UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10K
(Mark One)
___
/X/10-K
FOR ANNUAL REPORTAND TRANSITION REPORTS PURSUANT TO SECTIONSECTIONS 13 OR 15(d)
OF THE --- SECURITIES AND EXCHANGE ACT OF 1934]
1934
(Mark One)
| x | | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended October 1, 2000
September 29, 2002
OR
---
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR
--- 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934]
| ¨ | | 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 1-8402
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IRVINE SENSORS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 33-0280334
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
3001 Redhill Avenue, Costa Mesa, California 92626
(Address of principal executive offices) (Zip Code)
(714) 549-8211
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
(Exact Name of each exchange on
Title of each class: which registered:
Common Stock Boston Stock Exchange Incorporated
Registrant as Specified in Its Charter)
Delaware (State or Other Jurisdiction of Incorporation or Organization) | | 33-0280334 (I.R.S. Employer Identification No.) |
|
3001 Redhill Avenue, Costa Mesa, California 92626 (Address of Principal Executive Offices) (Zip Code) |
|
Registrant’s Telephone Number, Including Area Code: (714) 549-8211 |
|
Securities registered pursuant to Section 12(b) of the Act: |
Title of each class: Common Stock | | Name of each exchange on which registered: Boston Stock Exchange Incorporated |
|
Securities registered pursuant to Section 12(g) of the Act: None |
To check or clear boxes, place cursor before box and enter Alt-X to Section 12(g) of the Act: None
check or Alt-C to clear.
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 ninety (90)90 days.
Yes Xþ No ----- -----
¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant'sregistrant’s knowledge, in definitive proxy ofor information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_]
x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2.
Yes ¨ No þ
To the extent known by the registrant, the aggregate market value of the Common
Stockcommon stock held beneficially by non-affiliates of the registrant was approximately $72,000,000$5.3 million based on December 15, 2000. As the Preferred Stock is not publicly traded
itclosing sales price on March 28, 2002 as reported by the Nasdaq SmallCap Market. The preferred stock has not been included in the computation.
computation because it is not publicly traded.
As of December 15, 2000,18, 2002, there were 46,736,7007,463,489 shares of Common Stock
outstanding.
Documents Incorporatedcommon stock outstanding
DOCUMENTS INCORPORATED BY REFERENCE:
Items 10-13 of Part III, to the extent not set forth herein, incorporate by
Reference:
Portions ofreference certain information contained in the
Registrant's Annual Report to Stockholders for the fiscal year
ended October 1, 2000 (Part II); portions of the Registrant'sRegistrant’s Definitive Proxy Statement to be used in connection with
Registrant'sthe Registrant’s 2003 Annual Meeting of
Stockholders to be held on March 7, 2001 (Part III).
Stockholders.
IRVINE SENSORS CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED OCTOBER 1, 2000
SEPTEMBER 29, 2002
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business ...................................................... 4
Item 2. Properties ..................................................... 14
Item 3. Legal Proceedings............................................... 14
Item 4. Submission of Matters to a Vote of Security Holders............. 14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters ........................................................ 16
Item 6. Selected Financial Data ........................................ 17
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations .......................................... 18
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ..... 18
Item 8. Financial Statements and Supplementary Data .................... 18
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure ........................................... 18
PART III
Item 10. Directors and Executive Officers of the Registrant ............. 18
Item 11. Executive Compensation ......................................... 18
Item 12. Stock Ownership of Certain Beneficial Owners and Management .... 18
Item 13. Certain Relationships and Related Transactions ................. 18
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K ....................................................... 19
Signatures................................................................. 21
| | | | PAGE
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| PART I | | | | |
| Item 1. | | | | 4 |
| | | | 12 |
| Item 2. | | | | 19 |
| Item 3. | | | | 19 |
| Item 4. | | | | 19 |
|
| PART II | | | | |
| Item 5. | | | | 20 |
| Item 6. | | | | 20 |
| Item 7. | | | | 21 |
| Item 7A. | | | | 27 |
| Item 8. | | | | 27 |
| Item 9. | | | | 27 |
|
| PART III | | | | |
| Item 10. | | | | 28 |
| Item 11. | | | | 28 |
| Item 12. | | | | 28 |
| Item 13. | | | | 28 |
| Item 14. | | | | 28 |
|
| PART IV | | | | |
| Item 15. | | | | 29 |
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| | 31 |
| | | | 32 |
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some
In this report, the terms “Irvine Sensors,” “ISC,” “Company,” “we,” “us” and “our” refer to Irvine Sensors Corporation and its subsidiaries.
This report contains forward-looking statements regarding Irvine Sensors which include, but are not limited to, statements concerning projected revenues, expenses, gross profit and income, market acceptance of products, the competitive nature of our business and markets, the success and timing of new product introductions and commercialization of our technologies, the need for additional capital, and the success of pending litigation. These forward-looking statements in the Annual Reportare based on Form 10-K constituteour current expectations, estimates and projections about our industry, management’s beliefs, and certain assumptions made by us. Words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “potential,” “believes,” “seeks,” “estimates,” “should,” “may,” “will” and variations of these words or similar expressions are intended to identify forward-looking statements. These statements involve knownare not guarantees of future performance and unknownare subject to risks, uncertainties and other factorsassumptions that may cause Irvine Sensors Corporation (the
"Company") or its industries'are difficult to predict. Therefore, our actual results levelscould differ materially and adversely from those expressed in any forward-looking statements as a result of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by such forward-
looking statements. Thesevarious factors. Such factors include, those listed under Part I "Business -
Factors that May Affect Future Results."
Forward-looking statements relatebut are not limited to future eventsthe following:
| • | | our ability to introduce new products, gain broad market acceptance for such products and ramp up manufacturing in a timely manner; |
| • | | our ability to secure additional research and development contracts; |
| • | | our ability to obtain expected procurements resulting from existing contracts; |
| • | | the pace at which new markets develop; |
| • | | the response of competitors, many of whom are bigger and better financed than us; |
| • | | our ability to successfully execute our business plan and control costs and expenses; |
| • | | the availability of additional financing; |
| • | | our ability to establish strategic partnerships to develop the business of our subsidiaries; |
| • | | our depressed market capitalization; |
| • | | general economic and political instability; and |
| • | | those additional factors which are listed under the section “Risk Factors” at the end of Item 1 of this report. |
We do not undertake any obligation to revise or our future financial
performance. The Company believes it is important to communicate its
expectations to its investors. In some cases, theupdate publicly any forward-looking statements may
be identified by terminology such as "may," "will," "should," "expects,"
"plans," "anticipates," "believes," "estimates," "predicts," "potential" or
"continue" or the negative of such terms or other comparable terminology. These
statements are only predictions. There may be events in the future that the
Company is not accurately able to predict or over which it may have no control.
Readers should consider statements that contain these or similar words carefully
because they (1) discuss expectations of Irvine the Company about its future
performance; (2) contain projections of the Company's future operating results
or of its future financial condition; (3) state other "forward-looking
information. In evaluating these statements, you should specifically consider
various factors, including the risks outlined under Partfor any reason.
3
PART I "Business - Factors
that May Affect Future Results." These factors may cause the Company's actual
results to differ materially from any forward-looking statement.
Although management believes that the expectations reflected in the
forward-looking statements are reasonable, there is no guarantee regarding
future results, levels of activity, performance or achievements. Moreover,
neither the Company nor any other person assumes responsibility for the accuracy
and completeness of such statements. The Company is under no duty to update any
of the forward-looking statements after the date of this Annual Report on Form
10-K to conform such statements to actual results.
Readers should be aware that the occurrence of any of the events described
in the risk factors and elsewhere in this Report, including the documents
incorporated by reference, could have a material and adverse effect on the
Company's business, results of operations and financial condition and that upon
the occurrence of any of these events, the trading price of the Company's Common
Stock could decline and investors could lose all or part of their investments.
3
PART I.
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GENERAL
The Company
We design, develop and its subsidiaries are involved in various business activitiesmanufacture electronic products, including subsystems and semiconductors, and other products related to miniaturized electronics and the applications thereof. The Company
isWe are organized into the following primary business groups:
Irvine Sensors Corporation
Irvine Sensors Corporation, - --------------------------
Irvine Sensors Corporation ("ISC") is the developer ofor ISC, develops proprietary technologies to produce extremely compact packages of solid state microcircuitry, which ISC
believeswe believe offer volume, power, weight and operational advantages versus less miniaturized alternatives. These advantages result from ISC'sour ability to assemble microelectronic chips in a three-dimensional "stack"“stack” instead of alongside each other on a flat surface, as is the case with more conventional methods. These stacking technologies have also led to ISC'sour development of collateral technologies for the design of low power and low noise chips, thinning of chips and various specialized applications of chips and stacked chip assemblies in a variety of fields, including wireless infrared transmission, miniaturized sensors, image processing, infrared cameras, digital photography and internet data transmission and switching.
ISC's
Our core chip-stacking technology was originally conceived and developed as a means of addressing the demands of space-based surveillance. However, the degree of miniaturization potentially realizable from ISC'sour technologies has attracted R&Dresearch and development sponsorship from various government funding agencies for a wide variety of potential military and space applications. Until the last few years,
ISCapplications, including but not limited to stacked memories, embedded systems, miniaturized cameras and other communications and electro-optical systems. For much of our operating history, we derived most of itsour revenues from such government-funded research and development. Currently, we conduct that funded research and development.
Recently,development through our Advanced Technology Division, or ATD. ISC also has an operating division, Microelectronics Product Division, or MPD, which we organized to build and sell specialized stacked chip products. MPD only started to become a material contributor to our consolidated revenues in fiscal 2002, when it contributed nearly 12% of our total revenues. In addition to contractually funded research and development, ATD and MPD incurred approximately $1.2 million and $71,100 of internally funded research and development expense, respectively, in fiscal 2002. Since MPD’s products relate to technologies developed by ATD, MPD ultimately benefits from ATD’s research and development activities, both externally and internally funded.
In recent years, we sought to commercialize itssome of our technologies by creating independently managed subsidiaries that cancould pursue their own financing strategies separately from the parent. ISC has received an increasing share of
its consolidated revenues from one such subsidiary.
InISC. We formed Novalog, Inc. in October 1995 ISC formed a subsidiary, Novalog, Inc. ("Novalog"), to commercially exploit itsour low power chip technology.technology as applied to wireless infrared data transmission. In April 1997, ISCwe formed aanother subsidiary, MicroSensors, Inc. ("MSI"), or MSI, to commercially exploit itsour technologies for low noise readout electronics and miniaturized inertial sensors. In June 1998, ISCwe formed a subsidiary, Silicon Film Technologies, Inc. ("Silicon Film"), to commercially exploit some of itsour digital photography technologies. Silicon Film suspended operations in September 2001 and was liquidated in fiscal 2002 pursuant to bankruptcy proceedings. In March 2000, ISCwe formed a subsidiary, RedHawk Vision Systems, Inc. ("RedHawk"), to commercially exploit itsour technologies for digitally extracting video data. As of
October 1, 2000, ISC owned approximately 95%, 98%, 83% and 95% of the issued
common stock of Novalog, MSI, Silicon Film and RedHawk, respectively. In October 2000, subsequent to the close of fiscal year 2000, ISCwe formed a subsidiary, iNetWorks Corporation, ("iNetWorks"), to commercially exploit itsour chip-stacking technologies to develop proprietary switches and routers for Internet and telecommunications networks.
Cumulatively over the last three years, we received approximately 35% of our total revenues from Novalog. However, the contribution from Novalog declined to approximately 14% of our total revenues in fiscal 2002, because of a decline in Novalog’s revenues and an increase in the revenues of ATD and MPD. Other than Novalog, none of our other commercial subsidiaries have contributed substantial revenues or earnings to our consolidated results. We have reduced our investments in subsidiaries since mid-fiscal 2001 to the point that the primary activity of the subsidiaries other than Novalog, and to a lesser degree, MSI, is the pursuit of licensing relationships and third-party strategic partners to further the commercial exploitation of those subsidiaries’ technologies.
ISC owns approximately 97% of iNetWorks as ofwas incorporated in California in December 15, 2000.
1974 and was reincorporated in Delaware in January 1988. Our principal executive offices are located at 3001 Redhill Avenue, Building 4, Costa Mesa, California 92626, and our telephone number is (714) 549-8211.
4
Novalog, Inc.
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Novalog is a consolidated95% owned subsidiary of ISC that designs, develops and sells proprietary integrated circuits ("ICs") and related products for use in wireless infrared communication. Novalog'sNovalog’s initial products, trademarked SIRComm(TM)SIRComm™, SIR2(TM)SIR2™, MiniSIR(TM)MiniSIR™ and MiniSIR2(TM)MiniSIR2™, enable infrared, line-of-sight data transfer between computers, electronic organizers, printers, modems and other electronic devices that have compatible ports. Novalog ishas been an active participant in the Infrared Data Association, ("IrDA"),or IrDA, which establishes the hardware and software protocols for such products. Novalog believes itsWe believe Novalog’s products have advantages in terms of power consumption, dynamic range, size and economics as compared to the products of its competitors. Novalog has shipped its productsNovalog’s revenues have declined from approximately $6.3 million in millionsfiscal 2000 to approximately $4.5 million in fiscal 2001 and approximately $2.1 million in fiscal 2002, largely as a result of units to manufacturers servicinga decline in the IrDA marketplace and, although
there can be no assurance, management anticipates growing demand for suchbusiness of Palm Computing, the primary end-user of Novalog’s products. In fiscal 2002, 2001 and 2000, Novalog accounted for approximately 14%, 42% and 59% of our total revenues, respectively. At September 29, 2002, Novalog had four employees and occupied approximately 2,660 square feet in ISC’s office complex in Costa Mesa, California. It incurred approximately $170,900 of internally funded research and development expense in fiscal 2002. At September 29, 2002, the Company's consolidated revenues.
Chief Executive Officer of Novalog was Robert G. Richards.
MicroSensors, Inc.
- ------------------
MSI is a consolidated98% owned subsidiary of ISC that was formed to develop, license and sell proprietary micromachined sensors and related electronics. Micromachining involves the use of semiconductor manufacturing processes to build electromechanical devices with feature sizes measured in microns or fractions thereof. As prices have declined for micromachined devices, such solid-state units have migrated from initial aerospace and military applications to automotive, industrial process-control and medical applications. MSI is
developinghas developed the prototype of a proprietary micromachined inertial sensor, called the Silicon MicroRing Gyro(TM)Gyro™. MSI has demonstrated early prototypes ofalso developed a proprietary 3-axis silicon accelerometer. MSI has licensed its gyro and accelerometer technology to a third party for further development applicable to automotive applications. This license is royalty bearing to us, but initially at levels that are not material. The licensee must meet specified financial objectives through December 2004 to retain exclusivity for the licensed use. We do not anticipate that we will receive significant royalties from this device and is
presently seeking strategic partners to facilitate its market introduction.license in the next several years, if at all. In addition to inertial sensors, MSI intends to offerhas designed Application Specific Integrated Circuits, ("ASICs") designedor ASICs, to read out micromachined sensors and other electronic systems. MSI is presently shippinghas shipped engineering samples, qualification lots and qualificationsmall production volumes of a proprietarysuch an ASIC product called the Universal Capacitive Readout (TM)
("UCR"(TM)) ASIC product to potential customers. The Company believes™, or UCR. We believe that there are many uncertainties surrounding 4
the development of MSI'sMSI’s business, including the risk that large companies may be reluctant to purchase critical parts of the nature that MSI is developing from a small company. This may be true even if MSI, succeedsor any licensees, succeed in surmounting all of the developmental challenges it currently faces.of the potential product applications. MSI accounted for less than
1%approximately 5.6% of the Company's consolidatedour total revenues in fiscal 2000.
Silicon Film Technologies, Inc. (formerly Imagek, Inc.)
- -------------------------------------------------------
Silicon Film Technologies, Inc. is a consolidated subsidiary2002. In the latter part of ISC that
designs, developsfiscal 2002, the operations of MSI were re-integrated with ATD to provide greater support and intends to sell proprietary electronic film systems and
other digital imaging products and services. Silicon Film has developed and had
manufactured pre-production quantities of a proprietary digital photography
system called "EFS"(TM) which includes a self-contained, compact, battery-
powered cartridge that fits into the film cavity of a standard 35mm camera thus
offering the flexibility to switch between conventional filmexploit MSI’s technology, and digital
photography. Silicon Film is presently qualifying an initial version of the EFS
in preparation to offer it for sale. Other collateral products and services are
planned for introduction by Silicon Film in the future. Silicon Filmat September 29, 2002, MSI had no revenuesseparate employees or facility. MSI incurred approximately $558,800 of internally funded research and development expense in fiscal 2000.
2002. At September 29, 2002, the Chief Executive Officer of MSI was John C. Carson. RedHawk Vision, Inc.
- --------------------
RedHawk Vision, Inc. is a consolidated70% owned subsidiary of ISC that designs, developsformed to design and intends to sell personal computer software tools that digitally enhance video data and extract 35mmimproved quality images from any video source including personal camcorders, the Internet and television. At the end of fiscal 2000,
RedHawk introducedhas realized limited revenues from an initial version of this software intended for professional use. RedHawk had nohas an agreement with a software developer to further develop this software and is seeking strategic partners to facilitate the further exploitation of this technology. We do not expect material revenues from this agreement in the foreseeable future, if at all. Pending such arrangements, the success of which we cannot assure, RedHawk is maintaining a minimal operating status. RedHawk did not generate any significant revenues in fiscal 2000.
2002. At September 29, 2002, RedHawk had one employee and occupied approximately 680 square feet in ISC’s office complex in Costa Mesa, California. It incurred approximately $11,000 of internally funded research and development expense in fiscal 2002. At September 29, 2002, the Chief Executive Officer of RedHawk was James Evert.
iNetWorks Corporation
- ---------------------
iNetWorks Corporation is a consolidated95% owned subsidiary of ISC organized in October 2000 to develop proprietary switches and routers for Internet and telecommunications networks. iNetWorks is a development stage company that has not yet generated material revenues. iNetWorks is seeking strategic partnerships and is not
expectedfinancing to generate revenuessupport its development plans.
5
We cannot assure you that such search will be successful. In the interim, ATD has sought and received government research and development contracts to further the development of iNetWorks’ technology. At September 29, 2002, iNetWorks had one employee and occupied approximately 300 square feet in our office complex in Costa Mesa, California. It incurred no internally funded research and development expenses in fiscal 2002. At September 29, 2002, the Chief Executive Officer of iNetWorks was Mel Brashears, who is also the current Chairman of the Board of ISC.
Silicon Film Technologies, Inc.
Silicon Film Technologies, Inc. is a former 51% owned subsidiary of ISC organized in June 1998 to develop and sell proprietary electronic film systems and other digital imaging products and services. Over the subsequent approximate three year period, Silicon Film secured third-party investments, developed and demonstrated product prototypes, entered into manufacturing and distribution agreements and completed certification testing on initial elements of its first planned product. Ultimately, however, Silicon Film was not able to achieve launch of its planned products within its available financing. Accordingly, Silicon Film suspended its operations in September 2001 and filed for liquidation through bankruptcy proceedings in October 2001. iNetWorks is not includedSilicon Film’s assets were liquidated through those proceedings in February 2002, and the Company's consolidatedbankruptcy was discharged in June 2002. All financial statements forand schedules of ISC reflect the year ended October 1, 2000.
Subsidiaries'discontinuation of Silicon Film’s operations.
Subsidiaries’ Capital Structure
- -------------------------------
The capital structure and ownership of ISC'sour subsidiaries vary depending on the extent to which the subsidiaries have received equity financing from third-party sources ratherother than ISC. After giving effectNovalog and RedHawk have received third party financing consisting of private sales of common stock of those subsidiaries representing approximately 32% and 30%, respectively, of their issued equity interests. These sales of subsidiary minority interests in Novalog and RedHawk resulted in net proceeds to those subsidiaries in the possible conversionaggregate of approximately $4.1 million and $581,000, respectively. In fiscal years 1998 and 1999, we repurchased approximately 27.5% of the common stock of Novalog from certain of the minority investors through the issuance of 96,100 shares of ISC common stock, as adjusted to reflect the 1-for-20 reverse stock split in September 2001. Those ISC shares were valued at approximately $3.2 million at the time of their issuance. Accordingly, as of September 29, 2002, our ownership of the issued and outstanding preferredcapital stock into common stock, ISC's ownership of all
equity securities of Novalog, MSI, Silicon Film, RedHawk and iNetWorks iswas approximately 95%, 98%, 52%, 62%70% and 97%95%, respectively. Giving full effect toAssuming the possible exercise of all of the outstanding options and warrants and additional options that may be granted under existing option plans, ISC's futureour ownership of these subsidiaries would be approximately 66%67%, 57%58%, 39%, 50%51% and 93%69%, for Novalog, MSI, Silicon Film, RedHawk and iNetWorks, respectively.
Novalog, MSI,
Silicon
Film, RedHawk and iNetWorks all have substantial intercompany debts payable to ISC.
At September 29, 2002, the amount of these intercompany obligations were approximately $3.1 million, $11.3 million, $1.5 million and $2.4 million for Novalog, MSI, RedHawk and iNetWorks, respectively. The obligations are not interest-bearing and contain no conversion rights. However, ISC could elect to cancel some of the indebtedness from Novalog to exercise warrants to purchase up to 3 million shares of Novalog’s common stock at the exercise price of $1.00 per share and to cancel some of the indebtedness from MSI to exercise warrants to purchase up to 4 million shares of MSI’s common stock at the exercise price of $1.00 per share. In the event that these subsidiaries are successful in attracting additional third-party equity financing, it is possible that
ISCwe may be required or may elect to convert these obligations into additional equity securities of these subsidiaries.
ISC was incorporated in Delaware in January 1988. Pursuant to a merger effective
in May 1988 with a corporation of the same name incorporated in California in
December 1974, the Company succeeded to all of the assets and liabilities of
such predecessor corporation. Its principal executive offices are located at
3001 Redhill Avenue, Building 4, Costa Mesa, California 92626, and its telephone
number is (714) 549-8211.
Novalog was incorporated in California in October 1995. Its principal executive
offices are located at 3001 Redhill Avenue, Building 4, Costa Mesa, California
92626, and its telephone number is (714) 429-1122.
MSI was incorporated in Delaware in April 1997. Its principal executive offices
are located at 3001 Redhill Avenue, Building 3, Costa Mesa, California 92626,
and its telephone number is (714) 444-8831.
Silicon Film was incorporated in Delaware in June 1998. Its principal executive
offices are located at 16265 Laguna Canyon Road, Irvine, California 92618, and
its telephone number is (949) 417-2260.
RedHawk was incorporated in Delaware in March 2000. Its principal executive
offices are located at 3001 Redhill Avenue, Building 4, Costa Mesa, California
92626, and its telephone number is (714) 444-8701.
iNetWorks was incorporated in Nevada in October 2000. Its principal executive
offices are located at 3001 Redhill Avenue, Building 3, Costa Mesa, California
92626, and its telephone number is (714) 444-8737.
5
Products and Technology
- -----------------------
The Company has
We have developed a wide variety of technologies that have been derived from itsour early entry into the field of chip stacking. The Company is seekingWe have previously sought to commercially exploit many of these technologies through subsidiaries organized to meet the needs of varying markets. The Company'sMore recently, we have begun integrating the development and marketing of both present and future products through ATD and MPD in order to reduce overall expenses. We are currently offering products in the following areas:
Stacked Chip Assemblies. We have developed a family of standard products consisting of stacked memory chips that are used for numerous applications, including solid state data recorders. Our technology is applicable to stacking of a variety of microchips, both packaged and unpackaged, that we believe can offer demonstrable benefits to designers of systems that incorporate numerous integrated circuits, both memory and otherwise, by improving speed and reducing size, weight and power usage. In addition, since our technology reduces the number of interconnections between chips, potential system failure points can also decrease. However, our revenues from these products represented only 5.4% of our total revenues in fiscal 2001 and 11.9% of our total revenues in fiscal year 2002, so we do not have sufficient history to assure you that such products will ever achieve broad market acceptance.
6
We believe that the features achievable with our chip stacking technology will have application in space and in aircraft in which weight and volume considerations are dominant, as well as in various other applications in which portability is required and speed is important. We are seeking to exploit our highest density chip stacking technology through the sale of funded development and products to high end, high margin government and commercial users to whom the technical improvement will be most valuable. While these applications tend to involve lower unit volume, the potential sales are anticipated to be at significantly higher prices than many applications involving high volume production. While we have existing relationships with some of the potential customers in this market, we are not presently generating significant revenues from product sales for these applications and may not be able to do so in the future.
Since fiscal 1995, we have shipped limited quantities of our stacked unpackaged chip products, largely stacked memory, to customers for both government and commercial purposes. We hope to be able to market such products for more widespread applications in the future, but cannot guarantee our success in that regard.
Customers’ demand for enhanced performance of electronic systems has produced a wide variety of competitors and competitive systems offering higher density microelectronics ranging from various three-dimensional designs to highly dense two-dimensional designs. Although some competitors are better financed, more experienced and organizationally stronger than us, we are not aware of any system in existence or under development that can stack chips more densely than our three-dimensional approach. See “Competition.”
Microchips and Sensors. Our Novalog subsidiary has developed a Serial Infrared Communicationsserial infrared communications chip using elements of the Company'sour sensor chip design technology. This device is being used in products in order to allow computers, computer peripherals and hand-held portable electronics devices such as personal organizers, pagers and cellular phones to communicate using infrared transmissions in a manner similar to that used by remote control units for televisions and video cassette recorders. Novalog has been shipping such devices since 1995.
The Company also
Our MSI subsidiary has chip design technology relating to electronic readouts that
it is seeking to exploit through its MSI subsidiary. In fiscal 1999, MSI
introduced a Universal Capacitive Readout (UCR) Application Specific Integrated
Circuit ("ASIC")the UCR ASIC intended for use by manufacturers of micromachined products.products who require low noise electronic readout circuitry. MSI is currently shippinghas shipped engineering samples, qualification volumes and small production qualification volumes of the UCR to various customers. MSI has also developed a proprietary inertial sensor, the Silicon MicroRing Gyro, intended to provide an inexpensive means to measure angular motion for a wide variety of potential applications.
Prototypes of the Silicon MicroRing Gyro are presently being demonstrated to
potential customers and strategic partners. In September 1999, a United States patent, assigned to MSI, was granted covering the design of the Silicon MicroRing Gyro. The commercial exploitation, if any, of the Silicon MicroRing Gyro is expected to be paced by product design-in lead times of customers, principally Original Equipment Manufacturers, ("OEMs"). Asor OEMs. Similarly, MSI has also developed a result, the Company
does not project material contributionsproprietary 3-axis silicon accelerometer that is also paced by OEM schedule considerations. MSI’s gyro and accelerometer technology has been licensed to its consolidated revenue from this
product during fiscal 2001. Furthermore, until potential customers and
strategic partners more fully evaluate the prototypesa third party for further development targeted toward automotive applications. Because of the Silicon MicroRing
Gyro,long lead-time of such product applications and the Company istechnical challenges of such development, we do not in a position to project when, or if,expect material revenues will be realized from this product thereafter.
In June 1998, the Company formed its Silicon Film (formerly Imagek) subsidiarygyro and accelerometer technology for several years, if at all.
Miniaturized Infrared Cameras. Several of our research and development contracts have involved the miniaturization of imaging devices, particularly those using infrared detectors that create images by sensing the heat emitted by objects being viewed. Such technology is directly applicable to commercially explore some of its proprietary technologies related to
miniaturized digital cameras. Silicon Film is presently qualifying anapplications requiring vision at night or in smoke-filled environments. Our initial product for sale, the EFS-1, and is developing additional products for future
introduction. Silicon Film believes that its proprietary EFSdevelopment using this technology has value advantages to potential customersfocused on low-power, rugged infrared cameras for security and surveillance applications. A combination of our miniaturization activities with substantial investments in
conventional 35mm camera equipment that inhibits the use by those consumers of
self-contained digital cameras. Byadvanced electronic packaging available using the optics of existing cameras, Silicon
Film believes that the EFS product line will be economically competitive to
comparable resolution digital cameras. Market responseour chip stacking has led to the EFS-1 will
determinedevelopment of an “instant-on” infrared camera that overcomes power limitations of competitive approaches. We have shipped early versions of such a product to a government contractor and have announced the degreeavailability of such a product to which Silicon Film contributesother potential customers. We also intend to the consolidated
revenues of the Company in fiscal 2001.market products utilizing this core technology to applications such as helmet-mounted imaging devices for firefighters and weapons sights.
Software. In March 2000, the Companywe formed itsour RedHawk subsidiary to exploit itsour proprietary software technology for extracting quality still photographs from any video source. In September 2000, RedHawk introduced an initial version of its software primarily intended for use by professionals.professionals in the video and photographic industries. RedHawk is developing additional
versions ofhas an agreement with an individual software developer to further develop this product for introduction in fiscal year 2001.and is seeking strategic relationships to more broadly exploit this technology. Pending such strategic relationships, an outcome that we cannot guarantee, RedHawk’s operations and revenues are minimal.
7
Potential Product Applications
Internet Routers. In October 2000, the Companywe formed itsour iNetWorks subsidiary to exploit itsour proprietary chip-stacking technology, combined with superconducting chip technology, to develop ultra-high-speed switches and routers for Internet and telecommunications networks. The Company is presently augmenting its fundedWe have sought and received government-funded research with its own resourcesand development to facilitatesupport the development of our technology related to this router technology while iNetWorks seeks appropriate strategic and financial partners. DevelopmentWe anticipate that development of this technology for its intended application is projected towill require two to
three years and substantial additional financial resources, sourceswhich may not be available on acceptable terms, if at all.
Embedded Systems. In fiscal 1998, we commenced exploration of whicha technology to stack chips of different functionality and dimensions within the same chip stack, in effect creating a complete, miniaturized electronic system that can be embedded in a higher-level product. We refer to this new technology as “NeoStack.” In fiscal 1999, a U.S. patent was granted on our NeoStack technology. We initially demonstrated our NeoStack technology to support a government program to develop a wearable computer. We are not
currently established.
In additionpresently developing potential commercial applications of this technology under government contract. Our NeoStack technology is also central to the products developed through its subsidiaries, the Company has
developed a familydevelopment of standard products consisting of stacked chips, both
packagedInternet and unpackaged, and believes that its chip stacking technology can
offer demonstrable benefits to designers of systems that incorporate numerous
integrated circuits, both memory and otherwise,telecommunications routers being undertaken by improving speed and reducing
size, weight and power usage. In addition, since ISC's technology reduces the
number of interconnections between chips, potential system failure points can
also decrease. However, the Company has only recently qualified some of its
stacked packaged chip products for volume production, and it did not realize
material revenues from these products in fiscal year 2000. The economic
attractiveness of the Company's stacked packaged chip products is highly
dependent on market pricing of competitive monolithic parts. The Company
believes,our iNetWorks subsidiary. We believe, but cannot assure, that such market conditionsour NeoStack approach will be favorableoffer advantages in terms of compactness and power consumption to developers of a wide variety of embedded computer and control systems. However, we have not yet developed this technology to the Company's productspoint at some time in fiscal year 2001, but becausewhich we can make forecasts of the
uncertainty in such market conditions is not able to estimate whether its
stacked packaged chip products will make a material contribution to the
Company's consolidated revenues.
The Company believes that the features achievable with its chip stacking
technology will havepotential revenue, if any, resulting from our licensing or application in space and in aircraft in which weight and
volume considerations are dominant, as well as in various other applications in
which portability is required and speed is important. The Company is seeking to
exploit its highest density chip stacking technology through the sale of funded
development and products to high end, high margin government and commercial
users to whom the technical improvement will be most valuable. While these
applications tend to require lower unit volume, the potential sales are at
significantly higher prices than many applications requiring high volume
production. Furthermore, the Company has existing relationships with someby OEMs.
