Kopin Corp Q2 FY2021 Earnings Call

Good day, and welcome to the Kopin Corporation Second Quarter 2021 Earnings Call. Today's conference is being recorded. At this time, I would turn the conference over to Mr. Richard Sneider. Please go ahead, sir.

Thank you, operator. Good morning and welcome everyone, and thank you for joining us this morning. John will begin today's call with a discussion about our strategy, technology, and market. I will then go to the second quarter results at a high level. John will conclude our prepared remarks, and then we'll be happy to take your questions. I'd like to remind everyone that during today's call, taking place on Tuesday, August 3, 2021, we will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on the company's current expectations, projections, beliefs, and estimates, and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those forward-looking statements. Potential risks include, but are not limited to, demand for our products, operating results for our subsidiaries, market conditions, and other factors discussed in our most recent Annual Report on Form 10-K and other documents filed with the Securities and Exchange Commission. The company undertakes no obligation to update these forward-looking statements made during today's call. And with that, I will turn the call over to John.

Thank you, Rich. Good morning and thank you for joining us to discuss our second quarter results. I want to start by expressing our hope that you and your families continue to stay safe. We continuously see growing demand for our products across our key business segments, including defense, industrial, and consumer. In our defense business, we remain on track on many development programs; two new programs entered low-rate initial production during our second quarter. A third is expected to enter low-rate production in the fourth quarter. During this quarter, we received an additional $1.6 million follow-up order for a high-brightness liquid crystal display for the F-35 Joint Strike Fighter program, with deliveries scheduled through the second quarter of 2022. Additional orders are expected throughout the lifetime of this program. For the FWS-I thermal weapon sight program, our customer requested we reduced shipments of our product during the quarter, while they made system and production enhancements. We are working closely with our customer and expect the lowest shipment rate to continue during the third quarter. We expect to increase the rate and make up some of the shortfall in the fourth quarter. Despite this short-term slowdown, there's no change in the overall profile of the program, and demand remains very strong. I would like to stress that there is no change in the overall outlook and the profile of the program. In fact, we expect soon to receive a significant follow-up order for this program, and we will continue delivery into 2022. Also, we are pleased with strong demand from our enterprise customers in Q2, and expect the momentum to continue. As discussed in our previous call, we have continued to increase our R&D activities as we see great opportunities in the coming augmented and virtual reality space. In fact, our customer-funded R&D revenue increased approximately 60% year-over-year, as a result of growing interest in our next-generation displays and display technologies. We achieved several very important display technology advancements in the quarter, including the world's first 35,000 nit HDR Green OLED Microdisplay. This leading-edge display can incorporate our duo-stack OLED structure for ultra-high brightness and unique patent-pending pixel structure backplane architecture for super-high dynamic range operation. This is a big milestone, not just for Kopin, but for AR and VR applications across all sectors. Our new HDR Green OLED Microdisplay is ideal for use in conditions ranging from very dark night to very bright daylight. In addition, we recently announced the successful development of All-Plastic Pancake Optics for VR, AR, and MR applications. This is another exciting achievement for Kopin. It is believed to be the first all-plastic Pancake optics in the world. While the Pancake optics are much thinner than conventional optics, it is important to note that previous Pancake optics needed at least one spherical glass lens to avoid image artifacts caused by birefringence of currently available plastic material. Our new patent-pending all-plastic Pancake optics with aspherical lens is sufficiently lighter than Pancake glass optics, while also providing better image quality and much lower cost. For years, bulky and heavy headsets have hindered consumer adoption of AR and VR glasses. Our new plastic Pancake optics enable an entirely new avenue for the industry to design and manufacture stylish super-light compact VR, AR, and MR high-performance smartglasses and headsets that we believe consumers will want to use. We have received strong interest from the market. As we mentioned in Q2, we also announced a multiyear development agreement with a leading global electronics company for our full-color LED microdisplays on silicon and expect to demonstrate a one-inch diagonal full-color 2K x 2K LED microdisplay within 24 months. As a reminder, LED microdisplays have a potential for super-high brightness, low-power consumption, high contrast, and wide viewing angle, which are all important features for many applications, including see-through augmented reality and mixed reality applications. We are excited to collaborate with our partner, which has already achieved significant milestones in color LED microdisplays. It is also important to note that this collaboration will expand our microdisplay portfolio, making us the world's only provider of a complete suite of LCD, LCOS, OLED, and LED microdisplays on silicon. Our breadth of technology and product capability for Kopin places us in the unique position to provide our customers with solutions that best fit their product and application needs. I would also like to stress our recent participation in the three-part webinar series AR, VR: The Paradigm Shift to Smartglasses Starts Now, which drew over 500 participants during the live event. Many homes are actively involved in the next-generation smartglasses and headsets. During the three-part series, we covered the past, addressing the initial efforts to create AR/VR solutions, the present covering the current state-of-the-art technologies, and the future addressing upcoming AR/VR smartglasses while offering a roadmap to successful product development. All three events had active and engaged participation, and the recordings are available on Kopin's website. We are pleased and committed to our strategy. In short, while we maintain our strong momentum in our growing revenue-generating businesses in defense and enterprise sectors, we continue to innovate aggressively and advance our technology for what we see as a growing wave of consumer AR, VR, and MR product applications. Many of you may have followed the increasing discussion of the transformational arrival of the Metaverse. While its definition is still not well-defined, in my view, as we discussed in my webinar, the Metaverse is composed of AR/VR hardware, smart glasses, and the application software providing a unique and exciting user experience for consumers. This transformation is happening and is already evident in defense and enterprise segments, and will soon arrive in the consumer sector. As we stress, the AR/VR hardware would come first. The technology advances and market conditions are very favorable, and Kopin is very well-positioned to capitalize. Now, I'll turn the call over to Rich to discuss the financial details of the quarter.

