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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report under Section 13 or 15(d) of the Securities and Exchange
Act of 1934
For the quarterly period ended June 30, 2004
[_] Transition report under Section 13 or 15(d) of the Exchange Act
For the transition period from ________________ to _______________
Commission File Number 000-19828
SPATIALIGHT, INC.
(Exact name of registrant as specified in its charter)
New York 16-1363082
(State or other jurisdiction of (IRS Employer Identification No.)
Incorporation or organization)
Five Hamilton Landing, Suite 100, Novato, California 94949
(Address of principal executive offices)
(415) 883-1693
(Issuer's telephone number)
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[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS:
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 34,848,874 common shares as of
August 3, 2004.
1
SPATIALIGHT, INC.
Quarterly Report on Form 10-Q
For the Quarter Ended June 30, 2004
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets dated
June 30, 2004 and December 31, 2003..............................3
Condensed Consolidated Statements of Operations
for the Three months and Six Months
Ended June 30, 2004 and 2003.....................................4
Condensed Consolidated Statement of Stockholders' Equity
for the Six months Ended June 30, 2004...........................5
Condensed Consolidated Statements of Cash Flows
for the Six months Ended June 30, 2004 and 2003..................6
Notes to Condensed Consolidated Financial Statements.............7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations................12
Item 3. Quantitative and Qualitative Disclosures about Market Risks.....26
Item 4. Controls and Procedures.........................................27
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.......................28
Item 4. Submission of Matters to a Vote of Security Holders.............29
Item 6. Exhibits and Reports on Form 8-K................................30
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (unaudited)
June 30, December 31,
2004 2003
------------ ------------
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 2,475,554 $ 6,359,969
Accounts receivable 826,930 117,530
Inventory 911,361 779,617
Prepaids and other current assets 614,799 175,848
Prepaid non-cash interest to related party 738,342 177,239
------------ ------------
Total current assets 5,566,986 7,610,203
Property and equipment, net 662,519 638,430
Other assets 105,163 101,063
------------ ------------
Total assets $ 6,334,668 $ 8,349,696
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 609,492 $ 863,284
Accrued expenses and other current liabilities 584,346 518,137
------------ ------------
Total current liabilities 1,193,838 1,381,421
Noncurrent liabilities
Convertible notes 1,166,000 1,155,000
------------ ------------
Total liabilities 2,359,838 2,536,421
------------ ------------
Commitments
Stockholders' equity:
Common shares, $.01 par value:
50,000,000 shares authorized; 34,792,905 and
33,229,191 shares issued and outstanding at
June 30, 2004 and December 31, 2003 347,929 332,292
Additional paid-in capital 67,306,231 61,046,425
Notes receivable (1,125,258) (1,096,926)
Common shares issuable -- 3,805,685
Accumulated deficit (62,554,072) (58,274,201)
------------ ------------
Total stockholders' equity 3,974,830 5,813,275
------------ ------------
Total liabilities and stockholders' equity $ 6,334,668 $ 8,349,696
============ ============
See acompanying notes to condensed consolidated financial statements.
3
SPATIALIGHT, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (unaudited)
Three Months Ended June 30, Six Months Ended June 30,
---------------------------- ------------------------------
2004 2003 2004 2003
------------ ------------ ------------ --------------
Revenue $ 540,775 $ -- $ 859,875 $ --
Cost of revenue 425,649 100,690 772,331 100,690
------------ ------------ ------------ --------------
Gross margin 115,126 (100,690) 87,544 (100,690)
Selling, general and administrative expenses:
Selling, general and administrative expenses 1,479,858 915,166 2,485,003 1,372,828
Stock-based compensation 218,250 1,485,179 261,174 1,658,932
------------ ------------ ------------ --------------
Total selling, general and administrative expenses 1,698,108 2,400,345 2,746,177 3,031,760
Research and development expenses 569,798 666,705 1,251,558 1,391,302
Total operating expenses 2,267,906 3,067,050 3,997,735 4,423,062
------------ ------------ ------------ --------------
Operating loss (2,152,780) (3,167,740) (3,910,191) (4,523,752)
------------ ------------ ------------ --------------
Other income (expenses):
Interest expense:
Interest expense (18,301) (38,239) (36,120) (109,189)
Non-cash interest expense (187,696) (142,812) (375,392) (278,977)
------------ ------------ ------------ --------------
Total interest expense (205,997) (181,051) (411,512) (388,166)
Interest and other income 24,800 18,588 42,632 37,976
------------ ------------ ------------ --------------
Total other expenses (181,197) (162,463) (368,880) (350,190)
------------ ------------ ------------ --------------
Loss before income tax expense (2,333,977) (3,330,203) (4,279,071) (4,873,942)
Income tax expense -- (808) 800 (8)
------------ ------------ ------------ --------------
Net loss $ (2,333,977) $ (3,329,395) $ (4,279,871) $ (4,873,934)
============ ============ ============ ==============
Net loss per share - basic and diluted $ (0.07) $ (0.13) $ (0.13) $ (0.19)
============ ============ ============ ==============
Weighted average shares used in computing
net loss per share- basic and diluted 32,955,434 33,153,429 26,354,526 25,963,626
============ ============ ============ ==============
See accompanying notes to condensed consolidated financial statements.
4
SPATIALIGHT, INC.
STATEMENT OF STOCKHOLDERS' EQUITY (unaudited)
SIX MONTHS ENDED JUNE 30, 2004
COMMON SHARES ADDITIONAL COMMON TOTAL
--------------------------- PAID-IN NOTES ACCUMULATED SHARES STOCKHOLDERS'
SHARES AMOUNT CAPITAL RECEIVABLE DEFICIT ISSUABLE EQUITY
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at
January 1, 2004 33,229,191 $ 332,292 $ 61,046,425 $ (1,096,926) $(58,274,201) $ 3,805,685 $ 5,813,275
Exercise of
stock options
and warrants 529,596 5,296 1,064,914 1,070,210
Accrued interest
on notes receivable
from stockholder (28,332) -- -- (28,332)
Issuance of options to
employees and directors 51,174 51,174
Issuance of warrant
for services 210,000 210,000
Issuance of stock for
prepayment of related
party interest 214,036 2,140 1,136,234 -- -- -- 1,138,374
Issuance of common
shares issuable 820,082 8,201 3,797,484 (3,805,685) --
Net loss (4,279,871) (4,279,871)
------------ ------------ ------------ ------------ ------------ ------------ ------------
34,792,905 $ 347,929 $ 67,306,231 ($ 1,125,258) $(62,554,072) $ -- $ 3,974,830
============ ============ ============ ============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements.
5
SPATIALIGHT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Six Months Ended June 30,
--------------------------
Cash flows from operating activities: 2004 2003
----------- -----------
Net loss $(4,279,871) $(4,873,934)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 219,991 128,728
Stock-based compensation 261,174 1,908,932
Non-cash interest expense 375,392 278,977
Accrued interest on note receivable from shareholder (28,332) --
Changes in operating assets and liabilities:
Accounts receivable (709,400) --
Inventories (131,744) (430,305)
Prepaid and other current assets (226,072) 267,713
Other assets (4,100) (85,795)
Accounts payable (253,792) (1,382,406)
Accrued expenses and other current liabilities 66,209 259,053
----------- -----------
Net cash used in operating activities (4,710,545) (3,929,037)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (244,080) (24,711)
----------- -----------
Net cash used in investing activities (244,080) (24,711)
----------- -----------
Cash flows from financing actitivies:
Proceeds from the sale of common shares -- 4,974,935
Proceeds from issuance of short term notes -- 657,500
Payments on notes receivable from shareholders -- 52,500
Proceeds from exercise of warrants and options 1,070,210 9,375
----------- -----------
Net cash provided by financing activities 1,070,210 5,694,310
----------- -----------
Net decrease in cash (3,884,415) 1,740,562
Cash and cash equivalents at beginning of period 6,359,969 575,663
----------- -----------
Cash and cash equivalents at end of period $ 2,475,554 $ 2,316,225
=========== ===========
Supplemental disclosure of cash flow information:
Income taxes paid during the period $ 800 $ 800
=========== ===========
Non cash financing activities:
Common stock issued for
prepayment of related party interest $ 1,138,374 $ 354,477
=========== ===========
See accompanying notes to condensed consolidated financial statements.
