more than 67%.
INTERNATIONAL STANDARDS FOR OPTICAL MEMORY CARDS
Standardization of optical memory cards allows interchange of the
digital information encoded on the cards and facilitates compatibility among
optical memory card systems. The Company participates in optical card standards
activities in the United States and internationally. Shown below is the current
status of optical memory card standards under ISO/IEC (the International
Organization for Standardization/International Electrotechnical Committee). The
LaserCard optical memory card system, complies with all of the documents listed.
o ISO/IEC 11693 describes the general characteristics of optical
memory cards. This international standard was first published in
1994.
o ISO/IEC 11694-1 describes the physical characteristics of the
card, such as height, width, thickness, etc. This international
standard was first published in 1994.
o ISO/IEC 11694-2 describes the dimensions and location of the
accessible area--the area on the card where data writing/reading
occurs. This international standard was first published in 1995.
o ISO/IEC 11694-3 describes the optical properties and
characteristics of the card and provides the technical
specifications which allow interchange. This international
standard was published in 1995.
8
o ISO/IEC 11694-4 describes the logical data structure on the card
and defines the method of writing and reading card data. This
international standard was published in 1996.
In the United States, ANSI (the American National Standards Institute)
has adopted all of the above ISO Standards as ANSI/ISO Standards.
Other standards defining the use of optical memory cards in certain
application areas, such as drivers license and machine readable travel
documents, also exist.
LASERCARD MANUFACTURING
The Company's LaserCard optical memory card manufacturing operations are
located in Mountain View, California, and Rastede, Germany. The Company produces
optical memory cards using the original roll-lamination process or a newer
sheet-lamination process. The sheet-lamination process is currently more labor
intensive than the roll-lamination process but allows the use of high security
offset printing and other special features, resulting in a premium card. The
Company has an annual production capacity of 10 million roll-process cards in
conjunction with approximately 6 million sheet-process cards depending with the
optimum mix of features. The optical memory card manufacturing facilities permit
incremental expansion of production capacity.
The March 31, 2004 acquisition of Challenge Card Design Plastikkarten
GmbH of Rastede, Germany, provides the Company with a card manufacturing base to
serve the European, Middle Eastern, African, and Asian markets, supplementing
the Company's card manufacturing operations in California. CCD has a
manufacturing capacity of up to 20 million non-optical cards per year. The
Company may enhance the existing CCD factory to manufacture finished optical
card blanks in Germany if and when European customer orders justify such
capacity expansion and such European expansion is determined to be cost
effective. This would enable CCD to manufacture cards featuring four of the key
ID card technologies (optical memory, contact IC chip, contactless RF ID, and
magnetic stripe) either singly or in combination, along with other high-security
features.
RAW MATERIALS
To maintain adequate raw material supplies for the manufacture of
optical memory cards, the Company establishes ongoing relationships with
principal suppliers, qualified and when commercially reasonable utilizes
multiple suppliers, and obtains information about alternate suppliers. The
Company maintains raw materials inventory levels that take into account current
expected demand, order-to-delivery lead times, supplier production cycles, and
minimum order quantities. If the Company is unable to buy raw materials in
sufficient quantities and on a timely basis, it would not be able to deliver
products to customers on time.
Most of the raw materials used in the manufacture of optical memory
cards are available from one or more qualified suppliers. Such materials include
plastic films used in optical memory card production, which are available from
one supplier in the U.S. and from multiple foreign suppliers. Processing
chemicals, inks, and bonding adhesives are obtained from various U.S. and
foreign suppliers. However, certain photographic films are commercially
available solely from Eastman Kodak Company, of the United States. No assurance
can be given that Kodak will continue to supply such photographic films on a
satisfactory basis and in sufficient quantities. If Kodak were to discontinue
manufacturing the film from which the optical media is made, the Company 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. The Company anticipates that an alternate supplier of such film could
be established and qualified; however, no assurance can be given that there will
be adequate demand to attract a second source for such film. 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. With
regard to the film from which the optical media is made, the Company currently
has an order which Kodak has accepted with deliveries scheduled through December
2005. If Kodak announced that it was no longer going to sell this film, the
Company would request that Kodak provide a last-buy opportunity, which the
Company would plan to take maximum advantage of, although no assurance can be
given that Kodak would provide such an opportunity. The Company has film on hand
plus on order that it believes would provide an adequate supply to meet
anticipated demand
9
until the Company could locate and begin volume purchases of film from a second
source. In addition, the Company is researching other materials for use as its
optical memory card media.
LASERCARD READ/WRITE DRIVES; MANUFACTURING AND PARTS/COMPONENTS
Optical memory cards are used in conjunction with a card read/write
device (drive) that connects to a personal computer. The price, performance, and
availability of read/write drives are factors in the commercialization of
optical cards. The Company maintains read/write drive manufacturing operations
in its Mountain View, California facilities. The Company continuously seeks
design and procurement changes to improve performance and reduce the drive
selling price.
