Kopin Corporation (KOPN) Q3 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to Kopin Corporation's Third 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 You may access an archived version of the call on Kopin's website at www.kopin.com.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 Fan; and Chief Financial Officer, Mr. Richard Sneider. Please go ahead, sir.

Thank you. Welcome, everyone. Thank you for joining us this morning. John will begin today's call with a review of the third quarter. I will take you through the financials, 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, November 6, 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, Forth Dimension Display, Kopin Taiwan Corporation, and Ikanos Consulting Limited, 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. Just about 2 weeks ago, on October 22, Kopin celebrated a milestone event several years in the making. I'm referring, of course, to the commercial introduction of the world's first hands-free computer headset, the Motorola HC1. This is based on Golden-i, our game-changing wireless hands-free mobile computing technology platform. Now this is indeed a very huge event for Kopin. And I will spend much of my time to elaborate on Kopin's approach and strategy for this exciting new class of mobile devices. Motorola Solutions, which 2 years ago, partnered with Kopin to develop and market a recognized headset computer for industrial arena launched its first Golden-i-enabled device called HC1, it is the world's first mobile headset computer. HC1 is an application software-driven device that features voice recognition using natural language, gesture control and head tracking capabilities. It runs Windows CE, offers Bluetooth and WiFi connectivities, and initially support 6 languages, English, French, German, Italian, Portuguese and Spanish. Motorola has identified the sizing end-user markets including aerospace, architecture, automobile, consumer packaging, energy, engineering, high-tech, industrial construction, industrial equipment, life sciences, and ship-building. Kopin's Golden-i platform technology completely changed the paradigm for mobile communications. It enables users to seamlessly command and control multiple independent devices and networks, all with hands-free and with natural voice recognition. There's nothing to hold, there's no frustrating keyboard to pack, there's no swiping necessary. Now don't get me wrong, on the standpoint of today's mobile device offerings, tablet computers are great for reading, dashing off an e-mail or surfing a Web. But if you are an electrical worker dangling on a utility pole 40 feet in the air, or you be a mechanic working on a GE or Rolls Royce engine, an airplane engine, or you're an EMT on a scene of accident, it really helps to have your hands completely free. You can't say you need to be typing, texting or swiping. With our Golden-i platform, you don't have to. Our platform is a wireless hands-free gateway that gives users information on very large scale. Golden-i platform enables device manufacturers to develop mobile headset computer systems that seamlessly command and control independent device's networks, all with natural voice-recognition. Voice will be the next user interface after the touch. To provide optimal viewing experience, Golden-i also incorporates our micro display technology, enabling users to see an equivalent of a 15-inch laptop screen in a very high resolution near-eye display. In this morning's earnings release, you will find a link to a very good instructional video from Motorola Solutions that explains HC1 in more detail. I encourage you to take a good look at it. Now HC1 launch is very significant not only for Kopin but also for many of our business partners, which have contributed their technology and product expertise to enhance the Golden-i user experience. In addition to Motorola Solutions, we want to acknowledge companies such as Microsoft, Texas Instruments, Nuance, Hill Crest, AeroScience [ph], and Ikanos. These companies, and there are many others actually, have been instrumental in helping us to develop the hardware and software components in the Golden-i platform. Let me give you an example. For those of you unfamiliar with Ikanos, it is a U.K.-based software consulting firm that plays a very key role in creating the Golden-i operating system. We began investing in the company early this year. We're so impressed by Ikanos' talent and technology that we acquired a controlling interest in the company in the third quarter. Ikanos will now also provide application development support for customers of the Golden-i-enabled products. Ikanos has done an excellent job with us. While we are always well-positioned with display technology, imaging systems and wireless electronic hardware systems, we have now put together a very strong software team. In addition to our software experts at Kopin, we have now Ikanos and we have Ask Ziggy which is a partner for our natural speech interface. Motorola's HC1 is just the first of what we expect with a new class of cloud computing headset devices with Kopin's Golden-i technology platform. The HC1, as I mentioned, is a ruggedized device designed primarily for the use in industrial setting. As a reminder, our business arrangement with Motorola Solutions is that we have exclusive rights with Motorola for ruggedized industrial applications. We license our Golden-i platform technology, which includes our Golden-i software operating system. We also provide the whole optical display system, which was HC1. We are not at liberty to disclose our royalty arrangements, but we're very satisfied with our business model. In some way, it is similar to that of QUALCOMM. Beyond this industrial segment, Kopin is now actively working with additional OEM partners on the development of Golden-i-enabled computer systems for professional consumers and other users. You may recall that early this year, we teamed with Verizon Wireless at the 2012 Consumer Electronics Show to demonstrate the remote video expertise capability of Golden-i computing systems, using Verizon's 4G network. Please stay tuned for future announcements and alliances, their view of this success and complement our objectives. I must say we are very excited about the market's response and reaction on HC1 and other to follow models. I would like to emphasize that the goal of our Golden-i platform is to generate sustainable and profitable growth by developing complete hardware reference systems and software solutions. For mobile digital device, it is now paramount to have hardware and software seamlessly integrated together. It covers really a whole range of technology and IPs. We have already filled a reservoir of knowledge, know-hows and IPs in this area. We believe Kopin has now a leading edge in this new class of software/hardware mobile devices. Now reaching this goal is not an overnight process. We have and we will continue to require time, investment and resources. Over the coming quarters, we will continue further to further our lead and to invest in the businesses and technologies that we believe will enable to enhance the commercial opportunities for Golden-i across a whole broad spectrum of applications. Based on conversations with prospective customers and partners, we believe there is a huge market of products through our Golden-i platform, and we believe we will position ourselves well in the development of this new and exciting markets. In fact, just yesterday, on November 5th, Jupiter Research published a new report on the outlook of wearable computer systems -- wearable technology. They declare 2014 will be the year of wearable technology. They estimate, in 2014, that market could be worth as much as up to $1.5 billion. Before turning the call to Richard, let me briefly discuss our near-term forecast. As noted in this morning's news release, we are on the pace to achieve our full-year 2012 revenue guidance of $90 million to $95 million. Based on the outlook of mobile phones market, we are reasonably optimistic about this side of business in Q4. A number of new models are ramping up, the industry has returned to a more seasonal order pattern. Our balance sheet which has more than $94 million in cash and cash equivalents and have no debt provides us with the financial resources and flexibility to pursue the strategic growth objective of our Golden-i platform, which will ultimately drive substantial value for our shareholders. With that, let me turn the call to Richard to review the detailed financials.

