SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2004
Commission file number 0-11254
COPYTELE, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 11-2622630
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification no.)
900 Walt Whitman Road
Melville, NY 11747
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(631) 549-5900
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
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
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
On August 27, 2004, the registrant had outstanding 84,751,183 shares of
Common Stock, par value $.01 per share, which is the registrant's only class of
common stock.
TABLE OF CONTENTS
-----------------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Condensed Balance Sheets as of July 31, 2004 (Unaudited) and
October 31, 2003 3
Condensed Statements of Operations (Unaudited) for the nine months
ended July 31, 2004 and 2003 4
Condensed Statements of Operations (Unaudited) for the three months
ended July 31, 2004 and 2003 5
Condensed Statements of Cash Flows (Unaudited) for the nine months
ended July 31, 2004 and 2003 6
Notes to Condensed Financial Statements (Unaudited) 7 - 13
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 14 - 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 26
Item 4. Controls and Procedures. 26
PART II. OTHER INFORMATION
Item 6. Exhibits. 27
SIGNATURES 27
2
PART I. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements.
---------------------
COPYTELE, INC.
--------------
CONDENSED BALANCE SHEETS
------------------------
(Unaudited)
------------
ASSETS July 31, October 31,
------ 2004 2003
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $1,040,283 $1,023,531
Accounts receivable, net of allowance for doubtful accounts of
$149,455 and $159,230, respectively 65,285 41,500
Other receivables, net of allowance for doubtful accounts of $108,793 and
$181,952 respectively 84,308 127,124
Inventories 1,032,754 1,044,875
Prepaid expenses and other current assets 18,451 47,972
------------ ------------
Total current assets 2,241,081 2,285,002
PROPERTY AND EQUIPMENT, net 33,995 39,480
OTHER ASSETS 5,509 6,009
------------ ------------
$2,280,585 $2,330,491
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $322,939 $316,865
Accrued liabilities 37,239 25,420
------------ ------------
Total current liabilities 360,178 342,285
SHAREHOLDERS' EQUITY:
Preferred stock, par value $100 per share; 500,000 shares authorized;
no shares issued or outstanding - -
Common stock, par value $.01 per share; 240,000,000 shares
authorized; 84,588,588 and 80,151,478 shares issued
and outstanding, respectively 845,886 801,515
Additional paid-in capital 68,708,693 66,282,397
Accumulated deficit (67,634,172) (65,095,706)
------------ ------------
1,920,407 1,988,206
------------ ------------
$2,280,585 $2,330,491
============ ============
The accompanying notes are an integral part of these condensed balance sheets.
3
COPYTELE, INC.
--------------
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
----------------------------------------------
For the Nine Months Ended
July 31,
-------------------------------
2004 2003
-------------- --------------
REVENUE $357,251 $196,322
COST OF REVENUE 129,518 108,182
-------------- --------------
Gross profit 227,733 88,140
-------------- --------------
OPERATING EXPENSES
Research and development expenses 1,732,345 1,351,072
Selling, general and administrative expenses 1,036,901 1,165,789
-------------- --------------
Total operating expenses 2,769,246 2,516,861
-------------- --------------
LOSS FROM OPERATIONS (2,541,513) (2,428,721)
INTEREST INCOME 3,047 3,336
-------------- --------------
NET LOSS $(2,538,466) $(2,425,385)
============== ==============
PER SHARE INFORMATION:
Net loss per share:
Basic and Diluted $(0.03) $(0.03)
============== ==============
Shares used in computing net loss per share:
Basic and Diluted 82,277,894 73,641,139
============== ==============
The accompanying notes are an integral part of these condensed statements.
4
COPYTELE, INC.
--------------
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
----------------------------------------------
For the Three Months Ended
July 31,
-------------------------------
2004 2003
-------------- --------------
REVENUE $216,447 $83,240
COST OF REVENUE 83,220 30,497
-------------- --------------
Gross profit 133,227 52,743
-------------- --------------
OPERATING EXPENSES
Research and development expenses 741,166 456,325
Selling, general and administrative expenses 427,352 247,951
-------------- --------------
Total operating expenses 1,168,518 704,276
-------------- --------------
LOSS FROM OPERATIONS (1,035,291) (651,533)
INTEREST INCOME 1,079 768
-------------- --------------
NET LOSS $(1,034,212) $(650,765)
============== ==============
PER SHARE INFORMATION:
Net loss per share:
Basic and Diluted $(0.01) $(0.01)
============== ==============
Shares used in computing net loss per share:
Basic and Diluted 84,048,249 76,449,699
============== ==============
The accompanying notes are an integral part of these condensed statements.
5
COPYTELE, INC.
--------------
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
----------------------------------------------
For the Nine Months Ended
July 31,
-------------------------------
2004 2003
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Payments to suppliers, employees and consultants $(1,257,899) $(831,699)
Cash received from customers 443,612 212,936
Interest received 3,047 3,336
-------------- --------------
Net cash used in operating activities (811,240) (615,427)
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for purchases of property and equipment (8,273) (981)
-------------- --------------
Net cash used in investing activities (8,273) (981)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options, net of registration costs 836,265 818,214
-------------- --------------
Net cash provided by financing activities 836,265 818,214
-------------- --------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 16,752 201,806
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,023,531 854,822
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $1,040,283 $1,056,628
============== ==============
RECONCILIATION OF NET LOSS TO NET CASH USED IN OPERATING ACTIVITIES:
Net loss $(2,538,466) $(2,425,385)
Stock option compensation to consultants 132,252 -
Stock awards granted to employees and consultants pursuant to stock
incentive plans 1,502,150 1,231,030
Provision for (recovery of) bad debts (73,159) 206,622
Depreciation and amortization 13,758 26,417
Change in operating assets and liabilities:
Accounts receivable and other receivables 92,190 16,614
Inventories 12,121 268,023
Prepaid expenses and other current assets 29,521 85,307
Other assets 500 145
Accounts payable and accrued liabilities 17,893 (24,200)
-------------- --------------
Net cash used in operating activities $(811,240) $(615,427)
============== ==============
The accompanying notes are an integral part of these condensed statements.
6
COPYTELE, INC.
--------------
NOTES TO CONDENSED FINANCIAL STATEMENTS
---------------------------------------
(UNAUDITED)
-----------
1. NATURE AND DEVELOPMENT OF BUSINESS AND FUNDING
----------------------------------------------
Organization and Basis of Presentation
- --------------------------------------
CopyTele, Inc. was incorporated on November 5, 1982. Our principal
operations include the development, production and marketing of thin, high
brightness, flat panel video displays and the development, production and
marketing of multi-functional encryption products that provide information
security for domestic and international users over virtually every
communications media.
