SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended June 30, 1998 Commission file number 0-12829
GRADCO SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Nevada 95-3342977
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3753 Howard Hughes Pkwy, Ste 200,
Las Vegas, Nevada 89109
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (702) 892-3714
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
------- -------
Applicable Only to Corporate Issuers:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
Number of Shares Outstanding
Class at June 30, 1998
------------- ----------------------------
Common Stock, without
par value 7,909,598
GRADCO SYSTEMS, INC.
INDEX
Page Number
Part I. Financial Information:
Consolidated Balance Sheets
at June 30, 1998 and March 31, 1998 3
Consolidated Statements of Income
for the Three Months Ended
June 30, 1998 and June 30, 1997 4
Consolidated Statements of Cash Flows
for the Three Months Ended
June 30, 1998 and June 30, 1997 5-6
Notes to Unaudited Consolidated Financial Statements 7-10
Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-13
Part II. Other Information 14
-2-
GRADCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
June 30, March 31,
1998 1998
------------ ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $13,407 $ 8,691
Accounts receivable, net 18,746 29,930
Inventories 2,244 1,608
Deferred income taxes 2,591 552
Other current assets 735 166
------- -------
Total current assets 37,723 40,947
Furniture, fixtures and equipment, net 1,213 1,290
Excess of cost over acquired net assets 1,223 1,234
Deferred income taxes 1,142 1,571
Other assets 3,313 3,429
------- -------
$44,614 $48,471
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,926 $10,241
Notes payable to suppliers 11,092 9,849
Accrued expenses 892 1,077
Income taxes payable 358 2,527
Current installments of long-term debt 11 13
------- -------
Total current liabilities 21,279 23,707
Long-term debt, excluding current installments - 2
Non-current liabilities 980 1,024
Excess of fair value of net assets acquired
over cost 1,500 1,600
Minority interest 583 665
Shareholders' equity:
Common stock, no par value; authorized
30,000,000 shares, 7,909,598 and
7,854,598 shares outstanding June 30, 1998
and March 31, 1998, respectively 45,564 45,325
Accumulated deficit (24,613) (23,972)
Currency translation adjustment (679) 120
------- -------
20,272 21,473
------- -------
$44,614 $48,471
======= =======
See accompanying notes to consolidated financial statements.
-3-
GRADCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(Unaudited)
Three Months Ended
----------------------
June 30, June 30,
1998 1997
---------- ----------
Revenues:
Net sales $23,132 $39,802
Development engineering services 251 295
Licenses and royalties 569 665
------- -------
23,952 40,762
------- -------
Costs and expenses:
Cost of sales 18,385 32,077
Research and development 836 960
Selling, general and administrative 1,954 2,582
Provision for doubtful Mita receivable 5,000 -
------- -------
26,175 35,619
------- -------
Income (loss) from operations (2,223) 5,143
Interest expense (1) (1)
Interest income 49 36
------- -------
Earnings (loss) before income taxes
and minority interest (2,175) 5,178
Income tax expense (1,474) 2,381
Minority interest (60) 1,023
------- -------
Net earnings (loss) $ (641) $ 1,774
======= =======
Basic earnings (loss) per common share $ (0.08) $ .23
======= =======
Average shares outstanding, basic EPS 7,857 7,799
======= =======
Diluted earnings (loss) per common share $ (0.08) $ .23
======= =======
Average shares outstanding, diluted EPS 7,857 7,851
See accompanying notes to consolidated financial statements.
