KOPIN CORP - Quarter Report: 2023 July (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended July 1, 2023

For the transition period from _____ to _____

Commission file number 0-19882

KOPIN CORPORATION

(Exact name of registrant as specified in its charter)

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

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

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

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

Kopin Corporation

INDEX

Part 1. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (Unaudited)

KOPIN CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

See notes to unaudited condensed consolidated financial statements

KOPIN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See notes to unaudited condensed consolidated financial statements

KOPIN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

See notes to unaudited condensed consolidated financial statements

KOPIN CORPORATION

Condensed Consolidated Statements of Stockholders’ Equity

(Unaudited)

See notes to unaudited condensed consolidated financial statements

KOPIN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See notes to unaudited condensed consolidated financial statements

KOPIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The condensed consolidated financial statements of Kopin Corporation as of July 1, 2023 and for the six month periods ended July 1, 2023 and June 25, 2022 are unaudited and include all adjustments that, 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 fiscal year ended December 31, 2022. 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. As used in this report, the terms “we”, “us”, “our”, “Kopin” and the “Company” mean Kopin Corporation and its subsidiaries, unless the context indicates another meaning.

The condensed consolidated financial statements for the six months ended July 1, 2023 include the accounts of Kopin Corporation and its wholly owned subsidiaries. The condensed consolidated financial statements for the six months ended June 25, 2022 include the accounts of Kopin Corporation and its wholly owned subsidiaries. Net loss attributable to noncontrolling interest in the Company’s condensed consolidated statements of operations for the six months ended June 25, 2022 represents the 20% of the results of operations of a former partially owned subsidiary which is allocated to the shareholders of the equity interests not owned by the Company. All intercompany transactions and balances have been eliminated.

The Company’s current strategy is to continue to invest in research and development, even during unprofitable periods, which may result in the Company continuing to incur net losses and negative cash flows from operations. If the Company is unable to achieve and maintain positive cash flows and profitability in the foreseeable future, its financial condition may ultimately be materially adversely affected such that management may be required to reduce operating expenses, including investments in research and development, or raise additional capital. While there can be no assurance the Company will be able to successfully reduce operating expenses or raise additional capital, management believes its historical success in managing cash flows and obtaining capital will continue in the foreseeable future.

On January 5, 2023, the Company entered into a Technology License Agreement and an Asset Purchase Agreement (the “LST Agreements”) with Lightning Silicon Technology, Inc. (“LST”). Pursuant to the LST Agreements, the Company issued a license to LST for certain technology associated with our Organic Light Emitting Technology, transferred in-process development contracts with two customers and accounts receivables that the Company had previously determined were not collectible. The technology license agreement provides for Kopin to transfer certain patents to LST if LST achieves certain milestones; however upon transfer, Kopin will receive a license to the technology. To the extent LST makes improvements to the technology licensed from Kopin, Kopin will receive a license for these improvements for certain markets. Kopin is not obligated to provide any additional funding support to LST. As consideration for the transaction, the Company received 18,000,000 preferred shares in LST, which the Company determined had no fair value as of the transaction date or as of July 1, 2023. While these shares represent a 20.0% equity stake in LST, they do not provide the Company with voting rights to elect LST’s Governance Board. The Company will also receive a royalty based on unit sales of products that utilize the technology licensed. Drs. John Fan, the Company’s former President, CEO and Chairman of the Board, Boryeu Tsaur, a former Executive Vice President of the Company and Hong Choi, the Company’s former Chief Technology Officer terminated their employment with the Company and became investors in and members of the management team of LST. Dr. Fan is the Founder of LST. As a result of this transaction, in 2022 the Company wrote off the two operating lease assets associated with facilities used for the development of our organic light emitting diode (OLED) products.

On January 27, 2023, the Company sold 17,000,000 shares of common stock and pre-funded warrants to purchase up to 6,000,000 shares of common stock at a public offering price of $0.99 per share for net proceeds of approximately $21.4 million. The Company believes that its existing cash, cash equivalents, will be adequate to satisfy its current operating plans for at least the next twelve months from the issuance of these financial statements. The Company has in the past sold equity securities through at-the-market equity offerings and in the traditional fashion of significant equity offerings. Nonetheless, management monitors the capital markets on an ongoing basis and may consider raising capital if favorable market conditions develop. If the Company’s actual results are less than projected or the Company needs to raise capital for additional liquidity, the Company may be required to do additional equity financings, reduce expenses, or enter into a strategic transaction. However, management can make no assurance that the Company will be able to raise additional capital, reduce expenses sufficiently, or enter into a strategic transaction on terms acceptable to the Company, or at all.

