10-Q 1 kopn-20120930x10q.htm 10-Q KOPN-2012.09.30-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
 FORM 10-Q
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 29, 2012
or
¨
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 0-19882
 
 
 KOPIN CORPORATION
(Exact name of registrant as specified in its charter)
 
 
Delaware

04-2833935
State or other jurisdiction of
incorporation or organization

(I.R.S. Employer
Identification No.)
 
 
 
200 John Hancock Rd., Taunton, MA

02780-1042
(Address of principal executive offices)

(Zip Code)
Registrant’s telephone number, including area code: (508) 824-6696
 
 
 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days.    Yes  x   No  ¨
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    x    No  ¨
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 definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer

¨
Accelerated filer

x
Non-accelerated filer

¨
Smaller reporting company

¨
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act).    Yes  ¨   No  x
Indicate the number of shares outstanding of each issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding as of November 2, 2012
Common Stock, par value $.01
66,295,412



Kopin Corporation
INDEX
 
 
 
 
 
 
Page
No.
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
Item 1.
Item 1A.
Item 2.
Item 5.
Item 6.
 

2


Part 1: FINANCIAL INFORMATION
 
Item 1:
Condensed Consolidated Financial Statements (Unaudited)
KOPIN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
 
September 29,
2012
 
December 31,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and equivalents
$
25,263,239

 
$
43,095,163

Marketable debt securities, at fair value
69,273,996

 
62,323,387

Accounts receivable, net of allowance of $454,000 and $513,000 in 2012 and 2011, respectively
12,293,195

 
16,510,851

Accounts receivable from unconsolidated affiliates
2,072,892

 
1,340,788

Unbilled receivables
587,652

 
36,115

Inventory
19,684,989

 
20,468,512

Prepaid taxes
878,320

 
667,759

Prepaid expenses and other current assets
1,052,351

 
1,294,368

Total current assets
131,106,634

 
145,736,943

Property, plant and equipment, net
33,710,208

 
32,369,441

Deferred tax assets, net
3,472,437

 
4,201,627

Goodwill
1,140,787

 
1,664,457

Intangible assets, net
1,829,151

 
1,953,660

Other assets
9,287,486

 
7,946,087

Total assets
$
180,546,703

 
$
193,872,215

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
9,503,243

 
$
12,384,869

Accrued payroll and expenses
3,037,011

 
4,182,505

Accrued warranty
1,015,000

 
1,318,000

Billings in excess of revenue earned
2,214,889

 
2,467,461

Other accrued liabilities
4,925,003

 
2,126,954

Total current liabilities
20,695,146

 
22,479,789

Asset retirement obligations
1,144,773

 
1,295,670

Commitments and contingencies

 

Stockholders’ equity:
 
 
 
Preferred stock, par value $.01 per share: authorized, 3,000 shares; none issued

 

Common stock, par value $.01 per share: authorized, 120,000,000 shares; issued 76,156,551 shares in 2012 and 76,123,940 shares in 2011; outstanding 63,414,292 shares in 2012 and 64,361,491 shares in 2011
732,754

 
732,263

Additional paid-in capital
318,515,179

 
315,710,160

Treasury stock (9,861,139 and 8,864,767 shares in 2012 and 2011, respectively, at cost)
(34,450,978
)
 
(30,995,449
)
Accumulated other comprehensive income
6,380,602

 
4,146,024

Accumulated deficit
(139,132,141
)
 
(124,631,665
)
Total Kopin Corporation stockholders’ equity
152,045,416

 
164,961,333

Noncontrolling interest
6,661,368

 
5,135,423

Total stockholders’ equity
158,706,784

 
170,096,756

Total liabilities and stockholders’ equity
$
180,546,703

 
$
193,872,215


See notes to condensed consolidated financial statements
3


KOPIN CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
 
Three Months Ended
 
Nine months ended
 
September 29,
2012
 
September 24,
2011
 
September 29,
2012
 
September 24,
2011
Revenues:
 
 
 
 
 
 
 
Net product revenues
$
21,013,668

 
$
28,512,486

 
$
67,449,979

 
$
91,031,145

Research and development revenues
926,690

 
1,053,964

 
2,585,900

 
4,900,754

 
21,940,358

 
29,566,450

 
70,035,879

 
95,931,899

Expenses:
 
 
 
 
 
 
 
Cost of product revenues
15,834,791

 
19,753,495

 
49,714,995

 
60,813,990

Research and development
6,399,053

 
6,381,089

 
16,519,193

 
19,905,398

Selling, general and administration
5,466,289

 
4,351,794

 
15,591,101

 
13,494,589

Impairment of goodwill

 

 
1,704,770

 

 
27,700,133

 
30,486,378

 
83,530,059

 
94,213,977

(Loss) income from operations
(5,759,775
)
 
(919,928
)
 
(13,494,180
)
 
1,717,922

Other income and expense:
 
 
 
 
 
 
 
Interest income
300,690

 
357,581

 
829,028

 
986,888

Other income net
148,845

 
190,453

 
290,114

 
190,212

Foreign currency transaction (losses) gains
(525,674
)
 
1,012,555

 
(656,334
)
 
374,519

Gain on sale of investments

 

 
856,170

 
368,641

Loss on investment in Ikanos
(557,594
)
 

 
(557,594
)
 

Impairment of marketable debt securities

 
(150,644
)
 

 
(150,644
)
Gain on sale of patents

 

 

 
155,658

 
(633,733
)
 
1,409,945

 
761,384

 
1,925,274

(Loss) income before provision for income taxes, equity losses in unconsolidated affiliates and net loss (income) attributable to noncontrolling interest
(6,393,508
)
 
490,017

 
(12,732,796
)
 
3,643,196

Tax provision
(470,500
)
 
(97,500
)
 
(1,335,500
)
 
(293,000
)
(Loss) income before equity losses in unconsolidated affiliates and net (loss) income of noncontrolling interest
(6,864,008
)
 
392,517

 
(14,068,296
)
 
3,350,196

Equity losses in unconsolidated affiliates
(202,278
)
 
(49,596
)
 
(592,480
)
 
(203,834
)
Net (loss) income
(7,066,286
)
 
342,921

 
(14,660,776
)
 
3,146,362

Net loss (income) attributable to the noncontrolling interest
344,274

 
(185,461
)
 
160,300

 
(118,861
)
Net (loss) income attributable to the controlling interest
$
(6,722,012
)
 
$
157,460

 
$
(14,500,476
)
 
$
3,027,501

Net (loss) income per share
 
 
 
 
 
 
 
Basic
$
(0.11
)
 
$
0.00

 
$
(0.23
)
 
$
0.05

Diluted
$
(0.11
)
 
$
0.00

 
$
(0.23
)
 
$
0.05

Weighted average number of common shares
 
 
 
 
 
 
 
Basic
63,415,345

 
64,292,212

 
63,572,753

 
64,519,225

Diluted
63,415,345

 
65,441,378

 
63,572,753

 
65,623,807

See notes to condensed consolidated financial statements

4


KOPIN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
 
 
Three Months Ended
 
Nine months ended
 
September 29, 2012
 
September 24, 2011
 
September 29, 2012
 
September 24, 2011
Net (loss) income
$
(7,066,286
)
 
$
342,921

 
$
(14,660,776
)
 
$
3,146,362

Foreign currency translation adjustments
1,665,381

 
(3,065,739
)
 
1,890,837

 
(1,981,067
)
Holding gain (loss) on marketable securities
(150,520
)
 
(1,260,634
)
 
1,220,149

 
(1,664,944
)
Reclassifications of gains in net (loss) income
(29,843
)
 
21,495

 
(574,202
)
 
(395,759
)
Comprehensive loss
$
(5,581,268
)
 
$
(3,961,957
)
 
$
(12,123,992
)
 
$
(895,408
)
Comprehensive income attributable to the noncontrolling interest
59,390

 
(158,480
)
 
(141,907
)
 
(236,399
)
Comprehensive loss attributable to controlling interest
$
(5,521,878
)
 
$
(4,120,437
)
 
$
(12,265,899
)
 
$
(1,131,807
)
See notes to condensed consolidated financial statements

5


KOPIN CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
 
 
Common Stock
 
Additional
Paid-in Capital
 
Treasury Stock
 
Accumulated
Other
Comprehensive Income
 
Accumulated Deficit
 
Total Kopin
Corporation
Stockholders’ Equity
 
Noncontrolling Interest
 
Total
Stockholders’ Equity
 
Shares
 
Amount
 
 
 
 
 
 
 
Balance, December 31, 2011
73,226,258

 
$
732,263

 
$
315,710,160

 
$
(30,995,449
)
 
