EMAGIN CORP - Quarter Report: 2017 September (Form 10-Q)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549 

 

 

Form 10-Q 

 



 

Commission file number 001-15751 

 

eMAGIN CORPORATION 

(Exact name of registrant as specified in its charter) 



 

2070 Route 52, Hopewell Junction, NY  12533

(Address of principal executive offices) 

 

(845)  838-7900 

(Registrant’s telephone number, including area code) 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 ☑     No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months ).     Yes ☑     No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.   (Check one): 

 

Large accelerated filer  ☐              Accelerated filer  ☐              Non-accelerated filer  ☐              Smaller reporting company  ☑



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act)     Yes ☐     No ☑

 

The number of shares of common stock outstanding as of October 30, 2017 was 34,972,589.



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eMagin Corporation 

Form 10-Q

For the Quarter ended September 30, 2017

 

Table of Contents

 



  



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STATEMENT REGARDING FORWARD-LOOKING INFORMATION 



This Quarterly Report on Form 10-Q, or Report, contains forward-looking statements that are based on our management’s belief and assumptions and on information currently available to our management. Although we believe that the expectations reflected in these forward-looking statements are reasonable, these statements relate to future events or our future financial performance, and involve known and unknown risks, uncertainties and other 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 these forward-looking statements.



In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. These statements are only predictions. You should not place undue reliance on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which are, in some cases, beyond our control and which could materially affect our results. Factors that may cause actual results to differ materially from current expectations include, among other things, those listed in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 . If one or more of these risks or uncertainties occur, or if our underlying assumptions prove to be incorrect, actual events or results may vary significantly from those implied or projected by the forward-looking statements. No forward-looking statement is a guarantee of future performance. You should read this Report and the documents that we reference in this Report and have filed with the Securities and Exchange Commission, or the SEC, as exhibits to this Report, completely and with the understanding that our actual future results may be materially different from any future results expressed or implied by these forward-looking statements.



In particular, forward-looking statements in this Report include statements about:







The forward-looking statements in this Report represent our views as of the date of this Report. We anticipate that subsequent events and developments may cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law. Therefore, these forward-looking statements do not represent our views as of any date other than the date of this Report. 



In this Report, references to “eMagin Corporation,” “eMagin,” “the Company,” “we,” “us,” and “our company” refer to eMagin Corporation and our wholly owned subsidiary, Virtual Vision, Inc.



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 ITEM 1.  Condensed Consolidated Financial Statements 



eMAGIN CORPORATION 

CONDENSED CONSOLIDATED BALANCE SHEETS 

(In thousands, except share data)







See notes to Condensed Consolidated Financial Statements.

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eMAGIN CORPORATION 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 

(In thousands, except share and per share data) 

(unaudited) 



 

See notes to Condensed Consolidated Financial Statements.

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eMAGIN CORPORATION 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 

(In thousands) 





 

See notes to Condensed Consolidated Financial Statements.

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eMAGIN CORPORATION 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 

 (unaudited) 

 

Note 1:   Summary of Significant Accounting Policies 



The Business 



eMagin Corporation (the “Company”) designs, develops, manufactures, and markets OLED (organic light emitting diode)–on-silicon microdisplays and virtual imaging products which utilize OLED microdisplays. The Company’s products are sold mainly in North America, Asia, and Europe. 



Basis of Presentation 



In the opinion of management, the accompanying unaudited condensed consolidated financial statements of eMagin Corporation and its subsidiary reflect all adjustments, including normal recurring accruals, necessary for a fair presentation.  All significant intercompany balances and transactions have been eliminated in consolidation.  Certain information and footnote disclosure normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to instructions, rules and regulations prescribed by the Securities and Exchange Commission.  The Company believes that the disclosures provided herein are adequate to make the information presented not misleading when these unaudited condensed consolidated financial statements are read in conjunction with the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.  The results of operations for the period ended September 30, 2017 are not necessarily indicative of the results to be expected for the full year.  The consolidated condensed financial statements as of December 31, 2016 are derived from audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. 



Evaluation of Ability to Maintain Current Level of Operations



As of September 30, 2017, the Company has an accumulated deficit of $226.2 million.  The Company incurred a net loss of $7.3 million and used cash in operating and investing activities of $8.1 million during the first nine months of 2017. In addition, at September 30, 2017, the Company had cash and cash equivalents of $2.0 million,  $0.9 million in outstanding borrowings under its asset based lending (“ABL”) debt facility, and borrowing availability under the facility of $3.7 million.

Management evaluated whether the conditions above raised substantial doubt about the Company’s ability to continue as a going concern.  The Company’s ability to continue current operations is dependent on its existing cash and working capital balances and the ability to generate sufficient cash flows from operations. The Company expects that it may need additional capital to fund its operations over the next twelve months from the date of issuance of these financial statements.  If the Company is unable to raise additional capital or obtain debt when required or on acceptable terms, the Company may have to reduce or delay operating expenses as deemed appropriate in order to conserve cash.

In March 2017, the Company entered into an unsecured debt financing arrangement with Stillwater Trust LLC, a significant investor in the Company.  Under the financing agreement, the Company may borrow through June 30, 2018, up to $2 million for general working capital purposes and up to an additional $3 million should the Company’s existing lender not provide borrowing availability under its normal terms and conditions through its ABL debt facility.  In accordance with the terms of the unsecured debt financing agreement, this arrangement expired on May 24, 2017, upon the completion of an equity offering.

On May 24, 2017, the Company completed an underwritten offering of 3,300,000 shares of its common stock and warrants to purchase up to 1,650,000 shares of common stock and realized net proceeds of $5.8 million dollars after underwriting discounts and offering expenses. 

Management believes its current operating plan, current working capital levels including proceeds from its May public offering, current financial projections, and the ability to borrow under its ABL debt facility, has alleviated substantial doubt about its ability to continue as a going concern.  Accordingly, these consolidated financial statements have been prepared on the basis that the Company will continue to meet its obligations and continue its operations for the next twelve months from the date of issuance of these financial statements.



