KOPIN CORP - FORM 10-Q - November 9, 2017

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EX-31.2 - EXHIBIT 31.2 - KOPIN CORPkopn-20170930xexx312.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
 FORM 10-Q
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
¨
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
 
 
 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days.    Yes  x   No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes    x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
 
 
Accelerated filer
 
x
Non-accelerated filer
 
¨
 
(Do not check if a smaller reporting company)
Smaller reporting company
 
¨
 
 
 
 
 
Emerging growth company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes  ¨   No  x
Indicate the number of shares outstanding of each issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding as of November 6, 2017
 
Common Stock, par value $0.01
75,336,563
 

1


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

2


Part 1: FINANCIAL INFORMATION
 
Item 1:
Condensed Consolidated Financial Statements (Unaudited)
KOPIN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
 
September 30, 2017
 
December 31, 2016
ASSETS
 
 
 
Current assets:
 
 
 
Cash and equivalents
$
25,882,554

 
$
15,822,495

Marketable debt securities, at fair value
51,454,910

 
61,375,401

Accounts receivable, net of allowance of $149,000 in 2017 and $136,000 in 2016
2,023,618

 
1,664,488

Unbilled receivables
124,068

 
34,707

Inventory
5,949,010

 
3,302,112

Prepaid taxes
166,461

 
341,144

Prepaid expenses and other current assets
1,089,948

 
853,757

Total current assets
86,690,569

 
83,394,104

Property, plant and equipment, net
3,660,925

 
2,976,006

Goodwill
2,376,577

 
844,023

Intangible assets, net
1,356,546

 
—

Other assets
968,083

 
618,139

Total assets
$
95,052,700

 
$
87,832,272

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
3,965,760

 
$
4,355,462

Accrued payroll and expenses
2,755,150

 
1,443,976

Accrued warranty
585,000

 
518,000

Billings in excess of revenue earned
728,281

 
981,761

Other accrued liabilities
4,792,347

 
2,560,144

Income tax payable
724,688

 
935,364

Deferred tax liabilities
2,606,312

 
2,571,000

Total current liabilities
16,157,538

 
13,365,707

Asset retirement obligations
268,068

 
246,922

Commitments and contingencies

 

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

 
—

Common stock, par value $.01 per share: authorized, 120,000,000 shares; issued 79,669,818
shares in 2017 and 79,648,618 in 2016; outstanding 72,187,688 shares in 2017 and 64,538,686 shares in 2016
767,009

 
766,409

Additional paid-in capital
331,008,801

 
328,524,644

Treasury stock (4,513,256 shares in 2017 and 12,102,258 shares in 2016, at cost)
(17,238,669
)
 
(42,741,551
)
Accumulated other comprehensive income
2,346,909

 
1,570,971

Accumulated deficit
(238,319,253
)
 
(214,042,787
)
Total Kopin Corporation stockholders’ equity
78,564,797

 
74,077,686

Noncontrolling interest
62,297

 
141,957

Total stockholders’ equity
78,627,094

 
74,219,643

Total liabilities and stockholders’ equity
$
95,052,700

 
$
87,832,272

                                          
See notes to unaudited condensed consolidated financial statements
               
                                       

3



KOPIN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
Revenues:
 
 
 
 
 
 
 
Net product revenues
$
5,589,402

 
$
5,522,584

 
$
14,501,945

 
$
15,597,247

Research and development revenues
549,765

 
272,222

 
1,942,819

 
671,972

 
6,139,167

 
5,794,806

 
16,444,764

 
16,269,219

Expenses:
 
 
 
 
 
 
 
Cost of product revenues
4,144,884

 
4,573,581

 
11,379,467

 
13,856,469

Research and development
5,253,860

 
4,123,268

 
14,213,950

 
12,282,620

Selling, general and administration
5,344,999

 
3,980,605

 
16,186,946

 
12,023,717

Gain on sale of property and plant
—

 
—

 
—

 
(7,700,522
)
 
14,743,743

 
12,677,454

 
41,780,363

 
30,462,284

Loss from operations
(8,604,576
)
 
(6,882,648
)
 
(25,335,599
)
 
(14,193,065
)
Other income (expense):
 
 
 
 
 
 
 
Interest income
191,613

 
191,472

 
611,532

 
532,185

Other (expense) income, net
(109,546
)
 
(257,384
)
 
215,883

 
(415,758
)
Foreign currency transaction gains (losses)
224,370

 
(1,124,526
)
 
(410,373
)
 
(1,581,962
)
Gain on investments
—

 
—

 
274,000

 
—

 
306,437

 
(1,190,438
)
 
691,042

 
(1,465,535
)
Loss before (provision) benefit for income taxes and net loss (income) attributable to noncontrolling interest
(8,298,139
)
 
(8,073,086
)
 
(24,644,557
)
 
(15,658,600
)
Tax (provision) benefit
(4,500
)
 
(114,000
)
 
1,141,500

 
(2,218,000
)
Net loss
(8,302,639
)
 
(8,187,086
)
 
(23,503,057
)
 
(17,876,600
)
Net loss (income) attributable to the noncontrolling interest
55,217

 
69,782

 
65,223

 
(367,640
)
Net loss attributable to the controlling interest
$
(8,247,422
)
 
$
(8,117,304
)
 
$
(23,437,834
)
 
$
(18,244,240
)
Net loss per share
 
 
 
 
 
 
 
Basic and diluted
$
(0.11
)
 
$
(0.13
)
 
$
(0.34
)
 
$
(0.29
)
Weighted average number of common shares outstanding
 
 
 
 
 
 
 
Basic and diluted
72,187,688

 
64,047,852

 
69,117,640

 
64,012,490

See notes to unaudited condensed consolidated financial statements

4


KOPIN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
Net loss
$
(8,302,639
)
 
$
(8,187,086
)
 
$
(23,503,057
)
 
$
(17,876,600
)
Other comprehensive (loss) income:
 
 
 
 
 
 
 
     Foreign currency translation adjustments
(272,618
)
 
1,718,596

 
658,443

 
2,362,552

     Unrealized holding gains on marketable securities
(29,584
)
 
(73,443
)
 
108,196

 
336,663

     Reclassification of holding losses in net loss
(1,238
)
 
(14,092
)
 
(5,138
)
 
(48,284
)
Other comprehensive (loss) income
(303,440
)
 
1,631,061

 
761,501

 
2,650,931

Comprehensive loss
$
(8,606,079
)
 
$
(6,556,025
)
 
$
(22,741,556
)
 
$
(15,225,669
)
Comprehensive income (loss) attributable to the noncontrolling interest
63,306

 
(19,656
)
 
79,660

 
(482,520
)
Comprehensive loss attributable to controlling interest
$
(8,542,773
)
 
$
(6,575,681
)
 
$
(22,661,896
)
 
$
(15,708,189
)
See notes to unaudited condensed consolidated financial statements

5




KOPIN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited) 
 
Common Stock
 
Additional
Paid-in Capital
 
Treasury Stock
 
Accumulated
Other
Comprehensive Income
 
Accumulated Deficit
 
Total Kopin
Corporation
Stockholders’ Equity
 
Noncontrolling Interest
 
Total
Stockholders’ Equity
 
Shares
 
Amount
 
 
 
 
 
 
 
Balance, December 31, 2016
76,640,943

 
$
766,409

 
$
328,524,644

 
$
(42,741,551
)
 
$
1,570,971

 
$
(214,042,787
)
 