6
SPATIALIGHT, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)
NOTE 1. BUSINESS DESCRIPTION
SpatiaLight, Inc. and Subsidiary (SpatiaLight or the Company) is in the business
of manufacturing high-resolution liquid crystal on silicon (LCoS) microdisplays
for applications such as high definition television, computer monitors, video
projectors and other applications. We are currently offering two types of
products to our customers and prospective customers primarily in the Republic of
Korea, China and Taiwan. One product is sets of three of our proprietary
SpatiaLight imagEngine(TM) LCoS microdisplays (LCoS Sets). Our other product,
the display unit, is comprised of three of our LCoS microdisplays fitted onto a
light engine designed by SpatiaLight and Fuji and manufactured by Fuji. To date,
SpatiaLight has received purchase orders for its microdisplay products from
eight Chinese original equipment manufacturers (OEMs) and one South Korean OEM
and has made product shipments to customers. The Company is currently
negotiating the terms of purchase orders for its products with certain other
prospective customers, primarily in the Pacific Rim region. There are
significant open issues with respect to these prospective purchase orders that
have to be finally negotiated, including prices and quantities of the Company's
products. The Company cannot assure it will receive any purchase orders binding
on any of these companies for their purchase of the Company's microdisplay
products in the near future.
NOTE 2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes necessary for a fair presentation of financial condition, results of
operations and cash flows in conformity accounting principles generally accepted
in United States of America. In the opinion of management of SpatiaLight, the
interim condensed consolidated financial statements included herewith contain
all adjustments (consisting of normal recurring accruals and adjustments)
necessary for their fair presentation. The unaudited interim condensed
consolidated financial statements should be read in conjunction with the
Company's Annual Report on Form 10-K, which contains the audited financial
statements and notes thereto, together with the Management's Discussion and
Analysis, for the year ended December 31, 2003. The interim results for the
period ended June 30, 2004 are not necessarily indicative of results for the
full fiscal year.
Certain prior period amounts have been reclassified in order to conform to
current period presentation.
NOTE 3. LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2004, the Company had net equity of approximately $3,975,000 and
net working capital of approximately $4,373,000. The Company expects to meet its
cash needs with existing cash balances, collections of notes receivable from
shareholders of approximately $1,125,000, and from the exercise of warrants held
by existing investors. As of June 30, 2004, there were approximately 770,000
warrants which are exercisable and in-the-money. The total value of these
warrants, should they be exercised, is approximately $3,300,000. In addition,
the Company expects to fund working capital requirements with payments received
from its customers in connection with signed purchase orders, and by obtaining
additional financing. There can be no assurances that SpatiaLight will be able
to obtain such financing or that existing investors will exercise their
warrants.
7
NOTE 4. PER SHARE INFORMATION
Basic loss per common share excludes dilution and is computed by dividing net
loss by the weighted average number of common shares outstanding for the period.
Excluded from weighted average shares outstanding for the three months and six
months ended June 30, 2004 are 1,346,268 shares of common shares issued but held
in escrow in connection with a private stock purchase agreement and warrant
installment note. Diluted loss per common share reflects the potential dilution
that could occur if securities or other contracts to issue common shares were
exercised or converted into common shares. Excluded from the computation of
diluted loss per share for the three months and six months ended June 30, 2004
and 2003, respectively, are options and warrants to acquire 5,938,195 and
5,968,289 shares of common stock, and 2,376,000 and 3,767,980 common share
equivalents relating to convertible secured notes, because the effect of their
assumed exercise would be antidilutive. The weighted average exercise price as
of June 30, 2004 for the options and warrants is $2.37 and $3.05, respectively;
the weighted average conversion price for the common share equivalents related
to convertible notes is $.50.
NOTE 5. NOTES PAYABLE
Convertible notes at June 30, 2004 consist of the following:
Argyle Notes:
In 1998, the Company received $1,188,000 in cash in exchange for notes issued in
that amount to Argyle Capital Management Corporation (Argyle), a company owned
and controlled by Robert A. Olins, Chief Executive Officer, Secretary,
Treasurer, and a director of the Company. The notes accrue interest at a
contractual rate of 6% per annum, and are secured by substantially all the
assets of the Company. Both principal and interest are convertible into the
Company's common shares at $0.50 per share. On May 23, 2001, the due date of the
notes was extended until December 31, 2002. On the extension date, the
beneficial conversion effect representing the excess aggregate value of the
common shares receivable upon conversion of the notes based on the then current
market price of $1.90 per share, over the aggregate conversion price for such
common shares (limited to the original proceeds of $1,188,000), was recorded as
additional paid-in capital. The resulting $1,188,000 discount to the debt
arising from the beneficial conversion feature was originally being amortized
through December 31, 2002. The notes were extended in September 2002 to March
31, 2004, and on December 31, 2003 were extended until June 30, 2005. At each
extension date, the amortization rate of the remaining unamortized discount was
also extended over the new life of the notes. The effective interest rate for
financial statement purposes due to this discount differs from the actual
contractual interest received or receivable in cash or shares by Argyle. The
current amortization rate of the discount, along with the contractual 6%
interest rate, resulted in a new effective interest rate of 8% per annum as of
the December 31, 2003 extension date when compared to the outstanding principal
balances.
On January 7, 2004, the Company issued 142,360 common shares for the prepayment
of interest of $800,063 for the year ended December 31, 2004. Interest was
computed using the closing price of the common shares on January 6, 2004 of
$5.62, and is being amortized through December 31, 2004. In addition, on March
4, 2004, the Company issued 71,676 common shares on the prepayment of interest
of $338,311 for the six months ended June 30, 2005 in order to coincide with the
maturity date of the notes. Interest was computed using the closing price of the
common shares on March 3, 2004 of $4.72, and is not currently being amortized.
At June 30, 2004, the carrying value of the Argyle notes total $1,166,000, which
includes the $1,188,000 principal balance net of unamortized discounts of
$22,000.
8
Activity in notes payable for the six months ended June 30, 2004 follows:
(PAYMENT)
BALANCE AT OR BALANCE AT
DECEMBER 31, ADDITION OR DISCOUNT CONVERSION JUNE 30,
DEBT PRINCIPAL: 2003 NEW DISCOUNT AMORTIZATION TO EQUITY 2004
----------- ---------------- ------------ ----------- -----------
Argyle $ 1,188,000 $ -- $ -- $ -- $ 1,188,000
Argyle discount
(33,000) -- 11,000 -- (22,000)
----------- ---------------- ------------ ----------- -----------
Total 1,155,000 -- 11,000 -- 1,166,000
----------- ---------------- ------------ ----------- -----------
INTEREST:
Accrued Argyle 6% -- 35,640 -- (35,640) --
Beneficial interest -- 364,392 -- (364,392) --
----------- ---------------- ------------ ----------- -----------
Total -- 400,032 -- (400,032) --
----------- ---------------- ------------ ----------- -----------
TOTAL $ 1,155,000 $ 400,032 $ 11,000 $ (400,032) $ 1,166,000
=========== ================ ============ =========== ===========
Non-cash interest expense is as follows:
Six Months Ended June 30,
--------------------------
2004 2003
------------ -----------
Amortization of note discounts 11,000 130,732
Effect of beneficial conversion privileges
on accrued interest 364,392 141,598
Other $ -- 6,647
------------ -----------
$ 375,392 $ 278,977
============ ===========
NOTE 6. ISSUANCE OF SECURITIES
Exercise of Stock Options and Warrants in the six months ended June 30, 2004
During the first six months of 2004, 122,500 and 407,096 common shares were
issued upon the exercise of employee stock options and warrants, respectively.
Total cash received was $1,070,210.
Issuance of Shares, Stock Options and Warrants in the six months ended June 30,
2004
In December 2003, the Company completed a private placement of 1,000,000 common
shares that were registered with the SEC in a "Shelf" Registration Statement at
a price of $5.00 per share for net proceeds of $4,955,255 received in December
2003. 300,000 of these shares were issued prior to December 31, 2003. The
remaining 700,000 shares were reflected in common shares issuable at December
31, 2003 and were issued in January 2004. In addition, 120,082 shares were
issued pursuant to a warrant exercised in 2003. The proceeds of approximately
$306,000 had been received and were included in common shares issuable as of
December 31, 2003.
9
Other expenses in the six months ended June 30, 2004 related to the valuation of
options granted to directors for additional services and employee options issued
with an exercise price lower than the market price totaled $51,174 and are
included in stock-based compensation.
In April 2004, the Company issued a fully vested warrant to purchase 250,000
common shares as payment to a sales agent. A value of $210,000 was assigned to
the warrant using a Black-Scholes pricing model and the following assumptions:
stock price $3.58, exercise price $3.75, historical volatility 59%, risk free
rate 4%, dividend yield of 0% and a contractual life of 13 months.
