LightPath Technologies, Inc. (LPTH) Q2 2012 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the LightPath Technologies' Second Quarter 2012 Financial Results Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Dorothy Cipolla, Corporate Vice President and Chief Financial Officer. Please go ahead.

Thank you, and good afternoon. I'd like to thank everyone for joining us today for LightPath Technologies' Fiscal 2012 Second Quarter Financial Results Conference Call. If anyone participating on the call this afternoon does not have a copy of the earnings release, you can find a copy on our website at lightpath.com or if you're unable to access the materials online, you may call LightPath at (407) 382-4003. I would like to start by reviewing the company's Safe Harbor statement. Statements in this conference call that are not descriptions of historical facts are forward-looking statements relating to future events. And as such, all forward-looking statements are made pursuant to the Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties, and actual results may differ materially. Forward-looking statements, when used in this call, can be defined by the words anticipate, could, enable, estimate, intend, expect, belief, potential, will, should, project and similar expressions as they relate to LightPath Technologies. Investors are cautioned that all forward-looking statements involve risks and uncertainties, which may cause actual results to differ from those anticipated by LightPath Technologies at this time. Factors that could cause or contribute to such differences include those risks fully described in LightPath Technologies' public filings with the U.S. Securities and Exchange Commission, which can be viewed at sec.gov. This time, it's my pleasure to turn the call over to our CEO, Jim Gaynor.

Thank you, Dorothy, and good afternoon, everyone. I'd like to thank you for joining us today for LightPath Technologies' Fiscal 2012 Second Quarter Financial Results Conference Call. Our second quarter results continue to demonstrate our successful execution of our growth plan, albeit not quite at the rate and pace we would like. As highlighted in our press release, when compared to the same period last year, our backlog grew 17%, revenue was up 6%, EBITDA improved to a positive $6,000, and by the way, has been positive for the last 3 years. Unit shipment volume grew 30%. Our net loss improved, cash provided by operations was a positive $139,000 and gross margin dipped to 32%. Overall, a very good quarter with the exception of the gross margin change. Gross margin was lower than the 40% we have been achieving in this particular quarter, however, and our costs -- but our costs -- our direct costs as a percentage of our sales was as expected at 26%. The change resulted from several specific issues, most of which we do not see continuing in the future. The first one, volume change mix. During the quarter, we shipped a higher number of units with lower prices in our telecom and laser tool businesses. These shipments were against longer-term contracts that had slightly lower prices. While our volumes were up, they were not at the levels we had forecasted due to the macroeconomic conditions that are affecting our markets. Second, we experienced some one-time expenses for severance, freight and an unusual product return as a customer accommodation for a specification change with a very good customer. The severance was associated with some necessary changes to better align the organization with our future backlog of work both in Shanghai and Orlando. Our product return average is 0.4% of sales for all reasons. And product return we took back as an accommodation is good product, and we believe it will be resold. We always try to work with our customers and adjust as their needs change. The extra freight cost was for a shipment of material we purchased as inventory as we qualify a new vendor and wanted to assure we have product available while we qualify the new source. If we had adjusted our cost of goods sold for these items, our gross margin for the quarter would have been 39% and in line with our recent history. As we do not anticipate this set of events to repeat, we fully expect our gross margins to return to the level in the prior 4 quarters. In addition, we have initiated several improvement programs to further lower our cost of goods. These programs address our lens coating costs, improvements to tool life and glass material cost. Several years ago, we converted our glass material to a glass we call ECO to comply with the RoHS environmental standards, which for us meant lead-free glass. As we have converted our tooling technology to ceramics, we can now convert our lens designs away from this ECO glass to our standard higher-temperature, lower-cost glass materials. This change will also improve our purchasing leverage as we standardize our material systems. As we implement these cost-reduction efforts, we expect to see further improvements to our gross margins. I would now like to turn the call over to Ms. Dorothy Cipolla, CFO, to discuss the financial results for fiscal 2012 in greater detail.

