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 January 31, 2006
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (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 March 7, 2006, the registrant had outstanding 94,135,771 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 January 31, 2006
(Unaudited) and October 31, 2005 3
Condensed Statements of Operations (Unaudited)
for the three months ended January 31, 2006 and 2005 4
Condensed Statements of Cash Flows (Unaudited)
for the three months ended July 31, 2006 and 2005 5
Notes to Condensed Financial Statements (Unaudited) 6 - 15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 16 - 29
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 29
Item 4. Controls and Procedures. 29
PART II. OTHER INFORMATION
Item 6. Exhibits. 30
SIGNATURES 30
2
PART I. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements.
---------------------
COPYTELE, INC.
--------------
CONDENSED BALANCE SHEETS
------------------------
(Unaudited)
-------------
January 31, October 31,
ASSETS 2006 2005*
------ ------------- -------------
CURRENT ASSETS:
Cash and cash equivalents $ 809,064 $ 506,517
Short-term investments 403,178 400,776
Accounts receivable 315 32,117
Other receivables, net 30,000 30,000
Inventories 330,023 384,996
Prepaid expenses and other current assets 37,935 79,829
------------ ------------
Total current assets 1,610,515 1,434,235
PROPERTY AND EQUIPMENT, net 30,631 27,131
OTHER ASSETS 4,887 4,887
------------ ------------
$ 1,646,033 $ 1,466,253
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 404,147 $ 270,806
Accrued liabilities 68,245 77,424
------------ ------------
Total current liabilities 472,392 348,230
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; 93,829,061
and 91,975,538 shares issued
and outstanding, respectively 938,291 919,755
Additional paid-in capital 74,382,525 73,105,886
Accumulated deficit (74,147,175) (72,907,618)
------------ ------------
1,173,641 1,118,023
------------ ------------
$ 1,646,033 $ 1,466,253
============ ============
* Derived from audited balance sheet included in our Annual Report on Form 10-K
for the fiscal year ended October 31, 2005.
The accompanying notes are an integral part of these condensed balance sheets.
3
COPYTELE, INC.
--------------
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
----------------------------------------------
For the Three Months
Ended
January 31,
-------------------------
2006 2005
----------- -----------
NET SALES $ 195,390 $ 212,591
COST OF SALES 55,458 64,573
----------- -----------
Gross profit 139,932 148,018
----------- -----------
OPERATING EXPENSES
Research and development expenses 656,588 589,953
Selling, general and administrative
expenses 729,096 566,271
----------- -----------
Total operating expenses 1,385,684 1,156,224
----------- -----------
LOSS FROM OPERATIONS (1,245,752) (1,008,206)
INTEREST INCOME 6,195 1,712
----------- -----------
NET LOSS $(1,239,557) $(1,006,494)
=========== ===========
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 93,255,081 86,163,574
=========== ===========
The accompanying notes are an integral part of these condensed statements.
4
COPYTELE, INC.
--------------
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
----------------------------------------------
For the Three Months
Ended
January 31,
----------------------
2006 2005
--------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Payments to suppliers, employees and
consultants $(631,743) $ (538,725)
Cash received from customers 227,192 71,966
Interest received 6,195 1,712
--------- ----------
Net cash used in operating activities (398,356) (465,047)
--------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of short-term investments
(certificates of deposit) (2,402) -
Payments for purchases of property and
equipment (7,415) (2,256)
--------- ----------
Net cash used in investing activities (9,817) (2,256)
--------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 710,720 476,480
--------- ----------
Net cash provided by financing
activities 710,720 476,480
--------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 302,547 9,177
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 506,517 1,002,777
--------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 809,064 $1,011,954
========= ==========
RECONCILIATION OF NET LOSS TO NET CASH USED
IN OPERATING ACTIVITIES:
Net loss $(1,239,557) $(1,006,494)
Stock option compensation to employees 115,681 -
Stock option compensation to consultants - 5,009
Stock awards granted to employees and
consultants pursuant to stock
incentive plans 468,774 461,272
Provision for doubtful accounts 6,286 -
Depreciation and amortization 3,915 3,631
Change in operating assets and
liabilities:
Accounts receivable and other
receivables 25,516 (140,625)
Inventories 54,973 22,052
Prepaid expenses and other current
assets 41,894 95,435
Accounts payable and accrued
liabilities 124,162 94,673
----------- -----------
Net cash used in operating
activities $ (398,356) $ (465,047)
=========== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH
FINANCING ACTIVITIES:
Unregistered common stock issued
to settle a liability $ - $115,372
=========== ===========
The accompanying notes are an integral part of these condensed statements.
5
COPYTELE, INC.
--------------
NOTES TO CONDENSED FINANCIAL STATEMENTS
---------------------------------------
(UNAUDITED)
-----------
1. ORGANIZATION AND FUNDING
------------------------
Organization and Basis of Presentation
- --------------------------------------
CopyTele, Inc. was incorporated on November 5, 1982. Our principal
operations are the development, production and marketing of multi-functional
encryption products that provide information security for domestic and
international users over virtually every communications media and the
development, production and marketing of thin, high-brightness, flat panel CRT
displays.
The condensed financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America ("US
GAAP") for interim financial reporting. Accordingly, they do not include all of
the information and footnotes required by US GAAP for complete financial
statements. The information contained herein is for the three-month periods
ended January 31, 2006 and 2005. 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. Certain prior year amounts have been reclassified to conform with
current year presentation.
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, 2005, for more extensive disclosures
than contained in these condensed financial statements.
Funding and Management's Plans
- ------------------------------
From our inception, we have met our liquidity and capital expenditure needs
primarily through the proceeds from sales of common stock in our initial public
offering, in private placements, upon exercise of warrants issued in connection
with the private placements and public offering, and upon the exercise of stock
options. In 2001 and 2002, we also received payments under a technology
development agreement. In addition, commencing in the fourth quarter of fiscal
1999, we have generated cash flows from sales of our encryption products.
During the three months ended January 31, 2006, our operating activities used
approximately $398,000 in cash. This resulted from payments to suppliers,
employees and consultants of approximately $632,000, which was offset by cash of
approximately $227,000 received from collections of accounts receivable related
to sales of encryption products and approximately $6,000 of interest income
received. In addition, we received approximately $711,000 in cash upon the
exercise of stock options, acquired approximately $2,000 of short-term
6
investments consisting of certificates of deposit and purchased approximately
$7,000 of equipment. As a result, our cash, cash equivalents, and short-term
investments increased to approximately $1,212,000 at January 31, 2006 from
approximately $907,000 at the end of fiscal 2005.
