Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis by our management of our financial condition and results of operations in conjunction with our consolidated financial statements and the accompanying notes.
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 Annual Report on Form 10-K regarding forward-looking statements.
The following discussions also include use of the non-GAAP term “gross margin,” as well as other non-GAAP measures discussed in more detail under the heading “Non-GAAP Financial Measures.” Gross margin is determined by deducting the cost of sales from operating revenue. Cost of sales includes manufacturing direct and indirect labor, materials, services, fixed costs for rent, utilities and depreciation, and variable overhead. Gross margin should not be considered an alternative to operating income or net income, both of which are determined in accordance with GAAP. We believe that gross margin, although a non-GAAP financial measure, is useful and meaningful to investors as a basis for making investment decisions. It provides investors with information that demonstrates our cost structure and indicates the amount of funds available to cover our total costs and expenses. We use gross margin in measuring the performance of our business and have historically analyzed and reported gross margin information publicly. Other companies may calculate gross margin in a different manner.
25
Table of Contents
Effect of Certain Events Occurring at Our Chinese Subsidiaries
In April 2021, we terminated several employees of our China subsidiaries, LPOIZ and LPOI, including the General Manager, the Sales Manager, and the Engineering Manager, after determining that they had engaged in malfeasance and conduct adverse to our interests, including efforts to misappropriate certain of our proprietary technology, diverting sales to entities owned or controlled by these former employees and other suspected acts of fraud, theft and embezzlement. In connection with such terminations, our China subsidiaries have engaged in certain legal proceedings with the terminated employees.
We incurred various expenses associated with our investigation into these matters prior and subsequent to the termination of the employees and the associated legal proceedings. These expenses, which included legal, consulting and other transitional management fees, totaled $718,000 and $400,000 during the years ended June 30, 2021 and 2022, respectively. During the years ended June 30, 2024 and 2023, expenses incurred related to the legal proceedings were immaterial. Such expenses were recorded as “Selling, general and administrative” expenses in the accompanying Consolidated Statements of Comprehensive Income (Loss). In December 2023, the Company recovered approximately $190,000 in funds that had been recovered by the Chinese authorities, which is included in Other income in the accompanying Consolidated Statements of Comprehensive Income (Loss) for the year ended June 30, 2024. We do not expect to incur additional legal fees or consulting expenses in future periods as we have exhausted nearly all of our legal options and remedies.
Knowing that employee transitions in international subsidiaries can lead to lengthy and expensive legal proceedings that can interrupt the subsidiary’s ability to operate, we chose to enter into severance agreements with certain of the employees at the time of termination. Pursuant to the severance agreements, LPOIZ and LPOI agreed to pay such employees severance of approximately $485,000 in the aggregate, to be paid over a six-month period. After the execution of the severance agreements, we discovered additional wrongdoing by the terminated employees. As a result, LPOIZ and LPOI did not immediately pay the severance payments and disputed the employees’ rights to such payments. However, based on the likelihood that the courts in China will determine that our subsidiaries would ultimately be obligated to pay these amounts, we have accrued for these payments as of June 30, 2021. As of June 30, 2022, approximately $430,000 remained accrued. The Chinese Labor Court ruled in favor of the former employees, as expected, and these severance payments were paid out during the first half of fiscal year 2023.
We have transitioned the management of LPOI and LPOIZ to a new management team without any significant detrimental effects on their ability to operate. We have not experienced any material adverse impact to the business operations of LPOI or LPOIZ as a result of the transition.
Results of Operations
Operating Results for Fiscal Year Ended June 30, 2024 compared to the Fiscal Year Ended June 30, 2023:
Revenue.
Revenue for fiscal year 2024 was approximately $31.7 million, a decrease of 4%, as compared to $32.9 million in fiscal year 2023. Revenue generated by the infrared components product group was approximately $14.1 million in fiscal year 2024, a decrease of 2%, as compared to the prior fiscal year. The decrease in revenue is related to a decrease in shipments against a germanium-based annual contract that was not renewed, which decrease was mostly offset by an increase in shipments against an annual contract for an international military program.
Revenue generated by the visible components product group was approximately $11.2 million for fiscal year 2024, a decrease of 16%, as compared to 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 by approximately 40%.
Revenue from the assemblies and modules product group was approximately $4.5 million in fiscal year 2024, a decrease of approximately 5% as compared to fiscal year 2023, primarily due to a decrease in shipments against a multi-year contract with a defense customer due to timing, as well as decreases in sales to certain industrial customers, particularly in China. These decreases were partially offset by the addition of Visimid revenue of approximately $900,000.
