Kopin Corp Q4 FY2021 Earnings Call

Please standby, we are about to begin. Good day, and welcome to the Kopin Fourth Quarter and Full Year 2021 Earnings Conference Call.

Thank you for joining us this morning. John will start today's call by discussing the market environment we are observing and our progress in executing our strategy, which includes our sales activity and technology development. I will provide a high-level overview of the fourth quarter and 2021 results. John will wrap up our prepared remarks, and we will be glad to take your questions. I want to remind everyone that during today's call on March 8, 2022, we will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements reflect the company's current expectations, projections, beliefs, and estimates, and they are subject to various risks and uncertainties that could lead to actual results differing significantly from these statements. Potential risks include, but are not limited to, demand for our products, performance of our subsidiaries, market conditions, and other factors discussed to update the forward-looking statements made during today's call. Now, I'll turn the call over to John.

Thank you, Richard. Good morning. Thank you all for joining us to discuss our fourth quarter and full-year fiscal 2021 financial results. 2021 was an exciting and productive year for Kopin. Despite the challenges of the pandemic, parts shortages, and FWS-I production retooling mid-year, we still achieved 14% revenue growth. This marks our fourth consecutive year of growth, and we expect this trend to continue this year. Demand for our product is strong, and our bookings for 2022 are very promising. However, we must remain cautious due to ongoing global supply chain issues that many industries face. Throughout fiscal 2021, through diligence and leveraging our industry contacts, we successfully maintained supplies of our necessary components. Our Industrial/Enterprise products led our growth in 2021, generating $9.7 million in revenue, a 41% increase over 2020. The demand for our Spatial Light Modulators, utilizing our Ferroelectric LCOS technology, was notably strong as contract manufacturers transitioned their production lines to implement 3D automatic optical inspection, commonly known as AOI machines, for quality control. Manufacturers of these 3D AOI machines are increasingly selecting our solutions. Our consumer product revenue rose from approximately $900,000 in fiscal year 2020 to $1.9 million in 2021, representing a 120% increase driven by sales of our Organic Light Emitting Diode display products. Although our OLED revenues are still modest in absolute terms, the growth indicates ongoing market traction and progress in bringing these new product lines to fruition, which we believe have substantial competitive advantages and market potential. Our defense product line also saw strong demand in 2021 with revenue reaching $18.2 million. We met our 2021 goal of having four development programs enter the low-rate initial production phase. Additionally, our pipeline of defense programs in development continues to grow, which we anticipate will drive further revenue growth in defense in the coming years. I'm also pleased to announce that we made significant process enhancements in the FWS-I thermal weapon sight program during 2021, which we expect will have positive long-term impacts on our revenue and margins. These enhancements are now completed. While our shipments in Q2 and Q3, as well as our yield in Q4, faced challenges, I'm happy to report that the FWS-I production rate and yield are recovering well. We achieved our highest shipping rate for these products in 2021 during Q4. Additionally, we received a $19.8 million follow-up order for an eyepiece subassembly, a vital component of the U.S. Army's family of Weapon Sight-Individual thermal sight system, with most of the order scheduled for shipment this year. In the fourth quarter, we also secured a full lot order worth $2.8 million for our high brightness and rugged liquid crystal display for the F-35 Joint Strike Fighter Program. This program incorporates the world's most advanced augmented reality helmet, providing pilots with essential flight, technical, and situational awareness information. This new order extends our delivery backlog into the third quarter of 2022. I would like to remind everyone that we are the sole source for this cutting-edge AR helmet. Lastly, we announced receiving a $1.1 million order to supply eyepieces for the Joint Effects Targeting System, JETS, with deliveries scheduled for this year. While these orders reflect our advanced display technology, our optical capabilities are also a critical aspect that may not be fully appreciated. We offer display optics in modules and advanced assemblies, which are essential for a quality AR/VR experience. In the fourth quarter, we introduced our innovative all-plastic Pancake optics that optimize performance for smaller, lighter VR and Metaverse headsets. We believe these optics are the first of their kind, providing vital components for VR headsets that are lightweight, comfortable, and user-friendly. Pancake optics are ideal for VR headsets, but previous designs required a spherical glass lens to mitigate image distortions caused by plastic birefringence, which added weight and complexity. I'm pleased to announce that we have resolved the birefringence issue. Our new P95 and P80 all-plastic Pancake optics deliver improved image quality, reduced size and weight, and lower costs compared to prior options. We expect this innovation will enhance the Metaverse experience for users. The P95 offers a 95-degree field of view, while the P80 provides an 80-degree field of view with a 1.3-inch diagonal micro-display. Our all-plastic Pancake optics not only deliver these advantages but also provide exceptionally sharp images with excellent eye relief and eye box, particularly with our novel P80 optics. We believe that our Pancake optics, combined with a micro-display, create an optimal match, yielding magnification from 30,000 to 50,000 times while ensuring clarity. Our goals remain focused on the critical areas required for AR/VR optics and micro-displays. I also want to mention our recent participation at CES this January, where we showcased our second-generation 2.6 K by 2.6 K OLED display alongside our all-plastic optics. Panasonic demonstrated their VR glasses using our display and optics at CES. We also hosted a fireside chat at CES discussing our perspectives on the exciting Metaverse landscape, led by Chris Chinnock, President of Insight Media and the 8K Association. The session was live-streamed and is available on YouTube. In summary, customer demand is robust across all our core product lines, and we are actively addressing supply chain challenges. We will maintain our momentum in innovating our technology for AR, VR, and MR applications. Interest in the Metaverse remains high, and we believe we are well-positioned to seize the opportunities it presents. We began 2022 with a strong backlog of orders, and we anticipate another year of growth. We are excited about Kopin's growth and see increasing interest in our AR, VR, and MR products. Our technological advancements have been strong, and current market conditions are favorable. Now, I will discuss the financial details of the quarter and the full year.

