KOPIN CORP - Quarter Report: 2005 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15d

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 24, 2005

Commission file number 0-19882

KOPIN CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (508) 824-6696

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    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

Indicate the number of shares outstanding of each issuer’s classes of common stock, as of the latest practicable date

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Kopin Corporation

INDEX

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RISK FACTORS

This Form 10-Q report contains forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995, including without limitation statements made relating to our expectation that our revenues derived from Skyworks Solutions, Samsung and JVC will represent a significant portion of revenues in the near term; our belief that Sony’s and Sanyo’s share of Samsung’s business will increase in 2006 and ours will decrease; our belief that the camcorder market, and sales of camcorders, will decline over the next few years; our expectation that sales to our camcorder customers will decline at a faster rate than the overall decline in the camcorder market; our belief that the average sales price of our consumer CyberDisplay and III-V products will decrease in the range of 10 to 15%; our belief that the sales price of our displays will have to decrease to be competitive; our belief that our success in penetrating the military and digital still camera markets will impact our ability to increase sales of CyberDisplay products; our expectation that sales of our CyberDisplay products to customers who use them in camcorder applications will decrease; our belief that the sales price of our HBT transistors will decline by 8-10% in 2005; our expectation that the KoBrite joint venture will incur additional losses in the near term; our expectation that competition will increase; our expectation that fourth quarter revenues will decline, as will overall manufacturing efficiencies and gross margin percentage; our intention to seek patents on our inventions; our expected adoption of Statement of Financial Accounting Standards (SFAS) No. 123R in the quarter ending April 1, 2006; our expectation that sale prices of our consumer displays will decline, and military product sales will increase, in fiscal year 2005; our belief that we will need to increase sales in applications other than wireless handsets and camcorders to generate revenue growth in our HBT and CyberDisplay product lines; our expectation to negotiate with customers for returns of CyberLite products and our expectation not to make future shipments of CyberLite products; our expectation that further CyberLite LED research and development activities will be performed directly by KoBrite; our belief that our available cash resources will support our operations and capital needs for at least the next 12 months; our expectation that we will expend between $6.0 and $7.0 million on capital expenditures over the next 12 months; our belief that our adoption of SFAS No.151 will not have a material impact on our consolidated financial statements; our belief that our strongest sales quarters (strongest to weakest) are third, second, fourth and first; our expectation that our disclosure control and procedure resolution will require hiring additional staff and increasing our level of accounting expertise; our expectation that any earnings will be retained for the development of our businesses; our expectation not to pay domestic federal taxes in the near term; our expectation that our military program will transition from an existing customer to two new customers; and our belief that the effect of possible near-term changes in interests rates on our financial position, results of operations and cash flows should not be material. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industries in which we operate, management’s beliefs, and assumptions made by management. In addition, other written or oral statements, which constitute forward-looking statements, may be made by or on behalf of us. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “could”, “seeks”, “estimates”, 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 and those set forth in our periodic filings filed with the Securities and Exchange Commission, including without limitation our Annual Report on Form 10-K for the fiscal year ended December 25, 2004.

Failure to achieve and maintain effective internal controls could have a material adverse effect on our business, operating results and stock price. Our management is required to periodically evaluate the design and effectiveness of our disclosure controls and procedures. During the course of its evaluation for the year ended December 25, 2004, our management identified a material weakness in our application of generally accepted accounting standards, which continues through September 24, 2005. In addition, we have documented and tested our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requires our management to annually assess the effectiveness of our internal control over financial reporting. During the course of our testing we identified the need to increase the number of accounting staff with knowledge of Securities and Exchange Commission rules and regulations and generally accepted accounting standards. Any failure to implement or difficulties experienced in implementing, improved controls or any failure to maintain existing effective controls could have a material adverse effect on our business, operating results and stock price. For the nine month period ended September 24, 2005 the Company has increased our accounting staff but several positions remain unfilled. As a result of the material weakness described above, the Company’s disclosure controls and procedures were not effective as of December 25, 2004 and September 24, 2005, which could result in a material misstatement in our annual and interim financial statements.

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We have experienced a history of losses and have a significant accumulated deficit. Since inception, we have incurred significant net operating losses. As of September 24, 2005 we had an accumulated deficit of $117.3 million. There can be no assurance that we will continue to achieve or maintain profitability in the future.

