Description of Business and Basis of Presentation

Our principal operations include the development, production and marketing of thin flat display technologies, including low-voltage phosphor color displays and low-power passive E-Paper^® displays, and the development, production and marketing of multi-functional encryption products that provide information security for domestic and international users over virtually every communications media.

The condensed consolidated financial statements are unaudited, and have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial reporting, and with the rules and regulations of the Securities and Exchange Commission ("SEC") regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The information contained herein is as of July 31, 2011 and for the nine-month and three-month periods ended July 31, 2011 and 2010. 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. 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 condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. We have evaluated subsequent events for possible disclosure through the date the condensed consolidated financial statements were issued.

The condensed consolidated financial statements include the accounts of CopyTele, Inc. and its wholly owned subsidiaries, CopyTele International Ltd. ("CopyTele International") and CopyTele Marketing Inc. ("CopyTele Marketing"). CopyTele International and CopyTele Marketing were incorporated in the British Virgin Islands in July 2007 and September 2007, respectively. CopyTele International was formed for the purpose of holding an investment in global depository receipts of Videocon Industries Limited, an Indian company ("Videocon"). As of July 31, 2011, CopyTele Marketing was inactive. All significant intercompany 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 consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2010, for more extensive disclosures than contained in these condensed consolidated financial statements.

All references in this Form 10-Q to "dollars" or "$" refer to US dollars.

Funding and Management's Plans

Since 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 our initial public offering, and upon the exercise of stock options. In addition, commencing in the fourth quarter of fiscal 1999, we have generated limited cash flows from sales of our encryption products and in May 2008 began receiving license fees from Videocon related to our display technology pursuant to the Videocon License Agreement (as defined below). In May 2011, we entered into the EPD License Agreement and Nano Display License Agreement (as defined below) with AU Optronics Corp., a Taiwanese company ("AUO"), and in June 2011 we received an initial license fee from AUO.

During the nine months ended July 31, 2011, our cash used in operating activities was approximately $3,000. This resulted from payments to suppliers, employees and consultants of approximately $2,567,000, which was offset by cash of approximately $130,000 received from collections of accounts receivable related to sales of encryption products, $2,400,000 received from display technology license fees and approximately $34,000 of dividend income received. Our cash used in investing activities during the nine months ended July 31, 2011 was approximately $2,888,000, which resulted from purchases of short-term investments consisting of certificates of deposit and U.S. government securities of approximately $3,748,000 and the purchase of equipment for approximately $9,000, offset by approximately $750,000 received upon the sale of short-term investments consisting of U.S. government securities and approximately $119,000 received upon the sale of Digital Info Security Co. Inc. ("DISC") common stock. Our cash provided by financing activities during the nine months ended July 31, 2011 was approximately $2,349,000, which resulted from cash of $1,250,000 received from the sale of common stock and warrants in a private placement and approximately $1,099,000 received upon the exercise of stock options. As a result, our cash, cash equivalents, and investments in certificates of deposit and U.S. government securities at July 31, 2011 increased to approximately $3,550,000 from approximately $1,094,000 at October 31, 2010.

Total employee compensation expense for the nine-month periods ended July 31, 2011 and 2010 was approximately $2,836,000 and $2,597,000, respectively, and for the three-month periods ended July 31, 2011 and 2010 was approximately $1,094,000 and $720,000, respectively. During the nine-months ended July 31, 2011 and 2010, a significant portion of employee compensation consisted of the issuance of stock and stock options to employees in lieu of cash compensation. We recorded stock-based compensation expense, related to stock awards granted to employees, for the nine-month periods ended July 31, 2011 and 2010 of approximately $1,313,000 and $1,392,000, respectively, and the three-month periods ended July 31, 2011 and 2010 of approximately $353,000 and $398,000, respectively. We recorded stock-based compensation expense, related to stock options granted to employees and directors, for the nine-month periods ended July 31, 2011 and 2010 of approximately $643,000 and $535,000, respectively and for the three-month periods ended July 31, 2011 and 2010 of approximately $334,000 and $96,000 respectively.