Thank you, John. Starting with the fourth quarter results for 2021, total revenues were $13.2 million, a decline from $13.9 million in the fourth quarter of 2020, reflecting a 5% year-over-year decrease. Product and royalty revenues fell by $648,000 and $552,000 respectively, although this was partially countered by an increase in funded R&D revenues of $476,000. I want to clarify that we had the highest unit shipment rate of FWS-I units in 2021 during the fourth quarter, despite a slight drop in defense revenues. According to the revenue recognition standard, ASC 606, we recorded most of our defense revenues based on the percentage of completion. Therefore, our revenues depend on both the units shipped during the quarter and the value of work in progress and finished goods remaining at the end of the quarter. As previously mentioned, the units shipped in the fourth quarter of 2021 were the highest for the year; however, the ASC 606 adjustment for Q4 2021 resulted in a negative impact of $308,000, contrasting with a positive adjustment of $1.3 million in Q4 of 2020. This essentially indicates that our Work in Progress and finished goods inventory levels were lower at the end of Q4 2021 compared to Q3 2021. The cost of product revenues as a percentage of net product revenues for the fourth quarter of 2021 and 2020 were 84.9% and 65.1% respectively. The increase in cost of product revenues as a percentage of net product revenues in Q4 2021 compared to Q4 2020 was mainly due to lower yields because of process changes we made in the second and third quarters, which affected productivity and scrap levels in Q4 2021. R&D expenses for Q4 2021 were $5.2 million, compared to $4.4 million in Q4 2020, marking a 19% increase. This rise in R&D expense for Q4 2021 versus Q4 2020 is primarily attributable to higher internal OLED development costs, along with a smaller increase in funded R&D for additional customer activities. SG&A expenses amounted to $4.1 million in Q4 2021, up from $2.4 million in Q4 2020, representing a 71% year-over-year increase. The increase in SG&A in Q4 2021 compared to Q4 2020 was mainly due to around $400,000 more in professional fees, $300,000 in non-cash stock-based compensation, and an additional $400,000 for compensation and other benefits. Other income was $46,000 in Q4 2021 and $286,000 in Q4 2020. Regarding net loss attributable to controlling interest, it was $3.6 million or $0.04 per share for Q4 2021, compared to net income of $1.3 million or $0.02 per share for Q4 2020. For the full year, revenues in 2021 saw an increase compared to 2020, largely driven by a 41% rise in industrial enterprise revenues and a 120% increase in consumer revenues, although this was partially offset by a 10% decline in defense product revenues. The cost of product revenues as a percentage of net product revenues for 2021 and 2020 were 83.8% and 75% respectively. The rise in cost of product revenues as a percentage of revenues in 2021 compared to 2020 was primarily due to lower production volumes in the second and third quarters of fiscal year '21. We reduced production of FWS-I products during these quarters due to process changes, which also negatively impacted production yields as productivity and scrap amounts were affected. R&D expenses for 2021 were $16.3 million, representing a 39% increase from $11.7 million in 2020. Funded R&D expenses totaled $10 million for 2021 compared to $7.7 million for 2020, reflecting a 29% increase. Funded R&D for 2021 saw an increase compared to 2020. Internal R&D expenses reached $6.3 million for 2021 versus $3.9 million for 2020, which is a 61% rise, mainly due to higher OLED development costs. SG&A expenses for 2021 were $18.1 million, a 53% increase from $11.8 million in 2020, primarily due to an increase of around $3.1 million in non-cash stock-based compensation, $1.4 million more in compensation and benefits, $0.3 million in insurance costs, and $0.9 million in bad debt expense, only partially offset by a $0.6 million reduction in professional fees. Other income for fiscal years 2021 and 2020 was $0.1 million and $0.4 million respectively, with fiscal '21 including $100,000 in foreign currency gains, compared to $300,000 in 2020. For our bottom line, the net loss for controlling interest for the fiscal year ending December 25th, 2021 was $13.7 million or $0.15 per share, in contrast to a net loss of $4.4 million or $0.05 per share for 2020. The top customers for 2021 included DRS Network Imaging at 31% and Collins Aerospace at 29%. Depreciation and stock compensation figures for the quarter and year-end amounts are detailed in the table attached to the press release. As of December 25th, 2021, Kopin's cash equivalents and marketable securities totaled about $29.3 million, up from $20.7 million as of December 26th, 2020. We continue to maintain no long-term debt. The amounts detailed above are current estimates, and listeners should refer to our Form 10-K for the year-end December 25th for any potential changes, as well as any additional filings. With that, we are ready to take questions.

