ITEM 1. BUSINESS
Company Background
Check Technology Corporation (the Company) was formed in 1981 to design and manufacture a sophisticated printing system. The original product concept for the Company was a computerized financial document production system, which integrated many of the functions required for the production of checkbooks. These functions included (i) automatic collation of checkbook components, (ii) high quality alphanumeric and graphics printing for customer personalization and bank address, and (iii) consistent Magnetic Ink Character Recognition (MICR) printing for the electronic processing of checks. Shipments of its first system, the Model 2000 Checktronic®, began in 1983.
Within a short time after the introduction of the Checktronic system, the Company recognized the product's applicability in such areas as insurance claim production and centralized funds disbursements. The latter includes payroll and accounts payable checks. The Company calls these "Checkwriting" applications. Checkwriting typically requires a high level of security (e.g., secure operator access and the ability to produce an audit trail after a batch of checks is produced). The Company developed sophisticated control software/hardware, which met these stringent operating requirements. This security capability is offered as an option on many of the Company's systems and differentiates the Company's products from many competitors' products.
The Company has had a significant presence in the international check production marketplace since 1983. The integration of the check production functions described above was found to result in the cost effective production of the small check order sizes common to most markets outside the United States. The production cost reductions for orders of 25-100 checks, as well as the improvement in printing quality, created a demand for the Company's systems in many international markets. In order to manage this demand and to provide the necessary technical support of the products after installation in the field, the Company opened its first subsidiary, Check Technology Limited, in England in 1983. The Company opened its French and Australian subsidiaries in 1987. At September 30, 1999, the Company had an installed base of over 400 systems located in 51 countries.
Business
The Company's business is the design, manufacture, sale and service of computerized financial document production systems. The systems can collate, personalize and encode documents into packages tailored to the customer's requirements. The systems are sold through the Company and its international subsidiaries.
Products
Check Technology sells a complete family of electronic production systems for use in both cut-sheet and continuous forms production environments. These systems can be used for four basic applications: folio production, insurance claims, fulfillments, and disbursements. Folio production includes the printing of checkbooks and financial payment coupon books. Insurance claim applications consist of explanation of benefit forms and insurance claim checks. Fulfillment applications include coupons and rebate checks, while disbursement applications include accounts payable checks and payroll checks. These electronic production systems enable companies, banks and government customers to easily and quickly transform blank paper stock into fully collated checks and forms.
Cut Sheet Production Systems. During fiscal 1998, the Company launched commercially the Imaggia MG20® product. Designed to respond to the changing demands of security printers and on-demand applications worldwide, the Imaggia system utilizes state-of-the-art digital, non-impact technology, offering print quality that is visually indistinguishable from offset print. The Company's other cut-sheet system is the Checktronic series. The Checktronic series uses a combination of ion-deposition and impact technology. The Company markets four Checktronic models to customers with medium to high volume folio production, insurance claim, and fulfillment and disbursement applications. The Model 1750X operates at a rated
speed of 45 pages per minute, while the Models 2100X, 4000X and 4500X operate at 60, 90 and 120 pages per minute, respectively. The Checktronic series can be purchased with advanced security/audit capability. The Company's Checktronic systems provide their owners with the flexibility, reliability and consistency to produce high quality documents while reducing production costs. In April 1999, the Company completed an agreement with Océ Printing Systems GmbH for worldwide exclusive rights to private label, sell, and service the PS75 MICR product. In addition, the Company obtained certain definable rights to private label, sell and service other Océ high-performance sheet-fed MICR and non-MICR printing systems.
Continuous Form Production Systems. The Company's CheckPrinter series consists of continuous form systems. These systems are available as either stand-alone MICR printers or as tandem systems. The Model 930 and Model 960 operate at over 300 and 600 documents per minute, respectively. These two models utilize impact technology to produce high quality MICR characters.
Finishing Units. In addition to the document production systems, the Company offers a finishing system to complement its cut-sheet product line. The Foliotronic® system incorporates a blend of proven concepts with new designs and advanced microprocessor controls. The Foliotronic system consists of a guillotine and stitcher/binder module. Its rated throughput is up to 2,000 books per hour. When used with the Company's electronic production systems, the Foliotronic system enables customers with folio production applications to transform blank paper stock into finished books.
