FORM 10-KSB
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 30, 2001 Commission File No. 0-10772
ESSEX CORPORATION
(Name of small business issuer in its charter)
Virginia 54-0846569
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
9150 Guilford Road, Columbia, Maryland 21046
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (301) 939-7000
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
None None
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK, NO PAR VALUE PER SHARE
(Title of Each Class)
Check whether the issuer (1)filed all reports required to be filed by Section 13
or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES X NO
--- ----
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.
State issuer's revenues for its most recent fiscal year. $2,641,776
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State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within the past 60
days. $19,114,904 as of March 6, 2002
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
CLASS OUTSTANDING AT MARCH 15, 2002
----- -----------------------------
Common Stock, no par value per share 5,290,868
DOCUMENTS INCORPORATED BY REFERENCE
None
================================================================================
A list of the Exhibits and Financial Statement Schedules in this Report on Form
10-KSB appears on page 52.
Transitional Small Business Disclosure Format YES NO X
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Table of Contents
FORM 10-KSB
Essex Corporation
PART I
Item No. Page
-- INTRODUCTORY STATEMENT............................................. 3
1. DESCRIPTION OF BUSINESS............................................ 3
2. DESCRIPTION OF PROPERTIES...........................................34
3. LEGAL PROCEEDINGS...................................................34
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................34
PART II
5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS............35
6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION...........35
7. FINANCIAL STATEMENTS................................................39
8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE................................................39
PART III
9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT...................40
10. EXECUTIVE COMPENSATION..............................................44
11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT......49
12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS......................51
13. EXHIBITS AND REPORTS ON FORM 8-K....................................52
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PART I
INTRODUCTORY STATEMENT
The information contained in this report pertains to the registrant, Essex
Corporation. References to the "Company", "Essex" or "we", "our" and "us" refers
to Essex Corporation.
FORWARD-LOOKING STATEMENTS
Some of the statements contained in this annual report discuss future
expectations, and other "forward-looking" information. Those statements are
subject to known and unknown risks, uncertainties and other factors that could
cause the actual results to differ materially from those contemplated by the
statements. The "forward-looking" information is based on various factors and
was derived using numerous assumptions. In some cases, you can identify these
so-called "forward-looking statements" by words like "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential," or "continue" or the negative of those words and other comparable
words. You should be aware that those statements only reflect our predictions.
Actual events or results may differ substantially. Important factors that could
cause our actual results to be materially different from the forward-looking
statements are disclosed under the heading "DESCRIPTION OF BUSINESS - Risk
Factors."
1. DESCRIPTION OF BUSINESS
GENERAL OVERVIEW
Based in Columbia, Maryland, Essex develops and commercializes
optoelectronic devices for industry and government. The Company was incorporated
in Virginia in 1969 and went public in 1981. The Company now has a team of over
25 engineers, most of whom have worked together for more than a decade. They
have historically provided optoelectronic and signal processing expertise to
highly classified government customers under advanced and next generation
research and development (R&D) contracts.
Since 1989, Essex's team has invented, built and fielded many complex
optical systems for U.S. Government agencies' R&D in the areas of fiber optic
communications, signal processing and code division multiple access (CDMA)
telecommunications systems. The Company is a pioneer in the development of
optoelectronic (OE) processors. OE processors are specialized, high-performance
computing systems that significantly outperform conventional general-purpose
computing systems in certain important applications. Optoelectronic processors
usually offer performance improvements of a factor of ten or more. They
accelerate conventional workstations in demanding computations in image, signal
and other types of technical data processing. In much the same way as an array
processor, an optoelectronic processor is integrated with or embedded in other
processors to render daunting processing problems feasible. ImSyn(TM) was the
Company's first commercially available processor that computes at an equivalent
all-digital rate of 1.6 teraflops at 120 dB dynamic range.
Capitalizing on its expertise and success in developing and building
optoelectronic systems for national security applications, Essex has developed
four core areas of technical expertise and intellectual property. The four core
areas are: HYPERFINE WAVELENGTH DIVISION MULTIPLEXING (WDM) technology for
telecommunications; Optical Processor Enhanced Receiver Architecture
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(OPERA(TM)) technology for wireless and Digital Subscriber Line (DSL)
applications; Advanced Optical Processor (AOP) technology for ballistic missile
defense; and Virtual Lens Imaging (VLI) technology, including the ImSyn(TM)
processor and technology, for surface and below surface imaging. The HYPERFINE
WDM technology is a passive optical technology for powering WDM networks of the
future. OPERA(TM) will be a system that combines an optoelectronic processor
with advanced multi-user detection algorithms to eliminate the "near-far"
problem for a CDMA system. All of these areas include significant intellectual
property that is patented or patent pending.
Essex currently does not have sufficient resources to bring its
telecommunications and optoelectronics processing devices to market. Accordingly
Essex will likely have to partner with or enter into licensing arrangements with
major industry participants in order to successfully introduce its technology
and products. In addition, several optical telecommunications and fiber optic
companies, both established and emerging, are currently developing products that
may compete in the specialty areas that Essex's technology is designed to
address. Many of these companies are larger and more established than Essex and
have existing customer bases and significantly greater access to capital
resources than Essex.
RECENT DEVELOPMENTS
In mid 2000, the Company began a transformation from a government
technology R&D contractor to a developer of products for the telecommunications
industry. Since that time, Essex has utilized approximately $5 million of
private equity capital to enable its optoelectronic development team to focus
primarily on developing commercial telecommunication products for
next-generation optical networking and wireless systems. The Company has adopted
a "smart revenue" policy for evaluating all proposals to provide its services to
government agencies on a contract basis, thus using the funds from the private
equity investors to substitute for revenues from government contract work that
did not promote the Company's technology development objectives. In connection
with its decision to raise private equity financing in mid 2000, Essex
management decided to concentrate its initial commercialization efforts on the
development of products for fiber optic networks based on the Company's
experience in producing all-passive, inexpensive, small and robust WDM devices
with very narrow channel spacing for national security applications.
FOCUS ON OPTICAL NETWORK TELECOMMUNICATIONS MARKET
The first products that Essex is preparing for market are built around the
Company's HYPERFINE WDM technology that provides a passive, low-cost method to
increase bandwidth capabilities within fiber optic networks. These products
under development have the potential to provide revolutionary capabilities in
the telecommunications markets to which they are applied because they share
certain key characteristics that the core HYPERFINE WDM technology provides:
All passive optical components;
Simple and small packaging;
Excellent channel isolation;
High density--50 MHz to 100 GHz spacing;
Superior response and flat filter shapes;
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Passband shapes that can be tailored for each application;
Low insertion loss;
Low temperature sensitivity;
Fixed or tunable designs; and
Standard manufacturing processes.
Essex believes that significant and unique opportunities exist for its
HYPERFINE WDM technology within the optical networking telecommunications
market. This market encompasses the long-haul, metro and access networks and the
test equipment industry. The Company believes that its HYPERFINE WDM technology
addresses the issues presented as carriers in each market move away from
"legacy" networks that entail rigid bandwidth provisioning, significant service
delays, truck rolls for required upgrades and extremely high life cycle costs to
next-generation systems that entail provisioning by wavelength, tunable
bandwidth, upgrades through installation of network cards and bandwidth on
demand "pay as you go" infrastructures. HYPERFINE WDM technology promises to
enable network operators to offer services more quickly, flexibly and
inexpensively, while at the same time scaling to higher bandwidths, offering
individual wavelengths, longer distance reach and supporting multiple protocols
and topologies.
DEMONSTRATION OF HYPERFINE WDM TECHNOLOGY
Within 6 months of the September 2000 completion of its initial $2 million
private placement with new investors, the Company demonstrated a lab version of
its HYPERFINE WDM device technology to representatives of select
telecommunications companies. By mid-2001, Essex began field trials of its
16-channel, OC-48, 6.25 GHz channel spacing demultiplexer based on the HYPERFINE
WDM technology. Currently, the devices are being evaluated and tailored for the
needs of telecommunications companies for application in back-bone fiber optic
networks, metro and access systems, and testing equipment. In addition, several
other products in the HYPERFINE WDM family of devices are currently in the
design and engineering phase.
FIELD TRIALS FOR PROTOTYPE DEVICES
These accomplishments have enabled Essex to meet with and discuss in depth
its HYPERFINE WDM technology with a broad range of major companies engaged in
the telecommunications industry. Many of these companies have agreed to field
trial Essex's HYPERFINE WDM prototype and/or work with Essex on this technology
in some fashion. In particular, Essex has announced relationships with Agilent,
MIT/Lincoln Labs and Harris Corporation. Relationships with other companies have
not yet been publicly announced due to nondisclosure agreements. The Company is
expecting to continue field trials in the first half of 2002, enter into one or
more alpha (early adopter test) programs to complete first production devices
and generate initial revenues with strategic partners beginning in mid 2002.
Limited production for fully operable HYPERFINE WDM devices is expected to
commence in early 2003. The Company is continuing to develop prototype products
for the remaining family of HYPERFINE WDM devices: laser locker/monitor, optical
spectrum analyzer, optical add/drop multiplexer and optical CDMA, with a goal of
placing these devices in field trials also.
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MANUFACTURING RELATIONSHIP WITH HARRIS CORPORATION
In November 2001, Essex announced a relationship with Harris Corporation of
Melbourne, Florida. The two companies have worked together on government
contracts in the past and Harris has a well-deserved reputation as a
manufacturer of optical networking products. The agreement established Harris as
the primary manufacturer of the HYPERFINE WDM product line.
MARKETING ALLIANCE WITH LASER COMPANY
Essex has established a joint marketing arrangement with FiberSpace, Inc.,
a Woodland Hills, California company that has developed a laser locker that
complements HYPERFINE WDM. The use of FiberSpace's Optical Phase Locked Loop
(OPLL) is expected to accelerate the deployment of Essex products.
OTHER TECHNOLOGY DEVELOPMENT
With HYPERFINE WDM progressing into field trials, Essex has turned its
attention to completing research and development work on the other HYPERFINE WDM
products. The Company has also begun the design work necessary for the
commercialization of the Optical Processor Enhanced Receiver Architecture
(OPERA(TM)) technology for wireless and DSL applications. The Company has begun
discussions with several wireless telecommunications companies to explore the
joint development of OPERA(TM), thus leveraging Essex's optoelectronic
experience with the wireless company's extensive wireless market and technical
experience. Essex also believes that OPERA(TM) has the capacity to provide
enhanced Digital Subscriber Line (DSL) technology solutions to semiconductor and
equipment companies that make products to enable simultaneous high-speed data
and regular voice transmissions over copper telephone lines by using optical
technology to reduce signal interference and extend the reach of DSL technology.
The Company is seeking to partner with one or more leading suppliers of
integrated circuits to develop chipsets that incorporate DSL technology to
develop and deploy OPERA(TM) technology for this application.
NATIONAL SECURITY RELATED INITIATIVES
Along with its technology development progress in 2001, the Company
continues to focus on "smart revenue" and has been successful in obtaining new
R&D government contracts that advance its core technology areas. Moreover, in
the wake of the tragic events of September 2001, Essex management is positioning
the Company to initiate new development efforts under contract to government
agencies for the adaptation of the HYPERFINE WDM and OPERA(TM) technologies for
national security programs. The Company intends to seek new business
opportunities to service highly classified customers under government contracts
which help to expand the Company's intellectual property and advance its core
technologies, thus enabling it to generate additional revenues as a developer of
optical systems for defense as well as commercial application. To advance such
new business initiatives, Essex announced in early 2002 that retired U.S. Army
Lieutenant General Claudia J. Kennedy and retired U.S. Air Force Lieutenant
General Kenneth A. Minihan joined the newly formed Essex National Programs
Advisory Board. This board provides strategic guidance concerning the
application of Essex optical signal processing technology for high priority
national security applications. Essex management also believes that market
fragmentation in the area of government contract R&D for national security
related technology and associated software systems present opportunities for
consolidation by companies, such as Essex, which have long-term experience in
these areas. Essex plans to draw
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on its legacy of work with government agencies in the areas of fiber optic
communications, signal processing and CDMA telecommunications systems to pursue
strategic affiliations or acquisitions that will provide us with additional key
technologies, complement technology development activities, enhance our related
software development capabilities, increase our "smart revenue" generation,
increase our sales channels to national security related government programs and
add to our overall level of expertise.
INDUSTRY BACKGROUND
Over the past decade, the volume of high-speed data traffic transmitted via
electronic media has expanded rapidly as a result of the introduction and
proliferation of bandwidth-intensive applications. To meet the demand for
high-speed data services created by these new network applications,
telecommunications service providers have already invested billions of dollars
in new infrastructure to upgrade the voice-centric public network infrastructure
to enable more efficient transmission of data traffic, and to deploy mobile
telecommunications systems that can transmit high-speed data traffic and improve
quality of service over more primitive first generation telephone cellular
systems.
Although 2001 witnessed a significant slowdown in new investment in
infrastructure within the telecommunications industry, it is expected that
businesses and residential consumers will continue to demand improved high-speed
network access to all available telecommunications networks, whether they are
optical, traditional telephone wirelines or wireless systems. High-speed
Internet access, scarcely available a few years ago, and wireless voice
transmission remain the primary applications driving customer demand today.
Introduction of new products and services with ever-broadening applications for
fixed-line networks and the transition from voice to data traffic as the
mainstay of mobile telecommunications systems will drive further growth. Thus,
second-line voice and data services, video download, video conferencing,
telecommuting, off-site data back-up storage systems, and mobile computing
devices with internet and data transmission capabilities will continue to fuel
demand for broadband services of all types in the future. Essex has initially
targeted applications of its optical processing and signal processing
technologies on the telecommunications industry because management believes that
as a result of the forces driving the trends noted above, the industry continues
to present exceptional long-term growth opportunities.
Essex management believes that the legacy technologies used to build
existing telecommunications networks do not provide cost-effective, fail-safe
and scalable platforms to support the massive demands for high-speed,
high-bandwidth applications that will drive future network growth. The Company
believes that service providers will require new solutions to relieve local and
metro network congestion, improve service profitability and to create new
services to support new data applications. New technologies that are adopted in
the future will be those that enable telecommunications service providers to
easily scale their existing networks, reduce capital and operational costs to
achieve greater service profitability, reduce the complexity of provisioning
high-speed services and to introduce new high-speed data services. Further,
Essex believes that many capital-constrained telecommunications service
providers are looking to identify new technologies that are designed to protect
service providers' existing investment in fiber optic networks and transmission
equipment, rather than requiring the construction of all new fiber optic
networks or investment in new transmission infrastructure. Essex believes that
simple, passive, inexpensive technologies will provide the basic infrastructure
for all-optical networks from the long-haul backbone to the metropolitan or edge
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segment of the network. We expect deployment of cheaper and improved access
technologies to fuel the next major wave of growth in bandwidth demand, opening
up broadband applications to other potential network users, such as residential
units and small businesses, that today find the costs or availability of access
technologies that leverage the use of fiber optic cable or dedicated T-1 service
prohibitive. In short, Essex believes that the driving force for the new
products sought by commercial telecommunications providers in coming years will
be a focus on reliability, efficiency, scalability and cost.
Essex is developing and testing products that the Company believes have the
potential to offer significant cost advantages, enable higher system
capabilities and increase quality of service and revenue generation potential
for next-generation optical, wireless and digital wireline communications
systems. In each of these areas, the Company operates on the premise that
fundamental barriers to the deployment of more cost-effective and higher
capability exist due to the limitations of legacy technology.
OPTICAL NETWORKS
Traditional SONET/SDH-based network architecture was originally designed to
transport voice traffic rather than the data traffic that is now fueling network
growth. Telecommunications service providers are constrained in the amount of
bandwidth they can allocate to their optical network resources because, in
typical ring-based architecture, the SONET/SDH equipment allocates half of the
bandwidth available on the fiber for back up in case of a network failure. Once
fully provisioned, the SONET/SDH ring can only be reconfigured to support the
delivery of additional bandwidth and services via complex and costly procedures
to upgrade the ring. In addition, once bandwidth is made available it cannot be
easily redeployed as customer demands change. In short, the ability to expand
the capacity of a SONET/SDH network to supply more bandwidth, or the flexibility
to assign bandwidth on a demand basis as is the case with electricity supply,
are severely constrained by the fact that any such reprovisioning requires
on-site technical changes at each network transit point and significant up-front
capital investment by the telecommunications service providers.
Future optical networks will need to be capable of quickly delivering and
redeploying large amounts of bandwidth cost-effectively, when and where it is
needed and for just as long as it is needed. Service providers will demand
equipment and devices that enable them to provide "just-in-time" investment and
a service delivery model allowing them to introduce and expand services when and
where needed in response to demand. This will require an all-optical network
architecture that is scalable, flexible and cost-effective and that is capable
of supporting the surges in growth in high-speed data communications services.
Telecommunications service providers, even in the midst of a downturn in
new investment, are scrambling to adjust to a rapidly changing competitive and
technology landscape and are seeking to bring all-optical networking from
long-haul DWDM networks to metro and access networks. Growth in the metro and
access networks is high and is driven by several factors:
More Bandwidth Demand - Metro networks are swamped by data traffic as
carriers deploy broadband access technologies.
Bandwidth Plus Services - Fiber optic networks are rapidly expanding deeper
into the metro and access areas and are accessible to more and more
buildings.
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The Emergence of Gigabit Ethernet - Gigabit Ethernet offers seamless
interconnection with customer LAN's, disruptive bandwidth pricing and
bandwidth efficiency.
Low Cost Needs - Introduction of low cost metro optical components such as
mux/demultiplexers, optical add/drop multiplexers, transceivers and
amplifiers.
WIRELESS COMMUNICATIONS
System capabilities in wireless communications are limited today by the
capacity constraints of existing base station and mobile unit configurations.
While the solution over the past decade has been to build more towers and base
station receivers to handle more traffic, the sheer volume of users, coupled
with the introduction of data transmission for mobile computing and hand-held
usage, are straining the capacity on most urban mobile telecommunications
networks. The Company believes that a fundamental problem lies in the design of
most transmitter-receiver systems utilized in the wireless industry today.
CDMA receivers are built around correlators which correlate the received
signal (containing the desired signal plus all of its environment) with the
known code, called the spreading code of the desired signal. Modern cellular
CDMA receivers do this with digital correlators and correlate not only the
direct-path signal, but also look for multipath signals (i.e., versions of the
desired signal delayed by bounces off of objects such as buildings). These
"RAKE" receivers typically have five correlation "fingers" (like a "rake") with
one finger tracking the direct path signal, three fingers tracking the strongest
3 multipath signals, and one scanning for other multipath signals. Each of these
fingers requires a correlation with the desired signal's spreading code, but at
a different time offset.
There are several shortcomings of the current architecture. First, there
are often more than three significant multipaths present, thus some energy which
could be used to enhanced signal quality will, in fact, appear as interference
to the desired signal. Second, multipath is very dynamic and while tracking of
the three principal multipath channels is performed adequately, the sequential
search of the fifth RAKE finger for new multipath can miss occurrences which
come and go before the finger scans over them. Again, energy which could
increase signal quality is wasted. Third, all other multiple access users of the
cell (and adjacent cells) are treated as noise in the receiver, but are, in
fact, just as receivable as the desired signal. In a cellular telephone system
when a large number of callers are permitted on the system, these multiple users
generate signals that are considered "noise" to each other. (That is to say, on
a cell phone the users compete with each other for the system's power and
capacity.) To maximize the number of simultaneous users, these systems must be
able to identify and remove this "noise" or interference. When many simultaneous
users increase the noise level so much that the systems cannot identify and
eliminate the noise, then calls are dropped and the system becomes "unavailable"
and communications become faulted.
