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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended October 31, 2008
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No Fee Required) For the transition period from
___________ to ___________
Commission file number: 0-11254
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COPYTELE, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 11-2622630
- ------------------------------------------ ------------------------------------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
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900 Walt Whitman Road
Melville, NY 11747
(631) 549-5900
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [_] No [x]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [_] No [x]
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [__] Accelerated filer [x]
Non-accelerated filer [__] (Do not check if a smaller reporting company)
Smaller Reporting Company [__]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [_] No [x]
Aggregate market value of the voting stock (which consists solely of shares of
Common Stock) held by non-affiliates of the registrant as of April 30, 2008 (the
last business day of the registrant's most recently completed second fiscal
quarter), computed by reference to the closing sale price of the registrant's
Common Stock on the Over-the-Counter Bulletin Board on such date ($1.01 ):
$128,998,453
On January 9, 2009, the registrant had outstanding 134,476,651 shares of Common
Stock, par value $.01 per share, which is the registrant's only class of common
stock.
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DOCUMENTS INCORPORATED BY REFERENCE:
NONE
PART I
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Item 1. Business.
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Forward-Looking Statements
Information included in this Annual Report on Form 10-K 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 this Annual Report on Form
10-K under "Item 1A. - Risk Factors" below. 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 Annual Report on Form 10-K.
Overview
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Our principal operations are the development, production and marketing
of thin, flat, low-voltage phosphor display technology 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.
Display Technology
------------------
We have pioneered the basic development of an innovative new type of
flat panel display technology, which is brighter, has higher contrast and
consumes less power than our prior display technology. This new proprietary
display is a color phosphor based display having a unique lower voltage electron
emission system to excite the color phosphors. As with our prior display
technology, the new technology emits light to display color images, such as
movies from DVD players. In addition, we are also developing another version of
our new type low voltage and low power display having a different matrix
configuration and phosphor excitation system. These new type of displays are
expected to be lower in cost than our prior displays.
In November 2007, we entered into a Technology License Agreement (as
amended, the "License Agreement") with Videocon Industries Limited, an Indian
company ("Videocon"). Under the License Agreement, we provide Videocon with a
non-transferable, worldwide license of our technology for thin, flat, low
voltage phosphor displays (the "Licensed Technology"), for Videocon (or a
Videocon Group company) to produce and market products, including TVs,
incorporating displays utilizing the Licensed Technology. Under the License
Agreement, we will receive a license fee of $11 million from Videocon, payable
in installments over a 27 month period and an agreed upon royalty from Videocon
based on display sales by Videocon. In April 2008, the Indian Government
approved the License Agreement and in May 2008, we received the first
installment of the license fee of $2 million.
1
Videocon Industries Limited is the flagship company of the Videocon
Group, one of India's leading business houses. Videocon Group is a fully
integrated consumer electronics and home appliances enterprise with backward
integration in plasma panel, CRT glass, color picture tubes and other key
components for the consumer electronics, home appliances and components
industries. The company also operates in the oil & gas sector. The Videocon
Group has sales and service networks throughout India and operates facilities in
Europe and elsewhere in the world.
CopyTele and Videocon are working together to implement our technology
into production display modules. The display modules consist of our low voltage
phosphor displays, the attached associated driver circuits, and controller
circuits. Under the License Agreement, Videocon, with assistance from CopyTele,
is to provide the design and process engineering required to produce such
display modules, and also is to provide all tooling and fixtures required for
the production process. Videocon has a group of qualified and experienced
personnel assigned to this program. As part of our assistance to Videocon to
produce such display modules, we have been exchanging information with this
group of personnel so that they may understand the CopyTele technology. We are
currently cooperating with Videocon to jointly implement the CopyTele technology
to produce prototypes of the modules. Videocon is utilizing its display
processing technology and facilities to produce our display matrix. The matrix
is the main component of our display, since it contains the structure to
accommodate our electron emission technology and the color phosphors that are
used to illuminate our display. CopyTele and Videocon are also working together
to incorporate advancements to our display technology. Improvements to the
technology are to be jointly owned by CopyTele and Videocon.
Under the License Agreement we continue to have the right to produce
and market products utilizing the Licensed Technology. We also continue to have
the right to utilize Volga Svet Ltd., a Russian display company that we have
been working with for more than eleven years ("Volga"), and an Asian company
that CopyTele has been working with for more than five years, to produce and
market, products utilizing the Licensed Technology. Additional licenses of the
Licensed Technology to third parties require the joint agreement of CopyTele and
Videocon.
In connection with the License Agreement, Videocon and CopyTele have
each appointed one senior advisor to the other's board of directors to advise
with respect to strategic planning and technology in the display field.
2
At the same time as we entered into the License Agreement, we entered
into a Share Subscription Agreement with an affiliate of Videocon ("Mars
Overseas") for Mars Overseas to purchase 20,000,000 shares of our common stock,
and a subsidiary of ours, CopyTele International Ltd. ("CopyTele
International"), entered into a GDR Purchase Agreement to purchase 1,495,845
global depository receipts ("GDRs") of Videocon. Both transactions were
completed in our first fiscal quarter of fiscal 2008. See Note 1 to the
Consolidated Financial Statements.
Our new technology improves on our prior carbon nanotube and
proprietary low voltage color phosphor display technology. We have developed
various engineering models using such prior technology, which demonstrated the
display's ability to show movies from DVD players by controlling the brightness
of selected individual pixels. The carbon nanotubes, which are supplied to us by
a U.S. company, require a low voltage for electron emission and are extremely
small - approximately 10,000 times thinner than the width of a human hair. The
5.5 inch (diagonal) display we developed has 960 x 234 pixels and utilizes a new
memory-based active matrix thin film technology with each pixel phosphor
activated by electrons emitted by a proprietary carbon nanotube network located
approximately 10 microns (1/10th of a human hair) from the pixels. As a result,
each pixel phosphor brightness is controlled using a maximum of only 40 volts.
The carbon nanotubes and proprietary color phosphors are precisely placed and
separated utilizing our proprietary nanotube and phosphor deposition technology.
We have developed a process of maintaining uniform carbon nanotube deposition
independent of phosphor deposition. We have also developed a method of enhancing
nanotube electron emission to increase the brightness of this type of display.
Some other characteristics of our display technology are as follows:
o We have developed a proprietary system which allows us to evacuate
our display; to rapidly vacuum seal it at a low temperature to
accommodate the matrix; and to create lithographic type spacers to
assemble our display utilizing only 0.7mm glass. We thus obtain a
display thickness of approximately 1/16th of an inch, thinner than
LCD (liquid crystal) and PDP (plasma) displays.
o The display matrix, phosphor excitation system, and drivers are
all on one substrate.
o Our display is able to select and change the brightness of each
individual pixel, requiring only 40 volts on each pixel phosphor
to change the brightness from black to white. This compares to
thousands of volts required for other video phosphor based
displays, which leads to inherent breakdowns and short life.
o Our display has no backlight. Because power is only consumed when
a pixel is turned on, low power is needed to activate the whole
display. The display requires less power than an LCD. This lower
power consumption could potentially allow use of rechargeable
batteries to operate TV products for wireless applications and
extend the battery operation time for portable devices.
3
o The same basic display technology could potentially be utilized in
various size applications, from hand-held to TV size displays.
o Our proprietary matrix structures can be produced by existing mass
production TFT (thin film technology) LCD facilities, or portions
of these facilities.
o Our display eliminates display flicker.
o Our display has an approximately 1,000 times faster video response
time than an LCD, and matches the response time of a cathode ray
tube (CRT).
o Our display can be viewed with high contrast over approximately a
180 degree viewing angle, in both the horizontal and vertical
directions, which exceeds the viewing angle of LCDs.
o Also like CRTs, our display is capable of operating over a
temperature range (-40(degree)C to 85(degree)C) which exceeds the
range over which LCDs can operate, especially under cold
temperature conditions.
We believe our displays could potentially have a cost similar to a CRT
and thus less than current LCD or PDP displays (our display does not contain a
backlight, or color filter or polarizer, which represent a substantial portion
of the cost of an LCD).
Encryption Products and Technology
----------------------------------
During the past year we have also continued to pursue our encryption
business. We have sought encryption opportunities in both the commercial and
government security markets.
Our government market has been primarily handled by The Boeing Company
("Boeing") and its large distributors of the Thuraya satellite phones. The
Thuraya Satellite Network has grown as a communications provider due to its
geographic coverage, quality of service and cost effective usage. The third
Thuraya Geo-mobile satellite was successfully launched in January 2008, allowing
Thuraya to embark on expansion plans to provide its mobile satellite services in
the Asia-Pacific region.
Our three year agreement with Boeing continued during fiscal 2008.
Boeing distributes 13 of our products, including our DCS-1400D (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, which were specifically designed for the Thuraya network. Boeing sells
these products under the brand name of Thuraya.
We are continuing to promote our Thuraya encryption solutions through
other Thuraya developers and resellers beside Boeing. We offer a full line of
voice, fax and data encryption products that secure these communications, and
our products are being used by government agencies, military, as well as
domestic and international non-governmental organizations (NGOs) in the Middle
East, Europe, Far East and Africa.
4
Asia Pacific Satellite Industries ("APSI") has manufactured new Thuraya
handsets and docking units that allow satellite and GSM cellular communications
both outdoors and indoors. CopyTele has developed connecting cables and
compatibility arrangements that customers can easily set up and utilize to
secure their communications over the Thuraya network and which are compatible
with landline telephone systems. APSI's new FDU-3500 docking unit for its
SO-2510 phone is now available in the market. This unit allows for outdoor and
indoor operation of the satellite phone on the Thuraya network. Our new PA-3500
and PA-3500T products allow compatibility between our DCS-1200, DCS-1400 and
USS-900T encryption devices and the APSI FDU-3500 docking unit and SO-2510
phone.
Our products provide secure communications with many different
satellite phones, including the Thuraya 7100/7101/SO-2510 handheld terminal
("HHT"), Globalstar GSP-1600 HHT, Telit SAT-550/600 HHT, Globalstar
GSP-2800/2900 fixed phone, Iridium 9500/9505/9505A 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 and FDU-3500 Fixed Docking Units, and Sattrans's SAT-OFFICE
Fixed Docking Unit and SAT-VDA Hands-Free Car Kit.
We have added Voice over Internet Protocol (VoIP) functions to the
DCS-1200 for corporate utilization over popular new telephone systems.
In the past year, we have uncovered new opportunities to market our
products for securing landline and wireless voice and fax communications. Our
USS-900AF, USS-900WF and USS-900WFL products are being evaluated for use by two
Middle Eastern governments for encrypting fax communications. Also, a Far
Eastern government is in the process of determining the system requirements
necessary to encrypt voice communications utilizing our DCS-1200 and DCS-1400
products.
In the commercial field, we have licensed our encryption system for
e-mail to Digital Info Security Co Inc. ("DISC"), located in Westminster,
Colorado. The system, our DCS-2200, integrates into DISC's e-mail services and
allows companies to encrypt all e-mail transactions in a manner transparent to
the individual user.
General
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We were incorporated on November 5, 1982 under the laws of the State of
Delaware. Our principal executive offices are located at 900 Walt Whitman Road,
Melville, New York 11747, our telephone number is 631-549-5900, and our Internet
website address is www.copytele.com. We make available free of charge on or
through our Internet website our annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, proxy statements on Schedule 14A, and
amendments to those reports filed or furnished pursuant to Section 13(a) of the
Securities Exchange Act of 1934 as soon as reasonably practicable after we
electronically file such materials with, or furnish them to, the Securities and
Exchange Commission.
5
New Technologies Under Development
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Display Technology
------------------
We are continuing to pursue our efforts to develop new technologies for
our color displays. We are continuing to develop another version of our new type
low voltage and low power display having a different matrix configuration and
phosphor excitation system. This new type of display is covered under the
license provided to Videocon and is expected to be lower in cost to produce than
our prior displays.
Encryption Technology
---------------------
We are continually engaged in the development of additional
capabilities for our current product lines as well as the development of new
products to meet current and anticipated customer applications. We are further
developing encryption products and pursuing commercial security opportunities
created by the Health Insurance Portability and Accountability Act ("HIPAA"),
the Sarbanes-Oxley Act, the Gramm-Leach-Bliley Act and other corporate
governance requirements.
Other products under development include the following:
o A voice encryption device for integration into the APSI SO-2510
handset that takes advantage of the Thuraya voice network. This
application simplifies the customer's security configuration while
reducing the utilization costs.
o Advancing our compatibility with Universal Serial Bus (USB)
connected cellular and satellite phones and our DCS-1200, DCS-1400
and USS-900T products. The additional services will expand our
wireless compatibility domestically and abroad.
Production
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Flat Panel Video Display Products
---------------------------------
Under our License Agreement with Videocon, Videocon (or a Videocon
Group company) is to produce products incorporating displays utilizing our
technology. We are working with Videocon to implement our display technology for
Videocon to produce the displays. We are also producing color displays, with the
assistance of Volga and the Asian company, which incorporate the new type of
matrix and phosphor excitation system described above.
Encryption Products
-------------------
Our hardware encryption products consist of a printed circuit board
populated with electronic components and connectors enclosed in a plastic case.
We design all the hardware, software, packaging and operating manuals for our
products. The four main electronic components - the Citadel(TM) CCX encryption
chip or hardware key generator chip; a digital signal processor; a vocoder; and
modems - are contained on a printed circuit board. We are currently using
several U.S.-based electronics-production contractors to procure the printed
circuit boards and mount the associated electronics components on the circuit
board. We currently use approximately a dozen primary component and printed
circuit-board suppliers and one production assembly contractor. Given normal
lead times, we anticipate having a readily available supply of all electronic
components that we require for assembling our encryption products.
6
Our production contractors produce and visually inspect the completed
circuit boards. We perform final assembly, including installation of the
software, by enclosing the completed printed circuit boards into the product and
performing functionality testing of all units at our premises at Melville, New
York prior to shipment to our customers. We test our finished products using
internally developed product assurance testing procedures. We currently produce
our line of products in quantities to meet marketing requirements.
Marketing and Sales
- -------------------
Flat Panel Video Display Products
---------------------------------
Under our License Agreement with Videocon, Videocon (or a Videocon
Group company) is to market the products it produces that incorporate displays
utilizing our technology. We are cooperating with Videocon to implement our
display technology for Videocon to produce such products, including TV's.
Encryption Products
-------------------
During the past year we have continued to direct our marketing efforts
to participate in the security opportunities created by the U.S. Department of
Homeland Security, the Defense Department, and the enactment of laws such as
HIPAA, the Sarbanes-Oxley Act, and Gramm-Leach-Bliley Act, which mandate that
government and private sector firms provide higher levels of information privacy
and security. For example, HIPAA requires certain privacy protection for medical
records and other health care information for individuals. We are working on
applications involving our encryption technology that offer simple,
straight-forward compliance measures for these laws. We have licensed to DISC an
encryption system that integrates our encryption technology into DISC's secure
e-mail services.
We have extended our long term agreement with Boeing, which is
distributing our line of encryption products. These include voice, fax and data
products on a non-exclusive basis. We also have entered into agreements with
Thuraya service providers to distribute our encryption equipment abroad. The
launch of the third Thuraya Geo-mobile satellite in January 2008 allowed Thuraya
to embark on major expansion plans to provide their mobile satellite services in
the Asia-Pacific region, potentially opening new markets for CopyTele security
solutions that are designed for the Thuraya network.
7
In addition, we presently use a network of distributors in the security
field and original equipment manufacturers which market our encryption products
on a non-exclusive basis. These distributors, along with our internal marketing
group, have sold and marketed our encryption products to multinational
corporations, U.S. and foreign governments and local and federal law enforcement
agencies.
We continue to provide training and technical support to our customers
and to our distributors and dealers.
Customers
- ---------
During fiscal 2008, we recognized $1,686,668 in revenue in our Display
Technology Segment from Videocon (constituting all of the revenue in such
segment), approximately 82% of our total net revenue. During fiscal 2007, we
recognized $240,000 in net revenue from DISC, approximately 49% of our total net
revenue, and approximately $143,000 in net revenue from Delta Bridge, Inc,
approximately 29% of total net revenue. During fiscal 2006, we recognized
approximately $204,000 in net revenue from GloCall Middle East FZE, a subsidiary
of France Telecom Mobile Satellite Communications and a Thuraya service
provider, approximately 40% of our total net revenue. Such revenue during fiscal
2007 and 2006 was in our Encryption Products and Services Segment.
Competition
- -----------
The market for encryption products and flat panel displays worldwide is
highly competitive and subject to technological changes. Although successful
product and systems development is not necessarily dependent on substantial
financial resources, most of our competitors are larger than us and possess
financial, research, service support, marketing, manufacturing and other
resources significantly greater than ours.
There are several other companies that sell hardware and/or software
encryption products and there are many large companies that sell flat panel
displays. We believe, however, that the technology contained in our encryption
products and our flat panel displays have features that distinguish them from
the products being sold by our competitors. The encryption security and flat
panel display markets are likely to be characterized by rapid advances in
technology and the continuing introduction of new products that could render our
products obsolete or non-competitive. We cannot give you any assurance that we
will be able to compete successfully in the market for our encryption products
and our flat panel displays.
Patents
- -------
We have received patents from the United States and certain foreign
patent offices, expiring at various dates between 2009 and 2025. We have also
filed or are planning to file patent applications for our display technologies
and for our encryption technologies.
8
We have received from the U.S. patent office patents for seven
variations of our video display technology. We have also received patents
related to the design, structure and method of construction of the E-Paper(TM)
flat panel display, methods of operating the display, particle generation,
applications using the E-Paper(TM) flat panel display, and for our solid state
and thin film video color display. In addition, seven of our patent applications
describing our display technology have been published. We have received from the
U.S. patent office eight patents related to our encryption technology.
We cannot assure you that patents will be issued for any of our pending
applications. In addition, we cannot assure you that any patents held or
obtained will sufficiently protect us against our competitors. We are not aware
that any of our encryption products are infringing upon the patents of others.
We cannot assure you, however, that other products developed by us, if any, will
not infringe upon the patents of others, or that we will not have to obtain
licenses under the patents of others, although we are not aware of any such
infringement at this time.
We believe that the foregoing patents are significant to our future
operations.
Research and Development
- ------------------------
Research and development expenses were approximately $4,127,000,
$3,404,000, and $4,614,000 for the fiscal years ended October 31, 2008, 2007 and
2006, respectively. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" below and our Consolidated Financial
Statements.
Employees and Consultants
- -------------------------
We had 20 employees and 12 consultants as of October 31, 2008. Eighteen
of these individuals, including our Chairman of the Board and Chief Executive
Officer, are engaged in research and development. Their backgrounds include
expertise in physics, chemistry, optics and electronics. Six individuals are
engaged in marketing and the remaining individuals are engaged in administrative
and financial functions for us. None of our employees is represented by a labor
organization or union.
Financial Information About Segments and Geographical Areas
- -----------------------------------------------------------
See our Financial Statements
Item 1A. Risk Factors.
-------------
Our business involves a high degree of risk and uncertainty, including
the following risks and uncertainties:
9
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 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 October 31, 2008. We have set
forth below our net losses, research and development expenses and net cash used
in operations for the three fiscal years ended October 31, 2008:
Fiscal Years Ended October 31,
------------------------------
2008 2007 2006
---- ---- ----
Net loss................................... $5,821,604 $5,458,218 $7,600,901
Research and development expenses.......... 4,127,393 3,403,943 4,614,300
Net cash used in operations................ 901,868 2,396,859 1,847,108
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.