-4-
GRADCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Three Months Ended
----------------------
June 30, June 30,
1998 1997
-------- --------
Cash flows from operating activities:
Net (loss) income $ (641) $ 1,774
------- -------
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 208 268
Amortization (2) 354
Deferred income taxes (1,643) 85
Provision for losses on accounts receivable 5,047 -
Stock-based compensation 83 -
Minority interest (60) 1,023
Decrease (increase) in accounts receivable 5,543 (13,087)
Increase in inventories (643) (144)
Increase in prepaid assets (591) (44)
Increase in other assets (511) (54)
(Decrease) increase in accounts payable (1,117) 1,352
Increase in notes payable to suppliers 1,687 9,530
(Decrease) increase in accrued expenses (169) 148
(Decrease) increase in income taxes payable (2,123) 943
(Decrease) increase in other liabilities (9) 56
------- -------
Total adjustments 5,700 430
------- -------
Net cash provided by operations 5,059 2,204
------- -------
Cash flows from investing activities:
Acquisition of property and equipment (155) (116)
------- -------
Net cash used in investing activities (155) (116)
------- -------
-5-
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
Three Months Ended
----------------------
June 30, June 30,
1998 1997
-------- --------
Cash flows from financing activities:
Repayment of notes in excess of three months (4) (3)
Proceeds from exercise of stock options 156 -
------- -------
Net cash provided by (used in)
financing activities 152 (3)
------- -------
Effect of exchange rate changes on cash (340) 1,123
------- -------
Net increase in cash and cash equivalents 4,716 3,208
Cash and cash equivalents at beginning of period 8,691 18,335
------- -------
Cash and cash equivalents at end of period $13,407 $21,543
======= =======
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest $ 1 $ 1
Income taxes 2,338 1,231
See accompanying notes to consolidated financial statements.
-6-
GRADCO SYSTEMS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: INTERIM ACCOUNTING POLICY
The accompanying consolidated financial statements include the accounts of
Gradco Systems, Inc. and its wholly and majority-owned subsidiaries (the
"Company"). All significant intercompany balances and transactions have been
eliminated in consolidation.
In the opinion of the Company's management, the accompanying unaudited
statements include all adjustments (which include only normal recurring
adjustments) necessary for a fair presentation of the financial position of the
Company at June 30, 1998 and the results of operations and cash flows for the
three months ended June 30, 1998 and 1997. Although the Company believes that
the disclosures in these financial statements are adequate to make the
information presented not misleading, certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to the rules and regulations of the Securities and Exchange
Commission. Results of operations for interim periods are not necessarily
indicative of results of operations to be expected for the full year.
Foreign currency translation gains of $426,000 and $167,000 are included in
selling, general and administrative expenses for the three months ended June
30, 1998 and 1997, respectively.
The financial information included in this quarterly report should be read in
conjunction with the consolidated financial statements and related notes
thereto in the Company's Annual Report on Form 10-K for the fiscal year ended
March 31, 1998.
NOTE 2: INVENTORIES
Inventories are summarized as follows:
(Dollars in Thousands)
June 30, March 31,
1998 1998
--------- ---------
Raw materials $ 142 $ 128
Work-in-process 1,669 992
Finished goods 433 488
------ ------
$2,244 $1,608
====== ======
NOTE 3: INCOME TAXES
The effective consolidated income tax rate used by the Company is based on the
estimated annual effective tax rates for the fiscal years in the countries
where the Company operates applied to results of the quarter.
-7-
GRADCO SYSTEMS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4: NET EARNINGS PER SHARE
Basic EPS is computed by dividing net income by the weighted average number of
common shares outstanding during the period. Diluted EPS reflects the
potential dilution that could occur if stock options and other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the entity.
For the current quarter, there is no difference in the average shares
outstanding between diluted and basic because there was a net loss for the
quarter. For all periods presented, the net earnings available to common
shareholders is the same for both basic and diluted EPS and is equal to the net
earnings or loss stated in the Consolidated Statements of Income. Basic and
diluted EPS do not differ materially from earnings per share previously
presented. A reconciliation of the average number of outstanding shares used
in the computation of basic EPS to that used in the computation of diluted EPS
is shown in the following table (in thousands):
Three Months Ended
----------------------
June 30, June 30,
1998 1997
-------- --------
Average shares outstanding, basic EPS 7,857 7,799
Effect of dilutive securities:
Stock options - 52
------ ------
Average shares outstanding, diluted EPS 7,857 7,851
====== ======
NOTE 5: COMPREHENSIVE INCOME
Effective in the first quarter of fiscal 1999, the Company adopted Statement of
Financial Accounting Standards No. 130 ("SFAS 130"), REPORTING COMPREHENSIVE
INCOME. SFAS 130 establishes standards for reporting and displaying of
comprehensive income and its components in the Company's consolidated financial
statements. Comprehensive income is defined in SFAS 130 as the change in
equity (net assets) of a business enterprise during a period from transactions
and other events and circumstances from nonowner sources. Total comprehensive
income was a loss of $1,056,000 and income of $2,238,000 for the three months
ended June 30, 1998 and 1997, respectively. The difference from net income or
loss as reported is the tax affected change in the cumulative currency
translation adjustment.
