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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(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, 2002 or

[   ]

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from _________ to _________

Commission file number: 001-15069

Duraswitch Industries, Inc.
(Exact name of registrant as specified in its charter)

Nevada	88-0308867
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

234 S. Extension Road
Mesa, Arizona 85210
(Address of principal executive offices)

(480) 586-3300
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]    No [   ]

APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS

     Indicate by check mark whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 after the distribution of securities under a plan confirmed by a court.

Yes [   ]    No [   ]

APPLICABLE ONLY TO CORPORATE ISSUERS

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 9,534,195 shares of common stock outstanding as of November 7, 2002.

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

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DURASWITCH INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

	Three Months Ended September 30,								Nine Months Ended September 30,
	2002				2001				2002				2001
NET REVENUE:
Licensing	$	150,164			$	226,182			$	572,508			$	583,271
Product		—				2,499				24,675				104,204
Total net revenue		150,164				228,681				597,183				687,475
COST OF GOODS SOLD:
Licensing		9,248				25,324				66,494				69,912
Product		—				1,193				—				125,939
Total cost of goods sold		9,248				26,517				66,494				195,851
Gross profit		140,916				202,164				530,689				491,624
OPERATING EXPENSES:
Selling, general and administrative		627,933				830,389				2,192,491				2,513,336
Research and development		606,159				785,137				2,013,588				1,980,366
Total operating expenses		1,234,092				1,615,526				4,206,079				4,493,702
LOSS FROM OPERATIONS		(1,093,176	)			(1,413,362	)			(3,675,390	)			(4,002,078	)
OTHER INCOME — Net		32,251				121,060				125,306				483,380
NET LOSS	$	(1,060,925	)		$	(1,292,302	)		$	(3,550,084	)		$	(3,518,698	)
NET LOSS PER COMMON SHARE, BASIC AND DILUTED	$	(0.11	)		$	(0.14	)		$	(0.37	)		$	(0.37	)
WEIGHTED AVERAGE SHARES OUTSTANDING, BASIC AND DILUTED		9,534,195				9,526,302				9,531,880				9,414,568
See notes to consolidated financial statements.

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DURASWITCH INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

	Nine Months Ended September 30,
	2002				2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(3,550,084	)		$	(3,518,698	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		312,983				297,061
Loss (gain) on disposal of equipment		5,224				(5,904	)
Bad debt expense		11,000				—
Reserve for inventory obsolescence		35,000				—
Changes in operating assets and liabilities:
Accounts receivable		17,802				142,968
Inventory		(75,129	)			(79,772	)
Prepaid expenses and other current assets		(28,492	)			(90,425	)
Decrease in other assets		7,914				—
Accounts payable		(61,310	)			31,406
Accrued salaries and benefits		33,901				70,899
Other accrued expenses and other current liabilities		53,700				(42,971	)
Other non-current liabilities		(181,240	)			—
Deferred licensing revenue		(270,982	)			(292,346	)
Net cash used in operating activities		(3,689,713	)			(3,487,782	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in patents		(152,912	)			(231,385	)
Proceeds from repayment of advance to employee		—				40,000
Proceeds from sale of equipment		—				7,000
Purchases of property and equipment		(120,127	)			(348,410	)
Net cash used in investing activities		(273,039	)			(532,795	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sale of stock		31,849				1,172,362
Principal payments on capital leases		(13,365	)			(29,629	)
Net cash provided by financing activities		18,484				1,142,733
DECREASE IN CASH AND CASH EQUIVALENTS		(3,944,268	)			(2,877,844	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		12,016,430				16,445,564
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	8,072,162			$	13,567,720
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest	$	4,300			$	9,688
See notes to consolidated financial statements.

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DURASWITCH INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.  BASIS OF PRESENTATION

     The accompanying interim financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for interim reporting. Accounting policies utilized in the preparation of financial information herein presented are the same as set forth in our annual financial statements. Certain disclosures and information normally included in financial statements have been condensed or omitted. In the opinion of the management of Duraswitch Industries, Inc. (the “Company”), these financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the interim financial statements. Interim results of operations are not necessarily indicative of the results of operations for the full year.

2.  DEFERRED LICENSING REVENUE

     In April 2000, the Company entered into a license agreement with Delphi Corp. (“Delphi”) that gives Delphi the exclusive right to utilize and manufacture the Company’s patented switch technologies for the automotive industry. In connection with the license agreement, the Company also issued a warrant to Delphi to purchase 225,000 shares of common stock at $7.00 per share and a short-term option to purchase 1,651,846 shares of common stock at $7.00 per share. In exchange, Delphi paid the Company a nonrefundable payment of $4.0 million and agreed to pay a royalty fee for each switch sold by Delphi. The term of the exclusive license agreement is seven years. The agreement also requires Delphi to make minimum royalty payments totaling $12.0 million during the initial seven-year term ending June 30, 2007. Delphi can maintain exclusivity for the automotive industry through June 30, 2012 by making additional minimum annual royalty payments during that period. After June 30, 2012, either Delphi or the Company may convert the agreement to a nonexclusive agreement through 2020.