Installment Note
In November 2002, a warrant to purchase 746,268 common shares was exercised at
$2.00 under a warrant installment agreement totaling $1,492,536. Payments of
$200,000 were made in 2002. An additional $402,500 was received in 2003.
Interest accrues at 6% per annum and is due with the final payment. As of June
30, 2004, approximately $107,700 of accrued interest has been recorded,
including interest of approximately $79,400 in 2003 and 2002. The shares were
issued in 2003, but are held in escrow by the Company pending receipt of the
remaining balance of $1,010,758.
On May 15, 2001, the Company sold 600,000 common shares under a private stock
purchase agreement. The shares were sold at a price of $1.75 per share. Cash
received was $262,500. The balance of $787,500 was to be paid in three equal
quarterly installments of $262,500. An escrow agent is holding the certificates
for the shares being purchased until all three installments have been paid in
full. At June 30, 2004 the remaining balance is $127,500.
Stock-based compensation is as follows:
Six Months Ended June 30,
-------------------------
2004 2003
---------- ----------
Common shares and options granted to employees and directors $ 51,174 $ 22,005
Common shares and warrants expensed for services 210,000 283,128
Stock to be issued in connection with stock purchase -- 326,086
Beneficial pricing on sale of stock and warrants to officers -- 958,913
Other -- 68,800
---------- ----------
$ 261,174 $1,658,932
========== ==========
NOTE 7. SEGMENT INFORMATION AND SIGNIFICANT CUSTOMER INFORMATION
The Company's chief operating decision-maker, the Chief Executive Officer,
reviews the Company's financial information as a single "operating segment" to
make decisions about the Company's performance and resource allocation.
Therefore the Company has determined that it operates in a single business
segment.
During the six months ended June 30, 2004, all revenues were derived from
customers abroad. Revenues from mainland China totaled $817,000 or 95% of total
revenue. The remaining 5%, or $42,875 were derived from customers in Hong Kong
and the Republic of Korea. There were no revenues in 2003.
10
Revenue from two customers accounted for 67% and 19%, respectively, of our total
revenues for the six months ended June 30, 2004. The loss of any one of these
customers and our inability to obtain new customers to replace the lost revenue
in a timely manner could harm our sales or results of operations. Accounts
receivable from these two customers accounted for 70% and 20%, respectively, of
total accounts receivable as of June 30, 2004.
NOTE 8. STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation arrangements for employees
and directors using the intrinsic value method pursuant to Accounting Principles
Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," As such,
compensation expense is recorded when, on the date of grant, the fair value of
the underlying common stock exceeds the exercise price for stock options or the
purchase price for issuances or sales of common stock. Pursuant to Statement of
Financial Accounting Standards (SFAS) No. 123 "Accounting for Stock-Based
Compensation," the Company discloses the pro forma effects of using the fair
value method of accounting for stock-based compensation arrangements and records
compensation expense for the fair value of options granted to non-employees.
If the Company had elected the fair value method of accounting for stock-based
compensation, compensation cost would have been accrued at the estimated fair
value of stock option grants over the service period, regardless of later
changes in stock prices and price volatility.
The table below shows net loss per share for the three months and six months
ended June 30, 2004 and 2003 as if the Company had elected the fair value method
of accounting for stock options.
Three Months Ended June 30, Six Months Ended June 30,
2004 2003 2004 2003
----------- ----------- ----------- -------------
Net loss as reported $(2,333,977) $(3,329,395) $(4,279,871) $ (4,873,934)
Stock-based employee/director compensation
included in reported net loss, net of
any applicable related tax effects
8,250 9,720 51,174 22,005
Deduct: total stock-based employee compensation
determined under fair value method for all awards,
net of any applicable related tax effects
(367,839) (355,984) (780,528) (755,886)
----------- ----------- ----------- -------------
Proforma net loss, as adjusted $(2,693,566) $(3,675,659) $(5,009,225) $ (5,607,815)
=========== =========== =========== =============
Loss per share:
Basic and diluted, as reported $ (0.07) $ (0.13) $ (0.13) $ (0.19)
Basic and diluted, as adjusted $ (0.08) $ (0.14) $ (0.15) $ (0.22)
11
NOTE 9. RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued Statement of Financial Accounting Standards, or
SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity. SFAS No. 150 establishes standards for how
companies classify and measure certain financial instruments with
characteristics of both liabilities and equity. It requires companies to
classify a financial instrument that is within its scope as a liability or, in
some circumstances, an asset. SpatiaLight adopted the provisions of SFAS No. 150
effective beginning with the second quarter of fiscal 2004, and such adoption
did not have a significant impact on SpatiaLight's financial position and
results of operations.
In November 2003, the Emerging Issues Task Force ("EITF") issued EITF No. 03-6
"Participating Securities and the Two-Class Method under FASB Statement No.
128," which provides for a two-class method of calculating earnings per share
computations that relate to certain securities that would be considered to be
participating in conjunction with certain common stock rights. This guidance
would be applicable to the Company starting with the third quarter beginning
July 1, 2004. The Company is currently evaluating the potential impact of this
pronouncement on its financial statements.
NOTE 10. SUBSEQUENT EVENTS
In July 2004, the Company entered into an agreement with LG Electronics, Inc.
(LGE), a worldwide leader in electronics and television manufacturing based in
the Republic of Korea, providing for the Company to sell sets of three
imagEngine(TM) LCoS microdisplays with an active matrix of 1920 pixels by 1080
pixels (LCoS Sets) to LGE. See Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations for a more detailed discussion of
the agreement with LGE.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This Form 10-Q contains certain forward-looking statements within the meaning of
Section 21E of the Securities and Exchange Act of 1934, as amended, which
statements are subject to the Safe Harbor provisions created by that statute. In
this report, the words "anticipates," "believes," "expects," "future,"
"intends," and similar expressions identify forward-looking statements. Such
statements are subject to certain risks and uncertainties, including, but not
limited to, those discussed herein, those contained in this Item 2 and those
discussed in the Company's Annual Report on Form 10-K as filed with the
Securities and Exchange Commission on March 30, 2004. Readers are cautioned not
to place undue reliance on these forward-looking statements, which speak only as
of the date hereof. The Company undertakes no obligation to publicly release the
results of any revisions to these forward-looking statements that may be needed
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
The following is a discussion and analysis of our consolidated financial
condition as of June 30, 2004, and the results of our operations for the three
months and six months ended June 30, 2004 and 2003. The following should be read
in conjunction with the unaudited financial statements and related notes
appearing elsewhere herein.
12
OVERVIEW
We are in the business of manufacturing liquid crystal on silicon (LCoS)
microdisplays that provide high resolution images suitable for applications
including high definition television, rear projection computer monitors and
video projectors, and potential applications such as those used in wireless
communication devices, portable games and digital assistants. Our imagEngine(TM)
microdisplays are designed for use in end products of original equipment
manufacturers, and therefore we work closely with customers and prospective
customers to incorporate our microdisplays into their final products. We
currently lease clean room space where we manufacture our SpatiaLight
imagEngine(TM) microdisplays. In January 2004, we expanded our clean room space
to address current and anticipated increased manufacturing demand. We believe
that these facilities are suitable to meet our current and immediate future
needs. We also believe that these current arrangements provide us with strong
quality controls and effectively protect our proprietary technology in our
products. We are in the final stages of negotiating a long-term lease in Jinsa,
Gyeongnam province, in the Republic of Korea, where we will immediately commence
operations to construct our state-of-the-art manufacturing facility with the
capacity to meet mass production-scale demand from our customers and prospective
customers. Internal manufacturing is subject to certain risks described under
"Business Risks and Uncertainties."
We are currently offering two types of products to our customers and prospective
customers primarily in the Republic of Korea, China and Taiwan. One product is
sets of three of our proprietary SpatiaLight imagEngine(TM) LCoS microdisplays
(LCoS Sets). Our other product, the display unit, is comprised of three of our
LCoS microdisplays fitted onto a light engine designed by SpatiaLight and Fuji
and manufactured by Fuji. We currently manufacture two models of our LCoS
microdisplays. The "T-1" model has an active matrix of 1280 pixels by 960 pixels
configuration and the newer generation "T-3" model has an active matrix of 1920
pixels by 1080 pixels configuration.
