Date: 3/5/2021 Form: 10-K - Annual Report
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

 

FORM 10-K

 

X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 26, 2020

 

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.)

 

125 North Drive, Westborough MA   01581-3335
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (508) 870-5959

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Trading Symbol(s)   Name of each exchange on which registered
Common Stock, par value $0.01   KOPN   Nasdaq Capital Market

 

Securities registered pursuant to Section 12(b) of the Act:

 

None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes X No ☐

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No X

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). X Yes ☐ No

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of "large accelerated filer,” "accelerated filer,” "smaller reporting company,” and emerging growth company in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer   Accelerated Filer X
Non-Accelerated Filer   Smaller Reporting Company X
      Emerging Growth Company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Yes ☐ No ☐

 

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. Yes X No ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yes No X

 

As of June 27, 2020 (the last business day of the registrant’s most recent second fiscal quarter), the aggregate market value of outstanding shares of voting stock held by non-affiliates of the registrant was $97,431,868.

 

As of March 1, 2021, 91,284,909 shares of the registrant’s Common Stock, par value $.01 per share, were issued and outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the definitive proxy statement relating to the registrant’s annual meeting of stockholders are incorporated by reference in response to Items 10, 11, 12, 13 and 14 of Part III of this Form 10-K.

 

 

 

 

 

   
 

 

INDEX

 

PART I    
Item 1. Business 3
Item 1A. Risk Factors 14
Item 1B. Unresolved Staff Comments 25
Item 2. Properties 25
Item 3. Legal Proceedings 25
Item 4. Mine Safety Disclosures 25
     
PART II    
Item 5. Market for Registrant’s Common Equity, Related stockholder Matters and Issuer Purchases of Equity Securities 26
Item 7. Management’s Discussion and Analysis 28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 39
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 39
Item 9A. Controls and Procedures 39
Item 9B. Other Information 40
     
PART III    
Item 10. Directors, Executive Officers and Corporate Governance 40
Item 11. Executive Compensation 40
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 40
Item 13. Certain Relationships and Related Transactions, and Director Independence 40
Item 14. Principal Accountant Fees and Services 40
     
Part IV    
Item 15. Exhibits and Financial Statement Schedules 41
Item 16. Form 10-K Summary 72
     
SIGNATURES 73

 

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Part I

 

Forward Looking Statements

 

 This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act”), which are subject to the safe harbor created by such sections. Words such as "expects,” "anticipates,” "intends,” "plans,” "believes,” "could,” "would,” "seeks,” "estimates,” and variations of such words and similar expressions, and the negatives thereof, are intended to identify such forward-looking statements. We caution readers not to place undue reliance on any such "forward-looking statements,” which speak only as of the date made, and advise readers that these forward-looking statements are not guarantees of future performance and involve certain risks, uncertainties, estimates, and assumptions by us that are difficult to predict. Various factors, some of which are beyond our control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements. All such forward-looking statements, whether written or oral, and whether made by us or on our behalf, are expressly qualified by these cautionary statements and any other cautionary statements which may accompany the forward-looking statements. In addition, we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of this report, except as may otherwise be required by the federal securities laws.

 

We have identified the following important factors that could cause actual results to differ materially from those discussed in our forward-looking statements. Such factors may be in addition to the risks described in Part I, Item 1A. "Risk Factors;” Part II, Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations;” and other parts of this Form 10-K. These factors include: our ability to continue as a going concern;; our expectation that some products that are currently in R&D to go into production; our expectation that our new products to start at lower yields and for us to improve these yields over time; our expectation that our 2021 cost of product revenues as a percentage of product revenues to be negatively affected by new products; our expectation that we will to incur significant development costs in fiscal year 2021 to develop OLED display products and defense products; our ability to obtain raw materials and other goods as well as services from our suppliers as needed; the potential for customers to choose our competitors as their supplier; our ability to prosecute and defend our proprietary technology aggressively or successfully; our ability to retain personnel with experience and expertise relevant to our business; our ability to invest in research and development to achieve profitability even during periods when we are not profitable; our ability to continue to introduce new products in our target markets; our ability to generate revenue growth and positive cash flow, and reach profitability; the strengthening of the U.S. dollar and its effects on the price of our products in foreign markets; the impact of new regulations and customer demands relating to conflict minerals; our ability to obtain a competitive advantage in the wearable technologies market through our extensive portfolio of patents, trade secrets and non-patented know-how; our ability to grow within our targeted markets; the importance of small form factor displays in the development of defense, consumer, and industrial products such as thermal weapon sights, safety equipment, virtual and augmented reality gaming, training and simulation products and metrology tools; the suitability of our properties for our needs for the foreseeable future; our expectation not to pay cash dividends for the foreseeable future and to retain earnings for the development of our businesses; our expectation that we will expend between $1.0 million and $2.0 million on capital expenditures over the next twelve months; if we do not soon achieve and maintain positive cash flow and profitability, our financial condition will ultimately be materially adversely affected, and we will be required to reduce expenses, including our investments in research and development or raise additional capital; our ability to support our operations and capital needs for at least the next twelve months through our available cash resources; our expectation that we will incur taxes based on our foreign operations in 2021; and our expectation that we will have a state tax provision in 2021.

 

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Item 1. Business

 

Overview

 

We were incorporated in Delaware in 1984 and are a leading developer and provider of high-resolution microdisplays, microdisplay subassemblies and related components for defense, enterprise, industrial, and consumer products. Our products are used for soldier, avionic, armored vehicle and training & simulation defense applications; industrial, public safety and medical headsets; 3D optical inspection systems; and consumer augmented reality ("AR”) and virtual reality ("VR”) wearable headsets systems.

 

Our primary current sources of product revenues are from the sale of display components and subassemblies for defense and industrial applications and development contracts primarily for U.S defense programs. In the future we believe we also are well-positioned with our technology and intellectual property, manufacturing capabilities and partnerships and reputation to take advantage of the emerging market for AR and VR applications and products from which microdisplays are the centerpiece technology. At the center of all of our products is a display. We are the only company, to our knowledge, that offers transmissive active-matrix liquid crystal displays (AMLCDs), reflective liquid crystal on silicon (LCOS) displays and organic light emitting diode (OLED), and related optics enabling us to serve the markets and customers based on their need and the problems they are trying to solve. We believe our display technologies combined with our extensive expertise in optics, system electronics and human factors, is the reason why many customers come to us.

 

The components we offer for sale consist of our proprietary miniature AMLCD, LCOS displays, OLED displays, application specific integrated circuits ("ASICs”), backlights, and optical lenses. We refer to our AMLCD as "CyberDisplay®,” our LCOS displays/Spatial Light Modulators (SLMs) as "Time Domain ImagingTM technology”, and our OLED as "Lightning® displays”. Our transmissive AMLCDs are designed in Westborough, Massachusetts, have initial manufacturing steps performed in Taiwan and then are completed in our facility in Westborough, Massachusetts.

 

Our AMLCD components are sold separately or in subassemblies. For example, we offer a display as a single product, a display module which includes a display, an optical lens and backlight contained in either plastic or metal housings, a binocular display module which has two displays, lenses and backlights, and a higher-level assembly which has additional components for defense applications. Examples of products manufactured by our customers that include our AMLCD components include:

 

  Weapon sights and target locators for soldiers to enable faster and more accurate target acquisition;
  Fighter pilot helmets that use our display to overlay information (targeting, plane operation, etc..) over the real world seen;
  Industrial headsets for applications such as field maintenance/service where a service worker can visually access diagrams and drawings in realtime while keeping both hands free to conduct work or access a remote expert with live video to help solve a problem remotely – thereby increasing productivity and effectiveness;
  Public safety devices such as firefighter masks which include our displays so that a firefighter may use the thermal imager to navigate a smoke-filled building; and
  AR and VR consumer products for recreational use including rifle sights.

 

Our LCOS products are designed and manufactured at our Forth Dimension Display (FDD) subsidiary in Dalgety Bay, Scotland. Our LCOS displays are often configured with drive electronics and sold as a package that makes it easier for our customers to design our displays into their end products. A significant portion of the FDD business is sold to customers for use in SLMs, which are used in manufacturing equipment for sophisticated 3D optical inspection.

 

Our OLED displays are designed in our San Jose, California facility and manufactured in Asia. Our displays provide either color or monochrome images and are offered in a variety of sizes and resolutions. The AMLCD display driver ASICs we offer are designed in our San Jose, California facility and are the electronic interfaces between our displays and the products into which the displays are incorporated. The optical lenses and backlights we offer are based on either our proprietary designs or design’s we license from third parties. The ASICs, optical lenses, and backlights are manufactured by third parties based on our purchase orders.

 

Our NVIS, Inc. ("NVIS”) subsidiary is a designer and manufacturer of defense and industrial head-mounted and hand-held VR products and training simulation defense equipment located in Reston, Virginia. Depending on the size of the order, NVIS’s products are either manufactured in its Reston, Virginia facility or by a contract manufacturer in the U.S.A. NVIS products allow customers to visualize and interact with simulated 3D environments and equipment for training purposes. Our customers develop high-fidelity training and simulation applications that require high-performance visuals, intuitive controls, and unsurpassed customer support. Some of NVIS’s products include our LCOS displays.

 

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We have designed systems that are focused on the emerging enterprise and consumer markets for head-worn, hands-free voice and gesture controlled wireless computing and communication devices. We recently reduced our investments in designing new systems, other than systems developed by our NVIS subsidiary, in order to focus on our display component business, in particular our OLED displays. However, we continue to license our previously designed systems under agreements that may include a royalty payable to us and a purchase and supply agreement that requires us to supply our customers and our customers to buy our components for integration into their products. The licenses may convey the right of exclusivity for a particular market or geographic area. These products include our components and a variety of commercially available software packages and our proprietary software. Our business model is to license our concept systems or technologies to branded original equipment manufacturers (OEM) customers who wish to develop and market head-worn products for both mobile enterprise and consumer applications.

 

In addition to sales of our components and subassemblies, we also derive a significant portion of our revenue from developing custom product solutions for our customers which we refer to as Funded Research and Development. We enter into development agreements with the goal of successfully developing a customer product and then winning the production orders for such products once design is complete and tested. These development programs can take several years. The funded development process typically adds to Kopin’s knowledge base and expertise, putting us in a better position for future business. The development arrangements typically have various milestones we are required to achieve in order to be reimbursed for our efforts. These arrangements are normally fixed price and may be cancelled by the customer on short notice. We also believe that the technologies developed for the U.S. defense industry can eventually be used in commercial and enterprise applications and then consumer applications.

 

Sales to significant non-affiliated customers for fiscal years 2020, 2019 and 2018, as a percentage of total revenues, was as follows:

 

   Sales as a Percent of Total Revenue 
   Fiscal Year 
   2020   2019   2018 
Customer               
Defense Customers in Total   50%   30%   36%
General Dynamics   *      *    11%
DRS Network & Imaging Systems, LLC   35%   17%   * 
Collins Aerospace   27%   *    20%
RealWear, Inc.   *    20%   * 
Funded Research and Development Contracts   25%   17%   20%

 

Note: The symbol "*” indicates that sales to that customer were less than 10% of the Company’s total revenues. The caption "Defense Customers in Total” excludes research and development contracts.

 

Our fiscal year ends on the last Saturday in December. The fiscal years ended December 26, 2020, December 28, 2019, and December 29, 2018 are referred to herein as fiscal years 2020, 2019 and 2018, respectively.

 

Defense Industry Overview

 

The introduction and wide acceptance of the smartphone has generated advances in many technologies including smaller and cheaper electronic components, voice search engines and wireless 4G and 5G networks. Smartphone adoption has also been the catalyst for the development of software for a wide-range of applications. Leveraging off of these new technologies and the growth of cloud computing, a new category of emerging AR and VR markets are starting to develop. These AR technologies are being used by the military to provide personnel with enhanced situational awareness by overlaying digital imaging over the real-world scene. These technologies can also be used for hundreds of different applications by enterprise workers, public safety officials and consumers, bringing ever-increasing productivity, fun and convenience.

 

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We believe that defense, industrial and consumer companies are looking at AR and VR as new applications and computing platforms. In addition, wireless network companies are encouraging the development of more products and applications that utilize their network capacity and other companies are developing products that provide continuous access to digital content. In order for these markets to develop and grow, advances and investment in display technology, optics, application software, and wireless communications systems with greater bandwidth such as 5G networks will be necessary. These advances in Display technologies must increase performance but at the same time the cost of displays must decrease.

 

Our Solution

 

Kopin Technology

 

Kopin technology includes components, subassemblies, and head-worn and hand-held system reference designs. The components we offer for sale primarily consist of our small form factor AMLCD, LCOS and OLED displays and optical lenses. Our components are used in our customers’ products, such as headsets for field service personnel, medical professionals or drone racing viewers. We also offer backlights and ASIC’s that work with our AMLCD displays. The subassemblies we offer combine one or two of our displays, backlight, ASIC, complex optics, and electronics in an assembly that is then included in a larger system, for example a weapon sight or a targeting system in an armored vehicle.

 

Display Products

 

Small form factor displays used in near-eye applications are widely used in defense in many applications such as thermal weapon sights, avionic helmets and training and simulation systems. Small form factor near-eye displays currently have more limited use in industrial products such as wearable headsets that allow user to view data, schematics and videos to enable them to perform production or repairs. In addition, we believe small form factor near-eye display are well suited for AR and VR consumer markets and will be a critical component in the development of these markets, which we believe will grow in the coming years. We believe our small form factor displays have certain advantages with respect to small size, resolution, brightness and low power consumption that are advantageous for product design and usage.

 

There are several micro display technologies commercially available including transmissive, reflective and emissive. Our principal display products are miniature high-density color or monochrome AMLCDs that range from approximately 428 x 240 resolution to 2048 x 2048 resolution and are sold in either a transmissive or reflective format. We are developing emissive OLED displays with a resolution of 1280 x 720 ("720p”), 2048 x 2048 ("2K”), 1280 x 960 ("QVGA”) and 2560 x 2560 ("2.6K”). We sell our displays individually or in combination with our other components assembled in a unit. For example, we offer a display as a product, a module product unit that includes a single display, backlight and optics in a plastic housing, a binocular display module product that includes two displays, backlights and optics in a plastic housing, and a Higher-Level Assembly ("HLA”) that contains a display, light emitting diode based illumination, optics, and electronics in a sealed housing, primarily for defense applications.

 

Our transmissive display products, which we refer to as CyberDisplay® products, utilize high quality, single-crystal-on-silicon, which is the same high-quality silicon used in conventional integrated circuits. This single-crystal-silicon is not grown on glass; rather, it is first formed on a silicon wafer and patterned into an integrated circuit (including the active matrix, driver circuitry and other logic circuits) at an integrated circuit foundry. These processes enable the manufacture of miniature active matrix circuits, that are comparable to higher resolution displays relative to passive and other active matrix displays that are fabricated on glass. Our foundry partners fabricate integrated circuits using our proprietary back plane designs for our CyberDisplay displays in their foundries in Taiwan. The fabricated wafers are then returned to our facilities, where we lift the integrated circuits off the silicon wafers and transfer them to glass using our proprietary Wafer Engineering technology. The transferred integrated circuits are then processed, packaged with liquid crystal and assembled into display panels at our Display Manufacturing Center in Westborough, Massachusetts.

 

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Our proprietary technology enables the production of transparent circuits on a transparent substrate, in contrast to conventional silicon circuits, which are on an opaque substrate. Our CyberDisplay products’ imaging properties are a result of the inclusion of a liquid crystal layer between the active matrix integrated circuit glass and the transparent cover glass. We believe our manufacturing process offers several advantages over conventional active matrix LCD manufacturing approaches, including:

 

  Greater miniaturization;
  Higher pixel density;
  Lower power consumption; and
  Higher brightness.

 

The color CyberDisplay products generate colors by using color filters with a white backlight. Color filter technology is a process in which display pixels are patterned with materials, which selectively absorb or transmit the red, green or blue colors of light.

 

Our reflective LCOS display products are miniature high density, dual mode color sequential/monochrome reflective microdisplays with resolutions which range from approximately 1280 x 768 pixels ("WXGA”) resolution to 2K x 2K resolution. These displays are manufactured by our FDD subsidiary in Scotland. Our reflective displays are based on a proprietary, high-speed, ferroelectric liquid crystal on silicon ("FLCOS”) platform. Our digital software and logic-based drive electronics combined with the very fast switching binary liquid crystal enables our microdisplay to process images purely digitally and create red, green and blue gray scale in the time domain. This architecture has major advantages in visual performance over other liquid crystal, organic light-emitting diode and microelectromechanical systems-based technologies: precisely controlled full color or monochrome gray scale is achieved on a matrix of undivided high fill factor pixels, motion artifacts are reduced to an insignificant level and there are no sub-pixels, no moving mirrors and no analog conversions to detract from the quality of the image.

 

The FLCOS device is comprised of two substrates. The first is a pixelated silicon-based CMOS substrate which is manufactured by our foundry partner based our proprietary back plane design using conventional silicon integrated circuit lithography processes. The silicon substrate forms the display’s backplane, serving as both the active matrix to drive individual pixels and as a reflective mirror. The second substrate is a front glass plate. Between the backplane and the front glass substrate is a ferroelectric liquid crystal material which, when switched, enables the incoming illumination to be modulated.

