-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UudCB3SOFC6bDSQ14/xAEK9aYAkj0198ciMrsJf9wsZF8yNx2w+Ayvk8mGdNDs0/ 5hNFM37P3hUjhU+9m4uuag== 0001021408-00-000009.txt : 20000104 0001021408-00-000009.hdr.sgml : 20000104 ACCESSION NUMBER: 0001021408-00-000009 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19991003 FILED AS OF DATE: 20000103 FILER: COMPANY DATA: COMPANY CONFORMED NAME: IRVINE SENSORS CORP/DE/ CENTRAL INDEX KEY: 0000357108 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 330280334 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-08402 FILM NUMBER: 500730 BUSINESS ADDRESS: STREET 1: 3001 REDHILL AVE CITY: COSTA MESA STATE: CA ZIP: 92626 BUSINESS PHONE: 7145498211 MAIL ADDRESS: STREET 1: 3001 REDHILL AVE STREET 2: BLDG 3 STE 104 CITY: COSTA MESA STATE: CA ZIP: 92626 10-K 1 FORM 10-K FOR PERIOD ENDING 10/03/1999 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934] For the fiscal year ended October 3, 1999 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND 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 (I.R.S. Employer Incorporation or organization) Identification No.) 3001 Redhill Avenue, Costa Mesa, California 92626 (Address of principal executive offices) (Zip Code) (714) 549-8211 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class: which registered: Common Stock Boston Stock Exchange Incorporated Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety (90) days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy of information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] To the extent known by the registrant, the aggregate market value of the Common Stock held beneficially by non-affiliates of the registrant was approximately $69,000,000 on December 22, 1999. As the Preferred Stock is not publicly traded it has not been included in the computation. As of December 22, 1999, there were 36,075,400 shares of Common Stock outstanding. Documents Incorporated by Reference: Portions of the Registrant's Annual Report to Stockholders for the fiscal year ended October 3, 1999 (Part II); portions of the Registrant's Definitive Proxy Statement to be used in connection with Registrant's Annual Meeting of Stockholders to be held on February 25, 2000 (Part III). - -------------------------------------------------------------------------------- FORWARD-LOOKING STATEMENTS Some of the information in this Report contains forward-looking statements which involve substantial risks and uncertainties. Readers can identify these statements by forward-looking words such as "may," "will," "expect," "anticipate," "believe," "estimate" and "continue" or similar words. Readers should consider statements that contain these or similar words carefully because they (1) discuss expectations of Irvine Sensors Corporation ("the Company") about its future performance; (2) contain projections of the Company's future operating results or of its future financial condition; (3) state other "forward-looking information. The Company believes it is important to communicate its expectations to its investors. There may be events in the future however, that the Company is not accurately able to predict or over which it may have no control. The risk factors discussed in "Factors that May Affect Future Results," later in this Report, as well as any cautionary language in this Report, including those portions incorporated by reference, provide examples of risks, uncertainties and events that may cause the Company's actual results to differ materially from the expectations described in the forward- looking statements. Readers should be aware that the occurrence of any of the events described in the risk factors and elsewhere in this Report, including the documents incorporated by reference, could have a material and adverse effect on the Company's business, results of operations and financial condition and that upon the occurrence of any of these events, the trading price of the Company's Common Stock could decline and investors could lose all or part of their investments. - -------------------------------------------------------------------------------- PART I. ------- Item 1. Business GENERAL The Company and its subsidiaries are involved in various business activities related to miniaturized electronics and the applications thereof. The Company is organized into the following primary business groups: Irvine Sensors Corporation - -------------------------- Irvine Sensors Corporation ("ISC") is the developer of proprietary technologies to produce extremely compact packages of solid state microcircuitry, which ISC believes offer volume, power, weight and operational advantages versus less miniaturized alternatives. These advantages result from ISC's ability to assemble microelectronic chips in a three-dimensional "stack" instead of alongside each other on a flat surface, as is the case with more conventional methods. These stacking technologies have also led to ISC's development of collateral technologies for the design of low power and low noise chips, thinning of chips and various specialized applications of chips and stacked chip assemblies in fields ranging from wireless infrared transmission to image processing to digital photography. ISC's core chip-stacking technology was originally conceived and developed as a means of addressing the demands of space-based surveillance. However, the degree of miniaturization potentially realizable from ISC's technologies has attracted R&D sponsorship from various government funding agencies for a wide variety of potential military and space applications. Until recently, ISC derived most of its revenues from such funded research and development. Recently, ISC has sought to commercialize its technologies by creating independently managed subsidiaries that can pursue their own financing strategies separately from the parent. ISC has received an increasing share of its consolidated revenues from one such subsidiary. In April 1996, upon termination of a joint development agreement, ISC purchased a memory-stacking line in Essex Junction, Vermont from IBM, and in October 1997, disposed of that line and consolidated that sector of its business with its California operation. In October 1995, ISC formed a subsidiary, Novalog, Inc. ("Novalog"), to commercially exploit its low power chip technology. In April 1997, ISC formed a subsidiary, MicroSensors, Inc. ("MSI"), to commercially exploit its technologies for low noise readout electronics and miniaturized inertial sensors. In June 1998, ISC formed a subsidiary, Silicon Film Technologies, Inc. ("Silicon Film"), formerly Imagek Inc. ("Imagek"), to commercially exploit some of its digital photography technologies. As of October 3, 1999 ISC owned approximately 95%, 98% and 84% of the issued common stock of Novalog, MSI and Silicon Film, respectively. Novalog, Inc. - ------------- Novalog is a subsidiary of ISC that designs, develops and sells proprietary integrated circuits ("ICs") and related products for use in wireless infrared communication. Novalog's initial products, trademarked SIRComm(TM), SIR2(TM), MiniSIR(TM), MiniSIR2(TM) and BayBeamer(TM), enable infrared, line-of-sight data transfer between computers, electronic organizers, printers, modems and other electronic devices that have compatible ports. Novalog is an active participant in the Infrared Data Association ("IrDA"), which establishes the hardware and software protocols for such products. Novalog believes its products have advantages in terms of power 2 consumption, dynamic range, size and economics as compared to the products of its competitors. Novalog has shipped more than fifteen million units of its products to manufacturers servicing the IrDA marketplace and, although there can be no assurance, management anticipates growing demand for such products. In fiscal 1999, Novalog accounted for approximately 61% of the Company's consolidated revenues. MicroSensors, Inc. - ------------------ MSI is a subsidiary of ISC that was formed to develop and sell proprietary micromachined sensors and related electronics. Micromachining involves the use of semiconductor manufacturing processes to build electromechanical devices with feature sizes measured in microns or fractions thereof. As prices have declined for micromachined devices, such solid-state units have migrated from initial aerospace and military applications to automotive, industrial process-control and medical applications. MSI is developing a proprietary micromachined inertial sensor, called the Silicon MicroRing Gyro(TM). MSI has demonstrated early prototypes of this device and is presently seeking strategic partners to facilitate its market introduction. In addition to inertial sensors, MSI intends to offer Application Specific Integrated Circuits ("ASICs") designed to read out micromachined sensors and other electronic systems. MSI is presently shipping engineering samples of a proprietary Universal Capacitive Readout(TM) ("UCR"(TM)) ASIC product to potential customers. MSI has delivered limited quantities of a multi-channel readout ASIC designed to the specifications of a specific customer for potential use in airport x-ray security systems. MSI is assisting this customer to evaluate whether it will order the MSI ASIC in quantity, which is presently undetermined. The Company believes that there are many uncertainties surrounding the development of MSI's business, including the risk that large companies may be reluctant to purchase critical parts of the nature that MSI is developing from a small company. This may be true even if MSI succeeds in surmounting all of the developmental challenges it currently faces. MSI accounted for approximately 2% of the Company's consolidated revenues in fiscal 1999. Silicon Film Technologies, Inc. (formerly Imagek, Inc.) - ------------------------------------------------------- Silicon Film Technologies Inc. is a subsidiary of ISC, incorporated in Delaware in June 1998. Silicon Film designs, develops and intends to sell proprietary electronic film systems and other digital imaging products and services. Silicon Film has developed and had manufactured pre-production quantities of a proprietary digital photography system called "EFS"(TM) which includes a self- contained, compact, battery-powered cartridge that fits into the film cavity of a standard 35mm camera thus offering the flexibility to switch between conventional film and digital photography. Silicon Film is presently evaluating the pre-production units of the EFS to determine if it is ready to accept orders for this product. Other collateral products and services are planned for introduction by Silicon Film in the future. Silicon Film had no revenues in fiscal 1999. Subsidiaries' Capital Structure - ------------------------------- The capital structure and ownership of ISC's subsidiaries vary depending on the extent to which the subsidiaries have received equity financing from third-party sources rather than ISC. After giving effect to the possible conversion of issued and outstanding preferred stock into common stock, ISC's ownership of all equity securities of Novalog, MSI and Silicon Film is approximately 95%, 98% and 64%, respectively. Giving full effect to the possible future exercise of authorized or issued securities for which additional funds must be conveyed to its subsidiaries to purchase equity interests, such as warrants and options, ISC's future ownership of these subsidiaries would be approximately 64%, 54% and 49% for Novalog, MSI and Silicon Film, respectively. In October 1999, Silicon Film entered into an agreement to potentially offer a significant percentage of its equity ownership at a valuation roughly equivalent to or greater than that it has achieved in prior private financings. Placement of this financing would result in an additional approximate 11% dilution of Irvine Sensors' ownership interests in Silicon Film. There is no assurance that Silicon Film will proceed with this financing, which would require Irvine Sensors to agree to contractually narrow its voting rights and business relations with Silicon Film. In addition, the proposed financing contains provisions that would require Silicon Film to repurchase the securities offered under certain circumstances and also contains default and price protection provisions that could further substantially dilute Irvine Sensors' ownership of Silicon Film under certain circumstances. ISC believes that Silicon Film's placement agent will have completed its due diligence by the first calendar quarter of 2000. ISC is continuing to evaluate the proposed financing as well as other potential financing alternatives. Both Novalog and MSI have substantial intercompany debts payable to ISC. In the event that these subsidiaries are successful in attracting third-party equity financing, it is possible that ISC may be required or may elect to convert these obligations into additional equity securities of these subsidiaries. ISC was incorporated in Delaware in January 1988. Pursuant to a merger effective in May 1988 with a corporation of the same name incorporated in California in December 1974, the Company succeeded to all of the assets and liabilities of such predecessor corporation. Its principal executive offices are located at 3001 Redhill Avenue, Building 3, Costa Mesa, California 92626, and its telephone number is (714) 549-8211. 3 Novalog was incorporated in California in October 1995. Its principal executive offices are located at 3001 Redhill Avenue, Building 4, Costa Mesa, California 92626, and its telephone number is (714) 429-1122. Novalog is a consolidated subsidiary of ISC. MSI was incorporated in Delaware in April 1997. Its principal executive offices are located at 3001 Redhill Avenue, Building 3, Costa Mesa, California 92626, and its telephone number is (714) 444-8831. MSI is a consolidated subsidiary of ISC. Silicon Film was incorporated in Delaware in June 1998. Its principal executive offices are located at 16265 Laguna Canyon Road, Irvine, California 92618, and its telephone number is (949) 417-2260. Silicon Film is a consolidated subsidiary of ISC. Products and Technology - ----------------------- The Company has a wide variety of technologies that have been derived from its early entry into the field of chip stacking. The Company is seeking to commercially exploit many of these technologies through subsidiaries organized to meet the needs of varying markets. The Company's Novalog subsidiary has developed a Serial Infrared Communications chip using elements of the Company's sensor chip design technology. This device is being used in products in order to allow computers, computer peripherals and hand-held portable electronics devices such as personal organizers, pagers and cellular phones to communicate using infrared transmissions in a manner similar to that used by remote control units for televisions and video cassette recorders. Novalog has been shipping such devices since 1995. The Company also has chip design technology relating to electronic readouts that it is seeking to exploit through its MSI subsidiary. In fiscal 1998, MSI entered into its first contractual relationship based on this technology, i.e., a contract to develop and subsequently ship production quantities of a readout chip for EG&G Astrophysics, Inc. ("EG&G") to be used in airport x-ray security systems. MSI completed the development phase of EG&G's contract in fiscal 1998 and commenced limited production shipments under the contract in fiscal 1999. EG&G is presently evaluating a redesign of their products, with MSI's assistance. In fiscal 1999, MSI also introduced a Universal Capacitive Readout (UCR) ASIC intended for use by manufacturers of micromachined products. MSI is currently shipping samples of the UCR to various customers for evaluation. MSI has also developed a proprietary inertial sensor, the Silicon MicroRing Gyro, intended to provide an inexpensive means to measure angular motion for a wide variety of potential applications. Prototypes of the Silicon MicroRing Gyro are presently being demonstrated to potential customers and strategic partners. In September 1999, a United States patent, assigned to MSI, was granted covering the design of the Silicon MicroRing Gyro. The commercial exploitation, if any, of the Silicon MicroRing Gyro is expected to be paced by product design-in lead times of customers, principally Original Equipment Manufacturers ("OEMs"). As a result, the Company does not project material contributions to its consolidated revenue from this product during fiscal 2000. Furthermore, until potential customers and strategic partners more fully evaluate the prototypes of the Silicon MicroRing Gyro, the Company is not in a position to project when, or if, material revenues will be realized from this product thereafter. In June 1998, the Company formed its Silicon Film (formerly Imagek) subsidiary to commercially explore some of its proprietary technologies related to miniaturized digital cameras. Silicon Film has recently begun to offer an initial product for sale, the EFS-1, and is developing additional products for future introduction. Silicon Film believes that its proprietary EFS technology has value advantages to potential customers with substantial investments in conventional 35mm camera equipment that inhibits the use by those consumers of self-contained digital cameras. By using the optics of existing cameras, Silicon Film believes that the EFS product line will be economically competitive to comparable resolution digital cameras. Market response to the EFS-1 will determine the degree to which Silicon Film contributes to the consolidated revenues of the Company in fiscal 2000. The Company believes, but cannot assure, that this contribution could be material. In addition to the products developed through its subsidiaries, the Company has developed a family of standard products consisting of stacked chips, both packaged and unpackaged, and believes that its chip stacking technology can offer demonstrable benefits to designers of systems that incorporate numerous integrated circuits, both memory and otherwise, by improving speed and reducing size, weight and power usage. In addition, since ISC's technology reduces the number of interconnections between chips, potential system failure points can also decrease. However, the Company has only recently qualified some of its stacked packaged chip products for volume production, and it did not realize material revenues from these products in fiscal year 1999. The economic attractiveness of the Company's stacked packaged chip products is highly dependent on market pricing of competitive monolithic parts. The Company believes, but cannot assure, that such market conditions will be favorable to the Company's products at some time in fiscal year 2000, but because of the uncertainty in such market conditions is not able to estimate whether its stacked packaged chip products will make a material contribution to the Company's consolidated revenues. The Company believes that the features achievable with its chip stacking technology will have application in space and in aircraft in which weight and volume considerations are dominant, as well as in various other applications in which portability is required and speed is important. The Company is seeking to exploit its highest density chip stacking technology through the sale of funded development and products to high end, high margin government and commercial users to whom the technical improvement will be most valuable. While these applications tend to require lower unit volume, the potential sales are at significantly higher prices than 4 many applications requiring high volume production. Furthermore, the Company has existing relationships with some of the potential customers in this market. Since fiscal 1995, the Company has been shipping quantities of its stacked unpackaged chip products, largely stacked memory, to customers for both government and commercial purposes. However, there is no assurance that the Company will be successful in marketing such products for widespread applications. The Company also intends to continue to market infrared sensing devices for surveillance, acquisition, tracking and interception applications for a variety of Defense Department and NASA missions. Customers' demand for enhanced performance of electronic systems has produced a wide variety of competitors and competitive systems offering higher density microelectronics ranging from various three-dimensional designs to highly dense two-dimensional designs. Although some competitors are generally believed to be better financed, more experienced and organizationally stronger, the Company is not aware of any system in existence or under development that can stack chips more densely than its three-dimensional approach. See "Competition." The Company is not aware of any technical disadvantages to its chip stacking technology. However, until high volume production is achieved, as to which there is no assurance, the ultimate cost of products using the Company's higher density chip stacking technology cannot be firmly established, and therefore, this uncertainty potentially places some of the Company's stacked chip products at a cost disadvantage. Accordingly, the Company expanded its product offerings in 1998 to include lower-density stacked electronics that could be more price competitive. Two U.S. patents have been allowed and others are pending covering these latest additions to the Company's range of stacked chip product offerings. Products employing these patented approaches have been qualified for potential use by large manufacturers, and the Company is currently seeking production orders for fiscal year 2000. Potential Product Application - ----------------------------- Neural Networks. In 1991, the Company received funding from the U.S. Navy's Office of Naval Research for potential use of certain of its technology in neural networks. After the successful completion of this phase 1 contract, the Company received a $5,200,000 follow-on contract from the Navy in June 1993 and an additional $1,700,000 add on in January 1997 to further develop the neural networks technology. This phase of the contract was completed, and the Company subsequently received approximately $1,900,000 in additional funding on two related programs through fiscal 1999. The Company is presently pursuing additional contracts under which it would deliver demonstration products to various branches of the DOD. Neural networks contain large numbers of sensing nodes which continuously interact with each other, similar to the way that the neurons of a human brain interact to process sensory stimuli. Neural networks are the subject of scientific inquiry because pattern recognition and learning tasks, which humans perform well, and computers perform poorly, appear to be dependent on such processing. Neither conventional computers nor advanced parallel processors have the interconnectivity needed to emulate neural network processing techniques. The Company believes its chip stacking technology offers a way to achieve the very high levels of interconnectivity necessary to construct an efficient artificial neural network. To the Company's knowledge, there are no competitive packaging approaches that are presently available which are believed to offer this potential. The full embodiment of its neural network technology is not expected to yield near-term products for the Company, although it is anticipated to keep the Company actively involved in advanced R&D relevant to the Company's long-range business interests. However, elements of this technology, including a proprietary chip set, are currently being developed with a view to early product utilization. Embedded Systems. In fiscal 1998, the Company commenced exploration of a technology to stack chips of different functionality and dimensions within the same chip stack, in effect creating a complete, miniaturized electronic system that can be embedded in a higher-level product. The Company refers to this new technology as "NeoStack." In fiscal 1999, a U.S. Patent was granted on the Company's NeoStack technology. The Company has initially demonstrated its NeoStack technology to support a government program to develop a wearable computer. The Company is also using the NeoStack technology in the development of a high-speed, removable optical storage system for Digital Versatile Disk ("DVD") systems. The Company believes, but cannot assure, that its NeoStack approach will offer advantages in terms of compactness and power consumption to developers of a wide variety of embedded computer and control systems. However, the Company has not yet developed this technology to the point at which it can make forecasts of potential revenue, if any, resulting from its licensing or application by OEMs. Development Contract - -------------------- In April 1980, the Company entered into an agreement with R & D Leasing Ltd., ("RDL"), a limited partnership in which the Company's Chairman of the Board and a Senior Vice-President are general partners with beneficial interests, to develop certain processes and technology related to chip stacking. The Company has exclusively licensed this technology from RDL. The Company's exclusive rights to the technology extend to all uses, both government and commercial. Under this agreement, the Company has been accruing royalty obligations to RDL at the rate of 3.5% of all Company revenues derived from the licensed technology. In addition, RDL is entitled to receive an amount equal to 7% of all royalties earned by the Company through the Company's sublicensees of the licensed technology, although to date, no such sublicensee royalty income has been earned. 