$
4,146,024

 
$
(124,631,665
)
 
$
164,961,333

 
$
5,135,423

 
$
170,096,756

Stock-based compensation

 

 
2,906,186

 

 

 

 
2,906,186

 

 
2,906,186

Vesting of restricted stock
78,000

 
780

 
(780
)
 

 

 

 

 

 

Net unrealized holding gain on marketable securities

 

 

 

 
645,947

 

 
645,947

 

 
645,947

Acquisition of Ikanos equity interest

 

 

 

 

 

 

 
1,384,039

 
1,384,039

Foreign currency translation adjustments

 

 

 

 
1,588,631

 

 
1,588,631

 
302,206

 
1,890,837

Restricted stock for tax withholdings
(28,823
)
 
(289
)
 
(100,387
)
 

 

 

 
(100,676
)
 

 
(100,676
)
Treasury stock purchase

 

 

 
(3,455,529
)
 

 

 
(3,455,529
)
 

 
(3,455,529
)
Net loss

 

 

 

 

 
(14,500,476
)
 
(14,500,476
)
 
(160,300
)
 
(14,660,776
)
Balance, September 29, 2012
73,275,435

 
$
732,754

 
$
318,515,179

 
$
(34,450,978
)
 
$
6,380,602

 
$
(139,132,141
)
 
$
152,045,416

 
$
6,661,368

 
$
158,706,784

See notes to condensed consolidated financial statements

6

KOPIN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 
Nine months ended
 
September 29,
2012
 
September 24,
2011
Cash flows from operating activities:
 
 
 
Net (loss) income
$
(14,660,776
)
 
$
3,146,362

Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
7,634,175

 
5,996,918

Amortization of premium or discount on marketable debt securities
(222,658
)
 
(110,162
)
Stock-based compensation
3,773,306

 
2,176,820

Net gain on sale of investments
(856,170
)
 
(368,641
)
Losses in unconsolidated affiliates
592,480

 
203,834

Impairment on investments
557,594

 

Impairment of goodwill
1,704,770

 

Deferred income tax asset
729,190

 

Foreign currency losses
595,016

 
(326,465
)
Impairment of marketable debt securities

 
150,644

Change in allowance for bad debt
(85,038
)
 
(107,726
)
Change in inventory reserves
668,320

 
408,900

Change in warranty reserves
(300,000
)
 

Changes in assets and liabilities:
 
 
 
Accounts receivable
3,150,525

 
1,358,326

Inventory
297,273

 
2,862,935

Prepaid expenses and other current assets
168,068

 
721,068

Accounts payable and accrued expenses
(1,998,170
)
 
(4,248,968
)
Billings in excess of revenue earned
(252,572
)
 
(747,914
)
Net cash provided by operating activities
1,495,333

 
11,115,931

Cash flows from investing activities:
 
 
 
Proceeds from sale of marketable debt securities
33,315,471

 
36,872,779

Purchase of marketable debt securities
(39,706,955
)
 
(38,976,135
)
Cash paid to acquire Ikanos, net of cash acquired
93,872

 

Cash paid to acquire FDD, net of cash acquired
94,351

 
(10,084,307
)
Purchase of investments
(2,249,784
)
 

Proceeds from sale of investments
856,170

 
392,196

Other assets
77,383

 
32,919

Capital expenditures
(8,464,076
)
 
(5,730,749
)
Net cash used in investing activities
(15,983,568
)
 
(17,493,297
)
Cash flows from financing activities:
 
 
 
Treasury stock purchases
(3,455,529
)
 
(3,060,156
)
Proceeds from exercise of stock options

 
72,445

Settlements of restricted stock for tax withholding obligations
(100,676
)
 
(72,374
)
Net cash used in financing activities
(3,556,205
)
 
(3,060,085
)
Effect of exchange rate changes on cash
212,516

 
(233,754
)
Net decrease in cash and equivalents
(17,831,924
)
 
(9,671,205
)
Cash and equivalents:
 
 
 
Beginning of period
43,095,163

 
49,834,547

End of period
$
25,263,239

 
$
40,163,342

Supplemental disclosure of cash flow information:
 
 
 
Income taxes paid
$
197,000

 
$
163,000

Supplemental schedule of noncash investing activities:
 
 
 
Construction in progress included in accrued expenses
$

 
$
526,000


See notes to condensed consolidated financial statements
7



KOPIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINCANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include the accounts of Kopin Corporation, its wholly-owned subsidiaries, Kowon Technology Co., Ltd. (Kowon), a majority owned (78%)  subsidiary located in Korea, Kopin Taiwan Corporation (KTC), a majority owned (90%) subsidiary located in Taiwan and Ikanos Consulting Ltd. (Ikanos) a (51%) owned subsidiary located in the United Kingdom (collectively the “Company”). Ownership interests of Kowon, KTC and Ikanos not attributable to the Company are referred to as noncontrolling interests. All intercompany transactions and balances have been eliminated. The condensed consolidated financial statements for the three and nine months ended September 29, 2012 and September 24, 2011 are unaudited and include all adjustments which, in the opinion of management, are necessary to present fairly the results of operations for the periods then ended. These condensed consolidated financial statements should be read in conjunction with the Company’s financial statements and notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
The results of the Company’s operations for any interim period are not necessarily indicative of the results of the Company’s operations for any other interim period or for a full fiscal year.
Immaterial Restatement
During the second quarter of 2012, the Company identified an error in the calculation of intercompany profit elimination in inventory for prior periods. While the Company believes the correction of this error is not material to its previously issued historical consolidated financial statements, the Company has restated certain balances within the condensed consolidated balance sheet as of December 31, 2011 to correct this error. The condensed consolidated statements of operations and comprehensive loss for the three and nine months ended September 24, 2011 and condensed consolidated statements of cash flows for the nine months ended September 24, 2011 were also corrected for this error.


8


The effects of this restatement on the consolidated statements of operations for the three and nine months ended September 24, 2011 are as follows (in thousands):
 
Three months ended September 24, 2011
 
Nine months ended September 24, 2011
 
As previously
reported
 
Adjustment
 
As
restated
 
As previously
reported
 
Adjustment
 
As
restated
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Net product revenues
$
28,512

 
$

 
$
28,512

 
$
91,031

 
$

 
$
91,031

Research and development revenues
1,054

 

 
1,054

 
4,901

 

 
4,901

Total revenues
29,566

 

 
29,566

 
95,932

 

 
95,932

Expenses:
 
 
 
 
 
 
 
 
 
 
 
Cost of product revenues
19,046

 
707

 
19,753

 
60,107

 
707

 
60,814

Research and development
6,381

 

 
6,381

 
19,905

 

 
19,905

Selling, general and administrative
4,352

 

 
4,352

 
13,495

 

 
13,495

 
29,779

 
707

 
30,486

 
93,507

 
707

 
94,214

(Loss) income from operations
(213
)
 
(707
)
 
(920
)
 
2,425

 
(707
)
 
1,718

Other income and expense:
 
 
 
 
 
 
 
 
 
 
 
Interest income
358

 

 
358

 
987

 

 
987

Other income net
190

 

 
190

 
190

 

 
190

Foreign currency gains
1,013

 

 
1,013

 
375

 

 
375

Gain of sale of investments

 

 

 
369

 

 
369

Impairment of marketable debt securities
(151
)
 

 
(151
)
 
(151
)
 

 
(151
)
Gain on sale of patents

 

 

 
156

 

 
156

 
1,410

 

 
1,410

 
1,926

 

 
1,926

Income (loss) before provision for income taxes, equity losses in unconsolidated affiliates and net income (loss) of noncontrolling interest
1,197

 
(707
)
 
490

 
4,351

 
(707
)
 
3,644

Tax provision
(98
)
 

 
(98
)
 
(293
)
 

 
(293
)
Income (loss) before equity losses in unconsolidated affiliates and net income (loss) of noncontrolling interest
1,099

 
(707
)
 
392

 
4,058

 
(707
)
 
3,351

Equity losses in unconsolidated affiliates
(50
)
 

 
(50
)
 
(204
)
 

 
(204
)
Net income (loss)
1,049

 
(707
)
 
342

 
3,854

 
(707
)
 
3,147

Net (income) loss attributable to the noncontrolling interest
(254
)
 
69

 
(185
)
 
(188
)
 
69

 
(119
)
Net income (loss) attributable to the controlling interest
$
795

 
$
(638
)
 
$
157

 
$
3,666

 
$
(638
)
 
$
3,028

Net income per share:
 
 
 
 
 
 
 
 
 
 
 
Basic
$
0.01

 
$
(0.01
)
 
$
0.00

 
$
0.06

 
$
(0.01
)
 
$
0.05

Diluted
$
0.01

 
$
(0.01
)
 
$
0.00

 
$
0.06

 
$
(0.01
)
 
$
0.05

Weighted average number of common shares:
 
 
 
 
 
 
 
 
 
 
 
Basic
64,292

 
 
 
64,292

 
64,519

 
 
 
64,519

Diluted
65,441

 
 
 
65,441

 
65,624

 
 
 
65,624

This error resulted in a decrease to net income of ($0.7) million and changes in inventory of $0.7 million within the condensed consolidated statements of cash flows for the nine months ended September 24, 2011. This error did not result in any changes to net cash flows from operating, investing or financing activities. This error resulted in a ($0.7) million increase in comprehensive loss for the three and nine months ended September 24, 2011.

