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 June 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 August 10, 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 9
Condition and Results of Operations
PART II OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 3. Defaults Upon Senior Securities 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
Signature page 17
Exhibit Index 18
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
PHOTRAN CORPORATION
BALANCE SHEETS (UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 9,210 $ 46,107
Accounts and notes receivable 491,602 722,113
Inventory 944,660 387,000
Prepaid expenses 89,597 37,814
Marketable securities, restricted 2,250,000
------------ ------------
Total current assets 1,535,069 3,443,034
PROPERTY AND EQUIPMENT, net 18,834,080 18,535,149
------------ ------------
$ 20,369,149 $ 21,978,183
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long term debt,
notes payable, and capital lease obligations 3,608,895 5,613,143
Borrowings under line of credit 546,458
Accounts payable 1,998,815 1,804,846
Accrued expenses 673,491 713,893
Customer advances and arbitration settlement payable 2,724,538
------------ ------------
Total current liabilities 6,827,659 10,856,420
LONG TERM DEBT, NOTES PAYABLE AND CAPITAL LEASE
OBLIGATIONS, less current portion 4,174,501 1,023,653
LITIGATION SETTLEMENT ACCRUAL (Note 5) 2,000,000
COMMITMENTS AND CONTINGENCIES (Notes 5 and 6)
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 26,140,334 24,824,175
Accumulated deficit (18,773,345) (14,726,065)
------------ ------------
Total shareholders' equity 7,366,989 10,098,110
------------ ------------
$ 20,369,149 $ 21,978,183
============ ============
</TABLE>
See notes to financial statements
<PAGE>
PHOTRAN CORPORATION
STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ---------------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES $ 660,570 $ 867,908 $ 2,610,112 $ 1,435,859
COST OF SALES 1,193,893 1,084,710 2,862,244 2,002,442
----------- ----------- ----------- -----------
Gross loss (533,323) (216,802) (252,132) (566,583)
OPERATING EXPENSES:
Process and product development and
engineering 247,485 54,445 551,376 202,170
General and administrative 435,700 492,403 927,892 769,021
Selling and marketing 65,973 89,921 168,627 246,488
Other nonrecurring charges 198,710
----------- ----------- ----------- -----------
Total operating expenses 749,158 636,769 1,647,895 1,416,389
----------- ----------- ----------- -----------
LOSS FROM OPERATIONS (1,282,481) (853,571) (1,900,027) (1,982,972)
LITIGATION SETTLEMENT EXPENSE 2,100,000
INTEREST EXPENSE (INCOME), net 27,648 (47,609) 47,552 (53,332)
OTHER EXPENSE (INCOME), net 1,789 (21,308) (299) (21,308)
----------- ----------- ----------- -----------
NET LOSS $(1,311,918) $ (784,654) $(4,047,280) $(1,908,332)
=========== =========== =========== ===========
BASIC AND DILUTED LOSS PER
COMMON SHARE $ (0.24) $ (0.15) $ (0.75) $ (0.37)
=========== =========== =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 5,512,068 5,156,392 5,395,871 5,156,092
=========== =========== =========== ===========
</TABLE>
See notes to financial statements.
<PAGE>
PHOTRAN CORPORATION
STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(4,047,280) $(1,908,332)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation and amortization - property and
equipment 536,912 409,927
Loss on disposal of fixed assets 16,202
Non-cash litigation settlement expense 2,000,000
Changes in assets and liabilities that provided (used) cash:
Accounts and notes receivable 3,519 116,901
Inventory (557,660) 258,926
Prepaid expenses (51,783) (38,855)
Accounts payable 231,557 60,950
Accrued expenses 47,051 (312,284)
Customer advances and arbitration settlement payable .. (1,500,000)
----------- -----------
Cash used in operating activities (3,321,482) (1,412,767)
CASH FLOWS FROM INVESTING ACTIVITIES
Property additions (912,766) (2,262,657)
Purchases of marketable securities (2,250,000)
----------- -----------
Cash used in investing activities (912,766) (4,512,657)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes payable and long-term debt 3,500,000 4,500,000
Payments of notes payable and long-debt (137,299) (242,887)
Borrowings under line of credit, net 546,458
Common stock and warrants issued 288,192 4,000
----------- -----------
Cash provided by financing activities 4,197,351 4,261,113
----------- -----------
DECREASE IN CASH (36,897) (1,664,311)
CASH AT BEGINNING OF PERIOD 46,107 2,038,955
----------- -----------
CASH AT END OF PERIOD $ 9,210 $ 374,644
=========== ===========
</TABLE>
See notes to financial statements.