The condensed financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America ("US
GAAP") for interim financial reporting. Accordingly, they do not include all of
the information and footnotes required by US GAAP for complete financial
statements. The information contained herein is for the nine-month and
three-month periods ended July 31, 2004 and 2003. In management's opinion, all
adjustments (consisting only of normal recurring adjustments considered
necessary for a fair presentation of the results of operations for such periods)
have been included herein.
The results of operations for interim periods may not necessarily reflect
the results of operations for a full year. Reference is made to the audited
financial statements and notes thereto included in our Annual Report on Form
10-K for the fiscal year ended October 31, 2003, for more extensive disclosures
than contained in these condensed financial statements.
Products and Key Relationships
- ------------------------------
Our line of hardware-based encryption products presently includes the
USS-900, the USS-900NB, the USS-900T, the USS-900TL, the USS-900WF, the
USS-900WFL, the DCS-1200, the DCS-1400, the DCS-1400D, the STS-1500 and the
ULP-1. These encryption products are multi-functional, hardware based digital
encryption systems that provide high-grade voice, fax and data encryption using
either the Citadel(TM) CCX encryption cryptographic chip (which is manufactured
by the Harris Corporation) or the Triple DES or AES algorithm (algorithms
available in the public domain which are used by many U.S. government agencies).
In addition, we have developed the USS-900 Security Software, a software
security product for the encryption of data files and e-mail attachments in both
desktop and laptop computers utilizing Microsoft Windows operating systems,
using either the Triple DES or the AES algorithm. We have also developed the
DCS-1800 Security Software to encrypt voice and data in cellular and satellite
phones, scanners, and printers. Furthermore, we have developed modifications of
our standard equipment for specific applications and are producing the USS-900T
and the USS-900TL to provide automatic fax security over the Thuraya satellite
network, built by Boeing Satellite Systems, Inc. ("Boeing"). We have also
developed and are producing the DCS-1400D which is combined with the Thuraya
handset to provide voice security over the Thuraya satellite network. We are
continuing our research and development activities for additional encryption
products. We sell our encryption products directly to end-users and through
dealers and distributors.
7
In April 2004, we entered into an agreement with Boeing, allowing Boeing to
provide our encryption products for use over the Thuraya satellite
communications network. Boeing is purchasing the USS-900T and USS-900TL for fax
encryption and the DCS-1400 and DCS-1400D for voice encryption and is selling
these units for use with its Thuraya handsets throughout the Thuraya satellite
network. Our encryption technology has been integrated directly into this phone
system. Our products enable the Thuraya satellite network to provide encrypted
communications between satellite phones, from satellite phones to desk-based
phones or between desk-based phones.
We have provided our hardware and software encryption solutions to several
other large organizations which are evaluating our solutions in connection with
their security requirements. Our USS-900 has been selected by a major U.S.
company to secure its worldwide fax communications. We have also entered into an
agreement with another major U.S. company to supply prototypes of our encryption
products configured to interface with its satellite global positioning system
("GPS") and data communication network
We are also continuing our research and development activities with respect
to flat panel display technologies, including our thin flat high brightness
video displays. We have been demonstrating our displays to a number of companies
involving applications where we believe our displays have performance advantages
over liquid crystal displays ("LCDs"). These applications include use in outdoor
products which operate over wide air temperature ranges, require wide viewing
angles, and must operate under high and low light ambient conditions. We have
received an initial order for a seed quantity of our display modules to replace
LCDs in an existing product which displays operating instructions and operates
in an outdoor environment. Based on this development, we have, together with
Volga Svet Ltd. ("Volga"), started to produce our 5-inch (diagonal)
high-brightness displays using Volga's current production facility. The initial
display modules we are producing are fulfilling the seed order and, based on
this, we are making modifications to the display modules to meet customer
requirements.
We announced in June 2004 an agreement for a U.S. company to supply us
prototypes of a proprietary array of low voltage controllable nanotubes for
electron emission. Under the arrangement, we have exclusive rights to the
nanotube system for display products. We also announced in June 2004 an
agreement with an Asian company to jointly produce prototypes of two products
having a proprietary thin film technology (TFT) color matrix structure based on
our high brightness video flat panel display technology. Under the agreement,
the Asian company will supply to us prototypes of the two products. The products
are modified TFT color matrix structures having a 7-inch (diagonal) with 1440 x
234 pixels and a 5-inch (diagonal) with 960 x 235 pixels. We will complete the
color displays by adding color phosphors in each pixel in the product matrices
and by using our current and nanotube electron emission technology to activate
the red, blue and green phosphors. We anticipate receiving prototypes of the two
products in October 2004 and we will then, with the assistance of Volga,
complete the fabrication, evaluate the performance, and, if necessary, make
modifications to the prototypes.
8
We have recently received from the U.S. patent office patents for four
variations of our video display technology and a notice of allowance of the
claims contained in our patent application for one other variation of our video
display technology.
Funding and Management's Plans
- ------------------------------
From our inception through June 2001, we had met our liquidity and capital
expenditure needs primarily through the proceeds from sales of common stock in
our initial public offering, in private placements, upon exercise of warrants
issued in connection with the private placements and public offering, and upon
the exercise of stock options. Commencing in the fourth quarter of fiscal 1999,
we began to generate cash flows from sales of our products, and, from June 2001
to January 2002, we received development payments from Futaba Corporation of
Japan.
During the nine months ended July 31, 2004, our operating activities used
approximately $811,000 in cash. This resulted from payments to suppliers,
employees and consultants of approximately $1,258,000, which was offset by cash
of approximately $444,000 received from collections of accounts receivable and
other receivables related to sales of encryption products and services and
approximately $3,000 of interest income received. In addition, we received
approximately $836,000 in cash upon the exercise of stock options and purchased
approximately $8,000 of equipment. As a result, our cash and cash equivalents at
July 31, 2004 increased to approximately $1,040,000 from approximately
$1,024,000 at the end of fiscal 2003.
The auditor's report on our financial statements as of October 31, 2003
states that the net loss incurred during the year ended October 31, 2003, our
accumulated deficit as of that date, and the other factors described in Note 1
to the Financial Statements included in our Annual Report on Form 10-K for the
year ended October 31, 2003, raise substantial doubt about our ability to
continue as a going concern. The auditor's report on our financial statements
for the year ended October 31, 2002 contained a similar statement. Our financial
statements have been prepared assuming we will continue as a going concern and
do not include any adjustments that might result from the outcome of this
uncertainty.
