EXHIBIT 13
Irvine Sensors Corporation
Annual Report 1997
Irvine Sensors Corporation
Financial Highlights
Fiscal Year Ended
-------------------------------------------------------------------------
September 28, September 29, October 1, October 2, October 3,
1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------
Revenues $ 13,693,200 $ 12,024,200 $ 8,041,400 $ 5,139,400 $ 4,286,300
=========================================================================
Loss from operations $(14,809,200) $(11,154,700) $(3,071,500) $(2,629,500) $(1,552,100)
=========================================================================
Net loss $(14,875,600) $(15,914,700) $(4,137,500) $(2,463,900) $(1,507,600)
=========================================================================
Net loss per common and
common equivalent share $ (0.73) $ (0.94) $ (0.28) $ (0.18) $ (0.12)
=========================================================================
Weighted average number of
shares outstanding 20,475,100 16,874,300 14,966,500 14,141,500 12,865,800
=========================================================================
Long-term debt $ 1,207,000 $ 3,165,600 $ 201,200 $ 81,100 $ 62,600
=========================================================================
Convertible debt $ 250,000 $ 3,400,000 $ 2,250,000 $ - $ -
=========================================================================
Total assets $ 9,449,300 $ 21,742,200 $15,609,200 $10,355,400 $ 3,897,500
=========================================================================
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 NasdaqStock Market. These prices
represent prices among dealers, do not include retail markups, markdowns or
commissions, and may not represent actual transactions:
Fiscal Year Ended
--------------------------------------------------
September 28, 1997 September 29, 1996
------------------------- -----------------------
High Low High Low
--------------------------------------------------
Common Stock Bid Prices
First Quarter $1-1/2 $0-27/32 $9-1/2 $5-1/4
Second Quarter $1-9/16 $1 $6-1/4 $4-5/8
Third Quarter $1-5/32 $0-31/32 $7-7/8 $4-5/8
Fourth Quarter $1-9/16 $1-7/32 $5-1/8 $2-1/4
On December 19, 1997, there were approximately 823 stockholders of record and
7,200 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.
Dear Shareholder:
________________________________________________________________________________
Fiscal 1997 saw major changes for Irvine Sensors Corporation. A new President
and Chief Executive Officer was named, the IBM cubing line was shut down and
MicroSensors, Inc. (MSI), a new subsidiary, was created. Although the full
effect of these changes will not be visible until fiscal 1998, some results were
already measurable at the end of fiscal 1997. Fiscal 1997 revenues reached a
record $13.7 million from $12 million in fiscal 1996. Fiscal 1997 losses of
$14.9 million, nearly a record, included almost $6 million of one-time, noncash
write-downs resulting from the shutdown of the IBMcubing line late in the year.
Excluding this plant closure cost, fiscal 1997 losses from operations were
reduced by more than $2 million compared to fiscal 1996.
Both the record revenues and near-record losses in fiscal 1997 were dominated by
results from our Vermont operations. Both effects will be largely gone in fiscal
1998, which is expected to see revenue growth from other segments of our
business replace much of the lost revenue from Vermont without the corresponding
losses. With the termination of the Vermont operations and a reduction in costs
in California, we expect major improvement in operating results in the new
fiscal year beginning with the first quarter.
In order to focus on areas with the most immediate prospects for return, major
changes were made in the management team, emphasizing marketing and commercial
skills, areas in which we have been woefully weak. This emphasis has already
produced expanded business opportunities for us, both in new types of stacked
memories targeted toward more price-sensitive markets and in the growing market
for microsensors which MSI is addressing.
MSI is an outgrowth of our years of government-funded R&D related to very-low-
noise readout electronics. This technology is highly desired by the rapidly
emerging commercial markets for MicroElectroMechanical Systems (MEMS). MEMS
devices encompass a variety of tiny, silicon and metal structures, built on
semiconductor lines, which perform functions as diverse as deploying airbags,
controlling printer heads and measuring blood pressure. Analysts project the
global MEMS market will grow to well over $10 billion annually by the year 2000.
A key enabler of these markets will be the ability to measure and control these
devices with very-low-noise electronics such as MSI has pioneered. MSI has
received its first commercial contract, the design and manufacture of a multi-
channel readout chip for EG&G Astrophysics, a major supplier of airport security
systems. Its technology has also led MSI to a patent-pending microgyro design
that could potentially offer a breakthrough combination of price and performance
to the automobile industry. The engineering design of such a product is
underway.
Although Novalog, Inc., our first commercial subsidiary, has been extremely
successful in adding to its list of "design-wins," it has been faced with a
wireless infrared market that is growing more slowly than expected. However,
recent increases in order rates from large customers suggest that these delays
may be ending. To position Novalog for its anticipated growth, approximately 10
percent of Novalog's stock was sold for approximately $2 million, a $20 million
valuation that is double that of the original Novalog private placement.
With the drain of the Vermont operations behind us, management and financial
resources can now turn toward the other parts of our business. We have an
extensive inventory of technologies with emerging commercial relevance, assets
which should become increasingly visible in fiscal 1998.
/s/ JAMES ALEXIOU /s/ JAMES D. EVERT
- --------------------- ---------------------
James Alexiou James D. Evert
Chairman of the Board President and CEO
December 22, 1997
The statements in this report that are forward-looking are dependent on risks
and uncertainties including such factors, among others, as the development risks
inherent in new technology, the impact of competitive technologies and the pace
at which new markets develop. Further information on Irvine Sensors Corporation
is contained in publicly filed disclosures available through the SEC's EDGAR
database (http://www.sec.gov) or from the Company's Investor Relations.
1
Irvine Sensors Corporation
Management's Discussion and Analysis of Financial Condition and Results of
Operations
________________________________________________________________________________
Results of Operations
FISCAL YEAR ENDED SEPTEMBER 28, 1997 vs.
FISCAL YEAR ENDED SEPTEMBER 29, 1996
Revenues in fiscal 1997 of $13,693,200 showed an increase of $1,669,000 or 14
percent compared to fiscal 1996. This increase was primarily attributable to the
Company's Advanced Technology Operations in Costa Mesa. In mid-fiscal year the
Company announced the closing of its Vermont facilities due to the lower than
required revenue base and high fixed cost of operations. In comparing revenues
generated by excluding the Vermont operations, fiscal 1997 revenues were
$6,604,700 compared to $5,460,300 in fiscal 1996, an increase of 21 percent.
Cost of revenues of $17,573,100 in fiscal 1997 was $435,500 higher than in
fiscal 1996; however, as a percentage of revenues, fiscal 1997 showed an
improvement of 14 percentage points over fiscal 1996. Operations excluding
Vermont recorded cost of revenues of $6,586,500 in fiscal 1997 compared to
$6,757,800 in fiscal 1996, a reduction of $171,300 or three percentage points.
