LIGHTPATH TECHNOLOGIES INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations is designed to provide a reader of the financial statements with a narrative report on our financial condition, results of operations, and liquidity. This discussion and analysis should be read in conjunction with the attached unaudited Condensed Consolidated Financial Statements and notes thereto and our Annual Report on Form 10-K for the year ended June 30, 2022, including the audited Consolidated Financial Statements and notes thereto. The following discussion contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations, and intentions. Our actual results could differ materially from those discussed in the forward-looking statements. Please also see the cautionary language at the beginning of this Quarterly Report regarding forward-looking statements. Potential Impact of COVID-19 In March 2020, the WHO declared the outbreak of COVID-19 as a pandemic based on the rapid increase in global exposure. COVID-19 has spread throughout world, including the U.S., and continues to spread as additional variants emerge. As a result of the COVID-19 pandemic, our employees at our facilities in China, Latvia, and the U.S. were subject to stay-at-home orders during a portion of fiscal year 2021, which restrictions have since been lifted. In addition to stay-at-home orders, many jurisdictions also implemented social distancing and other restrictions and measures to slow the spread of COVID-19. These restrictions significantly impacted economic conditions in the U.S. in 2020 that continued into 2021 and 2022. Beginning in the spring of 2021, restrictions began to lift as vaccines became more available. Despite these stay-at-home orders and other measures and restrictions implemented in the areas in which we operate, as a critical supplier to both the medical and defense industries, we were deemed to be an essential business; thus, regardless of the stay-at-home orders, our workforce was permitted to work from our facilities and our business operations have generally continued to operate as normal. Nonetheless, despite the lifting of these stay-at-home orders, out of concern for our workforce, our U.S.- and Latvia-based non-manufacturing employees have continued to work remotely to some extent. To date, we have not seen any significant direct financial impact of COVID-19 to our business. However, the COVID-19 pandemic continues to impact economic conditions, particularly in China, which has impacted the short-term and long-term demand from our customers and, therefore, has negatively impacted our results of operations, cash flows, and financial position in that region. Additionally, some areas still have travel restrictions in place, which has impacted some aspects of our operations that depend on travel, such as recruitment of senior positions, and travel of service providers to maintain our production equipment. Management is actively monitoring this situation and taking steps to mitigate the impact on our financial condition, liquidity, and results of operations globally. However, we are not presently able to estimate the effects of the continuing COVID-19 pandemic on our future results of operations, financials, or liquidity in fiscal year 2023 or beyond. Introduction We were incorporated in Delaware in 1992 as the successor to LightPath Technologies Limited Partnership, a New Mexico limited partnership, formed in 1989, and its predecessor, Integrated Solar Technologies Corporation, a New Mexico corporation, formed in 1985. Today, LightPath is a global company with major facilities in the United States, the People’s Republic of China, and the Republic of Latvia. Our capabilities include precision molded optics, thermal imaging optics, custom designed optics, and the design and manufacturing of optical assemblies and subsystems. These capabilities allow us to manufacture optical components and higher-level assemblies, including precision molded glass aspheric optics, molded and diamond-turned infrared aspheric lenses and other optical materials used to produce products that manipulate light. We design, develop, manufacture and integrate optical components and assemblies utilizing advanced optical manufacturing processes. Product verticals range from consumer (e.g., cameras, cell phones, gaming, and copiers) to industrial (e.g., lasers, data storage, and infrared imaging), from products where the lenses are the central feature (e.g., telescopes, microscopes, and lens systems) to products incorporating lens components (e.g., 3D printing, machine vision, LIDAR, robotics and semiconductor production equipment) and communications. As a result, we market our products across a wide variety of customer groups, including laser systems manufacturers, laser OEMs, infrared-imaging systems vendors, industrial laser tool manufacturers, telecommunications equipment manufacturers, medical instrumentation manufacturers and industrial measurement equipment manufacturers, government defense agencies, and research institutions worldwide. 22 Table of Contents Subsidiaries In November 2005, we formed LPOI, a wholly-owned subsidiary, located in Jiading, People’s Republic of China. LPOI provides sales and support functions. In December 2013, we formed LPOIZ, a wholly-owned subsidiary located in the New City district, of the Jiangsu province, of the People’s Republic of China. LPOIZ’s 55,000 square foot manufacturing facility (the “Zhenjiang Facility”) serves as our primary manufacturing facility in China and provides a lower cost structure for production of larger volumes of optical components and assemblies. In December 2016, we acquired ISP, and its wholly-owned subsidiary, ISP Latvia. ISP is a vertically integrated manufacturer offering a full range of infrared products from custom infrared optical elements to catalog and high-performance lens assemblies. Since June 2019, ISP’s manufacturing operation has been located at our Orlando Facility. ISP Latvia is a manufacturer of high precision optics and offers a full range of infrared products, including catalog and custom infrared optics. ISP Latvia’s facility in Riga, Latvia (the “Riga Facility”) functions as its manufacturing facility. For additional information, please refer to our Annual Report on Form 10-K for the year ended June 30, 2022. Product Groups Our business is organized in three product groups: PMO, infrared products and specialty products. These