Attached files
file | filename |
---|---|
EX-32 - EX-32 - ISC8 INC. /DE | a56102exv32.htm |
EX-10.9 - EX-10.9 - ISC8 INC. /DE | a56102exv10w9.htm |
EX-10.8 - EX-10.8 - ISC8 INC. /DE | a56102exv10w8.htm |
EX-10.2 - EX-10.2 - ISC8 INC. /DE | a56102exv10w2.htm |
EX-31.2 - EX-31.2 - ISC8 INC. /DE | a56102exv31w2.htm |
EX-10.6 - EX-10.6 - ISC8 INC. /DE | a56102exv10w6.htm |
EX-10.7 - EX-10.7 - ISC8 INC. /DE | a56102exv10w7.htm |
EX-31.1 - EX-31.1 - ISC8 INC. /DE | a56102exv31w1.htm |
EX-10.13 - EX-10.13 - ISC8 INC. /DE | a56102exv10w13.htm |
EX-10.11 - EX-10.11 - ISC8 INC. /DE | a56102exv10w11.htm |
EX-10.10 - EX-10.10 - ISC8 INC. /DE | a56102exv10w10.htm |
EX-10.12 - EX-10.12 - ISC8 INC. /DE | a56102exv10w12.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 28, 2010
OR
o | 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
IRVINE SENSORS CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 33-0280334 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) |
3001 Red Hill Avenue,
Costa Mesa, California 92626
(Address of Principal Executive Offices) (Zip Code)
Costa Mesa, California 92626
(Address of Principal Executive Offices) (Zip Code)
(714) 549-8211
(Registrants Telephone Number, Including Area Code)
(Registrants Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, (the Exchange
Act) 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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). Yes
o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Smaller reporting company þ | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
As of May 7, 2010, there were 16,526,966 shares of common stock outstanding.
IRVINE SENSORS CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE FISCAL PERIOD ENDED MARCH 28, 2010
FOR THE FISCAL PERIOD ENDED MARCH 28, 2010
TABLE OF CONTENTS
PAGE | ||||||||
3 | ||||||||
24 | ||||||||
40 | ||||||||
40 | ||||||||
42 | ||||||||
42 | ||||||||
54 | ||||||||
54 | ||||||||
54 | ||||||||
54 | ||||||||
54 | ||||||||
56 | ||||||||
EX-10.2 | ||||||||
EX-10.6 | ||||||||
EX-10.7 | ||||||||
EX-10.8 | ||||||||
EX-10.9 | ||||||||
EX-10.10 | ||||||||
EX-10.11 | ||||||||
EX-10.12 | ||||||||
EX-10.13 | ||||||||
EX-31.1 | ||||||||
EX-31.2 | ||||||||
EX-32 |
In this report, the terms Irvine Sensors, Company, we, us and our refer to Irvine Sensors
Corporation (ISC) and its subsidiaries.
Irvine Sensors®, TOWHAWK, iNetWorks, Novalog, Personal Miniature Thermal Viewer, PMTV®,
Cam-Noir, Eagle Boards and RedHawk are among the Companys trademarks. Any other trademarks or
trade names mentioned in this report are the property of their respective owners.
2
Table of Contents
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
IRVINE SENSORS CORPORATION
CONSOLIDATED BALANCE SHEETS
March 28, 2010 | ||||||||
(Unaudited) | September 27, 2009 | |||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 110,600 | $ | 125,700 | ||||
Accounts receivable, net of allowance for doubtful accounts of $15,000 and $15,000, respectively |
1,059,400 | 1,396,300 | ||||||
Unbilled revenues on uncompleted contracts |
765,900 | 885,300 | ||||||
Inventory, net |
928,500 | 441,100 | ||||||
Prepaid expenses and other current assets |
365,700 | 53,200 | ||||||
Total current assets |
3,230,100 | 2,901,600 | ||||||
Property and equipment, net |
2,364,800 | 2,845,200 | ||||||
Intangible assets, net |
50,500 | 67,300 | ||||||
Deferred financing costs |
501,900 | | ||||||
Deposits |
37,400 | 37,500 | ||||||
Total assets |
$ | 6,184,700 | $ | 5,851,600 | ||||
Liabilities and Stockholders Deficit |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 3,723,900 | $ | 3,427,100 | ||||
Accrued expenses |
3,707,800 | 3,730,800 | ||||||
Accrued estimated loss on contracts |
15,000 | | ||||||
Advance billings on uncompleted contracts |
323,700 | 249,600 | ||||||
Advances against accounts receivable |
329,100 | 985,800 | ||||||
Deferred revenue |
12,400 | 180,000 | ||||||
Restructured debt, net of debt discounts |
163,100 | 188,400 | ||||||
Promissory note payable related party |
| 400,000 | ||||||
Debentures, net of debt discounts |
1,398,500 | | ||||||
Capital lease obligations |
2,000 | 11,200 | ||||||
Total current liabilities |
9,675,500 | 9,172,900 | ||||||
Secured promissory note |
2,500,000 | | ||||||
Executive Salary Continuation Plan liability |
935,900 | 1,057,600 | ||||||
Total liabilities |
13,111,400 | 10,230,500 | ||||||
Commitments and contingencies (Note 10) |
||||||||
Stockholders deficit: |
||||||||
Preferred stock, $0.01 par value, 1,000,000 and 1,000,000 shares authorized, respectively; |
500 | 1,200 | ||||||
Series A-1 20,800 (unaudited) and 99,900 shares issued and outstanding, respectively (1);
liquidation preference of $670,800 (unaudited) and $3,586,200, respectively; |
||||||||
Series A-2 22,500 (unaudited) and 25,000 shares issued and outstanding, respectively (1);
liquidation preference of $908,700 (unaudited) and $1,043,500, respectively; |
||||||||
Series B -3,500 (unaudited) and 0 shares issued and outstanding, respectively (1);
liquidation preference of $3,490,000 (unaudited) and $0, respectively |
||||||||
Common stock, $0.01 par value, 150,000,000 and 150,000,000 shares authorized, respectively;
15,874,100 and 9,694,500 shares issued and outstanding, respectively (1) |
158,700 | 96,900 | ||||||
Common stock held by Rabbi Trust |
(1,169,600 | ) | (1,169,600 | ) | ||||
Deferred compensation liability |
1,169,600 | 1,169,600 | ||||||
Paid-in capital |
162,365,600 | 162,497,700 | ||||||
Accumulated deficit |
(169,775,900 | ) | (167,299,100 | ) | ||||
Irvine Sensors Corporation stockholders deficit |
(7,251,100 | ) | (4,703,300 | ) | ||||
Noncontrolling interest |
324,400 | 324,400 | ||||||
Total stockholders deficit |
(6,926,700 | ) | (4,378,900 | ) | ||||
Total liabilities and stockholders deficit |
$ | 6,184,700 | $ | 5,851,600 | ||||
(1) | The number of shares of preferred stock and common stock issued and outstanding have been rounded to nearest one hundred (100). |
See Accompanying Condensed Notes to Consolidated Financial Statements.
3
Table of Contents
IRVINE SENSORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
13 Weeks Ended | 26 Weeks Ended | |||||||||||||||
March 28, | March 29, | March 28, | March 29, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Revenues: |
||||||||||||||||
Contract research and development revenue |
$ | 2,014,300 | $ | 2,295,300 | $ | 4,773,700 | $ | 4,738,500 | ||||||||
Product sales |
700,400 | 545,900 | 1,147,400 | 836,700 | ||||||||||||
Other revenue |
6,700 | | 10,500 | 9,500 | ||||||||||||
Total revenues |
2,721,400 | 2,841,200 | 5,931,600 | 5,584,700 | ||||||||||||
Cost and expenses: |
||||||||||||||||
Cost of contract research and development revenue |
1,468,700 | 2,008,500 | 3,504,900 | 3,945,900 | ||||||||||||
Cost of product sales |
704,500 | 409,800 | 1,107,300 | 787,800 | ||||||||||||
General and administrative expense |
1,476,600 | 2,258,900 | 3,128,000 | 4,119,700 | ||||||||||||
Research and development expense |
601,000 | 436,300 | 1,356,200 | 786,700 | ||||||||||||
Total costs and expenses |
4,250,800 | 5,113,500 | 9,096,400 | 9,640,100 | ||||||||||||
Gain on sale or disposal of assets |
| 8,632,800 | 12,500 | 8,632,800 | ||||||||||||
Income (loss) from operations |
(1,529,400 | ) | 6,360,500 | (3,152,300 | ) | 4,577,400 | ||||||||||
Interest expense |
(131,200 | ) | (830,600 | ) | (246,100 | ) | (1,239,700 | ) | ||||||||
Provision for litigation judgment |
| | (20,200 | ) | | |||||||||||
Litigation settlement expense |
(1,820,700 | ) | | (1,820,700 | ) | | ||||||||||
Change in fair value of derivative instrument |
14,500 | | 60,000 | | ||||||||||||
Interest and other income (expense) |
700 | 15,100 | (300 | ) | 46,700 | |||||||||||
Income (loss) from continuing operations before
provision for income taxes |
(3,466,100 | ) | 5,545,000 | (5,179,600 | ) | 3,384,400 | ||||||||||
Benefit (provision) for income taxes |
46,500 | (410,100 | ) | 43,300 | (429,000 | ) | ||||||||||
Income (loss) from continuing operations |
(3,419,600 | ) | 5,134,900 | (5,136,300 | ) | 2,955,400 | ||||||||||
Discontinued operations: |
||||||||||||||||
Income (loss) from discontinued operations |
| (6,900 | ) | | 58,400 | |||||||||||
Net income (loss) |
(3,419,600 | ) | 5,128,000 | (5,136,300 | ) | 3,013,800 | ||||||||||
Add net income attributable to noncontrolling
interests in subsidiary |
| | | 100 | ||||||||||||
Net income (loss) attributable to Company |
$ | (3,419,600 | ) | $ | 5,128,000 | $ | (5,136,300 | ) | $ | 3,013,900 | ||||||
Basic and diluted net income (loss)
per common share information: |
||||||||||||||||
From continuing operations
attributable to Company |
$ | (0.24 | ) | $ | 0.87 | $ | (0.54 | ) | $ | 0.50 | ||||||
From discontinued operations
attributable to Company |
| | | 0.01 | ||||||||||||
Basic and diluted net income (loss) attributable to
Company per common share |
$ | (0.24 | ) | $ | 0.87 | $ | (0.54 | ) | $ | 0.51 | ||||||
Weighted average number of common shares
outstanding, basic and diluted |
14,351,900 | 5,790,500 | 12,246,700 | 5,544,700 | ||||||||||||
See Accompanying Condensed Notes to Consolidated Financial Statements.
4
Table of Contents
IRVINE SENSORS CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS DEFICIT
CONSOLIDATED STATEMENT OF STOCKHOLDERS DEFICIT
Common | ||||||||||||||||||||||||||||||||||||||||||||||||
Series A-1 and A-2 | Series B | Stock | ||||||||||||||||||||||||||||||||||||||||||||||
Preferred Stock | Preferred Stock | Common Stock | Warrants | Prepaid | Total | |||||||||||||||||||||||||||||||||||||||||||
Shares Issued (1) | Shares Issued (1) | Shares Issued (1) | Issued (1) | Stock-Based | Accumulated | Noncontrolling | Stockholders | |||||||||||||||||||||||||||||||||||||||||
Number | Amount | Number | Amount | Number | Amount | Number | Compensation | Paid-in Capital | Deficit | Interest | Equity (Deficit) | |||||||||||||||||||||||||||||||||||||
Balance at September 28, 2008 |
126,000 | $ | 1,300 | | $ | | 3,557,200 | $ | 35,600 | 717,900 | $ | | $ | 159,717,800 | $ | (168,213,900 | ) | $ | 411,600 | $ | (8,047,600 | ) | ||||||||||||||||||||||||||
Common stock issued to employee retirement plans |
| | | | 1,785,700 | 17,900 | | (750,000 | ) | 732,100 | | | | |||||||||||||||||||||||||||||||||||
Common stock issued to pay operating expenses |
| | | | 339,800 | 3,400 | | | 129,700 | | | 133,100 | ||||||||||||||||||||||||||||||||||||
Common stock issued to investment banking firm |
| | | | 315,000 | 3,100 | | | 122,400 | | | 125,500 | ||||||||||||||||||||||||||||||||||||
Common stock issued to purchasers of debt |
| | | | 575,600 | 5,800 | | | 244,200 | | | 250,000 | ||||||||||||||||||||||||||||||||||||
Stock-based compensation expense vested stock |
| | | | 1,600 | | | | 600 | | | 600 | ||||||||||||||||||||||||||||||||||||
Common stock warrants issued to investment banking firm |
| | | | | | 299,300 | | 92,100 | | | 92,100 | ||||||||||||||||||||||||||||||||||||
Additional common stock warrants
issued under anti-dilution provisions |
| | | | | | 504,000 | | | | | | ||||||||||||||||||||||||||||||||||||
Common stock warrants expired |
| | | | | | (59,900 | ) | | | | | | |||||||||||||||||||||||||||||||||||
Stock-based compensation expense options |
| | | | | | | | 27,900 | | | 27,900 | ||||||||||||||||||||||||||||||||||||
Preferred stock issued to retire debt |
25,000 | 300 | | | | | | | 999,700 | | | 1,000,000 | ||||||||||||||||||||||||||||||||||||
Common stock issued upon conversion of preferred stock |
(26,100 | ) | (400 | ) | | | 1,956,300 | 19,600 | | | (19,200 | ) | | | | |||||||||||||||||||||||||||||||||
Common stock issued to convert debt |
| | | | 1,089,000 | 10,800 | | | 337,600 | | | 348,400 | ||||||||||||||||||||||||||||||||||||
Amortization of deferred stock-based compensation |
| | | | | | | | 113,500 | | | 113,500 | ||||||||||||||||||||||||||||||||||||
Issuance of nonvested stock, net |
| | | | 74,300 | 700 | | | (700 | ) | | | | |||||||||||||||||||||||||||||||||||
Amortization of employee retirement plan contributions |
| | | | | | | 750,000 | | | | 750,000 | ||||||||||||||||||||||||||||||||||||
Optex minority interest |
| (87,100 | ) | (87,100 | ) | |||||||||||||||||||||||||||||||||||||||||||
Net income |
| | | | | | | | | 914,800 | (100 | ) | 914,700 | |||||||||||||||||||||||||||||||||||
Balance at September 27, 2009 |
124,900 | 1,200 | | | 9,694,500 | 96,900 | 1,461,300 | | 162,497,700 | (167,299,100 | ) | $ | 324,400 | (4,378,900 | ) | |||||||||||||||||||||||||||||||||
Cumulative-effect adjustment of adopting ASC 815-40 |
| | | | | | | | (4,230,000 | ) | 4,130,500 | | (99,500 | ) | ||||||||||||||||||||||||||||||||||
Sale of preferred stock, net of financing costs and
value assigned to warrants issued to investors |
| | 3,500 | | | | | | 1,307,900 | | 1,307,900 | |||||||||||||||||||||||||||||||||||||
Common stock warrants issued to preferred stock investors |
| | | | | | 2,094,000 | | 424,000 | | | 424,000 | ||||||||||||||||||||||||||||||||||||
Deemed dividend of beneficial conversion feature of
preferred stock issuance
to preferred stock investors |
| | | | | | | | 1,471,000 | (1,471,000 | ) | | | |||||||||||||||||||||||||||||||||||
Common stock issued upon conversion of preferred stock |
(81,500 | ) | (700 | ) | | | 6,176,600 | 61,800 | | | (61,100 | ) | | | | |||||||||||||||||||||||||||||||||
Stock-based compensation expense vested stock |
| | | | 1,800 | | | | 700 | | | 700 | ||||||||||||||||||||||||||||||||||||
Beneficial conversion feature of debentures |
| | | | | | | | 102,200 | | | 102,200 | ||||||||||||||||||||||||||||||||||||
Common stock warrants issued to debenture investors |
| | | | | | 860,000 | | 163,500 | | | 163,500 | ||||||||||||||||||||||||||||||||||||
Common stock warrants issued to investment banking firm |
| | | | | | 2,244,100 | | 643,800 | | | 643,800 | ||||||||||||||||||||||||||||||||||||
Common stock warrants expired |
| | | | | | (1,477,500 | ) | | | | | | |||||||||||||||||||||||||||||||||||
Additional common stock warrants
issued under anti-dilution provisions |
| | | | | | 715,500 | | | | | | ||||||||||||||||||||||||||||||||||||
Issuance of nonvested stock, net |
| | | | 1,200 | | | | | | | | ||||||||||||||||||||||||||||||||||||
Amortization of deferred stock-based compensation |
| | | | | | | | 43,700 | | | 43,700 | ||||||||||||||||||||||||||||||||||||
Stock-based compensation expense options |
| | | | | | | | 2,200 | | | 2,200 | ||||||||||||||||||||||||||||||||||||
Net loss |
| | | | | | | | | (5,136,300 | ) | | (5,136,300 | ) | ||||||||||||||||||||||||||||||||||
Balance at March 28, 2010 (Unaudited) |
43,400 | $ | 500 | 3,500 | $ | | 15,874,100 | $ | 158,700 | 5,897,400 | $ | | $ | 162,365,600 | $ | (169,775,900 | ) | $ | 324,400 | $ | (6,926,700 | ) | ||||||||||||||||||||||||||
(1) | Amounts of preferred stock, common stock and warrants issued have been rounded to nearest one hundred (100). |
See Accompanying Condensed Notes to Consolidated Financial Statements.