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. We believe that our
existing cash, cash equivalents, investments in certificates of deposit,
investments in U.S. government securities and accounts receivable, together with
cash flows from expected sales of our encryption products and revenue relating
to our thin, flat, low-voltage phosphor display technology, including license
fees and royalties from Videocon, and other potential sources of cash flows,
will be sufficient to enable us to continue our marketing, production, and
research and development activities. 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. The sale of additional equity securities or convertible debt could
result in dilution to our stockholders. It is also management's intention to
continue to compensate employees by issuing stock or stock options. 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, license fees and royalties, or otherwise) to satisfy our liquidity
requirements 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 other sources of funding would be
available, if needed, on favorable terms or at all. If we cannot obtain such
funds if needed, we would need to curtail or cease some or all of our
operations.
10
o We may not generate sufficient revenue to support our operations in the
future or to generate profits.
Our principal operations are the development, production and marketing
of thin, flat, low-voltage phosphor display technology 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. In May 2008, we commenced receiving license fees related
to our display technology from Videocon pursuant to the License Agreement. The
License Agreement provides for payment of additional license fees over the next
two fiscal years as well as the payment of certain royalties based on sales of
products containing our display technology. However, there can be no assurance
that thereafter we will receive any license or similar fees relating to our
display technology, nor that we will receive any royalty payments from Videocon.
In addition, our arrangements with Videocon involve counterparty risk. 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 and Videocon's ability to implement our technology for Videocon to
produce and market products containing our displays.
o The capability of Volga Svet Ltd. ("Volga"), a Russian display company
that we have been working with for eleven years, to produce color and
monochrome displays and supply them to us.
o Our ability to successfully market our line of encryption products.
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 and Videocon's 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 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 fiscal
year may not be indicative of future operating results. You should not rely on
year-to-year comparisons of results of operations as an indication of our future
performance.
11
o Our arrangements with Videocon involve market risks.
At the same time as we entered into the License Agreement, we entered
into a Share Subscription Agreement with an affiliate of Videocon, Mars
Overseas, for Mars Overseas to purchase 20,000,000 shares of our common stock
(the "CopyTele Shares"), and a subsidiary of ours, CopyTele International,
entered into a GDR Purchase Agreement to purchase 1,495,845 GDRs of Videocon
(the "Videocon GDRs"). The Videocon GDRs are listed on the Luxembourg Stock
Exchange. The value of the Videocon GDRs owned by us depends upon, among other
things, the value of Videocon's securities in its home market of India, as well
as exchange rates between the U.S. dollar and Indian rupee (the currency in
which Videocon's securities are traded in its home market). The value of the
Videocon GDRs declined substantially in fiscal 2008, and there can be no
assurance that the value of the Videocon GDRs will not further decline in the
future.
In addition, for the purpose of effecting a lock up of the Videocon
GDRs and CopyTele Shares (collectively, the "Securities") for a period of seven
years, and therefore restricting both parties from selling or transferring the
Securities during such period, CopyTele International and Mars Overseas have
entered into two Loan and Pledge Agreements. The Videocon GDRs are to be held as
security for a loan in principal amount of $5,000,000 from Mars Overseas to
CopyTele International, and the CopyTele Shares are similarly held as security
for a loan in principal amount of $5,000,000 from CopyTele International to Mars
Overseas. The loans are for a term of seven years and do not bear interest. The
loan agreements also provide for customary events of default which may result in
forfeiture of the Securities by the defaulting party. There can be no assurance
that the respective parties receiving such loans will not default on such loan.
o We are dependent upon a few key employees 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, who is
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, Mr. Krusos, as well as our other skilled
management and technical personnel, are important to our future business and
financial arrangements. We do not have an employment agreement with, nor do we
maintain "key person" life insurance on, Mr. Krusos. The loss of the services of
any such persons could have a material adverse effect on our business and
operating results.
12
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 their shares. 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 1B. Unresolved Staff Comments.
--------------------------
None.
Item 2. Properties.
-----------
We lease approximately 12,000 square feet of office and
laboratory research facilities at 900 Walt Whitman Road, Melville, New York (our
principal offices) from an unrelated party pursuant to a lease that expires
November 30, 2011. Our base rent is approximately $279,000 per annum with a 3%
annual increase and an escalation clause for increases in certain operating
costs. See Note 9 to our Consolidated Financial Statements.
We believe that the facilities described above are adequate
for our current requirements.
Item 3. Legal Proceedings.
------------------
We are not a party to any material pending legal proceedings. We are
party to claims, and complaints that arise in the ordinary course of business.
We believe that any liability that may ultimately result from the resolution of
these matters will not, individually or in the aggregate, have a material
adverse effect on our financial position or results of operations.
13
Item 4. Submission of Matters to a Vote of Security Holders.
----------------------------------------------------
At our Annual Meeting of Stockholders, held on August 28,
2008, three directors were elected and the selection of Grant Thornton LLP,
independent registered public accountants, as our independent auditors for the
fiscal year ending October 31, 2008 was ratified. The following is a tabulation
of the voting with respect to the foregoing matters:
(a) Election of Directors:
Nominee For Withheld
------- --- --------
Denis A. Krusos 101,363,923 10,823,382
Henry P. Herms 103,147,867 9,039,438
George P. Larounis 104,256,196 8,715,605
(b) Ratification of selection of Grant Thornton LLP as independent
auditors for the fiscal year ending October 31, 2008:
For Against Abstain
--- ------- -------
112,528,140 171,869 271,793
14
PART II
-------
Item 5. Market for the Registrant's Common Equity, Related Stockholder
--------------------------------------------------------------
Matters and Issuer Purchases of Equity Securities.
--------------------------------------------------
Our common stock is traded on the Over-the-Counter Bulletin Board,
under the symbol "COPY". The high and low sales prices as reported by the
Over-the-Counter Bulletin Board for each quarterly fiscal period during our
fiscal years ended October 31, 2007 and 2008 have been as follows:
- --------------------------------------------------------------------------------
Fiscal Period High Low
- --------------------------------------------------------------------------------
1st quarter 2007 $1.01 $0.50
2nd quarter 2007 0.94 0.56
3rd quarter 2007 0.75 0.46
4th quarter 2007 0.96 0.51
- --------------------------------------------------------------------------------
1st quarter 2008 $1.94 $0.80
2nd quarter 2008 1.39 0.69
3rd quarter 2008 1.15 0.65
4th quarter 2008 0.98 0.34
- --------------------------------------------------------------------------------
As of January 9, 2009, the approximate number of record holders of our
common stock was 1,256 and the closing price of our common stock was $0.40 per
share.
No cash dividends have been paid on our common stock since our
inception. We have no present intention to pay any cash dividends in the
foreseeable future.
15
Item 6. Selected Financial Data.
------------------------
The following selected financial data has been derived from our audited
Financial Statements and should be read in conjunction with those statements,
and the notes related thereto, which are included in this report.
-----------------------------------------------------------------------
As of and for the years ended October 31,
-----------------------------------------------------------------------
2008 2007 2006 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Net Revenue $ 2,063,123 $ 486,852 $ 508,651 $ 439,785 $ 494,462
- ---------------------------------------------------------------------------------------------------------------------------------
Cost of encryption products sold 95,594 73,953 104,672 112,321 176,112
- ---------------------------------------------------------------------------------------------------------------------------------
Provision for excess inventory -- -- -- 586,662 --
- ---------------------------------------------------------------------------------------------------------------------------------
Cost of encryption services -- 86,407 51,774 20,645 --
- ---------------------------------------------------------------------------------------------------------------------------------
Research and Development Expenses 4,127,393 3,403,943 4,614,300 2,266,911 2,164,427
- ---------------------------------------------------------------------------------------------------------------------------------
Selling, General and Administrative Expenses 3,829,654 2,414,916 3,365,521 1,919,010 1,518,911
- ---------------------------------------------------------------------------------------------------------------------------------
Dividend Income 130,886 -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Interest Income 37,028 34,149 26,715 14,507 4,333
- ---------------------------------------------------------------------------------------------------------------------------------
Net Loss (5,821,604) (5,458,218) (7,600,901) (4,451,257) (3,360,655)
- ---------------------------------------------------------------------------------------------------------------------------------
Net Loss Per Share of Common Stock - Basic and Diluted ($.05) ($.05) ($.08) ($.05) ($.04)
- ---------------------------------------------------------------------------------------------------------------------------------
Total Assets 7,497,869 1,870,159 1,863,629 1,466,253 2,316,050
- ---------------------------------------------------------------------------------------------------------------------------------
Long Term Obligations -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Shareholders' Equity 1,730,277 1,191,350 1,281,841 1,118,023 1,872,930
- ---------------------------------------------------------------------------------------------------------------------------------
Cash Dividends Per Share of Common Stock -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial
-------------------------------------------------
Condition and Results of Operations.
------------------------------------
Forward-Looking Statements
- --------------------------
Information included in this Annual Report on Form 10-K 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 this Annual Report on Form
10-K under the heading "Item 1A. Risk Factors." 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 Annual Report on Form 10-K.
16
General
- -------
Our principal operations are the development, production and marketing
of thin, flat, low-voltage phosphor display technology 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.
We have pioneered the basic development of an innovative new type of
flat panel display technology, which is brighter, has higher contrast and
consumes less power than our prior display technology. This new proprietary
display is a color phosphor based display having a unique lower voltage electron
emission system to excite the color phosphors. As with our prior display
technology, the new technology emits light to display color images, such as
movies from DVD players. In addition, we are also developing another version of
our new type low voltage and low power display having a different matrix
configuration and phosphor excitation system. These new type of displays are
expected to be lower in cost than our prior displays.
In November 2007, we entered into a Technology License Agreement (as
amended, the "License Agreement") with Videocon Industries Limited, an Indian
company ("Videocon"). Under the License Agreement, we provide Videocon with a
non-transferable, worldwide license of our technology for thin, flat, low
voltage phosphor displays (the "Licensed Technology"), for Videocon (or a
Videocon Group company) to produce and market products, including TVs,
incorporating displays utilizing the Licensed Technology. Under the License
Agreement, we will receive a license fee of $11 million from Videocon, payable
in installments over a 27 month period and an agreed upon royalty from Videocon
based on display sales by Videocon. In April 2008, the Indian Government
approved the License Agreement and in May 2008, we received the first
installment of the license fee of $2 million.
Videocon Industries Limited is the flagship company of the Videocon
Group, one of India's leading business houses. Videocon Group is a fully
integrated consumer electronics and home appliances enterprise with backward
integration in plasma panel, CRT glass, color picture tubes and other key
components for the consumer electronics, home appliances and components
industries. The company also operates in the oil & gas sector. The Videocon
Group has sales and service networks throughout India and operates facilities in
Europe and elsewhere in the world.
CopyTele and Videocon are working together to implement our technology
into production display modules. The display modules consist of our low voltage
phosphor displays, the attached associated driver circuits, and controller
circuits. Under the License Agreement, Videocon, with assistance from CopyTele,
is to provide the design and process engineering required to produce such
display modules, and also is to provide all tooling and fixtures required for
the production process. Videocon has a group of qualified and experienced
personnel assigned to this program. As part of our assistance to Videocon to
produce such display modules, we have been exchanging information with this
group of personnel so that they may understand the CopyTele technology. We are
currently cooperating with Videocon to jointly implement the CopyTele technology
to produce prototypes of the modules. Videocon is utilizing its display
processing technology and facilities to produce our display matrix. The matrix
is the main component of our display, since it contains the structure to
accommodate our electron emission technology and the color phosphors that are
used to illuminate our display. CopyTele and Videocon are also working together
to incorporate advancements to our display technology. Improvements to the
technology are to be jointly owned by CopyTele and Videocon.
17
Under the License Agreement we continue to have the right to produce
and market products utilizing the Licensed Technology. We also continue to have
the right to utilize Volga Svet Ltd., a Russian display company that we have
been working with for more than eleven years ("Volga"), and an Asian company
that CopyTele has been working with for more than five years, to produce and
market, products utilizing the Licensed Technology. Additional licenses of the
Licensed Technology to third parties require the joint agreement of CopyTele and
Videocon.
In connection with the License Agreement, Videocon and CopyTele have
each appointed one senior advisor to the other's board of directors to advise
with respect to strategic planning and technology in the display field.
At the same time as we entered into the License Agreement, we entered
into a Share Subscription Agreement with an affiliate of Videocon ("Mars
Overseas") for Mars Overseas to purchase 20,000,000 shares of our common stock,
and a subsidiary of ours, CopyTele International Ltd. ("CopyTele
International"), entered into a GDR Purchase Agreement to purchase 1,495,845
global depository receipts ("GDRs") of Videocon. Both transactions were
completed in our first fiscal quarter of fiscal 2008. See Note 1 to the
Condensed Consolidated Financial Statements.
Our new technology improves on our prior carbon nanotube and
proprietary low voltage color phosphor display technology. We have developed
various engineering models using such prior technology, which demonstrated the
display's ability to show movies from DVD players by controlling the brightness
of selected individual pixels. The carbon nanotubes, which are supplied to us by
a U.S. company, require a low voltage for electron emission and are extremely
small - approximately 10,000 times thinner than the width of a human hair. The
5.5 inch (diagonal) display we developed has 960 x 234 pixels and utilizes a new
memory-based active matrix thin film technology with each pixel phosphor
activated by electrons emitted by a proprietary carbon nanotube network located
approximately 10 microns (1/10th of a human hair) from the pixels. As a result,
each pixel phosphor brightness is controlled using a maximum of only 40 volts.
The carbon nanotubes and proprietary color phosphors are precisely placed and
separated utilizing our proprietary nanotube and phosphor deposition technology.
We have developed a process of maintaining uniform carbon nanotube deposition
independent of phosphor deposition. We have also developed a method of enhancing
nanotube electron emission to increase the brightness of this type of display.
18
Some other characteristics of our display technology are as follows:
o We have developed a proprietary system which allows us to evacuate
our display; to rapidly vacuum seal it at a low temperature to
accommodate the matrix; and to create lithographic type spacers to
assemble our display utilizing only 0.7mm glass. We thus obtain a
display thickness of approximately 1/16th of an inch, thinner than
LCD (liquid crystal) and PDP (plasma) displays.
o The display matrix, phosphor excitation system, and drivers are
all on one substrate.
o Our display is able to select and change the brightness of each
individual pixel, requiring only 40 volts on each pixel phosphor
to change the brightness from black to white. This compares to
thousands of volts required for other video phosphor based
displays, which leads to inherent breakdowns and short life.
o Our display has no backlight. Because power is only consumed when
a pixel is turned on, low power is needed to activate the whole
display. The display requires less power than an LCD. This lower
power consumption could potentially allow use of rechargeable
batteries to operate TV products for wireless applications and
extend the battery operation time for portable devices.
o The same basic display technology could potentially be utilized in
various size applications, from hand-held to TV size displays.
o Our proprietary matrix structures can be produced by existing mass
production TFT (thin film technology) LCD facilities, or portions
of these facilities.
o Our display eliminates display flicker.
o Our display has an approximately 1,000 times faster video response
time than an LCD, and matches the response time of a cathode ray
tube (CRT).
o Our display can be viewed with high contrast over approximately a
180 degree viewing angle, in both the horizontal and vertical
directions, which exceeds the viewing angle of LCDs.
o Also like CRTs, our display is capable of operating over a
temperature range (-40(degree)C to 85(degree)C) which exceeds the
range over which LCDs can operate, especially under cold
temperature conditions.
We believe our displays could potentially have a cost similar to a CRT
and thus less than current LCD or PDP displays (our display does not contain a
backlight, or color filter or polarizer, which represent a substantial portion
of the cost of an LCD).
During the past year we have also continued to pursue our encryption
business. We have sought encryption opportunities in both the commercial and
government security markets.
19
Our government market has been primarily handled by The Boeing Company
("Boeing") and its large distributors of the Thuraya satellite phones. The
Thuraya Satellite Network has grown as a communications provider due to its
geographic coverage, quality of service and cost effective usage. The third
Thuraya Geo-mobile satellite was successfully launched in January 2008, allowing
Thuraya to embark on expansion plans to provide its mobile satellite services in
the Asia-Pacific region.
Our three year agreement with Boeing continued during fiscal 2008.
Boeing distributes 13 of our products, including our DCS-1400D (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, which were specifically designed for the Thuraya network. Boeing sells
these products under the brand name of Thuraya.
We are continuing to promote our Thuraya encryption solutions through
other Thuraya developers and resellers beside Boeing. We offer a full line of
voice, fax and data encryption products that secure these communications, and
our products are being used by government agencies, military, as well as
domestic and international non-governmental organizations (NGOs) in the Middle
East, Europe, Far East and Africa.
Asia Pacific Satellite Industries ("APSI") has manufactured new Thuraya
handsets and docking units that allow satellite communications both outdoors and
indoors. CopyTele has developed connecting cables and compatibility arrangements
that customers can easily set up and utilize to secure their communications over
the Thuraya network and which are compatible with landline telephone systems.
APSI's new FDU-3500 docking unit for its SO-2510 phone is now available in the
market. This unit allows for outdoor and indoor operation of the satellite phone
on the Thuraya network. Our new PA-3500 and PA-3500T products allow
compatibility between our DCS-1200, DCS-1400 and USS-900T encryption devices and
the APSI FDU-3500 docking unit and SO-2510 phone.
Our products provide secure communications with many different
satellite phones, including the Thuraya 7100/7101/SO-2510 handheld terminal
("HHT"), Globalstar GSP-1600 HHT, Telit SAT-550/600 HHT, Globalstar
GSP-2800/2900 fixed phone, Iridium 9500/9505/9505A 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 and FDU-3500 Fixed Docking Units, and Sattrans's SAT-OFFICE
Fixed Docking Unit and SAT-VDA Hands-Free Car Kit.
We have added Voice over Internet Protocol (VoIP) functions to the
DCS-1200 for corporate utilization over popular new telephone systems.
20
In the past year, we have uncovered new opportunities to market our
products for securing landline and wireless voice and fax communications. Our
USS-900AF, USS-900WF and USS-900WFL products are being evaluated for use by two
Middle Eastern governments for encrypting fax communications. Also, a Far
Eastern government is in the process of determining the system requirements
necessary to encrypt voice communications utilizing our DCS-1200 and DCS-1400
products.
In the commercial field, we have licensed our encryption system for
e-mail to Digital Info Security Co Inc. ("DISC"), located in Westminster,
Colorado. The system, our DCS-2200, integrates into DISC's e-mail services and
allows companies to encrypt all e-mail transactions in a manner transparent to
the individual user.
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
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 and services. We are
continuing to direct our encryption marketing efforts to opportunities in both
the commercial and government security markets and have recently uncovered new
opportunities to market products to Middle Eastern and Far Eastern governments
to secure voice and fax communications. In addition, in fiscal 2008, we entered
into the License Agreement with Videocon and in May 2008, we commenced receiving
from Videocon license fees related to our display technology.
In reviewing Management's Discussion and Analysis of Financial
Condition and Results of Operations, you should refer to our Consolidated
Financial Statements and the notes thereto.
Critical Accounting Policies
- ----------------------------
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.
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.
21
We have assessed the guidance of Emerging Issues Task Force No. 00-21
"Revenue Arrangements with Multiple Deliverables" ("EITF 00-21") to determine
whether multiple deliverables in our arrangement with Videocon represent
separate units of accounting. Under the License Agreement, CopyTele is required
to: (a) disclose to Videocon the Licensed Technology and provide reasonable
training of Videocon personnel; (b) jointly cooperate with Videocon to produce
prototypes prior to production; and (c) assist Videocon in preparing for
production. CopyTele has determined that these performance obligations do not
have value to Videocon on a standalone basis, as defined in EITF 00-21, and
accordingly they do not represent separate units of accounting.
We have established objective and reasonable evidence of fair value for
the royalty to be earned during the production period based on analysis of the
pricing for similar agreements. Accordingly, we have determined that the license
fee of $11 million to be paid during the pre-production period and royalties on
product sales reflects the established fair value for these deliverables. We
will recognize the $11 million license fee over the estimated period that we
expect to provide cooperation and assistance during the pre-production period,
limiting the revenue recognized on a cumulative basis to the aggregate license
fee payments received from Videocon. We will assess at each reporting period the
progress and assistance provided and will continue to evaluate the period during
which this fee will be recognized. On this basis, we have recognized license fee
revenue during the year ended October 31, 2008 of approximately $1,687,000.