Thank you, John. Turning to our financial results. Total revenues for the second quarter ended June 26th, 2021 were $9.9 million compared with $8.8 million for the second quarter ended June 27th, 2020, a 12% increase year-over-year. Product revenues for the second quarter ended June 26th, 2021 were $6.9 million compared with $6.7 million for the second quarter ended June 27th, 2020. Our defense product revenues for the second quarter ended June 26th, 2021 were $3.8 million compared with $4.5 million for the second quarter ended June 27th, 2020. As John previously discussed during the three months ended June 26th, 2021, we reduced shipments of our thermal weapons sight systems to a customer who was making system and production enhancements. We expect the lower shipment rates to continue during the third fiscal quarter and then increase in the fourth quarter of 2021. Whether we can make up the revenues during the remainder of 2021 depends on how quickly the customer completes their process. Our industrial product revenues for the second quarter ended June 26th, 2021 were $2.6 million compared with $1.4 million for the second quarter ended June 27th, 2020, representing an approximate 86% increase on the strength of the sales of products used for 3D metrology and headsets used for applications in manufacturing distribution, partly offset by a decline in public safety wearable headsets. Project, research and development, and other revenues were $3 million for the second quarter ended June 26th, 2021 compared with $12.1 million for the second quarter ended June 27th, 2020, primarily due to an increase in fundings for U.S. defense programs. Cost of products sold for the second quarter ended June 26th, 2021 was $6 million compared to $4.8 million for the second quarter ended June 27th, 2020. The increase in product revenues as a percentage of net product revenues for the three months ended June 26th, 2021, compared to three months ended June 27th, 2020, was primarily due to lower manufacturing efficiencies driven by the lower FWS-I volumes regarding the global shortage of semiconductor components and production capacities affecting many industries. While we have, in some cases, had to find alternatives for sources, we have not experienced any shortage issues during the first six months of 2021. In some cases, we have seen price increases. The shortage of semiconductor components is a very dynamic situation and we continue to work on the issues it presents. Research and development expenses for the second quarter of 2021 were $3.9 million compared to $2.2 million for the second quarter of 2020, a 75% increase year-over-year. R&D expenses for the three months ended June 26, 2021 increased as compared to three months ended June 27th, 2020, primarily due to an increase in spending on U.S. funded development programs and internal R&D expenses for OLED development. Selling, general, and administrative expenses were $4 million for the second quarter of 2021 compared with $2.9 million for the second quarter of 2020. Excluding the non-cash stock-based compensation costs, SG&A expenses were $3.7 million for the second quarter of 2021 compared with $2.8 million for the second quarter of 2020, a 30% increase. The increase in SG&A, excluding non-cash stock compensation costs, was due to an increase in other compensation costs and bad debt expense. Other income expense was approximately $249,000 for the second quarter of 2021 compared with $6,000 of expense in the second quarter of 2020. During the three months ended June 26, 2021, we recorded $100,000 of foreign currency gains as compared to $10,000 of foreign currency gains for the three months ended June 27, 2020. Turning to the bottom line, our net loss attributable to the controlling interest for the second quarter of 2021 was $3.8 million or $0.04 per share compared with a net loss to controlling interest of $1.1 million or $0.01 per share for the second quarter of 2020. Non-GAAP net loss attributable to controlling interest for the second quarter of 2021 was $3.6 million or also $0.04 per share compared with a non-GAAP net loss to controlling interest of $1 million or $0.01 per share for the second quarter of 2020. Kopin's cash and marketable securities were approximately $30.7 million at June 26, 2021, compared to $20.7 million at December 26, 2020. Net cash used in operating activities for the second quarter ended June 26, 2021 was approximately $5.4 million. During the three months ended June 26, 2020, we sold 92,335 shares of our stock under our ATM program for gross proceeds of approximately $832,000 before deducting expenses paid by us of $24,000. For the six months ended June 26, 2021, we sold 2,496,690 shares for gross proceeds of approximately $16.8 million before deducting broker expenses paid by us of approximately $500,000 pursuant to our existing ATM and previous ATM agreement. On June 28, 2021, the first day of our fiscal third quarter, we sold 600,000 shares of common stock for gross proceeds of $4.8 million before deducting broker expenses paid by us of approximately $145,000 pursuant to our existing ATM program. Second quarter amounts for depreciation and stock compensation expense are attached in the table into the Q2 press release. The amounts discussed above are our current estimates, and listeners should review our Form 10-Q for the second quarter of 2021 for any possible changes and, of course, additional disclosures. And with that, operator, we'll take questions.

