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 April 30, 2005
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 __X__ No ___
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
On June 7, 2005, the registrant had outstanding 88,860,668 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 April 30, 2005 (Unaudited) and
October 31, 2004 3
Condensed Statements of Operations (Unaudited) for the six months
ended April 30, 2005 and 2004 4
Condensed Statements of Operations (Unaudited) for the three months
ended April 30, 2005 and 2004 5
Condensed Statements of Cash Flows (Unaudited) for the six months
ended April 30, 2005 and 2004 6
Notes to Condensed Financial Statements (Unaudited) 7 - 13
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 14 - 27
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 28
Item 4. Controls and Procedures. 28
PART II. OTHER INFORMATION
Item 6. Exhibits. 28
SIGNATURES 29
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
COPYTELE, INC.
CONDENSED BALANCE SHEETS
(Unaudited)
------------
April 30, October 31,
ASSETS 2005 2004*
------ ------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $ 640,622 $ 1,002,777
Short-term investments 395,964 --
Accounts receivable, net of allowance for doubtful accounts of $149,455 21,153 63,460
Other receivables, net of allowance for doubtful accounts of $100,171 and
$108,793, respectively 77,627 84,308
Inventories 877,239 999,429
Prepaid expenses and other current assets 16,536 122,482
------------ ------------
Total current assets 2,029,141 2,272,456
PROPERTY AND EQUIPMENT, net 33,042 38,085
OTHER ASSETS 5,509 5,509
------------ ------------
$ 2,067,692 $ 2,316,050
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 252,207 $ 402,640
Accrued liabilities 40,732 40,480
------------ ------------
Total current liabilities 292,939 443,120
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; 88,533,138 and 85,523,253 shares issued
and outstanding, respectively 885,331 855,233
Additional paid-in capital 71,532,272 69,474,058
Accumulated deficit (70,642,850) (68,456,361)
------------ ------------
1,774,753 1,872,930
------------ ------------
$ 2,067,692 $ 2,316,050
============ ============
* Derived from audited balance sheet included in our Annual Report on Form
10-K for the fiscal year ended October 31, 2004.
The accompanying notes are an integral part of these condensed balance sheets.
3
COPYTELE, INC.
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
For the Six Months Ended
-------------------------------------
April 30,
-------------------------------------
2005 2004
------------ ------------
REVENUE $ 259,300 $ 140,804
COST OF REVENUE 200,431 46,298
------------ ------------
Gross profit 58,869 94,506
------------ ------------
OPERATING EXPENSES
Research and development expenses 1,239,888 991,179
Selling, general and administrative expenses 1,011,742 609,549
------------ ------------
Total operating expenses 2,251,630 1,600,728
------------ ------------
LOSS FROM OPERATIONS (2,192,761) (1,506,222)
INTEREST INCOME 6,272 1,968
------------ ------------
NET LOSS $ (2,186,489) $ (1,504,254)
============ ============
PER SHARE INFORMATION:
Net loss per share:
Basic and Diluted $ (0.03) $ (0.02)
============ ============
Shares used in computing net loss per share:
Basic and Diluted 86,742,842 81,382,989
============ ============
The accompanying notes are an integral part of these condensed statements.
4
COPYTELE, INC.
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
For the Three Months Ended
-------------------------------------
April 30,
-------------------------------------
2005 2004
------------ ------------
REVENUE $ 46,709 $ 101,804
COST OF REVENUE 135,858 31,699
------------ ------------
Gross profit (loss) (89,149) 70,105
------------ ------------
OPERATING EXPENSES
Research and development expenses 649,935 506,636
Selling, general and administrative expenses 445,471 259,388
------------ ------------
Total operating expenses 1,095,406 766,024
------------ ------------
LOSS FROM OPERATIONS (1,184,555) (695,919)
INTEREST INCOME 4,560 1,019
------------ ------------
NET LOSS $ (1,179,995) $ (694,900)
============ ============
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 87,341,635 82,167,680
============ ============
The accompanying notes are an integral part of these condensed statements.
5
COPYTELE, INC.
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Six Months Ended
-------------------------------------
April 30,
-------------------------------------
2005 2004
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Payments to suppliers, employees and consultants $(1,184,067) $ (646,345)
Cash received from customers 316,910 211,609
Interest received 6,272 1,968
----------- -----------
Net cash used in operating activities (860,885) (432,768)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (certificates of deposit) (395,964) --
Purchases of property and equipment (2,256) (6,074)
----------- -----------
Net cash used in investing activities (398,220) (6,074)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 896,950 658,590
----------- -----------
Net cash provided by financing activities 896,950 658,590
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (362,155) 219,748
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,002,777 1,023,531
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 640,622 $ 1,243,279
=========== ===========
RECONCILIATION OF NET LOSS TO NET CASH USED IN OPERATING ACTIVITIES:
Net loss $(2,186,489) $(1,504,254)
Stock option compensation to consultants 44,609 17,136
Stock awards granted to employees and consultants pursuant to stock
incentive plans 1,031,381 947,881
Restricted stock issued for services rendered 115,372 --
Recovery of doubtful accounts (8,622) (52,772)
Provision for slow-moving inventory 125,000 --
Depreciation and amortization 7,299 10,691
Change in operating assets and liabilities:
Accounts receivable and other receivables 57,610 76,635
Inventories (2,810) (19,309)
Prepaid expenses and other current assets 105,946 24,689
Other assets -- 500
Accounts payable and accrued liabilities (150,181) 66,035
----------- -----------
Net cash used in operating activities $ (860,885) $ (432,768)
=========== ===========
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 are the development, production and marketing of multi-functional
hardware and software based encryption products that provide information
security for domestic and international users over virtually every
communications media and the development, production and marketing of thin, high
brightness, flat panel video displays.
