LightPath Technologies, Inc. (LPTH) Q4 2019 Earnings Report, Transcript and Summary

Good morning and welcome to the LightPath Technologies fiscal 2019 fourth quarter financial results conference call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please also note, this event is being recorded. And now I would like to turn the conference over to Donald Retreage. Please go ahead, sir.

Good morning. Before we get started, I would like to remind you that during the course of this conference call, the company will be making a number of forward-looking statements that are based on current expectations and involve various risks and uncertainties that are discussed in the periodic SEC filings. Although the company believes that the assumptions underlying these statements are reasonable, any of them can prove to be inaccurate and there can be no assurance that the results would be realized. In addition, references may be made to certain non-generally accepted accounting principles, or non-GAAP measures, for which you should refer to the appropriate disclaimers and reconciliations in the company's SEC filings and press releases. Following management discussion, there will be a formal Q&A session open to participants on the call. And now I would like to turn the conference call over to Jim Gaynor, LightPath's President and Chief Executive Officer. Jim, please go ahead.

Thank you and good morning. Welcome to LightPath Technologies' fiscal 2019 fourth quarter financial results conference call. Our financial results press release was issued after the market closed yesterday and posted to our corporate website. Following my remarks, our CFO, Don Retreage, will further review our financial results and provide more perspective on some key areas. We will then conduct a Q&A session and move on from there. LightPath experienced encouraging progress on many fronts during 2019 fiscal year that ended June 30, which were unfortunately masked by a few critical issues. The key takeaway is that the market acceptance of our diversified portfolio of visible and infrared lenses is on the rise. Here is the backdrop. We essentially have two primary sides of our business, precision molded lenses or PMO products is our legacy business which is slower growing and smaller than our infrared or IR business. The PMO addressable market is estimated at about $300 million, growing at about 3% to 5% annually. The IR addressable market is estimated at greater than $500 million, growing at about 7% to 10% annually. Each of these markets is impacted by seasonality and cyclicality. Third line of business falls outside both of these areas and is for specialty products and other projects which will have varying contributions to our consolidated financial results, typically 3% to 10% of total revenues. Fiscal 2019 revenue growth of IR was 8% and PMO was 4%. In the fourth quarter, revenue growth for IR accelerated with an increase of 19% while PMO growth was steady at 4%. On top of that, our 12-month backlog was $17.1 million at June 30, 2019, an increase of 33% as compared to $12.8 million at June 30, 2018. While these metrics were positive, they were not as high as we had expected. 2019 may be best characterized as transitional. Specifically, here are some of the challenges and opportunities that our transition has addressed. The closure of our New York facilities, balancing demand generation and fulfillment capacity, cost structure issues for margin and profitability enhancements, the impact of tariffs resulting from the U.S.-China trade war, and a non-cash tax and other charges taken to effectively clear house as we go into fiscal 2020. I will now address the first three areas to provide some context, and Don will address the tariffs and charges in his remarks. First, the closure of our New York facilities in Irvington was undertaken as we believe we would not be able to expand capacity in this facility to meet additional IR volume growth that we anticipate and certainly not set up to be able to supply defense IR opportunities. The cost of $1.2 million in fiscal 2019, $845,000 in the fourth quarter is expected to be more than offset with savings of at least an equal amount in fiscal 2020. With the functions and capacities primarily moved to Orlando, we are now positioned for more IR volume and to handle U.S. defense IR business. The New York move plays into our effort of balancing demand generation and fulfillment capacity. As previously disclosed, our increased order backlog is aligned with our operating objective of entering new fiscal quarters with at least 75% of capacity accounted for by our forecasted revenue. So, as our manufacturing capacity increases, we would be able to increase our revenue production. In looking back, when the PMO business was the majority of our forecast, we could book and ship these products within the quarter while most IR products cannot be turned that quickly. Thus we have focused on ways in which to reduce the delivery cycle time for our infrared products. While we are addressing this with the conversion of certain of these infrared products from diamond turned traditional infrared materials to molded BD6. We continue to implement cost reductions in our manufacturing process while simultaneously addressing our sales execution efficiency. The sales focus will be addressed in my comments in a few minutes. And in terms of shortening our process cycle times, we are making good progress as we continue to invest in capacity and capabilities in all our factories. Investments in systems and people are aimed at speeding our quote response time and fully integrating our capabilities between our global factories. With the increasing acceptance of our new BD6 glass product line, we have expanded our glass melting and coating capabilities in Orlando, expanded our coating and glass preparation capacity in China and improved our test and measurement capabilities in all of the factories. With the completion of our relocation of our New York facility to Orlando in June, we expect a significant reduction in operating costs in our fiscal 2020 that began July 1. On the visible PMO product lines, the work we did in 2018 on new designs for the telecom sector are moving into production. Several new designs went into production