Thank you. We'll now take our first question from Glenn Mattson of Ladenburg Thalmann. Please go ahead.

Thank you for taking my questions. Can you provide more details about the delays this quarter and possibly next quarter? Specifically, I'm interested in understanding the changes your end customers had to implement and what makes you confident about a potential recovery in the fourth quarter. Additionally, could you clarify the extent of that recovery? Do you believe you can recover most of the revenue lost, or will there be further delays into 2020?

Sure. So, first of all, this is a very long-running program. This is going to go for multiple years, and this is not unusual that they've made some number of full units, and they're looking to improve yield. Keep in mind, a lot of the government contracts today are firm fixed price. To the extent that you can make yield improvements, drive costs down, that all falls to the bottom line. We share in that. They've come up with some ideas for yield improvement on the overall system, and they slowed shipments down as they implemented those improvements. It requires us to do some engineering to work with them to make sure there's no downstream effects. That's what we're doing. How fast we can make it up, we've talked to the customer, and they are very eager to make it up themselves. It affects their revenues, too. Our interests are aligned. So, it's just a matter of going through and making sure all the testing gets done properly and that, as we mentioned, there are no downstream effects. Once that happens, we hopefully can turn this around. Then it will just be a matter of how many weeks are left and how much volume we can get out of the facility over the rest of the quarter. We're optimistic we can put a pretty good dent in the fourth quarter if we can get this thing turned on soon.

Okay. Great. And as far as the new programs that went into low-rate initial production, can you talk about any specifics about what exactly programs those are? And just kind of a sense of how it will ramp in the back half and into next year?

Yeah. So, it's a weapon sight. It's an avionic product. As soon as we get clearance from the customer, hopefully, we can give a little more detail on exactly who they are and what the programs are. We did recognize initial product revenues in the quarter, and hopefully, it will just continue on. Again, this is initial low-rate production, so there is still engineering going on as these units are being shipped. We haven't gone to full-rate production, which will happen next year.

Thanks, Rich. The gross margin was a bit weaker, which I believe is due to two factors. In the early stages, initial production doesn't yield the same margin as products in full production. Additionally, there was a decline in the weapons sights. Given this situation, should we anticipate similar margins in Q3, with the possibility of improvement starting in Q4 and afterward? Would that be an accurate way to view our model?

Yes.

Great. And then I just had a question about the new LED microdisplay. You talked about a global leader there as the partner. Maybe, I don't know, Rich, John, the best person to talk about it, but just love to get more insight into how big that could be down the road? And just any other color on the upside that opportunity presents would be great.

Yeah. Glenn, this is John Fan. This is a very interesting program, very, very exciting progress. We have been working on LCDs and our costs and recently really focused on micro OLED. But micro LED has a peculiar feature. It can be very, very bright. Some people think it is the ultimate display. If you can do the micro LED, the brightness is extremely high. It can be so efficient, and it would be very good for see-through AR optics, optical systems. As you know, the OLED reality optical see-through system, in many ways, is the ultimate dream for everybody. This is the ultimate dream; however, the technology is very difficult. We actually pioneered this process on silicon in 1991 with a partner and have now reactivated the process as funded by our customer. We have a very big company, already disclosed—it's from Japan. As a global consumer, it includes enterprise consumables. I think in two years, we will have that one-inch 2K x 2K full-color display. If we achieve that, that will be the world's leading display. There's no such ambitious program yet, and we will be the first one. We provide the backplane design. It's a very unique design that we are patenting right now.

