SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2004
Commission file number 0-11254
COPYTELE, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 11-2622630
- -------------------------------- ---------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification no.)
900 Walt Whitman Road
Melville, NY 11747
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(631) 549-5900
- -------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes __X__ No_____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes _____ No__X__
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
On May 24, 2004, the registrant had outstanding 83,736,028 shares of Common
Stock, par value $.01 per share, which is the registrant's only class of common
stock.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Condensed Balance Sheets as of April 30, 2004 (Unaudited) and
October 31, 2003 3
Condensed Statements of Operations (Unaudited) for the six months
ended April 30, 2004 and 2003 4
Condensed Statements of Operations (Unaudited) for the three months
ended April 30, 2004 and 2003 5
Condensed Statements of Cash Flows (Unaudited) for the six months
ended April 30, 2004 and 2003 6
Notes to Condensed Financial Statements (Unaudited) 7 - 13
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 14 - 26
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 26
Item 4. Controls and Procedures. 26
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K. 27
SIGNATURES 28
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
COPYTELE, INC.
CONDENSED BALANCE SHEETS
(Unaudited)
------------
April 30, October 31,
ASSETS 2004 2003
------ ------------ -------------
CURRENT ASSETS:
Cash and cash equivalents $ 1,243,279 $ 1,023,531
Accounts receivable, net of allowance for doubtful accounts of
$149,455 and $159,230, respectively 44,656 41,500
Other receivables 100,105 127,124
Inventories 1,064,184 1,044,875
Prepaid expenses and other current assets 23,283 47,972
------------ ------------
Total current assets 2,475,507 2,285,002
PROPERTY AND EQUIPMENT, net 34,863 39,480
OTHER ASSETS 5,509 6,009
------------ ------------
$ 2,515,879 $ 2,330,491
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 373,869 $ 316,865
Accrued liabilities 34,451 25,420
------------ ------------
Total current liabilities 408,320 342,285
SHAREHOLDERS' EQUITY:
Preferred stock, par value $100 per share; 500,000 shares authorized;
no shares issued or outstanding -- --
Common stock, par value $.01 per share; 240,000,000 shares
authorized; 83,609,478 and 80,151,478 shares issued
and outstanding, respectively 836,095 801,515
Additional paid-in capital 67,871,424 66,282,397
Accumulated deficit (66,599,960) (65,095,706)
------------ ------------
2,107,559 1,988,206
------------ ------------
$ 2,515,879 $ 2,330,491
============ ============
The accompanying notes are an integral part of these condensed balance sheets.
3
COPYTELE, INC.
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
For the Six Months Ended
April 30,
----------------------------
2004 2003
------------ ------------
REVENUE $ 140,804 $ 113,082
COST OF REVENUE 46,298 77,685
------------ ------------
Gross profit 94,506 35,397
------------ ------------
OPERATING EXPENSES
Research and development expenses 991,179 894,747
Selling, general and administrative expenses 609,549 917,838
------------ ------------
Total operating expenses 1,600,728 1,812,585
------------ ------------
LOSS FROM OPERATIONS (1,506,222) (1,777,188)
INTEREST INCOME 1,968 2,568
------------ ------------
NET LOSS $ (1,504,254) $ (1,774,620)
============ ============
PER SHARE INFORMATION:
Net loss per share:
Basic and Diluted $ (0.02) $ (0.02)
============ ============
Shares used in computing net loss per share:
Basic and Diluted 81,382,989 72,213,599
============ ============
The accompanying notes are an integral part of these condensed statements.
4
COPYTELE, INC.
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
For the Three Months Ended
April 30,
----------------------------
2004 2003
------------ ------------
REVENUE $ 101,804 $ 21,743
COST OF REVENUE 31,699 15,660
------------ ------------
Gross profit 70,105 6,083
------------ ------------
OPERATING EXPENSES
Research and development expenses 506,636 403,120
Selling, general and administrative expenses 259,388 573,886
------------ ------------
Total operating expenses 766,024 977,006
------------ ------------
LOSS FROM OPERATIONS (695,919) (907,923)
INTEREST INCOME 1,019 899
------------ ------------
NET LOSS $ (694,900) $ (970,024)
============ ============
PER SHARE INFORMATION:
Net loss per share:
Basic and Diluted $ (0.01) $ (0.01)
============ ============
Shares used in computing net loss per share:
Basic and Diluted 82,167,680 73,417,701
============ ============
The accompanying notes are an integral part of these condensed statements.
5
COPYTELE, INC.
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Six Months Ended
April 30,
--------------------------
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Payments to suppliers, employees and consultants $ (646,345) $ (631,616)
Cash received from customers 211,609 92,306
Interest received 1,968 2,568
----------- -----------
Net cash used in operating activities (432,768) (536,742)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for purchases of property and equipment (6,074) --
----------- -----------
Net cash used in investing activities (6,074) --
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options, net of registration costs 658,590 89,714
----------- -----------
Net cash provided by financing activities 658,590 89,714
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 219,748 (447,028)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,023,531 854,822
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,243,279 $ 407,794
=========== ===========
RECONCILIATION OF NET LOSS TO NET CASH USED IN OPERATING ACTIVITIES:
Net loss $(1,504,254) $(1,774,620)
Stock option compensation to consultants 17,136 --
Stock awards granted to employees and consultants pursuant to stock
incentive plans 947,881 772,205
Provision for (recovery of) bad debts (52,772) 206,622
Depreciation and amortization 10,691 18,927
Change in operating assets and liabilities:
Accounts receivable and other receivables 76,635 (20,776)
Inventories (19,309) 264,047
Prepaid expenses and other current assets 24,689 (10,484)
Other assets 500 145
Accounts payable and accrued liabilities 66,035 7,192
----------- -----------
Net cash used in operating activities $ (432,768) $ (536,742)
=========== ===========
The accompanying notes are an integral part of these condensed statements.
6
COPYTELE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. NATURE AND DEVELOPMENT OF BUSINESS AND FUNDING
----------------------------------------------
Organization and Basis of Presentation
- --------------------------------------
CopyTele, Inc. was incorporated on November 5, 1982. Our principal
operations include the development, production and marketing of thin, high
brightness, flat panel video displays and the development, production and
marketing of multi-functional encryption products that provide information
security for domestic and international users over virtually every
communications media.
The condensed financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
("US GAAP") for interim financial reporting. Accordingly, they do not include
all of the information and footnotes required by US GAAP for complete financial
statements. The information contained herein is for the six-month and
three-month periods ended April 30, 2004 and 2003. In management's opinion, all
adjustments (consisting only of normal recurring adjustments considered
necessary for a fair presentation of the results of operations for such periods)
have been included herein.
