Earnings Call Transcript - KOPN Q2 2020

Operator, Operator

Good day, and welcome to the Kopin Corporation Second Quarter 2020 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Rich 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 strategy, technology and markets. I will go through the second quarter results at a high level and then we'll be happy to take your questions. I would like to remind everyone that during today's call, taking place on Tuesday, August 4, 2020, 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 materially differ from those forward-looking statements. Potential risks include, but are not limited to, demand for our products, operating results of our subsidiaries and 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'll turn the call over to John.

John Fan, CEO

Good morning and thank you for joining us to discuss our second quarter results. Given the continued unprecedented circumstances that we all are currently facing, I want to start by expressing our hope that all of you and your families are staying well and safe. We are very pleased with our Q2 results both from our operations and technical standpoint. With a solid Q1 momentum continuing into the second quarter, we had very strong revenue growth, driven by defense business, which increased 150% over the prior year. We saw expanding gross margins for improved manufacturing efficiencies and our cost structure continues to decline significantly. As we continue to execute our strategy that reinstitutes our direction. The second quarter also saw the first production shipment of our OLED Backplane wafers, and we are encouraged by that as we increase our focus on our OLED displays. We also made a very exciting announcement this morning regarding our further technology development advancements in OLED. I will discuss that more in a moment. So, we had a very successful first half of the year and we look forward to continued momentum in the second half of this year and beyond. Well, let us look more closely at our defense business. As I have discussed previously, we have commenced production in our two important programs, the F-35 Fighter Jet program and the FWS-I program. These two programs again drove our defense business and revenue in the last quarter. We also made further progress on a number of other development programs moving closer to production as the scope of some of these programs continues to expand. These important steps on defense programs are actually related to many different areas, including fixed-wing and rotary planes, armed vehicles, and offerings for our soldiers already. We are gaining additional leverage for these development products as we can use the knowledge in future industrial and consumer applications. This large portfolio of programs presents significant revenue opportunities. However, there is no guarantee all those programs will reach production stages. We expect these additional programs will reach production by the end of 2021, so Kopin should have five to ten programs generating production and revenues. Shifting to initial production orders about OLED Backplane wafers, one of the important steps is by expanding into that business. We are also pleased to receive follow-up orders. Starting out from last quarter end, we will introduce a breakthrough lining 2.6K x 2.6K display based on our ColorMax technology. This technology utilizes what’s referred to as a reduced OLED, which has three OLED structures stacked on top of each other. The two OLEDs are connected in series with a carrier pass to the two-stack OLED which generates full touch flat instead of what exists in conventional single-stack OLED. The two-stack provides a lot more flexibility in the OLED design and a huge selection versus the single-stack, which can be much higher in efficacy and reduces real color consumption while having longer life. What’s particularly impressive about this dual-stack display is the ratio of Nits per amp. Now let me explain to you, Nits is a measure of brightness. Historically, you could keep a very high brightness in Nits by running a lot of current through the ambient. However, running at high current significantly shortens the life of the display and adds costs. Kopin is developing a unique technology we call ColorMax that allows the lining 2.6K x 2.6K display to achieve remarkable color fidelity, greater than 115% sRGB brightness while using a very low current. The ratio of candela per amp, which is an index of performance, is now over 6, which is particularly exciting. In the press release we issued this morning, we discussed Nits and highlighted a new level; our results came in above previous months' expectations and provided a lot of understanding and confidence. Essentially, Kopin has now achieved 7,000 Nits with our new lining 720p OLED display. Going back to the figures, the candela per amp has gone up from 6 to a total of 14 in two months. This new dual-stack can really now address the issues around brightness. As COVID-19 has accelerated interest in AR and VR, it is important to not only break through technological barriers. While it’s too early for this technology to reach its full potential, we look forward to sharing much more in the coming months. Finally, I have to thank the Kopin employees who are continuing to work throughout these challenging times. Their dedication has made this possible and we appreciate all their efforts to stay safe and healthy. With that, I will turn the call back to Rich.