5 In October 1989, RDL agreed to defer its royalty claims and subordinate them with respect to all other creditors in exchange for options to purchase up to 1,000,000 shares of the Company's Common Stock by applying the deferred royalties to the purchase at the exercise price of $1.00 per share. In September 1999, the Company and RDL negotiated an extension of the subordination and option exercise period through March 1999. If RDL exercises its option in whole or in part, title to RDL's technology would transfer to the Company and all further royalty obligations would cease. If the option expires unexercised, the subordination provisions would terminate and the accrued royalties would be due and payable in the same manner as any other corporate obligation. At October 3, 1999, the Company has accrued $1,000,000 in deferred royalties pursuant to a settlement agreement with RDL to limit total accrued royalties to $1,000,000 through April 3, 2000, in conjunction with the six-month extension of the subordination and option exercise period. No royalties were paid by the Company during fiscal years 1999, 1998 and 1997. The Company believes that the terms of these foregoing transactions were no less favorable to the Company than would have been obtained from a non-affiliated third party for similar services. Manufacturing - ------------- The Company's subsidiaries use contract manufacturers to fabricate and assemble their products. Novalog and MSI use semiconductor fabrication and related manufacturing sources that are widely available worldwide. Silicon Film uses product components that are also widely available with one exception. Silicon Film uses imaging chips which are currently available from one supplier. Silicon Film expects that additional sources of supply will become available for this component in the future, but the continuity of its supply of this key component may be at risk until that occurs. The Company's ultra-high-density stacking technology involves a standard manufacturing process which fabricates cubes comprising of approximately 50 die layers along with ceramic cap and base substrates laminated with an extremely thin adhesive layer and interconnected with a thin-film bus metalization to bring the chip input/output signals out to the top surface of the stacks. The cubes are then segmented or split into subsections as required for the particular product configuration being built. Finally, the cubes, mini-cubes or short stacks are burned in, tested, graded, kitted for packaging, out-sourced for packaging and screening, and returned for final test. The Company's facility is designed for low volume and prototype production of such parts. During fiscal 1998, the Company introduced more cost competitive products manufactured with current state of the art manufacturing technologies. The Company uses outside third party qualified source vendors for the manufacturing of these products. The primary components of the Company's non-memory products are integrated circuits and infrared detectors. The integrated circuits are designed by the Company for manufacture by others from silicon wafers and other materials readily available from multiple sources. Due to the ready availability of these materials, the Company does not have any special arrangements with suppliers for their purchase. The Company does not produce detectors. However, the Company has developed a process, which enables it to use relatively low cost, and unsophisticated detectors which are generally available from numerous sources. Because of the nature of the sophisticated research and development work performed under its development contracts, the Company designs and assembles equipment for testing and prototype development. The Company uses the unique capability of this equipment to seek, qualify for and perform additional contract research and development for its customers. Backlog - ------- At December 15, 1999, the Company's funded backlog was $3,041,600 compared to $3,468,600 at December 13, 1998. The Company anticipates that all of the funded backlog will be filled in fiscal 2000. In addition, the Company has unfunded backlog on contracts which typically are funded when the previously funded amounts have been expended. The Company is also continuing to negotiate for additional research contracts and commercial product sales, which, if obtained, could materially increase its backlog. Failure to obtain these contracts in a timely manner could materially affect the Company's short-term results. Customers and Marketing - ----------------------- The Company's Advanced Technology Division ("ATD") focuses its marketing efforts primarily on U.S. military agencies or contractors to those agencies. The Company is continually seeking and preparing proposals for additional contracts. The Company also develops potential non-military uses of its technology. As a result of the post cold-war defense cutbacks, many defense contractors have experienced declines in their business base as government agencies' budgets are reduced. However, even if this trend continues, the Company believes that there will be more emphasis and funds directed to advanced technology systems and research programs for which the Company believes it is qualified to compete. However, there can be no assurances that the Company will be successful in competing against the larger defense contractors for potential programs. The Company's Novalog subsidiary supports Original Equipment Manufacturers ("OEM's") supplying infrared communications devices complying with the standards of the Infrared Data Association ("IrDA"). The Company believes that Novalog's active participation in IrDA facilitates its marketing to those customers. 6 MSI directs its marketing toward three commercial areas: (i) Customers with a need for Application Specific Integrated Circuits such as the type developed for EG&G; (ii) OEMs that have a need for the cost and performance features that could be provided by MSI's Silicon MicroRing Gyro, with particular emphasis toward manufacturers of electronic toys and games, industrial monitoring equipment, medical instrumentation and automotive markets; and (iii) the manufacturers of micromachined sensors who may be able to utilize MSI's Universal Capacitive Readout (UCR) general purpose ASIC designed to support a variety of sensors requiring high accuracy capacitive readout and control electronics. Silicon Film is a consumer product-focused enterprise. Both the structure and staffing of Silicon Film was developed to bring digital imaging products to the consumer market. The initial product of Silicon Film, the Electronic Film System (EFS) is designed to enable 35mm camera owners to shoot digital or traditional photography with equipment they currently own. The initial target market, termed "prosumers" are defined as high end hobbyists and business photographers who have made a significant investment in their camera system. The EFS is being positioned as a camera accessory, leveraging off the growing adoption of digital cameras and their growing infrastructure. Pre-production units of the initial EFS-1 product have been manufactured, and Silicon Film is currently evaluating these units to determine when to accept general orders for this product. Silicon Film presently forecasts general availability of the EFS-1 for consumer sale in the first calendar quarter of 2000. Silicon Film plans its product roll out of the EFS-1 to be through direct follow-up of inquiries from potential customers it has previously received. Silicon Film expects to follow this initial roll out with an expansion of distribution, reseller channels and value-added resellers for broad and vertical markets through strategic OEM relationships with camera and film companies. Silicon Film plans to service its customers with an electronic commerce site and contracted customer service and support facilities. In fiscal 1999, contracts with all branches of the U.S. government and second- tier government contracts with prime government contractors accounted for 18 percent and 19 percent, respectively, of the Company's consolidated revenues; the remaining 63 percent of the Company's consolidated revenues was derived from non-government sources. During fiscal 1999, revenues derived from 3Com, Citizen Electronics, and the U.S. Army accounted for approximately 25 percent, 21 percent and 10 percent of total consolidated revenues, respectively. Loss of these customers would have a material adverse impact on the Company's short-term consolidated results. Contracts with government agencies may be suspended or terminated by the government at any time, subject to certain conditions. Similar termination provisions are typically included in agreements with prime contractors. There is no assurance the Company will not experience suspensions or terminations in the future. The Company focuses its marketing in specific areas of interest in order to best use its relatively limited marketing resources. Each operating unit or subsidiary has a designated individual to direct that unit's marketing efforts. Competition - ----------- The demand for high performance semiconductors has produced a wide variety of competitors and competitive systems, ranging from various three-dimensional designs to highly dense two-dimensional designs. For most commercial applications, the principal competitive factor for such products is the cost premium over less densely packaged electronics. For some applications in which volume and weight are critical, such as space or avionics, density becomes the principal competitive factor. Many of the Company's competitors are believed to be better financed, more experienced and organizationally stronger than the Company. Accordingly, there can be no assurances that the Company can successfully compete in such markets. The Company is aware of three large companies that have developed or acquired competing approaches to chip stacking. They are Texas Instruments, Inc. (TI), Thompson CSF (Thompson) and Vertical Circuits, Inc. (VCI), a newly formed subsidiary of TRW Inc. In addition, there are several small companies and divisions of large companies that have various technologies for stacking a limited number of chips. The Company is aware of many companies, which are currently servicing the military market for electro-optical sensors of the type which the Company's products are also designed to support. The principal competitive factor in this business area is the performance sensitivity and selectivity achievable by alternative sensor approaches and designs. Competitors to the Company include TI, Lockheed Martin Corporation, Raytheon, Litton Industries, Infrared Industries, Inc., EG&G Judson, OptoElectronics-Textron, Inc. and Boeing Corporation. The Company believes that most of its competitors in this area have financial, labor and capital resources greater than those of the Company, and there is no assurance that the Company will be able to compete successfully. The Company is aware of several companies that currently service the market for serial infrared detectors of the type sold by Novalog. For battery-powered applications, the principal competitive factors are power consumption and cost. For desktop and related applications, the principal competitive factor is the speed of data transmission achievable. Novalog believes it has competitive advantages in the battery-powered applications. Competitors to Novalog in this sector include Hewlett-Packard, Temic-Vishay and 7 Siemons Infenion, among others, all of whom have financial, labor and capital resources greater than those of Novalog. Although Novalog is currently experiencing material revenues in competition with such companies, its ability to protect or expand its market share in the future is not assured. MSI is competing in a market populated with several larger competitors relating to its Silicon MicroRing Gyro, including such companies as Delco Electronics, Motorola, Bosch Corporation, Siemans and Systron-Donner. The principal competitive factor for these applications is believed to be cost. MSI has no present knowledge of competitors planning to introduce ASICs competitive to its UCR product, but given the widespread availability of integrated circuit design capabilities in the electronics industry, the emergence of competitive products is believed to be likely. Silicon Film is not aware of any direct competitors to its EFS product and believes that its intellectual property will act as a barrier to competitors seeking to offer identical products, although there can be no assurance of that result. However, the EFS systems itself is expected to face competition from increasingly sophisticated generations of digital camera equipment. Peripheral equipment and services which Silicon Film intends to offer to complement its EFS products are also likely to attract strong competition if the EFS product line receives significant market acceptance. Research and Development - ------------------------ The Company believes government and commercial research contracts will provide the major portion of funding necessary for continuing development of some of its products. However, the manufacture of stacked circuitry modules in volume will require substantial additional funds, which may involve additional equity or debt financing or a joint venture, license or other arrangement. Furthermore, the development of some of the products of its subsidiaries is likely to require external funding. There can be no assurance that sufficient funding will be available from government or other sources or that new products of the Company of its subsidiaries will be successfully developed for volume production. The Company's expenditures for research and development for the fiscal years ended October 3, 1999, September 27, 1998, and September 28, 1997 were $5,528,000, $4,128,400 and $1,616,600, respectively. These expenditures of Company funds were in addition to the Company's cost of revenues associated with its customer-sponsored research and development activities. The spending levels of Company funds on research and development compared to its overall expenses are indicative of the Company's resolve to maintain its competitive advantage by developing new products and improving upon its existing technology. The Company has funded its research and development activities primarily through contracts with the federal government and with funds from the Company's public and private stock and bond offerings. Patents, Trademarks and Licenses - -------------------------------- The Company has a policy of protecting its investment in technology by seeking to obtain, where practical, patents on the inventions made by its employees. As of October 3, 1999, 53 U.S. and foreign patents have been issued and other U.S. and foreign patent applications are pending. Foreign patent applications corresponding to several of the U.S. patents and patent applications are also pending. There is no assurance that additional patents will issue in the U.S. or elsewhere. Moreover, the issuance of a patent does not carry any assurance of successful application, commercial success or adequate protection. There is no assurance that the Company's existing patents or any other patent that may issue in the future would be upheld if the Company seeks enforcement of its patent rights against an infringer or that the Company will have sufficient resources to prosecute its rights, nor is there any assurance that patents will provide meaningful protection from competition. The Company has been advised by its patent counsel, Thomas Plante, Esq., that no adverse patent has been found which might create an infringement problem in the marketing of the Company's products. If others were to assert that the Company is using technology covered by patents held by them, the Company would evaluate the necessity and desirability of seeking a license from the patent holder. There is no assurance that the Company is not infringing on other patents or that it could obtain a license if it were so infringing. Those products and improvements that the Company develops under government contracts are generally subject to royalty-free use by the government for government applications. However, the Company has negotiated certain "non- space" exclusions in government contracts and has the right to file for patent protection on commercial products which may result from government-funded research and development activities. The Company has exclusive rights to technology developed under an agreement with R & D Leasing, Ltd. ("RDL"), a limited partnership. Under the agreement, the Company will pay royalties of 3.5% of all direct sales by the Company, of the basic devices using the technology. RDL will also receive 7% of all income earned by the Company from sublicensees. The Company's Chairman of the Board and its Senior Vice-President and Chief Technical Officer have a beneficial interest in RDL. See "Development Contracts." 8 Silicon Film has exclusive world-wide rights to the technology developed in conjunction with a licensing agreement between the Company and I. Sapir, a foreign individual, who is now an employee of Silicon Film. Under this agreement, the Company issued 30,000 shares of its common stock to Mr. Sapir. Silicon Film has assumed the royalty obligations of this licensing agreement, which consist of a 1.5% royalty on products incorporating the licensed technology. This licensing agreement was executed in October 1997 and amended in March 1999. In 1999, Silicon Film filed ten additional patent applications relating to the proprietary methods and designs of its products. The Company has entered into an assignment of patent and intellectual rights agreement with F.L. Eide, a Vice-President of the Company. As part of an employment agreement, Mr. Eide assigned to the Company all rights and interests to five U.S. Provisional Patent Applications owned by him. In consideration for this assignment, Mr. Eide will receive a 1% royalty on the gross sales revenues of any products incorporating the technology of these patent assignments for the lifetime of these patents. This agreement was executed in February 1998. The Company entered into a sale and licensing of intellectual property rights related to the EFS to Advanced Technology Products, LLC ("ATPL"), a related party which funded early development of this technology, for which the Company's Senior Vice President and Chief Technical Officer serves as Managing Member. In September 1998, the Company assigned the rights and future royalty obligations of the ATPL license to Silicon Film. Concurrent with this assignment, ATPL reduced its royalty entitlements under the license in consideration for the issuance of 1,222,125 shares of Silicon Film common stock. ATPL retains a royalty entitlement of 2% of the first $30 million of EFS sales, declining thereafter as a function of sales volume. Environmental Matters - --------------------- The Company believes that it is substantially in compliance with all regulations concerning the discharge of materials into the environment, and such regulations have not had a material effect on the capital expenditures or operations of the Company. Employees - --------- As of October 3, 1999, the Company, including its consolidated subsidiaries, had 91 full-time employees and 10 consultants. Of the full-time employees, 66 were engaged in engineering, production and technical support, 8 in sales and marketing and 17 in finance and administration. None of the Company's employees is represented by a labor union, and the Company has experienced no work stoppages due to labor problems. The Company considers its employee relations to be excellent. The Year 2000 - ------------- The year 2000 issue is the result of computer programs using two digits, rather than four to define the applicable year. Programs that have time-sensitive software may recognize a date using "00" as the calendar year 1900 rather than the calendar year 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Company views the year 2000 problem as an important business issue that could affect its business, as well as that of its suppliers and customers. Until the last several years, the Company's business has primarily been R&D, and its more recent business activities have not involved the shipment of products or components with embedded controllers that might be affected by the Year 2000 problem. However, Irvine Sensors customers may have integrated the Company's devices into higher level products or systems affected by the Year 2000 problem, and, to the extent that its customers' business may be disrupted, the Company's business and that of its subsidiaries is also subject to potential disruptions from such a cause. The Company does not have sufficient access to higher-level designs of its customers' products to be able to definitively assess this risk, but does not currently view this risk to be high. In addition, the Company does utilize a number of computerized information systems to accurately process date-sensitive information across its operation, and any of these programs or computer systems is a potential source of year 2000 system failures. Irvine Sensors has worked to identify and resolve such potential impacts on the Company's computerized systems. The Company has been advised by its vendors that their systems are compliant with year 2000 issues. Finally, the Company's general business operations could be adversely impacted were there to be material interruptions either in the country's banking or financial systems or the procurement activities of its customers. The Company currently believes that costs of addressing these issues will not have a material adverse impact on the Company's financial position. Nevertheless, if Irvine Sensors and third parties upon which it relies are unable to address this issue in a timely manner, it could result in a material financial risk to the Company. In order to mitigate the various risks associated with the Year 2000 problem, Irvine Sensors continues to work with its suppliers and customers, including the disclosure and exchange of relevant information, to proactively manage the calendar transition. The Company does not have a formal contingency plan should these preparations prove inadequate. 