product groups are supported by our major product capabilities: molded optics, thermal imaging optics, and custom designed optics, with a product manager for each. Product management is principally a portfolio management process that analyzes products within the product capability areas as defined above. This function facilitates choosing investment priorities to help strategically align our competencies with strategic industry revenue opportunities. Over the longer term, this function will also help ensure successful product life cycle management. Our PMO product group consists of visible precision molded optics with varying applications. Our infrared product group is comprised of infrared optics, both molded and diamond-turned, and thermal imaging assemblies. This product group also includes both conventional and CNC ground and polished lenses. Between these two product groups, we have the capability to manufacture lenses from very small (with diameters of sub-millimeter) to over 300 millimeters, and with focal lengths from approximately 0.4 millimeters to over 2000 millimeters. In addition, both product groups offer both catalog and custom designed optics. Our specialty product group is comprised of value-added products, such as optical subsystems, assemblies, and collimators, and non-recurring engineering (“NRE”) products, consisting of those products we develop pursuant to product development agreements that we enter into with customers. Typically, customers approach us and request that we develop new products or applications for our existing products to fit their particular needs or specifications. The timing and extent of any such product development is outside of our control. We design, build, and sell optical assemblies in markets for test and measurement, medical devices, military, industrial, and communications based on our proprietary technologies. Many of our optical assemblies consist of several products that we manufacture. In connection with our new strategic direction and the expanding portfolio of products and services, we are evaluating the ways in which we may optimize the financial reporting of our product groups. Growth Strategy The industry is transforming from a fragmented industry with many component manufacturers into a solution-focused industry with the potential for partnerships for solution development and production. Based on the shifts in the marketplace and the changes that come when a technology, like photonics, moves from being a specialty product to being integrated into mainstream industries and applications, we redefined our strategic direction to leverage our strengths, and specifically our subject matter expertise in optics, to provide our wide customer base with complete optical and electro-optical solutions, and to become their partner for the optical engine of their systems. Since 2020, we have focused on developing a strategy and executing a plan that capitalizes on the changing market conditions, creates a unique and long-lasting value to our customers, and utilizes our unique capabilities and differentiators. We intend to use our differentiators to move up the value chain, thereby offering a more comprehensive value proposition to our customers. 23 Table of Contents We believe such partnerships can start with us as the supplier. We have in-house domain expertise in photonics, knowledge and experience in advanced optical technologies, and the necessary manufacturing techniques and capabilities. We believe we can develop these partnerships by working closely with the customer throughout their design process, designing an optical solution that is tailored to their needs, often times using unique technologies that we own, and supplying the customer with a complete optical subsystem to be integrated into their product. Such an approach builds on our unique, value-added technologies that we currently own, such as optical molding, fabrication, system design, and proprietary manufacturing technologies, along with other technologies that we may acquire or develop in the future, to create tailored solutions for our customers. A current example of a unique, value-added solution is our new multispectral camera, Mantis, that we recently developed as a showcase of our capabilities and to demonstrate what is possible with today’s technology. Our subject-matter experience and expertise and the extensive “know how” in optical design, fabrication, production and testing technologies will allow our customers to focus on their own development efforts, freeing them from the need to develop subject matter expertise in optics. By providing the bridge into the optical solution world, we are able to partner with our customers on a long-term basis, create value for our customers, and capture that value through the long-term supply relationships we seek to develop. Further information about our strategic direction can be found in our recent Annual Report on Form 10-K for the fiscal year ended June 30, 2022. Results of Operations Revenue Three months ended December 31, 2022, compared to three months ended December 31, 2021 Revenue for the second quarter of fiscal 2023 was approximately $8.5 million, a decrease of approximately $0.8 million, or 8%, as compared to approximately $9.2 million in the same period of the prior fiscal year, primarily due to a decrease in sales of infrared products. Revenue generated by infrared products was approximately $4.0 million in the second quarter of fiscal 2023, a decrease of approximately $1.1 million, or 21%, as compared to approximately $5.1 million in the same period of the prior fiscal year. The decrease in revenue is primarily due to timing sales of infrared products against a large annual contract, the shipments for which were completed in the second quarter of fiscal 2023, while shipments against the renewed contract signed in November 2022 will not begin until the third quarter of fiscal 2023. The renewed contract represents a 20% increase over the previous contract. Revenue generated by PMO products was approximately $3.9 million for the second quarter of fiscal 2023, an increase of approximately $114,000, or 3%, as compared to approximately $3.8 million in the same period of the prior fiscal year. The increase in revenue is due to increases in sales to defense, industrial and medical customers, offset by a decrease in sales to customers in the telecommunications industry. PMO product sales