5
Table of Contents
IRVINE SENSORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
26 Weeks Ended | ||||||||
March 28, 2010 | March 29, 2009 | |||||||
Cash flows from operating activities: |
||||||||
Net income (loss) |
$ | (5,136,300 | ) | $ | 3,013,900 | |||
Add back (income) loss from discontinued operations |
| (58,400 | ) | |||||
Income (loss) from continuing operations |
(5,136,300 | ) | 2,955,500 | |||||
Adjustments to reconcile income (loss) from continuing operations
to net cash used in operating activities: |
||||||||
Depreciation and amortization |
688,500 | 975,800 | ||||||
Provision for allowance for inventory valuation |
148,900 | 166,600 | ||||||
Non-cash interest expense |
15,800 | 829,200 | ||||||
Non-cash employee retirement plan contributions |
| 444,000 | ||||||
Non-cash litigation settlement |
1,820,700 | | ||||||
Gain on sales or disposal of assets |
(12,500 | ) | (8,632,800 | ) | ||||
Change in fair value of derivative instrument |
(60,000 | ) | | |||||
Net loss attributable to noncontrolling interests |
| (100 | ) | |||||
Common stock issued to pay operating expenses |
| 253,000 | ||||||
Non-cash stock-based compensation |
46,600 | 54,700 | ||||||
Decrease (increase) in accounts receivable |
336,900 | (575,300 | ) | |||||
Decrease in unbilled revenues on uncompleted contracts |
119,400 | 468,200 | ||||||
Increase in inventory |
(636,300 | ) | (283,900 | ) | ||||
Increase in prepaid expenses and other current assets |
(193,500 | ) | (187,800 | ) | ||||
Decrease in other assets |
100 | 63,500 | ||||||
Increase (decrease) in accounts payable and accrued expenses |
513,600 | (1,775,500 | ) | |||||
Increase (decrease) in accrued estimated loss on contracts |
15,000 | (144,500 | ) | |||||
Decrease in Executive Salary Continuation Plan liability |
(121,700 | ) | (62,200 | ) | ||||
Increase in advance billings on uncompleted contracts |
74,100 | 6,200 | ||||||
Decrease in deferred revenue |
(167,600 | ) | (95,000 | ) | ||||
Total adjustments |
2,588,000 | (8,495,900 | ) | |||||
Net cash used in operating activities |
(2,548,300 | ) | (5,540,400 | ) | ||||
Cash flows from investing activities: |
||||||||
Property and equipment expenditures |
(171,900 | ) | (40,500 | ) | ||||
Gross proceeds from sales of fixed assets and intangibles |
12,500 | 9,500,000 | ||||||
Receivable from patent sale |
| (1,000,000 | ) | |||||
Transfer of fixed asset from contract expense |
(19,300 | ) | (12,800 | ) | ||||
Acquisition and costs related to patents |
| (151,000 | ) | |||||
Increase in restricted cash |
| (5,700 | ) | |||||
Net cash used in investing activities |
(178,700 | ) | 8,290,000 | |||||
Cash flows from financing activities: |
||||||||
Proceeds from sale of preferred stock |
2,049,500 | | ||||||
Principal payments of notes payable |
(25,300 | ) | (3,063,700 | ) | ||||
Proceeds from senior promissory notes |
| 1,000,000 | ||||||
Proceeds from sale of debenture units |
1,651,300 | | ||||||
Debt issuance costs paid |
(297,700 | ) | (227,000 | ) | ||||
Decrease in advances against accounts receivable |
(656,700 | ) | | |||||
Principal payments of capital leases |
(9,200 | ) | (19,000 | ) | ||||
Net cash provided by (used in) financing activities |
2,711,900 | (2,309,700 | ) | |||||
Cash flows from discontinued operations: |
||||||||
Net cash used in operating activities |
| (275,000 | ) | |||||
Net increase (decrease) in cash and cash equivalents |
(15,100 | ) | 164,900 | |||||
Cash and cash equivalents at beginning of period |
125,700 | 638,600 | ||||||
Cash and cash equivalents at end of period |
$ | 110,600 | $ | 803,500 | ||||
Non-cash investing and financing activities: |
||||||||
Conversion of preferred stock to common stock |
$ | 2,470,600 | $ | | ||||
Issuance of warrants |
$ | 643,800 | $ | | ||||
Supplemental cash flow information: |
||||||||
Cash paid for interest |
$ | 155,700 | $ | 186,700 | ||||
Cash paid for income taxes |
$ | 3,200 | $ | 63,600 |
See Accompanying Condensed Notes to Consolidated Financial Statements.
6
Table of Contents
IRVINE SENSORS CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 General
The information contained in the following Condensed Notes to Consolidated Financial
Statements is condensed from that which appear in the audited consolidated financial statements for
Irvine Sensors Corporation (ISC) and its subsidiaries (together with ISC, the Company), and the
accompanying unaudited consolidated financial statements do not include certain financial
presentations normally required under accounting principles generally accepted in the United States
of America (GAAP). Accordingly, the unaudited consolidated financial statements included herein
should be read in conjunction with the audited consolidated financial statements and related notes
thereto contained in the Annual Report on Form 10-K of the Company for the fiscal year ended
September 27, 2009 (fiscal 2009). It should be understood that accounting measurements at
interim dates inherently involve greater reliance on estimates than at fiscal year-end. The
results of operations for the interim periods presented are not necessarily indicative of the
results expected for the entire fiscal year.
The consolidated financial information for the 13-week and 26-week periods ended March 28,
2010 and March 29, 2009 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 March 28, 2010, and the results of its operations
and its cash flows for the 13-week and 26-week periods ended March 28, 2010 and March 29, 2009.
On October 14, 2008, substantially all of the assets of Optex Systems, Inc., a Texas
corporation (Optex) and a wholly-owned subsidiary of ISC, were sold pursuant to a UCC public
foreclosure sale (the Optex Asset Sale). The Optex Asset Sale was completed as contemplated by a
binding Memorandum of Understanding for Settlement and Debt Conversion Agreement dated September
19, 2008 (the MOU) between the Company and its senior lenders, Longview Fund, L.P. (Longview)
and Alpha Capital Anstalt (Alpha). Longview and Alpha are sometimes collectively referred to as
the Lenders. As agreed to in the MOU, Optex Systems, Inc., a Delaware corporation controlled by
the Lenders (Optex-Delaware), credit bid $15 million in this UCC public foreclosure sale, and its
offer was the winning bid. As a result, $15 million of the Companys aggregate indebtedness to the
Lenders was extinguished. All of the Companys financial statements and notes and schedules thereto
give effect to this event and report Optex as a discontinued operation for both the current and
prior fiscal periods. Optex filed a voluntary petition for relief under Chapter 7 of the United
States Bankruptcy Code in the United States Bankruptcy Court for the District of California in
September 2009 (the Optex bankruptcy). None of the Companys subsidiaries accounted for more
than 10% of the Companys total assets at March 28, 2010 or had separate employees or facilities at
such date.
The consolidated financial information as of September 27, 2009 included herein has been
derived from the Companys audited consolidated financial statements as of, and for the fiscal year
ended, September 27, 2009.
Description of Business
The Company is a vision systems company enabled by technology for three-dimensional packaging
of electronics and manufacturing of electro-optical products. The Company designs, develops,
manufactures and sells vision systems, miniaturized electronic products and higher level systems
incorporating such products for defense, security and commercial applications. The Company also
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performs customer-funded contract research and development related to these systems and
products, mostly for U.S. government customers or prime contractors. Most of the Companys
historical business relates to application of its technologies for stacking either packaged or
unpackaged semiconductors into more compact three-dimensional forms, which the Company believes
offer volume, power, weight and operational advantages over competing packaging approaches, and
which the Company believes allows it to offer higher level products with unique operational
features. The Company has recently introduced certain higher level products in the fields of
thermal imaging, unmanned surveillance aircraft and high speed processing that take advantage of
the Companys packaging technologies.
Summary of Significant Accounting Policies
Consolidation. The consolidated financial statements include the accounts of ISC and its
subsidiaries, Optex, Novalog, Inc. (Novalog), MicroSensors, Inc. (MSI), RedHawk Vision Systems,
Inc. (RedHawk) and iNetWorks Corporation (iNetWorks). The Companys subsidiaries do not
presently have material operations or assets. All significant intercompany transactions and
balances have been eliminated in the consolidation. The accounts for Optex have been eliminated
from the balance sheets from September 27, 2009 forward due to the Optex bankruptcy in September
2009.
Fiscal Periods. The Companys fiscal year ends on the Sunday nearest September 30. Fiscal
2009 ended on September 27, 2009 and included 52 weeks. The fiscal year ending October 3, 2010
(fiscal 2010) will include 53 weeks. The Companys first two quarters of fiscal 2010 was the
26-week period ended March 28, 2010.
Warrant Valuation and Beneficial Conversion Feature. The Company calculates the fair value of
warrants issued with debt or preferred stock using the Black-Scholes valuation method. The total
proceeds received in the sale of debt or preferred stock and related warrants is allocated among
these financial instruments based on their relative fair values. The discount arising from
assigning a portion of the total proceeds to the warrants issued is recognized as interest expense
for debt from the date of issuance to the earlier of the maturity date of the debt or the
conversion dates using the effective yield method. Additionally, when issuing convertible
instruments (debt or preferred stock), including convertible instruments issued with detachable
warrants, the Company tests for the existence of a beneficial conversion feature. The Company
records the amount of any beneficial conversion feature (BCF), calculated in accordance with the
accounting standards, whenever it issues convertible instruments that have conversion features at
fixed rates that are in-the-money using the effective per share conversion price when issued. The
calculated amount of the BCF is accounted for as a contribution to additional paid-in capital and
as a discount to the convertible instrument. A BCF resulting from issuance of convertible debt is
recognized as interest expense from the date of issuance to the earlier of the maturity date of the
debt or the conversion dates using the effective yield method. A BCF resulting from the issuance of
convertible preferred stock is recognized as a deemed dividend and amortized over the period of the
securitys earliest conversion or redemption date. The maximum amount of BCF that can be
recognized is limited to the amount that will reduce the net carrying amount of the debt or
preferred stock to zero.
Reclassifications. Certain reclassifications have been made to the consolidated balance sheet
as of September 27, 2009 to conform to the current period presentation to reflect the adoption of
new accounting guidance regarding the presentation of minority interests in subsidiaries, as
discussed below.
Recently Issued Accounting Pronouncements. In December 2007, the Financial Accounting
Standards Board (FASB) issued guidance as codified in Accounting Standards Codification (ASC)
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810-10, Consolidation Noncontrolling Interests (previously SFAS No. 160, Noncontrolling
Interests in Consolidated Financial StatementsAmendments of ARB No. 51). ASC 810-10 states that
accounting and reporting for minority interests will be recharacterized as noncontrolling interests
and classified as a component of equity. ASC 810-10 also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the interests of the
parent and the interests of the noncontrolling owners. ASC 810-10 is effective for fiscal years
beginning after December 15, 2008, which for the Company is fiscal 2010. The adoption of ASC 810-10
has resulted in the reclassification on the balance sheet of minority interests from liabilities to
stockholders equity for the periods presented herein.
In June 2008, the FASB ratified guidance issued by the Emerging Issue Task Force (EITF) as
codified in ASC 815-40, Derivatives and Hedging Contracts in Entitys Own Equity (previously
EITF Issue No. 07-05, Determining Whether an Instrument (or an Embedded Feature) is Indexed to an
Entitys Own Stock). ASC 815-40 specifies that a contract that would otherwise meet the definition
of a derivative but is both (a) indexed to the companys own stock and (b) classified in
stockholders equity in the statement of financial position would not be considered a derivative
financial instrument. ASC 815-40 provides a new two-step model to be applied in determining
whether a financial instrument or an embedded feature is indexed to an issuers own stock and thus
able to qualify for the ASC 815-10 scope exception. ASC 815-40 is effective for fiscal years
beginning after December 15, 2008, which for the Company is fiscal 2010, and early adoption was not
permitted. Pursuant to ASC 815-40, the Company was required to reclassify certain warrants from
equity to liabilities, which resulted in a cumulative effect adjustment of approximately $4,230,000
to reduce paid-in capital for the original allocated value recorded for these affected warrants, a
corresponding reduction in accumulated deficit of $4,230,000 and recording of the fair market value
of the warrant derivative liability of $99,500 effective September 28, 2009, the first day of
fiscal 2010. The fair market value of the warrant derivative liability was re-measured at March 28,
2010 and adjusted to report the change in fair value, which was $14,500 and $60,000 for the 13
weeks and 26 weeks ended March 28, 2010, respectively. The warrant derivative liability is
included in accrued expenses on the consolidated balance sheet.
In January 2010, the FASB issued Accounting Standards Update (ASU) 2010-06, Improving
Disclosures about Fair Value Measurements amending ASC 820, Fair Value Measurements and Disclosures
requiring additional disclosure and clarifying existing disclosure requirements about fair value
measurements. ASU 2010-06 requires entities to provide fair value disclosures by each class of
assets and liabilities, which may be a subset of assets and liabilities within a line item in the
statement of financial position. The additional requirements also include disclosure regarding the
amounts and reasons for significant transfers in and out of Level 1 and 2 of the fair value
hierarchy and separate presentation of purchases, sales, issuances and settlements of items within
Level 3 of the fair value hierarchy. The guidance clarifies existing disclosure requirements
regarding the inputs and valuation techniques used to measure fair value for measurements that fall
in either Level 2 or Level 3 of the hierarchy. ASU 2010-06 is effective for interim and annual
reporting periods beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances and settlements which is effective for fiscal years beginning after December 15,
2010, and for interim periods within those fiscal years. There was no impact of the Companys
adoption of this guidance.
In February 2010, the FASB issued ASU 2010-09, Subsequent Events Amendments to Certain
Recognition and Disclosure Requirements, which no longer requires entities that file or furnish
financial statements with the SEC to disclose the date through which subsequent events have been
evaluated in originally issued and reissued financial statements. Other entities would continue to
be required to disclose the date through which subsequent events have been evaluated; however,
disclosures about the date through which subsequent events have been evaluated in reissued
financial statements would be
required only in financial statements revised because of an error correction or retrospective
application of
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U.S. GAAP. This consensus is effective upon issuance. The Companys adoption of ASU
2010-09 had no financial statement impact.
In April 2010, the FASB issued ASU 2010-17, Milestone Method of Revenue Recognition, which
provides guidance related to Revenue Recognition that applies to arrangements with milestones
relating to research or development deliverables. This guidance provides criteria that must be met
to recognize consideration that is contingent upon achievement of a substantive milestone in its
entirety in the period in which the milestone is achieved. This guidance is effective for us
starting fiscal year 2011. The Company is currently assessing the impact of the guidance, if any,
on its financial statements.
Note 2 Going Concern
These 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 significant net losses in fiscal years prior to fiscal 2009. In
fiscal 2009, the Company generated net income of $914,800, but this was primarily attributable to
the approximately $8.6 million of aggregate non-recurring gains realized by the Companys sale of
patent assets and substantial gains on the elimination of consolidated debt and reduction in
pension liability. In the first half of fiscal 2010, the 26-week period ended March 28, 2010, the
Company had a net loss of $5,136,300.
Management believes that the Companys losses in recent years have primarily resulted from a
combination of insufficient contract research and development revenue to support the Companys
skilled and diverse technical staff believed to be necessary to support monetization of the
Companys technologies, amplified by the effects of discretionary investments to productize a
variety of those technologies. The Company has not yet been successful in most of these product
activities, nor has it been able to raise sufficient capital to fund the future development of many
of these technologies. Accordingly, the Company has sharply curtailed the breadth of its product
investments, and instead has focused on the potential growth of its chip stacking business, various
miniaturized camera products and a system application incorporating such camera products. In
addition, the initial acquisition of Optex in December 2005 and the ultimate discontinuation of
Optexs operations in October 2008 pursuant to the Optex Asset Sale contributed to increases in the
Companys consolidated accumulated deficit, largely due to inadequate gross margins on Optexs
products and the related litigation, as well as insufficient capital resources.
As of March 28, 2010, the Company also had negative working capital and stockholders deficit
of approximately $6.4 million and $6.9 million, respectively. As of March 28, 2010, the Company
also had a litigation judgment pending, for which the Company has recorded expected expenses of
$1.2 million. (See Note 10).
Management is focused on managing costs in line with estimated total revenues for fiscal 2010
and beyond, including contingencies for cost reductions if projected revenues are not fully
realized. However, there can be no assurance that anticipated revenues will be realized or that the
Company will be able to successfully implement its plans. Accordingly, the Company anticipates
that it will need to raise additional funds to meet its continuing obligations and may incur
additional losses in the future.
The Companys common stock has traded below the $1.00 per share minimum continued listing
criterion of the Nasdaq Capital Market for substantial periods of time recently. On September 15,
2009,the Company received a written notice from Nasdaq of its lack of compliance with this
requirement and was given until March 15, 2010 to regain compliance. On March 19, 2010, the
Company received a
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notice from Nasdaq that it had not regained compliance with respect to this
listing criterion and that the Companys common stock was subject to delisting. The Company
appealed this notice and requested a hearing from a Nasdaq Hearings Panel (the Panel) to present
a revised plan of compliance and to seek an extension of time to implement said plan. This hearing
was held on May 6, 2010, but as of the date of this report, the Company has not received a
determination from the Panel regarding the Companys appeal. Even if the Companys appeal is
granted, there can be no assurance that the Company will be able to comply with the minimum $1.00
per share trading rule or other Nasdaq requirements for listing maintenance and be able to maintain
its listing on the Nasdaq Capital Market. Delisting from the Nasdaq Capital Market for any present
or future noncompliance with Nasdaqs listing requirements could significantly limit the Companys
ability to raise capital and adversely impact the price of and market for the Companys common
stock. If the Company requires additional financing to meet its working capital needs, there can be
no assurance that suitable financing will be available on acceptable terms, on a timely basis, or
at all.
The accompanying consolidated financial statements do not include any adjustments relating to
the recoverability and classification of asset carrying amounts or the amount and classification of
liabilities that might result should the Company be unable to continue as a going concern.
Note 3 Settlement of Litigation
Timothy Looney, Barbara Looney and TWL Group, L.P. (collectively, Looney), on the one hand,
and the Company and its Chief Executive Officer, John C. Carson and its Chief Financial Officer,
John J. Stuart, Jr., on the other hand, have been engaged in litigation since January 2008
regarding the acquisition of Optex and related matters. In March 2010, the Company and Messrs.
Carson and Stuart entered into a Settlement and Release Agreement with Looney pursuant to which the
Company and Messrs. Carson and Stuart, on the one hand, and Looney, on the other hand, settled and
released all claims and agreed to dismiss all litigation against each other relating to the
Companys acquisition of Optex in December 2005 and various transactions related thereto (the
Looney Settlement Agreement).
Pursuant to the terms of the Looney Settlement Agreement, the Company agreed to pay Mr. Looney
$50,000 and to issue to Mr. Looney a secured promissory note in the principal amount of $2,500,000
(the Secured Promissory Note). (See Note 4). In connection with issuing the Secured Promissory
Note, the Company also entered into a Security Agreement and an Intellectual Property Security
Agreement with Mr. Looney (collectively, the Security Agreements), which collectively provide a
security interest in all the Companys assets subject to and subordinate to the existing perfected
security interests and liens of the Companys senior creditors, Summit Financial Resources, L.P.
(Summit) and Longview.
The effectiveness of the Looney Settlement Agreement was conditioned upon the Companys
receipt of consents from Summit and Longview. The Company obtained said consents, and the Looney
Settlement Agreement was effective as of March 26, 2010. As one of the conditions of obtaining
the Longview consent, the Company agreed to issue Longview equity securities with a value of
$825,000 (the Waiver Securities) in consideration for Longviews waiver of potential future
entitlement to all accumulated, but undeclared and unpaid, dividends on the Companys Series A-1
10% Cumulative Convertible Preferred Stock (the Series A-1 Stock) and the Companys Series A-2
10% Cumulative Convertible Preferred Stock (the Series A-2 Stock) held by Longview from the respective dates of
issuance of the Series A-1 Stock and the Series A-2 Stock through July 15, 2010. The amount of said
accumulated, but undeclared and unpaid dividends through July 15, 2010 was estimated to be
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approximately equal to the value of the Waiver Securities. (See Note 5). The Waiver Securities were
issued to Longview on April 30, 2010 in the form of 27,500 shares of a newly created Series C
Convertible Preferred Stock. (See Note 11).
The Company recorded the $2.5 million Secured Promissory Note in its consolidated financial
statements for the 13-week period and 26-week periods ended March 28, 2010 and extinguished
$1,504,300 of previously recorded accrued expenses for litigation judgments related to these
matters. The Company also recorded an expense of $825,000 to reflect its obligation to issue the
Waiver Securities in the periods ended March 28, 2010. The net effect was an additional accrued
expense of $1,820,700 litigation settlement expense recorded in the 13-week and 26-week periods
ended March 28, 2010.
Note 4 Debt Instruments
Restructured Debt, Net of Debt Discounts
The restructured debt, net of debt discounts, consists of the remainder of a secured promissory
note payable to Longview originally entered into by the Company in July 2007, initially with a
six-month term, under a secured promissory note (the Longview Note) with a $2.0 million principal
due. The principal amount of the Longview Note was automatically increased by $100,000 on August
15, 2007, when the Company elected not to exercise an early payment feature of the Longview Note.
In connection with the Optex Asset Sale in October 2008, approximately $1,651,100 of the principal
balance of the Longview Note was retired. In March 2009, $260,500 of the then outstanding principal
balance of the Longview Note was repaid from proceeds of the Companys sale of patents, resulting
in an outstanding principal balance of the Longview Note of $188,400 at September 27, 2009. In
March 2010, $25,300 of the then outstanding principal balance of the Longview Note was repaid from
proceeds of the Debenture Private Placement (described more fully below), resulting in an
outstanding principal balance of the Longview Note of $163,100 at March 28, 2010. (See Note 11).