beginning in the middle of 2019. We have a number of new designs going forward for telecom alone, which experienced a 30% increase in revenue in the fourth quarter and 60% for the year. The largest area of growth in telecom is related to the 5G movement. Regardless of which OEM has the leading market share or which country invests more in capital expenditures for the 5G infrastructure being deployed, LightPath stands to benefit in a big way. This is an example of positioning LightPath at the intersection of our capabilities and the requirements of the market. We believe no other lens manufacturer offers the breadth of winning designs, engineering support for development of new products and global production capabilities for high-volume supply deals providing a competitive value proposition of performance and price. To this end, towards the beginning of our fiscal 2019, we announced comprehensive production capabilities and global availability for a new line of infrared lenses made of chalcogenide compound. We developed this glass capability and grew it internally to produce black diamond glass which has been trademarked and marketed as BD6. This lower cost alternative to traditional germanium material used for IR lenses is expected to benefit the cost structure of some of our current infrared products and allow us to expand our product offerings in response to the market's increasing requirement for low-cost infrared optics solutions. The interest in BD6 lenses has been incredibly gratifying. During fiscal 2019, we created 16 new lenses using BD6 and solidified 14 new design wins. At the Defense and Commercial Sensing tradeshow last April, we introduced several new IR lens assembly products for which we are now experiencing really good feedback and order interest. Since then, we have developed an entire family of lens assemblies ranging from 1.5 millimeter to 50-millimeter focal lengths. For the past several months, we have been ramping up production for end market applications that include rifle scopes, range finders, sensory equipment, wearable devices for first responders and more. Since the beginning of fiscal 2019 to-date, we have moved 10 BD6 IR lenses into production. This progress is truly impressive. Let me put this into more appropriate context. Responding to the high price of raw material that was eating away at our gross margin, in about 18 months we created a new family of lenses, launched a global marketing campaign, invested in a new manufacturing plant, and entered into high-volume production and delivery. Importantly, a significant portion of this new lines of lenses is able to be molded which will enable us to move faster from order placement to revenue recognition while further improving our margins beyond the cost of materials. As a reminder, in general most BD6 lenses are about 25% to 30% less expensive on 40% to 50% of the material component of the lens as compared to comparable lenses made of germanium. As we continue to convert lenses that are currently made out of germanium to BD6, we will see benefit there. On the molding of BD6 lenses, the growth rates, albeit of a small base, has been off the charts. IR molded grew 159% for fiscal 2019 versus fiscal 2018 and 364% in the fourth quarter of 2019 versus the fourth quarter of 2018. And by the way, it was 108% for the third quarter of 2019 versus the third quarter of 2018, all of which demonstrates that our growth has accelerated as the year progressed. Based on our improved competitive position globally and our large backlog as well as the interest in our diversified product lines, investments are being made to add capacity with IR production increases as the key focus. Capital expenditures including equipment purchased through capital leases were $2.5 million for the fiscal year ended June 30, 2019, compared to $3.3 million in the prior fiscal year. The heavier period of investment is behind us however, so we anticipate improved free cash flow as our order flow increases and we move into production at a faster rate. To ensure continued progress and long term success, another key initiative in fiscal 2019 was centered on the organization and its leadership. Just before the start of the fiscal year, we upgraded our finance department with the appointment of Donald Retreage as CFO. In June, we announced the succession plan which involves the search for a CEO to assume the role upon my retirement in 2020. The executive search is exploring both internal and external candidates. To ensure LightPath can proactively take maximum advantage of its capabilities and grow at our desired rates with our more complex and broader product portfolio, we have taken further actions to strengthen the organization. We created the position of Chief Operating Officer to better match supply with demand by combining operations, engineering and sales under a single leader. Al Symmons has been appointed to this position who is an industry veteran including 13 years with LightPath. LightPath has three distinct product capabilities, molded optics, thermal imaging lens assemblies and custom optics. Each of these capabilities involves products that have different growth rates, conversion rates and material content. To manage these different revenue streams, we have also implemented and staffed a product management function. The role of product managers is to manage each product portfolio and target the most probable high-growth opportunities that align with our capabilities. LightPath's vision is to be the most competitive supplier of optical lenses that will ultimately enhance stockholder value. Our strategy going forward is to position LightPath at the intersection of our unique capabilities and the optical lens requirements of our target industries with the shortest time to market. In summary, meaningful progress has been made in fiscal 2019 as well as in fiscal 2020 to-date toward our initiatives for delivering sustainable improvements in long-term revenue performance, profitability and cash flow. We look forward to realizing the full benefits of the actions taken last year and in the new fiscal year that began on July 1, 2019. I will now pass the call back to CFO, Donald Retreage, to provide more details on our fourth quarter and full-year financial results.