Based on reductions in operating expenses that have been made and
additional reductions that may be implemented, if necessary, we believe that our
existing cash and accounts receivable, together with cash flows from expected
sales of encryption products and flat panel displays, and other potential
sources of cash flows, will be sufficient to enable us to continue in operation
until at least the end of the third quarter of fiscal 2005. However, our
projections of future cash needs and cash flows may differ from actual results.
We are seeking to improve our liquidity through increased sales or license of
products and technology and may also seek to improve our liquidity through sales
of debt or equity securities. We currently have no arrangements with respect to
additional financing. There can be no assurance that we will generate
significant revenues in the future (through sales or otherwise) to improve our
liquidity, that we will generate sufficient revenues to sustain future
operations and/or profitability, that we will be able to expand our current
distributor/dealer network, that production capabilities will be adequate, that
other products will not be produced by other companies that will render our
products obsolete, or that other sources of funding would be available, if
needed, at terms that we would deem favorable.
9
2. Stock-Based Compensation
------------------------
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure", which addresses financial
accounting and reporting for recording expenses for the fair value of stock
options. SFAS No. 148 provides alternative methods of transition for a voluntary
change to fair value based method of accounting for stock-based employee
compensation. Additionally, SFAS No. 148 requires more prominent and more
frequent disclosures in financial statements about the effects of stock-based
compensation. The adoption of SFAS No. 148 disclosure requirements, effective
February 1, 2003, had no effect on our financial position or results of
operations. SFAS No. 123 "Accounting for Stock Based Compensation" encourages
but does not require companies to record compensation cost for stock-based
employee compensation plans at fair value. We account for stock options granted
to employees using the intrinsic value method prescribed in APB Opinion No. 25
"Accounting for Stock Issued to Employees" and comply with the disclosure
provisions of SFAS No. 123 and SFAS No. 148. Compensation cost for stock options
issued to employees and directors is measured as the excess, if any, of the
quoted market price of our stock at the date of grant over the amount an
employee or director must pay to acquire the stock. In accordance with APB
Opinion No. 25, we have not recognized any compensation cost, as all option
grants to employees and directors have been made at the fair market value of our
stock on the date of grant.
Had compensation cost for stock options granted to employees and directors
been determined at fair value, consistent with SFAS No. 123, our net loss and
net loss per share would have increased to the following adjusted amounts:
For the Nine Months For the Three Months
Ended Ended
July 31, July 31,
--------------------- -------------------
2004 2003 2004 2003
---- ---- ---- ----
Net loss as reported $(2,538,466)$(2,425,385) $(1,034,212) $(650,765)
Add: Total stock-based employee
compensation expense, determined
under fair value based method, for
all awards, net of related tax effect (1,272,801) (664,884) (910,758) (658,929)
---------- -------- -------- --------
Net loss as adjusted $(3,811,267)$(3,090,269) $(1,944,970) $(1,309,694)
=========== =========== =========== ===========
Net loss per share, basic and diluted:
As reported $(0.03) $(0.03) $(0.01) $(0.01)
====== ====== ====== ======
As adjusted $(0.05) $(0.04) $(0.02) $(0.02)
====== ====== ====== ======
10
The fair value of each option grant is estimated at the date of grant using
the Black-Scholes option pricing model. The following weighted-average
assumptions were used for grants during the nine months ended July 31, 2004:
risk free interest rates of 2.53%; expected dividend yields of 0%; expected
lives of 2.48 years; and expected stock price volatility of 123%. The weighted
average fair value of options granted under SFAS No. 123 for the nine months
ended July 31, 2004 was $0.42.
During the nine-month periods ended July, 2004 and 2003, we granted to
employees, directors and consultants options to purchase 3,340,000 shares and
6,330,000 shares, respectively, pursuant to the CopyTele, Inc. 2000 Share
Incentive Plan (the "2000 Share Plan") and the Copytele, Inc. 2003 Share
Incentive Plan (the "2003 Share Plan"). We account for options granted to
non-employee consultants using the fair value method required by SFAS No. 123.
Compensation expense for consultants, recognized during the nine-month and
three-month periods ended July 31, 2004, was approximately $132,000 and
$115,000, respectively. We recognized no such compensation expense for
consultants during the nine-month period ended July 31, 2003. Options granted
during the nine-month period ended July 31, 2004 included options to purchase
750,000 shares, 250,000 shares, 50,000 shares, 100,000 shares, and 60,000 shares
granted to Denis A. Krusos, our Chairman of the Board and Chief Executive
Officer, Frank J. DiSanto, our President, Henry P. Herms, our Vice President -
Finance and Chief Financial Officer, George P. Larounis, a director, and Anthony
Bowers, a director, respectively. During the nine-month periods ended July 31,
2004 and 2003, stock options to purchase 1,706,000 shares and 3,409,000 shares,
respectively, were exercised, with aggregate proceeds of approximately $836,000
and $827,000, respectively.
During the nine-month periods ended July 31, 2004 and 2003, we issued
2,102,250 shares and 3,961,175 shares, respectively, of common stock to certain
employees for services rendered, principally in lieu of cash compensation,
pursuant to the 2000 Share Plan and the 2003 Share Plan, which includes 235,000
shares and 25,000 shares issued during the nine-month period ended July 31, 2004
to Mr. Krusos and Mr. Herms, respectively. We recorded compensation costs for
the nine-month and three-month periods ended July 31, 2004 and 2003 of
approximately $1,175,000, $463,000, $963,000, and $389,000 respectively, for the
shares of common stock issued to employees. In addition, during the nine-month
periods ended July 31, 2004 and 2003, we issued 628,860 shares and 1,216,577
shares, respectively, of common stock to consultants for services rendered
pursuant to the 2000 Share Plan and the 2003 Share Plan. We recorded consulting
expense for the nine-month and three-month periods ended July 31, 2004 and 2003,
of approximately $328,000, $91,000, $268,000 and $70,000, respectively, for the
shares of common stock issued to consultants.
As of July 31, 2004, 42,048 shares and 364,019 shares, respectively, were
available for future grants under the 2000 Share Plan and the 2003 Share Plan.
3. OTHER RECEIVABLES
-----------------
In May and June 2002, we received restricted common stock from a customer
in connection with an outstanding accounts receivable of approximately $323,000
and anticipated settling this accounts receivable through the ultimate sale of
the common stock. This customer has agreed with us to cure any deficiency
between the proceeds from the sale of the common stock and the balance of the
outstanding accounts receivable. In addition, the customer's principal
shareholder has personally agreed to cure any deficiency in the event that the
customer defaults on its agreement to cure such deficiency, up to $292,000. As
of July 31, 2004, we received aggregate proceeds of approximately $124,000 from
the sale of a portion of the common stock and we intend to sell the remaining
portion of such stock during the next twelve months. This receivable is stated
at management's estimate of its net realizable value.