Of course, thank you. If you're using a speakerphone, please pick up your handset and ensure the mute function is turned off so that your signal reaches our equipment. I'll pause for a moment to allow everyone to signal for questions. I'll go ahead and take our first question from Glenn Mattson with Ladenburg Thalmann. Please go ahead.

Thank you for taking the questions. I'm curious about the optical inspection market. Has the solid growth in that space this year contributed to the industrial enterprise sector? I believe there is a long-term growth opportunity here, but could you provide more insight on how you foresee this developing in 2022?

I mean, this is a momentum that's been building for a period of time and we'll see what happens in 2022. It's an interesting situation in that the supply chain shortage is affecting everybody. And so forecasts that we're getting for customers are not as firm as we've gotten in the past. And frankly, if there continues to be a shortage of chips, that's going to cause a headwind in the demand for 3D automation equipment. Because what's the purpose of doing quality control on chips you don't have? So we've really got to see how this whole supply chain works its way out.

This is John Fan. All right, Glenn, this is a very good question. At a short-term cost, supply chain questions are affecting our customers too. However, the long-term trend to move from 2D to 3D is continuing. As you all know, electric cars are getting very complicated. Their PCB boards are very complicated. So the trend towards 3D is not going to be stopped; in fact, it's going to continue increasing. So this short-term effect of the shortage is just that, short-term. And even that we're overcoming it most of the time.

Thank you for that information. Moving on to defense, congratulations on the $19.8 million order you received in December. When you consider that order along with the fact that most of it should ship this year and the revenue from the Joint Strike Fighter through the third quarter, these two factors would ideally keep defense revenue somewhat flat in 2022, possibly even showing a slight increase. Additionally, there are other low-rate industrial production orders that could provide some positive impact on that figure. Is that a fair way to look at it? It would be helpful to get some insights on how that revenue flows throughout the year.

I think that is the correct way to think about it. Plus, we have a very healthy backlog of R&D contracts that we will be working on during the course of the year. And the timing of the four programs that are in LRIP, low-rate initial production, when they go into full production, will determine how well they LRIPs go. But they should provide us, if things go according to plan, with additional revenues during the course of this year. Probably more in the second half of the year.

Could you provide an update assuming there are no supply chain disruptions? In normal circumstances, if defense orders are received on time and you can ship them, along with a typical breakdown of component revenue versus R&D revenue being about two-thirds to one-third, what are the expected gross margins at certain volumes and where is breakeven? Any insights on this would be appreciated.

Sure, so break-even basically getting to the mix question that you're asking about can be anywhere from $50 million to $60 million, and we're fast approaching that number, and I think your ratios of product revenues to contract revenues is pretty close to what we've historically been running at.

In light of that, I would just like to ask if, with the balance sheet having almost $30 million in cash and no debt, and you being on track for break-even this year, it's safe to assume that there's not really much need for capital raise activity.

We have sufficient cash to execute our strategy where we are right now.

Okay, great. That's it for me. Thanks.

And we'll go ahead and move on to our next question from Kevin Dede with HCW. Please go ahead.

Good morning, everyone. Thank you for joining our call. John, could you provide some insights on how the Pancake optics is improving by reducing weight? I would appreciate your thoughts on this development in relation to SOLOS, RealWear, Scott, and the various enterprise and consumer applications you're involved with. How are your customers responding to this? Given the doubling of consumer revenues this year, how do you anticipate continued growth?

