QPC Lasers, Inc. Q2 2008 Earnings Call Transcript

| About: QPC Lasers, (QPCI)

QPC Lasers, Inc. (OTC:QPCI) Q2 2008 Earnings Call August 14, 2008 5:00 PM ET

Executives

Marie Dagresto - Director of Finance and Investor Relations

Jeffrey Ungar, Ph.D. - Chairman, Chief Executive Officer

George Lintz - Chief Financial Officer, Chief Operating Officer, Director

Paul Rudy, Ph.D. - Senior Vice President of Sales and Marketing

Blima Tuller - Vice President of Finance and Chief Accounting Officer

Analysts

Dennis Fisher - Dutton Associates

[Justin Goldman - Goldman Capital Management]

[William McArdinal] - Wedbush Morgan Securities

Operator

Welcome to the QPC Lasers second quarter 2008 financial results conference call (Operator Instructions) I would now like to turn the conference over to Marie Dagresto, Director of Investor Relations of QPC Lasers.

Marie Dagresto

Welcome to everyone joining in on QPC Lasers’ 2008 second quarter financial results conference call. I am Marie Dagresto, the Director of Finance and Investor Relations here at QPC Lasers. Our co-founders Dr. Jeffrey Ungar who serves as Chairman and Chief Executive Officer and George Lintz who serves as Executive Vice Chairman and Chief Financial Officer will be presenting today. Dr. Paul Rudy, our Senior VP of Sales and Marketing and Blima Tuller, our Vice President of Finance are also here with us to answer any questions.

Before we begin, I would like to read the Safe Harbor statement which is as follows: During this call management will make a number of forward-looking statements that involve risks and uncertainties as well as assumptions. These assumptions if they prove incorrect could cause our results to differ materially from those expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be deemed forward-looking statements including any future revenue guidance provided, statements about the company’s position to capitalize on a growing market, statements about the company’s technology or the company’s product pipeline, and statements regarding the future demands of the company’s technology. These and other risk factors that could cause events to differ materially from those expressed or implied by such forward-looking statements are described in our most recent Form 10K and Form 10Q as well as other subsequent filings with the Securities and Exchange Commission. We assume no obligation and do not intend to update these forward-looking statements.

Today’s call is being recorded and will accessible on our website www.qpclasers.com.

At this time I would like to introduce Dr. Jeff Ungar, President and CEO of QPC Lasers.

Jeffrey Ungar

Before I give an overview of the company, I’d first like to expand on the announcement the company released on Monday.

We have retained financial advisors to assist in forming strategic relationships with companies that we believe will significantly enhance the value of QPC going forward. The strategic relationships that we are currently exploring may take the form of a direct investment, merger or acquisition, joint venture or other significant commercial agreement between QPC and a company where mutual strategic value exists. Potential counterparts may include customers who would benefit from a captive source of laser light engines resulting in a truly vertically integrated system manufacturer. We have commenced discussions with companies in the US and in Asia who would potentially bring to QPC all or part of the following list of benefits: New capital, high-volume manufacturing capabilities, distribution channels, vertical integration, complementary technology, and industry expertise. While it’s not certain at this time that a transition of this kind will ultimately be completed, we are excited about the possibilities that have been presented to us so far.

Before I turn the call over to George to review our financials in more detail, I’ll first provide a brief overview for those of you who may still be learning about our company. QPC Lasers was founded in 2000 to develop and commercialize high brightness high powered semiconductor lasers. Our chip modules and substance in technology offer advantages in brightness, color purity, and ruggedness while simultaneously offering significant reductions in size, cost, weight and power consumption. Our technology and products are developed and manufactured in-house at our vertically-integrated and ISO certified facility here in Sylmar, California just north of Los Angeles. Today we have approximately 55 employees, roughly 30% of whom are Ph.D.s.

Our lasers are used in a wide variety of applications across four primary vertical markets: Consumer electronics, medical, industrial, and aerospace/defense. Our product portfolio includes three generations of products with progressively increasing technical sophistication. We have developed and patented proprietary high brightness chip-based plates or technologies and our IP portfolio is protected by items including 16 patents both issued and pending, as well as numerous trade secrets and unique processes.

I’m now going to turn over the call to George to review our financials in more detail.

George Lintz

If anyone has not received a copy of our press release and/or our quarterly filing with the Securities and Exchange Commission, you may retrieve both via our website at www.qpclasers.com and of course we encourage you to read these for a more thorough and detailed evaluation of our financials.

