Back to GetFilings.com
================================================================================
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended June 30, 2002
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ____________ to
_____________
Commission File Number
001-08402
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)
(714) 549-8211
(Registrant's Telephone Number, Including Area Code)
Indicate by check whether the registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
As of August 9, 2002, there were 6,900,820 shares of common stock outstanding.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
IRVINE SENSORS CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, September 30,
2002 2001
----------- -------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 1,122,900 $ 380,200
Marketable securities - 156,600
Restricted cash 435,100 400,000
Accounts receivable, net of allowances
of $57,300 and $57,700, respectively 1,922,300 2,685,900
Inventory, net 1,233,000 1,114,200
Stock subscriptions receivable - 216,900
Other current assets 130,600 70,400
----------- ------------
Total current assets 4,843,900 5,024,200
Equipment, furniture and fixtures, net 5,077,500 5,542,700
Other assets, net 645,550 574,750
----------- ------------
$10,566,950 $ 11,141,650
=========== ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 3,256,000 $ 2,427,600
Accrued expenses 1,572,700 1,764,600
Accrued loss on contracts 423,800 921,200
Customer advances 69,600 151,500
Line of credit 400,000 200,000
Short term notes payable, net of discount of $27,600 122,400 -
Current portion - capital lease obligations 71,000 228,200
----------- ------------
Total current liabilities 5,915,500 5,693,100
Capital lease obligations, less current portion 57,900 180,300
Minority interest in consolidated subsidiaries 485,300 579,300
----------- ------------
Total liabilities 6,458,700 6,452,700
----------- ------------
Commitments and contingencies - -
Stockholders' Equity:
Preferred stock, $0.01 par value, 500,000 shares authorized;
Series B Convertible Cumulative Preferred, 4,300 shares
outstanding; aggregate liquidation preference of $64,500 25 25
Series C Convertible Cumulative Preferred, 2,300 shares
outstanding; aggregate liquidation preference of $33,000 25 25
Common stock, $0.01 par value, 80,000,000 shares authorized;
6,857,300 and 3,305,300 shares issued and outstanding 68,600 33,100
Prepaid employee stock bonus plan contribution (39,900) -
Paid-in capital 102,043,900 97,220,300
Accumulated deficit ( 97,964,400) (92,564,500)
----------- ------------
Total stockholders' equity 4,108,250 4,688,950
----------- ------------
$ 10,566,950 $ 11,141,650
============ ============
See Accompanying Condensed Notes to Consolidated Financial Statements
2
IRVINE SENSORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
13 Weeks Ended 39 Weeks Ended
---------------------------------- ----------------------------------
June 30, July 1, June 30, July 1,
2002 2001 2002 2001
---------------- ---------------- ---------------- ----------------
Revenues:
Contract revenues $ 2,919,500 $ 1,896,400 $ 5,662,300 $ 3,392,400
Product sales 1,021,000 2,034,500 3,076,800 5,039,300
---------------- ---------------- ---------------- ----------------
Total revenues 3,940,500 3,930,900 8,739,100 8,431,700
---------------- ---------------- ---------------- ----------------
Cost and expenses:
Cost of contract revenues 1,752,300 1,762,200 3,798,300 2,890,100
Cost of product sales 1,338,600 1,417,900 3,036,900 4,308,000
General and administrative expense 1,967,400 2,028,800 5,653,400 8,259,700
Research and development expense 541,400 1,255,500 1,613,800 5,045,800
---------------- ---------------- ---------------- ----------------
Total costs and expenses 5,599,700 6,464,400 14,102,400 20,503,600
---------------- ---------------- ---------------- ----------------
Loss from operations (1,659,200) (2,533,500) (5,363,300) (12,071,900)
Interest expense (79,400) (24,900) (108,200) (92,500)
Interest income 3,900 7,700 10,700 149,800
---------------- ---------------- ---------------- ----------------
Loss from continuing operations before minority
interest and provision for income taxes (1,734,700) (2,550,700) (5,460,800) (12,014,600)
Minority interest in loss of subsidiaries 23,600 109,700 94,000 383,000
Provision for income taxes (13,100) - (33,100) (4,000)
---------------- ---------------- ---------------- ----------------
Loss from continuing operations (1,724,200) (2,441,000) (5,399,900) (11,635,600)
Discontinued operations:
Loss from operations of discontinued subsidiary - (1,660,100) - (4,066,200)
---------------- ---------------- ---------------- ----------------
Net loss $ (1,724,200) $ (4,101,100) $ (5,399,900) $ (15,701,800)
================ ================ ================ ================
Basic and diluted loss per share:
Loss from continuing operations $(0.30) $(0.98) $(1.02) $(4.81)
Loss from discontinued operations - (0.67) - (1.68)
--------------- ---------------- ---------------- ----------------
Net loss per common share $(0.30) $(1.64) $(1.02) $(6.49)
================ ================ ================ ================
Weighted average number
of shares outstanding 5,718,700 2,494,400 5,287,600 2,421,200
================ ================ ================ ================
See Accompanying Condensed Notes to Consolidated Financial Statements
3
IRVINE SENSORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
39 Weeks Ended
---------------------------------------------------
June 30, 2002 July 1, 2001
---------------------- ---------------------------
Cash flows from operating activities:
Loss from continuing operations $(5,399,900) $(11,635,600)
Adjustments to reconcile loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization 1,041,100 1,026,600
Noncash common stock warrants issued 86,600 865,000
Accrued interest on marketable securities (300) (24,300)
Noncash employee retirement plan contribution 560,100 740,400
Minority interest in net loss of subsidiaries (94,000) (382,900)
(Increase) decrease in accounts receivable 763,600 (1,097,500)
Increase in inventory (118,800) (697,200)
Increase in other current assets (60,200) (160,300)
Increase in accounts payable and accrued expenses 1,671,200 2,501,700
Decrease in accrued loss on contracts (497,400) (152,000)
Decrease in customer advances (81,900) -
-------------- ---------------
Total adjustments 3,270,000 2,619,500
-------------- ---------------
Net cash used in operating activities (2,129,900) (9,016,100)
-------------- ---------------
Cash flows from investing activities:
Proceeds from sales of marketable securities 156,900 1,250,000
Increase in restricted cash (35,100) (400,000)
Capital facilities and equipment expenditures (529,900) (3,064,900)
Acquisition of other assets (114,300) (326,200)
Capitalized software - (255,800)
Purchase of marketable securities - (150,000)
-------------- ---------------
Net cash used in investing activities (522,400) (2,946,900)
-------------- ---------------
Cash flows from financing activities:
Proceeds from issuance of common stock
and common stock warrants 3,129,600 4,356,800
Proceeds from line of credit 464,000 120,000
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 (169,100) (288,600)
Sale of minority interest in subsidiary - 670,000
Proceeds from options and warrants exercised 84,500 3,025,900
-------------- ---------------
Net cash provided by financing activities 3,395,000 7,884,100
-------------- ---------------
Net cash used in discontinued operations - (2,722,300)
-------------- ---------------
Net increase (decrease) in cash and cash equivalents 742,700 (6,801,200)
Cash and cash equivalents at beginning of period 380,200 7,630,900
-------------- ---------------
Cash and cash equivalents at end of period $ 1,122,900 $ 829,700
============== ===============
Noncash investing and financing activities:
Common stock issued to retire indebtedness $ 1,143,400 $ 115,300
Stock sold on a subscription basis $ 560,200 $ -
Equipment financed with capital leases $ 2,500 $ 240,200
See Accompanying Condensed Notes to Consolidated Financial Statements
4
IRVINE SENSORS CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - General
The information contained in the following Condensed Notes to Consolidated
Financial Statements is condensed from that which would appear in the annual
consolidated financial statements. The accompanying unaudited condensed
consolidated financial statements do not include certain footnotes and other
financial presentations normally required under generally accepted accounting
principles. Accordingly, the consolidated financial statements included herein
should be reviewed in conjunction with the consolidated financial statements and
related notes thereto contained in the Annual Report on Form 10-K of Irvine
Sensors Corporation and its subsidiaries (the "Company") for the year ended
September 30, 2001. It should be understood that accounting measurements at
interim dates inherently involve greater reliance on estimates than at year-end.