Note Payable Related Party
In December 2006, in consideration for amendments to the Stock Purchase Agreement, the Buyer
Option Agreement and the Escrow Agreement with Timothy Looney initially entered into on December
30, 2005 for the acquisition of Optex, the Company issued an unsecured subordinated promissory note
to Mr. Looney in the original principal amount of $400,000, bearing interest at a rate of 11% per
annum. The principal and accrued interest under this note was due and payable in full to Mr. Looney
on December 29, 2007. The Company had recorded the principal and accrued interest amount of this
note in its consolidated balance sheets at September 27, 2009 as a current liability. At March 28,
2010, this note had been extinguished as a result of the Looney Settlement Agreement.
Debentures
In March 2010, the Company sold and issued to 55 accredited investors (the Investors) an
aggregate of 275.22 convertible debenture units (the Units) at a purchase price of $6,000 per
Unit (the Unit Price) in two closings of a private placement (the Debenture Private Placement). The
$1,651,300 aggregate purchase price for these Units was paid in cash to the Company.
Each Unit was comprised of (i) one one-year, unsecured convertible debenture with a principal
repayment obligation of $5,000 (the Convertible Debenture) that is convertible at the election of
the holder into shares of the Companys common stock at a conversion price of $0.40 per share (the
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Principal Conversion Shares); (ii) one one-year, unsecured non-convertible debenture with a
principal repayment obligation of $5,000 that is not convertible into common stock (the
Non-Convertible Debenture and, together with the Convertible Debenture, the Debentures); and
(iii) a five-year warrant to purchase 3,125 shares of the Companys common stock (the Debenture
Investor Warrant). The conversion price applicable to the Debentures and the exercise price
applicable to the Debenture Investor Warrants is $0.40 per share.
The Debentures bear simple interest at a rate of 20% per annum. Interest on the Debentures
accrues and is payable quarterly in arrears and is convertible at the election of the Company into
shares of common stock at a conversion price of $0.40 per share. The conversion price of the
Debentures is subject to adjustment for stock splits, stock dividends, recapitalizations and the
like. Any unpaid and unconverted principal amount of the Debentures may be repaid in cash prior to
maturity at 110% of such principal amount. The amounts owing under the Debentures may be
accelerated upon the occurrence of certain events of default as set forth in the Debentures.
If all interest on the Debentures is converted into shares of common stock and the Convertible
Debentures are held to maturity and then converted, the total number of shares of Common Stock
issuable upon conversion of the principal and interest under the Debentures at the conversion price
is 4,816,300 in the aggregate. The total number of shares of common stock issuable upon exercise
of the Investor Warrants at the exercise price of $0.40 per share is 860,000 in the aggregate.
In consideration for services rendered as the lead placement agent in the Debenture Private
Placement, the Company paid the placement agent cash commissions, a management fee and an expense
allowance fee aggregating $214,700, which represents 13% of the gross proceeds of the closings of
the Debenture Private Placement, and issued to the placement agent five-year warrants to purchase
an aggregate of 536,700 shares of the Companys common stock at an exercise price of $0.40 per
share and, as a retainer, a five-year warrant to purchase an aggregate of 450,000 shares of the
Companys Common Stock at an exercise price of $0.40 per share. (See Note 5).
The $1,651,000 of aggregate gross proceeds received by the Company in the Debenture Private
Placement, comprised of the aggregate principal value of $2,752,200 of the Debentures, net of a
corresponding original issue discount of $1,101,000, was allocated to the individual components
comprising the Unit on a relative fair value basis. This resulted in approximately $163,000
allocated to the five year investor warrants and approximately $1,488,000 allocated to the
Debentures. In addition, because the effective conversion price of the Convertible Debentures was
below the current trading price of the Companys common shares at the date of issuance, the Company
recorded a BCF of approximately $102,000. The value of the warrants and the BCF have been recorded
as additional paid in capital in the accompanying consolidated financial statements.
Secured Promissory Note
The Secured Promissory Note issued by the Company as a result of the Looney Settlement
Agreement bears simple interest at a rate per annum of 10% of the outstanding principal balance and
is secured by substantially all of the assets of the Company (the Collateral) pursuant to the
terms and conditions of the Security Agreements, but such security interests are subject to and subordinate
to the existing perfected security interests and liens of the Companys senior creditors, Summit
and Longview. The Secured Promissory Note requires the Company to remit graduated monthly
installment payments over a 27-month period to Mr. Looney beginning with a payment of $8,000 in May
2010 and ending with a payment of $300,000 in June 2012. All such payments are applied first to
unpaid interest and then to outstanding principal. Scheduled payments in the next twelve months
apply only to interest. A final
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payment of the remaining unpaid principal and interest under the
Secured Promissory Note is due and payable in July 2012. Past due payments will bear simple
interest at a rate per annum of 18%. In the event the Company prepays all amounts owing under the
Secured Promissory Note within eighteen months after April 9, 2010, the $50,000 cash payment made
to Mr. Looney pursuant to the Looney Settlement Agreement will either be returned to the Company or
deducted from the final payment due on the Secured Promissory Note. The $50,000 cash payment is
recorded as a prepaid charge on the consolidated balance sheets as of March 28, 2010.
Note 5 Common Stock and Common Stock Warrants, Preferred Stock, Stock Incentive Plans, Employee
Retirement Plan and Deferred Compensation Plans
Non-Cash Common Stock Transactions. During the 26-week period ended March 28, 2010, the
Company issued an aggregate of 6,179,600 shares of common stock, net of the forfeiture of 8,500
shares of nonvested stock, with an aggregate valuation of $2,470,500, net of forfeitures, in the
following non-cash transactions: (i) an aggregate of 5,930,700 shares of common stock of the
Company were issued in various transactions in exchange for conversion and cancellation of
$2,372,300 of the Companys Series A-1 Stock; (ii) 245,900 shares of common stock of the Company
were issued in exchange for conversion and cancellation of $98,400 of the Companys Series A-2
Stock; and (iii) after giving effect to the forfeiture of 8,500 shares of nonvested stock, there
was a net increase of 3,000 shares and a net expense decrease of $200 associated with issuance of
common stock to employees as compensation for services rendered.
Common Stock Warrants. In the 26-week period ended March 28, 2010, the Company issued a
five-year warrant to purchase 907,400 shares of common stock at an exercise price of $0.55 per
share to its investment banking firm as partial consideration for services rendered in the private
placement of a preferred stock unit financing, as discussed below. As an element of that financing,
the Company issued five-year warrants to the investors to purchase an aggregate of 2,094,000 shares
of common stock at an exercise price of $0.55 per share. In the 26-week period ended March 28,
2010, the Company also issued a five-year warrant to purchase 350,000 shares of the Companys
common stock at an exercise price of $0.44 per share to its investment banking firm for a one-year
extension of an agreement with said firm to assist the Company to raise additional capital and to
provide financial advisory services. The estimated fair value of this warrant, $119,000, will be
amortized over the 12-month term of the extension.
As a result of the closing of the preferred stock financing and the warrant issued to the
investment banking firm in connection with the agreement extension discussed above, warrants to
purchase 762,000 shares of common stock at $3.18 per share were automatically adjusted to purchase
1,477,500 shares at $1.64 per share effective December 27, 2009, which warrants subsequently
expired on December 30, 2009.
In the 26-week period ended March 28, 2010, the Company issued five-year warrants to purchase
986,700 shares of common stock at an exercise price of $0.40 per share to its investment banking
firm as partial consideration for services rendered in the private placement of the Debenture
Private Placement. As an element of that financing, the Company issued five-year warrants to the
investors to purchase an aggregate of 860,000 shares of common stock at an exercise price of $0.40 per share. (See Note
4). The Company used the Black-Scholes model to value the warrants issued to the investment banking
firm and investors pursuant to the Debenture Private Placement using the following assumptions;
volatility of 95.9%, stock price $0.30 per share, exercise price $0.40 per share, risk-free
interest rate of 2.7%, and an expected term of five years.
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At March 28, 2010 and September 27, 2009, there were warrants outstanding to purchase
5,897,400 and 1,461,300 shares of the Companys common stock, respectively.
Preferred Stock. In the 26-week period ended March 28, 2010, the Company sold and issued an
aggregate of 3,490 preferred stock units (the Units) at a purchase price of $700 per Unit. The
$2,443,000 aggregate purchase price for the Units was paid in cash to the Company, from which fees
and expenses of $393,500 were disbursed to the placement agent and its counsel, resulting in net
proceeds of $2,049,500 to the Company. Each Unit was comprised of one share of the Companys newly
created Series B Convertible Preferred Stock (the Series B Stock), plus a five-year warrant to
purchase 600 shares of the Companys common stock at an exercise price of $0.55 per share. Each
share of Series B Stock is convertible at any time at the holders option into 2,000 shares of
common stock at a conversion price per share of common stock equal to $0.50. As of March 28, 2010,
an aggregate of 6,980,000 shares of the Companys common stock were issuable upon conversion of the
Series B Stock.
The Series B Stock is non-voting, except to the extent required by law. With respect to
distributions upon a deemed dissolution, liquidation or winding-up of the Company, the Series B
Stock ranks senior to the common stock and the Companys new Series C Convertible Preferred Stock
and junior to both the Companys Series A-1 Stock and Series A-2 Stock. The liquidation preference
per share of Series B Stock equals its stated value, $1,000 per share. The Series B Stock is not
entitled to any preferential cash dividends; however, the Series B Stock is entitled to receive,
pari passu with the Companys common stock, such dividends on the common stock as may be declared
from time to time by the Companys Board of Directors.
The Companys aggregate gross proceeds of $2,443,000 received from the sale of the Series B
Stock was allocated to the individual components comprising the stock units on a relative fair
value basis, resulting in approximately $424,000 of the proceeds allocated to the five-year warrant
and approximately $2,019,000 allocated to the Series B Stock. In addition, because the effective
conversion price of the Series B Stock was below the current trading price of the Companys shares
at the date of issuance, the Company recorded a BCF of approximately $1,471,000. Since the
preferred shares contain no set redemption date and they are convertible from inception by the
holder, the entire BCF amount was accreted as a preferred dividend as of the issuance date.
The Company used the Black-Scholes model to value the warrants issued to the placement agent
and those issued to the Series B Stock investors discussed above using the following assumptions;
volatility of 93.2%, stock price $0.50 per share, exercise price $0.55 per share, risk-free
interest rate of 2.3% and an expected term of five years.
In the 26-week period ended March 28, 2010, 79,076 shares of the Series A-1 Stock were
converted by Longview and Alpha into 5,930,700 shares of common stock and 2,500 shares of the
Series A-2 Stock were converted by Alpha into 245,900 shares of common stock.
Stock Incentive Plans. In June 2006, the Companys stockholders approved the Companys 2006
Omnibus Incentive Plan (the 2006 Plan), which is designed to serve as a comprehensive equity
incentive program to attract and retain the services of individuals essential to the Companys
long-term growth and financial success. The 2006 Plan permits the granting of stock options (including
both incentive and non-qualified stock options), stock-only stock appreciation rights, nonvested
stock and nonvested stock units, performance awards of cash, stock or property, dividend
equivalents and other stock grants. Upon approval of the 2006 Plan in June 2006, the Companys 2003
Stock Incentive Plan (the 2003 Plan), 2001 Non-Qualified Stock Option Plan (the 2001
Non-Qualified Plan), 2001 Stock Option Plan (the 2001 Plan) and 2000 Non-Qualified Stock
Option Plan (the 2000 Plan)
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(collectively, the Prior Plans) were terminated, but existing options
issued pursuant to the Prior Plans remain outstanding in accordance with the terms of their
original grants. As of March 28, 2010, options to purchase 4,000 shares of the Companys common
stock at an exercise price of $265.62 per share were outstanding and exercisable under the 2000
Plan, options to purchase 2,500 shares of the Companys common stock at an exercise price of $11.50
per share were outstanding and exercisable under the 2001 Plan, options to purchase 44,900 shares
of the Companys common stock were outstanding and exercisable under the 2001 Non-Qualified Option
Plan, at exercise prices ranging from $8.60 to $13.50 per share, and options to purchase 267,900
shares of the Companys common stock were outstanding under the 2003 Plan at exercise prices
ranging from $10.40 to $36.20 per share, of which options to purchase 267,600 shares were
exercisable at March 28, 2010.
Pursuant to an amendment of the 2006 Plan by stockholders in March 2009, the number of shares
of common stock reserved for issuance under the 2006 Plan shall automatically increase at the
beginning of each subsequent fiscal year by the lesser of 1,250,000 shares or 5% of the common
stock of the Company outstanding on the last day of the preceding fiscal year. As a result of
that provision, the number of shares issuable under the 2006 Plan increased by 484,800 shares in
the 26-week period ended March 28, 2010. The aggregate number of shares of common stock issuable
under all stock-based awards that may be made under the 2006 Plan at March 28, 2010 is 899,700
shares. As of March 28, 2010, there were options to purchase 249,600 shares of the Companys
common stock outstanding under the 2006 Plan, at exercise prices ranging from $0.35 to $14.10 per
share, of which options to purchase 212,600 shares were exercisable at March 28, 2010. In
addition, as of March 28, 2010, 43,100 shares of nonvested stock were issued and outstanding
pursuant to the 2006 Plan and 286,700 shares of vested stock were issued and outstanding pursuant
to the 2006 Plan.
The following table summarizes stock options outstanding as of March 28, 2010 as well as
activity during the 26-week period then ended:
Weighted Average | ||||||||
Shares (1) | Exercise Price | |||||||
Outstanding at September 27, 2009 |
568,900 | $ | 17.78 | |||||
Granted |
| | ||||||
Exercised |
| | ||||||
Forfeited |
| | ||||||
Outstanding at March 28, 2010 |
568,900 | $ | 17.78 | |||||
Exercisable at March 28, 2010 |
531,600 | $ | 18.32 | |||||
(1) | Rounded to nearest one hundred (100). |
The Company did not grant any options during the first 26 weeks of fiscal 2010. At March 28,
2010, the aggregate intrinsic value of unvested options outstanding and options exercisable was $0.
There were no options exercised during the 26 weeks ended March 28, 2010 and therefore, the total
intrinsic value of options exercised during that period was $0. The intrinsic value of a stock
option is the amount by which the market value of the underlying stock exceeds the exercise price
of the option. At
March 28, 2010, the weighted-average remaining contractual life of options outstanding and
exercisable was 4.9 years and 4.7 years, respectively.
The amount of compensation expense related to outstanding stock options not yet recognized at
March 28, 2010 was $2,700 and, assuming the grantees continue to be employed by or remain as
directors of the Company, that amount will be recognized as compensation expense as follows:
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FY 2010 (remainder of year) |
$ | 1,400 | ||
FY 2011 |
1,300 | |||
Total |
$ | 2,700 | ||
The following table summarizes nonvested stock grants outstanding as of March 28, 2010
as well as activity during the 26-week period then ended:
Weighted | ||||||||
Average Grant | ||||||||
Date Fair Value | ||||||||
Nonvested Shares | per Share | |||||||
Outstanding at September 27, 2009 |
90,400 | $ | 2.15 | |||||
Granted |
9,700 | $ | 0.32 | |||||
Vested |
(48,000 | ) | $ | 1.31 | ||||
Forfeited |
(8,500 | ) | $ | 0.46 | ||||
Outstanding at March 28, 2010 |
43,600 | $ | 5.20 | |||||
The amount of compensation expense related to nonvested stock grants not yet recognized at
March 28, 2010 was $31,900 and, assuming the grantees continue to be employed by or remain as
directors of the Company, that amount will be recognized as compensation expense as follows:
FY 2010 (remainder of year) |
$ | 22,000 | ||
FY 2011 |
8,600 | |||
FY 2012 |
1,200 | |||
FY 2012 |
100 | |||
Total |
$ | 31,900 | ||
Note 6 Income (Loss) per Share
Since the Company had losses for the 13-week and 26-week periods ended March 28, 2010, basic
and diluted net loss per common share for those periods are the same and are computed based solely
on the weighted average number of shares of common stock outstanding for the respective periods. In
the 13-week and 26-week periods ended March 29, 2009, application of the if-converted method to
the Companys convertible preferred stock and convertible debt resulted in said instruments being
anti-dilutive and therefore not impacting the calculation of income per share. Furthermore, the
Company had no outstanding, in-the-money stock options and warrants as of March 29, 2009.
Accordingly, the basic and diluted net income per common share for the 13-week and 26-week periods
ended March 29, 2009 are the same and are also computed based solely on the weighted average number
of shares of common
stock outstanding for the respective periods. Cumulative dividends on the Series A-1 Stock
and Series A-2 Stock for the 13-week and 26-week periods ended March 28, 2010 and the Series A-1
Stock for the 13-week and 26-week periods ended March 29, 2009, although not declared, constitute a
preferential claim against future dividends, if any, and are treated as an incremental expense of
continuing operations for purposes of determining basic and diluted net loss from continuing
operations per common share. As of March 28, 2010, cumulative dividends on the Series A-1 Stock
and Series A-2 Stock held by Longview, including those accumulated in the 13-week and 26-week
periods ended March 28, 2010, had been waived pursuant to the Looney Settlement Agreement. (See
Note 3). In like manner, the BCF associated
17
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with the issuance of the Companys Series B Stock in
the 26-week period ended March 28, 2010, although not recorded as an expense, is treated as a
deemed dividend and, therefore, an incremental expense of continuing operations for purposes of
determining basic and diluted net loss from continuing operations per common share.
The following table sets forth the computation of basic and diluted loss per common share:
13 Weeks Ended | 26 Weeks Ended | |||||||||||||||
March 28, | March 29, | March 28, | March 29, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Continuing Operations Numerator: |
||||||||||||||||
Income (loss) from continuing operations
attributable to Company |
$ | (3,419,600 | ) | $ | 5,134,900 | $ | (5,136,300 | ) | $ | 2,955,500 | ||||||
Undeclared cumulative dividends on Series
A-1 and Series A-2 preferred stock |
(600 | ) | (103,400 | ) | (5,200 | ) | (204,300 | ) | ||||||||
Deemed dividend for beneficial conversion
feature related to Series B preferred stock |
| | (1,471,000 | ) | | |||||||||||
Adjusted basic and diluted net income (loss)
attributable to Company common
stockholders |
$ | (3,420,200 | ) | $ | 5,031,500 | $ | (6,612,500 | ) | $ | 2,751,200 | ||||||
Discontinued Operations Numerator: |
||||||||||||||||
Income (loss) from discontinued operations |
$ | | $ | (6,900 | ) | $ | | $ | 58,400 | |||||||
Continuing and Discontinued Operations Numerator: |
||||||||||||||||
Weighted average number
of common shares outstanding |
14,351,900 | 5,790,500 | 12,246,700 | 5,544,700 | ||||||||||||
Basic and diluted net income (loss) per share information: |
||||||||||||||||
From continuing operations
attributable to Company |
$ | (0.24 | ) | $ | 0.87 | $ | (0.54 | ) | $ | 0.50 | ||||||
From discontinued operations
attributable to Company |
| (0.00 | ) | | 0.01 | |||||||||||
Basic and diluted net income (loss) attributable
to Company per common share |
$ | (0.24 | ) | $ | 0.87 | $ | (0.54 | ) | $ | 0.51 | ||||||
Note 7 Inventories, Net
Net inventories at March 28, 2010 and September 27, 2009 are set forth below.
