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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(Mark One)

    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2002

    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from _________ to _________

Commission file number: 001-15069

Duraswitch Industries, Inc.
(Exact name of registrant as specified in its charter)

234 S. Extension Road
Mesa, Arizona 85210
(Address of principal executive offices)
(480) 586-3300
(Issuer’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

         Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes     X        No           

APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS

         Indicate by check mark whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 after the distribution of securities under a plan confirmed by a court.

Yes  ______    No______

APPLICABLE ONLY TO CORPORATE ISSUERS

         Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 9,534,195 shares of common stock outstanding as of August 6, 2002.

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PART I     FINANCIAL INFORMATION

Item 1.     Financial Statements.

DURASWITCH INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements.

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DURASWITCH INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

See notes to consolidated financial statements.

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DURASWITCH INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See notes to consolidated financial statements.

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DURASWITCH INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.    BASIS OF PRESENTATION

         The accompanying interim financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for interim reporting. Accounting policies utilized in the preparation of financial information herein presented are the same as set forth in our annual financial statements. Certain disclosures and information normally included in financial statements have been condensed or omitted. In the opinion of the management of Duraswitch Industries, Inc. (the “Company”), these financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the interim financial statements. Interim results of operations are not necessarily indicative of the results of operations for the full year.

2.    DEFERRED LICENSING REVENUE

         In April 2000, the Company entered into a license agreement with Delphi Corp. (“Delphi”) that gives Delphi the exclusive right to utilize and manufacture the Company’s patented switch technologies for the automotive industry. In connection with the license agreement, the Company also issued a warrant to Delphi to purchase 225,000 shares of common stock at $7.00 per share and a short-term option to purchase 1,651,846 shares of common stock at $7.00 per share. In exchange, Delphi paid the Company a nonrefundable payment of $4.0 million and agreed to pay a royalty fee for each switch sold by Delphi. The term of the exclusive license agreement is seven years. The agreement also requires Delphi to make minimum royalty payments totaling $12.0 million during the initial seven-year term ending June 30, 2007. Delphi can maintain exclusivity for the automotive industry through June 30, 2012 by making additional minimum annual royalty payments during that period. After June 30, 2012, either Delphi or the Company may convert the agreement to a nonexclusive agreement through 2020.

         The estimated fair value of the warrant and the option was $1,134,338, as determined using the Black-Scholes valuation model. The remaining value of the nonrefundable payment, totaling $2,865,662, was recorded as deferred revenue and is being amortized over the initial seven-year term of the exclusive license agreement.

         The current portion of deferred licensing revenue includes the revenue to be recognized in the next twelve months related to the Delphi nonrefundable payment and royalty prepayments by other licensees that have been deferred until such royalties are earned under the licensing agreements.

3.     NEW ACCOUNTING STANDARDS

         In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangibles. SFAS No. 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001, for which the date of acquisition is July 1, 2001 or later, eliminates the pooling-of-interests method of accounting for business combinations, and identifies criteria for the establishment of identifiable intangible assets separate from goodwill resulting from a business combination. SFAS No. 142 requires companies to cease amortizing goodwill. SFAS No. 142 also establishes a new method of testing goodwill and other intangibles for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. The standard became effective for the Company’s fiscal year beginning January 1, 2002. The adoption of these standards did not have a material effect on the Company’s financial position or results of operations. Total goodwill amortization for the three and six months ended June 30, 2001 was $18,242 and $36,483, respectively. Accordingly, the net loss for the three and six months ended June 30, 2001, assuming non-amortization of goodwill, would have been $1,268,486 and $2,189,913 respectively. Net loss per share, basic and diluted, would have been $0.13 and $0.23 for the three and six months ended June 30, 2001, respectively.

         In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires that long-lived assets be measured at the lower of carrying amount or fair value for long-lived assets to be held and used or fair value less cost to sell for long-lived assets to be disposed of, whether reported in continuing operations or in discontinued operations. The standard became effective for the Company’s fiscal year beginning January 1, 2002. The adoption of this standard did not have a material effect on the Company’s financial position or results of operations.

