Earnings Call Transcript - KOPN Q1 2022

Operator, Operator

Ladies and gentlemen, please standby. We're about to begin. Good day and welcome to Kopin's first-quarter 2022 earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Richard Sneider, Chief Financial Officer. Please go ahead, sir.

Richard Sneider, CFO

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. And then I will go through the first quarter of 2022 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, May 3rd, 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.

John Fan, CEO

Thank you, Richard. Good morning. And thank you all for joining us to discuss our first quarter results of 2022. I am speaking from Hong Kong this evening, which is 12 hours ahead of Boston time. And hopefully, my home connection is good. I must say, I'm very happy to be able to travel again and to meet with customers, which is so important in developing our business. On my way home, I will be streamed by the 2022 Society of Information Displays Ossid Trade Show, which is taking place in early May in San Jose. Turning to that form of business, we are pleased with the results of the first quarter of 2022. Overall, year-over-year revenue was flat as our product sales were lowered. They were offset by our strong funded research and development revenues. Our product revenues were affected by the global supply chain issues, particularly during the last couple of weeks of the quarter. As a result, we were 12% or 14% lower than one of last year. In the past few quarters' earnings calls, we have mentioned our concern about the global supply chain production issues. While a 14% year-over-year decline in product revenues is not something that we're pleased with, given the circumstances we are now in, we're also not discouraged about it. Demand for our products remains strong. Let me explain why this issue is challenging to deal with. Because we make very complex components and their assemblies, which go into extremely sophisticated interdependent defense and industrial systems, we cannot simply switch a component to ensure supply with another component. When we identify an issue and see a need to switch to a different component, we must notify our customer, displaying our plan, and in most cases, have to obtain their formal approval. Then we must perform extensive testing on our revised product to ensure its compliance with the specifications, and provide the testing results to our customers for their review. Then our customer may be required to perform extensive system testing and obtain their own customer's approval. This process is time-consuming. It means that in addition to our normal development activities, we must allocate resources to identify replacement components and perform additional testing. In spite of all this, we were able to achieve a relatively high level of manufacturing while allocating resources to address these historic issues and also make progress in our development activities, which are really crucial to our long-term growth. This is why overall, we're satisfied with the first-quarter results. We continue to actively manage the supply chain issues. And while we expect intermittent supply chain disruptions of raw materials, we will have sufficient components to continue our 2022 growth over 2021. As we had previously discussed in the fourth quarter of 2021, we announced new orders of our current production program, F-35, and our major weapon sight program. This gives us a strong foundation for 2022 product revenues. Looking out into the future of our current programs, we received feedback that the very unfortunate situation in Ukraine may eventually result in more product demand. Turning to our Organic Light-Emitting Diode program, our briefing press release indicated we're making good progress in building this business. As discussed in the press release, we revealed that we received a production order for our 2720p lighting OLED displays. In other cases, a foundry customer is buying out silicon wafers, which are the fundamental building blocks to make OLED displays. We believe these two new orders are significant to the competitive advantage of our silicon backplane design and display performance, and also validates the power of our business model. Under our model, we either sell finished OLED displays to our customers, working with our OLED foundry partners, or we sell silicon wafers to our OLED OEM partners who complete the micro displays for sale to their own customer base. This business model provides us with a lot of visibility to meet customer demands without incurring the major fixed capital investment associated with our lead deposition process. We continue to work on design wins with other new customers. Regarding our research and development programs, we continue to make excellent progress on our customer-funded defense development programs, which include armored vehicle targeting systems, rotary wing aircraft, pilot helmets, and additional weapon sight programs. We expect the rotary wing program to go to production in the second half of this year and the armored vehicle program to go to production after 2023. Perhaps it is important to point out the breadth of the scope of our defense business. As a reminder, Kopin provides advanced backward space optics and rugged, dust-free assemblies. For fighter jets, such as F35 or rotary wing aircraft, we provide displays. For gun sights, we provide displays, optics, and module assemblies. Now, for armored vehicles, we actually provide complete system units that include displays, optics, electronics, etc. Currently, all our defense business and enterprise business are based on events, LCD on silicon displays. However, we've been actively developing OLED-On-Silicon displays for over five years, and now we are one of the leading OLED-On-Silicon displays developers. I must mention some longer-term development projects are focused on Macro LED. Macro LED displays have the potential for super high brightness and low power consumption, which can make them ideal for many applications, including see-through, augmented reality, and mixed reality applications. In summary, customer demand is strong across all our core product groups, and we are actively managing our supply chain challenges. We will continue our momentum in innovating and advancing our technology for AR/VR and MR applications. We believe strong interest in the Metaverse is just getting started, and we feel we are very well positioned to capitalize on the opportunities it provides. We entered 2022 with a very strong backlog of orders, and we believe 2022 will be another year of good growth. We're excited for the growth of Kopin as we see a wave of growing interest in AR/VR and MR product applications. Our technology advances and current market conditions are very favorable. And we believe Kopin is very well positioned to capitalize on this. Finally, I would like to make a comment on the equity gain in Q1. As some of you know, Kopin is very strong in IPs with over 200 patents and patent applications providing display optics and module assemblies. One of the IP monetization strategies is to license some of our IPs to startup companies. As a part of a conversation, we often receive equities in the startups. We've completed a few of those transactions and our goal is to do more. Some of the early transactions are moving to more mature stages. We're actually very excited with this IP business model.

