SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2007
Commission file number 0-11254
COPYTELE, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 11-2622630
- -------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification no.)
900 Walt Whitman Road
Melville, NY 11747
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(631) 549-5900
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes __X__ No ___
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ X ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes ___ No __X__
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
On September 12, 2007, the registrant had outstanding 105,280,755 shares of
Common Stock, par value $.01 per share, which is the registrant's only class of
common stock.
TABLE OF CONTENTS
-----------------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets as of July 31, 2007
(Unaudited) and October 31, 2006 3
Condensed Consolidated Statements of Operations (Unaudited) for
the nine months ended July 31, 2007 and 2006 4
Condensed Consolidated Statements of Operations (Unaudited) for
the three months ended July 31, 2007 and 2006 5
Condensed Consolidated Statements of Cash Flows (Unaudited) for
the nine months ended July 31, 2007 and 2006 6
Notes to Condensed Consolidated Financial Statements (Unaudited) 7 - 18
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 19 - 30
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 30
Item 4. Controls and Procedures. 31
PART II. OTHER INFORMATION
Item 1A. Risk Factors. 31
Item 6. Exhibits. 31
SIGNATURES 32
2
PART I. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements.
---------------------
COPYTELE, INC.
--------------
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
(Unaudited)
--------------
July 31, October 31,
ASSETS 2007 2006*
------ -------------- --------------
CURRENT ASSETS:
Cash and cash equivalents $ 652,765 $ 1,281,660
Short-term investments 400,000 38,000
Accounts receivable 60,000 10,165
Inventories 214,489 260,823
Prepaid expenses and other current assets 41,099 32,011
-------------- --------------
Total current assets 1,368,353 1,622,659
PROPERTY AND EQUIPMENT, net 24,154 23,083
INVESTMENT, at cost 417,000 207,000
OTHER ASSETS 10,887 10,887
-------------- --------------
$ 1,820,394 $ 1,863,629
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 243,927 $ 532,707
Accrued liabilities 76,416 49,081
-------------- --------------
Total current liabilities 320,343 581,788
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; 104,913,375
and 99,260,395 shares issued and outstanding,
respectively 1,049,134 992,604
Additional paid-in capital 85,220,287 80,797,756
Accumulated deficit (84,769,370) (80,508,519)
-------------- --------------
1,500,051 1,281,841
-------------- --------------
$ 1,820,394 $ 1,863,629
============== ==============
* Derived from audited balance sheet included in our Annual Report on Form 10-K
for the fiscal year ended October 31, 2006.
The accompanying notes are an integral part of these condensed balance sheets.
3
COPYTELE, INC.
--------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
-----------------------------------------------------------
For the Nine Months Ended
July 31,
------------------------------
2007 2006
-------------- -------------
NET SALES $ 341,177 $ 397,773
COST OF SALES 113,765 120,558
-------------- -------------
Gross profit 227,412 277,215
-------------- -------------
OPERATING EXPENSES
Research and development expenses 2,589,936 3,582,867
Selling, general and administrative expenses 1,923,448 2,514,218
-------------- -------------
Total operating expenses 4,513,384 6,097,085
-------------- -------------
LOSS FROM OPERATIONS (4,285,972) (5,819,870)
INTEREST INCOME 25,121 20,159
-------------- -------------
NET LOSS $ (4,260,851) $ (5,799,711)
============== =============
PER SHARE INFORMATION:
Net loss per share:
Basic and Diluted $ (0.04) $ (0.06)
============== =============
Shares used in computing net loss per share:
Basic and Diluted 102,422,570 94,551,079
============== =============
The accompanying notes are an integral part of these condensed statements.
4
COPYTELE, INC.
--------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
-----------------------------------------------------------
For the Three Months Ended
July 31,
------------------------------
2007 2006
-------------- -------------
NET SALES $ 114,000 $ 130,845
COST OF SALES 36,962 39,245
-------------- -------------
Gross profit 77,038 91,600
-------------- -------------
OPERATING EXPENSES
Research and development expenses 670,722 1,312,472
Selling, general and administrative expenses 469,089 933,854
-------------- -------------
Total operating expenses 1,139,811 2,246,326
-------------- -------------
LOSS FROM OPERATIONS (1,062,773) (2,154,726)
INTEREST INCOME 7,252 7,451
-------------- -------------
NET LOSS $ (1,055,521) $ (2,147,275)
============== =============
PER SHARE INFORMATION:
Net loss per share:
Basic and Diluted $ (0.01) $ (0.02)
============== =============
Shares used in computing net loss per share:
Basic and Diluted 104,121,311 95,985,622
============== =============
The accompanying notes are an integral part of these condensed statements.
5
COPYTELE, INC.
--------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
-----------------------------------------------------------
For the Nine Months Ended
July 31,
-----------------------------
2007 2006
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Payments to suppliers, employees and consultants $ (2,182,027) $ (1,920,582)
Cash received from customers 291,342 404,123
Interest received 25,121 20,159
------------- -------------
Net cash used in operating activities (1,865,564) (1,496,300)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of short-term
investments (certificates of deposit) 463,000 400,776
Disbursements to acquire short-term investments
(certificates of deposit) (825,000) (398,000)
Disbursements to acquire Digital Info Security
Co., Inc. common stock - (110,000)
Payments for purchases of property and equipment (8,781) (10,226)
------------- -------------
Net cash used in investing activities (370,781) (117,450)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 1,607,450 1,718,499
------------- -------------
Net cash provided by financing activities 1,607,450 1,718,499
------------- -------------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (628,895) 104,749
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,281,660 506,517
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 652,765 $ 611,266
============= =============
RECONCILIATION OF NET LOSS TO NET CASH USED IN
OPERATING ACTIVITIES:
Net loss $ (4,260,851) $ (5,799,711)
Stock option compensation to employees 1,074,504 2,469,563
Stock option compensation to consultants - 119,262
Stock awards granted to employees and consultants
pursuant to stock incentive plans 1,587,108 1,586,647
Provision for doubtful accounts and other
receivables - 18,287
Depreciation and amortization 7,709 11,616
Change in operating assets and liabilities:
Accounts receivable (49,835) 12,637
Inventories 46,334 103,889
Prepaid expenses and other current assets (9,088) 44,062
Other assets - (6,287)
Accounts payable and accrued liabilities (261,445) (56,265)
------------- -------------
Net cash used in operating activities $ (1,865,564) $ (1,496,300)
============= =============
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING
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 condensed statements.