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 six-month and
three-month periods ended April 30, 2005 and 2004. 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, 2004, for more extensive
disclosures than contained in these condensed financial statements.
Products
We currently have 18 different products in our line of hardware-based
encryption solutions. Our 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 two software-based security
products, one of which uses either the Triple DES or the AES algorithm to
encrypt data files and e-mail attachments in both desktop and laptop computers
utilizing Microsoft Windows operating systems, and the other of which can
encrypt voice and data in cellular and satellite phones, scanners, and printers.
We sell our encryption products directly to end-users and through dealers and
distributors.
7
We are also continuing our research and development work on our
electron emission display ("Flat CRT") technology. We have been developing a
Flat CRT display based on our thin film technology ("TFT") and have produced
Flat CRT displays containing TFT color matrix structures.
Funding and Management's Plans
From our inception, we have 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 encryption products.
During the six months ended April 30, 2005, our operating activities
used approximately $861,000 in cash. This resulted from payments to suppliers,
employees and consultants of approximately $1,184,000, which was offset by cash
of approximately $317,000 received from collections of accounts receivable
related to sales of encryption products and approximately $6,000 of interest
income received. In addition, we received approximately $897,000 in cash upon
the exercise of stock options, invested approximately $396,000 in short-term
investments consisting of certificates of deposit and purchased approximately
$2,000 of equipment. As a result, our cash and cash equivalents at April 30,
2005 decreased to approximately $641,000 from approximately $1,003,000 at the
end of fiscal 2004 and short-term investments consisting of certificates of
deposit increased to approximately $396,000 at April 30, 2005 from $0 at the end
of fiscal 2004.
We believe that our existing cash, cash equivalents, short-term
investments 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 second quarter of fiscal 2006. 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 second quarter of fiscal 2006. The sale of additional
equity securities or convertible debt could result in dilution to our
stockholders. We currently have no arrangements with respect to additional
financing. There can be no assurance that we will generate sufficient revenues
in the future (through sales or otherwise) to improve our liquidity or sustain
future operations, that our 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, on
favorable terms or at all.
The auditor's report on our financial statements as of October 31, 2004
states that the net loss incurred during the year ended October 31, 2004, 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, 2004, 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, 2003 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.
8
2. STOCK-BASED COMPENSATION
Financial Accounting Standards Board ("FASB") Statement of Financial
Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure" ("SFAS No. 148"), addresses financial
accounting and reporting for recording expenses for the fair value of stock
options. SFAS No. 148 requires prominent disclosures in financial statements
about the effects of stock-based compensation and provides alternative methods
of transition for a voluntary change to fair value based method of accounting
for stock-based employee compensation. SFAS No. 123 "Accounting for Stock Based
Compensation" ("SFAS No. 123") 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 and directors using the
intrinsic value method prescribed in Accounting Principles Board ("APB") Opinion
No. 25 "Accounting for Stock Issued to Employees" ("APB Opinion No. 25") 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 Six Months Ended For the Three Months Ended
April 30, April 30,
------------------------------------ -----------------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Net loss as reported $(2,186,489) $(1,504,254) $(1,179,995) $ (694,900)
Add: Total stock-based employee
compensation expense, determined
under fair value based method, for
all awards, net of related tax effect (1,730,134) (362,043) (1,403,518) (177,920)
------------ ----------- ----------- ------------
Net loss as adjusted $(3,916,623) $(1,866,297) $(2,583,513) $ (872,820)
============ =========== =========== ===========
Net loss per share, basic and diluted:
As reported (0.03) (0.02) (0.01) (0.01)
As adjusted (0.05) (0.02) (0.03) (0.01)
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 six months ended April 30, 2005 and
2004: risk free interest rates of 3.39% and 2.00%; expected dividend yields of
0% for both periods; expected lives of 2.50 years and 2.44 years; and expected
stock price volatility of 110% and 120%. The weighted average fair value of
options granted under SFAS No. 123 for the six months ended April 30, 2005 and
2004 was $0.42 and $0.29.