Revenue from engineering services increased by $1.5 million for fiscal 2024, as compared to the same period of the prior fiscal year. Approximately $1.4 million of this increase is due to the addition of Visimid revenue, primarily driven by Visimid’s contract with Lockheed Martin, where revenue is generally recognized based on the achievement of milestones. The remaining increase is driven by revenue from one of our space-related funded research contracts.
26
Table of Contents
Cost of Sales and Gross Margin.
Gross margin for fiscal year 2024 was approximately $8.6 million, a decrease of 22%, as compared to approximately $11.1 million in fiscal year 2023. Total cost of sales was approximately $23.1 million for fiscal year 2024, compared to $21.9 million for fiscal year 2023, an increase of 6%. Gross margin as a percentage of revenue was 27% for fiscal year 2024 as compared to 34% for fiscal year 2023. The decrease in gross margin as a percentage of revenue is primarily due to the decrease in visible components sales, which typically have higher margins than our infrared components product group. Our infrared components product group comprised a greater portion of our sales for fiscal year 2024. In addition, gross margin as a percentage of revenue for the fiscal year 2024 was unfavorably impacted by the revaluation of inventory during the third quarter of fiscal 2024. The revaluation resulted in a net write-down of inventory.
Selling, General and Administrative.
For fiscal year 2024, Selling, General and Administrative (“SG&A”) costs were approximately $12.3 million, an increase of approximately $860,000, or 8%, as compared to the prior fiscal year. The increase in SG&A for fiscal year 2024 is primarily due to an increase in wages, including non-recurring executive severance costs of $136,000, and an increase in legal and consulting fees related to business development initiatives. These increases are partially offset by a decrease in stock-based compensation, whereas fiscal year 2023 included increased stock compensation costs associated with two director retirements. We also incurred additional legal and professional fees in the fiscal year 2024 associated with our rescheduled annual stockholder meeting and previously disclosed Delaware chancery court proceedings. We expect SG&A costs to remain elevated for the next several quarters as we continue with certain business development initiatives.
New Product Development.
New product development costs were approximately $2.4 million in fiscal year 2024, an increase of approximately 12% as compared to 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, including additional product offerings following the MANTIS reference design camera which we began developing in fiscal year 2023.
Amortization of Intangibles.
Amortization of intangibles increased by $510,000 for fiscal year 2024, as compared to the prior fiscal year, due to the amortization of identifiable intangible assets associated with the Visimid acquisition. See Note 3, Acquisition of Visimid , in the Consolidated Financial Statements included in this Annual Report on Form 10-K, for further information.
Other Expense.
Interest expense was approximately $192,000 for fiscal year 2024, compared to approximately $283,000 in the prior fiscal year. The decrease in interest expense is due to the 59% reduction in our total debt, including finance lease obligations, and excluding operating lease liabilities, as of June 30, 2024, as compared to the end of the prior fiscal year.
Other income, net, was approximately $79,000 for fiscal year 2024, compared to $25,000 for fiscal year 2023. Other income, net, for fiscal year 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 15, Contingencies , in the Consolidated Financial Statements included in this Annual Report on Form 10-K. This gain was largely offset by expenses of $183,000 associated with an event of default by a sub-tenant of a portion of our Orlando Facility lease. Other income, net also includes net foreign currency transaction gains and losses. 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. During fiscal year 2024, we incurred net foreign currency transaction gains of approximately $73,000, compared to net foreign currency transaction losses of $37,000 for fiscal year 2023.
Income Taxes.
During fiscal year 2024, we recorded income tax expense of approximately $67,000, compared to approximately $234,000 in fiscal year 2023, primarily related to our operations in China. Income taxes for fiscal years 2024 and 2023 include Chinese withholding tax expenses of $170,000 and $235,000, respectively, the majority of which are associated with intercompany dividends declared by LPOIZ, payable to us as the parent company. While these repatriation transactions result in some additional Chinese withholding taxes, LPOIZ currently qualifies for a reduced Chinese income tax rate; therefore, the total tax on those earnings was still below the normal income tax rate. Income tax expense for fiscal years 2024 and 2023 are also offset by deferred income tax benefits from the turnaround of temporary differences, and increased by deferred income tax expense related to certain indefinite lived temporary differences. Please refer to Note 9, Income Taxes , in the Notes to the Consolidated Financial Statements in this Annual Report on Form 10-K for additional information related to each of our tax jurisdictions.
27
Table of Contents
Net Income (Loss).
