U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
(Mark One)
X Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the quarterly period ended September 30, 1998
Transition report under Section 13 or 15(d) of the Exchange Act For the
transition period from __________________ to _________________
Commission file number 000-20731
PHOTRAN CORPORATION
(Exact Name of Small Business Issuer as Specified in Its Charter)
MINNESOTA 41-1697628
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
21875 GRENADA AVENUE
LAKEVILLE, MN 55044
(Address of Principal Executive Offices)
(612) 469-4880
(Issuer's Telephone Number, Including Area Code)
(Former Name, Former Address and Former Fiscal Year, if Changed Since
Last Report)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 ____________.
The number of the registrant's common shares outstanding as of November 12, 1998
was 5,556,024
Transitional Small Business Disclosure Format (check one):
Yes____________ No ______X______.
<PAGE>
PHOTRAN CORPORATION
FORM 10-QSB
TABLE OF CONTENTS
PAGE
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Balance Sheets 2
Statements of Operations 3
Statements of Cash Flows 4
Notes to Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
PART II OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 3. Defaults Upon Senior Securities 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
Signature page 20
Exhibit Index 21
1
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
PHOTRAN CORPORATION
BALANCE SHEETS (UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 75,575 $ 46,107
Accounts and notes receivable 303,033 722,113
Inventory 850,770 387,000
Prepaid expenses 53,978 37,814
Marketable securities, restricted 2,250,000
------------ ------------
Total current assets 1,283,356 3,443,034
PROPERTY AND EQUIPMENT, net 17,106,900 18,535,149
------------ ------------
$ 18,390,256 $ 21,978,183
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long term debt,
notes payable, and capital lease obligations 9,041,477 5,613,143
Borrowings under line of credit 516,526
Accounts payable 1,991,171 1,804,846
Accrued expenses 785,882 713,893
Customer advances and arbitration settlement payable 2,724,538
------------ ------------
Total current liabilities 12,335,056 10,856,420
LONG TERM DEBT, NOTES PAYABLE AND CAPITAL LEASE
OBLIGATIONS, less current portion 34,671 1,023,653
LITIGATION SETTLEMENT ACCRUAL (Note 6) 2,000,000
COMMITMENTS AND CONTINGENCIES (Notes 6 and 7)
SHAREHOLDERS' EQUITY
Undesignated stock, no par value, 6,000,000 shares
authorized, no shares issued
Common stock, no par value, 24,000,000 shares authorized,
5,556,024 and 5,230,303 shares issued and outstanding,
respectively 26,168,334 24,824,175
Accumulated deficit (22,147,805) (14,726,065)
------------ ------------
Total shareholders' equity 4,020,528 10,098,110
------------ ------------
$ 18,390,256 $ 21,978,183
============ ============
</TABLE>
See notes to financial statements.
2
<PAGE>
PHOTRAN CORPORATION
STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES $ 164,895 $ 1,135,462 $ 2,775,007 $ 2,571,321
COST OF SALES 722,689 1,142,765 3,584,933 3,145,207
----------- ----------- ----------- -----------
Gross loss (557,794) (7,303) (809,926) (573,886)
OPERATING EXPENSES:
Process and product development and engineering 224,555 223,591 775,931 425,761
General and administrative 341,703 614,347 1,269,595 1,383,368
Selling and marketing 28,068 88,964 196,695 335,452
Arbitration settlement expense 689,565 689,565
Asset impairment charge 2,162,000 2,162,000 198,710
----------- ----------- ----------- -----------
Total operating expenses 2,756,326 1,616,467 4,404,221 3,032,856
----------- ----------- ----------- -----------
LOSS FROM OPERATIONS (3,314,120) (1,623,770) (5,214,147) (3,606,742)
LITIGATION SETTLEMENT EXPENSE 19,909 2,119,909
INTEREST INCOME, net 45,806 (20,216) 93,358 (73,548)
OTHER EXPENSE (INCOME), net (5,375) (2,675) (5,674) (23,983)
----------- ----------- ----------- -----------
NET LOSS $(3,374,460) $(1,600,879) $(7,421,740) $(3,509,211)
=========== =========== =========== ===========
BASIC AND DILUTED LOSS PER
COMMON SHARE $ (0.61) $ (0.31) $ (1.36) $ (0.68)
=========== =========== =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING (BASIC AND DILUTED) 5,556,024 5,167,433 5,449,842 5,159,887
=========== =========== =========== ===========
</TABLE>
See notes to financial statements.
3
<PAGE>
PHOTRAN CORPORATION
STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(7,421,740) $(3,509,211)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation and amortization - property and
equipment 693,776 717,186
Loss on disposal of fixed assets 16,201
Non-cash asset impairment charges 2,162,000
Non-cash arbitration settlement expense 2,039,981 689,565
Non-cash loss on lease restructuring 49,586
Non-cash consulting expense 12,000
Changes in assets and liabilities that provided (used) cash:
Accounts and notes receivable 192,088 20,737
Inventory (463,770) 207,944
Prepaid expenses (16,164) 99,358
Accounts payable 223,913 7,576
Accrued expenses 119,461 (92,529)
Customer advances and arbitration settlement payable (1,500,000)
----------- -----------
Cash used in operating activities (3,954,254) (1,797,788)
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (1,511,633) (3,177,495)
Purchases of marketable securities (2,250,000)
----------- -----------
Cash used in investing activities (1,511,633) (5,427,495)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable and long-term debt 4,830,160 5,500,000
Payments of notes payable and long-debt (141,785) (314,871)
Borrowings under line of credit, net 516,526
Common stock and warrants issued 290,454 107,500
----------- -----------
Cash provided by financing activities 5,495,354 5,292,629
----------- -----------
INCREASE (DECREASE) IN CASH 29,468 (1,932,654)
CASH AT BEGINNING OF PERIOD 46,107 2,038,955
----------- -----------
CASH AT END OF PERIOD $ 75,575 $ 106,301
=========== ===========
</TABLE>
See notes to financial statements.
4
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying financial statements are unaudited and reflect all
adjustments (consisting only of normal recurring adjustments, except the
litigation settlement accrual and asset impairment charges), which are, in
the opinion of management, necessary for a fair presentation. Operating
results for the three- and nine-month periods ended September 30, 1998 are
not necessarily indicative of the results that may be expected for the
year ending December 31, 1998. Certain reclassifications have been made to
the 1997 financial statements to conform to the 1998 presentation. These
reclassifications had no effect on net loss or shareholders' equity as
previously reported. Comprehensive loss, as defined by Statement of
Financial Accounting Standards (SFAS) No. 130, REPORTING COMPREHENSIVE
INCOME, was the same as net loss for the three- and nine-month periods
ended September 30, 1998 and 1997.