License fee payments received from Videocon which are in excess of the amounts
recognized as revenue (approximately $313,000 as of October 31, 2008) are
recorded as non-refundable deferred revenue on the accompanying consolidated
balance sheet.
Investment Securities
---------------------
We classify our investment securities in one of two categories:
available-for-sale or held-to-maturity. Available-for-sale securities are
recorded at fair value. Unrealized gains and losses, net of the related tax
effect, on available-for-sale securities are excluded from earnings and are
reported as a component of accumulated other comprehensive income (loss) until
realized. Realized gains and losses from the sale of available-for-sale
securities are determined on a specific identification basis. Held-to-maturity
securities, which are Investment securities that the company has the intent and
ability to hold to maturity, are carried at amortized cost. The amortization of
premiums and accretion of discounts are recorded on the level yield (interest)
method, over the period from the date of purchase to maturity. When sales do
occur, gains and losses are recognized at the time of sale and the determination
of cost of securities sold is based upon the specific identification method.
Dividend and interest income are recognized when earned.
We monitor the value of our investments for indicators of impairment,
including changes in market conditions and the operating results of the
underlying investment that may result in the inability to recover the carrying
value of the investment. We will record an impairment charge if and when we
believe any such investment has experienced a decline that is other than
temporary.
22
Accounts Receivable
-------------------
Accounts receivable are stated at amounts due from customers net of an
allowance for doubtful accounts. Management reviews our accounts receivable for
potential doubtful accounts and maintains an allowance for estimated
uncollectible amounts. Accounts receivable are written off when we determine
that they become uncollectible.
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.
Stock-Based Compensation
------------------------
We account for stock options granted to employees, directors and
consultants using Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based
Payment" (SFAS No.123R"). We recognize compensation expense for stock option
awards on a straight-line basis over the requisite service period of the grant.
We recorded stock-based compensation expense, related to stock options granted
to employees and non-employee directors, of approximately $2,614,000, $1,081,000
and $2,973,000 during the years ended October 31, 2008, 2007 and 2006,
respectively, in accordance with SFAS No. 123R. See Note 2 to the Consolidated
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.
23
Results of Operations
- ---------------------
Fiscal Year Ended October 31, 2008 Compared to Fiscal Year Ended
-----------------------------------------------------------------------
October 31, 2007
----------------
Net Revenue
Net revenue increased by approximately $1,576,000 in fiscal 2008, to
approximately $2,063,000, as compared to approximately $487,000 in fiscal 2007.
Revenue recognized during fiscal 2008 included display technology license fees
related to the License Agreement with Videocon of approximately $1,687,000
compared to none in fiscal 2007. Revenue from sales of encryption products
increased by approximately $129,000 in fiscal 2008, to approximately $376,000,
as compared to approximately $247,000 in fiscal 2007. The increase in revenue
from encryption products sold was primarily due to an increase in unit
shipments. Revenue from encryption services decreased from $240,000 in the
fiscal 2007 to none in fiscal 2008. The revenue from encryption services in the
prior year period resulted from engineering services billed to DISC. Our
encryption revenue has been limited and is 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.
Cost of Encryption Products Sold
The cost of encryption products sold increased by approximately $22,000
in fiscal 2008, to approximately $96,000, as compared to approximately $74,000
in fiscal 2007. The increase in cost of encryption products sold was primarily
due to an increase in unit shipments of encryption products as well as a
reduction of cost of products sold in fiscal 2008 of approximately $19,000
resulting from the sale during fiscal 2008 of inventory for which a provision
for excess inventory of that amount was recorded in prior periods.
Cost of Encryption Services
The cost of encryption services decreased from $86,000 in fiscal 2007
to none in fiscal 2008 as there was no revenue from encryption services.
Research and Development Expenses
Research and development expenses increased by approximately $723,000
in fiscal 2008, to approximately $4,127,000, from approximately $3,404,000 in
fiscal 2007. The increase in research and development expenses was principally
due to an increase in employee stock option compensation expense of
approximately $878,000, offset by a decrease outside research and development
expense of approximately $55,000, a decrease in patent-related expenses of
approximately $41,000, a decrease in employee compensation and related costs,
other than stock option expense, of approximately $34,000, and a decrease in
outside engineering services of approximately $32,000.
24
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by approximately
$1,415,000 to approximately $3,830,000 in fiscal 2008, from approximately
$2,415,000 in fiscal 2007. The increase in selling, general and administrative
expenses was principally due to an increase in employee stock option
compensation expense of approximately $655,000, an increase in consultant stock
option compensation expense of approximately $172,000, an increase in the
provision for doubtful accounts of $223,000 of which $120,000 related to an
accounts receivable in that amount from DISC, an increase in employee
compensation and related costs, other than stock option expense, of
approximately $90,000, an increase in professional fees of approximately
$86,000, an increase in shareholder relations expense of approximately $72,000,
an increase in travel expense of approximately $49,000, and an increase in
consulting expense, other than consultant stock option compensation expense, of
approximately $41,000.
Dividend Income
Dividend income, which was received in connection with the Videocon
GDRs we acquired in December 2007, was approximately $131,000 in fiscal 2008. We
received no dividend income in fiscal 2007.
Interest Income
Interest income was approximately $37,000 in fiscal 2008, compared to
approximately $34,000 in fiscal 2007. The interest income earned on the
additional funds available for investment on the current period was offset by a
reduction in prevailing interest rates.
Fiscal Year Ended October 31, 2007 Compared to Fiscal Year Ended
-----------------------------------------------------------------------
October 31, 2006
----------------
Net Sales and Gross Profit
Net Sales. Net sales decreased by approximately $22,000 in fiscal 2007,
to approximately $487,000, as compared to approximately $509,000 in fiscal 2006.
All sales during both periods were from encryption products and services. The
decrease in net sales resulted from a reduction in sales of encryption products
of approximately $131,000, to approximately $247,000, as compared to
approximately $378,000 in fiscal 2006, offset by an increase in revenue from
encryption services of $109,000, to $240,000, as compared to $131,000 in fiscal
2006. The revenue from encryption services in both periods resulted from
engineering services billed to DISC. Our encryption sales have been limited and
are sensitive to individual large transactions. We believe that changes in sales
of our encryption products between periods generally represent the nature of the
early stage of our product and sales channel development. Revenue from sales of
encryption services is generally non-recurring due to the nature of the
individual transactions.
25
Cost of Encryption Products Sold
The cost of encryption products sold decreased by approximately $31,000
in fiscal 2007, to approximately $74,000, as compared to approximately $105,000
in fiscal 2006. The decrease in cost of encryption products sold was primarily
due to a decrease in unit shipments of encryption products.
Cost of Encryption Services
The cost of encryption services increased by approximately $34,000 in
the fiscal 2007, to approximately $86,000, as compared to approximately $52,000
in fiscal 2006. The increase in the cost of encryption services was primarily
due to an increase in billable services.
Research and Development Expenses
Research and development expenses decreased by approximately $1,210,000
in fiscal 2007, to approximately $3,404,000, from approximately $4,614,000 in
fiscal 2006. The decrease in research and development expenses was principally
due to a decrease in employee stock option compensation expense of approximately
$1,421,000, to approximately $607,000 in fiscal 2007 compared to approximately
$2,028,000 in fiscal 2006, offset by an increase of approximately $153,000 in
outside research and development expense primarily relating to development of
our display technology and an increase in employee compensation, other than
stock option expense, and related costs of approximately $77,000.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased by approximately
$951,000 to approximately $2,415,000 in fiscal 2007 from approximately
$3,366,000 in fiscal 2006. The decrease in selling, general and administrative
expenses was principally due to a decrease in employee stock option compensation
expense of approximately $471,000, to approximately $474,000 in fiscal 2007
compared to approximately $945,000 in fiscal 2006, a decrease in professional
fees of approximately $312,000, a decrease in consulting services of
approximately $118,000 and a decrease in shareholder relations expense of
approximately $64,000, offset by an increase in employee compensation, other
than stock option expense, and related costs of approximately $59,000.
Interest Income
Interest income was approximately $34,000 in fiscal 2007, compared to
approximately $27,000 in the comparable prior-year period. The increase in
interest income was principally due to an increase in prevailing interest rates.
26
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 addition, commencing in the fourth quarter of
fiscal 1999, we have generated cash flows from sales of our encryption products
and in May 2008 commenced receiving license fees related to our display
technology from Videocon pursuant to the License Agreement.
During fiscal 2008, our cash used in operating activities was
approximately $902,000. This resulted from payments to suppliers, employees and
consultants of approximately $3,236,000, which was offset by cash of
approximately $170,000 received from collections of accounts receivable related
to sales of encryption products, cash received from display technology licensing
fee of $2,000,000, approximately $131,000 of dividend income received and
approximately $33,000 of interest income received. Our cash used by investing
activities during fiscal 2008 was approximately $18,001,000, which resulted from
a disbursement of $16,200,000 for the purchase of Videocon GDRs, a purchase of
short-term investments consisting of certificates of deposit and U.S. government
securities of approximately $2,880,000, purchases of long-term investments
consisting U.S. government securities of approximately $999,000 and purchases of
approximately $14,000 of equipment, offset by approximately $1,841,000 received
upon maturities of short-term investments consisting of certificates of deposit
and U.S. government securities and approximately $252,000 received upon the sale
of long-term investments consisting of U.S. government securities. Our cash
provided by financing activities during fiscal 2008 was approximately
$18,712,000, which resulted from the sale of our common stock to Videocon for
$16,200,000, and cash received upon the exercise of stock options of
approximately $2,512,000. Accordingly, during fiscal 2008 our cash and cash
equivalents decreased by approximately $191,000 and our investments in
certificates of deposit and U.S. government securities increased by
approximately $1,793,000. As a result, our cash, cash equivalents, and
investments in certificates of deposit and U.S. government securities at October
31, 2008 increased to approximately $2,671,000 from approximately $1,069,000 at
the end of fiscal 2007. Our operating cash accounts are maintain at FDIC-insured
banks. Our bank accounts and certificates of deposit are maintained within FDIC
coverage limits.
Net accounts receivable decreased by $17,000, from $120,000 at the end
of fiscal 2007 to $103,000 at October 31, 2008. The decrease is primarily the
result of an account receivable from one customer of $206,000 related to sales
in fiscal 2008, offset by a provision for doubtful accounts in fiscal 2008 of
$223,000 of which $103,000 related to the account receivable from such customer
and $120,000 related to accounts receivable from DISC. Inventories decreased by
approximately $14,000 from approximately $192,000 at October 31, 2007 to
approximately $178,000 at October 31, 2008, primarily as a result of the timing
of shipments and production schedules. Investment in Videocon is recorded at
fair value and increased to approximately $3,620,000 at October 31, 2008 from
zero at the end of fiscal 2007, as a result of our purchase of Videocon global
depository receipts for $16,200,000 in December 2007 and the recording of an
unrealized loss of approximately $12,580,000 as of October 31, 2008. Investment
in DISC increased by $425,000 as a result of recording the investment at fair
value of $842,000 as of October 31, 2008 compared to recording the investment at
cost of $417,000 the end of fiscal 2007. Accounts payable and accrued
liabilities decreased by approximately $225,000 from approximately $679,000 at
the end of fiscal 2007 to approximately $454,000 at October 31, 2008, as a
result the timing of payments. Deferred revenue increased by approximately
$313,000 at October 31, 2008 from zero at the end of fiscal 2007, as a result of
the receipt of the display technology license fee of $2,000,000 in May 2008
reduced by the license fee revenue recognized during fiscal 2008. Loan payable
increased to $5,000,000 at October 31, 2008 from zero at the end of fiscal 2007,
as a result obtaining a loan from Mars Overseas in December 2007. Loan
receivable, which is classified as a contra-equity in the accompanying
consolidated balance sheet, increased to $5,000,000 at October 31, 2008 from
zero at the end of fiscal 2007, as a result of issuing a loan in that amount to
Mars Overseas in December 2007.
27
As a result of these changes, working capital at October 31, 2008
increased to approximately $1,489,000 from approximately $748,000 at the end of
fiscal 2007.
Our working capital includes inventory of approximately $178,000 and
$192,000 at October 31, 2008 and 2007, respectively. 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.
Total employee compensation expense during fiscal 2008, 2007 and 2006
was approximately $5,164,000, $3,661,000 and $5,416,000, respectively. During
fiscal 2008, 2007 and 2006, a significant portion of employee compensation
consisted of the issuance of stock and stock options to employees in lieu of
cash compensation. We recorded compensation expense for the fiscal years ended
October 31, 2008, 2007 and 2006 of approximately $1,877,000, $1,735,000 and
$1,897,000, respectively, for shares of common stock issued to employees. We
recorded approximately $2,614,000, $1,081,000 and $2,973,000 of stock-based
compensation expense, related to stock options granted to employees and
directors, during the years ended October 31, 2008, 2007 and 2006, respectively.
It is managements' intention to continue to compensate employees by issuing
stock or stock options.
In addition, during fiscal 2008, 2007 and 2006, we issued shares of
common stock to consultants for services rendered. We recorded consulting
expense for the fiscal years ended October 31, 2008, 2007 and 2006 of
approximately $95,000, $182,000 and $287,000, respectively, for shares of common
stock issued to consultants. In addition, during fiscal 2008, 2007 and 2006, we
recorded approximately $217,000, $-0- and $131,000, respectively, of consulting
expense for stock options granted to consultants. It is managements' intention
to continue to compensate consultants by issuing stock or stock options also.
28
During fiscal 2008, we issued 20,000,000 shares of our common stock to
an affiliate of Videocon for an aggregate purchase price of $16,200,000 and we
purchased 1,495,845 Videocon GDRs for an aggregate purchase price of
$16,200,000. In April 2008, we received a dividend of approximately $131,000 on
the Videocon GDRs we hold. While the Videocon GDRs are held as security for the
loan payable to Mars Overseas, the agreement governing such loan provides that
any dividends, distributions, rights or other proceeds or benefits in respect of
the Videocon GDRs shall be promptly transferred to us free and clear of any
encumbrances under the agreements.
We believe that our existing cash, cash equivalents, investments in
certificates of deposit, investments in U.S. government securities and accounts
receivable, together with cash flows from expected sales of our encryption
products and revenue relating to our thin, flat, low-voltage phosphor display
technology, including license fees and royalties from Videocon, and other
potential sources of cash flows, will be sufficient to enable us to continue our
marketing, production, and research and development activities. 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. The sale of additional equity
securities or convertible debt could result in dilution to our stockholders. It
is also management's intention to continue to compensate employees by issuing
stock or stock options. 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, license fees and royalties, or otherwise)
to satisfy our liquidity requirements 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
other sources of funding would be available, if needed, on favorable terms or at
all. 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. In fiscal 2008, we entered into the
License Agreement with Videocon. Under the License Agreement, we will receive a
license fee of $11 million from Videocon, payable in installments over a 27
month period and an agreed upon royalty from Videocon based on display sales by
Videocon. During fiscal 2008, we have recognized revenue from sales of
encryption products of approximately $376,000 and we received the first
installment of the license fee from Videocon of $2,000,000.
29
The following table presents our expected cash requirements for
contractual obligations outstanding as of October 31, 2008:
Payments Due by Period
----------------------
Less
than 1-3 4-5 After
Contractual Obligations 1 year years years 5 years Total
- ------------------------ ---------- ---------- ---------- ---------- ----------
Consulting
Agreement $ 170,000 -- -- -- $ 170,000
Noncancelable Operating
Leases $ 286,000 $ 623,000 -- -- $ 909,000
---------- ---------- ---------- ---------- ----------
Total Contractual
Cash Obligations $ 456,000 $ 623,000 -- -- $1,079,000
========== ========== ========== ========== ==========
We have no variable interest entities or other off-balance sheet
obligation arrangements.
Effect of Recent Accounting Pronouncements
- ------------------------------------------
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes," an interpretation of FASB Statement No. 109
("FIN 48"). FIN 48 clarifies the accounting for uncertainties in income taxes
recognized in an enterprise's financial statements. The interpretation requires
that the Company determine whether it is more likely than not that a tax
position will be sustained upon examination by the appropriate taxing authority.
If a tax position meets the more likely than not recognition criteria, FIN 48
requires the tax position be measured at the largest amount of benefit greater
than 50 percent likely of being realized upon ultimate settlement. This
accounting standard is effective for fiscal years beginning after December 15,
2006. We adopted FIN 48 on November 1, 2007. There were no unrecognized tax
benefits as of the date of our adoption of FIN 48 and as of October 31, 2008.
The adoption of FIN 48 did not have a material effect on our consolidated
financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements" ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value under generally accepted accounting
principles, and expands disclosures about fair value measurements. SFAS No. 157
emphasizes that fair value is a market-based measurement, not an entity-specific
measurement, and states that a fair value measurement should be determined based
on the assumptions that market participants would use in pricing the asset or
liability. In February 2008, the FASB issued FASB Staff Position ("FSP") No. FAS
157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and Other
Accounting Pronouncements That Address Fair Value Measurements for Purposes of
Lease Classification or Measurement under Statement 13," and FSP No. FAS 157-2,
"Effective Date of FASB Statement No. 157." Collectively, these Staff Positions
allow a one-year deferral of adoption of SFAS No. 157 for nonfinancial assets
and liabilities that are recognized or disclosed at fair value in the financial
statements on a non-recurring basis and amend SFAS No. 157 to exclude FASB
Statement No. 13 and its related interpretive accounting pronouncements that
address leasing transactions. We adopted SFAS No. 157 on November 1, 2008,
except for non financial assets and liabilities measured at fair value on a
non-recurring basis, which will be effective for us November 1, 2009. The
adoption of SFAS No. 157 on November 1, 2008 did not have a material effect on
our consolidated financial statements. The adoption of the deferred portion of
SFAS No. 157 is not expected to have a material effect on our consolidated
financial statements.
30
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities" ("SFAS No. 159"). SFAS No. 159
expands opportunities to use fair value measurement in financial reporting and
permits entities to choose to measure many financial instruments and certain
other items at fair value. SFAS No. 159 is effective for fiscal years beginning
after November 15, 2007. We adopted SFAS No. 159 on November 1, 2008. The
adoption of SFAS No. 159 did not have a material effect on our consolidated
financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
"Business Combinations" ("SFAS No. 141R"), which changes how an entity accounts
for the acquisition of a business. When effective, SFAS No. 141R will replace
existing SFAS No. 141, "Business Combinations" ("SFAS No. 141"), in its
entirety. SFAS No. 141R carries forward the existing requirements to account for
all business combinations using the acquisition method (formerly called the
purchase method). In general, SFAS No. 141R will require acquisition-date fair
value measurement of identifiable assets acquired, liabilities assumed, and
noncontrolling interest in the acquired entity. SFAS No. 141R will eliminate the
current cost-based purchase method under SFAS No. 141. SFAS No. 141R is
effective for fiscal years and interim periods within those fiscal years
beginning on or after December 15, 2008. The adoption of SFAS No. 141R is not
expected to have a material effect on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements, an amendment of ARB No. 51"
("SFAS No. 160"). SFAS No. 160 establishes accounting and reporting standards
for the noncontrolling interests in a subsidiary and for the deconsolidation of
a subsidiary. SFAS No. 160 is effective for fiscal years and interim periods
within those fiscal years beginning on or after December 15, 2008. The adoption
of SFAS No. 160 is not expected to have a material effect on our consolidated
financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
-----------------------------------------------------------
As of October 31, 2008, we had 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
short-term 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.
31
We also had investments in U.S. government securities recorded at
amortized cost of approximately $750,000, having a length of time until maturity
of fifteen months. We do not consider this investment to have a significant
market risk since our existing cash on hand and expected cash flows indicate
that this can be held until maturity.