2. ACCOUNTING STANDARDS

ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments became effective for smaller reporting companies for fiscal years beginning after December 15, 2022. The amendments in ASU 2016-13 are intended to provide more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The Company adopted this standard on January 1, 2023 and there was not a material impact.

3. CASH AND CASH EQUIVALENTS AND MARKETABLE DEBT 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 records the amortization of premium and accretion of discounts on marketable debt securities in the results of operations.

The Company uses the specific identification method as a basis for determining cost and calculating realized gains and losses with respect to marketable debt securities. The gross gains and losses realized related to sales and maturities of marketable debt securities were not material during the three and six months ended July 1, 2023 and June 25, 2022.

Investments in available-for-sale marketable debt securities were as follows at July 1, 2023 and December 31, 2022:

 SCHEDULE OF AVAILABLE-FOR-SALE MARKETABLE DEBT SECURITIES 

The contractual maturity of the Company’s marketable debt securities was as follows at July 1, 2023:

 SCHEDULE OF MARKETABLE DEBT SECURITIES 

4. 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:

 SCHEDULE OF FAIR VALUE MEASUREMENTS OF FINANCIAL ASSETS 

Transfers between levels of the fair value hierarchy are reported at the beginning of the reporting period in which they occur. Changes in Level 3 investments were as follows:

 SCHEDULE OF FAIR VALUE, LIABILITIES MEASURED ON RECURRING BASIS 

The carrying amounts of cash and cash 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.

Marketable Debt Securities

Corporate debt consists of floating rate notes with a maturity that is over multiple years but has interest rates that 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 that 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.

Equity Investments

From 2017 through 2019, the Company made several equity investments in a customer. In the fourth quarter of 2019, the Company reviewed the financial condition and other factors of the customer and, as a result, recorded an impairment charge of $5.2 million to reduce its investment in the customer to zero as of December 28, 2019. In the first quarter of 2022 the customer raised additional equity capital and based on an observable price change of the customer’s share prices and terms of the equity sale the Company remeasured the fair market value of its investment and recorded a gain of $4.7 million. In the second quarter of 2022, the Company made an additional equity investment of $0.5 million. During the quarter ended July 1, 2023, the Company received common stock of the equity investment valued at approximately $0.4 million for the payment of royalties. The Company also performed an impairment evaluation and as a result recorded an impairment charge of approximately $3.1 million. As of July 1, 2023, the Company owned an approximate 3.4% interest in this investment.

On September 30, 2019, the Company entered into an Asset Purchase Agreement pursuant to which the Company sold and licensed certain assets of our SolosTM product line and WhisperTM Audio technology. As consideration for the transaction, the Company received a 20.0% equity stake in Solos Incorporation (“Solos Inc.”). The Company’s 20.0% equity stake will be maintained until Solos Inc. has raised a total of $7.5 million in equity financing. Based on the price paid for equity by the other 80.0% owners of Solos Inc. and other factors, the Company estimated the fair value of its equity holdings at $0.6 million and in 2019 recorded a $0.6 million gain on its investment for this equity transaction as the basis of assets transferred was zero. The investment was written down to $0.4 million as a result of an impairment analysis and write down performed in 2020. In the second quarter ending July 1, 2023 the Company reviewed its investment and wrote-down the investment to $0.2 million.

During the three and six months ended July 1, 2023, the Company recorded less than $0.2 million of unrealized losses on an equity interest in a company due to a fluctuation in the foreign exchange rate.