DIGITAL SUBSCRIBER LINES
During recent years, telephone companies responded to large demands for
bandwidth by focusing their investments on increasing the data transmission
speed and capacity of the core infrastructure, or "backbone", that links their
central office locations. Improving access speeds and capacity along the "last
mile" or the "local loop" that connects their central office locations with
homes and businesses has largely not been a focus of significant infrastructure
investment except in the major and affluent metropolitan areas. Many residential
and small business users
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must still rely on conventional voiceband modems for their Internet access and
communication needs. Even optimized voiceband modems transmit data at speeds
that are still too slow for some existing and many anticipated data
applications, and these systems are further limited by their either/or nature
because they cannot support simultaneous voice and data services. In recent
years, new technological advances in semiconductor integration and digital
signal processing have led to the development of a broadband access technology,
known as Digital Subscriber Line or DSL, which can transmit data over copper
telephone lines significantly faster than voiceband modems by using frequencies
higher than those used for voice and voiceband modems. DSL delivers "always on"
availability, eliminating the dial-up process associated with voiceband modems.
DSL is a point-to-point technology that connects the end user to a
telecommunications service provider's central office or to an intermediate hub.
DSL equipment is deployed at each end of the copper wire and the transmission
speed depends on the length and condition of the existing wire.
DSL technology is inherently limited because of distance and noise. New
technology that could extend DSL signals even short additional distances could
lead to a significant increase in revenue for providers.
THE ESSEX TECHNOLOGY SOLUTIONS UNDER DEVELOPMENT
1) An all-optical, all-passive technique, HYPERFINE WDM FIBER OPTIC
COMMUNICATIONS TECHNOLOGY, has shown in laboratory tests and prototype
demonstrations to significantly increase the number of channels and
their combined bandwidth used for DWDM.
2) An optically enhanced digital signal processing technology, OPTICAL
PROCESSOR ENHANCED RECEIVER ARCHITECTURE (OPERATM), has demonstrated in
laboratory modeling a dramatic increase in the quality of service and
carrying capacity for CDMA wireless telecommunications systems. The
OPERA(TM) technology has the potential to revolutionize current and
future 2.5G and 3G CDMA systems, when deployed, by eliminating the
"near-far" interference problem and allowing significantly more
channels (users) per base station. Essex is in continuing discussions
with wireless industry representatives regarding development of initial
prototypes. Further development and testing of OPERA(TM) has been
temporarily delayed until funding is identified and obtained to finance
such activity.
3) A high-speed optoelectronic processor, IMAGE SYNTHESIS (IMSYNTM),
enabling extraordinarily fast processing of data for complex visual
image systems including radar imaging, magnetic resonance imaging
(MRI), microscopy and ultrawideband signal processing. The second
generation ImSyn(TM) optoelectronic processor can accelerate computing
speed for processing of large volumes of data by factors of up to one
hundred times over comparable digital-only processing. Partial
development of the second generation of ImSyn(TM) is taking place under
a government contract for the development of advanced synthetic
aperture radar techniques. We are currently seeking additional funding
to further the development and testing of second generation ImSyn(TM)
processors in 2002.
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HYPERFINE WDM TECHNOLOGY
Deriving originally from the Company's legacy business in optical signal
processing engineering, Essex has invented and is currently developing a passive
and low-cost optical technology called HYPERFINE WDM that accommodates the
differing network types by passively subchannelizing wideband channels into
useable narrowband channels. Channel resolutions range from the ultra-narrow 50
MHz to coarse 100 GHz. For example, in the long-haul network with channel
spacing of 6.25GHz, HYPERFINE WDM can pack 16 OC-48 channels into one 100 GHz
"Virtual OC-768" channel while keeping power density levels low and thereby
minimizing non-linear effects such as chromatic dispersion and polarization
dispersion. In the metro and access markets, HYPERFINE WDM accommodates
differing network types by passively subchannelizing wideband channels into
useable narrowband channels, e.g., OC-192/48/12/3, Fast/Gigabit Ethernet, Fibre
Channel, ESCON or any digital or analog channel bandwidth required for the
application.
At narrower bandwidths, alternative architectures can be used that do not
require expensive intermediate switching and routing technology layers, such as
SONET and ATM. Bandwidth can be allocated to meet surges in demand and flexible
network configurations can be designed to accommodate dynamic traffic patterns
and multi-use channel allocation for different types of broadband media.
Individual wavelengths can be dedicated to specific users and protocols,
something that is impractical today. For long-haul DWDM networks, HYPERFINE WDM
can be used to compensate for the negative effects of dispersion because
narrowband channels are less sensitive to dispersion. Use of this passive,
intrinsically low cost optical technology could make possible a new generation
of less expensive optical and digital networking devices, even bringing optical
channels to the desktop.
HYPERFINE WDM technology is intrinsically lower in cost than existing
technologies (array wave guides (AWG's), thin films, fiber bragg gratings).
HYPERFINE WDM provides a low cost means to not only increase bandwidth but also
to allow for massive connectivity such that each user can have its own
wavelength and have true bandwidth on demand. The Company believes that the
HYPERFINE WDM technology provides the most efficient method of provisioning many
narrowband channels in optical networks.
ADVANTAGES OF HYPERFINE WDM TECHNOLOGY. The key characteristics of the
HYPERFINE WDM technology are: (1) high resolution, (2) high efficiency, (3)
massive parallelism, (4) passivity, (5) simplicity, and (6) intrinsically low
cost. These key characteristics join to meet the functional requirements that
long-haul, metro and access network providers are searching for in such new
technologies.
OPTICAL TRANSPARENCY, MULTI-PROTOCOL, MULTI-SERVICE USING A SINGLE
INFRASTRUCTURE
Currently, implementing dedicated wavelengths per user is not practical.
HYPERFINE WDM promises to increase the number of independent optical
channel carriers that can be used. Instead of 40 or 80 channels there can
now be 4,000 to 40,000 channels (wavelengths), allowing each user to have
an independent wavelength. A pair of HYPERFINE WDM devices (a coarse
channelizer followed by a fine channelizer) can channelize the entire
bandwidth of a fiber to high resolution (1 GHz or less). Access providers
will have the capability to integrate with wideband transmissions. The
promise of optical transparency is fulfilled with the capability to
multiplex different formats with less complexity and cost.
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LOW COST
HYPERFINE WDM can subchannelize from 50 MHz to 200 GHz; however, the target
bandwidth ranges are OC-12 (622 Mbps), Gigabit Ethernet (1.22 Gbps) and
OC-48 (2.5 Gbps). These bandwidths permit lower cost signal demodulation
terminals using low bandwidth electronics, optical detectors and
modulators. Each receiver operates at CMOS logic rates, greatly reducing
cost. HYPERFINE WDM should allow access providers to bring optical
bandwidth to end-users. HYPERFINE WDM also offers a significant improvement
in the data capacity of a single fiber by more efficient use of the optical
bandwidth due to superior passband filter shape. This permits very close
channel spacing without interference.
FLEXIBLE DEMAND-BASED PROVISIONING
Many parallel channels permits the network management system to provide
"bandwidth on demand" by allocating many hyperfine channels to users after
seeing spikes in demand using network load management tools.
RELIABILITY
HYPERFINE WDM is passive technology that does not rely upon electronics or
moving components for operation. Thus, each HYPERFINE WDM device will have
a relatively long-life and be multi-functional. With single channel data
bandwidths within the capabilities of silicon technology, the complexity
and costs of the drive electronics will be exceedingly low. The burden is
then shifted to the complexity of maintaining laser sources within the line
width and stability ranges necessary to stay adequately within the narrow
channel width. Essex believes that continuing advances in laser quality and
stability have made possible inexpensive solutions to this issue. One
potential solution being tested is to use tunable lasers with a
hyperfine-based spectrum analyzer feedback loop to keep the laser properly
tuned. Another is to use a single stable laser modulated with a
comb-generator waveform to produce all of the laser lines needed in the
fiber network. Each user would then be provided an unmodulated carrier
wavelength which can be modulated with data.
SIMPLICITY AND ROBUSTNESS
HYPERFINE WDM technology is simple and robust. Package sizing for a
channelizer is in the 35 cubic inches range, about the size of a modern PC
hard drive unit. Since HYPERFINE WDM channelizers are passive
non-interferometric devices, thermal stability can be rather simply
obtained by a combination of the use of minimal thermal coefficient of
expansion materials combined with optical compensation for residual
expansion.
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HYPERFINE WDM FAMILY OF DEVICES. The four main markets identified by Essex
for its HYPERFINE WDM technology are the long haul, metro, access and test
equipment markets. The HYPERFINE WDM unprecedented channel spacing enables low
cost applications in each of these markets. The HYPERFINE WDM family of devices
under development that support the various markets are the following:
Multiplexer/Demultiplexer - Channel spacing can range from conventional
DWDM widths of 100 or 200 GHz down to much narrower bandwidths as fine
as 50 MHz. Used in conjunction with traditional DWDM devices, HYPERFINE
WDM can be a post-channelizer or pre-channelizer (used as a multi-port
interleaver).
Optical Add/Drop Multiplexer (OADM) - HYPERFINE WDM can be designed as
a passive fixed configuration (single or multi-channel) add/drop
multiplexer. When integrated with MEMS or liquid crystal switching
technology, HYPERFINE WDM can be a dynamically tunable OADM.
Wavelength Locker/Monitor - A single channel HYPERFINE WDM coupled with
a relatively low cost laser can provide narrowband outputs to maintain
laser frequency stability and assure reliable transmissions. This
device can also accurately and dynamically monitor laser wavelength
performance.
Optical Spectrum Analyzer - The HYPERFINE WDM high-resolution
characteristics make it an excellent spectrum analyzer for use in
spectrum analyzers providing up to 0.4 picometer resolution.
13
"WAVELENGTH PER USER" CAPABILITIES OF HYPERFINE WDM TECHNOLOGY. In the
metro network, a hyperfine OADM integrated with MEMS is a simple and low cost
solution for real time provisioning that offers N by X redundancy and bandwidth
on demand. Similarly, in the access network, HYPERFINE WDM narrowband
channelizers will allow access providers to dedicate hundreds or thousands of
wavelengths from a central office to the customer's premises. This "Wavelength
Per User" architecture is protocol neutral, and simplifies network management
and provisioning. Essex's 16-channel OC-48 (2.5 Gbps) demultiplexer with channel
spacing of 6.25 GHz can be used with traditional DWDM devices to serve as a pre-
or post- channelizer.
As a pre-channelizer, when used in front of a traditional DWDM with 100 GHz
spacing, HYPERFINE WDM is a multi-port interleaving technology yielding as many
as 640 2.5 Gbps channels within the C band. As a post-channelizer, when used
after traditional DWDM, HYPERFINE WDM can subchannelize a single 100 GHz channel
into multiple 2.5Gbps data streams.
Using HYPERFINE WDM in the metro and access networks is presented as
follows:
(PICTURE)
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"VIRTUAL OC-768" FOR THE LONG-HAUL MARKET. In the long-haul network,
HYPERFINE WDM'S multiple narrowband channels instead of a single OC-768 40 Gbps
channel keeps power density levels low which minimizes non-linear effects such
as chromatic and polarization dispersion. Essex's 16 channel demultiplexer with
channel spacing of 6.25 GHz can pack 16 OC-48 channels into one 100 GHz "Virtual
OC-768" channel. A schematic presentation of Virtual OC-768 is as follows:
(PICTURE)
HYPERFINE WDM IN TEST EQUIPMENT. As the access, metro and long-haul
companies are striving for more narrowband (fine) channels, one item becomes
apparent--the need for new test equipment for the new components and circuits.
The HYPERFINE WDM technology and products under development fill this need in
three main areas. First, a HyperLocker is a wavelength locking technology for
existing and future tunable lasers. By integrating a single or multi-channel
HYPERFINE WDM device into a laser cavity, the laser will be locked to a specific
wavelength, with precision down to 50MHz. Second, in order to analyze the
spectrum of the narrowband channels, a HYPERFINE WDM device with a 50Mhz channel
spacing will enable a resolution of .4 Pico meters. Third, a HyperMonitor using
a HYPERFINE WDM demultiplexer will accurately and dynamically monitor laser
wavelength performance.
In management's opinion, the HYPERFINE WDM based test equipment under
development offers significant advantages over traditional test equipment, such
as fine resolution, high reliability due to very reduced cross talk risk, allows
the use of low cost lasers and filters and enables narrowband technologies.
OPTICAL PROCESSOR ENHANCED RECEIVER ARCHITECTURE (OPERA(TM))
OPERA(TM) is an interference cancellation technology for use in multiple
access communication systems that have many simultaneous users (such as a CDMA
spread spectrum or a DSL system). In such systems, interference and noise
created by multiple users are the limiting factors to reliable and clear
communications. OPERA(TM) provides a means by which to identify and eliminate
all the noise so a particular user device "thinks" it is the only user on the
system.
OPERA(TM) is based on an optical correlator which is a signal correlator
that uses optical techniques to compute the correlation combined with multi-user
detection algorithms. Thus, if
15
the receiver were to correlate on all of the spreading codes in its environment,
it could receive all of the signals and use that knowledge to improve the
reception of the desired signal.
The OPERA(TM) correlator in laboratory modeling performs signal
correlations using optical techniques that enable the system to productively use
all the received signals. While digital processing primitives are add, subtract,
multiply and divide for performing signal processing functions, optical
processor primitives are Fourier transforms and multiplies which encompass
correlation functions. Thus, what is difficult digitally is easy optically, and
vice versa. So, while implementing a digital five-finger one channel RAKE
receiver is challenging in cellular applications, an optical 100 finger by
100-channel correlator is not.
POTENTIAL ADVANTAGES OF OPERA(TM) CORRELATOR. The OPERA(TM) correlator
under development shows promise to overcome the three key deficiencies that
management believes continue to reduce the quality of service and capacity of
existing cellular and wireless systems. First, instead of sensing only three
multipaths, the OPERA(TM) correlator can be configured to sense 100 to 1000
multipaths. This is particularly important because as cellular bandwidths
increase, the number of significant multipaths increases proportionally. Second,
with so many "fingers", the OPERA(TM) correlator does not need to search for
multipaths since it has instantaneous access to all possible multipath delays.
Third, instead of sensing only the multipath from the desired signal, the
OPERA(TM) correlator can sense the multipaths from all signals in the
environment and thus provide the data necessary to remove them as interferers
using multiple user detection (MUD) techniques.
In laboratory modeling and analysis, the OPERA(TM) correlator not only has
been shown to perform these functions, but it also achieves them within a small
size, low weight and low power module. In management's opinion, these
characteristics not only give OPERA(TM) a clear advantage over conventional
digital processing in base-station applications, but also make it a viable
candidate for handset applications where lots of processing power can be
advantageously applied in a small, low-power device.
KEY POTENTIAL MARKETS FOR OPERA(TM) TECHNOLOGY. The ability of the
OPERA(TM) technology to eliminate noise and cancel interference is applicable to
technologies where noise and interference are limiting factors. The two main
markets identified by Essex for application of its OPERA(TM) technology are the
wireless CDMA spread spectrum enhancement market and the Digital Subscriber Line
(DSL) enhancement markets. The OPERA(TM) family of devices under development
that will support each market are as follows:
OPERA(TM) Correlator - This is an optoelectronic processor for CDMA
environments that applies to the base stations and handset receivers. In
laboratory modeling, the OPERA(TM) Correlator increases cell capacity by
300 to 400%, eliminates noise, cancels interference and performs 911
geolocation.
OPERA(TM) DSL Enhancement - The OPERA(TM) optoelectronic processor would be
incorporated into an ASIC chip that would sit either in the splitter or the
modem at the customer premise and increase the distance of the DSL.
Currently, because of the noise factor, DSL is limited to about 12,000 feet
from the Central Office. The goal for an OPERA(TM) DSL Enhancement is to
double the distance.
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ADVANCED OPTICAL PROCESSOR
The Advanced Optical Processor (AOP) being developed by Essex under
contract for the United States Missile Defense Agency is a third generation
device which leverages spread spectrum signal analysis, wideband ELINT
(electronic intelligence) and cryptologic exploitation. The AOP is used for
ballistic missile defense environments. In these environments, not only must the
missile target be identified using Range-Doppler Imaging (RDI) but also other
items that are sent into the threat environment to make it harder to identify
and "kill" the missile target. Other items launched along with the missile
include chaff, debris, closely spaced objects, jammers, spoofers and missile
decoys. The AOP is a high performance radar signal processor that provides the
true correlation-based image formation for ballistic missile defense in a
cost-effective, low size, low weight and low power package.
Essex is able to provide superior performance to the Missile Defense Agency
in its AOP using its core optical technologies and experience. Management
continues to support and encourage this "smart revenue"; that is, revenue on
government contracts that advances Essex's core optical technologies.
VIRTUAL LENS IMAGING TECHNOLOGIES
The Virtual Lens Imaging technology (VLI) is a patented high-resolution
imaging system that leverages Essex's experience in synthetic aperture imagery
and optoelectronic system development. The Company's VLI technology is based on
the key features of its optoelectronic processor and its ability to calculate
images from non-uniform data in real time. Such equivalent processing from an
all-digital system would need to operate at 1.6 teraflops per second which
cannot be done inexpensively in the digital domain. Essex has, however, produced
a few small, robust, lower cost optical processors capable of such high speeds.
The main markets identified by Essex for its VLI technology are the
following:
Synthetic Aperture Radar (SAR) - Under certain government contracts, Essex
provides SAR image processing to its government customers using its
optoelectronic (ImSyn(TM)) processors;
Ground Penetrating Radar (GPR) - Essex has tested its VLI technology to
process ground penetrating radar data to produce images of items that are
located beneath the ground. Such items may include, mines, utility lines
and pipes, telecommunication fibers and natural resources;
Homeland Security Image Processing - VLI technology may be used to scan
baggage, in real time, and produce images; and
Biomedical imaging - VLI technology has been tested to perform real time
MRI processing.
TELECOMMUNICATIONS SYSTEMS ENGINEERING
The Company has provided high-end systems engineering support to government
sponsors and prime contractors in the definition and development of aerospace
communications and reconnaissance systems. The Company has significant
experience in modeling, simulation and analysis of commercial and defense
satellite systems (LEO, MEO, HEO and GEO) that include
17
Iridium(R), Teledesic(TM), MILSTAR, TDRSS, Intelsat and others. The Company has
developed software for mission planning, payload data processing, geolocation,
payload test and evaluation, and on-board channel management and data routing.
System modeling and simulation supports the entire system life cycle,
including system definition, performance analysis, space segment definition and
ground segment design. The Company has developed custom models for the design
and analysis of mobile voice and wideband data systems, and has developed
algorithms for communications system operations.
The Company's satellite system models consist of several integrated
software modules hosted on a computer network. The satellite orbital propagation
and geometry software module models the coverage and performance aspects of
multiple vehicle constellations, including single or statistical events, motion
and pointing effects and comparisons of constellations. They deal with passive
geolocation, time difference of arrival, frequency difference of arrival, time
of arrival, frequency of arrival, angle of arrival and numerous error sources,
and provide automated link budget computation. The geographical software module
plots parameter versus parameter outputs from other modules. The mapping module
plots data and contours from other computational modules on map backgrounds. It
provides selectable projections, user-specified levels of detail and various
antenna patterns.
STRATEGY AND BUSINESS MODEL
Essex has developed proprietary photonic-related technologies and solutions
to overcome critical technical challenges that inhibit the capacity and quality
of traditional telecommunications systems. The Company's goal is to become a
leader in low-cost, optical telecommunications products that exploit its
HYPERFINE WDM and OPERA(TM) technologies and other intellectual property derived
from its optoelectronic expertise. The Essex business strategy is to exploit the
commercial potential of its intellectual property by embedding these
technologies into an array of components, devices and subsystems for sale to
major telecommunications companies. While the markets for new telecommunication
systems are depressed in early 2002, the Company believes that its products
under development have the potential to offer significant cost advantages,
enable higher system capabilities and increase quality of service and revenue
generation potential for current and next-generation optical, wireless and
digital wireline communications networks. As such, Essex management believes
that the Company must be in a position by late 2002 to meet potential demand for
its products for commercial telecommunications providers whose focus will be on
reliability, efficiency and cost.
INDEPENDENT TECHNOLOGY DEVELOPER
The Essex strategy is to serve as an independent technology developer and
provider in key telecommunications markets as these markets require cheaper,
more efficient and less capital intensive solutions in coming years.
Telecommunications providers increasingly want to rely on multiple independent
sources of technology to provide flexible technology solutions while leveraging
their own and their customers' strengths without having to make significant
expenditures and to influence the establishment of industry technology standards
where appropriate.