 

Our OLED technology has the ability to emit light when electrical current flows through its electroluminescent layers as opposed to our AMLCD which requires a separate light source. Our OLED microdisplays have a top-emitting structure built on opaque silicon integrated circuits rather than on glass. An OLED display typically has a wider viewing angle than an AMLCD. Light from an OLED appears fairly evenly distributed in the forward directions and so a slight movement of the eye does not perceive the change in the image brightness or color. OLED displays can also have a much higher contrast ratio than AMLCDs, which is desirable for some user applications.

 

Kopin is aiming at disrupting the OLED microdisplay industry with a new fabless, scalable business model. We believe the partitioning of the OLED manufacturing into multiple parties, each focusing on their core competencies, can make a huge difference in the OLED microdisplay performance and supply chain, while reducing the capital cost and overhead costs of entering this business. Making OLED microdisplays consists of three major steps: designing backplane circuits, processing silicon wafers to generate backplane wafers, and deposition of OLED layers on silicon backplane wafers and packaging the displays. We believe backplane design is the most intellectual property-intensive area. Kopin has more than 20 patents granted or pending on the design of OLED backplanes to get low power consumption, high frame rates and more uniform display images. Kopin has established close relationships with multiple silicon foundries to produce the OLED backplane wafers. We believe Kopin’s Lightning® backplane technology and the emergence of high-volume OLED manufacturing facilities can reduce the cost to manufacture OLED displays thereby expanding the applications for OLED microdisplays.

 

Our proprietary technology in OLED microdisplays lies mainly in the design of the integrated circuits or "back plane” upon which OLED microdisplays are built. The back plane drives the performance of the display.

 

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Two of the biggest challenges for the OLED microdisplay for AR and VR applications is low brightness and short lifetime. Kopin is working to solve both of these issues with a double OLED stack approach. We believe most OLED microdisplays commercially available in volume to-date have been made with a single-stack OLED structure, namely consisting of a one junction organic diode structure. A duo-stack OLED consists of two OLED structures connected in series so that carriers (electrons-holes) pass through the duo-stack OLED and generate photons twice, instead of once in the case of a single-stack OLED structure. This structure enables higher brightness without a commensurate increase in power and without the longevity (burn-in) issues which have plagued previous high-brightness single-stack OLED displays. In addition, we believe Kopin’s proprietary ColorMax ™ technology provides an accurate and wide color spectrum without the color mixing that has previously prevented duo-stack OLED structures from rendering accurate color. In addition, we have a proprietary embedded anode structure within the back plane design which we believe will make the design integration of our display in a finished product less complicated for product designers. We call this technology Display on a Chip (DoC). We believe our patent-pending backplane technologies can provide far superior performance compared to other OLED product in the market in terms of brightness, power consumption, longevity and color accuracy and we believe these features will improve further as our technology matures.

 

We have engaged foundry services for the fabrication of the Lightning OLED back plane wafers. Our model is to sell these wafers to deposition foundries that deposit the organic material on the backplane and manufacture the displays. The deposition foundries will either sell the displays to their customer or to us for resale to our customers. We believe this outsourcing model allows us to leverage our underlying back plane intellectual property as well as the existing infrastructure to obtain lower cost manufacturing and avail ourselves of manufacturing technology improvements as they occur.

 

Currently Kopin has two OLED microdisplays on the market: a 2K x 2K display with 2048 x 2048 resolution in a 0.99” diagonal size, which is aimed at VR and Mixed Reality (MR) applications; and a 720p display with 1280 x 720 resolution in a 0.49” diagonal size, which is aimed at AR applications. Kopin has also demonstrated a QVGA display with 1280 x 960 resolution in a 0.5” diagonal size, which is aimed at electronic viewfinder (EVF) and AR applications, and a 2.6K x 2.6K display with 2560 x 2560 resolution in a 1.3” diagonal size. Our OLED microdisplay has a combo C-PHY/D-PHY Mobile Industry Processor Interface (MIPI) and display stream compression DSC) to allow 120 Hz operation at the full resolution. This display is designed for high-end VR and content streaming applications.

 

Kopin is also exploring the development of MicroLED microdisplays which offer the possibility of high brightness, wide viewing angle, excellent contrast and low cost. Kopin is working with other partners to explore the potential benefits and implementation of the technology. If Kopin is successful in developing prototypes, then high volume manufacturing process development will be required including the development of equipment.

 

By offering transmissive, reflective and emissive microdisplay technologies today and working with potential customers for MicroLEDs in the future, we believe we can uniquely support whichever technology is best suited for a given application. Transmissive and reflective AMLCDs are typically used in bright light conditions as their brightness can be modulated over a wide range by controlling the backlight operation. OLED displays currently have less brightness range but offer superior contrast and response time characteristics and therefore are better suited in an immersive products environment that blocks out ambient light.

 

Optical Lenses and Backlights

 

We offer a variety of optical lenses some of which we have developed internally and others for which we license the rights to sell. We also offer a variety of backlights, some of which we have developed internally and some of which are "off-the-shelf” components. The lenses come in a variety of sizes with the smallest being our Pupil, followed by our Pearl and Pancake lenses. The different sizes of lenses give us and our customers design flexibility when creating headset systems. There is a trade-off between the lens size and the size of the perceived image to the viewer. For example, a Pearl lens will provide the viewer with an image approximately equivalent to what the viewer would see looking directly at a smartphone, whereas a Pancake lens will provide the viewer with an immersive experience. We use third parties to manufacture these lenses.

 

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Headset Systems

 

We license an industrial headset reference design which is a complete head-worn computer that connects to the Internet wirelessly and includes an optical pod with one of our display products, a microprocessor, battery, camera, memory and various commercially available software packages that we license. We also licensed an industrial headset reference design which is a device that attaches to a pair of safety glasses, includes an optical pod with one of our display products and a camera and is operated primarily through the use of voice. The display module or optical pod allows users to view the information such as maintenance diagrams and instruction sets, Internet data, emails, text messages, maps or other data at a "normal” size because of our specialized optics. Our industrial headsets provide the capability of viewing technical diagrams, by enabling the user to zoom in to see finer details or zoom out to see a larger perspective.

 

Strategy

 

Our product strategy is to enter into funded development programs with U.S. defense prime contractors to invent, develop, manufacture and sell (or license) leading-edge critical technology and microdisplay components and subassemblies that will be used in rugged environments. We intend to use the know-how gained and technology developed from these defense development programs and products to create products that can be used in industrial, enterprise, medical and ultimately consumer applications. The products we develop typically include a microdisplay, optics, and an ASIC in a sealed housing. The products we make for the defense market must be able to withstand the extreme shock and vibration experienced in weapons fire. Accordingly, our intellectual property includes not just microdisplays but a broad range of optics and our know-how includes the ability to manufacture products that can withstand extreme environments. The critical elements of our strategy include:

 

  Broad Portfolio of Intellectual Property. We believe that our extensive portfolio of patents, trade secrets and non-patented know-how provides us with a competitive advantage in our markets and we have been accumulating, a significant patent and know-how portfolio either by internal efforts or through acquisition. We own, exclusively license or have the exclusive right to sublicense approximately 200 patents and patent applications issued and/or pending worldwide. An important piece of our strategy is to continue to accumulate valuable patented and non-patented technical know-how relating to our microdisplays, including back plane design, and other critical technologies for advanced wearable systems such as optics and drive electronics.
     
  Maintain Our Technological Leadership in Defense and Industrial Markets. We are a recognized leader in the design, development and manufacture of high resolution microdisplay components and subassemblies for defense and industrial applications. We believe our ability to continue to develop components and subassemblies for defense applications enhances our opportunity to grow within our other non-defense targeted markets such as industrial, medical and eventually AR and VR consumer markets. We perform research and development contracts for U.S. government agencies and prime contractors of the U.S government. Under these contracts, the U.S. Government funds all or a portion of our efforts to develop next-generation microdisplay related technologies and products for aviation systems such as pilot helmets, soldier centric systems such as weapon sights, training and simulation systems and defense armored vehicles. This enables us to supplement our internal research and development budget with additional funding and adds to our expertise in technology, products and systems.
     
  Understand Our Customer Needs. We believe our system know-how, be it a defense, industrial or consumer system is a compelling reason why customers choose Kopin as their supplier. Unlike many of our competitors we offer a range of display technologies, optics, backlights, and ASICs as either an individual component or in a system. We believe this enables us to provide superior technology solutions for our customer’s needs. Additionally, our human-factors and system understanding enables us to offer our customers valuable engineering services to solve their issues and reduce time to market for their products.

 

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  Internally Manufactured Products and Use of Third Party Manufacturing. We design and manufacture our transmissive and reflective display products in facilities that we lease and manage. However, the initial manufacturing steps fabricating the silicon wafers are performed at capital-intensive Taiwan foundries. With OLED displays, which we design, we similarly use silicon wafer foundries to produce our back planes, and we also use OLED deposition foundries to perform the OLED deposition steps for our displays. The use of these third-party foundries reduces our investments in plant and equipment and working capital for new products and enables us to update designs as technology and manufacturing trends change.

 

Markets and Customers

 

Our business model is to primarily generate product revenues by selling display components and subassemblies to customers who offer defense, industrial or consumer products and to a lesser extent license our system designs and know-how. We also enter into development contracts from customers to either design custom products for them or help them integrate our technology into their products (Funded Research and Development).

 

We currently sell our display products to our customers in various configuration including but not limited to a single display component, a module that includes a display, optic, backlight and focus mechanism and electronics, a binocular display module that includes two displays, lenses, and backlights, and as HLAs for defense customers. A HLA is similar to a module but includes additional components such as an eye cup specific to a defense application.

 

We have sold our AMLCD products to Collins Aerospace, Elbit, and DRS RSTA Inc. for use in defense applications, to Vuzix, and RealWear for enterprise wearable products, and to Scott Safety for public safety applications. We have sold our LCOS display products to Saki, Jutze and Mirtec for use in 3D metrology equipment. Our revenues from our OLED displays have primarily been from development contracts with customers that are designing our displays into their products.

 

In order for our AMLCD display products to function properly in their intended applications, ASICs and backlights are generally required. Several companies have designed ASICs to work with our display products and our customers can procure these chip sets directly from the manufacturer or through us.

 

For fiscal years 2020, 2019 and 2018, sales to defense customers, excluding research and development contracts, as a percentage of total revenue were 50%, 30% and 36%, respectively. For fiscal year 2020, Collins Aerospace and DRS Network & Imaging Systems LLC each accounted for approximately 27% and 35% of our revenue, respectively.

 

For fiscal years 2020, 2019 and 2018, research and development revenues, primarily from multiple contracts with various prime contractors of U.S. government agencies, accounted for approximately 25%, 17% and 20%, respectively, of our total revenues.

 

Product Development

 

We believe that continued introduction of new products in our target markets is essential to our growth. Our industrial and consumer products tend to have one to three-year life cycles. We have assembled a group of highly skilled engineers who work internally as well as with our customers to continue our product development efforts. Our primary development efforts are focused on AMLCD display subassemblies for defense and industrial applications and OLED display components for defense, industrial and consumer applications. In 2019 we commenced MicroLED display development and we are evaluating the commercial viability of MicroLED display products.

 

Component Products and Subassemblies

 

The pixel size of our current AMLCD transmissive display products ranges from 6.8 to 15 microns. These pixel sizes are much smaller than a pixel size of approximately 100 microns in a typical laptop computer display. The resolutions of our current commercially available AMLCD display products are 320 x 240, 432 x 240, 640 x 360, 640 x 480, 854 x 480, 800 x 600, 1,280 x 720 and 1,280 x 1,024 pixels. The pixel size of our current reflective display products ranges from 8.2 to 13.6 microns. The resolutions of our current commercially available reflective display products are 1,280 x 768, 1,280 x 1,024, 2,048 x 1,536, 2,048 x 2,048 and 2,560 x 1,440 pixels.

 

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Our AMLCD display product development efforts are primarily focused on improving performance and reducing the manufacturing costs. We are continually evaluating our display manufacturing process in order to reduce cost. Our defense products include subassemblies and our advanced subassemblies are referred to as HLAs. The HLA may include a display, multiple optical lenses in a hermetically sealed housing. The HLAs are made to very exact tolerances which require Kopin to manage its supply chain in order to procure raw materials that meet specification while enabling Kopin to achieve high yields.

 

The pixel size of our current OLED displays range from 7.8 to 9.2 microns with resolutions of 1,280 x 720, 2,048 x 2,048 and 2,560 x 2,560. We have only recently commenced OLED display developments and therefore our OLED products are much less mature than our AMLCD products. Accordingly, our current development efforts include expanding the resolutions offered, increasing the quantity of display active matrix pixel arrays processed on each wafer by further reducing the display size, increasing the light throughput of our pixels, increasing manufacturing yields, and increasing the functionality of our OLED products.

 

We offer components such as our optical lenses, backlights and ASICs, manufactured to our specifications, which we then buy and resell. The components which are made to order include either intellectual property we developed or that we license from third parties.

 

Funded Research and Development

 

We have entered into various development contracts with agencies and prime contractors of the U.S. government and commercial customers. These contracts help support the continued development of our core technologies. We intend to continue to pursue development contracts for applications that relate to our defense and commercial product applications. Our contracts contain certain milestones relating to technology development and may be terminated prior to completion of funding. Our funded development projects often lead to a product or component supply agreement. Our policy is to retain our proprietary rights with respect to the principal commercial applications of our technology, however, we are not always able to retain our proprietary rights. To the extent technology development has been funded by a U.S. federal agency, under applicable U.S. federal laws the federal agency that provided the funding has the right to obtain a non-exclusive, non-transferable, irrevocable, fully paid license to practice or have practiced this technology for governmental use. In addition we may be required to negotiate intellectual property rights with our defense prime contractors. For our commercial development agreements customers often obtain exclusive rights to a particular display or technology that is developed either permanently or for some period of time. Revenues attributable to research and development contracts for fiscal years 2020, 2019 and 2018 totaled $10.1 million, $5.0 million and $5.3 million, respectively.

 

Competition

 

The general commercial display market is highly competitive and is currently dominated by large Asian-based electronics companies including AUO, BOE Technology Group, Himax, LG Display, Samsung, Sharp and Sony. In additional, several companies focus on microdisplays including eMAGIN, Himax, MicroOLED, Olightek, BOE Technology, Seeya, Seiko Epson and Sony. The display market consists of multiple segments, each focusing on different end-user applications applying different technologies. Competition in the display field is based on price and performance characteristics, product quality, size and the ability to deliver products in a timely fashion. The success of our display product offerings will also depend upon the adoption of our display products by consumers as an alternative to other active matrix LCDs or OLEDs and upon our ability to compete against other types of well-established display products and new emerging display products. Particularly significant is a consumer’s willingness to use a near eye display device, as opposed to a direct view display that may be viewed from a distance of several inches to several feet. Assuming a user is willing to use a near eye display device, companies such as Samsung and Oculus are offering near eye virtual reality headset products that use large display panels on glass to provide the image as opposed to using microdisplays. Displays on glass typically have lower resolution than our products but are lower in cost on a per square inch basis. We cannot be certain that we will be able to compete against these companies and technologies, or that consumers will accept the use of such eyewear in general or our customer’s product form-factor specifically.

 

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There are also a number of AMLCD, LCOS, OLED, MicroLED and alternative display technologies in development and production. There are many large and small companies that manufacture or have in development products based on these technologies. We out-source the manufacturing of our OLED displays to Chinese foundries. We expect these foundries to offer their own products. Our display products will compete with other displays utilizing these and other competing display technologies.

 

There are many companies whose sole business is the development and manufacture of optical lenses, backlights, and ASICs. These companies may have significantly more intellectual property and experience than we do in the design and development of these components. We do not manufacture optical lenses, backlights, or ASICs but we either have them made to our specifications or buy standard off-the-shelf products.

 

Patents, Proprietary Rights and Licenses

 

An important part of our product development strategy is to seek, when appropriate, protection for our products and proprietary technology through the use of various U.S. and foreign patents and contractual arrangements. We intend to prosecute and defend our proprietary technology aggressively. Many of our U.S. patents and applications have counterpart foreign patents, foreign patent applications or international patent applications through the Patent Cooperation Treaty.

 

Government Regulations

 

Our business is subject to extensive regulation in the industries we serve. We deal with numerous U.S. government agencies and entities, including but not limited to branches of the DoD.

 

U.S. defense contractors are among our largest customers, representing a substantial majority of our total revenues. The U.S. government may terminate a contract with us or our customers either "for convenience” (for instance, due to a change in its perceived needs) or if we default due to our failure or the failure of a general or subcontractor to perform under the contract. If the federal government terminates a contract with one of our customers, our contract with our customers generally would entitle us to recover only our incurred or committed costs, settlement expenses and possibly profit on the work completed prior to termination. However, under certain circumstances, our recovery costs upon termination for convenience of such a contract may be limited. If terminated by the government as a result of our default, we could be liable for payments made to us for undelivered goods or services, additional costs the government incurs in acquiring undelivered goods or services from another source and any other damages it suffers.

 

In addition, we are subject to a variety of federal, state and local governmental regulations including the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in our manufacturing process. The failure to comply with present or future regulations could result in fines being imposed on us, suspension of production or cessation of operations. Any failure on our part to control the use of, or adequately restrict the discharge of, hazardous substances, or otherwise comply with environmental regulations, could subject us to significant future liabilities. We also cannot be certain that past use or disposal of environmentally sensitive materials in conformity with then existing environmental laws and regulations will protect us from required remediation or other liabilities under current or future environmental laws or regulations. Certain chemicals we import are subject to regulation by the U.S. government. If we or our suppliers do not comply with applicable laws, we could be subject to adverse government actions and may not be able to import critical supplies.