We believe that our existing cash, short-term investments and accounts
receivable, together with cash flows from expected sales of encryption products
and flat panel CRT 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
first quarter of fiscal 2007. 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 2007. The sale of additional equity securities or convertible debt could
result in dilution to our stockholders. We currently have no arrangements with
respect to additional financing. There can be no assurance that we will generate
sufficient revenues in the future (through sales or otherwise) to improve our
liquidity or sustain future operations, that our production capabilities will be
adequate, that other products will not be produced by other companies that will
render our products obsolete, or that funds will be available to us from debt or
equity financings or that, if available, we will be able to obtain such funds on
favorable terms and conditions. If we cannot obtain such funds if needed, we
would need to curtail or cease some or all of our operations.
The auditor's report on our financial statements as of October 31, 2005
states that the net loss incurred during the year ended October 31, 2005, 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, 2005, 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, 2004 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.
2. STOCK-BASED COMPENSATION
------------------------
We maintain stock equity incentive plans under which we may grant
non-qualified stock options, incentive stock options, stock appreciation rights,
stock awards, performance and performance-based awards, or stock units to
employees, non-employee directors and consultants.
Prior to November 1, 2005, we followed Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure" ("SFAS No.
148"), which addressed financial accounting and reporting for recording expenses
for the fair value of stock options. SFAS No. 148 required prominent disclosures
in financial statements about the effects of stock-based compensation and
provided alternative methods of transition for a voluntary change to fair
value-based method of accounting for stock-based employee compensation. SFAS No.
123 "Accounting for Stock Based Compensation" ("SFAS No. 123") encouraged but
did not require companies to record compensation cost for stock-based employee
compensation plans at fair value. During this period, we accounted for stock
options granted to employees and directors using the intrinsic value method
7
prescribed in Accounting Principles Board ("APB") Opinion No. 25 "Accounting for
Stock Issued to Employees" ("APB Opinion No. 25") and complied with the
disclosure provisions of SFAS No. 123 and SFAS No. 148 through October 31, 2005.
Compensation cost for stock options issued to employees and directors was
measured as the excess, if any, of the quoted market price of our stock at the
date of grant over the amount an employee or director must pay to acquire the
stock. In accordance with APB Opinion No. 25, we did not recognize any
compensation cost for stock options issued to employees and directors for the
quarter ended January 31, 2005, as all option grants to employees and directors
during such quarter were made at the fair market value of our stock on the date
of grant.
Had compensation cost for stock options granted to employees and directors
been determined at fair value, consistent with SFAS No. 123, our net loss and
net loss per share for the quarter ended January 31, 2005 would have increased
to the following adjusted amounts:
For the Three
Months Ended
January 31, 2005
----------------
Net loss as reported $ (1,006,494)
Add: Total stock-based employee compensation
expense, determined under fair value based method,
for all awards, net of related tax effect (326,616)
----------------
Net loss as adjusted $ (1,333,110)
================
Net loss per share, basic and diluted:
As reported $ (0.01)
========
As adjusted $ (0.02)
========
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS No. 123R") which addresses the accounting for share-based
payment transactions in which a company receives employee services in exchange
for either equity instruments of the company or liabilities that are based on
the fair value of the company's equity instruments or that may be settled by the
issuance of such equity instruments. SFAS No. 123R eliminates the ability to
account for share-based compensation transactions using the intrinsic value
method and requires, instead, that such transactions be accounted for using a
fair-value-based method and recognized as expense in the statement of
operations. In March 2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 107 ("SAB No. 107") relating to SFAS No. 123R.
Effective November 1, 2005, the beginning of our first quarter of fiscal
2006, we adopted SFAS No. 123R. We have elected to use the modified prospective
transition method as permitted by SFAS No. 123R and therefore, our financial
statements for prior periods have not been restated to reflect, and do not
include, the effect of SFAS No. 123R. Under this transition method, we will
apply the provisions of SFAS No. 123R to new awards and to awards modified,
8
repurchased, or cancelled after October 31, 2005. We recognize compensation
expense for stock option awards on a straight-line basis over the requisite
service period of the grant. Additionally, we will recognize compensation cost
for the portion of awards that were outstanding, but for which the requisite
service had not been rendered (unvested awards), as of October 31, 2005, as the
remaining service is rendered. The compensation cost we record for these awards
will be based on their grant date fair value as calculated for the pro forma
disclosures required by SFAS No. 123.
Stock Option Compensation Expense
- ---------------------------------
We recorded approximately $116,000 of stock-based compensation expense,
related to stock options granted to employees and directors, for the fiscal
quarter ended January 31, 2006, in accordance with SFAS No. 123R. Such
compensation expense is included in the accompanying statement of operations for
the fiscal quarter ended January 31, 2006 in either research and development
expenses or selling, general and administrative expenses, as applicable based on
the functions performed by such employees and directors. Such stock-based
compensation expense had no material effect on either the basic or diluted
earnings per share for the fiscal quarter ended January 31, 2006.
Included in the approximately $116,000 of stock-based compensation cost
related to stock options granted to employees and directors recorded during the
first quarter of fiscal 2006 was approximately $5,000 of expense related to the
amortization of compensation cost for stock options granted prior to but not yet
vested as of October 31, 2005. As of January 31, 2006, there was approximately
$14,000 of total unrecognized compensation cost related to non-vested
share-based compensation arrangements. This unrecognized cost is expected to be
fully amortized over the remaining portion of the current fiscal year.
We account for options granted to non-employee consultants using the fair
value method required by SFAS No. 123. During the three-month periods ended
January 31, 2006 and 2005, we recognized consulting expense for options granted
to consultants of approximately $0 and $5,000, respectively. Such consulting
expense is included in either research and development expenses or selling,
general and administrative expenses, as applicable, in the accompanying
statements of operations.
Fair Value Determination
- ------------------------
In accordance with SFAS No. 123R, we estimate the fair value of stock
options granted to employees on the date of grant using the Black-Scholes
pricing model. We also used this method prior to the adoption of SFAS No. 123R
to estimate the fair value of stock options granted to employees for purposes of
the pro forma financial information set forth in our financial statements in
accordance with SFAS No. 123.
Upon the adoption of SFAS No. 123R, we separated the individuals we grant
stock options to into three relatively homogenous groups, based on exercise and
post-vesting employment termination behaviors. To determine the weighted average
fair value of stock options granted to employees on the date of grant, we take a
weighted average of the assumptions used for each of these groups. All of the
9
stock options we granted during the fiscal quarter ended January 31, 2006 were
within a single group, consisting of awards of options with 10-year terms which
vested immediately.