Only a limited number of technology companies currently supply markets
addressed by the Company's OPERA(TM) technology, and most of them are affiliated
with semiconductor or
18
equipment manufacturers. Essex believes that this presents a significant
opportunity for independent providers that are able to supply technology to
chipset manufacturers for mobile telecommunications and DSL equipment markets.
The Company believes that as the markets for broadband access products and
services grows, semiconductor manufacturers and other market participants will
increasingly seek reliable independent sources of new technology.
PROTECT AND EXPAND CORE INTELLECTUAL PROPERTY
Essex is building its commercial business on the foundation of its legacy
of lengthy experience and intellectual property in the fields of optoelectronic
and signal processing. To realize and protect the economic value of its
technical accomplishments in these fields, the Company has concentrated recently
on expanding its portfolio of core hardware devices, mathematical algorithms and
executable software code protected by patents and trade secrets. Essex intends
to exploit and create value from this portfolio by designing and building a
family of hardware products and supporting it with design services.
FIELD TRIALS OF OPTICAL NETWORKING PRODUCTS
Essex's 6.25 GHz prototype optical product has been taken into field trials
by several major telecommunications service providers and equipment companies to
date. Essex has met with important leading edge systems and service providers in
the optical networking markets who have indicated interest in encouraging their
vendors to commence field testing the prototypes of the HYPERFINE WDM family of
devices--the Optical Add/Drop Multiplexer, the optical spectrum analyzer, the
Virtual OC-768 device and the Wavelength Locker. Further, Essex will put such
units in field trials to work with the end customer to determine what the final
production units will contain.
TECHNOLOGY DEVELOPMENT AGREEMENTS WITH STRATEGIC PARTNERS
Pursuant to the ongoing field trial process, Essex will likely seek to
partner with or enter into licensing arrangements with major industry
participants in order to successfully introduce its technology and products. It
is expected that major systems and component manufacturers will become "Alpha
Partners" wherein they will specify particular applications of HYPERFINE WDM and
place orders contingent on Essex's satisfaction of their specifications.
In addition to these specific development agreements, Essex intends to seek
one or more strategic partners with experience and stature in the
telecommunications industry to better position the Company to meet its
aggressive product development schedule and undertake final product design and
large-scale manufacturing. Such a strategic alliance could provide for a license
to utilize Essex technology in one or more specific market applications and
could also include the formation of a broad partnership to develop new products
based upon the expertise and intellectual property of Essex.
INCORPORATE COMMERCIALLY AVAILABLE OPTICAL COMPONENTS
In designing its initial products for use in optical networks, Essex has
sought to use commercially available hardware and outsource our glass coatings
for use in our products. The Company believes that by using these third-party
components and the services of other providers, Essex will benefit from the
research and development of the vendors of these products, as well as
19
from the efficiencies of scale that these vendors have already achieved by
producing components for many customers in higher volumes than Essex could
produce. As a result, the Company believes that it can more quickly bring to
market a broad-based product line at a lower cost than if the Company sought to
maintain captive manufacturing facilities for its component and glass coating
needs.
OUTSOURCE PRODUCT DESIGN AND MANUFACTURING
When its optical networking devices reach the commercial manufacturing
stage, the Company intends to outsource the manufacturing of its products. Essex
believes that this will enable the Company to reduce its cost structure and to
maintain its focus on the development of value-added intellectual property and
technology for integration into our optical devices and components.
Historically, many optical networking companies have manufactured their own
products in order to implement specialized manufacturing techniques. However,
Essex has experience in working with subcontractors for product design and
manufacturing and management believes that the quality and consistency of
optical design and manufacturing techniques have evolved such that it is
possible to engage third party product designers and manufacturers to build the
Company products without sacrificing quality or performance. Indeed, the Harris
relationship has added considerable capability that Essex could not afford to
duplicate in house. Harris has significant capability in manufacturing optical
components and the two companies have worked together for many years; thus,
complementing each other well. Harris has supported HYPERFINE WDM by providing
economical and effective services to Essex through the prototype stages of the
product and is poised to manufacture in volume. In particular, Harris engineers
have been invaluable in design of the final product including advising on the
ultimate manufacturability and reliability of HYPERFINE WDM.
SPECIALIZED LICENSING PARTNERSHIPS
Similarly, Essex may seek to partner with one or more leading suppliers of
integrated circuits to develop chipsets that incorporate DSL technology to
develop and deploy OPERA(TM) technology for this application. The Company would
enter into such arrangements to issue exclusive or non-exclusive licenses to any
such partner to manufacture and sell the chipsets integrating the OPERA(TM)
technology in exchange for the right to receive royalty payments from such
business relationships.
PURSUE COMPLEMENTARY JOINT VENTURES AND ACQUISITIONS
In addition, Essex may seek to take advantage of market fragmentation in
several of its legacy areas of business by seeking opportunities for
consolidation. For example, Essex management believes that market fragmentation
in the area of government contract R&D for national security related technology
and associated software systems present opportunities for consolidation by
companies, such as Essex, which have long experience in these areas. Essex plans
to draw on its legacy of work with government agencies in the areas of fiber
optic communications, signal processing and CDMA telecommunications systems to
pursue strategic affiliations or acquisitions that will provide the Company with
additional key technologies, complement technology development activities,
enhance its related software development capabilities, increase its "smart
revenue" generation, increase its sales channels to national security related
government programs, and add to its overall level of expertise.
20
RISK FACTORS
Our business, results of operations and financial condition are subject to
the risks set forth below. You should carefully consider these risks. Additional
risks and uncertainties, including those that are not yet identified or that we
currently think are insignificant, may also adversely affect our business,
results of operations and financial condition.
RISKS RELATED TO OUR FINANCIAL RESULTS
WE HAVE A HISTORY OF NET LOSSES AND EXPECT TO CONTINUE TO INCUR NET LOSSES FOR
THE FORESEEABLE FUTURE, AND MAY NEVER ACHIEVE OR SUSTAIN PROFITABILITY.
We incurred a net loss for our fiscal years ended December 30, 2001 and
December 31, 2000. The Company also incurred net losses in fiscal 1998 and 1997.
In 1999, we reported a small net income. As of fiscal year end 2001, we had an
accumulated deficit of $12.2 million. Our revenues have declined from $3.3
million in fiscal 2000 to $2.6 million in fiscal 2001, primarily as a result of
our focus on commercial optoelectronics telecommunications products which have
not yet generated revenue. We expect to incur net losses for the foreseeable
future. To date, we have primarily funded our operations from the sale of equity
securities. We also expect to incur significant product development and
administrative expenses, and, as a result, we will need to significantly
increase revenues to achieve profitability. Even if we achieve profitability,
given the competition in, and the evolving nature of, the optical and wireless
telecommunications markets, we may not be able to sustain or increase
profitability on a quarterly or annual basis. As a result, we will need to
generate significantly higher revenues while containing costs and operating
expenses if we are to become and remain profitable.
IF OUR ACTUAL CAPITAL REQUIREMENTS VARY SIGNIFICANTLY FROM OUR EXPECTATIONS, WE
MAY REQUIRE ADDITIONAL FINANCING SOONER THAN ANTICIPATED.
Since September 2000 we have received approximately $5.0 million from
private investors to pursue commercial applications of our optical and wireless
communications technologies and resulting products. We have commitments for an
additional $1 million of investment on an as needed basis from these private
investors. Additional funds are critical to our ability to continue to develop
our commercial technologies and products because we currently experience and
expect to continue to experience negative cash flows. The funds available and
committed are projected to last through 2002. Our actual capital requirements
depend upon several factors that are difficult to predict, including the timing
of market acceptance of our commercial products under development, our ability
to establish and expand our customer base for our commercial products and
services, the level of expenditures for sales and marketing and general and
administrative functions, the level of revenues from our U.S. Government
contracts, the cost of offering additional services and other factors. If our
capital requirements vary materially from those currently planned, we may
require additional financing sooner than anticipated. There can be no assurance
that such funding will be available or could be obtained in sufficient amounts
or on terms acceptable to us, if at all, or on terms that would not include
substantial dilution to our stockholders. Without timely financing, we would
have to curtail or eliminate development and immediately reduce expenditures.
21
RISKS RELATED TO OUR BUSINESS
THE EARLY STAGE OF DEVELOPMENT OF OUR OPTICAL AND WIRELESS TELECOMMUNICATIONS
PRODUCTS MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS AND PROSPECTS.
We have traditionally derived our revenues from providing engineering and
signal processing services to the U.S. Government. While we continue to provide
these services, over the past year we have increasingly emphasized our work on
developing new optoelectronics telecommunications products, including HYPERFINE
WDM fiber optic communications technology and OPERA(TM). Because our development
efforts on these products are ongoing and we have not begun commercial sales of
these products, our revenue and profit potential is unproven and our limited
history in the commercial telecommunications field makes it difficult to
evaluate our business and prospects. Further, due to our shift in focus, we have
difficulty accurately forecasting our revenue, and we have limited historical
financial data upon which to base operating expense budgets. You should consider
our business and prospects in light of the heightened risks and unexpected
expenses and problems we may face as a company in an early stage of development
in a rapidly-evolving industry.
WE CURRENTLY RELY ON SALES TO U.S. GOVERNMENT ENTITIES, AND THE LOSS OF SUCH
CONTRACTS WOULD HAVE A MATERIAL ADVERSE IMPACT ON OUR OPERATING RESULTS.
During fiscal 2001, contracts with the U.S. Government, primarily the
military services and other departments and agencies of the Department of
Defense (DoD), accounted for approximately 73% or $1.9 million of our revenues.
In fiscal 2000, revenues on U.S. Government programs were $2.4 million, or 73%
of our revenues. The reduction in revenues from commercial customers in 2000 and
2001 has increased dependence upon such government program revenues. Our
business with the agencies of the Department of Defense (DoD) is focused
increasingly on our proprietary optoelectronics technology and products. Until
we are able to generate revenues from sales of our commercial optoelectronics
telecommunication products, our results of operations will continue to depend on
sales to the DoD and other U.S. Government departments and agencies. The loss of
any significant contract or a significant reduction in or cancellation of these
contracts would adversely affect our revenues and impair our ability to continue
the development of our proprietary communications products.
The loss or significant reduction in government funding of a large program
in which we participate could also materially adversely affect our future
revenues, earnings and cash flows and thus our ability to meet our financial
obligations. U.S. Government contracts are conditioned upon the continuing
approval by Congress of the amount of necessary spending. Congress usually
appropriates funds for a given program each fiscal year even though contract
periods of performance may exceed one year. Consequently, at the beginning of a
major program, the contract is usually partially funded, and additional monies
are normally committed to the contract only if appropriations are made by
Congress for future fiscal years.
GOVERNMENT CONTRACTS CONTAIN UNFAVORABLE TERMINATION PROVISIONS AND ARE SUBJECT
TO AUDIT AND MODIFICATION.
Companies engaged in supplying defense-related services and equipment to
U.S. Government agencies are subject to certain business risks peculiar to the
defense industry. These risks include the ability of the U.S. Government to
unilaterally:
22
o suspend us from receiving new contracts pending resolution of alleged
violations of procurement laws or regulations;
o terminate existing contracts;
o reduce the value of existing contracts;
o audit our contract-related costs and fees, including allocated
indirect costs; and
o control and potentially prohibit the export of our products.
Any of our U.S. Government contracts can be terminated by the U.S.
Government either for its convenience or if we default by failing to perform
under the contract. Termination for convenience provisions provide only for our
recovery of costs incurred or committed, settlement expenses and profit on the
work completed prior to termination. Termination for default provisions provide
for the contractor to be liable for excess costs incurred by the U.S. Government
in procuring undelivered items from another source.
OUR FIXED PRICE CONTRACTS MAY COMMIT US TO UNFAVORABLE TERMS.
We provide some of our products and services through fixed price contracts.
Fixed price contracts provided 22% and 45% of our sales for fiscal 2000 and
fiscal 2001, respectively. In a fixed price contract, the price is not subject
to adjustment based on cost incurred to perform the required work under the
contract. Therefore, we fully absorb cost overruns on fixed price contracts and
this reduces our profit margin on the contract. Those cost overruns may result
in a loss. A further risk associated with fixed price contracts is the
difficulty of estimating sales and costs that are related to performance in
accordance with contract specifications and the possibility of obsolescence in
connection with long-term procurements. Failure to anticipate technical
problems, estimate costs accurately or control costs during performance of a
fixed price contract may reduce our profit or cause a loss on the contract.
WE MAY NOT SUCCESSFULLY IMPLEMENT OUR PLAN TO EXPAND INTO COMMERCIAL MARKETS.
Our revenues currently come from business with the DoD and other U.S.
Government agencies. In addition to continuing to pursue these market areas, we
will focus our technical capabilities and expertise on related commercial
markets, including HYPERFINE WDM, OPERA(TM) and ImSyn(TM). These products are
still under various stages of development. As such, these products are subject
to certain risks and may require us to:
o develop marketing, sales and customer support capabilities;
o obtain customer and/or regulatory certification;
o respond to rapid technological advances; and
o obtain customer acceptance of these products and product performance.
Our efforts to enter commercial markets will require significant resources,
including additional working capital and capital expenditures, as well as the
use of management's time. Our efforts to sell our commercial telecommunications
products, particularly our optical networking and broadband wireless
communications products, also may depend to a significant degree on the efforts
of independent distributors or communication service providers. We can give no
assurance
23
that these distributors or service providers will be able to market our products
or their services successfully or that we will be able to realize a return on
our investments in them. If we are not successful in addressing these risks or
in developing these commercial business opportunities we may not be able to
reach profitability or remain in business.
OUR SUCCESS LARGELY DEPENDS ON OUR ABILITY TO RETAIN KEY PERSONNEL.
Our success has always depended in large part on our ability to attract and
retain highly-skilled technical, managerial, sales and marketing personnel,
particularly those skilled and experienced in optoelectronics and optical
communications equipment. We have entered into agreements with our employees
that limit the employee's ability to work for a competitor following termination
of employment. We expect our competitors will respect these agreements and not
interfere with them. We can make no assurances of that, or that we will be able
to retain all of our key contributors or attract new personnel to add to or
replace them. The loss of key personnel would prevent us from completing current
development and restrict new development.
IF BROADBAND WIRELESS TECHNOLOGY OR OUR IMPLEMENTATION OF THIS TECHNOLOGY IS NOT
BROADLY ACCEPTED, WE WILL NOT BE ABLE TO EXPAND OUR BUSINESS.
The future success of OPERA(TM) and other wireless products we are
currently developing depends on high-speed wireless communications products
gaining market acceptance as a means to provide improved voice and data
communications services. Because these markets are relatively new, it is
difficult to predict which market segments will develop or expand. We have
recently invested and expect to continue to invest significant time and
resources in the development of new products for this market. In the event that
service providers adopt technologies other than the high-speed access and other
wireless technologies or delay in their deployment of high-speed wireless
communication products, we will not be able to generate significant revenues
from our wireless products and our results of operations and financial condition
could be materially and adversely affected.
IF WE ARE UNABLE TO DEVELOP AND SUCCESSFULLY INTRODUCE NEW AND ENHANCED PRODUCTS
THAT MEET THE NEEDS OF OUR CUSTOMERS IN A TIMELY MANNER, OUR REVENUES AND
RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED.
Our future success depends on our ability to anticipate our customers'
needs and develop products that address those needs. Technological change in the
optical networking industry is occurring at a rapid pace. As a result, we expect
there to be frequent new product introductions, changes in customer requirements
and evolving industry standards. We may not be able to develop new products or
enhancements to our existing products in a timely manner, or at all. This would
cause potential customers to seek other solutions, which would reduce our
revenues and adversely affect our results of operations and financial condition.
We are currently developing many potential optical networking products
through our research and development efforts. Although we have several products
in development, we may not bring all of these potential products into commercial
production due to:
o changes in customer demand;
o technological developments that make our products less competitive;
24
o evolving industry standards; or
o allocation of our limited resources to other products or technologies.
If we incur significant expenses developing products that we do not produce
commercially, or if we select the wrong products or technologies to bring into
commercial production, our revenues and results of operations could be adversely
affected and we may not recover significant research and development expenses.
OUR SUCCESS IS DEPENDENT ON OUR OPTOELECTRONICS TELECOMMUNICATIONS PRODUCTS
BEING DEVELOPED. FAILURE OF OUR PRODUCTS TO OPERATE AS EXPECTED COULD DELAY OR
PREVENT THEIR DEPLOYMENT AND SALE AND COULD SERIOUSLY IMPAIR OUR BUSINESS AND
PROSPECTS.
Our future growth and success largely depends on the commercial success of
our optical and wireless telecommunications products being developed. We have
not begun commercial sales of our products and have produced devices only to
specifications required in order to conduct laboratory tests and field trials.
Some of our devices have been deployed in field trials, others have been tested
in our laboratories and still others are in earlier stages of development. If
our products fail to operate as expected, this could delay or prevent their
deployment and sale and could seriously impair our business and prospects. If
our customers do not successfully test and deploy our products and technologies,
we may not be able to reach profitability or remain in business.
THE MARKET WE INTEND TO SERVE IS HIGHLY COMPETITIVE AND WE MAY NOT BE ABLE TO
ACHIEVE OR MAINTAIN PROFITABILITY.
Competition in the network communications equipment market is intense. This
market has historically been dominated by large companies, such as Alcatel,
Ciena, Cisco Systems, JDS Uniphase, Lucent Technologies, NEC and Nortel
Networks. Some of these companies, as well as emerging companies, are currently
developing products that may compete in the specialty areas that Essex's
technology is designed to address. We may face competition from other large
communications companies who may enter our proposed markets. Many of our
competitors have longer operating histories, greater name recognition, larger
customer bases and greater financial, technical and sales and marketing
resources than we do and may be able to undertake more extensive marketing
efforts and adopt more aggressive pricing policies than we can. Moreover, our
competitors may foresee the course of market developments more accurately than
we do and could develop new technologies that compete with our products or
render our products obsolete. Due to the rapidly evolving markets in which we
compete, additional competitors with significant market presence and financial
resources may enter our markets, further intensifying competition.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY EFFECTIVELY, WE MAY BE
UNABLE TO PREVENT THIRD PARTIES FROM USING OUR TECHNOLOGIES, WHICH WOULD IMPAIR
OUR COMPETITIVE ADVANTAGE.
We rely on a combination of patent, copyright, trademark and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
We also enter into confidentiality or license agreements with our employees and
consultants and control access to and distribution of our software,
documentation and other proprietary information. The Company believes that its
patents and patent applications provide it with a competitive
25
advantage. Accordingly, in the event the Company's products and technologies
under development gain market acceptance, patent protection would be important
to the Company's business. However, obtaining patent and other intellectual
property protection may not adequately protect our rights or permit us to gain
or keep any competitive advantage. For instance, unauthorized parties may
attempt to copy, reverse engineer or otherwise obtain and use our patented
products or technology without our permission, thus eroding or eliminating the
competitive advantage we hope to gain though the exclusive rights provided by
patent protection. Moreover, our existing patents and patents we have applied
for (if granted) may not protect us against competitors that independently
develop proprietary technologies that are substantially equivalent or superior
to our technologies, or design around our patents. In addition, the competitive
advantage provided by patenting our technology may erode if we do not upgrade,
enhance and improve our technology on an ongoing basis to meet competitive
challenges.
Monitoring unauthorized use of our technology is difficult, and we cannot
be certain that the steps we have taken will prevent unauthorized use of our
technology, particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States. A complete description of
Essex's patents and patent applications is contained in this Annual Report on
Form 10-KSB.
THERE IS A RISK THAT OUR PATENT APPLICATIONS WILL NOT BE GRANTED.
Although we have filed several applications for U.S. patents relating to
our HYPERFINE WDM and OPERA(TM) technologies, there is a risk that some or all
of our pending applications will not issue as patents. Although we believe our
patent applications are valid, the failure of our pending applications to issue
as patents would eliminate the competitive advantage we hope to gain by
obtaining patent protection and thus likely would have a material adverse effect
upon our business and results of operations.
WE MAY BECOME INVOLVED IN INTELLECTUAL PROPERTY DISPUTES, WHICH COULD SUBJECT US
TO SIGNIFICANT LIABILITY, DIVERT THE TIME AND ATTENTION OF OUR MANAGEMENT AND
PREVENT US FROM SELLING OUR PRODUCTS.