Net loss for fiscal year 2024 was approximately $8.0 million, or $0.21 basic and diluted loss per share, compared to approximately $4.0 million, or $0.13 basic and diluted loss per share, for fiscal year 2023. The increase in net loss for fiscal year 2024, as compared to fiscal year 2023, is attributable to the approximately $4.3 million increase in operating loss resulting from lower revenue and gross margin and increased operating expenses. This loss increase was partially offset by a decrease in other expense, net, of approximately $145,000, primarily due to the decrease in interest expense. In addition, there was a favorable difference of approximately $167,000 in the provision for income taxes for fiscal year 2024 as compared to fiscal year 2023.
Weighted-average common stock shares outstanding were 37,944,935 for both basic and diluted in fiscal year 2024, compared to 31,637,445 for both basic and diluted in fiscal year 2023. The increase in the weighted-average basic common shares was primarily 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 585,483 shares issued during the second half of fiscal year 2024 pursuant to the at-the-market equity program. The increase is also attributable to the shares of Class A common stock issued in conjunction with the acquisition of Visimid, as well as the issuance of shares of Class A common stock under the 2014 ESPP and underlying vested RSUs and RSAs. Potential dilutive common stock equivalents were excluded from the calculation of diluted shares for fiscal years 2024 and 2023, as their effects would have been anti-dilutive due to the net loss in those periods.
Liquidity and Capital Resources
At June 30, 2024, we had working capital of approximately $7.5 million and total cash and cash equivalents of approximately $3.5 million. Less than 50% of our total cash, cash equivalents and restricted cash was held by our foreign subsidiaries in China and Latvia. 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 year 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.
In China, before any funds can be repatriated, the retained earnings of the legal entity must equal at least 50% of the registered capital. During fiscal years 2024 and 2023, we repatriated approximately $1.4 million and $1.9 million, respectively, from LPOIZ. As of June 30, 2024, LPOIZ had approximately $1.6 million in retained earnings 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 June 30, 2024. Based on our previous intent, we had not historically provided for future Chinese withholding taxes on the related earnings. However, during fiscal year 2020 we began to accrue for these taxes on the portion of earnings that we intend to repatriate.
Loans payable as of June 30, 2024 consisted of two equipment loans (as defined below). As of June 30, 2023, loans payable consisted of the term loan in the original principal amount of approximately $5.8 million (the “BankUnited Term Loan”) issued in favor of BankUnited, N.A. (“BankUnited”) and two third-party equipment loans. Details of the loans are as follows:
Equipment Loans.
In December 2020, ISP Latvia entered into an equipment loan with a third party (the “2020 Equipment Loan”), which is also a customer. The 2020 Equipment Loan is subordinate to the Term Loan and is collateralized by certain equipment. The initial advance under the 2020 Equipment Loan was 225,000 EUR (or USD $275,000), payable in equal installments over 60 months, the proceeds of which were used to make a prepayment to a vendor for equipment to be delivered at a future date. The 2020 Equipment Loan bears interest at a fixed rate of 3.3%. An additional 225,000 EUR (or USD $267,000) was drawn in September 2021, which proceeds were paid to the vendor for the equipment, payable in equal installments over 52 months. As of June 30, 2024, the outstanding balance on the 2020 Equipment Loan was 138,750 EUR (or USD $148,532).
In May 2023, ISP Latvia entered into an equipment loan with a third party financial institution (the “2023 Equipment Loan”). The 2023 Equipment Loan is collateralized by certain equipment. The initial advance under the 2023 Equipment Loan was 128,815 EUR (or USD $141,245), the proceeds of which were used to make a prepayment to a vendor for equipment to be delivered at a future date. The final advance for the final payment to the equipment vendor was 132,674 EUR (or USD $141,815). The 2023 Equipment Loan is payable over 48 months, with monthly installments beginning January 1, 2024. The 2023 Equipment Loan bears interest at the six-month EURIBOR rate, plus 2.84% (6.39% as of June 30, 2024).
28
Table of Contents
BankUnited Loans.
On February 26, 2019, we entered into a Loan Agreement (the “Loan Agreement”) with BankUnited for (i) a revolving line of credit up to a maximum amount of $2,000,000 (the “Revolving Line”), (ii) a term loan in the amount of up to $5,813,500 (“Term Loan”), and (iii) a non-revolving guidance line of credit up to a maximum amount of $10,000,000 (the “Guidance Line” and, together with the Revolving Line and Term Loan, the “BankUnited Loans”) as evidenced by certain promissory notes we executed in favor of BankUnited (the “BankUnited Notes”). Pursuant to that certain Fifth Amendment to the Loan Agreement dated May 9, 2023, the Term Loan, the only remaining BankUnited Loan, was paid in full in February 2024, prior to its maturity date of December 31, 2024.
