U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-QSB/A
(Mark One)
[X] Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended September 30, 2004
[ ] Transition report pursuant section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from ____________ to ________________
eMAGIN CORPORATION
(Exact name of small business issuer as specified in its charter)
Commission file number: 000-24757
DELAWARE 56-1764501
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
10500 N.E. 8th Street
Suite 1400
Bellevue, WA 98004
(Address of principal executive offices)
(425) 749-3600
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS: Not applicable
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
APPLICABLE ONLY TO CORPORATE REGISTRANTS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of November 4, 2004 the Registrant
had 79,332,589 shares of Common Stock outstanding.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (check one): Yes [ ] No [X]
PRELIMINARY NOTE (restated):
This Amended Quarterly Report on Form 10-QSB/A is being filed to provide
additional information to clarify the corrections reported in the previously
Amended Quarterly Report on Form 10-QSB/A filed by the Company on April 12,
2005. The Consolidated Balance Sheets, Consolidated Statements of Operations,
Consolidated Statements of Cash Flows, and Statement of Changes in Shareholders'
Equity and Selected Notes to Consolidated Financial Statements are labeled as
"restated" where applicable. The restatement was in connection with the
preparation of the Company's annual report on Form 10-KSB for the year ended
December 31, 2004 where it was determined that the re-pricing of the original
warrants should have been classified as an equity transaction and therefore no
expense should have been recorded in connection with the re-pricing of the
warrants and that the unamortized debt discount and the deferred financing costs
should have been recorded as interest expense. The restated statements reflect
the elimination of $594,568 of interest expense in relation to the re-pricing of
warrants issued for the non-participation of investors and the reclassification
of approximately $1.67 million of unamortized debt discount and deferred
financing costs from additional paid-in-capital to interest expense in relation
to the March 3, 2004 debt conversion of approximately $8.567 million in
principal and accrued interest. The following table presents the impact of the
corrections:
Unaudited Consolidated Statements of Operations
------------------------------------------------------------------------------------------------------------------------------------
Three months ended September 30, Nine months ended September 30,
2004 2004
-------------------------------- ---------------------------------------
Originally Filed Restated Originally Filed Restated
----------------- -------------- ------------------- ----------------
Other income (expense) $ (568,561) $ 26,007 $ (3,963,658) $(5,042,062)
Net loss $(2,349,467) $(1,754,899) $ (8,681,161) $(9,759,565)
Basic and diluted loss per common share $ (0.04) $ (0.03) $ (0.14) $ (0.16)
In all other material respects this Amended Quarterly Report on Form 10-QSB/A is
unchanged from the Amended Quarterly Report on Form 10-QSB/A previously filed by
the Company on April 12, 2005.
In addition, we are revising Item 3, Controls and Procedures, to disclose that
the Company's management believes that its controls and procedures were not
effective as of the end of the period covered by this report due to the
restatements to the Company's financial statements as set forth above.
2
PART I. FINANCIAL INFORMATION
Index Page Number
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at September 30, 2004 (Unaudited) and
December 31, 2003 (restated) 4
Unaudited Consolidated Statements of Operations for the Three and
Nine Months ended September 30, 2004 and September 30, 2003 (restated) 5
Unaudited Consolidated Statements of Cash Flows for the Nine Months
ended September 30, 2004 and September 30, 2003 (restated) 6
Unaudited Consolidated Statement of Changes in Shareholders' Equity from
December 31, 2003 to September 30, 2004 (restated) 7
Selected Notes to Consolidated Financial Statements (restated) 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operation (restated) 14
Item 3. Controls and Procedures 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURE 26
CERTIFICATION See Exhibits
31.1 Certification by Chief Executive Officer pursuant to Sarbanes
Oxley Section 302.
31.2 Certification by Chief Financial Officer pursuant to Sarbanes
Oxley Section 302.
32.1 Certification by Chief Executive Officer pursuant to 18 U.S. C.
Section 1350
32.2 Certification by Chief Financial Officer pursuant to 18 U.S. C.
Section 1350
3
eMAGIN CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
ASSETS 2004 2003
------------------------------
(Unaudited)
(Restated)
CURRENT ASSETS:
Cash and cash equivalents ..................................... $ 4,051,286 $ 1,053,895
Trade receivables, net ........................................ 869,622 768,537
Unbilled costs and estimated profits on contracts in progress . -- 75,359
Inventory ..................................................... 1,457,907 275,417
Prepaid expenses and other current assets ..................... 617,064 287,958
------------------------------
Total current assets ....................................... 6,995,879 2,461,166
EQUIPMENT AND LEASEHOLD IMPROVEMENTS: ............................ 3,827,649 3,350,930
Less: Accumulated depreciation .................................. (2,604,631) (2,149,991)
------------------------------
Equipment and leasehold improvements, net ........................ 1,223,018 1,200,939
INTANGIBLE ASSETS ................................................ 53,819 --
Less: Accumulated amortization ................................... (1,378) --
------------------------------
Intangible assets, net ........................................... 52,441 --
OTHER LONG-TERM ASSETS ........................................... 36,258 86,907
------------------------------
Total assets ............................................... $ 8,307,596 $ 3,749,011
==============================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable .............................................. $ 736,284 $ 234,869
Accrued payroll and benefits .................................. 541,827 952,850
Other accrued expenses ........................................ 211,967 988,569
Advanced payments ............................................. 41,903 122,362
Current portion of long term debt ............................. 13,588 38,184
Other current liabilities ..................................... 34,762 18,008
------------------------------
Total current liabilities .................................. 1,580,331 2,354,842
Capitalized lease obligations .................................... 25,887 36,257
Notes payable and short-term debt subsequently converted to equity -- 6,124,451
------------------------------
Total liabilities .......................................... 1,606,218 8,515,550
SHAREHOLDERS' EQUITY (CAPITAL DEFICIENCY)
Common Stock, par value $0.001 per share
Shares authorized - 200,000,000
Shares issued and outstanding - 66,257,590 and 42,695,412 .. 66,258 42,694
Additional paid-in capital .................................... 152,715,263 131,598,910
Deferred compensation ......................................... -- (87,565)
Accumulated deficit ........................................... (146,080,143) (136,320,578)
------------------------------
Total shareholders' equity (capital deficiency) ............ 6,701,378 (4,766,539)
------------------------------
Total liabilities and shareholders' equity ................. $ 8,307,596 $ 3,749,011
==============================
See selected notes to financial statements.
4
eMAGIN CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, 2004 September 30, 2003 September 30, 2004 September 30, 2003
(Restated) (Restated)
------------------------------------------------------------------------------
REVENUE:
Contract revenue $ 108,000 $ 275,504 $ 108,000 $ 275,504
Product revenue, net of returns 980,928 472,983 2,967,151 1,245,353
------------------------------------------------------------------------------
Total revenue 1,088,928 748,487 3,075,151 1,520,857
------------------------------------------------------------------------------
COST OF GOODS SOLD:
Direct cost of goods sold 615,890 393,660 1,632,323 1,665,969
Indirect cost of goods sold 992,102 945,779 2,875,837 1,841,145
------------------------------------------------------------------------------
Total cost of goods sold 1,607,992 1,339,439 4,508,160 3,507,114
------------------------------------------------------------------------------
Gross Loss (519,064) (590,952) (1,433,009) (1,986,257)
------------------------------------------------------------------------------
COSTS AND EXPENSES:
Research and development 359,453 571 443,349 22,419
Stock based compensation - 1,896,011 87,565 2,095,407
Selling, general and administrative 902,389 732,438 2,753,580 2,614,918
------------------------------------------------------------------------------
Total costs and expenses, net 1,261,842 2,629,020 3,284,494 4,732,744
------------------------------------------------------------------------------
Interest income (expenses) 26,007 (441,749) (5,042,062) (717,735)
Gain on payable forgiveness - 2,752,570 - 4,637,993
------------------------------------------------------------------------------
Other income (expenses), net 26,007 2,310,821 (5,042,062) 3,920,258
------------------------------------------------------------------------------
------------------------------------------------------------------------------
Net loss $ (1,754,899) $ (909,151) $ (9,759,565) $ (2,798,743)
==============================================================================
Basic and diluted loss per common share $ (0.03) $ (0.02) $ (0.16) $ (0.08)
==============================================================================
Weighted average common shares outstanding 65,260,205 38,360,090 60,277,581 34,404,367
==============================================================================
See selected notes to financial statements.
