Paul Campbell - Chief Financial Officer Andrew Sculley - Chief Executive Officer

Andrew Uerkwitz - Oppenheimer Kevin Dede - Rodman & Renshaw Dennis Van Zelfden - Brazos Research Tom Rath - Davidson Investment Advisors

Good afternoon, and welcome to the eMagin Second Quarter 2015 Earnings Conference Call. [Operator Instructions] I'd now like to turn the conference over to Paul Campbell. Please go ahead.

Thanks very much, Jamie. Welcome everyone, thanks for joining us today for our second quarter 2015 earnings conference call. It's good to be with you today, and we look forward to updating you on the company's performance. As always, before we begin, please note that we will be referring to numbers that are part of our quarterly report on Form 10-Q for the second fiscal quarter ended June 30, 2015. During today's call, we may make forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the company's current expectations, projections and beliefs, and are subject to a number of risks and uncertainties. Such statements include references to projections of future revenues, plans for product development and production, the company's ability to ramp up production, future contracts, product benefits, operations, liquidity and capital resources, as well as statements containing words like believe, expect, plan, target, et cetera. Our risk factors are included in the company's Form 10-K for 2014, on file with the SEC. Except where required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements for any reason. Now, I will turn the call over to eMagin's CEO, Andrew Sculley.