NOTE 6: NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION. This statement, which will become
effective in fiscal 1999, expands or modifies disclosures and will have no
impact on the Company's consolidated financial position, results of operations
or cash flows.
-8-
GRADCO SYSTEMS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7: COMMITMENTS AND CONTINGENCIES
In the following litigation, material claims have been asserted against the
Company:
HAMMA V. GRADCO SYSTEMS, INC. ET AL., DUBOIS V. GRADCO SYSTEMS, INC. ET AL. In
March 1988, the Company and its (now former) president, Keith Stewart, were
sued in the U.S. District Court in Connecticut by John C. Hamma and R. Clark
DuBois, both of whom are former employees of the Company. The complaints in
the two cases, which were consolidated for certain pretrial purposes, primarily
allege misrepresentation and fraudulent concealment by Gradco and Mr. Stewart
in connection with agreements entered into in 1982 with Mr. Hamma and in 1983
with Mr. DuBois terminating and releasing the Company from royalty obligations
under prior royalty agreements. The complaints, which have been amended a
number of times, seek unspecified damages and other relief. For each of these
cases, the Court bifurcated the liability and damages issues so that an initial
trial would determine whether liability exists and, if so, a subsequent trial
would determine damages.
In March 1992, each plaintiff filed an Application for Prejudgment Remedy
against the Company and Gradco (Japan) Ltd. ("GJ") seeking to attach
$10,000,000 of assets of each of these two defendants. This Application was
dismissed as respects GJ. In November 1992, the Company and the plaintiffs
agreed in principle to a Consent Order instead of proceeding with a hearing on
the Application. If during the pendency of the lawsuits the Company desires to
sell, transfer or take any other action which would affect its ownership of
stock in GJ, it has agreed to give 30 days prior notice to the plaintiffs, who
will then be permitted, if they so request, to renew the Application within the
notice period. Should plaintiffs do so, the Company has agreed to forbear from
proceeding with any such transaction for a limited period. The Company would
vigorously oppose a renewed Application. Management believes that the Consent
Order is in the Company's best interests because it precludes any attachment of
the Company's assets until such time as a proposed transaction which would
affect its ownership of stock in GJ may arise, and it avoids the legal expense
which would have resulted from a current hearing on the Application.
In June 1995, a jury found the Company to have liability in the lawsuit filed
by John C. Hamma and the Company filed a motion in August 1995 to reverse the
verdict.
In July 1995, the plaintiffs filed another Application for a Prejudgment Remedy
("July PJR Application") seeking to attach Gradco Systems' assets. The July
PJR Application sets forth various theories of damages including a theory
calling for treble damages under Connecticut law in the amount of $70,500,000.
The July PJR Application asserts that there is probable cause that a verdict in
an amount greater than $70,500,000 will be rendered in the damages part of the
case after trial on those issues. It is Gradco's belief that damages based on
applicable law would result in a significantly smaller damages award even if
the motion by Gradco for judgment as a matter of law is denied. The Court has
determined that it will rule on the July PJR Application only after ruling on
the August 1995 motion for judgment as a matter of law.
-9-
GRADCO SYSTEMS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7: COMMITMENTS AND CONTINGENCIES (Continued)
In November 1995, the Court ordered the plaintiffs to submit a memorandum
regarding the legal theories on which they based their damages claims and for
the defendants to respond. This issue is under consideration by the Court. If
Gradco's view prevails, the magnitude of damages, even should the August 1995
motion prove unavailing, will be reduced substantially from the amount sought
in the July PJR Application.
In July 1998, the Court issued a decision on the Company's August 1995 motion,
sustaining the jury verdict on all issues other than a RICO claim against Keith
Stewart. The Court has not yet ruled on the proper measure of damages, which
ruling the Company believes is necessary before discovery and trial on the
issue of damages can take place. The Court has also not yet ruled on the July
PJR Application.
The Court has permitted the Company to file a motion for reconsideration of the
Court's decision as it relates to recision of the release agreement executed by
Hamma in 1982. The Company expects to file this motion on August 14, 1998.