These financial statements should be read in conjunction with the
financial statements and notes thereto for the year ended December 31,
1997, filed with the Securities and Exchange Commission (SEC) as part of
the Company's Annual Report on Form 10-KSB.
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company
has incurred cumulative losses aggregating $22,147,805 since its
inception, and incurred negative cash flows from operating activities of
$3,954,254 for the nine months ended September 30, 1998. In addition, at
September 30, 1998, the Company had a working capital deficiency of
$11,051,700. These factors, among others, indicate the Company may be
unable to continue as a going concern for a reasonable period of time.
The financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts
and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern. As described below and
in Note 4, at September 30, 1998, the Company was not in compliance with
the terms of two lease agreements and certain loan obligations and has
been unable to cure or obtain waivers for the defaults. The Company has
reached an agreement in principal with the lender to restructure the
leases, however this transaction has not been finalized as of the filing
date of this report. Accordingly, the balances of the lease obligations
(approximately $3,100,000) and loan obligations (approximately $5,864,000)
have been classified as current liabilities. In addition, as described in
Notes 6 and 7, the Company is currently under investigation by the SEC,
and is the defendant in a number of legal actions which have been
tentatively settled as of the filing date of this report. However,
significant management time and financial resources could be required to
completely resolve these matters.
The Company's continuation as a going concern is dependent on its ability
to generate sufficient cash flow to meet its obligations on a timely
basis, to achieve acceptable resolutions of the defaulted lease and loan
obligations and to comply with the terms and conditions of all its
financing agreements going forward, to obtain additional financing or
refinancing as may be required; and to successfully resolve the SEC
investigation and the various other legal actions, to obtain agreement
from its vendors regarding repayment plans on its past due trade payables,
and ultimately to attain sales and operating levels sufficient to achieve
profitability.
Management is continuing its efforts to control costs, diversify its
product lines, and secure orders from new customers, so the Company can
meet its obligations and sustain its operations. As discussed in more
detail in Note 2, however, management has determined that it will be
necessary to sell certain production assets in order to achieve these
objectives. As of September 30, 1998, the Company's principal sources of
liquidity included cash and cash equivalents of $75,575 and net
5
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
accounts receivable of $303,033, as well as an $833,000
transaction-specific working capital line of credit against which there
were borrowings of $516,526 outstanding as of September 30, 1998. In July
of 1998 the Company entered into a $2,500,000 private debt placement (see
Note 7). At September 30, 1998 $1,296,000 had been advanced under the
terms of the debt agreement. This financing is intended to allow the
Company to complete the construction and installation of its P-2
(construction and installation were completed in the third quarter) and
P-3 production lines, sustain its operations during the current market
slowdown, as well as allow for the potential early buyout on a pending
lease restructuring on the defaulted lease obligations discussed above.
The funding of a portion of this debt placement is contingent upon a
number of factors, including the consummation of the pending restructured
lease agreement and the ability of the Company to attain certain
production and cash flow levels. Due to the uncertainties surrounding the
timing of the reversal of the current slowdown in the market for the
Company's existing products and the Company's ability to generate sales of
new products to new customers, management believes that the Company's
existing sources of liquidity and anticipated funds from operations,
combined with the balance of proceeds to be received from the $2,500,000
private debt placement, will be insufficient to satisfy the Company's
projected working capital and capital expansion requirements.
2. ASSET IMPAIRMENT CHARGES
In response to current market conditions, the Company's debt and lease
defaults, significant past-due accounts payable, and cash flow shortage,
the Company has determined that it is necessary to sell the P-1 and P-2
production lines. During the third quarter of 1998, the Company has made
significant progress in completing the P-3 production line and expects
that line to be fully operational in the fourth quarter of 1998. The
expected capacity of the P-3 line is more than the combined capacity of
the P-1 and P-2 lines and is expected to be sufficient to meet the
Company's estimated demand for ITO coated glass for the foreseeable
future. Any proceeds from the equipment sales will be used to reduce debt
and for working capital purposes. However, even with these proceeds the
Company may still not be able to satisfy its projected working capital and
capital expansion requirements.
During the third quarter of 1998, the Company decided to sell the P-1 and
P-2 production lines. However, because the P-3 line is not yet available
for production, the P-1 and P-2 have not been classified as "assets to be
disposed of."
As a result of reductions in the market price for ITO coated glass
experienced during the third quarter of 1998 and a continued softness in
market demand, cash flows from anticipated P-1 and P-2 production from
September 30, 1998 through the date of disposal are expected to be
nominal. Accordingly, management has estimated the future undiscounted
cash flows to be generated from the P-1 and P-2 lines based upon the
expected net proceeds from the sale of these assets. Based upon this
analysis, the carrying value of these assets exceeded the estimated net
proceeds from the sale by $2,162,000 indicating that these assets are
impaired at September 30, 1998. Accordingly, during the third quarter of
1998, the Company recorded an impairment charge to reduce the carrying
value of these assets to their estimated fair value.
Due to the nature of these assets, the extremely competitive ITO market,
and the Company's inability to wait for the market to stabilize, it is
very difficult to estimate the net proceeds to be realized upon the sale
of the assets. Accordingly, as management continues to market these
assets, it is possible that additional write-downs may be required and
such write-downs may be significant.
6
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
3. INVENTORIES
Inventories consist of the following:
September 30, December 31,
1998 1997
------------ ------------
Raw materials and supplies at cost $ 642,683 $ 562,254
Finished goods 393,096 65,355
------------ ------------
1,035,779 627,609
Less obsolescence reserve 185,009 240,609
------------ ------------
$ 850,770 $ 387,000
============ ============
4. LONG-TERM DEBT AND CAPITAL LEASES
In February 1998, the Company issued a $3,500,000 convertible note in a
private financing transaction. The funds were used primarily to fund the
$1,500,000 settlement with the Company's former Chinese joint venture
partner, and to sustain its operations and to continue the construction
and installation of the Company's P-2 and P-3 production lines. The note
bears interest at 10 percent per annum and matures in August 1999. All
principal and accrued interest are payable at maturity, but may be prepaid
at any time without penalty. The note and all accrued interest are
convertible into shares of common stock of the Company at the option of
the lender at any time up to 30 days following maturity, at a rate of
$4.00 per share (amended to $2.25 per share, see below). The note is
secured by an interest in substantially all of the fixed assets of the
Company, except the P-3 production line which is the subject of a
sale-leaseback transaction. In connection with this transaction, the
Company issued to the lender five-year warrants to purchase a total of
1,225,000 shares of common stock of the Company at $4.00 per share.
Original issue discount of approximately $90,000 was recorded as interest
in the first quarter and was capitalized to construction in progress. The
conversion price of the principal and accrued interest and the exercise
price of the warrants are subject to certain anti-dilution provisions (see
Note 7).
