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KOPIN CORP - 10-Q - : Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Forward Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995, including, without limitation, statements made relating to our expectation that we will continue to pursue other U.S. government development contracts for applications that relate to our commercial product applications; our expectation that we will prosecute and defend our proprietary technology aggressively; our belief that it is important to retain personnel with experience and expertise relevant to our business; our belief that our products are targeted towards markets that are still developing and our competitive strength is creating new technologies; our belief that it is important to invest in research and development to achieve profitability even during periods when we are not profitable; our belief that we are a leading developer and manufacturer of advanced miniature displays; our belief that our products enable our customers to develop and market an improved generation of products; our belief that the technical nature of our products and markets demands a commitment to close relationships with our customers; our belief that our Golden-i industrial reference design will provide for increased worker productivity, safety and improved manufacturing quality; our belief that our ability to develop and expand our wearable technologies and to market and license our wearable technologies will be important for our revenue growth and ability to achieve profitability and positive cash flow; the impact of the timing of development of the market segment for our wearable computing products on our ability to grow revenues; our expectation that we will incur significant development and marketing costs in fiscal year 2014 to commercialize our wearable technologies; our statement that we may make equity investments in companies; our expectation that the cash and marketable debt securities held by Kowon will eventually be remitted back to the U.S.; our expectation that sales of our display products to the U.S government for use in thermal weapon sights with continue through the first six months of 2015; our expectation that revenue will be between $24 million and $28 million for fiscal year 2014; our ability to forecast our revenues and operating results; our expectation that we will have a consolidated net loss in the range of $29 million to $33 million in fiscal year 2014; our expectation that excluding the effects of working capital and other investing and financing activities our cash usage will be between $23 million and $26 million to fund operations for fiscal year 2014; our expectation that the U.S. government will significantly reduce funding for programs through which we sell high margin military products; our inability to predict the amount of funding for research and development by the U.S. government; our belief that a strengthening of the U.S. dollar could increase the price of our products in foreign markets; the impact of new regulations relating to conflict minerals on customer demands and increased costs related to compliance with such regulations; our belief that our future success will depend primarily upon the technical expertise, creative skills and management abilities of our officers and key employees rather than on patent ownership; our belief that our extensive portfolio of patents, trade secrets and non-patented know-how provides us with a competitive advantage in the wearable technologies market; our belief that our ability to develop innovative products enhances our opportunity to grow within our targeted markets; our belief that continued introduction of new products in our target markets is essential to our growth; our expectation that our display products will benefit from further general technological advances in the design and production of integrated circuits and active matrix LCDs, resulting in further improvements in resolution and miniaturization; our belief that our manufacturing process offers greater miniaturization, reduced cost, higher pixel density, full color capability and lower power consumption compared to conventional active matrix LCD manufacturing approaches; our expectation not to pay cash dividends for the foreseeable future and to retain earnings for the development of our businesses; our expectation that we will expend between $2 million and $3 million on capital expenditures over the next twelve months; our expectation that competition will increase; our belief that small form factor displays will be a critical component in the development of advanced wireless communications systems; our belief that wireless handset makers are looking to create products that complement or eventually replace wireless handsets; our belief that general technological advances in the design and fabrication of integrated circuits, LCD technology and LCD manufacturing processes will allow us to continue to enhance our display product manufacturing process; our belief that continued introduction of new products in our target markets is essential to our growth; our belief that our available cash resources will support our operations and capital needs for at least the next twelve months; our expectation that we may be subject to alternative minimum taxes, foreign taxes and state income taxes in 2014; our expectation that the adoption of certain accounting standards will not have a material impact on our financial position or results of operations; our belief that our business is not disproportionately affected by climate change regulations; our belief that our operations have not been materially affected by inflation; and our belief that the effect, if any, of reasonably possible near-term changes in interest rates on our financial position, results of operations, and cash flows should not be material. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industries in which we operate, management's beliefs, and assumptions made by management. In addition, other written or oral statements, which constitute forward-looking statements, may be made by or on behalf of us. Words such as "expects", "anticipates", "intends", "plans", "believes", "could", "seeks", "estimates" and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements, whether as a result of new information, future events or otherwise. Factors that could cause or contribute to such differences in outcomes and results include, but are not limited to, those discussed below in Item 1A and those set forth in our other periodic filings filed 16-------------------------------------------------------------------------------- Table of Contents with the Securities and Exchange Commission. Except as required by law, we do not intend to update any forward-looking statements even if new information becomes available or other events occur in the future. Critical Accounting Policies Management's discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. We continually evaluate our estimates used in the preparation of our financial statements, including those related to revenue recognition under the percentage of completion method, bad debts, inventories, warranty reserves, investment valuations, valuation of stock compensation awards and recoverability of deferred tax assets. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not apparent from other sources. Actual results will most likely differ from these estimates. Further detail regarding our critical accounting policies can be found in "Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 28, 2013. Business Matters On January 16, 2013 (the Closing Date), we completed the sale of our III-V product line, including all of the outstanding equity interest in KTC Wireless, LLC, a wholly-owned subsidiary that held our investment in Kopin Taiwan Corporation (KTC), to IQE KC, LLC and IQE plc (collectively the ''Buyer''). The aggregate purchase price was approximately $70 million of which $15 million is scheduled to be paid to us on the third anniversary of the Closing Date. We discounted the $15 million and recorded the amount due at $14.8 million on the Closing Date. The Buyer has outstanding debt and the repayment of the receivable is subject to the Buyer remaining within its debt compliance obligations at the time of repayment. Our Kowon facility is for sale and when it is sold we anticipate that a final determination of the value of the shares held by the minority shareholders will be made and we will purchase these shares. The sale of the facility does not meet the criteria for assets held for sale based on the anticipated time to sell the facility. Ikanos Consulting Limited (Ikanos) changed its name as of September 30, 2014 and is now known as Intoware Limited (Intoware). We were incorporated in Delaware in 1984 and offer Kopin Wearable technology, a collection of component technologies and software which can be integrated to create headset reference designs which use voice as the user interface and through the use of wireless technologies can contact other users or information from the cloud. Our customers can license the reference design or purchase our components individually. The headset reference designs range from a headset which resembles typical eyeglasses but includes audio capabilities allowing the user to communicate with other users to our industrial headset reference design, called Golden-i, which includes an optical pod with one of our display products, a microprocessor, memory and various commercially available software packages that we license, such as Microsoft Windows CE or Android, Nuance Dragon NaturallySpeaking, and Hillcrest Labs motion control. Our headset reference designs typically utilize operating system software we developed and include our proprietary noise cancellation technologies. Certain reference designs include an optical pod which allows the user to view information such as WEB data, technical diagrams, streaming video or face to face communication. When viewing schematics or similar documents the user is capable of zooming-in to see finer details or zooming out to see an entire system perspective. Some headset reference designs have a camera feature which enables the user to stream live video to a remote subject matter expert so that both the user and expert can analyze the issue at the same time. We believe Kopin's Wearable technology will provide for increased worker productivity, safety and improved manufacturing quality through more efficient issue resolution and improved communication. Kopin Wearable reference designs are targeted for markets where the user needs a much greater range of functionality than is typically provided by wireless devices such as handsets, smart phones, tablets or Bluetooth headsets and either due to the requirements of their usage patterns, occupation, or for improved productivity the user is better served with voice recognition as the primary interface as opposed to a touch screen or keyboard. The components we offer include micro displays, backlights, optic, and noise cancellation technologies. Our principal display products are miniature high density color or monochrome active matrix LCDs with resolutions which range from approximately 320 x 240 resolution to 2048 x 2048 resolution sold in either a transmissive or reflective format. We sell our displays individually, in an Electronic Viewfinder (EVF) which includes a single display, backlight and optics in a plastic housing or in a Higher-Level Assembly (HLA) which contain a display, light emitting diode based illumination, optics, and electronics in a sealed housing. EVFs are sold to commercial and industrial customers and HLA's are specifically configured and sold to military customers. 