Active Imaging Systems. Many of the potential customersgovernment applications for which we have received developmental funding over the years have involved advanced techniques for acquiring and interpreting images. In fiscal 2002, an industry team that we formed and led, and one other industry team, won an open competition to design an advanced imaging system based on integration of laser pulse returns to allow the extraction of images of objects concealed by foliage. The demonstration units being built under this contract are planned to be field tested in this market.
Since fiscal 1995,2003. If these tests are successful, of which there can be no guarantee, we believe that such systems could become a significant product opportunity for us in the Companyfuture.
Infrared Sensors. The focus of our original government funded research and development and much of our subsequent follow on awards has been shipping quantitiesin the field of its stacked
unpackaged chip products, largely stacked memory, to customers for both
government and commercial purposes. However, there is no assurance that the
Company will be successful in
6
marketing such products for widespread applications. The Company also intendsapplications of infrared sensors. We intend to continue to marketpursue such contracts with the goal of developing and selling infrared sensing devicessensors for surveillance, acquisition, tracking and interception applications for a variety of Department of Defense Department and NASA missions.
Customers' demand for enhanced performance of electronic systems has produced a
wide variety of competitors and competitive systems offering higher density
microelectronics ranging from various three-dimensional designs to highly dense
two-dimensional designs. Although some competitors are generally believed to be
better financed, more experienced and organizationally stronger, the Company is
not aware of any system in existence or under development that can stack chips
more densely than its three-dimensional approach. See "Competition."
The Company is not aware of any technical disadvantages to its chip stacking
technology. However, until high volume production is achieved, as to which
there is no assurance, the ultimate cost of products using the Company's higher
density chip stacking technology cannot be firmly established, and therefore,
this uncertainty potentially places some of the Company's stacked chip products
at a cost disadvantage. Accordingly, the Company expanded its product offerings
in 1998 to include lower-density stacked electronics that could be more price
competitive. Three U.S. patents have been issued and others are pending
covering these latest additions to the Company's range of stacked chip product
offerings. Products employing these patented approaches have been qualified for
potential use by large manufacturers, and the Company is currently seeking
production orders for fiscal year 2001.
Potential Product Application
- -----------------------------
Neural Networks. In 1991, the Company received initial funding from the U.S.
Navy's Office of Naval Research for potential use of certain of its technology
in neural networks. After the successful completion of this phase 1 contract,
the Company We have received a $5,200,000 follow-on contractnumber of material contracts from government agencies regarding the Navy in June 1993
and an additional $1,700,000 add on in January 1997 to further develop thedevelopment of artificial neural networks technology. This phase of the contract was completed, and the
Company subsequently received approximately $2,050,000 in additional funding on
related programs through fiscal 2000. The Company is presently pursuing
additional contracts under which it would deliver demonstration products to
various branches of the DOD.networks. Neural networks contain large numbers of sensingprocessing nodes which continuously interact with each other, similar to the way that the neurons of a human brain interact to process sensory stimuli. Neural networks are the subject of scientific inquiry because pattern recognition and learning tasks, which humans perform well, and computers perform poorly, appear to be dependent on such processing. Neither conventional computers nor advanced parallel processors have the interconnectivity needed to emulate neural network processing techniques. The Company believes itsWe are presently pursuing additional contracts under which we would deliver demonstration products to various branches of the Department of Defense incorporating such technology. We believe our chip stacking technology offers a way to achieve the very high levels of interconnectivity necessary to construct an efficient artificial neural network. ToWhile the Company's knowledge,
there are no competitive packaging approaches that are presently available which
are believed to offer this potential. The full embodiment of itsour neural network technology is not expectedyears away, if at all, we intend to yield near-term products forcontinue to pursue research and development in this area in order to broaden the Company, although
it is anticipated to keep the Company actively involved in advanced R&D relevant
to the Company's long-range business interests. However, elements of this
technology, including a proprietary chip set, are currently being developed with
a view to earlypotential product utilization.
Embedded Systems. In fiscal 1998, the Company commenced exploration of a
technology to stack chips of different functionality and dimensions within the
same chip stack, in effect creating a complete, miniaturized electronic system
that can be embedded in a higher-level product. The Company refers to this new
technology as "NeoStack." In fiscal 1999, a U.S. Patent was granted on the
Company's NeoStack technology. The Company has initially demonstrated its
NeoStack technology to support a government program to develop a wearable
computer. The Company is presently developing potential commercial applications
of this technology under government contract. The Company's NeoStack technology
is also central to the development of Internet and telecommunications routers
being undertaken by its iNetWorks subsidiary. The Company believes, but cannot
assure, that its NeoStack approach will offer advantages in terms of compactness
and power consumption to developers of a wide variety of embedded computer and
control systems. However, the Company has not yet developed this technology to
the point at which it can make forecasts of potential revenue, if any, resulting
from its licensing or application by OEMs.
Development Contract
- --------------------
In April 1980, the Company entered into an agreement with R & D Leasing Ltd.
("RDL"), a limited partnership in which the Company's Chairman of the Board and
a Senior Vice-President are general partners with beneficial interests, to
develop certain processes and technology related to chip stacking. The Company
has exclusively licensed this technology from RDL. The Company's exclusive
rights to the technology extend to all uses, both government and commercial.
Since entering into the licensing agreement, the Company had accrued royalty
obligations to RDL at the rate of 3.5 percent of all Company sales of chip
stacks using the licensed technology.
In October 1989, RDL agreed to defer its royalty claims and subordinate them
with respect to all other creditors in exchange for options to purchase up to
1,000,000 shares of the Company's Common Stock at $1 per share, which were
exercisable by applying the deferred royalties to the purchase.
As of March 15, 2000, the Company entered into an Agreement and Plan of
Reorganization to acquire substantially all of the assets of Research &
Development Leasing, Inc. ("RDL") solely in exchange for 1,000,000 shares of
voting common stock of the Company. Prior to March 15, 2000, the Company had
been accruing obligations to RDL for a license to exclusive rights to certain
processes and
7
technology related to chip stacking. By consummating the Agreement and Plan of
Reorganization to acquire RDL assets, including its patents and technology, the
Company has terminated its obligation for any further licensing payments to RDL.
The Company's Chairman of the Board and a Senior Vice President were the sole
shareholders of RDL prior to the Company's acquisition of RDL's assets.
Manufacturing
- -------------
The Company's hardware subsidiaries
We use contract manufacturers to fabricate and assemble theirour stacked chip, microchip and sensor products. Novalog and MSIFor such products, we use semiconductor fabrication and related manufacturing sources that we believe are widely available worldwide. Silicon Film
uses product components that are also widely available with one exception.
Silicon Film uses imaging chips which are currently available from limited
sources of supply. Silicon Film expects that additional sources of supply will
become available for this component in the future, but the continuity of its
supply of this key component may be at risk until that occurs. RedHawk'sAt their present low volumes, we manufacture our camera and software products are easily manufacturable by either the RedHawk itself or
external vendors.ourselves. iNetWorks does not yet manufacture products and is seeking strategic partners to provide manufacturing support in the future.
The Company's
Our ultra-high-density stacking technology involves a standard manufacturing process whichthat fabricates cubes comprising of approximately 50 die layers or more along with ceramic cap and base substrates laminated with an extremely thin adhesive layer and interconnected with a thin-film bus metalization to bring the chip input/output signals out to the top surface of the stacks. The cubes arecan then be segmented or split into subsections as required for the particular product configuration being built. Finally, the cubes, mini-cubes or short stacks are burned in, tested, graded, kitted for packaging, out-sourced for packaging and screening, and returned for final test. The Company'sOur facility is designed for low volume and prototype production of such parts.
During fiscal 1998,
8
In the Companylast several years, we have introduced more cost competitive products manufactured with current state of the artstate-of-the-art manufacturing technologies. The
Company uses outsideWe use independent third party qualified source vendors for the manufacturing of these products. We have currently have no long-term manufacturing contracts for our products.
The primary components of the Company'sour non-memory products are integrated circuits and infrared detectors. TheWe typically design the integrated circuits are designed by the
Company or its subsidiaries for manufacture by othersthird parties from silicon wafers and other materials readily available from multiple sources. Due to the ready
availability of these materials, the Company doesWhile we do not have any speciallong-term arrangements with suppliers for their purchase. The Company does not produce
detectors. However, the Company has developed a process, which enables itpurchase of these materials, we believe we will have sufficient capacity to use relatively low cost, and unsophisticated detectors which are generally
available from numerous sources.
address our near term needs.
Because of the nature of the sophisticated research and development work performed under itsour development contracts, the Company designswe design and assemblesassemble equipment for testing and prototype development. The Company usesWe use the unique capability of this equipment to seek, qualify for and perform additional contract research and development for itsour customers.
Backlog
- -------
Funded backlog includes contract amounts that we have authority to bill. At November 26, 2000, the Company's24, 2002, our consolidated funded backlog was $6,056,600approximately $1.6 million compared to $3,041,600approximately $1.8 million at December 15, 1999. The Company anticipatesNovember 26, 2001. We anticipate that substantially all of theour current funded backlog will be filled in fiscal 2001.2003. In addition, the Company
haswe have unfunded backlog on contracts that we have won, but that have not yet been fully funded in which typicallyfunding increments are fundedexpected to be received when the previously funded amounts have been expended. The Company isWe are also continuing to negotiate for additional research contracts and commercial product sales, which, if obtained, could materially increase itsour backlog. Many of these proposals for additional research contracts are submitted under the Small Business Innovation Research provisions of all government agencies that conduct funded research and development. In the past, we have submitted 50 or more Phase 1 SBIR proposals in any given fiscal year, with between five and ten of those proposals generally leading to initial contract awards valued between $50,000—$100,000 each. Of those Phase 1 contracts, approximately half of them have historically resulted in follow-on Phase 2 awards, usually valued between $500,000 – $1,000,000 each. In fiscal 2002, fiscal 2001 and fiscal 2000, we generated approximately $2 million, $2.4 million and $1.9 million, respectively, of funded contract revenue from these proposals. We cannot guarantee you that our future SBIR contract awards will match or exceed our historical experience, and we may not be successful in securing future contract awards. Failure to continue to obtain these SBIR awards and other funded research and development contracts in a timely manner, or at all, could materially and adversely affect the Company's short-term
results.
our business, financial condition and results of operations.
Customers and Marketing
- -----------------------
The Company's Advanced Technology Division ("ATD")
ATD primarily focuses its marketing efforts primarilydirectly on U.S. militarygovernment agencies or contractors to those agencies. The
Company is continually seekingWe intend to continue to seek and preparingprepare proposals for additional contracts.
The Companycontracts from such sources. We also developsdevelop potential non-military uses of itsour technology. As a
result of the post cold-war defense cutbacks, many defense contractors have
experienced declines in their business base as government agencies' budgets are
reduced. However, even if this trend continues, the Company believesWe believe that there will be more emphasis and funds directed to advanced technology systems and research programs for which the Company believes it iswe are qualified to compete. However, there can be no assurancesWe believe that the Company willwe may be successful in competing against the larger defense contractors for some potential programs.
The Company's Novalog subsidiary supports Original Equipment Manufacturers
("OEM's") supplyingprograms of this nature, although we cannot guarantee this outcome.
We market our infrared sensors and related microchips directly to OEMs that supply infrared communications devices complying with the standards of the Infrared Data Association, ("IrDA"). The Company believesor IrDA. Novalog has established relationships with these OEMs and their suppliers. We also believe that Novalog's
activeNovalog’s participation in IrDA facilitates its marketing to those customers.
MSI directs its marketing
We market our UCR microchips and related inertial sensors toward three commercial areas: (i)
Customerscustomers with a need for
Application Specific Integrated Circuits;custom ASICs that require low capacitance; (ii) OEMs that have a need for the cost and performance features that could be provided by
MSI'sMSI’s Silicon MicroRing Gyro
or 3-axis accelerometer, with particular emphasis toward manufacturers of electronic toys and games, industrial monitoring equipment, medical instrumentation and automotive markets; and (iii) the manufacturers of micromachined sensors who may be able to utilize
MSI's Universal Capacitive Readout (UCR)MSI’s UCR general purpose ASIC designed to support a variety of sensors requiring high accuracy capacitive readout and control electronics.
8
Silicon Film is a consumer product-focused enterprise. Both the structure and
staffing of Silicon Film was developed to bring digital imaging products to the
consumer market. The initial product of Silicon Film, the Electronic Film
System (EFS) is designed to enable 35mm camera owners to shoot digital or
traditional photography with equipment they currently own. The initial target
market, termed "prosumers" are defined as high end hobbyists and business
photographers who have made a significant investment in their camera system.
The EFS is being positioned as a camera accessory, leveraging off the growing
adoption of digital cameras and their growing infrastructure.
Silicon Film is currently qualifying its initial EFS-1 product for sale. Silicon
Film plans its primary product roll outBecause of the EFS-1scale of many of these markets, MSI has licensed a third party to be through direct
follow-up of inquiries from potential customers it has previously received.
Silicon Film expectspursue development and marketing for automotive applications and is focused on securing strategic partnerships with significant, existing market presence in other business areas to follow this initial roll out with an expansion of
distribution, reseller channels and value-added resellers for broad and vertical
markets through strategic OEM relationships with camera and film companies.
Silicon Film plans to servicemarket its customers with an electronic commerce site and
contracted customer service and support facilities.
RedHawk hasproducts. We have focused itsour initial marketing effortefforts for our software product on high-end users of professional photo-editing software. RedHawk'sOur initial product has been designed as a plug-in to such software. RedHawk has licensed a software developer to further develop its product and is presently developing stand-
aloneseeking strategic partners to facilitate the development and marketing of future versions of its software to address broader market opportunities.
iNetWorks
The ultimate target market for our Super Router is expected to be OEMs and carriers that support the Internet and
9
telecommunications infrastructure. It isWe are presently seeking strategic relationships with such entities to facilitate the development and marketing of itsthe contemplated Super Router and related products.
In fiscal 2000,2002, direct contracts with all branches of the U.S. government accounted for 20%approximately 66% of the Company's consolidatedour total revenues and second-tier government contracts with prime government contractors accounted for 12 percentapproximately 3% of the Company's
consolidated revenues; theour total revenues. The remaining 68 percent31% of the Company's consolidatedour total revenues was derived from non-government sources. During fiscal 2000,2002, revenues derived from M-Flex, Manufacturers' Services, and the U.S. Army, the U.S. Navy, and L-3 Communications accounted for approximately 16 percent, 13 percent45%, 16% and 12 percent11% of total consolidated
revenues, respectively. Loss of any of these customers would have a material adverse impact on the Company's short-term consolidated results.
our business, financial condition and results of operations. No other customer accounted for more than 10% of our total revenues for fiscal 2002.
Contracts with government agencies may be suspended or terminated by the government at any time, subject to certain conditions. Similar termination provisions are typically included in agreements with prime contractors. There
is no assurance the CompanyWe cannot assure you that we will not experience suspensions or terminations in the future.
The Company focuses
We focus marketing in specific areas of interest in order to best use itsour relatively limited marketing resources. Each operating unit orWith the de-emphasis on subsidiaries and reintegration of subsidiary hasoperations, we are coordinating the marketing through a designated individual to directcentralized director of marketing and individuals with specific responsibilities for Novalog, MSI and MPD products. The marketing of RedHawk products is conducted through a service relationship with the software developer licensee of that unit's marketing efforts.
technology.
Competition
- -----------
The demand for high performance semiconductors has produced a wide variety of competitors and competitive systems, ranging from various three-dimensional designs to highly dense two-dimensional designs. For most commercial applications, the principal competitive factor for such products is the cost, premium over less densely packaged electronics.although operating speed is increasingly becoming a factor. For some applications in which volume and weight are critical, such as space or avionics, density becomes the principal competitive factor. ManyWe believe that many of the Company'sour competitors are believed to
be better financed, more experienced and organizationally stronger than the
Company.us. Accordingly, there canwe may not be no assurances that the Company canable to successfully compete in such markets.
The Company ismarkets in the future.
We are aware of three largeprimary companies that have developed or acquired competing approaches to high-density chip stacking. They are Texas Instruments,Micro Technologies, Inc. (TI), Thompson CSF (Thompson)3D Plus and Vertical Circuits, Inc. (VCI), a subsidiary of TRW Inc. In addition, there are several smallindependent companies such as Staktek Corporation and DPAC Technologies Corp. and divisions of large companies that have various technologies for stacking a limited number of chips.
The Company is
We are also aware of many companies whichthat are currently servicing the military market for electro-optical sensors of the type which the Company'sthat our products are also designed to support. The principal competitive factor in this business area is the performance sensitivity and selectivity achievable by alternative sensor approaches and designs. Competitors to the CompanyOur primary competitors include TI,Texas Instruments, Inc., Lockheed Martin Corporation, Raytheon, Litton Industries,Northrop Grumman, BAE Systems, Infrared Industries, Inc., EG&G Judson, OptoElectronics-Textron, Inc. and Boeing Corporation. The Company believesWe believe that most of itsour competitors in this area have financial, labor and capital resources greater than those of the Company,us, and there is no assurance that the Company willaccordingly, we may not be able to compete successfully.
The Company is aware ofsuccessfully in this market.
We currently compete with several companies that currently service the market for serial infrared detectors of the type sold by Novalog.detectors. For battery-powered applications, we believe that the principal competitive factors for such products are costs and power consumption and cost.consumption. For desktop and related applications, we believe that the principal competitive factor is the speed of data transmission achievable. Novalog believes it hasWe believe that our serial infrared detectors have competitive advantages in the battery-powered applications. Competitors to NovalogOur primary competitors in this sector include Hewlett-Packard, Temic-VishayAgilent and Siemens Infineon,Vishay Intertechnology, Inc., among others, allboth of whom have financial, labor and capital resources greater than those of
Novalog. Although Novalog is currently experiencing material revenues in
competition with such companies, its ability to protect or expand its market
share inus.
We believe that the
future is not assured.
9
MSI is competing in a market populated with several largerprimary competitors relating
to itsfor our Silicon MicroRing Gyro includinginclude several larger companies, such companies as Delco Electronics, Motorola, Bosch Corporation Siemens and Systron-Donner. TheWe believe that the principal competitive factor for these applications is believedcost. The expected costs for products utilizing Silicon MicroRing Gyroand accelerometer technology are anticipated to be cost. MSI hasprovide a significant competitive advantage through a lower market price if our licensees can successfully develop and qualify products using our technology. We have no present knowledge of competitors planning to introduce ASICs competitive to itsour UCR product, but given the widespread availability of integrated circuit design capabilities in the electronics industry, the emergence of competitive products is believed to be likely. Silicon Film is notTo address these competitive challenges, we are seeking strategic partners with appropriate market presence and financial resources. We are aware of any direct competitorssome competitive software products intended to its EFS product and
believes that its intellectual property will act as a barrier to competitors
seeking to offer identical products, although there can be no assurance of that
result. However, the EFS systems itself is expected to face competition from
increasingly sophisticated generations of digital camera equipment. Peripheral
equipment and services which Silicon Film intends to offer to complement its EFS
products are also likely to attract strong competition if the EFS product line
receives significant market acceptance.
RedHawk is not aware of any direct competitors that presently offer PC-based
software for sale as means to capture quality still photographs from streaming
video. RedHawk is aware of such competitive software products under developmentvideo and the existence of a number of hardware applications to achieve this result, but we are not presently ataware of any significant
10
competitor that is able to attain the quality level achievable with the RedHawk software. GivenWe are currently seeking strategic partners to enhance our ability to compete in this market.
We believe the potential size of the market represented by video captured by consumer
camcorders, RedHawk expects material competition to emerge.
iNetWorks is directly addressing the market currently dominated byprimary competitors for our Super Router are Cisco Systems, Inc. and including such strong competitors as Juniper Networks, Inc. Given the anticipated size and growth of the market opportunity, iNetWorks expectswe believe we will have to face numerous large competitors of this nature if it iswith respect to our planned router product, and we may not be able to compete successfully development its planned router product.
in this market.
Research and Development
- ------------------------
The Company believes
We believe that government and commercial research contracts will provide the majora portion of the funding necessary for continuing development of some of itsour products. However, the manufacture of stacked circuitry modules in volume will require substantial additional funds, which may involve additional equity or debt financing or a joint venture, license or other arrangement. Furthermore, the development of some of the products of itsour subsidiaries, particularly iNetWorks, is likely to require substantial external funding. There can be no
assuranceWe cannot assure you that sufficient funding will be available from government or other sources or that we will successfully develop new products of the Company or its subsidiaries will be
successfully developed for volume production.
The Company's expenditures for
Our consolidated research and development expenses for the fiscal years ended September 29, 2002, September 30, 2001 and October 1, 2000 October 3, 1999,were $1,991,700, $5,951,700 and September 27, 1998 were $8,948,200,
$5,528,000 and $4,128,400,$4,980,400, respectively. These expenditures of Company funds were in addition to the Company's cost of revenues associated with its customer-
sponsoredour customer-sponsored research and development activities. The spending levels of Companyour own funds on research and development have declined markedly in fiscal 2002, reflecting the de-emphasis on internal financing of product development at subsidiaries. However, even given this reduction, the substantial research and development expenses in fiscal 2002 compared to itsour overall expenses are indicative of the Company'sour resolve to maintain itsour competitive advantage by developing new products and improving upon itsour existing technology.
The Company has
We have historically funded itsour research and development activities primarily through contracts with the federal government and with funds from the Company'sour public and private stock and bond offerings.
Patents, Trademarks and Licenses
- --------------------------------
The Company has a policy of protecting its investment in
We primarily protect our proprietary technology by seeking to obtain, where practical, patents on the inventions made by itsour employees. As of October 1, 2000, 53September 29, 2002, 56 currently effective U.S. and foreign patents have been issued and other U.S. and foreign patent applications are pending. Foreign patent applications corresponding to several of the U.S. patents and patent applications are also pending. Nine of these patents, covering early versions of our stacking technology, expire in two years or less. An additional five patents covering early versions of our stacking technology expire in three to five years. The remainder of our stacking patents, including those covering the stacking technologies that are the basis of our current product and product development activities, have durations ranging from 8 to 15 years. We also have patents on a variety of collateral technologies that we developed to support or facilitate our stacking technologies. Those patents have durations ranging from 1-16 years. The patent covering certain circuit technology embodied in Novalog’s products has a remaining duration of over 11 years. There is no assurance that additional patents will issue in the U.S. or elsewhere. Moreover, the issuance of a patent does not carry any assurance of successful application, commercial success or adequate protection. There is no assurance that the Company'sour existing patents or any other patent that may issue in the future would be upheld if the Company seekswe seek enforcement of itsour patent rights against an infringer or that the Companywe will have sufficient resources to prosecute itsour rights, nor is there any assurance that patents will provide meaningful protection from competition. The Company has been advised by its patent counsel, Myers, Dawes & Andras LLP,
that no adverse patent has been found which might create an infringement problem
in the marketing of the Company's products. IfIn addition, if others were to assert that the
Company iswe are using technology covered by patents held by them, the Companywe would evaluate the necessity and desirability of seeking a license from the patent holder. There is no assurance that the Company iswe are not infringing on other patents or that itwe could obtain a license if itwe were so infringing.
Those
The products and improvements that
the Company developswe develop under government contracts are generally subject to royalty-free use by the government for government applications. However,
the Companywe have has negotiated certain
"non-
space"“non- space” exclusions in government contracts and
hashave the right to file for patent protection on commercial products which may result from government-funded research and development activities.
10
Silicon Film has exclusive world-wide rights to the technology developed in
conjunction with a licensing agreement between the Company and I. Sapir, a
foreign individual, who is now an employee of Silicon Film. Under this
agreement, the Company issued 30,000 shares of its common stock to Mr. Sapir.
Silicon Film has assumed the royalty obligations of this licensing agreement,
which consist of a 1.5% royalty on products incorporating the licensed
technology. This licensing agreement was executed in October 1997 and amended in
March 1999. Silicon Film has received four additional patents and has filed
thirteen additional patent applications relating to the proprietary methods and
designs of its products.
The Company has We have entered into an assignment of patent and intellectual rights agreement with F.L.F.K. Eide, a Vice-President of the Company.our Vice-President. As part of an employment agreement, Mr. Eide assigned to the Companyus all rights and interests to five U.S. Provisional Patent Applications owned by him. In consideration for this assignment, Mr. Eide will receive a 1% royalty on the gross sales revenues, if any, of any products incorporating the technology of these patent assignments for the lifetime of these patents. This agreement was executed in February 1998.
The Company entered into a sale and licensing of intellectual property rights
related to the EFS to Advanced Technology Products, LLC ("ATPL"), a related
party which funded early development of this technology, for which the Company's
Senior Vice President and Chief Technical Officer serves as Managing Member. In
September 1998, the Company assigned the rights and future royalty obligations
of the ATPL license to Silicon Film. Concurrent with this assignment, ATPL
reduced its royalty entitlements under the license in consideration for the
issuance of 1,222,125 shares of Silicon Film common stock. ATPL retains a
royalty entitlement of 2% of the first $30 million of EFS sales, declining
thereafter as a function of sales volume.
Environmental Matters
- ---------------------
The Company believes that it is substantially in compliance with all regulations
concerning the discharge of materials into the environment, and such regulations
have not had a material effect on the capital expenditures or operations of the
Company.
11
Employees
- ---------
As of October 1, 2000, the Company,November 27, 2002, we, including itsour consolidated subsidiaries, had 13475 full-time employees and 238 consultants. Of the full-time employees, 8958 were engaged in engineering, production and technical support, 114 in sales and marketing and 3413 in finance and administration. None of the Company'sour employees is represented by a labor union, and the Company haswe have experienced no work stoppages due to labor problems. The Company considers itsWe consider our employee relations to be excellent.good.
Risk Factors that may Affect Future Results
- --------------------------------------
The Our future operating results of the Company are highly uncertain, anduncertain. Before deciding to invest in Irvine Sensors or to maintain or increase your investment, you should carefully consider the following factors should be carefully reviewedrisks described below, in addition to the other information contained in this annual report on Form 10-K and in our other public
disclosuresfilings with the Commission, including any subsequent reports filed on Forms 10-K, 10-Q and 8-K. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business and results of operations. If any of these risks actually occur, our business, financial condition or results of operations could be seriously harmed. In that event, the Company.
Shiftmarket price for our common stock could decline and you may lose all or part of your investment.
We have historically generated substantial losses, which, if continued, could make it difficult to fund our operations or successfully execute our business plan, and could adversely affect our stock price. We experienced net losses of $6.0 million for the fiscal year ended September 29, 2002, $14.6 million for the year ended September 30, 2001 and $15 million for the year ended October 1, 2000. In recent years, much of our losses were incurred as a result of our significant investments in Business Focus. Since commencing operations, ISC has developed
technology, principally under government research contracts, for various
defense-based applications. Since 1992, ISC has been implementing a fundamental
shiftour development stage operating subsidiaries. While we have significantly reduced our investment in its business, broadening its focus to include commercial exploitation
of its technology. This shift has been manifested by the purchase and later shut
down of the IBM cubing line, the "carve-out" of the Novalog, MSI, Silicon Film,
RedHawk and iNetWorks subsidiaries and the development of various stacked-memory
products intended for military and aerospace markets. To date, these changescorrespondingly have developed new revenue sources but have not yet produced sustained
consolidated profitability. Because of this limited and not-yet successful
history, there can be no assurancesreduced our losses, we cannot assure you that ISC's present and contemplated future
products will be widely accepted in commercial marketplaces.
Financing Needs. Although the Company believes that it has adequate liquidity
for its core level of operations, ISC and its subsidiaries have developed
business plans for several emerging product areas based on its technologies. The
product development and market introduction costs of these products cannot
presently be fully funded from internal cash flow. There can be no assurances
that ISC or its subsidiarieswe will be able to locate externalachieve or sustain profitability on a quarterly or annual basis in the future. In addition, because a large portion of our expenses are fixed, we generally are unable to reduce expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues. As a result, we may continue to experience net losses, which will make it difficult to fund our operations and achieve our business plan, and could cause the market price of our common stock to decline.
We will likely need to raise additional capital in the future, and additional funds may not be available on terms that are acceptable to us, or at all. We have generated significant net losses in recent periods, and experienced negative cash flows from operations in the amount of approximately $1.4 million for the fiscal year ended September 29, 2002 and approximately $10.2 million for the year ended September 30, 2001. To offset the financial effects of these negative cash flows, we sold approximately 2.5 million shares of our common stock in various financing for their
businesstransactions in fiscal years 2000, 2001 and 2002, realizing net proceeds of approximately $25.2 million. At September 29, 2002, we had consolidated negative working capital of approximately $1.5 million. We cannot guarantee that we will be able to generate sufficient funds from our operations to meet our immediate working capital needs. In addition, our current growth plans require certain equipment, facility and product development expenditures that cannot be funded from cash generated from operations unless and until our current liabilities are substantially retired. Accordingly, we anticipate that we will likely need to raise additional capital in the near future to fund our aggregate requirements although the nature, timing and amount of that need is not immediately determinable. We cannot assure you that any additional capital may be available on a timely basis, on acceptable terms.terms, or at all. If we are not able to obtain additional capital, our business, financial condition and results of operations will be materially adversely affected.
We anticipate that our capital requirements will depend on many factors, including:
| • | | our ability to control costs; |
| • | | our ability to commercialize our technologies and achieve broad market acceptance for such technologies; |
| • | | our ability to procure additional government research and development contracts; |
| • | | the timing of payments and reimbursements from government and other contracts; |
| • | | research and development funding requirements and required investments in our subsidiaries; |
| • | | increased sales and marketing expenses; |
| • | | technological advancements and competitors’ response to our products; |
| • | | capital improvements to new and existing facilities; |
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| • | | our relationships with customers and suppliers; and |
| • | | general economic conditions including the effects of the current economic slowdown and international conflicts. |
If our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. Additional funds may be raised through borrowings, other debt or equity financings, or the divestiture of business units or select assets. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common stock. Additional funds may not be available on favorable terms or at all, particularly in view of the significant decline in our market capitalization. If adequate funds are not available on acceptable terms, or at all, we may be unable to finance our operations, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures.
Financing, if available, could result in significant costs to us, even if not consummated. In certain circumstances, it is possible that we could experience very substantial transaction costs or break-up fees in connection with efforts to obtain financing. For example, we entered into a non-binding letter of intent related to the possible financing of our iNetWorks subsidiary in 2001 that obligated us to pay $1.0 million to the investor if we had rejected the financing. Although we ultimately were not required to pay this break-up fee because it was the investor, not us, that withdrew from the agreement, it is not uncommon for prospective investment agreements to contain these contractual provisions. Financings, in general, also require a significant amount of management’s time and can distract us from executing our business plan. Furthermore, the costs and expenses of such financings, including legal fees, can significantly increase our operating expenses.
Our common stock may be delisted from the Nasdaq Listing Requirements; Penny Stock. ISC's Common StockSmallCap Market if our stock price declines further or if we cannot maintain Nasdaq’s minimum net worth listing requirements. In such case, the market for your shares may be limited, and it may be difficult for you to sell your shares at an acceptable price, if at all. Our common stock is publicly tradedcurrently listed on the Nasdaq SmallCap Market. Effective February 23, 1998, new and more
restrictive standards became effective forAmong other requirements, to maintain this listing, maintenance on this market.
Priorour common stock must continue to the implementation of these new regulations, ISC briefly dropped below
the pending standards due to the loss associated with its Vermont plant closure
andtrade above $1.00 per share. In July 2001, our stock had to establish to the satisfaction of the Nasdaq staff that it had met the
new standards in order to retain its listing. While the Company was ablefailed to meet this requirement, there can be no assurancescriterion for over 30 consecutive trading days. Therefore, in accordance with Marketplace Rule 4310(c)(8)(B), we were notified by Nasdaq that we had 90 calendar days or until October 2001 to regain compliance with this Rule by reestablishing a sales price of $1.00 per share or greater for ten consecutive trading days. To regain compliance, we sought and received approval from our stockholders to effectuate a 1-for-20 reverse split of our common stock that became effective in September 2001, resulting in recompliance by the Nasdaq deadline. However, subsequent to the reverse split, our stock has, at various times, traded close to or below the $1.00 per share minimum standard, and we cannot assure you that the Companysales price will be ablecontinue to maintain its compliancemeet Nasdaq minimum standards. At December 18, 2002, the closing sales price of our common stock was $1.87 per share.