$
74,077,686

 
$
141,957

 
$
74,219,643

Stock-based compensation
—

 
—

 
2,484,757

 
—

 
—

 
—

 
2,484,757

 
—

 
2,484,757

Vesting of restricted stock
60,000

 
600

 
(600
)
 
—

 
—

 
—

 
—

 
—

 
—

Other comprehensive income
—

 
—

 
—

 
—

 
775,938

 
—

 
775,938

 
(14,437
)
 
761,501

Sale of unregistered stock
—

 
—

 
—

 
25,502,882

 
—

—

(838,632
)
—

24,664,250

—

—

—

24,664,250

Net loss
—

 
—

 
—

 
—

 
—

 
(23,437,834
)
 
(23,437,834
)
 
(65,223
)
 
(23,503,057
)
Balance, September 30, 2017
76,700,943

 
$
767,009

 
$
331,008,801

 
$
(17,238,669
)
 
$
2,346,909

 
$
(238,319,253
)
 
$
78,564,797

 
$
62,297

 
$
78,627,094

See notes to unaudited condensed consolidated financial statements

6

KOPIN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
Cash flows from operating activities:
 
 
 
Net loss
$
(23,503,057
)
 
$
(17,876,600
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
1,878,363

 
949,854

Accretion of premium or discount on marketable debt securities
40,204

 
104,282

Stock-based compensation
2,990,157

 
1,479,481

Foreign currency losses
400,542

 
1,715,901

Unrealized gain on warrant
(274,000
)
 
—

Deferred income taxes
(1,170,017
)
 
1,192,128

Gain on sale of property and plant
—

 
(7,700,522
)
Other non-cash items
673,720

 
503,115

Change in warranty reserves
68,003

 
—

Changes in assets and liabilities, net of acquired assets and liabilities:
 
 
 
Accounts receivable
71,400

 
(524,084
)
Inventory
(2,519,197
)
 
(1,231,705
)
Prepaid expenses and other current assets
13,345

 
213,028

Accounts payable and accrued expenses
1,743,215

 
1,271,171

Billings in excess of revenue earned
(253,480
)
 
(132,740
)
Net cash used in operating activities
(19,840,802
)
 
(20,036,691
)
Cash flows from investing activities:
 
 
 
Other assets
(79,916
)
 
(7,801
)
Capital expenditures
(1,341,744
)
 
(329,414
)
Proceeds from sale of marketable debt securities
33,395,422

 
43,836,978

Purchase of marketable debt securities
(22,974,668
)
 
(45,905,075
)
Proceeds from sale of property and plant
—

 
8,106,819

Cash paid for acquisition, net of cash acquired
(3,690,047
)
 
—

Proceeds from sale of III-V product line
—

 
15,000,000

Net cash provided by investing activities
5,309,047

 
20,701,507

Cash flows from financing activities:
 
 
 
Sale of unregistered stock
24,664,250

 
—

Settlements of restricted stock for tax withholding obligations
—

 
(9,153
)
Net cash provided by (used in) financing activities
24,664,250

 
(9,153
)
Effect of exchange rate changes on cash
(72,436
)
 
574,850

Net increase in cash and equivalents
10,060,059

 
1,230,513

Cash and equivalents:
 
 
 
Beginning of period
15,822,495

 
19,767,889

End of period
$
25,882,554

 
$
20,998,402

Supplemental disclosure of cash flow information:
 
 
 
Income taxes paid
$
—

 
$
366,000

See notes to unaudited condensed consolidated financial statements


7



KOPIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1.
BASIS OF PRESENTATION
The condensed consolidated financial statements of Kopin Corporation (the Company) as of September 30, 2017 and for the three and nine month periods ended September 30, 2017 and September 24, 2016 are unaudited and include all adjustments which, in the opinion of management, are necessary to present fairly the results of operations for the periods then ended. These condensed consolidated financial statements should be read in conjunction with the Company’s financial statements and notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. The results of the Company's operations for any interim period are not necessarily indicative of the results of the Company's operations for any other interim period or for a full fiscal year.
Recently Issued Accounting Pronouncements
Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). This new standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which is an amendment on assessing whether an entity is a principal or an agent in a revenue transaction. This amendment addresses issues to clarify the principal versus agent assessment and lead to more consistent application. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which contains amendments to the new revenue recognition standard on identifying performance obligations and accounting for licenses of intellectual property. The amendments related to identifying performance obligations clarify when a promised good or service is separately identifiable and allows entities to disregard items that are immaterial in the context of a contract. The licensing implementation amendments clarify how an entity should evaluate the nature of its promise in granting a license of intellectual property, which will determine whether revenue is recognized over time or at a point in time. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which provides clarity and implementation guidance on assessing collectability, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition. The new standards have the same effective date and transition requirements as ASU 2014-09. The new standard also requires entities to enhance disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
The Company continues to evaluate the potential impact of ASC 606 on its consolidated financial statements and related disclosures. As part of the Company's assessment work to date, the Company with assistance from an external consulting firm is continuing to review and finalize its conclusions relative to is contracts with customers. For the remainder of 2017, the Company plans to finalize its evaluation and implement any required policy, process, and internal control changes required as a result of that evaluation. While the Company continues to assess all potential impacts of the new standard on its consolidated financial statements, the adoption of ASC 606 may accelerate the timing of revenue recognition for certain research and development contracts and the sale of products to military programs whereby revenue will be recognized as the product is produced (as opposed to at a point in time when the product is shipped to the customer) as the Company has an enforceable right to payment for performance completed to date and the inventory has no alternative use. Upon the adoption of ASC 606 using the modified retrospective method on December 31, 2017, the Company expects to record an adjustment to accumulated deficit for the amount that would have been recognized in 2017 under the new guidance and would not have been recognized until shipment of the product in 2018 under the current guidance. The new standard will also require an enhanced level of disclosures in the Company’s quarterly and annual consolidated financial statements.
Leases    
In February 2016, the FASB issued Accounting Standards Update No. 2016-02 (Topic 842) Leases. Topic 842 supersedes the lease recognition requirements in Accounting Standards Codification Topic 840, "Leases". Under Topic 842, lessees are required to recognize assets and liabilities on the balance sheet for most leases and provide enhanced disclosures. Leases will continue to be classified as either finance or operating. Topic 842 is effective for annual reporting periods, and interim periods within those years beginning after December 15, 2018. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements, and there are certain optional practical expedients that an entity may elect to apply. Full retrospective application is prohibited and early adoption by public entities is permitted. The Company expects to complete its assessment in 2018 and is required to adopt ASU

8


2016-02 as of January 1, 2019 using the modified retrospective method. The Company expects the potential impact of adopting ASU 2016-02 to be material to our lease liabilities and assets on its consolidated balance sheets.

Business Combinations

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805). The new guidance clarifies the definition of a business that an entity uses to determine whether a transaction should be accounted for as an asset acquisition (or disposal) or a business combination. The guidance is expected to cause fewer acquired sets of assets (and liabilities) to be identified as businesses. The guidance is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted for transactions that meet certain requirements. The Company is evaluating the impact this standard will have on its financial statements.

