Lightpath Technologies Inc (LPTH) Q2 2020 Earnings Call Transcript

Good afternoon, and welcome to the LightPath Technologies Second Quarter 2020 Financial Results Conference Call. Please also note today’s event is being recorded. I will now pass the call off to Donald Retreage, Chief Financial Officer of LightPath Technologies. Please go ahead.

Good afternoon. Before we get started, I would like to remind you that during the course of this conference call, the company will be making a number of forward-looking statements that are based on current expectations and involve various risks and uncertainties that are discussed in the periodic SEC filings. Although the company believes that the assumptions underlying these statements are reasonable, any of them can prove to be inaccurate, and there can be no assurance that the results will be realized. In addition, references may be made to certain non-generally accepted accounting principles or non-GAAP measures, for which you should refer to the appropriate disclaimers and reconciliations in the company's SEC filings and press releases. Following management discussions, there will be a formal Q&A session open to participants on the call. I would now like to turn the conference call over to Jim Gaynor, LightPath's President and Chief Executive Officer.

Thank you and good afternoon. Welcome to LightPath Technologies fiscal 2020 second quarter financial results conference call. Our financial results press release was issued after the market closed today and posted to our corporate website. Following my remarks, our CFO, Don Retreage will further review our financial results and provide more perspective on some key areas. We are very pleased with our fiscal 2020 second quarter results. Our performance reflects a rebound from the last several quarters during which time we implemented several transitional strategies. At the end of last quarter’s call, I remarked that we had made significant progress on the major steps taken to restructure our business last year. In the first quarter, our true performance was masked by two issues; the customer-requested shipment delay and yields on our new BD6 products. Both of these areas have been addressed, which now enables more visibility into the progress as reported with our 2Q results. I further noted last quarter that our outlook would be favorably impacted by a few factors. These were one, our IR business growth will increase with the addition of our new family of lens assemblies using our proprietary BD6 material system. Two, our precision molded optics business will benefit from demand relating to the 5G network build-out. Three, that we have right-sized our operating expenses, reduced debt, and invested to improve and expand our production capacity, and four, that we have sufficient cash to execute our growth strategies. All of these factors contributed to our record quarterly revenues, record bookings, and record backlog. For full transparency, our record quarterly revenue of 9.6 million included about 500,000 of orders that had been delayed from the previous periods, but excluding this amount from our 2Q results, we still reached a record level of revenue for the quarter. A record bookings of 15.4 million in 2Q includes the renewal of our largest annual contract. The record 12-month backlog of 19.1 million at December 31, 2019 will likely come down a bit in subsequent quarters as we work through and deliver orders against that large contract. Overall, however, our steady progress on sales and marketing, global branding, and product development can be seen in our backlog, which has significantly increased. With a backlog at 19.1 million at December 31, 2019, we grew that from 18.1 million at December 31, 2018, and 12.3 million at December 31, 2017. So, in two years, we've increased our backlog by over 25% annually. The progress revealed in the second quarter goes beyond contracts and revenues. We have also been focused on improving our profitability and overall financial condition. In terms of profitability, we saw significant gross margin improvement in comparison to the first quarter of fiscal 2020, as the issues that were negatively impacting our gross margin were largely mitigated in the second quarter, including the resolution of our BD6 and kneeling yields, which hurt us in the first quarter. Our gross margins also continued to benefit from the reduction in overhead expenses associated with the relocation of our New York facility. Don will further address our gross margins and tariffs in his remarks. A gross margin improvement strategy coupled with continued management of operating expenses resulted in an EBITDA margin of 21% of revenues in the second quarter, which demonstrates the improved leverage in our business when compared to 11% in the prior year and a negative EBITDA margin in the first quarter of this year. On an annualized basis, our target near-term EBITDA