Service and Maintenance. Service and maintenance revenue results from the sale of maintenance contracts, the sale of proprietary consumable and supply items and the sale of spare parts to customers who have purchased the Company's equipment. Supplies are operating materials that are consumed during normal operation of the Company's systems. Examples of these supplies are MICR ribbon consumed in the printing of each MICR code line and toner, which is consumed in the personalization of each document. The Company believes that its service network and spare parts business operated profitably for the years ended September 30, 1999, 1998 and 1997, based upon the economies of scale achieved from the expansion of the installed base of the Company's financial document production equipment.
The Company employs customer engineers at each of its operating units. For customers who purchase maintenance contracts after the warranty period, which typically is 90 days from customer acceptance of a system, the Company provides ongoing customer support through its service network, for which it charges for time and materials on an annual service contract basis. Some customers elect to provide their own maintenance and service on the system they have purchased. Historically, warranty service expense has not been significant to the Company after the initial units of a new product have been placed with customers. While the Company believes it will have a similar experience with the Imaggia, it does not yet have the experience base to determine if this will be the case.
Sales and Marketing
Organization. The Company's system sales are made predominately through direct sales personnel based in the United States and abroad. Marketing activities for the Company and its subsidiaries are centralized at the Company's headquarters in Minnetonka, Minnesota, USA. These activities include the development and implementation of product pricing, advertising and public relations strategies. In addition, the Company utilizes market research and market development resources in order to anticipate changes in the Company's competitive environment.
United States Market. The market in the United States for checks and other financial documents is the largest in the world, notwithstanding the fact that the annual consumption of checks has shown a slowing growth rate over the last five years. The Company believes that alternatives to the check document such as debit and credit cards will eventually reduce the number of checks used, although the size and rate of reduction is difficult to predict. It is estimated that other documents produced by the Company's systems have shown higher growth rates over the same period. These documents include payment coupons, tax payment and other installment payment products.
Checkwriting activities have been affected by alternative payment technologies. These substitutes include Electronic Funds Transfer (EFT) and Electronic Data Interchange (EDI). Although these alternatives comprise only a small percentage of total payment transactions in the United States, they are expected to have an increasingly significant impact on U.S. disbursement activities over the next ten years.
The Company's systems have also been sold in the United States primarily to check printers, payment coupon producers, service bureaus and large corporations. These organizations all have requirements for the production of personalized encoded document packages such as small personal check orders, installment payment books, payroll, payables and insurance claims checks. The Company expects to continue to increase its installed system base in the United States.
International Market. The market for the Company's products outside the United States has been primarily in personalized check production. The average personalized check order size in most international markets is between 25 and 100 checks. These small order sizes are produced cost effectively on the Company's products because of their automatic collation capabilities. Stringent MICR quality standards, enforced by the major clearing banks in most international markets, are also met by the Company's high quality MICR printing capabilities. As a result of these market factors, the Company has had success in penetrating the largest personal check production markets outside of the United States. These include Australia, Brazil, France, Mexico, Spain and the United Kingdom.
Competition
The Company's products are sold into a number of different market segments. Competition will differ depending on the segment and application in which the Company competes. Many of the Company's competitors are well established and have significantly greater access to financial, technical and personnel resources. The Company believes that the sale of the Imaggia family of check production systems is critical to its ability to remain competitive in the markets it serves. See "Research and Development."
Folio production involves the manufacture of checkbooks and payment coupon books. In the United States, check production is dominated by a small number of companies such as Deluxe Corporation (St. Paul, Minnesota), John H. Harland Company (Decatur, Georgia), and Clarke American (San Antonio, Texas), all of which are customers of Check Technology Corporation. Competitive standards for alphanumeric print quality, MICR print quality and delivery time in this segment are established by these major players. All of these market standards must be met or surpassed by any new market competitor or production technology in order to capture a substantial share of the United States personal check market. To date, the Company has been able to establish itself only in the production of new account kits, money market checkbooks and other applications which do not require offset or letterpress quality. The Imaggia family of check production systems has been designed to provide entry into the U.S. check production market. See "Research and Development."