In February 2011, we sold 7,000,000 unregistered shares of our common stock in a private placement at a price of $0.1786 per share, for proceeds of $1,250,000, of which 3,360,000 shares were sold to our Chairman and Chief Executive Officer, our Chief Financial Officer and director, and the two other directors of the Company. In conjunction with the sale of the common stock, we issued warrants to purchase 7,000,000 unregistered shares of our common stock. Each warrant grants the holder the right to purchase one share of our common stock (or 7,000,000 shares of common stock in the aggregate) at the purchase price of $0.1786 per share on or before February 8, 2016. The warrants were valued at $0.0756 per share using a Black-Scholes pricing model, adjusted for the estimated impact on fair value of the restrictions relating to the warrants.

We believe that our existing cash, cash equivalents, investments in U.S. government securities and certificates of deposit, and accounts receivable, together with cash flows from expected sales of our encryption products and revenue relating to our display technologies, and other potential sources of cash flows, will be sufficient to enable us to continue our marketing, production, and research and development activities for at least 12 months from the end of this reporting period, if not longer. However, our projections of future cash needs and cash flows may differ from actual results. If current cash on hand and cash that may be generated from operations are insufficient to satisfy our liquidity requirements, we may seek to sell our investment securities or other financial assets or our debt or additional equity securities or obtain loans from various financial institutions where possible. 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 and consultants by issuing stock or stock options. We currently have no arrangements with respect to additional financing. We can give 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, such as sales of equity or debt, would be available, if needed, on favorable terms or at all. If we cannot obtain such funding if needed, we would need to curtail or cease some or all of our operations.

AU Optronics Corp.

On May 27, 2011, we entered into an Exclusive License Agreement (the "EPD License Agreement") with AUO. Under the EPD License Agreement, we provided AUO with an exclusive, non-transferable, worldwide license of our E-Paper ^® display patents and technology (the "EPD Licensed Technology"), for AUO (or an AUO subsidiary) to produce, market and sell products containing the EPD Licensed Technology, with the right to sublicense the technology to third parties. We retained the non-exclusive right to use the EPD Licensed Technology in a non-competitive manner.

On May 27, 2011, we also entered into another license agreement (the "Nano Display License Agreement") with AUO. Under the Nano Display License Agreement, we provided AUO with a non-exclusive, non-transferable, worldwide license of our Nano Display patents and technology (the "Nano Display Licensed Technology"), for AUO (or an AUO subsidiary) to produce, market and sell products containing the Nano Display Licensed Technology, with the right to consent to the granting of licenses of the Nano Display Licensed Technology to third parties.

Under these agreements, AUO has agreed to pay CopyTele a potential aggregate license fee of $10 million, of which $3 million was paid by AUO in June 2011 and an additional $7 million is payable upon completion of certain conditions for the respective technologies, in each case subject to a 20% withholding tax, which at the election of the Company could be deducted or credited against future US income tax. Accordingly, in June 2011 we received a payment from AUO, net of the withholding tax, of $2.4 million. In addition, each of the agreements also provides for the basis for royalty payments by AUO to CopyTele.

Related Party Transactions with Videocon Industries Limited

In November 2007, we entered into a Technology License Agreement (as amended in May 2008), (the "Videocon License Agreement") with Videocon. In April 2008, the Indian Government approved the Videocon License Agreement. Under the Videocon License Agreement, we provide Videocon with a non-transferable, worldwide license of our technology for thin, flat, low voltage phosphor, Nano Displays (the "Licensed Technology"), for Videocon (or a Videocon Group company) to produce and market products, including TVs, incorporating displays utilizing the Licensed Technology. With the approval and support of Videocon, in May 2011 we entered into license agreements with AUO, a large LCD display producer, for AUO to utilize their production facilities to produce our display technologies, including the Licensed Technology, for their own products and potentially for Videocon products. Additional licenses of the Licensed Technology to third parties require the joint agreement of CopyTele, Videocon, and AUO.

Under the terms of the Videocon License Agreement, we were scheduled to receive a license fee of $11 million from Videocon, payable in installments over a 27 month period which commenced in May 2008, and an agreed upon royalty from Videocon based on display sales by Videocon. The license fee payments were subsequently deferred as described in more detail in our Annual Report on Form 10-K for fiscal year ended October 31, 2010. We presently anticipate that ongoing improvements to our display technology will likely result in future modifications of the timing of payments from Videocon. Accordingly, we cannot presently estimate specific future payment dates; however, we are in discussion with Videocon for additional payments. During the nine-months ended July 31, 2011 and 2010, we received license fee payments from Videocon of $-0- and $300,000, respectively. No such license fee payments were received from Videocon during the three-month periods ended July 31, 2011 and 2010. As of July 31, 2011, we have received aggregate license fee payments from Videocon of $3.2 million.