To maintain adequacy of parts and components for the manufacture of
read/write drives, the Company attempts to establish ongoing relationships with
principal suppliers and obtains information about alternate suppliers. If the
Company is unable to buy parts and components in sufficient quantities and on a
timely basis, it would not be able to deliver products to customers on time. The
Company purchases read/write drive parts for its anticipated read/write drive
demand, taking into consideration the order-to-delivery lead times of vendors
and the economic purchase order quantity for such parts. For read/write drives,
the optical recording head for the current drive is a Company-specific part
obtained from one supplier: Audio-Technica Corp., of Japan.
APPLICATION PROGRAMMING INTERFACE (APIS) AND APPLICATION SOFTWARE
APIS. As part of its read/write drive and system sales, LaserCard
includes a comprehensive set of APIs in order for its customers to develop
optical card applications. An API is a set of routines, protocols, and tools
used by programmers for building software applications. LaserCard-related APIs
control or facilitate the basic operations and read/write functions of optical
memory card drives so that they can interface directly with personal computers.
LaserCard develops LaserCard-related APIs such as device drivers, file system
DLLs (dynamic link libraries), and custom software tools to enhance read/write
drive integration.
CUSTOM APPLICATIONS. The Company also offers contract services for
purchase by customers that require custom programming in the development and
integration of their LaserCard applications. It also makes available for
purchase by customers, software for demonstrating data storage, medical, and
security concepts involving the LaserCard, software-development tools for
related peripherals, and a card issuance application software package.
APPLICATION SOFTWARE. End-user application software is an important
factor in developing commercial markets for optical memory cards because it
directs computers to do specific tasks related to the customer's end-user
application for the LaserCard. Typically, the Company's VARs and/or their
customers develop software for specific end-user applications. In this role,
VARs may integrate optical card products into existing software products, write
new application software for specific optical memory card programs, or license
software from other VARs. Several VARs have written optical card software
programs for applications. C&M markets the BadgeMaker card personalization and
issuing applications used for card issuance and data management; the Company
markets the LaserBadge derivative of BadgeMaker, and a Biometric ID Verification
System application (discussed below).
API and application software sales have not been a significant portion
of revenues thus far. To date, the Company's software development has been
completed concurrent with the establishment of technological feasibility and,
accordingly, all software development costs have been charged to research and
engineering expense in the accompanying statements of operations.
LASERCARD BIOMETRIC ID VERIFICATION SYSTEM
The Company has developed a LaserCard Biometric ID Verification System
that can quickly confirm validity of optical memory card biometric ID cards,
read and display digitally stored photographs and other digital data from the
cards, and biometrically verify the cardholders' live-scanned fingerprints with
the fingerprint templates stored on the cards at time of card issuance.
During the fiscal 2004 third quarter, the Company received an order for
and delivered 1,000 optical memory card read/write drives and biometric
verification system software for a Department of Homeland Security program.
These
10
1,000 drives and software systems have been deployed by the DHS at U.S. borders,
to enable the DHS to read the encoded data on more than 16 million Green Cards
and Border Crossing Cards previously manufactured by the Company and issued by
the U.S. government since 1998.
The Company also is marketing the LaserCard Biometric ID Verification
System as a "concept" package, meaning that software which performs the same
functions (but not usable with U.S. government cards) is available in customized
form to other customers for government, industrial, and commercial applications.
OTHER ADVANCED-TECHNOLOGY CARDS
Acquired by the Company on March 31, 2004, Challenge Card Design
Plastikkarten GmbH and cards & more GmbH are recognized leaders in Europe as
providers of advanced contactless card solutions, primarily in the consumer,
event, and access control sectors. CCD has the production capacity to
manufacture up to 20 million advanced-technology cards per year--including
contact IC chip cards, contactless RFID cards, and magnetic stripe cards--while
C&M markets CCD cards, thermal card printers, and system solutions worldwide.
The CCD card manufacturing plant in Rastede provides significant capacity and
product flexibility to the Company's product line. With expertise in contactless
IC technology and high resolution security printing, the European factory
positions the Company to move into new market areas.
SALES AND MARKETING
The Company markets its OMC products, primarily through value-added
resellers (VARs) of the Company in the United States and other countries. The
Company makes available for sale optical memory cards, optical card read/write
drives and software, and third-party peripherals to its VARs. VARs/licensees may
add value in the form of services, application-specific software, personal
computers, or other peripherals, and then resell these products as integrated
systems. Sales to the United States government and foreign governments are made
indirectly through VARs and licensees. For example, products are sold indirectly
to ultimate use customers such as the U.S. Department of State, U.S. Department
of Defense, U.S. Department of Homeland Security, and the government of Canada,
through a VAR that is a government subcontractor.
