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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 March 31, 2005
|_| 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 |X| No |_|
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: 35,925,406 common shares as
of May 9, 2005.
1
SPATIALIGHT, INC.
Quarterly Report on Form 10-Q
For the Quarter Ended March 31, 2005
Table of Contents
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of
March 31, 2005 and December 31, 2004.........................3
Condensed Consolidated Statements of Operations
for the Three Months Ended March 31, 2005 and 2004...........4
Condensed Consolidated Statements of Stockholders'
Equity for the Three Months Ended March 31, 2005.............5
Condensed Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 2005 and 2004...........6
Notes to Condensed Consolidated Financial Statements.........7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations............15
Item 3. Quantitative and Qualitative Disclosures about Market
Risks.......................................................32
Item 4. Controls and Procedures.....................................33
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds...................36
Item 6. Exhibits and Reports on Form 8-K............................37
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
SPATIALIGHT, INC.
CONSDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2005 2004
------------ ------------
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 4,115,598 $ 9,087,551
Accounts receivable, net of allowance of $345,030 at March 31,
2005 and December 31, 2004 45,707 264,053
Inventory 1,324,102 1,173,314
Prepaids and other current assets 594,575 949,711
Prepaid non-cash interest to related party 1,037,005 913,889
------------ ------------
Total current assets 7,116,987 12,388,518
Property and equipment, net 6,239,877 858,212
Construction in progress -- 2,801,521
Prepaid non-cash interest to related party 3,182,115 3,474,386
Other assets 125,868 123,774
------------ ------------
Total assets $ 16,664,847 $ 19,646,411
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 952,074 $ 601,394
Note purchase option liability 8,639 659,874
Accrued expenses and other current liabilities 1,720,272 2,533,546
------------ ------------
Total current liabilities 2,680,985 3,794,814
Senior secured and other convertible notes 10,001,633 9,885,140
------------ ------------
Total liabilities 12,682,618 13,679,954
------------ ------------
Commitments
Stockholders' equity:
Common stock, $.01 par value:
50,000,000 shares authorized;
35,925,441 and 35,326,436 shares issued and outstanding,
at March 31, 2005 and December 31, 2004, respectively 359,254 353,264
Additional paid-in capital 73,565,555 69,384,146
Notes receivable (243,793) (241,462)
Common shares issuable -- 4,038,149
Other comprehensive income 90,950 73,562
Accumulated deficit (69,789,737) (67,641,202)
------------ ------------
Total stockholders' equity 3,982,229 5,966,457
------------ ------------
Total liabilities and stockholders' equity $ 16,664,847 $ 19,646,411
============ ============
See accompanying notes to condensed consolidated financial statements.
3
SPATIALIGHT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Three months ended March 31,
2005 2004
------------ ------------
Revenue $ 97,759 $ 319,100
Cost of revenue (69,844) (346,682)
------------ ------------
Gross margin 27,915 (27,582)
------------ ------------
Selling, general and administrative expenses:
Selling, general and administrative expenses 1,707,265 1,005,144
Stock-based general and administrative expenses 99,050 42,924
------------ ------------
Total selling, general and administrative expenses 1,806,315 1,048,068
Research and development expenses 493,496 681,760
------------ ------------
Total operating expenses 2,299,811 1,729,828
------------ ------------
Operating loss (2,271,896) (1,757,410)
------------ ------------
Other income (expenses):
Interest expense:
Interest expense (267,135) (17,820)
Non-cash interest expense (277,592) (187,696)
------------ ------------
Total interest expense (544,727) (205,516)
------------ ------------
Other income:
Gain from the revaluation of note purchase option liability 651,235 --
Interest and other income 19,153 17,833
------------ ------------
Total other income 670,388 17,833
------------ ------------
Total other income (expenses) 125,661 (187,683)
------------ ------------
Loss before income tax expense (2,146,235) (1,945,093)
Income tax expense 2,300 800
------------ ------------
Net loss $ (2,148,535) $ (1,945,893)
============ ============
Net loss per share - basic and diluted $ (0.06) $ (0.06)
============ ============
Weighted average shares used in computing
net loss per share- basic and diluted 35,817,964 32,760,703
============ ============
See accompanying notes to condensed consolidated financial statements
4
SPATIALIGHT, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (unaudited)
THREE MONTHS ENDED MARCH 31, 2005
ADDITIONAL
COMMON STOCK PAID-IN NOTES ACCUMULATED
SHARES AMOUNT CAPITAL RECEIVABLE DEFICIT
------------ ---------- ------------ ------------ ------------
Balance, January 1, 2005 35,326,436 $ 353,264 $ 69,384,146 $ (241,462) $(67,641,202)
Exercise of stock options and warrants 17,500 175 50,025 -- --
Issuance of common shares issuable 581,505 5,815 4,032,334 -- --
Issuance of options to employees and directors -- -- 8,250 -- --
Issuance of warrant for services -- -- 90,800 -- --
Accrued interest on notes receivable from stockholder -- -- -- (2,331) --
Comprehensive loss:
Net loss -- -- -- -- (2,148,535)
Foreign currency translation adjustment -- -- -- -- --
------------ ---------- ------------ ------------ ------------
Total comprehensive loss -- -- -- -- --
------------ ---------- ------------ ------------ ------------
Balance March 31, 2005 35,925,441 $ 359,254 $ 73,565,555 $ (243,793) $(69,789,737)
============ ========== ============ ============ ============
OTHER COMMON TOTAL
COMPREHEN- STOCK STOCKHOLDERS'
SIVE INCOME ISSUABLE EQUITY
------------ ------------ ------------
Balance, January 1, 2005 $ 73,562 $ 4,038,149 $ 5,966,457
Exercise of stock options and warrants -- -- 50,200
Issuance of common shares issuable -- (4,038,149) --
Issuance of options to employees and directors -- -- 8,250
Issuance of warrant for services -- -- 90,800
Accrued interest on notes receivable from stockholder -- -- (2,331)
Comprehensive loss:
Net loss -- -- (2,148,535)
Foreign currency translation adjustment 17,388 -- 17,388
------------ ------------ ------------
Total comprehensive loss -- -- (2,131,147)
------------ ------------ ------------
Balance March 31, 2005 $ 90,950 $ -- $ 3,982,229
============ ============ ============
5
SPATIALIGHT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Three months ended March 31,
----------------------------
2005 2004
----------- -------------
Cash flows from operating activities:
Net loss $(2,148,535) $(1,945,893)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization 119,284 130,596
Stock-based general and administrative expense 99,050 42,924
Non-cash interest expense 277,592 187,696
Gain from revaluation of note purchase option liability (651,235) --
Accrued interest on notes receivable from stockholder (2,331) (13,202)
Changes in operating assets and liabilities:
Accounts receivable 218,346 (253,000)
Inventory (150,788) (18,108)
Prepaid and other current assets 363,192 12,931
Other assets 15,294 (11,000)
Accounts payable 350,680 (232,844)
Accrued expenses and other current liabilities (199,339) (65,098)
----------- -----------
Net cash used in operating activities (1,708,790) (2,164,998)
----------- -----------
Cash flows from investing activities:
Construction of building and improvements,
and acquisition of equipment (3,310,285) (97,727)
----------- -----------
Net cash used in investing activities (3,310,285) (97,727)
----------- -----------
Cash flows from financing actitivies:
Proceeds from exercise of warrants and options 50,200 338,210
----------- -----------
Net cash provided by financing activities 50,200 338,210
----------- -----------
Net decrease in cash and cash equivalents (4,968,875) (1,924,515)
Effect of exhange rate differences on cash (3,078) --
Cash and cash equivalents at beginning of period 9,087,551 6,359,969
----------- -----------
Cash and cash equivalents at end of period $ 4,115,598 $ 4,435,454
=========== ===========
Non cash financing activities:
Common shares issued upon conversion of interest and notes $ -- $ 1,138,374
=========== ===========
See accompanying notes to condensed consolidated financial statements
6
SPATIALIGHT, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)
NOTE 1. BUSINESS DESCRIPTION
We are in the business of manufacturing high-resolution liquid crystal on
silicon (LCoS) microdisplays. Our current customers and prospective customers
are original equipment manufacturers (OEMs) engaged in the businesses of
manufacturing high definition televisions or manufacturing light engines for
incorporation into high definition televisions. Our products are also suitable
for incorporation into other potential display applications including rear
projection computer monitors, wireless communication devices, portable games and
digital assistants, although we are not currently working with OEMs of any of
these products.
