U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] Quarterly report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended June 30, 2003
[ ] Transition report pursuant section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ____________ to
________________
eMAGIN CORPORATION
(Exact name of small business issuer as specified in its charter)
Commission file number: 000-247
DELAWARE 56-1764501
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
2070 Route 52
Hopewell Junction, New York 12533
(Address of principal executive offices)
(845) 892-1900 (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 [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Not applicable
APPLICABLE ONLY TO CORPORATE REGISTRANTS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of August 18, 2003 the Registrant
had 38,502,090 shares of Common Stock outstanding.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (check one): Yes [ ] No [X]
PART I. FINANCIAL INFORMATION
Index Page Number
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at June 30, 2003 (Unaudited) and 3
December 31, 2002 *
Unaudited Consolidated Statements of Operations for the Three and Six Months ended
June 30, 2003 and June 30, 2002 4
Unaudited Consolidated Statements of Cash Flows for the Six Months ended
June 30, 2003 and June 30, 2002 5
Unaudited Consolidated Statement of Changes in Stockholder Equity from
December 31, 2002 to June 30, 2003 6
Selected Notes to Consolidated Financial Statements 7
* Information with respect to December 31, 2002 is derived from our audited
financial statements included on form 10KSB
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operation 16
Item 3. Controls and Procedures 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 2. Changes in Securities and Use of Proceeds 27
Item 3. Defaults Upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29
SIGNATURE 30
2
eMAGIN CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS June 30, 2003 December 31, 2002
---------------------------------
CURRENT ASSETS: (Unaudited)
Cash and cash equivalents ...................................................... $ 530,524 $ 82,951
Trade receivables, net of allowance for doubtful accounts of $37,398 and $36,144 407,154 240,136
at June 30, 2003 and December 31, 2002, respectively
Unbilled costs and estimated profits on contracts in progress .................. 75,359 125,359
Inventory ...................................................................... 522,299 250,998
Prepaid expenses and other current assets ...................................... 1,044,755 113,849
------------- --------------
Total current assets ........................................................ 2,580,091 813,293
EQUIPMENT AND LEASEHOLD IMPROVEMENTS: ............................................. 2,341,621 2,230,674
Less: Accumulated Depreciation ................................................... (1,846,169) (1,596,142)
------------- --------------
Total equipment and leasehold improvements, net ................................... 495,452 634,532
Intangible Assets ................................................................. 18,020,000 18,020,000
Less: Accumulated Amortization .................................................... (18,020,000) (17,688,558)
------------- --------------
Total intangible assets, net ...................................................... -- 331,442
Other long-term assets ............................................................ 109,407 55,117
------------- --------------
Total assets ................................................................ $ 3,184,950 $ 1,834,384
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ............................................................... $ 324,860 $ 6,381,036
Accrued payroll and benefits ................................................... 1,207,646 1,031,958
Other accrued expenses ......................................................... 1,041,716 1,207,693
Current portion of long-term debt .............................................. 408,171 49,275
Other short term debt .......................................................... 1,617,340 5,690,889
Other current liabilities ...................................................... 500 53,905
------------- --------------
Total current liabilities ................................................... 4,600,233 14,414,756
------------- --------------
NOTES PAYABLE ..................................................................... 1,815,872 --
OTHER LONG-TERM DEBT .............................................................. 3,141,460 227,742
SHAREHOLDERS' EQUITY:
Common Stock, par value $0.001 per share
Shares authorized - 100,000,000
Shares issued and outstanding - 38,061,383 and 30,854,980 .................. 38,172 30,855
Additional paid-in capital ..................................................... 127,339,654 119,221,277
Deferred compensation .......................................................... (263,587) (462,983)
Accumulated deficit ............................................................ (133,486,854) (131,597,263)
------------- --------------
Total shareholders' equity .................................................. (6,372,615) (12,808,114)
------------- --------------
Total liabilities and shareholders' equity .................................. $ 3,184,950 $ 1,834,384
============= ==============
See selected notes to financial statements
3
eMAGIN CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
REVENUE:
Contract revenue $ - $ - $ - $ 14,108
Product revenue, net of returns 306,991 268,127 772,370 412,046
---------------------------------------------------------
Total Revenue 306,991 268,127 772,370 426,154
---------------------------------------------------------
Cost of Goods Sold:
Costs of goods sold 122,441 - 1,257,309 -
Sales Commissions - - 15,000 -
---------------------------------------------------------
Total Cost of Goods Sold 122,441 - 1,272,309 -
---------------------------------------------------------
Gross Profit (loss) 184,550 268,127 (499,939) 426,154
COSTS AND EXPENSES:
Research and development, net of funding - 3,343,048 21,848 5,487,814
Production expense 895,366 - 895,366
Amortization of purchased intangibles 110,483 331,442 662,898
Gain on payable forgiveness (1,885,423) (1,885,423)
Selling, general and administrative 633,702 379,473 1,750,434 3,351,447
---------------------------------------------------------
Total costs and expenses, net (356,355) 3,833,004 1,113,667 9,502,159
---------------------------------------------------------
OTHER INCOME (EXPENSE):
Interest expense (234,526) (627,344) (485,506) (1,563,476)
Interest income 128,690 - 128,690
Other Income (expense) 209,520 62,487 209,520 20,233
---------------------------------------------------------
Other income (expense) (25,006) (436,167) (275,986) (1,414,553)
---------------------------------------------------------
Gain (loss) before provision for income taxes 515,899 (4,001,044) (1,889,592) (10,490,558)
---------------------------------------------------------
PROVISION FOR INCOME TAXES - - - -
---------------------------------------------------------
Net income (loss) $ 515,899 $(4,001,044) $(1,889,592) $(10,490,558)
=========================================================
Basic gain (loss) per common share $ 0.02 $ (0.13) $ (0.06) $ (0.37)
Diluted gain (loss) per common share $ 0.02 $ (0.13) $ (0.06) $ (0.37)
Weighted average common shares outstanding 34,037,250 30,294,980 32,393,723 28,482,450
See selected notes to financial statements.
4
eMAGIN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Six Months
ended ended
June 30, 2003 June 30, 2002
------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,889,592) $ (10,490,557)
Adjustments to reconcile net loss to net cash
used in operating activities-
Depreciation and amortization 245,661 912,575
Writedown of goodwill and purchased intangibles 331,442 -
Loss on sale of assets - 437
Amortization of debt discount 53,169 (182,516)
Non-cash compensation for beneficial conversion 24,688 -
Non-cash charge for stock based compensation 199,396 980,972
Non-cash interest related charges 409,305 1,538,138
Non-cash charge for services received 153,121 -
Non-cash debt restructure (1,885,423) -
Proceeds from sale of equipment, net 209,520 -
Changes in operating assets and liabilities:
Trade receivables (167,018) (311,170)
Unbilled costs and estimated profits on contracts in progress 50,000 (269,253)
Inventory (271,300) 354,887
Prepaid expenses and other current assets (1,035,908) 179,693
Other long-term assets 50,710 (14,447)
Advanced payment on contracts to be completed 9,385 332,597
Deferred Revenue (29,900) -
Accounts payable, accrued expenses and accrued payroll 850,209 1,810,585
Other current liabilities (204,214) -
------------------------------------------
Net cash used in operating activities (2,896,749) (5,158,059)
------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment (109,619) (84,745)
------------------------------------------
Net cash used in investing activities (109,619) (84,745)
------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sales of common stock, net of issuance costs - 3,475,620
Proceeds from exercise of stock options and warrants 103,940 887
Proceeds from long and short term debt 3,350,000 1,200,000
Payments of long term debt and capital leases - (15,097)
------------------------------------------
Net cash provided by financing activities 3,453,940 4,661,410
------------------------------------------
NET INCREASE IN CASH AND CASH EQUIVALENT'S 447,572 (581,394)
CASH AND CASH EQUIVALENTS, beginning of period 82,951 738,342
------------------------------------------
CASH AND CASH EQUIVALENTS, end of period $ 530,523 $ 156,948
==========================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
NON-CASH FINANCING ACTIVITIES:
Settlements of long term debt and payables in shares of common stock 4,845,537 -
Interest prepaid in shares of common stock 748,116 -
See selected notes to financial statements.
5
eMAGIN CORPORATION
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
Additional
Common Stock Deferred Paid-in Accumulated
Shares $ Compensation Capital Deficit Total
Balance, December 31, 2002 30,854,980 $ 30,855 $ (462,983) 119,221,276 (131,597,263) (12,808,115)
================ =============== ================= ============== ================= ==============
Stock warrants exercised 91,425 91 49,909 50,000
-----------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock for
services 339,433 340 273,457 273,796
-----------------------------------------------------------------------------------------------------------------------------------
Amortization of deferred
compensation 111,385 111,385
-----------------------------------------------------------------------------------------------------------------------------------
Net loss for period (2,405,491) (2,405,491)
-----------------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 2003 $ 31,285,838 $ 31,286 $ (351,598) $ 119,544,643 (134,002,753) (14,778,422)
-----------------------------------------------------------------------------------------------------------------------------------
Conversion to common stock for 4,633,590 4,633 4,239,260 4,243,893
debt
-----------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock for 125,002 125 91,970 92,095
services
-----------------------------------------------------------------------------------------------------------------------------------
Exercise of options 129,675 130 53,810 53,940
-----------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock for 1,997,840 1,998 1,409,971 1,411,969
payable forgiveness
-----------------------------------------------------------------------------------------------------------------------------------
Amortization of deferred 88,011 88,011
compensation
-----------------------------------------------------------------------------------------------------------------------------------
Warrants issued with 1,383,203 1,383,203
convertible notes payable
-----------------------------------------------------------------------------------------------------------------------------------
Beneficial conversion on 616,797 616,797
financing
-----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) for period 515,899 515,899
-----------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 2003 38,171,945 $ 38,172 $ (263,587) $ 127,339,654 $ (133,486,854) $ (6,372,615)
================ =============== ================= ============== ================= ==============
-----------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
6
eMAGIN CORPORATION
Selected Notes to Consolidated Financial Statements
Note 1 - BASIS OF PRESENTATION
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. Certain information or footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to the rules and regulations of the Securities and Exchange Commission.