At October 31, 2008, our investment in Videocon GDRs is recorded at
fair value of approximately $3,620,000 including an unrealized loss of
approximately $12,580,000 and has exposure to price risk. The fair value of the
Videocon GDRs is based on the underlying price of Videocon's equity shares which
are traded on stock exchanges in India with prices quoted in rupees.
Accordingly, the fair value of the Videocon GDRs is subject to price risk and
foreign exchange risk. The potential loss in fair value resulting from a
hypothetical 10% adverse change in prices of Videocon equity shares quoted by
Indian stock exchanges and in foreign currency exchange rates, as of October 31,
2008 amounts to approximately $362,000.
Our investment in DISC common stock at October 31, 2008 is recorded at
fair value of approximately $842,000 including an unrealized gain of $425,000
and has exposure to price risk. DISC's common stock is not registered under the
Securities Exchange Act of 1934, but is quoted on the Pink Sheets. Accordingly,
the fair value of DISC's common stock is subject to price risk. The potential
loss in fair value resulting from a hypothetical 10% adverse change in price of
this investment, as of October 31, 2008 amounts to approximately $84,000.
Item 8. Financial Statements and Supplementary Data.
--------------------------------------------
See accompanying "Index to Financial Statements."
Item 9. Changes in and Disagreements With Accountants on Accounting
--------------------------------------------------------------
and Financial Disclosure.
-------------------------
None.
Item 9A. Controls and Procedures
-----------------------
Disclosure 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 Chief Financial Officer and Vice President - Finance,
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, the Chairman of the Board and Chief
Executive Officer and the Chief Financial Officer and Vice President - Finance
concluded that our disclosure controls and procedures were effective as of the
end of fiscal 2008.
32
Management's Report on Internal Control Over Financial Reporting
- ----------------------------------------------------------------
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting as such term is defined in the
Securities and Exchange Act Rules 13a-15(f) and 15d-15(f). Our management,
including the principal executive officer and principal financial officer, does
not expect that our internal controls over financial reporting will prevent all
errors and all fraud. A control system, no matter how well designed and
operated, cannot provide full assurance that the objectives of the control
system are met, and no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, within a company have
been detected. Our internal control over financial reporting is designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles.
Our management has assessed the effectiveness of our internal control
over financial reporting as of October 31, 2008. This assessment of our internal
control over financial reporting used the criteria for effective internal
control established in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this
assessment, our management concluded that our internal control over financial
reporting was effective as of October 31, 2008.
The effectiveness of our internal control over financial reporting as
of October 31, 2008, has been audited by Grant Thornton LLP, an independent
registered public accounting firm, as stated in their report below.
Change in Internal Control Over Financial Reporting
- ---------------------------------------------------
There was no change in our internal control over financial reporting
during the fourth quarter of fiscal 2008 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
33
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
CopyTele, Inc. and Subsidiaries
We have audited CopyTele, Inc. and Subsidiaries' (the "Company")
internal control over financial reporting as of October 31, 2008, based on
criteria established in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). The
Company's management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting, included in the accompanying Management's
Report on Internal Control Over Financial Reporting. Our responsibility is to
express an opinion on the Company's internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk, and performing such other
procedures as we considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
34
In our opinion, CopyTele, Inc. and Subsidiaries maintained, in all
material respects, effective internal control over financial reporting as of
October 31, 2008, based on criteria established in Internal Control --
Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets of the Company as of October 31, 2008 and 2007, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended October 31, 2008 and our report
dated January 14, 2009 expressed an unqualified opinion on those financial
statements.
/s/ GRANT THORNTON LLP
Melville, New York
January 14, 2009
Item 9B. Other Information.
------------------
None.
35
PART III
--------
Item 10. Directors, Executive Officers and Corporate Governance.
-------------------------------------------------------
The following table sets forth certain information with respect to all
of our directors and executive officers:
- -----------------------------------------------------------------------------------------------------------
Director and/or
Name Position with the Company and Age Executive Officer
Principal Occupation Since
- -----------------------------------------------------------------------------------------------------------
Denis A. Krusos Director, Chairman of the Board and Chief 81 1982
Executive Officer
- -----------------------------------------------------------------------------------------------------------
Henry P. Herms Director, Chief Financial Officer and Vice 63 2000
President - Finance
- -----------------------------------------------------------------------------------------------------------
George P. Larounis Director 80 1997
- -----------------------------------------------------------------------------------------------------------
Mr. Krusos has served as one of our Directors and as our Chairman of
the Board and Chief Executive Officer since November 1982. He holds an M.S.E.E.
degree from Newark College of Engineering, a B.E.E. degree from City College of
New York and a J.D. degree from St. John's University.
Mr. Herms has served as our Chief Financial Officer and Vice President
- - Finance since November 2000 and as one of our Directors since August 2001. Mr.
Herms was also our Chief Financial Officer from 1982 to 1987. He is also a
former audit manager and CPA with the firm of Arthur Andersen LLP. He holds a
B.B.A. degree from Adelphi University.
Mr. Larounis has served as one of our Directors since September 1997,
prior to which he served as a consultant to us. Mr. Larounis is currently
retired. From 1960 to 1993, he held numerous positions as a senior international
executive of The Bendix Corporation and Allied Signal Inc., which is now known
as Honeywell International, Inc. He has also served on the Boards of Directors
of numerous affiliates of Allied Signal in Europe, Asia and Australia. He holds
a B.E.E. degree from the University of Michigan and a J.D. degree from New York
University.
Section 16(a) Beneficial Ownership Reporting Compliance
- -------------------------------------------------------
Section 16(a) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), requires our directors, executive officers and ten
percent stockholders to file initial reports of ownership and reports of changes
in ownership of our common stock with the Securities and Exchange Commission
("SEC"). Directors, executive officers and ten percent stockholders are required
to furnish us with copies of all Section 16(a) forms that they file. Based upon
a review of these filings, we believe that all required Section 16(a) reports
were made on a timely basis during fiscal year 2008, except that our former
President, Frank J. DiSanto, failed to timely file reports with respect to at
least two transactions during fiscal 2008.
36
Code of Ethics
- --------------
In July 2005, our Board of Directors adopted a formal code of ethics
that applies to our principal executive officer, principal financial officer,
principal accounting officer or controller or persons performing similar
functions. We will provide to any person without charge, upon request, a copy of
such code of ethics. Requests may be made in writing at CopyTele, Inc., 900 Walt
Whitman Road, Melville, New York 11747, Attn: Secretary, or by telephone at
631-549-5900.
Nomination Procedures
- ---------------------
There were no changes to the procedures by which security holders may
recommend nominations to our Board of Directors during our fiscal year 2008.
Audit Committee Financial Expert
- --------------------------------
The Securities and Exchange Commission has adopted rules implementing
Section 407 of the Sarbanes-Oxley Act of 2002 requiring public companies to
disclose information about "audit committee financial experts." We do not have a
standing Audit Committee. The functions of the Audit Committee have been assumed
by our full Board of Directors. Our Board of Directors has not concluded that
Mr. Larounis, the sole non-management director, meets the definition of "audit
committee financial expert." The Securities and Exchange Commission's rules do
not require us to have an audit committee financial expert, and our Board of
Directors has determined that it possesses sufficient financial expertise to
effectively discharge its obligations.
Item 11. Executive Compensation.
-----------------------
Compensation Discussion and Analysis
- ------------------------------------
The following provides an overview and analysis of our executive
compensation programs and policies:
Compensation Program Philosophy and Objectives
----------------------------------------------
Our vision is to develop, produce and market our thin, flat,
low-voltage phosphor display and the development, production and marketing of
our multi-functional encryption products that provide information security for
domestic and international users over virtually every communication media.
Competition for talented executives in the display and encryption industry is
intense. Our ability to attract and retain executives with the requisite skills
and experience to grow our business and achieve our business strategies is
crucial to our ability to realize this vision. Accordingly, we have designed our
executive compensation program to meet the following objectives:
37
o Attract, motivate and retain highly qualified executives;
o Align management interests with those of shareholders; and
o Reward and encourage superior performance.
To attain these objectives, our executive compensation program contains
both short-term and long term incentives rewarding individual and company
performance that generates returns for our shareholders.
Role of the Board of Directors
------------------------------
The Board of Directors is primarily responsible for overseeing our
compensation and employee benefit plans and practices. In determining the
compensation of our senior management, the Board of Directors decisions are
influenced by each individual's experience level and scope of responsibility,
and the overall performance of the Company and the individual.
The Board of Directors takes into account each person's performance in
helping the Company achieve certain goals, including the following: (i)
development of its flat panel technology, (ii) making business arrangements for
licensing its technology, (iii) development of encryption products, (iv) and
making business arrangements to license and market its encryption products. The
Board of Directors evaluates the performance of our Chief executive Officer, Mr.
Denis A. Krusos, directly. Mr. Krusos is not present during the Board of
Directors deliberations as to his compensation. With respect to senior
management other than Mr. Krusos, the Board of Directors relies upon the
recommendation of Mr. Krusos, as the person in the best position to judge the
respective performances of such individuals.
Because the market for talented executives is extremely competitive,
the Board of Directors also considers, from time to time, the form and amount of
compensation paid to executives of other companies, compiled from publicly
available information. While the Board of Directors can engage compensation
consultants to assist with this task, it did not engage any such consultants in
fiscal 2008. The Board of Directors does not target a specific benchmark for
compensation from the other companies whose compensation it reviews, but rather
uses the information in light of the other factors.
Elements of Executive Compensation
----------------------------------
Our executive compensation consists primarily of two elements: base
salary and stock options under our stock equity incentive plans, which provides
long-term equity incentives.
Base Salary-
------------
We determine base salaries for our executives based on, among other
things, job responsibilities, their tenure with and individual contribution to
the Company, and their prior relevant background and experience. We also take
account competitive market data, but do not target base salary at any particular
level in comparison to the market. Our Board of Directors reviews base salaries
annually. To maintain flexibility, we do not target base salary at any
particular percent of total compensation.
38
Stock Options-
--------------
The Board of Directors believes it is important to provide our senior
management with stock-based incentive compensation that increases in value in
direct correlation with improvement in the performance of our common stock. This
aligns management's interests with those of our stockholders and supports the
creation of long-term shareholder value. The fundamental philosophy is to link
the amount of compensation for an executive to his or her contribution to the
Company's success in achieving financial and other objectives. In general, we
grant stock options under stock equity incentive plans to directors, officers,
and other employees upon commencement of their employment with us and
periodically thereafter. We generally grant stock options at regularly scheduled
Board meetings.
As with other elements of compensation, the Board of Directors
considers a combination of factors, such as job responsibility, individual
contribution and market competition, in establishing the amount of compensation
provided by options to each individual executive. Equity incentives are not set
at any particular percentage of total compensation.
The option awards are granted at an exercise price equal to the closing
price of common stock on the grant date (the date the grant is approved.)
Options for directors and officers generally vest on the date of grant or after
a 6 or 12 month period following the grant date, provided the grantee remains
employed on the vesting date, so that such compensation is at risk of forfeiture
based on the executive's continued service with us. The stock equity incentive
plans also provide for the award of restricted stock, although such awards have
not been used in any material respect. No restricted stock was awarded during
fiscal 2008.
Other Benefits-
---------------
We provide our executives with customary, board-based benefits that are
provided to all employees, including medical insurance, life, and disability
insurance. We also provide our executives with certain perquisites which are not
a significant element of executive compensation.
Policy on Ownership of Stock and Options
----------------------------------------
We do not have any policy regarding levels of equity ownership (stock
or options) by our executive officers or directors.
39
Policy on Deductibility of Compensation
---------------------------------------
Section 162(m) of the Internal Revenue Code limits the deductibility of
compensation in excess of $1 million paid to certain executive officers named in
the proxy statement, unless certain requirements are met. To maintain
flexibility in compensating executive officers in a manner designed to aid in
retention and promote varying corporate performance objectives, the Board of
Directors has not adopted a policy of meeting the section 162(m) requirements.
Compensation Committee Interlocks and Insider Participation
- -----------------------------------------------------------
As disclosed above, the Board of Directors is primarily responsible for
overseeing our compensation and employee benefit plans and practices. We do not
have a compensation committee or other Board committee that performs equivalent
functions.
Board of Directors Report on Executive Compensation
- ---------------------------------------------------
We have reviewed and discussed the above "Compensation Discussion and
Analysis" with management. Based upon this review and discussion, we have
recommended that the "Compensation Discussion and Analysis" be included in this
Annual Report on Form 10-K.
Denis A Krusos
Henry P. Herms
George P. Larounis
Executive Compensation
- ----------------------
The following table sets forth certain information for our fiscal year
ended October 31, 2008, or fiscal 2008, with respect to compensation awarded to,
earned by or paid to our Chief Executive Officer, our former President and our
Chief Financial Officer (the "Named Executives"). No other executive officer
received total compensation in excess of $100,000 during fiscal 2008.
- -----------------------------------------------------------------------------------------------------------
SUMMARY COMPENSATION TABLE
- -----------------------------------------------------------------------------------------------------------
Option All Other Total
Name and Salary Awards Compensation Compensation
Principal Position Year ($) ($) (1) ($) (2) ($)
- -----------------------------------------------------------------------------------------------------------
Denis A. Krusos,
Chairman of the Board, 2008 $250,000 $967,000 $33,929 $1,250,929
Chief Executive Officer and Director 2007 $250,000 $422,170 $28,532 $700,702
- -----------------------------------------------------------------------------------------------------------
Frank J. DiSanto (3) 2008 $42,000 $117,178 $9,969 $169,147
Former President and former Director
- -----------------------------------------------------------------------------------------------------------
Henry P. Herms
Chief Financial Officer, Vice 2008 $125,000 $72,525 $21,777 $219,302
President- Finance and Director 2007 $100,000 $30,155 $14,300 $144,455
- -----------------------------------------------------------------------------------------------------------
40
(1) Amounts in the Option Awards column represent the dollar amounts
recognized for financial statement reporting purposes for fiscal
2007 and fiscal 2008 for each Named Executive in accordance with
Statement of Financial Accounting Standards No. 123 (revised
2004). A discussion of assumptions used in valuation of option
awards may be found in Note 2 to our Consolidated Financial
Statements for the year ended October 31, 2008, included elsewhere
in this Annual Report on Form 10-K.
(2) Amounts in the All Other Compensation column reflect, for each
Named Executive, the sum of the incremental cost to us of all
perquisites and personal benefits, which consisted solely of auto
allowance and related expenses for each of fiscal 2007 and fiscal
2008.
(3) Frank J. DiSanto's employment with us terminated effective
November 30, 2008.
The following table sets forth certain information with respect to
grants of stock options to the Named Executives during fiscal 2008:
- -----------------------------------------------------------------------------------------------------------
GRANTS OF PLAN BASED AWARDS
- -----------------------------------------------------------------------------------------------------------
All Other Option
Awards: Number of
ecurities Underlying Exercise price of Grant Date
Options Options Award Fair Value
Name Grant Date (#) ($/Sh) ($)
- -----------------------------------------------------------------------------------------------------------
Denis A. Krusos 11/12/07 1,000,000 $1.17 $967,000
- -----------------------------------------------------------------------------------------------------------
Frank J. DiSanto 11/12/07 300,000 $1.17 $290,100
- -----------------------------------------------------------------------------------------------------------
Henry P. Herms 11/12/07 75,000 $1.17 $72,525
- -----------------------------------------------------------------------------------------------------------
41
The following table sets forth certain information with respect to
unexercised stock options held by the Named Executives outstanding on October
31, 2008:
- -----------------------------------------------------------------------------------------------------------
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
- -----------------------------------------------------------------------------------------------------------
Option Awards (1)
- -----------------------------------------------------------------------------------------------------------
Number of Securities Number of Securities
Underlying Underlying Unexercised Option Exercise
Unexercised Options Options (#) Price Option Expiration
Name (#) Exercisable Un-Exercisable ($) Date
- -----------------------------------------------------------------------------------------------------------
Denis A. Krusos 50,000 $1.313 4/8/2009
250,000 $1.063 10/26/2010
250,000 $0.688 1/1/2011
250,000 $0.400 9/19/2011
500,000 $0.250 5/5/2013
500,000 $0.430 2/22/2014
250,000 $0.810 5/10/2014
1,000,000 $1.040 10/25/2014
1,500,000 $0.650 2/17/2015
1,000,000 $0.520 10/30/2015
1,000,000 $0.830 5/31/2016
700,000 $0.700 11/20/16
1,000,000 $1.170 11/11/17
- -----------------------------------------------------------------------------------------------------------
Frank J. DiSanto (1) 43,000 $1.313 4/8/2009
400,000 $1.040 10/25/2014
500,000 $0.650 2/17/2015
300,000 (2) $1.170 11/11/2017
- -----------------------------------------------------------------------------------------------------------
Henry P. Herms 100,000 $0.938 11/19/2010
50,000 $0.688 1/1/2011
100,000 $0.400 9/19/2011
50,000 $0.810 5/10/2014
70,000 $1.040 10/25/2014
100,000 $0.650 2/17/2015
100,000 $0.520 10/30/2015
50,000 $0.830 5/31/2016
50,000 $0.700 11/20/2016
75,000 $1.170 11/11/17
- -----------------------------------------------------------------------------------------------------------
42
(1) Frank J. DiSanto's stock options expired upon his termination of
employment with us on November 30, 2008.
(2) Stock options held by Frank J. DiSanto for 150,000 shares and
150,000, shares were exercisable on November 11, 2009 and November
11, 2010, respectively.
The following table summarizes the exercise of stock options during
fiscal 2008 by Named Executives:
----------------------------------------------------------------------------------------------------
OPTION EXERCISES AND STOCK VESTED TABLE
----------------------------------------------------------------------------------------------------
Option Awards
----------------------------------------------------------
Number of Shares Acquired Value Realized
on Exercise on Exercise
Name (#) ($) (1)
----------------------------------------------------------------------------------------------------
Frank J. DiSanto 455,000 $310,185
----------------------------------------------------------------------------------------------------
(1) The value realized on exercise is calculated based on the
difference between the exercise price of the options and the
market price of the stock at the time of exercise.
Director's Compensation
- -----------------------
There is no present arrangement for cash compensation of directors for
services in that capacity. Under the 2003 Share Incentive Plan, each
non-employee director is entitled to receive nonqualified stock options to
purchase 60,000 shares of common stock each year that such director is elected
to the Board of Directors. Mr. Larounis received such an award upon his election
to our Board of Directors at our 2008 Annual Meeting of Shareholders and in
November 2007, he received an additional award of stock options for his services
as a director.
Our employee directors, Denis A. Krusos and Henry P. Herms, and our
former employee director, Frank J. DiSanto, did not receive any additional
compensation for services provided as a director during fiscal 2008. The
following table sets forth compensation of George P. Larounis, our sole
non-employee director for fiscal 2008:
-------------------------------------------------------------------------------------------------
DIRECTORS COMPENSATION
-------------------------------------------------------------------------------------------------
All Other
Option Awards Compensation
Name ($) (1) ($)
-------------------------------------------------------------------------------------------------
George P. Larounis $50,866 -
-------------------------------------------------------------------------------------------------
(1) Amounts in the Option Awards column represent the dollar amounts
recognized for financial statement reporting purposes for fiscal
2008 for Mr. Larounis in accordance with Statement of Financial
Accounting Standards No. 123 (revised 2004) ("SFAS No. 123R"). A
discussion of assumptions used in valuation of option awards may
be found in Note 2 to our Consolidated Financial Statements for
the year ended October 31, 2008, included elsewhere in this Annual
Report on Form 10-K. At October 31, 2008, Mr. Larounis held
unexercised stock options to purchase 720,000 shares of our common
stock. The grant date fair value of awards to Mr. Larounis in
fiscal 2008, calculated in accordance SFAS No. 123R was $74,977.