The Company is presently unable to determine the amount of damages which is
likely to be awarded, but the amount of damages sought by the plaintiffs,
including punitive damages, could only be settled from assets of Gradco
Systems, Inc. (which consist primarily of the capital stock of its
subsidiaries). An award of damages of the magnitude sought by the plaintiffs
could have a material adverse effect on the Company's financial position and
might threaten the Company's existence as an ongoing enterprise. Gradco
(Japan) Ltd., Gradco (USA) Inc. and Venture Engineering, Inc. are not parties
to the lawsuit and any judgment awarded will not affect their operations, since
those operations are independent of Gradco Systems, Inc.
There are substantial differences between the Hamma and DuBois cases. Although
the DuBois case will also be tried before a jury so that there are substantial
elements of uncertainty, the Company continues to believe that the DuBois case
alone will not have a material adverse effect on its consolidated financial
position, or on its results of operations or liquidity.
NOTE 8: SUBSEQUENT EVENT
On August 10, 1998, the Company learned that Mita Industrial Co. Ltd. ("Mita"),
one of GJ's largest customers, had filed a petition in Japan along with five of
its affiliates for the Japanese equivalent of a Chapter XI Reorganization. The
Company has established an allowance of $5,000,000, representing nearly all of
Mita's indebtedness to Gradco as of June 30, 1998. On an after tax and
minority interest basis, this charge amounted to $2,529,000 or $.32 per share.
-10-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In addition to historical information, management's discussion and analysis
includes certain forward-looking statements, including those related to the
Company's growth and strategies, regarding events and financial trends that may
affect the Company's future results of operations and financial position. The
Company's actual results and financial position could differ materially from
those anticipated in the forward-looking statements as a result of competition,
general economic and business conditions, changes in technology, fluctuations
in the rates of exchange of foreign currency and other risks and uncertainties
over which the Company has little or no control.
The Company's operations are conducted principally through its wholly-owned
subsidiaries Venture Engineering, Inc. ("Venture") and Gradco (USA) Inc. ("GU")
and its majority-owned subsidiary Gradco (Japan) Ltd. ("GJ"). Venture performs
contract engineering and manufacturing services for OEMs and other customers,
primarily for the U.S. market. GJ and GU design, develop, produce (by
contract) and market on a worldwide basis, intelligent paper handling devices
for office copiers, computer controlled printers and facsimile machines.
GJ and GU operate jointly in the development and marketing of products to their
customer base, primarily OEMs. Both companies sell into the U.S. domestic and
foreign marketplace at similar profit margins, after elimination of
intercompany profits. Sales are denominated for the most part in Japanese yen
and U.S. dollars, corresponding to the currency charged for the product by the
contract manufacturer. Although the gross profit margin percentage is thus
protected from foreign currency fluctuations, translation gains and losses can
still occur when receivables and payables are denominated in other than the
local currency of each company.
RESULTS OF OPERATIONS
Revenues for the three months ended June 30, 1998 decreased $16,810,000 from
the amount in the prior year's first quarter principally from a 42% decrease in
net sales, reflecting a 40% reduction in unit sales in the copier market. Unit
sales in the first quarter of the prior year were abnormally high because of
the introduction of a new product line which resulted in a temporary spike in
demand as customers purchased the new products before phasing out the old
versions. When compared to the preceding quarter, unit sales were only down
6%. Sales denominated in yen were $1.8 million lower than they would have been
had the yen not decreased by 13% against the dollar when compared to the same
period in the previous year.
Gross margin on net sales increased to 20.5% from 19.4% for the three months
ended June 30, 1998 and June 30, 1997, respectively, reflecting improved
margins at Venture.
Research and development expenses ("R&D") in the current quarter totaled
$836,000, 3.5% of revenues, compared to $960,000, 2.4% of revenues, in the
prior year's comparable period.