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 the United States of America. In our management's opinion, 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 our 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, 2004. The interim results for the period ended March 31, 2005
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
Through March 31, 2005 we have sustained recurring net losses from operations
and at March 31, 2005 had total equity of approximately $3,982,000 and net
working capital of approximately $4,436,000. During the three months ended March
31, 2005, we experienced negative cash flows from operating activities of
approximately $1,709,000 and had a net loss of approximately $2,149,000. We
expect to meet our cash needs and fund our working capital requirements with our
existing cash balances and from additional sources as follows: the purchasers in
the November 2004 Financing have the option, which expires on August 31, 2005,
to lend us an additional $5,000,000 on the same terms as the November 2004
Financing. Robert A. Olins, our Chief Executive Officer and a director of
SpatiaLight, and Greenpark Limited, an unaffiliated shareholder, jointly and
severally committed to provide us with additional financing as more fully
described in Note 6. We also expect to receive cash payments from our customers
and from the exercises of options and warrants. There can be no assurances that
existing investors will exercise their warrants or that the purchasers in the
November 2004 Financing will exercise their right to make the additional lending
investment. We also filed a "shelf" registration statement on Form S-3 with the
SEC on January 31, 2005, for the sale of up to two million of our common shares,
in one or more offerings. As of the date hereof, this "shelf" registration
statement has not been declared effective by the SEC, and we cannot offer any
assurances as to when such registration statement may become effective. We
believe that our current cash and cash equivalents combined with the financing
7
commitment from Robert A. Olins and Greenpark Limited will be sufficient to meet
our capital and liquidity requirements for our operations for the twelve months
following the date of this filing.
NOTE 4. STOCK-BASED COMPENSATION
We account for our 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," we disclose the pro forma effects of using the fair value method
of accounting for stock-based employee and director compensation arrangements
and record compensation expense for the fair value of options granted to
non-employees.
If we had elected the fair value method of accounting for employee and director
stock options, 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.
The table below shows net loss per share for the three months ended March 31,
2005 and 2004 as if we had elected the fair value method of accounting for stock
options.
Three months ended March 31,
2005 2004
----------- -----------
Net loss as reported $(2,148,535) $(1,945,893)
Add: Stock-based employee/director compensation
included in reported net loss, net of any
applicable related tax effects 8,250 42,924
Deduct: total stock-based employee compensation
determined under fair value method for all awards,
net of any applicable related tax effects (1,043,100) (786,081)
----------- -----------
Proforma net loss, as adjusted $(3,183,385) $(2,689,050)
=========== ===========
Loss per share:
Basic and diluted, as reported $ (0.06) $ (0.06)
Basic and diluted, as adjusted $ (0.09) $ (0.08)
NOTE 5. 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.
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 ended March 31, 2005 and March 31, 2004,
respectively, are options and warrants to acquire 6,917,761 and 6,352,183 common
shares, and 3,404,807 and 2,376,000 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 March 31, 2005 for the
8
options and warrants is $4.01 and $3.25, respectively; the weighted average
conversion price for the common share equivalents related to convertible notes
is $3.29.
NOTE 6. NOTES PAYABLE
Convertible notes at March 31, 2005 consist of the following:
Argyle Notes:
In 1998, we received $1,188,000 in cash in exchange for notes payable in that
amount to Argyle Capital Management Corporation (Argyle), a company owned and
controlled by Robert A. Olins, Chief Executive Officer, Secretary, Treasurer,
and a Director of SpatiaLight. The notes accrue interest at a contractual rate
of 6% per annum, and are secured by substantially all of our assets. Both
principal and interest are convertible into our 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 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 was 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 December 31, 2003, the due date was extended until June
30, 2005. Accordingly, the remaining unamortized discount of $33,000 at the
extension date was being amortized through June 30, 2005, resulting in a new
effective interest rate of 8% per annum when compared to the outstanding
principal balances. On November 30, 2004, the due date was extended until
December 31, 2008. The remaining unamortized discount of $11,000 at the
extension date will be amortized through June 30, 2005.
On March 4, 2004, we issued 71,676 common shares with a market value of $338,311
as a prepayment of interest payable on the Argyle notes of $35,640 for the
period January 1, 2005 to June 30, 2005. Prepaid interest was computed using the
closing price of the shares of $4.72 on March 3, 2004. On December 22, 2004, we
issued 50,000 common shares, and 448,764 common shares became issuable (and were
issued in January 2005), as a prepayment of interest payable on the Argyle notes
of $249,480 for the period July 1, 2005 through December 31, 2008. These shares
had a market value of $4,049,964, based on the closing price of the shares of
$8.12 on December 21, 2004. As of March 31, 2005, total prepaid interest on the
Argyle notes for the period April 1, 2005 to December 31, 2008 is $4,219,120
with $1,037,005 classified as a current asset, and $3,182,115 classified as a
noncurrent asset.
At March 31, 2005, the carrying value of the Argyle notes totals $1,182,500,
which includes the $1,188,000 principal balance, net of the unamortized discount
of $5,500.
9
The November 2004 Financing:
On November 30, 2004, we completed a non-brokered private placement of $10
million of senior secured notes (the 2004 Senior Secured Convertible Notes). The
2004 Senior Secured Notes accrue interest at 10%, payable quarterly, and the
interest is payable in cash or common shares, at our option (if certain
conditions are met). The value of the shares for the purposes of calculating
interest payments shall be equal to the 20-day trailing average of the volume
weighted average prices of our common shares at the end of each quarterly
interest period. The 2004 Senior Secured Notes are due November 30, 2007.
The 2004 Senior Secured Convertible Notes are convertible, at the option of the
holders, into our common shares at the conversion price of $9.72 per share. The
conversion price of the principal amount of the 2004 Senior Secured Convertible
Notes is equal to a 25% premium above the ten-day trailing average of the volume
weighted average price of our common shares for the period ended November 29,
2004, which was $7.78. As part of the November 2004 Financing, the purchasers
required Argyle to enter into an intercreditor and subordination agreement (the
Intercreditor Agreement) pursuant to which Argyle agreed to subordinate our
obligations to Argyle and the senior security interest in substantially all of
our assets that were granted under the Argyle Notes to the interest represented
by the purchasers of the 2004 Senior Secured Convertible Notes. In addition,
under the terms of the November 2004 Financing, we are prohibited from using the
funds to repay debt or to pay dividends.
We are required to file a registration statement for resale of the shares
issuable upon conversion of the notes and have the registration statement
declared effective no later than 120 days after November 30, 2004. Pursuant to
our amended registration rights agreement with the noteholders, if the
registration does not become effective by April 20, 2005, or does not remain
effective, we may be required to pay each noteholder cash equal to 1% of the
purchase price of the notes, and 1% for every 30 days thereafter until the
registration becomes effective. As of the date of this filing, that registration
statement that we filed with the SEC has not been declared effective by the SEC.
In consideration for Argyle entering into the Intercreditor Agreement, our Board
of Directors authorized us to enter into an extension and modification agreement
between SpatiaLight and Argyle with respect to the Argyle Notes (the Extension
Agreement) under which the due date of the Argyle Notes was extended to December
31, 2008.
Under the terms of the November 2004 Financing, Robert A. Olins and Greenpark
Limited, an unaffiliated shareholder of SpatiaLight, jointly and severally
committed, in the event that the Board determines that such financing is
necessary, to provide us with up to an additional $6 million in future financing
on terms and conditions to be determined at the time of any such transaction.
That financing commitment shall be reduced by any funds that we receive from
10
future sales or exercises of our equity, debt or derivative securities,
including the sale of our common shares under the Prospectus that we filed with
the SEC on January 28, 2005, as a part of a "shelf" registration process. At
March 31, 2005, we had received an aggregate total of $726,200 of such funds,
thereby reducing the commitment by Mr. Olins and Greenpark Limited by an equal
aggregate amount.