The results of operations for interim periods may not necessarily
reflect the results of operations for a full year. Reference is made to the
audited financial statements and notes thereto included in our Annual Report on
Form 10-K for the fiscal year ended October 31, 2003, for more extensive
disclosures than contained in these condensed financial statements.
Products and Key Relationships
- ------------------------------
Our line of hardware-based encryption products presently includes the
USS-900, the DCS-1200, the DCS-1400, the STS-1500 and the ULP-1. These
encryption products are multi-functional, hardware based digital encryption
systems that provide high-grade voice, fax and data encryption using either the
Citadel(TM) CCX encryption cryptographic chip (which is manufactured by the
Harris Corporation) or the Triple DES or AES algorithm (algorithms available in
the public domain which are used by many U.S. government agencies). In addition,
we have developed the USS-900 Security Software, a software security product for
the encryption of data files and e-mail attachments in both desktop and laptop
computers utilizing Microsoft Windows operating systems, using either the Triple
DES or the AES algorithm. We have also developed the DCS-1800 Security Software
to encrypt voice and data in cellular and satellite phones, scanners, and
printers. Furthermore, we have developed modifications of our standard equipment
for specific applications and are producing the USS-900T to provide automatic
fax security and the USS-900TD to provide voice and fax security over the
Thuraya satellite network, built by Boeing Satellite Systems, Inc. ("Boeing). We
have also developed and are producing the DCS-1400D which is combined with the
Thuraya handset to provide
7
voice security over the Thuraya satellite network. We are continuing our
research and development activities for additional encryption products. We sell
our encryption products through a distributor/dealer network and to end-users.
In April 2004, we entered into an agreement with Boeing, allowing
Boeing to provide our encryption products for use over the Thuraya satellite
communications network. Boeing will use the USS-900 for fax and/or voice
encryption, and the DCS-1200 and DCS-1400 for voice encryption. Boeing will sell
these units for use with its Thuraya handsets throughout the Thuraya satellite
network. Our encryption technology has been integrated directly into this phone
system. Our products enable the Thuraya satellite network to provide encrypted
communications between satellite phones, from satellite phones to desk-based
phones or between desk-based phones. We are supplying Boeing our USS-900,
USS-900T, USS-900TD, DCS-1200, DCS-1400, DCS-1400D products in connection with
our agreement.
We have provided our hardware and software encryption solutions to
several other large organizations which are evaluating our solutions in
connection with their security requirements. Our USS-900 has recently been
selected by a major U.S. company to secure its worldwide fax communications.
We are also continuing our research and development activities with
respect to flat panel display technologies, including our thin flat high
brightness video displays. We have developed, in conjunction with Volga Svet
Ltd. ("Volga"), several engineering models of high-brightness, monochrome video
displays, including a 3.7-inch (diagonal) display having 160 x 80 pixels, a
5-inch (diagonal) display having 320 x 240 pixels, and a 3.5-inch (diagonal)
display having 320 x 160 pixels, and we believe that smaller and larger displays
can be made with our technology. We have been demonstrating our displays to a
number of companies involving applications where we believe our displays have
performance advantages over LCDs. These applications include use in outdoor
products which operate over wide air temperature ranges, require wide viewing
angles, and must operate under high and low light ambient conditions. We have
received an initial order for a seed quantity of our display modules to replace
LCDs in an existing product which displays operating instructions and operates
in an outdoor environment. Based on this requirement and the interest of several
potential purchasers, together with Volga, we have started to produce monochrome
versions of our high brightness displays using Volga's current production
facilities. The initial display modules we are producing are fulfilling the seed
order and, based on this, we have made modifications to the display modules to
meet customer requirements.
We have recently received from the U.S. patent office patents for four
variations of our video display technology and a notice of allowance of the
claims contained in our patent application for one other variation of our video
display technology.
Funding and Management's Plans
- ------------------------------
From our inception through June 2001, we had met our liquidity and
capital expenditure needs primarily through the proceeds from sales of common
stock in our initial public offering, in private placements, upon exercise of
warrants issued in connection with the private placements and
8
public offering, and upon the exercise of stock options. Commencing in the
fourth quarter of fiscal 1999, we began to generate cash flows from sales of our
products, and, from June 2001 to January 2002, we received development payments
from Futaba Corporation of Japan.
During the six months ended April 30, 2004, our operating activities
used approximately $433,000 in cash. This resulted from payments to suppliers,
employees and consultants of approximately $646,000, which was offset by cash of
approximately $212,000 received from collections of accounts receivable and
other receivables related to sales of encryption products and services and
approximately $2,000 of interest income received. In addition, we received
approximately $659,000 in cash upon the exercise of stock options and purchased
approximately $6,000 of equipment. As a result, our cash and cash equivalents at
April 30, 2004 increased to approximately $1,243,000 from approximately
$1,024,000 at the end of fiscal 2003.
The auditor's report on our financial statements as of October 31, 2003
states that the net loss incurred during the year ended October 31, 2003, our
accumulated deficit as of that date, and the other factors described in Note 1
to the Financial Statements included in our Annual Report on Form 10-K for the
year ended October 31, 2003, raise substantial doubt about our ability to
continue as a going concern. The auditor's report on our financial statements
for the year ended October 31, 2002 contained a similar statement. Our financial
statements have been prepared assuming we will continue as a going concern and
do not include any adjustments that might result from the outcome of this
uncertainty.
Based on reductions in operating expenses that have been made and
additional reductions that may be implemented, if necessary, we believe that our
existing cash and accounts receivable, together with cash flows from expected
sales of encryption products and flat panel displays, and other potential
sources of cash flows, will be sufficient to enable us to continue in operation
until at least the end of the second quarter of fiscal 2005. However, our
projections of future cash needs and cash flows may differ from actual results.
We are seeking to improve our liquidity through increased sales or license of
products and technology and may also seek to improve our liquidity through sales
of debt or equity securities. We currently have no arrangements with respect to
additional financing. There can be no assurance that we will generate
significant revenues in the future (through sales or otherwise) to improve our
liquidity, that we will generate sufficient revenues to sustain future
operations and/or profitability, that we will be able to expand our current
distributor/dealer network, that production capabilities will be adequate, that
other products will not be produced by other companies that will render our
products obsolete, or that other sources of funding would be available, if
needed, at terms that we would deem favorable.