We or our customers may be a party to litigation in the future to protect
our intellectual property or to respond to allegations that we infringe on
others' intellectual property. Any parties asserting that our products infringe
upon their proprietary rights would force us to defend ourselves and possibly
our customers against the alleged infringement. If we are unsuccessful in any
intellectual property litigation, we could be subject to significant liability
for damages and loss of our proprietary rights. Intellectual property
litigation, regardless of its success, would likely be time consuming and
expensive to resolve and would divert management's time and attention. In
addition, we could be forced to do one or more of the following:
o stop selling, incorporating or using our products that include the
challenged intellectual property;
o obtain from the owner of the infringed intellectual property right
a license to sell or use the relevant technology, which license
may not be available on reasonable terms, or at all; or
o redesign those products that use the technology.
26
If we are forced to take any of these actions, our business would be
seriously harmed.
IF NECESSARY LICENSES OF THIRD-PARTY TECHNOLOGY ARE NOT AVAILABLE TO US OR ARE
VERY EXPENSIVE, OUR BUSINESS WOULD BE SERIOUSLY HARMED.
From time to time we may be required to license technology from third
parties to sell or develop our products and product enhancements. These
third-party licenses may not be available to us on commercially reasonable
terms, if at all. Our inability to maintain or obtain any third-party license
required to sell or develop our products and product enhancements could require
us to obtain substitute technology of lower quality or performance standards or
at greater cost. If we were required to use technology with lower performance
standards or quality, customers may stop buying our products and this would
cause our revenues to decline. Similarly, if our costs rise significantly,
customers may choose less expensive alternative products, which would cause our
revenues to decline.
RISKS RELATED TO THE OPTICAL NETWORKING INDUSTRY
THE OPTICAL NETWORKING INDUSTRY IS DEVELOPING, UNPREDICTABLE AND CHARACTERIZED
BY RAPID TECHNOLOGICAL CHANGES AND EVOLVING STANDARDS. IF THIS INDUSTRY DOES NOT
DEVELOP AND EXPAND AS WE ANTICIPATE, DEMAND FOR OUR PRODUCTS MAY FAIL TO GROW OR
MAY DECLINE, WHICH WOULD ADVERSELY AFFECT OUR REVENUES.
The optical networking industry is developing and characterized by rapid
technological change, frequent new product introductions, changes in customer
requirements and continuously evolving industry standards. As a result, it is
difficult to predict its potential size and future growth rate. In addition,
evolving customer requirements and industry standards are uncertain. Our success
in generating revenues in this evolving market will depend on our ability to:
o establish, maintain and enhance our relationships with optical
networking customers;
o convince our customers of the benefits of next-generation optical
networks; and
o predict accurately, and develop our products to meet, evolving
customer requirements and industry standards.
If we fail to address changing market conditions, sales of our products may
fail to grow or may decline, which would adversely affect our revenues.
THE OPTICAL NETWORKING EQUIPMENT INDUSTRY IS EXPERIENCING DECLINING AVERAGE
SELLING PRICES, WHICH COULD ADVERSELY AFFECT OUR REVENUES AND GROSS MARGINS.
The optical networking equipment industry is experiencing declining average
selling prices as a result of increasing competition and greater unit volumes as
communications service providers continue to deploy fiber optic networks. We
anticipate that average selling prices will continue to decrease in the future
in response to product introductions by competitors, price pressures from
significant customers and greater manufacturing efficiencies. These average
selling price declines may contribute to a decline in our gross margins, which
could adversely affect our results of operations.
27
IF THE INTERNET AND COMMERCIAL DATA NETWORKS DO NOT CONTINUE TO EXPAND AND
NEXT-GENERATION OPTICAL NETWORKS ARE NOT DEPLOYED AS RAPIDLY AS WE ANTICIPATE,
SALES OF OUR PRODUCTS UNDER DEVELOPMENT MAY DECLINE, AND OUR REVENUES MAY BE
ADVERSELY AFFECTED.
Our future success depends on the continued growth of the Internet and
commercial data networks for commerce and communications, the continuing
increase in the amount of data transmitted over communications networks and the
increasing adoption of, and improvements to, optical networks to meet the
increased demand for bandwidth. If data networks, including the Internet, do not
continue to expand as a widespread communications medium and commercial
marketplace, the need for significantly increased bandwidth across networks and
the market for optical networking products may not continue to develop. Future
demand for the products we are developing is uncertain and will depend to a
great degree on the continued growth and upgrading of optical networks. If this
growth does not continue, we may be unable to reach profitability or remain in
business.
BECAUSE OPTICAL PRODUCTS ARE COMPLEX AND ARE DEPLOYED IN COMPLEX ENVIRONMENTS,
THE PRODUCTS WE ARE DEVELOPING MAY HAVE DEFECTS THAT WE DISCOVER ONLY AFTER FULL
DEPLOYMENT, WHICH COULD SERIOUSLY HARM OUR BUSINESS.
Optical products are complex and are designed to be deployed in large
quantities across complex networks. Because of the nature of the products, they
can only be fully tested when completely deployed in large networks with high
amounts of traffic. Customers may discover errors or defects in the hardware or
the software, or products we develop may not operate as expected, after they
have been fully deployed. If we are unable to fix defects or other problems that
may be identified in full deployment, we would experience:
o loss of, or delay in, revenue and loss of market share;
o loss of existing customers;
o failure to attract new customers or achieve market acceptance;
o diversion of development resources;
o increased service and warranty costs;
o legal actions by our customers; and
o increased insurance costs.
The occurrence of any of these problems could seriously harm our business,
financial condition and results of operations. Defects, integration issues or
other performance problems could result in financial or other damages to our
customers or could negatively affect market acceptance for the products we
develop. Our customers could also seek damages for losses from us, which, if
they were successful, would seriously harm our business, financial condition and
results of operations. A product liability claim brought against us, even if
unsuccessful, would likely be time consuming and costly and would put a strain
on management and resources.
28
RISKS RELATED TO OUR COMPANY
WE ARE CONTROLLED BY A LIMITED NUMBER OF STOCKHOLDERS THAT WILL BE ABLE TO EXERT
SIGNIFICANT INFLUENCE OVER MATTERS REQUIRING STOCKHOLDER APPROVAL.
We are controlled by two private investment firms, GEF Optical Investment
Company, LLC and Networking Ventures, L.L.C. We refer to these firms as the
"Investors." Together the Investors own preferred stock having voting rights
equivalent to 51% of the voting power of all shares of voting stock on all
stockholder matters through mid-September 2002, at which time such preferred
stock will be converted to 2 million shares of common stock. In addition, the
Investors and their affiliates have directly acquired or contracted to acquire
1,026,000 shares of common stock. Accordingly, the Investors will control us and
have the power to elect all of our directors, appoint new management and approve
certain actions requiring the approval of the holders of shares of our common
stock. This concentration of ownership may also delay or prevent a change in
control of Essex or reduce the price investors might be willing to pay for our
common stock. The interests of the Investors may conflict with the interests of
other holders of our common stock.
THERE IS CURRENTLY ONLY A LIMITED PUBLIC MARKET FOR OUR COMMON STOCK AND OUR
COMMON STOCK IS SUBJECT TO SIGNIFICANT PRICE fluctuations.
Our Common Stock is listed on the OTC Bulletin Board and there has only
been a limited public market for our common stock. Unless and until our common
stock is admitted for quotation on a national securities exchange it is unlikely
that any active trading market will develop or, if any such market develops,
that it will be sustained. Even if our common stock is admitted for quotation or
listing on a national securities exchange, an active trading market may not
develop unless the number of shares in the hands of the public is substantially
increased. In addition, in the event our operating results fall below the
expectations of public market analysts and investors, the market price of our
common stock would likely be materially adversely affected.
The trading price of our common stock is likely to be volatile and
sporadic. The stock market in general, and the market for technology companies
in particular, has experienced extreme volatility. This volatility has often
been unrelated to the operating performance of particular companies. Volatility
in the market price of our common stock may prevent investors from being able to
sell their common stock at or above the price such investors paid for their
shares or at any price at all.
SALES BY THE INVESTORS OR OTHERS OF A SIGNIFICANT NUMBER OF SHARES OF COMMON
STOCK COULD HAVE A MATERIAL ADVERSE EFFECT ON PREVAILING MARKET PRICES.
We cannot predict what effect, if any, that future sales of shares, or the
availability of shares for future sale, will have on the market price of our
common stock prevailing from time to time. Nevertheless, sales of substantial
amounts of common stock by the Investors, or the perception that such sales may
occur, could have a material adverse effect on prevailing market prices.
At March 15, 2002, we have outstanding approximately 5.3 million shares of
our common stock, 776,000 of which were issued and sold by us in private
transactions in reliance upon exemptions from registration under the Securities
Act. (See "Other Business Information - Recent Developments" section which
follows for further information.) These privately placed shares may be sold only
pursuant to an effective registration statement filed by Essex or an applicable
29
exemption, including the exemption contained in Rule 144 promulgated under the
Securities Act. In general, under Rule 144 as currently in effect, a
shareholder, including an affiliate of Essex, may sell shares of common stock
after at least one year has elapsed since such shares were acquired from us or
an affiliate of ours. The number of shares of common stock which may be sold
within any three- month period is limited to the greater of one percent of the
then outstanding number of shares of common stock or the average weekly trading
volume in the common stock during the four calendar weeks preceding the date on
which notice of such sale was filed under Rule 144. Certain other requirements
of Rule 144 concerning availability of public information, manner of sale and
notice of sale must also be satisfied. In addition, a shareholder who is not our
affiliate (and who has not been our affiliate for 90 days prior to the sale) and
who has beneficially owned shares acquired from us or our affiliate for over two
years may resell the shares without compliance with the foregoing requirements
under Rule 144.
The Investors have been granted rights to have up to 4,000,000 shares of
common stock issuable upon conversion of preferred stock and underlying warrants
registered under the Securities Act upon demand. In addition, 660,000 shares of
common stock held by the Investors are covered by a registration statement on
Form S-2 that allows the Investors to sell the shares from time to time on the
over-the-counter market or otherwise. Sales of substantial amounts of common
stock under Rule 144 or pursuant to the Investor's registration rights, or the
perception that such sales may occur, could have a material adverse effect on
prevailing market prices.
WE ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION DUE TO OUR EXPECTED STOCK
PRICE VOLATILITY.
In the past, securities class action litigation has often been brought
against companies after periods of volatility in the market price of their
securities. Securities litigation could result in substantial costs and divert
management's attention and resources from our business. Due to the potential
volatility of our stock price, we may be the target of securities litigation in
the future.
OTHER BUSINESS INFORMATION
MARKETING AND FINANCING
From September 2000 through December 2001, the Company has closed on
several private placement funding transactions with GEF Optical Investment
Company, LLC and Networking Ventures, L.L.C., or their affiliates (the "Investor
Group") aggregating $4,650,000. The funds have been and are to be used
substantially to patent, develop and commercialize its key leading-edge optical
technologies, principally HYPERFINE WDM and OPERA(TM). (See "Management's
Discussion and Analysis - Liquidity and Capital Resources" for further details
about the private placements.)
Although constrained by limited financial resources, the Company's
commercial marketing has expanded through use of internal staff and consultants.
Military end-use marketing continues to be carried out by key employees, both
directly to government agencies and indirectly through prime contractors,
through the submission of proposals. Such proposals may be in response to
customer requests while others are unsolicited proposals by the Company to
potential customers to solicit new work.
30
RECENT DEVELOPMENTS
In March 2002, the Company amended existing private placement agreements
for its common stock with its Investor Group or their affiliates. The agreements
were increased from $500,000 to $1.5 million, of which $250,000 was received in
December 2001 and $500,000 was received in the first quarter of 2002. The
remaining $750,000 is subject to a call by the Company on an as needed basis
during 2002. These agreements provide for the shares of common stock to be
issued at an initial price per share of $6.50, subject to effective downward
price adjustment, but not less than $3 per share, should additional private
placements be done with other institutional investors during 2002 at a lower
price per share.
The proceeds will primarily be used to expand development in the Company's
optoelectronic telecommunications device technologies.
CONTRACT MIX
Services of the Company are performed under fixed-price (45% and 22% in
2001 and 2000, respectively), cost-reimbursement (39% and 45% in 2001 and 2000,
respectively) or time and material (16% and 33% of revenues in 2001 and 2000,
respectively) contracts and subcontracts. Fixed-price contracts have a greater
degree of risk and higher potential reward than cost-type contracts since the
Company is obligated to provide specific deliverables within the confines of the
contracted price.
GOVERNMENT PROGRAMS
Historically, a significant portion of the Company's revenues have been
derived from contracts, or subcontracts thereunder, with departments or agencies
of the U.S. Government, primarily the military services and other departments
and agencies of the Department of Defense (DoD). In both 2001 and 2000, 73% of
the Company's total revenues were derived from government DoD contracts or
subcontracts. Government military programs include work principally with the
Army, and to a lesser extent with the Air Force, Navy and other DoD entities.
The Company also works with industrial companies, engineering firms, equipment
manufacturers and research institutions.
The Company's business is focused upon applications of its proprietary
optoelectronics technology and products. During 2001, the Company worked on
several contracts for Small Business Innovation Research (SBIR) and a similar
program that deal with ImSyn(TM) Processor applications. Work based on the
patented ImSyn(TM) Processor has continued on a DoD program and an application
contract by the Defense Advanced Research Projects Agency (DARPA) for the
development of advanced synthetic aperture radar (SAR) techniques. This effort
is a Phase 2 SBIR. Naval Air Warfare Center, Patuxent Naval Air Station, had
Essex install certain performance upgrades to its ImSyn(TM) Processor. This work
was in support of the Naval Air Warfare Center Advanced Development NP-3
Synthetic Aperture Radar (SAR) program. The U.S. Army Space Missile Defense
Command is using Essex to create related algorithms for enhanced 2D or 3D
imaging using Essex's optical hardware processing and techniques.
31
PATENTS
The Company has a significant patent portfolio covering the core
intellectual property for the Company's products. The portfolio is divided into
four technology groups: HYPERFINE WDM, OPERATM, ImSynTM and Virtual Lens Imaging
(VLI).
The Company believes that its patents and patent applications provide it
with a competitive advantage. Accordingly, in the event the Company's products
and technologies under development gain market acceptance, patent protection
would be important to the Company's business. However, obtaining patent and
other intellectual property protection may not adequately protect our rights or
permit us to gain or retain any competitive advantage. For instance,
unauthorized parties may attempt to copy, reverse engineer or otherwise obtain
and use our patented products or technology without our permission, thus eroding
or eliminating the competitive advantage we hope to gain through the exclusive
rights provided by patent protection. Moreover, our existing patents and patents
we have applied for (if granted) may not protect us against competitors that
independently develop proprietary technologies that are substantially equivalent
or superior to our technologies, or design around our patents. In addition, the
competitive advantage provided by patenting our technology may erode if we do
not upgrade, enhance and improve our technology on an ongoing basis to meet
competitive challenges.
HYPERFINE WDM
The first HYPERFINE WDM U.S. and International patents were filed on
October 13, 2000 and cover the use of the device as a receiver and demultiplexer
for wavelength division multiplexing fiber optic networks. A provisional U.S.
patent application was filed on March 19, 2001 for a HYPERFINE WDM wavelength
locker and on July 20, 2001 a U.S. provisional patent application was filed for
integrated optics HYPERFINE WDM technology. On January 22, 2002 two full U.S.
and International utility patent applications were filed for a HYPERFINE WDM
add/drop multiplexer and for a HYPERFINE WDM optical code division multiple
access system.
OPERATM
The OPERA(TM) application was filed with the U.S. and International Patent
offices on January 19, 2001. OPERA(TM) is an optoelectronic system for wireless
communications that eliminates interfering signals using optical correlation
combined with Multi-User Detection (MUD) algorithms.
IMSYNTM
There are currently four ImSyn(TM) patents which have issued in the U.S.
The first three patents cover the optoelectronic architecture and applications
including accelerating image reconstructions for SAR and MRI. The claims in the
fourth patent cover the sensing and reconstruction techniques of the Virtual
Lens Microscope(TM) (VLM) technology which is part of the Company's VLI
technology family. The VLM has application for semiconductor inspection, ground
penetrating radar, biomedical imaging, and non-destructive testing.
The first ImSyn(TM)U.S. Patent No. 5,079,555, "Sequential Image
Synthesizer", includes 20 claims and expires January 7, 2009. The corresponding
patent, No. 2,058,209, issued in Canada, expires November 25, 2011. The
corresponding European patent for a subset of the claims, No. 0543064, is in
force in Great Britain and Germany, and will expire November 21, 2011. Japan has
issued Patent No. 3113338 for the same claims as the U.S. version and it will
expire on October 29, 2011.
32
The second ImSyn(TM)patent, U.S. Patent No. 5,384,573, "Image Synthesis
Using Time Sequential Holography" includes 157 claims and expires on January 24,
2012. Applications for the same set of claims as the U.S. patent are in process
in Canada and Japan. In France, Great Britain, Germany and Italy, Patent
EP0617797B1 has been awarded for a subset of the claims in the U.S. patent and
this patent expires December 17, 2012. Another European application for a subset
of the claims in the U.S. patent is still in process.
The third ImSyn(TM)U.S. Patent No. 5,736,958, "Image Synthesis Using Time
Sequential Holography", with 8 claims expires April 7, 2015.
The fourth ImSyn(TM)U.S. Patent No. 5,751,243, "Image Synthesis Using Time
Sequential Holography" with 21 claims expires May 11, 2015.
VIRTUAL LENS IMAGING (VLI)
The ImSyn(TM)U.S. Patent No. 5,751,243 discloses the Virtual Lens
Microscope, a 2D and 3D sensing and reconstruction technique called the
Synthetic Aperture Microscope. On December 11, 2001 a full U.S. and
International utility patent application entitled "Efficient Fourier Transform
Algorithm For Non-Uniform Data" was filed within the VLST technology family.
COMPETITION
Competition for U.S. Government and commercial professional and technical
services contracts has grown in intensity and proposals have become increasingly
costly. This stimulated the Company to initiate its program to develop
proprietary products and services, particularly for the commercial market. As
such proprietary items are developed, the Company has relied increasingly upon
offers of its specialized optical engineering capabilities, sharply reducing
resources applied in response to proposals for solely professional and technical
services. Examples of such proprietary items include HYPERFINE WDM and OPERA(TM)
as well as ImSyn(TM) processors.
Market acceptance of Essex optical products and technology has not yet been
accomplished. The Company only began in late 2000 to announce the capabilities
of its HYPERFINE WDM and OPERA(TM) technologies. Since then, the Company has
been in contact with major telecommunications firms which are users and/or
supplies of equipment and services where the Company's technology would be
beneficial. In the telecommunications industry, all the largest international
telecommunications firms such as Lucent, Nortel, WorldCom, and all the largest
international fiber optic equipment manufacturers and suppliers such as JDS
Uniphase, Avanex, Ciena and Corvis, have the ability to produce competing
products in the specialty areas which Essex technology and products would
address. These companies are all larger and well established and have existing
customer bases. Essex will likely have to partner with or license to one of the
major industry entities in order to successfully introduce its technology and
products.
In business areas where ImSyn(TM) processors could be utilized, Essex is
just beginning to express itself outside the development laboratory and is not
yet firmly in the market. ImSyn(TM) processors need enhancement development and
testing which are not expected to occur until additional sources of funds for
such development are obtained.
33
BACKLOG
As of December 30, 2001, the Company had a total backlog (funded and
unfunded) of approximately $621,000 as compared with $1,229,000 at December 31,
2000. Of these amounts, backlog was $567,000 funded and $54,000 unfunded at
yearend 2001 as compared to all backlog being funded at yearend 2000. In early
2002, the Company was awarded a follow-on contract for $1,299,000 with an
effective date of January 1, 2002. This effectively increased yearend 2001
backlog to $1,920,000, of which $1,025,000 was funded and $894,000 was unfunded.