The results of operations for the interim periods presented are not necessarily
indicative of the results expected for the entire year.
The consolidated financial information as of June 30, 2002 and July 1, 2001
included herein is unaudited but includes all normal recurring adjustments
which, in the opinion of management of the Company, are necessary to present
fairly the consolidated financial position of the Company at June 30, 2002, the
results of its operations for the 39-week periods ended June 30, 2002 and July
1, 2001, and its cash flows for the 39-week periods ended June 30, 2002 and July
1, 2001.
The consolidated financial statements include the accounts of Irvine
Sensors Corporation ("ISC") and its subsidiaries, Novalog, Inc., MicroSensors,
Inc. ("MSI"), RedHawk Vision, Inc., iNetWorks Corporation, and 3D Microsystems,
Inc. All significant intercompany transactions and accounts have been eliminated
in the consolidation. Silicon Film was treated as a discontinued operation in
2001 due to its bankruptcy.
Note 2 - Common Stock
During the 13-week period ended December 30, 2001, the Company sold 300,000
common stock units to investors pursuant to its shelf registration statement on
Form S-3 that was declared effective in May 2001, 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.
Pursuant to its shelf registration statement, during the 13-week period
ended December 30, 2001, the Company also issued 660,000 shares of common stock
to investors generating net proceeds of $817,000, and issued 198,500 shares of
its common stock to two creditors in consideration for the cancellation and
retirement of $216,400 of existing indebtedness of the Company. During the
13-week period ended March 31, 2002, the Company issued 4,000 shares of its
common stock as part of a settlement agreement of a dispute in the amount of
$4,640 regarding the Company's guarantee of a $180,000 obligation of a former
subsidiary. During the 13-week period ended June 30, 2002, the Company sold
700,000 shares of common stock to investors in a private placement, generating
net proceeds of $1.23 million. 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
$2.32 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. During
the 13-week period ended June
5
30, 2002, the Company also sold 278,707 shares of its common stock to a
corporate investor for the cancellation and retirement of $500,000 of existing
indebtedness of iNetWorks.
During the 13-week period ended December 30, 2001, the Company issued an
aggregate of 194,300 shares of its common stock pursuant to the Company's 2001
Compensation Plan, which included (a) 162,200 shares issued to employees of the
Company in consideration for the cancellation of $184,200 of compensation
obligations of the Company and (b) 32,100 shares of its common stock to
consultants in consideration for the cancellation of $37,500 of existing
indebtedness of the Company. During the 13-week period ended March 31, 2002, the
Company issued an additional 415,910 shares of common stock pursuant to the
Company's 2001 Compensation Plan, which included (a) 397,910 shares issued to
employees of the Company in consideration for the cancellation and retirement of
$433,300 of compensation obligations of the Company and (b) 18,000 shares of its
common stock to a consultant in consideration for the cancellation of $18,000 of
existing indebtedness of the Company. During the 13-week period ended June 30,
2002, the Company issued an additional 247,052 shares of common stock pursuant
to the Company's 2001 Compensation Plan, which included (a) 242,052 shares
issued to employees of the Company in consideration for the cancellation and
retirement of $309,493 of compensation obligations of the Company and (b) 5,000
shares of its common stock sold to a consultant in consideration for net sales
proceeds of $8,925. During the 39-week period ended June 30, 2002, the Company
received $730,700 of net cash proceeds from stock subscriptions under the 2001
Compensation Plan.
The following is a summary of equity transactions in the 39-week period
ended June 30, 2002 that involved the issuance of common stock.
Increase in
Common stock Stockholders'
shares issued Equity
------------- -------------
Sale of common stock and common stock units 2,168,900 $2,916,900
Common stock issued to employee retirement plan 480,000 600,000
Common stock issued to pay operating expenses 829,500 1,143,400
Common stock options exercised 73,600 73,600
------------- -------------
Total for 39 weeks ended June 30, 2002 3,552,000 $4,733,900
Note 3 - Stock Option Plans and Employee Retirement Plan
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 Qualified Stock Option Plan; however, only non-statutory options may be
issued under the 2001 Non-Qualified Option Plan. During the 39-week period ended
June 30, 2002, the Company granted 1,508,750 options to employees and directors
at exercise prices ranging from $0.77 to $1.16 per share. During the 39-week
period ended June 30, 2002, the Company cancelled 60,250 options that had been
previously granted under the 2001 Non-Qualified Option Plan.
In October 2001, the Board of Directors authorized a contribution of
$600,000 to the Company's retirement plan, the Employee Stock Bonus Plan ("ESB
Plan"), which represented a contribution for the fiscal year ending September
29, 2002. The Company's contribution was based on an estimate of 10% of the
Company's gross salary and wages for fiscal year 2002. In October 2001, the
Company issued
6
480,000 shares of common stock to the ESB Plan to satisfy this contribution for
fiscal year 2002. At June 30, 2002, the unamortized prepaid ESB Plan
contribution of $39,900 has been recorded as a prepaid Employee Stock Bonus Plan
contribution in equity and will be amortized over the remaining quarter of
fiscal year 2002. If required, the Company may elect to make an additional
contribution at year-end to fulfill the planned 10% contribution level.
