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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, 2004
|_| 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: 35,232,905 common shares as of
November 9, 2004.
1
SPATIALIGHT, INC.
Quarterly Report on Form 10-Q
For the Quarter and the Nine Months Ended September 30, 2004
Table of Contents
-----------------
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets dated
September 30, 2004 and December 31, 2003.....................3
Condensed Consolidated Statements of Operations
for the Three and Nine Months
Ended September 30, 2004 and 2003............................4
Condensed Consolidated Statements of Stockholders' Equity
for the Nine Months Ended September 30, 2004.................5
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2004 and 2003........6
Notes to Condensed Consolidated Financial Statements.........7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations............13
Item 3. Quantitative and Qualitative Disclosures about Market Risks.25
Item 4. Controls and Procedures.....................................25
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds...................27
Item 6. Exhibits and Reports on Form 8-K............................28
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (unaudited)
SPATIALIGHT, INC.
BALANCE SHEET (unaudited)
September 30, December 31,
2004 2003
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 1,089,278 $ 6,359,969
Accounts receivable 1,031,722 117,530
Inventory 942,310 779,617
Prepaids and other current assets 354,861 175,848
Prepaid non-cash interest to related party 538,327 177,239
------------ ------------
Total current assets 3,956,498 7,610,203
Property and equipment, net 910,076 638,430
Other assets 133,315 101,063
------------ ------------
Total assets $ 4,999,889 $ 8,349,696
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 898,111 $ 863,284
Accrued expenses and other current liabilities 641,069 518,137
Deferred revenue 100,000 --
------------ ------------
Total current liabilities 1,639,180 1,381,421
Noncurrent liabilities
Convertible notes 1,171,500 1,155,000
------------ ------------
Total liabilities 2,810,680 2,536,421
------------ ------------
Commitments
Stockholders' equity:
Common stock, $.01 par value:
50,000,000 shares authorized;
34,926,905 and 33,229,191 shares issued and outstanding 349,269 332,292
Additional paid-in capital 67,628,441 61,046,425
Notes receivable (1,084,054) (1,096,926)
Common shares issuable -- 3,805,685
Other comprehensive income (loss) (2,024) --
Accumulated deficit (64,702,423) (58,274,201)
------------ ------------
Total stockholders' equity 2,189,209 5,813,275
------------ ------------
Total liabilities and stockholders' equity $ 4,999,889 $ 8,349,696
============ ============
See accompanying notes to condensed consolidated financial statements.
3
SPATIALIGHT, INC.
STATEMENTS OF OPERATIONS (unaudited)
Three months ended September 30, Nine months ended September 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenue $ 268,200 $ 82,152 $ 1,128,075 $ 82,152
Cost of revenue (125,190) (73,875) (897,521) (174,565)
------------ ------------ ------------ ------------
Gross margin 143,010 8,277 230,554 (92,413)
------------ ------------ ------------ ------------
Selling, general and administrative expenses:
Selling, general and administrative expenses 1,432,458 972,882 3,917,460 2,346,211
Stock-based compensation 8,250 71,705 269,424 1,730,637
------------ ------------ ------------ ------------
Total selling, general and administrative expenses 1,440,708 1,044,587 4,186,884 4,076,848
Research and development expenses 662,124 597,148 1,913,682 1,988,449
------------ ------------ ------------ ------------
Total operating expenses 2,102,832 1,641,735 6,100,566 6,065,297
------------ ------------ ------------ ------------
Operating loss (1,959,822) (1,633,458) (5,870,012) (6,157,710)
------------ ------------ ------------ ------------
Other income (expenses):
Interest expense:
Interest expense (17,820) (71,418) (53,942) (180,607)
Non-cash interest expense (187,696) (138,416) (563,087) (417,393)
------------ ------------ ------------ ------------
Total interest expense (205,516) (209,834) (617,029) (598,000)
Interest and other income 17,662 18,350 60,294 56,326
------------ ------------ ------------ ------------
Total other expenses (187,854) (191,484) (556,735) (541,674)
------------ ------------ ------------ ------------
Loss before income tax expense (2,147,676) (1,824,942) (6,426,747) (6,699,384)
Income tax expense (benefit) 675 -- 1,475 (8)
------------ ------------ ------------ ------------
Net loss $ (2,148,351) $ (1,824,942) $ (6,428,222) $ (6,699,376)
============ ============ ============ ============
Net loss per share - basic and diluted $ (0.06) $ (0.06) $ (0.19) $ (0.25)
============ ============ ============ ============
Weighted average shares used in computing
net loss per share- basic and diluted 33,824,409 29,194,477 33,122,270 27,260,754
============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements
4
SPATIALIGHT, INC.