9
During the six-month periods ended April 30, 2005 and 2004, we granted
to employees and consultants options to purchase 4,175,000 shares and 1,320,000
shares, respectively, pursuant to the CopyTele, Inc. 2003 Share Incentive Plan
(the "2003 Share Plan"). During the six-month periods ended April 30, 2005 and
2004, stock options to purchase 1,288,800 shares and 1,438,500 shares,
respectively, were exercised, with aggregate proceeds of approximately $897,000
and $659,000, respectively.
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 six-month periods ended April 30, 2005 and
2004, was approximately $45,000 and $17,000, respectively, and during the
three-month periods ended April 30, 2005 and 2004, was approximately $40,000 and
$17,000, respectively. Such compensation expense was recognized in accordance
with Emerging Issues Task Force Issue No. 00-08, "Accounting by a Grantee for an
Equity Instrument to be Received in Conjunction with Providing Goods or
Services" and No. 96-18 "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services," and is included in either research and development expenses or
selling, general and administrative expenses, as applicable, in the accompanying
statements of operations.
During the six-month periods ended April 30, 2005 and 2004, we issued
1,512,085 shares and 1,498,665 shares, respectively, of common stock to certain
employees for services rendered, principally in lieu of cash compensation,
pursuant to the 2003 Share Plan. We recorded compensation expense for the
six-month periods ended April 30, 2005 and 2004 of approximately $1,009,000 and
$712,000, respectively, and for the three-month periods ended April 30, 2005 and
2004 of approximately $561,000 and $381,000, respectively, for the shares of
common stock issued to employees. In addition, during the six-month periods
ended April 30, 2005 and 2004, we issued 30,000 shares and 520,835 shares,
respectively, of common stock to consultants for services rendered pursuant to
the 2003 Share Plan. We recorded consulting expense for the six-month periods
ended April 30, 2005 and 2004 of approximately $22,000 and $236,000,
respectively, and for the three-month periods ended April 30, 2005 and 2004 of
approximately $9,000 and $109,000, respectively, for the shares of common stock
issued to consultants.
As of April 30, 2005, 6,889,044 shares and 25,773 shares, respectively,
were available for future grants under the 2003 Share Plan and the CopyTele,
Inc. 2000 Share Incentive Plan.
During the six-month period ended April 30, 2005, we issued 179,000
shares of restricted common stock to our outside legal counsel in satisfaction
of outstanding bills for services rendered in the amount of approximately
$115,000.
In December 2004, the FASB issued SFAS No. 123(R), "Accounting for
Stock-Based Compensation" ("SFAS No. 123(R)"). SFAS No. 123(R) establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. This Statement focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123(R) requires that the fair value
of such equity instruments be recognized as an expense in the historical
financial statements as services are performed. Prior to SFAS No. 123(R), only
certain pro forma disclosures of fair value were required. The provisions of
this Statement were effective for the first interim reporting period beginning
after June 15, 2005. In April 2005, the Securities and Exchange Commission
announced a deferral of the effective date of SFAS No. 123(R) until the first
interim reporting period of the first fiscal year beginning after June 15. 2005.
Accordingly, we will adopt SFAS No. 123(R) commencing with the quarter ending
January 31, 2006. We are currently evaluating the impact of SFAS No. 123(R). The
adoption of SFAS No. 123(R) is expected to have a material effect on our
financial statements.
10
3. CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject us to concentrations of
credit risk consist principally of accounts receivable from sales in the
ordinary course of business. Management reviews our accounts receivable and
other receivables for potential doubtful accounts and maintains an allowance for
estimated uncollectible amounts. Generally, no collateral is received from
customers for our accounts receivable. At April 30, 2005, two customers in the
Encryption Products and Services Segment represented 76% and 24%, respectively,
of net accounts receivable. At October 31, 2004, two customers in the Encryption
Products and Services Segment represented 48% and 44%, respectively, of net
accounts receivable. During the six months ended April 30, 2005, one customer in
the Encryption Products and Services Segment represented 83% of total net
revenues. During the six months ended April 30, 2004, one customer in the
Encryption Products and Services Segment represented 66% of total net revenues.
4. SHORT-TERM INVESTMENTS
Short-term investments represent certificates of deposits, carried at
amortized cost, with maturities of less than twelve months. The fair values of
the certificates of deposits, including accrued interest, approximate their
carrying value due to their short maturities.
5. 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. During the six months ended April 30, 2005, we received aggregate
proceeds of approximately $15,000 from the sale of a portion of the common
stock. As of April 30, 2005, we hold 200,000 shares of such common stock,
subject to no restrictions, with a fair value of approximately $60,000, 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
6. INVENTORIES
Inventories consist of the following as of:
April 30, October 31,
2005 2004
---------- -----------
Component parts $ 269,109 $ 304,862
Work-in-process 59,606 114,075
Finished products 548,524 580,492
---------- ---------
$ 877,239 $ 999,429
========== =========
7. NET INCOME (LOSS) PER SHARE OF COMMON STOCK
We comply with the provisions of SFAS No. 128, "Earnings Per Share"
("SFAS No. 128"). 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 six-month periods
ended April 30, 2005 and 2004, were options to purchase 20,505,246 shares and
14,879,546 shares, respectively.
