10-Q 1 c04707e10vq.htm FORM 10-Q Form 10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 27, 2010
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 1-8402
IRVINE SENSORS CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
 
     
Delaware
(State or Other Jurisdiction of Incorporation or Organization)
  33-0280334
(I.R.S. Employer Identification No.)
3001 Red Hill Avenue,
Costa Mesa, California 92626

(Address of Principal Executive Offices) (Zip Code)
(714) 549-8211
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Smaller reporting company þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of August 6, 2010, there were 28,744,644 shares of common stock outstanding.
 
 

 

 


 

IRVINE SENSORS CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE FISCAL PERIOD ENDED JUNE 27, 2010
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 Exhibit 10.6
 Exhibit 10.7
 Exhibit 10.8
 Exhibit 10.9
 Exhibit 10.10
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32
In this report, the terms “Irvine Sensors,” “Company,” “we,” “us” and “our” refer to Irvine Sensors Corporation (“ISC”) and its subsidiaries.
Irvine Sensors®, TOWHAWK™, iNetWorks™, Novalog™, Personal Miniature Thermal Viewer™, PMTV®, Cam-Noir™, Eagle Boards™ and RedHawk™ are among the Company’s trademarks. Any other trademarks or trade names mentioned in this report are the property of their respective owners.

 

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PART I — FINANCIAL INFORMATION
Item 1.   Financial Statements
IRVINE SENSORS CORPORATION
CONSOLIDATED BALANCE SHEETS
                 
    June 27, 2010        
    (Unaudited)     September 27, 2009  
Assets
               
Current assets:
               
Cash and cash equivalents
  $ 154,900     $ 125,700  
Accounts receivable, net of allowance for doubtful accounts of $15,000 and $15,000, respectively
    1,730,100       1,396,300  
Unbilled revenues on uncompleted contracts
    710,900       885,300  
Inventory, net
    824,900       441,100  
Prepaid expenses and other current assets
    225,200       53,200  
 
           
Total current assets
    3,646,000       2,901,600  
Property and equipment, net (including construction in process of $806,000 and $35,000, respectively)
    2,684,000       2,845,200  
Intangible assets, net
    35,500       67,300  
Deferred financing costs
    414,000        
Deposits
    87,400       37,500  
 
           
Total assets
  $ 6,866,900     $ 5,851,600  
 
           
Liabilities and Stockholders’ Deficit
               
Current liabilities:
               
Accounts payable
  $ 4,243,500     $ 3,427,100  
Accrued expenses
    4,238,100       3,730,800  
Accrued estimated loss on contracts
    15,000        
Advance billings on uncompleted contracts
    301,000       249,600  
Advances against accounts receivable
    604,800       985,800  
Deferred revenue
    155,400       180,000  
Restructured debt, net of debt discounts
    163,100       188,400  
Promissory note payable — related party
          400,000  
Secured promissory note, current portion
    159,000        
Debentures, net of debt discounts
    1,638,700        
Capital lease obligations
          11,200  
 
           
Total current liabilities
    11,518,600       9,172,900  
Secured promissory note
    2,341,000        
Executive Salary Continuation Plan liability
    875,000       1,057,600  
 
           
Total liabilities
    14,734,600       10,230,500  
 
           
Commitments and contingencies (Note 10)
               
Stockholders’ deficit:
               
Convertible Preferred stock, $0.01 par value, 1,000,000 and 1,000,000 shares authorized, respectively;
    600       1,200  
Series A-1 — 12,200 (unaudited) and 99,900 shares issued and outstanding, respectively (1); liquidation preference of $410,800 (unaudited) and $3,586,200, respectively;
               
Series A-2 — 22,500 (unaudited) and 25,000 shares issued and outstanding, respectively (1); liquidation preference of $908,700 (unaudited) and $1,043,500, respectively;
               
Series B — 1,900 (unaudited) and 0 shares issued and outstanding, respectively (1); liquidation preference of $1,561,600 (unaudited) and $0, respectively
               
Series C — 27,500 (unaudited) and 0 shares issued and outstanding, respectively (1); liquidation preference of $825,000 (unaudited) and $0, respectively
               
Common stock, $0.01 par value, 150,000,000 and 150,000,000 shares authorized, respectively; 24,570,500 and 9,694,500 shares issued and outstanding, respectively (1)
    245,700       96,900  
Prepaid stock-based compensation
    (347,000 )      
Common stock held by Rabbi Trust
    (1,169,600 )     (1,169,600 )
Deferred compensation liability
    1,169,600       1,169,600  
Paid-in capital
    164,309,900       162,497,700  
Accumulated deficit
    (172,401,300 )     (167,299,100 )
 
           
Irvine Sensors Corporation stockholders’ deficit
    (8,192,100 )     (4,703,300 )
Noncontrolling interest
    324,400       324,400  
 
           
Total stockholders’ deficit
    (7,867,700 )     (4,378,900 )
 
           
Total liabilities and stockholders’ deficit
  $ 6,866,900     $ 5,851,600  
 
           
     
(1)   The number of shares of preferred stock and common stock issued and outstanding have been rounded to the nearest one hundred (100).
See Accompanying Condensed Notes to Consolidated Financial Statements.

 

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IRVINE SENSORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
                                 
    13 Weeks Ended     39 Weeks Ended  
    June 27, 2010     June 28, 2009     June 27, 2010     June 28, 2009  
Revenues:
                               
Contract research and development revenue
  $ 2,171,000     $ 2,508,500     $ 6,944,700     $ 7,247,000  
Product sales
    1,402,800       262,700       2,550,200       1,099,400  
Other revenue
    2,300       3,300       12,800       12,800  
 
                       
Total revenues
    3,576,100       2,774,500       9,507,700       8,359,200  
 
                       
Cost and expenses:
                               
Cost of contract research and development revenue
    1,565,300       1,705,200       5,070,200       5,651,100  
Cost of product sales
    1,335,500       323,000       2,442,800       1,110,800  
General and administrative expense
    1,565,100       2,862,500       4,693,100       6,982,200  
Research and development expense
    655,200       531,300       2,011,400       1,318,000  
 
                       
Total costs and expenses
    5,121,100       5,422,000       14,217,500       15,062,100  
Gain on sale or disposal of assets
    100       8,000       12,600       8,640,800  
 
                       
Income (loss) from operations
    (1,544,900 )     (2,639,500 )     (4,697,200 )     1,937,900  
Interest expense
    (636,500 )     (218,400 )     (882,600 )     (1,458,100 )
Provision for litigation judgment
                (20,200 )      
Litigation settlement expense
    (450,000 )           (2,270,700 )      
Change in fair value of derivative instrument
    7,000             67,000        
Interest and other income (expense)
    (1,000 )     5,000       (1,300 )     51,700  
 
                       
Income (loss) from continuing operations before benefit (provision) for income taxes
    (2,625,400 )     (2,852,900 )     (7,805,000 )     531,500  
Benefit (provision) for income taxes
          308,000       43,300       (121,000 )
 
                       
Income (loss) from continuing operations
    (2,625,400 )     (2,544,900 )     (7,761,700 )     410,500  
Discontinued operations:
                               
Income from discontinued operations
                      58,400  
 
                       
Net income (loss)
    (2,625,400 )     (2,544,900 )     (7,761,700 )     468,900  
Add net income attributable to noncontrolling interests in subsidiary
                      100  
 
                       
Net income (loss) attributable to Company
  $ (2,625,400 )   $ (2,544,900 )   $ (7,761,700 )   $ 469,000  
 
                       
Basic net income (loss) per common share information:
                               
From continuing operations attributable to Company
  $ (0.15 )   $ (0.35 )   $ (0.66 )   $ 0.01  
From discontinued operations attributable to Company
                      0.01  
 
                       
Basic net income (loss) attributable to Company per common share
  $ (0.15 )   $ (0.35 )   $ (0.66 )   $ 0.02  
 
                       
Diluted net income (loss) per common share information:
                               
From continuing operations attributable to Company
  $ (0.15 )   $ (0.35 )   $ (0.66 )   $ 0.01  
From discontinued operations attributable to Company
                      0.01  
 
                       
Diluted net income (loss) attributable to Company per common share
  $ (0.15 )   $ (0.35 )   $ (0.66 )   $ 0.02  
 
                       
 
                               
Weighted average number of common shares outstanding — basic
    17,302,800       7,708,400       13,932,100       6,257,000  
 
                       
 
                               
Weighted average number of common shares outstanding — diluted
    17,302,800       7,708,400       13,932,100       6,259,500  
 
                       
See Accompanying Condensed Notes to Consolidated Financial Statements.

 

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IRVINE SENSORS CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIT
                                                                                                                 
                                                                    Common                                      
    Series A-1 and A-2     Series B     Series C                     Stock                                      
    Preferred Stock     Preferred Stock     Preferred Stock     Common Stock     Warrants     Prepaid                             Total  
    Shares Issued (1)     Shares Issued (1)     Shares Issued (1)     Shares Issued (1)     Issued (1)     Stock-Based     Paid-in     Accumulated     Noncontrolling     Stockholders’  
    Number     Amount     Number     Amount     Number     Amount     Number     Amount     Number     Compensation     Capital     Deficit     Interest     Equity (Deficit)  
Balance at September 28, 2008
    126,000     $ 1,300           $           $       3,557,200     $ 35,600       717,900     $     $ 159,717,800     $ (168,213,900 )   $ 411,600     $ (8,047,600 )
Common stock issued to employee retirement plan
                                        1,785,700       17,900             (750,000 )     732,100                    
Common stock issued to pay operating expenses
                                        339,800       3,400                   129,700                   133,100  
Common stock issued to investment banking firm
                                        315,000       3,100                   122,400                   125,500  
Common stock issued to purchasers of debt
                                        575,600       5,800                   244,200                   250,000  
Stock-based compensation expense — vested stock
                                        1,600                         600                   600  
Common stock warrants issued to investment banking firm
                                                    299,300             92,100                   92,100  
Additional common stock warrants issued under anti-dilution provisions
                                                    504,000                                
Common stock warrants expired
                                                    (59,900 )                              
Stock-based compensation expense — options
                                                                27,900                   27,900  
Preferred stock issued to retire debt
    25,000       300                                                       999,700                   1,000,000  
Common stock issued upon conversion of preferred stock
    (26,100 )     (400 )                             1,956,300       19,600                   (19,200 )                  
Common stock issued to convert debt
                                        1,089,000       10,800                   337,600                   348,400  
Amortization of deferred stock-based compensation
                                                                113,500                   113,500  
Issuance of nonvested stock, net
                                        74,300       700                   (700 )                  
Amortization of employee retirement plan contributions
                                                          750,000                         750,000  
Optex minority interest
                                                                                                  (87,100 )     (87,100 )
Net income
                                                                      914,800       (100 )     914,700  
 
                                                                                   
Balance at September 27, 2009
    124,900       1,200                               9,694,500       96,900       1,461,300             162,497,700       (167,299,100 )     324,400       (4,378,900 )
Cumulative-effect adjustment of adopting ASC 815-40
                                                                (4,230,000 )     4,130,500             (99,500 )
Common stock issued to employee retirement plan
                                        2,673,800       26,700             (750,000 )     723,300                    
Sale of preferred stock, net of financing costs and value assigned to warrants issued to investors
                3,500                                                 1,307,900                     1,307,900  
Issuance of preferred stock as litigation settlement expense
                            27,500       300                               824,700                     825,000  
Common stock warrants issued to preferred stock investors
                                                    2,094,000             424,000                   424,000  
Sale of common stock units
                                        1,902,200       19,000       627,700             284,300                   303,300  
Common stock issued to pay interest
                                        346,800       3,500                   135,300                   138,800  
Deemed dividend of beneficial conversion feature of preferred stock issuance
                                                                1,471,000       (1,471,000 )            
Common stock issued upon conversion of preferred stock
    (90,200 )     (900 )     (1,600 )                       9,949,800       99,500                   (98,600 )                  
Stock-based compensation expense — vested stock
                                        1,800       100                   500                   600  
Beneficial conversion feature of debentures
                                                                102,200                   102,200  
Common stock warrants issued to debenture investors
                                                    860,000             163,500                   163,500  
Common stock warrants issued to investment banking firm
                                                    2,244,100             643,800                   643,800  
Common stock warrants expired
                                                    (1,477,500 )                              
Additional common stock warrants issued under anti-dilution provisions
                                                    715,500                                
Issuance of nonvested stock, net
                                        1,600                                            
Amortization of deferred stock-based compensation
                                                                57,200                   57,200  
Amortization of employee retirement plan contributions
                                                          403,000                         403,000  
Stock-based compensation expense — options
                                                                3,100                   3,100  
Net loss
                                                                      (7,761,700 )           (7,761,700 )
 
                                                                                   
 
                                                                                                               
Balance at June 27, 2010 (Unaudited)
    34,700     $ 300       1,900     $       27,500     $ 300       24,570,500     $ 245,700       6,525,100     $ (347,000 )   $ 164,309,900     $ (172,401,300 )   $ 324,400     $ (7,867,700 )
 
                                                                                   
     
(1)   Amounts of preferred stock, common stock and warrants issued have been rounded to nearest one hundred (100).
See Accompanying Condensed Notes to Consolidated Financial Statements.

 

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IRVINE SENSORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
                 
    39 Weeks Ended  
    June 27, 2010     June 28, 2009  
Cash flows from operating activities:
               
Net income (loss)
  $ (7,761,700 )   $ 469,000  
Add back income from discontinued operations
          (58,400 )
 
           
Income (loss) from continuing operations
    (7,761,700 )     410,600  
Adjustments to reconcile income (loss) from continuing operations to net cash used in operating activities:
               
Depreciation and amortization
    1,002,900       1,398,600  
Provision for allowance for inventory valuation
    148,900       121,000  
Non-cash interest expense
    343,900       829,200  
Non-cash employee retirement plan contributions
    403,000       562,500  
Non-cash litigation settlement
    2,270,700        
Gain on sales or disposal of assets
    (12,600 )     (8,640,800 )
Change in fair value of derivative instrument
    (67,000 )      
Net loss attributable to noncontrolling interests
          (100 )
Common stock issued to pay operating expenses
          503,000  
Non-cash stock-based compensation
    60,900       112,900  
Increase in accounts receivable
    (333,800 )     (349,300 )
Decrease in unbilled revenues on uncompleted contracts
    174,400       680,400  
Increase in inventory
    (532,700 )     (349,700 )
Increase in prepaid expenses and other current assets
    (53,000 )     (105,900 )
Increase (decrease) in other assets
    (49,900 )     63,500  
Increase (decrease) in accounts payable and accrued expenses
    2,084,400       (2,678,800 )
Increase (decrease) in accrued estimated loss on contracts
    15,000       (144,500 )
Decrease in Executive Salary Continuation Plan liability
    (182,600 )     (93,200 )
Increase in advance billings on uncompleted contracts
    51,400       133,100  
Decrease in deferred revenue
    (24,600 )     (115,000 )
 
           
Net cash used in operating activities
    (2,462,400 )     (7,662,500 )
 
           
Cash flows from investing activities:
               
Property and equipment expenditures
    (781,800 )     (62,500 )
Gross proceeds from sales of fixed assets and intangibles
    12,500       9,500,000  
Transfer of fixed asset from contract expense
    (28,000 )     (43,000 )
Acquisition and costs related to patents
          (145,500 )
Increase in restricted cash
          (4,600 )
 
           
Net cash provided by (used in) investing activities
    (797,300 )     9,244,400  
 
           
Cash flows from financing activities:
               
Proceeds from sale of preferred stock
    2,049,500        
Principal payments of notes payable
    (25,300 )     (3,063,700 )
Proceeds from senior promissory notes
          1,000,000  
Proceeds from sale of debenture units
    1,651,300        
Proceeds from sale of common stock units
    303,300        
Debt issuance costs paid
    (297,700 )     (227,000 )
Proceeds from (decrease in) advances against accounts receivable
    (381,000 )     448,200  
Principal payments of capital leases
    (11,200 )     (23,300 )
 
           
Net cash provided by (used in) financing activities
    3,288,900       (1,865,800 )
 
           
Cash flows from discontinued operations:
               
Net cash used in operating activities
          (275,000 )
 
           
Net increase (decrease) in cash and cash equivalents
    29,200       (558,900 )
Cash and cash equivalents at beginning of period
    125,700       638,600  
 
           
Cash and cash equivalents at end of period
  $ 154,900     $ 79,700  
 
           
Non-cash investing and financing activities:
               
Conversion of preferred stock to common stock
  $ 4,292,200     $  
Issuance of warrants to investment banking firm
  $ 643,800     $  
Debt conversion to common stock
        $ 330,000  
Interest conversion to common stock
  $ 138,800     $ 18,500  
Debt conversion to preferred stock
        $ 1,000,000  
Supplemental cash flow information:
               
Cash paid for interest
  $ 305,800     $ 283,600  
Cash paid for income taxes
  $ 7,700     $ 91,700  
See Accompanying Condensed Notes to Consolidated Financial Statements.

 

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IRVINE SENSORS CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 — General
The information contained in the following Condensed Notes to Consolidated Financial Statements is condensed from that which appear in the audited consolidated financial statements for Irvine Sensors Corporation (“ISC”) and its subsidiaries (together with ISC, the “Company”), and the accompanying unaudited consolidated financial statements do not include certain financial presentations normally required under accounting principles generally accepted in the United States of America (“GAAP”). Accordingly, the unaudited consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and related notes thereto contained in the Annual Report on Form 10-K of the Company for the fiscal year ended September 27, 2009 (“fiscal 2009”). It should be understood that accounting measurements at interim dates inherently involve greater reliance on estimates than at fiscal year-end. The results of operations for the interim periods presented are not necessarily indicative of the results expected for the entire fiscal year.
The consolidated financial information for the 13-week and 39-week periods ended June 27, 2010 and June 28, 2009 included herein is unaudited but includes all normal recurring adjustments which, in the opinion of management of the Company, are necessary to present fairly the consolidated financial position of the Company at June 27, 2010, and the results of its operations and its cash flows for the 13-week and 39-week periods ended June 27, 2010 and June 28, 2009.
On October 14, 2008, substantially all of the assets of Optex Systems, Inc., a Texas corporation (“Optex”) and a wholly-owned subsidiary of ISC, were sold pursuant to a UCC public foreclosure sale (the “Optex Asset Sale”). The Optex Asset Sale was completed as contemplated by a binding Memorandum of Understanding for Settlement and Debt Conversion Agreement dated September 19, 2008 (the “MOU”) between the Company and its senior lenders, Longview Fund, L.P. (“Longview”) and Alpha Capital Anstalt (“Alpha”). Longview and Alpha are sometimes collectively referred to as the “Lenders.” As agreed to in the MOU, Optex Systems, Inc., a Delaware corporation controlled by the Lenders (“Optex-Delaware”), credit bid $15 million in this UCC public foreclosure sale, and its offer was the winning bid. As a result, $15 million of the Company’s aggregate indebtedness to the Lenders was extinguished. All of the Company’s financial statements and notes and schedules thereto give effect to this event and report Optex as a discontinued operation for both the current and prior fiscal periods. Optex filed a voluntary petition for relief under Chapter 7 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of California in September 2009 (the “Optex bankruptcy”). None of the Company’s subsidiaries accounted for more than 10% of the Company’s total assets at June 27, 2010 or had separate employees or facilities at such date.
The consolidated financial information as of September 27, 2009 included herein has been derived from the Company’s audited consolidated financial statements as of, and for the fiscal year ended, September 27, 2009.

