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 December 31, 2002
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 001-15069
| Duraswitch Industries, Inc. | |
| (Exact name of registrant as specified in its charter) | |
| Nevada | 88-0308867 |
| (State or other jurisdiction of | (I.R.S. Employer |
| incorporation or organization) | Identification No.) |
| 234 S. Extension Road | 85210 |
| Mesa, Arizona | (Zip Code) |
| (Address of principal executive offices) | |
| (480) 586-3300 | |
| (Registrant’s telephone number, including area code) | |
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.001.
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. Yes X 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 Rule 12b-2 of the Act). Yes No X .
The aggregate market value of common stock held by nonaffiliates of the registrant (5,695,045 shares) based on the closing price of the registrant’s common stock as reported on the NASDAQ National Market on June 28, 2002, which was the last business day of the registrant’s most recently completed second fiscal quarter, was $43,339,292. For purposes of this computation, all officers, directors, and 10% beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed to be an admission that such officers, directors, or 10% beneficial owners are, in fact, affiliates of the registrant.
Number of registrant’s shares of common stock outstanding as of February 28, 2003 was 9,617,673.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the 2003 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.
| Duraswitch Industries, Inc. | |||
| Form 10-K | |||
| For the Year Ended December 31, 2002 | |||
| Table of Contents | |||
| Page | |||
| PART I | |||
| Item 1. | Business | 3 | |
| Item 2. | Properties | 8 | |
| Item 3. | Legal Proceedings | 8 | |
| Item 4. | Submission of Matters to a Vote of Security Holders | 8 | |
| PART II | |||
| Item 5. | Market for Registrant’s Common Equity and Related Stockholder Matters | 9 | |
| Item 6. | Selected Financial Data | 9 | |
| Item 7. | Management’s Discussion and Analysis of Financial Condition | ||
| and Results of Operations | 10 | ||
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk | 17 | |
| Item 8. | Financial Statements and Supplementary Data | 18 | |
| Item 9. | Changes in and Disagreements With Accountants on Accounting | ||
| and Financial Disclosure | 31 | ||
| PART III | |||
| Item 10. | Directors and Executive Officers of the Registrant | 32 | |
| Item 11. | Executive Compensation | 32 | |
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and | ||
| Related Stockholder Matters | 32 | ||
| Item 13. | Certain Relationships and Related Transactions | 32 | |
| Item 14. | Controls and Procedures | 32 | |
| PART IV | |||
| Item 15. | Exhibits, Financial Statement Schedules and Reports on Form 8-K | 33 | |
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PART I
Item 1. Business.
Overview
We have developed, patented and licensed innovative technologies utilizing a magnetic-based design for electronic switches. We are currently expanding the use of these technologies by licensing manufacturers to produce and sell products using our technologies. We believe these patented technologies allow us and our licensees to provide innovative solutions to the electronic switch design challenges faced by original equipment manufacturers, or OEMs, and component suppliers.
Industry Analysis
Electronic switches and Integrated Control Panels, or ICPs, are used in a wide variety of consumer, industrial and agricultural products, such as appliances, military equipment, airplanes, automobiles, security systems, temperature controls, point-of-sale systems, elevators, medical equipment, computers, gas pumps, beverage dispensers, gaming units, fitness equipment, consumer electronics and commercial food preparation equipment.
History of Electronic Switches. In the last hundred years, two basic switches have dominated the market for our switch technologies: electro-mechanical and membrane. In its simplest form, an electronic switch controls the flow of electric current: press the switch to complete the circuit and the current flows to operate a microprocessor, which in turn, performs the desired function. Electro-mechanical switches operate by pushing, turning or sliding a button, knob or lever to mechanically activate a series of movable parts that will close or complete a circuit within the switch itself. Although they offer excellent tactile feedback for the user, electro-mechanical switches are bulky, mechanically complex and can be difficult to manufacture.
Membrane switches consist of multiple, thin-film layers topped by an overlay with printed graphics or instructions to operate the device in which the switch is incorporated. A typical example of a membrane switch is found on most microwave oven control panels. Without tactile feedback, users may activate the switch multiple times, which could cause the opposite effect of what the user intended. To solve the feedback response problem, membrane switch manufacturers typically have offered a “beep” sound, light, or status icon on a display to inform the user when the switch has been activated. However, this solution increases the cost, complexity and size of the product to which it is added, thus decreasing the advantages of a membrane switch over an electro-mechanical switch.
The second option to overcome the feedback response problem is to incorporate a metal, rubber or plastic dome as part of the membrane switch. When pressed by a user, the center of the dome will invert and contact the circuit on the membrane layer beneath it. Domed membrane switches are prone to failure due to material fatigue, are much less reliable than membrane switches without domes and require inconsistent amounts of force to be activated. These limitations have frustrated users and increased the cost and design complexity while decreasing the reliability of the switch.
The Duraswitch Competitive Advantage
The keys to our technologies are simplicity of design and reliance on magnetic force, rather than mechanical parts or the elastic properties of materials, to operate a switch. Based on our experience and available research in the electronic switch and ICP industries, we believe our technologies offer several competitive advantages compared to switches and ICPs using traditional electro-mechanical or membrane switch technologies, including the following:
Significantly Greater Durability and Reliability. Our technologies rely on a magnetic-based design with few moving parts and virtually no stress, fatigue, or potential breaking points. By eliminating or reducing the mechanical complexity and precision required by traditional technologies, we believe switches made with our technologies are significantly more durable and reliable than traditional electro-mechanical and membrane switches. From January 1998 to January 2001, we tested one of our PushGate® pushbutton switches. It exceeded 500 million activations on an electronic counter. Additionally, multiple samples of new PushGate switch designs routinely successfully complete durability tests of between three and 50 million activations. We believe these test results support our belief in the reliability and durability of products manufactured using our PushGate technologies.
