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, 2023, 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. 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. 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. In July 2023, we acquired Liebert Consulting LLC, dba Visimid Technologies (“Visimid”). Visimid is an engineering and design firm specializing in thermal imaging, night vision and IOT applications. Visimid provides design and consulting services for DoD contractors, commercial and industrial customers, and OEMs for original new products. Visimid’s core competency is developing and producing custom thermal and night vision cores. We believe that Visimid’s capabilities are aligned with our strategy to focus on engineered solutions. Visimid’s facility is located in Plano, TX. For additional information, please refer to our Annual Report on Form 10-K for the year ended June 30, 2023. 23 Table of Contents Product Groups We previously organized our products in three groups: PMO, infrared, and specialty products. Revenues from product development agreements for engineering services were included in specialty products. With our strategic transition into more value-added solutions, and the addition of Visimid in July 2023, we reorganized our products into four product groups: infrared components, visible components, assemblies and modules, and engineering services. Assemblies and modules were previously included in infrared or specialty products, depending on the lens type. Our visible components product group consists of visible precision molded optics with varying applications. Our infrared product group is comprised of infrared optical components, including molded, diamond-turned, or polished lenses. Polished lenses include both conventional and CNC (computer numerical control) ground and polished lenses. Between these two product groups, we have the capability to manufacture lenses from very small (with diameters of a sub-millimeter) to over 300 millimeters, and with focal lengths from approximately 0.4 millimeters to over 2,000 millimeters. In addition, both product groups offer both catalog and custom designed optics. Our assemblies and modules product group is comprised of value-added engineered solutions, such as infrared cameras, infrared imaging modules and cores, optical assemblies, thermal imaging assemblies, and collimators. Products in this category are typically designed for specific customer needs and requirements, and are sold into OEMs that further integrate them into their systems. We design, build, and sell cameras and optical assemblies in markets for defense use, industrial test and measurement, medical devices, sporting, and communications based on our proprietary technologies. Our solutions and assemblies can vary in complexity level from assemblies of lenses that get mounted on a customer’s camera, laser or detector, to complete imaging systems that generate a processed image electronically. Our engineering services product group represents services we provide pursuant to product development agreements that we enter into with customers. Typically, customers approach us and request that we develop new products or applications utilizing our existing products to fit their particular needs or specifications. The timing and extent of any such product development requests are outside of our control, and the related revenue is recognized upon satisfaction of the performance obligation, and transfer of control of the agreed-upon deliverable. As we continue down the path of strategic shift into highly engineered solutions, we expect this product group to grow in a similar way as our assemblies and modules business. Furthermore, as the engineering effort precedes the product revenue, the revenue from this product group is often, but not always, a lead indicator to the revenue in assemblies and modules product group. We believe these four product groups better align with our strategic direction and will allow us to better track the results of our focus on engineered solution and assemblies. 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. Understanding the shifts that are happening in the marketplace and the changes that come when a technology, like photonics, moves from being a specialty to being integrated into mainstream industries and applications, we redefined our strategic direction to provide our wide customer base with domain expertise in optics, and became their partner for the optical engine of their systems. In our view, as the use of photonics evolves, so do customer needs. The industry is transforming from a fragmented industry with a component-oriented supply chain, into a solution-focused industry with the potential for partnerships for solution development and production. Over the last couple of years we have worked to align our organization to this strategy, and leverage our in-house domain expertise in photonics, knowledge and experience in advanced optical technologies, and the necessary manufacturing techniques and capabilities. We have been developing these partnerships by working closely with our customers throughout their design process, designing optical solutions that are 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 infrared materials, 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. 