2023-07-26 21:40:01 ET
Summary
- We assumed that a revival of investor interest in Kopin needs a significant win in the consumer market that no longer seems necessary, although it's still quite possible.
- There are other reasons for the optimism, the new CEO has brought needed focus on value creation and a move up the value chain.
- Besides, the military and industrial markets have increasingly bigger opportunities for the company.
- We certainly haven't written off the possibilities for the company in the consumer market, given its micro LED and OLED solutions and pancake lenses, for instance.
Kopin ( KOPN ) delivers parts and assemblies to the AR/VR market, serving three segments, the military; industrial; and consumer. It also gains revenue through funded research income for third parties (mostly military).
They have been mostly focused on developing critical components for the military, with the expectation that these developed technologies would trickle down to the industrial and consumer market when these take off.
Without giving up on its product focus, the company has hired a new CEO in the form of Michael Murry, previously with Analog Devices. He will bring a renewed focus on operational efficiencies and cost and expects to be able to increase margins and cash flow.
Murry has embarked on a quality improvement program, which involved ( Q1CC ):
how often we deliver products to a customer on time in total with full quality and without the customer identifying any quality issues.
He's off to a strong start. They hired a few quality specialists (like this one ), have cut product costs and headcounts are down, and from roughly 60% of products arriving on time and without quality issues this has already increased to the high 80s and low 90s. Management expects to maintain this consistently in the 90s going forward.
The company is retooling the Massachusetts facility and this will give gross margins a boost when it's done. Management believes that there is another 5-10 points in possible gross margin improvement.
There is also a concentration of R&D efforts on less speculative projects and internally funded R&D costs (as opposed to third-party funded R&D) were down over 50% (from $2M in Q1/22 to $672K in Q1/23).
A large part of this is R&D employees going over to the new company, Lightening Silicon, started by Kopin's former CEO in which Kopin has a 20% stake and with which they cooperate for a consumer fab for 12-inch wafers for OLED consumer displays.
There is of course tailwind as the microdisplay market growth is expected to be 20%+ for the coming 5-7 years and there seems to be a bit of a cyclical upturn going on as the book-to-bill ratio in Q1 was above 1 and will likely stay that way in Q2.
Technology
For a quick recap, here are some of the company's most important products and technologies are:
- P80 Pancake plastic optics
- 2.6K x 2.6K OLED microdisplay
- Patented Silicon dual stack backplane
- Patent pending ColorMax
The company offers a host of display technologies and assemblies, Q1CC :
Our proprietary AMLCD technology, our broad portfolio of OLED displays, our FO cost displays and our soon to be released micro LED technology. What makes Kopin unique and valued by our customers is our ability to couple of the right display technology and advanced optics, drive electronics, and housings to solve our customer's needs in defense, commercial and consumer applications.
The company is going to release a Micro-LED device soon with the customer still testing it and the technicals to be announced soon but management is very excited here. Micro-LED is especially suitable for the consumer market (and also the medical market) as OLED has brightness issues. But it will be 2024 for this to get traction.
An important part of the strategy of the incoming CEO is to move up the value chain, solving more of the customers' problems.
Military
This is still their main market and it had a terrific quarter as the Ukraine war has given the military segment a renewed impulse (for a good discussion of that see the article by SA author Sean Daly). Some of the wins the past 12 months:
- The company gained a $3M initial production defense contract , as well as increasing segment revenue by 115% in Q3.
- There was an earlier $3.8M order in late July/22 for its new proprietary Brillian AMLCD (Active Matrix Liquid Crystal Display) used by helicopter pilots to display real-time flight and targeting information.
- A $4.8M additional order for the joint-strike fighter (May/22)
- A $2M development contract for in-vehicle displays (Jun/22). Then there was the huge $19.8M FWS-I order in December 2021.
Most recently (April 2023) the company received a $1.1M follow-on production order for an application-specific, long-range optical weapon sight module.
received a $4.4M PPAP ( Production Part Approval Process ) award for an armed vehicle program. This is potentially a $100M contract for the company and the PPAP certification also qualifies Kopin for additional automotive applications, both military and civilian.
