KOPN - NASDAQ

Good day, ladies and gentlemen and welcome to the Kopin's Third Quarter 2022 Earnings Call. Today's conference is being recorded. At this time, I’d like to turn the conference over to Richard Sneider. Please go ahead.

Thank you, operator. Welcome, everyone and thank you for joining us this morning. John will begin today's call with a brief discussion of his new role with Kopin and then he'll introduce Michael Murray, our new CEO, who will discuss the strategy for Kopin and our progress in the third quarter. I'll review the third quarter of 2022 results at a high level. And after concluding remarks from Michael, we'll be happy to take your questions. I would like to remind everyone that during today's call taking place on Tuesday, November 1, 2022, 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 differ materially from those forward-looking statements. Potential risks include but not limited to, demand for our products, operating results of 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'll turn the call over to John.

Good morning and thank you all for joining us to discuss our third quarter fiscal 2022 operating results. I'm calling in from Asia as I'm meeting with our OLED partners. Hopefully, this call is clear to you. I'm delighted to and excited to introduce Michael Murray as Kopin's new CEO. I believe Michael has experience to successfully lead Kopin to its next stage of stage of growth. I will remain Chairman of Kopin and we'll work closely with Michael on this important transition while continue to focus on the strategy and scientific matters, especially related to AR and VR. I will now turn the call over to Michael.

Thanks, John. Good morning, everyone. I also hope you can hear me clearly as I'm calling in from Europe, where I'm meeting with current and potential customers as well as some partners. First, I'd like to take a moment to thank John, the Kopin Board and the talented and hard-working folks of Kopin for their warm welcome to the company. John has led our company through many business cycles and growth over the past 35-plus years and we're fortunate to have him remain as Chairman of the Board and a critical visionary thought leader and partner in our technical strategy as I lead the company into the next stage of growth. I decided to join Kopin due to the company's unique culture of innovation, technical curiosity and a rich blend of consumer, industrial and military opportunities which closely aligns with my background and interest. I also believe that I bring a more systematic approach to business development, product commercialization and program management while still facilitating the culture of technical curiosity and freedom of experimentation which is core to at the Kopin culture. With that said, we'll turn to the third quarter results. We had a good quarter. The total revenue is up 23% over the third quarter of last year, our third consecutive quarter of sequential growth. Top line was driven by 50% year-over-year growth in product revenue. Interestingly, our defense and consumer revenues were very strong in third quarter of 2022 with 115% and 76% year-over-year growth, respectively. The growth in these segments was partially offset, however, by a 37% year-over-year decline in our industrial revenues. Now while the supply chain issues appear to be lessening, we continue to experience challenges, one of which resulted, unfortunately, in a warranty issue within the quarter which we have since addressed and we are hopeful that the $1 million charge will be the last related to the specific situation. Currently, the supply chain cadence appears to be improving, though we do continue to experience intermittent challenges from time to time. Importantly, we are on track for growth in the second half of the year to exceed the first half as promised. And as a result, the fifth consecutive year Kopin will achieve year-over-year growth. And I think this is a good segue to discuss our outlook. Beginning in Q4 and throughout 2023, my focus will be driving on yield improvements and achieving on-time in full deliveries while identifying opportunities to reduce costs. We expect these steps to result in improved margins and cash flow. I also see significant revenue opportunities in 2023. As an example, our AR and VR market is an exciting market in which Kopin is well positioned for growth. We are working hard to develop and further develop the technology required to mature this market. For example, we are the world's largest provider of this technology and the world's largest customers demand displays with higher brightness at lower power and thinner sizes. Again, as a reminder, Kopin is the world leader in supplying this technology. Other emerging markets for AR and VR, such as health care is still nascent. However, we do see adoption rates increasing in these markets which will also drive higher growth in 2023. Lastly, our military and defense business has significant order cover heading into 2023. And Furthermore, on recent customer visits, I clearly saw and heard how much they value Kopin's vast display capabilities, our swap C value and the unique ability to offer complex integrated optical display assemblies. The growing global concerns surrounding the war in Ukraine have generated further opportunities for Kopin to expand our customer base and support our current customers with new international variants of our products. Specifically, the recently announced $3 million initial production award is a great example of this. We see this order in similar potential deals like this as exciting new opportunities to expand our defense business. My trip to Europe this week directly supports that global defense business and opportunity level. Before I turn the call over to Rich, however, to review our Q3 financials in more detail, I did want to make one comment on our financial position. The $900,000 raised from the ATM this past quarter was related to the sale announced actually in Q2 before I joined Kopin which was completed in Q3. I’m confident that the steps I’ve outlined, we have the financial and contracting strategies. These things will help us drop increased profits to the bottom line. So Rich, over to you.