Our revenue and cash flow could be negatively affected by the loss of any of the few customers who account for a substantial portion of our revenues. A few customers account for a substantial portion of our revenues. The table below indicates what the percentages of our total revenues were from a particular customer in a given year. The symbol “*” indicates that sales to that particular customer for the given year were below 10 percent of our total revenues. Skyworks Solutions, Inc. was formed through the merger of Conexant Systems’ wireless division and Alpha Industries in 2002. The sales to Skyworks Solutions as a percent of Kopin’s total revenues described below are on a pro forma basis assuming the merger occurred on January 1, 2002.

We anticipate that sales to Skyworks Solutions, Samsung and JVC will continue to represent a significant portion of our revenues for the near future, although we expect that our revenues from Samsung and JVC may decrease. We believe that historically we have provided Skyworks Solutions with the vast majority of its HBT transistor wafers. Our primary competition for display sales to Samsung is Sony and Sanyo. Based on current negotiations we anticipate that Sony and Sanyo’s share of camcorder business will increase in 2006 and our business will decline. A significant reduction or delay in orders from any of our significant customers, particularly Skyworks Solutions and Samsung, would materially reduce our revenue and cash flow and adversely affect our ability to achieve or maintain profitability in the future. We have increased sales of CyberDisplay products for military applications in the nine months ended September 24, 2005 from historical levels. Such sales are to government contractors for the United States military. The amount and timing of such orders is dependent upon the United States military procurement processes, the government contractors ability to successfully manage the program, and our ability to deliver more sophisticated CyberDisplay products.

We may be unable to increase revenues from CyberDisplay^™ products if new products and applications are not developed. CyberDisplay revenues for the fiscal years 2004, 2003 and 2002 were $49.1 million, $43.6 million and $44.1 million, respectively. The change in CyberDisplay revenues has resulted primarily from an increase in sales of our displays to the military products and digital still camera markets, offset by a decrease in the average sales price of our CyberDisplay product to customers for use in camcorders. We believe the average sales price of our consumer displays will decrease in the range of 10% to 15% during the fiscal year 2005. However, discussions with our customers indicate that our competition is dramatically reducing their prices and we believe the average sales price of our displays to consumer product customers will have to decline if we are to remain competitive in the market place. We believe that we have captured significant market share in the camcorder market; however, we believe that the camcorder market will decline over the next few years as new technologies, particularly digital video recorders, enter the market. In addition we expect our sales to camcorder manufacturers to decline at a faster rate than the overall decline in the camcorder market as we may choose not to match the lower prices being offered by our competitors. Accordingly, if we are unable to expand into new markets, revenues from CyberDisplay products will decline, which may impact our ability to achieve or maintain profitability in the future.

In fiscal year 2004 we had initial sales of display products into the military product and digital still camera markets. We are gaining experience in selling displays into these markets. We believe that our success in penetrating these and other markets, particularly military night vision goggles, will significantly impact our ability to increase sales of CyberDisplays. In addition, our military products have a higher gross margin than our consumer display products and our success in increasing sales of military products will significantly impact our ability to achieve or maintain profitability. Accordingly, if we are unable to successfully sell our display products to digital still camera, binocular display modules (BDMs), and military product makers, we may be unable to grow CyberDisplay product revenues and our ability to achieve or maintain profitability will be adversely affected.

We may not be able to increase our military production capacity. A critical part of our business strategy is to expand production capacity to manufacture displays for the military product market. A significant part of this strategy is the implementation of a new manufacturing line which can utilize 8 inch wafers for our display production. The conversion of our existing 6 inch line to 8 inch will require the investment in new equipment and the redesign of our existing display products. It may also require the requalification of our existing display products with our customers. If we are unable to execute our military product display production facility plan, including the implementation of an 8 inch production line, or we can only manufacture and ship our CyberDisplay products in limited quantities, our revenues from CyberDisplay products may not grow, which may impact our ability to achieve or maintain profitability in the future.

