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 You may access an archived version of the call on Kopin's website at www.kopin.com.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…

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,…

[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.