March 31, 2005 Form 10QSB

U.S. Securities and Exchange Commission
Washington, D.C. 20549

 
FORM 10-QSB

(Mark One)

[X] Quarterly report under section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 2005

[   ] Transition report under section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ____________ to ________________


eMAGIN CORPORATION
(Exact name of small business issuer as specified in its charter)

Commission file number: 000-24757

 
 DELAWARE
  56-1764501
 
 
 (State or other jurisdiction
  (IRS Employer Identification No.)
 
 of incorporation or organiztion)
    
 
 

2070 Route 52
Hopewell Junction, New York 12533
(Address of principal executive offices)

(845) 838-7900
(Issuer's telephone number)
___________________

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]

As of April 28, 2005 the Registrant had 82,172,176 shares of Common Stock outstanding.

TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (check one): Yes [ ] No [X]
 
 

 
 PART I. FINANCIAL INFORMATION
 Page Number
     
 Index    
     
 Item 1.  
 
 3
 
 4
 
 5
 
 6
 
 7
     
 Item 2.
 11
     
 Item 3.
 20
     
 PART II.       OTHER INFORMATION  
     
 Item 1.
Legal Proceedings
 21
 Item 2.
Changes in Securities and Use of Proceeds
 21
 Item 3.
Defaults Upon Senior Securities
 21
 Item 4.
Submission of Matters to a Vote of Security Holders
 21
 Item 5.
Other Information
 21
 Item 6.
Exhibits
 21
     
 SIGNATURE SIGNATURE PAGE
 22
     
 CERTIFICATION  
 30
     
 31.1  
 31.2  
 32.1  
 32.2  
 
 
 
eMAGIN CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands)
 
 
 ASSETS
  
March 31, 2005 
  
December 31, 2004 
 
 CURRENT ASSETS:  
(Unaudited) 
    
 Cash and cash equivalents 
  $10,769   $13,457  
 Accounts receivables, net 
  507   536  
 Inventory 
  2,926   2,018  
 Prepaid expenses and other current assets 
  500   880  
Total current assets 
  14,702   16,891  
        
 EQUIPMENT AND LEASEHOLD IMPROVEMENTS:  4,304   4,072  
 Less: Accumulated depreciation   (2,956)  (2,767) 
 Total equipment and leasehold improvements, net   1,348   1,305  
        
 Intangible assets   64   56  
 Less: Accumulated amortization   (3)  (2) 
 Total intangible assets, net   61   54  
 Other long-term assets   151   186  
Total assets 
  $16,262   $18,436  
        
 LIABILITIES AND SHAREHOLDERS' EQUITY
       
 CURRENT LIABILITIES:       
 Accounts payable 
  $824   $822  
 Accrued payroll and benefits 
  577   674  
 Other accrued expenses 
  529   357  
 Advanced payments 
  18   64  
 Current portion of capitalized lease obligation 
  15   14  
 Other current liabilities 
  45   35  
Total current liabilities 
  2,008   1,966  
 Capitalized lease obligations - long term  18   22  
Total liabilities 
  2,026   1,988  
        
 SHAREHOLDERS' EQUITY:       
 Common stock, par value $0.001 per share
       
Shares authorized - 100,000,000
       
Shares issued and outstanding - 82,072,176 and 79,638,817 
  82   80  
 Additional paid-in capital 
  166,654   165,399  
 Accumulated deficit 
  (152,500)  (149,031) 
Total shareholders' equity 
  14,236   16,448  
 
 
 
Total liabilities and shareholders' equity 
  $16,262   $18,436  
 See notes to financial statements.
 
 
 
 
eMAGIN CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands except per share amounts)
(Unaudited)
 
     
Three Months Ended 
    
Three Months Ended 
  
     
March 31, 2005 
    
March 31, 2004 
  
 REVENUE:              
 Product revenue, net of returns
   $ 690     $ 540   
               
 COST OF GOODS SOLD:              
 Direct cost of goods sold
     177      209   
 Production expenses
     1,780      1,154   
 Total cost of goods sold
     1,957      1,363   
 Gross Loss     (1,267)     (823)  
               
 OPERATING EXPENSES:              
 Research and development
     866      8   
 Stock based compensation 
    -      84   
 Selling, general and administrative
     1,335      615   
 Total costs and expenses, net
    2,221      707   
 Interest income (expense), net
      19       (5,076)  
 Net loss 
   $ (3,469)    $ (6,606)  
 Basic and diluted net loss per common share    $ (0.04)    $ (0.13)  
 Weighted average common shares outstanding     81,432      51,940   
               
 See notes to financial statements.
      
 
eMAGIN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
     
Three Months Ended 
    
Three Months Ended 
  
     
March 31, 2005 
    
March 31, 2004 
  
 CASH FLOWS FROM OPERATING ACTIVITIES:              
 Net loss    $ (3,469)    $ (6,606)  
 Adjustments to reconcile net loss to net cash              
 used in operating activities-
              
 Depreciation and amortization                                                  
    188      159   
 Bad debt expense                                                                
    19      34   
 Amortization of financing fees                                                   
    -      8   
 Non-cash charge for stock based compensation                                     
    -      84   
 Non-cash interest related charges                                                
    -      126   
 Non-cash charge for services received                                           
    12      8   
 Non-cash financing expense                            
    -      4,955   
 Changes in operating assets and liabilities:
              
 Trade receivables                                                           
    10      151   
 Inventory   
    (908)     (38)  
 Prepaid expenses and other current assets                                  
    271      (658)  
 Other long-term assets                                                      
    35      -   
 Advanced payment on contracts to be completed                              
    (47)     2   
 Accounts payable, accrued expenses and accrued payroll                     
    180      (425)  
 Other current liabilities                                                   
    10      (4)  
 Net cash used in operating activities                              
    (3,699)     (2,204)  
               
 CASH FLOWS FROM INVESTING ACTIVITIES:              
 Purchases/Sales of equipment, net                                                
    (232)     (109)  
 Net cash used in investing activities                              
    (232)     (109)  
               