Revenues by geographic region are shown in Note 4 of the "Notes to
Consolidated Financial Statements" in Item 8, "Consolidated Financial Statements
and Supplementary Data." Substantially all foreign product sales have been made
through VARs and licensees. The Company believes that international markets will
be an important source of product sales and license revenue in the future.
LaserCard marketing operations are conducted through its offices in
California, New York, and Germany. In addition, the LaserCard Corporation
website (www.lasercard.com) supports worldwide marketing activities. The
Company's marketing staff, general management, and technical personnel work
closely with customers and provide pre-sales technical support to assist VARs
and licensees.
EUROPEAN OPERATIONS. The Company's German subsidiaries, Challenge Card
Design and cards & more, provide the marketing base for most of Europe, Middle
East, and Africa (EMEA), and also maintain a sales office in Korea. These
subsidiaries give the Company an established position in the European Union in
the advanced-technology card market. CCD and C&M have become recognized leaders
in Europe as providers of advanced contactless card solutions, primarily in the
consumer, event, and access control sectors. C&M heads the Company's European
marketing effort in coordination with LaserCard Corporation. The Company
believes that the European marketing base, along with the optical card
manufacturing capability in Germany, will accelerate European acceptance of the
use of optical memory products in EU government and business solutions.
The cards & more subsidiary serves and supports its existing customer
base for advanced-technology cards and thermal printers, while adding new
resources to build the optical memory card business throughout the EMEA region.
The Company intends to focus principally on biometric ID solutions for national
and regional governments in this region, as well as promoting optical cards in
commercial and industrial markets which can benefit from the large data capacity
and robust security that optical cards offer.
MARKETING OBJECTIVES.
11
o Maintain, leverage and expand existing OMC user base
o Broaden the OMC range to address lower end applications
characterized by higher price sensitivity
o Diversify Optical Memory (OM) products into, and effectively
penetrate, industrial and commercial markets
o Expand hardware product offerings to address new markets and add
value to current offering
o Increase OM product revenues by selling more application
software and integrated solutions, such as personalization and
kiosk systems
o Increase market share for non-OM card and related products
LICENSING
The Company has entered into three nonexclusive, royalty bearing, patent
and know-how licenses for optical memory card manufacture. The first such
license was sold in fiscal 1989 to Canon Inc. The second was sold in fiscal 1991
to Optical Memory Card Business Corporation (OMCBC), a joint venture formed by
four Japanese companies (three of the Company's read/write drive equipment
licensees and Dai Nippon Printing Co., Ltd.). On July 1, 2002, the joint
venture's license was fully assumed by Dai Nippon Printing. These two licensees
are not manufacturing or selling such cards at this time.
In the fiscal 2005 first quarter, the Company announced the sale of a
royalty-bearing, optical memory card manufacturing license to Global Investments
Group (GIG) for card manufacturing in Slovenia. The license agreement provides
for payments to the Company of $29 million for the license (including a
five-year training support package, followed by an ongoing support phase for an
additional 15 years). Additionally, the Company agreed to sell approximately $12
million worth of manufacturing equipment and installation support for the new
facility to provide a targeted initial manufacturing capacity of 10 million
optical cards annually, with options to increase capacity to 30 million cards
per year. As of March 31, 2005, the Company has received $15 million in payments
called for in the agreements, consisting of a partial payment for equipment and
support of $13 million, recorded as advance payments, and $2 million toward the
license fee, recorded as deferred revenue. The payments of $41 million called
for in the agreements will be recognized as revenue over the remaining term of
the arrangement beginning when operation of the factory commences, presently
targeted by GIG for early in 2006. Direct and incremental costs will also be
deferred and recorded as cost of sales along with the revenue. In addition, the
agreement calls for royalty payments based upon unit sales and for purchases of
certain raw materials for card manufacture from the Company.
Also from time to time, the Company has offered nonexclusive, royalty
bearing licenses for optical card read/write drive manufacture, for assembly of
read/write drives from kits, for optical card finishing using Company-supplied
materials, and for card manufacturing. In the past, the Company also offered
card distribution licenses to create distributors, in selected regions of the
world that can buy cards wholesale from the Company at prices lower than those
charged to VARs. During the past five years, there have been no material
purchases of optical memory cards by the licensees. The Company conducts its
licensing efforts on a selective basis. The timing, number, type, and magnitude
of future license sales, if any, cannot be predicted or inferred from past
events. There is no assurance that any of the Company's licensing efforts will
be successful.
License revenues for fiscal 2005, 2004, and 2003 are detailed in the
"Management's Discussion and Analysis" section of this report, under the heading
"License Fees and Other Revenues."