Intangibles- Goodwill and Other

In January 2017, the FASB issued ASU 2017-04, Intangibles- Goodwill and Other (Topic 350). The new guidance simplifies the accounting for goodwill impairments by eliminating Step 2 from the goodwill impairment test. The guidance requires, among other things, recognition of an impairment loss when the carrying amount of a reporting unit exceeds its fair value. The loss recognized is limited to the total amount of goodwill allocated to that reporting unit. The guidance is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is evaluating the impact this standard will have on its financial statements.
2.
CASH AND EQUIVALENTS AND MARKETABLE SECURITIES
The Company considers all highly liquid, short-term debt instruments with original maturities of three months or less to be cash equivalents.
Marketable debt securities consist primarily of commercial paper, medium-term corporate notes, and U.S. government and agency backed securities. The Company classifies these marketable debt securities as available-for-sale at fair value in “Marketable debt securities, at fair value”. The Company's investment in GCS Holdings is included in "Other Assets" as available-for-sale and at fair value. The Company records the amortization of premium and accretion of discounts on marketable debt securities in the results of operations.

9


The Company uses the specific identification method as a basis for determining cost and calculating realized gains and losses with respect to marketable debt securities. The gross gains and losses realized related to sales and maturities of marketable debt securities were not material during the three and nine months ended September 30, 2017 and the year ended December 31, 2016.
Investments in available-for-sale marketable debt securities are as follows at September 30, 2017 and December 31, 2016
 
Amortized Cost

Unrealized Gains

Unrealized Losses

Fair Value
 
2017

2016

2017

2016

2017

2016

2017

2016
U.S. government and agency backed securities
$
36,365,672


$
36,343,817


$
—


$
—


$
(180,768
)

$
(252,556
)

$
36,184,904


$
36,091,261

Corporate debt and certificates of deposit
15,311,458


25,323,428


—


—


(41,452
)

(39,288
)

15,270,006


25,284,140

Total
$
51,677,130

 
$
61,667,245

 
$
—

 
$
—

 
$
(222,220
)
 
$
(291,844
)
 
$
51,454,910

 
$
61,375,401

The contractual maturity of the Company’s marketable debt securities is as follows at September 30, 2017:
 
Less than
One year
 
One to
Five years
 
Greater than
Five years
 
Total
U.S. government and agency backed securities
$
21,245,723

 
$
12,993,121

 
$
1,946,060

 
$
36,184,904

Corporate debt and certificates of deposit
9,585,467

 
5,684,539

 
—

 
15,270,006

Total
$
30,831,190

 
$
18,677,660

 
$
1,946,060

 
$
51,454,910

The Company conducts a review of its marketable debt securities on a quarterly basis for the presence of other-than-temporary impairment (OTTI). The Company assesses whether OTTI is present when the fair value of a debt security is less than its amortized cost basis at the balance sheet date. Under these circumstances OTTI is considered to have occurred (1) if the Company intends to sell the security before recovery of its amortized cost basis; (2) if it is “more likely than not” the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost basis.
The Company further estimates the amount of OTTI resulting from a decline in the creditworthiness of the issuer (credit-related OTTI) and the amount of non credit-related OTTI. Non credit-related OTTI can be caused by such factors as market illiquidity. Credit-related OTTI is recognized in earnings while non credit-related OTTI on securities not expected to be sold is recognized in other comprehensive income (loss). The Company did not record an OTTI for the three and nine months ended September 30, 2017 and September 24, 2016.

10


3.
FAIR VALUE MEASUREMENTS
Financial instruments are categorized as Level 1, Level 2 or Level 3 based upon the method by which their fair value is computed. An investment is categorized as Level 1 when its fair value is based on unadjusted quoted prices in active markets for identical assets that the Company has the ability to access at the measurement date. An investment is categorized as Level 2 if its fair market value is based on quoted market prices for similar assets in active markets, quoted prices for identical or similar assets in markets that are not active, based on observable inputs such as interest rates, yield curves, or derived from or corroborated by observable market data by correlation or other means. An investment is categorized as Level 3 if its fair value is based on assumptions developed by the Company about what a market participant would use in pricing the assets.
The following table details the fair value measurements of the Company’s financial assets:
 
 
 
Fair Value Measurement September 30, 2017 Using:
 
Total
 
Level 1
 
Level 2
 
Level 3
Cash and Equivalents
$
25,882,554

 
$
25,882,554

 
$
—

 
$
—

U.S. Government Securities
36,184,904

 
6,923,591

 
29,261,313

 
—

Corporate Debt
7,652,455

 
—

 
7,652,455

 
—

Certificates of Deposit
7,617,551

 
—

 
7,617,551

 
—

GCS Holdings
365,017

 
365,017

 
—

 
—

Warrant
274,000

 
—

 
—

 
274,000

 
$
77,976,481

 
$
33,171,162

 
$
44,531,319

 
$
274,000

 
 
 
 
 
 
 
 
 
 
 
Fair Value Measurement December 31, 2016 Using:
 
Total
 
Level 1
 
Level 2
 
Level 3
Cash and Equivalents
$
15,822,495

 
$
15,822,495

 
$
—

 
$
—

U.S. Government Securities
36,091,261

 
7,144,767

 
28,946,494

 
—

Corporate Debt
7,557,029

 
—

 
7,557,029

 
—

Certificates of Deposit
17,727,111

 
—

 
17,727,111

 
—

GCS Holdings
331,454

 
331,454

 
—

 
—

 
$
77,529,350

 
$
23,298,716

 
$
54,230,634

 
$
—

The corporate debt consists of floating rate notes with a maturity that is over multiple years but has interest rates which are reset every three months based on the then-current three month London Interbank Offering Rate (three month Libor). The Company validates the fair market values of the financial instruments above by using discounted cash flow models, obtaining independent pricing of the securities or through the use of a model which incorporates the three month Libor, the credit default swap rate of the issuer and the bid and ask price spread of the same or similar investments which are traded on several markets. The Company has a warrant to acquire up to 15% of the next round of equity offered by a customer as part of the licensing of technology to the customer. The fair market value of the warrant was determined based upon expectations from the customer’s management and then applying probabilities of occurrence and discounting back the values using expected returns required for similar instruments.
The carrying amounts of cash and equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value because of their short-term nature. If accrued liabilities were carried at fair value, these would be classified as Level 2 in the fair value hierarchy.
4.
 INVENTORY
Inventory is stated at the lower of cost (determined on the first-in, first-out) or market and consists of the following at September 30, 2017 and December 31, 2016:
 
September 30, 2017
 
December 31, 2016
Raw materials
$
2,517,803

 
$
1,986,491

Work-in-process
2,552,517

 
1,186,162

Finished goods
878,690

 
129,459

 
$
5,949,010

 
$
3,302,112


11


5. 
NET LOSS PER SHARE
Basic net loss per share is computed using the weighted average number of shares of common stock outstanding during the period less any non-vested restricted shares. Diluted earnings per common share, if applicable, is calculated using weighted average shares outstanding and contingently issuable shares, less weighted average shares reacquired during the period. The net outstanding shares are adjusted for the dilutive effect of shares issuable upon the assumed conversion of the Company’s common stock equivalents, which consist of outstanding stock options and non-vested restricted stock units.
The following were not included in weighted average common shares outstanding-diluted because they are anti-dilutive or performance or market conditions had not been met at the end of the period:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
Non-vested restricted common stock
2,968,874