Thank you Jim. First, I would like to mention that much of the information we are discussing during this call is also included in the press release issued yesterday and in our annual report on Form 10-K filed with the SEC. I encourage you to visit our website at lightpath.com and specifically the section titled Investor Relations. Now onto my remarks pertaining to the fourth quarter and full year fiscal 2019. Rather than recite all of the financial details in the press release, I will review some of the highlights and then address the items Jim has referenced in his remarks. Revenue for the fourth quarter of fiscal 2019 was $8.7 million, an increase of 8% as compared to $8.1 million in the fourth quarter of fiscal 2018. Revenue for the full year was $33.7 million for fiscal 2019, an increase of 4% as compared to $32.5 million in fiscal 2018. For our geographic revenue mix in the fourth quarter, we had 39% from North America, 24% from Asia, 34% from Europe and 2% from the rest of the world. For the year, 38% was from North America, 23% from Asia, 36% from Europe and 4% from the rest of the world. Now onto our vertical markets sales review for the first quarter. Sales to catalogs and distributors were 18% of revenue, defense was 14%, industrial was 40%, commercial was 10%, medical was 4% of the total revenue, telecom was 15%. The 12-month was $17.1 million at June 30, 2019 and increased 33% as compared to $12.8 million at June 30, 2018. In addition, we have an undisclosed backlog that goes out from months 13 to 36 which together with our 12-months backlog provides us with enhanced visibility to manage the business and invest according to future manufacturing capacity needs. Net loss for the fourth quarter of fiscal 2019 was $1.8 million compared to a net loss of $807,000 for the fourth quarter of fiscal 2018. The fiscal 2019 period includes nonrecurring charges of $845,000 relating to the transition out of New York, a non-cash reversal of $406,000 of income tax benefits recorded in the first half of fiscal 2019. this was due to a change in the company's estimated utilization of net operating loss carryforward benefits for fiscal 2019. We incurred EBITDA losses in fourth quarter of both 2019 and 2018 in the amounts in excess of $200,000 for each period. Total 2019 EBITDA was $1.9 million as compared with $4 million for all of 2018. EBITDA, as reported for fiscal 2019, was 6% of revenue. If we adjust it for nonrecurring cost related to relocation of New York facilities as mentioned above, EBITDA would have been 10% of revenue. If we further consider the cost improvements we expect from the relocation, quoting improvements and material cost saving we procure from our vendors, we believe our EBITDA would have been in the range of 12% to 15% of revenue which compares with 12% of EBITDA margin for all of 2018. Total debt, including capital leases, was $6.6 million at June 30, 2019, a decrease of 11% as compared to $7.4 million at June 30, 2018. Cash and cash equivalents were $4.6 million at June 30, 2019, compared to $6.5 million at June 30, 2018. The decrease in cash of $1.5 million or 29% from the prior year end is primarily related to capital expenditures, debt reduction and inventory build. With a higher backlog and anticipated revenue, we increased the amount of inventory being carried from the beginning of the year. In anticipation of the increased IR business, BD6 and GE, we increased the inventory by approximately $1.3 million to $7.6 million. Moving on to other areas that Jim referenced and the impact of tariffs resulting from the U.S.-China trade war, it should be understood that not all our products are subject to tariffs. About 64% of our consolidated business is international, which does not have to come through the U.S. and our China facilities only exports 55% of its output. That being said, in fiscal 2019, the company paid approximately $940,000 in tariffs. This represents an increase of $400,000 of tariffs paid in 2018, of which $175,000 was incurred in the fourth quarter due to rate increases that took effect during the quarter. We have taken several actions that will mitigate most of the impact of these tariffs starting in Q2 2020 or the quarter beginning October 1, 2019. We have increased some inventories in country so that the impact would be limited for a while and we are taking advantage of these and other mitigating steps including where we limit some of things that we ship through the U.S. and may even put a surcharge on certain items where we don't have international latitude. In the fourth quarter, we took charges to restructure expenses for the reversal of non-cash income tax benefit. The charges included nonrecurring charges $845,000 related to the transition out of New York and non-cash reversal of $406,000 income tax benefit recorded in the first half of the fiscal 2019, again due to changes in the company's estimated utilization of net operating loss carryforward benefits for 2019. A large part of the restructure is to accrue for the remaining rents in the New York facilities. Should we be able to sublet the real estate, we will recapture the cash income. The facility consolidation and other previously announced organizational changes are expected to allow for investments in marketing and product management to further grow our revenue base, while still reducing total operating costs and expenses. Our remaining NOL, net operating loss, as of June 30, 2019 were $74 million. With this review of our financial highlights concluded, I will turn back to the operator so that we may begin with our question-and-answer session. Thank you.