2. Stock-Based Compensation
- ---------------------------
In December 2002, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure", which addresses
financial accounting and reporting for recording expenses for the fair value of
stock options. SFAS 148 provides alternative methods of transition for a
voluntary change to fair value based method of accounting for stock-based
employee compensation. Additionally, SFAS 148 requires more prominent and more
frequent disclosures in
9
financial statements about the effects of stock-based compensation. The adoption
of SFAS No. 148 disclosure requirements, effective February 1, 2003, had no
effect on our financial position or results of operations. SFAS No. 123
"Accounting for Stock Based Compensation" encourages but does not require
companies to record compensation cost for stock-based employee compensation
plans at fair value. We account for stock options granted to employees using the
intrinsic value method prescribed in APB Opinion No. 25 "Accounting for Stock
Issued to Employees" and comply with the disclosure provisions of SFAS No. 123
and SFAS No. 148. Compensation cost for stock options is measured as the excess,
if any, of the quoted market price of our stock at the date of grant over the
amount an employee must pay to acquire the stock. In accordance with APB Opinion
No. 25, we have not recognized any compensation cost, as all option grants to
employees have been made at the fair market value of our stock on the date of
grant.
Had compensation cost for stock options granted to employees been
determined at fair value, consistent with SFAS No. 123, our net loss and net
loss per share would have increased to the following adjusted amounts:
For the Six Months Ended For the Three Months Ended
April 30, April 30,
-------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ---------- ---------
Net loss as reported $(1,504,254) $(1,774,620) $(694,900) $(970,024)
Add: Total stock-based employee
compensation expense, determined
under fair value based method, for
all awards, net of related tax effect (362,043) (5,955) (177,920) (3,081)
----------- ----------- --------- ---------
Net loss as adjusted $(1,866,297) $(1,780,575) $(872,820) $(973,105)
=========== =========== ========= =========
Net loss per share, basic and diluted:
As reported $ (0.02) $ (0.02) $ (0.01) $ (0.01)
=========== =========== ========= =========
As adjusted $ (0.02) $ (0.02) $ (0.01) $ (0.01)
=========== =========== ========= =========
During the six-month periods ended April 30, 2004 and 2003, we granted
to employees and consultants options to purchase 1,320,000 shares and 460,000
shares, respectively, pursuant to the CopyTele, Inc. 2000 Share Incentive Plan
(the "2000 Share Plan") and the Copytele, Inc. 2003 Share Incentive Plan (the
"2003 Share Plan"). We account for options granted to non-employee consultants
using the fair value method required by SFAS No. 123. Compensation expense for
consultants, recognized during the six-month and three-month periods ended April
30, 2004, was each approximately $17,000. We recognized no such compensation
expense for consultants during the six-month period ended April 30, 2003.
Options granted during the six-month period ended April 30, 2004 included
options to purchase 500,000 shares and 150,000 shares granted to Denis A.
Krusos, our Chairman of the Board and Chief Executive Officer, and Frank J.
DiSanto, our President, respectively. In addition, during the period from May 1,
2004 through May 24, 2004, we granted options to purchase 250,000 shares,
100,000 shares, 60,000 shares, 60,000 shares, and 50,000 shares, to Mr. Krusos,
Mr. DiSanto, Anthony Bowers, a director, George P. Larounis, a director, and
Henry P. Herms, our Vice President - Finance and Chief Financial Officer,
respectively. During the six-month periods ended April 30, 2004 and 2003, stock
options to
10
purchase 1,438,500 shares and 440,000 shares, respectively, were exercised, with
aggregate proceeds of approximately $659,000 and $99,000, respectively.
During the six-month periods ended April 30, 2004 and 2003, we issued
1,498,665 shares and 2,761,175 shares, respectively, of common stock to certain
employees for services rendered, principally in lieu of cash compensation,
pursuant to the 2000 Share Plan and the 2003 Share Plan, which includes 135,000
shares issued to Mr. Krusos during the six-month period ended April 30, 2004. We
recorded compensation costs of approximately $712,000 and $575,000 for the
six-month periods ended April 30, 2004 and 2003, respectively, for the shares of
common stock issued to employees. In addition, during the six-month periods
ended April 30, 2004 and 2003, we issued 520,835 shares and 991,777 shares,
respectively, of common stock to consultants for services rendered pursuant to
the 2000 Share Plan and the 2003 Share Plan. We recorded consulting expense of
approximately $236,000 and $198,000 for the six-month periods ended April 30,
2004 and 2003, respectively, for the shares of common stock issued to
consultants.
As of April 30, 2004, 2,548 shares and 3,095,629 shares, respectively,
were available for future grants under the 2000 Share Plan and the 2003 Share
Plan.
3. OTHER RECEIVABLES
In May and June 2002, we received restricted common stock from a
customer in connection with an outstanding accounts receivable of approximately
$323,000 and anticipated settling this accounts receivable through the ultimate
sale of the restricted common stock. This customer has agreed with us to cure
any deficiency between the proceeds from the sale of the restricted common stock
and the balance of the outstanding accounts receivable. In addition, the
customer's principal shareholder has personally agreed to cure any deficiency in
the event that the customer defaults on its agreement to cure such deficiency,
up to $292,000. As of April 30, 2004, we received aggregate proceeds of
approximately $88,000 from the sale of a portion of the restricted common stock
and we intend to sell the remaining portion of such stock during fiscal 2004.
This receivable is stated at management's estimate of its net realizable value.
4. INVENTORIES
Inventories consist of the following as of:
April 30, October 31
2004 2003
---------- ----------
Component parts $ 354,477 $ 341,344
Work-in-process 82,452 48,324
Finished products 627,255 655,207
---------- ----------
$1,064,184 $1,044,875
========== ==========
5. NET INCOME (LOSS) PER SHARE OF COMMON STOCK
-------------------------------------------
We comply with the provisions of SFAS No. 128, "Earnings Per Share." In
accordance with SFAS No. 128, basic net income (loss) per common share ("Basic
EPS") is computed by dividing net income (loss) by the weighted average number
of common shares outstanding. Diluted net
11
income (loss) per common share ("Diluted EPS") is computed by dividing net
income (loss) by the weighted average number of common shares and dilutive
common share equivalents and convertible securities then outstanding. Diluted
EPS for all periods presented is the same as Basic EPS, as the inclusion of the
effect of common stock equivalents then outstanding would be anti-dilutive. For
this reason, excluded from the calculation of Diluted EPS for the six-month and
three-month periods ended April 30, 2004 and 2003 were options to purchase
14,879,546 shares and 14,004,746 shares, respectively.
6. SEGMENT INFORMATION
-------------------
We follow the provisions of SFAS No. 131,"Disclosures about Segments of
an Enterprise and Related Information." Reportable operating segments are
determined based on management`s approach. The management approach, as defined
by SFAS No. 131, is based on the way that the chief operating decision-maker
organizes the segments within an enterprise for making operating decisions and
assessing performance. While our results of operations are primarily reviewed on
a consolidated basis, the chief operating decision-maker also manages the
enterprise in two segments: (i) Flat-panel display and (ii) Encryption products
and services.