In the opinion of management, the statements include all adjustments necessary
(which are of a normal and recurring nature) for the fair presentation of the
results of the interim periods presented. The results of operations for the
period ended June 30, 2003 are not necessarily indicative of the results to be
expected for the full year.
Note 2 - NATURE OF BUSINESS
Fashion Dynamics Corporation (FDC) was organized January 23, 1996, under the
laws of the State of Nevada. FDC had no active business operations other than to
acquire an interest in a business. On March 16, 2000, FDC acquired FED
Corporation ("FED") (the Merger). The merged company changed its name to eMagin
Corporation (the "Company" or "eMagin") (Note 3). eMagin is a developer and
manufacturer of optical systems and microdisplays for use in the electronics
industry. eMagin's wholly-owned subsidiary, Virtual Vision Inc., develops and
markets microdisplay systems and optics technology for commercial, industrial
and military applications. Following the Merger, the business conducted by the
Company is the business conducted by FED prior to the Merger.
As of January 1, 2003 the Company has completed its development stage, as
defined by Statement of Financial Accounting Standards ("SFAS") No. 7,
Accounting and Reporting by Development Stage Enterprises". The financial
statements results as of December 31, 2002 and the period ended March 31, 2002
have been restated to reflect the current status. The Company expects its
product revenues to increase as we concentrate on trade revenue, once additional
supplies begin to arrive and shipments of finished product again begin to ship.
The effects on accounting for 2003 will be substantial. The majority of sales
before 2003 were Contract Revenue in which our costs were treated as overall
company losses. In 2002 we started minimal production. We initially shipped only
developer kits and sample quantities of our SVGA+ OLED microdisplay product. We
expanded the product line with a SVGA 3D product. We now provide both color and
several variations of monochrome versions of these products. Our customers
generally spend six to over twelve months evaluating and testing our product and
developing their own end product, which uses our display before committing to
larger orders. We expect the quantities of products shipped to increase as we
receive the materials and supplies we ordered after our recent financing and we
hire additional staff to increase our manufacturing capacity, enabling us to
begin shipping products to fulfill our backlog of orders as well as ship new
orders.
The cost of the products we sold in 2002 were predominately recorded in R&D and
Direct Contracts as we modified our product to create commercial products. In
the third quarter of 2002, we developed a glass cover that improved the
robustness of our products. In the fourth quarter of 2002, we purchased a
machine that allowed us to produce the products in production quantities. In the
first quarter of 2003, the machine came on-line.
In 2003 we will keep track of costs of production, classifying direct and
indirect costs to costs of goods sold and tracking our gross profit. Although
R&D is no longer our primary focus, we have a few employees that will
7
work on projects to create new products and enhance existing products. We are
working to secure new, R&D contracts to help create the next generation of lower
cost and/or higher resolution products, as well as to develop other performance
and life-luminance product enhancements. Contract R&D is expected to continue in
2003, but at proportionately much smaller levels than in prior years.
There can be no assurance that the Company will generate sufficient revenues to
provide positive cash flows from operations. These and other factors raise
substantial doubt about the Company's ability to continue as a going concern.
The accompanying consolidated financial statements do not include any
adjustments that might result should the Company be unable to continue in
existence.
Note 3 - REVENUE AND COST RECOGNITION
The Company has historically earned revenues from certain of its research and
development activities under both firm fixed-price contracts and cost-type
contracts, including some cost-plus-fee contract. Revenues relating to firm
fixed-price contracts are generally recognized on the percentage-of-completion
method of accounting as costs are incurred (cost-to-cost basis). Revenues on
cost-plus-fee contracts include costs incurred plus a portion of estimated fees
or profits based on the relationship of costs incurred to total estimated costs.
Contract costs include all direct material and labor costs and an allocation of
allowable indirect costs as defined by each contract, as periodically adjusted
to reflect revised agreed upon rates. These rates are subject to audit by the
other party. Amounts can be billed on a bi-monthly basis. Billing is based on
subjective cost investment factors. The company is currently under contract to
one or more entities for research and development, and expects to undertake
activities and realize revenues related to such research and development work in
future quarters.
In addition, the Company has product sales, which are recognized when
merchandise is shipped and such revenue is recorded net of estimated sales
returns based upon past experience. Adjustments to such returns are made as new
information becomes available.
In 2003 we will keep track of costs of production, classifying direct and
indirect costs to cost of goods sold and tracking our gross profit. Although R&D
as our primary focus will end, we have a few employees that will occasionally
work on projects to create new products and enhance existing products. At
present, we have no direct contracts we are billing to, but we may at times be
asked to work on a completed contract. Although we will not have any income from
that work, it may provide a foundation for future contracts and we will record
those costs in direct contracts.
Note 4 - RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred. To date, activities of
the Company (and its predecessor) have included the performance of research and
development under cooperative agreements with United States Government agencies.
Funding from such research and development contracts is recognized as a
reduction in operating expenses during the period in which the services are
performed and related direct expenses are incurred.
Note 5 - NET (LOSS) PER COMMON SHARE
In accordance with SFAS No. 128, net income (loss) per common share amounts
("basic EPS") were computed by dividing net income (loss) by the weighted
average number of common shares outstanding and excluding any potential
dilution. Net loss per common share assuming dilution ("diluted EPS") was
computed by reflecting potential dilution from the exercise of stock options,
warrants and convertible debt where all
8
contingencies have been met. Common equivalent shares totaling 13,247,270 have
been excluded from the computation of diluted EPS for the three and six months
ended June 30, 2003, which include 961,260 weighted options in-the-money,
826,147 weighted warrants in-the-money and 11,459,863 convertible shares. Common
equivalent shares totaling 11,767,740 have been excluded from the computation of
diluted EPS for the three and six month period ending June 30, 2002.
Note 6 - DEBT
----- --------------------------------------- -----------------------
a Current portion of long term debt $ 408,171
----- --------------------------------------- -----------------------
b Other short term debt 1,617,340
----- --------------------------------------- -----------------------
c Notes payable 1,815,872
----- --------------------------------------- -----------------------
d Other long term debt 3,141,460
----- --------------------------------------- -----------------------
e Total debt $ 6,982,843
----- --------------------------------------- -----------------------
(a) This amount includes (i) $11,374 due to Citicorp leasing over the next 12
months in lease payments for equipment; and (ii) $42,297 due to IBM over the
next 12 months for leasehold improvements; and (iii) $354,500 due to Finova over
the next twelve months in lease payments for equipment.
(b) On April 25, 2003, we entered into a global restructuring and secured note
purchase agreement with a group of several accredited institutional and
individual investors whereby the Investors agreed to lend us $6,000,000 in
exchange for (i) the issuance of $6,000,000 principal amount of 9.00% secured
convertible promissory notes due and payable on November 1, 2005 and (ii)
warrants to purchase an aggregate of 7,749,921 shares of common stock of eMagin
(subject to certain customary anti-dilution adjustments), such warrants are
exercisable for a period of three (3) years.
Interest is payable on the notes at a rate of 9% per annum and, at our option,
may be paid through the delivery of shares of our common stock (registered
pursuant to the registration rights agreement referred to below) in lieu of cash
interest payments on the maturity date of the loan, November 1, 2005. Subject to
certain limitations, the notes may be converted, at the option of the holder, in
whole or in part, into common shares with a conversion price equal to 105% of
the volume weighted average of the closing price of our common shares as
reported on The American Stock Exchange by the Wall Street Journal, New York
City edition, for the five (5) trading days immediately preceding the closing
date. The exercise price of the warrants on a per share basis is $.8110, an
amount equal to 110% of the volume weighted average of the closing price of our
common shares as reported on The American Stock Exchange by the Wall Street
Journal, New York City edition, for the five (5) trading days immediately
preceding the closing date.
Receipt of the $6 million financing is payable in increments according to a set
schedule through October 2003. As of June 30, 2003 we received $3,350,000. In
June 2003, the company recorded $1,289,575 for the debt discount and $510,425
for the beneficial conversion as paid in surplus, which is amortized through
November 2005. For the quarter ended June 30, 2003, $67,340 has been amortized
to interest expense.
The terms of the notes contain certain revisions, including financial and other
covenants, which covenants relate to expenses, direct cost of goods sold,
revenue and quarterly revenue. In the event that the company is not in
compliance with these covenants, 50% or more of the holders of the notes (in
terms of the aggregate dollar value of the principal of the notes then issued
and outstanding under the note purchase agreement) would be able to call an
event of default. As of the date of the final tranche closing related to the
April 2003 financing, we were in violation of one of the representations and
warranties contained in the Note Purchase Agreement, which violation may be
deemed to constitute a default under the promissory notes issued in connection
with the April
9
2003 financing. Such violation relates to the litigation commenced by Vertical
Ventures. We are in the process of seeking to obtain a forbearance from a
majority in interest of the investors in the April 2003 Financing pursuant to
which they will agree not to enforce their remedies for such event of default.