Thank you, Jim. First, I'll talk about the 3 months ended December 31, which is our fiscal second quarter. Revenue for the second quarter totaled $2.67 million compared to $2.53 million for the second quarter of last year, which is an increase of 6%. The increase from last year was primarily attributable to a 30% increase in sales volume of precision molded optics lenses, which account for 78% of our revenue. Despite the increase in the sales of precision molded optic lenses during the period, our average per unit selling price was lower due to a higher percentage of our sales being shipped against longer-term negotiated contracts, which have slightly lower prices. Our gross margin percentage in the second quarter compared to last year decreased to 32% from 40%. Total manufacturing cost of $1.83 million was approximately $300,000 higher in the second quarter compared to last year. This increase in total manufacturing cost was due primarily to a change in the mix of the products sold as compared to the same period last year. Also, a one-time severance cost incurred with respect to Orlando and Shanghai employees and a charge for the return of products by a customer resulting from customer spec changes. Unit shipment volumes in precision molded optics was up 30% in the second quarter compared to last year, but our average selling prices were lower in the second quarter of fiscal 2012. 46% of our precision molded optics sales in units were of the more expensive glass type compared to 15% in the same period last year. Direct costs, which include material, labor and services, decreased to 26% of revenue in the second quarter as compared to 28% of revenue in the second quarter last year. The decrease in direct costs was primarily due to lower lens coating costs and improved labor productivity. We experienced an increase in labor costs at our Shanghai facility due to increases in the minimum wage and higher benefit costs and increases in employee headcount during portions of last year and this year. Headcount in Shanghai was reduced during the second quarter to reflect our improved productivity and yield and to better match our production requirements to our current 12-month backlog. During the second quarter, total operating costs and expenses decreased by approximately $90,000 to $1.16 million compared to $1.25 million for the same period last year. Selling, general and administrative or SG&A expenses decreased by approximately $113,000 to $884,000 in the second quarter compared to last year. This decrease was primarily due to a $75,000 decrease in investor relations expenses and a $33,000 decrease in legal expenses. We intend to maintain SG&A costs generally at current levels with some increases expected for sales and marketing. The net result of the higher cost of goods sold and the lower total operating costs and expenses is a net operating loss of approximately $320,000 for the second quarter. Interest expense was approximately $23,000 in the second quarter as compared to $113,000 for last year. This higher interest expense last year resulted from the accelerated conversion by certain investors as they debentured into common stock, which reduced the company's debt obligation by $100,000. The accelerated conversion resulted in approximately $56,000 of costs associated with the principal amount converted to the expense during the second quarter of last year due to the interest and debt issuance costs being amortized over the full life of the debentures. The debentures, which were issued August 1, 2008, accounted for approximately all the interest, which accrues at 8% per annum during the second quarter of this year and last year. Net loss for the second quarter was approximately $343,000 or $0.04 per basic and diluted common share compared to approximately $374,000 or $0.04 per basic and diluted common share for last year. Weighted average basic shares outstanding increased to 9.8 million compared to 9.7 million last year, primarily due to the conversion of the debentures last year. Now I'd like to talk about the 6 months or our first half, which also ended December 31. Revenue for the first half totaled approximately $5.41 million compared to approximately $4.78 million for the first half of last year. This is an increase of 13%. The increase from last year was primarily attributable to higher sales volumes in precision molded optics, which accounted for 78% of our revenue, and higher sales of collimators. Although unit volumes of precision molded optics were 50% higher than last year, our average selling price was 20% lower. This is due to the product volume/mix change we experienced as high-volume precision molded optics products became a larger percentage of our overall sales. Growth in sales going forward is expected to be derived primarily from the precision molded optics product line, particularly our low-cost lenses being sold in Asia, our infrared lenses and our collimators. Our gross margin percentage in the first half compared to last year decreased to 36% from 38%. Total manufacturing cost of approximately $3.48 million was approximately $523,000 higher in the first half compared to last year. The decrease in gross margin was due primarily to a change in the mix of the products sold as compared to last year, not achieving projected revenues and as well as increased costs. We