We estimated the fair value of stock option awards using the following
assumptions:
For the Three
For the Three Months Ended
Months Ended January 31, 2005
January 31, 2006 (pro forma)
---------------- ----------------
Expected term (in years) 1.2 2.5
Volatility 81% 122%
Risk-free interest rate 4.25% 2.75%
Dividend yield 0 0
Weighted average fair value
at grant date $0.22 $0.50
Discussion of assumptions for fair value of stock option awards under SFAS
No. 123R.
The expected term of stock options represents the weighted average period
the stock options are expected to remain outstanding. Because we consider our
options to be "plain vanilla", we estimated the expected term using a modified
version of the simplified method of calculation, as prescribed by SAB No. 107.
This modified calculation uses the actual life for options that have been
settled, and a uniform distribution assumption for the options still
outstanding. Under SAB No. 107, options are considered to be "plain vanilla" if
they have the following basic characteristics: granted "at-the-money";
exercisability is conditioned upon service through the vesting date; termination
of service prior to vesting results in forfeiture; limited exercise period
following termination of service; and options are non-transferable and
non-hedgeable.
We estimated the expected volatility of our shares of common stock based
upon the historical volatility of our share price over a period of time equal to
the expected life of the options.
We estimated the risk-free interest rate based on the implied yield
available on the applicable grant date on a U.S. Treasury note with a term equal
appropriate for the expected term of the underlying grants.
We made the dividend yield assumption based on our history of not paying
dividends and our expectation not to pay dividends in the future.
Under SFAS No. 123R, the amount of stock-based compensation expense
recognized is based on the portion of the awards that are ultimately expected to
vest. Accordingly, we have reduced the fair value of the stock option awards for
expected forfeitures, which are forfeitures of the unvested portion of
surrendered options. We estimated expected forfeitures based on our historical
experience.
10
Discussion of assumptions for fair value of stock option awards under SFAS
No. 123.
Prior to adoption of SFAS 123R, we used similar assumptions to estimate the
fair value of stock options granted to employees for purposes of the pro forma
financial information set forth in our Financial Statements in accordance with
SFAS No. 123, except that forfeitures were accounted for as they occurred and we
did not separated the individuals we grant options to into separate groups.
We will reconsider use of the Black-Scholes pricing model if additional
information becomes available in the future that indicates another model would
be more appropriate, or if grants issued in future periods have characteristics
that cannot be reasonably estimated using this model.
Stock Option Activity
- ---------------------
During the fiscal quarters ended January 31, 2006 and 2005, we granted to
employees and consultants options to purchase 500,000 shares and 640,000 shares,
respectively, of common stock at an exercise price of $.62 and $.74 per share,
respectively, pursuant to the CopyTele, Inc. 2003 Share Incentive Plan (the
"2003 Share Plan"). During the fiscal quarters ended January 31, 2006 and 2005,
stock options to purchase 1,275,000 shares and 637,500 shares, respectively, of
common stock were exercised with aggregate proceeds of approximately $711,000
and $476,000, respectively.
Stock Option Plans
- ------------------
As of January 31, 2006, we have three stock option plans: the CopyTele,
Inc. 1993 Stock Option Plan (the "1993 Plan"), the CopyTele, Inc. 2000 Share
Incentive Plan (the "2000 Share Plan") and the 2003 Share Plan, which were
adopted by our Board of Directors on April 28, 1993, May 8, 2000 and April 21,
2003, respectively.
Information regarding the 1993 Plan for the first quarter ended January 31,
2006 is as follows:
Current Weighted
Average Exercise Aggregate
Shares Price Per Share Intrinsic Value
---------------------------------------------------------
Shares Under Option at October 31, 2005 6,718,580 $3.86
Cancelled (120,000) $4.75
--------------
Shares Under Option and Exercisable at January 31, 2006
6,598,580 $3.84 $-0-
==============
11
The following table summarizes information about stock options outstanding
under the 1993 Plan as of January 31, 2006:
Options Outstanding Options Exercisable
------------------------------------------------------- --------------------------------
Weighted Weighted
Number Weighted Average Average Number Average
Range of Outstanding Remaining Exercise Price Exercisable at Exercise Price
Exercise Prices at 1/31/06 Contractual Life 1/31/06
- ------------------------- --------------- ---------------------- ---------------- ---------------- ---------------
.84 to $1.56 784,000 3.79 $1.10 784,000 $1.10
$2.28 855,000 2.45 $2.28 855,000 $2.28
$3.38 to $4.81 4,564,580 .79 $4.39 4,564,580 $4.39
$6.38 395,000 .63 $6.38 395,000 $6.38
The exercise price of all of the options granted under the 1993 Plan, since
its inception, was equal to the fair market value of the underlying common stock
at the grant date.
Information regarding the 2000 Share Plan for the quarter ended January 31,
2006 is as follows:
Current Weighted
Average Exercise Aggregate
Shares Price Per Share Intrinsic Value
-----------------------------------------------------------
Shares Under Option at October 31, 2005 2,788,466 $0.73
Exercised (55,000) $0.48 $ 17,880
--------------
Shares Under Option and Exercisable at January 31, 2006
2,733,466 $0.74 $ 551,109
==============
The following table summarizes information about stock options outstanding
under the 2000 Share Plan as of January 31, 2006:
Options Outstanding Options Exercisable
------------------------------------------------------- --------------------------------
Weighted Weighted
Number Weighted Average Average Number Average
Range of Outstanding Remaining Exercise Exercisable at Exercise
Exercise Prices at 1/31/06 Contractual Life Price 1/31/06 Price
- ------------------------- --------------- ---------------------- ---------------- ---------------- ---------------
$0.34 - $0.40 921,000 5.39 $0.40 921,000 $0.40
$0.44 - $0.74 710,466 4.67 $0.68 710,466 $0.68
$0.94 - $1.09 1,102,000 4.68 $1.06 1,102,000 $1.06
The exercise price of all of the options granted under the 2000 Share Plan
since its inception, was equal to the fair market value of the underlying common
stock at the grant date. As of January 31, 2006, 45,773 shares were available
for future grants under the 2000 Share Plan.
