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 March 31, 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
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 May 12, 2004 the Registrant had
63,677,618 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 Stockholders'
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 unamortized debt discount and
the deferred financing costs should have been recorded as interest expense. The
restated statements increase additional paid-in capital by approximately $1.67
million representing unamortized debt discount and deferred financing costs and
increase 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 March 31, 2004
Originally
Filed Restated
---------------- -----------------
Other income (expense) $(3,403,110) $(5,076,082)
Net loss $(4,932,972) $(6,605,944)
Basic and diluted loss per common share $ (0.09) $ (0.13)
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 as of March 31, 2004 (unaudited) and 4
December 31, 2003 (restated)
Unaudited Consolidated Statements of Operations for the
Three-Months ended March 31, 2004 and March 31, 2003 (restated) 5
Unaudited Consolidated Statements of Cash Flows for the
Three-Months ended March 31, 2004 and March 31, 2003 (restated) 6
Unaudited Consolidated Statement of Changes in Stockholders'
Equity from December 31, 2003 to March 31, 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 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURE 28
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
ASSETS March 31, 2004 December 31, 2003
-----------------------------------------
CURRENT ASSETS: (Unaudited)
(Restated)
Cash and cash equivalents $ 4,714,959 $ 1,053,895
Trade receivables 659,099 768,537
Unbilled costs and estimated profits on contracts in progress - 75,359
Inventory 513,880 275,417
Prepaid expenses and other current assets 827,516 287,957
-----------------------------------------
Total current assets 6,715,454 2,461,165
EQUIPMENT AND LEASEHOLE IMPROVEMENTS: 3,460,571 3,350,930
Less: Accumulated Depreciation (2,309,250) (2,149,991)
-----------------------------------------
Total equipment and leasehold improvements, net 1,151,321 1,200,939
Intangible Assets 13,504 -
Less: Accumulated Amortization (156) -
-----------------------------------------
Total intangible assets, net 13,348 -
Other long-term assets 4,407 86,907
-----------------------------------------
Total assets $ 7,884,530 $ 3,749,011
=========================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 255,301 $ 234,869
Accrued payroll and benefits 554,744 952,850
Other accrued expenses 366,192 988,569
Advanced payments 124,653 122,362
Current portion of long term debt 27,826 38,184
Other current liabilities 14,109 18,008
-----------------------------------------
Total current liabilities 1,342,825 2,354,842
Capitalized lease obligations 32,923 36,257
Notes payable and short-term debt subsequently converted to equity - 6,124,451
-----------------------------------------
Total liabilities 1,375,748 8,515,550
SHAREHOLDERS' EQUITY (CAPITAL DEFICIENCY):
Common Stock, par value $0.001 per share
Shares authorized - 100,000,000
Shares issued and outstanding - 63,043,682 and 42,695,412 63,044 42,694
Additional paid-in capital 149,375,720 131,598,910
Deferred compensation (3,460) (87,565)
Accumulated deficit (142,926,522) (136,320,578)
-----------------------------------------
Total shareholders' equity 6,508,782 (4,766,539)
-----------------------------------------
Total liabilities and shareholders' equity $ 7,884,530 $ 3,749,011
=========================================
See notes to financial statements.
4
eMAGIN CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Three Months
Ended Ended
March 31, 2004 March 31, 2003
(Restated)
------------------------------------
REVENUE:
Product revenue, net of returns $ 540,088 $ 465,379
------------------------------------
Total Revenue 540,088 465,379
------------------------------------
Cost of Goods Sold:
Direct cost of goods sold 208,599 198,951
Production expenses 1,154,123 950,917
------------------------------------
Total Cost of Goods Sold 1,362,722 1,149,868
------------------------------------
Gross Loss (822,634) (684,489)
------------------------------------
COSTS AND EXPENSES:
Research and development 7,990 21,848
Amortization of purchased intangibles 156 331,442
Stock based compensation 84,105 111,385
Selling, general and administrative 614,977 1,005,347
------------------------------------
Total costs and expenses, net 707,228 1,470,022
------------------------------------
Interest expense, net (5,076,082) (250,980)
------------------------------------
Net loss $ (6,605,944) $ (2,405,491)
====================================
Basic and diluted loss per common share $ (0.13) $ (0.08)
====================================
Weighted average common shares outstanding 51,940,205 30,731,934
====================================
See notes to financial statements.