Under the terms of the November 2004 Financing, the purchasers received the
right to purchase up to an additional $5 million of senior secured convertible
notes (additional investment rights or AIR) subject to the same terms and
conditions, including the same conversion price as the notes issued in the
November 2004 Financing. The AIR originally expired on November 30, 2005, but
was amended on December 21, 2004 to expire on August 31, 2005. The fair value of
the AIR was calculated on the November 30, 2004 issuance date at $1,072,248
using the Black-Scholes option pricing model and the following assumptions:
stock price $8.83, exercise price $9.72, volatility 67%, risk free interest rate
2.50%, a contractual term of one year and a dividend yield of 0. This AIR is
being treated as a derivative and has been recorded as a note purchase option
liability and as a discount on the 2004 Senior Secured Convertible Notes. The
AIR is not a hedging derivative. The fair value of the derivative will be
recalculated on a quarterly basis until exercise or expiration to reflect the
changing market price of the stock, the remaining contractual term, and the
changing volatility. The objective in entering into the agreement for the AIR
was that it was required by the lenders in order to complete the financing
agreement.
The fair value was recalculated as of December 31, 2004 at $659,874 using the
Black-Scholes option pricing model and the following assumptions: stock price on
December 31, 2004 of $8.95, exercise price $9.72, volatility 52%, risk free
interest rate 2.50%, the remaining contractual term of eight months and a
dividend yield of 0. The reduction in the liability of $412,374 was recorded as
a gain from the revaluation of the note purchase option liability and is
included in other income. The assumptions changed from the November valuation
date in that the market price of our common shares had changed, the contractual
life had changed due to the December 21, 2004 amendment, and the volatility
changed as a result of the changes in market price and contractual life.
On March 31, 2005 the AIR was revalued at $8,639 using the Black-Scholes option
pricing model and the following assumptions: stock price $5.05, exercise price
$9.72, volatility 49%, risk free interest rate 2.50%, a remaining contractual
life of five months and a dividend yield of 0. The reduction in the liability of
$651,235 was recorded as a gain from the revaluation of the note purchase option
liability and is included in other income. The assumptions changed from the
December valuation date for the same reasons stated above.
The $1,072,248 discount applied to the 2004 Senior Secured Convertible Notes
gave rise to a beneficial conversion feature of $156,610 resulting from the
excess aggregate value of the common shares issuable upon conversion of the 2004
Senior Secured Convertible Notes into common shares over the discounted carrying
value of the 2004 Senior Secured Convertible Notes at the issuance date. The
resulting beneficial conversion feature is treated as an additional discount to
the 2004 Senior Secured Convertible Notes and an increase in additional paid-in
capital, and will be amortized, along with the original discount related to the
value of the AIR, over the life of the Notes. In addition, $100,000 of legal
fees reimbursed to one of the lenders was recorded as a note discount and is
being amortized over the life of the notes. Additional financing costs of
$117,162 were recorded in prepaid expenses and are being amortized over the life
of the notes.
11
Activity in notes payable for the three months ended March 31, 2005 is as
follows:
Balance at Additional (Payment) or Reduction in
December 31, or New Discount Prepaid Balance at
Debt Principal: 2004 Discount Amortization Interest March 31, 2005
------------ ------------ ------------ ------------ -------------
Argyle $ 1,188,000 $ -- $ -- $ -- $ 1,188,000
Argyle discount (11,000) -- 5,500 -- (5,500)
November financing 10,000,000 -- -- -- 10,000,000
November financing beneficial conversion (152,260) -- 13,050 -- (139,210)
Reimbursement of investor's legal fees (97,222) -- 8,333 -- (88,889)
November financing AIR discount (1,042,378) -- 89,610 -- (952,768)
------------ ------------ ------------ ------------ ------------
Total principal $ 9,885,140 $ -- $ 116,493 $ -- $ 10,001,633
============ ============ ============ ============ ============
Interest:
Accrued Argyle 6% $ -- $ 17,820 $ -- $ (17,820) $ --
Beneficial interest -- 151,335 -- (151,335) --
November financing 84,932 250,000 (250,000) -- 84,932
------------ ------------ ------------ ------------ ------------
Total interest $ 84,932 $ 419,155 $ (250,000) $ (169,155) $ 84,932
============ ============ ============ ============ ============
Non-cash interest expense is as follows:
Three months
ended March 31,
-------------------
2005 2004
-------- --------
Amortization of note discounts and prepaid financing costs $126,257 $ 5,500
Effect of beneficial conversion privileges
on accrued interest 151,335 182,196
-------- --------
$277,592 $187,696
======== ========
NOTE 7. ISSUANCE OF SECURITIES
Exercise of Stock Options in the three months ended March 31, 2005
- ------------------------------------------------------------------
During the first three months of 2005, 17,500 common shares were issued upon the
exercise of employee stock options. Total cash received was $50,200.
Issuance of Shares, Stock Options and Warrants in the three months ended March
31, 2005
- ------------------------------------------------------------------------------
In February 2005, we issued a fully vested warrant to purchase 75,000 common
shares as payment to a sales agent. A value of $90,800 was assigned to the
warrant using the Black-Scholes pricing model and the following assumptions:
stock price $4.66, exercise price $4.50, historical volatility 64%, risk free
rate 2.50%, dividend yield of 0 and a contractual life of 10 months. This amount
is included in stock-based general and administrative expenses.
In January 2005, 581,505 common shares with a value of $4,038,149 previously
recorded as common shares issuable were issued.
12
Other expenses totaling $8,250 in the three months ended March 31, 2005 relate
to the valuation of employee option issued with an exercise price lower than the
market price on the grant date and are also included in stock-based general and
administrative expenses.
Issuance of Shares Under Installment Note
In November 2002, a warrant to purchase 746,268 common shares was exercised by
the purchaser of the warrant at $2.00 per share under a warrant installment
agreement totaling $1,492,536. Payments of $200,000 were made in 2002. An
additional $402,500 was received in 2003. In 2004, a payment of $142,350 was
made which represented interest accrued through March 2004 of $92,350, and an
installment payment of $50,000 for April 2004. Interest accrues at 6% per annum
and is due with the final payment. The 746,268 shares were issued to the
purchaser in the third quarter of 2003. On July 7, 2004, the Board of Directors
approved an agreement with the purchaser that, in consideration for the
purchaser's involvement in our efforts to obtain financing, we would suspend the
warrant installment payments through the end of the third quarter of 2004, at
which time the Board would evaluate the financing efforts and the involvement
attributed to the purchaser. On November 30, 2004, the Board resolved that in
connection with the November 2004 Financing, the purchaser and Robert A. Olins,
the Chief Executive Officer and a director SpatiaLight, were each entitled to
receive due consideration from us for their respective financing commitments.
Mr. Olins communicated with the Board his desire to forego any consideration in
favor of the purchaser. We agreed with the purchaser to reduce the amount owed
by the purchaser under the warrant installment agreement by $600,000. At March
31, 2005, the remaining balance of the note receivable, plus accrued interest,
under the warrant installment agreement is $243,793. This note is payable in
monthly installments of $48,055, with the final payment due May 17, 2005. At
March 31, 2005 the monthly installments due in the first quarter 2005 have not
been made.
Stock-based compensation is as follows:
Three months ended March 31,
2005 2004
--------------- ---------------
Options granted to employees and directors $ 8,250 $ 42,924
Warrants issued for services 90,800 --
--------------- ---------------
$ 99,050 $ 42,924
=============== ===============
NOTE 8. SEGMENT INFORMATION AND SIGNIFICANT CUSTOMER INFORMATION
Our chief operating decision-maker is our Chief Executive Officer. The chief
operating decision-maker reviews only financial information prepared on a basis
substantially consistent with the accompanying financial statements of
operations. Therefore, we have determined that we operate in a single business
segment. All of our assets are located at our facilities in the United States at
March 31, 2005, except for the following:
13
Korea Hong Kong Japan Total
-------------------------------------------------------
Cash $1,261,944 $ -- $ -- $1,261,944
Property and equipment, net 1,325,913 -- -- 1,325,913
Building and improvements 3,927,500 -- -- 3,927,500
Inventory 134,349 428,321 467,201 1,029,871
-------------------------------------------------------
$6,649,706 $ 428,321 $ 467,201 $7,545,228
=======================================================
Of our total revenue in 2005, 69% was derived from the sales of our LCoS Sets to
a customer located in the Republic of Korea. The remaining 30% was derived sales
of our LCoS Sets to customers in Hong Kong, Taiwan, China and the United States.
For the three months ended March 31, 2005, 69% of revenue was derived from one
customer. This customer made up 84% of the accounts receivable balance at March
31, 2005.