Note 4 - Cash Equivalents
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 5 - Inventories, Net
Inventories, net consist of the following:
June 30, 2002 September 30, 2001
------------- ------------------
(Unaudited)
Work in process $1,151,800 $892,700
Finished goods 81,200 221,500
---------- ----------
Total $1,233,000 $1,114,200
========== ==========
Inventories have been presented above net of reserves for excess and obsolete
inventories of approximately $8,196,300 and $8,183,500 at June 30, 2002 and
September 30, 2001, respectively.
Note 6 - Short-Term Debt Instruments
Novalog, a 95% owned subsidiary of the Company, has a secured credit line
of up to $400,000, bearing interest at the prime rate, 4.75% at June 30, 2002.
The credit line is collateralized by a $400,000 certificate of deposit that is
recorded as restricted cash on the consolidated balance sheet. The balance of
the restricted cash is attributable to the Company's deposit on its executive
life insurance. There was $400,000 of unpaid principal and interest due on this
revolving credit line at June 30, 2002.
In March 2002 and April 2002, the Company borrowed $200,000 pursuant to
promissory notes payable in May 2002 and June 2002 from three investors, one of
whom is a director of the Company. The promissory notes bear no interest, but
are partially secured by receivables pursuant to a specific contract. In
consideration of the issuance of the notes, investors received warrants to
purchase an aggregate of 100,000 shares of the Company's common stock at an
exercise price of $1.20 per share. The warrants are exercisable nine months from
the issuance of the notes payable, 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 fair value of the warrants of $51,000 has been
recorded as a discount to the related notes payable and is being amortized over
the term of the notes of 75 days.
In May 2002, the due date of two of the promissory notes, with an aggregate
principal value of $150,000, was extended to July 2002 in consideration for the
issuance of additional warrants to purchase 40,000 shares of the Company's
common stock at an exercise price of $2.40 per share. The other terms of the
additional warrants are similar to those initially issued to the holders of the
promissory notes
7
except that the warrants 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 fair value of the additional
warrants of $42,000 has been recorded as a discount to the related notes payable
and is being amortized over the extended term of the notes. Subsequently, the
due dates of the notes were further extended from July 2002 to September 2002 in
consideration for interest at the rate of 1.5% per month.
Note 7 - Reportable Segments
The Company's operating segments are distinct business units operating in
different industries, except the Corporate Headquarters segment, which includes
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"), MSI, RedHawk, iNetWorks and Corporate Headquarters.
All operating segments except RedHawk and iNetWorks meet the criteria for
reportable segments disclosure as of June 30, 2002. Since no other operating
segments would be included with RedHawk and iNetWorks in a nonspecific category,
the Company has included RedHawk and iNetWorks as reportable operating segments.
ATD derives most of its revenues from research and development contracts funded
primarily by governmental agencies. Novalog designs, develops and sells
proprietary integrated circuits and related products for use in wireless
infrared communications. 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.
The accounting policies used to develop segment information correspond to
those described in the summary of significant accounting policies. Segment loss
is based on loss from continuing operations before minority interest in loss of
subsidiaries and provision for income taxes.
8
The following information about the Company's seven business segments is
for the 39-week period ended June 30, 2002:
RedHawk Corporate
ATD Novalog MSI MPD iNetWorks Vision Headquarters Totals
--- ------- --- --- --------- ------ ------------ ------
Revenues from
external customers $5,662,300 $1,721,500 $533,800 $798,200 $ - $ 23,300 $ - $ 8,739,100
Interest income - 8,000 - - - - 2,700 10,700
Interest expense 12,900 8,500 3,100 1,700 - - 82,000 108,200
Depreciation and 610,200 41,600 153,500 44,700 300 22,800 168,000 1,041,100
amortization
Segment loss (1,003,900) (1,014,000) (921,500) (759,000) (249,100) (142,700) (1,370,600) (5,460,800)
Changes to segment 12,800 5,900 - - - - - 18,700
inventory provision
Segment inventory writedown - 141,500 - - - - - 141,500
Segment assets 7,616,400 1,827,050 672,400 350,000 5,700 95,400 22,447,900 33,014,850
Expenditures for
segment assets 485,500 83,900 39,500 33,000 - - 2,300 644,200
Reconciliation to Consolidated
Amounts Assets
Total assets for reportable segments 33,014,850
Elimination of intersegment assets (22,447,900)
-------------
Total consolidated assets $ 10,566,950
=============
The following information about the Company's seven business segments is
for the 13-week period ended June 30, 2002:
RedHawk Corporate
ATD Novalog MSI MPD iNetWorks Vision Headquarters Totals
--- ------- --- --- --------- ------ ------------ ------
Revenues from
external customers $2,919,500 $744,400 $154,700 $114,500 $ - $ 7,400 $ - $ 3,940,500
Interest income - 3,700 - - - - 200 3,900
Interest expense 4,300 5,600 1,300 800 - - 67,400 79,400
Depreciation and 210,700 14,600 50,400 15,000 100 7,600 54,100 352,500
amortization
Segment operating income 44,500 (530,800) (337,500) (293,200) (25,100) 9,600 (602,200) (1,734,700)
(loss)
Changes to segment (800) 3,300 - - - - - 2,500
inventory provision
Segment inventory writedown - 141,500 - - - - - 141,500
Expenditures for
segment assets 135,100 68,500 23,400 10,700 - - 2,100 239,800
9
After giving effect to the deconsolidation of Silicon Film, the Company had
the following four reportable segments as of July 1, 2001: ATD, Novalog, MSI and
Corporate Headquarters. RedHawk, iNetWorks and MPD were not treated as
reportable segments at July 1, 2001 and are aggregated below as "Other." The
following information about the four segments is for the 39-week period ended
July 1, 2001.
Corporate
ATD Novalog MSI Headquarters Other Totals
--- ------- --- ------------ ----- ------
Revenues from external customers $3,711,400 $4,347,700 $ 108,700 $ - $ 263,900 $ 8,431,700
Interest income 15,800 21,900 - 106,700 5,400 149,800
Interest expense 49,000 700 2,900 34,700 5,200 92,500
Depreciation and amortization 516,200 47,800 145,000 108,500 209,100 1,026,600
Segment operating loss (3,339,700) (233,800) (2,383,100) (2,002,500) (4,055,500) (12,014,600)
Changes to segment inventory
provision 2,296,900 - - - - 2,296,900
Segment assets 7,993,400 2,916,000 812,300 29,770,800 1,457,150 42,949,650
Expenditures for segment assets 2,034,900 147,500 109,200 825,700 529,600 3,646,900
Reconciliation to Consolidated
Amounts
Assets
Total assets for reportable segments $42,949,650
Elimination of intersegment assets (29,770,800)
-------------
Total consolidated assets $13,178,850
=============
The following information about the four segments is for the 13-week period
ended July 1, 2001.