Richard Sneider, CFO

Thank you, John. Turning to our financial results. Product revenues for the second quarter ended June 27, 2020 were $8.7 million compared to $4.4 million for the second quarter ended June 29, 2019, which is a 50% increase year-over-year. Research and development and other revenues were $2.1 million for the second quarter ended June 27, 2020, compared with $4.7 million for the second quarter ended June 29, 2019. Included in the $4.7 million of revenues in the second quarter of 2019 was a one-time license fee payment of $3.5 million. Total revenues for Q2 2020 were $8.8 million versus $9.1 million in the prior year, with 2019 reflecting the $3.5 million one-time payment. Cost of goods sold for the second quarter of 2020 was $4.8 million or 72% of product revenue, compared with $5.3 million or 118% for the second quarter of last year. The significant decrease in cost of product revenue is attributed to a decline in net product revenues for the three months ended June 27, 2020, compared to the same period in 2019, primarily due to lower fuel costs, along with improvements in manufacturing yield efficiencies due to higher sales volume and reduced fixed costs per unit than we have planned. As a reminder, we were commencing production of certain products and experienced higher than normal scrap for the first three and six months of 2019 as compared to the same period of 2020. R&D expenses in the second quarter of 2020 were $2.2 million, compared with $3.3 million for the second quarter of 2019. The lower R&D costs for the second quarter of 2020 compared to the prior year were a result of IT commercialization strategies put in place in 2019, specifically the licensing of Golden-I Infinity and Solos smart glasses. SG&A expenses were $2.9 million in the second quarter of 2020, compared to $5.4 million in the second quarter of 2019. The decrease was primarily due to lower compensation expenses, including stock-based compensation, bad debt expense, professional fees, information technology expenses, travel, and the accretion of the NVIS contingent consideration. Other income, expense was an expense of approximately $6,000 for the second quarter of 2020, compared with $627,000 of income for the second quarter of 2019. During the three months ended June 27, 2020, we recorded $10,000 of foreign currency gains as compared to $184,000 of foreign currency losses for the three months ended June 29, 2019. The three months ended June 29, 2019 also included a mark-to-market gain on an investment of $768,000. Turning to the bottom line, our net loss attributable to controlling interest for the quarter was approximately $1 million, or $0.01 per share, compared with a net loss of $4.3 million, or $0.05 per share in the second quarter of 2019, which is a 77% improvement. Kopin’s cash equivalent and marketable securities were approximately $15.3 million at June 27, 2020, as compared to $21.8 million at December 28, 2019. Second quarter amounts for depreciation and stock compensation are attached in the table to the Q2 press release. The above amounts discussed are based on current estimates, and listeners should review our final Form 10-Q for the second quarter of 2020 for any possible changes and additional disclosures. And with that operator, we will take questions.

Operator, Operator

And we will take our first question from Glenn Mattson with Ladenburg.

Glenn Mattson, Analyst

Hi. Thanks for taking the question and congrats on the results. So, for Rich first, just – you just mentioned some of the operating highlights, the decrease in cost of goods sold. It sounds like a lot of leverage due to efficiencies related to volume. I guess, the gross margin was in line with what we expected, so, is that kind of the run rate we should expect as a ballpark going forward for a while here or just some color there please?

Richard Sneider, CFO

Yes. The current gross margin percentage is a good parameter for the next couple of quarters.

Glenn Mattson, Analyst

Great. And on the SG&A expense, you also noted that some of that is the reduced travel and other efficiencies. Is that also – maybe there is a lower sales expense related to selling to military perhaps. Again, that’s the bigger portion of that pie right now or are there also some sales expenses?

Richard Sneider, CFO

Yes. We would expect SG&A might pop up a little bit over the next couple of quarters. We do have some litigation which frankly has been on the back burner as the courts have been closed. Assuming they come back, there are also going to be traditional legal expenses of a couple of hundred thousand to $300,000 a quarter. Otherwise, it should be relatively consistent.