9


The effects of this restatement on the consolidated balance sheet as of December 31, 2011 are as follows (in thousands): 
 
December 31, 2011 as previously reported
 
 
 
December 31, 2011 as restated
 
 
Adjustment
 
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and equivalents
$
43,095

 
$

 
$
43,095

Marketable debt securities, at fair value
62,323

 

 
62,323

       Accounts receivable, net of allowance of $513,000 in 2011
16,511

 

 
16,511

Accounts receivable from unconsolidated affiliates
1,341

 

 
1,341

Unbilled receivable
36

 

 
36

Inventory
21,416

 
(947
)
 
20,469

Prepaid taxes
412

 
256

 
668

Prepaid expenses and other current assets
1,294

 

 
1,294

Total current assets
146,428

 
(691
)
 
145,737

Property, plant & equipment, net
32,369

 

 
32,369

Deferred tax assets
4,202

 

 
4,202

Goodwill
1,665

 

 
1,665

Intangible assets
1,954

 

 
1,954

Other assets
7,946

 

 
7,946

Total assets
$
194,564

 
$
(691
)
 
$
193,873

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
Current Liabilities:
 
 
 
 
 
Accounts payable
$
12,385

 
$

 
$
12,385

Accrued payroll and expenses
4,183

 

 
4,183

Accrued warranty
1,318

 

 
1,318

Billings in excess of revenue earned
2,467

 

 
2,467

Other accrued liabilities
2,127

 

 
2,127

Total current liabilities
22,480

 

 
22,480

Asset Retirement obligations
1,296

 

 
1,296

Commitments and contingencies
 
 
 
 


Stockholders’ equity:
 
 
 
 
 
Preferred stock
 
 
 
 

Common stock
732

 

 
732

Additional paid-in capital
315,710

 

 
315,710

Treasury stock
(30,995
)
 

 
(30,995
)
Accumulated other comprehensive income
4,146

 

 
4,146

Accumulated deficit
(124,008
)
 
(623
)
 
(124,631
)
Total Kopin Corporation stockholders’ equity
165,585

 
(623
)
 
164,962

Non controlling interest
5,203

 
(68
)
 
5,135

Total stockholder’ equity
170,788

 
(691
)
 
170,097

Total liabilities and stockholders’ equity
$
194,564

 
$
(691
)
 
$
193,873


10


2. CASH AND EQUIVALENTS AND MARKETABLE SECURITIES
The Company considers all highly liquid, short-term debt instruments with original maturities of three months or less to be cash equivalents.
Marketable debt securities consist primarily of commercial paper, medium-term corporate notes, and United States government and agency backed securities. The Company classifies these marketable debt securities as available-for-sale in “Marketable Debt Securities”. The investments in Advanced Wireless Semiconductor Company (AWSC) and WIN Semiconductor Corp. (WIN) are included in “Other Assets” as available-for-sale and recorded at fair value. The Company records the amortization of premium and accretion of discount on marketable debt securities in the results of operations.
The Company uses the specific identification method as a basis for determining cost and calculating realized gains and losses with respect to marketable debt securities. The gross gains and losses realized related to sales and maturities of marketable debt securities were not material during the nine months ended September 29, 2012 and the year ended December 31, 2011.
Investments in available-for-sale marketable debt securities are as follows at September 29, 2012 and December 31, 2011:
 
Amortized Cost

Unrealized Gains

Unrealized Losses

Fair Value
 
2012

2011

2012

2011

2012

2011

2012

2011
U.S. government and agency backed securities
$
38,104,940


$
31,480,482


$
580,067


$
665,171


$


$


$
38,685,007


$
32,145,653

Corporate debt and certificates of deposit
30,995,263


30,879,717






(406,274
)

(701,983
)

30,588,989


30,177,734

Total
$
69,100,203

 
$
62,360,199

 
$
580,067

 
$
665,171

 
$
(406,274
)
 
$
(701,983
)
 
$
69,273,996

 
$
62,323,387

The contractual maturity of the Company’s marketable debt securities is as follows at September 29, 2012:
 
Less than
One year
 
One to
Five years
 
Greater than
Five years
 
Total
U.S. government and agency backed securities
$
11,039,060

 
$
21,216,761

 
$
6,429,186

 
$
38,685,007

Corporate debt and certificates of deposit
20,550,637

 
9,137,102

 
901,250

 
30,588,989

Total
$
31,589,697

 
$
30,353,863

 
$
7,330,436

 
$
69,273,996

The Company conducts a review of its marketable debt securities on a quarterly basis for the presence of other-than-temporary impairment (OTTI). The Company assesses whether OTTI is present when the fair value of a debt security is less than its amortized cost basis at the balance sheet date. Under these circumstances OTTI is considered to have occurred (1) if the Company intends to sell the security before recovery of its amortized cost basis; (2) if it is “more likely than not” the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost basis.
The Company further estimates the amount of OTTI resulting from a decline in the credit worthiness of the issuer (credit-related OTTI) and the amount of non credit-related OTTI. Noncredit-related OTTI can be caused by such factors as market illiquidity. Credit-related OTTI is recognized in earnings while noncredit-related OTTI on securities not expected to be sold is recognized in other comprehensive loss. The Company did not record an OTTI for the three and nine months ended September 29, 2012. The Company recorded an OTTI adjustment of $0.2 million for the three and nine months ended September 24, 2011.

11


3. FAIR VALUE MEASUREMENTS
Financial instruments are categorized as Level 1, Level 2 or Level 3 based upon the method by which their fair value is computed. An investment is categorized as Level 1 when its fair value is based on unadjusted quoted prices in active markets for identical assets that the Company has the ability to access at the measurement date. An investment is categorized as Level 2 if its fair market value is based on quoted market prices for similar assets in active markets, quoted prices for identical or similar assets in markets that are not active, based on observable inputs such as interest rates, yield curves, or derived from or corroborated by observable market data by correlation or other means. An investment is categorized as Level 3 if its fair value is based on assumptions developed by the Company about what a market participant would use in pricing the assets.
The following table details the fair value measurements of the Company’s financial assets:
 
 
 
Fair Value Measurement at September 29, 2012 Using:
 
 
 
Level 1
 
Level 2
 
Level 3
Money Markets, Cash and Equivalents
$
25,263,239

 
$
25,263,239

 
$

 
$

U.S. Government Securities
38,685,007

 
17,589,512

 
21,095,495

 

Corporate Debt
11,955,688

 

 
11,955,688

 

Certificates of Deposit
18,633,301

 

 
18,633,301

 

WIN Semiconductor Corp.
1,568,673

 
1,568,673

 

 

Advanced Wireless Semiconductor Company
2,177,955

 
2,177,955

 

 

 
$
98,283,863

 
$
46,599,379

 
$
51,684,484

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fair Value Measurement at December 31, 2011 Using:
 
 
 
Level 1
 
Level 2
 
Level 3
Money Markets, Cash and Equivalents
$
43,095,163

 
$
43,095,163

 
$

 
$

U.S. Government Securities
32,145,653

 
12,892,670

 
19,252,983

 

Corporate Debt
18,754,992

 

 
18,754,992

 

Certificates of Deposit
11,422,742

 

 
11,422,742

 

WIN Semiconductor Corp.
1,709,189

 
1,709,189

 

 

Advanced Wireless Semiconductor Company
1,602,096

 
1,602,096

 

 

 
$
108,729,835

 
$
59,299,118

 
$
49,430,717

 
$


The corporate debt consists of floating rate notes with a maturity that is over multiple years but has interest rates which are reset every three months based on the then current three month London Interbank Offering Rate (three month Libor). The Company determines the fair market values of these corporate debt instruments through the use of a model which incorporates the three month Libor, the credit default swap rate of the issuer and the bid and ask price spread of same or similar investments which are traded on several markets.
The carrying amounts of cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value because of their short-term nature. The carrying amount of accrued liabilities is classified as Level 3 in the fair value hierarchy.