 

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Description of Business
The Company is a vision systems company enabled by technology for three-dimensional packaging of electronics and manufacturing of electro-optical products. The Company designs, develops, manufactures and sells vision systems, miniaturized electronic products and higher level systems incorporating such products for defense, security and commercial applications. The Company also performs customer-funded contract research and development related to these systems and products, mostly for U.S. government customers or prime contractors. Most of the Company’s historical business relates to application of its technologies for stacking either packaged or unpackaged semiconductors into more compact three-dimensional forms, which the Company believes offer volume, power, weight and operational advantages over competing packaging approaches, and which the Company believes allows it to offer higher level products with unique operational features. The Company has recently introduced certain higher level products in the fields of thermal imaging cores, unmanned surveillance aircraft and high speed processing that take advantage of the Company’s packaging technologies.
Summary of Significant Accounting Policies
Consolidation. The consolidated financial statements include the accounts of ISC and its subsidiaries, Optex, Novalog, Inc. (“Novalog”), MicroSensors, Inc. (“MSI”), RedHawk Vision Systems, Inc. (“RedHawk”) and iNetWorks Corporation (“iNetWorks”). The Company’s subsidiaries do not presently have material operations or assets. All significant intercompany transactions and balances have been eliminated in the consolidation. The accounts for Optex have been eliminated from the balance sheets from September 27, 2009 forward due to the Optex bankruptcy in September 2009.
Fiscal Periods. The Company’s fiscal year ends on the Sunday nearest September 30. Fiscal 2009 ended on September 27, 2009 and included 52 weeks. The fiscal year ending October 3, 2010 (“fiscal 2010”) will include 53 weeks. The Company’s first three quarters of fiscal 2010 was the 39-week period ended June 27, 2010.
Warrant Valuation and Beneficial Conversion Feature. The Company calculates the fair value of warrants issued with debt or preferred stock using the Black-Scholes valuation method. The total proceeds received in the sale of debt or preferred stock and related warrants is allocated among these financial instruments based on their relative fair values. The discount arising from assigning a portion of the total proceeds to the warrants issued is recognized as interest expense for debt from the date of issuance to the earlier of the maturity date of the debt or the conversion dates using the effective yield method. Additionally, when issuing convertible instruments (debt or preferred stock), including convertible instruments issued with detachable warrants, the Company tests for the existence of a beneficial conversion feature. The Company records the amount of any beneficial conversion feature (“BCF”), calculated in accordance with the accounting standards, whenever it issues convertible instruments that have conversion features at fixed rates that are in-the-money using the effective per share conversion price when issued. The calculated amount of the BCF is accounted for as a contribution to additional paid-in capital and as a discount to the convertible instrument. A BCF resulting from issuance of convertible debt is recognized as interest expense from the date of issuance to the earlier of the maturity date of the debt or the conversion dates using the effective yield method. A BCF resulting from the issuance of convertible preferred stock is recognized as a deemed dividend and amortized over the period of the security’s earliest conversion or redemption date. The maximum amount of BCF that can be recognized is limited to the amount that will reduce the net carrying amount of the debt or preferred stock to zero.
Reclassifications. Certain reclassifications have been made to the consolidated balance sheet as of September 27, 2009 to conform to the current period presentation to reflect the adoption of new accounting guidance regarding the presentation of minority interests in subsidiaries, as discussed below.

 

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Recently Issued Accounting Pronouncements. In December 2007, the Financial Accounting Standards Board (“FASB”) issued guidance as codified in Accounting Standards Codification (“ASC”) 810-10, Consolidation — Noncontrolling Interests (previously SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—Amendments of ARB No. 51). ASC 810-10 states that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. ASC 810-10 also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. ASC 810-10 is effective for fiscal years beginning after December 15, 2008, which for the Company is fiscal 2010. The adoption of ASC 810-10 has resulted in the reclassification on the balance sheet of minority interests from liabilities to stockholders’ equity for the periods presented herein.
In June 2008, the FASB ratified guidance issued by the Emerging Issue Task Force (“EITF”) as codified in ASC 815-40, Derivatives and Hedging — Contracts in Entity’s Own Equity (previously EITF Issue No. 07-05, Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own Stock). ASC 815-40 specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the company’s own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument. ASC 815-40 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the ASC 815-10 scope exception. ASC 815-40 is effective for fiscal years beginning after December 15, 2008, which for the Company is fiscal 2010, and early adoption was not permitted. Pursuant to ASC 815-40, the Company was required to reclassify certain warrants from equity to liabilities, which resulted in a cumulative effect adjustment of approximately $4,230,000 to reduce paid-in capital for the original allocated value recorded for these affected warrants, a corresponding reduction in accumulated deficit of $4,230,000 and recording of the fair market value of the warrant derivative liability of $99,500 effective September 28, 2009, the first day of fiscal 2010. The fair market value of the warrant derivative liability was re-measured at June 27, 2010 and adjusted to report the change in fair value, which was $7,000 and $67,000 for the 13 weeks and 39 weeks ended June 27, 2010, respectively. The warrant derivative liability is included in accrued expenses on the consolidated balance sheet.
In January 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-06, Improving Disclosures about Fair Value Measurements amending ASC 820, Fair Value Measurements and Disclosures requiring additional disclosure and clarifying existing disclosure requirements about fair value measurements. ASU 2010-06 requires entities to provide fair value disclosures by each class of assets and liabilities, which may be a subset of assets and liabilities within a line item in the statement of financial position. The additional requirements also include disclosure regarding the amounts and reasons for significant transfers in and out of Level 1 and 2 of the fair value hierarchy and separate presentation of purchases, sales, issuances and settlements of items within Level 3 of the fair value hierarchy. The guidance clarifies existing disclosure requirements regarding the inputs and valuation techniques used to measure fair value for measurements that fall in either Level 2 or Level 3 of the hierarchy. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements which is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. There was no impact of the Company’s adoption of this guidance.
In February 2010, the FASB issued ASU 2010-09, Subsequent Events — Amendments to Certain Recognition and Disclosure Requirements, which no longer requires entities that file or furnish financial statements with the SEC to disclose the date through which subsequent events have been evaluated in originally issued and reissued financial statements. Other entities would continue to be required to disclose the date through which subsequent events have been evaluated; however, disclosures about the date through which subsequent events have been evaluated in reissued financial statements would be required only in financial statements revised because of an error correction or retrospective application of GAAP. This consensus is effective upon issuance. The Company’s adoption of ASU 2010-09 had no financial statement impact.

 

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In April 2010, the FASB issued ASU 2010-17, Milestone Method of Revenue Recognition, which provides guidance related to Revenue Recognition that applies to arrangements with milestones relating to research or development deliverables. This guidance provides criteria that must be met to recognize consideration that is contingent upon achievement of a substantive milestone in its entirety in the period in which the milestone is achieved. This guidance is effective for us starting fiscal year 2011. The Company is currently assessing the impact of the guidance, if any, on its financial statements.
Note 2 — Going Concern
These consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company generated significant net losses in fiscal years prior to fiscal 2009. In fiscal 2009, the Company generated net income of $914,800, but this was primarily attributable to the approximately $8.6 million of aggregate non-recurring gains realized by the Company’s sale of patent assets and substantial gains on the elimination of consolidated debt and reduction in pension liability. In the first three quarters of fiscal 2010, the 39-week period ended June 27, 2010, the Company had a net loss of $7,761,700.
Management believes that the Company’s losses in recent years have primarily resulted from a combination of insufficient contract research and development revenue to support the Company’s skilled and diverse technical staff believed to be necessary to support monetization of the Company’s technologies, amplified by the effects of discretionary investments to productize a variety of those technologies. The Company has not yet been successful in most of these product activities, nor has it been able to raise sufficient capital to fund the future development of many of these technologies. Accordingly, the Company has sharply curtailed the breadth of its product investments, and instead has focused on the potential growth of its chip stacking business, various miniaturized camera products and a system application incorporating such camera products. In addition, the initial acquisition of Optex in December 2005 and the ultimate discontinuation of Optex’s operations in October 2008 pursuant to the Optex Asset Sale contributed to increases in the Company’s consolidated accumulated deficit, largely due to inadequate gross margins on Optex’s products and the related litigation, as well as insufficient capital resources.
As of June 27, 2010, the Company also had negative working capital and stockholders’ deficit of approximately $7.9 million and $7.9 million, respectively. As of June 27, 2010, the Company also had a litigation judgment pending, for which the Company has recorded expected expenses of approximately $1.2 million. (See Note 10).
Management is focused on managing costs in line with estimated total revenues for the balance of fiscal 2010 and beyond, including contingencies for cost reductions if projected revenues are not fully realized. However, there can be no assurance that anticipated revenues will be realized or that the Company will be able to successfully implement its plans. Accordingly, the Company anticipates that it will need to raise additional funds to meet its continuing obligations in the near future and may incur additional future losses.

 

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The Company’s common stock has traded below the $1.00 per share minimum continued listing criterion of the Nasdaq Capital Market for substantial periods of time recently. On September 15, 2009, the Company received a written notice from Nasdaq of its lack of compliance with this requirement and was given until March 15, 2010 to regain compliance. On March 19, 2010, the Company received a notice from Nasdaq that it had not regained compliance with respect to this listing criterion and that the Company’s common stock was subject to delisting. The Company appealed this notice and requested a hearing from a Nasdaq Hearings Panel (the “Panel”) to present a revised plan of compliance and to seek an extension of time to implement said plan. This hearing was held on May 6, 2010, and on June 8, 2010, the Company received a notice from Nasdaq that it had been granted an extension to evidence a closing bid price for its common stock of $1.00 per share or more for a minimum of ten consecutive trading days on or before September 13, 2010. To this end, the Company sought and obtained stockholder approval on July 28, 2010 to effectuate a reverse stock split in a ratio that the Company believes is sufficient to meet the $1.00 bid price requirement for continued listing. However, there can be no assurance that the Company will implement such authority, or if implemented, that the Company will be able to comply with the minimum $1.00 per share trading rule or other Nasdaq requirements for listing maintenance and be able to maintain its listing on the Nasdaq Capital Market. Delisting from the Nasdaq Capital Market for any present or future noncompliance with Nasdaq’s listing requirements could significantly limit the Company’s ability to raise capital and adversely impact the price of and market for the Company’s common stock. If the Company requires additional financing to meet its working capital needs, there can be no assurance that suitable financing will be available on acceptable terms, on a timely basis, or at all.
The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.
Note 3 — Settlement of Litigation
Timothy Looney, Barbara Looney and TWL Group, L.P. (collectively, “Looney”), on the one hand, and the Company and its Chief Executive Officer, John C. Carson and its Chief Financial Officer, John J. Stuart, Jr., on the other hand, had been engaged in litigation since January 2008 regarding the acquisition of Optex and related matters. In March 2010, the Company and Messrs. Carson and Stuart entered into a Settlement and Release Agreement with Looney pursuant to which the Company and Messrs. Carson and Stuart, on the one hand, and Looney, on the other hand, settled and released all claims and agreed to dismiss all litigation against each other relating to the Company’s acquisition of Optex in December 2005 and various transactions related thereto (the “Looney Settlement Agreement”).
Pursuant to the terms of the Looney Settlement Agreement, the Company agreed to pay Mr. Looney $50,000 and to issue to Mr. Looney a secured promissory note in the principal amount of $2,500,000 (the “Secured Promissory Note”). (See Note 4). In connection with issuing the Secured Promissory Note, the Company also entered into a Security Agreement and an Intellectual Property Security Agreement with Mr. Looney (collectively, the “Security Agreements”), which collectively provide a security interest in all the Company’s assets subject to and subordinate to the existing perfected security interests and liens of the Company’s senior creditors, Summit Financial Resources, L.P. (“Summit”) and Longview.

 

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The effectiveness of the Looney Settlement Agreement was conditioned upon the Company’s receipt of consents from Summit and Longview. The Company obtained said consents, and the Looney Settlement Agreement was effective as of March 26, 2010. As one of the conditions of obtaining the Longview consent, the Company agreed to issue Longview equity securities with a value of $825,000 (the “Waiver Securities”) in consideration for Longview’s waiver of potential future entitlement to all accumulated, but undeclared and unpaid, dividends on the Company’s Series A-1 10% Cumulative Convertible Preferred Stock (the “Series A-1 Stock”) and the Company’s Series A-2 10% Cumulative Convertible Preferred Stock (the “Series A-2 Stock”) held by Longview from the respective dates of issuance of the Series A-1 Stock and the Series A-2 Stock through July 15, 2010. The amount of said accumulated, but undeclared and unpaid dividends through July 15, 2010 was estimated to be approximately equal to the value of the Waiver Securities. The Waiver Securities were issued to Longview on April 30, 2010 in the form of 27,500 shares of the Company’s newly created Series C Convertible Preferred Stock (the “Series C Stock”). (See Note 5).
As another condition for Longview’s consent for the Looney Settlement Agreement, the Company and Longview agreed that if the Company did not arrange for a third-party investor to purchase Longview’s holdings of the Company’s Series A-1 Stock and Series A-2 Stock on or before July 15, 2010 (the “Buyout”), the Company would be obligated to issue to Longview (a) non-voting equity securities, with terms junior to the Company’s Series B Convertible Preferred Stock (the “Series B Stock”), convertible into 1,000,000 shares of the Company’s common stock (the “Contingent Securities”) and (b) a two-year warrant to purchase 1,000,000 shares of the Company’s common stock at an exercise price per share of $0.30 (the “Contingent Warrant”). The terms of the Contingent Securities and the Contingent Warrant were mutually agreed upon by the parties such that the Contingent Securities were to consist of 10,000 shares of the Company’s Series C Stock convertible into 1,000,000 shares of the Company’s common stock, subject to receipt of stockholder approval for such issuance if required by Nasdaq. The Buyout did not occur on or before July 15, 2010, and stockholder approval for the issuance of the Contingent Securities in the form of Series C Stock was obtained on July 28, 2010. Accordingly, the Contingent Securities and Contingent Warrant were issued to Longview in August 2010. (See Note 11.)
The Company recorded the $2.5 million Secured Promissory Note in its consolidated financial statements for the 39-week period ended June 27, 2010 and extinguished $1,504,300 of previously recorded accrued expenses for litigation judgments related to these matters. The Company also recorded an expense of $825,000 for the issuance of the Waiver Securities in the 39-week period ended June 27, 2010. The Company also recorded a $450,000 expense for the obligation to issue the Contingent Securities and the Contingent Warrant in the 13-week and 39-week periods ended June 27, 2010. The net effect was a litigation settlement expense of $450,000 and $2,270,700 recorded in the 13-week and 39-week periods ended June 27, 2010, respectively.
Note 4 — Debt Instruments
Restructured Debt, Net of Debt Discounts
The restructured debt, net of debt discounts, consists of the remainder of a secured promissory note payable to Longview originally entered into by the Company in July 2007, initially with a six-month term, under a secured promissory note (the “Longview Note”) with a $2.0 million principal due initially. The principal amount of the Longview Note was automatically increased by $100,000 on August 15, 2007, when the Company elected not to exercise an early payment feature of the Longview Note. In connection with the Optex Asset Sale in October 2008, approximately $1,651,100 of the principal balance of the Longview Note was retired. In March 2009, $260,500 of the then outstanding principal balance of the Longview Note was repaid from proceeds of the Company’s sale of patents, resulting in an outstanding principal balance of the Longview Note of $188,400 at September 27, 2009. In March 2010, $25,300 of the then outstanding principal balance of the Longview Note was repaid from proceeds of the Debenture Private Placement (described more fully below), resulting in an outstanding principal balance of the Longview Note of $163,100 at June 27, 2010.

 

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Note Payable — Related Party
In December 2006, in consideration for amendments to the Stock Purchase Agreement, the Buyer Option Agreement and the Escrow Agreement with Timothy Looney initially entered into on December 30, 2005 for the acquisition of Optex, the Company issued an unsecured subordinated promissory note to Mr. Looney in the original principal amount of $400,000, bearing interest at a rate of 11% per annum. The principal and accrued interest under this note was due and payable in full to Mr. Looney on December 29, 2007. The Company had recorded the principal and accrued interest amount of this note in its consolidated balance sheets at September 27, 2009 as a current liability. At June 27, 2010, this note had been extinguished as a result of the Looney Settlement Agreement.
Debentures
In March 2010, the Company sold and issued to 55 accredited investors (the “Debenture Investors”) an aggregate of 275.22 convertible debenture units (the “Debenture Units”) at a purchase price of $6,000 per Unit (the “Debenture Unit Price”) in two closings of a private placement (the “Debenture Private Placement”). The $1,651,300 aggregate purchase price for these Debenture Units was paid in cash to the Company.
Each Debenture Unit was comprised of (i) one one-year, unsecured convertible debenture with a principal repayment obligation of $5,000 (the “Convertible Debenture”) that is convertible at the election of the holder into shares of the Company’s common stock at a conversion price of $0.40 per share (the “Principal Conversion Shares”); (ii) one one-year, unsecured non-convertible debenture with a principal repayment obligation of $5,000 that is not convertible into common stock (the “Non-Convertible Debenture” and, together with the Convertible Debenture, the “Debentures”); and (iii) a five-year warrant to purchase 3,125 shares of the Company’s common stock (the “Debenture Investor Warrant”). The conversion price applicable to the Debentures and the exercise price applicable to the Debenture Investor Warrants is $0.40 per share.
The Debentures bear simple interest at a rate of 20% per annum. Interest on the Debentures accrues and is payable quarterly in arrears and is convertible at the election of the Company into shares of common stock at a conversion price of $0.40 per share. In the 13-week and 39-week periods ended June 27, 2010, interest in the amount of $138,800 was converted into 346,800 shares of common stock. (See Note 5). The conversion price of the Debentures is subject to adjustment for stock splits, stock dividends, recapitalizations and the like. Any unpaid and unconverted principal amount of the Debentures may be repaid in cash prior to maturity at 110% of such principal amount. The amounts owing under the Debentures may be accelerated upon the occurrence of certain events of default as set forth in the Debentures.
If all interest on the Debentures is converted into shares of common stock and the Convertible Debentures are held to maturity and then converted, the total number of shares of Common Stock issuable upon conversion of the principal and interest under the Debentures at the conversion price is 4,816,300 in the aggregate. The total number of shares of common stock issuable upon exercise of the Debenture Investor Warrants at the exercise price of $0.40 per share is 860,000 in the aggregate.
In consideration for services rendered as the lead placement agent in the Debenture Private Placement, the Company paid the placement agent cash commissions, a management fee and an expense allowance fee aggregating $214,700, which represents 13% of the gross proceeds of the closings of the Debenture Private Placement, and issued to the placement agent five-year warrants to purchase an aggregate of 536,700 shares of the Company’s common stock at an exercise price of $0.40 per share and, as a retainer, a five-year warrant to purchase an aggregate of 450,000 shares of the Company’s Common Stock at an exercise price of $0.40 per share. (See Note 5).

 

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The $1,651,000 of aggregate gross proceeds received by the Company in the Debenture Private Placement, comprised of the aggregate principal value of $2,752,200 of the Debentures, net of a corresponding original issue discount of $1,101,000, was allocated to the individual components comprising the Debenture Unit on a relative fair value basis. This resulted in approximately $163,000 allocated to the five year investor warrants and approximately $1,488,000 allocated to the Debentures. In addition, because the effective conversion price of the Convertible Debentures was below the current trading price of the Company’s common shares at the date of issuance, the Company recorded a BCF of approximately $102,200. The value of the warrants and the BCF have been recorded as additional paid in capital in the accompanying consolidated financial statements.
Secured Promissory Note
The Secured Promissory Note issued by the Company as a result of the Looney Settlement Agreement bears simple interest at a rate per annum of 10% of the outstanding principal balance and is secured by substantially all of the assets of the Company (the “Collateral”) pursuant to the terms and conditions of the Security Agreements, but such security interests are subject to and subordinate to the existing perfected security interests and liens of the Company’s senior creditors, Summit and Longview. The Secured Promissory Note requires the Company to remit graduated monthly installment payments over a 27-month period to Mr. Looney beginning with a payment of $8,000 in May 2010 and ending with a payment of $300,000 in June 2012. All such payments are applied first to unpaid interest and then to outstanding principal. Scheduled payments through April 2011 apply only to interest. A final payment of the remaining unpaid principal and interest under the Secured Promissory Note is due and payable in July 2012. Past due payments will bear simple interest at a rate per annum of 18%. In the event the Company prepays all amounts owing under the Secured Promissory Note within eighteen months after April 9, 2010, the $50,000 cash payment made to Mr. Looney pursuant to the Looney Settlement Agreement will either be returned to the Company or deducted from the final payment due on the Secured Promissory Note. The $50,000 cash payment is recorded as a prepaid charge on the consolidated balance sheet as of June 27, 2010.
Note 5 — Common Stock and Common Stock Warrants, Preferred Stock, Stock Incentive Plans, Employee Retirement Plan and Deferred Compensation Plans
During the 39-week period ended June 27, 2010, the Company issued an aggregate of 14,876,000 shares of common stock, net of the forfeiture of 9,700 shares of nonvested stock, with an aggregate valuation of $5,561,700, in both cash and non-cash transactions.
Cash Common Stock Transactions. In June 2010, the Company sold and issued to 18 accredited investors (the “Common Stock Investors”) an aggregate of 19,022.47 common stock units (the “Common Stock Units”) at a purchase price of $20.025 per Common Stock Unit (the “Common Stock Unit Price”) in an initial closing of a private placement (the “Common Stock Private Placement”). The Common Stock Unit Price was equal to 100 shares of the Company’s Common Stock multiplied by 75% of the last consolidated closing bid price of the Company’s Common Stock as determined in accordance with Nasdaq rules immediately preceding the Company entering into binding subscription agreements with the Common Stock Investors. The approximate $380,900 aggregate purchase price for these Common Stock Units was paid in cash to the Company. There was a second closing of the Common Stock Private Placement subsequent to June 27, 2010. (See Note 11.)