11
4. INVENTORIES
-----------
Inventories consist of the following as of:
April 30, October 31,
2004 2003
---- ----
Component parts $ 323,338 $ 341,344
Work-in-process 95,849 48,324
Finished products 613,567 655,207
----------- ----------------
$ 1,032,754 $ 1,044,875
=========== ================
5. NET INCOME (LOSS) PER SHARE OF COMMON STOCK
-------------------------------------------
We comply with the provisions of SFAS No. 128, "Earnings Per Share." In
accordance with SFAS No. 128, basic net income (loss) per common share ("Basic
EPS") is computed by dividing net income (loss) by the weighted average number
of common shares outstanding. Diluted net income (loss) per common share
("Diluted EPS") is computed by dividing net income (loss) by the weighted
average number of common shares and dilutive common share equivalents and
convertible securities then outstanding. Diluted EPS for all periods presented
is the same as Basic EPS, as the inclusion of the effect of common stock
equivalents then outstanding would be anti-dilutive. For this reason, excluded
from the calculation of Diluted EPS for the nine-month and three-month periods
ended July 31, 2004 and 2003 were options to purchase 16,252,546 shares and
16,835,746 shares, respectively.
6. SEGMENT INFORMATION
-------------------
We follow the provisions of SFAS No. 131,"Disclosures about Segments of an
Enterprise and Related Information." Reportable operating segments are
determined based on management`s approach. The management approach, as defined
by SFAS No. 131, is based on the way that the chief operating decision-maker
organizes the segments within an enterprise for making operating decisions and
assessing performance. While our results of operations are primarily reviewed on
a consolidated basis, the chief operating decision-maker also manages the
enterprise in two segments: (i) Flat-panel display and (ii) Encryption products
and services.
The following represents selected financial information for our segments
for the nine-month and three-month periods ended July, 2004 and 2003:
Encryption Products
Segment Data Flat-Panel Display and Services Total
- ------------------------------------------- --------------------- ---------------------- ---------------------
Nine Months Ended July 31, 2004:
Revenue $ - $ 357,251 $ 357,251
Net loss (1,452,496) (1,085,970) (2,538,466)
Nine Months Ended July, 2003:
Revenue $ - $ 196,322 $ 196,322
Net loss (1,234,356) (1,191,029) (2,425,385)
12
Encryption Products
Segment Data Flat-Panel Display and Services Total
- ------------------------------------------- --------------------- ---------------------- ---------------------
Three Months Ended July 31, 2004:
Revenue $ - $ 216,447 $ 216,447
Net loss (715,151) (319,061) (1,034,212)
Three Months Ended July 31, 2003:
Revenue $ - $ 83,240 $ 83,240
Net loss (445,558) (250,207) (650,765)
7. Impact of Recent Accounting Pronouncements
------------------------------------------
In December 2003, the Security and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 104, "Revenue Recognition", which codifies,
revises and rescinds certain sections of SAB No. 101, "Revenue Recognition", in
order to make this interpretive guidance consistent with current authoritative
accounting and auditing guidance and SEC rules and regulations. The issuance of
SAB No. 104 did not have a material effect on our financial position or results
of operations.
13
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
-----------------------------------------------------------------------
GENERAL
- -------
Our principal operations include the development, production and marketing
of thin, high-brightness, flat panel video displays and the development,
production and marketing of multi-functional encryption products that provide
information security for domestic and international users over virtually every
communications media.
Our line of hardware-based encryption products presently includes the
USS-900, the USS-900NB, the USS-900T, the USS-900TL, the USS-900WF, the
USS-900WFL, the DCS-1200, the DCS-1400, the DCS-1400D, the STS-1500 and the
ULP-1. These encryption products are multi-functional, hardware based digital
encryption systems that provide high-grade voice, fax and data encryption using
either the Citadel(TM) CCX encryption cryptographic chip (which is manufactured
by the Harris Corporation) or the Triple DES or AES algorithm (algorithms
available in the public domain which are used by many U.S. government agencies).
In addition, we have developed the USS-900 Security Software, a software
security product for the encryption of data files and e-mail attachments in both
desktop and laptop computers utilizing Microsoft Windows operating systems,
using either the Triple DES or the AES algorithm. We have also developed the
DCS-1800 Security Software to encrypt voice and data in cellular and satellite
phones, scanners, and printers. Furthermore, we have developed modifications of
our standard equipment for specific applications and are producing the USS-900T
and USS-900TL to provide automatic fax security over the Thuraya satellite
network, built by Boeing Satellite Systems, Inc. ("Boeing"). We have also
developed and are producing the DCS-1400D which is combined with the Thuraya
handset to provide voice security over the Thuraya satellite network. We are
continuing our research and development activities for additional encryption
products.
We are currently using several U.S.-based electronic production contractors
to produce the components for our encryption devices. We sell our encryption
products directly to end-users and through dealers and distributors.
In April 2004, we entered into an agreement with Boeing, allowing Boeing to
provide our encryption products for use over the Thuraya satellite
communications network. Boeing is purchasing the USS-900T and USS-900TL for fax
encryption and the DCS-1400 and DCS-1400D for voice encryption and is selling
these units for use with its Thuraya handsets throughout the Thuraya satellite
network. Our encryption technology has been integrated directly into this phone
system. Our products enable the Thuraya satellite network to provide encrypted
communications between satellite phones, from satellite phones to desk-based
phones or between desk-based phones. The use of encryption is expected to
benefit Thuraya satellite telecommunications customers that Boeing is currently
serving in Iraq. Boeing provides mobile satellite services to officials in
Baghdad's governing ministries, to U.S. military forces and to other U.S.
personnel in Iraq.
We have provided our hardware and software encryption solutions to several
other large organizations which are evaluating our solutions in connection with
their security requirements. Our USS-900 has been selected by a major U.S.
company to secure its worldwide fax communications. We have also entered into an
agreement with another major U.S. company to supply prototypes of our encryption
products configured to interface with its satellite global positioning system
("GPS") and data communication network. In addition, we have received orders
from other U.S. companies that principally supply U.S. government agencies and
foreign governments, to provide our USS-900, DCS-1200, and DCS-1400 to encrypt
voice, fax, and data over satellite communication systems. Such companies placed
their orders after an extended evaluation of our products' performance using the
Iridium, Globalstar, Immarset, Immarset M-4, Mini M and Thuraya satellite
communication networks. We believe that encrypting information over satellite
networks is in the early stages and expect this field to be an expanding
opportunity for our encryption products due to the rising demand for information
security over many regions of the world.