In fiscal 1997, cost of revenues included a charge of $1,156,100 to increase the
Company's inventory reserve for, first: Wide Word SRAM memory cubes the Company
has been producing for future deliveries pursuant to an anticipated contract
which has not yet materialized and, second: slower than anticipated sales of its
Flash memory cubes.
General and administrative expenses were reduced by $592,300 in fiscal 1997
compared to fiscal 1996, and research and development expenses were also reduced
by $393,100 in fiscal 1997 compared to fiscal 1996.
These combined reductions of $1,156,700 in cost of sales, general and
administrative, and research and development reflect actual cost reductions
accomplished in fiscal 1997 while management re-structured the Company to take
advantage of new product opportunities and to expand the Company's traditional
customer R&D base.
With the decision to close the Vermont facilities, the Company incurred a loss
of $5,873,400 in fiscal 1997 related to the sale of the surplus facilities and
equipment.
Interest income declined by $69,000 in fiscal 1997 primarily related to the
Vermont facilities.
The Company originally accounted for its convertible debentures in accordance
with APB 14, "Accounting for Convertible Debt and Debt Issued with Stock
Purchase Warrants." However, the Securities and Exchange Commission (SEC) staff
has indicated that convertible debt instruments which are convertible at a
discount from market should be accounted for by treating the maximum discount as
interest expense with an offset to paid-in capital. In November 1997, the
Company was advised that past issuers of such securities have recently restated
prior financial statements to comport with the SEC view. In conformance
therewith, the Company has calculated noncash interest expense of $4,396,700
with a like amount added to paid-in capital in the second quarter of fiscal
1996. The Company also recorded a noncash interest expense of $1,101,700 in the
fourth quarter of fiscal 1995 related to convertible debentures issued in fiscal
1995 which were convertible at a discount from the market price of the common
stock. Because of the offsetting nature of these entries, there is no effect on
Shareholders' equity.
Net loss of $14,875,600 in fiscal 1997 was $1,039,100 lower than the net loss
reported for fiscal 1996. On a comparable basis, excluding plant closure costs
in fiscal 1997, and noncash debenture interest in fiscal 1996, the adjusted net
loss excluding the Vermont operations was $3,381,100 in fiscal 1997 compared to
$5,520,500 in fiscal 1996 - an overall improvement of $2,139,400.
FISCAL YEAR ENDED SEPTEMBER 29, 1996 vs.
FISCAL YEAR ENDED OCTOBER 1, 1995
The Company continued in fiscal 1996 with record-setting revenues of
$12,024,200, which represents a 50 percent increase from fiscal 1995. The growth
in revenues was primarily attributable to increases in shipments of products
from the Company's Computer Products Operations (CPO) in Vermont and, to a
lesser extent, shipments of the Company's new serial infrared communications
chip (SIRComm) from the Company's subsidiary, Novalog, Inc. The SIRComm chip has
continued to gain market acceptance since its introduction in late fiscal 1995.
The increase in shipments from CPO was a result of substantial increases in
bookings that began in the second half of fiscal 1995 combined with the
continued ramp-up in production of stacked memory products achieved
2
Irvine Sensors Corporation
Management's Discussion and Analysis of Financial Condition and Results of
Operations
________________________________________________________________________________
during fiscal 1996. The increase in product revenues was offset slightly by a
decrease in contract revenues which was primarily attributable to procurement
delays related to the Company's Advanced Technology Operations (ATO). ATO, which
is largely dependent on contracts from the U.S. government's military agencies
and subcontracts from major government contractors, continued to be adversely
impacted during fiscal 1996 by delays in contracts funding and awards caused by
the federal government's budget crisis earlier in the year. The Company
anticipates some delays in contract funding and awards to be rectified in the
first quarter of fiscal 1997.
Other revenues were derived from a license agreement with Unitrode Corporation
which involves the transfer of technology allowing Unitrode to produce Novalog's
SIRComm chip.
Cost of revenues as a percentage of revenues for fiscal year 1996 was 143
percent as compared to 90 percent in fiscal year 1995. The increase was
attributable to the Company's inability to absorb additional indirect costs
incurred while it ramped up its revenue-generating capacities during fiscal
1996. A substantial escalation of overhead costs occurred at CPO as a result of
the IBM cubing line acquisition and facility lease, the completion of the joint
development activities with IBM to commercialize the Company's chip-stacking
technology, and from efforts to ramp up production of stacked memory products to
meet existing backlog requirements and projected bookings. After management's
review of the existing backlog of orders at CPO for stacked memory cubes and the
anticipated cost to complete such orders at CPO, the Company, in keeping with
its policy to recognize losses when they are first identified, established a
reserve at September 29, 1996, for the estimated loss upon completion of these
orders. The anticipated future loss which would be incurred upon completion of
the manufacturing process and shipment to the customer was charged to cost of
revenues in fiscal 1996 and the corresponding credit was recorded as an increase
to the work in process inventory reserve to be applied as a reduction of the
manufacturing cost in fiscal 1997 when product will be made and shipped to the
customer. This accrued loss resulted in a reduction of the inventory valuation
at September 29, 1996. Funding delays on existing contracts and the delays in
obtaining new contracts created under-absorbed costs at ATO. The increase in
costs of revenues was offset slightly by Novalog's improved margins experienced
during fiscal 1996 attributable to efficiencies realized from the increase in
shipments of its SIRComm chip. The Company anticipates the cost of revenues
ratio to improve during fiscal 1997 at CPO resulting from anticipated
manufacturing efficiencies and at ATO attributable to improved backlog of funded
research and development contracts.
The Company increased its expenditure in research and development by $729,700 or
57 percent compared to fiscal 1995. The increase was primarily attributable to
efforts directed at developing new products.
During fiscal 1996, the Company experienced growth in its administrative
infrastructure in conjunction with the increase in business activity and the
anticipation of future growth driven by the transition to a products-based
company. General and administrative (G&A) expense increased $1,497,400 compared
to fiscal 1995. As a percentage of revenues, G&A was 34 percent in fiscal 1996
compared to 32 percent in fiscal 1995. The increase in G&A expense is primarily
attributable to additional marketing costs associated with promoting the
Company's products and efforts directed toward obtaining new research and
development contract awards. In addition, the Company incurred non-recurring
legal expense in connection with negotiation of the IBM cube line acquisition
and facility lease, and negotiation of its bank loan financing activities, and
in the incorporation of its subsidiary, Novalog, Inc.
Interest expense increased $413,900 during fiscal 1996 compared to fiscal 1995.