We recently formed SpatiaLight Korea, Inc. (SLK), a corporation of the Republic
of Korea and our wholly-owned subsidiary for the purpose of establishing a
large-scale manufacturing facility in Korea and for facilitating business
relationships in Korea and throughout all of Asia. SLK is in the final stages of
negotiating a long-term lease for 8.3 acres of land in Jinsa, Gyeongnam
province, in the Republic of Korea, on which we will immediately commence
operations to construct our expandable, approximately 25,000 square foot
state-of-the-art manufacturing facility with the capacity to meet mass
production-scale demand from our customers and prospective customers. We expect
to commence physical construction for building the facility by the end of the
third quarter of 2004. We expect the aggregate cost of building and equipping
the facility to be approximately $11,000,000. The opening of such a
manufacturing facility will be for the purpose of expanding our manufacturing
capacity and we do not intend to layoff or otherwise terminate the employment of
any employees in the United States as the result of opening such a manufacturing
facility in Korea.
In July 2004, we entered into an agreement with LG Electronics, Inc. (LGE), a
worldwide leader in electronics and television manufacturing based in the
Republic of Korea, providing for us to sell a specially tailored version of our
T-3 LCoS Sets to LGE. Under the terms of the agreement, LGE has committed to
purchase a minimum of 21,000 LCoS Sets from us over an initial six-month ramp-up
delivery period commencing in January 2005. The agreement forecasts that LGE
will commence mass production-scale purchases of LCoS Sets from us in the second
half of 2005. The agreement has a two-year delivery term ending on December 31,
2006. All of the rights and obligations of the parties under the agreement are
subject to a limited quantity of trial LCoS Sets, a portion of which have been
delivered to LGE, meeting certain final technical specifications. Under the
agreement, LGE and we have agreed to work together to the extent necessary to
ensure that the trial LCoS Sets meet the final specifications.
13
The agreement provides that we will be the exclusive supplier of three-chip LCoS
microdisplay products to LGE in 2005 and potentially in 2006 as well. LGE will
have the exclusive right in Korea to purchase T-3 microdisplay products from us
in 2005 and potentially in 2006 as well.
The agreement with LGE occurred as the result of our working together with LGE
pursuant to a joint development agreement entered into in May 2003. During the
course of that work, we made specially tailored modifications to our new
generation of T-3 microdisplays for LGE's development of a new line of
state-of-the-art high definition products. LGE has advised us that it intends to
sell high definition LCoS products to the worldwide consumer market commencing
in early 2005.
In March 2004, we entered into a purchase order agreement with SVA Information
Industry Co., Ltd. (SVA) for the purchase of 2,205 display units by SVA. The
purchase order provides for initial integration, certification and product
introduction phases followed by deliveries of display units for commercial sale
purposes. We provided SVA with two prototype display units in the second quarter
of 2004. Pursuant to the terms of the purchase order, future obligations of SVA
will be backed by letters of credit in our favor. The purchase order is
cancelable by SVA and is subject to other customary terms and conditions.
In December 2003, we entered into a purchase order agreement with Shanghai China
Display Co., Ltd. (China Display). The agreement provides for the purchase by
China Display of 1,000 sets of three SpatiaLight imagEngine(TM) microdisplays.
Pursuant to the purchase order, we completed an initial delivery of 100
microdisplay sets to China Display in December 2003. We completed a second
delivery of 100 microdisplay sets in March 2004 and a third delivery of 200
microdisplay sets in June 2004. We expect to continue shipping microdisplay sets
to China Display in the third quarter according to a revised delivery schedule.
Pursuant to the terms of the purchase order, the obligations of China Display
are and will be backed by three letters of credit, the first of which was issued
and paid to us. The purchase order is not cancelable by China Display, according
to the terms of the purchase order, because the first 100 delivered microdisplay
sets met China Display's specifications. The purchase order is subject to other
customary terms and conditions.
In September 2003, we announced that we signed a purchase order agreement with
China Electronics Corporation (CEC), for the purchase by CEC of 2,000 display
units from us. The agreement provides for an initial delivery of ten display
units, which was completed in September 2003, and a second delivery of 100
units, which was completed in March 2004. Additional shipments will be made
periodically according to a schedule to be determined by CEC and us. The
purchase order was cancelable by CEC after delivery of 110 units but CEC has
elected to proceed with additional deliveries. The agreement is subject to other
customary terms and conditions.
14
In January 2003, we announced that we signed a purchase order agreement with
Skyworth Display, Ltd. for the purchase by Skyworth of 14,100 SpatiaLight
display units during a one-year delivery period. The purchase order originally
provided for 200 units to be delivered in each of February, March and April 2003
with larger monthly deliveries thereafter until the order is completed. Skyworth
and we subsequently agreed to delay the delivery schedule. In 2003, we completed
shipment of 100 of the 200 units originally scheduled for delivery in the first
month and in the first quarter of 2004 we completed shipment of an additional
100 units. Skyworth advised us in late 2003 that it had decided to change the
target market for its LCoS televisions that it intended to manufacture using our
display units, which caused serious delays to the delivery schedule set forth in
the purchase order agreement. We shipped 400 display units to Skyworth in the
second quarter of 2004. The purchase order agreement, by its terms, is currently
cancelable by Skyworth.
In October 2003, we announced that we had signed a purchase order agreement with
Nanjing Panda Electronics Co. (Panda), for the purchase of 2,610 display units
by Panda. The agreement provides for an initial television box integration
phase, which was completed in late 2003. The agreement then provides for
delivery of ten display units to Panda, which we completed in March. Panda is
currently conducting system integration phase testing with the units that we
delivered. A delivery of 100 display units is scheduled to follow such testing.
Subsequent shipments under the purchase order will be made periodically
according to a schedule to be determined by the parties. Pursuant to the terms
of the purchase order, the future obligations of Panda will be backed by letters
of credit in our favor. The purchase order is cancelable by Panda after delivery
of ten display units and is subject to other customary terms and conditions.
In December 2003, we entered into a purchase order agreement with Global Display
Limited, a Chinese OEM, for the purchase of 2000 display units from SpatiaLight.
We completed an initial delivery of 20 display units in March 2004. We worked
with Global Display during the second quarter of 2004 on integrating our display
units with Global Display's technology. Future shipments are scheduled to be
made periodically according to a schedule to be finally determined by the
parties. The purchase order is cancelable by Global Display after the initial
delivery of display units provided for under the agreement and is subject to
other customary terms and conditions.
In December 2003, we entered into a purchase order agreement with SCT Optronics
Company Ltd. (SCT), a Chinese OEM, for the purchase of 2,020 display units. The
initial shipment of ten display units provided for under the agreement was
completed in December 2003. Future shipments are scheduled to be made
periodically according to a schedule to be finally determined by SCT and us. The
purchase order is cancelable by SCT after delivery of ten display units and is
subject to other customary terms and conditions.
In May 2004, we entered into a purchase order and development agreement with a
leading light engine manufacturing company based in Taiwan. We have agreed with
such customer not to disclose its name at this time. The purchase order is for
2000 of our LCoS Sets. We shipped one prototype display unit and one prototype
LCoS Set to this customer in the second quarter of 2004 and we are working
closely with them on technology integration. The purchase order is cancelable by
the customer and is subject to other customary terms and conditions.
We are currently negotiating the terms of purchase orders for our products with
certain other prospective customers, primarily in China. There are significant
open issues with respect to these prospective purchase orders that have to be
finally negotiated, including prices and quantities of our products. We cannot
assure whether we will receive any purchase orders binding on any of these
companies for their purchase of our microdisplay products in the near future.
Even assuming that we receive purchase orders that are binding on the
prospective customers, these orders and our sales to these customers are subject
to certain contingencies described under "Risks Factors."
15
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2004, we had approximately $2,476,000 in cash and cash
equivalents, a decrease of approximately $3,884,000 from the December 31, 2003
amount of $6,360,000. Our net working capital at June 30, 2004 was approximately
$4,373,000 compared to net working capital of approximately $6,229,000 at
December 31, 2003. This change is due to the use of cash to fund operating
expenses, offset by an increase in accounts receivable and non-cash prepaids.
Net cash used in operating activities totaled approximately $4,711,000 and
$3,930,000 for the six months ended June 30, 2004 and 2003, respectively. Cash
was used primarily to fund the operating loss.
Net cash provided by financing activities in the six months ended June 30, 2004
was approximately $1,070,000 as compared to approximately $5,700,000 for the six
months ended June 30, 2003. In the second quarter of 2004, cash was provided
primarily from the exercise of employee stock options and warrants. In the same
period in 2003, cash was provided primarily from the sale of common shares and
issuance of short-term notes.
We expect to meet our cash needs with our existing cash balances and collections
from notes receivable from shareholders of approximately $1,125,000 and from the
exercise of warrants held by existing investors. As of June 30, 2004, there were
approximately 770,000 warrants which are exercisable and in-the-money. The total
value of these warrants, should they be exercised, is approximately $3,300,000.