12
Information regarding the 2003 Share Plan for the quarter ended January 31,
2006 is as follows:
Current Weighted
Average Exercise Aggregate
Shares Price Per Share Intrinsic Value
----------------- ---------------------- ------------------
Shares Under Option at October 31, 2005 12,505,200 $0.61
Granted 500,000 $0.62
Exercised (1,220,000) $0.56 $ 38,950
------------
Shares Under Option at January 31, 2006 11,785,200 $0.62 $ 3,810,048
============
Shares Under Exercisable at January 31, 2006 11,700,200 $0.62 $ 3,780,598
============
The following table summarizes information about stock options outstanding
under the 2003 Share Plan as of January 31, 2006:
Options Outstanding Options Exercisable
----------------------------------------------------- --------------------------------
Weighted Weighted
Number Weighted Average Average Number Average
Range of Outstanding at Remaining Exercise Price Exercisable Exercise Price
Exercise Prices 1/31/06 Contractual Life at 1/31/06
- ----------------------------- ---------------- ---------------------- --------------- -- ---------------- -----------------
$0.25 - $0.46 3,583,000 7.53 $0.29 3,583,000 $0.29
$0.51 - $0.77 4,891,200 8.96 $0.61 4,806,200 $0.61
$0.81 - $1.07 3,311,000 8.52 $0.92 3,311,000 $0.92
The exercise price of all of the options granted under the 2003 Share Plan
since its inception, was equal to the fair market value of the underlying common
stock at the grant date. As of January 31, 2006, 143,121 shares were available
for future grants under the 2003 Share Plan. In February 2006, our Board of
Directors adopted an amendment to the 2003 Share Plan authorizing an additional
15,000,000 shares, which are available for future grants.
Stock Grants
- ------------
We account for stock awards granted to employees and consultants based on
their grant date fair value. During the three-month periods ended January 31,
2006 and 2005, we issued 460,860 shares and 530,945 shares, respectively, of
common stock to certain employees for services rendered, principally in lieu of
cash compensation, pursuant to the 2003 Share Plan. We recorded compensation
expense for the three-month periods ended January 31, 2006 and 2005 of
approximately $376,000 and $449,000, respectively, for the shares of common
stock issued to employees. In addition, during the three-month periods ended
January 31, 2006 and 2005, we issued 117,663 shares and 15,000 shares,
respectively, of common stock to consultants for services rendered pursuant to
the 2003 Share Plan. We recorded consulting expense for the three-month periods
ended January 31, 2006 and 2005 of approximately $92,000 and $13,000,
respectively, for the shares of common stock issued to consultants.
13
3. CONCENTRATION OF CREDIT RISK
----------------------------
Financial instruments that potentially subject us to concentrations of
credit risk consist principally of accounts receivable from sales in the
ordinary course of business. Management reviews our accounts receivable and
other receivables for potential doubtful accounts and maintains an allowance for
estimated uncollectible amounts. Generally, no collateral is received from
customers for our accounts receivable. During the three months ended January 31,
2006, one customer in the Encryption Products and Services Segment represented
84% of total net sales. During the three months ended January 31, 2005, one
customer in the Encryption Products and Services Segment represented 94% of
total net sales. At January 31, 2006, one customer in the Encryption Products
and Services Segment represented 100% of net accounts receivable and at October
31, 2005, one customer in the Encryption Products and Services Segment
represented 100% of net accounts receivable.
4. SHORT-TERM INVESTMENTS
----------------------
Short-term investments represent certificates of deposits, carried at
amortized cost, with maturities of less than twelve months. The fair values of
the certificates of deposits, including accrued interest, approximate their
carrying value due to their short maturities.
5. INVENTORIES
-----------
Inventories consist of the following as of:
January 31, October 31,
2006 2005
------------ ------------
Component parts $133,842 $134,084
Work-in-process 39,787 41,379
Finished products 156,394 209,533
------------ ------------
$330,023 $384,996
============ =============
6. NET INCOME (LOSS) PER SHARE OF COMMON STOCK
-------------------------------------------
We comply with the provisions of SFAS No. 128, "Earnings Per Share" ("SFAS
No. 128"). In accordance with SFAS No. 128, basic net income (loss) per common
share ("Basic EPS") is computed by dividing net income (loss) by the weighted
average number of common shares outstanding. Diluted net income (loss) per
common share ("Diluted EPS") is computed by dividing net income (loss) by the
weighted average number of common shares and dilutive common share equivalents
and convertible securities then outstanding. Diluted EPS for all periods
presented is the same as Basic EPS, as the inclusion of the effect of common
stock equivalents then outstanding would be anti-dilutive. For this reason,
excluded from the calculation of Diluted EPS for the three-month periods ended
January 31, 2006 and 2005, were options to purchase 21,117,246 shares and
17,819,546 shares, respectively.
14
7. SEGMENT INFORMATION
-------------------
We follow the provisions of SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"). Reportable operating
segments are determined based on management's approach. The management approach,
as defined by SFAS No. 131, is based on the way that the chief operating
decision-maker organizes the segments within an enterprise for making operating
decisions and assessing performance. While our results of operations are
primarily reviewed on a consolidated basis, the chief operating decision-maker
also manages the enterprise in two segments: (i) Flat-panel display and (ii)
Encryption products and services. The following represents selected financial
information for our segments for the three-month periods ended January 31, 2006
and 2005:
Encryption Products
Segment Data Flat-Panel Display and Services Total
- -------------------------------------- --------------------- ---------------------- ---------------------
Three Months Ended January 31, 2006:
Net sales $ - $ 195,390 $ 195,390
Net loss (664,756) (574,801) (1,239,557)
Three Months Ended January 31, 2005:
Net sales $ - $ 212,591 $ 212,591
Net loss (517,239) (489,255) (1,006,494)
8. DIGITAL INFO SECURITY CO. AGREEMENTS
In February 2006, we entered into a Software License and Distribution
Agreement (the "License Agreement") to license to Digital Info Security Co.,
Inc. ("DISC"), a privately held corporation, an encryption system that
integrates our encryption technology into DISC's secure e-mail services. The
system is intended to allow companies to encrypt all e-mail transactions in a
manner transparent to the individual user. We developed the system jointly with
DISC. Concurrently with entering into the License Agreement with DISC, we
entered into an Exchange Agreement whereby we acquired a minority interest in
DISC by exchanging 100,000 shares of our common stock for 5,000,000 shares of
DISC's common stock. As of the date of the agreements, DISC had 63,233,300
shares of common stock outstanding, including the shares we received.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations.
- --------------
GENERAL
- -------
Our principal operations are the development, production and marketing of
thin, high-brightness, flat panel CRT 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.
After more than eight years of developing our high-brightness, thin, flat
panel CRT display technology, we have achieved our goal of producing a flat
panel display ("Flat Panel CRT") that not only preserves many of the beneficial
characteristics of a cathode ray tube ("CRT") but is thin, operates at a low
voltage and consumes less power. Our Flat Panel CRT display operates at a low
voltage of 40 volts as compared to voltages up to 10,000 volts for CRT and field
emission displays. We achieved this goal by creating a TFT (thin film
technology) based pixel matrix electron control system ("PMECS") that can
operate with virtually any electron emission system. We have begun to market our
Flat Panel CRT by demonstrating it at flat panel display exhibitions and we are
presently involved in discussions with potential customers and licensees. We
have produced models of full color thin Flat Panel CRT displays that are able to
show TV programs and can be connected to a DVD or VCR player to show color or
black and white movies.