The increase in interest expense was primarily attributable to interest incurred
on subordinated debenture bonds (see Note 6 of Notes to Consolidated Financial
Statements) and, to a lesser extent, interest on capital lease obligations
incurred primarily during fiscal 1995. Interest income increased slightly from
fiscal 1995 as a result of additional cash and cash equivalents held in deposits
during fiscal 1996 which were obtained from the financing activities discussed
above.
The Company originally accounted for its convertible debentures in accordance
with APB 14, "Accounting for Convertible Debt and Debt Issued with Stock
Purchase Warrants." However, the Securities and Exchange Commission (SEC) staff
has indicated that convertible debt instruments which are convertible at a
discount from market should be accounted for by treating the maximum discount as
interest expense with an offset to paid-in capital. In November 1997, the
Company was advised that past issuers of such securities have recently restated
prior financial statements to comport with the SEC view. In conformance
therewith, the Company has calculated noncash interest expense of $4,396,700
with a like amount added to paid-in capital
3
Irvine Sensors Corporation
Management's Discussion and Analysis of Financial Condition and Results of
Operations
________________________________________________________________________________
in the second quarter of fiscal 1996. The Company also recorded a noncash
interest expense of $1,101,700 in the fourth quarter of fiscal 1995 related to
convertible debentures issued in fiscal 1995 which were convertible at a
discount from the market price of the common stock. Because of the offsetting
nature of these entries, there is no effect on Shareholders' equity.
Net loss for fiscal 1996 was $15,914,700 compared to $4,137,500 in fiscal 1995
and net loss per share went from ($0.28) per share in fiscal 1995 to ($0.94) per
share in fiscal 1996.
Liquidity, Capital Resources and Impact of Changing Prices
The primary uses of cash and cash equivalents during fiscal 1997 were to support
the winding down and exit from the Vermont facility and funding of the Company's
net loss, which also included R&D and start-up costs for its MicroSensors, Inc.
subsidiary. In addition, during fiscal 1997, the Company sold $4.1 million of
common stock in Novalog for a total of a 31 percent minority interest.
At September 28, 1997, the Company had cash and cash equivalents of $1,639,300,
and subsequent to September 28, 1997, has obtained $1,148,000 cash in additional
equity financing. The Company anticipates that the existing working capital and
its projected operating results will meet its cash requirements for the
immediate future and for the growth of its subsidiary businesses.
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. In 1983
the Company experienced such termination of one of its contracts. 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 September 28, 1997, the Company's funded backlog, excluding the Vermont
operations, was approximately $1,902,800 compared to $1,800,000 at September 29,
1996. 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 $4,308,000 as of December 1,
1997.
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.
4
Irvine Sensors Corporation
Consolidated Balance Sheet
September 28, September 29,
1997 1996
- ---------------------------------------------------------------------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 1,639,300 $1,954,000
Accounts receivable, net of allowances
of $10,000 1,237,700 3,023,900
Inventory 2,577,300 4,386,700
Other current assets 1,182,900 283,600
-------------------------------------
Total current assets 6,637,200 9,648,200
-------------------------------------
Equipment, furniture and fixtures, net 2,775,800 11,906,700
Other assets 36,300 187,300
-------------------------------------
$ 9,449,300 $21,742,200
=====================================
Liabilities and Shareholders' Equity (Deficit)
Current Liabilities:
Accounts payable $ 4,370,800 $2,197,800
Accrued expenses 684,700 936,100
Deferred revenue 106,100 2,382,600
Notes payable and current portion of long-term debt 2,234,000 270,600
-------------------------------------
Total current liabilities 7,395,600 5,787,100
-------------------------------------
Long-term debt 593,200 2,809,900
Deferred royalties payable - affiliated company 613,800 355,700
Convertible subordinated debentures 250,000 3,400,000
Preferred stock of consolidated subsidiary 118,500 118,500
Minority interest in consolidated subsidiary 3,418,100 500,000
Long-term accrued expenses - 458,300
Commitments and Contingencies
Shareholders' Equity (Deficit):
Preferred stock, $0.01 par value, 500,000 shares authorized;
8,785 shares Series B Convertible Cumulative Preferred
outstanding; aggregate liquidation preference of $237,200 50 50
4,974 shares Series C Convertible Cumulative Preferred
outstanding; aggregate liquidation preference of $253,700 50 50
Common stock, $0.01 par value, 40,000,000 shares authorized;
21,541,300 and 18,710,000 shares issued and outstanding 215,400 187,100
Common stock warrants; 340,000 and 239,200 issued and
outstanding - -
Paid-in capital 46,424,100 42,829,400
Accumulated deficit (49,579,500) (34,703,900)
-------------------------------------
Total shareholders' equity (deficit) (2,939,900) 8,312,700
-------------------------------------
$ 9,449,300 $ 21,742,200
=====================================
See accompanying Notes to Consolidated Financial Statements.
5
Irvine Sensors Corporation
Consolidated Statement of Operations
Fiscal Year Ended
--------------------------------------------
September 28, September 29, October 1,
1997 1996 1995
- --------------------------------------------------------------------------------------------
Revenues--contract research and development $ 5,821,100 $ 3,614,300 $ 5,844,700
Product sales 7,872,100 8,283,900 2,032,300
Other - 126,000 164,400
--------------------------------------------
Total revenues 13,693,200 12,024,200 8,041,400
--------------------------------------------
Costs and expenses:
Cost of contract revenues 5,737,800 4,694,400 5,030,800
Cost of product sales 11,835,300 12,443,200 2,267,900
General and administrative 3,439,300 4,031,600 2,534,200
Research and development 1,616,600 2,009,700 1,280,000
Loss related to plant closure 5,873,400 - -
--------------------------------------------
28,502,400 23,178,900 11,112,900
--------------------------------------------
Loss from operations (14,809,200) (11,154,700) (3,071,500)
Interest expense (443,600) (469,800) (55,900)
Interest income 39,300 108,300 92,600
Noncash interest expense related to
convertible debentures - (4,396,700) (1,101,700)
--------------------------------------------
Loss before minority interest and
provision for income taxes (15,213,500) (15,912,900) (4,136,500)
Minority interest in loss of subsidiary (340,500) - -
Provision for income taxes 2,600 1,800 1,000
--------------------------------------------
Net loss $ (14,875,600) $(15,914,700) $(4,137,500)
============================================
Net loss per common and
common equivalent share $ (0.73) $ (0.94) $ (0.28)
============================================
Weighted average number of
shares outstanding 20,475,100 16,874,300 14,966,500
============================================
See accompanying Notes to Consolidated Financial Statements.