5
eMAGIN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Three Months
ended ended
March 31, 2004 March 31, 2003
(Restated)
-------------------- ---------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (6,605,944) $ (2,405,491)
Adjustments to reconcile net loss to net cash
used in operating activities-
Depreciation and amortization 159,259 124,474
Bad debt expense 33,656 -
Amortization of intangibles 157 331,442
Amortization of financing fees 7,863 -
Non-cash charge for stock based compensation 84,105 111,385
Non-cash interest related charges 125,833 245,962
Non-cash charge for services received 8,400 163,134
Non-cash financing expense 4,955,186 -
Changes in operating assets and liabilities:
Trade receivables 151,142 110,528
Unbilled costs and estimated profits on contracts in progress - (50,000)
Inventory (38,741) 124,841
Prepaid expenses and other current assets (658,443) (609)
Other long-term assets - (7,244)
Advanced payment on contracts to be completed 2,291 -
Deferred Revenue - (29,900)
Accounts payable, accrued expenses and accrued payroll (425,247) 1,109,609
Other current liabilities (3,899) (21,231)
-------------------- ---------------------
Net cash used in operating activities (2,204,382) (193,100)
-------------------- ---------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases/Sales of equipment (109,097) 139,095
-------------------- ---------------------
Net cash used in investing activities (109,097) 139,095
-------------------- ---------------------
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 2,073,400 50,000
Payments of long term debt and capital leases (15,393) (13,692)
-------------------- ---------------------
Net cash provided by financing activities 5,974,543 36,308
-------------------- ---------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 3,661,064 (17,697)
CASH AND CASH EQUIVALENTS, beginning of period 1,053,895 82,951
-------------------- ---------------------
CASH AND CASH EQUIVALENTS, end of period $ 4,714,959 $ 65,254
==================== =====================
Supplemental Cash Flow Disclosure:
Conversion of debt to equity $ 8,567,424
Payments of A/P through issuance of stock $ 34,599
Stock issued for prepaid services $ 16,800
Cash payments of interest $ 2,508
See notes to financial statements.
6
eMAGIN CORPORATION
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
(Unaudited)
(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)
Sale of equity 3,333,364 3,334 3,913,203 3,916,537
Conversion of debt to equity 11,394,621 11,395 8,556,029 8,567,424
Issuance of warrants for
equity transaction 3,180,000 3,180,000
Stock options exercised 5,089,134 5,089 1,337,784 1,342,873
Stock warrants exercised 498,829 499 730,028 730,527
Issuance of common stock for
services 32,322 33 59,766 59,799
Amortization of deferred
compensation 84,105 84,105
Net loss for period (6,605,944) (6,605,944)
----------------- ------------ --------------- -------------- --------------- -----------------
Balance, March 31, 2004 63,043,682 $ 63,044 $ (3,460) $ 149,375,720 $ (142,926,522) $ 6,508,782
================= ============ =============== ============== =============== =================
See 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 generally
accepted accounting principles in the United States 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 March 31, 2004 are not
necessarily indicative of the results to be expected for the full year.
As a result of a subsequent analysis of the three months ended March 31, 2004
Statements of Operations, we noted that the Revenue and Cost of Goods Sold
related to intercompany transactions had not been eliminated. Accordingly,
product revenue, net of returns and direct cost of goods sold have been reduced
by $143,028. These amounts offset and do not affect previously reported Gross
Margins or Net Loss for the three months ended March 31, 2004. In addition, the
footnotes to the March 31, 2004 financial statements have been updated to
conform to the results presented in the amended March 31, 2004 quarterly
financial statements.
This Amended Quarterly Report is being filed 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. In connection with the preparation of the Company's annual
report on Form 10-KSB for the year ended December 31, 2004, on March 28, 2005
the Company was advised by its independent registered public accounting firm
that the unamortized debt discount and the deferred financing costs should be
recorded as interest expense. 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 August 16, 2004.
Stock-Based Compensation (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 Statement of Financial Accounting
Standards No.123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation."
The following table illustrates the effect on net loss and loss per share as if
the Company had applied the fair value recognition provision of SFAS No. 123.
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 first quarter of 2004 and 2003, respectively: (1) average expected
volatility of 100% and 162%, (2) average risk-free interest rates of 3.31% and
3.64%, and (3) expected lives of seven years and ten years.
The pro forma amounts that are disclosed in accordance with SFAS No. 123 reflect
the portion of the estimated fair value of awards that were earned for the three
months ended March 31, 2004 and 2003.