The Company has had success in the United States folio production segment involved in the production of personalized payment books such as installment loan and tax payment books. This market is dominated by a small number of companies such as NCP (Birmingham), Cummins Allison (Indianapolis) and Venture Encoding (Dallas). The predominant personal checkbook manufacturers discussed above also produce payment books. The Company's products have found market acceptance in this segment because they provide the efficiency, reliability and production flexibility sought by this segment. Xerox (United States) and Siemens (West Germany) are presently the Company's major competition for the production of payment books.
International folio production markets, like the United States payment book production market, are also driven more by cost and production efficiency factors than by alphanumeric print quality standards. In addition, enforcement of high MICR standards by the clearing banks in most international markets makes MICR printing quality an extremely important competitive factor. The Company's Checktronic family of products has found a high degree of acceptance in the international market segments because these systems provide the efficiency, production flexibility and MICR quality sought by the major check
producers. The Company competes in the international marketplace with Troy, Xerox, Siemens and Nipson Bull.
The centralized high volume production of insurance claims and check disbursements does not require extensive collation. For this reason, the Company finds many competitors in this market segment. Specific competitors include Xerox, Siemens, Troy, and IBM (United States). The Company's products offer security and audit control, which for companies that generate many checks is a significant advantage as it restricts unauthorized access to data printed on Check Technology systems. The Company's security/audit capability also physically tracks the total number of documents printed and maintains a running total of the dollar amounts printed in each run.
Backlog
At December 1, 1999, the Company had a backlog of approximately $4,082,000 as compared to a backlog of $3,000,000 as of December 1, 1998. The Company defines its backlog as purchase orders which are unfilled. Because of customer changes in delivery schedules and potential cancellation of orders, the Company's backlog as of any particular date may not be representative of the Company's actual sales for any succeeding fiscal period. The Company's equipment is manufactured to orders received, and to date the Company has never been in a position where it was unable to meet a scheduled shipment date because of excessive order backlog. During fiscal year 1999, there were periods when the Company had only a nominal backlog. The Company expects that it will continue to have periods during which there will be little or no backlog.
Manufacturing and Sources of Supply
Since the Company has not developed a sustained backlog, it has adopted a manufacturing process to enable it to produce a "generic" product that can be quickly configured to a customer's specific order without rework. This process has enabled the Company to begin manufacturing without firm final orders. As a result, the Company has been able to reduce manufacturing parts and material inventories while, at the same time, being able to respond quickly to new orders.
The components of the Company's financial document production systems are manufactured by outside vendors, tested and then incorporated into the systems by Company personnel. While the Company uses only one source for many of the key components of its printing systems, most components, with the exception of the non-impact alphanumeric printer and the MICR printer hammer bank component, are available from multiple sources. However, many of the critical components of the Company's systems would require redesign if new vendors were used.
The non-impact alphanumeric printers and associated spare parts and consumables for both theChecktronic and the Imaggia systems are supplied to the Company by Delphax Systems, which has its manufacturing facilities in Toronto, Canada. Delphax has been the supplier of the printers used in the Company's systems since the Company's inception. Xerox, one of the Company's competitors, owned a one third partnership interest in Delphax for many years and in November 1997 acquired the remaining equity of Delphax. In connection with this acquisition, Xerox has advised the Company that its intention is to have Delphax comply with all of Delphax's existing contractual obligations to the Company, that Xerox hopes to expand Delphax's relationship with the Company in the future and that Xerox does not anticipate that the competitive relationship between the Company and Xerox will be a factor in the relationship of Delphax with the Company. The expressed intentions of Xerox could change to the detriment of the Company. No assurance can be given at this time that the Company will be able to secure a replacement source of supply for the alphanumeric printers supplied by Delphax.
Research and Development
Since its formation, the Company's research and development activities have been focused on the development of computerized printing systems capable of producing on a precision basis financial documents at required speeds and volumes. The Company is completing development of a new family of
check production systems, called Imaggia, which is targeted at the high volume U.S. check market as well as offering potential for increasing the Company's international business. The Company is using Delphax Systems Gemini digital printing technology as the initial print engine for the Imaggia system. Delays occurred in introducing the system, due in part to development delays associated with the Gemini print engine and finalization of the engine's toner formulation, were outside of the Company's control. No assurances can be given that the product will be successful in the market place or that further product engineering delays will not occur.