STATEMENT OF STOCKHOLDERS' EQUITY (unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 2004
COMMON ADDITIONAL
COMMON SHARES PAID-IN NOTES
SHARES AMOUNT CAPITAL RECEIVABLE
------------ ------------ ------------ ------------
Balance at January 1, 2004 33,229,191 $ 332,292 $ 61,046,425 $ (1,096,926)
Exercise of stock options and warrants 613,596 6,136 1,204,374
Issuance of common shares issuable 820,082 8,201 3,797,484 --
Issuance of options to employees and directors -- -- 59,424 --
Issuance of warrant for services -- -- 210,000 --
Exercise of warrant in exchange for note receivable 50,000 500 174,500 (175,000)
Issuance of stock for prepayment of related party interest 214,036 2,140 1,136,234 --
Payments on notes receivable -- -- -- 229,851
Accrued interest on notes receivable from stockholder -- -- -- (41,979)
Translation adjustment -- -- -- --
Net loss -- -- -- --
------------ ------------ ------------ ------------
34,926,905 $ 349,269 $ 67,628,441 $ (1,084,054)
============ ============ ============ ============
OTHER TOTAL
COMPREHEN- COMMON STOCK-
ACCUMULATED SIVE INCOME SHARES HOLDERS'
DEFICIT (LOSS) ISSUABLE EQUITY
------------ ------------ ------------ ------------
Balance at January 1, 2004 $(58,274,201) $ -- $ 3,805,685 $ 5,813,275
Exercise of stock options and warrants -- -- -- 1,210,510
Issuance of common shares issuable -- -- (3,805,685) --
Issuance of options to employees and directors -- -- -- 59,424
Issuance of warrant for services -- -- -- 210,000
Exercise of warrant in exchange for note receivable -- -- -- --
Issuance of stock for prepayment of related party interest -- -- -- 1,138,374
Payments on notes receivable -- -- -- 229,851
Accrued interest on notes receivable from stockholder -- -- -- (41,979)
Translation adjustment -- (2,024) -- (2,024)
Net loss (6,428,222) -- -- (6,428,222)
------------ ------------ ------------ ------------
$(64,702,423) $ (2,024) $ -- $ 2,189,209
============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements
5
SPATIALIGHT, INC.
STATEMENTS OF CASH FLOWS (unaudited)
Nine months ended September 30,
-------------------------------
Cash flows from operating activities: 2004 2003
----------- -----------
Net loss $(6,428,222) $(6,699,376)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization 416,427 271,467
Stock-based compensation 269,424 1,730,637
Non-cash interest expense 563,087 417,393
Inventory writedown -- 100,690
Translation adjustment (2,024)
Accrued interest on notes receivable from shareholders (41,979) (56,326)
Changes in operating assets and liabilities:
Accounts receivable (914,192) (84,452)
Inventory (162,693) (811,934)
Prepaid and other current assets 51,686 300,625
Other assets (32,252) (33,038)
Accounts payable 34,827 (1,377,723)
Accrued expenses and other current liabilities 122,932 378,285
Deferred revenue 100,000 --
----------- -----------
Net cash used in operating activities (6,022,979) (5,863,752)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (688,073) (409,399)
----------- -----------
Net cash used in investing activities (688,073) (409,399)
----------- -----------
Cash flows from financing actitivies:
Proceeds from issuance of short term notes -- 917,500
Payment on short term notes and convertible notes -- (505,000)
Payments on notes receivable from shareholders 229,851 152,500
Proceeds from the sale of common shares -- 7,513,786
Proceeds from exercise of warrants and options 1,210,510 38,363
----------- -----------
Net cash provided by financing activities 1,440,361 8,117,149
----------- -----------
Net increase (decrease) in cash and cash equivalents (5,270,691) 1,843,998
Cash and cash equivalents at beginning of period 6,359,969 575,663
----------- -----------
Cash and cash equivalents at end of period $ 1,089,278 $ 2,419,661
=========== ===========
Supplemental disclosure of cash flow information:
Income taxes paid during the period $ 1,475 $ --
----------- -----------
Interest paid during the period $ -- $ 26,474
----------- -----------
Non cash financing activities:
Exercise of warrant in exchange for notes receivable $ 175,000 $ --
----------- -----------
Common stock issued upon conversion of interest and notes $ 1,138,374 $ 354,477
----------- -----------
See accompanying notes to condensed consolidated financial statements.
6
SPATIALIGHT, INC.
Notes to Condensed Financial Statements (Unaudited)
NOTE 1. BUSINESS DESCRIPTION
SpatiaLight, Inc. and its subsidiaries (SpatiaLight or the Company) are in the
business of manufacturing high-resolution liquid crystal on silicon (LCoS)
microdisplays for applications such as high definition television, computer
monitors, video projectors and other applications. The Company is currently
offering two types of products to its customers and prospective customers
primarily in the Republic of Korea, China, Taiwan and Japan. One product is a
set of three proprietary SpatiaLight imagEngine(TM) LCoS microdisplays (LCoS
Sets). The Company's other product, the display unit, is comprised of three of
its LCoS microdisplays fitted onto a light engine designed by SpatiaLight and
Fuji Photo Optical Co., Ltd. (Fuji) and manufactured by Fuji.
NOTE 2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. 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 accounting principles generally
accepted in United States of America. In the opinion of management of
SpatiaLight, the interim condensed consolidated financial statements included
herewith contain all adjustments (consisting of normal recurring accruals and
adjustments) necessary for their fair presentation. The unaudited interim
condensed consolidated financial statements should be read in conjunction with
the Company's Annual Report on Form 10-K, which contains the audited financial
statements and notes thereto, together with the Management's Discussion and
Analysis, for the year ended December 31, 2003. The interim results for the
period ended September 30, 2004 are not necessarily indicative of results for
the full fiscal year.
Certain prior period amounts have been reclassified in order to conform to
current period presentation.