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Our ability to offer and manufacture higher level CyberDisplay assemblies and modules will impact our ability to increase revenues and achieve or maintain profitability. An important factor in our ability to expand into new markets, such as BDMs, digital still cameras and military products, will be the development of new display products, which offer enhanced features, have higher or lower resolution than current displays offered or are sold at a lower price. These products will require more complex integration of a greater variety of components than we currently use for our existing display products. They will require us to invest in additional engineering and manufacturing capability. Accordingly, if we are unable to develop and market these new display products or if we are unable to manufacture them in a cost-effective manner, our revenues may not grow and we may not be able to achieve or maintain profitability.

Our competitors can provide integrated solutions. Many portable consumer electronic devices, including camcorders and digital still cameras, have two displays for viewing images, an electronic viewfinder and a flip-out or group view display. We only provide the display that is used as the electronic viewfinder. Our competitors may offer both displays and both displays may be run by the same interface electronics. A customer who buys our display is required to buy the flip-out or group view display from another vendor who may compete with us. This may require our customer to purchase additional interface electronics to run our display. Our competitors may be able to offer a bundled solution of both displays and the interface electronics cheaper than the cost of buying our display and the other display and the interface electronics separately. If we are unable to offer displays with sufficient performance advantages over other displays to justify the additional cost of buying individual components versus a bundled solution or if our customers can not procure cost efficient interface electronics to run our display products we may lose market share or be unable to grow our business which in turn would adversely affect our ability to achieve or maintain profitability.

Our CyberDisplay^™ products may not be widely accepted by the market. Our success will in large part depend on the widespread adoption of the viewing format of our CyberDisplay products in multiple applications. Our success also depends upon the widespread consumer acceptance of our customers’ products. CyberDisplay products work best when used close to the eye, which may not be acceptable to consumers. Potential customers may be reluctant to adopt our CyberDisplay products because of concerns surrounding perceived risks relating to:

In addition, our customers may be reluctant to rely upon a relatively small company like us for a critical component. We cannot assure investors that prospective customers will adopt our CyberDisplay products or that consumers will accept our CyberDisplay products in future applications. If we fail to achieve market acceptance of our CyberDisplay products, our business may not be successful and we may not be able to achieve or maintain profitability.

Our ability to manufacture and distribute our CyberDisplay^™ products would be severely limited if the third parties that we rely on to manufacture integrated circuits for our CyberDisplay^™ products fail to provide those services. We depend on a Taiwanese and a Korean company for the fabrication of integrated circuits for our CyberDisplay products. We have no long-term contracts with either of these two companies. These two companies use different methods to manufacture the integrated circuits and a shortage in one company cannot necessarily be supplied by the other company. If either company were to terminate its arrangement with us or become unable to provide the required capacity and quality on a timely basis, we would be able to manufacture and ship our CyberDisplay products only in limited quantities until replacement foundry services could be obtained. Furthermore, we cannot assure investors that we would be able to establish alternative manufacturing and packaging relationships on acceptable terms.

Our reliance on these foundries involves certain risks, including:

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One of the foundries and several other third parties with which we do business are located in Taiwan. Due to the earthquake that occurred in Taiwan in 1999 and the typhoon that occurred in Taiwan in September 2001, many Taiwanese companies, including the Taiwanese foundry we use, experienced related business interruptions. Our business could suffer significantly if either of the foundries we use had operations which were disrupted for an extended period of time, due to natural disaster, political unrest or otherwise. In addition, our CyberDisplays are manufactured on 6-inch silicon wafers. State of the art silicon production uses 8-inch wafers. We cannot be assured that if the 6-inch manufacturing facilities we use were damaged they would be restored. If the 6-inch production facilities were not restored we may be required to redesign our displays so that they can be manufactured on an 8-inch production line. If the displays had to be redesigned we may have to have the displays re-qualified by our customers, which would adversely affect our business until such qualification is complete.

In fiscal year 2003, there was an outbreak of Severe Acute Respiratory Syndrome (SARS). There were reports that consumer demand was negatively impacted by the outbreak of SARS. Our sales, manufacturing and distribution processes, and in turn our overall business operations, may be adversely affected if SARS or similar situations occurred again in the future.