Thank you, Kevin. This is a very interesting question. In the earlier days, I think in the last earnings call, I mentioned that we actually used Pancake in our defense products in several places. In fact, FWS-I, our biggest production program is using our Pancake optics. Except that case, we used one of the lenses as a glass lens. Now we always believed the Pancake is the way to go for VR headsets and however in the consumer world, we think the glass lens must go away because of their weight and shape. So the all-plastic optics will be working on for several years to develop a special material and a process that allows us to do that. Now, fast-forward, we have P95 and P80. We displayed these at CES. I must say that the response in the field is very strong. Not only do they want our Pancake optics to couple with our OLED display, but also from people who have their own displays, they want optics as well. So we're now actively planning on how to get the Pancake optics, all-plastic Pancake optics to satisfy our customers' needs. So we're very optimistic about Pancake optics, as it is really a separate product line for us.

Can you discuss the cost you'll offer at volume? I'm curious about their usage this year and whether you expect to deliver to the market at a lower price point than the previous Pancake. My main question is how you see VR evolving compared to Oculus. With the Oculus Quest 2 headset currently using an outdated cell phone display, and considering the advanced technology you are developing, I hope you can provide more insight into its market timeline.

My impression is that Oculus 2 is integrated accurately into the system, utilizing a large LCD display around two to two and a half inches. Currently, it employs a plastic funnel lens which contributes to a bulky and thick appearance. I believe that the funnel lens will transition to our Pancake lens, which is a type of plastic lens. This transition is widely recognized in the industry as inevitable. Our Pancake technology, which we trademarked years ago due to our work in the defense sector, is designed to provide the thinnest and lightest optics with a magnified display. On the display front, we are working towards a 2.6k resolution that we hope to begin producing this year, aiming for an ultimate goal of around 3.5 to possibly 4k resolution. We are planning with our partners to achieve this ambitious target. To reiterate, we have a 2.6k by 2.6k OLED, 1.3-inch display, and we are already in the second generation while others have yet to catch up. This gives us great optimism for the future, although it may be closer to the end of this year or next year before the product is fully available, leading to increased revenue in the following year.

Okay. Thanks, John. I appreciate that.

Our defense and other programs are performing well, so we still expect good growth this year.

Can we talk a little bit about the programs that could go from LRIP to full production this year? Could you give us just maybe a little more depth on the unit size? I mean, I know FWS-I is a huge number of units, and I'm wondering if you can compare some of these other LRIP programs on sort of a unit basis just to maybe help us understand how large they could be.

Something like FWS-I is a very rare program because it goes into most of the soldiers who get it in one form or another. The rest of the programs tend to be more specialized with much lower volumes. But commercially, they carry a much higher price. And so the margins on those programs are very good. They range from additional scopes to rotary aircraft, pilot helmets, and tripod rocket launchers. So how they roll out, particularly given what's happening around the world today, we will see how that goes, but they are, as I said, lower units, but higher prices.

To provide more clarity on the situation, one of the programs involves international gun sights. Currently, we are uncertain about the speed of its growth.

All right, I don't have anything to add at the moment, but I might come back to it. On the enterprise side, John, could you provide some insight from a Scott perspective or a views perspective on the adoption of Pancake? I understand that consumers are still a bit distant, but I know your enterprise business is expanding. Is there potential for Pancake to be adopted there at a lower price point, and how does that translate?

The Pancake has many advantages, but one disadvantage is its optical efficiency, which is quite low at around 10%. For outdoor AR enterprise applications, this low efficiency results in a very bright display, so people tend to avoid using Pancake in that context. However, in the VR scenario, people choose to use Pancake. It's a different case depending on the intended use. We have other optics with much higher optical efficiency that are suited for the enterprise sector, and those are currently in use. When we ship products to customers, we usually include displays with optics packaged together. The choice depends on the application, as we offer a wide range of displays including LCD, LCOS, OLED, and we are developing LED as well. In terms of optics, we provide glass optics, special optics, Pancake optics, and all-plastic optics. Additionally, we supply web optics, which require effort for proper application.

Thank you, John. I appreciate it. Thanks, Rich. Thanks for taking our questions.

All right.

And with that, that does conclude our question-and-answer session. I would like to hand the call back over to our speakers for any additional or closing remarks.

Thank you very much for joining us, and hope to see you in the next meeting. Thank you, bye-bye.

And with that, that concludes today's call. Thank you for your participation. You may now disconnect.