sold 50% more precision molded optics lenses units as compared to last year, the first half of last year, but our average selling price was 20% lower. The decrease in our average selling price per unit is due to a higher percentage of our sales being shipped against longer-term negotiated contracts, which have slightly lower prices. In the first half, 50% of sales of our precision molded optics lenses were produced with the more expensive glass types compared to 15% of sales last year. This increase was due to a mix change with fewer low-cost precision molded optics lenses than forecasted. Our industrial tool lens volume grew but was under forecast as construction in China remained weak, impacted by the continued tight monetary policy of the Chinese government. Management is committed to continuing efforts to transition more precision molded optics lenses to less expensive glass, which will contribute towards achieving profitability, assuming we meet our sales targets and goals for producing and selling more low-cost lenses at higher volumes. We also experienced an increase in labor costs and some one-time costs for severance incurred with respect to Orlando and Shanghai employees, an unusual charge for the return of products by a customer resulting from customer specification changes. We experienced an increase in labor costs at our Shanghai facility due to increases in the minimum wage and also higher benefit costs and an increase in employee headcount during portions of both this year and last year. Headcount in Shanghai was reduced during the first of this year to reflect the improved productivity and yield and to better match our production requirements to our current 12-month backlog. Overtime expense paid to employees at our Orlando and Shanghai facilities also improved during the first half. This increase in overtime expense was primarily due to certain production equipment being taken offline for repairs during a time when we were implementing a planned machine conversion. This led to a temporary decrease in tooling capacity and required that our employees work extra shifts in order to meet the demand for our products. Both the machine repairs to our Computerized Numerical Control or CNC equipment and the machine conversion are complete, which we anticipate will reduce the likelihood of incurring significant overtime expense in the future. Direct costs, which include material, labor and services, decreased to 27% of revenue in the first half as compared to 28% for last year, primarily due to productivity and yield improvements. During the first half, total operating costs and expenses decreased by approximately $100,000 to $2.46 million compared to $2.56 million for last year. SG&A expenses decreased by approximately $189,000 to $1.88 million in the first half of last -- compared to the first half of last year. This decrease was due to a $130,000 decrease in investor relations expenses, a $46,000 decrease in fees paid to NASDAQ and a $12,000 decrease in expenses for press releases. We intend to maintain SG&A costs generally at current levels with some increases expected for sales and marketing. The net result of the higher cost of goods sold and lower total operating cost and expenses is a net operating loss of approximately $529,000 for the first half. Interest expense was approximately $47,000 in the first half compared to $494,000 for last year. The higher expense last year resulted from the accelerated conversion by certain investors of their debentures into common stock, which reduced the company's debt obligation by $832,500. These accelerated conversions resulted in approximately $256,000 of debt cost associated with the principal amount converted to the expense during the first half of last year due to interest and debt issuance costs being amortized over the full life of the debentures. The debentures issued in August 1, 2008, accounted for approximately all of the interest which as we reported, which accrues at 8% per annum during both the first half of this year and last year. Net loss for the first half was approximately $542,000 or $0.06 per basic and diluted common share compared to $1.23 million or $0.13 per basic and diluted share for the same period last year. Weighted average basic shares outstanding increased to 9.8 million compared to 9.4 million last year, the difference primarily due to the shares which converted -- the conversion of the debentures. I would now like to talk about key areas on the balance sheet. Cash and cash equivalents totaled approximately $595,000 at December 31. Total current assets and total assets were $4.61 million and $7.09 million compared to $4.61 million and $7.12 million last year -- I'm sorry, June 30, our fiscal year end. Total current liabilities and total liabilities at December 31 were $1.85 million and $3.34 million compared to $1.53 million and $3.09 million for June 30, 2011. As a result, the current ratio as of December decreased to $2.49 million -- to 2.49:1 compared to 3.01:1 at June 30. Total stockholder's equity at December 31 totaled $3.75 million compared to $4.04 million at June 30. As of December 31, 2011, our backlog of orders scheduled to ship in the next 12 months was $3.83 million, which compared to $3.87 million at June 30, 2011. I would now like to turn the call back over to Jim for some closing comments.