Inherent Feedback Response. Membrane switches and some electro-mechanical switches require additional cues such as beeps, lights or status icons to artificially provide feedback to the user which increases the complexity and total cost of the switch. Our PushGate design consistently produces a distinctive “click” each time the user activates our switch and eliminates the costs associated with additional cues.
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Ease of Integration in Slim Profile, Environmentally Sealed Design. Because switches produced using our technologies use a thin, multiple layer design that incorporates a flexible circuit rather than bulky mechanical parts, they are easily integrated into flat panel/slim profile products currently desired by the market. This design also eliminates the need to breach the surface of the ICP, enabling our ICPs to be easily sealed, cleaned, disinfected and protected from harsh environmental conditions.
Value Engineering Alternative. We believe switches produced using our technologies offer a better overall value compared to switches using traditional technologies. The integration attributes of our technologies allow for a complete value engineering alternative to switch panel designs, which can allow for cost reductions in various components and manufacturing processes. In addition, devices using our switches are more durable and reliable than electro-mechanical switches and are therefore less costly to maintain.
Strategy
Our objective is to become the leading switch technology licensor in the electronic switch and ICP industries. In order to achieve this objective, we intend to implement the following strategies:
Maintain and Further Our Patented Technologies’ Competitive Advantages. We intend to maintain and further our patented technologies’ competitive advantages in order to make our technologies standard in the industry. We intend to pursue this strategy by aggressively marketing our technologies’ advantages and broaden market awareness within our target industries. We are focusing our sales and marketing efforts on our licensing program and will work together with licensees and technology partners to develop further these technologies for specific commercial applications as it makes economic sense.
Increase Market Awareness of Duraswitch’s Patented Technological Advantages. We plan to aggressively promote our patented technologies and design expertise to achieve widespread market awareness of our technologies’ advantages. Our promotional efforts will target design engineers and purchasing managers, whom we believe are the primary decision makers within the switch purchasing market. These efforts will include increasing exposure in trade magazines, increasing traffic to our Web site, participating actively in vendor-sponsored seminars for design engineers and aggressively promoting our technologies in the trade media. We believe that promoting our success and our licensees’ successes in providing custom-designed solutions for a number of high-profile companies will further enhance market awareness of our technologies and their unique competitive advantages.
License Switch Manufacturers and OEMs. We plan to continue to offer to license Duraswitch technologies to switch manufacturers, turnkey manufacturers and OEMs as a product extension and a market differentiation. We intend to target manufacturers in countries where we currently have little or no representation, as well as manufacturers and OEMs who directly manufacture for, or have key customers in, our target markets. When targeting OEMs, we offer to license directly, license preferred manufacturers or provide information on currently licensed manufacturers. We believe this flexible approach and the simplified requirement of our license agreements, whereby a non-exclusive licensee pays us per-switch royalties for use of our technologies, reduces barriers common to traditional licensing models that often require significant up-front fees to gain access and charge royalties on a percentage-of-sales basis.
Provide Full Service Training, Design Engineering and Marketing Support. We intend to be a “one stop shop” for electronic switch solution design engineering and marketing support for licensees of our technologies. We plan to provide engineering and sales training at our licensees’ facilities, as well as quarterly sales training in various locations across North America and Europe. We believe we add value to our licensees’ efforts by offering design reviews for new projects and by offering direct access to online design manuals. We will continue to expand our lead generation efforts to drive potential business to our licensees through e-mail and direct marketing campaigns. We plan to continue to enhance communications of our technology updates and sales techniques in order to support our licensees.
Form Strategic Technology Alliances. During 2002 and 2001, we entered into seven strategic technology alliances. We formed alliances with:
We believe that technology and marketing alliances not only help expand our reach, but also help us to source
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materials for our licensees. We intend to pursue additional strategic technology alliances with companies offering complementary technologies to leverage resources and expertise in engineering, marketing, training and purchasing and to increase the variations and options that licensees can offer their customers by designing our technologies into their products.
Target Key Industries with Potential for High-Volume Applications. We intend to continue to market the advantages of our patented technologies to key high-volume markets including appliance, medical and industrial controls. We believe that we have developed the technologies that meet the needs of these industries and can educate OEMs on the benefits of utilizing our technologies in future designs. In marketing directly to OEMs, we plan to be a source for design ideas by educating engineers on the benefits our technologies offer. We promote the solutions our technologies have provided for similar industries. We will also support our licensees’ sales efforts through sales calls and engineering support.
Our Company’s History
We were incorporated on May 1, 1997, as Total Switch, Inc. In order to establish a market value for our stock to acquire other businesses necessary for our growth, we combined with an inactive, publicly traded company on December 31, 1997, and changed its name to Duraswitch Industries, Inc. As a result of this transaction, Total Switch became a wholly-owned subsidiary of Duraswitch, and Total Switch’s former stockholders acquired a controlling interest in Duraswitch. During 1998, through the acquisition of Aztec Industries, Inc., formerly a manufacturer of membrane switches, we commenced operations and designed, manufactured, marketed and distributed integrated electronic control panels developed with our patented technologies.
During 2000, we started to implement a business model of licensing our technologies rather than manufacturing switches ourselves. During 2001, we completed this transition and expect substantially all of our future revenue to come from our licensing efforts. As of February 28, 2003, we had 24 licensees, foreign and domestic, and we are continuing our efforts to expand our licensee base worldwide.
Technologies
We have a number of switch applications based on our patented magnetic-based technologies. We have licensed the PushGate®, thiNcoder® and MagnaMouse™ to our licensees. Our non-exclusive licensees typically pay royalties of $0.08 per PushGate, ($0.10 including the licensed component charge), between $0.25 and $0.75 per thiNcoder, and between $0.25 and $0.75 per MagnaMouse, depending on volume. Licensees are charged separately for any licensed components they purchase from us. Current prices for licensed components range from $0.02 per PushGate to $1.75 per thiNcoder subassembly. Fees for additional technologies will be determined upon release.