 CASH FLOWS FROM FINANCING ACTIVITIES:              
 Proceeds from sales of common stock, net of issuance costs                       
    -      3,916   
 Proceeds from exercise of stock options and warrants                         
    1,246      2,073   
 Payments of long term debt and capital leases 
    (3)     (15)  
 Net cash provided by financing activities                          
    1,243      5,974   
             
 NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                          (2,688)     3,661   
 CASH AND CASH EQUIVALENTS, beginning of period                                      13,457       1,054   
 CASH AND CASH EQUIVALENTS, end of period                                  $ 10,769     $ 4,715   
               
 Supplemental Cash Flow Disclosure:              
 Conversion of debt to equity    $ -     $ 8,567   
 Payments of A/P through issuance of stock    $ -     $ 35   
 Stock issued for prepaid services    $ -     $ 17   
 Cash payments of interest    $ 1     $ 3   
               
 See notes to financial statements.
              
 
 
5
 
eMAGIN CORPORATION
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
(Unaudited)
 

 
     
Common
    
Stock 
    
Addition paid-in 
    
Accumulated 
        
     
Shares 
    
$ 
    
Capital 
    
Deficit 
    
Total 
  
 Balance, December 31, 2004     79,639     $ 80     $ 165,399     $ (149,031)    $ 16,448   
 Stock options exercised     8            6            6   
 Stock warrants exercised     2,413      2      1,237            1,239   
 Issuance of common stock for services     12            12            12   
 Net loss for period                       (3,469)     (3,469)  
   
 
 
 
 
 
 Balance, March 31, 2005     82,072     $ 82     $ 166,654     $ (152,500)    $ 14,236   
 See notes to financial statements.
  
 
 
 
 
 
 
 
 
6
 
eMAGIN CORPORATION
Selected Notes to Consolidated Financial Statements

Note 1 - ACCOUNTING POLICIES

Basis of Presentation

In the opinion of  management,  the  accompanying  unaudited  interim  financial information  reflects all adjustments,  consisting of normal recurring accruals, necessary for a fair presentation.  Certain  information and footnote disclosure normally included in financial  statements prepared in accordance with generally accepted  accounting  principles  in the United  States 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 interim  condensed  consolidated  financial  statements are read in conjunction with the audited consolidated financial statements contained in the company's Annual  Report on Form 10-KSB/A for the year ended  December 31, 2004.  The  results of  operations  for the period  ended March 31, 2005 are not necessarily indicative of the results to be expected for the full year.

Stock-Based Compensation

The Company has elected to follow  Accounting  Principles  Board  Opinion No. 25 ("APB  No.  25"),  "Accounting  for  Stock  Issued to  Employees,"  and  related interpretations in accounting for its employee stock options.  Under APB No. 25, when the exercise price of employee stock options equals the market price of the underlying stock on the date of grant, no compensation  expense is recorded. The Company discloses information  relating  to  the  fair  value  of  stock-based compensation  awards  in  accordance  with  Statement  of  Financial  Accounting Standards  No.123 ("SFAS No. 123"),  "Accounting for Stock-Based  Compensation."The following table  illustrates the effect on net loss and loss per share as if the Company had applied the fair value  recognition  provision  of SFAS No. 123. The fair value of each option  grant is estimated on the date of grant using the Black-Scholes  option-pricing  model  with the  following  assumptions  used for grants in the first quarter of 2005 and 2004, respectively: (1) average expected volatility  of 64% and 63%, (2)  average  risk-free  interest rates of 4.33% and 3.31%, and (3) expected lives of seven years.

The pro forma amounts that are disclosed in accordance with SFAS No. 123 reflect the portion of the estimated fair value of awards that were earned for the three months ended March 31, 2005 and 2004.


 For the three months ended March 31,    
2005
    
2004
  
 Net loss applicable to common stockholders', as reported    $ (3,469)    $ (6,606)  
 Add: Stock based employee compensation expense included in reported net loss     -      84   
 Deduct:  Stock-based employee compensation expense determined under fair value method     (1,481)     (1,288)  
 Pro forma net loss    $  (4,950)    $ (7,810)  
 Net loss per share applicable to common stockholders':              
 Basic and diluted, as reported    $ (0.04)    $ (0.13)  
 Basic and diluted, pro forma    $ (0.06)    $ (0.15)  
 
In March of 2005 the Company granted 1,100,000 stock options to certain officers and employees of the Company.  The exercise price of these options was equal to the market price of the stock on the date of grant.  The options vest over five years unless there is a change in control or a dismissal without cause in which case the options would vest immediately.
 
7
 
Note 2 - NATURE OF BUSINESS

eMagin  Corporation  is a  developer  and manufacturer of  optical  systems  and microdisplays  for use in  the  electronics  industry.  eMagin also develops and markets microdisplay  systems and  optics technology for commercial,  industrial and military applications.

Note 3 - REVENUE AND COST RECOGNITION

Revenue is recognized when products are shipped to customers,  net of allowances for anticipated  returns.  The Company's  revenue-earning  activities  generally involve  delivering  products and revenues are  considered to be earned when the Company has  completed  the  process by which it is  entitled to such  revenues. Revenue  is  recognized  when  persuasive  evidence  of an  arrangement  exists, delivery has occurred,  selling price is fixed or determinable and collection is reasonably assured.

The Company also earns  revenues from certain of eMagin's R&D  activities  under both  firm  fixed-price  contracts  and  cost-type  contracts,   including  some cost-plus-fee  contracts.  Revenues  relating to firm fixed-price  contracts are generally  recognized  on the  percentage-of-completion  method of accounting as costs are incurred  (cost-to-cost  basis).  Revenues on cost-plus-fee  contracts include costs  incurred plus a portion of estimated fees or profits based on the relationship of costs incurred to total estimated costs.  Contract costs include all direct  material and labor costs and an  allocation  of  allowable  indirect costs as defined by each contract,  as periodically  adjusted to reflect revised agreed upon rates. These rates are subject to audit by the other party.  Amounts can be  billed  on a  bi-monthly  basis.