6
Irvine Sensors Corporation
Consolidated Statement of Shareholders' Equity (Deficit)
Common Stock Common Stock Preferred Stock
Shares Issued Warrants Issued Shares Issued Total
----------------- ---------------- ---------------- Paid-in Accumulated Shareholders'
Number Amount Number Amount Number Amount Capital (Deficit) Equity (Deficit)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at October 2, 1994 14,710,700 $147,100 291,200 $- 16,190 $ 200 $23,304,800 $(14,651,700) $ 8,800,400
-------------------------------------------------------------------------------------------------------
Stock options exercised 103,100 1,000 - - - - 219,900 - 220,900
Common stock issued to
employee retirement plan 68,000 700 - - - - 471,600 - 472,300
Sale of common stock 382,100 3,800 - - - - 1,933,500 - 1,937,300
Common stock warrants issued - - 79,700 - - - - - -
Common stock warrants
exercised 244,000 2,500 (244,000) - - - 1,096,500 - 1,099,000
Series B and Series C
preferred stock converted
to common stock 58,900 600 - - (1,177) - (600) - -
Net loss - - - - - - - (4,137,500) (4,137,500)
Additional paid-in capital
related to convertible
debentures - - - - - - 1,101,700 - 1,101,700
-------------------------------------------------------------------------------------------------------
Balance at October 1, 1995 15,566,800 $155,700 126,900 $- 15,013 $ 200 $28,127,400 $(18,789,200) $ 9,494,100
-------------------------------------------------------------------------------------------------------
Stock options exercised 257,100 2,600 - - - - 209,100 - 211,700
Common stock issued to
employee retirement plan 172,900 1,700 - - - - 685,700 - 687,400
Common stock warrants issued - - 222,000 - - - - - -
Common stock warrants
exercised 109,700 1,100 (109,700) - - - 293,400 - 294,500
Series B and Series C
preferred stock converted
to common stock 50,100 500 - - (1,002) (100) (400) - -
Convertible debentures
converted to common stock 2,553,400 25,500 - - - - 9,117,500 - 9,143,000
Net loss - - - - - - - (15,914,700) (15,914,700)
Additional paid-in capital
related to convertible
debentures - - - - - - 4,396,700 - 4,396,700
-------------------------------------------------------------------------------------------------------
Balance at September 29,
1996 18,710,000 $187,100 239,200 $- 14,011 $ 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 - - (252) - (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 $- 13,759 $ 100 $46,424,100 $(49,579,500) $ (2,939,900)
=======================================================================================================
See accompanying Notes to Consolidated Financial Statements.
7
Irvine Sensors Corporation
Consolidated Statement of Cash Flows
Fiscal Year Ended
----------------------------------------
September 28, September 29, October 1,
1997 1996 1995
- --------------------------------------------------------------------------------
Cash flows from operating activities:
Cash received from customers $ 15,479,400 $ 11,388,300 $ 7,237,900
Cash paid to suppliers and employees (18,342,500) (19,008,200) (10,457,200)
Interest received 39,300 108,300 92,600
Interest paid (443,600) (469,800) (55,900)
Income taxes paid (2,600) (1,800) (1,000)
------------ ------------ ------------
Net cash used in operating
activities $ (3,270,000) $ (7,983,200) $ (3,183,600)
Cash flows from investing activities:
Marketable securities, at cost - - 4,447,500
Capital facilities and equipment
expenditure (1,113,400) (8,525,200) (3,105,500)
Proceeds from refund on equipment
purchase 324,500 - -
Proceeds from sale of equipment 1,051,900 - -
------------ ------------ ------------
Net cash provided by (used in)
investing activities 263,000 (8,525,200) 1,342,000
Cash flows from financing activities:
Principal payments under notes
payable and capital lease
obligations (253,300) (217,100) (131,600)
Proceeds from issuance of long-term
debt - 3,013,200 395,800
Proceeds from issuance of convertible
subordinate debentures - 10,293,000 2,250,000
Minority interest in subsidiary 2,918,100 500,000
Proceeds from issuance of common
stock and common stock warrants 27,500 506,200 3,257,200
------------ ------------ ------------
Net cash provided by financing
activities 2,692,300 14,095,300 5,771,400
------------ ------------ ------------
Net increase (decrease) in cash and
cash equivalents (314,700) (2,413,100) 3,929,800
Cash and cash equivalents at beginning
of year 1,954,000 4,367,100 437,300
------------ ------------ ------------
Cash and cash equivalents at end of
year $ 1,639,300 $ 1,954,000 $ 4,367,100
============ ============ ============
Reconciliation of net loss to net cash
used in operating activities:
Net loss $(14,875,600) $(15,914,700) $ (4,137,500)
Adjustments to reconcile net loss to
net cash used in operating
activities:
Depreciation and amortization $ 2,994,500 $ 2,268,100 $ 1,004,600
Loss on sale of capital facilities
and equipment 5,873,400 - -
Common stock issued to employee
retirement plan 445,500 687,400 472,300
Noncash interest expense related to
convertible debentures - 4,396,700 1,101,700
(Increase) decrease in accounts
receivable 1,786,200 (635,900) (803,500)
(Increase) decrease in inventory 1,809,400 (1,455,800) (2,677,800)
(Increase) decrease in other
current assets (899,300) (42,100) (168,400)
(Increase) decrease in other assets 151,000 (155,200) (20,900)
Increase in accounts payable and
accrued expenses 1,921,600 1,159,900 828,000
Increase (decrease) in deferred
revenue (2,276,500) 1,017,600 1,174,200
Increase (decrease) in accrued rent (458,300) 458,300 -
Increase in royalties accrued -
affiliated company 258,100 232,500 43,700
------------ ------------ ------------
Total adjustments 11,605,600 7,931,500 953,900
------------ ------------ ------------
Net cash used in
operating activities $ (3,270,000) $ (7,983,200) $ (3,183,600)
============ ============ ============
Noncash investing and financing
activities:
Common stock issued to employee
retirement plan $ 445,600 $ 687,400 $ 472,300
------------ ------------ ------------
Capitalized lease obligations $ - $ 3,200 $ 395,800
------------ ------------ ------------
Conversion of debentures to common
stock $ 3,150,000 $ 10,450,000 $ -
------------ ------------ ------------
Noncash interest expense related to
convertible debentures $ - $ 4,396,700 $ 1,101,700
------------ ------------ ------------
See accompanying Notes to Consolidated Financial Statements.
8
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., MicroSensors,
Inc., 3D Microelectronics, Inc., 3D MicroSystems, Inc. and Carson Alexiou
Corporation (CAC). 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 1997
(52 weeks) ended on September 28, 1997, fiscal 1996 (52 weeks) ended on
September 29, 1996, and fiscal 1995 (52 weeks) ended on October 1, 1995.
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.
REVENUES
The Company's revenues were derived from shipments of functional memory stacks
from its Vermont facility, shipments of the SIRComm 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 and MicroSensors 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
1994. Contract revenues have been recorded in amounts which are expected to be
realized upon final settlement.