5. ACCOUNTS RECEIVABLE, NET

Accounts receivable consisted of the following:

 SCHEDULE OF ACCOUNTS RECEIVABLE

Changes to the allowance for credit losses for the six months ended July 1, 2023 were as follows:

 SCHEDULE OF CHANGE IN ALLOWANCE FOR CREDIT LOSSES

6. INVENTORY

Inventories are stated at standard cost adjusted to approximate the lower of cost (first-in, first-out method) or net realizable value and consist of the following at July 1, 2023 and December 31, 2022:

 SCHEDULE OF INVENTORY 

7. 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 unvested restricted shares. Diluted net loss per share is calculated using weighted-average shares outstanding and contingently issuable shares, less weighted-average shares reacquired during the period. The net outstanding shares are adjusted for the dilutive effect of shares issuable upon the assumed conversion of the Company’s common stock equivalents, which consist of unvested restricted stock.

The following were not included in weighted-average common shares outstanding-diluted because they are anti-dilutive or performance conditions have not been met at the end of the period:

 SCHEDULE OF WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING DILUTED 

8. STOCKHOLDERS’ EQUITY AND STOCK-BASED COMPENSATION

Registered sale of equity securities

On January 27, 2023, the Company sold 17,000,000 shares of common stock and pre-funded warrants to purchase up to 6,000,000 shares of common stock at a public offering price of $0.99 per pre-funded warrant, for gross proceeds of $22.9 million before deducting underwriting discounts and offering expenses paid by the Company of $1.5 million. The offering price of the pre-funded warrant equals the public offering price per share of the common stock less the $0.01 per share exercise price of each pre-funded warrant.

During the three months ended June 25, 2022, the Company sold 1.5 million shares of common stock and 0.2 million shares of treasury stock for gross proceeds of $2.1 million (average of $1.26 per share) before deducting broker expenses paid by us of less than $0.1 million, pursuant to the Company’s At-The-Market Equity Offering Sales Agreement dated as of March 5, 2021 (the” ATM Agreement”) with Stifel, Nicolaus & Company, Incorporated, as agent, under which we may sell up to $50 million of our common stock. The Company has approximately $41.4 million worth of common stock remaining available for sale under the ATM Agreement.

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 that 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 that 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.

The Company granted 3,136,844 and 186,500 restricted stock units to its employees, executives and the Board of Directors in the six months ended July 1, 2023 and June 25, 2022, respectively. 1,416,294 shares of the 3,136,844 shares are time-based and will vest on average over three equal annual installments. 1,720,550 shares of the 3,136,844 shares will vest upon the successful achievement of certain fiscal year 2023 milestones. The fair value of the restricted stock units was based on the fair market value of the Company’s stock on the date of grant. The time-based shares are expensed over the service period and the milestone based shares are expensed based upon the probability of achievement.

Restricted stock activity for the six months ended July 1, 2023 was as follows:

SCHEDULE OF NON-VESTED RESTRICTED STOCK ACTIVITY 

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 six months ended July 1, 2023 and June 25, 2022 (no tax benefits were recognized):

 SCHEDULE OF STOCK-BASED COMPENSATION EXPENSE 

Unrecognized compensation expense for non-vested restricted common stock as of July 1, 2023 totaled $4.0 million and is expected to be recognized over a weighted average period of approximately three years.

9. ACCRUED WARRANTY

The Company typically warrants its products against defect for 12 to 18 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 is 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 six months ended July 1, 2023 were as follows:

 SCHEDULE OF ACCRUED WARRANTY 

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 to 18 month warranty. The Company classifies the current portion of deferred revenue under Other accrued liabilities in its condensed consolidated balance sheets. At July 1, 2023, the Company had less than $0.1 million of deferred revenue related to extended warranties.

10. INCOME TAXES

The Company recorded a provision for income taxes of less than $0.1 million in each of the three and six months ended July 1, 2023 and June 25, 2022, respectively. As of July 1, 2023, the Company has available for tax purposes U.S. federal net operating loss carryforwards (“NOLs”) of approximately $135.5 million expiring 2023 through 2038 and $93.1 million that have an unlimited carryover period. Under the provisions of Section 382, certain substantial changes in Kopin’s ownership may limit in the future the amount of net operating loss carryforwards that could be used annually to offset future taxable income and income tax liability. The Company has recognized a full valuation allowance on its domestic and certain foreign net deferred tax assets due to the uncertainty of realization of such assets. The Company 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 foreign subsidiaries.