Note 4 - RECEIVABLES

The  majority  of our  commercial  accounts  receivable  are due  from  Original Equipment  Manufacturers  ("OEM"s).  Credit is extended based on an evaluation of a customers'  financial  condition  and,  generally,  collateral  is not required. Accounts  receivable are payable in U.S. dollars,  are due within 30-90 days and are  stated at amounts  due from  customers  net of an  allowance  for  doubtful accounts.  Any account  outstanding longer than the contractual payment terms is considered  past due. The Company  determines  the  allowance by  considering  a number of factors,  including the length of time trade  accounts  receivable are past due, eMagin's previous loss history,  the customer's current ability to pay its  obligation,  and the condition of the general economy and the industry as a whole.   The  Company   writes  off   accounts   receivable   when  they  become uncollectable,  and  payments  subsequently  received  on such  receivables  are reported as income in the year the payment is received.

Receivables consisted of the following:

 
     
March 31, 2005 
    
December 31, 2004 
  
 Trade receivables    $ 1,297     $ 1,282   
 Contract receivables     -      25   
 Total      1,297      1,307   
 Less allowance for doubtful accounts     (790)     (771)  
   
 
 
 Net receivables     $ 507     $ 536   
   
 
 
 
 
8
 
Note 5 - RESEARCH AND DEVELOPMENT COSTS

Research and development costs are expensed as incurred.

Note 6 - NET LOSS PER COMMON SHARE

In accordance with SFAS No. 128, net loss per common share amounts ("basic EPS") were  computed by dividing  net loss by the  weighted  average  number of common shares  outstanding  and excluding any potential  dilution.  Net loss per common share assuming  dilution  ("diluted  EPS") was computed by reflecting  potential dilution  from the exercise of stock  options and  warrants.  Common  equivalent shares totaling 6,010,882 and 36,594,874 have been excluded from the computation of  diluted EPS for  the three  months ended  March 31, 2005 and March 31, 2004, respectively.

Note 7 - INVENTORIES

Inventory is stated at the lower of cost or market. Cost is determined using the first-in  first-out  method.  The Company reviews the value of its inventory and reduces the inventory  value to its net realized value based upon current market prices and contracts for future sales.

The components of inventories are as follows:
 
     
March 31, 2005 
    
December 31, 2004 
  
             
 Raw materials     $ 2,265     $ 1,420   
 Work in process     114      169   
 Finished goods      547      429   
   
 
 
 Total Inventory    $ 2,926     $ 2,018   
   
 
 

Note 8 - DEBT

Debt consisted of capitalized leased obligation for equipment as follows:
 
     
March 31, 2005
    
December 31, 2004 
  
             
 Current portion of capitalized lease obligations    $ 15     $ 14   
 Long-term capitalized lease obligations     18      22   
   
 
 
 Total debt    $ 33     $ 36   
   
 
 

 
9
 
Note 9 - STOCKHOLDERS' EQUITY

The authorized common stock of the Company consists of 200,000,000 shares with a par value of $0.001 per share.

In the first quarter of 2005, the Company  received  $1,246,046 for the exercise of 2,421,359  warrants and options. 

The Company also issued 12,000 shares of common stock for the payment of $12,000 for  services  rendered and to be rendered in the future.  As such,  the Company recorded  the fair  value of the  services  rendered  in  selling,  general  and dministrative  expenses in the accompanying  unaudited  consolidated  statement of operations for the three months ended March 31, 2005.

Note 10 - STOCK COMPENSATION

As of March 31, 2005, the Company has outstanding  options to purchase 15,252,688 shares. The Company issued all outstanding options at or above fair market value, or has previously expensed those options repriced below fair market value.

Note 11 - COMMITMENTS AND CONTINGENCIES

[a] Royalty payments:

The  Company,  in  accordance  with a royalty  agreement,  is  obligated to make minimum annual royalty payments of $125,000  to a corporation which commented on January 1, 2001. Under this agreement, the Company must pay to the corporation a certain percentage of  net sales of certain products,  which percentages  are defined in the agreement. The percentages are on a sliding scale depending on the amount of sales  generated. Any minimum royalties paid will be credited against the amounts due based on the percentage of sales. The royalty  agreement terminates upon the expiration of the last-to-expire issued patent.

In April 2005,  the Company paid $125,000 for the minimum amount due for 2005. The amount was recorded in prepaid  expenses  and will be mortized as the Company  records the royalty expense as defined in the agreement. Royalty expense was $22,556 and $22,855, respectively, for the three months ended March 31, 2005 and 2004.

[b] Contractual obligations:

The  Company  leases  certain  office  facilities  and  office,  lab and factory equipment under operating leases expiring  through 2009.  Certain leases provide for payments of monthly operating expenses. The approximate future minimum lease payments for 2005 are as follows:

 
 Operating leases     $ 705   
 Capital leases                             14   
 
 
 Total contractual obligations    $ 719   
   

We currently  lease space  from  IBM for  approximately  $74,000 per  month that houses our own equipment for OLED microdisplay  fabrication and for research and development plus additional space for  assembly and  administrative offices.  In 2004  we entered into an amended lease agreement which  extends the term of this lease to May 31, 2009.

10
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation

Statement of Forward-Looking Information

This report contains  forward-looking  statements  within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  These  statements  relate to future  events  or our  future  financial performance.  In some cases,  you can  identify  forward-looking  statements  by terminology such as "may," "will,"  "should,"  "expect,"  "plan,"  "anticipate," "believe,"  "estimate,"  "predict,"  "potential" or "continue,"  the negative of such  terms,  or  other  comparable  terminology.   These  statements  are  only predictions.  Actual events or results may differ  materially  from those in the forward-looking statements as a result of various important factors. Although we believe that the expectations  reflected in the  forward-looking  statements are reasonable,  such should not be regarded as a representation by the Company,  or any other person,  that such  forward-looking  statements will be achieved.  The business and operations of the Company are subject to substantial  risks,  which increase the uncertainty inherent in the forward-looking statements contained in this release.

