Lightpath Technologies Inc Q3 FY2021 Earnings Call

Good afternoon and welcome to the LightPath Technologies Fiscal 2021 Third Quarter Financial Results Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note, today's event is being recorded. I will now pass the call off to Don Retreage, Chief Financial Officer of LightPath Technologies.

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, including the impact of the COVID-19 pandemic that are discussed in this periodic SEC filings. Although the company believes that the assumptions underlying these statements are reasonable, any of them can prove to be inaccurate, and therefore, there can be no assurance that the results would 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's discussion, 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 Sam Rubin, LightPath's President and Chief Executive Officer. Sam, please go ahead.

Thank you and good afternoon. Welcome to LightPath Technologies fiscal 2021 third 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 Donald Retreage will further review our financial results and provide more perspective on key areas. We will then conduct a Q&A session. For those of you who have been following the company closely, you know that the past nine months have been marked by changes designed to position LightPath for growth. I'm very pleased to report that our long-term growth plans are beginning to yield their intended results, and we have seen stronger results for the quarter, including the highest level of quarterly revenue in our history. This marks the second consecutive quarter, in which we set a new record for quarterly revenues, and we continue to deliver double-digit growth rates on an annual basis. In the nine months since the beginning of our fiscal year, we won over 15 new business contracts, including 16 from new design wins. This supports both our new strategic direction of being a partner for solutions, as well as our goals to diversify our customer base and reduce our customer concentration. Reflecting on my appointment as CEO of LightPath a little more than a year ago, my initial focus was to assess the company's strengths, weaknesses, opportunities, and leadership capabilities as they relate to our strategy moving forward. Once we completed the initial assessment, we began implementing our new strategy with an orientation towards becoming a valued and trusted photonics partner by providing engineered solutions, which goes beyond serving as a component manufacturer. Our strategy is based on the fact that photonics as a technology is being adopted into more applications and integrated into more products such that there is a growing number of companies that need a partner who can support them through extensive knowledge and experience with the technology. This makes the adoption of photonics technology easier for them. This is a powerful growth mechanism, as reflected in the strong revenue growth we reported today and in our fast-growing number of design wins and prototype development work for our customers. During this time, our focus has not only been on growing at the top line. From the beginning of the fiscal year to the end of the third quarter, our financial and operational focus resulted in our cash increasing by 10%, even as we reduced our debt by 8% and funded capital expenditures at nearly 80% more than the prior year. Those investments have been focused on ways to better serve larger multinational customers and satisfy a higher volume production demand, which supports our solutions orientation. Along the same lines, our investment in R&D has grown this year by 24% as we invest in developing unique technologies and capabilities, which in turn translates to technological differentiators that allow us to provide our customers with solutions that enable them to better use photonics technologies in their applications. This last part is the essence of our strategy, and we are pursuing an increasing number of sizable opportunities in diversified vertical markets, where our engineering expertise, volume production capabilities, and proprietary technology are our competitive advantages. The growth we're seeing in sales is fueling the company and driving the need for additional changes and improvements. This has led to the next step of our long-term growth plan, which requires strengthening and expanding our leadership team. With our recently announced changes in management, the focus has turned towards operations, efficiencies, and overall performance, similar to the efforts that led to our initial growth in this fiscal year, which took a couple of quarters to be realized. Our shareholders should expect a period of adjustment with the new leadership team until we begin to more fully experience the intended results of operational optimization. Our objective has been to secure the right talent for the company, who have the skills and experience to drive forward our long-term goals and implement our strategy to be the preferred partner for our customers in all things photonics. This included several changes to our leadership ranks and filling out the depth of our board, middle, and senior areas of management. During and following the end of our fiscal third quarter, we announced a series of management appointments with corresponding one-time expenses for the associated changeover as we put our new team in place. The normalized amount of operating expenses is expected to be reached through the course of the next few quarters as we eliminate temporary redundancies and other one-time costs. This conference call provides a good opportunity to summarize LightPath's recently expanded management and leadership team. Earlier this week, we announced two significant changes. First is the retirement of our longtime Chairman Bob Ripp, who has held the position since 1999. Bob has served the shareholders