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Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

         This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The words “believe,” “expect,” “anticipate,” “intend,” “estimate” and other expressions that are predictions of or indicate future events and trends and which do not relate to historical matters identify forward-looking statements.

         Some examples of forward-looking statements in this report include our estimation of our capital requirements, our ability to fund those requirements, the credit worthiness of our customers, the profit margins associated with our licensing business model and our estimation of interest rate and foreign currency risks. These forward-looking statements are not guarantees of performance and are inherently subject to risks and uncertainties, a number of which cannot be predicted or anticipated.

         Many factors could cause actual results to differ from those expressed in the forward-looking statements including: unexpected expenses such as the cost of protecting our intellectual property and increased sales and marketing expenses; fluctuations in revenue as a result of fluctuations in demand from our customers; and changes in the mix of licensing revenue between royalties on licensed components, royalties on switches manufactured using our technologies and the amortization of deferred revenue from our license agreement with Delphi Corp. (“Delphi”).

         Readers are cautioned not to place undue reliance on such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. There can be no assurance that the forward-looking statements contained in this document will, in fact, transpire or prove to be accurate. For a more detailed description of these and other cautionary factors that may affect our future results, please refer to the “Forward-Looking Statements” section of our Annual Report on Form 10-K for our fiscal year ended December 31, 2001 filed with the Securities and Exchange Commission.

Critical Accounting Policies

         In accordance with recent Securities and Exchange Commission guidance, the material accounting policies that we believe are the most critical to an investor’s understanding of our financial results and condition and require management’s judgment are discussed below. As a technology licensing company, we believe our critical accounting policies are those that deal with our method of recognizing revenue and with the value of our patents and goodwill.

         Revenue Recognition – We enter into licensing agreements with our customers. Our licensing strategy incorporates a simplified requirement whereby the licensee purchases defined licensed components from Duraswitch. The component cost includes the royalty for the rights to manufacture, assemble and sell patented Duraswitch technologies. In some cases where no components are supplied, we are paid a royalty per switch manufactured.

         We support licensees with engineering, design, testing, specification materials, training programs, marketing assistance, customer leads and patent protection. Every licensee has strict qualitative standards to maintain as part of its licensing agreement. Our non-exclusive license agreements specify per switch fees of $0.10 to $0.78 depending on the type of switch and volume.

         The terms of some of our license agreements require prepayment of royalties to Duraswitch. The prepayments are recorded as deferred revenue and licensing revenue is recognized when the royalties are earned under the licensing agreements. Royalties are considered earned when the licensee purchases component parts from Duraswitch or, when component parts are not supplied by Duraswitch, royalties are considered earned when the licensee manufactures a switch utilizing Duraswitch technology. The deferred revenue received from Delphi (see Note 2 of Notes to Consolidated Financial Statements) in 2000 is being amortized over the initial seven-year term of the exclusive license agreement.

         Impairment or Disposal of Long-Lived Assets – We review our long-lived assets and identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Additionally, goodwill is reviewed on an annual basis. Our intangible assets are primarily our patents and the goodwill associated with the acquisition of Aztec Industries. If such assets were considered to be impaired, the impairment to be recognized would be measured by the amount by which the carrying amount of the assets exceeds the fair market value of the assets.

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         We evaluate the recoverability of property and equipment and intangibles (excluding goodwill) not held for sale by comparing the carrying amount of the asset or group of assets against the estimated undiscounted future net cash flows expected to result from the use of the asset or group of assets. If the undiscounted estimated cash flows are less than the carrying value of the asset or group of assets being reviewed, an impairment loss would be recorded. The loss would be measured based on the estimated fair value of the asset or group of assets compared to carrying value. The estimated fair value would be based on the best information available under the circumstances, including prices for similar assets and the results of valuation techniques, including the present value of expected future cash flows using a discount rate commensurate with the risks involved.