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Use of estimates 



In accordance with accounting principles generally accepted in the United States of America, management utilizes certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments related to, among others, allowance for doubtful accounts, warranty reserves, inventory reserves, stock-based compensation expense, deferred tax asset valuation allowances, litigation and other loss contingencies. Management bases its estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. 



Reclassifications



Certain immaterial prior period amounts have been reclassified to conform to current period presentation with no impact on previously reported net income, assets or shareholders’ equity.



Revenues and Cost Recognition 



Revenues from product sales are 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 and risk of loss 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. Product revenue is generally recognized when products are shipped to customers.



Revenues from research and development activities 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, labor and subcontractor 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.



Revenues from sales or licenses of intellectual property are recognized when transferred to the customer, provided the license has stand-alone value and the contract provides the right to use the intellectual property as it exists at the point the license is granted, without further obligations of the Company to update the intellectual property after the license is transferred.  If the license does not have standalone value, then the license is combined with other deliverables, such as Research and Development (“R&D”) or manufacturing services into a single unit of account.  Revenue from the single unit of account is recognized when earned, typically as the R&D or manufacturing services are performed over the life of the contract.



Recently issued accounting pronouncements



In January 2017, the Financial Accounting Standards Board (“FASB”) issued guidance that narrows the application of when an integrated set of assets and activities is considered a business and provides a framework to assist entities in evaluating whether both an input and a substantive process are present to be considered a business. It is expected that the new guidance will reduce the number of transactions that would need to be further evaluated and accounted for as a business. The guidance is required to be applied by the Company in the first quarter of 2018, although early adoption is permitted. The Company is currently evaluating the impact of this standard on its consolidated financial statements.



In March 2016, the FASB issued guidance which simplifies the accounting for share-based payment transactions including the income tax consequences, classification of awards as either equity or liabilities, financial statement presentation of excess tax benefits or deficiencies, and classification in the Consolidated Statement of Cash Flows. The guidance is effective for interim and annual reporting periods beginning after December 15, 2016, although early adoption is permitted.  The Company elected to early adopt this guidance on a prospective basis as of December 31, 2016.  The adoption of the new accounting guidance did not have a material impact on the company’s financial statements. 



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In February 2016, the FASB issued guidance which changes the accounting for leases. The guidance requires lessees to recognize a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term and, a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis for all leases (with the exception of short-term leases).  Under the new guidance, leases previously defined as operating leases will be presented on the balance sheet. As a result, these leases will be recorded as an asset and a corresponding liability at the present value of the total lease payments. The asset will be decremented over the life of the lease on a pro-rata basis resulting in lease expense while the liability will be decremented using the interest method (i.e. principal and interest). As such, the Company expects the new guidance will impact the asset and liability balances of the Company’s financial statements and related disclosures at the time of adoption.  The new guidance is effective January 1, 2019.



In November 2015, the FASB issued guidance which requires deferred tax liabilities and assets be classified as noncurrent in the statement of financial position. This guidance requires entities with a classified balance sheet to present all deferred tax assets and liabilities as non-current. The guidance is effective for annual and interim periods beginning after December 15, 2016 and can be applied prospectively or retrospectively to adjustments with early adoption permitted at the beginning of an interim or annual reporting period. The adoption of the new accounting guidance did not have a material impact on the Company’s financial statements.



In July 2015, the FASB issued guidance on the measurement of inventory, which requires that inventory be measured at the lower of cost or net realizable value.   The updated standard was adopted prospectively and is effective for annual reporting periods (including interim periods therein) beginning after December 15, 2016 with early adoption permitted. The adoption of the new accounting guidance did not have a material impact on the Company’s financial statements.



In April 2015, the FASB issued guidance that simplifies the presentation of debt issuance costs. The guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.  The Company adopted this guidance in the first quarter of 2016 and has presented its revolving credit facility debt net of unamortized debt issuance costs in the accompanying consolidated balance sheet.



In August 2014, the FASB issued guidance which defines management’s responsibility to assess an entity’s ability to continue as a going concern; and to provide related footnote disclosures if there is substantial doubt about its ability to continue as a going concern. The pronouncement was effective for annual reporting periods ending after December 15, 2016 with early adoption permitted. The Company has provided an assessment and related disclosures in Note 1 to the Condensed Consolidated Financial Statements.



In May 2014, the FASB issued guidance on the recognition of revenue from contracts with customers, which will require an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance when it becomes effective.  The guidance is effective for fiscal years and interim periods within those years, beginning after December 15, 2017.  The Company is still finalizing its assessment of this guidance, but does not currently expect its adoption to have a material impact on its consolidated financial statements.  Based on the evaluation of its product, contract and licensing revenue streams, most will be recorded consistently under both the current and new guidance with differences possible in the accounting for product warranties which are not expected to be material. The Company has determined it will use the modified retrospective method as its transition method in the adoption of the new revenue guidance. The Company will continue to accumulate information that will be necessary for implementation and will identify and implement any changes in its processes, systems and controls necessary to meet the new standards enhanced reporting and disclosure requirements.   The Company will continue its evaluation of this new guidance though the date of adoption. 



Unbilled Accounts Receivable



Unbilled accounts receivable represents contract revenue recognized but not yet invoiced due to contract terms or the timing of the accounting invoicing cycle.



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Intangible Assets – Patents



Acquired patents are recorded at purchase price as of the date acquired and amortized over the expected useful life which is generally the remaining life of the patent.   



The total intangible amortization expense was approximately $14 thousand and $41 thousand for the three and nine month periods ended September 30, 2017 and 2016, respectively.  Estimated future amortization expense as of September 30, 2017 is as follows (in thousands):







Product warranty



The Company generally offers a one-year product replacement warranty. The standard policy is to repair or replace the defective products. The Company accrues for estimated returns of defective products at the time revenue is recognized based on historical activity as well as for specific known product issues. The determination of these accruals requires the Company to make estimates of the frequency and extent of warranty activity and estimate future costs to replace the products under warranty. If the actual warranty activity and/or repair and replacement costs differ significantly from these estimates, adjustments to cost of revenue may be required in future periods.