NOTE 9. INVENTORY
Inventory consisted of the following as of March 31, 2005 and December 31, 2004:
March 31, December 31,
2005 2004
------------------ -----------------
Raw materials $ 661,105 $ 691,168
Work-in-progress 41,545 31,684
Finished goods 621,452 450,462
------------------ -----------------
$ 1,324,102 $ 1,173,314
================== =================
14
NOTE 10. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment" to revise
SFAS No. 123. "Accounting for Stock-Based Compensation," and supersede APB
Opinion No. 25, "Accounting for Stock Issued to Employees" and its related
implementation guidance. It requires companies to measure and recognize
compensation expense for all share-based payments at fair value. SFAS No. 123R
is to be applied in the first quarter of 2006. We have not yet evaluated the
impact that the adoption of SFAS No. 123R will have on our consolidated
financial statements; however, the adoption could materially impact our results
of operations.
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/A as filed with the
Securities and Exchange Commission on April 27, 2005. 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 our condensed consolidated
financial condition as of March 31, 2005, and our results of operations for the
three months ended March 31, 2005 and 2004. The following should be read in
conjunction with our unaudited financial statements and related notes appearing
elsewhere herein.
OVERVIEW
We are in the business of manufacturing high-resolution LCoS microdisplays. Our
current customers and prospective customers are original equipment manufacturers
(OEMs) engaged in the businesses of manufacturing high definition televisions or
manufacturing light engines for incorporation into high definition televisions.
Our products are also suitable for incorporation into other potential display
applications including rear projection computer monitors, wireless communication
devices, portable games and digital assistants, although we are not currently
working with OEMs of any of these products.
Status of Business with LG Electronics, Inc.
In July 2004, we entered into an agreement with LG Electronics, providing for us
to sell a specially tailored version of our T-3 LCoS Sets to LG Electronics (see
a description of our products under "Business Strategy," discussed below). Under
the agreement, LG Electronics agreed to purchase from us a minimum of 21,000
LCoS Sets over an initial six-month delivery period. Based upon progress to
date, we currently anticipate that the initial six-month delivery period for the
LCoS Sets, which was scheduled to commence in January, will begin in the second
quarter of 2005, subject to LG Electronics' completion of pre-production
requirements. Subsequent deliveries scheduled under our agreement with LG
Electronics (which was filed as Exhibit 10.5 to our Annual Report on Form 10-K/A
on April 27, 2005) are now scheduled to follow the first delivery on a monthly
basis. Under the agreement, commencing in the first delivery month, LG
Electronics is required to provide us with rolling monthly firm purchase orders
15
six months in advance of the scheduled delivery and rolling twelve-month advance
projections of its anticipated future orders. Although the agreement does not
contain any minimum purchase requirements after the initial six-month delivery
period, it projects that LG Electronics will commence larger mass-production
scale purchases of LCoS Sets from us in the seventh delivery month, which we
currently expect to occur in the fourth quarter of 2005. The agreement is
scheduled to have a two-year delivery term with monthly deliveries of LCoS Sets.
All of the rights and obligations of the parties under the agreement are subject
to a limited quantity of trial LCoS Sets, all of which have been delivered to LG
Electronics, meeting certain final technical specifications for product
performance. As provided in our agreement, LG Electronics and we have been
cooperating to the extent necessary to assure that the trial LCoS Sets meet the
final specifications called for by the agreement. We are currently working with
LG Electronics on the final stage integration of our LCoS Sets into LG
Electronics' rear projection televisions and we expect that this final
integration process will be completed and we expect to receive written
confirmation from LG Electronics that we have met the final technical
specifications during the second quarter of 2005.
Our agreement with LG Electronics provides that we will be their exclusive
supplier of three-chip LCoS microdisplay products for twelve months beginning
from the date that we commence shipments under the agreement. Furthermore, our
agreement provides that LG Electronics will have the exclusive right in Korea to
purchase T-3 microdisplay products from SpatiaLight for the twelve months
beginning from the date that we commence shipments under the agreement. In the
event that LG Electronics purchases more than 60,000 LCoS Sets for delivery
between the seventh (7th) and twelfth (12th) delivery months of our agreement,
LG Electronics has the right to extend its exclusivity period for twelve
additional months.
The agreement with LG Electronics occurred as the result of LG Electronics
working with us pursuant to a joint development agreement entered into in May
2003. During the course of that work, we made specially tailored modifications
to our new generation of T-3 microdisplays for LG Electronics' development of a
new line of state-of-the-art high definition televisions.
In January 2005, LG Electronics announced in a joint press release with us that
they are currently planning an initial rollout of 71-inch and 62-inch LCoS
televisions incorporating our LCoS Sets commencing in the second quarter of
2005, subject to the completion of pre-production requirements. LG Electronics
also announced that its initial product rollout will be into the United States,
Korean and Australian consumer markets, with future plans for expansion into
other markets.
Commencing in the second quarter of 2005, we expect that a substantial
percentage of our product deliveries will be made to LG Electronics. 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 under the
heading "Risk Factors."
Status of Business in China
To date, we have made deliveries of our microdisplay products to our Chinese
customers in limited quantities. The quantities of our products that we have
delivered to our Chinese customers are sufficient for engineering testing and
pilot program purposes. To date, our Chinese customers have not ordered
quantities of our products that would enable them to launch commercial sales of
LCoS high definition televisions. A substantial portion of our product
deliveries were in 2004. We have entered into business transactions with
approximately ten customers and prospective customers in China. Current Chinese
customers are at different stages in the development and product introduction
16
processes, and their efforts are progressing at a slower rate than we originally
anticipated. There were no shipments to our Chinese customers in the fourth
quarter of 2004, but we expect that shipments will resume in the second quarter
of 2005. We are maintaining our plans to ship our products to our Chinese
customers, although at a slower rate of shipment than originally expected. While
we have purchase orders in place with our Chinese customers, such orders are for
limited quantities of our products and they are cancelable at any time by such
customers. We therefore cannot provide assurances that we will sell significant
quantities to our Chinese customers in the future.
Although our Chinese customers' progression from product prototyping to mass
production has been far slower than we had anticipated, we remain positive about
our business prospects in China and the potential for China to become a large
market for us. We currently believe that Chinese television manufacturers tend
to apply a market strategy of following the successful business models of global
television manufacturing leaders, rather than acting as leaders themselves in
terms of introducing new technologies to the marketplace. We therefore believe
that if the LCoS technology gains greater acceptance in the high definition
television marketplace, and if industry leaders, such as Sony, JVC and LG
Electronics, present their LCoS based televisions to the worldwide consumer
markets in a prominent fashion, it will then be more likely that the Chinese
television manufacturers will follow these business models and ramp up their own
lines of LCoS high definition televisions. We believe that our present course of
continuing to transact business with major Chinese television manufacturers is
positioning us to be a leading LCoS supplier in China in the future.
Other Business Development
We are currently developing working relationships with prospective customers,
located primarily in Japan and other parts of the Pacific Rim region. These
prospective customers fall into two general categories: television manufacturers
and light engine suppliers. We have provided samples of our LCoS Sets to certain
of such prospective customers, but we do not have any formal agreements with
such parties. 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.
Even assuming that we receive purchase orders that are binding on the
prospective customers, these orders and our sales to these customers and to our
existing customers are subject to certain contingencies described under "Risks
Factors."
Manufacturing Capacity
We have completed construction on our new manufacturing facility located in the
Republic of Korea. The Korean facility will serve as our central commercial
manufacturing base. We expect that the facility will commence producing products
for commercial sale in the second quarter of 2005. The facility is designed with
the capacity, on full employment, to produce up to 28,000 LCoS Sets per month.
The facility has been specially designed so that capacity may be increased up to
120,000 LCoS Sets per month in several expansion phases. We believe that the
facility can be expanded in an expedient manner in the event that such expansion
becomes necessary based upon increased or perceived increased demand for our
products from our customers.
We are actively hiring personnel for our Korean manufacturing facility. We are
currently training our new operators and supervisors in key processes and
equipment familiarization prior to beneficial occupancy of the new facility. We
believe that this will make our production transition more efficient and reduce
17
the chances of our incurring unexpected delays in the transition process. While
we cannot provide any assurances against unexpected delays, we believe that our
transition approach constitutes a proactive, measured and responsible plan to
deal with facility completion risks and to prepare ourselves to manage our
manufacturing facility in Korea on a basis consistent with the anticipated
demand for our products.
