Kopin Corporation (KOPN) Q2 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to Kopin Corporation's Second Quarter 2012 Financial Results Conference Call. Today's call is being recorded for Internet replay. You may access an archived version of the call on Kopin's website at www.kopin.com. With us today from the company are Chairman and Chief Executive Officer, Dr. John C.C. Fan; and Chief Financial Officer, Mr. Richard Sneider. Mr. Schneider, please go ahead.

Thank you, operator. Welcome, everyone. Thank you for joining us this morning. John will begin today's call by showing his perspectives on future opportunities and summarizing our second quarter results. I will take you through the financials in more detail, 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, August 7, 2002 (sic) [2012], 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 display and III-V products, development of Golden-i, operating results of our foreign subsidiaries, Kowon, Forth Dimension Displays and Kopin Taiwan Corporation, 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.

Thank you, Rich. Good morning, everyone, and thank you for joining us. Today, I'm going to focus my remarks on the opportunities that we are pursuing, particularly with our Golden-i technology and how we plan to monetize them. Specifically, I want to speak on how we are creating technology to develop a platform that we believe has the potential to guide the future of mobile communications. I'm talking, of course, about Golden-i. I want to make clear that when we say Golden-i, we are not talking about a device or piece of hardware, the way most of us would commonly refer to a cell phone or laptop computer. Instead, Golden-i is a software-based, application driven platform technology that we believe will enable both device makers and software application developers the opportunity to create a new breed of wireless, head-worn, hands-free mobile devices for numerous applications. Our broad platform incorporates numerous technologies developed by Kopin overlaid on our proprietary operating system. Golden-i creates a new mobile device category, wearable communication and computing device. The mobile device makers can create a group of new devices and new products for markets they will identify with new applications of this platform. No one can argue about the profound impact smartphones have had on our lives, both at work and at home. But even the smartphones is not without inconvenience. For example, the news constantly showed individuals walking into doors or falling into manholes as they try to walk and text on their smartphones simultaneously. Golden-i platform improves the user interface by using voice and gesture controls, as well as speech recognition. Now many of you may have used speech recognition in the past, and results today have been mixed. Although, clearly, it is improving now. So why is our voice recognition better? First, we have developed the latest state-of-the-art technology. Actually, it's simpler than that. The Golden-i is a head-worn device, the microphone locations are well tailored to the user, and so opposed as smartphone where the distance and locations vary among users. This feature also enables us to optimize our noise cancellation software. Golden-i speech was initially tailored for industrial applications. And accordingly, was more command-and-controlled oriented. This required the users both go through a series of command statements. Our efforts now focus on natural speech to improve the industrial user's experience. We're currently injecting artificial intelligence into the speech and we expected to have a natural speech system for Golden-i by the end of this year. Another area we believe Golden-i will provide a superior experience is the use of our micro display. Many smartphone operators and providers are still trying to determine the best size for the screen. Is it a current 4 inch or the tablet's size of 10 inches or somewhere in between? Whatever their solution, it will be a compromise of form factor, power and user experience. By contrast, our display technology provides a virtual image equivalent to looking at your laptop computer screen, hence, we're able to develop platform that uses small form factors and low power and still providing a large image. The third area where the Golden-i platform delivers unique capabilities is the use of Bluetooth, Wi-Fi, 3G and 4G technologies. Golden-i users have advanced camera feature to stream video back to other Golden-i users or anyone with access to streaming video. This enables collaborative problem-solving between field servicemen and technicians and headquartered engineers. So where are we today? The Golden-i platform technology is currently being put through its paces by more than 100 prospective industrial customers, partners and software developers. With their current feedback, we're identifying the features and market verticals that show the greatest promise. Over the coming months, we will be working with our partners, most notably, Motorola Solutions, to finalize our operating systems, improve our current features such as providing a more natural speech interface, and develop various application software. Application software is key to our long-term successful of Golden-i. This is why in the second quarter we have made strategic investments in 2 software companies that we believe can accelerate the development of application software and adoption of Golden-i technology. Presently, we are focused on industrial markets. According to Forrester Research, 25% of computers using work settings are tablets and smartphones, not personal computers. What this is telling us is that, there is a demand for Golden-i software technology platform, we're actively evaluating possible future products such as a professional or prosumer version and we're in the product definition phase. Our business model focused on generating revenue by licensing the Golden-i platform technology and selling our innovative imaging display system. We also are looking at selling or licensing software applications and various hardware accessories. Our first Golden-i enabled product for the industrial market is expected to be launched by our partners later on this year. So what is our vision for Golden-i? A complete platform technology that delivers a seamless user interface experience, highlighted with a robust operating system, natural speech recognition and precise gesture control. For Phase 2 for Golden-i development updates and other interesting, important announcements. Now let me comment about second quarter results, starting with our III-V business. While III-V was up about $0.5 million on year-to-year basis this first half, we believe the business will pick up in the second half of this year based on the design wins captured by the integrated circuit partners on the upcoming new smartphones and other advanced mobile devices. I also want to mention that Kopin and our biggest -- largest customer, Skyworks Solutions, has extended our purchase and supply agreement through December 2013 on essentially the same terms as the previous agreement. Skyworks has been an excellent partner and customer for many, many years and we're excited about our partnership going forward. Moving onto Display. As we mentioned on previous conference calls, Display revenues will be down due to a lower Military spending as a result of our U.S. withdrawal from Iraq and reduced activities in Afghanistan. The possible sequential budget cuts had further limited visibility for our Military Display business. We certainly anticipate a decline due to the decrease in Military spending. But as we noted in this morning's news release, the expected drop-off in Military revenue is sharper than we initially expected. While the Display product line faces some near-term challenges, we are optimistic about the future. Our III-V business is strong and with our renewed agreement with Skyworks should remain so. Golden-i Technology is on course to create a new class of products and working diligently with our industrial partners towards the first product launch later on this year. So with this, let me turn the call to Rich for his financial review.