For the three months ended March 31, 2004 2003
(Restated)
----------------------------------------------- --------------------- ---------------------
Net loss applicable to common stockholders', $ (6,605,944) $ (2,405,491)
as reported
----------------------------------------------- --------------------- ---------------------
Add: Stock based employee compensation
expense included in reported net loss - -
----------------------------------------------- --------------------- ---------------------
Deduct: Stock-based employee compensation
expense determined under fair value method (1,288,000) (1,441,445)
----------------------------------------------- --------------------- ---------------------
Pro forma net loss $ (7,893,944) $ (3,846,836)
----------------------------------------------- --------------------- ---------------------
Net loss per share applicable to common
stockholders':
----------------------------------------------- --------------------- ---------------------
Basic and diluted, as reported $ (0.13) $ (0.08)
----------------------------------------------- --------------------- ---------------------
Basic and diluted, pro forma $ (0.15) $ (0.13)
----------------------------------------------- --------------------- ---------------------
8
Note 2 - NATURE OF BUSINESS
Through December 31, 2002, the Company was considered a development stage
enterprise, in accordance with Statement of Financial Accounting Standards
("SFAS") No. 7, "Accounting and Reporting by Development Stage Enterprises". As
of January 1, 2003, the Company has commenced planned principal operations and
as such it is no longer considered to be a development stage enterprise in
accordance with SFAS No 7.
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, 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 be billed on a bi-monthly basis. Billing is based on subjective cost
investment factors.
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 become
uncollectable, and payments subsequently received on such receivables are
reported as income in the year the payment is received.
Receivables consist of the following:
March 31, 2004 December 31, 2003
Trade receivables $ 848,033 $ 899,174
Contract receivables 73,809 173,809
Unbilled receivables - 75,359
------------ ------------
Total 921,842 1,148,342
Less allowance for doubtful accounts (262,743) (304,446)
------------ ------------
Net receivables $ 659,099 $ 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")
were computed by dividing net loss by the weighted average number of common
shares outstanding and excluding any potential dilution. Net loss per common
share assuming dilution ("diluted EPS") was computed by reflecting potential
dilution from the exercise of stock options and warrants. Common equivalent
shares totaling 36,594,874 and 39,686,573 have been excluded from the
computation of diluted EPS for the three months ended March 31, 2004 and March
31, 2003, respectively.
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:
March 31, 2004 December 31, 2003
Raw materials $ 229,157 $ 20,416
Work in process 142,811 43,750
Finished goods 141,912 211,251
------------ -------------
Total Inventory $ 513,880 $ 275,417
============ =============
Note 8 - DEBT (Restated)
The debt consisted of following:
March 31, 2004 December 31, 2003
a Current portion of long term debt $ 27,826 $ 38,184
b Restructuring Agreement and
Original Secured Notes - 6,124,451
c Long-term capitalized lease obligations 32,923 36,257
-------------- ---------------
Total debt $ 60,749 $ 6,198,892
============== ===============
10
a) This amount includes (i) $12,655 due to Citicorp Leasing over the next 12
months in lease payments for equipment; and (ii) $15,171 due to IBM over the
next 12 months for leasehold improvements. The remaining balance under the
Citicorp lease is due in 2005.
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 100% 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. The listing of the shares issuable
pursuant to such agreement was approved by the American Stock Exchange on March
3, 2004. 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 are exercisable until
the later of (i) twelve (12) months from the date upon which a registration
statement covering the shares issuable upon exercise of the Warrants is declared
effective by the Securities and Exchange Commission, or (ii) December 31, 2005.
The remaining 1.0 million of the Warrants are exercisable until four (4) years
from the date upon which the registration statement covering such shares is
declared effective by the Securities and Exchange Commission. $3.18 million was
recorded in interest expense for the fair value estimate of these warrants.
c) This amount is due to Citicorp Leasing as long-term debt for lease payments
for equipment.
Note 9 - STOCKHOLDERS' EQUITY (Restated)
The authorized common stock of the Company consists of 200,000,000 shares with a
par value of $0.001 per share.
On January 9, 2004, we entered into a Securities Purchase Agreement with several
accredited institutional and private investors whereby such investors purchased
an aggregate of 3,333,364 shares of common stock for an aggregate purchase price
of $4,200,039. The Company also entered into a registration rights agreement
with the aforementioned investors with respect to the common stock issued and
common stock issuable upon the exercise of the warrants. The Company filed a
registration statement for the sales of these shares in February 2004.