In addition to the price requirement, in the
future. In the foreseeable future, the
Companyabsence of sustained profitability, we must
also meet at least one of the two following
additional standards to maintain
itsour Nasdaq
listing; (i)listing: (1) maintenance of
its tangible net worth at $2 million or greater or
(ii)stockholders’ equity at $2.5 million or greater, or (2) maintenance of a market capitalization figure in excess of $35 million as measured by market prices for trades executed on Nasdaq.
The Company
presently meetsIn July 2001, Nasdaq notified us that we were deficient with respect to both
standards.these additional standards based on our balance sheet as of April 1, 2001. In August 2001, we were advised by Nasdaq that, based on updated information, we had reestablished compliance with the $35 million market capitalization standard. However, the
consolidated lossessubsequent decline in the price of our common stock resulted in another deficiency notice from Nasdaq in August 2001. At that time we did not comply with either the market capitalization standard or the stockholders’ equity standard. However, based solely on improvements in our stockholders’ equity resulting from the
development expensesnet gain of
someapproximately $0.9 million realized from the discontinuance of
its subsidiariesoperations of our Silicon Film subsidiary in September 2001, we were able to meet the minimum stockholders’ equity standard. In November 2001, we were notified by Nasdaq that we had reestablished compliance. Although we are currently in compliance with Nasdaq’s listing maintenance requirements, we cannot assure you that we will
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continuebe able to erode its tangible net worth during fiscal 2001. In that instance
and absent additional equity financing, which cannot be guaranteed,maintain our compliance with these requirements in the Company
would be subject to market price risks for the maintenance of its Nasdaq
listing.future. If ISC were towe fail to meet these or other listing requirements, our common stock could be delisted, which would eliminate the maintenance requirementsprimary market for listing onyour shares of common stock. As a result, you may not be able to sell your shares at an acceptable price, if at all. If we are delisted from the Nasdaq inSmallCap Market, your ability to sell your shares of our stock would also be limited by the future andpenny stock restrictions, which could further limit the pricemarketability of ISC's Common Stock was below $5 at such
time, such securitiesyour shares. If our common stock is delisted, it would come within the definition of "penny stock"“penny stock” as defined in the Securities Exchange Act of 1934, as amended, (the "Exchange Act")
and would be covered by Rule 15g-9 of the Exchangethat Act. That Rule imposes additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors. FromFor transactions covered by Rule 15g-9, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser'spurchaser’s written agreement to the transaction prior to
13
the sale. Consequently, Rule 15g-9, if it were to become applicable, would affect the ability or willingness of broker-
dealersbroker-dealers to sell ISC'sour securities and thereforeaccordingly would affect the ability of shareholdersstockholders to sell their securities in the public marketmarket. These additional procedures could also limit our ability to raise additional capital in the future.
We are defendants in a class-action stockholders lawsuit, an unfavorable outcome of which could harm our ability to continue our operations, and the Company'sdefense of which is also substantially increasing our on-going operating expenses. We have been sued by certain stockholders who allege that we made false and misleading statements about the prospects of our Silicon Film subsidiary during the period January 6, 2000 to September 15, 2001, inclusive. The complaint asserts claims for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5, and seeks damages of an unspecified amount. We believe that the class action is without merit and have retained counsel to vigorously defend against the lawsuit. Nonetheless, the defense of this lawsuit increased our legal expenses by $250,000 in fiscal 2002. In addition, the outcome of any litigation is inherently uncertain, and we may not be able to satisfy an unfavorable outcome in this litigation, which could cause us to discontinue operations.
If we are not able to commercialize our technology, we may not be able to increase our revenues or achieve or sustain profitability. Since commencing operations, we have developed technology, principally under government research contracts, for various defense-based applications. Contract research and development accounted for approximately 69% of our total revenues for the year ended September 29, 2002. However, since our margins on government contracts are generally limited, and our revenues from such contracts are tied to government budget cycles and influenced by numerous political and economic factors beyond our control, and are subject to our ability to finance itswin additional contracts, our long-term prospects of realizing significant returns from our technology will likely also require penetration of commercial markets. In prior years, we have made significant investments to commercialize our technologies without significant success. These efforts included the purchase and later shut down of the IBM cubing line, the formation of the Novalog, MSI, Silicon Film, RedHawk and iNetWorks subsidiaries and the development of various stacked-memory products intended for military, aerospace and commercial markets. While these changes have developed new revenue sources, they have not yet resulted in consolidated profitability to date, and a majority of our total revenues for the year ended September 29, 2002 were still generated from contract research and development. Only our Novalog subsidiary has experienced periods of profitability, and that subsidiary is not currently profitable due to the decline in the sales of Palm PDAs, the largest end use application of Novalog’s products. We cannot assure you that any of our present and contemplated future products will achieve broad market acceptance in commercial marketplaces, and if they do not, our business, plans.
Equity Capital Structure. Atresults of operations and financial condition will be materially and adversely affected.
Significant sales of our common stock in the public market will cause our stock price to fall. As of September 29, 2002, we had approximately 7 million shares of common stock outstanding, of which approximately 5 million shares were freely tradable, other than restrictions imposed upon our affiliates. An additional 1 million shares were subject to contractual restrictions on trading on September 29, 2002, but became freely tradable between October 1, 2000,2002 and November 2002 when the Company had 46,637,800 commoncontractual restrictions expired. The average daily trading volume of our shares issued and outstanding. Approximately 6,420,000 commonin September 2002 was only approximately 14,500 shares. The freely tradable shares are also
reserved forsignificantly greater in number than the daily average trading volume of our shares. If the holders of the freely tradable shares were to sell a significant amount of our common stock in the public market, the market price of our common stock would likely be significantly adversely affected.
From time to time, we may elect to retire obligations of our subsidiaries with cash payments or through the issuance pursuant to existing preferred stock conversion rights,
and outstanding warrants and options. The approximately 6,940,000 unreserved
commonof shares of the Company's authorized capital structureour common stock, which could result in dilution to our existing stockholders and a decrease in our stock price. In June 2002, we issued approximately 279,000 shares of our common stock to BBNT Solution, LLC, an indirect wholly-owned subsidiary of Verizon Communications, Inc., representing approximately 4% of our shares outstanding, to retire $500,000 of debt incurred by our iNetWorks subsidiary. We elected to enter into this agreement to preserve a strategic working relationship with BBNT related to our prospective Internet router development. We have also settled certain disputed obligations of our former Silicon Film subsidiary with cash payments and may be insufficientelect to facilitate the financingsettle obligations of all of the Company's existing and planned
commercial initiatives. There can be no assurances that the Company's
stockholders will authorize an increaseother subsidiaries in the Company's authorizedfuture. We have recorded these payments as intercompany debt to preserve the possibility of repayment in the future, but such repayment would likely be contingent on future third party investments in subsidiaries that we cannot guarantee. Although we are not required to retire the obligations of our subsidiaries, we may make such business decisions again, which could have a dilutive impact to our existing stockholders or could negatively impact our available capital. Furthermore, when and if the recipients of any such shares elect to sell them in the public market, the market price of our common shares.
Third-Party Financingstock could likely be materially and adversely affected.
Our equity and voting interests in our subsidiaries were significantly diluted in the past as a result of Subsidiaries.private placements, and further financings could cause us to lose control of our subsidiaries. We have historically funded the operations of our subsidiaries with equity financings. The financing of the Company'sour Novalog and Silicon FilmRedHawk subsidiaries to date have involved significant private sales of minority equity interests. The Company has repurchased a substantial portioncommon stock of those subsidiaries
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representing approximately 32% of the minority equity interestsoutstanding capital stock of Novalog but doesand approximately 30% of the outstanding capital stock of RedHawk, generating net proceeds to Novalog of approximately $4.1 million and approximately $581,000 for RedHawk. In the case of RedHawk, the private sales to third party minority investors occurred in the first fiscal quarter of fiscal 2001 at prices higher than the exercised prices of options and warrants granted to RedHawk employees in the last fiscal quarter of fiscal 2000. While we repurchased approximately 28% of the common stock of Novalog from minority investors during fiscal years 1998 and 1999, we do not nowcurrently have sufficient discretionary capital to continue this practice with respect torepurchase additional shares of Novalog or any other subsidiarysubsidiary. As a result of our decision to significantly reduce our expenditures related to our subsidiaries and increase our emphasis on government contracts, our development stage subsidiaries, MSI, iNetWorks and RedHawk, have consolidated their separate operations with ATD to reduce costs. Novalog has also downsized to be consistent with its reduced sales level. In order to continue their developmental activities, our subsidiaries would have to partner with a third party or to adequately finance the future business plans of any of
its subsidiaries. The Company's subsidiaries are seeking to sell additional equity interests to finance at least some portion of their business plans. The
Company'sSuch partnering relationship or additional financings may not be available on acceptable terms, it at all. Even if financing becomes available, our ability to enjoy the benefits of any potential increase in value on the part of itsour subsidiaries can be greatly reduced by third-party financings.
This is true both because of reducedinvestments. Additional financings by our subsidiaries will result in a reduction in our equity interests in the subsidiaries and because the Company'sreduced control of its subsidiaries is lessened or eliminated.our subsidiaries. Significant third-party investment in the Company'sour subsidiaries will likely result in third-party investors receiving subsidiary board representation and/or protective covenants that could result infurther reduce our control over the Company losing voting controlday-to-day operations and strategic direction of itsour subsidiaries. In certain circumstances, it is possible that the Company or
its subsidiaries could experience very substantial transaction costs or "break-
up" fees in connection with efforts to obtain financing. Third-party financings of subsidiaries will also inherently complicate our fiduciary and contractual obligations and could leave us more vulnerable to potentialcostly and uncertain litigation in the future, litigation.
The outcome of litigation is inherently unpredictable, and even the costs of
prosecutionwhich could have a materiallymaterial adverse effect on our business, financial condition and results of operations.
Dependence
Our government-funded research and development business depends on Defense Contract Revenues.a limited number of customers, and if any of these customers terminate or reduce their contracts with us, or if we cannot obtain additional government contracts in the future, our revenues will decline and our results of operations will be adversely affected. In the fiscal year ended September 29, 2002, all of our revenues from government agencies were derived from three governmental agencies, the U.S. Navy, the U.S. Air Force and the U.S. Army. The Air Force accounted for approximately 5% of our total revenues, but the U.S. Army and the U.S. Navy accounted for approximately 46% and 16%, respectively, of our total revenues. In addition, approximately 1% of ur total revenues was derived from a limited number of prime government contractors. Although ISC has been shifting itswe ultimately plan to shift our focus to include commercial exploitationthe commercialization of itsour technology, it expectswe expect to continue to be dependent upon research and development contracts with federal agencies and their contractors for a substantial but diminishing portion of itsour revenues for the foreseeable future. This dependency on a few contract sources increases the risks of disruption in this area of our business that could adversely affect our consolidated revenues and results of operations.
Because we currently depend on government contracts and subcontracts, we face additional risks related to contracting with the federal government, including federal budget issues and fixed price contracts. General political and economic conditions, which cannot be accurately predicted, directly and indirectly affect the quantity and allocation of expenditures by federal agencies. Even the timing of incremental funding commitments to existing, but partially funded, contracts can be affected by suchthese factors. Therefore, cutbacks or re-allocations in the federal budget could have a material adverse impact on ISC'sour results of operations as long as research and development contracts remain an important element of our business. Obtaining government contracts may also involve long purchase and payment cycles, competitive bidding, qualification requirements, delays or changes in funding, budgetary constraints, political agendas, extensive specification development and price negotiations and milestone requirements. Each government agency also maintains its business.
Market Acceptanceown rules and regulations with which we must comply and which can vary significantly among agencies. Governmental agencies also often retain some portion of New Products. Both ISCfees payable upon completion of a project and collection of these fees may be delayed for several months or even years, in some instances. In addition, an increasing number of our government contracts are fixed price contracts which may prevent us from recovering costs incurred in excess of its budgeted costs. Fixed price contracts require us to estimate the total project cost based on preliminary projections of the project’s requirements. The financial viability of any given project depends in large part on our ability to estimate such costs accurately and complete the project on a timely basis. In the fiscal year ended September 29, 2002, we completed fixed-price contracts with an aggregate value of $1,969,900. We experienced approximately $307,800 in overruns on those contracts, representing approximately 16% of the aggregate funded amount. While those overruns were largely discretionary in nature, we may not be able to achieve or improve upon this performance in the future since each contract has its own unique technical and schedule risks. In the event our actual costs exceed the fixed contractual cost, we will not be able to recover the excess costs. Some of our government contracts are also subject to termination or renegotiation at the convenience of the government, which could result in a large decline in revenue in any given quarter. Although government contracts have provisions providing for the reimbursement of costs associated with termination, the termination of a material contract at a time when our Company’s funded backlog does not permit redeployment of our staff could result in reductions of employees. In April 1999, we experienced the termination of one of our contracts, but this termination did not result in the non-
15
recovery of costs or layoff of employees. We also have had to reduce our staff from time-to-time because of fluctuations in our funded government contract base. In addition, the timing of payments from government contracts is also subject to significant fluctuation and potential delay, depending on the government agency involved. Any such delay could result in a temporary shortage in our working capital. Since nearly 70% of our total revenues in the year ended September 29, 2002 were derived directly of indirectly from government contractors, these risks can significantly affect our business, results of operations and financial condition.
We also depend on a limited number of non-government customers. The loss of any such customer could seriously impact our consolidated revenues and harm our business. Our existing product sales have largely been derived from our Novalog subsidiary, which is heavily dependent upon sales to a limited number of original equipment manufacturers, four of which, Flextronics, MSL, Interlogix and Inventec Electronics., accounted for approximately 15%, 8%, 8%, and 7%, respectively, of our product sales. Three of these four OEMs are suppliers to Palm Computing. A majority of Novalog’s product sales in fiscal 2000, fiscal 2001 and fiscal 2002 were derived from sales for use in Palm’s products. As such, the decline in Palm’s business beginning in fiscal 2001 was a primary cause of the 29% decline in Novalog’s sales for that period and the approximately 54% decline in Novalog’s sales for fiscal 2002 as compared to fiscal 2001. Novalog has had to significantly downsize its operations to reflect this decline in business of its primary customer. The planned business models of our MicroSensors and iNetWorks subsidiaries have similar expected dependencies on a limited number of OEM customers. Disruption of any of these relationships could materially and adversely affect our consolidated revenues and results of operations.
If we are focusednot able to obtain market acceptance of our new products, our revenues and results of operations will be adversely affected. We focus on markets that are emerging in nature and potentially subject to rapid growth. Market reaction to new products in suchthese circumstances can be difficult to predict. There can be no assuranceMany of our planned products incorporate our chip stacking technologies that thehave not yet achieved broad market acceptance. We cannot assure you that our present or future products of ISC
or its subsidiaries will be favorably accepted by such marketsachieve market acceptance on a sustained basis. In addition, because ISC hasdue to our historical focus on research and development, we have a limited history of competing in the intensely competitive commercial electronics industry, there is no assuranceindustry. As such, we cannot assure you that itwe will successfully be able to develop, manufacture and market additional commercial product lines or that such product lines will be accepted in the commercial marketplace. PatentsIf we are not successful, our ability to generate revenues and Proprietary Right Protection; Infringement. ISC believesour business, financial condition and results of operations will be adversely affected.
If we are not able to adequately protect or enforce our patent or other intellectual property rights, our ability to compete in our target markets could be materially and adversely affected. We believe that its
ultimateour success, and that of itsour subsidiaries, will depend, in part, on the strength of itsour existing patent protection and the additional patent protection that itwe and itsour subsidiaries may acquire in the future. As of the date hereof,
ISC owns 45September 29, 2002, Irvine Sensors owned forty-one U.S. patents in force and 8fifteen foreign patents and has other patent applications pending before the U.S. Patent and Trademark Office as well as various foreign jurisdictions. Although ISC believes many of these patents to be fundamental in
nature, there can be no assuranceIt is possible that any existing patents or future patents, will
survive a challengeif any, could be challenged, invalidated or will otherwisecircumvented, and any right granted under these patents may not provide us with meaningful protection from competition. Furthermore, there is also no assurance that ISCDespite our precautions, it may be possible for a third party to copy or its
subsidiaries will have the financial resourcesotherwise obtain and use our products, services or technology without authorization, to provide vigorous defensedevelop similar technology independently or enforcement ofto design around our patents. Protection of Proprietary Information. ISC and its subsidiariesIn addition we treat technical data as confidential and generally rely on internal nondisclosure safeguards, including confidentiality agreements with employees, and on laws protecting trade secrets, to protect proprietary information. There can be no assuranceWe cannot assure you that these measures will adequately protect the confidentiality of theour proprietary information of ISC or its subsidiaries or that others will not independently develop products or technology that are equivalent or superior to those of ISC
or its subsidiaries. ISC or its subsidiariesours.
Our ability to exploit our own technologies may receive inbe constrained by the future
communications from third parties asserting that the products of ISC or its
subsidiaries infringe the proprietary rights of third parties. There can be no
assurance that any such claims
12
would not resultparties who could prevent us from selling our products in protracted andcertain markets or could require us to obtain costly litigation. There can be no assurance
that any particular aspect of the technology owned by ISC or its subsidiaries
will not be found to infringe the products of other companies.licenses. Other companies may hold or obtain patents or inventions or may otherwise claim proprietary rights to technology useful or necessary to ISC's or its subsidiaries'our business. TheWe cannot predict the extent to which ISC or its subsidiarieswe may be required to seek licenses under such proprietary rights of third parties and the cost or availability of such license, cannot be predicted.these licenses. While it may be necessary or desirable in the future to obtain licenses relating to one or more of its proposed products or relating to current or future technologies, there can be no assurancewe cannot assure you that ISC
or its subsidiarieswe will be able to do so on commercially reasonable terms.
Government Rights.terms, if at all. If our technology is found to infringe upon the rights of third parties, or if we are unable to gain sufficient rights to use key technologies, , our ability to compete would be harmed and our business, financial condition and results of operations would be materially and adversely affected. Enforcing and protecting our patents and other proprietary information can be costly. If we are not able to adequately protect or enforce our proprietary information or if we become subject to infringement claims by others, our business, results of operations, and financial condition may be materially adversely affected. We may need to engage in future litigation to enforce our intellectual property rights or the rights of our customers, to protect our trade secrets or to determine the validity and scope of proprietary rights of others, including our customers. We also may need to engage in litigation in the future to enforce our patent rights. In addition, we may receive in the future communications from third parties asserting that our products infringe the proprietary rights of third parties. We cannot assure you that any such claims would not result in protracted and
16
costly litigation. This litigation could result in substantial costs and diversion of our resources and could materially and adversely affect our business, financial condition and results of operations. Furthermore, there is also no assurance that we will have the financial resources to vigorously defend or enforce our patents or other proprietary technology.
Our proprietary information and other intellectual property rights are subject to government use which, in some instances, limits our ability to capitalize on them. Whatever degree of protection, if any, is afforded ISC or
its subsidiariesto us through itsour patents, proprietary information and other intellectual property, this protection will not extend to government markets that utilize certain segments of ISC'sour technology. The government has the right to royalty-free use of technologies that ISC haswe have developed under government contracts, including portions of ISC'sour stacked circuitry technology. ISC isWhile we are generally free to commercially exploit suchthese government-funded technologies and we may assert itsour intellectual property rights to seek to block other non-government users thereof, but there canof the same, we cannot assure you that we will be no assurances of successsuccessful in such endeavors.
Competition. ISCour attempts to do so.
We are subject to significant competition that could harm our ability to win new business or attract strategic partnerships and its subsidiariescould increase the price pressure on our products. We face strong competition.competition from a wide variety of competitors, including large, multinational semiconductor design firms and aerospace firms. Most of our competitors have considerably greater financial, marketing and technological resources than does ISCwe or its subsidiaries. There is no assuranceour subsidiaries do, which may make it difficult to win new contracts or to attract strategic partners. This competition has resulted and may continue to result in declining average selling prices for our products. We cannot assure you that ISC or
its subsidiarieswe will be able to compete successfully with suchthese companies. Certain of our competitors operate their own fabrication facilities and have longer operating histories and presence in key markets, greater name recognition, larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other companies.
Dependence on Suppliers. ISCresources than us. As a result, these competitors may be able to adapt more quickly to new or emerging technologies and its subsidiaries extensively use supplierschanges in customer requirements. They may also be able to devote greater resources to the manufacturepromotion and sale of their products. AtIncreased competition has in the projected levelpast resulted in price reductions, reduced gross margins and loss of operations, both
ISCmarket share, and its subsidiaries have identified sourcesthis trend may continue in the future. We cannot assure you that are believed to be
adequate to meet identified needs. However, there is no assurance that ISC or
its subsidiarieswe will be able to cover changingcontinue to compete successfully or that competitive pressures will not materially and adversely affect our business, financial condition and results of operations.
We do not have guaranteed long-term supply relationships with any of our contract manufacturers which could make it difficult to fulfill our backlog in any given quarter and could reduce our revenues in future periods. We extensively rely on contract manufacturers but do not have the financial resources to maintain long-term supply agreements with contract manufacturers or other suppliers. Accordingly, because our contract manufacturers allocate their manufacturing resources in periods of high demand, we face several significant risks,
including a lack of adequate supply, potential product shortages and higher prices and limited control over delivery schedules, quality assurance and control, manufacturing yields and production costs. We cannot assure you that we will be able to satisfy our manufacturing needs in the future. Failure to do so will have a material adverse impact on our operations and the operationsamount of ISC and its subsidiaries.
Possible Technological Advances. ISC and its subsidiaries areproducts we can ship in any period.
If we cannot adapt to unforeseen technological advances, we may not be able to successfully compete with our competitors. We operate in industries characterized by continuing technological development and, accordingly,development. Accordingly, we will be required to devote substantial resources to improve already technologically complex products. Many companies in these industries devote considerably greater resources to research and development than does ISC or its subsidiaries.we do. Developments by any of these companies could have a materially adverse effect on ISC.
Dependenceus if we are not able to keep up with the same developments. Our future success will depend on Key Personnel. ISCour ability to successfully adapt to any new technological advances in a timely manner, or at all.
We do not have any long-term employment agreements with any of our key personnel. If we are not able to retain our key personnel, we may not be able to implement our business plan and its subsidiaries willour results of operations could be materially and adversely affected. We depend to a large extent on the abilities and continued participation of certainour executive officers and other key employees.employees, particularly John Carson, our president and John Stuart, our chief financial officer. The loss of any key employeesemployee could have a material adverse effect on the businesses
of ISC and its subsidiaries. ISC and its subsidiariesour business. While we have adopted employee Stock Option Plansstock option plans designed to attract and retain key employees. The amount of
options available pursuant to shareholder-approved option plans have been
depleted,employees, our stock price has declined in recent periods, and there can be nowe cannot guarantee that shareholders will approve
additionaloptions granted under our plans in the future. The value of stock option plans to the
subsidiaries will be strongly tied to the timing of any future IPOs, of which
there can be no assurance, and there can, accordingly, be no guarantee of the
efficacy of such optionseffective in retaining key employees. Neither ISC nor its
subsidiariesWe do not presently maintain "key man"“key man” insurance on any key employees. ISC
believesWe believe that, as itsour activities and those of its subsidiaries increase and change in character, additional, experienced personnel will be required to implement theour business plans of ISC and its subsidiaries.plan. Competition for such personnel is intense and there is no assurancewe cannot assure you that they will be available when required, or that ISC or its subsidiarieswe will have the ability to attract and retain them.
Our stock price has been subject to significant volatility. You may not be able to sell your shares of common stock at or above the price you paid for them. The trading price of our common stock has been subject to wide fluctuations in the past. Since January 2000, the common stock has traded at prices as low as $0.75 per
17
share and as high as $375.00 per share, after giving effect to the 1-for-20 reverse stock split in September 2001. We may not be able to increase or sustain the current market price of our common stock in the future. As such, you may not be able to resell your shares of common stock at or above the price you paid for them. The abovemarket price of the common stock could continue to fluctuate in the future in response to various factors, including, but not limited to:
| • | | quarterly variations in operating results; |
| • | | our ability to control costs and improve cash flow; |
| • | | announcements of technological innovations or new products by us or our competitors; |
| • | | changes in investor perceptions; |
| • | | economic and political instability; |
| • | | new products or product enhancements by us or our competitors; and |
| • | | changes in earnings estimates or investment recommendations by securities analysts. |
The stock market in general has continued to experience volatility, which has particularly affected the market price of equity securities of many high technology companies. This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. We are not intendedcurrently subject to be inclusive. Failureclass action lawsuits that could result in substantial losses and divert management’s attention and resources from other matters.
Our international operations are subject to satisfactorily
achievemany inherent risks, any of the Company's objectives or avoid any of the above or other risks
would likely have a material adverse effect on the Company'swhich may adversely affect our business, financial condition and results of operations.
13
Approximately 6% of our total revenues in the year ended September 29, 2002 was derived from sales outside the United States. In the future, we intend to continue to expand our international business activities. International operations are subject to many inherent risks that may adversely effect our business, financial condition and operating results, including: | • | | political, social and economic instability; |
| • | | the imposition of governmental controls; |
| • | | exposure to different legal standards, particularly with respect to intellectual property; |
| • | | burdens of complying with a variety of foreign laws; |
| • | | import and export license requirements and restrictions of the United States and each other country in which we operate; |
| • | | unexpected changes in regulatory requirements; |
| • | | foreign technical standards; |
| • | | fluctuations in currency exchange rates; |
| • | | difficulties in managing foreign operations and collecting receivables from foreign entities; and |
| • | | potentially adverse tax consequences. |
We may be subject to additional risks. The risks and uncertainties described above are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also adversely affect our business operations.
18
The following table sets forth information with respect to the Company'sour facilities:
Location
| | Square Feet
| | Monthly Rent
| | Lease Expiration
|
| Costa Mesa, CA (1) | | 42,400 | | $58,400 | | September 2004 and 2006 |
Location Square Feet Monthly Rent Lease Expiration
------------------------------- ------------- --------------- ----------------
ISC(1) Costa Mesa, CA 42,600 $50,100 September 2001
Silicon Film Technologies, Inc. Irvine, CA 10,300 15,450 May 2004
------------ ---------------
Total 52,900 $65,550
============ ===============
| (1) | | Includes facilities for ISC corporate headquarters, ATD, MPD, MSI, RedHawk, iNetWorks and Novalog. |
____________
(1) Includes facilities for ISC corporate headquarters, ATD, MPD, MSI, RedHawk,
iNetWorks and Novalog.
The facilities used by Advanced Technology DivisionATD include laboratories containing clean rooms for operations requiring a working environment with reduced atmospheric particles. The Company believesWe believe that itsour facilities are adequate for their respectiveour operations and thatfor the facilities of the Company
are maintained in good repair.
current fiscal year.
Item 3. Legal Proceedings
None.
Irvine Sensors was named as a defendant in a lawsuit entitled “Irvine Oaks Realty v. Silicon Film Technologies, Inc., et al.” Irvine Oaks Realty claimed that Irvine Sensors was liable for past and future lost rents of Silicon Film’s previous tenancy, as a guarantor of Silicon Film’s lease with Irvine Oaks, in the amount of at least $250,000. We asserted that we had complied with applicable exclusion clauses in the guarantee, and therefore were not liable for any damages. In September 2002, we entered into a settlement agreement with the plaintiff in this lawsuit for a monetary amount within the amount we had previously reserved, and in October 2002, the lawsuit was dismissed.
From February 14 to March 15, 2002, five purported class action complaints were filed in the United States District Court for the Central District of California against Irvine Sensors, certain of our current and former officers and directors, and an officer and director of our former subsidiary Silicon Film Technologies, Inc. By stipulated Order dated May 10, 2002, the Court consolidated these actions. Pursuant to the order, plaintiffs served an amended complaint on July 5, 2002. The amended complaint alleges that defendants made false and misleading statements about the prospects of Silicon Film during the period January 6, 2000 to September 15, 2001, inclusive. The amended complaint asserts claims for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5, and seeks damages of an unspecified amount.
There has been no discovery to date and no trial has yet been scheduled. We believe that we have meritorious defenses to the consolidated action and intend to defend it vigorously. We have filed a motion to dismiss the consolidated action that is presently scheduled to be heard by the Court on February 3, 2003. If we do not obtain a favorable resolution of the claims set forth in the action, such an outcome could have a material adverse effect on our business, results of operations and financial condition. Currently, the amount of such material adverse effect cannot reasonably be estimated.
Item 4. Submission of Matters to a Vote of Security Holders None.
14
EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Position
---- --- --------
Robert G. Richards 72 President and Chief Executive Officer
Bernhard Baumgartner 52 Senior Vice President and General Manager -
Commercial Products Group
Mel R. Brashears 55 Senior Vice President and a Director
John C. Carson 62 Senior Vice President, Chief Technical Officer
and a Director
John J. Stuart, Jr. 61 Senior Vice President, Chief Financial Officer and
Treasurer
Mr. Richards has been President and Chief Executive Officer of the Company since
June 2000 and a director of its iNetWorks subsidiary since November 2000. Since
April 1999, Mr. Richards has also served as a member of our Scientific Advisory
Board. Mr. Richards retired as President of Aerojet Electronic Systems Division
in 1993. He is co-author of the book, Infrared Physics and Engineering,
published by McGraw-Hill, and has a M.A. degree from the University of
California at Berkeley.
Mr. Baumgartner has been Senior Vice President and General Manager of the
Company's Commercial Products Group and a director of its Novalog, MSI and
Silicon Film subsidiaries since December 2000. From February 1998 through
November 2000, he was President and CEO of Krones Inc., the U.S. subsidiary of a
German company specializing in industrial control systems and hardware. From
April 1994 to January 1998, he was CEO of Kettner, O+H, a German supplier in the
same industry. Mr. Baumgartner has an MBA from International Institute for
Management Development, Switzerland, an International Senior Management Program
Certificate from Harvard Business School and an M.S. in Civil Engineering from
the University of Graz, Austria.
Dr. Brashears has been Senior Vice President and Chairman and Chief Executive
Officer of the Company's iNetWorks Corporation subsidiary since October 2000.
He has also been a director of ISC since December 2000. From 1999 to September
2000, Dr. Brashears was a self-employed management consultant. From 1996
through 1998, he was President and Chief Operating Officer of Lockheed Martin's
Space & Strategic Missiles Sector, culminating a 27-year career of increasing
management responsibility with Lockheed Missiles and Space Company and its
successors. Dr. Brashears is a graduate of the University of Missouri with B.
S., M. S. and Ph.D. degrees in engineering.
Mr. Carson is a co-founder of ISC and has served as a director and Vice
President since its inception in 1974, becoming a Senior Vice President in April
1982. He was elected Chief Technical Officer in February 1997. Mr. Carson also
serves as a director of MSI (since October 1997) and iNetWorks (since November
2000). Mr. Carson has been awarded 15 patents for smart sensors, 3D packaging
and single processing architectures, including neural networks. Mr. Carson holds
a B S. in Physics from the Massachusetts Institute of Technology.