For additional information regarding the BankUnited Loans and the equipment loans, see Note 14, Loans Payable , to the Notes to the Consolidated Financial Statements to this Annual Report on Form 10-K.
Bridge Promissory Note
On August 6, 2024, we entered into a bridge promissory note (the “Note") with Lytton-Kambara Foundation (the “Lender”) pursuant to which the Lender extended a loan to us in the principal amount of $3,000,000 (the “Loan”). The Loan is subject to an original issue discount of 7% and bears interest at the rate of 12.5% per annum. The Loan has a 1-year term, maturing on August 6, 2025, at which time the entire principal amount of the Loan and all accrued but unpaid interest is due and payable in full. After deducting the original issue discount, fees paid to the Company’s placement agent, and certain expenses, the Company received net proceeds of $2,700,000. For additional information regarding this note, see Note 19, Subsequent Events , in the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K.
Equity Financing.
In February 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 our shelf registration statement to $50.6 million. The shelf registration statement was declared effective by the SEC on March 1, 2022. During the year ended June 30, 2024, we issued 585,483 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.
There are a number of factors that could result in the need to raise additional funds in the longer term, 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, greater than 25% of our cash and cash equivalents was held by our foreign subsidiaries as of June 30, 2024 and, although we regularly repatriate cash, it may not be readily available to repay our liabilities in the U.S. should our cash assets in the U.S. not be sufficient. We may also 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.
We intend to continue efforts to keep costs under control as we seek renewed sales growth. Our efforts are directed toward generating positive cash flow and profitability. If these efforts are not successful, we may need to raise additional capital. Should capital not be available to us at reasonable terms, other actions may become necessary in addition to cost control measures and continued efforts to increase sales. These actions may include the sale of certain product lines, the creation of joint ventures or strategic alliances under which we will pursue business opportunities, the creation of licensing arrangements with respect to our technology, or other alternatives.
Cash Flows – Operating.
Cash provided by operations was approximately $0.5 million for fiscal year 2024, compared to cash used in operations of approximately $2.8 million for fiscal year 2023. The increase in cash flows from operations during fiscal year 2024 is primarily due decreases in accounts receivable and inventory, due to lower sales in fiscal year 2024, as compared to fiscal year 2023. Cash used in operations for fiscal year 2023 was primarily due to an increase in accounts receivable, due to higher sales in the fourth quarter of fiscal year 2023 as compared to fiscal 2022, and an increase in inventory during the second half of fiscal year 2023. The cash outflow for accounts payable and accrued liabilities for fiscal year 2023 was largely due to the previously described events that occurred at our Chinese subsidiaries, for which certain expenses were accrued as of June 30, 2021 and paid during fiscal years 2022 and 2023. During fiscal year 2023 we also made the final installment payment for payroll taxes deferred in fiscal year 2020 under the CARES Act.
We anticipate continued improvement in our cash flows provided by operations in future years, as many of these non-recurring payables are behind us, and as we continue to focus on managing our receivables, payables and inventory, while continuing to grow our sales and improve gross margins, with moderate increases in general, administrative, sales and marketing and new product development costs.
29
Table of Contents
Cash Flows – Investing.
During fiscal year 2024, we expended approximately $2.2 million for capital equipment, as compared to approximately $3.1 million during fiscal year 2023. We also expended approximately $847,000, net of cash acquired, to acquire Visimid during fiscal year 2024, as disclosed in Note 3, Acquisition of Visimid Technologies , in the Consolidated Financial Statements in this Annual Report on Form 10-K. Fiscal year 2024 also reflects proceeds of approximately $365,000 from sale-leasebacks of equipment. During fiscal years 2024 and 2023, our capital expenditures were primarily related to the expansion of our Orlando Facility. In August 2023, we completed the construction of certain tenant improvements subject to our continuing lease for our Orlando Facility, of which the landlord provided $2.4 million in tenant improvement allowances. We funded the balance of the tenant improvement costs of approximately $3.7 million over fiscal years 2023 and 2024.
We anticipate a moderate level of capital expenditures during fiscal year 2025; however, the total amount expended will depend on sales growth opportunities and other circumstances.
Cash Flows – Financing.
Net cash used in financing activities was approximately $1.5 million, compared to cash provided by financing activities of approximately $7.5 million in fiscal year 2023. Cash used in financing activities for fiscal year 2024 reflects approximately $2.6 million in principal payments on our loans and finance leases, offset by $279,000 in proceeds from the 2023 Equipment Loan, $806,000 in proceeds from the sale of Class A common stock pursuant to the at-the-market equity program and $40,000 in proceeds from the sale of Class A common stock under the 2014 ESPP. Cash provided by financing activities for fiscal year 2023 reflects equity proceeds of $9.2 million from a public offering of Class A common stock, which closed in January 2023, offset by approximately $1.9 million in principal payments on our loans and finance leases, offset by proceeds of approximately $141,000 from the 2023 Equipment Loan and approximately $40,000 in proceeds from the sale of Class A common stock under the 2014 ESPP.