The following table provides a summary of the activity related to the Company's warranty liability included in other current liabilities, (in thousands): 





Net Loss per Common Share   



Basic loss per share is computed using the weighted average number of common shares outstanding during the period, and excludes any dilutive effects of common stock equivalent shares such as stock options, warrants, and convertible preferred stock. Diluted loss per share is computed using the weighted average number of common shares outstanding and potentially dilutive common stock equivalent shares outstanding during the period. Common stock equivalent shares are excluded from the computation if their effect is anti-dilutive. 



The Company’s Series B Convertible Preferred stock (“Preferred Stock – Series B”) is considered a participating security as the preferred stock participates in dividends with the common stock, which requires the use of the two-class method when computing basic and diluted earnings per share.  The Preferred Stock – Series B is not required to absorb any net loss. Although the Company paid a one-time special dividend in 2012, the Company does not expect to pay dividends on its common or preferred stock in the near future.   



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The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share and share data) for the three and nine months ended September 30, 2017 and 2016:







The following table sets forth the potentially dilutive common stock equivalents for the three and nine month periods ended September, 2017 and 2016 that were not included in diluted EPS as their effect would be anti-dilutive:





 

Note 2:  Accounts Receivable, net 



The majority of the Company’s commercial accounts receivable are due from Original Equipment Manufacturers (“OEM’s”). Credit is extended based on an evaluation of a customer’s financial condition and, generally, collateral is not required.  



Accounts receivable consisted of the following (in thousands):



 



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Note 3:  Inventories, net 



The components of inventories are as follows (in thousands):    

 

Note 4:  Line of Credit 



On December 21, 2016, the Company entered into a revolving credit facility with a lender that provides for up to a maximum amount of $5 million based on a borrowing base equivalent of 85% of eligible accounts receivable plus the lesser of $2 million or 50% of eligible inventory, (the “ABL facility”). The interest on the ABL facility is equal to the Prime Rate plus 3% but may not be less than 6.5% with a minimum monthly interest payment of $2 thousand. The Company is also obligated to pay the lender a monthly administrative fee of $1 thousand and an annual facility fee equal to 1% of the maximum amount borrowable under the facility. The ABL facility will automatically renew on December 31, 2019 for a one-year term unless written notice to terminate the agreement is provided by either party. In conjunction with entering into the financing, the Company incurred $228 thousand of debt issuance costs including lender and legal costs that will be amortized over the life of the ABL facility.  In accordance with recently issued accounting guidance, the revolving credit facility balance is presented net of these unamortized debt issuance costs on the accompanying Consolidated Balance Sheet.



The ABL facility is secured by a lien on all receivables, property and the proceeds thereof, credit insurance policies and other insurance relating to the collateral, books, records and other general intangibles, inventory and equipment, proceeds of the collateral and accounts, instruments, chattel paper, and documents.  Collections received on accounts receivable are directly used to pay down the outstanding borrowings on the credit facility.



 The ABL facility contains customary representations and warranties, affirmative and negative covenants and events of default.  The Company is required to maintain a minimum tangible net worth of $13 million and a minimum working capital balance of $4 million at all times.  As of September 30, 2017, we had unused borrowing availability of $3.7 million and were in compliance with all debt covenants.



For the three and nine months ended September 30, 2017, interest expense includes interest paid, capitalized or accrued of $27 thousand and $249 thousand, respectively, on outstanding debt.   Interest expense for the nine months ended September 30, 2017, also includes the write off of $158 of capitalized debt issuance costs associated with the expiration of the unsecured debt financing agreement. 



On March 24, 2017, the Company entered into an unsecured debt financing arrangement with Stillwater Trust LLC, an investor who, with affiliates, collectively control approximately 46% of the Company’s outstanding common stock.   Under the financing agreement, the Company may borrow, through June 30, 2018, up to $2 million for general working capital purposes and up to an additional $3 million should the Company’s lender not provide borrowing availability under its normal terms and conditions through its ABL facility.   The agreement expires and borrowings become due upon the earlier of June 30, 2020; the completion of one or a series of equity financings which raise collectively $5 million or greater of gross proceeds; or an event of default, as defined in the agreement.  Amounts borrowed under the financing agreement, once repaid, cannot be reborrowed. In accordance with the terms of the agreement, this arrangement expired on May 24, 2017, upon the completion of an equity offering. Upon termination of this facility, the Company wrote off $158 thousand of related debt issuance costs, and recorded a charge to interest expense in the second quarter of 2017.



Mr. Christopher Brody, a member of the Company’s board of directors, is also the President and Managing Director of Stillwater Holdings LLC and is the Vice President of Stillwater Trust LLC, which is the Company’s largest stockholder. The decision of Stillwater Trust LLC to enter into the financing arrangement was made independently of Mr. Brody and the financing was not required or suggested by Mr. Brody. The terms of the financing were determined solely by negotiation among the Company and Stillwater Trust LLC. Mr. Brody did not participate in the deliberations of the Company’s board of directors or the special committee of the Company’s board formed to review the terms of the financing with respect to the approval of the financing and abstained from voting thereon.

 

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Note 5:  Stock-based Compensation 



The Company uses the fair value method of accounting for share-based compensation arrangements. The fair value of stock options is estimated at the date of grant using the Black-Scholes option valuation model.  Stock-based compensation expense is reduced for estimated forfeitures and is amortized over the vesting period using the straight-line method. 



The following table summarizes the allocation of non-cash stock-based compensation to our expense categories for the three and nine month periods ended September 30, 2017 and 2016 (in thousands): 







At September 30, 2017, total unrecognized compensation costs related to stock options was approximately  $0.7 million, net of estimated forfeitures.  Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures and is expected to be recognized over a weighted average period of approximately 3 years.   



The following key assumptions were used in the Black-Scholes option pricing model to determine the fair value of stock options granted:                   





The Company does not expect to pay dividends in the near future.  Therefore, the Company used an expected dividend yield of 0%.  The risk-free interest rate used in the Black-Scholes option pricing model is based on yield available at dates of option grant, on U.S. Treasury securities with an equivalent term.  Expected volatility is based on the weighted average historical volatility of the Company’s common stock for the equivalent term.  The expected term of the options represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on historical experience and vesting schedules of similar awards. 