Currently we manufacture our LCoS Sets in limited commercial quantities at our
facility in California. Once the Korean facility reaches full-production mode,
we intend to transition the California facility to research and development and
special project operations. We will not lay off any U.S. employees as the result
of opening the Korean facility.
Business Strategy
We are currently offering two types of products to our customers and prospective
customers, all of whom are located primarily in Asia. One product is our LCoS
Set, which is comprised of three of our proprietary SpatiaLight imagEngine(TM)
LCoS microdisplays. They are constructed with a silicon chip, a layer of liquid
crystals and a glass cover plate in contrast to the more common construction of
liquid crystals sandwiched between two glass plates. Our displays are also known
as, and commonly referred to as, liquid crystal on silicon (LCoS), liquid
crystal displays (LCD), active matrix liquid crystal displays and spatial light
modulators. Our other product, the display unit, is comprised of LCoS Sets
fitted onto a light engine designed by SpatiaLight and Fuji Photo Optical Co.,
Ltd. (Fuji) and manufactured by Fuji. We do not currently have any formal
agreement in place with Fuji.
We currently manufacture two models of our LCoS Sets. The "T-1" model has a 1280
pixels by 960 pixels configuration and the newer generation "T-3" model has a
higher resolution 1920 pixels by 1080 pixels configuration.
Since we commenced delivering our products to our customers in the third quarter
of 2003, there has been a significant shift in the type of product that we have
delivered to our customers based upon their demand. The shift in deliveries has
been in the direction of more LCoS Sets and less display units. We believe that
this shift is significant because LCoS Sets are a higher margin product line and
require less working capital than display units, although LCoS Sets yield less
revenue than display units per unit sold. It is our short-term strategic
objective to operate primarily as a seller of LCoS Sets and decrease our supply
of display units to our customers. It is our longer-term strategic goal to
exclusively sell LCoS Sets to our customers.
A number of our Chinese customers currently purchase display units because they
have not yet developed their own light engines. We believe that the display
unit, which is a turnkey product offering, has served as a short-term solution
and helped us to capture market share in China because many of our competitors
did not possess a turnkey solution.
While we will continue to offer display units to those current customers who do
not have their own light engine solution, we expect that new customer business
in the future will exclusively be for LCoS Sets rather than display units. Our
supply agreement with LG Electronics is exclusively for LCoS Sets, as LG
Electronics has developed its own light engine designed to incorporate our LCoS
Sets. We expect that there will be a shift in products demanded by our Chinese
customers, over time, from display units to LCoS Sets. These trends are
consistent with our overall product strategy.
18
We believe that the T-3 model will become the standard for the next generation
of rear projection display devices and will provide the most cost effective,
high-resolution microdisplays in the industry and will position us to be a
potential market leader. We believe that the T-3's ability to deliver 2
megapixel resolution in a high performance, reliable, and cost effective manner
was a key factor in our obtaining the supply agreement with LG Electronics. The
T-3 model is the central component of our ongoing customer acquisition strategy
described above.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2005, we had approximately $4,116,000 in cash and cash
equivalents, a decrease of approximately $4,972,000 from the December 31, 2004
amount of $9,088,000. Our net working capital at March 31, 2005 was
approximately $4,436,000 compared to a net working capital of approximately
$8,594,000 at December 31, 2004. This working capital change is primarily due to
the use of cash to fund the construction of our manufacturing facility and
purchase of the equipment for that facility, as well as fund our operating
expenses.
Net cash used in operating activities totaled approximately $1,709,000 and
$2,165,000 for the three months ended March 31, 2005 and 2004, respectively,
representing a decrease of approximately $456,000.
Net cash provided by financing activities in the three months ended March 31,
2005 was approximately $50,000 as compared to approximately $340,000 for the
three months ended March 31, 2004. In the first quarter of 2005 and 2004, cash
was provided primarily from the exercise of employee stock options.
We expect to meet our cash needs and fund our working capital requirements with
our existing cash balances and from additional sources as follows: the
purchasers in the November 2004 Financing have the option, which expires on
August 31, 2005, to lend us an additional $5,000,000 on the same terms as the
November 2004 Financing. Robert A. Olins, our Chief Executive Officer and a
director of SpatiaLight, and Greenpark Limited, an unaffiliated shareholder,
jointly and severally committed to provide us with additional financing as more
fully described in Note 6. We also expect to receive cash payments from our
customers and from the exercises of options and warrants. There can be no
assurances that existing investors will exercise their warrants or that the
purchasers in the November 2004 Financing will exercise their right to make the
additional lending investment. We also filed a "shelf" registration statement on
Form S-3 with the SEC on January 31, 2005, for the sale of up to two million of
our common shares, in one or more offerings. As of the date hereof, such
registration statement has not been declared effective by the SEC. We believe
that our current cash and cash equivalents combined with the financing
commitment from Robert A. Olins and Greenpark Limited will be sufficient to meet
our capital and liquidity requirements for our operations for the twelve months
following the date of this filing.
RESULTS OF OPERATIONS
Revenue. We recognized revenue of approximately $98,000 and $319,000 for the
three months ended March 31, 2005 and 2004, respectively. Revenue for the
three-month period in 2005 was from the sale of LCoS Sets and supporting
electronics. Revenue in the three months ended March 31, 2004 was primarily from
the sale of display units. Our revenue for the 2005 period was lower than the
comparable period in 2004 because LCoS Sets have a lower sales price than
display units and because our sales strategy has changed, as more fully
described under the heading Business Strategy above.
19
Revenue from one customer, LG Electronics, accounted for 69% of our total
revenue for the three months ended March 31, 2005. The loss of this customer and
our inability to obtain additional purchase orders from our current or
prospective customers to replace the lost expected revenue in a timely manner
could harm our sales or results of operations. Accounts receivable from this
customer accounted for 84% of total accounts receivable as of March 31, 2005.
Cost of revenue. Cost of revenue was approximately $70,000 and $347,000 in the
three months ended March 31, 2005 and 2004, respectively. Cost of revenue
consists primarily of product costs. Cost of revenue in 2004 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. The gross margin for the three months ended March 31, 2005
increased approximately $55,000 from our gross margin for the same period in
2004. This is due to the higher gross margin on our LCoS Sets in addition to the
inventory adjustment in 2004 that had no comparable expense in 2005.
Selling, general and administrative costs. Selling, general and administrative
costs were approximately $1,710,000 and $1,005,000 in the three months ended
March 31, 2005 and 2004 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 $225,000 as a result of the increase in administrative staff, due
in part to the hiring of a sales and marketing team. In addition, travel and
lodging expenses increased by approximately $80,000 due to increase in travel to
Asia in the three months ended March 31, 2005. This was related to the building
and completion of our manufacturing facility in the Republic of Korea. In
addition, professional services increased approximately $200,000 in the three
months ended March 31, 2005 due to the various filings related to our November
2004 Financing. Rent increased approximately $70,000, while office supplies and
other general and administrative expenses related to our new Korean facility
were incurred that had no comparable expense in the first quarter of 2004.
Stock-based compensation. Stock-based compensation was approximately $100,000 in
the three months ended March 31, 2005 and approximately $43,000 in the three
months ended March 31, 2004. The amounts incurred relate to common shares, stock
options, and warrants issued. Expenses in 2005 and 2004 relate primarily to a
warrant and stock options issued in exchange for services and the issuance of
options to an employee in 2003 that are being expensed over the vesting period.
Research and development costs. Research and development costs were
approximately $493,000 and $682,000 in the three months ended March 31, 2005 and
2004, respectively. During the first quarter of 2005, significant effort has
been expended on assisting the manufacturing ramp-up, with a corresponding
reduction in research and development project spending. As the ramp-up is
completed, it is anticipated that the effort will be redirected to research and
development projects.
Interest expense. Interest expense for the three months ended March 31, 2005
increased approximately $250,000 from the same period in 2004 due to the
issuance of $10,000,000 of Senior Secured Convertible Notes in November 2004,
which accrue interest at 10% annually.
Non-cash interest expense. Non-cash interest expense was approximately $278,000
and $188,000 for the three months ended March 31, 2005 and 2004, 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
20
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. Also included in non-cash interest expense is the
amortization of note discounts and prepaid financing costs.
