Attached files
file | filename |
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EX-32 - EXHIBIT 32 - ISC8 INC. /DE | c12641exv32.htm |
EX-31.2 - EXHIBIT 31.2 - ISC8 INC. /DE | c12641exv31w2.htm |
EX-10.7 - EXHIBIT 10.7 - ISC8 INC. /DE | c12641exv10w7.htm |
EX-31.1 - EXHIBIT 31.1 - ISC8 INC. /DE | c12641exv31w1.htm |
EX-10.9 - EXHIBIT 10.9 - ISC8 INC. /DE | c12641exv10w9.htm |
EX-10.14 - EXHIBIT 10.14 - ISC8 INC. /DE | c12641exv10w14.htm |
EX-10.11 - EXHIBIT 10.11 - ISC8 INC. /DE | c12641exv10w11.htm |
EX-10.17 - EXHIBIT 10.17 - ISC8 INC. /DE | c12641exv10w17.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 January 2, 2011
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 |
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 February 9, 2011, there were 99,869,909 shares of common stock outstanding.
IRVINE SENSORS CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE FISCAL PERIOD ENDED JANUARY 2, 2011
FOR THE FISCAL PERIOD ENDED JANUARY 2, 2011
TABLE OF CONTENTS
PAGE | ||||||||
3 | ||||||||
23 | ||||||||
35 | ||||||||
35 | ||||||||
36 | ||||||||
36 | ||||||||
45 | ||||||||
45 | ||||||||
45 | ||||||||
45 | ||||||||
46 | ||||||||
49 | ||||||||
Exhibit 10.7 | ||||||||
Exhibit 10.9 | ||||||||
Exhibit 10.11 | ||||||||
Exhibit 10.14 | ||||||||
Exhibit 10.17 | ||||||||
Exhibit 31.1 | ||||||||
Exhibit 31.2 | ||||||||
Exhibit 32 |
In this report, the terms Irvine Sensors, the Company, we, us and our refer to Irvine
Sensors Corporation (ISC) and its subsidiaries.
Irvine Sensors®, Neo-Chip, Neo-Stack®, TOWHAWK, Novalog, Personal Miniature Thermal
Viewer, PMTV®, Cam-Noir®, Eagle Boards, Vault, RedHawk and Silicon MicroRing Gyro 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
CONDENSED CONSOLIDATED BALANCE SHEETS
CONDENSED CONSOLIDATED BALANCE SHEETS
January 2, 2011 | ||||||||
(Unaudited) | October 3, 2010 | |||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 6,746,900 | $ | 281,600 | ||||
Accounts receivable, net of allowance for doubtful accounts of $13,600 and $15,000, respectively |
1,701,400 | 382,100 | ||||||
Unbilled revenues on uncompleted contracts |
492,600 | 630,300 | ||||||
Inventory, net |
1,507,700 | 1,715,800 | ||||||
Prepaid expenses and other current assets |
226,100 | 182,300 | ||||||
Total current assets |
10,674,700 | 3,192,100 | ||||||
Property and equipment, net (including construction in process of $204,000 and $35,000, respectively) |
2,698,400 | 2,730,000 | ||||||
Intangible assets, net |
11,900 | 12,400 | ||||||
Deferred financing costs |
1,540,700 | 302,900 | ||||||
Deposits |
169,000 | 87,400 | ||||||
Total assets |
$ | 15,094,700 | $ | 6,324,800 | ||||
Liabilities and Stockholders Deficit |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 1,672,700 | $ | 4,724,100 | ||||
Accrued expenses |
3,132,300 | 4,097,700 | ||||||
Accrued estimated loss on contracts |
29,000 | 29,000 | ||||||
Advance billings on uncompleted contracts |
352,500 | 321,800 | ||||||
Advances against accounts receivable |
53,100 | 99,700 | ||||||
Deferred revenue |
1,402,200 | 1,515,400 | ||||||
Restructured debt, net of debt discounts |
| 163,100 | ||||||
Secured promissory note, current portion |
752,500 | 402,500 | ||||||
Debentures, net of debt discounts |
2,300,900 | 1,935,200 | ||||||
Unsecured convertible promissory notes, net of discounts |
1,492,900 | | ||||||
Settlement agreements obligations, current portion |
832,200 | | ||||||
Total current liabilities |
12,020,300 | 13,288,500 | ||||||
Secured promissory note |
1,747,500 | 2,097,500 | ||||||
Subordinated secured convertible promissory notes, net of discounts |
2,335,000 | | ||||||
Settlement agreements obligations |
451,600 | | ||||||
Derivative liability |
13,349,800 | 4,000 | ||||||
Executive Salary Continuation Plan liability |
1,015,400 | 1,030,700 | ||||||
Total liabilities |
30,919,600 | 16,420,700 | ||||||
Commitments and contingencies (Note 7) |
||||||||
Stockholders deficit: |
||||||||
Convertible preferred stock, $0.01 par value, 1,000,000 and 1,000,000 shares authorized, respectively; |
500 | 500 | ||||||
Series A-2 3,700 and 8,300 shares issued and outstanding, respectively (1);
liquidation preference of $154,700 and $333,300, respectively; |
||||||||
Series B 1,800 and 1,900 shares issued and outstanding, respectively (1);
liquidation preference of $1,821,300 and $1,892,700, respectively |
||||||||
Series C 37,500 and 37,500 shares issued and outstanding, respectively (1);
liquidation preference of $1,125,000 and $1,125,000, respectively |
||||||||
Common stock, $0.01 par value, 150,000,000 and 150,000,000 shares authorized, respectively;
98,505,500 and 33,535,400 shares issued and outstanding, respectively (1) |
985,100 | 335,400 | ||||||
Common stock held by Rabbi Trust |
(1,169,600 | ) | (1,169,600 | ) | ||||
Deferred compensation liability |
1,169,600 | 1,169,600 | ||||||
Paid-in capital |
169,492,700 | 165,039,200 | ||||||
Accumulated deficit |
(186,627,600 | ) | (175,795,400 | ) | ||||
Irvine Sensors Corporation stockholders deficit |
(16,149,300 | ) | (10,420,300 | ) | ||||
Noncontrolling interest |
324,400 | 324,400 | ||||||
Total stockholders deficit |
(15,824,900 | ) | (10,095,900 | ) | ||||
Total liabilities and stockholders deficit |
$ | 15,094,700 | $ | 6,324,800 | ||||
(1) | The number of shares of preferred stock and common stock issued and outstanding have been rounded to the nearest one hundred (100). |
See
Accompanying Notes to Condensed Consolidated Financial Statements.
3
Table of Contents
IRVINE SENSORS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
13 Weeks Ended | ||||||||
January 2, | December 27, | |||||||
2011 | 2009 | |||||||
Total revenues |
$ | 4,300,900 | $ | 3,210,200 | ||||
Cost and expenses |
||||||||
Cost of revenues |
4,039,200 | 2,439,000 | ||||||
General and administrative expense |
1,914,400 | 1,651,400 | ||||||
Research and development expense |
533,900 | 755,200 | ||||||
Total costs and expenses |
6,487,500 | 4,845,600 | ||||||
Gain on sale or disposal of assets |
| 12,500 | ||||||
Loss from operations |
(2,186,600 | ) | (1,622,900 | ) | ||||
Interest expense |
(2,156,300 | ) | (114,900 | ) | ||||
Provision for litigation judgment |
| (20,200 | ) | |||||
Change in fair value of derivative liability |
(6,482,700 | ) | 45,500 | |||||
Other expense |
(6,600 | ) | (1,000 | ) | ||||
Loss before provision for income taxes |
(10,832,200 | ) | (1,713,500 | ) | ||||
Provision for income taxes |
| (3,200 | ) | |||||
Net loss |
$ | (10,832,200 | ) | $ | (1,716,700 | ) | ||
Less net loss attributable to noncontrolling interests in subsidiary |
| | ||||||
Net loss attributable to Irvine Sensors Corporation |
$ | (10,832,200 | ) | $ | (1,716,700 | ) | ||
Basic and diluted net loss attributable to Irvine Sensors
Corporation per common share |
$ | (0.26 | ) | $ | (0.33 | ) | ||
Weighted average number of common shares outstanding, basic and
diluted |
41,612,200 | 10,141,400 | ||||||
See Accompanying Notes to Condensed Consolidated Financial Statements.
4
Table of Contents
IRVINE SENSORS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS DEFICIT
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS DEFICIT
Common | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Series A-1 and A-2 | Series B | Series C | Stock | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Preferred Stock | Preferred Stock | Preferred Stock | Common Stock | Warrants | Prepaid | Total | ||||||||||||||||||||||||||||||||||||||||||||||||||
Shares Issued (1) | Shares Issued (1) | Shares Issued (1) | Shares Issued (1) | Issued (1) | Stock-Based | Accumulated | Noncontrolling | Stockholders | ||||||||||||||||||||||||||||||||||||||||||||||||
Number | Amount | Number | Amount | Number | Amount | Number | Amount | Number | Compensation | Paid-in Capital | Deficit | Interest | Deficit | |||||||||||||||||||||||||||||||||||||||||||
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 | ) | ||||||||||||||||||||||||||||||||||||||||
Common stock issued to employee retirement plan |
| | | | | | 2,673,800 | 26,700 | | (750,000 | ) | 723,300 | | | | |||||||||||||||||||||||||||||||||||||||||
Sale of preferred stock, net of financing costs and
value assigned to warrants issued to investors |
| | 3,500 | | | | | | | | 1,307,900 | | 1,307,900 | |||||||||||||||||||||||||||||||||||||||||||
Issuance of preferred stock as litigation settlement expense |
| | | | 37,500 | 400 | | | | | 1,124,600 | | 1,125,000 | |||||||||||||||||||||||||||||||||||||||||||
Issuance of warrants as litigation settlement expense |
| | | | | | | | 1,000,000 | | 150,000 | | 150,000 | |||||||||||||||||||||||||||||||||||||||||||
Common stock warrants issued to preferred stock investors |
| | | | | | | | 2,094,000 | | 424,000 | | | 424,000 | ||||||||||||||||||||||||||||||||||||||||||
Sale of common stock units, net of issuance costs |
| | | | | | 3,469,500 | 34,700 | 693,900 | | 437,000 | | | 471,700 | ||||||||||||||||||||||||||||||||||||||||||
Sale of common stock |
| | | | | | 138,500 | 1,400 | | | 16,600 | | | 18,000 | ||||||||||||||||||||||||||||||||||||||||||
Common stock issued to pay interest |
| | | | | | 693,600 | 6,900 | | | 270,500 | | | 277,400 | ||||||||||||||||||||||||||||||||||||||||||
Common stock options exercised |
| | | | | | 10,000 | 100 | | | 1,500 | | | 1,600 | ||||||||||||||||||||||||||||||||||||||||||
Deemed dividend of beneficial conversion feature of
preferred stock issuance |
| | | | | | | | | | 1,471,000 | (1,471,000 | ) | | | |||||||||||||||||||||||||||||||||||||||||
Common stock issued upon conversion of preferred stock |
(116,600 | ) | (1,100 | ) | (1,600 | ) | | | | 16,851,000 | 168,500 | | | (167,400 | ) | | | | ||||||||||||||||||||||||||||||||||||||
Stock-based compensation expense vested stock |
| | | | | | 1,800 | 200 | | | 600 | | | 800 | ||||||||||||||||||||||||||||||||||||||||||
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 |
| | | | | | | | 2,695,100 | | 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 |
| | | | | | 2,700 | | | | | | | | ||||||||||||||||||||||||||||||||||||||||||
Amortization of deferred stock-based compensation |
| | | | | | | | | | 65,100 | | | 65,100 | ||||||||||||||||||||||||||||||||||||||||||
Amortization of employee retirement plan contributions |
| | | | | | | | | 750,000 | | | | 750,000 | ||||||||||||||||||||||||||||||||||||||||||
Stock-based compensation expense options |
| | | | | | | | | | 37,300 | | | 37,300 | ||||||||||||||||||||||||||||||||||||||||||
Net loss |
| | | | | | | | | | | (11,155,800 | ) | | (11,155,800 | ) | ||||||||||||||||||||||||||||||||||||||||
Balance at October 3, 2010 |
8,300 | 100 | 1,900 | | 37,500 | 400 | 33,535,400 | 335,400 | 8,042,300 | | 165,039,200 | (175,795,400 | ) | 324,400 | (10,095,900 | ) | ||||||||||||||||||||||||||||||||||||||||
Common stock issued upon conversion of preferred stock |
(4,600 | ) | | (100 | ) | | | | 1,592,800 | 15,900 | | | (15,900 | ) | | | | |||||||||||||||||||||||||||||||||||||||
Issuance of common stock as debt discount |
| | | | | | 5,758,100 | 57,600 | | | 692,400 | | | 750,000 | ||||||||||||||||||||||||||||||||||||||||||
Sale of common stock, net of issuance costs |
| | | | | | 51,788,600 | 517,900 | | | 2,789,300 | | | 3,307,200 | ||||||||||||||||||||||||||||||||||||||||||
Forfeiture of nonvested stock |
| | | | | | (1,200 | ) | | | | | | | | |||||||||||||||||||||||||||||||||||||||||
Common stock warrants issued to investment banking firm |
| | | | | | | | 2,382,400 | | 190,600 | | | 190,600 | ||||||||||||||||||||||||||||||||||||||||||
Common stock issued to pay interest |
| | | | | | 343,000 | 3,400 | | | 133,700 | | | 137,100 | ||||||||||||||||||||||||||||||||||||||||||
Common stock issued upon conversion of debt |
| | | | | | 5,488,800 | 54,900 | | | 329,300 | | | 384,200 | ||||||||||||||||||||||||||||||||||||||||||
Stock-based compensation expense options |
| | | | | | | | | | 326,700 | | | 326,700 | ||||||||||||||||||||||||||||||||||||||||||
Amortization of deferred stock-based compensation |
| | | | | | | | | | 7,400 | | | 7,400 | ||||||||||||||||||||||||||||||||||||||||||
Net loss |
| | | | | | | | | | | (10,832,200 | ) | | (10,832,200 | ) | ||||||||||||||||||||||||||||||||||||||||
Balance at January 2, 2011 (Unaudited) |
3,700 | $ | 100 | 1,800 | $ | | 37,500 | $ | 400 | 98,505,500 | $ | 985,100 | 10,424,700 | $ | | $ | 169,492,700 | $ | (186,627,600 | ) | $ | 324,400 | $ | (15,824,900 | ) | |||||||||||||||||||||||||||||||
(1) | Amounts of preferred stock, common stock and warrants issued have been rounded to nearest one hundred (100). |
See Accompanying Notes to Condensed Consolidated Financial Statements.
