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EMAN > SEC Filings for EMAN > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for EMAGIN CORP

Form 10-Q for EMAGIN CORP


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Statement of Forward-Looking Information

In this quarterly report, references to "eMagin Corporation," "eMagin," "Virtual Vision," "the Company," "we," "us," and "our" refer to eMagin Corporation and its wholly owned subsidiary, Virtual Vision, Inc.

Except for the historical information contained herein, some of the statements in this Report contain forward-looking statements that involve risks and uncertainties. These statements are found in the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operation" and "Risk Factors." They include statements concerning: our business strategy; expectations of market and customer response; liquidity and capital expenditures; future sources of revenues; expansion of our proposed product line; and trends in industry activity generally. In some cases, you can identify forward-looking statements by words such as "may," "will," "should," "expect," "plan," "could," "anticipate," "intend," "believe," "estimate," "predict," "potential," "goal," or "continue" or similar terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including, but not limited to, the risks outlined under "Risk Factors," that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. For example, assumptions that could cause actual results to vary materially from future results include, but are not limited to:
our ability to successfully develop and market our products to customers; our ability to generate customer demand for our products in our target markets; the development of our target markets and market opportunities; our ability to manufacture suitable products at competitive cost; our ability to successfully launch new equipment on our manufacturing line; market pricing for our products and for competing products; the extent of increasing competition; technological developments in our target markets and the development of alternate, competing technologies in them; and sales of shares by existing shareholders. Although we believe that the expectations reflected in the forward looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Unless we are required to do so under federal securities laws or other applicable laws, we do not intend to update or revise any forward-looking statements.

Overview

We design and manufacture miniature displays, which we refer to as OLED-on-silicon-microdisplays, and microdisplay modules for virtual imaging, primarily for incorporation into the products of other manufacturers. Microdisplays are typically smaller than many postage stamps, 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 the device. 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.

We have developed a strong intellectual property portfolio that includes patents, manufacturing know-how and unique proprietary technologies to create high performance OLED-on-silicon microdisplays and related optical systems. We believe our technology, intellectual property portfolio and position in the marketplace, gives us a leadership position in OLED and OLED-on-silicon microdisplay technology. We are one of only a few companies in the world to market and produce significant quantities of high resolution full-color small molecule OLED-on-silicon microdisplays.

At September 30, 2012, we had a total of 95 full-time and part-time employees as compared to 92 employees at December 31, 2011.

In the third quarter of 2012, we continued work on bringing up our new OLED deposition machine and qualifying the process for production. Our work to fully automate the tool was completed and we began manufacturing displays using this machine. Since there are numerous products and each requires a separate qualification process to be completed, we plan to continue to run some production on the Satella (our other OLED deposition machine) as necessary to meet customer demand.

Also in the third quarter 2012, we completed our initial version of our new XGA display and sent samples to a prospective customer. This display is intended to be used in electronic viewfinders of cameras. This development extends our product line further, enabling us to more favorably address more applications and opportunities for OLED microdisplays.

A detailed discussion of our business may be found in Part I, "Business," of our 2011 Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the Securities and Exchange Commission on March 10, 2012.


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CRITICAL ACCOUNTING POLICIES

Revenue and Cost Recognition

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, selling price is fixed or determinable and collection is reasonably assured. Product revenue is generally recognized when products are shipped to customers. We defer revenue recognition on products sold directly to the consumer with a maximum thirty day right of return. Revenue is recognized upon the expiration of the right of return.

We also earn revenues from certain R&D activities (contract revenues) under both firm fixed-price contracts and cost-type contracts. Revenues relating to firm fixed-price contracts and cost-type contracts are generally recognized on the percentage-of-completion method of accounting as costs are incurred (cost-to-cost basis). Progress is generally based on a cost-to-cost approach however an alternative method may be used such as physical progress, labor hours or others depending on the type of contract. Physical progress is determined as a combination of input and output measures as deemed appropriate by the circumstances. 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.