margin is in the 15% to 20% range. We have proven that our investment in production capacity enables us to deliver quarterly revenues between $9 million and $10 million. Our total production capacity enables the capability to produce far more than this, positioning the company for growth. Unit volume sold was up 35% as compared to the first quarter of fiscal 2020 and 23% as compared to the second quarter of the prior fiscal year. Growth in precision molded optics or PMO products continues to be driven by 5G demand. The average selling price for our PLO product group is lower in comparison to prior periods, driven by the volume increase in lower-price-point products. Moreover, we did not experience price erosion for any product group in the second quarter. With the change in average selling prices solely reflecting revenue mix, which shifts from quarter to quarter depending on the products we were manufacturing. We also continue to see significant growth in the BD6 based IR products, where we experienced a 215% increase in units sold quarter-over-quarter. BD6 based products now represent just over 10% of our total revenue and approximately 20% of our infrared revenue and continue to experience strong demand. LightPath’s product development pipeline is robust. We've talked about the high demand for our new BD6 IR product lines. Another product we reviewed as being critical components to our OEM customers, and this brings me to a touch point relating to the coronavirus outbreak. This crisis, which has grown in size significantly, has not impacted us initially, but more recently travel advisories, quarantines, and other governmental restrictions have resulted in some of our staff not being able to report to work. You may recall in China we have manufacturing facilities in Jinjiang, which is in the Jiangsu province of China and located about 500 miles northeast of Wuhan, the epicenter of the crisis. We also have administrative functions and sales personnel located in Shanghai, which is about 550 miles east of Wuhan and about 200 miles southwest of Jinjiang. According to research from the John Hopkins Center for Systems Science and Engineering, as of February 4, of the 20,704 confirmed cases of the virus, only 308 cases were reported and zero deaths in the entire Jiangsu province, while 219 cases and one death were reported in the Shanghai region. Our nearly 50,000 square foot facility in Jinjiang provides a significant amount of our molded product production. This facility has been running at about 50% capacity for the past two weeks, following a period of four days it was closed for the Chinese New Year. The Chinese government extended the holiday shutdown and has required all companies to remain closed through February 9. We appealed to government authorities and were allowed to open and operate at a reduced level as we are a critical supplier of components for medical products and to medical equipment OEMs that are supplying medical equipment like X-ray and blood analyzers to hospitals and other medical facilities combating the virus in China. At least one of our large medical device OEM customers in China has written the Chinese government a request that LightPath remain open given the critical components we provide to the medical device supply chain. At this time of need, we are pleased that LightPath's innovative and globally respected technologies can play an important role in dealing with the coronavirus healthcare crisis. Of course, the safety and health of our employees is our priority while we closely monitor the situation and take every action we can to protect our employees. We are proud of our technological platform and our IP position, which continues to grow. We made some investments in patents during the second quarter of fiscal 2020 as part of our strategy to leverage technology as a differentiator. We’ve recently received one patent approval and have several others in process. Approximately $300,000 in cash was used during the first half of fiscal 2020, including spending on manufacturing capacity and IP. Our cash flow from operations has remained positive while we continue to make strategic capital investments and pay down debt. Total debt, including financial leases, was reduced by 7% in the first half of fiscal 2020 following an 11% reduction during fiscal 2019. Our fiscal 2020 second quarter results reflect our ability to create demand for differentiated products in our key target markets of infrared and visible optical components. We have demonstrated operating leverage, which has been aimed through top-line growth and disciplined cost management. It has taken time to get here, but we are now in a stronger position both financially and operationally and more optimized to deliver value for our shareholders. Now I'll pass the call to our CFO Don Retreage to provide more detail on some other critical areas of our second quarter 2020 financial results.