Mr. Stuart joined ISC in January 1983 as its Manager of Special Projects and
Communications, became ISC's Chief Financial Officer and Treasurer in July 1985,
a Vice President in June 1995 and Senior Vice President in November 1998. He
relinquished the position of Treasurer in February 1995 and re-assumed it in
October 1998. Mr. Stuart is also a member of the Board of Directors and is Vice
President of Finance and Chief Financial Officer of Novalog (since October
1995), MSI (since October 1997), RedHawk (since March 2000) and iNetWorks (since
November 2000). He also acted as Chief Financial Officer of Silicon Film from
its organization in August 1998 until May 1999. Mr. Stuart also serves as a
director of euro909.com, a Danish telecommunications and Internet services
company and TaskForce, Inc., an Internet software company, both of which are
unaffiliated with ISC. Mr. Stuart holds a B.S. in Industrial Management from
the Massachusetts Institute of Technology.
15
19
PART II
-------
Item 5. Market for Registrant'sRegistrant’s Common Equity and Related Stockholder Matters The following table sets forth the range of representative high and low closing bidsales prices of the Company's Common Stockour common stock (Nasdaq SmallCap Market symbol: IRSN) in the over-the-counter market for the periods indicated, as furnishedreported by NASD, Inc.the Nasdaq SmallCap Market, and giving effect to the 1-for-20 reverse stock split effected in September 2001. These prices represent prices among dealers, do not include retail markups, markdowns or commissions, and may not represent actual transactions:
Common Stock
Bid Prices
--------------------------
High Low
--------- -------
Fiscal Year Ended October 1, 2000:
First Quarter $ 2.5625 $1.2188
Second Quarter $18.7500 $1.7500
Third Quarter $11.2500 $3.5000
Fourth Quarter $ 4.5000 $2.0938
Fiscal Year Ended October 3, 1999:
First Quarter $ 1.9375 $1.4063
Second Quarter $ 1.6563 $1.3125
Third Quarter $ 2.0000 $1.4375
Fourth Quarter $ 1.8438 $2.1875
| | | High
| | Low
|
| Fiscal Year Ended September 29, 2002: | | | | |
| First Quarter | | $ 2.26 | | $ 1.05 |
| Second Quarter | | 1.41 | | 0.77 |
| Third Quarter | | 2.84 | | 1.07 |
| Fourth Quarter | | 1.67 | | 1.00 |
|
| Fiscal Year Ended September 30, 2001: | | | | |
| First Quarter | | $63.75 | | $20.62 |
| Second Quarter | | 70.62 | | 25.00 |
| Third Quarter | | 30.00 | | 10.60 |
On December 15, 2000,18, 2002, the closing bid and asked priceslast sales price for the Company's Common
Stockour common stock on the Nasdaq SmallCap Market were $1 9/16 and $1 13/16 respectively.
was $1.87.
On December 15, 2000,18, 2002, there were approximately 819428 stockholders of record and
approximately 20,000 beneficial holders based on information provided by the
Company'sour transfer agent.
The Company has not
We have never declared or paid cash dividends on any class of itsour common stock since its
incorporation.our incorporation and do not anticipate paying any cash dividends on our common stock in the foreseeable future. Under Delaware law there are certain restrictions that limit the
Company'sour ability to pay cash dividends in the future.
Recent Sales of Unregistered Securities
All sales of unregistered securities sold during fiscal year 2002 have been previously reported except for the following transactions:
In May 2002, we issued warrants to purchase 200,000 shares of common stock, at an exercise price of $2.34 per share and with a three-year term, to a consulting firm that provided finder services in connection with a private placement of our common stock. In June 2002, we issued warrants to purchase 25,000 shares of our common stock at an exercise price of $1.52 per share and that expire June 25, 2005 to a financial consultant for services rendered, including introduction of the finder for the May private placement. Both of the warrant holders are accredited investors.
The issuance of the warrants described in the previous paragraph were deemed to be exempt from registration under the Securities Act of 1933, as amended (the “Act”), in reliance on Section 4(2) of the Act as transactions by an issuer not involving any public offering.
Item 6. Selected Financial Data The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial data included elsewhere in this report. The consolidated statement of operations data for the fiscal years ended September 29, 2002, September 30, 2001 and October 1, 2000, and the consolidated balance sheet data at September 29, 2002 and September 30, 2001 are derived from audited consolidated financial statements incorporated by reference in this report. The consolidated statement of operations data for the fiscal years ended October 3, 1999 and September 27, 1998, and the consolidated balance sheet data at October 1, 2000, October 3, 1999 and September 27, 1998 are derived from audited consolidated financial statements not included in this report. The historical results are not necessarily indicative of results to be expected in any future period.
20
| | | Fiscal Year Ended
| |
| | | September 29, 2002
| | | September 30, 2001
| | | October 1, 2000
| | | October 3, 1999
| | | September 27, 1998
| |
Consolidated Statement of Operations Data:
| | | | | | | | | | | | | | | | | | | | |
|
| Total revenues | | $ | 15,342,300 | | | $ | 10,657,300 | | | $ | 10,769,800 | | | $ | 11,098,600 | | | $ | 9,314,500 | |
|
| Loss from operations | | | (5,926,900 | ) | | | (16,126,000 | ) | | | (9,972,400 | ) | | | (5,989,900 | ) | | | (4,756,000 | ) |
|
| Loss from continuing operations | | | (6,072,500 | ) | | | (15,525,500 | ) | | | (8,994,900 | ) | | | (5,323,100 | ) | | | (3,201,300 | ) |
|
| Gain (loss) from discontinued operations | | | 35,000 | | | | 938,000 | | | | (6,043,400 | ) | | | (3,792,600 | ) | | | (1,042,200 | ) |
|
| Net loss | | | (6,037,500 | ) | | | (14,587,500 | ) | | | (15,038,300 | ) | | | (9,115,700 | ) | | | (4,243,500 | ) |
|
| Basic net loss per common and common equivalent share | | $ | (1.06 | ) | | $ | (5.72 | ) | | $ | (7.44 | ) | | $ | (5.84 | ) | | $ | (3.45 | ) |
|
| Weighted average number of shares outstanding | | | 5,694,800 | | | | 2,549,500 | | | | 2,201,400 | | | | 1,562,200 | | | | 1,229,900 | |
|
| Shares used in computing net loss per share (1) | | | 5,694,800 | | | | 2,549,500 | | | | 2,201,400 | | | | 1,562,200 | | | | 1,229,900 | |
| (1) | | Loss per common and common equivalent shares includes, where applicable, cumulative and imputed dividends on preferred stock that have not been declared or paid. |
| | | Fiscal Year Ended
|
| | | September 29, 2002
| | | September 30, 2001
| | | October 1, 2000
| | October 3, 1999
| | September 27, 1998
|
Consolidated Balance Sheet Data:
| | | | | | | | | | | | | | | | | |
|
| Current assets | | $ | 4,756,500 | | | $ | 5,024,200 | | | $ | 11,784,900 | | $ | 5,972,650 | | $ | 4,752,700 |
|
| Current liabilities | | | 6,239,700 | | | | 5,693,100 | | | | 3,088,900 | | | 4,581,100 | | | 2,179,900 |
|
| Working capital (deficit) | | | (1,483,200 | ) | | | (668,900 | ) | | | 8,696,000 | | | 1,391,550 | | | 2,572,800 |
|
| Total assets | | | 10,394,750 | | | | 11,141,650 | | | | 15,853,850 | | | 9,716,150 | | | 6,948,600 |
|
| Long-term debt | | | 61,300 | | | | 180,300 | | | | 173,800 | | | 433,200 | | | 933,700 |
|
| Stockholders’ equity | | | 3,626,550 | | | | 4,688,950 | | | | 7,586,550 | | | 2,212,650 | | | 2,347,000 |
Item | | 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation |
OVERVIEW
We currently have seven operating segments: ATD, Novalog, MPD, MSI, RedHawk, iNetWorks and Corporate Headquarters. In years prior to fiscal 2002, each segment was separately managed, with separate marketing and distribution systems. In the latter part of fiscal 2002, the operations of MSI, RedHawk, and iNetWorks were consolidated with those of ATD to reduce aggregate operating expenses. Corporate Headquarters provides accounting, inventory control and management consulting services to the consolidated subsidiaries. Corporate revenue consists of charges to the subsidiaries for these services and corporate assets consist of loans to subsidiaries and goodwill for reacquisition of subsidiary stock.
Historically, we have made significant investments to fund research and development for our operating subsidiaries. To date, other than Novalog, none of our subsidiaries have contributed material revenues or earnings to our consolidated results of operations. Starting in fiscal 2001, we adopted a policy to significantly reduce our investments in our subsidiaries for the foreseeable future. As a result, the subsidiaries will need to seek independent funding or partner with third parties to further develop their products. In addition, in the latter part of fiscal 2002, we consolidated the operations of MSI, RedHawk, and iNetWorks with those of ATD to reduce aggregate expenses. In September 2001, Silicon Film Technologies, a former subsidiary of ISC, suspended operations and in October 2002 filed for liquidation through bankruptcy proceedings. Silicon Film’s assets were liquidated through those proceedings in February 2002, and the bankruptcy was discharged in June 2002. All financial statements and schedules of ISC give effect to the liquidation of Silicon Film and report Silicon Film as a discontinued operation. All significant intercompany transactions and balances have been eliminated in this consolidation.
21
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. As such, management is required to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The significant accounting policies that are most critical to aid in fully understanding and evaluating reported financial results include the following:
Revenue Recognition
Our research and development contracts are usually cost plus fixed fee. United States government contract costs, including indirect costs, are subject to audit and adjustment by negotiations between us and government representatives. Our accounting policies regarding the recognition of revenue for these contractual arrangements is fully described in Note 1 of Notes to Consolidated Financial Statements. Generally, revenues are recognized using percentage of completion accounting for contracts.
We consider many factors when applying accounting principles generally accepted in the United States of America related to revenue recognition. These factors generally include, but are not limited to:
| 1. | | The actual contractual terms, such as payment terms, delivery dates, and pricing of the various product and service elements of a contract; |
| 2. | | Time period over which services are to be performed; |
| 3. | | Costs incurred to date; |
| 4. | | Total estimated costs of the project; |
| 5. | | Anticipated losses on contracts; and |
| 6. | | Collectibility of the revenues. |
Each of the relevant factors is analyzed to determine its impact, individually and collectively with other factors, on the revenue to be recognized for any particular contract with a customer. Management is required to make judgments regarding the significance of each factor in applying the revenue recognition standards, as well as whether or not each factor complies with such standards. Any misjudgment or error by management in its evaluation of the factors and the application of the standards, could have a material adverse affect on our future operating results.
Inventory
Inventories are stated at the lower of cost or market. Each quarter, we evaluate our inventories for excess quantities and obsolescence. Inventories that are considered obsolete are written off. Remaining inventory balances are adjusted to approximate the lower of cost or market value. The valuation of inventories at the lower of cost or market requires the use of estimates as to the amounts of current inventories that will be sold. These estimates are dependent on our assessment of current and expected orders from our customers.
Costs on long-term contracts and programs in progress represent recoverable costs incurred. ATD’s marketing involves the identification and pursuit of specific government budgets and programs. ATD is frequently involved in the pursuit of a specific anticipated contract that is a follow-on or related to an existing contract. ATD often determines that it is probable that a subsequent award will be successfully received, particularly if ATD can demonstrate continued progress against anticipated technical goals of the projected new program while the government goes through its lengthy process required to allocate funds and award contracts. Accordingly, ATD from time-to-time capitalizes material, labor and overhead costs expected to be recovered from a probable new contract. Due to the uncertain timing of ATD being awarded a contract, we maintain significant reserves for this inventory to avoid overstating its value. We have adopted this practice because we are typically able to more fully recover such costs under the provisions of government contracts by direct billing of inventory rather than by seeking recovery of such costs through permitted indirect rates.
Valuation Allowances
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance.
22
FISCAL YEAR ENDED SEPTEMBER 29, 2002 vs. FISCAL YEAR ENDED SEPTEMBER 30, 2001
Fiscal 2002 product sales of $4,641,700 decreased by $622,900, or approximately 12%, from the $5,264,600 of product sales generated in fiscal 2001. This decrease was the primarily due to a continuing decline in the sales of products intended for use in products of Palm Computing, sold by our Novalog subsidiary, offset by an increase in product sales of MPD and MSI. Novalog’s product sales, including $49,200 of other revenues generated during fiscal 2002, declined approximately 54%, to $2,074,500 in fiscal 2002 from $4,511,700 in fiscal 2001. MPD’s and MSI’s product sales, including $28,500 and $61,400 of other revenues generated during fiscal 2002 respectively, increased approximately 213% and 600%, respectively, to $1,823,100 in fiscal 2002 versus $582,500 in fiscal 2001 for MPD and to $853,600 in fiscal 2002 versus $121,900 in fiscal 2001 for MSI. Fiscal 2002 cost of product sales was $4,048,800, or approximately 88% of product sales, a decrease from $5,697,000 or approximately 108% of product sales in fiscal 2001. The improvement in gross margins was almost completely due to the absence in fiscal 2002 of product costs incurred in fiscal 2001 that did not recur in fiscal 2002, namely approximately $180,000 relating to fiscal 2001 testing and qualifying of MPD’s new products and the $638,600 fiscal 2001 write-down of RedHawk’s capitalized software development costs. Novalog’s unit volume of products shipped in fiscal 2002 was approximately 38% of its unit volume shipped in fiscal 2001, accounting for approximately 113% of the reduction in Novalog’s revenues from fiscal 2002 to fiscal 2001, which was offset, in part, by an approximately 13% increase in the average unit price.
Fiscal 2002 contract research and development revenue of $10,561,500 increased by $5,180,700, an approximate 96% improvement over the $5,380,800 of such revenue in fiscal 2001. Contract research and development revenue is predominantly conducted through ATD. During fiscal 2002, ATD received the largest initial grant of such a contract in its history, an approximate $9.6 million award to develop an airborne laser-based sensor. This contract accounted for approximately $4.7 million of fiscal 2002 contract research and development revenue. During fiscal 2002, ATD recovered approximately $262,800 of its previously inventoried labor, material and overhead costs through sales to government contracts. However, ATD added new inventoried labor, material and overhead costs of $472,700, net of reserves, in fiscal 2002 in anticipation of new contracts in the future, resulting in a net increase of $209,900 in ATD’s inventoried labor, material and overhead costs in fiscal 2002. Of this new inventory, $304,500 was related to our miniaturized infrared camera technology, with the balance related to our chip stacking and image processing technologies. Cost of contract research and development revenue in fiscal 2002 was $7,752,100 or approximately 73% of contract research and development revenue, improved from $4,364,200 or 81% of contract research and development revenue in fiscal 2001. This improvement included a decrease of approximately $477,000, or 52%, in ATD’s accrued reserve for potential losses on ongoing research contracts, from $921,200 at September 30, 2001 to $442,200 at September 29, 2002. Of this fiscal 2002 decrease, $327,400 was related to possible cost-sharing obligations of a government contract that had not been resolved at September 30, 2001, but that were resolved favorably during fiscal 2002. The balance of the fiscal 2002 improvement in contract research and development revenue was the net of (i) a $300,400 fiscal 2002 decrease in reserves for seven contracts that were outstanding at September 30, 2001; (ii) a fiscal 2002 increase of $23,400 in the reserve for one contract outstanding at September 30, 2001; (iii) the establishment at September 29, 2002 of reserves in the aggregate amount of $350,500 for seven new contracts and; (iv) elimination of the September 30, 2001 general contract reserve in the amount of $223,100 in recognition of the establishment of specific reserves for all open contracts at September 29, 2002. The specific contract reserves are all based on the estimates of program managers of the future effort required to achieve desired technical objectives
General and administrative expense of $7,476,600 in fiscal 2002 decreased by $3,293,800 or approximately 31%, from the $10,770,400 of general and administrative expenses of fiscal 2001. Of this decrease, $1,859,000 was attributable to reductions in salary and related benefit costs. An additional $750,800 reduction was due to the lower amount and imputed value of warrants issued to service providers in fiscal 2002 versus fiscal 2001. An aggregate $660,200 of the remaining reduction was attributable to reductions in services and supplies at MSI, iNetWorks and RedHawk in the amounts of $133,700, $288,300 and $238,200, respectively. As a percentage of total revenues, general and administrative expense was approximately 49% in fiscal 2002 compared to 101% in fiscal 2001.
Research and development expense was reduced to $1,991,700 in fiscal 2002 compared to $5,951,700 in fiscal 2001. Of this $3,960,000 decrease, a 67% reduction from fiscal 2001, $2,570,800 was attributable to our decision to reduce investments in subsidiaries absent commitments from strategic partners to exploit subsidiary technologies. Approximately $1.3 million of the decrease in research and development expense was due to the increase in ATD’s funded contract research and development in fiscal 2002 and the corresponding unavailability of discretionary resources in ATD to conduct internally funded research and development. Since the nature of ATD’s contracts tends to advance our technology in any event, we believe that the reduction in research and development expense in fiscal 2002 has not impaired our technology. As a percentage of revenues, R&D accounted for approximately 13% in fiscal 2002 versus 56% in fiscal 2001. We intend to manage our internally funded research and development expense in the future to levels more consistent with those of fiscal 2002 than those of fiscal 2001.
23
Other than the $1.3 million research and development reduction in ATD noted above, the aggregate decrease of $7,253,800 in operating costs and expenses during fiscal 2002 is largely the result of our decision to reduce our investments in our subsidiaries and the administrative support required for the separate operations of those subsidiaries.
The consolidated loss from continuing operations of $6,072,500 in fiscal 2002 was $9,453,000, or approximately 61%, less than the $15,525,500 of such loss in fiscal 2001. Losses at the three development stage subsidiaries, MSI, iNetWorks and RedHawk, were approximately $926,000, $277,000 and $161,000, respectively, representing reductions of approximately $1.92 million, $1.28 million and $1.54 million, respectively, from fiscal 2001 as a result of reductions in product development and associated activities at those subsidiaries. Novalog’s loss in fiscal 2002 was approximately $1,268,000, an increase of $761,000 from fiscal 2001, reflecting the effect of the decline in its fiscal 2002 revenues. Of the remaining approximate $5.3 million improvement in consolidated loss from continuing operations, approximately $4.7 million was realized as a result of improved absorption of indirect expenses and margins from increased revenues, with $3.5 million of that improvement occurring at ATD, which reduced its fiscal 2002 loss to approximately $1,151,900, and $0.9 million of the improvement occurring at MPD, which reduced its fiscal 2002 loss to approximately $653,000. The remaining approximate $961,600 improvement in operating loss was primarily due to net reduced expenses in our corporate headquarters segment. These net reductions included a decrease in consultant expense of $862,400, a reduction in labor expense of $645,700 and a decrease in services, supplies and miscellaneous operating expenses aggregating $273,600. These improvements in the expenses of our corporate headquarters segment were offset, in part, by increased legal expense of $373,500, a reduction of $176,400 in expenses allocable to subsidiaries, an increase in unfunded pension expense of $110,000, an increase in interest expense of $90,200 and a reduction in interest income of $70,000.
The consolidated loss from continuing operations is net of the allocation of a portion of the loss from operations attributable to minority ownership interests of consolidated subsidiaries. In fiscal 2002, the consolidated amount of minority interest loss allocation was $112,200, of which $48,800 was attributable to RedHawk and $63,400 was attributable to Novalog. This aggregate minority loss allocation was $497,400 less than the aggregate $609,600 allocated minority interest of fiscal 2001.
FISCAL YEAR ENDED SEPTEMBER 30, 2001 vs. FISCAL YEAR ENDED OCTOBER 1, 2000
Fiscal 2001 product sales of $5,264,600 decreased by $841,100 or 14% compared to fiscal 2000. This decrease was largely due to a decline in the sales of products intended for use in products of Palm Computing, sold by our Novalog subsidiary. Fiscal 2001 cost of product sales was $5,697,000 or 108% of product sales, an increase from $4,707,300 or 77% of product sales in fiscal 2000. The decrease in gross margins is largely due to the start-up expense of approximately $180,000 relating to the extensive testing and qualification associated with the introduction of MPD’s products and the write-down of RedHawk’s previously capitalized software development costs of $638,600 in fiscal 2001. Additionally, Novalog’s product mixture changed somewhat during fiscal 2001 to a composition of approximately 40% of products with a lower margin as opposed to approximately 25% lower margin products in fiscal 2000. Novalog’s unit volume of products shipped in fiscal 2001 was approximately 76% of its unit volume shipped in fiscal 2000, accounting for all but 5% of the reduction in Novalog’s revenues from fiscal 2000 to fiscal 2001. The remainder of the revenue reduction in fiscal 2001 was primarily attributable to price pressure on Novalog’s products and the changed product composition noted above.
Fiscal 2001 contract research and development revenue of $5,380,800 increased by $1,097,900 or 26% compared to fiscal 2000. Contract research and development revenue is predominantly conducted through ATD. ATD was awarded several material contracts during the year, and focused its resources more on contract activity instead of internal research and development projects, especially during the last half of fiscal 2001. ATD’s focus on contract research and development revenue also resulted in better personnel utilization and a corresponding increase in margins on contract research and development revenue. During fiscal 2001, ATD recovered approximately $562,000 of its inventoried labor, material and overhead costs through sales to government contracts. However, ATD added new inventoried labor, material and overhead costs of $2,416,200 in fiscal 2001 in anticipation of new
contracts in the future. $2,148,600 of this new inventory was related to our advanced router technology, with the balance related to our chip stacking and image processing technologies. Consistent with our policy, the increase in ATD’s inventory in fiscal 2001 was fully offset by an increase in inventory reserve. Cost of contract research and development revenue in fiscal 2001 was $4,364,200 or 81% of contract research and development revenue, an improvement from 95% of contract research and development revenue reported in fiscal 2000. This improvement was realized despite an increase of approximately $359,000, or approximately 64%, in ATD’s accrued reserve for potential losses on ongoing research contracts, from $582,700 at October 1, 2000 to approximately $921,200 at September 30, 2001. Of this fiscal 2001 increase, $234,000 was related to possible cost-sharing obligations of a government contract that had not been resolved at September 30, 2001, and approximately $178,000 was established to recognize a discretionary decision to expend additional resources in two of our contracts related to
24
a multi-million dollar competitive procurement expected to be awarded in fiscal 2002. An aggregate of $286,000 of additional reserves was also established related to seven other contracts based on the estimates of program managers of the future effort required to achieve desired technical objectives. These increases were offset by a reserve decrease of approximately $174,000 on the close out of a government contract and a reduction of approximately $166,000 in a general accrual established to reserve against possible losses on government contracts for which no specific reserves had been established. The reduction in this general reserve reflected improvements in the accuracy and quarter-to-quarter variability of contract estimated costs in fiscal 2001 versus fiscal 2000. In the future, we plan to increase the number of contracts for which specific reserves are established and reduce or eliminate this general reserve accordingly.
General and administrative expenses of $10,770,400 increased by $3,803,200 or 55% compared to fiscal 2000. Approximately $900,000 of this increase was the result of the addition of three senior management personnel to facilitate strategic initiatives with respect to our subsidiaries and approximately $100,000 of this increase was due to added legal services related to those initiatives. This increase also includes the fair value of warrants issued to service providers for strategic planning services in fiscal 2001, valued at $865,000. It also includes a writedown of capitalized RedHawk software in the amount of $638,600. This compared to non-recurring equipment writedowns aggregating $205,200 in fiscal 2000. Additionally, our iNetWorks subsidiary, which was founded at the end of fiscal 2000, incurred approximately $1 million in general and administrative costs in fiscal 2001 related to managing and marketing the intellectual property associated with the Internet router technology. As a percentage of total revenues, general and administrative expenses were approximately 101% in fiscal 2001 compared to 65% in fiscal 2000.
Research and development expense increased to $5,951,700 in fiscal 2001 compared to $4,980,400 in fiscal 2000. The increase of $971,300, or 20%, was primarily due to the development of Internet router technology for iNetWorks. As a percentage of revenues, R&D accounted for approximately 56% in fiscal 2001 compared to 46% in fiscal 2000. We anticipate the cost of consolidated our internally-funded research and development in absolute dollars will decline in the near future as a result of our reduced funding of our subsidiaries.
The aggregate increase of $6,041,100 in operating costs and expenses during fiscal 2001 is largely the result of management’s decision to continue implementation of our strategy to develop, market and sell commercial products through our subsidiaries during fiscal 2001, prior to the decision that was made later in the year to reduce such investments.
The consolidated loss from continuing operations of $15,525,500 in fiscal 2001 was $6,530,600 or 73% greater than fiscal 2000. Losses from RedHawk and iNetWorks, largely incurred in the first part of the fiscal year, accounted for approximately 60% of this increase, and the expenses incurred by our corporate headquarters segment related to its increase in personnel and legal services accounted for 30%. Novalog experienced a loss from operations of $507,600 in fiscal 2001 versus a profit of $478,700 in fiscal 2000, an aggregate change of $986,300 or 15% of the increased loss. MicroSensors, however, experienced a reduced loss from operations of $2,848,800 in fiscal 2001 down from a loss from operations of $3,303,700 in fiscal 2000. MPD had a loss from continuing operations of $1,560,600 in fiscal 2001 versus a loss of $986,800 in fiscal 2000, an increase of $573,800. ATD had a loss from operations of $4,621,000 in fiscal 2001, up from a $4,442,900 loss in fiscal 2000. We recorded a net gain from discontinued operations of Silicon Film Technologies, Inc., our former subsidiary, of $938,000 in fiscal 2001, compared to a loss of $6,043,400 in fiscal 2000.
The consolidated loss from continuing operations is net of the allocation of a portion of the loss from operations attributable to minority ownership interests of consolidated subsidiaries. In fiscal 2001, the consolidated amount of minority interest loss allocation was $609,600, of which $466,700 was attributable to RedHawk, $89,300 was attributable to iNetWorks, $28,200 was attributable to MicroSensors and $25,400 was attributable to Novalog. This aggregate minority loss allocation was $356,300 less than the aggregate $965,900 allocated minority interest of fiscal 2000, reflecting the prior year inclusion of approximately $945,000 of allocated losses attributable to Silicon Film.
Liquidity and Capital Resources
At September 29, 2002, we had consolidated cash and cash equivalents of $696,300, which represents an increase of $316,100 since September 30, 2001. The net cash used in operating activities was $1,436,000 during fiscal 2002. This net cash use was largely attributable to our fiscal 2002 loss from continuing operations of $6,072,500, offset by significant non cash expenses of $1,381,600 from depreciation and amortization and $710,000 from non-cash stock contributions to our employee retirement plan, the $1,811,400 of operating expenses retired by issuance of common stock and the $849,100 increase in accounts payable and accrued expenses. Of the operating expenses retired by issuance of common stock, $1,034,900 was the result of cancellation of compensation obligations due to
25
employees pursuant to our 2001 Compensation Plan. Other adjustments included a $477,000 decrease in accrued loss on contracts, the net repayment of employee advances in the amount of $174,700, a net decrease in inventory of $176,200, a decrease of $112,100 in minority interest in net loss of subsidiaries, a $108,400 decrease in customer advances and a $99,500 decrease in accounts receivable. Of the approximate $1.4 million net cash used in operations in fiscal 2002, over $1.3 million was incurred in the first three fiscal quarters. The significant increase in ATD’s revenues and the approximate $1 million revenue contribution from MPD in the fourth fiscal quarter contributed to cash used in operations of less than $80,000 during the last fiscal quarter of the year. Cash flow from operating activities during this fourth fiscal quarter would have been further improved were it not for the fact that ATD’s largest contract, awarded in May 2002, involves significant subcontractor support for which we receive only a management fee, but no recovery of indirect expenses.
We used $783,800 in investing activities during fiscal 2002. We realized $156,900 on the sale of marketable securities, and used $168,400 to invest in patents. Of the $737,100 used to acquire property, plant and equipment, $190,600 was for equipment, $160,100 was for leasehold improvements, $30,600 was for software programs, and $355,800 was for construction in progress. The construction in progress included $328,500 for stacked neo-processor tools. If our funded contract activity continues to grow in the future, an outcome that we are seeking, but cannot guarantee, our capital expenditures will likely grow from the level experienced in fiscal 2002.
During fiscal 2002, we generated net cash of $2,500,900 from financing activities. Cash provided by financing activities included $2,255,000 from the issuance of common and preferred stock and common stock warrants and proceeds from common stock options and warrants exercised of $84,500. Novalog also borrowed a net of $200,000 from its secured line of credit at various times during the fiscal year. The line of credit is for borrowings up to $400,000, and is secured by restricted cash of $400,000 at September 29, 2002. Net cash provided by equity transactions was reduced by principal payments on capital leases payable of $188,600.
As a result of net losses during fiscal 2002, including approximately $450,000 of legal costs associated with two lawsuits, our consolidated working capital decreased from $(668,900) at September 30, 2001 to $(1,483,200) at September 29, 2002. One of the lawsuits that contributed to this legal expense was settled in September 2002. Furthermore, approximately 46% of ATD’s fiscal 2002 revenue and approximately 56% of MPD’s fiscal 2002 revenue was realized in the fourth fiscal quarter ended September 29, 2002. As a result of this fourth fiscal quarter revenue growth, our consolidated net loss for the fourth fiscal quarter was approximately $637,600 and approximately $290,000 of this amount was attributable to the legal costs noted above. We believe, but cannot guarantee, that the timing and size of the fourth quarter revenue increase is indicative of aggregate growth in these segments of our business in fiscal 2003. We believe that such growth will allow us to meet our current cash requirements and improve our liquidity position in fiscal 2003. However, it is not likely that we will be able to generate enough cash from operations to fully retire our negative working capital at September 29, 2002 during fiscal 2003. Accordingly, we are currently seeking equity financing and may also seek to retire some of these obligations through the additional issuance of debt or equity securities in fiscal 2003. We believe that the combination of such actions and anticipated improvements in results of operations will allow us to improve our working capital position during fiscal 2003. However, financing to achieve this objective may not be available on a timely basis, on acceptable terms, or at all.
For the longer term, our belief in the prospects for growth in our government-funded contract business stems from budgetary decisions of various government agencies that favorably affected our business in fiscal 2002 and could continue to do so throughout fiscal 2003 and beyond. Such growth would be expected to improve our cash flow from operations and resulting liquidity because of improved absorption and recovery of our relatively fixed indirect expenses through allowable billing rates of government contracts. However, contracts with government agencies may be suspended or terminated by the government at any time, subject to certain conditions. Similar termination provisions are typically included in agreements with prime contractors. Since our inception, we have experienced such termination of our contracts on three occasions, the latest of which being April 1999. There is no assurance that we will not experience suspensions or terminations in the future. Any such termination, if material, could cause a disruption of our revenue stream, adversely affect our results of operations and could result in employee layoffs.
We believe that a majority of our consolidated losses in recent years have been the result of discretionary investments in subsidiaries, and in our infrastructure to support those subsidiaries, for the purpose of attempting to commercialize various technologies. We have not been successful in many of these activities, nor have we been able to raise sufficient capital to fund the future development of these technologies. Starting in fiscal 2001 and continuing through most of fiscal 2002 until separate operations at all subsidiaries were reduced or eliminated, we sharply curtailed direct investments in our subsidiaries in favor of the pursuit of appropriate third party strategic relationships. We also developed and implemented a business plan to reduce our expenditures in order to manage our cash flow and maintain our operations. This plan included staff reductions, salary reductions, sharp curtailment of discretionary budgets related to internal research and development and subsidiary investments and deferral of planned capital expenditures. In October 2002, after growth in revenues in the fourth fiscal quarter of 2002, salaries
26
were reinstated to prior levels. We have not identified any long-term sources of internal liquidity improvement other than indirect cost reductions and anticipated growth in our government contract and stacked memory revenues.
At September 29, 2002, our funded backlog was approximately $1,762,600 compared to $2,144,400 at September 30, 2001. In addition, existing contracts include a large amount of unfunded backlog, which typically is funded when the previously funded amounts have been expended. Subsequent to fiscal year end the total backlog was $1,624,600 as of November 24, 2002.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk None.
Item 8. Financial Statements and Supplementary Data The financial statements, together with the report thereon of Grant Thornton LLP dated December 13, 2002, as listed under Item 15, appear in a separate section of this report beginning on page F-1.
