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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
- --------------------------------------------------------------------------------
FORM 10-Q
(Mark One)
[X] Quarterly Report under Section 13 or 15(d) of the Securities and Exchange
Act of 1934
For the quarterly period ended September 30, 2003
[ ] Transition report under Section 13 or 15(d) of the Exchange Act
For the transition period from to
------------------ -----------------
Commission File Number 000-19828
SPATIALIGHT, INC.
(Exact name of registrant as specified in its charter)
New York 16-1363082
-------- ----------
(State or other jurisdiction of (IRS Employer Identification No.)
Incorporation or organization)
Five Hamilton Landing, Suite 100, Novato, California 94949
----------------------------------------------------------
(Address of principal executive offices)
(415) 883-1693
--------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS:
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 31,977,000 shares of
common stock as of November 11, 2003.
1
SPATIALIGHT, INC.
Quarterly Report on Form 10-Q
For the Quarter Ended September 30, 2003
Table of Contents
PART I FINANCIAL INFORMATION
Item 1. Condensed Financial Statements (unaudited)
Condensed Balance Sheets dated
September 30, 2003 and December 31, 2002..................................3
Condensed Statements of Operations
for the Three and Nine Months
Ended September 30, 2003 and 2002.........................................4
Condensed Statements of Stockholders' Deficit
for the Nine Months Ended September 30, 2003..............................5
Condensed Statements of Cash Flows
for the Nine Months Ended September 30, 2003 and 2002.....................6
Notes to Condensed Financial Statements...................................7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations..........................16
Item 3. Quantitative and Qualitative Disclosures About Market Risks...............28
Item 4. Controls and Procedures...................................................29
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.................................30
Item 6. Exhibits and Reports on Form 8-K..........................................34
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Financial Statements (unaudited)
SPATIALIGHT, INC.
BALANCE SHEET
September 30 December 31,
2003 2002
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 2,419,661 $ 575,663
Accounts Receivable 84,452 -
Inventory 987,203 275,959
Prepaids and other current assets 406,971 565,515
----------------- -------------------
Total current assets 3,898,287 1,417,137
Property and equipment, net 644,900 506,968
Other assets 167,387 134,349
----------------- -------------------
Total assets $ 4,710,574 $ 2,058,454
================= ===================
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Accounts payable $ 640,507 $ 2,018,230
Other short-term notes 512,500 -
Current portion of convertible notes 4,388,956 -
Accrued expenses and other current liabilities 385,457 206,796
----------------- -------------------
Total current liabilities 5,927,420 2,225,026
Noncurrent liabilities
Convertible notes, net of current portion - 4,207,232
----------------- -------------------
Total liabilities 5,927,420 6,432,258
----------------- -------------------
Commitments
Stockholders' deficit:
Common stock, $.01 par value:
50,000,000 shares authorized;
31,157,357 and 26,018,658 shares issued and outstanding 311,573 260,187
Additional paid-in capital 55,259,604 45,550,830
Notes and stock subscriptions receivable (1,330,825) (1,426,999)
Accumulated deficit (55,457,198) (48,757,822)
----------------- -------------------
Total stockholders' deficit (1,216,846) (4,373,804)
----------------- -------------------
Total liabilities and stockholders' deficit $ 4,710,574 $ 2,058,454
================= ===================
See accompanying notes to financial statements.
3
SPATIALIGHT, INC.
STATEMENTS OF OPERATIONS (unaudited)
Three months ended September 30, Nine months ended September 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues $ 82,152 $ - $ 82,152 $ -
Cost of revenues (73,875) - (73,875) -
Inventory writedown - - (100,690) -
------------ ------------ ------------ ------------
Gross profit (loss) 8,277 - (92,413) -
------------ ------------ ------------ ------------
Selling, general and administrative expenses:
Selling, general and administrative expenses $ 972,882 $ 629,145 $ 2,346,211 $ 1,795,495
Stock-based general and administrative expenses 71,705 141,737 1,730,637 410,706
------------ ------------ ------------ ------------
Total selling, general and administrative
expenses 1,044,587 770,882 4,076,848 2,206,201
Research and development expenses 597,148 858,635 1,988,449 2,234,601
------------ ------------ ------------ ------------
Total operating expenses 1,641,735 1,629,517 6,065,297 4,440,802
------------ ------------ ------------ ------------
Operating loss (1,633,458) (1,629,517) (6,157,710) (4,440,802)
------------ ------------ ------------ ------------
Other income (expenses):
Interest expense:
Interest expense (71,418) (66,294) (180,607) (194,161)
Stock-based interest expense (138,416) (536,478) (417,393) (1,510,785)
------------ ------------ ------------ ------------
Total interest expense (209,834) (602,772) (598,000) (1,704,946)
Interest and other income 18,350 91 56,326 8,689
------------ ------------ ------------ ------------
Total other expenses (191,484) (602,681) (541,674) (1,696,257)
------------ ------------ ------------ ------------
Loss before income tax expense (1,824,942) (2,232,198) (6,699,384) (6,137,059)
Income tax expense (benefit) - - (8) 1,425
------------ ------------ ------------ ------------
Net loss $ (1,824,942) $ (2,232,198) $ (6,699,376) $ (6,138,484)
============ ============ ============ ============
Net loss per share - basic and diluted $ (0.06) $ (0.09) $ (0.25) $ (0.25)
============ ============ ============ ============
Weighted average shares used in computing
net loss per share- basic and diluted 29,194,477 24,263,706 27,260,754 24,175,222
============ ============ ============ ============
See accompanying notes to financial statements
4
SPATIALIGHT, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT (unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 2003
ADDITIONAL
COMMON STOCK PAID-IN NOTES
SHARES AMOUNT CAPITAL RECEIVABLE
------------- ------------- ---------------- -----------------
Balance, January 1, 2003 26,018,658 $ 260,187 $ 45,550,830 $ (1,426,999)
August private placement net of issuance cost of $224,648 1,212,061 12,120 2,526,731 -
May private placement net of issuance cost of $175,065 2,796,325 27,963 4,946,972 -
Beneficial pricing on stock and warrants sold in
private placements - - 958,913 -
Issuance of shares to third party for finder's fee in
conjunction with May private placement 130,435 1,304 375,653 -
Conversion of accrued interest 142,360 1,423 353,054 -
Warrants issued in lieu of interest on short term borrowings - - 6,647 -
Exercise of stock options and warrants 32,250 323 38,040 -
Issuance of stock, stock options, and warrants for services 79,000 790 467,388 -
Issuance of stock and options to employees and directors - - 42,839 -
Shares issued on exercise of warrant under 2002 installment
note 746,268 7,463 (7,463) -
Payments on notes receivable from stockholders - - - 152,500
Accrued interest on notes receivable from stockholders - - - (56,326)
Net loss - -
------------- ------------- ---------------- ----------------
Balance, September 30, 2003 31,157,357 $ 311,573 $ 55,259,604 $ (1,330,825)
============= ============= ================ ================
TOTAL
ACCUMULATED STOCKHOLDERS'
(DEFICIT) DEFICIT
---------------- ------------------------
Balance, January 1, 2003 $ (48,757,822) $ (4,373,804)
August private placement net of issuance cost of $224,648 - 2,538,851
May private placement net of issuance cost of $175,065 - 4,974,935
Beneficial pricing on stock and warrants sold in
private placements - 958,913
Issuance of shares to third party for finder's fee in
conjunction with May private placement - 376,957
Conversion of accrued interest - 354,477
Warrants issued in lieu of interest on short term borrowings - 6,647
Exercise of stock options and warrants - 38,363
Issuance of stock, stock options, and warrants for services - 468,178
Issuance of stock and options to employees and directors - 42,839
Shares issued on exercise of warrant under 2002 installment
note - -
Payments on notes receivable from stockholders - 152,500
Accrued interest on notes receivable from stockholders - (56,326)
Net loss (6,699,376) (6,699,376)
--------------- --------------------
Balance, September 30, 2003 $ (55,457,198) $ (1,216,846)
=============== ====================
See accompanying notes financial statements
5
SPATIALIGHT, INC.
STATEMENTS OF CASH FLOW (unaudited)
Nine months ended September 30,
--------------------------------
Cash flows from operating activities: 2003 2002
--------------- ---------------
Net loss $(6,699,376) $(6,138,484)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization 271,467 295,230
Stock-based general and administrative expense 1,730,637 410,706
Stock-based interest expense 417,393 1,510,785
Inventory writedown 100,690 -
Accrued interest on notes receivable from shareholders (56,326) -
Changes in operating assets and liabilities:
Accounts receivable (84,452) -
Inventory (811,934) (94,809)
Prepaid and other current assets 300,625 (480,519)
Other assets (33,038) (80,805)
Accounts payable (1,377,723) 593,064
Accrued expenses and other current liabilities 378,285 93,551
Net cash used in operating activities (5,863,752) (3,891,281)
--------------- ---------------
Cash flows from investing activities:
Purchase of property and equipment (409,399) (451,730)
--------------- ---------------
Net cash used in investing activities (409,399) (451,730)
--------------- ---------------
Cash flows from financing actitivies:
Payments on capital lease obligations - (4,483)
Proceeds from issuance of short term notes 917,500 -
Payment on short term notes and convertible notes (505,000) -
Payments on stock subscriptions and notes receivable from shareholders 152,500 831,533
Proceeds from issuance of common stock 7,513,786 -
Proceeds from exercise of warrants and options 38,363 892,483
--------------- ---------------
Net cash provided by financing activities 8,117,149 1,719,533
--------------- ---------------
Net increase(decrease) in cash and cash equivalents 1,843,998 (2,623,478)
Cash and cash equivalents at beginning of period 575,663 2,728,134
--------------- ---------------
Cash and cash equivalents at end of period $ 2,419,661 $ 104,656
=============== ===============
Supplemental disclosure of cash flow information:
Income taxes paid during the period $ 8 $ 1,425
--------------- ---------------
Interest paid during the period $ 26,474 $ 348
--------------- ---------------
Non cash financing activities:
Exercise of warrants in exchange for notes receivable $ - $ 1,747,347
--------------- ---------------
Common stock issued upon conversion of interest and notes $ 354,477 $ 691,400
--------------- ---------------
See accompanying notes to financial statements.