March 28, | September 27, | |||||||
2010 | 2009 | |||||||
Inventory: |
||||||||
Work in process |
$ | 1,410,500 | $ | 1,128,000 | ||||
Raw materials |
678,200 | 326,800 | ||||||
Finished goods |
163,400 | 161,000 | ||||||
2,252,100 | 1,615,800 | |||||||
Less reserve for obsolete inventory |
(1,323,600 | ) | (1,174,700 | ) | ||||
$ | 928,500 | $ | 441,100 | |||||
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The Company uses the average cost method for valuation of its product inventory.
Title to all inventories remains with the Company. Inventoried materials and costs relate to:
work orders from customers; the Companys generic module parts and memory stacks; and capitalized
material, labor and overhead costs expected to be recovered from probable new research and
development 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.
Note 8 Reportable Segments
The Company manages its operations through two reportable segments, the contract research and
development segment and the product segment.
The Companys contract research and development segment provides services, largely to U.S.
government agencies and government contractors, under contracts to develop prototypes and provide
research, development, design, testing and evaluation of complex detection and control defense
systems. The Companys research and development contracts are usually cost reimbursement plus fixed
fee, which require the Companys good faith performance of a statement of work within overall
budgetary constraints, but with latitude as to resources utilized, or fixed price level of effort,
which require the Company to deliver a specified number of labor hours in the performance of a
statement of work. Occasionally, the Companys research and development contracts are firm fixed
price, which require the delivery of specified work products independent of the resources or means
employed to satisfy the required deliveries.
Currently, the Companys product segment primarily consists of stacked semiconductor chip
assemblies, electronic chips, miniaturized cameras and thermal imaging cores, largely all of which
are based on proprietary designs of the Company.
The Companys management evaluates financial information to review the performance of the
Companys research and development contract business separately from the Companys product
business, but only to the extent of the revenues and the cost of revenues of the two segments.
Because the various indirect expense operations of the Company, as well as its assets, now support
all of its revenue-generating operations, frequently in circumstances in which a distinction
between research and
development contract support and product support is difficult to identify, segregation of
these indirect costs and assets is impracticable. The revenues and gross profit or loss of the
Companys two reportable segments for the 13-week and 26-week periods ended March 28, 2010 and
March 29, 2009 are shown in the following table.
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13 Weeks Ended | 26 Weeks Ended | |||||||||||||||
March 28, 2010 | March 29, 2009 | March 28, 2010 | March 29, 2009 | |||||||||||||
Contract research and development revenue |
$ | 2,014,300 | $ | 2,295,300 | $ | 4,773,700 | $ | 4,738,500 | ||||||||
Cost of contract research and development revenue |
1,468,700 | 2,008,500 | 3,504,900 | 3,945,900 | ||||||||||||
Contract research and development segment gross profit |
$ | 545,600 | $ | 286,800 | $ | 1,268,800 | $ | 792,600 | ||||||||
Product sales |
$ | 700,400 | $ | 545,900 | $ | 1,147,400 | $ | 836,700 | ||||||||
Cost of product sales |
704,500 | 409,800 | 1,107,300 | 787,800 | ||||||||||||
Product segment gross profit (loss) |
$ | (4,100 | ) | $ | 136,100 | $ | 40,100 | $ | 48,900 | |||||||
Reconciliations of segment revenues to total revenues are as follows:
13 Weeks Ended | 26 Weeks Ended | |||||||||||||||
March 28, 2010 | March 29, 2009 | March 28, 2010 | March 29, 2009 | |||||||||||||
Contract research and development revenue |
$ | 2,014,300 | $ | 2,295,300 | $ | 4,773,700 | $ | 4,738,500 | ||||||||
Product sales |
700,400 | 545,900 | 1,147,400 | 836,700 | ||||||||||||
Other revenue |
6,700 | | 10,500 | 9,500 | ||||||||||||
Total revenues |
$ | 2,721,400 | $ | 2,841,200 | $ | 5,931,600 | $ | 5,584,700 | ||||||||
Reconciliations of segment gross profit (loss) to loss from continuing operations before
provision for income taxes are as follows:
13 Weeks Ended | 26 Weeks Ended | |||||||||||||||
March 28, 2010 | March 29, 2009 | March 28, 2010 | March 29, 2009 | |||||||||||||
Contract research and development segment gross profit |
$ | 545,600 | $ | 286,800 | $ | 1,268,800 | $ | 792,600 | ||||||||
Product segment gross profit (loss) |
(4,100 | ) | 136,100 | 40,100 | 48,900 | |||||||||||
Net segment gross profit |
541,500 | 422,900 | 1,308,900 | 841,500 | ||||||||||||
Add (deduct) |
||||||||||||||||
Other revenue |
6,700 | | 10,500 | 9,500 | ||||||||||||
General and administrative expense |
(1,476,600 | ) | (2,258,900 | ) | (3,128,000 | ) | (4,119,700 | ) | ||||||||
Research and development expense |
(601,000 | ) | (436,300 | ) | (1,356,200 | ) | (786,700 | ) | ||||||||
Interest expense |
(131,200 | ) | (830,600 | ) | (246,100 | ) | (1,239,700 | ) | ||||||||
Provision for litigation judgment |
| | (20,200 | ) | | |||||||||||
Litigation settlement expense |
(1,820,700 | ) | | (1,820,700 | ) | | ||||||||||
Change in fair value of derivative instrument |
14,500 | | 60,000 | | ||||||||||||
Gain on sale or disposal of assets |
| 8,632,800 | 12,500 | 8,632,800 | ||||||||||||
Interest and other income (expense) |
700 | 15,100 | (300 | ) | 46,700 | |||||||||||
Income (loss) from continuing operations before
provision for income taxes |
$ | (3,466,100 | ) | $ | 5,545,000 | $ | (5,179,600 | ) | $ | 3,384,400 | ||||||
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Note 9 Concentration of Revenues and Sources of Supply
In the 13-week and 26-week periods ended March 28, 2010, direct contracts with the U.S.
government accounted for 68% and 69%, respectively, of the Companys total revenues, and
second-tier government contracts with prime government contractors accounted for 27% and 27% of
total revenues, respectively. The remaining 5% and 4% of the Companys total revenues in the
13-week and 26-week periods ended March 28, 2010, respectively, were derived from non-government
sources. Of the revenues derived directly or indirectly from U.S. government customers, classified
agencies, the U. S. Army, the U.S. Air Force and Oasys Technology, a defense contractor accounted
for 40%, 16%, 12% and 11% respectively, of the Companys total revenues in the 13-week period ended
March 28, 2010, and classified agencies, the U. S. Army and the U.S. Air Force accounted for 32%,
24%, and 12%, respectively, of the Companys total revenues in the 26-week period ended March 28,
2010. Loss of any of these customers would have a material adverse impact on our business,
financial condition and results of operations. No other single governmental or non-governmental
customer accounted for more than 10% of the Companys total revenues in the 13-week and 26-week
periods ended March 28, 2010.
In the 13-week and 26-week periods ended March 29, 2009, direct contracts with the U.S.
government accounted for 54% and 57%, respectively, of the Companys total revenues, and
second-tier government contracts with prime government contractors accounted for 27% and 20% of
total revenues, respectively. The remaining 19% and 23% of the Companys total revenues in the
13-week and 26-week periods ended March 29, 2009, respectively, were derived from non-government
sources, of which 6% and 12% of the Companys total revenues in the 13-week and 26-week periods
ended March 29, 2009, respectively, were derived from one customer, Pixel Optics. Of the revenues
derived directly or indirectly from U.S. government agencies, the U. S. Air Force and the U.S. Army
accounted for 17% and 19%, respectively, of the Companys total revenues in the 13-week period
ended March 29, 2009 and 28% and 14%, respectively, of the Companys total revenues in the 26-week
period ended March 29, 2009. No other single governmental or non-governmental customer accounted
for more than 10% of the Companys total revenues in the 13-week and 26-week periods ended March
29, 2009.
The Company primarily uses contract manufacturers to fabricate and assemble its stacked chip,
microchip and sensor products. At current limited levels of sales, the Company typically uses a
single contract manufacturer for such products and, as a result, is vulnerable to disruptions in
supply. The Company also uses contract manufacturers for production of its visible camera products,
except for final testing, which the Company performs itself. The Company currently assembles,
calibrates and tests its thermal camera and software products itself, given the relatively low
volumes of these products. The Company presently relies on a limited number of suppliers of imaging
devices that meet the quality and performance requirements of the Companys thermal imaging
products, which makes the Company vulnerable to potential disruptions in supply of such imaging
devices.
Note 10 Commitments and Contingencies
Litigation. In March 2009, FirstMark III, LP, formerly known as Pequot Private Equity Fund
III, LP, and FirstMark III Offshore Partners, LP, formerly known as Pequot Offshore Private Equity
Partners III, LP, filed a lawsuit in the state Supreme Court, State of New York, County of New
York, against the Company. The plaintiffs allege the Company breached a settlement agreement dated
December 29, 2006 with them that allegedly required the Company to make certain payments to the
plaintiffs that were not made, in the principal amounts of approximately $539,400 and $230,000 plus
interest thereon allegedly accruing at 18% from March 14, 2007 and May 31, 2007, respectively. At
March 28, 2010, the
Company has approximately $1,196,900 of expense accrued reflecting these alleged obligations.
The
21
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plaintiffs filed a motion for summary judgment in this matter, which was granted in January
2010, although judgment has not yet been entered as of the date of this report. The Company is
currently in negotiations with the plaintiffs to settle this matter, but such an outcome cannot be
assured.
The Company has been, and may from time to time, become a party to various other legal
proceedings arising in the ordinary course of its business. The Company does not presently know of
any such other matters, the disposition of which would be likely to have a material effect on the
Companys consolidated financial position, results of operations or liquidity.
Longview Agreement, Consent and Waiver. In connection with Longviews consent for the Looney
Settlement Agreement, the Company and Longview entered into an Agreement, Consent and Waiver (the
Longview Agreement) pursuant to which the Company and Longview made certain agreements related to
such consent. In addition to the issuance of the Waiver Securities (see Note 3), the Longview
Agreement also provided (i) that the Company will repay to Longview all principal and interest due
under the Longview Note dated July 13, 2007 upon the closing of an equity or debt financing (or a
series of equity or debt financings) which results in gross proceeds to the Company in the
aggregate in excess of $1,500,000; (ii) if the Company arranges for a third-party investor to
purchase the Companys Series A-1 Stock and Series A-2 Stock beneficially owned by Longview
(collectively, the Preferred Stock) at its Stated Value (as defined in the respective
Certificates of Designations) pursuant to a binding letter of intent delivered to Longview no later
than June 1, 2010 (the LOI), Longview will sell the Preferred Stock to such investor on such
terms and also sell all the Waiver Securities to such investor at a price per share of $0.30 (the
Buyout), provided that the closing of such sale occurs no later than July 15, 2010; and (iii) in
the event the LOI is not delivered on or prior to June 1, 2010, the Buyout has not closed on or
prior to July 15, 2010 or Longview still owns Preferred Stock on July 15, 2010 (each, a
Contingency Date), the Company shall issue to Longview (x) non-voting equity securities, with
terms junior to the Companys Series B Convertible Preferred Stock, convertible into 1,000,000
shares of the Companys common stock (the Contingent Securities) and (y) a two-year warrant to
purchase 1,000,000 shares of the Companys common stock at an exercise price per share of $0.30
(the Contingent Warrant). The terms of the Contingent Securities and the Contingent Warrant will
be negotiated in good faith and mutually agreed upon by the parties if such issuances are required,
except that the Contingent Securities are expected to consist of 10,000 shares of Series C
Convertible Preferred Stock, Both the Contingent Securities and the Contingent Warrant must
include a blocker which would preclude conversion into Common Stock resulting in beneficial
ownership by the holder and its affiliates of more than 4.99% of the Companys outstanding common
ctock, the Contingent Warrant will include a cashless exercise provision, and neither the
Contingent Securities nor the Contingent Warrant will be convertible or exercisable within six
months of issuance. Management believes there is a reasonable possibility a third-party investor
will purchase the Preferred Stock beneficially owned by Longview no later than July 15, 2010,
therefore management has not recorded a liability for the Contingent Securities and the Contingent
Warrants as of March 28, 2010.
Note 11 Subsequent Events
Issuance of Series C Preferred Stock
The effectiveness of the Looney Settlement Agreement was conditioned upon the Companys
receipt of consents from its senior creditors, one of which, Longview, required the Company to
agree to issue the Waiver Securities in consideration for Longviews waiver of potential future
entitlement to all accumulated, but undeclared and unpaid, dividends on the Companys Series A-1
Stock and the
Companys Series A-2 Stock held by Longview from the respective dates of issuance of the
Series A-1
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Stock and Series A-2 Stock through July 15, 2010. The Company effectuated this
requirement in April 2010 through the issuance of 27,500 shares of the Companys newly created
Series C Convertible Preferred Stock (the Series C Stock) to Longview. Each share of Series C
Stock is convertible at any time at the holders option into 100 shares of common stock at an
initial conversion price per share of common stock equal to $0.30. The Series C Stock is
non-voting, except to the extent required by law. With respect to distributions upon a deemed
dissolution, liquidation or winding-up of the Company, the Series C Stock ranks senior to the
common stock and junior to the Companys Series A-1 Stock, Series A-2 Stock and Series B Stock. The
liquidation preference per share of Series C Stock equals its stated value, $30 per share. The
Series C Stock is not entitled to any preferential cash dividends; however, the Series C Stock is
entitled to receive on an as-converted basis, pari passu with the Companys common stock, but after
payment of dividends to the Series A-1 Stock, Series A-2 Stock and Series B Stock at the time
outstanding, such dividends on the common stock as may be declared from time to time by the
Companys Board of Directors. The Series C Stock is not redeemable by the holder thereof, but the
Company will have the right, upon 30 calendar days prior written notice, to redeem the Series C
Stock at its stated value, $30 per share. The Series C Stock is also subject to a blocker that
would prevent each holders common stock ownership at any given time from exceeding 4.99% of the
Companys outstanding common stock (which percentage may increase but never above 9.99%).
23
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations.
In this report, the terms Irvine Sensors, Company, we, us and our refer to Irvine
Sensors Corporation (ISC) and its subsidiaries.
This report contains forward-looking statements regarding Irvine Sensors which include, but
are not limited to, statements concerning our projected revenues, expenses, gross profit and
income, mix of revenue, demand for our products, the need for additional capital, the outcome of
existing litigation and potential settlements of such litigation, our ability to obtain and
successfully perform additional new contract awards and the related funding of such awards, market
acceptance of our products and technologies, the competitive nature of our business and markets,
the success and timing of new product introductions and commercialization of our technologies,
product qualification requirements of our customers, our significant accounting policies and
estimates, and the outcome of expense audits. These forward-looking statements are based on our
current expectations, estimates and projections about our industry, managements beliefs, and
certain assumptions made by us. Words such as anticipates, expects, intends, plans,
predicts, potential, believes, seeks, estimates, should, may, will, with a view
to 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, our 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:
| our ability to obtain additional financing for working capital on acceptable terms in a timely manner or at all; | ||
| our ability to regain and maintain compliance with Nasdaqs listing requirements; | ||
| our ability to settle a pending judgment on existing litigation with FirstMark on acceptable terms; | ||
| our ability to continue as a going concern; | ||
| our ability to obtain critical and timely product and service deliveries from key vendors due to our working capital limitations, competitive pressures or other factors; | ||
| our ability to successfully execute our business plan and control costs and expenses; | ||
| our ability to obtain expected and timely bookings and orders resulting from existing contracts; | ||
| our ability to secure and successfully perform additional research and development contracts, and achieve greater contracts backlog; | ||
| governmental agendas, budget issues and constraints and funding or approval delays; | ||
| our ability to maintain adequate internal controls and disclosure procedures, and achieve compliance with Section 404 of the Sarbanes-Oxley Act; | ||
| our ability to introduce new products, gain broad market acceptance for such products and ramp up manufacturing in a timely manner; | ||
| new products or technologies introduced by our competitors, many of whom are bigger and better financed than us; | ||
| the pace at which new markets develop; | ||
| our ability to establish strategic partnerships to develop our business; | ||
| our limited market capitalization; | ||
| general economic and political instability; and |
24
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| those additional factors which are listed under the section Risk Factors in Part II, Item 1A of this report. |
We do not undertake any obligation to revise or update publicly any forward-looking statements
for any reason, except as required by law. Additional information on the various risks and
uncertainties potentially affecting our operating results are discussed below and are contained in
our publicly filed documents available through the SECs website (www.sec.gov) or upon written
request to our Investor Relations Department at 3001 Red Hill Avenue, Costa Mesa, California 92626.
The information contained in, or that can be accessed through, such website does not constitute a
part of this report.
Overview
We are a vision systems company enabled by technology for three-dimensional packaging of
electronics and manufacturing of electro-optical products. We design, develop, manufacture and sell
vision systems, miniaturized electronic products and higher level systems incorporating such
products for defense, security and commercial applications. We also perform customer-funded
contract research and development related to these products, mostly for U.S. government customers
or prime contractors. Most of our historical business relates to application of our technologies
for stacking either packaged or unpackaged semiconductors into more compact three-dimensional
forms, which we believe offer volume, power, weight and operational advantages over competing
packaging approaches, and which we believe allows us to offer proprietary higher level products
with unique operational features.
In December 2005, we completed the initial acquisition (the Initial Acquisition) of 70% of
the outstanding capital stock of Optex Systems, Inc. (Optex), a privately held manufacturer of
telescopes, periscopes, lenses and other optical systems and instruments whose customers were
primarily agencies of and prime contractors to the U.S. Government. In consideration for the
Initial Acquisition, we paid the sole shareholder of Optex, Timothy Looney, cash in the amount of
approximately $14.1 million. As additional consideration, we were initially required to pay to Mr.
Looney cash earnout payments in the aggregate amount up to $4.0 million based upon the net cash
generated from the Optex business, after debt service, for the fiscal year ended October 1, 2006
(fiscal 2006) and the next two subsequent fiscal years. Mr. Looney was not entitled to any
earnout payments for fiscal 2006, for the fiscal year ended September 30, 2007 (fiscal 2007) or
for the fiscal year ended September 28, 2008 (fiscal 2008). In January 2007, we negotiated an
amendment to our earnout agreement with Mr. Looney that extended his earnout period to December
2009 and reduced the aggregate maximum potential earnout by $100,000 to $3.9 million in
consideration for a secured subordinated term loan providing for advances from an entity owned by
Mr. Looney to Optex of up to $2 million. This term loan bore interest at 10% per annum and matured
on the earlier of February 2009 or 60 days after repayment of our senior debt. As of September 27,
2009, this term loan was fully advanced to Optex. Optex ceased operations in October 2008 as a
result of a UCC foreclosure sale (the Optex Asset Sale) as described more fully below. In
September 2009, Optex filed a voluntary petition for relief under Chapter 7 of the United States
Bankruptcy Code in the United States Bankruptcy Court for the District of California. As a result
of this filing, the accounts of Optex have been deconsolidated from the consolidated balance sheet
of the Company at September 27, 2009, including the obligations of Optex to the entity owned by Mr.
Looney described above. We believe that Mr. Looney was not entitled to any earnout for fiscal
2009. However, Mr. Looney brought a lawsuit against us alleging that we were obligated to pay him
the full potential earnout as a result of the Optex Asset Sale. To mitigate the risks of this and
other related lawsuits brought by Mr. Looney and his affiliated entity, we entered into a
settlement of various legal disputes with Mr. Looney, including the
earnout matter, in March 2010 (the Looney Settlement Agreement) pursuant to which we issued
Mr. Looney a $2.5 million secured promissory note (the Secured Promissory Note). (See Note 3 of
the Condensed Notes to the Consolidated Financial Statements).