 
2,692,516

 
2,968,874

 
2,692,516

6.
STOCKHOLDERS' EQUITY AND STOCK-BASED COMPENSATION
On April 20, 2017, the Company sold 7,589,000 shares of unregistered common stock to Goertek Inc. for $24,664,250 ($3.25 per share). This represents approximately 10.1% of Kopin’s total outstanding shares of common stock as of the date of purchase. In addition, Kopin and Goertek have entered into agreements to jointly develop and commercialize a range of technologies and wearable products. Goertek is a leading innovative global technology company headquartered in Weifang, China that designs and manufactures a range of consumer electronics products for brand customers including wearables, virtual and augmented reality headsets, and audio products. The transaction was accounted for under FASB ASC 505-30 "Treasury Stock", and the loss on the sale of the treasury stock of approximately $0.8 million was charged to retained earnings. See "Note 13. Amounts Due To/Due From Affiliates" for additional discussion around agreements with Goertek.
Non-Vested Restricted Common Stock
The fair value of non-vested restricted common stock awards is generally the market value of the Company’s common stock on the date of grant. The non-vested restricted common stock awards require the employee to fulfill certain obligations, including remaining employed by the Company for one, two or four years (the vesting period) and in certain cases also require meeting either performance criteria or the Company’s stock achieving a certain price. For non-vested restricted common stock awards which solely require the recipient to remain employed with the Company, the stock compensation expense is amortized over the anticipated service period. For non-vested restricted common stock awards which require the achievement of performance criteria, the Company reviews the probability of achieving the performance goals on a periodic basis. If the Company determines that it is probable that the performance criteria will be achieved, the amount of compensation cost derived for the performance goal is amortized over the anticipated service period. If the performance criteria are not met, no compensation cost is recognized and any previously recognized compensation cost is reversed. Some of the restricted stock awards vest upon our stock price achieving certain levels. These awards are referred to as Liability Awards and are mark-to-market. Accordingly in some periods there is expense and in other periods the expense may reverse. The Company recognizes compensation costs on a straight-line basis over the requisite service period for time-vested awards.
 
Shares
 
Weighted
Average
Grant
Fair
Value
Balance, December 31, 2016
3,007,674

 
$
3.21

Granted
120,000

 
3.44

Forfeited
(98,800
)
 
3.17

Vested
(60,000
)
 
1.70

Balance, September 30, 2017
2,968,874

 
$
3.26


12


Stock-Based Compensation
The following table summarizes stock-based compensation expense within each of the categories below as it relates to non-vested restricted common stock awards for the three and nine months ended September 30, 2017 and September 24, 2016 (no tax benefits were recognized):
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
Cost of product revenues
$
142,604

 
$
136,420

 
$
405,778

 
$
426,357

Research and development
203,288

 
129,308

 
616,500

 
378,156

Selling, general and administrative
676,137

 
262,700

 
1,967,879

 
674,968

Total
$
1,022,029

 
$
528,428

 
$
2,990,157

 
$
1,479,481

Unrecognized compensation expense for non-vested restricted common stock as of September 30, 2017 totaled $3.8 million and is expected to be recognized over a weighted average period of approximately two years.
The selling, general and administrative expense includes Liability Awards and the increase in expense for the nine months ended September 30, 2017 as compared to September 24, 2016 is partially the result of a higher stock price of the Company at September 30, 2017 as compared to September 24, 2016. Included in Other accrued liabilities is $1.6 million in deferred compensation from equity awards which are classified as Liability Awards.
7. 
NOTE RECEIVABLE
In January 2016, the Company received the final $15.0 million payment resulting from the sale of its III-V product line and its investment in KTC.
8. 
ACCRUED WARRANTY
The Company typically warrants its products against defect for 12 months, however, for certain products a customer may purchase an extended warranty. A provision for estimated future costs and estimated returns for credit relating to such warranty is recorded in the period when product is shipped and revenue recognized, and is updated as additional information becomes available. The Company’s estimate of future costs to satisfy warranty obligations is based primarily on historical warranty expense experienced and a provision for potential future product failures. Changes in the accrued warranty for the nine months ended September 30, 2017 are as follows:
Balance, December 31, 2016
$
518,000

Additions
83,000

Claims
(16,000
)
Balance, September 30, 2017
$
585,000

Extended Warranties
Deferred revenue represents the purchase of extended warranties by the Company's customers. The Company recognizes revenue from an extended warranty on the straight-line method over the life of the extended warranty, which is typically 12 to 15 months beyond the standard 12 month warranty. The Company classifies deferred revenue under other accrued liabilities in its consolidated balance sheets. The Company currently has $0.5 million of deferred revenue related to extended warranties.


13


9.
INCOME TAXES
The Company’s tax benefit of approximately $1.1 million for the nine months ended September 30, 2017 represents the net of $0.1 million for foreign income taxes related to uncertain tax positions and a benefit for the net reduction in estimated foreign withholding. We reduced the valuation allowance on our net deferred tax assets in the amount of $1.0 million and such reduction was recognized as a benefit for income taxes for the nine months ended September 30, 2017. The Company’s tax provision of approximately $0.1 million for the three months ended September 24, 2016, represents less than $14,000 of state income tax and $0.1 million of foreign income taxes including interest income on intercompany loan and net movement in estimated foreign withholding. The Company’s tax provision of approximately $2.2 million for the nine months ended September 24, 2016, represents $1.0 million of income taxes on the gain on the sale of Kowon’s plant and land, $1.2 million of net movement in estimated foreign withholding on anticipated future remitted earnings of a foreign subsidiary, and $22,000 in state income taxes. As of September 30, 2017, the Company has available for tax purposes U.S. federal NOLs of approximately $153.0 million expiring through 2036. The Company has recognized a full valuation allowance on its domestic and certain foreign net deferred tax assets due to the uncertainty of realization of such assets.
Ownership changes, as defined by the Internal Revenue Code, may substantially limit the amount of net operating loss carryforwards that can be utilized annually to offset future taxable income. The ownership change in 2017 did not result in an annual net operating loss limitation as the acquired entity was an S Corporation and did not have loss carryforwards. Subsequent ownership changes could affect the limitation in future years. Such annual limitations could result in the expiration of net operating loss and tax credit carryforwards before utilization.
The tax years 2001 through 2016 remain open to examination by major taxing jurisdictions to which the Company is subject to United States federal tax. These periods have carryforward attributes generated in years past that may still be adjusted upon examination by the Internal Revenue Service or state tax authorities if they have or will be used in a future period. State statutes are generally shorter with shorter carryforward periods. The Company is currently not under examination by the Internal Revenue Service and is currently under examination by Massachusetts for the 2013 tax year. The Company recognizes both accrued interest and penalties related to its uncertain tax positions related to intercompany loan interest and potential transfer pricing exposure related to its Korean subsidiary.
The Company has concluded that it does not maintain its permanent reinvestment assertion with regard to the unremitted earnings of its Korean subsidiaries. As such, it accrues U.S. tax for the possible future repatriation of these unremitted foreign earnings. If the Company were to repatriate these earnings, it expects to have foreign withholding at a rate of 16.5% and does not expect any taxes to be paid in the U.S when repatriated as it currently is expected to be a return of capital.
10.
BUSINESS COMBINATION AND GOODWILL
In March 2017, the Company purchased 100% of a company for $3.7 million. The acquired company produces virtual reality systems for 3D applications. Additional payments of up to $2.0 million may be required if certain future operating performance milestones are met and the selling shareholders remain employed through March 2020. As there is a requirement to remain employed to earn the contingent payments, these contingent payments will be treated as compensation expense. Commencing on the date of acquisition, the Company consolidated the financial results of the acquired company. The identifiable assets acquired and liabilities assumed at the acquisition date have been recognized at fair value.