In July 1998, the Company closed on a $2,500,000 private financing
transaction. Of this amount, $1,500,000 will be used to sustain the
Company's operations, to fund the down payment of the pending restructured
lease agreement discussed below, and to complete the construction and
installation of the Company's P-2 (construction and installation completed
during the third quarter) and P-3 production lines. As of September 30,
1998, $1,296,000 has been advanced under the terms of the note. The
remaining $1,000,000 available under the $2,500,000 private financing is
intended to assist the Company in exercising the incentive buyout options
under the proposed restructured lease agreement. The funding of this
portion of the placement is contingent upon the Company finalizing the
lease agreement, achieving certain operating levels, and maintaining
certain other covenants. As of September 30, 1998 the Company had not
achieved set operating levels and was not in compliance with the necessary
covenants. The $1,500,000 note bears interest at 10 percent per annum and
matures in January 2000. All principal and accrued interest are payable at
maturity, but may be prepaid at any time without penalty. The $1,000,000
note would bear interest at 12 percent per annum, and require monthly
payments of $25,000 until maturity in January 2000. The outstanding
principal of both notes and all accrued interest are convertible into
shares of common stock of the Company at the option of the lender at any
time up to 30 days following maturity, at a rate of $2.25 per share. The
notes are secured by an interest in substantially all of the fixed assets
of the Company, except the P-3 production line, unless and until such time
as the Company buys out the lease on such line, at which time it also
becomes part of the security under the notes. In connection with this
transaction, the Company issued to the lender five-year warrants to
purchase a total of 800,000 shares of common stock of the Company at $2.25
per share. The Company will issue additional warrants to purchase a total
of 200,000 shares of common stock of the Company at $2.25
7
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
when and if the $1,000,000 note funds are advanced. Original issue
discount of approximately $28,000 was recorded as interest in the first
quarter and was capitalized to construction in progress.
As a result of this transaction, in accordance with the original terms of
the $3,500,000 private financing transaction discussed above, the
conversion or exercise price of certain outstanding securities of the
Company has been reduced to $2.25 per share.
In the third quarter of 1998, the Company was unable to continue to make
payments required under the terms of the shareholder loan discussed below.
The Company has not yet resolved the defaults on this loan. Under the
terms of the convertible notes, in the event of a default on any financial
obligation, the Company is in default on the convertible notes and can be
required to immediately repay all principal and accrued interest.
Accordingly, the entire principal and accrued interest balances of
approximately $4,796,000 and $192,000, respectively have been classified
as current liabilities at September 30, 1998.
In October 1997, the Company was unable to continue to make payments on
certain of its lease obligations. As of December 31, 1997, the Company was
in default on two leases which aggregated approximately $5,400,000,
including the sale-lease back transaction on the Company's P-3 line. The
Company has not yet resolved the defaults on these transactions. Under the
terms of the leases, in the event of a default, the Company can be
required to immediately pay all future lease payments under the lease.
During the first quarter of 1998, the lessor demanded payment of such
amounts and requested the trustee holding the $2,250,000 in marketable
securities which were being held as a compensating balance to liquidate
the account and forward the proceeds to the lessor in partial payment of
amounts owed by the Company. The Company is attempting to negotiate a
restructuring of the leases with the lender, and has reached an agreement
in principle on such a restructuring. The restructuring, which is subject
to certain approvals by the lender and completion of final documentation,
requires an immediate down payment of approximately $131,000 and monthly
payments of $27,500 over the 24-month term of the lease. The proposed
restructured lease would require a balloon payment of $1,800,000 at the
end of the lease, but would contain incentive buyout options at earlier
times during the lease. Pending the closing of the restructured agreement,
the remaining gross lease payments on the leases currently in default,
including past due payments, of approximately $3,100,000 have been
classified as current liabilities at September 30, 1998. At such time as
the restructured lease is finalized, the recorded liability will be
reduced to the total of the future payments under the lease, and the
difference will be recorded as an extraordinary gain in that period.
In the third and fourth quarters of 1997, the Company obtained a loan from
a shareholder who is also a director in the amount of $1,100,000. In
connection with the loan, the Company issued to the shareholder warrants
for the purchase of 110,000 shares of the Company's common stock at a
price of $4.00 per share. The warrants are exercisable between September
1998 and September 2007. In February 1998, as consideration for extension
of the $1,100,000 loan and modification of the security agreement
collateralizing the loan, the Company issued a warrant to the shareholder
to purchase 100,000 shares of common stock of the Company at $4.25 per
share. The warrant is exercisable from February 1999 to September 2007.
The estimated fair value of the warrant, as determined by a third party,
is not material. In the third quarter of 1998, the Company was unable to
continue to make payments required under the terms of the loan. The
Company has not yet resolved the defaults on this loan. Under the terms of
the loan, in the event of a default, the Company can be required to
immediately repay all principal and accrued interest. Accordingly, the
entire principal and accrued interest balances of approximately $1,099,000
and $116,000, respectively have been classified as current liabilities at
September 30, 1998.
5. CUSTOMER ADVANCES AND ARBITRATION SETTLEMENT PAYABLE
The Company and its former Chinese joint venture partner, Shenzhen WABO
Group Company Limited (WABO) finalized a negotiated settlement in January
1998 which was approved by the Chinese arbitration board in February 1998.
Under the terms of the settlement, the Company was
8
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
required to pay WABO $1,500,000 in cash and issue 200,000 shares of common
stock to settle all claims in connection with the joint venture contract,
the equipment contract, and related agreements. The cash and common stock
were delivered to WABO in April 1998.
6. LITIGATION SETTLEMENT ACCRUAL
In May of 1997 the Company was served with two separate lawsuits against
the Company, certain officers and directors of the Company, and the
Company's former president. These lawsuits were filed by certain
purchasers of the Company's common stock alleging that the Company's
actions with respect to the financial and accounting irregularities
announced by the Company in March of 1997 artificially inflated its stock
price between May 29, 1996 and March 24, 1997. The plaintiffs in these
actions are seeking class certification. Both suits were filed in the
United States District Court for the District of Minnesota. In July 1997,
the court consolidated these lawsuits into a single action captioned In Re
Photran Corporation Securities Litigation.
In April 1998, all parties to the lawsuit participated in a mediation, and
a tentative settlement was reached, subject to approval by the court.
Under the terms of this tentative settlement, the Company has agreed to
pay $50,000 in cash, issue five-year warrants valued at up to $500,000
(based on a Black-Scholes valuation) to purchase common stock of the
Company for $4.00 per share, and issue shares of common stock worth
$1,725,000 less the value of shares of the Company's stock being
contributed by another defendant. The Company's estimated liability under
this settlement, based on the market price of the Company's common stock
as of the date of the mediation, is $2,050,000. This estimate is subject
to change based on fluctuations in the market price of the Company's
common stock between the date of the tentative settlement and final
approval by the court. The settlement is also contingent upon the
registration of the common stock and the common stock issuable upon
exercise of the warrants within a six-month period following the date of
the tentative settlement.