Thank you, John. Beginning with the top line. Total revenues for the second quarter were $22.8 million, down 20% year-over-year from $31.4 million in Q2 of 2011. III-V revenues were $15.8 million for the second quarter of 2012 versus $16 million in the second quarter of 2011, while Display revenues decreased to $7 million from $15.4 million a year earlier. On the III-V front, we anticipate a stronger second half of the year than the first. In terms of Display revenues, Military applications represent $3.1 million of revenues compared to $9.2 million for the same period of last year and sales of Display for consumer applications were $3 million as compared to $4.5 million in Q2 2011. Gross margin for the second quarter was 26.9% of product revenue, compared with 35.4% of second quarter last year. The decrease reflects lower revenues in 2012 from Military Display products. R&D expenses declined from $7.1 million in Q2 2011 to $5 million, down in dollars, but up slightly as a percentage of revenue from 22% to 23%. SG&A expense increased from $4.7 million to $5 million in the second quarter of this year and rose as a percentage of revenues to 22% from 15% in Q2 2011. The Increasing SG&A is primarily related to noncash stock compensation costs. Operating for the second quarter of 2012, including noncash, intangible assets and goodwill impairment charge of $2.4 million associated with our Forth Dimension Display limited subsidiary. Impairment charge is our current estimate and investors should refer to our Form 10-Q for the period ended June 30, 2012, for a complete description of the impairment charge. For the full year 2012, we are targeting R&D expenses to be in the range of 15% to 20% of revenues and SG&A expenses to be in the range of 10% to 15% of revenue. The net loss in the second quarter of 2012 was $5.9 million or $0.09 per share compared with net income of $0.8 million or $0.01 per diluted share for the second quarter of 2011. Cash and equivalents and marketable securities totaled $96.3 million at June 30, 2012, compared with $105.4 million at year-end. We continue to have no long-term debt. Capital expenditures were $4.1 million in the quarter and $5.8 million year-to-date. Depreciation, amortization was $2.6 million for Q2 of 2012 and $5.1 million year-to-date. Year-to-date, we have repurchased $3.5 million of our stock of which $2.2 million was in the second quarter. Stock compensation expense was $1.1 million for the second quarter, and was allocated as follows: $916,000 to SG&A; $135,000, the cost of product revenues; and $89,000 to R&D. Accounts receivable days outstanding at June 30, 2012 were 59 days compared with 58 at the end of the second quarter of 2011. Turning to our full year 2012 guidance. The renewed purchase and supply agreement with Skyworks, combined our strong relationship with our other customers, positions our III-V business well for the future. While the growth trajectory of the wireless handset market may not be as steep [ph] as anticipated at the beginning of 2012, the market remains strong. On the Display side, as we've been discussing with our shareholders for over a year now, we expect a decrease in Military Display sales. Military market size is decreasing as the war winds down and there's a significant pricing pressure as the Pentagon deals with the budget deficit. Specific to Kopin, the decline in defense spending has prompted one customer through [ph] Various options to reduce cost, which is currently affecting an existing program. As a result of this review, orders we had anticipated in our 2012 guidance likely will not occur this year. Consequently, we are reducing our full 2012 revenue guidance to $90 million to $100 million from a previous range of $110 million to $112 million. Operator?