During fiscal 1999 the Company has continued product engineering on the Imaggia system to improve its performance to meet market demands. The Company expects that product engineering efforts seeking further improvements and enhancements will be ongoing. The Company has also continued product engineering on its established product lines. The Company's research and development expenditures were $2,710,000, $2,728,000 and $2,521,000 for the years ended September 30, 1999, 1998 and 1997, respectively.
Patents
In July 1997, the Company received a patent covering certain aspects of its Imaggia printing system. In prior years, the Company has received patents covering the Model 2000 Checktronic printing system, its fusing process and the autotaper for the Foliotronic system. There is no assurance that such patents will afford the Company any competitive advantage. The Company believes that its future success will depend primarily upon the technical competence and creative skills of its personnel rather than on patents. The Company cannot be assured that its printing system, or any components of such system, will not be covered in whole or part by existing patents. Although the Company is not presently aware of such patents, the Company could be required to obtain patent licenses in order to conduct its business.
Employees
As of December 1, 1999, the Company had 182 full-time employees, including 35 in executive and administrative positions, 32 in electronic engineering and product development, 25 in manufacturing, 13 in sales and marketing and 77 in customer service.
Many of the Company's employees are highly skilled, and the Company's future success will depend in part upon its ability to attract and retain such employees. The Company is not subject to any collective bargaining agreement and considers its employee relations to be good.
ITEM 2.
ITEM 2. PROPERTIES
The Company's corporate and manufacturing offices are located in Minnetonka, a suburb of Minneapolis, Minnesota. The company leases a 75,000 square foot building under a lease that expires on September 15, 2010. The annual rent is $410,000, increasing to $481,000 on September 15, 2005, and thereafter, plus operating expenses and real estate taxes.
In addition, the Company leases office space for its European sales and service center in Crawley, England under a lease which expires in 2013 and provides for annual lease payments of $191,000, subject to adjustment every five years, plus a pro rata portion of the operating expenses. The Company leases smaller office premises for its operations in Australia and France.
The Company believes that its current arrangements for facilities are adequate to meet its present needs and those for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor its subsidiaries are a party to, nor is any of their property the subject of, any material pending legal proceedings. From time to time, the Company and its subsidiaries receive complaints from customers with respect to product performance and occasionally such complaints evolve into litigation. The Company regards these matters as routine litigation incidental to its business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year ended September 30, 1999.
Executive Officers of the Company
The names and ages of all of the Company's executive officers and the positions held as of the date of this report are:
Officers of the Company are elected annually by the Board of Directors and serve until their successors are duly elected and qualified. There are no family relationships among the Company's officers and directors.
Set forth below is a summary of the business experience of each of the executive officers of the Company:
Jay A. Herman joined the Company as Executive Vice President and Chief Financial Officer in May of 1988 and was promoted to President in June 1989. Prior to joining the Company, Mr. Herman was Vice President and Chief Financial Officer of Gelco Corporation's International Division. He held that post from 1986 to 1988. Between 1979 and 1986, Mr. Herman held positions of Vice President of Administrative Services for Gelco Corporation and Director of Planning and Budgets for Gelco's Fleet Leasing Division. Before joining Gelco, Mr. Herman held several positions with General Mills.
Peter J. Wood joined the Company as Vice President of Engineering in July 1997. Mr. Wood has over 30 years experience in the development and user application of electronic digital product technology. Prior to joining the Company, Mr. Wood served as Principal Consultant to Vivo Software, Inc. from 1996 to 1997, as Vice President, Engineering and Technology, for Iris Graphics Inc. from 1995 to 1996 and as President of Vital Imaging Systems, Inc. from 1993 to 1995.
Dieter P. Schilling was promoted to Vice President of Operations and Customer Service in October of 1989. From October 1986 until October 1989 he held the position of Vice President of Customer Service. Mr. Schilling joined Check Technology as Director of Field Services in 1985 and was promoted to Director of Customer Service in April of 1986. Previous to this, Mr. Schilling was a co-founder and President of Southern California Telephone, a telephone interconnects company, which was sold to American Telecommunications, Inc. in 1985.
