EMAGIN CORP - Quarter Report: 2020 March (Form 10-Q)

 



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549 



 

Form 10-Q 



☑ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended March 31, 2020

Or



☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



 For the transition period from                        to



Commission file number 001-15751 

 

eMAGIN CORPORATION

(Exact name of registrant as specified in its charter) 



 

700 South Drive, Suite 201, Hopewell Junction, NY 12533

(Address of principal executive offices) (Zip Code)

 

(845) 838-7900 

(Registrant’s telephone number, including area code) 



 Securities registered pursuant to Section 12(b) of the Act:





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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    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 the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.





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 in Rule 12b-2 of the Exchange Act)    Yes ☐     No ☑



As of April 30, 2020, there were 53,818,852 common shares at $0.001 par value per share of the registrant outstanding.



---

 



Table of Contents



---

 

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. 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, 2019, and in this Report on Form 10-Q. 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. References to “Consumer Night Vision Business” refers to our consumer night vision products business.



eMagin® is a registered trademark of eMagin Corporation. dPdTM is an unregistered trademark of eMagin. All rights reserved. All other trademarks used in this Report are the property of their respective owners.

---

 



 ITEM 1.  Financial Statements 



eMAGIN CORPORATION 

CONDENSED CONSOLIDATED BALANCE SHEETS 

(In thousands, except share data)

(unaudited) 





See notes to Condensed Consolidated Financial Statements.

---

 

eMAGIN CORPORATION 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 

(In thousands, except share and per share data) 

(unaudited) 







 

See notes to Condensed Consolidated Financial Statements.



---

 

eMAGIN CORPORATION 

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDER’S EQUITY

(In thousands, except share data) 

(unaudited) 



















See notes to Condensed Consolidated Financial Statements



---

 

eMAGIN CORPORATION 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 

(In thousands) 

(unaudited)











 

See notes to Condensed Consolidated Financial Statements.

---

 

eMAGIN CORPORATION 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 

 

 

Note 1 – Description of the Business and 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 interim 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 SEC. The Company believes that the disclosures provided herein are adequate to make the information presented not misleading when these unaudited 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, 2019. The results of operations for the periods ended March 31, 2020 are not necessarily indicative of the results to be expected for the full year. The consolidated financial statements as of December 31, 2019 are derived from audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.



Use of estimates



In accordance with accounting principles generally accepted in the United States of America (“GAAP”), 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. 



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 $2.0 thousand and $9.0 thousand for the three months ended March 31, 2020 and 2019 respectively.



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.



For the three months ended March 31, 2020 and 2019, the Company reported a net loss and as a result, basic and diluted loss per common share are the same. Therefore, in calculating net loss per share amounts, shares underlying the potentially dilutive common stock equivalents were excluded from the calculation of diluted net income per common share because their effect was anti-dilutive.



The following table sets forth the potentially dilutive common stock equivalents for the three months ended March 31, 2020 and 2019 that were not included in diluted EPS as their effect would be anti-dilutive:







Fair Value of Financial Instruments



Cash, cash equivalents, accounts receivable, short-term investments and accounts payable are stated at cost, which approximates fair value, due to the short-term nature of these instruments. The asset based lending facility (the “ABL Facility”) is also stated at cost, which approximates fair value because the interest rate is based on a market based rate plus a margin. 



We have categorized our assets and liabilities that are valued at fair value on a recurring basis into a three-level fair value hierarchy in accordance with GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets and liabilities (Level 1) and lowest priority to unobservable inputs (Level 3).

 

Assets and liabilities recorded in the balance sheets at fair value are categorized based on a hierarchy of inputs as follows:

 

Level 1 – Unadjusted quoted prices in active markets of identical assets or liabilities.

Level 2 – Quoted prices for similar assets or liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.

Level 3 – Unobservable inputs for the asset or liability.

---

 



The common stock warrant liability is currently the only financial asset or liability recorded at fair value on a recurring basis, and is considered a Level 3 liability. The fair value of the common stock warrant liability is included in current liabilities on the Condensed Consolidated Balance Sheets, as the warrants are currently exercisable.



The following table shows the reconciliation of the Level 3 warrant liability measured and recorded at fair value on a recurring basis, using significant unobservable inputs (in thousands):







The fair value of the liability for common stock purchase warrants at issuance and at March 31, 2020 was estimated using the Black Scholes option pricing model based on the market value of the underlying common stock at the measurement date. The remaining contractual term of the warrants ranging from 2.2 to 2.8 years, at risk-free interest rates of 0.5%, with no expected dividends, and expected volatility of the price of the underlying common stock of 73.1%.



Concentrations



The Company purchases principally all of its silicon wafers, which are a key ingredient in its OLED production process, from two suppliers located in Taiwan and Korea.



For the three months ended March 31, 2020, three customers accounted for 19.5%,  14.9%, and 10.2% of net revenues, respectively. For the three months ended March 31, 2019, one customer accounted for 11.0% of net revenues. As of March 31, 2020,  three customers accounted for 34.2%,  16.1%,  and 10.2% of the Company’s consolidated accounts receivable balance.

 

Liquidity and Going Concern



The accompanying consolidated financial statements have been prepared on a going concern basis, which assumes that the Company will continue to operate as a going concern and which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. For the three months ended March 31, 2020, the Company incurred a net loss of $1.4 million and used cash in operating activities of $0.9 million. As of March 31, 2020, the Company had $3.1 million of cash, $2.2 million of outstanding indebtedness and borrowing availability of $0.9 million under its ABL Facility.  For the three months ended March 31, 2020, the Company raised $1.6 million, net of offering expenses, through the sale of shares under its At The Market (“ATM”) facility entered into in November 2019. For the year ended December 31, 2019, the Company incurred a net loss of $4.3 million and used cash in operating activities of $5.1 million.