Our Flat Panel CRT displays incorporating PMECS consist of two thin glass
substrates which are vacuumed and sealed using our unique low temperature
technology that is compatible with amphorous silicon TFT technology, which is
the dominant TFT LCD technology. Our Flat Panel CRT displays can operate with
virtually any type of electron emission system, have gray scale and color or
monochrome capability, operate at low voltages, have no pixel cross-talk (i.e.,
the operation of a pixel does not interfere with other pixels), and consume low
power. We have developed proprietary red, green and blue color phosphors that
are utilized for our color displays. In addition, PMECS, in conjunction with our
electron emission technologies, is applicable to any size display from small
hand-held devices to large HDTV products. We believe that Flat Panel CRT
displays with PMECS could potentially have a cost similar to a CRT and thus cost
less than current LCD or plasma displays.
The PMECS, which is located on one of the substrates, is being exclusively
produced for us by an Asian company utilizing its mass production TFT liquid
crystal display ("LCD") facilities. Our supplier has incorporated the PMECS into
5.5 inch (diagonal) TFT color matrix structures with 960 x 234 pixels. We are
now producing, with the assistance of Volga Svet Ltd. ("Volga"), a Russian
display company that we have been working with for more than eight years, our
CTVD-201 monochrome and CTVD-202 color displays using these structures in
combination with our proprietary electron emission technologies. These emission
technologies, which include carbon nanotubes, both reflective and non-reflective
planar edge, and thin filaments, are suitable for a variety of display
applications. In particular, we are incorporating our low voltage and low power
carbon nanotube electron emission system into our displays. These carbon
16
nanotubes are extremely small carbon elements, approximately 10,000 times
thinner than the width of a human hair, that emit electrons under controllable
conditions. We are working with one of our sources of nanotubes, a U.S. company,
to incorporate its carbon nanotubes into our 5.5 inch diagonal color and
monochrome displays.
We have successfully tested our Flat Panel CRT displays under various
environmental conditions. This included subjecting our displays to shock,
vibration, and operating temperatures from -40(degree)C to 85(degree)C. Our
displays are capable of operating under both sunlight and nighttime conditions.
As a result, we believe that our displays can meet performance requirements for
both outdoor and indoor applications. We have also reduced the operating voltage
requirements of our displays to further improve the reliability and extend the
life of our displays.
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. See "General Risks and Uncertainties" below.
We produce and market a line of high-grade, hardware and software based
encryption products that provide security for voice, fax, and data transmissions
utilizing cellular, satellite, digital and analog communication media. Our
encryption technology products encode information through a complex mathematical
formula called an algorithm. The algorithm requires a secret "key" to both
encrypt and decrypt information. Only the secret key that is used to encrypt the
information can be used to decrypt the information. Our products automatically
generate new secret keys electronically with each call. When communicating
encrypted information over a communications media, all of our products generally
are required at both the sending and receiving end.
Our line of encryption products consists mainly of our multi-functional,
hardware-based digital encryption systems that provide high-grade voice, fax and
data encryption using either the Citadel(TM) CCX encryption cryptographic chip
(which is manufactured by the Harris Corporation) or the Triple DES or AES
algorithm (algorithms available in the public domain which are used by many U.S.
government agencies). In addition, we have developed two software-based security
products - one that uses either the Triple DES or the AES algorithm to encrypt
data files and e-mail attachments in both desktop and laptop computers utilizing
Microsoft Windows operating systems and another that is able to encrypt voice
and data transmitted between cellular and satellite phones and among servers,
scanners, and printers. We sell our encryption products directly to end-users
and through dealers and distributors.
We have expanded our encryption product line and currently have 18
different products in our product line. We have continued to direct our
marketing efforts toward participation in the security opportunities created by
the U.S. Department of Homeland Security, the U.S. Defense Department, the
Health Insurance Portability and Accountability Act ("HIPAA"), the
Sarbanes-Oxley Act, and the Gramm-Leach-Bliley Act. We have entered into
agreements with three major U.S. companies to supply them with our encryption
equipment, which is capable of securing fax, voice, and data information over
satellite, digital, and analog communication networks. We are also working with
two companies to secure information between corporate servers and printers, and
between users and high speed networks.
17
In February 2006, we licensed to Digital Info Security Co., Inc. ("DISC"),
an encryption system that integrates our encryption technology into DISC's
secure e-mail services. The system, our DCS-2200, is intended to allow companies
to encrypt all e-mail transactions in a manner transparent to the individual
user. We developed the system jointly with DISC. With this product, DISC is able
to differentiate itself from other e-mail compliance companies. In furtherance
of the relationship between the two companies, we exchanged 100,000 shares of
our common stock for 5,000,000 shares of DISC's common stock. As of the date of
the agreements, DISC had 63,233,300 shares of common stock outstanding,
including the shares we received.
We have developed a line of products for use over the satellite
communications network of the Thuraya Satellite Telecommunications Company
("Thuraya"), located in Dubai, United Arab Emirates. The Thuraya network,
developed by the Boeing Company ("Boeing"), provides satellite communications in
Europe, Africa, Russia, the Middle East and Asia. Our products enable the
Thuraya network to provide encrypted communications between satellite phones,
from satellite phones to desk-based phones, or between desk-based phones. Our
products can encrypt both data and, with our DCS-1400-D, which uses a compact
encryption module attached to the Thuraya handset, voice communication over the
Thuraya network. End-users benefiting from our encryption technology include
Thuraya customers served by Boeing in Iraq, U.S. military forces in the Middle
East, and other U.S. government personnel.
Several companies are distributing and marketing our line of products for
use with the Thuraya network. We have an agreement with Boeing under which
Boeing is a distributor of such products. In addition, a major Thuraya service
provider has also become a distributor of, and has purchased, certain of such
products. Thuraya itself has included 13 of our encryption products sold by
Boeing on the Boeing page of Thuraya's website,
http://www.thuraya.com/country/int_sp/boeing/products.htm. Our products are also
being marketed by another of Thuraya's international service providers, Fort
Info Technology FZC, located in Dubai, and are listed on Fort Info Technology's
website, www.forttel.com, under Secure Communications.