5
Table of Contents
IRVINE SENSORS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
13 Weeks Ended | ||||||||
January 2, 2011 | December 27, 2009 | |||||||
Cash flows from operating activities: |
||||||||
Net loss |
$ | (10,832,200 | ) | $ | (1,716,700 | ) | ||
Adjustments to reconcile net loss
to net cash used in operating activities: |
||||||||
Depreciation and amortization |
273,600 | 348,200 | ||||||
Provision for allowance for inventory valuation |
| 17,500 | ||||||
Non-cash interest expense |
1,039,800 | | ||||||
Gain on sales of assets |
| (12,500 | ) | |||||
Change in fair value of derivative liability |
6,482,700 | (45,500 | ) | |||||
Non-cash stock-based compensation |
334,100 | 26,300 | ||||||
Decrease (increase) in accounts receivable |
(1,319,300 | ) | 289,400 | |||||
Decrease in unbilled revenues on uncompleted contracts |
137,700 | 209,900 | ||||||
Decrease in inventory |
208,100 | 35,800 | ||||||
Increase in prepaid expenses and other current assets |
(43,800 | ) | (148,800 | ) | ||||
(Decrease) increase in deposits |
(81,600 | ) | 100 | |||||
Decrease in accounts payable and accrued expenses |
(1,889,100 | ) | (499,100 | ) | ||||
Decrease in Executive Salary Continuation Plan liability |
(15,300 | ) | (60,800 | ) | ||||
Increase in advance billings on uncompleted contracts |
30,700 | 174,500 | ||||||
Decrease in deferred revenue |
(113,200 | ) | (161,100 | ) | ||||
Total adjustments |
5,044,400 | 173,900 | ||||||
Net cash used in operating activities |
(5,787,800 | ) | (1,542,800 | ) | ||||
Cash flows from investing activities: |
||||||||
Property and equipment expenditures |
(185,300 | ) | (3,700 | ) | ||||
Gross proceeds from sales of fixed assets |
| 12,500 | ||||||
Transfer of fixed asset from contract expense |
| (19,300 | ) | |||||
Net cash used in investing activities |
(185,300 | ) | (10,500 | ) | ||||
Cash flows from financing activities: |
||||||||
Proceeds
from sale of common stock, net of issuance costs |
3,307,200 | | ||||||
Proceeds from sale of preferred stock |
| 2,049,500 | ||||||
Proceeds from subordinated secured convertible promissory notes |
7,774,800 | | ||||||
Proceeds from unsecured convertible promissory notes |
3,000,000 | | ||||||
Debt issuance costs paid |
(1,426,500 | ) | | |||||
Decrease in advances against accounts receivable |
(46,600 | ) | (493,500 | ) | ||||
Principal payments of notes payable and settlement agreements |
(170,500 | ) | ||||||
Principal payments of capital leases |
| (5,900 | ) | |||||
Net cash provided by financing activities |
12,438,400 | 1,550,100 | ||||||
Net increase (decrease) in cash and cash equivalents |
6,465,300 | (3,200 | ) | |||||
Cash and cash equivalents at beginning of period |
281,600 | 125,700 | ||||||
Cash and cash equivalents at end of period |
$ | 6,746,900 | $ | 122,500 | ||||
Non-cash investing and financing activities: |
||||||||
Non-cash conversion of preferred stock to common stock |
$ | 257,400 | $ | 500,000 | ||||
Issuance of warrants recorded as deferred financing costs |
$ | | $ | 119,000 | ||||
Property and
equipment secured for note payable |
$ | 56,200 | $ | | ||||
Conversion
of Bridge Notes and accrued interest to common stock |
$ | 199,400 | $ | | ||||
Common Stock
issued to pay accrued interest |
$ | 137,100 | $ | | ||||
Accrued
expenses settled with settlement agreement obligations |
$ | 1,235,000 | $ | | ||||
Supplemental cash flow information: |
||||||||
Cash paid for interest |
$ | 116,900 | $ | 73,700 | ||||
Cash paid for income taxes |
$ | | $ | |
See Accompanying Notes to Condensed Consolidated Financial Statements.
6
Table of Contents
IRVINE SENSORS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 General
The information contained in the following Notes to Condensed 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 condensed 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 condensed 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
October 3, 2010 (fiscal 2010). It should be understood that accounting measurements at interim
dates inherently involve greater reliance on estimates than at year-end. The results of operations
for the interim periods presented are not necessarily indicative of the results expected for the
entire year.
The consolidated financial information for the 13-week periods ended January 2, 2011 and
December 27, 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 January 2, 2011, and the results of its operations and its
cash flows for the 13-week periods ended January 2, 2011 and December 27, 2009.
None of the Companys subsidiaries accounted for more than 10% of the Companys total assets
at January 2, 2011 and October 3, 2010 or had separate employees or facilities at such dates.
The condensed consolidated financial information as of January 2, 2011 included herein has
been derived from the Companys audited consolidated financial statements as of, and for the year
ended, October 3, 2010.
Description of Business
The Company is a vision systems and information security 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 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 introduced certain higher-level products in the fields of
thermal imaging cores and high speed processing for information security that take advantage of the
Companys packaging technologies.
7
Table of Contents
Summary of Significant Accounting Policies
Consolidation. The consolidated financial statements include the accounts of ISC and its
subsidiaries, 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 another of the Companys subsidiaries,
Optex Systems, Inc. (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
2010 ended on October 3, 2010 and included 53 weeks. The fiscal year ending October 2, 2011
(fiscal 2011) will include 52 weeks. The Companys first quarter of fiscal 2011 was the 13 weeks
ended January 2, 2011.
Reportable
Segments and Reclassifications. In the 13-week period ended January 2, 2011, the Company reorganized, in
conjunction with a financing, to focus its operations on development and sale of products derived
from its technology. As a result, the Company is managing its operations as a single business
segment in fiscal 2011 and has presented its consolidated statement of operations for the 13-week
period ended January 2, 2011 accordingly. The consolidated statement of operations for the 13-week
period ended December 27, 2009 has been reclassified to conform to the current period presentation.
Comparable reclassification of prior year periods is anticipated as future periods of fiscal 2011
are presented. In addition, to facilitate comparison to the significant derivative liability
recorded in the 13-week period ended January 2, 2011, the derivative liability at October 3, 2010
has been reclassified and presented separately in the Consolidated Balance Sheets included in this
report, as opposed to being included in accrued expenses as previously presented.
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.
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Derivatives. A derivative is an instrument whose value is derived from an underlying
instrument or index such as a future, forward, swap, option contract, or other financial instrument
with similar characteristics, including certain derivative instruments embedded in other contracts
(embedded
derivatives) and for hedging activities. As a matter of policy, the Company does not invest
in separable financial derivatives or engage in hedging transactions. However, the Company has
entered into complex financing transactions, including the convertible debt transactions entered
into in the 13-week period ended January 2, 2011, that involve financial instruments containing
certain features that have resulted in the instruments being deemed derivatives or containing
embedded derivatives. The Company may engage in other similar complex debt transactions in the
future, but not with the intention to enter into derivative instruments. Derivatives and embedded
derivatives, if applicable, are measured at fair value using the
binomial lattice pricing model and marked to market through earnings.
However, such new and/or complex instruments may have immature or limited markets. As a result, the
pricing models used for valuation of derivatives often incorporate significant estimates and
assumptions, which may impact the level of precision in the financial statements. Furthermore,
depending on the terms of a derivative or embedded derivative, the valuation of derivatives may be
removed from the financial statements upon conversion of the underlying instrument into some other
security.
Recently Issued Accounting Pronouncements. 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
was fiscal 2010, and early adoption was not permitted. On the first day of fiscal 2010, pursuant
to ASC 815-40, the Company was required to reclassify certain warrants from equity to liabilities,
resulting in a cumulative effect adjustment to reduce paid-in capital for the original allocated
value recorded for the these affected warrants and a corresponding reduction in accumulated deficit
and recording of the fair market value of the associated warrant derivative liability, which was
then subsequently re-measured and adjusted to report the change in fair value at the end of each
subsequent fiscal quarter, including the 13-week period ended January 2, 2011. In addition, as
noted above, the Company entered into a transaction on December 23, 2010 that, pursuant to ASC
815-40, required the Company to estimate the fair market value of features deemed to be embedded
derivatives in convertible debt instruments issued in or related to this transaction and to again
re-measure this derivative liability at January 2, 2011. As a result of this issuance and the
pre-existing warrant derivative, the Companys aggregate derivative liability was valued at
$13,349,800 at January 2, 2011, of which $6,482,700 was a change in derivative liability, largely
as a result of an increase in the market value of the Companys common stock between December 23,
2010 and January 2, 2011.
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 from the Companys adoption of this guidance.
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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 the
Company starting fiscal year 2011. There was no impact from the Companys adoption of this
guidance.