6
COPYTELE, INC.
--------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
(UNAUDITED)
-----------
1. BUSINESS AND FUNDING
--------------------
Description of Business and Basis of Presentation
- -------------------------------------------------
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.
The condensed consolidated financial statements are unaudited, and have
been prepared in accordance with accounting principles generally accepted in the
United States of America ("US GAAP") for interim financial reporting, and with
the rules and regulations of the Securities and Exchange Commission regarding
interim financial reporting. Accordingly, they do not include all of the
information and footnotes required by US GAAP for complete financial statements.
The information contained herein is for the nine-month and three-month periods
ended July 31, 2007 and 2006. In management's opinion, all adjustments
(consisting only of normal recurring adjustments considered necessary for a fair
presentation of the results of operations for such periods) have been included
herein. Certain prior year amounts have been reclassified to conform with
current year presentation.
The condensed consolidated financial statements include the accounts of
CopyTele, Inc. and its wholly owned subsidiary, CopyTele International, Ltd.
CopyTele International, Ltd. was incorporated in the British Virgin Islands on
July 12, 2007, and as of July 31, 2007 was inactive. All significant
intercompany accounts and transactions have been eliminated in consolidation.
The results of operations for interim periods presented are not necessarily
indicative of the results that may be expected for a full year or any interim
period. Reference is made to the audited financial statements and notes thereto
included in our Annual Report on Form 10-K for the fiscal year ended October 31,
2006, for more extensive disclosures than contained in these condensed financial
statements.
Funding and Management's Plans
- ------------------------------
From our inception, we have met our liquidity and capital expenditure needs
primarily through the proceeds from sales of common stock in our initial public
offering, in private placements, upon exercise of warrants issued in connection
with the private placements and public offering, and upon the exercise of stock
options. In 2001 and 2002, we also received payments under a technology
development agreement. In addition, commencing in fiscal 1999, we have generated
cash flows from sales of our encryption products.
7
During the nine months ended July 31, 2007, our cash used in operating
activities was approximately $1,866,000. This resulted from payments to
suppliers, employees and consultants of approximately $2,182,000, which was
offset by cash of approximately $291,000 received from collections of accounts
receivable related to sales of encryption products and services, and
approximately $25,000 of interest income received. Our cash used in investing
activities during the nine months ended July 31, 2007 was approximately
$371,000, which resulted from purchases of short-term investments consisting of
certificates of deposit of approximately $825,000 and purchases of approximately
$9,000 of equipment, offset by approximately $463,000 received upon maturities
of short-term investments consisting of certificates of deposit. Our cash
provided by financing activities during the nine months ended July 31, 2007 of
approximately $1,607,000 resulted from cash received upon the exercise of stock
options. Accordingly, during the nine months ended July 31, 2007, our cash and
cash equivalents decreased by approximately $629,000 and our short-term
investments increased by approximately $362,000. As a result, our cash, cash
equivalents, and short-term investments, at July 31, 2007 decreased to
approximately $1,053,000 from approximately $1,320,000 at the end of fiscal
2006.
We are seeking to improve our liquidity through increased sales or license
of products and technology. In an effort to generate sales, we have marketed our
encryption products directly to U.S. and international distributors, dealers and
original equipment manufacturers that market our encryption products and to
end-users. We have been working with several large organizations to provide them
with both our hardware and software encryption solutions for them to evaluate
whether the solutions meet their security requirements and have begun supplying
several major U.S. companies with our encryption products. We are also
continuing to pursue marketing and licensing opportunities for our display
technology. As of July 31, 2007, we had not yet recorded any revenue from sales
or licensing of our display. During the nine-month period ended July 31, 2007,
we recognized revenue from sales of encryption products and services of
approximately $341,000.
We believe that our existing cash, cash equivalents, short-term investments
and accounts receivable, together with cash flows from expected sales of
encryption products and flat panel displays, and other potential sources of cash
flows, will be sufficient to enable us to continue in operation until at least
the end of the third quarter of fiscal 2008. We anticipate that, thereafter, we
will require additional funds to continue our marketing, production, and
research and development activities, and we will require outside funding if cash
generated from operations is insufficient to satisfy our liquidity requirements.
However, our projections of future cash needs and cash flows may differ from
actual results. If current cash and cash that may be generated from operations
are insufficient to satisfy our liquidity requirements, we may seek to sell debt
or equity securities or to obtain a line of credit prior to the third quarter of
fiscal 2008. The sale of additional equity securities or convertible debt could
result in dilution to our stockholders. We currently have no arrangements with
respect to additional financing. There can be no assurance that we will generate
sufficient revenues in the future (through sales or otherwise) to improve our
liquidity or sustain future operations, that our production capabilities will be
adequate, that other products will not be produced by other companies that will
render our products obsolete, or that 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.
8
The auditor's report on our financial statements as of October 31, 2006
states that the net loss incurred during the year ended October 31, 2006, our
accumulated deficit as of that date, and the other factors described in Note 1
to the Financial Statements included in our Annual Report on Form 10-K for the
year ended October 31, 2006, raise substantial doubt about our ability to
continue as a going concern. The auditor's report on our financial statements
for the year ended October 31, 2005 contained a similar statement. Our financial
statements have been prepared assuming we will continue as a going concern and
do not include any adjustments that might result from the outcome of this
uncertainty.
2. STOCK-BASED COMPENSATION
------------------------
We maintain stock equity incentive plans under which we may grant
non-qualified stock options, incentive stock options, stock appreciation rights,
stock awards, performance and performance-based awards, or stock units to
employees, non-employee directors and consultants.
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004),
"Share-Based Payment" ("SFAS No. 123R") which addresses the accounting for
share-based payment transactions in which a company receives employee services
in exchange for either equity instruments of the company or liabilities that are
based on the fair value of the company's equity instruments or that may be
settled by the issuance of such equity instruments. In March 2005, the
Securities and Exchange Commission issued Staff Accounting Bulletin No. 107
("SAB No. 107") relating to SFAS No. 123R. We account for stock options granted
to employees and directors using SFAS No. 123R. We recognize compensation
expense for stock option awards on a straight-line basis over the requisite
service period of the grant.
Stock Option Compensation Expense
- ---------------------------------
We recorded stock-based compensation expense related to stock options
granted to employees and non-employee directors of approximately $1,075,000 and
$2,470,000 for the nine-month periods ended July 31, 2007 and 2006,
respectively, and of approximately $88,000 and $952,000 for the three-month
periods ended July 31, 2007 and 2006, respectively, in accordance with SFAS No.