The following represents selected financial information for our
segments for the six-month and three-month periods ended April 30, 2004 and
2003:
Encryption Products
Segment Data Flat-Panel Display and Services Total
- ------------------------------------------- --------------------- ---------------------- ---------------------
Six Months Ended April 30, 2004:
Revenue $ -- $ 140,840 $ 140,804
Net loss (737,345) (766,909) (1,504,254)
Six Months Ended April 30, 2003:
Revenue $ -- $ 113,082 $ 113,082
Net loss (788,798) (985,822) (1,774,620)
Encryption Products
Segment Data Flat-Panel Display and Services Total
- ------------------------------------------- --------------------- ---------------------- ---------------------
Three Months Ended April 30, 2004:
Revenue $ -- $ 101,804 $ 101,804
Net loss (299,277) (395,623) (694,900)
Three Months Ended April 30, 2003:
Revenue $ -- $ 21,743 $ 21,743
Net loss (425,323) (544,701) (970,024)
12
7. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
------------------------------------------
In December 2003, the Security and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition", which
codifies, revises and rescinds certain sections of SAB No. 101, "Revenue
Recognition", in order to make this interpretive guidance consistent with
current authoritative accounting and auditing guidance and SEC rules and
regulations. The issuance of SAB No. 104 did not have a material effect on our
financial position or results of operations.
13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
-------------------------------------------------
Forward-Looking Statements
- --------------------------
Information included in this Quarterly Report on Form 10-Q may contain
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are not statements of
historical facts, but rather reflect our current expectations concerning future
events and results. We generally use the words "believes," "expects," "intends,"
"plans," "anticipates," "likely," "will" and similar expressions to identify
forward-looking statements. Such forward-looking statements, including those
concerning our expectations, involve risks, uncertainties and other factors,
some of which are beyond our control, which may cause our actual results,
performance or achievements, or industry results, to be materially different
from any future results, performance, or achievements expressed or implied by
such forward-looking statements. These risks, uncertainties and factors include,
but are not limited to, those factors set forth in "General Risks and
Uncertainties" below and Note 1 to Condensed Financial Statements. You should
read the following discussion and analysis along with our Annual Report on Form
10-K for the year ended October 31, 2003 and the condensed financial statements
included in this Report. We undertake no obligation to publicly update or revise
any forward-looking statements, whether as a result of new information, future
events or otherwise. You are cautioned not to unduly rely on such
forward-looking statements when evaluating the information presented in this
Report.
GENERAL
- -------
Our principal operations include the development, production and
marketing of thin, high-brightness, flat panel video displays and the
development, production and marketing of multi-functional encryption products
that provide information security for domestic and international users over
virtually every communications media.
Our line of hardware-based encryption products presently includes the
USS-900, the DCS-1200, the DCS-1400, the STS-1500 and the ULP-1. These
encryption products are multi-functional, hardware based digital encryption
systems that provide high-grade voice, fax and data encryption using either the
Citadel(TM) CCX encryption cryptographic chip (which is manufactured by the
Harris Corporation) or the Triple DES or AES algorithm (algorithms available in
the public domain which are used by many U.S. government agencies). In addition,
we have developed the USS-900 Security Software, a software security product for
the encryption of data files and e-mail attachments in both desktop and laptop
computers utilizing Microsoft Windows operating systems, using either the Triple
DES or the AES algorithm. We have also developed the DCS-1800 Security Software
to encrypt voice and data in cellular and satellite phones, scanners, and
printers. Furthermore, we have developed modifications of our standard equipment
for specific applications and are producing the USS-900T to provide automatic
fax security and the USS-900TD to provide voice and fax security over the
Thuraya satellite network, built by Boeing Satellite Systems, Inc. ("Boeing").
We have also developed and are producing the DCS-1400D which is combined with
the Thuraya handset to provide voice security over
14
the Thuraya satellite network. We are continuing our research and development
activities for additional encryption products.
We are currently using several U.S.-based electronic production
contractors to produce the components for our encryption devices. We sell our
encryption products through a distributor/dealer network and to end-users.
In April 2004, we entered into an agreement with Boeing, allowing
Boeing to provide our encryption products for use over the Thuraya satellite
communications network. Boeing will use the USS-900 for fax and/or voice
encryption, and the DCS-1200 and DCS-1400 for voice encryption. Boeing will sell
these units for use with its Thuraya handsets throughout the Thuraya satellite
network. Our encryption technology has been integrated directly into this phone
system. Our products enable the Thuraya satellite network to provide encrypted
communications between satellite phones, from satellite phones to desk-based
phones or between desk-based phones. The use of encryption is expected to
benefit Thuraya satellite telecommunications customers that Boeing is currently
serving in Iraq under a recently awarded contract. Boeing is providing mobile
satellite services to the Coalition Provisional Authority, to officials in
Baghdad's 18 governing ministries, to U.S. military forces and to other U.S.
personnel in Iraq. We are supplying Boeing our USS-900, USS-900T, USS-900TD,
DCS-1200, DCS-1400, DCS-1400D products in connection with our agreement.
We have provided our hardware and software encryption solutions to
several other large organizations which are evaluating our solutions in
connection with their security requirements. Our USS-900 has recently been
selected by a major U.S. company to secure its worldwide fax communications. In
addition, we have received orders from other U.S. companies that principally
supply U.S. government agencies and foreign governments, to provide our USS-900,
DCS-1200, and DCS-1400 to encrypt voice, fax, and data over satellite
communication systems. Such companies placed their orders after an extended
evaluation of our products' performance using the Iridium, Globalstar, Immarset,
Immarset M-4, Mini M and Thuraya satellite communication networks. We believe
that encrypting information over satellite networks is in the early stages and
expect this field to be an expanding opportunity for our encryption products due
to the rising demand for information security over many regions of the world.
We have made significant advancements to develop and produce our thin
film video flat panel displays utilizing our electronic emission technology.
With Volga Svet Ltd. ("Volga"), a Russian display company that we have been
working with for more than six years, we have developed several engineering
models of high-brightness, monochrome video displays, including a 3.7-inch
(diagonal) display having 160 x 80 pixels, a 5-inch (diagonal) display having
320 x 240 pixels, and a 3.5-inch (diagonal) display having 320 x 160 pixels. We
are providing funding to Volga for this work; these development payments to
Volga are included in research and development expenses in the accompanying
condensed financial statements. Volga has agreed to produce an initial quantity
of these displays for commercial sales on a fixed price basis. We anticipate
that Volga may in the future produce additional quantities of displays for
commercial sales also on a fixed price basis, but we have not entered into any
agreements with Volga for such future production.