6
SPATIALIGHT, INC.
Notes to Condensed Financial Statements (Unaudited)
NOTE 1. BUSINESS DESCRIPTION
SpatiaLight, Inc. (SpatiaLight or the Company) is in the business of
manufacturing high-resolution microdisplays for applications such as high
definition television, computer monitors, video projectors and other
applications. To date, the Company has entered into agreements or memoranda of
understanding (MOUs) with eight original equipment manufacturers (OEMs) in China
and two such agreements with OEMs in the Republic of South Korea. Each MOU
contemplates definitive purchase order agreements in the event that certain
testing conditions are satisfied.
In late January 2003, the Company announced that it had signed an agreement with
Skyworth, one of the Chinese OEMs with which the Company had an agreement to
test prototypes of its microdisplay products, for the purchase by Skyworth of
14,100 display units during a one year delivery period. The purchase order
originally provided for 200 units to be delivered in February and an additional
200 units in each of March and April 2003. Skyworth and SpatiaLight subsequently
agreed to delay the first delivery of units. To date, the Company has completed
partial shipment of the 200 units originally scheduled for delivery in the first
month. Following the initial delivery provisions of 200 units per month for the
first three months, the Company is scheduled to deliver 1,500 units per month
until the order is completed. Pursuant to the terms of the purchase order, the
current obligations of Skyworth are backed by letters of credit in SpatiaLight's
favor. The purchase order is cancelable by Skyworth on a quarterly basis and is
subject to pricing contingencies and other customary terms and conditions.
In September 2003, the Company announced an agreement with China Electronics
Corporation (CEC), another of the Chinese OEMs with which the Company had an
agreement to test prototypes of its microdisplay products, for the purchase by
CEC of 2,000 display units from SpatiaLight. The agreement provides for an
initial delivery of ten display units, which was completed in September, with a
second delivery of 100 units to follow. Additional shipments will be made
periodically according to a schedule to be determined by CEC and the Company.
The purchase order is cancelable by CEC after delivery of 110 units and is
subject to other customary terms and conditions.
In October 2003, the Company announced that it had signed an agreement with
Nanjing Panda Electronics Co., Ltd. (Panda), for the purchase of 2,610 display
units by Panda. The agreement provides for an initial television box integration
phase followed by delivery of ten display units to Panda with a second delivery
of 100 units to follow. Subsequent shipments under the purchase order will be
made periodically according to a schedule to be determined by the parties. The
purchase order is cancelable by Panda after delivery of ten display units and is
subject to other customary terms and conditions.
NOTE 2. BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q of Item 303 of Regulation
S-K. Accordingly, they do not include all of the information and footnotes
necessary for a fair presentation of financial condition, results of operations
and cash flows in conformity with generally accepted accounting principles. In
the opinion of management of SpatiaLight, the interim condensed financial
statements included herewith contain all adjustments (consisting of normal
recurring accruals and adjustments) necessary for their fair presentation. The
unaudited interim condensed financial statements should be read in conjunction
with the Company's Annual Report on Form 10-KSB, which contains the audited
7
financial statements and notes thereto, together with the Management's
Discussion and Analysis, for the year ended December 31, 2002. The interim
results for the period ended September 30, 2003 are not necessarily indicative
of results for the full fiscal year.
Revenue is recognized when there is persuasive evidence of an arrangement, the
product has been delivered, the sales price is fixed or determinable, and
collectibility is reasonably assured. The product is considered delivered to the
customer once title and risk of loss have transferred. The Company defers
revenue if there is uncertainty about payment. The Company reduces revenue for
customer returns and allowances, which may occur under arrangements the Company
has with its customers.
Certain prior period amounts have been reclassified in order to conform to
current year presentation.
NOTE 3. LIQUIDITY
As of September 30, 2003 the Company has sustained recurring losses and had a
net capital deficiency of approximately $1,200,000, and a net working capital
deficiency of approximately $2,000,000. Reflected in these amounts are gross
proceeds of $5,150,000, and $2,763,500 raised in stock financings completed in
May 2003 and August 2003, respectively (See Note 6). Management believes that
these funds along with existing cash balances, anticipated collections of stock
subscriptions receivable of $1,300,000 and the anticipated exercise of warrants
held by existing investors will fund the Company's ongoing operations through
2004. Management anticipates that cash expenditures during 2003 will approximate
$400,000 per month, or approximately $5 million for the year, without regard to
any revenues in 2003. The Company's continued existence is dependent upon its
ability to generate revenue by successfully marketing and selling its products;
however, there can be no assurance that the Company's efforts will be
successful.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. This contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business. The
Company incurred significant operating losses in each of the last five fiscal
years and incurred a net loss of approximately $6,699,000 in the nine months
ended September 30, 2003. Of this amount, approximately $2,148,030 was non-cash
stock-based expenses. Additionally, as of September 30, 2003, the Company's
accumulated deficit totaled approximately $55,500,000. The Company has generated
limited revenues to date and the commercialization and marketing of the
Company's products will require substantial expenditures in the foreseeable
future. The successful completion of the Company's development program and
ultimately, the attainment of profitable operations is dependent upon future
events. These events include successful launching of the commercial production
and distribution of its products and achieving a level of sales adequate to
support the Company's cost structure. These matters, among others, may indicate
that the Company will be unable to continue as a going concern for a reasonable
period of time. The Company's auditors included a paragraph in their report on
the audited financial statements for the year ended December 31, 2002,
indicating that substantial doubt exists as to the Company's ability to continue
as a going concern.
The condensed financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts or the amounts
and classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
8
NOTE 4. PER SHARE INFORMATION
Basic loss per common share available to common shareholders excludes dilution
and is computed by dividing loss available to common shareholders by the
weighted-average number of Common Shares for the period. Excluded from weighted
average shares outstanding for the three months and nine months ended September
30, 2003 are 1,346,268 Common Shares issued but held in escrow in connection
with private stock purchase agreements and warrant installment notes. Diluted
loss per Common Share reflects the potential dilution that could occur if
securities or other contracts to issue Common Shares were exercised or
converted. Options and warrants to acquire 6,046,216 and 6,953,768 Common
Shares, and 3,702,966 and 3,428,603 Common Share equivalents relating to
convertible secured notes, for the three and nine months ended September 30,
2003 and 2002, respectively, are excluded from the computation of diluted loss
per share because the effect of their assumed exercise would be antidilutive.
The weighted average exercise price as of September 30, 2003 for the options and
warrants is $2.40 and $2.96, respectively; the weighted average conversion price
for the Common Share equivalents related to convertible notes is $1.14.
NOTE 5. NOTES PAYABLE
Convertible notes at September 30, 2003 consist of the following:
Argyle Notes:
In 1998, the Company received $1,188,000 in cash in exchange for notes in that
amount to Argyle Capital Management Corporation (Argyle), a company owned and
controlled by Robert A. Olins, Acting Chief Executive Officer, Secretary,
Treasurer, and a director of the Company. The notes accrue interest at a
contractual rate of 6% per annum, and are secured by substantially all the
assets of the Company. Both principal and interest are convertible into the
Company's Common Shares at $.50 per share. On May 23, 2001, the due date of the
notes was extended until December 31, 2002. On the extension date, the
beneficial conversion effect representing the excess aggregate value of the
Common Shares receivable upon conversion of the notes based on the then current
market price of $1.90 per share, over the aggregate conversion price for such
Common Shares (limited to the original proceeds of $1,188,000), was recorded as
additional paid-in capital. The resulting $1,188,000 discount to the debt
arising from the beneficial conversion feature was being amortized through
December 31, 2002. The effective interest rate for financial statement purposes
due to this discount differs from the actual contractual interest received or
receivable in cash or shares by Argyle. This discount, along with the
contractual 6% interest rate, resulted in a new effective interest rate of 72%
per annum as of the May 23, 2001 extension date when compared to the outstanding
principal balances. The effective rate prior to extension had been the 6% per
annum contractual rate. On September 20, 2002, the due date was extended until
March 31, 2004. Accordingly, the remaining unamortized discount at the extension
date of $198,000 is being amortized through March 31, 2004, resulting in a new
effective interest rate of 17% per annum when compared to the outstanding
principal balances.
On January 3, 2003 the Company issued 142,360 Common Shares upon the conversion
of prepaid interest of $354,477. Prepaid interest was computed using the closing
price of the Common Shares on December 31, 2002 of $2.49, and is being amortized
through December 31, 2003. For the nine months ended September 30, 2003,
additional stock-based interest expense of approximately $212,400 was recorded
due to the beneficial conversion feature of the prepaid interest, representing
the excess value of the Common Shares received upon conversion of the prepaid
interest. At September 30, 2003, the carrying value of the Argyle notes totals
$1,122,000, which includes the $1,188,000 principal balance net of unamortized
discounts of $66,000. See also Note 6.
9
Alabama Group Notes:
In December 1999, the Company received $1,437,500 in cash and issued notes in
that amount to a group of investors (the Alabama Group), which includes a trust
for the benefit of Steven F. Tripp, a director of the Company. Mr. Tripp is not
the trustee of this trust and has no power to vote or dispose of the Common
Shares of the Company or any other securities held by that trust. Marcia K.