123R. Such compensation expense is included in the accompanying condensed
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 nine-month periods
ended July 31, 2007 and 2006 by $0.01 and $0.03, respectively, and for the
three-month periods ended July 31, 2007 and 2006 by $0.00 and $0.01,
respectively.
Expense related to the amortization of compensation cost for stock options
granted prior to but not yet vested as of the end of the prior fiscal year,
included in the stock-based compensation cost related to stock options granted
to employees and directors, was approximately $19,000 and $14,000 for the
nine-month periods ended July 31, 2007 and 2006, respectively, and approximately
$6,000 and $5,000 for the three-month periods ended July 31, 2007 and 2006,
respectively. As of July 31, 2007, there was approximately $6,000 of total
unrecognized compensation cost related to non-vested share-based compensation
arrangements. This unrecognized cost is expected to be fully amortized over the
remaining portion of the current fiscal year.
9
We account for options granted to consultants using the fair value method
required by SFAS No. 123R. We recognized consulting expense for options granted
to consultants, during the nine-month periods ended July 31, 2007 and 2006, of
approximately $-0- and $119,000, respectively, and during the three-month
periods ended July 31, 2007 and 2006, of approximately $-0- and $97,000,
respectively. Such consulting expense is included in the accompanying condensed
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.
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. All of the
stock options we granted during the nine-month periods ended July 31, 2007 and
2006 consisted of awards of options with 10-year terms which vested immediately.
We estimated the fair value of stock option awards using the following
assumptions:
For the Nine For the Three
Months Ended Months Ended
July 31, July 31,
--------------- ---------------
2007 2006 2007 2006
------- ------- ------- -------
Expected term (in years) 3.0 3.0 1.5 4.3
Volatility 92% 99% 78% 104%
Risk-free interest rate 4.64% 4.36% 4.87% 4.37%
Dividend yield 0 0 0 0
Weighted average fair value at grant date $0.37 $0.47 $0.22 $0.55
The expected term of stock options represents the weighted average period
the stock options are expected to remain outstanding. Because we consider our
options to be "plain vanilla", we estimated the expected term using a modified
version of the simplified method of calculation, as prescribed by SAB No. 107.
This modified calculation uses the actual life for options that have been
settled, and a uniform distribution assumption for the options still
outstanding. Under SAB No. 107, options are considered to be "plain vanilla" if
they have the following basic characteristics: granted "at-the-money";
exercisability is conditioned upon service through the vesting date; termination
of service prior to vesting results in forfeiture; limited exercise period
following termination of service; and options are non-transferable and
non-hedgeable.
10
We estimated the expected volatility of our shares of common stock based
upon the historical volatility of our share price over a period of time equal to
the expected life of the options.
We estimated the risk-free interest rate based on the implied yield
available on the applicable grant date 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 estimate 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.
Stock Option Activity
- ---------------------
During the nine-month periods ended July 31, 2007 and 2006, we granted
options to purchase 2,880,000 shares and 5,460,000 shares, respectively, to
employees, non-employee directors and consultants of common stock at weighted
average exercise prices of $.66 and $.82 per share, respectively, pursuant to
the CopyTele, Inc. 2003 Share Incentive Plan (the "2003 Share Plan"). During the
nine-month periods ended July 31, 2007 and 2006, stock options to purchase
2,997,230 shares and 2,697,725 shares, respectively, of common stock were
exercised with aggregate proceeds of approximately $1,607,000 and $1,718,000,
respectively.
Stock Option Plans
- ------------------
As of July 31, 2007, we have three stock option plans: the CopyTele, Inc.
1993 Stock Option Plan (the "1993 Plan"), the CopyTele, Inc. 2000 Share
Incentive Plan (the "2000 Share Plan") and the 2003 Share Plan, which were
adopted by our Board of Directors on April 28, 1993, May 8, 2000 and April 21,
2003, respectively.
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.
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.
11
Information regarding the 1993 Plan for the nine months ended July 31, 2007
is as follows:
Current Weighted Aggregate
Average Exercise Intrinsic
Shares Price Per Share Value
----------- ---------------- ---------
Shares Under Option at October 31, 2006 4,167,000 $3.13
Expired (1,553,000) $4.46
-----------
Shares Under Option and Exercisable at
July 31, 2007 2,614,000 $2.33 $-0-
-----------
The following table summarizes information about stock options outstanding
under the 1993 Plan as of July 31, 2007:
Options Outstanding Options Exercisable
----------------------------------- -----------------------------------
Weighted Weighted
Average Weighted Average Weighted
Number Remaining Average Number Remaining Average
Range of Outstanding Contractual Exercise Exercisable Contractual Exercise
Exercise Prices at 7/31/07 Life Price at 7/31/07 Life Price
- -----------------------------------------------------------------------------------------
$0.84 to $1.56 784,000 2.29 $1.10 784,000 2.29 $1.10
$2.28 855,000 .95 $2.28 855,000 .95 $2.28
$3.38 975,000 0.28 $3.38 975,000 0.28 $3.38
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.
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.
12
Information regarding the 2000 Share Plan for the nine months ended July
31, 2007 is as follows:
Aggregate
Current Weighted ---------
Average Exercise Intrinsic
Shares Price Per Share Value
----------- ---------------- ---------
Shares Under Option at October 31, 2006 2,268,466 $0.80
Exercised (66,000) $0.41 $24,720
-----------
Shares Under Option and Exercisable at
July 31, 2007 2,202,466 $0.81 $-0-
-----------
The following table summarizes information about stock options outstanding
under the 2000 Share Plan as of July 31, 2007:
Options Outstanding Options Exercisable
----------------------------------- -----------------------------------
Weighted Weighted
Average Weighted Average Weighted
Number Remaining Average Number Remaining Average
Range of Outstanding Contractual Exercise Exercisable Contractual Exercise
Exercise Prices at 7/31/07 Life Price at 7/31/07 Life Price
- -----------------------------------------------------------------------------------------
$0.34 - $0.40 465,000 3.97 $0.40 465,000 3.97 $0.40
$0.69 635,466 3.42 $0.69 635,466 3.42 $0.69
$0.94 - $1.09 1,102,000 3.19 $1.06 1,102,000 3.19 $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 July 31, 2007, 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, 45,000,00
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.