COMPETITION
The Company's primary competition is other card products. Competitive
factors among the various card technologies include system/card portability,
interoperability, price-performance ratio of cards and associated read/write
drive equipment, installed base of compatible equipment, durability,
environmental tolerance, and card security. The Company believes its optical
memory cards offer key technological and security advantages. The current price
of optical card read/write drives is a competitive disadvantage to the Company
in some markets because alternative technologies typically have lower priced
drives. However, when the cost of drives and a large number of cards is factored
together, the Company's optical memory card technology can offer competitive
pricing compared with its closest competitor, high capacity IC cards, especially
when the very high cost of Public Key encryption is
12
factored into the cost of an IC card system. Another disadvantage is the
widespread use and availability of equipment for reading magnetic stripes. There
are companies known to the Company, and there may be other companies unknown to
the Company, which are working on optical memory and optical memory card
products which could compete with the Company.
Other card technologies that compete with optical memory cards include
integrated circuit (IC) cards, 2-dimensional bar code cards and symbology cards,
CD-read only cards and recordable cards, and RF (radio frequency) cards. The
financial and marketing resources of some of the competing companies are greater
than the Company's resources. The Company believes that the LaserCard's storage
capacity, read/write capability, price-performance ratio, rugged card
construction and flexibility, optional technology add-ons, ability to store
audit trails, and resistance to counterfeiting and tampering make the LaserCard
optical memory card a viable choice for a variety of digital card applications.
In addition, centralized on-line databases combined with wide-area
networks may limit the penetration of optical memory cards in certain
applications, and are a form of competition.
SMART CARDS. The LaserCard competes primarily with cards that contain an
integrated circuit (IC) microprocessor and memory. Known as "smart cards," or
"chip cards," their prices and performance vary widely. The smart card uses a
much lower cost read/write unit than is currently used with an optical card,
whereas a typical smart card containing a 64-kilobyte IC and a microprocessor is
typically more than the cost of the Company's 2,800 kilobyte optical memory
card. The IC card is more vulnerable to tampering and can be more easily damaged
in everyday use, whereas the Company's card construction and the use of
polycarbonate plastic make the LaserCard more rugged. For multi-function
applications, the Company currently offers "chip ready" optical cards to which
an IC chip can be added to create a hybrid smart card, called an
OpticalSmart(TM) card. Companies that manufacture IC cards of various types aND
storage capacities include Gemplus, Axalto, Sharp, Orga Card Systems, Oberthur
Card Systems, and others.
CONTACTLESS CHIPS. Sometimes referred to as "RFID", this technology has
a predominant background in transit fare token applications and facility access.
It has recently attracted a lot of attention for identity verification and
border inspection applications and has been seen as competition to optical
memory card in these markets.
Contactless chips exhibit the same characteristics as the contact chips
used on smart cards - limited memory, volatile storage and a relative lack of
durability. However, the technology has proven itself effective in certain
markets, such as access control. One limitation of the typical contactless
access control card is that there is no control on who is carrying the card.
Thus, the system will grant access to anyone who finds or steals a genuine card.
To address this, the Company has recently entered into a collaborative
development with HID Corporation to integrate HID's world leading contactless
access control system with the security of optical memory. With the
OpticalProximity card, the optical memory would be used to verify the
cardholder's ID using on-board biometrics BEFORE the cardholder's (contactless)
access privileges are confirmed for that day (or other period).
The Company believes that this development illustrates that there are
often no absolutes in comparing one card technology with another. Rather, each
technology will either stand on its own merits when viewed against specific
application requirements or a hybrid combination of technologies will deliver
the "best of all worlds" solution.
OTHER CARD PRODUCTS. Read/write magnetic-stripe cards and read-only
memory cards such as 2-dimensional bar code cards and symbology cards are lower
priced and compete with the Company's read/write optical memory cards for
certain markets, such as identification cards. However, the Company's cards have
significantly higher storage capacity and offer unique security features to
deter counterfeiting and data tampering. Commercial magnetic-stripe cards are
relatively easy to duplicate and, because they are erasable and rerecordable,
are highly susceptible to unauthorized erasure and alteration. Two-dimensional
bar codes on cards and other symbology cards store relatively small amounts of
data compared to the LaserCard and are not recordable/updatable after they are
issued. Moreover, alternative technologies--such as magnetic stripes, IC chips,
radio frequency (RF) circuitry, and bar codes/symbology--can be incorporated
into the Company's optical memory cards, thereby adding additional performance
features to the LaserCard. The Company believes that magnetic-based cards (which
are easily erasable) may not have the security and audit trail features required
for government ID cards or medical record cards.
13
Experimental card technologies probably are under development at other
companies.
A small company in San Jose, California, has announced a flexible,
magnetic disk that rotates inside a plastic card body, with data claims of high
transfer speeds. The Company does not believe that this will lead to competition
in the secure identification field because of susceptibility of data to erasure
or corruption, unknown durability and the lack of international standards for
such a card.