Glenn Mattson, Analyst

Okay. And do you have any operating cash burn in CapEx in the quarter? Or operating cash flows?

Richard Sneider, CFO

Yes. So the burn for the quarter, cash used in operations was $2.9 million. CapEx was de minimis and sort of in line with our plans.

Glenn Mattson, Analyst

And lastly, on the top-line, was there anything in terms of the order flow that boosted this quarter, the pull in on the military side or is this just a function of the programs kicking in?

Richard Sneider, CFO

Well, yes. I mean, you will see that the contract assets on the balance sheet are up, and that’s a function of the 606 revenue recognition standard. So, two years ago, units that we would have made would have been sitting in finished goods. Today, those are sitting in contract assets and there is revenue recognized on them. That’s really the only difference. The other piece, of course, is that we have a significant number of R&D programs going on and that revenue is also recognized on a percent of completion basis. So, when we hit a billing milestone, the 'unbilled' receivable collection goes into the contract asset account. But that’s fairly consistent with what we’ve been doing for the last 20 years.

Glenn Mattson, Analyst

Right. On the military side, I missed the quote was, three programs to reach production by the end of 2020 or 2021, three programs?

Richard Sneider, CFO

So this, we will end 2020 with the two programs in production and we expect to end 2021 with five programs in production.

Glenn Mattson, Analyst

Right. And can you give us any big investor calls as a concern of order of magnitude of how decisive either what that incremental adds or would the total pie look like with these five programs' earnings revenue?

Richard Sneider, CFO

No, we are not going to give any revenue guidance for 2021 today. I mean, these are all very large programs. I can’t say that, but we have to look at qualification. Whether and if during the course of the next year they get into production depends upon the R&D qualifying them. So, we do feel confident that we will actually be able to reach production, but we’ve got to focus on new purchases and production after reaching that stage.

Glenn Mattson, Analyst

Okay, great. Thanks. On the industrial side, if you want to answer this, that would be great. It’s just the – I guess, two things. One, the way I think about it - correct me if I am wrong, is that 2019 was a year when a lot of these heading out to display, headsets were put into various corporations, Honeywell, and people like that and perhaps they went into the field quickly. In 2020 maybe there has been a bit of a digestion period where these companies are deciding just where they want to put their products, how they most efficiently use this and then maybe work around some safety and security issues there. So, maybe 2020 becomes a digesting year and 2021 maybe sees a bit of a bounce back. Is that the way we should think about it for the head mounted displays market?

Richard Sneider, CFO

Yes. I think that’s exactly right. In other revenues, for the quarter it’s $300,000 to $400,000 of royalties, and that’s consistent with the prior years. So, it tells us that they are selling units – our customers are selling units, but they may be working off of inventory because, as you say, there are products we introduced last year, so you are really doing a lot of guesswork regarding inventory levels. But it looks like they are selling toward the endpoint because they are paying us royalties.

Glenn Mattson, Analyst

Okay, great. And then, I guess, lastly, John, I know you had the new product announcement today, but I guess, one of the exciting news about Kopin is that, at some point down the line, would VR, some sort of mixed reality or maybe the latest sports or general entertainment, when it gets hold on the consumer side, you guys are positioned to benefit. Is this product announcement getting one step closer to that point and just your outlook for a timeframe when you think that kind of market could come alive for you guys?

John Fan, CEO

Yes. Thanks for asking the question. I think it’s important to understand in the world of AR and VR which, of course, conveys to our interest. The biggest problem facing everybody is really the brightness and the differences in frequency of the display and we’ve been focusing on that for the last few years, how to achieve high brightness with variable current. What happened today is that, in fact, what we have achieved in the past nine months seems to have broken through, and we are actually getting very rapid improvement. There will be a lot more discussion on this as what happened today requires substantial explanation in physics because it is not intuitively obvious. But I think we will explain to the world what has happened, and I think it represents a critical turning point in the development of our products.

Glenn Mattson, Analyst

Okay, great. That’s it for me. Thanks guys.