Rob Barniskis joined the Company as Chief Financial Officer in November 1999. Prior to joining the Company, Mr. Barniskis spent 14 years in various financial roles within Rosemount Inc., a wholly owned subsidiary of Emerson Electric Company. He was Finance Director, Americas, of Rosemount's Measurement Division from 1998 to 1999. Between 1996 and 1998, Mr. Barniskis was Finance Director, Asia Pacific, for Fisher-Rosemount Systems, Inc., based in Singapore. Previous to this, Mr. Barniskis was Director of Finance and MIS for Kay-Ray/Sensall, Inc., a wholly owned subsidiary of Rosemount Inc., from 1993 to 1995.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on the over-the-counter market and is quoted on the National Association of Securities Dealers Automated Quotation System ("Nasdaq") under the symbol "CTCQ." The following table sets forth for the periods indicated the range of high and low closing prices per share as reported by Nasdaq. The Nasdaq bid quotations represent inter-dealer prices, without retail markup, markdown, or commissions, and may not necessarily represent actual transactions.
Stock Repurchase Program
In September 1998, the Company announced a stock repurchase program of up to 500,000 shares of Common Stock. At September 30, 1999, the Company had repurchased 170,500 shares at a cost of $434,400.
Holders
As of December 1, 1999, the Company had 359 holders of Common Stock of record.
Dividends
The holders of Common Stock are entitled to receive dividends when and as declared by the Company's Board of Directors. Since its inception, the Company has not paid any dividends and does not anticipate paying any dividends in the foreseeable future. The Company intends to retain any earnings it may generate to provide for the operation and projected expansion of its business.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
(1)Earnings per share of Common Stock is computed by dividing the net income for the period by the weighted average number of shares of Common Stock.
(2)Earnings per share of Common Stock is computed by dividing the net income for the period by the weighted average number of shares of Common Stock and equivalents outstanding during the period.
Results of Operations
The Company's revenues consist of (i) sales of document production systems and related equipment, and (ii) maintenance contracts, spare parts, supplies and consumable items. For the year ended September 30, 1999 (fiscal 1999), sales of document production equipment decreased 15% over the year ended September 30, 1998 (fiscal 1998), compared to an increase of 16% in fiscal 1998 over the year ended September 30, 1997 (fiscal 1997). The decrease in fiscal 1999 arose primarily from the strategic decision to limit sales of its new Imaggia product, as well as lower Checktronic sales in Latin America and Asia. The Company completed the sale of seven Imaggia systems in fiscal 1999, compared to five in fiscal 1998, and has orders for its Imaggia system, which it expects to ship in fiscal 2000. With respect to the Checktronic equipment, the Company has held for some time a dominant market position in many of the international markets in which the Checktronic is sold. As a result of that dominant position demand for the Checktronic product line has softened in these established international markets and revenues from this product line are now largely dependent on sales to emerging markets such as Latin America, Asia and Africa. The present recessionary environments in Asia, South America, and other emerging markets has limited the Company's current opportunities to sell high-end capital equipment into those regions. The increase in fiscal 1998 was due primarily to the first sales of the Company's new Imaggia product, together with increased Checktronic sales into Latin America, offset by reduced sales by the Company's Australian and United Kingdom subsidiaries.
Revenues from maintenance contracts, spare parts, supplies, and consumable items decreased less than 1% in fiscal 1999 over fiscal 1998 compared to a 3% decrease in fiscal 1998 over fiscal 1997. The decreases in both fiscal 1999 and fiscal 1998 were primarily due to a reduction in maintenance and consumables revenue from Pacific Rim customers.
The gross margin percentage in fiscal 1999 was 53% compared to 58% in fiscal 1998 and 60% in fiscal 1997. The decreases are primarily due to differences in product mix, increased pricing pressures for the Company's traditional products, and costs associated with the Imaggia product line. The Company anticipates that its gross margin percentage in fiscal 2000 may be somewhat lower than fiscal 1999 as revenue from the Imaggia and Océ lines constitute a larger portion of the Company's revenues.
Selling, general, and administrative expenses were flat in fiscal 1999 as compared to fiscal 1998 and fiscal 1997.