We depend on third parties to provide integrated circuit chip sets and other critical raw materials for use with our CyberDisplay^™ products. We do not manufacture the integrated circuit chip sets necessary for use with our CyberDisplay products. Instead, we rely on third party independent contractors for these integrated circuit chip sets and other critical raw materials such as special glasses and chemicals. The critical raw materials, including the glasses and chemicals used in manufacturing the CyberDisplay products are used by other display manufacturers, many of which are much larger than Kopin. In addition, our higher-level CyberDisplay assemblies and modules include lenses, backlights, printed circuit boards and other components, which we purchase from third party suppliers. Some of these third party contractors and suppliers are small companies with limited financial resources. We believe that one of the suppliers of a critical component for our higher-end Cyberdisplay assemblies may be in having financial difficulties. We are currently attempting to find another source for the manufacture of this component. If any of these third party contractors or suppliers were unable or unwilling to supply these integrated circuit chip sets or other critical raw materials to us, we would be unable to manufacture and sell our CyberDisplay products until a replacement supplier could be found. We cannot assure investors that a replacement third party contractor or supplier could be found on reasonable terms or in a timely manner. In the past we have experienced situations when our vendors could not supply the quantity or quality of critical raw materials we needed. As a result, we were unable to meet customer demand and our revenues, manufacturing yield and gross margins were adversely affected. Currently there is strong worldwide demand for display materials because of the significant growth of display sales over the last few years. Any interruption in our ability to manufacture and distribute our CyberDisplay products could cause our display business to be unsuccessful and the value of investors’ investment in us may decline.

If we are unable to significantly increase our unit sales volume and reduce our production costs, our business will suffer. Our III-V and CyberDisplay product lines currently have significant fixed costs and our ability to achieve or maintain profitability depends upon achieving significant sales volumes and higher gross profit margins. Our heterojunction bipolar transistor (HBT) products comprise our III-V product group. If we are unable to increase our III-V and CyberDisplay production levels and reduce manufacturing costs, we may lose customer orders and our business may be unprofitable.

We may be unable to increase revenues from HBT transistor wafers if new product applications are not developed. A critical market for our HBTs is wireless handsets. The growth rate of the wireless handset market has been very unpredictable over the last several years. We expect prices of our HBT transistor will decline by approximately 8 to 10 percent during fiscal year 2005. If the wireless handset market grows in the range of 5 to 10 percent for the fiscal year 2005 our HBT revenues may decrease unless we increase our market share or new markets are developed. Revenues may also decline if we lose any of our customers or such customers reduce their orders from us. Accordingly, if we are unable to find additional applications for our HBT transistor wafers or increase our market share, our HBT transistor revenue may not grow and such absence of growth may impact our ability to achieve or maintain profitability.

We generally do not have long-term contracts with our CyberDisplay 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 and shipment schedules 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. Our operating results are difficult to forecast because we are continuing to invest in capital equipment and increasing our operating expenses for new product

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development. If we fail to accurately forecast our revenues and operating results, our business may not be successful and the value of investors’ investment in us may decline.

We may not be able to realize any profits under a multi-year supply agreement with a significant HBT customer. In October 2003 we amended a supply agreement with a significant HBT customer that expires in July 2006. Under the terms of this agreement we agreed to maintain capacity levels for manufacturing HBT wafers and we committed to a declining pricing schedule. The agreement also requires us to give prior notice if we exit our HBT product line. In consideration for this agreement the customer agreed to source 100% of its HBT wafer needs from us subject to the customer’s right to source HBT wafers from other sources if we are unable to meet its requirements under certain circumstances. We agreed that failure to meet our supply obligations under the agreement would allow our customer to obtain court ordered specific performance. If we do not perform we could then be liable for monetary damages up to a maximum of $45 million. The agreement obligates us to provide wafers at preset prices and as a result, our ability to make a profit under this agreement will be subject to fluctuations in the prices of raw materials and to any increase in costs of goods or services required for us to perform under the agreement. If we are unable to manufacture the HBT wafers below these preset prices we may not be able to achieve or maintain profitability.

