Zecotek Photonics Inc. (ZMSPF)

[someconcerns]

http://finance.yahoo.com/news/zms-v-lawsuit-resolution-opens-210000040.html

ZMS.V: Lawsuit Resolution Opens Up Inflection Opportunity in 2015
Zacks Small Cap Research
By Zacks Small Cap Research 1 hour ago

By Brian Marckx, CFA
OTC:ZMSPF
TSX:ZMS.V

Resolution of lawsuit, significant development progress bodes well for revenue inflection in 2015

By several measures 2014 was a disappointing year for Zecotek (ZMS.V) (ZMSPF). This was particularly true from an income statement standpoint which suffered from delays in recognizing order revenue, product introductions being pushed back and elevated legal expenses. Despite $2.0 million in orders placed by Hamamatsu since the end of fiscal 2013, Zecotek recognized only about $200k in 2014. We do not expect a repeat in fiscal 2015.

We think a major hindrance to order fulfillment, as well as consummation of a supply agreement with CERN, was the outstanding lawsuit with Philips / St. Gobain. The lawsuit was settled in late December. And while terms were not disclosed, language in the press release indicates that a “business relationship” between Zecotek and Philips may have been part of the settlement. As we have discussed since initiating coverage of the company in late 2013, we felt Zecotek had a position of strength in the action against Philips and St. Gobain as a result of precedent from similar scintillation crystal lawsuits which were ruled in favor of the patent infringement claimant.

What, if anything, was awarded to Zecotek from settlement of the lawsuit we do not know. We think it is a reasonable assumption however, that Zecotek would not have agreed to settle if Philips intended to continue to purchase crystals from St. Gobain and St. Gobain intended to continue to supply them. Using that logic, it is also not unreasonable to assume that it is possible (probable?) a supply agreement between Zecotek and Philips was a part of (or the heart of) the settlement. In fact just days after announcement of the lawsuit settlement, Zecotek announced a new $500k crystals order for use in a next-gen Time-of-Flight PET (TOF) scanner.

We think another issue that may have been created while the lawsuit was ongoing was potential hesitance from other would-be customers to purchase the LFS crystals from Zecotek given the ambiguity over the related patent. So now with lawsuit settled, we think order flow and order fulfillment will increase and improve overall. We expect Zecotek will begin to recognize a significant portion of the $2.5 million orders-to-date (includes the aforementioned $2M order from Hamamatsu plus $500k from the TOF customer) over the near-term.

And we continue to view Zecotek’s crystals as ultra-competitive in the PET scanner space. The company has indicated that they are seeing demand from both the human PET scanner industry as well as pharmaceutical research. And the fact that orders were placed for a TOF machine, which are high-end scanners and require the highest performance components, speaks to the quality of the LFS crystals. In addition to quality and performance, Zecotek has the advantage of low cost production via its Chinese partner BOET. So we continue to view their potential customer base as not just the deep-pocketed major domestic OEMs but also overseas manufacturers including those in emerging markets where industry research expects particularly rapid growth in the PET scanner space.

And while Zecotek has had an ongoing relationship with CERN, which has been validating the crystals for potential use in the rebuild of the Large Hadron Collider, the organization has yet to place a significant order. We also expect this to change for the better with the lawsuit now settled. In early December ZMS announced that a new configuration of their LFS crystals was requested by CERN for their Compact Muon Solenoid (CMS) experiment and that a supply agreement with CERN should be consummated in early 2015. Based on our understanding, this remains the expectation and, as such, we expect a formal announcement will be forthcoming. The language in the recent press release also mentions that Zecotek has been working with BOET in order to fulfill the supply agreement – which we think may suggest discussions regarding increasing production capacity – which we would view as another positive sign.

Product development continues on Zecotek’s other PET components including their MAPD and IDM. The company expects to showcase their next-gen MAPD (“MAPD-3N”) in April which we think could also potentially commercially launch during the year. And although we do not foresee a commercial introduction of the IDM in 2015, we think a launch the following year, assuming development continues on-track, is a fair estimate. The IDM, as we have explained in prior reports, combines the LFS crystals, an array of their MAPD photo detectors and a readout system into a single assembly for use in PET and gamma scanners. PET manufacturers are trending towards plug-and-play capability in building their scanners but this is largely not available today. Therefore a high-performance IDM could see strong demand from OEMs.

And Zecotek has another shot on goal – which could begin to materialize during 2015. That being products from their Display segment and, in particular, glasses-free 3D display. While the company had initially focused their 3D technology on the consumer TV space, Zecotek now believes there are greater opportunities elsewhere. Our recent discussions with our contacts has revealed that the company may make a meaningful announcement in the near-term related to their focused pursuits with their 3D technology – which we eagerly await to hear more about.

And as it related to 3D printing, which is another endeavor in the Display segment, the company has indicated that they think they may have a commercially-viable product within the coming months. As a reminder, over the last few quarters Zecotek began designing a 3D interface platform between 3D printers and their 3D display technology as well as developing their own 3D printer. The interface would allow someone to see a 3D image of an object prior to actually printing it on a 3D printer. The user would be able to view the object from all angles and make any desired adjustments before they printed it, affording time, cost and materials savings. Relative to a 3D printer, Zecotek is working with their long-time contracting partner LT-Pyrkal (Armenia) in designing a compact, high speed and more efficient printer than the 3D printers currently on the market. Development has progressed fairly rapidly and as early as May 2014 the initial design for a 3D processing module was completed. Testing began in July and, as noted, the company expects to have a working unit sometime in 2015.

With the rapid growth in popularity of 3D printing, this could be another high-potential opportunity for Zecotek's 3D display technology. The company envisions initially subcontracting production of the 3D display units for the 3D printer application and then potentially partnering for wider distribution.

Our updated Outlook

We have updated our financial model and outlook since the resolution of the lawsuit which, as we have explained above, we think will open up order flow and fulfillment and provides Zecotek with significantly greater opportunity for new customer wins. We look for a significant increase in the rate of recognition of the outstanding portion of the $2.5 million in orders over the near-term. We also incorporate the assumption that crystals orders that St. Gobain had been getting that infringed ZMS’s 7,132,060 patent now go to Zecotek – which obviously includes orders from Philips.

CERN order flow had also been relatively minimal but, again, based on resolution of the lawsuit, we think this now accelerates and contributes during the current year. And while it's still too early to speculate on specific quantities that CERN may order from Zecotek, we think that it's reasonable that it could eventually be in the several million dollars to potentially tens of millions of dollars worth of product.

We also think there are other revenue opportunities that may materialize in the current year that we have not modeled. These could encompass licensing deals with either the Imaging and / or Display business products and patents.

In terms of operating expenses, we expect to see a substantial reduction in professional fees in (which aggregated to over $3.8 million in 2014) as a result of conclusion of the lawsuit. While we think R&D may remain elevated with ongoing development of various products, we look for improvement in operating loss with a ramp in revenue.

We are maintaining our Outperform rating and $2.00/share price target. We continue to think the shares remain highly undervalued with the delay in recognition of the Hamamatsu order and CERN supply agreement putting downward pressure on the stock price and offering an attractive entry point. With the lawsuit now resolved, we think revenue growth steepens significantly. See below for free access to our updated report on Zecotek.