We have reclassified this debt to short term debt until the forbearance is
obtained.
c) This amount includes (i) On August 21, 2002, the Company issued two Series B
Convertible Debentures in the amount of $121,739 each. The debentures bear
interest at the rate of 8% per annum and are due August 21, 2004. The Debenture
also includes a fixed conversion rate of $0.18 per share. Based on the terms of
the loan arrangement, the conversion terms of the debt provide for a beneficial
conversion feature. Due to the fact that the note holder had the option to
convert the note immediately upon execution of the agreement, the value of the
beneficial conversion feature of approximately $108,000 was recognized
immediately as interest expense. As of June 30, 2003, we show $31,561 balance to
be amortized.
(ii) On January 14, 2002, the Company entered into a $1.0 million bridge loan
arrangement with a private investor in connection with a secured note purchase
agreement executed by the Company on November 27, 2001. This transaction
increased the total amount of the secured convertible loan outstanding under
this arrangement to $1,625,000, including amounts previously made available to
the Company in connection with the November 27, 2001 secured note arrangement,
net of repayments of $250,000 to certain investors who elected not to reinvest.
The secured convertible notes accrue interest at a rate of 9.00% per annum and
mature on November 1, 2005 as a result of a financing we completed in April
2003. Terms of the notes issued on January 14, 2002 also included a fixed
conversion rate of $0.5264 per share. The Company also granted warrants
purchasing 921,161 shares of common stock with an exercise price of $0.5468 per
share to the Investor. Such warrants are exercisable through January 2005.
Certain investors (the "Investors") of the November 27, 2001 financing who
elected to remain in the new bridge loan arrangement received reset provisions
of the previous conversion rate and warrant exercise prices issued in November
2001 equivalent to the terms granted to the investors in January 2002.
The total of the intrinsic value of the warrants issued to the new Investor and
the incremental intrinsic value of the repriced warrants of certain existing
investors of approximately $480,000 has been recorded as original issue
discount, resulting in a reduction in the carrying value of this debt. The
original issue discount was amortized into interest expense over the original
period of the debt.
In addition, based on the terms of the bridge loan arrangement, the conversion
terms of the debt provide for a beneficial conversion feature. The total value
of the beneficial feature of the new debt and the incremental value of the reset
conversion feature of the existing debt of approximately $780,000 was recorded
at January 14, 2002 as non-cash interest expense.
In connection with the April 2003 financing described above, the Investor
agreed, to (a) amend the secured note issued to them, (b) terminate the security
agreement dated November 20, 2001 that was entered into in connection with the
purchase of the original secured notes and allow the new investors to enter into
a new security agreement with them on a pari passu basis in order for eMagin to
continue its operations as a developer of virtual imaging technology, and (c)
simultaneously participate in the new financing. The amendments to the notes
included (i) extending the maturity dates of the note from June 30, 2003 to
November 1, 2005, and (ii) revising and clarifying certain of the other terms
and conditions of the note, including provisions relating to default and
assignment of the note. The defaults of this note were modified to the same
conditions as the new financing.
(iii) On June 20, 2002, the Company entered into a $0.2 million Secured Note
Purchase Agreement with an Investor. The secured note accrues interest at 11%
per annum and was due to mature on November 1, 2005 as a result of a financing
we completed in April 2003. The Company also granted warrants, exercisable for a
period
10
of five years, to purchase 300,000 shares of common stock with an exercise price
of $0.4257 per share to the investor; provided, however, this warrant may not be
exercised by the investor so long as the investor is the beneficial owner,
directly or indirectly, of more than ten percent (10%) of the common stock of
eMagin for purposes of Section 16 of the Securities Exchange Act 1934. The fair
value of the warrants issued to this Investor, which approximated $84,000, has
been recorded as original issue discount, resulting in a reduction in the
carrying value of this debt. The original issue discount was amortized into
interest expense over the period of the debt. Pursuant to the April 2003
financing described above, the investor agreed, to (a) amend the secured note
issued to them, (b) terminate the security agreement dated June 20, 2002 that
was entered into in connection with the purchase of the original secured notes
and allow the new investors to enter into a new security agreement with them on
a pari passu basis in order for eMagin to continue its operations as a developer
of virtual imaging technology, and (c) simultaneously participate in the new
financing. The amendments to the note included (i) amending the note issued on
June 20, 2002 so as to provide that the note shall be convertible and will have
the same conversion price as the notes issued pursuant to the April 2003 secured
note purchase agreement, (ii) extending the maturity dates of the note from June
30, 2003 to November 1, 2005, and (iii) revising and clarifying certain of the
other terms and conditions of the note, including provisions relating to
interest payments, conversions, default and assignment of the note. Due to the
amendment to a convertible note, we recorded $106,372 beneficial conversion
discount and $93,628 original debt discount, to be amortized through November
2005. For the quarter ended June 30, 2003, $10,517 has been amortized to
interest expense.
(d) This amount includes (i) $42,581 due to Citicorp leasing as long-term debt
for lease payments for equipment; and (ii) $3,879 due to IBM as long-term debt
for leasehold improvements; and (iii) $3,095,000 due to Finova as long-term debt
in lease payments and mandatory buyout for equipment.
(e) In April 2003, we entered into an agreement to convert $3 million principal
note to Common Stock at a conversion price from the original agreement of $1.28
per share, for a total of 2,495,833 shares. This transaction includes the
original $3,000,000 net of approximately $114,000 original issue discount as
well as approximately $43,000 in financing costs not amortized as of the date of
stock issuance.
Also in April 2003, we also entered into an agreement to convert $1 million
principal convertible note plus related interest into our common stock at a
conversion price from the original agreement of approximately $0.53 per share,
for a total of 2,137,757 shares.
Note 7 - Debt Restructure
In connection with the completion of the transactions under the note purchase
agreement, we entered into a security agreement with the Investors dated as of
April 25, 2003, and a registration rights agreement dated as of April 25, 2003
providing the investors with certain registration rights under the Securities
Act of 1933, as amended, with respect to our common stock issued or issuable in
lieu of cash interest payments on the notes, upon conversion of the notes and/or
exercise of the warrants.
In addition to the foregoing, as a condition to and simultaneously with the
closing of the transaction pursuant to the secured note purchase agreement,
certain holders of our convertible notes agreed to convert approximately $4.9
million of notes and accrued interest into shares of our common stock, subject
to a "lock up" arrangement allowing only limited sales through private
transactions for their remaining shares through December 31, 2003. Specifically,
The Travelers Insurance Company agreed to convert their $1 million convertible
note plus related interest into our common stock at a conversion price from the
original agreement of approximately $0.53 per share, and SK Corporation has
agreed to convert its $3 million convertible note and accrued interest into our
common stock at an approximate conversion price of approximately $1.28 per
share. There was no gain on this
11
transaction. As further conditions to the closing of the transaction pursuant to
the secured note purchase agreement, we have also entered into settlement or
restructuring agreements with certain of our other creditors to whom we owed
approximately $5.2 million of current payables, pursuant to which the creditors
have agreed to accept shares of our common stock in full or partial satisfaction
of the amount owed to them, or which allow us to either make discounted payments
to them or to make payments under more favorable payment terms than previously
were in place. The Company converted the $1,000,000 loan plus interest to
Travelers in common shares totaling 2,137,757 at a conversion price from the
original agreement of approximately $0.53 per share, based on the market value
of our common stock on the date the agreement was entered into. The Company
recorded 1,013,017 as paid in capital for this transaction. The company also
converted the $3,000,000 loan plus interest to SK Corporation in common shares
totaling 2,495,833 at a conversion price from the original agreement of
approximately $1.28 per share, based on the market value of our common stock on
the date the agreement was entered into. The Company recorded 2,883,394 as paid
in capital for this transaction.
In June 2003, the Company negotiated settlement of amounts due and amounts for
future services totaling $418,207 to related parties for services rendered via
issuance of 125,002 shares of common stock. The Company also received
approximately $52,000 for the exercise of 129,675 option shares. The Company
also issued 1,997,840 shares in partial payment of debt in conjunction with the
$1,885,423 reduction of expense recorded in the financial statement ended June
30, 2003.
Note 8 - STOCKHOLDERS' EQUITY
The authorized common stock of the Company consisted of 100,000,000 shares with
a par value of $0.001 per share. On July 2, 2003 the shareholders approved an
increase to 200,000,000 shares.
In connection with the April 2003 financing, we issued 387,496 warrants for
services rendered for financing expense.
In March 2003, the Company negotiated settlement of amounts due and amounts for
future services to related parties for services rendered via issuance of 339,433
shares of common stock. As such, the Company recorded the fair value of the
services received of approximately $273,796 in selling, general and
administrative expenses, prepaid expenses and reduction of accounts payable in
the accompanying audited consolidated statement of operations for the six months
ended June 30, 2003. Also in March 2003, we received $50,000 for the exercise of
91,415 warrants in exchange for shares of common stock used for general
operating expenses.
Note 9 - STOCK COMPENSATION
As of June 30, 2003, we have outstanding options to purchase 12,769,010 shares.
The Company has elected to follow Accounting Principles Board Opinion No. 25
("APB No. 25"), "Accounting for Stock Issued to Employees," and related
interpretations in accounting for its employee stock options. Under APB No. 25,
when the exercise price of employee stock options equals the market price of the
underlying stock on the date of grant no compensation expense is recorded. The
Company discloses information relating to the fair value of stock-based
compensation awards in accordance with Statement of Financial Accounting
Standards No.123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation."
The following table illustrates the effect on net loss and loss per share as if
the Company had applied the fair value recognition provision of SFAS No. 123.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions used for
grants in the second quarter of 2003 and 2002, respectively: (1) average
expected volatility of 162% and 150%, (2) average risk-free interest rates of
3.33%
12
and 6.00%, and (3) expected lives of five and ten years for the period ended
June 30, 2003 and expected lives of five and eight years for the period ended
June 30, 2002.