We may have to record additional impairment losses. In fiscal year 2004 we entered into an agreement to transfer our CyberLite LED operations into the KoBrite joint venture. Our CyberLite LED operations were performed in our facility located at 200 John Hancock Road, Taunton, MA. In addition, a portion of our III-V product line operations was performed in our 200 John Hancock Road facility. With the discontinuance of the CyberLite LED operations the recoverability of the 200 John Hancock Road leasehold improvement assets will be evaluated based on the cash flow from our III-V product line. In fiscal year 2004, based upon forecasted cash flow of our III-V product line, we recorded an impairment charge of $3.2 million. The forecast also indicated that an impairment charge might be necessary in the future unless the cash flows from our III-V product line continue at current levels. Our 2004 forecast was based on certain estimates relating to III-V product line cash flows. If such estimates were too high, we may be required to record an additional impairment charge in the future. In addition, in fiscal year 2006 we are anticipating a decline in sales of our CyberDisplay products to customers who use them in camcorder applications. If sales of our CyberDisplay products decline significantly we may be required to record an impairment charge in the future for long lived assets that support these products.

We may record additional losses from our investment in the KoBrite joint venture, which may impact our ability to achieve or maintain profitability. We account for our investment in the KoBrite joint venture using the equity method, which requires us to record our proportional share of their operating results up to the amount we have invested or committed to support, which is our current $3.0 million investment. In the nine months ended September 24, 2005 we recorded $168,023 of losses from the KoBrite joint venture. We anticipate that the joint venture will incur additional losses in the near term. If the joint venture generates operating losses in the future we will record additional losses, which will impact our ability to achieve or maintain profitability.

A disruption to our information technology systems could significantly impact our operations and impact our revenue and profitability. We maintain proprietary data processing systems and use customized software systems. An interruption to these systems for an extended period may impact our ability to operate the businesses and process transactions which could result in a decline in sales and affect our ability to achieve or maintain profitability.

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 several reasons, including:

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We typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. Our operating results are difficult to forecast because we are continuing to invest in capital equipment and increasing our operating expenses for new product development.

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.

We may be unable to modify our products to meet regulatory or customer requirements. From time to time our products are subject to new domestic and international requirements such as the European Union’s Restriction on Hazardous Substances (RoHS) Directive. 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 achieving or maintaining profitability.

Increased competition may result in decreased demand or lower prices for our products. Competition in the markets for our products is intense and we may not be able to compete successfully. We compete with several companies primarily engaged in the business of designing, manufacturing and selling integrated circuits or alternative display technologies, as well as the supply of other discrete products. Our competitors could develop new process technologies that may be superior to ours, including technologies that target markets in which our products are sold. Many of our existing and potential competitors have strong market positions, considerable internal manufacturing capacity, established intellectual property rights and substantial technological capabilities. Furthermore, they also have greater financial, technical, manufacturing, marketing and personnel resources than we do, and we may not be able to compete successfully with them.

In addition, many of our existing and potential customers manufacture or assemble displays, wireless communications devices and light emitting diodes and have substantial in-house technological capabilities and substantially greater resources than we do. We may not be able to sell our products to these customers and they may commercialize their internal capabilities to become our competitors. If one of our large customers establishes internal design and manufacturing capabilities, it could have an adverse effect on our operating results.

We expect competition to increase. This could mean lower prices or reduced demand for our products. Any of these developments would have an adverse effect on our operating results.

Disruptions of our production of our III-V and CyberDisplay products would 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 III-V and CyberDisplay products to our customers. Our manufacturing processes are highly complex and customer specifications are extremely precise. We periodically modify our processes in an effort to improve yields and product performance and to meet particular customer requirements. Process changes or other problems that occur in the complex manufacturing process can result in interruptions in production or significantly reduced yields. Additionally, as we introduce new equipment into our manufacturing processes, our III-V and CyberDisplay 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. We are also subject to the risks associated with the shortage of raw materials used in the manufacture of 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 the light emitting diode (LED), wireless communications, semiconductor materials and display 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. If we cannot keep pace with these changes, our business could suffer.

We 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 inventions made by them while in our employ. These measures may not adequately protect our intellectual and proprietary rights. Existing trade secret, trademark and copyright laws afford only limited protection and our patents could be invalidated or circumvented. Moreover, the laws of certain foreign countries in which our products are or may be manufactured or sold may not fully protect our intellectual property rights. Misappropriation of our technology and the costs of defending our intellectual property rights

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from misappropriation could substantially impair our business. If we are unable to protect our intellectual property and proprietary rights, our business may not be successful and the value of investors’ investment in us may decline.