Tripp, Steven F. Tripp's mother, is the trustee of this trust and directs and is
responsible for all of the investment decisions of this trust. In the opinion of
the Company, no other investor in the Alabama Group is an affiliate of the
Company and Mr. Tripp is not an affiliate of any other investor in the Alabama
Group. The notes accrue interest at a contractual rate of 6% per annum, and are
secured by substantially all the assets of the Company. At the time of issuance,
this portion of the notes was convertible into shares of the Company's Common
Shares at $3.50 per share. Upon issuance of the notes, the Company also issued
warrants to purchase 821,429 Common Shares. The warrants were exercised on June
28, 2002. The warrants were valued using the Black-Scholes option-pricing model
and the following assumptions: contractual life 2.5 years; volatility 114%;
risk-free interest rate 6%; and dividend yield of $0. The total cash received
from the issuance of this tranche of notes of $1,437,500 was less than the
calculated value associated with the warrants. Therefore, the value assigned to
the warrants was limited to the original proceeds of $1,437,500, and has been
recorded as a discount on the notes. The effective interest rate for financial
statement purposes due to this discount differs from the actual contractual
interest received or receivable in cash by the holders of the Alabama Group
Notes. This discount, along with the contractual 6% per annum interest rate,
resulted in an effective interest rate of 70% per annum when compared to the
outstanding principal balances.
The proceeds of the second tranche of notes, also totaling $1,437,500 and
carrying interest at 6% per annum, were originally to be received by the Company
upon the achievement of certain performance targets. The proceeds were received
in November 2000, prior to reaching those targets, in exchange for reducing the
conversion price of the notes to the then-market price of $2.25 per share. No
warrants were issued with the second tranche of notes. The remaining unamortized
discount for the first tranche, along with the contractual interest on both
tranches, resulted in a combined effective interest rate of 87% per annum as of
the issuance date for the second tranche when compared to the outstanding
principal balances.
On June 15, 2001, the due date of both tranches was extended until December 31,
2002. On the extension date, the excess $255,000 aggregate value of the Common
Shares receivable upon conversion of the notes based on the then current market
price of $2.65 per share, over the aggregate conversion price for the notes
convertible at $2.25 per share, was recorded as a debt discount and additional
paid-in capital. The resulting $255,000 discount to the debt, along with the
remaining unamortized discount for the first tranche, was being amortized
through December 31, 2002. The effective interest rate for financial statement
purposes due to these discounts differed from the actual contractual interest
received or receivable by the holders of the Alabama Group Notes. These
discounts, along with the contractual 6% per annum interest rate, resulted in a
new effective interest rate upon extension of 25% per annum as of the extension
date when compared to the outstanding principal balances. On September 20, 2002,
the due date of both tranches was extended until March 31, 2004. On the
extension date, the excess $58,000 aggregate value of the Common Shares
receivable upon conversion of the notes based on the then current market price
of $2.34 per share over the aggregate conversion price for the notes convertible
at $2.25 per share was recorded as a debt discount and additional
paid-in-capital. Accordingly, the remaining unamortized discount at the
10
extension date of $194,195 including the new discount of $58,000 is being
amortized through March 31, 2004, resulting in a new effective interest rate of
10.5% per annum when compared with to the outstanding principal balances.
On May 21, 2003, the Alabama Group released its security interest in the assets
of the Company in consideration for a reduction in the conversion price of the
first tranche of notes from $3.50 to $2.25. The market price on the day of
conversion, which was deemed to be the commitment date for accounting purposes,
was lower than the new conversion price; therefore, there was no beneficial
conversion effect. On July 31, 2003, the Company retired principal of $100,000
to certain investors. Additional principal was converted to Common Shares during
the fourth quarter (See Note 10: Subsequent Events). At September 30, 2003, the
remaining carrying value of the Alabama notes totals $3,266,956, which includes
principal balance plus accrued interest of $554,436, net of unamortized
discounts of $62,480.
Other Short-term Notes
During the first nine months of 2003, the Company received proceeds of $917,500
from borrowings under short-term notes. Of this amount, $260,000 was retired
during the first and second quarters and an additional $145,000 was retired
during the third quarter. At September 30, 2003 the outstanding balance on
short-term notes, excluding the Alabama and Argyle notes discussed above, was
$512,500. Of this outstanding balance, $250,000 was a convertible note, with a
conversion price of $2.67, which approximated the stock price on the date of
issuance. Therefore, there is no beneficial conversion effect associated with
this note. A warrant to purchase 10,000 shares of the Company's Common Shares
were issued in lieu of interest for a short-term note. Interest expense of
$6,647 was recorded during the second quarter using a Black-Scholes
option-pricing model. (See Note 6). The note was repaid during the second
quarter. All outstanding notes at September 30, 2003 accrue interest at 6% per
annum and have maturity dates ranging from immediately to 92 days.
Activity in notes payable for the nine months ended September 30, 2003 follows:
(PAYMENT) OR BALANCE AT
BALANCE AT ADDITION OR NEW DISCOUNT CONVERSION TO SEPTEMBER 30,
DEBT PRINCIPAL: DECEMBER 31, 2002 DISCOUNT AMORTIZATION EQUITY 2003
------------------ ---------------- ------------------- ----------------- --------------
Argyle $ 1,188,000 $ - $ - $ - $ 1,188,000
Argyle discount (165,000) - 99,000 - (66,000)
Alabama Group 2,875,000 - (100,000) - 2,775,000
Alabama Group discount (161,829) - 99,349 - (62,480)
Other short term notes (convertible and other) - 917,500 (405,000) - 512,500
------------------ ---------------- ------------------- ----------------- --------------
Total 3,736,171 917,500 (306,651) - 4,347,020
------------------ ---------------- ------------------- ----------------- --------------
INTEREST:
Accrued Argyle 6% - 53,460 - (53,460) -
Accrued Alabama 6% 471,061 105,240 (21,865) - 554,436
Beneficial interest - Argyle - 212,397 - (212,397) -
------------------ ---------------- ------------------- ----------------- --------------
Total 471,061 371,097 (21,865) (265,857) 554,436
------------------ ---------------- ------------------- ----------------- --------------
TOTAL $ 4,207,232 $ 1,288,597 $ (328,516) $ (265,857) $ 4,901,456
================== ================ =================== ================= ==============
11
Stock-based interest expense discussed above is as follows:
Nine months ended September 30,
-------------------------------
2003 2002
--------------- --------------
Amortization of Alabama group discount $ 99,349 $ 408,579
Amortization of Argyle Capital discount 99,000 594,000
Effect of beneficial conversion priviledges
on accrued interest 212,397 378,900
Other 6,647 129,306
-------------------------------
$ 417,393 $ 1,510,785
===============================
NOTE 6. ISSUANCE OF SECURITIES
Issuance of Stock during the nine months ended September 30, 2003
- -----------------------------------------------------------------
In August 2003, the Company completed a private sale of 1,212,061 of its Common
Shares and fully vested warrants, with a strike price of $3.29, to purchase
303,015 Common Shares in exchange for net proceeds of $2,538,851, with six
purchasers, none of whom is an affiliate of the Company. In addition, warrants
to purchase 48,482 Shares were granted to the placement agent for the financing.
There was no earnings impact for these warrants.
In May 2003, the Company issued 2,796,325 Common Shares at $1.84 per share and
699,080 fully vested warrants with a strike price of $2.65 in exchange for net
proceeds of $4,974,935. Of this amount 1,357,441 shares and 339,360 warrants
were purchased by Robert A. Olins, Acting Chief Executive Officer and a
director. Consequently, the Company recognized non-cash expense of $958,913
related to the deemed beneficial pricing Robert A. Olins received; the expense
consists of two components. First, an expense of $538,106, representing the fair
value of the warrant issued to Robert A. Olins was recognized in stock-based
general and administrative expense in the second quarter, using a Black-Scholes
option pricing model and the following assumptions: stock price $2.15,
historical volatility 105%, risk free rate of 2.27%, dividend rate of 0, and a
contractual term of five years. Second, since the market price on the day of
closing of $2.15 was higher than the issuance price of $1.84 a charge of
$420,807 was recognized in stock-based general and administrative expenses for
the 1,357,441 shares purchased by Robert A. Olins.
In order to complete this stock financing, the outside investors required
significant participation from Robert A. Olins. To achieve this, Mr. Olins
borrowed funds to purchase his share of the stock financing. The Company's board
of directors unanimously (except for Mr. Olins, who did not vote on this matter)
approved reimbursements for certain expenses incurred in connection with the
personal loan to Mr. Olins made by an unaffiliated bank, and $300,000, payable
through the issuance of 130,435 Common Shares, for a finder's fee that Mr. Olins
was obligated to pay to an unaffiliated third party. Another shareholder of the
Company, to whom the Company subsequently issued 130,435 Shares, undertook Mr.
Olins' obligations to the finder. The $376,957 fair value of the 130,435 shares
is included in stock-based general and administrative expense.
12
Additionally, warrants in the aggregate of 77,126 shares were issued to the
placement agent handling the financing. There was no earnings impact for these
warrants.
The Company has become aware that the current interpretations of the NASDAQ
rules by the NASDAQ staff require shareholder approval of the sale by the
Company to Mr. Olins of 1,357,441 shares at the same discount received by the
other investors in that transaction. Upon review, the Company has determined to
seek shareholder ratification of the sale to Mr. Olins at the Company's next
annual meeting of shareholders. Mr. Olins has informed the Company that in the
interim he will not dispose of, nor vote, these shares until such ratification
is obtained. In the event that such ratification is not obtained, Mr. Olins and
the Company have agreed that the matter will be addressed consistent with the
rules and regulations of the NASDAQ.
Interest Conversion
- -------------------
On January 3, 2003 the Company issued 142,360 Common Shares upon the conversion
of prepaid interest of $354,477. Prepaid interest was computed using the closing
price of the Common Shares on December 31, 2002 of $2.49, and is being amortized
through December 31, 2003. (See also Note 5).