8. SEGMENT INFORMATION
We follow the provisions of SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS No. 131"). 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 six-month and three-month periods ended
April 30, 2005 and 2004:
Encryption Products
Segment Data Flat-Panel Display and Services Total
- ------------------------------------------- --------------------- ---------------------- -----------------
Six Months Ended April 30, 2005:
Revenue $ - $ 259,300 $ 259,300
Net loss (948,120) (1,238,369) (2,186,489)
Six Months Ended April 30, 2004:
Revenue $ - $ 140,804 $ 140,804
Net loss (737,345) (766,909) (1,504,254)
12
Encryption Products
Segment Data Flat-Panel Display and Services Total
- ------------------------------------------- --------------------- ---------------------- -----------------
Three Months Ended April 30, 2005:
Revenue $ - $ 46,709 $ 46,709
Net loss (430,881) (749,114) (1,179,995)
Three Months Ended April 30, 2004:
Revenue $ - $ 101,804 $ 101,804
Net loss (299,277) (395,623) (694,900)
13
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
GENERAL
Our principal operations are the development, production and marketing
of multi-functional hardware and software based encryption products that provide
information security for domestic and international users over virtually every
communications media and the development, production and marketing of thin, high
brightness, flat panel video displays ("Flat CRT").
We currently have 18 different products in our line of hardware-based
encryption solutions. Our 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 two software-based security
products, one of which uses either the Triple DES or the AES algorithm to
encrypt data files and e-mail attachments in both desktop and laptop computers
utilizing Microsoft Windows operating systems, and the other of which can
encrypt voice and data in cellular and satellite phones, scanners, and printers.
We sell our encryption products directly to end-users and through dealers and
distributors.
We have developed modifications of our standard products for specific
applications. We have developed and are producing several products for use with
the satellite communications network of Thuraya Satellite Telecommunications
Company ("Thuraya"), a network built by Boeing Satellite Systems, Inc.
("Boeing") that provides communication in Europe, Africa, Russia, the Middle
East and Asia. Our products can encrypt voice communication, using a compact
encrypted module attached to the Thuraya handset, and automatically encrypt fax
communications over the Thuraya network. Our products thus enable the Thuraya
network to provide encrypted communications between satellite phones, from
satellite phones to desk-based phones, or between desk-based phones.
Additionally, we have developed three products to provide satellite and cellular
fax encryption between fax machines and between computers and fax machines.
In April 2004, we entered into an agreement with Boeing to provide our
encryption products for use over the Thuraya network. Under a September 2004
modification to the agreement, Boeing is the exclusive distributor of eight of
our products.
In connection with Boeing becoming the exclusive distributor of some of
our products, Boeing authorized us to use its name on our website. Accordingly,
customers desiring to purchase such products can find authorized Boeing sales
information on the "Encryption Products" page of our website. In January 2005,
Boeing introduced, demonstrated and began marketing our encryption products to
more than 100 Thuraya service providers. We assisted Boeing with such
demonstrations. The products introduced included two new encryption products
that we are selling to Boeing, the Thuraya DCS-1400 for voice encryption and the
Thuraya USS-900T for fax encryption between fax machines. We recently started
selling to Boeing the USS-900TC, which provides satellite and cellular fax
encryption between computers and fax machines. These products contain the brand
name of Thuraya and their operating controls are in the Arabic language.
14
We have also developed a method for encrypting Short Message Service
("SMS"), an inexpensive text message communication protocol that is used in many
cellular and satellite phones. We will utilize this encryption solution in
conjunction with the Thuraya handsets.
Our wireless encryption products are providing secure communications
with many different satellite phones, including the Thuraya 7100/7101 handheld
terminal ("HHT"), Globalstar GPS-1600 HHT, Telit SAT-550/600 HHT, Globalstar
GPS-2800/2900 fixed phone, Iridium 9500/9505 HHT, Inmarsat M4 and Mini "M" HHT
units from Thrane & Thrane and Nera. Through the use of our products, encrypted
satellite communications are available for many Thuraya docking units, including
Teknobli's Next Thuraya Docker, Thuraya Fixed Docking Adapter, APsi's FDU-2500
Fixed Docking Unit, Sattrans' SAT-OFFICE Fixed Docking Unit and SAT-VDA
Hands-Free Car Kit.
We also have developed modifications of our standard equipment for
other applications. We have provided modifications of our hardware and software
encryption solutions to several large organizations which are evaluating our
products in connection with their security requirements. We are supplying to a
major U.S. defense contractor our USS-900AF automatic fax encryption product to
secure its worldwide fax communication. We have entered into an agreement with
another major U.S. company and supplied an initial proof of concept encryption
solution utilizing another of our products that has been configured to interface
with that company's satellite global positioning system ("GPS") and data
communication fleet management network.