and the company very well, navigating the company through periods of economic and market changes. He was instrumental in guiding the company's strategic direction, and I'd like to personally thank him for this opportunity and assure him that we will continue to follow the strategic direction shared in this call today. The boardroom is in the process of appointing a new chairman to replace Bob in the coming week. The second major appointment announced this week was Peter Greif to the position of Vice President, Operations. This position has been vacant for about a year, and we have finally found the right person for the job. Peter comes to us from New York Stock Exchange listed Jabil, one of the largest manufacturing solutions providers in Florida, with a market cap of over $8 billion and more than 260,000 employees worldwide, across 100 locations in 30 countries. Al Miranda, who is also sitting in today's call, was appointed to the position of Vice President, Finance effective April 19 as part of our CFO succession plan. We're grateful for the contributions of Donald Retreage, our outgoing CFO, who announced his retirement that will take place following the closing of this quarter. I'd like to personally thank Don, who I have worked closely with for the past year. He has been an important contributor to the company's transitional periods during the expansion into the infrared market and in building out our global manufacturing operations. As Don's successor, Al previously was president of the North American subsidiary of a publicly traded company with a $0.5 billion market cap, Jenoptik, Germany-based. Jenoptik led a North American subsidiary to top and bottom line double-digit growth. Jenoptik is known globally for specializing in photonics and space technology across several markets. Now operating in China, Joseph Wang was appointed General Manager, replacing Hui Yue. Joseph has more than 30 years of experience in OEM manufacturing, working in various international markets with a focus on China, including 10 years with Samsung and IBM. This change in management in our China group, which included dismissing the previous General Manager as well as the sales manager and the engineering manager, was necessitated by certain Code of Conduct infractions by the previous leadership of our China operation. This includes an attempt to set up a competing business against LightPath, as well as an attempt to misappropriate part of our intellectual property. While we're confident that the swift corrective actions we have taken have resolved this issue, this also resulted in some additional one-time expenses in our fiscal third and fourth quarters. Additionally, we expect some limited impact to our domestic sales in China for the next two quarters while we stabilize our domestic sales operation in China. Finally, in another board-level move, we were joined by Eric Creviston, who is president of the global products group at NASDAQ listed Qorvo, a $22 billion technology company that develops and commercializes semiconductor products and software for advanced wireless and wired technology. Eric is an exceptional addition to our board. This series of management and leadership changes reflects opportunities for LightPath to accelerate global growth. Furthermore, the appointments, as well as the results this quarter, are in line with what our focus has been, which essentially is a departure from the old way and in support of our new vision. These operational changes may take a few quarters to materially impact the company, with additional ebb and flow during the change management period before becoming substantial. One area of operational improvement is our gross margin performance. You'll note that our gross margin as a percentage of revenue has declined meaningfully in the third quarter and to a lesser extent for the first nine months of the fiscal year. This is due to the lifecycle of new design wins going into larger production runs and our yields in two specific parts of the process, which I discussed in last quarter's call. Our team has continued to focus on developing both unique technologies and processes and products, particularly as they scale from prototype to mass production. Our R&D spending has been higher in part to develop new products that get us to the design win stage. Therefore, we have equally important work to do in scaling new products into volume production. We have encountered several technical challenges related to the fabrication of components as well as some of the value activities such as coatings and assembly. While we have not yet completely resolved those issues, we are very encouraged and confident that we are on track to have them resolved in the coming weeks. On the sales side, we see demand growing based on a number of new opportunities in our sales funnel both from existing customers and new customers alike. We are continuing to report another record performance for quarterly revenues which turned to double-digit growth and marks another goal we set for the company this year, along with further improvements to our balance sheet. I am confident that our strengthened management team will lead us through our next phase of growth. This sustained growth is based on organic expansion, and additionally, we intend to pursue selective acquisitions to bolster our product lines and manufacturing capabilities. Our innovative product development capabilities and deep customer relationships enable us to extend our leadership position in the market. We are leveraging our competitive advantages to deliver a stable return on investment and ultimately returns for our shareholders. I'm energized by the outlook for our business and believe we're making considerable progress in our growth strategies. Now I will pass over to our CFO Donald Retreage to provide more detail on recent financial performance.