 

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Each Common Stock Unit is comprised of (i) 100 shares of the Company’s Common Stock (the “Shares”) and (ii) a five-year warrant to purchase 20 shares of the Company’s Common Stock (the “Common Stock Investor Warrants”). The exercise price applicable to the Common Stock Investor Warrants is $0.32 per share, which was greater than the last consolidated closing bid price of the Company’s Common Stock as determined in accordance with Nasdaq rules immediately preceding the Company entering into the binding subscription agreements with the Investors.
A total of approximately 1,902,200 Shares were issued in the Common Stock Private Placement, and the total number of shares of Common Stock issuable upon exercise of the Common Stock Investor Warrants at the exercise price is approximately 380,400 in the aggregate.
In consideration for services rendered as the lead placement agent in the Common Stock Private Placement, the Company paid the placement agent cash commissions, a management fee and an expense allowance fee aggregating approximately $49,500, which represents 13% of the gross proceeds of the initial closing of the Common Stock Private Placement, the Company paid the placement agent an expense reimbursement of $5,000, and the Company issued to the placement agent a five-year warrant to purchase an aggregate of approximately 247,300 shares of the Company’s Common Stock at an exercise price of $0.32 per share (the “Common Stock Agent Warrant”), which was greater than the last consolidated closing bid price of the Company’s Common Stock as determined in accordance with Nasdaq rules immediately preceding the Company entering into such warrant.
Non-Cash Common Stock Transactions. During the 39-week period ended June 27, 2010, the Company issued an aggregate of 12,973,700 shares of common stock, net of the forfeiture of 9,700 shares of nonvested stock, with an aggregate valuation of $5,180,800, net of forfeitures, in the following non-cash transactions: (i) an aggregate of 6,580,700 shares of common stock of the Company were issued in various transactions in exchange for conversion and cancellation of $2,632,300 of the stated value of the Company’s Series A-1 Stock; (ii) 245,900 shares of common stock of the Company were issued in exchange for conversion and cancellation of $98,400 of the stated value of the Company’s Series A-2 Stock; (iii) an aggregate of 3,123,100 shares of common stock of the Company were issued in various transactions in exchange for conversion and cancellation of $1,561,600 of the stated value of the Company’s Series B Stock; (iv) after giving effect to the forfeiture of 9,700 shares of nonvested stock, there was a net increase of 3,400 shares and a net expense decrease of $300 associated with issuance of common stock to employees as compensation for services rendered; (v) 2,673,800 shares of common stock of the Company were issued to effectuate $750,000 of non-cash contributions by the Company to the Company’s employee retirement plan, the Cash or Deferred & Stock Bonus Plan (“ESBP”), for fiscal 2010, $403,000 of which has been recognized as expense in the 39-week period ended June 27, 2010 and the balance of which is reflected as a deferred expense expected to be realized in the fourth quarter of fiscal 2010; and (vi) 346,800 shares of common stock of the Company were issued to pay interest in the amount of $138,800 on the Company’s Debentures pursuant their terms. (See Note 4).
Common Stock Warrants. In the 39-week period ended June 27, 2010, the Company issued a five-year warrant to purchase 907,400 shares of common stock at an exercise price of $0.55 per share to its investment banking firm as partial consideration for services rendered in the private placement of a preferred stock unit financing, as discussed below. As an element of that financing, the Company issued five-year warrants to the investors, valued at $424,000 pursuant to the Black-Scholes model, to purchase an aggregate of 2,094,000 shares of common stock at an exercise price of $0.55 per share. In the 39-week period ended June 27, 2010, the Company also issued a five-year warrant to purchase 350,000 shares of the Company’s common stock at an exercise price of $0.44 per share to its investment banking firm for a one-year extension of an agreement with said firm to assist the Company to raise additional capital and to provide financial advisory services. The estimated fair value of this warrant, $119,000, will be amortized over the 12-month term of the extension.

 

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As a result of the closing of the preferred stock financing and the warrant issued to the investment banking firm in connection with the agreement extension discussed above, warrants to purchase 762,000 shares of common stock at $3.18 per share were automatically adjusted to purchase 1,477,500 shares at $1.64 per share effective December 27, 2009, which warrants subsequently expired on December 30, 2009.
In the 39-week period ended June 27, 2010, the Company issued five-year warrants to purchase 986,700 shares of common stock at an exercise price of $0.40 per share to its investment banking firm as partial consideration for services rendered in the private placement of the Debenture Private Placement. As an element of that financing, the Company issued five-year warrants to the investors to purchase an aggregate of 860,000 shares of common stock at an exercise price of $0.40 per share. (See Note 4). The Company used the Black-Scholes model to value the warrants issued to the investment banking firm and investors pursuant to the Debenture Private Placement using the following assumptions; volatility of 95.9%, stock price $0.30 per share, exercise price $0.40 per share, risk-free interest rate of 2.7%, and an expected term of five years.
In the 39-week period ended June 27, 2010, the Company issued five-year warrants to purchase 247,300 shares of common stock at an exercise price of $0.32 per share to its investment banking firm as partial consideration for services rendered in the Common Stock Private Placement described above. As an element of that financing, the Company issued five-year warrants to the Common Stock Investors to purchase an aggregate of 380,400 shares of common stock at an exercise price of $0.32 per share.
At June 27, 2010 and September 27, 2009, there were warrants outstanding to purchase 6,525,100 and 1,461,300 shares of the Company’s common stock, respectively.
Preferred Stock. In the 39-week period ended June 27, 2010, the Company sold and issued an aggregate of 3,490 preferred stock units (the “Preferred Stock Units”) at a purchase price of $700 per Preferred Stock Unit. The $2,443,000 aggregate purchase price for the Preferred Stock Units was paid in cash to the Company, from which fees and expenses of $393,500 were disbursed to the placement agent and its counsel, resulting in net proceeds of $2,049,500 to the Company. Each Preferred Stock Unit was comprised of one share of the Company’s Series B Stock, plus a five-year warrant to purchase 600 shares of the Company’s common stock at an exercise price of $0.55 per share. Each share of Series B Stock is convertible at any time at the holder’s option into 2,000 shares of common stock at a conversion price per share of common stock equal to $0.50. During the 13-week and 39-week periods ended June 27, 2010, approximately 1,562 shares of the Series B Stock were converted into approximately 3,123,100 shares of the Company’s common stock. As of June 27, 2010, an aggregate of approximately 3,856,900 shares of the Company’s common stock were issuable upon conversion of the remaining shares of Series B Stock.
The Series B Stock is non-voting, except to the extent required by law. With respect to distributions upon a deemed dissolution, liquidation or winding-up of the Company, the Series B Stock ranks senior to the common stock and the Company’s new Series C Convertible Preferred Stock and junior to both the Company’s Series A-1 Stock and Series A-2 Stock. The liquidation preference per share of Series B Stock equals its stated value, $1,000 per share. The Series B Stock is not entitled to any preferential cash dividends; however, the Series B Stock is entitled to receive, pari passu with the Company’s common stock, such dividends on the common stock as may be declared from time to time by the Company’s Board of Directors.

 

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The Company’s aggregate gross proceeds of $2,443,000 received from the sale of the Series B Stock was allocated to the individual components comprising the stock units on a relative fair value basis, resulting in approximately $424,000 of the proceeds allocated to the five-year warrant and approximately $2,019,000 allocated to the Series B Stock. In addition, because the effective conversion price of the Series B Stock was below the current trading price of the Company’s shares at the date of issuance, the Company recorded a BCF of approximately $1,471,000. Since the preferred shares contain no set redemption date and they are convertible from inception by the holder, the entire BCF amount was accreted as a preferred dividend as of the issuance date.
The Company used the Black-Scholes model to value the warrants issued to the placement agent and those issued to the Series B Stock investors discussed above using the following assumptions; volatility of 93.2%, stock price $0.50 per share, exercise price $0.55 per share, risk-free interest rate of 2.3% and an expected term of five years.
In the 13-week and 39-week periods ended June 27, 2010, the Company issued 27,500 shares of the Company’s newly created Series C Stock to Longview to effectuate the requirement to issue Waiver Securities related to the Looney Settlement Agreement. (See Note 3.) Each share of Series C Stock is convertible at any time at the holder’s option into 100 shares of common stock at an initial conversion price per share of common stock equal to $0.30. The Series C Stock is non-voting, except to the extent required by law. With respect to distributions upon a deemed dissolution, liquidation or winding-up of the Company, the Series C Stock ranks senior to the common stock and junior to the Company’s Series A-1 Stock, Series A-2 Stock and Series B Stock. The liquidation preference per share of Series C Stock equals its stated value, $30 per share. The Series C Stock is not entitled to any preferential cash dividends; however, the Series C Stock is entitled to receive on an as-converted basis, pari passu with the Company’s common stock, but after payment of dividends to the Series A-1 Stock, Series A-2 Stock and Series B Stock at the time outstanding, such dividends on the common stock as may be declared from time to time by the Company’s Board of Directors. The Series C Stock is not redeemable by the holder thereof, but the Company will have the right, upon 30 calendar days’ prior written notice, to redeem the Series C Stock at its stated value, $30 per share. The Series C Stock is also subject to a blocker that would prevent each holder’s common stock ownership at any given time from exceeding 4.99% of the Company’s outstanding common stock (which percentage may increase but never above 9.99%).
At June 27, 2010, the Company also had an obligation to issue an additional 10,000 shares of the Series C Stock, convertible into 1,000,000 shares of the Company’s common stock, to Longview (the “Contingent Securities”), if Longview’s holdings of Series A-1 Stock, Series A-2 Stock and Series C Stock had not been purchased at their aggregate Stated Value by a third party on or before July 15, 2010 (See Note 10). Such purchase did not occur, and the Company issued the Contingent Securities, pursuant to stockholder authorization, in August 2010. (See Note 11.)
In the 39-week period ended June 27, 2010, 87,743 shares of the Series A-1 Stock were converted by Longview and Alpha into 6,580,700 shares of common stock and 2,500 shares of the Series A-2 Stock were converted by Alpha into 245,900 shares of common stock. At June 27, 2010, as a result of the Common Stock Private Placement in June 2010, the conversion price of the Series A-1 Stock and Series A-2 Stock had been automatically reset to $0.20025 per share. In July 2010, the conversion price of the Series A-1 Stock and Series A-2 Stock was automatically reset to $0.12825 per share as a result of of a subsequent close of the Common Stock Private Placement. (See Note 11.)

 

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Stock Incentive Plans. In June 2006, the Company’s stockholders approved the Company’s 2006 Omnibus Incentive Plan (the “2006 Plan”), which is designed to serve as a comprehensive equity incentive program to attract and retain the services of individuals essential to the Company’s long-term growth and financial success. The 2006 Plan permits the granting of stock options (including both incentive and non-qualified stock options), stock-only stock appreciation rights, nonvested stock and nonvested stock units, performance awards of cash, stock or property, dividend equivalents and other stock grants. Upon approval of the 2006 Plan in June 2006, the Company’s 2003 Stock Incentive Plan (the “2003 Plan”), 2001 Non-Qualified Stock Option Plan (the “2001 Non-Qualified Plan”), 2001 Stock Option Plan (the “2001 Plan”) and 2000 Non-Qualified Stock Option Plan (the “2000 Plan”) (collectively, the “Prior Plans”) were terminated, but existing options issued pursuant to the Prior Plans remain outstanding in accordance with the terms of their original grants. As of June 27, 2010, options to purchase 4,000 shares of the Company’s common stock at an exercise price of $265.62 per share were outstanding and exercisable under the 2000 Plan, options to purchase 2,500 shares of the Company’s common stock at an exercise price of $11.50 per share were outstanding and exercisable under the 2001 Plan, options to purchase 44,900 shares of the Company’s common stock were outstanding and exercisable under the 2001 Non-Qualified Option Plan, at exercise prices ranging from $8.60 to $13.50 per share, and options to purchase 267,900 shares of the Company’s common stock were outstanding under the 2003 Plan at exercise prices ranging from $10.40 to $36.20 per share, of which options all were exercisable at June 27, 2010.
Pursuant to an amendment of the 2006 Plan by stockholders in March 2009, the number of shares of common stock reserved for issuance under the 2006 Plan shall automatically increase at the beginning of each subsequent fiscal year by the lesser of 1,250,000 shares or 5% of the common stock of the Company outstanding on the last day of the preceding fiscal year. As a result of that provision, the number of shares issuable under the 2006 Plan increased by 484,800 shares in the 39-week period ended June 27, 2010. The aggregate number of shares of common stock issuable under all stock-based awards that may be made under the 2006 Plan at June 27, 2010 is 896,300 shares. As of June 27, 2010, there were options to purchase 249,600 shares of the Company’s common stock outstanding under the 2006 Plan, at exercise prices ranging from $0.35 to $14.10 per share, of which options to purchase 240,400 shares were exercisable at June 27, 2010. As of June 27, 2010, 42,800 shares of nonvested stock were issued and outstanding pursuant to the 2006 Plan and 287,300 shares of vested stock were issued and outstanding pursuant to the 2006 Plan. In addition, as of June 27, 2010, 500 shares of nonvested stock were issued and outstanding pursuant to the 2003 Plan.
The following table summarizes stock options outstanding as of June 27, 2010 as well as activity during the 39-week period then ended:
                 
            Weighted Average  
    Shares (1)     Exercise Price  
 
               
Outstanding at September 27, 2009
    568,900     $ 17.78  
Granted
           
Exercised
           
Forfeited
           
 
           
Outstanding at June 27, 2010
    568,900     $ 17.78  
 
           
Exercisable at June 27, 2010
    559,700     $ 18.06  
 
           
     
(1)   Rounded to nearest one hundred (100).
The Company did not grant any options during the first 39 weeks of fiscal 2010. At June 27, 2010, the aggregate intrinsic value of unvested options outstanding and options exercisable was $0. There were no options exercised during the 39 weeks ended June 27, 2010 and therefore, the total intrinsic value of options exercised during that period was $0. The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option. At June 27, 2010, the weighted-average remaining contractual life of options outstanding and exercisable was 4.6 years and 4.6 years, respectively.

 

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The amount of compensation expense related to outstanding stock options not yet recognized at June 27, 2010 was $1,900 and, assuming the grantees continue to be employed by or remain as directors of the Company, that amount will be recognized as compensation expense as follows:
         
FY 2010 (remainder of year)
  $ 600  
FY 2011
    1,300  
 
     
Total
  $ 1,900  
 
     
The following table summarizes nonvested stock grants outstanding as of June 27, 2010 as well as activity during the 39-week period then ended:
                 
            Weighted  
            Average Grant  
            Date Fair Value  
    Nonvested Shares     per Share  
 
               
Outstanding at September 27, 2009
    90,300     $ 2.15  
Granted
    11,300     $ 0.32  
Vested
    (48,600 )   $ 1.39  
Forfeited
    (9,700 )   $ 0.48  
 
             
Outstanding at June 27, 2010
    43,300     $ 2.89  
 
           
The amount of compensation expense related to nonvested stock grants not yet recognized at June 27, 2010 was $18,300 and, assuming the grantees continue to be employed by or remain as directors of the Company, that amount will be recognized as compensation expense as follows:
         
FY 2010 (remainder of year)
  $ 8,200  
FY 2011
    8,600  
FY 2012
    1,300  
FY 2012
    200  
 
     
Total
  $ 18,300  
 
     

 

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Note 6 — Income (Loss) per Share
Since the Company had losses for the 13-week and 39-week periods ended June 27, 2010, basic and diluted net loss per common share for those periods are the same and are computed based solely on the weighted average number of shares of common stock outstanding for the respective periods. In the 13-week and 39-week periods ended June 27, 2010, application of the “if-converted” method to the Company’s convertible preferred stock and convertible debt resulted in said instruments being anti-dilutive and therefore not impacting the calculation of income per share. However, as of June 28, 2009, the Company had outstanding stock options and nonvested stock with exercise or valuation prices less than the average closing market price of the Company’s common stock over the 39-week period ended June 28, 2009. Such “in-the money” instruments are assumed to have been exercised or vested at the beginning of a period (or at time of issuance, if later) for purposes of calculating diluted income per share if the Company has recorded a year-to-date income through said period, which was the case in the 39-week period ended June 28, 2009. As a result, basic and diluted net income per common share are different for the 39-week period ended June 28, 2009. Cumulative dividends on the Series A-1 Stock and Series A-2 Stock for the 13-week and 39-week periods ended June 27, 2010 and the Series A-1 Stock for the 13-week and 39-week periods ended June 28, 2009, although not declared, constitute a preferential claim against future dividends, if any, and are treated as an incremental expense of continuing operations for purposes of determining basic and diluted net loss from continuing operations per common share. As of June 27, 2010, cumulative dividends on the Series A-1 Stock and Series A-2 Stock held by Longview through July 15, 2010, including those accumulated in the 13-week and 39-week periods ended June 27, 2010, had been waived pursuant to the Looney Settlement Agreement. (See Note 3). In like manner, the BCF associated with the issuance of the Company’s Series B Stock in the 39-week period ended June 27, 2010, although not recorded as an expense, is treated as a deemed dividend and, therefore, an incremental expense of continuing operations for purposes of determining basic and diluted net loss from continuing operations per common share.

 

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The following table sets forth the computation of basic and diluted loss per common share:
                                 
    13 Weeks Ended     39 Weeks Ended  
    June 27, 2010     June 28, 2009     June 27, 2010     June 28, 2009  
Continuing Operations Numerator:
                               
Income (loss) from continuing operations attributable to Company
  $ (2,625,400 )   $ (2,544,900 )   $ (7,761,700 )   $ 410,600  
Undeclared cumulative dividends on Series
                               
A-1 and Series A-2 preferred stock*
          (121,700 )           (325,900 )
Deemed dividend for beneficial conversion feature related to Series B preferred stock
                (1,471,000 )      
 
                       
Adjusted basic and diluted net income (loss) attributable to Company common stockholders
  $ (2,625,400 )   $ (2,666,600 )   $ (9,232,700 )   $ 84,700  
 
                       
 
                               
Discontinued Operations Numerator:
                               
Income (loss) from discontinued operations
  $     $     $     $ 58,400  
 
                       
 
                               
Basic Net Income (Loss) Continuing and Discontinued Operations Denominator:
Weighted average number of common shares outstanding — basic
    17,302,800       7,708,400       13,932,100       6,257,000  
 
                       
Basic net income (loss) per share information:
                               
From continuing operations attributable to Company
  $ (0.15 )   $ (0.35 )   $ (0.66 )   $ 0.01  
From discontinued operations attributable to Company
                      0.01  
 
                       
Basic net income (loss) per common share
  $ (0.15 )   $ (0.35 )   $ (0.66 )   $ 0.02  
 
                       
 
                               
Diluted Net Income (Loss) Continuing and Discontinued Operations Denominator:
Assumed net exercise and vesting of options and nonvested stock
                      2,500  
Weighted average number of common shares outstanding — diluted
    17,302,800       7,708,400       13,932,100       6,257,000  
 
                       
Assumed weighted common shares outstanding
    17,302,800       7,708,400       13,932,100       6,259,500  
 
                       
Diluted net income (loss) per share information:
                               
From continuing operations attributable to Company
  $ (0.15 )   $ (0.35 )   $ (0.66 )   $ 0.01  
From discontinued operations attributable to Company
                      0.01  
 
                       
Basic and diluted net income (loss) attributable to Company per common share
  $ (0.15 )   $ (0.35 )   $ (0.66 )   $ 0.02  
 
                       
     
*   Potential undeclared dividends accumulated prior to July 15, 2010 were waived in April 2010. (See Note 3).

 

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Note 7 — Inventories, Net
Net inventories at June 27, 2010 and September 27, 2009 are set forth below.
                 
    June 27,     September 27,  
    2010     2009  
Inventory:
               
Work in process
  $ 1,581,900     $ 1,128,000  
Raw materials
    307,600       326,800  
Finished goods
    244,900       161,000  
 
           
 
    2,134,400       1,615,800  
Less reserve for obsolete inventory
    (1,309,500 )     (1,174,700 )
 
           
 
  $ 824,900     $ 441,100  
 
           
The Company uses the average cost method for valuation of its product inventory.
Title to all inventories remains with the Company. Inventoried materials and costs relate to: work orders from customers; the Company’s generic module parts and memory stacks; and capitalized material, labor and overhead costs expected to be recovered from probable new research and development contracts. Work in process includes amounts that may be sold as products or under contracts. Such inventoried costs are stated generally at the total of the direct production costs including overhead. Inventory valuations do not include general and administrative expenses. Inventories are reviewed quarterly to determine salability and obsolescence.
Note 8 — Reportable Segments
The Company manages its operations through two reportable segments, the contract research and development segment and the product segment.
The Company’s contract research and development segment provides services, largely to U.S. government agencies and government contractors, under contracts to develop prototypes and provide research, development, design, testing and evaluation of complex detection and control defense systems. The Company’s research and development contracts are usually cost reimbursement plus fixed fee, which require the Company’s good faith performance of a statement of work within overall budgetary constraints, but with latitude as to resources utilized, or fixed price level of effort, which require the Company to deliver a specified number of labor hours in the performance of a statement of work. Occasionally, the Company’s research and development contracts are firm fixed price, which require the delivery of specified work products independent of the resources or means employed to satisfy the required deliveries.
Currently, the Company’s product segment primarily consists of stacked semiconductor chip assemblies, electronic chips, high-speed processing boards, miniaturized cameras and thermal imaging cores, particularly clip-on thermal imagers (“COTIs”), largely all of which are based on proprietary designs of the Company.