15
Currently, liquid crystal displays ("LCDs") are the most commonly used
flat panel displays in commercial products. We believe that our display has the
following advantages over LCD displays:
o No backlight (LCDs require a backlight that results in high power
consumption and contains mercury)
o No thermistor (LCDs require thermistors to control operation at
various temperatures)
o No polarizer (required in LCDs)
o No color filter (required in color LCDs)
o Almost hemispherical viewing angle (LCDs have limited viewing angles)
o Higher contrast ratio
o Faster video response time
o Operates in a wider range of air temperatures
o Longer life
o Not affected by ultraviolet light (LCDs contain a liquid crystal which
may deteriorate after long exposure to direct sunlight)
o Safer (leakage of liquid crystal from LCDs may be dangerous)
We are initially pursuing applications for our display that we believe
will demonstrate these performance advantages. In particular, we have been
demonstrating our displays to a number of companies for use in outdoor products
made by them that operate over wide air temperature ranges and under high and
low light ambient conditions, and that require wide viewing angles.
We provided our display to a company to evaluate the display's
performance in a product produced by the company that operates over a wide air
temperature range in an outdoor environment. After successfully testing our
display, that company recently issued to us a purchase order for a seed quantity
of modules containing our display, to replace LCD modules in the company's
product. Another company has evaluated our display for a product the company is
developing in the field of emergency communication, and we are modifying our
display in response to the requirements of such product. Based on these
developments, we have, together with Volga, started to produce our 5-inch
(diagonal) high-brightness displays using Volga's current production facility.
The initial display modules we are producing are fulfilling the seed order and,
based on this, we have made modifications to the display modules to meet
customer requirements.
16
In addition, we are pursuing other opportunities by demonstrating our
displays to companies having large quantity display applications, and we are in
the process of responding to their requests for pricing based on their display
specifications and quantity requirements. These companies' applications would
require large quantities of displays to be located in retail stores, airports,
vending machines and automobiles. For automobiles, the displays would be
required to have the capability to provide wide-screen or standard TV formats
for digital TV and DVD operation. To prepare for these potential opportunities,
we are working with several Asian companies to supplement Volga's production and
to produce larger size color displays.
We also are developing modifications to our display technology to
incorporate the matrix structure and drivers of LCDs into our display so that
our display may be produced more easily by facilities currently producing LCDs.
We have been working with an LCD manufacturing company, located in Asia, to
incorporate its LCD technology as part of our display. We have received samples
of that company's color LCDs which incorporate TFT (thin film technology) and
LCD driver technology, and we have performed tests and simulations to determine
the modifications necessary to that technology to meet to our display
requirements. We are in the process of finalizing a design for up to a 7-inch
(diagonal) color display with 1,440 x 234 pixels. The design is expected to
operate using low voltages and contain color phosphors in each pixel. The design
is also contemplated to use our electron emission technology to activate the
phosphors. We anticipate that the display will be compatible with both
wide-screen and standard TV formats for digital TV and DVD operation. We believe
that this will enable us to be able to produce displays which could meet the
requirements of several companies' large quantity applications. There can be no
assurance that we can develop or produce color video displays or displays using
modified TFT technology or that we can produce larger display sizes or greater
quantities using such technology.
We have recently received from the U.S. patent office patents for four
variations of our video display technology and a notice of allowance of the
claims contained in our patent application for one other variation of our video
display technology. We are continuing to apply for additional patents for our
video display technology.
There can be no assurance that we can produce commercial quality
displays, that we can produce such displays in commercial quantities, that we
can successfully market our displays, or of the revenue we might derive from
sales of our displays.
CRITICAL ACCOUNTING POLICES
- ---------------------------
Our financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America. As such, we are
required to make certain estimates, judgments and assumptions that management
believes are reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenue and expenses during the reporting
periods.
17
We believe the following critical accounting polices affect the more
significant judgments and estimates used in the preparation of our financial
statements. For additional discussion on the application of these and other
accounting polices, refer to the financial statements and notes thereto included
in our Annual Report on Form 10-K for the year ended October 31, 2003.
REVENUE RECOGNITION
- -------------------
Sales
-----
Revenues from sales are recorded when all four of the
following criteria are met: (i) persuasive evidence of an arrangement
exists; (ii) delivery has occurred and title has transferred or
services have been rendered; (iii) our price to the buyer is fixed or
determinable; and (iv) collectibility is reasonably assured.
Sales Returns and Allowances
----------------------------
Revenues are recorded net of estimated sales returns.
INVENTORIES
- -----------
Inventories are stated at the lower of cost, including material, labor
and overhead, determined on a first-in, first-out basis, or market, which
represents our best estimate of market value. We regularly review inventory
quantities on hand, particularly finished goods, and record a provision for
excess and obsolete inventory based primarily on forecasts of future product
demand. Our net income (loss) is directly affected by management's estimate of
the realizability of inventories. To date, sales of our products have been
limited. Accordingly, there can be no assurance that we will not be required to
reduce the selling price of our inventory below our current carrying value.
STOCK BASED COMPENSATION
- ------------------------
We account for stock options granted to employees using the intrinsic
value method prescribed in APB Opinion No. 25 "Accounting for Stock Issued to
Employees" and comply with the disclosure provision of SFAS No. 123 "Accounting
for Stock Based Compensation" and SFAS No. 148 "Accounting for Stock Based
Compensation - Transition and Disclosure, an amendment of SFAS No. 123". If we
were to include the cost of employee stock option compensation in the financial
statements, our net loss for the six-month and three-month periods ended April
30, 2004 and 2003 would have increased by approximately $362,000, $6,000,
$178,000 and $3,000, respectively, based on the fair value of the stock options
granted to employees.
18
RESULTS OF OPERATIONS
- ---------------------
Six months ended April 30, 2004 compared with six months ended April 30, 2003
- -----------------------------------------------------------------------------
SALES
-----
Revenue. Revenue from sales increased by approximately $28,000 in the
six-month period ended April 30, 2004, to approximately $141,000, as compared to
approximately $113,000 in the comparable prior-year period. All revenue during
both periods was from encryption products and services. The increase in revenue
was principally due to an increase in unit sales of our encryption products. Our
encryption sales have been limited and are sensitive to individual large
transactions. We believe that changes in revenue between periods generally
represent the nature of the early stage of our product and sales channel
development.