Our products could infringe on the intellectual property rights of others. Companies in the light emitting diode (LED), wireless communications, semiconductor and display industries steadfastly pursue and protect intellectual property rights. This has resulted in considerable and costly litigation to determine the validity 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 or inventions or other proprietary rights in technology necessary for our business. If we are forced to defend against infringement claims, we may face such costly litigation, diversion of technical and management personnel, and product shipment delays, even if the allegations of infringement are unwarranted. If there is a successful claim 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, it could adversely affect our business.

Our business could suffer if we lose the services of, or fail to attract, key personnel. In order 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. If the III-V or CyberDisplay markets experience an upturn, we may need to increase our workforce. 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.

We may pursue acquisitions and investments that could adversely affect our business. 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 negotiate or finance the acquisition or 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.

We may incur significant liabilities if we fail to comply with stringent environmental regulations or if we did not comply with these regulations in the past. We are subject to a variety of federal, state and local governmental regulations related to the use, storage, discharge and disposal of toxic 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 a cessation of operations. We cannot assure investors that we have not, in the past, violated applicable laws or regulations, which could result in required remediation or other liabilities.

Investors should not expect to receive dividends from us. 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.

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.

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Part 1: FINANCIAL INFORMATION

Item 1: Consolidated Financial Statements (unaudited)

KOPIN CORPORATION

CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements.

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KOPIN CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(unaudited)

See notes to consolidated financial statements

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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Nine months ended September 24, 2005 and September 25, 2004

(unaudited)

See notes to consolidated financial statements.

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KOPIN CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

See notes to consolidated financial statements.

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KOPIN CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The consolidated financial statements for the nine months ended September 24, 2005 and September 25, 2004 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. All such adjustments are of a normal recurring nature.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Kopin Corporation’s (the “Company”) Annual Report on Form 10-K filed with the Securities and Exchange Commission (File No. 000-19882) for the year ended December 25, 2004.

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.

The consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and Kowon Technology Co., Ltd. (“Kowon”), a majority owned (73%) subsidiary located in Korea. All intercompany transactions and balances have been eliminated.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications were to group related party receivables in a separate line item in the balance sheet and to separately present certain components of other income and expense in the statement of operations.

2. FOREIGN CURRENCY TRANSLATION

Assets and liabilities of non-U.S. operations are translated into U.S. dollars at period-end exchange rates, and revenues and expenses at rates prevailing during the period. Currency translation adjustments are recorded as part of accumulated other comprehensive income and aggregate $2,113,000 of accumulated other comprehensive income at September 24, 2005. Transaction gains or losses are recognized in income or loss currently.

3. INVENTORY

Inventory is stated at the lower of cost (determined on the first-in, first-out or specific identification method) or market and consists of the following at September 24, 2005 and December 25, 2004:

4. NET INCOME (LOSS) PER SHARE AND STOCK COMPENSATION

Basic net income (loss) per share is computed using the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per share is computed using the weighted average number of common shares and potential common shares outstanding during the period using the treasury stock method. Potential common shares have not been included in any periods in which the effect would be antidilutive. For the three and nine months ended September 24, 2005, 1,542,883 and 639,540 shares are included in the diluted earnings per share calculation from the assumed exercise of outstanding stock options and repurchased under the treasury stock method. For the three and nine months ended September 24, 2005 and September 25, 2004, stock options and non vested restricted shares aggregating 4,001,121 and 7,111,581 shares and 9,381,420 and 9,389,105 shares, respectively, were outstanding but not included in the computation of diluted earnings per share as the net loss for this period would have made their effect antidilutive.

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Stock-Based Compensation

The Company accounts for its stock-based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees”, using the intrinsic value method. Under APB Opinion No. 25, stock compensation expense is recognized for the excess, if any, of intrinsic value of the award over the exercise price.