Item 12. Security Security Ownership of Certain Beneficial Owners and
--------------------------------------------------------------
Management and Related Stockholder Matters.
-------------------------------------------
The following table sets forth certain information with respect to our
common stock beneficially owned as of January 9, 2009 by (a) each person who is
known by us to be the beneficial owner of more than 5% of our outstanding common
stock, (b) each of our directors and executive officers, and (c) all directors
and executive officers as a group:
43
- -----------------------------------------------------------------------------------------------------------
Amount and Nature of
Beneficial
Name and Address of Beneficial Owner Ownership(1)(2) Percent of Class
===========================================================================================================
Mars Overseas Limited (3) 20,000,000 14.87%
P.O. Box 309, GI Ugland House
South Church Street, George Town
Grand Cayman, Cayman Islands
- -----------------------------------------------------------------------------------------------------------
Denis A. Krusos 10,089,880 7.07%
900 Walt Whitman Road
Melville, NY 11747
- -----------------------------------------------------------------------------------------------------------
Henry P. Herms 956,575 *
900 Walt Whitman Road
Melville, NY 11747
- -----------------------------------------------------------------------------------------------------------
George P. Larounis 680,000 *
900 Walt Whitman Road
Melville, NY 11747
- -----------------------------------------------------------------------------------------------------------
All Directors and Executive Officers as a Group (3 11,726,455 8.14%
persons)
- -----------------------------------------------------------------------------------------------------------
* Less than 1%.
(1) A beneficial owner of a security includes any person who directly
or indirectly has or shares voting power and/or investment power
with respect to such security or has the right to obtain such
voting power and/or investment power within sixty (60) days.
Except as otherwise noted, each designated beneficial owner in
this report has sole voting power and investment power with
respect to the shares of our common stock beneficially owned by
such person.
(1) Includes 8,250,000 shares, 745,000 shares, 660,000 shares and
9,655,000 shares which Denis A. Krusos, Henry P. Herms, George P.
Larounis, and all directors and executive officers as a group,
respectively, have the right to acquire within 60 days upon
exercise of options granted pursuant to the 1993 Stock Option
Plan, 2000 Share Incentive Plan and the 2003 Share Incentive Plan.
(2) Based on the information provided in a Schedule 13G for such
entity filed with the Securities and Exchange Commission on
November 9, 2007.
Equity Compensation Plan Information
- ------------------------------------
The following is information as of October 31, 2008 about shares of our
common stock that may be issued upon the exercise of options, warrants and
rights under all equity compensation plans in effect as of that date, including
our 1993 Stock Option Plan, our 2000 Share Incentive Plan and our 2003 Share
Incentive Plan. See Note 8 to Consolidated Financial Statements for more
information on these plans.
44
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
Plan category warrants and rights warrants and rights column (a))
- -------------------------- ---------------------- ----------------------- --------------------------
(a) (b) (c)
Equity compensation
plans approved by
security holders 2,551,466 $0.88 21,508
Equity compensation
plans not approved by
security holders 17,217,045 $0.79 2,432,721
Total 19,768,511 $0.80 2,454,229
Item 13. Certain Relationships and Related Transactions, and Director
--------------------------------------------------------------
Independence.
-------------
Related Person Transaction Approval Policy
Our Board of Directors review and approve all transactions between us
and a related person, to the extent required by applicable rules and
regulations. Generally, management would present to the Board of Directors for
approval at the next regularly scheduled Board meeting any related person
transactions proposed to be entered into by us.
Director Independence
Our Board of Directors oversees the activities of our management in the
handling of the business and affairs of our company. None of our directors are
"independent" under the rules applicable to the Nasdaq Stock Market.
Item 14. Principal Accountant Audit Fees and Services.
---------------------------------------------
The following table describes fees for professional audit services
rendered by Grant Thornton LLP, our present independent registered public
accounting firm and principal accountant, for the audit of our annual financial
statements and for other services for the years ended October 31, 2008, and
2007.
45
Type of Fee 2008 2007
----------- ---- ----
Audit Fees $ 432,151 $ 272,620
Audit Related Fees (1) 11,644 --
Tax Fees (2) 1,000 6,098
All Other Fees -- --
--------- ----------
Total $ 444,795 $ 278,718
========= ==========
(1) Audit related fees consist of fees related to an SEC comment letter.
(2) Tax fees consist of tax consulting services.
Procedures For Board of Directors Pre-Approval of Audit and Permissible
- --------------------------------------------------------------------------------
Non-Audit Services of Independent Auditor
- -----------------------------------------
Our Board of Directors is responsible for reviewing and approving, in
advance, any audit and any permissible non-audit engagement or relationship
between us and our independent registered public accounting firm. Grant Thornton
LLP's engagement to conduct our audit was approved by the Board of Directors on
July 18, 2008. We did not enter into any non-audit engagement or relationship
with Grant Thornton LLP during fiscal 2008.
46
PART IV
Item 15. Exhibits and Financial Statement Schedules
------------------------------------------
(a)(1)(2) Financial Statement Schedules
-----------------------------
See accompanying "Index to Financial Statements."
(a)(3) Executive Compensation Plans and Arrangements
---------------------------------------------
CopyTele, Inc. 1993 Stock Option Plan (filed as Annex A to our
Proxy Statement dated June 10, 1993).
Amendment No. 1 to CopyTele, Inc. 1993 Stock Option Plan
(filed as Exhibit 4(d) to our Form S-8 dated September 6,
1995).
Amendment No. 2 to CopyTele, Inc. 1993 Stock Option Plan
(filed as Exhibit 10.32 to our Quarterly Report on Form 10-Q
for the fiscal quarter ended April 30, 1996).
CopyTele, Inc. 2000 Share Incentive Plan (filed as Annex A of
our Proxy Statement dated June 12, 2000).
Amendment No. 1 to CopyTele, Inc. 2000 Share Incentive Plan
(filed as Exhibit 10.1 to our Quarterly Report on Form 10-Q
for the fiscal quarter ended July 31, 2001).
Amendment No. 2 to CopyTele, Inc. 2000 Share Incentive Plan
(filed as Exhibit 4(e) to our Form S-8 dated September 18,
2002).
CopyTele, Inc. 2003 Share Incentive Plan (filed as Exhibit 4
to our Form S-8 dated May 5, 2003).
Amendment No. 1 to the CopyTele, Inc. 2003 Share Incentive
Plan (filed as Exhibit 4(e) to our Form S-8 dated November 9,
2004).
Amendment No. 2 to the CopyTele, Inc. 2003 Share Incentive
Plan (filed as Exhibit 10.1 to our Quarterly Report on Form
10-Q for the fiscal quarter ended January 31, 2006).
Amendment No. 3 to the CopyTele, Inc. 2003 Share Incentive
Plan (filed as Exhibit 10.2 to our Quarterly Report on Form
10-Q for the fiscal quarter ended January 31, 2006).
47
Form of Stock Option Agreement under CopyTele, Inc. 2003 Share
Incentive Plan (filed as Exhibit 10.1 to our Quarterly Report
on Form 10-Q for the fiscal quarter ended July 31, 2004).
Form of Stock Award Agreement under CopyTele, Inc. 2003 Share
Incentive Plan (filed as Exhibit 10.2 to our Quarterly Report
on Form 10-Q for the fiscal quarter ended July 31, 2004).
(b) Exhibits
--------
3.1 Certificate of Incorporation, as amended.
(Incorporated by reference to Form 10-Q for the
fiscal quarter ended July 31, 1992 and to Form 10-Q
for the fiscal quarter ended July 31, 1997.)
3.2 Amended and Restated By-laws. (Incorporated by
reference to Exhibit 3.2 to our Form 8-K dated August
4, 2008.)
10.1 CopyTele, Inc. 1993 Stock Option Plan, adopted on
April 28, 1993 and approved by shareholders on July
14, 1993. (Incorporated by reference to Proxy
Statement dated June 10, 1993.)
10.2 Amendment No. 1 to the CopyTele, Inc. 1993 Stock
Option Plan, adopted on May 3, 1995 and approved by
shareholders on July 19, 1995. (Incorporated by
reference to Form S-8 (Registration No. 33-62381)
dated September 6, 1995.)
10.3 Amendment No. 2 to the CopyTele, Inc. 1993 Stock
Option Plan, adopted on May 10, 1996 and approved by
shareholders on July 24, 1996. (Incorporated by
reference to Form 10-Q for the fiscal quarter ended
April 30, 1996.)
10.4 Agreement dated March 3, 1999 between Harris
Corporation and CopyTele, Inc. (Incorporated by
reference to Form 10-Q for the fiscal quarter ended
January 31, 1999.)
10.5 Agreement dated July 28, 1999, among CopyTele, Inc.,
Harris Corporation and RF Communications.
(Incorporated by reference to Form 8-K dated July 28,
1999.)
10.6 CopyTele, Inc. 2000 Share Incentive Plan.
(Incorporated by reference to Annex A of our Proxy
Statement dated June 12, 2000.)
10.7 Amendment No. 1 to the CopyTele, Inc. 2000 Share
Incentive Plan, adopted on July 6, 2001 and approved
by shareholders on August 16, 2001. (Incorporated by
reference to Form 10-Q for the fiscal quarter ended
July 31, 2001.)
48
10.8 Amendment No. 2 to the CopyTele, Inc. 2000 Share
Incentive Plan, adopted on July 16, 2002 and approved
by shareholders on September 12, 2002. (Incorporated
by reference to Exhibit 4(e) to our Form S-8
(Registration No. 333-99717) dated September 18,
2002.)
10.9 Amendment, dated May 10, 2001, to the Joint
Cooperation Agreement between CopyTele, Inc. and
Volga Svet Ltd. (Incorporated by reference to Exhibit
10.14 to our Form 10-K for the fiscal year ended
October 31, 2001.)
10.10 Letter Agreement between CopyTele, Inc. and Volga
Svet Ltd., dated as of February 1, 2002.
(Incorporated by reference to Exhibit 10.15 to our
Form 10-K for the fiscal year ended October 31,
2001.)
10.11 CopyTele, Inc. 2003 Share Incentive Plan.
(Incorporated by reference to Exhibit 4 to our Form
S-8 dated May 5, 2003).
10.12 Amendment No. 1 to the CopyTele, Inc. 2003 Share
Incentive Plan. (Incorporated by reference to Exhibit
4(e) to our Form S-8 dated November 9, 2004.)
10.13 Amendment No. 2 to the CopyTele, Inc. 2003 Share
Incentive Plan. (Incorporated by reference to Exhibit
10.1 to our Quarterly Report on Form 10-Q for the
fiscal quarter ended January 31, 2005).
10.14 Amendment No. 3 to the CopyTele, Inc. 2003 Share
Incentive Plan. (Incorporated by reference to Exhibit
10.2 to our Quarterly Report on Form 10-Q for the
fiscal quarter ended January 31, 2005).
10.15 Form of Stock Option Agreement under CopyTele, Inc.
2003 Share Incentive Plan. (Incorporated by reference
to Exhibit 10.1 to our Quarterly Report on Form 10-Q
for the fiscal quarter ended July 31, 2004).
10.16 Form of Stock Award Agreement under CopyTele, Inc.
2003 Share Incentive Plan. (Incorporated by reference
to Exhibit 10.2 to our Quarterly Report on Form 10-Q
for the fiscal quarter ended July 31, 2004).
10.17 Long Term Agreement dated May 23, 2007, between The
Boeing Company and CopyTele, Inc. (Incorporated by
reference to Exhibit 10.1 to our Form 8-K dated May
23, 2007.)
49
10.18 Amended and Restated Technology License Agreement,
dated May 16, 2008, between CopyTele, Inc. and
Videocon Industries Limited. (Incorporated by
reference to Exhibit 10.1 to our Quarterly Report on
Form 10-Q for the fiscal quarter ended July 31,
2008.)
10.19 Loan and Pledge Agreement, dated November 2, 2007,
Between Mars Overseas Limited and CopyTele
International Ltd. (Incorporated by reference to
Exhibit 10.5 to our Quarterly Report on Form 10-Q for
the fiscal quarter ended January 31, 2008.)
10.20 Loan and Pledge Agreement, dated November 2, 2007,
Between CopyTele International Ltd. and Mars Overseas
Limited. (Incorporated by reference to Exhibit 10.6
to our Quarterly Report on Form 10-Q for the fiscal
quarter ended January 31, 2008.)
21 Subsidiaries of CopyTele, Inc. (Filed herewith.)
23.1 Consent of Grant Thornton LLP. (Filed herewith.)
31.1 Certification of Chief Executive Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated
January 14, 2009. (Filed herewith.)
31.2 Certification of Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated
January 14, 2009. (Filed herewith.)
32.1 Statement of Chief Executive Officer, pursuant to
Section 1350 of Title 18 of the United States Code,
dated January 14, 2009. (Filed herewith.)
31.2 Statement of Chief Financial Officer, pursuant to
Section 1350 of Title 18 of the United States Code,
dated January 14, 2009. (Filed herewith.)
50
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) 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
January 14, 2009 Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the date indicated.
By: /s/ Denis A. Krusos
-------------------
Denis A. Krusos
Chairman of the Board,
Chief Executive Officer
and Director (Principal Executive
January 14, 2009 Officer)
By: /s/ Henry P. Herms
-------------------
Henry P. Herms
Vice President - Finance,
Chief Financial Officer and
Director (Principal Financial
January 14, 2009 and Accounting Officer)
By: /s/ George P. Larounis
-------------------
George P. Larounis
January 14, 2009 Director
51
COPYTELE, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 2008
Page
----
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets as of October 31, 2008 and 2007 F-2
Consolidated Statements of Operations for the years ended October 31, 2008, 2007 and 2006 F-3
Consolidated Statement of Shareholders' Equity for the years ended October 31, 2008, 2007 and 2006 F-4 - F-5
Consolidated Statements of Cash Flows for the years ended October 31, 2008, 2007 and 2006 F-6
Notes to Consolidated Financial Statements F-7 - F-27
Schedule of Valuation and Qualifying Accounts S-1
Additional information required by schedules called for under Regulation S-X is
either not applicable or is included in the financial statements or notes
thereto.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
CopyTele, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of CopyTele, Inc.
and Subsidiaries (the "Company") as of October 31, 2008 and 2007, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended October 31, 2008. Our
audits of the basic financial statements included the financial statement
schedule listed in the index appearing under Item 15 (a)(2). These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of CopyTele, Inc. and
Subsidiaries as of October 31, 2008 and 2007, and the results of their
operations and their cash flows for each of the three years in the period ended
October 31, 2008, in conformity with accounting principles generally accepted in
the United States of America. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of October 31, 2008, based on
criteria established in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our
report dated January 14, 2009 expressed an unqualified opinion thereon.
/s/ GRANT THORNTON LLP
Melville, New York
January 14, 2009
F-1
COPYTELE, INC. AND SUBSIDIARES
CONSOLIDATED BALANCE SHEETS
October 31, October 31,
ASSETS 2008 2007
-------------------- ------------- -------------
CURRENT ASSETS:
Cash and cash equivalents $ 478,599 $ 669,141
Short-term investments in certificates of deposit and U.S. government securities 1,442,484 400,000
Accounts receivable, net of allowance for doubtful accounts of $223,000 and
$-0-, respectively 103,000 120,000
Inventories 178,144 191,923
Prepaid expenses and other current assets 54,348 45,442
------------- -------------
Total current assets 2,256,575 1,426,506
INVESTMENT in U.S. government securities, noncurrent, at amortized cost 749,711 --
INVESTMENT in Videocon Industries Limited global depository receipts,
at fair value 3,619,945 --
INVESTMENT in Digital Info Security Co. Inc. common stock, at fair value and
cost, respectively 841,800 417,000
PROPERTY AND EQUIPMENT, net of accumulated depreciation and
amortization of $2,151,344 and $2,140,675, respectively 29,838 26,653
------------- -------------
$ 7,497,869 $ 1,870,159
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 384,896 $ 347,141
Accrued liabilities 69,364 331,668
Deferred revenue, non-refundable license fee 313,332 --
------------- -------------
Total current liabilities 767,592 678,809
LOAN PAYABLE TO RELATED PARTY 5,000,000 --
COMMITMENTS AND CONTINGENCIES
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;
132,497,881 and 106,911,315 shares issued and outstanding, respectively 1,324,979 1,069,113
Additional paid-in capital 109,348,894 86,088,974
Loan receivable from related party (5,000,000) --
Accumulated deficit (91,788,341) (85,966,737)
Accumulated other comprehensive loss (12,155,255) --
------------- -------------
1,730,277 1,191,350
------------- -------------
$ 7,497,869 $ 1,870,159
============= =============
The accompanying notes are an integral part of these statements.
F-2
COPYTELE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended October 31,
2008 2007 2006
------------------ ------------------ ------------------
NET REVENUE
Revenue from sales of encryption products, net $ 376,455 $ 246,852 $ 377,651
Revenue from encryption services, net -- 240,000 131,000
Display technology license fee 1,686,668 -- --
------------------ ------------------ ------------------
Total net revenue 2,063,123 486,852 508,651
------------------ ------------------ ------------------
COST AND OPERATING EXPENSES
Cost of encryption products sold 95,594 73,953 104,672
Cost of encryption services -- 86,407 51,774
Research and development expenses 4,127,393 3,403,943 4,614,300
Selling, general and administrative expenses 3,829,654 2,414,916 3,365,521
------------------ ------------------ ------------------
Total costs and operating expenses 8,052,641 5,979,219 8,136,267
------------------ ------------------ ------------------
LOSS FROM OPERATIONS (5,989,518) (5,492,367) (7,627,616)
DIVIDEND INCOME 130,886 -- --
INTEREST INCOME 37,028 34,149 26,715
------------------ ------------------ ------------------
NET LOSS $ (5,821,604) $ (5,458,218) $ (7,600,901)
================== ================== ==================
PER SHARE INFORMATION:
Net loss per share:
Basic and Diluted $ (.05) $ (.05) $ (.08)
================== ================== ==================
Shares used in computing net loss per share:
Basic and Diluted 129,490,238 103,487,032 95,291,780
================== ================== ==================
The accompanying notes are an integral part of these statements.
F-3
COPYTELE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED OCTOBER 31, 2008, 2007 AND 2006
Loan Accumulated
Receivable Other
Common Stock Additional From Compre-
--------------------------- Paid-in Related Accumulated hensive
Shares Par Value Capital Party Deficit Loss
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, October 31, 2005 91,975,538 $ 919,755 $ 73,105,886 $ -- $(72,907,618) $ --
Stock option compensation to employees -- -- 2,972,793 -- -- --
Stock option compensation to consultants -- -- 130,724 -- -- --
Common stock issued upon exercise of
stock options under stock option plans 4,147,725 41,478 2,339,021 -- -- --
Common stock issued to employees pursuant
to stock incentive plans 2,670,010 26,700 1,869,879 -- -- --
Common stock issued to consultants
pursuant to stock incentive
plans 367,122 3,671 283,453 -- -- --
Unregistered common stock issued to
Digital Info Security Co., Inc. 100,000 1,000 96,000 -- -- --
Net loss -- -- -- -- (7,600,901) --
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, October 31, 2006 99,260,395 992,604 80,797,756 -- (80,508,519) --
Stock option compensation to employees -- -- 1,080,882 -- -- --
Common stock issued upon exercise of
stock options under stock option plans 4,582,230 45,822 2,113,977 -- -- --
Common stock issued to employees pursuant
to stock incentive plans 2,528,365 25,284 1,709,657 -- -- --
Common stock issued to consultants
pursuant to stock incentive plans 240,325 2,403 179,702 -- -- --
Unregistered common stock issued to
Digital Info Security Co., Inc. 300,000 3,000 207,000 -- -- --
Net loss -- -- -- -- (5,458,218) --
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, October 31, 2007 106,911,315 $ 1,069,113 $ 86,088,974 $ -- $(85,966,737) $ --
Continued
The accompanying notes are an integral part of this statement.