to customers in China continue to be soft across all of the industries we serve due to unfavorable economic conditions in that region. Revenue generated by our specialty products was approximately $571,000 in the second quarter of fiscal 2023, an increase of approximately $166,000, or 41%, compared to $406,000 in the same period of the prior fiscal year. The increase is primarily due to increased demand for collimator assemblies. Six months ended December 31, 2022, compared to six months ended December 31, 2021 Revenue for the first half of fiscal 2023 was approximately $15.8 million, a decrease of approximately $2.5 million, or 14%, as compared to approximately $18.3 million in the same period of the prior fiscal year. Revenue generated by infrared products was approximately $7.7 million in the first half of fiscal 2023, a decrease of approximately $2.3 million, or 23%, as compared to approximately $9.9 million in the same period of the prior fiscal year. The decrease in revenue is primarily driven by sales of diamond-turned infrared products, primarily attributable to customers in the defense and industrial markets, including the timing of sales of infrared products against a large annual contract, the shipments for which were completed in the second quarter of fiscal 2023, while shipments against the renewed contract signed in November 2022 will not begin until the third quarter of fiscal 2023. The renewed contract represents a 20% increase over the previous contract. Sales of molded infrared products made from our proprietary BD6 material also decreased, particularly to customers in the China industrial market. 24 Table of Contents Revenue generated by PMO products was approximately $7.1 million for the first half of fiscal 2023, a decrease of approximately $426,000, or 6%, as compared to approximately $7.6 million in the same period of the prior fiscal year. The decrease in revenue is primarily attributed to decreases in sales to customers in the telecommunications and commercial industries. PMO product sales to customers in China continue to be soft across all of the industries we serve due to unfavorable economic conditions in that region. Revenue generated by our specialty products was approximately $1.0 million in the first half of fiscal 2023, an increase of approximately $218,000, or 27%, compared to $808,000 in the same period of the prior fiscal year. The increase is primarily due to increase demand for collimator assemblies, as well as a charge for in-process materials billed to a customer upon order cancellation, during the first quarter of fiscal 2023. Cost of Sales and Gross Margin Three months ended December 31, 2022, compared to three months ended December 31, 2021 Gross margin in the second quarter of fiscal 2023 was approximately $3.2 million, an increase of 15%, as compared to approximately $2.8 million in the same period of the prior fiscal year. Total cost of sales was approximately $5.2 million for the second quarter of fiscal 2023, compared to approximately $6.4 million for the same period of the prior fiscal year. Gross margin as a percentage of revenue was 38% for the second quarter of fiscal 2023, compared to 30% for the same period of the prior fiscal year. The increase in gross margin as a percentage of revenue is partially due to the mix of products sold in each respective period. PMO products, which typically have higher margins than our infrared products, comprised 46% of revenue for the second quarter of fiscal 2023, as compared to 41% of revenue for the second quarter of fiscal 2022. In addition, within our infrared product group, sales for the second quarter of fiscal 2023 were more heavily weighted toward molded infrared products than in the same quarter of the prior fiscal year. Molded infrared products typically have higher margins than non-molded infrared products. During the second quarter of fiscal 2022, infrared product margins were also negatively impacted by increased costs associated with the completion of the coating department in our Riga Facility, which have since improved as that facility is now producing at volume. Six months ended December 31, 2022, compared to six months ended December 31, 2021 Gross margin in the first half of fiscal 2023 was approximately $5.4 million, a decrease of 9%, as compared to approximately $6.0 million in the same period of the prior fiscal year. Total cost of sales was approximately $10.4 million for the first half of fiscal 2023, compared to approximately $12.4 million for the same period of the prior fiscal year. Gross margin as a percentage of revenue was 34% for the first half of fiscal 2023, compared to 33% for the same period of the prior fiscal year. The lower revenue level for the first half of fiscal 2023, as compared to the same period of the prior fiscal year, resulted in less contribution toward fixed manufacturing costs, however the mix of products shipped in the first half of fiscal 2023 was more favorable and also reflects the benefit of a number of the operational and cost structure improvements that we have been implementing. Selling, General and Administrative Three months ended December 31, 2022, compared to three months ended December 31, 2021 SG&A costs were approximately $3.0 million for the second quarter of fiscal 2023, an increase of approximately $84,000, or 3%, as compared to approximately $2.9 million in the same period of the prior fiscal year. The increase in SG&A costs is primarily due to an increase in stock compensation, partially due to director retirements that occurred during the quarter, as well as increases in other personnel-related costs. SG&A costs for the second quarter of fiscal 2023 also include approximately $45,000 in fees paid to BankUnited under our Amended Loan Agreement for not prepaying the BankUnited Term Loan by December 31,2022. Please refer to Note 11, Loans Payable , in the unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for additional information. These increases are partially offset by a decrease of $248,000 in VAT and related taxes from prior years that were accrued by one of our Chinse subsidiaries in the second quarter of fiscal 2022, as well as a decrease of approximately $150,000 of expenses associated with the previously disclosed events that occurred at our Chinese subsidiaries, including legal and consulting fees. Please refer to Note 13, Contingencies , in the unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for additional information. 