Thanks, Paul. And thanks, everyone, for being on the call today. I'll begin with some corporate remarks, then turning over to Paul for the financial results. And then I’ll have some additional remarks, before we open the call up to questions. We've discussed augmented reality or AR and Virtual Reality VR displays with companies working in these spaces. We continue to get positive feedback on how our display technology will fit the requirements. We've given proposals to tier 1 companies on displays that we believe will meet their future needs. To give you a sense for the interest one of the companies in this space introduced us to a potential foundry manufacturing partner. And we of course are having follow-up discussions. These companies have a common view point on the growth they expect in these markets. This view point is discussed in May reports on AR or VR, the super online search will give you a large numbers of headsets therefore displays over the next five years or so. All this translates to potentially very high microdisplay revenue market for us. One firm is quoted often, they say the AR and VR market will grow to $120 billion and $30 billion respectively by 2020. Now displays are only a component of that, but a very important component. Two other research firms say, there will be about 40 million units of Virtual Reality headsets sold in 2018. And that would require a mixture of 40 million pairs of microdisplays/or cellphone displays. Note that the microdisplays or the displays that have the pixel density required by these applications, and I’ll mention a little bit more about that. Before we build our new wide field of view headsets, we hope helped a tier 1 company with a study on virtual reality headsets for gaming. We used two earlier headsets from eMagin, one cellphone display headset that’s popular in the news today and an entertainment headset for the study. One eMagin HMD was built for U.S. army medical training and the other one was built for simulation and training for the military. So they’re not built for the gaming space, but they do give us or have given us a good comparison. The cellphone display HMD had a wide field of view, which was good for the gamers in the study. However, the gamers could see the pixels and the spaces between them. This is the so called screen door effect and they complain that this was distracting. I think you can imagine the gamers are used to playing games with the TV or PC monitor, and I know unless you are sitting right up next to them with a magnifying glass you can’t see the pixels or the sub pixels. The gamers' comments on the older eMagin HMDs that used our microdisplays were that the displays were outstanding, they are what a VR headsets needs. However, the field of view was about 60 degrees or so and that needs to be increased so they like the cellphone headset for the field view. And with these comments that’s why we built the new virtual reality headset, it has both a wide field of view and uses our 2000X2000 displays, which means 4 million pixels and that's four times greater than the cellphone display headsets. We’re on a path now towards full productization of the headset. We’re reviewing the product specs, industrial design, the optics, the electronics with the goal of ensuring it’s suitability for volume production. We’re also enhancing the existing prototypes to make them ready for a potential appearance at the Consumer Electronics Show and that’s CES, so will be in January of 2016. The HMD Group continues to - this is our team, continues to demonstrate the headset at conferences, press interviews and with potential partners and this is receiving very positive reviews. The markets - these markets are very exciting for us from both a display and a headset point of view. Now we heard about cellphone companies working on higher density pixels, as I’m sure you’ve heard. The current cellphone displays and the VR headsets have gaps between the sub pixels that are 25 times bigger than the gaps in our - between our sub pixels and that’s behind the screen door affect that's seen and that's why when the display is magnified the individual sup pixels can be seen as well. So our displays are built to be magnified and that's why the tier 1 companies are talking to us about the next generation. Now I have been working on OLED displays for the last 15 years. First half of those years were for direct view displays i.e. the ones that we you use in the cellphone or digital camera or TV etcetera. In my group we have a joint venture that had installed two large OLED deposition machines, brought them up to manufacturing and manufactured displays for digital camera backs, camcorders at that time as well. And so I know it’s going to be very difficult to use one of those displays as they are manufactured today by those who are manufacturing i.e. Samsung or LG, [the roots of] [ph] desired pixel pitches for augmented reality, and virtual reality requirements. And the other thing to note is that for virtual reality, you also need small size, you can’t use a big display. And so that means microdisplays will absolutely be there. And our microdisplays are designed for HMDs, they have the resolution, pixel density, the high speed, low power consumption, eye contrast and large dynamic range that’s needed for these applications. Power for AR is extremely important. Just you may recall the best known AR glass product so far needed to be recharged after two hours of continuous use and we know this because one of our guys wore it during a ski trip and that’s too short. Our HMD Group knows both the AR and the VR markets very well, and we’ve hired some people who know those markets very well and we believe our HMD and the displays will play a significant role here. We've discussed with tier 1 companies what we need to do in these markets. It's worth mentioning cost here, and I know I said that before, but we had – we’ve explored the changes we need to make for cost reduction. And the easy example is that our displays are built today for military purposes and that means they have to go from minus 40 degree C, which is minus 40 Fahrenheit to plus 70 degrees C or 158 Fahrenheit. And this is not necessary for both the industrial or consumer markets. And we’ve taken creative effort here to see what cost reduction ideas we can make by changing the displays so they don’t fit these military requirements. And we’re pleased with what we’ve come up with, filed IP on what we’ve come up with, and we’ve talked to potential customers who are interested in these lower cost displays. In addition, we've - for potential customers who are working on plans, which show how we can scale up to higher volume production for microdisplays in these consumer space. We have their attention and they of course have ours. For the AR market the tier 1 companies told us the brightness is important and hence our program on high brightness full color displays will service well here. Just because the AR device maybe used outdoors, which would require higher brightness in VR HMD and that's because you’re fighting sunlight out sunny. You should note here that the consumer AR market may not require the same brightness as what we’re doing for military avionics. And in addition many industrial usage will indoors and warehouse for example. We have many examples of that and many of these requirements we can meet today with our displays that we have. Higher full color brightness can be reached with our direct patterning technology, so we have a path even for the very high brightness requirement. The highest brightness requirements come from the military avionic usage, and I’ll speak a minute on how we’re progressing on this project, it’s very important to us. We can reach the desired luminance for monochrome displays today for full color, the ultra-high brightness program will deliver the needed brightness. We continue to make significant progress in this program. You may recall the goal is 10,000 nits or candelas per meter square, full color microdisplay. And as a comparison, I had mentioned before, we measured the popular cellphone dialing up to full brightness and measured at 450 nits. And we will accomplish the 10,000 nits in 2x2 methods. One is direct patterning, the OLED layers that are very small pixel sizes and very small gaps between the pixels and we demonstrated we can do that, government is really happy with this, responding us. Plus, we have a program to enhance the OLED stack to make it more efficient. For our first efforts at directly patterning, the full color displays, we reached 6,500 nits, that's enormous for us and we’re very happy with that result. And for the effort to improve the efficiency, we've done a significant improvement as well. So the combination not quite as 10,000 but we feel comfortable that we’re going to get there. But also part of the program with the government is to improve the manufacture readiness of the displays and we’re working very diligently on that as well. Final program for these funded efforts is for more efficient silicon backplane, and this will give us about 30% reduction in power, obviously very important for mobile display applications. These programs are multi-year, they started - some date was various, depending upon which one but it were all of them in middle of 2014, some little later. And the largest dollar value, the ManTech program is scheduled to go over 30 months. And these are multi-year programs, so they will not be very good for our revenue as well. In summary statement, the programs will give us full color displays with above 10,000 nits brightness, and again that's more than 20x brighter than your smartphone LCOS silicon backplane, it gives us 30% less power. The power consumption of the displays will be significantly better than our current displays when run at the same luminance even without the new backplane. This is a very impressive improvement in our technology. The funding of the program of $6.8 million helps us move this more quickly. So, on the avionics market, just to talk for a minute about specific revenue for that market, we've designed a new display for customer and we have a second customer who want us to modify our current display and we’re actually pretty much done with both of those and the customers funded those respected programs and now we’re selling displays to them for their military HMD qualifications. So they’re going through testing, once that passes, we’ll have volume sales for them. And we do expect these customers to win the programs. In many respects this market is the most demanding one, it requires augmented reality and bright sunlight, and both augmented reality and night vision in low light, the very high contrast of our OLED displays are what brought these customers to us in the first place. And the example here is, the Navy pilots landing at night needed much higher contrast than what the LCOS or LCDs could provide. We have gentleman in our group, Doug Hughes, who is working in – well, he's a former Navy ship captain, who is an expert here on the items issues with jet landing at night. Let me see a video that - you can actually find it on the web of what this is like landing in a jet at night on the back of a carrier, and I have to agree they do need our OLED displays. We've sold the displays for qualifications, there are very high brightness monochrome displays that’s what we’re selling today, the green can run at over 20,000 nits or 40 times brighter than your smartphone. And beyond they will carry avionics one company is working on using microdisplays for commercial helicopter and fixed wing pilots. And this is a much bigger potential market for us. We have discussed augmented reality, virtual reality displays with companies working - sorry about that. I think, now I’ll turn the call back over to Paul, to take you through our second quarter financial results and then I’ll follow-up with few other comments.