14
We have made significant advancements to develop and produce our thin film
video flat panel displays utilizing our electronic emission technology. We are
initially pursuing applications for our display that we believe will demonstrate
its performance advantages over liquid crystal displays ("LCDs"). In particular,
we have been demonstrating our displays to a number of companies for use in
outdoor products made by them that operate over wide air temperature ranges and
under high and low light ambient conditions, and that require wide viewing
angles.
We provided our display to a company to evaluate the display's performance
in a product produced by the company that operates over a wide air temperature
range in an outdoor environment. After successfully testing our display, that
company issued to us a purchase order for a seed quantity of modules containing
our display, to replace LCD modules in the company's product. Based on this
development, we have, together with Volga Svet Ltd. ("Volga"), a Russian display
company that we have been working with for approximately seven years, started to
produce our 5-inch (diagonal) high-brightness displays using Volga's current
production facility. The initial display modules we are producing are fulfilling
the seed order and, based on this, we are making modifications to the display
modules to meet customer requirements. We are providing funding to Volga for
this work; these development payments to Volga are included in research and
development expenses in the accompanying condensed financial statements. Volga
has agreed to produce an initial quantity of these displays for commercial sales
on a fixed price basis. We anticipate that Volga may in the future produce
additional quantities of displays for commercial sales also on a fixed price
basis, but we have not entered into any agreements with Volga for such future
production.
In addition, we are pursuing other opportunities by demonstrating our
displays to companies having large quantity display applications, and we are in
the process of responding to their requests for pricing based on their display
specifications and quantity requirements. These companies' applications would
require large quantities of displays to be located in retail stores, airports,
vending machines and automobiles. For automobiles, the displays would be
required to have the capability to provide wide-screen or standard TV formats
for digital TV and DVD operation.
We announced in June 2004 an agreement for a U.S. company to supply us
prototypes of a proprietary array of low voltage controllable nanotubes for
electron emission. Under the arrangement, we have exclusive rights to the
nanotube system for display products. We also announced in June 2004 an
agreement with an Asian company to jointly produce prototypes of two products
having a proprietary thin film technology (TFT) color matrix structure based on
our high brightness video flat panel display technology. Under the agreement,
the Asian company will supply to us prototypes of the two products. The products
15
are modified TFT color matrix structures having a 7-inch (diagonal) with 1440 x
234 pixels and a 5-inch (diagonal) with 960 x 235 pixels. We will complete the
color displays by adding color phosphors in each pixel in the product matrices
and by using our current and nanotube electron emission technology to activate
the red, blue and green phosphors. We have completed our design modifications
with the Asian company and they have completed the masks which are being
utilized to produce the prototypes of the two products. We anticipate receiving
prototypes of the two products in October 2004 and we will then, with the
assistance of Volga, complete the fabrication, evaluate the performance, and, if
necessary, make modifications to the prototypes. We anticipate that the displays
will be compatible with both wide-screen and standard TV formats for digital TV
and DVD operation. We believe that this will enable us to be able to produce
displays which could meet the requirements of several companies' large quantity
applications. There can be no assurance that we can develop or produce color
video displays or displays using controllable nanotubes and modified TFT
technology or that we can produce larger display sizes or greater quantities
using such technology.
Currently, LCDs are the most commonly used flat panel displays in
commercial products. We believe that our display has the following advantages
over LCD displays:
o No backlight (LCDs require a backlight that results in high power
consumption and contains mercury)
o No thermistor (LCDs require thermistors to control operation at
various temperatures)
o No polarizer (required in LCDs)
o No color filter (required in color LCDs)
o Almost hemispherical viewing angle (LCDs have limited viewing angles)
o Higher contrast ratio
o Faster video response time
o Operates in a wider range of air temperatures
o Longer life
o Not affected by ultraviolet light (LCDs contain a liquid crystal which
may deteriorate after long exposure to direct sunlight)
o Safer (leakage of liquid crystal from LCDs may be dangerous)
We have recently received from the U.S. patent office patents for four
variations of our video display technology and a notice of allowance of the
claims contained in our patent application for one other variation of our video
display technology. We are continuing to apply for additional patents for our
video display technology.
There can be no assurance that we can produce commercial quality displays,
that we can produce such displays in commercial quantities, that we can
successfully market our displays, or of the revenue we might derive from sales
of our displays.
16
CRITICAL ACCOUNTING POLICES
- ---------------------------
Our financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America. As such, we are
required to make certain estimates, judgments and assumptions that management
believes are reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenue and expenses during the reporting
periods.
We believe the following critical accounting polices affect the more
significant judgments and estimates used in the preparation of our financial
statements. For additional discussion on the application of these and other
accounting polices, refer to the financial statements and notes thereto included
in our Annual Report on Form 10-K for the year ended October 31, 2003.
Revenue Recognition
- -------------------
Sales
-----
Revenues from sales are recorded when all four of the following
criteria are met: (i) persuasive evidence of an arrangement
exists; (ii) delivery has occurred and title has transferred or
services have been rendered; (iii) our price to the buyer is
fixed or determinable; and (iv) collectibility is reasonably
assured.
Sales Returns and Allowances
----------------------------
Revenues are recorded net of estimated sales returns.
Inventories
- -----------
Inventories are stated at the lower of cost, including material, labor and
overhead, determined on a first-in, first-out basis, or market, which represents
our best estimate of market value. We regularly review inventory quantities on
hand, particularly finished goods, and record a provision for excess and
obsolete inventory based primarily on forecasts of future product demand. Our
net income (loss) is directly affected by management's estimate of the
realizability of inventories. To date, sales of our products have been limited.
Accordingly, there can be no assurance that we will not be required to reduce
the selling price of our inventory below our current carrying value.
Stock Based Compensation
- ------------------------
We account for stock options granted to employees and directors using the
intrinsic value method prescribed in APB Opinion No. 25 "Accounting for Stock
Issued to Employees" and comply with the disclosure provision of SFAS No. 123
"Accounting for Stock Based Compensation" and SFAS No. 148 "Accounting for Stock
Based Compensation - Transition and Disclosure, an amendment of SFAS No. 123".
If we were to include the cost of employee stock option compensation in the
financial statements, our net loss for the nine-month and three-month periods
ended July 31, 2004 and 2003 would have increased by approximately $1,273,000,
$665,000, $911,000 and $659,000, respectively, based on the fair value of the
stock options granted to employees.
17
RESULTS OF OPERATIONS
- ---------------------
Nine months ended July 31, 2004 compared with nine months ended July 31, 2003
- -----------------------------------------------------------------------------
Sales
-----
Revenue. Revenue from sales increased by approximately $161,000 in the
nine-month period ended July 31, 2004, to approximately $357,000, as compared to
approximately $196,000 in the comparable prior-year period. All revenue during
both periods was from our encryption products and services segment. The increase
in revenue was principally due to an increase in unit sales of our encryption
products to Boeing. Our encryption sales have been limited and are sensitive to
individual large transactions. We believe that changes in revenue between
periods generally represent the nature of the early stage of our product and
sales channel development.