The Duraswitch PushGate®. A typical Duraswitch PushGate switch consists of up to five bonded micro-thin layers of material, which collectively measure less than 1/10th of an inch. The top layer of the switch is printed with a graphical overlay that indicates which buttons must be pressed to activate a desired function, such as the “on”, “defrost” and “cook” buttons on a microwave oven. Below the top layer is a thin, flexible layer of magnetic material. Below the magnetic layer is spacer material containing a hole through which a patented metal disc is pushed. The disc has a small, raised, off-center button that is pushed by the user through the surface of the switch. A flexible circuit is located at the bottom of the switch. When the button is pressed, the disc separates from the magnet and the underside of the disc completes the circuit by touching the contacts located on the flexible circuit. When the button is released, the magnet pulls the disc upward and away from the switch contacts into its resting position, and the circuit is broken. This magnetic-based design produces a consistent tactile feedback response to the user each time the switch is activated.
In 2001, we introduced the PushGate Island construction which reduces the number of material layers and allows for the switching element of the PushGate to be fabricated as a freestanding subassembly that can be easily inserted into a foam layer. The ability to manufacture the PushGate as an Island simplifies the manufacturing process and reduces cost.
In 2002, we introduced a number of unique constructions including the Large-Key PushGate, High-Impact PushGate and a tact switch incorporating PushGate technology. Each of these constructions provide distinct advantages in certain applications.
The Duraswitch thiNcoder®. The Duraswitch thiNcoder resembles a typical volume control knob on a car radio or a selector knob on a washing machine, except that unlike an electro-mechanical rotary switch, our switch is integrated on a flex-circuit. The entire assembly can be less than 1/10th of an inch thick. The Duraswitch thiNcoder consists of a rotary knob containing embedded magnets all fastened to a flat surface. The top of the surface displays instructions for the user. The bottom of the surface seals a circular space below the magnet containing small gold-plated balls. Between the magnets and the gold-plated balls are printed electronic circuits, which are activated through contact with the gold-plated balls.
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When the user turns the knob, the magnet within the rotary knob causes the gold-plated balls to rotate within their circular space. As the balls roll across the flex-circuit membrane, they close or open the circuit and convey the user’s instructions to the device. The design of the Duraswitch thiNcoder also allows for a tactile feedback response to the user, such that the user can feel each “click” as the knob is turned. The thiNcoder can be utilized by the appliance industry and other industries that require a large number of selector positions.
The Duraswitch MagnaMouse™. The Duraswitch MagnaMouse is an omni-directional switch that works by using a disc-shaped actuator held by magnetic attraction. Pushing on the switch surface or any custom designed key cap closes the contact and actuates the MagnaMouse. Electrodes are arranged to produce different outputs when contacted in different locations. The MagnaMouse allows for the integration of cursor control devices into ultra-thin, durable control panels.
Customers
Our success depends in part on our licensees’ ability to incorporate our technologies into OEM’s designs and products in key industry segments. As a result, we have licensed various custom and turnkey switch manufacturers to produce switches for devices in a wide variety of industries. Some of the key industries in which our licensees operate include the following: elevator, beverage dispensing, energy management, test and measurement, medical, point-of-sale, appliance, vending machine, gaming, recreational marine, industrial automation, health and fitness, restaurant equipment, gas pump, mass transit, computer, lighting and sound, aerospace and industrial controls.
In May 2000, Duraswitch received $4 million from Delphi Automotive Systems LLC, in exchange for: (a) Delphi’s exclusive right to utilize and manufacture our patented switch technologies for the automotive industry, (b) a warrant to purchase 225,000 shares of our common stock at $7 per share and (c) an option to purchase approximately 1.65 million shares of our stock. The license agreement with Delphi generated licensing revenue of $409,380 or 55% of licensing revenue and $411,362 or 49% of licensing revenue in 2002 and 2001, respectively. Licensing revenue from Delphi primarily resulted from the recognition of deferred licensing revenue which was received in 2000.
Intellectual Property
Our success also depends in part on maintaining and protecting our proprietary technologies. As a result, we have adopted an intellectual property protection policy designed to deter and stop infringement. To deter infringement, we file U.S. and foreign patents for relevant material technological advances and warn against potential infringement by posting patent numbers on our products, packaging and published materials. Examples of these materials include our Web site, brochures, advertisements and some technology samples. We have not had to become involved in infringement litigation to protect our intellectual property, however, we intend to prosecute litigation against infringers if necessary.
In order to protect our trade secrets and other intellectual property, we also require our employees, contract workers, consultants, advisors and collaborators to enter into confidentiality agreements, which prohibit the disclosure of proprietary information to third parties or the use of our proprietary information for commercial purposes. Our technical and sales employees also must agree to disclose and assign to us all methods, improvements, modifications, developments, discoveries and inventions conceived or developed on the job, using our property, or relating to our business. As of December 31, 2002, we had $743,447 of capitalized costs related to patents.
As of December 31, 2002, we held 15 U.S. patents, four Taiwanese patents, two Australian patents, one Chinese patent, one Canadian patent and one Mexican patent. We also have several patent applications pending in the United States, Mexico, Canada, France, Great Britain, China, Taiwan, Italy and Germany. We have made further filings under the Patent Cooperation Treaty which makes it possible to seek patent protection for an invention simultaneously in each of a large number of countries by filing an “international” patent application.
We have registered the following trademarks with the United States Patent and Trademark Office: “Duraswitch®”, “Duraswitch” as a stylized word with a unique “D”, “The World is Switching®”, “PushGate®”, and “thiNcoder®”.
Research and Development
We have 11 people in our research and development department who focus on patenting and adapting our technologies for commercialization through our licensees. In 2002 and 2001, we dedicated a large amount of our resources to research and development and the protection of our patented technologies. Through those efforts, we believe we developed a portfolio of patented and patent-pending technologies that meet the needs of our licensees, their customers and our target markets. We will focus future efforts on the commercialization of these technologies through our licensees. In late 2002, we announced cost-cutting initiatives that included significant personnel reductions. The majority of the
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initiatives were related to a reduction of internal research and development efforts, including personnel, and were implemented during the fourth quarter of 2002. During 2002, 2001 and 2000, we spent $2,614,905, $2,773,221, and $1,716,825, respectively, on research and development efforts. Based on the previously announced cost-cutting initiatives, we expect research and development expenses to decrease in 2003 as compared to 2002 levels.