-11-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Selling, general and administrative expenses ("SG&A") in the current quarter
totaled $1,954,000, 8.2% of revenues, compared to $2,582,000, 6.3% of revenues,
in the prior year's comparable period, a decrease of $628,000. Approximately
$243,000 of this decrease is due to the favorable translation of SG&A at the
Company's Japanese subsidiary ("GJ") caused by the weaker yen and there was an
increase of $259,000 in foreign currency translation gains in the current
quarter. In addition to the normal SG&A expenses, the Company has taken a
$5,000,000 charge in the current quarter due to the bankruptcy petition filed
by one of GJ's largest customers. For further information regarding this
situation, see Note 8 of Notes to Unaudited Consolidated Financial Statements.
As a result of the above factors, earnings before income taxes and minority
interest decreased to a loss of $2,175,000 in the current quarter from income
of $5,178,000 in the first quarter of fiscal 1998. The effective tax rate
increased to 67.8% from 46.0% because there was pre-tax income generated
domestically and a pre-tax loss in Japan where the tax rate is considerably
higher.
Minority interest decreased more than proportionally due to the buyback of GJ
shares in the second and third quarters of the prior year which increased the
Company's ownership in GJ from 58.6% to 97.3%.
FINANCIAL CONDITION
Working capital decreased to $16,444,000 at June 30, 1998 from $17,240,000 at
March 31, 1998. At June 30, 1998, the Company had $13,407,000 in cash, an
increase of $4,716,000 from March 31, 1998, and no long-term debt. $5.1
million of cash was provided by operations. $3.0 million was provided by net
earnings before non-cash provisions for depreciation, amortization, deferred
taxes, provision for losses on accounts receivable and stock-based
compensation. $5.5 million was provided by a decrease in accounts receivable
and $1.7 million from an increase in notes payable to suppliers. $1.7 million
was used to fund increases in inventories, prepaid expenses and other assets
and $3.4 to pay down accounts payable, income taxes payable and accrued
expenses. Cash decreased $0.3 million as a result of exchange rate changes.
GJ has informal credit facilities with a Japanese bank. There were no
borrowings under this facility at June 30, 1998.
The Company believes that its cash and credit facilities are adequate for its
short and long-term operational needs. At June 30, 1998, there were no
material commitments for capital expenditures.
further information regarding this litigation, see Note 6 of Notes to Unaudited
Consolidated Financial Statements.
-12-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In June 1995, a jury found the Company to have liability in a lawsuit by John
C. Hamma, a former employee. In July 1998, in response to a motion filed by
the Company in August 1995, the Court sustained the jury verdict on all issues
other than a RICO claim against Keith Stewart, which the Court dismissed. A
separate proceeding to determine the amount of damages is now required. An
award of damages of the magnitude sought by Mr. Hamma could have a material
adverse effect on the Company's financial position and might threaten its
existence as an ongoing enterprise. The Company believes that as a matter of
law the damages claimed by Mr. Hamma are excessive to a substantial extent.
For further information regarding this litigation, see Note 7 of Notes to
Unaudited Consolidated Financial Statements.
The lawsuit by R. Clark DuBois, a former employee, has not yet been tried.
Although the case will be tried before a jury, so that there are substantial
elements of uncertainty, the Company continues to believe that the DuBois case
alone will not have a material adverse effect on its consolidated financial
position, or on its results of operations or liquidity.
Impact of the Year 2000
The Registrant and its subsidiaries have addressed the impact of the year
2000 on their internal accounting and operating systems and have determined
that these systems are Year 2000 compliant as a result of the recent purchases
of computer software upgrades. The Registrant is completing an assessment of
how its interface with customers and suppliers, through sales and purchase
orders might be impacted. This assessment is expected to be completed before
the end of the current fiscal year. To date, there do not appear to be any
issues which would have a material impact on the Registrant's results of
operations, liquidity or capital resources.
-13-
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information regarding the current status of the Hamma and DuBois
lawsuits, contained in Note 7 of Notes to Unaudited Consolidated
Financial Statements set forth in Part I of this Report, is hereby
incorporated by reference in response to this Item 1.
ITEM 2. CHANGES IN SECURITIES
Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
None.
(b) Reports on Form 8-K.
None.
-14-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GRADCO SYSTEMS, INC.
Registrant
By:
Date: August 13, 1998 HARLAND L. MISCHLER
Harland L. Mischler
Executive Vice President, Chief Financial Officer
(Principal Financial and Chief Accounting Officer)
-15-
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This schedule contains summary financial information extracted from the 6/30/98
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