12


4. INVENTORY
Inventory is stated at the lower of cost (determined on the first-in, first-out or specific identification method) or market and consists of the following at September 29, 2012 and December 31, 2011:
 
September 29,
2012
 
December 31,
2011
Raw materials
$
9,698,862

 
$
9,934,724

Work-in-process
3,206,065

 
5,220,353

Finished goods
6,780,062

 
5,313,435

 
$
19,684,989

 
$
20,468,512

Inventory on consignment at customer locations was $4.2 million and $3.4 million at September 29, 2012 and December 31, 2011, respectively.
5. NET (LOSS) INCOME PER SHARE
Basic net (loss) income per share is computed using the weighted average number of shares of common stock outstanding during the period less any non-vested restricted shares. Diluted earnings per common share is calculated using weighted average shares outstanding and contingently issuable shares, less weighted average shares reacquired during the period. The net outstanding shares are adjusted for the dilutive effect of shares issuable upon the assumed conversion of the Company’s common stock equivalents, which consist of outstanding stock options and unvested restricted stock units.
Weighted average common shares outstanding used to calculate earnings per share are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 29, 2012
 
September 24,
2011
 
September 29,
2012
 
September 24,
2011
Weighted average common shares outstanding-basic
63,415,345

 
64,292,212

 
63,572,753

 
64,519,225

Stock options and non-vested restricted common stock

 
1,149,166

 

 
1,104,582

Weighted average common shares outstanding-diluted
63,415,345

 
65,441,378

 
63,572,753

 
65,623,807

The following were not included in weighted average common shares outstanding-diluted because they are anti-dilutive or performance conditions have not been met at the end of the period.
 
September 29, 2012
 
September 24, 2011
Non-vested restricted common stock
2,881,116

 
879,012

Stock options
1,838,345

 
1,583,550

Total
4,719,461

 
2,462,562

6. STOCK-BASED COMPENSATION
The fair value of stock option awards is estimated on the date of grant using the Black-Scholes-Merton option-pricing model. There were no stock options granted in the nine month period ended September 29, 2012, or in fiscal year 2011. The fair value of non-vested restricted common stock awards is generally the market value of the Company’s equity shares on the date of grant. The non-vested common stock awards require the employee to fulfill certain obligations, including remaining employed by the Company for one, two or four years (the vesting period) and in certain cases also require meeting either performance criteria or the Company’s stock achieving a certain price. The performance criteria primarily consist of the achievement of the Company’s annual incentive plan goals. For non-vested restricted common stock awards which solely require the recipient to remain employed with the Company, the stock compensation expense is amortized over the anticipated service period. For non-vested restricted common stock awards which require the achievement of performance criteria, the Company reviews the probability of achieving the performance goals on a periodic basis. If the Company determines that it is probable that the performance criteria will be achieved, the amount of compensation cost derived for the performance goal is amortized over the service period. If the performance criteria are not met, no compensation cost is recognized and any previously recognized compensation cost is reversed. The Company recognizes compensation costs on a straight-line basis over the requisite service period for time-vested awards.

13


In 2011, the Company granted 380,000 shares of phantom stock which will be settled in cash at the end of the first 10 consecutive trading day period following the grant date during which the Company’s common stock trades at a price per share equal to or greater than $5.25, prior to September 12, 2016. The vesting of the awards upon achieving a closing stock price of $5.25 for 10 consecutive days is considered a market condition which requires the Company to periodically assess the fair market value of the award, with increases or decrease in the fair market value being reflected in the statement of operations.
A summary of award activity under the stock option plans as of September 29, 2012 and changes during the nine month period is as follows (all options were vested as of September 29, 2012):
 
Nine months ended September 29, 2012
 
Shares
 
Weighted
Average
Exercise
Price
Balance, December 31, 2011
1,903,325

 
$
5.07

Options forfeited/cancelled
(64,980
)
 
7.98

Options exercised

 

Balance, all exercisable, September 29, 2012
1,838,345

 
$
4.97

The following table summarizes information about stock options outstanding and exercisable at September 29, 2012:
 
Options Outstanding and Exercisable
Range of Exercise Prices
Number
Outstanding
and
Exercisable
 
Weighted
Average
Remaining
Contractual
Life (Years)
 
Weighted
Average
Exercise
Price
$ 0.01—$ 3.50
130,000

 
4.00
 
$
3.49

$ 3.75—$ 4.82
1,069,340

 
1.60
 
4.45

$ 5.00—$ 8.03
539,005

 
2.23
 
5.40

$10.00—$10.00
100,000

 
4.00
 
10.00


1,838,345

 
2.09
 
$
4.97

Aggregate intrinsic value on September 29, 2012
$
37,641

 

 

As of September 29, 2012, the Company had a warrant outstanding to purchase 200,000 shares of the Company’s stock at $3.49. The warrant became fully vested as of June 30, 2012.
Non-Vested Restricted Common Stock
A summary of the activity for non-vested restricted common stock awards as of September 29, 2012 and changes during the nine month period is presented below:
 
Shares
 
Weighted
Average
Grant
Fair
Value
Balance, December 31, 2011
2,897,682

 
$
4.20

Granted
85,000

 
3.60

Forfeited
(23,566
)
 
4.36

Vested
(78,000
)
 
3.54

Balance, September 29, 2012
2,881,116

 
$
4.20


14


Stock-Based Compensation
The following table summarizes stock-based compensation expense within each of the categories below as it relates to non-vested restricted common stock awards for the nine months ended September 29, 2012 and September 24, 2011 (no tax benefits were recognized):
 
Nine Months Ended
 
September 29,
2012
 
September 24,
2011
Cost of product revenues
$
390,702

 
$
432,816

Research and development
271,297

 
417,698

Selling, general and administrative
3,111,307

 
1,326,306

Total
$
3,773,306

 
$
2,176,820

Total unrecognized compensation expense for non-vested restricted common stock as of September 29, 2012 totals $5.5 million and is expected to be recognized over a weighted average period of 2 years.
7. OTHER ASSETS AND AMOUNTS DUE TO / FROM AFFILIATES
Marketable Equity Securities
As of September 29, 2012 and December 31, 2011, the Company had an investment in AWSC, with a fair market value of $2.2 million and $1.6 million, respectively and an adjusted cost basis of $0.7 million and $0.7 million, respectively. One of the Company’s directors is a director of AWSC and several directors and officers own amounts ranging from 0.1% to 0.5% of the outstanding stock of AWSC.
As of September 29, 2012 and December 31, 2011, the Company had an investment in WIN, with a fair market value of $1.6 million and $1.7 million, respectively. The adjusted cost basis of the WIN investment is $0. In the nine month period ended September 29, 2012 the Company sold 500,000 shares of WIN and recorded a gain of $0.9 million.
AWSC and WIN are listed on the Gre Tai Securities Exchange in Taiwan. The Company determines the fair market value of these investments based on the quoted prices from this exchange.
Non-Marketable Securities—Equity Method Investments
The Company has an approximate 12% interest in KoBrite at September 29, 2012. The Company accounts for its interest using the equity method and at September 29, 2012 the carrying value of the investment was $1.9 million. One of the Company’s directors, who is the chairman of KTC, is a member of the Board of Directors of Bright LED, one of the other principal investors of KoBrite.
During the period ended March 31, 2012 the Company acquired a 25% interest in Ikanos, a private company, for $0.7 million and subsequent to June 30, 2012 invested an additional $2.5 million, which increased the Company’s interest in Ikanos to 51%. For the period ended June 30, 2012 the Company recorded the results of operation of Ikanos on the equity method of accounting and commencing in the third quarter of 2012 the Company consolidated Ikanos.
Summarized financial information for KoBrite for the three and nine month periods ended June 30, 2012 and June 25, 2011 (KoBrite’s results are recorded one quarter in arrears) and Ikanos for the nine month period ended September 29, 2012 are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 29,
2012
 
September 24,
2011
 
September 29,
2012
 
September 24,
2011
Revenue
$
1,599,000

 
$
2,883,000

 
$
4,517,000

 
$
5,172,000

Gross margin
(1,343,000
)
 
(52,000
)
 
(2,228,000
)
 
(451,000
)
Loss from operations
(1,751,000
)
 
(595,000
)
 
(4,034,000
)
 
(1,849,000
)
Net loss
$
(1,723,000
)
 
$
(423,000
)
 
$
(4,566,000
)
 
$
(1,737,000
)