Income Taxes

Our deferred tax assets and their potential realizability are evaluated each quarter to determine if any changes should be made to the valuation allowance. As of September 30, 2012, we have determined based on the weight of the available evidence, both positive and negative, it is more likely than not that $8.1 million of our deferred tax asset will be realized and no additional valuation allowance was released. In the fourth quarter of 2012, we expect to have additional information regarding a future, large government program and future sales of our new XGA display for electronic viewfinders which may have an impact on our judgment about the realizability of our deferred tax assets and we may adjust a portion of the valuation allowance as applicable.

Other critical accounting policies, as described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, relate to product warranty, use of estimates, fair value of financial instruments and stock-based compensation, and additional information on accounting for income taxes.

NEW ACCOUNTING PRONOUNCEMENTS

See Note 1 of the Condensed Consolidated Financial Statements in Item 1 for a description of recent account pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition.

RESULTS OF OPERATIONS

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2011

Revenues

Revenues for the three and nine months ended September 30, 2012 were approximately $7.5 million and $22.2 million, respectively, as compared to approximately $8.3 million and $21.2 million, respectively, for the three and nine months ended September 30, 2011, a decrease of approximately $0.8 million or 9% for the three month period and an increase of approximately $1.0 million or 5% for the nine month period.

Product revenue is comprised of sales of displays, Z800 systems, and other hardware. For the three months ended September 30, 2012, product revenue increased approximately $3 thousand as compared to the three months ended September 30, 2011. For the nine months ended September 30, 2012, product revenue increased approximately $2.7 million or 16% as compared to the nine months ended September 30, 2011. The increase in product revenue for the nine month periods was driven primarily by an increase in sales volume as the average sales price per display decreased 1% which is due to the mix of displays sold. For the three and nine months ended September 30, 2012, we shipped 5% and 18%, respectively, more displays as compared to the three and nine months ended September 30, 2011.

Contract revenue is comprised of revenue from research and development or non-recurring engineering ("NRE") contracts. For the three and nine months ended September 30, 2012, contract revenue decreased approximately $0.8 million or 39% and $1.6 million or 35%, respectively, as compared to the three and nine months ended September 30, 2011. The decrease in contract revenue for the three and nine month period in 2012 was a result of fewer and smaller active contracts as compared to 2011. Historically, many of these contracts are with U.S. government agencies. Although eMagin has been and expects to continue to be successful on winning new R&D contracts, including the contracts won this year such as USSOCOM and U.S. Navy, it is likely that the current U.S. government budget issues have impacted the number and amount of contracts available.


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Cost of Goods Sold

Cost of goods sold is comprised of costs of product and contract revenues. Cost of product revenue includes materials, labor and manufacturing overhead related to our products. Cost of contract revenue includes direct and allocated indirect costs associated with performance of contracts. Cost of goods sold was approximately $3.9 million for the three month periods ended September 30, 2012 and 2011. Cost of goods sold for the nine months ended September 30, 2012 was approximately $11.4 million as compared to approximately $10.9 million for the nine months ended September 30, 2011, an increase of approximately $0.5 million. Cost of goods sold as a percentage of revenues was 51% for both the three and nine months ended September 30, 2012 as compared to 47% and 52% for the three and nine months ended September 30, 2011, respectively.