25 Table of Contents Six months ended December 31, 2022, compared to six months ended December 31, 2021 SG&A costs were approximately $5.7 million for the first half of fiscal 2023, a decrease of approximately $147,000, or 3%, as compared to approximately $5.8 million in the same period of the prior fiscal year. The decrease in SG&A costs reflects a decrease of $248,000 in VAT and related taxes from prior years that were accrued by one of our Chinse subsidiaries in the second quarter of fiscal 2022, as well as a decrease of approximately $480,000 of expenses associated with the previously disclosed events that occurred at our Chinese subsidiaries, including legal and consulting fees. Please refer to Note 13, Contingencies , in the unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for additional information. These decreases were partially offset by an increase in stock compensation, partially due to director retirements that occurred during the quarter, as well as increases in other personnel-related costs. SG&A costs for the second quarter of fiscal 2023 also include the aforementioned fees of approximately $45,000 paid to BankUnited. Please refer to Note 11, Loans Payable, in the unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for additional information. New Product Development New product development costs were approximately $466,000 in the second quarter of fiscal 2023, a decrease of approximately $86,000, or 16%, as compared to the same period of the prior fiscal year. For the first half of fiscal 2023, new product development costs were approximately $1.0 million, an increase of $37,000, or 4%, as compared to the same period of the prior fiscal year. The differences are primarily due to varying allocations of personnel resources among our new product development and manufacturing engineering functions, the latter of which is included in cost of goods sold. In addition, the second quarter of fiscal 2023 reflects some cost savings from seasoned engineer retirements. Other Income (Expense) Interest expense, net, was approximately $81,000 for the second quarter of fiscal 2023, as compared to $50,000 for the same period of the prior fiscal year. For the first half of fiscal 2023, interest expense, net was approximately $152,000, as compared to $96,000 for the same period of the prior fiscal year. The increase in interest expense is due to higher interest rates and increased amortization of loan fees. Total debt has decreased 21% as of the quarter ended December 31, 2022, as compared to the quarter ended December 31, 2021. Other expense, net, was approximately $1,300 for the second quarter of fiscal 2023, as compared to other income, net, of $11,000 for the same period of the prior fiscal year. For the first half of fiscal 2023, other income, net was approximately $26,000, as compared to other expense, net, of $40,000 for the same period of the prior fiscal year. Other income and expenses are primarily comprised of net gains losses on foreign exchange transactions. We execute all foreign sales from our U.S. facilities and inter-company transactions in U.S. dollars, partially mitigating the impact of foreign currency fluctuations. Assets and liabilities denominated in non-United States currencies, primarily the Chinese Yuan and Euro, are translated at rates of exchange prevailing on the balance sheet date, and revenues and expenses are translated at average rates of exchange for the year. We incurred foreign currency transaction losses of $29,000 and $14,000 during the second quarter of fiscal year 2022 and 2021, respectively. For the first half of fiscal year 2023 and 2022, we recognized net foreign currency transaction losses of $7,000 and $40,000, respectively. Income Taxes During the second quarter of fiscal 2023, income tax expense was $55,000, compared to approximately $35,000 for the same period of the prior fiscal year. During the first half of fiscal 2023, income tax expense was approximately $157,000, compared to approximately $165,000 for the same period of the prior fiscal year. Income tax expense is primarily related to income taxes from our operations in China, including estimated Chinese withholding taxes associated with intercompany dividends declared by LPOIZ and payable to us as its parent company. The decrease is due to lower taxable income in that jurisdiction. Net Loss Net loss for the second quarter of fiscal 2023 was approximately $694,000, or $0.03 basic and diluted loss per share, compared to $1.1 million, or $0.04 basic and diluted loss per share, for the same quarter of the prior fiscal year. The decrease in net loss for the second quarter of fiscal 2023, as compared to the same period of the prior fiscal year, was primarily attributable to higher gross margin, despite the decrease in revenue. 26 Table of Contents Net loss for the first half of fiscal 2023 was approximately $2.1 million, or $0.08 basic and diluted loss per share, compared to $1.7 million, or $0.06 basic and diluted loss per share, for the same quarter of the prior fiscal year. The increase in net loss for the first half of fiscal 2023, as compared to the same period of the prior fiscal year, was primarily attributable to lower revenue and gross margin, partially offset by lower operating expenses. Weighted-average common shares outstanding were 27,172,226, basic and diluted, in the second quarter of fiscal 2023, compared to 27,008,748, basic and diluted, in the second quarter of fiscal 2022. For the first half of fiscal 2023, weighted-average common shares outstanding were 27,121,583, basic and diluted, as compared to 27,001,360, basic and diluted, in the first half of fiscal 2022. The increase in the weighted-average basic common shares was due to the issuance of shares of Class A common stock under the 2014 ESPP and underlying vested RSUs and RSAs. Potential Impact of Economic Conditions in China Due to our operations in China, our business, results of operations, financial condition and prospects may be influenced to a significant degree by economic, political, legal and social conditions in China. China’s economy differs from the economies of other countries in many respects, including with respect to the level of development, growth rate, amount of government involvement, control of foreign exchange and allocation of resources. While China’s economy has experienced significant growth over the past several