The COVID-19 pandemic has significantly increased economic and demand uncertainty. It is likely that the current outbreak and continued spread of COVID-19 will cause the economic slowdown to continue, and it is possible that it could cause a global recession. There is a significant degree of uncertainty and lack of visibility as to the extent and duration of the current slowdown or any recession. If either were prolonged, demand for the Company’s products will be significantly harmed. The Company is currently seeing delays in product shipments and is expecting slowing economic conditions to adversely affect its business in the second half of 2020. Given the significant economic uncertainty and volatility created by the pandemic, it is difficult to predict the nature and extent of the impact on demand for the Company’s products. These expectations are subject to change without warning and investors are cautioned not to place undue reliance on them. Unanticipated consequences of the pandemic and resulting economic uncertainty could adversely affect the Company’s liquidity and capital resources in the future as well as its ability to continue as a going concern.



Due to continuing losses, the Company’s financial position, the COVID-19 pandemic, and uncertainty regarding the Company’s ability to borrow under its ABL Facility, or continue to raise funds under its ATM facility, the Company may not be able to meet its financial obligations as they become due without additional financing or sources of capital. Management is prepared to reduce expenses and raise additional capital, but there can be no assurance that the Company will be successful in sufficiently reducing expenses or raising capital to meet its operating needs.



---

 

The Company’s ABL Facility expires on December 31, 2020, and renews automatically for another year unless terminated pursuant to its terms. Although preliminary renewal discussions with the lender are positive there is no assurance the lender will renew or extend this facility, or continue to make funds available during 2020 and beyond at present availability levels, or at all. Therefore, in accordance with applicable accounting guidance, and based on the Company’s current financial condition and availability of funds, there is substantial doubt about the Company’s ability to continue as a going concern through twelve months from the date these financial statements were issued.



The Company has taken actions to increase revenues and to reduce expenses and is considering financing alternatives. In addition, the Company has entered into its ATM Facility. There can be no assurance,  however, that the Company will be successful in sufficiently increasing revenues, mitigating the impacts of COVID-19, reducing expenses or securing additional financing to meet its operating needs. The Company’s plans with regard to these matters include the following actions: 1) focus production and engineering resources on improving manufacturing yields and increasing production volumes, 2) continuing a Work Status Reduction program that began in October 2019 wherein senior management work status was reduced by approximately 20%, 3) reduce headcount and not replace departed employees, 4) reduce discretionary and other expenses, and 5) considering financing and/or strategic alternatives.



Based on the Company’s current projections, operational and yield improvements, and the anticipated availability of the ABL Facility, the Company estimates it will have sufficient liquidity to fund operations through the end of the first quarter of 2021. However, there can be no assurance the Company’s plans will be achieved, or that the Company will be able to continue to borrow under its ABL Facility, continue to raise funds under its ATM facility, secure additional financing, and/or pursue strategic alternatives on terms acceptable to the Company, or at all. The Company’s common stock is listed on the NYSE American, and it is subject to its continued listing requirements, including maintaining certain share prices and a minimum amount of shareholder’s equity. If the Company is unable to comply with the NYSE American continued listing requirements, including its trading price requirements, our common stock may be suspended from trading on and/or delisted from the NYSE American.



Recently adopted accounting pronouncements



The Company's accounting policies are the same as those described in Note 1 to the Company's consolidated financial statements in its Annual Report on Form 10-K for the year ended December 31, 2019.



In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820) a guidance that adds, amends, and removes certain disclosure requirements related to fair value measurements. Among other changes, this standard requires certain additional disclosure surrounding Level 3 assets, including changes in unrealized gains or losses in other comprehensive income and certain inputs in those measurements. This new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The Company adopted the guidance on January 1, 2020, on a prospective basis and such adoption did not have a material impact on our financial statements.



Recently issued accounting pronouncements



In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740) as part of its initiative to reduce complexity in accounting standards. This standard simplify the accounting for income taxes. This new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. This standard may be adopted early, while certain additional disclosure requirements in this standard can be adopted on its effective date. In addition, certain changes in the standard require retrospective adoption, while other changes must be adopted prospectively. The Company does not expect the adoption of this ASU to have a significant impact on the consolidated financial statements.



In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) and subsequently issued amendments. The guidance affects the Company's accounts receivable, and it requires the measurement of expected credit losses to be based on relevant information from past events, including historical experiences, current conditions and reasonable and supportable forecasts that affect collectability. This new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Based on the composition of the Company's receivables, current market conditions and historical credit loss activity, the Company does not expect the adoption of this ASU to have a significant impact on the consolidated financial statements.



---

 

Note 2 – Revenue Recognition



All of the Company’s revenues are earned from contracts with customers and are classified as either Product or Contract revenues. Contracts include R&D activities performed pursuant to written agreements and purchase orders, as well as arrangements that are implied by customary practices or law.



Product revenue is generated primarily from contracts to produce, ship and deliver OLED microdisplays. eMagin’s performance obligations are satisfied, control of our products is transferred, and revenue is recognized at a single point in time when control transfers to our customer for product shipped. Our customary terms are FOB our factory and control is deemed to transfer upon shipment. The Company has elected to treat shipping and other transportation costs charged to customers as fulfillment activities and are recorded in both revenue and cost of sales at the time control is transferred to the customer. As customers are invoiced at the time control transfers and the right to consideration is unconditional at that time, the Company does not maintain contract asset balances for product revenue. Additionally, the Company does not maintain contract liability balances for product revenues, as performance obligations are satisfied prior to customer payment for product. The Company generally offers a one-year product warranty, for replacement of product only, and does not allow returns. The Company offers industry standard payment terms that typically require payment from our customers from 30 to 60 days after title transfers.



The Company also recognizes revenues under the over time method from certain research and development (“R&D”) activities (contract revenues) under both firm fixed-price contracts and cost-type contracts. Progress and revenues from research and development activities relating to firm fixed-price contracts and cost-type contracts are generally recognized on an input method of accounting as costs are incurred. Under the input method, revenue is recognized based on efforts expended to date (e.g., the costs of resources consumed or labor hours worked, or machine hours used) relative to total efforts intended to be expended. 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. Any changes in estimate related to contract accounting are accounted for prospectively over the remaining life of the contract. Under the over time method, billings may not correlate directly to the revenue recognized. Based upon the terms of the specific contract, billings may be in excess of the revenue recognized, in which case the amounts are included in deferred revenues as a liability on the Condensed Consolidated Balance Sheets. Likewise, revenue recognized may exceed customer billings in which case the amounts are reported as unbilled receivables. Unbilled revenues are expected to be billed and collected within one year. The incidental costs related to obtaining product sales contracts are non-recoverable from customers and, accordingly, are expensed as incurred.