 

We are also subject to federal International Traffic in Arms Regulations ("ITAR”) laws which regulate the protection (Cybersecurity) and export of technical data and export of products to other nations which may use such data or products for defense purposes. The failure to comply with present or future regulations could result in fines being imposed on us, suspension of production, or a cessation of operations. Any failure on our part to obtain any required licenses for the export of technical data and/or export of our products or to otherwise comply with ITAR, could subject us to significant future liabilities.

 

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We are also subject to federal importation laws which regulate the importation of raw materials and equipment from other nations which are used in our products. The failure to comply with present or future regulations could result in fines being imposed on us, suspension of production, or a cessation of operations.

 

Investments in Related Businesses

 

On September 30, 2019 we entered into an Asset Purchase Agreement (the "Solos Purchase Agreement”) with Solos Technology Limited ("Solos Technology”), pursuant to which we sold and licensed certain assets of our Solos ("Solos”) product line and Whisper Audio ("Whisper”) technology. As consideration for the transaction we received 1,172,000 common shares representing a 20.0% equity stake in the Solos Technology’s parent company, Solos Incorporation ("Solos Inc”). Our 20.0% equity stake will be maintained until Solos Inc. has raised a total of $7.5 million in equity financing after which we will have to participate in future equity offerings or have our ownership percentage decline.

 

We acquired an equity interest in Lenovo New Vision in the first quarter of 2018 for $1.0 million and the Company also contributed certain intellectual property. As of December 26, 2020, we own an 11% interest in this investment and the carrying value of our investment is $3.8 million.

 

We own 100% of the outstanding common stock of NVIS and FDD and 80% of the outstanding common stock of e-MDT America ("eMDT”) and we consolidate each of their financial results within our consolidated financial statements.

 

We terminated operations of our subsidiary, Kopin Software Ltd., in Q3 2019 and are in the process of liquidating it.

 

We may from time to time make further equity investments in these and other companies engaged in certain aspects of the display, electronics, optical and software industries as part of our business strategy. In addition, the wearable computing product market is relatively new and there may be other technologies we need to invest in to enhance our product offering. These investments may not provide us with any financial return or other benefit and any losses by these companies or associated losses in our investments may negatively impact our operating results.

 

Employees

 

As of December 26, 2020, our consolidated business employed 160 individuals. Of these employees, eight hold Ph.D. degrees in Material Science, Electrical Engineering or Physics. Our management and professional employees have significant prior experience in semiconductor materials, device transistor and display processing, manufacturing and other related technologies. Our employees are located in the U.S., Europe and Asia and the laws regarding employee relationships are different by jurisdiction. None of our employees are covered by a collective bargaining agreement. We consider relations with our employees to be good.

 

Sources and Availability of Raw Materials and Components

 

We rely on third party independent contractors for certain integrated circuit chip sets, backlights and other critical raw materials such as special glasses, wafers and chemicals. In addition, our CyberDisplay subassemblies, HLAs, binocular display modules, and other modules include lenses, backlights, printed circuit boards and other components that we purchase from third-party suppliers. Some of these third-party contractors and suppliers are small companies with limited financial resources. In addition, our defense customers typically buy a small number of units which prevents us from qualifying and buying components economically from multiple vendors. As a result, we are highly dependent on a select number of third-party contractors and suppliers.

 

Availability Information

 

We make available free of charge through our website, www.kopin.com, our Annual Reports on Form 10-K and other reports that we file or furnish with the SEC as soon as reasonably practicable after they are filed or furnished, as well as certain of our corporate governance policies, including the charters for the Board of Directors’ audit, compensation and nominating and corporate governance committees and our code of ethics, corporate governance guidelines and whistleblower policy. We will also provide to any person without charge, upon request, a copy of any of the foregoing materials. Any such request must be made in writing to us, c/o Investor Relations, Kopin Corporation, 125 North Drive, Westborough, MA, 01581.

 

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Item 1A. Risk Factors

 

Our business and financial results are subject to a number of risks and uncertainties, including those set forth below. Additional risks and uncertainties that are not currently known to us or that we currently do not believe to be material may also negatively affect our business and financial results.

 

We have experienced a history of losses, have a significant accumulated deficit, have had negative cash flow from operating activities in fiscal years 2020, 2019, and 2018, and expect to have negative cash flow from operating activities in fiscal year 2021. Since inception, we have incurred significant net operating losses. As of December 26, 2020, we had an accumulated deficit of $305.6 million. At December 26, 2020 and December 28, 2019, we had $20.7 million and $21.8 million of cash and cash equivalents and marketable securities, respectively. For the years 2020 and 2019, net cash used in operating activities was $4.4 million and $21.0 million, respectively. The decline in our cash and cash equivalents and marketable securities is primarily a result of funding our operating losses, of which a significant component is our investments in research and development and professional fees, partially offset by the sale of our common stock. We plan to continue to invest in research and development even during periods when we are not profitable, which may result in our incurring losses from operations and negative cash flow. If we do not soon achieve and maintain positive cash flow and profitability, our financial condition will ultimately be materially and adversely affected, and we will be required to raise additional capital. We may not be able to raise any necessary capital on commercially reasonable terms or at all. If we fail to achieve or maintain profitability on a quarterly or annual basis within the timeframe expected by investors, the market price of our common stock may decline.

 

The widespread outbreak of an illness or any other communicable disease, or any other public health crisis, including the COVID-19 pandemic, could adversely affect our business, results of operations and financial condition. The COVID-19 pandemic has negatively affected the global and national economy, disrupted global supply chains, and created significant volatility in and disruption of financial markets. The extent of the impact of the COVID-19 pandemic on our operational and financial performance, including the ability to execute business strategies and initiatives in the expected time frame, will depend on future developments, including the duration and spread of the pandemic and related restrictions on travel and transportation, all of which are uncertain and cannot be predicted at this time. An extended period of global supply chain and economic disruption could materially affect our business, results of operations, financial condition, and access to sources of liquidity.

 

We generally do not have long-term contracts with our customers, which makes forecasting our revenues and operating results difficult. We generally do not enter into long-term agreements with our customers obligating them to purchase our products. Our business is characterized by short-term purchase orders with shipment schedules within one year and we generally permit orders to be canceled or rescheduled before shipment without significant penalty. As a result, our customers may cease purchasing our products at any time, which makes forecasting our revenues difficult. In addition, due to the absence of substantial non-cancelable backlog, we typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. The uncertainty of product orders makes it difficult for us to forecast our sales and allocate our resources in a manner consistent with our actual sales. Moreover, our expense levels and the amounts we invest in capital equipment and new product development costs are based in part on our expectations of future sales and, if our expectations regarding future sales are inaccurate, we may be unable to reduce costs in a timely manner to adjust for sales shortfalls. If we fail to accurately forecast our revenues and operating results, our business may not be successful, and the price of our common stock may decline. As a result of these and other factors, investors should not rely on our revenues and our operating results for any one quarter or year as an indication of our future revenues or operating results. If our quarterly revenues or results of operations fall below expectations of investors or public market analysts, the price of our common stock could fall substantially.

 

Fluctuations in operating results make financial forecasting difficult and could adversely affect the price of our common stock. Our quarterly and annual revenues and operating results may fluctuate significantly for numerous reasons, including:

 

  The timing of the initial selection of our display products as components in our customers’ new products;
  Availability of interface electronics for our display products;

 

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  Competitive pressures on selling prices of our products;
  The timing and cancellation of customer orders;
  Our ability to introduce new products and technologies on a timely basis;
  Our ability to successfully reduce costs;
  The cancellation of U.S. government contracts; and
  Our ability to secure agreements from our major customers for the purchase of our products.

 

As a result of these and other factors, investors should not rely on our revenues and our operating results for any one quarter or year as an indication of our future revenues or operating results. If our quarterly revenues or results of operations fall below expectations of investors or public market analysts, the price of our common stock could fall substantially.

 

Our revenues and cash flows could be negatively affected if sales of our Display products for defense applications significantly decline or the current defense development programs are either cancelled or ultimately do not result in future product sales. The sale of our display products to the military for use in thermal weapon sights and avionic helmets have been a primary source of our defense revenues and cash flows over the last several years. We currently are designed in the Family Weapon Sight ("FWS”) Individual program and the Joint Strike Fighter (F-35) jet fighter. We are in development and qualification in additional defense programs related to avionic helmets, armored vehicles and soldier rifle scopes. Our ability to generate revenues and cash flow from sales to the U.S. military depends on our Display products remaining qualified in the F-35 Strike Fighter, FWS and other U.S. defense programs and on the U.S. government/military funding these programs. Our ability to generate revenues and cash flows also depends on the products we are developing and qualifying for other U.S. military programs being successfully qualified and the U.S. government/military funding these programs. We may not be awarded contracts for the systems we are in qualification for, and for the systems we are qualified for we may only be awarded a portion of the program as the U.S. military looks to have multiple sources when possible. In addition, the government could postpone or cancel these programs. We believe the U.S. defense is evaluating alternative display technologies for the F-35 Strike Fighter program. Our ability to generate revenues and cash flow from sales to the U.S. military also depends on winning contracts over our competitors. If we are unable to be qualified into new U.S. defense programs, remain qualified in existing programs, or win orders against our competition, or if defense programs are not funded, then our ability to generate revenues and achieve profitability and positive cash flow will be negatively impacted.

 

Our customers who purchase display products for defense applications typically incorporate our products into their products, which are sold to the U.S. government under contracts. U.S. government contracts generally are not fully funded at inception and may be terminated or modified prior to completion, which could adversely affect our business. Congress funds the vast majority of the federal budget on an annual basis, and Congress often does not provide agencies with all the money requested in their budget. Many of our customers’ contracts cover multiple years and, as such, are not fully funded at contract award. If Congress or a U.S. government agency chooses to spend money on other programs, our customers’ contracts may be terminated for convenience. Federal laws, collectively called the Anti-Deficiency Act, prohibit involving the government in any obligation to pay money before funds have been appropriated for that purpose, unless otherwise allowed by law. Therefore, the Anti-Deficiency Act indirectly regulates how agencies awards our contracts and pays our invoices. Federal government contracts generally contain provisions that provide the federal government rights and remedies not typically found in commercial contracts, including provisions permitting the federal government to, among other things: terminate our existing contracts; modify some of the terms and conditions in our existing contracts; subject the award to protest or challenge by competitors; suspend work under existing multiple year contracts and related delivery orders; and claim rights in technologies and systems invented, developed or produced by us.

 

The federal government may terminate a contract with us or our customers either "for convenience” (for instance, due to a change in its perceived needs) or if we default due to our failure or the failure of a general or subcontractor to perform under the contract. If the federal government terminates a contract with one of our customers, our contract with our customers generally would entitle us to recover only our incurred or committed costs, settlement expenses and possibly profit on the work completed prior to termination. However, under certain circumstances, our recovery costs upon termination for convenience of such a contract may be limited. As is common with government contractors, we have experienced occasional performance issues under some of our contracts. We have received Stop Work Orders wherein work is suspended pending a review of the program. We may in the future receive show-cause or cure notices under contracts that, if not addressed to the federal government’s satisfaction, could give the government the right to terminate those contracts for default or to cease procuring our services under those contracts.

 

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In addition, U.S. government contracts and subcontracts typically involve long purchase and payment cycles, competitive bidding, qualification requirements, delays or changes in funding, extensive specification and performance requirements, price negotiations and milestone requirements. Each U.S. government agency often also maintains its own rules and regulations with which we must comply, and which can vary significantly among agencies.

 

Most of our defense sales are on a fixed-price basis, which could subject us to losses if there are cost overruns. Under a fixed-price contract, we receive only the amount indicated in the contract, regardless of the actual cost to produce the goods. While firm fixed-price contracts allow us to benefit from potential cost savings, they also expose us to the risk of cost overruns. If the initial estimates that we use to calculate the sales price and the cost to perform the work prove to be incorrect, we could incur losses. We have had situations where we have underestimated the cost of a program and incurred losses on fulfilling the contract. In addition, some of our contracts have specific provisions relating to cost, scheduling, and performance. If we fail to meet the terms specified in those contracts, then our cost to perform the work could increase, which would adversely affect our financial position and results of operations. Some of the contracts we bid on have Indefinite Delivery, Indefinite Quantity ("IDIQ”) provisions. This means we are bidding a fixed price but are not assured of the quantity the government will buy or when it will buy during the term of the contract. This means we are exposed to the risk of price increases for labor, overhead and raw materials during the term of the contract. We may incur losses on fixed-price and IDIQ contracts that we had expected to be profitable, or such contracts may be less profitable than expected, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

 

We recognize revenue for our defense contracts and some commercial contracts based on percentage of completion which require significant management judgement and errors in our judgement could result in our revenue being overstated or understated and the profits or loss reported could be subject to adjustment. For certain contracts with the U.S. government, the Company recognizes revenue over time as we perform because of continuous transfer of control to the customer and the lack of an alternative use for the product. The continuous transfer of control to the customer is supported by liability clauses in the contract that allow the U.S. government to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. Contracts with commercial customers may have a similar liability clause. In situations where control transfers over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. We generally use the cost-to-cost approach to measure the extent of progress towards completion of the performance obligation for our contracts. Under the cost-to-cost measure approach, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenues are recorded proportionally as costs are incurred. Accounting for design, development and production contracts requires judgment relative to assessing risks, estimating contract revenues and costs and making assumptions for schedule and technical issues. Due to the size and nature of the work required to be performed on many of our contracts, the estimation of total revenue and cost at completion is complicated and subject to many variables. Contract costs include material, labor and subcontracting costs, as well as an allocation of indirect costs. We have to make assumptions regarding the number of labor hours required to complete a task, the complexity of the work to be performed, the availability and cost of materials and performance by our subcontractors. For contract change orders, claims or similar items, we apply judgment in estimating the amounts and assessing the potential for realization. These amounts are only included in contract value when they can be reliably estimated, and realization is considered probable. If our estimate of total contract costs or our determination of whether the customer agrees that a milestone is achieved is incorrect, our revenue could be overstated or understated, and the profits or loss reported could be subject to adjustment. If our revenues and costs require adjustment our stock price could decline.

 

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A decline in the U.S. government defense budget, changes in spending or budgetary priorities, a prolonged U.S. government shutdown or delays in contract awards may significantly and adversely affect our future revenues, cash flow and financial results. In recent years, U.S. government appropriations have been affected by larger U.S. government budgetary issues and related legislation. In 2011, Congress enacted the of Budget Control Act 2011 ("BCA”), which established specific limits on annual appropriations for fiscal years 2012-2021 and has since been amended a number of times, most recently by the Bipartisan Budget Act of 2019 ("BBA19”). As a result, Department of Defense ("DoD”) funding levels have fluctuated over this period and have been difficult to predict. Future spending levels are subject to a wide range of outcomes, depending on Congressional action. In addition, in recent years the U.S. government has been unable to complete its budget process before the end of its fiscal year, resulting in both a government shutdown and continuing resolutions to extend sufficient funds only for U.S. government agencies to continue operating. Most recently, the federal government was shut down due to lack of funding for over one month between late 2018 and early 2019. Additionally, the national debt has recently threatened to reach the statutory debt ceiling, and such an event in future years could result in the U.S. government defaulting on its debts.

 

As a result, defense spending levels are difficult to predict beyond the near-term due to numerous factors, including the external threat environment, future government priorities and the state of government finances. Significant changes in defense spending or changes in U.S. government priorities, policies and requirements could have a material adverse effect on our results of operations, financial condition or liquidity.

 

Our ability to manufacture and distribute our Display products would be severely limited if the foundries that we rely on to manufacture integrated circuits for our Display products fail to provide those services. We depend principally on a Taiwanese foundry for the fabrication of integrated circuits for our display products. In addition, our strategy is to use Chinese foundries services for OLED deposition and processing of OLED displays. We have no long-term contracts with foundries and from time to time we have been put on allocation, which means the foundry will limit the number of wafers they will process for us. If foundries were to terminate their arrangement with us or become unable to provide the required capacity and quality on a timely basis, we may not be able to manufacture and ship our Display products or we may be forced to manufacture them in limited quantities until replacement foundry services can be obtained. Furthermore, we cannot assure that we would be able to establish alternative manufacturing and packaging relationships on acceptable terms.

 

Our reliance on these foundries involves certain risks, including but not limited to:

 

  Lack of control over production capacity and delivery schedules;
  Limited control over quality assurance, manufacturing yields and production costs;
  The risks associated with international commerce, including unexpected changes in legal and regulatory requirements, changes in tariffs and trade policies and political and economic instability; and
  Natural disasters such as earthquakes, tsunami, mudslides, drought, hurricanes and tornadoes.

 

Due to natural disasters such as earthquakes and typhoons that have occasionally occurred in Asia, many Taiwanese companies, including the Taiwanese foundry we use, have experienced related business interruptions. Our business could suffer significantly if any of the foundries we use have their operations disrupted for an extended period of time due to natural disaster, political unrest or financial instability.