We undertake no duty to update any of the forward-looking statements, whether as a result of new information,  future events or otherwise.  Readers are cautioned not to place undue reliance on the forward-looking  statements contained in this report.

Overview

We design  and  manufacture  miniature displays, which we  refer to as  OLED-on-silicon  microdisplays, and  microdisplay modules for virtual imaging, primarily for  incorporation into the products of  other manufacturers. Microdisplays  are typically smaller than many postage stamps, but when viewed  through a magnifier they can contain all of the information appearing on a  high-resolution personal computer screen.  Our microdisplays use organic light emitting diodes, or OLEDs, which  emit light  themselves when  a current is passed  through the device. Our technology  permits  OLEDs  to  be  coated  onto  silicon  chips to produce high resolution OLED-on-silicon microdisplays.

We believe that our OLED-on-silicon  microdisplays offer a  number of advantages in  near  to the eye applications over  other current microdisplay technologies, including  lower  power  requirements,  less  weight,  fast video speed  without flicker,  and  wider  viewing  angles.  In  addition,  many  computer  and video electronic  system  functions  can  be  built directly into the  OLED-on-silicon microdisplay,  resulting  in compact systems with  lower expected overall system costs relative to alternate microdisplay technologies.

Since our inception in 1996,  we derived the  majority of our revenues from fees paid to  us under  research and  development contracts,  primarily with the U.S. federal government.  We have devoted  significant  resources to  the development and  commercial  launch of our products.  We commenced  limited initial sales of our SVGA+ microdisplay in May 2001 and commenced shipping samples of our SVGA-3D microdisplay in February 2002.  As of March 31, 2005, we have  recognized an  aggregate of approximately $8.0 million  from sales  of our products,  and have a backlog of more  than $28 million in products  ordered for delivery through 2007.  These products are being applied or considered for near-eye  and  headset  applications  in  products  such as  entertainment and gaming headsets, handheld Internet and telecommunication appliances, viewfinders, and wearable computers to be manufactured by original equipment manufacturer (OEM) customers.  In addition to marketing OLED-on-silicon microdisplays as components, we also offer microdisplays as an integrated package, which we call Microviewer that includes a compact lens for viewing the microdisplay and electronic interfaces to convert the signal from our customer's product into a viewable image on the microdisplay. Through our operations in Washington State we are also developing head-wearable displays that incorporate our Microviewer.

We license our core OLED technology from Eastman Kodak and we have developed our own technology to create high performance OLED-on-silicon microdisplays and related optical systems. We believe our technology licensing agreement with Eastman Kodak, coupled with our own intellectual property portfolio, gives us a leadership position in OLED and OLED-on-silicon microdisplay technology. We are the only company to demonstrate publicly and market full-color OLED-on-silicon microdisplays.
 
 
Company History

Our history has been as a developmental stage company. As of January 1, 2003, we are no longer a development stage Company. We have transitioned to manufacturing our product and intend to  significantly  increase  our  marketing,  sales,  and research and development efforts, and expand our operating infrastructure.  Most of our  operating  expenses  are  fixed in the near  term.  If we are  unable to generate  significant  revenues,  our net  losses in any given  period  could be greater than expected.

CRITICAL ACCOUNTING POLICIES

The Securities and Exchange  Commission  ("SEC")  defines  "critical  accounting policies" as those that require  application  of  management's  most  difficult, subjective or complex judgments, often as a result of the need to make estimates about the  effect of matters  that are  inherently  uncertain  and may change in subsequent periods.

Not  all of the  accounting  policies  require  management  to  make  difficult, subjective or complex judgments or estimates.  However,  the following  policies could be deemed to be critical within the SEC definition.

Revenue Recognition

Revenue  on  product  sales  is  recognized  when  persuasive   evidence  of  an arrangement  exists,  such as when a purchase order or contract is received from the customer,  the price is fixed, title to the goods has changed and there is a reasonable  assurance of collection  of the sales  proceeds.  We obtain  written purchase  authorizations from our customers for a specified amount of product at a  specified  price  and  consider  delivery  to have  occurred  at the  time of shipment.  Revenue  is  recognized  at  shipment  and we  record a  reserve  for estimated  sales  returns,  which is  reflected as a reduction of revenue at the time of revenue recognition.

Revenues from research and development  activities  relating to firm fixed-price contracts are generally  recognized  on the  percentage-of-completion  method of accounting as costs are incurred  (cost-to-cost  basis).  Revenues from research and development  activities  relating to cost-plus-fee  contracts  include costs incurred plus a portion of estimated  fees or profits based on the  relationship of costs incurred to total  estimated  costs.  Contract costs include all direct material  and labor  costs and an  allocation  of  allowable  indirect  costs as defined by each contract,  as  periodically  adjusted to reflect  revised agreed upon rates. These rates are subject to audit by the other party. 

Use of estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles  requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates and assumptions relate to recording net revenue, collectibility of accounts receivable, useful lives and impairment of tangible and intangible assets, accruals, income taxes, inventory realization and other factors. Management has exercised reasonable judgment in deriving these estimates. Consequently, a change in conditions could affect these estimates.

Fair value of financial instruments

The Company's cash, cash equivalents, accounts receivable and accounts payable are earned at cost which appropriates fair value due to the short-term nature of these instruments.

Results of Operations

THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THREE MONTHS ENDED MARCH 31, 2004

Revenues

Revenues  for the three  months  ended  March 31,  2005  were $0.7  million,  a 28% increase as compared to $0.5 million for the three months ended March 31, 2004.  The increase was attributable to increased unit shipments of our microdisplays.  Average selling price per unit decreased to $332 from $434 as compared to the first quarter of 2004. This was due to quantity discounts.
 
 
12
 
Cost of Goods  Sold
 
Cost of goods  sold  includes  direct and  indirect  costs associated with production.  Cost of goods sold for the three months ended March 31, 2005 was $2.0  million,  as compared  to $1.4  million for the three  months ended March 31, 2004.  Gross loss for the three months ended March 31, 2005 was ($1.3)  million,  as  compared to ($0.8)  million for the three  months ended March 31, 2004. This translates to a Gross Margin of (183%) and (152%) for the three months ended March 31, 2005 and 2004, respectively.