Other revenues in fiscal 1996 and 1995 were derived from a licensing agreement
with Unitrode to transfer technology required to produce the Company's
SIRComm chip. (See Note 14 - Technology Licenses.)
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 in 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 saleability 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.
Expenditures for repairs and maintenance were $275,100, $369,500 and $210,800 in
fiscal years 1997, 1996 and 1995, respectively.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (FAS 109). Under the
liabilities method specified by FAS 109, the deferred tax assets and liabilities
are measured each year based on the difference between the financial statement
and tax bases of assets and liabilities at the applicable enacted tax rates.
Additionally, a valuation allowance is recorded for that portion of deferred tax
assets for which it is more likely than not that the assets will not be
realized. The deferred tax provision is the result of changes in the deferred
tax assets and liabilities.
EARNINGS PER SHARE
Computations of primary earnings per share are based on the weighted average
number of shares of common stock outstanding, including dilutive stock options,
convertible preferred stock and common stock warrants where applicable.
9
Irvine Sensors Corporation
Notes to Consolidated Financial Statements
________________________________________________________________________________
STATEMENT OF CASH FLOWS
For purposes of the Consolidated Statement 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 sheet 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.
ACCOUNTING FOR STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123), which establishes financial accounting and reporting
standards for stock-based employee compensation. Under SFAS 123, companies are
encouraged, but not required, to adopt a method of accounting for stock
compensation awards based upon the estimated fair value at the date the
options/awards are granted as determined through the use of a pricing model (the
"Fair Value Method"). Companies continuing to account for such awards in
accordance with the existing guidance of Accounting Principles Board Option No.
25, "Accounting for Stock Issued to Employees" (APB 25), have to disclose in the
notes to their financial statements the pro forma impact on net income and net
income per share had they utilized the Fair Value Method. This statement is
effective for the Company in fiscal year 1997. The Company continues to account
for stock compensation awards in accordance with APB 25, with the appropriate
footnote disclosure required under SFAS 123.
IMPAIRMENT OF LONG-LIVED ASSETS
In March 1995, The Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121, "Accounting For the Impairment of Long-
Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121), which
establishes accounting standards for the impairment of long-lived assets to be
reviewed whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. In addition, SFAS 121 requires that
certain long-lived assets be reported at the lower of carrying amount or fair
value less cost to sell. The Company adopted SFAS 121 in fiscal 1997. The
adoption of SFAS 121 had no significant impact on its consolidated financial
position or results of operations.
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). SFAS
128 simplifies the standards for computing Earnings per Share (EPS), eliminating
the presentation of primary EPS (currently required by Accounting Principles
Board Opinion No. 15, "Earnings per Share") and requiring dual presentation of
basic and diluted EPS on the face of the income statement for all public
corporations with complex capital structures. SFAS 128 is effective for
financial statements for both interim and annual periods ending after December
15, 1997. Early adoption is not permitted, although pro forma disclosure is
optional. SFAS 128 is not expected to have a significant impact on per share
data.
NOTE 2 - ISSUANCE OF COMMON STOCK AND SERIES A PREFERRED STOCK
In August 1995, the Company completed the sale of approximately 382,100
unregistered shares of the Company's common stock in a private financing
pursuant to Regulation S to institutional and private investors in Canada and
Europe. The Company agreed to use its best efforts to register these shares for
subsequent resale by the holders thereof. After regulatory requirements were met
by holders of these securities, restrictive legends on these shares were removed
and the shares could then be traded without restrictions. The net proceeds of
approximately $1.9 million were added to the Company's general fund.
During fiscal 1995, the Company issued 103,100 shares of common stock to ten
employees and one non-employee director upon exercise of options granted under
the Company's Stock Option plans.
Net proceeds of $220,900 were added to the Company's general fund.
During fiscal 1996, the Company issued 257,100 shares of common stock to seven
employees, two of whom are officers and one officer-director, and three non-
employee directors upon exercise of options granted under the Company's Stock
Option Plans. Net proceeds of $211,700 were added to the Company's general fund.
In conjunction with the fiscal 1995 private financing of $2.25 million of 8
percent convertible subordinated debentures (the "1995 Debentures"), the Company
issued an additional $500,000 of 1995 Debentures in October 1995 to
institutional investors in Europe. The gross proceeds less expenses were added
to the Company's general funds. During fiscal 1996, the Company, at the request
of bondholders, converted the entire $2.75 million of outstanding 1995
Debentures at varying rates into 509,400 shares of the Company's common stock,
which were subsequently registered and may be traded without restrictions.
10
Irvine Sensors Corporation
Notes to Consolidated Financial Statements
________________________________________________________________________________
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 are convertible into shares of common stock at varying rates
which are contingent upon the closing bid prices of the common stock. The
Company has the right to demand conversion of the 1996 Debentures at any time
after March 1997. Interest is payable semiannually on January 31 and July 31 of
each year. The 1996 Debentures are subordinated to prior payment of bank
indebtedness of the Company. 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
pursuant to conversions through September 28, 1997, exceeded this registration.
Furthermore, the Company projects that approximately 100,000 additional
unregistered shares could be required to convert the remaining outstanding 1996
Debentures at September 28, 1997. The Company is currently in the process of
preparing a new registration statement to register the resale of the additional
shares issued and issuable pursuant to 1996 Debenture conversions, which have
not yet been sold subject to Rule 144.
Note 3 - Common Stock Warrants
In July 1992, the Company consummated a public offering of 750,000 shares of
common stock and granted the Underwriter an option to purchase up to 112,500
additional shares of common stock to cover over-allotments. In connection with
this offering, the Company granted to the Underwriter warrants to purchase up to
75,000 shares of common stock at a price of $5.10 per share, which was 120
percent of the public offering price of the shares. The warrants are exercisable
during the four-year period beginning July 9, 1993, and expiring July 8, 1997.
During fiscal 1995, 57,800 of these warrants were exercised. The remaining
17,200 were not exercised and expired on July 8, 1997.
In February 1993 and July 1993, the Company granted warrants to two consultants
to purchase 25,000 and 30,000 unregistered shares of common stock at prices of
$4.72 and $8.875 per share, respectively, in connection with services rendered.
The shares underlying these warrants were registered in fiscal 1995 and the
prices reduced to $4.50 per share. The warrant for 25,000 shares was exercised
in fiscal 1995 and the warrant for 30,000 shares was exercised in fiscal 1996.
In connection with the February 1994 sale of approximately 1.36 million shares
of common stock to investors in Canada and Europe, the Company granted warrants
to the foreign investment banker to purchase up to 136,200 shares of common
stock at an average price of $8.23 per share. In fiscal 1995, the price was
reduced to $4.50 per share and the warrants were exercised.