Corporate
ATD Novalog MSI Headquarters Other Totals
--- ------- --- ------------ ----- ------
Revenues from external customers $2,215,400 $1,584,500 $ 93,100 $ - $ 37,900 $ 3,930,900
Interest income - 4,200 - 3,400 100 7,700
Interest expense 14,000 700 - 8,700 1,500 24,900
Depreciation and amortization 199,000 18,300 55,200 27,000 74,000 373,500
Segment operating loss (102,200) (32,400) (501,400) (285,300) (1,629,400) (2,550,700)
Changes to segment inventory (31,300) - - - - (31,300)
provision
Expenditures for segment assets 559,100 113,300 46,500 119,700 279,000 1,117,600
Note 8 - Commitments and Contingencies
From February 14, 2002 to March 15, 2002, five purported class action
complaints were filed in the United States District Court for the Central
District of California against the Company, certain of its current and former
officers and directors, and an officer and director of its 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. Defendants' time to answer or
otherwise respond to the amended complaint is September 3, 2002.
There has been no discovery to date and no trial has yet been scheduled.
The Company believes that it has meritorious defenses to these actions and
intends to defend them vigorously. Failure by the Company to obtain a favorable
resolution of the claims set forth in the actions could have a material
10
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.
In October 2001, a lawsuit was served against the Company in connection
with the Company's guarantee of the abandoned office lease of its former
subsidiary, Silicon Film. The maximum amount of this claim is approximately
$800,000, including past and future rents and excluding any potential sublease
rents. The Company is vigorously defending against this action, and has accrued
for management's estimate of the minimum amount of liability as of June 30,
2002. (see Part II, Item 1. Legal Proceedings)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Report contains forward-looking statements regarding Irvine Sensors
Corporation and its subsidiaries, which include, but are not limited to,
statements concerning projected revenues, expenses, gross profit and income,
market acceptance of the Company's products, the competitive nature of the
Company's business and its markets, the success and timing of new product
introductions and commercialization of the Company's technologies, the need for
additional capital and the outcome of pending litigation. These forward-looking
statements are based on the Company's current expectations, estimates and
projections about the Company's industry, management's beliefs, and certain
assumptions made by management. 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 are not
guarantees of future performance and are subject to risks, uncertainties and
assumptions that are difficult to predict. Therefore, the Company's actual
results could differ materially and adversely from those expressed in any
forward-looking statements as a result of various factors. Such factors include,
but are not limited to the following:
. the ability of the Company to secure additional research and
development contracts;
. the ability of the Company to introduce new products, gain broad
market acceptance for such products and ramp-up manufacturing in a
timely manner;
. the pace at which new markets develop;
. the response of competitors, many of whom are bigger and better
financed than the Company;
. the Company's ability to successfully execute its business plan and
control costs and expenses;
. the Company's ability to establish strategic partnerships to develop
the business of its subsidiaries;
. the depressed market capitalization of the Company;
. the availability of additional financing;
. general economic and political instability; and
. those additional factors which are listed under the section "Risk
Factors" at the end of Item 2 of this Report.
The Company does not undertake any obligation to revise or update publicly
any forward-looking statements for any reason. Additional information on various
risk and uncertainties potentially affecting the Company's results are discussed
below and are contained in publicly filed disclosures available through the
Securities and Exchange Commission EDGAR database (http://www.sec.gov) or from
the Company's Investor Relations Department.
11
Overview
The Company currently has seven operating segments: ATD, Novalog, MPD, MSI,
RedHawk, iNetWorks and Corporate Headquarters. Each segment is separately
managed, with separate marketing and distribution systems. Corporate
Headquarters provides accounting, inventory control and management consulting
services to the consolidated subsidiaries.
Historically, ISC has made significant investments to fund research and
development for its operating subsidiaries. To date, other than Novalog, none of
ISC's subsidiaries have contributed material revenues or earnings to the
Company's consolidated results of operations. During fiscal 2001, ISC adopted a
policy to significantly reduce its investments in its subsidiaries for the near
future. As a result, the subsidiaries may need to seek independent funding or
partner with third parties to finance their operations.
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 which
are most critical to aid in fully understanding and evaluating reported
financial results include the following:
Revenue Recognition
The Company's 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 the Company and
government representatives. The Company's 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.
The Company considers many factors when applying accounting principles
generally accepted in the United States of America related to revenue
recognition. These factors include, but are not limited to:
. The actual contractual terms, such as payment terms, delivery dates,
and pricing of the various product and service elements of a contract;
. Time period over which services are to be performed;
. Costs incurred to date;
. Total estimated costs of the project;
. Anticipated losses on contracts; and
. 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
12
misjudgment or error by management in its evaluation of the factors and the
application of the standards, could have a material adverse affect on the
Company's future operating results.
Valuation Allowances
The Company maintains 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.
Inventories are stated at the lower of cost or market. Each quarter, the
Company evaluates its 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 of the Company's assessment of current and expected
orders from its customers.
The Company recorded a valuation allowance to reduce its deferred tax
assets to the amount that is more likely than not to be realized. The Company
has considered future taxable income and ongoing prudent and feasible tax
planning strategies in assessing the need for the valuation allowance.
Results of Operations
Revenues
Contract revenue consists of proceeds realized from funded research and
development contracts, largely from U.S. Government customers and primarily
conducted by ATD. ATD has recently focused its efforts more on the production of
contract revenue and less on the conduct of internal research and development
projects. The Company's contract revenue for the 13-week and 39-week periods
ended June 30, 2002 was $2,919,500 and $5,662,300, respectively, which
represented an increase of $1,023,100, or 54%, and $2,269,900, or 67%,
respectively, over the 13-week and 39-week periods ended July 1, 2001. The
increase in contract revenue is primarily attributable to the receipt of new
funded contracts and the Company's strategic decision to allocate more resources
to the performance of contract backlog during the current period as opposed to
internal research and development during the comparable period of fiscal 2001.
The Company's product sales decreased $1,013,500 or 50% and $1,962,500 or
39% for the 13-week and 39-week periods ended June 30, 2002, respectively,
compared to the 13-week and 39-week periods ended July 1, 2001. This decrease
was primarily due to a decline in the volume of sales of Novalog products for
use in products by Palm Computing, a primary customer of Novalog. To a much
lesser extent, this decline was also due to pricing pressure on Novalog's
products.