We currently record all expenses  associated with manufacturing in Cost of Goods Sold. The full facility over head as well as the expense of non-capitalized  raw materials is matched against our units sold. While our production volume is low, the Gross  Margin  reflects  the  costs  that  will be  shared  when  quantities increase.

The increased costs of goods sold is directly attributable to our preparation for increased production volumes.  Expenses for the three months ended March 31, 2005 reflect two full shifts of production and a partial third shift.  Expenses for the three months ended March 31, 2004 represented staff required to run a single shift at relatively low throughput.  During the first quarter of 2005 we redesigned our processes to support what we believe will be increased throughput of between 10 - 30 times year ago levels.  While these changes were being implemented, the majority of overhead and staff cost was directly expensed to cost of goods sold.

Operating Expenses

Research and Development.  Research and development  expenses included salaries, development materials and other costs specifically  allocated to the development of new products.  Gross research and  development  expenses for the three months ended March 31, 2005 was $0.9 million,  as compared to $8 thousand for the three months  ended  March  31,  2004.  During the second half of 2004 we initiated two new design projects that are projected to yield future microdisplay products.  To accommodate these efforts our costs for the three months ended March 31, 2005 reflect expanded staff size and outsourced design services as compared to the three months ended March 31, 2004.   

Non-cash  Stock Based  Compensation.  Non-cash  expenses  related to stock-based compensation  amortization  for the three  months  ended   March 31, 2005 was $0 as compared to $84 thousand for the three months ending March 31, 2004. Non-cash stock-based  compensation costs are the result of amortization of the  intrinsic  value  ascribed for the issuance of stock  options at below fair market values. The amortization is done over the vesting period of such options and was fully expensed during 2004.

Selling, General and Administrative. Selling, general and administrative expenses  consist  principally of salaries and fees for  professional  services, legal fees  incurred  in  connection  with patent  filings and related  matters,   as well as other marketing and administrative expenses.  Selling, general and administrative  expenses,  for the three months ended March 31, 2005 were $1.3 million,  as compared to $0.6 million for the three months ended March 31,  2004.  The $0.7  million  increase  was primarily due to an increase in staff and personnel costs.  Company headcount increased from 37 on March 31, 2004 to 79 on March 31, 2005.

Interest  Income (expense). Interest income (expense) for the three months ending March 31, 2005 was $18 thousand as compared to ($5.1)  million  for the three  months  ended March 31, 2004. The ($5.1) million decrease  in  interest expense  for  the  three  months ended March 31, 2005 was attributable to three factors recorded in 2004; (1) $3.18 million of non-cash charges  related to the value of the warrants issued to induce the  holders of the $7.825 million in Notes to  agree to  an early  conversion  of  the  Notes into  common stock, (2) $1,598,325 in  non-cash  charges  related  to  the  remaining  unamortized  debt discount  and beneficial  conversion feature associated  with the aforementioned Notes,  and (3) $74,637 in  non-cash  charges  related to the  write-off of  the remaining unamortized deferred financing costs.

Liquidity and Capital Resources

Current Financial Position

We have total liabilities and contractual  obligations of $6,650,746 as of March 31,  2005.  These  contractual  obligations,  along with the dates on which such payments are due, are described below:
 

 
 


 
           
One Year 
    
More Than 
  
 Contractual Obligations    
Total 
    
or Less 
    
One Year 
  
 Operating leases    $ 3,747     $ 927     $ 2,820   
 Royalties      625      125      500   
 Capital leases      38      18      20   
   
 
 
 
 Total contractual obligations    $ 4,410     $ 1,070     $ 3,340   
   
 
 
 
 
 
We currently anticipate that we will experience a significant increase in sales if we are successful in fulfilling product shipments to clients reflected in our backlog and if our new products meet with commercial success.  As a result we anticipate that working capital to facilitate higher accounts receivable and inventories will be our most significant use of cash in 2005.  We   anticipate that we will continue to experience  moderate growth in our  operating  expenses for the  foreseeable  future as well and that our  operating expenses will be one of the principal  uses of our cash. In  particular,  we expect that salaries for employees engaged in production  operations,  purchase of inventory and expenses of increased  sales and  marketing  efforts should also be a principle uses of cash. We expect that our cash  requirements over the next 12 months will be met by a  combination  of cash on hand,  additional  financing,  exercising  of  outstanding  options and warrants, and revenues generated by operations.  

We have  received  purchase  agreements  for  approximately  $28 million for our products to be delivered  now through early 2007. 

Scheduled   deliveries  against  our  purchase  agreements  and  other  customer requirements are subject to change  depending on a number of factors  including, our production  capacity,  our customers'  production  timing of related systems into which they are integrating our products and their other supplier schedules, changes in the  expected  procurement  periods  for  military  programs  and the requirements  of the  individual  agreements and contracts that we have with our customers.  We currently  are undergoing a  ramp up in our supplies and staffing  in order to  be  prepared  to meet  the  currently  anticipated shipping schedules, which we anticipate will require significant added effort.


Our longer term cash requirements  depend on numerous factors,  including  completion of our product development  activities,  ability to continue to commercialize our products,  timely market  acceptance  of our  products  and our  customers'  products,  and  other factors.  We expect to  carefully  devote  capital  resources  to  continue  these efforts.  
 
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Factors Which May Affect Future Results

In  evaluating  our business,  prospective  investors  and  shareholders  should carefully consider the risks factors, any of which could have a material adverse impact on our business,  operating results and financial condition and result in a complete loss of your investment.

Risks Related To Our Financial Results

WE HAVE A HISTORY OF LOSSES SINCE OUR INCEPTION AND MAY INCUR LOSSES FOR THE FORESEEABLE FUTURE.