 

We may be unable to adequately control purchase pricing of certain critical materials, which may materially adversely affect our sales or profitability. We have no long-term pricing contracts on foundry wafers and certain other materials that represent a significant portion of product bill of material costs. We cannot provide assurance against supplier price increases that negatively impact the cost of producing products, which may adversely affect sales or profitability. Finding and/or qualifying a more cost-effective replacement supplier may take significant time.

 

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We depend on third parties to provide integrated circuit chip sets and critical raw materials and we periodically receive "end of life” notices from suppliers that they will no longer be providing a raw material. We do not manufacture the integrated circuit chip sets that are used to electronically interface between our display products and our customers’ products. Instead, we rely on third party independent contractors for these integrated circuit chip sets. We purchase critical raw materials such as special glasses, special silicon on insulator ("SOI”) wafers, light emitting diodes, adhesives, chemicals, lenses, backlights, printed circuit boards and other components from third party suppliers. Some of these third party contractors and suppliers are small companies with limited financial resources. In addition, relative to the commercial market, the military buys a small number of units, which prevents us from qualifying and buying components economically from multiple vendors. We periodically receive notices from suppliers of our critical raw materials regarding their plans to stop selling those raw materials. This requires us to identify another raw material and/or raw material supplier to replace the discontinued item/supplier, which would then require us to internally re-qualify the product with the new material as well as possibly re-qualify the product with our customer. If any of these third party contractors or suppliers were unable or unwilling to supply these integrated circuit chip sets or critical raw materials to us, whether for business or regulatory reasons, we would be unable to manufacture and sell our display products until a replacement material could be found. We may not be able to find a replacement material or if we are able to find a replacement material we may be unable to sell our products until they have been qualified both internally and with the customer. Lower volume purchases may make it uneconomical for some of our suppliers to provide the raw materials we need. We cannot assure that a replacement third party contractor or supplier could be found on reasonable terms or in a timely manner. Any interruption in our ability to manufacture and distribute our display products could cause our display business to be unsuccessful and the price of our common stock may decline.

 

Our investments in the development and sale of OLED microdisplays may not be successful which may materially adversely affect our sales, profitability and cash flow. We historically have sold products that incorporate our proprietary AMLCDs. We believe that for certain applications OLED microdisplays have performance advantages and we believe some customers have switched or will want to switch from AMCLDs to OLED microdisplays in the next two to three years. We are in the process of designing and developing OLED microdisplays. We expect to make significant monetary investments in the development of OLED microdisplays. Our plan is to outsource the production of the OLED microdisplays. We have little experience in production outsourcing. If we are unsuccessful in designing and developing OLED microdisplays or if we are unable to find cost-effective third party production partners our sales and profitability may be negatively affected.

 

The markets in which we operate are highly competitive and rapidly changing and we may be unable to compete successfully. There are a number of companies that develop or may develop products that compete in our targeted markets. The individual components that we offer for sale (displays, optical lenses, backlights and ASICs) are also offered by companies whose sole business focuses on that individual component. For example, there are companies whose sole business is to sell optical lenses. Accordingly, our strategy requires us to develop technologies and to compete in multiple markets. Some of our competitors are much larger than we are and have significantly greater financial, development and marketing resources than we do. The competition in these markets could adversely affect our operating results by reducing the volume of the products we sell or the prices we can charge. These competitors may be able to respond more rapidly than us to new or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotion and sale of their products than we do.

 

Our success will depend substantially upon our ability to enhance our products and technologies and to develop and introduce, on a timely and cost-effective basis, new products and features that meet changing customer requirements and incorporate technological enhancements. If we are unable to develop new products and enhance functionalities or technologies to adapt to these changes, our business will suffer.

 

Disruptions of our production could adversely affect our operating results. If we were to experience any significant disruption in the operation of our facilities, we would be unable to supply our products to our customers. Many of our sales contracts include financial penalties for late delivery. In the past, we have experienced power outages at our facilities, which ranged in duration from one to four days. We have certain critical pieces of equipment necessary to operate our facilities that are no longer offered for sale and we may not have service contracts or spare parts for the equipment. Additionally, as we introduce new equipment into our manufacturing processes, our display products could be subject to especially wide variations in manufacturing yields and efficiency. We may experience manufacturing problems that would result in delays in product introduction and delivery or yield fluctuations.

 

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A disruption to our information technology systems could significantly impact our operations, revenue and profitability. Our data processing systems and our Enterprise Resource Planning ("ERP”) software are cloud-based and hosted by third parties. We also use software packages that are no longer supported by their developer. We have experienced short-term (i.e., a few days) interruptions in our Internet connectivity. An interruption of the third party systems or the infrastructure that allows us to connect to the third party systems for an extended period may affect our ability to operate our business and process transactions, which could result in a decline in sales and affect our ability to achieve or maintain profitability.

 

If our information technology security systems were infiltrated and confidential and or proprietary information were taken, we could be subject to fines, lawsuits and loss of customers. Significantly larger organizations with much greater resources than us have been the victim of cybercrimes. We routinely receive emails probing our Internet security, and our Internet security systems have detected outside organizations attempting to install Trojan virus software packages in our systems. We rely on our electronic information systems to perform the routine transactions to run our business. We transact business over the Internet with customers, vendors and our subsidiaries and have implemented security measures to protect unauthorized access to this information. We have also implemented security policies that limit access via the Internet from the Company to the outside world based on the individual’s position in the Company. We routinely receive security patches from software providers for the software we use. Our primary concerns are inappropriate access to personnel information, information covered under the International Traffic in Arms Regulation, product designs and manufacturing information, financial information and our intellectual property, trade secrets and know-how.

 

We may not achieve some or all of the anticipated benefits of our equity investments. At December 26, 2020 we had equity investments in companies totaling $4.5 million, where we have limited, if any, control over their governance, financial reporting and operations. As a result, we face certain operating, financial and other risks relating to these investments, including risks related to the financial strength of the investments. We are required to periodically review the value of these investments for impairment. For example, in the fourth quarter of 2019, we reviewed the financial condition and other factors of RealWear and as a result, in the fourth quarter of 2019, we recorded an impairment charge of $5.2 million to reduce our investment in RealWear to zero. These investments may not contribute to our earnings or cash flows. In addition, these investments may be required to raise additional capital, which may result in our ownership percentage being decreased.

 

If we are unable to obtain or maintain existing software license relationships or other relationships relating to the intellectual property we use, our ability to grow revenue and achieve profitability and positive cash flow may be negatively affected. Our headset systems include software that we license from other companies. Should we violate the terms of a license, our license could be canceled. Companies may decide to stop supporting the software we license or new versions of the software may not be compatible with our software, which would require us to rewrite our software, which we may not be able to do. Moreover, the license fees we pay may be increased, which would negatively affect our ability to achieve profitability and positive cash flow.

 

The process of seeking patent protection can be time consuming and expensive and we cannot be certain that patents will be issued from currently pending or future patent applications or that our existing patents or any new patents that may be issued will be sufficient in scope and strength to provide meaningful protection or any commercial advantage to us. We may be subject to or may initiate contested patent or patent application proceedings in the United States Patent and Trademark Office, foreign patent offices or the courts, which can demand significant financial and management resources. Patent applications in the U.S. typically are maintained in secrecy until they are published about 18 months after their earliest claim to priority. As publication of discoveries in the scientific and patent literature lags behind actual discoveries, we cannot be certain that we were the first to conceive of inventions covered by our pending patent applications or the first to file patent applications on such inventions. We also cannot be certain that our pending patent applications or those of our licensors will result in issued patents or that any issued patents will afford protection against a competitor. In addition, we cannot be certain that others will not obtain patents that we would need to license, circumvent or cease manufacturing and sales of products covered by these patents, nor can we be sure that licenses, if needed, would be available to us on favorable terms, if at all.

 

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We may incur substantial costs in defending our intellectual property and may not be successful in protecting our intellectual property and proprietary rights. Our success depends in part on our ability to protect our intellectual property and proprietary rights. We have obtained certain domestic and foreign patents and we intend to continue to seek patents on our inventions when appropriate. We also attempt to protect our proprietary information with contractual arrangements and under trade secret laws. Our employees and consultants generally enter into agreements containing provisions with respect to confidentiality and the assignment of rights to us for inventions made by them while in our employ or consulting for us. These measures may not adequately protect our intellectual property or proprietary rights. Existing trade secret, trademark and copyright laws afford only limited protection and our patents could be invalidated, held to be unenforceable or circumvented. Moreover, the laws of certain foreign countries in which our products are or may be manufactured or sold may not provide full protection of our intellectual property rights. Misappropriation of our technology and the costs of defending our intellectual property rights from misappropriation could substantially impair our business. If we are unable to protect our intellectual property or proprietary rights, our business may not be successful, and the price of our common stock may decline.

 

We cannot be certain that foreign intellectual property laws will allow protection of our intellectual property rights or that others will not independently develop similar products, duplicate our products or design around any patents issued or licensed to us. Our products might infringe upon the patent rights of others, whether existing now or in the future. For the same reasons, the products of others could infringe upon our patent rights. We may be notified, from time to time, that we could be or we are infringing certain patents or other intellectual property rights of others. Litigation, which could be very costly and lead to substantial diversion of our resources, even if the outcome is favorable, may be necessary to enforce our patents or other intellectual property rights or to defend us against claimed infringement of the rights of others. These problems can be particularly severe in foreign countries. In the event of an adverse ruling in litigation against us for patent infringement, we might be required to discontinue the use of certain processes, and cease the manufacture, use, importation and/or sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to patents of third parties covering the infringing technology. We cannot be certain that licenses will be obtainable on acceptable terms, if at all, or that damages for infringement will not be assessed or that litigation will not occur. The failure to obtain necessary licenses or other rights or litigation arising out of any such claims could adversely affect our ability to conduct our business as we presently conduct it and as we plan to conduct it in the future.

 

We also attempt to protect our proprietary information with contractual arrangements and under trade secret laws. We believe that our future success will depend primarily upon the technical expertise, creative skills and management abilities of our officers and key employees in addition to patent ownership. Our employees enter into agreements containing provisions with respect to confidentiality and assignment of rights to us for inventions made by them while in our employ. Agreements with consultants generally provide that rights to inventions made by them while consulting for us will be assigned to us unless the assignment of rights is prohibited by the terms of any of their prior agreements. Agreements with employees, consultants and collaborators contain provisions intended to further protect the confidentiality of our proprietary information. To date, we have had no experience in enforcing these agreements. We cannot be certain that these agreements will not be breached or that we would have adequate remedies for any breaches. Our trade secrets may not be secure from discovery or independent development by competitors, in which case we may not be able to rely on these trade secrets to prevent our competitors from using them.

 

Our products could infringe on the intellectual property rights of others. Companies in the display industry steadfastly pursue and protect their intellectual property rights. This has resulted in considerable and costly litigation to determine the validity and enforceability of patents and claims by third parties of infringement of patents or other intellectual property. Our products could be found to infringe on the intellectual property rights of others. Other companies may hold or obtain patents on inventions or other proprietary rights in technology necessary for our business. Periodically, companies inquire about our products and technology in their attempts to assess whether we violate their intellectual property rights. If we are forced to defend against patent infringement claims, we may face costly litigation, diversion of technical and management personnel, and product shipment delays, even if the allegations of infringement are unwarranted. If there are one or more successful claims of infringement against us and we are unable to develop non-infringing technology or license the infringed or similar technology on a timely basis, or if we are required to cease using one or more of our business or product names due to a successful trademark infringement claim against us, our business could be adversely affected. We are currently involved in an intellectual property dispute with Blue Radios, Inc., as described under Item 3. Legal Proceedings. If the outcome of such dispute is adverse to us, our business could be adversely affected.

 

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Our business could suffer if we lose the services of, or fail to attract, key personnel. To continue to provide quality products in our rapidly changing business, we believe it is important to retain personnel with experience and expertise relevant to our business. Our success depends in large part upon a number of key management and technical employees. The loss of the services of one or more key employees, including Dr. John C.C. Fan, our President and Chief Executive Officer, could seriously impede our success. We do not maintain any "key-man” insurance policies on Dr. Fan or any other employees. In addition, due to the level of technical and marketing expertise necessary to support our existing and new customers, our success will depend upon our ability to attract and retain highly skilled management, technical, and sales and marketing personnel. Competition for highly skilled personnel is intense and there may be only a limited number of persons with the requisite skills to serve in these positions. Due to the competitive nature of the labor markets in which we operate, we may be unsuccessful in attracting and retaining these personnel. Our inability to attract and retain key personnel could adversely affect our ability to develop and manufacture our products.

 

If we fail to keep pace with changing technologies, we may lose customers. Rapidly changing customer requirements, evolving technologies and industry standards characterize our industries. To achieve our goals, we need to enhance our existing products and develop and market new products that keep pace with continuing changes in industry standards, requirements and customer preferences. We may be unable to bring to market technologies and products that are attractive to our customers, and as a result our business, financial condition and results of operations may be materially adversely affected.

 

If we fail to comply with complex procurement laws and regulations, we could lose business and be liable for various penalties or sanctions. We must comply with laws and regulations relating to the formation, administration and performance of federal government contracts. These laws and regulations affect how we conduct business with our federal government customers. In complying with these laws and regulations, we may incur additional costs, and non-compliance may result in fines and penalties, including contractual damages. Among the more significant laws and regulations affecting our business are:

 

  The Federal Acquisition Regulation, which comprehensively regulates the formation, administration and performance of federal government contracts;
  The Truth in Negotiations Act, which requires certification and disclosure of all cost and pricing data in connection with contract negotiations;
  The Cost Accounting Standards and Cost Principles, which impose accounting requirements that govern our right to reimbursement under certain cost-based federal government contracts; and
  Laws, regulations and executive orders restricting the use and dissemination of information classified for national security purposes and the export of certain products, services and technical data. We engage in international work falling under the jurisdiction of U.S. export control laws. Failure to comply with these control regimes can lead to severe penalties, both civil and criminal, and can include debarment from contracting with the U.S. government.

 

Our contracting agency customers may review our performance under and compliance with the terms of our federal government contracts. If a government review or investigation uncovers improper or illegal activities, we may be subject to civil or criminal penalties or administrative sanctions, including:

 

  Termination of contracts;
  Forfeiture of profits;

 

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  Cost associated with triggering of price reduction clauses;
  Suspension of payments;
  Fines; and
  Suspension or debarment from doing business with federal government agencies.

 

Additionally, the False Claims Act provides for substantial civil penalties where, for example, a contractor presents a false or fraudulent claim to the government for payment or approval. Civil actions under the False Claims Act may be brought by the government or by other persons on behalf of the government (who may then share a portion of any recovery).

 

If we fail to comply with these laws and regulations, we may also suffer harm to our reputation, which could impair our ability to win awards of contracts in the future or receive renewals of existing contracts. If we are subject to civil or criminal penalties and administrative sanctions or suffer harm to our reputation, our current business, future prospects, financial condition or operating results could be materially harmed.

 

The U.S. government may also revise its procurement practices or adopt new contracting rules and regulations, including cost accounting standards, at any time. Any new contracting methods could be costly to satisfy, be administratively difficult for us to implement and could impair our ability to obtain new contracts.

 

Customer demands and new regulations related to conflict-free minerals may adversely affect us. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act”) imposes disclosure requirements regarding the use of "conflict” minerals mined from the Democratic Republic of Congo and adjoining countries in products, whether or not these products are manufactured by third parties. These requirements could affect the pricing, sourcing and availability of minerals used in the manufacture of semiconductor devices (including our products). We have incurred additional costs associated with complying with the disclosure requirements, such as costs related to determining the source of any conflict minerals used in our products. Our supply chain is complex and we may be unable to verify the origins for all metals used in our products. We purchase materials from foreign sources that may not cooperate and provide us with the necessary information to allow us to comply with the Dodd-Frank Act. This may require us to find alternative sources, which could delay product shipments. We may also encounter challenges with our customers and stockholders if we are unable to certify that our products are conflict-free.

 

Changes in tax laws, unfavorable resolution of tax examinations, or exposure to additional tax liabilities could have a material adverse effect on our results of operations, financial condition and liquidity. We are subject to taxes in the U.S., Korea, China and the United Kingdom. Governments in the jurisdictions in which we operate implement changes to tax laws and regulations periodically. Any implementation of tax laws that fundamentally change the taxation of corporations in the U.S. or in the foreign jurisdictions in which we operate could materially affect our effective tax rate and could have a significant adverse impact on our financial results.

 

We may incur significant liabilities if we fail to comply with stringent environmental laws and regulations and the ITAR, or if we did not comply with these regulations in the past. We are subject to a variety of federal, state and local government regulations related to the use, storage, discharge and disposal of toxic or other hazardous chemicals used in our manufacturing process. We are also subject to federal ITAR laws that regulate the export of technical data and export of products to other nations that may use these products for defense purposes. The failure to comply with present or future regulations could result in fines, suspension of production, or a cessation of operations. Any failure on our part to control the use of, or adequately restrict the discharge of, hazardous substances, or otherwise comply with environmental regulations, could subject us to significant future liabilities. Any failure on our part to obtain any required licenses for the export of technical data and/or export of our products or to otherwise comply with ITAR, could subject us to significant future liabilities. In addition, we cannot be certain that we have not violated applicable laws or regulations in the past, which violations could result in required remediation or other liabilities. We also cannot be certain that past use or disposal of environmentally sensitive materials in conformity with then existing environmental laws and regulations will protect us from required remediation or other liabilities under current or future environmental laws or regulations.

