Kopin Corp Q2 FY2022 Earnings Call

Welcome to Kopin's Second Quarter 2022 Earnings Conference Call. I would now like to turn the conference over to Rich Sneider, Chief Financial Officer. Please go ahead.

Thank you, Operator. Welcome, everyone and thank you for joining us this morning. John will begin today's call with a discussion of our progress in executing our strategy. Then I will go through the second quarter of 2022 results at a high level. John will conclude our prepared remarks, and we'll be happy to take your questions. I'd like to remind everyone that during today's call taking place on Tuesday, August 2, 2022, we'll 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 the 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 all for joining us to discuss our second quarter 2022 operating results. We are very pleased with the results of the second quarter of 2022. Total revenues were up 20% year-over-year, driven by about 30% growth of our product revenues. In addition, our customer funded research and development revenues remain strong, which we view as an indicator of our future growth opportunities as we expect most of these development programs to transition to production in time. Our revenue from defense products was particularly strong, growing 87% year-over-year in the second quarter. During the second quarter of 2022, we received additional orders for the spatial F35 pilot helmets and imaging systems for armored vehicles. In July, we announced a production order for our brilliant high brightness color displays for helicopter pilot helmets. During the second quarter, we also announced the expansion of our industrial customer base, adding a new Korean 3D automated optical inspection system customer. They use our spatial light modulator or SLM as critical components in their system. With this particular win, we're now supplying a high-speed, high-performance SLM, which is based on proprietary ferroelectric liquid crystal display technology to all three leading Korean 3D AOI equipment manufacturers, in addition to other market-leading manufacturers in China, Japan, and Germany. These announcements are important in several ways: to add to our already strong backlog of orders, but equally important, they represent the variety of microdisplay technologies Kopin offers. We believe we are the only company in the world with active matrix liquid crystal display, ferroelectric liquid crystal display, and organic light-emitting diodes or OLED displays. We are working with partners to develop organic light-emitting diode displays, which our company names Micro LEDs. All our microdisplays are optimized on silicon. Just as important as our breadth of display technologies to meet customer needs is the variety of advanced specialized optics that we offer, providing our customers with an integrated turnkey solution. This allows our customers to offer high-quality visual solutions to meet various needs in the market. For example, our new patent-pending All-Plastic Pancake Optics enables smaller and much lighter weight VR headsets, including Metaverse headsets, compared to the optics used in headsets today. We believe our All-Plastic Pancake Optics are the first in the world providing critical components for Metaverse headsets that are thinner, lighter, more comfortable, and easy to use, which has been one of our critical objectives. Our all-plastic pancake optics provide not only the clear advantages mentioned before, but most importantly, they provide a very sharp image with good eye relief. We believe combining our all-plastic pancake optics with our 2.6 OLED microdisplays represents a perfect match providing magnification from 30,000 to 50,000 times while maintaining a very sharp image. Our goal has always remained the same, which is to lead in these two critical technology areas essential for great VR and AR experiences. This is a good place to emphasize the importance of microdisplays and pancake optics in the proper context. These two technologies are analogous in importance as lithium battery technologies to the electric vehicle industry. Our second quarter growth occurred amidst global supply chain issues. While we are pleased with our growth, it did come at a cost. As our press release indicates, we will incur more costs to keep our customers and operations running than we would normally expect. Typically, a defense product design has a lifecycle of about five to seven years. However, due to supply chain issues and our limited visibility regarding when those will be resolved, we have designed several products to automate semiconductor components, so we have flexibility and a backup plan. This has increased our engineering impact costs. We also incurred additional costs due to sourcing alternative semiconductor components. The positive news is, based on discussions with our vendors, it appears the supply chain issues are improving, and we believe our operations in the second half of 2022 will run closer to normal. Furthermore, we expect our second half revenue to be higher than our first half revenue as our defense business is expected to be stronger. Now let me provide an update on the progress of developing our micro-OLED product line. We're currently designing multiple backplanes for partners and customers and are also in discussions with partners for more advanced OLED designs for use in virtual reality and augmented reality systems. What draws customers to us is our unique, industry-leading 2.6k OLED display and our deep knowledge of display and optics as a system. Customers appreciate the high resolution, and the 1.3-inch size provides for better optics. The 2.6 display is essentially a display on a chip, which features embedded circuits and digital processing that simplify the interface and significantly reduce power consumption. One additional technical advantage we provide is the built-in drive in OLED displays as opposed to the current drive. Kopin has designed our 2.6 OLED display using built-in drive technology. This is a significant improvement, as built-in versus current drive discussion is currently a hot topic in the industry. This improvement results in much lower power consumption, especially as micro-display resolutions increase. Kopin's micro OLED displays have been shown to consume significantly less power than those of other suppliers. We are now discussing how to leverage our 2.6 display design to achieve higher resolutions, such as 4K HDR displays. As we have previously mentioned, our OLED product line operates on a fabless business model. Under this model, we sell finished OLED microdisplays to customers while working with our OLED foundry partners who complete the microdisplay for their own customer base. This business model gives us flexibility to meet customer demands. Turning to our research and development activities, we continue to make excellent progress in developing a micro LED display. This is a customer-funded project with many partners, similar to how we created our current LCD in the early 1990s with a $50 million funding from DARPA. To be clear, this is a long-term development project, but if we are successful, the display will open tremendous opportunities. In summary, customer demand is strong for our core product line, especially in our defense sector. We are aggressively managing our supply chain challenges, continuing our momentum on innovating and advancing our technology for Metaverse applications. We continue to see strong interest in developing products targeted for defense, and we feel we're well-positioned to capitalize on the opportunities it presents. We are excited for the growth of Kopin, as we see a wave of rapidly growing interest in our microdisplay and optics in AR and VR across our products and applications, starting from defense and enterprise and now moving into consumer sectors. Our technology advances and current market conditions are very favorable, and we believe Kopin is well-positioned to capitalize.