Total contract and product sales revenues for the 13-week period ended June
30, 2002 were $3,940,500, an increase of $9,600 or 0.2% compared to the
$3,930,900 realized in the 13-week period ended July 1, 2001. Total contract and
product sales revenues for the 39-week period ended June 30, 2002 were
$8,739,100, an increase of $307,400 or 4% compared to the $8,431,700 of total
revenues in the 39-week period ended July 1, 2001. Based on existing backlog,
the Company expects that its contract revenue will continue to represent a
higher percentage of its total revenue compared to revenue from product sales
for the balance of fiscal 2002.
13
Cost of Revenues
The Company's cost of contract revenue for the 13-week period ended June
30, 2002 was $1,752,300, which represented a decrease of $9,900, or
approximately 0.6%, from $1,762,200 for the 13-week period ended July 1, 2001.
The cost of contract revenues as a percentage of contract revenues decreased to
60% in the 13-week period ended June 30, 2002 from 93% in the 13-week period
ended July 1, 2001. For the 39-week period ended June 30, 2002, the cost of
contract revenues was $3,798,300, an increase of $908,200 or 31% from $2,890,100
for the 39-week period ended July 1, 2001. The cost of contract revenues as a
percentage of contract revenues was 67% during the 39-week period ended June 30,
2002 as compared to 85% for the 39-week period ended July 1, 2001. The decrease
in costs of contract revenues for the 13-week period ended June 30, 2002 in both
absolute dollars and as a percent of contract revenues, despite the increase in
revenues during that period, was due to a $348,500 reduction in accrued loss on
contracts based on improved performance under existing contracts. The increase
in costs of contract revenues for the current 39-week period reflected the
additional costs incurred to generate the increased revenues from contracts that
are of a cost-plus-fixed fee nature. The improved margin on contract revenues in
the 13-week period ended June 30, 2002, reflects lower labor costs of
approximately $95,000 due to salary reductions during the period.
The Company's cost of product sales for the 13-weeks ended June 30, 2002
was $1,338,600, a decrease of $79,300, or 6%, from $1,417,900 for the 13-week
period ended July 1, 2001. The cost of product sales for the 39-week period
ended June 30, 2002 was $3,036,900, a decrease of $1,271,100, or 30%, from
$4,308,000 for the 39-week period ended July 1, 2001. The 13-week and 39-week
reductions were largely attributable to a decline in the volume of products sold
during those periods in fiscal 2002 versus the comparable periods of fiscal
2001. The cost of product sales as a percentage of product sales increased from
70% to 131% in the 13-week period ended June 30, 2002 compared to the 13-week
period ended July 1, 2001, and increased from 85% to 99% in the 39-week period
ended June 30, 2002 versus July 1, 2001. The decrease in gross margins during
the 13-week and 39-week periods primarily reflects price pressure on Novalog's
products. Novalog recorded a $141,500 inventory writedown and an increase to its
inventory reserve of $3,300 during the 13-week period ended June 30, 2002 to
reflect the lower of cost or market.
General and Administrative Expense
General and administrative expense for the 13-week and 39-week periods
ended June 30, 2002 was $1,967,400 or 50% of total revenues, and $5,653,400 or
65% of total revenues, respectively, as compared to $2,028,800, or 52% of total
revenues, and $8,259,700, or 98% of total revenues, respectively, for the
comparable periods ended in 2001. The current fiscal year figures were
reductions of $61,400, or 3%, and $2,606,300, or 32%, respectively, compared to
the prior year 13-week and 39-week periods ended July 1, 2001. This decrease was
largely attributable to substantial salary and expense reductions in the
Company's operations during the first three quarters of fiscal 2002 versus the
comparable period of fiscal 2001. Management believes that salary and expense
reductions will also favorably impact general and administrative expense in the
last fiscal quarter of fiscal 2002.
Research and Development Expense
The Company's research and development expense for the 13-week period ended
June 30, 2002 was $541,400, which represented a decrease of $714,100, or
approximately 57%, from $1,255,500 for the 13-week period ended July 1, 2001.
For the 39-week period ended June 30, 2002, research and development expense
declined $3,432,000, or 68%, to $1,613,800 from $5,045,800 for the 39-week
period ended July 1, 2001. Research and development expense represented
approximately 14% of the
14
Company's total revenue for the 13-week period ended June 30, 2002, compared to
approximately 32% of the Company's total revenue for the 13-weeks ended July 1,
2001. For the 39-week period ended June 30, 2002, research and development
expense represented approximately 18% of total revenue versus 60% for the
39-week period ended July 1, 2001. These substantial decreases in both absolute
dollars and as a percentage of total revenues were attributable to a shift of
resources from internally funded research, particularly to support the business
plans of subsidiaries, and an increased focus on third-party contract-funded
work, which results in more reimbursed research and development expense. The
Company currently intends to continue focusing its efforts and resources more on
third party contract-related work than on internal research and development.
Accordingly, the Company does not believe that its research and development
expense will increase significantly, either in absolute amount or as a
percentage of total revenues, in the near future.
Interest Expense, Net
Interest expense, net for the 13-week period ended June 30, 2002 was
$79,400, which represented an increase of $54,500 from the 13-week period ended
July 1, 2001. Interest expense, net for the 39-week period ended June 30, 2002
was $108,200, an increase of $15,700 from the 39-week period ended July 1, 2001.
This increase was primarily due to imputed interest associated with short-term
promissory notes issued in March 2002 and April 2002.
Interest income for the 13-week period ended June 30, 2002 was $3,900,
which represented a decrease of $3,800 from the 13-week period ended July 1,
2001. Interest income for the 39-week period ended June 30, 2002 was $10,700, a
decrease of $139,100 from the 39-week period ended July 1, 2001. These
reductions were largely due to lower average interest rates and cash balances
during the 13-week and 39-week periods in fiscal 2002 compared to the
corresponding periods in fiscal 2001, which still reflected cash balances from a
large financing completed in August 2000.
Minority Interest
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. For the 13-week period ended June 30,
2002, the consolidated amount of minority interest loss allocation was $23,600,
of which $26,500 was attributable to Novalog, offset by a minority interest
profit allocation of $2,900 attributable to RedHawk. This aggregate minority
loss allocation was $86,100 less than the aggregate $109,700 allocated minority
interest of the 13-week period ended July 1, 2001, which consisted of $66,400 of
allocated losses attributable to RedHawk, $41,700 of allocated losses
attributable to iNetWorks and $1,600 of allocated losses attributable to
Novalog. For the 39-week period ended June 30, 2002, the consolidated amount of
minority interest loss allocation was $94,000, of which $50,700 was attributable
to Novalog and $43,300 was attributable to RedHawk. This compared to a minority
interest loss allocation of $383,000 for the 39-week period ended July 1, 2001,
consisting of $253,700 attributable to RedHawk, $89,300 attributable to
iNetWorks, $28,200 attributable to MSI and $11,800 attributable to Novalog.