Accumulated losses excluding non-cash transactions as of March  31, 2005, were $51 million and acquisition related non-cash transactions were $102 million, which resulted in an accumulated deficit of $153 million, the majority of which was related to the March 2000 merger and the subsequent write-down of our goodwill. The non-cash losses were dominated by the amortization and write-down of goodwill and purchased intangibles and write-down of acquired in process research and development related to the March 2000 acquisition, and also included some non-cash stock-based compensation. We have not yet achieved profitability and we can give no assurances that we will achieve profitability within the foreseeable future as we fund operating and capital expenditures in areas such as establishment and expansion of markets, sales and marketing, operating equipment and research and development. We cannot assure investors that we will ever achieve or sustain profitability or that our operating losses will not increase in the future.

WE MAY NOT BE ABLE TO EXECUTE OUR BUSINESS PLAN AND MAY NOT GENERATE CASH FROM OPERATIONS

In the event that cash flow from operations is less than anticipated and we are unable to secure additional funding to cover our expenses, in order to preserve cash, we would be required to reduce expenditures and effect reductions in our corporate infrastructure, either of which could have a material adverse effect on our ability to continue our current level of operations. To the extent that operating expenses increase or we need additional funds to make acquisitions, develop new technologies or acquire strategic assets, the need for additional funding may be accelerated and there can be no assurances that any such additional funding can be obtained on terms acceptable to us, if at all. If we were not able to generate sufficient capital, either from operations or through additional debt or equity financing, to fund our current operations, we would be forced to significantly reduce or delay our plans for continued research and development and expansion. This could significantly reduce the value of our securities.

RISKS RELATED TO MANUFACTURING

THE MANUFACTURE OF OLED-ON-SILICON IS NEW AND OLED MICRODISPLAYS HAVE NOT BEEN PRODUCED IN SIGNIFICANT QUANTITIES.

If we are unable to produce our products in sufficient quantity, we will be unable to meet our customers time requirements and would have difficulties in attracting new customers. In addition, we cannot assure you that once we commence volume production we will attain yields at high throughput that will result in profitable gross margins or that we will not experience manufacturing problems which could result in delays in delivery of orders or product introductions.

WE ARE DEPENDENT ON A SINGLE MANUFACTURING LINE.

We initially expect to manufacture our products on a single manufacturing line. If we experience any significant disruption in the operation of our manufacturing facility or a serious failure of a critical piece of equipment, we may be unable to supply microdisplays to our customers. For this reason, some OEMs may also be reluctant to commit a broad line of products to our microdisplays without a second production facility in place. Interruptions in our manufacturing could be caused by manufacturing equipment problems, the introduction of new equipment into the manufacturing process or delays in the delivery of new manufacturing equipment. Lead-time for delivery of manufacturing equipment can be extensive. No assurance can be given that we will not lose potential sales or be unable to meet production orders due to production interruptions in our manufacturing line. In order to meet the requirements of certain OEMs for multiple manufacturing sites, we will have to expend capital to secure additional sites and may not be able to manage multiple sites successfully.

WE EXPECT TO DEPEND ON SEMICONDUCTOR CONTRACT MANUFACTURERS TO SUPPLY OUR SILICON INTEGRATED CIRCUITS AND OTHER SUPPLIERS OF KEY COMPONENTS, MATERIALS AND SERVICES.

We do not manufacture the silicon integrated circuits on which we incorporate our OLED technology. Instead, we expect to provide the design layouts to semiconductor contract manufacturers who will manufacture the integrated circuits on silicon wafers. We also expect to depend on suppliers of a variety of other components and services, including circuit boards, graphic integrated circuits, passive components, materials and chemicals, and equipment support. Our inability to obtain sufficient quantities of high quality silicon integrated circuits or other necessary components, materials or services on a timely basis could result in manufacturing delays, increased costs and ultimately in reduced or delayed sales or lost orders which could materially and adversely affect our operating results.

RISKS RELATED TO OUR INTELLECTUAL PROPERTY

We rely on our license agreement with Eastman Kodak for the development of our products, and the termination of this license, Eastman Kodak's licensing of its OLED technology to others for microdisplay applications, or the sublicensing by Eastman Kodak of our OLED technology to third parties, could have a material adverse impact on our business.
 
 
Our principal products under development utilize OLED technology that we license from Eastman Kodak. We rely upon Eastman Kodak to protect and enforce key patents held by them, relating to OLED display technology. Eastman Kodak's patents expire at various times in the future. Our license with Eastman Kodak could terminate if we fail to perform any material term or covenant under the license agreement. Since our license from Eastman Kodak is non-exclusive, Eastman Kodak could also elect to become a competitor itself or to license OLED technology for microdisplay applications to others who have the potential to compete with us. The occurrence of any of these events could have a material adverse impact on our business.

WE MAY NOT BE SUCCESSFUL IN PROTECTING OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS.

We rely on a combination of patents, trade secret protection, licensing agreements and other arrangements to establish and protect our proprietary technologies. If we fail to successfully enforce our intellectual property rights, our competitive position could suffer, which could harm our operating results. Patents may not be issued for our current patent applications, third parties may challenge, invalidate or circumvent any patent issued to us, unauthorized parties could obtain and use information that we regard as proprietary despite our efforts to protect our proprietary rights, rights granted under patents issued to us may not afford us any competitive advantage, others may independently develop similar technology or design around our patents, our technology may be available to licensees of Eastman Kodak, and protection of our intellectual property rights may be limited in certain foreign countries. We may be required to expend significant resources to monitor and police our intellectual property rights. Any future infringement or other claims or prosecutions related to our intellectual property could have a material adverse effect on our business. Any such claims, with or without merit, could be time consuming to defend, result in costly litigation, divert management's attention and resources, or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. Protection of intellectual property has historically been a large yearly expense for eMagin. We have not been in a financial position to properly protect all of our intellectual property, and may not be in a position to properly protect our position or stay ahead of competition in new research and the protecting of the resulting intellectual property.

RISKS RELATED TO THE MICRODISPLAY INDUSTRY

THE COMMERCIAL SUCCESS OF THE MICRODISPLAY INDUSTRY DEPENDS ON THE WIDESPREAD MARKET ACCEPTANCE OF MICRODISPLAY SYSTEMS PRODUCTS.