Note 2 Debt Instruments
Restructured Debt, Net of Debt Discounts
The restructured debt, net of debt discounts, consisted of the remainder of a 12% secured
promissory note payable to Longview Fund, L.P. (Longview) originally entered into by the Company
in July 2007 (the Longview Note) with a $2.0 million principal due initially, which had been
reduced to an outstanding principal balance of $163,100 at October 3, 2010 as a result of various
payments. In December 2010, the Company paid all remaining obligations of the Longview Note in
full.
Debentures, Net of Debt Discounts
In March 2010, the Company sold and issued to 55 accredited investors (the Debenture
Investors) an aggregate of 275.22 convertible debenture units (the Debenture Units) at a
purchase price of $6,000 per Unit (the Debenture Unit Price) in two closings of a private
placement (the Debenture Private Placement). The $1,651,300 aggregate purchase price for these
Debenture Units was paid in cash to the Company.
Each Debenture 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 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. In the first 13 weeks of fiscal
2011, interest in the amount of $137,200 was converted into 343,000 shares of common stock. (See
Note 3). 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.
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If all remaining 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 3,779,500 in the aggregate. The total number of shares of common stock
issuable upon exercise of the Debenture 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 3).
Aggregate gross proceeds of $1,651,300 received by the Company in connection with the
Debenture Private Placement is comprised of the aggregate principal balance of $2,752,200 of the
Debentures, net of a corresponding original issue discount of $1,101,000 and was allocated to the
individual components comprising the Debenture 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 $102,200. 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 to Timothy Looney by the Company in the principal amount of
$2,500,000 (the Looney Note) as a result of the Settlement Agreement with Mr. Looney (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 Agreement and Intellectual
Property Security Agreement related thereto (the Security Agreements), but such security
interests are subject to and subordinate to the existing perfected security interests and liens of
the Companys senior creditor, Summit Financial Resources, L.P. (Summit). The Looney 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 through April 2011 apply only to interest. A final payment of the remaining
unpaid principal and interest under the Looney 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 Looney 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 Looney Note. The $50,000 cash payment is
recorded as a prepaid charge on the consolidated balance sheet as of October 3, 2010 and January 2,
2011.
During November and December 2010, the Company issued the following debt instruments:
Principal balance at issuance date | ||||
Unsecured Convertible Promissory Notes |
$ | 3,000,000 | ||
Subordinated Secured Convertible Promissory Notes |
$ | 7,774,800 |
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The terms of the foregoing notes are as follows:
Unsecured Convertible Promissory Notes, Net of Discounts
In November and December 2010, the Company sold and issued to 47 accredited investors
unsecured convertible promissory notes of the Company (the Bridge Notes) in multiple closings of
a private placement (the Bridge Private Placement). The $3,000,000 aggregate principal balance of
the Bridge Notes in said closings was paid in cash to the Company.
The Bridge Notes bear simple interest at a rate per annum of 10% and have a maturity date of
May 31, 2011. Interest on the Notes accrues and is payable in arrears at maturity. At the
discretion of an investor holding a Bridge Note (a Bridge Note Holder), any outstanding principal
and accrued interest remaining under the Bridge Note at maturity may be converted into shares of
the Companys common stock at a conversion price equal to $0.13 per share (the Conversion Price),
provided, however, that the Company has a sufficient number of authorized shares of common stock to
allow such conversion at such time, and that the investor is an accredited investor at the time of
such conversion as such term is defined in Rule 501 under the Securities Act of 1933, as amended
(the Securities Act). There is no assurance that a sufficient number of authorized shares of the
Companys common stock will be available for conversion of any outstanding principal and accrued
interest under the Bridge Notes. Unpaid and unconverted principal balance and accrued interest of
the Bridge Notes may be repaid in cash prior to maturity in whole or in part at any time without
premium or penalty.
Also at the discretion of each Bridge Note Holder, any outstanding principal and accrued
interest under a Bridge Note held by said Bridge Note Holder may be converted as a result of the
closing of a subsequent private placement of the Companys securities with gross proceeds of at
least $8.0 million (a Subsequent Financing) into the securities issued in a Subsequent Financing
on the same terms and conditions as the other investors in said Subsequent Financing, provided,
however, that the Bridge Note Holder is an accredited investor at the time of such conversion as
such term is defined in Rule 501 under the Securities Act; and provided, further, that such Bridge
Note Holder enters into and executes the same documents, satisfies the same conditions and agrees
to be bound by the same terms as all other investors in said Subsequent Financing. The Company
consummated such a Subsequent Financing in December 2010, and as described below, certain of the
Bridge Note Holders elected to convert their Bridge Notes into the securities issued in the
Subsequent Financing.
As
additional consideration for the Bridge Notes, in December 2010,
the Company issued an aggregate of 5,758,100 shares
of its common stock to the Bridge Note Holders with a value equal to 25% of the principal amount of
the Bridge Notes purchased by the Bridge Note Holders, based on a valuation per share (the Initial
Valuation) which was the greater of (i) the fair market value of the Companys common stock (as
determined by the last closing sales price of the Companys common stock prior to the date of
issuance of the Notes) (the Market Value), and (ii) $0.13 per share, but not greater than $0.14
per share.
In consideration for services rendered as the lead placement agent in the Bridge Private
Placement, the Company paid the placement agent cash commissions, a management fee and an expense
allowance fee aggregating $309,700, which represents 10.3% of the gross proceeds of the Bridge
Private Placement, and agreed to issue to the placement agent a five-year warrant to purchase an
aggregate of 2,227,400 shares of the Companys common stock at an exercise price of $0.13 per share
and a five-year warrant to purchase an aggregate of 155,000 shares of the Companys common stock at
an exercise price of $0.135 per share, which prices were equal to the Market Value (collectively,
the Bridge Agent Warrants).
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The Companys obligation to issue the Bridge Agent Warrants was established in December 2010,
but the Bridge Agent Warrants shall not be exercisable unless and until stockholder authority has
been obtained to increase the Companys authorized shares of common stock to a number adequate to
reserve for both any shares of common stock to be issued in connection with the Subsequent
Financing and the Bridge Agent Warrants, as well as any other known issuances of common stock for
which the Company must reserve shares for issuance. The Bridge Agent Warrants have a net cashless
exercise feature.
Subordinated Secured Convertible Promissory Notes
In December 2010, the Company entered into a Securities Purchase Agreement (the Purchase
Agreement) with two accredited investors, Costa Brava Partnership III L.P. (Costa Brava) and The
Griffin Fund LP (Griffin), pursuant to which the Company issued and sold to Costa Brava and
Griffin 12% Subordinated Secured Convertible Notes due December 23, 2015 (the Subordinated Notes)
in the aggregate principal amount of $7,774,800 and an aggregate of 51,788,571 shares of common
stock of the Company for $3,625,200, or $0.07 per share, and agreed to issue and sell in a
subsequent closing not later than April 30, 2011 (subject to the amendment of the Companys
Certificate of Incorporation to increase the Companys authorized common stock and provided that
there has not been a material adverse change in the Companys relationship with Optics 1, Inc.)
additional 12% Subordinated Secured Convertible Notes (the Milestone Notes) to Costa Brava and
Griffin for an aggregate purchase price of $1.2 million (collectively, the Institutional
Financing).
The Subordinated Notes bear interest at a rate of 12% per annum, due and payable quarterly
within 10 business days of the end of each calendar quarter, calculated on the simple interest
basis of a 365-day year for the actual number of days elapsed. For the first two years of the term
of the Subordinated Notes, the Company has the option, subject to the satisfaction of certain
customary equity conditions, to pay all or a portion of the interest due on each interest payment
date in shares of common stock, with the price per share calculated based on the weighted average
price of the Companys common stock over the last 20 trading days ending on the second trading day
prior to the interest payment date. The foregoing notwithstanding, until the Looney Note is repaid
in full, cash interest on the Subordinated Notes must instead be paid by adding the amount of such
interest to the outstanding principal amount of the Subordinated Notes as PIK interest. The
principal and accrued but unpaid interest under the Subordinated Notes is convertible at the option
of the holder, any time after amendment of the Companys Certificate of Incorporation to increase
the Companys authorized common stock, into shares of the Companys common stock at an initial
conversion price of $0.07 per share. The conversion price is subject to full ratchet adjustment for
certain price dilutive issuances of securities by the Company and proportional adjustment for
events such as stock splits, dividends, combinations and the like. Beginning after the first two
years of the term of the Subordinated Notes, the Company can force the Subordinated Notes to
convert to common stock if certain customary equity conditions have been satisfied and the volume
weighted average price of the common stock is $0.25 or greater for 30 consecutive trading days.
The Subordinated Notes and the Milestone Notes are and will be secured by substantially all of
the assets of the Company pursuant to a Security Agreement dated December 23, 2010 between the
Company and Costa Brava as representative of the Subordinated Note holders, but the liens securing
the Subordinated Notes and Milestone Notes are and will be subordinate to the liens securing the
indebtedness of the Company to Summit Financial Resources, L.P. under that certain Financing
Agreement dated as of June 16, 2009, and subordinate in right of payment to the Looney Note.
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The Subordinated Notes restrict the Company from (A) directly or indirectly, incurring or
guaranteeing, assuming or suffering to exist any indebtedness, other than (i) the Notes, (ii)
certain
permitted indebtedness and (iii) the Looney Note; (B) allowing or suffering to exist any
mortgage, lien, pledge, charge, security interest or other similar encumbrance upon or in any
property or assets (including accounts and contract rights) owned by the Company or any of its
subsidiaries other than (i) existing liens securing the Looney Note and (ii) certain permitted
liens; and (C) during an event of default, directly or indirectly, redeeming, defeasing,
repurchasing, repaying or making any payments in respect of, by the payment of cash or cash
equivalents (in whole or in part, whether by way of open market purchases, tender offers, private
transactions or otherwise), all or any portion of any indebtedness expressly subordinate to the
Subordinated Notes.
The book value of the Subordinated Notes, net of discounts, at January 2, 2011 is $2,335,000.
The debt discounts will be amortized over the 5-year term of the Subordinated Notes, unless such
amortization is accelerated due to earlier conversion of the Subordinated Notes pursuant to their
terms.
Conversion of Bridge Notes into Subordinated Notes
As discussed above, the Company had previously sold Bridge Notes to investors in an aggregate
principal amount of $3,000,000, the terms of which permit the Bridge Note Holders to convert up to
and including the aggregate outstanding principal amount of such Bridge Notes and any accrued
interest thereon (the amount converted, the Conversion Amount) into the same securities issued
in, and upon the same terms and conditions of, the Institutional Financing (the Bridge Note
Conversion). Pursuant to the terms of the Bridge Private Placement, in December 2010, holders of
Bridge Notes with a principal balance of $1,208,200 (including accrued interest of $9,600)
converted their Bridge Notes into securities issued in the Institutional Financing. Of the
converted Bridge Notes, Costa Brava and Griffin were holders of notes with an aggregate principal
balance of $581,300 (including accrued interest of $2,700). Under the terms of the Purchase
Agreement, these Bridge Notes were converted into 5,488,800 shares valued at $384,200 and
Subordinated Notes with a principal balance of $824,000.
Conversion Features of the Bridge Notes and the Subordinated Notes.
The conversion features of the Bridge Notes and the Subordinated Notes contain provisions that
adjust the conversion price in the event of certain dilutive issuances of securities. Accordingly,
the Company considered such conversion features to be derivatives and recorded their fair value of
$6,867,100 at the date of issuance as a liability and as a discount to the underlying notes. In addition, the Company re-measured the fair
value of such liability to be $13,349,800 as of January 2, 2011.
The following outlines the significant weighted average assumptions
the Company used to estimate the fair value information presented,
with respect to derivative liabilities utilizing the Binomial
Lattice pricing model at the date of issuance and January 2, 2011:
Risk free interest rate |
2.01%-2.09 | % | ||
Expected volatility |
74.8%-75.4 | % | ||
Expected dividends |
None |
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Note 3 Common Stock and Common Stock Warrants, Preferred Stock, Stock Incentive Plans,
Employee Retirement Plan and Deferred Compensation Plans
During the 13-week period ended January 2, 2011, the Company issued an aggregate of 64,970,100
shares of common stock, with an aggregate valuation of $5,153,600, in both cash and non-cash
transactions.