Gross Profit. Gross profit from sales of encryption products and
services increased by approximately $59,000 in the six-month period ended April
30, 2004, to approximately $95,000, as compared to approximately $35,000 in the
comparable prior-year period. The increase in gross profit was due to the
increase in revenue and to higher gross profit percentages on certain
transactions as compared to the prior-year period. Gross profit as a percent of
revenue increased to approximately 67% in the six-month period ended April 30,
2004, as compared to approximately 31% in the comparable prior-year period.
Because of the limited number of transactions during each of the periods, gross
profit percentages are sensitive to individual transactions.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased by approximately $96,000 in
the six-month period ended April 30, 2004, to approximately $991,000, from
approximately $895,000 in the comparable prior-year period. The increase in
research and development expenses is principally due to an increase in employee
compensation and related costs of approximately $59,000 and an increase in
consultant expense of approximately $42,000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased by approximately
$308,000 to approximately $610,000 in the six-month period ended April 30, 2004,
from approximately $918,000 in the comparable prior-year period. The decrease in
selling, general and administrative expenses is principally due to a decrease in
the provision for bad debts of approximately $259,000 resulting from an increase
in the allowance for doubtful accounts in the prior year of approximately
$207,000 and a decrease in the current period of approximately $53,000 resulting
from a recovery of previously reserved amounts, a write down of Magicom
inventory in the prior year of approximately $58,000, a decrease in advertising
expense of approximately $41,000 and the elimination of expenses related to
listing on the Nasdaq Stock Market of approximately $34,000, offset by an
increase employee compensation and related costs of approximately $63,000.
19
INTEREST INCOME
The decrease in interest income in the six months ended April 30, 2004
to approximately $2,000 from approximately $3,000 in the comparable prior-year
period resulted primarily from a reduction in the prevailing interest rates.
Three months ended April 30, 2004 compared with three months ended April 30,
2003
- --------------------------------------------------------------------------------
SALES
Revenue. Revenue from sales increased by approximately $80,000 in the
three-month period ended April 30, 2004, to approximately $102,000, as compared
to approximately $22,000 in the comparable prior-year period. All revenue during
both periods was from encryption products and services. The increase in revenue
was principally due an increase unit sales of our encryption products. Our
encryption sales have been limited and are sensitive to individual large
transactions. We believe that changes in revenue between periods generally
represent the nature of the early stage of our product and sales channel
development.
Gross Profit. Gross profit from sales of encryption products and
services increased by approximately $64,000 in the three-month period ended
April 30, 2004, to approximately $70,000, as compared to approximately $6,000 in
the comparable prior-year period. The increase in gross profit was primarily due
to the increase in revenue. Gross profit as a percent of revenue increased to
approximately 69% in the three-month period ended April 30, 2004, as compared to
approximately 28% in the comparable prior-year period. Because of the limited
number of transactions during each of the periods, gross profit percentages are
sensitive to individual transactions.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased by approximately $104,000
in the three-month period ended April 30, 2004, to approximately $507,000, from
approximately $403,000 in the comparable prior-year period. The increase in
research and development expenses is principally due to an increase in employee
compensation and related costs of approximately $76,000 and an increase in
consultant expense of approximately $27,000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased by approximately
$315,000 to approximately $259,000 in the three-month period ended April 30,
2004, from approximately $574,000 in the comparable prior-year period. The
decrease in selling, general and administrative expenses is principally due to a
decrease in the provision for bad debts of approximately $252,000 resulting from
an increase in the allowance for doubtful accounts in the prior year of
approximately $200,000 and a decrease in the current period of approximately
$53,000 resulting from a recovery of previously reserved amounts, a write down
of Magicom inventory in the prior year of approximately $58,000 and the
elimination of expenses related to listing on the Nasdaq Stock Market of
approximately $24,000, offset by an increase employee compensation and related
costs of approximately $71,000.
20
INTEREST INCOME
Interest income in each of the three-month periods ended April 30, 2004
and 2003 was approximately $1,000.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
From our inception through June 2001, we met our liquidity and capital
expenditure needs primarily through the proceeds from sales of common stock in
our initial public offering, in private placements, upon exercise of warrants
issued in connection with the private placements and public offering, and upon
the exercise of stock options. Commencing in the fourth quarter of fiscal 1999,
we also began to generate cash flows from sales of our products, and, from June
2001 to January 2002, we received development payments from Futaba Corporation
of Japan.
During the six months ended April 30, 2004, our operating activities
used approximately $443,000 in cash. This resulted from payments to suppliers,
employees and consultants of approximately $646,000, which was offset by cash of
approximately $212,000 received from collections of accounts receivable and
other receivables related to sales of encryption products and services and
approximately $2,000 of interest income received. In addition, we received
approximately $659,000 in cash upon the exercise of stock options and purchased
approximately $6,000 of equipment. As a result, our cash and cash equivalents at
April 30, 2004 increased to approximately $1,243,000 from approximately
$1,024,000 at the end of fiscal 2003.
Accounts receivable increased by approximately $3,000 from
approximately $42,000 at the end of fiscal 2003 to approximately $45,000 at
April 30, 2004. The increase in accounts receivable is a result of an increase
in revenue and the timing of collections. Other receivables decreased by
approximately $27,000 from approximately $127,000 at the end of fiscal 2003 to
approximately $100,000 at April 30, 2004. The decrease in other receivables is a
result of proceeds received from the sale of a portion of the common stock
received from a customer to settle this accounts receivable and other receipts
from the customer aggregating approximately $80,000, offset by a reduction of
the provision for bad debts related to this accounts receivable of approximately
$53,000. The reduction of the provision for bad debts is based on management's
estimate of the other receivables' net realizable value. Inventories increased
approximately $19,000 from approximately $1,045,000 at October 31, 2003 to
approximately $1,064,000 at April 30, 2004, as a result of the timing of
shipments and production schedules. Prepaid expenses and other current assets
decreased by approximately $25,000 from approximately $48,000 at the end of
fiscal 2003 to approximately $23,000 at April 30, 2004, as a result of the
timing of payments. Accounts payable and accrued liabilities increased by
approximately $66,000 from approximately $342,000 at the end of fiscal 2003 to
approximately $408,000 at April 30, 2004, as a result of the timing of payments.
As a result of these changes, working capital at April 30, 2004
increased to approximately $2,067,000 from approximately $1,943,000 at the end
of fiscal 2003.
21
Our working capital includes inventory of approximately $1,064,000 at
April 30, 2004. Management has recorded our inventory at the lower of cost or
our current best estimate of net realizable value. To date, sales of our
products have been limited. Accordingly, there can be no assurance that we will
not be required to reduce the selling price of our inventory below our current
carrying value.