 

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We may be unable to modify our products to meet regulatory or customer requirements. From time to time our display products are subject to new domestic and international requirements, such as the European Union’s Restriction on Hazardous Substances Directive. Our customers’ terms and conditions require us to be in compliance with "all laws.” If we are unable to comply with these regulations, we may not be permitted to ship our products, which would adversely affect our revenue and ability to maintain profitability. In addition, if we are found to be in violation of laws we may be subject to fines and penalties.

 

We may be unable to successfully integrate new strategic acquisitions and investments, which could materially adversely affect our business, results of operations and financial condition. In the past we have made, and in the future we may make, acquisitions of, and investments in, businesses, products and technologies that could complement or expand our business. If we identify an acquisition candidate, we may not be able to successfully integrate the acquired businesses, products or technologies into our existing business and products. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities, amortization expenses and write-downs of acquired assets. In 2017, 2012 and 2011, we acquired 100% of the outstanding shares of NVIS, 80% of the outstanding shares of eMDT Inc. and 100% of the outstanding shares of FDD, respectively. If we are unable to operate NVIS, eMDT, and FDD profitably, our results of operations will be negatively affected. We perform periodic reviews to determine if these investments are impaired, but such reviews are difficult and rely on significant judgment about the company’s technology, ability to obtain customers, and ability to become cash flow positive and profitable. We may take future impairment charges which will have an adverse impact of on our results of operations.

 

Additionally, we have several investments where we may have limited, if any, control over their governance, financial reporting and operations. As a result, we face certain operating, financial and other risks relating to these investments, including risks related to the financial strength of the investments. As a result, these investments may not contribute to our earnings or cash flows. In addition, these investments may be required to raise additional capital, which may result in our ownership percentage being decreased.

 

Changes in China’s laws, legal protections or government policies on foreign investment in China may harm our business. Our business and corporate transactions are subject to laws and regulations applicable to foreign investment in China as well as laws and regulations applicable to foreign-invested enterprises. These laws and regulations frequently change, and their interpretation and enforcement involve uncertainties that could limit the legal protections available to us. Regulations and rules on foreign investments in China impose restrictions on the means that a foreign investor like us may apply to facilitate corporate transactions we may undertake. In addition, the Chinese legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until sometime after the violation. If any of our past operations are deemed to be non-compliant with Chinese law, we may be subject to penalties and our business and operations may be adversely affected. For instance, under the catalogue for the Guidance of Foreign Investment Industries, some industries are categorized as sectors that are encouraged, restricted or prohibited for foreign investment. As the catalogue for the Guidance of Foreign Investment Industries is updated every few years, there can be no assurance that China’s government will not change its policies in a manner that would render part or all of our business to fall within the restricted or prohibited categories. If we cannot obtain approval from relevant authorities to engage in businesses that has become prohibited or restricted for foreign investors, we may be forced to sell or restructure such business. Furthermore, China’s government has broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business and other licenses and requiring actions necessary for compliance. In particular, licenses and permits issued or granted to us by relevant governmental bodies may be revoked at a later time by higher regulatory bodies. If we are forced to adjust our corporate structure or business as a result of changes in government policy on foreign investment or changes in the interpretation and application of existing or new laws, our business, financial condition, results of operations and prospects may be harmed. Moreover, uncertainties in the Chinese legal system may impede our ability to enforce contracts with our business partners, customers and suppliers, or otherwise pursue claims in litigation to recover damages or loss of property, which could adversely affect our business and operations.

 

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Raising additional funds by issuing securities may cause dilution to our existing stockholders or restrict our operations. To the extent that we raise additional capital by issuing equity securities, the share ownership of existing stockholders will be diluted. The terms of any financing may adversely affect the holdings or the rights of our stockholders and the issuance of additional securities, whether equity or debt, or the possibility of such issuance, may cause the market price of our shares to decline. We may sell shares or other securities in other offerings at a price per share that is less than the prices per share paid by other investors, and investors purchasing shares of our common stock or other securities in the future could have rights superior to existing stockholders. The sale of additional equity or convertible securities would dilute all of our stockholders and the terms of these securities may include liquidation or other preferences that adversely affect our existing stockholders.

 

We have no present intention to pay dividends on our common stock in the foreseeable future and, consequently, your only opportunity to achieve a return on your investment during that time is if the price of our common stock appreciates. We have no present intention to pay dividends on our common stock in the foreseeable future. Historically, our earnings, if any, have been retained for the development of our businesses. Any recommendation by our Board of Directors to pay dividends will depend on many factors, including our financial condition, results of operations, and other factors. Accordingly, if the price of our common stock declines in the foreseeable future, you will incur a loss on your investment, without the likelihood that this loss will be offset in part or at all by potential future cash dividends.

 

Our stock price may be volatile in the future. The trading price of our common stock has been subject to wide fluctuations in response to quarter-to-quarter variations in results of operations, announcements of technological innovations or new products by us or our competitors, general conditions in the wireless communications, semiconductor and display markets, changes in earnings estimates by analysts or other events or factors. In addition, the public stock markets recently have experienced extreme price and trading volatility. This volatility has significantly affected the market prices of securities of many technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.

 

Our operations are subject to political, legal and economic risks and natural disasters, which could adversely affect our business, results of operations, financial condition and prospects. Credit rating downgrades in certain European countries and/or speculation regarding changes to the composition or viability of the EU create uncertain global economic conditions. The ongoing uncertainty could have a negative economic impact and result in further volatility in the markets for several years. The impact of the Brexit referendum and such ongoing uncertainty may result in various economic and financial consequences for businesses operating in the UK, the EU and beyond. We hold significant assets in the UK and operate a UK subsidiary, and the future impacts of the Brexit and the continued uncertainty surrounding the EU could have a material impact on our business, financial condition, results of operations and cash flows.

 

Changes in government trade policies may increase the cost of our products, which may materially adversely affect our sales or profitability. We depend on a Taiwanese foundry for the manufacture of integrated circuits for our AMLCD display products and on Chinese and Korean foundries for our OLED display products. In recent years the U.S. has imposed, among other actions, new or higher tariffs on specified imported products originating from China in response to what it characterizes as unfair trade practices, and China has responded by proposing or implementing new or higher tariffs on specified products imported from the U.S. Tariffs on components that we import from China or other nations that have imposed, or may in the future impose, tariffs have in some case and may in the future cause our expenses to increase, which would adversely affect our profitability unless we were able to exclude our products from the tariffs or we raise prices for our products, which may result in our products becoming less attractive relative to products offered by our competitors. In addition, future actions or escalations by either the U.S. or China that affect trade relations may also affect our business or that of our suppliers or customers, and we cannot provide any assurances as to whether such actions will occur or the form that they may take. Moreover, it is uncertain to what extent, if any, the U.S. tariffs on components that we import from China will affect the Taiwanese foundries on which we depend, in part because many Taiwanese foundries conduct parts of their manufacturing in China.

 

A protectionist trade environment in either the U.S. or those foreign countries in which we do business, such as a change in the current tariff structures, export compliance or other trade policies, may materially adversely affect our ability to sell our products in foreign markets. To the extent that our sales or profitability are affected negatively by any such tariffs or other trade actions, our business and results of operations may be materially adversely affected.

 

As a publicly traded company, we are subject to a significant body of regulation, including the Sarbanes-Oxley Act of 2002. While we have developed and instituted a corporate compliance program based on what we believe are the current best practices in corporate governance and continue to update this program in response to newly implemented or changing regulatory requirements, we cannot provide assurance that we are or will be in compliance with all potentially applicable corporate regulations. If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, fines or other sanctions or litigation. If we must disclose any material weakness in our internal control over financial reporting, our stock price could decline.

 

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Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

We lease our 74,000 square foot production facility in Westborough, Massachusetts, 10,000 square feet of which is contiguous environmentally controlled production clean rooms operated between Class 10 and Class 1,000 levels. In addition to our Massachusetts facility, we lease a 10,000 square foot facility in San Jose, California which houses our OLED design team and ASIC development. We also have a lease in Tokyo, Japan.

 

NVIS, our subsidiary in Reston, Virginia, leases 6,100 square feet in Reston. FDD, our subsidiary in Scotland, leases 20,000 square feet in Dalgety Bay, 5,000 square feet of which is contiguous environmentally controlled production clean rooms operated between Class 10 and Class 10,000 levels. FDD also leases an office in Berlin, Germany.

 

At this time, we believe these properties are suitable for our needs for the foreseeable future.

 

Item 3. Legal Proceedings

 

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.

 

BlueRadios, Inc. v. Kopin Corporation, Civil Action No. 16-02052-JLK (D. Col.):

 

On August 12, 2016, BlueRadios, Inc. ("BlueRadios”) filed a complaint in the U.S. District Court for the District of Colorado, alleging that the Company breached a contract between it and BlueRadios concerning an alleged joint venture between the Company and BlueRadios to design, develop and commercialize micro-display products with embedded wireless technology referred to as "Golden-i” breached the covenant of good faith and fair dealing associated with that contract, breached its fiduciary duty to BlueRadios, and misappropriated trade secrets owned by BlueRadios in violation of Colorado law (C.R.S. § 7-74-104(4)) and the Defend Trade Secrets Act (18 U.S.C. § 1836(b)(1)). BlueRadios further alleges that the Company was unjustly enriched by its alleged misconduct, BlueRadios is entitled to an accounting to determine the amount of profits obtained by the Company as a result of its alleged misconduct, and the inventorship on at least ten patents or patent applications owned by the Company need to be corrected to list BlueRadios’ employees as inventors and thereby list BlueRadios as co-assignees of the patents. BlueRadios seeks monetary, declaratory, and injunctive relief, including for alleged non-payment of engineering retainer fees.

 

On October 11, 2016, the Company filed its Answer and Affirmative Defenses. The parties completed expert depositions on November 15, 2019. On December 2, 2019, the Company filed a Motion for Partial Summary Judgment requesting the Court dismiss counts 2-7 in their entirety and counts 1 and 8 in part. BlueRadios also filed a Motion for Partial Summary Judgment alleging it is the co-owner of U.S. Patent No. 8,909,296. Responses to the Motions for Partial Summary Judgment were filed on January 15, 2020, and replies were filed on February 19, 2020. On September 25, 2020, the Court denied BlueRadios’ Motion for Partial Summary Judgment. A trial date has not yet been set by the Court. The Company has not concluded a loss from this matter is probable; therefore, we have not recorded an accrual for litigation or claims related to this matter for the period ended December 26, 2020. The Company will continue to evaluate information as it becomes known and will record an estimate for losses at the time or times when it is both probable that a loss has been incurred and the amount of the loss is reasonably estimable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

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Part II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Our common stock is traded on the Nasdaq Capital Market under the symbol "KOPN”.

 

As of March 1, 2021, there were approximately 320 stockholders of record of our common stock, which does not reflect those shares held beneficially or those shares held in "street” name.

 

We have not paid cash dividends in the past, nor do we expect to pay cash dividends for the foreseeable future. We anticipate that earnings, if any, will be retained for the development of our businesses.

 

Equity Compensation Plan Information

 

The following table sets forth information as of December 26, 2020 about shares of the Company’s common stock issuable upon exercise of outstanding options, warrants and rights and available for issuance under our existing equity compensation plans.

 

Plan Category  Number of securities to be issued upon exercise of outstanding options,
warrants and rights (a)
   Weighted-average exercise price of outstanding options, warrants and rights (b)   Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column
 
(a) (b)
 
Equity compensation plans approved by security holders      $    2,386,387(1)
Equity compensation plans not approved by security holders            

 

(1) Amount includes shares available under the 2020 Equity Incentive Plan.

 

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Company Stock Performance

 

The following graph shows a five-year comparison of cumulative total shareholder return for the Company, the Nasdaq US Benchmark TR Index and the S&P 500 Information Technology index. The graph assumes $100 was invested in each of the Company’s common stock, the Nasdaq US Benchmark TR Index and the S&P 500 Information Technology index on December 31, 2015. Data points on the graph are annual. Note that historical price performance is not necessarily indicative of future performance.

 

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

The following discussion should be read in conjunction with our consolidated financial statements and notes to those statements and other financial information appearing elsewhere in this Form 10-K. The following discussion contains forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of a number of factors, including the risks discussed in Item 1A "Risk Factors,” and elsewhere in this Form 10-K. Please refer to our cautionary note on Forward Looking Statements on page 3 of this Form 10-K.

 

We are a leading developer, manufacturer and seller of miniature displays and optical lenses (our "components”) for sale as individual displays, components, modules or higher-level subassemblies. We also license our intellectual property through technology license agreements. Our component products are used in highly demanding high-resolution portable defense, enterprise and consumer electronic applications, training and simulation equipment and 3D metrology equipment. Our products enable our customers to develop and market an improved generation of products for these target applications.

 

Critical Accounting Estimates

 

Management’s discussion and analysis of our financial condition and results of operations are based upon our audited 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 disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition under the percentage-of-completion method, bad debts, inventories, warranty reserves, investment valuations, valuation of stock compensation awards, recoverability of deferred tax assets, liabilities for uncertain tax positions and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for judgments about carrying values of assets and liabilities that are not apparent from other sources. Actual results may differ from these estimates under different assumptions.

 

We adopted the Financial Accounting Standards Board’s ("FASB”) Accounting Standards Update ("ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) effective December 31, 2017 (the first day of our fiscal year 2018) and applied the modified retrospective method. Our results for reporting periods beginning after December 31, 2017 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting policies ASC 605. We believe the following critical accounting policies are most affected by our more significant judgments and estimates used in the preparation of our consolidated financial statements:

 

Revenue Recognition

 

Substantially all of our product revenues are primarily derived from the sales of microdisplays, which are sold as individual displays, modules which include electronics and optics, or higher-level subassemblies for use in defense, industrial and consumer near-eye applications such as avionic helmets, thermal weapon sights or virtual reality headsets. We also have development contracts for the design, manufacture and modification of products for the U.S. government or a prime contractor for the U.S. government or for a customer that sells into the industrial or consumer markets. The Company’s contracts with the U.S. government are typically subject to the Federal Acquisition Regulations ("FAR”) and are priced based on estimated or actual costs of producing goods. The FAR provides guidance on the types of costs that are allowable in establishing prices for goods provided under U.S. government contracts. The pricing for non-U.S. government contracts is based on the specific negotiations with each customer.

 

Our fixed-price contracts with the U.S. government or other customers may result in revenue recognized in excess of amounts currently billed. We disclose the excess of revenues over amounts actually billed as Contract assets and unbilled receivables on the balance sheet. Amounts billed and due from our customers are classified as Accounts receivable on the balance sheets. In some instances, the U.S. government retains a small portion of the contract price until completion of the contract. The portion of the payments retained until final contract settlement is not considered a significant financing component because the intent is to protect the customer. For contracts with the U.S. government, we typically receive interim payments either as work progresses or by achieving certain milestones or based on a schedule in the contract. We recognize a liability for these advance payments in excess of revenue recognized and present it as Contract liabilities and billings in excess of revenue earned on the balance sheets. The advanced payment typically is not considered a significant financing component because it is used to meet working capital demands that can be higher in the early stages of a contract and to protect us from the other party failing to adequately complete some or all of its obligations under the contract. For industrial and consumer purchase orders, we typically receive payments within 30 to 60 days of shipments of the product, although for some purchase orders, we may require an advanced payment prior to shipment of the product.

 

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To determine the proper revenue recognition method for contracts with the same customer, we evaluate whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. For most of our development contracts and contracts with the U.S. government, the customer contracts with us to provide a significant service of integrating a set of components into a single unit. Hence, the entire contract is accounted for as one performance obligation. Less frequently, however, we may promise to provide distinct goods or services within a contract in which case we separate the contract into more than one performance obligation. If a contract is separated into more than one performance obligation, we allocate the total transaction price to each performance obligation in an amount based on the estimated relative standalone selling prices of the promised goods or services underlying each performance obligation. In cases where we sell standard products, the observable standalone sales are used to determine the standalone selling price.

 

The Company recognizes revenue from a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.

 

For certain contracts with the U.S. government, the Company recognizes revenue over time as we perform because of continuous transfer of control to the customer and the lack of an alternative use for the product. The continuous transfer of control to the customer is supported by liability clauses in the contract that allow the U.S. government to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. For contracts with commercial customers, while the contract may have a similar liability clause, our products historically have an alternative use and thus, revenue is recognized at a point in time.

 

In situations where control transfers over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. We generally use the cost-to-cost approach to measure the extent of progress towards completion of the performance obligation for our contracts because we believe it best depicts the transfer of assets to the customer. Under the cost-to-cost measure approach, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenues are recorded proportionally as costs are incurred.

 

Accounting for design, development and production contracts requires judgment relative to assessing risks, estimating contract revenues and costs and making assumptions for schedule and technical issues. Due to the size and nature of the work required to be performed on many of our contracts, the estimation of total revenue and cost at completion is complicated and subject to many variables. Contract costs include material, labor and subcontracting costs, as well as an allocation of indirect costs. We have to make assumptions regarding the number of labor hours required to complete a task, the complexity of the work to be performed, the availability and cost of materials and performance by our subcontractors. For contract change orders, claims or similar items, we apply judgment in estimating the amounts and assessing the potential for realization. These amounts are only included in contract value when they can be reliably estimated and realization is considered probable. If our estimate of total contract costs or our determination of whether the customer agrees that a milestone is achieved is incorrect, our revenue could be overstated or understated and the profits or loss reported could be subject to adjustment.