Operator, Operator

And next we will move to Jeff Bernstein with Cowen.

Jeff Bernstein, Analyst

Yes. Hi, nice quarter guys. So, a couple of questions for you. The FWS speed of taking production to start by the end of this year, it sounds like it’s going out into 2021, is that really?

Richard Sneider, CFO

I am sorry, Jeff. You pulled a couple, but do you repeat the question?

Jeff Bernstein, Analyst

Yes, the FWS-II program, I guess, you’ve won that but we are waiting for production to begin, is that now early 2021?

Richard Sneider, CFO

Yes. We are still going through development, but we expect production in 2021, yes.

Jeff Bernstein, Analyst

Got you. Early or late 2021?

Richard Sneider, CFO

That ultimately depends on the military, but we would think it’s in the first half.

Jeff Bernstein, Analyst

Great. And then on the FWS-CS, I guess you still view it as impending for that. Have you won that yet, or what’s the progress of both there?

Richard Sneider, CFO

Okay. So, Jeff, I understand your question, but I thought the first question was about the CS.

Jeff Bernstein, Analyst

Yes, what was the unit status?

Richard Sneider, CFO

I am sorry, Jeff. I understand you. I thought the first question with CS and the question was FWS-I, and we are in production in that.

Jeff Bernstein, Analyst

Right. I thought that was Q1 and thought that was – and kind of who served the CS is something?

Richard Sneider, CFO

No, it’s two pieces. It’s the FWS-I and the CS who served.

Jeff Bernstein, Analyst

Got you. Okay. So that’s production in 2021, potentially?

Richard Sneider, CFO

Yes.

Jeff Bernstein, Analyst

But – and then the pilot helmet?

Richard Sneider, CFO

That’s still in development. They’ve actually been awarded the program. We’ve been awarded the contract, but it’s still in development, and again, we expect that to go into production in 2021.

Jeff Bernstein, Analyst

Okay. And then, first you mentioned it looks like industrial took a little bit of a step down, pretty understandable considering what’s going on in there. Can you give a little more insight into what’s going on in terms of recovery expectations as the economies reopen?

Richard Sneider, CFO

Yes, actually, FED was pretty consistent with the prior year. As Glenn just mentioned, it was really on industrial – it was really more of the wearable headsets. As a reminder, the slip in volume in business for 3D metrology now seems pretty consistent. They have to do military development for us. Some of their displays go into General Dynamics armored vehicles. But it was really the wearable headset. I would believe this is – as Glenn alluded to, that’s one of the functions of the units just came out last year for the most part. People are guessing their inventory levels in adoptions, but – so, sales of their displays seem to have moved down. However, as I mentioned, the royalties were consistent with prior periods last year, which tells us they are selling end-units. It’s just they are getting their inventories managed.

Jeff Bernstein, Analyst

So on the – sort of four-dimensional car displays that go into machines, we’ve been waiting for a ramp here with Chinese buyers being the biggest market for this. Where are we on that?

John Fan, CEO

I think the question for Jeff is, how is China taking into account FED’s quality. If you look on, as you all know, China also had the pandemic and they closed down for a few months. But they are getting back to work right now, so we are cautiously optimistic about the situation right now.

Jeff Bernstein, Analyst

Got you. Okay. And it sounds like your hitting now with the new duo-stack technology hitting metrics that other people haven’t been able to accomplish. People have been showing that this is what you have to get to in the critical market in AR and VR. So, I guess, the final onus is to make these things at a cost and gross margin that’s worth more?

John Fan, CEO

Yes. You are breaking up, so again, I guess your question was about the duo-stack and how easy it can be manufactured and how much additional cost is associated with this performance. I think I've gone through these two questions separately. On the micro OLED, I think we know there’s a lot of activity on the micro LED side. The latest call identified about 200 companies in the world working on micro LED. The reason everyone is moving to micro LED is because micro OLED is being limited in brightness versus current which is really required for AR and VR. What we’ve done on Duo-Stack, we basically increased the potential brightness by about four to five times to get into the range where AR and VR can actually operate satisfactorily. Now, the additional cost of making this on micro LED versus the duo-stack we achieved is quite extensive, due to the intricacies involved. The difficulty lies not in the manufacturing but in the technology itself, how do you maximize efficiency and optimize production, and how do you understand the physics behind it. If you look back, we do understand it now and we will come out and explain to the world what really has happened.