15


During the nine month period ended September 29, 2012, the Company acquired a 5% interest in a private company for $1.0 million. If the private company achieves certain development milestones, the Company is obligated to acquire up to an additional 17.5% interest in the private company for a total of $2.0 million. In addition, for an eight month period after the achievement of all of the development milestones, the Company has the right to acquire an additional 10% interest in the private company for $2.0 million or the private company can require the Company to purchase an additional 25% interest for $2.0 million.
Amounts Due from and Due to Affiliates
Related party receivables from AWSC approximated $1.9 million and $1.1 million at September 29, 2012 and December 31, 2011, respectively. At September 29, 2012 and December 31, 2011 the Company also had $0.2 million and $0.2 million, respectively, due from other related parties.
The Company has entered into an agreement wherein it agreed to sell certain of its patents that it was no longer using to a party who would attempt to sublicense the patents. Under the terms of the agreement the amount the Company would receive for the sale of the patents was a percentage of any license fees, after expenses, from the sublicense. In the three and nine months ended September 29, 2012 and September 24, 2011 the Company recorded $0 million and $0.2 million of gains, respectively, from the sale of these patents.
8. ACQUISITION OF IKANOS
On July 10, 2012, the Company purchased an additional 70,748 newly issued shares of Ikanos common stock for approximately $2,500,000, from Ikanos (the “Transaction”). As a result of this transaction and the Company's previous investment in Ikanos, the Company owns approximately 51% of the now outstanding common stock of Ikanos. The remaining 49% is held by other investors and employees of Ikanos. The Company began consolidating Ikanos on July 1, 2012.
The total purchase price was $2,581,000 and is comprised of:
Cash consideration
$
2,500,000

Fair market value of Kopin's previously held equity method investment in Ikanos
81,000

Total purchase price
$
2,581,000

The preliminary allocation of the purchase price is as follows:
Cash and equivalents
$
2,594,000

Accounts receivable
167,000

Property, plant and equipment
277,000

Goodwill
1,141,000

Other identifiable assets
111,000

Identifiable liabilities
(325,000
)
Noncontrolling interest in Ikanos
(1,384,000
)
Total
$
2,581,000

The allocation of purchase price is preliminary as the Company is finalizing the value of assets acquired, including the identification of intangible assets acquired.
The Company remeasured and wrote down its investment in Ikanos by approximately $558,000 within the statement of operations which represented the fair market value of the investment immediately prior to the Transaction.
The following supplemental pro forma disclosures are provided for the nine months ended September 29, 2012, assuming the acquisition of the controlling interest in Ikanos had occurred as January 1, 2012 (the first day of the Company's 2012 fiscal year), and for the nine months ended September 24, 2011, assuming the acquisition of the controlling interest in Ikanos had occurred as December 26, 2010 (the first day of the Company's 2011 fiscal year). All intercompany transactions have been eliminated.

16


 
Nine Months
Ended
September 29, 
 
Nine Months
Ended
September 24,
 
2012
 
2011
Revenues
$
70,120,000

 
$
96,566,000

Net (loss) income
(15,484,000
)
 
3,068,000

9. GOODWILL AND INTANGIBLES
The Company’s goodwill balance is as follows:
 
 
Goodwill, December 31, 2011
$
1,664,457

Acquisition of Ikanos
1,140,787

Impairment of goodwill
(1,704,770
)
Foreign currency translation
40,313

Goodwill, September 29, 2012
$
1,140,787

As of June 30, 2012, the Company performed an interim impairment analysis of its finite-lived intangible assets and goodwill balance related to its wholly-owned subsidiary Forth Dimension Displays, Ltd (FDD), as FDD’s actual results were less than originally forecast for the six month period. The Company performed its analysis of its finite-lived intangible assets based on a comparison of the undiscounted cash flows to the recorded carrying value of the intangible assets. As a result, there was no change in the carrying values of the finite-lived intangible assets.
After completing its finite-lived intangible asset impairment test, the Company completed its impairment analysis of the goodwill derived from the FDD acquisition and determined the goodwill was impaired. The Company’s impairment analysis for goodwill consisted of comparing the implied fair value of goodwill to its carrying value as of June 30, 2012. Determining the fair value of goodwill required determining the fair value of the FDD reporting unit using certain assumptions, including the consideration of two generally accepted valuation methodologies: (i) the income approach and (ii) the market approach. The income approach is based upon the present value of the expected income that can be generated through the ownership of the property. The market approach is a process by which the market value estimate is derived analyzing similar assets that have been recently sold or licensed and then comparing them to the subject. The Company concluded that, given the size of FDD and it’s relatively niche business, the income approach provided the most accurate method of valuation.
Based on this analysis, the Company recorded a $1.7 million goodwill impairment charge as of and for the nine month period ended September 29, 2012.
The discount rate used was the value-weighted average of the Company’s estimated cost of equity and debt (“cost of capital”) derived using both known and estimated customary market metrics.
The identified intangible assets will be amortized on a straight-line basis over the following lives:
 
 
 
Years
Customer relationships
7
Developed technology
7
Trademark portfolio
7
The Company recognized $0.1 million and $0.2 million in amortization for the three and nine months ended September 29, 2012, respectively, related to its intangible assets.
Customer relationships represent the fair value of the underlying relationships and agreements with FDD customers. Developed technology represents the fair value of FDD’s technology as it exists in current products and has value through its continued use or reuse. The trademark represents the brand and name recognition associated with the marketing of FDD products and was determined to have a finite life.

17


10. ACCRUED WARRANTY
The Company warrants its products against defect for 12 months. A provision for estimated future costs and estimated returns for credit relating to warranty is recorded in the period when product is shipped and revenue recognized, and is updated as additional information becomes available. The Company’s estimate of future costs to satisfy warranty obligations is based primarily on historical warranty expense experienced and a provision for potential future product failures. Changes in the accrued warranty for the nine month period ended September 29, 2012 are as follows:
 
 
Beginning Balance, December 31, 2011
$
1,318,000

Additions
1,544,000

Claim and reversals
(1,847,000
)
Ending Balance, September 29, 2012
$
1,015,000

11. INCOME TAXES
The Company’s tax provision of approximately $470,500 and $1,335,500 for the three and nine months ended September 29, 2012, respectively, and $98,000 and $293,000 for the corresponding periods in 2011, represents state income taxes and foreign tax expenses, which are partially offset by tax credits.
As of September 29, 2012, the Company has available for tax purposes U.S. federal NOLs of $22.1 million expiring through 2032. The Company has recognized a full valuation allowance on its domestic and certain foreign net deferred tax assets due to the uncertainty of realization of such assets. The Company has not historically recorded, nor does it intend to record the tax benefits from stock awards until realized. Unrecorded benefits from stock awards approximate $13.1 million.
The Company’s income tax returns have not been examined by the Internal Revenue Service and are subject to examination for all years since 2002. State income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective return. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states.
12. SEGMENTS AND GEOGRAPHICAL INFORMATION
The Company’s chief operating decision maker is its Chief Executive Officer. The Company’s chief operating decision maker evaluates the operating results of the Company’s reportable segments based on revenues and net (loss) income attributable to the controlling interest.

18


The Company has four operating and reporting segments: (i) Kopin U.S., which includes the operations in the United States, the Company’s equity method investments and Ikanos, (ii) Kowon, (iii) KTC and (iv) Forth Dimension Displays, Ltd. The following table presents the Company’s reportable segment results for the three and nine month periods ended September 29, 2012 and September 24, 2011 (in thousands):
 
Kopin U.S.
 