Disaggregation of Revenue



The Company sells products directly to military contractors and OEM’s and they use our displays in a diverse range of applications encompassing the military and commercial, including medical and industrial, market sectors. Revenues are classified as either military, commercial, consumer or multiple based on management’s knowledge of the customer’s products and markets served by displays or the R&D contract work. Revenues classified as multiple are for sales to customers that incorporate the Company’s displays in products that could be used for either military or commercial applications. R&D activities are performed for both military customers and U.S. Government defense related agencies and consumer companies. Product and contract revenues are disclosed on the Consolidated Statements of Operations.



Additional disaggregated revenue information for three months ended March 31, 2020 and 2019 were as follows (in thousands):







---

 



Accounts Receivable from Customers



Accounts receivable, net of allowances, associated with revenue from customers were approximately $3.7 million and $4.0 million for the three months ended March 31, 2020 and December 31, 2019, respectively.



Contract Assets and Liabilities



Unbilled Accounts Receivables (Contract Assets) - Pursuant to the over time revenue recognition model, revenue may be recognized prior to the customer being invoiced. An unbilled accounts receivable is recorded to reflect revenue that is recognized when the cost based input method is applied and such revenue exceeds the amount invoiced to the customer. Unbilled receivables are disclosed on the Condensed Consolidated Balance Sheet.



Customer Advances and Deposits (Contract Liabilities) - The Company recognizes a contract liability when it has billed and received consideration from the customer pursuant to the terms of a contract but has not yet recognized the related revenue. These billings in excess of revenue are classified as deferred revenue on the Condensed Consolidated Statements of Operations.



Total contract assets and liabilities consisted of the following amounts (in thousands):





For the three months ended March 31, 2020 and 2019 the Company recognized $30 thousand and $38 thousand of revenue related to its contract liabilities that existed at December 31, 2019 and 2018, respectively.



Remaining Performance Obligations



The Company has elected the practical expedient, which allows disclosure of remaining performance obligations only for contracts with an original duration of greater than one year. Such remaining performance obligations primarily relate to engineering and design services. For the three months ended March 31, 2020, the aggregate amount of the transaction price allocated to remaining performance obligations was $1.0 million. The Company expects to recognize revenue on all of its remaining performance obligations over the next 12 months.

 

---

 

Note 3 – Accounts Receivable, net 



The majority of the Company’s commercial accounts receivable are due from 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):





 

Note 4 – Inventories, net



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



 

Note 5 – Line of Credit 







On December 21, 2016, the Company entered into the ABL Facility with a lender that provides for up to a maximum amount of $5 million based on a borrowing base equivalent to 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 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, 2020 for a one-year term unless written notice to terminate the 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. 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. For the three months ended March 31, 2020, the Company had $2.2 million in borrowings outstanding, had unused borrowing availability of $0.9 million and was in compliance with all financial debt covenants.



Note 6 – Stock 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 months ended March 31, 2020 and 2019 (in thousands): 









At March 31, 2020, total unrecognized compensation costs related to stock options was approximately $0.2 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 0.4 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 applicable yield available at the date of the 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. 



A summary of the Company’s stock option activity for three months ended March 31, 2020 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. The aggregate intrinsic value of options exercised was zero for the three months ended March 31, 2020. The Company issues new shares of common stock upon exercise of stock options.

---

 

 

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 was 0% for the three months ended March 31, 2020 and 2019.  The difference between the effective tax rate of 0% and the U.S. federal statutory rate of 21% for the three months ended March 31, 2020 and 2019 was primarily due to recognizing a full valuation allowance on deferred tax assets.



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 as of March 31, 2020.



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



Due to the Company’s operating loss carry-forwards, 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.



On March 27, 2020, the President of the United States signed the Coronavirus Aid Relief and Economic Security Act (“CARES Act”). The CARES Act provides several provisions that effect businesses from an income tax perspective. Due to the history of the tax losses, most of the CARES Act provisions have no current benefit to the Company. The Company can, however, benefit from one provision which allows for the immediate refund of the Alternative Minimum Tax Credit (“AMT Credit”). The Company has filed an amendment to claim the AMT Credit and is anticipating a refund of $212 thousand.  This tax receivable was recorded during 2017, in Prepaid Expenses and Other Current Assets on the condensed consolidated balance sheet as of March 31, 2020.

 

Note 8 – Commitments and Contingencies 



Equipment Purchase Commitments 



The Company has committed to equipment purchases of approximately $0.2 million at March 31, 2020.



Litigation



From time to time, the Company may become subject to various legal proceedings that are incidental to the ordinary conduct of is business. In March 2019, the Company received a demand letter seeking payment of $0.9 million of outstanding invoices relating to purchased inventory from Suga Electronics Limited, (“Suga”), a contract manufacturer located in China, which manufactured product sold by our consumer night vision business. The Company has responded to the demand letter, and requested that Suga provide substantiation of purchased inventory. On August 1, 2019 the Company was notified by Suga that they intend to pursue arbitration. During September and October, 2019, Company held preliminary discussions with Suga to attempt to reach a settlement, however in November 2019 the Company received a formal request for arbitration which Suga filed with the International Chamber of Commerce (“ICC”). The Company retained local counsel in Hong Kong to represent it before the ICC and in December 2019 filed an answer to Suga’s request for arbitration including a counterclaim seeking repayment of amounts previously paid to Suga. An arbitrator has been appointed and arbitral proceedings for the consideration of the claims and counterclaims are expected to run through the first quarter of 2021. The parties are permitted to settle at any point during the arbitration proceedings.



As disclosed in the financial statements of our Annual Report on Form 10-K for the year ended December 31, 2018, during the quarter ended June 30, 2018, the Company made a decision to exit the Consumer Night Vision Business and accrued approximately $1.0 million related to invoices received for inventory purchased by Suga in anticipation of future production. While the Company believes that it has adequately accrued for the losses and is in discussions to resolve related claims by the contract manufacturers, there is the risk that additional losses or litigation related expenses may be incurred above the amounts accrued for as of March 31, 2020 if the Company fails to resolve these claims in a timely and/or favorable manner.