Richard Sneider, CFO

Total revenues for the first quarter ended March 26, 2022, were $11.6 million compared with $11.7 million for the first quarter ended March 27, 2021, essentially flat year-over-year. Cost of products sold for the first quarter ended March 26, 2022, were $7.8 million compared with $6.4 million for the first quarter ended March 27, 2021. The increase in cost of sales as a percent of product revenues for the first quarter of 2022 as compared to the first quarter of 2021 was due to lower production efficiencies resulting from the lower volume of units produced. Approximately $450,000 of warranty costs reserves and approximately $300,000 of additional reserves for excess material. The lower production volumes resulted in less absorption of overhead costs. The additional warranty costs reserves relate to units shipped before the new production processes the company implemented in 2021, and the additional reserves for excess material are a result of the company procuring materials for contingency purposes as a result of the supply chain situation. Research and development, or R&D expenses for the first quarter of 2022 were $5.4 million compared to $3.6 million for the first quarter of 2021, a 52% increase year-over-year. R&D expenses for the three months ended March 26th increased as compared to three months ended March 27th, 2021, primarily due to increased spending on U.S.-funded development programs and internal R&D expenses for Organic Light Emitting Diode or OLED development. SG&A expenses were $4.4 million for the first quarter of 2022 compared to $5.9 million for the first quarter of 2021. SG&A expenses ended March 27th, 2021, with approximately $2.4 million of stock-based compensation costs as compared to $440,000 for the same period in 2022. Excluding the stock-based compensation costs, SG&A expenses were $4 million for the first quarter of 2022 compared to $3.5 million for the first quarter of 2021. The increase is attributed to marketing expenses, which were curtailed during COVID, and additional compensation costs. Other income was approximately $4.7 million for the first quarter of 2022, primarily resulting from the mark-to-market of an equity investment. As John discussed, part of Kopin's strategy is to monetize our deep intellectual property portfolio, and as part of that, we received an equity interest in certain licensee companies when we licensed the IP to them. During the three months ended March 26, 2021, we recorded $35,000 of foreign currency gains as compared to $28,000 of foreign currency gains for the three months ended March 27th, 2021. Bottom line, our net loss attributable to Kopin Corporation for the first quarter of 2022 was approximately $1.4 million or $0.02 per share compared to a net loss attributable to Kopin Corporation of $4.1 million or $0.05 per share for the first quarter of 2021. Kopin's cash and equivalents and marketable securities were approximately $26.3 million at March 26th, 2022, as compared to $29.2 million at December 25th, 2021. First quarter amounts for depreciation stock comp expense are attached in the table for the Q1 press release. The amounts discussed above are based on current estimates and listeners should review our Form 10-Q for the first quarter of 2022 for any possible changes and additional disclosures.