5
eMAGIN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Nine Months
ended ended
September 30, September 30,
2004 2003
(Restated)
---------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .................................................... $(9,759,565) $(2,798,743)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization ............................ 454,640 365,535
Amortization of intangibles ............................. 1,378 331,442
Amortization of financing fees ........................... 7,863 69,432
Bad debt expense ......................................... 33,656 --
Non-cash charge for stock based compensation ............. 87,565 2,095,407
Non-cash interest related charges ........................ 130,419 384,368
Non-cash charge for services received .................... 8,400 443,252
Non-cash financing expense ............................... 4,955,186 103,899
Non-cash debt restructure ................................ -- (4,637,993)
Changes in operating assets and liabilities:
Trade receivables .................................... (59,381) (545,353)
Unbilled costs and estimated profits on contracts in
progress ............................................ -- 50,000
Inventory ............................................ (982,768) (113,258)
Prepaid expenses and other current assets ............ (318,850) (312,833)
Other long-term assets ............................... (31,851) 61,960
Advanced payment on contracts to be completed ........ (80,459) 59,385
Deferred revenue ..................................... -- (29,900)
Accounts payable and accrued expenses ................ 53,882 (560,665)
Other current liabilities ............................ 16,754 282,676
---------------------------
Net cash used in operating activities .......... (5,483,131) (4,751,389)
---------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment ................................... (476,175) (880,572)
---------------------------
Net cash used in investing activities .......... (476,175) (880,572)
---------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sales of common stock, net of issuance costs 3,916,536 --
Proceeds from exercise of stock options and warrants ..... 5,078,423 986,054
Proceeds from long and short term debt ................... -- 6,000,000
Payments for capital leases .............................. (38,262) --
---------------------------
Net cash provided by financing activities ...... 8,956,697 6,927,676
---------------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS .................. 2,997,391 1,295,715
CASH AND CASH EQUIVALENTS, beginning of period .............. 1,053,895 82,951
---------------------------
CASH AND CASH EQUIVALENTS, end of period .................... $ 4,051,286 $ 1,378,666
===========================
Supplemental Cash Flow Disclosure:
Conversion of debt to equity ................................ $ 8,567,424 $ 4,845,537
Payments of A/P through issuance of stock ................... 202,875 --
Stock issued for prepaid services ........................... 186,257 748,116
Cash payments of interest ................................... 5,172 --
See selected notes to financial statements.
6
eMAGIN CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (CAPITAL DEFICIENCY)
(Restated)
Additional
Common Stock Deferred paid-in Accumulated
Shares $ Compensation Capital Deficit Total
-----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 42,695,412 $ 42,694 $ (87,565) $ 131,598,910 $(136,320,578) $ (4,766,539)
Conversion of debt to equity 11,394,621 11,395 8,556,029 8,567,424
Stock options exercised 5,221,052 5,221 1,379,263 1,384,484
Sale of equity 3,333,363 3,334 3,913,204 3,916,538
Issuance of warrants for debt
conversion 3,180,000 3,180,000
Stock warrants exercised 3,358,691 3,359 3,690,581 3,693,940
Issuance of common stock for
services 254,451 255 397,275 397,530
Amortization of deferred
compensation 87,565 87,565
Net loss for period (9,759,565) (9,759,565)
------------------------------ ----------------- --------------- ----------------- ---------------- ---------------- --------------
Balance, September 30,
2004 (Unaudited) 66,257,590 $ 66,258 $ - $ 152,715,263 $(146,080,143) $ 6,701,378
============================== ================= =============== ================= ================ ================ ==============
See selected notes to financial statements.
7
eMAGIN CORPORATION
Selected Notes to Consolidated Financial Statements
Note 1 - ACCOUNTING POLICIES
Basis of Presentation (Restated)
In the opinion of management, the accompanying unaudited interim financial
information reflects all adjustments, consisting of normal recurring accruals,
necessary for a fair presentation. Certain information and footnote disclosure
normally included in financial statements prepared in accordance with U.S.
generally accepted accounting principles have been condensed or omitted pursuant
to instructions, rules and regulations prescribed by the Securities and Exchange
Commission. The company believes that the disclosures provided herein are
adequate to make the information presented not misleading when these unaudited
interim condensed consolidated financial statements are read in conjunction with
the audited consolidated financial statements contained in the company's Annual
Report on Form 10-KSB for the year ended December 31, 2003. The results of
operations for the period ended September 30, 2004 are not necessarily
indicative of the results to be expected for the full year.
This Amended Quarterly Report on Form 10-QSB/A is being filed to reflect the
elimination of $594,568 of interest expense in relation to the re-pricing of
warrants issued for the non-participation of investors and to reflect the
reclassification of approximately $1.67 million of unamortized debt discount and
deferred financing costs from additional paid-in-capital to interest expense in
relation to the March 3, 2004 debt conversion of approximately $8.567 million in
principal and accrued interest.
Stock-Based Compensation Expense (Restated)
The Company has elected to follow Accounting Principles Board Opinion No. 25
("APB No. 25"), "Accounting for Stock Issued to Employees," and related
interpretations in accounting for its employee stock options. Under APB No. 25,
when the exercise price of employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recorded. The
Company discloses information relating to the fair value of stock-based
compensation awards in accordance with Statements of Financial Accounting
Standards No.123, "Accounting for Stock-Based Compensation" And No. 148
"Accounting for Stock-Based Compensation - Transition and Disclosure". The
following table illustrates the effect on net loss and loss per share as if the
Company had applied the fair value to all awards. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions used for grants in the third quarter of
2004 and 2003, respectively: (1) average expected volatility of 99% and 162%,
(2) average risk-free interest rates of 3.79% and 3.74%, and (3) average
expected lives of seven years.
The pro forma amounts that are disclosed reflect the portion of the fair value
of awards that were earned for the three and nine months ended September 30,
2004 and 2003.