NOTE 3. LIQUIDITY
As of September 30, 2004, the Company had net equity of approximately $2,190,000
and net working capital of approximately $2,317,000. The Company expects to meet
its cash needs and fund its working capital requirements by obtaining additional
financing. The Company believes that it is in the final phases of negotiations
for such financing with multiple prospective sources. In addition, the Company
expects to receive cash upon the collection of notes receivable from
shareholders and from the exercise of warrants held by existing investors. There
can be no assurances that SpatiaLight will be able to obtain such additional
financing, collect upon such notes receivable or that existing investors will
exercise their warrants.
NOTE 4. PER SHARE INFORMATION
Basic loss per common share excludes dilution and is computed by dividing net
loss by the weighted average number of common shares outstanding for the period.
Excluded from weighted average shares outstanding for the three months and nine
months ended September 30, 2004 are 1,396,268 common shares issued but held in
escrow in connection with a private stock purchase agreement 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 into common shares. Excluded from the computation of
diluted loss per share for the three months and nine months ended September 30,
2004 and 2003, respectively, are options and warrants to acquire 6,682,528 and
6,046,216 common shares, and 2,376,000 and 3,702,966 common share equivalents
relating to convertible secured notes, because the effect of their assumed
exercise would be antidilutive. The weighted average exercise price as of
September 30, 2004 for the options and warrants is $3.83 and $3.19,
respectively; the weighted average conversion price for the common share
equivalents related to convertible notes is $0.50.
7
NOTE 5. NOTES PAYABLE
In 1998, the Company received $1,188,000 in cash in exchange for notes issued to
Argyle Capital Management Corporation (Argyle), a company owned and controlled
by Robert A. Olins, 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 $0.50
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 originally being amortized through December
31, 2002. The notes were extended in September 2002 to March 31, 2004, and on
December 31, 2003 were extended until June 30, 2005. At each extension date, the
amortization rate of the remaining unamortized discount was also extended over
the new life of 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 or shares by Argyle. The current amortization
rate of the discount, along with the contractual 6% interest rate, resulted in a
new effective interest rate of 8% per annum as of the December 31, 2003
extension date when compared to the outstanding principal balances.
On January 7, 2004, the Company issued 142,360 common shares for the prepayment
of interest of $800,063 for the year ended December 31, 2004. Interest was
computed using the closing price of the common shares on January 6, 2004 of
$5.62, and is being amortized through December 31, 2004. In addition, on March
4, 2004, the Company issued 71,676 common shares on the prepayment of interest
of $338,311 for the six months ended June 30, 2005 in order to coincide with the
maturity date of the notes. Interest was computed using the closing price of the
common shares on March 3, 2004 of $4.72, and is not currently being amortized.
At September 30, 2004, the carrying value of the Argyle notes is $1,171,500,
which includes the $1,188,000 principal balance net of the unamortized discount
of $16,500.
8
Activity in notes payable for the nine months ended September 30, 2004 follows:
BALANCE AT (PAYMENT) OR CONVERSION BALANCE AT
DECEMBER 31, ACCRUED DISCOUNT TO SEPTEMBER 30,
DEBT PRINCIPAL: 2003 INTEREST AMORTIZATION EQUITY 2004
----------- ----------- ----------- ----------- -----------
Argyle $ 1,188,000 $ -- $ -- $ -- $ 1,188,000
Argyle discount (33,000) -- 16,500 -- (16,500)
----------- ----------- ----------- ----------- -----------
Total 1,155,000 -- 16,500 -- 1,171,500
----------- ----------- ----------- ----------- -----------
INTEREST:
Accrued Argyle 6% -- 53,460 -- (53,460) --
Beneficial interest -- 546,587 -- (546,587) --
----------- ----------- ----------- ----------- -----------
Total -- 600,047 -- (600,047) --
----------- ----------- ----------- ----------- -----------
TOTAL $ 1,155,000 $ 600,047 $ 16,500 $ (600,047) $ 1,171,500
=========== =========== =========== =========== ===========
Non-cash interest expense is as follows:
Nine months ended
September 30,
----------------------
2004 2003
-------- --------
Amortization of note discount $ 16,500 $198,349
Effect of beneficial conversion privileges
on accrued interest 546,587 212,397
Other -- 6,647
-------- --------
$563,087 $417,393
======== ========
NOTE 6. ISSUANCE OF SECURITIES
Exercise of Stock Options and Warrants in the nine months ended September 30,
2004
During the first nine months of 2004, 206,500 and 457,069 common shares were
issued upon the exercise of employee stock options and warrants, respectively.
Total cash received was $1,210,510.
Issuance of Shares, Stock Options and Warrants in the nine months ended
September 30, 2004
In December 2003, the Company completed a private placement of 1,000,000 common
shares that were registered with the SEC in a "Shelf" Registration Statement at
a price of $5.00 per share for net proceeds of $4,955,255 received in December
2003. 300,000 of these shares were issued prior to December 31, 2003. The
remaining 700,000 shares were reflected in common shares issuable at December
31, 2003 and were issued in January 2004. In addition, 120,082 shares were
issued pursuant to a warrant exercised late in 2003. The proceeds of
approximately $306,000 had been received and were included in common shares
issuable as of December 31, 2003. Other expenses in the nine months ended
September 30, 2004 related to the valuation of options granted to directors for
additional services and employee options issued with an exercise price lower
than the market price totaled $59,424 and are included in stock-based
compensation.