F-4
COPYTELE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED OCTOBER 31, 2008, 2007 AND 2006
Continued
Loan Accumulated
Receivable Other
Common Stock Additional From Compre-
-------------------------- Paid-in Related Accumulated hensive
Shares Par Value Capital Party Deficit Loss
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, October 31, 2007 106,911,315 $ 1,069,113 $ 86,088,974 $ -- $(85,966,737) $ --
Stock option compensation to employees -- -- 2,613,731 -- -- --
Stock option compensation to consultants -- -- 216,896 -- -- --
Common stock issued upon exercise of
stock options under stock option plans 3,354,200 33,542 2,478,763 -- -- --
Common stock issued to employees pursuant
to stock incentive plans 2,142,400 21,424 1,856,067 -- -- --
Common stock issued to consultants
pursuant to stock incentive plans 89,966 900 94,463 -- -- --
Unregistered common stock issued to
Videocon Industries Limited 20,000,000 200,000 16,000,000 (5,000,000) -- --
Unrealized loss on investment in Videocon
Industries Limited global depository
receipts -- -- -- -- -- (12,580,055)
Unrealized gain on investment in Digital
Info Security Co., Inc. -- -- -- -- -- 424,800
Net loss -- -- -- -- (5,821,604) --
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, October 31, 2008 132,497,881 $ 1,324,979 $109,348,894 $ (5,000,000) $(91,788,341) $(12,155,255)
============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of this statement.
F-5
COPYTELE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended October 31,
-----------------------------------------------
2008 2007 2006
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Payments to suppliers, employees and consultants $ (3,236,351) $ (2,808,025) $ (2,398,142)
Cash received from encryption products and services 170,445 377,017 524,319
Cash received from display technology license fees 2,000,000 -- --
Dividend received 130,886 -- --
Interest received 33,152 34,149 26,715
------------- ------------- -------------
Net cash used in operating activities (901,868) (2,396,859) (1,847,108)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Disbursements to acquire Videocon Industries Limited global depository
receipts (16,200,000) -- --
Disbursements to acquire short-term investments (certificates of deposit
and U.S. government securities) (2,880,166) (825,000) (398,000)
Proceeds from maturities of short-term investments (certificates of deposit
and U.S. government securities) 1,841,000 463,000 760,776
Disbursements to acquire long-term investments (U.S. government securities) (999,525) -- --
Proceeds from sales of long-term investments (U.S. government securities) 251,565 -- --
Disbursements to acquire Digital Info Security Co., Inc. common stock -- -- (110,000)
Payments for purchases of property and equipment (13,853) (13,459) (11,024)
------------- ------------- -------------
Net cash (used in) provided by investing activities (18,000,979) (375,459) 241,752
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock to Videocon Industries Limited 16,200,000 -- --
Issuance of loan receivable from related party (5,000,000) -- --
Proceeds from issuance of loan payable to related party 5,000,000 -- --
Proceeds from exercise of stock options 2,512,305 2,159,799 2,380,499
------------- ------------- -------------
Net cash provided by financing activities 18,712,305 2,159,799 2,380,499
------------- ------------- -------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (190,542) (612,519) 775,143
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 669,141 1,281,660 506,517
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 478,599 $ 669,141 $ 1,281,660
============= ============= =============
RECONCILIATION OF NET LOSS TO NET CASH USED IN
OPERATING ACTIVITIES:
Net loss $ (5,821,604) $ (5,458,218) $ (7,600,901)
Stock option compensation to employees 2,613,731 1,080,882 2,972,793
Stock option compensation to consultants 216,896 -- 130,724
Stock awards granted to employees pursuant to stock incentive plans 1,877,491 1,734,941 1,896,579
Stock awards granted to consultants pursuant to stock incentive plans 95,363 182,105 287,124
Provision for doubtful accounts and other receivables 223,000 -- 30,287
Provision for (recovery of) slow-moving inventory reserve (19,379) -- --
Depreciation and amortization 10,669 9,889 15,072
Amortized discount on investments (U.S. government securities) (3,403) -- --
Gain on sale of investments (U.S. government securities) (1,667) -- --
Change in operating assets and liabilities:
Accounts receivable (206,000) (109,835) 21,952
Inventories 33,158 68,900 124,173
Prepaid expenses and other current assets (8,906) (2,544) 41,531
Accounts payable and accrued liabilities (224,549) 97,021 233,558
Deferred revenue 313,332 -- --
------------- ------------- -------------
Net cash used in operating activities $ (901,868) $ (2,396,859) $ (1,847,108)
============= ============= =============
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING
ACTIVITIES:
Unregistered common stock issued in connection with investment in
Digital Info Security Co., Inc. $ -- $ 210,000 $ 97,000
============= ============= =============
The accompanying notes are an integral part of these statements.
F-6
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND FUNDING
--------------------
Description of Business
- -----------------------
Our principal operations are the development, production and
marketing of thin, flat, low-voltage phosphor display technology 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.
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 addition, commencing in the fourth quarter of
fiscal 1999, we have generated cash flows from sales of our encryption products
and in May 2008 commenced receiving license fees related to our display
technology from Videocon Industries Limited, an Indian company ("Videocon")
pursuant to the License Agreement (as defined below).
During fiscal 2008, our cash used in operating activities was
approximately $902,000. This resulted from payments to suppliers, employees and
consultants of approximately $3,236,000, which was offset by cash of
approximately $170,000 received from collections of accounts receivable related
to sales of encryption products, cash received from display technology licensing
fee of $2,000,000, approximately $131,000 of dividend income received and
approximately $33,000 of interest income received. Our cash used by investing
activities during fiscal 2008 was approximately $18,001,000, which resulted from
a disbursement of $16,200,000 for the purchase of 1,495,845 global depository
receipts of Videocon (the "Videocon GDRs"), a purchase of short-term investments
consisting of certificates of deposit and U.S. government securities of
approximately $2,880,000, purchases of long-term investments consisting U.S.
government securities of approximately $999,000 and purchases of approximately
$14,000 of equipment, offset by approximately $1,841,000 received upon
maturities of short-term investments consisting of certificates of deposit and
U.S. government securities and approximately $252,000 received upon the sale of
long-term investments consisting of U.S. government securities. Our cash
provided by financing activities during fiscal 2008 was approximately
$18,712,000, which resulted from the sale of our common stock to Videocon for
$16,200,000, and cash received upon the exercise of stock options of
approximately $2,512,000. Accordingly, during fiscal 2008 our cash and cash
equivalents decreased by approximately $191,000 and our investments in
certificates of deposit and U.S. government securities increased by
approximately $1,793,000. As a result, our cash, cash equivalents, and
investments in certificates of deposit and U.S. government securities at October
31, 2008 increased to approximately $2,671,000 from approximately $1,069,000 at
the end of fiscal 2007. Our operating cash accounts are maintain at FDIC-insured
banks. Our bank accounts and certificates of deposit are maintained within FDIC
coverage limits.
Total employee compensation expense during fiscal 2008, 2007 and
2006 was approximately $5,164,000, $3,661,000 and $5,416,000, respectively.
During fiscal 2008, 2007 and 2006, a significant portion of employee
compensation consisted of the issuance of stock and stock options to employees
in lieu of cash compensation. We recorded compensation expense for the fiscal
years ended October 31, 2008, 2007 and 2006 of approximately $1,877,000,
$1,735,000 and $1,897,000, respectively, for shares of common stock issued to
employees. We recorded approximately $2,614,000, $1,081,000 and $2,973,000 of
stock-based compensation expense, related to stock options granted to employees
and directors, during the years ended October 31, 2008, 2007 and 2006,
respectively. It is managements' intention to continue to compensate employees
by issuing stock or stock options.
F-7
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We believe that our existing cash, cash equivalents, investments
in certificates of deposit, investments in U.S. government securities and
accounts receivable, together with cash flows from expected sales of our
encryption products and revenue relating to our thin, flat, low-voltage phosphor
display technology, including license fees and royalties from Videocon, and
other potential sources of cash flows, will be sufficient to enable us to
continue our marketing, production, and research and development activities.
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. The sale of additional
equity securities or convertible debt could result in dilution to our
stockholders. It is also management's intention to continue to compensate
employees by issuing stock or stock options. 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, license fees and
royalties, or otherwise) to satisfy our liquidity requirements 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 other sources of funding would be available, if needed, on
favorable terms or at all. If we cannot obtain such funds if needed, we would
need to curtail or cease some or all of our operations.
Investment in and Related Party Transactions with Videocon Industries Limited
- -----------------------------------------------------------------------------
In November 2007, we entered into a Technology License Agreement
(as amended in May 2008, the "License Agreement") with Videocon Industries
Limited, an Indian company ("Videocon"). Under the License Agreement, we provide
Videocon with a non-transferable, worldwide license of our technology for thin,
flat, low voltage phosphor displays (the "Licensed Technology"), for Videocon
(or a Videocon Group company) to produce and market products, including TVs,
incorporating displays utilizing the Licensed Technology. Under the License
Agreement, we will receive a license fee of $11 million from Videocon, payable
in installments over a 27 month period commencing in May 2008, and an agreed
upon royalty from Videocon based on display sales by Videocon. In April 2008,
the Indian Government approved the License Agreement and in May 2008, we
received the first installment of the license fee of $2 million.
Under the License Agreement, Videocon, with our assistance, is to
provide the design and process engineering required to produce such display
modules, and also is to provide all tooling and fixtures required for the
production process. As part of our assistance to Videocon to produce such
display modules, we have been exchanging information with Videocon employees so
that they may understand the CopyTele technology. We are currently cooperating
with Videocon to jointly implement the CopyTele technology prior to production,
to produce prototypes of the modules. CopyTele and Videocon are also working
together to incorporate advancements to our display technology. Improvements to
the technology, when and if available, are to be jointly owned by CopyTele and
Videocon. Significant improvements, as defined in the License Agreement, may
result in additional compensation to CopyTele. CopyTele has determined that any
improvements which are not significant in nature are inconsequential.
The arrangement with Videocon also provides for each of the
parties to designate an advisor to the other party's Board of Directors. The
purpose of the advisor to the Board of Directors is to provide knowledge to the
Board of the display market and to apprise the Board of developments in this
market. CopyTele believes this to be inconsequential to the operation of the
License Agreement.
F-8
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Under the License Agreement we continue to have the right to
produce and market products utilizing our technology. We also continue to have
the right to utilize Volga Svet Ltd., a Russian display company that we have
been working with for more than eleven years ("Volga"), and an Asian company
that CopyTele has been working with for more than five years, to produce and
market, products utilizing the Licensed Technology. Additional licenses of the
Licensed Technology to third parties require the joint agreement of CopyTele and
Videocon.
In November 2007, we also entered into a Share Subscription
Agreement (the "Subscription Agreement") with Mars Overseas Limited, an
affiliate of Videocon ("Mars Overseas"). Under the Subscription Agreement, Mars
Overseas purchased 20,000,000 shares of our common stock (the "CopyTele Shares")
from us for an aggregate purchase price of $16,200,000, which was determined by
management to approximate fair market value. The purchase of the CopyTele Shares
pursuant to the Subscription Agreement closed in November 2007.
Also in November 2007, our wholly-owned British Virgin Islands
subsidiary, CopyTele International Ltd. ("CopyTele International"), entered into
a GDR Purchase Agreement (the "Purchase Agreement") with Global EPC Ventures
Limited ("Global"), for CopyTele International to purchase the Videocon GDRs
from Global, acquired by Global on the open market for an aggregate purchase
price of $16,200,000, which was determined by management to approximate fair
market value. Videocon's global depository receipts are listed on the Luxembourg
Stock Exchange. The purchase of the Videocon GDRs pursuant to the Purchase
Agreement closed in December 2007.
For the purpose of effecting a lock up of the Videocon GDRs and
CopyTele Shares (collectively, the "Securities") for a period of seven years,
and therefore restricting both parties from selling or transferring the
Securities during such period, CopyTele International and Mars Overseas entered
into two Loan and Pledge Agreements in November 2007. The Videocon GDRs are to
be held as security for a loan in principal amount of $5,000,000 from Mars
Overseas to CopyTele International, and the CopyTele Shares are similarly held
as security for a loan in principal amount of $5,000,000 from CopyTele
International to Mars Overseas. The loans are for a term of seven years and do
not bear interest. Prepayment of each loan requires payment of a premium by the
borrower and, in any event, the lien on the Securities securing the prepaid loan
will not be released until the seventh anniversary of the closing of the loans
and the prepaid amount would be held in escrow until such date. The loan
agreements required the parties to enter into an escrow agreement under which
the parties deposited the Securities with an escrow agent for the term of the
loans. The loan agreements also provide for customary events of default which
may result in forfeiture of the Securities by the defaulting party. The loan and
escrow agreements also provide for the transfer to the respective parties, free
and clear of any encumbrances under the agreements, any dividends,
distributions, rights or other proceeds or benefits received by the escrow agent
in respect of the Securities. The closing of the loans took place in December
2007. The loan receivable from Mars Overseas is classified as a contra-equity
under Shareholders' Equity in the accompanying consolidated balance sheet,
because the loan receivable is secured by the CopyTele Shares and the
Subscription Agreement and Loan and Pledge Agreement were entered into
concurrently.
F-9
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Investment in Videocon
----------------------
Our investment in Videocon is classified as an
"available-for-sale security" and reported at fair value, with unrealized gains
and losses excluded from operations and reported as a component of accumulated
other comprehensive income, net of the related tax effects, in shareholders'
equity. Cost is determined using the specific identification method. The fair
value of the Videocon GDRs is based on the price on the Luxembourg Stock
Exchange, which price is based on the underlying price of Videocon's equity
shares which are traded on stock exchanges in India with prices quoted in
rupees. The cost, unrealized loss and fair value of our investment in Videocon
as of October 31, 2008 are as follows:
October 31, 2008
----------------
Cost $ 16,200,000
Unrealized loss (12,580,055)
----------------
Fair Value $ 3,619,945
================
Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt or Equity Securities", requires an
evaluation to determine if the decline in fair value of an investment is either
temporary or other than temporary. Unless evidence exists to support a
realizable value equal to or greater than the cost of the investment, a
write-down accounted for as a realized loss should be recorded. We assess at
each reporting period our investment in Videocon to determine if a decline that
is other than temporary has occurred. In evaluating the realizable value of the
investment in Videocon, consideration was given to the Loan and Pledge Agreement
with Mars Overseas, which requires CopyTele to hold the Videocon GDRs in escrow
for seven years from the purchase closing date of December 2007 as security for
the loan from Mars Overseas to CopyTele International. Videocon's financial
condition and its future potential in both its Consumer Electronics & Home
Appliances segment and its Crude Oil & Natural Gas segment are also evaluated.
On this basis, we have determined that a write-down for a realized loss was not
required as of October 31, 2008.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
Basis of Presentation
- ---------------------
The consolidated financial statements include the accounts of
CopyTele, Inc. and its wholly owned subsidiaries, CopyTele International and
CopyTele Marketing Inc. ("CopyTele Marketing"). CopyTele International and
CopyTele Marketing were incorporated in the British Virgin Islands on July 12,
2007 and September 5, 2007, respectively. CopyTele International was formed for
the purpose of holding an investment in global depository receipts of Videocon.
As of October 31, 2008, CopyTele Marketing was inactive. All intercompany
transactions have been eliminated in consolidation.
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.
We have assessed the guidance of Emerging Issues Task Force No.
00-21 "Revenue Arrangements with Multiple Deliverables" ("EITF 00-21") to
determine whether multiple deliverables in our arrangement with Videocon
represent separate units of accounting. Under the License Agreement, CopyTele is
required to: (a) disclose to Videocon the Licensed Technology and provide
reasonable training of Videocon personnel; (b) jointly cooperate with Videocon
to produce prototypes prior to production; and (c) assist Videocon in preparing
for production. CopyTele has determined that these performance obligations do
not have value to Videocon on a standalone basis, as defined in EITF 00-21, and
accordingly they do not represent separate units of accounting.
F-10
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We have established objective and reasonable evidence of fair
value for the royalty to be earned during the production period based on
analysis of the pricing for similar agreements. Accordingly, we have determined
that the license fee of $11 million to be paid during the pre-production period
and royalties on product sales reflects the established fair value for these
deliverables. We will recognize the $11 million license fee over the estimated
period that we expect to provide cooperation and assistance during the
pre-production period, limiting the revenue recognized on a cumulative basis to
the aggregate license fee payments received from Videocon. We will assess at
each reporting period the progress and assistance provided and will continue to
evaluate the period during which this fee will be recognized. On this basis, we
have recognized license fee revenue during the year ended October 31, 2008 of
approximately $1,687,000. License fee payments received from Videocon which are
in excess of the amounts recognized as revenue (approximately $313,000 as of
October 31, 2008) are recorded as non-refundable deferred revenue on the
accompanying consolidated balance sheet.
Warranty Policy
- ---------------
We warrant that our products are free from defects in material
and workmanship for a period of one year from the date of initial purchase. The
warranty does not cover any losses or damage that occur as a result of improper
installation, misuse or neglect. Management has recorded a nominal amount of
warranty liability as of October 31, 2008 and 2007, based upon historical
experience and management's best estimate of future warranty claims.
Statements of Cash Flows
- ------------------------
Cash and cash equivalents consist of highly liquid instruments
that are readily convertible into cash and have original maturities of less than
one year. During the years ended October 31, 2008, 2007 and 2006, we did not pay
any interest on U.S. Federal or state income taxes.
Short-term investments and investments in U.S. government securities
- --------------------------------------------------------------------
Short-term investments represent certificates of deposit and U.S.
government securities with maturities of less than twelve months. Noncurrent
investments in U.S. government securities represent securities with maturities
of more than twelve months. Each of the investments are carried at amortized
cost as management has the intention and ability to hold these to maturity.
Fair Value of Financial Instruments
- -----------------------------------
In the opinion of management, the carrying value of all financial
instruments, consisting primarily of cash and cash equivalents, short-term
investments, accounts and other receivables and accounts payable, reflected in
the accompanying balance sheets, approximates fair value as of October 31, 2008
and 2007, due to their short term nature. Noncurrent investments in U.S.
Government securities approximates fair value as of October 31, 2008, based on
current market prices.
F-11
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Accounts Receivable
- -------------------
Accounts receivable are stated at amounts due from customers net
of an allowance for doubtful accounts. Management reviews our accounts
receivable for potential doubtful accounts and maintains an allowance for
estimated uncollectible amounts. Accounts receivable are written off when we
determine that they become uncollectible.
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. 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.
Property and Equipment
- ----------------------
Property and equipment, consisting primarily of engineering
equipment, is stated at cost less accumulated depreciation. Depreciation is
calculated on a straight-line basis over the estimated useful lives of the
related assets, primarily five years. We capitalize items in excess of $500.
Minor replacements and maintenance and repair items are charged to expense as
incurred. Upon disposal or retirement of assets, the cost and related
accumulated depreciation are removed from our balance sheet.
Investment Securities
- ---------------------
We classify our investment securities in one of two categories:
available-for-sale or held-to-maturity. Available-for-sale securities are
recorded at fair value. Unrealized gains and losses, net of the related tax
effect, on available-for-sale securities are excluded from earnings and are
reported as a component of accumulated other comprehensive income (loss) until
realized. Realized gains and losses from the sale of available-for-sale
securities are determined on a specific identification basis. Held-to-maturity
securities, which are Investment securities that the company has the intent and
ability to hold to maturity, are carried at amortized cost. The amortization of
premiums and accretion of discounts are recorded on the level yield (interest)
method, over the period from the date of purchase to maturity. When sales do
occur, gains and losses are recognized at the time of sale and the determination
of cost of securities sold is based upon the specific identification method.
Dividend and interest income are recognized when earned.