Thank you Sam. First, I'd like to mention that much of the information we're discussing during this call is also included in a press release issued earlier today and in our 10-Q filed with the SEC. I encourage you to visit our website at LightPath.com, specifically the section titled Investor Relations. Now onto my remarks pertaining to the fiscal 2021 third quarter and nine months ended March 31, 2021. Sam's remarks covered the highlights of the changes that came in the form of strategies designed to position LightPath for growth. I will be specifically discussing some of the key financial performance areas. Revenue for the third quarter of fiscal 2021 was $10.7 million, up 8% sequentially from $9.9 million in the second quarter of 2021, and an increase of 23% compared to $8.7 million in the third quarter of 2020. Revenue for the first nine months of fiscal 2021 was $30.1 million, an increase of $4.2 million, or 17% compared to $25.9 million in the same period of the prior fiscal year. Infrared products revenue was $6.5 million in the third quarter of fiscal 2021 or 60% of the total revenue. This is up from $4.4 million or 50% of the total in the third quarter of fiscal 2020. IR revenues grew sequentially from the second quarter of 2021 by 35%. Visible precision molded optics (PMO) product revenue in the third quarter of fiscal 2021 was $3.9 million, or 36% of the total, up from $3.8 million or 44% of the total in the third quarter of fiscal 2020. PMO products revenues were down sequentially from the second quarter of this year by approximately $800,000, primarily due to reduced spending by a large telecom customer's long-term supplier agreement following accelerated purchases during the first half of the year. The balance of our revenue for the third quarter was $334,000 from specialty products, which vary greatly from quarter to quarter but are substantially smaller contributors to consolidated revenue. Revenue from this group in the prior year was $561,000. Moving on to gross margins, generally speaking, PMO products are smaller and almost entirely molded, allowing for faster turnaround times, higher volume applications, and more automated processing. These products are also generally lower in price compared to infrared lenses. Historically, we have had margins averaging in the 40% to 50% range for PMO lenses, which have been about 10 to 20 points higher than the margin on all infrared lenses. Of the two primary revenue reporting groups, PMO is a smaller group with a higher margin. Therefore, on a consolidated basis, our gross margin will skew more towards infrared products, which comprise a greater percentage of revenue in the quarter. The infrared product group represents a larger and faster-growing market opportunity. Infrared margins have historically been in the 20% to 30% range. The average selling price can vary based on the product and market, so we do not believe that this is a meaningful performance metric. Instead, we encourage investors to focus on our revenue and gross margin as a percentage of revenue over the long term, not necessarily on a quarterly basis. Perhaps the most important factor affecting our gross margin this year has been the number of new product launches coming online. As I mentioned, we are experiencing traction in the market with an increased number of design wins, as well as the factors negatively impacting margins in the early months of new designs going into volume production. Therefore, product lines coming into production volumes in the second and third quarters of this year are from our new infrared lens family of products. These will come in at the higher end of the margin range once we see the benefits of volume efficiencies. Gross margin as a percentage of revenue was 38% for the first nine months of fiscal 2021 compared to 40% for the same period of the prior fiscal year. The gross margin in the third quarter of 2021 was brought down by the 36% margin in the third quarter, which included the primary influence of the revenue mix skewed towards infrared products, along with the near-term impact of the many new designs still in their early stages. We continue to produce more lenses overall. Again, the key performance indicator is best viewed on a longer-term basis, as revenue mix and production ramp-ups come into play, as they did in the third quarter. Total production for our product lines increased to nearly 3.3 million lenses in the first nine months, up from 2.4 million lenses in the same period of the prior year. In the third quarter, our revenue mix was heavily weighted towards infrared lenses, and given the factors discussed, total units declined to 862,000 units this year from 905,000 units last year, a decline of 5% even as our revenues increased 23%. Moving on to operating expenses, during the third quarter of fiscal 2021, total operating expenses were approximately $3.7 million, up by about $790,000 compared to $2.9 million in the same period of the prior fiscal year. The increase is primarily due to approximately $194,000 in non-recurring legal fees and consulting expenses associated with the hiring of new employees and the termination of certain existing employees within the company's China subsidiary, along with a moderate increase in headcount and costs associated with operational improvement and growth strategies that Sam addressed in