[Operator Instructions]. And the first question comes from Marc Wiesenberger with B. Riley FBR.

Thank you. Good morning.

Well, good morning to you, Marc. It's early morning there.

It is. Can you walk me through your thinking on gross margins over the coming year and some of the puts and takes that are going to go into that?

Well, sure. I think the gross margins and the cost of goods sold were impacted in 2019 by some of these restructure charges and a few other costs that are nonrecurring as well as some redundant labor that we had while we were moving that operation. So, we expect those things, that margin to improve dramatically in fiscal 2020 as we start to take advantage of these programs that we put in place last year. So, I think we will see a significant improvement in the margins as we move forward, and you have already started to see it in the current quarters. If you look back, we went from 30% to 32%, and you know, as we do some of this conversion, you are going to see some improvements as we start to take advantage of the BD6 benefits over germanium costs and those kinds of things moving forward. So, we feel pretty good about that. I think maybe a better metric to consider is how the EBITDAs will change. We reported a 6% EBITDA this year as reported. If you adjusted that for just the cost of the relocation and the redundant labor we had, that would move to 10%. And then if you start to put in some of the cost savings that we expect to see -- that we have already put in place, but the benefits haven't fully flown through the financials yet, then we would move that EBITDA into the range of 12% to 15% and then we continue to go from there. So that's without any volume changes whatsoever. If you start to grow the business as we expect, then I think you will see the EBITDAs return into the margins that we would like to see into the 20s more than likely as we move forward over the next year or two.