OTHER OPTICAL MEMORY CARDS AND EQUIPMENT. As described in the
"Licensing" section, the Company previously licensed its card patents to two
Japanese companies, Canon Inc. and Dai Nippon Printing, which the Company
believes are not manufacturing or selling such cards at this time. In addition,
in April 2004, the Company sold a card manufacturing license to Global
Investments Group for the manufacture of optical memory cards in Slovenia. Under
these royalty-bearing licenses, the licensees have the right to manufacture and
sell optical memory cards in competition with the LaserCard. The newly licensed
Slovenian operation under the Global Investments Group license is not yet
capable of manufacturing optical cards, but is expected to become a
second-source for the Company's cards over time. Global Investments Group could
become a competitor in certain Western European countries; however, exclusivity
provisions of the license preclude competition in certain markets. For example,
the Company is prohibited from competing in certain Eastern European countries,
and Global Investments Group is prohibited from competing outside European
countries.
Recordable CD and DVD optical media are currently made in card shaped
form factors that function with standard CD and DVD players. These cards have
high-data capacity, storing hundreds of megabytes of data, and have high data
transfer rates. The typical purchase price is less than $1.00 each for a blank
card. The cards are typically 1.2-millimeter thick and therefore they do not
meet the ISO Standards for either credit cards or ID-1 identification cards.
These cards typically serve other markets such as advertising and promotional
applications.
OTHER MATTERS
RESEARCH AND ENGINEERING EXPENSES
Research and engineering expenses were $3 million for fiscal 2005; $2.6
million for fiscal 2004; and $2.8 million for fiscal 2003. The Company is
continuing its efforts to develop new optical memory card features, including
the insertion of contactless chips with radio frequency (RF) capability, optical
memory card media, optical memory card read/write drives, read-only drives
(readers), OptiChip small form factor optical media, OpticalProximity systems,
and software products in an effort to provide new products that can stimulate
optical memory card sales growth. For example, the Company has developed a
prototype of a LaserCard portable reader. The Company anticipates that these
ongoing research and engineering efforts will result in new or enhanced card
capabilities, production-model read-only drives, or drives with advanced
security features and lower manufacturing costs; however, there is no assurance
that such product development efforts will be successful. These factors are
important for the Company's existing and future optical memory card markets.
Also see Item 7, "Management's Discussion and Analysis."
PATENTS AND TRADEMARKS
OPTICAL DATA STORAGE. As of March 31, 2005, the Company owned
approximately 30 U.S. patents relating to optical data storage (including
optical storage media, optical cards, formats, equipment, systems, software, the
utilization of optical storage media, and e-commerce technology), and other U.S.
and foreign patent applications have been filed. Approximately 19 counterpart
patents of certain U.S. patents are issued in various foreign countries.
However, the Company owns certain U.S. patents as to which foreign counterparts
have either not been filed or the examination process has been terminated
without issuance of the foreign patents. From time to time, the Company elects
to allow some of its U.S. or foreign patents to expire when maintenance fees
become due, if the patents are deemed no longer relevant. In addition, the
Company protects as trade secrets some refinements to the optical media and
cards and know-how related to card production. Also, the Company's know-how and
experience in volume card production, system development and software
capabilities, brand-name recognition within its card markets, and
dominant-supplier status for optical-memory cards are of far greater importance
than the Company's patents. Therefore, at this time, the Company believes that
its patent portfolio is helpful but is no longer essential for maintaining the
LaserCard's market position.
14
The Company's U.S. patents have expiration dates ranging from 2006 to
2022, with the majority expiring during the first part of this period.
Counterpart patents in foreign countries also expire during this period, usually
about two to three years after the U.S. patent expires.
The Company cannot predict whether the expiration or invalidation of its
patents would result in the introduction of competitive products which would
affect its future revenues adversely. The Company presently intends to pursue
any infringement of its patents either by litigation, arbitration, or
negotiation. However, there can be no assurance that any of the Company's
patents will be sufficiently broad in scope to afford protection from products
with comparable characteristics that may be sold by competitors in the future.
There also can be no assurance that the validity of any patents actually granted
will not be challenged.
LaserCard(R) and Drexon(R) are federally registered trademarks of
LaserCard Corporation. The Company believes that its LaserCARD brand name, trade
name, and other trademarks are important assets in marketing optical memory card
products.
EMPLOYEES
As of March 31, 2005, the Company and its U.S. subsidiaries employed 122
persons (including four executive officers). This workforce consisted of 109
persons in administration, marketing/sales, manufacturing, and research and
engineering, plus 13 temporary personnel mainly engaged in the inspection of
cards for quality assurance. In addition, the two German subsidiaries acquired
by the Company on March 31, 2004 employed 76 people as of March 31, 2005. None
of the Company's employees is represented by a labor union.