The following table outlines product, contract and total gross profit and related gross margins for the three and nine months ended September 30, 2012 and 2011 (dollars in thousands):

                                               Three months ended September 30,             Nine months ended September 30,
                                                 2012                     2011                2012                  2011
                                                          (unaudited)                                 (unaudited)
Product revenue gross profit               $          3,177         $          3,404     $         9,349       $         8,010
Product revenue gross margin                             50 %                     54 %                49 %                  48 %
Contract revenue gross profit              $            472         $            955     $         1,494       $         2,221
Contract revenue gross margin                            39 %                     49 %                50 %                  48 %
Total gross profit                         $          3,649         $          4,359     $        10,843       $        10,231
Total gross margin                                       49 %                     53 %                49 %                  48 %

The gross profit for the three and nine months ended September 30, 2012 was approximately $3.6 million and $10.8 million, respectively, as compared to approximately $4.4 million and $10.2 million, respectively, for the three and nine months ended September 30, 2011, a decrease of approximately $0.8 million for the three month period and an increase of approximately $0.6 million for the nine month period. Gross margin was 49% for both the three and nine months ended September 30, 2012 and 53% and 48%, respectively, for the three and nine months ended September 30, 2011.

The product gross profit for the three and nine months ended September 30, 2012 was approximately $3.2 million and $9.3 million, respectively, as compared to approximately $3.4 million and $8.0 million, respectively, for the three and nine months ended September 30, 2011, a decrease of $0.2 million for the three month period and an increase of $1.3 million for the nine month period. Product gross margin was 50% and 49%, respectively, for the three and nine months ended September 30, 2012 down from 54% for the three month period and up from 48% for the nine month period. For the three month period of 2012, our gross margin decreased as compared to the three month period of 2011 as the cost per display produced in Q3 2012 was slightly higher than displays produced in Q3 2011 and we had a decrease in the average selling price. For the nine month period of 2012, our gross margin was favorably impacted as fixed production costs are spread over a higher revenue base. For the nine month period of 2012, the cost per display produced was lower than for displays produced in the nine month period in 2011 which was offset by a small decrease in the average selling price.

The contract gross profit for the three and nine months ended September 30, 2012 was approximately $0.5 million and $1.5 million, respectively, as compared to approximately $1.0 million and $2.2 million, respectively, for the three and nine months ended September 30, 2011, a decrease of approximately $0.5 million and $0.7 million, respectively. Contract gross margin was 39% and 50%, respectively, for the three and nine months ended September 30, 2012, a decrease from 49% for the three month period and an increase from 48% for the nine month period. The contract gross margin is dependent upon the nature of the contract, the amount of costs actually incurred and mix of costs, internal versus external third party costs. External third party costs lower gross margins and reduce the contract gross profit.


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Operating Expenses

Research and Development. Research and development ("R&D") expenses are company-funded and include salaries and related benefits, development materials and other costs specifically allocated to the development of new microdisplay products, OLED materials and subsystems. R&D related costs associated with fulfilling contracts are categorized as contract cost of goods sold. R&D expenses for the three and nine months ended September 30, 2012 were approximately $1.2 million and $3.6 million, respectively, as compared to approximately $0.8 million and $2.1 million, respectively, for the three and nine months ended September 30, 2011. The increase of approximately $0.4 million and $1.5 million, respectively, is related to an increase in personnel costs and related expenses to support R&D activities.

Selling, General and Administrative. Selling, general and administrative expenses consist principally of salaries and related benefits, professional services fees and marketing, general corporate, and administrative expenses. Selling, general and administrative expenses for the three and nine months ended September 30, 2012 were approximately $1.9 million and $6.5 million, respectively, as compared to approximately $2.0 million and $6.4 million, respectively, for the three and nine months ended September 30, 2011. The decrease in selling, general and administrative expenses for the three month period is attributable to a reduction of personnel and recruiting expenses. Year to date, selling, general and administrative costs have increased slightly, 2.6%.

Other Income (Expense), net. Other income (expense), net consists primarily of interest income earned on investments, interest expense, and income (expense) applicable to the change in the fair value of the warrant liability. For the three and nine months ended September 30, 2012, interest expense was approximately $10 thousand and $18 thousand, respectively, offset by the capitalization of interest $13 thousand for the nine month period as compared to approximately $26 thousand and $85 thousand, respectively, for the three and nine months ended September 30, 2011. We have no debt upon which we are incurring interest expense however we pay fees to keep our line of credit available. Other income, primarily interest income, for the three and nine months ended September 30, 2012 was approximately $13 thousand and $32 thousand, respectively, as compared to approximately $3 thousand and $32 thousand, respectively, for the three and nine months ended September 30, 2011.