Thank you, Jim. First I would like to mention that much of the information we are discussing during the call is also included in a press release issued earlier today in our 10-Q filed with the SEC. I encourage you to visit our website at lightpath.com and specifically the section titled Investor Relations. Now on to my remarks pertaining to the second quarter of fiscal 2020. Jim's remarks covered a lot of our financial performance. So I will be specifically discussing key performance areas. Gross margin in the second quarter of fiscal 2020 was approximately $3.9 million, an increase of 11% as compared to the approximately $3.5 million in the same quarter of the prior fiscal year and 63% higher than the $2.4 million in the first quarter of 2020. Gross margin for the percentage of revenue was 41%, the second quarter of fiscal 2020 consistent with the second quarter of fiscal 2019 but increased from the first quarter of 2020 when gross margin as a percentage of revenue was 32%. Improvement in gross margin was due to increased volumes, yield improvement, and mitigation of the impact of the tariff increases. Yield issues relating to BD6 products, which we experienced in the first quarter of 2020, were substantially mitigated during the second quarter. We identified the root cause of the yield issue early in the second quarter and have implemented corrective action. We continue to make process improvements that we believe will further improve our BD6 yields and margins going forward. Total cost of sales was approximately $5.7 million for the second quarter of fiscal 2020 compared to $5.2 million in the first quarter of 2020. While revenues of $9.66 million in the second quarter of 2020 increased only 6% from $7.6 million in the first quarter of 2020, cost of sales increased only 10%. The year-over-year comparison is not as favorable since the revenue mix in the second quarter of 2020 had a higher concentration of lower-margin IR products. Our first-quarter gross margin was also impacted by the tariff increases resulting from the U.S. and China trade negotiations, the majority of which went into effect in June 2019. As we anticipated, the net impact of the tariff increases were significantly reduced beginning in the second quarter as mitigation actions we took were effective for the full quarter. To offset the tariff increase, we began adding a surcharge to certain customer invoices, which is included as an offset to the cost of goods sold and is not included in the revenues. The surcharge may be removed in the future once the corresponding trade settlement is reached that reduces the tariffs that are at previous low levels or eliminates the tariffs entirely. As a result of tariff mitigation efforts, a net increase in tariff expenses quarter-over-quarter was negligible. Our estimate from our last quarter's conference call was that our gross margin as a percentage of sales was negatively impacted by approximately 2 percentage points as a result of the tariff increase in the first quarter of 2020 when compared to the first quarter of 2019. With the BD6 yield issue almost entirely behind us, we have been able to improve our factory utilization. We continue to manage this process, particularly since we have substantially added more production capacity on the client flow over the past 12 months. We can handle a lot more production, which should lead to more efficiencies to improve gross profit and gross margins. Again, the margin can fluctuate depending on the product mix of our revenues. We continue to benefit from the significant improvements in operating costs following the relocation of our New York facility and the implementation of other cost-saving measures. As previously discussed, we had a few vacant positions in sales and other areas. So expenses will increase somewhat as those positions are filled. But our backlog and sales pipeline, as well as manufacturing efficiency improvements, are looking to improve our operating margin even after the vacant positions are filled. Our IR capabilities and overall production capacity are growing steadily. While our overhead has significantly declined following our transition of New York. This facility relocation and other cost savings eliminated about $800,000 in operating expenses in the first half of fiscal 2020. During the first half of the year, total operating costs and expenses were approximately $5.9 million, a decrease of $793,000 or 5% as compared to $6.7 million in the same period for the prior fiscal year. During the second quarter of fiscal 2020, total operating costs and expenses were approximately $2.9 million, a decrease of $475,000 or 14% as compared to $3.3 million in the same period of the prior fiscal year. In terms of operating categories, both SG&A and R&D were lower in the second quarter of 2020 as compared with 2019 second quarter. SG&A was lower in the second quarter as compared with the first quarter of 2020, but R&D was a bit higher due to aforementioned improvement program activities. Going forward, we expect a slight increase over our second quarter 2020 SG&A and R&D as we add some planned positions in the sales and engineering area, as mentioned before. Similar to the first quarter of this year, the second quarter's overall performance was highlighted by fiscal discipline, following the completion of planned spending last year enabling significant production increases and strengthening of our balance sheet. Capital investment in fiscal 2019 to increase vertically integrated regional production capacity enabled us to reduce capital expenditures this year. Capital expenditures, including equipment finance releases, were $1.2 million for the first half of fiscal 2020, down from $1.6 million in the first half of fiscal 2019. Meanwhile, net cash provided by operations was $938,000 in the first half of the year as compared with net cash used in operations of $398,000 in the prior year period. Subsequently, from the first quarter, cash flow from operations increased by about 9%. Due to capital investments and the reduction of debt in the quarter, our cash balance at December 31, 2019 was $4.3 million as compared to $4.6 million at June 30, 2019. Capital investments were modestly higher in the second quarter of fiscal 2020 than in the previous quarter due to the timing of completion of certain projects that were initiated at the end of the fiscal 2019 and in response to the growth and market acceptance for all products. We continue to invest in our IR glass production coating and molding capacity to meet the increasing demand for both telecommunication products and BD6 based infrared products. Both of these product areas are expected to continue to grow as the year progresses. During the second quarter, as part of our cash management, we declared an intercompany dividend of approximately $2 million to our U.S. operations from our divisions in China, as this was determined to be the most cost-efficient way to rebalance our cash positions around the globe. In doing so, we incurred additional Chinese tax expense of $200,000 in the quarter, of which $100,000 was paid during the quarter. For consolidated corporate income tax in the U.S., it is shielded by our net operating losses forward benefits of approximately $74 million at December 31, 2019, but we do have to pay income tax to the countries of certain foreign subsidiaries. With our operational strategies delivering these intended results for growth and margin expansion, we look forward to telling our story to prospective investors. We will be participating in a conference in New York on March 26 and hope to see you there. With this review of all financial highlights and recent developments concluded, I will turn the call over to the operator so we may begin with the question-and-answer session.