The pro forma amounts that are disclosed in accordance with SFAS No. 123 reflect
the portion of the estimated fair value of awards that were earned for the three
months ended June 30, 2003 and 2002.
---------------------------------------------- --------------------- -------------------- --------------------- ------------------
For the three and six months ended June 30, Three Months Six Months Three Months Six Months
(In thousands, except per share 2003 2003 2002 2002
amounts)
---------------------------------------------- --------------------- -------------------- --------------------- ------------------
Net income (loss) applicable to common $ 515,899 $ (1,889,592) $ (4,001,043) $ (10,490,558)
stockholders', as reported
---------------------------------------------- --------------------- -------------------- --------------------- ------------------
Adjust: Stock-based employee compensation
expense determined under fair value method (44,264) (1,485,709) (3,116,892) (6,233,784)
---------------------------------------------- --------------------- -------------------- --------------------- ------------------
Pro forma net loss. $ 501,518 (3,375,301) $ (7,117,935) $ (16,724,342)
---------------------------------------------- --------------------- -------------------- --------------------- ------------------
Net loss per share applicable to common
stockholders':
---------------------------------------------- --------------------- -------------------- --------------------- ------------------
Basic and diluted, as reported $ 0.02 $ (0.06) $ (0.13) $ (0.37)
---------------------------------------------- --------------------- -------------------- --------------------- ------------------
Basic and diluted, pro forma $ 0.01 $ (0.10) $ (0.23) $ (0.59)
---------------------------------------------- --------------------- -------------------- --------------------- ------------------
Note 10 - EFFECT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB, issued SFAS, No. 143, "Accounting for Obligations
Associated with the Retirement of Long-Lived Assets." SFAS No. 143 addresses
financial accounting and reporting for the retirement obligation of an asset.
This statement provides that companies should recognize the asset retirement
cost at its fair value as part of the cost of the asset and classify the accrued
amount as a liability. The asset retirement liability is then accreted to the
ultimate payout as interest expense. The initial measurement of the liability
would be subsequently updated for revised estimates of the discounted cash
outflows. The Statement will be effective for fiscal years beginning after June
15, 2002. On January 31, 2003, eMagin adopted SFAS No. 143. The adoption of this
standard did not have a significant impact on eMagin's consolidated financial
position, results of operations or cash flows.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
This statement eliminates the requirement under SFAS 4 to aggregate and classify
all gains and losses from extinguishment of debt as an extraordinary item, net
of related income tax effect. This statement also amends SFAS 13 to require that
certain lease modifications with economic effects similar to sale-leaseback
transactions be accounted for in the same manner as sale-leaseback transactions.
In addition, SFAS No. 145 requires reclassification of gains and losses in all
prior periods presented in comparative financial statements related to debt
extinguishment that do not meet the criteria for extraordinary item in
Accounting Principles Board Opinion ("APB") 30. The statement is effective for
fiscal years beginning after May 15, 2002 with early adoption encouraged. The
Company adopted SFAS No. 145 on January 1, 2003; the adoption had no effect on
the financial results of the Company.
On July 30, 2002, The FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." The standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity.
13
eMagin adopted SFAS No. 146 as of January 1, 2003. Upon adoption of SFAS 146,
there was no effect on its financial position, cash flows or results of
operations.
In November 2002, the EITF reached a consensus on Issue 00-21 ("EITF 00-21"),
"Multiple-Deliverable Revenue Arrangements." EITF 00-21 addresses how to account
for arrangements that may involve the delivery or performance of multiple
products, services, and/or rights to use assets. The consensus mandates how to
identify whether goods or services or both that are to be delivered separately
in a bundled sales arrangement should be accounted for separately because they
are separate units of accounting. The guidance can affect the timing of revenue
recognition for such arrangements, even though it does not change rules
governing the timing or pattern of revenue recognition of individual items
accounted for separately. The final consensus will be applicable to agreements
entered into in fiscal years beginning after June 15, 2003 with early adoption
permitted. Additionally, companies will be permitted to apply the consensus
guidance to all existing arrangements as the cumulative effect of a change in
accounting principle in accordance with APB Opinion No. 20, "Accounting
Changes." The Company is assessing, but at this point does not believe the
adoption of EIFT 00-21 will have a material impact on its financial position,
cash flows or results of operations.
On April 30, 2003, the FASB issued Statement No. 149 ("SFAS No. 149"),
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities."
SFAS No. 149 amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under Statement No. 133. In particular, this statement
clarifies under what circumstances a contract with an initial net investment
meets the characteristic of a derivative as discussed in Statement No. 133, and
it clarifies when a derivative contains a financing component that warrants
special reporting in the statement of cash flows. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003 and is to be applied prospectively.
The Company has not yet completed its analysis of SFAS No. 149 and, therefore,
the effect on the Company's combined financial statements of the implementation
of SFAS No. 149, when effective, has not yet been determined. On May 15, 2003,
the FASB issued Statement No. 150 ("FAS No. 150"), Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity. FAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). FAS No. 150 affects the
issuer's accounting for three types of freestanding financial instruments.
o mandatorily redeemable shares, which the issuing company is obligated
to buy back in exchange for cash or other assets
o instruments that do or may require the issuer to buy back some of its
shares in exchange for cash or other assets; includes put options and
forward purchase contracts
o obligations that can be settled with shares, the monetary value of
which is fixed, tied solely or predominantly to a variable such as a
market index, or varies inversely with the value of the issuers'
shares.
FAS No. 150 does not apply to features embedded in a financial instrument that
is not a derivative in its entirety. Most of the guidance in FAS No. 150 is
effective for all financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The Company has not yet completed its analysis of
SFAS No. 150 and, therefore, the effect on the Company's combined financial
statements of the implementation of SFAS 150, when effective, has not yet been
determined.
14
Note 11 - RECLASSIFICATIONS
Certain amounts in the June 30, 2002 financial statements have been reclassified
to conform to the June 2003 classification. As of January 1, 2003 the Company
has completed its development stage, as defined by Statement of Financial
Accounting Standards ("SFAS") No. 7, Accounting and Reporting by Development
Stage Enterprises". The financial statements results as of December 31, 2002 and
the period ended June 30, 2002 have been restated to reflect the current status.
NOTE 12 - SUBSEQUENT EVENTS
None
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operation
Statement of Forward-Looking Information
This report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. These statements relate to future events or our future financial
performance. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expect," "plan," "anticipate,"
"believe," "estimate," "predict," "potential" or "continue," the negative of
such terms, or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially from those in the
forward-looking statements as a result of various important factors. Although we
believe that the expectations reflected in the forward-looking statements are
reasonable, such should not be regarded as a representation by the Company, or
any other person, that such forward-looking statements will be achieved. The
business and operations of the Company are subject to substantial risks, which
increase the uncertainty inherent in the forward-looking statements contained in
this release.
We undertake no duty to update any of the forward-looking statements, whether as
a result of new information, future events or otherwise. Readers are cautioned
not to place undue reliance on the forward-looking statements contained in this
report.
Overview
We design and manufacture miniature display modules, which we refer to as
OLED-on-silicon-microdisplays, primarily for incorporation into the products of
other manufacturers. Microdisplays are typically smaller than a postage stamp,
but when viewed through a magnifier they can contain all of the information
appearing on a high-resolution personal computer screen. Our microdisplays use
organic light emitting diodes, or OLEDs, which emit light themselves when a
current is passed through them. Our technology permits OLEDs to be coated onto
silicon chips to produce high resolution OLED-on-silicon microdisplays.
We believe that our OLED-on-silicon microdisplays offer a number of advantages
in near to the eye applications over other current microdisplay technologies,
including lower power requirements, less weight, fast video speed without
flicker, and wider viewing angles. In addition, many computer and video
electronic system functions can be built directly into the OLED-on-silicon
microdisplay, resulting in compact systems with lower expected overall system
costs relative to alternate microdisplay technologies.
Since our inception in 1996, we derived substantially all of our revenues from
fees paid to us under research and development contracts, primarily with the
U.S. federal government. We have devoted significant resources to the
development and commercial launch of our products. We commenced limited initial
sales of our SVGA+ microdisplay in May 2001 and commenced shipping samples of
our SVGA-3D microdisplay in February 2002. As of June 30, 2003, we had
recognized approximately $3.0 million from sales of our products, and have a
backlog of more than $27 million in products ordered for delivery through 2004.
These products are being applied or considered for near-eye and headset
applications in products such as entertainment and gaming headsets, handheld
Internet and telecommunication appliances, viewfinders, and wearable computers
to be manufactured by original equipment manufacturer (OEM) customers. We have
also shipped a limited number of prototypes of our eGlass II Head-wearable
Display systems. In addition to marketing OLED-on-silicon microdisplays as
components, we also offer microdisplays as an integrated package, which we call
Microviewer, that includes a compact lens for viewing the microdisplay and
electronic interfaces to convert the signal from our customer's product into a
viewable image on the microdisplay. Through our wholly owned subsidiary, Virtual
Vision, Inc., we are also developing head-wearable displays that incorporate our
Microviewer.
16
We license our core OLED technology from Eastman Kodak and we have developed our
own technology to create high performance OLED-on-silicon microdisplays and
related optical systems. We believe our technology licensing agreement with
Eastman Kodak, coupled with our own intellectual property portfolio, gives us a
leadership position in OLED and OLED-on-silicon microdisplay technology. We are
the only company to demonstrate publicly and market full-color OLED-on-silicon
microdisplays.
Company History
Our history has been as a developmental stage company. As of January 1, 2003, we
are no longer a development stage Company. We have transitioned to manufacturing
our product and intend to significantly increase our marketing, sales, and
research and development efforts, and expand our operating infrastructure. Most
of our operating expenses are fixed in the near term. If we are unable to
generate significant revenues, our net losses in any given period could be
greater than expected.