In May 2003, the Company issued a fully vested warrant to purchase 10,000 Common
Shares in lieu of interest on a short-term note. A value of $6,647 was assigned
to this warrant using a Black-Scholes option pricing model and the following
assumptions: stock price $2.15, historical volatility 79%, risk free rate of
1.01%, dividend yield of 0, and a contractual term of 1 year. The value of this
warrant was recorded in non-cash interest expense in the second quarter 2003.
Exercise of Stock Options and Warrants during the nine months ended
- -------------------------------------------------------------------
September 30, 2003
- ------------------
During the first nine months of 2003, 32,250 Common Shares were issued upon the
exercise of employee stock options. Total cash received was $38,363.
Issuance of Stock, Stock Options and Warrants for services in the nine months
- --------------------------------------------------------------------------------
ended September 30, 2003
- ------------------------
On October 14, 2002 the Company issued a fully vested warrant to purchase
250,000 Common Shares at an exercise price of $3.50 in exchange for consulting
services rendered over a six-month period. A value of $91,000 was assigned to
the warrants for the portion of the services rendered in 2003 using the
Black-Scholes option pricing model and the following assumptions: stock price
$1.84, historical volatility 100%, risk free rate 5%, a dividend yield of 0, and
a contractual term of two years, and is reflected in the statement of operations
as stock-based general and administrative expense.
In March 2003, the Company issued a fully vested warrant to purchase 200,000
Common Shares in exchange for services rendered in the first quarter of 2003. A
value of $85,400 was assigned to the warrant using the Black-Scholes option
pricing model and the following assumptions: stock price $2.43, historical
volatility 100%, risk free rate 5%, a dividend yield of 0, and a contractual
term of five months. The value of the warrant is included in stock-based general
and administrative expense in the first quarter of 2003.
In May 2003, the Company issued a fully vested option to purchase 25,000 Common
Shares in exchange for services rendered. A value of $49,734, was assigned to
this option using a Black-Scholes option pricing model and the following
assumptions: stock price $2.14, historical volatility 112%, risk free rate of
3.33%, a dividend yield of 0, and a contractual term of 10 years. The value of
13
this option was recorded in stock-based general and administrative expense in
the second quarter.
In May 2003, the Company issued a fully vested warrant to purchase 125,000
Common Shares in exchange for consulting services. A value of $56,994 was
assigned to the warrant using a Black-Scholes option pricing model and the
following assumptions: stock price $2.05, historical volatility 79%, risk free
rate of 1.01%, dividend yield of 0, and a contractual term of 18 months.
In May 2003, the Company issued 32,000 Common Shares to an outside consultant.
The shares were issued in consideration of services rendered by the consultant
in 2003. These shares were valued at $68,800, the market value of the shares on
the date of grant.
In March 2003, the Company issued 47,000 Common Shares in exchange for
consulting services provided in 2002 totaling $116,250. The expense associated
with these services was recorded in 2002.
Other expenses in 2003 related to the valuation of options granted to directors
for additional services totaled $42,839 and are included in stock-based general
and administrative.
Issuance of Stock Under Installment Note
- ----------------------------------------
In November 2002, a warrant to purchase 746,268 Common Shares was exercised at
$2.00 per share under a warrant installment agreement totaling $1,492,536.
Payments of $200,000 were made in 2002. An additional $152,500 was received in
2003. Interest accrues at 6% per annum and is due with the final payment. As of
September 30, 2003, approximately $63,000 of accrued interest has been recorded,
including interest of approximately $56,000 in 2003. The shares were issued in
2003, but are held in escrow by the Company pending receipt of the remaining
balance of $1,140,036, which is included in the notes and stock subscriptions
receivable balance as of September 30, 2003.
Stock-based general and administrative expense discussed above is as follows:
Stock based general and administrative expense discussed above
is as follows:
Nine months ended September 30,
2003 2002
---------------- ----------------
Stock and options granted to employees and directors $ 42,839 $ 237,277
Common stock and warrants expensed for services 283,128 103,652
Stock issued in connection with May
stock purchase 376,957 -
Beneficial pricing on sale of stock and warrants
to officer 958,913 -
Other 68,800 69,777
---------------- ----------------
$ 1,730,637 $ 410,706
================ ================
14
NOTE 7. SEGMENT INFORMATION
The Company's chief operating decision-maker, the Chief Executive Officer (CEO),
reviews the Company's financial information as a single "operating segment" to
make decisions about the Company's performance and resource allocation.
Therefore the Company has determined that it operates in a single business
segment.
NOTE 8. STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation arrangements for employees
and directors using the intrinsic value method pursuant to Accounting Principles
Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees." As such,
compensation expense is recorded when, on the date of grant, the fair value of
the underlying Common Shares exceeds the exercise price for stock options or the
purchase price for issuances or sales of Common Shares. Pursuant to Statement of
Financial Accounting Standards (SFAS) No. 123 "Accounting for Stock-Based
Compensation," the Company discloses the pro forma effects of using the fair
value method of accounting for stock-based compensation arrangements and records
compensation expense for the fair value of options granted to non-employees.
If the Company had elected the fair value method of accounting for stock-based
compensation, compensation cost would be accrued at the estimated fair value of
stock option grants over the service period, regardless of later changes in
stock prices and price volatility.
The table below shows net income per share for the three months and nine months
ended September 30, 2003 and 2002 as if the Company had elected the fair value
method of accounting for stock options.
Three months ended September 30, Nine months ended September 30,
2003 2002 2003 2002
----------------- ------------------ ---------------- -----------------
Net loss as reported $ (1,824,942) $ (2,232,198) $ (6,699,376) $ (6,138,484)
Deduct: total stock-based employee compensation
determined under fair value method for all awards,
net of any applicable related tax effects (230,425) (556,027) (1,096,680) (2,330,360)
----------------- ------------------ ---------------- -----------------
Proforma net loss, as adjusted $ (2,055,367) $ (2,788,225) $ (7,796,056) $ (8,468,844)
Loss per share:
Basic and diluted, as reported $ (0.06) $ (0.09) $ (0.25) $ (0.25)
Basic and diluted, as adjusted $ (0.07) $ (0.11) $ (0.29) $ (0.35)
NOTE 9. RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board (FASB) issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities," which
addresses financial accounting and reporting for costs associated with exit or
disposal activities. SFAS No. 146 requires that a liability for a cost
15
associated with an exit or disposal activity be recognized when the liability is
incurred. This Statement also establishes that fair value is the objective for
initial measurement of the liability. Severance pay under SFAS No. 146, in many
cases, would be recognized over time rather than up front. The provisions of
this statement are effective for exit or disposal activities that are initiated
after December 31, 2002. Adoption of this Statement did not have a material
impact on the Company's financial condition or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which provides alternative methods of
transition for a voluntary change to fair value based method of accounting for
stock-based employee compensation as prescribed in SFAS No. 123. Additionally,
SFAS No. 148 requires more prominent and more frequent disclosures in financial
statements about the effects of stock-based compensation. The provisions of this
Statement are effective for fiscal years ending after December 15, 2002.
Adoption of this Statement did not have a material impact on the Company's
financial condition or results of operation, as the Company is not currently
planning to make a voluntary change to the fair value method of accounting for
stock-based employee compensation.
In May 2003, the FASB issued SFAS No. 150, Accounting For Certain Financial
Instruments with Characteristics of Both Liabilities and Equity, which
establishes standards for how an issuer of financial instruments classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument within
its cope as a liability (or an asset in some circumstances) if, at inception,
the monetary value of the obligation is based solely or predominantly on a fixed
monetary amount known at inception, variations in something other than the fair
value of the issuer's equity shares or variations inversely related to changes
in the fair value of the issuer's equity shares. SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2002, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. Implementation did not have a material impact on the Company's
financial condition or results of operations.
In November 2002, the FASB issued FASB Interpretation (FIN) No. 45. "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN No. 45 requires a guarantor to
recognize, at the inception of a qualified guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee. FIN No. 45 is
effective on a prospective basis for qualified guarantees issued or modified
after December 31, 2002. Adoption of this Interpretation did not have a material
impact on the Company's financial condition or results of operations.
NOTE 10. SUBSEQUENT EVENTS
In October 2003, certain investors included in the Alabama Group converted their
outstanding notes and interest thereunder to Common Shares. As of the date of
this filing, investors in the Alabama Group have converted principal of
$2,500,000 and accrued interest of $508,892 into 1,211,645 Common Shares.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Form 10-Q contains certain forward-looking statements within the meaning of
Section 21E of the Securities and Exchange Act of 1934, as amended, which
statements are subject to the Safe Harbor provisions created by that statute. In
this report, the words "anticipates," "believes," "expects," "future,"
"intends," and similar expressions identify forward-looking statements. Such
statements are subject to certain risks and uncertainties, including, but not
limited to, those discussed herein, those contained in this Item, 2 and those
discussed in the Company's Annual Report on Form 10-KSB as filed with the
Securities and Exchange Commission on April 14, 2003. Readers are cautioned not
to place undue reliance on these forward-looking statements, which speak only as
of the date hereof. The Company undertakes no obligation to publicly release the
results of any revisions to these forward-looking statements that may be needed
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
The following is a discussion and analysis of the consolidated financial
condition of the Company as of September 30, 2003, and the results of operations
for the Company for the three months and nine months ended September 30, 2003
and 2002. The following should be read in conjunction with the unaudited
financial statements and related notes appearing elsewhere herein.
GENERAL
Our operations are constrained by an insufficient amount of working capital, and
we continue to experience negative cash flows and net operating expenses. Our
ongoing operations are expected to be funded by the gross proceeds of $5.15
million received from the stock financing completed in May 2003, the $2.76
million of gross proceeds raised in the August 2003 stock financing, and funds
from the exercise of warrants and options. Our auditors have included a
paragraph in their report on the audited financial statements as of the year
ended December 31, 2002, indicating that substantial doubt exists as to our
ability to continue as a going concern.