decades, its growth rate has declined in recent years and may continue to decline. According to the National Bureau of Statistics of China, the annual economic growth rate in China was 6.9% in 2017, 6.8% in 2018, 6.1% in 2019, 2.3% in 2020, and 8.1% in 2021. The annual economic growth rate in 2022 is estimated to be 4.8%, although some analysts have indicated that China’s economic growth could be lower. Deteriorating economic conditions in China generally and as a result of China’s zero-COVID strategy, have led to lower demand for the Company’s products in China and thus lower revenues and net income for our subsidiaries in China and the Company overall. A continuation of China’s current economic conditions or a further slowdown in the economic growth, an economic downturn, a recession, or other adverse economic conditions in China is likely to have a material adverse effect on our business and results of operations in future quarters. Liquidity and Capital Resources As of December 31, 2022, we had working capital of approximately $9.6 million and total cash and cash equivalents of approximately $3.8 million, of which, greater than 50% of our cash and cash equivalents was held by our foreign subsidiaries. Cash and cash equivalents held by our foreign subsidiaries in China and Latvia were generated in-country as a result of foreign earnings. Historically, we considered unremitted earnings held by our foreign subsidiaries to be permanently reinvested. However, during fiscal 2020, we began declaring intercompany dividends to remit a portion of the earnings of our foreign subsidiaries to us, as the U.S. parent company. It is still our intent to reinvest a significant portion of earnings generated by our foreign subsidiaries, however, we also plan to repatriate a portion of their earnings. During fiscal 2020, we began to accrue for these taxes on the portion of earnings that we intend to repatriate. In China, before any funds can be repatriated, the retained earnings of the legal entity must equal at least 50% of the registered capital. As of December 31, 2022, LPOIZ had approximately $3.9 million available for repatriation and LPOI did not have any earnings available for repatriation, based on earnings accumulated through December 31, 2022, the end of the most recent statutory tax year, that remained undistributed as of December 31, 2022. Loans payable consists of the BankUnited Term Loan, pursuant to the Amended Loan Agreement, and the subordinated Equipment Loan. As of December 31, 2022, the outstanding balance on the BankUnited Term Loan was approximately $3.6 million. The outstanding balance on the Equipment Loan was approximately $305,000 as of December 31, 2022. The Amended Loan Agreement and the Letter Agreement includes certain customary covenants. As of December 31, 2022, we obtained a waiver of compliance for both the fixed charge coverage ratio and total leverage ratio, and we were in compliance with all other covenants, as amended. For additional information, see Note 11, Loans Payable , to the unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q. 27 Table of Contents On February 16, 2022, we filed a shelf registration statement to facilitate the issuance of our Class A common stock, warrants exercisable for shares of our Class A common stock, and/or units up to an aggregate offering price of $75.8 million from time to time. In connection with the filing of the shelf registration statement, we also included a prospectus supplement relating to an at-the-market equity program under which we may issue and sell shares of our Class A common stock up to an aggregate offering price of $25.2 million from time to time, decreasing the aggregate offering price available under the shelf registration statement to $50.6 million. The shelf registration statement was declared effective by the SEC on March 1, 2022. As of December 31, 2022, we had not issued any shares of our Class A common stock pursuant to the at-the-market equity program. On January 12, 2023, the Company entered into a securities purchase agreement (“Purchase Agreement”), pursuant to which the Company agreed to issue and sell in a public offering under the shelf registration statement an aggregate of 9,090,910 shares of the Company’s Class A common stock, par value $0.01 per share for a purchase price of $1.10 per share and filed a prospectus supplement with the SEC related thereto. The sale of shares pursuant to the Purchase Agreement closed on January 17, 2023, and resulted in net proceeds of approximately $9.2 million after payment of placement agent fees, and certain other costs and expenses of the offering. Based on the capital raise that was completed in January 2023, we do not expect to need additional equity capital for the foreseeable future, however there are a number of factors that could result in the need to raise additional funds, including a decline in revenue or a lack of anticipated sales growth, increased material costs, increased labor costs, planned production efficiency improvements not being realized, increases in property, casualty, benefit and liability insurance premiums, and increases in other costs. In addition, we may identify opportunities for acquisitions and other strategic transactions to expand and further enhance our business that may require that we raise additional capital should we elect to pursue any of such transactions. Cash Flows – Operating: Cash used in operations was approximately $752,000 for the first half of fiscal 2023, compared to approximately $157,000 for the same period of the prior fiscal year.Cash used in operations for the first half of fiscal 2023 was largely driven by a decrease in accounts payable and accrued liabilities, including the payment of severance related to the previously disclosed employee terminations that occurred at our Chinese subsidiaries, which liability has been accrued since June 30, 2021. The first half of fiscal 2023 also reflects the final payment of payroll taxes deferred in fiscal 2020 under the CARES act. Cash used in operations in the first half of fiscal 2022 also reflects a decrease in accounts payable and accrued liabilities during such period resulting from the payment of certain other expenses related to previously disclosed events that occurred at our Chinese subsidiaries which were accrued as of June 30, 2021, partially offset by a decrease in inventory. Cash Flows – Investing: During the first half of fiscal 