 

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For our commercial customers, the Company’s revenue is recognized when obligations under the terms of a contract with our customer is satisfied and the Company transfers control of the products or services, which is generally upon delivery to the customer. Revenue is recorded as the amount of consideration we expect to receive in exchange for transferring goods or providing services. Provisions for product returns and allowances are reductions in the transaction price and are recorded in the same period as the related revenues. We analyze historical returns, current economic trends and changes in customer demand when evaluating the adequacy of sales returns and other allowances. Certain product sales are made to distributors under agreements allowing for a limited right of return on unsold products. Sales to distributors are primarily made for sales to the distributors’ customers and not for stocking of inventory. Sales, value add and other taxes we collect concurrent with revenue-producing activities are excluded from revenue.

 

The Company also licenses its intellectual property ("IP”) through technology license agreements which provides the customer the right to use our IP as it exists at a point in time. These agreements may include other performance obligations including the sale of product to the customer. The satisfaction of the Company’s performance obligation, and related recognition of revenue, occurs when the IP is delivered to the customer, the license period has begun and there are no additional performance obligations in the agreement. When the license is distinct from other obligations in the agreement, the Company treats the license and other performance obligations as separate performance obligations. Accordingly, the license is recognized at a point in time or over time based on the standalone selling price. Under certain license agreements, we may receive royalties based on the sales of the licensed product. We recognize royalty revenue upon the later of when the related sales occur, or when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). Under our current license agreements for which a royalty exists, we have recorded revenue when the related sales by our customer occurs because the performance obligation related to the delivery of the license to the customer has been satisfied.

 

Inventory

 

We provide a reserve for estimated obsolete or unmarketable inventory based on assumptions about future demand and market conditions and our production plans. Inventories that are obsolete or slow moving are generally fully reserved (representing the estimated net realizable value) as such information becomes available. Our display products are manufactured based upon production plans whose critical assumptions include non-binding demand forecasts provided by our customers, lead times for raw materials, lead times for wafer foundries to perform circuit processing and yields. If a customer were to cancel an order or actual demand was lower than forecasted demand, we may not be able to sell the excess display inventory and additional reserves would be required. If we were unable to sell the excess inventory, we would establish reserves to reduce the inventory to its estimated realizable value (generally zero).

 

Investment Valuation

 

We periodically make equity investments in private companies, accounted for as an equity investment, whose values are difficult to determine. The Company adopted ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities and the related amendments on December 31, 2017. The Company adopted the measurement alternative for equity investments without readily determinable fair values (often referred to as cost method investments) on a prospective basis. When assessing investments in private companies for impairment, we consider such factors as, among others, the share price from the investee’s latest financing round, the performance of the investee in relation to its own operating targets and its business plan, the investee’s revenue and cost trends, the liquidity and cash position, including its cash burn rate and market acceptance of the investee’s products and services. Because these are private companies which we do not control we may not be able to obtain all of the information we would want in order to make a complete assessment of the investment on a timely basis. Accordingly, our estimates may be revised if other information becomes available at a later date.

 

In addition to the above, we make investments in government and agency-backed securities and corporate debt securities. For all of our investments we provide for an impairment valuation if we believe a decline in the value of an investment is other-than-temporary, which may have an adverse impact on our results of operations. The determination of whether a decline in value is other-than-temporary requires that we estimate the cash flows we expect to receive from the security. We use publicly available information such as credit ratings and financial information of the entity that issued the security in the development of our expectation of the cash flows to be received. Historically, we have periodically recorded other than temporary impairment losses, however we have not done so recently.

 

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Income Taxes

 

We have historically incurred domestic operating losses from both a financial reporting and tax return standpoint. We establish valuation allowances if it appears more likely than not that our deferred tax assets will not be realized. These judgments are based on our projections of taxable income and the amount and timing of our tax operating loss carryforwards and other deferred tax assets. Given our federal operating tax loss carryforwards, we do not expect to pay domestic federal taxes in the near term. It is possible that we could pay foreign and state income taxes. We are also subject to foreign taxes from our Korean and U.K. subsidiary operations.

 

Our income tax provision is based on calculations and assumptions that will be subject to examination by tax authorities. Despite our history of operating losses there can be exposures for state taxes or foreign tax that may be due. We regularly assess the potential outcomes of these examinations and any future examinations for the current or prior years in determining the adequacy of our provision for income taxes. Should the actual results differ from our estimates, we would have to adjust the income tax provision in the period in which the facts that give rise to the revision become known. Such adjustment could have a material impact on our results of operations. We have historically established valuation allowances against all of our net deferred tax assets because of our history of generating operating losses and restrictions on the use of certain items. Our evaluation of the recoverability of deferred tax assets has also included analysis of the expiration dates of net operating loss carryforwards. In forming our conclusions as to whether the deferred tax assets are more likely than not to be realized we consider the sources of our income and the projected stability of those sources and product life cycles.

 

Goodwill

 

We account for goodwill in accordance with ASC Topic 350. Under ASC Topic 350, goodwill is considered to have an indefinite life, and is carried at cost. Goodwill is not amortized, but is subject to an annual impairment test, as well as between annual tests when events or circumstances indicate that the carrying value may not be recoverable.

 

The Company performs impairment tests of goodwill at its reporting unit level. The goodwill valuations that are utilized to test these assets for impairment are depending on a number of significant estimates and assumptions, including macroeconomic conditions, overall growth rates, competitive activities, cost containment, Company business plans and the discount rate applied to cash flows. We believe these estimates and assumptions are reasonable and are comparable to those that would be used by other market participants. However, actual events and results could differ substantially from those used in our valuations. At December 26, 2020 and December 28, 2019, the ending balance of goodwill was zero.

 

Results of Operations

 

We have two principal sources of revenues: product revenues and research and development ("R&D”) revenues. R&D revenues consist primarily of development contracts with agencies or prime contractors of the U.S. government and commercial enterprises.

 

We manufacture transmissive microdisplays and reflective microdisplays. Our commercial and defense transmissive display production is being performed entirely in our Westborough, Massachusetts facility. FDD, our wholly-owned subsidiary, manufactures our reflective microdisplays in its facility located in Scotland. In 2017, we commenced development of OLED displays which are designed by us and manufactured by third parties for us.

 

We are a display supplier for the U.S. Army’s Family of Weapon Sights Individual program and are undergoing qualification for the FWS - Crew Served variant. We are also in development for a new series of displays for armored vehicles under the M1A2 program. The FWS, M1A2 and our existing production avionic programs are expected to increase production for the next several years. There are other firms offering products which compete against us in the defense programs and all of the programs we supply product to are subject to the U.S. government defense budget and procurement process. Accordingly, there can be no assurances we will continue to ship under our defense contracts.

 

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We offer microdisplays and optical lenses for use in consumer, enterprise and public safety products and systems which are targeted at AR and VR markets, among other areas. We refer to the sale of microdisplays and optical lenses as our component sales. We also offer head mounted, voice and gesture controlled, hands-free headset system designs that include our components and software for consumer and enterprise applications.

 

Predicting our R&D revenue and related trends is challenging because we have limited ability to forecast if we will be awarded additional R&D contracts in the future as such awards depend on the U.S. military budget and priorities. We cannot assure that the R&D contracts will result in workable products or if successful our products developed under these contracts will be procured but our customers. If we do not continue to win R&D contracts or if there is no demand for the products developed under these contracts, our ability to achieve profitability and positive cash flow could be negatively affected because the R&D revenues (or the products derived from the R&D contracts) would not be available to cover the allocated overhead and selling, general and administrative costs which may remain. Some of our contracts are fixed priced and we may incur cost overruns which would result on losses on the contracts. If we incur such losses on our contracts our ability to achieve profitability and positive cash flow could be negatively affected.

 

Because our fiscal year ends on the last Saturday of December every seven years we have a fiscal year with 53 weeks. Our fiscal years 2020, 2019, and 2018 were each 52 week years.

 

Revenues. Our revenues by display application, which include product sales and amounts earned from research and development contracts, for fiscal years 2020, 2019 and 2018 by category, were as follows:

 

(In thousands)  2020   2019   2018 
Defense  $20,231   $8,729   $8,724 
Industrial/Enterprise   6,882    9,717    6,066 
Consumer   852    1,777    4,146 
Research and Development   10,123    4,983    5,254 
Other   553    61    275 
License and royalties   1,487    4,252     
Total Revenues  $40,128   $29,519   $24,465 

 

Fiscal Year 2020 Compared to Fiscal Year 2019

 

Sales of our products for Defense applications include systems used by the military both in the field and for training and simulation. Sales of our products for Defense applications may be for a one-time purchase order or for programs that run for several years. Product sales to defense customers increased in 2020 compared to 2019 due to an increase in shipments of our products into the Family of Weapon Sights Individual (FWS-I) program and the Joint Strike Fighter program. FWS-I and Joint Strike Fighter revenues increased in 2020 over 2019 by 167% and 139%, respectively.

 

Industrial/Enterprise applications revenues represent customers who purchase our display products for use in headsets used for manufacturing, distribution, public safety, 3D metrology equipment and other industrial applications. Our 3D metrology customers are primarily located in Asia and they sell to Asian contract manufacturers who use the 3D metrology machines for quality control purposes. The decrease in Industrial/Enterprise applications revenues in 2020 compared to 2019 was primarily due to a decrease in sales to customers who use our display components in industrial headsets, 3D metrology and safety applications.

 

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Sales of our displays for Consumer applications is primarily for the use in thermal imaging products, recreational rifle and hand-held scopes and drone racing headsets. The decrease in Consumer applications in 2020 compared to 2019 was primarily due to decreased demand for displays and components used in drone racing headsets.

 

R&D revenues increased in 2020 as compared to 2019 primarily due to the completion of performance obligations on funded U.S. defense programs partially offset by lower revenues from OLED development contracts. R&D revenues primarily increased in 2020 over 2019 because we were awarded and commenced work on new contracts to develop technologies we believe will be used in U.S. defense programs. These contracts typically reimburse us for direct costs and allocated overhead and selling, general and administrative costs and in some cases profit. In 2020 and 2019 our R&D revenues exceeded funded R&D expenses by approximately $2.4 million and $0.8 million, respectively, and this increase aided our improved operating results in 2020 as compared to 2019.

 

The decrease in license and royalty revenue in 2020 compared to 2019 is due to the one-time license of IP to RealWear for $3.5 million in 2019 partially offset by royalties earned under IP license agreements.

 

International sales represented approximately 20% and 44% of product revenues for 2020 and 2019, respectively. 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, which could result in a reduction in sales or profitability in those foreign markets. 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 Japanese yen, Great Britain pound and the U.S. dollar. Foreign currency translation impact on our results, if material, is described in further detail under "Item 7A. Quantitative and Qualitative Disclosures About Market Risk” section below.

 

Fiscal Year 2019 Compared to Fiscal Year 2018

 

Sales of our products for Defense applications include systems used by the military both in the field and for training and simulation. Sales of our products for Defense applications may be for a one-time purchase order or for programs that run for several years. Product sales to defense customers were essentially flat for 2019 and 2018.

 

Industrial applications revenues represent customers who purchase our display products for use in headsets used for manufacturing, distribution, public safety, 3D metrology equipment and other industrial applications. Our 3D metrology customers are primarily located in Asia and they sell to Asian contract manufacturers who use the 3D metrology machines for quality control purposes. The increase in Industrial applications in 2019 compared to 2018 was primarily due to an increase in sales to customers who use our display components in industrial headsets and safety applications.

 

Sales of our displays for Consumer applications is primarily for the use in thermal imaging products, recreational rifle and hand-held scopes and drone racing headsets. The decrease in Consumer applications in 2019 compared to 2018 was primarily due to decreased demand for displays and components used in drone racing headsets.

 

Research & Development ("R&D”) revenues decreased in 2019 as compared to 2018 primarily due to due to the completion of performance obligations on funded U.S. defense programs partially offset by revenues from OLED development contracts.

 

The increase in license and royalty revenue in 2019 is due to the one-time license of IP to RealWear for $3.5 million and royalties earned under IP license agreements.

 

International sales represented approximately 44% and 41% of product revenues for 2019 and 2018, respectively. Our international sales are primarily denominated in U.S. currency.

 

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Cost of Product Revenues. Cost of product revenues, which is comprised of materials, labor and manufacturing overhead related to the production of our products for fiscal years 2020, 2019 and 2018 were as follows:

 

(In thousands, except percentages)  2020   2019   2018 
Cost of product revenue  $21,398   $20,902   $15,831 
Cost of product revenues as a % of net product revenues   75.0%   103.0%   82.4%

 

Fiscal Year 2020 Compared to Fiscal Year 2019

 

Cost of product revenues decreased as a percentage of revenues in 2020 as compared to 2019 primarily due to improved yields from our manufacturing process. Improved yields result in lower material cost per unit because we are scrapping less material to produce a unit. In addition, the labor cost per unit declined as employees are not reworking or performing the same manufacturing process multiple times to create a finished product. Also, fixed overhead costs per unit decline because we are producing more units in the manufacturing facility but the cost to run the manufacturing facility does not significantly increase. We were able to improve yields because we have more experience manufacturing our two primary defense products and we are learning ways to improve our processes. In addition, we are working with our subcontractors to improve the quality and lower the cost of the raw materials we acquire. In 2021 we expect some products that are currently in R&D to go into production. We expect these new products to start at lower yields and for us to improve these yields over time. Accordingly, we expect our 2021 cost of product revenues as a percentage of product revenues to be negatively affected by these new products. We are unable to forecast whether our continued yield improvement efforts on our existing products will offset the initial negative impact of the new products coming into production in 2021.

 

Fiscal Year 2019 Compared to Fiscal Year 2018

 

Cost of product revenues increased as a percentage of revenues in 2019 as compared to 2018 primarily due to lower than historical yields from our manufacturing process as a result of initial production of our FWS programs and a charge for inventory obsolescence that resulted from the discontinuance of certain products and the write-off of materials as we have found substitute materials that will provide for better long-term manufacturing yields. The FWS program went into volume production in 2019 and our yields were lower than we historically have as our supply chain took time to consistently meet quality standards.

 

Research and Development. R&D expenses are incurred in support of internal display development programs or programs funded by agencies or prime contractors of the U.S. government and commercial partners. R&D costs include staffing, purchases of materials and laboratory supplies, circuit design costs, fabrication and packaging of display products and allocated overhead. In fiscal year 2020, our R&D expenditures were primarily related to our display products and defense systems. R&D expenses for fiscal years 2020, 2019 and 2018 were as follows:

 

(In thousands)  2020   2019   2018 
Funded  $7,746   $4,216   $4,892 
Internal   3,924    9,133    12,553 
Total  $11,670   $13,349   $17,445 

 

Fiscal Year 2020 Compared to Fiscal Year 2019

 

Funded R&D expense for 2020 increased as compared to 2019 primarily due to an increase in the number of defense related contracts we have been awarded. Internal R&D expense for 2020 decreased as compared to the prior year primarily due to the licensing of certain products and other development programs being curtailed. We expect to incur significant development costs in fiscal year 2021 to develop OLED display products and defense products.

 

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Fiscal Year 2019 Compared to Fiscal Year 2018

 

Funded R&D expense for 2019 decreased as compared to 2018 primarily due to due to the completion of performance obligations on funded U.S. defense programs. Internal R&D expense for 2019 decreased as compared to the prior year primarily due to the licensing of certain products and other development programs being curtailed.

 

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. SG&A expenses for the fiscal years 2020, 2019 and 2018 were as follows:

 

(In thousands, except percentages)  2020   2019   2018 
Selling, general and administrative expense  $11,823   $21,316   $27,211 
Selling, general and administrative expense as a % of total revenue   29.5%   72.2%   111.2%

 

Fiscal Year 2020 Compared to Fiscal Year 2019

 

S,G&A for 2020 decreased as compared to 2019 primarily due to decreases of approximately $1.2 million in non-cash stock-based compensation, $2.9 million in professional fees, $1.4 million in bad debt expense, $1.5 million in product promotion and marketing expenses, and $0.7 million in travel and related expenses.

 

Fiscal Year 2019 Compared to Fiscal Year 2018

 

S,G&A for 2019 decreased as compared to 2018 primarily due to decrease of approximately $2.0 million in non-cash stock-based compensation, $1.0 million in product promotion and marketing expenses, $0.8 million in IT spending, $0.9 million amortization of intangibles and $0.8 million of accrued contingent consideration which were partially offset by an approximate increase of $1.0 million in professional fees.

 

Impairment of Goodwill and Intangibles. Goodwill and intangibles are evaluated for impairment annually or more often if indicators of a potential impairment are present. Our annual impairment testing of goodwill is performed separately from our impairment testing of intangibles. The Company performs impairment tests of goodwill at its reporting unit level. The goodwill valuations that are utilized to test these assets for impairment are depending on a number of significant estimates and assumptions, including macroeconomic conditions, overall growth rates, competitive activities, cost containment, Company business plans and the discount rate applied to cash flows. We believe these estimates and assumptions are reasonable and are comparable to those that would be used by other market participants. Impairment of goodwill for the fiscal years 2020, 2019 and 2018 were as follows:

 

(In thousands)  2020   2019   2018 
Impairment of goodwill  $––   $331   $1,417 

 

During fiscal 2019, we recognized a $0.3 million goodwill impairment charge related to our e-MDT subsidiary. During fiscal 2018, we recognized a $1.4 million goodwill impairment charge related to our NVIS and our Kopin Software Ltd. subsidiaries. See Note 5 of the "Notes to Consolidated Financial Statements” for more information.