24 Table of Contents Our domain 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 Annual Report on Form 10-K for the fiscal year ended June 30, 2023. Results of Operations Revenue Three months ended December 31, 2023, compared to three months ended December 31, 2022 Revenue for the second quarter of fiscal 2024 was approximately $7.3 million, a decrease of approximately $1.2 million, or 14%, as compared to approximately $8.5 million in the same quarter of the prior fiscal year, primarily driven by a decrease in sales of visible components. Revenue generated by infrared components was approximately $3.6 million in the second quarter of fiscal 2024, an increase of approximately $0.3 million, or 9%, as compared to approximately $3.3 million in the same quarter of the prior fiscal year. The increase in revenue is primarily due to an increase in shipments against an annual contract for an international military program. Revenue from the visible components product group for the second quarter of fiscal 2024 was $2.7 million, a decrease of approximately $1.2 million, or 31%, as compared to the same quarter of the prior fiscal year. The decrease in revenue is primarily due to a decrease in sales to customers in the defense industry, as well as a decrease in sales through catalog and distribution channels in the U.S. and in Europe. Sales to customers in the telecommunications industry in China also decreased. Revenue from assemblies and modules decreased by 20%, as compared to the same quarter of the prior fiscal year, primarily due to timing of shipments against a multi-year contract with a defense customer. This decrease was partially offset by the addition of Visimid revenue. Revenue from engineering services was flat for the second quarter of fiscal 2024, as compared to the same quarter of the prior fiscal year. Six months ended December 31, 2023, compared to six months ended December 31, 2022 Revenue for the first half of fiscal 2024 was approximately $15.4 million, a decrease of approximately $0.4 million, or 3%, as compared to approximately $15.8 million in the same period of the prior fiscal year, primarily driven by a decrease in sales of visible components. Revenue generated by infrared components was approximately $7.4 million in the first half of fiscal 2024, an increase of approximately $0.9 million, or 14%, as compared to approximately $6.5 million in the same period of the prior fiscal year. The increase in revenue is primarily due to an increase in shipments against an annual contract for an international military program. Revenue from the visible components product group for the first half of fiscal 2024 was $5.4 million, a decrease of approximately $1.8 million, or 25%, as compared to the same period of the prior fiscal year. The decrease in revenue is primarily due to a decrease in sales to customers in the defense industry, as well as a decrease in sales through catalog and distribution channels in the U.S. and in Europe. Sales to customers in the telecommunications industry in China also decreased. Revenue from assemblies and modules increased by 7%, as compared to the same period of the prior fiscal year, primarily due to the addition of Visimid revenue, which increase was partially offset by a decrease in shipments against a multi-year contract with a defense customer due to timing. Revenue from engineering services increased by $253,000, as compared to the same period of the prior fiscal year, primarily due to the addition of Visimid revenue as well as revenue from one of our space-related funded research contracts. Cost of Sales and Gross Margin Three months ended December 31, 2023, compared to three months ended December 31, 2022 Gross margin in the second quarter of fiscal 2024 was approximately $2.2 million, a decrease of $1.1 million, or 33%, as compared to the same quarter of the prior fiscal year. Total cost of sales was approximately $5.1 million for the second quarter of fiscal 2024, compared to approximately $5.2 million for the same quarter of the prior fiscal year. Gross margin as a percentage of revenue was 30% for the second quarter of fiscal 2024, compared to 38% for the same quarter of the prior fiscal year. The decrease in gross margin as a percentage of revenue is due to the decrease in visible components sales, which typically have higher margins than our infrared components product group, which comprised a greater portion of our sales for the second quarter of fiscal 2024. 25 Table of Contents Six months ended December 31, 2023, compared to six months ended December 31, 2022 Gross margin in the first half of fiscal 2024 was approximately $4.5 million, a decrease of $1.0 million, or 18%, as compared to the same period of the prior fiscal year. Total cost of sales was approximately $10.9 million for the first half of fiscal 2024, compared to approximately $10.4 million for the same period of the prior fiscal year. Gross margin as a percentage of revenue was 29% for the first half of fiscal 2024, compared to 34% for the same period of the prior fiscal year. The decrease in gross margin as a percentage of revenue is due to the decrease in visible components sales, which typically have higher margins than our infrared components product group, which comprised a greater portion of our sales for the first half of fiscal 2024. Selling, General and Administrative Three months ended December 31, 2023, compared to three months ended December 31, 2022 SG&A costs were approximately $2.9 million for the second quarter of fiscal 2024, a decrease of approximately $172,000, or 6%, as compared to approximately $3.0 million in the same quarter of the prior fiscal year. The decrease in SG&A costs is primarily due to a decrease in stock-based compensation, partially offset by an increase in wages. Six months ended December 31, 2023, compared to six months ended December 31, 2022 SG&A costs were approximately $5.5 million for the first half of fiscal 2024, a decrease of approximately $149,000, or 3%, as compared to approximately $5.7 million in the same period of the prior fiscal year. The decrease in SG&A costs is primarily due to a decrease in stock-based compensation, partially offset by an increase in wages. This decrease was also partially