We have supplied another major U.S. company our USS-900AF and our
DCS-1700 products. The DCS-1700 secures data links between scanners and printers
in multi-functional products. That company is in the process of evaluating the
market potential for these products for the health care industry. We are
providing the DCS-1700 to another major U.S. company to secure the data links
between the scanners and servers in their multi-functional products. We are also
marketing the DCS-1700 to other major companies to meet the security
requirements of their products.
We are also continuing our research and development work on our Flat
CRT electron emission display technology. We have provided our model CTVD-101
Flat CRT display to a potential customer for evaluation of the display's
performance in a product which must operate over a wide ambient temperature
range in an outdoor environment. After successfully testing our display, the
customer ordered a seed quantity of modules containing our display, to replace
liquid crystal display ("LCD") modules in our customer's product. We have
initially supplied the customer with model CTVD-101 displays. To be able to
supply large quantities of displays to this customer and other potential
customers, however, we are planning to produce our CTVD-201 and CTVD-202 Flat
CRT displays, which are based on our more current thin film technology ("TFT"),
rather than the CTVD-101. We are planning to replace the CTVD-101 displays
previously provided to our customer with CTVD-201 displays for our customer's
evaluation.
15
We entered into an agreement, in June 2004, with an Asian company,
which currently mass produces TFT LCDs, to jointly produce prototypes of two
modified TFT color matrix pixel structures for our Flat CRT display based on our
high brightness technology. The two color matrix structures, which are
components of our displays, are a 7-inch (diagonal) with 1440 x 234 pixels and a
5.5 inch (diagonal) with 960 x 234 pixels. As part of our TFT color matrix
design, each pixel contains memory to achieve high brightness at video rates. We
have funded the development of these prototypes, and may enter into a further
agreement for commercial production of the structures or the complete color
displays. The company has agreed to produce such structures only for us.
We have developed, with the assistance of Volga Svet Ltd. ("Volga"), a
Russian display company that we have been working with for over seven years, our
Model CTVD-201 and Model CTVD-202 displays, which contain the modified TFT color
matrix structures we received under our agreement with the Asian company. The
Model CTVD-201 display is a 5.5 inch (diagonal) monochrome display with 320 x
234 pixels and the Model CTVD-202 is a 5.5 inch (diagonal) color display with
960 x 234 pixels. We are also completing the assembly of a 7.0 inch (diagonal)
prototype color display containing the modified TFT color matrix structures with
1,440 x 234 pixels. The Asian company has supplied several hundred of the TFT
color matrix structures for the CTVD-201 and CTVD-202. We are producing the
CTVD-201 and CTVD-202 displays which contain these matrix structures to evaluate
the performance and reliability of our displays.
We have successfully tested our display modules under various
environmental conditions. This included subjecting our display modules to shock,
vibration, and operating temperatures from -40(degree)C to +85(degree). Also,
our display modules are capable of operating under both sunlight and nighttime
conditions. As a result, we believe that our display modules can meet
performance requirements to both outdoor and indoor applications. We have also
successfully reduced the operating voltage requirements of our display modules
to further improve the reliability and extend the life performance of our
displays. We are continuing to obtain further performance data to insure
reliable operation within the limits of our specifications.
We recently exhibited our Flat CRT display at the Society for
Information Display International Symposium, Seminar and Exhibition, the premier
international gathering of scientists, engineers, manufacturers and users for
the discussion, presentation, viewing and exhibiting of information display
technology with more than 250 exhibits. We demonstrated our 5.5 inch (diagonal)
display with 320 x 234 pixels and our 5.0 inch (diagonal) display with 320 x 240
pixels to scientists, engineers, manufacturers and users from more than one
hundred companies and government agencies. We have been requested by many of the
organizations to meet for further discussions.
Also, we have modified the color matrix structures to incorporate chip
on glass ("COG") technology which will be utilized for production of these
displays. As part of our reliability evaluation, we are using both the CTVD-201
and CTVD-202 color Flat CRT displays. Upon the completion of our evaluation of
the structures, we believe that Volga will be able to supply a limited
production capability. We anticipate utilizing either the Asian company or other
TFT LCD production companies to mass produce the display for potential users.
However, we have not yet entered into any agreement for such production, and
there can be no assurance that we can do so on commercially acceptable terms or
at all.
16
To activate the red, green and blue phosphors contained in the modified
TFT color matrix pixel structure in our displays, we are using our current
electron emission technology and are developing a new electron emission system
using nanotube technology in cooperation with a U.S. company. The new technology
consists of a unique array of low voltage controllable nanotubes for electron
emission. These nanotubes are extremely small carbon elements, approximately
2,500 times thinner than the width of a human hair, that emit electrons under
controllable conditions. In cooperation with that company, we are continuing to
produce experimental nanotube design configurations to meet our design
requirements. We have the exclusive right to use this company's nanotube
technology for display applications.
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.