7. COMMITMENTS AND CONTINGENCIES
In connection with the coating equipment that the Company was building for
sale to its former Chinese joint venture, the Company entered into a
contract with a third party to design and build power supplies to be sold
under the equipment contract, as well as for the Company's own use. The
Company terminated the contract in March 1997. In June 1997, the third
party formally brought an action against the Company in Dakota County
District Court. The third party's demand for damages was $1,300,000. In
April 1998, the Company reached a settlement with the vendor whereby the
Company will give the vendor cash and equipment in exchange for a
promissory note payable to the Company. The settlement was executed and
the assets were exchanged in June 1998, resulting in a non-cash decrease
in property and equipment of $160,000 and an increase in notes receivable
of $70,000.
In April 1997, the SEC informed the Company that it was conducting a
formal investigation with respect to certain financial and accounting
irregularities announced by the Company in March 1997 relating to fiscal
1996. The Company has submitted documents to the SEC pursuant to requests
from the SEC as part of the investigation. The SEC has also interviewed
current and former employees of the Company. In the fourth quarter of
1997, the Company was informed by the SEC that is has expanded its
investigation to include certain accounting and financial reporting
irregularities prior to 1996 which the Company announced in October 1997.
The investigation is not yet completed and it is not possible to determine
what impact, if any, the investigation will have on the Company's
financial condition or results of operations.
In August 1997, the Company was served with a lawsuit by its former
president, David E. Stevenson, demanding the return of certain stock
certificates registered in his name which are currently in the possession
of the Company. In October 1997, the Company filed a counterclaim alleging
that Stevenson had committed fraud and had damaged the Company and that
his shares should be awarded to the Company. The Company further alleged
that Stevenson did not provide adequate consideration for such shares and
that therefore they are not properly issued. In connection with the
9
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
tentative settlement reached in the shareholder class action lawsuit
discussed in Note 6 above, the Company and Mr. Stevenson have agreed to
dismiss all claims against each other upon the closing of the settlement
of the shareholder case.
10
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
THIS FORM 10-QSB CONTAINS FORWARD-LOOKING STATEMENTS AS DEFINED IN SECTION 21E
OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE FORWARD-LOOKING
STATEMENTS INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES, INCLUDING DEMAND FROM
MAJOR CUSTOMERS, EFFECTS OF COMPETITION, CHANGES IN THE PRODUCT OR CUSTOMER MIX
OR REVENUES AND IN THE LEVEL OF OPERATING EXPENSES, RAPIDLY CHANGING
TECHNOLOGIES AND THE COMPANY'S ABILITY TO RESPOND THERETO, THE IMPACT OF
COMPETITIVE PRODUCTS AND PRICING, THE TIMELY COMPLETION OF CONSTRUCTION AND
INSTALLATION, AND THE ACTUAL PERFORMANCE OF NEW MANUFACTURING EQUIPMENT, THE
COMPANY'S ABILITY TO SELL CERTAIN PRODUCTION LINES AND/OR SELL ON TERMS
ACCEPTABLE TO THE COMPANY, THE TIMELY DEVELOPMENT AND ACCEPTANCE OF NEW
PRODUCTS, THE EFFECTS OF THE ASIAN ECONOMIC CRISIS ON THE COMPANY'S CUSTOMERS
AND SUPPLIERS, THE IMPACT OF PENDING AND THREATENED LITIGATION, INADEQUATE
WORKING CAPITAL, CURRENT DEFAULT UNDER CAPITAL LEASES AND OTHER LOAN OBLIGATIONS
AND OTHER FACTORS DISCLOSED THROUGHOUT THIS FORM 10-QSB. THE ACTUAL RESULTS THAT
THE COMPANY ACHIEVES MAY DIFFER MATERIALLY FROM ANY FORWARD-LOOKING STATEMENTS
DUE TO SUCH RISKS AND UNCERTAINTIES. THE COMPANY UNDERTAKES NO OBLIGATION TO
REVISE ANY FORWARD-LOOKING STATEMENTS IN ORDER TO REFLECT EVENTS OR
CIRCUMSTANCES THAT MAY ARISE AFTER THE DATE OF THIS REPORT. READERS ARE URGED TO
CAREFULLY REVIEW AND CONSIDER THE VARIOUS DISCLOSURES MADE BY THE COMPANY IN
THIS REPORT, INCLUDING THE DISCUSSION SET FORTH IN THE SECTION TITLED
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS," AND IN
THE COMPANY'S OTHER REGISTRATION STATEMENTS AND REPORTS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION FROM TIME TO TIME THAT ATTEMPT TO ADVISE
INTERESTED PARTIES OF THE RISKS AND FACTORS THAT MAY AFFECT THE COMPANY'S
BUSINESS AND RESULTS OF OPERATIONS.
The interim financial statements of the Company included within this report have
been prepared on a going concern basis which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business. The
accompanying financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. See further discussion at "Liquidity and
Capital Resources."
RESULTS OF OPERATIONS
REVENUES
For the quarter ended September 30, 1998, revenues decreased to $164,895 from
$1,135,462 for the quarter ended September 30, 1997. Revenues consisted
primarily of sales of TN grade ITO coated glass. The majority of the Company's
customers for ITO coated glass are Asian liquid crystal display (LCD)
manufacturers and the Company believes that the decrease in revenue is due
primarily to the economic slowdown in Asia. In addition, these Asian
manufacturers had accumulated large inventories of raw materials in response to
the shortages experienced during 1996 and 1997. These customers have delayed
delivery of existing orders, and have not placed new orders pending the
reduction in these inventories.
For the nine months ended September 30, 1998, revenues increased to $2,775,007
from $2,571,321 for the nine months ended September 30, 1997. Revenues consisted
primarily of sales of TN grade ITO coated glass. The increase in revenue is due
to a per unit selling price increase due to a change in customer mix. In 1997
the majority of the Company's sales were to a customer who supplied their own
glass, therefore the unit selling price was for coating only. In 1998 this
customer accounted for substantially less of the Company's total sales and sales
to other customers include both coating and glass revenue components. In May of
1998 the demand for the Company's ITO coated glass decreased. The majority of
the
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Company's customers for ITO coated glass are Asian liquid crystal display (LCD)
manufacturers and the Company believes that the decrease in demand is due
primarily to the economic slowdown in Asia. In addition, these Asian
manufacturers had accumulated large inventories of raw materials in response to
the shortages experienced during 1996 and 1997. These customers have delayed
delivery of existing orders, and have not placed new orders pending the
reduction in these inventories.