 

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The Company’s management evaluates financial information to review the performance of the Company’s research and development contract business separately from the Company’s product business, but only to the extent of the revenues and the cost of revenues of the two segments. Because the various indirect expense operations of the Company, as well as its assets, now support all of its revenue-generating operations, frequently in circumstances in which a distinction between research and development contract support and product support is difficult to identify, segregation of these indirect costs and assets is impracticable. The revenues and gross profit or loss of the Company’s two reportable segments for the 13-week and 39-week periods ended June 27, 2010 and June 28, 2009 are shown in the following table.
                                 
    13 Weeks Ended     39 Weeks Ended  
    June 27,     June 28,     June 27,     June 28,  
    2010     2009     2010     2009  
Contract research and development revenue
  $ 2,171,000     $ 2,508,500     $ 6,944,700     $ 7,247,000  
Cost of contract research and development revenue
    1,565,300       1,705,200       5,070,200       5,651,100  
 
                       
Contract research and development segment gross profit
  $ 605,700     $ 803,300     $ 1,874,500     $ 1,595,900  
 
                       
 
                               
Product sales
  $ 1,402,800     $ 262,700     $ 2,550,200     $ 1,099,400  
Cost of product sales
    1,335,500       323,000       2,442,800       1,110,800  
 
                       
Product segment gross profit (loss)
  $ 67,300     $ (60,300 )   $ 107,400     $ (11,400 )
 
                       
Reconciliations of segment revenues to total revenues are as follows:
                                 
    13 Weeks Ended     39 Weeks Ended  
    June 27,     June 28,     June 27,     June 28,  
    2010     2009     2010     2009  
Contract research and development revenue
  $ 2,171,000     $ 2,508,500     $ 6,944,700     $ 7,247,000  
Product sales
    1,402,800       262,700       2,550,200       1,099,400  
Other revenue
    2,300       3,300       12,800       12,800  
 
                       
Total revenues
  $ 3,576,100     $ 2,774,500     $ 9,507,700     $ 8,359,200  
 
                       

 

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Reconciliations of segment gross profit (loss) to loss from continuing operations before provision for income taxes are as follows:
                                 
    13 Weeks Ended     26 Weeks Ended  
    June 27,     June 28,     June 27,     June 28,  
    2010     2009     2010     2009  
Contract research and development segment gross profit
  $ 605,700     $ 803,300     $ 1,874,500     $ 1,595,900  
Product segment gross profit (loss)
    67,300       (60,300 )     107,400       (11,400 )
 
                       
Net segment gross profit
    673,000       743,000       1,981,900       1,584,500  
Add (deduct)
                               
Other revenue
    2,300       3,300       12,800       12,800  
General and administrative expense
    (1,565,100 )     (2,862,500 )     (4,693,100 )     (6,982,200 )
Research and development expense
    (655,200 )     (531,300 )     (2,011,400 )     (1,318,000 )
Interest expense
    (636,500 )     (218,400 )     (882,600 )     (1,458,100 )
Provision for litigation judgment
                (20,200 )      
Litigation settlement expense
    (450,000 )           (2,270,700 )      
Change in fair value of derivative instrument
    7,000             67,000        
Gain on sale or disposal of assets
    100       8,000       12,600       8,640,800  
Interest and other income (expense)
    (1,000 )     5,000       (1,300 )     51,700  
 
                       
Income (loss) from continuing operations before provision for income taxes
  $ (2,625,400 )   $ (2,852,900 )   $ (7,805,000 )   $ 531,500  
 
                       
Note 9 — Concentration of Revenues and Sources of Supply
In the 13-week and 39-week periods ended June 28, 2010, direct contracts with the U.S. government accounted for 40% and 58%, respectively, of the Company’s total revenues, and second-tier government contracts with prime government contractors accounted for 59% and 40% of total revenues, respectively. The remaining 1% and 2% of the Company’s total revenues in the 13-week and 39-week periods ended June 27, 2010, respectively, were derived from non-government sources. Of the revenues derived directly or indirectly from U.S. government customers, Optics 1, Inc., a defense contractor, certain classified agencies and the U. S. Army accounted for 42%, 21% and 13% respectively, of the Company’s total revenues in the 13-week period ended June 28, 2010, and certain classified agencies, the U. S. Army and Optics 1, Inc. accounted for 28%, 20%, and 19%, respectively, of the Company’s total revenues in the 39-week period ended June 27, 2010. Loss of any of these customers would have a material adverse impact on the Company’s business, financial condition and results of operations. No other single governmental or non-governmental customer accounted for more than 10% of the Company’s total revenues in the 13-week and 39-week periods ended June 28, 2010.
In the 13-week and 39-week periods ended June 28, 2009, direct contracts with the U.S. government accounted for 57% and 57%, respectively, of the Company’s total revenues, and second-tier government contracts with prime government contractors accounted for 39% and 26% of total revenues, respectively. The remaining 4% and 17% of the Company’s total revenues in the 13-week and 39-week periods ended June 28, 2009, respectively, were derived from non-government sources, of which 6% and 12% of the Company’s total revenues in the 13-week and 39-week periods ended June 28, 2009, respectively, were derived from one customer, Pixel Optics. Of the revenues derived directly or indirectly from U.S. government agencies, the U. S. Air Force and the U.S. Army accounted for 41% and 12%, respectively, of the Company’s total revenues in the 13-week period ended June 28, 2009 and 33% and 13%, respectively, of the Company’s total revenues in the 39-week period ended June 28, 2009. No other single governmental or non-governmental customer accounted for more than 10% of the Company’s total revenues in the 13-week and 39-week periods ended June 28, 2009.

 

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The Company primarily uses contract manufacturers to fabricate and assemble its stacked chip, microchip and sensor products. At current limited levels of sales, the Company typically uses a single contract manufacturer for such products and, as a result, is vulnerable to disruptions in supply. The Company also uses contract manufacturers for production of its visible camera products, except for final testing, which the Company performs itself. The Company currently assembles, calibrates and tests its thermal camera and software products itself, given the relatively low volumes of these products. The Company presently relies on a limited number of suppliers of imaging devices that meet the quality and performance requirements of the Company’s thermal imaging products, which makes the Company vulnerable to potential disruptions in supply of such imaging devices.
Note 10 — Commitments and Contingencies
Litigation. In March 2009, FirstMark III, LP, formerly known as Pequot Private Equity Fund III, LP, and FirstMark III Offshore Partners, LP, formerly known as Pequot Offshore Private Equity Partners III, LP, filed a lawsuit in the state Supreme Court, State of New York, County of New York, against the Company. The plaintiffs allege the Company breached a settlement agreement dated December 29, 2006 with them that allegedly required the Company to make certain payments to the plaintiffs that were not made, in the principal amounts of approximately $539,400 and $230,000 plus interest thereon allegedly accruing at 18% from March 14, 2007 and May 31, 2007, respectively. At June 27, 2010, the Company has approximately $1,231,900 of expense accrued reflecting these alleged obligations. The plaintiffs filed a motion for summary judgment in this matter, which was granted in January 2010, although judgment has not yet been entered as of the date of this report. The Company is currently in negotiations with the plaintiffs to settle this matter, but such an outcome cannot be assured.
The Company has been, and may from time to time, become a party to various other legal proceedings arising in the ordinary course of its business. The Company does not presently know of any such other matters, the disposition of which would be likely to have a material effect on the Company’s consolidated financial position, results of operations or liquidity.
Longview Agreement, Consent and Waiver. In connection with Longview’s consent for the Looney Settlement Agreement, the Company and Longview entered into an Agreement, Consent and Waiver (the “Longview Agreement”) pursuant to which the Company and Longview made certain agreements related to such consent. In addition to the issuance of the Waiver Securities (see Note 3), the Longview Agreement also provided (i) that the Company will repay to Longview all principal and interest due under the Longview Note dated July 13, 2007 upon the closing of an equity or debt financing (or a series of equity or debt financings) which results in gross proceeds to the Company in the aggregate in excess of $1,500,000; (ii) if the Company arranges for a third-party investor to purchase the Company’s Series A-1 Stock and Series A-2 Stock beneficially owned by Longview (collectively, the “Preferred Stock”) at its Stated Value (as defined in the respective Certificates of Designations), Longview agreed to sell the Preferred Stock to such investor on such terms and also sell all the Waiver Securities to such investor at a price per share of $0.30 (the “Buyout”), provided that the closing of such sale occurred no later than July 15, 2010; and (iii) in the event the Buyout had not closed on or prior to July 15, 2010 or Longview still owned Preferred Stock on July 15, 2010 (each, a “Contingency Date”), the Company was obligated to issue to Longview (x) non-voting equity securities, with terms junior to the Company’s Series B Convertible Preferred Stock, convertible into 1,000,000 shares of the Company’s

 

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common stock (the “Contingent Securities”) and (y) a two-year warrant to purchase 1,000,000 shares of the Company’s common stock at an exercise price per share of $0.30 (the “Contingent Warrant”). The terms of the Contingent Securities and the Contingent Warrant were mutually agreed upon by the parties such that the Contingent Securities were to consist of 10,000 shares of Series C Convertible Preferred Stock convertible into 1,000,000 shares of common stock, subject to receipt of stockholder approval for such issuance if required by Nasdaq. The Buyout did not occur on or before July 15, 2010, and stockholder approval for the issuance of the Contingent Securities in the form of Series C Stock was obtained on July 28, 2010. Accordingly, the Contingent Securities and Contingent Warrant were issued to Longview in August 2010. (See Note 11.) Although the Buyout contingency was not fully resolved until July 15, 2010, the Company recorded a charge of $450,000 for the value of the Contingent Securities and Contingent Warrant to litigation settlement expense in the 13-week period ended June 27, 2010 to reflect management’s estimate at June 27, 2010 that it was probable that the Company would be unable to arrange for a successful Buyout of Longview’s holdings by the July 15, 2010 deadline. Both the Contingent Securities and the Contingent Warrant include a blocker which would preclude conversion into Common Stock resulting in beneficial ownership by the holder and its affiliates of more than 4.99% of the Company’s outstanding common stock, the Contingent Warrant includes a cashless exercise provision, but is not exercisable within six months of issuance.
Note 11 — Subsequent Events
Second Close of Private Placement of Common Stock Units
On July 15, 2010, the Company sold and issued to 12 accredited investors (the “2nd Close Investors”) an aggregate of 15,672.51 Common Stock Units at a purchase price of $12.825 per Common Stock Unit (the “2nd Close Unit Price”) in a second closing of the Common Stock Private Placement (the “Second Close”). (See Note 5.) The Common Stock Unit Price was equal to 100 shares of the Company’s Common Stock multiplied by 75% of the last consolidated closing bid price of the Company’s Common Stock as determined in accordance with Nasdaq rules immediately preceding the Company entering into binding subscription agreements with the 2nd Close Investors. The $201,000 aggregate purchase price for these Common Stock Units was paid in cash to the Company.
Each Common Stock Unit is comprised of (i) 100 shares of the Company’s Common Stock (the “Shares”) and (ii) a five-year warrant to purchase 20 shares of the Company’s Common Stock (the “2nd Close Investor Warrants”). The exercise price applicable to the 2nd Close Investor Warrants is $0.21 per share, which was greater than the last consolidated closing bid price of the Company’s Common Stock as determined in accordance with Nasdaq rules immediately preceding the Company entering into the binding subscription agreements with the 2nd Close Investors.
A total of approximately 1,567,200 Shares were issued in the Second Close, and the total number of shares of Common Stock issuable upon exercise of the 2nd Close Investor Warrants at the exercise price is approximately 313,400 in the aggregate.
In consideration for services rendered as the lead placement agent in the Second Close, on July 15, 2010, the Company paid the placement agent cash commissions, a management fee and an expense allowance fee aggregating approximately $26,100, which represents 13% of the gross proceeds of the Second Close, and the Company issued to the placement agent a five-year warrant to purchase an aggregate of approximately 203,700 shares of the Company’s Common Stock at an exercise price of $0.21 per share (the “2nd Close Agent Warrant”), which was greater than the last consolidated closing bid price of the Company’s Common Stock as determined in accordance with Nasdaq rules immediately preceding the Company entering into such warrant.
Issuance of Contingent Securities and Contingent Warrant
Because the Company was unable to arrange for a third-party Buyout of the Company’s Preferred Stock beneficially owned by Longview by July 15, 2010, and because stockholder approval for issuance of the Contingent Securities in the form of an additional 10,000 shares of the Company’s Series C Stock was obtained on July 28, 2010, the Company issued the Contingent Warrant and 10,000 shares of Series C Stock to Longview on August 2, 2010, pursuant to the terms of the Longview Agreement. (See Note 3).

 

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.
In this report, the terms “Irvine Sensors,” “Company,” “we,” “us” and “our” refer to Irvine Sensors Corporation (“ISC”) and its subsidiaries.
This report contains forward-looking statements regarding Irvine Sensors which include, but are not limited to, statements concerning our projected revenues, expenses, gross profit and income, mix of revenue, demand for our products, the need for additional capital, the outcome of existing litigation and potential settlements of such litigation, our ability to obtain and successfully perform additional new contract awards and the related funding of such awards, market acceptance of our products and technologies, the competitive nature of our business and markets, the success and timing of new product introductions and commercialization of our technologies, product qualification requirements of our customers, our significant accounting policies and estimates, and the outcome of expense audits. These forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs, and certain assumptions made by us. Words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “potential,” “believes,” “seeks,” “estimates,” “should,” “may,” “will”, “with a view to” and variations of these words or similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. Such factors include, but are not limited to the following:
    our ability to obtain additional financing for working capital on acceptable terms in a timely manner or at all;
    our ability to regain and maintain compliance with Nasdaq’s listing requirements;
    our ability to settle a pending judgment on existing litigation with FirstMark on acceptable terms;
    our ability to continue as a going concern;
    our ability to obtain critical and timely product and service deliveries from key vendors due to our working capital limitations, competitive pressures or other factors;
    our ability to successfully execute our business plan and control costs and expenses;
    our ability to obtain expected and timely bookings and orders resulting from existing contracts;
    our ability to secure and successfully perform additional research and development contracts, and achieve greater contracts backlog;
    governmental agendas, budget issues and constraints and funding or approval delays;
    our ability to maintain adequate internal controls and disclosure procedures, and achieve compliance with Section 404 of the Sarbanes-Oxley Act;
    our ability to introduce new products, gain broad market acceptance for such products and ramp up manufacturing in a timely manner;
    new products or technologies introduced by our competitors, many of whom are bigger and better financed than us;
    the pace at which new markets develop;
    our ability to establish strategic partnerships to develop our business;
    our limited market capitalization;
    general economic and political instability; and
    those additional factors which are listed under the section “Risk Factors” in Part II, Item 1A of this report.

 

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We do not undertake any obligation to revise or update publicly any forward-looking statements for any reason, except as required by law. Additional information on the various risks and uncertainties potentially affecting our operating results are discussed below and are contained in our publicly filed documents available through the SEC’s website (www.sec.gov) or upon written request to our Investor Relations Department at 3001 Red Hill Avenue, Costa Mesa, California 92626. The information contained in, or that can be accessed through, such website does not constitute a part of this report.
Overview
We are a vision systems company enabled by technology for three-dimensional packaging of electronics and manufacturing of electro-optical products. We design, develop, manufacture and sell vision systems, miniaturized electronic products and higher level systems incorporating such products for defense, security and commercial applications. We also perform customer-funded contract research and development related to these products, mostly for U.S. government customers or prime contractors. Most of our historical business relates to application of our technologies for stacking either packaged or unpackaged semiconductors into more compact three-dimensional forms, which we believe offer volume, power, weight and operational advantages over competing packaging approaches, and which we believe allows us to offer proprietary higher level products with unique operational features.
In December 2005, we completed the initial acquisition (the “Initial Acquisition”) of 70% of the outstanding capital stock of Optex Systems, Inc. (“Optex”), a privately held manufacturer of telescopes, periscopes, lenses and other optical systems and instruments whose customers were primarily agencies of and prime contractors to the U.S. Government. In consideration for the Initial Acquisition, we paid the sole shareholder of Optex, Timothy Looney, cash in the amount of approximately $14.1 million. As additional consideration, we were initially required to pay to Mr. Looney cash earnout payments in the aggregate amount up to $4.0 million based upon the net cash generated from the Optex business, after debt service, for the fiscal year ended October 1, 2006 (“fiscal 2006”) and the next two subsequent fiscal years. Mr. Looney was not entitled to any earnout payments for fiscal 2006, for the fiscal year ended September 30, 2007 (“fiscal 2007”) or for the fiscal year ended September 28, 2008 (“fiscal 2008”). In January 2007, we negotiated an amendment to our earnout agreement with Mr. Looney that extended his earnout period to December 2009 and reduced the aggregate maximum potential earnout by $100,000 to $3.9 million in consideration for a secured subordinated term loan providing for advances from an entity owned by Mr. Looney to Optex of up to $2 million. This term loan bore interest at 10% per annum and matured on the earlier of February 2009 or 60 days after repayment of our senior debt. As of September 27, 2009, this term loan was fully advanced to Optex. Optex ceased operations in October 2008 as a result of a UCC foreclosure sale (the “Optex Asset Sale”) as described more fully below. In September 2009, Optex filed a voluntary petition for relief under Chapter 7 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of California. As a result of this filing, the accounts of Optex have been deconsolidated from the consolidated balance sheet of the Company at September 27, 2009, including the obligations of Optex to the entity owned by Mr. Looney described above. We believe that Mr. Looney was not entitled to any earnout for fiscal 2009. However, Mr. Looney brought a lawsuit against us alleging that we were obligated to pay him the full potential earnout as a result of the Optex Asset Sale. To mitigate the risks of this and other related lawsuits brought by Mr. Looney and his affiliated entity, we entered into a settlement of various legal disputes with Mr. Looney, including the earnout matter, in March 2010 (the “Looney Settlement Agreement”) pursuant to which we issued Mr. Looney a $2.5 million secured promissory note (the “Secured Promissory Note”). (See Note 3 of the Condensed Notes to the Consolidated Financial Statements).

 

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In connection with the Initial Acquisition, we entered into an agreement with Mr. Looney, pursuant to which we agreed to purchase the remaining 30% of the capital stock of Optex held by Mr. Looney (the “Buyer Option”), subject to stockholder approval, which approval was received in June 2006. On December 29, 2006, we amended certain of our agreements with Mr. Looney regarding the Buyer Option. In consideration for such amendments, we issued a one-year unsecured subordinated promissory note to Mr. Looney in the principal amount of $400,000, bearing interest at a rate of 11% per annum. This obligation was extinguished in March 2010 upon issuance of the Secured Promissory Note. We exercised the Buyer Option on December 29, 2006 and issued Mr. Looney approximately 269,231 shares of our common stock, after giving effect to our one-for-ten reverse stock split effectuated in August 2008 (the “2008 Reverse Split”), as consideration for our purchase of the remaining 30% of the outstanding common stock of Optex held by him. As a result of the Initial Acquisition and exercise of the Buyer Option, Optex became our wholly-owned subsidiary.
We financed the Initial Acquisition of Optex by a combination of $4.9 million of senior secured debt from Square 1 Bank under a term loan and $10.0 million of senior subordinated secured convertible notes from two private equity funds, which are sometimes referred to in this Report collectively as “Pequot.” In December 2006, both of these obligations were refinanced with two new senior lenders, Longview Fund, LP (“Longview) and Alpha Capital Anstalt (“Alpha”) (collectively, the “Lenders”). In November 2007, we restructured these obligations, as well as a short-term $2.1 million debt obligation to Longview, to extend the maturity date of all of such obligations, including the related interest, to December 30, 2009 in consideration for a restructuring fee of approximately $1.1 million, which fee was also initially payable December 30, 2009, but which was extended to September 30, 2010 in connection with partial repayment of the original obligations.
In September 2008, we entered into a binding Memorandum of Understanding for Settlement and Debt Conversion Agreement (the “MOU”) with the Lenders with the intent to effect a global settlement and restructuring of our aggregate outstanding indebtedness payable to the Lenders, which was then approximately $18.4 million. In October 2008, pursuant to the MOU, an entity controlled by the Lenders delivered a notice to us and to Optex of the occurrence of an event of default and acceleration of the obligations due to the Lenders and their assignee and conducted the aforementioned Optex Asset Sale, a public UCC foreclosure sale of the assets of Optex. The entity controlled by the Lenders credit bid $15 million in the Optex Asset Sale, which was the winning bid. As a result, $15 million of our aggregate indebtedness to the Lenders was extinguished. All financial statements and schedules of the Company give effect to this event and report Optex as a discontinued operation.
In March 2009, we sold most of our patent portfolio to a patent acquisition company for $9.5 million in cash, $8.5 million of which was paid in March 2009 and $1.0 million of which was paid in April 2009, and the patent acquisition company granted us a perpetual, worldwide, royalty-free, non-exclusive license to use the sold patents in our business (the “Patent Sale and License”). In order to secure the release of security interests to effectuate the Patent Sale and License, we agreed to pay $2.8 million of the aggregate principal and accrued interest owed to the Lenders from the proceeds of the Patent Sale and License. After such payment, our aggregate principal and accrued interest owed to the Lenders was approximately $1.2 million. As a result of our satisfying certain conditions, including our consummation of a $1.0 million bridge debt financing, in April 2009, the Lenders exchanged $1.0 million of our residual principal obligations for the issuance of 24,999 shares of our newly-created Series A-2 10% Cumulative Convertible Preferred Stock (the “Series A-2 Stock”), a non-voting convertible preferred stock of the Company. The conversion of the Series A-2 Stock into shares of our common stock is subject to the same conversion blocker as contained in our Series A-1 10% Cumulative Convertible Preferred Stock (the “Series A-1 Stock”), which would prevent each Lender’s common stock ownership at any given time from exceeding 4.99% of our outstanding common stock (which percentage may increase but not above 9.99%).