9 Factors that may affect Future Results - -------------------------------------- The future operating results of the Company are highly uncertain, and the following factors should be carefully reviewed in addition to the other information contained in this annual report on Form 10-K and in other public disclosures of the Company. Shift in Business Focus. Since commencing operations, ISC has developed technology, principally under government research contracts, for various defense-based applications. Since 1992, ISC has been implementing a fundamental shift in its business, broadening its focus to include commercial exploitation of its technology. This shift has been manifested by the purchase and later shut down of the IBM cubing line, the "carve-out" of the Novalog, MSI and Silicon Film subsidiaries and the development of various stacked-memory products intended for military and aerospace markets. To date, these changes have developed new revenue sources but have not yet produced sustained consolidated profitability. Because of this limited and not-yet successful history, there can be no assurances that ISC's present and contemplated future products will be widely accepted in commercial marketplaces. Financing Needs. Although the Company believes that it has adequate liquidity for its core level of operations, ISC and its subsidiaries have developed business plans for several emerging product areas based on its technologies. The product development and market introduction costs of these products cannot presently be fully funded from internal cash flow. There can be no assurances that ISC or its subsidiaries will be able to locate external financing for their business plans on acceptable terms. Nasdaq Listing Requirements. ISC's Common Stock is publicly traded on the Nasdaq SmallCap Market. Effective February 23, 1998, new and more restrictive standards became effective for listing maintenance on this market. Prior to the implementation of these new regulations, ISC briefly dropped below the pending standards due to the loss associated with its Vermont plant closure and had to establish to the satisfaction of the Nasdaq staff that it had met the new standards in order to retain its listing. While the Company was able to meet this requirement, there can be no assurances that the Company will be able to maintain its compliance in the future. In the foreseeable future, the Company must meet at least one of the two following standards to maintain its Nasdaq listing; (i) maintenance of its tangible net worth at $2 million or greater, or (ii) maintenance of a market capitalization figure in excess of $35 million as measured by market prices for trades executed on Nasdaq. While the Company presently has a market cap substantially in excess of the $35 million Nasdaq standard, its tangible net worth is slightly below $2 million. Furthermore, the consolidated losses resulting from the development expenses of some of its subsidiaries will continue to erode its tangible net worth for at least a portion of fiscal 2000. In that instance and absent additional equity financing, which cannot be guaranteed, the Company would be subject to market price risks for the maintenance of its Nasdaq listing. If ISC were to fail to meet the maintenance requirements for listing on Nasdaq in the future and the price of ISC's Common Stock was below $5 at such time, such securities would come within the definition of "penny stock" as defined in the Securities Exchange Act of 1934, as amended (the "Exchange Act") and be covered by Rule 15g-9 of the Exchange Act. That Rule imposes additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors. From transactions covered by Rule 15g-9, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser's written agreement to the transaction prior to the sale. Consequently, Rule 15g-9, if it were to become applicable, would affect the ability or willingness of broker-dealers to sell ISC's securities and therefore would affect the ability of shareholders to sell their securities in the public market and the Company's ability to finance its business plans. Equity Capital Structure. At October 3, 1999, the Company had 35,035,100 common shares issued and outstanding. The common shares reserved for issuance pursuant to existing preferred stock conversion rights, royalty conversion agreements and outstanding warrants and options have essentially depleted the balance of the Company's authorized capital structure of 40,000,000 common shares. Although the Company has authorized preferred stock which is presently unissued and unreserved, without an increase in its authorized common shares, the Company will be severely hampered in seeking equity financing in the future. Since the Company does not presently have sources of significant debt financing, unavailability of equity financing could impair the Company's ability to finance its future business plans or those of its present or future subsidiaries or its ability to respond to unforeseen circumstances. There can be no assurances that the Company's stockholders will authorize an increase in the Company's authorized common shares. Third-Party Financing of Subsidiaries. The financing of the Company's Novalog and Silicon Film subsidiaries to date have involved significant sales of minority equity interests. The Company has repurchased a substantial portion of the minority equity interests of Novalog, but does not now have sufficient discretionary capital to continue this practice with respect to Novalog or any other subsidiary or to adequately finance the future business plans of any of its subsidiaries. The Company's subsidiaries are seeking to sell additional equity interests to finance at least some portion of their business plans. The Company's ability to enjoy the benefits of any potential increase in value on the part of its subsidiaries can be greatly reduced by third-party financings. This is true both because of reduced equity interests in the subsidiaries and because the Company's control of its subsidiaries is lessened or eliminated. Significant third-party investment in the Company's subsidiaries will likely result in third-party investors receiving subsidiary board representation and/or protective covenants that could result in the Company losing voting control of its 10 subsidiaries. In the case of Silicon Film, it presently has an investment banking relationship seeking significant third-party financing involving such features plus additional investor protection. If approved by the Company and subsequently consummated, this financing would reduce the Company's ownership interest in Silicon Film to slightly above 50% after the placement of the financing and to slightly below 40% after the fully-dilutive effect of warrants and options. Additional dilution could be experienced due to default or price anti-dilution provisions or a subsequent IPO. In certain circumstances, it is possible that we or our subsidiaries could experience very substantial transactions costs or "break-up" fees in connection with efforts to obtain financing. Third-party financings of subsidiaries will inherently complicate our fiduciary and contractual obligations and could leave us more vulnerable to potential future litigation. The outcome of litigation is inherently unpredictable, and even the costs of prosecution could have a materially adverse effect on our results of operations. Dependence on Defense Contract Revenues. Although ISC has been shifting its focus to include commercial exploitation of its technology, it expects to continue to be dependent upon research and development contracts with federal agencies and their contractors for a substantial, but diminishing portion of its revenues for the foreseeable future. General political and economic conditions, which cannot be accurately predicted, directly and indirectly affect the quantity and allocation of expenditures by federal agencies. Even the timing of incremental funding commitments to existing, but partially-funded contracts can be affected by such factors. Therefore, cutbacks in the federal budget could have a material adverse impact on ISC's results of operations as long as research and development contracts remain an important element of its business. Market Acceptance of New Products. Both ISC and its subsidiaries are focused on markets that are emerging in nature and potentially subject to rapid growth. Market reaction to new products in such circumstances can be difficult to predict. There can be no assurance that the present or future products of ISC or its subsidiaries will be favorably accepted by such markets on a sustained basis. In addition, because ISC has a limited history of competing in the intensely competitive commercial electronics industry, there is no assurance that it will successfully be able to develop, manufacture and market additional commercial product lines or that such product lines will be accepted in the commercial marketplace. Patents and Proprietary Right Protection; Infringement. ISC believes that its ultimate success, and that of its subsidiaries, will depend, in part, on the strength of its existing patent protection and the additional patent protection that it and its subsidiaries may acquire in the future. As of the date hereof, ISC owns 44 U.S. patents and 8 foreign patents and has other patent applications pending before the U.S. Patent and Trademark Office as well as various foreign jurisdictions. Although ISC believes many of these patents to be fundamental in nature, there can be no assurance that any existing or future patents will survive a challenge or will otherwise provide meaningful protection from competition. Furthermore, there is also no assurance that ISC or its subsidiaries will have the financial resources to provide vigorous defense or enforcement of patents. Protection of Proprietary Information. ISC and its subsidiaries treat technical data as confidential and rely on internal nondisclosure safeguards, including confidentiality agreements with employees, and on laws protecting trade secrets, to protect proprietary information. There can be no assurance that these measures will adequately protect the confidentiality of the proprietary information of ISC or its subsidiaries or that others will not independently develop products or technology that are equivalent or superior to those of ISC or its subsidiaries. ISC or its subsidiaries may receive in the future communications from third parties asserting that the products of ISC or its subsidiaries infringe the proprietary rights of third parties. There can be no assurance that any such claims would not result in protracted and costly litigation. There can be no assurance that any particular aspect of the technology owned by ISC or its subsidiaries will not be found to infringe the products of other companies. Other companies may hold or obtain patents or inventions or may otherwise claim proprietary rights to technology useful or necessary to ISC's or its subsidiaries' business. The extent to which ISC or its subsidiaries may be required to seek licenses under such proprietary rights of third parties and the cost or availability of such license, cannot be predicted. While it may be necessary or desirable in the future to obtain licenses relating to one or more of its proposed products or relating to current or future technologies, there can be no assurance that ISC or its subsidiaries will be able to do so on commercially reasonable terms. Government Rights. Whatever degree of protection, if any, is afforded ISC or its subsidiaries through its patents, proprietary information and other intellectual property, this protection will not extend to government markets that utilize certain segments of ISC's technology. The government has the right to royalty-free use of technologies that ISC has developed under government contracts, including portions of ISC's stacked circuitry technology. ISC is free to commercially exploit such government-funded technologies and may assert its intellectual property rights to seek to block other non-government users thereof, but there can be no assurances of success in such endeavors. Competition. ISC and its subsidiaries face strong competition. Most competitors have considerably greater financial, marketing and technological resources than does ISC or its subsidiaries. There is no assurance that ISC or its subsidiaries will be able to compete successfully with such other companies. 11 Dependence on Suppliers. ISC and its subsidiaries extensively use suppliers in the manufacture of their products. At the projected level of operations, both ISC and its subsidiaries have identified sources that are believed to be adequate to meet identified needs. However, there is no assurance that ISC or its subsidiaries will be able to cover changing manufacturing needs in the future. Failure to do so will have a material adverse impact on the operations of ISC and its subsidiaries. Possible Technological Advances. ISC and its subsidiaries are in industries characterized by continuing technological development and, accordingly, will be required to devote substantial resources to improve already technologically complex products. Many companies in these industries devote considerably greater resources to research and development than does ISC or its subsidiaries. Developments by any of these companies could have a materially adverse effect on ISC. Dependence on Key Personnel. ISC and its subsidiaries will depend to a large extent on the abilities and continued participation of certain key employees. The loss of key employees could have a material adverse effect on the businesses of ISC and its subsidiaries. ISC and its subsidiaries have adopted employee Stock Option Plans designed to attract and retain key employees. The value of such options to the subsidiaries will be strongly tied to the timing of any future IPOs, of which there can be no assurance, and there can, accordingly, be no guarantee of the efficacy of such options in retaining key employees. Neither ISC or its subsidiaries presently maintain "key man" insurance on any key employees although Silicon Film is planning to secure such insurance on its Chief Executive Officer. ISC believes that, as its activities and those of its subsidiaries increase and change in character, additional, experienced personnel will be required to implement the business plans of ISC and its subsidiaries. Competition for such personnel is intense and there is no assurance that they will be available when required, or that ISC or its subsidiaries will have the ability to attract them. The above factors are not intended to be inclusive. Failure to satisfactorily achieve any of the Company's objectives or avoid any of the above or other risks would likely have a material adverse effect on the Company's business and results of operations. 12 Item 2. Properties The following table sets forth information with respect to the Company's facilities:
Square Monthly Location Feet Rent Lease Expiration -------- ------ ------- ---------------- ISC(1) Costa Mesa, CA 30,339 $32,300 September 2001 Silicon Film Technologies, Inc. Irvine, CA 10,300 7,725 May 2004 ------ ------- Total 40,639 $40,025 ====== =======
- ------------ (1) Includes facilities for ISC corporate headquarters, ATD, MPD, MSI and Novalog. The facilities used by Advanced Technology Division include laboratories containing clean rooms for operations requiring a working environment with reduced atmospheric particles. The Company believes that its facilities are adequate for their respective operations, and that the facilities of the Company are maintained in good repair. Item 3. Legal Proceedings. None. Item 4. Submission of Matters to a Vote of Security Holders. None. 13 EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Position ---- --- -------- James D. Evert 57 President, Chief Executive Officer and a Director John C. Carson 61 Senior Vice President, Chief Technical Officer and a Director John J. Stuart, Jr. 60 Senior Vice President, Chief Financial Officer and Treasurer Floyd L. Eide 63 Vice President and General Manager - MicroElectronics Division
Mr. Evert has been President, Chief Executive Officer and a director of ISC since February 1997. He also serves in those capacities for Novalog since February 1997 and as a director of MSI since October 1997 and a director of Silicon Film since August 1998. Prior to joining ISC, Mr. Evert was an independent management consultant. In that role from December 1993 until January 1995, he assisted Fujitsu Microelectronics, Inc. in the formation of a graphics product subsidiary and subsequently served as Vice-President of that unit from January 1995 to February 1996. Mr. Evert is a graduate of Syracuse University with a B.S. degree in Electrical Engineering. Mr. Carson is a co-founder of ISC and has served as a Senior Vice President since its inception in 1974 and a director since April 1982. He was elected Chief Technical Officer in February 1997. Mr. Carson also serves as a director of MSI (since October 1997). Mr. Carson has been awarded 15 patents for smart sensors, 3D packaging and single processing architectures, including neural networks. Mr. Carson holds a B S. in Physics from the Massachusetts Institute of Technology. Mr. Stuart joined ISC in January 1983 as its Manager of Special Projects and Communications, became ISC's Chief Financial Officer and Treasurer in July 1985, and a Vice President in June 1995. He relinquished the position of Treasurer in February 1995. Effective October 1998, Mr. Stuart re-assumed the position of Treasurer in addition to his other responsibilities. Mr. Stuart is also a member of the Board of Directors and is Vice President of Finance and Chief Financial Officer of both Novalog (since October 1995) and MSI (since October 1997). He also acted as Chief Financial Officer of Silicon Film since its organization in August 1998 until May 1999. Mr. Stuart holds a B.S. in Industrial Management from the Massachusetts Institute of Technology. Mr. Eide joined ISC in August 1997 as Vice President and General Manager - MicroElectronics Division. From November 1987 to August 1997, Mr. Eide was Chief Operating Officer and Vice President, Engineering of Dense-Pac Microsystems Inc. He is a graduate of Fairleigh Dickenson University with a M.S. in Solid State Physics and a B.S. in Physics. 14 PART II ------- Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The following table sets forth the range of representative high and low bid prices of the Company's Common Stock (Nasdaq SmallCap Market symbol: IRSN) in the over-the-counter market for the periods indicated, as furnished by NASD, Inc. These prices represent prices among dealers, do not include retail markups, markdowns or commissions, and may not represent actual transactions:
Common Stock Bid Prices High Low ---- --- Fiscal Year Ended October 3, 1999: First Quarter $1 15/16 $1 13/32 Second Quarter $1 21/32 $1 5/16 Third Quarter $2 $1 7/16 Fourth Quarter $1 27/32 $1 7/32 Fiscal Year Ended September 27, 1998: First Quarter $1 1/32 $1 Second Quarter $2 21/32 $2 19/32 Third Quarter $2 1/32 $2 Fourth Quarter $2 29/32 $1 11/32
On December 22, 1999, the closing bid and asked prices for the Company's Common Stock on the Nasdaq SmallCap Market were $2 1/8 and $2 3/32 respectively. On December 22, 1999, there were approximately 885 stockholders of record and approximately 9,500 beneficial holders based on information provided by the Company's transfer agent. The Company has not paid cash dividends on any class of its stock since its incorporation. Under Delaware law there are certain restrictions which limit the Company's ability to pay cash dividends in the future. 15 Item 6. Selected Financial Data The following table summarizes certain selected consolidated financial data and is qualified by the more detailed Consolidated Financial Statements incorporated herein by reference (see Item 8, below): Fiscal Year Ended -----------------
October 3, September 27, September 28, September 29, October 1, 1999 1998 1997 1996 1995 Consolidated Statement of Operations Data: - ------------------------------------------ Total revenues $11,100,200 $ 9,314,500 $ 13,693,200 $ 12,024,200 $ 8,041,400 Loss from operations (9,785,700) (5,798,200) (14,809,200) (11,154,700) (3,071,500) Net loss (9,115,700) (4,243,500) (14,875,600) (15,914,700) (4,137,500) Basic and diluted net loss per common and common equivalent share $ (0.29) $ (0.19) $ (0.73) $(0.94) $(0.28) Weighted average number of shares outstanding 31,244,300 24,597,700 20,475,100 16,874,300 14,966,500 Shares used in computing net loss per share 31,244,300 24,597,700 20,475,100 16,874,300 14,966,500
Loss per common and common equivalent shares includes, where applicable, cumulative and imputed dividends on Preferred Stock which have not been declared or paid.