Thank you, Michael. Turning to our financial results. Product revenues for the third quarter ended September 24, 2022, were $9.9 million compared with $6.6 million for the third quarter ended September 25, 2021, a 50% increase year-over-year. The increase in product revenues were driven by a 115% increase in defense revenues and a 76% increase in consumer revenues. These were partially offset by a 37% decline in industrial revenues. Funded research and development revenues were $3.4 million for the third quarter of '22 compared with $4.1 million for the third quarter of 2021, an 18% decline. The decline in funded research development programs is due to transitioning programs into production and billings from subcontractors. Total revenues from Q3 2022 were $13.4 million versus $10.9 million for the prior year and overall 23% increase year-over-year. Cost of goods sold for the third quarter of 2022 was $8 million or 81% of product revenues compared with $5.1 million or 78% for the third quarter of last year. The increase in cost of product revenues as a percent of net product revenues for the 3 months ended September 25, 2022, as compared to the prior year was primarily due to a $1 million warranty charge partially related to the quality issues from a vendor that Michael discussed. R&D expenses in the third quarter of 2022 were $3.4 million compared with $3.8 million for the third quarter of 2021. The decrease in 2022 third quarter R&D expense as compared to the prior year was equally split between internal R&D and customer-funded R&D activities. SG&A expenses were $4.3 million in the third quarter of 2022 compared to $4 million in the third quarter of 2021. SG&A increases for the 3 months ended September 24, 2022, as compared to 3 months ended September 25, 2021, were primarily due to an increase in compensation and professional fees which were partially offset by lower stock-based compensation. Other income and expense was an expense of approximately $2.1 million for the third quarter of 2022 compared with an expense of $51,000 for the third quarter of '21. In the third quarter of 2022, we recorded a $2 million noncash impairment charge related to an investment in Asia. During the 3 months ended September 24, 2022, we recorded $112,000 of foreign currency losses as compared to $29,000 of foreign currency losses for the 3 months ended September 25, 2021. Turning to the bottom line. The net loss out Coke for the third quarter was approximately $4.5 million or $0.05 per share compared with $2.1 million or $0.02 per share for the third quarter of '21. Net cash used in operating activities for the 9 months ended September 24, 2022, was approximately $15.6 million. Kopin's cash and marketable securities were approximately $15 million at September 24 as compared to 29 at December 25, 2021. We have no long-term debt. Third quarter amounts for depreciation and stock comp expense are attached in the table to the Q3 2022 press release. The amounts discussed above our current are based on current estimates and listeners should review our Form 10-K for the third quarter 2022 for any possible changes and, of course, additional disclosure quarter and year. And with that, I’ll turn the call back over to Michael for closing remarks and then we’ll take your questions.

Thanks very much, Rich. Ultimately, this quarter was a reflection of Kopin's resilience, hard work and dedication to manage through global supply chain issues, the remnants hopefully of COVID and deliver a solid result. We remain cautiously optimistic that we've identified and have mitigation plans for us to play chain challenges and we expect to have a good fourth quarter. Now as we look forward, we are excited for the future and focused on pursuing an ambitious strategic growth plan while not losing sight of the current macro uncertainties. We remain optimistic and ever focused on the vision that has guided us from the beginning to be a company where imagination and experimentation seed innovation and invention and that invention ignites innovation. This innovation is why customers have partnered with us for the past 35 years and it's core of all the things that we do and achieve. Our goal now is to pare this innovation with a renewed focus of operational excellence which will benefit our customers, our partners, employees and our shareholders. So for me to you and Olive Kopin, thank you very much for your interest in Kopin and we'll now be happy to answer any questions that you may have. Operator?