Thank you, John. Beginning with the top line, total revenues for the third quarter were $21.9 million, down 26% year-over-year from $29.6 million in Q3 of 2011. III-V revenues were $13.7 million for the third quarter of 2012 versus $15.5 million in the third quarter of 2011, reflecting slower growth in mobile phone demand in 2012 period. Display revenues decreased to $8.2 million from $14.1 million a year earlier. Looking at Display revenues in more detail. Military applications represented $4.3 million of revenue compared with $7.2 million for the same period last year, reflecting reduced demand from the U.S. government. Sales of displays for consumer applications was $3 million compared with $5.8 million in Q3 2011, reflecting a decrease in sales of our products for digital cameras. R&D revenues decreased to $0.9 million from $1 million from last year. Ikanos revenue contributions during the quarter were nominal, I will describe the Ikanos investment accounting in a little but more detail in a moment. Gross margin for the third quarter was 24.6% of product revenues compared with 30.7% for the third quarter of last year. The decrease reflects both lower overall revenues and lower revenues from higher-margin military display products in 2012 period. R&D expenses in Q3 of 2012 remains flat at $6.4 million compared with Q3 of 2011. Included in Q3 2012 R&D expense was approximately $600,000 from Ikanos. SG&A expenses increased from $4.4 million to $5.5 million in the third quarter this year. The increase in SG&A is primarily related to an increase in non-cash stock compensation of approximately $800,000, as well as approximately $40,000 related to Ikanos. The increase in non-cash stock compensation primarily relates to awards, which are marked to marketed. For the full-year 2012, we continued to target R&D expense to be approximately 20% of revenue, with SG&A to be in the range of 10% to 15% of revenue. During the quarter, we invested an additional $2.5 million in Ikanos. As Kopin acquired a majority interest in the company, prior to our obtaining and controlling Ikanos, we were required to determine the fair market value of the company. This resulted in a non-cash write down of approximately $600,000. Beginning with the third quarter of 2012, our condensed consolidated financial statements include the accounts of Ikanos. On the bottom line, the third quarter 2012 net loss was $6.7 million or $0.11 per share compared with net income of approximately $0.2 million or breakeven for the third quarter of 2011, reflecting the impact of lower revenues over higher fixed costs. Results for the 2012 period include $0.5 million loss related to foreign currency fluctuation, as well as the previously mentioned $0.6 million loss related to the investment in Ikanos. Cash and marketable securities totaled $94.5 million at September 29, 2012, compared with $105.4 million at yearend. We continue to have no long-term debt. Cash flow from operating activities was essentially breakeven for the quarter and $1.3 million year-to-date. Capital expenditures were $2.6 million in the quarter and $8.5 million year-to-date. Depreciation and amortization was $2.5 million for Q3 of 2012, and $7.6 million year-to-date. Year-to-date, we have repurchased 3.5 million of our stock. We did not repurchase any of our stocks during the quarter. Stock compensation expense was $1.5 million for the third quarter and was allocated as follows: $1.3 million to SG&A, $125,000 cost of product revenues; and $97,000 to R&D. Accounts receivable days outstanding at September 29, 2012 were 59 days compared to 51 at the end of the third quarter of 2011. And as John mentioned, we expect our revenue guidance to be in the range of $90 million to $95 million for the full-year 2012. And with that, operator, we're ready to take some calls -- questions.