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying financial statements are unaudited and reflect all
adjustments consisting of normal recurring adjustments (except the
litigation settlement accrual), which are, in the opinion of management,
necessary for a fair presentation. Operating results for the three- and
six-month periods ended June 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 six-month periods ending June 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 $18,773,345 since its inception, and incurred
negative cash flows from operating activities of $3,321,482 for the six
months ended June 30, 1998. In addition, at June 30, 1998, the Company had
a working capital deficiency of $5,292,590. 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 in Note 3,
at June 30, 1998, the Company was not in compliance with the terms of two
lease agreements 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 balance of these
lease obligations (approximately $3,100,000) has been classified as a
current liability. In addition, as described in Notes 5 and 6, 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, including legal
defense costs which could be significant, on a timely basis, to comply with
the terms and conditions of its financing agreements, to obtain additional
financing or refinancing as may be required, to achieve acceptable
resolutions of the defaulted lease obligations, 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
attain sales and operating levels sufficient to achieve profitability.
Management is continuing its efforts to control costs, diversify its
product lines, secure orders from new customers, and obtain sufficient
financing so the Company can meet its obligations and sustain its
operations. As of June 30, 1998, the Company's principal sources of
liquidity included cash and cash equivalents of $9,210 and net accounts
receivable of $491,602, as well as an $833,000 transaction-specific working
capital line of credit against which there were borrowings of $546,458
outstanding as of June 30, 1998. Subsequent to June 30, 1998, the Company
entered into a $2,500,000 private debt placement (see Note 7). This
financing is intended to allow the Company to complete the construction
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
and installation of its P-2 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, it is
possible that the Company's existing sources of liquidity and anticipated
funds from operations, combined with 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 for
1998.
2. INVENTORIES
Inventories consist of the following:
June 30, December 31,
1998 1997
---------------- ---------------
Raw materials and supplies at cost $ 631,053 $ 562,254
Finished goods 548,137 65,355
---------------- ---------------
1,179,190 627,609
Less obsolescence reserve 234,530 240,609
---------------- ---------------
$ 944,660 $ 387,000
================ ===============
3. 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.
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). The issuance of this debt is largely responsible for the increase
in long-term debt from December 31, 1997 to June 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. This payment is largely responsible for the decrease in the
short-term portion of long-term debt from December 31, 1997 to June 30,
1998. The Company is attempting to negotiate a restructuring of the leases
with the lender, and has reached an agreement in
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
principal 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 June 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.
4. 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 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.
5. 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.
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
6. 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 tentative
settlement reached in the shareholder class action lawsuit discussed in
Note 5 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.
7. SUBSEQUENT EVENTS
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 in Note 3, and to complete the construction and
installation of the Company's P-2 and P-3 production lines. The remaining
$1,000,000 is intended to assist the Company in exercising the incentive
buyout options under the proposed restructured lease agreement, and 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. 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 bears interest at 12 percent per annum, and
requires 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 1,000,000 shares of common stock of the Company at
$2.25 per share.
As a result of this transaction, the conversion or exercise price of
certain outstanding convertible securities of the Company, including those
issued in connection with the $3,500,000 private financing transaction
discussed in Note 3, has been reduced to $2.25 per share.