[Operator Instructions] Our first question comes from Matt Robison of the Wunderlich Securities.

Rich, I'll start with a couple of housekeeping items. I missed what you said operating cash flow was.

Year-to-date, our cash flow from operations is about $1.1 million.

Okay. Can you give us a little breakdown of the other income?

It's primarily interest income. There's a very small ForEx piece.

So the interest income went up quite a bit then in the last couple of quarters?

Well, relatively speaking.

Okay. So I think ForEx was something like -- was a loss of $160,000 last quarter. So we should take that to be 0, and there was no gains on IP or stock sales or anything like that?

Right. There was a small gain on ForEx but it was a small number.

Okay. How much did you guys spend on the strategic investments that John mentioned?

A couple of million dollars.

Care to mention who those were with?

One of them as a company called Ikanos out of the U.K., and the other one is a private company. The reason why we mentioned Ikanos is that as a result of our investment and additional investments, you'll actually see them showing up in our Q3 10-Q as a consolidated entity. The other one is just a small private company that we have a small percentage equity interest in.

Can you spell it for us the Ikanos?

I-K-A-N-O-S.

Okay. Some of the Military defense contractors have talked about actually an increase in bookings in advance of sequestration or planning for sequestration. It seems like your products, your type of product for the Military don't fit in that category. Can you talk about whether there's any future at all for your displays and also, if there's been some it looks like competitive incursion on some of the Military products -- projects. Can you give us what we should be thinking about as we look further into next year?

At this point, I mean, we still obviously are very viable players in the Military and we're working on a number of programs. The reality of the situation is that the Military budget is getting cut. There are some new entrants, I shouldn't say new, but there are some existing folks who are making a bigger play to get into the Military space that we currently occupy. And between -- essentially more people trying to chop up a smaller pie, we have to look at our resources, and honestly, the next big deployment contracts are not scheduled until 2014, 2015. So we will maintain our existing programs at lower levels. What you'll see next year is more R&D oriented for the bigger deployment projects that are scheduled for 2014, 2015. And that's the current strategy on the Military.

Why was the CapEx up from the quarter?

We've made a number of investments in some III-V equipment.

Okay. Is that -- should we expect this level to continue?

Our guidance for the year is $5 million to $8 million.

Okay. Now can you comment -- I think I've seen in some of your press releases, you talk about 200 patents awarded or in process. What percentage of those should we think of to be applicable for portable devices like Golden-i or Project Glass and that sort of thing?

Well, I think your question -- this is John Fan, you're talking about the IP filing. I would say right now, maybe 70% of new filings are in the Golden-i area, and 30% in III-V.

Well, what's new out of the 200?