Operator, Operator

We will now take questions.

Glenn Mattson, Analyst

Hi, thanks for taking the question. Regarding the top-line, can you just talk about the lower component revenue being pretty evenly split, I guess, between military and industrial? Is that all related to supply chain issues and there was nothing around demand? Also, can you just touch on the status of the customer where mid last year you had to retool the facility and that kind of ramp back up and got into back to normal production? Is that still the case with that customer as well?

Richard Sneider, CFO

In both cases, yes, it was supply chain issues in both the defense and the industrial. And it really was the last couple of weeks of the quarter when it hit us. And so as John indicated in prepared remarks, we think we're in good shape going forward. We do expect intermediate supply chain issues now and again. We're not out of the woods. There are some indications that the situation is getting better, but we want to be cautious to the investors. And at this point, yes, the process changes have been made that we discussed in 2021. The $450,000 of additional warranty costs was the last piece of it. It was a negotiated settlement of units shipped before the process changes. So we think for the most part it's behind us now and now it's just fulfilling demand, which as John indicated, we start the year off with a very strong backlog.

Glenn Mattson, Analyst

Would there be any catch-up in revenue over the next couple of quarters, based on the fact that the demand was there and now the supply chain issues perhaps are in a better situation? Is that something to think about?

Richard Sneider, CFO

It's definitely the goal.

John Fan, CEO

Yeah, that's why we said it's a big growth.

Glenn Mattson, Analyst

Can you discuss the upcoming Oculus? I understand they are incorporating an OLED display. What are your thoughts on this new product and its implications for your work? It doesn't seem like you're directly involved with them, but if the industry is heading in that direction, could that benefit your company?

John Fan, CEO

This is not completely official yet, but we can make an educated guess. It appears to be OLED, specifically OLED on glass. It is not OLED on silicon, which is still positive news. Currently, the existing technology involves LCD on glass, indicating a transition from LCD to OLED that we have always expected. We believe the next step will be OLED on silicon, which is promising news. Additionally, we have a global trademark on Pancake optics. One version of our Pancake includes some glass, although it is not entirely plastic. This version reflects the current direction of the market. Technology in optics is advancing towards Pancake, while displays are transitioning to OLED, but not entirely; displays are moving to OLED on glass, rather than OLED on silicon, and Pancake will have glass components, not plastic. I hope this addresses your question. It's a positive trend.

Glenn Mattson, Analyst

That's very helpful.

Kevin Dede, Analyst

Could you comment on the number of devices that you had to re-engineer the supply chain on and, I guess, the number of components that had to go through additional testing?

John Fan, CEO

There's so much involved with defense.

Richard Sneider, CFO

Honestly, Kevin, we did get a notification from the U.S. government that there are a lot of supply chain issues out there, and they are somewhat concerned about companies defaulting information around it. And they referenced us through the regulations, which prohibit discussions about systems and how they operate.

John Fan, CEO

I think, Kevin, as you well know, the supply chain issue is not unique to Kopin. It's just semiconductor chips that are missing. Some of the chips, they're really not advanced, but they are missing. This affects everybody, whether it's defense industry or industrial industry. In many ways, I am pleased that people are actually managing it reasonably well.

Kevin Dede, Analyst

Rich, you mentioned you didn't think you were out of the woods yet. What do you think we should look out for?

Richard Sneider, CFO

We have commitments from vendors, which suggests that we are in a good position for the remainder of the year. However, I want to emphasize that it is unrealistic to believe that we have fully resolved the challenges. Based on our conversations with industry peers, there seems to be some optimism about improvements ahead. Nevertheless, we want to ensure we achieve a couple more solid quarters before anyone concludes that the difficulties are completely behind us.