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission ("SEC") defines "critical accounting
policies" as those that require application of management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain and may change in
subsequent periods.
Not all of the accounting policies require management to make difficult,
subjective or complex judgments or estimates. However, the following policies
could be deemed to be critical within the SEC definition.
Revenue Recognition
Revenue on product sales is recognized when persuasive evidence of an
arrangement exists, such as when a purchase order or contract is received from
the customer, the price is fixed, title to the goods has changed and there is a
reasonable assurance of collection of the sales proceeds. We obtain written
purchase authorizations from our customers for a specified amount of product at
a specified price and consider delivery to have occurred at the time of
shipment. Revenue is recognized at shipment and we record a reserve for
estimated sales returns, which is reflected as a reduction of revenue at the
time of revenue recognition.
Revenues from research and development activities relating to firm fixed-price
contracts are generally recognized on the percentage-of-completion method of
accounting as costs are incurred (cost-to-cost basis). Revenues from research
and development activities relating to cost-plus-fee contracts include costs
incurred plus a portion of estimated fees or profits based on the relationship
of costs incurred to total estimated costs. Contract costs include all direct
material and labor costs and an allocation of allowable indirect costs as
defined by each contract, as periodically adjusted to reflect revised agreed
upon rates. These rates are subject to audit by the other party. Amounts can be
billed on a bi-monthly basis. Billing is based on subjective cost investment
factors.
Results of Operations
THREE AND SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 2002
Revenues
Revenues for the three and six months ended June 30, 2003 were $0.3 million and
$0.8 million, respectively, as compared to $0.3 million and $0.4 million for the
three and six months ended June 30, 2002. Current year revenues consisted
totally of product sales. The low revenue total was due primarily to the lack of
operating
17
cashflow, which did not allow us to purchase the necessary raw materials in a
timely manner in the first quarter of 2003. We ended the first quarter with a
purchase agreement backlog of over $27 million primarily for delivery in late
2003 through 2005. There were no Government R&D contract revenues for the three
and six months ended June 30, 2003, or the three and six months ended June 30,
2002. Government R&D contract revenues will remain significantly lower in 2003
as the company focuses on product revenues rather than performing Government R&D
contracts, although product revenues include sales to government contractors
which are funded by Government development or procurement contracts.
Costs and Expenses
Cost of Goods Sold. Cost of goods sold includes direct and indirect costs
associated with production, inventory loss and outside commissions. Cost of
goods sold for the three and six months ended June 30, 2003 was $0.1 million and
$1.3 million, respectively. We were not in full production in 2002 and had no
cost of goods sold to compare against. Gross profit (loss) was $0.2 million and
($0.5) million, respectively, for the three and six months ended June 30, 2003
due primarily to line stoppages resulting from lack of production materials as
well as machinery downtime.
Research and Development. Research and development expenses for prior periods
include salaries, development materials, equipment leases and depreciation
expenses, electronics, rent, utilities and costs associated with operating the
Company's manufacturing facility. In 2003, research and development expenses
included salaries, development materials and other costs specifically allocated
to the development of new products. Research and development expenses were $0.0
and $22 thousand, respectively, for the three and six months ended June 30, 2003
as compared to $3.3 million and $5.5 million respectively for the three and six
months ended June 30, 2002. Of these amounts, the Company received $0 million in
2003, as compared to $0.2 million and $0.3 million for the three and six months
ended June 30, 2002, respectively, in cost sharing from the U.S. Government. The
$3.3 million and $5.5 million decrease in gross expenses for the three and six
months ended June 30, 2003, as compared to the three and six months ended June
30, 2002, reflects reduction in staffing and reduction in expenditures related
to the company's difficult cash position.
Selling, General and Administrative. Selling, general and administrative
expenses consist principally of salaries and fees for professional services,
legal fees incurred in connection with patent filings and related matters,
amortization, as well as other marketing and administrative expenses. Selling,
general and administrative expenses, for the three and six months ended June 30,
2003 were $0.6 million and $1.8 million, respectively, as compared to $0.4
million and $3.4 million for the three and six months ended June 30, 2002. The
$0.2 million increase in the three months ended June 30, 2003 as compared to the
three months ended June 30, 2002, was a result of the rehiring of personnel
laid-off in December of 2001. The $1.6 million decrease in the six months ended
June 30, 2003 as compared to the six months ended June 30, 2002, was primarily
due to the efforts of finding lower cost suppliers and equity agreements for
professional fees, legal fees and insurance. We expect marketing, general and
administrative expenses to increase in future periods as we add to our sales
staff and make additional investments in marketing activities. Included in
selling, general and administrative expenses are non-cash expenses related to
stock-based compensation amortization. Non-cash stock-based compensation expense
for the three and six months ended June 30, 2003 was $0.1 million and $0.2
million, respectively, as compared to ($0.4) million and $0.9 million,
respectively, for the three and six months ended June 30, 2002. The non-cash
stock-based compensation expense for the three and six months ending June 30,
2003 increased by $0.5 million and decreased by $0.7 million, respectively.
Non-cash stock-based compensation costs are the result of amortization of the
intrinsic value ascribed for the issuance of stock options at below fair market
values. The amortization is done over the vesting period of such options.
Gain on payable forgiveness. The company has completed negotiations with various
creditors. We have been mostly successful in obtaining lower negotiated payment
requirements from our larger creditors. The company
18
has made the negotiated payments on its debt, using the funds from the April
2003 financing. A credit of $1,885,423 was recorded as a reduction of expense in
the financial statements ended June 30, 2003 from these negotiations.
Amortization of Purchased Intangibles. There was no amortization and write down
of purchased intangibles expense for the three months ended June 30, 2003 as
compared to $0.1 million for the three months ended June 30, 2002. Amortization
of purchased intangibles expense for the six months ended June 30, 2003 was $0.3
million, as compared to $0.7 million for the six months ended June 30, 2002.
This is the result of the purchased intangibles being fully amortized by March
31, 2003.
Other Income (Expense). Other income (expenses) for the three and six months
ended June 30, 2003 was $0.2 million and $0.2 million, respectively, as compared
to $0.1 million and $20 thousand, respectively, for the three and six months
ended June 30, 2002. The increase of $0.1 million and $0.2 million,
respectively, in expense for this non-cash charge was due primarily to the sale
of old, unused equipment. . The Company recorded the receipt of $0.2 million
from the sale of old unused equipment.
Liquidity and Capital Resources
Current Financial Position
In April 2003, the Company closed on a $6 million financing (see Changes in
Securities and Use of Proceeds, Part II Item - 2). We estimate that this $6
million financing is the minimum amount of funds that we require to support us
until we begin realizing profits from production in sufficient amount to become
profitable through production alone. As of August 12, 2003 we have received
$4,725,000. No assurance can be given that our estimates will prove to be
correct, or that the Company will generate sufficient revenues to provide
positive cash flows from operations. These and other factors raise substantial
doubt about the Company's ability to continue as a going concern.
During April 2003, eMagin reached agreements with certain creditors and these
agreements were primarily conditioned upon actions to be taken and installment
payments to be made by eMagin through June 30, 2003. After making these
payments, eMagin recorded approximately $1.9 million in reduction of expenses in
the financial statements ended June 30, 2003
We currently anticipate that we will continue to experience significant growth
in our operating expenses for the foreseeable future and that our operating
expenses will be the principal use of our cash. In particular, we expect that
salaries for employees engaged in production operations, purchase of inventory
and expenses of increased sales and marketing efforts would be the principle
uses of cash. We expect that our cash requirements over the next 12 months will
be met by a combination of additional equity or debt financing, and revenues
generated by sales. We expect to continue to devote substantial resources to
manufacturing, marketing and selling our products.
We have received purchase agreements for our products to be delivered now
through 2004 and into early 2005. Management believes that the prospects for
growth of product revenue remain high.
Our customer schedules have been necessarily pushed out due to our financing
issues, but these shipments are being renegotiated now that the funding is
committed. We do not currently anticipate any significant loss of business as a
result of our prior financing related product ramp delays, other than the shift
in out of delivery schedules. We must ramp our supplies and staffing quickly and
efficiently to meet the anticipated shipping schedules. A significant level of
effort will be required.
19
Initial orders for supplies were placed during the 2-3 weeks after the
financing. A 3-month supply delivery schedule and one month in house production
cycle is anticipated before shipments can begin ramping. Some earmarked supplies
are already in hand for customers that provided prepayments for supplies in late
2002 and for small quantity deliveries. Initial supply orders will be modest
until we insure our supplier quality is high after a long stagnant period of
time. Continuous monthly orders of wafers, Circuit Boards, and other supplies
are planned to insure a continuing product flow to customers, after the supplier
re-qualification cycle.
We are in the early phases of production, although our progress has been impeded
by our prior cash position. Anticipated increased shipments in the first quarter
were delayed, primarily due to our inability to purchase raw materials. Based on
the planned schedule, we should have resolved our supplier issues and be able to
produce quantities in the late third quarter of 2003.
Our cash requirements depend on numerous factors, including completion of our
product development activities, ability to commercialize our products, timely
market acceptance of our products and our customer's product, and other factors.
We expect to carefully devote capital resources to continue our development
programs directed at commercializing our products in our target markets, hire
and train additional staff, expand our research and development activities,
develop and expand our manufacturing capacity and begin production activities.
Any delays could change the cash requirements of the company. While we believe
that we are in position to handle a significant production increase, there can
be no assurance that we will not experience some issues relating to yield and
throughput risk that could result in production delays.