We anticipate that our cash expenditures during 2003 will approximate $400,000
per month, or approximately $5 million for the year, without regard to any
additional revenues in 2003. We expect to meet our cash needs with our existing
cash balances from collections of stock subscriptions receivable of
approximately $1,300,000 and from the exercise of warrants held by existing
investors. In addition, we expect to fund working capital requirements by
drawing on letters of credit issued by customers in connection with signed
purchase orders. However, there can be no assurance that any significant number
of these other warrants will be exercised. If no warrants are exercised, and the
Company does not derive any significant revenues from its operations during
2003, it is likely that we will need to raise additional debt or equity
financing during 2004 or beyond. There can be no assurances that such additional
debt or equity funding will be available from our current investors or from any
other source.
OVERVIEW
We manufacture microdisplays that provide high resolution images suitable for
applications such as high definition television, rear projection computer
monitors, video projectors, and potential applications such as those used in
wireless communication devices, portable games and digital assistants. Our
microdisplays are designed for use in end products of original equipment
manufacturers, and therefore we work closely with prospective and actual
customers to incorporate our microdisplays into their final products. While in
the past we have had working arrangements with several independent liquid
crystal display fabricators to manufacture certain of our prototype products, we
17
are now manufacturing our microdisplays ourselves in a 500 square foot Class 100
cleanroom and a 1200 square foot Class 1000 cleanroom. We have enhanced quality
control and we have more effective protection of our proprietary technology in
our products. Internal manufacturing is subject to certain risks described under
"Business Risks and Uncertainties." We have patents covering parts of our
designs; however, the key designs of the circuitry in the silicon, drive
electronics, and liquid crystal assembly techniques are proprietary and not
covered by patents.
In May 2001, we entered into an arrangement with Fuji Photo Optical Co., Ltd.
(Fuji), for the manufacture of light engines. In September 2002, we accepted
delivery of the first pre-production SpatiaLight/Fuji display units. These
pre-production display units incorporate mechanical changes and technical
enhancements that we initiated based upon the results of extensive testing of
the prototype display units. In September 2003, the first production display
units were shipped to Skyworth Display Ltd. (Skyworth).
Since late October 2001, we have entered into agreements or memoranda of
understanding with eight original equipment manufacturers (OEMs) in China
contemplating the purchase by these prospective customers of our display units
and/or SpatiaLight imagEngine(TM) microdisplays for use in certain of their
products. All of these agreements require that we supply prototypes of our
display units and/or SpatiaLight imagEngine(TM) microdisplays and that they meet
technical criteria satisfactory to each of such prospective customers. In 2003,
we entered into Agreements of Principal Terms with two OEMs in the Republic of
South Korea. One of these agreements is a development agreement and the second
contemplates the purchase of our display units for use in certain of the OEM
products. This agreement requires that we supply a prototype of our display unit
and that it meet technical criteria satisfactory to the prospective customer.
In late January 2003, we announced that we had signed an agreement with
Skyworth, one of the Chinese OEMs with which we had an agreement to test
prototypes of our microdisplay products, for the purchase by Skyworth of 14,100
SpatiaLight display units during a one year delivery period. The purchase order
originally provided for 200 units to be delivered in February and an additional
200 units in each of March and April 2003. Skyworth and we subsequently agreed
to delay the first delivery of units. To date, we have completed partial
shipment of the 200 units originally scheduled for delivery in the first month.
Following the initial delivery provisions of 200 units per month for the first
three months, we are scheduled to deliver 1,500 units per month until the order
is completed. Pursuant to the terms of the purchase order, the current
obligations of Skyworth are backed by letters of credit in our favor. The
purchase order is cancelable by Skyworth on a quarterly basis and is subject to
pricing contingencies and other customary terms and conditions.
In September 2003 we announced that we signed an agreement with China
Electronics Corporation (CEC), another of the Chinese OEMs with which we had an
agreement to test prototypes of our microdisplay products, for the purchase by
CEC of 2,000 display units from us. The agreement provides for an initial
delivery of ten display units, which was completed in September, with a second
delivery of 100 units to follow. Additional shipments will be made periodically
according to a schedule to be determined by CEC and us. The purchase order is
cancelable by CEC after delivery of 110 units and is subject to other customary
terms and conditions.
In October 2003, we announced that we had signed a purchase order with Nanjing
Panda Electronics Co., Ltd. (Panda), for the purchase of 2,610 display units by
Panda. The agreement provides for an initial television box integration phase
followed by delivery of ten display units to Panda with a second delivery of 100
18
units to follow. Subsequent shipments under the purchase order will be made
periodically according to a schedule to be determined by the parties. The
purchase order is cancelable by Panda after delivery of ten display units and is
subject to other customary terms and conditions.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2003, we had approximately $2,420,000 in cash and cash
equivalents, an increase of approximately $1,845,000 from the December 31, 2002
amount of $575,000. Our net working capital deficit at September 30, 2003 was
approximately $2,000,000 compared to a net working capital deficit of
approximately $800,000 at December 31, 2002. This working capital deficit change
is primarily due to the reclassification of the Argyle and Alabama group notes
to current liabilities based on their maturity date of March 31, 2004 and
recurring losses, offset by the proceeds of the May and August stock issuances.
Net cash used in operating activities totaled approximately $5,864,000 and
$3,891,000 for the nine months ended September 30, 2003 and 2002, respectively.
Cash was used primarily to fund the operating loss.
Net cash provided by financing activities in the nine months ended September 30,
2003 was approximately $8,117,000 as compared to approximately $1,720,000 for
the nine months ended September 30, 2002. This increase is due primarily to the
two stock issuances during 2003, which raised net proceeds of approximately
$7,514,000. This increase is offset by reduced payments on stock subscriptions
receivable and a decrease in proceeds from the exercise of options and warrants
for the nine months ended September 30, 2003. (see Note 5 and Note 6 to the
accompanying condensed financial statements).
As of September 30, 2003, we had an accumulated deficit of approximately
$55,500,000. We have realized significant losses in the past and we expect that
these losses will continue at least through 2003. It is likely that we will have
quarterly and annual losses in 2003 and beyond. We have generated limited
revenues and no profits from operations. The development, commercialization and
marketing of our products will require substantial expenditures for the
foreseeable future. Consequently, we may continue to operate at a loss for the
foreseeable future and there can be no assurance that our business will operate
on a profitable basis or will be able to continue as a going concern.
RESULTS OF OPERATIONS
Revenues. Total revenues were $82,152 for the nine and three months ended
September 30, 2003. Total revenues were $0 for the nine and three months ended
September 30, 2002. Revenues in 2003 were the result of our delivery of display
units to Skyworth and CEC.
Cost of Revenues. Cost of revenues represents product costs associated with the
production of display units. Cost of revenues was $73, 875 for the nine and
three months ended September 30, 2002, $0 for the nine and three months ended
September 30, 2002, respectively. Gross margins associated with sales are not
indicative of the gross margins that we expect to realize on sales of units
produced in quantity.
Inventory writedown. The adjustment to restate inventory at the lower of cost or
market value was $100,690 for the nine months ended September 30, 2003. Our
initial purchases of inventory components were at a cost higher than we expect
to incur for future purchases.
19
Selling, general and administrative costs. Selling, general and administrative
costs were approximately $973,000 and $629,145 in the three months ended
September 30, 2003 and 2002, respectively and $2,346,000 and $1,795,000 in the
nine months ended September 30, 2003 and 2002, respectively, and include
professional services, salaries and related taxes and benefits, rent,
depreciation, travel, insurance and office expenses. General and administrative
expense increased year over year due to the reimbursement of banking fees of
$250,000 incurred by Robert A. Olins, Acting Chief Executive Officer and a
director, in conjunction with his participation in the May 2003 stock financing.
Additional increase in general and administrative expenses year over year are
due to an increase in headcount, rent associated with new facilities, and travel
expenses.
Stock-based general and administrative costs. Stock-based general and
administrative costs were approximately $72,000 and $142,000 in the three months
ended September 30, 2003 and 2002, respectively, and approximately $1,731,000
and $411,000 in the nine months ended September 30, 2003 and 2002, respectively.
The increase in the nine months ended September 30, 2003 relates primarily to
stock-based costs of $1,300,000 associated with the May 2003 stock financing.
(See Note 6 to the accompanying condensed financial statements).
Research and development costs. Research and development costs were
approximately $1,988,000 and $2,235,000 in the nine months ended September 30,
2003 and 2002, respectively and $597,000 and $859,000 in each of the three
months ended September 30, 2003 and 2002, respectively. In 2002 we incurred
approximately $161,000 in costs associated with testing of prototypes in
conjunction with our manufacturing arrangement with Fuji. Additional decrease in
expense year over year is due to a decrease in costs associated with outside
consultants. We expect to continue incurring significant research and
development costs in order to meet the technical criteria from current and
prospective customers.
Interest expense. Interest expense for the nine months ended September 30, 2003
increased approximately $14,000 from the same period in 2002, due to interest
paid on short-term borrowings.
Stock-based interest expense. Stock-based interest expense was approximately
$417,000 and $1,510,785 for the nine months ended September 30, 2003 and 2002,
respectively, and $138,000 and $536,000 for the three months ended September 30,
2003 and 2002, respectively. Stock-based interest expense relates to the
beneficial conversion feature of interest converted and convertible into equity
on the notes payable to Argyle Capital Management Corporation, a company wholly
owned by Robert A. Olins, Acting Chief Executive Officer of the Company. The
beneficial conversion interest represents the excess value of the shares
received or receivable at current market prices over the $0.50 per share
conversion price. For the nine months ended September 30, 2003, interest expense
related to the beneficial conversion feature decreased approximately $165,000
due to the extension of the amortization period resulting from an extension of
the due date of the note until March 31, 2004. In addition, stock-based interest
expense relates to amortization of the discounts on notes payable to Argyle
Capital Management Corporation and to the Alabama Group, a group of investors,
which includes a trust for the benefit of Steven F. Tripp, a director of the
Company. In September 2002 the notes were extended 18 months, thereby reducing
the monthly amortization of the discount. Interest expense related to the
reduction of discount amortization was approximately $804,000 for the nine
months ended September 30, 2003. Also included in stock-based interest is a
warrant with a fair value of $6,700 issued in lieu of interest on a short-term
note payable, which note was issued and retired during the second quarter of
2003.