Cash Common Stock Transactions. In December 2010, the Company issued an aggregate of
approximately 51,788,600 shares of common stock of the Company for approximately $3,625,200, or
$0.07 per share in the Institutional Financing. (See Note 2.)
Non-Cash Common Stock Transactions. During the 13-week period ended January 2, 2011, the
Company issued an aggregate of 13,181,500 shares of common stock, net of forfeitures, with an
aggregate valuation of $1,528,400, in the following non-cash transactions: (i) an aggregate of
5,758,100 shares of common stock of the Company, valued at $750,000, were issued to the Bridge Note
Holders pursuant to the Bridge Private Placement (see Note 2); (ii) an aggregate of 5,488,800
shares of common stock of the Company, valued at $384,200, were issued to certain Bridge Note
Holders for conversion of the aggregate outstanding principal amount of the Bridge Notes and any
accrued interest thereon held by said Bridge Note Holders into the same securities issued in, and
upon the same terms and conditions of, the Institutional Financing (see Note 2); (iii) an aggregate
of 1,450,000 shares of common stock of the Company were issued in various transactions in exchange
for conversion and cancellation of $186,000 of the stated value of the Companys Series A-2 10%
Cumulative Convertible Preferred Stock (the Series A-2 Stock); (iv) an aggregate of 142,800
shares of common stock of the Company was issued in a transaction in exchange for conversion and
cancellation of $71,400 of the stated value of the Companys Series B Convertible Preferred Stock
(the Series B Stock); (v) 343,000 shares of common stock of the Company were issued to pay
interest in the amount of $137,100 on the Companys Debentures pursuant their terms (see Note 2); and (vi) 1,200
shares of nonvested shares of common stock of the Company were forfeited.
Common Stock Warrants. In the 13-week period ended January 2, 2011, as a result of the
Institutional Financing, and pursuant to existing price anti-dilution provisions, the exercise
prices of the Class A Common Stock Purchase Warrants (the Class A Warrants) and the Class B
Common Stock Purchase Warrant (the Class B Warrant) issued by the Company, were automatically
adjusted to $0.07 per share. The number of shares of common stock of the Company issuable upon
exercise of the Class A Warrants and Class B Warrant did not change. (See Note 2).
In the 13-week period ended January 2, 2011, the Bridge Private Placement established an
obligation for the Company to issue Bridge Agent Warrants, consisting of a warrant to purchase
approximately 2,227,400 shares of common stock of the Company at an exercise price of $0.13 per
share and a warrant to purchase approximately 155,000 shares of common stock of the Company at an
exercise price of $0.135 per share, subject to the requirement that said warrants shall not be
exercisable unless and until stockholder authority has been obtained to increase the Companys
authorized shares of common stock to a number adequate to reserve for both any shares of common
stock to be issued in connection with the Institutional Financing and the Bridge Agent Warrants, as
well as any other known issuances of common stock for which the Company must reserve shares for
issuance. The Company has scheduled a stockholder vote for such authority to be taken at its
Annual Meeting of Stockholders to be held in March 2011. In the 13-week period ended January 2,
2011, the Company has recorded the $190,600 expense of this obligation as a debt discount to be
amortized over the term of the Bridge Notes. The Company used the Black-Scholes model to value the
Bridge Agent Warrants using the following
assumptions; volatility of 74.82%, common stock price $0.13 per share, exercise price of
$0.13, risk-free interest rate of 1.89% and an expected term of five years. (See Note 2).
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At January 2, 2011 and October 3, 2010, there were warrants outstanding to purchase 10,424,700
and 8,042,300 shares of the Companys common stock, respectively, although as noted above, issuance
of approximately 2,382,400 shares of the Companys common stock pursuant to the Bridge Agent
Warrants as of January 2, 2011 will require stockholder approval of an amendment to the Companys
Certificate of Incorporation to increase the Companys authorized capital stock.
Preferred Stock. In the 13-week period ended January 2, 2011, as a result of the Institutional
Financing, and pursuant to existing price anti-dilution provisions of the Companys Certificate of
Incorporation, as amended, the conversion price of the Series A-2 Stock was automatically adjusted
to $0.07 per share, such that the Series A-2 Stock is now convertible at such conversion price into
an aggregate of 2,104,143 shares of common stock of the Company. (See Note 2).
In the 13-week period ended January 2, 2011, approximately 4,650 shares of the Series A-2
Stock were converted by Longview into 1,450,000 shares of common stock, and approximately 71 shares
of the Series B Stock were converted into approximately 142,800 shares of common stock, as
discussed above.
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) (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 January 2, 2011, there were no options to purchase shares of the Companys common stock
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 43,300 shares of the Companys common stock were outstanding and
exercisable under the 2001 Plan, at exercise prices ranging from $8.60 to $13.50 per share, and
options to purchase 266,800 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 all were exercisable at
January 2, 2011.
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 1,250,000 shares in
the 13-week period ended January 2, 2011. As of January 2, 2011, there were options to purchase
2,034,600 shares of the Companys common stock outstanding under the 2006 Plan, at exercise prices
ranging from $0.09 to $14.10 per share, of which options to purchase 643,100 shares were
exercisable at January 2, 2011. In addition, as of January 2, 2011, 29,000 shares of nonvested
stock were issued and outstanding pursuant
to the 2006 Plan and 291,100 shares of vested stock were issued and outstanding pursuant to
the 2006 Plan. The aggregate number of shares of common stock issuable under all stock-based awards
that may be made under the 2006 Plan at January 2, 2011 is approximately 335,400 shares.
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In December 2010, in connection with the Institutional Financing, the Companys Board adopted
the Companys 2010 Non-Qualified Stock Option Plan (the 2010 Plan) under which the Companys
eligible officers, directors and employees, consultants and advisors who qualify as accredited
investors within the meaning of Rule 501 under the Securities Act, may be granted non-incentive
stock options. 18,500,000 shares of the Companys common stock were reserved for issuance under the
2010 Plan, and options to purchase 18,500,000 shares of the Companys Common Stock at an exercise
price of $0.09 per share were issued to certain of the Companys officers and directors in December
2010 pursuant to the 2010 Plan. No further grants may presently be made under the 2010 Plan.
The following table summarizes stock options outstanding as of January 2, 2011 as well as
activity during the 13-week period then ended:
Weighted Average | ||||||||
Shares (1) | Exercise Price | |||||||
Outstanding at October 3, 2010 |
1,373,900 | $ | 7.44 | |||||
Granted |
19,500,000 | 0.09 | ||||||
Exercised |
| | ||||||
Expired |
(4,000 | ) | 265.62 | |||||
Forfeited |
(22,700 | ) | 1.16 | |||||
Outstanding at January 2, 2011 |
20,847,200 | $ | 0.52 | |||||
Exercisable at January 2, 2011 |
5,455,700 | $ | 1.74 | |||||
(1) | Rounded to nearest one hundred (100). |
At January 2, 2011, the aggregate intrinsic value of unvested options outstanding and options
exercisable was $975,000 and $225,000, respectively. There were no options exercised during the 13
weeks ended January 2, 2011 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 January 2, 2011, the
weighted-average remaining contractual life of options outstanding and exercisable was 9.8 years
and 9.3 years, respectively. The weighted average grant date fair value of options granted during
the 13 weeks ended January 2, 2011 was $0.06 per share.
The amount of compensation expense related to outstanding stock options not yet recognized at
January 2, 2011 was $877,800 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 2011 (remainder of year) |
$ | 212,600 | ||
FY 2012 |
272,100 | |||
FY 2013 |
237,200 | |||
FY 2014 |
155,900 | |||
Total |
$ | 877,800 | ||
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The following table summarizes nonvested stock grants outstanding as of January 2, 2011 as
well as activity during the 13-week period then ended:
Weighted | ||||||||
Average Grant | ||||||||
Date Fair Value | ||||||||
Nonvested Shares | per Share | |||||||
Outstanding at October 3, 2010 |
35,200 | $ | 2.88 | |||||
Granted |
| | ||||||
Vested |
(5,000 | ) | 9.73 | |||||
Forfeited |
(1,200 | ) | 0.27 | |||||
Outstanding at January 2, 2011 |
29,000 | $ | 1.37 | |||||
The amount of compensation expense related to nonvested stock grants not yet recognized at
January 2, 2011 was $2,100 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 2011 (remainder of year) |
$ | 800 | ||
FY 2012 |
900 | |||
FY 2013 |
400 | |||
Total |
$ | 2,100 | ||
Note 4 Loss per Share
Since the Company had losses for the 13-week periods ended January 2, 2011 and December 27,
2009, basic and diluted net loss per common share are the same and are computed based solely on the
weighted average number of shares of common stock outstanding for the respective periods.
Cumulative dividends on the Series A-2 Stock for the 13-week period ended January 2, 2011 and on
the Companys Series A-1 10% Cumulative Convertible Preferred Stock (the Series A-1 Stock) and
the Series A-2 Stock for the 13-week period ended December 27, 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. In like manner, the beneficial conversion feature
associated with the issuance of the Companys Series B Stock in the 13-week period ended December
27, 2009, 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.
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The following table sets forth the computation of basic and diluted loss per common share:
13 Weeks Ended | ||||||||
January 2, | December 27, | |||||||
2011 | 2009 | |||||||
Net Loss Numerator: |
||||||||
Net loss attributable to Irvine Sensors Corporation |
$ | (10,832,200 | ) | $ | (1,716,700 | ) | ||
Undeclared cumulative dividends on Series A-1 Stock and
Series A-2 Stock* |
(7,400 | ) | (112,900 | ) | ||||
Deemed dividend for beneficial conversion feature
related to Series B preferred stock |
| (1,471,000 | ) | |||||
Adjusted net loss attributable to Irvine
Sensors Corporation common stockholders |
$ | (10,839,600 | ) | $ | (3,300,600 | ) | ||
Net Loss Denominator: |
||||||||
Weighted average number of common shares outstanding |
41,612,200 | 10,141,400 | ||||||
Basic and diluted net loss attributable to Irvine Sensors
Corporation per common share |
$ | (0.26 | ) | $ | (0.33 | ) | ||
* | Potential undeclared dividends accumulated prior to July 15, 2010 were waived in April 2010. |
Options, warrants and convertible instruments outstanding at January 2, 2011 and December 27, 2009
to purchase approximately 50,010,000 and 5,528,200 shares of the Companys common stock,
respectively, were not included in the above computation because they were anti-dilutive.
Note 5 Inventories, Net
Net inventories at January 2, 2011 and October 3, 2010 are set forth below.
January 2, | October 3, | |||||||
2011 | 2010 | |||||||
Inventory: |
||||||||
Work in process |
$ | 750,000 | $ | 360,800 | ||||
Raw materials |
653,700 | 781,500 | ||||||
Finished goods |
354,000 | 823,500 | ||||||
1,757,700 | 1,965,800 | |||||||
Less reserve for obsolete inventory |
(250,000 | ) | (250,000 | ) | ||||
$ | 1,507,700 | $ | 1,715,800 | |||||
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. The net book value of capitalized
pre-contract costs, which gross costs are included in the caption Work in process, at January 2,
2011 and October 3, 2010 was $82,900 and $360,800, respectively.
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Note 6 Concentration of Revenues and Sources of Supply
In the 13-week period ended January 2, 2011, direct contracts with the U.S. government
accounted for 13% of the Companys total revenues, and second-tier government contracts with prime
government contractors accounted for 84% of total revenues. The remaining 3% of the Companys total
revenues were derived from non-government sources. Of the revenues derived directly or indirectly
from U.S. government agencies, Optics 1, a defense contractor, accounted for 76% of total revenues
in the 13-week period ended January 2, 2011. Loss of this customer 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 period ended January 2, 2011.