offset by costs of approximately $97,000 associated with the acquisition of Visimid, which closed in July 2023. New Product Development New product development costs were approximately $608,000 in the second quarter of fiscal 2024, an increase of approximately $142,000, or 30%, as compared to the same quarter of the prior fiscal year. For the first half of fiscal 2024, new product development costs were $1.2 million, an increase of $232,000 or 23%, as compared to the same period of the prior fiscal year. These increases are primarily due to the addition of engineering personnel as a result of the Visimid acquisition, as well as an increase in materials and outside services utilized for development projects. Amortization of Intangibles Amortization of intangibles increased by $204,000 for both the second quarter and first half of fiscal 2024, due to the amortization of identifiable intangible assets associated with the Visimid acquisition. See Note 3, Acquisition of Visimid , in the unaudited Condensed Consolidated Financial Statements, for further information. Other Income (Expense) Interest expense, net, was approximately $54,000 for the second quarter of fiscal 2024, as compared to $81,000 for the same quarter of the prior fiscal year. For the first half of fiscal 2024, interest expense was approximately $111,000, as compared to $152,000 for the same period of the prior fiscal year. The decrease in interest expense is primarily due to a decrease in amortization of loan costs, as all loan costs have been fully amortized in prior periods. Total debt has decreased 35% as of the quarter ended December 31, 2023, as compared to the quarter ended December 31, 2022, while the interest rate on our largest loan balance has increased from 5% to 8.5% for the same period. Other income, net, was approximately $200,000 for the second quarter of fiscal 2024, as compared to other expense, net, of $1,000 for the same quarter of the prior fiscal year. For the first half of fiscal 2024, other income, net, was $205,000, as compared to $26,000 for the same period of the prior fiscal year. Other income for the second quarter and first half of fiscal 2024 includes a gain of $190,000 for the return of funds previously misappropriated by our former Chinese management team, as a result of the ongoing legal proceedings described in Note 14, Contingencies , in the unaudited Condensed Consolidated Financial Statements. 26 Table of Contents Other income and expenses also include net gains and 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. Income Taxes 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. Income tax expense was approximately $76,000 for the second quarter of fiscal 2024, as compared to $55,000 for the same period of the prior year. The increase is due to timing of intercompany dividends. During the first half of fiscal 2024, income tax expense was approximately $116,000, compared to $157,000 for the same period of the prior fiscal year. The decrease is due to lower taxable income in that jurisdiction. Net Loss Net loss for the second quarter of fiscal 2024 was approximately $1.7 million, or $0.05 basic and diluted loss per share, compared to $0.7 million, or $0.03 basic and diluted loss per share, for the same quarter of the prior fiscal year.The increase in net loss of approximately $1 million for the second quarter of fiscal 2024, as compared to the same quarter of the prior fiscal year, was primarily attributable to the decrease in revenue and gross margin, partially offset by the aforementioned other income in our Chinese subsidiary. Net loss for the first half of fiscal 2024 was approximately $3.1 million, or $0.08 basic and diluted loss per share, compared to $2.1 million, or $0.08 basic and diluted loss per share, for the same period of the prior fiscal year. The increase in net loss of approximately $1 million for the first half of fiscal 2024, as compared to the same period of the prior fiscal year, was primarily attributable to the decrease in revenue and gross margin, partially offset by the aforementioned other income in our Chinese subsidiary. Weighted-average common shares outstanding were 37,501,683, basic and diluted, in the second quarter of fiscal 2024, compared to 27,172,226, basic and diluted, in the same quarter of fiscal 2023. For the first half of fiscal 2024, weighted-average common shares outstanding were 37,446,714, basic and diluted, as compared to 27,121,583, basic and diluted, in the first half of fiscal 2023. The increase in the weighted-average basic common shares was due to the sale of an aggregate of 9,090,910 shares of Class A common stock pursuant to a public offering which closed January 17, 2023, as well as the issuance of shares of Class A common stock under the 2014 ESPP and underlying vested RSUs and RSAs. Potential Impact of Economic Conditions and Policies 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, 8.1% in 2021, a3% in 2022, and 5.2% in 2023. The annual economic growth rate in 2024 is estimated to be 4.6%, although some analysts have indicated that China’s economic growth could be lower. Deteriorating economic conditions in China generally 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. 