DEPENDENCE ON GOVERNMENT SUBCONTRACTS THROUGH SOLE CONTRACTORS
The largest purchaser of LaserCard products is Anteon International
Corporation, 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 U.S. Permanent Resident Cards (Green Cards) and DOS
Laser Visa Border Crossing Cards (BCCs); the DOD purchases Automated Manifest
System cards; and the Canadian government purchases Permanent Resident Cards.
Encompassing all of these programs, the Company's product sales to Anteon
represented 31% of total revenues for fiscal 2005; 72% of total revenues for
fiscal 2004; and 94% of total revenues for fiscal 2003. The proportion of
revenues represented by Anteon decreased in fiscal 2005 as compared to fiscal
2004, and is anticipated to continue to decrease as the Company generates
increased revenues from other sources. Since the ultimate customers are national
governments, the Company is 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 program delays.
U.S. government subcontract release orders for DHS Green Cards and DOS
Laser Visa BCCs represented approximately 21% of the Company's revenue for
fiscal 2005; 44% of revenues for fiscal year 2004; and 82% of revenues for
fiscal 2003. The percentage declined during fiscal 2005 as revenues from other
sources increased and the Company included the results of the German
acquisitions for the first time in fiscal 2005.
The Company's revenues derived from sales to the government of Italy for
its national ID card program, Carta d'Identita Elettronica (CIE), accounted for
26% of revenues for fiscal 2005 and 22% of revenues for fiscal 2004. The
revenues generated from this program were immaterial in fiscal 2003. Card orders
under this program are placed with the Company through a value-added reseller,
Laser Memory Card SPA of Italy. The Italian government successfully concluded
the experimental phase of National ID CIE program using LaserCard optical memory
cards and enacted a law to replace paper ID documents with electronic documents
starting January 2006. LaserCard's optical memory stripe is contained in CIE
national ID cards and new PSE foreign worker cards. 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.
15
BACKLOG
As of March 31, 2005, the backlog for LaserCard optical memory cards
totaled $0.9 million scheduled for delivery in fiscal 2006. As of March 31,
2004, the backlog for LaserCard optical memory cards totaled $4.1 million. 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 of May 26, 2005, subsequent to year-end, the
Company had received additional orders bringing its optical memory card orders
from all customers scheduled for shipment during fiscal 2006 to approximately
$10 million.
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 March 31, 2005 for specialty cards and printers
totaled 1.2 million euros (approximately $1.6 million) and for a contract to
develop a conventional non-optical card production facility totaled 0.8 million
euros ($1 million). Revenue on the contract for a conventional non-optical card
production facility contract is being booked on a zero profit margin basis as
discussed in revenue recognition under "Critical Accounting Polices". Therefore,
the total profit under this contract, if any, will be booked at completion on or
about December 2006. Total backlog for the German subsidiaries at March 31, 2004
was 2.1 million euros (approximately $2.6 million).
The $1.1 million included in the March 31, 2004 backlog of the Company's
German operations for a partially completed contract for an amusement park gate
system has been canceled due to the insolvency of the customer. This does not
affect the financial position of the Company since we did not anticipate any
gross profit or loss from the contract because it was substantially completed
prior to the March 31, 2004 acquisition and all profit accrued to the prior
entity. In addition to cancellation of the backlog, we removed the $1.2 million
of deferred costs from inventory, $0.8 million from deferred revenue, and $0.3
million from accounts payable and accrued liabilities since the contract will
not be completed and the Company has been indemnified for potential losses.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
Financial information about geographic areas is described in Note 4 to
Item 8, "Consolidated Financial Statements and Supplementary Data."
16
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.
WE HAVE INCURRED NET LOSSES DURING THE PAST NINE QUARTERS AND MAY NOT BE
ABLE TO GENERATE SUFFICIENT REVENUE IN THE FUTURE TO ACHIEVE OR SUSTAIN
PROFITABILITY. As of March 31, 2005, we had an accumulated deficit of $27.1
million and we incurred losses of $8.9 million in fiscal 2005 and $12.4 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 delays 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 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 during the experimental phase of the program. A new
VAR has been chosen for the implementation phase and we have been negotiating
with the new prime contractor for us to continue in the program. 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
17
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 Defense, and the
government of Canada. Under government contracts with Anteon, the U.S.
Department of Homeland Security purchases Green Cards and U.S. Department of
State purchases LaserVisa BCCs; the U.S. Department of Defense purchases
Automated Manifest System cards; and the Canadian government purchases Permanent
Resident Cards. Encompassing all of these programs, our product 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 Srl, of Rome, Italy. According to
Italian government sources, the distribution of this new national ID card has
started in a number of the 56 Italian communities that were scheduled to be
activated under the program during 2004. If this program were to be discontinued
or interrupted by the Italian government, the Company would lose one of its
significant sources of optical memory card revenues.
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
18
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.
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
19
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 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 BE 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
20
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, 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.
21
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.