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In connection with the Initial Acquisition, we entered into an agreement with Mr. Looney,
pursuant to which we agreed to purchase the remaining 30% of the capital stock of Optex held by Mr.
Looney (the Buyer Option), subject to stockholder approval, which approval was received in June
2006. On December 29, 2006, we amended certain of our agreements with Mr. Looney regarding the
Buyer Option. In consideration for such amendments, we issued a one-year unsecured subordinated
promissory note to Mr. Looney in the principal amount of $400,000, bearing interest at a rate of
11% per annum. This obligation was extinguished in March 2010 upon issuance of the Secured
Promissory Note. We exercised the Buyer Option on December 29, 2006 and issued Mr. Looney
approximately 269,231 shares of our common stock, after giving effect to our one-for-ten reverse
stock split effectuated in August 2008 (the 2008 Reverse Split), as consideration for our
purchase of the remaining 30% of the outstanding common stock of Optex held by him. As a result of
the Initial Acquisition and exercise of the Buyer Option, Optex became our wholly-owned subsidiary.
We financed the Initial Acquisition of Optex by a combination of $4.9 million of senior
secured debt from Square 1 Bank under a term loan and $10.0 million of senior subordinated secured
convertible notes from two private equity funds, which are sometimes referred to in this Report
collectively as Pequot. In December 2006, both of these obligations were refinanced with two new
senior lenders, Longview Fund, LP (Longview) and Alpha Capital Anstalt (Alpha) (collectively,
the Lenders). In November 2007, we restructured these obligations, as well as a short-term $2.1
million debt obligation to Longview, to extend the maturity date of all of such obligations,
including the related interest, to December 30, 2009 in consideration for a restructuring fee of
approximately $1.1 million, which fee was also initially payable December 30, 2009, but which was
extended to September 30, 2010 in connection with partial repayment of the original obligations.
In September 2008, we entered into a binding Memorandum of Understanding for Settlement and
Debt Conversion Agreement (the MOU) with the Lenders with the intent to effect a global
settlement and restructuring of our aggregate outstanding indebtedness payable to the Lenders,
which was then approximately $18.4 million. In October 2008, pursuant to the MOU, an entity
controlled by the Lenders delivered a notice to us and to Optex of the occurrence of an event of
default and acceleration of the obligations due to the Lenders and their assignee and conducted the
aforementioned Optex Asset Sale, a public UCC foreclosure sale of the assets of Optex. The entity
controlled by the Lenders credit bid $15 million in the Optex Asset Sale, which was the winning
bid. As a result, $15 million of our aggregate indebtedness to the Lenders was extinguished. All
financial statements and schedules of the Company give effect to this event and report Optex as a
discontinued operation for both the current and prior fiscal periods.
In March 2009, we sold most of our patent portfolio to a patent acquisition company for $9.5
million in cash, $8.5 million of which was paid in March 2009 and $1.0 million of which was paid in
April 2009, and the patent acquisition company granted us a perpetual, worldwide, royalty-free,
non-exclusive license to use the sold patents in our business (the Patent Sale and License). In
order to secure the release of security interests to effectuate the Patent Sale and License, we
agreed to pay $2.8 million of the aggregate principal and accrued interest owed to the Lenders from
the proceeds of the Patent Sale and License. After such payment, our aggregate principal and
accrued interest owed to the Lenders was approximately $1.2 million. As a result of our satisfying
certain conditions, including our consummation of a $1.0 million bridge debt financing, in April
2009, the Lenders exchanged $1.0 million of our residual principal obligations for the issuance of
24,999 shares of our newly-created Series A-2 10% Cumulative Convertible Preferred Stock (the
Series A-2 Stock), a non-voting convertible preferred stock of the Company. The conversion of the
Series A-2 Stock into shares of our common stock is subject to the same conversion blocker as
contained in our Series A-1 10% Cumulative Convertible Preferred Stock (the Series A-1 Stock),
which would prevent each Lenders common stock ownership at any given time
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from exceeding 4.99% of our outstanding common stock (which percentage may
increase but not above 9.99%).
Since 2002, we historically derived a substantial majority of our total revenues from
government-funded research and development rather than from product sales. We anticipate that a
substantial majority of our total revenues will continue to be derived from government-funded
sources in the immediately foreseeable future. In fiscal 2008 and fiscal 2009, our contract
research and development revenues were adversely affected by procurement delays and capital
constraints, as well as diversion of management and financial resources to address issues related
to operations at Optex, the Optex Asset Sale and the various lawsuits with Mr. Looney. Our current
marketing efforts are focused on government programs that we believe have the potential to
transition to government production contracts. If we are successful in this transition, our future
revenues may become more dependent upon production elements of U.S. defense budgets, funding
approvals and political agendas. We are also attempting to increase our revenues from product
sales by introducing new products with commercial applications, in particular, miniaturized cameras
and stacked computer memory chips. We cannot assure you that we will be able to complete
development, successfully launch or profitably manufacture and sell any such products on a timely
basis, if at all. We generally use contract manufacturers to produce these products or their
subassemblies, and all of our other current operations occur at a single, leased facility in Costa
Mesa, California.
Prior to the fiscal year ended September 27, 2009 (fiscal 2009), we had a history of
unprofitable operations due in part to our investment in Optex and in part to discretionary
investments that we made to commercialize our technologies and to maintain our technical staff and
corporate infrastructure at levels that we believed were required for future growth. In fiscal
2009, we did achieve profitable operating results, largely due to certain nonrecurring events such
as the Patent Sale and License and elimination of certain obligations. In the 13-week and 26-week
periods ended March 28, 2010, we again experienced unprofitable operations. With respect to our
investments in staff and infrastructure, the advanced technical and multi-disciplinary content of
our technologies places a premium on a stable and well-trained work force. As a result, we
generally maintain the size of our work force even when anticipated government contracts are
delayed, a circumstance that has occurred with some frequency in the past and that has resulted in
under-utilization of our labor force for revenue generation from time to time. Delays in receipt of
research and development contracts are unpredictable, but we believe such delays represent a
recurring characteristic of our research and development contract business. We anticipate that the
impact on our business of future delays can be mitigated by the achievement of greater contract
backlog and are seeking growth in our research and development contract revenue to that end. We
are also seeking to expand the contribution to our total revenues from product sales, which have
not historically experienced the same types of delays that can occur in research and development
contracts. We have not yet demonstrated the level of sustained research and development contract
revenue or product sales that we believe, by itself, is required to sustain profitable operations.
Our ability to recover our investments through the cost-reimbursement features of our government
contracts is constrained due to both regulatory and competitive pricing considerations.
To offset the adverse working capital effect of our net losses, we have historically financed
our operations through various equity and debt financings. To finance the acquisition of Optex, we
also incurred material long-term debt, and we have exchanged a significant portion of that debt
into preferred stock that is convertible into our common stock. In our last four fiscal years, we
have issued approximately 7.8 million shares of our common stock, an increase of over 400% from the
approximately 1.9 million shares of our common stock outstanding at the beginning of that period,
which resulted in a substantial dilution of stockholder interests. At March 28, 2010, our fully
diluted common stock position was approximately 39.3 million shares, which assumes the conversion
into common stock of all of the Companys preferred stock and convertible debentures outstanding or obligated for issuance as
of March
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28, 2010 and the exercise for cash of all warrants and options to purchase the Companys
securities outstanding as of March 28, 2010. At March 28, 2010, we had approximately $5.4 million
of debt.
None of our subsidiaries accounted for more than 10% of our total assets at March 28, 2010 or
have separate employees or facilities. We currently report our operating results and financial
condition in two operating segments, our research and development business and our product
business.
Critical Accounting Estimates
Our consolidated financial statements have been prepared in conformity with GAAP. 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 are the same as those disclosed in our Form 10-K for the 52-week period ended September 27,
2009.
Results of Operations
Total Revenues. Our total revenues decreased approximately 4% in the 13-week period ended
March 28, 2010 as compared to the 13-week period ended March 29, 2009, but increased approximately
6% in the 26-week period ended March 28, 2010 as compared to the 26-week period ended March 29,
2009. The elements of the total revenues that produced these opposite outcomes are discussed more
fully below.
13-Week Comparisons | Total Revenues | |||
13 weeks ended March 29, 2009 |
$ | 2,841,200 | ||
Dollar decrease in current comparable 13 weeks |
(119,800 | ) | ||
13 weeks ended March 28, 2010 |
$ | 2,721,400 | ||
Percentage decrease in current 13 weeks |
(4 | )% |
26-Week Comparisons | Total Revenues | |||
26 weeks ended March 29, 2009 |
$ | 5,584,700 | ||
Dollar increase in current comparable 26 weeks |
346,900 | |||
26 weeks ended March 28, 2010 |
$ | 5,931,600 | ||
Percentage increase in current 26 weeks |
6 | % |
Contract Research and Development Revenue. Contract research and development revenue consists
of amounts realized or realizable from funded research and development contracts, largely from U.S.
government agencies and government contractors. Contract research and development revenue for the
13-week period ended March 28, 2010 declined 12% from contract research and development revenue of
the 13-week period ended March 29, 2009, but increased 1% for the 26-week period ended March 28,
2010 from contract research and development revenue of the 26-week period ended March 29, 2009, as
shown in the following tables:
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Contract Research and | Percentage of | |||||||
13-Week Comparisons | Development Revenue | Total Revenue | ||||||
13 weeks ended March 29, 2009 |
$ | 2,295,300 | 81 | % | ||||
Dollar decrease in current comparable
13 weeks |
(281,000 | ) | ||||||
13 weeks ended March 28, 2010 |
$ | 2,014,300 | 74 | % | ||||
Percentage decrease in current 13 weeks |
(12 | )% |
Contract Research and | Percentage of | |||||||
26-Week Comparisons | Development Revenue | Total Revenue | ||||||
26 weeks ended March 29, 2009 |
$ | 4,738,500 | 85 | % | ||||
Dollar increase in current comparable 26 weeks |
35,200 | |||||||
26 weeks ended March 28, 2010 |
$ | 4,773,700 | 80 | % | ||||
Percentage increase in current 26 weeks |
1 | % |
The decrease in our contract research and development revenue in the 13-week period ended
March 28, 2010 as compared to the 13-week period ended March 29, 2009 was partially related to the
timing of the start of new contract awards that experienced procurement delays. In addition,
completion of some of the technical milestones of existing contracts was delayed during the current
13-week period by our working capital limitations that impacted the schedule at which we could
receive necessary vendor and subcontractor support, which would have generated revenue under the
cost reimbursement features of many of our contract research and development contracts. Over the
full 26-week period ended March 28, 2010, the various timing issues related to performance of
research and development contracts, particularly those derived from vendor and subcontractor
support, largely evened out, resulting in nearly equal contract research and development revenue
for the current year 26-week period compared to the first 26 weeks of fiscal 2009. We believe that
these variances are related to the specific procurement and technical milestones of our present
research and development contracts, rather than being indicative of a trend. However, if we
require substantially increased subcontractor and vendor support to increase our contract research
and development revenue in future fiscal quarters, such an outcome will likely be dependent on our
ability to raise additional capital, which we cannot guarantee.
Cost of Contract Research and Development Revenue. Cost of contract research and development
revenue consists of wages and related benefits, as well as subcontractor, independent consultant
and vendor expenses directly incurred in support of research and development contracts, plus
associated indirect expenses permitted to be charged pursuant to the relevant contracts. Our cost
of contract research and development revenue for the first 13 weeks and 26 weeks of fiscal 2010
decreased as compared to the first 13 weeks and 26 weeks of fiscal 2009, both in terms of absolute
dollars and as a percentage of contract research and development revenue as shown in the following
tables:
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Percentage of | ||||||||
Cost of Contract | Contract Research | |||||||
Research and | and Development | |||||||
13-Week Comparisons | Development Revenue | Revenue | ||||||
13 weeks ended March 29, 2009 |
$ | 2,008,500 | 88 | % | ||||
Dollar
decrease in current comparable 13 weeks |
(539,800 | ) | ||||||
13 weeks ended March 28, 2010 |
$ | 1,468,700 | 73 | % | ||||
Percentage decrease in current 13 weeks |
(27 | )% |
Percentage of | ||||||||
Cost of Contract | Contract Research | |||||||
Research and | and Development | |||||||
26-Week Comparisons | Development Revenue | Revenue | ||||||
26 weeks ended March 29, 2009 |
$ | 3,945,900 | 83 | % | ||||
Dollar decrease in current comparable 26 weeks |
(441,000 | ) | ||||||
26 weeks ended March 28, 2010 |
$ | 3,504,900 | 73 | % | ||||
Percentage decrease in current 26 weeks |
(11 | )% |
The improved margins on our contract research and development revenue in the 13-week and
26-week periods ended March 28, 2010, as compared to the respective 13-week and 26-week periods
ended March 29, 2010, were largely the result of a substantial reduction in our indirect expenses
and the corresponding overhead costs of contract research and development revenue in the current
year periods as compared to such costs in the 13-week and 26-week periods ended March 29, 2009.
This overhead reduction, largely derived from reduced labor and labor-related expenses, resulted in
a disproportionate decrease in our costs of contract research and development revenue in the
current fiscal year periods, with the corresponding improvements in costs of contract research and
development revenue as a percentage of such revenue.
Product Sales. Our product sales are generally derived from sales of miniaturized camera
products, specialized chips, modules, stacked chip products and chip stacking services. Product
sales for the 13-week and 26-week periods ended March 28, 2010 increased both in terms of absolute
dollars and as a percentage of total revenue as compared to the 13-week and 26-week periods ended
March 29, 2009 as shown in the following tables:
Product | Percentage of | |||||||
13-Week Comparisons | Sales | Total Revenue | ||||||
13 weeks ended March 29, 2009 |
$ | 545,900 | 19 | % | ||||
Dollar increase in current comparable 13 weeks |
154,500 | |||||||
13 weeks ended March 28, 2010 |
$ | 700,400 | 26 | % | ||||
Percentage increase in current 13 weeks |
28 | % |
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Product | Percentage of | |||||||
26-Week Comparisons | Sales | Total Revenue | ||||||
26 weeks ended March 29, 2009 |
$ | 836,700 | 15 | % | ||||
Dollar increase in current comparable 26 weeks |
310,700 | |||||||
26 weeks ended March 28, 2010 |
$ | 1,147,400 | 19 | % | ||||
Percentage increase in current 26 weeks |
37 | % |
The increase in product sales in the current fiscal year periods compared to the prior fiscal
year periods is largely the result of substantially increased sales of our thermal imaging
products. This increase in thermal imaging product sales offset a decrease in sales of stacked chip
products, resulting in our aggregate 28% and 37% increase in product sales in the 13-week and
26-week periods ended March 28, 2010, respectively, as compared to the 13-week and 26-week periods
ended March 29, 2009. Based on the composition of our backlog at the date of this report, we
expect that sales of thermal imaging products will continue to represent a larger percentage of our
product sales throughout fiscal 2010 as compared to fiscal 2009.
Cost of Product Sales. Cost of product sales consists of wages and related benefits of our
personnel, as well as subcontractor, independent consultant and vendor expenses directly incurred
in the manufacture of products sold, plus related overhead expenses. Our cost of product sales for
the 13-week and 26-week periods ended March 28, 2010 and March 29, 2009 is shown in the following
tables:
Cost of | Percentage of | |||||||
13-Week Comparisons | Product Sales | Product Sales | ||||||
13 weeks ended March 29, 2009 |
$ | 409,800 | 75 | % | ||||
Dollar increase in current comparable 13 weeks |
294,700 | |||||||
13 weeks ended March 28, 2010 |
$ | 704,500 | 101 | % | ||||
Percentage increase in current 13 weeks |
72 | % |
Cost of | Percentage of | |||||||
26-Week Comparisons | Product Sales | Product Sales | ||||||
26 weeks ended March 29, 2009 |
$ | 787,800 | 94 | % | ||||
Dollar increase in current comparable 26 weeks |
319,500 | |||||||
26 weeks ended March 28, 2010 |
$ | 1,107,300 | 97 | % | ||||
Percentage increase in current 26 weeks |
41 | % |
A substantial portion of the increase in absolute dollars of cost of product sales in the
current fiscal year periods was related to the increase in product sales in those periods as
discussed above. However, the absolute dollar increase in cost of product sales in the 13-week and
26-week periods ended March 28, 2010 as compared to the 13-week and 26-week periods ended March 29,
2009 was disproportionately greater than the increase in product sales for the respective periods.
This disproportionate increase was substantially derived from increased product support and startup
costs associated with the Company new clip-on thermal imaging products in the current year
periods. The impact of product support costs may continue to produce fluctuations in product
margins unless and until our sales of thermal imaging
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products increase substantially, thereby reducing the percentage impact of such costs, which
typically are less elastic than the associated revenues.
General and Administrative Expense. General and administrative expense largely consists of
wages and related benefits for our executive, financial, administrative and marketing staff, as
well as professional fees, primarily legal and accounting fees and costs, plus various fixed costs
such as rent, utilities and telephone. General and administrative expense for the 13-week and
26-week periods ended March 28, 2010 declined substantially compared to the 13-week and 26-week
periods ended March 29, 2009 as shown in the following tables:
General and | ||||||||
Administrative | Percentage of | |||||||
13-Week Comparisons | Expense | Total Revenue | ||||||
13 weeks ended March 29, 2009 |
$ | 2,258,900 | 80 | % | ||||
Dollar decrease in current comparable
13 weeks |
(782,300 | ) | ||||||
13 weeks ended March 28, 2010 |
$ | 1,476,600 | 54 | % | ||||
Percentage decrease in current 13 weeks |
(35 | )% |
General and | ||||||||
Administrative | Percentage of | |||||||
26-Week Comparisons | Expense | Total Revenue | ||||||
26 weeks ended March 29, 2009 |
$ | 4,119,700 | 74 | % | ||||
Dollar decrease in current comparable 26 weeks |
(991,700 | ) | ||||||
26 weeks ended March 28, 2010 |
$ | 3,128,000 | 53 | % | ||||
Percentage decrease in current 26 weeks |
(24 | )% |
Approximately $257,800, or 33%, of the dollar decrease in general and administrative expense
in the 13-week period ended March 28, 2010 as compared to the 13-week period ended March 29, 2009,
was the result of decreased labor expense and related employee benefits in the current fiscal year
period. Similarly, approximately $401,600, or 41%, of the dollar decrease in general and
administrative expense in the 26-week period ended March 28, 2010 as compared to the 26-week period
ended March 29, 2009, was also the result of decreased labor expense and related employee benefits
in the current period. Our overall reduction in our labor-related overhead costs also contributed
to $130,200 and $231,100 reductions in bid and proposal general and administrative expenses in the
13-week and 26-week periods ended March 28, 2010, respectively, as compared to the 13-week and
26-week periods ended March 29, 2009. Our general and administrative service expense in the
13-week and 26-week periods ended March 2010, largely accounting expenses, also decreased $73,800
and $134,300, respectively, compared to the 13-week and 26-week periods ended March 29, 2009. These
current period reductions were partially offset by $240,600 and $140,800 increases in the 13-week
and 26-week periods ended March 28, 2010, respectively, in our unallowable general and
administrative expense for which we cannot seek reimbursement under most of our government
contracts, largely litigation expenses, compared to the prior fiscal year periods. Since we settled
our litigation in March 2010 with Timothy Looney, the original owner of Optex, our discontinued
subsidiary, we expect that the dollar magnitude of our unallowable general and administrative
expense is likely to decline in subsequent periods. Since our total revenues for the fiscal 2010
periods were relatively similar to those of the fiscal 2009 periods, the magnitude of our
decrease in absolute dollars of general and administrative expense in the 13-week and 26-week
periods ended March 28, 2010 as compared to the absolute dollars of general and administrative
expense in the 13-
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week and 26-week periods ended March 29, 2009 also resulted in general and administrative
expense as a percentage of total revenue being substantially decreased in the current fiscal year
periods.