Thank you, John. Turning to our financial results, product revenues for the second quarter ended June 25, 2022, were $9 million compared with $6.9 million for the second quarter ended June 26, 2021, representing a 30% increase year-over-year. Funded research and development revenues were $2.8 million for the second quarter ended June 25, 2022, compared with $2.7 million for the second quarter ended June 26, 2021, essentially flat. Total revenues for Q2 2022 were $11.9 million versus $9.9 million in the prior year, reflecting an overall 20% increase year-over-year. Cost of Goods Sold for the second quarter of 2022 was $7.9 million or 88% of product revenues, compared with $6 million or 87% for the second quarter of last year. The slight increase in cost as a percentage of net product revenues for the three months ended June 25, 2022, compared to the prior year, was primarily due to manufacturing inefficiencies caused by supply chain disruptions. R&D expenses in the second quarter of 2022 were $5.1 million, compared with $3.7 million for the second quarter of 2021. The increase in the 2022 second quarter R&D expense compared to the prior year was almost equally split between internal R&D expenses and customer-funded R&D activities. The increase in internal R&D was primarily due to an uptick in OLED development costs and the redesign of specific products to incorporate alternative semiconductor components due to the shortage of legacy semiconductor components. The increase in funded R&D was in support of customer-funded activities related to defense programs. SG&A was $4.3 million in the second quarter of 2022, compared to $4 million in the second quarter of 2021. The SG&A increase for the three months ended June 25, 2022, compared to the same period in 2021, was primarily due to increased compensation, information technology, and travel costs, which were partially offset by lower bad debt expenses and stock-based compensation expenses. Other income/expense was an expense of approximately $141,000 for the second quarter of 2022, compared with $104,000 of income for the second quarter of 2021. During the three months ended June 25, 2022, we recorded a foreign currency loss of $150,000 compared to a foreign currency gain of $101,000 for the three months ended June 26, 2021. Turning to the bottom line, our net loss attributable to controlling interest for the quarter was approximately $5.6 million or $0.06 per share, compared with a net loss of $3.8 million or $0.04 per share in the second quarter of 2021. Net cash used in operating activities for the six months ended June 25, 2022, was approximately $11.4 million. As John and I have discussed, supply chain issues affected our manufacturing efficiencies, which increased costs and negatively impacted working capital flow in the first half of the year. In addition, as we mentioned, we received a production order for beryllium displays for rotary wing aircraft, and we expect another program to transition into production in the second half of 2022, which may require additional working capital. Accordingly, the management team approved partial funding for our working capital needs through our at-the-market equity offering program or ATM. During the second quarter of 2022, we sold 1.7 million shares of common stock resulting in gross proceeds of $2.1 million before deducting broker expenses of less than $100,000 pursuant to the company's ATM. Going forward, we're reviewing other funding alternatives. Kopin's cash equivalents and marketable securities were approximately $18.6 million at June 25, 2022, compared to $29.3 million at December 25, 2021. We have no long-term debt. Second quarter amounts for depreciation and stock compensation expenses are attached in a table to the Q2 press release. The amounts discussed above are based on current estimates, and listeners should review our Form 10-Q for the second quarter of 2022 to see any possible changes and additional disclosures. And with that operator, we'll be happy to take questions.