Factors Which May Affect Future Results
In evaluating our business, prospective investors and shareholders should
carefully consider the risks factors, any of which could have a material adverse
impact on our business, operating results and financial condition and result in
a complete loss of your investment.
Risks Related To Our Financial Results
If we cannot operate as a going concern, our stock price will decline and you
may lose your entire investment. Our auditors included an explanatory paragraph
in their report on our financial statements for the year ended December 31, 2002
which states that, due to recurring losses from operations since inception of
the Company, there is substantial doubt about our ability to continue as a going
concern. Our financial statements for the three months ended June 30, 2003 do
not include any adjustments that might result from our inability to continue as
a going concern. These adjustments could include additional liabilities and the
impairment of certain assets. If we had adjusted our financial statements for
these uncertainties, our operating results and financial condition would have
been materially and adversely affected.
If we do not obtain additional cash to operate our business, we may not be able
to execute our business plan and may not achieve profitability. In the event
that cash flow from operations is less than anticipated and we are unable to
secure additional funding to cover these added losses, in order to preserve
cash, we would be required to further reduce expenditures and effect further
reductions in our corporate infrastructure, either of which could have a
material adverse effect on our ability to continue our current level of
operations. To the extent that operating expenses increase or we need additional
funds to make acquisitions, develop new technologies or acquire strategic
assets, the need for additional funding may be accelerated and there can be no
assurances that any such additional funding can be obtained on terms acceptable
to us, if at all. If we are not able to generate sufficient capital, either from
operations or through additional financing, to fund our current operations, we
may not be able to continue as a going concern. If we are unable to continue as
a going concern, we may be forced to significantly reduce or cease our current
operations. This could significantly reduce the value of our securities, which
could result in our de-listing from the American Stock Exchange and cause
20
investment losses for our shareholders.
The financing commitments provided in April 2003 substantially improves our
probability of success, but there is no guarantee that any additional expenses
or delays may not adversely effect our cash requirements beyond that provided by
the recent financing. Any significant delay in revenue or increased expense
could result in the default of the secured note agreement, which could result in
a significant or total loss of any unsecured investments in eMagin.
We may not be able to satisfy The American Stock Exchange's (the "Exchange")
continued listing requirements. To maintain the listing of our common stock on
the Exchange, we are required to meet certain continued listing requirements,
including, but not limited to, the requirement that our common stock not sell
for a substantial period of time at a low price per share, the requirement that
we maintain a minimum of $2 million in shareholder equity. In its review of
whether a share price is too low or whether a reverse split is appropriate, the
Exchange will consider all pertinent factors, including market conditions in
general, the number of shares outstanding, plans which may have been formulated
by management, applicable regulations of the state of incorporation or of any
governmental agency having jurisdiction over eMagin, and the relationship to
other Exchange policies regarding continued listing. If the Exchange were to
determine that our share price is too low and that we should reverse split our
shares but we were unable to comply for any reason, our common stock may be
delisted from the Exchange. Delisting of our common stock could materially
adversely affect the market price, the market liquidity of our common stock and
our ability to raise necessary capital. Moreover, it would likely be more
difficult to trade in or to obtain accurate quotations as to the market price of
our common stock. If the Exchange were to determine that we were filing to
satisfy the minimum shareholder equity standards, then we may be required to
establish a plan to increase the shareholder equity to over $2 million. The
financing that we completed in April 2003 was debt based, and did not directly
increase shareholder equity. However, shareholder equity did improve through the
related conversion of other debt to stock and through negotiated write-downs of
debt. Nevertheless, there will still be a substantial gap remaining that may
increase in subsequent quarters before it beings to improve. If this additional
equity cannot be accomplished through operations, then it may be done through
the sale of equity, which could result in additional dilution to existing
shareholders. The failure to satisfy any Exchange concerns regarding the minimum
equity standards could result in a delisting of our common stock from the
Exchange. We are currently not in communication with any regulatory agencies
concerning noncompliance with or deficiencies in financial reporting or other
practices, except that we were recently required to submit a plan to the
Exchange setting forth the action that we have taken, or will take, that will
bring us into compliance within 18 months with the Exchange's continued listing
standards relating to achieving and maintaining profitability and maintaining at
least $2 million of shareholder equity. Other as yet unidentified issues may
arise that could adversely affect the financial or the potential listing status
of the company.
We have a history of losses since our inception and expect to incur losses for
the foreseeable future. Accumulated losses excluding non-cash transactions as of
June 30, 2003, were $32.1 million and acquisition related non-cash transactions
were $101.9 million, which resulted in an accumulated net loss of $134 million,
the majority of which was related to the March 2000 merger and its subsequent
write-down of its goodwill. The non-cash losses were dominated by the
amortization and write-down of goodwill and purchased intangibles and write-down
of acquired in process research and development related to the March 2000
acquisition, and also included some non-cash stock-based compensation. We have
not yet achieved profitability and we can give no assurances that we will
achieve profitability within the foreseeable future as we fund operating and
capital expenditures in areas such as establishment and expansion of markets,
sales and marketing, operating equipment and research and development. We cannot
assure investors that we will ever achieve or sustain profitability or that our
operating losses will not increase in the future.
We were previously primarily dependent on U.S. government contracts. The
majority of our revenues to date have been derived from research and development
contracts with the U.S. federal government. We cannot continue
21
to rely on such contracts for revenue. We plan to submit proposals for
additional development contract funding; however, funding is subject to
legislative authorization and even if funds are appropriated such funds may be
withdrawn based on changes in government priorities. No assurances can be given
that we will be successful in obtaining new government contracts. Our inability
to obtain revenues from government contracts could have a material adverse
effect on our results of long-term operations, unless substantial product or
non-government contract revenue offsets any lack of government contract revenue,
unless substantial product or non-government contract revenue offsets any lack
of government contract revenue
Risks Related To Our Intellectual Property
We rely on our license agreement with Eastman Kodak for the development of our
products, and the termination of this license, Eastman Kodak's licensing of its
OLED technology to others for microdisplay applications, or the sublicensing by
Eastman Kodak of our OLED technology to third parties, could have a material
adverse impact on our business. Our principal products under development utilize
OLED technology that we license from Eastman Kodak. We rely upon Eastman Kodak
to protect and enforce key patents held by Eastman Kodak, relating to OLED
display technology. Eastman Kodak's patents expire at various times in the
future. Our license with Eastman Kodak could terminate if we fail to perform any
material term or covenant under the license agreement. Since our license from
Eastman Kodak is non-exclusive, Eastman Kodak could also elect to become a
competitor itself or to license OLED technology for microdisplay applications to
others who have the potential to compete with us. The occurrence of any of these
events could have a material adverse impact on our business.
We may not be successful in protecting our intellectual property and proprietary
rights. We rely on a combination of patents, trade secret protection, licensing
agreements and other arrangements to establish and protect our proprietary
technologies. If we fail to successfully enforce our intellectual property
rights, our competitive position could suffer, which could harm our operating
results. Patents may not be issued for our current patent applications, third
parties may challenge, invalidate or circumvent any patent issued to us,
unauthorized parties could obtain and use information that we regard as
proprietary despite our efforts to protect our proprietary rights, rights
granted under patents issued to us may not afford us any competitive advantage,
others may independently develop similar technology or design around our
patents, our technology may be available to licensees of Eastman Kodak, and
protection of our intellectual property rights may be limited in certain foreign
countries. We may be required to expend significant resources to monitor and
police our intellectual property rights. Any future infringement or other claims
or prosecutions related to our intellectual property could have a material
adverse effect on our business. Any such claims, with or without merit, could be
time consuming to defend, result in costly litigation, divert management's
attention and resources, or require us to enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to us, if at all. Protection of intellectual
property has historically been a large yearly expense for eMagin. We have not
been in a financial position to properly protect all of our intellectual
property, and may not be in a position to properly protect our position or stay
ahead of competition in new research and the protecting of the resulting
intellectual property.
Risks Related To the Microdisplay Industry
The commercial success of the microdisplay industry depends on the widespread
market acceptance of microdisplay systems products. The market for microdisplays
is emerging. Our success will depend on consumer acceptance of microdisplays as
well as the success of the commercialization of the microdisplay market. As an
OEM supplier, our customer's products must also be well accepted. At present, it
is difficult to assess or predict with any assurance the potential size, timing
and viability of market opportunities for our technology in this market. The
viewfinder microdisplay market sector is well established with entrenched
competitors who we must displace.
22
The microdisplay systems business is intensely competitive. We do business in
intensely competitive markets that are characterized by rapid technological
change, changes in market requirements and competition from both other suppliers
and our potential OEM customers. Such markets are typically characterized by
price erosion. This intense competition could result in pricing pressures, lower
sales, reduced margins, and lower market share. Our ability to compete
successfully will depend on a number of factors, both within and outside our
control. We expect these factors to include the following: our success in
designing, manufacturing and delivering expected new products, including those
implementing new technologies on a timely basis; our ability to address the
needs of our customers and the quality of our customer services; the quality,
performance, reliability, features, ease of use and pricing of our products;
successful expansion of our manufacturing capabilities; our efficiency of
production, and ability to manufacture and ship products on time; the rate at
which original equipment manufacturing customers incorporate our product
solutions into their own products; the market acceptance of our customers'
products; and product or technology introductions by our competitors. Our
competitive position could be damaged if one or more potential OEM customers
decide to manufacture their own microdisplays, using OLED or alternate
technologies. In addition, our customers may be reluctant to rely on a
relatively small company such as eMagin for a critical component. We cannot
assure you that we will be able to compete successfully against current and
future competition, and the failure to do so would have a materially adverse
effect upon our business, operating results and financial condition.