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, optical system or sub-system designs that we call “engineered solutions.” This is followed by “sampling” or prototyping 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 makes the best use of our production capacity and longer-term revenue planning, 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 sampling capability, including a high-quality and responsive optical design engineering staff;
·
The fact that as our customers take products of this nature into higher volume, commercial production they begin to work seriously to reduce costs – which may lead them to turn to larger producers, domestic or overseas, 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” business, we nevertheless believe we can be successful in procuring this business because of our unique capabilities in optical design engineering that we make available on the market to our current and potential customers looking for specific solutions to their needs. 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 critical component(s) from foreign sources. For information regarding revenue recognition related to our various revenue streams, refer to Critical Accounting Policies and Estimates in this Annual Report on Form 10-K.
30
Table of Contents
Our Key Performance Indicators
Usually on a weekly basis, management reviews several performance indicators. Some of these indicators 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 units of shippable output by 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 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. We believe that our non-financial production indicators, such as those noted, are proprietary information.
Financial indicators that are usually reviewed at the same time include the major elements of the micro-level business cycle:
·
sales backlog;
·
revenue by product group;
·
inventory levels;
·
accounts receivable levels and quality;
·
EBITDA; and
·
other key indicators.
These indicators are similarly used to determine tactical operating actions and changes and are discussed in more detail below. Management will evaluate these key indicators as we transition to our new strategic plan to determine whether any changes or updates to our key indicators are warranted.
Sales Backlog.
We believe 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.
Quarterly backlog levels for fiscal years 2024 and 2023 are as follows:
Quarter
Total Backlog
($ 000)
Change From Prior Year End
Change From Prior Quarter End
Q1 2023
$ 22,973
29 %
29 %
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 %
Q3 2024
$ 21,967
1 %
4 %
Q4 2024
$ 19,268
-11 %
-12 %
The decrease in backlog during fiscal year 2024 as compared fiscal year 2023 is primarily due to shipments against the prior period backlog under several annual and multi-year contract renewals. 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. The reduction in backlog as a result of these shipments during fiscal year 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 Lockheed Martin in December 2023. In previous years we have typically received a significant contract renewal from a key 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 the second quarter of fiscal 2024 we did not book 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.
31
Table of Contents
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 BDNL-4 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 BlackDiamond materials, and other materials we are currently developing under an exclusive license with the Naval Research Lab.
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 line 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.
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.
The following table sets forth revenue dollars and units by our three product groups for the three months and year ended June 30, 2024 and 2023:
(unaudited)
Three Months Ended
June 30,
Quarter
Year Ended
June 30,
Year-to-date
2024
2023
% Change
2024
2023
% Change
Revenue
Infrared components
$ 3,043,148
$ 4,769,363
-36 %
$ 14,089,277
$ 14,392,960
-2 %
Visible components
3,178,023
3,189,957
0 %
11,233,737
13,438,814
-16 %
Assemblies and modules
1,373,178
1,595,098
-14 %
4,451,165
4,680,354
-5 %
Engineering services
1,039,783
130,303
698 %
1,952,013
421,821
363 %
Total revenue
$ 8,634,132
$ 9,684,721
-11 %
$ 31,726,192
$ 32,933,949
-4 %
Three months ended June 30, 2024 compared to three months ended June 30, 2023.
Our revenue decreased by 11% in the fourth quarter of fiscal year 2024, as compared to the same quarter of the prior fiscal year, driven by decreases in infrared components and assemblies and modules, partially offset by an increase in engineering services.
Revenue generated by the infrared components product group for the fourth quarter of fiscal year 2024 was $3.0 million, a decrease of 36%, as compared to the same quarter of the prior fiscal year. The decrease in revenue is primarily due to a decrease in sales against a large annual contract for Germanium-based products, which was not renewed in the second quarter of fiscal year 2024, as 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. We continue to work with this customer, as well as other customers to convert their systems to use BlackDiamond optics. In addition, several other customers had timing differences with larger shipments in the fourth quarter of fiscal year 2023. These decreases were partially offset by an increase in shipments against an annual contract for an international military program.