Then there is the IVAS program, a $2.5B (and possibly $21B) DoD program to provide soldiers with an augmented reality headset (Q1CC):
If you look at the IVAS head mounted display, in essence and essentially, it's a head mounted display weapons site, where we have the significant expertise and pedigree to serve this market. The IVAS opportunity is significant in this program, so success here would be monumental for the company.
There are also emerging opportunities in the military training and simulation market which is showing increasing signs of activity and which the company can serve through its NVIS division (which it bought in 2017)
Enterprise
Clients here buy display products for their 3D AOI (automated optical inspection) metrology equipment (used for quality control), which was affected by the shortage of parts, and headsets.
We covered quite a bit of this market in a previous article but there are some new developments like an order from a new customer for its Lightning 720p OLED microdisplays for use in thermal imaging viewfinders and:
- RealWear's Navigator 500 headset (Jan/22)
- RealWear and OPTAC-X joint solution for telehealth (Dec/22)
5G can actually produce a considerable impulse to the enterprise market as it enables the offloading of much of the processing to the cloud, like translation, or computer vision (for recognizing situations and sending real-time instructions to maintenance people on the ground, for instance).
The company is also entering the lucrative medical market where they have been working with a company called HMDmd on a head-mounted display system for surgeons which enables them to zoom into a specific area while performing a surgery (Q1CC):
We've been working with them for well over a year on developing a surgical apparatus, a visualization, 3D visualization of a surgery. I just received the new mockup of the final product and it's brilliant, it's absolutely spectacular. So we're very excited about that market, the customer is seeing tremendous demand pull for that technology.
This is a 2024 issue though, but it's nice to know it's coming and speaking of moving up the value chain (Q1CC):
Kopin doesn't just provide the displays, we provide the entire assembly, including the molded assembly, the optics, the LCDs, and displays as well as the overall assembly. So, instead of selling one display, and a few hundreds of dollars, were selling the entire module to HMDMD for 1000s.
This is pretty interesting stuff, we have to say.
Consumer
While the company can supply all four display technologies (AMLCD, LCOS, AMOLED, uLED), it's the OLED panels that seem to be set for a dominant position in the consumer AR/VR market.
Their OLED panels in combination with the double-stack backplane, ColorMax and especially their pancake optics should give them a good competitive position in the consumer market.
They have lots of patents on the double-stack backplane technology (for a description of the tech see here and here ) which boost brightness, a weak point of OLED screens.
The P80 all-plastic pancake optics enable much thinner and lighter headsets (but at the cost of brightness and some FOV, field of view). They have some successes in this market already:
- Solos smart glasses
- Shiftall (Panasonic) VR glasses (Jan/21)
- Moziware smart headset (July/22)
- New OLED and backplane orders (April/22)
The Panasonic Shiftall VR glasses experienced significant delays for worrying reasons :
Panasonic aimed to start shipping the MeganeX in early 2022, but it was delayed and now it plans to ship it by March 2023 (which will mean that in total it took around 6 years of development). Panasonic further says that as Kopin's production (at Lakeside) suffers from very low yields, it had to increase the price of the display and so the cost of the VR headset increased from 100,000 Yen (around $750) to 250,000 Yen (almost $2,000).
And Kopin has taken some measures to boost its OLED capabilities and the above-mentioned cooperation deal with Lightening Silicon for 12-inch wafers is another possible solution.
There is also the Pico 4 , which has a compact and lightweight design (a little over half the weight of the Quest 2 from Meta), the result of pancake optics:
This has been made possible thanks to the internal pancake lens. Compared to more traditional alternatives, the pancake lens takes up less space, therefore allowing manufacturers to shrink the size of the headset.
This helps to drastically reduce the weight, with the Pico 4 hitting the scales at just 295 grams. That’s almost half the heft of the Meta Quest 2, which weighs 503 grams.