Got it. And expanding on our last one a little bit. How do we think about the potential growth of the business now that some of the moving pieces have been resolved?

Well, I think as we said, these markets are growing at a compounded annual rate of 7% to 8%, particularly I mean for the infrared business and about 3% to 5% for the PMO business. We think the visible business is going to be pretty stable at that kind of growth rate. It's going to be driven by the 5G demand. So, we see that continuing. The IR, I think, we will see growing at much faster rate, probably double that at a minimum. We saw some acceleration of that growth rate in the fourth quarter where we had 19% growth. You also saw some very good growth of the molded IR as that starts to pick up steam. So I think we would see that kind of growth there. The specialty business is kind of up and down, depending of what kind of projects that we are able to become involved in. But I would expect that to stay in the range that it typically runs around 6% of our revenue.

Understood. Can you talk about some of the dynamics with regards to the strength in telecom and industrial maybe and then offset by the weakness in the commercial vertical? And how we should think about that going forward?

Well, I think, obviously, our focus has been on the infrared sector which is where we think we see the fastest growth. So, I think that's going to continue. I think the telecom business, being driven by 5G is the main driver of that. We did a lot of work in 2018 developing and designing lenses for that application for our customers there, and those are starting to move in production. So, I think we will see that. I don't see that backing off. That's one of the areas that has the potential to be impacted, in our case, by what's going on with the relation of the tariffs with China. But a lot of that business is built in China and sold in China, so it's not heavily impacted there. But I think that's going to continue to drive that business. That's the main driver there. The types of applications in the infrared that we are doing with riflescopes and sensors and those kinds of things, I think are going to drive the business in the infrared and particularly some of the things that we like are the smaller-type lenses because those are all moldable for us. We have moved these processes around. We have brought the coating processes in-house and developed wear-resistant coatings for both the capabilities for LightPath, anyway for germanium and also for the BD6. So, I think that will help accelerate that conversion to the chalcogenide material system. So those are all things that I think are going to drive the business as we go forward.

Okay. Also, you noted a shortfall of customers. Just crystallize a little more how some of the operational changes you are making will help improve that going forward?

Yes. I think one of the issues that we faced last year was demand generation. And by that, we mean although we grew, we didn't grow at the expected rates that we would like and part of that was impacted by the relocation of the New York operation and bringing up the coating operation here in Orlando. It went smoothly until the last three or four months and then we had some struggles with it, which we have gotten through, but it impacted the rate and pace with which we could take on new projects. We also had this communication problem between some of our functional groups as well as our geographic groups as we made this transition. And one of the things that we are trying to address that, that communication issue really slowed down the quoting process and so we weren't able to get quotes out as timely as our customers would like and then we lost some opportunities as a result of that. So what we have tried to do with the organizational changes is address that problem, one, by creating the Chief Operating Officer position so that we consolidate under a single leader the sales, engineering and operations functions and improve that combination and the communication between those groups as well as between the different physical facilities where the various processes reside. In addition, as I said, we brought the operation up in Orlando to also shorten the lead times and bring up the capabilities that we had. So I think that that kind of thing generates it and then in addition, we created and staffed a product management function. The idea behind that is for the portfolio management. So with the integration of the ISP products and the development of the BD6 and the legacy products, our product portfolio became a lot bigger and a lot more complex. And so what we have now done is try to break it down into these various product groups with a product manager to manage that portfolio and ensure that we are looking at the right types of opportunities, not chasing things that tend to be one-off and go for things that have a little more life to them, bigger opportunities and just manage that process much better. So we are in the beginning stages of that. We have staffed that. Those guys are in place and they are starting to impact that process and make sure that things move through our system more smoothly. So I think that kind of generates that. Also tying together the engineering and operations and sales, now we have a better way of balancing the supply with the demand and make sure that we have the right capacities in place for the right products.