Revenue from the visible components product group for the fourth quarter of fiscal year 2024 was $3.2 million, or flat in comparison to the same quarter of the prior fiscal year. By industry, there was a decrease in sales to defense customers due to timing of orders, and an increase in sales through U.S. catalog and distribution channels.
Revenue from assemblies and modules decreased by 14% for the fourth quarter of fiscal 2024, as compared to the same quarter of the prior fiscal year. The majority of the decrease is due to sales of a custom visible lens assembly to a medical customer, for which we have an end of life order in backlog going into fiscal 2025. In the fourth quarter of fiscal year 2023, this customer requested a greater number of units shipped, whereas in fiscal year 2024 we have shipped a lower but more consistent amount each quarter. Another portion of the decrease is due to timing of shipments against a multi-year contract with a defense customer. These decreases were partially offset by the addition of Visimid revenue of approximately $397,000.
32
Table of Contents
Revenue from engineering services increased $0.9 million, for the fourth quarter of fiscal 2024, as compared to the same quarter of the prior fiscal year. This increase was primarily driven by Visimid’s contract with Lockheed Martin, where revenue is generally recognized based on the achievement of milestones.
Year ended June 30, 2024 compared to year ended June 30, 2023.
Our revenue decreased by approximately 4%, for fiscal year 2024, as compared to fiscal year 2023, primarily driven by a decrease in sales of visible components, partially offset by an increase in engineering services.
Revenue generated by the infrared components product group for fiscal year 2024 was $14.1 million, a decrease of approximately 2%, as compared to the prior fiscal year. The decrease in revenue related to the germanium-based annual contract that was not renewed was mostly offset by an increase in shipments against an annual contract for an international military program. This contract was 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 fiscal year 2024 was $11.2 million, a decrease of 16%, as compared to fiscal year 2023. 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 by approximately 40%.
Revenue from assemblies and modules for fiscal year 2024 was $4.5 million, a decrease of 5%, as compared to the same period of the prior fiscal year, primarily due to a decrease in shipments against a multi-year contract with a defense customer due to timing, as well as decreases in sales of infrared assemblies to industrial customers in China and the U.S. Customers in both regions have been steadily decreasing orders since the peak of COVID-19. These decreases were partially offset by the addition of Visimid revenue of approximately $900,000.
Revenue from engineering services increased by $1.5 million for fiscal year 2024, as compared to the same period of the prior fiscal year. Approximately $1.4 million of this increase is due to the addition of Visimid revenue, primarily driven by Visimid’s contract with Lockheed Martin, where revenue is generally recognized based on the achievement of milestones. The remaining increase is driven by revenue from one of our space-related funded research contracts.
Inventory Levels.
We manage inventory levels to minimize investment in working capital but still have the flexibility to meet customer demand to a reasonable degree. We review our inventory for obsolete items quarterly. While the mix of inventory is an important factor, including adequate safety stocks of long lead-time materials, an important aggregate measure of inventory in all phases of production is the quarter’s ending inventory expressed as a number of days’ worth of the quarter’s cost of sales, also known as “days cost of sales in inventory,” or “DCSI.” It is calculated by dividing the quarter’s ending inventory by the quarter’s cost of goods sold, multiplied by 365 and divided by 4. Generally, a lower DCSI measure equates to a lesser investment in inventory, and, therefore, more efficient use of capital. The table below shows our DCSI for the immediately preceding eight fiscal quarters:
Fiscal
Quarter
Ended
DCSI (days)
Q4-2024
6/30/2024
98
Q3-2024
3/31/2024
98
Q2-2024
12/31/2023
133
Q1-2024
9/30/2023
119
Fiscal Year 2024 Average
112
Q4-2023
6/30/2023
102
Q3-2023
3/31/2023
154
Q2-2023
12/31/2022
120
Q1-2023
9/30/2022
125
Fiscal Year 2023 Average
125
Our average DCSI for fiscal year 2024 was 112, compared to 125 for fiscal year 2023. The decrease in average DCSI is driven by the decrease in inventory levels, which aligns with the decrease in sales. We expect DCSI to maintain an average of between 110 to 120.
33
Table of Contents
Accounts Receivable Levels and Quality.