13
Information regarding the 2003 Share Plan for the nine months ended July
31, 2007 is as follows:
Aggregate
Current Weighted ---------
Average Exercise Intrinsic
Shares Price Per Share Value
------------ ---------------- ---------
Shares Under Option at October 31, 2006 16,092,475 $0.68
Granted 2,880,000 $0.66
Exercised (2,931,230) $0.54 $462,285
------------
Shares Under Option at July 31, 2007 16,041,245 $0.70 $-0-
------------
Options Exercisable at July 31, 2007 15,981,245 $0.70 $-0-
------------
The following table summarizes information about stock options outstanding
under the 2003 Share Plan as of July 31, 2007:
Options Outstanding Options Exercisable
----------------------------------- -----------------------------------
Weighted Weighted
Average Weighted Average Weighted
Number Remaining Average Number Remaining Average
Range of Outstanding Contractual Exercise Exercisable Contractual Exercise
Exercise Prices at 7/31/07 Life Price at 7/31/07 Life Price
- -----------------------------------------------------------------------------------------
$0.25 - $0.46 2,505,000 6.02 $0.29 2,505,000 6.02 $0.29
$0.52 - $0.77 6,125,170 7.97 $0.63 6,065,170 8.00 $0.63
$0.81 - $1.07 7,411,075 7.99 $0.91 7,411,075 7.99 $0.91
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 July 31, 2007, 758,027 shares
were available for future grants under the 2003 Share Plan.
Stock Grants
- ------------
We account for stock awards granted to employees and consultants based on
their grant date fair value. During the nine-month periods ended July 31, 2007
and 2006, we issued 2,191,730 shares and 1,695,050 shares, respectively, of
common stock to certain employees for services rendered, principally in lieu of
cash compensation, pursuant to the 2003 Share Plan and the 2000 Share Plan. We
recorded compensation expense for the nine-month periods ended July 31, 2007 and
2006 of approximately $1,473,000 and $1,342,000, respectively, and for the
three-month periods ended July 31, 2007 and 2006 of approximately $404,000 and
$583,000, respectively, for the shares of common stock issued to employees. In
addition, during the nine-month periods ended July 31, 2007 and 2006, we issued
164,020 shares and 293,360 shares, respectively, of common stock to consultants
for services rendered pursuant to the 2003 Share Plan. We recorded consulting
expense for the nine-month periods ended July 31, 2007 and 2006 of approximately
$114,000 and $245,000, respectively, and for the three-month periods ended July
31, 2007 and 2006 of approximately $9,000 and $35,000, respectively, for the
shares of common stock issued to consultants.
14
3. CONCENTRATION OF CREDIT RISK
----------------------------
Financial instruments that potentially subject us to concentrations of
credit risk consist principally of accounts receivable from sales in the
ordinary course of business. Management reviews our accounts receivable and
other receivables for potential doubtful accounts and maintains an allowance for
estimated uncollectible amounts. Generally, no collateral is received from
customers for our accounts receivable. During the nine months ended July 31,
2007, two customers in the Encryption Products and Services Segment represented
53% and 25%, respectively, of total net sales. During the nine months ended July
31, 2006, two customers in the Encryption Products and Services Segment
represented 51% and 24%, respectively, of total net sales. At July 31, 2007, one
customer in the Encryption Products and Services Segment represented 100% of
accounts receivable and at October 31, 2006, two customers in the Encryption
Products and Services Segment represented 89% and 11%, respectively, of accounts
receivable.
4. SHORT-TERM INVESTMENTS
----------------------
Short-term investments represent certificates of deposits, carried at
amortized cost, with maturities of less than twelve months. The fair values of
the certificates of deposits, including accrued interest, approximate their
carrying value due to their short maturities.
5. INVESTMENT IN AND RELATED PARTY TRANSACTIONS WITH DIGITAL INFO SECURITY CO
--------------------------------------------------------------------------
INC.
- ----
On February 13, 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. On May 17, 2006 and July 14, 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. On
November 27, 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 July 31, 2007, 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.
Our investment in DISC as of July 31, 2007, is recorded in the accompanying
condensed 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. As of July
31, 2007 we held approximately 13% of the outstanding common stock of DISC. Net
sales for the nine-month periods ended July 31, 2007 and 2006 included billings
to DISC for engineering services of $180,000 and $95,000 respectively. Net sales
for the three-month periods ended July 31, 2007 and 2006 included billings to
DISC for engineering services of $60,000 and $45,000, respectively. Accounts
receivable at July 31, 2007 include $60,000 from DISC.
15
6. INVENTORIES
-----------
Inventories consist of the following as of:
July 31, October 31,
2007 2006
---------- -----------
Component parts $ 113,531 $ 117,040
Work-in-process 26,387 43,135
Finished products 74,571 100,648
---------- -----------
$ 214,489 $ 260,823
========== ===========
7. NET LOSS PER SHARE OF COMMON STOCK
----------------------------------
We comply with the provisions of SFAS No. 128, "Earnings Per Share" ("SFAS
No. 128"). In accordance with SFAS No. 128, basic net 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 periods presented is the same as Basic EPS, as
the inclusion of the effect of common stock equivalents then outstanding would
be anti-dilutive. For this reason, excluded from the calculation of Diluted EPS
for the nine-month and three-month periods ended July 31, 2007 and 2006, were
options to purchase 20,857,711 shares and 22,597,941 shares, respectively.
8. 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. FIN 48 is
effective for fiscal years beginning after December 15, 2006. We are currently
evaluating the effect, if any, that the adoption of FIN 48 will have on our
financial statements.
In September 2006, the Securities and Exchange Commission ("SEC") released
Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year
Misstatements When Quantifying Misstatements in Current Year Financial
Statements" ("SAB No. 108"). SAB No. 108 provides interpretative guidance on how
public companies are to quantify financial statement misstatements. There have
been two common approaches used to quantify such errors. Under an income
statement approach (the "roll-over" method) the error is quantified as the
amount by which the current year income statement is misstated. Alternatively,
under a balance sheet approach (the "iron curtain" method) the error is
quantified as the cumulative amount by which the current year balance sheet is
misstated. In SAB No. 108, the SEC established an approach that requires
quantification of financial statement misstatements based on the effects of the
misstatements on each of the company's financial statements and the related
financial statement disclosures. This model is commonly referred to as a "dual
approach" because it requires quantification of errors under both the roll-over
and iron curtain methods. SAB No. 108 is effective for annual financial
statements covering the first fiscal year ending after November 15, 2006. The
adoption of SAB No. 108 is not expected to have a material effect on our
financial statements.