27 Table of Contents In addition, on July 4, 2023 China announced export limitations on Germanium and Gallium, two materials that are commonly used in infrared optical components. A certain portion of our infrared optics revenue has always been dependent on those materials. As a precaution to the disruption in the supply chain of Germanium, and in anticipation of customers ordering more optics produced from other materials, primarily our own BlackDiamond materials, we have, in agreement with one key customer, proactively canceled some of our sales orders for optics made of Germanium. This serves to both reduce our exposure to possible shortages in Germanium material supply, as well as to free up capacity for orders for optics made of materials other than Germanium. This also led to us intentionally not renew a large annual customer order for optics made of Germanium from the same customer. This annual order is typically renewed during our second fiscal quarter; the prior renewal was announced in December 2022 for over $5 million. The lack of this renewal impacts our backlog in the short term, as we would typically have received this order during the second fiscal quarter. The lack of this order booking does not mean, however, that we have lost the customer. Instead, we expect this order to renew in coming months, as the customer completes evaluating, and working toward transitioning to optics made of our BlackDiamond materials. Liquidity and Capital Resources As of December 31, 2023, we had working capital of approximately $9.1 million and total cash, cash equivalents and restricted cash of approximately $5.9 million, of which, greater than 25% 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. We routinely declare 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, and we 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, 2023, LPOIZ had approximately $2.0 million available for repatriation and LPOI did not have any earnings available for repatriation, based on earnings accumulated through December 31, 2023, the end of the most recent statutory tax year, that remained undistributed as of December 31, 2023. Loans payable consists of the BankUnited Term Loan, pursuant to the Amended Loan Agreement, two third-party equipment loans, and the ANBTX Note. As of December 31, 2023, the outstanding balance on the BankUnited Term Loan was approximately $1.8 million, the outstanding balance on the equipment loans was approximately $504,000, and the outstanding balance on the ANBTX Note was $150,000. Pursuant to that certain Fourth Amendment to the Loan Agreement dated February 7, 2023, the BankUnited Term Loan, the only remaining BankUnited Loan, matures and is due and payable in full on December 31, 2024. The BankUnited Term Loan bears interest at BankUnited’s then prime rate of interest, as adjusted from time to time (8.5% as of December 31, 2023). Monthly payments of $75,000 are due and payable on the first day of each month, and commencing on January 1, 2024 and continuing on the first day of each month thereafter until the maturity date, monthly payments will increase to $100,000, with each such payment applied first to interest, costs and expenses and then to principal. Upon maturity, all principal and interest shall be immediately due and payable. Pursuant to that certain Fifth Amendment to the Loan Agreement dated May 9, 2023, the security interest in certain collateral securing the Term Loan as of such date terminated and was replaced by a security interest in a cash collateral account maintained at BankUnited, initially in the amount of approximately $2,457,000, with a portion of such cash collateral to be released on a quarterly basis equal to 110% of the principal reductions effected during that quarter. The cash collateral is reflected as Restricted Cash in the accompanying unaudited Condensed Consolidated Balance Sheets as of December 31, 2023 and June 30, 2023. An exit fee equal to 1% of the outstanding principal balance as of December 31, 2023 will be incurred and a further exit fee of 4% of the outstanding principal balance as of December 31, 2024 will be incurred (to the extent the Term Loan is still outstanding on the respective dates and has not been refinanced with another lender). 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. We have not issued any shares of our Class A common stock pursuant to the at-the-market equity program. 28 Table of Contents 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. 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 provided by operations was approximately $851,000 for the first half of fiscal 2024, compared to cash used in operations of approximately $751,000 for the same period of the prior fiscal year.Cash provided by operations for the first half of fiscal 2024 was largely driven by decrease in accounts receivable, as sales were higher in the fourth quarter of fiscal 2023 than in each of the first two quarters of fiscal 2024. Cash used in operations in the first half of fiscal 2023 reflects a decrease in accounts payable and accrued liabilities during such period resulting from the payment of certain expenses related to previously disclosed events that occurred at our Chinese subsidiaries, which were accrued in prior periods. Cash Flows – Investing: During the first half of fiscal 2024, we expended approximately $1.5 million in investments in capital equipment, compared to approximately $412,000 in the same period of the prior fiscal year. We also expended approximately $722,000, net of cash acquired, to acquire Visimid during the first half of fiscal 2024, as disclosed in Note 3, Acquisition of Visimid Technologies , in the unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q. The first half of fiscal 2024 also reflects proceeds of approximately $365,000 from sale-leasebacks of equipment. The spending in the first half of fiscal 2024 is largely driven by the Orlando Facility expansion, whereas the majority of our capital expenditures during the first half of fiscal 2023 reflected only maintenance capital expenditures.As disclosed in Note 11, Leases , in the unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q, we constructed additional tenant improvements in our Orlando Facility subject to our continuing lease, of which the landlord agreed to provide $2.4 million in tenant improvement allowances. The