Liquidity and Capital Resources
At June 30, 2002, the Company had consolidated cash and cash equivalents of
$1,122,900, which represents an increase of $742,700 from $380,200 as of
September 30, 2001. The net cash used in operating activities was $2,129,900
during the first 39-week period of fiscal 2002. The primary use of cash was to
fund the loss from the Company's continuing operations.
15
The Company used a net of $522,400 of cash in investing activities during
the 39-week period of fiscal 2002, consisting of $114,300 invested primarily in
patents, $529,900 invested in capital facilities and equipment, a $35,100
increase in restricted cash which was offset by $156,900 in proceeds from sales
of marketable securities. Except for lease agreements for the acquisition of
capital equipment, the Company had no other material capital commitments as of
June 30, 2002. Management expects capital expenditures to remain at comparable
levels for the balance of fiscal 2002.
During the first 39-week period of fiscal 2002, the Company generated net
cash of $3,395,000 from financing activities. Cash provided by financing
activities included $300,000 from the sale of common stock units, $2,241,700
from the sale of common stock, and $587,900 from stock subscriptions received.
During the first 39-week period of fiscal 2002, the Company's subsidiary,
Novalog, borrowed an aggregate of $464,000 and repaid an aggregate of $264,000,
for a net increase of $200,000, under its secured credit line. The credit line
is for borrowings up to $400,000, and is secured by restricted cash of $400,000.
As of June 30, 2002, $400,000 was outstanding under this credit line.
Net cash provided by equity and minority interest transactions was reduced
by principal payments on capital leases payable of $169,100 during the 39-week
period ended June 30, 2002. As a result of net losses during the first 39 weeks
of fiscal 2002, partially offset by cash provided by financing activities, the
Company's consolidated working capital deficit increased from $668,900 at
September 30, 2001 to $1,071,600 at June 30, 2002. This increased working
capital deficit is due to the net effect of the Company's operating losses
during the period versus the financing it has secured during the same interval.
Management believes that its government-funded contract business and its
stacked-memory business will grow during the remainder of fiscal 2002 and
beyond, providing a potential source of working capital growth. However, it may
take several months for the Company to receive payment for receivables generated
by anticipated new contract-related work. Accordingly, in April 2002, the
Company entered into a financing relationship to borrow against government
receivables as they are generated. This agreement permits the Company to borrow
against assigned contracts at its discretion in consideration for interest at a
rate dependent upon duration of borrowing, limited to a maximum of 2% per month.
Management believes that its projected operating results and such receivables
financing, together with its current cash balances, will meet its cash
requirements for the immediate future; however, if this belief proves to be
incorrect there can be no assurance that the Company will be able to secure any
required alternate financing to continue its operations.
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
its inception, the Company has experienced such termination of its contracts on
three occasions. There is no assurance the Company will not experience
suspensions or terminations in the future. Any such termination, if material,
could cause a disruption of the Company's revenue stream, adversely affecting
the Company's results of operations and could result in employee layoffs. At
June 30, 2002, as a result of significant new contract awards in fiscal 2002,
the Company's funded backlog was approximately $5.5 million compared to
approximately $2.1 million at September 30, 2001.
The Company has reserved 171,728 shares of common stock for issuance to its
employees and consultants under its 2001 Compensation Plan as of June 30, 2002.
During the first 39-week period of fiscal 2002, the Company issued 857,262
shares of common stock under this plan as consideration for the cancellation of
outstanding compensation obligations of $991,418 to its employees and two
consultants. The Company currently intends to continue issuing shares of its
common stock to employees and consultants from time to time under this plan.
16
Risk Factors
Our future operating results are highly uncertain. Before deciding to
invest in Irvine Sensors or to maintain or increase your investment, you should
carefully consider the risks described below, in addition to the other
information contained in this prospectus, our Annual Report on Form 10-K, as
amended, and Quarterly Reports on Form 10-Q and in our other filings with the
Commission, including any subsequent reports filed on Forms 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
market price for our common stock could decline and you may lose all or part of
your investment.
If we continue to incur substantial losses, we will not be able to generate
sufficient revenues to fund our operations or achieve profitability. We
experienced net losses of $14.6 million for the year ended September 30, 2001,
$15.0 million for the year ended October 1, 2000 and $9.1 million for the year
ended October 3, 1999. We also incurred net losses of approximately $5.4 million
for the 39 weeks ended June 30, 2002. In recent years, much of our losses were
incurred as a result of our significant investments in our development stage
operating subsidiaries. While we have significantly reduced our investment in
subsidiaries, we anticipate that we will continue to generate net losses in the
future and cannot assure you that we will be able to achieve 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 $10.2 million
for the year ended September 30, 2001 and $2.1 million for the 39 weeks ended
June 30, 2002. At June 30, 2002, we had consolidated negative working capital of
approximately $1.0 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 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
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, 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.
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;
17
. 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;
. 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.
Our common stock may be delisted from the Nasdaq SmallCap 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 currently listed on the Nasdaq SmallCap Market.
Among other requirements, to maintain this listing, our common stock must
continue to trade above $1.00 per share. In July 2001, our stock had failed to
meet this criterion 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 trading 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 the $1.00 per share minimum standard, and we cannot
assure you that the market price will continue to meet Nasdaq minimum standards.
In addition to the price requirement, in the absence of sustained
profitability, we must also meet at least one of the two following additional
standards to maintain our Nasdaq listing: (1) maintenance of tangible net worth
at $2 million or greater or 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. In July 2001, Nasdaq
notified us that we were deficient with respect to both 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
subsequent decline in the price of our common
18
stock resulted in another deficiency notice from Nasdaq in August 2001. In
December 2001, we were notified by Nasdaq that we had reestablished compliance
under the additional compliance requirements. This recompliance was based on
improvements in our stockholders' equity resulting from the net gain of
approximately $1.9 million realized from the discontinuance of operations of our
Silicon Film subsidiary in September 2001. We cannot assure you that we will be
able to maintain compliance with Nasdaq's listing maintenance requirements in
the future. If we fail to meet these or other listing requirements, our common
stock could be delisted, which would eliminate the primary market for your
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 SmallCap Market, your ability to sell
your shares of our stock would also be limited by the penny stock restrictions,
which could further limit the marketability of your shares. If our common stock
is delisted, it would come within the definition of "penny stock" as defined in
the Securities Exchange Act of 1934, as amended, and would be covered by Rule
15g-9 of that Act. That Rule imposes additional sales practice requirements on
broker-dealers who sell securities to persons other than established customers
and accredited investors. For transactions covered by Rule 15g-9, the
broker-dealer must make a special suitability determination for the purchaser
and receive the purchaser's written agreement to the transaction prior to the
sale. Consequently, Rule 15g-9, if it were to become applicable, would affect
the ability or willingness of broker-dealers to sell our securities and
accordingly would affect the ability of stockholders to sell their securities in
the public market. These additional procedures could also limit our ability to
raise additional capital in the future.