Research and development expenses were flat in fiscal 1999 compared to fiscal 1998 and increased 8% in fiscal 1998 over fiscal 1997. The increase in fiscal 1998 was primarily due to increased expenditures on the Company's Imaggia product development program.
Net interest income was $114,000 in fiscal 1999 compared to $334,000 in fiscal 1998 and $389,000 in fiscal 1997. The decreases in both fiscal 1999 and fiscal 1998 were due to lower cash balances available for investment and lower interest rates.
The Company recorded an income tax benefit of 17% in fiscal 1999 compared to income tax expense of 33% in fiscal 1998 and 32% in fiscal 1997. The 1999 income tax benefit reflects the recording of $261,000 in deferred tax assets from the net operating loss generated in fiscal 1999. Despite the reported cumulative net loss for fiscal 1999, the Company believes recorded net deferred tax assets are more likely than not to be recoverable, based upon its estimates of future sources of taxable income and the expected timing of temporary difference reversals. The Company believes it will generate sufficient future taxable income to recover its net deferred tax assets from increased sales of its Imaggia product line, sales of the Océ product line and continued sales of maintenance, spares, and supplies. Further information about income taxes is provided in Note B to the consolidated financial statements.
Net loss for the year amounted to ($0.26) per share compared to net income of $0.03 per share in fiscal 1998 and net income of $0.05 per share in fiscal 1997. The net loss in fiscal 1999 was primarily due to the decrease in the level of document production systems revenue, the effect of reduced gross margins, and
the unfavorable effects of foreign currency exchange rate fluctuations. The decrease in fiscal 1998 was due to the effect of reduced gross margins and increased research and development expenditures, offset by the favorable effects of foreign currency exchange rate fluctuations.
Market Risk
The Company presently has three foreign subsidiaries, located in England, France, and Australia, does business in 51 countries, and generates approximately 80% of its revenue from outside North America. The Company's ability to sell its products in these foreign markets may be affected by changes in economic, political, or market conditions in the foreign markets in which it does business.
The Company experiences foreign currency gains and loss, which are reflected on the Company's income statement, due to the strengthening and weakening of the U.S. dollar against the currencies of the Company's three foreign subsidiaries and the resulting effect on the valuation of the intercompany accounts and certain assets of the subsidiaries, which are denominated in U.S. dollars. The net exchange loss arising from this was $120,000 in fiscal 1999, compared to a gain of $132,000 in fiscal 1998 and a loss of $72,000 in fiscal 1997. The Company anticipates that it will continue to have exchange gains or losses from foreign operations in the future.
The Company's net investment in its foreign subsidiaries was $8,443,000 and $8,681,000 at September 30, 1999, and 1998 translated into U.S. dollars using the year end exchange rates. The potential loss value resulting from a hypothetical 10% change in foreign currency exchange rates is not material in 1999 and 1998. The impact of the stronger U.S. dollar on the translation of foreign currency denominated sales and related gross profit thereon was not material in 1999 and 1998.
Factors Affecting Results of Operations
The Company is continuing development of the Imaggia system, including improving its overall reliability and performance. The Company is using the Gemini digital print technology, which has been developed by Delphax Systems, as the print engine for the Imaggia system. Over the course of the development, the Company has experienced delays due in part to development delays associated with the Gemini print engine and finalization of the engine's toner formulation, which are outside of the Company's control. No assurance can be given that further delays will not occur, that Imaggia will gain market acceptance or that product development or warranty expenses will not be higher than anticipated. Achievement of the Company's future revenue plans depends upon the successful market acceptance of the Imaggia system. The Company's revenues and operating results may also fluctuate from quarter to quarter because (i) the Company's sales cycle is relatively long, (ii) the size of orders may vary significantly, (iii) the availability of financing for customers in some countries is variable, (iv) customers may postpone or cancel orders, and (v) economic, political and market conditions in some markets change with minimal notice and affect the timing and size of orders. Because the Company's operating expenses are based on anticipated revenue levels and a high percentage of the Company's operating costs are relatively fixed, variations in the timing of revenue recognition could result in significant fluctuations in operating results from period to period.