The shares of common stock were priced at a 20% discount to the average closing
price of the stock from December 30, 2003 to January 6, 2004, which ranged from
$1.38 to $1.94 per share during the period for an average closing price of $1.26
per share. In addition, the investors received warrants to purchase an aggregate
of 2,000,019 shares of common stock (subject to anti-dilution adjustments)
exercisable at a price of $1.74 per share for a period of five (5) years. The
warrants were priced at a 10% premium to the average closing price of the stock
for the pricing period.
In connection with the private placement, eMagin also issued additional warrants
to the investors to acquire an aggregate of 2,312,193 shares of common stock.
1,206,914 of such warrants are exercisable, within 6 months from the effective
date of the registration statement covering these securities, at a price of
$1.74 per share (a 10% premium to the average closing price of the stock for the
pricing period), and 1,105,279 of such warrants are exercisable within 12 months
from the effective date of the registration statement covering these securities,
at a price of $1.90 per share (a 20% premium to the average closing price of the
stock for the pricing period).
11
In February 2004, the Company and all of the holders of the Secured Convertible
Notes (the "Notes"), which were due in November 2005, entered into an agreement
whereby the holders agreed to an early conversion of 100% of the principal
amount of the Notes aggregating $7.825 million, together with all of the accrued
interest of approximately $742,000 on the Notes, into 11,394,621 shares of
common stock of eMagin. The listing of the shares issuable pursuant to such
agreement was approved by the American Stock Exchange. 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 agreed to issue 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 are
exercisable until the later of (i) twelve (12) months from the date upon which a
registration statement covering the shares issuable upon exercise of the
Warrants is declared effective by the Securities and Exchange Commission, or
(ii) December 31, 2005. The remaining 1.0 million of the warrants are
exercisable until June 10, 2008. Using the Black Scholes method of valuing
warrants, an expense totaling $3.18 million was recorded in interest expense in
the first quarter of 2004 to record the estimated fair value of 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 12 month warrants and 1,460 for
the 4 year warrants.
In connection with the above conversion, eMagin also entered into a Registration
Rights Agreement with the holders of the Notes providing the holders with
certain registration rights under the Securities Act of 1933, as amended, with
respect to the common stock issuable upon exercise of the warrants.
In the first quarter of 2004, the Company received $2,073,400 for the exercise
of 5,089,134 options and 498,829 warrants.
The Company also issued 32,322 shares of common stock for the payment of $59,799
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, prepaid expenses and reduction of accounts payable in
the accompanying unaudited consolidated statement of operations for the three
months ended March 31, 2004.
Note 10 - STOCK COMPENSATION
As of March 31, 2004, the Company has outstanding options to purchase 7,902,924
shares.
In 2000 the Company issued options below fair market value. The Company recorded
$84,105 in the first quarter of 2004, in expense, for the amortization of those
options. The amount was recorded in Selling, General & Administrative.
Note 11 - COMMITMENTS AND CONTINGENCIES
[a] Royalty payments:
The Company, in accordance with a royalty agreement, is obligated to make
minimum annual royalty payments to a corporation commencing January 1, 2001. The
minimum annual royalty of $31,500 per year due under this agreement commences in
the first year of the agreement, and increases to minimum royalty payments of
$125,000 in 2006. Under this agreement, the Company must pay to the corporation
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 first quarter of 2004, $22,855 was recorded in royalty expense. In April
2004, the Company paid $125,000 for the minimum amount due for 2004. The amount
was recorded in prepaid expenses and will be amortized as the Company records
the royalty expense as defined in the agreement.
[b] Contractual obligations:
The Company leases certain office facilities and office, lab and factory
equipment under operating leases expiring through 2008. Certain leases provide
for payments of monthly operating expenses. The approximate future minimum lease
payments for 2004 are as follows:
Operating leases $ 234,242
Capital leases 29,523
----------
Total contractual obligations $ 263,765
==========
12
We currently lease space from IBM for $73,914 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 - SUBSEQUENT EVENTS
eMagin Corporation filed a shelf registration statement on Form S-3 with the
Securities and Exchange Commission (SEC). The shelf registration statement, when
declared effective by the SEC, will allow the company, from time to time, to
raise up to $50 million through the sale of securities, which may consist of
common stock, preferred stock and/or warrants, in one or more offerings in the
future. Specific terms and prices will be determined at the time of any offering
and included in a prospectus supplement to be filed with the SEC relating to
that offering.