The market for microdisplays is emerging. Our success will depend on consumer acceptance of microdisplays as well as the success of the commercialization of the microdisplay market. As an OEM supplier, our customer's products must also be well accepted. At present, it is difficult to assess or predict with any assurance the potential size, timing and viability of market opportunities for our technology in this market. The viewfinder microdisplay market sector is well established with entrenched competitors with whom we must compete.
 
 
THE MICRODISPLAY SYSTEMS BUSINESS IS INTENSELY COMPETITIVE.

We do business in intensely competitive markets that are characterized by rapid technological change, changes in market requirements and competition from both other suppliers and our potential OEM customers. Such markets are typically characterized by price erosion. This intense competition could result in pricing pressures, lower sales, reduced margins, and lower market share. Our ability to compete successfully will depend on a number of factors, both within and outside our control. We expect these factors to include the following:

 
·
our success in designing, manufacturing and delivering expected new products, including those implementing new technologies on a timely basis;

 
·
our ability to address the needs of our customers and the quality of our customer services;

 
·
the quality, performance, reliability, features, ease of use and pricing of our products;

 
·
successful expansion of our manufacturing capabilities;

 
·
our efficiency of production, and ability to manufacture and ship products on time;

 
·
the rate at which original equipment manufacturing customers incorporate our product solutions into their own products;

 
·
the market acceptance of our customers' products; and

 
·
product or technology introductions by our competitors.


Our competitive position could be damaged if one or more potential OEM customers decide to manufacture their own microdisplays, using OLED or alternate technologies. In addition, our customers may be reluctant to rely on a relatively small company such as eMagin for a critical component. We cannot assure you that we will be able to compete successfully against current and future competition, and the failure to do so would have a materially adverse effect upon our business, operating results and financial condition.

The display industry is cyclical.

The display  industry  is  characterized  by  fabrication  facilities  that require  large  capital  expenditures  and long lead times for  supplies and the subsequent  processing time,  leading to frequent  mismatches between supply and demand. The OLED microdisplay sector may experience overcapacity if and when all of the  facilities  presently  in the  planning  stage come on line leading to a difficult market in which to sell our products.

Competing products may get to market sooner than ours.

Our   competitors  are  investing   substantial  resources  in  the  development  and manufacture  of microdisplay  systems using  alternative  technologies such as  reflective liquid  crystal  displays  (LCDs),  LCD-on-Silicon  ("LCOS")  microdisplays, active matrix electroluminescence and scanning image systems, and transmissive active matrix LCDs.


Our competitors have many advantages over us.

As the  microdisplay  market  develops,  we  expect to  experience  intense competition   from   numerous   domestic   and   foreign   companies   including well-established  corporations possessing worldwide manufacturing and production facilities,  greater name  recognition,  larger  retail bases and  significantly greater financial,  technical,  and marketing resources than us, as well as from emerging companies  attempting to obtain a share of the various markets in which our microdisplay products have the potential to compete.
 
 
 
Our products are subject to lengthy OEM development periods.

We plan to sell most of our microdisplays and related products to OEMs who will incorporate them into or with products they sell. OEMs determine during their product development phase whether they will incorporate our products. The time elapsed between initial sampling of our products by OEMs, the custom design of our products to meet specific OEM product requirements, and the ultimate incorporation of our products into OEM consumer products is significant. If our products fail to meet our OEM customers' cost, performance or technical requirements or if unexpected technical challenges arise in the integration of our products into OEM consumer products, our operating results could be significantly and adversely affected. Long delays in achieving customer qualification and incorporation of our products could adversely affect our business.

Our products will likely experience rapidly declining unit prices.

In the markets in which we expect to compete, prices of established products tend to decline significantly over time. In order to maintain our profit margins over the long term, we anticipate that we will need to continuously develop product enhancements and new technologies that will either slow price declines of our products or reduce the cost of producing and delivering our products. While we anticipate many opportunities to reduce production costs over time, there can be no assurance that these cost reduction plans will be time, there can be no assurance that these cost reduction plans will be successful. We may also attempt to offset the anticipated decrease in our average selling price by introducing new products, increasing our sales volumes or adjusting our product mix. If we fail to do so, our results of operations would be materially and adversely affected.

RISKS RELATED TO OUR BUSINESS

OUR SUCCESS DEPENDS ON ATTRACTING AND RETAINING HIGHLY SKILLED AND QUALIFIED TECHNICAL AND CONSULTING PERSONNEL.

We must hire highly skilled technical personnel as employees and as independent contractors in order to develop our products. The competition for skilled technical employees is intense and we may not be able to retain or recruit such personnel. We must compete with companies that possess greater financial and other resources than we do, and that may be more attractive to potential employees and contractors. To be competitive, we may have to increase the compensation, bonuses, stock options and other fringe benefits offered to employees in order to attract and retain such personnel. The costs of retaining or attracting new personnel may have a materially adverse affect on our business and our operating results. In addition, difficulties in hiring and retaining technical personnel could delay the implementation of our business plan.

OUR SUCCESS DEPENDS IN A LARGE PART ON THE CONTINUING SERVICE OF KEY PERSONNEL.

Changes in management could have an adverse effect on our business. We are dependent upon the active participation of several key management personnel, including Gary W. Jones, our chief executive officer. We will also need to recruit additional management in order to expand according to our business plan. The failure to attract and retain additional management or personnel could have a material adverse effect on our operating results and financial performance.

OUR BUSINESS DEPENDS ON NEW PRODUCTS AND TECHNOLOGIES.

The market for our products is characterized by rapid changes in product, design and manufacturing process technologies. Our success depends to a large extent on our ability to develop and manufacture new products and technologies to match the varying requirements of different customers in order to establish a competitive position and become profitable. Furthermore, we must adopt our products and processes to technological changes and emerging industry standards and practices on a cost-effective and timely basis. Our failure to accomplish any of the above could harm our business and operating results.