Okay. Thanks, Andrew. We had a good quarter financially. So let's start with the income statement. The revenue on the second quarter was $7 million that was up 17% from quarter one, nice increase there. And it was equal with quarter two last year. So quarter-over-quarter we were $7 million each quarter. And $7 million in total revenue equals our highest revenue quarter in the past eight quarters. So, on both measures it was a good quarter for total revenue. Breaking it down, product revenue was $5.4 million and that was down from Q2 last year. We did ship fewer displays, but we had a rather strong comparative of $7 million in product revenue last year. And that $7 million was the highest product revenue in the past eight quarters. So it was a tough comparison. Average price was nearly the same in both quarters. Moving on to our R&D contract revenue, that increased very strongly this quarter to $1.6 million from only $62,000 in Q2 last year. This increase is due primarily to the work completed so far on the multi-year R&D contract awards that Andrew, just mentioned that we received in 2014. As you probably know, most of our contract revenues are comprised of U.S. Government related spending. We’ve reported previously how we believe the R&D funding from the Government has been impacted by sequestration and budget issues over the last couple of years. And if you look back to years prior to 2013, our R&D contract revenue range from about 15% to a size 22% of total revenue. Past couple of years we recorded R&D revenues of less than 1% of revenue for Q1 and Q2 last year. And then when we got the new awards mid-year, Q3 grew at 9% of revenue and then Q4 was 16% of revenue, Q1 2015 was about 15% of revenue and now Q2 is strong 23% of total revenue. So this is a very positive dynamic for us to have this strong R&D revenue coming back to us and it really helps cushion the ebb and flow, up and down of the display revenue. So, we’re very happy about that. Gross margin for Q2 improved to 37% from 31% Q2 last year. And the gross margin increase was due primarily to the large boost in gross profit from the R&D contract revenue and also to lower manufacturing cost. The R&D gross profit contribution this quarter was $715,000 or 44% of R&D contract revenue. That’s pretty strong percentage on a fairly big number. On the product side, the yield in Q2 improved from Q2 last year and labor cost were better controlled than last year as well. Looking at operating expenses, these are comprised of internal non-funded R&D expense and selling general administrative expense or SG&A. R&D expense for the second quarter decreased about 28% from second quarter last year to about $929,000. The decrease was due to more of our R&D expense going against the funded R&D contracts as costs of goods sold through those contracts. And this decrease our non funded internal R&D expense. And this is one of the positive effects that we get from having a large amount of R&D contract revenue as we offset more of our expense and helps profitability. This dynamic we should see continue going forward. SG&A expenses for the second quarter were $1.7 million down from $1.9 million in Q2 last year. We did reduce our allowance for doubtful accounts by about $96,000, as we made progress with a slow paying customer. Salaries and benefits, rent and noncash comp were all lower than last year and these expense reductions are driven by having fewer people in the company, issuing fewer stock options and we renegotiated lower rents on all three of our facilities since mid-2014. So we have some very strong expense reductions and these were offset somewhat by increases in expenses for it, amount of display, depreciation and travel. But still overall we were down in SG&A expense by about $200,000. Operating loss for Q2 was $50,000 and EBITDA cash flow was a positive $421,000. This EBITDA is quite a strong improvement of about$ 1 million over EBITDA in Q2 last year. Our year-over-year up strongly in EBITDA. Taking a look at the balance sheet, June 30, cash balance was about $5.4 million and it was $6.7 in March 31. We did have the good positive EBITDA cash flow in Q2 but this was offset by some investment in new equipment and an increase in our inventory. We continue to have no debt and we haven’t done any equity raises since 2008 which you all know, which is I say every quarter but I think it's important to note that we haven’t suffered any dilution due to these kind of equity transactions in the last 6.5 years. And finally regarding our guidance for 2015, based on current and forecasted market conditions, expected orders and current backlog, we affirm our previous guidance that we expect revenues will total between $26 million and $29 million for the year. I'll turn it now back over to Andrew.