Funded backlog generally consists of the sum of all contract amounts of work for
which funding has been approved and contracts signed, less the value of work
performed under such contracts. Even though such contracts are fully funded by
appropriations, they are subject to other risks inherent in government and
commercial contracts, such as termination for the convenience of the customer.
RESEARCH AND DEVELOPMENT
The Company incurred and expensed approximately $2,417,000 and $771,000 in
2001 and 2000, respectively, on internally-funded research and development
activities.
EMPLOYEES
As of February 28, 2002, the Company had approximately 44 employees, of
whom 29 were full-time employees.
2. DESCRIPTION OF PROPERTIES
OFFICE FACILITIES
The Company leases its offices. The Company's corporate headquarters and
offices are located in a one-story building at 9150 Guilford Road, Columbia,
Maryland where the Company occupies approximately 18,000 square feet. The lease
is through October 2005. The Company believes that its present facility is
adequate for its current business needs.
EQUIPMENT
The Company owns a variety of computer workstations, test equipment,
microcomputers, printers and reproduction equipment. The Company leases computer
workstations in support of customer work. Other computer hardware and software,
test equipment, word processing and reproduction equipment used by the Company
are leased.
OPTOELECTRONICS LABORATORY
The laboratory consists of optical hardware and computer hardware and
software, optical benches and test equipment. The laboratory includes the
physical property which demonstrates and tests the capabilities of the Company's
patent-pending HYPERFINE WDM and OPERA(TM) and patented Image Synthesizer
(ImSyn(TM)) technology as well as other optoelectronic devices and applicatioNS.
3. LEGAL PROCEEDINGS - None
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None
34
PART II
5. MARKET FOR THE COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's common stock is quoted and trades are executed through the
OTC Bulletin Board under the symbol "ESEX".
The following table sets forth the range of high and low actual sales
prices of the Common Stock for the periods indicated. Sales prices include
prices between dealers, may not reflect mark-ups, mark-downs or commissions and
may not represent final actual transactions.
2001 2000
------------------- -------------------
------------------- -------------------
High Low High Low
-------- -------- -------- --------
-------- -------- -------- --------
First Quarter........ $ 5.25 $ 2.22 $ 3.31 $ 1.00
Second Quarter....... 4.80 2.88 2.25 0.63
Third Quarter........ 6.70 3.30 5.13 1.06
Fourth Quarter....... 7.50 5.55 4.09 1.50
At March 1, 2002, there were approximately 1,500 beneficial owners of the
Company's Common Stock which includes 297 holders of record.
SALE OF UNREGISTERED SECURITIES
In December 2001, the Company sold 38,462 shares of unregistered Common
Stock to an accredited investor affiliated with the Investor Group, for
$250,000. The stock was sold in reliance upon the exemption from registration
provided for private offerings provided by Section 4(2) of the Securities Act of
1933, as amended (the "Securities Act") and Regulation D. Appropriate
restrictive legends were placed on the shares. No placement agent or underwriter
was involved in the sale of the common stock and the Company did not pay any
commissions. This private placement provides that if other institutional private
placements are made during 2002 at a lower price per share, that the effective
share price will be adjusted.
6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION AND OTHER
SECTIONS CONTAIN FORWARD-LOOKING STATEMENTS THAT ARE BASED ON MANAGEMENT'S
EXPECTATIONS, ESTIMATES, PROJECTIONS AND ASSUMPTIONS. WORDS SUCH AS "EXPECTS",
"ANTICIPATES", "PLANS", "BELIEVES", "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 AND UNCERTAINTIES THAT ARE DIFFICULT TO PREDICT. SEE "FORWARD LOOKING
STATEMENTS."
STATUS
The Company's business is focused upon applications of its proprietary
optoelectronics technology and products.
35
In September 2000 the Company closed on a private placement funding
transaction with the Investor Group. Under the terms of the funding, the Company
received $1,250,000 in 2000 and $750,000 in 2001. The Investor Group received
preferred stock that must be converted into 2,000,000 shares of common stock by
mid-September 2002. The Investor Group was also issued warrants for an
additional 2 million shares of common stock. The warrants can be exercised for a
nominal price under certain terms and conditions. In December 2000, the Company
received a separate additional investment of $400,000 from the Investor Group
for the purchase of 160,000 shares of common stock. In March 2001, the Company
closed on a $2 million private placement funding transaction with the same
Investor Group. During 2001, the Company issued 500,000 shares of its common
stock in connection with this transaction. As part of a $1.5 million financing
commitment from the Investor Group or its affiliates, in December 2001, the
Company sold 38,462 shares of common stock for $250,000. In the first quarter of
2002, the Company received $500,000 under this commitment for 76,924 shares of
common stock. See Note 11 of Notes to Financial Statements for further details.
The Company's primary use of the funds is to patent, develop and
commercialize its key leading-edge optical technologies, principally the
fiberoptic HYPERFINE WDM devices and wireless OPERA(TM) technology. The Company
began the internal work to support patent filings and the related development
work on the technology devices during the third quarter of 2000. The purpose of
the HYPERFINE WDM device is to increase the number of usable communications
channels within a single optical fiber. The purpose of OPERA(TM) is to increase
capacity and improve voice and data quality of wireless systems. These
inventions arose from the Company's work and expertise in the optical device and
communications fields.
The Company has prototypes of the HYPERFINE WDM technology which are being
demonstrated to prospective strategic partners and investors. The Company began
placing prototypes of its initial HYPERFINE WDM devices in field trials by
potential customers in late September 2001. The Company is developing
simulations of its OPERA(TM) wireless receiver device technology and is
undertaking to determine the various market entry points for such device
technology. The Company is also holding discussions with various established
commercial entities that are in the wireless communications market in order to
determine the best commercial applications of such technology.
The development of these devices required a diversion of labor resources
from revenue generation in 2001 and 2000 and is expected to continue to do so in
2002. The Company may hire additional personnel to augment existing technical
staff. Since the Company is investing the new capital in such research and
development, the financial statements reflect higher than normal expenses which
increases the Company's reported losses.
Because of the emphasis on development, the Company has been unable to
maintain customer programs of sufficient volume and to expand such work to
consistently achieve an overall breakeven or better level of operations on such
revenues. Work based on or related to the patented ImSyn(TM) Processor and other
Essex optical hardware processing and techniques continues for the development
of advanced SAR techniques. These efforts generally fall under SBIR programs.
The Company is working to reduce the deficit from such operations and to
improve its cash flows. Backlog and order issues will continue to be major
concerns until substantial improvements realized from customer funded
development programs have been achieved. The
36
Company has established significant reserves against its ImSyn(TM) inventory for
such changes and delays in the introduction of upgraded units. The existing
configuration of finished goods in inventory is being redesigned. The current
inventory has been written down to its estimated net realizable value as
components or subassemblies in the redesigned and upgraded units.
The Company currently does not have sufficient resources to bring its
telecommunications and optoelectronics processing devices to market.
Accordingly, the Company will likely have to partner with or enter into
licensing arrangements with major industry participants in order to successfully
introduce its technology and products. There can be no assurance that the
Company will be successful in entering into such agreements.
2001 COMPARED TO 2000
Revenues were $2,642,000 and $3,255,000 for fiscal 2001 and 2000,
respectively, a decrease of 19%. The decrease was primarily due to the reduction
in revenue from commercial satellite communications systems as discussed below.
The Company's revenue on U.S. Government programs for research on the use of the
Company's optoelectronics products was approximately $2.2 million in both fiscal
2001 and 2000, respectively, representing 82% of revenue in 2001 compared to 67%
of revenue in fiscal 2000. The Company has a backlog of approximately $1,849,000
on programs related to optoelectronic devices and services.
The Company's work in satellite communication systems for General Dynamics
Decision Systems (successor to Motorola on this program work) accounted for
revenues of $431,000 in fiscal 2001 and $733,000 in fiscal 2000, respectively.
This represented approximately 16% and 23% of revenues for fiscal 2001 and
fiscal 2000, respectively. There has been a decrease in revenues from this
program since 1999 as the Company's involvement on the initial satellite system
was essentially completed in December 1999. The Company continues to bid on new
work for the current and successor satellite systems. The balance of the
Company's revenues in fiscal 2000 came from providing software and engineering
services primarily to other government prime contractors and from final billings
for recovery for excess indirect costs on government contracts completed in
prior years.
There was an operating loss of $3,577,000 in fiscal 2001 compared to an
operating loss of $1,183,000 in fiscal 2000. Cost of goods sold and services
provided as a percentage of revenue (excluding revenue from recovery of prior
year excess costs) for fiscal 2001 was relatively unchanged at 51.6% as compared
to 53.5% in fiscal 2000.
Research and development (R&D) increased in fiscal 2001 to approximately
$2,417,000 from approximately $771,000 in fiscal 2000. The majority of the R&D
costs were incurred on efforts related to the development of optical
telecommunications technology. The Company has greatly increased its R&D
spending since the September 2000 capital infusions and expects to continue its
R&D spending in the optical and telecommunications areas in fiscal 2002.
Selling, general and administrative expenses in both fiscal 2001 and fiscal
2000 remained high and increased in fiscal 2001 as a percentage of revenue as
the Company continues to seek to commercialize its optoelectronic products and
services. The Company increased its expenditures in fiscal 2001 for marketing,
consultants and public relations relating to its telecommunications device
technology.
37
CORPORATE MATTERS
The Company had net interest income of $8,000 in 2001 compared to net
interest expense and debenture financing amortization costs of $9,000 in 2000.
In these amounts, the Company netted $26,000 and $39,000 of interest income in
2001 and 2000, respectively, primarily from the temporary investment of funds
from the private placements. In 2001, there were no debenture financing
amortization costs and there were lower average accounts receivable financings
under its working capital financing agreement.
The Company recognized the majority of its remaining tax benefit amount
recoverable from the carryback of net operating losses prior to 1994. The
Company is in a net operating loss (NOL) carryforward position. No provision or
benefit from income taxes was recognized in 2001 or 2000.
LIQUIDITY AND CAPITAL RESOURCES
The Company evaluates its liquidity position using various factors as is
discussed below:
SELECTED FINANCIAL DATA
($ Thousands)
as of
---------------------------------
December 30, December 31,
2001 2000
-------------- --------------
Total Assets $ 1,553 $ 1,619
============== ==============
Working Capital $ 112 $ 736
============== ==============
Current Ratio 1.13:1 2.39:1
============== ==============
Capital Leases $ 191 $ 23
-------------- --------------
Total Debt/Financing $ 191 $ 23
============== ==============
Stockholders' Equity $ 645 $ 1,091
============== ==============
The net cash provided by financing activities in 2001 and 2000 is from the
Company completing several private placements of equity securities to its
Investor Group or their affiliates. The Company received $3,400,000 and
$1,250,000 in 2001 and 2000, respectively, from these private placements. The
funds have been and are to be used primarily for the development of the optical
telecommunications device technologies.
The net cash used in operating activities has resulted from the significant
losses incurred by the Company in 2001 and 2000, primarily due to the increased
expenditures for development of its optoelectronics products and services,
particularly in the optical telecommunications device technologies field. The
Company's working capital and ratio at the end of fiscal 2001 decreased
primarily due to these losses. The Company plans to continue R&D spending in
2002 in the optoelectronics operations. In order to maintain spending levels,
the Company will need additional funds.
The Company is seeking to establish joint ventures or strategic
partnerships including licensing of its technologies to major industrial
concerns to facilitate these goals. The Company will also seek additional funds
under appropriate terms from private sources, including the Investor Group,
38
to continue to finance development and to achieve initial market penetration. As
part of this funding effort, the Investor Group or their affiliates committed to
purchase an additional $1.5 million of Common Stock at an initial per share
price of $6.50 subject to an anti dilution adjustment feature for issuing
additional shares should other financings be done in 2002 at a lower price per
share. Of the $1.5 million, $250,000 was received in December 2001 and $500,000
was received in the first quarter of 2002. (See "Description of Business -
Recent Developments".) Significant delays in the commercialization of the
Company's optoelectronic products, failure to market such products or failure to
raise substantial additional working capital would have a significant adverse
effect on the Company's future operating results and financial position.
The Company has a working capital financing arrangement with an accounts
receivable factoring organization. Under such an agreement, the factoring
organization may purchase certain of the Company's accounts receivable subject
to full recourse against the Company in the case of nonpayment by the customers.
The Company generally receives 85%-90% of the invoice amount at the time of
purchase and the balance when the invoice is paid. The Company is charged an
interest fee and other processing charges, payable at the time each invoice is
paid. There were no funds advanced as of December 30, 2001.
The Company believes that it will be able to meet its 2002 funding
requirements and obligations from the aforementioned sources of revenue and
capital, and if necessary, by cost reductions. However, there can be no
assurances in this regard and the Company expects that it will need significant
additional financing in the future.
THE PRECEDING PARAGRAPHS CONTAIN FORWARD-LOOKING STATEMENTS AND THE FACTORS
AFFECTING THE ABILITY OF THE COMPANY TO MEET ITS FUNDING REQUIREMENTS AND MANAGE
ITS CASH RESOURCES INCLUDE, AMONG OTHER THINGS, THE MAGNITUDE AND TIMING OF
PRODUCT SALES AND THE MAGNITUDE OF FIXED COSTS, ALL OF WHICH INVOLVE RISKS AND
UNCERTAINTIES THAT ARE DIFFICULT TO PREDICT.
INFLATION
The Company, because of its substantial activities in professional services
and product development, is more labor intensive than firms involved primarily
in industrial activities. To attract and maintain higher caliber professional
staff, the Company must structure its compensation programs competitively. The
wage demand effect of inflation is felt almost immediately in its costs;
however, the net effect during the years presented is minimal.
The inflation rate in the United States generally has little impact on the
Company's cost-reimbursable type contracts and other short-term contracts. For
longer-term, fixed-price type contracts, the Company endeavors to protect its
margins by including cost escalation provisions or other specific inflation
protective terms in these contracts.
7. FINANCIAL STATEMENTS
See Item 13(a)(1) in Part III of this Form 10-KSB.
8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
39
PART III
9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The Directors* and executive officers elected by the Board are:
NAME AGE POSITION
Leonard E. Moodispaw 59 President; Chief Executive Officer and
Director (3)(4)
Terry M. Turpin 59 Sr. Vice President; Chief Technical
Officer and Director
Joseph R. Kurry, Jr. 51 Sr. Vice President; Treasurer and Chief
Financial Officer
Matthew S. Bechta 48 Vice President
Craig H. Price 52 Vice President
Gerald J. Davieau 45 Vice President
Kimberly J. DeChello 41 Chief Administrative Officer and
Secretary
H. Jeffrey Leonard 47 Chairman; Director (4)
Frank E. Manning 82 Chairman Emeritus; Director (2)
John G. Hannon 64 Director (2)
Robert W. Hicks 64 Director (1)
Ray M. Keeler 70 Director (1)(2)
Marie S. Minton 40 Director (1)
Caroline S. Pisano 35 Director (3)(4)
* Directors are elected annually at the Company's Annual Meeting of
Stockholders.
(1) Member of the Audit Committee of the Board of Directors.
(2) Member of the Compensation Committee of the Board of Directors.
(3) Member of the Ethics Committee of the Board of Directors.
(4) Member of the Executive Committee of the Board of Directors.
Leonard E. Moodispaw, President, Chief Executive Officer and Director of
the Company, rejoined Essex in 1998. He held the office of Chief Operating
Officer until September 2000 when he was elected Chief Executive Officer. Mr.
Moodispaw was an employee and consultant with Essex during 1988 to 1993. From
1988 to 1993, he was President of the former Essex subsidiary, System
Engineering and Development Corporation (SEDC), and later served as Essex Chief
Administrative Officer and General Counsel. From April 1994 to April 1998, Mr.
Moodispaw was President of ManTech Advanced Systems International, Inc. (MASI),
a subsidiary of ManTech International Corporation. Early in his career, Mr.
Moodispaw was engaged in the private practice of law, and from 1965 to 1978 was
a senior manager in the National Security Agency (NSA). He is the Founder of the
Security Affairs Support Association (SASA) that brings government and industry
together to solve problems of mutual interest. He received a Bachelor of Science
degree in Business Administration from the American University in Washington,
D.C. in 1965, a Master of Science degree in Business Administration from George
Washington University in Washington D.C. in 1969 and Juris Doctor in Law from
the University of Baltimore, Maryland in 1977.
Terry M. Turpin was elected a Director of the Company in January 1997. He
is Senior Vice President and Chief Technical Officer for the Company, positions
he has held since 1996. He joined Essex through merger with SEDC where he was
Vice President and Chief Scientist from September 1984 through June 1989. From
December 1983 to September 1984 he was an
40
independent consultant. From 1963 through December 1983, Mr. Turpin was employed
by the NSA. He was Chief of the Advanced Processing Technologies Division for
ten years. He holds patents for optical computers and adaptive optical
components. Mr. Turpin represented NSA on the Tri-Service Optical Processing
Committee organized by the Under Secretary of Defense for Research and
Engineering. He received a Bachelor of Science degree in Electrical Engineering
from the University of Akron in 1966 and a Master of Science degree in
Electrical Engineering from Catholic University in Washington, D.C. in 1970.
Joseph R. Kurry, Jr. joined Essex Corporation in March 1985. He is
Treasurer and Chief Financial Officer, positions he has held since 1985. Mr.
Kurry was controller of ManTech International Corporation from December 1979 to
March 1985. Mr. Kurry received a Bachelor of Science degree in Business
Administration in 1972 from Georgetown University, in Washington, D.C. and is a
Certified Public Accountant.
Matthew S. Bechta was elected Vice President in October 1993. As Director
of the Processing Systems Group, Mr. Bechta is responsible for the development
and delivery of signal processing solutions to government, industry and
commercial customers. Mr. Bechta is also the acting Director of Business
Operations responsible for program controls, marketing support, information
systems, security and purchasing. Mr. Bechta joined Essex in 1989 with the
merger of Essex and SEDC. As one of the founders of SEDC, he served in various
technical and management capacities since incorporation in 1980. From 1975-1980,
Mr. Bechta was employed by NSA as a systems engineer. Mr. Bechta holds a
Bachelor of Science degree in Electrical Engineering from Spring Garden College,
Pennsylvania and a Master of Science degree in Computer Science from the Johns
Hopkins University.
Craig H. Price was elected Vice President in October 1993. Dr. Price,
Director of Optoelectronic Products, is responsible for the development of
products utilizing Essex patented optical technologies. Dr. Price joined Essex
in 1989 as a result of the merger of Essex and SEDC. Dr. Price had joined SEDC
in 1985, with varied assignments in engineering, analysis and advanced
technologies. Previously, he served in numerous technical and project positions
in the U.S. Air Force during the period 1974 - 1985, and he was awarded the
Distinguished Service Medal. Dr. Price holds a Bachelor of Science degree in
Electrical Engineering from Kansas State University, a Master of Science degree
in Electrical Engineering from Purdue University and a Doctor of Philosophy
degree in Electrical Engineering, from Stanford University.
Gerald J. Davieau joined Essex in 1989 as a result of the merger of Essex
with SEDC, and was elected Vice President in November 1997. From 1996 to 1997
Mr. Davieau was technical director of telecommunications systems engineering
operations. Mr. Davieau is responsible for design and analysis of wireless
satellite applications. He is listed on more than 20 Motorola patent disclosures
from work on Iridium(R) and Teledesic(TM) satellite programs. Mr. Davieau was
employed by SPACECOM in Gaithersburg, Maryland, 1982-1987. He served in the U.S.
Army from 1978 to 1982. Mr. Davieau holds a Bachelor of Science degree in
Electrical Engineering from Lehigh University and a Master of Science degree in
Electrical Engineering from the University of Maryland.
Kimberly J. DeChello joined Essex in May 1987 and has served in various
administrative and management capacities. She was appointed Chief Administrative
Officer in November 1997 and Corporate Secretary in January 1998. Ms. DeChello
is responsible for administration, human resources, investor relations and
industrial insurance. Ms. DeChello received a Master of Science
41
degree in Human Resources Management in 2000 from the University of Maryland.
Ms. DeChello also holds an Associate of Arts degree in Accounting and a Bachelor
of Science degree in Criminal Justice/Criminology from the University of
Maryland.