Thank you. We will now start the question-and-answer session. The first question comes from Glenn Mattson with Ladenburg Thalmann. Please go ahead.

Hi, thanks for taking my question. Rich, you mentioned something previously that piqued my interest regarding cash burn and your current situation. I assume you anticipate a stronger second half with the new orders and ongoing defense projects. However, you also mentioned the need to build working capital. Do you foresee continuing to burn cash at the current rate, or will the burn be less severe, or is there a chance for cash flow from operations to turn positive? What’s your outlook for the second half? Thanks.

Yes. The first half, we look at as an anomaly. We had supply chain disruptions at the end of the first quarter that carried into the second quarter. As a result, receivables got collected during the second quarter but then had to be rebuilt at the end of the second quarter. So, when you see the cash flow statement coming out, what you'll see is a change in the receivables that really caused the issue. We expect that to moderate as we've rebuilt the receivables. So our working capital looks more normalized than it should be. We don't expect any working capital fluctuations in the second half. With improving operations, and the fact that we're not going to experience this anomaly of receivables getting burned down, we expect the cash flow to be better in the second half.

Okay. And I'm curious about the decision to sell stock at that level and what kind of signal it sends. I understand that you adjusted to grow more comfortable around preparing for these bigger orders. Also, could you elaborate, have you done any more sales since the quarter ended? Are you also kind of mentioned that there are other options for capital raising activity if needed? So can you just elaborate on that? Thanks.

Sure. Yes. I mean, nobody was particularly happy exercising at that price in the ATM that we had down a quarter, but we did think it was prudent. There's a lot of talk about recession, and we weren't sure what the supply chain situation was going to look like. As John stated in his prepared remarks, the good news is, it looks like from what we're hearing that supply chain issues for us seem to have, for the most part, been sorted out for the rest of the year. We took a lot of actions just in case. We redesigned some of the boards we use in our products, which led to incremental development costs we hadn't anticipated. We sourced alternative semiconductor materials, which now seems like we probably won't use in the short term. There were just expenses associated with ensuring that we could fulfill our contractual obligations, but we don't see any of that in the second half of the year. In the past, when we had sufficient time to explore other types of funding, it usually revolved around getting pre-payments on long-term contracts from customers. We’ll continue to explore those opportunities. The other important factor is that, sitting here today, we have two programs, F-35 and FWS-I, which are in solid production, and we have three emerging production programs for which we are the sole source. Maintaining a very strong balance sheet is crucial for ensuring these programs continue. For these reasons, we thought it was the right move to exercise the ATM.

I think Glenn, one more thing I want to mention is that we are looking at other ways, but our customers, because we're the sole source for them, are helping us alleviate some of those procurement issues. So we expect much better performance in the next half.

Great. That's it for me. Thanks for the insight guys, and it seems the defense business is going really well, so it's exciting to watch that continue. Thanks.

Yes. We are winning a lot more orders, and this is certainly the most important thing that technology and orders we currently have.

The next question comes from Kevin Dede with H.C. Wainwright. Please go ahead.

Good morning, gentlemen. Thanks for having me on the call. A couple of things, I guess one is tied to inventory. I understand the supply chain issue and sourcing, inventories seem to have increased sequentially compared to how they were probably depressed in the March quarter. I know Rich you just mentioned that you probably acquired material you won't sell. What do you suspect happens with inventory and its tie to margin through the balance of the year?