Research and Development Expense. Research and development expense consists of wages and
related benefits for our research and development staff, independent contractor consulting fees and
subcontractor and vendor expenses directly incurred in support of internally funded research and
development projects, plus associated overhead expenses. Research and development expense for the
13-week and 26-week periods ended March 28, 2010, as compared to the 13-week and 26-week periods
ended March 29, 2009, is shown in the following tables:
Research and | ||||||||
Development | Percentage of | |||||||
13-Week Comparisons | Expense | Total Revenue | ||||||
13 weeks ended March 29, 2009 |
$ | 436,300 | 15 | % | ||||
Dollar increase in current comparable 13 weeks |
164,700 | |||||||
13 weeks ended March 28, 2010 |
$ | 601,000 | 22 | % | ||||
Percentage increase in current 13 weeks |
38 | % |
Research and | ||||||||
Development | Percentage of | |||||||
26-Week Comparisons | Expense | Total Revenue | ||||||
26 weeks ended March 29, 2009 |
$ | 786,700 | 14 | % | ||||
Dollar increase in current comparable 26 weeks |
569,500 | |||||||
26 weeks ended March 28, 2010 |
$ | 1,356,200 | 23 | % | ||||
Percentage increase in current 26 weeks |
72 | % |
The increase in research and development expense in the fiscal 2010 periods as compared to the
fiscal 2009 periods is largely related to labor deployment issues in the respective fiscal periods.
We use the same technical staff for both internal and customer funded research and development
projects, as well as the preparation of technical proposals, so the availability of direct labor in
terms of man hours and skill mix has a strong bearing on the amount of internally funded research
and development expense we undertake in any given period. We used less of our direct labor on
funded contracts in the current fiscal year periods than the prior fiscal year periods. Generally,
this difference in labor deployment does not reflect any trends, but rather is tied to specific
milestones of both funded and internal research projects. Accordingly, both the absolute dollar and
percentage increases in research and development expense in the fiscal 2010 periods as compared to
the fiscal 2009 periods reflect these milestones, rather than a change in priorities related to
internally funded research and development.
Gain On Sale or Disposal of Assets. We recorded a gain on sale or disposal of assets from our
Patent Sale and License of $8,632,800 in the 13-week and 26-week periods ended March 29, 2009. In
the 13-week and 26-week periods ended March 28, 2010, our gain on sale or disposal of assets was
only $0 and $12,500, respectively.
Interest Expense. Our interest expense for the 13-week and 26-week periods ended March 28,
2010, as compared to the 13-week and 26-week periods ended March 29, 2009, decreased substantially,
as shown in the following tables:
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13-Week Comparisons | Interest Expense | |||
13 weeks ended March 29, 2009 |
$ | 830,600 | ||
Dollar decrease in current comparable 13 weeks |
(699,400 | ) | ||
13 weeks ended March 28, 2010 |
$ | 131,200 | ||
Percentage decrease in current 13 weeks |
(84 | )% |
26-Week Comparisons | Interest Expense | |||
26 weeks ended March 29, 2009 |
$ | 1,239,700 | ||
Dollar decrease in current comparable 26 weeks |
(993,600 | ) | ||
25 weeks ended March 28, 2010 |
$ | 246,100 | ||
Percentage decrease in current 26 weeks |
(80 | )% |
The decline in interest expense in the fiscal 2010 periods as compared to the fiscal 2009
periods was primarily due to the reduction in our debt, and corresponding interest, that resulted
from application of proceeds from the Patent Sale and License, the exchange of a portion of our
debt for our Series A-2 Stock and the partial repayment of debt from proceeds of the Debenture
Private Placement.
Litigation Settlement Expense. In March 2010, we entered into the Looney Settlement Agreement,
pursuant to which we agreed to pay Timothy Looney $50,000 and to issue to Mr. Looney a secured
promissory note in the principal amount of $2,500,000 in settlement of litigation with Mr. Looney.
We recorded the Secured Promissory Note in our consolidated financial statements for the 13-week
and 26-week periods ended March 28, 2010 and extinguished the previously recorded expenses for
litigation judgments related to these matters in the same period. The effectiveness of the Looney
Settlement Agreement was conditioned upon our receipt of consents from our senior creditors, Summit
and Longview. As one of the conditions of obtaining Longviews Consent, we agreed to issue to
Longview equity securities with a value of $825,000 (the Waiver Securities) in consideration for
Longviews waiver of potential future entitlement to all accumulated, but undeclared and unpaid,
dividends on our Series A-1 Stock and our Series A-2 Stock held by Longview from the respective
dates of issuance of the Series A-1 Stock and Series A-2 Stock through July 15, 2010. The Waiver
Securities were issued to Longview on April 30, 2010 in the form of 27,500 shares of a newly
created Series C Convertible Preferred Stock. We recorded the expense of the obligation to issue
the Waiver Securities in the 13-week and 26-week periods ended March 28, 2010. The net effect was
an aggregate recording of $1,820,700 as a litigation settlement expense in the 13-week and 26-week
periods ended March 28, 2010. No comparable expense was incurred in the comparable prior fiscal
year periods. (See Note 3 of the Condensed Notes to the Consolidated Financial Statements).
Income From Discontinued Operations. As a result of the Optex Asset Sale, in the 13-week
period ended March 29, 2009, we recorded a loss from discontinued operations of $6,900, largely as
a result of taxes, and in the 26-week period ended March 29, 2009 realized a gain on Optexs
discontinued operations of $58,400, reflecting results for the interval from September 29, 2008
through October 14, 2008, the date of the Optex Asset Sale. Since Optex had no operations
subsequent to the Optex Asset Sale, no comparable result from discontinued operations was
recognized in the 13-week and 26-week periods ended March 28, 2010.
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Net Income (Loss). Our net income (loss) for the 13-week and 26-week periods ended March 28,
2010, as compared to the 13-week and 26-week periods ended March 29, 2009, is shown in the
following tables:
13-Week Comparisons | Net Income (Loss) | |||
13 weeks ended March 29, 2009 |
$ | 5,128,000 | ||
Dollar change in current comparable 13 weeks |
(8,547,600 | ) | ||
13 weeks ended March 28, 2010 |
$ | (3,419,600 | ) | |
Percentage decrease for current 13 weeks |
(167 | )% |
26-Week Comparisons | Net Income (Loss) | |||
26 weeks ended March 29, 2009 |
$ | 3,013,900 | ||
Dollar change in current comparable 26 weeks |
(8,150,200 | ) | ||
26 weeks ended March 28, 2010 |
$ | (5,136,300 | ) | |
Percentage decrease for current 26 weeks |
(270 | )% |
Our net income in the 13-week and 26-week periods ended March 29, 2009 was substantially the
result of our gain on sale or disposal of assets resulting from our non-recurring Patent Sale and
License in March 2009. The absence of a comparable-sized gain in the 13-week and 26-week periods
ended March 28, 2010 was the principal cause for the change in our results for the current fiscal
year periods compared to the 13-week and 26-week periods ended March 29, 2009. The net loss in the
current fiscal year periods was partially reduced by the decrease in interest expense and the
reduction in general and administrative expense in the 13-week and 26-week periods ended March 28,
2010 as discussed above.
Liquidity and Capital Resources
Our liquidity did not change substantially in the first 26 weeks of fiscal 2010 in terms of
our consolidated cash and cash equivalents and our working capital deficit as shown in the
following table:
Cash and | Working Capital | |||||||
Cash Equivalents | (Deficit) | |||||||
September 27, 2009 |
$ | 125,700 | $ | (6,271,300 | ) | |||
Dollar change in the 26 weeks ended March 28, 2010 |
(15,100 | ) | 174,100 | |||||
March 28, 2010 |
$ | 110,600 | $ | (6,445,400 | ) | |||
Percentage change in the 26 weeks ended March 28, 2010 |
(12 | )% | 3 | % |
The aggregate of our non-cash expenses in the 26 weeks ended March 28, 2010 was $2,511,600,
largely consisting of non-cash litigation settlement expense and depreciation and amortization
expense, and to a much lesser extent, non-cash interest expense, change in fair value of derivative
instruments and non-cash stock-based compensation. These non-cash expenses partially offset the
use of cash derived from our net loss and various timing effects and resulted in an operational use
of cash in the amount of $2,548,300 in the 26-week period ended March 28, 2010. These and other
uses of cash, including a reduction of $656,700 in factoring advances against receivables, were
offset by $2,049,500 of net
proceeds from our preferred stock financing and $1,651,300 from our debenture unit financing
in the
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current fiscal year period, resulting in the net $15,100 decrease of cash in the 26-week
period ended March 28, 2010.
During the 26 weeks ended March 28, 2010, we continued to incur fees and expenses in the
lawsuits related to the ongoing disputes with Mr. Looney and his affiliated entity. In that period,
these fees and expenses amounted to an aggregate of $290,100. In March 2010, we settled these
lawsuits with Mr. Looney and his affiliated entity in consideration of our payment of $50,000 in
cash and issuance of a $2.5 million 27-month secured promissory note to Mr. Looney. (See Note 3 of
the Condensed Notes to the Consolidated Financial Statements). Debt service on this note will have
a material adverse effect on our future liquidity so long as the note remains outstanding.
Under litigation related to obligations allegedly owed to FirstMark III, LP, formerly known as
Pequot Private Equity Fund III, LP, and FirstMark III Offshore Partners, LP, formerly known as
Pequot Offshore Private Equity Partners III, LP (collectively, FirstMark), FirstMark filed a
motion for summary judgment, which was granted in January 2010, although to our knowledge, judgment
has not yet been entered as of the date of this report. (See Note 10 of the Condensed Notes to the
Consolidated Financial Statements). We are in negotiations to settle this matter, but such an
outcome cannot be assured. If we are unable to settle this matter in a satisfactory manner,
execution on the anticipated final judgment could have a material adverse effect on us and our
financial condition, including our liquidity.
The small increase in the working capital deficit in the 26-week period ended March 28, 2010
was largely the result of the proceeds from our preferred stock and debenture unit financings in
the current period offseting the impact of our net loss and other factors. Deployment of the net
proceeds from those financings allowed us to reduce our factoring advances against receivables by
$656,700 in the 26-week period ended March 28, 2010. At March 28, 2010, our factoring lender had
advances of approximately $329,100 to us.
At March 28, 2010, our funded backlog was approximately $7.0 million. We expect, but cannot
guarantee, that a substantial portion of our funded backlog at March 28, 2010 will result in
revenue recognized in fiscal 2010. In addition, our government research and development contracts
and product purchase orders typically include unfunded backlog, which is funded when the previously
funded amounts have been expended or product delivery schedules are released. As of March 28, 2010,
our total backlog, including unfunded portions, was approximately $13.6 million. Subsequent to
March 28, 2010, we disclosed that we had received and accepted product delivery schedules related
to our thermal imaging products that have substantially increased our funded backlog.
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. While we have only experienced a small number of contract
terminations, none of which were recent, we cannot assure you 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 liquidity and results of operations and
could result in employee layoffs.
We have developed an operating plan to manage costs in line with estimated total
revenues for the balance of fiscal 2010 and beyond, including contingencies for cost reductions if
projected revenues are not fully realized. However, there can be no assurance that anticipated
revenues will be realized or that we will be able to successfully implement our plans. Accordingly,
we anticipate that we will need to raise additional funds in fiscal 2010 to meet our continuing
obligations.
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Off-Balance Sheet Arrangements
Our conventional operating leases are either immaterial to our financial statements or do not
contain the types of guarantees, retained interests or contingent obligations that would require
their disclosures as an off-balance sheet arrangement pursuant to Regulation S-K Item 303(a)(4).
As of March 28, 2010 and September 27, 2009, we did not have any other relationships with
unconsolidated entities or financial partners, such as entities often referred to as structured
finance or special purpose entities, which would have been established for the purpose of
facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Contractual Obligations and Commitments
Debt. At March 28, 2010, we had approximately $5,415,300 of debt, which consisted of (i) a
secured promissory note payable to Longview, described more fully below, the principal amount of
which was reduced from $2.1 million to approximately $163,100 through partial exchange of such debt
pursuant to the credit bid that effectuated the Optex Asset Sale and partial repayment from
proceeds of the Patent Sale and License and the Debenture Private Placement; (ii) unsecured
convertible and non-convertible debentures issued in the Debenture Private Placement with an
aggregate principal balance of $2,752,200; and (iii) a $2,500,000 secured subordinated promissory
note payable to Timothy Looney pursuant to settlement of litigation, described more fully below.
We also had contingent secured subordinated notes originally issued in the aggregate principal
amount of $1,115,000 (the Contingent Notes), which were issued in connection with our November
2007 debt restructuring, described more fully below. Of the principal amount of the Contingent
Notes, only $9,100 remained potentially outstanding as of March 28, 2010.
On July 19, 2007, we entered into a Loan Agreement, a secured promissory note (the Longview
Note) and an Omnibus Security Interest Acknowledgement with Longview, pursuant to which we closed
a short-term non-convertible loan in the original principal amount of $2.0 million (the Loan),
which was subsequently increased by $100,000 to $2.1 million pursuant to the terms of the Longview
Note s. The Longview Note bore interest at a rate of 12% per annum, due together with the unpaid
principal amount when the Longview Note matures, which was originally on January 19, 2008, but was
extended to December 30, 2009 pursuant to our November 2007 debt restructuring and further extended
to September 30, 2010 pursuant to partial repayment terms related to the Patent Sale and License.
If we fail to pay the principal and accrued interest within ten days after the maturity date, we
will incur a late fee equal to 5% of the amount remaining unpaid at that time.
In October 2008, approximately $1,651,100 of the principal due under the Longview Note was
retired pursuant to the Optex Asset Sale. In March 2009, in connection with the Patent Sale and
License, the outstanding principal of the Longview Note was further reduced to $188,400, and the
maturity date of the Longview Note was extended to September 30, 2010. In March 2010, in
connection with the Debenture Private Placement, the outstanding principal of the Longview Note was
further reduced to $163,100.
In November 2007, we restructured all of our debt obligations with Longview and Alpha. In
consideration for this debt restructuring, we issued the Contingent Notes to Longview and Alpha in
the aggregate principal amount of $1.0 million and $115,000, respectively, which Contingent Notes
do not accrue interest, and in general, are not due and payable until September 30, 2010. The
Contingent Notes will be discharged (and cancelled) in pro rata proportion to the amount that the
total indebtedness owed to Longview and Alpha is repaid in full by September 30, 2010. If the total
principal and accrued interest payable to Longview and Alpha on existing obligations is repaid in full, then the Contingent
Notes will be
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cancelled in their entirety. The Contingent Notes are secured by substantially all of
our assets. The reduction of our obligations to Longview and Alpha pursuant to the Optex Asset
Sale, the Patent Sale and License, the exchange and cancellation of debt for the issuance of Series
A-2 Preferred Stock and repayments in connection with the Debenture Private Placement has
correspondingly reduced our potential obligations under the Contingent Notes to approximately
$9,100 at March 28, 2010, which has not been recorded in our accounts due to its contingent nature.
This residual balance under the Contingent Notes only relates to obligations due to Longview,
inasmuch as the debt obligations to Alpha have been fully paid.
In March 2010, we sold and issued convertible debenture units (the Units) with an aggregate
principal balance of $2,752,200 in two closings of a private placement (the Debenture Private
Placement). Each Unit is comprised of (i) one one-year, unsecured convertible debenture with a
principal repayment obligation of $5,000 (the Convertible Debenture) that is convertible at the
election of the holder into shares of our common stock at a conversion price of $0.40 per share
(the Principal Conversion Shares); (ii) one one-year, unsecured non-convertible debenture with a
principal repayment obligation of $5,000 that is not convertible into common stock (the
Non-Convertible Debenture and, together with the Convertible Debenture, the Debentures); and
(iii) a five-year warrant to purchase 3,125 shares of our common stock (the Debenture Investor
Warrant). The conversion price applicable to the Debentures and the exercise price applicable to
the Debenture Investor Warrants is $0.40 per share. The Debentures bear simple interest at a rate
per annum of 20% of their original principal value. Interest on the Debentures accrues and is
payable quarterly in arrears and is convertible at our election into shares of our common stock at
a conversion price of $0.40 per share. The conversion price of the Debentures is subject to
adjustment for stock splits, stock dividends, recapitalizations and the like. We may repay any
unpaid and unconverted principal amount of the Debentures in cash prior to maturity at 110% of such
principal amount.
The Secured Promissory Note issued by the Company in connection with the Looney Settlement
Agreement bears simple interest at a rate per annum of 10% of the outstanding principal balance and
is secured by substantially all of our assets (the Collateral) pursuant to the terms and
conditions of a Security Agreements and Intellectual Property Security Agreement with Mr. Looney
(the Security Agreements), but such security interests are subject to and subordinate to the
existing perfected security interests and liens of our senior creditors, Summit and Longview. The
Secured Promissory Note requires the Company to remit graduated monthly installment payments over a
27-month period to Mr. Looney beginning with a payment of $8,000 in May 2010 and ending with a
payment of $300,000 in June 2012. All such payments are applied first to unpaid interest and then
to outstanding principal. A final payment of the remaining unpaid principal and interest under the
Secured Promissory Note is due and payable in July 2012. Past due payments will bear simple
interest at a rate per annum of 18%. In the event we prepay all amounts owing under the Secured
Promissory Note by October 9, 2011, the $50,000 cash payment made to Mr. Looney pursuant to the
Looney Settlement Agreement will either be returned to us or will be deducted from our final
payment due on the Secured Promissory Note.
Capital Lease Obligations. Our outstanding principal balance on our capital lease obligations
of $2,000 at March 28, 2010 relate primarily to manufacturing and test equipment and are included
as part of current liabilities within our consolidated balance sheet.
Operating Lease Obligations. We have various operating leases covering equipment and
facilities located in Costa Mesa, California.
Deferred Compensation. We have a deferred compensation plan, the Executive Salary
Continuation Plan (the ESCP), for select key employees. Benefits payable under the ESCP are
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established on the basis of years of service with the Company, age at retirement and base salary,
subject to a maximum benefits limitation of $137,000 per year for any individual. The ESCP is an
unfunded plan. The recorded liability for future expense under the ESCP is determined based on
expected lifetime of participants using Social Security mortality tables and discount rates
comparable to that of rates of return on high quality investments providing yields in amount and
timing equivalent to expected benefit payments. At the end of each fiscal year, we determine the
assumed discount rate to be used to discount the ESCP liability. We considered various sources in
making this determination for fiscal 2009, including the Citigroup Pension Liability Index, which
at September 30, 2009 was 5.54%. Based on this review, we used a 5.5% discount rate for
determining the ESCP liability at September 27, 2009. There are presently two of our retired
executives who are receiving benefits aggregating $184,700 per annum under the ESCP. As of March
28, 2010, $1,120,600 has been accrued in the accompanying consolidated balance sheet for the ESCP,
of which amount $184,700 is a current liability we expect to pay during the remainder of fiscal
2010 and the first half of fiscal 2011.
Stock-Based Compensation
Aggregate stock-based compensation for the 26-week periods ended March 28, 2010 and March 29,
2009 was $46,600 and $54,700, respectively, and was attributable to the following:
26 Weeks Ended | 26 Weeks Ended | |||||||
March 28, 2010 | March 29, 2009 | |||||||
Cost of contract research and
development revenue |
$ | 10,700 | $ | 13,900 | ||||
General and administrative expense |
35,900 | 40,800 | ||||||
$ | 46,600 | $ | 54,700 | |||||
All transactions in which goods or services are the consideration received for equity
instruments issued to non-employees are accounted for based on the fair value of the consideration
received or the fair value of the equity instrument issued, whichever is more reliably measurable.