 

---

 

Note 9 – Warrants



The Company accounts for common stock warrants pursuant to applicable accounting guidance contained in ASC 815, "Derivatives and Hedging - Contracts in Entity's Own Equity" and makes a determination as to their treatment as either equity instruments or a warrant liability based on an analysis of the underlying warrant agreements.









Equity classified warrants



The 2015, 2016, and 2019 warrants share similar terms, and the exercise price of the Warrant Shares are subject to adjustment in the event of any stock dividends and splits, reverse stock splits, stock dividends, recapitalizations, reorganizations or similar transactions. The Warrants will be exercisable on a “cashless” basis in certain circumstances, including in the event a registration statement is not in effect at time of exercise. The warrant agreements contain a clause specifying that in the event there is no effective registration in effect for the underlying warrant shares to be issued at time of exercise, in no circumstance will the Company be required to net cash settle the warrants.



Based on the Company’s analysis of the terms and conditions of the warrants, the Company has concluded that they meet the conditions outlined in applicable accounting guidance to be classified as equity instruments. As a result, the Company has accounted for the exercise price paid by investors for purchase of the pre-funded warrants as additional paid in capital on the accompanying Balance Sheets.



Liability classified warrants



The 2017 and 2018 warrants have alternative settlement provisions that, at the option of the holder, provide for physical settlement or if, at the time of settlement there is no effective registration statement, a cashless exercise as defined in the warrant agreement.



Based on analysis of the underlying warrant agreement and applicable accounting guidance, the Company concluded that these registered warrants require the issuance of registered securities upon exercise and do not sufficiently preclude an implied right to net cash settlement. Accordingly, these warrants were classified in the accompanying Consolidated Balance Sheet as a current liability upon issuance and will be revalued at each subsequent balance sheet date.



The fair value of the liability for common stock purchase warrants is estimated using the Black Scholes option pricing model based on the market value of the underlying common stock at the measurement date, the contractual term of the warrant, risk-free interest rates, expected dividends and expected volatility of the price of the underlying common stock.



---

 

Based on the Black Sholes method the fair value of the Company’s warrants are as follows (in thousands):













 

Note 10 – Leases



The Company leases office and manufacturing facilities in Hopewell Junction, NY under a non-cancelable operating lease agreement. The lease for these facilities, as amended, expires in May 2024 and does not contain a renewal option. The lease agreement does not contain any residual value guarantees, or material restrictive covenants.



The Company also leases an office facility for its design group in Santa Clara, California. During the fourth quarter of 2019, the Company signed a two-year extension of this lease that expires on October 31, 2021. The lease agreement does not contain any residual value guarantees or material restrictive covenants.



The Company's operating leases generally do not provide an implicit rate, and therefore the Company uses its incremental borrowing rate as the discount rate when measuring operating lease liabilities. The incremental borrowing rate represents an estimate of the interest rate the Company would incur at lease commencement to borrow an amount equal to the lease payments on a collateralized basis over the term of a lease within a particular currency environment. The Company used incremental borrowing rates as of January 1, 2019 for operating leases that commenced prior to that date.



The components of lease expense were as follows (in thousands):

















---

 





Future annual minimum lease payments and finance lease commitments as of March 31, 2020 were as follows (in thousands):

















Note 11 – Shareholders’ Equity



Equity Raises



On February 13, 2020, the Company entered into an amendment to its ATM facility, dated November 22, 2019, with H. C. Wainwright & Co., LLC (“Wainwright”). The amendment modifies the agreement to increase the aggregate offering price up to $2.5 million related to shares that the Company may offer and sell through Wainwright from time to time. The Company intends to use the net proceeds from sales made under the ATM offering for working capital and other general corporate purposes. During the quarter ended March 31, 2020 the Company raised $1.6 million, net of offering expenses, through the sale of shares under the ATM facility.



---

 

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



The following discussion should be read in conjunction with our financial statements and notes thereto. Our fiscal year ends December 31. This Report contains certain forward‑looking statements including, among others, anticipated trends in our financial condition and results of operations and our business strategy. These forward‑looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Please see "Statement Regarding Forward-Looking Information" and Part II, Item 1A, "Risk Factors". Actual results could differ materially from these forward‑looking statements. Important factors to consider in evaluating such forward‑looking statements include changes in external factors or in our internal budgeting process which might impact trends in our results of operations, unanticipated working capital or other cash requirements, changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the industries in which we operate, and various competitive market factors that may prevent us from competing successfully in the marketplace. Forward-looking statements do not represent our views as of any date other than the date of this Report.



Business



We design, develop, manufacture and market organic light emitting diode, or OLED miniature displays, which we refer to as OLED-on silicon microdisplays, virtual imaging products that utilize OLED microdisplays, and related products. We also perform research in the OLED field. Our virtual imaging products integrate OLED technology with silicon chips to produce high-resolution microdisplays which, when viewed through a magnifying headset, create virtual images that appear comparable in size to that of a computer monitor or a large‑screen television. Our products enable our original equipment manufacturer, or OEM, customers in the military and commercial markets to develop and market improved or new electronic products.



We believe that our OLED microdisplays offer a number of significant advantages over comparable liquid crystal microdisplays, including higher contrast, greater power efficiency, less weight, more compact size, and negligible image smearing. Using our active matrix OLED technology, many computer and electronic system functions can be built directly into the OLED microdisplays silicon backplane, resulting in compact, high resolution and power efficient systems. Already proven in military and commercial systems, our product portfolio of OLED microdisplays deliver high‑resolution, virtual images that perform effectively even in extreme temperatures and high‑vibration conditions.



We have been deemed to be an essential business in New York State and have continued to produce and ship products during the COVID-19 pandemic. We have implemented employee health and safety measures per Centers for Disease Control and Prevention, or CDC, guidelines and continued to supply products to our customers as well as maintain continuity in our supply chain and expect to continue our operations throughout the duration of the pandemic and beyond. To date we have experienced disruptions in supply, had two employees test positive for the COVID-19 virus and had to close our facilities for cleaning purposes. There is no assurance that our operations will not be disrupted in the future by additional impacts of the COVID-19 virus on either our internal operations or those of our suppliers or customers. In addition, please review the various risk factors relating to the COVID-19 pandemic discussed in Part II, Item 1A of this Report. 