The display industry is cyclical. The display industry is characterized by
fabrication facilities that require large capital expenditures and long lead
times go construct leading to frequent mismatches between supply and demand. The
OLED microdisplay sector may experience overcapacity if and when all of the
facilities presently in the planning stage come on line leading to a difficult
market in which to sell our products.
Competing products may get to market sooner than ours. Our competitors are
investing substantial resources in the development and manufacture of
microdisplay systems using alternative technologies such as reflective liquid
crystal displays (LCDs), LCD-on-Silicon ("LCOS") microdisplays, active matrix
electroluminescence and scanning image systems, and transmissive active matrix
LCDs.
Our competitors have many advantages over us. As the microdisplay market
develops, we expect to experience intense competition from numerous domestic and
foreign companies including well-established corporations possessing worldwide
manufacturing and production facilities, greater name recognition, larger retail
bases and significantly greater financial, technical, and marketing resources
than us, as well as from emerging companies attempting to obtain a share of the
various markets in which our microdisplay products have the potential to
compete.
Our products are subject to lengthy OEM development periods. We plan to sell
most of our microdisplays to OEMs who will incorporate them into products they
sell. OEMs determine during their product development phase whether they will
incorporate our products. The time elapsed between initial sampling of our
products by OEMs, the custom design of our products to meet specific OEM product
requirements, and the ultimate incorporation of our products into OEM consumer
products is significant. If our products fail to meet our OEM customers' cost,
performance or technical requirements or if unexpected technical challenges
arise in the integration of our products into OEM consumer products, our
operating results could be significantly and adversely affected. Long delays in
achieving customer qualification and incorporation of our products could
adversely affect our business.
Our products will likely experience rapidly declining unit prices. In the
markets in which we expect to compete, prices of established products tend to
decline significantly over time. In order to maintain our profit margins over
the long term, we believe that we will need to continuously develop product
enhancements and new technologies that will either slow price declines of our
products or reduce the cost of producing and delivering our products. While we
anticipate many opportunities to reduce production costs over time, there
23
can be no assurance that these cost reduction plans will be successful. We may
also attempt to offset the anticipated decrease in our average selling price by
introducing new products, increasing our sales volumes or adjusting our product
mix. If we fail to do so, our results of operations would be materially and
adversely affected
Risks Related To Manufacturing
We expect to depend on semiconductor contract manufacturers to supply our
silicon integrated circuits and other suppliers of key components, materials and
services. We do not manufacture our silicon integrated circuits on which we
incorporate the OLED. Instead, we expect to provide the design layouts to
semiconductor contract manufacturers who will manufacture the integrated
circuits on silicon wafers. We also expect to depend on suppliers of a variety
of other components and services, including circuit boards, graphic integrated
circuits, passive components, materials and chemicals, and equipment support.
Our inability to obtain sufficient quantities of high quality silicon integrated
circuits or other necessary components, materials or services on a timely basis
could result in manufacturing delays, increased costs and ultimately in reduced
or delayed sales or lost orders which could materially and adversely affect our
operating results.
The manufacture of OLED-on-silicon is new and OLED microdisplays have not been
produced in significant quantities. We expect to begin commercial production
during 2003 and 2004 to meet anticipated demand for our products. If we are
unable to produce our products in sufficient quantity, we will be unable to
attract customers. In addition, we cannot assure you that once we commence
volume production we will attain yields at high throughput that will result in
profitable gross margins or that we will not experience manufacturing problems
which could result in delays in delivery of orders or product introductions.
We are dependent on a single manufacturing line. We initially expect to
manufacture our products on a single manufacturing line. If we experience any
significant disruption in the operation of our manufacturing facility or a
serious failure of a critical piece of equipment, we may be unable to supply
microdisplays to our customers. For this reason, some OEMs may also be reluctant
to commit a broad line of products to our microdisplays without a second
production facility in place. Interruptions in our manufacturing could be caused
by manufacturing equipment problems, the introduction of new equipment into the
manufacturing process or delays in the delivery of new manufacturing equipment.
Lead-time for delivery of manufacturing equipment can be extensive. No assurance
can be given that we will not lose potential sales or be unable to meet
production orders due to production interruptions in our manufacturing line. In
order to meet the requirements of certain OEMs for multiple manufacturing sites,
we will have to expend capital to secure additional sites and may not be able to
manage multiple sites successfully.
Risks Related To Our Business
Our success depends in a large part on the continuing service of key personnel.
Changes in management could have an adverse effect on our business. We are
dependent upon the active participation of several key management personnel
including Gary W. Jones, our Chief Executive Officer. This is especially an
issue while the company staffing is small. We will also need to recruit
additional management in order to expand according to our business plan. The
failure to attract and retain additional management or personnel could have a
material adverse effect on our operating results and financial performance.
Our success depends on attracting and retaining highly skilled and qualified
technical and consulting personnel. We must hire highly skilled technical
personnel as employees and as independent contractors in order to develop our
products. The competition for skilled technical employees is intense and we may
not be able to retain or recruit such personnel. We must compete with companies
that possess greater financial and other resources than we do, and that may be
more attractive to potential employees and contractors. To be competitive, we
may have to increase the compensation, bonuses, stock options and other fringe
benefits
24
offered to employees in order to attract and retain such personnel. The costs of
retaining or attracting new personnel may have a materially adverse affect on
our business and our operating results. In addition, difficulties in hiring and
retaining technical personnel could delay the implementation of our business
plan.
Our business depends on new products and technologies. The market for our
products is characterized by rapid changes in product, design and manufacturing
process technologies. Our success depends to a large extent on our ability to
develop and manufacture new products and technologies to match the varying
requirements of different customers in order to establish a competitive position
and become profitable. Furthermore, we must adopt our products and processes to
technological changes and emerging industry standards and practices on a
cost-effective and timely basis. Our failure to accomplish any of the above
could harm our business and operating results.
We generally do not have long-term contracts with our customers. Our business is
operated on the basis of short-term purchase orders and we cannot guarantee that
we will be able to obtain long-term contracts for some time. Our current
purchase agreements can be cancelled or revised without penalty or a minimal
penalty, depending on the circumstances. In the absence of a backlog of orders
that can only be canceled with penalty, we plan production on the basis of
internally generated forecasts of demand, which makes it difficult to accurately
forecast revenues. If we fail to accurately forecast operating results, out
business may suffer and the value of your investment in the Company may decline.
Our business strategy may fail if we cannot continue to form strategic
relationships with companies that manufacture and use products that could
incorporate our OLED-on-silicon technology. Our prospects will be significantly
affected by our ability to develop strategic alliances with OEMs for
incorporation of our OLED-on-silicon technology into their products. While we
intend to continue to establish strategic relationships with manufacturers of
electronic consumer products, personal computers, chipmakers, lens makers,
equipment makers, material suppliers and/or systems assemblers, there is no
assurance that we will be able to continue to establish and maintain strategic
relationships on commercially acceptable terms, or that the alliances we do
enter in to will realize their objectives. Failure to do so would have a
material adverse effect on our business.
We may need to obtain additional financing, which may not be available on
suitable terms, and as a result our ability to grow or continue existing
operations may be limited. Our future liquidity and capital requirements are
difficult to predict because they depend on numerous factors, including our
success in completing the development of our products, manufacturing and
marketing our products and competing technological and market developments. We
may not be able to generate sufficient cash from our operations to meet
additional working capital requirements, support additional capital expenditures
or take advantage of acquisition opportunities. In addition, substantial
additional capital may be required in the future to fund product development and
product launches. No assurance can be given that such additional financing will
be available or that, if available, such financing will be obtainable on terms
favorable to our shareholders or us. To the extent we raise additional capital
by issuing equity or securities convertible into equity, our current
shareholders will suffer dilution in ownership. If needed capital is
unavailable, our ability to continue to operate and grow our business could be
adversely affected. Even if capital is available at acceptable cost, we might
not be able to manage growth effectively.
Our business depends to some extent on international transactions. We purchase
needed materials from companies located abroad and may be adversely affected by
political and currency risk, as well as the additional costs of doing business
with a foreign entity. Some customers in other countries have longer receivable
periods or warranty periods. In addition, many of the OEMs that are the most
likely long-term purchasers of our microdisplays are located abroad exposing us
to additional political and currency risk. We may find it necessary to locate
manufacturing facilities abroad to be closer to our customers which could give
expose us to various risks including management of a multi-national
organization, the complexities of complying with foreign law and custom,
political instability and the complexities of taxation in multiple
jurisdictions.
25
Our business may expose us to product liability claims. Our business exposes us
to potential product liability claims. Although no such claim has been brought
against us to date, and to our knowledge no such claim is threatened or likely,
we may face liability to product users for damages resulting from the faulty
design or manufacture of our products. While we plan to maintain product
liability insurance coverage, there can be no assurance that product liability
claims will not exceed coverage limits, fall outside the scope of such coverage,
or that such insurance will continue to be available at commercially reasonable
rates, if at all.
Our business is subject to environmental regulations and possible liability
arising from potential employee claims of exposure to harmful substances used in
the development and manufacture of our products. We are subject to various
governmental regulations related to toxic, volatile, experimental and other
hazardous chemicals used in our design and manufacturing process. Our failure to
comply with these regulations could result in the imposition of fines or in the
suspension or cessation of our operations. Compliance with these regulations
could require us to acquire costly equipment or to incur other significant
expenses. We develop, evaluate and utilize new chemical compounds in the
manufacture of our products. While we attempt to ensure that our employees are
protected from exposure to hazardous materials we cannot assure you that
potentially harmful exposure will not occur or that we will not be liable to
employees as a result.