Frank E. Manning, Chairman Emeritus, is the founder of the Company. Mr.
Manning has served as a Director of the Company since its organization in 1969.
Mr. Manning has been a special advisor to the CEO for the past five years. Mr.
Manning received a Bachelor of Science degree in Economics from Franklin and
Marshall College in 1942, and a Masters of Letters degree in Industrial
Relations from the University of Pittsburgh in 1946.
H. Jeffrey Leonard, was elected a Director of the Company in September 2000
and Chairman of the Board in December 2000. Dr. Leonard is the President and
founding shareholder of Global Environment Fund. Since 1989, Dr. Leonard has
served as Chairman of the Investment Committee for GEF's five investment funds.
He has extensive experience in international private equity and project finance
investments, and advanced technology investments in the energy, environmental,
applications software, intelligent systems engineering, biological and medical
fields. Dr. Leonard also serves as a member of the Board of Directors of
Measuring and Monitoring Inc., Aurora Flight Sciences Corp., Athena
Technologies, Sorbent Technologies, International Pepsi-Cola Bottlers Limited
and Global Forest Products Company Limited. He has served as an advisor to the
U.S. Office of Technology Assessment and is a member of the Board of Directors
of the National Council for Science and the Environment. Dr. Leonard received a
Bachelor of Arts degree in 1976 from Harvard College, a Master of Science degree
from the London School of Economics in 1978 and a Doctor of Philosophy degree
from Princeton University in 1984.
John Hannon was elected a Director of the Company in September 2000. He is
a partner in Networking Ventures, L.L.C., a privately held company dedicated to
investing in and guiding technology companies in the expanding optical and
information security sector. From 1979 to March 2000, Mr. Hannon served as the
Chief Executive Officer of Pulse Engineering, Inc. an information security and
signals processing company which was sold in March 2000. Mr. Hannon started his
business career in 1963 after serving in the United States Marine Corps. Since
that time, he has been involved in numerous entrepreneurial ventures. He is a
Director of the Armed Forces Communications and Electronics Association (AFCEA).
Robert W. Hicks was elected a Director of the Company in August 1988. He
has been an independent consultant since 1986. During this period he was engaged
for three and one-half years by the State of Maryland Deposit Insurance Fund
Corporation, Receiver of several savings and loan associations, first as an
Agent and then as a Special Representative (both court-approved positions). He
was a principal officer and stockholder in Asset Management & Recovery, Inc., a
consulting firm which primarily provided services, directly and as a
subcontractor, to the Resolution Trust Corporation and law firms engaged by the
Resolution Trust Corporation. Mr. Hicks is also a Director and the Corporate
Secretary of the Kirby Lithographic Company, Inc. In 1998 he formed Hicks Little
Company, LLC for the purpose of conducting consulting activity.
Ray M. Keeler was elected a Director of the Company in July 1989. Since
1986, he has been an independent consultant to both industry and government
organizations in areas related to national and tactical intelligence programs.
Mr. Keeler served on the Board of Directors of SEDC from December 1987 through
April 1989. From 1988 to November 1995, he was President of CRYTEC, Inc., a
service company providing management, business development and technical support
to companies involved in classified cryptologic projects. Since December 1995,
he has
42
been a consultant to companies involved in national technical intelligence
programs. From 1982 to 1986, Mr. Keeler was Director of Program and Budget for
the NSA. He received a Bachelor of Arts degree from the University of
Wisconsin-Madison in 1957.
Marie S. Minton was elected a Director of the Company in December 2000. Ms.
Minton is the Chief Financial Officer and Director of Global Environment Fund,
an international private equity investment management firm. Ms. Minton has been
a member of the senior management team of GEF since 1994. Before joining GEF,
Ms. Minton was the Vice President of Finance for Clean Air Capital Markets
Corporation, a boutique investment banking firm. Prior to that, Ms. Minton was
an Audit Manager in the Entrepreneurial Services Division of Ernst & Young from
1986 through 1993. Ms. Minton graduated from the University of Virginia in 1986
with a Bachelor of Science degree in Commerce. She is a member of the Virginia
Society and American Institute of Certified Public Accountants, the Washington
Society of Investment Analysts and the Association for Investment Management and
Research. Ms. Minton is a Certified Public Accountant and a Chartered Financial
Analyst.
Caroline Pisano was elected a Director of the Company in September 2000.
She is a partner in Networking Ventures, L.L.C., a privately held company
dedicated to investing in and guiding technology companies in the expanding
optical and information security sector. From August 1996 to March 2000, Ms.
Pisano served as the Chief Financial Officer of Pulse Engineering, Inc., an
information security and signal processing company which was sold in March 2000.
From August 1992 to July 1996 Ms. Pisano served as a senior transactional
attorney with the law firm of Wechsler, Selzer, and Gurvitch, Chartered. From
June 1988 to August 1990, Ms. Pisano, a Certified Public Accountant, practiced
public accounting with Arthur Andersen & Co. Ms. Pisano received her Juris
Doctor from the Washington College of Law at the American University in
Washington, D.C. Ms. Pisano graduated Magna Cum Laude with a Bachelor of Science
degree in Accounting from the University of Maryland.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires the Company's officers and directors, and persons who
own more than ten percent of a registered class of the Company's equity
securities (the "Reporting Persons"), to file reports of ownership and changes
in ownership of equity securities of the Company with the Securities and
Exchange Commission ("SEC"). Officers, directors, and greater than ten percent
shareholders are required by SEC regulations to furnish the Company with copies
of all Section 16(a) forms that they file.
Based solely upon a review of Forms 3 and Forms 4 furnished to the Company
pursuant to Rule 16(a)-3 under the Exchange Act during its most recent fiscal
year and Forms 5 with respect to its most recent fiscal year, the Company
believes that all such forms required to be filed pursuant to Section 16(a) of
the Exchange Act were timely filed by the Reporting Persons during the fiscal
year ended December 30, 2001.
43
10. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth the aggregate cash compensation paid for
services rendered to the Company during the last three fiscal years by the
Company's Chief Executive Officer and the Company's four other most highly
compensated executive officers who served as such at the end of the last fiscal
year and whose total compensation exceeds $100,000.
=================================================================================================================
LONG-TERM COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------- ------
Other Securities
Annual Underlying
Name and Compensation Options/SARs
Principal Position Year Salary($)(1) Bonus ($) ($)(2) (#)
--------------------------------------------------------------------------------------------------------------
Leonard E. Moodispaw 2001 175,032 0 1,616 85,000
President and CEO 2000 136,404 0 0 100,000
1999 124,800 0 0 45,000
Terry M. Turpin 2001 155,064 0 4,652 70,000
Senior Vice President 2000 134,496 25,000 4,785 52,000
and Director 1999 122,720 0 3,682 15,000
Joseph R. Kurry, Jr. 2001 134,992 0 4,050 40,000
Treasurer, Senior Vice 2000 122,804 15,000 4,134 61,500
President and CFO 1999 114,400 0 3,432 15,000
Craig H. Price 2001 134,992 0 4,050 25,000
Vice President 2000 114,184 15,000 3,875 27,500
1999 103,260 0 3,098 10,000
Matthew S. Bechta 2001 130,000 0 3,900 25,000
Vice President 2000 112,840 10,000 3,685 31,000
1999 102,960 0 3,089 10,000
==============================================================================================================
(1) Includes amounts deferred at the election of the named executive officer
pursuant to Section 401(k) of the Internal Revenue Code ("401(k)").
(2) Represents matching 401(k) contributions made on behalf of the respective
named executive officer pursuant to the Company's Retirement Plan and
Trust. Excludes other perquisites and benefits not exceeding the lesser of
$50,000 or 10% of the named executive officer's total annual salary and
bonus.
DEFINED CONTRIBUTION RETIREMENT PLAN
The Company has a qualified defined contribution retirement plan, the Essex
Corporation Retirement Plan and Trust, which includes a 401(k) salary reduction
feature for its employees. The Plan calls for an employer matching contribution
of up to 3% of eligible employee compensation under the salary reduction feature
and a discretionary contribution as determined by the Board of Directors. No
discretionary contribution was made by the Company to the Retirement Plan for
44
1999 - 2001. The total authorized contribution under the matching contribution
feature of the Plan was approximately $64,000 in 2001. All employee
contributions are 100% vested at all times and Company contributions vest based
on length of service. Vested contributions are distributable and benefits are
payable only upon death, disability, retirement or break in service.
Participants may request that their accrued benefits under the Section 401(k)
portion of the Plan be allocated among various investment options established by
the Plan administrator.
The Company contributions under the Retirement Plan for the persons
referred to in the Summary Compensation Table are included in that Table.
EMPLOYEE INCENTIVE PERFORMANCE AWARD PLAN
The Company has an Employee Incentive Performance Award Plan under which
bonuses are distributed to employees. All employees are eligible to receive such
awards under flexible criteria designed to compensate for superior division and
individual performance during each fiscal year. Awards are generally recommended
annually by management and approved by the Board of Directors. Such awards may
be constrained by overall Company performances. There was approximately $141,000
awarded in 2000, including the $65,000 awarded to persons named in the Summary
Compensation Table. No awards were made in 1999 and 2001.
RESTRICTED STOCK BONUS PLAN
Essex has a Restricted Stock Bonus Plan under which up to 50,000 shares of
the Company's common stock may be reserved for issuance to non-employee members
of the Board of Directors and key employees of the Company selected by the Board
of Directors. Shares of restricted stock may be issued under the Plan subject to
forfeiture during a restriction period, fixed in each instance by the Board of
Directors, whereby all rights of the grantee to the stock terminate upon certain
conditions such as cessation of continuous employment during the restriction
period. Upon expiration of the restriction period, or earlier upon the death or
substantial disability of the grantee, the restrictions applicable to all shares
of restricted stock of the grantee expire. The Plan also provides that loans may
be advanced by the Company to a grantee to pay income taxes due on the taxable
value of shares granted under the Plan. Such loans must be evidenced by an
interest bearing promissory note payable five (5) years after the date of the
loan, and be secured by shares of stock of the Company (which may be restricted
stock) having a fair market value equal to 200 percent of the loan.
During 1999 - 2001, no awards were made. There were approximately 4,000
shares remaining in the plan as of December 30, 2001.
EMPLOYMENT AGREEMENTS
In September 2000 the Company entered into two-year employment agreements
with Terry M. Turpin, Craig H. Price and Matthew S. Bechta. The agreements
provide for an annual base salary of $155,000, $135,000 and $130,000 for each of
Messrs. Turpin, Price and Bechta, respectively. The agreements also contain
standard intellectual property and confidentiality provisions.
45
The above agreements restrict the individuals' right to compete with the
Company and prohibit misappropriation of proprietary rights of the Company, both
during and after the term of employment.
OPTIONS TO PURCHASE SECURITIES
The Company has established an Essex Corporation 2001 Stock Option and
Appreciation Rights Plan (the "2001 Plan"). The 2001 Plan provides for the grant
of options to purchase shares of common stock of the Company, no par value per
share (the "Common Stock"), which qualify as incentive stock options ("Incentive
Options") under Section 422 of the Internal Revenue Code of 1986, as amended
(the "Code"), to persons who are employees, as well as options which do not so
qualify ("Non-Qualified Options") to be issued to persons or consultants,
including those who are not employees. The 2001 Plan also provides for grants of
stock appreciation rights ("SARs") in connection with the grant of options under
this 2001 Plan. The exercise price of an Incentive Option under the 2001 Plan
may not be less than the "fair market value" of the shares of Common Stock at
the time of grant; the exercise price of Non-Qualified Options and the
appreciation base price of SARs are determined in the discretion of the Board of
Directors except that the SAR appreciation base price may not be less than 50%
of the fair market value of a share of Common Stock on the grant date with
respect to awards to persons who are officers or directors of the Company. The
2001 Plan reserves 300,000 shares of Common Stock for issuance. As of February
28, 2002, there have been no options or rights granted under the 2001 Plan.
The Company has established a 2000 Stock Option and Appreciation Rights
Plan (the "2000 Plan"). The 2000 Plan as presently in effect is similar to the
2001 Plan described above. The 2000 Plan reserves 300,000 shares of Common Stock
for issuance. As of February 28, 2002, options for 263,800 shares of the
Company's Common Stock were outstanding at exercise prices ranging from $3.00 -
$6.07. As of February 28, 2002, there remained 36,200 shares available for
future grants of options or SARs. The Company has established a 1999 Stock
Option and Appreciation Rights Plan (the "1999 Plan"). The 1999 Plan as
presently in effect is similar to the Plans described above. The 1999 Plan
reserves 300,000 shares of Common Stock for issuance. As of February 28, 2002,
options for 300,000 shares of the Company's Common Stock were outstanding at
exercise prices ranging from $2.04 - $3.96. The Company also has established a
1998 Stock Option and Appreciation Rights Plan (the "1998 Plan"). The 1998 Plan
as presently in effect is similar to the Plans described above. The 1998 Plan
reserves 292,300 shares of Common Stock for issuance. As of February 28, 2002,
options for 292,000 shares of the Company's Common Stock were outstanding at
exercise prices ranging from $1.00 - $6.07. As of February 28, 2002, there
remained 300 shares available for future grants of options or SARs.
In addition, the Company has a 1996 Stock Option and Appreciation Rights
Plan (the "1996 Plan"). The 1996 Plan as presently in effect is similar to the
Plans described above. The 1996 Plan reserves 225,818 shares of the Company's
Common Stock for issuance. As of February 28, 2002, options for 225,668 shares
of the Company's Common Stock remained outstanding and exercisable under this
Plan at exercise prices ranging from $1.00 - $3.96. As of February 28, 2002,
there remained 150 shares available for future grants of options or SARs.
The Company had an Option and Stock Appreciation Rights Plan which expired
as to new grants on January 31, 1997. As of February 28, 2002, options for
243,150 shares of the Company's Common Stock remained outstanding and
exercisable under this Plan at a price of $3.00 per share.
46
The Company grants non plan non-qualified options from time to time
directly to certain parties. The Company issued such options for 85,000 shares
to its President and 40,000 to its Chief Financial Officer/Treasurer in 2001.
Also in 2001, such options for 45,000 shares were issued to another employee of
the Company.
The following table shows for the fiscal year ended December 30, 2001 for
the persons named in the Summary Compensation Table, information with respect to
options to purchase Common Stock granted during 2001.
STOCK OPTIONS GRANTS
FOR FISCAL YEAR ENDED DECEMBER 30, 2001
NUMBER OF
SECURITIES
UNDERLYING % OF TOTAL OPTIONS/
OPTIONS SARS GRANTED TO EXERCISE OR
GRANTED EMPLOYEES IN BASE PRICE EXPIRATION
NAME (#) FISCAL YEAR ($/SH) DATE
================================================================================
Leonard E. Moodispaw 60,000 (1) 10.6 3.96 01/22/11
25,000 (2) 4.4 6.07 10/02/11
Terry M. Turpin 50,000 (1) 8.8 3.96 01/22/11
20,000 (2) 3.5 6.07 10/02/11
Joseph R. Kurry, Jr. 30,000 (1) 5.3 3.96 01/22/11
10,000 (2) 1.8 6.07 10/02/11
Craig H. Price 15,000 (1) 2.6 3.96 01/22/11
10,000 (2) 1.8 6.07 10/02/11
Matthew S. Bechta 15,000 (1) 2.6 3.96 01/22/11
10,000 (2) 1.8 6.07 10/02/11
=========================
(1) Such options became exercisable beginning January 23, 2001.
(2) Such options became exercisable beginning October 3, 2001.
47
The following table shows for the fiscal year ended December 30, 2001 for
the persons named in the Summary Compensation Table, information with respect to
option/SAR exercises and fiscal year end values for unexercised options/SARs.
AGGREGATED OPTION/SAR EXERCISES AND FY-END OPTION/SAR VALUES
TABLE FOR FISCAL YEAR ENDED DECEMBER 30, 2001
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF
OPTIONS AT UNEXERCISED
FY-END (#) IN-THE-MONEY
OPTIONS AT
EXERCISABLE/ FY-END($)(1)
SHARES UNEXERCISABLE
ACQUIRED ON VALUE EXERCISABLE/
NAME EXERCISE (#) REALIZED ($) UNEXERCISABLE
================================================================================================
Leonard E. Moodispaw --- --- 333,000/12,500 $1,721,875/$17,250
Terry M. Turpin --- --- 126,800/53,200 $665,752/$143,468
Joseph R. Kurry, Jr. --- --- 165,000/5,000 $802,665/$6,900
Craig H. Price 1,500 $ 6,510 86,000/12,500 $425,925/$33,075
Matthew S. Bechta 1,850 $11,100 82,650/12,500 $411,903/$33,075
3,000 $12,000
--------------------------------------------------------------------
(1) Market value of underlying securities based on the closing price of the
Company's Common Stock on December 28, 2001 (last trading day of fiscal
2001) on the OTC Bulletin Board system of $7.45 minus the exercise price.
REMUNERATION OF DIRECTORS
The Company's Board of Directors generally meets quarterly. Additionally,
the By-Laws provide for special meetings and, as also permitted by Virginia law,
Board action may be taken without a meeting upon unanimous written consent of
all Directors. There are two Board members not employed by the Company who
receive a maximum of $1,500 for each Board or $750 for each Board Committee
Meeting attended. In 2001 the Board held two meetings; the entire membership of
the Board was present at both meetings. There are four Board members who are
employed by either Global Environment Fund or Networking Ventures, L.L.C. and
who have waived any board fees.
48
11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT
The following table and accompanying notes set forth as of December 30,
2001, information with respect to the beneficial ownership of the Company's
voting securities by (i) each person or group who beneficially owns more than 5%
of the voting securities, (ii) each of the directors of the Company, (iii) each
of the officers of the Company named in the Summary Compensation Table, and (iv)
all directors and executive officers of the Company as a group.
Amount and Nature Approximate
Name and Address of Beneficial Percentage of
OF BENEFICIAL OWNER* OWNERSHIP (1) CLASS
-------------------------------------- ------------------------------- ---------------
John G. Hannon (2) Common Stock 2,796,387 39.1
Preferred Stock 500,000 100.0
H. Jeffrey Leonard (3) Common Stock 2,789,200 39.0
Preferred Stock 500,000 100.0
Caroline S. Pisano (4) Common Stock 2,763,700 38.6
Preferred Stock 500,000 100.0
Marie S. Minton (5) Common Stock 2,757,700 38.5
Preferred Stock 500,000 100.0
Terry M. Turpin (6) Common Stock 430,493 8.1
Leonard E. Moodispaw (7) Common Stock 390,150 7.1
Joseph R. Kurry, Jr. (8) Common Stock 203,359 3.8
Matthew S. Bechta (9) Common Stock 132,648 2.5
Frank E. Manning (10) Common Stock 126,775 2.4
Craig H. Price (11) Common Stock 108,728 2.1
Robert W. Hicks (12) Common Stock 71,700 1.4
Ray M. Keeler (13) Common Stock 47,500 **
James P. Gregory (14) Common Stock 2,757,700 38.5
Preferred Stock 500,000 100.0
Harry Letaw, Jr. (15) Common Stock 669,859 13.0
Paul R. Young (16) Common Stock 301,790 5.9
GEF Optical Investment
Company, LLC (17)(21) Common Stock 2,757,700 38.5
Preferred Stock 500,000 100.0
Networking Ventures, L.L.C. (18)(21) Common Stock 2,757,700 38.5
Preferred Stock 500,000 100.0
Global Environment Capital
Co. LLC ("GECC") (19)(21) Common Stock 2,757,700 38.5
Preferred Stock 500,000 100.0
All Directors and Executive Officers
as a Group (14 persons) (20) Common Stock 4,445,080 54.3
Preferred Stock 500,000 100.0
* Except as noted below, all beneficial owners are directors and/or
officers of the Company and can be reached c/o Essex Corporation, 9150
Guilford Road, Columbia, MD 21046.
** Less than 1%.
(1) The shares listed above include options and rights to acquire shares
within sixty (60) days and shares held of record by the Essex Corporation
Retirement Trust as to which shares the respective participant has
disposition and voting rights. The percentage ownership is computed based
upon the number of shares which would be outstanding if such options and
rights were exercised.