Thank you. We will now begin the question-and-answer session. Today's first question will come from Marc Weissenberg of B Riley FBR. Please go ahead.

Thank you. Good afternoon. Can you talk about the increase in the BD6 lenses? Is the increase coming from new customers, new applications, or existing customers that are really seeing the benefits and are substituting materials?

I think the answer to that question is yes to all three parts, Marc. I mean we're seeing increased volume on some of the products that we had developed for customers, and they're repeating those orders and increasing them. A lot of this material is going into new projects as we develop those lens designs. I think so I think all of those things are contributing to that growth, and we are substituting and we're working on, and I think we'll see the substitution of the product for some germanium products increase, although we haven't seen a tremendous amount of that to date, but there are some of our customers who are working on that type of substitution.

I think you put out a release recently talking about the diamond-like coating. Talk about how that's going to impact the application and potentially accelerate the substituting of the BD6 lenses.

In our opinion, the chalcogenide glass, which is BD6, is technically superior to germanium in many ways, as it has a wider thermal operating temperature range and is lighter in weight. However, one drawback of this product was that it is softer and did not have good wear characteristics if it was used for the front element in an assembly. So with the diamond-like carbon coatings now, we can provide a wear surface on that and correct that deficiency. Therefore, I think overall it's a better material choice and worth mentioning that it is somewhat less expensive.

I think you noted that the BD6 is making up about 10% of total revenue and about 20% of the IR revenue. What are your expectations going forward as to how much of the business that could grow into?

Well, I mean, I think in general the infrared business is probably going to be 60% or greater of our total revenue. I think we'll kind of settle into that 60/40 split between the visible and the infrared type business. As we go through the next couple of years, I think the chalcogenide material will be probably the majority of that, although I think germanium will still have its place. Our molding capability enables us to provide these types of products in large volumes as the sensor market and the surveillance market, which are emerging applications for this material, continue to grow. Then with our diamond turning capability, we can create larger lenses, and BD6 is turnable as well as moldable, allowing us to conduct the full range of lens fabrication with it. So I would imagine that the chalcogenide for us will probably be the majority of the material over time.

Great. What percentage of the business was attributed to the big uptick in 5G this quarter?

We saw the PMO business grow, but the revenue was actually down a little bit. However, the unit volumes were up about 20%, and I think that's mainly driven by the telecom sector at this point. There is still general weakness in the industrial and commercial areas, particularly in Asia, but telecom is still growing quite rapidly and we expect that increase to continue in the next two to three quarters.