9
In April 2004, the Company issued a fully vested warrant to purchase 250,000
common shares as payment to a sales agent. A value of $210,000 was assigned to
the warrant using a Black-Scholes pricing model and the following assumptions:
stock price $3.58, exercise price $3.75, historical volatility 59%, risk free
rate 4%, dividend yield of 0% and a contractual life of 13 months.
Installment Notes
In July 2004, a warrant to purchase 50,000 common shares was exercised at $3.50
under a warrant installment agreement totaling $175,000. The total is payable in
six equal installments of $29,167 beginning on the date of the execution of the
agreement. The shares are being held in escrow pending the receipt of the
remaining balance of $87,500.
In November 2002, a warrant to purchase 746,268 common shares was exercised at
$2.00 under a warrant installment agreement totaling $1,492,536. A payment of
$142,350 was received in 2004, which included accrued interest of $92,350.
Interest accrues at 6% per annum and is due with the final payment. As of
September 30, 2004, approximately $29,000 of accrued interest has been recorded.
The shares were issued in 2003, but are held in escrow by the Company pending
receipt of the remaining balance of $869,055.
On May 15, 2001, the Company sold 600,000 common shares under a private stock
purchase agreement. The shares were sold at a price of $1.75 per share. Cash
received was $262,500. The balance of $787,500 was to be paid in three equal
quarterly installments of $262,500. An escrow agent is holding the certificates
for the shares being purchased until all three installments have been paid in
full. At September 30, 2004 the remaining balance is $127,500.
Stock-based compensation is as follows:
Nine months ended
September 30,
2004 2003
---------- ----------
Common shares and options granted to employees and directors $ 59,424 $ 42,839
Common shares and warrants expensed for services 210,000 283,128
Stock issued in connection with May 2003 stock purchase -- 376,957
Beneficial pricing on sale of stock and warrants to officers -- 958,913
Other -- 68,800
---------- ----------
$ 269,424 $1,730,637
========== ==========
NOTE 7. DEFERRED REVENUE
In the third quarter of 2004, the Company received a purchase order from a new
customer. Upon reviewing the order, it was noted that not all elements required
for revenue recognition were present. The product was shipped at the end of the
third quarter. The revenue of $216,000 and the related cost of revenue of
$116,000 were recorded as deferred revenue until all of the necessary elements
for revenue recognition had been met. These elements were met early in the
fourth quarter.
10
NOTE 8. SEGMENT INFORMATION AND SIGNIFICANT CUSTOMER INFORMATION
The Company's chief operating decision-maker, the Chief Executive Officer,
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.
During the nine months ended September 30, 2004, all revenues were derived from
customers abroad. Revenues from mainland China totaled $1,078,400 or 96% of
total revenue. The remaining 4%, or $49,675 were derived from customers in Hong
Kong, Taiwan and the Republic of Korea. Revenues in 2003 were derived 100% from
customers in China.
Revenue from two customers accounted for 51% and 47%, respectively, of the
Company's total revenues for the nine months ended September 30, 2004. The loss
of any one of these customers and the inability to obtain additional purchase
orders from current or prospective customers to replace the lost revenue in a
timely manner could harm the Company's sales or results of operations. Accounts
receivable from these two customers accounted for 33% and 45%, respectively, of
total accounts receivable as of September 30, 2004.
NOTE 9. 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 stock. 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 have been accrued at the estimated fair
value of stock option grants over the service period, regardless of later
changes in stock prices and price volatility.
11
The table below shows net loss per share for the three months and nine months
ended September 30, 2004 and 2003 as if the Company had elected the fair value
method of accounting for stock options.
Three months ended Nine months ended
September 30, September 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net loss as reported $(2,148,351) $(1,824,942) $(6,428,222) $(6,699,376)
Stock-based employee/director compensation
included in reported net loss, net of any
applicable related tax effects 8,250 20,834 59,424 42,839
Deduct: total stock-based employee compensation
determined under fair value method for all awards,
net of any applicable related tax effects (329,912) (288,546) (1,111,590) (1,044,432)
----------- ----------- ----------- -----------
Proforma net loss, as adjusted $(2,470,013) $(2,092,654) $(7,480,388) $(7,700,969)
=========== =========== =========== ===========
Loss per share:
Basic and diluted, as reported $ (0.06) $ (0.06) $ (0.19) $ (0.25)
Basic and diluted, as adjusted $ (0.07) $ (0.07) $ (0.22) $ (0.29)
NOTE 10. RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued Statement of Financial Accounting Standards, or
SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity. SFAS No. 150 establishes standards for how
companies classify and measure certain financial instruments with
characteristics of both liabilities and equity. It requires companies to
classify a financial instrument that is within its scope as a liability or, in
some circumstances, an asset. SpatiaLight adopted the provisions of SFAS No. 150
effective beginning with the second quarter of fiscal 2004, and such adoption
did not have a significant impact on SpatiaLight's financial position and
results of operations.
In November 2003, the Emerging Issues Task Force ("EITF") issued EITF No. 03-6
"Participating Securities and the Two-Class Method under FASB Statement No.
128," which provides for a two-class method of calculating earnings per share
computations that relate to certain securities that would be considered to be
participating in conjunction with certain common stock rights. This guidance
would be applicable to the Company starting with the third quarter beginning
July 1, 2004. The Company is currently evaluating the potential impact of this
pronouncement on its financial statements.