As of March 31, 2005, we had not entered into a forward exchange contract to
hedge against or potentially minimize the foreign currency exchange risk. During
fiscal 2005, we experienced a $0.2 million loss on foreign currency exchange.
WE ACQUIRED TWO CARD COMPANIES LOCATED IN GERMANY ON MARCH 31, 2004 AND
MAY ENCOUNTER DIFFICULTIES IN INTEGRATING THEM INTO OUR BUSINESS. We may
encounter unforeseen difficulties in managing Challenge Card Design GmbH (CCD)
and cards & more GmbH, in which case we may not obtain some of the hoped-for
benefits of these acquisitions, such as expanded manufacturing capacity and
establishment of a significant European presence. Further integration of these
acquired companies may result in problems related to integration of technology,
management, personnel, or products. If we fail to successfully integrate these
acquisitions or if they fail to perform as we anticipated, our operations and
business could be harmed. Likewise, if the due diligence and audit of these
operations performed by third parties on our behalf was inadequate or flawed, we
could later discover unforeseen financial or business liabilities. Additionally,
in the future we may evaluate other acquisition opportunities that could provide
additional product or services offerings or technologies. Any recent or future
acquisition could result in difficulties assimilating acquired operations and
products, diversion of capital and management's attention away from other
business issues and opportunities and may result in an expense if goodwill is
impaired or other intangible assets acquired are subsequently determined to be
impaired. Goodwill may become impaired if the acquired German companies cannot
demonstrate sufficient profitability over a reasonable forecast period. Such
profitability depends on the processing of a significant quantity of CIE cards
at CCD. One customer represents more than 10% of the revenue and margin of the
German companies so the loss of that customer could also lead to goodwill
impairment.
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
22
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.
ITEM 2. PROPERTIES
MOUNTAIN VIEW, CA
As of March 31, 2005, approximately 70,000 square feet of floor space
are leased by the Company on a long-term basis for card manufacturing,
read/write drive production, administration, sales, and research and
engineering, in two buildings located in Mountain View, California. These
facilities have a current total annualized rental of approximately $885,000 on
leases that expire in October 2013 and in March 2014. One 27,000-square foot
building is used for optical memory card production and one 43,000 square-foot
building is used for optical card production, read/write drive production,
administration, sales, and research and engineering. In addition, one 5,000
square-foot building with an annual rent of $75,000 that was used for
administration will be vacated when the lease expires in July 2005.
GERMANY
The Company leases a portion of a building in Ratingen, Germany, and a
building in Rastede, Germany totaling approximately 15,000 square feet, for
optical and specialty card manufacturing, distribution, administration and
sales, for a total annualized rental of 239,000 euros on leases that expire on
dates from February 2009 to August 2009. Also, the Company owns land and a
building in Rastede, Germany that is used in production of specialty cards and
research and engineering.
OTHER
The Company also leases a small marketing office in New York.
Management believes these leased and owned facilities to be satisfactory
for its present operations. Upon expiration of the leases, management believes
that these or other suitable buildings will be able to be leased on a reasonable
basis.
23
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's only class of common stock, $.01 par value, is traded on
The Nasdaq Stock Market(R) under the symbol LCRD and iS quoted in THE WALL
STREET JOURNAL and other newspapers. Stock price information and other data also
can be obtained on the Internet directly from Nasdaq at: www.nasdaq.com. The
table below sets forth the high and low trade prices for the Company's common
stock (rounded to two decimal points) as reported by Nasdaq during the fiscal
periods indicated.
Quarterly Stock Prices
Fiscal 2005 Fiscal 2004
High Trade Low Trade High Trade Low Trade
---------- --------- ---------- ---------
First Quarter $ 21.37 $ 11.40 $ 22.25 $ 13.03
Second Quarter 13.48 6.49 20.84 14.00
Third Quarter 11.75 7.86 17.14 13.00
Fourth Quarter 11.89 4.77 16.95 12.46
As of March 31, 2005, there were approximately 880 holders of record of
the Company's common stock. The total number of stockholders is believed by the
Company to be several thousand higher since many holders' shares are listed
under their brokerage firms' names.
The Company has never paid cash dividends on its common stock. The
Company anticipates that for the foreseeable future, it will retain any earnings
for use and reinvestment in its business.
The Company did not repurchase any of its outstanding shares or other
securities during its fourth quarter ended March 31, 2005.
On August 2, 2004, our board of directors authorized a 350,000 share
repurchase program to acquire shares of our common stock in the open market for
up to an aggregate of $3 million for four-month period beginning August 2, 2004.
