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KOPN > SEC Filings for KOPN > Form 10-Q on 8-Aug-2013All Recent SEC Filings

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Form 10-Q for KOPIN CORP


8-Aug-2013

Quarterly Report


Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations

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 that the technical nature of our products and markets demands a commitment to close relationships with our customers; our belief that our Golden-i technology will provide for increased worker productivity, safety and improved manufacturing quality; our belief that our ability to develop and expand the Golden-i technologies and to market and license the Golden-i technology will be important for our revenue growth and ability to achieve profitability; our expectation that we will incur significant development and marketing costs in 2013 to commercialize the Golden-i technologies; our belief that we have an opportunity to position ourselves in the growing wearable cloud computing market; our statement that we may make equity investments in companies; our expectation that KoBrite will incur additional losses in the near term; our expectation that the operations at our Korean facility, Kowon, will cease and approximately $13.4 million of cash and marketable debt held by Kowon will eventually be remitted back to the U.S.; our expectation that revenue will be between $18 million and $22 million for 2013; our expectation that we will have a consolidated net loss in the range of $28 million to $33 million in 2013, excluding the gain on our sale of our III-V product line and our investment in KTC; our expectation that the U.S. government will significantly reduce funding for programs through which we sell high margin military products; our expectation that we will not achieve the milestones in the state grant from Massachusetts and our expectation that we will be required to repay some or all of such grant; our belief that a strengthening of the U.S. dollar could increase the price of our products in foreign markets; our expectation that we will not receive additional amounts from the sale of patents; 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 micro-display industry; our belief that our ability to develop innovative products based on our extensive materials science expertise 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, based on current negotiations with our customers and certain contractual obligations, that the sales prices of certain products will decline in fiscal year 2013; our expectation that sales of our displays into the TWS program will decline significantly in 2013; our plan to base production and inventory levels based on internal forecasts of customer demands; our belief that the overall increase or decrease in the average sales price of our display products will be dependent on the sales mix of commercial and military display sales; our belief that the U.S. military will evaluate competitors' products for the next thermal weapon sight program; our expectation that we will expend between $2.0 and $3.0 million on capital expenditures over the next twelve months; our expectation that competition will increase; our belief that our display products are well suited for new applications such as reading e-mail and browsing the Internet using digital wireless devices and other consumer electronics devices; our belief that small form factor displays will be a critical component in the development of advanced wireless communications systems; our belief that one of the benefits of our display technology is the ability to produce high-resolution displays in small form factors; 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 expectation that a significant market for new wireless communication devices, including personal entertainment systems, will develop; 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 our interest income will decline in 2013; our expectation that we will not pay domestic federal taxes in the near term; our expectation that we will have taxes based on U.S. federal tax liabilities, on federal alternative minimum tax rules and on our foreign operations in 2013; our expectation that we will have a state tax provision in 2013; 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


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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 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 29, 2012.
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. The aggregate purchase price was approximately $70 million of which $15 million will be paid to us on the third anniversary of the Closing Date. We have discounted the $15 million and recorded the amount due at $14.8 million.
During the first quarter of 2013, we paid approximately $3.7 million to acquire an additional 15% ownership in our Kowon subsidiary from the minority shareholders as part of our plan to close Kowon. The facility is for sale and when it is sold we anticipate that a final determination of the value of the remaining 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. We were incorporated in Delaware in 1984 and are a leading developer of body-worn voice activated and gesture controlled cloud computing systems and display products. Our technologies are used to create hands-free voice and gesture controlled wireless computing systems primarily worn on the head that include an optical pod featuring our proprietary miniature flat panel displays. Our systems include both commercially available software packages such as Microsoft Windows CE, Nuance Dragon NaturallySpeaking and Hillcrest Labs as well as our proprietary operating, noise cancellation and speech enhancement software. The systems we create are concept designs which we license to customers who wish to develop industrial and military products for sale to end customers. We licensed our first concept design in 2010 and our customer anticipates shipping products based on our technology in 2013. Through 2012 our revenues from licensing our Golden-i technologies has been de minimis. Our display products consist of miniature, high performance, high resolution displays either sold separately or in various configurations with optical lenses and electronics contained in either plastic or metal housings. Current applications which include our miniature, high performance, high resolution display products are military devices, such as thermal weapon sights, and consumer devices such as digital cameras; devices that are capable of accessing the Internet using digital wireless devices and viewing data or video from other consumer electronics devices such as wireless handsets. When our display products are configured as spatial light modulators, the applications include industrial equipment for 3D Automated Optical Inspection and cinematography cameras.
We have two sources of revenues: product revenues are our primary source of revenues and we also receive research and development (R&D) revenues primarily from contracts issued by branches of the U.S. military. For the three and six months