his comments. I will note that additional legal fees, consulting expenses, and severance expenses associated with these changes in operations in China will be incurred in the fourth quarter of this year. In April 2021, we entered into a severance agreement with certain employees for a total of $470,000 over the next six months, provided that these employees comply with certain terms set forth in the severance agreements. The third quarter and fourth quarter expenses, as well as the second quarter charges related to a former CEO, amounted to about $400,000 combined for nearly $1 million in one-time items for the year. New product development costs in the third quarter of 2021 increased by approximately $249,000 from the prior year period, which was necessary to address the demand for advanced optical designs, including to accelerate the level of design wins expected to lead to future revenue growth. We added to our engineering headcount and related outside services to support demand for custom optical design. Partially offsetting these expenses in operating expenses was limited travel and marketing expenses due to COVID-19 restrictions, even as we incurred some pandemic-related costs for cleaning and safety measures. Our consolidated corporate income tax in the U.S. is shielded by our net operating loss carryforward benefits of approximately $74 million as of March 31, 2021. However, we must pay income tax in countries of certain foreign subsidiaries. The third quarter 2021 income tax expense was approximately $308,000 compared to approximately $203,000 for the same period of the prior year, primarily related to income tax from the company's operations in China. The income tax return also included Chinese withholding taxes of $100,000 associated with intercompany dividends declared by a company's Chinese subsidiary payable to the parent company in the U.S. The net loss for the third quarter of 2021 was $223,000, or $0.01 per share, compared to a net income of $816,000, or $0.03 per share in the prior year. The net loss for the first nine months of fiscal 2021 was approximately $272,000, or $0.01 basic and diluted loss per share, compared to net income of $210,000, or $0.01 basic and diluted earnings per share for the first nine months of fiscal 2020. Our EBITDA, a non-GAAP measure which we believe provides important insight into our performance and progress, was approximately $1 million in the third quarter of 2021, as compared to $1.9 million for the third quarter 2020. This decrease was primarily due to lower operating income from decreased gross margins and increased SG&A, which included significant non-recurring costs and high product development expenses. Again, looking at our longer-term progress, which is more meaningful, EBITDA for the first nine months of fiscal 2021 was $3.5 million, or approximately $4.1 million, excluding one-time non-recurring expenses related to executive changes, as compared to $3.7 million for the first nine months of fiscal 2020. Nine months EBITDA performance also benefited from favorable differences of approximately $325,000 in foreign exchange gains and losses. Moving to balance sheet and cash flow related items, capital expenditures totaled $0.05 million in the third quarter, and $2.7 million for the first nine months of fiscal 2021. This is an increase from $300,000 and $1.5 million in the respective areas of fiscal 2020. We are on track for capital expenditures for the year to come in with a range of around $3 million for the year. Meanwhile, net cash provided by operations was $3.1 million for the first nine months of fiscal 2021, up 64% from $1.9 million in the prior period. Total debt, including financial leases, was $5.5 million as of March 31, 2021, a reduction of approximately 8% or $482,000 from $6 million at the beginning of the fiscal year. Approximately $200,000 of this reduction came in the third quarter. Our cash balance on March 31, 2021, was $5.9 million, up $600,000 from the end of the second quarter and as compared with $5.4 million at the beginning of the fiscal year. Regarding our backlog, as of March 31, 2021, LightPath's total backlog was $19.5 million, down from $23.8 million at the end of the fiscal second quarter and $21.9 million as of June 30, 2020. Our production capacity has grown, enabling us to deliver on more high-value IR contracts. Our backlog at the end of the third quarter has come down from the second quarter, which was the highest level in the company's history. It should be noted that it is natural for backlog to fluctuate during the year because of the timing of bookings of large orders and annual renewals. Our single largest contract, valued at nearly 25% of our total backlog, was renewed during the second quarter, and we continue to deliver against this contract as the fiscal year progresses. Finally, on a personal note, as I will be retiring from my role as CFO of LightPath tomorrow, I just wanted to say that it's been a pleasure getting to know many of you in the investment and banking communities and to serve as CFO for the company's shareholders. LightPath is in very good hands with Sam and the expanding leadership team. With this review of our financial highlights and recent developments concluded, I will now turn the call over to the operator so that he may begin with our question and answer session. Thank you.