In addition, we expect to fund working capital requirements with payments
received from our customers in connection with current purchase orders and by
obtaining additional financing. There can be no assurances that we will be able
to obtain such financing or that existing investors will exercise their
warrants.
RESULTS OF OPERATIONS
Revenue. We recognized revenue of approximately $541,000 and $860,000 in the
three and six months ended June 30, 2004, respectively. The increase in revenue
in the second quarter was related primarily to an increase in shipments against
purchase orders entered into in 2003 and 2004. No revenue was recognized in the
three months or six months ended June 30, 2003.
Revenue from two customers accounted for 67% and 19%, respectively, of our total
revenue for the six months ended June 30, 2004. Revenue recognized from these
customers was pursuant to purchase agreements entered into in 2003. The loss of
any one of these customers and our inability to obtain new customers to replace
the lost revenue in a timely manner could harm our sales and results of
operations. Accounts receivable from these two customers, Skyworth and China
Display, accounted for 70% and 20%, respectively, of total accounts receivable
as of June 30, 2004.
Cost of revenue. Cost of revenue was $426,000 and $772,000 in the three and six
months ended June 30, 2004, respectively and $100,690 in the three and six
months ended June 30, 2003. Cost of revenue consists primarily of product costs
and the increase in the second quarter of 2004 is related to the increase in
shipments of our products. Cost of revenue in 2003 relates to an adjustment to
restate inventory at the lower of cost or market as our initial purchases were
at a cost higher than we expected to incur for future purposes.
16
Selling, general and administrative costs. Selling, general and administrative
costs were approximately $1,480,000 and $915,000 in the three months ended June
30, 2004 and 2003, respectively and $2,485,000 and $1,373,000 in the six months
ended June 30, 2004 and 2003, respectively, and include professional services,
salaries and related taxes and benefits, rent, depreciation, travel, insurance
and office expenses. Salaries and related taxes and benefits increased
approximately $1,090,000 as a result of the reassignment of employees from
research and development to general and administrative duties and the increase
in the number of administrative staff, which was due to the transition toward
commercial-scale manufacturing of our microdisplay products and the hiring of
technical support staff in Asia. In addition, travel and lodging expenses
increased by approximately $175,000 due to increase in travel to Asia in the six
months ended June 30, 2004, related to work performed in connection with
purchase order agreements entered into during 2003 and other business
development matters. These increases were offset by a one time expense of
$250,000 in 2003 related to costs of obtaining financing that had no comparable
expense in 2004.
Stock-based compensation. Stock-based compensation was approximately $218,000
and $1,485,000 in the three months ended June 30, 2004 and 2003, respectively,
and approximately $261,000 and $1,659,000 in the six months ended June 30, 2004
and 2003, respectively. The amounts incurred relate to common shares, stock
options, and warrants issued. The decrease in stock-based compensation is due to
expenses totaling approximately $960,000 incurred in 2003 related to the May
financing and the beneficial pricing received by Robert A. Olins, Chief
Executive Officer, that had no comparable expense in 2004.
Research and development costs. Research and development costs were
approximately $1,251,000 and $1,391,000 in the six months ended June 30, 2004
and 2003, respectively and $570,000 and $667,000 in each of the three months
ended June 30, 2004 and 2003, respectively. Salaries and related benefits
decreased approximately $900,000 due to the reclassification of employees from
research and development to selling, general and administrative. Other research
and development expenses increased approximately $600,000 due to an increase in
consulting services as well as costs associated with the development of newer
generation LCoS microdisplay. These costs include primarily materials and
equipment.
Interest expense. Interest expense for the six months ended June 30, 2004
decreased approximately $74,000 from the same period in 2003 due to the
conversion of $2,975,000 of convertible notes in November 2003.
Non-cash interest expense. Non-cash interest expense was approximately $375,000
and $279,000 for the six months ended June 30, 2004 and 2003, respectively.
Non-cash interest expense relates to the beneficial price of shares issued to
prepay interest on the notes payable to Argyle Capital Management Corporation, a
company wholly owned by Robert A. Olins, Chief Executive Officer and a director
of the Company. The beneficial conversion interest represents the excess value
of the shares received or receivable at current market prices over the $0.50 per
share conversion price. Interest expense related to the beneficial conversion
feature increased approximately $222,000 due to the increase in the price of our
common shares from 2003 to 2004. Also included in non-cash interest expense is
the amortization of note discounts. This amount decreased approximately $126,000
due primarily to the conversion of the Alabama Group notes in November 2003.
Critical Accounting Policies
17
Revenue Recognition - We enter into commercial transactions to sell our
products. We evaluate revenue recognition for these transactions using the
following criteria (collectively called the Revenue Recognition Criteria):
o Evidence of an arrangement: Before revenue is recognized, we must have
evidence of an agreement with the customer reflecting the terms and
conditions to deliver our products.
o Delivery: For products, delivery is considered to occur when title and
risk of loss have been transferred, which, for us, is generally when
product has been delivered to a common carrier.
o Fixed or determinable fee: We consider a fee to be fixed or
determinable if the fee is not subject to refund or adjustment. If a
portion of the arrangement fee is not fixed or determinable, we
recognize that amount as revenue when the amount becomes fixed or
determinable. We do not consider a fee to be fixed and determinable if
any amount is due more than 180 days from the delivery date. Payment
terms of less than 180 days are evaluated based upon the country in
which the arrangement is entered into to assess whether the fee is
fixed and determinable.
o Collection is deemed reasonably assured: Collection is deemed
reasonably assured if we expect the customer to be able to pay amounts
under the arrangement as those amounts become due. If we determine
that collection is not probable, we recognize revenue when collection
becomes reasonably assured (generally upon cash collection).
Inventory valuation - We value inventories at the lower of cost (based on the
first-in, first-out method) or market value. We include materials, labor and
manufacturing overhead in the cost of inventories. In determining inventory
market values, we give substantial consideration to the expected selling price
of the product based on historical recovery rates. If we assess the market value
of our inventory to be less than cost given current prices and future sales
commitments we write it down to its replacement cost or net realizable value.
Our estimates may differ from actual results due to the quantity and quality and
mix of products in inventory, consumer and retailer preferences and economic
conditions.
Income tax assets and liabilities - In establishing our deferred income tax
assets and liabilities, we make judgments and interpretations based on the
enacted tax laws and published tax guidance that are applicable to our
operations. We record deferred tax assets and liabilities and evaluate the need
for valuation allowances to reduce the deferred tax assets to realizable
amounts. The likelihood of a material change in our expected realization of
these assets is dependent on future taxable income, our ability to use foreign
tax credit carryforwards and carrybacks, final U.S. and foreign tax settlements,
and the effectiveness of our tax planning strategies in the various relevant
jurisdictions. Due to our lack of profitable operating history, potential
limitations on usage of operating losses and general uncertainty, we provided
for a 100% valuation allowance against our deferred tax assets. We are also
subject to examination of our income tax returns for multiple years by the
Internal Revenue Service and other tax authorities. We periodically assess the
likelihood of adverse outcomes resulting from these examinations to determine
the adequacy of our provision for income taxes. Changes to our income tax
provision or the valuation of the deferred tax assets and liabilities may affect
our annual effective income tax rate.
BUSINESS RISKS AND UNCERTAINTIES
WE HAVE A HISTORY OF LOSSES AND MAY INCUR LOSSES IN THE FUTURE AND THEREFORE
CANNOT ASSURE YOU THAT WE WILL ACHIEVE PROFITABILITY.
We have incurred losses to date and have experienced cash shortages. For the six
months ended June 30, 2004, we incurred net losses of approximately $4,280,000.
In addition, we had an accumulated deficit of approximately $62,554,000 as of
June 30, 2004. We expect additional losses as we continue spending for
production and other business activities as well as further research and
development of our products. As a result, we will need to generate substantial
sales to support our costs of doing business before we can begin to recoup our
operating losses and accumulated deficit and achieve profitability.
18
IF WE ARE UNABLE TO OBTAIN FURTHER FINANCING OR GENERATE REQUIRED WORKING
CAPITAL, OUR ABILITY TO OPERATE COULD SUFFER OR CEASE.