<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
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 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 June 30, 1998, revenues decreased to $660,570 from
$867,908 for the quarter ended June 30, 1997. Revenues consisted primarily of
sales of TN grade ITO coated glass. The decrease in revenue is due to a
combination of a 50 percent decrease in unit sales partially offset by a per
unit selling price increase due to a change in customer mix. During the second
quarter of 1997, the Company's principal customer accounted for 91 percent of
the Company's revenues and was supplying the raw glass, paying only for the
coating applied by the Company. In the second quarter of 1998, this customer
accounted for 24 percent of the Company's revenues. One other customer who
accounted for 59 percent of the Company's revenues, as well as all of the
Company's remaining customers, did not supply their own glass and prices charged
these customers were therefore higher. The decrease in unit sales is due
primarily to a postponement in scheduled customer shipments to its Asian
customers as the Company had previously indicated it expected would occur.
For the six months ended June 30, 1998, revenues increased to $2,610,112
from $1,435,859 for the six months ended June 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. During the
first half of 1997, the Company's principal customer accounted for 89 percent of
the Company's revenues
<PAGE>
and was supplying the raw glass, paying only for the coating applied by the
Company. In the first half of 1998, this customer accounted for 31 percent of
the Company's revenues. Two other customers who accounted for 41 percent and 20
percent of the Company's revenues, respectively, as well as all of the Company's
remaining customers, did not supply their own glass and prices charged these
customers were therefore higher. The level of unit sales remained substantially
the same during the first half of 1998 compared to the first half of 1997.
The Company expects the market price for TN grade ITO coated glass will
remain stable for the foreseeable future. The Company expects to expand its
productive capacity in 1998 by making some final modifications to it P-2
production line to bring it to full capacity and by completing its P-3
production line. 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 the second
half of 1998, primarily in the fourth quarter. The anticipated return to
previous shipping levels is not likely to occur soon enough to result in
increases in revenue during the the third quarter. In addition, management
anticipates further growth in revenue from the sale of ITO coated glass in the
second half of 1998 following the addition of productive capacity.
GROSS LOSS
Gross loss was $533,323 for the quarter ended June 30, 1998, compared to
gross loss of $216,802 for the quarter ended June 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. In addition, cost of sales for the 1998 quarter included
approximately $350,000 in production costs associated with pilot-level
production and production of samples for prospective customers on the Company's
P-2 production line. Cost of sales consists of substrate costs, target material
costs, labor and overhead related to the Company's manufacturing operations.
Gross loss was $252,132 for the six months ended June 30, 1998, compared to
gross loss of $566,583 for the six months ended June 30, 1997. The improvement
in margins was due primarily to the change in customer mix discussed above, as
the Company realized profit on the cost of the glass sold as well as the cost of
the coating. In addition, cost of sales for the 1998 period included
approximately $650,000 in production costs associated with pilot-level
production and production of samples for prospective customers on the Company's
P-2 production line.
PROCESS AND PRODUCT DEVELOPMENT AND ENGINEERING EXPENSES
Process and product development and engineering expenses increased to
$247,485 in the second quarter of 1998 from $54,445 in the second 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 line. 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
$551,376 in the first half of 1998 from $202,170 in the first half of 1997. The
increase in 1998 was due to the factors discussed above related to the P-2 line.
The Company anticipates that product and process development and engineering
expenses will continue at approximately current levels in the future as the
Company adds productive capacity and develops its manufacturing processes for
new equipment and new products.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses decreased to $435,700 for the quarter
ended June 30, 1998 from $492,403 for the quarter ended June 30, 1997. These
expenses consist primarily of compensation expenses
<PAGE>
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.
General and administrative expenses increased to $927,892 for the six
months ended June 30, 1998 from $769,021 for the six months ended June 30, 1997.
The increase is primarily a result of increased 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 these matters in Part II, Item 1. Legal
Proceedings.
SELLING AND MARKETING
Selling and marketing expenses decreased to $65,973 for the quarter ended
June 30, 1998 from $89,921 for the quarter ended June 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 $168,627 for the six months
ended June 30, 1998 from $246,488 for the six months ended June 30, 1997. The
decrease is due to decreases in salaries, trade shows and consulting fees,
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 are expected to
increase during the remainder of 1998. The Company also plans to increase
staffing in its sales and marketing department later in 1998 to better analyze
the market demand for the various new products it is planning to introduce in
the future.