Thank you .[Operator Instructions] We'll take our first question from Glenn Mattson with Ladenburg.

Michael, first one for you. Interested given your background and history and everything, you talked a little bit about commercializing some of the great innovation that exists inside of Kopin. Can you just balance like how you intend to do that kind of thing in light of -- especially like in spaces like commercial -- I’m sorry, consumer where maybe like the AR and VR market is maybe still emerging or as you mentioned. Some color on that would be great.

Sure. Glenn, I think I got that. Yes, great question. So I think there's multiple strategies at play, Glenn. When you think about consumer and volume and display markets, Dr. Fan has been working very hard in China on that strategy with partnerships and exciting opportunities that we have there. When we look at industrial and enterprise technologies, that's more of a licensing model that we already have in place and really taking latent IP and IP that we can take to the market and monetizing it and we'll do more of that in the future because it's a great model for us and very profitable. And then when we think about defense business, I think there's opportunities there to use more of our technologies in the defense market. And one of the things that I've learned and will bring to Kopin is how to move up the value stack line. And what I mean by that is our customers want us to provide them more capability. defense companies these days don't want to necessarily do everything internally. And our biggest customers want us to do more. So that, I think, is the way I would answer the question is for our mutual fund business which is our defense business that pays the bills, we're going to do more for our customers and monetize more of their system, move up the value stream and stack with them because they want us to and we'll monetize that with us. On the industrial front, we'll continue to do our IP licensing and expand upon that business. And then, Dr. Fan is working on more of the strategy around how to move forward with higher volume OLED business with our partners, customers and strategies in China. So those are the 3 aspects of our strategy that we're moving forward with and we will refine more in the next month or 2 as we have our strategic plan updates.

Great. And the next one, I don’t know if it’s better for you, Mike or for Rich. But can you give us a sense on the defense side, some new programs have kind of emerged more recently, what stage you are in terms of low rate initial production versus full scale and on some of the existing ones that have been around for a while, can you give us a sense of like the runway as we start to kind of think about a little more about 2023 and the outlook as we push out a little bit.

I was just going to answer with I think folks are familiar with the FWSI program. I think that's still got a lot of legs to it and we're in production with that and will be for quite some time, I believe. There are other offshoot programs with that, that I don't have permission to state yet but they're more on the international side of things. That's just coming into LRIP or low rate initial production. We have 3 or 4 other defense programs that are just hitting early-stage productions that we're excited about. So when you think about next year for us, we have a good blend of existing order book. And I think this is to answer the question more succinctly, we have a great order book cover for next year for our defense business which is up, what was it, 115%, roughly speaking. So we have that rolling into next year and we also have some new programs with Tier 1 customers that are just coming online. So it's an exciting place to be. Rich, do you want to add any color to that?

No, I think that’s exactly what I was going to say, we have a very solid base. And as we've talked about with a common helmet program for helicopter pilots, the international markets, a number of the other programs that have gone into low rate, we have excellent growth potentials on top of those.

[Operator Instructions] We'll take our next question from Kevin Dede with H.C. Wainwright.

Mike, Rich, John, thanks for dialing in from so far away. Mike, first, just welcome to the new role. It’s great to hear from you and apologies for not having to be able to touch space earlier. I’m curious, though, you mentioned a systematic approach. And I’m wondering if you could characterize that for us. What did you see when you walked in the door and started working on things, peeling the onion back, what do you think can change? How detailed will your oversight be on that type of thing on those types of things? And then more specifically, what do you think you can do to improve yields as you’ve spoken to?

Sure. Great question, Kevin. So one of the things that I've learned in my career is that process does not stifle innovation if done properly. Innovation can exist and flourish through process and what have you. So I think one of the things from a systematic approach is putting in an approach for innovation that still allows for free thinking, preform experimentation and then monetizing that freeform experimentation into innovation. That's the process. Keeping the great things about Kopin which is the MIT type of culture of innovation while making it monetizable and profitable, that's the systematic approach that I'm going to bring. I learned that Analog Devices, a very innovative company, still full of great ideas and wonderful engineering capabilities but they're able to monetize it very, very well. that's the type of systematic approach that I'm speaking of. Furthermore, we're embarking upon a revisit of our strategic plan this month as well as a more robust budgeting process which I think is important for the company. And then from there, we're going to look at the programmatic capabilities of the company in terms of running programs and making sure that we're delivering on time in full to our customer base. So that's how I look at more of a systematic approach. And while we put that in place, we don't want to hinder any of our innovation or invention along the way. So that's how I answer that question. Kevin, did I answer it fully for you?