October 3, September 27, September 28, September 29, October 1, 1999 1998 1997 1996 1995 ----------------------------------------------------------------------------------- Consolidated Balance Sheet Data: - --------------------------------- Current assets $ 6,640,850 $4,802,700 $ 6,637,200 $ 9,648,200 $ 9,927,500 Current liabilities $ 5,375,300 $2,296,000 $ 7,395,600 $ 5,787,100 $ 3,545,400 Working capital (deficit) $ 1,265,550 $2,506,700 $ (758,400) $ 3,861,100 $ 6,382,100 Total assets $10,510,350 $7,064,700 $ 9,449,300 $21,742,200 $15,609,200 Long-term debt $ 433,200 $ 933,700 $ 1,207,000 $ 3,165,600 $ 201,200 Shareholders' equity (deficit) $ 2,212,650 $2,347,000 $(2,939,900) $ 8,312,700 $ 9,494,100
16 Item 7. Management's Discussion and Analysis of Financial Condition ----------------------------------------------------------- and Results of Operation ------------------------ The information required by Item 7 of this report is set forth on pages 2 through 4 of the Company's 1999 Annual Report to Stockholders and is incorporated by reference in this Annual Report on Form 10-K. Item 7A. Quantitative and Qualitative Disclosures About Market Risk ---------------------------------------------------------- None. Item 8. Financial Statements and Supplementary Data ------------------------------------------- The financial statements, together with the reports thereon of Grant Thornton LLP, dated December 21, 1999 and PricewaterhouseCoopers LLP, dated December 16, 1997, appearing on pages 5 through 22 of the Company's 1999 Annual Report to Stockholders are incorporated by reference to this Annual Report on Form 10-K. With the exception of the aforementioned information and the information incorporated in Item 7, the 1999 Annual Report to Stockholders is not deemed to be filed as part of this Annual Report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and --------------------------------------------------------------- Financial Disclosure -------------------- On October 1,1998, the Company dismissed PricewaterhouseCoopers LLP as its independent accountants effective as of the Company's fiscal year ended September 27,1998. The Registrant's Audit Committee participated in and approved the decision to change independent accountants. On October 1, 1998, the Company selected Grant Thornton LLP to act as its independent accountants effective as of the company's fiscal year ended September 27,1998. At the Company's Annual Meeting of February 26, 1999, shareholders approved the selection of Grant Thornton LLP to act as its independent accountants for the fiscal year ended October 3, 1999. PART III --------- The following items included in the Company's Definitive Proxy Statement dated January 25, 1999 to be used in connection with the Company's Annual Meeting of Stockholders to be held on February 26, 1999 are incorporated herein by reference:
Pages in Proxy ----------------- Item 10. Directors and Executive Officers of the Registrant 2-5 Item 11. Executive Compensation 7-10 Item 12 Security Ownership of Certain Beneficial Owners and Management 7-8 Item 13. Certain Relationships and Related Transactions 15
17 PART IV ------- Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) The following documents are filed as part of this Report: 1. Financial Statements Pages in Annual Report* -------------- Consolidated Balance Sheets 5 Consolidated Statements of Operations 6 Consolidated Statement of Shareholders' Equity (Deficit) 7 Consolidated Statements of Cash Flows 8 Notes to Consolidated Financial Statements 9-21 Reports of Independent Certified Public Accountants 22 * Incorporated by reference from the indicated pages of the 1999 Annual Report to Stockholders. 2. Financial Statement Schedule: Reports of Independent Certified Public Accountants on Financial Statement Schedules Schedule for the fiscal years ended October 3, 1999, September 27, 1998, and September 28, 1997. Schedule II - Valuation and Qualifying Accounts All other schedules have been omitted because they are not applicable, or not required, or because the required information is included in the financial statements or notes thereto which have been incorporated herein by reference. 3. Exhibits - The following is a list of the exhibits encompassed in this report: Exhibit Number Exhibit Description ------ ------------------- 3.1 Certificate of Incorporation of the Registrant, as amended and currently in effect (1) 3.2 Certificate of Designation of Preferences of Series D Convertible Preferred Stock (2) 3.3 By-laws, as amended to date (3) 4.1 Specimen Common Stock certificate (1) 5.1 Opinion of Grover T. Wickersham, P.C.re legality (4) 10.1 Lease Agreement for the premises at 3001 Redhill Avenue, Building III, Costa Mesa, California (5) 10.2.1 Employee Stock Bonus Plan and Trust Agreement dated June 29, 1982 effective December 31,1982 (6) 10.2.2 Amendment to Employee Stock Bonus Plan and Trust Agreement dated December 14, 1982 (7 ) 10.2.3 Amendment to Employee Stock Bonus Plan and Trust Agreement dated September 25, 1990 (1) 10.2.4 Master Trust Agreement for Employee Deferred Benefit Plans dated August 22, 1990 (8) 10.2.5 Amendment to Employee Stock Bonus Plan and Trust Agreement dated October 4, 1993 (9) 10.3 Agreement with R&D Leasing, Ltd. and Note Payable dated June 23, 1989 (10) 10.4 License Agreement with R&D Leasing, Ltd. dated October 20, 1989 (10) 10.5 Agreement with R&D Leasing, Ltd. dated October 1, 1990 (11) 10.6 1991 Stock Option Plan (12) 10.7 1995 Stock Option Plan (13) 10.8 Contract between the Company and NASA Management Office - JPL dated March 12, 1996 (3) 10.9 Contract between the Company and Wright-Patterson Air Force Base dated August 12, 1996 (3) 10.10 Contract #DAAH01-9B-C-R075 with U.S. Army Aviation and Missile Command (14) 10.11 1999 Stock Option Agreement (4) 21.1 Subsidiaries of the Registrant (2) 13 Portions of Registrant's Annual Report to Stockholders for the fiscal year ended October 3, 1999 21.1 Subsidiaries of the Registrant (2) 23.1 Consent of Grant Thornton LLP, Independent Certified Public Accountants (see page II-11 of the Registration Statement) 23.2 Consent of PricewaterhouseCoopers LLP, Independent Accountants (4) 23.3 Consent of Thomas J. Plante, Esq., Patent Counsel (see page II-12 of the Registration Statement) 23.4 Consent of Grover T. Wickersham, P.C. (included in Exhibit 5.1, above) 27 Financial Data Schedule 18 - ----------- (1) Incorporated by reference to Part IV of Registrant's Annual Report on Form 10-K for the fiscal year ended September 29, 1991. (2) Incorporated by reference to the Registrant's Registration Statement on Form S-1 filed with the Commission on October 4, 1999 (Registration Number 333-88385). (3) Incorporated by reference to Part IV of Registrant's Annual Report on Form 10-K/A for the fiscal year ended September 28, 1996. (4) To be filed by amendment. (5) Incorporated by reference to Part IV of Registrant's Annual Report on Form 10-K for the fiscal year ended October 2, 1994. (6) Incorporated by reference to Part II of Pre-effective Amendment No. 3 to the S-18 Registration Statement filed with the Commission's Los Angeles Regional Office on May 27, 1982. (7) Incorporated by reference to Part II of Registrant's Registration Statement on Form S-1 filed with the Commission on March 23, 1983 (Registration No. 2-82596) (the "S-1 Registration Statement"). (8) Incorporated by reference to Part II of Pre-effective Amendment No. 3 to the Form S-2 filed with the Commission on March 3, 1987 (Registration No. 33-10134). (9) Incorporated by reference to Part IV of Registrant's Annual Report on Form 10-K/A for the fiscal year ended October 1, 1995. (10) Incorporated by reference to Part IV of Registrant's Annual Report on Form 10-K for the fiscal year ended October 1, 1989. (11) Incorporated by reference to Part IV of Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1990. (12) Incorporated by reference to Part II of Pre-effective Amendment No. 2 to the Form S-2 filed with the Commission on July 9, 1992 (Registration No. 33-47977). (13) Incorporated by reference to Registrant's Form S-8 Registration Statement filed February 11, 1999. (14) Incorporated by reference to Registrant's Form 10-Q for the Period Ended June 27, 1998, filed August 12, 1998. (b) Reports on Form 8-K: ------------------------ No report on Form 8-K was filed by the Company with respect to the quarter ended October 3, 1999. 19 SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. IRVINE SENSORS CORPORATION -------------------------- By: /s/ James Alexiou _____________________________ James Alexiou Chairman of the Board Date: December 31, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: /s/ James Evert /s/ John J. Stuart, Jr. _____________________________ __________________________ James Evert John J. Stuart, Jr. Chief Executive Officer Chief Financial Officer (Principal Executive Officer) (Principal Accounting Date: December 31, 1999 Officer) Date: December 31, 1999 /s/ John C. Carson /s/ Frank P. Ragano _____________________________ __________________________ John C.Carson, Director Frank P. Ragano, Director Date: December 31, 1999 Date: December 31, 1999 /s/ Joanne S. Carson /s/ Vincent F. Sollitto, Jr. _____________________________ __________________________ Joanne S. Carson, Director Vincent F. Sollitto, Jr., Date: December 31, 1999 Director Date: December 31, 1999 /s/ Marc Dumont /s/ Wolfgang Seidel _____________________________ __________________________ Marc Dumont, Director Wolfgang Seidel, Director Date: December 31, 1999 Date: December 31, 1999 /s/ Walter E. Garrigan _____________________________ Walter E. Garrigan, Director Date: December 31, 1999 20 REPORTS OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS --------------------------------------------------- ON FINANCIAL STATEMENT SCHEDULES -------------------------------- To the Board of Directors of Irvine Sensors Corporation Our audits of the consolidated financial statements referred to in our report dated December 21, 1999 appearing on page 22 of the 1999 Annual Report to Shareholders of Irvine Sensors Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules listed in Item 14(a) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ GRANT THORNTON LLP Irvine, California December 21, 1999 To the Board of Directors of Irvine Sensors Corporation Our audit of the consolidated financial statements referred to in our report dated December 16,1997 appearing on page 22 of the 1999 Annual Report to Shareholders of Irvine Sensors Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules for the year ended September 28, 1997 listed in Item 14(a) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PRICEWATERHOUSECOOPERS LLP PRICE WATERHOUSE LLP Costa Mesa, California December 16, 1997 21 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS ----------------------------------------------
Balance at Charged to Balance Beginning Costs and at End of Year Expenses Deductions of Year ---------- ---------- ---------- ---------- Year ended October 3,1999: - -------------------------- Allowance for doubtful accounts $ 10,000 $ 31,268 $ 4,567 $ 36,701 Inventory reserves 2,456,800 2,245,600 983,600 3,718,800 Year ended September 27,1998: - ----------------------------- Allowance for doubtful accounts $ 10,000 $ - $ - $ 10,000 Inventory reserves 2,184,800 1,306,700 1,034,700 2,456,800 Year ended September 28, 1997: - ------------------------------ Allowance for doubtful accounts $ 10,000 $ - $ - $ 10,000 Inventory reserves 2,043,700 1,156,100 1,015,000 2,184,800
22 EX-13 2 ANNUAL REPORT EXCERPT FOR PERIOD ENDING 10/03/1999 EXHIBIT 13 Irvine Sensors Corporation Financial Highlights Fiscal Year Ended
October 3, September 27, September 28, September 29, October 1, 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------- Revenues $ 11,100,200 $ 9,314,500 $ 13,693,200 $ 12,024,200 $ 8,041,400 =============================================================================== Loss from operations $ (9,785,700) $ (5,798,200) $ (14,809,200) $ (11,154,700) $ (3,071,500) =============================================================================== Net Loss $ (9,115,700) $ (4,243,500) $ (14,875,600) $ (15,914,700) $ (4,137,500) =============================================================================== Basic and diluted net loss per common and common equivalent share $ (0.29) $ (0.19) $ (0.73) $ (0.94) $ (0.28) =============================================================================== Weighted average number of shares outstanding 31,244,300 24,597,700 20,475,100 16,874,300 14,966,500 =============================================================================== Long-term debt $ 433,200 $ 933,700 $ 1,207,000 $ 3,165,600 $ 201,200 =============================================================================== Convertible debt $ - $ - $ 250,000 $ 3,400,000 $ 2,250,000 =============================================================================== Total assets $ 10,510,350 $ 7,064,700 $ 9,449,300 $ 21,742,200 $ 15,609,200 ===============================================================================
Price Range of Common Stock The following table sets forth the range of representative high and low bid prices of the Company's common stock in the over-the-counter market for the periods indicated, as furnished by The Nasdaq Stock Market. These prices represent prices among dealers, do not include retail markups, markdowns or commissions, and may not represent actual transactions: Fiscal Year Ended
October 3, 1999 September 27, 1998 High Low High Low Common Stock Bid Prices First Quarter $1 15/16 $1 31/32 $1 1/32 $1 Second Quarter $1 21/32 $1 5/16 $2 21/32 $2 19/32 Third Quarter $2 $1 7/16 $2 1/32 $2 Fourth Quarter $1 27/32 $1 7/32 $2 29/32 $1 11/32
On December 22, 1999, there were 885 stockholders of record and approximately 9,000 beneficial holders, based on information provided by the Company's transfer agent. The Company has not paid cash dividends on any class of its stock since its incorporation; under Delaware law there are certain restrictions, which limit the Company's ability to pay cash dividends in the future. Irvine Sensors Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations FISCAL YEAR ENDED OCTOBER 3, 1999 vs. FISCAL YEAR ENDED SEPTEMBER 27, 1998 Consolidated revenues in fiscal 1999 of $11,100,200 increased by $1,785,700 or 19 percent compared to fiscal 1998. The primary reason for this increase is the increased sales realized by Novalog. Cost of contract revenues of $3,163,200 was 78 percent of contract revenues, an improvement from the 86 percent figure of fiscal 1998. This improvement was primarily due to attempts made to reduce cost of operations during fiscal 1999. Cost of product sales was $5,197,600 or approximately 74 percent of product sales in fiscal 1999. By comparison, fiscal 1998 cost of product sales was 85 percent of product sales, reflecting final shutdown costs of the Vermont facility, which did not recur in fiscal 1999. Additionally, the Company realized better product margins due to the increase in sales volume. General and administrative expenses of $6,997,100 increased by $3,506,700 or 100 percent in relation to fiscal 1998, largely as a result of the growth in the Company's consolidated subsidiaries. As a percentage of total revenues, general and administrative expenses were approximately 63 percent in fiscal 1999 compared to 37 percent in fiscal 1998, again reflecting the substantial fiscal 1999 increase in expenses of the Company's subsidiaries, two of which generated no revenues. Research and Development increased to $5,528,000 in fiscal 1999, a growth of $1,399,600 or 34 percent in the year-to-year comparison. The growth was due to the product development expenses of the MicroSensors and Silicon Film consolidated subsidiaries. As a percentage of revenues, R&D accounted for approximately 49 percent in fiscal 1999 compared to approximately 44 percent in fiscal 1998, with the product development expenses of MicroSensors and Silicon Film accounting for the difference, without corresponding revenues. The aggregate increase of $5,773,200 in fiscal 1999 of operating costs and expenses are the direct result of management's decision to further implement the Company's strategy to develop, market and sell commercial products through its subsidiaries. Interest expense declined by $161,900 in fiscal 1999 due to final retirement of debt associated with the Vermont facility in fiscal 1998, which did not recur in fiscal 1999. Interest income increased by $26,100 in fiscal 1999 due to the short-term investment of proceeds from the Company's equity offerings. The consolidated net loss of $9,115,700 in fiscal 1999 was $4,872,200, or 115 percent greater than fiscal 1998. The increased net loss of the MicroSensors and Silicon Film subsidiaries accounted for over 88 percent of this increase. FISCAL YEAR ENDED SEPTEMBER 27, 1998 vs. FISCAL YEAR ENDED SEPTEMBER 28, 1997 Revenues in fiscal 1998 of $9,314,500 decreased by $4,378,700 or 32 percent compared to fiscal 1997. The primary reason for this decrease is attributed to the closure of the Vermont facility. The decision to close the Vermont location was centered on lower revenue and the continued increased cost of operations. When considering corporate revenues generated by excluding the Vermont location, fiscal 1998 revenues of $9,314,500 increased by $2,709,800 or approximately 41 percent. Cost of contract revenues of $5,711,700 was 86 percent of contract revenues compared to 94 percent in fiscal 1997. Cost of product sales of $1,942,200 or 85 percent of product sales includes the final shutdown costs related to the Vermont facility. By comparison, in fiscal 1997 cost of product sales was 150 percent of product sales. Management is continuing to address the high product costs and believes that gross margins will improve as sales increase and the effect of implemented cost reductions is realized. General and administrative expenses of $3,490,400 were decreased by $231,600 or 6 percent in relation to fiscal 1997. As a percentage of total revenues general and administrative expenses were 37 percent in fiscal 1998 compared to 27 percent in fiscal 1997. However, fiscal 1997 included revenues from the Vermont facility. Research and development expenses increased by $2,511,800 or 155 percent in the year-to-year comparison. The growth was due to the product development expenses of the MicroSensors and Silicon Film consolidated subsidiaries. As a percentage of revenues R&D accounted for approximately 44 percent in fiscal 1998 compared to approximately 12 percent in fiscal 1997. The R&D expense in fiscal 1998 includes significant costs associated with Silicon Film's development of the electronic film product. The aggregate decrease of $7,356,300 in fiscal 1998 in cost of revenues, general and administrative expenses and R&D are the direct result of management's decision to streamline and control its expenses to fall in line with the reduced revenue from the Vermont plant closing. Interest expense declined by $177,400 in fiscal 1998, primarily attributable to settlement of the Company's bank debt. Interest income declined by $26,800 in fiscal 1998, primarily attributable to lower interest rates and the debt pay-off associated with the Vermont facility. The net loss of $4,243,500 in fiscal 1998 was $10,632,100 or 71 percent less than fiscal 1997. The Vermont plant closing in fiscal 1997 accounted for $5,873,400 or 55 percent of this reduced loss. Liquidity, Capital Resources and