The measurement date used to determine the fair value of any such equity instrument is the earliest
to occur of (i) the date on which the third-party performance is complete, (ii) the date on which
it is probable that performance will occur, or (iii) if different, the date on which the
compensation has been earned by the non-employee. In the 26-week period ended March 28, 2010, we
issued warrants to purchase an aggregate of 350,000 shares of our common stock, valued at $119,000,
to an investment banking firm for a one-year extension of an agreement for said firm to assist us
in raising additional capital and to provide financial advisory services.
We calculate stock option-based compensation by estimating the fair value of each option
granted using the Black-Scholes option valuation model and various assumptions that are described
in Note 1 of Condensed Notes to Consolidated Financial Statements included in this report. Once the
compensation cost of an option is determined, we recognize that cost on a straight-line basis over
the requisite service period of the option, which is typically the vesting period for options
granted by us. We calculate compensation expense of both vested and nonvested stock grants by
determining the fair value of each such grant as of their respective dates of grant using our stock
price at such dates with no discount. We recognize compensation expense on a straight-line basis
over the requisite service period of a nonvested stock award.
For the 13-week and 26-week periods ended March 28, 2010, stock-based compensation included
compensation costs attributable to such periods for those options that were not fully vested upon
adoption of ASC 718, Compensation Stock Compensation, adjusted for estimated forfeitures. We have
estimated
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forfeitures to be 7%, which reduced stock-based compensation cost by $200 in the 26-week
period ended March 28, 2010. There were no grants of options made in the 13-week and 26-week
periods ended March 28, 2010. Aggregate awards of 1,800 shares of vested stock were made in the
13-week and 26-week periods ended March 28, 2010. During the 26-week period ended March 29, 2009,
one option to purchase 12,000 shares of our common stock was granted and one award of 1,000 shares
of vested stock was made to an employee. During the 13-week period ended March 29, 2009, we did
not grant any options or vested stock awards.
At March 28, 2010, the total compensation costs related to nonvested option awards not yet
recognized was $2,100. The weighted-average remaining vesting period of nonvested options at
March 28, 2010 was 0.2 years.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 4T. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. Our management, with the participation
of our Chief Executive Officer and our Chief Financial Officer, has evaluated the effectiveness of
our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon
that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, as of
the end of the period covered by this report, our disclosure controls and procedures were effective
in ensuring that information required to be disclosed by us in the reports that we file or submit
under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported,
within the time periods specified in the rules and forms of the Securities and Exchange Commission
and (ii) accumulated and communicated to our management, including our principal executive and
principal accounting officers, or persons performing similar functions, as appropriate to allow
timely decisions regarding required disclosure.
(b) Changes to Internal Control over Financial Reporting. We believe that the increasing
experience of our staff in working with enhanced resources and new procedures have produced
improvements to our internal controls over financial reporting over the last several fiscal years.
However, the extent of improvement in the first 26 weeks of fiscal 2010 has been relatively modest,
largely modification or expansion of internal process documentation, reflecting what we believe
were significant improvements in prior periods. Notwithstanding such improvement to date, we
believe that we will have to further strengthen our financial resources if we undertake the
additional growth that we have stated that we seek or if we consummate further complex
transactions. We cannot guarantee that our actions in the future will be sufficient to accommodate
possible future growth or complex transactions, or that such actions will not prevent material
weaknesses in our internal controls over financial reporting. Furthermore, we do not presently have
the financial resources and infrastructure to address our future plans, which puts us at risk of
future material weaknesses.
We have undertaken, and will continue to undertake, an effort for compliance with Section 404
of the Sarbanes-Oxley Act of 2002. This effort, under the direction of senior management, includes
the documentation, testing and review of our internal controls. During the course of these
activities, we have identified other potential improvements to our internal controls over financial
reporting, including some that we have implemented in the first half of fiscal 2010, largely the
modification or expansion of internal process documentation noted above, and some that we are
currently evaluating for possible future
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implementation. We expect to continue documentation,
testing and review of our internal controls on an on-going basis and may identify other control
deficiencies, possibly including material weaknesses, and other potential improvements to our
internal controls in the future. We cannot guarantee that we will remedy any potential material
weaknesses that may be identified in the future, or that we will continue to be able to comply with
Section 404 of the Sarbanes-Oxley Act.
Other than as described above, there have not been any other changes that have materially
affected or are reasonably likely to materially affect our internal control over financial
reporting.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
The information set forth under Litigation in Note 10 of Condensed Notes to Unaudited
Consolidated Financial Statements, included in Part I, Item 1 of this report, is incorporated
herein by reference. For an additional discussion of certain risks associated with legal
proceedings, see Risk Factors immediately below.
Item 1A. Risk Factors
A restated description of the risk factors associated with our business is set forth below.
This description includes any changes (whether or not material) to, and supersedes, the description
of the risk factors associated with our business previously discussed in Part I, Item 1A of our
Annual Report on Form 10-K for the fiscal year ended September 27, 2009.
Our future operating results are highly uncertain. Before deciding to invest in our common
stock or to maintain or increase your investment, you should carefully consider the risks described
below, in addition to the other information contained in our Annual Report on Form 10-K, and in our
other filings with the SEC, 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.
We will need to raise additional capital in the near future to fund our operations, and if
such capital is not be available to us on terms that are acceptable to us, on a timely basis or at
all, our viability will be threatened and we may be forced to discontinue our operations. Except
for fiscal 2009, in which we realized substantial income from the Patent Sale and License, the
deconsolidation of the balance sheet of Optex due to its bankruptcy and a significant reduction of
potential future pension expenses, we have historically experienced significant net losses and
significant negative cash flows from operations or other uses of cash. As of March 28, 2010 and
September 27, 2009, our cash and cash equivalents were $110,600 and $125,700, respectively, and our
working capital deficit during such periods was $6.4 million and $6.3 million, respectively. To
offset the effect of negative net cash flows, we have historically funded a portion of our
operations through multiple equity and debt financings, and to a lesser extent through receivable
financing. Our revenues were reduced in fiscal 2009 partially due to our liquidity limitations,
which may continue to adversely affect our revenues in the future. We anticipate that we will
require additional capital to meet our working capital needs and fund our operations. We cannot
assure you that any additional capital from financings or other sources will be available on a
timely basis, on acceptable terms, or at all, or that the proceeds from any financings will be
sufficient to address our near term liquidity requirements. If we are not able to obtain additional
capital in the near future, we anticipate that our business, financial condition and results of
operations will be materially and adversely affected and we may be forced to discontinue our
operations.
We anticipate that our future capital requirements will depend on many factors, including:
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| our ability to meet our current obligations, including trade payables, payroll and fixed costs; | ||
| our ability to procure additional production contracts and government research and development contracts, and the timing of our deliverables under our contracts; | ||
| the timing of payments and reimbursements from government and other contracts; | ||
| the expenses and outcome of litigation; | ||
| our ability to control costs; | ||
| our ability to commercialize our technologies and achieve broad market acceptance for such technologies; | ||
| research and development funding requirements; | ||
| increased sales and marketing expenses; | ||
| technological advancements and competitors responses to our products; | ||
| capital improvements to new and existing facilities; | ||
| our relationships with customers and suppliers; and | ||
| general economic conditions including the effects of future economic slowdowns, a slump in the semiconductor market, acts of war or terrorism and the current international conflicts. |
Even if available, financings can involve significant costs and expenses, such as legal and
accounting fees, diversion of managements time and efforts, or substantial transaction costs or
break-up fees in certain instances. Financings may also involve substantial dilution to existing
stockholders, and may cause additional dilution through adjustments to certain of our existing
securities under the terms of their antidilution provisions. If adequate funds are not available on
acceptable terms, or at all, our business and revenues will be adversely affected and we may be
unable to continue 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 by the Nasdaq Capital Market if we cannot maintain Nasdaqs
listing requirements, which could limit your ability to sell shares of common stock and could limit
our ability to raise additional capital. We are not currently in compliance with the $1.00 minimum
bid price requirement of the Nasdaq Capital Market and have historically failed to meet that
requirement from time to time. On September 15, 2009, we received a written notice from Nasdaq of
our present lack of compliance with this requirement and were given until March 15, 2010 to regain
compliance. We did not meet the minimum bid requirements by such date, and we received a delisting
notice from Nasdaq that we then appealed pursuant to Nasdaqs rules. A hearing on our appeal was
held on May 6, 2010 before a Nasdaq Hearing Panel, the outcome of which is not known at the date of
this Report. To obtain an extension to the delisting notice, the Nasdaq Hearing Panel may require
us to seek stockholder authority to effect another reverse stock split to meet the $1.00 minimum
bid price requirement. In such an event, we cannot assure you that our stockholders will approve
such a reverse split or that a reverse split will be sufficient to maintain our Nasdaq listing if
effectuated. On January 14, 2009, we also received written notice from Nasdaq of our lack of
compliance with a Nasdaq Marketplace Rule that requires us to have a minimum of $2,500,000 in
stockholders equity or $35,000,000 market value of listed securities or $500,000 of net income
from continuing operations for our most recently completed fiscal year or two of our three most
recently completed fiscal years. We ultimately regained compliance with this requirement in
October 2009. We cannot assure you that we will be able to satisfy Nasdaqs listing maintenance
requirements in the future, or be able to maintain our listing on the Nasdaq Capital Market. If our
common stock is delisted from the Nasdaq Capital Market, the market for your shares may be limited,
and as a result, you may not be able to sell your shares at an acceptable price, or at all. In
addition, a delisting may make it more difficult or expensive for us to raise additional capital in
the future. A delisting would also constitute a default under our Longview agreements.
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If we are delisted from the Nasdaq Capital Market, your ability to sell your shares of our
common 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 and would be covered by Rule
15g-9 of the Securities Exchange Act of 1934. 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 purchasers 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.
Since 2006, we have engaged in multiple financings, which have significantly diluted existing
stockholders and will likely result in substantial additional dilution in the future. Assuming
conversion of all of our existing convertible securities and exercise in full of all options and
warrants outstanding as of March 28, 2010, an additional approximate 23.4 million shares of our
common stock would be outstanding, as compared to the approximately 15.9 million shares of our
common stock that were issued and outstanding at that date. Since the start of fiscal 2006 through
March 28, 2010, we have issued approximately 14.0 million shares of our common stock, largely to
fund our operations and to acquire the remaining 30% interest in Optex, resulting in significant
dilution to our existing stockholders. On August 26, 2008, pursuant to approval of our
stockholders, we amended our Certificate of Incorporation to increase our authorized common stock
issuable for any purpose from 80,000,000 shares to 150,000,000 shares, which further increased the
potential for significant dilution to our existing stockholders. Our secured bridge note financing
in November 2008 through February 2009 resulted in the automatic application of price anti-dilution
features in our existing securities, which in conjunction with other issuances, substantially
increased the potential fully diluted number of shares of our common stock. The Series A-2 Stock
that we issued in April 2009 in exchange for convertible notes, resulting in the cancellation of $1
million of debt, as well as the shares of common stock that we issued to the bridge financing
investors in April 2009, the Series B Stock and common stock warrants that we issued in September
2009, the convertible debentures and warrants that we issued in our debenture financing in March
2010 and the Series C Stock that we issued in April 2010 further diluted interests of existing
stockholders, such that our potential fully diluted number of shares of our common stock is
approximately 39.3 million as of March 28, 2010. We anticipate we will pursue additional
financings in the future. Any additional equity or convertible debt financings in the future could
result in further dilution to our stockholders. Existing stockholders also will suffer significant
dilution in ownership interests and voting rights and our stock price could decline as a result of
potential future application of price anti-dilution features of our Series A-1 Stock and Series A-2
Stock and certain warrants, if not waived.
The contingencies associated with our agreement to obtain Longviews consent to the settlement
of litigation with Timothy Looney may result in material additional dilution to stockholders. If
we are not able to arrange for a third-party investor to purchase the Series A-1 Stock, Series A-2
Stock and Series C Stock beneficially owned by Longview at a pre-specified price pursuant to a
binding letter of intent delivered to Longview no later than June 1, 2010 or if the closing of such
sale does not occur on or before July 15, 2010, we will be required to issue an additional 10,000
shares of Series C Stock to Longview convertible into 1,000,000 shares of our common stock and a
two-year warrant to purchase 1,000,000 shares of the our common stock at an exercise price per
share of $0.30. In addition to the direct dilution resulting from these issuances, the issuance of
the warrant will cause the conversion price of the Series A-1 Stock and Series A-2 Stock to
automatically be reset to $0.30, if it has not already been
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reset to this price or lower due to other financing transactions, thereby posing the potential
for additional dilution to existing stockholders.
Significant sales of our common stock in the public market will cause our stock price to fall.
The average trading volume of our shares in March 2010 was approximately 646,400 shares per day,
compared to the approximately 15.9 million shares outstanding and the additional approximate 23.4
million shares potentially outstanding on a fully diluted basis at March 28, 2010. Other than
volume limitations imposed on our affiliates, most of the issued shares of our common stock are
freely tradable. 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 decline.
If we raise additional capital in the future through the sale of shares of our common stock to
private investors, we may, subject to existing restrictions lapsing or being waived, agree to
register these shares for resale on a registration statement as we have done in the past. Upon
registration, these additional shares would become freely tradable once sold in the public market,
assuming the prospectus delivery and other requirements were met by the sellers, and, if
significant in amount, such sales could further adversely affect the market price of our common
stock. We have filed a registration statement covering the resale of approximately 2.5 million
shares of our common stock in connection with potential conversion of Series B Stock. The sale of a
large number of shares of our common stock also might make it more difficult for us to sell equity
or equity-related securities in the future at a time and at the prices that we deem appropriate.
The recent settlement of our various lawsuits with Timothy Looney, the former owner of Optex,
resulted in us issuing $2.5 million of secured debt to Mr. Looney, the service of which will pose a
significant strain on our liquidity. In April 2010, we issued a 27-month promissory note to Mr.
Looney secured by liens and security interests against all of our assets (to the extent permitted
by contract, the UCC or other applicable laws), subject to and subordinate to the existing
perfected security interests and liens of our senior creditors, Summit and Longview. This note
requires us to remit graduated monthly installment payments over a 27-month period to Mr. Looney
beginning with a payment of $8,000 in May 2010 and ending with a payment of $300,000 in June 2012.
All such payments are applied first to unpaid interest and then to outstanding principal. A final
payment of all remaining unpaid principal and interest is due and payable in July 2012. These loan
payments may be difficult for us to make from our cash flow from operations and will likely
necessitate future financing, the success of which cannot be assured.
Enforcement of an anticipated final judgment could threaten our financial viability.
Investors that originally financed our acquisition of Optex filed a motion for summary judgment
against us regarding alleged unpaid obligations under a December 2006 settlement agreement between
us and them and, although the motion was granted in January 2010, the judgment has not yet been
entered as of the date of this report. We have recorded $1.2 million of expense in our financial
statements related to these obligations at March 28, 2010, which we expect to be the approximate
amount of this judgment when it is entered. We have attempted to settle this dispute with the
plaintiffs, but with no success to date. If the plaintiffs attempt to enforce collection of the
expected final judgment, rather than entering into some kind of manageable settlement agreement,
our financial condition could be materially and adversely impacted and our ability to continue our
operations could be threatened.
Our 2008 Reverse Split has had, and may continue to have, a material adverse effect on our
market capitalization. While our 2008 Reverse Split temporarily addressed Nasdaqs minimum bid
price standard at that time, our market capitalization as of March 28, 2010 dropped to only
approximately $4.4 million and our market float decreased considerably. Adverse market reaction to
the split may have contributed to the decline in our market capitalization that we have recently
experienced. Such reaction and reduced market float and sales volume may result in further
material adverse impact to our market capitalization and the market price of our common stock. We may be required to conduct an
additional
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reverse stock split in fiscal 2010 to maintain our Nasdaq listing and cannot assure you
of the impact such reverse stock split will have on our market capitalization and market price of
our common stock, if it were to occur.
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. Since our inception, we have generated net losses in most of our fiscal
periods. We experienced a net loss of approximately $21.6 million for fiscal 2008, including the
non-recurring charges associated with the retirement of $15 million of debt owed to Longview and
Alpha as a result of the Optex Asset Sale. Had it not been for the gains from the Patent Sale and
License, the deconsolidation of Optex due to its bankruptcy and a significant reduction of
potential future pension expenses, we would have experienced a substantial net loss in fiscal 2009
as well. We experienced a net loss of approximately $5.1 million in our first half of fiscal 2010.
We cannot assure you that we will be able to achieve or sustain profitability in the future. In
addition, because we have significant expenses that are fixed or difficult to change rapidly, we
generally are unable to reduce expenses significantly in the short-term to compensate for any
unexpected delay or decrease in anticipated revenues. We are dependent on support from
subcontractors to meet our operating plans and susceptible to losses when such support is delayed.
Such factors could cause us to continue to experience net losses in future periods, 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.
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. For fiscal 2009, approximately 33% of our total
revenues were generated from research and development contracts with the U.S. Air Force and
approximately 16% of our total revenues were generated from research and development contracts with
the U.S. Army. For the first half of fiscal 2010, approximately 32%, 24% and 12% of our total
revenues were generated from research and development contracts with classified U. S. government
agencies, the U. S. Army and the U.S. Air Force, respectively. 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. Our dependency on a few contract
sources increases the risks of disruption in this area of our business or significant fluctuations
in quarterly revenue, either of which could adversely affect our consolidated revenues and results
of operations.
Because our operations 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, that could materially and adversely affect our business. Future
political and economic conditions are uncertain and may 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, a number of
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our government contracts are fixed price contracts, which may
prevent us from recovering costs incurred in excess of budgeted costs for such contracts. Fixed
price contracts require us to estimate the total project cost based on preliminary projections of
the projects 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 fixed contractual costs of either our research and development
contracts or our production orders, we will not be able to recover the excess costs.
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 funded backlog does not
permit redeployment of our staff could result in reductions of employees. We have in the past
chosen to incur excess overhead in order to retain trained employees during delays in contract
funding. 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 adverse effect to our liquidity. Since a
substantial majority of our total revenues in the last two fiscal years were derived directly or
indirectly from government customers, these risks can significantly affect our business, results of
operations and financial condition.
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. 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 or
achieving and maintaining profitability 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 a manufacturing
line co-located at an IBM facility, the formation of the Novalog, MSI, Silicon Film, RedHawk and
iNetWorks subsidiaries and the development of various stacked-memory products intended for
commercial markets in addition to military and aerospace applications. These investments have not
resulted in consolidated profitability to date, other than the profit realized in fiscal 2009
largely from the significant gains described above, and a majority of our total revenues for fiscal
2008, fiscal 2009 and the first half of fiscal 2010 were still generated from governmental
customers. Furthermore, the Optex Asset Sale has eliminated a substantial future contributor to our
consolidated revenues.
The significant military operations in the Middle East or elsewhere may require diversions of
government research and development funding, thereby causing disruptions to our contracts or
otherwise adversely impact our revenues. In the near term, the funding of significant U.S. military
operations may cause disruptions in funding of government contracts. Since military operations of
substantial magnitude are not routinely included in U.S. defense budgets, supplemental legislative
funding actions are required to finance such operations. Even when such legislation is enacted, it
may not be adequate for ongoing operations, causing other defense funding sources to be temporarily
or permanently diverted. Such diversion could produce interruptions in funding or delays in receipt
of our research and development contracts, causing disruptions and adverse effects to our
operations. In addition, concerns about international conflicts and the effects of terrorist and
other military activity have
resulted in unsettled worldwide economic conditions. These conditions make it difficult for our
customers to accurately forecast and plan future business opportunities, in turn making it
difficult for us to plan our
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current and future allocation of resources and increasing the risks
that our results of operations could be adversely affected.