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 50% of our revenues for the year ended
September 30, 2001, and represented approximately 65% of our revenues for the 39
weeks ended June 30, 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 win 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 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, 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 consolidated revenues for the year ended September
30, 2001 and for the 39 weeks ended June 30, 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-top computers, the largest user 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, results 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 June 30, 2002, we had approximately 6.9 million
shares of common stock outstanding, of which approximately 4.8 million shares
were freely tradeable, other than restrictions imposed upon our affiliates. This
amount includes the 1,555,707 shares of our common stock for re-sale pursuant to
the registration statement of which this prospectus is a part. An additional 1.0
million shares are subject to contractual restrictions on trading, but become
freely tradable between October 2002 and November
19
2002 when the contractual restrictions expire. The average daily trading volume
of our shares in July 2002 was only approximately 15,800 shares. The freely
tradeable shares, along with the contractually restricted shares, are
significantly greater in number than the daily average trading volume of our
shares. If the selling stockholders, or 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.
Our equity and voting interests in our subsidiaries may become
significantly diluted. The financing of our Novalog and RedHawk subsidiaries to
date have involved significant private sales of common stock of those
subsidiaries representing approximately 32% of the outstanding capital stock of
Novalog and approximately 30% of the outstanding capital stock of RedHawk,
generating net proceeds of approximately $4.1 million for Novalog and
approximately $581,000 for RedHawk. While we repurchased approximately 28% of
the common stock of Novalog from minority investors during fiscal years 1998 and
1999, we do not currently have sufficient discretionary capital to repurchase
additional shares of Novalog or any other subsidiary. As a result of our
decision to significantly reduce our expenditures related to our subsidiaries,
our subsidiaries are independently seeking to sell additional equity interests
to finance at least some portion of their business plans. Such additional
financings may not be available on acceptable terms, it at all. Our ability to
enjoy the benefits of any potential increase in value on the part of our
subsidiaries can be greatly reduced by third-party financings. Additional
financings by our subsidiaries will result in a reduction in our equity
interests in the subsidiaries and reduced control of our subsidiaries.
Significant third-party investment in our subsidiaries will likely result in
third-party investors receiving subsidiary board representation and/or
protective covenants that could further reduce our voting control over the
subsidiaries.
In certain circumstances, it is possible that we or our subsidiaries 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, it is not uncommon for prospective investment agreements to contain these
contractual provisions.
Third-party financings of subsidiaries will also inherently complicate our
fiduciary and contractual obligations and could leave us more vulnerable to
potential future litigation. The outcome of litigation is inherently
unpredictable, and even the costs of prosecution could have a materially adverse
effect on our results of operations.
Our government-funded research and development business depends on 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 30, 2001, 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 Army and the Air Force
each accounted for approximately 5% of our consolidated revenues, but the U.S.
Navy accounted for approximately 32% of our consolidated revenues. In addition,
approximately 9% of our consolidated revenues were derived from a limited number
of prime government contractors. Although we ultimately plan to shift our focus
to include the commercialization of our technology, we expect to continue to be
dependent upon research and development contracts with federal agencies and
their contractors for a substantial portion of our 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.
20
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 these factors. Therefore,
cutbacks or re-allocations in the federal budget could have a material adverse
impact on our 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 own rules and regulations with which we must comply and which can vary
significantly among agencies. Governmental agencies also often retain some
portion of fees 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 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. 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 of working capital. Because
over 50% of our consolidated revenues in the year ended September 30, 2001 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, two of which accounted for approximately 12%
and 10% of our consolidated revenues. Both of these OEMs are suppliers to Palm
Computing. A majority of Novalog's product sales in fiscal 2000 and fiscal 2001
were derived from sales for use in Palm's products. As such, the decline in
Palm's business during fiscal 2001 was a primary cause of the 29% decline in
Novalog's sales for that period and the approximately 60% decline in Novalog's
sales for the first 39 weeks of fiscal 2002 as compared to the comparable period
in fiscal 2001. 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 not 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 these circumstances can be difficult to
predict. Many of our planned products incorporate our chip stacking technologies
that have not yet achieved broad market acceptance. We cannot assure you that
our present or future products will achieve market acceptance on a sustained
basis. In addition, due to our historical focus on research and development, we
have a limited history of competing in the intensely competitive commercial
electronics industry. As such, we cannot assure you that we will successfully
develop, manufacture and market additional commercial product lines or that such
product lines will be accepted in the commercial
21
marketplace. If we are not successful, our ability to generate revenues and our
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 our success, and that of
our subsidiaries, will depend, in part, on the strength of our existing patent
protection and the additional patent protection that we and our subsidiaries may
acquire in the future. As of June 30, 2002, Irvine Sensors owned 43 U.S. patents
in force and nine foreign patents and has other patent applications pending
before the U.S. Patent and Trademark Office as well as various foreign
jurisdictions. It is possible that any existing patents or future patents, if
any, could be challenged, invalidated or circumvented, and any right granted
under these patents may not provide us with meaningful protection from
competition. Despite our precautions, it may be possible for a third party to
copy or otherwise obtain and use our products, services or technology without
authorization, to develop similar technology independently or to design around
our patents. In 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. We cannot assure you that these measures will adequately protect
the confidentiality of our proprietary information or that others will not
independently develop products or technology that are equivalent or superior to
ours.
In addition, other companies may hold or obtain patents or inventions or
may otherwise claim proprietary rights to technology useful or necessary to our
business. We cannot predict the extent to which we may be required to seek
licenses under such proprietary rights of third parties and the cost or
availability of these licenses. While it may be necessary or desirable in the
future to obtain licenses relating to one or more proposed products or relating
to current or future technologies, we cannot assure you that we will be able to
do so on commercially reasonable terms, if at all. If we are not able to obtain
crucial 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 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 provide vigorous defense or enforcement of our patents or
other proprietary information.