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ended June 29, 2013, R&D revenues were $0.5 million and $1.2 million, respectively. This contrasted with $0.9 million and $1.4 million, respectively, for the corresponding period in 2012.
On August 6, 2013, we issued a press release and filed a Form 8-K with a preliminary net income of $13.8 million and a preliminary cash used in operations of $6.7 million for the six months ended June 29, 2013. Subsequent to the press release, certain adjustments were made which resulted in a net income of $13.7 million and cash used in operations of $7.2 million for the six month period ended June 29, 2013.
Results of Operations
The three and six month periods ended June 29, 2013 and June 30, 2012 are referred to as 2013 and 2012, respectively. The year ended period December 29, 2012 is referred to as fiscal year 2012.
Revenues. For the three and six month periods ended June 29, 2013 and June 30, 2012, our revenues, which include product sales and amounts earned from research and development contracts, were as follows (in millions):

                                            Three Months Ended                     Six Months Ended
Display Revenues by Category (in
millions )                           June 29, 2013     June 30, 2012       June 29, 2013       June 30, 2012
Military Applications                $       3.1     $           3.1     $       5.7         $          10.7
Consumer Electronic Applications             2.5                 3.0             5.5                     5.8
Research & Development                       0.5                 0.9             1.2                     1.4
Total                                $       6.1     $           7.0     $      12.4         $          17.9

Sales of our products for military applications declined in 2012 because of reduced demand from the U.S. government. Our military products have higher profit margins than our other display products and have been a significant contributor to our overall profitability for the past several years. The U.S. government is projected to incur large budget deficits for the near future and is expected to reduce spending on military programs as part of the solution to decrease these deficits.
Sales of our products for Consumer Electronic Applications, which are primarily digital still cameras, were flat compared to the same periods in the prior year. Our ability to forecast our revenues in this category is very difficult as sales of our product ultimately depend on how successful our customers are in promoting their digital still camera models. There are many digital still camera models offered by a number of large consumer electronics companies and it is a very competitive product category. In addition, we typically rebid to win this business each year. The decrease in Research and Development revenues is the result of a decrease in funding from the U.S. government. We are unable to predict the amount of funding for research and development by the U.S. government as it addresses its budget deficit issues.
In 2011, we began offering a headworn, voice and gesture controlled, hands-free cloud computing concept design that has an optical pod with a microdisplay. Our plan is to license concept designs and sell the optical pod. The concept design encompasses a number of different technologies including but not limited to voice and gesture control, noise cancellation, and web browsing. Some of the technologies included in the concept design we license from other companies. Customers may license only a subset of these technologies depending on whether they wish to develop a military, industrial or consumer product. We have entered into an agreement to license technology concept design and know-how to a company that is developing an industrialized product which they announced in 2012 and anticipate offering in 2013. The license is exclusive for the industrial market; non-exclusive for certain other markets and prohibits the licensee from selling to other markets. Under the terms of the license we will sell an optical pod which includes our display, optics and a back light. License revenues and sales of components in 2013 and 2012 were de minimis and were primarily to demonstrate the product concept. We believe that in subsequent years our ability to develop and expand our technologies and to market and license our concept designs will be important for our revenue growth and ability to achieve profitability. Our concept designs have a significant software component and we have limited experience in developing software. The markets to which our concept designs are targeted 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 2013 to commercialize concept designs. We currently expect revenue of between $18 million and $22 million for fiscal year 2013, however our ability to forecast revenues derived from Golden-i technology which may significantly impact our results of operations is very limited. We currently expect to have a consolidated net loss in the range of $28 million to $33 million in 2013, excluding the gain on the sale of our III-V product line and investment in KTC.
We have provided estimated 2013 revenue and net loss ranges in order for the investor to understand the impact of both the sale of our III-V product line and expected changes in our remaining business in 2013 as compared to 2012. However, we


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believe we have an opportunity to position ourselves in the growing wearable cloud computing market and therefore our primary focus in 2013 is on developing technology and products and establishing relationships, and not necessarily by achieving revenue, net loss or any other particular financial metric. Accordingly, our 2013 net losses may exceed our current estimates. International sales represented 38% and 22% of product revenues for the six months ended June 29, 2013 and June 30, 2012, 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 Product Revenues.
                                             Three Months Ended                    Six Months Ended
                                      June 29, 2013      June 30, 2012      June 29, 2013     June 30, 2012
Cost of product revenues (in
millions):                           $        6.2       $          5.0     $       12.2      $        12.1
Cost of product revenues as a % of
net product revenues                        110.6 %               81.5 %          108.9 %             73.4 %