 

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Since 2002, we historically derived a substantial majority of our total revenues from government-funded research and development rather than from product sales. We anticipate that a substantial majority of our total revenues will continue to be derived from government-funded sources in the immediately foreseeable future. In fiscal 2008 and fiscal 2009, our contract research and development revenues were adversely affected by procurement delays and capital constraints, as well as diversion of management and financial resources to address issues related to operations at Optex, the Optex Asset Sale and the various lawsuits with Mr. Looney. Our current marketing efforts are focused on government programs that we believe have the potential to transition to government production contracts. If we are successful in this transition, our future revenues may become more dependent upon production elements of U.S. defense budgets, funding approvals and political agendas. We are also attempting to increase our revenues from product sales by introducing new products with commercial applications, in particular, miniaturized cameras and stacked computer memory chips. We cannot assure you that we will be able to complete development, successfully launch or profitably manufacture and sell any such products on a timely basis, if at all. We generally use contract manufacturers to produce these products or their subassemblies, and all of our other current operations occur at a single, leased facility in Costa Mesa, California.
Prior to the fiscal year ended September 27, 2009 (“fiscal 2009”), we had a history of unprofitable operations due in part to our investment in Optex and in part to discretionary investments that we made to commercialize our technologies and to maintain our technical staff and corporate infrastructure at levels that we believed were required for future growth. In fiscal 2009, we did achieve profitable operating results, largely due to certain nonrecurring events such as the Patent Sale and License and elimination of certain obligations. In the 13-week and 39-week periods ended June 27, 2010, we again experienced unprofitable operations. With respect to our investments in staff and infrastructure, the advanced technical and multi-disciplinary content of our technologies places a premium on a stable and well-trained work force. As a result, we generally maintain the size of our work force even when anticipated government contracts are delayed, a circumstance that has occurred with some frequency in the past and that has resulted in under-utilization of our labor force for revenue generation from time to time. Delays in receipt of research and development contracts are unpredictable, but we believe such delays represent a recurring characteristic of our research and development contract business. We anticipate that the impact on our business of future delays can be mitigated by the achievement of greater contract backlog and are seeking growth in our research and development contract revenue to that end. We are also seeking to expand the contribution to our total revenues from product sales, which have not historically experienced the same types of delays that can occur in research and development contracts. We have not yet demonstrated the level of sustained research and development contract revenue or product sales that we believe, by itself, is required to sustain profitable operations. Our ability to recover our investments through the cost-reimbursement features of our government contracts is constrained due to both regulatory and competitive pricing considerations.
In February 2010, one of our existing purchase orders with Optics 1, Inc., of Manchester, New Hampshire, an optical systems designer and manufacturer and our strategic partner for certain thermal imaging products, was modified to include initial units of Clip-On Thermal Imager (“COTI”) systems to be built under a $37.8 million contract awarded to Optics 1 by the Naval Surface Warfare Center of Crane, Indiana. We are acting as the subcontractor supplying thermal imaging cores to Optics 1 for integration into COTIs. Prior to this award, we and Optics 1 had been jointly developing the COTI over the last several years under government sponsorship, based on technology originally conceived by us. The COTI has been designed to clip onto existing military night vision goggles and provide users with thermal images to complement the amplified low-light images that such goggles can currently provide. Such dual capability is intended to both enhance imagery obtainable from the existing night vision goggles as well as providing images in circumstances where physical barriers, atmospheric conditions or lack of light limit the effectiveness of the existing goggles. We have subsequently received additional releases of COTI imager orders from Optics 1 that have contributed to a substantial increase in our backlog and our realized product sales in fiscal 2010. We believe that further substantial increases in our backlog and product sales, and the related shift in emphasis in our overall business, could result from future COTI sales if we are able to improve our liquidity to support such growth, which is an outcome we cannot assure.

 

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To offset the adverse working capital effect of our net losses, we have historically financed our operations through various equity and debt financings. To finance the acquisition of Optex, we also incurred material long-term debt, and we have exchanged a significant portion of that debt into preferred stock that is convertible into our common stock. Since September 30, 2007 through the date of this report, we have issued approximately 26.0 million shares of our common stock, an increase of approximately 970% from the approximately 2.7 million shares of our common stock outstanding at that date, which resulted in a substantial dilution of stockholder interests. At June 27, 2010, our fully diluted common stock position was approximately 48.0 million shares, which assumes the conversion into common stock of all of the Company’s preferred stock and convertible debentures outstanding or obligated for issuance as of June 27, 2010 and the exercise for cash of all warrants and options to purchase the Company’s securities outstanding as of June 27, 2010. Subsequent to June 27, 2010, our fully diluted common stock position increased further pursuant to the issuance of the Contingent Securities and Contingent Warrant and the price adjustment of the Series A-1 Stock and Series A-2 Stock resulting from the 2nd Close of the Common Stock Private Placement in July 2010. At June 27, 2010, we had approximately $5.4 million of debt.
None of our subsidiaries accounted for more than 10% of our total assets at June 27, 2010 or have separate employees or facilities. We currently report our operating results and financial condition in two operating segments, our research and development business and our product business.
Critical Accounting Estimates
Our consolidated financial statements have been prepared in conformity with GAAP. As such, management is required to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The significant accounting policies that are most critical to aid in fully understanding and evaluating reported financial results are the same as those disclosed in our Form 10-K for the 52-week period ended September 27, 2009.
Results of Operations
Total Revenues. Our total revenues increased approximately 29% in the 13-week period ended June 27, 2010 as compared to the 13-week period ended June 28, 2009 and approximately 14% in the 39-week period ended June 27, 2010 as compared to the 39-week period ended June 28, 2009. The elements of the total revenues that produced these outcomes are discussed more fully below.
         
13-Week Comparisons   Total Revenues  
13 weeks ended June 28, 2009
  $ 2,774,500  
Dollar increase in current comparable 13 weeks
    801,600  
 
     
13 weeks ended June 27, 2010
  $ 3,576,100  
Percentage increase in current 13 weeks
    29 %
         
39-Week Comparisons   Total Revenues  
39 weeks ended June 28, 2009
  $ 8,359,200  
Dollar increase in current comparable 39 weeks
    1,148,500  
 
     
39 weeks ended June 27, 2010
  $ 9,507,700  
Percentage increase in current 39 weeks
    14 %

 

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Contract Research and Development Revenue. Contract research and development revenue consists of amounts realized or realizable from funded research and development contracts, largely from U.S. government agencies and government contractors. Contract research and development revenue for the 13-week period ended June 27, 2010 declined 13% from contract research and development revenue of the 13-week period ended June 28, 2009 and 4% for the 39-week period ended June 27, 2010 from contract research and development revenue of the 39-week period ended June 28, 2009, as shown in the following tables:
                 
    Contract Research and     Percentage of  
13-Week Comparisons   Development Revenue     Total Revenue  
13 weeks ended June 28, 2009
  $ 2,508,500       90 %
Dollar decrease in current comparable 13 weeks
    (337,500 )        
 
             
13 weeks ended June 27, 2010
  $ 2,171,000       61 %
Percentage decrease in current 13 weeks
    (13 %)        
                 
    Contract Research and     Percentage of  
39-Week Comparisons   Development Revenue     Total Revenue  
39 weeks ended June 28, 2009
  $ 7,247,000       87 %
Dollar decrease in current comparable 39 weeks
    (302,300 )        
 
             
39 weeks ended June 27, 2010
  $ 6,944,700       73 %
Percentage decrease in current 39 weeks
    (4 %)        

 

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The decrease in our contract research and development revenue in the 13-week period and 39-week periods ended June 27, 2010 as compared to the 13-week and 39-week periods ended June 28, 2009 was partially related to the timing of the start of new contract awards that experienced procurement delays. In addition, completion of some of the technical milestones of existing contracts was delayed during the current periods by our working capital limitations that impacted the schedule at which we could receive necessary vendor and subcontractor support, which would have generated revenue under the cost reimbursement features of many of our contract research and development contracts. We believe that these variances are related to the specific procurement and technical milestones of our present research and development contracts, rather than being indicative of a trend. However, if we require substantially increased subcontractor and vendor support to increase our contract research and development revenue in future fiscal quarters, such an outcome will likely be dependent on our ability to raise additional capital, which we cannot guarantee.
Cost of Contract Research and Development Revenue. Cost of contract research and development revenue consists of wages and related benefits, as well as subcontractor, independent consultant and vendor expenses directly incurred in support of research and development contracts, plus associated indirect expenses permitted to be charged pursuant to the relevant contracts. Our cost of contract research and development revenue for the first 13 weeks and 39 weeks of fiscal 2010 decreased in terms of absolute dollars as compared to the first 13 weeks and 39 weeks of fiscal 2009. Our cost of contract research and development revenue for the first 13 weeks of fiscal 2010 increased as a percentage of contract research and development revenue as compared to the first 13 weeks of fiscal 2009, but decreased as a percentage of contract research and development revenue for the first 39 weeks of fiscal 2010 as compared to the first 39 weeks of fiscal 2009 as shown in the following tables:
                 
            Percentage of  
    Cost of Contract     Contract Research  
    Research and     and Development  
13-Week Comparisons   Development Revenue     Revenue  
13 weeks ended June 28, 2009
  $ 1,705,200       68 %
Dollar decrease in current comparable 13 weeks
    (139,900 )        
 
             
13 weeks ended June 27, 2010
  $ 1,565,300       72 %
Percentage decrease in current 13 weeks
    (8 %)        
                 
            Percentage of  
    Cost of Contract     Contract Research  
    Research and     and Development  
39-Week Comparisons   Development Revenue     Revenue  
39 weeks ended June 28, 2009
  $ 5,651,100       78 %
Dollar decrease in current comparable 39 weeks
    (580,900 )        
 
             
39 weeks ended June 27, 2010
  $ 5,070,200       73 %
Percentage decrease in current 39 weeks
    (10 %)        

 

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The improved margin on our contract research and development revenue in the 39-week period ended June 27, 2010, as compared to the 39-week period ended June 28, 2009, was largely the result of a substantial reduction in our indirect expenses and the corresponding overhead costs of contract research and development revenue in the current year period as compared to such costs in the 39-week period ended June 28, 2009. This overhead reduction, substantially derived from reduced labor and labor-related expenses and reduced depreciation and amortization expense, resulted in a disproportionate decrease in our costs of contract research and development revenue in the current fiscal year period, with the corresponding improvement in costs of contract research and development revenue as a percentage of such revenue. The decreased margin on our contract research and development revenue in the 13-week period ended June 27, 2010, as compared to the 13-week period ended June 28, 2009, was largely due to a timing effect related to the discretionary contribution and related recording of overhead expenses related to the Company’s ESBP that had occurred early in the 39-week period ended June 28, 2009. In fiscal 2010, this discretionary contribution did not occur until the 13-week period ended June 27, 2010.
Product Sales. Our product sales are generally derived from sales of miniaturized camera products, specialized chips, modules, stacked chip products and chip stacking services. Product sales for the 13-week and 39-week periods ended June 27, 2010 increased both in terms of absolute dollars and as a percentage of total revenue as compared to the 13-week and 39-week periods ended June 28, 2009 as shown in the following tables:
                 
    Product     Percentage of  
13-Week Comparisons   Sales     Total Revenue  
13 weeks ended June 28, 2009
  $ 262,700       9 %
Dollar increase in current comparable 13 weeks
    1,140,100          
 
             
13 weeks ended June 27, 2010
  $ 1,402,800       39 %
Percentage increase in current 13 weeks
    434 %        
                 
    Product     Percentage of  
39-Week Comparisons   Sales     Total Revenue  
39 weeks ended June 28, 2009
  $ 1,099,400       13 %
Dollar increase in current comparable 39 weeks
    1,450,800          
 
             
39 weeks ended June 27, 2010
  $ 2,550,200       27 %
Percentage increase in current 39 weeks
    132 %        
The increase in product sales in the current fiscal year periods compared to the prior fiscal year periods is largely the result of substantially increased sales of our thermal imaging products, particularly our COTIs. Based on the composition of our backlog at the date of this report, we expect that sales of thermal imaging products will continue to represent a larger percentage of our product sales in the balance of fiscal 2010 as compared to the balance of fiscal 2009.

 

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Cost of Product Sales. Cost of product sales consists of wages and related benefits of our personnel, as well as subcontractor, independent consultant and vendor expenses directly incurred in the manufacture of products sold, plus related overhead expenses. Our cost of product sales for the 13-week and 39-week periods ended June 27, 2010 and June 28, 2009 is shown in the following tables:
                 
    Cost of     Percentage of  
13-Week Comparisons   Product Sales     Product Sales  
13 weeks ended June 28, 2009
  $ 323,000       123 %
Dollar increase in current comparable 13 weeks
    1,012,500          
 
             
13 weeks ended June 27, 2010
  $ 1,335,500       95 %
Percentage increase in current 13 weeks
    313 %        
                 
    Cost of     Percentage of  
39-Week Comparisons   Product Sales     Product Sales  
39 weeks ended June 28, 2009
  $ 1,110,800       101 %
Dollar increase in current comparable 39 weeks
    1,332,000          
 
             
39 weeks ended June 27, 2010
  $ 2,442,800       96 %
Percentage increase in current 39 weeks
    120 %        
A substantial portion of the increase in absolute dollars of cost of product sales in the current fiscal year periods was related to the increase in product sales in those periods as discussed above. However, the absolute dollar increase in cost of product sales in the 13-week and 39-week periods ended June 27, 2010 as compared to the 13-week and 39-week periods ended June 28, 2009 was disproportionately less than the increase in product sales for the respective periods. This disproportionate decrease was substantially related to product support associated with the Company’s new COTI products in the current year periods, which although increasing with sales, did not increase proportionately to such sales once the start-up costs of the new product introduction were largely absorbed. However, the impact of product support costs may continue to produce fluctuations in product margins unless and until our sales of thermal imaging products increase further, thereby reducing the percentage impact of such costs, which typically are less elastic than the associated revenues.
General and Administrative Expense. General and administrative expense largely consists of wages and related benefits for our executive, financial, administrative and marketing staff, as well as professional fees, primarily legal and accounting fees and costs, plus various fixed costs such as rent, utilities and telephone. General and administrative expense for the 13-week and 39-week periods ended June 27, 2010 declined substantially compared to the 13-week and 39-week periods ended June 28, 2009 as shown in the following tables:
                 
    General and        
    Administrative     Percentage of  
13-Week Comparisons   Expense     Total Revenue  
13 weeks ended June 28, 2009
  $ 2,862,500       103 %
Dollar decrease in current comparable 13 weeks
    (1,297,400 )        
 
             
13 weeks ended June 27, 2010
  $ 1,565,100       44 %
Percentage decrease in current 13 weeks
    (45 %)        
                 
    General and        
    Administrative     Percentage of  
39-Week Comparisons   Expense     Total Revenue  
39 weeks ended June 28, 2009
  $ 6,982,200       84 %
Dollar decrease in current comparable 39 weeks
    (2,289,100 )        
 
             
39 weeks ended June 27, 2010
  $ 4,693,100       49 %
Percentage decrease in current 39 weeks
    (33 %)        

 

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Approximately $292,500, or 23%, of the dollar decrease in general and administrative expense in the 13-week period ended June 27, 2010 as compared to the 13-week period ended June 28, 2009, was the result of decreased labor expense and related employee benefits in the current fiscal year period. Similarly, approximately $693,900, or 30%, of the dollar decrease in general and administrative expense in the 39-week period ended June 27, 2010 as compared to the 39-week period ended June 28, 2009, was also the result of decreased labor expense and related employee benefits in the current period. Since a significant element of bid and proposal expenses are the labor costs incurred for such activities, our overall reduction in our labor-related overhead costs also contributed to $293,500 and $524,600 reductions in bid and proposal general and administrative expenses in the 13-week and 39-week periods ended June 27, 2010, respectively, as compared to the 13-week and 39-week periods ended June 28, 2009. Our unallowable general and administrative expense for which we cannot seek reimbursement under most of our government contracts, largely litigation expenses, decreased by $535,100 and $676,000 in the 13-week and 39-week periods ended June 27, 2010, respectively, as compared to the 13-week and 39-week periods ended June 28, 2009. This was largely the result of settling our litigation in March 2010 with Timothy Looney, the original owner of Optex, our discontinued subsidiary. Given this settlement, we expect that the dollar magnitude of our unallowable general and administrative expense is likely to continue to decline in subsequent periods, as compared to prior year periods. Our general and administrative service expense in the 13-week and 39-week periods ended June 27, 2010, largely accounting expenses, also decreased $82,500 and $218,800, respectively, compared to the 13-week and 39-week periods ended June 28, 2009. Since our total revenues for the fiscal 2010 periods increased compared to those of the fiscal 2009 periods, the magnitude of our decrease in absolute dollars of general and administrative expense in the 13-week and 39-week periods ended June 27, 2010 as compared to the absolute dollars of general and administrative expense in the 13-week and 39-week periods ended June 28, 2009 also resulted in general and administrative expense as a percentage of total revenue being substantially decreased in the current fiscal year periods.
Research and Development Expense. Research and development expense consists of wages and related benefits for our research and development staff, independent contractor consulting fees and subcontractor and vendor expenses directly incurred in support of internally funded research and development projects, plus associated overhead expenses. Research and development expense for the 13-week and 39-week periods ended June 27, 2010, as compared to the 13-week and 39-week periods ended June 28, 2009, is shown in the following tables:
                 
    Research and        
    Development     Percentage of  
13-Week Comparisons   Expense     Total Revenue  
13 weeks ended June 28, 2009
  $ 531,300       19 %
Dollar increase in current comparable 13 weeks
    123,900          
 
             
13 weeks ended June 27, 2010
  $ 655,200       18 %
Percentage increase in current 13 weeks
    23 %        
                 
    Research and        
    Development     Percentage of  
39-Week Comparisons   Expense     Total Revenue  
39 weeks ended June 28, 2009
  $ 1,318,000       16 %
Dollar increase in current comparable 39 weeks
    693,400          
 
             
39 weeks ended June 27, 2010
  $ 2,011,400       21 %
Percentage increase in current 39 weeks
    53 %        

 

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The increase in research and development expense in the fiscal 2010 periods as compared to the fiscal 2009 periods is largely related to labor deployment issues in the respective fiscal periods. We use the same technical staff for both internal and customer funded research and development projects, as well as the preparation of technical proposals, so the availability of direct labor in terms of man hours and skill mix has a strong bearing on the amount of internally funded research and development expense we undertake in any given period. We used less of our direct labor on funded contracts in the current fiscal year periods than the prior fiscal year periods, contributing to greater labor deployment and associated expense to research and development expense in the fiscal 2010 periods. This increase may have been greater had it not been for the deployment of $336, 600 of labor and associated overhead to capital projects related to our COTI product. Generally, this difference in labor deployment does not reflect any trends, but rather is tied to specific milestones of both funded and internal research projects. Accordingly, the absolute dollar increases in research and development expense in the fiscal 2010 periods as compared to the fiscal 2009 periods reflect these milestones, rather than a change in priorities related to internally funded research and development.
Gain On Sale or Disposal of Assets. We recorded a gain on sale or disposal of assets of $8,640,800 in the 39-week period ended June 28, 2009, largely as a result of our Patent Sale and License. In the 39-week period ended June 27, 2010, our gain on sale or disposal of assets was only $12,600.
Interest Expense. Our interest expense for the 13-week and 39-week periods ended June 27, 2010, as compared to the 13-week and 39-week periods ended June 28, 2009 is shown in the following tables:
         
