Kopin Corporation — Q2 2017 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the three and six months ended July 1, 2017, compared with periods ended June 25, 2016. Kopin develops and sells wearable-technology components and systems, including displays, optics, electronics and headsets; it also earns research and development (R&D) revenue. The company reports Kopin and Industrial segments.
Key financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $5.93 million | $4.36 million | $10.31 million | $10.47 million |
| Operating loss | $8.07 million | $0.99 million | $16.73 million | $7.31 million |
| Net loss attributable to controlling interest | $7.33 million | $3.19 million | $15.19 million | $10.13 million |
| Basic and diluted loss per share | $0.10 | $0.05 | $0.22 | $0.16 |
| Operating cash flow | Not separately stated for quarter | $(12.68) million | $(12.28) million |
- Q2 revenue rose about 36% year over year, while six-month revenue decreased about 2%. Q2 product revenue was $4.98 million and R&D revenue was $0.95 million; six-month amounts were $8.91 million and $1.39 million, respectively.
- Product gross margin was approximately 17.3% in Q2 and 18.8% for the six months, based on product revenue less product cost. The comparable 2016 margins were negative 13.4% and 7.9%. Management attributed improvement to a greater contribution from higher-margin industrial products.
- Cash and equivalents were $30.54 million and marketable debt securities were $54.37 million at July 1, for combined liquidity of $84.91 million, versus $77.20 million at December 31, 2016. Working capital was $77.8 million. Total liabilities were approximately $15.25 million; the balance sheet reports no debt balance.
- Six-month investing cash flow was positive $2.71 million, including $7.51 million net proceeds from marketable-security sales and purchases, offset in part by $3.69 million paid for an acquisition and $1.07 million of capital expenditures. Financing cash flow was positive $24.66 million from the Goertek stock sale. Cash increased $14.72 million to $30.54 million.
Material changes and unusual items
- Q2 operating loss widened substantially year over year. The 2016 comparison included a $7.70 million gain on the sale of property and plant, making the prior-year operating result unusually favorable. Six-month SG&A rose to $10.84 million from $8.04 million, reflecting higher stock compensation, intangible amortization, contingent earn-out accruals and professional fees.
- Wearable-application revenue fell to $0.9 million in Q2 and $1.5 million for the first half, compared with $1.8 million and $4.4 million. Military and industrial applications increased; R&D revenue also rose, principally in connection with military programs. NVIS, acquired in March for approximately $3.7 million, contributed $1.7 million of first-half revenue and $0.5 million of net loss.
- On April 20, Kopin sold 7,589,000 treasury shares to Goertek for $24.66 million, approximately 10.1% of the company’s shares at the transaction date. Kopin and Goertek also entered into development, supply and manufacturing arrangements. Up to $2.0 million of additional acquisition consideration may be payable if specified operating milestones and employee-service conditions are met.
- The company recorded a $1.1 million six-month tax benefit, including a $1.0 million valuation-allowance reduction associated with deferred tax liabilities recognized in the acquisition. A noncash $0.27 million warrant gain was recorded in the first half. The filing also reports approximately $0.33 million of restitution recovered in the first half related to prior embezzlement.
Outlook, risks and controls
- Management expects significant 2017 development and marketing costs to commercialize wearable technologies and develop military products. It plans $2.0–$3.0 million of capital expenditures over the next 12 months and believes available cash resources will fund operations and capital needs for at least 12 months.
- Kopin was qualifying for the U.S. military Family of Weapon Sights programs and receiving low-volume FWS-I orders; future program awards and wearable-product demand remain uncertain. Management also cited potential foreign-exchange effects and does not hedge currency risk.
- Two proposed joint ventures remained subject to closing conditions and government approvals; if completed, Kopin may contribute intellectual property valued at up to $3.0 million. The company is also evaluating a possible purchase of the remaining 7% of Kowon.
- Disclosure controls and internal control over financial reporting were reported ineffective because of previously disclosed material weaknesses. Remediation measures include independent custody of the Korean subsidiary’s corporate seal, outsourced accounting, and enhanced corporate review; management said remediation would require controls to operate effectively for a period of time.
- The filing describes a $1.59 million embezzlement at the Korean subsidiary occurring from 2011 through 2016. Ordinary-course legal matters are possible, but the filing does not identify a specific material proceeding or quantify a related loss.
- Revenue from customer contracts and leases are upcoming accounting-standard adoption matters. Management expected to complete its revenue-standard assessment in 2017 and stated the lease standard could materially affect recognized lease assets and liabilities.
Important facts for investors to verify
- Whether wearable-product demand recovers and military qualification efforts convert into meaningful production revenue.
- Whether cost reductions and product mix can improve margins enough to offset continuing R&D and SG&A spending and operating cash outflows.
- Final acquisition valuations, amortization, and any contingent consideration; and the status and financial terms of proposed joint ventures or a Kowon minority buyout.
- Whether internal-control remediation is completed and whether any further findings arise from the Korean subsidiary embezzlement.
- Liquidity composition and accessibility: the filing says Kowon holds about $18.1 million of cash and marketable securities expected eventually to be remitted to the U.S., while other foreign-subsidiary balances are not planned for repatriation.