We monitor the value of our investments for indicators of
impairment, including changes in market conditions and the operating results of
the underlying investment that may result in the inability to recover the
carrying value of the investment. We will record an impairment charge if and
when we believe any such investment has experienced a decline that is other than
temporary.
Research and Development Expenses
- ---------------------------------
Research and development expenses are expensed in the year
incurred.
Advertising Expense
- -------------------
Advertising expense is included in the accompanying statements of
operations in selling, general and administrative expenses in the year incurred.
Advertising expense for the years ended October 31, 2008, 2007 and 2006, was
approximately $3,000, $2,000, and $27,000, respectively.
F-12
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Income Taxes
- ------------
We recognize deferred tax assets and liabilities for the
estimated future tax effects of events that have been recognized in our
financial statements or tax returns. Under this method, deferred tax assets and
liabilities are determined based on the difference between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect in the years in which the differences are expected to reverse. A
valuation allowance is established, when necessary, to reduce deferred tax
assets to the amount expected to be realized.
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.
Stock Option Compensation Expense
- ---------------------------------
We account for stock options granted to employees and directors
using SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No.123R"). We
recognize compensation expense for stock option awards on a straight-line basis
over the requisite service period of the grant. We recorded stock-based
compensation expense, related to stock options granted to employees and
non-employee directors, of approximately $2,614,000, $1,081,000 and $2,973,000
during the years ended October 31, 2008, 2007 and 2006, respectively, in
accordance with SFAS No. 123R. Such compensation expense is included in the
accompanying statements of operations 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 increased both basic and diluted net loss per share for the
years ended October 31, 2008, 2007 and 2006 by $0.02, $0.01 and $0.03,
respectively.
Included in the stock-based compensation cost related to stock
options granted to employees and directors recorded during the years ended
October 31, 2008, 2007 and 2006 was approximately $-0-, $26,000 and $19,000,
respectively, of expense related to the amortization of compensation cost for
stock options granted in prior periods but not yet vested. As of October 31,
2008, there was approximately $197,000 of unrecognized compensation cost related
to non-vested share-based compensation arrangements for stock options granted to
employees and directors. Due to discontinuation of the optionee's service,
non-vested stock options representing approximately $163,000 of this
unrecognized compensation cost were cancelled in November 2008. Approximately
$34,000 of the remaining unrecognized cost is expected to be amortized during
fiscal 2009.
We also account for stock options granted to consultants using
SFAS No. 123R. We recognized consulting expense for options granted to
non-employee consultants, during the years ended October 31, 2008, 2007 and
2006, of approximately $217,000, $-0- and $131,000, respectively. Such
consulting expense is included in the accompanying consolidated statements of
operations in either research and development expenses or selling, general and
administrative expenses, as applicable based on the functions performed by such
consultants. As of October 31, 2008, there was approximately $13,000 of
unrecognized consulting expense related to non-vested share-based compensation
arrangements for stock options granted to consultants which is expected to be
amortized during fiscal 2009.
F-13
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value Determination
------------------------
In accordance with SFAS No. 123R, we estimate the fair value of
stock options granted to employees, non-employee directors and consultants on
the date of grant using the Black-Scholes pricing model. We separate 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 on the date of grant,
we take a weighted average of the assumptions used for each of these groups.
Stock options we granted during the year ended October 31, 2008 consisted of
awards of options with 10-year terms which vested either immediately or over
future periods of from three months to three years. All of the stock options we
granted during the years ended October 31, 2007 and 2006 consisted of awards of
options with either 5-year terms, which vested over one year, or 10-year terms,
which vested immediately.
We estimated the fair value of stock option awards using the
following assumptions:
For the Year Ended October 31,
----------------------------------
2008 2007 2006
-------- -------- --------
Expected term (in years) 3.4 3.0 2.9
Volatility 90% 92% 98%
Risk-free interest rate 3.07% 4.64% 4.38%
Dividend yield 0 0 0
Weighted average fair value at grant date $0.53 $0.37 $0.43
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
Staff Accounting Bulletin No. 107, "Share-Based Payment" ("SAB 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 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. In December 2007, the
Securities and Exchange Commission ("SEC") staff issued Staff Accounting
Bulletin No. 110, "Share-Based Payment" ("SAB 110"). SAB 110 permits the use of
the simplified method in SAB 107 for employee option grants after December 31,
2007 for companies whose historical data about their employees' exercise
behavior does not provide a reasonable basis for estimating the expected term of
the options. We have adopted SAB 110 and continued to use the simplified method
to estimate the expected term for options granted after December 2007, as
adequate historical experience is not available to provide a reasonable
estimate. We intend to continue applying the simplified method until enough
historical experience is readily available to provide a reasonable estimate of
the expected term for employee option grants.
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.
F-14
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We estimated the risk-free interest rate based on the implied
yield available on the applicable grant date of a U.S. Treasury note with a term
equal to 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 reduce 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.
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.
Net Loss Per Share of Common Stock
- ----------------------------------
In accordance with SFAS No. 128, "Earnings Per Share" ("SFAS No.
128"), basic net loss per common share ("Basic EPS") is computed by dividing net
loss by the weighted average number of common shares outstanding. Diluted net
loss per common share ("Diluted EPS") is computed by dividing net loss by the
weighted average number of common shares and dilutive common share equivalents
and convertible securities then outstanding. Diluted EPS for all years presented
is the same as Basic EPS, as the inclusion of the effect of common share
equivalents then outstanding would be anti-dilutive. For this reason, excluded
from the calculation of Diluted EPS for the years ended October 31, 2008, 2007
and 2006, were options to purchase 19,768,511 shares, 19,272,711 shares and
22,527,941 shares, respectively.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Estimates and assumptions are
used for, but not limited to, determining the allowance for doubtful accounts,
inventory obsolescence, depreciation lives, asset impairment evaluations, tax
assets and liabilities, license fee revenue, stock-based compensation and other
contingencies. Actual results could differ from those estimates.
Reclassifications
- -----------------
Certain prior year amounts have been reclassified to conform with
current year presentation.
Effect of Recently Issued Pronouncements
- ----------------------------------------
In June 2006, the FASB issued FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes," an interpretation of FASB
Statement No. 109 ("FIN 48"). FIN 48 clarifies the accounting for uncertainties
in income taxes recognized in an enterprise's financial statements. The
interpretation requires that the Company determine whether it is more likely
than not that a tax position will be sustained upon examination by the
appropriate taxing authority. If a tax position meets the more likely than not
recognition criteria, FIN 48 requires the tax position be measured at the
largest amount of benefit greater than 50 percent likely of being realized upon
ultimate settlement. This accounting standard is effective for fiscal years
beginning after December 15, 2006. We adopted FIN 48 on November 1, 2007. There
were no unrecognized tax benefits as of the date of our adoption of FIN 48 and
as of October 31, 2008. The adoption of FIN 48 did not have a material effect on
our consolidated financial statements.
F-15
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements" ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value under generally accepted accounting
principles, and expands disclosures about fair value measurements. SFAS No. 157
emphasizes that fair value is a market-based measurement, not an entity-specific
measurement, and states that a fair value measurement should be determined based
on the assumptions that market participants would use in pricing the asset or
liability. In February 2008, the FASB issued FASB Staff Position ("FSP") No. FAS
157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and Other
Accounting Pronouncements That Address Fair Value Measurements for Purposes of
Lease Classification or Measurement under Statement 13," and FSP No. FAS 157-2,
"Effective Date of FASB Statement No. 157." Collectively, these Staff Positions
allow a one-year deferral of adoption of SFAS No. 157 for nonfinancial assets
and liabilities that are recognized or disclosed at fair value in the financial
statements on a non-recurring basis and amend SFAS No. 157 to exclude FASB
Statement No. 13 and its related interpretive accounting pronouncements that
address leasing transactions. We adopted SFAS No. 157 on November 1, 2008,
except for non financial assets and liabilities measured at fair value on a
non-recurring basis, which will be effective for us November 1, 2009. The
adoption of SFAS No. 157 on November 1, 2008 did not have a material effect on
our consolidated financial statements. The adoption of the deferred portion of
SFAS No. 157 is not expected to have a material effect on our consolidated
financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities" ("SFAS No. 159"). SFAS
No. 159 expands opportunities to use fair value measurement in financial
reporting and permits entities to choose to measure many financial instruments
and certain other items at fair value. SFAS No. 159 is effective for fiscal
years beginning after November 15, 2007. We adopted SFAS No. 159 on November 1,
2008. The adoption of SFAS No. 159 did not have a material effect on our
consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
"Business Combinations" ("SFAS No. 141R"), which changes how an entity accounts
for the acquisition of a business. When effective, SFAS No. 141R will replace
existing SFAS No. 141, "Business Combinations" ("SFAS No. 141"), in its
entirety. SFAS No. 141R carries forward the existing requirements to account for
all business combinations using the acquisition method (formerly called the
purchase method). In general, SFAS No. 141R will require acquisition-date fair
value measurement of identifiable assets acquired, liabilities assumed, and
noncontrolling interest in the acquired entity. SFAS No. 141R will eliminate the
current cost-based purchase method under SFAS No. 141. SFAS No. 141R is
effective for fiscal years and interim periods within those fiscal years
beginning on or after December 15, 2008. The adoption of SFAS No. 141R is not
expected to have a material effect on our consolidated financial statements.
F-16
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements, an amendment of ARB No. 51"
("SFAS No. 160"). SFAS No. 160 establishes accounting and reporting standards
for the noncontrolling interests in a subsidiary and for the deconsolidation of
a subsidiary. SFAS No. 160 is effective for fiscal years and interim periods
within those fiscal years beginning on or after December 15, 2008. The adoption
of SFAS No. 160 is not expected to have a material effect on our consolidated
financial statements.
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 fiscal 2008, one
customer in the Display Technology Segment represented 82% of total net revenue.
During fiscal 2007, two customers in the Encryption Products and Services
Segment represented 49% and 29%, respectively, of total net revenue. During
fiscal 2006, two customers in the Encryption Products and Services Segment
represented 40% and 26% of total net revenue. At October 31, 2008 and 2007, one
customer in the Encryption Products and Services Segment represented 100% of net
accounts receivable.
4. SHORT-TERM INVESTMENTS AND INVESTMENT IN U.S. GOVERNMENT
-----------------------------------------------------------------
SECURITIES
----------
At October 31, 2008 and 2007, we had marketable securities that
were classified as "held-to-maturity securities" and were carried at amortized
costs. Held-to-maturity securities consist of the following:
October 31, October 31,
2008 2007
---------- ----------
Current:
U.S. Government securities $ 999,484 $ --
Certificates of deposit 443,000 400,000
---------- ----------
Total current held-to-maturity securities $1,442,484 $ 400,000
========== ==========
Noncurrent:
U.S. Government securities $ 749,711 $ --
---------- ----------
Total noncurrent held-to-maturity securities $ 749,711 $ --
========== ==========
Total held-to-maturity securities $2,192,195 $ 400,000
========== ==========
At October 31, 2008, the length of time until maturity of current
held-to-maturity securities was less than twelve months and the length of time
until maturity of noncurrent held-to-maturity securities was fifteen months. At
October 31, 2008, and October 31, 2007, the estimated fair value of each
investment approximated its amortized cost, and, therefore, there were no
significant unrecognized holding gains or losses.
5. INVESTMENT IN AND RELATED PARTY TRANSACTIONS WITH DIGITAL INFO
-----------------------------------------------------------------
SECURITY CO., INC.
------------------
In February 2006, we entered into a Software License and
Distribution Agreement (the "DISC License Agreement") to license to Digital Info
Security Co. Inc. ("DISC"), an encryption system that integrates our encryption
technology into DISC's e-mail services. The system allows companies to encrypt
all e-mail transactions in a manner transparent to the individual user.
Concurrently with entering into the DISC License Agreement with DISC, we
acquired a minority interest in DISC by exchanging 100,000 unregistered shares
of our common stock for 5,000,000 shares of DISC's common stock. In May and July
2006, we purchased an additional 1,000,000 shares and 1,200,000 shares,
respectively, of DISC's common stock for $50,000 and $60,000 in cash,
respectively. In November 2006, we acquired an additional 5,000,000 shares of
DISC's common stock in exchange for 300,000 unregistered shares of our common
stock. Accordingly, as of October 31, 2008, we held 12,200,000 shares of DISC's
common stock, all of which were restricted securities. DISC's common stock is
not registered under the Securities Exchange Act of 1934, but is quoted on the
Pink Sheets. Based on the number of DISC shares outstanding as set forth in
DISC's June 30, 2008 public financial report, the most recent available, as of
October 31, 2008 we held approximately 11% of the outstanding common stock of
DISC.
F-17
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The DISC stock held by CopyTele is restricted stock and cannot be
sold or otherwise disposed of in the absence of either a registration statement
under the Securities Act of 1933 ("Securities Act") or an exemption from the
registration provisions of the Securities Act. For CopyTele to sell or dispose
of the DISC stock under the exemption provided by Rule 144 under the Securities
Act, all of the requirements of Rule 144 must be satisfied.
As of October 31, 2007, all of the requirements of Rule 144 were
not satisfied for CopyTele to sell or dispose of the DISC stock held by us.
Accordingly, as of October 31, 2007, our investment in DISC was recorded in the
accompanying consolidated balance sheet at cost of $417,000, based on the
closing price of our common stock on the dates we acquired DISC common stock in
exchange for our common stock, and the price paid for the shares purchased for
cash. Because CopyTele now believes it may sell or dispose of the DISC stock
pursuant to Rule 144, as of October 31, 2008, our investment in DISC is
classified as an "available-for-sale security" in the accompanying condensed
consolidated financial statements and reported at fair value, with unrealized
gains and losses excluded from operations and reported as a component of
accumulated other comprehensive income, net of the related tax effects, in
shareholders' equity. The cost, unrealized gain and fair value of our investment
in DISC as of October 31, 2008 are as follows:
October 31, 2008
--------------------------
Cost $ 417,000
Unrealized gain 424,800
--------------------------
Fair Value $ 841,800
==========================
Net revenue for the years ended October 31, 2007 and 2006
included billings to DISC for engineering services of $240,000 and $131,000,
respectively. We had no net revenue relating to DISC for the year ended October
31, 2008. Net accounts receivable at October 31, 2008 and October 31, 2007
include $-0- and $120,000, respectively, from DISC.
6. INVENTORIES
-----------
Inventories consist of the following as of:
October 31,
---------------------------
2008 2007
-------- --------
Component parts $ 67,853 $113,458
Work-in-process 5,079 26,597
Finished products 105,212 51,868
-------- --------
$178,144 $191,923
======== ========
F-18
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. ACCRUED LIABILITIES
-------------------
Accrued liabilities consist of the following as of:
October 31,
-------------------
2008 2007
-------- --------
Accrued professional fees $ 18,451 $ 24,600
Accrued payroll and related expenses 35,545 289,564
Accrued other 15,368 17,504
-------- --------
$ 69,364 $331,668
======== ========
8. SHAREHOLDERS' EQUITY
--------------------
Common Stock Issuances
- ----------------------
We account for stock grants to employees and consultants based on
their grant date fair value. During the years ended October 31, 2008, 2007 and
2006, we issued 2,142,400 shares, 2,528,365 shares and 2,670,010 shares,
respectively, of common stock to certain employees for services rendered,
principally in lieu of cash compensation, 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 recorded compensation expense for the
years ended October 31, 2008, 2007 and 2006 of approximately $1,877,000,
$1,735,000 and $1,897,000, respectively, for shares of common stock issued to
employees. In addition during fiscal 2008, 2007 and 2006, we issued 89,966
shares, 240,325 shares and 367,122 shares, respectively, of common stock to
consultants for services rendered pursuant to the 2003 Share Plan. We recorded
consulting expense for the years ended October 31, 2008, 2007 and 2006 of
approximately $95,000, $182,000 and $287,000, respectively, for shares of common
stock issued to consultants.
During the year ended October 31, 2008, we issued 20,000,000
shares of unregistered common stock to Mars Overseas in exchange for cash.
During the years ended October 31, 2007 and 2006, we issued 300,000 shares and
100,000 shares, respectively, of unregistered common stock to acquire Digital
Info Security Co., Inc. common stock.
Preferred Stock
---------------
On May 29, 1986, our shareholders authorized 500,000 shares of
preferred stock with a par value of $100 per share. The shares of preferred
stock may be issued in series at the direction of the Board of Directors, and
the relative rights, preferences and limitations of such shares will all be
determined by the Board of Directors. As of October 31, 2008 and 2007, there was
no preferred stock issued and outstanding.
Stock Option Plans
- ------------------
As of October 31, 2008, we have three stock option plans: the
CopyTele, Inc. 1993 Stock Option Plan (the "1993 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.
On July 14, 1993, our shareholders approved the 1993 Plan. The
1993 Plan was amended as of May 3, 1995 and May 10, 1996 to, among other things,
increase the number of shares available for issuance thereunder from 6,000,000
shares to 20,000,000 shares, after giving consideration to stock splits. The
1993 Plan provided for the granting of incentive stock options and stock
appreciation rights to key employees, and non-qualified stock options and stock
appreciation rights to key employees and consultants of the Company.
F-19
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The 1993 Plan was administered by the Stock Option Committee,
which determined the option price, term and provisions of each option. However,
the purchase price of shares issuable upon the exercise of incentive stock
options could not be less than the fair market value of such shares at the date
of grant and incentive stock options are not exercisable for more than 10 years.
Upon approval of the 2000 Share Plan by our shareholders in July 2000, the 1993
Plan was terminated with respect to the grant of future options. Since June
2004, the 1993 Plan has been administered by the Board of Directors.
Information regarding the 1993 Plan for the three years ended
October 31, 2008 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
Expired (2,551,580) $5.05
------------
Shares Under Option at October 31, 2006 4,167,000 $3.13
Expired (1,553,000) $4.46
------------
Shares Under Option at October 31, 2007 2,614,000 $2.33
Expired (1,830,000) $2.86
Exercised (5,000) $1.31
============
Shares Under Option and Exercisable at
October 31, 2008 779,000 $1.10 $-0-
============
The following table summarizes information about stock options
outstanding under the 1993 Plan as of October 31, 2008:
Options Outstanding and Exercisable
-----------------------------------
Weighted
Average Weighted
Range of Number Remaining Average
Exercise Prices Outstanding Contractual Life Exercise Price
------------------------------ ----------------------- --------------------- ----------------------
$0.84 to $1.00 575,000 1.04 $0.99
$1.13 to $1.56 204,000 1.04 $1.41
The exercise price with respect to 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.
On July 25, 2000, our shareholders approved the 2000 Share Plan.
The maximum number of shares of common stock that may be granted was 5,000,000
shares. On July 6, 2001 and July 16, 2002, the 2000 Share Plan was amended by
our Board of Directors to increase the maximum number of shares of common stock
that may be granted to 10,000,000 shares and 15,000,000 shares, respectively.
These amendments were approved by our shareholders on August 16, 2001 and
September 12, 2002, respectively. The 2000 Share Plan provides for the grant of
incentive stock options, nonqualified stock options, stock appreciation rights,
stock awards, performance awards and stock units to key employees and
consultants of the Company.
F-20
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The 2000 Share Plan was administered by the Stock Option
Committee through June 2004 and since that date has been administered by the
Board of Directors, which determines the option price, term and provisions of
each option; however, the purchase price of shares issuable upon the exercise of
incentive stock options will not be less than the fair market value of such
shares at the date of grant and incentive stock options will not be exercisable
for more than 10 years.