Sales and Marketing
We have five people in the sales and marketing department who focus on supporting our existing licensees, marketing our technologies to OEMs, obtaining new licensees and forming technology alliances. In support of our licensees, we train their internal and independent sales and marketing teams on Duraswitch technologies.
Web Site: www.duraswitch.com. We believe design engineers and purchasing managers, the individuals most likely to make the decision to incorporate our technologies in their products, frequently use the Internet to search for design solutions. Therefore, our Web site, www.duraswitch.com, is a key component of our current direct marketing efforts. Most of our advertising and promotional materials direct readers to our Web site. In addition to attracting potential licensees to our Web site for information, we use our Web site to generate interest in our technologies. Using our Web site as a promotional tool is also less expensive than other methods, is interactive and reaches a global audience. Our Web site has several features, including the following:
Public Relations. We target technical periodicals for media exposure in an effort to raise awareness of Duraswitch technologies and our licensing strategy. Our public relations campaigns have included editorial coverage of our technologies, co-operative advertising opportunities with licensees and listings in industry-specific supplier guides. We believe this is a cost-effective method of capturing the attention of design engineers and OEMs and educating them on the benefits of our technologies. Articles on our technologies have been included in numerous trade publications including Design News, EDN (Electronic Design News), EE Times, Electronic Buyers News, ECN (Electronic Component News), as well as industry-specific publications such as Appliance Magazine, National Petroleum News, and Elevator World.
Seminars and Trade Shows. We present educational seminars about our technologies at vendor-sponsored events for product design engineers. At these seminars, we are able to meet attendees and provide them with information about our technologies through multi-media presentations, product demonstrations, brochures and samples. We support the efforts of, and often partner with, licensees and technology partners to broaden awareness of our technologies at these events. For example, at electronica 2002, the world’s largest international summit for the electronics industry held bi-annually in Germany, Duraswitch technologies were represented in several licensee booths in addition to our own sales team’s attendance.
Our sales and marketing team conducts regional training seminars for licensees and their sales representatives. Over the past year, we have held six seminars, training approximately 115 sales representatives on the advantages of our technologies.
Competition
We operate in an industry characterized by intense competition. We believe that our primary competitors are manufacturers of electro-mechanical and dome membrane switches. Many of these manufacturers have established products, broad brand and name recognition and significantly greater resources than we do. Our strategy has not been to compete directly with these manufacturers, but to offer to license them our switch technologies. If these manufacturers, as licensees, incorporate our technology into their switches, we will have converted our competitors into business partners.
While a licensing business model fosters cooperation, switch manufacturers may not adopt Duraswitch’s technologies. In particular, manufacturers may be reluctant to alter current designs or have other long-standing relationships that may affect the manufacturers’ decision to use one technology over another, even if our technologies offer additional benefits.
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Employees
As of February 28, 2003, we had 26 employees. None of our employees are covered by collective bargaining agreements and we consider our employee relations to be good.
Item 2. Properties.
Our principal administrative, design, testing and prototype manufacturing facilities are located in Mesa, Arizona, where we presently lease 33,650 square feet of office and manufacturing space in a building located at 234 South Extension Road. This facility consists of approximately 10,000 square feet of office space and 23,650 square feet of testing and prototype manufacturing space. Our lease terminates on January 1, 2004, subject to our option to extend the term for an additional two years. We believe our current facilities will be sufficient for our operational purposes for the foreseeable future and any additional facilities needed thereafter will be available on commercially reasonable terms.
Item 3. Legal Proceedings.
From time to time we may be subject to claims and litigation incident to our business. As of February 28, 2003, we were not a party to any material legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
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PART II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.
Market Information
Our common stock has been listed on the NASDAQ SmallCap Market under the symbol “DSWT” since December 20, 2002 and was listed on the NASDAQ National Market System from October 11, 2000 to December 19, 2002. Between August 26, 1999 and October 10, 2000, our common stock was traded on the American Stock Exchange under the symbol “DRA.” Prior to August 26, 1999, our common stock was traded on the OTC Bulletin board under the symbol “DSWT.” The following table sets forth high and low sale prices of the common stock for each calendar quarter indicated as reported on the NASDAQ National Market or NASDAQ SmallCap Market, as applicable.
| High | Low | |||||
| Fiscal Year Ended December 31, 2002 | ||||||
| First Quarter | $ | 9.20 | $ | 7.00 | ||
| Second Quarter | 8.02 | 4.93 | ||||
| Third Quarter | 7.41 | 2.40 | ||||
| Fourth Quarter | 2.53 | 0.89 | ||||
| Fiscal Year Ended December 31, 2001 | ||||||
| First Quarter | $ | 12.25 | $ | 10.13 | ||
| Second Quarter | 17.92 | 12.70 | ||||
| Third Quarter | 16.25 | 12.33 | ||||
| Fourth Quarter | 12.50 | 7.04 | ||||
Dividends
We have never declared any cash dividends on our common stock since we currently intend to retain any future earnings to finance future growth. We do not intend to declare any dividends on our common stock in the foreseeable future.
Holders
As of February 28, 2003, there were approximately 308 holders of record of our common stock. We believe that our common stock is held by more than 2,500 beneficial holders.