16
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. SFAS 157 applies to other accounting
pronouncements that require or permit fair value measurements. The provisions of
SFAS 157 are effective for fiscal years beginning after November 15, 2007. The
adoption of SFAS 157 is not expected to have a material effect on our financial
statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" ("SFAS 159"). SFAS 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 159 is effective for fiscal years beginning after November
15, 2007. We are currently evaluating the effect, if any, that the adoption of
SFAS 159 will have on our financial statements.
9. SEGMENT INFORMATION
-------------------
We follow the provisions of SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"). Reportable operating
segments are determined based on management's approach. The management approach,
as defined by SFAS No. 131, is based on the way that the chief operating
decision-maker organizes the segments within an enterprise for making operating
decisions and assessing performance. While our results of operations are
primarily reviewed on a consolidated basis, the chief operating decision-maker
also manages the enterprise in two segments: (i) Flat-panel display and (ii)
Encryption products and services. The following represents selected financial
information for our segments for the nine-month and three-month periods ended
July 31, 2007 and 2006:
17
Encryption
Flat-Panel Products
Segment Data Display and Services Total
- --------------------------------- ------------- ------------- -------------
Nine Months Ended July 31, 2007:
Net sales $ - $ 341,177 $ 341,177
Net loss (2,174,229) (2,086,622) (4,260,851)
Nine Months Ended July 31, 2006:
Net sales $ - $ 397,773 $ 397,773
Net loss (2,772,330) (3,027,381) (5,799,711)
Three Months Ended July 31, 2007:
Net sales $ - $ 114,000 $ 114,000
Net loss (578,123) (477,398) (1,055,521)
Three Months Ended July 31, 2006:
Net sales $ - $ 130,845 $ 130,845
Net loss (1,070,044) (1,077,231) (2,147,275)
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations.
- --------------
GENERAL
- -------
Our principal operations are the development, production and marketing of
thin, 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 improves on our prior display technology. This
new proprietary display is a color phosphor based display having a unique low
voltage phosphor excitation system. 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. We are now focusing our business discussions
with respect to our new type of flat panel display technology with a major
consumer electronics company.
This 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 and PDP (plasma)
displays.
o The display matrix, phosphor excitation system, and drivers are all on
one substrate.
19
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 than 20% the power required by an LCD. This
low 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 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).
We have continued to direct our encryption marketing efforts towards both
the government and commercial security markets. Our government market has been
primarily handled by The Boeing Company ("Boeing") and its large distributors of
the Thuraya satellite phones. As a result, we have provided our security
products to customers using the Thuraya network in the Middle East, Europe, and
Africa. Thuraya is scheduled to start providing satellite service to the Far
East later this year, which could potentially create larger marketing
opportunities for our encryption products. Our security products for the Thuraya
network are being used by government agencies, the military and domestic and
international non-governmental organizations (NGOs).
20
We have supplied USS-900, DCS-1400, and DCS-1200 products to major Thuraya
distributors for use by government agencies and NGOs in Middle Eastern,
European, and African countries. We are hopeful that these developments will
lead to larger commitments for our security products. In addition, we have
supplied our USS-900AF automatic fax encryption product to a major U.S. defense
contractor to secure its worldwide fax communications and have supplied our
encryption solution to a major U.S. company to secure its executive
teleconferencing system.
We have recently entered into a new three year agreement with Boeing, under
which Boeing distributes certain of our encryption products. This replaces our
prior agreement with Boeing, which had expired. Boeing now 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 have also developed for Boeing a voice product to
operate over the Thuraya network having a higher level of security.
We are cooperating with Asia Pacific Satellite Industries ("APSI"), the
supplier of the next generation voice and data handsets for the Thuraya network,
and with Boeing to integrate our encryption solution into APSI's handset. As a
first step, we are producing and are selling an interconnect cable incorporating
active circuits which provide compatibility between APSI's next generation
satellite telephone (the "SO-2510") and our current DCS-1200, DCS-1400 and
USS-900T models. This solution has been field tested by APSI and by Boeing over
the Thuraya network and is currently being marketed to consumers by Boeing and
Thuraya distributors. In addition, the new APSI FDU-3500 docking unit for the
SO-2510 phone is now available on the market from APSI. The docking unit allows
for outdoor and indoor operation of the satellite phone on the Thuraya network.
We are producing and have received orders for the CopyTele PA-3500 and PA-3500T
products that allow compatibility between our DCS-1200, DCS-1400 and USS-900T
encryption devices and the APSI FDU-3500 docking unit.
We also are developing, together with APSI and Boeing, a small voice-only
encryption device that will directly connect to the satellite phone, offering
simplified operation in a highly convenient package. We have built samples of
our design which are now being evaluated and tested by APSI. We believe that
this enhanced offering will be useful by Thuraya customers that require
confidential and secure communications. The new device is designed to provide a
better customer interface in a smaller more portable size.
In connection with our agreement with Boeing, Boeing authorized us to use
its name on our website. Accordingly, customers desiring to purchase certain of
our encryption products can find authorized Boeing sales information on the
"Encryption Products" page of our website or on the Thuraya website at
http://www.thuraya.com/content/thuraya-products-boe.html. Boeing is continuing
to demonstrate our encryption products to Thuraya service providers at annual
Service Providers Conferences in the United Arab Emirates and elsewhere.
21
Our encryption products also can be used to encrypt data over the
Globalstar network. Globalstar provides satellite voice and data service
throughout a world-wide coverage area. Our DCS-1200 and DCS-1400 encryption
devices are included on the Globalstar webpage,
http://www.globalstarusa.com/en/products/encryption.php. These same products
offer voice and data encryption compatibility with the Iridium and Inmarsat
satellite networks.
Our products provide secure communications with many different satellite
phones, including the Thuraya 7100/7101 and SO-2510 handheld terminals ("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 are currently advising APSI and Sattrans on
their development of new docking units for the Thuraya handsets which will allow
greater flexibility and usage of our encryption products.
We are continuing to pursue 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.
In February 2006, we licensed to Digital Info Security Co Inc. ("DISC"), an
encrypted system for e-mail that integrates into DISC's e-mail services. The
system, our DCS-2200, allows companies to encrypt all e-mail transactions in a
manner transparent to the individual user. DISC is adding our e-mail encryption
system to their suite of management products and services, which includes e-mail
compliance and archiving, remote backup, recovery, and spam and antivirus
protection functions. DISC has recently opened an office in Singapore, which
will serve as its headquarters for the Asia-Pacific region, and will purse sales
to government entities and other parties in the region. DISC is now marketing
this system through presentations to commercial customers directly and through
trade shows. These efforts have led to customer commitments.