Our operations to date have consumed substantial amounts of cash and will
continue to require substantial amounts of capital in the future. In order to
remain competitive, we must continue to make significant investments essential
to our ability to operate profitably, including investments in further research
and development, equipment, facilities and production activities. Although our
financial condition and liquidity have been assisted through the exercises of
warrants and public and private purchases of our common shares, including the
approximately $12.5 million raised by us in 2003 equity financings and
$1,070,000 raised through exercises of stock options and warrants during 2004,
we will still require additional financing to satisfy our increasing working
capital requirements. Reliance for financing upon exercise of warrants, private
equity purchase agreements and public offerings entails the additional risks of
non-exercise of such warrants because of the prevailing market prices of our
underlying common shares, default by purchasers under these agreements or
inability to sell publicly registered shares. In the event that we are unable to
obtain further financing on satisfactory terms, or we are unable to generate
sales sufficient to offset our costs, or if our costs of development and
operations are greater than we anticipate, we may be unable to grow our business
at the rate desired or may be required to delay, reduce, or cease certain of our
operations, any of which could materially harm our business and financial
results.
WE ARE SUBJECT TO LENGTHY DEVELOPMENT PERIODS AND PRODUCT ACCEPTANCE CYCLES,
WHICH MAY SIGNIFICANTLY HARM OUR BUSINESS.
Our business model requires us to develop microdisplays that perform better than
existing technologies, manufacture our SpatiaLight imagEngine(TM) microdisplays
and/or display units in bulk, and sell the resulting microdisplays and/or
display units to original equipment manufacturers that will then incorporate
them into their products. Original equipment manufacturers make the
determination during their product development programs whether or not to
incorporate our SpatiaLight imagEngine(TM) microdisplays and/or display units in
their products. This requires us to invest significant amounts of time and
capital in designing our SpatiaLight imagEngine(TM) microdisplays and/or display
units before we can be assured that we will generate any significant sales to
our customers or even recover our investment. If we fail to recover our
investment in the SpatiaLight imagEngine(TM) microdisplays and/or display units,
it could seriously harm our financial condition. In addition, the length of time
that our products may be successfully received by our customers could be limited
by the acceptance of new technologies developed by our competitors.
WE INCUR SUBSTANTIAL RESEARCH AND DEVELOPMENT COSTS IN CONNECTION WITH
TECHNOLOGIES THAT MAY NOT BE SUCCESSFUL.
We currently have eleven full-time engineering and eleven full-time
manufacturing personnel based in California working on microdisplays. This
staffing creates significant research and development costs that may not be
recouped. Even if our current microdisplays become accepted or successful, due
to the rapid technological changes in our industry, we must continue to use, and
may increase in number, our engineering and manufacturing personnel to develop
future generations of our microdisplays. As a result, we expect to continue
incurring significant research and development costs.
19
WE ARE CURRENTLY MANUFACTURING AND SHIPPING OUR MICRODISPLAYS, BUT UNANTICIPATED
DIFFICULTIES IN MANUFACTURING OUR MICRODISPLAYS MAY MAKE IT DIFFICULT TO MEET
CUSTOMER DEMANDS FROM TIME TO TIME AND OUR OPERATING RESULTS COULD BE
SIGNIFICANTLY HARMED BY SUCH DIFFICULTIES.
We need to work closely with our manufacturing sources to assure production of
our current microdisplays. Problems in production or lower than expected
manufacturing yields could significantly harm our business because we will have
already incurred the costs for the materials used in the microdisplay
manufacturing process. These problems could cause delays that might lead our
potential customers to seek other sources.
We currently obtain silicon backplanes, a vital component in our microdisplays,
from the Far East. Some Asian countries are subject to earthquakes, typhoons and
political instability. Unless we obtain an alternative source, any disruption or
termination of our silicon manufacturing source's operation in Taiwan or air
transportation with the Far East could significantly harm our operations.
Our microdisplays are assembled by combining the silicon backplanes with
electronic components. The design and manufacture of liquid crystal displays and
display units are highly complex processes that are sensitive to a wide variety
of factors, including the level of contaminants in the manufacturing
environment, impurities in the materials used, and the performance of personnel
and equipment. We lease clean room space in California where we currently
manufacture our SpatiaLight imagEngine(TM) microdisplays. In January 2004, we
leased additional clean room space to address current and anticipated increased
manufacturing demand. We believe that these current arrangements provide us with
strong quality controls and effectively protect our proprietary technology in
our products, but the risks discussed above associated with the highly complex
processes of manufacturing these liquid crystal microdisplays remain applicable.
We continue to have working arrangements with the manufacturer of the light
engines and lamps required in the assembly of our display units. We have entered
into an agreement for the supply of prisms and filters which are also required
for the assembly of such units. We do not have other such written agreements
which are binding upon the manufacturers of the other components and no such
manufacturer is bound to furnish us with any specific quantities of their
products at previously specified prices. At this date, we are not aware that any
of our component manufacturers have known shortages of critical material.
Because the manufacture of our SpatiaLight imagEngine(TM) microdisplays involves
highly complex processes and technical problems may arise, we, in our capacity
as manufacturing our liquid crystal microdisplays, which are an integral part of
the display units, cannot assure the manufacturing yields of our products.
Current purchase orders and future purchase orders, as to which we cannot give
any assurance, will require us to produce greater quantities of our microdisplay
products than we have produced in the past. Problems in production, including
problems associated with increasing our production output or lower than expected
manufacturing yields could significantly harm our business and operating
results. In addition, the complexity of our manufacturing processes will
increase as the sophistication of our microdisplays and display units increases,
and such complexities may lend to similar difficulties that could harm our
business and operating results.
WHILE WE INTEND TO OPEN A MANUFACTURING FACILITY IN THE REPUBLIC OF KOREA AS THE
PRINCIPAL FACILITY FOR MANUFACTURING OUR MICRODISPLAY PRODUCTS, WE MAY ENCOUNTER
DELAYS IN BUILDING SUCH A FACILITY, DIFFICULTIES IN TRANSITIONING OUR
MANUFACTURING OPERATIONS AND DIFFICULTIES IN MAINTAINING OUR QUALITY CONTROLS
OVER THE MANUFACTURING AND PRODUCTION PROCESSES, ANY OF WHICH WOULD BE LIKELY TO
CAUSE SIGNIFICANT HARM TO OUR BUSINESS.
20
Our decision to locate our principal manufacturing operations in the Republic of
Korea may cause us to encounter one or more potential problems that could
severely harm our business. Such potential problems could arise in connection
with constructing the facility to our specifications in a timely manner to allow
us to meet the product demand from our customers, which would negatively impact
our ability to sustain current purchase orders and enter into new purchase order
arrangements with our current and prospective customers. Other problems may
arise in the training of employees, which may occur as the result of cultural or
language differences, which may create misunderstandings or cause inefficiencies
in our operations. The geographic separation between our corporate offices in
the United States and our principal manufacturing operation in Korea could
result in managerial or supervisory problems, which could lead to decreased
quality controls and a subsequent material harm to our business.
IF MARKETS FOR OUR PRODUCTS DO NOT CONTINUE TO DEVELOP, OUR BUSINESS WILL LIKELY
BE SIGNIFICANTLY HARMED.
Various target markets for our microdisplays, including high-definition
televisions, projectors, monitors, and portable microdisplays, are uncertain and
may be slow to develop. In addition, companies in those markets could utilize
competing technologies. High-definition television has only recently become
available to consumers, and widespread market acceptance, although anticipated,
is uncertain. In addition, the commercial success of the portable microdisplay
market is uncertain. The acceptance of our display units and/or SpatiaLight
imagEngine(TM) microdisplays will be dependent upon the pricing, quality,
reliability and useful life of these units compared to competing technologies,
as to which there can be no assurance. In order for us to succeed, not only must
we offer end-product manufacturers better and less expensive microdisplays than
our competitors, but the manufacturers themselves must also develop commercially
successful products using our microdisplays. SpatiaLight's marketing efforts are
focused on developing strategic customer and governmental relationships in China
and the Republic of South Korea. Our failure to sell our microdisplays to such
manufacturers or the failure of the ultimate target markets to develop as we
expect will negatively effect our anticipated growth.
IF OUR MICRODISPLAYS DO NOT BECOME WIDELY ACCEPTED BY OUR CUSTOMERS OR THE
END-USERS, OUR BUSINESS COULD BE SIGNIFICANTLY HARMED.
Our microdisplays may not be accepted by a widespread market. Even if we
successfully obtain customer orders, our customers may determine not to
introduce or may terminate products utilizing the technology for a variety of
reasons, including the following:
o superior technologies developed by our competitors;
o price considerations; and
o lack of anticipated or actual market demand for the products.
We currently have purchase order agreements with a limited number of customers.
Despite our reasonable efforts to retain these customers and obtain new
customers, we may not be successful in either of these regards. The loss of any
one or more of these customers or a failure to obtain new customers could
materially harm our business and financial condition.