Thank you. We will now begin the question and answer session. Today's first question comes from Brian Kinstlinger from Alliance Global Partners. Please go ahead.

Hi, thanks for taking my questions. This is Jacob on for Brian. Can you talk about the slowdown in PMO orders related to inventory for 5G rollouts? Can you talk about what's causing this? And do you believe this is temporary and related to global supply chain shortages? Or do you think this will persist?

Yes, first of all, hi, Jacob. And thanks for joining us. The slowdown that we're seeing is specific to one geographical area, specifically customers in China. The reasoning for that is two-fold: first, there has been significant overstocking on the part of that customer earlier on in 2020, and second, there is some slowdown that they are seeing in the rollout of their equipment. We're pretty confident that this is a temporary situation. In fact, the customer is already discussing with us the timeline for their future releases of orders. However, right now, this customer typically releases orders on a quarter-by-quarter basis, which is affecting both our backlog number as well as sales for the coming two quarters.

Okay, and are there any industries that you sell to facing inventory shortages which will result in fewer numbers of lenses in the near term? And if so, which ones?

Yes, we've definitely seen our share of customers mentioning shortages in certain chips or devices that are impacting the supply chain. We've had a couple of customers shuffle around their schedules. I think a couple of quarters ago, we talked about one of our larger customers moving shipments around and doing so with short notice, which impacted our inventory levels back then. Since then, however, we haven't seen anything at a level that leads to order cancellations, nor have we seen any significant delays in our shipments due to shortages of other components.

Thanks. I have one more question and then I'll hop back in the queue if I have any more. Can you talk about how far along you are in correcting the yield issues? You identified those in the year-end conference call, particularly the coating issue at the end of the process and the problem in the middle of the process. I think you said before that you plan on having this addressed in the next couple of weeks.

Yes, we're definitely very close to this. I think the results we're getting are extremely encouraging. They're not yet statistically significant to the point where we can definitively say we have resolved the issues, but our engineers are optimistic, which is very encouraging.

Alright, thanks so much.

The next question comes from Scott [indiscernible]. Please go ahead.

Hey, good afternoon, guys. And Don, congrats on your retirement.

Thank you, Scott.

Of course. My first question is on gross margin. Is it possible to give us a percentage point impact of some of these new product issues had on the quarter? I mean, was it 200 basis points, 300 basis points? Is that even something that you could do?

Overall, it's between 1.5% to 2%. Overall, it normally would have been closer to 40%.

Perfect, that's great. And second one for me on capacity. Could you give a little color around your comfort level with where capacity is today? And maybe what that means for your CapEx assumptions moving into your next fiscal year?

Yes, definitely. Some of the growth we're seeing now is a result of the capacity expansions that we have been doing over the last few quarters, especially in the PMO and molding area, which affects both some of the infrared that is molded with infrared and, of course, the PMO itself. At this point, capacity-wise, we're not seeing ourselves limited in any specific area. Most of our investments at this point are focused on efficiencies and technological advancements, investing in new technology that allows us to capture new business and do existing business better.