Yes, that helps a lot. Maybe you could get a little more granular as you discuss where you see yields and how you'll work to improve those.

So from a yield perspective, we have a lot of processes in the company that I think are good. We'll put in place more of an agile methodology when it comes to our programmatic reviews as well as more statistical analysis or SEC thought processes around our manufacturing. So that's already underway. That was already involved and in process within Kopin previously. However, the way that I look at statistical analysis of yield is a little bit different and we'll look at it at a more broken-down level so that we know if we're going around earlier in the process versus at the end of the process. So it's more of a statistical approach, Kevin.

Okay. You seem to be more comfortable about supply chain issues. Can you offer a little more insight on -- I mean, given the short tenure, where your comfort is coming from?

Sure. Mainly, I understand the FPGA market very well. And I think you'll find other companies such as Kopin are struggling with FPGA deliveries. I can mention 5 off the top of my head. They are getting better because of their supply chain is getting better and that we've had direct relationships and conversations with the specific FPGA supplier that we work with. So they're getting better clarity. Therefore, we're getting better clarity and better confidence and that seems to be across the board. In fact, I was listening to Intel and their earnings call and it seems like they're getting a hold of their supply chain. So it's a ripple effect, Kevin and we're at the end of that we're at the end of that supply chain. And I think we're just getting better clarity and better confidence that our suppliers are getting their supply chain corrected.

Okay. I mean, everyone spoken to the improvement consumer, right, almost -- actually more than doubled, I think, in business from the June quarter. And I’m just curious what you see driving that and how consistent that sales level might be, albeit minor compared to the defense business, it’s still a nice little pop and potentially indicative.

Indeed, Kevin, it's exactly right. It's off a smaller base. But having said that, it's about the funnel. And we're filling the funnel with new opportunities with Tier 1 customers and they're starting to mature as time goes on here because the market is maturing. And I think we're well positioned for growth in it. But the way I view the consumer business is that's the pop, that's the fizzle, right? We're positioned well. We have a strong portfolio of products. Dr. Fans working on some really interesting things with our Chinese partners that I think is going to help fuel that growth. But then I think about the overall business. As consumer grows, we're going to have this wonderful base business that's profitable and will move along at a decent compound annual growth rate. while the consumer business will ebb and flow as they do. But I do believe our consumer business will grow next year based on some of the LRIP that we've got there with some key customers. And you're starting to hear some of the announcements that are coming out recently of Kopin being involved with Pantile Optics and some AR VR headsets. And I think you're going to hear more of those in the future. And to that end, I highly recommend we'll be at CES this year, Kevin. Hopefully, you're able to come visit us and you'll see some more of our new products in that suite and we're hopeful to have a great CES this year.

Last question for me, if I may, Mike. We talked about a I think it was $2 million -- I think on the P&L, it showed $2 million write-off and you spoke to $1 million. Can we just have a little more detail on that it kind of went by a little too quick for me. Apologies for the burden of maybe not a complete deck that you're talking to here. I was just wondering about the write-down, Rich. I showed us 2, I think, on the P&L and Michael mentioned one, I was just looking for a little more color on that. And it seems that you folks are confident that, that might be the end of it.

Well, so as you know, we have a number of investments, equity investments. In this particular case, we have a significant investment in a company located in Asia. Their business has been significantly affected by COVID. And every quarter, we go through and do an impairment review on our investments. And based upon the current situation in Asia related to COVID and this customer, we get a valuation and determined it was impaired and we took it. And we did not fully write the investment off. We just rolled it down to what our analysis says it’s worth. It’s all part of the fair market value of accounting that the financial statements are based on. There’s a lot of assumptions in there about future growth rates and so on and so forth as promulgated by the accounting literature. So it’s a noncash charge. And it’s something we’re required to do every quarter. But it’s directly related to the impacts of COVID in the countries that they operate in.