NOTE 11. SUBSEQUENT EVENTS
In September 2004, SpatiaLight entered into a long-term lease with the Gyeongnam
provincial government for 8.3 acres of undeveloped land in Jinsa, Gyeongnam
province in the Republic of Korea. SpatiaLight has received a 100% land lease
payment exemption based upon the location of the land in a Korean national
government designated "free economic zone" and the Korean government's
certification of SpatiaLight as a "high technology" company.
In October 2004, SpatiaLight contracted with Sung Do Engineering, a designer and
manufacturer of high-tech processing plants, as the lead contractor for
SpatiaLight's new manufacturing facility to be located on the leased land. Also
in October 2004, Sung Do Engineering commenced construction of the facility.
Under SpatiaLight's agreement with Sung Do Engineering, the Company will be
required to make periodic payments for an aggregate total of 4,400,000,000
Korean Won (approximately $3,800,000) over a four-month period concluding in the
first quarter of 2005. The Company made its first payment of $500,000 to the
contractors in November 2004. SpatiaLight expects that construction of the
manufacturing facility will be completed and the facility will be fully
operational in the first quarter of 2005.
12
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-K as filed with the
Securities and Exchange Commission on March 30, 2004. 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 condensed consolidated
financial condition of the Company as of September 30, 2004, and the results of
operations for the Company for the three months and nine months ended September
30, 2004 and 2003. The following should be read in conjunction with the
unaudited financial statements and related notes appearing elsewhere herein.
OVERVIEW
We are in the business of manufacturing liquid crystal on silicon (LCoS)
microdisplays that provide high resolution images suitable for applications
including high definition television, rear projection computer monitors and
video projectors, and potential applications such as those used in wireless
communication devices, portable games and digital assistants. Our imagEngine(TM)
microdisplays are designed for use in end products of original equipment
manufacturers, and therefore we work closely with customers and prospective
customers to incorporate our microdisplays into their final products. We lease
clean room space in California where we currently manufacture our SpatiaLight
imagEngine(TM) microdisplays in limited commercial quantities. Internal
manufacturing is subject to certain risks described under "Business Risks and
Uncertainties."
In September 2004, we entered into a long-term lease with the Gyeongnam
provincial government for 8.3 acres of undeveloped land in Jinsa, Gyeongnam
province in the Republic of Korea. We leased the land for the purpose of
constructing a state-of-the-art manufacturing facility with the anticipated
capacity to meet mass production-scale demand from our customers and prospective
customers. We have received a 100% land lease payment exemption because the land
has been designated a "free economic zone" by the Korean national government and
the Korean government also certified us as a "high technology" company.
13
In October 2004, we contracted with Sung Do Engineering, a designer and
manufacturer of high-tech processing plants, as the lead contractor for
constructing our new manufacturing facility on the leased land. In October 2004,
Sung Do Engineering commenced construction of our new facility. Under the
agreement with Sung Do Engineering, we will be required to make periodic
payments for an aggregate total of 4,400,000,000 Korean Won (approximately
$3,800,000) over a four-month period concluding in the first quarter of 2005. We
made an initial payment of $500,000 to the contractor in November 2004. We
expect that construction of the manufacturing facility will be completed and the
facility will be fully operational in the first quarter of 2005.
We are currently offering two types of products to our customers and prospective
customers primarily in the Republic of Korea, China, Taiwan and Japan. One
product is a set of three of our proprietary SpatiaLight imagEngine(TM) LCoS
microdisplays (LCoS Sets). Our other product, the display unit, is comprised of
three of our LCoS microdisplays fitted onto a light engine designed by
SpatiaLight and Fuji Photo Optical Co., Ltd. (Fuji) and manufactured by Fuji. We
currently manufacture two models of our LCoS microdisplays. The "T-1" model has
an active matrix of 1280 pixels by 960 pixels configuration and the newer
generation "T-3" model has an active matrix of 1920 pixels by 1080 pixels
configuration.
To date, we have completed deliveries of our microdisplay products to our
customers in limited quantities. A substantial portion of such delivered
products have been to our customers located in China. Commencing in the first
quarter of 2005, we expect that a greater percentage of future deliveries will
be made to LG Electronics, our Korean customer, pursuant to our purchase
agreement with them. The loss of LG Electronics as a customer, or any delays in
our delivery schedule to LG Electronics, could harm our future sales or results
of operations and our substantial dependence on one customer is subject to risks
set forth in "Business Risks and Uncertainties." We are currently developing
working relationships with other prospective customers, located primarily in
Japan and other parts of the Pacific Rim region. While we have made significant
progress with respect to product integration and negotiating purchase orders
with certain of these prospective customers, we cannot assure that we will
receive any purchase orders binding on any of these companies for their purchase
of our products in the near future.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2004, we had approximately $1,090,000 in cash and cash
equivalents, a decrease of approximately $5,270,000 from the December 31, 2003
amount of $6,360,000. Our net working capital at September 30, 2004 was
approximately $2,317,000 compared to a net working capital of approximately
$6,229,000 at December 31, 2003. This working capital change is primarily due to
the use of cash to fund operating expenses offset by an increase in accounts
receivable.
Net cash used in operating activities totaled approximately $6,020,000 and
$5,860,000 for the nine months ended September 30, 2004 and 2003, respectively.
Cash was used primarily to fund the operating loss.
Net cash provided by financing activities in the nine months ended September 30,
2004 was approximately $1,440,000 as compared to approximately $8,120,000 for
the nine months ended September 30, 2003. In the third quarter of 2004, cash was
provided primarily from the exercise of employee stock options and warrants. In
the same period in 2003, cash was provided primarily from the sale of common
shares and issuance of short-term notes.