17-------------------------------------------------------------------------------- Table of Contents Our transmissive display products, which we refer to as CyberDisplay™ products, utilize high quality, single crystal silicon-the same high quality silicon used in conventional integrated circuits. This single crystal silicon is not grown on glass; rather, it is first formed on a silicon wafer and patterned into an integrated circuit (including the active matrix, driver circuitry and other logic circuits) in an integrated circuit foundry. The silicon wafer is then sent to our facility and the integrated circuit is lifted off as a thin film and transferred to glass using our proprietary Wafer™ Engineering technology, so that the transferred layer is a fully functional active matrix integrated circuit which now resides on a transparent substrate. We have three sources of revenues: component revenues, which are our primary source of revenues, research and development (R&D) revenues primarily from contracts issued by branches of the U.S. military and license revenues from our reference designs. To date our license revenues have been de minimis. For the three and nine months ended September 27, 2014, R&D revenues were $0.5 million and $3.0 million, or 0.5% and 14% of total revenues, respectively. This contrasted with $0.1 million and $1.3 million or 1% and 7% of total revenues, respectively, for the corresponding period in 2013. Results of Operations The three and nine month periods ended September 27, 2014 and September 28, 2013 are referred to as 2014 and 2013, respectively. The year ended period December 28, 2013 is referred to as fiscal year 2013. Revenues. For the three and nine month periods ended September 27, 2014 and September 28, 2013, our revenues, which include component sales and amounts earned from research and development contracts, were as follows (in millions): Three Months Ended Nine Months Ended September 27, Display Revenues by Category 2014 September 28, 2013 September 27, 2014 September 28, 2013 Military Applications $ 5.7 $ 1.5 $ 8.3 $ 7.5 Consumer Applications 0.6 1.7 2.3 4.0 Industrial Applications 1.0 0.5 2.8 1.8 Wearable Applications 1.7 1.2 4.8 2.8 Research & Development 0.5 0.1 3.0 1.3 Total $ 9.5 $ 5.0 $ 21.2 $ 17.4 Sales of our products for Military Applications increased in 2014 as compared to 2013 because of an increase in demand from the U.S. government for our products that are used in thermal weapon sights. We expect orders to continue for this program through the first six months of 2015. Consumer Applications primarily represents customers who purchase our products for digital still camera (DSC) applications. We believe the overall market for DSCs has been declining due to the increase in use of cameras in smartphones. Industrial Applications represents customers who purchase display products for use in equipment such as 3D metrology. The increase in Wearable Applications revenues in 2014 as compared to 2013 is as a result of both increased sales to existing customers and obtaining new customers. Wearable Applications represents sales of our components for products that are worn on the body for other than military applications. We have developed headworn, voice and gesture controlled, hands-free cloud computing reference designs that have an optical pod which includes our microdisplay, a backlight and an optical lens. We refer to the headset reference designs and other technologies we have developed as Kopin Wearable technologies. We offer to license the headset reference designs and sell our components. To date licensing revenues have been di minimis and sales of our components are shown in the table above under Wearable Applications. We believe our ability to develop and expand the Kopin Wearable technologies and to market and license the Kopin Wearable technologies will be important for us to achieve revenue growth, positive cash flow and to achieve profitability. This is the first product that we have developed that has a significant software component. The markets the Kopin Wearable technologies can be used in already have a number of existing product offerings such as ruggedized lap-top computers and tablets. The companies that offer these products are significantly larger than we are. We expect to incur significant development and marketing costs in fiscal year 2014 to commercialize the Kopin Wearable technologies. We currently expect to have revenues of between $24 million and $28 million for fiscal year 2014, however our ability to forecast revenues derived from Kopin Wearable technologies, which may significantly impact our results of operations, is very limited. We currently expect to have a consolidated net loss in the range of $29 million to $33 million in fiscal year 2014 and, excluding the impact of the effects of working capital and other investing and financing activities, we expect cash usage between $23 million and $26 million to fund