During the fourth quarter of 2018, equipment issues led to lower yields and decreased production volumes, which resulted in a lower gross margin and reduced display revenues. Although we began implementing remedial production measures during the fourth quarter of 2018, manufacturing issues continued into the second quarter of 2019, resulting in shipments for the second quarter of fiscal 2019 that were less than forecast and yields and production volumes that were below pre-fourth quarter 2018 levels. As a result, early in the third quarter of 2019 we began accelerating the implementation of remedial measures. There can be no assurance as to the ongoing effectiveness of any remedial measures we have implemented or that yields and production volumes will return to the levels previously achieved.



As a result of these efforts, production yields in the second half of 2019 improved over yields experienced in the first half of 2019 and production volumes were up over 50% during the second half of 2019 as compared to the first half of 2019 reflecting greater second half demand, which increased revenues and reduced unit costs. As a result of the improvements in manufacturing efficiency and throughput, our on time delivery of customer orders reached levels of over 95% during the third and fourth quarter of 2019 and continued through the first quarter of 2020. During the first quarter of 2020, our yields were consistent with the second half of 2019; however, our gross margin declined slightly over the year ago period, due to lower production volumes. Our backlog at March 31, 2020 was $13.3 million compared to backlog of $11.7 million at December 31, 2019 reflecting increased bookings during the quarter.



During the fourth quarter of 2019, we also implemented spending reductions and controls to reduce our overall cost structure. These measures lowered our overall spending as evidenced by the reduction during the second quarter of our research and development, or R&D, and Selling, General and Administrative, or SG&A, expenses both year-over-year and sequentially quarter-to-quarter. These measures included a work status reduction, or Work Status Reduction, with the objective of reducing expenses and saving cash. Pursuant to the Work Status Reduction, the work status of each of our executive officers was reduced by twenty percent (20%) and the work status of certain of our vice presidents was reduced by either twenty percent (20%) or ten percent (10%). We also negotiated

---

 

reductions in service fees, which are expected to further reduce our expenses going forward.



During the quarter, we shipped a significant amount of product for the ENVG-B program. The improved design of the wafers for the next generation F-35 HMD systems was recently completed with first shipments planned for later in the year. In addition, we received awards for two-multiyear U.S. helicopter helmet programs, one of which is for a new program with deliveries starting in the second quarter and the other, an upgrade, which will begin shipping in the fourth quarter. Finally, we received an order from a European military customer for displays used in shoulder fired weapon systems. Our USA-based design and manufacturing, combined with in-house advanced backplane design, and the promise of our Direct Patterning Display (dPdTM) technology continues to give us a competitive advantage more than ever before in these markets.



Consumer, medical, and military customers are increasingly turning to eMagin because of our technological leadership in display brightness and resolution. This leadership in brightness is further demonstrated by our proprietary dPdTM capability. Unlike traditional OLEDs that produce colors by using a white source with filters that eliminate about 80% of the emitted light, with dPdTM, we make full color displays by directly depositing each of the primary color materials (RGB) on respective sub-pixels, without the use of filters. This advanced technology gives us an increase in brightness of over 10X versus the competition and we are on track to achieve 10,000 cd/m2 by Q4 2020, and expect to achieve a brightness level of over 28,000 cd/m2  ready for mass production of full color displays by 2023. We achieved the highest monochrome brightness levels in the market years ago and are continuing our leadership with color displays. Display brightness is critical for AR/VR devices because of optics inefficiency and the need to eliminate motion artifacts. This is especially important for Heads Up Display’s (HUDs) used in bright, daylight environments.



Liquidity and Going Concern



As explained below under Liquidity and Capital Resources, the accompanying consolidated financial statements have been prepared on the going concern basis, which assumes we will continue to operate as a going concern and which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. However due to continuing losses, our financial position, and uncertainty regarding our ability to borrow under the ABL Facility, or continue to raise funds under our at the market facility, or ATM, facility, we may not be able to meet our financial obligations as they become due without additional financing or sources of capital.



For the three months ended March 31, 2020, we incurred a net loss of $1.4 million and used cash in operating activities of $0.9 million. At March 31, 2020, we had $3.1 million of cash, net working capital of $9.2 million, $2.2 million of outstanding indebtedness and borrowing availability of $0.9 million under the ABL Facility.  For the three months ended March 31, 2020, we raised $1.6 million, net of offering expenses, through the sale of shares under our At The Market (“ATM”) facility entered into in November 2019. This is in comparison with cash and working capital of $3.5 million and $8.8 million, respectively, $2.9 million debt outstanding and borrowing availability under the ABL Facility of $1.2 million at December 31, 2019. Net cash used in operating activities for the year ended March 31, 2020 was $0.9 million, compared to $2.3 million for the year ended March 31, 2019. Our backlog at March 31, 2020 was $13.3 million compared to backlog of $11.7 million at December 31, 2019.



The COVID-19 pandemic has significantly increased economic and demand uncertainty. It is likely that the current outbreak and continued spread of COVID-19 will cause the economic slowdown to continue, and it is possible that it could cause a global recession. There is a significant degree of uncertainty and lack of visibility as to the extent and duration of the current slowdown or any recession. If either were prolonged, demand for our products will be significantly harmed. We are currently seeing delays in product shipments and are expecting slowing economic conditions to adversely affect our business in the second half of 2020. Given the significant economic uncertainty and volatility created by the pandemic, it is difficult to predict the nature and extent of the impact on demand for our products. These expectations are subject to change without warning and investors are cautioned not to place undue reliance on them. Unanticipated consequences of the pandemic and resulting economic uncertainty could adversely affect our liquidity and capital resources in the future as well as our ability to continue as a going concern.