Our plans and expectations for our working capital needs also assume
that our Chairman of the Board and Chief Executive Officer and our President
will continue to perform services without significant cash compensation or
pension benefits. There can be no assurance that they will continue to provide
such services under such compensation arrangements.
The auditor's report on our financial statements as of October 31, 2003
states that the net loss incurred during the year ended October 31, 2003, our
accumulated deficit as of that date, and the other factors described in Note 1
to the Financial Statements included in our Annual Report on Form 10-K for the
year ended October 31, 2003, raise substantial doubt about our ability to
continue as a going concern. The auditor's report on our financial statements
for the year ended October 31, 2002 contained a similar statement. Our financial
statements have been prepared assuming we will continue as a going concern and
do not include any adjustments that might result from the outcome of this
uncertainty.
Based on reductions in operating expenses that have been made and
additional reductions that may be implemented, if necessary, we believe that our
existing cash and accounts receivable, together with cash flows from expected
sales of encryption products and flat panel displays, and other potential
sources of cash flows, will be sufficient to enable us to continue in operation
until at least the end of the second quarter of fiscal 2005. We anticipate that,
thereafter, we will require additional funds to continue our marketing,
production, and research and development activities, and we will require outside
funding if cash generated from operations is insufficient to satisfy our
liquidity requirements. However, our projections of future cash needs and cash
flows may differ from actual results. If current cash and cash that may be
generated from operations are insufficient to satisfy our liquidity
requirements, we may seek to sell debt or equity securities or to obtain a line
of credit prior to the first quarter of fiscal 2005. The sale of additional
equity securities or convertible debt could result in dilution to our
stockholders. We can give you no assurance that we will be able to generate
adequate funds from operations, that funds will be available to us from debt or
equity financings or a line of credit or that, if available, we will be able to
obtain such funds on favorable terms and conditions. We currently have no
arrangements with respect to additional financing.
We are seeking to improve our liquidity through increased sales or
license of products and technology. In an effort to generate sales, we have
marketed our encryption products directly to U.S. and international
distributors, dealers and original equipment manufacturers that market our
encryption products on a non-exclusive basis and to end-users. We have provided
several large organizations our hardware and software encryption solutions and
they are evaluating our solutions in connection with their security
requirements. We have also begun to market our flat panel video display products
to potential purchasers for incorporation into their products. During the
six-month period ended April, 2004, we have recognized revenue from sales of
approximately $141,000.
22
The following table presents our expected cash requirements for
contractual obligations outstanding as April 30, 2004:
Payments Due by Period
-----------------------------------------------------------------------------------
Less
Contractual than 1-3 4-5 After
Obligations 1 year years years 5 years Total
- ---------------------------- -------------- -------------- -------------- -------------- -------------
Noncancelable
Operating Leases $ 251,000 $ 280,000 -- -- $ 531,000
-------------- -------------- -------------- -------------- --------------
Total Contractual
Cash Obligations $ 251,000 $ 280,000 -- -- $ 531,000
============== ============== ============== ============== ==============
IMPACT OF RECENT ACCOUNTING PPRONOUNCEMENTS
- -------------------------------------------
In December 2003, the Security and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition", which
codifies, revises and rescinds certain sections of SAB No. 101, "Revenue
Recognition", in order to make this interpretive guidance consistent with
current authoritative accounting and auditing guidance and SEC rules and
regulations. The issuance of SAB No. 104 did not have a material effect on our
financial position or results of operations.
GENERAL RISKS AND UNCERTAINTIES
- -------------------------------
Our business involves a high degree of risk and uncertainty, including,
but not limited to, the following risks and uncertainties:
o WE HAVE EXPERIENCED SIGNIFICANT NET LOSSES AND NEGATIVE CASH FLOWS FROM
OPERATIONS AND THEY MAY CONTINUE.
We have had net losses and negative cash flows from operations in each
year since our inception and in the six months ended April 30, 2004, and we may
continue to incur substantial losses and experience substantial negative cash
flows from operations. We have incurred substantial costs and expenses in
developing our encryption and flat panel display technologies and in our efforts
to produce commercially marketable products incorporating our technology. We
have had limited sales of products to support our operations from inception
through April 30, 2004. We have set forth below our net losses, research and
development expenses and net cash used in operations for the six-month periods
ended April 30, 2004 and 2003, and for the fiscal years ended October 31, 2003
and 2002:
23
(Unaudited)
Six Months Ended Fiscal Years Ended
April 30, October 31,
------------------------------ ------------------------------
2004 2003 2003 2002
------------ ------------- -------------- ------------
Net loss $ 1,504,254 $ 1,774,620 $ 3,114,411 $ 3,285,240
Research and development expenses $ 991,179 $ 894,747 $ 1,807,742 $ 1,625,974
Net cash used in operations $ 432,768 $ 536,742 $ 958,501 $ 431,471
o WE MAY NEED ADDITIONAL FUNDING IN THE FUTURE WHICH MAY NOT BE AVAILABLE
ON ACCEPTABLE TERMS AND, IF AVAILABLE, MAY RESULT IN DILUTION TO OUR
STOCKHOLDERS, AND OUR AUDITORS HAVE ISSUED A "GOING CONCERN" AUDIT
OPINION.
We anticipate that, if cash generated from operations is insufficient
to satisfy our requirements, we will require additional funding to continue our
research and development activities and market our products. The auditor's
report on our financial statements as of October 31, 2003 states that the net
loss incurred during the year ended October 31, 2003, our accumulated deficit as
of that date, and the other factors described in Note 1 to the Financial
Statements included in our Annual Report on Form 10-K for the year ended October
31, 2003, raise substantial doubt about our ability to continue as a going
concern. The auditor's report on our financial statements for the year ended
October 31, 2002 contained a similar statement. Our financial statements have
been prepared assuming we will continue as a going concern and do not include
any adjustments that might result from the outcome of this uncertainty.
Based on reductions in operating expenses that have been made and
additional reductions that may be implemented, if necessary, we believe that our
existing cash and accounts receivable, together with cash flows from expected
sales of encryption products and flat panel displays, and other potential
sources of cash flows, will be sufficient to enable us to continue in operation
until at least the end of the second quarter of fiscal 2005. We anticipate that,
thereafter, we will require additional funds to continue marketing, production,
and research and development activities, and we will require outside funding if
cash generated from operations is insufficient to satisfy our liquidity
requirements. However, our projections of future cash needs and cash flows may
differ from actual results. If current cash and cash that may be generated from
operations are insufficient to satisfy our liquidity requirements, we may seek
to sell debt or equity securities or to obtain a line of credit prior to the
second quarter of fiscal 2005. The sale of additional equity securities or
convertible debt could result in dilution to our stockholders. We can give you
no assurance that we will be able to generate adequate funds from operations,
that funds will be available to us from debt or equity financings or a line of
credit or that, if available, we will be able to obtain such funds on favorable
terms and conditions. We currently have no arrangements with respect to
additional financing.
o WE MAY NOT GENERATE SUFFICIENT REVENUES TO SUPPORT OUR OPERATIONS IN THE
FUTURE OR TO GENERATE PROFITS.