[Operator Instructions] Our first question comes from Blaine Carroll of Avian Securities.

Just a very quick housekeeping question, what is the previous target, $90 million to $100 million for 2012, Richard?

That's correct. So we're narrowing it, given that we only have 1 quarter to go.

Okay. And I guess, what changed to bring it down towards the lower end?

We just last week, received an order for some Military revenue, which we had thought was going to come earlier, and we just cannot get the parts in time to put it out in the fourth quarter, so it's going to fall over to the first quarter.

Okay. And I mean, that's actually a good sign because the Military revenue, we haven't been expecting much out of it. Is that business changing somehow? Positive, Rich as opposed to...

Well, I think everyone is still leery about the fiscal cliff and how that's going to get resolved, but clearly, the order was good news.

John, one of the things that you mentioned was that the III-V business is returning to normal type of seasonality. It's been a long time since we've had normal seasonality, so can you sort of refresh our memory on what you would consider normal seasonality?

Well, I will say that we're happy that we're seeing some increase in our --- in the growth in the area. So normally, the third quarter and fourth quarter are strong. And this year, it is true. Third quarter and fourth quarter is better.

But the third quarter, the $13.7 million, I mean, that's down year-over-year and down sequentially. So that was -- when I was plugging in the numbers, that was a little disappointing to me.

Yes. Overall, I think that the handset sales haven't been as strong as we thought, and we look at this from a variety of different ways. Our competitors report numbers, and their numbers frankly have been down in the third quarter, so it hasn't been a market share issue for us. ASP declines have been just about 7% for the year, which is right in our range that we give, 5% to 7%. So it's not a pricing issue for us. It doesn't seem to be a market share issue. I think it's just an overall handset sale issue.

Okay. But do you expect an uptick in the fourth quarter, Rich?

We expect a slight uptick in the fourth quarter.

Slight uptick. What -- how you define slight?

Less than 5%.

Okay. Last question for me and I'll pass on. The CapEx, Rich, that was -- it seems if we're now above, wasn't the original guidance $5 million to $8 million for the year or something, now we're over $9 million?

Yes, we're going to go over $9 million. Today is a political day and we don't want to talk about regulations. But as you know, we put in a whole gallium nitride system as part of our III-V operations, and I won't get into all the details but there are a lot more regulations around, particularly bulk ammonia storage that we put in that required some overruns, some facilities that the EPA and the state of Massachusetts wanted us to develop, which we hadn't thought about or didn't anticipate, so that's where the overrun came from.