Thank you, Dorothy. Our focus remains on growing our revenue. The number and quality of opportunities under review continues to grow. In the past 9 months, our product development team reviewed new designs, which represent more than $8 million in sales opportunities. These opportunities are in addition to our current molded optics products. While we will not convert all of these opportunities to new business, it supports the level of growth we expect. These new lens opportunities, combined with the growth we are seeing in collimators and infrared products, confirms our belief that we have positioned the company for growth. We are very excited about the opportunities available to us. Now this concludes my comments at this time. And operator, I would like to open the call for questions, so please start the Q&A portion of the call.

[Operator Instructions] And our first question will come from Bob Ainbinder of J.P. Turner.

Well, my first question is regarding the recent withdrawal of the financing. Can you address why you did that?

Well,basically, Bob, the financing, we withdrew it because we didn't think that the pricing at the time that we were doing this raise was in the best interest of the company or our shareholders. And in addition to that, the -- we were raising this money to accelerate the development of our infrared program. So it wasn't a case of trying to raise money to support operations, it was for future growth and development. And so we didn't want to raise that money under such adverse conditions.

Okay, very good. Jim, could you also then address some of the business issues that you've seen? I mean, I congratulate you on obviously growing the business in a very tough environment around the world, what's going on in Europe and what's -- some of the issues in Asia. Could you kind of address what's going on there after the flooding in Thailand and some of the issues in China and how you see that shaping up as we move forward?

Sure. I think what we've seen was certainly, we have been impacted by some of these -- and our customers have been impacted by some of these macroeconomic conditions that we have very little control over. In Europe, I mean, the uncertainty in that situation there, we believe, has impacted our catalog and distribution sales. I mean, they have weakened a little, and in terms of timing. Although there are still a lot of good opportunities over there, and actually I have -- our technical people and our sales people are traveling Europe right now meeting with some of our major customers on new projects. So I think we will start to see some recovery there. But in the past few months, we certainly saw the impact of that uncertainty towards the end of the year. In China, we have a big market in the industrial tool, which is a lot of our high-volume, lower-cost type of products. We continue to see a weak construction market in Asia as a result, and particularly in China, as a result of their tight money policy as they try to engineer their economy and take the heat off of some of its explosive growth. The good news there is we're still growing the business, it has increased in unit volume, just not as fast as we had liked. And we are starting to see some initial signs there that those tight money policies may be being relaxed somewhat, and there's some renewed activity going on. So I'll think we'll start to see that change as we go forward. The natural disaster that occurred in Thailand with the flooding affected one of the major contract manufacturers for many of our telecom customers. In Fabrinet, they had there some very serious damage done to their facilities that impacted a couple of our telecom customers, and in particular, we have one opportunity where we were sole source for the optics into some of these high-speed tunable lasers that are used for high-speed 100s and 40G-type networks, high-speed data communications, that are really supporting the growth for 4G and LTE-type applications. And this thing has delayed that ramp as they lost some very major production lines. We were concerned about how long it was going to take them to recover. We have met with several of those customers. And the good news is, is they are rebuilding those lines and they have gotten major commitments from their customers that once they get that capacity put back in place, that business is solid. And they wanted that before they invested the millions of dollars required to replace some of that equipment that was lost. So the very good news is, is that business is still there. We're still a sole source to them for that -- those types of optics. And we expect to see that business start to come back in volume later this spring towards the April and May timeframe. The good news is, the short-term, it's kind of difficult. But in the longer-term and the intermediate-term, we see that recovering quite nicely. So there's a lot of encouragement there, and I'm looking forward to getting that -- those products back online.

Okay. Well, it kind of answers my next question a little bit. But if you can elaborate and give us a little more color on what's driving the growth in the backlog. And do you see that backlog continuing to increase as we move forward?