Jeff Bernstein, Analyst

Okay. But you are saying from a cost standpoint that these can be made to achieve good gross margin and at reasonable cost measures?

John Fan, CEO

In fact, we predict that in a year or two, nobody will want to do single-stack displays.

Jeff Bernstein, Analyst

I’m sorry, no one will still be considering what?

John Fan, CEO

Nobody is going to be using single-stack technology anymore because the additional cost of implementing double-stack versus the performance improvement is overwhelmingly beneficial.

Jeff Bernstein, Analyst

Got you. Okay. Thank you.

Operator, Operator

And there are no further questions. At this time, I would like to turn the call back over to Dr. Fan for any additional or closing remarks.

Richard Sneider, CFO

Yes.

Operator, Operator

Okay. We’ll hear from Patrick Metcalf with I-bankers.

Patrick Metcalf, Analyst

Hey guys. Congratulations on a great quarter. Just wanted to ask if you guys, most recently we saw Facebook invest in Classy for their technologies. Considering the breakthrough today, do you believe that you can secure a partner like Facebook to invest behind you?

John Fan, CEO

I am glad if I am correctly interpreting to say that activities surrounding Facebook’s investment in Classy focuses on micro LED. As I mentioned, in the last few months, people began to recognize brightness as the most important factor, and theoretically, LED micro has a great advantage. However, what we announced today regarding the 2.6K x 2.6K display, showing the index around 6 candela per amp, now jumps to 14 candela per amp with this current setup. These numbers are unprecedented and I believe the first reactions may be disbelief followed by amazement when they see it displayed. This will certainly enter a range where most applications of AR can be first-class, and yes, I think they will react positively to it.

Patrick Metcalf, Analyst

Okay, great. And then my next question is, I see your investment in RealWear and you are a licensee with them gaining real momentum with Microsoft Teams and Cisco WebEx now backing them. I want to see, A, does RealWear have an exclusive on the device or on the Golden-I software? And B, what does the Golden-I software mean to Kopin shareholders in the future if AR actually takes hold?

Richard Sneider, CFO

They have exclusivity in the field for certain Kopin technologies, but RealWear at least, I should clarify that RealWear has developed quite a bit of software themselves. We’ve provided the hardware aspect to it while they’ve developed the software as part of the equation.

John Fan, CEO

And let me add a bit more color to that. At RealWear, the Golden-I systems are a very high-quality system. We have several engagements for licensing our technology to them; our design for the system as well as some of the software. The software uses voice commands that allow for text recognition. Everyone praises how good the voice command is and how accurately text is recognized. In addition to that, our modules have been designed for those purposes. So, their exclusivity involves the modules and the use of software for audio, and this has indeed been a licensed development for the entire program they are utilizing. This provides several ways for us to assist them and help improve the market position that we know they’re striving to enhance.

Patrick Metcalf, Analyst

Okay. And then lastly, Lenovo. Does Lenovo have a Golden-I license? Or is Lenovo a different joint venture?

John Fan, CEO

It’s a different kind of license, and Lenovo is also doing pretty well. But they are focusing primarily on the Asian and China markets.

Patrick Metcalf, Analyst

Okay. Alright. Thank you guys and I look forward to seeing your next quarter results.

John Fan, CEO

Thank you.

Richard Sneider, CFO

Thank you, Pat.

Operator, Operator

And there are no further questions at this time. I would like to turn the call back over to Dr. Fan for any additional or closing remarks.

John Fan, CEO

Well, thank you for joining us this morning, and please, everybody stay safe. Thank you.

Operator, Operator

And that will conclude today's call. We thank you for your participation.