Under our agreement with Boeing, Boeing is the exclusive distributor of our
DCS-1400-D (docker voice encryption device), USS-900T (satellite fax encryption
device), USS-900TL (landline to satellite fax encryption device), USS-900WF
(satellite and cellular fax encryption device), USS-900WFL (landline to
satellite and cellular fax encryption device) and USS-900TC (satellite fax
encryption to computer) products. We have expanded our line of products
distributed by Boeing, which now consists of 13 products. These products contain
the brand name of Thuraya and have operating controls in Arabic. We are also
developing for Boeing, a voice product to operate over the Thuraya network
having a higher level of security. We are also developing and have produced a
prototype of a product to encrypt the next generation voice and data handset
over the Thuraya network and are working with the supplier of the handsets to
integrate our encryption solution with the new handset.
In connection with Boeing becoming the exclusive distributor of certain of
our products, Boeing authorized us to use its name on our website. Accordingly,
customers desiring to purchase these encryption products can find authorized
18
Boeing sales information on the "Encryption Products" page of our website. In
January 2005, Boeing introduced, demonstrated (with our assistance) and began
marketing our encryption products to more than 100 world-wide Thuraya service
providers.
Our encryption products can also be used to further encrypt data over the
Globalstar network. Globalstar provides a satellite voice and data service
throughout a world-wide coverage area. Our DCS-1200 and DCS-1400 encryption
devices are included on the Globalstar webpage,
http://www.globalstarusa.com/en/products/encryption.php.
We are continuing to develop a hardware device to encrypt Short Message
Service ("SMS"), an inexpensive text message communication protocol that is used
in many cellular and satellite phones and networks. We currently plan to utilize
this encryption solution in conjunction with the Thuraya handsets, but it can be
used for data communications across other platforms as well.
Our products provide secure communications with many different satellite
phones, including the Thuraya 7100/7101 handheld terminal ("HHT"), Globalstar
GPS-1600 HHT, Telit SAT-550/600 HHT, Globalstar GPS-2800/2900 fixed phone,
Iridium 9500/9505 HHT, Inmarsat M4 and Mini "M" HHT units from Thrane & Thrane
and Nera. Through the use of our products, encrypted satellite communications
are available for many Thuraya docking units, including Teknobil's Next Thuraya
Docker, Thuraya's Fixed Docking Adapter, APsi's FDU-2500 Fixed Docking Unit, and
Sattrans's SAT-OFFICE Fixed Docking Unit and SAT-VDA Hands-Free Car Kit.
We have also developed modifications of our standard equipment for other
applications. We have provided modifications of our hardware and software
encryption solutions to several large organizations which are evaluating our
products in connection with their security requirements. We are supplying our
USS-900AF automatic fax encryption product to a major U.S. defense contractor to
secure its worldwide fax communication. We have entered into an agreement with
another major U.S. company and supplied an initial proof of concept encryption
solution utilizing another of our products that has been configured to interface
with that company's satellite global positioning system ("GPS") and data
communication fleet management network.
We are supplying another major U.S. company with our USS-900AF to secure
fax communication of personal medical records. We are also providing our
DCS-1700 to several U.S. companies to encrypt the network data communication
links between corporate servers, scanners, and printers contained in
multi-functional products. The TCP/IP encryption provided by our DCS-1700 is
also being evaluated by firms that require secure data backup to meet HIPAA,
Sarbanes-Oxley, Gramm-Leach-Bliley and other corporate governance requirements.
There is continued interest in our encryption products by governments
located in the Americas, Europe, Africa, Asia and the Middle East. Applications
for these customers include voice, fax and data security using land-line and
wireless phones. Product evaluations by these customers are usually thorough and
take time to materialize into firm orders.
Our operations and the achievement of our objectives in marketing,
production, and research and development are dependent upon an adequate cash
flow. Accordingly, in monitoring our financial position and results of
operations, particular attention is given to cash and accounts receivable
19
balances and cash flows from operations. Since our initial public offering, our
cash flows have been primarily generated through the sales of common stock in
private placements and upon exercise of stock options. Since 1999 we have also
generated cash flows from sales of our encryption products. In an effort to
generate sales, we have marketed our encryption products directly to U.S. and
international distributors, dealers and original equipment manufacturers that
market our encryption products and to end-users. We have also been working with
several large organizations to provide them with both our hardware and software
encryption solutions for them to evaluate whether the solutions meet their
security requirements and have begun supplying several major U.S. companies with
our encryption products. We have also begun to market our flat panel video
display products to potential purchasers for incorporation into their products.
We anticipate that current cash on hand, cash generated from operations, and
cash generated from the exercise of employee options will be adequate to fund
our operations at least through the end of the first quarter of fiscal 2007.
CRITICAL ACCOUNTING POLICES
- ---------------------------
Our financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America. As such, we are
required to make certain estimates, judgments and assumptions that management
believes are reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenue and expenses during the reporting
periods.
We believe the following critical accounting polices affect the more
significant judgments and estimates used in the preparation of our financial
statements. For additional discussion on the application of these and other
accounting polices, refer to the financial statements and notes thereto included
in our Annual Report on Form 10-K for the year ended October 31, 2005.
Revenue Recognition
- -------------------
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.
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 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 in the future.
20
Stock Based Compensation
- ------------------------
Prior to November 1, 2005, we accounted for stock options granted to
employees and directors using the intrinsic value method prescribed in
Accounting Principles Board ("APB") Opinion No. 25 "Accounting for Stock Issued
to Employees" ("APB Opinion No. 25") and complied with the disclosure provision
of Statement of Financial Accounting Standards ("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". In
December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No.
123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"), which addresses the
accounting for share-based payment transactions in which a company receives
employee services in exchange for either equity instruments of the company or
liabilities that are based on the fair value of the company's equity instruments
or that may be settled by the issuance of such equity instruments. SFAS No. 123R
eliminates the ability to account for share-based compensation transactions
using the intrinsic value method and requires that such transactions be
accounted for using a fair-value-based method and recognized as expense in the
statement of operations.
Effective November 1, 2005, we adopted SFAS No. 123R. Under the fair value
recognition provisions of SFAS No. 123R, stock-based compensation cost is
estimated at the grant date based on the fair value of the award and is
recognized as expense ratably over the requisite service period of the award. We
recorded for the three-month period ended January 31, 2006 approximately
$116,000 of stock-based compensation expense related to stock options granted to
employees and directors. Under the accounting method we followed prior to
November 1, 2005, we did not record any stock-based compensation expense related
to stock options granted to employees and directors for the three-month period
ended January 31, 2005. If we had included the cost of employee stock option
compensation in the financial statements for the three-month period ended
January 31, 2005, our net loss would have increased by approximately $327,000,
based on the fair value of the stock options granted to employees. See Note 2 to
the Financial Statements for additional information.
Determining the appropriate fair value model and calculating the fair value
of stock-based awards requires judgment, including estimating stock price
volatility, forfeiture rates and expected life. If factors change and we employ
different assumptions in the application of SFAS No. 123R in future periods, the
compensation expense that we record under SFAS No. 123R may differ significantly
from what we have recorded in the current period.