Impact of Changing Prices At October 3, 1999, the Company had consolidated cash and cash equivalents of $981,100, which represents a decrease of $329,300 since September 27, 1998. The net cash used in operating activities was $7,704,000 during fiscal 1999. The primary use of cash was to fund the research and development and other operating expenses of its MicroSensors and Silicon Film subsidiaries. The Company used $1,530,600 in investing activities during fiscal 1999. Cash used in investing activities primarily consisted of acquiring property, plant and equipment for $1,453,400. The Company also entered into capital lease agreements to acquire an additional $780,300 of equipment. During fiscal 1999, the Company obtained net cash of $8,905,300 from financing activities. Cash provided by financing activities included $6,439,400 from the issuance of common and preferred stock and common stock warrants, and $2,661,100 from the sale of common and preferred stock in subsidiaries to minority interest shareholders. Net cash provided by equity and minority interest transactions was reduced by principal payments for capital leases payable of $195,200. Subsequent to year-end, the Company collected $600,000 for the sale of 444,444 additional shares of the Company's common stock. As a result of equity financing in fiscal 1999, the further development activities of MicroSensors and Silicon Film were accomplished while limiting the net reduction of the Company's working capital to $1,241,150. The Company anticipates that the existing working capital and its projected operating results will meet its cash requirements for the immediate future. Contracts with government agencies may be suspended or terminated by the government at any time, subject to certain conditions. Similar termination provisions are typically included in agreements with prime contractors. Since its inception, the Company has experienced such termination of its contracts on two occasions. There is no assurance the Company will not experience suspensions or terminations in the future. Such termination, if material, could cause a disruption of the Company's revenue stream and could result in employee layoffs. At October 3, 1999, the Company's funded backlog was approximately $3,928,900 compared to $ 1,897,800 at September 27, 1998. In addition, existing contracts include a large amount of unfunded backlog, which typically is funded when the previously funded amounts have been expended. Subsequent to fiscal year end the total backlog was $3,041,600 as of December 15, 1999. Except for historical information contained herein, this Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The forward- looking statements contained herein are subject to certain risks and uncertainties, including such factors, among others, as the pace at which new markets develop, the ability of the Company to introduce new products and ramp up manufacturing in a timely manner while controlling its operating expenses and the response of competitors, many of whom are bigger and better financed than the Company. In addition, the scope of the Company's growth plan may introduce unanticipated risks and financial requirements. The availability of external financing for the Company's plan cannot be assured and is subject to numerous factors including those unrelated to the Company's performance such as economic and market conditions. Further, the Company's financial performance prior to substantial growth in revenues may not permit additional equity financing and may place at risk the continuation of its long-term debt financing because of inability to achieve financial covenants. Accordingly, investors are advised to assess forward-looking statements contained herein with caution. Additional information on various risks and uncertainties potentially affecting the Company's results are contained in publicly filed disclosures available through the Securities and Exchange Commission EDGAR database (http://www.sec.gov) or from the Company's Investor Relations. Irvine Sensors Corporation Consolidated Balance Sheets
October 3, September 27, 1999 1998 ----------------------------------- Assets Current Assets: Cash and cash equivalents $ 981,100 $ 1,310,400 Accounts receivable, net of allowances of $36,700 in 1999 and $10,000 in 1998 2,401,500 1,766,100 Stock subscriptions receivable 600,000 - Inventory 2,219,800 1,532,700 Other current assets 438,450 193,500 ----------------------------------- Total current assets 6,640,850 4,802,700 Equipment, furniture and fixtures, net 3,546,900 2,224,000 Goodwill 171,600 - Other assets 151,000 38,000 ----------------------------------- $ 10,510,350 $ 7,064,700 =================================== Liabilities and Shareholders' Equity Current Liabilities: Accounts payable $ 3,310,800 $ 1,570,800 Accrued expenses 752,600 622,400 Deferred revenues - 50,000 Deferred and subordinated royalties payable - 1,000,000 - affiliated company Capital lease obligations - current portion 311,900 52,800 ----------------------------------- Total current liabilities 5,375,300 2,296,000 Capital lease obligations 433,200 107,500 Deferred and subordinated royalties payable - affiliated company - 826,200 Minority interest in consolidated subsidiaries 2,489,200 1,488,000 ----------------------------------- Total liabilities 8,297,700 4,717,700 Shareholders' Equity: Preferred stock, $0.01 par value, 500,000 shares authorized; 6,400 and 6,966 shares Series B Convertible Cumulative Preferred outstanding; aggregate liquidation preference of $95,600 50 50 3,500 and 3,964 shares Series C Convertible Cumulative Preferred outstanding; aggregate liquidation preference of $105,840 50 50 2,400 and 4,400 shares Series D Convertible Preferred outstanding; aggregate liquidation preference of $240,000 50 50 Common stock, $0.01 par value, 40,000,000 shares authorized; 35,035,100 and 28,457,700 shares issued and outstanding 350,300 284,600 Common stock warrants and unit warrants; 147,000 and 162,000 outstanding - - Paid-in capital (including common stock subscribed) 64,796,500 55,885,250 Accumulated deficit (62,938,700) (53,823,000) ----------------------------------- Total shareholders' equity 2,212,650 2,347,000 ----------------------------------- $ 10,510,350 $ 7,064,700 ===================================
See Accompanying Notes to Consolidated Financial Statements. Irvine Sensors Corporation Consolidated Statements of Operations
Fiscal Year Ended ----------------------------------------------------------------- October 3, September 27, September 28, 1999 1998 1997 ----------------------------------------------------------------- Revenues: Product sales $ 7,017,900 $ 2,289,800 $ 7,872,100 Contract research & development 4,080,700 6,624,700 5,821,100 Other 1,600 400,000 - ----------------------------------------------------------------- Total revenues 11,100,200 9,314,500 13,693,200 ----------------------------------------------------------------- Cost and expenses: Cost of contract revenues 3,163,200 5,711,700 5,455,200 Cost of product sales 5,197,600 1,942,200 11,835,200 General and administrative 6,997,100 3,490,400 3,722,000 Research and development 5,528,000 4,128,400 1,616,600 (Gain) loss related to plant closure - (160,000) 5,873,400 ----------------------------------------------------------------- 20,885,900 15,112,700 28,502,400 ----------------------------------------------------------------- Loss from operations (9,785,700) (5,798,200) (14,809,200) Interest expense (104,300) (266,200) (443,600) Interest income 38,600 12,500 39,300 Other - 299,700 - ----------------------------------------------------------------- Loss before minority interest and provision for income taxes (9,851,400) (5,752,200) (15,213,500) Minority interest in loss of subsidiaries 738,500 365,200 340,500 Provision for income taxes (2,800) (2,600) (2,600) ----------------------------------------------------------------- Loss before extraordinary item (9,115,700) (5,389,600) (14,875,600) Extraordinary item - debt extinguishment - 1,146,100 - ----------------------------------------------------------------- Net loss $ (9,115,700) $ (4,243,500) $ (14,875,600) ================================================================= Basic and Diluted Loss Per Share : Loss before extraordinary item $ (0.29) $ $(0.24) $ $(0.73) Extraordinary item - 0.05 - ----------------------------------------------------------------- Net loss $ (0.29) $ $(0.19) $ $(0.73) ================================================================= Weighted average number of shares outstanding 31,244,300 24,597,700 20,475,100 =================================================================
See Accompanying Notes to Consolidated Financial Statements. Irvine Sensors Corporation Consolidated Statement of Shareholders' Equity (Deficit)
Common Stock Common Stock Preferred Shares Issued Warrants Issued Shares Issued ------------- --------------- ------------- Paid-in Accumulated Shareholders' Number Amount Number Amount Number Amount Capital Deficit Equity (Deficit) -------------------------------------------------------------------------------------------------------- Balance at September 29, 1996 18,710,000 $187,100 239,200 $ - 14,000 $ 100 $42,829,400 $(34,703,900) $ 8,312,700 -------------------------------------------------------------------------------------------------------- Common stock issued to employee retirement plan 347,600 3,500 - - - - 442,000 - 445,500 Convertible debentures converted to common stock 2,441,400 24,400 - - - - 3,125,600 - 3,150,000 Series B and Series C preferred stock converted to common stock 12,600 100 - - (250) - (100) - - Sale of common stock 22,200 200 - - - - 19,800 - 20,000 Common stock bonus issued 7,500 100 - - - - 7,400 - 7,500 Common stock warrants issued - - 118,000 - - - - - - Common stock warrants expired - - (17,200) - - - - - - Net loss - - - - - - - (14,875,600) (14,875,600) -------------------------------------------------------------------------------------------------------- Balance at September 28, 1997 21,541,300 $215,400 340,000 $ - 13,750 $ 100 $46,424,100 $(49,579,500) $ (2,939,900) -------------------------------------------------------------------------------------------------------- Common stock issued to employee retirement plan 333,300 3,400 - - - - 496,600 - 500,000 Convertible debentures converted to common stock 100,000 1,000 - - - - 249,000 - 250,000 Series B and Series C preferred stock converted to common stock 140,900 1,400 - - (2,800) - (1,400) - - Common stock issued to retire liabilities 487,800 4,900 - - - - 753,200 - 758,100 Sale of common stock and common stock units 2,091,700 20,900 - - - - 3,712,900 - 3,733,800 Stock options exercised 8,200 100 - - - - (100) - - Common stock warrants issued - - 116,200 - - - 303,900 - 303,900 Common stock warrants exercised 294,200 2,900 (294,200) - - - 274,100 - 277,000 Series D preferred units sold - - - - 37,750 400 3,283,700 - 3,284,100 Series D preferred units converted 3,460,300 34,600 - - (33,350) (350) (34,250) - - Preferred stock of dissolved subsidiary - - - - - - 118,500 - 118,500 Capital contributed by ATPL - - - - - - 305,000 - 305,000 Net loss - - - - - - - (4,243,500) (4,243,500) -------------------------------------------------------------------------------------------------------- Balance at September 27, 1998 28,457,700 $284,600 162,000 $ - 15,350 $ 150 $55,885,250 $(53,823,000) $ 2,347,000 -------------------------------------------------------------------------------------------------------- Common stock issued to employee retirement plan 330,000 3,300 - - - - 496,900 - 500,200 Series B and Series C preferred stock converted to common stock 51,500 500 - - (1,050) - (500) - - Series D preferred units converted 206,100 2,000 - - (2,000) - 163,500 - 165,500 Common stock issued to retire liabilities 190,000 1,900 - - - - 280,600 - 282,500 Common stock issued to purchase shares of subsidiaries 1,127,500 11,300 - - - - 1,147,950 - 1,159,250 Sale of common stock and common stock units 4,536,400 45,400 - - - - 6,077,700 - 6,123,100 Common stock subscribed, 444,400 shares - - - - - - 600,000 - 600,000 Common stock options exercised 120,900 1,200 - - - - 131,200 - 132,400 Common stock warrants exercised 15,000 100 (15,000) - - - 13,900 - 14,000 Net loss - - - - - - - (9,115,700) (9,115,700) ------------------------------------------------------------------------------------------------------------ Balance at October 3, 1999 35,035,100 $350,300 147,000 - $ 12,300 $ 150 $64,796,500 $(62,938,700) $ 2,212,650 =============================================================================================================
See Accompanying Notes to Consolidated Financial Statements. Irvine Sensors Corporation Consolidated Statements of Cash Flows
Fiscal Year Ended ----------------------------------------------------------------------- October 3, September 27, September 28, 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net loss $(9,115,700) $(4,243,500) $(14,875,600) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation $ 911,450 $ 1,546,700 $ 2,994,500 (Gain) loss on disposal of equipment - (309,700) 5,873,400 Non-cash employee retirement plan contribution 500,200 500,000 445,500 Minority interest in net loss of subsidiaries (738,500) (365,200) - Extraordinary gain - (1,146,100) - Common stock issued to pay operating expenses 380,800 (261,700) - (Increase) decrease in accounts receivable (635,400) (528,400) 1,786,200 (Increase) decrease in inventory (687,100) 1,044,600 1,809,400 (Increase) decrease in other current assets (280,750) 989,400 (899,300) (Increase) decrease in other assets - (1,700) 151,000 Increase (decrease) in accounts payable and accrued expenses 1,837,200 (1,454,500) 1,463,300 (Decrease) in deferred revenues (50,000) (56,100) (2,276,500) Increase in royalties accrued- affiliated company 173,800 212,400 258,100 ----------- ----------- ----------- Total adjustments 1,411,700 169,700 11,605,600 ---------- ----------- ---------- Net cash used in operating activities (7,704,000) (4,073,800) (3,270,000) Cash flows from investing activities: Capital facilities and equipment expenditures (1,453,400) (390,800) (1,113,400) Proceeds from refund on equipment purchase - - 324,500 Proceeds from sale of equipment - 149,700 1,051,900 Acquisition of intangible assets (77,200) - - Net cash (used in) provided by investing activities (1,530,600) (241,100) 263,000 Cash flows from financing activities: Proceeds from issuance of common and preferred stock and common stock warrants 6,439,400 5,063,100 27,500 Sale of minority interest in subsidiary 2,661,100 - 2,918,100 Proceeds from stock sale by bank - 954,800 - Contributed capital by ATPL - 305,000 - Principal payments of notes payable and capital leases (195,200) (2,336,900) (253,300) ----------- ----------- ----------- Net cash provided by financing activities 8,905,300 3,986,000 2,692,300 --------- ----------- ---------- Net decrease in cash and cash equivalents (329,300) (328,900) (314,700) Cash and cash equivalents at beginning of period 1,310,400 1,639,300 1,954,000 ---------- ----------- ----------- Cash and cash equivalents at end of period $ 981,100 $ 1,310,400 $ 1,639,300 ========== =========== =========== Noncash investing and financing activities: Principal payment of note payable by issuance of common stock $ - $ 500,000 $ - ========== =========== =========== Conversion of debentures to common stock $ - $ 250,000 $ 3,150,000 Conversion of preferred ========== =========== =========== stock to common stock $ 500 $ 34,600 $ - ========== =========== =========== Exchange of subsidiary stock $ 987,650 $ 1,564,900 $ - ========== =========== =========== Equipment financed with capital leases $ 780,300 $ 170,000 $ - ========== =========== =========== Paid-in capital from dissolution of subsidiary $ $ 118,500 $ - ========== =========== =========== Stock issued in exchange for shares in subsidiary $ 171,600 $ - $ - ========== =========== =========== Stock sold on a subscription basis $ 600,000 $ - $ - ========== =========== =========== Costs of financing paid with options in subsidiaries $ 38,500 $ - $ - ========== =========== ===========
See Accompanying Notes to Consolidated Financial Statements. Irvine Sensors Corporation Notes to Consolidated Financial Statements Note 1 - Summary of Significant Accounting Policies CONSOLIDATION The consolidated financial statements include the accounts of Irvine Sensors Corporation (the Company) and its subsidiaries, Novalog, Inc. ("Novalog"), MicroSensors, Inc. ("MSI"), 3D Microelectronics, Inc., 3D MicroSystems, Inc., and Silicon Film Technologies, Inc. ("Silicon Film") (formerly Imagek, Inc.). Carson Alexiou Corporation ("CAC"), a former subsidiary of the Company, was dissolved in fiscal 1998. All significant intercompany transactions and balances have been eliminated in consolidation. FISCAL YEAR The Company's fiscal year ends on the Sunday nearest September 30. Fiscal 1999 (53 weeks) ended on October 3, 1999, fiscal 1998 (52 weeks) ended on September 27, 1998, and fiscal 1997 (52 weeks) ended on September 28, 1997. USE OF ESTIMATES The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The Company believes its estimates of inventory reserves and estimated costs to complete on contracts to be the most sensitive estimates impacting financial position and results of operations in the near term. REVENUES The Company's revenues were derived from shipments of functional memory stacks, shipments of the SIRComm(TM) infrared chip and the development and manufacture of prototype and sample products for its customers. The Company continues to contract to develop prototypes and provide research, development, design, testing and evaluation of complex detection and control defense systems. The Company's R&D contracts are usually cost plus fixed fee (best effort) or fixed price and revenues are recognized as costs are incurred and include applicable fees or profits primarily in the proportion that costs incurred bear to estimated final costs. Production orders for memory stacks and SIRComm chips are generally priced in accordance with the Company's established price list. The Novalog, MSI and Silicon Film subsidiaries are product-oriented companies with sales primarily to OEM manufacturers and revenues are recorded when products are shipped. The Company provides for anticipated losses on contracts by a charge to income during the period in which they are first identified. Unbilled accounts receivable are stated at estimated realizable value. United States government contract costs, including indirect costs, are subject to audit and adjustment by negotiations between the Company and government representatives. Indirect contract costs have been agreed upon through fiscal 1997. Contract revenues have been recorded in amounts that are expected to be realized upon final settlement. Other revenues in fiscal 1998 were derived from sale of intellectual property to ATPL. (See Note 7 - Related Party Transactions.) RESEARCH AND DEVELOPMENT COSTS A major portion of the Company's operations is comprised of customer-funded research and prototype development or related activities. The Company also incurs costs for research and development of new concepts in proprietary products. Such costs are charged to expense as incurred. INVENTORY Inventory is valued at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) basis. Inventories are reviewed quarterly to determine salability and obsolescence. A reserve is established for slow moving and obsolete items. EQUIPMENT, FURNITURE AND FIXTURES The Company capitalizes costs of additions to equipment, furniture and fixtures, together with major renewals and betterments. In addition, the Company capitalizes overhead and general and administrative costs for all in-house capital projects. Maintenance, repairs, and minor renewals and betterments are charged to expense. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized. Depreciation of equipment, furniture and fixtures is provided over the estimated useful lives of the assets, primarily using the straight-line method. The useful lives are three to seven years. Leasehold improvements are amortized over the terms of the leases. INTANGIBLE ASSETS The excess of total acquisition cost over the fair value of net assets acquired (goodwill) is being amortized on a straight-line basis over 15 years. The Company reviews the carrying value of goodwill for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Other acquired intangibles are being amortized on a straight-line basis over their estimated useful lives of 3 years. INCOME TAXES Deferred tax assets and liabilities are recorded for differences between the financial statement and tax basis of the assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is recorded for the amount of income tax payable or refundable for the period increased or decreased by the change in deferred tax assets and liabilities during the period. BASIC AND DILUTED NET LOSS PER SHARE Basic net loss per share is based upon the weighted average number of common shares outstanding. Diluted net loss per share is based on the assumption that options, warrants, and convertible preferred stock are included in the calculation of diluted earnings per share, except when their effect would be anti-dilutive. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS ADOPTED In fiscal 1999, the Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." SFAS No. 131 revised standards for the way that a public enterprise reports information about key revenue producing segments in the annual financial statements and selected information in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. All periods presented have been restated in accordance with this pronouncement. See Note 17 - - Reportable Segments. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 is required to be adopted for fiscal years beginning after June 15, 1999. Management does not expect the adoption of SFAS 133 to have a significant effect on earnings or the financial position of the Company. In April 1998, the American Institute of Certified Public Accountants' (AICPA) issued SOP 98-5, "Reporting on the Costs of Start-up Activities" (SOP 98-5). SOP 98-5 is required to be adopted for fiscal years beginning after December 15, 1998. Management does not expect the adoption of SOP 98-5 to have a significant effect on earnings or the financial position of the Company. STATEMENTS OF CASH FLOWS For purposes of the Consolidated Statements of Cash Flows, the Company considers all demand deposits and Certificates of Deposit with original maturities of 90 days or less to be cash equivalents. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reported in the balance sheets for cash and cash equivalents, accounts receivable and payable, other liabilities and debt approximate fair value. The fair value of royalties payable to affiliate is not determinable due to their related party nature. CONCENTRATION OF CREDIT RISK The Company has cash deposits at U.S. banks and financial institutions, which exceed federally insured limits at October 3,1999. The Company is exposed to credit loss for amounts in excess of insured limits in the event of non- performance by the institution; however, the Company does not anticipate non- performance. ACCOUNTING FOR STOCK-BASED COMPENSATION The Company accounts for stock-based employee compensation as prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees," and has adopted the disclosure provisions of Statement of Financial Accounting Standards 123, "Accounting for Stock-based Compensation" ("SFAS 123"). SFAS 123 requires pro forma disclosures of net income and net income per share as if the fair value based method of accounting for stock-based awards had been applied. Under the fair value based method, compensation cost is recorded based on the value of the award at the grant date and is recognized over the service period. RECLASSIFICATIONS Certain reclassifications have been made to the 1998 and 1997 fiscal year financial statements to conform to the current year presentation. Note 2 - Issuance of Common and Preferred Stock In a private financing during February and March 1996, the Company issued $11.1 million of 8 percent convertible subordinated debentures due in 1998 (the "1996 Debentures") to institutional and private investors in Canada and Europe. The 1996 Debentures were convertible into shares of common stock at varying rates which were contingent upon the closing bid prices of the common stock. The Company had the right to demand conversion of the 1996 Debentures at any time after March 1997. Interest was payable semiannually on January 31 and July 31 of each year. The gross proceeds less expenses were added to the Company's general funds. During fiscal 1997, the Company, at the request of bondholders, converted $3,150,000 of the outstanding 1996 Debentures at varying rates into 2,441,400 shares of the Company's common stock. With these conversions, all but $250,000 of the original issue of $11.1 million of the 1996 Debentures was retired. In May 1996, the Company had registered the resale of 2,997,000 shares of common stock which the Company then believed would be sufficient to cover the conversion of the entire $11.1 million series of 1996 Debentures and related warrants, which had been issued in February and March 1996. However, due to the decline in the price of the Company's common stock, the number of shares issued upon conversion of all the Debentures, exceeded the number of shares previously registered. In January 1998 the Company filed a registration statement which included the resale of 1,114,810 unregistered shares issued upon conversion of the 1996 Debentures. The Securities and Exchange Commission declared this registration effective in April 1998. In fiscal 1998, the Company forced conversion of the remaining $250,000 of outstanding 8 percent Convertible Subordinated Debentures into 100,000 shares of the Company's common stock. The common shares underlying the convertible debentures were included in the Company's January 1998 registration statement. In connection with settlement of bank debt, the Company issued 550,000 unregistered shares of common stock in December 1997. (See Note 10 - Extraordinary Item - Debt Extinguishment.) The Company began the sale of Series D Convertible Preferred Stock Units in a private placement to certain accredited investors in December 1997 and continued to accept subscriptions thereto through January 2, 1998, at which time, the Company sold an additional 24,750 Units. The Company issued an aggregate of 37,750 Units at a price of $100.00 per Unit and the net proceeds of $3,284,100 from the sale of these securities were added to the Company's general funds. The Series D Convertible Preferred Stock Units consist of one share of Convertible Preferred Stock, plus one five-year Warrant to purchase one share of common stock of Novalog, Inc., a subsidiary of the Company, and one five-year Warrant to purchase one share of common stock of MSI, a wholly-owned subsidiary of the Company (see Note 5). Each share of Convertible Preferred Stock is convertible into common stock of the Company at the rate of 100 shares of common stock for each share of Preferred D, subject to adjustment for stock splits, reverse stock splits and other similar recapitalization events. The Preferred D shares have no voting rights, except as required by law, and bear no dividends. (See Note 17 for calculation of beneficial conversion and imputed dividend resulting from issuance of Series D Convertible Preferred Stock.) The common shares underlying the Preferred D shares were included in the April 1998 registration statement. In connection with this private placement of 37,750 units, the Company granted to the placement agent a warrant to purchase up to 3,775 units of Series D Convertible Preferred Stock units at a price of $110 per unit which was 110 percent of the private placement price of the Units. The warrant is exercisable during the period beginning the earlier of one year from January 2, 1998 or the date of registration and expiring on January 2, 2003. The placement agent exercised warrants to purchase 500 units in May 1998 and 1,000 units in the period between October and December 1998. Additional warrants to purchase 500 units were exercised in March 1999. All of the proceeds were added to the Company's general funds. As of October 3, 1999, at the request of the holders thereof, a total of 35,350 shares of Series D Convertible Preferred Stock Units have been converted into 3,666,400 shares of common stock. In January 1998, the Board of Directors authorized a contribution to the Employee Stock Bonus Plan (the Company's ERISA-qualified Employee Retirement Plan). The amount represents an annual contribution for fiscal year 1998 and was made in 333,334 shares of the Company's common stock, which have been issued to the Plan. In January 1998, the Company sold 125,000 Common Stock Units to investors in a private placement. Each Common Stock Unit consists of one share of common stock of the Company, plus one five-year Warrant to purchase one share of common stock of Novalog, Inc., a subsidiary of the Company, and one five-year Warrant to purchase one share of common stock of MicroSensors, Inc., a wholly-owned subsidiary of the Company. The proceeds of $125,000 from these transactions were added to the Company's general funds. In January 1998, a warrant holder exercised outstanding warrants to purchase 222,000 shares of common stock at a price of $1.00 per share. The proceeds from this warrant exercise have been added to the Company's general funds. In April 1998, the Company issued, in a private placement to accredited investors, 700,000 unregistered shares of the Company's common stock. The net proceeds of $980,000 from this private placement have been added to the Company's general funds. In August 1998, holders of 1,128,000 shares of common stock of Novalog exercised warrants to exchange these shares for 905,000 unregistered shares of common stock of the Company resulting in an increase of $1,564,900 in total shareholders' equity and a corresponding decrease in minority interest in consolidated subsidiary. In fiscal 1998, distribution of vested benefits was made from the Company's Employee Retirement Plan to former employees. Subsequently, 1,819 shares of Series B and 1,010 shares of Series C Convertible Preferred stock were surrendered for conversion into 140,900 shares of common stock. The converted Preferred shares have been retired. In December 1998, the Board of Directors authorized a contribution to the Employee Stock Bonus Plan (the Company's ERISA-qualified Employee Retirement Plan). The amount represents an annual contribution for fiscal year 1999 and was made in 330,000 shares of the Company's common stock, which have been issued to the Plan. During fiscal 1999, the Company sold 4,980,800 shares of unregistered common stock of the Company to accredited investors in connection with a series of private placement offerings. Included in these offerings was the sale of 267,670 units, which consisted of two shares of unregistered common stock of the Company, one two-year warrant to purchase one share of common stock of Silicon Film owned by the Company and one three-year warrant to purchase one common share of MSI owned by the Company. The net proceeds were $6,439,400. During fiscal 1999, the Company issued 190,000 shares of unregistered common stock of the Company to vendors and consultants in exchange for services provided. During fiscal 1999, holders of 120,900 common stock options exercised their options to purchase unregistered common stock of the Company. The net proceeds were $132,400. During fiscal 1999, holders of 1,655,000 shares of common stock of Novalog exchanged these shares for 1,017,500 unregistered shares of common stock of the Company through warrant exercise and other means. These transactions resulted in a decrease of $1,038,000 to the minority interest liability. During fiscal 1999, the Company issued 110,000 shares of common stock of the Company to an unrelated party in exchange for an ownership interest in ATPL, a related party (See Note 7 - Related Party Transactions). The ownership interest includes 127,500 shares of common stock of Silicon Film and rights to future royalties under the ATPL license terms. The transaction resulted in recording goodwill of $171,600 related to the acquisition of the common stock of Silicon Film, and a net increase of $121,300 to shareholders' equity, which is net of losses previously allocated to minority interest shareholders. In October 1999, the Company filed a registration statement which included the resale of 8,270,731 unregistered shares; this registration statement included all previously unregistered shares that had been issued as of October 3, 1999. The Securities and Exchange Commission declared this registration effective in October 1999. Note 3 - Common Stock Warrants In connection with the sale of $11.1 million of the 1996 Debentures, the Company granted warrants to the foreign investment banker to purchase up to 222,000 shares of common stock at a price to be determined based on the average conversion prices of the 1996 Debentures. The warrants were exercised in fiscal 1998. In fiscal 1997 the Company granted warrants, the value of which it believes to be not material, to four consultants in varying amounts to purchase up to 118,000 shares of unregistered common stock at prices ranging from $0.9375 to $1.50. In fiscal 1998 the Company granted warrants, the value of which it believes to be not material, to five former employees in varying amounts to purchase up to 44,000 shares of unregistered common stock at a price of $1.00. Warrants to purchase 15,000 shares of common stock of the Company were exercised in 1999; the proceeds were $14,000. As of October 3, 1999, there are a total of 147,000 warrants outstanding of which 74,000 expire in the year 2000 and 73,000 expire in the year 2002. Note 4 - Series B and Series C Convertible Preferred Stocks The Series B and Series C Convertible Cumulative Preferred Stocks, which were originally issued to the Company's Employee Retirement Plan, each bear a 10 percent cumulative annual dividend, which under Delaware law may generally be paid only out of (i) retained earnings or (ii) net profit in the current or preceding fiscal year. To the extent that the dividends are not declared and paid in any fiscal year, the obligation carries over to the next fiscal year. These shares of Series B and Series C Convertible Cumulative Preferred Stocks are not redeemable, carry a liquidation preference over the common stock of $15.00 and $30.00, respectively, per share and are convertible, at the option of the holder, into 50 shares of common stock for each share of Series B and Series C Convertible Cumulative Preferred Stock, respectively. Distributions of vested benefits made from the Plan to former employees and the subsequent surrender and conversion into shares of common stock are as follows:
Preferred Stock Common Series B Series C Stock --------------------------------------------- Distribution dates: Fiscal 1997 50 200 12,600 Fiscal 1998 1,800 1,000 140,900 Fiscal 1999 500 500 51,500 --------------------------------------------- 2,400 1,700 205,000 =============================================
The shares of Preferred Series B and Series C tendered for conversion have been retired. Undeclared dividends of $103,600 and $105,700 on the remaining outstanding Preferred Series B and Series C, respectively, will be carried forward to fiscal 2000. Note 5 - Minority Interest in Subsidiaries During fiscal 1999, Silicon Film sold 83,900 shares of its Series A Convertible Preferred Stock (the "Series A Preferred") in a Private Placement. The Series A Preferred bears no yield, has a priority in liquidation and is convertible into common stock of Silicon Film, at the election of the holder, at the rate of 25 common shares (as adjusted for a price protection feature which was resolved by Silicon Film's Board of Directors on October 19, 1998) for each 1 share of Series A Preferred tendered for conversion. The net proceeds of $1,136,900 are reflected in the consolidated cash position of the Company and increased minority interest in consolidated subsidiaries. During fiscal 1999, Silicon Film sold 143,400 and 150,000 shares of its Series B Convertible Preferred Stock (the "Series B Preferred") to outsiders and to the Company, respectively, in a series of Private Placements. The Series B Preferred bears no yield, has a priority in liquidation and is convertible into common stock of Silicon Film, at the election of the holder, at the rate of 16-2/3 common shares for each 1 share of Series B Preferred tendered for conversion. The proceeds were $1,365,700, net of financing costs (includes $38,500 financing costs satisfied with noncash sources) and purchases by the Company, and are reflected in the consolidated cash position of the Company. The resulting increase in minority interest in consolidated subsidiaries was $1,365,700. Subsequent to October 3, 1999, Silicon film sold an additional 85,750 and 10,000 shares of its Series B Preferred Stock to outsiders and to ISC, respectively. The net cash proceeds were $957,500. During fiscal 1999, Silicon Film issued 85,000 options to purchase common shares of Silicon Film's stock at exercise prices ranging from $0.60 to $1.00 in exchange for various services. These transactions resulted in a net increase in minority interest liability of $98,300. During fiscal 1999, Silicon Film granted 3,311,500 options to employees, officers and directors to purchase common shares of Silicon Film's stock. As of October 3, 1999, there are 4,561,500 options outstanding, of which 466,700 are exercisable. As of October 3, 1999, Silicon Film has 720,000 warrants outstanding, all of which are exercisable at prices ranging from $0.60 to $2.00. The Company sold Series D Convertible Preferred Stock Units in a private placement to certain accredited investors in December 1997 and January 1998 (See Note 2 - Issuance of Common and Preferred Stock). During the second quarter of fiscal 1999, holders of 125,000 shares of Series D Convertible Preferred Stock Units exercised warrants attached to the Units to purchase 125,000 shares of common stock of MSI. The net proceeds of $125,000 were added to the Company's general funds and are reflected in the consolidated cash position of the Company. The transaction resulted in an increase in minority interest in consolidated subsidiaries of $125,000. During fiscal 1999, MSI granted 815,500 options to employees, officers and directors to purchase common shares of MSI's stock. As of October 3, 1999, there are 1,636,500 options outstanding, of which 235,600 are exercisable. During fiscal 1999, Novalog granted 625,000 options to employees, officers and directors to purchase common shares of Novalog's stock. As of October 3, 1999, there are 1,878,000 options