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).
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
21
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
three months ended March 31, 2005, we incurred net losses of approximately
$2,149,000. In addition, we had an accumulated deficit of approximately
$69,790,000 as of March 31, 2005. 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.
WHILE WE HAVE OBTAINED FINANCING AND FINANCING COMMITMENTS THAT WE EXPECT WILL
BE SUFFICIENT TO FUND OUR CURRENTLY ANTICIPATED FINANCIAL NEEDS THROUGH THE
SECOND QUARTER OF 2006, IF WE ARE UNABLE TO OBTAIN FURTHER FINANCING IN THE
FUTURE OR GENERATE REQUIRED WORKING CAPITAL FOR FUTURE CAPITAL NEEDS, 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 further investments in research
and development, equipment, facilities and production activities. Our financial
condition and liquidity have been strongly assisted through private sales of our
common shares, the $10 million, less expenses, raised by us in the November 2004
Financing, the approximately $4,955,000 raised from the sale in December 2003 of
one million of our common shares which were registered for sale by means of a
"shelf" registration process, and $2,888,703 raised through exercises of stock
options and warrants during 2004. The purchasers in the November 2004 Financing
also have the option, which expires on August 31, 2005, to lend an additional $5
million on the same terms, as more fully described in Note 6. In addition,
Robert A. Olins, Chief Executive Officer and a director of SpatiaLight and
Greenpark Limited, jointly committed to provide us with additional financing,
subject to the conditions more fully described in Note 6. Despite these
financing and commitments, we may still require additional financing to satisfy
our increasing working capital requirements in the future. Reliance on private
equity purchase agreements and public offerings and exercises of derivative
securities to finance our future operations entails the additional risks of
default by purchasers under such equity purchase agreements or our inability to
sell publicly registered shares and an insufficient number of warrants being
exercised owing to the prevailing market prices of our underlying common shares.
In the event that we require additional financing in the future and 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 increase the
size of 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.
THE OBLIGATIONS ARISING FROM THE NOVEMBER 2004 FINANCING RESTRICTS OUR FUTURE
FINANCING ALTERNATIVES AND MAY RESULT IN FINANCIAL DIFFICULTIES FOR US IN THE
FUTURE.
22
The $10,000,000 2004 Senior Secured Convertible Notes issued pursuant to the
November 2004 Financing bear a 10% rate of interest and are not prepayable, in
whole or in part, prior to their maturity on November 30, 2007. Therefore, we do
not have the ability to refinance the 2004 Senior Secured Convertible Notes with
debt obligations bearing more favorable terms to us or out of the proceeds of an
equity financing until their above-noted maturity date. However, after the first
anniversary of the November 2004 Financing's closing, we have the right to force
conversion of the 2004 Senior Secured Convertible Notes into our common shares
in the event that our common shares trade at or above $14.58 (150% of the $9.72
conversion price of the 2004 Senior Secured Convertible Notes) for twenty
consecutive trading days. Furthermore, the 2004 Senior Secured Convertible Notes
are secured by virtually all of the assets of our Company, other than those
located in Korea, and it may therefore be difficult for us to obtain future debt
financing; however, the terms of the November 2004 Financing allow us to
subordinate the security interests of the 2004 Senior Secured Convertible Notes
to a security interest given to a bank or other institution arising from
accounts receivable, contractual rights, inventory or similar financing. If we
default in meeting our obligations under the 2004 Senior Secured Convertible
Notes, the indebtedness which they evidence will become immediately due and
payable, and the holders of such 2004 Senior Secured Convertible Notes will be
entitled to foreclose on our assets to the serious detriment of our future
operations. As noted elsewhere in this 10-Q, the 2004 Senior Secured Convertible
Notes are convertible into our common shares and the issuance of such shares
(including any shares issued in payment of interest on such notes) may have a
dilutive effect on the value of our outstanding common shares.
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 LCoS Sets and/or display units in bulk,
and sell the resulting LCoS Sets 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 to incorporate our LCoS Sets and/or display units in their
products. This requires us to invest significant amounts of time and capital in
designing our LCoS Sets 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 LCoS Sets and/or display
units, it could seriously harm our financial condition. In addition, the time
period 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 OPERATIONAL AND RESEARCH AND DEVELOPMENT COSTS IN
CONNECTION WITH PRODUCTS AND TECHNOLOGIES THAT MAY NOT BE SUCCESSFUL.
We currently have nine full-time engineering and ten full-time manufacturing
personnel based in California working on microdisplays. We are currently
actively hiring personnel for our manufacturing facility located in the Republic
of Korea. We currently have six full-time engineering and 27 full-time
manufacturing personnel based in the Republic of Korea and we expect to hire an
additional five engineers and 75 manufacturing personnel by the end of 2005.
This staffing creates significant operational and research and development costs
that may not be recouped. Even if our current LCoS Sets become accepted and/or
successful, we must continue to use, and may increase in number, our engineering
and manufacturing personnel to develop future generations of our microdisplays
because of the rapid technological changes in our industry. As a result, we
expect to continue incurring significant operational and research and
development costs.
23
WE ARE CURRENTLY MANUFACTURING AND SHIPPING OUR PRODUCTS IN LIMITED COMMERCIAL
QUANTITIES, BUT UNANTICIPATED DIFFICULTIES IN MANUFACTURING OUR PRODUCTS IN
LARGER QUANTITIES MAY MAKE IT DIFFICULT TO MEET CUSTOMER DEMANDS FROM TIME TO
TIME AND OUR OPERATING RESULTS COULD BE SIGNIFICANTLY HARMED BY SUCH
DIFFICULTIES.
Problems in production of our LCoS Sets or display units 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
current and prospective 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 LCoS Sets are assembled by combining the silicon backplanes with electronic
components. The design and manufacture of LCoS Sets 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 LCoS Sets. 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 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 has a known shortage of critical material.
Because the manufacture of our LCoS Sets involves highly complex processes and
technical problems may arise as we manufacture our liquid crystal microdisplays,
we cannot assure the manufacturing yields of our products. Although we believe
that we will be able to mass produce our LCoS Sets, other companies, including
some with substantially greater resources than us, have found great difficulty
or failed to do so. Current purchase orders and anticipated future purchase
orders, which we cannot assure, will require us to produce greater quantities of
our LCoS Sets 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 LCoS Sets and display units
increases, and such complexities may lend to similar difficulties that could
harm our business and operating results.
WHILE WE INTEND, IN THE NEAR FUTURE, TO COMMENCE OPERATIONS IN OUR NEW
MANUFACTURING FACILITY IN THE REPUBLIC OF KOREA, WHICH WILL SERVE AS OUR
PRINCIPAL FACILITY FOR MANUFACTURING OUR MICRODISPLAY PRODUCTS, WE MAY ENCOUNTER
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.
24
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 harm
our business. Such potential problems could arise in connection with
transitioning our manufacturing operations to the new facility in Korea. 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.
GEOPOLITICAL CONDITIONS OR POTENTIAL MILITARY CONFLICTS BETWEEN ALLIES THE
UNITED STATES AND THE REPUBLIC OF KOREA AND NORTH KOREA MAY NEGATIVELY IMPACT
OUR BUSINESS.
We intend to operate our principal manufacturing operations in the Republic of
Korea commencing in the second quarter of 2005 and our largest expected
customer, LG Electronics, resides in the Republic of Korea. The Republic of
Korea and North Korea are technically at war with each other, despite the
sanctioned existence of the Demilitarized Zone and the relative absence of
physical conflict for several decades. Any escalation in the existing military
conflict between these countries or any commencement, or perceived commencement
of a military conflict between the United States and North Korea, may limit our
ability to effectively operate our manufacturing facility in the Republic of
Korea and also may substantially limit our ability to sell products into the
Republic of Korea because of the negative economic, physical or other
destructive impact that such a conflict could have on our most important
customer. Any such disruptions to our manufacturing operations and/or ability to
consummate sales to a substantial customer could adversely affect the
development of our business and our financial condition.
IF THE HIGH DEFINITION TELEVISION MARKET DOES NOT CONTINUE TO DEVELOP AND IF
OTHER POTENTIAL MARKETS FOR OUR PRODUCTS DO NOT MATERIALIZE, THEN OUR BUSINESS
WILL LIKELY BE SIGNIFICANTLY HARMED.