Sure. I think even though we saw some weakness in the industrial tool markets and the telecom markets as we just discussed, we've picked up some business in our custom optics and the designs there and some of the defense-related type of business that we do. And this is one of the strengths of LightPath. I mean, LightPath is a -- we do very good and are known for our very elegant optical solutions, and so we get a lot of custom works. We have recently done quite a few designs for some of this new technology that's out there, and it keeps LightPath on the leading edge of the technology. As I said, in the telecom area, we have a series of lenses there geared toward these tunable XFP laser systems that are used for these high-speed networks, which is being driven -- the demand for bandwidth for all these smartphones that are coming online and the 4G LTE-type applications. And that puts us right in the forefront of that. So we've got those kinds of things with several of our customers. Coherent is a big -- probably the world's largest producer of lasers. We're working with them developing some optics that they want to use in their fiber laser delivery systems. And we think that, that's -- we're going to have -- that should be coming to production, and that's a collimator-type product. Another major customer, one of the world's leading producers of optical encoders, has designed our optics into their products, and we see that coming. So all of these things are leading-edge technology, brand-new type product lines coming online, and we see that business. And that's where we're seeing a lot of strength right now. And then from our point of view, we have that business doing relatively well in this marketplace. And then when we combine that with our high-volume, lower-cost business, we have the best of both worlds in this company. And the more commercial business and the lower-cost, high-volume stuff starts coming back online a little stronger, I think we see a very bright future for that.

Very good. Well, lastly -- and that just really sounds exciting as we move forward. But if you could kind of address the margin issue a little bit more. I understand some of what has impacted us. Looking backward, you're expecting that margin improvement to just -- to come back to where we were. And then you gave us a little color as to some of the other things you would be doing to increase margins. Where do you see that bringing us in terms of margin expansion?

Well, I mean, there's no question that the dip we saw this past quarter, we believe to be an anomaly based on circumstances that we talked about. I mean, we had several one-time expenses in there. We saw some -- we're seeing a shift in our business as we bring more of high-volume business online, which has some lower pricing associated with it. And that's a volume issue. So as that volume builds, you just tend to spread the overheads per lens more appropriately as we fill up our capacity. So that tends to improve your margins overall as well. So until we get the volume up where it was, and obviously, this is where I say we're not running at quite the rate and pace that we had forecasted, which is kind of a result of some of the market conditions going on, we will see that improvement come. As always, we are continuing to keep our eye on cost reductions and trying to improve our processes as much as we can. And we do have several programs initiated. We're continuing to work on things that will improve our tool life. We're continuing to work on things that improve our coat -- our lens coating costs, which are 2 big opportunities for us. And we're continuing to go back through the legacy products and redesign them so that we can use the lower-cost, more standard glass materials. And we're able to do that because we've now got our tooling essentially set up on ceramics as opposed to the lower-temperature nickel in kernel [ph] system that we've historically used. So as we do those things, those will continue to lower our costs going forward. And as the volumes build, that begins to give us purchasing leverage so that we can even work with our vendors from that perspective as well. So I think all of those things together will improve the margins. And I continue to see good progress made in that direction.

[Operator Instructions] And our next question will come from Michael Dyett, a private investor.

Just thinking back on some of our earlier call, I had a couple of specific questions. I was curious in Shanghai as to whether some of the older equipment might need to be replaced. And can you do that in the absence of the capital raise, which is equipment loans? And what that might mean to your competitive advantage?