A registration statement relating to the securities listed in the shelf
registration has been filed with the SEC, but has not yet become effective.
These securities may not be sold, nor may offers to buy such securities be
accepted, before the time that the registration statement becomes effective.
Note 13 - RELATED PARTY TRANSACTIONS
A family member of an outside director of eMagin participated in the Securities
Purchase Agreement in January's private placement in the amount of $90,000. The
family member received the same considerations as all other investors.
eMagin is party to a financial advisory and investment banking agreement with
Larkspur Capital Corporation. An outside director of emagin is a founder and
shareholder of Larkspur Capital Corporation. Larkspur Capital Corporation
received as compensation for financial advisory and investment banking services
in connection with the January 2004 private placement a cash fee of 6 3/4% of
the funds raised and warrants to purchase eMagin shares of common stock equal to
2.5% of the cash netted to eMagin. $283,503 and 43,651 common stock purchase
warrants exercisable at $2.41 per share which expire in January 2009, were paid
under the terms of the agreement.
In February 2004, the Company and all of the holders of the Secured Convertible
Notes (the "Notes"), which were due in November 2005, entered into an agreement
whereby the holders agreed to an early conversion of 100% of the principal
amount of the Notes.
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. Stillwater LLC, a limited liability company and
a beneficial owner of more than five percent of the outstanding shares of
eMagin's common stock, held an aggregate of $4 million of the notes converted.
Ginola Limited, a beneficial owner of more than five percent of the outstanding
shares of eMagin's common stock, held an aggregate of $1.3 million of the notes
converted.
An outside director of eMagin, held an aggregate of $0.25 million of the notes
converted.
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. federal 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 March 31, 2004, we had
recognized approximately $2.6 million from sales of our products, and have a
backlog of more than $27 million in products ordered for delivery through 2005.
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. We have
also shipped a limited number of prototypes of our eGlass II Head-wearable
Display systems. In addition to marketing OLED-on-silicon microdisplays as
components, we also offer microdisplays as an integrated package, which we call
Microviewer, that 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 market 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. Most
of our operating expenses are fixed in the near term. If we are unable to
generate significant revenues, our net losses in any given period could be
greater than expected.
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 MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
Revenues
Revenues for the three months ended March 31, 2004 were $0.5 million, as
compared to $0.5 million for the three months ended March 31, 2003.
15
Cost of Goods Sold. Cost of goods sold includes direct and indirect costs
associated with production. Cost of goods sold for the three months ended March
31, 2004 was $1.4 million, as compared to $1.1 million for the three months
ended March 31, 2003. Gross profit (loss) for the three months ended March 31,
2004 was ($0.8) million, as compared to ($0.7) million for the three months
ended March 31, 2003. This translates to a Gross Margin of (152%) and (147%) for
the three months ended March 31, 2004 and 2003, respectively.
We currently record all expenses associated with manufacturing in Cost of Goods
Sold. The full facility over head as well as the expense of non-capitalized raw
materials is matched against our units sold. While our production volume is low,
the Gross Margin reflects the costs that will be shared 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. Gross research and development expenses for the three months
ended March 31, 2004 was $8 thousand, as compared to $22 thousand for the three
months ended March 31, 2003. Our plans to ramp up our R&D department are
directly tied to our cash management and projections. We expect to begin
increasing this department when we have sufficient excess capital to fund these
expenses.
Amortization of Purchased Intangibles. Amortization of purchased intangibles
expense for the three months ending March 31, 2004 was $156 as compared to $0.3
million for the three months ended March 31, 2003. The decrease of $0.3 million
in these non-cash charges is the result of the purchased intangibles being fully
amortized as of March 31, 2003.
Non-cash Stock Based Compensation. Non-cash expenses related to stock-based
compensation amortization for the three months ended March 31, 2004 was $84
thousand, as compared to $111 thousand for the three months ending March 31,
2003. Non-cash stock-based compensation costs are the result of amortization of
the intrinsic value ascribed for the issuance of stock options at below fair
market values. The amortization is done over the vesting period of such options.
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, for the three months ended March 31, 2004
were $0.5 million, as compared to $1.0 million for the three months ended March
31, 2003. The $0.5 million decrease was due to a reduction in legal and
accounting fees.