2023, we expended approximately $412,000 in investments in capital equipment, compared to approximately $1.3 million in the same period of the prior fiscal year. The first half of fiscal 2023 primarily includes maintenance capital expenditures, whereas the majority of our capital expenditures during the first half of fiscal 2022 were related to the continued expansion of our infrared coating capacity as well as increasing our lens diamond turning capacity to meet current and forecasted demand.As disclosed in Note 10, Leases , in the unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q, we are constructing additional tenant improvements in our Orlando Facility subject to our continuing lease, of which the landlord has agreed to provide $2.4 million in tenant improvement allowances. We will fund the balance of the tenant improvement costs, estimated to be approximately $2.5 million, the majority of which will be expended during the second half of fiscal 2023. Cash Flows – Financings: Net cash used in financing activities was approximately $443,000 for the first half of fiscal 2023, compared to approximately $243,000 in the same period of the prior fiscal year. Cash used in financing activities for the first half of fiscal 2023 reflects approximately $463,000 in principal payments on our loans and finance leases offset by approximately $20,000 in proceeds from the sale of Class A common stock under the 2014 ESPP. Cash used in financing activities for the first half of fiscal 2022 reflects approximately $470,000 in principal payments on our loans and finance leases, loan costs of approximately $61,000 associated with the restructure of the BankUnited Term Loan, offset by proceeds of approximately $267,000 from the Equipment Loan, and approximately $22,000 in proceeds from the sale of Class A common stock under the 2014 ESPP. 28 Table of Contents Contractual Obligations and Commitments As of December 31, 2022, our principal commitments consisted of obligations under operating and finance leases, and debt agreements. No material changes occurred during the first six months of fiscal 2023 in our contractual cash obligations to repay debt or to make payments under operating and finance leases, or in our contingent liabilities as disclosed in our Annual Report on Form 10-K for the year ended June 30, 2022. Off Balance Sheet Arrangements We do not engage in any activities involving variable interest entities or off-balance sheet arrangements. Critical Accounting Policies and Estimates There have been no material changes to our critical accounting policies and estimates during the six months ended December 31, 2022 from those disclosed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended June 30, 2022. How We Operate We have continuing sales of two basic types: sales via ad-hoc purchase orders of mostly standard product configurations (our “turns” business) and the more challenging and potentially more rewarding business of customer product development. In this latter type of business, we work with customers to help them determine optical specifications and even create certain optical designs for them, including complex, multi-component, integrated designs that we call “engineered solutions.” These engineered solutions are often based on existing reference designs we have demonstrated, that then get further customized to the customer's specific needs. This is followed by “sampling” small numbers of the product for the customers’ test and evaluation. Thereafter, should a customer conclude that our specification or design is the best solution to their product need; we negotiate and “win” a contract (sometimes called a “design win”) – whether of a “blanket purchase order” type or a supply agreement. The strategy is to create an annuity revenue stream that leverages our engineering capabilities and makes the best use of our production capacity, as compared to the turns business, which is unpredictable and uneven. A key business objective is to convert as much of our business to the design win and annuity model as is possible. We face several challenges in doing so: · Maintaining an optical design and new product design and sampling capability, including a high-quality and responsive optical design engineering staff, and proactive design of reference design or technology demonstrators; · The fact that as our customers take products of this nature into higher volume, commercial production (for example, in the case of molded optics, this may be volumes over one million pieces per year) they begin to focus on reducing costs – which often leads them to turn to larger or overseas producers, even if sacrificing quality; and · Our small business mass means that we can only offer a moderate amount of total productive capacity before we reach financial constraints imposed by the need to make additional capital expenditures – in other words, because of our limited cash resources and cash flow, we may not be able to service every opportunity that presents itself in our markets without arranging for such additional capital expenditures. Despite these challenges to winning more “annuity” and “engineered solutions” business, we nevertheless believe we can be successful in procuring this business because of our unique capabilities in optical design engineering and manufacturing. Additionally, we believe that we offer value to some customers as a source of supply in the U.S. should they be unwilling to commit to purchase their supply of a critical component from foreign production sources. For information regarding revenue recognition related to our various revenue streams, refer to Critical Accounting Policies and Estimates in our Annual Report on Form 10-K dated June 30, 2022. Our Key Performance Indicators: Typically, on a weekly basis, management reviews a number of performance indicators, both qualitative and quantitative. These indicators change from time to time as the opportunities and challenges in the business change. These indicators are used to determine tactical operating actions and changes. We believe that our non-financial production indicators, such as those noted, are proprietary information. 