11. CONTRACT ASSETS AND LIABILITIES

Contract assets include unbilled amounts typically resulting from sales under contracts when the cost-to-cost method of revenue recognition is utilized and revenue recognized from customer arrangements, including licensing, exceeds the amount billed to the customer, and right to payment is not just subject to the passage of time. Amounts may not exceed their net realizable value. Contract assets are generally classified as current. The Company classifies the noncurrent portion of contract assets under other assets in its condensed consolidated balance sheets.

Contract liabilities consist of advance payments and billings in excess of cost incurred and deferred revenue.

Net contract assets (liabilities) consisted of the following:

SCHEDULE OF CONTRACT WITH CUSTOMER, ASSET AND LIABILITY   

The $0.4 million increase in the Company’s net contract assets at July 1, 2023 as compared to December 31, 2022 was primarily due to a change in its fixed price contracts with the U.S. government that resulted in revenue recognized in excess of amounts billed and product revenue recognized over time for defense programs.

In the three and six months ended July 1, 2023, the Company recognized revenue of $0.1 million and $0.6 million, respectively, related to our contract liabilities at December 31, 2022. In the three and six months ended June 25, 2022, the Company recognized revenue of $2.9 million and $0.2 million, respectively, related to our contract liabilities at December 25, 2021.

The Company did not recognize impairment losses on our contract assets in the three or six months ended July 1, 2023 or June 25, 2022.

Performance Obligations

The Company’s revenue recognition related to performance obligations that were satisfied at a point in time and over time were as follows:

SCHEDULE OF SATISFACTION OF PERFORMANCE OBLIGATION  

Remaining performance obligations represent the transaction price of orders for which work has not been performed and excludes unexercised contract options and potential orders under ordering-type contracts (e.g., indefinite-delivery, indefinite-quantity (“IDIQ”)). As of July 1, 2023, the aggregate amount of the transaction price allocated to remaining performance obligations was $14.6 million which the Company expects to recognize over the next 12 months. The remaining performance obligations represent amounts to be earned under government contracts, which are subject to cancellation.

12. LEASES

The Company enters into operating leases primarily for: real estate, including for manufacturing, engineering, research, administration and sales facilities, and information technology (“IT”) equipment. At July 1, 2023 and December 31, 2022, the Company did not have any finance leases. Approximately all of our future lease commitments, and related lease liability, relate to the Company’s real estate leases. Some of the Company’s leases include options to extend or terminate the lease.

The components of lease expense were as follows:

 SCHEDULE OF LEASE EXPENSE 

At July 1, 2023, the Company’s future lease payments under non-cancellable leases were as follows:

 SCHEDULE OF FUTURE LEASE PAYMENT UNDER NON-CANCELLABLE LEASE  

The Company’s lease liabilities recognized in the Company’s condensed consolidated balance sheets at July 1, 2023 were as follows:

SCHEDULE OF OPERATING LEASE PAYMENTS RECOGNIZED IN CONSOLIDATED BALANCE SHEETS   

Supplemental cash flow information related to leases was as follows:

 SCHEDULE OF SUPPLEMENTAL INFORMATION RELATED TO LEASES  

Other information related to leases was as follows:

13. SEGMENTS AND DISAGGREGATION OF REVENUE

We continually monitor and review our segment reporting structure in accordance with authoritative guidance to determine if any changes have occurred that would affect our reportable segments. We report under one segment, as our Chief Executive Officer, who is our chief operating decision maker (“CODM”), reviews results on a total company basis.

Total long-lived assets by country at July 1, 2023 and December 31, 2022 were:

 SCHEDULE OF LONG-LIVED ASSETS BY GEOGRAPHIC AREAS  

We disaggregate our revenue from contracts with customers by geographic location and by display application, as we believe it best depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors.