14
We expect to meet our cash needs and fund our working capital requirements by
obtaining additional financing. We believe that we are in the final phases of
negotiations for such financing with multiple prospective sources. In addition,
we expect to receive cash upon the collection of notes receivable from
shareholders and from the exercise of warrants held by existing investors. There
can be no assurances that we will be able to obtain such additional financing,
collect upon such notes receivable or that existing investors will exercise
their warrants.
RESULTS OF OPERATIONS
Revenue. We recognized revenue of approximately $268,000 and $1,128,000 in the
three and nine months ended September 30, 2004, respectively. Revenues for the
nine-month period were approximately $508,000 from the sale of LCoS Sets, and
$620,000 from the sales of display units. Revenues for the three-month period
were primarily from the sales of our LCoS Sets. Revenue in 2003 was from the
sale of display units.
In the third quarter of 2004, the Company received a purchase order from a new
customer. Upon reviewing the order, it was noted that not all elements required
for revenue recognition were present. The product was shipped at the end of the
third quarter. The revenue of $216,000 and the related cost of revenue of
$116,000 were recorded as deferred revenue until all of the necessary elements
for revenue recognition had been met. These elements were met early in the
fourth quarter.
Revenue from two customers accounted for 51% and 47%, respectively, of our total
revenues for the nine months ended September 30, 2004. The loss of any one of
these customers and our inability to obtain additional purchase orders from our
current or prospective customers to replace the lost revenue in a timely manner
could harm our sales or results of operations. Accounts receivable from these
two customers accounted for 33% and 45%, respectively, of total accounts
receivable as of September 30, 2004.
Cost of revenue. Cost of revenue was approximately $125,000 and $898,000 in the
three and nine months ended September 30, 2004, respectively, and approximately
$74,000 and $175,000 in the three and nine months ended September 30, 2003. Cost
of revenue consists primarily of product costs. Cost of revenue in 2003 includes
an adjustment to restate inventory at the lower of cost or market as our initial
purchases were at a cost higher than we expected to incur for future purposes.
Gross margin. Gross margin increased overall in 2004, due to increased sales of
our LCoS Sets, which have a higher gross margin than our display units.
Selling, general and administrative costs. Selling, general and administrative
costs were approximately $1,432,000 and $973,000 in the three months ended
September 30, 2004 and 2003, respectively, and $3,917,000 and $2,346,000 in the
nine months ended September 30, 2004 and 2003, respectively, and include
professional services, salaries and related taxes and benefits, rent,
depreciation, travel, insurance and office expenses. Salaries and related taxes
and benefits increased approximately $1,480,000 as a result of the reassignment
of employees from research and development to general and administrative duties
and the increase in the number of administrative staff. These changes were due
to the transition toward commercial-scale manufacturing of our microdisplay
products and the hiring of technical support staff in Asia. In addition, travel
and lodging expenses increased by approximately $270,000 due to increase in
travel to Asia in the nine months ended September 30, 2004, related to work
performed in connection with purchase order agreements entered into during 2003
and other business development matters. These increases were offset by a one
time expense of $250,000 in 2003 related to costs of obtaining financing that
had no comparable expense in 2004.
Stock-based compensation. Stock-based compensation was approximately $8,200 and
$71,000 in the three months ended September 30, 2004 and 2003, respectively, and
approximately $270,000 and $1,730,000 in the nine months ended September 30,
2004 and 2003, respectively. The amounts incurred relate to common shares, stock
options, and warrants issued. The decrease in stock-based compensation is due to
expenses totaling approximately $960,000 incurred in 2003 related to the May
financing and the beneficial pricing received by Robert A. Olins, Chief
Executive Officer, that had no comparable expense in 2004. Expenses in 2004
relate primarily to a warrant issued in exchange for services and issuance of
options to an employee in 2003 that are being expensed over the vesting period.
15
Research and development costs. Research and development costs were
approximately $1,914,000 and $1,988,000 in the nine months ended September 30,
2004 and 2003, respectively and $662,000 and $597,000 in each of the three
months ended September 30, 2004 and 2003, respectively. Salaries and related
benefits decreased approximately $1,060,000 due to the reclassification of
employees from research and development to selling, general and administrative.
Other research and development expenses increased approximately $1,000,000 due
to an increase in consulting services as well as costs associated with the
development of a newer generation LCoS microdisplay. These costs include
primarily materials, equipment and design.
Interest expense. Interest expense for the nine months ended September 30, 2004
decreased approximately $127,000 from the same period in 2003 due to the
conversion of $2,975,000 of convertible notes in November 2003.
Non-cash interest expense.. Non-cash interest expense was approximately $563,000
and $417,000 for the nine months ended September 30, 2004 and 2003,
respectively. Non-cash interest expense relates to the beneficial price of
shares issued to prepay interest on the notes payable to Argyle Capital
Management Corporation, a company wholly owned by Robert A. Olins, Chief
Executive Officer and a director 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. Interest
expense related to the beneficial conversion feature increased approximately
$146,000 due to the increase in the price of our common shares from 2003 to
2004. Also included in non-cash interest expense is the amortization of note
discounts.
Critical Accounting Policies
Revenue Recognition - We enter into commercial transactions to sell our
products. We evaluate revenue recognition for these transactions using the
following 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. Contracts are used for
specialized arrangements with customers, including deliveries over
an extended period of time, and arrangements for letters of credit.