balance of the tenant improvement costs is estimated to be $3.7 million, pending final construction invoices. During the first half of fiscal 2024, we expended $994,000 toward this project, with the remaining estimated $380,000 expected to be expended during the second half of fiscal 2024. Cash Flows – Financings: Net cash used in financing activities was approximately $304,000 for the first half of fiscal 2024, compared to approximately $443,000 in the same period of the prior fiscal year. Cash used in financing activities for the first half of fiscal 2024 reflects $466,000 in principal payments on our loans and finance leases, offset by approximately $143,000 in proceeds from the 2023 Equipment Loan, and $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 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. Contractual Obligations and Commitments As of December 31, 2023, our principal commitments consisted of obligations under operating and finance leases, and debt agreements. No material changes occurred during the first half of fiscal 2024 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, 2023. Off Balance Sheet Arrangements We do not engage in any activities involving variable interest entities or off-balance sheet arrangements. 29 Table of Contents 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, 2023 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, 2023. 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 designs 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, 2023. 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. Financial indicators that are considered key and reviewed regularly are as follows: · Sales backlog; · Revenue 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 continues to evaluate these key indicators as we transition to our new strategic plan, and is implementing certain changes and updates as further described below. 30 Table of Contents 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, 2023 was approximately $21.2 million, a decrease of 28%, as compared to $29.4 million as of December 31, 2022. Compared to the end of fiscal 2023, our total backlog decreased by 2% during the first half of fiscal 2024. Backlog change rates for the last five fiscal quarters are: Quarter Total Backlog ($ 000) Change From Prior Year End Change From Prior Quarter End Q2 2023 $ 29,427 66 % 28 % Q3 2023 $ 26,620 50 % -10 % Q4 2023 $ 21,652 22 % -19 % Q1 2024 $ 21,303 -2 % -2 % Q2 2024 $ 21,220 -2 % 0 % The decrease in backlog during the first half of fiscal 2024 is primarily due shipments against several annual and multi-year contract renewals, which orders were added to the backlog in prior periods. Shipments during the first half of fiscal 2024 were partially offset by the following: (i) a significant contract renewal for advanced infrared optics for a critical international military program, which renewal represented a 40% increase in dollar value as compared to the previous order; and (ii) a significant contract awarded to Visimid by a defense customer in December 2023. In previous years we have typically received a significant contract renewal from our largest customer for infrared products made of Germanium during the second fiscal quarter. However, as previously disclosed we have decided to reduce the amount of optics we produce from Germanium, both to reduce our risk of supply chain disruption, and more importantly, to work with customers to convert their systems to use optics made of our own BlackDiamond materials. As such, in second quarter of fiscal 2024 we have not booked our typical annual renewal order for Germanium optics with this customer. Instead, we continue to work with this customer, as well as other customers to convert their systems to use BlackDiamond optics. 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 anticipate that our existing annual and multi-year contracts will 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, ongoing global events are generating renewed interest in germanium alternatives such as our proprietary BlackDiamond materials, and other materials we are currently developing under an exclusive license with the Naval Research Lab. While the process of converting those systems over is progressing, it is not an immediate transition and as a result we may experience a short term adverse impact on our revenues and backlog as we decrease the orders for optics made of Germanium, before we start receiving the new orders for optics made of BlackDiamond. As we have outlined in our strategic direction, we do not expect to see significant growth in our visible components product group in the near future. Competition in that product group has grown substantially over the last few years, and some of our new molding capabilities and technologies such as free-form molded optics, might take longer than anticipated to reach full commercialization, depending on economic conditions and technology trends in the area of AR/VR. 31 Table of Contents In addition, order bookings for both visible and infrared components and assemblies continue to be slow in China. Domestic sales in China have also been adversely impacted by the economic downturn in China, which continues to negatively impact revenue and bookings in that region. Revenue by Product Group We previously organized our products in three groups: precision molded optics (“PMO”), infrared, and specialty products. Revenues from product development agreements for engineering services were included in specialty products. With our strategic transition into more value-added solutions, and the addition of Visimid in July 2023, we reorganized our products into four product groups: infrared components, visible components, assemblies and modules, and engineering services. Assemblies and