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 to us
through our patents, proprietary information and other intellectual property,
will not extend to government markets that utilize certain segments of our
technology. The government has the right to royalty-free use of technologies
that we have developed under government contracts, including portions of our
stacked circuitry technology. While we are generally free to commercially
exploit these government-funded technologies and we may assert our intellectual
property rights to seek to block other
22
non-government users of the same, we cannot assure you that we will be
successful in our attempts to do so.
We are subject to significant competition which could prevent us from
increasing or sustaining our revenue. We face strong 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 we or our 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 we will be
able to compete successfully with these other 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 resources than us. As a result, these
competitors may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements. They may also be able to devote greater
resources to the promotion and sale of their products. Increased competition has
in the past resulted in price reductions, reduced gross margins and loss of
market share, and this trend may continue in the future. We cannot assure you
that we will be able to continue to compete successfully or that competitive
pressures will not materially and adversely affect our business, financial
condition and results of operations.
If we are unable to maintain our relationships with contract manufacturers,
we may not be able to fulfill our backlog in any given quarter and our revenues
could be materially adversely affected. We extensively rely on contract
manufacturers and do not have any long-term supply agreements with contract
manufacturers or other suppliers. Because we rely on contract manufacturers with
limited capacity, we face several significant risks, including a lack of ensured
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 cover changing
manufacturing needs in the future. Failure to do so will have a material adverse
impact on our operations.
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. 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 we do. Developments by any of these
companies could have a materially adverse effect on us if we are not able to
keep up with the same developments. Our future success will depend on our
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 our results of operations could be materially
and adversely affected. We depend to a large extent on the abilities and
continued participation of our executive officers and other key employees,
particularly John Carson, our president and John Stuart, our chief financial
officer. The loss of any key employee could have a material adverse effect on
our business. While we have adopted employee stock option plans designed to
attract and retain key employees, our stock price has declined in recent
periods, and we cannot guarantee that options granted under our plans will be
effective in retaining key employees. We do not presently maintain "key man"
insurance on any key employees. We believe that, as our activities increase and
change in character, additional, experienced personnel will be required to
implement our
23
business plan. Competition for such personnel is intense and we cannot assure
you that they will be available when required, or that we 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 $0.77 per 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 market 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;
. 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 currently subject to class
action lawsuits that could result in substantial losses and divert management's
attention and resources from other matters.
Our international operations are subject to many inherent risks, any of
which may adversely affect our business, financial condition and results of
operations. Approximately 10% of our consolidated total revenues in the year
ended September 30, 2001 and approximately 5% for the 39 weeks ended June 30,
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;
. trade restrictions;
. 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;
24
. 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 facing our company. Additional risks and
uncertainties not presently known to us or that we currently deem immaterial may
also adversely affect our business operations.
25
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
From February 14, 2002 to March 15, 2002, five purported class action
complaints were filed in the United States District Court for the Central
District of California against the Company, certain of its current and former
officers and directors, and an officer and director of its 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. Defendants' time to answer or
otherwise respond to the amended complaint is September 3, 2002.
There has been no discovery to date and no trial has yet been scheduled.
The Company believes that it has meritorious defenses to these actions and
intends to defend them vigorously. Failure by the Company to obtain a favorable
resolution of the claims set forth in the actions 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.
On October 11, 2001, a complaint was filed in the California Superior Court
in and for the County of Orange alleging that the Company had breached a
guaranty of its former subsidiary Silicon Film's office lease in Irvine,
California. The complaint seeks back rent in the amount of approximately
$205,700 and future rent in an unspecified amount. On May 14, 2002, the
plaintiff moved for summary judgment in the amount of approximately $842,700.
The Court issued a tentative ruling denying summary judgment at a hearing on
July 19, 2002, indicating that triable issues of material fact existing
regarding plaintiff's calculation of damages and efforts to mitigate its damage.
Significant discovery remains outstanding and depositions remain to be
scheduled. Plaintiff's counsel has recently represented that plaintiff is in the
final stages of negotiations with a prospective tenant for the premises formerly
occupied by Silicon Film. In the event that the premises were re-let,
plaintiff's counsel has indicated that the Company's potential liability under
the guarantee would be reduced to a range between $550,000 to $600,000.
Management believes that the Company has defenses against this potential
liability and has accrued for management's estimate of the minimum liability as
of June 30, 2002. The Company is defending the matter vigorously and is pursuing
defenses to both liability and the amount of alleged damages. Failure by the
Company to obtain a favorable resolution of the claims set forth in the
complaint could have a material adverse effect on the Company's business,
results of operations and financial condition.
Item 2. Changes in Securities and Use of Proceeds
(c) In March 2002 and April 2002, the Company issued $200,000 aggregate
principal amount of non-interest bearing promissory notes to three private
accredited investors, including Wolfgang Seidel, one of the Company's outside
directors. The notes mature 75 days from issuance. In connection with this loan,
the Company also issued to these investors warrants to purchase up to 100,000
shares of the Company's common stock at a price per share of $1.20. The warrants
become exercisable nine months
26
after issuance and expire 18 months after issuance. Mr. Seidel received warrants
to purchase 25,000 shares in this transaction. In May 2002, the due date of two
of the promissory notes, with an aggregate principal value of $150,000, was
extended to July 2002 in consideration for the issuance of additional warrants
to purchase 40,000 shares of the Company's common stock at an exercise price of
$2.40 per share. Mr. Seidel did not receive any of these additional warrants.
The Company believes the issuance of the warrants was exempt from registration
under the 1933 Securities Act (the "Act") pursuant to the private placement
exemption available under Section 4(2) of the Act.
In April 2002, the Company issued 700,000 shares of common stock and
warrants to purchase an additional 210,000 shares of its common stock to two
accredited investors in a private placement. The warrants are exercisable for
three years from their issuance at an exercise price of $2.32 per share. The
Company believes the issuance of the shares and warrants was exempt from
registration under Act pursuant to the private placement exemption available
under Section 4(2) of the Act.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
10.1 Contract No. DAAD17-01-D-0006, dated May 21, 2002, by and between
the Company and the Army Research Laboratory, as amended.
10.2 Contract No. DASG60-02-C-0029, dated May 7, 2002, by and between
the Company and the U.S. Army Space and Missile Defense, as
amended.
99.1 Periodic Report Certification of the Chief Executive Officer and
Chief Financial Officer.
(b) Reports on Form 8-K.
Form 8-K filed on May 3, 2002, including a message from Robert G. Richards,
the Company's Chief Executive Officer.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 14, 2002 Irvine Sensors Corporation
(Registrant)
By: /s/ John J. Stuart, Jr.
John J. Stuart, Jr.
Chief Financial Officer
(Principal Financial and Chief Accounting Officer)
28