As always -- I mean, that's the last 1.5 year we filing a lot of patents.

Right, I know. But in your press releases, you talk about this number, it's a big number of 200. So how should we think about your patent position?

Very strong.

Can you help me understand what, of the 200, which apply to this wearable-type technology?

I would say in the Display and Wearable Technology, at least over half of them are there -- over the 200.

Matt, just for clarification, we use the number 200 because it's round number. We actually have in excess of 200, but we don't get down to 3-digit accuracy, so we just kind of use the general 200.

But also, I guess, we don't even know how many of those are actually granted versus filed, right?

Yes, that's true.

So it's really a very vague number, and so if you -- if you looked out a year, in a year's time, when -- I think it's a year's time or maybe a little bit longer that when Project Glass developers are supposed to get their prototypes, what -- how many patents do you think you'll have granted by then?

Well, I think, we have to look at the situation on the Golden-i technology. We've been working on the Golden-i about 20 years ago. And we're the first one ever going into the Golden-i area. So we have patents that go all the way back and we're filing patents very, very aggressively the last 2 years. So we're in good shape.

Our next question comes from Blaine Carroll of Avian Technologies.

Rich, you guys actually cut-out during John's commentary so I just was wondering if you could talk about your gross margins are a little bit better than we were looking for, they still remain depressed. But any commentary around gross margin?

Well, the Military honestly has been a higher gross margin product for us. And so, obviously, the decline there impacts the overall weighted average gross margin of the company. We would expect if some of the projections for some of the smartphones, which are to be released in the coming months, if those projections are accurate, then we should leverage very nicely in our III-V business and we should see some gross margin expansion there.

Okay. Is there a way of thinking of what the contribution margin is on a dollar of revenue within III-V business?

In what contribution?

To the gross margin. An incremental $5 million in revenue, what does that fall through on the gross margin line?

We actually have that number down to the penny, but I'm reticent to provide that because it impacts our pricing with our customers.

Fair enough. And then, John, on the new guidance, the $20 million reduction on the annual guidance, what would you say the split of that is coming from Display versus the III-V business?

I would say almost a vast majority comes from Display area.

Okay, good. Let me see -- with RFMD, they mentioned that they had sold their MBE business IQE, but one of the things they talked about in their release was that they could buy some MOCVD wafers from IQE and get most favored nation pricing. Have you seen any change in the relationship there or in the overall pricing environment?

With the RFMD question is that we have seen no change. In fact, no change at all.

Right. And then any thoughts or anything you can share with us on what Motorola's marketing strategy is going to be as we go through the end of the year?

I think the question relates to our partnership with Motorola on the industrial version using our Golden-i technology. Our guidance is always that they're on schedule and we expect such product will be launched this year. And how they're going to market it, I think you will relate to them. I'm sure they will do a very good job. Remember, this is the first [indiscernible] computer ever in the market. This is the first one, first headset. So it's going to be a very interesting time.

Okay. This speech technology that you talked about, does that push out the launch of the device at all?

No. You see, in the case of speech search, it's not critical for the initial product, although it would really enhance it. So when the product launches, you will have in there anyway. We are far along in getting it done. That's actually a very interesting thing. It actually fares well for industrial application because your domain search is limited. It defines domain search instead of a generic domain search, so the accuracy is much better and much more useful.

With the current version?

No, with the search -- the natural speech search of a limited domain, like industrial domain. This is much more effective. That's why we think it lends itself to introduce this part of a search for industrial application right away.

Okay. And, John, one of the things that you said was you said 100 units, and I know it's not an exact number with customers and partners. How many units are in the field right now, and how many partners do you have versus how many customers are currently trialing the product, if you will? Maybe they're one and the same.

Yes. So, Blaine, what we're saying is that over 100 partners have units. There's more than a couple of hundred units in the field.

Okay. So this is no way is in exclusivity with Motorola that you're doing right now? Is there any exclusivity in the period of time?

Blaine, just to clarify. Those prospective customers would be Motorola. We're working with them.