Our operations and the achievement of our objectives in marketing,
production, and research and development are dependent upon an adequate cash
flow. Accordingly, in monitoring our financial position and results of
operations, particular attention is given to cash and accounts receivable
balances and cash flows from operations. Since our initial public offering, our
cash flows have been primarily generated through the sales of common stock in
private placements and upon exercise of stock options. We also generate cash
flows from sales of our encryption products. 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 and to end-users. We have also been working with several
large organizations to provide them with both our hardware and software
encryption solutions for them to evaluate whether the solutions meet their
security requirements and have begun supplying several major U.S. companies with
our encryption products. We have also begun to market our flat panel video
display products to potential purchasers for incorporation into their products.
We anticipate that current cash on hand, cash generated from operations, and
cash generated from the exercise of employee options will be adequate to fund
our operations at least through the end of the second quarter of fiscal 2006.
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, 2004.
17
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. During the three-month period ended April 30, 2005, we recorded a
provision for slow-moving inventory of $125,000. 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 six-month periods ended April 30,
2005 and 2004 would have increased by approximately $1,730,000 and $362,000,
respectively, and for the three-month periods ended April 30, 2005 and 2004
would have increased by approximately $1,404,000 and $178,000, respectively,
based on the fair value of the stock options granted to employees. See "-Impact
of Recent Accounting Pronouncements."
18
RESULTS OF OPERATIONS
Six months ended April 30, 2005 compared with six months ended April 30, 2004
Sales
Revenue. Revenue from sales increased by approximately $118,000 in the
six-month period ended April 30, 2005, to approximately $259,000, as compared to
approximately $141,000 in the comparable prior-year period. All revenue during
both periods was from encryption products and services. The increase in sales
was principally due to an increase in unit sales of our encryption products. Our
encryption sales have been limited and are sensitive to individual large
transactions which can vary from period to period. We believe that changes in
sales 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 decreased by approximately $36,000 in the six-month period ended April
30, 2005, to approximately $59,000, as compared to approximately $95,000 in the
comparable prior-year period. Gross profit as a percent of revenue decreased to
approximately 23% in the six-month period ended April 30, 2005, as compared to
approximately 67% in the comparable prior-year period. The decrease in gross
profit and gross profit as a percent of revenue is primarily the result of the
provision for slow-moving inventory of $125,000 recorded in the three-month
period ended April 30, 2005, offset by an increase in revenue during such
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 $249,000
in the six-month period ended April 30, 2005, to approximately $1,240,000, from
approximately $991,000 in the comparable prior-year period. The increase in
research and development expenses was principally due to an increase in employee
compensation and related costs of approximately $248,000, primarily resulting
from the grant of employee bonuses.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by approximately
$402,000 to approximately $1,012,000 in the six-month period ended April 30,
2005, from approximately $610,000 in the comparable prior-year period. The
increase in selling, general and administrative expenses was principally due to
an increase in professional fees of approximately $230,000, approximately
$50,000 of which was incurred with respect to a theft by a former employee (see
"-Investigation and Recovery Efforts Regarding Misappropriated Funds" in our
Annual Report on Form 10-K for the fiscal year ended October 31, 2004), an
increase in employee compensation and related costs of approximately $80,000,
the recovery in the prior year of previously reserved amounts of approximately
$53,000 and an increase in stock option compensation to consultants of
approximately $27,000.
19
Interest Income
Interest income was approximately $6,000 in six-month period ended
April 30, 2005, compared to approximately $4,000 in the comparable prior-year
period. The increase in interest income was the result of an increase in average
funds available for investment and an increase in prevailing interest rates.
Three months ended April 30, 2005 compared with three months ended April 30,
2004
Sales
Revenue. Revenue from sales decreased by approximately $55,000 in the
three-month period ended April 30, 2005, to approximately $47,000, as compared
to approximately $102,000 in the comparable prior-year period. All revenue
during both periods was from encryption products and services. The decrease in
sales was principally due to a decrease in unit sales of our encryption products
related to customer procurement delays. Our encryption sales have been limited
and are sensitive to individual large transactions which can vary from period to
period. We believe that changes in sales between periods generally represent the
nature of the early stage of our product and sales channel development.
Gross Profit (loss). Gross profit from sales of encryption products
and services decreased by approximately $159,000 in the three-month period ended
April 30, 2005, to a loss of approximately $89,000, as compared to a gross
profit of approximately $70,000 in the comparable prior-year period. The
decrease gross profit is primarily the result of the provision for slow-moving
inventory of $125,000 recorded in the three-month period ended April 30, 2005.