Risks Related To Our Stock
The substantial number of shares that are or will be eligible for sale could
cause our common stock price to decline even if the Company is successful. Sales
of significant amounts of common stock in the public market, or the perception
that such sales may occur, could materially affect the market price of our
common stock. These sales might also make it more difficult for us to sell
equity or equity-related securities in the future at a time and price that we
deem appropriate. As of June 30, 2003, we have outstanding options to purchase
12,769,010 shares. There are also outstanding warrants to purchase 14,359,101
shares of common stock. Conversion of the secured notes is not certain, even if
the share price increases substantially. If the secured were to convert, they
would result in additional outstanding common shares.
We have a staggered Board of Directors and other anti-takeover provisions, which
could inhibit potential investors or delay or prevent a change of control that
may favor you. Our Board of Directors is divided into three classes and our
Board members are elected for terms that are staggered. This could discourage
the efforts by others to obtain control of the company. Some of the provisions
of our certificate of incorporation, our bylaws and Delaware law could, together
or separately, discourage potential acquisition proposals or delay or prevent a
change in control. In particular, our board of directors is authorized to issue
up to 10,000,000 shares of preferred stock (less any outstanding shares of
preferred stock) with rights and privileges that might be senior to our common
stock, without the consent of the holders of the common stock.
ITEM 3: Controls and Procedures
An evaluation was performed under the supervision and with the participation of
our management, including the chief executive officer, or CEO, who is also the
acting chief financial officer, or CFO, of the effectiveness of the design and
operation of our disclosure procedures. Based on that evaluation, our
management, including the CEO and CFO, concluded that our disclosure controls
and procedures were effective as of June 30, 2003. There have been no
significant changes in our internal control over financial reporting in the
second quarter of 2003 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
We are not a party to any material legal proceedings, except as described below.
On or about April 21, 2003, eMagin and IBM entered into a Stipulation in
order to settle an eviction proceeding originally commenced by IBM against
eMagin on or about April 9, 2003. Thereafter, in accordance with the
Stipulation, on April 23, 2003 the Stipulation was presented to, and approved
by, the court, and a Judgment was issued in favor of IBM. Pursuant to the
Judgment and Stipulation, (i) eMagin paid IBM all rent due and owing to IBM, and
(ii) IBM was awarded possession of the leased premises, was issued a warrant to
remove eMagin from possession of the leased premises, and obtained a monetary
judgment for rent arrears in the sum of Eight Hundred Thirteen Thousand Fifty
Five and 65/100 ($813,055.65) Dollars, which sum is to be paid in equal monthly
installments during the period commencing May 1, 2003 and ending on March 1,
2004.
Such Judgment is being held in escrow by IBM's attorney and the warrant of
eviction is being stayed, so long as the Company continues to timely pay make
the installment payments during the next 12 months and any additional rent
and/or other sums due under the Lease.
On or about May 19, 2003, an action was commenced against the Company by
Vertical Ventures Investments LLC in the Supreme Court of the State of New York,
County of New York, Index No. 3601562/03. In this action, the plaintiff has
asserted claims for the breach of a Registration Rights Agreement, and seeks
compensatory damages against the Company in the amount of $1,500,000. The
Company filed its answer on June 23, 2003 and has denied any and all wrongdoing.
The Company intends to vigorously defend this matter. The parties are in the
process of conducting discovery, but at this juncture, it is difficult to
estimate the likelihood of any unfavorable outcome and estimate the amount or
range of potential loss at this time.
Item 2. Changes in Securities and Use of Proceeds
On April 25, 2003, we entered into a global restructuring and secured note
purchase agreement with a group of several accredited institutional and
individual investors whereby the Investors agreed to lend us $6,000,000 in
exchange for (i) the issuance of $6,000,000 principal amount of 9.00% secured
convertible promissory notes due on November 1, 2005 and (ii) warrants to
purchase an aggregate of 7,749,921 shares of common stock of eMagin (subject to
certain customary anti-dilution adjustments), which Warrants are exercisable for
a period of three (3) years.
Interest is payable on the notes at a rate of 9% per annum and, at our option,
may be paid through the delivery of shares of our common stock (registered
pursuant to the registration rights agreement referred to below) in lieu of cash
interest payments. Subject to certain limitations, the notes may be converted,
at the option of the holder, in whole or in part, into common shares with a
conversion price equal to $0.7742 per share, 105% of the volume weighted average
of the closing price of our common shares as reported on The American Stock
Exchange by the Wall Street Journal, New York City edition, for the five (5)
trading days immediately preceding the closing date (April 25, 2003). The
exercise price of the warrants on a per share basis is $.8110, an amount equal
to 110% of the volume weighted average of the closing price of our common shares
as reported
27
on The American Stock Exchange by the Wall Street Journal, New York City
edition, for the five (5) trading days immediately preceding the closing date
(April 2003).
As part of the transactions, the existing the holders of an aggregate of
$1,625,000 principal amount of secured notes that were purchased pursuant to a
secured note purchase agreement entered into as of November 27, 2001, and the
holder of a $200,000 principal amount secured note that was purchased pursuant
to a secured note purchase agreement entered into as of June 20, 2002, agreed to
(a) amend their respective notes issued to them, (b) terminate the respective
security agreements dated November 20, 2001 and June 20, 2002 that were entered
into in connection with the purchase of their notes and allow the new investors
to enter into a new security agreement with them on a pari passu basis in order
for eMagin to continue its operations as a developer of virtual imaging
technology, and (c) simultaneously participate in this new round of financing
(subject to the terms and conditions set forth in the April 2003 secured note
purchase agreement). The amendments to the notes included (i) amending the note
issued on June 20, 2002 so as to provide that the note shall be convertible and
will have the same conversion price as the notes issued pursuant to the April
2003 secured note purchase agreement, (ii) extending the maturity dates of the
notes from June 30, 2003 to November 1, 2005, and (iii) revising and clarifying
certain of the other terms and conditions of the notes, including provisions
relating to interest payments, conversions, default and assignments of the
notes.
In connection with the completion of the transactions under the April 2003
securities purchase agreement, we also entered into a security agreement with
the Investors dated as of April 25, 2003, and a registration rights agreement
dated as of April 25, 2003 providing the investors with certain registration
rights under the Securities Act of 1933, as amended, with respect to our common
stock issued or issuable in lieu of cash interest payments on the notes, upon
conversion of the notes and/or exercise of the warrants.
In addition to the foregoing, as a condition to and simultaneously with the
closing of the transaction pursuant to the secured note purchase agreement,
certain holders of our convertible notes agreed to convert approximately $4.9
million of notes and accrued interest into shares of our common stock, subject
to a "lock up" arrangement allowing only limited sales through private
transactions for their remaining shares through December 31, 2003. Specifically,
The Travelers Insurance Company agreed to convert their $1 million convertible
note plus related interest into our common stock at a conversion price of
approximately $0.53 per share, and SK Corporation has agreed to convert its $3
million convertible note and accrued interest into our common stock at an
approximate conversion price of approximately $1.28 per share. As further
conditions to the closing of the transaction pursuant to the secured note
purchase agreement, we have also entered into settlement or restructuring
agreements with certain of our other creditors to whom we owed approximately
$5.2 million of current payables, pursuant to which the creditors have agreed to
accept shares of our common stock in full or partial satisfaction of the amount
owed to them, or which allow us to either make discounted payments to them or to
make payments under more favorable payment terms than previously were in place.
The issuance of the shares and the warrants was exempt from registration
requirements of the Securities Act of 1933 pursuant to Section 4(2) of such
Securities Act and Regulation D promulgated thereunder based upon the
representations of each of the Investors that it was an "accredited investor"
(as defined under Rule 501 of Regulation D) and that it was purchasing such
securities without a present view toward a distribution of the securities. In
addition, there was no general advertisement conducted in connection with the
sale of the securities.
Item 3. Defaults Upon Senior Securities
As of the date of the final tranche closing related to the April 2003 financing,
we were in violation of one of the representations and warranties contained in
the Note Purchase Agreement, which violation may be deemed to constitute a
default under the promissory notes issued in connection with the April 2003
financing. Such
28
violation relates to the litigation commenced by Vertical Ventures. We are in
the process of seeking to obtain a forbearance from a majority in interest of
the investors in the April 2003 Financing pursuant to which they will agree not
to enforce their remedies for such event of default.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
EXHIBIT
NUMBER DESCRIPTION
31.1 Certification by Chief Executive Officer and Acting Chief Financial
Officer pursuant to Sarbanes -Oxley Section 302.
32.1 Certification by Chief Executive Officer and Acting Chief Financial
Officer and pursuant to 18 U.S. C. Section 1350
(b) Reports on Form 8-K
The Company filed three reports on form 8-K during the quarter ended June 30,
2003. Information regarding the items reported on is as follows:
DATE OF REPORT ITEM REPORTED ON
April 28, 2003 Disclosed that eMagin had completed a $6 million financing as of April 25,
2003, and that the holders of its Convertible Promissory Note and Secured
Convertible Notes that were set to mature on June 30, 2003 had either agreed to
convert their debt into equity of the Company or had agreed to extend the
maturity date of their Notes to November 1, 2005. Disclosed that eMagin entered
into a registration agreement with investors above investors.
June 11, 2003 Gary W Jones, President and CEO of eMagin Corporation entered into a written
trading plan relating to the future sales of part of his shares of eMagin's
common stock. This plan is intended to enable Mr. Jones to sell shares over a
period of time without unduly effecting the market. This plan has a term of six
months and expires on December 12, 2003.
June 23, 2003 Gary W. Jones terminated his trading plan from June 11, 2003.
29
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
eMAGIN CORPORATION
Dated: August 19, 2003 By:/s/ Gary W. Jones
--------------------------------
Gary W. Jones
Chief Executive Officer and
Acting Chief Financial Officer
30