outstanding, of which 797,200 are exercisable. Note 6 - Convertible Subordinated Debentures In a private financing during February and March 1996, the Company issued $11.1 million of 8 percent convertible subordinated debentures due in 1998 (the "1996 Debentures") to institutional and private investors in Canada and Europe. The 1996 Debentures were convertible into shares of common stock at varying rates which were contingent upon the closing bid prices of the common stock. The Company had the right to demand conversion of the 1996 Debentures at any time after March 1997. Interest was payable semiannually on January 31 and July 31 of each year. The 1996 Debentures were subordinated to prior payment of bank indebtedness of the Company. (See Note 2.) During fiscal 1997, the Company, at the request of bondholders, converted $3,150,000 of the outstanding 1996 Debentures at varying rates into 2,441,400 shares of the Company's common stock. With these conversions, all but $250,000 of the original issue of $11.1 million of the 1996 Debentures was retired. In fiscal 1998, the Company forced the conversion of these remaining 1996 Debentures into 100,000 shares of common stock. In May 1996, the Company had registered the resale of 2,997,000 shares of common stock which the Company then believed would be sufficient to cover the conversion of the entire $11.1 million series of 1996 Debentures and related warrants. However, due to the decline in the price of the Company's common stock, the number of shares issued upon conversion of all the Debentures, exceeded the number of shares previously registered. In January 1998 the Company filed a registration statement which included the resale of an additional 1,114,810 unregistered shares issued upon conversion of the 1996 Debentures. The Securities and Exchange Commission declared this registration effective in April 1998. Note 7 - Related Party Transactions In April 1980, the Company entered into an agreement with R & D Leasing Ltd. ("RDL"), a limited partnership in which the Company's Chairman of the Board and a Senior Vice-President are general partners with beneficial interests, to develop certain processes and technology related to chip stacking. The Company has exclusively licensed this technology from RDL. The Company's exclusive rights to the technology extend to all uses, both government and commercial. Since entering into the licensing agreement, the Company has accrued royalty obligations to RDL at the rate of 3.5 percent of all Company sales of chip stacks using the licensed technology. In addition, RDL is entitled to receive an amount equal to 7 percent of all royalties earned by the Company from sales of any such products by the Company's sublicensees, although to date, no such sublicensee royalty income has been earned. In October 1989, RDL agreed to defer its royalty claims and subordinate them with respect to all other creditors in exchange for options to purchase up to 1,000,000 shares of the Company's Common Stock, which are exercisable by applying the deferred royalties to the purchase. The 1,000,000 options are exercisable at $1.00 each until April 2000. If RDL exercises its option in whole or in part, title to RDL's technology would transfer to the Company and all further royalty obligations would cease. If the option expires unexercised, the subordination provisions would terminate and the accrued royalties would be due and payable in the same manner as any other corporate obligation. As of October 3, 1999, the Company had accrued $1,000,000 in deferred royalties pursuant to this agreement. Due to the RDL subordination, royalties accrued, but none were paid by the Company during fiscal years 1999, 1998 and 1997. The Company has entered into an Assignment of Patent and Intellectual Rights (the "Assignment") with F. L. Eide ("Eide"), a Vice-President of the Company. As part of his employment agreement, Eide has assigned to the Company all rights and interests to five (5) U.S. Provisional Patent applications owned by him. In consideration for this Assignment, Eide will receive a 1 percent royalty on the gross sales revenues of any products incorporating elements of the assigned technology for the lifetime of any patents resulting from the Provisional Patent Applications. This Assignment was executed in February 1998. In October 1997, the Company entered a License Agreement with Itzhak Sapir. Pursuant to which Sapir granted a royalty bearing exclusive, worldwide license under various U.S. and foreign patents owned by Sapir relating to digital photographic products, principally a product which allows an unmodified 35mm SLR camera to capture digital images. In connection with the Technology Assignment Agreement mentioned above, Silicon Film acquired all of the Company's rights under the License Agreement, and Sapir entered into an agreement with Silicon Film to such effect. In February 1999, Sapir became a senior mechanical engineer at Silicon Film. Effective March 26, 1999, Silicon Film issued Sapir a warrant (which vested in full upon issuance) to purchase 275,000 share of Silicon Film's common stock at a price of $1.00 per share in exchange for a reduction in Silicon Film's royalty obligation to Sapir under the License Agreement from their original levels to 1.5% of all EFS sales. During fiscal 1998, the Company entered into a sale and licensing of intellectual property rights agreement covering the Company's Electronic Film System(TM) ("EFS(TM)") to Advanced Technology Products, LLC ("ATPL"). The Company's Senior Vice President and Chief Technical Officer, John C. Carson, serves as Managing Member of ATPL. The Company was the successor to the licensed rights and future royalty obligations under this agreement until September 1998, when the Company granted Silicon Film a license to use the technology and intellectual property rights of the Company that are necessary to Silicon Film's business. Silicon Film has agreed to prospectively grant, upon the Company's request, a license to the Company to access Silicon Film's technology and intellectual property rights when necessary for the Company to participate in government contracts. In September 1998, another agreement was consummated with ATPL under which the future royalty obligation was reduced in consideration for the issuance of 1,222,125 shares of Silicon Film common stock. No value was recorded by Silicon Film as a result of this transaction due to the uncertainty related to valuing either the consideration given or received in this exchange. Note 8 - Composition of Certain Financial Statement Captions
October 3, September 27, 1999 1998 --------------------------------------- Accounts receivable: U.S. government $ 1,115,000 $ 1,235,300 Other customers 1,286,400 530,800 ---------------------------------------- $ 2,401,500 $ 1,766,100 ========================================
Accounts receivable include unbilled amounts of $452,600 and $886,200 at October 3, 1999 and September 27, 1998, respectively. Unbilled amounts represent contract revenues for which billings have not been presented to customers at year-end. These amounts are billed in accordance with applicable contract terms, usually within 30 days. Accounts receivable also includes billed retentions of $5,000 and $73,900 at October 3, 1999, and September 27, 1998, respectively. These amounts are normally collected upon final audit of costs by the U.S. government.
October 3, September 27, 1999 1998 --------------------------------------- Inventory: Raw materials $ 49,900 $ - Work in process 1,995,500 1,435,400 Finished goods 174,400 97,300 --------------------------------------- $ 2,219,800 $ 1,532,700 =======================================
Title to all inventories remains with the Company. Inventoried materials and costs relate to work in process on customers' orders and on the Company's generic module parts and memory stacks, which the Company anticipates it will sell to customers including potential R&D contracts. Work in process includes amounts that may be sold as products or under contracts. Such inventoried costs are stated generally at the total of the direct production costs including overhead. Inventory valuations do not include general and administrative expenses. Inventories are reviewed quarterly to determine salability and obsolescence. A reserve is established for slow moving and obsolete items.
October 3, September 27, 1999 1998 --------------------------------------- Equipment, furniture and fixtures: Engineering and production equipment $ 7,415,100 $ 7,553,700 Furniture and fixtures 438,300 409,500 Construction in progress 866,500 - Computer software programs 872,400 741,100 Leasehold improvements 808,800 777,000 --------------------------------------- 10,401,100 9,481,300 Less accumulated depreciation and amortization 6,854,200 7,257,300 --------------------------------------- $ 3,546,900 $ 2,224,000 ========================================
October 3, September 27, 1999 1998 --------------------------------------- Accrued expenses: Salaries and wages $ 335,600 $ 211,000 Vacation 267,300 235,700 Payroll taxes 16,100 14,700 Accounting fees 21,000 50,000 Royalties 75,000 - Other accrued expenses 37,600 111,000 --------------------------------------- $ 752,600 $ 622,400 =======================================
Note 9 - Commitments and Contingencies The Company leases certain facilities and equipment under cancelable and noncancelable capital and operating leases. Minimum payments under capital lease obligations and operating lease commitments existing at October 3, 1999 are as follows:
Capital Operating Fiscal Year Leases Leases - ----------- ------ ------ 2000 $ 419,100 $ 605,200 2001 383,300 618,700 2002 125,600 217,600 2003 - 207,500 2004 - 122,600 Thereafter - - ------------ ------------ Future minimum lease payments 928,000 $ 1,771,600 ============ Amounts representing interest (182,900) ------------ Present value of net minimum lease payments $ 745,100 ============
Total rental expense for operating leases amounted to $525,900, $559,000 and $1,685,200 for the fiscal years ended October 3, 1999, September 27, 1998, and September 28, 1997, respectively. Subsequent to October 3, 1999, Silicon Film obtained a revolving bank line of credit in the amount of $500,000. Unpaid principal advances bear interest at the bank's prime rate and are to be paid in full on April 1, 2000. The line of credit is guaranteed by the Chairman of Silicon Film's Board of Directors. Subsequent to October 3, 1999, Silicon Film obtained a promissory bridge note from their placement agent, which provides for advances totaling $750,000. Unpaid principal advances bear interest at 7.0% per annum. The unpaid principal balance plus accrued interest are due and payable on the earlier of 90 days from the date of the promissory bridge note (December 10, 1999) or the closing of Silicon Film's planned offering of equity securities. The promissory bridge note is unsecured. Note 10 - Extraordinary Item - Debt Extinguishment In December 1997, the Company executed a Forbearance Agreement with its lending bank whereby the Company agreed to accelerate repayment of the Note Payable to the bank. The current portion of the debt was reduced by $1,026,900, which was received from the sale of the assets in October 1997. The Company also agreed, among other requirements, to reduce the principal balance by payments of $250,000 in each of the calendar quarters ending December 1997 and March 1998 and thereafter to reduce the remaining balance by a minimum of $200,000 quarterly. Execution of the Forbearance Agreement also resulted in a waiver of the Company's financial covenant defaults and an amendment to the loan agreement eliminating such financial covenants on a prospective basis. In connection therewith, the Company pledged as collateral one million shares of Novalog, Inc. common stock held by the Company. The Company also paid down $500,000 of the Note with 550,000 shares of its stock and under the terms of the agreement, dependent on the market price of the shares when sold, the Company would receive a refund if the proceeds from the sale exceeded $500,000. Subsequently, the Company was informed by the bank that it sold the 550,000 shares and that the proceeds exceeded $500,000. After applying the proceeds to the then remaining balance of the note the bank, through September 27, 1998, remitted $772,000 to the Company and advised the Company that additional proceeds of $183,000 were to be remitted to the Company. The Company received these additional funds during fiscal 1999. The Company recorded the proceeds that exceeded $500,000 as paid-in capital. Note 11 - Income Taxes Deferred tax assets and liabilities are recorded for differences between the financial statement and tax basis of the assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is recorded for the amount of income tax payable or refundable for the period increased or decreased by the change in deferred tax assets and liabilities during the period. The tax effects of significant items comprising the Company's income tax calculation as of October 3, 1999 and September 27, 1998, are as follows:
October 3, September 27, 1999 1998 --------------------------------------- Current deferred tax assets: Reserves not currently deductible $ 1,591,000 $ 1,057,000 Long-term deferred tax assets: Operating loss carryforwards 19,988,000 16,763,000 Tax credit carryforwards 866,000 541,000 Valuation allowance (22,445,000) (18,361,000) --------------------------------------- Net deferred tax asset $ - $ - =======================================
The differences between the Company's effective income tax rate and the statutory U.S. federal income tax rate for the fiscal years ended October 3, 1999, and September 27, 1998, respectively, related primarily to the total valuation allowance changing $4,084,000 from September 27, 1998 to October 3, 1999 and $334,300 from September 28, 1997 to September 27, 1998. The provisions for income taxes for the fiscal years ended October 3, 1999, September 27, 1998, and September 28, 1997, consist of provisions for state income taxes of $2,800, $2,600 and $2,600, respectively. No provisions for federal income taxes have been made in these fiscal years due to the net operating losses. At October 3, 1999, the Company had net operating loss carryforwards of approximately $56,144,400 for financial reporting and federal income tax purposes expiring in varying amounts from fiscal year 1999 through fiscal year 2018, and $15,596,800 for California tax purposes expiring in varying amounts from fiscal year 1999 through fiscal year 2004, available to offset future federal and California taxable income. In addition, as of October 3, 1999, the Company had investment tax credits and qualified research credits of $328,000 and $489,000, respectively, expiring in varying amounts through fiscal year 2010 and available to offset future federal taxes. The ability of the Company to utilize the net operating loss and credit carryforwards may be restricted by certain provisions of the Internal Revenue Code due to changes in ownership of the Company's common stock. Note 12 - Stock Option Plans and Employee Retirement Plan In December 1991, the Board of Directors adopted the 1991 Stock Option Plan to replace 1981 Stock Option Plans, which had expired. This new Plan was approved by shareholders at the Company's Annual Meeting in February 1992. Under the 1991 Plan, options to purchase an aggregate of 675,000 shares of the Company's common stock may be granted to both key management employees and non-employee directors. Options granted may be either Incentive Stock Options or Nonstatutory Stock Options, and the requirements for participation, exercise price and other terms are similar to the 1981 Plans. As of October 3, 1999, options to purchase 238,100 shares at prices ranging from $0.98 (83,300 shares) to $1.50 (6,000 shares) were outstanding under the 1991 Plan, of which 129,000 were exercisable at October 3, 1999. In January 1995, the Board of Directors adopted the 1995 Stock Option Plan to replace the 1991 Plan, which was fully subscribed at the time. The 1995 Plan was approved by shareholders at the Company's Annual Meeting in February 1995. Under the 1995 Plan, options to purchase an aggregate of 700,000 shares of the Company's common stock may be granted to both key management employees and non- employee directors. In August 1997, the Board of Directors authorized an increase in the number of options to an aggregate of 1,650,000 shares, which was ratified by shareholders at the Company's Annual Meeting in February 1998. Options granted may be either Incentive Stock Options or Nonstatutory Stock Options, and requirements for participation, exercise price and other terms are similar to the 1991 Plan. As of October 3, 1999, options to purchase 1,510,400 shares at prices ranging from $0.98 (411,700 shares) to $6.25 (62,500 shares) were outstanding under the 1995 Plan, of which 730,700 were exercisable at October 3, 1999. In November 1998, the Board of Directors approved a new plan, "The 1999 Stock Option Plan." Under the 1999 Plan, options to purchase an aggregate of 1,000,000 shares of common stock may be granted to both key management employees and non-employee directors. The 1999 Plan was ratified by shareholders at the Company's Annual Meeting in February 1999. Options granted may be either Incentive Stock Options or Nonstatutory Stock Options. Requirements for participation, exercise price and other terms are similar to the 1991 and 1995 Plans. As of October 3, 1999, options to purchase 597,900 shares at prices ranging from $1.34 (13,400 shares) to $1.92 (115,000 shares) were outstanding under the 1999 Plan, of which 102,000 were exercisable at October 3, 1999. Stock option activity is summarized as follows:
Option Price Shares Per Share ------------------------------------ 1991 Plan: - ---------- Options outstanding at September 29, 1996 210,700 $4.28 to $8.625 Granted 143,000 1.4375 to 2.3125 Cancelled (76,500) 6.00 to 7.6875 Expired (51,700) 4.28 to 8.6520 -------------- Options outstanding at September 28, 1997 225,500 1.4375 to 7.75 Granted 120,000 1.50 to 2.4375 Exercised (8,300) 0.98 Cancelled (52,400) 1.50 to 7.50 Expired (25,000) 7.125 to 7.75 -------------- Options outstanding at September 27, 1998 259,800 0.98 to 7.50 Granted 27,000 1.3438 to 1.6876 Exercised (15,000) 0.98 to 1.4375 Cancelled (26,200) 1.50 to 1.5938 Expired (7,500) 7.50 -------------- Options outstanding at October 3, 1999 238,100 $0.98 to $1.50 ============== 1995 Plan: - ---------- Options outstanding at September 29, 1996 454,000 $5.00 to $8.50 Granted 1,053,000 0.98 to 2.3125 Cancelled (371,900) 1.00 to 8.50 --------------- Options outstanding at September 28, 1997 1,135,100 0.98 to 6.50 Granted 581,500 1.00 to 2.8750 Exercised (8,300) 0.98 Cancelled (57,300) 1.00 to 6.25 --------------- Options outstanding at September 27, 1998 1,651,000 0.98 to 6.50 Granted 23,900 0.98 to 1.15 Exercised (114,300) 1.4687 to 1.6876 Cancelled (50,200) 1.00 to 6.50 ------------------- Options outstanding at October 3, 1999 1,510,400 $0.98 to $6.25 =================== 1999 Plan: - ---------- Options outstanding at September 27, 1998 - - Granted 622,900 $1.3438 to $1.9219 Cancelled (25,000) 1.3594 to 1.5313 ------------------- Options outstanding at October 3, 1999 597,900 $1.3438 to $1.9219 ===================
A summary of outstanding options exercisable under the 1991, 1995 and 1999 Stock Option Plans is shown below.