That's helpful. Thank you. And one last one for me. Jim, you have been with LightPath for over 12 years. You have helped expand the product and geographic footprint pretty significantly. But you announced you are going to be stepping down next year. Can you provide with some more details about that transition and maybe the timeline for succession?

Yes. I am going to let my boss answer that question. Bob Ripp happens to be here today. So I am going to turn that one over to him.

Good morning Marc. Good morning everybody. With respect to the succession plan, the Nominating and Governance Committee of the Board, which consists of myself, Louis Leeburg and Sohail Khan, we looked at six different search firms, interviewed three and have an engagement letter with one of them as of now. Each of them that we interviewed were pretty positive about attracting the type of individuals that we would want to lead LightPath. They all were very confident about how quickly they thought they can do it, sometimes in the order of 90 to 100 days. I told them I want right to trump fast in this particular case. But where we stand right now, as we are going through with the search firm that we have engaged through the process of lining up the first round of process to get on with culling from all the applicants that that search firm would be looking at, to a narrower list. And I am sure that within the next two weeks, we will be starting our first interviews. So how long that all will take, based on their forecast, it's about end of year target in their minds. But we will just see how that process goes.

Great. Thank you very much.

Thank you. And the next question comes from Michael Dyett, a private investor.

Thank you Jim and Bob, good to hear your voice. I wondered if you could expand on the sales strategy concept to the extent to which you will be continuing to use the trade shows versus other initiatives and what the post 12-month backlog has looked like in this current year?

Well, I think obviously the backlog, let me go there first, is up about 33% over where it was last year. I mean that's the disclosed backlog. So that means that's what's shippable in the next 12 months. It continues. The infrared business is becoming a larger part of our business and that's where we wanted to be. So the reason is that it's a bigger market, it's faster growing. And so that is reflected in that backlog as we move forward. So I think we have a pretty healthy backlog as it stands right now and that's continuing. I think from a sales process point of view, we are transitioning the sales strategy to a product centric strategy. That's a very technically based process. We put the product managers in place as a way of input into that process to make sure we are looking at the right opportunities as well as to manage that portfolio. I think we have also introduced the concept of capture teams in our sales process, which means that we bring in the right mix, depending on what's the particular opportunity they are looking at, of technical support sales support, operational support. So we form this team to look at the opportunity and develop the quote response and make sure that we have the capabilities in place. We put the right design in place and we have the capacities necessary to execute. So that's basically the process as we move it forward. So we are in that process. We are also increasing our emphasis on the inside sales, so that this group, the sales group has good support for the back-office type things that are included as well as there is a large portion of our business that can be handled by inside sales that's recurring legacy type business.

Thank you Jim. And I will say, this is the best conference call I have heard in probably eight or 10 years. Thank you again and good luck.

All right. Thank you Michael.

Thank you. And as there are currently no more questions in queue, I would like to return the floor to Jim Gaynor for any closing comments.

All right. Thank you operator. Well, thank you all for joining our call today. We have covered a lot of detailed information today. So one of the things I would like to do before we close is summarize what I think the key takeaways are. First, our IR business is growing rapidly with the addition of the BD6 material system, our new family of lens assemblies and the release of several new products. Second, our precision molded optics business is stable with growth being driven primarily by 5G demand. Third, we will benefit significantly from the savings generated by the closing of the New York facility. And fourth, we have sufficient cash to fund operational growth through continued investments in product development, manufacturing capacity and the expansion of our customer base. In conclusion, 2019 presented many challenges and some disappointments, which we have addressed and through which we will pave the way for improved financial performance on both the top and bottom lines. We are excited for the future and the continued growth of LightPath. We will also talk more about our strategy and progress at the upcoming Sidoti Conference in New York later this month and I hope to see you there. Thanks again for participating on today's conference call and we look forward to speaking with you next quarter.

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