We have taken actions to increase revenues and to reduce expenses and are considering financing alternatives, but there can be no assurance that we will be successful in sufficiently increasing revenues, mitigating the impacts of COVID-19, reducing expenses or securing additional financing to meet our operating needs. The Company’s plans with regard to these matters include the following actions: 1) focus production and engineering resources on improving manufacturing yields and increasing production volumes, 2) continuing a Work Status Reduction program that began in October 2019 wherein senior management work status was reduced by approximately 20%, 3) reduce headcount and not replace departed employees, 4) reduce discretionary and other expenses, and 5) considering financing and/or strategic alternatives.



Based on our current projections, operational and yield improvements, and the anticipated availability of the ABL Facility, we estimate we will have sufficient liquidity to fund operations through the end of the first quarter of 2021. However, there can be no assurance our plans will be achieved, or that we will be able to continue to borrow under our ABL Facility, continue to raise funds under our ATM facility, secure additional financing, and/or pursue strategic alternatives on terms acceptable to us, or at all. Our common stock

---

 

is listed on the NYSE American, and we are subject to its continued listing requirements, including maintaining certain share prices and a minimum amount of shareholder’s equity. If we are unable to comply with the NYSE American continued listing requirements, including its trading price requirements, our common stock may be suspended from trading on and/or delisted from the NYSE American.



In addition, even if we successfully generate additional funds through the sale of additional equity securities, borrowings or alternative financing, there can be no assurances that the revenue or capital infusion will be sufficient to enable the Company to develop its business to a level where it will be profitable or generate positive cash flow. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders could be significantly diluted, and these newly issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we incur additional debt, a substantial portion of its operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, thus limiting funds available for our operational business activities. The terms of any debt securities issued could also impose significant restrictions on our operations. In addition, broad market and industry factors may seriously harm the market price of our common stock, regardless of its operating performance, and may adversely impact its ability to raise additional funds.



Critical Accounting Policies



Please refer to the information provided under the heading "Critical Accounting Policies and Estimates" included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 11, 2020, for a discussion of our critical accounting policies. There were no material changes to such policies in the quarter ended March 31, 2020. New accounting policies adopted during the quarter are described in Note 1, "Summary of Significant Accounting Policies," to our unaudited consolidated financial statements included in this Report.

---

 

Results of Operations 

 

Comparative results of operations for the three months ended March 31, 2020 and 2019 (in thousands):



Revenues 







Revenues for the three months ended March 31, 2020 and 2019 were $6.7 million and $6.1 million, respectively.



Product revenue is comprised primarily of sales of displays as well as sales of other hardware. For the three months ended March 31, 2020 product revenue increased by $0.1 million, from the comparable prior year period. The increase in display revenues during the three months ended March 31, 2020 was primarily due to changes in the mix of display types, resulting in displays shipped at higher average selling prices, as compared to the three months ended March 31, 2019. Revenues in 2019 were impacted by manufacturing challenges that began in the fourth quarter of 2018 and continued through the second quarter of 2019, which affected yields and throughput and resulted in lower than planned shipments during the first six months of 2019.



Contract revenue is comprised of revenue from R&D and non-recurring engineering contracts. For the three months ended March 31, 2020, contract revenue increased by $0.5 million, from the comparable prior year period. The increase in contract revenue was primarily due a project to design a display for a Tier One customer in the consumer space.



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. Total cost of revenues for the three months ended March 31, 2020 increased by $0.5 million, from the comparable prior year period due to increased revenues in three months ended March 31, 2020.



The following table outlines product and contract total gross profit and related gross margins for the three months ended March 31, 2020 and 2019 (dollars in thousands): 







Total gross profit is a function of revenues less cost of revenues. Gross profit for the three months ended March 31, 2020 increased $0.1 million, from the comparable prior year period primarily reflecting increased contract revenue gross profit in the three months ended March 31, 2020. Total gross margin was 21% and 22% for the three months ended March 31, 2020 and 2019, respectively.



---

 

The product gross profit for the three months ended March 31, 2020 decreased from the comparable prior year period because of lower production volumes in the three months ended March 31, 2020 compared to the prior year period, and the resultant decrease of product costs capitalized into finished good inventory. The decrease in product gross margins for the three months ended March 31, 2020, were impacted by the lowered production volumes as compared to the prior year period.



Contract gross margin is dependent upon the mix of internal versus external third party costs and materials, with the external third party costs and materials causing a lower gross margin and reducing the contract gross profit. For the three months ended March 31, 2020, contract revenue gross profit was $0.6 million compared to $0.3 million for the prior year period. Increased contract revenue gross profit in the three months ended March 31, 2020 was primarily due to the increase in contract revenues related to design work for a Tier One customer.



Operating Expenses 







Research and Development



R&D expenses are company funded and are primarily compromised of salaries and related benefits, development materials and other costs specifically allocated to the development of new technologies, microdisplay products, OLED technologies and production processes. R&D related costs associated with fulfilling contracts are categorized as contract cost of revenues. R&D expenses were $1.0 million and $1.6 million for the three months ended March 31, 2020 and 2019 respectively. The decrease in R&D costs in the first quarter of 2020 reflects increased allocations of R&D expenses to contracts related to the increases in contract revenues.



Selling, General and Administrative 



SG&A expenses consist primarily of personnel expenses, professional services fees, as well as other marketing, general corporate and administrative expenses. SG&A expenses were $1.8 million and $1.9 million for the three months ended March 31, 2020 and 2019, respectively. The decrease was primarily due to lower spending salaries resulting from a 20% work status reduction implemented in October 2019 and reductions in non-cash compensation related to a reduction in the amount of stock options granted to the Board of Directors that took effect in December 2019.



Other Income (Expense)



Other income (expense), net consists of changes in the fair value of warrant liability as well as interest income earned on cash balances. Income or expenses related to the change in fair value of warrant liability were $20 thousand and $0.8 million, for the three months ended March 31, 2020 and 2019, respectively. This non-cash income or expense is associated with changes in the liability related to registered warrants issued in May 2017 and January 2018. We are required to revalue warrants classified on our balance sheet as a liability at the end of each reporting period and reflect a gain or loss from the change in fair value in the period in which the change occurred. We calculate the fair value of the warrants outstanding using the Black-Scholes model.