RESULTS OF OPERATIONS
- ---------------------
Three months ended January 31, 2006 compared with three months ended January 31,
- --------------------------------------------------------------------------------
2005
- ----
Net Sales and Gross Profit
Net Sales. Net sales decreased by approximately $18,000 in the three-month
period ended January 31, 2006, to approximately $195,000, as compared to
approximately $213,000 in the comparable prior-year period. All revenue during
both periods was from encryption products and services. The decrease in net
21
sales was principally due to a decrease 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 sales between periods generally
represent the nature of the early stage of our product and sales channel
development.
Gross Profit. Gross profit from sales of encryption products and services
decreased by approximately $8,000 in the three-month period ended January 31,
2006, to approximately $140,000, as compared to approximately $148,000 in the
comparable prior-year period. The decrease in gross profit was primarily due to
the decrease in sales. Gross profit as a percent of net sales in the three-month
period ended January 31, 2006 was approximately 72%. Gross profit as a percent
of revenue in the three-month period ended January 31, 2005 was approximately
70%. 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 $67,000 in the
three-month period ended January 31, 2006, to approximately $657,000, from
approximately $590,000 in the comparable prior-year period. The increase in
research and development expenses was principally due to stock option
compensation expense of approximately $44,000 in the current period compared to
$0 in the prior-year period and an increase in outside research and development
expense of approximately $27,000. The stock option compensation expense included
in our financial statements in the current period is a result of our adopting
SFAS No. 123R, effective November 1, 2005.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by approximately
$163,000 to approximately $729,000 in the three-month period ended January 31,
2006, from approximately $566,000 in the comparable prior-year period. The
increase in selling, general and administrative expenses was principally due to
an increase in professional fees of approximately $92,000 and stock option
compensation expense of approximately $71,000 in the current period compared to
$0 in the prior-year period.
Interest Income
Interest income was approximately $6,000 in three-month period ended
January 31, 2006, compared to approximately $2,000 in the comparable prior-year
period. The increase in interest income was the result of an increase in average
funds available for investment and an increase in prevailing interest rates.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
From our inception, we have met our liquidity and capital expenditure needs
primarily through the proceeds from sales of common stock in our initial public
offering, in private placements, upon exercise of warrants issued in connection
with the private placements and public offering, and upon the exercise of stock
options. In 2001 and 2002, we also received payments under a technology
22
development agreement. In addition, commencing in the fourth quarter of fiscal
1999, we began to generate cash flows from sales of our encryption products.
During the three months ended January 31, 2006, our operating activities
used approximately $398,000 in cash. This resulted from payments to suppliers,
employees and consultants of approximately $632,000, which was offset by cash of
approximately $227,000 received from collections of accounts receivable related
to sales of encryption products and approximately $6,000 of interest income
received. In addition, we received approximately $711,000 in cash upon the
exercise of stock options, acquired approximately $2,000 of short-term
investments consisting of certificates of deposit and purchased approximately
$7,000 of equipment. As a result, our cash, cash equivalents, and short-term
investments increased to approximately $1,212,000 at January 31, 2006 from
approximately $907,000 at the end of fiscal 2005.
Accounts receivable decreased by approximately $32,000 from approximately
$32,000 at the end of fiscal 2005 to approximately $0 at January 31, 2006. The
decrease in accounts receivable is a result of the timing of collections. Other
receivables were approximately $30,000 at both January 31, 2006 and at the end
of fiscal 2005. Inventories decreased approximately $55,000 from approximately
$385,000 at October 31, 2005 to approximately $330,000 at July 31, 2005, as a
result of the timing of shipments and production schedules. Prepaid expenses and
other current assets decreased by approximately $42,000 from approximately
$80,000 at the end of fiscal 2005 to approximately $38,000 at January 31, 2006.
The decrease in prepaid expenses and other current assets resulted primarily
from a prepaid payment of outside research and development expense of
approximately $50,000 at October 31, 2005 which was charged to expense during
the first quarter of fiscal 2006. Accounts payable and accrued liabilities
increased by approximately $124,000 from approximately $348,000 at the end of
fiscal 2005 to approximately $472,000 at January 31, 2006, as a result the
timing of payments.
As a result of these changes, working capital at January 31, 2006 increased
to approximately $1,138,000 from approximately $1,086,000 at the end of fiscal
2005.
Our working capital includes inventory of approximately $330,000 at January
31, 2006. Management has recorded our inventory at the lower of cost or our
current best estimate of net realizable value. To date, sales of our products
have been limited. Accordingly, there can be no assurance that we will not be
required to reduce the selling price of our inventory below our current carrying
value.
During the three-month periods ended January 31, 2006 and 2005, we issued
460,860 shares and 530,945 shares, respectively, of common stock to certain
employees for services rendered, principally in lieu of cash compensation,
pursuant to the 2003 Share Plan. We recorded compensation expense for the
three-month periods ended January 31, 2006 and 2005 of approximately $376,000
and $449,000, respectively, for the shares of common stock issued to employees.
In addition, during the three-month periods ended January 31, 2006 and 2005, we
issued 117,663 shares and 15,000 shares, respectively, of common stock to
consultants for services rendered pursuant to the 2003 Share Plan. We recorded
consulting expense for the three-month periods ended January 31, 2006 and 2005
of approximately $92,000 and $13,000, respectively, for the shares of common
stock issued to consultants.
The auditor's report on our financial statements as of October 31, 2005
states that the net loss incurred during the year ended October 31, 2005, 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, 2005, 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, 2004 contained a similar statement. Our financial
23
statements have been prepared assuming we will continue as a going concern and
do not include any adjustments that might result from the outcome of this
uncertainty
We believe that our existing cash, short-term investments and accounts
receivable, together with cash flows from expected sales of encryption products
and flat panel CRT 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
first quarter of fiscal 2007. 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 2007. The sale of additional equity securities or convertible debt could
result in dilution to our stockholders. We currently have no arrangements with
respect to additional financing. There can be no assurance that we will generate
sufficient revenues in the future (through sales or otherwise) to improve our
liquidity or sustain future operations, that our production capabilities will be
adequate, that other products will not be produced by other companies that will
render our products obsolete, or that funds will be available to us from debt or
equity financings or that, if available; we will be able to obtain such funds on
favorable terms and conditions. If we cannot obtain such funds if needed, we
would need to curtail or cease some or all of our operations.