49
(2) John G. Hannon is a Director of the Company and a managing member of
Networking Ventures. Of the shares of Common Stock shown as beneficially
owned, 38,687 are owned directly by Mr. Hannon. In addition, 500,000 shares
of Preferred Stock and 2,757,700 shares of Common Stock may be deemed to be
beneficially owned by Mr. Hannon as described in footnotes (18) and (21)
below. Mr. Hannon's address is c/o Networking Ventures, 9150 Guilford Road,
Columbia, MD 21046.
(3) H. Jeffrey Leonard is Chairman of the Board of the Company and a director
of the managing member of GEF. Of the shares of Common Stock shown as
beneficially owned, 31,500 are owned directly by Mr. Leonard. In addition,
500,000 shares of Preferred Stock and 2,757,700 shares of Common Stock may
be deemed to be beneficially owned by Mr. Leonard as described in footnotes
(17) and (21) below. Mr. Leonard's address is c/o GEF, 1225 Eye Street,
N.W., Suite 900, Washington, DC 20005.
(4) Caroline S. Pisano is a Director of the Company and a managing member of
Networking Ventures. Of the shares of Common Stock shown as beneficially
owned, 6,000 are owned directly by Ms. Pisano. In addition, 500,000 shares
of Preferred Stock and 2,757,700 shares of Common Stock may be deemed to be
beneficially owned by Ms. Pisano as described in footnotes (18) and (21)
below.
(5) Marie S. Minton is a Director of the Company and a director of the managing
member of GEF. Ms. Minton may be deemed to be the beneficial owner of these
shares by virtue of the arrangements described in footnotes (17) and (21)
below. Ms. Minton's address is c/o GEF, 1225 Eye Street, N.W., Suite 900,
Washington, DC 20005.
(6) Terry M. Turpin is a Director, Senior Vice President and Chief Technical
Officer of the Company. Of the shares shown as beneficially owned, 151,800
represent presently exercisable rights to acquire Common Stock through
stock options.
(7) Leonard E. Moodispaw is President, Chief Executive Officer and a Director
of the Company. Of the shares shown as beneficially owned, 333,000
represent presently exercisable rights to acquire Common Stock through
stock options.
(8) Joseph R. Kurry, Jr. is Senior Vice President, Treasurer and Chief
Financial Officer of the Company. Of the shares shown as beneficially
owned, 165,000 represent presently exercisable rights to acquire Common
Stock through stock options.
(9) Matthew S. Bechta is Vice President of the Company. Of the shares shown as
beneficially owned, 90,150 represent presently exercisable rights to
acquire Common Stock through stock options.
(10) Mr. Manning is the Chairman Emeritus and a Director of the Company. Of the
shares shown as beneficially owned, 44,000 represent presently exercisable
rights to acquire Common Stock through stock options. Does not include
40,000 shares of the Company's Common Stock owned of record and
beneficially by Mrs. Eva L. Manning, wife of Mr. Frank E. Manning. Also
does not include 169,000 shares beneficially owned by six separate family
trusts of which Mrs. Manning is the sole trustee and over which trusts she
has exclusive voting and dispositive power.
(11) Craig H. Price is Vice President of the Company. Of the shares shown as
beneficially owned, 93,500 represent presently exercisable rights to
acquire Common Stock through stock options.
(12) Robert W. Hicks is a Director of the Company. Of the shares shown as
beneficially owned, 31,500 represent presently exercisable rights to
acquire Common Stock through stock options.
(13) Ray M. Keeler is a Director of the Company. Of the shares shown as
beneficially owned, 32,500 represent presently exercisable rights to
acquire Common Stock through stock options.
(14) James P. Gregory is a director of the managing member of GEF. Mr. Gregory
may be deemed to be the beneficial owner of these shares by virtue of the
arrangements described in footnotes (17) and (21) below. Mr. Gregory's
address is c/o GEF, 1225 Eye Street, N.W., Suite 900, Washington, DC 20005.
(15) Dr. Harry Letaw,Jr. is the former Chairman of the Board and Chief Executive
Officer of the Company. His address is 1023 Benfield Boulevard,
Millersville, MD 21108.
(16) Mr. Young is a private investor and the information is based on a Schedule
13D filed with the SEC on November 15, 2000. Mr. Young's address is 11890-T
Old Baltimore Pike, Beltsville, MD 20705.
(17) Consists of 1,000,000 shares of Common Stock issuable upon conversion of
250,000 shares of Preferred Stock and 330,000 shares of Common Stock
directly owned by GEF. Also consists of (i) 1,000,000 shares of Common
Stock issuable on conversion of 250,000 shares of Preferred Stock, (ii)
330,000 shares of Common Stock directly owned by Networking Ventures and
(iii) 97,700 shares of Common Stock directly owned by GECC, by virtue of
the voting arrangements described in footnote (21) below. GEF is a Delaware
limited liability company with its principal executive offices located at
1225 Eye Street, N.W., Suite 900, Washington, DC 20005.
(18) Consists of 1,000,000 shares of Common Stock issuable upon conversion of
250,000 shares of Preferred Stock and 330,000 shares of Common Stock
directly owned by Networking Ventures. Also consists of (i) 1,000,000
shares of Common Stock issuable on conversion of 250,000 shares of
Preferred Stock, (ii) 330,000 shares of Common Stock directly owned by GEF
and (iii) 97,700 shares of Common Stock directly owned by GECC, by virtue
of the voting arrangements described in
50
footnote (21) below. Networking Ventures is a Maryland limited liability
company with its principal executive offices located at 9150 Guilford Road,
Columbia, MD 21046.
(19) Consists of 1,000,000 shares of Common Stock issuable upon conversion of
250,000 shares of Preferred Stock and 330,000 shares of Common Stock
directly owned by GEF. Also consists of (i) 1,000,000 shares of Common
Stock issuable on conversion of 250,000 shares of Preferred Stock, (ii)
330,000 shares of Common Stock directly owned by Networking Ventures and
(iii) 97,700 shares of Common Stock directly owned by GECC, by virtue of
the voting arrangements described in footnote (21) below. GECC is a
Delaware limited liability company with its principal executive offices
located at 1225 Eye Street, N.W., Suite 900, Washington, DC 20005.
(20) Of the shares shown as beneficially owned, 1,036,218 represent presently
exercisable rights to acquire Common Stock through stock options. Also
includes 2,000,000 shares of Common Stock which are presently issuable upon
conversion of the Preferred Stock.
(21) Based on a Schedule 13D/A filed with the SEC on October 16, 2001, each of
GEF, GECC, Mr. Leonard, Ms. Minton, Mr. Gregory, Networking Ventures, Mr.
Hannon and Ms. Pisano may be deemed the beneficial owner of 2,000,000
shares of Common Stock issuable upon conversion of 500,000 shares of
Preferred Stock and 757,700 shares of Common Stock directly held for the
account of GEF, Networking Ventures and GECC by virtue of the provisions of
a Shareholders Voting Agreement between GEF and Networking Ventures
providing for certain voting arrangements with respect to such shares. A
copy of the Shareholders Voting Agreement is included as Exhibit 3 to the
Schedule 13D/A.
12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - None
51
13. EXHIBITS AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
Report of Independent Auditors 54
Balance Sheet 55
Statements of Operations 56
Statements of Changes in Stockholders' Equity 57
Statements of Cash Flows 58
Notes to Financial Statements 59 - 69
(2) Exhibits
(i) None.
(ii) Exhibit 3(i) - Articles of Incorporation A
Exhibit 3(i) - Articles of Amendment B
Exhibit 3(ii) -By-Laws, as amended C
(iii) Exhibit 4 - Instruments defining the Rights of Holders
4.3 Specimen of Common Stock Certificate D
(iv) Exhibit 10 - Material Contracts
10.3 Restricted Stock Bonus Plan D
10.4 Option and Stock Appreciation Rights Plan D
10.6 Pension Plan and Trust Agreement D
10.7 Defined Contribution Retirement Plan D
10.8 Incentive Performance Award Plan D
10.11 Option Agreement between the Company and Rumsey D
Associates Limited Partnership
10.13 Registration Rights Agreement D
10.15 1996 Stock Option and Appreciation Rights Plan E
10.22 1998 Stock Option and Appreciation Rights Plan F
10.23 1999 Stock Option and Appreciation Rights Plan G
10.24 2000 Stock Option and Appreciation Rights Plan H
10.25 Flex Lease Agreement Between PHL-OPCO, LP, as I
Landlord and Essex Corporation, As Tenant, Rivers
95 Columbia, MD
10.26 2001 Stock Option and Appreciation Rights Plan J
(v) Exhibit 23 - Consent of Experts and Counsel
23.1 Consent of Independent Auditors 70
(vi) Exhibit 99
(a) Securities Purchase Agreement dated September 7, 2000 B
(b) Registration Rights Agreement dated September 7, 2000 B
(c) Common Stock Purchase Warrants dated September 12, 2000 B
(b) Reports on Form 8-K
None.
-----------------------
A Filed as Exhibit 3(i) to Registrant's Registration Statement on Form SB-2
filed October 17, 1994, Registration No. 33-82920
B Filed as Exhibit to Registrant's Form 8-K dated September 20, 2000
C Filed as Exhibit 3(ii) to Registrant's Registration Statement on Form SB-2
filed October 17, 1994, Registration No. 33-82920
D Filed as Exhibit to Registrant's Registration Statement on Form SB-2 filed
October 17, 1994, Registration No. 33-82920
E Filed as Exhibit to Registrant's Form 8-K dated November 13, 1996
F Filed as Exhibit to Form Def 14a - Definitive Proxy Statement dated October
12, 1998
G Filed as Exhibit to Form Def 14a - Definitive Proxy Statement dated October
11, 1999
H Filed as Exhibit to Form Def 14a - Definitive Proxy Statement dated November
10, 2000
I Filed as Exhibit to Registrant's Form 8-K dated December 12, 2001
J Filed as Exhibit to Form Def 14a - Definitive Proxy Statement dated May 23,
2001
52
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ESSEX CORPORATION
(Registrant)
By: /S/ LEONARD E. MOODISPAW
--------------------------------------------
Leonard E. Moodispaw
President and Chief Executive Officer;
Principal Executive Officer
March 27, 2002
By: /S/ JOSEPH R. KURRY, JR.
--------------------------------------------
Joseph R. Kurry, Jr.
Senior Vice President, Treasurer and Chief Financial Officer;
Principal Financial and Accounting Officer
March 27, 2002
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
/S/ JOHN G. HANNON /S/ MARIE S. MINTON
----------------------------- -----------------------------
John G. Hannon, Director Marie S. Minton, Director
March 27, 2002 March 27, 2002
/S/ ROBERT W. HICKS /S/ LEONARD E. MOODISPAW
----------------------------- -----------------------------
Robert W. Hicks, Director Leonard E. Moodispaw, Director
March 27, 2002 March 27, 2002
/S/ RAY M. KEELER /S/ CAROLINE S. PISANO
----------------------------- ----------------------------
Ray M. Keeler, Director Caroline S. Pisano, Director
March 27, 2002 March 27, 2002
/S/ H. JEFFREY LEONARD /S/ TERRY M. TURPIN
----------------------------- ----------------------------
H. Jeffrey Leonard, Director Terry M. Turpin, Director
March 27, 2002 March 27, 2002
/S/ FRANK E. MANNING
-----------------------------
Frank E. Manning, Director
March 27, 2002
53
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of Essex Corporation:
Columbia, Maryland
We have audited the accompanying balance sheet of Essex Corporation as of
December 30, 2001 and the related statements of operations, changes in
stockholders' equity and cash flows for the fiscal years ended December 30, 2001
and December 31, 2000. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Essex Corporation as of
December 30, 2001 and the results of its operations and its cash flows for the
fiscal years ended December 30, 2001 and December 31, 2000 in conformity with
accounting principles generally accepted in the United States of America.
Stegman & Company
Baltimore, Maryland
February 22, 2002
54
ESSEX CORPORATION
BALANCE SHEET
AS OF DECEMBER 30, 2001
ASSETS
CURRENT ASSETS
Cash $ 568,178
Accounts receivable, net 284,649
Prepayments and other 76,969
Inventory 29,983
--------------
959,779
PROPERTY AND EQUIPMENT
Computers and special equipment 849,453
Furniture, equipment and other 260,526
--------------
1,109,979
Accumulated depreciation and amortization (747,059)
--------------
362,920
OTHER ASSETS
Patents, net 211,030
Other 19,213
--------------
230,243
TOTAL ASSETS $ 1,552,942
------------ ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 313,741
Accrued wages and vacation 239,476
Capital leases 130,961
Accrued retirement 62,000
Other accrued expenses 101,387
--------------
847,565
LONG-TERM DEBT
Capital leases, net of current portion 60,078
--------------
Total Liabilities 907,643
--------------
COMMITMENTS AND CONTINGENCIES (NOTE 6)
STOCKHOLDERS' EQUITY
Common stock, no par value; 25 million shares
authorized; 5,155,605 shares issued and outstanding 8,870,044
Convertible preferred stock, $0.01 par value; 1 million
total shares authorized; 500,000 shares of Series B
authorized and outstanding 2,000,000
Additional paid-in capital 2,000,000
Accumulated deficit (12,224,745)
--------------
Total Stockholders' Equity 645,299
--------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,552,942
------------------------------------------ ==============
The accompanying notes are an integral part of this statement.
55
ESSEX CORPORATION
STATEMENTS OF OPERATIONS
FOR THE FIFTY-TWO WEEK FISCAL YEAR ENDED
DECEMBER 30, 2001 AND
FOR THE FIFTY-THREE WEEK FISCAL YEAR ENDED
DECEMBER 31, 2000
2001 2000
---------------- ----------------
Revenues $ 2,641,776 $ 3,255,500
Cost of goods sold and services provided (1,342,444) (1,625,644)
Research and development (2,416,837) (771,234)
Selling, general and administrative expenses (2,459,631) (2,041,482)
--------------- ---------------
Operating Loss (3,577,136) (1,182,860)
Interest income (expense), net and debenture
financing amortization 7,937 (8,556)
--------------- ----------------
Loss Before Income Taxes (3,569,199) (1,191,416)
Provision for income taxes -- --
--------------- ---------------
Net Loss (3,569,199) (1,191,416)
Beneficial conversion feature of convertible
preferred stock (750,000) (1,250,000)
--------------- ----------------
Net Loss Attributable to Common Stockholders $ (4,319,199) $ (2,441,416)
=============== ================
Weighted Average Number of Shares
Outstanding 6,493,665 4,717,276
=============== ===============
Basic Loss Per Common Share $ (0.67) $ (0.52)
=============== ===============
Diluted Loss Per Common Share $ (0.67) $ (0.52)
=============== ===============
The accompanying notes are an integral part of these statements.
56
ESSEX CORPORATION
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
Common Stock Preferred Stock
---------------------------------- ----------------------------------
Total
Additional Stock-
Shares Shares Paid-In Accumulated holders'
Issued Amount Issued Amount Capital Deficit Equity
------------ ------------ ----------- ------------ ----------- ------------ ----------
BALANCE, DECEMBER 26, 1999 4,397,861 $ 439,786 -- $ -- $ 5,634,234 $ (5,464,130) $ 609,890
Amend par value to no par -- 5,634,234 -- -- (5,634,234) -- --
Preferred stock issued -- -- 312,500 1,250,000 -- -- 1,250,000
Beneficial conversion feature of
preferred stock -- -- -- -- 1,250,000 (1,250,000) --
Common stock issued 160,000 400,000 -- -- -- -- 400,000
Stock options exercised 12,500 12,500 -- -- -- -- 12,500
Stock option compensation -- 9,800 -- -- -- -- 9,800
Net loss -- -- -- -- -- (1,191,416) (1,191,416)
------------ ------------ --------- ----------- ----------- ----------- ----------
BALANCE, DECEMBER 31, 2000 4,570,361 6,496,320 312,500 1,250,000 1,250,000 (7,905,546) 1,090,774
Preferred stock issued -- -- 187,500 750,000 -- -- 750,000
Beneficial conversion feature of
preferred stock -- -- -- -- 750,000 (750,000) --
Common stock issued 538,462 2,250,000 -- -- -- -- 2,250,000
Stock options exercised 49,182 91,806 -- -- -- -- 91,806
Retired shares/cashless stock
option tender (2,400) (17,082) -- -- -- -- (17,082)
Stock option compensation -- 49,000 -- -- -- -- 49,000
Net loss -- -- -- -- -- (3,569,199) (3,569,199)
------------ ------------ ----------- ----------- ----------- ------------ ----------
BALANCE, DECEMBER 30, 2001 5,155,605 $ 8,870,044 500,000 $ 2,000,000 $ 2,000,000 $(12,224,745) $ 645,299
============ ============ =========== =========== =========== ============ ==========
The accompanying notes are an integral part of these statements.
57
ESSEX CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
2001 2000
-------------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
------------------------------------
Net Loss $ (3,569,199) $ (1,191,416)
Adjustments to reconcile Net Loss to Net Cash
Used In Operating Activities:
Depreciation and amortization 193,117 98,674
Inventory valuation reserve 60,000 115,000
Stock option compensation expense 49,000 9,800
Other (1,047) (3,981)
Change in Assets and Liabilities:
Accounts receivable (119,035) 479,950
Inventory (40,126) 15,321
Prepayments and other (43,536) 13,362
Accounts payable 181,807 53,595
Accrued lease settlement (107,766) (15,682)
Other assets and liabilities 75,539 (222,787)
------------ ------------
Net Cash Used In Operating Activities (3,321,246) (648,164)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
------------------------------------
Purchases of property and equipment (81,965) (54,072)
Proceeds from sale of fixed assets 1,047 5,471
------------ ------------
Net Cash Used In Investing Activities (80,918) (48,601)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
------------------------------------
Sale of common stock 2,250,000 400,000
Sale of preferred stock 750,000 1,250,000
Exercise of stock options 74,724 12,500
Short-term repayments of receivables financing, net -- (59,470)
Repayment of convertible debentures -- (375,714)
Payment of capital lease obligations (120,016) (17,580)
------------ ------------
Net Cash Provided By Financing Activities 2,954,708 1,209,736
------------ ------------
CASH AND CASH EQUIVALENTS
Net (decrease) increase (447,456) 512,971
Balance - beginning of year 1,015,634 502,663
------------ ------------
Balance - end of year $ 568,178 $ 1,015,634
============ ============
The accompanying notes are an integral part of these statements.
58
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER IMPORTANT FACTORS
These statements cover Essex Corporation (the "Company"). Certain amounts
for prior years have been reclassified or recalculated to conform to the
2001 presentation.
REPORTING YEAR
The Company is on a 52-53 week fiscal year ending the last Sunday in
December. Year 2001 was a 52-week fiscal year. Year 2000 was a 53-week
fiscal year.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Estimates
are used when accounting for uncollectible accounts receivable, inventory
obsolescence and valuation, depreciation and amortization, intangible
assets, employee benefit plans and contingencies, among others. Actual
results could differ from those estimates.
IMPORTANT BUSINESS RISK FACTORS
The Company has historically been principally a supplier of technical
services under contracts or subcontracts with departments or agencies of
the U.S. Government, primarily the military services and other departments
and agencies of the Department of Defense. In recent years, the Company's
revenues had been primarily from a commercial customer in the satellite
communications business area. This work substantially ended in 1999 and
limited other work has continued.
The Company has expended significant funds to transition into the
commercial marketplace, particularly the productization of its proprietary
technologies in telecommunications and optoelectronic processors. In June
2000, the Company announced that it had filed applications to secure
patent protection for innovative technologies in two communications device
families: Fiberoptic HYPERFINE WDM (wavelength division multiplexing)
devices and wireless optical processor enhanced receiver architecture.
Since September 2000, the Company has received nearly $5 million in
financing to advance its programs to capitalize upon these inventions. The
long-term success of the Company in these areas is dependent on its
ability to successfully develop and market products related to its
communications devices and optoelectronic processors. The success of these
efforts is subject to changing technologies, availability of additional
financing, competition, and, ultimately, market acceptance.
Primarily due to the increased expenditures for research and development
of its optoelectronics products and services, particularly the optical
telecommunications device technologies, the
59
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
Company incurred significant losses in 2001 and 2000. The Company plans to
continue research and development spending in 2002 in the optoelectronics
operations. In order to maintain spending levels, the Company will need
additional funds.