Item | | 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
27
PART III
Item 10. Directors and Executive Officers of the Registrant | (2) | | Identification of Directors. Information concerning directors, under the caption “Proposal One: Election of Directors,” appears in the Proxy Statement for the 2003 Annual Meeting and is incorporated herein by reference. |
| (3) | | Identification of Executive Officers. The information, under the caption “Executive Officers and Key Employees,” appears in the Proxy Statement for the 2003 Annual Meeting and is incorporated herein by reference. |
| (4) | | Compliance with Section 16(a) of the Exchange Act. The information, under the caption “Section 16(a) Beneficial Ownership Reporting Compliance,” appears in the Proxy Statement for the 2003 Annual Meeting and is incorporated herein by reference. |
Item 11. Executive Compensation The information, under the caption “Executive Compensation and Other Information,” appears in the Proxy Statement for the 2003 Annual Meeting and is incorporated herein by reference.
Item 12. Stock Ownership of Certain Beneficial Owners and Management The information, under the caption “Ownership of Securities,” appears in the Proxy Statement for the 2003 Annual Meeting and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions The response to this Item will be contained in the Proxy Statement for the 2003 Annual Meeting under the heading “Certain Relationships and Related Transactions” and is incorporated herein by reference.
Item 14. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures. Based on their evaluation as of a date within 90 days of the filing date of this Report, our principal executive officer and principal financial officer have concluded that Irvine Sensors’ disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) are effective to ensure that information required to be disclosed by Irvine Sensors in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
(b) Changes in Internal Controls. There have been no significant changes in our internal controls or in other factors that could significantly affect our internal controls subsequent to the date that our principal executive officer and principal financial officer carried out their evaluation.
28
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K | (a) (1) | | Financial Statements |
See Index to Consolidated Financial Statements on page F-1
| (2) | | Financial Statement Schedules: |
The following financial statement schedule is filed as part of this Form 10-K. All other schedules have been omitted because they are not applicable, not required, or the information is included in the consolidated financial statements or notes thereto.
| | | | Page
|
| Schedule II—Valuation and Qualifying Accounts S-1 | | | | S-1 |
The following is a list of the exhibits encompassed in this Annual Report on Form 10-K:
Exhibit Number
| | Exhibit Description
|
| 3.1 | | Certificate of Incorporation of the Registrant, as amended and currently in effect (1) |
| 3.3 | | By-laws, as amended to date |
| 4.1 | | Specimen Common Stock certificate (1) |
| 10.1.1* | | Employee Stock Bonus Plan and Trust Agreement dated June 29, 1982 effective December 31,1982 (2) |
| 10.1.2* | | Amendment to Employee Stock Bonus Plan and Trust Agreement dated December 14, 1982 (3) |
| 10.1.3* | | Amendment to Employee Stock Bonus Plan and Trust Agreement dated September 25, 1990 (1) |
| 10.1.4* | | Master Trust Agreement for Employee Deferred Benefit Plans dated August 22, 1990 (4) |
| 10.1.5* | | Amendment to Employee Stock Bonus Plan and Trust Agreement dated October 4, 1993 (5) |
| 10.2* | | 1991 Stock Option Plan (6) |
| 10.3* | | 1995 Stock Option Plan (7) |
| 10.4* | | 1999 Stock Option Plan (8) |
| 10.5* | | 2000 Non-Qualified Stock Option Plan |
| 10.6* | | 2001 Stock Option Plan (9) |
| 10.7* | | 2001 Non-Qualified Stock Option Plan (10) |
| 10.8* | | 2001 Compensation Plan (11) |
| 10.9 | | Government Contract DAAD17-01-D-0006 dated June 29, 2001 (13) |
| 10.10 | | Delivery Order 0001 to Government Contract DAAD17-01-D-0006 dated June 29, 2001 (14) |
| 10.11 | | Amendment to Government Contract DAAD17-01-D-0006-0002 dated September 27, 2002 |
| 10.12 | | Government Contract NAAS5-02129 dated September 13, 2002 |
| 10.13 | | Form of Indemnification Agreement between the Registrant and its directors and officers (12) |
| 10.14 | | Lease Agreement for premises at 3001 Redhill Avenue, Bldg. 3, Costa Mesa, California, dated October 19, 2001 (15) |
| 10.15 | | Lease Agreement for premises at 3001 Redhill Avenue, Bldg. 4 Downstairs, Costa Mesa, California, dated October 19, 2001 (16) |
| 10.16 | | Lease Agreement for premises at 3001 Redhill Avenue, Bldg. 4 Upstairs, Costa Mesa, California, dated October 19, 2001 (17) |
| 21.1 | | Subsidiaries of the Registrant |
| 23.1 | | Consent of Grant Thornton LLP, Independent Certified Public Accountants |
| 99.1 | | Periodic Report Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| (1) | | Incorporated by reference to Exhibit 3.1 filed with the Registrant’s Annual Report on Form 10-K for the fiscal year ended September 29, 1991. |
| (2) | | Incorporated by reference to Part II of Pre-effective Amendment No. 3 to the S-18 Registration Statement filed with the Commission’s Los Angeles Regional Office on May 27, 1982. |
29
| (3) | | Incorporated by reference to Part II of Registrant’s Registration Statement on Form S-1 filed with the Commission on March 23, 1983 (Registration No. 2-82596) (the “S-1 Registration Statement”). |
| (4) | | Incorporated by reference to Part II of Pre-effective Amendment No. 3 to the Form S-2 filed with the Commission on March 3, 1987 (Registration No. 33-10134). |
| (5) | | Incorporated by reference to Exhibit 10.16 filed with the Registrant’s Annual Report on Form 10-K/A for the fiscal year ended October 1, 1995. |
| (6) | | Incorporated by reference to Part II of Pre-effective Amendment No. 2 to the Form S-2 filed with the Commission on July 9, 1992 (Registration No. 33-47977). |
| (7) | | Incorporated by reference to Exhibit 99.1 filed with the Registrant’s Registration Statement on Form S-8 (File No. 333-72201), filed February 11, 1999. |
| (8) | | Incorporated by reference to Exhibit 99.1 filed with the Registrant’s Registration Statement on Form S-8 (File No. 333-94071), filed January 4, 2000. |
| (9) | | Incorporated by reference to the Registrant’s Definitive Proxy Statement for the March 7, 2001 Annual Meeting of Stockholders. |
| (10) | | Incorporated by reference to Exhibit 10.1 filed with the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended December 30,2001. |
| (11) | | Incorporated by reference to Exhibit 99.1 filed with the Registrant’s Registration Statement on Form S-8 (File No. 333-94071), filed January 15, 2002. |
| (12) | | Incorporated by reference to Exhibit 10.9 filed with the Registrant’s Annual Report on Form 10-K/A for the fiscal year ended October 1, 2000. |
| (13) | | Incorporated by reference to Exhibit 10.9 filed with the Registrant’s Annual Report on Form 10-K/A for the fiscal year ended September 30, 2001. |
| (14) | | Incorporated by reference to Exhibit 10.10 filed with the Registrant’s Annual Report on Form 10-K/A for the fiscal year ended September 30, 2001. |
| (15) | | Incorporated by reference to Exhibit 10.13 filed with the Registrant’s Annual Report on Form 10-K/A for the fiscal year ended September 30, 2001. |
| (16) | | Incorporated by reference to Exhibit 10.14 filed with the Registrant’s Annual Report on Form 10-K/A for the fiscal year ended September 30, 2001. |
| (17) | | Incorporated by reference to Exhibit 10.15 filed with the Registrant’s Annual Report on Form 10-K/A for the fiscal year ended September 30, 2001. |
* Management contract or compensatory plan or arrangement
No reports on Form 8-K were filed for the fiscal quarter ended September 29, 2002.
The exhibits filed as part of this report are listed in Item 15(a)(3) of this Form 10-K.
(d) | | Financial Statement Schedules |
The Financial Statement Schedules required by Regulation S-X and Item 8 of this Form are listed in Item 15(a)(2) of this Form 10-K.
30
Pursuant to the requirements of Section 13 or 15(d) 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.
IRVINE SENSORS CORPORATION |
|
| By: | | /s/ Robert G. Richards
|
| | Robert G. Richards Chief Executive Officer and Director (Principal Executive Officer) Dated: December 26, 2002 |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
|
/s/ Robert G. Richards
| | | | /s/ John J. Stuart, Jr.
|
Robert G. Richards Chief Executive Officer and Director (Principal Executive Officer) Dated: December 26, 2002 | | | | John J. Stuart, Jr. Chief Financial Officer and Secretary (Principal Financial and Chief Accounting Officer) Dated: December 26, 2002 |
|
/s/ Mel R. Brashears
| | | | /s/ Marc Dumont
|
Mel R. Brashears, Chairman of the Board Dated December 26, 2002 | | | | Marc Dumont, Director Dated: December 26, 2002 |
|
/s/ Maurice C. Inman, Jr.
| | | | /s/ Thomas M. Kelly
|
Maurice C. Inman, Jr., Director Dated December 26, 2002 | | | | Thomas M. Kelly, Director Dated: December 26, 2002 |
|
/s/ Wolfgang Seidel
| | | | /s/ Vincent F, Sollitto, Jr.
|
Wolfgang Seidel, Director Dated December 26, 2002 | | | | Vincent F, Sollitto, Jr., Director Dated: December 26, 2002 |
31
I, Robert G. Richards, certify that:
1. I have reviewed this annual report on Form 10-K of Irvine Sensors Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
| a) | | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; |
| b) | | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and |
| c) | | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
| a) | | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and |
| b) | | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and |
6. The registrant’s other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Dated: December 26, 2002
|
/s/ Robert G. Richards
|
Chief Executive Officer (Principal Executive Officer) |
32
I, John J. Stuart, Jr., certify that:
1. I have reviewed this annual report on Form 10-K of Irvine Sensors Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
| a) | | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; |
| b) | | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and |
| c) | | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
| a) | | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and |
| b) | | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and |
6. The registrant’s other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: December 26, 2002
|
/s/ John J. Stuart, Jr.
|
John J. Stuart, Jr. Chief Financial Officer (Principal Financial and Chief Accounting Officer) |
33
IRVINE SENSORS CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| | Page |
Financial Statements | | |
|
| Consolidated Balance Sheets | | F-2 |
| Consolidated Statements of Operations | | F-3 |
| Consolidated Statement of Stockholders’ Equity | | F-4 |
| Consolidated Statements of Cash Flows | | F-5 |
| Notes to Consolidated Financial Statements | | F-6 |
| Report of Independent Certified Public Accountants | | F-27 |
F-1
Irvine Sensors Corporation
Consolidated Balance Sheets
| | | September 29, 2002
| | | September 30, 2001
| |
Assets | | | | | | | | |
|
Current Assets: | | | | | | | | |
| Cash and cash equivalents | | | 696,300 | | | $ | 380,200 | |
| Marketable securities | | | — | | | | 156,600 | |
| Restricted cash | | | 435,200 | | | | 400,000 | |
| Accounts receivable, net of allowance for doubtful accounts of $76,300 in 2002 and $57,700 in 2001 | | | 2,586,400 | | | | 2,685,900 | |
| Inventory | | | 938,000 | | | | 1,114,200 | |
| Employee advances | | | — | | | | 216,900 | |
| Other current assets | | | 100,600 | | | | 70,400 | |
| | |
|
|
| Total current assets | | | 4,756,500 | | | | 5,024,200 | |
|
| Equipment, furniture and fixtures, net | | | 4,959,200 | | | | 5,542,700 | |
| Other assets, net | | | 679,050 | | | | 574,750 | |
| | |
|
|
| | | $ | 10,394,750 | | | $ | 11,141,650 | |
| | |
|
|
Liabilities and Stockholders’ Equity | | | | | | | | |
|
Current Liabilities: | | | | | | | | |
| Accounts payable | | $ | 3,880,100 | | | $ | 2,427,600 | |
| Accrued expenses | | | 1,205,400 | | | | 1,764,600 | |
| Accrued loss on contracts | | | 444,200 | | | | 921,200 | |
| Customer advances | | | 43,100 | | | | 151,500 | |
| Line of credit | | | 400,000 | | | | 200,000 | |
| Short term notes payable | | | 150,000 | | | | — | |
| Capital lease obligations – current portion | | | 116,900 | | | | 228,200 | |
| | |
|
|
| Total current liabilities | | | 6,239,700 | | | | 5,693,100 | |
| Capital lease obligations | | | 61,300 | | | | 180,300 | |
| Minority interest in consolidated subsidiaries | | | 467,200 | | | | 579,300 | |
| | |
|
|
| Total liabilities | | | 6,768,200 | | | | 6,452,700 | |
| | |
|
|
| Commitments and contingencies (Note 11) | | | — | | | | — | |
|
Stockholders’ Equity: | | | | | | | | |
| Preferred stock, $0.01 par value, 500,000 shares authorized: | | | | | | | | |
| Series B Convertible Cumulative Preferred, 4,300 and 4,300 shares outstanding; aggregate liquidation preference of $64,500 | | | 25 | | | | 25 | |
| Series C Convertible Cumulative Preferred, 2,300 and 2,300 shares outstanding; aggregate liquidation preference of $33,000 | | | 25 | | | | 25 | |
| Common stock, $0.01 par value, 80,000,000 shares authorized; 7,027,900 and 3,305,300 shares issued and outstanding | | | 70,300 | | | | 33,100 | |
| Common stock warrants and unit warrants; 1,094,800 and 223,250 outstanding | | | — | | | | — | |
| Paid-in capital | | | 102,158,200 | | | | 97,220,300 | |
| Accumulated deficit | | | (98,602,000 | ) | | | (92,564,500 | ) |
| | |
|
|
| Total stockholders’ equity | | | 3,626,550 | | | | 4,688,950 | |
| | |
|
|
| | | $ | 10,394,750 | | | $ | 11,141,650 | |
| | |
|
|
See Accompanying Notes to Consolidated Financial Statements
F-2
Irvine Sensors Corporation
Consolidated Statements of Operations
| | | Fiscal Year Ended
| |
| | | September 29, 2002
| | | September 30, 2001
| | | October 1, 2000
| |
Revenues: | | | | | | | | | | | | |
| Contract research and development | | $ | 10,561,500 | | | $ | 5,380,800 | | | $ | 4,282,900 | |
| Product sales | | | 4,641,700 | | | | 5,264,600 | | | | 6,105,700 | |
| Other | | | 139,100 | | | | 11,900 | | | | 381,200 | |
| | |
|
|
| Total revenues | | | 15,342,300 | | | | 10,657,300 | | | | 10,769,800 | |
|
Cost and expenses: | | | | | | | | | | | | |
| Cost of contract revenues | | | 7,752,100 | | | | 4,364,200 | | | | 4,087,300 | |
| Cost of product sales | | | 4,048,800 | | | | 5,697,000 | | | | 4,707,300 | |
| General and administrative | | | 7,476,600 | | | | 10,770,400 | | | | 6,967,200 | |
| Research and development | | | 1,991,700 | | | | 5,951,700 | | | | 4,980,400 | |
| | |
|
|
| | | | 21,269,200 | | | | 26,783,300 | | | | 20,742,200 | |
| | |
|
|
Loss from operations | | | (5,926,900 | ) | | | (16,126,000 | ) | | | (9,972,400 | ) |
| Interest expense | | | (230,400 | ) | | | (141,500 | ) | | | (144,800 | ) |
| Interest income | | | 10,100 | | | | 136,400 | | | | 158,800 | |
| | |
|
|
| Loss from continuing operations before minority interest and provision for income taxes | | | (6,147,200 | ) | | | (16,131,100 | ) | | | (9,958,400 | ) |
| Minority interest in loss of subsidiaries | | | 112,200 | | | | 609,600 | | | | 965,900 | |
| Provision for income taxes | | | (37,500 | ) | | | (4,000 | ) | | | (2,400 | ) |
| | |
|
|
Loss from continuing operations | | | (6,072,500 | ) | | | (15,525,500 | ) | | | (8,994,900 | ) |
| | |
|
|
| Discontinued operations: | | | | | | | | | | | | |
| Loss from operations of discontinued subsidiary | | | — | | | | (4,658,400 | ) | | | (6,043,400 | ) |
| Gain on disposal of subsidiary | | | 35,000 | | | | 5,596,400 | | | | — | |
| | |
|
|
| Gain (loss) from discontinued operations | | | 35,000 | | | | 938,000 | | | | (6,043,400 | ) |
| | |
|
|
Net loss | | $ | (6,037,500 | ) | | $ | (14,587,500 | ) | | $ | (15,038,300 | ) |
| | |
|
|
| Loss per common share: | | | | | | | | | | | | |
| Basic and diluted loss per share | | | | | | | | | | | | |
| Loss from continuing operations | | $ | (1.07 | ) | | $ | (6.09 | ) | | $ | (4.45 | ) |
| | |
|
|
| Gain (loss) from discontinued operations | | | 0.01 | | | | 0.37 | | | | (2.99 | ) |
| | |
|
|
| Net loss | | $ | (1.06 | ) | | $ | (5.72 | ) | | $ | (7.44 | ) |
| | |
|
|
| Weighted average number of shares outstanding | | | 5,694,800 | | | | 2,549,500 | | | | 2,021,400 | |
| | |
|
|
See Accompanying Notes to Consolidated Financial Statements
F-3
Irvine Sensors Corporation
Consolidated Statement of Stockholders’ Equity
| | | Common Stock Shares Issued
| | Common Stock Warrants Issued
| | | Preferred Stock Shares Issued
| | | Paid-in Capital
| | | Accumulated Deficit
| | | Total Stockholders’ Equity
| |
| | | Number
| | | Amount
| | Number
| | | Number
| | | Amount
| | | | |
Balance at October 3, 1999 | | 1,751,750 | | | $ | 17,500 | | 7,350 | | | 12,300 | | | $ | | | | $ | 65,133,700 | | | | | | | $ | 2,212,650 | |
| Sale of common stock and common stock units | | 369,750 | | | | 3,700 | | — | | | — | | | | — | | | | 16,415,800 | | | | — | | | | 16,419,500 | |
| Issuance of common stock subscribed in 1999 | | 22,200 | | | | 200 | | — | | | — | | | | — | | | | (200 | ) | | | — | | | | — | |
| Common stock issued to employee retirement plan | | 6,800 | | | | 100 | | — | | | — | | | | — | | | | 462,000 | | | | — | | | | 462,100 | |
| Common stock issued to retire royalty liabilities | | 50,000 | | | | 500 | | — | | | — | | | | — | | | | 999,500 | | | | — | | | | 1,000,000 | |
| Common stock issued to pay operating expenses | | 900 | | | | — | | — | | | — | | | | — | | | | 178,400 | | | | — | | | | 178,400 | |
| Common stock issued to acquire capital assets | | 100 | | | | — | | — | | | — | | | | — | | | | 13,500 | | | | — | | | | 13,500 | |
| Common stock options exercised | | 66,500 | | | | 700 | | — | | | — | | | | — | | | | 1,785,200 | | | | — | | | | 1,785,900 | |
Series B and Series C preferred stock
converted to common stock | | 8,300 | | | | 100 | | — | | | (3,300 | ) | | | (50 | ) | | | (50 | ) | | | — | | | | — | |
Series D preferred units converted
to common stock | | 23,600 | | | | 200 | | — | | | (2,400 | ) | | | (50 | ) | | | (150 | ) | | | — | | | | — | |
| Series D warrants exercised | | 9,500 | | | | 100 | | — | | | — | | | | — | | | | 208,900 | | | | — | | | | 209,000 | |
| Common stock warrants issued | | — | | | | — | | 195,500 | | | — | | | | — | | | | — | | | | — | | | | — | |
| Common stock warrants exercised | | 22,500 | | | | 200 | | (22,500 | ) | | — | | | | — | | | | 644,000 | | | | — | | | | 644,200 | |
| Common stock warrants expired | | — | | | | — | | (2,750 | ) | | — | | | | — | | | | — | | | | — | | | | — | |
| Dividends on Series C preferred stock of subsidiary | | — | | | | — | | — | | | — | | | | — | | | | (300,400 | ) | | | — | | | | (300,400 | ) |
| Net loss | | — | | | | — | | — | | | — | | | | — | | | | — | | | | (15,038,300 | ) | | | (15,038,300 | ) |
| | |
|
| |
|
| |
|
| |
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
|
Balance at October 1, 2000 | | 2,331,900 | | | | 23,300 | | 177,600 | | | 6,600 | | | | 50 | | | | 85,540,200 | | | | (77,977,000 | ) | | | 7,586,550 | |
| Sale of common stock and common stock units | | 435,400 | | | | 4,400 | | — | | | — | | | | — | | | | 5,872,850 | | | | — | | | | 5,877,250 | |
| Common stock issued to employee retirement plan | | 232,200 | | | | 2,300 | | — | | | — | | | | — | | | | 1,174,500 | | | | — | | | | 1,176,800 | |
| Common stock issued to pay operating expenses | | 178,600 | | | | 1,800 | | — | | | — | | | | — | | | | 443,200 | | | | — | | | | 445,000 | |
| Common stock options exercised | | 9,600 | | | | 100 | | — | | | — | | | | — | | | | 218,300 | | | | — | | | | 218,400 | |
| Common stock warrants issued | | — | | | | — | | 165,600 | | | — | | | | — | | | | 865,000 | | | | — | | | | 865,000 | |
| Common stock warrants exercised | | 117,700 | | | | 1,200 | | (117,700 | ) | | — | | | | — | | | | 2,806,200 | | | | — | | | | 2,807,400 | |
| Common stock warrants expired | | — | | | | — | | (2,250 | ) | | — | | | | — | | | | — | | | | — | | | | — | |
| Cash in lieu for fractional shares resulting form reverse stock split | | (100 | ) | | | — | | — | | | — | | | | — | | | | (350 | ) | | | — | | | | (350 | ) |
| Reversal of Series C preferred stock dividends of discontinued subsidiary | | — | | | | — | | — | | | — | | | | — | | | | 300,400 | | | | — | | | | 300,400 | |
| Net loss | | — | | | | — | | — | | | — | | | | — | | | | — | | | | (14,587,500 | ) | | | (14,587,500 | ) |
| | |
|
| |
|
| |
|
| |
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
|
Balance at September 30, 2001 | | 3,305,300 | | | | 33,100 | | 223,250 | | | 6,600 | | | | 50 | | | | 97,220,300 | | | | (92,564,500 | ) | | | 4,688,950 | |
| Sale of common stock and common stock units | | 1,665,000 | | | | 16,700 | | — | | | — | | | | — | | | | 2,238,300 | | | | — | | | | 2,255,000 | |
| Common stock issued to employee retirement plan | | 571,700 | | | | 5,700 | | — | | | — | | | | — | | | | 704,300 | | | | — | | | | 710,000 | |
| Common stock issued to pay operating expenses | | 1,412,400 | | | | 14,100 | | — | | | — | | | | — | | | | 1,797,300 | | | | — | | | | 1,811,400 | |
| Common stock options exercised | | 73,500 | | | | 700 | | — | | | — | | | | — | | | | 83,900 | | | | — | | | | 84,600 | |
| Common stock warrants issued | | — | | | | — | | 873,000 | | | — | | | | — | | | | 114,100 | | | | — | | | | 114,100 | |
| Common stock warrants expired | | — | | | | — | | (1,450 | ) | | — | | | | — | | | | — | | | | — | | | | — | |
| Net loss | | — | | | | — | | — | | | — | | | | — | | | | — | | | | (6,037,500 | ) | | | (6,037,500 | ) |
| | |
|
| |
|
| |
|
| |
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
|
Balance at September 29, 2002 | | 7,027,900 | | | $ | 70,300 | | 1,094,800 | | | 6,600 | | | $ | 50 | | | $ | 102,158,200 | | | $ | (98,602,000 | ) | | $ | 3,626,550 | |
| | |
|
| |
|
| |
|
| |
|
| |
|
|
| |
|
|
| |
|
|
| |
|
|
|
See Accompanying Notes to Consolidated Financial Statements
F-4
Irvine Sensors Corporation
Consolidated Statements of Cash Flows
| | | Fiscal Year Ended
| |
| | | September 29, 2002
| | | September 30, 2001
| | | October 1, 2000
| |
Cash flows from operating activities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Loss from continuing operations | | | | | | $ | (6,072,500 | ) | | | | | | $ | (15,525,500 | ) | | | | | | $ | (8,994,900 | ) |
| Adjustments to reconcile loss from continuing operations to net cash used in operating activities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Depreciation and amortization | | $ | 1,381,600 | | | | | | | $ | 1,571,400 | | | | | | | $ | 936,700 | | | | | |
| Non-cash incentive common stock warrants issued | | | 114,200 | | | | | | | | 865,000 | | | | | | | | — | | | | | |
| Provision for obsolete inventory | | | 410,900 | | | | | | | | 2,416,200 | | | | | | | | 2,166,700 | | | | | |
| Accrued interest on marketable securities | | | (300 | ) | | | | | | | (25,700 | ) | | | | | | | (35,500 | ) | | | | |
| Loss on disposal of equipment | | | 1,800 | | | | | | | | 638,600 | | | | | | | | 205,200 | | | | | |
| Non-cash employee retirement plan contribution | | | 710,000 | | | | | | | | 1,176,800 | | | | | | | | 668,100 | | | | | |
| Minority interest in net loss of subsidiaries | | | (112,100 | ) | | | | | | | (609,600 | ) | | | | | | | (965,900 | ) | | | | |
| Common stock issued to pay operating expenses | | | 1,811,400 | | | | | | | | 368,800 | | | | | | | | 178,400 | | | | | |
| Write-off of employee advances | | | 42,200 | | | | | | | | — | | | | | | | | — | | | | | |
| (Increase) decrease in accounts receivable | | | 99,500 | | | | | | | | (363,400 | ) | | | | | | | 78,500 | | | | | |
| (Increase) decrease in employee advances | | | 174,700 | | | | | | | | (216,900 | ) | | | | | | | — | | | | | |
| Increase in inventory | | | (234,700 | ) | | | | | | | (3,040,800 | ) | | | | | | | (486,500 | ) | | | | |
| (Increase) decrease in other current assets | | | (30,200 | ) | | | | | | | 40,600 | | | | | | | | 30,450 | | | | | |
| (Increase) decrease in other assets | | | 3,800 | | | | | | | | (6,200 | ) | | | | | | | (22,150 | ) | | | | |
| Increase (decrease) in accounts payable and accrued expenses | | | 849,100 | | | | | | | | 2,031,200 | | | | | | | | (1,224,300 | ) | | | | |
| Increase (decrease) in accrued loss on contracts | | | (477,000 | ) | | | | | | | 338,500 | | | | | | | | 582,700 | | | | | |
| Increase (decrease) in customer advances | | | (108,400 | ) | | | | | | | 151,500 | | | | | | | | — | | | | | |
| | |
|
|
| | | | | |
|
|
| | | | | |
|
|
| | | | |
| Total adjustments | | | | | | | 4,636,500 | | | | | | | | 5,336,000 | | | | | | | | 2,112,400 | |
| | | | | | |
|
|
| | | | | |
|
|
| | | | | |
|
|
|
| Net cash used in operating activities | | | | | | | (1,436,000 | ) | | | | | | | (10,189,500 | ) | | | | | | | (6,882,500 | ) |
| | | | | | |
|
|
| | | | | |
|
|
| | | | | |
|
|
|
Cash flows from investing activities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Proceeds from sales of marketable securities | | | 156,900 | | | | | | | | 1,250,000 | | | | | | | | 2,437,600 | | | | | |
| Capital facilities and equipment expenditures | | | (737,100 | ) | | | | | | | (3,396,300 | ) | | | | | | | (1,480,100 | ) | | | | |
| Acquisition of intangible assets | | | (168,400 | ) | | | | | | | (325,500 | ) | | | | | | | (200,700 | ) | | | | |
| Increase in restricted cash | | | (35,200 | ) | | | | | | | — | | | | | | | | — | | | | | |
| Purchase of marketable securities | | | — | | | | | | | | (150,000 | ) | | | | | | | (3,633,000 | ) | | | | |
| Purchase of restricted certificate of deposit | | | — | | | | | | | | (400,000 | ) | | | | | | | — | | | | | |
| Capitalized software | | | — | | | | | | | | (270,000 | ) | | | | | | | (376,500 | ) | | | | |
| | |
|
|
| | | | | |
|
|
| | | | | |
|
|
| | | | |
| Net cash used in investing activities | | | | | | | (783,800 | ) | | | | | | | (3,291,800 | ) | | | | | | | (3,252,700 | ) |
| | | | | | |
|
|
| | | | | |
|
|
| | | | | |
|
|
|
Cash flows from financing activities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Proceeds from issuance of common and | | | | | | | | | | | | | | | | | | | | | | | | |
| preferred stock and common stock warrants | | | 2,255,000 | | | | | | | | 5,873,900 | | | | | | | | 17,019,500 | | | | | |
| Proceeds from options and warrants exercised | | | 84,500 | | | | | | | | 3,025,800 | | | | | | | | 2,430,100 | | | | | |
| Proceeds from line of credit | | | 464,000 | | | | | | | | 200,000 | | | | | | | | — | | | | | |
| Payments on line of credit | | | (264,000 | ) | | | | | | | — | | | | | | | | — | | | | | |
| Proceeds from notes payable | | | 200,000 | | | | | | | | — | | | | | | | | — | | | | | |
| Principal payments of notes payable | | | (50,000 | ) | | | | | | | — | | | | | | | | — | | | | | |
| Principal payments of capital leases | | | (188,600 | ) | | | | | | | (371,000 | ) | | | | | | | (323,600 | ) | | | | |
| Sale of minority interest in subsidiary | | | — | | | | | | | | 670,000 | | | | | | | | 6,199,300 | | | | | |
| Proceeds from Series D Units exercised | | | — | | | | | | | | — | | | | | | | | 209,000 | | | | | |
| | |
|
|
| | | | | |
|
|
| | | | | |
|
|
| | | | |
| Net cash provided by financing activities | | | | | | | 2,500,900 | | | | | | | | 9,398,700 | | | | | | | | 25,534,300 | |
| | | | | | |
|
|
| | | | | |
|
|
| | | | | |
|
|
|
Net cash provided by (used in) discontinued operations | | | | | | | 35,000 | | | | | | | | (3,168,100 | ) | | | | | | | (8,428,500 | ) |
| | | | | | |
|
|
| | | | | |
|
|
| | | | | |
|
|
|
| Net increase (decrease) in cash and cash equivalents | | | | | | | 316,100 | | | | | | | | (7,250,700 | ) | | | | | | | 6,970,600 | |
| Cash and cash equivalents at beginning of period | | | | | | | 380,200 | | | | | | | | 7,630,900 | | | | | | | | 660,300 | |
| | | | | | |
|
|
| | | | | |
|
|
| | | | | |
|
|
|
| Cash and cash equivalents at end of period | | | | | | $ | 696,300 | | | | | | | $ | 380,200 | | | | | | | $ | 7,630,900 | |
| | | | | | |
|
|
| | | | | |
|
|
| | | | | |
|
|
|
Noncash investing and financing activities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Common stock issued to retire indebtedness | | | | | | $ | 1,811,400 | | | | | | | $ | — | | | | | | | $ | — | |
| Equipment financed with capital leases | | | | | | $ | 2,500 | | | | | | | $ | 260,500 | | | | | | | $ | 97,400 | |
| Settlement of capital lease obligation with accounts payable | | | | | | $ | 113,000 | | | | | | | $ | — | | | | | | | $ | — | |
| Common stock issued to retire deferred and | | | | | | | | | | | | | | | | | | | | | | | | |
| subordinated royalties payable to affiliated company | | | | | | $ | — | | | | | | | $ | — | | | | | | | $ | 1,000,000 | |
| Common stock issued to acquire equipment | | | | | | $ | — | | | | | | | $ | — | | | | | | | $ | 13,500 | |
| Conversion of preferred stock to common stock | | | | | | $ | — | | | | | | | $ | — | | | | | | | $ | 100 | |
See Accompanying Notes to Consolidated Financial Statements
F-5
Irvine Sensors Corporation
Notes to Consolidated Financial Statements
Note 1—Summary of Significant Accounting Policies
COMPANY OPERATIONS
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company generated losses from continuing operations of $ 6,037,500, $15,525,500 and $8,994,900 in fiscal years 2002, 2001 and 2000, respectively. In addition, the Company had total stockholders’ equity of $3,626,550 and a working capital deficit of $1,483,200 at September 29, 2002. These factors, among others, raise doubt about the Company’s ability to continue as a going concern. Management believes that a majority of the losses in recent years have been the result of discretionary investments in subsidiaries for the purpose of attempting to commercialize various technologies. The Company has not been successful in many of these activities, nor has it been able to raise sufficient capital to fund the future development of these technologies.