The market price for TN grade ITO coated glass has decreased by approximately
20%. The Company believes that this decrease is due to excess supply of ITO
coated glass related to the current Asian economic slowdown. The Company expects
the price of ITO coated glass to stabilize in the first quarter of 1999, but
does not currently expect prices to return to their former levels. The Company
expects its production costs to drop when its P-3 line is completed and is
available for production. The Company believes that with this high-volume
production line it will be able to effectively compete in the ITO market. In
addition, the Company is actively pursuing additional selling agents and new
customers in Asia and in Europe to obtain orders to fill this capacity once the
line becomes operational. The Company is also developing full-scale production
processes for several new products, such as high-reflection front-surface
mirrors, touch screen panels, and anti-static photocopier top glass in an effort
to reduce its dependence on a single product line. Based on recent discussions
with its Asian selling agents and current customers, management believes the
current market slowdown is temporary and expects deliveries to existing
customers to resume their previous levels in 1999. The anticipated return to
previous shipping levels is not likely to occur soon enough to result in
significant increases in revenue during the fourth quarter.
GROSS LOSS
Gross loss was $557,794 for the quarter ended September 30, 1998, compared to
gross loss of $7,303 for the quarter ended September 30, 1997. The decline in
margins was due primarily to lower unit sales volumes which resulted in higher
costs per unit due to the high level of fixed costs in the Company's
manufacturing process and, to a lesser extent, a decline in the market price of
ITO coated glass. In the 1998 quarter cost of sales consisted primarily of fixed
costs and production costs associated with pilot-level production, product
development and production of samples for prospective customers. Cost of sales
consists of substrate costs, target material costs, labor and overhead related
to the Company's manufacturing operations.
Gross loss was $809,926 for the nine months ended September 30, 1998, compared
to gross loss of $573,886 for the nine months ended September 30, 1997. The
decrease in margins was due to the lower unit sales volume since May of 1998 and
the high level of fixed costs in the Company's manufacturing process. In
addition, cost of sales for the 1998 period included production costs associated
with pilot-level production, product development and production of samples for
prospective customers.
PROCESS AND PRODUCT DEVELOPMENT AND ENGINEERING EXPENSES
Process and product development and engineering expenses increased to $224,555
in the third quarter of 1998 from $223,591 in the third quarter of 1997. These
expenses consist of personnel costs, consulting, testing, supplies, facilities
and depreciation expenses. The increase in 1998 was due primarily to increased
personnel expenses incurred while the Company undertook manufacturing process
development on its P-2 and P-3 production lines. During the 1997 quarter, many
of the costs associated with such equipment were capitalized as a cost of
construction in progress. Costs incurred during 1998 related to manufacturing
process development did not qualify as capital expenditures and were expensed.
Process and product development and engineering expenses increased to $775,931
in the nine months ended September 30, 1998 from $425,761 for the nine months
ended September 30, 1997. The increase in 1998 was due to the factors discussed
above related to the P-2 and P-3 lines. The Company has reduced its engineering
and process staff and anticipates that product and process development and
engineering expenses will be less in the future.
GENERAL AND ADMINISTRATIVE EXPENSES
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General and administrative expenses decreased to $341,703 for the quarter ended
September 30, 1998 from $614,347 for the quarter ended September 30, 1997. These
expenses consist primarily of compensation expenses for administration, finance,
and general management personnel, as well as office supplies, depreciation, bad
debt and professional fees. The decrease is primarily a result of decreased
professional fees related to various legal matters in which the Company is
involved and staff reductions in response to the revenue decreases.
General and administrative expenses decreased to $1,269,595 for the nine months
ended September 30, 1998 from $1,383,368 for the nine months ended September 30,
1997. The decrease is primarily a result of decreased professional fees related
to various legal matters in which the Company is involved, as well as legal fees
related to the private debt placements that the Company has undertaken. Most of
the legal issues have been settled, although some only tentatively, and the
Company expects future legal fees to continue to decline as these matters are
finally settled. See further discussion of these matters in Part II, Item 1.
Legal Proceedings. In addition, the administrative staff reductions implemented
in the third quarter of 1998 contributed to the decrease.
SELLING AND MARKETING
Selling and marketing expenses decreased to $28,068 for the quarter ended
September 30, 1998 from $88,964 for the quarter ended September 30, 1997. These
expenses consisted principally of compensation costs for sales personnel,
commissions, travel expenses, trade show expenses, and freight out costs. The
decrease is due primarily to decreased freight out costs on the lower volume of
unit sales during the 1998 quarter.
Selling and marketing expenses decreased to $196,695 for the nine months ended
September 30, 1998 from $335,452 for the nine months ended September 30, 1997.
The decrease is due to decreases in salaries, trade shows, consulting fees, and
decreased freight out costs on the lower volume of unit sales during 1998 offset
partially by increases in sales commissions to independent sales agents. Because
sales commissions are the most significant component of this category, the
Company expects selling expenses to increase as revenues increase during the
1999. The Company also plans to increase staffing in its sales and marketing
department later in 1999 to better analyze the market demand for the various new
products it is planning to introduce in the future.
ASSET IMPAIRMENT CHARGES
In response to current market conditions, the Company's debt and lease defaults,
significant past-due accounts payable, and cash flow shortage, the Company has
determined that it is necessary to sell the P-1 and P-2 production lines. During
the third quarter of 1998, the Company has made significant progress in
completing the P-3 production line and expects that line to be fully operational
in the fourth quarter of 1998. The expected capacity of the P-3 line is more
than the combined capacity of the P-1 and P-2 lines and is expected to be
sufficient to meet the Company's estimated demand for ITO coated glass for the
foreseeable future. Any proceeds from the equipment sales will be used to reduce
debt and for working capital purposes. However, even with these proceeds, the
Company may still not be able to satisfy its projected working capital and
capital expansion requirements.
During the third quarter of 1998, the Company decided to sell the P-1 and P-2
production lines. However, because the P-3 line is not yet available for
production, the P-1 and P-2 have not been classified as "assets to be disposed
of."
As a result of reductions in the market price for ITO coated glass experienced
during the third quarter of 1998 and a continued softness in market demand, cash
flows from anticipated P-1 and P-2 production from September 30, 1998 through
the date of disposal are expected to be nominal. Accordingly, management has
estimated the future undiscounted cash flows to be generated from the P-1 and
P-2 lines based upon the expected net proceeds from the sale of these assets.
Based upon this analysis, the carrying value of these assets exceeded the
estimated net proceeds from the sale by $2,162,000 indicating that these assets
are impaired at September 30, 1998. Accordingly, during the third quarter of
1998, the
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Company recorded an impairment charge to reduce the carrying value of these
assets to their estimated fair value.
Due to the nature of these assets, the extremely competitive ITO market, and the
Company's inability to wait for the market to stabilize, it is very difficult to
estimate the net proceeds to be realized upon the sale of the assets.