     The estimated fair value of the warrant and the option was $1,134,338, as determined using the Black-Scholes valuation model. The remaining value of the nonrefundable payment, totaling $2,865,662, was recorded as deferred revenue and is being amortized over the initial seven-year term of the exclusive license agreement.

     The current portion of deferred licensing revenue includes the revenue to be recognized in the next twelve months related to the Delphi nonrefundable payment and royalty prepayments by other licensees that have been deferred until such royalties are earned under the licensing agreements.

3.  INVENTORY

     The Company’s inventory is primarily comprised of licensed components and raw materials. The licensed components are sold to licensees and the raw materials are primarily used for research and development projects and marketing samples. The sale of licensed components and other materials to licensees is recognized as licensing revenue and the cost of the components and other materials sold to licensees are recorded as licensing cost of goods sold when the components and other materials are shipped to the licensee. Raw materials are primarily used to produce research and development pieces and marketing samples, which are expensed when used.

4.  NEW ACCOUNTING STANDARDS

     In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangibles . SFAS No. 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001, eliminates the pooling-of-interests method of accounting for business combinations, and identifies criteria for the establishment of identifiable intangible assets separate from goodwill resulting from a business combination. SFAS No. 142 requires companies to cease amortizing goodwill. SFAS No. 142 also establishes a new method of testing goodwill and other intangibles for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. The standard became effective for the Company beginning January 1, 2002. The adoption of these standards did not have a material effect on the Company’s financial position or results of operations. Total goodwill amortization for the three and nine months ended September 30, 2001 was $18,241 and $54,724, respectively. Accordingly, the net loss for the three and nine months ended September 30, 2001, assuming non-amortization of goodwill, would have been

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$1,274,061 and $3,463,974, respectively. Net loss per share, basic and diluted, would have been $0.13 and $0.37 for the three and nine months ended September 30, 2001, respectively.

     In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires that long-lived assets be measured at the lower of carrying amount or fair value for long-lived assets to be held and used or fair value less cost to sell for long-lived assets to be disposed of, whether reported in continuing operations or in discontinued operations. The standard became effective for the Company beginning January 1, 2002. The adoption of this standard did not have a material effect on the Company’s financial position or results of operations.

     In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The standard is effective for disposal activities that are initiated after December 31, 2002. The Company does not expect this standard will have a material effect on its financial position or results of operations.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

     This report of Duraswitch Industries, Inc. (the “Company”) 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. The words “believe,” “expect,” “anticipate,” “intend,” “estimate” and other expressions that are predictions of or indicate future events and trends and which do not relate to historical matters identify forward-looking statements.

     Some examples of forward-looking statements in this report include our estimation of our capital requirements, our ability to fund those requirements, the credit worthiness of our customers, the profit margins associated with our licensing business model, anticipated cost reductions and our estimation of interest rate and foreign currency risks. These forward-looking statements are not guarantees of performance and are inherently subject to risks and uncertainties, a number of which cannot be predicted or anticipated.

     Many factors could cause actual results to differ from those expressed in the forward-looking statements including: unexpected expenses such as the cost of protecting our intellectual property and increased sales and marketing expenses; fluctuations in revenue as a result of fluctuations in demand from our customers; and changes in the mix of licensing revenue between royalties on licensed components, royalties on switches manufactured using our technologies and the amortization of deferred revenue from our license agreement with Delphi Corp. (“Delphi”).

     Readers are cautioned not to place undue reliance on such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. There can be no assurance that the forward-looking statements contained in this document will, in fact, transpire or prove to be accurate. For a more detailed description of these and other cautionary factors that may affect our future results, please refer to the “Forward-Looking Statements” section of our Annual Report on Form 10-K for our fiscal year ended December 31, 2001 filed with the Securities and Exchange Commission.

Critical Accounting Policies

     In accordance with recent Securities and Exchange Commission guidance, the material accounting policies that we believe are the most critical to an investor’s understanding of our financial results and condition and require management’s judgment are discussed below. As a technology licensing company that also sells component parts, we believe our critical accounting policies are those that deal with our method of recognizing revenue and with the valuation of inventory, patents and goodwill.

     Revenue Recognition – We enter into licensing agreements with our customers. Our licensing strategy incorporates a simplified requirement whereby the licensee purchases licensed components from us. When the components are shipped, we recognize licensing revenue and licensing cost of goods sold. In some cases where no licensed components are supplied, we are paid a royalty per switch manufactured by the licensee.

     Some of our licensees have prepaid royalties to us pursuant to their license agreements. These prepayments are recorded as deferred revenue. This deferred revenue is recognized as licensing revenue when the royalty is earned under the licensing agreement. If a licensee purchases a licensed component from us, the royalty is earned when the licensed component is shipped. If the licensee is directly manufacturing our switches without purchasing licensed

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components from us, we consider the royalty earned when the switch is manufactured. In other cases, like our exclusive license agreement with Delphi, the up-front payment is nonrefundable and the portion of the $4.0 million payment allocated to deferred revenue is being amortized over the seven-year term of the agreement. (See Note 2 of the Notes to the Unaudited Consolidated Financial Statements.)