Liquidity and Capital Resources



For the three months ended March 31, 2020, we had $3.1 million in cash, working capital of $9.2 million and borrowings outstanding and borrowing availability under the ABL Facility of $2.2 million and $0.9 million, respectively. This is in comparison with $3.5 million in cash, working capital and $8.8 million and borrowings outstanding and borrowing availability under the ABL Facility of $2.9 million and $1.2 million, respectively, at December 31, 2019.



For the three months ended March 31, 2020 cash used in operating activities were $0.9 million, which was attributable to a net loss of $1.4 million and changes in operating assets and liabilities of $0.3 million, partially offset by non-cash income and expenses of $0.7 million. Cash used in operating activities for the three months ended March 31, 2019 was $2.3 million.

 

---

 

For three months ended March 31, 2020 cash used in investing activities was $0.3 million related to equipment purchases primarily to improve manufacturing yields and production capacity and to advance the Company’s dPdTM technology. As of March 31, 2020, we had outstanding commitments to purchase approximately $0.2 million in capital expenditures, and expect to make additional capital expenditures during the remainder of 2020 to improve our manufacturing and R&D capabilities. Cash used in investing activities during the three months ended March 31, 2019 was $0.2 million for equipment purchases.



For the three months ended March 31, 2020, cash provided by financing activities was $0.9 million, from equity financing with net proceeds of $1.6 million offset by net repayments of $0.7 million under our credit facility. Net cash provided by financing activities during the three months ended March 31, 2019 was $2.6 million.



Going concern



For the three months ended March 31, 2020, we incurred a net loss of $1.4 million and used cash in operating activities of $0.9 million. At March 31, 2020, we had cash and cash equivalents of $3.1 million, net working capital of $9.2 million, $2.2 million of debt outstanding under our ABL Facility and borrowing availability of $0.9 million.



Due to continuing losses, the Company’s financial position, uncertainty related to the COVID-19 pandemic described above, and uncertainty regarding the Company’s ability to borrow under its ABL Facility, or continue to raise funds under its ATM facility, the Company may not be able to meet its financial obligations as they become due without additional financing or sources of capital. Management is prepared to reduce expenses and raise additional capital, but there can be no assurance that the Company will be successful in sufficiently reducing expenses or raising capital to meet its operating needs.



The Company’s ABL Facility expires on December 31, 2020 and renews automatically for another year unless terminated pursuant to its terms. Although preliminary renewal discussions with the lender are positive there is no assurance the lender will renew or extend this facility, or continue to make funds available during 2020 and beyond at present availability levels, or at all. Therefore, in accordance with applicable accounting guidance, and based on the Company’s current financial condition and availability of funds, there is substantial doubt about the Company’s ability to continue as a going concern through twelve months from the date these financial statements were issued.



The Company has taken actions to increase revenues and to reduce expenses and is considering financing alternatives, but there can be no assurance that the Company will be successful in sufficiently increasing revenues, mitigating the impact of COVID-19, reducing expenses or securing additional financing to meet its operating needs. The Company’s plans with regard to these matters include the following actions: 1) focus production and engineering resources on improving manufacturing yields and increasing production volumes, 2) continuing a Work Status Reduction program that began in October 2019 wherein senior management work status was reduced by approximately 20%, 3) reduce headcount and not replace departed employees, 4) reduce discretionary and other expenses, and 5) considering financing and/or strategic alternatives.



Equity Raises



On February 13, 2020, we amended our ATM facility, dated November 22, 2019, with Wainwright. The amendment modifies the agreement to increase the aggregate offering price up to $2.5 million related to shares that we may offer and sell through Wainwright from time to time. The Company intends to use the net proceeds from sales made under the ATM offering for working capital and other general corporate purposes. During the quarter ended March 31, 2020, we raised $1.6 million, net of offering expenses, through the sale of shares under the ATM facility.



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, 2020 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 March 31, 2020, we had $2.2 million in borrowings, had unused borrowing availability of $0.9 million and were in compliance with all financial debt covenants.

---

 



Off-Balance Sheet Arrangements 



We have no 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. 



---

 

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 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.



Changes in Internal Control Over Financial Reporting



During the quarter ended March 31, 2020, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. As a result of the COVID-19 pandemic, the majority of our finance and administrative workforce began working remotely in March 2020. These changes to the working environment did not have a material effect on our internal controls over financial reporting during the most recent quarter. We are continually monitoring and assessing the COVID-19 pandemic on our internal controls to minimize the impact on their design and operating effectiveness.



PART II - OTHER INFORMATION

 

ITEM 1.   Legal Proceedings



From time to time, we may become subject to various legal proceedings that are incidental to the ordinary conduct of our business. In March 2019, we received a demand letter seeking payment of $0.9 million of outstanding invoices relating to purchased inventory from Suga Electronics Limited, or Suga, a contract manufacturer located in China, which manufactured product sold by our consumer night vision business. We have responded to the demand letter, and requested that Suga provide substantiation of purchased inventory. On August 1, 2019 we were notified by Suga that they intend to pursue arbitration. During September and October, 2019, we held preliminary discussions with Suga to attempt to reach a settlement, however in November 2019 we received a formal request for arbitration which Suga filed with the International Chamber of Commerce or ICC. We retained local counsel in Hong Kong to represent it before the ICC and in December 2019 filed an answer to Suga’s request for arbitration including a counterclaim seeking repayment of amounts previously paid to Suga. An arbitrator has been appointed and arbitral proceedings for the consideration of the claims and counterclaims are expected to run through the first quarter of 2021. The parties are permitted to settle at any point during the arbitration proceedings.