CopyTele has been working closely with DISC personnel and their potential
clients to improve the look and feel of our DCS-2200 system as well as adding
new features which make the system even more flexible. The DCS-2200
Encrypting/Decrypting system has been integrated to work with Microsoft Exchange
Server email server program. Integrating use with Microsoft Exchange Server, one
of the most popular business e-mail systems, allows corporate users an array of
features available in the Microsoft platform
The CopyTele DCS-2200 e-mail system consists of an encryption/decryption
software module, which is used within Microsoft Outlook(R) to transparently
encrypt and decrypt e-mails at the source or destination, and an
Encrypting/Decrypting e-mail server program, which receives clear text or
encrypted e-mail communication and re-encrypts it for forwarding to the
recipient if required. Copies of e-mails can also be archived in accordance with
the tracking and monitoring requirements of the Sarbanes-Oxley Act and
Gramm-Leach-Bliley Act and monitored for compliance with other regulatory
requirements and with corporate e-mail policies. In addition, the system
notifies corporate administrators when e-mails violate such requirements or
corporate e-mail policies. In furtherance of the relationship between us and
DISC, at the time we licensed our technology to DISC, we acquired 5,000,000
shares of DISC's common stock in exchange for 100,000 shares of our common
stock. Since then, we have acquired an additional 7,200,000 shares of DISC's
common stock, in the aggregate, for cash and an additional 300,000 shares of our
common stock. Accordingly, as of July 31, 2007, 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. As of July 31, 2007, we held approximately 13% of the
outstanding common stock of DISC.
22
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. During the past year
we have continued to direct our encryption 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. We are continuing to pursue marketing and licensing opportunities for
our display technology. We anticipate that current cash on hand, cash generated
from operations, and cash generated from the exercise of employee options will
be adequate to fund our operations at least through the end of the third quarter
of fiscal 2008.
CRITICAL ACCOUNTING POLICES
- ---------------------------
Our financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America. As such, we are
required to make certain estimates, judgments and assumptions that management
believes are reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenue and expenses during the reporting
periods.
We believe the following critical accounting polices affect the more
significant judgments and estimates used in the preparation of our financial
statements. For additional discussion on the application of these and other
accounting polices, refer to the financial statements and notes thereto included
in our Annual Report on Form 10-K for the year ended October 31, 2006.
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.
23
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 SFAS No. 123R. We recognize compensation expense for stock
option awards on a straight-line basis over the requisite service period of the
grant. Determining the appropriate fair value model and calculating the fair
value of stock-based awards requires judgment, including estimating stock price
volatility, forfeiture rates and expected life. If factors change and we employ
different assumptions in the application of SFAS No. 123R in future periods, the
compensation expense that we record under SFAS No. 123R may differ significantly
from what we have recorded in the current period.
RESULTS OF OPERATIONS
- ---------------------
Nine months ended July 31, 2007 compared with nine months ended July 31, 2006
- -----------------------------------------------------------------------------
Net Sales and Gross Profit
Net Sales. Net sales decreased by approximately $57,000 in the nine-month
period ended July 31, 2007, to approximately $341,000, as compared to
approximately $398,000 in the comparable prior-year period. All revenue during
both periods was from encryption products and services. The decrease in net
sales resulted from a reduction in unit sales of approximately $142,000, to
approximately $161,000, as compared to approximately $303,000 in the comparable
prior-year period, offset by an increase in revenue from encryption services of
$85,000, to $180,000, as compared to $95,000 in the comparable prior-year
period. The revenue from encryption services in the 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
between periods generally represent the nature of the early stage of our product
and sales channel development.
Gross Profit. Gross profit from sales of encryption products and services
decreased by approximately $50,000 in the nine-month period ended July 31, 2007,
to approximately $227,000, as compared to a gross profit of approximately
$277,000 in the comparable prior-year period. The decrease in gross profit is
primarily due to the decrease in sales. Gross profit as a percent of net sales
in the nine-month period ended July 31, 2007 was approximately 67%, as compared
to approximately 70% in the comparable prior-year period. Because of the limited
number of transactions during each of the periods, gross profit percentages are
sensitive to individual transactions.
24
Research and Development Expenses
Research and development expenses decreased by approximately $993,000 in
the nine-month period ended July 31, 2007, to approximately $2,590,000, from
approximately $3,583,000 in the comparable prior-year period. The decrease in
research and development expenses was principally due to a decrease in employee
stock option compensation expense of approximately $1,105,000, offset by an
increase in employee compensation, other than stock option expense, and related
costs of approximately $66,000, primarily resulting from the grant of employee
bonuses, and an increase in outside research and development expense of
approximately $55,000.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased by approximately
$591,000 to approximately $1,923,000 in the nine-month period ended July 31,
2007, from approximately $2,514,000 in the comparable prior-year period. The
decrease in selling, general and administrative expenses was principally due to
a decrease in employee stock option compensation expense of approximately
$291,000, a decrease in professional fees of approximately $227,000, a decrease
in consultant stock option expense of approximately $119,000 and a decrease in
advertising expense of approximately $25,000, offset by an increase in employee
compensation, other than stock option expense, and related costs of
approximately $72,000, primarily resulting from the grant of employee bonuses.
Interest Income
Interest income was approximately $25,000 in the nine-month period ended
July 31, 2007, compared to approximately $20,000 in the comparable prior-year
period. The increase in interest income was principally the result of an
increase prevailing interest rates.
Three months ended July 31, 2007 compared with three months ended July 31, 2006
- -------------------------------------------------------------------------------
Net Sales and Gross Profit
Net Sales. Net sales decreased by approximately $17,000 in the three-month
period ended July 31, 2007, to approximately $114,000, as compared to
approximately $131,000 in the comparable prior-year period. All revenue during
both periods was from encryption products and services. The decrease in net
sales resulted from a decrease in unit sales of approximately $32,000, to
approximately $54,000, as compared to approximately $86,000 in the comparable
prior-year period, offset by an increase in revenue from encryption services of
$15,000, to $60,000, as compared to $45,000 in the comparable prior-year period.
The revenue from encryption services in the 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
between periods generally represent the nature of the early stage of our product
and sales channel development.