operations for fiscal 2014. We have provided estimated fiscal year 2014 revenue and net loss ranges in order for the investor to understand the impact of expected changes in our business in fiscal year 2014 as compared to 2013. However, we believe we have an opportunity to position ourselves in the growing wearable cloud computing market and therefore our primary focus in fiscal 18-------------------------------------------------------------------------------- Table of Contents year 2014 is on developing technology and products and establishing relationships, and not necessarily achieving revenue, net loss or any other particular financial metric. Accordingly, our fiscal year 2014 net losses may exceed our current estimates. International sales represented 43% and 39% of product revenues for the nine months ended September 27, 2014 and September 28, 2013, respectively. Our international sales are primarily denominated in U.S. currency. Consequently, a strengthening of the U.S. dollar could increase the price in local currencies of our products in foreign markets and make our products relatively more expensive than competitors' products that are denominated in local currencies, leading to a reduction in sales or profitability in those foreign markets. In addition, our Korean subsidiary, Kowon, holds U.S. dollars. As a result, our financial position and results of operations are subject to exchange rate fluctuation in transactional and functional currency. We have not taken any protective measures against exchange rate fluctuations, such as purchasing hedging instruments with respect to such fluctuations, because of the historically stable exchange rate between the Japanese yen, Korean won and the U.S. dollar. Cost of Component Revenues. Three Months Ended Nine Months Ended September 27, 2014 September 28, 2013 September 27, 2014 September 28, 2013 Cost of component revenues (in millions): $ 5.2 $ 4.6 $ 13.6 $ 16.8 Cost of component revenues as a % of net component revenues 57.4 % 94.5 % 74.6 % 104.5 % Cost of component revenues, which is comprised of materials, labor and manufacturing overhead related to the production of our products decreased as a percentage of revenues in 2014 as compared to 2013 due an increase in sales of higher margin products in 2014 and the usage of certain raw materials used in military programs that were previously written-off as excess but were used in the 2014 production. In 2013, we compared forecasted demand for our military programs against inventory on-hand and provided reserves for estimated excess inventory. In the second quarter of 2014, we received additional orders for military products and we have been using the inventory reserved as excess in the fulfillment of the orders. Research and Development. Research and development (R&D) expenses are incurred in support of internal development programs or programs funded by agencies or prime contractors of the U.S. government and commercial partners. In fiscal year 2014, our R&D expenditures will be related to our display products and wearable technologies. R&D revenues associated with funded programs are presented separately in revenue in the statement of operations. Research and development costs include staffing, purchases of materials and laboratory supplies, circuit design costs, fabrication and packaging of display products, and overhead. For the nine months ended September 27, 2014 and September 28, 2013, R&D expense was as follows (in millions): Three Months Ended Nine Months Ended September 27, 2014 September 28, 2013 September 27, 2014 September 28, 2013 Funded $ 1.0 $ 0.2 $ 3.3 $ 1.0 Internal 3.8 5.4 11.8 12.5 Total research and development expense $ 4.8 $ 5.6 $ 15.1 $ 13.5 R&D expense increased in the nine months ended September 27, 2014 as compared to the prior year primarily because of an increase in costs to support customer funded R&D programs. Selling, General and Administrative. Selling, general and administrative (S,G&A) expenses consist of the expenses incurred by our sales and marketing personnel and related expenses, and administrative and general corporate expenses. Three Months Ended Nine Months Ended September 27, 2014 September 28, 2013 September 27, 2014 September 28, 2013 Selling, general and administration expense (in millions): $ 5.0 $ 5.0 $ 14.9 $ 15.7 Selling, general and administration expense as a % of revenues 52.6 % 102.0 % 70.5 % 90.2 % S,G&A expenses are comparable in the third quarter of 2014 to the same quarter in 2013 which reflects an increase in stock compensation expenses being offset by a reduction in patent and certain other expenses. Other Income and Expense 19-------------------------------------------------------------------------------- Table of Contents Three Months Ended Nine Months Ended September 27, 2014 September 28, 2013 September 27, 2014 September 28, 2013Other income and expense (in millions): $ 0.5 $ 1.5 $ (0.6 ) $ 0.2 Other income and expense, net, is primarily composed of interest income, foreign currency transaction and remeasurement gains and losses incurred by our Korean and UK-based subsidiaries and gains and losses resulting from the impairment or sale of investments. During the three months ended September 27, 2014 and September 28, 2013, we recorded $0.2 million of foreign currency gains and $0.8 million of foreign currency losses, respectively. For the nine months ended September 27, 2014 and September 28, 2013, we recorded $0.2 million of foreign currency losses. During the nine months ended September 27, 2014, we recorded an impairment of $1.3 million