20
Interest income. Interest income for the nine months ended September 30, 2003
and 2002 was approximately $56,000 and $8,600, respectively. Interest income for
the three months ended September 30, 2003 and 2002 was approximately $18,400 and
$100, respectively. The increase is due to accrued interest on a note receivable
from a shareholder in the nine months of 2003.
Critical Accounting Policies
- ----------------------------
Outlined below are accounting policies that we believe are key to a full
understanding of our operations and financial results. All our accounting
policies are in compliance with accounting principles generally accepted in the
United States of America.
Revenue Recognition - SpatiaLight enters into transactions to sell its products.
We evaluate revenue recognition for these transactions using the following basic
criteria (collectively called the Revenue Recognition Criteria):
o Evidence of an arrangement: Before revenue is recognized, we must have
evidence of an agreement with the customer reflecting the terms and
conditions to deliver our products.
o Delivery: For products, delivery is considered to occur when title and
risk of loss have been transferred.
o Fixed or determinable fee: We consider a fee to be fixed or
determinable if the fee is not subject to refund or adjustment. If a
portion of the arrangement fee is not fixed or determinable, we
recognize that amount as revenue when the amount becomes fixed or
determinable. We do not consider a fee to be fixed and determinable if
any amount is due more than 180 days from the delivery date. Payment
terms of less than 180 days are evaluated based upon the country in
which the arrangement is entered into to assess whether the fee is
fixed and determinable.
o Collection is deemed probable: Collection is deemed probable if we
expect the customer to be able to pay amounts under the arrangement as
those amounts become due. If we determine that collection is not
probable, we recognize revenue when collection becomes probable
(generally upon cash collection).
Stock-based Compensation - We account for our stock-based compensation
arrangements with employees and directors using the intrinsic value method
pursuant to Accounting Principles Board Opinion (APB) No. 25, as clarified by
Financial Accounting Standards Board (FASB) Interpretation No. 44. As such,
compensation expense is recorded when, on the date of grant, the fair value of
the underlying Common Shares exceeds the exercise price for stock options or the
purchase price for issuances or sales of Common Shares. Pursuant to Statement of
Financial Accounting Standards (SFAS) No. 123 as amended by SFAS No. 148, we
disclose the pro forma effects of using the fair value method of accounting for
stock-based compensation arrangements and records compensation expense for the
fair value of options granted to non-employees.
Research and Development - Research and development costs are charged to expense
when incurred.
Inventory valuation - We value inventories at the lower of cost (based on the
first-in, first-out method) or market value. We include materials, labor and
manufacturing overhead in the cost of inventories. In determining inventory
market values, we give substantial consideration to the expected product-selling
price based on historical recovery rates. If we assess the market value of our
inventory to be less than costs we write it down to its replacement cost or its
net realizable value. Our estimates may differ from actual results due to the
quantity and quality and mix of products in inventory, consumer and retailer
21
preferences and economic conditions. At June 30, 2003, inventories (consisting
entirely of raw materials components) were written down by $100,690, as prices
on initial order quantities were higher than those expected in the future, and
would otherwise have resulted in losses on sales of finished goods in 2003.
Income tax assets and liabilities - In establishing our deferred income tax
assets and liabilities, we make judgments and interpretations based on the
enacted tax laws and published tax guidance that are applicable to our
operations. We record deferred tax assets and liabilities and evaluate the need
for valuation allowances to reduce the deferred tax assets to realizable
amounts. The likelihood of a material change in our expected realization of
these assets is dependent on future taxable income, our ability to use foreign
tax credit carryforwards and carrybacks, final U.S. and foreign tax settlements,
and the effectiveness of our tax planning strategies in the various relevant
jurisdictions. Due to our lack of profitable operating history, potential
limitations on usage of operating losses and general uncertainty, we provided
for a 100% valuation allowance against our deferred tax assets for all periods
presented. We are also subject to examination of our income tax returns for
multiple years by the Internal Revenue Service and other tax authorities. We
periodically assess the likelihood of adverse outcomes resulting from these
examinations to determine the adequacy of our provision for income taxes.
Changes to our income tax provision or the valuation of the deferred tax assets
and liabilities may affect our annual effective income tax rate.
BUSINESS RISKS AND UNCERTAINTIES
WE HAVE A HISTORY OF LOSSES AND MAY INCUR LOSSES IN THE FUTURE AND THEREFORE
CANNOT ASSURE YOU THAT WE WILL ACHIEVE PROFITABILITY.
We have incurred losses over the past five years and have experienced cash
shortages. For the nine months ended September 30, 2003 and 2002, we incurred
net losses of approximately $6,699,000 and $6,138,000, respectively. In
addition, we had an accumulated deficit of $55,500,000 as of September 30, 2003.
We expect additional losses as we continue spending for production and other
business activities as well as further research and development of our products.
As a result, we will need to generate substantial sales to support our costs of
doing business before we can begin to recoup our operating losses and
accumulated deficit and achieve profitability.
IF WE ARE UNABLE TO OBTAIN FURTHER FINANCING OR GENERATE REQUIRED WORKING
CAPITAL OUR ABILITY TO OPERATE COULD SUFFER OR CEASE. OUR AUDITORS HAVE ISSUED A
REPORT ON OUR FINANCIAL STATEMENTS, WHICH CONTAINS AN EXPLANATORY PARAGRAPH
REGARDING SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN.
Our operations to date have consumed substantial amounts of cash and will
continue to require substantial amounts of capital in the future. In order to
remain competitive, we must continue to make significant investments essential
to our ability to operate profitably, including investments in further research
and development, equipment, facilities and production activities. Although our
financial condition and liquidity have been assisted through the previous
exercises of warrants and private purchases of our Common Shares including the
approximately $8.0 million raised by us in the two recently completed stock
financings, we may still require additional financing to satisfy our increasing
working capital requirements. Reliance for financing upon exercise of warrants
and private stock purchase agreements entails the additional risks of
non-exercise of such warrants because of the prevailing market prices of our
underlying Common Shares or default by stock purchasers under these agreements.
In the event that we are unable to obtain further financing on satisfactory
terms or at all, generate sales sufficient to offset our costs, or if the costs
of development and operations are greater than we anticipated, we may be unable
22
to grow our business at the rate desired or may be required to delay, reduce, or
cease certain of our operations, any of which could materially harm our business
and financial results. Our independent auditors have included an explanatory
paragraph in their report in our Form 10-KSB on our financial statements for our
last fiscal year regarding substantial doubt about our ability to continue as a
going concern.
WE ARE SUBJECT TO LENGTHY DEVELOPMENT PERIODS AND PRODUCT ACCEPTANCE CYCLES,
WHICH MAY SIGNIFICANTLY HARM OUR BUSINESS.
Our business model requires us to develop microdisplays that perform better than
existing technologies, contract with one or more third-party manufacturers to
manufacture our display units in bulk, and sell the resulting display units to
original equipment manufacturers that will then incorporate them into their
products. Original equipment manufacturers make the determination during their
product development programs whether or not to incorporate our SpatiaLight
imagEngine(TM) microdisplays and/or display units in their products. This
requires us to invest significant amounts of time and capital in designing our
SpatiaLight imagEngine(TM) microdisplays and/or display units before we can be
assured that we will generate any significant sales to our customers or even
recover our investment. If we fail to recover our investment from the
SpatiaLight imagEngine(TM) microdisplays and/or display units, it could
seriously harm our financial condition. In addition, the length of time that our
products may be successfully received by our customers could be limited by the
acceptance of new technologies developed by our competitors.
WE INCUR SUBSTANTIAL RESEARCH AND DEVELOPMENT COSTS IN CONNECTION WITH
TECHNOLOGIES THAT MAY NOT BE SUCCESSFUL.
We currently have eleven full-time engineering and six full-time manufacturing
personnel based in California working on microdisplays. This staffing creates
significant research and development costs that may not be recouped. Even if our
current microdisplays become accepted or successful, due to the rapid
technological change in our industry, we must continue to use, and may increase
in number, our engineering and manufacturing personnel to develop future
generations of our microdisplays. As a result, we expect to continue incurring
significant research and development costs.
IN RECENT MONTHS WE HAVE COMMENCED MANUFACTURING AND SHIPPING OUR MICRODISPLAYS
IN COMMERCIAL QUANTITIES, BUT UNANTICIPATED DIFFICULTIES IN CONTINUING
MANUFACTURING OUR MICRODISPLAYS MAY MAKE IT DIFFICULT TO MEET CUSTOMER DEMANDS
FROM TIME TO TIME AND OUR OPERATING RESULTS COULD BE SIGNIFICANTLY HARMED BY
SUCH DIFFICULTIES.
We need to work closely with our manufacturing sources to assure production of
our current display units. Problems in production or lower than expected
manufacturing yields could significantly harm our business because we will have
already incurred the costs for the materials used in the microdisplay
manufacturing process. These problems could cause delays that might lead our
potential customers to seek other sources.
We currently obtain silicon backplanes, a vital component in our microdisplays,
from the Far East. Some Asian countries are subject to earthquakes, typhoons and
political instability. Unless we obtain an alternative source, any disruption or
termination of our silicon manufacturing source's operation in Taiwan or air
transportation with the Far East could significantly harm our operations.