Thanks Paul. I just had a few other summary points. As you all know the military is very important to us. Our display order books are very high this quarter from a military customer's and that includes a number of new international orders that we're very pleased with places that we haven’t gotten orders before. So this helps us out with the – we have small programs slowing down like the French soldier modernization program. We have lower orders in that in some of the U.S. programs. So the higher order books feel good to us because we know that we are on some new programs so that says what the new ones are moving forward - moving us forward towards higher volume. Our high brightness R&D work is progressing very well. We delivered the right pattern WUXGA displays in second quarter and this is important because alights the U.S. military funding us here and it moves us to be first in line when companies need avionic displays for valuations. That's why they come to us and that’s why we book those modification new display. Right now we are still selling for monochrome high brightness. We are in the colors group for nearing 10,000 nits who will also be selling to military aviation for that. One more unique thing this quarter, we delivered a subsystem to DARPA for their computational weapon optic program and actually participated in live fire DARPA demos for the IPs. This was reported in the press that was gizmodo.com so you can take a look at very interesting article. Our displays of course report very well there. The AR market is a high potential for us. Our HMD Group believes there are spaces likely to get a good start in the industrial segment. We have some people who have done this before and that will be a lower volume and higher prices, which is a good place for us to start, that looks more of our current business. The VR market can be best satisfied with the pair of microdisplays and I will remind you that some of the tier 1 companies are interested in working with us on our technology for these headsets and we're putting a lot of effort in this and gaining some traction. Work on our VR HMD is progressing and we are planning to show in CES at January and we are on track to do that. So those are just some things to take away. I would like to use that to complete the formal remarks and then open up the call for questions.

[Operator Instructions] And our first question comes from Andrew Uerkwitz of Oppenheimer.

Thanks, gentlemen, for taking my questions. I just had two quick ones here, the first one is, it sounds like you’re going from older programs to newer programs in the military segment. Could you talk a little bit about the visibility that you have and the comfort level you have with kind of where you think revenues could be going forward there?

The bookings are - companies is placing order for the displays and we not always but generally for many of them that are high, we know what they are going for and in many of the bookings for newer displays so we have a good idea. So we do have visibility to that and that's why we feel comfortable with the revenue estimate range. And we do have an idea of how big the programs are going to be. You never know exactly the government is going to do but that gives us again good feeling for this year.

Great. I appreciate that. And then secondly, you said you're targeting CES, to show off a commercial VR microdisplay., So is there – should we assume that potential customers are going to have it before then or they’ll start seeing it after that. And then also how should we think about the design cycle there?

In this case we’ve talked to potential companies who would be interested in this and interested in partnering with us and we were open to suggestions by those companies, with respect to how we actually sell it. So, companies have already seen them. And we have actually sold one of them and there was another company in the entertainment field who asked us [indiscernible], we're not ready for that yet. So those seen before. We will continue to show it prior to CES, just that we want to do a few things with it, we want to make an improvement to the display that makes it more suited, we did the display for military purpose and we need to tweak a little bit, and we’ll be able to do that later this year and then we want to make the display a little bit more easy to put on, and keep on [indiscernible] wires fall out too easily now so things like that. Just simple stuff.

Sure. I appreciate the responses, and I look forward to see you CES. Thank you guys.

The next question is from Kevin Dede from Rodman & Renshaw.

Good afternoon, gentlemen. Andrew I was hoping you could help me understand how far you got to go in cost reduction from your military pricing level to meet consumer requirement, where you think you’d be a viable - sort of a viable component in AR and VR in the consumer market?. Is there any way you can quantify that and give the sort of your timeline on getting to that sort of more consumable type of product?.