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A summary of the Company’s stock option activity for the nine months ended September 30, 2017 is presented in the following table (unaudited):       





The aggregate intrinsic value in the table above represents the difference between the exercise price of the underlying options and the quoted price of the Company’s common stock.  For the nine months ended September 30, 2017 the aggregate intrinsic value of options exercised was $35 thousand   The Company issues new shares of common stock upon exercise of stock options.

 

Note 6:  Shareholders’ Equity 



Preferred Stock - Series B Convertible Preferred Stock



As of September 30, 2017 and December 31, 2016, there were 5,659 shares of Preferred Stock – Series B issued and outstanding. 



Common Stock 



During the nine-month period ended September 30, 2017, options to purchase 46,073 shares were exercised for proceeds of $69 thousand.



Underwritten Public Offering



On May 24, 2017, the Company completed an underwritten offering of 3,300,000 shares of its common stock at an offering price of $2.00 and warrants to purchase up to 1,650,000 shares of common stock and realized net proceeds of $5.8 million dollars after underwriting discounts and offering expenses.   The shares and warrants were purchased by a single institutional investor and by Stillwater, LLC, an affiliate of the Company.  The Warrants have an exercise price of $2.45 per common share and a term of five years. 



Warrants



On August 18, 2016, the Company entered into letter agreements with certain warrant holders pursuant to which such warrant holders agreed to exercise warrants to purchase a total of 2,216,500 of the Company’s common stock, at an exercise price of $2.05 per share, which they acquired in December 2015.



On August 24, 2016, in consideration for the exercise of the 2,216,500 warrant shares, the Company issued new common stock purchase warrants (the “New Warrants”) to purchase 2,947,949 shares of the Company’s common stock which is equal to 133% of the 2,216,500 warrant shares exercised. The  New Warrants have an exercise price of $2.60 per share and are substantially similar to the warrants issued in December 2015, except that they are: (a) restricted; (b) not exercisable for six months from the date of issuance; and (c) have a term of five and a half years from the issuance date.



The Company raised approximately $4.5 million in gross proceeds from the transaction, which was used for general corporate purposes.



The issuance of the New Warrants was exempt from federal and state registration requirements.  The Company has filed a resale registration statement to register the shares of the Company’s common Stock issuable upon the exercise of the New Warrants.

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At September 30, 2017 there were New Warrants outstanding to purchase 2,947,949 shares of Company’s common stock at an exercise price of $2.60, which expire in February 2023.  Warrants to purchase 383,500 shares remaining from the December 2015 issuance were outstanding at September 30, 2017 at an exercise price of $2.05, which expire in June 2021. 



In addition, on March 24, 2017 a warrant to purchase 100,000 shares of common stock at an exercise price of $2.25 per share, was issued in conjunction with an unsecured line of credit as described in Note 4: Line of Credit, all of which remain outstanding as of September 30, 2017.



On May 24, 2017, as described above, the Company issued warrants to purchase up to 1,650,000 shares of common stock at an exercise price of $2.45 in conjunction with a public offering, all of which remain outstanding as of September 30, 2017.

 

Note 7:  Income Taxes    



The Company’s effective tax rate is calculated quarterly based upon current assumptions relating to the full year’s estimated operating results and various tax-related items. The Company’s effective tax rate for the three and nine month periods ended September 30, 2017 and 2016 was 0%.  The difference between the effective tax rate of 0% and the U.S. federal statutory rate of 34% for the three and nine month periods ended September 30, 2017 and 2016 was primarily due to recognizing a full valuation allowance on deferred tax assets.  



As of September 30, 2017, the Company determined that based on all available evidence, both positive and negative, including the Company’s latest forecasts and cumulative losses in recent years, it was more likely than not that none of its deferred tax assets would be realized and therefore it continued to record a full valuation allowance.  



The Company’s net operating loss carry forward amounts expire through 2037 and are subject to certain limitations that may occur due to change in ownership provisions under Section 382 of the Internal Revenue Code and similar state provisions.



Due to the Company’s operating loss carryforwards, all tax years remain open to examination by the major taxing jurisdictions to which the Company is subject. In the event that the Company is assessed interest or penalties at some point in the future, it will be classified in the financial statements as tax expense. 

 

Note 8:  Commitments and Contingencies 



Equipment Purchase Commitments 



The Company has committed to equipment purchases of approximately $0.2 million at September 30, 2017.



Litigation



From time to time, the Company is subject to various legal proceedings and claims that arise in the ordinary course of business. The Company accrues for losses related to litigation when a potential loss is probable and the loss can be reasonably estimated. Significant judgment is required to determine the probability that a liability has been incurred and whether such liability is reasonably estimable. All estimates are based on the best information available at the time which can be highly subjective.



During 2015, the Company received a letter from an attorney representing a former employee claiming damages for age discrimination and wrongful termination.  In September 2016, this former employee commenced action against the Company in Superior Court for the State of Washington. In February 2017, the former employee’s counsel sent a discovery request to the Company. In October 2017, the parties reached a tentative settlement, subject to payment of an amount not material to the Company, documentation of the terms and the expiration of a revocation period.

 

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Note 9:  Concentrations    



The following is a schedule of revenues by geographic location (in thousands):  



The following table represents the domestic and international revenues as a percentage of total net revenues:







The Company purchases principally all of its silicon wafers from two suppliers located in Taiwan and Korea.   



For the nine months ended September 30, 2017,  one customer accounted for 10% of net revenues and there were no other single customers accounting for over 10% of net revenues.  For the three months ended September 30, 2017,  one customer accounted for over 10% of net revenues.     As of September 30, 2017, two customers accounted for 15 % and 10%, respectively of the Company’s consolidated accounts receivable balance and no other single customer accounted for over 10% of the consolidated accounts receivable.