         We evaluate goodwill for impairment by comparing the estimated fair value of the Company, which is the only reporting unit, with its carrying value, including goodwill. The estimated fair value is based on the best information available under the circumstances, including quoted market prices in stock markets, valuation techniques based on earnings, or independent valuations. If the fair value of the Company exceeds its carrying amount, goodwill is not considered impaired. If the carrying amount of the Company exceeds its fair value, the fair value of the goodwill is calculated, and the excess of the carrying value of the goodwill over its fair value is recorded as an impairment loss. To determine the fair value of the Company’s goodwill, the fair value of the Company is allocated to all of its assets and liabilities, and any excess of fair value of the Company over the fair value of its assets and liabilities is the estimated fair value of goodwill.

Results of Operations

         During 2000, we started to implement our new business model of licensing our technologies rather than manufacturing switches ourselves. We have completed this transition and expect almost all of our future revenues to come from our licensing efforts. As of June 30, 2002, we had 23 licensees, foreign and domestic. Because the revenue generated from licensing switch technologies is lower than the revenue from manufacturing the same number of switches, we expected our net revenue to decline during our transition to licensing. Concurrently, our gross profits increased because the cost of goods sold associated with licensing is much lower than with manufacturing.

Net Revenue:

         Net revenue was $237,412 and $197,218 for the three months ended June 30, 2002 and 2001, respectively, an increase of $40,194 or 20%. Net revenue was $447,019 and $458,794 for the six months ended June 30, 2002 and 2001, respectively, a decrease of $11,775 or 3%. By the second quarter of 2001, our transition to a licensing business model was substantially complete. The increase in quarterly net revenue was due entirely to our increase in licensing revenue. The relative decrease in net revenue for the six-month periods ended June 30, 2001 and June 30, 2002 was a result of residual revenue from the sale of products in the first three months of fiscal 2001.

         Licensing revenue was $237,412 and $174,620 for the three months ended June 30, 2002 and 2001, respectively, an increase of $62,792 or 36%. Licensing revenue was $422,344 and $357,089 for the six months ended June 30, 2002 and 2001, respectively, an increase of $65,255 or 18%. Our licensing revenue is comprised of revenue from licensees who manufacture switches incorporating our technologies and includes per-switch royalties, revenue from the sale of licensed components and recognition of revenue resulting from the amortization of deferred revenue from our license agreement with Delphi. The increase in licensing revenue for the three and six month periods was due to increased per-switch royalties and revenue from the sale of licensed components. For each of the three months ended June 30, 2002 and 2001, recognition of revenue from the Delphi license agreement generated $102,345 of licensing revenue, representing 43% and 59% of licensing revenue in 2002 and 2001, respectively, and 43% and 52% of total net revenue in 2002 and 2001, respectively. For each of the six months ended June 30, 2002 and 2001, the Delphi license agreement generated $204,690 of licensing revenue representing 48% and 57% of licensing revenue in 2002 and 2001, respectively, and 46% and 45% of total net revenue in 2002 and 2001, respectively.

         We had no revenue from the sale of products in the three months ended June 30, 2002, reflecting our transition to a technology licensing company. Our transition was substantially complete by June 30, 2001. Our $24,675 of product revenue for the six months ended June 30, 2002 was related to fees for engineering services we had provided to a customer in prior periods. We do not expect to have any significant product revenue in the future.

Cost of Goods Sold:

         Total cost of goods sold was $41,222 and $48,918 for the three months ended June 30, 2002 and 2001, respectively, a decline of $7,696 or 16%. Total cost of goods sold was $57,246 and $169,334 for the six months ended June 30, 2002 and 2001, respectively, a decline of $112,088 or 66%. As a result, gross profit as a percentage of revenue

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increased to 83% for the three months ended June 30, 2002 from 75% for the three months ended June 30, 2001 and increased to 87% for the six months ended June 30, 2002 from 63% for the six months ended June 30, 2001. The increase in gross profit and gross profit as a percentage of revenue reflects our transition from the low-margin business of manufacturing to the high-margin business of licensing.

         During the second quarter of 2002, licensing cost of goods sold was $41,222 compared to $15,936 for the three months ended June 30, 2001, an increase of $25,286 or 159%. Licensing cost of goods sold was $57,246 and $44,588 for the six months ended June 30, 2002 and 2001, respectively, an increase of $12,658 or 28%. The increases in licensing cost of goods sold for the three and six-month periods ended June 30, 2002 were due to increased sales of licensed components, which has a higher cost of goods sold than licensing revenue resulting from the amortization of deferred revenue from our license agreement with Delphi.