Standard agreements require receipt of a purchase order.
o Delivery: For products, delivery is considered to occur when title
and risk of loss have been transferred, which, for us, is generally
when product has been delivered to a common carrier.
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 reasonably assured: Collection is deemed
reasonably assured 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 reasonably assured (generally upon cash
collection).
16
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 selling price
of the product based on historical recovery rates. If we assess the market value
of our inventory to be less than cost given current prices and future sales
commitments we write it down to its replacement cost or 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 preferences and economic
conditions.
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. 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 to date and have experienced cash shortages. For the
nine months ended September 30, 2004, we incurred net losses of approximately
$6,428,000. In addition, we had an accumulated deficit of approximately
$64,702,000 as of September 30, 2004. 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 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 exercises of
warrants and public and private purchases of our common shares, including the
approximately $12.5 million raised by us in 2003 equity financings and
$1,440,000 raised through exercises of stock options and warrants during 2004,
we will still require additional financing to satisfy our increasing working
capital requirements. Reliance on the exercise of warrants, private equity
purchase agreements and public offerings to finance our operations entails the
additional risks that such warrants may not be exercised due to the prevailing
market prices of our underlying common shares, default by purchasers under such
equity purchase agreements or our inability to sell publicly registered shares.
In the event that we are unable to obtain further financing on satisfactory
terms, or we are unable to generate sales sufficient to offset our costs, or if
our costs of development and operations are greater than we anticipate, we may
be unable 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.
17
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, manufacture our SpatiaLight imagEngine(TM) microdisplays
and/or display units in bulk, and sell the resulting microdisplays and/or
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 in 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 demanded 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 twelve full-time engineering and eleven 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 changes 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.
WE ARE CURRENTLY MANUFACTURING AND SHIPPING OUR MICRODISPLAYS, BUT UNANTICIPATED
DIFFICULTIES IN 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 microdisplays. 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
customers and 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.
18
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
of factors, including the level of contaminants in the manufacturing
environment, impurities in the materials used, and the performance of personnel
and equipment. We lease clean room space in California where we currently
manufacture our SpatiaLight imagEngine(TM) microdisplays. We believe that these
current arrangements provide us with strong quality controls and effectively
protect our proprietary technology in our 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. We do not have other such 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, in our capacity as
manufacturers of our liquid crystal microdisplays, we cannot assure the
manufacturing yields of our products. Current purchase orders and future
purchase orders, which we cannot assure, will require us to produce greater
quantities of our microdisplay products than we have produced in the past.
Problems in production, including problems associated with increasing our
production output 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, and such complexities may lead to
similar difficulties that could harm our business and operating results.
WHILE WE INTEND TO OPEN A MANUFACTURING FACILITY IN THE REPUBLIC OF KOREA AS THE
PRINCIPAL FACILITY FOR MANUFACTURING OUR MICRODISPLAY PRODUCTS, WE MAY ENCOUNTER
DELAYS IN BUILDING SUCH A FACILITY, DIFFICULTIES IN TRANSITIONING OUR
MANUFACTURING OPERATIONS AND DIFFICULTIES IN MAINTAINING OUR QUALITY CONTROLS
OVER THE MANUFACTURING AND PRODUCTION PROCESSES, ANY OF WHICH WOULD BE LIKELY TO
CAUSE SIGNIFICANT HARM TO OUR BUSINESS.
Our decision to locate our principal manufacturing operations in the Republic of
Korea may cause us to encounter one or more potential problems that could
severely harm our business. Such potential problems could arise in connection
with constructing the facility to our specifications in a timely manner to allow
us to meet the product demand from our customers, which would negatively impact
our ability to sustain current purchase orders and enter into new purchase order
arrangements with our current and prospective customers. Other problems may
arise in the training of employees, which may occur as the result of cultural or
language differences, which may create misunderstandings or cause inefficiencies
in our operations. The geographic separation between our corporate offices in
the United States and our principal manufacturing operation in Korea could
result in managerial or supervisory problems, which could lead to decreased
quality controls and a subsequent material harm to our business.
19
IF MARKETS FOR OUR PRODUCTS DO NOT CONTINUE TO DEVELOP, OUR BUSINESS WILL LIKELY
BE SIGNIFICANTLY HARMED.
Various target markets for our microdisplays, including high-definition
televisions, projectors, monitors, 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, although anticipated,
is uncertain. In addition, the commercial success of the portable microdisplay
market is uncertain. The acceptance of our SpatiaLight imagEngine(TM)
microdisplays and/or display units 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 relationships with television OEMs, who
are located principally in the Pacific Rim Region. Our failure to sell our
microdisplays to such manufacturers or the failure of the ultimate target
markets to develop as we expect will negatively effect 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;
o price considerations; and
o lack of anticipated or actual market demand for the products.
We currently have purchase order agreements with a limited number of customers.
Despite our reasonable efforts to retain these customers and obtain new
customers, we may not be successful in either of these regards. The loss of any
one or more of these customers or a failure to obtain new customers could
materially harm our business and financial condition.
WE MAY BECOME LARGELY DEPENDENT ON ONE CUSTOMER FOR OUR FUTURE REVENUES AND
FAILURE TO EXPAND OUR CUSTOMER BASE OR RECEIVE ADDITIONAL ORDERS FROM OUR
EXISTING CUSTOMER BASE WILL MAKE US VULNERABLE TO SUBSTANTIAL LOSS OF POTENTIAL
REVENUES.