WE MAY BECOME LARGELY DEPENDENT ON ONE CUSTOMER FOR OUR FUTURE REVENUES AND
FAILURE TO EXPAND OUR CUSTOMER BASE OR RECEIVE ADDITIONAL ORDERS FROM OUR
EXISTING CUSTOMER BASE WILL MAKE US VULNERABLE TO SUBSTANTIAL LOSS OF POTENTIAL
REVENUES.
21
Commencing in January 2005, it is possible that a substantial percentage of our
anticipated revenues will be derived from LG Electronics, Inc., based upon our
agreement with LGE discussed in Note 10 to the financial statements. If we
cannot diversify our customer base or derive increased revenues from our
existing customer base through additional purchase orders and product
deliveries, and therefore we rely on only one customer for a substantial
percentage of our anticipated revenues, we will be vulnerable to a substantial
decline in anticipated revenues if we lose LGE as a customer for any reason or
if LGE were to otherwise reduce, delay or cancel its orders. Any such events
could cause a material and adverse effect on our business, operations and
financial condition and the value of our common shares could decline
substantially.
WE CANNOT ASSURE YOU THAT WE WILL OBTAIN ADDITIONAL PURCHASE ORDERS FROM OUR
CURRENT OR PROSPECTIVE CUSTOMERS, OR, IF WE DO, THAT SUCH ORDERS WILL GENERATE
SIGNIFICANT REVENUES.
Even though we have received purchase orders for our microdisplay products from
a major Korean OEM and from eight Chinese OEMs and we may receive additional
purchase orders from our prospective customers, we may have problems
implementing volume production of such microdisplay products. Furthermore, sales
to manufacturers in the electronics industry are subject to severe competitive
pressures, rapid technological change and product obsolescence. Manufacturers
may, at any time, cancel purchase orders or commitments or reduce or delay
orders, thereby increasing our inventory and overhead risks. Therefore, despite
the purchase orders received from current customers and other purchase orders
that we may receive from prospective customers, we cannot assure you that these
agreements will result in significant revenues to us.
IF OUR CUSTOMERS' PRODUCTS ARE NOT SUCCESSFUL, OUR BUSINESS WOULD BE MATERIALLY
HARMED.
We do not currently sell any products to end-users. Instead, we design and
manufacture various product solutions that our customers (i.e., OEMs) may
incorporate into their products. As a result, our success depends almost
entirely upon the widespread market acceptance of our customers' products. Any
significant slowdown in the demand for our customers' products would materially
harm our business.
Our dependence on the success of the products of our customers exposes us to a
variety of risks, including our need to do the following:
o maintain customer satisfaction with our design and manufacturing
services;
o match our design and manufacturing capacity with customer demand and
maintain satisfactory delivery schedules;
o anticipate customer order patterns, changes in order mix, and the
level and timing of orders that we can meet; and
o adjust to the cyclical nature of the industries and markets we serve.
Our failure to address these risks may cause us to lose sales or for sales
to decline.
THE ELECTRONICS INDUSTRY IS HIGHLY COMPETITIVE, WHICH MAY RESULT IN LOST SALES
OR LOWER GROSS MARGINS.
We serve highly competitive industries that are characterized by price erosion,
rapid technological change and competition from major domestic and international
companies. This intense competition could result in pricing pressures, lower
sales, reduced margins and lower market share. Some of our competitors have
greater market recognition, larger customer bases, and substantially greater
financial, technical, marketing, distribution and other resources than we
possess. As a result, they may be able to introduce new products and respond to
customer requirements more quickly and effectively than we can.
22
Our competitive position could suffer if one or more of our customers decide to
design and manufacture their own microdisplay products, to contract with our
competitors, or to use alternative technologies. In addition, our customers
typically develop a second source. Second source suppliers may win an increasing
share of a program. Our ability to compete successfully depends on a number of
factors, both within and outside our control. These factors include the
following:
o our success in designing and manufacturing new display technologies;
o our ability to address the needs of customers;
o the quality, performance, reliability, features, ease of use, pricing,
and diversity of our display products;
o foreign currency fluctuations, which may cause a foreign competitor's
products to be priced significantly lower than our displays;
o the quality of our customer services;
o the efficiency of our production sources;
o the rate at which customers incorporate our displays into their own
products; and
o products or technologies introduced by our competitors.
OUR BUSINESS IS SIGNIFICANTLY AFFECTED BY CONDITIONS OR EVENTS OCCURRING IN THE
ELECTRONICS INDUSTRY GENERALLY.
The electronics industry has experienced significant economic downturns at
various times, characterized by diminished product demand, accelerated erosion
of average selling prices, and production over-capacity. Since the electronics
industry is cyclical in nature, we may experience substantial period-to-period
fluctuations in future operating results because of general industry conditions
or events occurring in the general economy.
OUR OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS.
Our results of operations have varied significantly from quarter-to-quarter in
the past and are likely to vary significantly in the future, which makes it
difficult to predict our future operating results. Accordingly, we believe that
quarter-to-quarter comparisons of our operating results are not meaningful and
should not be relied upon as an indicator of our future performance. Some of the
factors that cause our operating results to fluctuate include the following:
o introductions of displays and market acceptance of new generations of
displays;
o timing of expenditures in anticipation of future orders;
o changes in our cost structure;
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o availability of labor and components;
o pricing and availability of competitive products and services;
o the timing of orders;
o the volume of orders relative to the capacity we can contract to
produce;
o evolution in the life cycles of customers' products; and
o changes or anticipated changes in economic conditions.
THE MARKET PRICE OF OUR COMMON SHARES IS HIGHLY VOLATILE.
The market price of our common shares has been highly volatile, reflecting
reported losses and receipt of additional financing. Other companies have found
similar volatility correlates with class action securities lawsuits although to
date we have not been a defendant in any such lawsuit. The trading price of our
common shares in the future could continue to be subject to wide fluctuations in
response to various factors, including the following:
o quarterly variations in our operating results;
o actual or anticipated announcements of technical innovations or new
product developments by us or our competitors;
o public announcements regarding our business developments;
o changes in analysts' estimates of our financial performance;
o sales of large numbers of our common shares by our shareholders;
o general conditions in the electronics industry; and
o worldwide economic and financial conditions.
In addition, the stock market has experienced significant price and volume
fluctuations that have particularly affected the market prices for many
high-technology companies and that often have been unrelated to the operating
performance of these companies. These broad market fluctuations and other
factors may adversely affect the market price of our common shares.
BY FURTHER INCREASING THE NUMBER OF OUR COMMON SHARES THAT MAY BE SOLD INTO THE
MARKET, ANY FUTURE OFFERINGS OF OUR EQUITY SECURITIES COULD CAUSE THE MARKET
PRICE OF OUR COMMON SHARES TO DECREASE SIGNIFICANTLY, EVEN IF OUR BUSINESS
OPERATIONS ARE PERFORMING WELL.
The total number of our common shares and warrants to purchase our common
shares, sold in three separate equity financings completed in 2003 represents
approximately 14.37% of the total number of our common shares that are issued
and outstanding as of August 3, 2004. Sales of these shares, into and within the
public market, or the perception that future sales of these common shares could
occur, might adversely affect the prevailing market price of our common shares
in the near future.
OUR COMMON SHARES MAY NOT BE LIQUID.
Our common shares are currently traded on The NASDAQ SmallCap Market. Our
shareholders may find that it is more difficult to sell our common shares than
shares that are listed on The NASDAQ National Market, American Stock Exchange or
New York Stock Exchange. The trading volume of our common shares may be
adversely affected due to the limited marketability of our common shares. Any
substantial sales of our common shares may result in a material reduction in
price because relatively few buyers may be available to purchase our common
shares.
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IF WE LOSE OUR KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN ADDITIONAL
PERSONNEL, OUR ABILITY TO COMPETE COULD BE HARMED.
Our development and operations depend substantially on the efforts and abilities
of our senior management and qualified technical personnel. Our products require
sophisticated production, research and development and technical support. The
competition for qualified management and technical personnel is intense. The
loss of services of one or more of our key employees or the inability to add key
personnel could have a material adverse affect on us; particularly since
currently we do not have any insurance policies in place to cover that
contingency. Our success will depend upon our ability to attract and retain
highly qualified scientific, marketing, manufacturing, financial and other key
management personnel. We face intense competition for the limited number of
people available with the necessary technical skills and understanding of our
products and technology. We cannot assure you that we will be able to attract or
retain such personnel or not incur significant costs in order to do so. If we
are unable to protect our intellectual property from use by third parties, our
ability to compete in the industry will be harmed.