 

Impairment of Assets. The Company periodically reviews the carrying value of its long-lived assets to determine if facts and circumstances suggest that they may be impaired or that the amortization or depreciation period may need to be changed. The carrying value of a long-lived asset is considered impaired when the anticipated identifiable undiscounted cash flows from such asset are less than its carrying value. For assets that are to be held and used, impairment is measured based upon the amount by which the carrying amount of the asset exceeds its fair value. Impairment of assets for the fiscal years 2020, 2019 and 2018 were as follows:

 

(In thousands)  2020   2019   2018 
Impairment of assets  $   $   $2,527 

 

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During fiscal 2018, we recognized a $2.5 million asset impairment charge related to equipment as discussed further in Note 2. of the "Notes to Consolidated Financial Statements.”

 

Total Other Income (Expense), Net. Other income (expense), net, is primarily composed of interest income, foreign currency transaction, remeasurement gains and losses incurred by our UK-based subsidiaries and other non-operating income items. Other income (expense), net, for the fiscal years 2020, 2019 and 2018 were as follows:

 

(In thousands)  2020   2019   2018 
Total other income (expense), net  $361   $(2,887)  $5,514 

 

Fiscal Year 2020 Compared to Fiscal Year 2019

 

In 2020 we recorded $0.3 million of foreign currency gains compared to $0.2 million of foreign currency gains recorded in 2019. In 2019, we recorded a non-cash $1.4 million gain on equity investments and an impairment charge of $5.2 million on equity investment.

 

Fiscal Year 2019 Compared to Fiscal Year 2018

 

In 2019 we recorded $0.2 million of foreign currency gains compared to $1.2 million of foreign currency gains recorded in 2018. In 2019, we recorded a non-cash $1.4 million gain on equity investments and an impairment charge of $5.2 million on equity investment. In 2018, we recorded a non-cash $2.8 million gain on equity investments. In 2018, the Company received $1.0 million of insurance proceeds related to the embezzlement at our former Korean subsidiary.

 

Tax provision

 

(In thousands)  2020   2019   2018 
Tax provision  $(129)  $(108)  $(30)

 

Fiscal Year 2020 Compared to Fiscal Year 2019

 

The provision for income taxes for the fiscal years ended 2020 and 2019 of approximately $(0.1) million was due to a change in estimates related to uncertain tax positions and deferred tax liabilities for the Company’s former Korean subsidiary.

 

Fiscal Year 2019 Compared to Fiscal Year 2018

 

The provision for income taxes for the fiscal years ended 2019 and 2018 of approximately $(0.1) and $(0.03) million respectively, was due to a change in estimates related to uncertain tax positions and deferred tax liabilities for the Company’s former Korean subsidiary.

 

Net (income) loss attributable to noncontrolling interest. As of December 26, 2020, we owned 80% of the equity of eMDT. Net loss 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 in 2020 compared to 2019 is $0.3 million and is a result of net loss attributable to minority shareholders of eMDT.

 

The change in net (income) loss attributable to noncontrolling interest in 2019 compared to 2018 is $0.1 million and is a result of net income attributable to minority shareholders of eMDT.

 

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Liquidity and Capital Resources

 

At December 26, 2020 and December 28, 2019, we had cash and cash equivalents and marketable securities of $20.7 million and working capital of $22.6 million compared to $21.8 million and $22.5 million, respectively. The change in cash and cash equivalents and marketable securities was primarily due to net outflow of cash used in operating activities of $4.4 million, which was offset by financing activities of $3.7 million.

 

In the fourth quarter of 2020, we issued 1.9 million shares of our common stock pursuant to our At-The-Market Equity Offering Sales Agreement dated as of February 8, 2019 with Stifel, Nicolaus & Company, Incorporated, as agent (the "ATM Agreement”) for $4.0 million (average of $2.05 per share) in gross proceeds before deducting broker expenses paid by us of $0.1 million. The net proceeds from the sale of common shares were used for general corporate purposes, including working capital. In Q1 2021, we sold 2.4 million shares of common stock for gross proceeds of $16 million (average of $6.66 per share), before deducting broker expenses paid by us of $0.5 million under the ATM Agreement. The ATM Agreement has since terminated pursuant to its terms as a result of the sale of all the shares subject to such agreement.

 

During the second quarter of the fiscal year ending December 26, 2020, we received the proceeds from loans in the amount of approximately $2.2 million (the "PPP Loan”) pursuant to the Paycheck Protection Program ("PPP”) of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act”). During the second quarter of the fiscal year ending December 26, 2020 we repaid $2.1 million of the loans and we repaid $0.1 million in July 2020. Our decision to terminate the loans was based on additional guidance issued by the Small Business Administration. There were no prepayment penalties in connection with the voluntary repayment.

 

On March 15, 2019, we sold 7.3 million shares of registered common stock for gross proceeds of $8.0 million ($1.10 per share), before deducting underwriting discounts and offering expenses paid by us of $0.7 million. This represented approximately 8.9% of Kopin’s total outstanding shares of common stock as of the date of purchase. The net proceeds from the offering were used for general corporate purposes, including working capital. On April 10, 2019, we sold 0.7 million shares of registered common stock for gross proceeds of $0.8 million ($1.10 per share), before deducting underwriting discounts and offering expenses paid by us of less than $0.1 million, pursuant to the partial exercise of the underwriters’ overallotment option in connection with the March 15, 2019 public offering. This represented approximately 0.8% of Kopin’s total outstanding shares of common stock as of the date of purchase.

 

Cash and cash equivalents and marketable debt securities held in U.S. dollars at:

 

   December 26,
2020
   December 28,
2019
 
Domestic locations  $19,724,103   $21,148,381 
Foreign locations   340,217    145,240 
Subtotal cash and cash equivalents and marketable debt securities held in U.S. dollars   20,064,320    21,293,621 
Cash and cash equivalents held in other currencies and converted to U.S. dollars   684,230    488,623 
Total cash and cash equivalents and marketable debt securities  $

20,748,550

   $21,782,244 

 

We have no plans to repatriate the cash and cash equivalents held in our foreign subsidiary FDD.

 

The manufacturing operations at our Korean facility, Kowon, have ceased and Kowon was liquidated at fiscal year ended 2018. The Company has approximately $0.4 million of cash and cash equivalents in Korea at December 26, 2020. The Company has recorded deferred tax liabilities for any additional withholding tax that may be due to the Korean government upon Kowon’s final tax return acceptance.

 

In March 2017, we purchased 100% of the outstanding stock of NVIS, a producer of virtual reality systems for 3D applications, for $3.7 million. As part of the purchase, we agreed to pay up to an additional $2.0 million if certain future operating performance milestones are met and the selling shareholders remain employed with NVIS through March 2020. We have paid $1.8 million in contingent consideration through December 26, 2020 and there are no remaining contingent payment obligations related to the NVIS purchase as of December 26, 2020. As there was a requirement to remain employed to earn the contingent payments, these contingent payments were treated as compensation expense.

 

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We expect to expend between $1.0 million and $2.0 million on capital expenditures over fiscal 2021.

 

We entered into an agreement in August 2017 to acquire an approximate 3.5% equity interest in Kunming BOE Display Technology Co., Ltd. ("BOE”), which is located in China, for 35.0 million Chinese Yuan Renminbi (approximately $5.0 million). We initially attempted to make our investment but were unable to due to Chinese investment rules and we received an extension to make our investment. However, BOE needed to complete the fund raising and we agreed to transfer our rights to the equity to another shareholder of BOE.

 

In the second quarter of 2019, we made an additional equity investment in RealWear, Inc. of $2.5 million by participating in an equity raise by RealWear. In the fourth quarter of 2019 Kopin reviewed the financial condition and other factors of RealWear and as a result, in the fourth quarter of 2019, we recorded an impairment charge of $5.2 million to reduce our investment in RealWear to zero as of December 28, 2019.

 

On September 30, 2019 we entered into the Solos Purchase Agreement with Solos Technology, pursuant to which we sold and licensed certain assets of our Solos product line and Whisper technology. As consideration for the transaction, we received a 20.0% equity stake in Solos Technology’s parent company, Solos Inc. Our 20.0% equity stake will be maintained until Solos Inc. has raised a total of $7.5 million in equity financing. We will also receive a royalty in the single digits on the net sales amount of Solos products for a three-year period, after commencement of commercial production. Based on the price paid for equity by the other 80% owners of Solos Inc., volatility based on a peer group and assumptions about the risk free interest rate, we estimated the fair value of our equity holdings at $0.6 million and recorded $0.6 million gain on investment for this equity transaction as the basis of assets transferred was zero.

 

We have incurred net losses of $4.4 million, $29.5 million and $34.5 million for the fiscal years 2020, 2019 and 2018, respectively, and net cash outflows from operations of $4.4 million, $21.0 million and $28.1 million for the fiscal years ended 2020, 2019 and 2018, respectively. Our decline in cash and cash equivalents and marketable debt securities was partially a result of funding our ongoing investments in research and development which we believe will continue. We have in the past sold equity securities through an At The Money program and in the traditional fashion of significant equity offerings. We estimate we will have sufficient liquidity to fund operations at least through Q1 2022. Nonetheless, we monitor the capital markets on an ongoing basis and may consider raising capital if favorable market conditions develop. If our actual results are less than projected or we need to raise capital for additional liquidity, we may be required to do additional equity financings, reduce expenses or enter into a strategic transaction. However, we can make no assurance that we will be able to raise additional capital, reduce expenses sufficiently, or enter into a strategic transaction on terms acceptable to us, or at all.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements.

 

Seasonality

Our revenues have not followed a seasonal pattern for the past three years and we do not anticipate any seasonal trend to our revenues in 2021.

 

Contractual Obligations

 

The following is a summary of our contractual lease payment obligations as of December 26, 2020:

 

   Payment due by period 
   Total   Less than 1 year   1-3 Years   4-5 years   More than 5 years 
Operating Lease Obligations  $1,924,296    1,065,879    858,417       $ 

 

38
 

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

We invest our excess cash in high-quality U.S. government, government-backed (i.e.: Fannie Mae, FDIC guaranteed bonds and certificates of deposit) and corporate debt instruments, which bear lower levels of relative risk. We believe 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 to our cash flows or income. It is possible that interest rate movements would increase our unrealized gain or loss on debt securities. We are exposed to changes in foreign currency exchange rates primarily through our translation of our foreign subsidiaries’ financial position, results of operations, and transaction gains and losses as a result of non U.S. dollar denominated cash flows related to business activities in Asia and Europe, and remeasurement of U.S. dollars to the functional currency of our U.K. subsidiary. We are also exposed to the effects of exchange rates in the purchase of certain raw materials which are in U.S. dollars but the price on future purchases is subject to change based on the relationship of the Japanese yen to the U.S. dollar. We do not currently hedge our foreign currency exchange rate risk. We estimate that any market risk associated with our international operations or investments is unlikely to have a material adverse effect on our business, financial condition or results of operation. Our portfolio of marketable debt securities is subject to interest rate risk although our intent is to hold securities until maturity. The credit rating of our investments may be affected by the underlying financial health of the guarantors of our investments. We use silicon wafers in our production processes but do not enter into forward or futures hedging contracts.

 

Item 8. Financial Statements and Supplementary Data

 

The financial statements required by this Item are included in this Report on pages 41 through 70. Reference is made to Item 15 of this Report.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

Not applicable.

 

Item 9A. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

In connection with filing the Form 10-K, management, under the supervision of and with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act”), as of the end of the period covered by our Annual Report on Form 10-K for the fiscal year ended December 26, 2020. Based upon that evaluation, our CEO and CFO concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in ensuring that material information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, including ensuring that such material information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

 

Management’s Annual Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the Company’s Board of Directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and include those policies and procedures that:

 

  Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
  Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made in accordance with authorizations of management and directors of the company; and
  Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our internal control over financial reporting as of December 26, 2020, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that evaluation, our management concluded that, as of December 26, 2020, internal control over financial reporting was effective based on criteria established in Internal Control-Integrated Framework issued by the COSO.

 

39
 

 

Remediation

 

To remediate the material weakness, we implemented additional review procedures, including increasing the scope of activities from the accounting firm we use to assist us in internal control reviews, to ensure the financial statements we issue are prepared in accordance with GAAP and are fairly presented in all material respects. During 2019 and 2020 we did not identify any deficiencies in the monitoring and of accounting for non-routine transactions and therefore management concluded that the material weakness has been remedied as of December 26, 2020.

 

Changes in Internal Control Over Financial Reporting

 

Except for the change in our internal controls, as discussed in this Item 9A, there were no changes in our internal control over financial reporting that occurred during the fiscal year ended December 26, 2020 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

Item 9B. Other Information

 

None.

 

Item 10. Directors, Executive Officers and Corporate Governance

 

The information required under this item is incorporated herein by reference from our Proxy Statement relating to our 2021 Annual Meeting of Stockholders (the "Proxy Statement”). We expect to file the Proxy Statement with the SEC in April, 2021 (and, in any event, no later than 120 days after the close of our last fiscal year).

 

Code of Ethics. We have adopted a Code of Business Conduct and Ethics (the Code) that applies to all of our employees (including our CEO and CFO) and directors. The Code is available on our website at www.kopin.com. We intend to satisfy the disclosure requirement regarding any amendment to or waiver of a provision of the Code applicable to any executive officer or director, by posting such information on our website.

 

Our corporate governance guidelines, whistleblower policy and the charters of the audit committee, compensation committee and nominating and corporate governance committee of the Board of Directors as well as other corporate governance document materials are available on our website at www.kopin.com under the heading "Investors,” then "Corporate Governance” then "Governance Documents.”

 

Item 11. Executive Compensation

 

The information required by this item is incorporated herein by reference from the Proxy Statement.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The information required by this item is incorporated herein by reference from the Proxy Statement. Refer also to the equity compensation plan information set forth in Part II Item 5 of this Annual Report on Form 10-K.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

 

The information required by this item is incorporated herein by reference from the Proxy Statement.

 

Item 14. Principal Accounting Fees and Services

 

The information required by this item is incorporated herein by reference from the Proxy Statement.

 

40
 

 

Part IV

 

Item 15. Exhibits and Financial Statement Schedules

 

(1) Consolidated Financial Statements:

 

   Page 
Reports of Independent Registered Public Accounting Firm   42 
      
Consolidated Balance Sheets   44 
      
Consolidated Statements of Operations   45 
      
Consolidated Statements of Comprehensive Loss   46 
      
Consolidated Statements of Stockholders’ Equity   47 
      
Consolidated Statements of Cash Flows   48 
      
Notes to Consolidated Financial Statements   49 

 

(2) Financial Statement Schedules:

 

Financial Statement Schedules have been omitted because the information required to be set forth therein is not applicable or is shown in the accompanying Consolidated Financial Statements or notes thereto.

 

(3) Exhibits:

 

The exhibits filed as part of this Form 10-K are listed on the exhibit index immediately preceding such exhibits and is incorporated herein by reference.

 

41
 

 

Report of Independent Registered Public Accounting Firm

 

To the Stockholders and the Board of Directors of Kopin Corporation

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of Kopin Corporation and its subsidiaries (the Company) as of December 26, 2020 and December 28, 2019, the related consolidated statements of operations, comprehensive loss, stockholders’ equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 26, 2020 and December 28, 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

Critical Audit Matters

 

The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

 

Research and Development Revenues

 

As described in Note 1 of the consolidated financial statements, the Company’s research and development revenues were $11,609,795 for the year ending December 26, 2020. The Company recognizes revenue for certain of its research and development contracts over time, generally using the input method. Progress and revenues from research and development contracts are generally recognized on an input method of accounting as costs are incurred. Under the input method, revenue is recognized based on contract costs expended to date relative to total contract costs intended to be expended. Management exercises significant judgment in determining revenue recognition for these customer contracts as the estimate of the total contract costs is critical to the recognition of revenue based under the input method.

 

We identified the Company’s accounting for revenue recognition of research and development contracts to be a critical audit matter because of the significant assumptions and judgments used by management in determining the estimated costs to be incurred throughout the customer contract. Auditing management’s estimation of cost recognition required significant audit effort and a high degree of auditor judgment and subjectivity to evaluate the audit evidence obtained.

 

Our audit procedures related to the Company’s revenue recognition of research and development contracts included the following, among others:

 

    Evaluated the reasonableness of management estimates of cost recognition for a selection of contracts by comparing costs incurred under completed contracts to the costs estimated by management.
  We selected a sample of customer contracts and performed the following procedures:
      Read the underlying contracts and agreed the Company’s total budgeted costs to approved management budgets.
      Evaluated management’s ability to achieve the estimates of total profit by performing corroborating inquiries with Company personnel, including project managers, and comparing the estimates to actual subsequent results and documentation such as management’s internal budgets and specified contract terms.

 

/s/ RSM US LLP

 

We have served as the Company’s auditor since 2019.

 

Stamford, Connecticut

March 5, 2021

 

42

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Stockholders and the Board of Directors of Kopin Corporation

 

Opinion on the 2018 Financial Statements

 

We have audited the consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows of Kopin Corporation and subsidiaries (the "Company”) for the year ended December 29, 2018, and the related notes (collectively referred to as the "2018 financial statements”). In our opinion, the 2018 financial statements, present fairly, in all material respects, the results of the Company’s operations and its cash flows for the year ended December 29, 2018, in conformity with accounting principles generally accepted in the United States of America.