13-Week Comparisons   Interest Expense  
13 weeks ended June 28, 2009
  $ 218,400  
Dollar increase in current comparable 13 weeks
    418,100  
 
     
13 weeks ended June 27, 2010
  $ 636,500  
Percentage increase in current 13 weeks
    191 %
         
39-Week Comparisons   Interest Expense  
39 weeks ended June 28, 2009
  $ 1,458,100  
Dollar decrease in current comparable 39 weeks
    (575,500 )
 
     
39 weeks ended June 27, 2010
  $ 882,600  
Percentage decrease in current 39 weeks
    (39 %)

 

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The increase in interest expense in the 13-week period ended June 27, 2010 as compared to the 13-week period ended June 28, 2009 was primarily due to the issuance of our Debentures in that current period, for which no comparable debt existed in the prior period. The decline in interest expense in the 39-week period ended June 27, 2010 as compared to the 39-week period ended June 28, 2009 was primarily due to the reduction in our debt, and corresponding interest, that resulted from application of proceeds from the Patent Sale and License, the exchange of a portion of our debt for our Series A-2 Stock and the partial repayment of debt from proceeds of the Debenture Private Placement, partially offset by interest derived from the Debentures issued in the current year period.
Litigation Settlement Expense. In March 2010, we entered into the Looney Settlement Agreement, pursuant to which we agreed to pay Timothy Looney $50,000 and to issue to Mr. Looney a secured promissory note in the principal amount of $2,500,000 in settlement of litigation with Mr. Looney. We recorded the Secured Promissory Note in our consolidated financial statements for the 39-week period ended June 27, 2010 and extinguished the previously recorded expenses for litigation judgments related to these matters in the same period. The effectiveness of the Looney Settlement Agreement was conditioned upon our receipt of consents from our senior creditors, Summit and Longview. As one of the conditions of obtaining Longview’s Consent, we agreed to issue to Longview equity securities with a value of $825,000 (the “Waiver Securities”) in consideration for Longview’s waiver of potential future entitlement to all accumulated, but undeclared and unpaid, dividends on our Series A-1 Stock and our Series A-2 Stock held by Longview from the respective dates of issuance of the Series A-1 Stock and Series A-2 Stock through July 15, 2010. The Waiver Securities were issued to Longview on April 30, 2010 in the form of 27,500 shares of a newly created Series C Convertible Preferred Stock. We recorded the expense of the Waiver Securities in the 39-week period ended June 27, 2010. In connection with Longview’s consent for the Looney Settlement Agreement, the Company and Longview entered into an Agreement, Consent and Waiver (the “Longview Agreement”) pursuant to which the Company and Longview made certain agreements related to such consent. One of those agreements was that if the Company did not arrange for a third-party investor to purchase Longview’s holdings of the Company/s preferred stock on or before July 15, 2010, the Company was obligated to issue to Longview (a) non-voting equity securities, with terms junior to the Company’s Series B Convertible Preferred Stock, convertible into 1,000,000 shares of the Company’s common stock (the “Contingent Securities”) and (b) a two-year warrant to purchase 1,000,000 shares of the Company’s common stock at an exercise price per share of $0.30 (the “Contingent Warrant”). The terms of the Contingent Securities and the Contingent Warrant were mutually agreed upon by the parties such that the Contingent Securities were to consist of 10,000 shares of Series C Convertible Preferred Stock convertible into 1,000,000 shares of common stock, subject to receipt of stockholder approval for such issuance if required by Nasdaq. The Buyout did not occur on or before July 15, 2010, and stockholder approval for the issuance of the Contingent Securities in the form of Series C Stock was obtained on July 28, 2010. Accordingly, the Contingent Securities and Contingent Warrant were issued to Longview in August 2010. The Company recorded a $450,000 expense for the obligation to issue the Contingent Securities and the Contingent Warrant in the 13-week and 39-week periods ended June 27, 2010. The net effect of these various expenses was an aggregate recording of $450,000 and $2,270,700 as a litigation settlement expense in the 13-week and 39-week periods ended June 27, 2010, respectively. No comparable expense was incurred in the 13-week and 39-week periods ended June 28, 2009. (See Note 3 of the Condensed Notes to the Consolidated Financial Statements).
Income From Discontinued Operations. As a result of the Optex Asset Sale, in the 39-week period ended June 28, 2009, we realized a gain on Optex’s discontinued operations of $58,400, reflecting results for the interval from September 29, 2008 through October 14, 2008, the date of the Optex Asset Sale. Since Optex had no operations subsequent to the Optex Asset Sale, no comparable result from discontinued operations was recognized in the 13-week and 39-week periods ended June 27, 2010.

 

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Net Income (Loss). Our net income (loss) for the 13-week and 39-week periods ended June 27, 2010, as compared to the 13-week and 26-week periods ended June 28, 2009, is shown in the following tables:
         
13-Week Comparisons   Net Income (Loss)  
13 weeks ended June 28, 2009
  $ (2,544,900 )
Dollar change in current comparable 13 weeks
    (80,500 )
 
     
13 weeks ended June 27, 2010
  $ (2,625,400 )
Percentage increase for current 13 weeks
    3 %
         
39-Week Comparisons   Net Income (Loss)  
39 weeks ended June 28, 2009
  $ 469,000  
Dollar change in current comparable 39 weeks
    (8,230,700 )
 
     
39 weeks ended June 27, 2010
  $ (7,761,700 )
Percentage increase for current 39 weeks
    (1,755 %)
Our net income in the 39-week period ended June 28, 2009 was substantially the result of our gain on sale or disposal of assets resulting from our non-recurring Patent Sale and License in March 2009. The absence of a comparable-sized gain in the 39-week period ended June 27, 2010 was the principal cause for the change in our results for the current fiscal year period compared to the 39-week period ended June 28, 2009. The net loss in the 13-week period ended June 27, 2010 increased because of the increase in interest expense discussed above and the litigation settlement expense of $450,000. Also, the net loss in the 13-week and 39-week periods ended June 27, 2010 were partially reduced by the decline in general and administrative expense in the 13-week and 39-week periods ended June 27, 2010 discussed above.
Liquidity and Capital Resources
Our liquidity did not change substantially in the first 39 weeks of fiscal 2010 in terms of absolute dollars of our consolidated cash and cash equivalents, but did exhibit a more substantial change in terms of absolute dollars of our working capital deficit as shown in the following table:
                 
    Cash and     Working  
    Cash Equivalents     Capital (Deficit)  
September 27, 2009
  $ 125,700     $ (6,271,300 )
Dollar change in the 39 weeks ended June 27, 2010
    29,200       (1,601,300 )
 
           
June 27, 2010
  $ 154,900     $ (7,872,600 )
Percentage change in the 39 weeks ended June 27, 2010
    23 %     (26 %)
The aggregate of our non-cash expenses in the 39 weeks ended June 27, 2010 was $4,163,300, largely consisting of non-cash litigation settlement expense and depreciation and amortization expense, and to a lesser extent, non-cash employee retirement plan contributions, non-cash provision for allowance for inventory valuation, non-cash interest expense, change in fair value of derivative instruments and non-cash stock-based compensation. These non-cash expenses partially offset the use of cash derived from our net loss and various timing effects and resulted in an operational use of cash in the amount of $2,462,400 in the 39-week period ended June 27, 2010. These and other uses of cash, including property and equipment expenditures of $781,800 and a reduction of $381,000 in factoring advances against receivables, were offset by $2,049,500 of net proceeds from our preferred stock financing, $1,651,300 from our debenture unit financing and $303,300 of net proceeds from our common stock unit financing in the current fiscal year period, resulting in the net $29,200 increase of cash in the 39-week period ended June 27, 2010.

 

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During a portion of the 39 weeks ended June 27, 2010, we continued to incur fees and expenses in the lawsuits related to the ongoing disputes with Mr. Looney and his affiliated entity. In that period, these fees and expenses amounted to an aggregate of $336,300. In March 2010, we settled these lawsuits with Mr. Looney and his affiliated entity in consideration of our payment of $50,000 in cash and issuance of a $2.5 million 27-month secured promissory note to Mr. Looney. (See Note 3 of the Condensed Notes to the Consolidated Financial Statements). Debt service on this note will have a material adverse effect on our future liquidity so long as the note remains outstanding.
Under litigation related to obligations allegedly owed to FirstMark III, LP, formerly known as Pequot Private Equity Fund III, LP, and FirstMark III Offshore Partners, LP, formerly known as Pequot Offshore Private Equity Partners III, LP (collectively, “FirstMark”), FirstMark filed a motion for summary judgment, which was granted in January 2010, although to our knowledge, judgment has not yet been entered as of the date of this report. (See Note 10 of the Condensed Notes to the Consolidated Financial Statements). We are in negotiations to settle this matter, but such an outcome cannot be assured. If we are unable to settle this matter in a satisfactory manner, execution on the anticipated final judgment could have a material adverse effect on us and our financial condition, including our liquidity.
The increase in the working capital deficit in the 39-week period ended June 27, 2010 was largely the result of the impact of our net loss partially offset by the net proceeds from our preferred stock, debenture unit and common stock unit financings in the current period. Deployment of the net proceeds from those financings allowed us to reduce our factoring advances against receivables by $381,000 in the 39-week period ended June 27, 2010. At June 27, 2010, our factoring lender had advances of approximately $604,800 to us.
At June 27, 2010, our funded backlog was approximately $10.6 million. We expect, but cannot guarantee, that a substantial portion of our funded backlog at June 27, 2010 will result in revenue recognized in the next twelve months, provided that we are able to enhance our liquidity to meet our working capital requirements. In addition, our government research and development contracts and product purchase orders typically include unfunded backlog, which is funded when the previously funded amounts have been expended or product delivery schedules are released. As of June 27, 2010, our total backlog, including unfunded portions, was approximately $31.4 million.
Contracts with government agencies may be suspended or terminated by the government at any time, subject to certain conditions. Similar termination provisions are typically included in agreements with prime contractors. While we have only experienced a small number of contract terminations, none of which were recent, we cannot assure you that we will not experience suspensions or terminations in the future. Any such termination, if material, could cause a disruption of our revenue stream, adversely affect our liquidity and results of operations and could result in employee layoffs.
We anticipate that we will need to raise additional funds in the near future to meet our continuing obligations.

 

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Off-Balance Sheet Arrangements
Our conventional operating leases are either immaterial to our financial statements or do not contain the types of guarantees, retained interests or contingent obligations that would require their disclosure as an “off-balance sheet arrangement” pursuant to Regulation S-K Item 303(a)(4). As of June 27, 2010 and September 27, 2009, we did not have any other relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Contractual Obligations and Commitments
Debt. At June 27, 2010, we had approximately $5,415,300 of debt, which consisted of (i) a secured promissory note payable to Longview, described more fully below, the principal amount of which was reduced from $2.1 million to approximately $163,100 through partial exchange of such debt pursuant to the credit bid that effectuated the Optex Asset Sale and partial repayment from proceeds of the Patent Sale and License and the Debenture Private Placement; (ii) unsecured convertible and non-convertible debentures issued in the Debenture Private Placement with an aggregate principal balance of $2,752,200; and (iii) a $2,500,000 secured subordinated promissory note payable to Timothy Looney pursuant to settlement of litigation, described more fully below. We also had contingent secured subordinated notes originally issued in the aggregate principal amount of $1,115,000 (the “Contingent Notes”), which were issued in connection with our November 2007 debt restructuring, described more fully below. Of the principal amount of the Contingent Notes, only $9,400 remained potentially outstanding as of June 27, 2010.
On July 19, 2007, we entered into a Loan Agreement, a secured promissory note (the “Longview Note”) and an Omnibus Security Interest Acknowledgement with Longview, pursuant to which we closed a short-term non-convertible loan in the original principal amount of $2.0 million (the “Loan”), which was subsequently increased by $100,000 to $2.1 million pursuant to the terms of the Longview Note s. The Longview Note bore interest at a rate of 12% per annum, due together with the unpaid principal amount when the Longview Note matures, which was originally on January 19, 2008, but was extended to December 30, 2009 pursuant to our November 2007 debt restructuring and further extended to September 30, 2010 pursuant to partial repayment terms related to the Patent Sale and License. If we fail to pay the principal and accrued interest within ten days after the maturity date, we will incur a late fee equal to 5% of the amount remaining unpaid at that time.
In October 2008, approximately $1,651,100 of the principal due under the Longview Note was retired pursuant to the Optex Asset Sale. In March 2009, in connection with the Patent Sale and License, the outstanding principal of the Longview Note was further reduced to $188,400, and the maturity date of the Longview Note was extended to September 30, 2010. In March 2010, in connection with the Debenture Private Placement, the outstanding principal of the Longview Note was further reduced to $163,100.
In November 2007, we restructured all of our debt obligations with Longview and Alpha. In consideration for this debt restructuring, we issued the Contingent Notes to Longview and Alpha in the aggregate principal amount of $1.0 million and $115,000, respectively, which Contingent Notes do not accrue interest, and in general, are not due and payable until September 30, 2010. The Contingent Notes will be discharged (and cancelled) in pro rata proportion to the amount that the total indebtedness owed to Longview and Alpha is repaid in full by September 30, 2010. If the total principal and accrued interest payable to Longview and Alpha on existing obligations is repaid in full, then the Contingent Notes will be cancelled in their entirety. The Contingent Notes are secured by substantially all of our assets. The reduction of our obligations to Longview and Alpha pursuant to the Optex Asset Sale, the Patent Sale and License, the exchange and cancellation of debt for the issuance of Series A-2 Preferred Stock and repayments in connection with the Debenture Private Placement has correspondingly reduced our potential obligations under the Contingent Notes to approximately $9,400 at June 27, 2010, which has not been recorded in our accounts due to its contingent nature. This residual balance under the Contingent Notes only relates to obligations due to Longview, inasmuch as the debt obligations to Alpha have been fully paid.

 

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In March 2010, we sold and issued convertible debenture units (the “Units”) with an aggregate principal balance of $2,752,200 in two closings of a private placement (the “Debenture Private Placement”). Each Unit is comprised of (i) one one-year, unsecured convertible debenture with a principal repayment obligation of $5,000 (the “Convertible Debenture”) that is convertible at the election of the holder into shares of our common stock at a conversion price of $0.40 per share (the “Principal Conversion Shares”); (ii) one one-year, unsecured non-convertible debenture with a principal repayment obligation of $5,000 that is not convertible into common stock (the “Non-Convertible Debenture” and, together with the Convertible Debenture, the “Debentures”); and (iii) a five-year warrant to purchase 3,125 shares of our common stock (the “Debenture Investor Warrant”). The conversion price applicable to the Debentures and the exercise price applicable to the Debenture Investor Warrants is $0.40 per share. The Debentures bear simple interest at a rate per annum of 20% of their original principal value. Interest on the Debentures accrues and is payable quarterly in arrears and is convertible at our election into shares of our common stock at a conversion price of $0.40 per share. We elected to pay the first quarterly interest due in June 2010 on the Debentures in the amount of $138,800 through conversion into 346,800 shares of our common stock. The conversion price of the Debentures is subject to adjustment for stock splits, stock dividends, recapitalizations and the like. We may repay any unpaid and unconverted principal amount of the Debentures in cash prior to maturity at 110% of such principal amount.
The Secured Promissory Note issued by the Company in connection with the Looney Settlement Agreement bears simple interest at a rate per annum of 10% of the outstanding principal balance and is secured by substantially all of our assets (the “Collateral”) pursuant to the terms and conditions of a Security Agreements and Intellectual Property Security Agreement with Mr. Looney (the “Security Agreements”), but such security interests are subject to and subordinate to the existing perfected security interests and liens of our senior creditors, Summit and Longview. The Secured Promissory Note requires the Company to remit graduated monthly installment payments over a 27-month period to Mr. Looney beginning with a payment of $8,000 in May 2010 and ending with a payment of $300,000 in June 2012. All such payments are applied first to unpaid interest and then to outstanding principal. A final payment of the remaining unpaid principal and interest under the Secured Promissory Note is due and payable in July 2012. Past due payments will bear simple interest at a rate per annum of 18%. In the event we prepay all amounts owing under the Secured Promissory Note by October 9, 2011, the $50,000 cash payment made to Mr. Looney pursuant to the Looney Settlement Agreement will either be returned to us or will be deducted from our final payment due on the Secured Promissory Note.
Capital Lease Obligations. We had no outstanding principal balance on capital lease obligations at June 27, 2010.
Operating Lease Obligations. We have various operating leases covering equipment and facilities located in Costa Mesa, California.

 

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Deferred Compensation. We have a deferred compensation plan, the Executive Salary Continuation Plan (the “ESCP”), for select key employees. Benefits payable under the ESCP are established on the basis of years of service with the Company, age at retirement and base salary, subject to a maximum benefits limitation of $137,000 per year for any individual. The ESCP is an unfunded plan. The recorded liability for future expense under the ESCP is determined based on expected lifetime of participants using Social Security mortality tables and discount rates comparable to that of rates of return on high quality investments providing yields in amount and timing equivalent to expected benefit payments. At the end of each fiscal year, we determine the assumed discount rate to be used to discount the ESCP liability. We considered various sources in making this determination for fiscal 2009, including the Citigroup Pension Liability Index, which at September 30, 2009 was 5.54%. Based on this review, we used a 5.5% discount rate for determining the ESCP liability at September 27, 2009. There are presently two of our retired executives who are receiving benefits aggregating $184,700 per annum under the ESCP. As of June 27, 2010, $1,059,700 has been accrued in the accompanying consolidated balance sheet for the ESCP, of which amount $184,700 is a current liability we expect to pay during the remainder of fiscal 2010 and the first three quarters of fiscal 2011.
Stock-Based Compensation
Aggregate stock-based compensation for the 39-week periods ended June 27, 2010 and June 28, 2009 was $60,900 and $113,000, respectively, and was attributable to the following:
                 
    39 Weeks Ended     39 Weeks Ended  
    June 27, 2010     June 28, 2009  
Cost of contract research and development revenue
  $ 13,900     $ 30,900  
General and administrative expense
    47,000       82,100  
 
           
 
  $ 60,900     $ 113,000  
 
           
All transactions in which goods or services are the consideration received for equity instruments issued to non-employees are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date used to determine the fair value of any such equity instrument is the earliest to occur of (i) the date on which the third-party performance is complete, (ii) the date on which it is probable that performance will occur, or (iii) if different, the date on which the compensation has been earned by the non-employee. In the 39-week period ended June 27, 2010, we issued warrants to purchase an aggregate of 350,000 shares of our common stock, valued at $119,000, to an investment banking firm for a one-year extension of an agreement for said firm to assist us in raising additional capital and to provide financial advisory services.
We calculate stock option-based compensation by estimating the fair value of each option granted using the Black-Scholes option valuation model and various assumptions that are described in Note 1 of the Condensed Notes to Consolidated Financial Statements included in this report. Once the compensation cost of an option is determined, we recognize that cost on a straight-line basis over the requisite service period of the option, which is typically the vesting period for options granted by us. We calculate compensation expense of both vested and nonvested stock grants by determining the fair value of each such grant as of their respective dates of grant using our stock price at such dates with no discount. We recognize compensation expense on a straight-line basis over the requisite service period of a nonvested stock award.

 

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For the 13-week and 39-week periods ended June 27, 2010, stock-based compensation included compensation costs attributable to such periods for those options that were not fully vested upon adoption of ASC 718, Compensation — Stock Compensation, adjusted for estimated forfeitures. We have estimated forfeitures to be 7%, which reduced stock-based compensation cost by $300 in the 39-week period ended June 27, 2010. There were no grants of options made in the 13-week and 39-week periods ended June 27, 2010. Aggregate awards of 0 and 1,800 shares of vested stock were made to employees in the 13-week and 39-week periods ended June 27, 2010, respectively. During the 13-week and 39-week periods ended June 28, 2009, options to purchase 110,000 and 122,000 shares of our common stock were granted, respectively, and awards of 0 and 1,600 shares of vested stock were made to employees, respectively.
At June 27, 2010, the total compensation costs related to nonvested option awards not yet recognized was $1,900. The weighted-average remaining vesting period of nonvested options at June 27, 2010 was 0.7 years.
Item 3.   Quantitative and Qualitative Disclosures About Market Risk
Not applicable.