Cost of product revenues, which is comprised of materials, labor and manufacturing overhead related to the production of our products increased as a percentage of revenues in 2013 as compared to 2012 due to a decrease in the sale of our display products for military applications, normal price declines and lower unit sales of our display products. Military products historically have had higher gross margins than commercial products.
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 2013 our R&D expenditures will be related to our display products and Golden-i 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 fiscal years 2013 and 2012 R&D expense was as follows (in millions):

                                                  Three Months Ended                       Six Months Ended
                                           June 29, 2013         June 30, 2012     June 29, 2013     June 30, 2012
Funded                                 $       0.2             $           0.5     $       0.7     $           0.8
Internal                                       3.5                         2.4             7.2                 5.1
Total research and development expense $       3.7             $           2.9     $       7.9     $           5.9

R&D expense increased in 2013 as compared to the prior year primarily because of an increase in costs to develop our concept designs including investments in software development.
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                     Six Months Ended
                                      June 29, 2013      June 30, 2012      June 29, 2013     June 30, 2012
Selling, general and administration
expense (in millions):               $        4.9       $          4.1     $       10.6      $        8.3
Selling, general and administration
expense as a % of revenues                   79.8 %               58.7 %           85.5 %            46.6 %

S,G&A expenses increased in the first half of 2013 as compared to 2012 because of increases of approximately $0.5 million in compensation cost, $0.3 million in professional fees and approximately $0.6 million of patent amortization and other patent related expenses.


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On May 9, 2013 the Compensation Committee of the Company approved the issuances of 1,051,000 shares of non-vested restricted common stock to officers and other employees of the Company which vest at the rate of 20% per year over 5 years if the officer or employee remains with the Company. The Compensation Committee of the Company also approved the issuance of 600,000 shares of non-vested restricted common stock to the Chief Executive Officer (CEO) of the Company which vest if certain performance and market criteria are met and the CEO remains with the Company during the period in which the criteria are met. We filed Form 4s with the Securities & Exchange Commission explaining the terms of the above grants to officers. The Form 4s are available at our website www.kopin.com.

Other Income and Expense
                                               Three Months Ended                     Six Months Ended
                                        June 29, 2013     June 30, 2012      June 29, 2013       June 30, 2012
Other income and expense (in millions): $       0.9     $           0.4     $       (1.3 )     $           1.4

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 (losses) gains resulting from the impairment or sale of investments. For the three months ended June 29, 2013 we recorded $0.4 million of foreign currency gains as compared to $0.1 million of foreign currency gains for the three months ended June 30, 2012. For the six months ended June 29, 2013 we recorded $ 0.6 million of foreign currency gains as compared to $0.1 million of foreign currency losses for the six months ended June 30, 2012.
During the six months ended June 29, 2013, the Company recorded an impairment of $2.5 million related to the write-off a cost based investment.
Equity Losses in Unconsolidated Affiliates. For the three and six months ended June 29, 2013 the equity loss in unconsolidated affiliate consists of our approximate 12% share of the losses of KoBrite. For the three and six months ended June 30, 2012 the equity losses is a result of our approximate 12% share of the losses of KoBrite and our 25% share of the losses of Ikanos. Tax provision. For the three and six months ended June 29, 2013 we recorded a tax provision of $0.2 million and tax benefit of $12.8 million, respectively, compared to a tax benefit of $0.1 million and a tax provision of $0.0 million, respectively, for the three and six months ended June 30, 2012. 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.
For the three months ended June 29, 2013 our $0.2 million provision for income taxes is comprised of our state income tax liabilities on our domestic taxable earnings and estimated foreign taxes due on our international subsidiaries' taxable earnings.
Net income attributable to noncontrolling interest. We own approximately 93% of the equity of Kowon and approximately 51% of the equity of Ikanos and e-MDT. Net
(loss) income 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 for the three and six month periods ended June 29, 2013 and June 30, 2012, Ikanos for the three and six month periods ended June 29, 2013 and eMDT for the three month period ended June 29, 2013. Liquidity and Capital Resources
As of June 29, 2013, we had cash and equivalents and marketable securities of $130.4 million and working capital of $125.9 million compared to $92.5 million and $106.8 million, respectively, as of December 29, 2012. The change in cash and equivalents and marketable securities was primarily due to cash provided by investing activities of $19.0 million partially offset by net outflow of cash used in operating activities of $7.2 million, the repurchase of our common stock of $2.2 million and our purchase of shares of our Korean subsidiary, Kowon, of $3.7 million.

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