The allocation of the purchase price is as follows:
Cash and marketable securities
$
2,600

Accounts receivable
490,700

Inventory
768,400

Other identifiable assets
46,800

Order backlog
840,000

Customer relationships
1,000,000

Developed technology
460,000

Trademark portfolio
160,000

Current liabilities
(480,500
)
Net deferred tax liabilities
(1,084,000
)
Goodwill
1,489,000

Total
$
3,693,000


14


Goodwill represents the recording of the excess of the purchase price over the fair values of the net tangible assets acquired. The values assigned to the acquired assets and liabilities are based on preliminary estimates of fair value available as of the date of this filing and will be adjusted upon completion of final valuations of certain assets and liabilities. Any changes in these fair values could potentially result in an adjustment to the goodwill recorded for this transaction.
The identified intangible assets will be amortized on a straight-line basis over the following lives, in years:
Order backlog
1
Customer relationships
2
Developed technology
2
Trademark portfolio
2
The Company recognized $1.1 million in amortization for the nine month period ended September 30, 2017 related to its intangible assets. In conjunction with the acquisition the Company recorded deferred tax liabilities of approximately $1.0 million associated with the future non-deductible amortization of the intangible assets. These deferred tax liabilities can be used to offset the Company’s net deferred tax assets in future years. The Company reduced the valuation allowance on its net deferred tax assets in the amount of $1.0 million and such reduction was recognized as a benefit for income taxes for the nine month period ended September 30, 2017. Acquisition expenses were approximately $0.2 million and are recorded in selling, general and administration expenses.
The following unaudited supplemental pro forma disclosures are provided for the three and nine month periods ended September 24, 2016 and the nine month period ended September 30, 2017, assuming the acquisition of the company had occurred as of December 26, 2015. All intercompany transactions have been eliminated.
 
Three months ended
 
Nine months ended
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
Revenues
$
6,698,701

 
$
17,081,144

 
$
17,894,777

Net loss
(7,710,770
)
 
(23,271,116
)
 
(18,226,203
)
Since the date of acquisition, the Company recorded revenue and net loss of $1.9 million and $0.1 million, respectively, in the three month period ended September 30, 2017, and for the nine month period ended September 30, 2017 the revenues and net loss from the acquired company were $3.7 million and $0.5 million, respectively.
A rollforward of the Company's goodwill by segment is as follows:
 
Kopin
 
Industrial
 
Total
Balance, December 31, 2016
$
844,023

 
$
—

 
$
844,023

March 2017 acquisition
—

 
1,488,650

 
1,488,650

Change due to exchange rate fluctuations
43,904

 
—

 
43,904

Balance, September 30, 2017
$
887,927

 
$
1,488,650

 
$
2,376,577

The Company has entered into two joint venture agreements and other agreements which are subject to certain closing conditions including government approvals. If the transactions close the Company will contribute certain intellectual property and approximately $8.0 million.
11.     SEGMENTS AND GEOGRAPHICAL INFORMATION
The Company’s chief operating decision maker is its Chief Executive Officer. The Company has determined it has two reportable segments, Industrial, which includes the operations that develop and manufacture its reflective display products and virtual reality systems for test and simulation products, and Kopin, which includes the operations that develop and manufacture its other products. Previously, the Company had two segments consisting of Kopin and FDD. The acquired company is included in the segment formerly known as FDD and the segment has been renamed to Industrial.

15


The following table presents the Company’s reportable segment results (in thousands):
 
Three Months Ended
 
September 30, 2017
 
September 24, 2016
 
Kopin
 
Industrial
 
Total
 
Kopin
 
Industrial
 
Total
Revenues
$
3,744

 
$
2,395

 
$
6,139

 
$
4,708

 
$
1,087

 
$
5,795

Net loss attributable to the controlling interest
(8,117
)
 
(130
)
 
(8,247
)
 
(7,901
)
 
(216
)
 
(8,117
)
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
Kopin
 
Industrial
 
Total
 
Kopin
 
Industrial
 
Total
Revenues
$
10,409

 
$
6,036

 
$
16,445

 
$
13,176

 
$
3,093

 
$
16,269

Net loss attributable to the controlling interest
(23,170
)
 
(268
)
 
(23,438
)
 
(17,628
)
 
(616
)
 
(18,244
)
Total assets
87,043

 
8,010

 
95,053

 
92,799

 
1,699

 
94,498

Long-lived assets
3,544

 
117

 
3,661

 
2,937

 
—

 
2,937

The total assets of Kopin are net of $6.0 million and $6.2 million in intercompany loans to Industrial as of September 30, 2017 and September 24, 2016, respectively.
During the three and nine month periods ended September 30, 2017 and September 24, 2016, the Company derived its sales from the following geographies (as a percentage of net revenues):
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
United States
47
%
 
49
%
 
48
%
 
36
%
Asia-Pacific
22
%
 
37
%
 
25
%
 
48
%
Europe
31
%
 
14
%
 
27
%
 
16
%
       Total Revenues
100
%
 
100
%
 
100
%
 
100
%
12. 
LITIGATION
The Company may be named 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.
 

16


13.     RELATED PARTY TRANSACTIONS
The Company may from time to time enter into agreements with shareholders, affiliates 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 the Company needs to purchase from affiliates in order to enhance its product offering. The Company and Goertek have entered into agreements to jointly develop and commercialize a range of technologies and wearable products. These include: a mutual exclusive supply and manufacturing arrangement for a certain display product for twenty four months after mass production begins; an agreement that provides the Company with the right of first refusal to invest in certain manufacturing capacity for certain products with Goertek; an agreement whereby Goertek will provide system level original equipment manufacturing services for the Company's wearable products; an arrangement whereby the Company will supply display modules for Goertek's virtual reality and augmented reality products; and other agreements related to promotion around certain products as well as providing designs relating to head mounted displays.
During the three and nine month periods ended September 30, 2017, the Company had the following transactions with related parties:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 30, 2017
 
Sales
 
Purchases
 
Sales
 
Purchases
Goertek
$
—

 
$
207,694

 
$
—

 
$
390,619

Affiliate 1
48,320

 
—

 
109,952

 
—

 
$
48,320

 
$
207,694

 
$
109,952

 
$
390,619

At September 30, 2017, the Company had the following receivables and payables with related parties:
 
Receivables
 
Payables
Goertek
$
—

 
$
103,100


14. 
EMBEZZLEMENT
During the third quarter of 2016, the Company discovered embezzlement activities at its Korean subsidiary. Based upon the results of forensic investigation procedures, the Company identified that the embezzlement activities occurred from fiscal year 2011 through fiscal year 2016. The embezzlement resulted in a total theft loss of $1,589,000 over that period and as a result of the embezzlement the Company has made the following correcting adjustments to the amounts presented in its previously issued quarterly financial information.
    