We believe our expanded product offerings and our entry into the consumer electronics market offer potential for significant growth over the next two years. To accelerate this growth we directed substantial resources into developing products for consumer electronics in the second quarter of 2008. Although it is still early stage in the product development cycle and sales cycle, we believe that these efforts will benefit the company by accelerating new contract wins and ultimately revenue as the contracts ramp up its production.

In the second quarter we negotiated and signed a $3.5 million contract to develop and deliver laser light engines which are intended to be used by our customer in developing 3D projection systems for entertainment applications. We will recognize revenue from this contract as we are paid for the developments that we have conducted and as we deliver products. At this time we expect the revenue to be recognized over the coming 12 months.

Between the $11 million left on the Asia Optical contract and the $3.5 million of the new 3D projection contract we have a pipeline of over $14 million of contracts in the consumer electronics industry in addition to several hundred thousand dollars of seat orders from major consumer electronics’ OEMs that we have not specified. The current backlog is the largest that QPC has ever had.

I’ll now go over the second quarter 2008 financials. During the three months ended June 30, 2008 the company recognized revenue of $1.3 million compared to revenue of $1.8 million during the quarter ended June 30, 2007. The decrease in revenues was due in part to decreased government contract revenues during 2008. As we have discussed in the past, government contract revenues tend to be lumpy by nature for QPC and for many other companies who work with the federal government. In some quarters this attribute works in our favor and in some quarters it does not. We continue to work on a number of development contracts from the Department of Defense and we are optimistic that we will be awarded additional government contracts in the future. We also continue to work on both development and production contracts for other defense customers such as the government of Israel and prime defense contractors in the United States and abroad.

Product sales increased from $850,000 in the second quarter of 2007 to $932,000 in the second quarter of 2008. This increase in product sales revenue would likely have been greater but it was offset by the company’s cessation of work for a major medical customer that, as reported last quarter, commenced Chapter 11 proceedings during the first quarter of 2008. We reported no revenue from this customer during the first half of 2008 compared to $220,000 of revenue during the first six months of 2007. We reported an allowance for bad debt of $225,000 in connection with the bankruptcy filing of this customer during the first quarter of 2008 for the outstanding accounts receivable balance at the time the customer declared bankruptcy. We are pleased to report at this time that the customer was purchased by a medical equipment manufacturer and the acquirer has indicated that they plan to restart production of the products that incorporate our lasers. In addition we may be able to recover payment for the accounts receivable balance that was outstanding at the time the customer filed for bankruptcy.

Gross profit margin for the second quarter of 2008 was 32% versus 47% for the same period last year. As a percentage of revenue cost of sales increased as we saw a drop of non-recurring engineering revenues and revenues from government programs, both of which typically have higher margins than sales of existing products.

Our operating loss for the three months ended June 30, 2008 was $3.5 million versus $1.6 million for the same period last year. The increase in net operating loss results from a combination of the decrease in revenue and increase in research and development costs and selling, general and administrative costs. We invested $1.4 million in R&D for the second quarter of this year versus $1.1 million for research and development for the same period last year. The increase in R&D reflects the focus on development of new products. SG&A costs were $2.5 million for the second quarter of 2008 compared with $1.4 million for the second quarter of 2007. The increase in SG&A costs were due largely to increased sales, marketing and investor relations costs.

Net loss for the second quarter was $4.7 million compared to a loss of $1.2 million for the same quarter ended June 30, 2007. This was in significant part due to increased operating expenses and the amortization of loan discounts.

Cash and cash equivalents including restricted cash from subscriptions to a pending offering as of June 30, 2008 totaled $698,383. The company requires additional capital to sustain our operations and capitalize on significant new opportunities that have been identified in the consumer electronics market and we are currently pursuing a number of alternative financing strategies. As Jeff noted, we have retained financial advisors and we have commenced discussions with a number of potential strategic partners who could potentially offer not only capital but also strategic and tactical advantages that could enable us to grow our position in the consumer electronics market more aggressively. We believe that a strategic partner would be the most advantageous type of financing for the company at this time; however, we are exploring other financing options simultaneously and hope to report back to you regarding the results soon.