 

Going Concern

 

The 2018 financial statements were prepared assuming that the Company would continue as a going concern. The Company had suffered recurring losses from operations and recurring negative operating cash flows that raised substantial doubt about its ability to continue as a going concern. The 2018 financial statements did not include any adjustments that might result from the outcome of this uncertainty.

 

Change in Accounting Principle

 

As discussed in Note 1 to the 2018 financial statements, the Company adopted Accounting Standards Codification (ASC) Topic 606, "Revenue from Contracts with Customers,” using the modified retrospective adoption method on December 31, 2017.

 

Basis for Opinion

 

These 2018 financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s 2018 financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 2018 financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the 2018 financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the 2018 financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the 2018 financial statements. We believe that our audit provides a reasonable basis for our opinion.

 

/s/ Deloitte and Touche LLP

Boston, Massachusetts

March 13, 2019 (November 7, 2019, as to the effects of the correction of previously issued financial statements)

 

We served as the Company’s auditor since at least 1987; however, an earlier year could not be reliably determined. In 2019 we became the predecessor auditor.

 

43

 

 

KOPIN CORPORATION

CONSOLIDATED BALANCE SHEETS

 

   December 26, 2020   December 28, 2019 
ASSETS          
Current assets:          
Cash and cash equivalents  $17,112,869   $6,029,247 
Marketable debt securities, at fair value   3,635,681    15,752,997 
Accounts receivable, net of allowance of $175,000 and $938,000 in 2020 and 2019, respectively   9,260,865    6,023,250 
Contract assets and unbilled receivables   3,521,753    921,082 
Inventory   4,455,756    3,768,696 
Prepaid taxes   205,568    104,442 
Prepaid expenses and other current assets   1,263,688    1,164,927 
Total current assets   39,456,180    33,764,641 
Property, plant and equipment, net   1,626,930    1,473,341 
Operating lease right-of-use assets   1,780,039    2,753,963 
Other assets   162,473    517,411 
Equity investments   4,523,525    4,537,159 
Total assets  $47,549,147   $43,046,515 
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current liabilities:          
Accounts payable  $5,606,910   $3,998,234 
Accrued payroll and expenses   1,977,851    2,203,773 
Accrued warranty   508,000    509,000 
Contract liabilities and billings in excess of revenue earned   1,493,847    796,794 
Operating lease liabilities   982,375    1,041,695 
Other accrued liabilities   1,809,495    2,202,217 
Customer deposits   3,950,031    33,000 
Deferred tax liabilities   554,000    525,000 
Total current liabilities   16,882,509    11,309,713 
Noncurrent contract liabilities and asset retirement obligations   276,409    268,440 
Operating lease liabilities, net of current portion   821,306    1,791,590 
Other long-term liabilities   1,270,328    1,085,160 
Commitments and contingencies (Note 13)   -    - 
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 91,059,407 shares in 2020 and 88,912,796 shares in 2019; outstanding 85,443,378 in 2020 and 82,536,416 in 2019, respectively   880,075    870,496 
Additional paid-in capital   341,512,893    344,456,537 
Treasury stock (2,564,155 and 4,513,256 shares in 2020 and 2019, at cost)   (9,793,946)   (17,238,669)
Accumulated other comprehensive income   1,484,434    1,757,184 
Accumulated deficit   (305,648,025)   (301,236,913)
Total Kopin Corporation stockholders’ equity   28,435,431    28,608,635 
Noncontrolling interest   (136,836)   (17,023)
Total stockholders’ equity   28,298,595    28,591,612 
Total liabilities and stockholders’ equity  $47,549,147   $43,046,515 

 

See Accompanying Notes to Consolidated Financial Statements.

 

44

 

 

KOPIN CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

 

  2020   2019   2018 
Fiscal year ended  2020   2019   2018 
Revenues:               
Net product revenues  $28,517,874   $20,283,888   $19,211,115 
Research and development and other revenues   11,609,795    9,234,921    5,253,890 
Total revenue   40,127,669    29,518,809    24,465,005 
Expenses:               
Cost of product revenues   21,398,381    20,901,538    15,831,441 
Research and development-funded programs   7,745,762    4,216,161    4,892,066 
Research and development-internal   3,924,241    9,132,969    12,553,237 
Selling, general and administrative   11,822,703    21,316,459    27,210,849 
Impairment of goodwill       331,344    1,417,470 
Impairment of assets           2,526,669 
Total operating expenses   44,891,087    55,898,471    64,431,732 
Loss from operations   (4,763,418)   (26,379,662)   (39,966,727)
Non-operating income (expense), net:               
Interest income   132,642    543,759    640,059 
Other (expense) income, net   (35,463)   225,617    855,106 
Foreign currency transaction gains   293,670    202,517    1,169,254 
(Loss) gain on investments   (29,356)   (3,858,453)   2,849,816 
Total non-operating income (expense)   361,493    (2,886,560)   5,514,235 
Loss before provision for income taxes and net loss (income) of noncontrolling interest   (4,401,925)   (29,266,222)   (34,452,492)
Tax provision   (129,000)   (108,000)   (30,000)
Net loss   (4,530,925)   (29,374,222)   (34,482,492)
Net loss (income) attributable to the noncontrolling interest   119,813    (132,030)   (51,050)
Net loss attributable to Kopin Corporation  $(4,411,112)  $(29,506,252)  $(34,533,542)
Net loss per share:               
Basic and diluted  $(0.05)  $(0.37)  $(0.47)
Weighted average number of common shares outstanding:               
Basic and diluted   82,347,741    80,282,126    73,156,545 

 

See Accompanying Notes to Consolidated Financial Statements.

 

45

 

 

KOPIN CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

 

  2020   2019   2018 
Fiscal year ended  2020   2019   2018 
Net loss  $(4,530,925)  $(29,374,222)  $(34,482,492)
Other comprehensive income (loss), net of tax:               
Foreign currency translation adjustments   (67,852)   (206,580)   (1,912,427)
Unrealized holding gain (loss) on marketable securities   (183,870)   446,533    (264,949)
Reclassifications of (loss) gain in net loss on marketable securities   (21,028)   (37,356)   49,525 
Other comprehensive income (loss), net of tax   (272,750)   202,597    (2,127,851)
Comprehensive loss   (4,803,675)   (29,171,625)   (36,610,343)
Comprehensive (income) loss attributable to the noncontrolling interest   119,813    (132,030)   66,609 
Comprehensive loss attributable to Kopin Corporation  $(4,683,862)  $(29,303,655)  $(36,543,734)

 

See Accompanying Notes to Consolidated Financial Statements.

 

46

 

 

KOPIN CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

   Shares   Amount   Capital   Stock   Income   Deficit   Equity   Interest   Equity 
   Common Stock   Additional Paid-in   Treasury   Accumulated Other Comprehensive   Accumulated   Total Kopin Corporation Stockholders’   Noncontrolling   Total Stockholders’ 
   Shares   Amount   Capital   Stock   Income   Deficit   Equity   Interest   Equity 
Balance at December 30, 2017   77,572,038   $775,720   $329,917,858   $(17,238,669)  $3,564,779   $(240,256,502)  $76,763,186   $616,661   $77,379,847 
Vesting of restricted stock   1,093,000    10,930    (10,930)                        
Stock-based compensation expense           4,791,054                4,791,054        4,791,054 
Other comprehensive income (loss)                   (2,010,192)       (2,010,192)   (117,659)   (2,127,851)
Restricted stock for tax withholding obligations   (142,972)   (1,430)   (206,585)               (208,015)       (208,015)
Distribution to noncontrolling interest holder                               (699,105)   (699,105)
Adoption of accounting standard                       3,059,383    3,059,383        3,059,383 
Net (loss) income                       (34,533,542)   (34,533,542)   51,050    (34,482,492)
Balance at December 29, 2018   78,522,066    785,220    334,491,397    (17,238,669)   1,554,587    (271,730,661)   47,861,874    (149,053)   47,712,821 
Vesting of restricted stock   634,511    6,345    (6,345)                        
Stock-based compensation expense           2,057,400                2,057,400        2,057,400 
Other comprehensive loss                   202,597        202,597        202,597 
Restricted stock for tax withholding obligations   (86,086)   (861)   (44,652)               (45,513)       (45,513)
Sale of registered stock, net of costs   7,979,181    79,792    7,958,737                8,038,529        8,038,529 
Net (loss) income                       (29,506,252)   (29,506,252)   132,030    (29,374,222)
Balance at December 28, 2019   87,049,672    870,496    344,456,537    (17,238,669)   1,757,184    (301,236,913)   28,608,635    (17,023)   28,591,612 
Vesting of restricted stock   1,038,655    10,387    (10,387)                        
Stock-based compensation expense           821,122                821,122        821,122 
Other comprehensive loss                   (272,750)       (272,750)       (272,750)
Restricted stock for tax withholding obligations   (80,792)   (808)   (139,118)               (139,926)       (139,926)
Sale of treasury stock, net of costs           (3,615,261)   7,444,723            3,829,462        3,829,462 
Net loss                       (4,411,112)   (4,411,112)   (119,813)   (4,530,925)
Balance at December 26, 2020   88,007,535   $880,075   $341,512,893   $(9,793,946)  $1,484,434   $(305,648,025)  $28,435,431   $(136,836)  $28,298,595 

 

See Accompanying Notes to Consolidated Financial Statements.

 

47

 

 

KOPIN CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

  2020   2019   2018 
Fiscal year ended  2020   2019   2018 
Cash flows from operating activities:               
Net loss  $(4,530,925)  $(29,374,222)  $(34,482,492)
Adjustments to reconcile net loss to net cash used in operating activities:               
Depreciation and amortization   651,083    792,221    1,958,680 
Accretion of premium or discount on marketable debt securities   7,762    21,838    15,948 
Stock-based compensation   821,122    2,057,400    4,791,054 
Net loss (gain) on investment transactions   29,356    3,858,453    (2,849,816)
Income taxes   116,536    105,036    4,185 
Foreign currency (gains) losses   (289,471)   (220,015)   (1,096,487)
Loss on sale of property and plant       508,833    51,159 
Impairment of assets           2,526,669 
Impairment of goodwill       331,344    1,417,470 
Change in allowance for bad debt   (763,159)   633,131    (155,000)
Write-off of excess inventory   667,019    1,834,300    832,615 
Change in warranty reserves   (1,172)   (62,107)   (79,633)
Changes in assets and liabilities:               
Accounts receivable   (2,954,703)   (3,944,859)   853,163 
Contract assets and unbilled receivables   (2,600,671)   2,168,581    865,474 
Inventory   (1,332,139)   (792,165)   (1,656,196)
Prepaid expenses, other current assets and other assets   (160,371)   821,340    113,015 
Accounts payable and accrued expenses   5,227,011    (163,084)   (1,208,848)
Billings in excess of revenue earned   695,565    397,121    (4,742)
Net cash used in operating activities   (4,417,157)   (21,026,854)   (28,103,782)
Cash flows from investing activities:               
Proceeds from sale of marketable debt securities   12,148,117    7,454,139    26,646,078 
Purchase of marketable debt securities           (5,697,329)
Equity investments purchase       (2,500,000)   (1,000,000)
Other assets   193,186    (41,031)   (8,373)
Capital expenditures   (542,862)   (170,186)   (1,183,131)
Net cash provided by investing activities   11,798,441    4,742,922    18,757,245 
Cash flows from financing activities:               
Sale of treasury stock, net of costs   3,829,462         
Sale of registered stock, net of costs       8,038,529     
Settlements of restricted stock for tax withholding obligations   (139,926)   (45,513)   (208,015)
Distribution to noncontrolling interest holder           (699,105)
Net cash provided by (used in) financing activities   3,689,536    7,993,016    (907,120)
Effect of exchange rate changes on cash   12,802    (6,184)   (268,223)
Net increase (decrease) in cash and cash equivalents   11,083,622    (8,297,100)   (10,521,880)
Cash and cash equivalents at beginning of year   6,029,247    14,326,347    24,848,227 
Cash and cash equivalents at end of year  $17,112,869   $6,029,247   $14,326,347 
Supplemental disclosure of cash flow information:               
Income taxes paid  $   $   $1,374,000 
Construction in progress included in accrued expenses  $257,000   $   $ 

 

See Accompanying Notes to Consolidated Financial Statements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Summary of Significant Accounting Policies

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As used in these notes, the terms "we,” "us,” "our,” "Kopin” and the "Company” mean Kopin Corporation and its subsidiaries, unless the context indicates another meaning.

 

Fiscal Year

 

The Company’s fiscal year ends on the last Saturday in December. The fiscal years ended December 26, 2020, December 28, 2019, and December 29, 2018 includes 52 weeks and are referred to as fiscal years 2020, 2019 and 2018, respectively, herein. Because our fiscal year ends on the last Saturday of December every seven years we have a fiscal year with 53 weeks.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Kopin Corporation, its wholly owned subsidiaries and a majority owned 80% subsidiary, eMDT America Inc. ("eMDT”), located in California (collectively the Company). Net loss attributable to noncontrolling interest in the Company’s Consolidated Statement of Operations represents the portion of the results of operations of which is allocated to the shareholders of the equity interests not owned by the Company. All intercompany transactions and balances have been eliminated.

 

Revenue Recognition

 

The Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) effective December 31, 2017 and applied the modified retrospective method. The Company recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of accumulated deficit.

 

Substantially all of our product revenues are either derived from the sales of components or subassemblies for use in defense applications or industrial headset systems. We also have development contracts for the design, manufacture and or modification of products for the U.S. government or prime contractors for the U.S. government and for customers that expects to sell into the industrial or consumer markets. The Company’s contracts with the U.S. government are typically subject to the Federal Acquisition Regulations ("FAR”) and are priced based on estimated or actual costs of producing goods. The FAR provides guidance on the types of costs that are allowable in establishing prices for goods provided under U.S. government contracts. The pricing for non-U.S. government contracts is based on the specific negotiations with each customer.

 

Our fixed-price contracts with the U.S. government or other customers may result in revenue recognized in excess of amounts currently billed. We disclose the excess of revenues over amounts actually billed as Contract assets and unbilled receivables on the balance sheet. Amounts billed and due from our customers are classified as Accounts receivable on the balance sheets. In some instances, the U.S. government retains a small portion of the contract price until completion of the contract. The portion of the payments retained until final contract settlement is not considered a significant financing component because the intent is to protect the customer. For contracts with the U.S. government and some commercial customers, we typically receive interim payments either as work progresses or by achieving certain milestones or based on a schedule in the contract. We recognize a liability for these advance payments in excess of revenue recognized and present it as Contract liabilities and billings in excess of revenue earned on the balance sheets. The advanced payment typically is not considered a significant financing component because it is used to meet working capital demands that can be higher in the early stages of a contract and to protect us from the other party failing to adequately complete some or all of its obligations under the contract. For industrial and consumer purchase orders, we typically receive payments within 30 to 60 days of shipments of the product, although for some purchase orders, we may require an advanced payment prior to shipment of the product.

 

49

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

 

To determine the proper revenue recognition method for contracts with the same customer, we evaluate whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. For most of our development contracts and contracts with the U.S government, the customer contracts with us to provide a significant service of integrating a set of components into a single unit. Hence, the entire contract is accounted for as one performance obligation. Less frequently, however, we may promise to provide distinct goods or services within a contract in which case we separate the contract into more than one performance obligation. If a contract is separated into more than one performance obligation, we allocate the total transaction price to each performance obligation in an amount based on the estimated relative standalone selling prices of the promised goods or services underlying each performance obligation. In cases where we sell standard products, the observable standalone sales are used to determine the standalone selling price.

 

The Company recognizes revenue from a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.

 

For certain contracts with the U.S. government, the Company recognizes revenue over time as we perform because of continuous transfer of control to the customer and the lack of an alternative use for the product. The continuous transfer of control to the customer is supported by liability clauses in the contract that allow the U.S. government to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. For contracts with commercial customers, while the contract may have a similar liability clause, our products historically have an alternative use and thus, revenue is recognized at a point in time.

 

In situations where control transfers over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. We generally use the cost-to-cost approach to measure the extent of progress towards completion of the performance obligation for our contracts because we believe it best depicts the transfer of assets to the customer. Under the cost-to-cost measure approach, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenues are recorded proportionally as costs are incurred.

 

Accounting for design, development and production contracts requires judgment relative to assessing risks, estimating contract revenues and costs, and making assumptions for schedule and technical issues. Due to the size and nature of the work required to be performed on many of our contracts, the estimation of total revenue and cost at completion is complicated and subject to many variables. Contract costs include material, labor and subcontracting costs, as well as an allocation of indirect costs. We have to make assumptions regarding the number of labor hours required to complete a task, the complexity of the work to be performed, the availability and cost of materials, and performance by our subcontractors. For contract change orders, claims or similar items, we apply judgment in estimating the amounts and assessing the potential for realization. These amounts are only included in contract value when they can be reliably estimated and realization is considered probable. If our estimate of total contract costs or our determination of whether the customer agrees that a milestone is achieved is incorrect, our revenue could be overstated or understated and the profits or loss reported could be subject to adjustment.

 

For our commercial customers, the Company’s revenue is recognized when obligations under the terms of a contract with our customer is satisf