     Inventory Valuation – Our inventory is primarily comprised of licensed components which are sold to licensees and raw materials which are primarily used for research and development projects and manufacturing marketing samples. We state inventories at the lower of cost or market value, determined using the first-in, first-out method. Our policy is to write down our inventory for estimated obsolescence or unmarketable inventory to the extent the cost exceeds the estimated market value. We base the estimate on our assumptions about future demand and market conditions. If actual market conditions are less favorable than those assumed in our estimates, additional inventory write-downs might be required. Our policy is to reflect any write-down of inventory in the period in which the facts giving rise to the inventory write-down become known to us.

     Impairment or Disposal of Long-Lived Assets – We review our long-lived assets and identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Additionally, goodwill is reviewed on an annual basis. Our intangible assets are primarily our patents and the goodwill associated with the acquisition of Aztec Industries. If such assets were considered to be impaired, the impairment to be recognized would be measured by the amount by which the carrying amount of the assets exceeds the fair market value of the assets.

     We evaluate the recoverability of property and equipment and intangibles (excluding goodwill) not held for sale by comparing the carrying amount of the asset or group of assets against the estimated undiscounted future net cash flows expected to result from the use of the asset or group of assets. If the undiscounted estimated cash flows are less than the carrying value of the asset or group of assets being reviewed, an impairment loss would be recorded. The loss would be measured based on the estimated fair value of the asset or group of assets compared to carrying value. The estimated fair value would be based on the best information available under the circumstances, including prices for similar assets and the results of valuation techniques, including the present value of expected future cash flows using a discount rate commensurate with the risks involved.

     We evaluate goodwill for impairment by comparing the estimated fair value of the Company, which is the only reporting unit, with its carrying value, including goodwill. The estimated fair value is based on the best information available under the circumstances, including quoted market prices in stock markets, valuation techniques based on earnings, or independent valuations. If the fair value of the Company exceeds its carrying amount, goodwill is not considered to be impaired. If the carrying amount of the Company exceeds its fair value, the fair value of the goodwill is calculated, and the excess of the carrying value of the goodwill over its fair value is recorded as an impairment loss. To determine the fair value of the Company’s goodwill, the fair value of the Company is allocated to all of its assets and liabilities, and any excess of fair value of the Company over the fair value of its assets and liabilities is the estimated fair value of goodwill.

Results of Operations

     During 2000, we started to implement our new business model of licensing our technologies rather than manufacturing switches ourselves. We completed this transition in June 2001 and expect substantially all of our future revenues to come from our licensing efforts. As of September 30, 2002, we had 22 licensees, foreign and domestic. Because the revenue generated from licensing switch technologies is lower than the revenue from manufacturing the same number of switches, we expected our net revenue to decline during our transition to licensing. Concurrently, our gross profits increased because the cost of goods sold associated with licensing is much lower than with manufacturing.

Net Revenue:

     Net revenue was $150,164 and $228,681 for the three months ended September 30, 2002 and 2001, respectively, a decrease of $78,517 or 34%. Net revenue was $597,183 and $687,475 for the nine months ended September 30, 2002 and 2001, respectively, a decrease of $90,292 or 13%. The decrease for the three-month period resulted primarily from a 47% decrease in the unit sales of licensed components. For the nine months ended September 30, 2002, we experienced an increase of 98% in the unit sales of licensed components. This unit increase was offset by a decrease of 35% in per-switch royalties and residual revenue from the sale of products in the first three months of 2001. For the nine months ended September 30, 2002, the increase in the quantity of licensed components sold and the decrease in per-switch royalties resulted primarily from the sale of a large quantity of licensed components at a volume discount to one licensee. We anticipate that licensing revenue will fluctuate from period to period. It will be difficult to

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predict the timing and magnitude of such revenue because it is dependent on the licensees’ ability to market, produce and ship products that incorporate our technologies. We believe that the amount of licensing revenue for any period is not necessarily indicative of results for any future period.

     Licensing revenue was $150,164 and $226,182 for the three months ended September 30, 2002 and 2001, respectively, a decrease of $76,018 or 34%. Licensing revenue was $572,508 and $583,271 for the nine months ended September 30, 2002 and 2001, respectively, a decrease of $10,763 or 2%. Our licensing revenue is primarily comprised of per-switch royalties from licensees who manufacture switches incorporating our technologies, revenue from the sale of licensed components and recognition of revenue resulting from the amortization of deferred revenue from our license agreement with Delphi. For the three-month period ended September 30, 2002, the decrease in revenue was due primarily to a decrease in the volume of switches on which we earned royalties. For the nine-month period ending September 30, 2002, licensing revenue was impacted by an increase in the quantity of licensed components sold, which was offset by a decrease in the average per-switch royalty and a decrease in fees related to the review of customer designs. The primary reason for the decrease in design review fees was a reduction of the amount billed per design review. As contemplated in our license agreements, we have lowered these fees as our licensees have gained experience and become more proficient with Duraswitch technologies and to remove barrie