Similarly, we manage our accounts receivable to minimize investment in working capital. We measure the quality of receivables by the proportions of the total that are at various increments past due from our normally extended terms, which are generally 30 days. The most important aggregate measure of accounts receivable is the quarter’s ending balance of net accounts receivable expressed as a number of days’ worth of the quarter’s net revenues, also known as “days sales outstanding,” or “DSO.” It is calculated by dividing the quarter’s ending net accounts receivable by the quarter’s net revenues, multiplied by 365 and divided by 4. Generally, a lower DSO measure equates to a lesser investment in accounts receivable and, therefore, more efficient use of capital. The table below shows our DSO for the preceding eight fiscal quarters:
Fiscal
Quarter
Ended
DSO (days)
Q4-2024
6/30/2024
52
Q3-2024
3/31/2024
55
Q2-2024
12/31/2023
59
Q1-2024
9/30/2023
57
Fiscal Year 2024 Average
56
Q4-2023
6/30/2023
63
Q3-2023
3/31/2023
59
Q2-2023
12/31/2022
52
Q1-2023
9/30/2022
57
Fiscal Year 2023 Average
58
Our average DSO for fiscal year 2024 was 56, compared to 58 for fiscal year 2023. The decrease in average DSO for fiscal year 2024 is driven by decreases in revenue from some key accounts with longer payment cycles, which revenue has been largely replaced by customer accounts with shorter payment cycles. In addition, we continue to focus on collections. We strive to maintain a DSO of less than 60.
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 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 measures 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 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.”
34
Table of Contents
The following table adjusts net income to EBITDA for the three months and year ended June 30, 2024 and 2023:
(unaudited)
Three Months Ended June 30,
Year Ended June 30,
2024
2023
2024
2023
Net loss
$ (2,353,773 )
$ (808,840 )
$ (8,007,346 )
$ (4,046,871 )
Depreciation and amortization
1,062,559
815,019
4,048,409
3,174,569
Income tax provision
(53,912 )
11,618
67,490
234,034
Interest expense
42,814
54,561
191,862
283,266
EBITDA
$ (1,302,312 )
$ 72,358
$ (3,699,585 )
$ (355,002 )
% of revenue
-15 %
1 %
-12 %
-1 %
Our EBITDA for the quarter ended June 30, 2024 was a loss of approximately $1.3 million, compared to income of $0.1million for the same period of the prior fiscal year. The decrease in EBITDA in the fourth quarter of fiscal year 2024 was primarily attributable to the decrease in revenue and gross margin, coupled with increases in SG&A and Other expenses, net, which expense increases primarily related to non-recurring items, including certain business development initiatives.
Our EBITDA for fiscal year 2024 was a loss of approximately $3.7 million, compared to $0.4 million for fiscal year 2023. The decrease in EBITDA for fiscal year 2024 is primarily attributable to lower revenue and gross margin, coupled with increased operating expenses, including SG&A and new product development. SG&A for fiscal year 2024 includes a number of non-recurring items, particularly as related to certain business development initiatives.
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
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of income and expense during the reporting periods presented. Our critical estimates include the allowance for trade receivables, which is made up of allowances for bad debts, allowances for obsolete inventory, valuation of compensation expense on stock-based awards and accounting for income taxes. Although we believe that these estimates are reasonable, actual results could differ from those estimates given a change in conditions or assumptions that have been consistently applied. We also have other policies that we consider key accounting policies, such as our policy for revenue recognition, however, the application of these policies does not require us to make significant estimates or judgments that are difficult or subjective.
Management has discussed the selection of critical accounting policies and estimates with our Board, and the Board has reviewed our disclosure relating to critical accounting policies and estimates in this Annual Report on Form 10-K. The critical accounting policies used by management and the methodology for its estimates and assumptions are as follows:
Allowance for credit losses is based on the best estimate of the amount of probable credit losses in existing accounts receivable. We determine the allowance based on historical write-off experience and expected future default probabilities based on our ongoing evaluations of our customers’ financial condition. The allowance consists of an amount identified for specific customers and an amount based on overall estimated exposure. Accounts receivable are customer obligations due under normal trade terms. Recovery of bad debt amounts which were previously written off is recorded as a reduction of bad debt expense in the period the payment is collected. If our actual collection experience changes, revisions to our allowance may be required. After attempts to collect a receivable have failed, the receivable is written off against the allowance. To date, our actual results have been materially consistent with our estimates, and we expect such estimates to continue to be materially consistent in the future.
35
Table of Contents
Inventory obsolescence allowance is calculated by reserving 100% for items that have not been sold in two years or that have not been purchased in two years. These items, as identified, are allowed for at 100%, as well as allowing 50% for other items deemed to be slow moving within the last twelve months and allowing 25% for items deemed to have low material usage within the last six months. Items of which we have greater than a two-year supply are also reserved at 25% to 100%, depending on usage rates. The parts identified are adjusted for recent order and quote activity to determine the final inventory allowance. To date, our actual results have been materially consistent with our estimates, and we expect such estimates to continue to be materially consistent in the future.