In the 13-week period ended December 27, 2009, direct contracts with the U.S. government
accounted for 70% of the Companys total revenues, and second-tier government contracts with prime
government contractors accounted for 27% of total revenues. The remaining 3% of the Companys total
revenues were derived from non-government sources. Of the revenues derived directly or indirectly
from U.S. government agencies, the U. S. Army, certain classified government agencies, Alion
Science and Technology Corporation, a defense contractor, and the U.S. Air Force accounted for 30%,
26%, 13% and 12%, respectively, of total revenues in the 13-week period ended December 27, 2009. No
other single governmental or non-governmental customer accounted for more than 10% of the Companys
total revenues in the 13-week period ended December 27, 2009.
The Company primarily uses contract manufacturers to fabricate and assemble its stacked chip,
microchip, information security and sensor products. At its 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.
The Companys various thermal and visible camera products presently rely on a limited number of
suppliers of imaging chips that meet the quality and performance requirements of the Companys
products, which makes the Company vulnerable to potential disruptions in supply of such imaging
chips.
Note 7 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 (collectively, FirstMark), filed a lawsuit in the state Supreme Court, State of
New York, County of New York, against the Company. The plaintiffs alleged that 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 October 3, 2010, the Company had approximately $1,269,600
of expense accrued reflecting these alleged obligations.
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In December 2010, the Company entered into a Settlement Agreement and Release with FirstMark,
pursuant to which the Company settled all claims between the Company and FirstMark, including those
relating to the lawsuit discussed above. Pursuant to the Settlement Agreement and Release, the
Company will pay FirstMark a total sum of $1,235,000 in eighteen monthly payments commencing
January 15, 2011. In the event that a monthly installment payment is not paid by the Company
within 30 days of the date it is due, FirstMark may enter a Confession of Judgment in the amount of
the total settlement less any payment made by the Company prior to such default. This lawsuit was
dismissed with prejudice in December 2010.
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.
Note 8 Fair Value Measurements
The Company measures the fair value of applicable financial and non-financial assets and
liabilities based on the following levels of inputs.
| Level 1 inputs: Level 1 inputs are quoted market prices in active markets for identical assets or liabilities that are accessible at the measurement date. |
| Level 2 inputs: Level 2 inputs are from other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. |
| Level 3 inputs: Level 3 inputs are unobservable and should be used to measure fair value to the extent that observable inputs are not available. |
The hierarchy noted above requires the Company to minimize the use of unobservable inputs and
to use observable market data, if available, when determining fair value. There were no transfers
between Level 1, Level 2 and/or Level 3 during the 13 weeks ended January 2, 1011. Financial
liabilities carried at fair value as of January 2, 1011 are classified below:
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Derivative liabilities |
$ | | $ | 13,349,800 | $ | | $ | 13,349,800 | ||||||||
Total |
$ | | $ | 13,349,800 | $ | | $ | 13,349,800 |
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Note 9 Subsequent Events
Conversion of Bridge Notes
In January 2011, Bridge Note Holders of $246,400 of principal balance of the Bridge Notes
elected to convert the principal outstanding under such said Bridge Notes, plus accrued interest of
approximately $1,100, into the securities issued in the Institutional Financing, resulting in an
aggregate outstanding unpaid principal balance of the Bridge Notes of $1,555,000 after said
conversion. (See Note 2). As a result of this conversion, the Company issued an aggregate of
approximately 1,138,400 shares of its common stock and approximately $170,900 of principal balance
of Subordinated Notes to the converting Bridge Note Holders.
Exercise of Warrants
In February 2011, Longview exercised their Class A Warrant and Class B Warrant on a cashless
basis. As a result of this exercise, the Company issued an aggregate of approximately 221,000
shares of its common stock to Longview.
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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, 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, if required, on acceptable terms, in a timely manner or at all; |
| changes in the fair value of derivative instruments expense; |
| our ability to obtain critical and timely product and service deliveries from key vendors; |
| our ability to successfully execute our business and operating plans 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 execute additional product orders and contracts, and achieve greater backlog; |
| our ability to fulfill our backlog; |
| governmental agendas, budget issues and constraints and funding or approval delays; |
| our ability to maintain adequate internal controls and disclosure procedures, and maintain 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 and maintain strategic partnerships to develop our business; |
| our market capitalization; |
| general economic and political instability; and |
| those additional factors which are listed under the section Risk Factors in Part II, Item 1A of this report. |
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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.
Overview
We are a vision systems and information security 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. We have introduced certain higher-level
products in the fields of thermal imaging cores and high speed processing for information security
that take advantage of the our packaging technologies.
We have historically derived a substantial majority of our total revenues from
government-funded sources and anticipate that a substantial majority of our total revenues will
continue to be derived from government-funded sources in the immediately foreseeable future. We
have introduced thermal imaging and information security products incorporating our technologies
that are initially intended for government applications. We have achieved initial market
penetration for some of these products and are focusing our marketing efforts on achieving growth
in revenues derived from sale of these products. If we are successful in achieving such growth, 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, products with
information security applications. 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 leased facility in Costa Mesa,
California.
Other than the fiscal year ended September 27, 2009 (fiscal 2009), we have a history of
unprofitable operations due in part to our investment in an unprofitable subsidiary 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 2010 and the first 13 weeks of fiscal 2011, we continued to experience
unprofitable operations, due to insufficient total revenues to fully absorb our costs and expenses.
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 have historically maintained our work force as much as possible even when
anticipated revenues were 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. Our current increased emphasis on securing sales of our products is, in part, motivated by
the desire to achieve more predictable revenues that should mitigate this effect, but we anticipate
we may continue to experience underutilization of our workforce in the near future.
We have recently implemented a reduction-in-force to decrease this anticipated effect. We
have not yet demonstrated the level of sustained revenue that we believe, by itself, is required to
sustain profitable operations. Our ability to recover our investments through the
cost-reimbursement features of certain of our government contracts is constrained due to both
regulatory and competitive pricing considerations.
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To offset the adverse working capital effect of our net losses, we have historically financed
our operations through multiple debt and equity financings. To finance the December 2005
acquisition of a subsidiary, now discontinued, we had incurred material long-term debt at that
time, and we exchanged a significant portion of that debt into preferred stock that is convertible
into our common stock. Since September 30, 2007 through the date of this report, we have issued
approximately 95.8 million shares of our common stock, an increase of approximately 3,570% from the
approximately 2.7 million shares of our common stock outstanding at that date, which has resulted
in a substantial dilution of stockholder interests. At January 2, 2011, our fully diluted common
stock position as presently authorized was approximately 148.5 million shares, which assumes the
conversion into common stock of all of the Companys preferred stock and convertible debentures and
notes outstanding as of January 2, 2011 and the exercise for cash of all warrants and options to
purchase the Companys securities outstanding as of January 2, 2011. If our stockholders approved
an increase in our authorized shares of common stock from 150,000,000 shares to 500,000,000 shares
at our annual meeting of stockholders in March 2011, over 140 million additional shares of our
common stock will become issuable pursuant to the conversion of our Subordinated Notes, conversion
of our Bridge Notes and exercise of the Agent Warrants issued in the Bridge Private Placement. At
January 2, 2011, we had approximately $15.7 million of debt, of which a substantial majority was
incurred in November and December 2010.
None of our subsidiaries accounted for more than 10% of our total assets at January 2, 2011 or
have separate employees or facilities. As a result of the Institutional Financing and the related
management and organizational changes that occurred in the 13-week period ended January 2, 2011, we
currently report our operating results and financial condition in a single segment.
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 53-week period ended October 3,
2010.
Results of Operations
Total Revenues. Our total revenues are generally derived from sales of miniaturized camera
products, specialized chips, modules, stacked chip products and amounts realized or realizable from
funded research and development contracts, largely from U.S. government agencies and government
contractors. Our total revenues increased in the 13-week period ended January 2, 2011 as compared
to the 13-week period ended December 27, 2009 and changed markedly in composition as shown in the
following table and discussed more fully below.
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Table of Contents
13-Week Comparisons | Total Revenue | |||
13 weeks ended December 27, 2009 |
$ | 3,210,200 | ||
Dollar increase in current comparable 13 weeks |
1,090,700 | |||
13 weeks ended January 2, 2011 |
$ | 4,300,900 | ||
Percentage increase in current 13 weeks |
34 | % |
The increase in our total revenues in the 13-week period ended January 2, 2011 as compared to
the 13-week period ended December 27, 2009 was largely the result of increased sales of our thermal
imaging products in the current period, particularly our cores for clip-on thermal imager (COTI)
products intended to add thermal imaging capability to existing night vision goggles. Sales of our
COTI products are substantially derived from a government contract awarded to our strategic partner
Optics 1, Inc., with whom we have a teaming agreement, in the first half of fiscal 2010, but not
released for significant shipments by the government customer until the current 13-week period
ended January 2, 2011, thereby accounting for the increase in total revenue derived from these
products in the current period as compared to the 13-week period ended December 27, 2009. This
increase in sales of COTI cores more than offset a decrease in our revenues derived from funded
research and development contracts in the 13-week period ended January 2, 2011 as compared to the
13-week period ended December 27, 2009. We believe the decrease in revenues derived from funded
research and development contracts in the current year period as compared to the first quarter of
fiscal 2010 was substantially related to the delay in approval of the U.S. defense budget, which at
the date of this report is still unresolved. This delay has introduced uncertainty into the
timing of funding or shipment releases under existing contracts and the possible award of new
contracts. Until the defense budget is finalized, we are unable to ascertain what future effects
this delay may have on our total revenues in the future. We are seeking sales of our other
recently introduced products, in particular our Vault information storage devices, which if
achieved could become a material contributor to our total revenues in subsequent reporting periods
of fiscal 2011.
Cost of Revenues. Cost of revenues includes wages and related benefits of our personnel, as
well as subcontractor, independent consultant and vendor expenses directly incurred in the
manufacture of products sold or in the performance of funded research and development contracts,
plus related overhead expenses and, in the case of funded research and development contracts, such
other indirect expenses as are permitted to be charged pursuant to the relevant contracts. Our
cost of revenues for the first 13 weeks of fiscal 2011 increased as compared to the first 13 weeks
of fiscal 2010 in terms of both absolute dollars and as a percentage of total revenues, as shown in
the following table:
Percentage of | ||||||||
13-Week Comparisons | Cost of Revenues | Total Revenues | ||||||
13 weeks ended December 27, 2009 |
$ | 2,439,000 | 76 | % | ||||
Dollar increase in current comparable 13 weeks |
1,600,200 | |||||||
13 weeks ended January 2, 2011 |
$ | 4,039,200 | 94 | % | ||||
Percentage increase in current 13 weeks |
66 | % |
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The current period increase in absolute dollar cost of revenues as compared to the prior
fiscal years first quarter was partially the result of the corresponding increase in total
revenues in the 13-week
period ended January 2, 2011 as compared to the 13-week period ended December 27, 2009.
However, the increase in cost of revenues in the current period was proportionately greater than
the related increase in total revenues, resulting in the large increase in cost of revenues as a
percentage of total revenues in the 13-week period ended January 2, 2011 as compared to the 13-week
period ended December 27, 2009. This disproportionate increase in cost of revenues for the
current fiscal year first quarter compared to the first quarter of fiscal 2010 was largely the
result of the timing and amount of overhead expenses recorded in the current period, which did not
occur in the prior fiscal years first fiscal quarter. In the first half of fiscal 2010, we had
not yet decided whether we were going to continue our practice of annual stock contributions to our
Employee Stock Bonus Plan (ESBP). In the third quarter of fiscal 2010, we made the decision to
continue our practice of such contributions and began accruing for the expense, including a
catch-up accrual for the first half of fiscal 2010, of which approximately $136,400 applicable to
costs of revenues would have been recorded in the 13-week period ended December 27, 2009 had the
contribution decision been made in that period. In fiscal 2011, we have accrued for this expense
from the beginning of the fiscal year. In addition, in December 2010, we accrued and paid
non-recurring compensation to our staff in consideration of the salary reductions and deferrals
they had experienced in fiscal 2010 and the first quarter of fiscal 2011, of which $200,300 was
allocated to overhead applied to cost of revenues. No comparable expense was incurred in the first
quarter of fiscal 2010. Because of these timing variances and non-recurring expenses, we do not
believe that the increase in cost of revenues as a percentage of total revenues in the 13-week
period ended January 2, 2011 as compared to the 13-week period ended December 27, 2009 is
indicative of a continuing trend.
