Good day, and welcome to the Kopin Corporation Third Quarter 2020 Earnings Call. As a reminder, today’s conference is being recorded. At this time, I would like to turn the conference over to Richard Sneider, Chief Financial Officer. Please go ahead..

Thank you, operator. Welcome, everyone, and thank you for joining us this morning. John will begin today’s call with a discussion about the market environment that we see and our progress in executing our strategy includes the sales activity and technology development. I will go through the third quarter results at a high level.

John will conclude our prepared remarks, and then we happy to take your questions. I would like to remind everyone that during today’s call taking place on Tuesday, November 3, 2020 and we’ll be making forward-looking statements as defined in the private Securities Litigation Reform Act of 1995.

These statements are based on is expectations, projections, beliefs, 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 of our products, operating results for our subsidiaries, market conditions and other factors discussed in our most recent annual report on Form 10-K and other documents filed with the Securities and Exchange Commission.

The company undertakes no obligation to update the forward-looking statements. And with that, I will turn it over to John..

Good morning. Thank you for joining us to discuss our third quarter results. I want to start by expressing our hope that you and your families continue to stay well and safe during this unprecedented time. Looking into after quarter, we are very pleased with many aspects of our business.

Our current product sales are increasing, our 100 development program that are averting stronger. We continue to make major improvements in our product cost and yields while maintaining tight expense control. In addition, we are making great strides in our next-generation EVAS display development.

Our total revenue increased 55% and compared to the third quarter of 2019, which represents the fifth straight quarter with double-digit year-on-year top line growth, excluding our one-time asset sales in quarter three 2019. It has been a very good year for us so far.

And we look forward to continue strong momentum through the fourth quarter and into 2021. Leading our third quarter revenue growth, product strength in defense product revenues which grew 140% year-over-year. Our two primary production programs are the F-355 fighter jet helmet and FWS-I program.

In September, we announced that we were awarded a $22.9 million follow-on contract for the FWS-I Family of Weapon Sight program, with deliveries through the third quarter of 2021. Including this recent one, we have received total orders to-date of approximately $33 million for this program.

As discussed in the news release announcing that contract win, the FWS-I program is a clip-on thermal weapon sight that provides users with the ability to identify targets in the most extreme circumstances. Kopin is the sole source on that contract as it is in F-35. We expect both programs to continue for many years into the future.

Our funded development program revenues grew over 100% year-over-year, which is a clear indication of the strength of our future growth potential. These programs funded by our customers, including both product-specific development as well as new advanced micro-display technology development.

In fact, much of the new fund R&D growth is for advanced micro-display development. We expect these development programs will further build on our current production business in the coming years. We currently have over 10 different programs in various stages of development, which is the stronger sign up in our history.

These development programs, including the use of our products in our vehicles, [indiscernible] systems, rotary wing aircraft helmets, [indiscernible]. Three of these defense development programs are expected to start the production next year, adding to our two current production programs.

We are also very excited to see growth coming from our enterprise customers who have incorporated orchestration modules into their AR products. The first was the social distance approach to work driven by COVID-19 has shown the power of our technology as we are seeing a solid adoption and rollout are devices to enterprise workforces.

We expect the enterprise market in AR to continue to gain traction and the ecosystem infrastructure elements necessary for the enterprise markets, such as 5G, will help accelerate the mass-market for consumers, AR and VR adoption. Kopin is already benefiting from the defense enterprise adoption.

And we are ideally positioned to meet those demands of this market with a broad lineup of micro debate products and module solutions, including both LCD and RM micro-displays. In fact, it is important to emphasize here the importance of a larger solution, the micro-display to be used in practice.

It must be offered [indiscernible] margin, which consists of sophisticated optics and electronics within a sealed housing. Kopin has deep experience in this area and it’s why many customers turn to Kopin for their micro-display solutions. We also are excited about the technical benefits of the light emitting diode, or OLED micro-displays.

We had the opportunity to highlight these OLED [indiscernible] in a recent webinar sponsored by Insight Media, where we shared results of our patent assets to achieve industry leading high brightness OLED micro-displays.

As mentioned in the second quarter, achieving high bandwidth with low power consumption, while maintaining color fidelity as the obstacle to create AR/VR [indiscernible]. In the webinar, we described our color 720p OLED micro-display, 7,000 nits of brightness with much lower power that was previously to achieve this level of pricing.

We also outlined our technical path to achieve even greater brightness as high as 30,000 nits or color OLED microdisplay in the coming years.

It is important to note that color mixing among the [indiscernible] OLED micro-displays normally result in poor color performance due to color mixing of the individual RF [indiscernible] duo-stack structures not practical for color displays.

We took on this challenge and introduced our ColorMax Technology, which controls the color mixing calming among [indiscernible] in our duo-stack OLED architecture. ColorMax Technology now enables a much wider color pigment of up to 115% [indiscernible], which is recognized as a very significant breakthrough.

We believe our innovative approach is lower manufacturable and cost competitive. It is a huge achievement for the OLED micro-displays. It is an important step in opening up the market for expanding use of AR/VR. Our view of the market is that the long-awaited adoption AR/VR system is starting to begin.

As we said, these systems are being adopted first in defense, followed by industrial enterprise and consumer application. Almost all of our defense programs are related to AR/VR applications. As VR and AR continue to gain traction in this new remote world, we feel we are very well positioned to meet this growing demand.

Our technology and products have been aiming for these AR/VR applications and solutions. In short, we are making great progress in executing our strategy and it is showing in our performance. The market conditions are favorable and we are very well positioned to capitalize in our Q4 and beyond [indiscernible] our future.

Finally, I would like to once again thank our Kopin employees who are continuing working through this unprecedented environment and are the reason of Kopin’s growing success. Now I will turn this call to Richard..

Thank you, John. Turning to our financial results, product revenues for the third quarter ended September 26, 2020 were $6.5 million compared with $5 million for the third quarter September 28, 2019, a 31% increase year-over-year.

Funded research development and other tax revenue were $3 million for the third quarter September 26, 2020 compared with $1.2 million for the third quarter ended September 28, 2019, an increase of over 100%. Total revenues for Q3 2020 were $9.5 million versus $6.1 million the prior year.

Cost of goods sold for the third quarter of 2020 was $4.8 million or 74% of product revenues compared with $4.7 million or 95% for the third quarter of last year.

The significant decrease in cost of product revenues as a percent of net product revenue for the 3 months ended September 26, 2020 as compared to the 3 months ended September 28, 2019 was primarily due to lower material costs, along with improved manufacturing yields and efficiencies gained due to higher sales, which reduced fixed cost per unit at our U.S.

plants. In addition, we are commencing production of certain products and we have fared higher than normal scrap for the first 3 and 9 months of 2019 as compared to the same period of 2020. Combined, internal and externally funded R&D expenses in the third quarter of 2020 were $2.7 million compared with $2.4 million for the third quarter of 2019.

The higher R&D costs for the third quarter of 2020 as compared to the prior year was a result of an increase in customer-funded R&D expense of approximately $500,000 in support of several development programs. SG&A expenses were $3.1 million in the third quarter of 2020 compared to $5.1 million in the third quarter of 2019.

The decrease was primarily due to lower compensation expenses, including stock-based compensation, bad debt expenses, professional fees, information technology and travel expenses. Other income expense was income of approximately $158,000 for the third quarter of 2020 compared with a loss of $78,000 for the third quarter of 2019.

During the 3 months ended September 26, 2020, we recorded $184,000 of foreign currency gains as compared to $88,000 of foreign currency losses for the 3 months ended September 28, 2019.

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 loss of $6.6 million or $0.08 per share in the third quarter of 2019, an 87%.

Kopin’s cash and marketable securities were approximately $15.6 million at September 26, 2020 as compared to $21.8 million at December 28, 2019. Net cash provided by operating activities for the third quarter ended September 26, 2020 was approximately $500,000, which was a result of improving operations and managing working capital.

During the third quarter, we had four patents granted. Third quarter amounts for depreciation and stock comp expense are attached in the tables of the Q3 press release. The amounts discussed above are based on current estimates and listeners should review our Form 10-Q for the third quarter 2020 for any possible changes and additional disclosures.

Operator, we will now take questions..

Thank you. [Operator Instructions] We will now take our first question from Glenn Mattson from Ladenburg Thalmann. Please go ahead. Your line is now open..

Glenn Mattson:.

–:.

So I am not sure we want to give guidance today on 2021 revenues, but I can tell you over the next several years, we expect these to go into the $80 million to $100 million range of annual revenues..

Yes, I think, Glenn, this is John Fan speaking. Those programs are all [indiscernible] programs, but we will know when this starts ramping up at the beginning this does slow and then it ramps, just like the other two programs we have now, but they are [indiscernible] of the programs..

Great.

And being that it’s Election Day and obviously no one knows the outcome, but what’s your confidence that under either administration that these programs would continue to advance the way they have been going?.

Well, I can tell you right now, for the next 3, 4 months, everything we are doing is for the 2022 budget, 2021 from purposes as well, so not much is going to change. And so literally, by January, most of 2022 budgets have a lot. Yes, I think it is a very good question, Glenn.

The defense budgets, especially decided a long time before this election, okay, second is [indiscernible] programs for military defense systems are determining a long time ago and we are so soft now, a new system that decided a year ago.

So today’s brand-new programs, which maybe coming [indiscernible] 5, 10 years from now, those programs can be affected, but weapon systems have decided many, many years ago and we are so soft – we have gone through a very elaborate conventional process in testing. So those are programs are usually [indiscernible]..

Glenn Mattson:.

–:.

Yes. It’s a very interesting phenomenon going out, all this remote learning, as we now are working for home, we see a lot of traffic in effect, I think, increase towards tech never been higher. So it’s come from all sectors, the enterprise sectors as well as the consumer sectors.

But I’m must cautioned when those things get designed into the products you will take at least a year. Even consumer products will take a year from today to go to products. So those are a little bit further out, but we are never seeing as high-traffic current before. So this is all very encouraging. I mean positive things happen in defense.

In a defense world, as I will talk about this area, we have more than 10 programs going on and lot of funded programs, coming in from all sectors, enterprise sectors, consumers after defense sectors. We’re seeing a lot of traffic.

And we’re here because we provide displays we provide the optics will provide the electronics will provide assembly will provide the whole solution. And people want right away because of the pool in they have no time to shop around. They went to the top five..

And on the industrial side, in particular, the 2019 seems to be like a big year where a lot of people adopted some products and tried to maybe work them into their workflow and things, but 2020 maybe has been a little quieter.

So that period of digestion kind of played itself out? And do you expect that to pick back up a little bit in the medium term?.

John Fan:.

–:.

Great. Thanks for the color. Just last thing for me, Rich, just on the gross margin, it’s two quarters in a row where it’s been better than unexpected.

So is that perhaps as a function of the products getting a little more mature and the processes get a little more advanced? So is that something we should expect kind of these high 40s or so in the total gross margin line?.

Richard Sneider:.

–:.

John Fan:.

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Great. Okay, thanks for the clarification. Thank you very much..

Thank you. We’ll now take our next question from Kevin Dede from H.C. Wainwright. Please go ahead. Your line is now open..

Thanks. Hi, John, Rich. Thanks for taking my questions..

Hi, Kevin. Hi, good morning..

Kevin Dede:.

–:.

So I assume you’re talking about the funded R&D revenue, not expense. So in any given quarter, who drives it changes by programs. So some programs that do a lot of development, then we sent it off to the customer, and we’re kind of doing it for a while as they run through their test and of course, then we outsourced to another program.

So there’s no one particular program that’s a significantly bigger driver per se than all the rest right now. It just changes month-to-month really based upon where they are in the program where various resources are coming through. So no, there’s no one particular one big guy driver..

John Fan:.

–:.

Okay. The enterprise, industrial revenue was still about third of the defense revenue, John. But your commentary speaks to growth is there. And I think it was up I don’t know, a couple of hundred thousand dollars sequentially.

Can we just hear a little bit more about the specific products and their use that drove that increase?.

Yes. As you well know, Kevin, we’ve been waiting for this variable handsfree transformation for years. And what we noticed is that actually, like we thought, but we never see the waves away that the first wave is actually in the defense world. And when it started, it’s one and not two. There are also some 10 programs and more.

So we begin to understand when the transformation occurs [indiscernible]. In the enterprise world, we’ve seen some, and we see especially one or two companies are doing very well. I think the value and benefits are still to be fully recognized. And once they occur, I think it’s probably just like defense [indiscernible].

The consumer world, I’m still I looking at it. I think the pace for AR in consumer world, I still think that people are still looking for the whole where the benefits are and how we’re going to provide it with the consumers..

Okay. So I guess, so not a hockey stick, yes, but a mix well..

We expect, not right now, maybe a couple of years right now..

Okay. Okay.

But I guess, it’s a mix of wearables really, I guess, is what you’re pointing to in terms of what you’re seeing driving the revenues now?.

Well, I think it’s very interesting. It’s not like the revenue growth in defense will be very interesting indeed and is very surprising to us..

Okay. John, you referenced ColorMax in your press release.

And I was wondering if that references the duo-stack or the fact that you’re just able to, I guess, keep colors from mixing and decreasing that fidelity, what specifically does that refer to in your OLED design?.

Yes. See in the RX situation, especially in AR applications, people would like to have the ore to be much brighter than what they have today, so the two ways to solve it. And well, of course, the webinar we described it, one is in direct happening, which are that for more display and very small pistols is very, very high, difficult to manufacture.

So what we did is, okay, but we do double stack. So you say one junction to two junction product. Now we will not be true going to pole try to a sale because in a small micro-display, the business are so small, they begin to talk to each other and cross cost and the color trade away.

So what we did is we’re doing a wafer in a bad plan, some structures in there to control the spreading of basically spreading our current between different OS. So we did it and what out the color goes back in very good. Do not allow you to go double that. On the double staff can get much brighter.

And in fact, that is the fact of too, like I say, a double step. Now it’s already over 5x brighter than single stack. And we think can go best in that. So this is really our target. And it has a shocking thing. And I’d say, when we first released it, we will shock the world sort and we actually have water out to explain why it is.

I think it was absolutely different to explain how it works, how can you get double setting, seeing double, we got more than 5x better. So it’s a very significant improvement. And it’s true, and that’s what we explained to people, it’s not though we explain it, and people understand it now. And with that, we can go even higher.

We think we can go the 30,000 hits. So the whole world, Michael, on is different now..

Kevin Dede:.

–:.

Well, there is a development we need to say to few years. If you will know, it’s not something that has ever been achieved. 3 months ago, nobody would even say that the even say that people are saying, you’re crazy. So we’ll not say something is possible, but we will say it will take a few years..

Kevin Dede:.

–:.

Richard Sneider:.

–:.

Okay.

Do you think there is more beyond that or do you think the army switches to something else?.

No. The TWS program that this is replacing went 10 years. And so we think this has a long life to it..

If I understand correctly, I am sorry, John, go ahead..

Go ahead and finish your question before I make a comment. Yes. Go ahead..

Okay, okay. Yes. So a 10-year life program, if you were to comp it against what it’s replacing. And if I remember correctly, went into production about this time last year.

Is that true?.

Yes. Yes, I think the way well cost, we can learn from what happened last time. Lifetime TWS program, we are total shipment to the customer is around 200,000 units. Okay. So give order, of course, we will not say every how many units are, is still a very small part of the 200,000 units that we shipped for TWS..

Okay, okay.

But am I right in assuming that FWS-I started about a year ago, I mean, at production, is that right?.

Yes..

Okay, okay.

I know Glenn asked about gross margin already, Rich, but I’m just I guess what I’m wondering is where you think it can go if product revenues nudge a little bit higher, which is sort of where my estimates haven’t going given your commentary? Or do you start getting pushback from your customers? I’m wondering if they pretty much are stuck with their, you will see the yield improvement.

And you’ll be able to recognize that as production levels increase, but do you start getting some pushback from some of your customers at all?.

Richard Sneider:.

–:.

Yes. In those programs, Kevin, this mint defect programs and maybe in some cases, enterprise go in the same way. The customer knows so not making any money when you first start because you use law, you a learning curve is so big so the investment.

So as the investment goes, later on, we turn into some harvesting they actually wanted to be able to do some harvesting. So again support the next program. So everybody understood is that even out at the beginning not many, and they do no trial to recover some of them. So we’re going through this harvesting period on this program right now..

Okay. I guess it’s a good way to look at it. Thank you for the color, John. I really appreciate it. Rich, last question for me, you mentioned currency gains. I’m just kind of wondering, I know it’s inconsequential.

But I’m just sort of wondering how that happens in your other account?.

Richard Sneider:.

–:.

Okay, alright. Listen, you didn’t speak too much about this. And I guess it would be interesting just to get my arm sort of around how you’re handling your employees. I mean, I know that you’re really careful in manufacturing location in Massachusetts. I’m just sort of wondering how you’re handling safety for some of your other manufacturing sites..

Richard Sneider:.

–:.

–:.

Are you considering like taking employees temperatures kind of the way they do in restaurants here in San Francisco?.

No. We did look into it. Obviously, with all employees, if you don’t feel well. If there’s any issue, don’t come to work, we had somewhat of a couple of people that were nervous last week. We set them off it tested, they were fine. So no, we haven’t gone through the temperature taking step. We have looked at it.

But and again, even in the room we separate workers, similar what they’re doing to schools as far as havening cohorts and so if someone did get skilled to be contributed confined to a certain number of people and so on..

Okay. Well thank you gentlemen. Congratulations on the results and thanks again..

Thank you very much, Kevin..

Thank you. We will now take our next question from the queue. This comes from Jeff Bernstein from Cowen. Please go ahead. Your line is now open..

Congratulations. First off on the positive cash flow from operations and it seems like you are on a positive track here.

Do we think we are going to be free cash flow positive for 2021?.

Correct. We expect to peak break exit 2021 breakeven cash flow positive. I don’t want to say for the whole year right now..

Okay, great. And I apologize I don’t have the best connection, so I think I might have missed a couple of things.

I wanted to just make sure you said the FWS-I follow on order, $22.9 million was that on top of $33 million already awarded? Or did that total $33 million with what was already awarded?.

$33million is a total. It includes the $22 million..

Got it. Okay. So that’s it. Alright. And then I want to make sure you were talking about the externally funded R&D and that it’s not just military.

So you have some commercial customers who are actually paying some money for you to do R&D?.

Yes..

Great. And then I wanted you to touch on fourth dimension and what’s going on with 3D machine version, I think Chinese economy seems to be rebounding at the big end market.

What are we looking forward to here in the next 12 months?.

Richard Sneider:.

–:.

Jeff Bernstein:.

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So, that we are working with the three big Chinese boundaries and so we really can’t talk about who their customers are..

Yes. I think it’s also clear for the enterprise world, as you will know, real way definitely will now on Google Gramaltoe, so there is the usual suspect and there are obviously a lot of traffic right now. So we are on pet talk about, yes..

So you are saying you have some additional customers that are customers of the Chinese families?.

Yes. The Chinese is very interesting. And Richard touch upon that, they definitely have recovered a lot more than a lot of activities but let’s say that we cannot go there. I’m not on there for most a year. So a lot of things, we try to not say too much about that because I don’t have this face-to-face we are people to an age for a year.

So they tend to recover. There’s quite a lot of activity and how they are going to sell-through and everything we are more cautious about until we brought the staff..

Okay.

And then ColorMax, is that in those foundries now? Is that being produced on a scale basis or is it just a prototype or where are we on that the anode technology?.

ColorMax is manufacturable. In fact, we are manufacturing them and people are using it and displays are coming out from them and customers are sampling the machine now..

That’s terrific. That’s just great, guys. And then just to beat up one more time on the gross margin. So the incremental gross margins have been crazy, the 90% this quarter.

So are you telling us that new military programs will come in with lower margins that kind of tamp that down or are there some reversals from some prior written off inventory or something that’s helping that incremental gross margin right now?.

Yes. So I think a combination of anything that you mentioned. So the first couple of quarters of 2019 were artificially low because of FWS-I was just really getting going, and we had a lot of scrap associated with design changes and so on and so forth.

And so now it’s hitting its stride, and we are continuing to make improvements, both in how we manufacture. So our yields are going up and being able to get lower pricing for materials by having multiple vendors and so on. So knock our wood FWS-I has been a nice move right now and doing well.

F-35 is in a nice, steady state, and we continue to make improvements on the yield. F-35 is really just a display sale. So it’s really just manufacturing efficiencies.

And then next year, as John indicated, some of these new products will come on, and they will have lower gross margins that are ultimately steady state, but the sheer volume of having these additional programs is going to suck up more fixed cost per unit over the whole broad base.

And so we think that will ultimately increase the margins on everything. It helps us continue to grow towards our goal of 35% to 40%..

That’s great. Okay.

And then, Rich, did you say for some of the new programs, it was a total of $80 million of potential revenues or something next year, I missed that?.

I was talking 3, 4 years out..

Okay, okay great. Thank you so much guys..

Thank you we will now take our next question from Patrick Metcalf from I-bankers Direct. Please go ahead. Your line is now open..

Good morning guys. Congratulations on not only on a great quarter, cash flow positive, but the military contract you guys announced last quarter that went unrecognized unappreciated very thankful for that. And I am just very excited. Secondly, I want to ask you about double stack.

John, last quarter, you told, I believe, Jeffrey, last quarter on the conference call that no 1 will be doing a couple stack in a year. That being said, I’ve always viewed you as a competitor to other OLED players.

But to me, today, after the white paper and the webinar, kitchen, you’re almost agnostic to me where you can supply the wafers to as many fabs as you want.

Is your architecture similar in nature to Sony to BOE to LG to Samsung, can you give me some color on how you see yourself being agnostic or someone as a competitor to these type of players in the marketplace? I have a follow-up question after that..

John Fan:.

–:.

Yes. Because the reason why I ask that is, in case COVID has come unexpectedly. We have had AR/VR Tier 1 players in our hopper, in our pipeline. And I am thinking if you have now found double speck where numerous parties have not reached double-stack at the ATA family.

Maybe these fabs will come to us quicker because the Tier 1s in COVID want to push these products out the door faster. And Kopin now has a display, double stacked, 5x brighter, more power efficient.

And I believe you should be able to win business that people don’t even think that you could be in? Is that possible? It’s a possible result what we wish for. And I think is very interesting.

For the VR case, you may not need such a high brightness, but it doesn’t matter, because you can really soon turn the power down and people have much lower power consumption and much longer lifetime. So either way, when you make the display efficient is always good. So yes, people begin to recognize it.

And then the wearable you don’t want to carry too much battery on your body. So, all these are benefits. So we just see. But remember, things take time to go to full protection, people go and try it and by time I see product out a year later. So we’re not going to see an immediate large revenue growth from these activities for these sometime out.

Right now, current growth is going to be for our some defense project, which has been around, we are working with them for years and how they are going to production. So those are the revenue growth and then the rest of them will come a year, 2 years from now..

Okay, great. And then lastly, John, this goes to Rich, I guess. You guys have four equity stakes in Lenovo new vision, Realwear, Solos and HND and the way I see it. And they all contain licensing agreements.

I would like to know, are there any new developments or updates on these investments because the analysts initiated coverage on us, but they never talk about our off-balance sheet assets or these things that I think represent a lot more value than some of our competitors? So I would like to know if you guys can just add a little bit more color on these equity stakes.

How you seen anything you can add that could bring some value out in our stock because the equity, I think, doesn’t represent these off-balance sheet assets, if you will?.

Yes. Just one correction, MDMD, we do not have an equity stake in it. But we are working with them Lenovo continues to make progress. We get the financial statements, and we mark-to-market the investment as needed. Solos is a new company, launching a new product, obviously, they’re dealing with COVID over in China.

And I think you really have talked to real aware about how they’re doing. But I think they put out in a press to indicate that they are having they are being pretty bullish..

Okay alright. Thank you guys. Good luck. Great quarter. Look forward talking to you down the road..

Thank you, Pat..

There are no more questions in the queue at this time. I would like to pass back to the room..

Thank you very much for joining us this morning and we look forward to talking to you again in the next quarter. Stay safe. Thank you..

Ladies and gentlemen, this concludes today’s call. Thank you for your participation. You may now disconnect..