Management has implemented a plan to sharply curtail such investments in the Company’s subsidiaries absent the consummation of appropriate strategic relationships and believes that this reduction in expenses will correspondingly reduce the Company’ future cash requirements. Management also developed and implemented a business plan to reduce its expenditures to levels commensurate with the current business of its Advanced Technology Division (“ATD”) and Microelectronics Product Division (“MPD”) operations in order to manage its cash flow and maintain its operations for the longer term. This plan included a 20% reduction in salaries for much of fiscal 2002, pending projected growth in revenues, and deferral of major capital expenditures. Salaries returned to former levels in October 2002 in recognition of revenue growth achieved in the latter portion of fiscal 2002. The Company believes that recent budgetary decisions made by various government agencies could lead to further growth in its funded contract business both in fiscal 2003 and beyond. Such growth would be expected to have a favorable impact on the Company’s cash flow and liquidity due to greater absorption of the Company’s relatively fixed indirect expenses through allowable billing rates of government contracts.
Based upon discussions with government agencies, management believes that it will continue to receive government contract awards through fiscal 2003. Management continues to manage costs in line with estimated revenues, and has combined the personnel of several subsidiaries to reduce expenses. If necessary, management would reinstate salary reductions. Management is also actively seeking additional financing to support the Company’s working capital requirements. Accordingly, management believes that the Company’s operations will generate sufficient cash to meet its continuing obligations for the foreseeable future. However there can be no assurance that this revenue growth will occur or that the Company will successfully implement its plans. Additionally, although the Company is seeking additional equity financing to mitigate its working capital deficit, there can be no assurance that suitable financing will be available on acceptable terms, or at all.
CONSOLIDATION
The consolidated financial statements include the accounts of Irvine Sensors Corporation (the “Company”) and its subsidiaries, Novalog, Inc. (“Novalog”), MicroSensors, Inc. (“MSI”), RedHawk Vision Systems, Inc. (“RedHawk”), iNetWorks Corporation (“iNetWorks”), 3D Microelectronics, Inc. and 3D MicroSystems, Inc. Silicon Film Technologies, Inc. (“Silicon Film”), a former subsidiary of the Company, was dissolved in fiscal 2001 and is reported as discontinued operations. 3Dmicroelectronics and 3D Microsystems are shell corporations and do not have material assets, liabilities or operations. All significant intercompany transactions and balances have been eliminated in consolidation.
FISCAL YEAR
The Company’s fiscal year ends on the Sunday nearest September 30. Fiscal 2002 (52 weeks) ended on September 29, 2002, Fiscal 2001 (52 weeks) ended on September 30, 2001 and fiscal 2000 (52 weeks) ended on October 1, 2000.
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The Company believes its estimates of inventory reserves and estimated costs to complete on contracts to be the most sensitive estimates impacting financial position and results of operations in the near term.
F-6
REVENUES
The Company’s consolidated revenues were primarily derived from shipments of Novalog’sinfrared chips and modules, MPD’s shipments of memory stack products, and the development and manufacture of prototype and sample products for its customers. Production orders for memory stacks and Novalog’s products are generally priced in accordance with the Company’s established price list. The Novalog, MSI and RedHawk subsidiaries and MPD are product-oriented companies with sales primarily to OEM manufacturers. Revenues are recorded when products are shipped. Their terms are FOB shipping point. Novalog generally provides a 90-day warranty on its products, but has experienced minimal returns. RedHawk sells a shrink-wrapped software product that has also experienced minimal returns. Products sold by the other product-oriented units have largely been for developmental and qualification use to date and have not been sold under formal warranty terms. None of the product-oriented units offer contractual price protection. Accordingly, the Company does not presently maintain any reserves for returns under warranty or post-shipment price adjustment.
The Company also contracts to develop prototypes and provide research, development, design, testing and evaluation of complex detection and control defense systems. The Company’s research and development contracts are usually cost plus fixed fee (best effort) or fixed price, and revenues are recognized as costs are incurred and include applicable fees or profits primarily in the proportion that costs incurred bear to estimated final costs. Costs in excess of billings under government contracts are accounted for as unbilled accounts receivable. The Company provides for anticipated losses on contracts by a charge to income during the period in which a loss is first identified. The accrual for contract losses is adjusted quarterly based on review of outstanding contracts. Unbilled accounts receivable are stated at estimated realizable value.
United States government contract costs, including indirect costs, are subject to audit and adjustment by negotiations between the Company and government representatives. Indirect contract costs have been agreed upon through fiscal 2000. Contract revenues have been recorded in amounts that are expected to be realized upon final settlement.
RESEARCH AND DEVELOPMENT COSTS
A major portion of the Company’s operations is comprised of customer-funded research and prototype development or related activities that are recorded as cost of contract revenues. The Company also incurs costs for research and development of new concepts in proprietary products. Such unfunded research and development costs are charged to research and development expense as incurred.
INVENTORY
Product inventory is valued at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) basis. Inventories are reviewed quarterly to determine salability and obsolescence. A reserve is established for slow moving and obsolete product inventory items. In addition, ATD’s marketing of specific government budgets and programs is facilitated by the capitalization of material, labor and overhead costs that are recoverable under government research and development contracts. Due to the uncertain timing of such contract awards, the Company maintains significant reserves for this inventory to avoid overstating its value. (See Note 10.)
EQUIPMENT, FURNITURE AND FIXTURES
The Company capitalizes costs of additions to equipment, furniture and fixtures, together with major renewals and betterments. Some projects require several years to complete and are classified as construction in progress, including expansion of the Company’s clean room facilities and related equipment. In addition, the Company capitalizes overhead costs for all in-house capital projects. Maintenance, repairs, and minor renewals and betterments are charged to expense. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized. Depreciation of equipment, furniture and fixtures is provided over the estimated useful lives of the assets, primarily using the straight-line method. The useful lives are three to seven years. Leasehold improvements are amortized over the terms of the leases.
SOFTWARE DEVELOPMENT AND PURCHASED SOFTWARE
Software development and purchased software costs are capitalized when technological feasibility and marketability of the related product have been established. The Company amortizes capitalized software costs beginning when the product is available for general release to customers. Annual amortization expense is calculated using the straight-line method over the estimated useful life of the product, not to exceed five years. The Company evaluates the carrying value of unamortized capitalized software costs at each balance sheet date to determine whether any net realizable value adjustments are required.
F-7
During fiscal 2001, the Company recorded a writedown of $638,600 of its unamortized software development costs. The Company determined the amount of the writedown based on the amount of the unamortized software development costs that exceeded the estimated net realizable value of the RedHawk software in accordance with SFAS 86. The Company determined the net estimated realizable value of the RedHawk software based on the estimated future revenues from the RedHawk product. The writedown is included in cost of product sales for fiscal 2001.
LONG-LIVED ASSETS
The Company continually monitors events or changes in circumstances that could indicate that the carrying amount of long-lived assets to be held and used, including goodwill and intangible assets, may not be recoverable. The determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. When impairment is indicated for a long-lived asset, the amount of impairment loss is the excess of net book value over fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
INTANGIBLE AND OTHER ASSETS
Other assets consist principally of patents and trademarks related to the Company’s various technologies. Capitalized costs include amounts paid to third parties for legal fees, application fees and other direct costs incurred in the filing and prosecution of patent and trademark applications. These assets are amortized on a straight-line method over their estimated useful life of 10 years.
INCOME TAXES
Deferred tax assets and liabilities are recorded for differences between the financial statement and tax basis of the assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is recorded for the amount of income tax payable or refundable for the period increased or decreased by the change in deferred tax assets and liabilities during the period.
SALES OF STOCK BY SUBSIDIARIES
The Company records the sale of stock by a subsidiary as an equity transaction by recording minority interest, when the subsidiary is newly formed, in the development stage, has limited operating history, or when additional sales of the subsidiary’s stock are expected to fund further development activities. The Company does not record any gains on sales of stock by subsidiaries.
BASIC AND DILUTED NET LOSS PER SHARE
Basic net loss per share is based upon the weighted average number of common shares outstanding. Diluted net loss per share is based on the assumption that options, warrants, and convertible preferred stock are included in the calculation of diluted earnings per share, except when their effect would be anti-dilutive. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.
STATEMENTS OF CASH FLOWS
For purposes of the Consolidated Statements of Cash Flows, the Company considers all demand deposits and Certificates of Deposit with original maturities of 90 days or less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reported in the balance sheets for cash and cash equivalents, accounts receivable and payable, other liabilities and debt approximate fair value due to the short term nature of these items. Short term notes payable approximate fair value due to their floating interest rates.
CONCENTRATION OF CREDIT RISK
The Company has cash deposits at U.S. banks and financial institutions, which exceed federally insured limits at September 29, 2002. The Company is exposed to credit loss for amounts in excess of insured limits in the event of non-performance by the institution; however, the Company does not anticipate non-performance.
F-8
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based employee compensation as prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and has adopted the disclosure provisions of Statement of Financial Accounting Standards 123, “Accounting for Stock-based Compensation” (“SFAS 123”). SFAS 123 requires pro forma disclosures of net income and net income per share as if the fair value based method of accounting for stock-based awards had been applied. The Company accounts for stock options and warrants issued to non-employees based on the fair value method. Under the fair value based method, compensation cost is recorded based on the value of the award at the grant date and is recognized over the service period.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2001 and 2000 fiscal year financial statements to conform with the current year presentation.
RECENTLY ISSUED STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS
In June 2001, the FASB issued Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS 143), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and associated asset retirement costs. The new rules apply to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) normal operation of a long-lived asset. SFAS 143 is effective for the Company at the beginning of fiscal 2003. The Company believes the adoption of SFAS 143 will not have a material impact on its consolidated financial position or results of operations.
In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 establishes a single accounting model for the Impairment or disposal of long-lived assets, including discontinued operations. SFAS 144 superseded Statement of Financial Accounting Standards No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” (SFAS 121), and APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. The provisions of SFAS 144 are effective in fiscal years beginning after December 15, 2001, with early adoption permitted, and in general are to be applied prospectively. The Company believes the adoption of SFAS 144 will not have a material impact on its consolidated financial position or results of operations.
In April 2002, the FASB issued FAS No. 145, “Rescission of FAS Statements No. 4, 44 and 64, Amendment of FAS Statement No. 13, and Technical Corrections,” to update, clarify and simplify existing accounting pronouncements. FAS Statement No. 4, which required all gains and losses from debt extinguishment to be aggregated and, if material, classified as an extraordinary item, net of related tax effect, was rescinded. Consequently, FAS Statement No. 64, which amended FAS Statement No. 4, was rescinded because it was no longer necessary. The adoption of this statement did not have a material effect on the Company’s consolidated financial statements.
In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146), which provides financial accounting and reporting guidance for costs associated with exit or disposal activities, including one-time termination benefits, contract termination costs other than for a capital lease, and costs to consolidate facilities or relocate employees. SFAS 146 nullifies EITF Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).
Under SFAS 146, a liability for a cost associated with an exit or disposal activity should be recognized and measured initially at its fair value in the period in which the liability is incurred, except for a liability for one-time termination benefits that is incurred over time. Accounting for one-time benefits depends on whether the employee will be providing future services. In addition, a liability for costs to terminate a contract before the end of its term should be recognized and measured at its fair value at the time the entity terminates the contract in accordance with its terms. A liability for costs that will continue to be incurred under the contract for its remaining term without economic benefit to the entity should be recognized and measured at its fair value when the entity ceases to use the right conveyed by the contract. SFAS 146 is effective for exit or disposal activities initiated after December 31, 2002. The Company has not determined the impact the adoption of SFAS 146 will have on its consolidated financial position or results of operations.
Note 2—Issuance of Common Stock and Preferred Stock
On September 26, 2001, a 1-for-20 reverse split of the Company’s common stock approved by stockholders became effective. All references in these financial statements and schedules to the number of shares of common stock of the Company give effect to this reverse split.
F-9
During the first quarter of fiscal 2000, the Company sold and issued the following
unregistered securities:
On February 29, 2000, the Company issued 3,142,100 shares ofapproximately 1,570 common stock to nineteen accredited investors to satisfy the terms of a subscription units. Each unit sold during the first fiscal quarter, that was subject to shareholder approval
of amendment to the Company's Certificate of Incorporation increasing the number
of authorized shares of common stock. The purchase price of each unit was $135,
and a unit consistedconsists of the right to acquire one hundred shares of unregistered common stock of the Company, with registration rights, plus a warrant to purchase ten shares of unregistered common stock of the Company, with registration rights, at an exercise price of $2$40.00 per share. The Company received approximately $3,660,000$3.6 million in net proceeds from this transaction. In connection with the sale of these subscription units, the Company granted warrants to purchase 19,000 and 11,200 shares of common stock to agents at an exercise price of $29.80 and $40.00 per share, respectively. The issuance of common shares required the Company’s stockholders to approve an amendment to the Company’s Certificate of Incorporation increasing the number of authorized shares of common stock or be required to pay subscribers a registration incentive up to $2,120,900. The stockholders approved the amendment at the Annual Stockholder’s Meeting in February 2000. The Company issued 157,100 shares of common stock to the unit subscribers and subsequently registered these shares in March 2000 (See below). Consequently, the Company reclassified its contingent liability on common stock subscribed of $2,120,900 (recorded as of the end of the Company’s first fiscal 2000 quarter) to stockholders’ equity.
During the second quarter of fiscal 2000, the Company sold approximately 115 common stock subscription units. Each unit consists of the right to acquire one hundred shares of unregistered common stock of the Company, with registration rights, plus a warrant to purchase ten shares of unregistered common stock of the Company, with registration rights, at an exercise price of $240.00 per share. The Company received approximately $1.9 million in net proceeds from this transaction. The placement
agent retained byCompany issued 11,400 shares of common stock to the unit subscribers and subsequently registered these shares in March 2000. In connection with the sale of these subscription units, the Company granted warrants to purchase 1,100 and 100 shares of common stock to agents at an exercise price of $185.00 and $240.00 per share, respectively.
During fiscal 2000, holders of 61,200 common stock options exercised their options to purchase common stock of the Company. The net proceeds were $1,785,900. Holders of an additional 6,500 common stock options exercised their options through the sale of 1,200 shares of common stock to the Company valued at $142,400, which was recorded as treasury stock.
During fiscal 2000, the Company issued 900 and 100 shares of its common stock to vendors and consultants in exchange for services provided valued at $178,400, and capital assets valued at $13,500, respectively, based on the recorded net expenses of the retired obligations. The aggregate market value of the common stock issued was $189,500 at the time of the transactions
During fiscal 2000, the Company issued 22,200 shares of its common stock to accredited investors who had subscribed to purchase such stock during fiscal 1999. The Company received approximately $600,000 in net proceeds from this transaction.
During fiscal 2000, at the request of the preferred holders, 100 shares of Series B, 65 shares of Series C and 120 shares of Series D Preferred Stock were converted into 31,900 shares of the Company’s common stock.
In March 2000, the Company filed a registration statement, which included the resale of 21,700 unregistered shares. This registration statement included all previously unregistered shares that had been issued as of March 17, 2000. The Securities and Exchange Commission declared this registration effective in March 2000.
In July and August 2000, the Company sold approximately 198,200 shares of its unregistered common stock, with registration rights, plus warrants to purchase 99,100 shares of unregistered common stock of the Company, with registration rights, for aggregate gross proceeds of approximately $11.9 million. After expenses of the offering, net proceeds were approximately $10.9 million. In connection with this offering the Company issued 34,800 warrants to agents and investment bankers at exercise prices of $60 and $120.
During fiscal 2000 the Company entered into an Agreement and Plan of Reorganization to acquire substantially all of the assets of Research & Development Leasing, Inc. (“RDL”), a related party (Note 9), by issuance of 50,000 shares of the Company’s common stock to settle $1,000,000 of accrued royalty obligations and to terminate any further obligations under an agreement entered into in April 1980.
During fiscal 2000, the Board of Directors authorized contributions to the Employee Stock Bonus Plan, representing the annual contribution for fiscal year 2000. The contribution was made in 6,800 shares of the Company’s common stock, which have been issued to the Plan.
F-10
During fiscal 2001, holders of 150 common stock options exercised their options to purchase common stock of the Company by canceling their options to purchase 350 shares of common stock of the Company having an aggregate exercise price of $14,400 in a cashless exercise. Additionally, holders of 9,450 common stock options exercised their options to purchase common stock of the Company, which resulted in net proceeds of $218,400.
In January 2001, the Company sold 11,875 common stock Units to investors in a private placement. Each common stock Unit consists of three shares of common stock of the Company, plus one two-year Warrant to purchase twenty shares of common stock of Silicon Film at $4.00 per share. The private placement generated net proceeds of $1,306,350.
In April 2001, the Company filed a registration statement using a shelf registration process. This registration statement included the resale of all previously unregistered shares and unregistered shares sold subsequent to May 2001, covered by supplements to the S-3 up to an aggregate amount of $100,000,000. The Securities and Exchange Commission declared this registration statement effective in April 2001.
In May 2001, the Company sold 32,600 shares of common stock of the Company to investors in an offering pursuant to the shelf registration, which generated net proceeds of $624,800. In connection with the sale of these shares, the Company granted warrants to purchase 1,600 shares of common stock to agents at an exercise price of $24.60 per share.
In June 2001, the Company sold 123,100 common stock Units to investors in another offering pursuant to its shelf registration. Each common stock Unit consists of one share of common stock of the Company, plus one four-year warrant to purchase one share of common stock of the Company at an exercise price of $27.00 per share. In connection with the sale of these common stock Units, the Company granted warrants to purchase 12,300 shares of common stock to agents at an exercise price of $27.00 per share. The shelf offering generated net proceeds of $1,520,000.
In June 2001, the Company sold 70,800 common stock Units to investors in another offering pursuant to its shelf registration. Each common stock Unit consists of one share of common stock of the Company, plus one five-year warrant to purchase twenty shares of common stock of iNetWorks at an exercise price of $1.00 per share. In connection with the sale of these common stock Units, the Company granted 3,125 Finders’ Warrants to agents, each representing the right to purchase one share of the Company’s common stock and twenty shares of iNetWorks’ common stock at an exercise price of $27.00 and $1.00 per share, respectively. The shelf offering generated net proceeds of $790,500. The warrants to purchase the iNetworks common stock were not registered on the shelf.
In July 2001, the Company sold 173,300 common stock Units to investors in another offering pursuant to its shelf registration. Each common stock Unit consists of one share of common stock of the Company, plus one five-year warrant to purchase forty shares of common stock of iNetWorks at an exercise price of $1.00 per share. The shelf offering generated net proceeds of $1,635,600. The warrants to purchase the iNetworks common stock were not registered on the shelf.
In September 2001, the Company sold 167,700 shares of common stock of the Company to employees under the 2001 Compensation Plan (See Note 6 – Compensation Plan) to settle compensation and consulting invoices of $293,100, net of expenses. No sales were made to any executive officers under the Plan. These transactions were made at an aggregate discount of approximately $25,400, or 7.9%, from market prices on the dates of subscription. In conjunction with some of the transactions, the Company concurrently made advances to employees in the aggregate amount of $216,900 at September 30, 2001. These advances were substantially repaid in October 2001. During fiscal 2001, the Company issued 10,900 shares of common stock to consultants for services provided, valued at $151,900 based on invoices and service agreements with the providers. The aggregate market value of the common stock issued in settlement of these obligations was $93,660 at the time of the transactions.
During fiscal 2001, the Board of Directors authorized contributions to the Employee Stock Bonus Plan, representing the annual contribution for fiscal year 2001. The contribution was made in 232,200 shares of the Company’s common stock, which have been issued to the Plan.
During fiscal 2002, the Company issued an aggregate of 3,722,700 shares of common stock in various transactions. Of this amount, 1,738,600 shares were issued for cash, realizing aggregate proceeds of $2,339,500, and 1,984,100 were issued to settle operating expenses of the Company aggregating $2,521,400. These transactions are separately discussed below.
F-11
The Company issued 960,000 shares for cash in fiscal 2002 in two placements pursuant to the Company’s shelf registration statement that was declared effective in May 2001 and that expired December 30, 2001. In the first of these two shelf placements, the Company sold 300,000 common stock units to investors, generating net proceeds of $300,000. Each common stock unit consisted of (a) one share of common stock of the Company, (b) one five-year warrant to purchase one share of common stock of the Company at an exercise price of $2.19 per share, and (c) one five-year warrant to purchase one share of common stock of iNetWorks Corporation, a subsidiary of the Company, at an exercise price of $0.10 per share. In the second of these two shelf placements, the Company issued 660,000 shares of common stock to investors generating net proceeds of $817,000.
An additional 700,000 unregistered shares of common stock were issued for cash in fiscal 2002 to accredited investors in a private placement, generating net proceeds of $1,129,000. In addition to the shares of common stock, investors in this private placement also received three-year warrants to purchase 210,000 shares of common stock of the Company at an exercise price of $2.34 per share and three-year warrants to purchase 70,000 shares of common stock of iNetWorks common stock at an exercise price of $0.25 per share. Also during fiscal 2002, an aggregate of 73,500 shares were issued for cash pursuant to the exercise of stock options, realizing net proceeds of $84,600. An additional 5,000 shares were issued for cash in fiscal 2002, realizing net proceeds of $8,900, as a result of a sale of shares to a consultant of the Company pursuant to the Company’s 2001 Compensation Plan.
Of the 1,984,100 shares of common stock issued in fiscal 2002 to settle operating expenses of the Company, 198,500 shares were issued to two creditors in consideration for the cancellation and retirement of $216,500 of existing indebtedness of the Company. These shares were issued pursuant to the Company’s shelf registration statement that was declared effective in May 2001. The Company issued 4,000 unregistered shares of its common stock in fiscal 2002 as the non-cash portion of a settlement agreement of a dispute in the amount of $4,600 related to the Company’s guarantee of a $180,000 obligation of a former subsidiary. The Company also issued 278,700 unregistered shares of its common stock to a corporate investor for the cancellation and retirement of $500,000 of existing accounts payable of iNetWorks.
During fiscal 2002, the Company issued an aggregate of 931,200 shares of its common stock pursuant to the Company’s 2001 Compensation Plan for the cancellation of $1,090,300 of payroll and consulting expense obligations of the Company. This consisted of (a) 881,100 shares issued to employees of the Company in consideration for the cancellation of $1,034,900 of compensation obligations and (b) 50,100 shares of common stock to consultants in consideration for the cancellation of $55,400 of existing accounts payable. (See Note 6).
During fiscal 2002, the Company issued 571,700 shares of common stock to the Company’s retirement plan as a non-cash contribution of $710,000 for fiscal year 2002. (See Note 14).
The following is a summary by category of aggregate equity transactions in fiscal 2002 that involved the issuance of common stock.
| | | Common stock shares issued
| | Increase in Stockholders’ Equity
|
Balance at September 30, 2001 | | | | 3,305,300 | | | | | | |
| Shelf registration placements | | 960,000 | | | | $ | 1,117,000 | | | |
| Private placement | | 700,000 | | | | $ | 1,129,000 | | | |
| Common stock options exercised for cash | | 73,600 | | | | $ | 84,600 | | | |
| Sales to consultant under 2001 Compensation Plan | | 5,000 | | | | $ | 8,900 | | | |
| | |
| | | |
|
| | | |
| Sale of common stock and common stock units for cash | | | | 1,738,600 | | | | | $ | 2,339,500 |
| Issuance to employees under 2001 Compensation Plan | | 881,100 | | | | $ | 1,034,900 | | | |
| Issuance to consultants under 2001 Compensation Plan | | 50,100 | | | | $ | 55,400 | | | |
| Cancellation of subsidiary payable | | 278,700 | | | | $ | 500,000 | | | |
| Cancellation of creditors payables | | 198,500 | | | | $ | 216,500 | | | |
| Settlement of disputed subsidiary debt guarantee | | 4,000 | | | | $ | 4,600 | | | |
| Issuance to employee retirement plan | | 571,700 | | | | | 710,000 | | | |
| | |
| | | |
|
| | | |
| Non-cash issuance of common stock to pay operating expenses | | | | 1,984,100 | | | | | $ | 2,521,400 |
| | | | |
| | | | |
|
|
| Total for fiscal 2002 | | | | 3,722,700 | | | | | $ | 4,860,900 |
Balance at September 29, 2002 | | | | 7,028,000 | | | | | | |
F-12
Note 3—Common Stock Warrants
During fiscal 2000, the Company granted warrants to purchase 750 and 1,250 shares of the Company’s common stock at an exercise price of $30 per share to individuals for services provided. The value of these warrants was not material.
During fiscal 2000, the Company granted five-year warrants to purchase 1,400 shares of the Company’s common stock at an exercise price of $30 per share to a leasing company in connection with equipment financing. Due to the size of the transaction, no compensation expense was recorded for the issuance of the warrants.
In connection with the sale of common stock subscription units in the first and second quarters of fiscal 2000, the Company granted warrants to purchase 48,300 shares of common stock to investors and agents, respectively at exercise prices of $29.80 to $240.00 per share.
In connection with the sale of common stock in July and August of fiscal 2000, the Company granted warrants to purchase 99,100, 19,800 and 15,000 shares of common stock to investors, agents and investment bankers, respectively at exercise prices of $50.00, $60.00 and $120.00 per share, respectively.
Warrants to purchase 22,500 shares of the Company’s common stock were exercised during fiscal 2000 and generated net proceeds of $644,200.
Warrants to purchase 2,750 shares of the Company’s common stock expired during fiscal 2000.
In November 2000, the Company granted warrants to purchase 25,000 shares of the Company’s common stock at an exercise price of $42.20 per share to non-employees for services rendered and as incentives. Two of the recipients were directors of the Company and two provided legal and other consulting services to the Company. The value of the warrants of $865,000 was calculated using the Black-Scholes valuation model, and was recorded as an expense.
Warrants to purchase 117,700 shares of the Company’s common stock were exercised during fiscal 2001, and generated net proceeds of $2,807,400. Warrants to purchase 2,250 shares of the Company’s common stock expired during fiscal 2001.
Warrants to purchase 140,600 shares of the Company’s common stock were granted to investors and agents during the first three quarters of fiscal 2001 in connection with the issuance of common stock as described in Note 2 – Issuance of Common and Preferred Stock.
In March 2002 and April 2002, the Company borrowed $200,000 pursuant to three promissory notes originally payable in May 2002 and June 2002 from three investors, one of whom is a director of the Company. The promissory notes bore no interest, but were partially secured by receivables pursuant to a specific contract. The due date of one note, with a $50,000 principal value, was extended to July 2002, at which time it was retired. In June 2002, the due dates of the other two notes, with aggregate principal value of $150,000, were extended to September 30, 2002, at which time they were paid off. In consideration of the issuance of the notes, investors initially received warrants to purchase 224,014 units identicalan aggregate of 100,000 shares of the Company’s common stock at an exercise price of $1.20 per share, and the investors holding the promissory notes that were extended received warrants to purchase an additional 40,000 shares of the Company’s common stock at an exercise price of $2.40 per share The initial warrants to purchase 100,000 shares are exercisable nine months from issuance of the promissory notes, have a term of nine months thereafter and are callable by the Company if the stock issuable from the warrants has been registered and the Company’s stock has traded over $2.00 per share for ten consecutive trading days. The warrants issued for extension of the promissory notes to purchase 40,000 shares are exercisable nine months from extension of the promissory notes, have a term of nine months thereafter and are callable by the Company if the stock issuable from the warrants has been registered and the Company’s stock has traded over $4.00 per share for ten consecutive trading days. The $51,000 fair value of the warrants was recorded as a discount to the related notes payable, and was amortized over the term of the notes as interest expense in the consolidated statements of operations. Taking into account this non-cash amortization expense, the effective interest rate of the promissory notes was 126%.
During fiscal 2002, the Company issued warrants to purchase 510,000 shares of the Company’s common stock in connection with various sales of common stock. In connection with these transactions, the Company also issued warrants to purchase 223,000 shares of common stock to consultants who introduced the Company to investors participating in these transactions. (See Note 2).
F-13
As of September 29, 2002, there were a total of 1,094,800 warrants outstanding, with exercise prices ranging from $1.20 to $240.00, of which 165,000 expire in the year 2003, 1,600 expire in the year 2004, 487,800 expire in the year 2005, and 440,400 expire in the year 2006.
Note 4—Series B and Series C Convertible Preferred Stock
The shares of Series B and Series C Convertible Cumulative Preferred Stock, which were originally issued to the Company’s Employee Retirement Plan, each bear a 10 % cumulative annual dividend, which under Delaware law may generally be paid only out of (i) retained earnings or (ii) net profit in the current or preceding fiscal year. To the extent that the dividends are not declared and paid in any fiscal year, the obligation carries over to the next fiscal year. These shares of Series B and Series C Convertible Cumulative Preferred Stock are not redeemable, carry a liquidation preference over the common stock of $15.00 and $30.00, respectively, per share and are convertible, at the option of the holder, into 2.5 shares of common stock for each share of Series B and Series C Convertible Cumulative Preferred Stock, respectively. Distributions of vested benefits made from the Plan to former employees and the subsequent surrender and conversion into shares of common stock are as follows:
| | | Series B Preferred Stock
| | Series C Preferred Stock
| | Common Stock
|
| Distribution dates: |
| Fiscal 2000 | | 2,000 | | 1,300 | | 165,100 |
| Fiscal 2001 | | — | | — | | — |
| Fiscal 2002 | | — | | — | | — |
The shares of Preferred Series B and Series C tendered for conversion have been retired. Undeclared dividends of $78,200 and $81,000 on the remaining outstanding Preferred Series B and Series C, respectively, will be carried forward to fiscal 2003. The Company has not accrued these dividends due to the accumulated deficit and historical losses.
Note 5—Series D Convertible Preferred Stock Units
In connection with a Series D Convertible Preferred Stock Unit private placement in fiscal 1998, the Company granted to the placement agent warrants to purchase up to 3,775 units purchasedof Series D Convertible Preferred Stock units (“Agent Warrants”) at a price of $110 per unit, which was 110% of the private placement price of the Units. The Series D Convertible Preferred Stock units consisted of one share of Convertible Preferred Stock, plus one five-year warrant to purchase one share of common stock of Novalog, Inc., and one five-year warrant to purchase one share of common stock of MSI. Each share of Convertible Preferred Stock was convertible into common stock of the Company at the rate of five shares of common stock for each share of Preferred D. Agent warrants to purchase 1,900 units were exercised during fiscal 2000, which resulted in the issuance of 9,500 shares of common stock of the Company. The Company realized proceeds of $209,000 from this exercise. There are no further shares of Series D Convertible Preferred Stock issued or issuable pursuant to warrants.