modules were previously included in PMO, infrared or specialty products, depending on the lens type. We also previously presented the number of units sold by product group, however this is no longer a measure that we focus on internally, as our focus moves toward engineered solutions. The following table sets forth revenue for our four product groups for the three and six-month periods ended December 31, 2023 and 2022: (unaudited) Three Months Ended December 31, Quarter Six Months Ended December 31, Year-to-date 2023 2022 % Change 2023 2022 % Change Revenue Infrared components $ 3,572,853 $ 3,290,328 9 % $ 7,407,455 $ 6,479,879 14 % Visible components 2,678,904 3,876,627 -31 % 5,367,239 7,144,285 -25 % Assemblies and modules 986,683 1,227,873 -20 % 2,248,722 2,098,605 7 % Engineering services 77,197 77,851 -1 % 369,469 116,811 216 % Total revenue $ 7,315,637 $ 8,472,679 -14 % $ 15,392,885 $ 15,839,580 -3 % Three months ended December 31, 2023 Our revenue decreased by 14% in the second quarter of fiscal 2024, as compared to the same quarter of the prior fiscal year, driven by a decrease in sales of visible components. Revenue generated by the infrared components product group for the second quarter of fiscal 2024 was $3.6 million, an increase of 9%, as compared to same quarter of the prior fiscal year. The increase in revenue is primarily due to an increase in sales to customers in the defense industry, including an increase in shipments against an annual contract for an international military program. This contract was also renewed during the first quarter of fiscal 2024 for a higher dollar value than the previous contract. Revenue from the visible components product group for the second quarter of fiscal 2024 was $2.7 million, a decrease of 31%, as compared to the same quarter of the prior fiscal year. The decrease in revenue is primarily due to a decrease in sales to customers in the defense industry, as well as a decrease in sales through catalog and distribution channels in the U.S. and in Europe. Sales to customers in the telecommunications industry in China also decreased. Revenue from assemblies and modules decreased by 20% for the second quarter of fiscal 2024, as compared to the same quarter of the prior fiscal year. The majority of the decrease is due to timing of shipments against a multi-year contract with a defense customer. This decrease was partially offset by the addition of Visimid revenue of approximately $146,000. Revenue from engineering services was flat for the second quarter of fiscal 2024, as compared to the same period of the prior fiscal year. Six months ended December 31, 2023 Our revenue decreased by 3% in the first half of fiscal 2024, as compared to the same period of the prior fiscal year, driven by a decrease in sales of visible components. Revenue generated by the infrared components product group for the first half of fiscal 2024 was $7.4 million, an increase of 14%, as compared to same period of the prior fiscal year. The increase in revenue is primarily due to an increase sales to customers in the defense industry, including an increase in shipments against an annual contract for an international military program. This contract was also renewed during the first quarter of fiscal 2024 for a higher dollar value than the previous contract. 32 Table of Contents Revenue from the visible components product group for the first half of fiscal 2024 was $5.4 million, a decrease of 25%, as compared to the same period of the prior fiscal year. The decrease in revenue is primarily due to a decrease in sales to customers in the defense industry, as well as a decrease in sales through catalog and distribution channels in the U.S. and in Europe. Sales to customers in the telecommunications industry in China also decreased. Revenue from assemblies and modules increased by 7% for the first half of fiscal 2024, as compared to the same period of the prior fiscal year, primarily due to the addition of Visimid revenue of approximately $281,000, partially offset by a decrease in shipments against a multi-year contract with a defense customer due to timing. Revenue from engineering services increased by $253,000, as compared to the same period of the prior fiscal year. Approximately $186,000 of this increase is due to the addition of Visimid revenue. The remaining increase is driven by revenue from one of our space-related funded research contracts. 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, 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. 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.” 33 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, 2023 and 2022: (unaudited) Three Months Ended December 31, Six Months Ended December 31, 2023 2022 2023 2022 Net loss $ (1,713,663 ) $ (694,061 ) $ (3,056,039 ) $ (2,074,761 ) Depreciation and amortization 1,129,444 764,548 1,943,000 1,580,882 Income tax provision 76,058 55,000 115,604 157,134 Interest expense 53,788 81,241 111,399 151,611 EBITDA $ (454,373 ) $ 206,728 $ (886,036 ) $ (185,134 ) % of revenue -6 % 2 % -6 % -1 % Our EBITDA for the quarter ended December 31, 2023 was a loss of approximately $454,000, compared to income of $207,000 for the same quarter of the prior fiscal year. The decrease in EBITDA in the second quarter of fiscal 2024 was primarily attributable to lower sales and gross margin, partially offset by the aforementioned other income in our Chinese subsidiary. Our EBITDA for the six months ended December 31, 2023 was a loss of approximately $886,000, compared to $185,000 for the same period of the prior fiscal year. The decrease in EBITDA in the first half of fiscal 2024 was primarily attributable to lower revenue and gross margin, partially offset by the aforementioned other income in our Chinese subsidiary.