Year 2000
The Company began evaluating the potential impact of the Year 2000 date conversion on its operations in 1997. This evaluation included three major elements: (i) information technology (IT) systems, (ii) non-IT, or embedded technology systems, and (iii) relationships with its key business suppliers. For its IT systems, the Company has assessed its hardware and applications (software and operating systems) and has substantially finalized its plans to address all assessed risks. The Company believes that it has planned for the most reasonably likely worst case scenarios. It anticipates that its IT systems will be ready for the Year 2000, although it may experience isolated instances of non-compliance. During 1999 the
Company has continued to follow up with critical business partners to assess their readiness and establish appropriate contingency plans if necessary. The Company's cost for achieving Year 2000 compliance is part of the cost of an overall upgrade of its information technology systems. The Company completed this upgrade in 1999 at an approximate cost of $300,000, of which approximately $200,000 was incurred prior to fiscal 1999.
Euro Conversion
On January 1, 1999, certain member countries of the European Union established fixed conversion rates between their existing currencies and the European Union's common currency (Euro). The transition period for the introduction of the Euro is January 1, 1999 to January 1, 2002. The Company has prepared for the introduction of the Euro and has evaluated methods to address the many issues involved with the introduction of the Euro, including the conversion of information technology systems, recalculating currency risk, strategies concerning continuity of contracts, and impacts on the processes for preparing taxation and accounting records. The Company believes the Euro conversion will not have a material impact on its financial statements.
Liquidity and Capital Resources
Working capital was $15.7 million at September 30, 1999, compared to $17.6 million at September 30, 1998. The decline is primarily due to changes in inventory levels and cash balances. The Company's inventory levels increased from $10.2 million at September 30, 1998, to $10.5 million at September 30, 1999, primarily due to an increase in Imaggia related inventory. Cash and short-term investments amounted to $3.0 million at September 30, 1999, compared to $5.3 million at September 30, 1998. The reduction in cash and short-term investments is due to the net loss during the first three fiscal quarters and the increase in the Imaggia inventory. Stockholders' equity was $16.7 million at September 30, 1999, compared to $18.6 million at September 30, 1998. In September 1998, the Company announced a stock repurchase program of up to 500,000 shares. At September 30, 1999, the Company had repurchased 170,500 shares at a cost of $434,000. Stockholders' equity was also affected in 1999 by a negative change of $266,000 in the foreign currency adjustment arising from the translation of the assets and liabilities of the Company's subsidiaries from their functional currencies to U.S. dollars.
The Company's long-term debt to equity ratio was less than 0.01 at September 30, 1999, and September 30, 1998. The Company maintains a $2.5 million unsecured bank line of credit. At September 30, 1999, the line was unused. The credit agreement expires March 31, 2000, and the Company expects to negotiate a new bank line of credit. The Company believes that its current capital resources, unused financing source, and anticipated level of internally generated funds will be sufficient to fund its working capital requirements in fiscal 2000.
At September 30, 1999, the Company had no material commitments for capital expenditures.
Cautionary Statement
Statements included in this Management's Discussion and Analysis of Financial Condition and Results of Operations, in the Company's Annual Report, in the Company's Form 10-K, in other filings with the Securities and Exchange Commission, in the Company's press releases and in oral statements made to securities market analysts and stockholders, which are not historical or current facts, are "forward-looking statements" made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties that could cause the Company's actual results to differ materially from historical earnings and those presently anticipated or projected. Examples of such forward-looking statements include: (i) the last paragraph under the heading "Business-Research and Development" concerning the development and timing of the introduction of the Imaggia system, (ii) the last sentence of the second paragraph under the subheading "Market Risk" concerning unrealized
gains or losses from foreign operations, and (iii) the last sentence of the second paragraph under the subheading "Liquidity and Capital Resources" concerning adequacy of working capital. The factors mentioned under the subheading "Factors Affecting Results of Operations" are among those that in some cases have affected and in the future could affect the Company's actual results and could cause the Company's actual financial performance to differ materially from that expressed in any forward-looking statement.
ITEM 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The qualitative and quantitative disclosures about market risk are included in Item 7
ITEM 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION AND TRANSACTIONS
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
SIGNATURES
Form 10-K-Item 14(a)(1) and (2)