We expect to have an adjustment to the conversion price of our convertible debentures and the exercise price of our warrants as of next week. The 2007 debentures set certain revenue milestones for September 30, 2007, December 31, 2007, and June 30, 2008. We successfully achieved the first two of these three milestones; however we did not achieve the June 30, 2008 revenue milestone. As a result, a potential conversion and warrant exercise price adjustment has been triggered. We had previously announced this through the filing of a Form 8K with the Securities and Exchange Commission and I believe that the anticipated dilution to the common stockholders has had a downward influence on the price of our stock recently.

As usual I’ll conclude the review of our financial results by breaking down the discussion into three parts: Our operating plan, our sales and marketing plan, and our future prospects.

Our operating plan remains mostly the same. However, we have placed additional focus on approving our operational efficiencies while growing our top line revenue, our customer base, and our global presence. We continue to target cash flow positive in 2009 and to further this end we recently made cutbacks that have significantly reduced our operational expenses. We believe that this focus is in the long term best interest of QPC and our shareholders.

Our sales and marketing team continues to work aggressively to capture additional market share in all of our target markets. We have increased product marketing in trade shows presence and we continue to manage a worldwide panel of rep organizations in over 20 countries. We also continually explore new strategic distribution relationships around the world.

As for future prospects we believe that our business opportunities in all four of our target markets are robust and growing particularly our consumer electronics business as is evidenced by our increased backlog and sales opportunities. We are progressing in our discussions with strategic partners who may provide capital and other resources to execute on our business plan and to take advantage of a variety of opportunities that will enhance our growth prospects and increase shareholder value.

At this time I’ll turn the call back over to Jeff.

Jeffrey Ungar

I’d like to review some of the exciting developments that have taken place at QPC over the last quarter. As many of you know we inaugurated a new generation of laser products in September of last year. These third generation products provide our customers with new levels of performance and sophistication in a number of crucial areas.

Let me start by describing our newly deployed high-power long wavelength surgical lasers. The development of these surgical lasers comes on the heels of our previously developed Generation II lasers which are widely used in the treatment of conditions such as varicose veins. Our new Generation III lasers which are based on our new Ultra 500 product platform generate 100 watts or more of laser power precisely tuned to a wavelength chosen for efficient energy absorption in human tissue. These laser beams are focused into a tiny optical fiber with cross-sectional area only a fractional square millimeter in area and can be used as an optical scalpel for surgery. Efficient energy absorption at these wavelengths means that the laser energy is absorbed precisely where needed vaporizing only the targeted tissue while causing little damage to neighboring healthy tissue and simultaneously cauterizing neighboring capillaries to minimize bleeding. In the hands of a skilled surgeon these lasers are being applied to remove multiple malignancies from highly vascular tissue such as the lung and liver that would be difficult or impossible to remove using conventional surgical techniques or even with other types of lasers.

Until now the only way to generate the required laser light required very bulky, inefficient and expensive solid state lasers that sharply limited the availability of this technique to a few major medical centers.

QPC’s high-power all diode surgical lasers at these wavelengths are an important development which is generating strong interest from the medical community. These lasers incorporate a host of features specifically oriented towards the medical market which we plan to incorporate into future products as we extend our medical laser product family. We’ve been told by our customers that these lasers offer new hope to patients that would otherwise have been considered unsuitable candidates for treatment.

Another very exciting application being enabled by QPC’s flagship BrightLock lasers is enhanced MRI imaging. Conventional MRI imaging depends on the presence of water in the imaged organ and is largely ineffective in relatively dry areas of the body such as air passages in the lungs and ventricles in the brain. QPC has been shipping sophisticated BrightLock lasers that optically activate gases such as Xenon that are then infused into the target organ allowing specially designed MRI machines to image these organs in stunning detail. We are very excited and proud of the fact that our technology is at the forefront of this revolution in medical technology.

On the military side we have continued to push the state-of-the-art in high brightness lasers in our ongoing development contracts with the US Army and the Navy as well as supplying lasers to most of the major US prime defense contractors as well as the Israeli Ministry of Defense. We are actively working to expand our R&D activities with various elements of the US Department of Defense. We have however been challenged by a reduction in DOD spending on advanced weapons such as lasers due to what we believe is a temporary redirection for military budgets towards funding immediate operational needs related to our commitments in Iraq and Afghanistan. We are very bullish about the opportunities for QPC in defense R&D but in the short term this has contributed to a shortfall in the expected DOD funded R&D activities at QPC.

Fortunately QPC’s market diversity has allowed us to redirect our R&D resources to commercial areas that are unaffected by these factors and we are hopeful that we will soon see an upturn in government funded R&D as well.