Our microdisplays are assembled by combining the silicon backplanes with
electronic components. The design and manufacture of liquid crystal displays and
display units are highly complex processes that are sensitive to a wide variety
23
of factors, including the level of contaminants in the manufacturing
environment, impurities in the materials used, and the performance of personnel
and equipment. While in the past we have had working arrangements with several
independent liquid crystal display fabricators to manufacture certain of our
products, we are now manufacturing our microdisplays ourselves. We believe that
the internal manufacture of all such liquid crystal microdisplays will benefit
us by allowing us to enhance quality control over such products as well as
protect more effectively our proprietary interest in those products, but the
risks discussed above associated with the highly complex processes of
manufacturing these liquid crystal microdisplays remain applicable.
We continue to have working arrangements with the manufacturer of the light
engines and lamps required in the assembly of our display units. We have entered
into an agreement for the supply of prisms and filters which are also required
for the assembly of such units. Except for that agreement, we do not have
written agreements which are binding upon the manufacturers of the other
components and no such manufacturer is bound to furnish us with any specific
quantities of their products at previously specified prices. At this date, we
are not aware that any of our component manufacturers have known shortages of
critical material.
Because the manufacture of our SpatiaLight imagEngine(TM) microdisplays involves
highly complex processes and technical problems may arise, we, in our capacity
as internally manufacturing the liquid crystal microdisplays, which are an
integral part of the display units, cannot assure the manufacturing yields of
our products. Problems in production or lower than expected manufacturing yields
could significantly harm our business and operating results. In addition, the
complexity of our manufacturing processes will increase as the sophistication of
our microdisplays and display units increases.
IF A MARKET FOR OUR PRODUCTS DOES NOT DEVELOP, OUR BUSINESS WILL LIKELY BE
SIGNIFICANTLY HARMED.
Various target markets for our microdisplays, including projectors, monitors,
high-definition televisions, and portable microdisplays, are uncertain and may
be slow to develop. In addition, companies in those markets could utilize
competing technologies. High-definition television has only recently become
available to consumers, and widespread market acceptance is uncertain. In
addition, the commercial success of the portable microdisplay market is
uncertain. The acceptance of our display units and/or SpatiaLight imagEngine(TM)
microdisplays will be dependent upon the pricing, quality, reliability and
useful life of these units compared to competing technologies, as to which there
can be no assurance. In order for us to succeed, not only must we offer
end-product manufacturers better and less expensive microdisplays than our
competitors, but the manufacturers themselves must also develop commercially
successful products using our microdisplays. SpatiaLight's marketing efforts are
focused on developing strategic customer and governmental relationships in China
and the Republic of South Korea. Our failure to sell our microdisplays to such
manufacturers or the failure of the ultimate target markets to develop as we
expect will negatively affect our anticipated growth.
IF OUR MICRODISPLAYS DO NOT BECOME WIDELY ACCEPTED BY OUR CUSTOMERS OR THE
END-USERS, OUR BUSINESS COULD BE SIGNIFICANTLY HARMED.
Our microdisplays may not be accepted by a widespread market. Even if we
successfully obtain customer orders, our customers may determine not to
introduce or may terminate products utilizing the technology for a variety of
reasons, including the following:
o superior technologies developed by our competitors;
24
o price considerations; and
o lack of anticipated or actual market demand for the products.
We currently have agreements with a limited number of customers. Despite our
reasonable efforts to retain these customers, we may not be successful in this
regard. The loss of any one or more of these customers could materially harm our
business and financial condition.
WE CANNOT ASSURE YOU THAT WE WILL OBTAIN ADDITIONAL PURCHASE ORDERS FROM OUR
CURRENT OR PROSPECTIVE CUSTOMERS, OR, IF WE DO, THAT SUCH ORDERS WILL GENERATE
SIGNIFICANT REVENUES.
Since late October 2001, we have entered into agreements or memoranda of
understanding with eight OEMs in China contemplating the purchase by these
prospective customers of our display units and/or SpatiaLight imagEngine(TM)
microdisplays for use in certain of their products. All of these agreements
require that we supply prototypes of our display units and/or SpatiaLight
imagEngine(TM) microdisplays and that they meet technical criteria satisfactory
to each of such prospective customers. In 2003 we entered into Agreements of
Principal Terms with two OEMs in the Republic of South Korea. One of these
agreements is a development agreement and the second contemplates the purchase
of our display units for use in certain of the OEM's products. This agreement
requires that we supply a prototype of our display unit and that it meet
technical criteria satisfactory to the prospective customer. As of the date
hereof, we have received purchase orders from three of the Chinese OEMs. Certain
other prospective Chinese customers have advised the Company that they are
satisfied with the results of the testing of the prototypes under their
agreements with the Company and we are currently negotiating terms of purchase
orders for our display units and/or SpatiaLight imagEngine(TM) microdisplays
with each of them. There remain open issues that have to be finally negotiated,
including prices and quantities of our products. We cannot offer assurances that
we will receive, in the future, binding purchase orders from any of these
companies for their purchase of commercial quantities of our microdisplay
products.
In addition, even if we receive purchase orders from our current or prospective
customers for our display units, we may have problems implementing volume
production of such display units. Furthermore, sales to manufacturers in the
electronics industry are subject to severe competitive pressures, rapid
technological change, and product obsolescence. Manufacturers may, at any time,
cancel purchase orders or commitments or reduce or delay orders, thereby
increasing our inventory and overhead risks. Therefore, even if we obtain
purchase orders from several current or prospective customers, we cannot assure
you that these agreements will result in significant revenues to us.
IF OUR CUSTOMERS' PRODUCTS ARE NOT SUCCESSFUL, OUR BUSINESS WOULD BE MATERIALLY
HARMED.
We do not sell any products to end-users. Instead, we design and manufacture
various product solutions that our customers (i.e., OEMs) may incorporate into
their products. As a result, our success depends almost entirely upon the
widespread market acceptance of our customers' products. Any significant
slowdown in the demand for our customers' products would materially harm our
business.
Our dependence on the success of the products of our customers exposes us to a
variety of risks, including our need to do the following:
o maintain customer satisfaction with our design and manufacturing
services;
25
o match our design and manufacturing capacity with customer demand and
maintain satisfactory delivery schedules;
o anticipate customer order patterns, changes in order mix, and the level
and timing of orders that we can meet; and
o adjust to the cyclical nature of the industries and markets we serve.
Our failure to address these risks may cause us to lose sales or for sales to
decline. THE ELECTRONICS INDUSTRY IS HIGHLY COMPETITIVE, WHICH MAY RESULT IN
LOST SALES OR LOWER GROSS MARGINS.
We serve highly competitive industries that are characterized by price erosion,
rapid technological change and competition from major domestic and international
companies. This intense competition could result in pricing pressures, lower
sales, reduced margins and lower market share. Some of our competitors have
greater market recognition, larger customer bases, and substantially greater
financial, technical, marketing, distribution and other resources than we
possess. As a result, they may be able to introduce new products and respond to
customer requirements more quickly than we can.
Our competitive position could suffer if one or more of our customers decide to
design and manufacture their own display units, to contract with our
competitors, or to use alternative technologies. In addition, our customers
typically develop a second source. Second source suppliers may win an increasing
share of a program. Our ability to compete successfully depends on a number of
factors, both within and outside our control. These factors include the
following:
o our success in designing and manufacturing new display technologies;
o our ability to address the needs of customers;
o the quality, performance, reliability, features, ease of use, pricing,
and diversity of our display products;
o foreign currency fluctuations, which may cause a foreign competitor's
products to be priced significantly lower than our displays;
o the quality of our customer services;
o the efficiency of our production sources;
o the rate at which customers incorporate our displays into their own
products; and
o products or technologies introduced by our competitors.
OUR BUSINESS IS SIGNIFICANTLY AFFECTED BY CONDITIONS OR EVENTS OCCURRING IN THE
ELECTRONICS INDUSTRY GENERALLY.
The electronics industry has experienced significant economic downturns at
various times, characterized by diminished product demand, accelerated erosion
of average selling prices, and production over-capacity. Since the electronics
industry is cyclical in nature, we may experience substantial period-to-period
26
fluctuations in future operating results because of general industry conditions
or events occurring in the general economy.
OUR OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS.
Our results of operations have varied significantly from quarter to quarter in
the past and are likely to vary significantly in the future, which makes it
difficult to predict our future operating results. Accordingly, we believe that
quarter-to-quarter comparisons of our operating results are not meaningful and
should not be relied upon as an indicator of our future performance. Some of the
factors, which cause our operating results to fluctuate include the following:
o introductions of displays and market acceptance of new generations of
displays;
o timing of expenditures in anticipation of future orders;
o changes in our cost structure;
o availability of labor and components;
o pricing and availability of competitive products and services;
o the timing of orders;
o the volume of orders relative to the capacity we can contract to
produce;
o evolution in the life cycles of customers' products; and
o changes or anticipated changes in economic conditions.
THE MARKET PRICE OF OUR COMMON SHARES IS HIGHLY VOLATILE.
The market price of our Common Shares has been extremely volatile, reflecting
reported losses, receipt of additional financing and changes of management.
Other companies have found similar volatility correlates with class action
securities lawsuits although to date we have not been a defendant in any such
lawsuit. The trading price of our Common Shares in the future could continue to
be subject to wide fluctuations in response to various factors, including the
following:
o quarterly variations in our operating results;
o actual or anticipated announcements of technical innovations or new
product developments by us or our competitors;
o public announcements regarding our business developments;
o changes in analysts' estimates of our financial performance;
o sales of large numbers of our Common Shares by our shareholders;
o general conditions in the electronics industry; and
27
o worldwide economic and financial conditions.
In addition, the stock market has experienced significant price and volume
fluctuations that have particularly affected the market prices for many
high-technology companies and that often have been unrelated to the operating
performance of these companies. These broad market fluctuations and other
factors may adversely affect the market price of our Common Shares.