Kowon
 
KTC
 
FDD
 
Adjustments
 
Total
Three Months Ended
 
 
 
 
 
 
 
 
 
 
 
September 29, 2012
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
21,224

 
$
1,415

 
$
7,429

 
$
716

 
$
(8,844
)
 
$
21,940

Net (loss) income attributable to the controlling interest
(7,349
)
 
(465
)
 
1,230

 
(482
)
 
344

 
(6,722
)
September 24, 2011
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
28,038

 
$
2,734

 
$
5,892

 
$
1,492

 
$
(8,590
)
 
$
29,566

Net income (loss) attributable to the controlling interest
2

 
797

 
135

 
(593
)
 
(184
)
 
157

Nine Months Ended
 
 
 
 
 
 
 
 
 
 
 
September 29, 2012
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
68,124

 
$
4,193

 
$
24,907

 
$
1,912

 
$
(29,100
)
 
$
70,036

Net (loss) income attributable to the controlling interest
(14,387
)
 
(639
)
 
3,894

 
(3,528
)
 
160

 
(14,500
)
September 24, 2011
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
91,838

 
$
7,927

 
$
12,232

 
$
4,014

 
$
(20,079
)
 
$
95,932

Net income (loss) attributable to the controlling interest
3,707

 
305

 
627

 
(1,492
)
 
(119
)
 
3,028

The adjustments to reconcile the consolidated financial statement total revenue and net (loss) income include the elimination of intercompany sales and noncontrolling interest in income of subsidiaries.
During the three and nine month periods ended September 29, 2012 and September 24, 2011, the Company derived its sales from the following geographies (as a percentage of net revenues):
 
Three Months Ended
 
Nine Months Ended
 
September 29, 2012
 
September 24, 2011
 
September 29, 2012
 
September 24, 2011
Asia-Pacific
26
%
 
19
%
 
22
%
 
21
%
Americas
72
%
 
79
%
 
76
%
 
78
%
Europe
2
%
 
2
%
 
2
%
 
1
%
Total Revenues
100
%
 
100
%
 
100
%
 
100
%
During the three and nine periods ended September 29, 2012 and September 24, 2011, revenues by product group consisted of approximately the following:
 
Three Months Ended
 
Nine Months Ended
 
September 29, 2012
 
September 24, 2011
 
September 29, 2012
 
September 24, 2011
Display
$
8,190,000

 
$
14,063,000

 
$
26,068,000

 
$
46,861,000

III-V
13,750,000

 
15,503,000

 
43,968,000

 
49,071,000

Total Revenues
$
21,940,000

 
$
29,566,000

 
$
70,036,000

 
$
95,932,000

13. LITIGATION
The Company may engage in legal proceedings arising in the ordinary course of business. Claims, suits, investigations and proceedings are inherently uncertain and it is not possible to predict the ultimate outcome of such matters and our business, financial condition, results of operations or cash flows could be affected in any particular period.
 

19


Item 2:
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995, including, without limitation, statements made relating to our expectation that sales to Skyworks Solutions and the customers who use our displays for military applications will represent a significant portion of our revenues for 2012; our expectation that we will continue developing HBT transistor wafers and other gallium arsenide products for advanced integrated circuit applications from other compound materials; our expectation that we will continue to pursue other U.S. government development contracts for applications that relate to our commercial product applications; our expectation that sales of our display products for consumer electronic applications will decline; our expectation that we will prosecute and defend our proprietary technology aggressively; our belief that it is important to invest in research and development to remain profitable even during periods when we are not profitable; our belief that we are a leading developer and manufacturer of advanced semiconductor materials and miniature displays; our belief that our products enable our customers to develop and market an improved generation of products; our belief that there will be increased sales of 3G, 4G and smart phones in 2012; our statement that we may make equity investments in companies; our expectation that KoBrite will incur additional losses in the near term; our expectation that revenue will be between $90 million and $95 million for 2012; our expectation that 2012 revenues will primarily be to customers located in the U.S.; our expectation that our revenues from sales of defense related products to the U.S. government will decline approximately $20 million to $30 million in 2012 as a result of the U.S. government's expected reduction in spending on military programs; our belief that we will see a reduction in revenues from the sale of our military products in 2012; our belief that a strengthening of the U.S. dollar could increase the price of our products in foreign markets; our expectation that a manufacturing/distribution partner will commence selling Golden-i products in 2012; our belief that revenue will not be significant in 2012 from sales of Golden-i products; our belief that in successive years products such as Golden-i will be important for our revenue growth and ability to achieve profitability; our expectation that we will not receive additional amounts from the sale of patents; our expectation that our CyberDisplay products will benefit from further general technological advances in the design and production of integrated circuits and active matrix LCDs, resulting in further improvements in resolution and miniaturization; our expectation that a significant reduction or delay in orders from any of our significant military customers could result in us not being able to achieve profitability in 2012; our belief that our HBT transistor wafers offer greater power efficiency, improved signal quality and less complexity over gallium arsenide field effect transistors; our belief that our manufacturing process offers greater miniaturization, reduced cost, higher pixel density, full color capability and lower power consumption compared to conventional active matrix LCD manufacturing approaches; our expectation not to pay cash dividends for the foreseeable future and to retain earnings for the development of our businesses; our expectation, based on current negotiations with our customers and certain contractual obligations, that the sales prices of certain products will decline in fiscal year 2012; our plan to base production and inventory levels based on internal forecasts of customer demands; our belief that the overall increase or decrease in the average sales price of our display products will be dependent on the sales mix of commercial and military display sales; our belief that market risk associated with our international operations is unlikely to have a material adverse effect on our business, financial condition or results of operation; our expectation that we will expend between $5.0 million and $8.0 million on capital expenditures over the next twelve months; our intent to reduce our per unit production costs primarily through increasing manufacturing yield, lowering fixed costs per unit through increased sales volume, and increasing productivity and efficiency; our expectation that the market for display products for military applications will not be seasonal; our expectation that prices of our HBT transistor and display products sold for consumer electronic applications will decline by approximately 5 to 8 percent during fiscal year 2012, but may decline more depending on final negotiations with our customers; our expectation that competition will increase; our belief that our CyberDisplay products are well suited for new applications such as reading e-mail and browsing the Internet using digital wireless devices and other consumer electronics devices; our belief that small form factor displays will be a critical component in the development of advanced wireless communications systems; our belief that general technological advances in the design and fabrication of integrated circuits, LCD technology and LCD manufacturing processes will allow us to continue to enhance our CyberDisplay product manufacturing process; our expectation that a significant market for new wireless communication devices, including personal entertainment systems, will develop; our belief that continued introduction of new products in our target markets is essential to our growth; our belief that our future success will depend primarily upon the technical expertise, creative skills and management abilities of our officers and key employees rather than on patent ownership; our belief that our available cash resources will support our operations and capital needs for at least the next twelve months; and our belief that the effect, if any, of reasonably possible near-term changes in interest rates on our financial position, results of operations, and cash flows should not be material. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industries in which we operate, management's beliefs, and assumptions made by management. In addition, other written or oral statements, which constitute forward-looking statements, may be made by or on behalf of us. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “could”, “seeks”, “estimates”, and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed

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or forecasted in such forward-looking statements, whether as a result of new information, future events or otherwise. Factors that could cause or contribute to such differences in outcomes and results include, but are not limited to, those discussed below in Item 1A and those set forth in our other periodic filings filed with the Securities and Exchange Commission.

Critical Accounting Policies
Management's discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. We continually evaluate our estimates used in the preparation of our financial statements, including those related to revenue recognition under the percentage of completion method, bad debts, inventories, warranty reserves, investment valuations, valuation of stock compensation awards and recoverability of deferred tax assets. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not apparent from other sources. Actual results will most likely differ from these estimates. Further detail regarding our critical accounting policies can be found in “Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2011.
Business Matters
We are a leading developer and manufacturer of advanced semiconductor products and miniature displays. We use our proprietary semiconductor material technology to design, manufacture and sell our III-V and display products for use in highly demanding commercial, industrial and military markets for use in mobile wireless communication and consumer electronic applications that include high resolution displays.
We have two principal sources of revenues: product revenues and research and development (R&D) revenues. Product revenues consist of sales of our display products and our III-V products, principally gallium arsenide (GaAs) HBT transistor wafers. R&D revenues consist primarily of development contracts with agencies of the U.S. government. For the three and nine months ended September 29, 2012, R&D revenues were $0.9 million and $2.6 million or 4% of total revenues, respectively. This contrasted with $1.1 million and $4.9 million or 5% of total revenues, respectively for the corresponding period in 2011.
 Results of Operations
The three and nine month periods ended September 29, 2012 and September 24, 2011 are referred to as 2012 and 2011, respectively. The year ended period December 31, 2011 is referred to as fiscal year 2011.
Revenues. For the three and nine month periods ended September 29, 2012 and September 24, 2011, our revenues, which include product sales and amounts earned from research and development contracts, were as follows (in millions):
 
Three Months Ended
 
Nine Months Ended
Revenues (in millions):
September 29, 2012
 
September 24, 2011
 
September 29, 2012
 
September 24, 2011
Display
$
8.2

 
$
14.1

 
$
26.0

 
$
46.8

III-V
13.7

 
15.5

 
44.0

 
49.1

Total revenues
$
21.9

 
$
29.6

 
$
70.0

 
$
95.9

The decrease in display revenues for the three month period ended September 29, 2012 compared to the same period in 2011 resulted from a decrease in sales of our display products to customers that use them for military applications, consumer electronic applications and R&D programs.
The decrease in our III-V revenues for the nine month period ended September 29, 2012 as compared to the same period in 2011 resulted primarily from a decrease in demand from customers who purchase our HBT transistor wafers for use in cellular handsets.
In July 2012, we acquired a 51% interest in Ikanos Consulting Ltd. (Ikanos), a software development company. Commencing in July 2012, we consolidated the financial position and results of operations of Ikanos into our results. Ikanos's revenues for the three months ended September 29, 2012 were deminimis.