----------------------------------------------- ----------------- -------------------- -------------------- --------------------
For the three and nine months ended September Three Months Three Months Nine Months Nine Months
30, 2004 2003 2004 2003
(Restated) (Restated)
----------------------------------------------- ----------------- -------------------- -------------------- --------------------
Net loss applicable to common stockholders,
as reported $ (1,754,899) $ (909,151) $ (9,759,565) $ (2,798,743)
----------------------------------------------- ----------------- -------------------- -------------------- --------------------
Add: Stock based employee compensation
expense included in reported net loss - - - -
----------------------------------------------- ----------------- -------------------- -------------------- --------------------
Deduct: Stock-based employee compensation
expense determined under fair value method (297,750) (316) (7,628,869) (1,486,025)
----------------------------------------------- ----------------- -------------------- -------------------- --------------------
Pro forma net loss $ (2,052,649) $ (909,467) $ (17,388,434) $ (4,284,768)
----------------------------------------------- ----------------- -------------------- -------------------- --------------------
Net loss per share applicable to common
stockholders:
Basic and diluted, as reported $ (0.03) $ (0.02) $ (0.16) $ (0.08)
Basic and diluted, pro forma $ (0.03) $ (0.02) $ (0.29) $ (0.12)
================= ==================== ==================== ====================
8
Note 2 - NATURE OF BUSINESS
We design and manufacture miniature display modules, which we refer to as
OLED-on-silicon-microdisplays, primarily for incorporation into the products of
other manufacturers. Microdisplays are typically smaller than a postage stamp,
but when viewed through a magnifier they can contain all of the information
appearing on a high-resolution personal computer screen. Our microdisplays use
organic light emitting diodes, or OLEDs, which emit light themselves when a
current is passed through them. Our technology permits OLEDs to be coated onto
silicon chips to produce high resolution OLED-on-silicon microdisplays.
Note 3 - REVENUE AND COST RECOGNITION
Revenue is recognized when products are shipped to customers, net of allowances
for anticipated returns. The Company's revenue-earning activities generally
involve delivering products and revenues are considered to be earned when the
Company has completed the process by which it is entitled to such revenues.
Revenue is recognized when persuasive evidence of an arrangement exists,
delivery has occurred, the selling price is fixed or determinable and collection
is reasonably assured.
The Company also earns revenues from certain of eMagin's R&D activities under
both firm fixed-price contracts and cost-type contracts, including some
cost-plus-fee contracts. Revenues relating to firm fixed-price contracts are
generally recognized on the percentage-of-completion method of accounting as
costs are incurred (cost-to-cost basis). Revenues on cost-plus-fee contracts
include costs incurred plus a portion of estimated fees or profits based on the
relationship of costs incurred to total estimated costs. Contract costs include
all direct material and labor costs and an allocation of allowable indirect
costs as defined by each contract, as periodically adjusted to reflect revised
agreed upon rates. These rates are subject to audit by the other party. Amounts
can typically be billed on a bi-monthly basis.
Note 4 - RECEIVABLES
The majority of our commercial accounts receivable are due from Original
Equipment Manufacturers ("OEM"s). Credit is extended based on evaluation of a
customers' financial condition and, generally, collateral is not required.
Accounts receivable are payable in U.S. dollars, are due within 30-90 days and
are stated at amounts due from customers net of an allowance for doubtful
accounts. Any account outstanding longer than the contractual payment terms is
considered past due. The Company determines the allowance by considering a
number of factors, including the length of time trade accounts receivable are
past due, eMagin's previous loss history, the customer's current ability to pay
its obligation, and the condition of the general economy and the industry as a
whole. The Company writes off accounts receivable when they are deemed
uncollectible.
Receivables consist of the following:
September 30, 2004 December 31, 2003
------------------ -----------------
Trade receivables $ 1,161,689 $ 899,174
Contract receivables 194,951 173,809
Unbilled receivables - 75,359
------------------ -----------------
Total 1,356,640 1,148,342
Less allowance for doubtful
accounts (487,018) (304,446)
------------------ -----------------
Net receivables $ 869,622 $ 843,896
================== =================
9
Note 5 - RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
Note 6 - NET LOSS PER COMMON SHARE
In accordance with SFAS No. 128, net loss per common share amounts ("basic EPS")
and ("diluted EPS") were computed by dividing the net loss by the weighted
average number of common shares outstanding, excluding any potential dilution.
Common equivalent shares totaling 11,366,619 and 32,828,735 have been excluded
from the computation of diluted EPS for the three and nine months ended
September 30, 2004 and 17,304,028 and 19,091,435 have been excluded from the
computation of diluted EPS for the three and nine months ended September 30,
2003, respectively as their inclusion would be antidilutive.
Note 7 - INVENTORIES
Inventory is stated at the lower of cost or market. Cost is determined using the
first-in first-out method. The Company reviews the value of its inventory and
reduces the inventory value to its net realized value based upon current market
prices and contracts for future sales.
The components of inventories are as follows:
September 30, 2004 December 31, 2003
------------------ -----------------
Raw materials $ 1,138,370 $ 20,416
Work in process 131,827 43,750
Finished goods 187,710 211,251
------------------ -----------------
Total Inventory $ 1,457,907 $ 275,417
================== =================
Note 8 - DEBT (Restated)
The debt consisted of the following:
September 30, 2004 December 31, 2003
------------------ -----------------
a Current portion of long
term debt $ 13,588 $ 38,184
b Restructuring Agreement
and Original Secured Notes - 6,124,451
c Long-term capitalized
lease obligations 25,887 36,257
------------------ -----------------
Total debt $ 39,475 $ 6,198,892
================== =================
10
a) This amount represents the amount due to Citicorp Leasing over the next 12
months in lease payments for equipment.
b) In February 2004, we entered into an agreement whereby the holders of our
Secured Convertible Notes (the "Notes"), which were due in November 2005, agreed
to an early conversion of all of the $7.825 million principal amount of the
Notes, together with the $742,424 of accrued interest on the Notes, into
11,394,621 shares of common stock of eMagin. On the date of the conversion the
Company recorded, $1,598,335 in non-cash interest expense related to the
unamortized debt discount and beneficial conversion feature and $74,637 in
non-cash interest expense related to the writeoff of deferred financing costs.
In consideration of the Noteholders agreeing to the early conversion of the
Notes, eMagin issued the Noteholders warrants to purchase an aggregate of 2.5
million shares of common stock (the "Warrants"), which Warrants are exercisable
at a price of $2.76 per share. 1.5 million of the Warrants, "D warrants", are
exercisable until December 31, 2005. The remaining 1.0 million of the Warrants,
"E warrants", are exercisable until June 10, 2008. Using the Black Scholes
method of valuating warrants, an expense totaling $3.18 million was recorded in
interest expense in the first quarter of 2004 to record an estimated value for
these warrants. The fair value of the warrants was estimated using the Black-
Scholes option-pricing model with the following assumptions for the two sets of
warrants: (1) average expected volatility of 100%, (2) average risk-free
interest rates of 3.52%, (3) Fair Market Value of $2.30, (4) dividends of 0%,
and (5) Average Term (in days) of 670 for the D warrants and 1,460 for the E
warrants.
c) This amount is due to Citicorp Leasing as long-term debt for lease payments
for equipment with this balance to be paid in 2005.
Note 9 - SHAREHOLDERS' EQUITY (Restated)
The authorized common stock of the Company consists of 200,000,000 shares with a
par value of $0.001 per share.
For the three months ended September 30, 2004, the Company received $1,926,795
for the exercise of 2,123,694 warrants. For the nine months ended September 30,
2004, the Company received a total of $5,078,424 for the exercise of 5,221,052
options and 3,358,690 warrants.
In August 2004, the Company and certain of the holders of its outstanding Class
A, B and C common stock purchase warrants entered into an agreement pursuant to
which the Company and the holders of the warrants agreed to the $0.90 re-pricing
and exercise of Class A, B and C common stock purchase warrants. As a condition
to the transaction, the holders of the warrants agreed to limit the right of
participation that they were granted in January 9, 2004. As a result of the
transaction, the holders agreed to re-price and exercise 2,099,894 Class A, B
and/or C common stock purchase warrants, for an aggregate of $1,889,900.