In February 1994, the Company granted a warrant to its legal counsel to purchase
25,000 unregistered shares of common stock at a price of $8.75 per share in
connection with services rendered. In fiscal 1995, the price was reduced to
$4.50 per share and the warrant was exercised.
In connection with the August 1995 sale of approximately 382,100 shares of
common stock and the issuance of approximately $2.75 million of the 1995
Debentures, the Company granted to the foreign investment banker warrants to
purchase up to approximately 79,700 shares of common stock at prices ranging
from $7.47 to $8.33 per share. In fiscal 1996, the price was reduced to $2.00
per share and the warrants were exercised.
In connection with the sale of $11.1 million of the 1996 Debentures in February
and March 1996, 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 are
exercisable beginning March 1997.
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.
As of September 28, 1997, there are a total of 340,000 warrants outstanding of
which 15,000 expire in August 2000, 222,000 expire in March 2001 and 103,000
expire between February and June 2002.
11
Irvine Sensors Corporation
Notes to Consolidated Financial Statements
________________________________________________________________________________
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:
October 1994 880 297 58,900
March 1996 522 480 50,100
January 1997 48 204 12,600
-----------------------------
1,450 981 121,600
=============================
The shares of Preferred Series B and Series C, respectively, tendered for
conversion have been retired. Undeclared dividends of $105,400 and $104,500 on
the remaining outstanding Preferred Series B and Series C, respectively, will be
carried forward to fiscal 1998.
Note 5 - Preferred Stock of Consolidated Subsidiary
The preferred stock outstanding represents an ownership interest in CAC by
former employees and an Employee Stock Bonus Plan which CAC had formed. The
preferred stock has a $100 par value and there are 1,400 shares authorized and
1,185 shares issued and outstanding. There are no conversion rights or
liquidation preferences of this preferred stock which extend to the common stock
of the Company.
Note 6 - Convertible Subordinated Debentures
In July, August and October 1995, the Company issued in a private financing
$2.75 million of 8 percent convertible subordinated debentures (the "1995
Debentures") due in 1997 to institutional and private investors in Canada and
Europe. The 1995 Debentures were convertible into shares of common stock at
$6.50 per share, subject to adjustment under certain conditions. The Company had
the right to demand conversion of the 1995 Debentures at any time after July 31,
1996. Interest was payable semi-annually on January 31 and July 31 of each year.
The 1995 Debentures were subordinated to prior payment of bank indebtedness of
the Company. The gross proceeds less expenses were added to the Company's
general funds. The Company registered the shares underlying the 1995 Debentures
and in fiscal 1996 the 1995 Debentures were converted into 509,400 shares of the
Company's common 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 are convertible into shares of common stock at varying rates
which are contingent upon the closing bid prices of the common stock. The
Company has the right to demand conversion of the 1996 Debentures at any time
after March 1997. Interest is payable semiannually on January 31 and July 31 of
each year. The 1996 Debentures are subordinated to prior payment of bank
indebtedness of the Company. The gross proceeds less expenses were added to the
Company's general funds. In May 1996, the Company filed a registration statement
covering 2,997,000 shares, the approximate number of shares estimated to underly
the 1996 Debentures and related warrants based on the then projected trading
range of the Company's stock.
The Company originally accounted for its convertible debentures in accordance
with APB 14, "Accounting for Convertible Debt and Debt Issued with Stock
Purchase Warrants." However, the Securities and Exchange Commission (SEC) staff
has indicated that convertible debt instruments which are convertible at a
discount from market should be accounted for by treating the maximum discount as
interest expense with an offset to paid-in capital. In November 1997, the
Company was advised that past issuers of such securities have recently restated
prior financial statements to comport with the SEC view. In conformance
therewith, the Company has calculated noncash interest expense of $4,396,700
with a like amount added to paid-in capital in the second quarter of fiscal
1996. The Company also recorded a noncash interest expense of $1,101,700 in the
fourth quarter of fiscal 1995 related to convertible debentures issued in fiscal
1995 which were convertible at a discount from the market price of the common
stock. Because of the offsetting nature of these entries, there is no effect on
Shareholders' equity.
12
Irvine Sensors Corporation
Notes to Consolidated Financial Statements
________________________________________________________________________________
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
pursuant to conversions through September 28, 1997, exceeded this registration
by 1,710,400 and the resale of such shares is presently unregistered.
Furthermore, the Company projects that approximately 100,000 additional
unregistered shares could be required to convert the remaining outstanding 1996
Debentures at September 28, 1997. The Company is currently in the process of
preparing a new registration statement to register the resale of the additional
shares issued and issuable pursuant to 1996 Debenture conversions.
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 CEO and a Senior Vice-
President are general partners with beneficial interests, to design an
electronic circuit, to develop certain fabrication processes and to build
equipment for testing electronic integrated circuits. In connection with the
development of the electronic test equipment under the RDL agreement, certain
other proprietary fabrication processes were developed to which RDL retained
ownership. Upon the occurrence of certain specified events, such as the use of
patented fabrication processes in connection with contracts, the agreement with
RDL provides that the Company will pay RDL a royalty fee of 3.5 percent of
revenues from sales of the basic devices using the processes created during the
development of this equipment. In June 1989, the Board of Directors approved an
agreement with RDL whereby $40,000 of royalty fees was converted to a long-term
note payable and a warrant to purchase shares of the Company's common stock. The
note was unsecured, bore no interest and had a due date of June 30, 1995. The
warrant to purchase 200,000 shares of common stock at $0.20 per share had an
expiration date of June 30, 1995. In October 1989, the Board of Directors
approved an amendment to the RDL agreement limiting the royalty fees under
certain circumstances and deferring and subordinating all royalty claims with
respect to all other creditors for an initial period of five years. The
amendment allows the Company, at RDL's option, to pay up to $250,000 of accrued
royalties in shares of the Company's common stock at a price of $0.50 per share.
In the event that RDL extends the period to ten years the amount would be
increased to $1,000,000 and the price would increase to $1.00 per share. Should
RDL exercise its option to accept payment in shares of the Company's common
stock, in whole or in part, title to RDL's technology would transfer to the
Company and future royalty obligations would cease. In fiscal 1994, RDL extended
the period to ten years.
In October 1990, the Company and RDL consummated an agreement in which full
settlement of the $40,000 note payable was arranged. RDL forgave $20,000 of the
Company's $40,000 debt, evidenced by the aforementioned $40,000 note payable,
and surrendered its warrant to purchase 200,000 shares of the Company's stock in
exchange for a cash payment of $5,000 and 200,000 unregistered shares of the
Company's common stock. As of September 28, 1997, the Company owed RDL $613,800
in deferred royalty fees.