Accordingly, as management continues to market these assets, it is possible that
additional write-downs may be required and such write-downs may be significant.
In the fourth quarter of 1996, the Company's Chinese joint venture partner
notified the Company of its intention to cancel the joint venture agreement and
a related equipment purchase contract with the Company. In connection with the
cancellation of the equipment purchase contract, the Company determined that
certain equipment which was to have been sold to the joint venture and equipment
that was under development for the Company's use was no longer economically
feasible or did not fit the Company's current manufacturing needs. This
equipment, which the Company determined had no foreseeable future value, was
deemed to be impaired and costs of $110,788 relating to this equipment that were
incurred during the quarter ended March 31, 1997 were written off.
In addition, the Company determined that as a result of refocusing its
operations, a facility it had been leasing was no longer necessary. Leasehold
improvements of $34,270 were written off in connection with the termination of
the lease agreement. Equipment which was determined to have future value to the
Company at March 31, 1997 has been written down to its fair value, resulting in
an impairment charge of $53,652.
NET INTEREST EXPENSE
For the quarter ended September 30, 1998, the Company had net interest expense
of $45,806 compared to net interest income of $20,216 for the quarter ended
September 30, 1997. For the nine months ended September 30, 1998, the Company
had net interest expense of $93,358 compared to net interest income of $73,548
for the nine months ended September 30, 1997. The increase in net expense in the
1998 quarter and for the nine months ended September 30, 1998 is due largely to
the interest the Company is incurring on borrowings under the working capital
line of credit which the Company obtained in December 1997 and the convertible
debt financing obtained in March and July 1998. Interest is no longer being
recorded with respect to certain capital lease obligations since the Company has
accrued all future gross lease payments as a result of the Company being in
default of these agreements. Interest on long-term debt being used to finance
capital expansion is capitalized into construction in progress. The Company
anticipates that net interest expense will increase in the future as long-term
borrowings increase and as construction projects become completed and such
interest amounts can no longer be capitalized.
LITIGATION SETTLEMENT EXPENSE
In May of 1997 two separate lawsuits were commenced against the Company, certain
officers and directors of the Company, and the Company's former president. These
lawsuits were filed by certain purchasers of the Company's common stock alleging
that the Company's actions with respect to the financial and accounting
irregularities announced by the Company in March of 1997 artificially inflated
its stock price between May 29, 1996 and March 24, 1997. The plaintiffs in these
actions are seeking class certification. Both suits were filed in the United
States District Court for the District of Minnesota. In July 1997, the court
consolidated these lawsuits into a single action captioned In Re Photran
Corporation Securities Litigation.
In April 1998, all parties to the lawsuit participated in a mediation, and a
tentative settlement was reached, subject to approval by the court. Under the
terms of this tentative settlement, the Company has agreed to pay $50,000 in
cash, issue five-year warrants valued at up to $500,000 (based on a
Black-Scholes valuation) to purchase common stock of the Company for $4.00 per
share, and issue shares of common stock worth $1,725,000 less the value of
shares of the Company's stock being contributed by another defendant. The
Company's estimated liability under this settlement, based on the market price
of the Company's common stock as of the date of the tentative settlement, is
$2,050,000. This estimate is subject to change based on fluctuations in the
market price of the Company's common stock between the
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date of the tentative settlement and final approval by the court. The settlement
is also contingent upon the Company's common stock being listed on a national
stock exchange and the registration of the common stock and the common stock
issuable upon exercise of the warrants within a six-month period following the
date of the tentative settlement.
In connection with the coating equipment that the Company was building for sale
to its former Chinese joint venture, the Company entered into a contract with a
third party to design and build power supplies to be sold under the equipment
contract, as well as for the Company's own use. The Company terminated the
contract in March 1997. In June 1997, the third party formally brought an action
against the Company in Dakota County District Court. The third party's demand
for damages was $1,300,000. In April, 1998, the Company reached a settlement
with the vendor whereby the Company will give the vendor cash and equipment in
exchange for a promissory note payable to the Company. The settlement was
executed and the assets were exchanged in June 1998, resulting in a non-cash
decrease in property and equipment of $160,000 and an increase in notes
receivable of $70,000.
NET OPERATING LOSS CARRYFORWARDS
In accordance with Section 382 of the Internal Revenue Code of 1986, as amended
(the Code), a change in ownership of greater than 50 percent of the Company
within a three year period results in an annual limitation on the Company's
ability to utilize its net operating loss (NOL) carryforwards which accrued
during the tax periods prior to the change in ownership. As of December 31,
1997, the Company had an NOL carryforward of approximately $11,900,000 which
expires in 2006 through 2012. Due to certain ownership changes which occurred
during the year ended December 31, 1993, the NOL carryforwards of $700,000
incurred through February 1993, which can be utilized by the Company on an
annual basis, are limited to approximately $50,000. The annual limitation may be
increased for any built-in gains recognized within five years of the date of the
ownership change. Utilization of the approximately $11,200,000 of NOL
carryforwards incurred after February 1993 is not limited under Section 382 of
the Code. However, the Company's ability to use its NOL carryforwards may be
further limited by subsequent issuances of common stock.
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred cumulative losses aggregating $22,147,805 since its
inception, and incurred negative cash flows from operating activities of
$3,954,254 for the nine months ended September 30, 1998. In addition, at
September 30, 1998, the Company had a working capital deficiency of $11,051,700.
These factors, among others, indicate the Company may be unable to continue as a
going concern for a reasonable period of time. The financial statements do not
include any adjustments relating to the recoverability and classification of
recorded asset amounts or the amounts and classification of liabilities that
might be necessary should the Company be unable to continue as a going concern.
At September 30, 1998, the Company was not in compliance with the terms of two
lease agreements and certain loan obligations and has been unable to cure or
obtain waivers for the defaults. Under the terms of the leases, in the event of
a default, the Company can be required to immediately pay all future lease
payments under the lease. During the first quarter of 1998, the lessor demanded
payment of such amounts and requested the trustee holding the $2,250,000 in
marketable securities which had been held as a compensating balance to liquidate
the account and forward the proceeds to the lessor in partial payment of amounts
owed by the Company. The Company has reached an agreement in principal with the
lender to restructure the defaulted leases, and management expects to finalize
the proposed restructuring of the leases during the fourth quarter of 1998. The
restructuring, which is subject to certain approvals by the lender and
completion of final documentation, requires an immediate payment of
approximately $131,000 and monthly payments of $27,500 over the 24-month term of
the lease. The proposed restructured lease would require a balloon payment of
$1,800,000 at the end of the lease, but would contain incentive buyout options
at earlier times during the lease. However, because the restructuring is subject
to certain approvals by the lender and other conditions beyond the control of
the Company, it is possible the Company may be unable to ultimately consummate
this transaction as it is currently proposed.