In last quarter’s call I briefly discussed a new and exciting market segment for QPC: Consumer electronics. QPC’s entry point into this market is as a supplier of compact, efficient and high-power lasers emitting red, green and blue beams for use in products such as projection TVs and digital projectors that currently use conventional light bulbs or LED sources. Replacing light bulbs with lasers provides dramatically improved color image quality and crucial advantages including better efficiency and much lower waste [inaudible].

QPC’s traditional laser product generated infrared beams which were invisible to the human eye but late last year QPC harnessed its unique technology capabilities to demonstrate our first visible laser which emitted an intense green beam. In November QPC, although a newcomer to this market, exploited this development and made a very rapid and dramatic entry into the market by securing a $12 million development and supply agreement to provide red, green and blue lasers for laser television to a then unnamed but very important customer from across the Pacific.

I’m very pleased that we now have permission to reveal that this customer is the Asia Optical Company, Inc., the billion dollar corporation which is Taiwan’s leading contract manufacturer of optical consumer products such as digital cameras and optical rangefinders. Asia Optical manufactures these products under contract to many major consumer product giants. Many or most of you likely own products manufactured by Asia Optical but because they bear the label of the household name consumer company you may not know it. I’m very pleased to report that last month QPC successfully completed its performance milestone under this contract for all three colors and these lasers have already been used to project 60-inch images with stunningly vivid color quality. The supply phase of this contract is an $11 million exclusive agreement between our companies over three years and carries a potential value of up to $230 million over the next 10 years.

In a second major development, QPC recently announced winning a $3.5 million development and supply contract for red-green-blue lasers to be used in full-color three-dimensional displays for gaming and entertainment. 3D laser displays represent quite literally a new market dimension for the company that complements our existing 2D display market and which significantly expands the already exciting opportunities. As exciting as the television market is, there’s an even larger potential market opportunity for QPC in ultraportable projector displays for products such as video games, PDAs and even cell phones. The existing displays for these products are based on LCD and related technology and are too small to provide an aesthetically pleasing experience. Laser projectors offered either as companion projects or even embedded in the PDA or cell phone offers an ideal combination of unmatched portability and large visually pleasing image quality.

The potential numbers are huge. Roughly a billion cell phones are sold each year. Imbedded digital cameras now account for most cell phones sold worldwide and there are strong reasons for expecting similar penetration of laser projectors when they too become available.

This past June QPC demonstrated an integrated prototype providing intense laser beams of all three colors in a miniature package which has generated strong interest in the projector district. Most recently QPC secured an order for the development of customized visible lasers from an undisclosed household name leading manufacturer of office equipment including projectors. We are very excited about this order and about the commercial importance of these lasers for QPC.

On behalf of the entire QPC team, thank you all for dialing in today. This concludes the prepared commentary and I would like now to open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Dennis Fisher - Dutton Associates.

Dennis Fisher - Dutton Associates

You say your goal is to achieve a cash flow of neutral for next year. What kind of revenues would support that kind of a goal?

George Lintz

That’s on the breakdown between what type of revenue it is, whether it’s development contracts or whether it’s -

Dennis Fisher - Dutton Associates

If you could just give me like a range? It doesn’t have to be precise.

George Lintz

It’s going to be a lower number if there are development contracts and probably a higher number for product revenue, but we’re looking at somewhere above $8 million per quarter to get to cash flow positive.

Operator

Our next question comes from Justin Goldman - Goldman Capital Management.

Justin Goldman - Goldman Capital Management

Congratulations on the record order stream. Based on the increased number of sales calls you’re receiving, what can we expect in the way of new order announcements for the second half or early 2009?

Jeffrey Ungar

There is quite an increase over the first half of the year so our order stream was more than double in the first half of this year compared to the prior year. We certainly expect that to continue and we’re anticipating a number of orders in all of the various markets. As Jeff mentioned we do see strong activity in not just the consumer market but in the defense, industrial and commercial markets. The RFP rate or the general rate of inquiries is quite high and the company has won a large number of seed orders over the last year or so that we believe will grow into larger contracts in the future.

Operator

Our next question comes from Dennis Fisher - Dutton Associates.

Dennis Fisher - Dutton Associates

Would you characterize the time which you’ve experienced between your initial proposal and the time you might secure a contract? I know you don’t have that many contracts but what would you expect in this regard? In other words if somebody says they’re going to buy your stuff and actually sell it?