In the three and nine month periods ended September 24, 2016, the Company has recorded in Other income (expense), net, embezzlement expense of approximately $200,000 and $420,000, respectively, representing the total amount of theft loss that occurred.
Item 2:
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements
This Quarterly Report on Form 10-Q (including the information incorporated by reference) contains ‘‘forward-looking statements’’ within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the United States Private Securities Litigation Reform Act of 1995, and that involve risks and uncertainties. These statements and other risks described below as well as those discussed elsewhere in this Quarterly Report Form 10-Q, documents incorporated by reference and other documents and reports that we file periodically with the Securities and Exchange Commission (“SEC”) include, without limitation, statements relating to our belief that we will incur significant development and marketing costs in 2017 to commercialize our Wearable technologies; our expectation that the cash and marketable debt securities held by Kowon will eventually be remitted back to the U.S.; our expectation that we will offer our proprietary noise cancellation chip which we refer to as “Whisper Chip™” in 2017; our expectation that any market risk associated with our international operations is unlikely to have a material adverse effect on our business, financial condition or results of operation; our belief that a strengthening of the U.S. dollar could increase the price of our products in foreign markets; our expectation that we will expend between $2.0 million and $3.0 million on capital expenditures over the next twelve months; our belief that our available cash resources will support our operations and capital needs for at least the next twelve months; our expectation that we will have a state tax provision in 2017; and our belief that the effect, if any, of reasonably possible near-term changes in interest rates on our financial position, results of operations, and cash flows should

17


not be material. This Quarterly Report on Form 10-Q should be read in conjunction with our Form 10-K and other documents filed with the Securities and Exchange Commission. Our Form 10-K and other documents we have filed with the Securities and Exchange Commission also contain these additional forward-looking statements. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industries in which we operate, management's beliefs, and assumptions made by management. In addition, other written or oral statements, which constitute forward-looking statements, may be made by or on behalf of us. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “could”, “seeks”, “estimates”, and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements, whether as a result of new information, future events or otherwise. Factors that could cause or contribute to such differences in outcomes and results include, but are not limited to, those discussed below in Item 1A and those set forth in our other periodic filings filed with the Securities and Exchange Commission. Except as required by law, we do not intend to update any forward-looking statements even if new information becomes available or other events occur in the future.
Critical Accounting Policies
Management's discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. We regularly evaluate our estimates used in the preparation of our financial statements, including those related to revenue recognition under the percentage of completion method, bad debts, inventories, warranty reserves, investment valuations, valuation of stock compensation awards and recoverability of deferred tax assets. When we make acquisitions we use estimates in determining the allocation of the purchase price. These estimates included the forecasted operating results and cash flow projections of the acquired company, the appropriate time period to analyze the forecasted operating results and cash flow projections, additional investments, if any, in order to complete development of products and the cost to bring them to market, the weighted average cost of capital for the Company and discount rates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not apparent from other sources. Actual results will most likely differ from these estimates. Further detail regarding our critical accounting policies can be found in “Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2016.
Business Matters
We were incorporated in Delaware in 1984 and are a leading inventor, developer, manufacturer and seller of Wearable technologies which include components and systems.
Kopin Wearable technology includes component technologies which can be integrated to create products, and proprietary headset systems which use voice as the primary user interface and, through the use of wireless technologies, can contact other user devices in close proximity or information from the cloud.
Components
The components we offer for sale primarily consist of our displays, backlights, ASICs and optical lenses. In 2017, we also anticipate offering our proprietary noise cancellation chip which we refer to as “Whisper Chip™”.
Our principal display products are miniature high density color or monochrome Active Matrix Liquid Crystal Displays (AMLCDs) with resolutions that range from approximately 320 x 240 resolution to 2048 x 2048 resolution, sold in either a transmissive or reflective format. We sell our displays individually or in combination with our other components assembled in a unit. For example, we sell a module unit which includes a single display, backlight and optics in a plastic housing, a binocular display module unit which includes two displays, backlights and optics in a plastic housing or a Higher-Level Assembly (HLA) which contains a display, light emitting diode based illumination, optics, and electronics in a sealed housing, primarily for military applications.
Our transmissive display products, which we refer to as CyberDisplay™ products, utilize high quality, single crystal silicon-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) in an integrated circuit foundry. The silicon wafer is then sent to our facilities and the integrated circuit is lifted off as a thin film and transferred to glass using our proprietary Wafer™ Engineering technology, so that the transferred layer is a fully functional active matrix integrated circuit which now resides on a transparent substrate.
Our reflective LCOS display products are miniature high density dual mode color sequential/monochrome reflective micro displays with resolutions which range from approximately 1280 x 720 pixels (720P) resolution to 2048 x 1536 pixels (QXGA) resolution. These displays are manufactured at our facility in Scotland, U.K. Our reflective displays are based on a

18


proprietary, very 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 micro display 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 MEMS 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.
We are developing organic light emitting diode (OLED) displays. We design the display and are using foundries services to manufacture the display. We are targeting virtual reality systems with the OLED displays and they are expected to be available in 2018.
We offer a variety of optical lenses, some of which we have developed internally and others we license the rights to sell. We also offer a variety of backlights, some of which we have developed and are “off-the-shelf” components. Our lenses come in a variety of sizes with the smallest being our Pupil lens, followed by our Pearl lens and then our largest being our Prism lens. 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 at a smart phone, whereas a Prism lens provides the viewer with an image approximately equivalent to what the viewer would see looking at a tablet. A Pearl lens is smaller than a Prism lens, however, it may enable a more fashionable design. Therefore a customer designing a consumer-oriented product may choose a Pearl lens but a customer designing an enterprise-oriented product might choose a Prism lens. We use third parties to manufacture these lenses.
The Whisper Chip is designed to enhance the performance of existing audio systems and speech recognition engines by allowing the speaker’s voice to be clearly “heard” by the listener, whether the “listener” is a person or a machine. The Whisper chip incorporates our Voice Extraction™ Filter (VEF). VEF is a patented approach to singulating the voice signal without distorting it. The Whisper Chip is an all-digital solution that runs at 16MHz, consumes less than 12mW of power and replaces the CODEC so no ADC or DAC is needed. The Whisper Chip is 4 x 4 mm in size and accepts up to four (4) digital microphone inputs. We use third parties to manufacture the Whisper Chip.
Headset Systems
Our headset systems include:
•
Consumer-oriented headsets which resemble typical eyeglasses but include voice and audio capabilities allowing the user to communicate with other users and a Pupil display module;
•
Augmented reality health and fitness sunglasses, called Solos™, that have voice and audio capabilities, a Pupil display module which overlays situational information on the glasses, our Whisper Chip;
•
Industrial headset reference design, which is essentially a complete head-worn computer that includes an optical pod with one of our display products, a microprocessor, battery, camera, memory and various commercially available software packages that we license; and
•
Professional virtual reality systems that allow customers to visualize and interact with simulated 3D environments.
Our headsets receive or transmit data from or to the internet by interfacing with a smartphone or similar device via WiFi or Bluetooth. They can also receive information from devices in close proximity using ANT+. The display module or optical pod allows users to view the information such as WEB data, emails, text messages, maps or biometric data (heart rate), situational data (speed, distance traveled, Watts produced) at a “normal” viewing size because of our specialized optics. Our industrial headset provides 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. Our industrial headset is equipped with a camera to enable a picture to be taken, video to be streamed or face-to-face communication to occur. The camera enables users to send pictures or stream live video to a remote subject matter expert so that both the user and expert can analyze an issue at the same time and collaboratively identify and implement a solution. Our headset reference designs utilize operating system software we developed. Our professional virtual reality systems allow our customers to develop high-fidelity training and simulation applications.
We have three sources of revenues: product revenues, which are our primary source of revenues, research and development (R&D) revenues primarily from development contracts with agencies or prime contractors of the U.S. government and commercial enterprises and license revenues from our reference designs. To date our license revenues have been de minimis. For the three and nine months ended September 30, 2017, R&D revenues were $0.5 million and $1.9 million, or 9.0% and 11.8% of total revenues, respectively. This contrasted with $0.3 million and $0.7 million, or 4.7% and 4.1% of total revenues for the corresponding period in 2016.