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In the third quarter of 1998, the Company was unable to make the principal and
interest payments required on the $1,100,000 shareholder loan. The Company has
not yet resolved the defaults on this loan. Under the terms of the loan, in the
event of a default, the Company can be required to immediately repay all
principlal and accrued interest. Accordingly, the entire principle and accrued
interest balances of approximately $1,099,000 and $116,000, respectively, have
been classified as current liabilities at September 30, 1998.
In the third quarter of 1998, the Company was unable to continue to make
payments required under the terms of the shareholder loan discussed above. The
Company has not yet resolved the defaults on this loan. Under the terms of the
convertible notes, in the event of a default on any financial obligation, the
Company is in default on the convertible notes and can be required to
immediately repay all principal and accrued interest. Accordingly, the entire
principal and accrued interest balances of approximately $4,796,000 and
$192,000, respectively, have been classified as current liabilities at September
30, 1998.
Management is continuing its efforts to control costs, diversify its product
lines, and secure orders from new customers so the Company can meet its
obligations and sustain its operations. As discussed in more detail under "Asset
Impairment Charges" above, however, management has determined that it will be
necessary to sell certain production assets in order to achieve these
objectives. As of September 30, 1998, the Company's principal sources of
liquidity included cash and cash equivalents of $75,575 and net accounts
receivable of $303,033, as well as an $833,000 transaction-specific working
capital line of credit against which there were borrowings of $516,526
outstanding as of September 30, 1998. In July of 1998 the Company entered into a
$2,500,000 private debt placement. At September 30, 1998, $1,296,000 had been
advanced under the terms of the note. This financing is intended to allow the
Company to complete the construction and installation of its P-2 (completed
during the third quarter) and P-3 production lines, sustain its operations
during the current market slowdown, as well as allow for the potential early
buyout on a pending lease restructuring on the defaulted lease obligations
discussed above. The funding of a portion of this debt placement is contingent
upon a number of factors, including the consummation of the pending restructured
lease agreement and the ability of the Company to attain certain production and
cash flow levels. Due to the uncertainties surrounding the timing of the
reversal of the current slowdown in the market for the Company's existing
products and the Company's ability to generate sales of new products to new
customers, management believes that the Company's existing sources of liquidity
and anticipated funds from operations, combined with the balance of the proceeds
to be received from the $2,500,000 private debt placement, will be insufficient
to satisfy the Company's projected working capital and capital expansion
requirements.
In response to the current market conditions, the Company's debt and lease
defaults, significant past due accounts payable, and cash flow shortage, the
Company has determined that it is necessary to sell the P-1 and P-2 production
lines. During the third quarter of 1998, the Company has made significant
progress in completing the P-3 production line and expects that line to be fully
operational in the fourth quarter of 1998. The expected capacity of the P-3 line
is more than the combined capacity of the P-1 and P-2 lines and is expected to
be sufficient to meet the Company's estimated demand for ITO coated glass for
the foreseeable future. Any proceeds from the equipment sales will be used to
reduce debt and for working capital purposes. However, even with these proceeds
the Company may still not be able to satisfy its projected working capital and
capital expansion requirements.
The net cash used in operating activities for nine months ended September 30,
1998 was $3,954,254 due principally to the net loss for the period which was
partially offset by non-cash charges for depreciation, arbitration settlement
expenses, and asset impairment charges. Increases in inventory used $463,770 in
cash during the nine months ended September 30, 1998. The Company also paid the
$1,500,000 settlement to its former Chinese joint venture partner in April 1998.
Cash used in investing activities was $1,511,633 for the nine months ended
September 30, 1998. This cash was used for the purchase of equipment and
leasehold improvements, primarily in connection with the Company's P-2 and P-3
production lines.
Cash to fund operations and capital expansion totaling $5,495,354 was provided
by financing activities during the nine months ended September 30, 1998. These
funds consisted primarily of $4,830,160 from
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private debt placements, as well as borrowings under the Company's working
capital line of credit, and the issuance of common stock pursuant to warrants
exercised.
OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
The Company's future operating results may fluctuate significantly due to
factors such as the timing of new product announcements and introductions by the
Company, its major customer and its competitors, market acceptance of new or
enhanced versions of the Company's products, changes in the product or customer
mix, changes in the level of operating expenses, inventory obsolescence and
asset impairments, competitive pricing pressures, the gain or loss of
significant customers, increased product and process development costs
associated with new product introductions, the timely completion of construction
and installation of new manufacturing equipment, the impact of pending
litigation and general economic conditions. All of the above factors are
difficult for the Company to forecast, and these and other factors may
materially adversely affect the Company's business and operating results for one
quarter or a series of quarters. The Company's current expense levels are based
in part on its expectations regarding future revenues and in the short term are
fixed to a large extent. Therefore, the Company may be unable to adjust spending
in a timely manner to compensate for any unexpected revenue shortfall.
Accordingly, any significant decline in demand relative to the Company's
expectations or any material delay of customer orders would have a material
adverse effect on the Company's financial condition, operating results, and cash
flows.
YEAR 2000
As is the case with most other companies using computers in their operations,
the Company is in the process of addressing the Year 2000 problem. The Company's
accounting and manufacturing systems include new hardware which the
manufacturers represent to be Year 2000 compliant and packaged software
purchased from large vendors who have indicated that there are updates available
to these systems which are Year 2000 compliant. The Company plans to purchase
such software updates and perform tests to verify that these assertions are
true. The Company has not yet developed a contingency plan in the event it is
unable to implement such upgrades or the vendors' assertions prove to be untrue.
Failure by the Company to address its Year 2000 issues in a timely manner could
have a material adverse effect on the Company's business.
The Company does not have electronic data interchange (EDI) relationships with
any of its vendors or customers, with the exception of its payroll disbursement
function. The Company is in the process of initiating formal communications with
all of its significant suppliers and large customers to determine the extent to
which the Company is vulnerable to those third parties' failure to remediate
their own Year 2000 issues. The Company can give no guarantee that the systems
of such companies will be converted on time. A failure by a key supplier or
major customer to address its Year 2000 issues in a timely manner thereby
resulting in a material adverse effect on such company's business could
potentially have a material adverse effect on the Company. Because the Company
has not yet fully assessed the readiness of its significant suppliers and
customers, it has not yet developed a contingency plan in the event that any of
these companies do not address their Year 2000 issues effectively.
The total cost to the Company of historical and currently planned Year 2000
compliance activities has not been and is not anticipated to be material to its
financial position or results of operations in any given year.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
During the quarter ended December 31, 1996, the Company was informed by its
Chinese joint venture partner, Shenzhen WABO Group Company Limited (WABO), of
their intention to dissolve the joint venture agreement and cancel the related
equipment purchase contract. In April 1997, the Company received notice that
arbitration proceedings have been commenced against it by WABO in Shenzhen,
China claiming approximately $4.4 million plus legal fees and costs. The Company
and WABO finalized a negotiated settlement in January 1998 which was approved by
the Chinese arbitration board in February 1998. Under the terms of the
settlement, the Company paid WABO $1,500,000 in cash and issued 200,000 shares
of common stock in April 1998 to settle all claims in connection with the joint
venture contract, the equipment contract, and related agreements. The total
value of this settlement is approximately $2,425,000 based on the market value
of the Company's common stock as of January 13, 1998.