Well, Michael, I mean, if you think about it, we have -- in Orlando, we're currently working on the -- I think, I'm going to call it the third iteration of our press station. And which means that from the basis that you're talking about, we have done 2 iterations to our press stations in Shanghai. So we started out with the glove boxes. Actually, we started out with the original Corning equipment, which was pressing in air, and then we move that equipment into glove boxes so we could press it in an atmosphere. And then we redesigned the press boxes, such that each press was in an individual atmospheric box. And then we've gone through and just recently completed a capacity expansion, as well as an upgrade, which we call our second iteration of what we refer to as the Viper press, which was the name we put on the project when we redesigned to move from a glove box to an individual press, and then mount those boxes, gang them up in a station. So that equipment actually that's in Shanghai is only about 1.5 years old from its latest upgrade and construction. So that stuff has got some life left in it. And what we're now trying to do is get it to the point -- the next generation for us is to go from an atmosphere control press, where we're using nitrogen to limit the oxidation during the press cycle, to a vacuum. And that's really what the next step is. So we're working on that and -- so I think we're in pretty good shape from that standpoint. And that -- when we made that last iteration and we put in all those new stations, we more than doubled our volume capacity.

That sounds great. But maybe you could tell me a bit more about Orlando then in the context of the infrared opportunities. Do you have what you need there to bid and produce?

We have -- 2 things here. One is we have what we need to be able to produce and do the development work and a lower level of manufacturing. Now what we had wanted to raise that money for was to do the development of that IR and to put in some additional capacity. And we wanted -- beyond that, we were looking for enough money to also do some -- buy some very expensive equipment for doing larger lenses that would be single-point diamond-turned or ground and polished and some metrology equipment. So if we back off the back end of that, in other words, we don't focus so much on the ability, installing the ability to ground and polished and diamond-turned lenses, and we delay or defer some of the equipment for the metrology in IR, which we can accomplish through outside services, then we need a much lesser amount of money to continue the capacity expansion for the molding portion of infrared and the development work. And I think where we are, we have some time until we need to do that. And we can continue to do that development work at a slower pace obviously than we would like to do that. And then at some point in time, we will need to go raise some amount of money to expand the capacity here in Orlando.

But basically saying you've got the capacity in both Shanghai and Orlando, more than sufficient. The only other -- or thinking back to a few calls, you'd mentioned the glass supply out of Japan. And I wondered in the post earthquake, post tsunami, is that all back in place, your raw material supplies?

I mean, the material we supply from Japan -- fortunately, our vendor in Japan didn't suffer very much damage at all from the earthquake. They were in a different area of the country, which was lucky for us. But the other thing that we're doing is we are moving away from that glass. That is, the primary grass that we buy from them today is the ECO, ECO glass and we are actively converting our designs to the more standard glass that we source from multiple vendors in China and other areas in the world. So our glass supply is in pretty good shape and probably less dependent on a single vendor than we've ever been.

Yes, great. And then just one more follow-up on the European trip up. You mentioned you've got a new distributor that's really covering a much larger area in Europe. Is that really working well?

Actually, they have become our largest or one of our largest customers. And they have been able to expand our business in that geographic region by more than double in the timeframe that we've been working with them. And they are a very, very good fit for LightPath because their approach to the marketplace is solution-oriented. All of their sales and applications people are decreed optical engineers, many with PhDs. And so they go in and search out applications and do designs, and then they bring us in on the front end of those, which is where we tend to be the most successful. And so we're working with 3 or 4 major customers in Europe right now, I mean, of the like of Coherent and others. And our volume, pretty wide array of opportunities. So I'm very, very pleased with those. If I could duplicate them, like in a place like Asia or some place like that, I'd be very happy. But we're very pleased with what they've been able to accomplish. They have -- their headquarters is in Germany, and then they have 5 offices in the major optical centers in Europe, in the U.K., Spain, Italy and France. So I think we're very well represented there by them, and it's a very good relationship at this point.

[Operator Instructions] I'm showing no further questions in the queue. I would like to turn the conference back over to Mr. Jim Gaynor for any closing remarks.

Thank you, Denise. I would like to thank our shareholders and everyone who's participated on today's call. And I would like to thank the team at LightPath Technologies for their hard work and dedication. I look forward to updating you again on our fiscal 2012 third quarter conference call. And please, if you have further questions, please feel free to contact myself or Dorothy Cipolla, or you may also visit us online at www.lightpath.com.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.