Item 6. Selected Financial Data.
| Year Ended December 31, | ||||||||||||||||
| 2002 | 2001 | 2000 | 1999 | 1998 | ||||||||||||
| (In thousands, except per share data) | ||||||||||||||||
| Consolidated Statement of Operations Data (1) | ||||||||||||||||
| Licensing revenue | $ | 747 | $ | 835 | $ | 533 | $ | — | $ | — | ||||||
| Product revenue | 25 | 150 | 1,786 | 1,674 | 1,355 | |||||||||||
| Total net revenue | 772 | 985 | 2,319 | 1,674 | 1,355 | |||||||||||
| Gross profit (loss) | 616 | 728 | 264 | (355 | ) | 55 | ||||||||||
| Net loss | (4,706 | ) | (5,390 | ) | (4,110 | ) | (3,475 | ) | (1,599 | ) | ||||||
| Non-cash discount (2) | — | — | — | — | (740 | ) | ||||||||||
| Net loss attributable to common stockholders | $ | (4,706 | ) | $ | (5,390 | ) | $ | (4,110 | ) | $ | (3,475 | ) | $ | (2,339 | ) | |
| Net loss per common share, | ||||||||||||||||
| basic and diluted | $ | (0.49 | ) | $ | (0.57 | ) | $ | (0.49 | ) | $ | (0.58 | ) | $ | (0.55 | ) | |
| Weighted average common shares outstanding, | ||||||||||||||||
| basic and diluted | 9,532 | 9,443 | 8,436 | 6,034 | 4,269 | |||||||||||
| (1) | No cash dividends were declared or paid in any year presented. | |
| (2) | A non-cash charge of $740,000 was
incurred in connection with a beneficial conversion feature relating to
the sale of convertible preferred stock on June 29, 1998. |
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| December 31, | ||||||||||||||||
| 2002 | 2001 | 2000 | 1999 | 1998 | ||||||||||||
| (In thousands) | ||||||||||||||||
| Consolidated Balance Sheet Data | ||||||||||||||||
| Cash and cash equivalents | $ | 7,037 | $ | 12,016 | $ | 16,446 | $ | 5,885 | $ | 144 | ||||||
| Total assets | 9,502 | 14,816 | 19,098 | 8,238 | 1,528 | |||||||||||
| Long-term debt, net of current portion | 8 | 26 | 44 | 125 | 158 | |||||||||||
| Total stockholders’ equity | $ | 6,857 | $ | 11,532 | $ | 15,749 | $ | 6,871 | $ | 752 | ||||||
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements regarding our plans, expectations, estimates and beliefs. Actual results could differ materially from those discussed in, or implied by, these forward-looking statements. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may” and other similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements in this report include, but are not necessarily limited to, those relating to our:
When you consider the forward-looking statements in this report, you should keep in mind the cautionary information located elsewhere in this report. Our performance may differ materially from that contemplated by such forward-looking statements as a result of certain risk factors, including but not limited to those set forth below.
Our technologies may not gain market acceptance. Our success will depend in part on the commercial acceptance of our patented technologies. To be accepted, our technologies must meet the expectations of our potential customers. We market our technologies directly to OEMs, whose products utilize switches, and to our licensees to encourage them to incorporate our technologies in the switches they supply to OEMs, focusing on the advantages of our switches over the electro-mechanical and dome membrane switches. If the OEMs or our licensees ultimately decide to continue with their existing switch technologies, our business would be adversely affected.
Should we be unable to protect our proprietary technologies, their value and our competitive position would be significantly impaired. Although we seek to protect our intellectual property rights through patents, copyrights, trade secret protection and other measures,
Claims that we infringe third-party intellectual property rights could result in significant expenses or restrictions on our ability to license technology. In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. From time to time, third parties may assert patent, copyright, trademark and other intellectual property claims against technologies used in our business. Any such claims, with or without merit, could be time-consuming to defend, would result in costly litigation and divert the efforts of our personnel. Claims of intellectual property infringement might require us to enter into costly royalty or license agreements. Additionally, we might be unable to obtain royalty or license agreements on terms acceptable to us. A successful claim of
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patent or other intellectual property infringement against us could have a material adverse affect on our business. We are not currently involved in any litigation to protect our technologies from infringement or to defend against claims of infringement.
Our quarterly revenue and operating results may fluctuate. Our results may fluctuate from those in prior quarters and will continue to do so due to a variety of factors. These factors include:
Our stock price may be volatile. The stock market has experienced extreme volatility that often has been unrelated or disproportionate to the performance of particular companies. These market fluctuations may cause our stock price to decrease regardless of our performance. The market price of our common stock has been, and in the future could be, significantly affected by factors such as, but not limited to:
The stock market has experienced significant price and volume fluctuations that have particularly affected the market prices of the stocks of technology companies. Recently, the market price of our common stock, like that of many technology companies, has experienced significant fluctuations. For instance, from August 26, 1999, the date we became a reporting company, to March 14, 2003, the price of our common stock ranged from $0.67 to $17.92 per share. On March 14, 2003, the last reported sale price of our common stock was $0.70.
The market price of our common stock has been, and is likely to continue to be, significantly affected by expectations of analysts and investors. Reports and statements of analysts do not necessarily reflect our views.
We depend on our management team. Our future success will be largely dependent on the efforts of key management personnel. The loss of one or more of these key employees could have a material adverse effect on our business. We depend upon the services of Robert J. Brilon, our Chief Executive Officer, President and Chief Financial Officer and Anthony J. Van Zeeland, our Chief Operating Officer and Executive Vice President Engineering. Mr. Brilon has extensive experience in the formation, financing and management of entrepreneurial companies. Mr. Van Zeeland has over 30 years experience in the switch industry. We have employment agreements with both of these individuals for terms that expire in April 2004.
We depend on our relationship with Delphi. We enter into license agreements and other similar contractual relationships under which we license our technologies. Any termination or breach of our relationship with Delphi, cessation of operations by Delphi, or non-performance under the license agreement by Delphi, could have a material adverse effect on our business. Our license agreement with Delphi requires Delphi to pay us minimum royalty payments, beginning July 1, 2004, totaling $12 million during the initial seven-year term ending June 30, 2007. Delphi can maintain exclusivity for the automotive industry through June 30, 2012 by making additional minimum royalty payments during that period. After June 30, 2012, either party may convert the agreement to a non-exclusive agreement through 2020.