The Company issued 162,412 and 254,451 shares of common stock for the payment of
$219,457 and $397,531, respectively, for the three and nine months ended
September 30, 2004, for services rendered and to be rendered in the future. As
such, the Company recorded the fair value of the services rendered in selling,
general and administrative expenses, services to be rendered as prepaid expenses
and reduction of accounts payable for services previously rendered in the
accompanying unaudited consolidated statements of operations.
11
Note 10 - STOCK COMPENSATION
As of September 30, 2004, the Company has outstanding options to purchase
12,233,306 shares. In 2000 the Company issued options below fair market value.
The Company recorded $87,565 in expense for the nine months ended September 30,
2004 for the amortization of those options. The transaction was fully amortized
in the second quarter of 2004, so no additional expense will be recorded. The
amount was recorded in Selling, General & Administrative expenses.
Note 11 - COMMITMENTS AND CONTINGENCIES
[a] Royalty payments:
The Company, in accordance with a royalty agreement, is obligated to make
minimum annual royalty payments. Under this agreement, the Company must pay a
certain percentage of net sales of certain products, which percentages are
defined in the agreement. The percentages are on a sliding scale depending on
the amount of sales generated. Any minimum royalties paid may be credited
against the amounts due based on the percentage of sales. The royalty agreement
terminates upon the expiration of the last-to-expire issued patent.
In the three and nine months ended September 30, 2004, $60,434 and $155,293 was
recorded in royalty expense.
[b] Contractual obligations:
We currently lease space from IBM for $78,045 per month that houses our
principal executive offices, our equipment for OLED microdisplay fabrication and
research and development, as well as our assembly operations and storage. We
currently occupy such space on a month-to-month basis. We are currently in
negotiations with IBM for a new lease. No assurance can be given that we will
execute a new lease, or that such new lease will be on terms that are favorable
to us. In the event that we are forced to locate new space, we may experience a
disruption in our operations, which could have a material adverse affect on our
results of operations.
NOTE 12 - RECLASSIFICATIONS
Certain amounts in the September 30, 2003 financial statements have been
reclassified to conform to the September 30, 2004 classification.
NOTE 13 - SUBSEQUENT EVENTS (Restated)
On October 21, 2004, we entered into a Securities Purchase Agreement, pursuant
to which we sold and issued 10,259,524 shares of common stock, par value $0. 001
per share, and series F common stock purchase warrants to purchase our common
stock to purchasers for an aggregate purchase price of $10,772,500. The Common
Shares were priced at $1.05. The Common Shares and the shares underlying the
warrants were drawn-down off of a shelf registration statement which was filed
by us on May 5, 2004, and declared effective by the Securities and Exchange
Commission on June 10, 2004. Net proceeds received after deducting expenses was
approximately $9.75 million.
The Series F Warrants are exercisable from April 25, 2005 until April 25, 2010
to purchase up to 5,129,762 shares of common stock at an exercise price of $1.21
per share, subject to adjustment upon the occurrence of specific events,
including stock dividends, stock splits, combinations or reclassifications of
12
our common stock or distributions of cash or other assets. In addition, the
Series F Warrants contain provisions protecting against dilution resulting from
the sale of additional shares of our common stock for less than the exercise
price of the Series F Warrants, or the market price of the common stock, on the
date of such issuance or sale.
On October 28, 2004, we entered into a Securities Purchase Agreement, pursuant
to which we sold and issued 2,740,476 shares of common stock, par value $0. 001
per share, and series F common stock purchase warrants to purchase our common
stock to purchasers for an aggregate purchase price of $2,877,500. The Common
Shares were priced at $1.05. The Common Shares and shares underlying the
warrants were drawn-down off of a shelf registration statement which was filed
by us on May 5, 2004, and declared effective by the Securities and Exchange
Commission on June 10, 2004. Net proceeds received after deducting expenses was
approximately $2.65 million.
The Series F Warrants are exercisable from April 25, 2005 until April 25, 2010
to purchase up to 1,370,238 shares of common stock at an exercise price of $1.21
per share, subject to adjustment upon the occurrence of specific events,
including stock dividends, stock splits, combinations or reclassifications of
our common stock or distributions of cash or other assets. In addition, the
Series F Warrants contain provisions protecting against dilution resulting from
the sale of additional shares of our common stock for less than the exercise
price of the Series F Warrants, or the market price of the common stock, on the
date of such issuance or sale.
We paid a Placement Agent a fee equal to 6% of the gross proceeds of these
offerings and agreed to reimburse them for reasonable expenses up to $50,000,
incurred in connection with the offerings.
In addition, we engaged Larkspur Capital Corporation to act as an adviser in
connection with the sale of these securities. For such services, we paid
Larkspur Capital Corporation a fee equal to 1% of the gross proceeds of these
offerings (see Note - 14).
As a result of the above transaction, the outstanding Series A Common Stock
Purchase Warrants that were issued to participants of the Securities Purchase
Agreement dated January 9, 2004 were re-priced from $1.74 to $1.05.
Note 14 - RELATED PARTY TRANSACTIONS
Paul Cronson, a member of our board of directors, is a founder and shareholder
of Larkspur Capital Corporation which was engaged as advisor in connection with
the sale of the securities listed above.
13
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operation
Statement of Forward-Looking Information
This report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. These statements relate to future events or our future financial
performance. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expect," "plan," "anticipate,"
"believe," "estimate," "predict," "potential" or "continue," the negative of
such terms, or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially from those in the
forward-looking statements as a result of various important factors. Although we
believe that the expectations reflected in the forward-looking statements are
reasonable, such should not be regarded as a representation by the Company, or
any other person, that such forward-looking statements will be achieved. The
business and operations of the Company are subject to substantial risks, which
increase the uncertainty inherent in the forward-looking statements contained in
this release.
We undertake no duty to update any of the forward-looking statements, whether as
a result of new information, future events or otherwise. Readers are cautioned
not to place undue reliance on the forward-looking statements contained in this
report.
Overview
We design and manufacture miniature display modules, which we refer to as
OLED-on-silicon-microdisplays, primarily for incorporation into the products of
other manufacturers. Microdisplays are typically smaller than a postage stamp,
but when viewed through a magnifier they can contain all of the information
appearing on a high-resolution personal computer screen. Our microdisplays use
organic light emitting diodes, or OLEDs, which emit light themselves when a
current is passed through them. Our technology permits OLEDs to be coated onto
silicon chips to produce high resolution OLED-on-silicon microdisplays.
We believe that our OLED-on-silicon microdisplays offer a number of advantages
in near to the eye applications over other current microdisplay technologies,
including lower power requirements, less weight, fast video speed without
flicker, and wider viewing angles. In addition, many computer and video
electronic system functions can be built directly into the OLED-on-silicon
microdisplay, resulting in compact systems with lower expected overall system
costs relative to alternate microdisplay technologies.