Note 8 - Composition of Certain Financial Statement Captions
September 28, September 29,
1997 1996
-----------------------------
Accounts receivable:
U.S. government $1,145,100 $1,608,800
Other customers 92,600 1,415,100
-----------------------------
$1,237,700 $3,023,900
=============================
Accounts receivable includes unbilled amounts of $600,900 and $1,151,600 at
September 28, 1997, and September 29, 1996, 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
retention of $28,700 and $63,000 at September 28, 1997, and September 29, 1996,
respectively. These amounts are normally collected upon final audit of costs by
the U.S. government.
September 28, September 29,
1997 1996
-----------------------------
Inventory:
Raw materials $ 185,400 $ 537,900
Work in process 2,382,900 2,862,300
Finished goods 9,000 986,500
-----------------------------
$2,577,300 $4,386,700
=============================
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
13
Irvine Sensors Corporation
Notes to Consolidated Financial Statements
________________________________________________________________________________
generic module parts and memory stacks which the Company anticipates it will
sell to customers. 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.
September 28, September 29,
1997 1996
-----------------------------
Equipment, furniture and fixtures:
Engineering and production
equipment $7,252,200 $16,615,800
Furniture and fixtures 330,700 353,300
Computer software programs 598,100 739,900
Leasehold improvements 765,400 900,700
-----------------------------
8,946,400 18,609,700
Less accumulated depreciation
and amortization 6,170,600 6,703,000
-----------------------------
$2,775,800 $11,906,700
=============================
Engineering and production equipment includes approximately $209,800 of
capitalized leases. Accumulated amortization of capitalized leases amounted to
$108,300 and $66,300 at September 28, 1997, and September 29, 1996,
respectively.
September 28, September 29,
1997 1996
-----------------------------
Accrued expenses:
Salaries and wages $267,800 $353,900
Vacation 217,700 236,900
Payroll taxes 58,300 57,100
Accounting fees 47,600 55,800
Accrued rent - 91,700
Other accrued expenses 93,300 140,700
-----------------------------
$684,700 $936,100
=============================
Note 9 - Notes Payable
Current and long-term debt consists of the following:
September 28, September 29,
1997 1996
----------------------------
Note payable to bank bearing
interest at prime (8.5 percent
at September 28, 1997) plus
1.5 percent due in monthly
installments of $63,400
beginning May 1997 $2,819,200 $3,000,000
Capitalized lease
obligations maturing at
various dates through 1997 8,000 80,500
Less current portion 2,234,000 270,600
----------------------------
$ 593,200 $2,809,900
============================
In accordance with a Forbearance Agreement executed subsequent to September 28,
1997, between the Company and the bank, the Company has agreed to accelerate
repayment of the Note Payable to the bank. The current portion of the debt
includes $1,026,900 due from the sale of assets which was received by the bank
in October 1997. The Company has also agreed, among other requirements, to
reduce the principal balance by $250,000 cash in each quarter ending December
1997 and March 1998 and thereafter to reduce the remaining balance by a minimum
of $200,000 quarterly.
The long-term portion of $593,200 comprises principal note payments of $93,200
due in fiscal 1999 and $500,000 that will be refinanced with the issuance of the
Company's common stock pursuant to the Forbearance Agreement. Execution of the
Forbearance Agreement also resulted in a waiver of the Company's financial
covenant defaults at September 28, 1997, 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.
Note 10 - Income Taxes
The tax effects of significant items comprising the Company's income tax
calculation as of September 28, 1997, are as follows:
Current deferred tax assets:
Reserves not currently deductible $ 709,700
Operating loss carryforwards 949,400
Long-term deferred tax assets:
Operating loss carryforwards 15,909,200
Tax credit carryforwards 449,900
Vapital loss carryforwards 8,500
Valuation allowance (18,026,700)
------------
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 September 28, 1997,
and September 29, 1996, respectively, are as follows:
The total valuation allowance changed $5,411,000 from September 29, 1996, to
September 28, 1997.
The provisions for income taxes for the fiscal years ended September 28, 1997,
September 29, 1996, and October 1, 1995, consist of provisions for state income
taxes of $2,600, $1,800 and $1,000, respectively. No provisions for federal
income taxes have been made in these fiscal years due to the net operating
losses.
At September 28, 1997, the Company had net operating loss carryforwards of
approximately $44,175,900 for financial reporting and federal income tax
purposes expiring in varying amounts from fiscal year 1998 through fiscal year
2012, and $23,767,000 for California and Vermont State Franchise tax purposes
expiring in varying amounts from fiscal year
14
Irvine Sensors Corporation
Notes to Consolidated Financial Statements
________________________________________________________________________________
1998 through fiscal year 2002, available to offset future federal, California
and Vermont taxable income. In addition, as of September 28, 1997, the Company
had investment tax credits and qualified research credits of $133,400 and
$316,500, respectively, expiring in varying amounts through fiscal year 2008 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.
Note 11 - Operating Leases
The Company leases certain facilities and equipment under cancelable and
noncancelable lease obligations. Total rental expense for operating leases
amounted to $1,685,200, $1,633,500 and $562,500 for the fiscal years ended
September 28, 1997, September 29, 1996, and October 1, 1995, respectively.
Minimum lease commitments existing at September 28, 1997, are approximately as
follows:
Fiscal years ending:
1998 $619,900
1999 104,000
2000 1,300
--------
Total minimum payments $725,200
========
Note 12 - Stock Option Plans and Employee Retirement Plan
In December 1981, the Company's shareholders adopted two stock option plans: the
1981 Incentive Stock Option Plan (Incentive Plan) and the 1981 Nonstatutory
Stock Option Plan (Nonstatutory Plan). The Incentive Plan provided for the
granting of options to key management employees and the Nonstatutory Plan
provided for the granting of options to both key management employees and non-
employee directors. The maximum number of shares which could be optioned and
sold under the two plans was 1,450,000 shares, of which no more than 800,000 and
400,000 could be optioned and sold to directors and non-director officers,
respectively. Under the terms of the Incentive Plan, options could be granted at
an exercise price equal to the fair market value of the Company's common stock
on the date the options were granted, and under the terms of the Nonstatutory
Plan, options could be granted at 85 percent of the fair market value, on the
date the options were granted. If, however, the optionee owned more than 10
percent of the outstanding common stock of the Company, the exercise price of
incentive stock options would be at least 110 percent of such fair market value.
Options, generally, are not exercisable before one year from the date of grant,
and are generally exercisable in installments. Options granted under the
Incentive Plan may not exceed five years in duration and options granted under
the Nonstatutory Plan may not exceed ten years in duration. The Plans terminated
on December 11, 1991, after which date no options could be granted under the
Plans. As of September 29, 1996, there were no outstanding options under the
Plans.
In December 1991, the Board of Directors adopted the 1991 Stock Option Plan to
replace the 1981 Plans, which had terminated. 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 September 28, 1997, options to
purchase 125,500 shares at prices ranging from $1.4375 (40,000 shares) to $7.75
(8,300 shares) were outstanding under the 1991 plan, of which 58,500 were
exercisable at September 28, 1997.