 

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

 

Business



eMagin Corporation is headquartered in Hopewell Junction, New York, and was incorporated in the state of Delaware in 1996.  We are the leader in OLED (organic light emitting diode) on silicon microdisplay technology, OLED microdisplay manufacturing know-how and mobile display systems. eMagin manufactures high-resolution OLED microdisplays and integrates them with magnifying optics to deliver virtual images comparable to large-screen computer and television displays in portable, low-power, lightweight personal displays. eMagin microdisplays provide near-eye imagery in a variety of products for military, industrial, medical and consumer OEMs.



We derive the majority of our revenue from sales of our OLED microdisplay products which we manufacture in our Hopewell Junction, New York, manufacturing facility. We also earn revenue from government and commercial development contracts that may complement and support our internal research and development programs. In addition, we generate sales from optics and microdisplays combined with optics. Our business model also includes licensing our intellectual property to consumer electronics companies for a broad range of applications, although revenues to date have not been material.



Our common stock is traded on the NYSE:American Market under the symbol EMAN.

 

Overview  



In the third quarter, we delivered display products to over 64 customers in 26 countries and performed contract services for 7 customers.  Revenues and gross profit in the quarter were affected by production problems associated with one machine that resulted in fewer displays being produced and sold during the quarter and higher unit material costs.  Those production issues have since been resolved.  We continue to anticipate a ramp up over the next several quarters from the addition of new military programs awarded over the past year and from shipments not made during the third quarter.   As a result of higher bookings towards the end of the third quarter and continuing into the fourth quarter, we believe we will experience greater shipments and higher revenues in the fourth quarter of 2017 than in the quarter ended September 30, 2017. 



We continue to make progress on our multi-year yield improvement initiative as we strengthen production resources, make key managerial and process engineering hires, and implement production equipment.  We believe this initiative will enable us to increase production capacity, lower unit costs and achieve greater operating efficiencies, positioning us to meet expanding customer demand and earning higher gross profits.  As part of our yield improvement initiative, we made capital equipment acquisitions over the past several quarters which we are currently implementing and qualifying.  We expect that these additions will reduce our dependency on critical equipment at key stages of the production process and provide greater operating flexibility which we believe will permit us to address the increasingly demanding needs of our customers without compromising throughput volumes or unit profitability.  



Throughout 2017, we expanded the marketing and commercialization of our handheld and wearable night vision products beyond the direct-to-consumer market to include commercial markets such as first responders and field service.  We believe that these commercial marketing efforts, along with our consumer marketing initiatives, will lead to a larger customer base for our products.  During the first nine months of 2017 we incurred expenses associated with the marketing of these products and utilized working capital to fund the buildup of inventory.  Working capital expenditures, along with marketing and promotional expenditures, are expected to continue during the fourth quarter, although at a lower level than in earlier quarters, as we continue to assess the sales potential of these markets.



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New Business



During the third quarter of 2017 we made significant progress in our negotiations with multiple major consumer electronics companies to enter into strategic partnerships to develop displays for these companies’ next generation VR/AR applications. We are pursuing what we believe to be the best paths to commercializing our Direct Patterning technology and establishing ourselves as the industry leader in microdisplays for the consumer market. 



Our overarching goal is to secure partnerships with industry leaders in consumer electronics who can help us capitalize on our technology to meet the needs of end users from a cost and performance standpoint.  Our partnership initiatives encompass scaling our product technology, entering into mass production agreements with manufacturing companies which possess capital resources and high volume production capability to enable us to manufacture in the volumes required for the consumer market, and securing sales and distribution channels to end users.



In concert with these efforts, we achieved the following:





During the quarter, we began to experience an improvement in booking activity as we made progress towards our goals of securing new, and expanding existing U.S. and foreign military programs while expanding our presence in foreign military, commercial and industrial markets.  We expect these efforts to result in greater bookings during the second half of 2017 as a whole than were achieved during the first half of 2017.  In the third quarter we booked over 90 new orders totaling more than $6.5 million.  Thirty of these orders were for new projects with existing and new customers and over 60 were follow-on/repeat orders with existing customers.  Among the orders received were: 





In addition, during the quarter we received confirmation from two defense prime contractors that we will be awarded contracts in the fourth quarter totaling over $5.2 million.  These anticipated orders comprise:





Also during the third quarter, we increased our presence in the aviation market with accelerated activity in several key programs.  The aviation market, while representing minimal revenues in previous years, is expected to become a major source of revenues for the Company.



During the quarter we:

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In addition, our development work under the Office of the Secretary of Defense-sponsored Mantech program progressed during the third quarter.  We continue to meet the milestones under this program and expect the project to be substantially completed by year-end 2017.  We believe these efforts will accelerate prototype development in subsequent quarters and enhance the warfighting effectiveness of ground, dismounted and aviation systems.



New Technology Development



We are continuing to make progress in our development of very high brightness full-color microdisplays incorporating our proprietary Direct Patterning technology.   Our latest efforts to improve device performance by modifying the device’s architecture and the materials used resulted in a reduction in power consumption by about 20%.   We have also begun to make progress to extend the functional lifetimes of the displays while continuing to increase the brightness beyond 5,000 nits.



We believe enhancements to the manufacturing processes for the displays are beginning to improve production yields with the initial goal of raising yields by over 50% from the current level. Equipment which is expected to simplify several process steps to improve yields and reduce cycle time was ordered in the third quarter.  Delivery is expected in November 2017 with qualification and implementation anticipated to be completed by second quarter 2018.



In the meantime, we are continuing to ship limited quantities of engineering samples to customers who are exploring applications that can utilize these displays and incorporate them into their existing and planned product lines to achieve superior performance.



To the best of our knowledge, our 2K x 2K displays demonstrate the highest brightness and smallest pixel pitch in the global market today.  We have designed these displays to incorporate the attributes that we believe consumer electronics companies seek for their next generation products including variable persistence and global addressing.  We believe the continued development and demonstration of the advantages of our Direct Patterning technology is integral to driving our growth in the consumer AR/VR markets with consumer electronics companies and to accelerating our discussions with mass production partners.



New Product Development



During the third quarter, we continued to develop both small pixel and large area microdisplay architectures for wearable consumer applications. These efforts are being driven by consumer electronics companies and are aimed at leveraging our Direct Patterning technology for cost effective, large volume production systems.