Interest Expense. Interest expense for the three months ending March 31, 2004
was ($5.0) million as compared to ($0.3) million for the three months ended
March 31, 2003. The $4.7 million increase in interest expense was recorded in
conjunction with the early conversion of the $7.825 million in Notes. The
increase in interest expense for the three months ended March 31, 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.
Liquidity and Capital Resources
Current Financial Position
We have total liabilities and contractual obligations of $1,217,593 as of March
31, 2004. These contractual obligations, along with the dates on which such
payments are due, are described below:
16
One Year More than
Contractual Obligations Total or Less One Year
------------------------- ------------- --------------- -------------
Operating leases $ 1,145,202 $ 234,242 $ 910,960
Capital leases 72,391 29,523 42,868
------------- -------------- ------------
Total contractual obligations $ 1,217,593 $ 263,765 $953,828
============= ============== ============
We currently anticipate that we will continue to experience significant 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
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 May 13 was approximately
$4.5 million, additional financing, exercising of outstanding options and
warrants, and revenues generated by operations. We expect to continue to devote
substantial resources to manufacturing, marketing and selling our products.
We have received purchase agreements for approximately $27 million for our
products to be delivered now through early 2005. 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, 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 may require significant added effort.
We are in the early phases of production, although our past progress had been
impeded by our prior cash position. Anticipated increased shipments in the first
quarter were delayed, primarily due to our inability to purchase raw materials.
Based on the planned schedule, we have resolved our supplier issues and have
been able to produce quantities late in the first quarter of 2004. We expect our
second quarter revenue to begin to reflect this change.
Our cash requirements depend on numerous factors, including completion of our
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 yield and
throughput risk that could result in production delays.
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.
Risks Related To Our Financial Results
If we do not obtain additional cash to operate our business, we may not be able
to execute our business plan and may not achieve profitability.
In the event that cash flow from operations is less than anticipated and we
are unable to secure additional funding to cover these added losses, in order to
preserve cash, we would be required to further reduce expenditures and effect
further reductions in our corporate infrastructure, either of which could have a
material adverse effect on our ability to continue or increase our current level
of operations. To the extent that operating expenses increase or we need
additional funds to make acquisitions, develop new technologies or acquire
strategic assets, the need for additional funding may be accelerated and there
can be no assurances that any such additional funding can be obtained on terms
acceptable to us, if at all. If we are not able to generate sufficient capital,
either from operations or through additional financing, to fund our current
operations, we may not be able to continue as a going concern. If we are unable
to continue as a going concern, we may be forced to significantly reduce or
cease our current operations. This could significantly reduce the value of our
securities, which could result in our de-listing from the American Stock
Exchange and cause investment losses for our shareholders.
We may not be able to satisfy the American Stock Exchange's continued listing
requirements.
The AMEX staff notified us in June 2003 that we have 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. The failure to execute our plan and remain in
compliance with the AMEX equity requirement could result in a delisting of our
common stock.
We will be subject to periodic review by the AMEX staff during the
extension period. During this time, we must make progress consistent with the
terms of the plan or maintain compliance with the continued listing standards.
While we anticipate that, as a result of our recently completed financing in
January 2004 and the conversion of our outstanding promissory notes in March
2004, our balance sheet as of March 31, 2004 will reflect that we meet AMEX's $2
million shareholder equity requirement, there can be no assurance that AMEX will
waive this requirement prior to December 2004 or that we will be in compliance
with this requirement at December 2004. Other unidentified issues may arise 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.
Accumulated losses excluding non-cash transactions as of March 31, 2004,
were $41 million and acquisition related non-cash transactions were $102
million, which resulted in an accumulated net loss of $143 million, the majority
of which was related to the March 2000 merger and the subsequent write-down of
our 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
18
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.
The majority of our revenues to date have been derived from research and
development contracts with the U.S. government. We cannot continue to 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.
Risks related to the microdisplay industry
The commercial success of the microdisplay industry depends on the
widespread market acceptance of microdisplay systems products.
19
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 expect to provide the design
layouts to semiconductor contract manufacturers who will manufacture the
integrated circuits on silicon wafers. We also expect to 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 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 at high 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 of 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 to our
microdisplays without a second production facility in place. Interruptions in
our manufacturing could be caused by manufacturing equipment problems, the
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.
21
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 may 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. We are
currently recruiting a chief financial officer. 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.