Okay, that's very helpful. And lastly, I'm curious if you could tell us when you became aware of the issue in China and how quickly you were able to act on it?

Yes, we became aware of it at the beginning of March, and I'd say within four weeks of identifying the issue, we had completely handled it and dismissed those employees.

Okay, great, guys. Thank you.

The next question comes from [indiscernible] FBR. Please go ahead.

Yes, Hi, good afternoon. First question is regarding the backlog between IR and PMO. Just wondering what the mix looks like? Is that kind of comparable to your revenue mix?

Well, because in the third quarter we increased sales by 60% in the IR, we reduced almost proportionately our backlog. So we're a little lower in the IR as of now, but we have a lot more things in the pipeline with IR.

IR is a place where we tend to get more longer-term contracts compared to PMO.

Sure. Regarding gross margin, just wondering how we should think about gross margin for the rest of this calendar year. I mean, did I hear you correctly that you expect IR to grow faster than PMO, so that will gross margin be trending down because IR carries lower gross margin?

Yes, in one way, as I mentioned, the turnaround period is longer. So you're not going to see the effect of higher margins on the IR next quarter. Also, remember that mix: you could do 50% of our total revenue in PMO at 50% gross margin and point to 30% of IR, which is 50% of our revenue. The average won't come out, it'll come out in the high 30s. As time goes by, the IR will sell more higher ASP and increase margin, but it won't be a jump from quarter to quarter.

Got it. Thank you.

[Operator Instructions] The next question comes from Gene Inger from The Inger Letter.com. Please go ahead.

Hi, gentlemen, and Sam, congrats on a good quarter, and Donald, congratulations on your retirement.

Thank you.

Thank you, Gene. It's good to hear your voice. Welcome back.

Yes, thank you, sir. I went through hell, but glad to be alive. In any event, it looks like you're talking about shrinking gross margins, but not by virtue of net margins, and not by virtue of price cuts, which used to be what would happen to me competition. Is that correct?

Yes, we're not seeing significant price pressure that leads to declines in gross margin. As always, we have a product mix that varies, and we can have different PMO and other lenses that carry much higher margins. However, I don't think there is anything indicating a long-term decline in our gross margins. We are facing yield issues that we've talked about at length last quarter, which still exist to some degree, but other than that, there’s no downward trend.

In your comments, you mentioned acquisitions are one of the areas of interest. Could you provide ideas of where you would consider those to be fruitful, or would you rather not disclose that to avoid giving competitors insight into your plans?

Yes, absolutely. It would not come as a surprise that given our focus on investing in technology and capabilities, some of the acquisition opportunities we are pursuing are similar in nature. This means we are looking for companies that could bring additional capabilities or technologies that would supplement ours and allow us to accelerate in our new strategic direction. We are not currently interested in acquisitions solely to bring over capacity.

When I look at the staff changes, I see the background of both Albert and Peter, and I welcome them to LightPath. What I see is not only optics expertise but also an industrial engineering background, and I’m wondering if these personnel changes relate to your new direction which I assume they do. Could you expand on that?

Yes, as you mentioned, we certainly look for people who fit our needs, and in this case, I think we're fortunate to have secured two exceptionally talented individuals who bring valuable experience and skill sets that align well with our strategic direction. Hence, it won’t come as a surprise that as we aim to grow vertically and create more value, we are looking for leadership that has previously played similar roles.

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

Thank you for participating in today's conference call. Before we leave, I would like to extend my gratitude and best wishes to our departing Chairman Bob Ripp. We look forward to speaking with you in the next quarter for our year-end results. As we've typically done, we intend to issue preliminary fourth-quarter results in August, with the full results coming out in September. Until then, our next public engagement will be at the Needham Virtual Technology and Media Conference on May 18. We hope our institutional investor followers will join us at the conference and that all of you continue to follow our progress. Thank you again, and goodbye.

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