WE GENERALLY DO NOT HAVE LONG-TERM CONTRACTS WITH OUR CUSTOMERS.

Our business is operated on the basis of short-term purchase orders and we cannot guarantee that we will be able to obtain long-term contracts for some time. Our current purchase agreements can be cancelled or revised without penalty, depending on the circumstances. In the absence of a backlog of orders that can only be canceled with penalty, we plan production on the basis of internally generated forecasts of demand, which makes it difficult to accurately forecast revenues. If we fail to accurately forecast operating results, our business may suffer and the value of your investment in the Company may decline.
 
 
 
OUR BUSINESS STRATEGY MAY FAIL IF WE CANNOT CONTINUE TO FORM STRATEGIC RELATIONSHIPS WITH COMPANIES THAT MANUFACTURE AND USE PRODUCTS THAT COULD INCORPORATE OUR OLED-ON-SILICON TECHNOLOGY.

Our prospects will be significantly affected by our ability to develop strategic alliances with OEMs for incorporation of our OLED-on-silicon technology into their products. While we intend to continue to establish strategic relationships with manufacturers of electronic consumer products, personal computers, chipmakers, lens makers, equipment makers, material suppliers and/or systems assemblers, there is no assurance that we will be able to continue to establish and maintain strategic relationships on commercially acceptable terms, or that the alliances we do enter in to will realize their objectives. Failure to do so would have a material adverse effect on our business.

OUR BUSINESS DEPENDS TO SOME EXTENT ON INTERNATIONAL TRANSACTIONS.

We purchase needed materials from companies located abroad and may be adversely affected by political and currency risk, as well as the additional costs of doing business with a foreign entity. Some customers in other countries have longer receivable periods or warranty periods. In addition, many of the OEMs that are the most likely long-term purchasers of our microdisplays are located abroad exposing us to additional political and currency risk. We may find it necessary to locate manufacturing facilities abroad to be closer to our customers which could expose us to additional risks, including management of a multi-national organization, the complexities of complying with foreign laws and customs, political instability and the complexities of taxation in multiple jurisdictions.

OUR BUSINESS MAY EXPOSE US TO PRODUCT LIABILITY CLAIMS.

Our business may expose us to potential product liability claims. Although no such claims have been brought against us to date, and to our knowledge no such claim is threatened or likely, we may face liability to product users for damages resulting from the faulty design or manufacture of our products. While we plan to maintain product liability insurance coverage, there can be no assurance that product liability claims will not exceed coverage limits, fall outside the scope of such coverage, or that such insurance will continue to be available at commercially reasonable rates, if at all.

OUR BUSINESS IS SUBJECT TO ENVIRONMENTAL REGULATIONS AND POSSIBLE LIABILITY ARISING FROM POTENTIAL EMPLOYEE CLAIMS OF EXPOSURE TO HARMFUL SUBSTANCES USED IN THE DEVELOPMENT AND MANUFACTURE OF OUR PRODUCTS.

We are subject to various governmental regulations related to toxic, volatile, experimental and other hazardous chemicals used in our design and manufacturing process. Our failure to comply with these regulations could result in the imposition of fines or in the suspension or cessation of our operations. Compliance with these regulations could require us to acquire costly equipment or to incur other significant expenses. We develop, evaluate and utilize new chemical compounds in the manufacture of our products. While we attempt to ensure that our employees are protected from exposure to hazardous materials, we cannot assure you that potentially harmful exposure will not occur or that we will not be liable to employees as a result.

Risks related to our stock

The  substantial  number of shares that are or will be  eligible  for sale could cause our common stock price to decline even if the company is successful.

Sales of significant  amounts of common stock in the public market,  or the perception that such sales may occur,  could materially  affect the market price of our common  stock.  These sales might also make it more  difficult  for us to sell equity or equity-related  securities in the future at a time and price that we deem  appropriate.  As of April 30, 2005, we have  outstanding (i) options to purchase  15,252,688 shares; and (ii) warrants to purchase  18,273,439 shares of common stock.

WE HAVE A STAGGERED BOARD OF DIRECTORS AND OTHER ANTI-TAKEOVER PROVISIONS, WHICH COULD INHIBIT POTENTIAL INVESTORS OR DELAY OR PREVENT A CHANGE OF CONTROL THAT MAY FAVOR YOU.

Our Board of Directors is divided into three classes and our Board members are elected for terms that are staggered. This could discourage the efforts by others to obtain control of the company. Some of the provisions of our certificate of incorporation, our bylaws and Delaware law could, together or separately, discourage potential acquisition proposals or delay or prevent a change in control. In particular, our board of directors is authorized to issue up to 10,000,000 shares of preferred stock (less any outstanding shares of preferred stock) with rights and privileges that might be senior to our common stock, without the consent of the holders of the common stock.
 
 
ITEM 3: Controls and Procedures

As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms. There was no change in our internal controls or in other factors that could affect these controls during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
20
 
 

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

The company is party to certain legal proceedings arising in the ordinary course of business. In the opinion of management, the outcome of such legal matters will not have a material adverse effect on the company's results of operations or financial position.

Item 2. Changes in Securities and Use of Proceeds

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None

Item 6. Exhibits

(a) Exhibits List

EXHIBIT NUMBER                         DESCRIPTION
 
31.1                     Certification by Chief Executive Officer pursuant to Sarbanes Oxley Section 302

31.2                     Certification by Chief Financial Officer pursuant to Sarbanes Oxley Section 302

32.1                     Certification by Chief Executive Officer pursuant to 18 U.S. C. Section 1350

32.2                     Certification by Chief Financial Officer pursuant to 18 U.S. C. Section 1350

 
 
 
 
SIGNATURES
 

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
     
  eMAGIN CORPORATION
 
 		  
 		  
 
Date: May 16, 2005 By:   /s/ Gary W. Jones
 
Gary W. Jones
  Chief Executive Officer
 
     
 
 		  
 		  
 
By:   /s/ John Atherly
 
John Atherly
  Chief Financial Officer
 
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