Qualification of our 2K x 2K microdisplay is progressing as planned with expected completion in the first quarter 2018.  In concert with this effort, we are developing a compact interface for the 2K x 2K microdisplay that will facilitate the integration of the display into optical solutions.  This hardware is targeted to be completed and introduced to the market during the second quarter 2018. 



Employees



At September 30, 2017 we had a total of 98 employees, of whom 95 were full-time employees, as compared to a total of 97 employees, of whom 93 were full-time employees, at December 31, 2016.   

 

A detailed discussion of our business and operations may be found in Part I, “Business,” of our 2016 Annual Report on Form 10-K for the year ended December 31, 2016, and as filed with the Securities and Exchange Commission on March 28, 2017. 



CRITICAL ACCOUNTING POLICIES 

 

Revenue and Cost 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 or determinable, title and risk of loss to the goods has transferred 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.

 

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Revenues from research and development activities 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, labor and subcontractor 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.



Revenues from sales or licenses of intellectual property is recognized when transferred to the customer, provided the license has stand-alone value and the contract provides the right to use the intellectual property as it exists at the point the license is granted, without further obligations by the Company to update the intellectual property after the license is transferred.  If the license does not have standalone value, then the license is combined with other deliverables, such as R&D or manufacturing services into a single unit of account.  Revenue from the single unit of account is recognized when earned, typically as the R&D or manufacturing services are performed over the life of the contract.



Income Taxes 

 

We evaluate our deferred tax assets and their potential realizability each quarter to determine if we should make  any changes to the valuation allowance.  As of September 30, 2017,  we determined that based on all available evidence, both positive and negative, including the Company’s latest forecasts and cumulative losses in recent years, it was more likely than not that none of our deferred tax assets would be realized and therefore, we continued to record a full valuation allowance. 



Other critical accounting policies, as described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, relate to product warranty, use of estimates, fair value of financial instruments and stock-based compensation, and additional information on accounting for income taxes. 



RESULTS OF OPERATIONS 

 

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2017 COMPARED TO THREE AND NINE MONTHS ENDED, SEPTEMBER 30, 2016



Revenues 







Revenues for the three and nine months ended September 30, 2017 were $4.3 million and $15.6 million respectively,  as compared to $4.3 million and $16.8 million, respectively, for the three and nine months ended September 30, 2016.     

 

Product revenue is comprised primarily of sales of displays, as well as sales of other hardware.   For the three and nine months ended September 30, 2017, product revenue increased by $0.5 million and decreased by $0.6 million, respectively, as compared to the three and nine months ended September 30, 2016.  The increase in display revenues in the third quarter of 2017 was primarily due to increased demand by international customers.  The decreased revenue in the year to date period was primarily due to lower demand from maturing military programs, and a larger proportion of sales of displays with lower average unit prices.  The 2017 product revenue in the nine months’ period was favorably impacted by saled of $0.3 million of newly developed Direct Patterned displays supported by R&D efforts.

 

Contract revenue is comprised of revenue from research and development (“R&D”), commercial contracts, or non-recurring engineering (“NRE”) contracts.  For the three and nine months ended September 30, 2017, contract revenue decreased by $0.5 million and increased by $0.3 million, respectively, as compared to the three and nine months ended September 30, 2016, primarily due to the addition of commercial contracts with several major consumer electronics companies earlier in 2017.

 

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License revenue for the nine months ended September 30, 2016 was comprised of revenue from a $1.0 million non-exclusive intellectual property license for our virtual reality headset technology. We produced engineering samples of our 2K x 2K pixel full-color displays in the fourth quarter of 2016 and expect that the licensee will use our 2K x 2K pixel full-color displays in their headsets upon their successful development.



Cost of Revenues







Total cost of revenues is comprised of costs of product and contract revenues.  Cost of product revenue includes materials, labor and manufacturing overhead, warranty costs and depreciation related to our products.  Cost of contract revenue includes direct and allocated indirect costs associated with performance of deliverables under contracts.  Total cost of revenues for the three and nine months ended September 30, 2017 increased by $1.0 million and $1.4 million, respectively, as compared to three and nine months ended September 30, 2016.   Total cost of revenues as a percentage of revenues was 94% and 79%, respectively, for the three and nine month periods ended September 30, 2017, respectively as compared to 70% and 65% for the three and nine month periods ended September 30, 2016.  Revenues for the nine months ended September 30, 2016 included $1.0 million of license revenue that had no associated cost of revenues.



The following table outlines product, contract and license total gross profit and related gross margins for the three and nine month periods ended September 30, 2017 and 2016 (dollars in thousands): 







Total gross profit is a function of revenues less cost of revenues.  The total gross profit for the three and nine months ended September 30, 2017 decreased $1.0 million and $2.6 million, respectively, as compared to the three and nine months ended September 30, 2016 primarily reflecting a decrease in product revenue gross profit in the three and nine month periods.  The total gross margin of 7% for the three months ended September 30, 2017 decreased from gross margin of 30% in the prior year period, primarily due to decreases in product revenues gross margin.  The gross margin of 21% for the nine months ended September 30, 2017 as compared to 35% for the prior year period primarily reflects the favorable impact of the $1.0 million of license revenue in the first quarter of 2016 that had no associated costs of goods sold.



The product gross profit and gross margins for the three months ended September 30, 2017 decreased compared to the prior year period, lower average selling prices in the 2017 period and higher product costs in the 2017 period related to yield losses and lower production volumes.    The product gross profit for the nine months ended September 30, 2017, decreased $1.8 million as compared to the prior year period.   Product gross margins of 16% for the nine months ended September 30, 2017 decreased from 29% in the prior year period due to lower average selling prices for certain product types in the current period and the favorable impacts of higher production volume in the first nine months of 2016.    



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For the three months ended September 30, 2017, contract revenue gross profit was $0.1 million compared to $0.3 million for three months ended September 30, 2016.  Contract revenue gross profit of $1.2 million and gross margin of 47% for the nine months ended September 30, 2017 increased from $1.0 million and 44% in the comparable prior year periods.    Increased contract revenue gross profit in the first nine months of 2017 was due to a higher proportion of commercial contract work performed in the current period and to changes in the nature of both the individual contracts and the work completed during each period.