 

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Item 4T.   Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission and (ii) accumulated and communicated to our management, including our principal executive and principal accounting officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
(b) Changes to Internal Control over Financial Reporting. We believe that the increasing experience of our staff in working with enhanced resources and new procedures have produced improvements to our internal controls over financial reporting over the last several fiscal years. However, the extent of improvement in the first 39 weeks of fiscal 2010 has been relatively modest, largely modification or expansion of internal process documentation, reflecting what we believe were significant improvements in prior periods. We have also increased our testing of our internal controls during the first 39 weeks of fiscal 2010. Notwithstanding such improvement to date, we believe that we will have to further strengthen our financial resources if we undertake the additional growth that we have stated that we seek or if we consummate further complex transactions. We cannot guarantee that our actions in the future will be sufficient to accommodate possible future growth or complex transactions, or that such actions will not prevent material weaknesses in our internal controls over financial reporting. Furthermore, we do not presently have the financial resources and infrastructure to address our future plans, which puts us at risk of future material weaknesses.
We have undertaken, and will continue to undertake, an effort for compliance with Section 404 of the Sarbanes-Oxley Act of 2002. This effort, under the direction of senior management, includes the documentation, testing and review of our internal controls. During the course of these activities, we have identified other potential improvements to our internal controls over financial reporting, including some that we have implemented in the first three quarters of fiscal 2010, largely the modification or expansion of internal process documentation noted above, and some that we are currently evaluating for possible future implementation. We expect to continue documentation, testing and review of our internal controls on an on-going basis and may identify other control deficiencies, possibly including material weaknesses, and other potential improvements to our internal controls in the future. We cannot guarantee that we will remedy any potential material weaknesses that may be identified in the future, or that we will continue to be able to comply with Section 404 of the Sarbanes-Oxley Act.
Other than as described above, there have not been any other changes that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

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PART II
OTHER INFORMATION
Item 1.   Legal Proceedings
The information set forth under “Litigation” in Note 10 of Condensed Notes to Unaudited Consolidated Financial Statements, included in Part I, Item 1 of this report, is incorporated herein by reference. For an additional discussion of certain risks associated with legal proceedings, see “Risk Factors” immediately below.
Item 1A.   Risk Factors
A restated description of the risk factors associated with our business is set forth below. This description includes any changes (whether or not material) to, and supersedes, the description of the risk factors associated with our business previously discussed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 27, 2009.
Our future operating results are highly uncertain. Before deciding to invest in our common stock or to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in our Annual Report on Form 10-K, and in our other filings with the SEC, including any subsequent reports filed on Forms 10-Q and 8-K. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business and results of operations. If any of these risks actually occur, our business, financial condition or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment.
We will need to raise additional capital in the near future to fund our operations, and if such capital is not be available to us on terms that are acceptable to us, on a timely basis or at all, our viability will be threatened and we may be forced to discontinue our operations. Except for fiscal 2009, in which we realized substantial income from the Patent Sale and License, the deconsolidation of the balance sheet of Optex due to its bankruptcy and a significant reduction of potential future pension expenses, we have historically experienced significant net losses and significant negative cash flows from operations or other uses of cash. As of June 27, 2010 and September 27, 2009, our cash and cash equivalents were $154,900 and $125,700, respectively, and our working capital deficit during such periods was $7.9 million and $6.3 million, respectively. To offset the effect of negative net cash flows, we have historically funded a portion of our operations through multiple equity and debt financings, and to a lesser extent through receivable financing. Our revenues were reduced in fiscal 2009 partially due to our liquidity limitations, which may continue to adversely affect our revenues in the future. We anticipate that we will require additional capital to meet our working capital needs and fund our operations. We cannot assure you that any additional capital from financings or other sources will be available on a timely basis, on acceptable terms, or at all, or that the proceeds from any financings will be sufficient to address our near term liquidity requirements. If we are not able to obtain additional capital in the near future, we anticipate that our business, financial condition and results of operations will be materially and adversely affected and we may be forced to discontinue our operations.

 

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We anticipate that our future capital requirements will depend on many factors, including:
    our ability to meet our current obligations, including trade payables, payroll and fixed costs;
    our ability to procure additional production contracts and government research and development contracts, and the timing of our deliverables under our contracts;
    the timing of payments and reimbursements from government and other contracts;
    the expenses and outcome of litigation;
    our ability to control costs;
    our ability to commercialize our technologies and achieve broad market acceptance for such technologies;
    research and development funding requirements;
    increased sales and marketing expenses;
    technological advancements and competitors’ responses to our products;
    capital improvements to new and existing facilities;
    our relationships with customers and suppliers; and
    general economic conditions including the effects of future economic slowdowns, a slump in the semiconductor market, acts of war or terrorism and the current international conflicts.
Even if available, financings can involve significant costs and expenses, such as legal and accounting fees, diversion of management’s time and efforts, or substantial transaction costs or break-up fees in certain instances. Financings may also involve substantial dilution to existing stockholders, and may cause additional dilution through adjustments to certain of our existing securities under the terms of their antidilution provisions. If adequate funds are not available on acceptable terms, or at all, our business and revenues will be adversely affected and we may be unable to continue our operations, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures.
Our common stock may be delisted by the Nasdaq Capital Market if we cannot maintain Nasdaq’s listing requirements, which could limit your ability to sell shares of common stock and could limit our ability to raise additional capital. We are not currently in compliance with the $1.00 minimum bid price requirement of the Nasdaq Capital Market and have historically failed to meet that requirement from time to time. On September 15, 2009, we received a written notice from Nasdaq of our present lack of compliance with this requirement and were given until March 15, 2010 to regain compliance. We did not meet the minimum bid requirements by such date, and we received a delisting notice from Nasdaq that we then appealed pursuant to Nasdaq’s rules. A hearing on our appeal was held on May 6, 2010 before a Nasdaq Hearing Panel, and on June 8, 2010, we received a notice from Nasdaq that we had been granted an extension to evidence a closing bid price for our common stock of $1.00 per share or more for a minimum of ten consecutive trading days on or before September 13, 2010. To this end, we sought and obtained stockholder approval on July 28, 2010 to effectuate a reverse stock split in a ratio sufficient to meet the $1.00 bid price requirement for continued listing, but we cannot assure you that we will implement such authority, or if implemented, that we will regain compliance with Nasdaq’s minimum $1.00 per share trading rule. On January 14, 2009, we also received written notice from Nasdaq of our lack of compliance with a Nasdaq Marketplace Rule that requires us to have a minimum of $2,500,000 in stockholders’ equity or $35,000,000 market value of listed securities or $500,000 of net income from continuing operations for our most recently completed fiscal year or two of our three most recently completed fiscal years. We ultimately regained compliance with this requirement in October 2009. We cannot assure you that we will be able to satisfy Nasdaq’s listing maintenance requirements in the future, or be able to maintain our listing on the Nasdaq Capital Market. If our common stock is delisted from the Nasdaq Capital Market, the market for your shares may be limited, and as a result, you may not be able to sell your shares at an acceptable price, or at all. In addition, a delisting may make it more difficult or expensive for us to raise additional capital in the future. A delisting would also constitute a default under our Longview agreements.

 

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If we are delisted from the Nasdaq Capital Market, your ability to sell your shares of our common stock would also be limited by the penny stock restrictions, which could further limit the marketability of your shares. If our common stock is delisted, it would come within the definition of “penny stock” as defined in the Securities Exchange Act of 1934 and would be covered by Rule 15g-9 of the Securities Exchange Act of 1934. That Rule imposes additional sales practice requirements on broker-dealers who sell securities to persons other than established customers and accredited investors. For transactions covered by Rule 15g-9, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser’s written agreement to the transaction prior to the sale. Consequently, Rule 15g-9, if it were to become applicable, would affect the ability or willingness of broker-dealers to sell our securities, and accordingly would affect the ability of stockholders to sell their securities in the public market. These additional procedures could also limit our ability to raise additional capital in the future.
Since 2006, we have engaged in multiple financings, which have significantly diluted existing stockholders and will likely result in substantial additional dilution in the future. Assuming conversion of all of our existing convertible securities and exercise in full of all options and warrants outstanding as of June 27, 2010, an additional approximate 23.4 million shares of our common stock would be outstanding, as compared to the approximately 24.6 million shares of our common stock that were issued and outstanding at that date. Since the start of fiscal 2008 through June 27, 2010, we have issued approximately 21.9 million shares of our common stock, largely to fund our operations, resulting in significant dilution to our existing stockholders. On August 26, 2008, pursuant to approval of our stockholders, we amended our Certificate of Incorporation to increase our authorized common stock issuable for any purpose from 80,000,000 shares to 150,000,000 shares, which further increased the potential for significant dilution to our existing stockholders. Our secured bridge note financing in November 2008 through February 2009 resulted in the automatic application of price anti-dilution features in our existing securities, which in conjunction with other issuances, substantially increased the potential fully diluted number of shares of our common stock. The Series A-2 Stock that we issued in April 2009 in exchange for convertible notes, resulting in the cancellation of $1 million of debt, as well as the shares of common stock that we issued to the bridge financing investors in April 2009, the Series B Stock and common stock warrants that we issued in September 2009, the convertible debentures and warrants that we issued in our debenture financing in March 2010, the Series C Stock that we issued in April 2010 and the common stock and common stock warrants that we issued in June 2010 further diluted interests of existing stockholders, such that our potential fully diluted number of shares of our common stock is approximately 48.0 million as of June 27, 2010. Subsequent to June 27, 2010, our fully diluted common stock position increased further pursuant to the issuance of the Contingent Securities and Contingent Warrant to Longview in August 2010 and the price adjustment of the Series A-1 Stock and Series A-2 Stock resulting from the 2nd Close of the Common Stock Private Placement in July 2010. We anticipate we will pursue additional financings in the future. Any additional equity or convertible debt financings in the future could result in further dilution to our stockholders. Existing stockholders also will suffer significant dilution in ownership interests and voting rights and our stock price could decline as a result of potential future application of price anti-dilution features of our Series A-1 Stock and Series A-2 Stock and certain warrants, if not waived.

 

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Significant sales of our common stock in the public market will cause our stock price to fall. The average trading volume of our shares in June 2010 was approximately 82,700 shares per day, compared to the approximately 24.6 million shares outstanding and the additional approximate 23.4 million shares potentially outstanding on a fully diluted basis at June 27, 2010. Other than volume limitations imposed on our affiliates, most of the issued shares of our common stock are freely tradable. If the holders of the freely tradable shares were to sell a significant amount of our common stock in the public market, the market price of our common stock would likely decline. If we raise additional capital in the future through the sale of shares of our common stock to private investors, we may, subject to existing restrictions lapsing or being waived, agree to register these shares for resale on a registration statement as we have done in the past. Upon registration, these additional shares would become freely tradable once sold in the public market, assuming the prospectus delivery and other requirements were met by the sellers, and, if significant in amount, such sales could further adversely affect the market price of our common stock. We have filed a registration statement covering the resale of approximately 2.5 million shares of our common stock issued or issuable upon conversion of Series B Stock. The sale of a large number of shares of our common stock also might make it more difficult for us to sell equity or equity-related securities in the future at a time and at the prices that we deem appropriate.
The recent settlement of our various lawsuits with Timothy Looney, the former owner of Optex, resulted in us issuing $2.5 million of secured debt to Mr. Looney, the service of which will pose a significant strain on our liquidity. In April 2010, we issued a 27-month promissory note to Mr. Looney secured by liens and security interests against all of our assets (to the extent permitted by contract, the UCC or other applicable laws), subject to and subordinate to the existing perfected security interests and liens of our senior creditors, Summit and Longview. This note requires us to remit graduated monthly installment payments over a 27-month period to Mr. Looney beginning with a payment of $8,000 in May 2010 and ending with a payment of $300,000 in June 2012. All such payments are applied first to unpaid interest and then to outstanding principal. A final payment of all remaining unpaid principal and interest is due and payable in July 2012. These loan payments may be difficult for us to make from our cash flow from operations and will likely necessitate future financing, the success of which cannot be assured.
Enforcement of an anticipated final judgment could threaten our financial viability. Investors that originally financed our acquisition of Optex filed a motion for summary judgment against us regarding alleged unpaid obligations under a December 2006 settlement agreement between us and them and, although the motion was granted in January 2010, the judgment has not yet been entered as of the date of this report. We have recorded approximately $1.2 million of expense in our financial statements related to these obligations at June 27, 2010, which we expect to be the approximate amount of this judgment when it is entered. We have attempted to settle this dispute with the plaintiffs, but with no success to date. If the plaintiffs attempt to enforce collection of the expected final judgment, rather than entering into some kind of manageable settlement agreement, our financial condition could be materially and adversely impacted and our ability to continue our operations could be threatened.
Our 2008 Reverse Split has had, and may continue to have, a material adverse effect on our market capitalization. While our 2008 Reverse Split temporarily addressed Nasdaq’s minimum bid price standard at that time, our market capitalization as of June 27, 2010 dropped to only approximately $6.4 million and our market float decreased considerably. Adverse market reaction to the split may have contributed to the decline in our market capitalization that we have recently experienced. Such reaction and reduced market float and sales volume may result in further material adverse impact to our market capitalization and the market price of our common stock.
We have stockholder authority for an additional reverse stock split in ratios ranging from one-for-two to one-for-ten. As required by Nasdaq, in July 2010, we received stockholder authority to effectuate a reverse stock split to maintain our Nasdaq listing. If our Board elects to implement this authority, we cannot assure you of the impact such reverse stock split will have on our market capitalization and market price of our common stock. In order to meet the Nasdaq deadline of September 13, 2010 for regaining compliance with the $1.00 per share minimum bid price through effectuation of a reverse split, such action would have to be implemented in August 2010.

 

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We have historically generated substantial losses, which, if continued, could make it difficult to fund our operations or successfully execute our business plan, and could adversely affect our stock price. Since our inception, we have generated net losses in most of our fiscal periods. We experienced a net loss of approximately $21.6 million for fiscal 2008, including the non-recurring charges associated with the retirement of $15 million of debt owed to Longview and Alpha as a result of the Optex Asset Sale. Had it not been for the gains from the Patent Sale and License, the deconsolidation of Optex due to its bankruptcy and a significant reduction of potential future pension expenses, we would have experienced a substantial net loss in fiscal 2009 as well. We experienced a net loss of approximately $7.8 million in our first three quarters of fiscal 2010. We cannot assure you that we will be able to achieve or sustain profitability in the future. In addition, because we have significant expenses that are fixed or difficult to change rapidly, we generally are unable to reduce expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues. We are dependent on support from subcontractors to meet our operating plans and susceptible to losses when such support is delayed. Such factors could cause us to continue to experience net losses in future periods, which will make it difficult to fund our operations and achieve our business plan, and could cause the market price of our common stock to decline.
Our government-funded research and development business depends on a limited number of customers, and if any of these customers terminate or reduce their contracts with us, or if we cannot obtain additional government contracts in the future, our revenues will decline and our results of operations will be adversely affected. For fiscal 2009, approximately 33% of our total revenues were generated from research and development contracts with the U.S. Air Force and approximately 16% of our total revenues were generated from research and development contracts with the U.S. Army. For the first three quarters of fiscal 2010, approximately 28%, 20% and 19% of our total revenues were generated from research and development contracts with certain classified U. S. government agencies, the U. S. Army and Optics 1, Inc., a defense contractor, respectively. Although we ultimately plan to shift our focus to include the commercialization of our technology, we expect to continue to be dependent upon research and development contracts with federal agencies and their contractors for a substantial portion of our revenues for the foreseeable future. Our dependency on a few contract sources increases the risks of disruption in this area of our business or significant fluctuations in quarterly revenue, either of which could adversely affect our consolidated revenues and results of operations.
Because our operations currently depend on government contracts and subcontracts, we face additional risks related to contracting with the federal government, including federal budget issues and fixed price contracts, that could materially and adversely affect our business. Future political and economic conditions are uncertain and may directly and indirectly affect the quantity and allocation of expenditures by federal agencies. Even the timing of incremental funding commitments to existing, but partially funded, contracts can be affected by these factors. Therefore, cutbacks or re-allocations in the federal budget could have a material adverse impact on our results of operations as long as research and development contracts remain an important element of our business. Obtaining government contracts may also involve long purchase and payment cycles, competitive bidding, qualification requirements, delays or changes in funding, budgetary constraints, political agendas, extensive specification development and price negotiations and milestone requirements. Each government agency also maintains its own rules and regulations with which we must comply and which can vary significantly among agencies. Governmental agencies also often retain some portion of fees payable upon completion of a project and collection of these fees may be delayed for several months or even years, in some instances. In addition, a number of our government contracts are fixed price contracts, which may prevent us from recovering costs incurred in excess of budgeted costs for such contracts. Fixed price contracts require us to estimate the total project cost based on preliminary projections of the project’s requirements. The financial viability of any given project depends in large part on our ability to estimate such costs accurately and complete the project on a timely basis. In the event our actual costs exceed fixed contractual costs of either our research and development contracts or our production orders, we will not be able to recover the excess costs.

 

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Our government contracts are also subject to termination or renegotiation at the convenience of the government, which could result in a large decline in revenue in any given quarter. Although government contracts have provisions providing for the reimbursement of costs associated with termination, the termination of a material contract at a time when our funded backlog does not permit redeployment of our staff could result in reductions of employees. We have in the past chosen to incur excess overhead in order to retain trained employees during delays in contract funding. We also have had to reduce our staff from time-to-time because of fluctuations in our funded government contract base. In addition, the timing of payments from government contracts is also subject to significant fluctuation and potential delay, depending on the government agency involved. Any such delay could result in a temporary adverse effect to our liquidity. Since a substantial majority of our total revenues in the last two fiscal years were derived directly or indirectly from government customers, these risks can significantly affect our business, results of operations and financial condition.
If we are not able to commercialize our technology, we may not be able to increase our revenues or achieve or sustain profitability. Since commencing operations, we have developed technology, principally under government research contracts, for various defense-based applications. However, since our margins on government contracts are generally limited, and our revenues from such contracts are tied to government budget cycles and influenced by numerous political and economic factors beyond our control, and are subject to our ability to win additional contracts, our long-term prospects of realizing significant returns from our technology or achieving and maintaining profitability will likely also require penetration of commercial markets. In prior years, we have made significant investments to commercialize our technologies without significant success. These efforts included the purchase and later shut down of a manufacturing line co-located at an IBM facility, the formation of the Novalog, MSI, Silicon Film, RedHawk and iNetWorks subsidiaries and the development of various stacked-memory products intended for commercial markets in addition to military and aerospace applications. These investments have not resulted in consolidated profitability to date, other than the profit realized in fiscal 2009 largely from the significant gains described above, and a majority of our total revenues for fiscal 2008, fiscal 2009 and the first three quarters of fiscal 2010 were still generated from governmental customers. Furthermore, the Optex Asset Sale has eliminated a substantial future contributor to our consolidated revenues.
The significant overseas military operations may require diversions of government research and development funding, thereby causing disruptions to our contracts or otherwise adversely impact our revenues. In the near term, the funding of significant U.S. military operations may cause disruptions in funding of government contracts. Since military operations of substantial magnitude are not routinely included in U.S. defense budgets, supplemental legislative funding actions are required to finance such operations. Even when such legislation is enacted, it may not be adequate for ongoing operations, causing other defense funding sources to be temporarily or permanently diverted. Such diversion could produce interruptions in funding or delays in receipt of our research and development contracts, causing disruptions and adverse effects to our operations. In addition, concerns about international conflicts and the effects of terrorist and other military activity have resulted in unsettled worldwide economic conditions. These conditions make it difficult for our customers to accurately forecast and plan future business opportunities, in turn making it difficult for us to plan our current and future allocation of resources and increasing the risks that our results of operations could be adversely affected.

 

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If we fail to scale our operations adequately, we may be unable to meet competitive challenges or exploit potential market opportunities, and our business could be materially and adversely affected. After giving effect to Optex as a discontinued operation, our consolidated total revenues in fiscal 2008, fiscal 2009 and the first three quarters of fiscal 2010 were $16.7 million, $11.5 million and $9.5 million, respectively. In order to absorb the recurring expenses of a publicly reporting company and remain profitable, we will need to materially grow our consolidated total revenues and/or substantially reduce our operating expenses. Such challenges are expected to place a significant strain on our management personnel, infrastructure and resources. To implement our current business and product plans, we will need to expand, train, manage and motivate our workforce, and expand our operational and financial systems, as well as our manufacturing and service capabilities. All of these endeavors will require additional capital and substantial effort by our management. If we are unable to effectively manage changes in our operations, we may be unable to scale our business quickly enough to meet competitive challenges or exploit potential market opportunities, and our current or future business could be materially and adversely affected.
Historically, we have primarily depended on third party contract manufacturers for the manufacture of a majority of our products and any failure to secure and maintain sufficient manufacturing capacity or quality products could materially and adversely affect our business. For our existing products, we primarily have used contract manufacturers to fabricate and assemble our stacked chip, microchip and sensor products. Our internal manufacturing capabilities consist primarily of assembly, calibration and test functions for our thermal camera products. We have typically used single contract manufacturing sources for our historical products and do not have long-term, guaranteed contracts with such sources. As a result, we face several significant risks, including:
    a lack of guaranteed supply of products and higher prices;
    limited control over delivery schedules, quality assurance, manufacturing yields and production costs; and
    the unavailability of, or potential delays in obtaining access to, key process technologies.
In addition, the manufacture of our products is a highly complex and technologically demanding process and we are dependent upon our contract manufacturers to minimize the likelihood of reduced manufacturing yields or quality issues. We currently do not have any long-term supply contracts with any of our manufacturers and do not have the capability or capacity to manufacture our products in-house in large quantities. If we are unable to secure sufficient capacity with our existing manufacturers, implement manufacturing of some of our new products at other contract manufacturers or scale our internal capabilities, our revenues, cost of revenues and results of operations would be negatively impacted.
If we are not able to obtain broad market acceptance of our new and existing products, our revenues and results of operations will be adversely affected. We generally focus on emerging markets. Market reaction to new products in these circumstances can be difficult to predict. Many of our planned products incorporate our chip stacking technologies that have not yet achieved broad market acceptance. We cannot assure you that our present or future products will achieve market acceptance on a sustained basis. In addition, due to our historical focus on research and development, we have a limited history of competing in the intensely competitive commercial electronics industry. As such, we cannot assure you that we will be able to successfully develop, manufacture and market additional commercial product lines or that such product lines will be accepted in the commercial marketplace. If we are not successful in commercializing our new products, our ability to generate revenues and our business, financial condition and results of operations will be adversely affected.