Gross Profit. Gross profit from sales of encryption products and services
increased by approximately $139,000 in the nine-month period ended July 31,
2004, to approximately $228,000, as compared to approximately $88,000 in the
comparable prior-year period. The increase in gross profit was due to the
increase in revenue and to higher gross profit percentages on certain
transactions as compared to the prior-year period. Gross profit as a percent of
revenue increased to approximately 64% in the nine-month period ended July 31,
2004, as compared to approximately 45% in the comparable prior-year period.
Because of the limited number of transactions during each of the periods, gross
profit percentages are sensitive to individual transactions.
Research and Development Expenses
Research and development expenses increased by approximately $381,000 in
the nine-month period ended July 31, 2004, to approximately $1,732,000, from
approximately $1,351,000 in the comparable prior-year period. The increase in
research and development expenses was principally due to an increase in outside
research and development expense, relating principally to our development of
modified TFT technology for our flat panel displays, of approximately $252,000
and an increase in employee compensation and related costs of approximately
$118,000.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased by approximately
$129,000 to approximately $1,037,000 in the nine-month period ended July 31,
2004, from approximately $1,166,000 in the comparable prior-year period. The
decrease in selling, general and administrative expenses was principally due to
a decrease in the provision for bad debts of approximately $280,000, a write
down of Magicom inventory in the prior year of approximately $58,000 and a
decrease in advertising expense of approximately $41,000, offset by compensation
expense of approximately $132,000 recorded in the current period for stock
options issued to consultants and an increase in employee compensation and
related costs of approximately $108,000. The decrease in the provision for bad
debts resulted from a provision for bad debts in the prior year of approximately
$207,000 and a recovery in the current period of previously reserved amounts of
approximately $73,000.
18
Interest Income
Interest income in each of the nine-month periods ended July 31, 2004 and
2003 was approximately $3,000.
Three months ended July 31, 2004 compared with three months ended July 31, 2003
- -------------------------------------------------------------------------------
Sales
Revenue. Revenue from sales increased by approximately $133,000 in the
three-month period ended July 31, 2004, to approximately $216,000, as compared
to approximately $83,000 in the comparable prior-year period. All revenue during
both periods was from our encryption products and services segment. The increase
in revenue was principally due to an increase unit sales of our encryption
products to Boeing. Our encryption sales have been limited and are sensitive to
individual large transactions. We believe that changes in revenue between
periods generally represent the nature of the early stage of our product and
sales channel development.
Gross Profit. Gross profit from sales of encryption products and services
increased by approximately $80,000 in the three-month period ended July 31,
2004, to approximately $133,000, as compared to approximately $53,000 in the
comparable prior-year period. The increase in gross profit was primarily due to
the increase in revenue. Gross profit as a percent of revenue decreased to
approximately 62% in the three-month period ended July 31, 2004, as compared to
approximately 63% in the comparable prior-year period. Because of the limited
number of transactions during each of the periods, gross profit percentages are
sensitive to individual transactions.
Research and Development Expenses
Research and development expenses increased by approximately $285,000 in
the three-month period ended July 31, 2004, to approximately $741,000, from
approximately $456,000 in the comparable prior-year period. The increase in
research and development expenses was principally due to an increase in outside
research and development expense, relating principally to our development of
modified TFT technology for our flat panel displays, of approximately $210,000
and an increase in employee compensation and related costs of approximately
$60,000.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by approximately
$179,000 to approximately $427,000 in the three-month period ended July 31,
2004, from approximately $248,000 in the comparable prior-year period. The
increase in selling, general and administrative expenses was principally due to
compensation expense of approximately $115,000 recorded in the current period
for stock options issued to consultants and an increase in employee compensation
and related costs of approximately $45,000.
19
Interest Income
Interest income in each of the three-month periods ended July 31, 2004 and
2003 was approximately $1,000.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
From our inception through June 2001, we met our liquidity and capital
expenditure needs primarily through the proceeds from sales of common stock in
our initial public offering, in private placements, upon exercise of warrants
issued in connection with the private placements and public offering, and upon
the exercise of stock options. Commencing in the fourth quarter of fiscal 1999,
we also began to generate cash flows from sales of our products, and, from June
2001 to January 2002, we received development payments from Futaba Corporation
of Japan.
During the nine months ended July 31, 2004, our operating activities used
approximately $811,000 in cash. This resulted from payments to suppliers,
employees and consultants of approximately $1,258,000, which was offset by cash
of approximately $444,000 received from collections of accounts receivable and
other receivables related to sales of encryption products and services and
approximately $3,000 of interest income received. In addition, we received
approximately $836,000 in cash upon the exercise of stock options and purchased
approximately $8,000 of equipment. As a result, our cash and cash equivalents at
July 31, 2004 increased to approximately $1,040,000 from approximately
$1,024,000 at the end of fiscal 2003.
Accounts receivable increased by approximately $23,000 from approximately
$42,000 at the end of fiscal 2003 to approximately $65,000 at July 31, 2004. The
increase in accounts receivable is a result of an increase in revenue and the
timing of collections. Other receivables decreased by approximately $43,000 from
approximately $127,000 at the end of fiscal 2003 to approximately $84,000 at
July 31, 2004. The decrease in other receivables is a result of proceeds
received from the sale of a portion of the common stock received from a customer
to settle this accounts receivable and other receipts from the customer
aggregating approximately $116,000, offset by a reduction of the provision for
bad debts related to this accounts receivable of approximately $73,000. The
reduction of the provision for bad debts is based on management's estimate of
the other receivables' net realizable value. Inventories decreased approximately
$12,000 from approximately $1,045,000 at October 31, 2003 to approximately
$1,033,000 at July 31, 2004, as a result of the timing of shipments and
production schedules. Prepaid expenses and other current assets decreased by
approximately $30,000 from approximately $48,000 at the end of fiscal 2003 to
approximately $18,000 at July 31, 2004, as a result of the timing of payments.
Accounts payable and accrued liabilities increased by approximately $18,000 from
approximately $342,000 at the end of fiscal 2003 to approximately $360,000 at
July 31, 2004, as a result of the timing of payments.
As a result of these changes, working capital at July 31, 2004 decreased to
approximately $1,881,000 from approximately $1,943,000 at the end of fiscal
2003.