Great. That’s helpful. Okay. That’s it for me. Thanks, guys.

Our next question comes from Kevin Dede of H.C. Wainwright. Please go ahead.

Good morning, gentlemen, and thank you for taking my questions. John, just to go back on the LED display, you mentioned a consumer company helping you develop that two-year program. What exactly are the design requirements for the full display? Do you have to include optics in that? Can you give us a little more insight on what your deliverables are?

It's a very good question, Kevin. Thank you for asking. For this particular project, the focus is on just the display, the full-color one-inch 2K x 2K display—not the end-user system. As you well know, just a display alone does not solve the problem of the AR/VR consumer application. Optics are just as important. You could have a great display, but without the right optics, you may not get a clear image. That's why Pancake optics help. Pancake optics are actually used in the defense industry, but previous designs usually had to incorporate glass lenses, which adds weight. Our all-plastic optics work to alleviate that by providing high-performance at a much lower weight, which is crucial for consumers. We decided to take this development on ourselves.

Okay. So, this optics development—is it sponsored by a consumer company, or was this something that you undertook on your own? And could you give us some insight on how you're pairing it with both this LED development and the OLED development in AR and VR?

Yes. Thank you for asking. For any AR/VR systems, you need a display, optics, and a well-designed package assembly. We have been delivering hundreds of thousands of units in the defense sector, and for those products, it has to be very well-packaged. As we shift our focus to consumer products, we understand that in addition to high-performance displays, very thin and high-quality optics are necessary, and Pancake optics is our solution for that. We're developing alongside material partners for this purpose, and we've filed three patents already. The savings we've seen is at least more than 10 grams per eye, which is significant.

Okay. So, was this development driven primarily by the need to shave off weight, or is it also a safety factor?

We've mentioned safety. While glass is generally strong, this is about cost, size, weight, and image quality. It's a comprehensive approach to improve performance.

Okay. So regarding the LED versus OLED, could you help me understand how Kopin is looking at the technology approach for these displays? You've mentioned that LED might be the ultimate solution for see-through AR, while OLED could embrace VR more readily. Could you clarify this balance for us?

Certainly. For consumer VR applications, micro OLED is currently sufficient. It delivers good performance in cost, brightness, and lightweight design. However, micro LED has the agility to achieve higher brightness if needed but the technology itself is still immature. Over the next five years, micro OLED will lead for VR applications, while micro LED will start to gain traction as technology matures.

That's helpful. Thank you.

We will now take our next question. It comes from Jeff Bernstein of Cowen. Please go ahead.

Yeah, hi, guys. Just a couple of quick questions. I know you guys have a JV with Lenovo. Not sure exactly what's come out of that, but they've started to sort of pre-advertise something called the ThinkReality A3. I'm wondering if that's under that program or if that's something else with a different vendor?

That's a different program. We are working with Lenovo NV, which is a joint venture of Lenovo with several other companies in China. The one you mentioned actually comes from Lenovo's parent.

Gotcha. Okay. And then, there was strength in the industrial segment. Can you differentiate for us? Was that from the 3D machine vision side, the fourth dimension LCoS piece? Or was that RealWear?

Yeah. It was primarily the FDD.

The 3D metrology business has taken off. The industry is recognizing the shift from 2D to 3D in manufacturing processes. Our 3D metrology is perfectly suited for high-density packaging needs. We have about 40% market share; our competitor TI also has about 40%.

Our next question comes from Craig Rose of Axiom Asset Management. Please go ahead.

Hello, John.

Hi, Craig.

Can you help us understand—could you help us understand—well, we know RealWear and SOLOS are not under your umbrella anymore. But could you explain how we benefit from their success? And maybe you could tell us your perception of RealWear's market share in the marketplace?

Okay. I'll answer some of that. This is a very good question. In our early years, we promoted our component displays, optics, and modules by creating reference systems. This helped us gain traction in the market. RealWear licensed our technology for their headsets. We receive equity and buy components from us, while also paying royalties. RealWear is very much a leader in the enterprise headset market right now. We are growing alongside them. Our return on investment comes from these licenses, royalties, and components. RealWear is performing well. SOLOS, meanwhile, has also rolled out its second generation of products, and we see the same opportunities there for growth and revenue through equity and royalties.

Thank you, John.

It appears we have no further questions at this time. I'd like to turn the call back to John Fan for any additional comments or closing remarks.

Well, thank you for joining us this quarter, and we look forward to seeing you in the next quarter. Thank you.

This concludes today's call. Thank you for your participation. You may now disconnect.