 

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Failure to achieve and maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business and stock price. Our fiscal 2005, fiscal 2006 and fiscal 2007 audits revealed material weaknesses in our internal controls over financial reporting, including the failure of such controls to identify the need to record a post-employment obligation for our Executive Salary Continuation Plan, which resulted in a restatement of our financial statements. We believe these types of material weaknesses relate primarily to the size and depth of our accounting staff. We have attempted to address these material weaknesses by expanding our staff and reassigning responsibilities and, based on information available to us as of the date of this report, we believe that we have remediated this condition as of September 28, 2008 and September 27, 2009. Our testing of our belief will be conducted pursuant to Section 404(a) of the Sarbanes-Oxley Act in fiscal 2010 and beyond. Such testing may ultimately reveal that previously identified material weaknesses have not been remediated or that new material weaknesses have developed. Furthermore, we do not presently have the financial resources and infrastructure to address our future plans, which puts us at risk of future material weaknesses. We are in the process of documenting and testing our internal control processes in order to satisfy the requirements of Section 404(a) of the Sarbanes-Oxley Act, which requires annual management assessments and a written report on the effectiveness of our internal controls over financial reporting. During the course of our testing, we may identify other significant deficiencies or material weaknesses, in addition to the ones previously identified, which we may not be able to remediate in time to meet future deadlines imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404(a). In addition, if we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we will not be able to conclude that we have effective internal controls over financial reporting in accordance with Section 404(a) of the Sarbanes-Oxley Act. Failure to achieve and maintain an effective internal control environment could cause investors to lose confidence in our reported financial information, which could result in a decline in the market price of our common stock, and cause us to fail to meet our reporting obligations in the future.
Our stock price has been subject to significant volatility. The trading price of our common stock has been subject to wide fluctuations in the past. Since January 2000, our common stock has traded at prices as low as $0.11 per share in March 2009 and as high as $3,750.00 per share in January 2000 (after giving effect to two reverse stock splits subsequent to January 2000). The current market price of our common stock may not increase in the future. As such, you may not be able to resell your shares of common stock at or above the price you paid for them. The market price of the common stock could continue to fluctuate or decline in the future in response to various factors, including, but not limited to:
    the impact and outcome of pending litigation;
    our cash resources and ability to raise additional funding and repay indebtedness;
    our ability to demonstrate compliance with Nasdaq’s listing maintenance requirements;
    quarterly variations in operating results;
    government budget reallocations or delays in or lack of funding for specific projects;
    our ability to control costs and improve cash flow;
    our ability to introduce and commercialize new products and achieve broad market acceptance for our products;
    announcements of technological innovations or new products by us or our competitors;
    our cash resources and ability to raise additional funding and repay indebtedness;
    changes in investor perceptions;
    economic and political instability, including acts of war, terrorism and continuing international conflicts; and
    changes in earnings estimates or investment recommendations by securities analysts.

 

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The trading markets for the equity securities of high technology companies have continued to experience volatility. Such volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. We were subject to a class action lawsuit that diverted management’s attention and resources from other matters until it was settled in June 2004. We cannot guarantee you that we will not be subject to similar class action lawsuits in the future.
Our Patent Sale and License has removed barriers to competition. We sold most of our then-issued and pending patents pursuant to the Patent Sale and License. Although we retain a worldwide, royalty-free, non-exclusive license to use the patented technology that we sold in our business, the purchaser of our patent assets is entitled to use those patents for any purpose, including possible competition with us. We treat technical data as confidential and generally rely on internal nondisclosure safeguards, including confidentiality agreements with employees, and on laws protecting trade secrets, to protect our proprietary information and maintain barriers to competition. However, we cannot assure you that these measures will adequately protect the confidentiality of our proprietary information or that others will not independently develop products or technology that are equivalent or superior to ours.
Our ability to exploit our own technologies may be constrained by the rights of third parties who could prevent us from selling our products in certain markets or could require us to obtain costly licenses. Other companies may hold or obtain patents or inventions or may otherwise claim proprietary rights to technology useful or necessary to our business. We cannot predict the extent to which we may be required to seek licenses under such proprietary rights of third parties and the cost or availability of these licenses. While it may be necessary or desirable in the future to obtain licenses relating to one or more proposed products or relating to current or future technologies, we cannot assure you that we will be able to do so on commercially reasonable terms, if at all. If our technology is found to infringe upon the rights of third parties, or if we are unable to gain sufficient rights to use key technologies, our ability to compete would be harmed and our business, financial condition and results of operations would be materially and adversely affected.
Enforcing and protecting patents and other proprietary information can be costly. If we are not able to adequately protect or enforce our proprietary information or if we become subject to infringement claims by others, our business, results of operations and financial condition may be materially adversely affected. We may need to engage in future litigation to enforce our future intellectual property rights or the rights of our customers, to protect our trade secrets or to determine the validity and scope of proprietary rights of others, including our customers. The purchaser of our patents may choose to be more aggressive in pursuing its rights with respect to these patents, which could lead to significant litigation and possible attempts by others to invalidate such patents. If such attempts are successful, we might not be able to use this technology in the future. We also may need to engage in litigation in the future to enforce patent rights with respect to future patents. In addition, we may receive in the future communications from third parties asserting that our products infringe the proprietary rights of third parties. We cannot assure you that any such claims would not result in protracted and costly litigation. Any such litigation could result in substantial costs and diversion of our resources and could materially and adversely affect our business, financial condition and results of operations. Furthermore, we cannot assure you that we will have the financial resources to vigorously defend our proprietary information.
Our proprietary information and other intellectual property rights are subject to government use which, in some instances, limits our ability to capitalize on them. Whatever degree of protection, if any, is afforded to us through patents, proprietary information and other intellectual property generally will not extend to government markets that utilize certain segments of our technology. The government has the right to royalty-free use of technologies that we have developed under government contracts, including portions of our stacked circuitry technology. While we are generally free to commercially exploit these government-funded technologies, and we may assert our intellectual property rights to seek to block other non-government users of the same, we cannot assure you that we will be successful in our attempts to do so.

 

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We are subject to significant competition that could harm our ability to win new business or attract strategic partnerships and could increase the price pressure on our products. We face strong competition from a wide variety of competitors, including large, multinational semiconductor design firms and aerospace firms. Most of our competitors have considerably greater financial, marketing and technological resources than we or our subsidiaries do, which may make it difficult to win new contracts or to attract strategic partners. This competition has resulted and may continue to result in declining average selling prices for our products. We cannot assure you that we will be able to compete successfully with these companies. Certain of our competitors operate their own fabrication facilities and have longer operating histories and presence in key markets, greater name recognition, larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than us. As a result, these competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources to the promotion and sale of their products. Increased competition has in the past resulted in price reductions, reduced gross margins and loss of market share. This trend may continue in the future. We cannot assure you that we will be able to continue to compete successfully or that competitive pressures will not materially and adversely affect our business, financial condition and results of operations.
We must continually adapt to unforeseen technological advances, or we may not be able to successfully compete with our competitors. We operate in industries characterized by rapid and continuing technological development and advancements. Accordingly, we anticipate that we will be required to devote substantial resources to improve already technologically complex products. Many companies in these industries devote considerably greater resources to research and development than we do. Developments by any of these companies could have a materially adverse effect on us if we are not able to keep up with the same developments. Our future success will depend on our ability to successfully adapt to any new technological advances in a timely manner, or at all.
If we effectuate additional acquisitions, it may further strain our capital resources, result in additional integration and assimilation challenges, be further dilutive to existing stockholders, result in unanticipated accounting charges and expenses, or otherwise adversely affect our results of operations. Our future business strategy may involve expansion through the acquisitions of businesses, assets or technologies that allow us to expand our capabilities and market coverage and to complement our existing product offerings. Optex, our first acquisition under this strategy, initially facilitated our market access, but did not achieve financial objectives. Acquisitions may require significant upfront capital as well as capital infusions, and typically entail many risks, including unanticipated costs and expenditures, changing relationships with customers, suppliers and strategic partners, or contractual, intellectual property or employment issues. We had not engaged in an acquisition strategy prior to our acquisition of Optex; we experienced difficulties in assimilating and integrating the operations, personnel, technologies, products and information systems of Optex, and the Optex acquisition was also costly and resulted in material adverse impacts to our overall financial condition. We may experience similar difficulties in assimilating any other companies or businesses we may acquire in the future. In addition, key personnel of an acquired company may decide not to work for us. The acquisition of another company or its products and technologies may also require us to enter into a geographic or business market in which we have little or no prior experience. These challenges could disrupt our ongoing business, distract our management and employees, harm our reputation and increase our expenses. These challenges are magnified as the size of the acquisition increases.

 

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Acquisitions or asset purchases made entirely or partially with cash or debt could also put a significant strain on our limited capital resources. Acquisitions may also require large one-time charges and can result in contingent liabilities, adverse tax consequences, deferred compensation charges, and the recording and later amortization of amounts related to deferred compensation and certain purchased intangible assets, any of which items could negatively impact our results of operations. In addition, we may record goodwill in connection with an acquisition and incur goodwill impairment charges in the future. Any of these charges could cause the price of our common stock to decline. In addition, we may issue equity or convertible debt securities in connection with an acquisition, as we did in connection with our acquisition of Optex. Any issuance of equity or convertible debt securities may be dilutive to our existing stockholders and such securities could have rights, preferences or privileges senior to those of our common stock.
We cannot assure you that we will be able to locate or consummate any future acquisitions, or that we will realize any anticipated benefits from these acquisitions. Even if we do find suitable acquisition opportunities, we may not be able to consummate the acquisition on commercially acceptable terms, and any decline in the price of our common stock may make it significantly more difficult and expensive to initiate or consummate an acquisition.
We do not plan to pay dividends to holders of common stock. We do not anticipate paying cash dividends to the holders of the common stock at any time. Accordingly, investors in our securities must rely upon subsequent sales after price appreciation as the sole method to realize a gain on investment. There are no assurances that the price of common stock will ever appreciate in value. Investors seeking cash dividends should not buy our securities.
We do not have long-term employment agreements with our key personnel. If we are not able to retain our key personnel or attract additional key personnel as required, we may not be able to implement our business plan and our results of operations could be materially and adversely affected. We depend to a large extent on the abilities and continued participation of our executive officers and other key employees. The loss of any key employee could have a material adverse effect on our business. While we have adopted employee equity incentive plans designed to attract and retain key employees, our stock price has declined in recent periods, and we cannot guarantee that options or non-vested stock granted under our plans will be effective in retaining key employees. We do not presently maintain “key man” insurance on any key employees. We believe that, as our activities increase and change in character, additional, experienced personnel will be required to implement our business plan. Competition for such personnel is intense and we cannot assure you that they will be available when required, or that we will have the ability to attract and retain them.
We may be subject to additional risks. The risks and uncertainties described above are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also adversely affect our business operations.

 

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Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3.   Defaults Upon Senior Securities
None.
Item 4.   (Removed and Reserved)
Item 5.   Other Information
None.
Item 6.   Exhibits
         
  3.1    
Certificate of Incorporation of the Company, as amended (1)
       
 
  3.2    
By-laws, as amended and currently in effect (2)
       
 
  3.3    
Certificate of Elimination of the Series B Convertible Cumulative Preferred Stock, Series C Convertible Cumulative Preferred Stock, Series D Convertible Preferred Stock and Series E Convertible Preferred Stock (3)
       
 
  3.4    
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series A-1 10% Cumulative Convertible Preferred Stock (4)
       
 
  3.5    
Certificate of Amendment of Certificate of Incorporation to increase the authorized shares of the Corporation’s common stock and the authorized shares of the Corporation’s Preferred Stock (5)
       
 
  3.6    
Certificate of Amendment of Certificate of Incorporation to reclassify, change, and convert each ten (10) outstanding shares of the Corporation’s common stock into one (1) share of common stock (6)
       
 
  3.7    
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series A-2 10% Cumulative Convertible Preferred Stock (7)
       
 
  3.8    
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series B Convertible Preferred Stock (8)
       
 
  3.9    
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series C Convertible Preferred Stock (9)
       
 
  10.1    
Agreement, Consent and Waiver dated April 9, 2010 by and between Irvine Sensors Corporation and Longview (10)
       
 
  10.2    
Secured Promissory Note to Timothy Looney dated April 14, 2010 (11)
       
 
  10.3  
Security Agreement to Timothy Looney dated April 14, 2010 (12)
       
 
  10.4  
Intellectual Property Security Agreement to Timothy Looney dated April 14, 2010 (13)
       
 
  10.5    
Clarification dated April 27, 2010 between Irvine Sensors Corporation and Longview (14)

 

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  10.6    
June 8, 2010 Waiver of Letter of Intent requirement of Agreement, Consent and Waiver dated April 9, 2010 by and between Irvine Sensors Corporation and Longview
       
 
  10.7    
Form of Subscription Agreement for Common Stock Unit Financing
       
 
  10.8    
Form of Investor Common Stock Warrant for Common Stock Unit Financing
       
 
  10.9    
Form of Placement Agent Common Stock Warrant for Common Stock Unit Financing
       
 
  10.10    
Form of Common Stock Warrant issued to Longview on August 2, 2010
       
 
  31.1    
Certification of the Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  31.2    
Certification of the Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  32    
Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith).
 
     
(1)   Incorporated by reference to Exhibit 3.1 filed with the Registrant’s Annual Report on Form 10-K for the fiscal year ended September 28, 2003
 
(2)   Incorporated by reference to Exhibit 3.1 filed with the Registrant’s Current Report on Form 8-K as filed with the SEC on September 21, 2007.
 
(3)   Incorporated by reference to Exhibit 3.3 filed with the Registrant’s Current Report on Form 8-K as filed with the SEC on April 18, 2008.
 
(4)   Incorporated by reference to Exhibit 3.4 filed with the Registrant’s Current Report on Form 8-K as filed with the SEC on April 18, 2008.
 
(5)   Incorporated by reference to Exhibit 3.5 to the Registrant’s Current Report on Form 8-K filed on August 27, 2008.
 
(6)   Incorporated by reference to Exhibit 3.6 to the Registrant’s Current Report on Form 8-K filed on August 27, 2008.
 
(7)   Incorporated by reference to Exhibit 3.1 filed with the Registrant’s Current Report on Form 8-K as filed with the SEC on March 24, 2009.
 
(8)   Incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on October 1, 2009.
 
(9)   Incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on May 4, 2010.
 
(10)   Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on April 15, 2010.
 
(11)   Incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on April 15, 2010.
 
(12)   Incorporated by reference to Exhibit 10.6 filed with the Registrant’s Quarterly Report on Form 10-Q as filed with the SEC on May 12, 2010.
 
(13)   Incorporated by reference to Exhibit 10.7 filed with the Registrant’s Quarterly Report on Form 10-Q as filed with the SEC on May 12, 2010.
 
(14)   Incorporated by reference to Exhibit 10.13 filed with the Registrant’s Quarterly Report on Form 10-Q as filed with the SEC on May 12, 2010.
 
  Confidential treatment has been requested for certain confidential portions of this exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934. In accordance with Rule 24b-2, these confidential portions were omitted from this exhibit and filed separately with the Securities and Exchange Commission.

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  Irvine Sensors Corporation
(Registrant)
 
 
Date: August 11, 2010 By:   /s/ John J. Stuart, Jr.    
    John J. Stuart, Jr.   
    Chief Financial Officer
(Principal Financial and Chief Accounting Officer) 
 
 

 

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Exhibit Index
         
  3.1    
Certificate of Incorporation of the Company, as amended (1)
       
 
  3.2    
By-laws, as amended and currently in effect (2)
       
 
  3.3    
Certificate of Elimination of the Series B Convertible Cumulative Preferred Stock, Series C Convertible Cumulative Preferred Stock, Series D Convertible Preferred Stock and Series E Convertible Preferred Stock (3)
       
 
  3.4    
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series A-1 10% Cumulative Convertible Preferred Stock (4)
       
 
  3.5    
Certificate of Amendment of Certificate of Incorporation to increase the authorized shares of the Corporation’s common stock and the authorized shares of the Corporation’s Preferred Stock (5)
       
 
  3.6    
Certificate of Amendment of Certificate of Incorporation to reclassify, change, and convert each ten (10) outstanding shares of the Corporation’s common stock into one (1) share of common stock (6)
       
 
  3.7    
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series A-2 10% Cumulative Convertible Preferred Stock (7)
       
 
  3.8    
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series B Convertible Preferred Stock (8)
       
 
  3.9    
Certificate of Designations of Rights, Preferences, Privileges and Limitations of Series C Convertible Preferred Stock (9)
       
 
  10.1    
Agreement, Consent and Waiver dated April 9, 2010 by and between Irvine Sensors Corporation and Longview (10)
       
 
  10.2    
Secured Promissory Note to Timothy Looney dated April 14, 2010 (11)
       
 
  10.3  
Security Agreement to Timothy Looney dated April 14, 2010 (12)
       
 
  10.4  
Intellectual Property Security Agreement to Timothy Looney dated April 14, 2010 (13)
       
 
  10.5    
Clarification dated April 27, 2010 between Irvine Sensors Corporation and Longview (14)
       
 
  10.6    
June 8, 2010 Waiver of Letter of Intent requirement of Agreement, Consent and Waiver dated April 9, 2010 by and between Irvine Sensors Corporation and Longview
       
 
  10.7    
Form of Subscription Agreement for Common Stock Unit Financing
       
 
  10.8    
Form of Investor Common Stock Warrant for Common Stock Unit Financing
       
 
  10.9    
Form of Placement Agent Common Stock Warrant for Common Stock Unit Financing
       
 
  10.10    
Form of Common Stock Warrant issued to Longview on August 2, 2010
       
 
  31.1    
Certification of the Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  31.2    
Certification of the Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  32    
Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith).
 
     
(1)   Incorporated by reference to Exhibit 3.1 filed with the Registrant’s Annual Report on Form 10-K for the fiscal year ended September 28, 2003

 

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(2)   Incorporated by reference to Exhibit 3.1 filed with the Registrant’s Current Report on Form 8-K as filed with the SEC on September 21, 2007.
 
(3)   Incorporated by reference to Exhibit 3.3 filed with the Registrant’s Current Report on Form 8-K as filed with the SEC on April 18, 2008.
 
(4)   Incorporated by reference to Exhibit 3.4 filed with the Registrant’s Current Report on Form 8-K as filed with the SEC on April 18, 2008.
 
(5)   Incorporated by reference to Exhibit 3.5 to the Registrant’s Current Report on Form 8-K filed on August 27, 2008.
 
(6)   Incorporated by reference to Exhibit 3.6 to the Registrant’s Current Report on Form 8-K filed on August 27, 2008.
 
(7)   Incorporated by reference to Exhibit 3.1 filed with the Registrant’s Current Report on Form 8-K as filed with the SEC on March 24, 2009.
 
(8)   Incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on October 1, 2009.
 
(9)   Incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on May 4, 2010.
 
(10)   Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on April 15, 2010.
 
(11)   Incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on April 15, 2010.
 
(12)   Incorporated by reference to Exhibit 10.6 filed with the Registrant’s Quarterly Report on Form 10-Q as filed with the SEC on May 12, 2010.
 
(13)   Incorporated by reference to Exhibit 10.7 filed with the Registrant’s Quarterly Report on Form 10-Q as filed with the SEC on May 12, 2010.
 
(14)   Incorporated by reference to Exhibit 10.13 filed with the Registrant’s Quarterly Report on Form 10-Q as filed with the SEC on May 12, 2010.
 
  Confidential treatment has been requested for certain confidential portions of this exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934. In accordance with Rule 24b-2, these confidential portions were omitted from this exhibit and filed separately with the Securities and Exchange Commission.

 

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