Gross profit as a percent of revenue in the three-month period ended April 30,
2004 was approximately 69%. Gross profit as a percent of revenue in the
three-month period ended April 30, 2005 is not meaningful due to the loss
recorded during the 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 $143,000
in the three-month period ended April 30, 2005, to approximately $650,000, from
approximately $507,000 in the comparable prior-year period. The increase in
research and development expenses was principally due to an increase in employee
compensation and related costs of approximately $133,000, primarily resulting
from the grant of employee bonuses.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by approximately
$186,000 to approximately $445,000 in the three-month period ended April 30,
2005, from approximately $259,000 in the comparable prior-year period. The
increase in selling, general and administrative expenses was principally due to
an increase in professional fees of approximately $63,000, the recovery in the
prior year of previously reserved amounts of approximately $53,000 and an
increase in employee compensation and related costs of approximately $39,000.
20
Interest Income
Interest income was approximately $5,000 in three-month period ended
April 30, 2005, compared to approximately $1,000 in the comparable prior-year
period. The increase in interest income was the result of an increase in average
funds available for investment and an increase in prevailing interest rates.
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 from sales of our encryption products, and, from
June 2001 to January 2002, we received development payments from Futaba
Corporation of Japan.
During the six months ended April 30, 2005, our operating activities
used approximately $861,000 in cash. This resulted from payments to suppliers,
employees and consultants of approximately $1,184,000, which was offset by cash
of approximately $317,000 received from collections of accounts receivable
related to sales of encryption products and approximately $6,000 of interest
income received. In addition, we received approximately $897,000 in cash upon
the exercise of stock options, invested approximately $396,000 in short-term
investments consisting of certificates of deposit and purchased approximately
$2,000 of equipment. As a result, our cash and cash equivalents at April 30,
2005 decreased to approximately $641,000 from approximately $1,003,000 at the
end of fiscal 2004 and short-term investments consisting of certificates of
deposit increased to approximately $396,000 at April 30, 2005 from $0 at the end
of fiscal 2004.
Accounts receivable decreased by approximately $42,000 from
approximately $63,000 at the end of fiscal 2004 and by approximately $183,000
from approximately $204,000 at January 31, 2005, to approximately $21,000 at
April 30, 2005. The decrease in accounts receivable is a result of the timing of
collections, in particular a large account receivable at January 31, 2005
related to our largest customer that was collected in February 2005. Other
receivables decreased by approximately $6,000 from approximately $84,000 at the
end of fiscal 2004 to approximately $78,000 at April 30, 2005. The decrease in
other receivables is a result of proceeds received of approximately $15,000 from
the sale of a portion of the common stock received from a customer to settle
such customer's accounts receivable, offset by a reduction of the allowance for
doubtful accounts related to this accounts receivable of approximately $9,000.
Inventories decreased approximately $122,000 from approximately $999,000 at
October 31, 2004 to approximately $877,000 at April 30, 2005, as a result of the
timing of shipments, production schedules and the provision for slow-moving
inventory of $125,000 recorded during the three-month period ended April 30,
2005. Prepaid expenses and other current assets decreased by approximately
$106,000 from approximately $122,000 at the end of fiscal 2004 to approximately
$16,000 at April 30, 2005. The decrease in prepaid expenses and other assets is
primarily due to the receipt of a receivable of approximately $100,000 from
insurance companies related to a theft by a former employee (see "-Investigation
and Recovery Efforts Regarding Misappropriated Funds" in our Annual Report on
Form 10-K for the fiscal year ended October 31, 2004). Accounts payable and
accrued liabilities decreased by approximately $150,000 from approximately
$443,000 at the end of fiscal 2004 to approximately $293,000 at April 30, 2005,
as a result of the issuance of restricted common stock to settle a liability of
approximately $115,000 and the timing of payments.
21
As a result of these changes, working capital at April 30, 2005
decreased to approximately $1,736,000 from approximately $1,829,000 at the end
of fiscal 2004.
Our working capital includes inventory of approximately $877,000 at
April 30, 2005. 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.
During the six-month periods ended April 30, 2005 and 2004, we issued
shares of common stock to certain employees for services rendered, principally
in lieu of cash compensation. We recorded compensation expense for the six-month
periods ended April 30, 2005 and 2004 of approximately $1,009,000 and $712,000,
respectively, and for the three-month periods ended April 30, 2005 and 2004 of
approximately $561,000 and $381,000, respectively, for the shares of common
stock issued to employees. In addition during the six-month periods ended April
30, 2005 and 2004, we issued shares of common stock to consultants for services
rendered. We recorded consulting expense for the six-month periods ended April
30, 2005 and 2004 of approximately $22,000 and $236,000, respectively, and for
the three-month periods ended April 30, 2005 and 2004 of approximately $9,000
and $109,000, respectively, for the shares of common stock issued to
consultants. During the three-month period ended April 30, 2005, we also issued
179,000 shares of restricted common stock to our outside legal counsel in
satisfaction of outstanding bills for services rendered in the amount of
approximately $115,000.
The auditor's report on our financial statements as of October 31, 2004
states that the net loss incurred during the year ended October 31, 2004, 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, 2004, 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, 2003 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.