We believe that our success depends in part on protecting our proprietary
technology. We rely on a combination of patent, copyright, trademark and trade
secret laws, as well as confidentiality and assignment of inventions agreements
from our employees, consultants and advisors and other contractual provisions,
to establish and protect our intellectual property rights. Policing unauthorized
use of our products and technology is difficult, however. Despite our efforts to
protect our proprietary rights, we face the following risks:
o pending patent applications may not be issued;
o patents issued to us may be challenged, invalidated, or circumvented;
o unauthorized parties may obtain and use information that we regard as
proprietary despite our efforts to protect our proprietary rights;
o others may independently develop similar technology or design around
any patents issued to us;
o breach of confidentiality agreements;
o intellectual property laws may not protect our intellectual property;
and
o effective protection of intellectual property rights may be limited or
unavailable in some foreign countries, such as China, in which we may
operate. Specifically, although we consider the following unlikely
because of the complex technological structure of our products, one or
more of our current or prospective Chinese or Korean customers, or
their respective employees or other persons including our competitors,
that have or gain access to our products for testing purposes, may
seek to misappropriate or improperly convert to their own use our
intellectual property and a lack of adequate remedies and impartiality
under the Chinese and Korean legal systems may adversely impact our
ability to protect our intellectual property.
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There can be no assurance that we will have adequate remedies in the event any
of the foregoing materializes. Failure to protect our intellectual property
would limit our ability to produce and market our products in the future, which
would materially adversely affect our revenues generated by the sale of such
products. In addition, third parties could assert that our products and
technology infringe their patents or other intellectual property rights. As a
result, we may become subject to future patent infringement claims or
litigation, the defense of which is costly, time-consuming and diverts the
attention of management and other personnel.
POLITICAL, ECONOMIC AND REGULATORY RISKS ASSOCIATED WITH INTERNATIONAL
OPERATIONS MAY LIMIT OUR ABILITY TO DO BUSINESS ABROAD.
A substantial number of our customers, manufacturers and suppliers are located
outside of the United States, principally in the Far East. Our international
operations are subject to political and economic conditions abroad, and
protectionist trade legislation in either the United States or foreign
countries, such as a change in the current tariff structures, export or import
compliance laws, or other trade policies, any of which could adversely affect
our ability to manufacture or sell displays in foreign markets and to purchase
materials or equipment from foreign suppliers. All of our current purchase order
agreements with customers are governed by foreign law and therefore, are subject
to uncertainty with regard to their enforceability.
RISKS RELATED TO DOING BUSINESS IN CHINA MAY NEGATIVELY AFFECT OUR BUSINESS.
Our business is subject to significant political and economic uncertainties and
may be adversely affected by political, economic and social developments in
China. Over the past several years, the Chinese government has pursued economic
reform policies including the encouragement of private economic activity and
greater economic decentralization. The Chinese government may not continue to
pursue these policies or may significantly alter them to our detriment from time
to time with little, if any, prior notice.
A lack of adequate remedies and impartiality under the Chinese legal system may
adversely impact our ability to do business in China and to enforce the
agreements or purchase orders to which we are, or may become, a party.
At various times during recent years, the United States and China have had
significant disagreements over political, economic and social issues.
Controversies may arise in the future between these two countries. Any political
or trade controversies between the United States and China, whether or not
directly related to our business, could adversely affect our ability to do
business in China.
WE DO NOT PAY CASH DIVIDENDS.
We have never paid any cash dividends on our common shares and do not anticipate
that we will pay cash dividends in the near future. Instead, we intend to apply
any future earnings to the expansion and development of our business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
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We place all of our excess cash and cash equivalents in a checking account or
money market account with a nationally reputable bank. As of June 30, 2004, our
cash and cash equivalents totaled approximately $2,476,000.
ITEM 4. CONTROLS AND PROCEDURES
Quarterly evaluation of the Company's Disclosure Controls. As of the end of the
quarterly fiscal period related to this Quarterly Report on Form 10-Q, we
evaluated the effectiveness of the design and operation of our "disclosure
controls and procedures" (Disclosure Controls), and our "internal controls and
procedures for financial reporting" (Internal Controls). This evaluation (the
Controls Evaluation) was done under the supervision and with the participation
of our principal executive officer (CEO) and principal financial officer (CFO).
Limitations on the Effectiveness of Controls. Our CEO and CFO do not expect that
our Disclosure Controls or our internal control over financial reporting will
prevent all error and all fraud. A control system, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that the
control system's objectives will be met. Further, the design of a control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. We have only had limited
revenue derived from the sale of our microdisplay products in the current
reporting period. While the Controls Evaluation has accounted for such limited
sales and revenue, new or additional controls may or may not be required once we
begin selling our microdisplay products in increased volume in the ordinary
course of business. Because of the inherent limitations in all control systems,
no evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or honest
mistake. Additionally, controls can be circumvented by the individual acts of
some persons, by collusion of two or more persons, or by management override of
the controls. The design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions. Over time, specific controls may or may not become
inadequate (e.g., when we commence to sell our products in increased volume in
the ordinary course of business) because of changes in conditions or
deterioration in the degree of compliance with policies or procedures. Because
of the inherent limitations in a cost-effective control system, misstatements
due to error or fraud may occur and not be detected. During the first quarter of
2004, we were advised by our independent public accountants of a "reportable
condition" in our system of Internal Controls pertaining to consistency of
procedures and documentation applied to certain personnel-related expenditures.
Management of the Company is currently addressing this condition through its
ongoing evaluation of Internal Controls.
Conclusions. Based upon the Controls Evaluation, our CEO and CFO have concluded
that, subject to the limitations mentioned in Limitations on Effectiveness of
Controls above, our Disclosure Controls are effective to ensure that material
information relating to the Company is made known to the CEO and CFO,
particularly during the period when our periodic reports are being prepared.
There have been no significant changes in the Company's internal control over
financial reporting that occurred during the quarter covered by this report that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In December 2003, we completed a private placement of 1,000,000 common shares
that were registered with the SEC in a "Shelf" Registration Statement at a price
of $5.00 per share for net proceeds of $4,955,255 received in December 2003.
300,000 of these shares were issued in December 2003, and the remaining shares
were issued in January 2004. We have used proceeds from this transaction to
reduce our liabilities, for working capital purposes and for other general
corporate purposes.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Shareholders held on June 16, 2004 and at the Adjourned
Annual Meeting of Shareholders held on July 7, 2004, the shareholders approved
the following:
PROPOSAL NO. 1
1. The election of Lawrence J. Matteson as a director of the Corporation to
serve for the ensuing year and until his successor is duly elected and
qualified.
For: 33,873,068 Against: 42,415 Abstain: 0
2. The election of Robert C. Munro as a director of the Corporation to serve
for the ensuing year and until his successor is duly elected and qualified.
For: 33,873,068 Against: 42,415 Abstain: 0
3. The election of Robert A. Olins as a director of the Corporation to serve
for the ensuing year and until his successor is duly elected and qualified.
For: 33,873,068 Against: 42,415 Abstain: 0
4. The election of Claude Piaget as a director of the Corporation to serve for
the ensuing year and until his successor is duly elected and qualified.
For: 33,873,068 Against: 42,415 Abstain: 0
PROPOSAL NO. 2
5. To adopt an amendment to the Corporation's 1999 Stock Option Plan to
increase the number of the Corporation's common shares reserved for
issuance thereunder.
For: 18,587,103 Against: 946,646 Abstain: 127,653
PROPOSAL NO. 3
6. To approve the sale by the Corporation to Robert A. Olins, Chief Executive
Officer and a Director of the Corporation, of 1,357,441 of the
Corporation's common shares and a Warrant to purchase 339,360 common
shares.
For: 18,568,283 Against: 973,889 Abstain: 119,230
PROPOSAL NO. 4
7. The ratification of the appointment of BDO Seidman, LLP as the
Corporation's independent public accountants for the fiscal year ending
December 31, 2004.
For: 33,833,775 Against: 31,737 Abstain: 49,971
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
4.1 Amended and Restated Certificate of Incorporation. *
4.2 Bylaws. *
31.1 Rule 13a-14(a)/15d-14(a) Certification of Robert A. Olins.
31.2 Rule 13a-14(a)/15d-14(a) Certification of Sidney B. Landman.
32.1 Certifications of Robert A. Olins and Sidney B. Landman pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(b) Report on Form 8-K:
None.
*Previously filed.
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
as amended, the Registrant has duly caused the report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Date: August 11, 2004
------------------------------
SPATIALIGHT, INC.
By: /s/ROBERT A. OLINS
--------------------------------
Robert A. Olins
Chief Executive Officer
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