25
Gross Profit. Gross profit from sales of encryption products and services
decreased by approximately $15,000 in the three-month period ended July 31,
2007, to approximately $77,000, as compared to a gross profit of approximately
$92,000 in the comparable prior-year period. The decrease in gross profit is
primarily due to the decrease in sales. Gross profit as a percent of net sales
in the three-month period ended July 31, 2007 was approximately 68%, as compared
to approximately 70% in the comparable prior-year period. Because of the limited
number of transactions during each of the periods, gross profit percentages are
sensitive to individual transactions.
Research and Development Expenses
Research and development expenses decreased by approximately $641,000 in
the three-month period ended July 31, 2007, to approximately $671,000, from
approximately $1,312,000 in the comparable prior-year period. The decrease in
research and development expenses was principally due to a decrease in employee
stock option compensation expense of approximately $559,000 and a decrease in
employee compensation, other than stock option expense, and related costs of
approximately $160,000, offset by an increase in outside research and
development expense of approximately $76,000.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased by approximately
$465,000 to approximately $469,000 in the three-month period ended July 31,
2007, from approximately $934,000 in the comparable prior-year period. The
decrease in selling, general and administrative expenses was principally due to
a decrease in employee stock option compensation expense of approximately
$305,000, a decrease in consultant stock option expense of approximately $97,000
and a decrease in employee compensation, other than stock option expense, and
related costs of approximately $76,000.
Interest Income
Interest income was approximately $7,000 in both of the three-month periods
ended July 31, 2007 and 2006.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
From our inception, we have met our liquidity and capital expenditure needs
primarily through the proceeds from sales of common stock in our initial public
offering, in private placements, upon exercise of warrants issued in connection
with the private placements and public offering, and upon the exercise of stock
options. In 2001 and 2002, we also received payments under a technology
development agreement. In addition, commencing in fiscal 1999, we have generated
cash flows from sales of our encryption products.
During the nine months ended July 31, 2007, our cash used in operating
activities was approximately $1,866,000. This resulted from payments to
suppliers, employees and consultants of approximately $2,182,000, which was
offset by cash of approximately $291,000 received from collections of accounts
receivable related to sales of encryption products and services, and
approximately $25,000 of interest income received. Our cash used in investing
activities during the nine months ended July 31, 2007 was approximately
$371,000, which resulted from purchases of short-term investments consisting of
certificates of deposit of approximately $825,000 and purchases of approximately
$9,000 of equipment, offset by approximately $463,000 received upon maturities
of short-term investments consisting of certificates of deposit. Our cash
provided by financing activities during the nine months ended July 31, 2007 of
approximately $1,607,000 resulted from cash received upon the exercise of stock
options. Accordingly, during the nine months ended July 31, 2007, our cash and
cash equivalents decreased by approximately $629,000 and our short-term
investments increased by approximately $362,000. As a result, our cash, cash
equivalents, and short-term investments, at July 31, 2007 decreased to
approximately $1,053,000 from approximately $1,320,000 at the end of fiscal
2006.
26
Accounts receivable increased by approximately $50,000 from approximately
$10,000 at the end of fiscal 2006 to approximately $60,000 at July 31, 2007. The
increase in accounts receivable is a result of the timing of collections.
Inventories decreased approximately $47,000 from approximately $261,000 at
October 31, 2006 to approximately $214,000 at July 31, 2007, primarily as a
result of the timing of shipments and production schedules. Investment at cost
increased to $417,000 at July 31, 2007 compared to $207,000 at October 31, 2006,
due to an additional non-cash investment in DISC. Accounts payable and accrued
liabilities decreased by approximately $262,000 from approximately $582,000 at
the end of fiscal 2006 to approximately $320,000 at July 31, 2007, as a result
the timing of payments.
As a result of these changes, working capital at July 31, 2007 increased to
approximately $1,048,000 from approximately $1,041,000 at the end of fiscal
2006.
Our working capital includes inventory of approximately $214,000 at July
31, 2007. Management has recorded our inventory at the lower of cost or our
current best estimate of net realizable value. To date, sales of our products
have been limited. Accordingly, there can be no assurance that we will not be
required to reduce the selling price of our inventory below our current carrying
value.
During the nine-month periods ended July 31, 2007 and 2006, we issued
2,191,730 shares and 1,695,050 shares, respectively, of common stock to certain
employees for services rendered, principally in lieu of cash compensation,
pursuant to the 2003 Share Plan and the 2000 Share Plan. We recorded
compensation expense for the nine-month periods ended July 31, 2007 and 2006 of
approximately $1,473,000 and $1,342,000, respectively, and for the three-month
periods ended July 31, 2007 and 2006 of approximately $404,000 and $583,000,
respectively, for the shares of common stock issued to employees. In addition,
during the nine-month periods ended July 31, 2007 and 2006, we issued 164,020
shares and 293,360 shares, respectively, of common stock to consultants for
services rendered pursuant to the 2003 Share Plan. We recorded consulting
expense for the nine-month periods ended July 31, 2007 and 2006 of approximately
$114,000 and $245,000, respectively, and for the three-month periods ended July
31, 2007 and 2006 of approximately $9,000 and $35,000, respectively, for the
shares of common stock issued to consultants.
27
During the nine-month periods ended July 31, 2007 and 2006, we granted
options to purchase 2,880,000 shares and 5,460,000 shares, respectively, to
employees, non-employee directors and consultants pursuant to the 2003 Share
Plan. We recorded stock-based compensation expense related to stock options
granted to employees, non-employee directors and consultants of approximately
$1,075,000 and $2,589,000 for the nine-month periods ended July 31, 2007 and
2006, respectively, and of approximately $88,000 and $1,050,000 for the
three-month periods ended July 31, 2007 and 2006, respectively.
During the nine-month period ended July 31, 2007, we acquired an additional
minority interest in DISC by exchanging 300,000 unregistered shares of our
common stock for 5,000,000 shares of DISC's common stock. DISC's common stock is
not registered under the Securities Exchange Act of 1934, but is quoted on the
Pink Sheets
The auditor's report on our financial statements as of October 31, 2006
states that the net loss incurred during the year ended October 31, 2006, our
accumulated deficit as of that date, and the other factors described in Note 1
to the Financial Statements included in our Annual Report on Form 10-K for the
year ended October 31, 2006, raise substantial doubt about our ability to
continue as a going concern. The auditor's report on our financial statements
for the year ended October 31, 2005 contained a similar statement. Our financial
statements have been prepared assuming we will continue as a going concern and
do not include any adjustments that might result from the outcome of this
uncertainty.