Information regarding the 2000 Share Plan for the three years
ended October 31, 2008 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
Expired (20,000) $0.74
Exercised (500,000) $0.42
------------
Shares Under Option at October 31, 2006 2,268,466 $0.80
Exercised (86,000) $0.39
------------
Shares Under Option at October 31, 2007 2,182,466 $0.82
Exercised ( 410,000) $0.95
Shares Under Option and Exercisable at
October 31, 2008 1,772,466 $0.79 $35,600
============
The following table summarizes information about stock options
outstanding under the 2000 Share Plan as of October 31, 2008:
Options Outstanding and Exercisable
-----------------------------------
Weighted
Average Weighted
Range of Number Remaining Average
Exercise Prices Outstanding Contractual Life Exercise Price
------------------------------ ----------------------- --------------------- ----------------------
$0.40 445,000 2.88 $0.40
$0.69 505,466 2.17 $0.69
$0.94 - $1.09 822,000 1.92 $1.06
The exercise price with respect to 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 October 31, 2008,
21,508 shares were available for future grants under the 2000 Share Plan.
The 2003 Share Plan provides for the grant of nonqualified stock
options, stock appreciation rights, stock awards, performance awards and stock
units to key employees and consultants of the Company. The maximum number of
shares of common stock available for issuance under the 2003 Share Plan
initially was 15,000,000 shares. On October 8, 2004, February 9, 2006 and August
22, 2007, the 2003 Plan was amended by our Board of Directors to increase the
maximum number of shares of common stock that may be granted to 30,000,000
shares, 45,000,000 shares and 55,000,000 shares, respectively. Current and
future non-employee directors are automatically granted nonqualified stock
options to purchase 60,000 shares of common stock upon their initial election to
the Board of Directors and at the time of each subsequent annual meeting of our
shareholders at which they are elected to the Board of Directors. The 2003 Share
Plan was administered by the Stock Option Committee through June 2004 and since
that date has been administered by the Board of Directors, which determines the
option price, term and provisions of each option.
F-21
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information regarding the 2003 Share Plan for the three years
ended October 31, 2008 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 7,235,000 $0.76
Exercised (3,647,725) $0.59
------------
Shares Under Option at October 31, 2006 16,092,475 $0.68
Granted 2,880,000 $0.66
Exercised (4,496,230) $0.47
------------
Shares Under Option at October 31, 2007 14,476,245 $0.74
Expired (60,000) $0.84
Granted 5,740,000 $0.88
Exercised (2,939,200) $0.72
Shares Under Option at October 31, 2008
17,217,045 $0.79 $173,100
------------
Options Exercisable at October 31, 2008 16,807,045 $0.79 $173,100
============
The following table summarizes information about stock options
outstanding under the 2003 Share Plan as of October 31, 2008:
Options Outstanding Options Exercisable
--------------------------- -------------------------
Weighted Weighted
Average Weighted Average Weighted
Range of Number Remaining Average Number Remaining Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Contractual Life Exercise Price
- -------------------- ----------------- ------------------- ---------------- ------------- ------------------ ----------------
$0.25 - $0.43 1,170,000 4.95 $0.33 1,170,000 4.95 $0.33
$0.52 - $0.77 5,920,970 6.94 $0.63 5,920,970 6.94 $0.63
$0.80 - $1.46 10,126,075 7.41 $0.94 9,716,075 7.40 $0.93
The exercise price with respect to 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 October 31, 2008,
2,432,721 shares were available for future grants under the 2003 Share Plan.
9. COMMITMENTS AND CONTINGENCIES
-----------------------------
Leases
- ------
We lease space at our principal location for office and
laboratory research facilities. The current lease is for approximately 12,000
square feet and expires on November 30, 2011. The lease contains base rentals of
approximately $279,000 per annum with a 3% annual increase and an escalation
clause for increases in certain operating costs. As of October 31, 2008, our
noncancelable operating lease commitments are approximately $909,000.
F-22
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Rent expense for the years ended October 31, 2008, 2007 and 2006,
was approximately $278,000, $269,000 and $261,000, respectively.
Litigation Matters
- ------------------
We are not a party to any material pending legal proceedings. We
are party to claims, and complaints that arise in the ordinary course of
business. We believe that any liability that may ultimately result from the
resolution of these matters will not, individually or in the aggregate, have a
material adverse effect on our financial position or results of operations.
Consulting Agreement
- --------------------
In addition, as of October 31, 2008 we had commitments under a
consulting agreement of $170,000, payable during the first quarter of fiscal
2009.
10. EMPLOYEE PENSION PLAN
---------------------
We adopted a qualified noncontributory defined contribution
pension plan, effective November 1, 1983, covering all of our present employees.
Contributions, which are made to a trust and have been funded on a current
basis, are based upon specified percentages of compensation, as defined in the
plan. During fiscal 2001, we amended the plan to suspend benefit accruals as of
November 1, 2000. Accordingly, we did not incur any pension expense for the
fiscal years ended October 31, 2008, 2007 and 2006.
11. INCOME TAXES
------------
Income tax provision (benefit) consists of the following:
Year Ended October 31,
-----------------------------------------
2008 2007 2006
----------- ----------- -----------
Federal:
Current $ -- $ -- $ --
Deferred 1,953,000 (1,505,000) (2,309,000)
State:
Current -- --
Deferred 1,392,000 4,393,000 (340,000)
Adjustment to valuation allowance related
to net deferred tax assets (3,345,000) (2,888,000) 2,649,000
----------- ----------- -----------
$ -- $ -- $ --
=========== =========== ===========
F-23
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The tax effects of temporary differences that give rise to
significant portions of the deferred tax asset, net, at October 31, 2008 and
2007, are as follows:
2008 2007
------------ ------------
Long-term deferred tax assets:
Barter Credits $ -- $ 999,000
Federal and state NOL and tax credit carryforwards 32,734,000 35,435,000
Unrealized loss on available for sale securities 4,140,000 --
Deferred Compensation 1,710,000 1,357,000
Other 252,000 250,000
------------ ------------
Subtotal 38,836,000 38,041,000
Less: valuation allowance (38,836,000) (38,041,000)
------------ ------------
Deferred tax asset, net $ -- $ --
============ ============
As of October 31, 2008, we had tax net operating loss and tax
credit carryforwards of approximately $90,387,000 and $1,838,000, respectively,
available, within statutory limits (expiring at various dates between 2009 and
2028), to offset any future regular Federal corporate taxable income and taxes
payable. If the tax benefits relating to deductions of option holders' income
are ultimately realized, those benefits will be credited directly to additional
paid-in capital. Certain changes in stock ownership can result in a limitation
on the amount of net operating loss and tax credit carryovers that can be
utilized each year.
We had tax net operating loss and tax credit carryforwards of
approximately $90,251,000 and $111,000, respectively, as of October 31, 2008,
available, within statutory limits, to offset future New York State corporate
taxable income and taxes payable, if any, under certain computations of such
taxes. The tax net operating loss carryforwards expire at various dates between
2008 and 2027 and the tax credit carryforwards expire between 2009 and 2023.
We have provided a valuation allowance against our deferred tax
asset due to our current and historical pre-tax losses and the uncertainty
regarding their realizability. The primary differences from the Federal
statutory rate of 34% and the effective rate of 0% is attributable to certain
permanent differences and a change in the valuation allowance. The tax benefit
related to the initial recognition of the deferred tax asset for the unrealized
loss on available for sale securities is reduced to zero with an increase to the
valuation allowance. During the year ended October 31, 2008, the $4,140,000
deferred tax asset unrealized loss on available for sale securities is reduced
by a full valuation allowance as a component of accumulated other comprehensive
income.
The following is a reconciliation of income taxes at the Federal
statutory tax rate to income tax expense (benefit):
Year Ended October 31,
----------------------------------------------------------------------------------
2008 2007 2006
---------------------- ---------------------- ----------------------
Income tax benefit at U.S.
Federal statutory income $(2,012,000) 34% $(1,854,000) 34% $(2,584,000) 34%
tax rate
State income taxes (4,000) .07% (88,000) 1.62% (464,000) 6.10%
Permanent differences 304,000 (5.14%) (228,000) 4.19% (49,000) (.64%)
Credits (119,000) 2.02% (117,000) 2.15% (100,000) 1.31%
Expiring net operating
losses and credits 3,798,000 (64.19%) 728,000 (13.35%) 548,000 (7.21%)
Change in New York State
tax rate 1,378,000 (23.29%) 4,447,000 (81.56%) - 0%
Change in valuation
allowance (3,345,000) 56.53% (2,888,000) 52.95% 2,649,000 (34.84%)
------------ ----------- ---------
Income tax provision $ - 0% $ - 0% $ - 0%
======= ======= =======
During the three years ended October 31, 2008, we incurred no
Federal and no State income taxes. We account for interest and penalties related
to income tax matters in selling, general and administrative expenses.
On November 1, 2007, we adopted FASB 48. FIN 48 clarifies the
accounting for uncertainties in income taxes recognized in an enterprise's
financial statements. There were no unrecognized tax benefits as of the date of
our adoption of FIN 48 and as of October 31, 2008. The adoption of FIN 48 did
not have a material effect on our consolidated financial statements.
F-24
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. 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) Display
Technology and (ii) Encryption Products and Services. The following represents
selected financial information for our segments for the years ended October 31,
2008, 2007 and 2006:
Encryption
Products
Display and
Segment Data Technology Services Total
- ----------------------------- ----------- ----------- -----------
Year Ended October 31, 2008:
Net revenue $ 1,686,668 $ 376,455 $ 2,063,123
Net loss (2,424,638) (3,396,966) (5,821,604)
Stock option compensation to
employees and consultants 1,479,494 1,351,133 2,830,627
Stock awards granted to
employees and consultants
pursuant to stock incentive
plans 891,013 1,081,841 1,972,854
Total assets 4,926,222 2,571,647 7,497,869
Investment in Videocon 3,619,945 -- 3,619,945
Investment in DISC -- 841,800 841,800
Additions to property and
equipment 6,568 7,285 13,853
F-25
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Encryption
Products
Display and
Segment Data Technology Services Total
- ----------------------------- ----------- ----------- -----------
Year Ended October 31, 2007:
Net revenue $ -- $ 486,852 $ 486,852
Net loss (2,932,179) (2,526,039) (5,458,218)
Stock option compensation to
employees and consultants 499,688 581,194 1,080,882
Stock awards granted to
employees and consultants
pursuant to stock incentive
plans 800,119 1,116,927 1,917,046
Total assets 547,409 1,322,750 1,870,159
Investment in DISC -- 417,000 417,000
Additions to property and
equipment 6,456 7,003 13,459
Year Ended October 31, 2006:
Net revenue $ -- $ 508,651 $ 508,651
Net loss (3,570,993) (4,029,908) (7,600,901)
Stock option compensation to
employees and consultants 1,336,373 1,767,144 3,103,517
Stock awards granted to
employees and consultants
pursuant to stock incentive
plans 885,893 1,297,810 2,183,703
Total assets 619,590 1,244,039 1,863,629
Investment in DISC -- 207,000 207,000
Additions to property and
equipment 4,951 6,073 11,024
F-26
COPYTELE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Geographic Information
- ----------------------
We generate revenue both domestically (United States) and
internationally. International revenue is based on the country in which our
customer (distributor) is located. For the years ended October 31, 2008, 2007
and 2006, and as of each respective year-end, revenue and accounts receivable by
geographic area are as follows:
Geographic Data 2008 2007 2006
- ----------------------------- ---------- ---------- ----------
Net revenue:
United States $ 121,030 $ 447,940 $ 269,221
United Arab Emirates 4,655 -- 204,325
Other International 250,770 38,912 35,105
India 1,686,668 -- --
---------- ---------- ----------
$2,063,123 $ 486,852 $ 508,651
========== ========== ==========
Accounts receivable, net:
United States $ -- $ 120,000 $ 9,040
International 103,000 -- 1,125
---------- ---------- ----------
$ 103,000 $ 120,000 $ 10,165
========== ========== ==========
13. QUARTERLY RESULTS AND SEASONALITY (UNAUDITED)
---------------------------------------------
The following table sets forth unaudited financial data for each
of our last eight fiscal quarters:
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ----------- ----------- -----------
Year Ended October 31, 2008:
Income Statement Data:
Net revenue $ 52,225 $ 165,355 $ 882,130 $ 963,413
Cost and operating expenses 2,744,757 2,143,467 1,623,512 1,540,905
Net loss (2,685,325) (1,841,351) (729,166) (565,762)
Net loss per share of common stock-
basic and diluted $ (0.02) $ (0.01) $ (0.01) $ (0.00)
Year Ended October 31, 2007:
Income Statement Data:
Net revenue $ 130,750 $ 96,427 $ 114,000 $ 145,675
Cost and operating expenses 1,913,838 1,536,538 1,176,773 1,352,070
Net loss (1,773,434) (1,431,896) (1,055,521) (1,197,367)
Net loss per share of common stock-
basic and diluted $ (0.02) $ (0.01) $ (0.01) $ (0.01)
F-27
COPYTELE, INC. AND SUSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
FOR THE FISCAL YEARS ENDED OCTOBER 31, 2008, 2007 AND 2006
- ------------------------------------- ------------- -------------------- ----------------- -----------------
Column A Column B Column C Column D Column E
- ------------------------------------- ------------- -------------------- ----------------- -----------------
Balance at Additions
beginning Charged to costs Balance at
Description of period and expenses Deductions (1) end of period
- ------------------------------------- ------------- -------------------- ----------------- -----------------
- ------------------------------------- ------------- -------------------- ----------------- -----------------
2008
Allowance for doubtful accounts $ - $ 223,000 $ - $ 223,000
Reserve against other receivables $ 171,798 $ 6,000 $ ( 177,798) $ -
- ------------------------------------- ------------- -------------------- ----------------- -----------------
- ------------------------------------- ------------- -------------------- ----------------- -----------------
2007
Allowance for doubtful accounts $ - $ - $ - $ -
Reserve against other receivables $ 171,798 $ - $ - $ 171,798
- ------------------------------------- ------------- -------------------- ----------------- -----------------
- ------------------------------------- ------------- -------------------- ----------------- -----------------
2006
Allowance for doubtful accounts $ - $ - $ - $ -
Reserve against other receivables $ 141,511 $ 30,287 $ - $ 171,798
- ------------------------------------- ------------- -------------------- ----------------- -----------------
(1) Represents write-offs to reserved balances or reductions in allowances previously provided.
This schedule should be read in conjunction with the accompanying financial statements and notes thereto.
S-1
EXHIBIT INDEX
-------------
No. Exhibit
--- -------
3.1 Certificate of Incorporation, as amended.
(Incorporated by reference to Form 10-Q for the
fiscal quarter ended July 31, 1992 and to Form 10-Q
for the fiscal quarter ended July 31, 1997.)
3.2 Amended and Restated By-laws. (Incorporated by
reference to Exhibit 3.2 to our Form 8-K dated August
4, 2008.)
10.1 CopyTele, Inc. 1993 Stock Option Plan, adopted on
April 28, 1993 and approved by shareholders on July
14, 1993. (Incorporated by reference to Proxy
Statement dated June 10, 1993.)
10.2 Amendment No. 1 to the CopyTele, Inc. 1993 Stock
Option Plan, adopted on May 3, 1995 and approved by
shareholders on July 19, 1995. (Incorporated by
reference to Form S-8 (Registration No. 33-62381)
dated September 6, 1995.)
10.3 Amendment No. 2 to the CopyTele, Inc. 1993 Stock
Option Plan, adopted on May 10, 1996 and approved by
shareholders on July 24, 1996. (Incorporated by
reference to Form 10-Q for the fiscal quarter ended
April 30, 1996.)
10.4 Agreement dated March 3, 1999 between Harris
Corporation and CopyTele, Inc. (Incorporated by
reference to Form 10-Q for the fiscal quarter ended
January 31, 1999.)
10.5 Agreement dated July 28, 1999, among CopyTele, Inc.,
Harris Corporation and RF Communications.
(Incorporated by reference to Form 8-K dated July 28,
1999.)
10.6 CopyTele, Inc. 2000 Share Incentive Plan.
(Incorporated by reference to Annex A of our Proxy
Statement dated June 12, 2000.)
10.7 Amendment No. 1 to the CopyTele, Inc. 2000 Share
Incentive Plan, adopted on July 6, 2001 and approved
by shareholders on August 16, 2001. (Incorporated by
reference to Form 10-Q for the fiscal quarter ended
July 31, 2001.)
10.8 Amendment No. 2 to the CopyTele, Inc. 2000 Share
Incentive Plan, adopted on July 16, 2002 and approved
by shareholders on September 12, 2002. (Incorporated
by reference to Exhibit 4(e) to our Form S-8
(Registration No. 333-99717) dated September 18,
2002.)
10.9 Amendment, dated May 10, 2001, to the Joint
Cooperation Agreement between CopyTele, Inc. and
Volga Svet Ltd. (Incorporated by reference to Exhibit
10.14 to our Form 10-K for the fiscal year ended
October 31, 2001.)
10.10 Letter Agreement between CopyTele, Inc. and Volga
Svet Ltd., dated as of February 1, 2002.
(Incorporated by reference to Exhibit 10.15 to our
Form 10-K for the fiscal year ended October 31,
2001.)
10.11 CopyTele, Inc. 2003 Share Incentive Plan.
(Incorporated by reference to Exhibit 4 to our Form
S-8 dated May 5, 2003).
10.12 Amendment No. 1 to the CopyTele, Inc. 2003 Share
Incentive Plan. (Incorporated by reference to Exhibit
4(e) to our Form S-8 dated November 9, 2004).
10.13 Amendment No. 2 to the CopyTele, Inc. 2003 Share
Incentive Plan. (Incorporated by reference to Exhibit
10.1 to our Quarterly Report on Form 10-Q for the
fiscal quarter ended January 31, 2005).
10.14 Amendment No. 3 to the CopyTele, Inc. 2003 Share
Incentive Plan. (Incorporated by reference to Exhibit
10.2 to our Quarterly Report on Form 10-Q for the
fiscal quarter ended January 31, 2005).
10.15 Form of Stock Option Agreement under CopyTele, Inc.
2003 Share Incentive Plan (Incorporated by reference
to Exhibit 10.1 to our Quarterly Report on Form 10-Q
for the fiscal quarter ended July 31, 2004).
10.16 Form of Stock Award Agreement under CopyTele, Inc.
2003 Share Incentive Plan (Incorporated by reference
to Exhibit 10.2 to our Quarterly Report on Form 10-Q
for the fiscal quarter ended July 31, 2004).
10.17 Long Term Agreement dated May 23, 2007, between The
Boeing Company and CopyTele, Inc. (Incorporated by
reference to Exhibit 10.1 to our Form 8-K dated May
23, 2007.)
10.18 Amended and Restated Technology License Agreement,
dated May 16, 2008, between CopyTele, Inc. and
Videocon Industries Limited. (Incorporated by
reference to Exhibit 10.1 to our Quarterly Report on
Form 10-Q for the fiscal quarter ended July 31,
2008.)
10.19 Loan and Pledge Agreement, dated November 2, 2007,
Between Mars Overseas Limited and CopyTele
International Ltd. (Incorporated by reference to
Exhibit 10.5 to our Quarterly Report on Form 10-Q for
the fiscal quarter ended January 31, 2008.)
10.20 Loan and Pledge Agreement, dated November 2, 2007,
Between CopyTele International Ltd. and Mars Overseas
Limited. (Incorporated by reference to Exhibit 10.6
to our Quarterly Report on Form 10-Q for the fiscal
quarter ended January 31, 2008.)
21 Subsidiaries of CopyTele, Inc. (Filed herewith.)
23.1 Consent of Grant Thornton LLP. (Filed herewith.)
31.1 Certification of Chief Executive Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated
January 14, 2009. (Filed herewith.)
31.2 Certification of Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated
January 14, 2009. (Filed herewith.)
32.1 Statement of Chief Executive Officer, pursuant to
Section 1350 of Title 18 of the United States Code,
January 14, 2009. (Filed herewith.)
31.2 Statement of Chief Financial Officer, pursuant to
Section 1350 of Title 18 of the United States Code,
January 14, 2009. (Filed herewith.)