Since our inception in 1996, we derived substantially all of our revenues from
fees paid to us under research and development contracts, primarily with the
U.S. government. We have devoted significant resources to the development and
commercial launch of our products. We commenced limited initial sales of our
SVGA+ microdisplay in May 2001 and commenced shipping samples of our SVGA-3D
microdisplay in February 2002. As of September 30, 2004, we have recognized
approximately $7.3 million from sales of our products, and have a backlog of
approximately $35 million in products ordered for delivery through 2007. These
products are being applied or considered for near-eye and headset applications
in products such as entertainment and gaming headsets, handheld Internet and
telecommunication appliances, viewfinders, and wearable computers to be
manufactured by original equipment manufacturer (OEM) customers. In addition to
marketing OLED-on-silicon microdisplays as components, we also offer
microdisplays in an integrated package, which we call Microviewer, which
includes a compact lens for viewing the microdisplay and electronic interfaces
to convert the signal from our customer's product into a viewable image on the
microdisplay. Through our wholly owned subsidiary, Virtual Vision, Inc., we are
also developing head-wearable displays that incorporate our Microviewer.
14
We license our core OLED technology from Eastman Kodak and we have developed our
own technology to create high performance OLED-on-silicon microdisplays and
related optical systems. We believe our technology licensing agreement with
Eastman Kodak, coupled with our own intellectual property portfolio, gives us a
leadership position in OLED and OLED-on-silicon microdisplay technology. We are
the only company to demonstrate publicly and offer commercially full-color
OLED-on-silicon microdisplays.
Company History
Our history has been as a developmental stage company. As of January 1, 2003, we
are no longer a development stage Company. We have transitioned to manufacturing
our product and intend to significantly increase our marketing, sales, and
research and development efforts, and expand our operating infrastructure. If we
are unable to generate significant revenues, our net losses in any given period
could increase and we may be forced to reduce our expenses or operations.
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission ("SEC") defines "critical accounting
policies" as those that require application of management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain and may change in
subsequent periods.
Not all of the accounting policies require management to make difficult,
subjective or complex judgments or estimates. However, the following policies
could be deemed to be critical within the SEC definition.
Revenue Recognition
Revenue on product sales is recognized when persuasive evidence of an
arrangement exists, such as when a purchase order or contract is received from
the customer, the price is fixed, title to the goods has changed and there is a
reasonable assurance of collection of the sales proceeds. We obtain written
purchase authorizations from our customers for a specified amount of product at
a specified price and consider delivery to have occurred at the time of
shipment. Revenue is recognized at shipment and we record a reserve for
estimated sales returns, which is reflected as a reduction of revenue at the
time of revenue recognition.
Revenues from research and development activities relating to firm fixed-price
contracts are generally recognized on the percentage-of-completion method of
accounting as costs are incurred (cost-to-cost basis). Revenues from research
and development activities relating to cost-plus-fee contracts include costs
incurred plus a portion of estimated fees or profits based on the relationship
of costs incurred to total estimated costs. Contract costs include all direct
material and labor costs and an allocation of allowable indirect costs as
defined by each contract, as periodically adjusted to reflect revised agreed
upon rates. These rates are subject to audit by the other party. Amounts can be
billed on a bi-monthly basis. Billing is based on subjective cost investment
factors.
Results of Operations
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 2003
Revenues
Revenues for the three and nine months ended September 30, 2004 were $1.1
million and $3.1 million, respectively as compared to $0.7 million and $1.5
15
million for the three and nine months ended September 30, 2003, an increase of
45% and 102%, respectively. The increase in revenue resulted from increased unit
volume to the Company's current customer base. Unit pricing was relatively
unchanged in 2004 as compared to 2003. We currently have firm orders or letters
of intent to purchase our products at significantly higher volume levels than we
have experienced historically. In order to realize revenue from these orders, we
will be required to increase unit production levels and the amount of capital
committed to pre-payments of raw materials and finished goods. The critical raw
materials in the manufacture of our products are silicon wafers used to create
our OLED microdisplays and lenses used in assembly of our subsystems. Both of
these items require significant cash pre-payments and can take up to six months
for delivery once ordered. While we anticipate that our revenues will increase
in the future, we can not reliably estimate when and by how much until
predictable raw material delivery is established or increased levels of these
materials are held in inventory.
Cost of Goods Sold. Cost of goods sold includes direct and indirect costs
associated with production and inventory loss. Cost of goods sold for the three
and nine months ended September 30, 2004 were $1.6 million and $4.5 million,
respectively, as compared to $1.3 million and $3.5 million for the three and
nine months ended September 30, 2003. The $0.3 million and $1.0 million
increase, respectively, in costs was directly related to higher unit volumes in
2004 as compared to 2003. However, our gross loss percentage during the 2004
periods has been reduced significantly due to volume and operating efficiencies
created as we increased production.
We currently record all expenses associated with manufacturing in cost of goods
sold. The full facility overhead as well as the expense of indirect materials is
matched against our units sold. While our production volume is low, the gross
margin reflects the costs that will be absorbed when quantities increase.
Costs and Expenses
Research and Development. Research and development expenses included salaries,
development materials and other costs specifically allocated to the development
of new products. Research and development expenses were $359 thousand and $443
thousand for the three months and nine months ended September 30, 2004,
respectively, as compared to $600 and $22,000 for the three and nine months
ended September 30, 2003. The increase was a result of new OLED microdisplay and
subsystem development initiatives. We currently anticipate that research and
development expenses will increase over the coming quarters as these projects
progress.
Selling, General and Administrative. Selling, general and administrative
expenses consist principally of salaries and fees for professional services,
legal fees incurred in connection with patent filings and related matters,
amortization, as well as other marketing and administrative expenses. Selling,
general and administrative expenses were $0.9 million and $2.8 million for the
three and nine months ended September 30, 2004, respectively, as compared to
$0.7 million and $2.6 million for the three and nine months ended September 30,
2003. The increase of $0.2 million in the three months ended September 30, 2004
as compared to the three months ended September 30, 2003 is primarily due to
relocation expenses associated with staff relocating to Washington State. The
increase of $0.1 million in the nine months ended September 30, 2004 as compared
to the nine months ended September 30, 2003 is primarily due to the same
factors. We currently anticipate that selling, general and administrative
expenses will increase over the coming quarters as we hire additional sales and
support staff.
Other Income (Expense). Other income (expense) for the three and nine months
ended September 30, 2004 were $26 thousand and ($5) million, respectively, as
compared to $(0.4) million and $(0.7) million for the three and nine months
ended September 30, 2003. The $0.4 million decrease in interest expense for the
16
three months ended September 30, 2004 as compared to the three months ended
September 30, 2003 was due to the elimination of approximately $7.825 million of
Notes Payable during the first quarter of 2004 and the associated interest
expense related to this debt that was no longer recorded in 2004. The increase
in interest expense for the nine months ended September 30, 2004 was
attributable to three factors; (1) $3.18 million of non-cash charges related to
the value of the warrants issued to induce the holders of the $7.825 million in
Notes to agree to an early conversion of the Notes into common stock, (2)
$1,598,325 in non-cash charges related to the remaining unamortized debt
discount and beneficial conversion feature associated with the aforementioned
Notes, and (3) $74,637 in non-cash charges related to the write-off of the
remaining unamortized deferred financing costs. Gain on Payable Forgiveness was
a result of restructuring our debt in 2003.
Liquidity and Capital Resources
Current Financial Position
We have total liabilities and contractual obligations of $2,250,089 as of
September 30, 2004. These contractual obligations, along with the dates on which
such payments are due, are described below:
Contractual Obligations Total One Year or Less More than One Year
----------------------- --------------- ---------------- ------------------
Royalties $ 531,250 $ 125,000 $ 406,250
Operating leases 110,892 110,892 -
Capital leases 47,461 18,372 29,089
----------- ------------ ----------
Total contractual obligations $ 689,603 $ 254,264 $ 435,339
=========== ============ ==========
As mentioned in Note 13 - Subsequent Events, in October and November of 2004 we
completed direct equity placements of common stock and warrants that resulted in
net proceeds after expenses of $12.4 million. These funds significantly
strengthen our liquidity and capital resources and will be used in part to fund
the working capital requirements discussed above.