Commencing in January 2005, it is possible that a substantial percentage of our
anticipated revenues will be derived from LG Electronics, Inc., based upon our
purchase agreement with LGE. If we cannot diversify our customer base or derive
increased revenues from our existing customer base through additional purchase
orders and product deliveries, and therefore we rely on only one customer for a
substantial percentage of our anticipated revenues, we will be vulnerable to a
substantial decline in anticipated revenues if we lose LGE as a customer for any
reason or if LGE were to otherwise reduce, delay or cancel its orders. Any such
events could cause a material and adverse effect on our business, operations and
financial condition and the value of our common shares could decline
substantially.
20
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.
Even though we have received purchase orders for our microdisplay products from
a major Korean OEM and from several Chinese OEMs and we may receive additional
purchase orders from our prospective customers, we may have problems
implementing volume production of such microdisplay products. 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, despite
the purchase orders received from current customers and other purchase orders
that we may receive from 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 currently 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;
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 and effectively than we can.
Our competitive position could suffer if one or more of our customers decide to
design and manufacture their own microdisplay products, 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:
21
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
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 that 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.
22
THE MARKET PRICE OF OUR COMMON SHARES IS HIGHLY VOLATILE.
The market price of our common shares has been highly volatile, reflecting
reported losses and receipt of additional financing. 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
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.
BY FURTHER INCREASING THE NUMBER OF OUR COMMON SHARES THAT MAY BE SOLD INTO THE
MARKET, ANY FUTURE OFFERINGS OF OUR EQUITY SECURITIES COULD CAUSE THE MARKET
PRICE OF OUR COMMON SHARES TO DECREASE SIGNIFICANTLY, EVEN IF OUR BUSINESS
OPERATIONS ARE PERFORMING WELL.
The total number of our common shares and warrants to purchase our common
shares, sold in three separate equity financings completed in 2003 represents
approximately 14.22% of the total number of our common shares that are issued
and outstanding as of November 9, 2004. Sales of these shares, into and within
the public market, or the perception that future sales of these common 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.
23
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 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
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 current or prospective Chinese or
Korean 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 and Korean
legal systems 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.
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POLITICAL, ECONOMIC AND REGULATORY RISKS ASSOCIATED WITH INTERNATIONAL
OPERATIONS MAY LIMIT OUR ABILITY TO DO BUSINESS ABROAD.
A substantial number of our customers, manufacturers 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 current purchase order
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
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 nationally reputable banks both in the United States
and South Korea. As of September 30, 2004, our cash and cash equivalents totaled
$1,090,000.
Item 4. Controls and Procedures.
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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), and our "internal controls and
procedures for financial reporting" (Internal Controls). This evaluation (the
Controls Evaluation) was done under the supervision and with the participation
of our Chief Executive Officer, who serves as our principal executive officer
and principal financial officer (CEO). Certain new procedures related to
contract /sales processes and the accounts payable/purchasing processes have
been initiated during the third quarter in order to improve our internal
controls in these areas.
Limitations on the Effectiveness of Controls. Our CEO does 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 increased 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 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 increased 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. We were recently advised by
our independent registered public accounting firm of the existence of a material
weakness in our system of internal controls over the shipments, billing and
revenue cycle. In the third quarter of 2004, we implemented a Purchase Order
Acceptance Process; however, this process failed to catch discrepancies in
shipping and credit terms on certain invoices produced and sent to a certain
customer due to a lack of a formal review by anyone other than the preparer of
the invoices and the shipping documents. In addition, we had no formal procedure
to timely document creditworthiness and/or credit considerations for new
customers. Although these control deficiencies did not result in a misstatement
of revenues and/or receivables, they relate closely to assuring the fulfilling
of critical components of revenue recognition criteria. We have subsequently
changed our procedures and review processes over the shipments, billing and
revenue cycle and do not foresee recurrence of such problem.
Conclusions. Based upon the Controls Evaluation, our CEO has 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 CEO, 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.
26
PART II. OTHER INFORMATION
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
In December 2003, we completed a private placement of 1,000,000 common shares
that were registered with the SEC in a "Shelf" Registration Statement at a price
of $5.00 per share for net proceeds of $4,955,255 received in December 2003.
300,000 of these shares were issued in December 2003, and the remaining shares
were issued in January 2004. We have used proceeds from this transaction to
reduce our liabilities, for working capital purposes and for other general
corporate purposes.
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ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
4.1 Amended and Restated Certificate of Incorporation. *
4.2 Bylaws. *
31.1 Rule 13a-14(a)/15d-14(a) Certification of Robert A. Olins.
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.
(b) Report on Form 8-K:
The Company filed two reports on Form 8-K during the quarter ended September 30,
2004. Information regarding the items reported is as follows:
Date Filed Item Reported On
---------- ----------------
August 27, 2004 Item 5.02(b) Departure of Principal Officer
November 15, 2004 Item 1.01.1 Entry into a Material Definitive
Agreement - Lease Agreement
Item 1.01.2 Entry into a Material Definitive
Agreement - Construction Agreement
*Previously filed.
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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 15, 2004
SpatiaLight, Inc.
By: /s/ ROBERT A. OLINS
--------------------------------
Robert A. Olins
Chief Executive Officer
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