Revenue is generally recognized upon transfer of control, including the risks and rewards of ownership, of products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. The performance obligations for the sale of optical components and assemblies are satisfied at a point in time. We generally bear all costs, risk of loss, or damage and retain title to the goods up to the point of transfer of control of products to customers. Shipping and handling costs are included in the cost of goods sold. Revenues from product development agreements are recognized as performance obligations are met in accordance with the terms of the agreements and upon transfer of control of products, reports or designs to the customer. Product development agreements are generally short term in nature, with revenue recognized upon satisfaction of the performance obligation, and transfer of control of the agreed-upon deliverable. Invoiced amounts for VAT related to sales are posted to the balance sheet and are not included in revenue.
Stock-based compensation is measured at grant date, based on the fair value of the award, and is recognized as an expense over the employee’s requisite service period. We estimate the fair value of each stock option as of the date of grant using the Black-Scholes-Merton pricing model. Our directors, officers, and key employees were granted stock-based compensation through our Amended and Restated Omnibus Incentive Plan, as amended (the “Omnibus Plan”), through October 2018 and after that date, the 2018 Stock and Incentive Compensation Plan (the “SICP”). Most options granted under the Omnibus Plan and the SICP vest ratably over two to four years and generally have ten-year contract lives. The volatility rate is based on four-year historical trends in common stock closing prices and the expected term was determined based primarily on historical experience of previously outstanding options. The interest rate used is the U.S. Treasury interest rate for constant maturities. The likelihood of meeting targets for option grants that are performance based are evaluated each quarter. If it is determined that meeting the targets is probable, then the compensation expense will be amortized over the remaining vesting period.
Goodwill and amortizable intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods. Purchased intangible assets other than goodwill are amortized over their useful lives unless these lives are determined to be indefinite. Purchased intangible assets are carried at cost, less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally two to fifteen years. We periodically reassess the useful lives of intangible assets when events or circumstances indicate that useful lives have significantly changed from the previous estimate. Amortizable intangible assets consist primarily of customer relationships, know-how/trade secrets and trademarks. They are generally valued as the present value of estimated cash flows expected to be generated from the asset using a risk-adjusted discount rate. When determining the fair value of our intangible assets, estimates and assumptions about future expected revenue and remaining useful lives are used. Goodwill and intangible assets are tested for impairment on an annual basis and during the period between annual tests if events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable.
We assess the qualitative factors to determine whether it is more likely than not that the fair value of its reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the goodwill impairment analysis. If we determine that it is more likely than not that its fair value is less than its carrying amount, then the goodwill impairment test is performed. The fair value of the reporting unit is compared to its carrying amount, and if the carrying amount exceeds its fair value, then an impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, up to the total amount of goodwill allocated to that reporting unit.
Accounting for income taxes requires estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of the recognition of revenue and expense for tax and financial statement purposes. We assessed the likelihood of the realization of deferred tax assets and concluded that a valuation allowance is needed to reserve the amount of the deferred tax assets that may not be realized due to the uncertainty of the timing and amount of taxable income in certain jurisdictions. In reaching our conclusion, we evaluated certain relevant criteria, including the amount of pre-tax income generated during the current and prior two years, as adjusted for non-recurring items, the existence of deferred tax liabilities that can be used to realize deferred tax assets, the taxable income in prior carryback years in the impacted jurisdictions that can be used to absorb net operating losses and taxable income in future years. Our judgments regarding future profitability may change due to future market conditions, changes in U.S. or international tax laws and other factors. These changes, if any, may require material adjustments to these deferred tax assets, resulting in a reduction in net income or an increase in net loss in the period when such determinations are made, which, in turn, may result in an increase or decrease to our tax provision in a subsequent period.
36
Table of Contents
In the ordinary course of global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of cost reimbursement and royalty arrangements among related entities, which could impact our income or loss in each jurisdiction in which we operate. Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome of these matters will not be different than that which is reflected in our historical income tax provisions and accruals. In the event our assumptions are incorrect, the differences could have a material impact on our income tax provision and operating results in the period in which such determination is made. In addition to the factors described above, our current and expected effective tax rate is based on then-current tax law. Significant changes during the year in enacted tax law could affect these estimates.
Impact of recently issued accounting pronouncements that have recently been issued but have not yet been implemented by us are described in Note 2, Summary of Significant Accounting Policies , to the Notes to the Consolidated Financial Statements to this Annual Report on Form 10-K, which describes the potential impact that these pronouncements are expected to have on our financial condition, results of operations and cash flows.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
As a Smaller Reporting Company as defined in Rule 12b-2 of the Exchange Act and in item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations with respect to this item and therefore are not required to provide the information requested by this Item 7A.