In connection with the coating equipment that the Company was building for sale
to its former Chinese joint venture, the Company entered into a contract with a
third party to design and build power supplies to be sold under the equipment
contract, as well as for the Company's own use. The Company terminated the
contract in March 1997. In June 1997, the third party formally brought an action
against the Company in Dakota County District Court. The third party's demand
for damages was $1,300,000. In April, 1998, the Company reached a settlement
with the vendor whereby the Company will provide the vendor cash and equipment
in exchange for a promissory note payable to the Company. The settlement was
consummated and assets were exchanged in June 1998, resulting in a non-cash
decrease in property and equipment of $160,000 and an increase in notes
receivable of $70,000.
In April 1997, SEC informed the Company that it was conducting an investigation
with respect to certain financial and accounting irregularities announced by the
Company in March 1997 relating to fiscal 1996. The Company has submitted
documents to the SEC pursuant to requests from the SEC as part of the
investigation. The SEC has also interviewed current and former employees of the
Company. In the fourth quarter of 1997, the Company was informed by the SEC that
is has expanded its investigation to include certain accounting and financial
reporting irregularities prior to 1996 which the Company announced in October
1997. The investigation is not yet completed and it is not possible to determine
what impact, if any, the investigation will have on the Company's financial
condition or results of operations.
In May of 1997 two separate lawsuits were commenced against the Company, certain
officers and directors of the Company, and the Company's former president. These
lawsuits were filed by certain purchasers of the Company's common stock alleging
that the Company's actions with respect to the financial and accounting
irregularities announced by the Company in March of 1997 artificially inflated
its stock price between May 29, 1996 and March 24, 1997. The plaintiffs in these
actions are seeking class certification. Both suits were filed in the United
States District Court for the District of Minnesota. In July 1997, the court
consolidated these lawsuits into a single action captioned In Re Photran
Corporation Securities Litigation.
In April 1998, all parties to the lawsuit participated in a mediation, and a
tentative settlement was reached, subject to approval by the court. Under the
terms of this tentative settlement, the Company has agreed to pay $50,000 in
cash, issue five-year warrants valued at up to $500,000 to purchase common stock
of the Company for $4.00 per share, and issue shares of common stock worth
$1,725,000 less the value of shares of the Company's stock being contributed by
another defendant. The Company's estimated liability under this settlement,
based on the market price of the Company's common stock as of the date of the
tentative settlement, is $2,050,000. This estimate is subject to change based on
fluctuations in the market price of the Company's common stock between now and
final approval by the court. The settlement is also contingent upon the
Company's common stock becoming listed on a stock exchange and the registration
of the common stock and the common stock issuable upon exercise of the warrants
within a six-month period following the date of the tentative settlement.
Because of these contingencies, certain of which are beyond the control of the
Company, it is possible the Company may be unable to ultimately consummate this
settlement as it is currently proposed.
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In August 1997, the Company was served with a lawsuit by its former president,
David E. Stevenson, demanding the return of certain stock certificates
registered in his name which are currently in the possession of the Company. In
October 1997, the Company filed a counterclaim alleging that Stevenson had
committed fraud and had damaged the Company and that his shares should be
awarded to the Company. The Company further alleged that Stevenson did not
provide adequate consideration for such shares and that therefore they are not
properly issued. In connection with the tentative settlement reached in the
shareholder class action lawsuit discussed above, the Company and Mr. Stevenson
have agreed to dismiss all claims against each other upon the closing of the
settlement of the shareholder case.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
In October of 1997, the Company became unable to continue making principal and
interest payments on the $4,500,000 lease financing entered into in the first
quarter of 1997. The lender has exercised its rights under the terms of the
lease and accelerated payment of all remaining lease payments. The Company is
currently in default on this lease in the amount of approximately $3,100,000.
In the third quarter of 1998, the Company was unable to make the principal and
interest payments required on the $1,100,000 shareholder loan. The Company has
not yet resolved the defaults on this loan. Under the terms of the loan, in the
event of a default, the Company can be required to immediately repay all
principal and accrued interest.
In the third quarter of 1998, the Company was unable to continue to make
payments required under the terms of the shareholder loan discussed above. The
Company has not yet resolved the defaults on this loan. Under the terms of the
convertible notes, in the event of a default on any financial obligation, the
Company is in default on the convertible notes and can be required to
immediately repay all principal and accrued interest.
ITEM 5. OTHER INFORMATION
The deadline for submission of shareholder proposals pursuant to Rule 14a-8
under the Securities Exchange Act of 1934, as amended, for inclusion in the
Company's proxy statement for its 1999 Annual Meeting of Shareholders is
December 16, 1998. Additionally, if the Company receives notice of a shareholder
proposal after March 1, 1999, such proposal will be considered untimely pursuant
to Rules 14a-4 and 14a-5(e) and the persons named in proxies solicited by the
Board of Directors of the Company for its 1999 Annual Meeting of Shareholders
may exercise discretionary voting power with respect to such proposal.
ITEM 6.
a. Exhibits
27 Financial Data Schedule
b. Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
September 30, 1998.
19
<PAGE>
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.
/s/ Paul T. Fink
Dated November 19, 1998 ----------------------------------
Paul T. Fink,
President, Chief Executive Officer
20
<PAGE>
EXHIBIT INDEX
EXHIBIT PAGE
NUMBER NUMBER
27 Financial Data Schedule
21
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 75,575
<SECURITIES> 0
<RECEIVABLES> 327,966
<ALLOWANCES> 24,933
<INVENTORY> 850,770
<CURRENT-ASSETS> 1,283,356
<PP&E> 19,925,020
<DEPRECIATION> 2,818,120
<TOTAL-ASSETS> 18,390,256
<CURRENT-LIABILITIES> 12,335,056
<BONDS> 34,671
0
0
<COMMON> 26,168,334
<OTHER-SE> (22,147,805)
<TOTAL-LIABILITY-AND-EQUITY> 18,390,256
<SALES> 2,775,007
<TOTAL-REVENUES> 2,775,007
<CGS> 3,584,933
<TOTAL-COSTS> 3,584,933
<OTHER-EXPENSES> 2,119,909
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 93,358
<INCOME-PRETAX> (7,421,740)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,421,740)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,421,740)
<EPS-PRIMARY> (1.36)
<EPS-DILUTED> (1.36)
</TABLE>