Change in Fair Value of Warrant Liability. For the three and nine months ended September 30, 2012, the change in fair value of the warrant liability was $0 as the Company had no warrants that are accounted for as a liability. For the three and nine months ended September 30, 2011, the change in fair value of the warrant liability was income of $3.0 and $2.5 million, respectfully. The change in the fair value of the warrant liability was primarily due to the change in the common stock price of eMagin period over period. The change in fair value of the warrant liability had no impact on our cash balances, operations, or operating income. The warrant was modified to remove the anti-dilution provision therefore there will be no change in the fair value of the existing warrant going forward.

Liquidity and Capital Resources

As of September 30, 2012, we had approximately $16.6 million of cash, cash equivalents, and investments as compared to $14.3 million at December 31, 2011. Of the $16.6 million in cash, approximately $9.0 million was invested in certificates of deposits ("CDs") and corporate bonds.

Cash flow provided by operating activities during the nine months ended September 30, 2012 was approximately $3.5 million, attributable to our net income of approximately $0.5 million, net non-cash expenses of $2.1 million and the change in operating assets and liabilities of $0.9 million. Cash flow provided by operating activities during the nine months ended September 30, 2011 was approximately $1.6 million, attributable to our net income of approximately $3.8 million offset by net non-cash expenses of $0.8 million and the change in operating assets and liabilities of $1.4 million.

Cash used in investing activities during the nine months ended September 30, 2012 was approximately $3.4 million of which $2.3 million purchased investments in CDs and corporate bonds and approximately $1.1 million purchased equipment primarily for upgrading our production line. Cash used in investing activities during the nine months ended September 30, 2011 was approximately $4.0 million of which $2.6 million purchased CDs and approximately $1.4 million purchased equipment primarily for upgrading our production line. Presently we have committed approximately $1.7 million for capital expenditures for the balance of 2012.

Cash used by financing activities during the nine months ended September 30, 2012 was approximately $0.1 million of which approximately $0.4 million was used to purchase treasury stock offset by proceeds from the exercise of stock options of $0.3 million. Cash provided by financing activities during the nine months ended September 30, 2011 was approximately $1.1 million, representing proceeds from the exercise of stock options and warrants.


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Credit Facility

At September 30, 2012, we had a credit facility with Access Business Finance, LLC ("Access") that provides for up to a maximum amount of $3 million based on a borrowing base equivalent of 75% of eligible accounts receivable. The interest on the credit facility is equal to the Prime Rate plus 5% but may not be less than 8.25% with a minimum monthly interest payment of $1 thousand. On September 1, 2012, we renewed our credit facility for a year. The credit facility will automatically renew on September 1, 2013 for a one year term unless written notice is provided. We did not draw on our credit facility during the quarter ended September 30, 2012, or at any time since its inception in September 2010 and there is no outstanding balance.

The credit facility contains the customary representations and warranties as well as affirmative and negative covenants. We were in compliance with all debt covenants as of September 30, 2012.

We expect our business to experience revenue growth which may result in higher accounts receivable levels and may require increased production and/or higher inventory levels. We anticipate that our cash needs to fund these requirements as well as other operating or investing cash requirements over the next twelve months will be less than our current cash on hand, investments and the cash we anticipate generating from operations. We anticipate that we will not require additional funds over the next twelve months other than perhaps for discretionary capital spending. If unanticipated events arise during the next twelve months, we believe we can raise sufficient funds. However, if we are unable to obtain sufficient funds, we may have to reduce the size of our organization and/or be forced to reduce and/or curtail our production and operations, all of which could have a material adverse impact on our business prospects.

Off-Balance Sheet Arrangements

We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity or capital expenditures.

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