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. The comparison of general and administrative expense for
the 13-week periods ended January 2, 2011 and December 27, 2009 is shown in the following table:
General and | ||||||||
Administrative | Percentage of | |||||||
13-Week Comparisons | Expense | Total Revenues | ||||||
13 weeks ended December 27, 2009 |
$ | 1,651,400 | 51 | % | ||||
Dollar increase in current comparable 13 weeks |
263,000 | |||||||
13 weeks ended January 2, 2011 |
$ | 1,914,400 | 45 | % | ||||
Percentage increase for current 13 weeks |
16 | % |
A portion of the increase in absolute dollars of general and administrative expense in the
13-week period ended January 2, 2011 as compared to the 13-week period ended December 27, 2009 was
derived from the same timing variance and non-recurring expense discussed above that affected the
cost of revenues, namely the timing of the accrued expenses for the ESBP and the non-recurring
staff compensation in December 2010. Approximately $50,200 of general and administrative expense
would have been recorded in the first quarter of fiscal 2010 had the ESBP contribution decision
been made in that period. In addition, approximately $56,400 of general and administrative
expense was recorded for non-recurring staff compensation in the first quarter of fiscal 2011, and
no comparable expense was incurred in the prior fiscal year period. The increases in general and
administrative expenses from these sources in the 13-week period ended January 2, 2011 were offset
by reductions in other categories of general and administrative expense, the largest such reduction
being an approximate $219,000 decrease compared to the prior fiscal year period in our unallowable
general and administrative expense for which we cannot seek reimbursement under most of our
government contracts, largely litigation expenses. During the
first quarter of fiscal 2010, we were still involved in litigation related to our discontinued
Optex subsidiary, but that litigation was subsequently settled and did not produce comparable legal
expenses in the first quarter of fiscal 2011. However, in connection with our Institutional
Financing in December 2010 and the related management and organizational changes, we incurred
$306,500 more stock-based compensation expense in the first quarter of fiscal 2011 than we did in
the first quarter of fiscal 2010, which was the largest contributor to the increase in general and
administrative expense in the current fiscal year period. Since our total revenues increased in
the fiscal 2011 first quarter as compared to the first quarter of fiscal 2010, our general and
administrative expense as a percentage of total revenues decreased in the current fiscal period,
despite the increase in absolute dollars of general and administrative expense during the same
period.
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Research and Development Expense. Research and development expense primarily 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 first quarter of fiscal 2011 as compared to the first quarter of fiscal 2010 is shown in the
following table:
Research and | ||||||||
Development | Percentage of | |||||||
13-Week Comparisons | Expense | Total Revenues | ||||||
13 weeks ended December 27, 2009 |
$ | 755,200 | 24 | % | ||||
Dollar decrease in current comparable 13 weeks |
(221,300 | ) | ||||||
13 weeks ended January 2, 2011 |
$ | 533,900 | 12 | % | ||||
Percentage decrease for current 13 weeks |
(29 | %) |
The decrease in research and development expense in the first quarter of fiscal 2011 as
compared to the first quarter of fiscal 2010 is largely related to labor deployment issues in the
respective fiscal quarters. We typically 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 direct
bearing on the amount of internally funded research and development expense we undertake in any
given period. 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 decreases in research and development expense in the
13-week period ended January 2, 2011 as compared to the 13-week period ended December 27, 2009
reflect these milestones, rather than a change in priorities related to internally funded research
and development.
Interest Expense. Our interest expense for the first 13 weeks of fiscal 2011, compared to the
first 13 weeks of fiscal 2010, increased substantially, as shown in the following table:
Interest Expense | ||||
13 weeks ended December 27, 2009 |
$ | 114,900 | ||
Dollar increase in current comparable 13 weeks |
2,041,400 | |||
13 weeks ended January 2, 2011 |
$ | 2,156,300 | ||
Percentage increase for current 13 weeks |
1,777 | % |
The increase in interest expense in the first quarter of fiscal 2011 as compared to the first
quarter of fiscal 2010 was primarily due to the increase in our debt at January 2, 2011 as compared
to December 27, 2009,
and the corresponding interest and amortization of debt discounts recorded as interest, that
resulted from the issuance of our debentures in March 2010, the Looney Note in April 2010, our
Bridge Notes in November and December 2010 and our Subordinated Notes in December 2010, all of
which debt issuances occurred subsequent to the first quarter of fiscal 2010.
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Change in Fair Value of Derivative Liability. We recorded a substantial increase in our change
in fair value of derivative liability for the first 13 weeks of fiscal 2011, compared to the first
13 weeks of fiscal 2010, as shown in the following table:
Change in Fair Value of | ||||
Derivative Liability | ||||
13 weeks ended December 27, 2009 |
$ | 45,500 | ||
Dollar change in current comparable 13 weeks |
(6,528,200 | ) | ||
13 weeks ended January 2, 2011 |
$ | (6,482,700 | ) | |
Percentage change for current 13 weeks |
14,348 | % |
In the first quarter of fiscal 2010, our only outstanding instruments deemed to be derivatives
were certain warrants, and the estimation of the value of those warrants at December 27, 2009
resulted in the recording of a $45,500 reduction in the value of those warrants in the 13 week
period ended December 27, 2009. At January 2, 2011, in addition to those warrants, we also had
Bridge Notes and Subordinated Notes outstanding, both of which were deemed to contain embedded
derivatives. The derivative liabilities of these instruments were required to be valued both at
December 23, 2010, when they were deemed to have been established, and again at January 2, 2011.
Largely because of the increase in market value of our common stock between these dates, this
re-measurement of value resulted in the recording of a $6,482,700 increase in fair value of
derivative liability for the 13-week period ended January 2, 2011. Given the price volatility of
our common stock, we anticipate that there could be additional substantial change in fair value of
derivative liability expense that we will be required to record in future reporting periods, unless
and until the Bridge Notes and Subordinated Notes are converted into our common stock pursuant to
their terms. In the event of such conversion, which we cannot guarantee, the derivative liability
associated with these instruments would be eliminated.
Net Loss Attributable to Irvine Sensors Corporation. Our net loss attributable to Irvine
Sensors Corporation increased in the 13-week period ended January 2, 2011, compared to the 13-week
period ended December 27, 2009, as shown in the following table:
Net Loss Attributable | ||||
13-Week Comparisons | to Company | |||
13 weeks ended December 27, 2009 |
$ | (1,716,700 | ) | |
Dollar change in current comparable 13 weeks |
(9,115,500 | ) | ||
13 weeks ended January 2, 2011 |
$ | (10,832,200 | ) | |
Percentage increase for current 13 weeks |
531 | % |
The increase in net loss attributable to the Irvine Sensors Corporation in the first quarter
of fiscal 2011 as compared to the first quarter of fiscal 2010 was substantially attributable to
expenses derived from our debt financings subsequent to December 27, 2009, in particular the
increased interest expense related to such financings, of which $1,039,800 was non-cash, and the
$6,482,700 non-cash change in fair value of derivative liability as a result of derivatives deemed
to be embedded in our Bridge Notes and
Subordinate Notes, as discussed above. In addition, the expenses in the current period
related to the timing of ESBP accruals and non-recurring compensation also contributed to the
increase in net loss in the 13-week period ended January 2, 2011 as compared to the 13-weeek period
ended December 27, 2009. Since these factors either represent timing or non-recurring factors or
do not relate to our basic operations, we do not believe that the increase in net loss in the first
quarter of fiscal 2011 as compared to the first quarter of fiscal 2010 is indicative of an
underlying continuing operational trend.
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Liquidity and Capital Resources
Our liquidity in terms of both cash and cash equivalents and reduction of working capital
deficit was substantially improved in the first 13 weeks of fiscal 2011, largely as a result of the
proceeds realized from our private placements of debt and equity in the current fiscal quarter, as
shown in the following table:
Cash and | Working Capital | |||||||
Cash Equivalents | (Deficit) | |||||||
October 3, 2010 |
$ | 281,600 | $ | (10,096,400 | ) | |||
Dollar change in the 13 weeks ended January 2, 2011 |
6,465,300 | 8,750,800 | ||||||
January 2, 2011 |
$ | 6,746,900 | $ | (1,345,600 | ) | |||
Percentage change in the 13 weeks ended January 2, 2011 |
2,296 | % | 87 | % |
The aggregate of our non-cash depreciation and amortization expense, non-cash interest
expense, non-cash change in fair value of derivative instruments and non-cash deferred stock-based
compensation was $8,130,200 in the 13 weeks ended January 2, 2011. These non-cash operational
expenses partially offset the use of cash derived from our net loss and various timing and cash
deployment effects, the largest of which were a $1,319,300 increase in accounts receivable and a
$1,889,100 decrease in our accounts payable and accrued expenses, resulting in an operational use
of cash in the amount of $5,787,800 in the current quarter. These and other uses of cash were
offset by $12,655,500 of net proceeds from our Bridge Financing and Institutional Financing in the
current period, resulting in the net $6,465,300 increase of cash in the 13-week period ended
January 2, 2011. These financing proceeds were also the primary source of improvement in our
working capital deficit in the current period.
At January 2, 2011, our funded backlog was approximately $5.5 million. We expect, but cannot
guarantee, that a substantial portion of our funded backlog at January 2, 2011 will result in
revenue recognized in the next twelve months 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
January 2, 2011, our total backlog, including unfunded portions, was approximately $26.8 million.
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, materially adversely affect our liquidity and results of
operations and could result in employee layoffs.
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We have developed an operating plan to manage costs in line with estimated total revenues for
the balance of fiscal 2011 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 successfully implement our plans.
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 January 2, 2011 and October 3, 2010, 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 January 2, 2011, we had approximately $15,652,400 of debt, which consisted of (i)
unsecured convertible and non-convertible debentures issued in the Debenture Private Placement with
an aggregate principal balance of $2,752,200; (ii) the Looney Note, with a principal balance of
$2,500,000; (iii) Bridge Notes with an aggregate principal balance of $1,801,400 and (iv)
Subordinated Notes with an aggregate principal balance of $8,598,800. Each of these instruments is
described more fully below. (See Note 2 of Condensed Notes to Consolidated Financial Statements).
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 principal balance. 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. We elected to pay the first, second and third quarterly
interest payments due in June 2010, September 2010 and December 2010, respectively, on the
Debentures in the aggregate amount of $414,700 through conversion into 693,600 shares of our common
stock. 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 Looney 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 Agreement 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 creditor, Summit. The Looney 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 Looney 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 Looney 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 Looney Note.
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In November and December 2010, we sold $3,000,000 aggregate principal balance of our Bridge
Notes, which are unsecured convertible promissory notes, in multiple closings of a private
placement. The Bridge Notes bear simple interest at a rate per annum of 10% and have a maturity
date of May 31, 2011. Interest on the Bridge Notes accrues and is payable in arrears at maturity.
At the discretion of an investor holding a Bridge Note (a Bridge Note Holder), any outstanding
principal and accrued interest remaining under the Bridge Note at maturity may be converted into
shares of our common stock at a conversion price equal to $0.13 per share (the Conversion Price),
provided, however, that we have a sufficient number of authorized shares of common stock to allow
such conversion at such time, and that the investor is an accredited investor at the time of such
conversion as such term is defined in Rule 501 under the Securities Act. There is no assurance that
a sufficient number of authorized shares of our common stock will be available for conversion of
any outstanding principal and accrued interest under the Bridge Notes. We may repay unconverted
principal balance and accrued interest of the Bridge Notes in cash prior to maturity in whole or in
part at any time without premium or penalty.