We are seeking to improve our liquidity through increased sales or license
of products and technology. In an effort to generate sales, we have marketed our
encryption products directly to U.S. and international distributors, dealers and
original equipment manufacturers that market our encryption products and to
end-users. We have been working with several large organizations to provide them
with both our hardware and software encryption solutions for them to evaluate
whether the solutions meet their security requirements and have begun supplying
several major U.S. companies with our encryption products. We have also begun to
market our flat panel video display products to potential purchasers for
incorporation into their products. During the three months ended January 31,
2006, we have recognized revenue from sales of encryption products and services
of approximately $195,000.
24
The following table presents our expected cash requirements for contractual
obligations outstanding as of January 31, 2006:
Payments Due by Period
----------------------
Less
Contractual than 1-3 4-5 After
Obligations 1 year years years 5 years Total
- ------------------------- ------------- -------------- ------------- ----------- -------------
Consulting
Agreement $ 127,500 - - - $ 127,500
Noncancelable Operating
Leases $ 261,000 $ 498,000 - - $ 759,000
------------- -------------- ------------- ----------- -------------
Total Contractual
Cash Obligations $ 388,500 $ 498,000 - - $ 886,500
============= ============== ============= =========== =============
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
- ------------------------------------------
In December 2004, the FASB issued SFAS No. 123R. SFAS No. 123R establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. This Statement focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123R requires that the fair value of
such equity instruments be recognized as an expense in the historical financial
statements as services are performed. Prior to SFAS No. 123R, only certain pro
forma disclosures of fair value were required. The provisions of this Statement
were effective for the first interim reporting period beginning after June 15,
2005. In April 2005, the Securities and Exchange Commission announced a deferral
of the effective date of SFAS No. 123R until the first interim reporting period
of the first fiscal year beginning after June 15, 2005. Accordingly, we adopted
SFAS No. 123R commencing with the quarter ending January 31, 2006. The adoption
of SFAS No. 123R is expected to have a material effect on our financial
statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154"). SFAS 154 replaces the Accounting Principles Board
Opinion No. 20, "Accounting Changes" and SFAS No. 3, "Reporting Accounting
Changes in Interim Financial Statements," to require retrospective application
to prior periods' financial statements of changes in accounting principle. The
provisions of SFAS 154 are effective for accounting changes made in fiscal years
beginning after December 15, 2005. The adoption of SFAS 154 is not expected to
have a material effect on our financial statements.
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,"
25
"plans," "anticipates," "likely," "will" and similar expressions to identify
forward-looking statements. Such forward-looking statements, including those
concerning our expectations, involve risks, uncertainties and other factors,
some of which are beyond our control, which may cause our actual results,
performance or achievements, or industry results, to be materially different
from any future results, performance, or achievements expressed or implied by
such forward-looking statements. These risks, uncertainties and factors include,
but are not limited to, those factors set forth in "General Risks and
Uncertainties" below and Note 1 to Condensed Financial Statements. You should
read this discussion and analysis along with our Annual Report on Form 10-K for
the year ended October 31, 2004 and the condensed financial statements included
in this Report. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. You are cautioned not to unduly rely on such
forward-looking statements when evaluating the information presented in this
Report.
GENERAL RISKS AND UNCERTAINTIES
- -------------------------------
Our business involves a high degree of risk and uncertainty, including, but
not limited to, the following risks and uncertainties:
o We have experienced significant net losses and negative cash flows from
operations and they may continue.
We have had net losses and negative cash flows from operations in each year
since our inception and in the three months ended January 31, 2006, 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 January 31, 2006. We have set forth below our net losses, research and
development expenses and net cash used in operations for the three-month periods
ended January 31, 2006 and 2005, and for the fiscal years ended October 31, 2005
and 2004:
(Unaudited)
Three Months Ended Fiscal Years Ended
January 31, October 31,
----------------------------- ---------------------------
2006 2005 2005 2004
---- ---- ---- ----
Net loss $ 1,239,557 $ 1,006,494 $ 4,451,257 $ 3,360,655
Research and development expenses $ 656,588 $ 589,953 $ 2,266,911 $ 2,164,427
Net cash used in operations $ 398,356 $ 465,047 $ 1,720,332 $ 1,205,122
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
26
report on our financial statements as of October 31, 2005 states that the net
loss incurred during the year ended October 31, 2005, 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, 2005, raise substantial doubt about our ability to continue as a going
concern. The auditor's report on our financial statements for the years ended
October 31, 2004 and 2003 contained a similar statement. Our financial
statements have been prepared assuming we will continue as a going concern and
do not include any adjustments that might result from the outcome of this
uncertainty.
We believe that our existing cash and accounts receivable, together with
cash flows from expected sales of encryption products and flat panel displays,
and other potential sources of cash flows, will be sufficient to enable us to
continue in operation until at least the end of the first quarter of fiscal
2007. 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 first quarter of fiscal 2007. The sale of additional
equity securities or convertible debt could result in dilution to our
stockholders. We can give no assurance that we will be able to generate adequate
funds from operations, that funds will be available to us from debt or equity
financings or that, if available; we will be able to obtain such funds on
favorable terms and conditions. We currently have no arrangements with respect
to additional financing. If we cannot obtain such funds if needed, we would need
to curtail or cease some or all of our operations.
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 CRT displays and (ii) the
development, production and marketing of multi-functional encryption products
that provide information security for domestic and international users over
virtually every communications media. We have only recently started to produce
color and monochrome versions of our high-brightness Flat Panel CRT 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 CRT displays and encryption products;
o the capability of Volga to produce thin high-brightness color and
monochrome Flat Panel CRT displays and supply them to us;
o our ability to jointly develop with Volga and produce a color Flat
Panel CRT display with various electron emission systems;
o our production capabilities and those of our suppliers as required for
the production of our encryption products;
27
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; and
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.
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
28
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 January 31, 2006 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
29
PART II. OTHER INFORMATION
--------------------------
Item 6. Exhibits.
---------
10.1 Amendment No. 2 to the CopyTele, Inc. 2003 Share
Incentive Plan.
10.2 Amendment No. 3 to the CopyTele, Inc. 2003 Share
Incentive Plan.
31.1 Certification of Chief Executive Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated
March 10, 2006.
31.2 Certification of Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated
March 10, 2006.
32.1 Statement of Chief Executive Officer, pursuant to
Section 1350 of Title 18 of the United States Code,
dated March 10, 2006.
32.2 Statement of Chief Financial Officer, pursuant to
Section 1350 of Title 18 of the United States Code,
dated March 10, 2006.
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 and
Chief Executive Officer
March 10, 2006 (Principal Executive Officer)
By: /s/ Henry P. Herms
----------------------------
Henry P. Herms
Vice President - Finance and
Chief Financial Officer
(Principal Financial and
March 10, 2006 Accounting Officer)
30