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Display revenues for military, consumer and R&D applications for 2012 and 2011 were as follows:
 
Three Months Ended
 
Nine Months Ended
Display Revenues by Category (in millions )
September 29, 2012
 
September 24, 2011
 
September 29, 2012
 
September 24, 2011
Military Application
$
4.3

 
$
7.3

 
$
15.0

 
$
27.5

Consumer Electronic Applications
3.0

 
5.8

 
8.8

 
14.7

Research & Development
0.9

 
1.0

 
2.2

 
4.6

Total
$
8.2

 
$
14.1

 
$
26.0

 
$
46.8

Sales of our products for military applications declined in 2012 because of reduced demand from the U.S. government. In addition to the reduced demand from the U.S. government our customers are reviewing ways to reduce their costs. Among the methods our customers are evaluating to reduce costs are doing more of the final unit assembly in-house, redesigning the unit with lower cost components, adjusting the delivery schedule of purchases to maximize economies from bulk purchases and requesting lower prices from vendors. As a result of the factors above our ability to forecast 2012 military revenues has declined as compared to prior years, but we do anticipate a reduction in revenues from the sale of our military products in 2012 by approximately $20 million to $30 million. In 2012, the U.S. government awarded the contract for next generation thermal weapon sights to one of our existing customers. Previously three of our customers supplied thermal weapon sights with our products incorporated in them to the U.S. government. The customer that was awarded the next generation contract has indicated that they anticipate building the unit which we sold them internally. For 2013 we may receive orders for the products we sold that were incorporated in the legacy models of thermal weapon sights. Our military products have higher profit margins than our other display products and have been a significant contributor to our overall profitability for the pasts several years.
The decrease in the Consumer Electronic Applications category is the result of a decrease in sales of our products for digital still cameras. Our ability to forecast our revenues in this category is very difficult as sales of our product ultimately depend on how successful our customers are in promoting their digital still cameras models and the trends in the overall digital still camera market. There are many digital still camera models offered by a number of large consumer electronics companies and it is a very competitive product category. In addition we typically rebid to win this business each year. The future trends of the digital still camera market are difficult to predict. Advanced wireless handsets, or smartphones, are offering higher resolution cameras within the handset and we believe this is reducing demand for low and mid-range digital still cameras. The customers for our eyewear products tend to be smaller companies and the economic down turn during the recent years has affected their ability to obtain credit with which to purchase our products.
The decrease in R&D revenue is the result of a decrease in funding from the U.S. government. We are unable to predict the amount of funding for R&D by the U.S. government as it addresses its fiscal deficit issues.
In 2011, we began offering a headworn hands-free cloud computing system with an optical pod that has a microdisplay which we refer to as the Golden-i system. Sales of Golden-i systems in 2012 and 2011 have been deminimis and were primarily to demonstrate the system capabilities for software and product developers. We have entered into an agreement to license the Golden-i technology and know-how to a company that has developed an industrialized product which they introduced in October 2012. The license agreement is exclusive for the industrial market, non-exclusive for certain other markets and prohibits sales to certain markets. Under the terms of the license we will also sell an optical pod which includes our display, optics and a back light. We do not believe Golden-i system related revenue will be significant in 2012 but we do believe in successive years that revenues from Golden-i related agreements will be important for our revenue growth and ability to achieve profitability. An important element in the successful adoption of the Golden-i system will be the development of application software by third parties in order to enable potential customers to utilize Golden-i's capabilities. This is the first product that we have developed that has a significant software component.
There are a number of different display technologies which can produce displays in small form factors. Consumer electronic customers primarily choose displays based on cost which has resulted in low margins on a per unit basis and therefore profitability is based on achieving sufficient volume. With the declining demand for displays by the military, our focus has shifted to creating products based on our Golden-i technologies. Our future success will be very dependent on our ability to commercialize our Golden-i technologies. We also anticipate, based on current discussions with our customers and certain contractual obligations that the prices of certain of our products will decline in fiscal year 2012. We anticipate the average selling price of our HBT transistor wafers and display products sold to customers for consumer electronics applications will decline approximately 5% to 8% during fiscal year 2012 relative to 2011and may continue to decline in 2013. We expect sales prices of our display products for military applications to remain relatively flat for 2012 as compared to 2011. The overall increase or decrease in the average sales price of our display products will be dependent on the sales mix of commercial and military displays.

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Our 2012 revenue expectation is $90 million to $95 million. However due to the current worldwide economic situation our ability to forecast revenues and results of operations is very limited. Our forecasts are based on numerous factors, including our discussions with customers and our expectations about the future global economy and are not based on firm non-cancellable orders. Our forecasts are also subject to the risk factors set forth in our Quarterly Reports on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2011.
International sales represented 24% and 22% of revenues for the nine months ended September 29, 2012 and September 24, 2011, respectively. The increase in international sales is primarily attributable to an increase in sales of our III-V products to customers who sell components to manufacturers of wireless handsets. We expect our 2012 revenues will primarily be from customers located in the U.S. International sales are primarily sales of display products to consumer electronics manufacturers located in Japan, Korea and China. Our international sales are primarily denominated in U.S. dollars. Consequently, a strengthening of the U.S. dollar could increase the price in local currencies of our products in foreign markets and make our products relatively more expensive than competitors' products that are denominated in local currencies, leading to a reduction in sales or profitability in those foreign markets. In addition, sales of our III-V products in Taiwan and display products in Korea are transacted through our Taiwanese subsidiary, Kopin Taiwan Corporation, and our Korean subsidiary, Kowon Technology Co., LTD, respectively. KTC and Kowon's sales are primarily denominated in U.S. dollars. However, KTC and Kowon's local operating costs are primarily denominated in Taiwan dollars and Korean won, respectively. KTC and Kowon also hold U.S. dollars in order to pay various expenses. As a result, our financial position and results of operations are subject to exchange rate fluctuation in transactional and functional currency. We have not taken any protective measures against exchange rate fluctuations, such as purchasing hedging instruments with respect to such fluctuations, because of the historically stable exchange rate between the Taiwan dollar, Japanese yen, Korean won and the U.S. dollar.

Cost of Product Revenue
 
Three Months Ended
 
Nine Months Ended
Cost of product revenues:
September 29, 2012
 
September 24, 2011
 
September 29, 2012
 
September 24, 2011
Cost of product revenues (in millions):
$
15.8

 
$
19.8

 
$
49.7

 
$
60.8

Cost of product revenues as a % of net product revenues
75.4
%
 
69.3
%
 
73.7
%
 
66.8
%
Cost of product revenues, which is comprised of materials, labor and manufacturing overhead related to the production of our products increased as a percentage of sales in 2012 as compared to 2011 because of a decline in sales of our display products for military applications and price declines in our III-V products. Our military products have higher gross margins as compared to our total company gross margins. Our gross margin is affected by increases or decreases in the sales prices of our products, changes in raw material prices, unit volume of sales, manufacturing efficiencies and the mix of products sold. As discussed above our sales prices historically decline on an annual basis. Our overhead costs and, to a lesser extent, our labor costs are normally stable and do not fluctuate significantly during any twelve month period. Essentially, we consider labor and overhead costs to be fixed in nature over the short term and therefore profitability is very dependent on the sales prices of our products and the volume of sales. For the remainder of 2012, we anticipate sale prices of display products for military applications to remain stable and sales prices of our III-V products for wireless handset applications and our displays products for consumer electronic applications to decline. As a result, in order for us to increase gross margins we need to increase manufacturing efficiencies and/or increase the unit volume of sales.
Research and Development. R&D expenses are incurred in support of internal display, Golden-i system and III-V product development programs or programs funded by agencies or prime contractors of the U.S. government and commercial partners. R&D revenues associated with funded programs are presented separately in revenue in the statement of operations. R&D costs include staffing, purchases of materials and laboratory supplies, circuit design costs, fabrication and packaging of display products, and overhead. For 2012 and 2011, R&D expense was as follows:
 
Three Months Ended
 
Nine Months Ended
Research and development expense (in millions):
September 29, 2012
 
September 24, 2011
 
September 29, 2012
 
September 24, 2011
Funded
$
0.6

 
$
0.8

 
$
1.6

 
$
3.3

Internal
5.8

 
5.6

 
14.9

 
16.6

Total research and development expense
$
6.4

 
$
6.4

 
$
16.5

 
$
19.9


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Funded R&D expense decreased in 2012 as compared to the prior year primarily because of a decrease in funded programs from agencies and prime contractors of the U.S. government.
In comparing internal R&D expenses for the three months ended September 29, 2012 to the corresponding period in 2011, we incurred increased costs for the development of our head worn cloud-computing Golden-i product and expenses of approximately $0.6 million incurred by Ikanos., which were offset by lower costs incurred to qualify our III-V operations in Taiwan.
Selling, General and Administrative. Selling, general and administrative (S,G&A) expenses consist of the expenses incurred by our sales and marketing personnel and related expenses, and administrative and general corporate expenses.
 