29 Table of Contents Financial indicators that are considered key and reviewed regularly are as follows: · Sales backlog; · Revenue dollars and units by product group; and · Other key indicators. These indicators are also used to determine tactical operating actions and changes and are discussed in more detail below. Management is evaluating these key indicators as we transition to our new strategic plan, and is implementing certain changes and updates as further described below. Sales Backlog We believe our sales growth has been and continues to be our best indicator of success. Our best view into the efficacy of our sales efforts is in our “order book.” Our order book equates to sales “backlog.” It has a quantitative and a qualitative aspect: quantitatively, our backlog’s prospective dollar value and qualitatively, what percent of the backlog is scheduled by the customer for date-certain delivery. We evaluate our total backlog, which includes all firm orders requested by a customer that are reasonably believed to remain in the backlog and be converted into revenues. This includes customer purchase orders and may include amounts under supply contracts if they meet the aforementioned criteria. Generally, a higher total backlog is better for us. Our total backlog at December 31, 2022 was approximately $29.4 million, an increase of 34%, as compared to $21.9 million as of December 31, 2021. Compared to the end of fiscal 2022, our total backlog increased by 66% during the first half of fiscal 2023. Backlog change rates for the last five fiscal quarters are: Quarter Total Backlog ($ 000) Change From Prior Year End Change From Prior Quarter End Q2 2022 $ 21,929 3 % 14 % Q3 2022 $ 19,678 -8 % -10 % Q4 2022 $ 17,767 -17 % -10 % Q1 2023 $ 22,973 29 % 29 % Q2 2023 $ 29,427 66 % 28 % The increase in backlog during the first half of fiscal 2023 was due to several large customer orders. One such order is a $4 million supply agreement with a long time European customer of precision motion control systems and OEM assemblies. The new supply agreement will go into effect in the fourth quarter of our fiscal year 2023 and is expected to run for around 12-18 months. During the second quarter of fiscal 2023 we also received the renewal of a large annual contract for infrared products, for an amount 20% greater than the previous renewal. We anticipate beginning to ship against the new contract in the third quarter of fiscal 2023, after shipments against the previous contract are completed. During the third quarter we were qualified to provide advanced infrared optics for a critical international military program, and received an initial order valued at $2.5 million from the related customer. This order represents a significant increase in this customer’s business with us. In addition, we received orders we received orders from existing customers in the U.S. and Europe related to several other significant long-term projects. The timing of multi-year contract renewals are not always consistent and, thus, backlog levels may increase substantially when annual and multi-year orders are received, and decrease as shipments are made against these orders.We believe we are in a good position with our existing annual and multi-year contracts to be renewed in future quarters. Markets continue to experience growing demand for infrared products used in the industrial, defense and first responder sectors. Demand for infrared products continues to be fueled by interest in lenses made with our proprietary BD6 and our new BDNL4 materials. With the global supply of germanium currently concentrated in Russia and China, recent global events are generating renewed interest in germanium alternatives such as our proprietary BD6 material, and other materials we are currently developing under an exclusive license with the Naval Research Lab. We expect to maintain moderate growth in our visible PMO product group by continuing to diversify and offer new applications, with a cost competitive structure. However, order bookings for both PMO and Infrared products continue to be slow in China. We believe the terminations of certain of our management employees in our China subsidiaries, LPOIZ and LPOI, and transition to new management personnel in fiscal year 2021, adversely impacted the domestic sales in China of these subsidiaries during fiscal year 2022 and fiscal year 2023. Although our new sales and management personnel have now established relationships with customers, domestic sales in China have also been adversely impacted by the economic downturn in China, which we expect to continue to negatively impact fiscal 2023 revenue in that region. 30 Table of Contents Revenue Dollars and Units by Product Group The following table sets forth revenue dollars and units for our three product groups for the three and six-month periods ended December 31, 2022 and 2021: (unaudited) Three Months Ended December 31, Quarter Six Months Ended December 31, Year-to-date 2022 2021 % Change 2022 2021 % Change Revenue PMO $ 3,876,627 $ 3,762,497 3 % $ 7,149,182 $ 7,575,447 -6 % Infrared Products 4,024,591 5,075,168 -21 % 7,664,250 9,963,086 -23 % Specialty Products 571,461 405,509 41 % 1,026,148 807,984 27 % Total revenue $ 8,472,679 $ 9,243,174 -8 % $ 15,839,580 $ 18,346,517 -14 % Units PMO 404,301 520,001 -22 % 851,787 1,014,308 -16 % Infrared Products 50,734 103,850 -51 % 96,109 248,297 -61 % Specialty Products 6,114 4,532 35 % 36,080 9,794 268 % Total units 461,149 628,383 -27 % 983,976 1,272,399 -23 % Three months ended December 31, 2022 Our revenue decreased by 8% in the second quarter of fiscal 2023, as compared to the same quarter of the prior fiscal year, primarily driven by a decrease in sales of infrared products. Revenue from the PMO product group for the second quarter of fiscal 2023 was $3.9 million, an increase of 3%, as compared to the same quarter of the prior fiscal year. The increase in revenue is due to increases in sales to defense, industrial and medical customers, offset by a decrease in sales to customers in the telecommunications industry. PMO product sales to customers in China continue to be soft across all of the industries we serve due to unfavorable economic conditions in that region. Revenue generated by the infrared product group for the second quarter of fiscal 2023 was $4.0 million, a decrease of 21%, as compared to same quarter of the prior fiscal year. The decrease in revenue is primarily due to timing sales of infrared products against a large annual contract, for which shipments against the prior contract were completed in the second quarter of fiscal 2023, while shipments against the renewed contract signed in November 2022 will not begin until the third