Jeffrey Ungar

There are wide differences in that depending on the market. In some markets, for instance the high power industrial market, from the initial inquiry to a seed order to being designed in for production could be several years. On the medical market if we’re replacing conventional technology, it could be just a few months. So it really does vary broadly. I would say a high power levels generally take longer than lower power levels and markets like medical and consumer electronics can react faster than markets like the industrial market.

Dennis Fisher - Dutton Associates

On the consumer market, generally they actually start several months ahead of time before they actually introduce a product in my experience and maybe as much as a year later might actually introduce the actual product. Has that been your experience there as well? How can you characterize that in the consumer products where you’re focusing?

Jeffrey Ungar

What we’ve experienced in the consumer space is there are substantial NREs available as with the Asia Optical contract to customize a product for the end customer and then there’s a ramp and certainly that ramp taking a year or so to get to the mass production is typical. It could take longer and if it’s really pressed, it would be feasible for it to be a bit shorter than that.

Dennis Fisher - Dutton Associates

So if we assume, and this is a big assumption, that the economy brightens up over the next year or so, you could potentially see your cash flow goal. That’s the way it looks to me I would say in the next year or so. Is that right? Is that what you’re expecting?

Jeffrey Ungar

Could you restate the question?

Dennis Fisher - Dutton Associates

It seems to me, and I’m a newbie so I’m not as well versed in your company as many, but it seems to me that your sales goal to get cash flow neutral would require an economic rebound. Is that true?

Jeffrey Ungar

Not necessarily. We believe that we’ll be able to get to cash flow positive in the current economic environment. I think that as the economic environment improves it certainly will improve our prospects and benefit the company. However, even in the current economic environment we believe that we’ll still be able to get to cash flow positive in 2009.

Dennis Fisher - Dutton Associates

So what you know now based on your conversations with your customers that’s how you feel?

Jeffrey Ungar

Yes, and that’s what we’re targeting and of course many things can change both on the revenue production side as well as the expense side.

Operator

Our next question comes from [William McArdinal] - Wedbush Morgan Securities.

[William McArdinal] - Wedbush Morgan Securities

Of the four markets that you are in, which of these is the largest user of lasers and how is QPC’s performance in that market? What did you generate in revenues from that market in this last quarter or for this first half?

Jeffrey Ungar

I can just make a comment on market breakouts. One of the largest areas of lasers being used today for high power lasers is the industrial market. That’s well over a billion dollars. The medical market is over half a billion, just the laser portion. And then defense certainly is very large. It’s difficult to put a number on that but it’s certainly a billion dollar plus. The consumer electronics side is really an emerging market for high power lasers because many of the laser-based display products aren’t currently out on the market. Of course the display market exists already but is being served by non-laser sources. And that market is much, much larger than any of the other markets that we’re talking about here.

In looking at revenues, certainly the medical has been our largest percentage of revenue over the past quarters. That was true in 2007; it’s been true in 2008 to date on the revenue side. An example of QPC’s uniqueness in that particular market where we’re having very near-term successes are the broad wavelength ranges that we offer particularly in this EyeSafe wavelength regime that Jeff described earlier, not only for varicose vein treatment and dermatology and some of the lower power applications but for this new set of surgical applications that are really exciting. QPC is helping to enable globalization of medical laser applications with these chip-based solutions there and the ability to generate these EyeSafe wavelengths and focus the light tightly into a very narrow core fiber is really a competitive strength of the company, as an example.

[William McArdinal] - Wedbush Morgan Securities

Time-wise how far away are you from making a deal with a strategic partner?

Jeffrey Ungar

We’ve commenced discussions with a number of different strategic partners as we mentioned earlier and we can’t comment on how far we are away, first of all because of course we don’t know when we would close but we have disclosed that we are in discussions with multiple strategic partners.

[William McArdinal] - Wedbush Morgan Securities

Yes, you have. But we don’t know if that’s a long-term potential or a short-term potential. Can you at least say that?

Jeffrey Ungar

I can tell you that we would like it to be short term.

[William McArdinal] - Wedbush Morgan Securities

Of course. With a half a million dollars in cash in your bank account, I don’t blame you.

Jeffrey Ungar

That’s really all we can say at this time.

Operator

That does conclude the question and answer session.

Jeffrey Ungar

Again we’d like to thank you very much for joining us and we look forward to reporting to you next quarter. Thank you very much.

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