20
Our working capital includes inventory of approximately $1,033,000 at July
31, 2004. Management has recorded our inventory at the lower of cost or our
current best estimate of net realizable value. To date, sales of our products
have been limited. Accordingly, there can be no assurance that we will not be
required to reduce the selling price of our inventory below our current carrying
value.
Our plans and expectations for our working capital needs also assume that
our Chairman of the Board and Chief Executive Officer and our President will
continue to perform services without significant cash compensation or pension
benefits. There can be no assurance that they will continue to provide such
services under such compensation arrangements.
The auditor's report on our financial statements as of October 31, 2003
states that the net loss incurred during the year ended October 31, 2003, our
accumulated deficit as of that date, and the other factors described in Note 1
to the Financial Statements included in our Annual Report on Form 10-K for the
year ended October 31, 2003, raise substantial doubt about our ability to
continue as a going concern. The auditor's report on our financial statements
for the year ended October 31, 2002 contained a similar statement. Our financial
statements have been prepared assuming we will continue as a going concern and
do not include any adjustments that might result from the outcome of this
uncertainty.
Based on reductions in operating expenses that have been made and
additional reductions that may be implemented, if necessary, we believe that our
existing cash and accounts receivable, together with cash flows from expected
sales of encryption products and flat panel displays, and other potential
sources of cash flows, will be sufficient to enable us to continue in operation
until at least the end of the third quarter of fiscal 2005. We anticipate that,
thereafter, we will require additional funds to continue our marketing,
production, and research and development activities, and we will require outside
funding if cash generated from operations is insufficient to satisfy our
liquidity requirements. However, our projections of future cash needs and cash
flows may differ from actual results. If current cash and cash that may be
generated from operations are insufficient to satisfy our liquidity
requirements, we may seek to sell debt or equity securities or to obtain a line
of credit prior to the third quarter of fiscal 2005. The sale of additional
equity securities or convertible debt could result in dilution to our
stockholders. We can give you no assurance that we will be able to generate
adequate funds from operations, that funds will be available to us from debt or
equity financings or a line of credit or that, if available, we will be able to
obtain such funds on favorable terms and conditions. We currently have no
arrangements with respect to additional financing.
We are seeking to improve our liquidity through increased sales or license
of products and technology. In an effort to generate sales, we have marketed our
encryption products directly to U.S. and international distributors, dealers and
original equipment manufacturers that market our encryption products on a
non-exclusive basis and to end-users. We have provided several large
organizations our hardware and software encryption solutions and they are
evaluating our solutions in connection with their security requirements. We have
also begun to market our flat panel video display products to potential
purchasers for incorporation into their products. During the nine-month period
ended July 31, 2004, we have recognized revenue from sales of approximately
$357,000.
21
The following table presents our expected cash requirements for contractual
obligations outstanding as July 31, 2004:
Payments Due by Period
---------------------------------------------------------------
Contractual Less
Obligations than 1-3 4-5 After
1 year years years 5 years Total
- --------------------- ----------- ----------- -------- --------- ----------------
Consulting Agreement $67,500 $ - $ - $ - $67,500
Noncancelable
Operating Leases 253,000 217,000 - - 470,000
----------- ----------- -------- --------- ----------------
Total Contractual
Cash Obligations $320,500 $217,000 $ - $ - $537,500
=========== =========== ======== ========= ================
IMPACT OF RECENT ACCOUNTING PPRONOUNCEMENTS
- -------------------------------------------
In December 2003, the Security and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 104, "Revenue Recognition", which codifies,
revises and rescinds certain sections of SAB No. 101, "Revenue Recognition", in
order to make this interpretive guidance consistent with current authoritative
accounting and auditing guidance and SEC rules and regulations. The issuance of
SAB No. 104 did not have a material effect on our financial position or results
of operations.
FORWARD-LOOKING STATEMENTS
- --------------------------
Information included in this Quarterly Report on Form 10-Q may contain
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are not statements of
historical facts, but rather reflect our current expectations concerning future
events and results. We generally use the words "believes," "expects," "intends,"
"plans," "anticipates," "likely," "will" and similar expressions to identify
forward-looking statements. Such forward-looking statements, including those
concerning our expectations, involve risks, uncertainties and other factors,
some of which are beyond our control, which may cause our actual results,
performance or achievements, or industry results, to be materially different
from any future results, performance, or achievements expressed or implied by
such forward-looking statements. These risks, uncertainties and factors include,
but are not limited to, those factors set forth in "General Risks and
Uncertainties" below and Note 1 to Condensed Financial Statements. You should
read this discussion and analysis along with our Annual Report on Form 10-K for
the year ended October 31, 2003 and the condensed financial statements included
in this Report. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. You are cautioned not to unduly rely on such
forward-looking statements when evaluating the information presented in this
Report.
22
GENERAL RISKS AND UNCERTAINTIES
- -------------------------------
Our business involves a high degree of risk and uncertainty, including, but
not limited to, the following risks and uncertainties:
o We have experienced significant net losses and negative cash flows from
operations and they may continue.
We have had net losses and negative cash flows from operations in each year
since our inception and in the nine months ended July 31, 2004, and we may
continue to incur substantial losses and experience substantial negative cash
flows from operations. We have incurred substantial costs and expenses in
developing our encryption and flat panel display technologies and in our efforts
to produce commercially marketable products incorporating our technology. We
have had limited sales of products to support our operations from inception
through July 31, 2004. We have set forth below our net losses, research and
development expenses and net cash used in operations for the nine-month periods
ended July 31, 2004 and 2003, and for the fiscal years ended October 31, 2003
and 2002:
(Unaudited)
Nine Months Ended Fiscal Years Ended
July 31, October 31,
-------------------------------- ------------------------------
2004 2003 2003 2002
---- ---- ---- ----
Net loss $ 2,538,466 $ 2,425,385 $ 3,114,411 $ 3,285,240
Research and development expenses $ 1,732,345 $ 1,351,072 $ 1,807,742 $ 1,625,974
Net cash used in operations $ 811,240 $ 615,427 $ 958,501 $ 431,471
o We may need additional funding in the future which may not be available on
acceptable terms and, if available, may result in dilution to our
stockholders, and our auditors have issued a "going concern" audit opinion.
We anticipate that, if cash generated from operations is insufficient to
satisfy our requirements, we will require additional funding to continue our
research and development activities and market our products. The auditor's
report on our financial statements as of October 31, 2003 states that the net
loss incurred during the year ended October 31, 2003, our accumulated deficit as
of that date, and the other factors described in Note 1 to the Financial
Statements included in our Annual Report on Form 10-K for the year ended October
31, 2003, raise substantial doubt about our ability to continue as a going
concern. The auditor's report on our financial statements for the year ended
October 31, 2002 contained a similar statement. Our financial statements have
been prepared assuming we will continue as a going concern and do not include
any adjustments that might result from the outcome of this uncertainty.