quarter of fiscal 2023. The renewed contract represents a 20% increase over the previous contract. Our specialty products revenue increased by 41%, as compared to the same period of the prior fiscal year. The increase is primarily due to increased demand for collimator assemblies. Six months ended December 31, 2022 Our revenue decreased by 14% in the first half of fiscal 2023, as compared to the same period of the prior fiscal year, driven by decreases in both PMO and Infrared products. Revenue from the PMO product group for the first half of fiscal 2023 was $7.1 million, a decrease of 6%, as compared to the same period of the prior fiscal year. The decrease in revenue is primarily attributed to decreases in sales to customers in the telecommunications and commercial industries. PMO product sales to customers in China continue to be soft across all of the industries we serve due to unfavorable economic conditions in that region. Revenue generated by the infrared product group for the first half of fiscal 2023 was $7.7 million, a decrease of 23%, as compared to same period of the prior fiscal year. The decrease in revenue is primarily driven by sales of diamond-turned infrared products, primarily attributable to customers in the defense and industrial markets, including the timing of sales of infrared products against a large annual contract. shipments against the prior contract were completed in the second quarter of fiscal 2023, while shipments against the renewed contract signed in November 2022 will not begin until the third quarter of fiscal 2023. The renewed contract represents a 20% increase over the previous contract. Sales of BD6-based molded infrared products also decreased, particularly to customers in the China industrial market. 31 Table of Contents Our specialty products revenue increased by 27%, as compared to the same period of the prior fiscal year, and represented 6% and 4% of total revenue for the first half of fiscal 2023 and 2022, respectively. The increase is primarily due to increase demand for collimator assemblies, as well as a charge for in-process materials billed to a customer upon order cancellation, during the first quarter of fiscal 2023. Other Key Indicators Other key indicators include various operating metrics, some of which are qualitative and others are quantitative. These indicators change from time to time as the opportunities and challenges in the business change. They are mostly non-financial indicators, such as evaluating the pipeline of sales opportunities, on time delivery trends, units of shippable output by major product line, production yield rates by major product line, and the output and yield data from significant intermediary manufacturing processes that support the production of the finished shippable product. These indicators can be used to calculate such other related indicators as fully-yielded unit production per-shift, which varies by the particular product and our state of automation in production of that product at any given time. Higher unit production per shift means lower unit cost and, therefore, improved margins or improved ability to compete, where desirable, for price sensitive customer applications. The data from these reports is used to determine tactical operating actions and changes. Management also assesses business performance and makes business decisions regarding our operations using certain non-GAAP measures. These non-GAAP measures are described in more detail below under the heading “Non-GAAP Financial Measures.” Non-GAAP Financial Measures We report our historical results in accordance with GAAP; however, our management also assesses business performance and makes business decisions regarding our operations using certain non-GAAP financial measures. We believe these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition and results of operations computed in accordance with GAAP; however, we acknowledge that our non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies use. EBITDA EBITDA is a non-GAAP financial measure used by management, lenders, and certain investors as a supplemental measure in the evaluation of some aspects of a corporation’s financial position and core operating performance. Investors sometimes use EBITDA, as it allows for some level of comparability of profitability trends between those businesses differing as to capital structure and capital intensity by removing the impacts of depreciation and amortization. EBITDA also does not include changes in major working capital items, such as receivables, inventory and payables, which can also indicate a significant need for, or source of, cash. Since decisions regarding capital investment and financing and changes in working capital components can have a significant impact on cash flow, EBITDA is not necessarily a good indicator of a business’s cash flows. We use EBITDA for evaluating the relative underlying performance of our core operations and for planning purposes. We calculate EBITDA by adjusting net income to exclude net interest expense, income tax expense or benefit, depreciation and amortization, thus the term “Earnings Before Interest, Taxes, Depreciation and Amortization” and the acronym “EBITDA.” 32 Table of Contents We believe EBITDA is helpful for investors to better understand our underlying business operations. The following table adjusts net loss to EBITDA for the three and six months ended December 31, 2022 and 2021: (unaudited) Quarter Ended December 31, Six Months Ended December 31, 2022 2021 2022 2021 Net loss $ (694,061 ) $ (1,055,291 ) $ (2,074,761 ) $ (1,687,388 ) Depreciation and amortization 764,548 928,439 1,580,882 1,839,401 Income tax provision 55,000 35,396 157,134 165,269 Interest expense 81,241 50,331 151,611 96,080 EBITDA $ 206,728 $ (41,125 ) $ (185,134 ) $ 413,362 % of revenue 2 % 0 % -1 % 2 % Our EBITDA for the quarter ended December 31, 2022 was approximately $207,000, compared to a loss of $41,000 for the same period of the prior fiscal year. The increase in EBITDA in the second quarter of fiscal 2023 was primarily attributable to higher gross margin. Our EBITDA for the six months ended December 31, 2022 was a loss of approximately $185,000, compared to earnings of $413,000 for the same period of the prior fiscal year. The decrease in EBITDA in the first half of fiscal 2023 was primarily attributable to lower revenue and gross margin, partially offset by lower operating costs.