         There were no product cost of goods sold for the three and six months ended June 30, 2002, a decline of $32,982 and $124,746 compared to the three and six months ended June 30, 2001. The declines in product cost of goods sold were due to the completion of our transition to a licensing business model from a product-based business model.

Selling, General and Administrative Expenses:

         Selling, general and administrative expenses were $745,745 and $900,380 for the three months ended June 30, 2002 and 2001, respectively, a decline of $154,635 or 17%. Selling general and administrative expenses were $1,564,558 and $1,682,947 for the six months ended June 30, 2002 and 2001, respectively, a decline of $118,389 or 7%. The decrease in selling, general and administrative expenses was primarily related to reductions in executive and support personnel.

Research and Development:

         Research and development expenses were $690,032 and $688,743 for the three months ended June 30, 2002 and 2001, respectively, an increase of $1,289. Research and development expenses were $1,407,429 and $1,195,229 for the six months ended June 30, 2002 and 2001, respectively, an increase of $212,200 or 18%. The increase for the six months was primarily attributable to costs related to additional research and development personnel, expanded modeling and testing capabilities and related occupancy costs.

Loss from Operations:

         As a result of the increase in gross profit and the decrease in selling, general and administrative expenses, loss from operations was $1,239,587 for the three months ended June 30, 2002, compared to $1,440,823 for the three months ended June 30, 2001, a decreased loss of $201,236 or 14%. Additionally, the loss from operations was $2,582,214 for the six months ended June 30, 2002, compared to $2,588,716 for the six months ended June 30, 2001, a decreased loss of $6,502 for the six months.

Other Income - Net:

         Other income - net was $43,241 and $154,095 for the three months ended June 30, 2002 and 2001, respectively, a decline of $110,854. Other income - net was $93,055 and $362,320 for the six months ended June 30, 2002 and 2001, respectively, a decline of $269,265. The decrease in other income - net is due to the decrease in investment income as a result of lower interest rates and lower average cash balances.

Net Loss:

         The decrease of $90,382 or 7% in the net loss to $1,196,346 for the three months ended June 30, 2002 from $1,286,728 for the three months ended June 30, 2001 was primarily a result of higher gross profit and decreased selling, general and administrative expenses, which was offset by the reduction in investment income. The increase of $262,763 or 12% in the net loss to $2,489,159 for the six months ended June 30, 2002 from $2,226,396 for the six months ended June 30, 2001 was primarily a result of increased research and development expenses and the decrease in investment income which was offset by the reduction in selling, general and administrative expenses.

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Liquidity and Capital Resources

         Cash and cash equivalents on June 30, 2002 were $9,190,999 compared to $12,016,430 on December 31, 2001. The decrease in cash and cash equivalents is primarily attributable to cash used in operations.

         Net cash used in operating activities was $2,618,151 for the six months ended June 30, 2002. The net use of cash was primarily attributable to the net loss.

         Net cash used in investing activities was $229,691 for the six months ended June 30, 2002. The net cash used in investing activities relates primarily to investment in patents and purchases of property and equipment.

         Net cash provided by financing activities was $22,411 for the six months ended June 30, 2002 and relates primarily to the proceeds from stock sales related to the exercise of employee stock options.

         At December 31, 2001, we had approximately $14,890,000 in net operating loss carry forwards available for federal and state income tax purposes. We have not recognized any benefit from these operating loss carry forwards that expire in 2011 through 2021.

         We have experienced significant operating losses since our inception. We expect that our capital expenditures and working capital requirements in the foreseeable future could increase depending on the rate of our expansion, our operating results, and other adjustments to our operating plan as may be needed to respond to competition or unexpected events. We believe that our cash on hand will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least 12 months. We continually evaluate our working capital needs and we may seek to obtain additional working capital through debt or equity offerings. There can be no assurance that additional funds will be available on acceptable terms.