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R), which requires the recognition of compensation cost for all share-based payments (including employee stock options) at fair value (generally grant date fair value). The standard is effective for us in the first quarter of fiscal 2006. SFAS 123R provides two alternative adoption methods. The first method is a modified prospective approach whereby a company would recognize share-based employee costs from the beginning of the fiscal period in which the recognition provisions are first applied as if the fair value-based accounting method had been used to account for all employee awards granted, modified, or settled after the effective date and to any awards that were not fully vested as of the effective date. Measurement and attribution of compensation cost for awards that are unvested as of the effective date of SFAS 123R would be based on the same estimate of the grant-date fair value and the same attribution method used previously under SFAS No. 123, “Accounting for Stock Based Compensation” (SFAS 123). The second adoption method is a modified retrospective approach whereby a company would recognize employee compensation cost for periods presented prior to the adoption of SFAS 123R in accordance with the original provisions of SFAS 123; that is, an entity would recognize employee compensation costs in the amounts reported in the pro forma disclosures provided in accordance with SFAS 123. A company would not be permitted to make any changes to those amounts upon adoption of SFAS 123R unless those changes represent a correction of an error. For periods after the date of adoption of SFAS 123R, the modified prospective transition method described above would be applied. The Company currently expects to adopt SFAS 123R beginning in the quarter ending April 1, 2006, using the modified prospective approach, although the Company continues to review its options for adoption under this new pronouncement. In addition, the Company is considering accelerating the vesting of certain stock options in fiscal year 2005 prior to the effectiveness of SFAS 123R. The effect of the adoption of SFAS 123R will be to increase the Company’s stock option compensation expense.

The following table illustrates the effect on the net income (loss) and net income (loss) per share had the Company used the fair-value recognition provisions of SFAS No. 123, and its amendment to measure employee stock compensation. The fair value of each option grant is estimated on the grant date using the Black-Scholes option pricing model with the following assumptions used for grants in the three and nine months ended September 24, 2005 and September 25, 2004: no expected dividend yield; expected volatility of 72.69%; risk-free interest rate of 4.22% in 2005 and in 2004; and expected lives of four to seven years. The weighted-average fair value of options on grant date was $2.34 in 2005 and $2.75 in 2004.

5. OTHER CURRENT AND NON CURRENT ASSETS

Other assets consist primarily of the Company’s investment in Micrel, Inc. and non-marketable equity securities in various companies.

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Marketable Equity Security

As of September 24, 2005, the Company held approximately 400,000 shares of Micrel common stock with a market value of approximately $4,595,000 and an adjusted cost basis of approximately $3,606,000. The fair value of this investment at December 25, 2004 was $4,350,000.

Non-Marketable Securities

Detailed related party receivable for the periods ended September 24, 2005 and December 25, 2004, is as follows:

At September 24, 2005, the Company had a 40% interest in Kopin Taiwan Corp (KTC), which is accounted for using the equity method and had a carrying value of $0. The Company has manufactured products for KTC to sell to their customers and KTC manufactures product for us to sell to our customers. In addition, the Company provides technical services to KTC and sells raw substrates. For the three and nine months ended September 24, 2005 the Company had sales to KTC of approximately $73,000 and $237,000, respectively, as compared to $263,000 and $1,930,000, respectively, for the three and nine months ended September 25, 2004. For the three and nine months ended September 24, 2005 the Company had purchases from KTC of approximately $392,000 and $1,677,000, respectively, as compared $0 and $344,000, respectively, for the three and nine months ended September 25, 2004. For the three and nine months ended September 25, 2004 the Company recorded losses of $178,411 and $778,411, respectively, in “Equity losses in unconsolidated affiliates” in the statement of operations, which represented its ownership percentage of KTC’s operating results. One of the Company’s Directors is chairman of KTC and owns approximately 1% of the outstanding common stock of KTC.

Summarized financial information for KTC for the three and nine months ended September 24, 2005 and September 25, 2004, is as follows:

In February 2005 the Company contributed its CyberLite LED technology, production know-how, and $3.0 million to a joint venture, KoBrite, formed to manufacture and sell LEDs. For its contribution, the Company received a 23% interest in KoBrite. In addition, KTC contributed $2.0 million for a 15% interest in KoBrite and unrelated investors contributed an additional $9.0 million. KoBrite was established under the laws of Mauritius for the purpose of constructing manufacturing operations in China and contract manufacturing operations in Taiwan. Subsequent to its establishment, KoBrite entered into an agreement, which requires it to pay the Company a total of $7.5 million for the transfer of certain equipment and the performance of research and training activities. During the fiscal year ended December 25, 2004, the Company recorded an impairment charge of $2.1 million to write down the optical equipment to its estimated $6.0 million fair value less estimated transfer costs. During the nine months ended September 24, 2005, the Company increased its estimate of costs associated with the sale of the equipment. Accordingly, the fair value less costs of sale is estimated to be $5.3 million and the Company recorded an additional $517,902 impairment charge.