We may have difficulty protecting our intellectual property rights overseas. The laws of some foreign countries do not protect proprietary rights to as great an extent as do the laws of the United States, and many U.S. companies have encountered substantial infringement problems in some foreign countries. Because some of our products are sold and a portion of our business is conducted overseas, our exposure to intellectual property risks may be higher.
Rights to acquire shares of common stock could result in dilution to other holders of common stock. As of December 31, 2002, we had issued options to purchase 1,072,699 shares of common stock under our stock option plans at a weighted average exercise price of $9.61 per share. We have filed registration statements under the securities laws to register the common stock to be issued under our stock option plans. As a result, shares issued under these plans will be freely tradable without restriction unless acquired by affiliates of our company, who will be subject to the volume and other limitations of Rule 144. In addition, there were outstanding warrants to purchase 472,059 shares of common stock at a weighted average exercise price of $7.15 per share. The existence of such stock options could adversely affect the terms on which we can obtain additional financing, and the option holders can be expected to purchase shares at a time when we, in all likelihood, would be able to obtain additional capital by offering shares of common stock on terms more favorable to us than those provided by such options.
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We have a history of operating losses and expect to incur losses in the immediate future. We have had substantial losses since our inception and we expect to incur additional losses as we expand our licensing business. We expect to commit substantial resources to the establishment of new licensee relationships and sales and training capabilities.
Because we have only recently completed our shift to a technology licensing business model, we are unable to accurately estimate future revenue and operating expenses based upon historical performance and we cannot assure you if and when we will become profitable.
Risks related to rapidly changing technology. Our results of operations will depend in part on successful management of the challenges of rapidly changing technology and evolving industry standards characteristic of the market for switch technology. These challenges include predicting the nature and timing of technological changes and the direction of evolving industry standards and identifying, developing and successfully marketing new technologies as they emerge. We work with our licensees and OEMs to design solutions specific to their needs and the needs of their customers.
Our growing international business activities subject us to risks that could reduce the demand for our products and increase our operating expense. In 2002, net revenue from international licensees represented 12% of our total net revenue. We have been expanding our licensing business with international licensees and expect that net revenue from international licensees will increase. To date, all of our licensing revenue and substantially all of our costs have been denominated in U.S. dollars. We expect that net revenue and substantially all of our costs will continue to be denominated in U.S. dollars for the foreseeable future. We could be significantly affected by other risks associated with international activities, including the following:
General
The following discussion should be read in conjunction with our audited consolidated financial statements and associated notes appearing elsewhere in this report.
We have developed, patented and licensed innovative technologies utilizing a magnetic-based design for electronic switches. We are currently expanding the use of these technologies by licensing manufacturers to produce and sell products using our technologies. We believe these patented and patent-pending technologies allow us and our licensees to provide innovative solutions to the design challenges faced by OEMs and component suppliers.
Our research and development expenses are comprised mainly of research and development personnel and occupancy costs. Our selling, general and administrative expenses are comprised mainly of labor costs associated with our sales and administrative salaries, depreciation and amortization, travel costs, advertising and occupancy costs.
During the second quarter of 2001, we completed the transition to a licensing business model away from switch manufacturing and, as a result, the relationship between net revenue, cost of goods sold and operating expenses reflected in our financial information may not represent future expected financial relationships. Given the early stage of our licensing business model, we do not believe period-to-period comparisons of results of operations are meaningful.
Critical Accounting Policies
We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations are discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations when such policies affect our reported or expected financial results.
In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our financial statements in conformity with accounting principles generally accepted in the United States. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results form the basis for making judgments about
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the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ significantly from those estimates under different assumptions and conditions. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require our most difficult, subjective, and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Revenue Recognition. We enter into licensing agreements with our customers. Our licensing strategy incorporates a simplified requirement whereby the licensee purchases licensed components from us. The purchase price of the licensed components includes the royalty fee. When the components are shipped, we recognize licensing revenue and licensing cost of goods sold. In some cases where no licensed components are supplied, we are paid a royalty per switch manufactured by the licensee.
Some of our licensees have prepaid royalties to us pursuant to their license agreements. These prepayments are recorded as deferred revenue. This deferred revenue is recognized as licensing revenue when earned under the licensing agreement. If a licensee purchases a licensed component from us, the royalty is earned when the licensed component is shipped. If the licensee is directly manufacturing our switches without purchasing licensed components from us, we consider the royalty earned when the switch is manufactured. In the case of our exclusive license agreement with Delphi, the up-front payment is nonrefundable and the portion of the $4.0 million payment allocated to deferred revenue is being amortized over the initial seven-year term of the agreement. (See Note 7 of our Notes to Consolidated Financial Statements.)
Inventory Valuation. Our inventory is primarily comprised of licensed components which are sold to licensees and raw materials which are primarily used for research and development projects and manufacturing marketing samples. We state inventories at the lower of cost or market value, determined using the first-in, first-out method. Our policy is to write down our inventory for estimated obsolescence or unmarketable inventory to the extent the cost exceeds the estimated market value. We base the estimate on our assumptions about future demand and market conditions. If actual market conditions are less favorable than those assumed in our estimates, additional inventory write-downs might be required. We reflect any write-down of inventory in the period in which the facts giving rise to the inventory write-down become known to us.
Impairment or Disposal of Long-Lived Assets. We review our long-lived assets and identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Additionally, goodwill is reviewed on an annual basis. Our intangible assets are primarily our patents and the goodwill associated with the acquisition of Aztec Industries. If such assets were considered to be impaired, the impairment to be recognized would be measured by the amount by which the carrying amount of the assets exceeds the fair market value of the assets .