Also at the discretion of each Bridge Note Holder, any outstanding principal and accrued
interest under a Bridge Note held by said Bridge Note Holder may be converted as a result of the
closing of a subsequent private placement of the Companys securities with gross proceeds of at
least $8.0 million (a Subsequent Financing) into the securities issued in a Subsequent Financing
on the same terms and conditions as the other investors in said Subsequent Financing, provided,
however, that the Bridge Note Holder is an accredited investor at the time of such conversion as
such term is defined in Rule 501 under the Securities Act; and provided, further, that such Bridge
Note Holder enters into and executes the same documents, satisfies the same conditions and agrees
to be bound by the same terms as all other investors in said Subsequent Financing. We consummated
such a Subsequent Financing in December 2010, as described below. In December 2010, Bridge Note
Holders of $1,198,600 of principal balance of the Bridge Notes elected to convert said Bridge Notes
into the securities issued in the Subsequent Financing, resulting in an aggregate outstanding
unpaid principal balance of the Bridge Notes of $1,801,400 at January 2, 2011.
In December 2010, we entered into a Securities Purchase Agreement (the Purchase Agreement)
with two accredited investors, Costa Brava Partnership III L.P. (Costa Brava) and The Griffin
Fund LP (Griffin), pursuant to which we issued and sold to Costa Brava and Griffin 12%
Subordinated Secured Convertible Notes due December 23, 2015 (the Subordinated Notes) in the
aggregate principal amount of $7,774,800, and agreed to issue and sell in a subsequent closing not
later than April 30, 2011 (subject to the amendment of our Certificate of Incorporation to increase
the our authorized common stock and provided that there has not been a material adverse change in
our relationship with Optics 1, Inc.) additional 12% Subordinated Secured Convertible Notes (the
Milestone Notes) to Costa Brava and Griffin for an aggregate purchase price of $1.2 million
(collectively, the Institutional Financing). The aggregate principal balance of the Subordinated
Notes at January 2, 2011 of $8,598,800 resulted from the elections of certain Bridge Holders to
convert their Bridge Notes, pursuant to their terms, into the securities issued in the
Institutional Financing.
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The Subordinated Notes bear interest at a rate of 12% per annum, due and payable quarterly
within 10 business days of the end of each calendar quarter, calculated on the simple interest
basis of a 365-day year for the actual number of days elapsed. For the first two years of the term
of the Subordinated Notes, we have the option, subject to the satisfaction of certain customary
equity conditions, to pay all or a portion of the interest due on each interest payment date in
shares of common stock, with the price per share calculated based on the weighted average price of
our common stock over the last 20 trading days ending on the second trading day prior to the
interest payment date. The foregoing notwithstanding, until (the Looney Note is repaid in full,
cash interest on the Subordinated Notes must instead be paid by adding the amount of such interest
to the outstanding principal amount of the Subordinated Notes as PIK interest. The principal and
accrued but unpaid interest under the Subordinated Notes is convertible at the option of the
holder, any time after amendment of our Certificate of Incorporation to increase the our authorized
common stock, into shares of our common stock at an initial conversion price of $0.07 per share.
The conversion price is subject to full ratchet adjustment for certain price dilutive issuances of
securities by us and proportional adjustment for events such as stock splits, dividends,
combinations and the like. Beginning after the first two years of the term of the Subordinated
Notes, we can force the Subordinated Notes to convert to common stock if certain customary equity
conditions have been satisfied and the volume weighted average price of our common stock is $0.25
or greater for 30 consecutive trading days.
The Subordinated Notes and the Milestone Notes are and will be secured by substantially all of
our assets pursuant to a Security Agreement dated December 23, 2010 between us and Costa Brava as
representative of the Subordinated Note holders, but the liens securing the Subordinated Notes and
Milestone Notes are and will be subordinate to the liens securing our indebtedness to Summit
Financial Resources, L.P. under that certain Financing Agreement dated as of June 16, 2009, and
subordinate in right of payment to the Looney Note.
Capital Lease Obligations. We had no outstanding capital lease obligations at January 2, 2011.
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 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 2010, including the Citigroup Pension Liability Index, which at September
30, 2010 was 5.158%. Based on this review, we used a 5.2% discount rate for determining the ESCP
liability at October 3, 2010. There are presently two of our retired executives who are receiving
benefits aggregating $184,700 per annum under the ESCP. As of January 2, 2011, $1,200,100 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 2011 and the first quarter of
fiscal 2012.
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Stock-Based Compensation
Aggregate stock-based compensation for the 13-week periods ended January 2, 2011 and December
27, 2009 was $334,100 and $26,300, respectively, and was attributable to the following:
13 Weeks Ended | 13 Weeks Ended | |||||||
January 2, 2011 | December 27, 2009 | |||||||
Cost of revenues |
$ | 8,900 | $ | 7,600 | ||||
General and administrative expense |
325,200 | 18,700 | ||||||
$ | 334,100 | $ | 26,300 | |||||
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 13-week period ended January 2, 2011, we
issued warrants to purchase 2,382,400 shares of our common stock, valued at $190,600, to an
investment banking firm for services rendered in our Bridge Private Placement. We have recorded
this expense as a debt discount, which is being amortized over the term of the Bridge Notes.
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 period ended January 2, 2011, stock-based compensation included compensation
costs attributable to such period for those options that were not fully vested upon adoption of ASC
718, Compensation Stock Compensation, adjusted for estimated forfeitures. We have estimated
forfeitures to be 7%, which reduced stock-based compensation cost by $24,600 in the 13-week period
ended January 2, 2011. There were grants of options to purchase 19,500,000 shares of common stock
made in the 13-week period ended January 2, 2011.
At January 2, 2011, the total compensation costs related to nonvested option awards not yet
recognized was $877,800. The weighted-average remaining vesting period of nonvested options at
January 2, 2011 was 1.9 years.
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Not applicable.
Item 4. | 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 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
potential improvements to our internal controls over financial reporting, including some that we
have implemented in the first quarter of fiscal 2011, largely the modification or expansion of
internal process documentation, and some that we are currently evaluating for possible future
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 7 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 October 3, 2010.
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 have significant debt that matures in the near term and the next fiscal year. In this
interval, these obligations will place priority demands on our liquidity and additional risks if
the repayment and covenant obligations of this debt are not fulfilled. As of the date of this
report, we have debentures with an aggregate principal balance of $2,752,200 that mature in March
2011, Bridge Notes with an aggregate principal balance of $1,555,000 that mature May 31, 2011 and a
$2,500,000 secured subordinated promissory note payable to Timothy Looney pursuant to settlement of
litigation, which has existing and increasing monthly debt service obligations through July 2012.
Some of this debt is potentially convertible into common stock, but such conversion is not assured.
If we choose to allocate some of the proceeds from our December 2010 Institutional Financing to
the retirement or service of this debt, such action will substantially decrease our discretionary
liquidity and potentially restrict our prospects to increase our total revenues to levels necessary
to achieve self-sustaining cash flow from operations. In such an instance, we may have to seek
additional financing, and there can be no guarantee that such financing would be available on a
timely basis, on terms that are acceptable or at all. Failure to meet the repayment or other
obligations of these debt instruments could result in acceleration of debt maturity, which could
materially adversely affect our business, results of operations and financial condition and
threaten our financial viability.
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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 as presently authorized and exercise in
full of all options and warrants outstanding as of January 2, 2011, an additional approximate 50.0
million shares of our
common stock would be outstanding, as compared to the approximately 98.5 million shares of our
common stock that were issued and outstanding at that date. If our stockholders approved an
increase in our authorized shares of common stock from 150,000,000 shares to 500,000,000 shares at
our annual meeting of stockholders in March 2011, over 140 million additional shares of our common
stock will become issuable pursuant to the conversion of our Subordinated Notes, the conversion of
our Bridge Notes and the exercise of the Agent Warrants issued in the Bridge Private Placement.
Since the start of fiscal 2008 through the date of this report, we have issued approximately 95.8
million shares of our common stock, largely to fund our operations and retire debt, resulting in
significant dilution to our existing stockholders. Any additional equity or convertible debt
financings in the future will likely 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-2 Stock and Subordinated Notes, if not waived.
We may need to raise additional capital to fund our operations and service our debt, and if
such capital is not available to us on terms that are acceptable to us, on a timely basis or at
all, our operations could be seriously curtailed. Largely as a result of the Institutional
Financing in December 2010, at January 2, 2011, our working capital deficit had been reduced to
$1,345,600, an improvement from our working capital deficit of $10,096,400 at October 3, 2010, but
still a deficit, nonetheless. We experienced an operational use of cash in the amount of
$5,787,800 in the 13-week period ended January 2, 2011. If we are not able to substantially grow
our revenues in the near future, we anticipate that we may require additional capital to meet our
working capital needs, fund our operations and meet our debt service obligations. 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 needed additional
capital, our business, financial condition and results of operations could be materially and
adversely affected, and we may be forced to curtail our operations.
We anticipate that our future capital requirements will depend on many factors, including:
| our ability to meet our current obligations, including trade payables, payroll and fixed costs; |
| our required service on our debt and settlement obligations, particularly the near-term obligations derived from our Debentures and Bridge Notes; |
| our ability to procure additional contracts, and the timing of our deliverables under our contracts; |
| the timing of payments and reimbursements from government and other contracts; |
| our ability to control costs; |
| our ability to commercialize our technologies and achieve broad market acceptance for such technologies; |
| 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. |
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Our ability to raise additional capital may be limited because, as a company that is quoted on
the OTCBB, we are no longer eligible to use Form S-3 to register the resale of securities issued in
private financings. 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 at current levels, develop or enhance our products, expand our
sales and marketing programs, take advantage of future opportunities or respond to competitive
pressures.
Our recent Institutional Financing has created substantial and continuing non-cash accounting
charges that will make it difficult for us to achieve net profit and positive net worth while our
new debt instruments are outstanding. The Subordinated Notes we issued in the Institutional
Financing in December 2010 contain features that are deemed to create a derivative liability under
accounting literature. The Bridge Notes, because of their convertibility into the Subordinated
Notes, also have an associated derivative liability. At January 2, 2011, our aggregate derivative
liability was valued at $13,349,800, largely as a result of these instruments. Because of the
price volatility of our common stock, this derivative liability could increase substantially in
future reporting periods if the market value of our common stock were to increase beyond the $0.14
per share value of January 2, 2011. Such change in the value of derivative liability would be
recorded as an expense in our consolidated statement of operations, making it difficult to achieve
net profit. In addition, the aggregate recorded derivative liability has already adversely
affected our stockholders deficit and any future increases in derivative liability would further
adversely affect such stockholders deficit, making it more difficult for us to meet criteria for
re-listing our common stock on Nasdaq or some other national securities exchange. The effect of
these derivative liabilities would ultimately be eliminated if the associated debt instruments were
converted to equity pursuant to their terms, but we cannot guarantee such an outcome.
Our recent Institutional Financing has also established substantial control by our new
investors over the outcome of stockholder voting and Board decisions. Costa Brava and Griffin, our
new institutional investors, collectively control more than 50% of our presently issued and
outstanding common stock and have the ability to convert their Subordinated Notes into additional
shares of common stock. In addition, they have nominated five of the ten directors that serve on
our Board of Directors. Accordingly, Costa Brava and Griffin have significant influence over the
outcome of matters that require stockholder votes or actions by our Board of Directors, and the
ability of other stockholders to influence such outcomes have been correspondingly diminished.