related to the write-off of our equity investment in KoBrite. During the nine months ended September 28, 2013, we recorded an impairment of $2.5 million related to the write-off of a cost based investment. During the three and nine month periods ended September 28, 2013 we recorded a $1.9 million gain on the sale of our investments in Advanced Semiconductor Company and WIN Semiconductor Corp. Equity Losses in Unconsolidated Affiliates. For the three and nine months ended September 27, 2014 and September 28, 2013, the equity loss in unconsolidated affiliate consists of our approximate 12% share of the losses of KoBrite, incurred prior to our writing the investment off. During the nine months ended September 27, 2014, we funded the operations of one of our investments. The impact for the three and nine month periods ended September 27, 2014 was approximately $35,000 and $157,000 respectively. Tax Benefit. For the three and nine months ended September 27, 2014, we recorded tax provision of $44,000 and a tax benefit of $62,000, respectively, compared to a tax benefit of $33,000 and $12.9 million, respectively, for the three and nine months ended September 28, 2013. The tax benefit recorded for the nine month period ended September 28, 2013 was a result of the gain on sale of our discontinued operations. In accordance with U.S. GAAP, intraperiod tax allocation provisions require allocation of a tax expense to the gain on discontinued operations based upon our statutory tax rate. We have net operating loss carryforwards available to offset the tax expense. The benefit of these net operating loss carryforwards is reflected in the tax benefit from continuing operations. Accordingly, we have recorded a tax expense in discontinued operations and a benefit in continuing operations of $13.1 million. Net Income Attributable to Noncontrolling Interest. We own approximately 93% of the equity of Kowon, approximately 58% of the equity of Intoware, and 80% of the equity of eMDT. Net loss attributable to noncontrolling interest on our consolidated statement of operations represents the portion of the results of operations of our majority owned subsidiaries which is allocated to the shareholders of the equity interests not owned by us. The change in net income attributable to noncontrolling interest is the result of the change in the results of operations of Kowon, Intoware and eMDT for the three and nine month periods ended September 27, 2014. Liquidity and Capital Resources As of September 27, 2014, we had cash and equivalents and marketable securities of $94.0 million and working capital of $91.8 million compared to $112.7 million and $108.4 million, respectively, as of December 28, 2013. The change in cash and equivalents and marketable securities was primarily due to cash provided by investing activities of $17.9 million and the exercise of stock options of $0.1 million, partially offset by net outflow of cash used in operating activities of $17.4 million and the repurchase of our common stock of $0.3 million. Cash and marketable debt securities held in U.S. dollars: Domestic $ 80,913,424 Foreign 10,557,302 Subtotal cash and marketable debt securities 91,470,726 Cash and marketable debt securities held in other currencies and converted to U.S. dollars 2,534,267 Total cash and marketable debt securities $ 94,004,993 We have no plans to repatriate the cash and marketable debt securities held in our foreign subsidiaries FDD and Intoware and, as such, we have not recorded any deferred tax liability with respect to such cash. The operations at our Korean facility, Kowon, have ceased. Kowon has approximately $13.0 million of cash and marketable debt securities which we anticipate will 20-------------------------------------------------------------------------------- Table of Contents eventually be remitted to the U.S. and, accordingly, we have recorded deferred tax liabilities associated with its unremitted earnings. We lease facilities located in Westborough, Massachusetts, Santa Clara, California and Scotts Valley, California under non-cancelable operating leases. The Westborough, Santa Clara and the Scotts Valley leases expire in 2023, 2016 and 2015, respectively. We lease a facility in Dalgety Bay, Scotland which expires in 2016, and also lease two facilities in Nottingham, United Kingdom, which expire in 2016 and 2017. We expect to expend between $2 million and $3 million on capital expenditures over the next twelve months. As of September 27, 2014, we had U.S. federal and state tax loss carry-forwards, which may be used to offset U.S. future federal and state taxable income. We also had tax loss carry-forwards generated in our foreign subsidiaries which may be used to offset future foreign taxable income. We may be subject to alternative minimum taxes, foreign taxes and state income taxes depending on our taxable income and sources of taxable income. Historically, we have financed our operations primarily through public and private placements of our equity securities and cash generated from operations. We believe our available cash resources will support our operations and capital needs for at least the next twelve months. Seasonality There has been no seasonal pattern to our sales in fiscal years 2014 and 2013. Contractual Obligations The following is a summary of our contractual payment obligations for operating leases as of September 27, 2014: Contractual Obligations Total Less than 1 year 1-3 Years 3-5 years More than 5 years Operating Lease Obligations $ 6,540,528 $ 1,248,984 - $ 2,363,627 $ 1,914,833 $ 1,013,084 |