As disclosed in the financial statements in our Annual Report on Form 10-K for the year ended December 31, 2018, during the quarter ended June 30, 2018, we made a decision to exit the consumer night vision business and accrued approximately $1.0 million related to invoices received for inventory purchased by Suga in anticipation of future production. While we believe that we have adequately accrued for the losses and are in discussions to resolve related claims by the contract manufacturers, there is the risk that additional losses or litigation related expenses may be incurred above the amounts accrued for as of September 30, 2019, if we fail to resolve these claims in a timely and/or favorable manner



---

 

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 Report and the risks discussed below, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our 2019 Form 10-K. In addition to our discussion in the MD&A, and other sections of this report, to address effects of the COVID-19 pandemic, we have provided an additional risk factor regarding COVID-19 below. The impact of COVID-19 can also exacerbate other risks discussed in the “Risk Factors” sections of our 2019 Form 10-K and this Report, which could in turn have a material adverse effect on us. The “Risk Factors” section in our 2019 Form 10-K otherwise remains current in all material respects. The risks discussed below and in the “Risk Factors” section in our 2019 Form 10-K do not identify all risks that we face—our operations could also be affected by factors that are not presently known to us or that we currently consider to be immaterial to our operations. Due to risks and uncertainties, known and unknown, our past financial results may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods.



The COVID-19 pandemic has affected our business and could materially adversely affect our financial condition and results of operations and ability to continue as a going concern.



The novel strain of the coronavirus identified in China in late 2019 (COVID-19) has globally spread throughout Asia, Europe, the Middle East, and North America and has resulted in authorities imposing, and businesses and individuals implementing, numerous unprecedented measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter-in-place/stay-at-home and social distancing orders, and shutdowns. These measures have impacted and may further impact our workforce and operations, the operations of our customers, and those of our respective vendors, suppliers, and partners.



The COVID-19 pandemic has impacted our business. We experienced closures of sections of our plant that lasted between one and two weeks after two of our employees tested positive for COVID-19. During the closures, we were unable to complete certain manufacturing stages and unable to ship some of our products. We have also experienced production disruptions related to the unwillingness or inability of certain of our equipment repair vendors to travel to our facility, the temporary loss of services of employees quarantined due to COVID-19 and delays in the supply of raw materials caused by disruptions due to COVID-19 at one of our vendors. Any period of interrupted access to our manufacturing facilities or our workforce, or similar limitations for our vendors and suppliers, can impact our ability to meet customer demand and could have a material adverse effect on our financial condition and results of operations, particularly if prolonged. In addition, if we are unable to continue regularly scheduled maintenance of our manufacturing equipment, our manufacturing capabilities may be negatively impacted and we may experience further unscheduled closures and/or production disruptions, which could have a material adverse effect on our financial condition and results of operations.



Due to the measures implemented to contain the COVID-19 outbreak, our suppliers, located both inside and outside of the United States, may have limited supplies of, or may be unable to produce, the components we use to manufacture our products. Any significant disruption in the supply of such components could impair our ability to satisfy customer orders, which could have a material adverse effect on our financial condition and results of operations. In addition, there has been an increase in demand, both inside and outside of the United States, for the personal protective equipment, or PPE, we use in our manufacturing facilities in order to maintain a safe working environment. If we are unable to obtain the required PPE, we may have to temporarily close certain sectors of our facilities until the needed supplies are obtained, which could have a material adverse effect on our financial condition and results of operations.



Certain of our customers have experienced, and may continue to experience, disruptions in their operations and supply chains, which can result in delayed, reduced, or canceled orders, or collection risks, and which may adversely affect our results of operations. We have been notified that certain of our customers are requesting delays in product deliveries due to plant closures related to COVID-19. In April, the US Defense Department announced a three-month slowdown in equipment procurement related to COVID-19. Due to shelter-in-place and similar measures, which restrict, and in some cases prohibit, elective medical procedures, in the future we may also experience delayed, reduced or canceled orders from our customers in the medical market sector. Any existing or future delays, reductions or cancellation of orders from our customers military, commercial or consumer market customers may adversely affect our results of operations.



Escalating trade tensions between the U.S. and China have led to increased tariffs and trade restrictions and have affected customer ordering patterns. The U.S. has imposed restrictions on the export of U.S.-regulated products and technology to our international customers, including those located in China. As a result of the COVID-19 pandemic, we believe there is a risk that U.S. laws and regulations governing the export of goods and technology, including the EAR and ITAR, may be revised to impose even tighter restrictions, which could negatively impact our ability to successfully market and sell our non-military products to customers located in China. Existing and future restrictions could also potentially interfere with our ability to pursue manufacturing in China and our efforts to partner with consumer companies who might seek to build displays using our technology at high volume manufacturing facilities located in China.



---

 

The spread of COVID-19 has caused us to modify our business practices (including employee travel, employee work locations, cancellation of physical participation in meetings, events and conferences, and social distancing measures), and we may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers, partners, vendors, and suppliers. Work-from-home and other measures introduce additional operational risks, including cybersecurity risks, and have affected the way we conduct our activities, which could have an adverse effect on our operations. Due to the increase in employees working from home and accessing our network and systems remotely, we face increased risk of security breaches and other disruptions which could compromise our information technology systems, and expose to liability, theft of sensitive data or damage to our reputation. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus, and future employee virus or workforce disruptions could lead to unavailability of key personnel and harm our ability to perform critical functions. In addition, our ability to attract, recruit and retain highly skilled and qualified technical and consulting personnel or other employees may be impacted by COVID-19 travel restrictions, and other COVID-19 health concerns related to relocation on the part of potential employees and their families.



The pandemic has significantly increased economic and demand uncertainty. It is likely that the current outbreak and continued spread of COVID-19 will cause the economic slowdown to continue, and it is possible that it could cause a global recession. There is a significant degree of uncertainty and lack of visibility as to the extent and duration of the current slowdown or any recession. If either were prolonged, demand for our products will be significantly harmed. We are currently seeing delays in product shipments. Slowing economic conditions could adversely affect our business in the second half of 2020. Given the significant economic uncertainty and volatility created by the pandemic, it is difficult to predict the nature and extent of the impact on demand for our products. These expectations are subject to change without warning and investors are cautioned not to place undue reliance on them. Unanticipated consequences of the pandemic and resulting economic uncertainty could adversely affect our liquidity and capital resources in the future as well as our ability to continue as a going concern.



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



None.



ITEM 3.   Defaults Upon Senior Securities 



None. 



ITEM 4.   Mine Safety Disclosures 



Not applicable. 



ITEM 5.   Other Information 



None. 



---

 

ITEM 6.   Exhibits



---

 

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. 

 

Date: May 14, 2020







---