Right, I need to in order to answer your question, I’m not going to give you specific details, but we know them, I’m going to separate the question into two pieces, one is the AR space and one is the VR space. And the AR space the reason I have to do this is because they are different size of displays. The displays in the AR space, and I’ll use an example, not our example, it's the Himax displays sold to Glass. Himax said during the Oppenheimer conference a while back that they were selling displays and they didn't do this under an NDA, they simply told the fund managers who turned [indiscernible] and told us that they were selling $30 to $35. Now in that space the displays they were using we could fit about 600 on a wafer, and you know the front end cost is the same if you put six on a wafer or 600. So when you have 600 displays on there, the display cost per wafer is the same, divide by 600, you get a much smaller number. So that plus volume does not worry us at all about getting to those price points, it’s not an issue. On the VR side, different story because here we had to satisfy two little different types of displays, one is the 2000X2000 that we put in our headset, and the other is a display that might go into a headset instead of that cellphone display. And we eventually worked out, we need to actually produce one of these, and we’re trying to get a company to help us pay for that. And I think if we can be successful on that, and once we re-spin it, our calculation says with high volume we can do what we need to meet the price points, and these companies have given us targets, you have to get to between A and B and I can tell you what they are because these companies told us this on their NDA. And we think we can get there and we’ve talked to them and showing them what we’re talking about so that we convince them as well.

All right. I appreciate that, Andrew, thank you., Can you speak a little bit to sort of the visibility that you have on timing and when you think there will be a critical point in the market that you’ll either be relevant or perhaps that window closes and you become irrelevant.

Well, I would think that the first headsets today have cellphone display in there and that's it, we’re not going to build the display tomorrow and put it in there because it takes a while as you know, nine months to a year to build a new display. So look for the next generation [to have us in it] [ph] and I don’t know that the statement about us being irrelevant is fits at all because generation number two is plausible and generation after that would be plausible as well.

And there is companies that are currently developing headsets that we could be generation one in –

Yes, I was thinking the VR side there, the AR side is a different story as well because that there are many people interested in the AR side now including us. So I don't think we're going to end up being irrelevant and I think we need to look for generation two from the VR point of view.

Okay. I was wondering if you could elaborate a little bit on your visibility in R&D rev, I asked the same question like last quarter, you mentioned ManTech being 30 months and that’s an extended period, some of the others that you spoke to in the call this afternoon are nearly as long, and if I remember correctly after the March quarter you said you had visibility to other development projects that might come on at some point and I’m wondering if you still feel comfortable that way and how you might suggest that we think about what you see?

The contracts always work like that, they run for a term and then they stop and what you do is you get new ones to replace them. And now that the environment has loosened up, we do have other contracts in the works that we are working on. Fortunately our big one, the ManTech is about $6 million of itself, and that one is a 30 month contract from the middle of last year, actually later in last year, so that one doesn't run out until 2017. So we are actually in pretty good shape just on what we have existing but we are working on more contracts potentially in the next couple of quarters that would come through.

And I'd just give you an example of that, we always end up coming up with new ideas as we are going through this. And so the one contract is to make the OLED's stack more efficient and in going through that we come up with new ideas on what we can do and those things are sometimes funded as well, and we are actually having some success now with respect to ideas like that.

Follow-on contracts.

Yes.

Okay, Andrew. Just to sort of piggyback on your response there, you mentioned that you are really close on direct pattern at 6500 nits, so you felt comfortable on the enhanced side of OLED, but could you talk - I mean sorry on the direct pattern side but could you speak a little bit to the timeline you’d see on enhancing OLED and getting to that 10-K nit level, what sort of timeline do you think you need or you need to achieve backhaul?

We do have this program on that too and let's see - right now - its middle of next year, or end of next year something like that. And we actually had some success on that already and we had some improvement of 70% in one of the stack structures and 40% in other. So I think those are pretty good, do not what we run, we still want it better but if you take 70% more on 6500, you get pretty close right. So we are feeling pretty comfortable, but we think we should be able to do better. And we know that every once in a while we need to do, when we make a change like this you introduce an inefficiency, so we need to be over in order to make sure we get there. But we are kind of conservative when we tell the government on goals, that's why we picked 10,000 nits we hope we do more than that. So this program on the enhancement side will run out next year and it will be done.

Last question before I hop in the queue, can you speak to the timeline on - you mentioned two avionic display customers, two new ones including some foreign ones, could you talk to the timeline on needing what you think would be volume of shipment there and in parallel the helicopter – the helicopter word that I think you alluded to, could you kind of talk to how you see volume developing for those?