Great. I think you talked about the large contract and delivering on that. Was there any pull-through to account for that based on the delivery timing, or that's not going to impact next quarter? Maybe you could discuss the dynamics of that contract and the volumes?

I think that we shipped, we were somewhere between $800,000 and a million delayed last quarter. Of that delay, we shipped an additional $0.5 million on top of what we'd normally ship. So there's still some of that delay that will fall into this quarter, which I pointed out that we would take some part of the second quarter and part of the third quarter to get completely caught up with that. It's not, it's additional type revenue if you want to think about it, but that contract has renewed, and the volumes in that contract are consistent with what we've had in the last two to three years with that contract, so it's just going to continue at that level.

Thank you. Maybe you could talk about the composition of the increase in the backlogs?

Yes, I think IR is certainly driving the majority of our growth and that's where it's coming from. I believe the precision molded optics, overall, our unit volume was up about 23%. As I mentioned, the infrared molded volume was up about 215%. I think the diamond-turned volume was also up in the mid 30s if I remember correctly. So the mix has stayed fairly consistent but is just continuing to grow.

That's nice to hear. You were overcoming some challenges. You've got a really solid quarter, but then the coronavirus hitting and impacting operation. What kind of impact do you foresee on growth in the quarter, or how do we think about that impacting what you could do in the second or third quarter?

Yes, we're still trying to assess what it means in the short-term. The interesting thing here is while we had a plant shut down for the Chinese New Year—which we actually shortened from what most companies in China do—we planned to start our operations packing up around the 28th of January, which is a couple of days earlier than the New Year holiday was originally planned to be. Then the Chinese government came in and extended that shut down period through the 9th of February, adding another 10 days to the shutdown. However, we had already started operating again and we were asked to continue to operate by some of our medical customers, who also petitioned the government, considering us as a critical component supplier. So, we've been running our plant since the 27th of January at roughly 50% of its operational capability. During the height of the crisis, we had about 50 people in there working; now we have over 100 working out of the 130 total employees we have in Jinjiang. Instead of losing 10 days of production, we're probably going to lose about five to six effective days, which we believe we can make up during the remainder of the quarter. So, it's still a dynamic situation, and it changes a little bit every day. But in the short-term, there may be some slowing; however, in the intermediate term, I think it's actually going to be an increase in production. During this period, our GM in China called me the other day and told me that he received several large requests for quotations from some of our major companies that we service, which would result in tremendous increases in volume related to making thermal analyzers for combating the coronavirus. So, some of that is infrared, some of it is visible product, and it may end up contributing to an increase in our overall production output as opposed to decreasing it over the long haul. I think for us, that's the silver lining in this very dark cloud, and I believe we will come out of this alright. As for the exact impact in the next six to eight weeks, particularly during the third quarter, I suspect that will be fairly minimal.

Understood, thank you. Just two more from me. I think you guys recently filed an 8-K regarding the extension from NASDAQ on the potential delisting. What are your strategies for addressing this? I think the deadline is sometime in the summer?

Yes, we were granted an extension on January 14th to July 11th. As we continue to report positive results, as we did this quarter, I hope to see the stock price return to more normal levels. If not, then we’ll consider other options to ensure that we maintain the listing. But that decision does not need to be made for at least another month or so.

Understood. Lastly, Jim, you're slated to depart in the summer as well. Previously, we talked about using external search firms. What's the status on the succession plan?

The plan remains the same. The search committee and board are continuing to interview candidates, both external and internal. A decision has not yet been made, but we will announce it once one is reached.

We show no additional questions. I'd like to turn the conference back over to Mr. Gaynor for any closing remarks.

Thank you. We conclude our second quarter 2020 conference call. I'd like to leave you with this final comment, which was part of our earnings press release. We have demonstrated operating leverage, gained through topline growth and disciplined cost management. It has taken time to get here, but we are now in a stronger position both financially and operationally, better optimized to deliver value for our shareholders. Thanks again for participating in today's conference call. We look forward to speaking with you again next quarter. I also want to thank all our employees, particularly our Chinese employees for working so diligently through a very difficult time. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.