INCREASING THE NUMBER OF OUR COMMON SHARES THAT MAY BE SOLD INTO THE MARKET
COULD CAUSE THE MARKET PRICE OF OUR COMMON SHARES TO DECREASE SIGNIFICANTLY,
EVEN IF OUR BUSINESS OPERATIONS ARE PERFORMING WELL.
We recently registered for resale 1,771,119 shares issued or issuable upon
exercise of the warrants in conjunction with the August 2003 stock financing and
shares issuable upon exercise of warrants that were issued in consideration of
consulting services rendered. All of these shares are freely salable. The
1,771,119 shares (including 428,443 shares issuable upon exercise of warrants)
represent approximately 5.7% of the total number of our Common Shares that are
issued and outstanding as of September 30, 2003. Sales of these shares in the
public market, or the perception that future sales of these shares could occur,
might adversely affect the prevailing market price of our Common Shares in the
near future.
OUR COMMON SHARES MAY NOT BE LIQUID.
Our Common Shares are currently traded on The NASDAQ SmallCap Market. Our
shareholders may find that it is more difficult to sell our Common Shares than
shares that are listed on The NASDAQ National Market, American Stock Exchange or
New York Stock Exchange. The trading volume of our Common Shares may be
adversely affected due to the limited marketability of our Common Shares. Any
substantial sales of our Common Shares may result in a material reduction in
price because relatively few buyers may be available to purchase our Common
Shares.
IF WE LOSE OUR KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN ADDITIONAL
PERSONNEL, OUR ABILITY TO COMPETE COULD BE HARMED.
Our development and operations depend substantially on the efforts and abilities
of our senior management and qualified technical personnel. Our products require
sophisticated production, research and development and technical support. The
competition for qualified management and technical personnel is intense. The
loss of services of one or more of our key employees or the inability to add key
personnel could have a material adverse affect on us, particularly since
currently we do not have any life insurance policies in place to cover that
contingency. Our success will depend upon our ability to attract and retain
highly qualified scientific, marketing, manufacturing, financial and other key
management personnel. We face intense competition for the limited number of
people available with the necessary technical skills and understanding of our
products and technology. We cannot assure you that we will be able to attract or
retain such personnel or not incur significant costs in order to do so. If we
are unable to protect our intellectual property from use by third parties, our
ability to compete in the industry will be harmed.
We believe that our success depends in part on protecting our proprietary
technology. We rely on a combination of patent, copyright, trademark and trade
secret laws, as well as confidentiality and assignment of inventions agreements
from our employees, consultants and advisors and other contractual provisions,
to establish and protect our intellectual property rights. Policing unauthorized
28
use of our products and technology is difficult, however. Despite our efforts to
protect our proprietary rights, we face the following risks:
o pending patent applications may not be issued;
o patents issued to us may be challenged, invalidated, or circumvented;
o unauthorized parties may obtain and use information that we regard as
proprietary despite our efforts to protect our proprietary rights;
o others may independently develop similar technology or design around
any patents issued to us;
o breach of confidentiality agreements;
o intellectual property laws may not protect our intellectual property;
and
o effective protection of intellectual property rights may be limited or
unavailable in some foreign countries, such as China, in which we may
operate. Specifically, although we consider the following unlikely
because of the complex technological structure of our products, one or
more of our prospective Chinese customers, or their respective
employees or other persons including our competitors, that have or gain
access to our products for testing purposes, may seek to misappropriate
or improperly convert to their own use our intellectual property and a
lack of adequate remedies and impartiality under the Chinese legal
system may adversely impact our ability to protect our intellectual
property.
There can be no assurance that we will have adequate remedies in the event any
of the foregoing materializes. Failure to protect our intellectual property
would limit our ability to produce and market our products in the future, which
would materially adversely affect our revenues generated by the sale of such
products. In addition, third parties could assert that our products and
technology infringe their patents or other intellectual property rights. As a
result, we may become subject to future patent infringement claims or
litigation, the defense of which is costly, time-consuming and diverts the
attention of management and other personnel.
POLITICAL, ECONOMIC AND REGULATORY RISKS ASSOCIATED WITH INTERNATIONAL
OPERATIONS MAY LIMIT OUR ABILITY TO DO BUSINESS ABROAD.
A substantial number of our manufacturers, customers and suppliers are located
outside of the United States, principally in the Far East. Our international
operations are subject to political and economic conditions abroad, and
protectionist trade legislation in either the United States or foreign
countries, such as a change in the current tariff structures, export or import
compliance laws, or other trade policies, any of which could adversely affect
our ability to manufacture or sell displays in foreign markets and to purchase
materials or equipment from foreign suppliers. All of our agreements with
customers are governed by foreign law and therefore, are subject to uncertainty
with regard to their enforceability.
RISKS RELATED TO DOING BUSINESS IN CHINA MAY NEGATIVELY AFFECT OUR BUSINESS.
Our business is subject to significant political and economic uncertainties and
may be adversely affected by political, economic and social developments in
China. Over the past several years, the Chinese government has pursued economic
reform policies including the encouragement of private economic activity and
29
greater economic decentralization. The Chinese government may not continue to
pursue these policies or may significantly alter them to our detriment from time
to time with little, if any, prior notice.
A lack of adequate remedies and impartiality under the Chinese legal system may
adversely impact our ability to do business in China and to enforce the
agreements or purchase orders to which we are, or may become, a party.
At various times during recent years, the United States and China have had
significant disagreements over political, economic and social issues.
Controversies may arise in the future between these two countries. Any political
or trade controversies between the United States and China, whether or not
directly related to our business, could adversely affect our ability to do
business in China.
WE DO NOT PAY CASH DIVIDENDS.
We have never paid any cash dividends on our Common Shares and do not anticipate
that we will pay cash dividends in the near future. Instead, we intend to apply
any future earnings to the expansion and development of our business.
Item 3. Quantitative and Qualitative Disclosures About Market Risks.
We place all of our excess cash and cash equivalents in a checking account or
money market account with a nationally reputable bank. As of September 30, 2003,
our cash and cash equivalents totaled $2,420,000.
Item 4. Controls and Procedures.
Quarterly evaluation of the Company's Disclosure Controls. As of the end of the
quarterly fiscal period related to this Quarterly Report on Form 10-Q, we
evaluated the effectiveness of the design and operation of our "disclosure
controls and procedures" (Disclosure Controls). Disclosure Controls include
components of our internal control over financial reporting. This evaluation
(the Controls Evaluation) was done under the supervision and with the
participation of our Chief Executive Officer and Chief Financial Officer.
Limitations on the Effectiveness of Controls. Our Chief Executive Officer and
Chief Financial Officer do not expect that our Disclosure Controls or our
internal control over financial reporting will prevent all error and all fraud.
A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the control system's objectives will be
met. Further, the design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered
relative to their costs. We have only had limited revenue derived from the sale
of our microdisplay products in the current reporting period. While the Controls
Evaluation has accounted for such limited sales and revenue, new or additional
controls may or may not be required once we begin selling our microdisplay
products in volume in the ordinary course of business. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected. These inherent limitations include the
30
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or honest mistake. Additionally, controls can
be circumvented by the individual acts of some persons, by collusion of two or
more persons, or by management override of the controls. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Over time, specific controls may or may not become inadequate (e.g., when we
commence to sell our products in volume in the ordinary course of business)
because of changes in conditions or deterioration in the degree of compliance
with policies or procedures. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
Conclusions. Based upon the Controls Evaluation, our Chief Executive Officer and
Chief Financial Officer have concluded that, subject to the limitations
mentioned in Limitations on Effectiveness of Controls above, our Disclosure
Controls are effective to ensure that material information relating to the
Company is made known to the Chief Executive Officer and Chief Financial
Officer, particularly during the period when our periodic reports are being
prepared. There have been no significant changes in the Company's internal
control over financial reporting that occurred during the quarter covered by
this report that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 19, 2003, the Company sold in a private sale $2,763,500 of Common
Shares and warrants to purchase Common Shares (August Transaction). Under the
terms of the August Transaction, the Company sold 1,212,061 shares at a price of
$2.28 per share, equal to a 20% discount to the trailing 30-day average closing
price of our Common Shares through August 5, 2003. Pursuant to the August
Transaction, the Company also granted warrants to purchase an aggregate of
303,015 Common Shares at an exercise price of $3.29 per share, equal to a 15%
premium to the foregoing 30-day trailing average closing price. The shares
issued in the August Transaction were previously authorized but unissued shares
of the Company. This issuance was made pursuant to an exemption from
registration provided by Section 4(2) of the Securities Act of 1933, as amended,
as such issuance did not involve a "public offering" pursuant to the Securities
Act given the limited number and scope of persons to whom the shares were
issued. In addition, warrants to purchase 48,482 shares were granted to the
placement agent for the financing. The proceeds of the August Transaction have
been used to augment the Company's working capital.
31
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K [TO BE MODIFIED]
(a) Exhibits
4.1 Amended and Restated Certificate of Incorporation. *
4.2 Bylaws. *
10.3 Employment Agreement between SpatiaLight, Inc. and Theodore
Banzhaf dated July 7, 2003. *
10.4 Time Accelerated Restricted Stock Award Plan ("TARSAP")
between SpatiaLight, Inc. and Theodore Banzhaf, dated July 7,
2003. *
31.1 Rule 13a-14(a)/15d-14(a) Certification of Robert A. Olins.
31.2 Rule 13a-14(a)/15d-14(a) Certification of Timothy Descamps.
32.1 Certifications of Robert A. Olins Pursuant to 18 U.S.C.
Section 1350, As Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Timothy Descamps Pursuant to 18 U.S.C.
Section 1350, As Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Report on Form 8-K:
None.
*Previously filed.
32
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, as amended, the Registrant has duly caused the report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: November 12, 2003
----------------------------------------
SpatiaLight, Inc.
By: /s/ROBERT A. OLINS
------------------------------------------
Robert A. Olins
Acting Chief Executive Officer
33