In September 2010, our common stock was delisted from the Nasdaq Capital Market for
non-compliance with Nasdaqs $1.00 per share minimum bid price continued listing requirement and
commenced trading on the Over-the-Counter Bulletin Board (the OTCBB), thereby causing your
ability to sell your shares of our common stock to be limited by penny stock restrictions and our
ability to raise additional capital to potentially be compromised. With the delisting of our common
stock, it comes within the definition of penny stock as defined in the Securities Exchange Act of
1934 and is 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
potentially affects the ability or willingness of broker-dealers to sell our securities, and
accordingly would also 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.
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Significant sales of our common stock in the public market will likely cause our stock price
to fall. The average trading volume of our shares in December 2010 was approximately 156,900 shares
per day, compared to the approximately 98.5 million shares outstanding and the additional
approximate 50.0 million shares potentially outstanding on a fully diluted basis at January 2,
2011. Other than volume limitations imposed on our affiliates, many of the issued and issuable
shares of our common stock are freely tradable. If the holders of 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. We have obligations to holders of our Subordinated Notes that could
require us to register shares of common stock held by them and shares issuable upon conversion of
those instruments for resale on a registration statement. If we raise additional capital in the
future through the sale of shares of our common stock or instruments convertible into 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. 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.
Because our operations currently depend on government sales, 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 or purchase orders can be affected by
these factors. As of the date of this report, the U.S. defense budget for fiscal 2011 has still not
been finalized, and the full impact of this delay to our sales is not ascertainable. Cutbacks or
re-allocations in the federal budget could have a material adverse impact on our results of
operations as long as we sell our products and perform our funded research and development largely
for government customers. 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 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 material adverse effect on 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 materially adversely affect our business, results of operations and
financial condition.
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We may consider divesting assets to improve our liquidity. We sold a large portion of our
patent portfolio in 2009 to address our financial needs and may enter into agreements to sell other
assets in the future. In order to fund our operations and repay our existing obligations, we may
need to sell certain other significant assets and have engaged in preliminary discussions in this
regard. We may not be able to complete such sales on acceptable terms, on a timely basis or at all,
and such sales could adversely affect our future revenues. Furthermore, we have lenders with
security positions in such assets, and such sales would therefore not be likely to generate any
direct benefits to stockholders and could materially impair our ability to maintain our current
operations.
We have cash payment obligations pursuant to a settlement agreement that, if not satisfied,
could put a significant strain on our liquidity. In December 2010, we entered into a Settlement
Agreement and Release with FirstMark, pursuant to which we settled a lawsuit between us and
FirstMark. Pursuant to this Settlement Agreement and Release, we are obligated to pay FirstMark a
total sum of $1,235,000 in eighteen monthly payments commencing January 15, 2011. In the event that
we do not make a monthly installment payment within 30 days of the date it is due, FirstMark may
enter a Confession of Judgment in the amount of the total settlement less any payment made by us
prior to such default. If FirstMark were to enter and seek to enforce such a judgment, our
liquidity and financial condition could be adversely affected and it would cause a default under
our other debt obligations, possibly threatening our financial viability.
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. Had it not been for the gains from a sale of patent assets, 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. We experienced a net loss of approximately
$11.2 million in fiscal 2010 and approximately $10.8 million in the first quarter of fiscal 2011.
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 current 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 business
in the future, our revenues will decline and our results of operations will be adversely affected.
For fiscal 2010, approximately 28%, 20% and 19% of our total revenues were generated from sales and
contracts with certain classified U. S. government agencies, the U. S. Army and Optics 1, Inc., a
defense contractor, respectively. For the first quarter of fiscal 2011, sales to Optics 1
accounted for 76% of our total revenues. Although we plan to shift our focus to include the
commercialization of our technology, we expect to continue to be dependent upon business with
federal agencies and their contractors for a substantial portion of our revenues for the
foreseeable future. Our dependency on a few customers
increases the risks of disruption in our business or significant fluctuations in quarterly revenue,
either of which could adversely affect our total revenues and results of operations.
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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. Furthermore, a majority of our historical
total revenues, including the first quarter of fiscal 2011, have been generated from governmental
customers.
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. Our consolidated total revenues in fiscal 2009, fiscal 2010 and the first quarter of
fiscal 2011 were $11.5 million, $11.7 million and $4.3 million, respectively. To become and remain
profitable, we will need to materially grow our consolidated total revenues 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 substantial 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 materially adversely impacted.
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If we are not able to obtain broad market acceptance of our new and existing products, our
revenues and results of operations will be materially 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 commercializing our new
products, our ability to generate revenues and our business, financial condition and results of
operations will be adversely affected.
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 $0.08 per share in September 2010 and December 2010 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:
| our cash resources and ability to raise additional funding and repay indebtedness; |
| changes in the fair value of derivative instruments expense; |
| reduced trading volume on the OTCBB; |
| 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; |
| changes in investor perceptions; |
| 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.
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We are subject to technological risk from the developments of competitors, and our fiscal 2009
sale of patent assets has removed barriers to competition. We sold most of our then-issued and
pending patents in fiscal 2009. Although we retained 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
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
the patents it purchased from us, 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, if any. 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.
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.
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.
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 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 materially adversely affect our business operations.
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
On February 1, 2011, we issued 221,001 shares of common stock to an accredited institutional
investor upon such investors cashless exercise in full of warrants to purchase 308,900 shares of
common stock at $0.07 per share, based on a value of $0.246 per share.
The above-described sale was determined to be exempt from registration under the Securities
Act in reliance on Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated
thereunder, as a transaction by an issuer not involving a public offering. The investor represented
that it is an accredited investor, as that term is defined in Regulation D, and that it has
acquired the securities for investment purposes only and not with a view to or for sale in
connection with any distribution thereof.
Item 3. | Defaults Upon Senior Securities |
None.
Item 4. | (Removed and Reserved) |
Item 5. | Other Information |
None.
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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 (9) |
|||
10.1 | Securities Purchase Agreement dated December 23, 2010 between the Company
and Costa Brava and Griffin (10) |
|||
10.2 | Form of 12% Subordinated Secured Convertible Note issued by the Company to
Costa Brava and Griffin on December 23, 2010 (11) |
|||
10.3 | Security Agreement dated December 23, 2010 between the Company and Costa
Brava as representative of the Note holders (12) |
|||
10.4 | Stockholders Agreement dated December 23, 2010 between the Company and
Costa Brava and Griffin (13) |
|||
10.5 | Voting Agreement dated December 23, 2010 among the Company, the Irvine
Sensors Corporation Cash or Deferred & Stock Bonus Plan, Costa Brava and
Griffin (14) |
|||
10.6 | Form of Indemnification Agreement for directors designated by Costa Brava
and Griffin (15) |
|||
10.7 | Settlement Agreement and Release between the Company and FirstMark |
|||
10.8 | * | Employment Agreement dated December 23, 2010 between the Company and
Bill Joll (16) |
||
10.9 | * | Non-Incentive Stock Option Agreement between the Company and Bill Joll |
||
10.10 | * | Employment Agreement dated December 23, 2010 between the Company and
John Carson (17) |
||
10.11 | * | Form of Non-Incentive Stock Option Agreement between the Company and
John Carson and John Stuart |
||
10.12 | * | Employment Agreement dated December 23, 2010 between the Company and
John Stuart (18) |
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10.13 | * | 2010 Non-Qualified Stock Option Plan (19) |
||
10.14 | * | Form of Stock Option Agreement for 2010 Non-Qualified Stock Option Plan |
||
10.15 | Form of Subscription Agreement for Bridge Notes (20) |
|||
10.16 | Form of Bridge Note (21) |
|||
10.17 | Form of Agent Common Stock Warrant for Bridge Note Financing |
|||
10.18 | Form of Joinder Agreement (22) |
|||
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 and by reference to Exhibit 3.1 filed with the Registrants Current Report on Form 8-K as filed with the SEC on December 29, 2010. | |
(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 3.1 to the Registrants Current Report on Form 8-K filed on May 4, 2010. | |
(10) | Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(11) | Incorporated by reference to Exhibit 10.2 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(12) | Incorporated by reference to Exhibit 10.3 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(13) | Incorporated by reference to Exhibit 10.4 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(14) | Incorporated by reference to Exhibit 10.5 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(15) | Incorporated by reference to Exhibit 10.6 to the Registrants Current Report on Form 8-K filed on December 29, 2010. |
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(16) | Incorporated by reference to Exhibit 10.8 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(17) | Incorporated by reference to Exhibit 10.9 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(18) | Incorporated by reference to Exhibit 10.10 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(19) | Incorporated by reference to Exhibit 10.11 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(20) | Incorporated by reference to Exhibit 10.12 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(21) | Incorporated by reference to Exhibit 10.13 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(22) | Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K filed on January 6, 2011. | |
* | Denotes management contract or compensatory plan or arrangement |
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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: February 16, 2011 | By: | /s/ John J. Stuart, Jr. | ||
John J. Stuart, Jr. | ||||
Chief Financial Officer (Principal Financial and Chief Accounting Officer) |
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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 (9) |
|||
10.1 | Securities Purchase Agreement dated December 23, 2010 between the Company
and Costa Brava and Griffin (10) |
|||
10.2 | Form of 12% Subordinated Secured Convertible Note issued by the Company to
Costa Brava and Griffin on December 23, 2010 (11) |
|||
10.3 | Security Agreement dated December 23, 2010 between the Company and Costa
Brava as representative of the Note holders (12) |
|||
10.4 | Stockholders Agreement dated December 23, 2010 between the Company and
Costa Brava and Griffin (13) |
|||
10.5 | Voting Agreement dated December 23, 2010 among the Company, the Irvine
Sensors Corporation Cash or Deferred & Stock Bonus Plan, Costa Brava and
Griffin (14) |
|||
10.6 | Form of Indemnification Agreement for directors designated by Costa Brava
and Griffin (15) |
|||
10.7 | Settlement Agreement and Release between the Company and FirstMark |
|||
10.8 | * | Employment Agreement dated December 23, 2010 between the Company and
Bill Joll (16) |
||
10.9 | * | Non-Incentive Stock Option Agreement between the Company and Bill Joll |
||
10.10 | * | Employment Agreement dated December 23, 2010 between the Company and
John Carson (17) |
||
10.11 | * | Form of Non-Incentive Stock Option Agreement between the Company and
John Carson and John Stuart |
||
10.12 | * | Employment Agreement dated December 23, 2010 between the Company and
John Stuart (18) |
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10.13 | * | 2010 Non-Qualified Stock Option Plan (19) |
||
10.14 | * | Form of Stock Option Agreement for 2010 Non-Qualified Stock Option Plan |
||
10.15 | Form of Subscription Agreement for Bridge Notes (20) |
|||
10.16 | Form of Bridge Note (21) |
|||
10.17 | Form of Agent Common Stock Warrant for Bridge Note Financing. |
|||
10.18 | Form of Joinder Agreement (22) |
|||
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 and by reference to Exhibit 3.1 filed with the Registrants Current Report on Form 8-K as filed with the SEC on December 29, 2010. | |
(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 3.1 to the Registrants Current Report on Form 8-K filed on May 4, 2010. | |
(10) | Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(11) | Incorporated by reference to Exhibit 10.2 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(12) | Incorporated by reference to Exhibit 10.3 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(13) | Incorporated by reference to Exhibit 10.4 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(14) | Incorporated by reference to Exhibit 10.5 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(15) | Incorporated by reference to Exhibit 10.6 to the Registrants Current Report on Form 8-K filed on December 29, 2010. |
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(16) | Incorporated by reference to Exhibit 10.8 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(17) | Incorporated by reference to Exhibit 10.9 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(18) | Incorporated by reference to Exhibit 10.10 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(19) | Incorporated by reference to Exhibit 10.11 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(20) | Incorporated by reference to Exhibit 10.12 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(21) | Incorporated by reference to Exhibit 10.13 to the Registrants Current Report on Form 8-K filed on December 29, 2010. | |
(22) | Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K filed on January 6, 2011. | |
* | Denotes management contract or compensatory plan or arrangement |
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