We believe that our existing cash, cash equivalents, short-term
investments 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 second quarter of fiscal 2006. 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 second quarter of fiscal 2006. The sale of additional
equity securities or convertible debt could result in dilution to our
stockholders. We currently have no arrangements with respect to additional
financing. There can be no assurance that we will generate sufficient revenues
in the future (through sales or otherwise) to improve our liquidity or sustain
future operations, that our 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, on
favorable terms or at all.
22
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 and to end-users. We have been working with several large
organizations to provide them with both our hardware and software encryption
solutions for them to evaluate whether the solutions meet their security
requirements and have begun supplying several major U.S. companies with our
encryption products. We have also begun to market our flat panel video display
products to potential purchasers for incorporation into their products. During
the six months ended April 30, 2005, we have recognized revenue from sales of
encryption products of approximately $259,000.
The following table presents our expected cash requirements for
contractual obligations outstanding as of April 30, 2005:
Payments Due by Period
---------------------------------------
Less
Contractual Obligations than 1-3 4-5 After
1 year years years 5 years Total
- ---------------------------- -------- ----------- -------- ---------- --------
Consulting
Agreement $ 70,000 - $ 70,000
- -
Noncancelable Operating $280,000
Leases $258,000 $ 22,000
- -
-------- ----------- -------- ---------- --------
Total Contractual
Cash Obligations $328,000 $ 22,000 - - $350,000
======== =========== ======== ========== ========
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123(R), "Accounting for
Stock-Based Compensation" ("SFAS No. 123(R)"). SFAS No. 123(R) establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. This Statement focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123(R) requires that the fair value
of such equity instruments be recognized as an expense in the historical
financial statements as services are performed. Prior to SFAS No. 123(R), only
certain pro forma disclosures of fair value were required. The provisions of
this Statement were effective for the first interim reporting period beginning
after June 15, 2005. In April 2005, the Securities and Exchange Commission
announced a deferral of the effective date of SFAS No. 123(R) until the first
interim reporting period of the first fiscal year beginning after June 15. 2005.
Accordingly, we will adopt SFAS No. 123(R) commencing with the quarter ending
January 31, 2006. We are currently evaluating the impact of SFAS No. 123(R). The
adoption of SFAS No. 123(R) is expected to have a material effect on our
financial statements.
23
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, 2004 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.
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 six months ended April 30, 2005, 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 April 30, 2005. We have set forth below our net losses, research and
development expenses and net cash used in operations for the six-month periods
ended April 30, 2005 and 2004, and for the fiscal years ended October 31, 2004
and 2003:
24
(Unaudited)
Six Months Ended Fiscal Years Ended
April 30, October 31,
-------------------------------- ---------------------------
2005 2004 2004 2003
------------ ----------- ----------- -----------
Net loss $ 2,186,489 $ 1,504,254 $ 3,360,655 $ 3,114,411
Research and development expenses $ 1,239,888 $ 991,179 $ 2,164,427 $ 1,807,742
Net cash used in operations $ 860,885 $ 432,768 $ 1,205,122 $ 958,501
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, 2004 states that the net
loss incurred during the year ended October 31, 2004, 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, 2004, 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, 2003 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.
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 second quarter
of fiscal 2006. 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 second quarter of fiscal 2006. 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 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.
25
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;
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.
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o The small size of our accounting and financial staff has exposed us, and
may expose us in the future, to risks relating to our internal control, and
may limit our growth.
The small size of our accounting and financial staff has exposed us to
risks relating to our internal control over financial reporting. In particular,
as discussed in our Annual Report on Form 10-K for the year ended October 31,
2004 under Item 9A, Controls and Procedures, in December 2004, we discovered
that an employee in our accounting staff had defrauded us of approximately
$189,000 (of which approximately $4,000 we believe was replaced) during fiscal
2004 and the first month of fiscal 2005 and approximately $28,000 during the
period from fiscal 2001 through fiscal 2003. While we have recovered
approximately $110,000 of such loss through insurance proceeds and will seek
additional recoveries from other parties, and we have taken steps to improve our
internal controls to prevent such activity in the future, there can be no
assurance that our controls and procedures will prevent all errors or fraud, or
that any future such losses would be insured or otherwise recoverable. We may
need to recruit additional staff to improve our internal controls or to support
growth of our business, the costs of which would reduce the funds available for
research and development and marketing activities.
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.
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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 April 30, 2005 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 6. Exhibits.
31.1 Certification of Chief Executive Officer, pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002, dated June 9, 2005.
31.2 Certification of Chief Financial Officer, pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002, dated June 9, 2005.
32.1 Statement of Chief Executive Officer, pursuant to Section 1350 of
Title 18 of the United States Code, dated June 9, 2005.
32.2 Statement of Chief Financial Officer, pursuant to Section 1350 of
Title 18 of the United States Code, dated June 9, 2005.
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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
June 9, 2005 (Principal Executive Officer)
By: /s/ Henry P. Herms
------------------------------------
Henry P. Herms
Vice President - Finance and
Chief Financial Officer (Principal
June 9, 2005 Financial and Accounting Officer)
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