KoBrite is required to pay the Company upon achievement of certain milestones. During the nine months ended September 24, 2005, the Company received $5.3 million for the achievement of some of the required milestones. An additional $1.5 million is due upon the successful installation of the equipment that we transferred to the joint venture at the KoBrite designated locations. The equipment has arrived at the KoBrite designated locations and is scheduled for installation by third parties in the fourth quarter of 2005, upon which time the additional $1.5 million is due. A final payment of $750,000 is due upon KoBrite achieving certain product performance characteristics as validation of the effective transfer of

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technology and training of KoBrite personnel. As this final deliverable is not within the control of the Company, such revenue will not be recognized until these criteria are achieved, which is currently scheduled to occur in the fourth quarter of fiscal 2005. During the nine months ended September 24, 2005, the Company recorded revenue of $650,000 of the $1.5 million total expected payments related to research and development and training services for KoBrite, the remaining payment contingent upon successful performance, will be recognized when such revenue is realizable.

The Company accounts for its ownership interest in KoBrite using the equity method. KoBrite’s results are recorded one quarter in arrears from the Company’s. During the three and nine months ended September 24, 2005 the Company recorded a loss of $18,515 and $168,023, respectively, in “Equity losses in unconsolidated affiliates” in the statement of operations.

At September 24, 2005, the Company had an investment in a company with a carrying value of approximately $2,896,000, which is carried under the cost method. The Company made investments of $1,274,272 in fiscal year 2004 and an aggregate $1,622,000 in fiscal years 2003 and 2002. The Company’s Chief Executive Officer is a founder and board member of this company and owns approximately 4.10% of this company. Certain directors and an officer of the Company have also invested in this company and their ownership ranges from 0.1% to 1.1%.

Certain officers and directors have invested in some of the Company’s investee companies, including Micrel.

One of the Company’s directors is also a member of the Board of Directors of one of its customers. This director does not sit on any committees of the Company.

6. STOCKHOLDERS’ EQUITY

In December 2003, the Company issued an aggregate of 272,500 shares of unvested stock to certain employees. In connection with the issuance of these awards the Company recorded the issuance of 272,500 shares of common stock at an issuance value of $5.29 and a deferred compensation expense of $1,442,000. On December 27, 2004 the Company granted an aggregate of 240,000 shares of restricted stock to certain employees. In connection with the issuance of these awards the Company recorded the issuance of 240,000 shares of common stock at an issuance value of $3.75 and a deferred compensation expense of $900,000. Each award requires the employee to fulfill certain obligations, including remaining employed by the Company for periods of either two or four years (the “vesting period”). However, for 200,000 of the 240,000 shares issued on December 27, 2004, the shares will vest immediately upon the Company achieving four consecutive profitable quarters. At September 24, 2005, the Company has achieved 3 consecutive profitable quarters.

Compensation expense is amortized over the vesting period for all awards. Compensation expense for awards subject to acceleration (200,000 shares) would be accelerated when it becomes probable that accelerated vesting would occur. If the Company is profitable in the fourth quarter of fiscal 2005, these awards would vest. For the three and nine months ended September 24, 2005 the Company recorded stock compensation expense of $180,740 and $536,398, respectively, and the Company recognized $130,265 and $382,530 for the three and nine months ended September 25, 2004, respectively.

The Company has an ongoing authorization, as amended, from the Board of Directors to repurchase the Company’s common stock in open market or negotiated transactions. As of September 24, 2005, the Company had a remaining authorization to repurchase up to $7,969,876 worth of its common stock. During the three and nine months ended September 24, 2005, the Company repurchased an aggregate of 275,700 and 1,656,000 shares of its common stock for an aggregate $1,683,718 and $6,358,889, respectively, an average per share price of $3.84 for the nine months ended September 24, 2005.

At September 24, 2005, the Company has reserved 1,581,368 shares of common stock for issuance under the Company’s stock award plans.

7. ACCRUED WARRANTY

Kopin warrants its products against defect for 12 months. A provision for estimated future costs and estimated returns for credit relating to warranty is recorded in the period when product is shipped and revenue recognized. Kopin’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.