The Company is seeking to establish joint ventures or strategic
partnerships including licensing of its technologies with major industrial
concerns to facilitate these goals. The Company will also seek additional
funds under appropriate terms from private sources to continue to finance
development and to achieve initial market penetration. Significant delays
in the commercialization of the Company's optoelectronic products, failure
to market such products or failure to raise substantial additional working
capital would have a significant adverse effect on the Company's future
operating results and future financial position.
CONTRACT ACCOUNTING
Revenues consist of services rendered on cost-plus-fixed-fee, time and
materials and fixed-price contracts. Revenue on fixed-price contracts
(approximately 45% and 22% of total revenues in 2001 and 2000,
respectively) is recognized on the percentage-of-completion method of
accounting based on costs incurred in relation to the total estimated
costs. Revenue on cost-plus-fixed-fee contracts (approximately 39% and 45%
of total revenues in 2001 and 2000, respectively) is recognized to the
extent of costs incurred plus a proportionate amount of fee earned.
Revenue on time and materials contracts (approximately 16% and 33% of
total revenues in 2001 and 2000, respectively) is recognized to the extent
of billable rates multiplied by hours delivered, plus other direct costs.
Anticipated losses are recognized as soon as they become known. A portion
of the Company's business is with agencies of the U.S. Government and such
contracts are subject to audit by cognizant government audit agencies.
Furthermore, while such contracts are fully funded by appropriations, they
may be subject to other risks inherent in government contracts, such as
termination for the convenience of the government. Because of the inherent
uncertainties in estimating costs and the potential for audit adjustments
by U.S. Government agencies, it is at least reasonably possible that the
estimates will change in the near term.
INCOME TAXES
Deferred income taxes are recorded under the asset and liability method
whereby deferred tax assets and liabilities are recognized for the future
tax consequences, measured by enacted tax rates, attributable to
differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and operating loss
carryforwards. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period the rate change
becomes effective. Valuation allowances are recorded for deferred tax
assets when it is more likely than not that such deferred tax assets will
not be realized.
INVENTORY
Inventory costs include purchased parts, labor and manufacturing overhead.
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out (FIFO)
60
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
method. Management monitors the market value of its inventory and records
valuation allowances when deemed necessary.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is calculated
using straight-line methods based on useful lives as follows:
Leasehold improvements Life of lease
Production and special equipment 3 to 5 years
Furniture and equipment 3 to 5 years
Repairs and maintenance are charged to expense as incurred. When assets
are retired or otherwise disposed of, the asset and related allowance for
depreciation are eliminated from the accounts and any resulting gain or
loss is reflected in income.
PATENT COSTS
Patent costs include legal and filing fees covering the various patents
which have been issued to the Company. Patent costs are amortized over
their respective lives (15 - 20 years) and amortization was $15,000 in
2001 and in 2000.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets and identifiable intangibles to be held and used are
reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount should be addressed. Impairment is
measured by comparing the carrying value to the estimated undiscounted
future cash flows expected to result from use of the assets and their
eventual disposition.
BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share are computed using the weighted
average number of common shares outstanding during the period and common
shares issuable upon the required conversion of preferred stock. Diluted
earnings per common share incorporates the incremental shares issuable
upon the assumed exercise of stock options and warrants. Such incremental
shares were anti dilutive for the periods presented.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred. Such costs
include direct labor and materials as well as a reasonable allocation of
indirect costs. However, no selling, general and administrative costs are
included. Equipment which has alternative future uses is capitalized and
charged to expense over its estimated useful life.
61
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
STATEMENTS OF CASH FLOWS
Supplemental disclosures of cash flow information are as follows:
2001 2000
--------- ---------
A. Cash paid during the year for-
Interest $ 16,600 $ 42,500
Income taxes $ -- $ --
B. In 2001 and 2000, there were new capital leases of $288,000 and $17,000,
respectively.
2. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
U.S. Government
Amounts billed, including retainages $ 263,733
Commercial and other 70,916
------------
334,649
Contract reserves and allowances for doubtful (50,000)
accounts ------------
$ 284,649
U.S. Government receivables arise from U.S. Government prime contracts and
subcontracts. Retainages (which are not material) will be collected upon
job completion or settlement of audits performed by cognizant U.S.
Government audit agencies. Company cost records have been audited through
2000. In the year an audit is settled, the difference between audit
adjustments and previously established reserves is reflected in income.
Contract reserves and allowances for doubtful accounts have been provided
where less than full recovery under the contract is expected.
3. ACCOUNTS RECEIVABLE FINANCING
The Company has a working capital financing agreement with an accounts
receivable factoring organization. Under such an agreement, the factoring
organization may purchase certain of the Company's accounts receivable
subject to full recourse against the Company in the case of nonpayment by
the customers. The Company generally receives 85%-90% of the invoice amount
at the time of purchase and the balance when the invoice is paid. The
Company is charged an interest fee and other processing charges, payable at
the time each invoice is paid. There were no funds advanced as of December
30, 2001.
62
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
4. INVENTORY
Inventory costs are all related to the Company's ImSyn(TM) optoelectronic
processor.
Finished Goods $ 94,730
Systems In-Process 46,330
Purchased Parts 164,205
------------
305,265
Valuation Reserve (275,282)
------------
$ 29,983
The existing configuration of finished goods in inventory is being
redesigned. The current inventory has been written down to its estimated
net realizable value as components or subassemblies in the redesigned and
upgraded units and a new cost basis established. Depending upon the time
to complete redesign and the ability to use the current inventory in the
upgraded units, it is at least reasonably possible that management's view
of the ultimate realizable value of inventory will change in the near
term.
5. MAJOR CUSTOMER INFORMATION
The Company's largest customer was for subcontract work to an agency of
the Department of Defense. The Company is continuing research work under
this subcontract on the use of its optoelectronics technology and devices
in certain customer systems and applications. Such work amounted to
approximately $1,030,000 (39%) of revenues in 2001 and $538,000 (17%) of
2000 revenues. A follow-on stage has begun in 2002.
6. COMMITMENTS AND CONTINGENCIES
LEASE OBLIGATIONS
The Company leases office space and certain equipment. As of December 30,
2001, the Company is committed to pay aggregate rentals under these leases
as follows:
2002 $ 371,000
2003 $ 291,000
2004 $ 238,000
2005 $ 199,000
Rental expense charged to operations, including payments made under
short-term leases, amounted to $261,000 and $174,000 in 2001 and 2000,
respectively.
The Company's office facility is under a long-term lease which expires
October 2005. The lease contains provisions to pay for proportionate
increases in operating costs and property taxes.
63
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
7. RETIREMENT PLAN
The Company has a qualified defined contribution retirement plan, the Essex
Corporation Retirement Plan and Trust, which includes a salary reduction
401(k) feature for its employees. The Plan calls for an employer matching
contribution of up to 3% of eligible employee compensation under the salary
reduction feature and allows for a discretionary contribution. Total
authorized contributions under the matching contribution feature of the
Plan were $64,000 in 2001 and approximately $67,000 in 2000. There were no
discretionary contributions in these years.
In accordance with the retirement plan and trust, as amended, such
authorized contributions and the resulting annual expense can be reduced by
forfeitures by terminated employees of unvested amounts of prior years'
contributions. Forfeitures of $2,000 and $7,000 were utilized to reduce
annual expenses in 2001 and 2000, respectively.
8. INCOME TAXES
The components of the Company's net deferred tax asset account are as
follows as of December 30, 2001:
NOL carryforward $ 3,056,000
Acquisition NOL and tax credit carryforward 137,000
Tax credit carryforward 167,000
Inventory valuation reserve 96,000
Accrued employee benefit costs 42,000
Allowance for doubtful accounts 17,500
Other, net 30,000
Valuation Reserve (3,545,500)
-------------
Net Deferred Tax Asset $ --
=============
The Company has a regular net operating loss ("NOL") carryforward of
$8,732,000 and tax credit carryforwards of $167,000 that are available,
subject to certain limitations, to offset future book income and taxes
payable. The NOL begins to expire in 2008 and the tax credit carryforwards
expire through 2021.
As a result of an acquisition, the Company also has an NOL carryforward of
approximately $392,000 that is available, subject to certain limitations,
to offset future book and taxable income and taxes payable. This NOL
expires in 2002.
The evaluation of the realizability of such deferred tax assets in future
periods is made based upon a variety of factors for generating future
taxable income, such as intent and ability to sell assets and historical
and projected operating performance. At this time, the Company has
established a valuation reserve for all of its deferred tax assets. Such
tax assets are available to be recognized and benefit future periods.
The Company recorded no benefit or provision for income taxes in 2001 or
2000.
64
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
9. STOCK OPTION AND STOCK BONUS PLANS; OTHER STOCK OPTIONS
The Company has a 2001 Stock Option and Appreciation Rights Plan (the "2001
Plan"). This plan reserves 300,000 shares of the Company's unissued shares
for option and stock appreciation rights ("SAR") grants. This plan expires
in 2011. Options, which may be tax qualified ("ISOs") and non-qualified
("NSOs"), are exercisable for a period of up to 10 years at prices at or
above market price as established on the date of grant. Upon the exercise
of a stock appreciation right, the recipient will receive payment in the
form of stock, cash, or both, as determined by the Company, equal to the
appreciation in value of the shares to which the rights were awarded.
Increases and decreases in the market price of the stock also cause an
increase in or reduction to plan expense to record the impact of the SARs
outstanding. No options or SARs under this plan were granted in 2001.
The Company has a 2000 Stock Option and Appreciation Rights Plan (the "2000
Plan"). This plan reserves 300,000 shares of the Company's unissued shares
for option and SAR grants. This plan is similar to the 2001 Plan and
expires in 2010.
2000 PLAN
-----------------------------------------
Number of
Shares Price Per Share
----------------- -----------------------
Outstanding, 12/31/00 0 -
Granted 248,800 $ 3.00 - $ 6.07
-----------------
Outstanding, 12/30/01 248,800 $ 3.00 - $ 6.07
=================
Exercisable, 12/30/01 167,525 $ 3.00 - $ 6.07
=================
Under the 2000 Plan, the weighted average price for options outstanding and
exercisable was $5.01 and $4.80, respectively. The weighted average life
for options outstanding and exercisable was 8.9 and 8.8 years,
respectively.
The Company has a 1999 Stock Option and Appreciation Rights Plan ("1999
Plan") and a 1998 Stock Option and Appreciation Rights Plan ("1998 Plan").
The 1999 Plan reserves 300,000 shares and the 1998 Plan reserves 292,500
shares of the Company's unissued shares for option and SAR grants. Each
plan is similar to the 2001 Plan. The 1999 Plan expires in 2010 and the
1998 Plan expires in 2008. There are no SARs outstanding in either plan.
65
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
1999 PLAN 1998 PLAN
---------------------------- --------------------
Number of Number of
Shares Price Per Share Shares Price Per Share
----------- ----------------- ------------ -----------------
Outstanding, 12/26/99 0 132,500 $ 1.00
Granted 110,000 $ 2.04 - $ 2.40 166,700 $ 1.69 - $ 2.40
Exercised 0 (2,500) $ 1.00
--------- -----------
Outstanding, 12/31/00 110,000 $ 2.04 - $ 2.40 296,700 $ 1.00 - $ 2.40
Granted 190,000 $ 3.00 - $ 3.96 500 $ 6.07
Exercised 0 (5,000) $ 1.00
--------- -----------
Outstanding, 12/30/01 300,000 $ 2.04 - $ 3.96 292,200 $ 1.00 - $ 6.07
========= ===========
Exercisable, 12/30/01 300,000 $ 2.04 - $ 3.96 292,200 $ 1.00 - $ 6.07
========= ===========
Under the 1999 Plan, the weighted average price for options outstanding and
exercisable was $3.27. The weighted average life for options outstanding
and exercisable was 8.7 years. Under the 1998 Plan, the weighted average
price for options outstanding and exercisable was $1.58. The weighted
average life for options outstanding and exercisable was 8 years.
The Company has a 1996 Stock Option and Appreciation Rights Plan ("1996
Plan") which reserves 261,818 shares of the Company's unissued shares for
option and SAR grants. This plan expires in 2006. This plan is similar to
the plans above. There are no SARs outstanding.
NUMBER OF SHARES PRICE PER SHARE
Outstanding, 12/26/99 288,450 $ 1.00 - $ 3.00
Granted 19,700 $ 1.69 - $ 2.04
Exercised (10,000) $ 1.00
Canceled (10,300) $ 1.00
----------------
Outstanding, 12/31/00 287,850 $ 1.00 - $ 3.00
Granted 2,000 $ 3.96
Exercised (28,182) $ 1.00 - $ 3.00
----------------
Outstanding, 12/30/01 261,668 $ 1.00 - $ 3.96
================
Exercisable, 12/30/01 261,668 $ 1.00 - $ 3.96
================
The weighted average price for options outstanding and exercisable was
$1.41. The weighted average life for options outstanding and exercisable
was 5 years.
An earlier Option and Stock Appreciation Rights Plan expired in 1997.
Outstanding ISO or NSO options previously granted are exercisable through
January 30, 2007. The activity in this plan for the last two years is as
follows.
NUMBER OF SHARES PRICE PER SHARE
Outstanding, 12/26/99 553,150 $ 2.94 - $ 3.00
Canceled/Expired (291,000) $ 2.94 - $ 3.00
----------------
Outstanding, 12/31/00 262,150 $ 3.00
Exercised (16,000) $ 3.00
----------------
Outstanding, 12/30/01 246,150 $ 3.00
================
Exercisable, 12/30/01 246,150 $ 3.00
================
66
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
The weighted average price for options outstanding and exercisable was
$3.00. The weighted average life for options outstanding and exercisable
was 2.7 years. Since this Plan expired in 1997, there are no shares
available for future grants. There are no SARs outstanding.
The following table summarizes information about all plan stock options
outstanding at December 30, 2001:
Options Outstanding Options Exercisable
------------------------------------ --------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Shares Contractual Exercise Shares Exercise
Exercise Prices # Life (Years) Price ($) # Price ($)
-------------------------------------------------------------------------------
$ 1.00 - $ 1.69 373,068 6.5 1.16 373,068 1.16
$ 2.04 - $ 2.40 254,300 7.7 2.07 254,300 2.07
$ 3.00 - $ 3.96 598,650 6.0 3.69 572,950 3.69
$ 6.07 122,800 9.4 6.07 67,225 6.07
--------- ---------
1,348,818 6.8 2.97 1,267,543 2.76
========= =========
The Company has a Restricted Stock Bonus Plan covering key employees and
directors of the Company. The Plan can reserve up to 50,000 of the
Company's unissued shares for awards. There were no shares awarded in 2001
or 2000. As of December 30, 2001, there were 4,050 shares available for
award under the Plan.
In 1994, the Company issued an option for 125,000 shares of unregistered
common stock under a lease settlement. The option is exercisable through
December 31, 2004 at an exercise price (as adjusted) of $1.29 per share.
The option price is subject to adjustment under anti-dilution provisions of
the option agreement. The optionholders have certain registration rights
for these shares of common stock. In January 2002, the optionholders
exercised options for 10,000 of these shares.
In 2001 and 2000, respectively, the Company issued non-qualified options
for 85,000 and 100,000 shares directly to its President and 40,000 and
61,500 to its Chief Financial Officer/Treasurer. Also in 2001, 45,000
shares were issued to another employee of the Company. The exercise price
is equal to the market price on the date of grant.
In October 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation". SFAS No. 123 defines a "fair value based
method" of accounting for an employee stock option or similar equity
instrument. Under the fair value based method, compensation cost is
measured at the grant date based on the value of the award and is
recognized over the service period. The Company has historically accounted
for employee stock options or similar equity instruments under the
"intrinsic value method" as defined by APB Opinion No. 25, "Accounting for
Stock Issued to Employees". Under the intrinsic value method, compensation
cost is the excess, if any, of the quoted market price of the stock at
grant date or other measurement date over the amount an employee must pay
to acquire the stock.
67
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
SFAS No. 123 allows an entity to continue to use the intrinsic value method
and management has elected to do so. However, entities electing to remain
with the accounting in APB Opinion No. 25 must make pro forma disclosures
of net income and earnings per share, as if the fair value based method of
accounting had been applied. Because the SFAS No. 123 method of accounting
has not been applied to options granted prior to January 1, 1995, the
resulting pro forma compensation costs may not be representative of the
cost to be expected in future years. Accordingly, net loss and loss per
share would be as follows:
As Reported Pro Forma
------------------------------ ---------------------------
Net Loss Net Loss
Attributable to Attributable to
Year Common Common
Ended Stockholders Per Share Stockholders Per Share
------- ------------------ --------- ----------------- ---------
2001 $ (4,319,199) $ (0.67) $ (5,544,173) $ (0.85)
2000 $ (2,441,416) $ (0.52) $ (2,909,650) $ (0.62)
The fair value of each option is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions:
2001 2000
--------- --------
Dividend yield 0.00% 0.00%
Volatility 84.85% 203.40%
Weighted average risk free interest rate 5.18% 6.05%
Weighted average expected lives of grants 9.6 years 10 years
The weighted average grant date fair value of the options issued in 2001
and 2000 was approximately $3.81 and $1.98, respectively.
10. COMMON STOCK; WARRANTS; PREFERRED STOCK
The Company's Articles of Incorporation authorize 1 million shares of
preferred stock, par value $0.01 per share, the series and rights of which
may be designated by the Board of Directors in accordance with applicable
state and federal law. In September 2000, the Board designated 500,000
shares of such preferred stock as Series B. There were 312,500 shares of
Series B issued in 2000 for $1,250,000 and the remaining 187,500 issued in
2001 for $750,000. Each Series B share must be converted into 4 shares of
common stock before September 12, 2002. The Series B has 51% voting
rights, subject to certain terms and conditions, on all stockholder
matters. No Series A preferred shares are currently outstanding.
68
ESSEX CORPORATION
NOTES TO FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED DECEMBER 30, 2001 AND DECEMBER 31, 2000
In connection with the issuance of the preferred stock, the Company also
issued common stock warrants to the preferred stock holders. These
warrants are for an additional 2 million shares of common stock. The
warrants have a term of 5 years and can be exercised at a nominal price of
$2,000. The warrants become exercisable under certain terms and
conditions, such as the market price of the common stock exceeding $10
through $20 per share for 5 consecutive days, or the occurrence of an
additional private placement of $10 million where the valuation of the
Company exceeds $50 million. The warrants would also become exercisable
upon a sale of all or substantially all of the assets of the Company or a
merger or acquisition of the Company. The Company has determined that the
warrants had a nominal fair value at issuance due to the restrictive
covenants. The Company has reserved 4 million shares of common stock in
connection with the convertible preferred stock and the possible exercise
of the related common stock warrants.
In accordance with Emerging Issues Task Force Issue No. 98-5 "Accounting
for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios", the Company has imputed and
recorded a deemed dividend of $2,000,000 on its Series B Preferred Stock
equal to the difference between the estimated current market price at
original date of issuance and the conversion price (the "beneficial
conversion feature"). Such imputed dividends have no impact on net loss
from operations or cash flows but have to be considered when calculating
loss per share attributable to common stockholders.
11. SUBSEQUENT EVENT
In March 2002, the Company amended existing private placement agreements
for its common stock with its Investor Group or their affiliates. The
agreements were increased from $500,000 to $1.5 million, of which $250,000
was received in December 2001 and $500,000 was received in the first
quarter of 2002. The remaining $750,000 is subject to a call by the
Company on an as needed basis during 2002. These agreements provide for
the shares of common stock to be issued at an initial price per share of
$6.50, subject to effective downward price adjustment, but not less than
$3 per share, should additional private placements be done with other
institutional investors during 2002 at a lower price per share.
69
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the incorporation of our report dated February 22,
2002, included in this Form 10-KSB, into Essex Corporation's previously filed
Registration Statements on Form S-8, File No. 33-47900, File No. 33-336770, File
No. 333-57122 and File No. 333-65466; and on Form S-2, File No. 333-61200.
Stegman & Company
Baltimore, Maryland
March 27, 2002
70