Kevin Dede, Analyst

You've referenced backlog a number of times. I guess you don't want to quantify it, which is fair, but can you give us a relative move versus the end of the year?

Richard Sneider, CFO

We did indicate that we had a $19.8 million quarter purchase order in December. In November, we had a 2.3 and then there was another million something for another program. So those were all in November, December. So you can assume that's all shipping this year and possibly into the beginning of next year. But the bulk of it will be this year.

John Fan, CEO

Micro OLED is often regarded as the ultimate display, which is accurate. We have developed and produced it in a cost-efficient manner. However, achieving all our objectives in AR/VR and MR has been challenging. We are collaborating with a Chinese company, Monochrome Micro OLED, as well as a Japanese company to create full-color Micro-LEDs. Both are advanced Micro-LED technologies. This is a significant customer-funded initiative, and progress is encouraging. There has been considerable purchasing activity in China, which has delayed some announcements for this quarter. Overall, we are making good progress, although some lockdowns have slowed certain activities.

Kevin Dede, Analyst

How would you recommend we look at time-to-market?

John Fan, CEO

Time-to-market for Macro LED, nobody can give you. Nobody is going to get into the real market for Macro LED this year, zero.

Kevin Dede, Analyst

That means you could have a product next year maybe, right '23?

John Fan, CEO

God willing. Our goal is to demonstrate the potential of this display and show the display this year. If we can do that, it could be a major achievement, not just for Kopin, but for the industry.

Kevin Dede, Analyst

I know you referenced the conflict in Europe. I was wondering if you've seen any change in thinking because of that from your defense-related customers.

John Fan, CEO

Well, I mean, nobody wants to celebrate for such a disaster, but we are in the defense industry, and we do make systems and help to components for the systems, which are used extensively in the war.

Kevin Dede, Analyst

Is there greater interest on the part of your customers in some of the products that you're making involved?

John Fan, CEO

That was announced, so we can say that. Germany announced that they want to buy more F-35. I think we can connect the dots.

Kevin Dede, Analyst

I'm also correct in assuming that the supply chain is predominantly in the U.S., or you're still sourcing products from Asia that go into defense-related components?

John Fan, CEO

Yeah. I think as you well know, a lot of supply chain problems are agonizing because the automobile industry is affected by that too. What you're missing is a microcontroller, which is a very low-tech product. It's made by everybody in the whole world; Taiwan, Korea, China, and Japan. But they're short. Once they're short, you can't even sell a car. Everybody that is a buyer of microcontroller, not advanced ICs, it's really maintain ICs. So for us, it's just like the automobile industry. You can't find an IC that's needed. You have to get your customers the proven and date of compliance, so you slow down things. But it's not fundamental. It's not that IC cannot be found anywhere. It is a very common IC. So patiently you cannot get it. For instance, the obvious one is in China. Those ICs come from everyone in the world. It's just that it's short. Everybody has double trouble buying them.

Kevin Dede, Analyst

Again, thank you. Could you share your thoughts on the progress of Real Wears OLOS in terms of making advancements?

Richard Sneider, CFO

Sort of just to finish that.

John Fan, CEO

I'm glad you mentioned it. Those are the companies that we license, and they in fact pay equities in. I don't want to go a lot into it obviously, some of them are already making progress and so we have an equity gain. And I think that will continue. The one that will form three, four, five years ago is just like a VC situation. Some of them have become mature stages now, and you're going to have a series of hopefully monetizations in the same way we did as like VC. Once we do sell products, we can do more and more into assemblies in the Amex vehicles, and with IP models.

Kevin Dede, Analyst

Okay. Thank you. Thanks for taking my questions, gentlemen. Appreciate it.

John Fan, CEO

Very good question, thank you. I wish that you were also in Asia. I was traveling. It's not easy traveling in Asia. I got locked down. I got quarantined for seven days, and I just got out.

Operator, Operator

We'll have the next question from Patrick Metcalf. Your line is open, Patrick. Please go ahead.