Weighted average Range of Number remaining contractual Weighted average Number Weighted average exercise prices outstanding life (years) exercise price exercisable exercise price - --------------------------------------------------------------------------------------------------------------------------------- $ 0.98 - 1.98 2,244,900 2 $1.39 875,200 $1.31 2.31 - 2.88 29,000 2 2.53 14,000 2.46 5.00 - 6.25 72,500 1 6.08 72,500 6.08 ------------ ----------- 2,346,400 961,700 ============ ===========
Pursuant to SFAS No. 123 "Accounting for Stock Based Compensation," the Company is required to disclose the effects on the net loss and per share data as if the Company had elected to use the fair value approach to account for all of its employee stock-based compensation plans. Had the compensation cost for the Company's Plans been determined using the fair value method, the compensation expense would have had the effects of increasing the Company's net loss for the years ended October 3, 1999, September 27, 1998 and September 28, 1997, to the pro forma amounts of $9,733,100, $4,754,000, and $15,041,000, respectively, with a corresponding pro forma loss per share of $0.31, $0.19, and $0.73, respectively. These pro forma amounts were determined estimating the fair value of each option granted during fiscal 1999, 1998 and 1997 on its grant date, using the Black-Scholes option-pricing model. Assumptions of no dividend yield, a risk-free interest rate of 6 percent which approximates the Federal Reserve Board's rate for treasuries at the time granted, an expected life of three years, and volatility rates varying from 86.9 to 73.2 percent were applied to options granted during fiscal years 1999, 1998 and 1997. The weighted average fair value at the grant date for the options granted during fiscal years 1999, 1998 and 1997 was $0.92, $1.57 and $0.75 per option, respectively. In fiscal 1982, the Company established an Employee Retirement Plan, which is effective for fiscal year 1982 and thereafter. The plan provides for annual contributions to the Company's Stock Bonus Trust (SBT) to be determined by the Board of Directors and which will not exceed 15 percent of total payroll. At the discretion of the Trustee, the SBT will purchase common stock at fair market value or other interest-bearing securities or investments for the accounts of individual employees who will gain a vested interest of 20 percent in their accounts after three years of service, and 20 percent each year of service thereafter, until fully vested after seven years of service. That portion of cash or stock held in an employee's account and not vested at termination of employment will be redistributed in accordance with a prearranged formula. Management believes that the contributions made by the Company to the SBT, to the extent they relate to government cost-plus-fixed-fee contracts, will be reimbursable by the U.S. government. In fiscal years 1999, 1998 and 1996 the Company's contributions to the SBT were 330,000, 333,300 and 347,600 shares of common stock, respectively, which had estimated market values of $500,200, $500,000 and $445,500 respectively. Note 13 - Revenues In fiscal 1999, contracts with all branches of the U.S. government accounted for 18 percent of the Company's revenues, and a second-tier government contract with a prime government contractor accounted for 19 percent. The remaining 63 percent of the Company's revenues were derived from non-government sources. Of the 18 percent related to the U.S. government agencies, the U.S. Army, the U.S. Air Force and the U.S. Navy accounted for 54 percent, 9 percent and 6 percent, respectively, with the remaining revenue of 31 percent being widely diversified among several other governmental agencies. Of the 36 percent applicable to non- governmental sources, 2 customers accounted for 33 percent and 29 percent, respectively, of the total commercial revenues In fiscal 1998, contracts with all branches of the U.S. government accounted for 27 percent of the Company's revenues, and a second-tier government contract with a prime government contractor accounted for 27 percent. The remaining 46 percent of the Company's revenues were derived from non-government sources. Of the 27 percent related to the U.S. government agencies, the U.S. Army, the U.S. Air Force and the U.S. Navy accounted for 24 percent, 12 percent and 8 percent, respectively, with the remaining revenue of 56 percent being widely diversified among several other governmental agencies. Of the 46 percent applicable to non- governmental sources, three (3) customers accounted for 35 percent, 14 percent and 7 percent, respectively, of the total commercial revenues. In fiscal 1997, contracts with all branches of the U.S. government accounted for 43 percent of the Company's revenues, and the remaining 57 percent of the Company's revenues was derived from non-government sources. Of the 43 percent applicable to the U.S. government, there were three agencies of the government that accounted for 55 percent, 13 percent and 11 percent. Other government agencies accounted for the remaining 21 percent. Of the 57 percent applicable to non-government sources, two customers accounted for 49 percent and 39 percent of the revenues. Note 14 - Deferred Revenues In fiscal 1998, the Company received prepayments from customers related to services and products that had not been delivered as of the balance sheet date. Revenues were recorded in fiscal 1999 upon delivery of these services and products. Note 15 - Acquisition and Disposal of Equipment On April 19, 1996, the Company consummated an agreement for the acquisition and operation of the equipment comprising IBM's cubing line located at IBM's Essex Junction, Vermont facility. The cubing line was established by IBM to manufacture the stacked-chip assemblies required to commercialize the Company's proprietary chip-stacking technology under the joint development alliance that IBM and the Company entered into in 1992. According to the terms of the agreement, the Company acquired the equipment and clean room, which comprises the cubing line for a cash payment of approximately $6.5 million. In addition, the Company signed a facility lease agreement for the space required to operate the cubing line under the Company's management within the IBM facility through December 1998. The terms of the facility lease agreement include escalating rent payments, which have been straight lined for financial reporting purposes. The difference between the amount paid and the amount expensed during fiscal 1996 has been reported as accrued rent. The agreement was terminated in fiscal 1997 and the deferred rent balances were netted against rent expense. As part of the process to terminate the agreement with IBM, the Company disposed of the equipment acquired from IBM in April 1996 and other fixed assets purchased and/or constructed at the IBM facility. These assets with a net book value of $6,925,300 were sold for proceeds of $1,051,900, resulting in a loss on the disposal of $5,873,400. During October 1997, $1,026,000 of these proceeds were received by the Company's lender and applied against the principal of the Company's long-term debt. In December 1997, the Company made a $490,000 cash payment to extinguish its remaining obligations under a Settlement Agreement. Accordingly, the Company recorded an extraordinary gain of $1,146,100 on the extinguishment of debt and reduced accounts payable by the corresponding amounts. Note 16 - Loss Per Share As the Company had a net loss from continuing operations for 1999, 1998 and 1997, basic and diluted net loss per share are the same. Net loss applicable to common stockholders for fiscal 1998 includes $465,300 for the non-cash imputed dividend related to the beneficial conversion feature on 24,750 Units of the Series D Convertible Preferred stock. (See Note 2 - Issuance of Common and Preferred Stock.) The beneficial conversion feature is computed as the difference between the quoted market price of a share of common stock on date of issue and the conversion price times all shares of preferred stock sold and under option. The imputed dividends are a non-cash, one-time charge based on the immediate conversion feature. Basic and diluted net loss per common share for fiscal years 1999, 1998 and 1997 were calculated as follows:
1999 1998 1997 ---------------------------------------------------------------------- Net loss $(9,115,700) $(4,243,500) $(14,875,600) Preferred Stock cumulative dividend (20,100) (20,700) (18,700) Preferred Stock imputed dividend - (465,300) - ---------------------------------------------------------------------- Net loss available to Common Stockholders $(9,135,800) $(4,729,500) $(14,894,300) ====================================================================== Basic & diluted net loss per share: $ (0.29) $(0.19) $ (0.73) ====================================================================== Weighted average number of shares outstanding 31,244,300 24,597,700 20,475,100 ======================================================================
Note 17 - Reportable Segments The Company has the following 5 reportable segments as of October 3, 1999: Advanced Technology Division (ATD), Novalog, MSI, Silicon Film and Corporate Headquarters. ATD derives most of its revenues from research and development contracts funded primarily by governmental agencies. Novalog designs, develops and sells proprietary integrated circuits ("ICs") and related products for use in wireless infrared communication. MSI develops and sells proprietary micromachined sensors and related electronics. Silicon Film designs and develops proprietary electronic films systems and other digital imaging products and services. Corporate Headquarters provides accounting, inventory control and management consulting services to the consolidated subsidiaries. Corporate revenue consists of charges to the subsidiaries for these services and corporate assets consist of loans to subsidiaries and goodwill for reacquisition of subsidiary stock. The accounting policies used to develop segment information correspond to those described in the summary of significant accounting policies. Segment profit or loss is based on profit or loss from operations before income taxes and minority interest in profit and loss of subsidiaries. The reportable segments are distinct business units operating in different industries, except the Corporate Headquarters segment, which spans the activities of the other segments. Each segment is separately managed, with separate marketing and distribution systems. The following information about the 5 segments is for the year ended October 3, 1999.
Silicon Corporate ATD Novalog MSI Film Headquarters Other Totals ------------ ----------- ------------ ------------ ------------- ---------- ------------- Revenues from external customers $ 4,080,700 $6,787,900 $ 197,300 $ 1,600 $ - $ 32,700 $ 11,100,200 Intersegment revenue - - - - 2,320,000 - 2,320,000 Interest revenue - 2,100 - 4,600 31,700 - 38,600 Interest expense - 500 3,700 1,600 97,800 700 104,300 Depreciation 694,950 118,100 58,400 32,000 - 8,000 911,450 Segment profit (loss) (2,275,200) 481,800 (2,641,400) (4,132,600) (536,600) (747,400) (9,851,400) Segment assets 5,816,200 2,392,900 503,100 1,517,500 12,721,100 109,050 23,059,850 Expenditures for segment assets 1,163,900 58,400 349,200 748,000 - 55,400 2,374,800 Reconciliation to Consolidated Amounts Revenues Total revenues for reportable segments $ 13,420,200 Elimination of intersegment revenues (2,320,000) ------------ Total consolidated revenues $ 11,100,200 ============ Assets Total assets for reportable segments $ 23,059,850 Elimination of intersegment assets (12,549,500) Total consolidated assets $ 10,510,350 ============
During fiscal 1998, the Company had the following 6 reportable segments: ATD, CPO, Novalog, MSI, Silicon Film and Corporate Headquarters. The following information about the 6 segments is for the year ended September 27, 1998.
Silicon Corporate ATD CPO Novalog MSI Film Headquarters Other Totals ------------ -------- ------------ ------------ ----------- -------------- ---------- ----------- Revenues from external customers $ 7,231,900 $352,700 $ 1,026,100 $ 300,000 $ - $ - $ 403,800 $ 9,314,500 Intersegment revenue - - - - - 1,911,000 - 1,911,000 Interest revenue - - 2,500 - - 10,000 - 12,500 Interest expense - 107,400 900 - - 157,900 - 266,200 Depreciation 1,221,100 166,700 108,300 - - 50,600 - 1,546,700 Segment profit (loss) (1,694,300) 99,000 (1,636,300) (1,080,400) (1,042,200) (172,700) (225,300) (5,752,200) Segment assets 5,728,100 65,900 710,500 233,200 321,400 27,631,800 5,600 34,696,500 Expenditures for segment assets 533,400 - 15,900 11,500 - - - 560,800 Reconciliation to Consolidated Amounts Revenues Total revenues for reportable segments $ 11,225,500 Elimination of intersegment revenues (1,911,000) ------------ Total consolidated revenues $ 9,314,500 ============ Assets Total assets for reportable segments $ 34,695,500 Elimination of intersegment assets (27,631,800) ------------ Total consolidated assets $ 7,064,700 ============
During fiscal 1997, the Company did not have operating segments for which separate financial information was produced internally to evaluate performance and allocate resources. Irvine Sensors Corporation Report of Independent Certified Public Accountants To the Board of Directors Irvine Sensors Corporation Costa Mesa, California - -------------------------------------------------------------------------------- We have audited the accompanying consolidated balance sheets of Irvine Sensors Corporation as of October 3, 1999 and September 27, 1998, and the related consolidated statements of operations, shareholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Irvine Sensors Corporation as of October 3, 1999 and September 27, 1998, and the consolidated results of its operations and its consolidated cash flows for the years then ended, in conformity with generally accepted accounting principles. Grant Thornton LLP Irvine, California December 21, 1999 Report of Independent Accountants To the Board of Directors and Shareholders of Irvine Sensors Corporation In our opinion, the consolidated statements of operations, of shareholders' (deficit) and of cash flows for the year ended September 28, 1997 present fairly, in all material respects, the results of operations and cash flows of Irvine Sensors Corporation and its subsidiaries for the year ended September 28, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with generally accepted auditing standards, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Costa Mesa, California December 16, 1997 Irvine Sensors Corporation Corporate Information Directors James Alexiou/1,2/, Chairman of the Board, Irvine Sensors Corporation John C. Carson, Senior Vice-President, Irvine Sensors Corporation Joanne S. Carson, Secretary, Irvine Sensors Corporation Marc Dumont/1/, Financial Advisor James D. Evert/1/, President and CEO, Irvine Sensors Corporation Walter E. Garrigan/2/, Financial Advisor General Frank P. Ragano/1/, Chairman and CEO of CMS, Inc., a manufacturer of defense munitions Wolfgang Seidel/1/, Principal, Seidel and Partner, a management consulting firm Vincent F. Sollitto Jr./2/, President and CEO of Photon Dynamics Inc., a manufacturer of electronic capital equipment /1/Member of the Compensation Committee /2/Member of the Audit Committee Officers John C. Carson, Senior Vice-President Joanne S. Carson, Secretary Floyd K. Eide, Vice-President James D. Evert, President and Chief Executive Officer John J. Stuart, Jr., Senior Vice-President, Chief Financial Officer and Treasurer Executive Offices Irvine Sensors Corporation, 3001 Redhill Avenue, Building III, Costa Mesa, California 92626 Counsel Grover T. Wickersham, P.C., Wickersham Law Offices, 430 Cambridge Avenue, Suite 100, Palo Alto, California 94306 Independent Certified Grant Thornton LLP Public Accountants Irvine, California Transfer Agent ChaseMellon Shareholder Services, 400 S. Hope St., 4th Floor, Los Angeles, California 90071 www.chasemellon.com Stock Data Nasdaq Listing: Common Stock - IRSN Boston Stock Exchange Listing: Common Stock - ISC Form 10-K Shareholders may obtain without charge a copy of the Company's Annual Report on Form 10-K for the fiscal year ended October 3,1999, as filed with the Securities and Exchange Commission, without exhibits thereto, and may obtain any exhibit thereto upon payment of a nominal copying charge, by writing to Joanne S. Carson, Secretary, Irvine Sensors Corporation, 3001 Redhill Avenue, Costa Mesa, California 92626. EX-21.1 3 SUBSIDIARIES OF THE REGISTRANT Subsidiaries of the Registrant - ------------------------------ Exhibit 21.1 ------------ Novalog, Inc. 3001 Redhill Ave., Building 4 Costa Mesa, California 92626 MicroSensors, Inc. 3001 Redhill Ave., Building 4 Costa Mesa, California 92626 Silicon Film Technologies, Inc. 16265 Laguna Canyon Road Irvine, California 92618 3D-Microelectronics, Inc. 3001 Redhill Ave., Building 3 Costa Mesa, California 92626 3D-Microsystems, Inc. 3001 Redhill Ave., Building 3 Costa Mesa, California 92626 EX-23.1 4 CONSENT OF GRANT THORNTON LLP CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS - --------------------------------------------------- Exhibit 23.1 ------------ We hereby consent to the incorporation by reference in the Prospectus constituting part of this Registration Statement on Form S-8 (No. 2-85501) of Irvine Sensors Corporation of our report dated December 21, 1999 which appears on page 22 of the Annual Report to Shareholders which is incorporated by reference in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedules, which appears on page 22 of this Form 10-K. /s/ GRANT THORNTON LLP Irvine, California December 21, 1999 EX-23.2 5 CONSENT OF PRICEWATERHOUSECOOPERS LLP CONSENT OF INDEPENDENT ACCOUNTANTS - ---------------------------------- Exhibit 23.2 ------------ We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 2-85501) of Irvine Sensors Corporation of our report dated December 16, 1997 relating to the financial statements, which appears in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated December 16, 1997 relating to the financial statement schedules, which appears in this Form 10-K. /s/ PRICEWATERHOUSECOOPERS LLP PricewaterhouseCoopers LLP Costa Mesa, California December 28, 1999 EX-27 6 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S FORM 10-K FOR THE YEAR ENDED OCTOBER 3, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS OCT-3-1999 SEP-28-1998 OCT-3-1999 981,100 0 2,401,500 36,700 2,219,800 6,640,850 10,401,100 6,854,200 10,510,350 5,375,300 0 150 0 350,300 64,796,500 10,510,350 7,017,900 11,100,200 5,197,600 20,885,900 0 0 104,300 (9,112,900) 2,800 (9,115,700) 0 0 0 (9,115,700) (0.29) (0.29)
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