Note 6—Compensation Plan
In September 2001, the Board of Directors adopted the 2001 Compensation Plan. Under this compensation plan, employees and consultants may elect to receive shares of common stock of the Company in lieu of the same amount of cash compensation for services previously rendered. The Board of Directors may determine to issue shares at a discount not to exceed 15% from their fair market value. During fiscal 2002, employees and consultants elected to receive 931,200 shares of common stock in exchange for a reduction in compensation and invoices of $1,090,300. During fiscal 2001, employees and consultants elected to receive 167,700 shares of common stock in exchange for a reduction in compensation and invoices of $293,100. (see Note 2)
Note 7—Minority Interest in Subsidiaries
The Company sold Series D Convertible Preferred Stock Units in a private placement to certain accredited investors in December 1997 and January 1998. During the second quarter of fiscal 2000, holders of 125,000 shares of Series D Convertible Preferred Stock Units exercised warrants attached to the Units to purchase 125,000 shares of common stock of MSI at $1.00 per share. The net proceeds of $125,000 were added to the Company’s general funds and are reflected in the consolidated cash position of the Company. The transaction resulted in an increase in minority interest in consolidated subsidiaries of $125,000. The Company’s ownership percentage of MSI was 100% and 98.5% before and after the exercise of the MSI warrants, respectively.
F-14
MSI granted 0, 1,204,700 and 553,500 options to purchase common shares of MSI stock to employees, officers and directors in fiscal years 2002, 2001 and 2000, respectively. The 2001 and 2000 options were granted at exercise prices of $0.50 and $0.70, respectively. The exercise price equaled the estimated fair market value of MSI’s common stock at the date of grant, and there was no compensation expense recorded related to the grant of these options. MSI’s Board of Directors estimated the fair market value of its common stock based on a variety of factors, including past and contemplated third party financings, if any. As of September 29, 2002, there were 1,061,100 MSI options outstanding, with a weighted average exercise price of $0.70 and a weighted average remaining life of 2.04 years. If the Company had elected to use the fair value approach using the Black-Scholes option-pricing model to account for these stock options, the Company would have recorded compensation expense of $0, $14,100 and $5,900 in fiscal years 2002, 2001 and 2000. Assumptions of no dividend yield, risk-free interest rate of 5%, an expected lives of three and four years, and a volatility rate of 0% were applied to the MSI options granted during fiscal years 2002, 2001 and 2000.
Novalog granted 0, 303,000, and 200,000 options to purchase common shares of Novalog stock to employees, officers and directors in fiscal years 2002, 2001 and 2000, respectively. The 2001 and 2000 options were granted at exercise prices of $1.00 and $1.40, respectively. The exercise price equaled the estimated fair market value of Novalog’s common stock at the date of grant, and there was no compensation expense recorded related to the grant of these options. Novalog’s Board of Directors estimated the fair market value of its common stock based on a variety of factors, including past and contemplated third party financings, if any. As of September 29, 2002, there were 1,087,900 Novalog options outstanding, with a weighted average exercise price of $1.22 and a weighted average remaining life of 1.63 years. If the Company had elected to use the fair value approach using the Black-Scholes option-pricing model to account for these stock options, the Company would have recorded compensation expense of $0, $76,800 and $65,800 in fiscal years 2002, 2001 and 2000, respectively. Assumptions of no dividend yield, risk-free interest rates ranging from 4.5% to 5%, an expected life of five years, and a volatility rate of 0% were applied to the Novalog options granted during fiscal years 2001 and 2000.
During fiscal 2000, Silicon Film issued shares of its common and preferred stock to certain existing stockholders for aggregate net proceeds of approximately $6.2 million, which resulted in a corresponding increase in minority interest in consolidated subsidiaries.
During fiscal 2001, RedHawk sold 1,650,000 shares of its common stock to third parties. The net proceeds of $575,000 from this transaction are reflected in the consolidated cash position of the Company and resulted in a corresponding increase in minority interest in consolidated subsidiaries. Also during fiscal 2001, warrants to purchase 507,000 shares of RedHawk’s common stock were exercised and generated net proceeds of $5,700. The Company’s ownership percentage of RedHawk was 100% and 70% before and after these RedHawk equity transactions, respectively.
Redhawk granted options to purchase 0, 325,700 and 1,515,000 common shares of Redhawk stock to employees, officers and directors in fiscal years 2002, 2001, and 2000, respectively. The 2001 and 2000 options were granted at exercise prices of $0.10 and $0.50, respectively. The exercise price equaled the estimated fair market value of Redhawk’s common stock at the date of grant, and there was no compensation expense recorded related to the grant of these options. Redhawk’s Board of Directors estimated the fair market value of its common stock based on a variety of factors, including past and contemplated third party financings, if any. As of September 29, 2002, there were 1,475,100 RedHawk options outstanding with a weighted average exercise price of $0.16 and a weighted average remaining life of 2.77 years. If the Company had elected to use the fair value approach using the Black-Scholes option-pricing model to account for these stock options, the Company would have recorded compensation expense of $0, $10,500 and $900 in fiscal years 2002, 2001 and 2000, respectively. Assumptions of no dividend yield, risk-free interest rate of 5%, expected lives of three and five years, and a volatility rate of 0% were applied to the RedHawk options granted during fiscal years 2001 and 2000.
iNetworks granted options to purchase 7,312,500 and 6,101,700 common shares of iNetworks stock to employees, officers and directors in fiscal years 2002 and 2001, respectively. The options were granted at an exercise price of $0.01 and $0.10, respectively. The exercise price equaled the estimated fair market value of iNetworks common stock at the date of grant, and there was no compensation expense recorded related to the grant of these options. iNetWorks’ Board of Directors estimated the fair market value of its common stock based on a variety of factors, including contemplated third party financings, if any. As of September 29, 2002, there were 12,425,600 iNetWorks options outstanding with a weighted average exercise price of $0.05 and a weighted average remaining life of 9.33 years. If the Company had elected to use the fair value approach using the Black-Scholes option-pricing model to account for these stock options, the Company would have recorded compensation expense of $8,800 and $5,100 in fiscal years 2002 and 2001, respectively. Assumptions of no dividend yield, risk-free
F-15
interest rate of 5%, an expected life of ten years, and a volatility rate of 0% were applied to the iNetWorks options granted during fiscal years 2002 and 2001.
During fiscal 2001, holders of 893,000 iNetWorks common stock options exercised their options to purchase common stock of iNetWorks, which resulted in net proceeds of $89,300. The proceeds from these exercises of iNetWorks stock options resulted in an increase in minority interest in consolidated subsidiaries. In addition, iNetWorks executed a technology licensing agreement and issued approximately 606,100 shares of its common stock as consideration for the license. The Company’s ownership percentage of iNetWorks was 100% and 95% before and after these option exercises and licensing transaction, respectively.
Note 8 – Discontinued Operations
In September 2001, Silicon Film suspended operations and terminated all of its employees in contemplation of liquidation through bankruptcy proceedings. Silicon Film completed its filing for protection under Chapter 7 of the U.S. Bankruptcy Code in October 2001. Consequently, the accompanying Consolidated Financial Statements reflect Silicon Film as discontinued operations in accordance with Accounting Principles Board Opinion No, 30 “Reporting the results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (“APB 30”). The financial position, results of operations and cash flows of Silicon Film’s business have been classified as discontinued for all periods presented. During 2001 the Company recognized a gain on the disposal of Silicon Film of $5.6 million, which includes an accrual of $200,000 for expenses related to the liquidation of Silicon Film.
During fiscal 2000, the Company recorded a cumulative dividend obligation of $300,400 on Silicon Film’s Series C preferred stock pending the satisfaction of future requirements with respect to earnings and liquidity. In connection with Silicon Film’s bankruptcy, the accrued dividend obligation was reversed in fiscal 2001.
During fiscal 2002, the Company recovered $35,000 from final discharge of the bankruptcy estate of Silicon Film. Silicon Film reported no material revenue during fiscal years 2002, 2001 and 2000.
Notes to these consolidated financial statements reflect the Company’s presentation of discontinued operations. Generally, information in the notes has been restated where amounts were included in net earnings from, or net investment in, discontinued operations.
Note 9—Related Party Transactions
In April 1980, the Company entered into an agreement with R & D Leasing Ltd. (“RDL”), a limited partnership in which the Company’s Chairman of the Board and a Senior Vice-President are general partners with beneficial interests, to develop certain processes and technology related to chip stacking. The Company has exclusively licensed this technology from RDL. The Company’s exclusive rights to the technology extend to all uses, both government and commercial. Since entering into the licensing agreement, the Company had accrued royalty obligations to RDL at the rate of 3.5% of all Company sales of chip stacks using the licensed technology. In October 1989, when the Company’s common stock had a market price of approximately $3.15 per share (giving effect to the 1-for-20 reverse stock split effective September 2001), RDL agreed to defer its royalty claims and subordinate them with respect to all other creditors in exchange for the option to purchase up to 50,000 shares of the Company’s common stock (as adjusted to give effect to the 1-for-20 stock split effective September 2001) at $20 per share, exercisable by applying the investors, exercisable at
$148.50.
Ondeferred royalties to the purchase. As of March 15, 2000, the Company sold 228,851 units,entered into an Agreement and Plan of Reorganization to acquire substantially all of the assets of Research & Development Leasing, Inc. (“RDL”) in exchange for 50,000 shares of the Company’s voting common stock. Prior to March 15, 2000, the Company had been accruing obligations to RDL for a license to exclusive rights to certain processes and technology related to chip stacking. By consummating the Agreement and Plan of Reorganization to acquire RDL’s assets in fiscal 2000, including its patents and technology, the Company settled $1,000,000 of accrued royalty obligations and terminated its obligation for any further licensing payments to RDL. The Company’s Chairman of the Board and a Senior Vice President were the sole stockholders of RDL prior to the Company’s acquisition of RDL’s assets.
The Company has entered into an Assignment of Patent and Intellectual Rights (the “Assignment”) with F. K. Eide (“Eide”), a Vice-President of the Company. As part of his employment agreement, Eide has assigned to the Company all rights and interests to five (5) U.S. Provisional Patent applications owned by him. In consideration for this Assignment, Eide will receive a 1% royalty on the gross sales revenues of any products incorporating elements of the assigned technology for the lifetime of any patents resulting from the Provisional Patent Applications. This Assignment was executed in February 1998.
F-16
In July 1997, the Company entered into a sale and licensing of intellectual property rights agreement with Advanced Technology Products, LLC (“ATPL”). Under this agreement, the Company received funding over the following twelve months aggregating approximately $1.5 million for the development of two technologies, the Electronic Film System™, which was subsequently to become the core technology conveyed to Silicon Film and a vector image processing technology related to the Company’s government business. As a result of this agreement, ATPL purchased the intellectual property rights related to these technologies and exclusively licensed said rights back to the Company in consideration of royalties on any future sales of products incorporating the technologies, at royalty rates starting at 15% and declining to 1.5% with volume. The Company paid no cash consideration for this license. The Company’s then Senior Vice President and Chief Technical Officer and current President, John C. Carson, serves as Managing Member of ATPL. Mr. Carson’s ownership position is less than 0.2% of ATPL. Mr. Carson’s wife, a former director of the Company, has an approximate 3.5% ownership position in ATPL. In September 1998 the Company granted Silicon Film a license to use the technology and intellectual property rights of the Company then deemed necessary to Silicon Film’s business, including the technology licensed pursuant to the ATPL agreement. As a result of this grant, Silicon Film became the successor to the licensed rights and future royalty obligations of the ATPL agreement as they pertained to the electronic film technology. In September 1998, another agreement was consummated with ATPL under which the future royalty obligation associated with the electronic film technology was reduced approximately 86% in consideration for the issuance of 228,851 unregistered1,222,125 shares of Silicon Film common stockstock. No value was recorded by Silicon Film as a result of this transaction due to the uncertainty related to valuing either the consideration given or received in this exchange.
Note 10—Composition of Certain Financial Statement Captions
| | | September 29, 2002
| | | September 30, 2001
| |
| Accounts receivable: | | | | | | | | |
| U.S. government | | $ | 1,567,500 | | | $ | 1,914,600 | |
| Other customers | | | 1,095,200 | | | | 829,000 | |
| | |
|
|
| |
|
|
|
| | | | 2,662,700 | | | | 2,743,600 | |
| Less allowance for doubtful accounts | | | (76,300 | ) | | | (57,700 | ) |
| | |
|
|
| |
|
|
|
| | | $ | 2,586,400 | | | $ | 2,685,900 | |
| | |
|
|
| |
|
|
|
Accounts receivable include unbilled amounts of $476,700 and warrants$543,900 at September 29, 2002 and September 30, 2001, respectively. Unbilled amounts represent contract revenues for which billings have not been presented to purchase
an additional 22,885 shares (exercisablecustomers at $12) to three accredited investorsyear-end. These amounts are billed in accordance with applicable contract terms, usually within 30 days. Included in these amounts are unbilled retentions of $64,900 and $136,200 at September 29, 2002 and September 30, 2001, respectively. The purchase price was $9.25 per unit, and the Company's net proceeds were
approximately $1,900,000. The placement agent retainedunbilled retentions are normally collected upon final audit of costs by the U.S. government.
| | | September 29, 2002
| | | September 30, 2001
| |
| Inventory: | | | | | | | | |
| Work in process | | $ | 9,414,100 | | | $ | 9,076,200 | |
| Finished goods | | | 50,300 | | | | 221,500 | |
| | |
|
|
| |
|
|
|
| | | | 9,464,400 | | | | 9,297,700 | |
| Less reserve for obsolete inventory | | | (8,526,400 | ) | | | (8,183,500 | ) |
| | |
|
|
| |
|
|
|
| | | $ | 938,000 | | | $ | 1,114,200 | |
| | |
|
|
| |
|
|
|
Title to all inventories remains with the Company. Inventoried materials and costs relate to work in process on customers’ orders and on the Company’s generic module parts and memory stacks, which the Company anticipates it will sell to customers including potential R&D contracts. Work in process includes amounts that may be sold as products or under contracts. Such inventoried costs are stated generally at the total of the direct production costs including overhead. Inventory valuations do not include general and administrative expenses. Inventories are reviewed quarterly to determine salability and obsolescence.
F-17
Costs on long-term contracts and programs in progress represent recoverable costs incurred. ATD’s marketing involves the identification and pursuit of specific government budgets and programs. ATD is frequently involved in the pursuit of a specific anticipated contract that is a follow-on or related to an existing contract. ATD often determines that it is probable that a subsequent award will be successfully received, particularly if ATD can demonstrate continued progress against anticipated technical goals of the projected new program while the government goes through its lengthy process required to allocate funds and award contracts. Accordingly, ATD from time-to-time capitalizes material, labor and overhead costs expected to be recovered from a probable new contract. Due to the uncertain timing of ATD being awarded a contract, the Company maintains significant reserves for this offering received warrantsinventory to purchase 22,885 units identicalavoid overstating its value.
| | | September 29, 2002
| | | September 30, 2001
| |
| Equipment, furniture and fixtures: | | | | | | | | |
| Engineering and production equipment | | $ | 9,522,200 | | | $ | 9,066,200 | |
| Furniture and fixtures | | | 323,200 | | | | 334,400 | |
| Construction in progress | | | 1,488,100 | | | | 1,697,100 | |
| Computer software programs | | | 1,400,800 | | | | 1,660,400 | |
| Leasehold improvements | | | 1,436,200 | | | | 1,278,750 | |
| | |
|
|
| |
|
|
|
| | | | 14,170,500 | | | | 14,036,850 | |
| Less accumulated depreciation and amortization | | | (9,211,300 | ) | | | (8,494,150 | ) |
| | |
|
|
| |
|
|
|
| | | $ | 4,959,200 | | | $ | 5,542,700 | |
| | |
|
|
| |
|
|
|
Construction in progress is primarily related to improvements to the units
purchased by the investors, exercisableCompany’s clean rooms and related equipment, a substantial portion of which is expected to be placed in service in fiscal 2003 at $10.175.
On July 21, 2000,which time the Company sold 2,033,334 units, resultingwill begin depreciation of these assets based upon their estimated useful life.
| | | September 29, 2002
| | September 30, 2001
|
| Other assets: | | | | | | |
| Patents and trademarks | | $ | 694,200 | | $ | 525,750 |
| Less accumulated amortization | | | 113,600 | | | 53,300 |
| | |
|
| |
|
|
| Patents and trademarks, net | | | 580,600 | | | 472,450 |
| Deposits | | | 98,450 | | | 102,300 |
| | |
|
| |
|
|
| | | $ | 679,050 | | $ | 574,750 |
| | |
|
| |
|
|
| | | | | | | |
| | | September 29, 2002
| | September 30, 2001
|
| Accrued expenses: | | | | | | |
| Salaries and wages | | $ | 476,400 | | $ | 774,200 |
| Vacation | | | 288,300 | | | 342,000 |
| Payroll taxes | | | 90,300 | | | 371,300 |
| Non-qualified retirement plan contribution | | | 110,000 | | | — |
| Silicon Film (discontinued) accrual | | | 100,000 | | | 200,000 |
| Other accrued expenses | | | 140,400 | | | 77,100 |
| | |
|
| |
|
|
| | | $ | 1,205,400 | | $ | 1,764,600 |
| | |
|
| |
|
|
F-18
Note 11—Commitments and Contingencies
The Company leases certain facilities and equipment under cancelable and noncancelable capital and operating leases. Future minimum payments under capital lease obligations and operating lease commitments with initial terms in
the
issuance of 2,033,334 unregistered shares of common stock and warrants to
purchase an additional 1,016,667 shares (exercisable at $2.50) to six accredited
investors. The purchase price was
16
$3.00 per unit, and the Company's net proceeds were approximately $5,648,000.
The placement agent retained by the Company for this offering received warrants
to purchase 203,334 units identical to the units purchased by the investors,
exercisable at $3.00.
Between August 2 and August 17, 2000, the Company issued and sold 1,930,665
unregistered shares of common stock and warrants to purchase an additional
965,333 shares (exercisable at $2.50) to ten accredited investors. The purchase
price was $3.00 per unit, and the Company's net proceeds were approximately
$5,261,000. The placement agents retained by the Company for this offering
received warrants to purchase 193,067 units consistingexcess of one shareyear at September 29, 2002 are as follows: Fiscal Year
| | Capital Leases
| | | Operating Leases
|
| 2003 | | $ | 132,800 | | | $ | 747,200 |
| 2004 | | | 40,600 | | | | 721,400 |
| 2005 | | | 26,100 | | | | 350,600 |
| 2006 | | | 13,100 | | | | 360,100 |
| 2007 | | | — | | | | 11,900 |
| Thereafter | | | — | | | | — |
| | |
|
|
| |
|
|
| Future minimum lease payments | | | 212,600 | | | $ | 2,191,200 |
| | | | | | |
|
|
| Amounts representing interest | | | (34,400 | ) | | | |
| | |
|
|
| | | |
| Present value of net minimum lease payments | | | 178,200 | | | | |
| Less current portion | | | (116,900 | ) | | | |
| | |
|
|
| | | |
| | | $ | 61,300 | | | | |
| | |
|
|
| | | |
Total rental expense for operating leases amounted to $694,900, $611,700 and one-half
warrant, exercisable at $3.00.
The issuances of the securities described in the previous four paragraphs
were deemed to be exempt from registration under the Securities Act of 1933, as
amended (the "Act"), in reliance on Section 4(2) of the Act as transactions by
an issuer not involving any public offering. In addition, the recipients of
securities in the above transactions each represented its intention to acquire
the securities for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends were affixed to
the share certificates issued in that transaction. The recipients each were
given access to information about the Company.
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and Notes thereto and
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other financial data included elsewhere in this 10-K filing. The
consolidated statement of operations data for the fiscal years ended October 1,
2000, October 3, 1999 and September 27, 1998 and the consolidated balance sheet
data at October 1, 2000 and October 3, 1999 are derived from audited
consolidated financial statements incorporated by reference in this 10-K filing.
The consolidated statement of operations data$582,000 for the fiscal years ended September 28, 199729, 2002, September 30, 2001 and October 1, 2000, respectively.
At September 29, 2002, the Company’s Novalog subsidiary had outstanding purchase orders with a major supplier that involve pricing discounts contingent on meeting volume purchase commitments. If Novalog does not meet these volume commitments or is not able to renegotiate the terms of these purchase orders, it may incur additional costs of up to $120,000 in fiscal 2003 on deliveries taken under these purchase orders.
Litigation
In October 2001, the Company was named as a defendant in a lawsuit involving a disputed guarantee of the facility lease of its former Silicon Film subsidiary. In September 2002, the Company entered into a settlement agreement with the plaintiff in this lawsuit for a monetary amount within the amount that had been reserved at September 30, 2001 for expenses associated with the Silicon Film bankruptcy. In October 2002, the lawsuit was dismissed.
The Company is a defendant in a class action lawsuit relating to the history of disclosures made by Silicon Film and the Company. There has been no discovery to date and no trial has yet been scheduled, although the Company has filed a motion to dismiss this lawsuit. If the Company does not ultimately obtain a favorable resolution of the claims set forth in this action, such an outcome could have a material adverse effect on the Company’s business, results of operations and financial condition. Currently, the amount of such material adverse effect cannot reasonably be estimated.
Note 12 – Line of Credit
At September 29, 2002, the Company’s Novalog subsidiary had a line of credit with a bank in the maximum amount of $400,000. Borrowings outstanding under the line of credit at September 29, 2002 and September 29, 1996,30, 2001 were $400,000. The line of credit was collateralized by a $400,000 certificate of deposit which is included in Restricted Cash on the accompanying consolidated balance sheets. Advances against the line of credit bore interest at the prime rate. The certificate of deposit was liquidated, and the line of credit was paid off and cancelled in October 2002.
F-19
Note 13—Income Taxes
The tax effect of significant temporary items comprising the Company’s deferred taxes as of September 29, 2002 and September 30, 2001, are as follows:
| | | September 29, 2002
| | | September 30, 2001
| |
| Current deferred tax assets: | | | | | | | | |
| Reserves not currently deductible | | $ | 150,000 | | | $ | 120,000 | |
|
| Long-term deferred tax assets: | | | | | | | | |
| Operating loss carryforwards | | | 33,082,000 | | | | 29,483,000 | |
| Tax credit carryforwards | | | 2,070,000 | | | | 1,522,000 | |
| Valuation allowance | | | (35,152,000 | ) | | | (31,125,000 | ) |
| | |
|
|
| |
|
|
|
| Net deferred tax asset | | $ | — | | | $ | — | |
| | |
|
|
| |
|
|
|
The differences between the Company’s effective income tax rate and the statutory U.S. federal income tax rate for the fiscal years ended September 29, 2002, September 30, 2001 and October 1, 2000, respectively, related primarily to the total valuation allowance changing $4,027,000 from September 30, 2001 to September 29, 2002 and $7,297,000 from October 1, 2000 to September 30, 2001.
The provision for income taxes for the fiscal years ended September 29, 2002, September 30, 2001 and October 1, 2000, consist of provisions for state franchise taxes of $37,500, $4,000 and $2,400, respectively. No provisions for federal income taxes have been made in these fiscal years due to the net operating losses.
At September 29, 2002, the Company had net operating loss carryforwards of approximately $92,646,000 for financial reporting and federal income tax purposes expiring in varying amounts from fiscal year 2003 through fiscal year 2022, and $27,146,000 for California tax purposes expiring in varying amounts from fiscal year 2003 through fiscal year 2012, available to offset future federal and California taxable income. In addition, as of September 29, 2002, the Company had investment tax credits and qualified research credits of $488,000 and $1,587,000, respectively, expiring in varying amounts through fiscal year 2022 and available to offset future federal taxes. The ability of the Company to utilize the net operating loss and credit carryforwards may be restricted by certain provisions of the Internal Revenue Code due to changes in ownership of the Company’s common stock.
Note 14—Stock Option Plans and Employee Retirement Plan
In December 1991, the Board of Directors adopted the 1991 Stock Option Plan to replace the 1981 Stock Option Plan, which had expired. The 1991 Stock Option Plan was approved by stockholders at the Company’s Annual Meeting in February 1992. Under the 1991 Plan, options to purchase an aggregate of 33,800 shares of the Company’s common stock may be granted to both key management employees and non-employee directors. Options granted may be either Incentive Stock Options or Nonstatutory Stock Options, and the requirements for participation, exercise price and other terms are similar to the 1981 Plan. As of September 29, 2002, options to purchase 800 shares at a price of $43.75 per share were outstanding under the 1991 Plan, of which 300 were exercisable at September 29, 2002.
In January 1995, the Board of Directors adopted the 1995 Stock Option Plan to replace the 1991 Plan, which was fully subscribed at the time. The 1995 Plan was approved by stockholders at the Company’s Annual Meeting in February 1995. Under the 1995 Plan, options to purchase an aggregate of 35,000 shares of the Company’s common stock may be granted to both key management employees and non-employee directors. In August 1997, the Board of Directors authorized an increase in the number of options to an aggregate of 82,500 shares, which was ratified by stockholders at the Company’s Annual Meeting in February 1998. Options granted may be either Incentive Stock Options or Nonstatutory Stock Options, and requirements for participation, exercise price and other terms are similar to the 1991 Plan. As of September 29, 2002, options to purchase 800 shares at prices ranging from $26.56 to $43.75 per share were outstanding under the 1995 Plan, of which 300 were exercisable at September 29, 2002.
In November 1998, the Board of Directors approved the 1999 Stock Option Plan. Under the 1999 Plan, options to purchase
F-20
an aggregate of 50,000 shares of common stock may be granted to both key management employees and non-employee directors. The 1999 Plan was ratified by stockholders at the Company’s Annual Meeting in February 1999. Options granted may be either Incentive Stock Options or Nonstatutory Stock Options. Requirements for participation, exercise price and other terms are similar to the 1991 and 1995 Plans. As of September 29, 2002, options to purchase 30,500 shares at prices ranging from $26.56 to $63.44 per share were outstanding under the 1999 Plan, of which 27,200 were exercisable at September 29, 2002.
In October 2000, the Board of Directors approved the 2000 Non-qualified Option Plan. Under the 2000 Plan, options to purchase an aggregate of 75,000 shares of common stock may be granted to both key management employees and non-employee directors. Options granted under the 2000 Plan may only be Nonstatutory Stock Options. Requirements for participation, exercise price and other terms are similar to the 1991, 1995 and 1999 Plans except for the limitation to Nonstatutory options. As of September 29, 2002, options to purchase 56,300 shares at prices ranging from $26.56 to $43.75 per share were outstanding under the 2000 Plan, of which 25,400 were exercisable at September 29, 2002.
In December 2000, the Board of Directors approved the 2001 Stock Option Plan. Under the 2001 Plan, options to purchase an aggregate of 75,000 shares of common stock may be granted to both key management employees and non-employee directors. The 2001 Plan was ratified by stockholders at the Company’s Annual Meeting in March 2001. Options granted may be either Incentive Stock Options or Nonstatutory Stock Options. Requirements for participation, exercise price and other terms are similar to the 1991, 1995 and 1999 Plans. As of September 29, 2002, options to purchase 10,700 shares at prices ranging from $20.60 to $25.62 per share were outstanding under the 2001 Plan, of which 10,700 were exercisable at September 29, 2002.
In October 2001, the Board of Directors adopted the 2001 Non-Qualified Option Plan, pursuant to which options to purchase an aggregate of 1,500,000 shares of common stock may be granted to attract and retain employees and directors. The terms of the 2001 Non-Qualified Option Plan are similar to the 2001 Stock Option Plan; however, only non-statutory options may be issued under the 2001 Non-Qualified Option Plan. As of September 29, 2002, options to purchase 1,359,900 shares at prices ranging from $0.77 to $1.16 per share were outstanding under the 2001 Non-Qualified Option Plan, of which 614,100 were exercisable at September 29, 2002.
Stock option activity is summarized as follows (adjusted to reflect the 1-for-20 reverse stock split of September 2001):
| | Shares
| | | Option Price Per Share
|
Options outstanding at
October 3, 1999 | | 117,300 | | | $19.60 to $125.00 |
| Granted | | 28,800 | | | 26.80 to 59.20 |
| Exercised | | (67,700 | ) | | 19.60 to 57.60 |
| Cancelled | | (5,900 | ) | | 20.00 to 46.20 |
| Expired | | (3,600 | ) | | 100.00 to 125.00 |
| |
|
| | |
Options outstanding at
October 1, 2000 | | 68,900 | | | $19.60 to $59.20 |
| Granted | | 93,700 | | | 20.60 to 63.44 |
| Exercised | | (8,400 | ) | | 19.60 to 31.87 |
| Cancelled | | (2,900 | ) | | 19.60 to 59.10 |
| Expired | | (5,100 | ) | | 19.60 to 20.00 |
| |
|
| | |
Options outstanding at
September 30, 2001 | | 146,200 | | | $20.00 to $63.44 |
| Granted | | 1,508,800 | | | .77 to 1.16 |
| Exercised | | (73,600 | ) | | 1.15 to 1.15 |
| Cancelled | | (106,000 | ) | | 20.60 to 59.10 |
| Expired | | (16,400 | ) | | 20.00 to 39.60 |
| |
|
| | |
Options outstanding at
September 29, 2002 | | 1,459,000 | | | $0.77 to $63.44 |
| |
|
| | |
A summary of outstanding options exercisable under the 1991, 1995, 1999, 2000 and 2001 Qualified and Non-Qualified Plans is shown below.
F-21
Range of exercise prices
| | Number Outstanding
| | Weighted average remaining contractual life (years)
| | Weighted average exercise price
| | Number Exercisable
| | Weighted average exercise price
|
| $ 0.77 – 1.16 | | 1,359,900 | | 9 | | $ | 1.08 | | 614,100 | | $ | 1.01 |
| 20.00 – 29.99 | | 70,400 | | 2 | | | 25.85 | | 42,000 | | | 25.37 |
| 30.00 – 39.99 | | 14,100 | | 1 | | | 34.71 | | 13,200 | | | 34.58 |
| 40.00 – 63.44 | | 14,600 | | 2 | | | 54.06 | | 8,600 | | | 56.13 |
| | |
| | | | | | |
| | | |
| | | 1,459,000 | | | | | | | 677,900 | | | |
| | |
| | | | | | |
| | | |
The Boards of Directors of the Company’s subsidiaries have adopted, and the Company has approved, stock option plans with requirements for participation, exercise price and other terms similar to the options plans of the Company. Under the subsidiary option plans, options may be granted to employees, non-employee directors and other individual service providers of the subsidiary or the Company. Options granted under the subsidiary option plans may be either Incentive Stock Options or Nonstatutory Stock Options. As of September 29, 2002, the Company’s subsidiaries have granted options to purchase an aggregate of 16,145,200 shares of their respective common stock, of which 15,050,031 options are exercisable at September 29, 2002. (See Note 7).
Pursuant to SFAS No. 123 “Accounting for Stock Based Compensation,” the Company is required to disclose the effects on the net loss and per share data as if the Company had elected to use the fair value approach to account for all of its employee stock-based compensation plans. Had the compensation cost for the Company’s Plans, including those of its subsidiaries, been determined using the fair value method, the compensation expense would have increased the Company’s net loss for the years ended September 29, 2002, September 30, 2001 and October 1, 2000, to the pro forma amounts of $7,247,900, $15,733,857 and $15,600,279, respectively, with a corresponding pro forma loss per share of $1.27, $6.17 and $7.72, respectively. These pro forma amounts were determined estimating the fair value of each option granted during fiscal 2002, 2001 and 2000 on its grant date, using the Black-Scholes option-pricing model. Assumptions of no dividend yield, risk-free interest rates ranging from 3.6% to 6% which approximate the Federal Reserve Board’s rates for treasuries at the time granted, an expected life of three years, and volatility rates varying from 73.2% to 159.8% were applied to ISC options granted during fiscal years 2002, 2001, and 2000. A volatility rate of 0% was applied to options granted by subsidiaries. The weighted average fair value at the grant date for the options granted during fiscal years 2002, 2001 and 2000 was $0.91, $1.15, and $1.74 per option, respectively.