Under the Videocon 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 corporation ("Volga"), in which we have a 19.9% ownership interest and with whom we have been working with for more than thirteen years, and an Asian company with whom we have been working with for more than seven years, to produce and market products utilizing the Licensed Technology.

At the same time we entered into the Videocon License Agreement in November 2007, we also entered into a Share Subscription Agreement (the "Share Subscription Agreement") with Mars Overseas Limited, an affiliate of Videocon ("Mars Overseas"). Under the Share Subscription Agreement, Mars Overseas purchased 20,000,000 unregistered shares of our common stock (the "CopyTele Shares") from us for an aggregate purchase price of $16,200,000. Also in November 2007, our wholly-owned subsidiary, CopyTele International, entered into a GDR Purchase Agreement with Global EPC Ventures Limited ("Global"), for CopyTele International to purchase from Global 1,495,845 global depository receipts of Videocon (the "Videocon GDRs"), for an aggregate purchase price of $16,200,000. See Note 4 "Fair Value Measurements" for additional information related to our investment in Videocon GDRs.

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 the 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 the principal amount of $5,000,000 from CopyTele International to Mars Overseas. The loans are for a period of seven years, do not bear interest, and prepayment of the loans will not release the lien on the Securities prior to end of the seven year period. The loan agreements provide for customary events of default, which may result in forfeiture of the Securities by the defaulting party, and 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 in respect of the Securities. The loan receivable from Mars Overseas is classified as a contra-equity under shareholders' equity in the accompanying condensed consolidated balance sheet, because the loan receivable is secured by the CopyTele Shares and the Share Subscription Agreement and Loan and Pledge Agreement were entered into concurrently.

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 revenue guidance of Accounting Standards Codification ("ASC") 605-25 "Multiple-Element Arrangements" ("ASC 605-25") to determine whether multiple deliverables in our arrangement with Videocon represent separate units of accounting. Under the Videocon 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 such accounting guidance, 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 from Videocon during the production period based on analysis of the pricing for similar agreements. Since the inception of the Videocon License Agreement, we have not earned any royalty income. In addition, 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, limiting the revenue recognized on a cumulative basis to the aggregate license fee payments received from Videocon. As a result of ongoing improvements to our display technology, we have extended the estimated period that we expect to provide cooperation and assistance. 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 recognized license fee revenue from Videocon for the nine-month periods ended July 31, 2011 and 2010 of $-0- and $300,000, respectively. No such license fee revenue from Videocon was recognized for the three-month periods ended July 31, 2011 and 2010.

We have also assessed the revenue guidance of ASC 605-25 to determine whether multiple deliverables in our arrangements with AUO represent separate units of accounting. Under the EPD License Agreement and Nano Display License Agreement, CopyTele received initial license fees of $3 million and will receive a potential $7 million of additional license fees upon completion of certain conditions for the respective technologies. CopyTele has determined that the transfer of the licensed patents and technology and the effort involved in completion of the conditions for the respective technologies represent a single unit of accounting. Accordingly, using a proportional performance method, we will recognize the $3 million initial license fees over the estimated period that we expect to complete the conditions for the respective technologies and not recognize the $7 million as it is considered contingent revenue. Upon completion of the various conditions for the respective technologies, the additional license fees of $7 million will be recognized over this performance period. We will assess at each reporting period the progress in completing these efforts and will continue to evaluate the period during which the license fee will be recognized. On this basis, we recognized license fee revenue from AUO for the nine-month and three-month periods ended July 31, 2011 of approximately $426,000. License fee payments received from AUO which are in excess of the amounts recognized as revenue (approximately $2,574,000 as of July 31, 2011) are recorded as non-refundable deferred revenue on the accompanying condensed consolidated balance sheet. The license agreements with AUO also provide for the basis for royalty payments by AUO to CopyTele, which we have determined represent separate units of accounting. We have not recognized any royalty income under the license agreements with AUO.