So we expect improving gross margins, and we would expect to maintain current inventory levels. We don’t see any major fluctuations in inventory levels at this time.

Okay. About the defense product projects aside from the FWS-I and F-35, can you talk to the three that you mentioned, Rich, and where they are in terms of their development cycle and transitioning to full production?

Yes. We expect all of them to enter full production in the first half of next year. One is the beryllium display for rotary aircraft; another is an international weapon's site similar to the FWS-I that we currently sell. As mentioned in the press release, the chaos in Europe is actually increasing demand for those types of products. We're receiving positive feedback from customers about future orders on those. The other involves a unique targeting system that we sell, but I can't go into further detail about its functionality.

Okay. Fair enough. Has the chaos in Europe accelerated development? It's interesting to see the sequential change in research and development costs, as I left the March quarter call thinking military development might increase. Could you help me understand that?

Well, again, we recognize revenue based on percent completion. As John mentioned, for instance, the micro LED program is a consortium of companies collaborating on that display, and our revenues are tied to their completion of tasks. So, to the extent that they make progress, we recognize more revenue. That’s why it’s challenging to project that funded R&D line because, as I said, particularly with the micro LED, we're depending on a number of subcontractors for performance.

Is that the lion's share of that line?

It's a significant part of it. Additionally, the beryllium display project was winding down during this period.

Yes. This is a consortium business technology, and early demonstrations of micro LEDs are already occurring. We have ongoing activities in the U.K. consortium as well as Japan and partially in China; however, most activities are based in the U.S. and the U.K. at this point.

Okay. I know you’ve provided some interesting insights into micro LED development over the past year. Could you possibly provide a better timeline for commercialization?

It’s a targeted tool at this point. This product is aimed first at defense and enterprise applications, with eventual transition to consumer markets as a very ambitious target. While I can't confirm success, if anyone can succeed, we stand a good chance.

Is it too early to offer a timeline?

I mean, we want to be optimistic. We have a very capable team in place, which improves our chances of success.

Regarding the Department of Defense projects you haven’t discussed, do you have any insight into how these may be advancing due to the geopolitical situation?

Yes. We announced activities about our imaging systems for armored vehicles. We believe political tensions will drive demand for new imaging systems, and we have a sole-sourced presence in that sector. Activities are progressing at full speed, and working capital has increased accordingly due to many new production programs transitioning to production and the R&D activity associated with this, some being internally funded. We're currently experiencing a winning cycle, and yes, the ATM is just one of our options for raising more funds, which we plan to explore.

Okay. There was a $2 million development related to vehicle imaging, is that the one you're referencing, John? That appears to be the second system development order?

Yes, that's the one, Kevin. I’m very excited about that program because I believe it will lead to a major pipeline of revenue for us as we are the sole source and working with a significant customer.

To circle back around on timing, was the second order expedited due to the situation in Europe? If so, how much quicker did it come in?

I can't comment specifically on that, as we have multiple simultaneous activities ongoing.

Can you discuss the metrology market, John? I know you mentioned that you have all three customers in South Korea, and I’d love to hear your perspective on fab development in the U.S. It's a highly controversial topic and would be interesting to hear your vision about how foundries and semiconductor manufacturing might expand in the U.S. and how that could benefit Kopin.

Yes, it is indeed a compelling topic. Countries are racing to develop new semiconductor fabs. As you may have noted recently, the industry is evolving towards a 3D chip design by stacking chips. We see a landscape shifting from 2D to 3D structures. We operate in what we call the 3D metrology sector, which is an emerging business. Currently, our portfolio-owned subsidiary FTD holds about 40% market share globally, while TI captures another 40% using DLP technology. This transition to 3D will take some time as manufacturers are hesitant to change their factories, but it will happen, and new factories will certainly require our expertise.

Thank you, gentlemen, for addressing my questions. I appreciate it.

Thank you for your questions, Kevin.

And that concludes our time for questions. I would like to turn the conference call back over to Dr. Fan for closing remarks.

Thank you for joining us today, and we hope to hear from you next time.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.