We evaluate the recoverability of property and equipment and intangibles (excluding goodwill) not held for sale by comparing the carrying amount of the asset or group of assets against the estimated undiscounted future net cash flows expected to result from the use of the asset or group of assets. If the undiscounted estimated cash flows are less than the carrying value of the asset or group of assets being reviewed, an impairment loss would be recorded. The loss would be measured based on the estimated fair value of the asset or group of assets compared to its carrying value. The estimated fair value would be based on the best information available under the circumstances, including prices for similar assets and the results of valuation techniques, including the present value of expected future cash flows using a discount rate commensurate with the risks involved.
We evaluate goodwill for impairment by comparing the estimated fair value of our company, which is the only reporting unit, with the carrying value, including goodwill. The estimated fair value is based on the best information available under the circumstances, including quoted market prices in stock markets, valuation techniques based on earnings, or independent valuations. If the fair value of our company exceeds the carrying amount, goodwill is not considered to be impaired. If the carrying amount of our company exceeds our fair value, the fair value of the goodwill is calculated, and the excess of the carrying value of the goodwill over its fair value is recorded as an impairment loss. To determine the fair value of goodwill, our fair value is allocated to all of our assets and liabilities, and any excess of fair value of our company over the fair value of our assets and liabilities is the estimated fair value of goodwill.
Results of Operations for the Year Ended December 31, 2002 Compared to the Year Ended December 31, 2001
Net Revenue. During 2000, we started to implement our new business model of licensing our technologies rather than manufacturing switches ourselves. We completed this transition in June 2001 and expect substantially all of our future revenues to come from our licensing efforts. As of December 31, 2002, we had 23 licensees, foreign and domestic. Because the revenue generated from licensing switch technologies is lower than the revenue from manufacturing the same number
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of switches, we expected our net revenue to decrease during our transition to licensing. Concurrently, our gross profits as a percentage of revenue increased because the cost of goods sold associated with licensing is much lower than with manufacturing.
We recorded net revenue of $772,169 for the year ended December 31, 2002, compared to $985,312 for the year ended December 31, 2001, a decrease of $213,143. The decrease is due primarily to the expected decrease in product revenue as a result of the completion of our transition from manufacturing to licensing switch technologies and decreased licensing revenue resulting from a decrease in per-switch royalties and a decrease in the per-design review revenue.
Licensing revenue was $747,494 and $835,541 for the years ended December 31, 2002 and 2001, respectively, a decrease of $88,047 or 11%. Our licensing revenue is primarily comprised of the recognition of revenue resulting from the recognition of deferred revenue from our license agreement with Delphi and per-switch revenue from non-exclusive licensees who manufacture switches incorporating our technologies. The per-switch revenue includes royalties and revenue from the sale of licensed components.
To date, the majority of non-exclusive licensing revenue has been related to our PushGate pushbutton technology. The number of unit sales of royalty-bearing PushGates has increased during the last three years from approximately one million in 2000, 1.8 million in 2001, to 2.8 million in 2002. Revenue has not tracked this increase because the average revenue earned per PushGate during 2002 was just over $0.10, the low end of the $0.10-0.30 range, compared to average per-PushGate revenue of $0.17 in 2001. The increase in the quantity of licensed components sold was primarily related to a large sale to one licensee. The decrease in the per-switch royalties resulted from volume discounts. Licensing revenue was also impacted by a decrease in fees related to the review of customer designs. The primary reason for the decrease in design review fees was a reduction of the amount billed per-design review. At the same time, we experienced an increase in the number of design reviews. As contemplated in our license agreements, we have lowered these fees as our licensees have gained experience and become more proficient with our technologies as well as to remove barriers to commercial acceptance.
We anticipate that licensing revenue will fluctuate from period to period. It will be difficult for us to predict the timing and magnitude of such revenue, as it depends on the licensees’ ability to market, produce and ship products that incorporate our technologies. We believe that the amount of licensing revenue for any period is not necessarily indicative of results for any future period.
Our license agreement with Delphi generated licensing revenue of $409,380 or 55% of our licensing revenue and 53% of our total net revenue for the year ended December 31, 2002 and $411,362 or 49% of our licensing revenue and 42% of our total net revenue for the year ended December 31, 2001. Licensing revenue from Delphi primarily resulted from the recognition of deferred licensing revenue, which was received in 2000.
Product revenue was $24,675 and $149,771 for the years ended December 31, 2002 and 2001, respectively, a decrease of $125,096. The decrease reflects our transition to a technology licensing company. The $24,675 of product revenue for the year ended December 31, 2002 was related to fees for engineering services we had provided to a customer in prior periods that were in dispute. We do not expect to have any significant product revenue in the future.
Cost of Goods Sold. Cost of goods sold was $156,406 for the year ended December 31, 2002, compared to $256,838 for the year ended December 31, 2001, a decrease of $100,432. The decrease in cost of goods sold and the increase in gross profit as a percentage of revenue to 80% in 2002 from 74% in 2001 reflects our transition from the low-margin business of manufacturing switch panels to the high-margin business of licensing. We anticipate that our gross profit as a percentage of revenue will fluctuate in future periods as we experience changes in the percentage of revenue generated from sales of licensed components, royalties from licensees who manufacture products utilizing our technologies without purchasing licensed components from us and the recognition of deferred revenue from our licensing agreement with Delphi.
Licensing cost of sales for 2002 was $156,406 compared to $100,540 in 2001, an increase of $55,866. The increase in licensing cost of goods sold for the year ended December 31, 2002 was primarily due to a $73,171 charge to licensing cost of goods sold related to earlier versions of licensed components that will no longer be promoted and will only be considered as an alternative to our current licensed component inventories in limited circumstances. This increase was offset by a 34% reduction in our per-unit cost of licensed components and decreased sales of other materials with low gross margins.
Product cost of goods sold was $0 in 2002 compared to $156,298 in 2001, a decrease of $156,298. The decrease in product cost of goods sold was due to the completion of our transition to a licensing business model from a product-based model.