19


 Results of Operations
The three and nine month periods ended September 30, 2017 and September 24, 2016 are referred to as 2017 and 2016, respectively. The year ended period December 31, 2016 is referred to as fiscal year 2016.
Revenues. For 2017 and 2016, our revenues, which include product sales and amounts earned from research and development contracts, were as follows (in millions):
 
Three Months Ended
 
Nine Months Ended
Display Revenues by Application
September 30, 2017
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
Consumer
$
1.3

 
$
1.5

 
$
2.8

 
$
5.9

Military
2.9

 
1.2

 
6.1

 
3.6

Industrial
1.1

 
2.4

 
4.3

 
4.6

Other
0.3

 
0.4

 
1.3

 
1.5

Research & Development
0.5

 
0.3

 
1.9

 
0.7

Total
$
6.1

 
$
5.8

 
$
16.4

 
$
16.3

Sales of our products to customers that use our products for Wearable Applications is a critical part of our strategy to increase revenues and return to profitability and positive cash flow. Our success in selling our products for Wearable Applications will depend on the demand for our customers’ new products, which we are unable to predict. Consumer Applications primarily represents sales of our components for products that are worn on the head and  body for gaming and other applications. The decrease in Consumer Applications revenues in 2017 as compared to 2016 is primarily because of a decrease in sales to customers who use our products for drone headset applications and a health and fitness application. Sales of our products for Military Applications increased in 2017 as compared to 2016 primarily because of a company we acquired in the first quarter of 2017 that produces virtual reality systems for professional 3D applications. Revenue from the 2017 acquired company were approximately $1.9 million and $3.7 million in the three and nine months ended September 30, 2017, respectively. Included in Military Applications is incremental revenue of the acquired company of $1.9 million and $3.2 million for the three and nine months ended September 30, 2017, respectively. We are in qualification for the U.S. military’s Family of Weapon Sights (FWS) program. The FWS program has several sub-programs and we are currently proposing to be a supplier for the FWS-I and FWS-C programs. As part of the qualification process we are receiving low volume orders for the FWS-I program. The revenues for the FWS programs are recorded in Research & Development (R&D) and are the reason for the increase in R&D revenues in 2017 as compared to 2016.
Industrial Applications represents customers who purchase our display products for use in headsets used for applications in public safety and equipment such as 3D metrology and training and simulation. Revenue from the 2017 acquired company were approximately $0.4 million in the nine months ended September 30, 2017 and are included in the Industrial category.
International sales represented 52% and 64% of product revenues for the nine months ended September 30, 2017 and September 24, 2016, respectively. Our international sales are primarily denominated in U.S. currency. Consequently, a strengthening of the U.S. dollar could increase the price in local currencies of our products in foreign markets and make our products relatively more expensive than competitors' products that are denominated in local currencies, leading to a reduction in sales or profitability in those foreign markets. In addition, our Korean subsidiary, Kowon, holds U.S. dollars. 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, Korean won and the U.S. dollar. Foreign currency translation impact on our results, if material, is described in further detail under "Item 3. Quantitative and Qualitative Disclosures About Market Risk" section below.
Cost of Product Revenues.
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
Cost of product revenues (in millions):
$
4.1

 
$
4.6

 
$
11.4

 
$
13.9

Cost of product revenues as a % of net product revenues
74.2
%
 
82.8
%
 
78.5
%
 
88.8
%
For the three and nine months ended September 30, 2017, cost of product revenues, which is comprised of materials, labor and manufacturing overhead related to the production of our products, decreased as a percentage of revenues in 2017 as

20


compared to 2016 because of a increase in sales of our military products which have higher gross margins than the other products sold during same period in 2016.
Research and Development. Research and development (R&D) expenses are incurred in support of internal development programs or programs funded by agencies or prime contractors of the U.S. government and commercial partners. R&D revenues associated with funded programs are presented separately in revenue in the statement of operations. Research and development costs include staffing, purchases of materials and laboratory supplies, circuit design costs, fabrication and packaging of display products, and overhead. For the three and nine months ended September 30, 2017 and September 24, 2016, R&D expense was as follows (in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
Funded
$
0.8

 
$
0.2

 
$
2.4

 
$
0.4

Internal
4.5

 
3.9

 
11.8

 
11.9

Total research and development expense
$
5.3

 
$
4.1

 
$
14.2

 
$
12.3


Funded R&D expense for the three and nine months ended September 30, 2017 increased as compared to the prior year due to an increase in spending for military programs. For the three months ended September 30, 2017, internal R&D increased as compared to prior year due to an increase in spending for wearable technology. For the nine months ended September 30, 2017, internal R&D was essentially flat with the same period in 2016. We expect to incur significant development costs in fiscal year 2017 to commercialize our Wearable technologies and develop military products.
Selling, General and Administrative.  Selling, general and administrative (S,G&A) expenses consist of the expenses incurred by our sales and marketing personnel and related expenses, and administrative and general corporate expenses.
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
Selling, general and administration expense (in millions)
$
5.3

 
$
4.0

 
$
16.2

 
$
12.0

Selling, general and administration expense as a % of revenues
87.1
%
 
68.7
%
 
98.4
%
 
73.9
%
        
S,G&A increased for the three months ended September 30, 2017 as compared to the same period in 2016, reflecting incremental S,G&A of $0.5 million from our acquisition of NVIS and an increase in stock-based compensation of $0.5 million. S,G&A increased for the nine months ended September 30, 2017 as compared to the same period in 2016, reflecting incremental S,G&A of $1.1 million from our acquisition of NVIS, an increase in stock-based compensation of $1.5 million and a $1.0 million increase in professional fees. The incremental S,G&A from NVIS for the three and nine months ended September 30, 2017 primarily relates to the amortization of intangibles resulting from the acquisition.
Other Income and Expense.
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
September 30, 2017
 
September 24, 2016
Other income (expense), net (in millions):
$
0.3

 
$
(1.2
)
 
$
0.7

 
$
(1.5
)
Other income (expense), net, is primarily composed of interest income, foreign currency transaction and remeasurement gains and losses incurred by our Korean and UK-based subsidiaries and other non-operating income items. During the three and nine months ended September 30, 2017, we recorded $0.2 million of foreign currency gains and $0.4 million of foreign currency losses, respectively. During the three and nine months ended September 24, 2016, we recorded $1.1 million and $1.6 million of foreign currency losses, respectively. During the nine months ended September 30, 2017, we recorded a non-cash $0.3 million gain on the mark-to-market of a warrant we received as part of a license of our technology.
In 2016, we discovered embezzlement at our Korean subsidiary of approximately $1.6 million which occurred during the period 2011 through 2016. In the three and nine month periods ended September 24, 2016, we recorded in Other income (expense), net, embezzlement expense of approximately $0.2 million and $0.4 million, respectively, representing the total amount of theft loss that occurred during those time periods. During the nine months ended September 30, 2017 we recognized a recovery of approximately $0.3 million received from the family of the embezzler as restitution.