During the three and six months ended July 1, 2023 and June 25, 2022, the Company derived its sales from the following geographies:

 SCHEDULE OF SEGMENT INFORMATION BY REVENUE TYPE  

During the three and six months ended July 1, 2023 and June 25, 2022, the Company derived its sales from the following display applications:

SCHEDULE OF SEGMENT REPORTING INFORMATION, BY SEGMENT   

14. LITIGATION

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

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

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

On October 11, 2016, the Company filed its Answer and Affirmative Defenses. The parties completed expert depositions on November 15, 2019. On December 2, 2019, the Company filed a Motion for Partial Summary Judgment requesting the Court dismiss counts 2-7 in their entirety and counts 1 and 8 in part. BlueRadios also filed a Motion for Partial Summary Judgment alleging it is the co-owner of U.S. Patent No. 8,909,296. Responses to the Motions for Partial Summary Judgment were filed on January 15, 2020, and replies were filed on February 19, 2020. On September 25, 2020, the Court denied BlueRadios’ Motion for Partial Summary Judgment. On August 3, 2022, the Court granted the Company’s Motion for Partial Summary Judgment by dismissing counts 3, 6, 7, punitive damages under count 2, and count 8 as it relates to patent applications, and denying the motion as it relates to counts 1, 4, and 5, and the remainder of counts 2 and 8. The Court also ordered discovery reopened for certain limited purposes. A trial date was set by the Court for January 22 – February 5, 2024. The Company has not concluded a loss from this matter is probable; therefore, we have not recorded an accrual for litigation or claims related to this matter for the period ended July 1, 2023. The Company will continue to evaluate information as it becomes known and will record an estimate for losses at the time or times when it is both probable that a loss has been incurred and the amount of the loss is reasonably estimable.

15. RELATED PARTY TRANSACTIONS

The Company may from time to time enter into agreements with stockholders, 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 to enhance its product offering.

During the three and six months ended July 1, 2023 and June 25, 2022, the Company had the following transactions with related parties:

SCHEDULE OF TRANSACTIONS WITH RELATED PARTIES   

At July 1, 2023 and December 31, 2022, the Company had the following receivables from and payables to related parties:

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

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

We have identified the following important factors that could cause actual results to differ materially from those discussed in our forward-looking statements. Such factors may be in addition to the risks described in Part I, Item 1A, “Risk Factors;” Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations; and other parts of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. These factors include: our ability to source semiconductor components and other raw materials used in the manufacturing of our products; our ability to prosecute and defend our proprietary technology aggressively or successfully; our ability to retain personnel with experience and expertise relevant to our business; our ability to invest in research and development to achieve profitability even during periods when we are not profitable; our ability to continue to introduce new products in our target markets; our ability to generate revenue growth and positive cash flow, and reach profitability; the strengthening of the U.S. dollar and its effects on the price of our products in foreign markets; the impact of new regulations and customer demands relating to conflict minerals; our ability to obtain a competitive advantage in the wearable technologies market through our extensive portfolio of patents, trade secrets and non-patented know-how; our ability to grow within our targeted markets; the importance of small form factor displays in the development of defense, consumer, and industrial products such as thermal weapon sights, safety equipment, virtual and augmented reality gaming, training and simulation products and metrology tools; the suitability of our properties for our needs for the foreseeable future; our expectation not to pay cash dividends for the foreseeable future and to retain earnings for the development of our businesses; our need to achieve and maintain positive cash flow and profitability; and our expectation that if we do not achieve and maintain positive cash flow and profitability; our financial condition will ultimately be materially adversely affected, and we will be required to reduce expenses, including our investments in research and development or raise additional capital and our ability to support our operations and capital needs for at least the next twelve months through our available cash resources.

Overview

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

The following discussion should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 and our unaudited condensed consolidated financial statements included in this Form 10-Q.

Results of Operations

Our interim period results of operations and period-to-period comparisons of such results may not be indicative of our future operating results. Additionally, we use a fiscal calendar, which may result in differences in the number of work days in the current and comparable prior interim periods and could affect period-to-period comparisons. The following discussions of comparative results among periods, including the discussion of results by display application, should be viewed in this context.

Revenues. For the three and six months ended July 1, 2023 and June 25, 2022, our revenues by display application, which include product sales and amounts earned from research and development contracts (“R&D”), were as follows:

Sales of our products for Defense applications include systems used by the military both in the field and for training and simulation. The decrease in Defense applications revenues for the three months ended July 1, 2023 as compared to the three months ended June 25, 2022 was primarily due to decreases in revenues from products used in pilot helmets and thermal weapon sight systems for soldiers. The decrease in Defense applications revenues for the six months ended July 1, 2023 as compared to the six months ended June 25, 2022 was primarily due to decreases in revenues from products used in thermal weapon sight systems for soldiers partially offset by an increase in sales of our products for pilot helmets.