Assuming we are able to increase our revenue, we anticipate that we will
continue to experience growth in our operating expenses for the foreseeable
future and that our operating expenses will be the principal use of our cash. In
particular, we expect that salaries for employees engaged in production
operations, purchase of inventory, funding of receivables and expenses of
increased sales and marketing efforts would be the principle uses of cash. We
expect that our cash requirements over the next 12 months will be met by a
combination of cash on hand, which, as of September 30, 2004 was $4.1 million,
additional financing, the exercise of outstanding options and warrants, and
revenues generated by operations.
We have purchase agreements for approximately $35 million of our products to be
delivered now through 2007. Management believes that the prospects for growth of
product revenue remain high.
Scheduled deliveries against our purchase agreements and other customer
requirements are subject to change depending on a number of factors including,
our production capacity which is heavily dependant on predictable silicon wafer
and lens delivery from our suppliers, our customers' production timing of
related systems into which they are integrating our products and their other
supplier schedules, changes in the expected procurement periods for military
programs and the requirements of the individual agreements and contracts that we
have with our customers. We currently anticipate the need to ramp our supplies
and staffing quickly and efficiently to be prepared to meet the currently
anticipated shipping schedules, which will require significant added effort and
capital.
Our cash requirements depend on numerous factors, including new product
development activities, ability to commercialize our products, timely market
acceptance of our products and our customers' products, and other factors. We
expect to carefully devote capital resources to continue our development
programs directed at commercializing our products in our target markets, hire
and train additional staff, expand our research and development activities, and
develop and expand our manufacturing capacity.
17
Any delays could change the cash requirements of the company. While we believe
that we are in position to handle the anticipated production increase, there can
be no assurance that we will not experience some issues relating to raw material
availability, yield and throughput risk that could result in product shipment
delays to customers.
Factors Which May Affect Future Results
In evaluating our business, prospective investors and shareholders should
carefully consider the risks factors, any of which could have a material adverse
impact on our business, operating results and financial condition and result in
a complete loss of your investment.
We remain subject to the American Stock Exchange's review regarding our
compliance with their continued listing requirements.
The AMEX staff notified us in June 2003 that we had fallen below Section
1003(a)(i) of the AMEX Company Guide for having shareholders' equity of less
than $2,000,000 and losses from continuing operations and/or net losses in two
out of the three most recent fiscal years. We were afforded the opportunity to
submit a plan of compliance to the AMEX and presented a plan to the AMEX in July
2003. On September 9, 2003, we received notice from the staff of the AMEX that
the AMEX had accepted our plan to regain compliance with AMEX's continued
listing standards and granted us an extension until December 4, 2004 to regain
compliance with those standards.
As a result of our financing activity throughout 2004 and the conversion of
our outstanding promissory notes in March 2004, our balance sheet as of
September 30, 2004 and our anticipated balance sheet at December 31, 2004 will
meet AMEX's $2 million shareholder equity requirement.
While we anticipate that AMEX will notify us that we have regained
compliance with their continued listing standards, we have not yet received such
notification. Other unidentified issues may arise in the future that could
adversely affect the financial or the potential listing status of the company.
We have a history of losses since our inception and may incur losses for the
foreseeable future.
18
Accumulated net losses as of September 30, 2004, were $(146) million, the
majority of which was related to the March 2000 merger and the subsequent
write-down of goodwill. The non-cash losses were dominated by the amortization
and write-down of goodwill and purchased intangibles and write-down of acquired
in-process research and development related to the March 2000 acquisition, and
also included some non-cash stock-based compensation. We have not yet achieved
profitability and we can give no assurances that we will achieve profitability
within the foreseeable future as we fund our operations and capital expenditures
in areas such as establishment and expansion of markets, sales and marketing,
operating equipment and research and development. We cannot assure investors
that we will ever achieve or sustain profitability or that our operating losses
will not increase in the future.
We were previously primarily dependent on U.S. government contracts.
For many years the majority of our revenues were derived from research and
development contracts with the U.S. government. We no longer rely on such
contracts for revenue. We plan to submit proposals for additional development
contract funding; however, funding is subject to legislative authorization and
even if funds are appropriated such funds may be withdrawn based on changes in
government priorities. No assurances can be given that we will be successful in
obtaining new government contracts. Our inability to obtain revenues from
government contracts could have a material adverse effect on our results of
long-term operations, unless substantial product or non-government contract
revenue offsets any lack of government contract revenue.
Risks related to our intellectual property
We rely on our license agreement with Eastman Kodak for the development of our
products. Eastman Kodak's licensing of its OLED technology to others for
microdisplay applications, or the sublicensing by Eastman Kodak of our OLED
technology to third parties, could have a material adverse impact on our
business.
Our principal products under development utilize OLED technology that we
license from Eastman Kodak. We rely upon Eastman Kodak to protect and enforce
key patents held by Eastman Kodak, relating to OLED display technology. Eastman
Kodak's patents expire at various times in the future from near term in 2004
through long term patents that are just being issued in 2004. Our license with
Eastman Kodak could terminate if we fail to perform any material term or
covenant under the license agreement. Since our license from Eastman Kodak is
non-exclusive, Eastman Kodak could also elect to become a competitor itself or
to license OLED technology for microdisplay applications to others who have the
potential to compete with us. The occurrence of any of these events could have a
material adverse impact on our business.
We may not be successful in protecting our intellectual property and proprietary
rights.
We rely on a combination of patents, trade secret protection, licensing
agreements and other arrangements to establish and protect our proprietary
technologies. If we fail to successfully enforce our intellectual property
rights, our competitive position could suffer, which could harm our operating
results. Patents may not be issued for our current patent applications, third
parties may challenge, invalidate or circumvent any patent issued to us,
unauthorized parties could obtain and use information that we regard as
proprietary despite our efforts to protect our proprietary rights, rights
granted under patents issued to us may not afford us any competitive advantage,
others may independently develop similar technology or design around our
patents, our technology may be available to licensees of Eastman Kodak, and
protection of our intellectual property rights may be limited in certain foreign
countries. We may be required to expend significant resources to monitor and
police our intellectual property rights. Any future infringement or other claims
or prosecutions related to our intellectual property could have a material
adverse effect on our business. Any such claims, with or without merit, could be
time consuming to defend, result in costly litigation, divert management's
attention and resources, or require us to enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to us, if at all. Protection of intellectual
property has historically been a large expense for eMagin. We have not been in a
financial position to properly protect all of our intellectual property, and may
not be in a position to properly protect our position or stay ahead of
competition in new research and the protecting of the resulting intellectual
property.
19
Risks related to the microdisplay industry
The commercial success of the microdisplay industry depends on the widespread
market acceptance of microdisplay systems products.
The market for microdisplays is emerging. Our success will depend on
consumer acceptance of microdisplays as well as the success of the
commercialization of the microdisplay market. As an OEM supplier, our customer's
products must also be well accepted. At present, it is difficult to assess or
predict with any assurance the potential size, timing and viability of market
opportunities for our technology in this market. The viewfinder microdisplay
market sector is well established with entrenched competitors with whom we must
compete.
The microdisplay systems business is intensely competitive.
We do business in intensely competitive markets that are characterized by
rapid technological change, changes in market requirements and competition from
both other suppliers and our potential OEM customers. Such markets are typically
characterized by price erosion. This intense competition could result in pricing
pressures, lower sales, reduced margins, and lower market share. Our ability to
compete successfully will depend on a number of factors, both within and outside
our control. We expect these factors to include the following:
o our success in designing, manufacturing and delivering expected new
products, including those implementing new technologies on a timely
basis;
o our ability to address the needs of our customers and the quality of
our customer services;
o the quality, performance, reliability, features, ease of use and
pricing of our products;
o successful expansion of our manufacturing capabilities;
o our efficiency of production, and ability to manufacture and ship
products on time;
o the rate at which original equipment manufacturing customers
incorporate our product solutions into their own products;
o the market acceptance of our customers' products; and
o product or technology introductions by our competitors.
Our competitive position could be damaged if one or more potential OEM
customers decide to manufacture their own microdisplays, using OLED or alternate
technologies. In addition, our customers may be reluctant to rely on a
relatively small company such as eMagin for a critical component. We cannot
assure you that we will be able to compete successfully against current and
future competition, and the failure to do so would have a materially adverse
effect upon our business, operating results and financial condition.
The display industry is cyclical.
The display industry is characterized by fabrication facilities that
require large capital expenditures and long lead times for supplies and the
subsequent processing time, leading to frequent mismatches between supply and
demand. The OLED microdisplay sector may experience overcapacity if and when all
of the facilities presently in the planning stage come on line leading to a
difficult market in which to sell our products.
Competing products may get to market sooner than ours.
Our competitors are investing substantial resources in the development and
manufacture of microdisplay systems using alternative technologies such as
reflective liquid crystal displays (LCDs), LCD-on-Silicon ("LCOS")
microdisplays, active matrix electroluminescence and scanning image systems, and
transmissive active matrix LCDs. Some of these products have been introduced
years ahead of our products and some are established in segments of the
microdisplay and virtual imaging markets that we have yet to enter. Displacing
entrenched competitors may be difficult, especially in long-term projects or
products, even if our product proves itself to be better.
Our competitors have many advantages over us.
As the microdisplay market develops, we expect to experience intense
competition from numerous domestic and foreign companies including
well-established corporations possessing worldwide manufacturing and production
facilities, greater name recognition, larger retail bases and significantly
greater financial, technical, and marketing resources than us, as well as from
emerging companies attempting to obtain a share of the various markets in which
our microdisplay products have the potential to compete.
20
Our products are subject to lengthy OEM development periods.
We plan to sell most of our microdisplays and related products to OEMs who
will incorporate them into or with products they sell. OEMs determine during
their product development phase whether they will incorporate our products. The
time elapsed between initial sampling of our products by OEMs, the custom design
of our products to meet specific OEM product requirements, and the ultimate
incorporation of our products into OEM consumer products is significant. If our
products fail to meet our OEM customers' cost, performance or technical
requirements or if unexpected technical challenges arise in the integration of
our products into OEM consumer products, our operating results could be
significantly and adversely affected. Long delays in achieving customer
qualification and incorporation of our products could adversely affect our
business.
Our products will likely experience rapidly declining unit prices.
In the markets in which we expect to compete, prices of established
products tend to decline significantly over time. In order to maintain our
profit margins over the long term, we believe that we will need to continuously
develop product enhancements and new technologies that will either slow price
declines of our products or reduce the cost of producing and delivering our
products. While we anticipate many opportunities to reduce production costs over
time, there can be no assurance that these cost reduction plans will be
successful. We may also attempt to offset the anticipated decrease in our
average selling price by introducing new products, increasing our sales volumes
or adjusting our product mix. If we fail to do so, our results of operations
would be materially and adversely affected.
Risks related to manufacturing
We expect to depend on semiconductor contract manufacturers to supply our
silicon integrated circuits and other suppliers of key components, materials and
services.
We do not manufacture the silicon integrated circuits on which we
incorporate our OLED technology. Instead, we provide the design layouts to
semiconductor contract manufacturers who manufacture the integrated circuits on
silicon wafers. We also depend on suppliers of a variety of other components and
services, including circuit boards, graphic integrated circuits, passive
components, materials and chemicals, and equipment support. Our inability to
obtain sufficient quantities of high quality silicon integrated circuits or
other necessary components, materials or services on a timely basis has resulted
in delays and could result in future manufacturing delays, increased costs and
ultimately in reduced or delayed sales or lost orders which could materially and
adversely affect our operating results.
The manufacture of OLED-on-silicon is new and OLED microdisplays have not been
produced in significant quantities.
If we are unable to produce our products in sufficient quantity, we will be
unable to attract customers. In addition, we cannot assure you that once we
commence volume production we will attain yields of throughput that will result
in profitable gross margins or that we will not experience manufacturing
problems which could result in delays in delivery of orders or product
introductions.
We are dependent on a single manufacturing line.
We initially expect to manufacture our products on a single manufacturing
line. If we experience any significant disruption in the operation at our
manufacturing facility or a serious failure of a critical piece of equipment, we
may be unable to supply microdisplays to our customers. For this reason, some
OEMs may also be reluctant to commit a broad line of products with our
microdisplays without a second production facility in place. Interruptions in
our manufacturing could be caused by manufacturing equipment problems, the
21
introduction of new equipment into the manufacturing process or delays in the
delivery of new manufacturing equipment. Lead-time for delivery of manufacturing
equipment can be long. No assurance can be given that we will not lose potential
sales or be able to meet sales orders delivery requirements due to production
interruptions in our manufacturing line. In order to meet the requirements of
certain OEMs for multiple manufacturing sites, we will have to expend capital to
secure additional sites and may not be able to manage multiple sites
successfully.
We currently lease space from IBM on a month-to-month basis.
We currently lease space from IBM that houses our principal executive
offices, our equipment for OLED microdisplay fabrication and research and
development, as well as our assembly operations and storage. We currently occupy
such space on a month-to-month basis. We are currently in negotiations with IBM
for a new lease. No assurance can be given that we will execute a new lease, or
that such new lease will be on terms that are favorable to us. In the event that
we are forced to locate new space, we will experience a disruption in our
operations, which could have a material adverse affect on our results of
operations.
Risks related to our business
Our success depends on attracting and retaining highly skilled and qualified
technical and consulting personnel.
We must hire highly skilled technical personnel as employees and as
independent contractors in order to develop our products. The competition for
skilled technical employees is intense and we may not be able to retain or
recruit such personnel. We must compete with companies that possess greater
financial and other resources than we do, and that may be more attractive to
potential employees and contractors. To be competitive, we may have to increase
the compensation, bonuses, stock options and other fringe benefits offered to
employees in order to attract and retain such personnel. The costs of retaining
or attracting new personnel may have a material adverse affect on our business
and operating results. In addition, difficulties in hiring and retaining
technical personnel could delay the implementation of our business plan.
Our success depends in a large part on the continuing service of key personnel.
Changes in management could have an adverse effect on our business. We are
dependent upon the active participation of several key management personnel,
including Gary W. Jones, our chief executive officer. This is especially an
issue while the company staffing is small. We will also need to recruit
additional management in order to expand according to our business plan. The
failure to attract and retain additional management or personnel could have a
material adverse effect on our operating results and financial performance.
Our business depends on new products and technologies.