High definition television programming has only recently become available to
consumers, and widespread market acceptance, although anticipated, is uncertain
at this time. The market demand for high definition televisions is considered
contingent upon such widespread acceptance of high definition television
programming. Our current sales and marketing efforts are focused on OEMs of high
definition televisions and OEMs of light engines designed for incorporation into
high definition televisions. Therefore, if the market for high definition
televisions does not continue to grow and develop, then we will have significant
difficulty selling our products, which will have a material adverse effect on
our results of operations.
Various potential target markets for our products, including projectors,
monitors, and portable microdisplays, are uncertain and may be slow to develop.
In addition, companies in those markets could utilize competing technologies.
For us to succeed in selling our products into these potential markets we must
offer end-product manufacturers better and less expensive microdisplay products
than our competitors, and the manufacturers themselves will also have to develop
commercially successful products using our products. In the event that we
attempt to market and sell our products into these potential target markets, if
we are not able to succeed in selling our products into these potential markets,
then our results of operations and overall business may be negatively affected.
IF OUR PRODUCTS DO NOT BECOME WIDELY ACCEPTED BY OUR CUSTOMERS OR THE END-USERS,
OUR BUSINESS COULD BE SIGNIFICANTLY HARMED.
25
Our LCOS Sets and/or display units 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 the second quarter of 2005, it is likely that a substantial
percentage of our anticipated revenues will be derived from LG Electronics,
based upon our agreement with LG Electronics. 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 become
primarily reliant 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 LG Electronics as a customer for any reason or
if LG Electronics were to otherwise reduce, delay or cancel its orders. Any such
events could cause a material adverse effect on our business, operations and
financial condition and the value of our common shares could decline
substantially.
Our ability to retain and receive additional purchase orders from our current
customers and to attract and receive purchase orders from prospective customers
may depend upon the acceptance of LG Electronics' products in the consumer
marketplace. If LG Electronics' television products incorporating our LCoS
technology are not commercially successful, demand for our products from our
current and prospective customers may not materialize, which could negatively
impact our results of operations and our 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.
Even though we have received purchase orders for our LCoS Sets and/or display
units from LG Electronics and from several Chinese OEMs and we may receive
additional purchase orders from our prospective customers, we may have problems
implementing volume production of our products. Furthermore, sales to
manufacturers in the electronics industry are subject to severe competitive
pressures, rapid technological change and product obsolescence. Customers may,
at any time, cancel purchase orders or commitments or reduce or delay orders,
thereby increasing our inventory and overhead risks. In addition, purchase
orders received from our Chinese customers are for limited quantities of our
products. 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.
26
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 absence of, or 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 HIGH DEFINITION TELEVISION INDUSTRY IS HIGHLY COMPETITIVE, WHICH MAY RESULT
IN LOST SALES OR LOWER GROSS MARGINS.
We serve the highly competitive high definition television industry that is
characterized by price erosion, rapid technological change and competition from
major domestic and international companies. This intense competition could
result in downward pricing pressures, lower sales, reduced margins and lower
market share.
Companies competing in the LCoS microdisplay market include Sony and JVC,
although we presently believe that Sony has developed LCoS microdisplays for its
own use and not for sale to other OEM's. A major competitor of ours in the
reflective microdisplay market, although not using liquid crystals in the
display, is Texas Instruments, which is producing a micro-mechanical structure
of moving mirrors on a silicon backplane, a technology known as digital light
processing, or DLP. Texas Instruments has had significant success selling its
DLP products to its customers in the business front projector market and the
rear projection high definition television market. Some of our competitors,
including Texas Instruments and JVC, 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.
Rapid and significant technological advances have characterized the microdisplay
market. There can be no assurance that we will be able to effect any of such
technological advances or that we will have sufficient funds to invest in new
technologies or products or processes. Although we believe that our displays
have specifications and capabilities, which equal or exceed that of commercially
available LCD, cathode ray tube (CRT) and DLP based display products, the
manufacturers of these products may develop further improvements of their
existing technology that would eliminate or diminish our anticipated advantage.
27
In addition, numerous competitors have substantially greater financial,
technical, marketing, distribution and other resources than we have. The
acceptance of our LCoS Sets and/or display units will be dependent upon the
pricing, quality, reliability and useful life of these products compared to
competing technologies, as to which there can be no assurance.
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, customers in the
television manufacturing industry typically develop a second source. Second
source suppliers may win an increasing share of our customers product demands.
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; and
o the rate at which customers incorporate our displays into their own
products; and products or technologies introduced by our
competitors.
FLUCTUATIONS IN THE EXCHANGE RATE OF THE UNITED STATES DOLLAR AND FOREIGN
CURRENCIES COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL PERFORMANCE AND
PROFITABILITY.
A portion of our costs is denominated in foreign currencies, including the
Korean Won, the Euro and the Japanese Yen. As a result, changes in the exchange
rates of these currencies or any other applicable currencies to the U.S. dollar
will affect our costs of good sold and operating margins, and could result in
exchange losses. We cannot fully predict the impact of future exchange rate
fluctuations on our profitability. From time to time, we may engage in exchange
rate hedging activities in an effort to mitigate the impact of exchange rate
fluctuations, although we have not engaged in any such hedging activities to
date. However, we cannot offer assurance that any hedging technique we may
implement will be effective. If it is not effective, we may experience reduced
operating margins.
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.
28
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.
THE MARKET PRICE OF OUR COMMON SHARES IS HIGHLY VOLATILE.
The market price of our common shares has been highly volatile, reflecting among
other things reported losses, receipts of additional financing and investors'
perceptions about our business prospects. Some research has shown that similar
volatility in other companies 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
29
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 common shares included in the Amendment No. 2 to Form S-3
Registration Statement that we filed with the SEC on April 27, 2005
(Registration Number 333-122391), principally relating to the November 2004
Financing represents approximately 5.69% of the total number of our common
shares that were issued and outstanding as of December 31, 2004. Sales of these
shares, as well as the 2,000,000 common shares included in the Form S-3 "Shelf"
Registration Statement filed by us with the SEC on January 31, 2005, into 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 has
historically been adversely affected due to their limited marketability, but
such volume has increased significantly in recent periods. Nevertheless, any
substantial sales of our common shares may result in a material reduction in
price, reflecting the volatility of the trading market for 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 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.
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR PROPRIETARY TECHNOLOGY
AND OUR REGISTERED INTELLECTUAL PROPERTY.
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. If we are unable to
protect our intellectual property from use by third parties, our ability to
compete in the industry will be harmed. Policing unauthorized use of our
products and technology is difficult, however. Despite our efforts to protect
our proprietary rights, we face the following risks:
30
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, Korean
or Taiwanese 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, Korean
and other foreign 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.
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. Certain 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
31
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. Moreover, under the terms of
the November 2004 Financing, we are prohibited from paying cash dividends while
the 2004 Senior Secured Convertible Notes issued in the November 2004 Financing
remain outstanding. Instead, we intend to apply any future earnings to the
expansion and development of our business.
OUR REPORTED FINANCIAL RESULTS MAY BE ADVERSELY AFFECTED BY CHANGES IN
ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE UNITED STATES.
We prepare our consolidated financial statements in conformity with accounting
principles generally accepted in the U.S. These accounting principles are
subject to interpretation by the Financial Accounting Standards Board, the
American Institute of Certified Public Accountants, the SEC and various bodies
formed to interpret and create appropriate accounting policies. A change in
these policies or interpretations could have a significant effect on our
reported financial results, and could affect the reporting of transactions
completed before the announcement of a change. For example, the FASB has
implemented changes to U.S. GAAP that require us to record a charge to earnings
for employee stock option grants for all awards unvested at and granted after
December 31, 2005. This regulation will negatively impact our earnings.
Technology companies generally, and our Company, specifically, rely on stock
options as a major component of our employee compensation packages. Due to the
new requirement to expense options, we are less likely to achieve profitability
and we may consider decreasing or eliminating option grants. Decreasing or
eliminating option grants may negatively impact our ability to attract and
retain qualified employees.
Item 3. Quantitative and Qualitative Disclosures About Market Risks.
We are exposed to the impact of interest rate changes and foreign currency
fluctuations.