Okay, do you have exclusivity with Motorola for 6 months, 1 year, 2 years or something?

They have exclusivity on the industrial market.

Our next question comes from Raji Gill of Needham & Company.

Actually, it's Simran Brar [ph] calling on behalf for Raji Gill. So my first question is how are you benefiting from the ramp at your major power amplifier customers, Skyworks, as they get prepared for their ramp at Apple?

Well, I mean, we're all hoping that the iPhone 5 is as successful as all the prognostications. Under the new agreement, we have the vast majority of Skyworks business. And so we think no one knows for sure, but we believe they're well represented in the phone, and therefore, it should pay good benefits to us if all the speculation is true.

Okay. And my second question is, when are you going to see a rebound in government spending on the Thermal Weapons program?

I don't honestly think you're going to see a rebound per se. The program is pretty well defined, how many units they want to buy, over what time frame. However, because of the cost-cutting and a whole bunch of other reasons, the actual delivery schedule hasn't been worked out. The contract hasn't been awarded, as we would have thought. There's a lot of confusion in the marketplace. So as I mentioned, the next -- there's a number of other programs which are designed for release in '14 and '15 are really kind of the next big deployment. And so we're focusing honestly on those more than the Thermal Weapon Sight program at this time.

Okay. And my last question is when should we see a return on investment of Golden-i?

Hopefully, it gets launched at the end of this year. The minute -- we've always said this year's revenue will be de minimus, and then next year, it will start to ramp. It will be like any other new product. We'd love to have it be a vertical takeoff, but that's probably not realistic. As John said in his prepared remarks, it will gain steam as we develop more application softwares, which expands its use horizons.

[Operator Instructions] Our next question comes from Patrick Wu [ph] of Battle Road Research.

Going back to the acquisitions you guys have been talking about, the 2 companies, 1 private, 1 being Ikanos. Can you -- I guess, you guys might have talked about it, can you elaborate on the plans you guys have with those companies moving forward?

Just to clarify. So one, we took a majority owned position, that's Ikanos. The other one was not an acquisition, it's a small investment. And, John, I don't know if you want to talk about that.

Well, I think that both are software companies, and one actually is involved in applications, as well as operating software. And the other company is involved with our natural speech search. So these are divided in 2 companies and, as far as we're concerned, they're the best of the breed and we're very happy with them.

Okay. I'm just taking a quick look at R&D. Can you guys help me just sort of understand in terms of R&D expenses, the percentage that goes into Golden-i and then what percentage goes into III-V, generally speaking? First quarter maybe also historically, that sort of range?

The R&D expense for III-V typically runs in the 10% to 15% range. And then right now, the majority of the R&D expense is running on the Display side towards the Golden-i. We actually don't consider Golden-i part of the Display. Frankly, it's a separate product line.

Okay. So Display runs at around 85% to 90%?

I'm not sure I understand that.

He said that the Golden-i can be either Display/Golden-i is around 80%, 90%. Maybe not as big as that.

Because you guys said the III-V usually occupies around 10% to 15%.

No, 10% to 15% of its sales, of the III-V sales and then you can figure out what the rest is.

Okay, sure. Last question is regarding the customer you guys talked about on the Defense that has sort of, I guess, exited relationship. Is that customer an agency of the DoD or is that actually a company that has a relationship with DoD and thus, having seen the DoD reduce their budgets, they are in turn, I guess, canceling that type of relationship?

It's not an agency of the DoD.

Okay. So it's a company that works with the government. Okay.

It appears we have no further questions at this time. I would now like to turn the floor over to management for closing comments.

Thank you for joining this morning's talk. As a reminder, next Tuesday afternoon, I will be presenting at the Oppenheimer Technology Internet and Communication Conference in Boston. I look forward to see a number of you there. While this will conclude today's call, we look forward to keep you updated on our progress. Have a good day. Thank you.

This concludes today's teleconference. You may now disconnect your lines at this time, and thank you for your participation.