Okay. And what did you say was on with the compound?

Gallium nitride.

Okay. But what was it, did you say it was ammonia?

Yes. So we used bulk ammonia in this space. But we had to build storage facilities outside the control above ammonia and they're pretty elaborate.

[Operator Instructions] Our next question comes from Blake Harper of Wunderlich Securities.

Could you guys talk about in the III-V business, do you have any -- what type of role or exposure you have with TD CDMA?

You're talking about the wide-band CDMA?

Yes.

We do not exactly fill all the PAs, we provide the transistors for our customers that build PAs. As far as we know, our biggest customer, of course, are Skyworks and TriQuint. And as far as we know, they are very much in this area. So I'm trying to -- let me try to understand your question.

So do you have any exposure, I guess, to really -- any of the -- more in China, with lower cost smartphones that are being introduced on the TD CDMA standard, are you going to have a role there with those customers that you mentioned?

Well, I think if you heard Dave Aldrich's comments or the Skyworks management's comments last Thursday, they're fairly bullish on their ability to penetrate. I think, Dave, if I got this right, he thought they have 40% of the 2G in China, and he -- and because of the customized solutions that were required in 3G, Skyworks is pretty bullish about next year. And so they are our largest customer and we're a critical supplier to them, so we would get exposure through that.

Okay, that's great. And then just kind of following on that with the III-V business, you had made some investments into recently -- can you just talk about some of those newer design wins that you have and with some more integration? Is there anything that you see with the newer designs as far as the margin trends that we see going forward that would be different from where you are with some of your order designs right now?

Well, the newer designs would be BiHEMTs which I can spell but don't really understand, I can't give you the science behind them. And I think that those are the more sophisticated -- again, as Dave -- as Skyworks mentioned and was talking about, you need much more customized -- much more sophisticated solutions for 3G, and we, in concert with them, have developed new structures with BiHEMT which are aimed specifically for those applications. It's actually a combination of an HBT and pHEMT, and so we expect those to be a larger piece of our business next year. They have higher price points, and so net-net, we think it's a good trend for us.

Yes. I think, I just want to elaborate a little bit of what Rich said, this is John Fan speaking. We're seeing additional activities in the BiHEMT right now, which is really a combination of HBT and pHEMT. And it's suffice to say, almost all our customers are beginning to use them.

Got you. And then, John, you also said to stay tune for some stuff with Golden-i coming-out. Are there any other drivers besides -- I mean, is there anything else besides Motorola or any other drivers or applications or customers that you can -- that you kind of have on the horizon that are something to pay attention to or can you kind of elaborate more on that a little bit if you can?

Obviously, in my discussion today, I focused a lot on the Golden-i and it's not accidental. We're seeing, I will consider a turning point. The Motorola HC1 is really the first. There is really a very large demand and requirement for hands-free devices. And it all goes all the way from industrial military all the way down to consumer. It's an entire new class and it's not going to be commanded by touch screen or keyboards, it's all going to be by voice control, gesture control. And we've been talking about it 4 or 5 years in a row and we're investing in it the last 4 years. And this is a new device. And I mentioned the Jupiter Research, I haven't read their report yet. In fact, I never even talked to them. They sent me this announcement yesterday. So I would say, I'll tell you, whatever that is, I do agree. I think this is going to be a surprise. I don't think people are that surprised anymore. I think Google Glass is another one of these hands-free devices that people are talking about. And they are, I guess, they got the Invention of the Year from Time Magazine. So I think, stay tuned is the -- we see a lot of activities in our days.

Got you. And then just in that area that you're talking about right there, can you talk about the number of patents that you have filed for and have been awarded in that area that you're talking about right there?

Yes. We have, overall, over 250 patents. Over -- above 60%, 70% of them are right now on display and related devices like Golden-i platform. And we varied all the way from devices to software with -- I would say, we're patenting random, maybe several patents per month, maybe more than several patents per month. Our IP filing costs is getting very high right now. But this is it, this is the big battle right now.