If we fail to scale our operations adequately, we may be unable to meet competitive challenges
or exploit potential market opportunities, and our business could be materially and adversely
affected. After giving effect to Optex as a discontinued operation, our consolidated total
revenues in fiscal 2008, fiscal 2009 and the first half of fiscal 2010 were $16.7 million, $11.5
million and $5.9 million, respectively. In order to absorb the recurring expenses of a publicly
reporting company and remain profitable, we will need to materially grow our consolidated total
revenues and/or substantially reduce our operating expenses. Such challenges are expected to place
a significant strain on our management personnel, infrastructure and resources. To implement our
current business and product plans, we will need to expand, train, manage and motivate our
workforce, and expand our operational and financial systems, as well as our manufacturing and
service capabilities. All of these endeavors will require additional capital and substantial effort
by our management. If we are unable to effectively manage changes in our operations, we may be
unable to scale our business quickly enough to meet competitive challenges or exploit potential
market opportunities, and our current or future business could be materially and adversely
affected.
Historically, we have primarily depended on third party contract manufacturers for the
manufacture of a majority of our products and any failure to secure and maintain sufficient
manufacturing capacity or quality products could materially and adversely affect our business. For
our existing products, we primarily have used contract manufacturers to fabricate and assemble our
stacked chip, microchip and sensor products. Our internal manufacturing capabilities consist
primarily of assembly, calibration and test functions for our thermal camera products. We have
typically used single contract manufacturing sources for our historical products and do not have
long-term, guaranteed contracts with such sources. As a result, we face several significant risks,
including:
| a lack of guaranteed supply of products and higher prices; | ||
| limited control over delivery schedules, quality assurance, manufacturing yields and production costs; and | ||
| the unavailability of, or potential delays in obtaining access to, key process technologies. |
In addition, the manufacture of our products is a highly complex and technologically demanding
process and we are dependent upon our contract manufacturers to minimize the likelihood of reduced
manufacturing yields or quality issues. We currently do not have any long-term supply contracts
with any of our manufacturers and do not have the capability or capacity to manufacture our
products in-house in large quantities. If we are unable to secure sufficient capacity with our
existing manufacturers, implement manufacturing of some of our new products at other contract
manufacturers or scale our internal capabilities, our revenues, cost of revenues and results of
operations would be negatively impacted.
If we are not able to obtain broad market acceptance of our new and existing products, our
revenues and results of operations will be adversely affected. We generally focus on emerging
markets. 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 be able to successfully develop, manufacture and market additional commercial
product lines or that such product lines will be accepted in the commercial marketplace. If we are
not successful in
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commercializing our new products, our ability to generate revenues and our
business, financial condition and results of operations will be adversely affected.
Failure to achieve and maintain effective internal controls in accordance with Section 404 of
the Sarbanes-Oxley Act could have a material adverse effect on our business and stock price. Our
fiscal 2005, fiscal 2006 and fiscal 2007 audits revealed material weaknesses in our internal
controls over financial reporting, including the failure of such controls to identify the need to
record a post-employment obligation for our Executive Salary Continuation Plan, which resulted in a
restatement of our financial statements. We believe these types of material weaknesses relate
primarily to the size and depth of our accounting staff. We have attempted to address these
material weaknesses by expanding our staff and reassigning responsibilities and, based on
information available to us as of the date of this report, we believe that we have remediated this
condition as of September 28, 2008 and September 27, 2009. Third party testing of our belief will
be conducted pursuant to Section 404 of the Sarbanes-Oxley Act beginning fiscal 2010. Such third
party testing may ultimately reveal that previously identified material weaknesses have not been
remediated or that new material weaknesses have developed. Furthermore, we do not presently have
the financial resources and infrastructure to address our future plans, which puts us at risk of
future material weaknesses. We are in the process of documenting and testing our internal control
processes in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which
requires annual management assessments and a written report on the effectiveness of our internal
controls over financial reporting and, commencing in our fiscal year 2010, a report by our
independent auditors on the effectiveness of our internal controls. During the course of our
testing, we may identify other significant deficiencies or material weaknesses, in addition to the
ones previously identified, which we may not be able to remediate in time to meet future deadlines
imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. In addition,
if we fail to maintain the adequacy of our internal controls, as such standards are modified,
supplemented or amended from time to time, we will not be able to conclude that we have effective
internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley
Act. Failure to achieve and maintain an effective internal control environment could cause
investors to lose confidence in our reported financial information, which could result in a decline
in the market price of our common stock, and cause us to fail to meet our reporting obligations in
the future.
Our stock price has been subject to significant volatility. The trading price of our common
stock has been subject to wide fluctuations in the past. Since January 2000, our common stock has
traded at prices as low as $0.11 per share in March 2009 and as high as $3,750.00 per share in
January 2000 (after giving effect to two reverse stock splits subsequent to January 2000). The
current market price of our common stock may not increase 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 or decline in the future in response to
various factors, including, but not limited to:
| the impact and outcome of pending litigation; | ||
| our cash resources and ability to raise additional funding and repay indebtedness; | ||
| our ability to demonstrate compliance with Nasdaqs listing maintenance requirements; | ||
| quarterly variations in operating results; | ||
| government budget reallocations or delays in or lack of funding for specific projects; | ||
| our ability to control costs and improve cash flow; | ||
| our ability to introduce and commercialize new products and achieve broad market acceptance for our products; | ||
| announcements of technological innovations or new products by us or our competitors; | ||
| our cash resources and ability to raise additional funding and repay indebtedness; | ||
| changes in investor perceptions; |
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| economic and political instability, including acts of war, terrorism and continuing international conflicts; and | ||
| changes in earnings estimates or investment recommendations by securities analysts. |
The trading markets for the equity securities of high technology companies have continued to
experience volatility. Such 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 were subject to a class
action lawsuit that diverted managements attention and resources from other matters until it was
settled in June 2004. We cannot guarantee you that we will not be subject to similar class action
lawsuits in the future.
Our Patent Sale and License has removed barriers to competition. We sold most of our patents
pursuant to the Patent Sale and License. Although we retain a worldwide, royalty-free,
non-exclusive license to use the patented technology that we sold in our business, the purchaser of
our patent assets is entitled to use those patents for any purpose, including possible competition
with us. 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 our proprietary information and maintain barriers to competition. However, 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.
Our ability to exploit our own technologies may be constrained by the rights of third parties
who could prevent us from selling our products in certain markets or could require us to obtain
costly licenses. 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 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 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 future
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. The
purchaser of our patents may choose to be more aggressive in pursuing its rights with respect to
these patents, which could lead to significant litigation and possible attempts by others to
invalidate such patents. If such attempts are successful, we might not be able to use this
technology in the future. We also may need to engage in litigation in the future to enforce patent
rights with respect to future patents. 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. Any
such 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, we cannot assure you that we will have the financial resources to vigorously defend our proprietary
information.
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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 patents, proprietary information and other
intellectual property generally 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 non-government users of the same, we
cannot assure you that we will be successful in our attempts to do so.
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We are subject to significant competition that could harm our ability to win new business or
attract strategic partnerships and could increase the price pressure on our products. 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 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. 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.
We must continually adapt to unforeseen technological advances, or we may not be able to
successfully compete with our competitors. We operate in industries characterized by rapid and
continuing technological development and advancements. Accordingly, we anticipate that 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.
If we effectuate additional acquisitions, it may further strain our capital resources, result
in additional integration and assimilation challenges, be further dilutive to existing
stockholders, result in unanticipated accounting charges and expenses, or otherwise adversely
affect our results of operations. Our future business strategy may involve expansion through the
acquisitions of businesses, assets or technologies that allow us to expand our capabilities and
market coverage and to complement our existing product offerings. Optex, our first acquisition
under this strategy, initially facilitated our market access, but did not achieve financial
objectives. Acquisitions may require significant upfront capital as well as capital infusions, and
typically entail many risks, including unanticipated costs and expenditures, changing relationships
with customers, suppliers and strategic partners, or contractual, intellectual property or
employment issues. We had not engaged in an acquisition strategy prior to our acquisition of Optex;
we experienced difficulties in assimilating and integrating the operations, personnel,
technologies, products and information systems of Optex, and the Optex acquisition was also costly
and resulted in material adverse impacts to our overall financial condition. We may experience
similar difficulties in assimilating any other companies or businesses we may acquire in the
future. In addition, key personnel of an acquired company may decide not to work for us. The
acquisition of another company or its products and technologies may also require us to enter into a
geographic or business market in which we have little or no prior experience. These challenges
could disrupt our ongoing business, distract our management and employees, harm our reputation and
increase our expenses. These challenges are magnified as the size of the acquisition increases.
Acquisitions or asset purchases made entirely or partially with cash or debt could also put a
significant strain on our limited capital resources. Acquisitions may also require large one-time
charges and can result in contingent liabilities, adverse tax consequences, deferred compensation
charges, and the recording and later amortization of amounts related to deferred compensation and certain purchased
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intangible assets, any of which items could negatively impact our results of operations. In
addition, we may record goodwill in connection with an acquisition and incur goodwill impairment
charges in the future. Any of these charges could cause the price of our common stock to decline.
In addition, we may issue equity or convertible debt securities in connection with an acquisition,
as we did in connection with our acquisition of Optex. Any issuance of equity or convertible debt
securities may be dilutive to our existing stockholders and such securities could have rights,
preferences or privileges senior to those of our common stock.
We cannot assure you that we will be able to locate or consummate any future acquisitions, or
that we will realize any anticipated benefits from these acquisitions. Even if we do find suitable
acquisition opportunities, we may not be able to consummate the acquisition on commercially
acceptable terms, and any decline in the price of our common stock may make it significantly more
difficult and expensive to initiate or consummate an acquisition.
We do not plan to pay dividends to holders of common stock. We do not anticipate paying cash
dividends to the holders of the common stock at any time. Accordingly, investors in our securities
must rely upon subsequent sales after price appreciation as the sole method to realize a gain on
investment. There are no assurances that the price of common stock will ever appreciate in value.
Investors seeking cash dividends should not buy our securities.
We do not have long-term employment agreements with our key personnel. If we are not able to
retain our key personnel or attract additional key personnel as required, 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. The loss of any key employee could have a material adverse effect
on our business. While we have adopted employee equity incentive plans designed to attract and
retain key employees, our stock price has declined in recent periods, and we cannot guarantee that
options or non-vested stock 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 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.
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.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. (Removed and Reserved)
Item 5. Other Information
None.
Item 6. Exhibits
3.1 | Certificate of Incorporation of the Company, as amended (1) | ||
3.2 | By-laws, as amended and currently in effect (2) | ||
3.3 | Certificate of Elimination of the Series B Convertible Cumulative Preferred Stock, Series C Convertible Cumulative Preferred Stock, Series D Convertible Preferred Stock and Series E Convertible Preferred Stock. (3) | ||
3.4 | Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series A-1 10% Cumulative Convertible Preferred Stock. (4) | ||
3.5 | Certificate of Amendment of Certificate of Incorporation to increase the authorized shares of the Corporations common stock and the authorized shares of the Corporations Preferred Stock (5) | ||
3.6 | Certificate of Amendment of Certificate of Incorporation to reclassify, change, and convert each ten (10) outstanding shares of the Corporations common stock into one (1) share of common stock (6) | ||
3.7 | Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series A-2 10% Cumulative Convertible Preferred Stock (7) | ||
3.8 | Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series B Convertible Preferred Stock (8) | ||
3.9 | Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series C Convertible Preferred Stock (13) | ||
10.1 | Longview consent and waiver extending default grace period relating to the judgment entered by the Court in the Looney lawsuit. (9) | ||
10.2 | Teaming Agreement between Irvine Sensors Corporation and Optics 1, Inc. | ||
10.3 | Settlement and Release Agreement dated March 26, 2010 by and between Timothy Looney, Barbara Looney and TWL Group, L.P., on the one hand, and Irvine Sensors Corporation, John C. Carson and John J. Stuart, Jr., on the other hand. (10) | ||
10.4 | Agreement, Consent and Waiver dated April 9, 2010 by and between Irvine Sensors Corporation and Longview. (11) |
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10.5 | Secured Promissory Note to Timothy Looney dated April 14, 2010. (12) | ||
10.6 | Security Agreement to Timothy Looney dated April 14, 2010 | ||
10.7 | Intellectual Property Security Agreement to Timothy Looney dated April 14, 2010 | ||
10.8 | Form of Subscription Agreement for Debenture Financing | ||
10.9 | Form of Unsecured Convertible Debenture | ||
10.10 | Form of Unsecured Non-Convertible Debenture | ||
10.11 | Form of Investor Common Stock Warrant for Debenture Financing | ||
10.12 | Form of Placement Agent Common Stock Warrant for Debenture Financing | ||
10.13 | Clarification dated April 27, 2010 between Irvine Sensors Corporation and Longview | ||
31.1 | Certification of the Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
31.2 | Certification of the Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
32 | Certifications 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 (furnished herewith). |
(1) | Incorporated by reference to Exhibit 3.1 filed with the Registrants Annual Report on Form 10-K for the fiscal year ended September 28, 2003 | |
(2) | Incorporated by reference to Exhibit 3.1 filed with the Registrants Current Report on Form 8-K as filed with the SEC on September 21, 2007. | |
(3) | Incorporated by reference to Exhibit 3.3 filed with the Registrants Current Report on Form 8-K as filed with the SEC on April 18, 2008. | |
(4) | Incorporated by reference to Exhibit 3.4 filed with the Registrants Current Report on Form 8-K as filed with the SEC on April 18, 2008. | |
(5) | Incorporated by reference to Exhibit 3.5 to the Registrants Current Report on Form 8-K filed on August 27, 2008. | |
(6) | Incorporated by reference to Exhibit 3.6 to the Registrants Current Report on Form 8-K filed on August 27, 2008. | |
(7) | Incorporated by reference to Exhibit 3.1 filed with the Registrants Current Report on Form 8-K as filed with the SEC on March 24, 2009. | |
(8) | Incorporated by reference to Exhibit 3.1 to the Registrants Current Report on Form 8-K filed on October 1, 2009. | |
(9) | Incorporated by reference to Exhibit 10.4 filed with the Registrants Quarterly Report on Form 10-Q as filed with the SEC on April 1, 2010. | |
(10) | Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K filed on April 1, 2010. | |
(11) | Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K filed on April 15, 2010. | |
(12) | Incorporated by reference to Exhibit 10.2 to the Registrants Current Report on Form 8-K filed on April 15, 2010. | |
(13) | Incorporated by reference to Exhibit 3.1 to the Registrants Current Report on Form 8-K filed on May 4, 2010 | |
| Confidential treatment has been requested for certain confidential portions of this exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934. In accordance with Rule 24b-2, these confidential portions were omitted from this exhibit and filed separately with the Securities and Exchange Commission. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Irvine Sensors Corporation (Registrant) |
||||
Date: May 12, 2010 | By: | /s/ John J. Stuart, Jr. | ||
John J. Stuart, Jr. | ||||
Chief Financial Officer | ||||
(Principal Financial and Chief Accounting Officer) |
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Table of Contents
Exhibit Index
3.1
|
Certificate of Incorporation of the Company, as amended (1) | |
3.2
|
By-laws, as amended and currently in effect (2) | |
3.3
|
Certificate of Elimination of the Series B Convertible Cumulative Preferred Stock, Series C Convertible Cumulative Preferred Stock, Series D Convertible Preferred Stock and Series E Convertible Preferred Stock. (3) | |
3.4
|
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series A-1 10% Cumulative Convertible Preferred Stock. (4) | |
3.5
|
Certificate of Amendment of Certificate of Incorporation to increase the authorized shares of the Corporations common stock and the authorized shares of the Corporations Preferred Stock (5) | |
3.6
|
Certificate of Amendment of Certificate of Incorporation to reclassify, change, and convert each ten (10) outstanding shares of the Corporations common stock into one (1) share of common stock (6) | |
3.7
|
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series A-2 10% Cumulative Convertible Preferred Stock (7) | |
3.8
|
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series B Convertible Preferred Stock (8) | |
3.9
|
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series C Convertible Preferred Stock (13) | |
10.1
|
Longview consent and waiver extending default grace period relating to the judgment entered by the Court in the Looney lawsuit. (9) |
10.2
|
Teaming Agreement between Irvine Sensors Corporation and Optics 1, Inc. | |
10.3
|
Settlement and Release Agreement dated March 26, 2010 by and between Timothy Looney, Barbara Looney and TWL Group, L.P., on the one hand, and Irvine Sensors Corporation, John C. Carson and John J. Stuart, Jr., on the other hand. (10) | |
10.4
|
Agreement, Consent and Waiver dated April 9, 2010 by and between Irvine Sensors Corporation and Longview. (11) | |
10.5
|
Secured Promissory Note to Timothy Looney dated April 14, 2010. (12) | |
10.6
|
Security Agreement to Timothy Looney dated April 14, 2010 | |
10.7
|
Intellectual Property Security Agreement to Timothy Looney dated April 14, 2010 | |
10.8
|
Form of Subscription Agreement for Debenture Financing | |
10.9
|
Form of Unsecured Convertible Debenture | |
10.10
|
Form of Unsecured Non-Convertible Debenture | |
10.11
|
Form of Investor Common Stock Warrant for Debenture Financing | |
10.11
|
Form of Placement Agent Common Stock Warrant for Debenture Financing | |
10.13
|
Clarification dated April 27, 2010 between Irvine Sensors Corporation and Longview | |
31.1
|
Certification of the Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2
|
Certification of the Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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Table of Contents
32
|
Certifications 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 (furnished herewith). |
(1) | Incorporated by reference to Exhibit 3.1 filed with the Registrants Annual Report on Form 10-K for the fiscal year ended September 28, 2003 | |
(2) | Incorporated by reference to Exhibit 3.1 filed with the Registrants Current Report on Form 8-K as filed with the SEC on September 21, 2007. | |
(3) | Incorporated by reference to Exhibit 3.3 filed with the Registrants Current Report on Form 8-K as filed with the SEC on April 18, 2008. | |
(4) | Incorporated by reference to Exhibit 3.4 filed with the Registrants Current Report on Form 8-K as filed with the SEC on April 18, 2008. | |
(5) | Incorporated by reference to Exhibit 3.5 to the Registrants Current Report on Form 8-K filed on August 27, 2008. | |
(6) | Incorporated by reference to Exhibit 3.6 to the Registrants Current Report on Form 8-K filed on August 27, 2008. | |
(7) | Incorporated by reference to Exhibit 3.1 filed with the Registrants Current Report on Form 8-K as filed with the SEC on March 24, 2009. | |
(8) | Incorporated by reference to Exhibit 3.1 to the Registrants Current Report on Form 8-K filed on October 1, 2009. | |
(9) | Incorporated by reference to Exhibit 10.4 filed with the Registrants Quarterly Report on Form 10-Q as filed with the SEC on April 1, 2010. | |
(10) | Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K filed on April 1, 2010. | |
(11) | Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K filed on April 15, 2010. | |
(12) | Incorporated by reference to Exhibit 10.2 to the Registrants Current Report on Form 8-K filed on April 15, 2010. | |
(13) | Incorporated by reference to Exhibit 3.1 to the Registrants Current Report on Form 8-K filed on May 4, 2010 | |
| Confidential treatment has been requested for certain confidential portions of this exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934. In accordance with Rule 24b-2, these confidential portions were omitted from this exhibit and filed separately with the Securities and Exchange Commission. |
58