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Selling, General and Administrative Expenses. Selling, general and administrative expenses were $2,857,609 for 2002, compared to $3,899,652 for 2001, a decrease of $1,042,043. Selling, general and administrative expenses in 2001 included a charge of $397,431 related to costs associated with the resignation of our former Chief Executive Officer. No such charge was recorded in 2002. The remainder of the decrease in selling, general and administrative expenses was primarily related to reductions in executive and support personnel.
Research and Development. Research and development expenses were $2,614,905 for 2002, compared to $2,773,221 for 2001, a decrease of $158,316. The decrease was primarily attributable to costs related to decreased research and development personnel. During 2001, research and development expenses increased every quarter as we ramped up our research and development activities to expand our technology portfolio and develop various adaptations of our core technologies. We added personnel and increased our modeling and testing capabilities, resulting in increased costs. As we entered 2002, we began to reduce these expenses primarily by reducing research and development personnel. In 2002, research and development expenses decreased each quarter from the preceding quarter.
In October 2002, we announced cost-cutting initiatives that included significant reductions in research and development personnel focused on new technologies. The personnel reductions were completed by the end of 2002. We have created a portfolio of patented and patent-pending technologies, which are available through our licensees. The efforts of our remaining research and development personnel will continue to be directed at gaining commercial acceptance of these technologies as opposed to also focusing on the creation of new technologies. They will continue to support our licensees in their efforts to commercialize our existing patented and patent-pending technologies.
Loss from Operations. As a result of the decreases in selling, general and administrative expenses and research and development expenses, loss from operations decreased to $4,856,751 for the year ended December 31, 2002, compared to $5,944,399 for the year ended December 31, 2001, a decreased loss of $1,087,648.
Other Income-Net. Other income-net was $150,699 for 2002, compared to $554,245 for 2001, a decrease of $403,546. The decrease in other income-net is due to the decrease in investment income as a result of lower interest rates and lower average cash balances.
Net Loss. The decrease of $684,102 or 13% in the net loss to $4,706,052 for the year ended December 31, 2002 from $5,390,154 for the year ended December 31, 2001 was primarily a result of decreased selling, general and administrative expenses and decreased research and development expenses, which were offset by the reduction in investment income.
Results of Operations for the Year Ended December 31, 2001 Compared to the Year Ended December 31, 2000
Net Revenue. We recorded net revenue of $985,312 for the year ended December 31, 2001, compared to $2,318,736 for the year ended December 31, 2000, a decrease of $1,333,424. The decrease in our net revenue was primarily due to our shift in our business model from switch manufacturing to technology licensing. Accordingly, our licensing revenue for 2001 increased to $835,541 compared to $533,137 in 2000, an increase of $302,404, and our product sales revenue decreased to $149,771 for 2001 compared to $1,785,599 for 2000, a decrease of $1,635,828.
During 2000, we started to implement our new business model of licensing our technologies rather than manufacturing switches ourselves. We completed this transition and expect almost all of our future revenue to come from our licensing efforts. As of December 31, 2001, we had 24 licensees, foreign and domestic. Because the revenue generated from licensing switch technologies is lower than the revenue from manufacturing the same number of switches, we expected our net revenue to decrease as we transitioned to a licensing business model. During the transition, we referred our switch customers and product sales leads to our licensees. As expected, product revenues decreased as we completed delivery against our remaining customer purchase orders.
The shift in our business model from manufacturing to licensing and the addition of licensed manufacturers during the year accounted for the increase in our licensing revenue. Our license agreement with Delphi generated licensing revenue of $411,362 or 49% of our licensing revenue and 42% of our total net revenue for the year ended December 31, 2001 and $277,860 or 52% of our licensing revenue and 12% of our total net revenue for the year ended December 31, 2000. Licensing revenue from Delphi primarily resulted from the recognition of deferred licensing revenue which was received in 2000.
Product revenue was $149,771 and $1,785,599 for the years ended December 31, 2001 and 2000, respectively, a decrease of $1,635,828 resulting from the implementation of our new business model, which called for transitioning away from switch manufacturing. Our revenue in 2000 was primarily generated from designing, developing, and producing
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prototypes of customer switch applications and low volume production runs. Additionally, we had been performing pursuant to a long-term purchase order with Siemens Building Technologies, Inc. This purchase order was completed in the second quarter of 2001 and generated 74% of our product revenue for the year ended December 31, 2001. This project has been transitioned to one of our licensees.
Cost of Goods Sold. Cost of goods sold was $256,838 for 2001, compared to $2,054,655 for 2000, a decrease of $1,797,817. The decrease in cost of goods sold reflected our transition from the low-margin business of manufacturing to the high-margin business of licensing. Licensing cost of sales for 2001 was $100,540 compared to $49,666 in 2000, an increase of $50,874 reflecting the growth of our licensing business.
Product cost of goods sold was $156,298 in 2001 compared to $2,004,989 in 2000, a decrease of $1,848,691. The decrease in product cost of goods sold was primarily due to our transition to a licensing business model from a manufacturing model. The decrease in overall cost of goods sold as a percentage of net revenue was primarily due to the higher gross margins we achieved through our licensing agreements and decreased manufacturing costs by utilizing our licensees and subcontractors for manufacturing.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $3,899,652 for 2001, compared to $3,343,605 for 2000, an increase of $566,047. The increase in selling, general and administrative expenses was primarily related to costs associated with the former Chief Executive Officer’s resignation. Under the terms of his agreement, in the event of resignation, he was entitled to salary and benefits for an 18-month period. As a result, we recorded a charge of $397,431 in 2001. Costs associated with additional sales and administrative personnel during 2001 also contributed to the increase.
Research and Development. Research and development expenses were $2,773,221 for 2001, compared to $1,716,825 for 2000, an increase of $1,056,396. The increase was primarily attributable to costs related to additional research and development personnel, expanded modeling and testing capabilities and related occupancy costs.
Loss from Operations. As a result of the factors described above, the loss from operations was $5,944,399 for 2001, compared to $4,796,349 for 2000, an increase of $1,148,050.
Other Income-Net