Operating Expenses 

 





Research and Development (“R&D”).   R&D expenses are company-funded and include salaries and related benefits, development materials and other costs specifically allocated to the development of new technologies and microdisplay products, OLED materials and subsystems.  R&D related costs associated with fulfilling contracts are categorized as contract cost of revenues.  R&D expenses decreased on a percentage basis for the three months and nine months ended September 30, 2017, respectively compared the prior year periods.   R&D costs in the current year reflected a decrease in consumer product R&D partially offset by the work performed on the Company’s Direct Patterning technology including product development and process development associated with the manufacture of the Direct Patterned displays. 



Selling, General and Administrative (“SG&A).   SG&A expenses consist principally of salaries and related benefits, professional services fees and marketing, general corporate, and administrative expenses.  SG&A expenses for the three and nine months ended September 30, 2017, decreased $0.1 million and increased $0.5 million, respectively compared to the comparable prior year periods. 



The increase in SG&A for the nine months ended September 30, 2017 over the prior year periods was largely due to higher spending on professional services, legal, and travel expenses associated with our negotiations with prospective consumer electronics and volume manufacturing partners, and promotional expenses related to our night vision consumer product activities. 



Other Income (Expense), net.  Other income (expense), net consists primarily of interest income earned on cash balances and interest expense.  Other expense, net for the three and nine months ended September 30, 2017, of $29 thousand and $238 thousand, respectively, reflects the write off of $158 thousand of Stillwater related debt issuance costs in May 2017 upon the termination of this facility.



Liquidity and Capital Resources 



For the first nine months of 2017, we had a net loss of $7.3 million and used $8.1 million in operating and investing activities.



Cash flow used in operating activities during the nine months ended September 30, 2017 was $6.9 million, attributable to net loss of $7.3 million partially offset by a net change in operating assets and liabilities of $1.8 million and non-cash expenses of $2.2 million. Cash flow used in operating activities during the nine months ended September 30, 2016 was $5.7 million.

 

Cash used in investing activities during the nine months ended September 30, 2017 was $1.2 million related to equipment purchases primarily to improve manufacturing yields and production capacity.   As of September 30, 2017, we had outstanding commitments to purchase approximately $0.2 million in capital expenditures, and expect to make additional capital expenditures during 2017 to improve our manufacturing and R&D capabilities.   Cash used in investing activities during the nine months ended September 30, 2016 was $1.0 million for equipment purchases. 



Cash provided by financing activities during the nine months ended September 30, 2017 of $4.8 million included net repayments under our credit facility of $0.9 million partially offset by $69 thousand from the exercise of stock options, and proceeds of $5.8 million from a public offering.  There were no financing activities during the prior year period.



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If we are not able to reach our anticipated level of profitability and cash flows over the next twelve months, it may be necessary to take actions to maintain our current levels of operations including; additional borrowings under our credit facilities, raising capital though issuance of equity, debt or equity linked securities, or to reduce our current levels of operations and implement cost reductions or restructuring activities.  As of September 30, 2017, we had cash and working capital of $2.0 million and $10.6 million, respectively, and borrowing availability under the ABL facility, net of borrowings of $0.9 million, of $3.7 million.  



Underwritten Public Offering



On May 24, 2017, we completed an underwritten offering of 3,300,000 shares of its common stock at an offering price of $2.00 and warrants to purchase up to 1,650,000 shares of common stock and realized net proceeds of $5.8 million dollars after underwriting discounts and offering expenses.   The shares and warrants were purchased by a single institutional investor and by Stillwater, LLC, an affiliate.  The Warrants have an exercise price of $2.45 per common share and a term of five years. 



The underlying shares of common stock and warrants issued in this offering completed the allotment of shares allowable for issuance pursuant to a shelf registration statement filed in 2014.  In June 2017, we filed a replacement shelf registration statement that will provide us with the flexibility, subject to certain limitations as a result of our current unaffiliated market capitalization, to raise capital over the next three years from the offering of common stock, preferred stock, warrants, units and debt securities, or any combination of these securities, in one or more future offerings.



Warrant Transaction



On August 18, 2016, we entered into letter agreements with certain of our warrant holders pursuant to which they agreed to exercise warrants to purchase a total of 2,216,500 shares of our common stock, at an exercise price of $2.05 per share, which they acquired in December 2015. 



On August 24, 2016, in consideration for the exercise of the 2,216,500 warrant shares, we issued new common stock purchase warrants (the “New Warrants”) to purchase 2,947,949 shares of our common stock or 1.33 New Warrant share for each warrant share exercised, with an exercise price of $2.60 per share, the approximate market price of the Company’s shares at the date of the letter agreement.  The terms of the warrants are substantially similar to the warrants issued in December 2015.  Similar to the earlier warrants, they are not exercisable for nine months from the date of issuance; and have a term of five and a half years from the issuance date.



We raised approximately $4.3 million in net proceeds from the transaction, which was used for general corporate purposes.



ABL Facility



On December 21, 2016, we entered into an asset based revolving credit facility with a lender that provides for up to a maximum amount of $5 million based on a borrowing base equivalent of 85% of eligible accounts receivable plus the lesser of $2 million or 50% of eligible inventory. The interest on the ABL Facility is equal to the Prime Rate plus 3% but may not be less than 6.5% with a minimum monthly interest payment of $2,000. We are obligated to pay the lender a monthly administrative fee of $1,000 and an annual facility fee equal to 1% of the maximum amount borrowable under the facility. The ABL Facility will automatically renew on December 31, 2019 for a one-year term unless written notice to terminate the Financing Agreement is provided by either party.

 

The ABL Facility is secured by a lien on all receivables, property and the proceeds thereof, credit insurance policies and other insurance relating to the collateral, books, records and other general intangibles, inventory and equipment, proceeds of the collateral and accounts, instruments, chattel paper, and documents.    The ABL Facility contains customary representations and warranties, affirmative and negative covenants and events of default, including a provision that we maintain a minimum tangible net worth of $13 million and a minimum working capital balance of $4 million.   As of September 30, 2017, we had 0.9 million in borrowings outstanding under the Financing Agreement and had unused borrowing availability of $3.7 million.  We were in compliance with all debt covenants.