Three Months Ended
 
Nine Months Ended
 
September 29, 2012
 
September 24, 2011
 
September 29, 2012
 
September 24, 2011
Selling, general and administration expense (in millions):
$
5.5

 
$
4.4

 
$
15.6

 
$
13.5

Selling, general and administration expense as a % of revenues
24.9
%
 
14.7
%
 
22.3
%
 
14.1
%
S,G&A expenses increased in the nine months of 2012 as compared to 2011 because of increases in compensation costs and depreciation partially offset by a decrease in warranty expense. In the third quarter of 2011 we granted compensation awards that contain a market condition. The accounting for the phantom stock award requires us to continually assess the fair market value of the award, with increases or decrease in the fair market value being reflected in the statement of operations over the derived service period or when the market condition is achieved.
Impairment. During the six months ended June 30, 2012, we had performed a review of intangible assets and goodwill. As a result of this review we recorded a non-cash charge of $1.7 million to write down the remaining carrying value of the goodwill to zero. FDD produces a very high resolution micro display for niche markets. The majority of its current and forecasted revenues are derived from a small group of customers (less than 10). If FDD loses any of its significant customers, or the products which it is projecting to provide significant revenue in the future fail to meet expectations and are not complimented by other revenue sources, additional impairment charges may be necessary to the remaining intangible assets. We did not identify any additional impairment charges for the three month period ended September 29, 2012.

Other Income and Expense
 
Three Months Ended
 
Nine Months Ended
 
September 29, 2012
 
September 24, 2011
 
September 29, 2012
 
September 24, 2011
Other income and expense (in millions):
$
(0.6
)
 
$
1.4

 
$
0.8

 
$
1.9

Other income and expense, net, is composed of interest income, foreign currency transaction and remeasurement gains and losses incurred by our Korean, Taiwanese and UK-based subsidiaries, other-than temporary impairment on marketable debt securities, gains resulting from the sale of investments and license fees. For the three months ended September 29, 2012 we recorded $0.6 million of foreign currency losses as compared to $1.0 million of foreign currency gains for the three months ended September 24, 2011. For the three and nine month periods ended September 29, 2012 we recorded a loss on acquisition of Ikanos of $0.6 million. For the nine months ended September 29, 2012 we recorded $0.7 million of foreign currency losses as compared to $0.4 million of foreign currency gains for the nine months ended September 24, 2011. In the nine months ended September 29, 2012 and September 24, 2011 we recorded gains of $0.9 million and $0.4 million respectively, on the sale of investments.
Equity Losses in Unconsolidated Affiliates. For the three months ended September 29, 2012, the equity losses in unconsolidated affiliates consists of our approximate 12% share of the losses of KoBrite. For the nine months ended September 29, 2012 the equity losses in unconsolidated affiliates consists of our approximate 12% share of the losses of KoBrite and our 25% share of the losses of Ikanos. In July of 2012 we increased our investment in Ikanos to 51% and commenced consolidating Ikanos's results of operation into our results of operations. Accordingly the equity losses in unconsolidated affiliates includes our equity losses of Ikanos from February 2012 through June 2012. For the three and nine months ended September 24, 2011, the equity loss is a result of our approximate 12% interest in the operating results of KoBrite.

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Tax provision. For the three and nine months ended September 29, 2012 we recorded a tax provision of $470,500 and $1,335,500 respectively, compared to provisions of $98,000 and $293,000 for the three and nine months ended September 24, 2011. Our provision for income taxes is comprised of our estimated state income tax liabilities on our domestic taxable earnings and estimated foreign taxes due on our Korean, Taiwanese and UK-based subsidiaries' taxable earnings.
Net income attributable to noncontrolling interest. We own approximately 78% of the equity of Kowon, approximately 90% of the equity of KTC, and in the three month period ended September 29, 2012 acquired a 51% interest in Ikano. Net (loss) income attributable to noncontrolling interest on our consolidated statement of operations represents the portion of the results of operations of our majority owned subsidiaries which is allocated to the shareholders of the equity interests not owned by us. The change in net (loss) attributable to noncontrolling interest is the result of the change in the results of operations of Kowon, KTC and Ikanos.

Liquidity and Capital Resources
As of September 29, 2012, we had cash and equivalents and marketable securities of $94.5 million and working capital of $110.4 million compared to $105.4 million and $123.3 million, respectively, as of December 31, 2011. The change in cash and equivalents and marketable securities was primarily due to cash provided by operating activities of $1.5 million, investments in capital equipment of $8.5 million and the repurchase of our common stock of $3.5 million, partially offset by proceeds from the sale of WIN stock of $0.9 million.
Cash and marketable debt securities held in U.S. dollars
 
 
Domestic
$
75,643,686

Foreign
14,461,671

Subtotal cash and marketable debt securities
90,105,357

Cash and marketable debt securities held in other currencies and converted to U.S. dollars
4,431,878

Total cash and marketable debt securities
$
94,537,235

We have no plans to repatriate the foreign cash and marketable debt securities and, as a result, we have not recorded any deferred tax liability.
We have a purchase and supply agreement with a significant III-V customer that expires in December 2013, excluding a last time buy option contained in the agreement. Under the terms of this agreement, we agreed to maintain capacity levels for manufacturing HBT wafers and we committed to a pricing schedule under certain circumstances. The agreement also requires us to give prior notice if we exit our HBT product line. In consideration for this agreement, the customer agreed to source a certain percentage of its HBT wafer needs from us subject to the customer's right to source HBT wafers from other sources if we are unable to meet their requirements under certain circumstances. We agreed that failure to meet our supply obligations under the agreement would allow our customer to obtain court-ordered specific performance and if we do not perform we could be liable for monetary damages up to a maximum of $40.0 million. To date we have met our commitments under the agreement.
We lease facilities located in Taunton and Westborough, Massachusetts, Scotts Valley, California, and Dalgety Bay, Scotland under non-cancelable operating leases. We have two Taunton facilities whose leases expire in 2012 and 2020. The Taunton lease which expires in 2020 may be extended for an additional 10 year term. The Westborough, Scotts Valley and Dalgety Bay leases expire in 2023, 2012, and 2013, respectively.
We expect to expend between $5.0 million and $8.0 million on capital expenditures over the next twelve months, primarily for the acquisition of equipment relating to the production of our III-V and display products.
We have entered into product development agreements with two companies under which we have agreed to fund up to $4.0 million of development expenses if certain milestones are achieved. It is anticipated that the milestones would be achieved in fiscal year 2012.
Included in the $2.2 million of billings in excess of revenue earned on the consolidated balance sheet at September 29, 2012 is approximately $1.3 million which we received from the state of Massachusetts as an incentive to retain jobs in Massachusetts. We earn amounts under the agreement by meeting certain employment milestones each year and amounts not earned will be repaid to the state of Massachusetts at the end of the agreement in 2017. The agreement also contains repayment

25


provisions which require us to repay certain amounts back to the state of Massachusetts if we fail to achieve certain employment milestones after years three and five of the agreement, or if we move certain parts of our operations out of the state. We paid the $1.3 million to the state of Massachusetts in October 2012.
As of September 29, 2012, we had tax loss carry-forwards, which may be used to offset future federal taxable income. We may record a tax provision in our financial statements but we may be able to offset some or all of the amounts that are payable with our tax loss carry-forwards We may be subject to alternative minimum taxes, foreign taxes and state income taxes depending on our taxable income and sources of taxable income.
Historically we have financed our operations primarily through public and private placements of our equity securities. Over the past several years we have generated sufficient cash from operations to fund the business. We believe our available cash resources will support our operations and capital needs for at least the next twelve months.
Seasonality
There has been no seasonal pattern to our sales in fiscal years 2012 and 2011.
Contractual Obligations
The following is a summary of our contractual payment obligations for operating leases as of September 29, 2012:
Contractual Obligations
Total
 
Less than 1 year
 
1-3 Years
 
3-5 years
 
More than 5 years
Operating Lease Obligations