Got you. And there are several patents per month that you're talking about, those are all in Display, right?

More in the Golden-i right now. A few of them in III-V because we also on the III-V worked on nitride on silicon which we are also very excited about but the Golden-i is a complete device, it goes from A to Z, software/hardware, seamlessly integrated together, and is a new class of mobile device, and I think it's going to be extremely exciting to a lot of people.

Okay. And then I just had one more, just a housekeeping item for Rich there. Rich, can you breakdown the other interest there, it was a loss of $600,000. I just wanted to see where -- the loss or you kind of breakdown anything that made up that?

So there is a -- it's kind of crazy accounting, but when we acquired a controlling interest in Ikanos, we actually have taken a write-down on our previous investment, so we took a controlling interest on Ikanos in 2 stages. First, we acquired 25%, and then later on, we acquired 26%. It required a 3 value of the original 25%. I won't get into it but the bottom line is that resulted in a $567,000 write-down, and then there is a roughly $500,000 loss on foreign exchange, and then the rest is all interest income.

Our next question is a follow-up from Blaine Carroll of Avian Securities.

A couple of other ones, guys, if I can. First of all, John, as you look out towards 2013 with the Golden-i, any thoughts on projections per units or any clarity on that?

Yes. Well, I obviously cannot comment on it, but all I can say is Motorola people projected that the business can be very good for hands-free. So the next -- the first year, of course, the ramp will be slower.

Okay. It's what you're saying, it's more of a...

Yes. I think it's important to look that this class of device is not just the HC1, how many they sell next year, every -- how the whole class of device can be accepted. So our milestone is really very interesting. With additional partners, we will bring it on next year and what are they for. I think you will see from industrial going down to professional and the consumer all the way down, it's a whole entire class, and we will continue to have alliances and partnerships that will show the people that this is really a huge class of devices.

Okay. And what's your turnaround time on the IP?

You mean, the filing to issue?

From the time you get an order to getting it out the door. And I guess what I'm trying to get at is visibility on that business, do they have to give you an order 3 months in advance or 3 weeks?

For us, it's not so hard. Maybe 1 month. But the whole assembly is done by Motorola.

Blaine, I'm not quite sure I understand the question. Are you asking if someone calls Motorola, how quickly can they get a unit?

No. It was more on -- I'm looking for visibility for your guys, Rich. So if Motorola calls you and says we need 1,000 units, do you have to say them that we need 60 or 90 days, it sounds like John is saying you can get that out in 30 days?

Under the terms of the agreement, Motorola is required to fund the working capital. And I don't want to quote, but I don't know exactly what it is, but I think Motorola has specific policies in place that if a customer like Wal-Mart calls, they have to be able to deliver the units within X days, it's a very short timeframe. So Motorola will be working with that and building inventory to meet those demands.

Yes, but we still provide them with the whole optical unit, optical units include display and the lenses. We have enough storage and enough inventory and, of course, our display turnaround time. So we can do that within 5 months visibility, yes.

Okay. And Rich, you recognize revenue when you ship it to Motorola?

It's a software-related product. So to the extent that it's just the optical part, the answer is yes. To the extent it's the licensing revenue, then you get all the crazy software revenue recognition.

Okay. And then, John, jumping back to the III-V business for a minute. Any change -- and actually, Rich, do you want to give us what the 10% customers were in the quarter? And then, John, is there any change going on with your customers? Skyworks, as Rich was saying, was very upbeat last week. RFMD signed this relationship with IQE, is there any change in your business with RFMD?

As far as 10% customers, we don't disclose it on a quarterly basis, but it hasn't significantly changed since last year-end.

Okay. And then, John, any change with RFMD and the IQE?

We don't see it so far. I mean, of course, it will stay in long-term, you have seen it, as you said. Right now seems to be it's equally better. So we should see what really develops, it's something to watch out. And of course, as we all know, RFMD seems to have many different activities. They just bought a silicon PA company yesterday.

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

Thank you very much for joining us this morning. We look forward to keep you updating on our process. Bye-bye.