We believe that our existing cash, cash equivalents, short-term investments
and accounts receivable, together with cash flows from expected sales of
encryption products and flat panel displays, and other potential sources of cash
flows, will be sufficient to enable us to continue in operation until at least
the end of the third quarter of fiscal 2008. We anticipate that, thereafter, we
will require additional funds to continue our marketing, production, and
research and development activities, and we will require outside funding if cash
generated from operations is insufficient to satisfy our liquidity requirements.
However, our projections of future cash needs and cash flows may differ from
actual results. If current cash and cash that may be generated from operations
are insufficient to satisfy our liquidity requirements, we may seek to sell debt
or equity securities or to obtain a line of credit prior to the third quarter of
fiscal 2008. The sale of additional equity securities or convertible debt could
result in dilution to our stockholders. We currently have no arrangements with
respect to additional financing. There can be no assurance that we will generate
sufficient revenues in the future (through sales or otherwise) to improve our
liquidity or sustain future operations, that our production capabilities will be
adequate, that other products will not be produced by other companies that will
render our products obsolete, or that 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. We have been working with several large organizations to provide them
with both our hardware and software encryption solutions for them to evaluate
whether the solutions meet their security requirements and have begun supplying
several major U.S. companies with our encryption products. We are also
continuing to pursue marketing and licensing opportunities for our display
technology. As of July 31, 2007, we had not yet recorded any revenue from sales
or licensing of our display. During the nine-month period ended July 31, 2007,
we recognized revenue from sales of encryption products and services of
approximately $341,000.
28
The following table presents our expected cash requirements for contractual
obligations outstanding as of July 31, 2007:
Payments Due by Period
----------------------
Less
Contractual than 1-3 4-5 After
Obligations 1 year years years 5 years Total
- ----------------- ---------- --------- ------- --------- ----------
Consulting
Agreement $ 40,000 - - - $ 40,000
Noncancelable
Operating Leases $ 274,000 $ 92,000 - - $ 366,000
---------- --------- ------- --------- ----------
Total Contractual
Cash Obligations $ 314,000 $ 92,000 - - $ 406,000
========== ========= ======= ========= ==========
IMPACT 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. FIN 48 is
effective for fiscal years beginning after December 15, 2006. We are currently
evaluating the effect, if any, that the adoption of FIN 48 will have on our
financial statements.
In September 2006, the Securities and Exchange Commission ("SEC") released
Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year
Misstatements When Quantifying Misstatements in Current Year Financial
Statements" ("SAB No. 108"). SAB No. 108 provides interpretative guidance on how
public companies are to quantify financial statement misstatements. There have
been two common approaches used to quantify such errors. Under an income
statement approach (the "roll-over" method) the error is quantified as the
amount by which the current year income statement is misstated. Alternatively,
under a balance sheet approach (the "iron curtain" method) the error is
quantified as the cumulative amount by which the current year balance sheet is
misstated. In SAB No. 108, the SEC established an approach that requires
quantification of financial statement misstatements based on the effects of the
misstatements on each of the company's financial statements and the related
financial statement disclosures. This model is commonly referred to as a "dual
approach" because it requires quantification of errors under both the roll-over
and iron curtain methods. SAB No. 108 is effective for annual financial
statements covering the first fiscal year ending after November 15, 2006. The
adoption of SAB No. 108 is not expected to have a material effect on our
financial statements.
29
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. SFAS 157 applies to other accounting
pronouncements that require or permit fair value measurements. The provisions of
SFAS 157 are effective for fiscal years beginning after November 15, 2007. The
adoption of SFAS 157 is not expected to have a material effect on our financial
statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" ("SFAS 159"). SFAS 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 159 is effective for fiscal years beginning after November
15, 2007. We are currently evaluating the effect, if any, that the adoption of
SFAS 159 will have on our financial statements.
FORWARD-LOOKING STATEMENTS
- --------------------------
Information included in this Quarterly Report on Form 10-Q may contain
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are not statements of
historical facts, but rather reflect our current expectations concerning future
events and results. We generally use the words "believes," "expects," "intends,"
"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 Part II, Item 1A - "Risk
Factors" below and Note 1 to Condensed Financial Statements. You should read
this discussion and analysis along with our Annual Report on Form 10-K for the
year ended October 31, 2006 and the condensed financial statements included in
this Report. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. You are cautioned not to unduly rely on such
forward-looking statements when evaluating the information presented in this
Report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
-----------------------------------------------------------
We have invested a portion of our cash on hand in short-term, fixed rate and
highly liquid instruments that have historically been reinvested when they
mature throughout the year. Although our existing instruments are not considered
at risk with respect to changes in interest rates or markets for these
instruments, our rate of return on these securities could be affected at the
time of reinvestment, if any.
30
Item 4. Controls and Procedures.
------------------------
We carried out an evaluation, under the supervision and with the
participation of our management including our Chairman of the Board and Chief
Executive Officer and our Vice President - Finance and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13-15(b) of the Securities Exchange Act of 1934, as
amended. Based upon that evaluation, our Chairman of the Board and Chief
Executive Officer and our Vice President - Finance and Chief Financial Officer
concluded that our disclosure controls and procedures are effective as of the
end of the period covered by this report.
There was no change in our internal control over financial reporting during
the quarter ended July 31, 2007 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
--------------------------
Item 1A. Risk Factors.
-------------
There have been no material changes in our risk factors from those
disclosed in our Annual Report on Form 10-K for the year ended October 31, 2006.
Item 6. Exhibits.
---------
31.1 Certification of Chief Executive Officer, pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, dated September 17, 2007.
31.2 Certification of Chief Financial Officer, pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, dated September 17, 2007.
32.1 Statement of Chief Executive Officer, pursuant to Section 1350 of
Title 18 of the United States Code, dated September 17, 2007.
32.2 Statement of Chief Financial Officer, pursuant to Section 1350 of
Title 18 of the United States Code, dated September 17, 2007.
31
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
COPYTELE, INC.
By: /s/ Denis A. Krusos
------------------------------
Denis A. Krusos
Chairman of the Board and
Chief Executive Officer
September 17, 2007 (Principal Executive Officer)
By: /s/ Henry P. Herms
------------------------------
Henry P. Herms
Vice President - Finance and
Chief Financial Officer (Principal
September 17, 2007 Financial and Accounting Officer)
32