OTHER NONRECURRING CHARGES
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 June 30, 1998, the Company had net interest expense
of $27,648 compared to net interest income of $47,609 for the quarter ended June
30, 1997. For the six months ended June 30, 1998, the Company had net interest
expense of $47,552 compared to net interest income of $53,332 for the six months
ended June 30, 1997. The increase in net expense in both 1998 periods 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. 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.
<PAGE>
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 date of the tentative
settlement 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.
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 $18,773,345 since
its inception, and incurred negative cash flows from operating activities of
$3,321,482 for the six months ended June 30, 1998. In addition, at June 30,
1998, the Company had a working capital deficiency of $5,292,590. These
<PAGE>
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 June 30, 1998, the Company was not in compliance with the terms of two
lease agreements and has been unable to cure or obtain waivers for the defaults.
The Company has not yet resolved the defaults on the lease 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 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 third 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.
Management is continuing its efforts to control costs, diversify its product
lines, secure orders from new customers, and obtain sufficient financing so the
Company can meet its obligations and sustain its operations. As of June 30,
1998, the Company's principal sources of liquidity included cash and cash
equivalents of $9,210 and net accounts receivable of $491,602, as well as an
$833,000 transaction-specific working capital line of credit against which there
were borrowings of $546,458 outstanding as of June 30, 1998. Subsequent to June
30, 1998, the Company entered into a $2,500,000 private debt placement. This
financing is intended to allow the Company to complete the construction and
installation of its P-2 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, it is
possible that the Company's existing sources of liquidity and anticipated funds
from operations, combined with the proceeds from the $2,500,000 debt placement,
will be insufficient to satisfy the Company's projected working capital and
capital expansion requirements for 1998.
The net cash used in operating activities for six months ended June 30, 1998
was $3,321,482 due principally to the net loss for the period which was
partially offset by non-cash charges for depreciation and litigation settlement
expenses. Increases in inventory used approximately $550,000 in cash during the
first half of 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 $912,766 for the six months ended
June 30. 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 $4,197,351 was
provided by financing activities during the six months ended June 30, 1998.
These funds consisted primarily of $3,500,000 from a private debt placement, as
well as borrowings under the Company's working capital line of credit, and the
issuance of common stock pursuant to warrants exercised.
<PAGE>
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 and operating results.
YEAR 2000 DISCLOSURES
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 is
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. During 1998 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.
<PAGE>
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.
<PAGE>
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.
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 June
30, 1998.
<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 August 14, 1998 ----------------------------
Paul T. Fink,
President, Chief Executive Officer
/s/ Judith E. Tucker
----------------------------
Judith E. Tucker,
Vice President for Finance and
Administration, Chief Financial
Officer
<PAGE>
EXHIBIT INDEX
EXHIBIT PAGE
NUMBER NUMBER
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 9,210
<SECURITIES> 0
<RECEIVABLES> 502,711
<ALLOWANCES> (11,109)
<INVENTORY> 944,660
<CURRENT-ASSETS> 1,535,069
<PP&E> 21,495,338
<DEPRECIATION> (2,661,258)
<TOTAL-ASSETS> 20,369,149
<CURRENT-LIABILITIES> 6,827,659
<BONDS> 4,174,501
0
0
<COMMON> 26,140,334
<OTHER-SE> (18,773,345)
<TOTAL-LIABILITY-AND-EQUITY> 20,369,149
<SALES> 2,610,112
<TOTAL-REVENUES> 2,610,112
<CGS> 2,862,244
<TOTAL-COSTS> 2,862,244
<OTHER-EXPENSES> 2,100,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 47,552
<INCOME-PRETAX> (4,047,280)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,047,280)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,047,280)
<EPS-PRIMARY> (0.75)
<EPS-DILUTED> (0.75)
</TABLE>