The market for our products is characterized by rapid changes in product,
design and manufacturing process technologies. Our success depends to a large
extent on our ability to develop and manufacture new products and technologies
to match the varying requirements of different customers in order to establish a
competitive position and become profitable. Furthermore, we must adopt our
products and processes to technological changes and emerging industry standards
and practices on a cost-effective and timely basis. Our failure to accomplish
any of the above could harm our business and operating results.
We generally do not have long-term contracts with our customers.
Our business is operated on the basis of short-term purchase orders and we
cannot guarantee that we will be able to obtain long-term contracts for some
time. Such purchase orders can be cancelled or revised without penalty,
depending on the circumstances. In the absence of a backlog of orders that can
only be canceled with penalty, we plan production on the basis of internally
generated forecasts of demand, which makes it difficult to accurately forecast
revenues. If we fail to accurately forecast operating results, our business may
suffer and the value of your investment in the Company may decline. Large,
long-term supply line commitments and large inventories of various types of
displays and other products will be required to support our business and provide
reasonable order turn around for customers. Potentially enabling rapid sales
growth targets can greatly increase the cash requirement for these accounts.
Such supplies and inventories are subject to potential obsolescence, long delays
before sale, and potential damage or loss.
Our business strategy may fail if we cannot continue to form strategic
relationships with companies that manufacture and use products that could
incorporate our OLED-on-silicon technology.
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Our prospects will be significantly affected by our ability to develop
strategic alliances with OEMs for incorporation of our OLED-on-silicon
technology into their products. While we intend to continue to establish
strategic relationships with manufacturers of electronic consumer products,
personal computers, chipmakers, lens makers, equipment makers, material
suppliers and/or systems assemblers, there is no assurance that we will be able
to continue to establish and maintain strategic relationships on commercially
acceptable terms, or that the alliances we do enter into will realize their
objectives. Failure to do so would have a material adverse effect on our
business.
Our business depends to some extent on international transactions.
We purchase needed materials from companies located abroad and may be
adversely affected by political and currency risk, as well as the additional
costs of doing business with a foreign entity. Some customers in other countries
have longer receivable periods. In addition, many of the OEMs that are the most
likely long-term purchasers of our microdisplays are located abroad exposing us
to additional political and currency risk. We may find it necessary to locate
manufacturing facilities abroad to be closer to our customers which could expose
us to various risks, including management of a multi-national organization, the
complexities of complying with foreign laws and customs, political instability
and the complexities of taxation in multiple jurisdictions.
Our business may expose us to product liability claims.
Our business may expose us to product liability claims. Although no such
claims have been brought against us to date, and to our knowledge no such claim
is threatened or likely, we may face liability to product users for damages
resulting from the faulty design or manufacture of our products. While we plan
to maintain product liability insurance coverage, there can be no assurance that
product liability claims will not exceed coverage limits, fall outside the scope
of such coverage, or that such insurance will continue to be available at
commercially reasonable rates, if at all.
Our business is subject to environmental regulations and possible liability
arising from governmental claims related to the disposal of hazardous substances
and/or potential employee claims of exposure to harmful substances used in the
development and manufacture of our products.
We are subject to various governmental regulations related to toxic,
volatile, experimental and other hazardous chemicals used in, and disposed of in
connection with, our design and manufacturing process. Our failure to comply
with these regulations could result in the imposition of fines or in the
suspension or cessation of our operations. Compliance with these regulations
could require us to acquire costly equipment or to incur other significant
expenses. We develop, evaluate and utilize new chemical compounds in the
manufacture of our products. While we attempt to ensure that our employees are
protected from exposure to hazardous materials, we cannot assure you that
potentially harmful exposure will not occur or that we will not be liable to
employees as a result.
Risks related to our stock
The substantial number of shares that are or will be eligible for sale could
cause our common stock price to decline even if the company is successful.
Sales of significant amounts of common stock in the public market, or the
perception that such sales may occur, could materially affect the market price
of our common stock. These sales might also make it more difficult for us to
sell equity or equity-related securities in the future at a time and price that
we deem appropriate. As of September 30, 2004, we had outstanding (i) options to
purchase 12,233,306 shares; and (ii) warrants to purchase 15,602,078 shares of
common stock.
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ITEM 3: Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. As of the end of the
period covered by this report, we conducted an evaluation, under the supervision
and with the participation of our chief executive officer and chief financial
officer of our disclosure controls and procedures (as defined in Rule 13a-15(e)
and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation, our chief
executive officer and chief financial officer concluded that our disclosure
controls and procedures are effective to ensure that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified
in the Commission's rules and forms.
Notwithstanding the foregoing, in connection with the audit of our annual
report on Form 10-KSB for the year ended December 31, 2004, on March 28, 2005 we
determined that the re-pricing of our original Class A, B and C warrants in
August 2004 should have been classified as an equity transaction and therefore
no expense should have been recorded in connection with the re-pricing of the
warrants and that the unamortized debt discount and the deferred financing costs
should have been recorded as interest expense. As set forth in this report and
in our quarterly report on Form 10-QSB/A for the period ended September 30, 2004
which was filed with the SEC on April 12, 2005, the Consolidated Balance Sheets,
Consolidated Statements of Operations, Consolidated Statements of Cash Flows,
Statement of Changes in Shareholders' Equity and Selected Notes to Consolidated
Financial Statements have been restated, where applicable, to record the
unamortized debt discount and the deferred financing costs as interest expense.
Accordingly, these restatements, which were due to interpretations of the
accounting treatment of such transactions which was subsequently determined to
be incorrect, has lead management to determine that our disclosure controls and
procedures were not effective as of the end of the period covered by this report
to ensure that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Commission's rules and forms.
(b) Changes in internal controls. There was no change in our internal controls
or in other factors that could affect these controls during our last fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
Notwithstanding the foregoing, we engaged John Atherly in June 2004 as our
Chief Financial Officer, and in May 2005, we appointed Irwin Engelman to our
board of directors and appointed Mr. Engelman as the Chairman of our Audit
Committee immediately following our annual meeting of shareholders which was
held on September 30, 2005. In addition, we have hired a new Director of Finance
to assist the Chief Financial Officer with our filing and other financial
reporting obligations. We believe these additions in personnel enhance our
ability to meet our financial and other reporting obligations as well as
strengthen our disclosure controls and procedures so that they are currently
effective to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Commission's
rules and forms.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The company is party to certain legal proceedings arising in the ordinary course
of business. In the opinion of management, the outcome of such legal matters
will not have a material adverse effect on the company's results of operations
or financial position.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits List
EXHIBIT
NUMBER DESCRIPTION
31.1 Certification by Chief Executive Officer pursuant to Sarbanes
Oxley Section 302.
31.2 Certification by Chief Financial Officer pursuant to Sarbanes
Oxley Section 302.
32.1 Certification by Chief Executive Officer pursuant to 18 U.S. C.
Section 1350
32.2 Certification by Chief Financial Officer pursuant to 18 U.S. C.
Section 1350
(b) Reports on Form 8-K
The Company filed one report on form 8-K during the quarter ended September 30,
2004. Information regarding the items reported on is as follows:
DATE OF REPORT ITEM REPORTED ON
August 9, 2004 eMagin Corporation ("eMagin"), and certain holders of its
outstanding Class A, B, and C common stock purchase warrants
entered into an agreement pursuant to which the company and
the holders of the warrants agreed to the re-pricing and
exercise of warrants.
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
eMAGIN CORPORATION
Dated: November 2, 2005 /s/ Gary W. Jones
-----------------------
Gary W. Jones
Chief Executive Officer
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