Industrial applications revenue represents customers who purchase our display products for use in 3D metrology equipment and headsets used for applications in manufacturing, distribution and public safety. Our 3D metrology customers are primarily located in Asia and sell to Asian contract manufacturers who use the 3D metrology machines for quality control purposes. The decreases in Industrial applications revenues for the three and six months ended July 1, 2023 as compared to the three and six months ended June 25, 2022 was due to a decline in sales of products for use in 3D metrology equipment and headsets.

Our displays for Consumer applications are used primarily in thermal imaging products and recreational rifles and hand-held scopes. The decreases in Consumer applications revenues for the three and six months ended July 1, 2023 as compared to the three and six months ended June 25, 2022 were primarily due to a decrease in sales for hand-held thermal imagers.

R&D revenues increased in the three months ended July 1, 2023 as compared to the three months ended June 25, 2022 primarily due to an increase in funding for display systems initially used in U.S. defense programs. R&D revenues decreased in the six months ended July 1, 2023 as compared to the six months ended June 25, 2022 primarily due to a decrease in funding for U.S. defense programs as certain programs transitioned to production programs.

On January 5, 2023, the Company entered into a Technology License Agreement and an Asset Purchase Agreement (the “LST Agreements”) with Lightning Silicon Technology, Inc. (“LST”). Pursuant to the LST Agreements, the Company transferred in-process development contracts with two customers. Included in R&D revenues for the six months ended July 1, 2023 and June 25, 2022 is approximately $500,000 and $400,000, respectively, related to OLED development programs with the transferred development contracts.

International revenues represented 14% and 15% of total revenues for the three and six months ended July 1, 2023, respectively, and 16% and 18% of total revenues for the three and six months ended June 25, 2022, respectively. We categorize our revenues as either domestic or international based upon the delivery destination of our product. For example, if the customer is located in Asia or if a U.S. customer has its Asian contract manufacturer order product from us and we deliver the product to Asia, we categorize both these sales as international. In addition, if we earn royalties on sales from a customer, the royalties are categorized as domestic or international based on how the product revenues are categorized. The decrease in international revenues was a result of a decrease in sales of products for 3D AOI metrology equipment and industrial wearable headset applications. 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, which could lead to a reduction in sales or profitability in those foreign markets. 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 British Pound Sterling (the functional currency of our U.K. subsidiary) 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. Cost of product revenues, which is comprised of materials, labor and manufacturing overhead related to the production of our products for the three and six months ended July 1, 2023 and June 25, 2022, were as follows:

The increase in cost of product revenues as a percentage of net product revenues for the three months ended July 1, 2023, as compared to the three months ended June 25, 2022, was primarily due to lower efficiencies from reduced product sale volumes. The decrease in cost of product revenues as a percentage of net product revenues for the six months ended July 1, 2023, as compared to the six months ended June 25, 2022, was primarily due to lower labor costs as a result of a reduction in force in the first quarter of 2023 and lower material costs for warranty issues of approximately $450,000.

During 2021, we became aware of global shortages of semiconductor components. During 2022, our manufacturing was impacted by a shortage of several semiconductor components from our normal vendors that are necessary to manufacture our products. For some components we were able to identify and use other sources for the components but for some components primarily used in defense related products, we were able to avail ourselves of alternate components because their use would have required a requalification of our product by our customer. The shortage of certain semiconductor components situation is very dynamic, and we rely on our vendors to provide information about the vendors that they use.

Research and Development. R&D expenses are incurred in support of internal display development programs and programs funded by agencies or prime contractors of the U.S. government and commercial partners. R&D costs include staffing, purchases of materials and laboratory supplies, circuit design costs, fabrication, and packaging of display products, and overhead. In fiscal year 2023, we expect our R&D expenditures to be related to our display products, overlay weapon sights and OLED display technologies. Funded and internal R&D expenses are combined in research and development expenses in the condensed consolidated statement of operations. R&D expenses for the three and six months ended July 1, 2023 and June 25, 2022 were as follows: