Kopin Corporation (NASDAQ:KOPN) Q4 2019 Results Earnings Conference Call March 10, 2020 8:30 AM ET

Company Participants

Richard Sneider - Treasurer & Chief Financial Officer
John Fan - Founder, Chairman & Chief Executive Officer

Conference Call Participants

Glenn Mattson - Ladenburg Thalmann
Jeffrey Bernstein - Cowen

Operator

Good day and welcome to the Kopin Corporation Fourth Quarter and Full Year 2019 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Rich Sneider, CFO. Please go ahead sir.

Richard Sneider

Welcome everyone and thank you for joining us this morning. John will begin today's call with a discussion of our strategy, technology, and markets; I will go through the fourth quarter and 2019 results at a high level; John will conclude our prepared remarks; and then we'll be happy to take your questions.

I would like to remind everyone that during today's call taking place on Tuesday, March 10, 2020, we will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on the company's current expectations, projections, beliefs, and estimates and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those forward-looking statements.

Potential risks include but are 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 it over to John.

John Fan

Thank you, Richard. Thank you for joining us this morning to discuss our fourth quarter and 2019 results. We are very pleased with the way the year ended. From an operations perspective, we saw strong demand for our products, from the Military and Public Safety segments. And we continued to make improvements in our cost structure.

From a technology perspective, we had an [indiscernible] Consumer Electronics Show in January at which we highlighted our proprietary double-stack organic light emitting diode or OLED micro displays, including a super-bright monochrome green display that emits over 20,000 nits. Honestly, it was too bright that it is difficult to look at.

For the fourth quarter, Military was a key revenue driver with the F-35 Joint Strike Fighter and FWS-I programs representing the majority of those revenues consistent with our experience all year. As we noted in our earnings call of third quarter 2019, we received a new FWS-I order that begins [indiscernible] in the fourth quarter.

In 2020 we expect FWS-I Crew Served in our armored vehicle development programs to be complete and the Joint F-35 and FWS-I product revenue generation. Historically, we have had only one or two major merger programs in place in any given time. Today, we have in place over 10 military programs that are either in current production or advanced development stage.

While some of them may not impact revenue generation until 2021 through 2023 timeframe, and we cannot be sure all will reach production after moving through development. The overall strength of our Military program and our success in winning programs over competition is the strongest in our history.

Turning to Public Safety, we had a very strong Q4 for shipments of our display products for the fireman's mask application. We believe this is a key application for our technology and we expect new products to be developed for our Public Safety applications in 2020.

You may recall in the third quarter of 2019 we took significant steps to reduce our cost structure. These reductions have improved our cash for operations reducing it from $7.8 million of cash used in operation in Q1 of 2019 to $4.2 million of cash used in operations in Q4. We are making good progress in rationalizing the business and expect further progress as we move through 2020.

As I mentioned, we had a very good showing at our CES event. We demonstrate 2k and 720p display using our new double-stack OLED microdisplay technology, which has a much higher brightness and longer life time. We also gave a preview of our new and the world's first 1.3" 2.6k x 2.6k display. That means 2560 pixels x 2560 pixels resolution for the next generation AR, VR, and XR applications.

Our OLED technologies [indiscernible] include patent-pending silicon backplane technology, which enables the creation of double-stack OLED structures for microdisplays. A double-stack OLED is two OLED structures on top of each other that are connected in series, so that a charge carrier pass through the double-stack OLED and generate photons twice, instead of once in a conventional single-stack OELD structure.

This results in much higher efficiency, higher brightness, lower power consumption, and longer life. While this approach has been used now for large panel displays, maintaining a good color fidelity has been [indiscernible] barrier for small pixel microdisplays. We have succeeded in solving this with a unique method in our silicon backplane design process.

In addition, our patented backplane design architecture enables a superior dynamic range which allows our display to be used in very bright sunlight and pitch black darkness. These displays can meet the demand of consumer enterprise applications being developed by the scientific [ph] network.

Finally, our stock is below $1 and we received a notice from Nasdaq that the Company is not in compliance with Nasdaq's minimum bid price listing rules. On March 02, 2020 we held a special shareholder meeting at which the shareholders authorized the company to affect a reverse stock split. The Board will decide the timing and size of the reverse split. Once we have clarity we have number of planning opportunities. In the meantime we expect to request an extension from Nasdaq to enable all options.

To summarize, we had a strong fourth quarter of 2019. We are excited by Kopin's long term opportunities as we see increased revenues and the benefit of our continuous cost reduction efforts. To further increase our efficiency, at year end we created a new position of VP of Operations and hired Eric Whitman. Eric brings expansive experience gained from operational positions at several aerospace, defense, and technology companies and will be focused on improving our manufacturing facilities.

Now, I'll turn the call over to Rich, so he can provide additional details especially of the cost structures.

Richard Sneider

Beginning with the results of the quarter, total revenues for the fourth quarter 2019 was $8.7 million compared with $7.7 million fourth quarter of 2018, a 13% increase year-over-year. The increase in sales for 2019 compared to 2018 was primarily due to increased sales of products for Public Safety applications and funded military projects.

Cost of sales for the fourth quarter was 81.1% of product revenues compared with 76.2% for the fourth quarter of last year. Cost of product revenues increased as a percentage of revenues in 2019 as compared to 2018 because of a lower than historical yield from our manufacturing process.

R&D expense in the fourth quarter of 2019 was $2.7 million compared with $3.9 million in the fourth quarter of 2018, a 31% reduction. R&D expense for Q4 2019 decreased $1.7 million as compared with the prior year primarily due to the licensing of certain products and other development programs being curtailed. This decrease was partially offset by increase in funding R&D expense of $500,000 for Q4 2019 compared with prior year due to an increase in funded R&D revenue for military programs.

SG&A expenses were $4.5 million in the fourth quarter of 2019 compared with $6.2 million in the fourth quarter of 2018, a reduction of 27%. SG&A for Q4 2019 increased as compared with the prior year primarily due to a decrease in noncash stock-based compensation of approximately $500,000, compensation expenses of $700,000, marketing expenses of $400,000 and IT and software spending of approximately 400 which was partially offset by a partial increase of $500,000 professional fees and $800,000 of bad debt expense. Included in the Q4 2018 operating expenses are $2.5 million from the write-off of fixed assets and $1.4 million from the impairment of goodwill charge.

Other income expense was expense of approximately $3.7 million in the fourth quarter of 2019 as compared to $1.1 million of income in the fourth quarter of 2018. Included in the fourth quarter of 2019 was a net write-down of equity investment of $4.6 million. The fourth quarter 2019 includes approximately $238,000 of foreign currency gains as compared to approximately $1.4 million of foreign currency gains in 2018.

Turning to the bottom line, our net loss attributable to controlling interest for the quarter was approximately $7.3 million or $0.09 per share compared with a loss of $10 million or $0.14 per share for the fourth quarter of 2018.

Turning to the results for the full year, total revenues for 2019 were $29.5 million compared with $24.4 million for 2018, a 21% increase. The increase in 2019 revenues as compared to 2018 was primarily due to an increase of sales for industrial applications and funded development programs, partially offset by decline in sales of our products from instrument applications.

Cost of goods sold for 2019 was 103% compared with 82% of product revenues in 2018. Cost of product revenues increased as a percentage of revenues in 2019 as compared to 2018 due to lower than historical yields from our manufacturing process as a result of the initial volume production of our FWS program and a charge for inventory obsolescence. The charge was due to the discontinuation of certain products and a write-off for materials as we found substitute materials that we provide for better long term manufacturing yield. The FWS program went into volume production in 2019 and our yields were lower than historical levels as our supply chain works to consistently meet quality standards.

R&D expense in 2019 was $13.3 million, a 23% decrease compared with $17.4 million in 2018. Funded R&D expense for 2019 decreased $700,000 as compared to 2018 primarily due to completion of our former obligations on funded U.S. military programs. Internal R&D expense for 2019 decreased $3.4 million as compared to the prior year primarily due to license of certain products and other development programs being curtailed as part of our strategic realignment.

SG&A expenses were $21.3 million for 2019, a 22% decrease compared with $27.2 million for 2018. SG&A for 2019 decreased as compared to the prior year primarily due to decrease of $2 million in noncash stock based compensation, $1 million in product promotion and marketing expenses, $900,000 in IT spending, $900,000 amortization intangibles and $800,000 accrued [ph] contingent consideration which were partially offset by an increase of $1 million in professional fees.

Included in 2019 and 2018 operating expenses was approximately $300,000 and 1.4 respectively from the impairment of goodwill and in 2018 $2.5 million from the write-down of fixed assets. Other income expense was expense of $2.9 million for 2019 as compared with income of $5.5 million for 2018. In 2019 we recorded a net write-down of equity investments of $3.9 million. In 2018 we recorded a noncash $2.8 million gain on equity investments as we received $1 million of insurance proceeds. 2019 included approximately $200,000 foreign currency gains as compared to 2018 which had approximately $1.2 million of foreign gains.

Turning to the bottom line, our net loss from controlling interest in 2019 was approximately $29.5 million or $0.37 per share, compared with a net loss of $34.5 million or $0.47 per share for 2018. Fourth quarter and year amounts appreciation stock compensation are cash on the table to the year-end press release. We concluded the year with approximately $21.8 million of cash and marketable securities and no long-term debt.

Regarding the coronavirus, it is affecting delivery of a couple of products parts that we procured from China. Although it has not yet had a significant effect, we are currently working with our suppliers to establish alternative sources for these components as a contingency plan. We are currently forecasting an increase in military revenues in 2020 as compared to 2019, but this will partially offset by lower forecast demand from industrial customers.

All amounts discussed are estimates and listeners should refer to our Form 10-K for the year ended December 28, 2019 for final disposition as well as important risk factors. And operator, we will take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Glenn Mattson with Ladenburg Thalmann.

Glenn Mattson

Hi, thanks for taking the question. So just Rich remaining on the guidance talked about increase in military partially offset by some other factors, so payments partially offset I assume, you talk about revenue growth for the year in aggregate, but then just as far as the industrial side - in the press release, you talk about issues perhaps around getting supply that you need, but then you say lower demand from industrial customers, so supply is the issue or demand is the issue?

And maybe you could give us some more color as to how the quarter performed in some of the other sectors industrial notably things like RealWear, and perhaps from partners like Google Glass, and just how you think that those guys will perform in 2020?

Richard Sneider

Sure, so as it relates to the coronavirus on the supply side, we have not yet had any specific issues. Our vendors are meeting their deliveries as required in the purchase orders. I will say though, there are a couple of parts literally to that. We're living someone hand-to-mouth. We are meeting deliveries, but we are concerned that there might be a hiccup, and so we are working with our vendors for possibly sourcing these parts in the United States.

So that's otherwise no real issues on the supply side. On the demand side, our customers are forecasting lower demand. I think it's all part of just the industry trends associated with the coronavirus and whatever else they may be factoring in. And so we're using those forecasts from our customers to come up with our guidance.

Glenn Mattson

Okay, and then as it relates to the Military business, you mentioned - maybe John mentioned that the – you expect to like maybe later in the year that the cruiser FWS Crew business begins to ramp and the armored vehicle begins to ramp or begins to produce revenue later in the year, is that are those programs kicking in how confident are you in that? And is that – is the guidance relying on those kicking in the second half? And then I guess the last thing I'll ask is just how gross margins shakeout if the business is more skewed towards Military in 2020?

Richard Sneider

So, as it relates to the programs, the first half of the year is essentially delivering prototypes, and assuming that those prototypes go through the normal shake and bake, you know at this point, they don't have progress on those programs, we do think that Q4 we are generating revenues and it will go into production. That's the schedule. We've been meeting schedule for the most part to date, and so we don't see anything changing on that.

As it relates to gross margin, last year we obviously took some significant hits on the yield on the FWS-I program, and during the course of that development, honestly, we identified better raw materials as the year went along and so the decision was made to scrap old material rather than run through the line if it's low yield. And so we took some significant inventory obsolescence. And so what we're looking for is something in the neighborhood of a 5% improvement in cost of sales gross margin each quarter during the year.

John Fan

Yes, I just wanted to add, of course, we also had additional management. So Eric Whitman who is very experienced in this particular area has been joining us at the end of the year last year.

Glenn Mattson

Okay, great, thanks for the color.

Operator

We will take our next question from Jeff Bernstein with Cowen.

Jeffrey Bernstein

Hi, guys a couple of questions. A number of months back you had a press release about a customer for fourth dimension that was using the cost displays in an optical compute platform and I was just wondering what the update there was had that ever become commercial?

Richard Sneider

Well, that's still in development.

Jeffrey Bernstein

Got you. What is the expectation on when that might have a commercial product?

Richard Sneider

I really couldn't talk to what their plans are.

Jeffrey Bernstein

Okay. And then I think you guys were working on a helmet that was more for rotary drive aircraft, helos and stuff. What is the status on that program?

Richard Sneider

So that's the common area helmet program were are working with on with Elbit. It continues to go through with - it's taking our old AMLCD and adding an ITO layer to it. I don't know what ITO really means. I don’t have to explain that to you, but it's supposed to be dramatically improved contrast. And so that problem continues along. And we believe Elbit has already been awarded the program and so now we're in just continued development phase. We expect somewhere between the second and third quarter that development phase will be completed.

John Fan

Yes. Just to add, that program Elbit already got awarded and now we are in the pre-production phase, trying to get into production. So that is a multiyear program and [indiscernible].

Jeffrey Bernstein

Got you. So that's one of the 10 that you talked about are in various stages. And then is there a theme among the others? Are there other ones that are additional sort of LCD replacement type contracts or is there anything to talk about on the others?

John Fan

Yes, I think this job has certain ideas. The situation with a microdisplay is of course dominant LCD, but there is a significant activity now going on trying to go to the next generation of microdisplays. So it is very active right now and I think we're very well positioned because we are the king of microdisplays.

Jeffrey Bernstein

Okay. And then just to clarify there was this confusion about the supply side versus demand side in China. So on the demand side, we're talking about the demand for the 3D machine vision for board inspection out of China, that's the demand side where customers right now are forecasting some lower demand, is that right?

Richard Sneider

Yes. But we also have customers who are doing some of the wearable technologies, and they're being cautious on their forecasts also at this point in time.

Jeffrey Bernstein

Got you. Yes.

John Fan

I think in near-term you will see some impact on this particular area. For the longer term, we think the customers and Chinese customers are in the factories were trying to go for more automation or something which instruments that new instruments we have been developing with our new displays. Are they useful for them? So you will see a short-term and may be a longer term as you come up better.

Jeffrey Bernstein

Okay. And then with regard to Panasonic's development, I guess you were showing some prototype at CES. I think you're still working on getting the color fidelity right on that, that's I guess the first contract that would use the BOE capacity that's coming up. Just give us an update on that and talk about what the pipeline looks like for additional people looking to use that BOE capacity potentially?

John Fan

Yes, the questions on this CES Panasonic has demonstrated they are the corner high class or high [indiscernible] it is that they are cool. They wanted to demonstrate openly of course is using 2k but they obviously are doing [indiscernible] which is in fact even more. So the demand for after the demonstrate for their customers are the strong [ph]. So they are making an active movement towards, they are making lot more systems.

I actually personally think that is that those are ways going to go, I think I talked at MIT about now about three weeks ago and it is now on YouTube if you want to see it, is I'd say that that's what is going to happen. The VR will come in first and then comes the AR so VR then our displays [indiscernible] especially [indiscernible] you know 2.6K displays using double-stack, which we have right now already we exposed now will be the purchase of VR.

Jeffrey Bernstein

So John, but the issue on the color fidelity has that been worked out or are you working on that now?

John Fan

The color fidelity was a huge problem for double-stack. And I shared it and we succeeded in solving the problem on using a special scheme on the backplane. So it's transparent to the [indiscernible] because we solved it on how that [indiscernible].

Jeffrey Bernstein

Got you. Okay, so you're saying this Panasonic 2.6K x 2.6K that's what they're going to go to market with and that is all ready to proceed?

John Fan

I don't know how we can proceed because that's our customers decision, but they are moving quite strongly forward, yes.

Jeffrey Bernstein

Yes. Got you. Okay. And then lastly, you talked about something about getting an extension for the reverse split, a number of opportunities, could you just flush out exactly what you mean there? Are you saying you expect a lot of good news to come and you think the stock will be a lot higher and you don't need to do a reverse split or what is this all about?

Richard Sneider

Yes, it's a combination of things. One, this uncertainty over the coronavirus, to be perfectly frank, we don't want to go through the whole process of reverse split, this corona thing blows up. And the next thing you know, the whole market is coming down, and we're getting dragged down with it. So we did want more visibility in the overall fact of corona. We also do think that organically, the company is going to do better over the next few quarters, and so we want to give that an opportunity to open into the stock price.

Jeffrey Bernstein

Okay. All right. And then Rich, I think you've talked about culturally Kopin is an R&D house that people want to spend money on R&D, and you've had to fight to bring that down. Do you need me to beat up John anymore about that or are you guys on track for getting the cost saves you need?

John Fan

I will answer that question Jeff. I mean, this is a very loaded question. But remember the last year so we already said that we have been doing a lot of investment in military programs, in technology, advancement like all that, and we expect investment will go down and revenue generation is fast. And I think we will see much online. We will see with finishing up this probably more then 10 now with your program development, and there will be revenue generation and we solved microdisplay problem that world people had never solved. So we are actually going for investment to revenue generation, was our plan. It just happened to be we actually did on schedule.

Jeffrey Bernstein

Okay, great, we're looking forward to it.

Operator

And it appears there are no further questions at this time. I'd like to turn the conference back to Dr. Fan for any additional or closing remarks.

John Fan

Well, thank you for joining us and everybody stay healthy. Thank you.

Operator

And that does conclude today's conference. We thank you for your participation. You may now disconnect.