We are engaged in two principal operations: (i) the development,
production and marketing of thin high-brightness flat panel video displays and
(ii) the development, production and marketing of multi-functional encryption
products that provide information security for domestic and
24
international users over virtually every communications media. We have only
recently started to produce monochrome versions of our high-brightness flat
panel displays and our encryption products are only in their initial stages of
commercial production. Our investments in research and development are
considerable. Our ability to generate sufficient revenues to support our
operations in the future or to generate profits will depend upon numerous
factors, many of which are beyond our control, including:
o our ability to successfully market our line of thin high-brightness
flat panel video displays and encryption products;
o the capability of Volga to produce thin high-brightness monochrome
video displays and supply them to us;
o our ability to jointly develop with Volga and produce a full-color
video display;
o our production capabilities and those of our suppliers as required for
the production of our encryption products;
o long-term performance of our products;
o the capability of our dealers and distributors to adequately service
our encryption products;
o our ability to maintain an acceptable pricing level to end-users for
both our encryption and display products;
o the ability of suppliers to meet our requirements and schedule;
o our ability to successfully develop other new products under
development;
o rapidly changing consumer preferences;
o the possible development of competitive products that could render our
products obsolete or unmarketable;
o our future negotiations with Volga with respect to payments and other
arrangements under our Joint Cooperation Agreement with Volga.
Because our revenue is subject to fluctuation, we may be unable to
reduce operating expenses quickly enough to offset any unexpected revenue
shortfall. If we have a shortfall in revenue in relation to expenses, our
operating results would suffer. Our operating results for any particular quarter
may not be indicative of future operating results. You should not rely on
quarter-to-quarter comparisons of results of operations as an indication of our
future performance.
o WE ARE DEPENDENT UPON A FEW KEY EXECUTIVES AND THE LOSS OF THEIR SERVICES
COULD ADVERSELY AFFECT US.
Our future success is dependent on our ability to hire, retain and
motivate highly qualified personnel. In particular, our success depends on the
continued efforts of our Chief Executive Officer, Denis A. Krusos, and our
President, Frank J. DiSanto, who founded our company in 1982 and are engaged in
the management and operations of our business, including all aspects of the
development, production and marketing of our encryption products and flat panel
display technology. In addition, Messrs. Krusos and DiSanto, as well as our
other skilled management and technical personnel, are important to our future
business and financial arrangements. The loss of the services of any such
persons could have a material adverse effect on our business and operating
results.
25
o THE VERY COMPETITIVE MARKETS FOR OUR ENCRYPTION PRODUCTS AND FLAT PANEL
DISPLAY TECHNOLOGY COULD HAVE A HARMFUL EFFECT ON OUR BUSINESS AND
OPERATING RESULTS.
The markets for our encryption products and flat panel display
technology worldwide are highly competitive and subject to rapid technological
changes. Most of our competitors are larger than us and possess financial,
research, service support, marketing, manufacturing and other resources
significantly greater than ours. Competitive pressures may have a harmful effect
on our business and operating results.
o OUR COMMON STOCK IS SUBJECT TO THE SEC'S PENNY STOCK RULES WHICH MAY MAKE
OUR SHARES MORE DIFFICULT TO SELL.
Our stock fits the definition of a penny stock. The SEC rules regarding
penny stocks may have the effect of reducing trading activity in our common
stock and making it more difficult for investors to sell. The rules require a
broker to deliver a risk disclosure document that provides information about
penny stocks and the nature and level of risks in the penny stock market. The
broker must also give bid and offer quotations and broker and salesperson
compensation information to the customer orally or in writing prior to effecting
a transaction and in writing with the confirmation. The SEC rules also require a
broker to make a special written determination that the penny stock is a
suitable investment for the purchaser and receive the purchaser's written
agreement to the transaction before completion of the transaction. These
requirements may result in a lower trading volume of our common stock and lower
trading prices.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
-----------------------------------------------------------
We have invested a portion of our cash on hand in short term, fixed
rate and highly liquid instruments that have historically been reinvested when
they mature throughout the year. Although our existing instruments are not
considered at risk with respect to changes in interest rates or markets for
these instruments, our rate of return on these securities could be affected at
the time of reinvestment, if any.
Item 4. Controls and Procedures
We carried out an evaluation, under the supervision and with the
participation of our management including our Chairman of the Board and Chief
Executive Officer and our Vice President - Finance and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13-15(b) of the Securities Exchange Act of 1934, as
amended. Based upon that evaluation, our Chairman of the Board and Chief
Executive Officer and our Vice President - Finance and Chief Financial Officer
concluded that our disclosure controls and procedures are effective as of the
end of the period covered by this report.
There was no change in our internal control over financial reporting
during the quarter ended April 30, 2004 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
26
PART II. OTHER INFORMATION
--------------------------
Item 6. Exhibits and Reports on Form 8-K.
---------------------------------
(a) Exhibits
--------
31.1 Certification of Chief Executive Officer, pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002, dated June 1, 2004.
31.2 Certification of Chief Financial Officer, pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002, dated June 1, 2004.
32.1 Statement of Chief Executive Officer, pursuant to Section 1350 of
Title 18 of the United States Code, dated June 1, 2004.
32.2 Statement of Chief Financial Officer, pursuant to Section 1350 of
Title 18 of the United States Code, dated June 1, 2004.
99.1 Grant Agreement between Copytele, Inc. and Denis A. Krusos, dated
February 23, 2004.
99.2 Grant Agreement between Copytele, Inc. and Frank J. DiSanto, dated
February 23, 2004.
99.3 Grant Agreement between Copytele, Inc. and Denis A. Krusos, dated
April 2, 2004.
(b) Reports on Form 8-K
-------------------
We filed no Current Reports on Form 8-K during the quarter ended April 30,
2004.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CopyTele, Inc.
By: /s/ Denis A. Krusos
-----------------------------------
Denis A. Krusos
Chairman of the Board,
Chief Executive Officer
June 1, 2004 (Principal Executive Officer)
By: /s/ Henry P. Herms
------------------------------------
Henry P. Herms
Vice President - Finance and
Chief Financial Officer (Principal
June 1, 2004 Financial and Accounting Officer)
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