Based on reductions in operating expenses that have been made and
additional reductions that may be implemented, if necessary, we believe that our
existing cash and accounts receivable, together with cash flows from expected
sales of encryption products and flat panel displays, and other potential
23
sources of cash flows, will be sufficient to enable us to continue in operation
until at least the end of the third quarter of fiscal 2005. We anticipate that,
thereafter, we will require additional funds to continue marketing, production,
and research and development activities, and we will require outside funding if
cash generated from operations is insufficient to satisfy our liquidity
requirements. However, our projections of future cash needs and cash flows may
differ from actual results. If current cash and cash that may be generated from
operations are insufficient to satisfy our liquidity requirements, we may seek
to sell debt or equity securities or to obtain a line of credit prior to the
third quarter of fiscal 2005. The sale of additional equity securities or
convertible debt could result in dilution to our stockholders. We can give you
no assurance that we will be able to generate adequate funds from operations,
that funds will be available to us from debt or equity financings or a line of
credit or that, if available, we will be able to obtain such funds on favorable
terms and conditions. We currently have no arrangements with respect to
additional financing.
o We may not generate sufficient revenues to support our operations in the
future or to generate profits.
We are engaged in two principal operations: (i) the development, production
and marketing of thin high-brightness flat panel video displays and (ii) the
development, production and marketing of multi-functional encryption products
that provide information security for domestic and international users over
virtually every communications media. We have only recently started to produce
monochrome versions of our high-brightness flat panel displays and our
encryption products are only in their initial stages of commercial production.
Our investments in research and development are considerable. Our ability to
generate sufficient revenues to support our operations in the future or to
generate profits will depend upon numerous factors, many of which are beyond our
control, including:
o our ability to successfully market our line of thin high-brightness
flat panel video displays and encryption products;
o the capability of Volga to produce thin high-brightness monochrome
video displays and supply them to us;
o our ability to jointly develop with Volga and produce a full-color
video display;
o our ability to develop and produce displays using controllable
nanotubes and modified TFT technology;
o our production capabilities and those of our suppliers as required for
the production of our encryption products;
o long-term performance of our products;
o the capability of our dealers and distributors to adequately service
our encryption products;
o our ability to maintain an acceptable pricing level to end-users for
both our encryption and display products;
o the ability of suppliers to meet our requirements and schedule;
o our ability to successfully develop other new products under
development;
o rapidly changing consumer preferences;
24
o the possible development of competitive products that could render our
products obsolete or unmarketable;
o our future negotiations with Volga with respect to payments and other
arrangements under our Joint Cooperation Agreement with Volga.
Because our revenue is subject to fluctuation, we may be unable to reduce
operating expenses quickly enough to offset any unexpected revenue shortfall. If
we have a shortfall in revenue in relation to expenses, our operating results
would suffer. Our operating results for any particular quarter may not be
indicative of future operating results. You should not rely on
quarter-to-quarter comparisons of results of operations as an indication of our
future performance.
o We are dependent upon a few key executives and the loss of their
services could adversely affect us.
Our future success is dependent on our ability to hire, retain and motivate
highly qualified personnel. In particular, our success depends on the continued
efforts of our Chief Executive Officer, Denis A. Krusos, and our President,
Frank J. DiSanto, who founded our company in 1982 and are engaged in the
management and operations of our business, including all aspects of the
development, production and marketing of our encryption products and flat panel
display technology. In addition, Messrs. Krusos and DiSanto, as well as our
other skilled management and technical personnel, are important to our future
business and financial arrangements. The loss of the services of any such
persons could have a material adverse effect on our business and operating
results.
o The very competitive markets for our encryption products and flat
panel display technology could have a harmful effect on our business
and operating results.
The markets for our encryption products and flat panel display technology
worldwide are highly competitive and subject to rapid technological changes.
Most of our competitors are larger than us and possess financial, research,
service support, marketing, manufacturing and other resources significantly
greater than ours. Competitive pressures may have a harmful effect on our
business and operating results.
o Our common stock is subject to the SEC's penny stock rules which may
make our shares more difficult to sell.
Our stock fits the definition of a penny stock. The SEC rules regarding
penny stocks may have the effect of reducing trading activity in our common
stock and making it more difficult for investors to sell. The rules require a
broker to deliver a risk disclosure document that provides information about
penny stocks and the nature and level of risks in the penny stock market. The
broker must also give bid and offer quotations and broker and salesperson
compensation information to the customer orally or in writing prior to effecting
a transaction and in writing with the confirmation. The SEC rules also require a
broker to make a special written determination that the penny stock is a
suitable investment for the purchaser and receive the purchaser's written
agreement to the transaction before completion of the transaction. These
requirements may result in a lower trading volume of our common stock and lower
trading prices.
25
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
-----------------------------------------------------------
We have invested a portion of our cash on hand in short term, fixed rate
and highly liquid instruments that have historically been reinvested when they
mature throughout the year. Although our existing instruments are not considered
at risk with respect to changes in interest rates or markets for these
instruments, our rate of return on these securities could be affected at the
time of reinvestment, if any.
Item 4. Controls and Procedures.
------------------------
We carried out an evaluation, under the supervision and with the
participation of our management including our Chairman of the Board and Chief
Executive Officer and our Vice President - Finance and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13-15(b) of the Securities Exchange Act of 1934, as
amended. Based upon that evaluation, our Chairman of the Board and Chief
Executive Officer and our Vice President - Finance and Chief Financial Officer
concluded that our disclosure controls and procedures are effective as of the
end of the period covered by this report.
There was no change in our internal control over financial reporting during
the quarter ended July 31, 2004 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
26
PART II. OTHER INFORMATION
--------------------------
Item 6. Exhibits.
---------
10.1 Form of Stock Option Agreement.
10.2 Form of Stock Award Agreement.
31.1 Certification of Chief Executive Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated
September 2, 2004.
31.2 Certification of Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated
September 2, 2004.
32.1 Statement of Chief Executive Officer, pursuant to Section
1350 of Title 18 of the United States Code, dated September
2, 2004.
32.2 Statement of Chief Financial Officer, pursuant to Section
1350 of Title 18 of the United States Code, dated September
2, 2004.
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CopyTele, Inc.
By: /s/ Denis A. Krusos
--------------------------------
Denis A. Krusos
Chairman of the Board,
Chief Executive Officer
September 2, 2004 (Principal Executive Officer)
By: /s/ Henry P. Herms
--------------------------------
Henry P. Herms
Vice President - Finance and
Chief Financial Officer (Principal
September 2, 2004 Financial and Accounting Officer)
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