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, subject
to ratification 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 September 28, 1997, options to
purchase 1,255,100 shares at prices ranging from $0.98 (580,000 shares) to $6.50
(10,000 shares) were outstanding under the 1995 Plan, of which 47,200 were
exercisable at September 28, 1997.
Stock option activity is summarized as follows:
Option Price
Shares Per Share
-------------------------------
1981 PLAN:
- ----------
Options outstanding at
October 2, 1994 52,400 $0.5625 to $1.5625
Exercised (48,400) 0.5625 to 1.5625
----------
Options outstanding at
October 1, 1995 4,000 0.5625
Exercised (4,000) $0.5625
----------
Options outstanding at
September 29, 1996 -
==========
15
Irvine Sensors Corporation
Notes to Consolidated Financial Statements
________________________________________________________________________________
1991 Plan:
- ----------
Options outstanding at October 2, 1994 527,000 $1.3125 to $8.625
Granted 98,500 6.00
Exercised (54,200) 1.3125 to 7.75
---------
Options outstanding at October 1, 1995 571,300 1.3125 to 8.625
Exercised (314,100) 1.3125 to 4.09
Cancelled (19,000) 4.09 to 8.625
Expired (27,500) 1.3125 to 4.09
---------
Options outstanding at September 29, 1996 210,700 4.28 to 8.625
Granted 43,000 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 125,500 $1.4375 to $7.75
=========
1995 Plan:
- ----------
Granted in fiscal 1995 228,500 $6.00 to $6.50
---------
Options outstanding at October 1, 1995 228,500 6.00 to 6.50
Granted 343,500 5.0625 to 8.50
Cancelled (128,000) 6.00 to 6.50
---------
Options outstanding at September 29, 1996 444,000 5.0625 to 8.50
Granted 1,153,000 0.98 to 2.3125
Cancelled (341,900) 1.00 to 8.50
---------
Options outstanding at September 28, 1997 1,255,100 $0.98 to $6.50
=========
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 September 28, 1997, and September 29, 1996, to the pro forma amounts
of $15,041,000 and $16,255,700, respectively, with a corresponding pro forma
loss per share of $0.73 and $0.96, respectively. These pro forma amounts were
determined estimating the fair value of each option granted during fiscal 1996
and fiscal 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 a volatility rate of 86.9 percent
were applied to all options granted during fiscal year 1996 and fiscal year
1997. The weighted average fair value at the grant date for the options granted
during fiscal years 1997 and 1996 was $0.75 and $3.47 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 1995, 1996 and 1997 the
Company's contributions to the SBT were 68,000, 172,900 and 347,600 shares of
common stock, respectively, which had estimated market values of $472,300,
$687,400 and $445,500, respectively.
Note 13 - 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.
In fiscal 1996, contracts with all branches of the U.S. government accounted for
31 percent of the Company's revenues, and the remaining 69 percent of the
Company's revenues was derived from non-government sources. of the 31 percent
applicable to the U.S. government, there was one agency of the government that
accounted for 16 percent. Other government agencies accounted for the remaining
15 percent. Of the 69 percent applicable to non-government sources, two
customers accounted for 23 percent and 21 percent of the revenues.
16
Irvine Sensors Corporation
Notes to Consolidated Financial Statements
________________________________________________________________________________
In fiscal 1995, contracts with all branches of the U.S. government accounted for
74 percent of the Company's revenues, and the remaining 26 percent of the
Company's revenues was derived from non-government sources. Of the 74 percent
applicable to the U.S. government, there were two agencies of the government
that accounted for 30 percent and 21 percent, respectively. Other government
agencies accounted for the remaining 23 percent. There were no non-government
customers who individually accounted for more than 10 percent.
Note 14 - Technology Licenses
In June 1992 the Company and International Business Machines (IBM) entered into
an agreement to develop manufacturing technology required to commercially
produce parts using the Company's technology for stacking integrated circuits.
In June 1993, IBM and the Company jointly announced the opening of a pilot
manufacturing line at an IBM facility. The agreement provided for the Company to
receive royalties on stacked chip parts sold by IBM and will share equally with
IBM any royalties received from the licensing of the jointly developed
manufacturing technology. In April 1996, the Company reached an agreement with
IBM wherein the Company acquired the operating line from IBM and leased the
facilities. This agreement was terminated in fiscal 1997.
In May 1995, the Company and Unitrode Corporation (Unitrode) entered into an
agreement to transfer to Unitrode the technology required to produce the
Company's wireless infrared communication integrated circuit (SIRComm). The
Company will receive licensing and royalty payments for the technology transfer
and on SIRComm products sold by Unitrode.
Note 15 - Deferred Revenues
The Company received prepayments from customers related to services and products
which had not been delivered as of the balance sheet date. Revenues are recorded
upon delivery of these services and products.
Note 16 - 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. At September 28, 1997, $1,026,900 of those proceeds
was still receivable and is included in Other current assets on the balance
sheet. During October 1997, these proceeds were received by the Company's lender
and applied against the principal of the Company's long-term debt.
17
Irvine Sensors Corporation
Report of Independent Accountants
________________________________________________________________________________
[LOGO OF PRICE WATERHOUSE LLP]
To the Board of Directors and Shareholders of Irvine Sensors Corporation
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of shareholders' equity (deficit) and of
cash flows present fairly, in all material respects, the financial position of
Irvine Sensors Corporation and its subsidiaries at September 28, 1997, and
September 29, 1996, and the results of their operations and their cash flows for
each of the three years in the period 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 audits. We conducted our
audits 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
audits provide a reasonable basis for the opinion expressed above.
/s/ Price Waterhouse
Costa Mesa, California
December 16, 1997
18
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, President and CEO, Irvine Sensors
Corporation
Walter E. Garrigan, Financial Advisor
Thomas H. Lenagh/2/, Financial Advisor
General Frank P. Ragano/1/, Chairman and CEO of CMS,
Inc., a manufacturer of defense munitions
Vincent F. Sollitto Jr., 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
David Pinto, Treasurer and Controller
John J. Stuart, Jr., Vice-President and Chief Financial
Officer
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 Accountants Price Waterhouse LLP, 575 Anton Boulevard,
Costa Mesa, California 92628
Transfer Agent ChaseMellon Shareholder Services, 400 S. Hope St., 4th
Floor, Los Angeles, California 90071
Stock Data Nasdaq Listing: Common Stock - IRSN
Boston Stock Exchange Listing: Common Stock - ISCB
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 September 28, 1997, 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.
19
Irvine Sensors Corporation
3001 Redhill Avenue
Costa Mesa, California 92626