But we don't know if it's from Kopin, but it's likely, as they haven't exactly denied it :
We reached out to Kopin Corporation to see if Pancake lenses — a specific brand name registered by Kopin — would be included in a potential upcoming Pico 4 Pro. Kopin replied that they had no comment to share at this time.
And Pico and Kopin had previously worked together so we think it's likely that it's Kopin's pancake optics inside the Pico 4. ByteDance, the parent company of TikTok, has taken over Pico in the meantime, so there is serious money behind it.
Now, Kopin does not have a monopoly on pancake optics, for instance, both the Apple AR set and Meta's Quest Pro headsets have pancake optics , but it validates the technology. Huawei also has a headset (or actually, more VR glasses) with pancake optics .
The CEO argued that the consumer market is stalled not because of technology flaws, but because of a lack of a killer app. This pause provides the company with an opportunity, according to him.
We're not sure we agree, for instance, the Apple AR headset has garnered rave reviews , but at a prospective price of $3.5K surely the tech needs to evolve in order to bring the cost down and in the meantime, Meta is discontinuing its Quest Pro (even a price decline could not revive sales, apparently).
While the market has developed nicely from 3.8M headset sales in 2017 to 19.14M units sold in 2022, the pace of growth is projected to slow significantly, only reaching 26.68M units in 2027.
The Quest 2 is the market leader with almost half the market, we expect the upcoming Quest 3 to consolidate that position.
Finances
Revenue growth has been brisk but has declined the last two years. Here is a disaggregated look at revenues from the 10Q :
KOPN 10-Q
Defense is still the biggest segment and the consumer segment is still tiny. SG&A expenses are relatively well behaved although there hasn't been progress for two years:
R&D has strongly declined in the last two quarters:
Cash flow has deteriorated again with a $4.2M operational cash outflow in Q1. The goal is exiting 2023 cash flow positive, we're not entirely convinced as that seems a pretty tall order at the moment but if they can boost gross margin by the suggested 500-1000bp it should become a lot easier.
Valuation
Apparently, the company hasn't yet made much use of its $50M ATM facility signed with Stifel in March 2021 of which there was $41.4M left at the end of Q2. But they did enter into new $19.9M equity financing in January involving:
- 14M +3M shares at $1
- 6M pre-funded warrants at $0.99
The company now has $29.6M left in cash and equivalents.
There are 1.53M restricted stocks and 194K options outstanding so fully diluted that's 113.2M shares for a market cap (at $2 share price) of $226M and an EV of $196.6 which is 4.5x the expected $43.3M revenue in 2023.
Profits are not expected with an EPS loss estimated at $0.07 this year. There have been a few recent insider buys by the new and old CEO.
Conclusion
The company's main segment, defense, is likely to maintain good growth or even accelerate under the impulse of the invasion of Ukraine and rising geopolitical tensions.
We thought for a long while that for this stock to become interesting again they need a big consumer market win, but it increasingly looks like this isn't necessary (even if it's still entirely possible and would provide added rocket fuel). Here is what is driving the rally:
- The opportunities in the military and corporate markets are much bigger now than a few years back.
- The new CEO has made some necessary organizational changes that increase the focus on shareholder value.
- Perhaps most importantly, the company is moving up the value chain, and an immediate example of this is the greatly enhanced input in the upcoming medical device from MDMmd
So we see increased revenue and margins for the company and the consumer segment might get a new impulse with the launch of the Apple VR/AR headset and the upcoming Quest 3 from Meta.
However, while the company has valuable technology and capabilities that have the potential to deliver significant gains in years to come, we're not convinced to step into the shares at these levels.
The shares at $2 trade at 4.5x EV/S while it is still making considerable losses and losing cash. While we do believe the new CEO is a breath of fresh air bringing necessary focus to what was almost like a research outfit (producing 200+ patents), we need some additional confirmation of progress to buy at these levels.
For further details see:
Kopin: New CEO Is A Breath Of Fresh Air