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Tax Provision. For the nine months ended September 30, 2017, we recorded a tax benefit of $1.1 million, which represents the net of $0.1 million for foreign income taxes related to uncertain tax positions and a benefit for the net reduction in estimated foreign withholding. In addition, as a result of the acquisition of a company, we recognized $1.0 million of net deferred tax liabilities which provides evidence of recoverability of our net deferred tax assets that previously carried a full valuation allowance. We reduced the valuation allowance on our net deferred tax assets in the amount of $1.0 million and such reduction was recognized as a benefit for income taxes for the nine months ended September 30, 2017. For the three and nine months ended September 24, 2016, we recorded a tax provision of $0.1 million and $2.2 million, respectively, for estimated foreign income taxes, an increase in estimated foreign withholding on anticipated future remitted earnings of a foreign subsidiary and estimated state income tax.
Net Income Attributable to Noncontrolling Interest. As of September 30, 2017, we owned approximately 93% of the equity of Kowon and 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 income attributable to noncontrolling interest is the result of the change in the results of operations of Kowon and eMDT for the three and nine months ended September 30, 2017 and September 24, 2016.
Liquidity and Capital Resources
At September 30, 2017, we had cash and equivalents and marketable securities of $77.3 million and working capital of $70.5 million compared to $77.2 million and $70.0 million, respectively, as of December 31, 2016. The change in cash and equivalents and marketable securities was primarily due to net outflow of cash used in operating activities of $19.8 million and acquisition of a company for $3.7 million, offset by cash provided by the sale of 7.6 million shares of treasury stock for $24.7 million.
Cash and marketable debt securities held in U.S. dollars at September 30, 2017:
Domestic
$
58,739,986

Foreign
9,166,205

Subtotal cash and marketable debt securities
67,906,191

Cash and marketable debt securities held in other currencies and converted to U.S. dollars
9,431,273

Total cash and marketable debt securities
$
77,337,464

We have no plans to repatriate the cash and marketable debt securities held in our foreign subsidiaries FDD and Kopin Software Ltd. and, as such, we have not recorded any deferred tax liability with respect to such cash. The manufacturing operations at our Korean facility, Kowon, have ceased. Kowon has approximately $18.0 million of cash and marketable debt securities which we anticipate will eventually be remitted to the U.S. and, accordingly, we have recorded deferred tax liabilities associated with its unremitted earnings.
In March 2017, we acquired 100% of the outstanding stock of a company for $3.7 million plus contingent consideration. An additional $2.0 million can be earned if certain cash flow milestones are met and certain employees remain with the company through March 2020.
We expect to expend between $2.0 million and $3.0 million on capital expenditures over the next twelve months. We own approximately 93% of Kowon, our Korean subsidiary. The owners of the remaining 7% have expressed a desire to sell their shares to us. We are evaluating whether to purchase the shares. The Company has entered into two joint venture agreements and other agreements which are subject to certain closing conditions including government approvals. If the transactions close the Company will contribute certain intellectual property and approximately $8.0 million
As of September 30, 2017, we had U.S. federal and state tax loss carry-forwards, which may be used to offset U.S. future federal and state taxable income. We also had tax loss carry-forwards generated in our foreign subsidiaries which may be used to offset future foreign taxable income. We may be subject to alternative minimum taxes, foreign taxes and state income taxes depending on our taxable income and sources of taxable income.
Historically, we have financed our operations primarily through public and private placements of our equity securities and cash generated from operations. We believe our available cash resources will support our operations and capital needs for at least the next twelve months.
Seasonality
There has been no seasonal pattern to our sales in fiscal years 2017 and 2016.

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Item 3.
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 interest rate 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. and Kowon subsidiaries. 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 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 but do not enter into forward or futures hedging contracts.
Item 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures

Based on an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) were not effective. This conclusion was based on the existence of the material weaknesses in our internal control over financial reporting previously disclosed and discussed below and as more fully discussed in our Annual Report on Form 10-K for the year ended December 31, 2016.

As disclosed in our Annual Report on Form 10-K, Item 9A, for the year ended December 31, 2016, our management concluded that our internal control over financial reporting was not effective at December 31, 2016. We are actively engaged in the implementation of a remediation plan, described below, to ensure that controls contributing to the material weaknesses are designed appropriately and will operate effectively.

Management's Plan to Remediate the Material Weaknesses

Our Korean subsidiary stopped production in 2013 and was maintained by a small staff, pending the sale of the facilities, which occurred in June of 2016. The employee responsible for the embezzlement was able, in large part, to perpetrate the fraud by obtaining the Company’s seal and using it to authenticate fraudulent documents. The Company's seal was removed from local management’s control by December 31, 2016 and now resides with an independent party. Local management must now make requests of our corporate accounting department to execute transactions. Our corporate accounting department coordinates with the independent party to execute any transactions. Our Korean subsidiaries' accounting function has been outsourced to an independent third party who reports directly to the corporate accounting department. In addition, enhanced reviews of bank statements, account reconciliations and supporting analysis are being performed by our corporate accounting department. We have also hired additional qualified personnel in our corporate accounting department who are implementing additional internal reporting procedures, including those designed to add depth to our review processes.

We expect that our remediation efforts will continue, although the material weaknesses will not be considered remediated until our controls have been operational for a period of time, such controls are tested and management concludes that such controls are effective.

Notwithstanding the identified material weakness and management’s assessment that internal control over financial reporting was ineffective as of September 30, 2017, management believes that the consolidated financial statements contained in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States of America.


23


Changes in Internal Control over Financial Reporting

There were no changes in the our internal controls over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that was conducted during the quarter ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, except for our remediation efforts described above.


Part II. OTHER INFORMATION
Item 1.
Legal Proceedings
We 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.
Item 1A.
Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for our fiscal year ended December 31, 2016. The risks discussed in our Annual Report on Form 10-K could materially affect our business, financial condition and future results. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition or operating results.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Sale of Unregistered Securities
In December 2016, we entered into an agreement with a Chinese company, Goertek Inc. (“Goertek”) pursuant to which Goertek would acquire 7,589,000 shares of unregistered stock of the Company for approximately $24.7 million. The transaction was completed on April 20, 2017. Other than the sale to Goertek we have not sold any securities in the past three years which were not registered under the Securities Act.
Use of Proceeds
The information required by this item regarding use of proceeds by the Company is reported herein in Part I, Item 2 under “Liquidity and Capital Resources”. 



24


Item 6.        Exhibits
Exhibit
No.
 
Description
 
 
 
 
101.INS
 
XBRL Instance Document*
101.SCH
 
XBRL Taxonomy Extension Schema Document*
101.CAL
 
XBRL Taxonomy Calculation Linkbase Document*
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB
 
XBRL Taxonomy Label Linkbase Document*
101.PRE
 
XBRL Taxonomy Presentation Linkbase Document*
 *
Submitted electronically herewith
**
Furnished and not filed herewith

Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets at September 30, 2017 (Unaudited) and December 31, 2016, (ii) Condensed Consolidated Statements of Operations (Unaudited) for the three and nine months ended September 30, 2017 and September 24, 2016, (iii) Condensed Consolidated Statement of Comprehensive (Loss) Income (Unaudited) for the three and nine months ended September 30, 2017 and September 24, 2016, (iv) Condensed Consolidated Statements of Stockholders’ Equity (Unaudited) for the nine months ended September 30, 2017, (v) Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2017 and September 24, 2016, and (vi) Notes to Unaudited Condensed Consolidated Financial Statements.


25


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
KOPIN CORPORATION
(Registrant)
 
 
 
 
 
Date:
November 9, 2017
 
By:
/S/    John C.C. Fan        
 
 
 
 
John C.C. Fan
 
 
 
 
President, Chief Executive Officer and
Chairman of the Board of Directors
 
 
 
 
(Principal Executive Officer)
 
 
 
 
 
Date:
November 9, 2017
 
By:
/S/    RICHARD A. SNEIDER        
 
 
 
 
Richard A. Sneider
 
 
 
 
Treasurer and Chief Financial Officer
 
 
 
 
(Principal Financial and Accounting Officer)

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