22
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 or warranty 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 April 30, 2004, we have outstanding (i) options to
purchase 7,794,856 shares; and (ii) warrants to purchase 18,187,964 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 conversion of the debt to equity during the first quarter of
2004 should have been classified as a debt transaction and therefore an expense
should have been recorded in connection with the conversion. As set forth in
this report and in our quarterly report on Form 10-QSB/A for the period ended
March 31, 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
classify the conversion as a debt transaction and record an expense in
connection with the conversion. 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.
24
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
On January 9, 2004, we entered into a Securities Purchase Agreement with several
accredited institutional and private investors whereby such investors purchased
an aggregate of 3,333,364 shares of common stock for an aggregate purchase price
of $4,200,039. The Company also entered into a registration rights agreement
with the aforementioned investors with respect to the common stock issued and
common stock issuable upon the exercise of the warrants.
The shares of common stock were priced at a 20% discount to the average closing
price of the stock from December 30, 2003 to January 6, 2004, which ranged from
$1.38 to $1.94 per share during the period for an average closing price of $1.26
per share. In addition, the investors received warrants to purchase an aggregate
of 2,000,019 shares of common stock (subject to anti-dilution adjustments)
exercisable at a price of $1.74 per share for a period of five (5) years. The
warrants were priced at a 10% premium to the average closing price of the stock
for the pricing period.
In connection with the private placement, eMagin also issued additional warrants
to the investors to acquire an aggregate of 2,312,193 shares of common stock.
1,206,914 of such warrants are exercisable, within 6 months from the effective
date of the registration statement covering these securities, at a price of
$1.74 per share (a 10% premium to the average closing price of the stock for the
pricing period), and 1,105,279 of such warrants are exercisable within 12 months
from the effective date of the registration statement covering these securities,
at a price of $1.90 per share (a 20% premium to the average closing price of the
stock for the pricing period).
The Company received $4.2 million on the initial purchase of investments, with a
potential of another $3.5 million on the 5-year warrants. The additional 2.3
million warrants could potentially allow the company to receive an additional
$4.2 million. The Company intends to invest the proceeds in raw materials,
supplies and equipment to increase production as well as increasing the sales
and marketing of our products.
In February 2004, the Company and all of the holders of the Secured Convertible
Notes (the "Notes"), which were due in November 2005, entered into an agreement
whereby the holders agreed to an early conversion of 100% of the principal
amount of the Notes aggregating $7.825 million, together with all of the accrued
interest of approximately $742,000 on the Notes, into 11,394,621 shares of
common stock of eMagin. The listing of the shares issuable pursuant to such
agreement was approved by the American Stock Exchange.
In consideration of the Noteholders agreeing to the early conversion of the
Notes, eMagin has agreed to issue 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 are
exercisable until the later of (i) twelve (12) months from the date upon which a
registration statement covering the shares issuable upon exercise of the
Warrants is declared effective by the Securities and Exchange Commission, or
(ii) December 31, 2005. The remaining 1.0 million of the warrants are
exercisable until four (4) years from the date upon which the registration
25
statement covering such shares is declared effective by the Securities and
Exchange Commission.
In connection with the above conversion, eMagin also entered into a Registration
Rights Agreement with the holders of the Notes providing the holders with
certain registration rights under the Securities Act of 1933, as amended, with
respect to the common stock issuable upon exercise of the warrants.
No proceeds were initially received for this transaction, although the future
exercise of the warrants could potentially bring in $6.9 million from the
exercise of the 2,500,000 warrants that were issued.
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 three reports on form 8-K during the quarter ended March 31,
2004. Information regarding the items reported on is as follows:
DATE OF REPORT ITEM REPORTED ON
--------------- ----------------
January 9, 2004 eMagin and several accredited institutional investors
entered into a Securities Purchase Agreement whereby the
Investors agreed purchase an aggregate of $4.2 million in
exchange for an aggregate of 3.3 million shares of common
stock.
26
March 4, 2004 eMagin Corporation and the holders of its Secured
Convertible Notes entered into an agreement whereby the
holders agreed to an early conversion of 100% of the
principal amount of the Notes, together with all of the
accrued interest on the Notes.
March 24, 2004 eMagin Corporation held an earnings call on March 23, 2004
to discuss the preliminary 2003 year end results.
27
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
By: /S/ Gary W. Jones
---------------
Gary W. Jones
Chief Executive Officer
28