In fiscal 1982, the Company established an Employee Retirement Plan, which is effective for fiscal year 1982 and thereafter. The plan provides for annual contributions to the Company’s Stock Bonus Trust (“SBT”) to be determined by the Board of Directors and which will not exceed 15% of total payroll. At the discretion of the Trustee, the SBT will purchase common stock at fair market value or other interest-bearing securities or investments for the accounts of individual employees who will gain a vested interest of 20% in their accounts after their first year of service, and 20 % each year of service thereafter, until fully vested after five years of service. That portion of cash or stock held in an employee’s account and not vested at termination of employment will be redistributed in accordance with a prearranged formula. Management believes that the contributions made by the Company to the SBT, to the extent they relate to government cost-plus-fixed-fee contracts, will be reimbursable by the U.S. government. In fiscal years 2002, 2001 and 2000, the Company’s contributions to the SBT were 571,700, 232,200, and 6,800 shares of common stock, respectively, which had estimated market values of $710,000, $1,176,800 and $462,100, respectively. In addition, there was $17,300 of accrued contribution for fiscal 2002 at September 29, 2002 that was subsequently effectuated by the issuance of 13,800 shares to the SBT in December 2002. In December 2002, the Company issued 416,000 shares to the SBT with an estimated market value of $520,000 to effectuate a contribution for fiscal 2003. In fiscal 2003, this contribution will be recorded as a prepaid Employee Stock Bonus Plan contribution in equity and will be amortized over each fiscal quarter.
In September 2002, the Company authorized a Non-Qualified Retirement Plan for employees with service currently in excess of ten years and an initial contribution to this plan of 100,000 shares of the Company’s common stock to be effectuated upon completion of appropriate plan documentation. The Company accrued $110,000 of expense for this contribution, the market value of such shares at September 29, 2002.
F-22
Note 15—Concentration of Revenues
In fiscal 2002, direct contracts with the U.S. government accounted for 66% of the Company’s revenues, and second-tier government contracts with prime government contractors accounted for 3%. The remaining 31% of the Company’s revenues were derived from non-government sources. Of the 66% related to the U.S. government agencies, the U.S. Army, the U.S.
Navy, and the U.S Air Force accounted for 45%, 16% and 5%, respectively. Of the 31% applicable to non-governmental sources, one customer accounted for 11% of the total consolidated revenues, and the 20% balance of consolidated revenues from non-governmental sources was derived from a number of customers contributing less than 5% each.
In fiscal 2001, direct contracts with the U.S. government accounted for 42% of the Company’s revenues, and second-tier government contracts with prime government contractors accounted for 9%. The remaining 49% of the Company’s revenues were derived from non-government sources. Of the 42% related to the U.S. government agencies, the U.S. Navy, the U.S. Army and the Air Force accounted for 32%, 5% and 5%, respectively. Of the 49% applicable to non-governmental sources, two customers accounted for 24% and 21%, respectively, of the total commercial revenues.
In fiscal 2000, direct contracts with the U.S. government accounted for 20% of the Company’s revenues, and a second-tier government contract with a prime government contractor accounted for 12%. The remaining 68% of the Company’s revenues were derived from non-government sources. Of the 32% related to the U.S. government agencies, the U.S. Army, the U.S. Air Force and the U.S. Navy accounted for 12%, 1% and 7%, respectively, with the remaining consolidated revenue of 12% being widely diversified among several other governmental agencies. Of the 68 % applicable to non-governmental sources, two customers accounted for 19% and 23%, respectively, of the total commercial revenues.
Note 16—Marketable Securities and Cash Equivalents
The Company’s marketable securities consisted of investments in short-term, government-backed securities, and commercial paper. The Company determines proper classification of investments at the time of purchase and re-evaluates such designations at each balance sheet datadate. All marketable securities were classified as held-to-maturity, and were stated at September 27, 1998, September 28, 1997amortized cost. For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
Note 17—Loss Per Share
Basic and diluted net loss per common share for fiscal years 2002, 2001 and 2000 were calculated as follows:
| | | 2002
| | | 2001
| | | 2000
| |
| Loss from continuing operations | | $ | (6,072,500 | ) | | $ | (15,525,500 | ) | | $ | (8,994,900 | ) |
| Gain (loss) from discontinued operations | | | 35,000 | | | | 938,000 | | | | (6,043,400 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
| Net loss | | $ | (6,037,500 | ) | | $ | (14,587,500 | ) | | $ | (15,038,300 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
| Loss per Share: | | | | | | | | | | | | |
| Loss from continuing operations | | $ | (1.07 | ) | | $ | (6.09 | ) | | $ | (4.45 | ) |
| Gain (loss) from discontinued operations | | | 0.01 | | | | 0.37 | | | | (2.99 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
| Net loss per share | | $ | (1.06 | ) | | $ | (5.72 | ) | | $ | (7.44 | ) |
| | |
|
|
| |
|
|
| |
|
|
|
Weighted average number of
shares outstanding | | | 5,694,800 | | | | 2,549,500 | | | | 2,021,400 | |
| | |
|
|
| |
|
|
| |
|
|
|
F-23
Note 18—Summarized Quarterly Financial Information (Unaudited)
The following table presents the Company’s operating results for each of the eight fiscal quarters in the period ended September 29, 1996 are
derived from2002. The information for each of these quarters is unaudited and has been prepared on the same basis as the audited consolidated financial statements. In the opinion of management, all necessary adjustments have been included to fairly present the unaudited quarterly results. This data should be read together with the consolidated financial statements notand the notes thereto included in this 10-K
filing. The historical results are not necessarily indicativeherein.
| | | Quarter Ended
| |
| | | December 30, 2001
| | | March 31, 2002
| | | June 30, 2002
| | | September 29, 2002
| |
| Fiscal 2002 | | | | | | | | | | | | | | | | |
| Total revenues | | $ | 2,497,500 | | | $ | 2,301,100 | | | $ | 3,940,400 | | | $ | 6,603,300 | |
| Loss from operations | | | (2,231,200 | ) | | | (1,472,900 | ) | | | (1,659,200 | ) | | | (563,600 | ) |
| Loss from continuing operations | | | (2,209,400 | ) | | | (1,466,300 | ) | | | (1,724,200 | ) | | | (672,600 | ) |
| Gain from discontinued operations | | | — | | | | — | | | | — | | | | 35,000 | |
| Net loss | | | (2,209,400 | ) | | | (1,466,300 | ) | | | (1,724,200 | ) | | | (637,600 | ) |
| | |
|
|
| |
|
|
| |
|
|
| |
|
|
|
| Net income (loss) per share | | | | | | | | | | | | | | | | |
| From continuing operations | | | (0.51 | ) | | | (0.28 | ) | | | (0.30 | ) | | | (0.10 | ) |
| Discontinued operations | | | — | | | | — | | | | — | | | | 0.01 | |
| Net loss per share | | $ | (0.51 | ) | | $ | 0.28 | ) | | $ | 0.30 | ) | | $ | (0.09 | ) |
| | |
|
|
| |
|
|
| |
|
|
| |
|
|
|
| Weighted average shares outstanding | | | 4,321,500 | | | | 5,319,600 | | | | 5,718,700 | | | | 6,872,100 | |
| | |
|
|
| |
|
|
| |
|
|
| |
|
|
|
|
| | | Quarter Ended
| |
| | | December 31, 2000
| | | April 1, 2001
| | | July 1, 2001
| | | September 30, 2001
| |
| Fiscal 2001 | | | | | | | | | | | | | | | | |
| Total revenues | | $ | 1,943,000 | | | $ | 2,557,800 | | | $ | 3,930,900 | | | $ | 2,225,600 | |
| Loss from operations | | | (4,888,800 | ) | | | (4,649,500 | ) | | | (2,533,500 | ) | | | (4,054,200 | ) |
| Loss from continuing operations | | | (4,463,500 | ) | | | (4,268,800 | ) | | | (2,121,400 | ) | | | (4,671,800 | ) |
| Gain (loss) from discontinued operations | | | (1,603,500 | ) | | | (1,264,900 | ) | | | (1,979,700 | ) | | | 5,786,100 | |
| Net loss | | | (6,067,000 | ) | | | (5,533,700 | ) | | | (4,101,100 | ) | | | 1,114,300 | |
| | |
|
|
| |
|
|
| |
|
|
| |
|
|
|
| Net income (loss) per share | | | | | | | | | | | | | | | | |
| From continuing operations | | | (1.91 | ) | | | (1.81 | ) | | | (0.85 | ) | | | (1.66 | ) |
| Discontinued operations | | | (0.69 | ) | | | (0.54 | ) | | | (0.79 | ) | | | 2.06 | |
| | |
|
|
| |
|
|
| |
|
|
| |
|
|
|
| Net income or loss per share | | $ | (2.60 | ) | | $ | (2.35 | ) | | $ | (1.64 | ) | | $ | 0.40 | |
| | |
|
|
| |
|
|
| |
|
|
| |
|
|
|
| Weighted average shares outstanding | | | 2,332,100 | | | | 2,353,700 | | | | 2,494,400 | | | | 2,809,500 | |
| | |
|
|
| |
|
|
| |
|
|
| |
|
|
|
Note 19—Subsequent Events
In December 2002, the Company raised net proceeds of
resultsapproximately $1,050,000 from the sale of 10,000 shares of its Series E non-voting, non-dividend-bearing convertible preferred stock at $120 per share. Each share of Series E stock is initially convertible to
be
expected in any future period.
Fiscal Year Ended
-----------------------------------------------------------------------------------------
October 1, October 3, September 27, September 28, September 29,
2000 1999 1998 1997 1996
--------------- --------------- ----------------- ----------------- -------------
Consolidated Statement100 shares of Operations Data:
- ------------------------------------------
Total revenues $ 10,769,800 $11,100,200 $ 9,314,500 $ 13,693,200 $ 12,024,200
Loss from operations (16,019,200) (9,785,700) (5,798,200) (14,809,200) (11,154,700)
Net loss (15,038,300) (9,115,700) (4,243,500) (14,875,600) (15,914,700)
Basic net loss per common
and common equivalent share $ (0.37) $ (0.29) $ (0.19) $ (0.73) $ (0.94)
Diluted net loss per common
and common equivalent share $ (0.38) $ (0.29) $ (0.19) $ (0.73) $ (0.94)
Weighted average number of
shares outstanding 40,428,600 31,244,300 24,597,700 20,475,100 16,874,300
Shares used in computing
net loss per share 40,428,600 31,244,300 24,597,700 20,475,100 16,874,300
Loss per common
and common equivalent shares includes, where applicable,
cumulative and imputed dividends on Preferred Stock which have not been declared
or paid.
October 1, October 3, September 27, September 28, September 29,
2000 1999 1998 1997 1996
----------------- --------------- --------------- --------------- ---------------
Consolidated Balance Sheet Data:
- ---------------------------------
Current assets $14,129,800 $ 6,439,150 $4,802,700 $ 6,637,200 $ 9,648,200
Current liabilities $ 4,683,400 $ 5,375,300 $2,296,000 $ 7,395,600 $ 5,787,100
Working capital (deficit) $ 9,446,400 $ 1,063,850 $2,506,700 $ (758,400) $ 3,861,100
Total assets $20,307,150 $10,510,350 $7,064,700 $ 9,449,300 $21,742,200
Long-term debt $ 224,700 $ 433,200 $ 933,700 $ 1,207,000 $ 3,165,600
Shareholders' equity (deficit) $ 7,586,550 $ 2,212,650 $2,347,000 $(2,939,900) $ 8,312,700
17
Item 7. Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operation
------------------------
The information required by Item 7 of this report is set forth on pages 2
through 4stock of the Company's 2000 Annual Reportcommon stock, or an effective purchase price of $1.20 per common share. This effective purchase price is adjustable to Stockholders and is
incorporated by reference in this Annual Report on Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
None.
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
The financial statements, together with85% of the report thereon of Grant Thornton LLP
dated November 30, 2000, appearing on pages 6 through 25weighted average trading price of the Company's 2000
Annual Reportcommon stock for the five consecutive trading days immediately preceding the conversion date(s), subject to Stockholders are incorporated by reference to this Annual
Report on Form 10-K. With the exceptiona ceiling of $1.50 per common share and a floor of $.85 per common share. The Series E stock is therefore convertible into between 800,000 and 1,411,765 shares of the aforementioned information andCompany's common stock. On the information incorporated in Item 7,date of issuance, the 2000 Annual ReportSeries E stock was then convertible into 800,000 shares of common stock, an effective purchase price of $1.50 per common share. In connection with this financing, the Company issued a three-year warrant to Stockholders
is not deemedthe investor to be filed as part of this Annual Report on Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
--------------------
None.
PART III
--------
Item 10. Directors and Executive Officerspurchase shares of the Registrant
--------------------------------------------------Company's common stock at $2.04 per share, the volume weighted average trading price of the Company's common stock for the five trading days prior to the transaction date. The responsemaximum number of shares of the Company's common stock issuable pursuant to this Item will be containedthe warrant is 250,000, reducible to a minimum of 80,276 depending on the number of shares of the Company’s common stock issued pursuant to conversion of the Series E stock. The warrants are exercisable 60 days after the date all of the convertible preferred stock has been converted into shares of the Company’s common stock. F-24
The intrinsic value of the beneficial conversion feature is approximately $650,000 for the 10,000 Series E shares issued, based on the excess of the quoted market price of a share of the Company's common stock on the date of issue above the 800,000 shares of common stock then issuable upon conversion. The imputed dividend is a one-time, non-cash charge based on the immediate conversion feature of the convertible preferred stock.
Note 20—Reportable Segments
The Company’s operating segments are distinct business units operating in different industries, except the Corporate Headquarters segment, which spans the activities of the other segments. Each segment is separately managed, with separate marketing and distribution systems. The Company’s seven operating segments are Advanced Technology Division (“ATD”), Novalog, Microelectronics Products Division (“MPD”), MicroSensors, Inc. (“MSI”), RedHawk Vision (“RedHawk”), iNetWorks Corporation (“iNetWorks”) and Corporate Headquarters. All operating segments except iNetWorks and RedHawk meet the criteria for reportable segments disclosure as of September 29, 2002. The Company has included iNetWorks and RedHawk as reportable operating segments to conform to prior year presentations. ATD derives most of its revenues from research and development contracts funded primarily by governmental agencies. Novalog designs, develops and sells proprietary integrated circuits (“ICs”) and related products for use in wireless infrared communication. MPD designs, develops and sells stacked 3D microelectronics for use in a variety of systems applications. MSI develops and sells proprietary micromachined sensors and related electronics. iNetWorks is focused on commercializing Irvine Sensors’ proprietary technology for high-speed telecommunications and Internet routers, including the SuperRouter. Corporate Headquarters provides accounting, inventory control and management consulting services to the consolidated subsidiaries. Corporate revenue consists of charges to the subsidiaries for these services and corporate assets consist of loans to subsidiaries and goodwill for reacquisition of subsidiary stock.
The accounting policies used to develop segment information correspond to those described in the Proxy Statementsummary of significant accounting policies. Segment profit or loss is based on profit or loss from operations before income taxes and minority interest in profit and loss of subsidiaries.
The following information about the Company’s seven business segments is for the 2001
Annual Meeting underyear ended September 29, 2002:
| | | ATD
| | | Novalog
| | | MSI
| | | MPD
| | | iNetWorks
| | | RedHawk Vision
| | | Corporate Headquarters
| | | Totals
| |
| Revenues from external customers | | $ | 10,561,500 | | | $ | 2,074,500 | | | $ | 853,600 | | | $ | 1,823,100 | | | $ | — | | | $ | 29,600 | | | $ | — | | | $ | 15,342,300 | |
| Segment net Inventory | | | 473,400 | | | | 381,200 | | | | — | | | | 83,400 | | | | — | | | | — | | | | — | | | | 938,000 | |
| Segment warrant expense | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 114,200 | | | | 114,200 | |
| Interest income | | | — | | | | 9,000 | | | | — | | | | — | | | | — | | | | — | | | | 1,100 | | | | 10,100 | |
| Interest expense | | | 53,300 | | | | 13,800 | | | | 15,500 | | | | 18,000 | | | | — | | | | — | | | | 129,800 | | | | 230,400 | |
| Depreciation and amortization | | | 813,100 | | | | 58,200 | | | | 195,900 | | | | 61,600 | | | | 400 | | | | 30,300 | | | | 222,100 | | | | 1,381,600 | |
| Segment loss | | | (1,151,900 | ) | | | (1,267,700 | ) | | | (925,600 | ) | | | (652,900 | ) | | | (276,900 | ) | | | (160,800 | ) | | | (1,711,400 | ) | | | (6,147,200 | ) |
| Changes to segment inventory reserve | | | 342,900 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 342,900 | |
| Segment assets | | | 7,311,500 | | | | 1,514,250 | | | | 744,500 | | | | 735,300 | | | | 3,700 | | | | 85,500 | | | | 22,965,700 | | | | 33,360,450 | |
| Expenditures for segment assets | | | 582,100 | | | | 103,700 | | | | 42,800 | | | | 174,600 | | | | — | | | | — | | | | 2,300 | | | | 905,500 | |
|
Reconciliation to Consolidated Amounts |
|
Assets |
| Total assets for reportable segments | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 33,360,450 | |
| Elimination of intersegment assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (22,965,700 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
|
|
| Total consolidated assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | 10,394,750 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
|
|
F-25
The following information about the heading "Nomination and Election of Directors" andCompany’s seven business segments is
incorporated herein by reference.
Item 11. Executive Compensation
----------------------
The response to this Item will be contained in the Proxy Statement for the 2001
Annual Meeting underyear ended September 30, 2001:
| | | ATD
| | | Novalog
| | | MSI
| | | MPD
| | | iNetWorks
| | | RedHawk Vision
| | | Corporate Headquarters
| | | Totals
| |
| Revenues from external customers | | $ | 5,380,800 | | | $ | 4,511,700 | | | $ | 121,900 | | | $ | 582,500 | | | $ | 11,900 | | | $ | 48,500 | | | $ | — | | | $ | 10,657,300 | |
| Intersegment revenue | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 2,570,100 | | | | 2,570,100 | |
| Segment software writedown | | | — | | | | — | | | | — | | | | — | | | | — | | | | (638,600 | ) | | | — | | | | (638,600 | ) |
| Segment net Inventory | | | 263,500 | | | | 653,400 | | | | — | | | | 197,300 | | | | — | | | | — | | | | — | | | | 1,114,200 | |
| Segment warrant expense | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 865,000 | | | | 865,000 | |
| Interest income | | | — | | | | 24,900 | | | | — | | | | — | | | | | | | | 5,500 | | | | 106,000 | | | | 136,400 | |
| Interest expense | | | 82,800 | | | | 4,400 | | | | 5,600 | | | | 8,100 | | | | — | | | | 1,000 | | | | 39,600 | | | | 141,500 | |
| Depreciation and amortization | | | 693,900 | | | | 67,500 | | | | 200,900 | | | | 44,900 | | | | 7,600 | | | | 241,100 | | | | 315,500 | | | | 1,571,400 | |
| Segment loss | | | (4,621,000 | ) | | | (506,800 | ) | | | (2,848,100 | ) | | | (1,560,600 | ) | | | (2,225,200 | ) | | | (1,699,500 | ) | | | (2,669,900 | ) | | | (16,131,100 | ) |
| Changes to segment inventory reserve | | | 2,416,200 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 2,416,200 | |
| Segment assets | | | 7,477,450 | | | | 2,151,300 | | | | 787,200 | | | | 563,600 | | | | 28,500 | | | | 133,600 | | | | 20,016,900 | | | | 31,158,550 | |
| Expenditures for segment assets | | | 2,328,000 | | | | 178,900 | | | | 225,500 | | | | 128,200 | | | | 10,900 | | | | 291,100 | | | | 829,200 | | | | 3,991,800 | |
|
Reconciliation to Consolidated Amounts |
|
Assets |
| Total assets for reportable segments | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 31,158,550 | |
| Elimination of intersegment assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (20,016,900 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
|
|
| Total consolidated assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | 11,141,650 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
|
|
The following information about the
heading "Executive Compensation and Related
Information" andCompany’s seven business segments is
incorporated herein by reference.
Item 12. Stock Ownership of Certain Beneficial Owners and Management
-----------------------------------------------------------
The response to this Item will be contained in the Proxy Statement for the
2001
Annual Meeting under the heading "Stock Ownership of Certain Beneficial Owners
and Management" and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
The response to this Item will be contained in the Proxy Statement for the 2001
Annual Meeting under the heading "Certain Relationships and Related
Transactions" and is incorporated herein by reference.
18
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) The following documents are filed as part of this Report:
1. Financial Statements
Pages in
Annual Report*
--------------
Consolidated Balance Sheets 9
Consolidated Statements of Operations 10
Consolidated Statement of Shareholders' Equity (Deficit) 11
Consolidated Statements of Cash Flows 12
Notes to Consolidated Financial Statements 13-27
Report of Independent Certified Public Accountants 28
* Incorporated by reference from the indicated pages of the 2000 Annual
Report to Stockholders.
2. Financial Statement Schedules:
year ended October 1, 2000: | | | ATD
| | | Novalog
| | MSI
| | | MPD
| | | iNetWorks
| | RedHawk Vision
| | | Corporate Headquarters
| | | Totals
| |
| Revenues from external customers | | $ | 4,282,900 | | | $ | 6,308,600 | | $ | 69,900 | | | $ | 107,100 | | | $ | — | | $ | 1,300 | | | $ | — | | | $ | 10,769,800 | |
| Intersegment revenue | | | — | | | | — | | | — | | | | — | | | | — | | | — | | | | 2,514,700 | | | | 2,514,700 | |
| Segment net Inventory | | | 278,600 | | | | 189,900 | | | — | | | | 21,100 | | | | — | | | — | | | | — | | | | 489,600 | |
| Interest income | | | — | | | | 6,400 | | | — | | | | — | | | | — | | | — | | | | 152,400 | | | | 158,800 | |
| Interest expense | | | — | | | | 500 | | | 4,700 | | | | 8,200 | | | | — | | | — | | | | 131,400 | | | | 144,800 | |
| Depreciation and amortization | | | 605,100 | | | | 79,900 | | | 111,500 | | | | 23,600 | | | | — | | | 10,200 | | | | 106,400 | | | | 936,700 | |
| Segment profit (loss) | | | (4,442,900 | ) | | | 472,800 | | | (3,299,000 | ) | | | (978,600 | ) | | | — | | | (930,900 | ) | | | (793,800 | ) | | | (9,972,400 | ) |
| Changes to segment inventory reserve | | | 2,166,700 | | | | — | | | (238,000 | ) | | | — | | | | — | | | — | | | | — | | | | 1,928,700 | |
| Segment assets | | | 11,986,100 | | | | 2,239,100 | | | 742,500 | | | | 180,900 | | | | — | | | 705,250 | | | | 12,944,800 | | | | 28,798,650 | |
| Expenditures for segment assets | | | 780,100 | | | | 46,900 | | | 495,500 | | | | 47,500 | | | | — | | | 509,700 | | | | 177,600 | | | | 2,057,300 | |
|
Reconciliation to Consolidated Amounts |
|
Assets |
| Total assets for reportable segments | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 28,798,650 | |
| Elimination of intersegment assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (12,944,800 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
|
|
| Total consolidated assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | 15,853,850 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
|
|
F-26
Irvine Sensors Corporation
Report of Independent Certified Public Accountants on Financial Statement
Schedules
Schedule for the fiscal years ended October 1, 2000, October 3, 1999, and
September 27, 1998:
Schedule II - Valuation and Qualifying Accounts
All other schedules have been omitted because they are not applicable, or
not required, or because the required information is included in the
financial statements or notes thereto which have been incorporated herein by
reference.
3. Exhibits - The following is a list of the exhibits encompassed in this
report:
Exhibit
Number Exhibit Description
------ -------------------
3.1 Certificate of Incorporation of the Registrant, as amended and
currently in effect (1)
3.2 Certificate of Designation of Preferences of Series D Convertible
Preferred Stock (2)
3.3 By-laws, as amended to date (3)
4.1 Specimen Common Stock certificate (1)
10.1.1 Employee Stock Bonus Plan and Trust Agreement dated June 29, 1982
effective December 31,1982 (4)
10.1.2 Amendment to Employee Stock Bonus Plan and Trust Agreement dated
December 14, 1982 (5)
10.1.3 Amendment to Employee Stock Bonus Plan and Trust Agreement dated
September 25, 1990 (1)
10.1.4 Master Trust Agreement for Employee Deferred Benefit Plans dated
August 22, 1990 (6)
10.1.5 Amendment to Employee Stock Bonus Plan and Trust Agreement dated
October 4, 1993 (7)
10.2 1991 Stock Option Plan (8)
10.3 1995 Stock Option Plan (9)
10.4 1999 Stock Option Plan (10)
10.5 Government Contract DASG60-00-C-0016 dated January 24, 2000
10.6 Government Contract N39998-97-C-5201 as modified March 9, 2000
10.7 Government Contract USZA22-00-C-0013 dated August 14, 2000
10.8 Government Contract N39998-00-C-08118 dated August 31, 2000
10.9 Form of Indemnification Agreement between the Registrant and its
directors and officers
10.10 Lease Agreement for premises at 3001 Redhill Avenue, Costa Mesa,
California, dated August 1, 1994 (11)
10.11 Amendments to Lease Agreement for premises at 3001 Redhill Avenue,
Bldg. III, Costa Mesa, California
10.12 Lease Agreement and Amendments for premises at 3001 Redhill Avenue,
Bldg. IV, Costa Mesa, California
10.13 Amendments to Lease Agreement for premises at 3001 Redhill Avenue,
Bldg. V, Costa Mesa, California
13.1 Portions of Registrant's Annual Report to Stockholders for the fiscal
year ended October 1, 2000
21.1 Subsidiaries of the Registrant
23.1 Consent of Grant Thornton LLP, Independent Certified Public
Accountants
27 Financial Data Schedule
19
___________
(1) Incorporated by reference to Part IV of Registrant's Annual Report on Form
10-K for the fiscal year ended September 29, 1991.
(2) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 filed with the Commission on October 4, 1999 (Registration Number
333-88385).
(3) Incorporated by reference to Part IV of Registrant's Annual Report on Form
10-K/A for the fiscal year ended September 28, 1996.
(4) Incorporated by reference to Part II of Pre-effective Amendment No. 3 to
the S-18 Registration Statement filed with the Commission's Los Angeles
Regional Office on May 27, 1982.
(5) Incorporated by reference to Part II of Registrant's Registration
Statement on Form S-1 filed with the Commission on March 23, 1983
(Registration No. 2-82596) (the "S-1 Registration Statement").
(6) Incorporated by reference to Part II of Pre-effective Amendment No. 3 to
the Form S-2 filed with the Commission on March 3, 1987 (Registration No.
33-10134).
(7) Incorporated by reference to Part IV of Registrant's Annual Report on Form
10-K/A for the fiscal year ended October 1, 1995.
(8) Incorporated by reference to Part II of Pre-effective Amendment No. 2 to
the Form S-2 filed with the Commission on July 9, 1992 (Registration No.
33-47977).
(9) Incorporated by reference to Registrant's Registration Statement on
Form S-8 (File No. 333-72201), filed February 11, 1999.
(10) Incorporated by reference to Registrant's Registration Statement on
Form S-8 (File No. 333-94071), filed January 4, 2000.
(11) Incorporated by reference to Part IV of Registrant's Annual Report on Form
10-K for the fiscal year ended October 2, 1994.
(b) Reports on Form 8-K:
------------------------
No report on Form 8-K was filed by the Company with respect to the quarter
ended October 1, 2000.
20
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) 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.
IRVINE SENSORS CORPORATION
--------------------------
By: /s/ James Alexiou
-----------------
James Alexiou
Chairman of the Board
Date: December 29, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated:
/s/ Robert G. Richards /s/ John J. Stuart, Jr.
- ---------------------- -----------------------
Robert G. Richards John J. Stuart, Jr.
Chief Executive Officer Chief Financial Officer
(Principal Executive Officer) (Principal Financial and
Date: December 29, 2000 Accounting Officer)
Date: December 29, 2000
/s/ Mel R. Brashears /s/ Thomas M. Kelly
- -------------------- -------------------
Mel R. Brashears, Director Thomas M. Kelly, Director
Date: December 29, 2000 Date: December 29, 2000
/s/ Joanne S. Carson /s/ Frank P. Ragano
- -------------------- -------------------
Joanne S. Carson, Director Frank P. Ragano, Director
Date: December 29, 2000 Date: December 29, 2000
/s/ John C. Carson /s/ Vincent F. Sollitto, Jr.
- ------------------ ----------------------------
John C.Carson, Director Vincent F. Sollitto, Jr.,
Director Date: December 29, 2000
Date: December 29, 2000
/s/ Marc Dumont /s/ Wolfgang Seidel
- --------------- -------------------
Marc Dumont, Director Wolfgang Seidel, Director
Date: December 29, 2000 Date: December 29, 2000
21
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
ON FINANCIAL STATEMENT SCHEDULE
-------------------------------
To the Board of Directors
Irvine Sensors Corporation
Costa Mesa, California
We have audited the accompanying consolidated balance sheets of Irvine Sensors Corporation as of September 29, 2002 and September 30, 2001, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended September 29, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in our report
dated November 30, 2000 appearing on page 28 ofall material respects, the 2000 Annual Report to
Shareholdersconsolidated financial position of Irvine Sensors Corporation (which reportas of September 29, 2002 and September 30, 2001, and the consolidated financial statements are incorporated by reference in this Annual Report on Form
10-K) also included an auditresults of its operations and its consolidated cash flows for each of the Financial Statementthree years in the period ended September 29, 2002, in conformity with accounting principles generally accepted in the United States of America.
We have also audited Schedule listedII for each of the three years in Item
14(a) of this Form 10-K.the period ended September 29, 2002. In our opinion, this Financial Statement Scheduleschedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein
when read in conjunction withtherein.
/s/ Grant Thornton LLP
Irvine, California
December 13, 2002, except for Note 19
as to which the
related consolidated financial statements.
/s/ GRANT THORNTON LLP
Irvine, California
November 30, 2000
22
date is December 23, 2002
F-27
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
----------------------------------------------
Balance at Charged to Balance
Beginning Costs and at End
of Year Expenses Deductions of Year
---------- ---------- ---------- ----------
Year ended October 1, 2000:
- ---------------------------
Allowance for doubtful accounts $ 36,700 $ 164,400 $ 74,700 $ 126,400
Inventory reserves 3,718,800 2,706,700 238,100 6,187,400
Year ended October 3, 1999:
- ---------------------------
Allowance for doubtful accounts $ 10,000 $ 31,300 $ 4,600 $ 36,700
Inventory reserves 2,456,800 2,245,600 983,600 3,718,800
Year ended September 27, 1998:
- ---------------------------------
Allowance for doubtful accounts $ 10,000 $ - $ - $ 10,000
Inventory reserves 2,184,800 1,306,700 1,034,700 2,456,800
23 | | | Balance at Beginning of Year | | Charged to Costs and Expenses | | Deductions | | Balance at End of Year |
Year ended September 29, 2002: |
| Allowance for doubtful accounts | | $ | 57,700 | | $ | 20,000 | | $ | 1,400 | | $ | 76,300 |
|
| Inventory reserves | | $ | 8,183,500 | | $ | 410,900 | | $ | 68,000 | | $ | 8,526,400 |
|
Year ended September 30, 2001: |
| Allowance for doubtful accounts | | $ | 126,400 | | $ | 36,500 | | $ | 105,200 | | $ | 57,700 |
|
| Inventory reserves | | $ | 5,767,400 | | $ | 2,416,200 | | $ | 100 | | $ | 8,183,500 |
|
Year ended October 1, 2000: |
| Allowance for doubtful accounts | | $ | 36,700 | | $ | 164,400 | | $ | 74,700 | | $ | 126,400 |
|
| Inventory reserves | | $ | 3,838,700 | | $ | 2,166,700 | | $ | 238,000 | | $ | 5,767,400 |
S-1