Interest Rate Risk. Our exposure to market rate risk for changes in interest
rates relates primarily to our cash accounts. We invest excess cash and cash
equivalents in a checking account or money market account with reputable banks
both in the United States and South Korea. Our cash accounts in the United
States are not FDIC or otherwise insured, to the extent that the accounts exceed
$100,000; and our cash accounts in South Korea are not insured. As of March 31,
2005, our cash and cash equivalents totaled $4,115,598.
32
Foreign Currency Risk. We are exposed to foreign exchange rates fluctuations as
we convert the financial statements of our foreign subsidiary into U.S. dollars
in consolidation. If there is a change in foreign currency exchange rates, the
conversion of the foreign subsidiary's financial statements into U.S. dollars
will lead to a translation gain or loss which is recorded as a component of
other comprehensive income and expenses. In addition, we have certain assets and
liabilities that are denominated in currencies other than the relevant entity's
functional currency. Changes in the functional currency value of these assets
and liabilities create fluctuations that will lead to a transaction gain or
loss. During the first quarter of 2005, the foreign currency transaction gains,
realized and unrealized, were not material.
Item 4. Controls and Procedures.
Disclosure Controls and Procedures. As of March 31, 2005, management of our
Company, under the supervision of our principal executive and financial officer
(CEO), evaluated (the Controls Evaluation) the effectiveness of the design and
operation of our "disclosure controls and procedures", as such term is defined
under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended (Disclosure Controls), and whether any changes in the Company's internal
control over financial reporting (Internal Controls), as such term is defined in
Rule 13a-15(f) under the Exchange Act, during the most recent fiscal quarter
have materially affected, or are reasonably likely to materially affect, our
Internal Controls (Internal Controls).
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 and since we commenced operations. 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 our 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.
CONCLUSION REGARDING THE EFFECTIVENESS OF DISCLOSURE CONTROLS AND PROCEDURES
Based on all of the material weaknesses related to our internal control over
financial reporting, which are set forth below, and which were identified during
the Controls Evaluation, the CEO concluded that our disclosure controls and
procedures were not effective as of the end of the period covered by this Form
10-Q.
33
CHANGES IN INTERNAL CONTROLS
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.
CONTROLS EVALUATION
The management of SpatiaLight, Inc. assessed the effectiveness of our internal
control over financial reporting as of March 31, 2005, and this assessment
identified the following material weaknesses in the company's internal control
over financial reporting.
The material weaknesses identified were:
o Our corporate governance and disclosure controls and procedures do
not provide reasonable assurance that material transactions are
timely and accurately reported in the financial statements and
related disclosures, or that the unauthorized disposition of assets
are prevented and detected. In particular:
o We do not have a corporate governance or disclosure committee.
o We do not have a fraud training program for employees, or a
mechanism to report fraud to the audit committee.
o The audit committee does not have a financial expert (as
defined by SEC rules) or procedures for archiving minutes of
its meetings.
o We do not currently have a chief financial officer to work with the
chief executive officer and chief operating officer in overseeing
and monitoring complex and significant transactions in order to
provide reasonable assurance that such transactions are reflected
accurately and fairly in the financial statements.
o We have inadequate controls and procedures (1) to monitor the
tracking and movement of inventory, and (2) to prevent and detect
the unauthorized use of inventory due to an inadequate segregation
of duties. The employee who performs the periodic physical inventory
counts also has access to the inventory and inventory records.
o We lack information technology controls and procedures that would
likely prevent unauthorized access to the accounting and financial
systems, and ensure that the accounting and financial records are
recoverable in the event of a disaster.
In making its assessment of internal control over financial reporting management
used the criteria issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) in Internal Control-Integrated Framework.
Each of the material weaknesses identified by management during the control
evaluation for the period ended December 31, 2004, was reported in Item 9A of
our Form 10-K/A, and filed with the SEC on April 27, 2005.
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Management has and is taking the following steps to address some of the material
weaknesses set forth in this report:
Fraud training program - We are in the process of implementing a
procedure for the reporting of fraud to the Audit Committee of the Board. This
procedure will include informing employees in writing about what constitutes
fraud. Our Audit Committee is establishing related procedures for the receipt,
retention and treatment of complaints regarding accounting, internal accounting
controls or auditing matters and the Audit Committee is establishing procedures
that will provide a mechanism for the confidential, anonymous submission by
employees of concerns regarding questionable accounting or auditing matters. We
expect that these procedures will be implemented during the second quarter of
2005.
Procedures for archiving audit committee meeting minutes - We have
implemented procedures for archiving minutes of meetings of the Audit Committee
and such procedures were in place for the most recent meeting of the Audit
Committee, which occurred in March 2005.
Issuance of common shares to a company wholly owned by our Chief
Executive Officer - The material weakness relating to issuance of common shares
arose in connection with a situation where the Board, in November 2004,
authorized the issuance of common shares to Argyle in January 2005, but a
portion of the authorized common shares were delivered to Argyle in December
2004. Through action taken by the Board in March 2005, we have implemented new
controls over the process for issuance of common shares to Robert Olins, our
CEO, secretary, treasurer and director, and to Argyle Capital Management
Corporation (Argyle), a company wholly-owned by Mr. Olins, whereby American
Stock Transfer & Trust Company, our transfer agent, is not permitted to transfer
any shares from our treasury account to Mr. Olins or to Argyle, without prior
written authorization executed by a majority of Board members excluding Mr.
Olins.
Safeguarding of our common shares held in connection with notes
receivable - Through action taken by the Board in March 2005, we have
implemented new procedures with respect to the safeguarding of our common shares
held in connection with notes receivable. We have established controls and
procedures for maintaining escrow accounts for common shares that are
deliverable to other parties upon the performance of certain future conditions,
such as fulfillments of payments under notes receivable.
Our management believes that the actions described in the two
immediately preceding paragraphs have fully and adequately addressed the
material weakness "We do not have adequate controls over (1) the process for
issuance of common shares to a company wholly-owned by the Company's chief
executive officer; and (2) the safeguarding of its common shares held in
connection with notes receivable." That material weakness was disclosed in our
Form 10-K/A filed with the SEC on April 27, 2005.
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Chief Financial Officer and Corporate Controller - We are currently
conducting a search for the position of full-time corporate controller and are
in the process of interviewing potential candidates. We have discontinued our
search for a CFO. Management believes that in the event that we are able to hire
a highly qualified full-time corporate controller, such person will obviate the
need for us to hire a CFO. We will reassess that position following the hiring
of a controller. We expect to hire a full-time corporate controller in the
second quarter of 2005.
Information technology controls and procedures - In March 2005, we
entered into an International Program License Agreement with Microsoft Business
Solutions Corporation, pursuant to which we are licensing the Microsoft Business
Solutions Navision software system (Navision). Navision is an advanced IT-ERP
system that has the capability to support our management's accounting and
financial systems. We also have contracted with a reputable company to lead the
company-wide implementation of the Navision system. In connection with the
implementation of Navision, we are implementing systematic controls designed to
prevent unauthorized access to our accounting and financial systems, which we
believe that Navision will facilitate. We are also implementing physical and
electronic back-up and storage procedures to help ensure that our accounting and
financial records will be recoverable in the event of a disaster.
Our management presently expects that implementation of Navision in our
California and South Korea offices will be completed and the system will become
active by the end of the second quarter of 2005.
Controls and procedures of inventory - We are in the process of
implementing the Navision ERP system referred to in the preceding paragraph.
Management believes that this will assist in addressing the identified
inadequate controls and procedures described in the Controls Evaluation.
We have not taken any steps, as of the date of this filing, to address the
material weaknesses relating to the facts that we do not have a corporate
governance or disclosure committee, and that the audit committee does not have a
financial expert, as defined by SEC rules. We do not presently have specific
plans with respect to adding a director who would constitute a financial expert
or with respect to establishing a corporate governance or disclosure committee.
PART II. OTHER INFORMATION
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
In February 2005, we issued a fully vested warrant to purchase 75,000 common
shares as payment to a sales agent in consideration for services. As of the date
of this filing, the sales agent has not exercised the warrant and therefore we
have not received any proceeds from that transaction.
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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 no reports on Form 8-K during the quarter ended
March 31, 2005.
*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: May 10, 2005
-----------------------------
SpatiaLight, Inc.
By: /s/ ROBERT A. OLINS
-------------------------------
Robert A. Olins
Chief Executive Officer
and Principal Financial Officer
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