Purchases under this program, which has now expired, were only made between
August 17, 2004 and August 26, 2004. The following table provides information
with respect to our repurchases of the common stock under this program:
Total Number of Total Dollar
Shares Purchased Value of Shares
Total Number as Part of Publicly that May Yet Be
of Shares Average Price Announced Purchased under
Period Purchased Paid per Share Programs the Programs(1)
- ------------------- -------------------- -------------------- -------------------- --------------------
August 2, 2004 -
August 31, 2004 91,630 $ 7.15 91,630 $2,345,000
------ ------ ----------
Total 91,630 $ 7.15 91,630 $0
====== ====== ==
(1) On August 2, 2004, our board of directors authorized a 350,000 share
repurchase program to acquire shares of our common stock in the open
market for up to an aggregate of $3 million for four-month period
beginning August 2, 2004. This program has now expired.
25
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information as of and for
each of the five years in the period ended March 31 is derived from the
consolidated financial statements of the Company. This financial data should be
read in conjunction with the consolidated financial statements and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing in Item 7 of this report.
LASERCARD CORPORATION AND SUBSIDIARIES
(Formerly Drexler Technology Corporation)
FIVE-YEAR SUMMARY OF CONSOLIDATED FINANCIAL INFORMATION
Fiscal Years Ended March 31, 2001 - 2005
(In thousands, except per share amounts)
OPERATIONS DATA 2005(2) 2004 2003 2002 2001(1)
--------- --------- --------- --------- ---------
Revenues $ 28,544 $ 16,963 $ 26,331 $ 20,889 $ 24,906
Cost of product sales 22,637 13,157 13,906 10,652 12,199
Selling, general, and administrative expenses 11,891 6,700 6,202 5,165 4,134
Research and engineering expenses 3,018 2,620 2,818 3,045 2,370
Interest and other income, net 240 176 397 386 612
--------- --------- --------- --------- ---------
Income (loss) before income taxes (8,762) (5,338) 3,802 2,413 6,815
Income tax (benefit) provision 139 7,089 1,520 (2,786) (1,097)
--------- --------- --------- --------- ---------
Net income (loss) $ (8,901) $ (12,427) $ 2,282 $ 5,199 $ 7,912
========= ========= ========= ========= =========
Net income (loss) per share:
Basic $ (.78) $ (1.15) $ .22 $ .52 $ .80
========= ========= ========= ========= =========
Diluted $ (.78) $ (1.15) $ .21 $ .50 $ .76
--------- --------- --------- --------- ---------
Weighted average number of common
and common equivalent shares:
Basic 11,362 10,761 10,356 9,961 9,897
Diluted 11,362 10,761 10,842 10,468 10,446
BALANCE SHEET DATA
Current assets $ 21,310 $ 23,294 $ 21,192 $ 28,118 $ 18,333
Current liabilities 6,764 11,271 3,620 7,501 7,324
Total assets 48,768 49,835 40,463 40,713 30,137
Long-term liabilities 15,326 2,878 -- -- --
Stockholders' equity 26,678 35,686 36,843 32,337 22,813
(1) As more fully described in the Company's Report on Form 8-K dated May 15,
2002, the financial statements for fiscal 2001 were restated due to changes
in the timing of revenue recognition of LaserCard optical memory cards that
have been delivered into a secure, government-funded vault built for the
government on Company premises to comply with security regulations under the
subcontract.
(2) Only fiscal 2005 operations data includes results of our German subsidiaries
acquired on March 31, 2004.
26
ITEM 7. 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-K Report for the year ended March 31, 2005.
FORWARD-LOOKING STATEMENTS. For a discussion of the risk factors related
to the Company's business operations, please refer to the "Forward-Looking
Statements" section starting at page 4 of this report and the section entitled
"Risk Factors and Factors that May Affect Future Operating Results" starting at
page 17 of this report.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. Note 2 to the Consolidated Financial Statements
describes the significant accounting policies and methods used in the
preparation of the Consolidated Financial Statements. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses. On an ongoing
basis, we evaluate our estimates, including those related to our revenues,
inventories, and income taxes. We base our estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources.
We consider the accounting policies described below to be our critical
accounting policies. Our critical accounting policies are those that both (1)
are most important to the portrayal of the financial condition and results of
operations and (2) require management's most difficult, subjective, or complex
judgments, often requiring estimates about matters that are inherently
uncertain. These critical accounting policies reflect our significant judgments,
assumptions, and estimates used in the preparation of the Consolidated Financial
Statements. Our management has discussed the development and selection of these
critical accounting policies and estimates with the audit committee of our board
of directors and the audit committee has reviewed our disclosures relating to
them in this report
REVENUE RECOGNITION. Product sales primarily consist of card sales,
sales of read/write drives, 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 was $373,000 in fiscal 2005. Warranty costs and return activity
were immaterial in fiscal 2004 and 2003.
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
27
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. For the year ended
March 31, 2005, the Company recognized approximately $127,000 of revenues based
on a zero profit margin related to a long-term contract. The Company had no
revenues generated from this type of contract for the years ended March 31, 2004
and 2003.
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 arrangemen