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Unsecured financing arrangement



On March 24, 2017, we entered into an unsecured debt financing arrangement with Stillwater Trust LLC, an investor who with affiliates collectively control approximately 46% of our outstanding common stock.   Under the financing agreement, we may borrow, through June 30, 2018, up to $2 million for general working capital purposes and up to an additional $3 million should our lender not provide borrowing availability under its normal terms and conditions through its ABL facility.   The agreement expires and borrowings become due upon the earlier of June 30, 2020; the completion of one or a series of equity financings which raise collectively $5 million or greater; or an event of default, as defined in the agreement.  Amounts borrowed under the financing agreement, once repaid, cannot be reborrowed. In accordance with the terms of the agreement, this arrangement expired on May 24, 2017, upon the completion of an equity offering.  Upon termination of this facility, the Company wrote off $158 thousand of related debt issuance costs, and recorded a charge to interest expense in the second quarter of 2017.



The amounts drawn on the line accrue interest at 6% per annum payable at maturity, and are subject to an upfront drawdown fee of 2% of the amount drawn and a quarterly interest surcharge of 2% paid upfront and due commencing on the 180-day anniversary of each draw regardless of whether the draw is still outstanding and then a 2% quarterly interest surcharge until the draws are repaid. In connection with the financing commitment, the investor received a $50,000 commitment fee and a warrant to purchase 100,000 shares of common stock at an exercise price of $2.25 per share, the closing market price of our common stock on the date the arrangement was executed.  In the event we do not raise at least $5 million in proceeds from an equity offering within 180 days of the first draw on the facility, we will be required to file a registered rights offering with the Securities and Exchange Commission within 45 days of the 180-day period to all holders of securities of the Company.  In connection with the facility, we, our lender and the investor entered into an intercreditor agreement.



Mr. Christopher Brody, a member of our board of directors, is also the President and Managing Director of Stillwater Holdings LLC and is the Vice President of Stillwater Trust LLC, which is our largest stockholder. The decision of Stillwater Trust LLC to enter into the financing arrangement was made independently of Mr. Brody and the financing was not required or suggested by Mr. Brody. The terms of the financing were determined solely by negotiation among us and Stillwater Trust LLC. Mr. Brody did not participate in the deliberations of our board or the special committee of our board formed to review the terms of the financing with respect to the approval of the financing and abstained from voting thereon.



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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ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk 



Not applicable.



ITEM 4.  Controls and Procedures 

  

Evaluation of Disclosure Controls and Procedures 

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this Quarterly Report on Form 10-Q.



Our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Based on our evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.



There were no changes in our internal controls over financial reporting during the fiscal quarter ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.



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PART II - OTHER INFORMATION 

 

ITEM 1.  Legal Proceedings



During 2015, the Company received a letter from an attorney representing a former employee claiming damages for age discrimination and wrongful termination.  In September 2016, this former employee commenced action against the Company in Superior Court for the State of Washington. In February 2017, the former employee’s counsel sent a discovery request to the Company.  In October 2017, the parties reached a tentative settlement, subject to payment of an amount not material to the Company, documentation of the terms and the expiration of a revocation period.



ITEM 1A.  Risk Factors   

 

We operate in a rapidly changing environment that involves a number of risks that could materially affect our business, financial condition or future results, some of which are beyond our control. In addition to the other information set forth in this Quarterly Report on Form 10-Q and the risks discussed below, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission, which could materially affect our business, financial condition or future results.



ITEM 2.  Unregistered Sales of Equity Securities and Use of Proceeds   



None







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ITEM 3.  Defaults Upon Senior Securities 

 

None. 



ITEM 4.  Mine Safety Disclosures 

 

Not applicable. 

 

ITEM 5.  Other Information 

 

On November 8, 2017, we entered into Change in Control Agreements (the “Change in Control Agreements”) with four of our executive officers, Steve Costello, Amalkumar Ghosh, Olivier Prache and Jeffrey P. Lucas (each an “Executive”). The Agreements provide that if, within the twelve-month period following a Change in Control of the Company (as defined in the Change in Control Agreements), the Executive suffers a Terminating Event (as defined below and in the Change in Control Agreements), he will be entitled to receive a lump sum cash payment in an amount equal to the Executive’s annual base salary in effect immediately prior to the Terminating Event (or the Executive’s annual base salary in effect immediately prior to the Change in Control, if higher), payable in a lump sum on the termination date, provided that the Executive executes and does not revoke a separation agreement and release in favor of us. In addition, if the Executive was participating in our group health plan immediately prior to termination and elects COBRA health continuation, then we will pay the Executive a monthly cash payment for 12 months or the Executive’s COBRA health continuation period, whichever ends earlier, in an amount equal to the monthly employer contribution that we would have made to provide health insurance to the Executive if he had remained employed by us.



A “Terminating Event” shall be deemed to have occurred under the Agreements if the Executive (i) is terminated by us other than for Cause (as defined in the Change in Control Agreements), death or Disability (as defined in the Change in Control Agreements) or (ii) terminates his employment with the Company for Good Reason (as defined in the Agreements).



The Change in Control Agreements became effective as of November 8, 2017 (the “Effective Date”) and shall terminate upon the earliest of (a) the termination of the Executive’s employment for any reason prior to a Change in Control, (b) the termination of the Executive’s employment with the Company after a Change in Control for any reason other than the occurrence of a Terminating Event or (c) the date which is twelve months and a day after a Change in Control if the Executive is still employed by the Company.



The foregoing description is a summary of the Change in Control Agreements and should be read in conjunction with the full text of the Form of Change in Control Agreement which is attached to this Quarterly Report on Form 10-Q as Exhibit 10.2 and is incorporated herein by reference.

 

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ITEM 6.  Exhibits      



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SIGNATURES 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. 

 

  



 





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