I will back up just a minute just to make sure I didn't miss - when I was speaking, for example the order bookings for this quarter is very high, those are predominantly but not all military customers, there is a large commercial side business there or VGA which by the way now is EAR99. So the military, including international waters are actually not avionics, but we do have two customers for avionics which -- who build displays, well one built it, one modified it. And they're in -- the one is little heavy the other one they're in testing now, i.e. putting it in some -- one is a fighter pilot helmet, they are testing it with the military and other companies. So, that one is pretty close, you know that these things -- anything with avionics takes a while before we get volume orders, so that’s going to be late into next year before lots of volume comes. And on the commercial one, I'll just mention that something you can find in the news, you can find that the company called Elbit, and you know they’re international, they are obviously I think piece of the U.S. military as well as Israeli military. But they are a premier company in this avionics market. They showed in a European Airshow, a helicopter headset. And I know we've talked to people about headsets for helicopters, that doesn't bother them. But when we talk about commercial pilots, and this company Elbit is pushing hard to get this to go. And I think if anybody can be successful, they will. When you think about a commercial pilot, the guy in the jet, [indiscernible] everybody says they’re not going to do that, and I agree when they’re reading, they're now on automatic pilot of drinking coffee, he is not to going to be wearing them. But when they land and the weather is not so good, if I were them, I'd put them on and I think that’s the plausible thing. The Helicopters are easier to see, they land in adverse conditions, with these headsets they do much better, just like those Navy pilots do better. So I think that will occur and if I want to put money on whether Elbit will be successful or not, I'll bet they will. I didn’t say our displays were in there at all, but I can't say anything like that because we’re in the [indiscernible]. So, Elbit is a good company.

Thank you for the color Andrew. Thanks for taking my questions.

You're welcome.

Thank you, Kevin.

[Operator Instructions] Our next question is from Dennis Van Zelfden at Brazos Research.

Hello, Andrew and Paul. You made the comment that you experienced one of the highest display order booking amounts than any quarter in your history. Can you be more specific like with the dollar amount? A – Andrew Sculley: Yes. We didn't make that public, so for that I apologize.

Okay. How about, can you give us the historical record of orders in any one quarter? A – Paul Campbell: We commented there, it was one of the highest because we did see a large number and we thought it was worth commenting on because there is a lot of buzz and interest in this space and we are part of that. And we are seeing a tick up in the order bookings, that was the purpose of that comment and we’ve gotten somewhere we've been trying to knock on doors for quite a while in places around the world. And some of those international bookings are now coming to us for the first time. So, we were excited about that and we thought it was relevant to the investors to know that we are getting some of these new bookings and they’re also on some of the new products that we have, which is also very exciting that -- we put a lot of money into these new products and lot of time and effort. We talk about the technology a lot, and higher resolution and everything that we do on all of these displays types and it's nice to see that the market likes that and we’re getting bookings on those products. So that was the reason for the comment, we didn’t release comparatives and prior numbers, and so we aren't going to be able to tell you some of what you asked, but that was the reason for the comment. A – Andrew Sculley: It is one of the highest. A – Paul Campbell: Yes, one of the highest.

Okay. One last shot of trying to get a number, whatever it is, in a backlog number, and will there be a backlog number in the queue? A – Paul Campbell: No. We don’t report the backlog in the queue, so, no.

Okay. I agree, it is good news. Moving on, the product gross margin was down from the first quarter even though I think you said the yields were up and costs improved. Did I hear correctly, and if so why was the product gross profit margin down from Q1? A – Paul Campbell: Yes. You’re comparing to Q1 this year?

I'm sorry. Yes, Q1 of this year. A little bit higher, revenue gross margins went down despite what I think you said about yields being up in better costs?

Yes, went down two points from 39% to 37%. And that's -- some of that is just noise. We also had some pick up in cost of goods sold last quarter, where we made some balance sheet adjustments. So I think that number was a couple of $100,000, if I remember correctly. So there were some one-time benefits in first quarter versus second quarter.

Okay. And my last question is, could you estimate how much you’re spending on a quarterly basis to develop this head mounted display, just to give us an idea of how much costs are in the income statement without any concurrent revenue?

We don’t break it out and we don’t report that. So I can’t really give you much of an idea there. We have – we do have a group of people, I don’t know if we want to say how large it is but it’s not terribly large. It’s a small group of people that work on the HMD side and they do generate expenses and we have had some development expenses around the HMD, travel expenses of course as we show the HMD. But we don’t release what those numbers are.

I think you'd get a feeling for it by saying, two people travel and actually working on the HMD itself, and the displays obviously come from inside the Company as well.

All right. Okay. Thank you very much.

Thank you.

Thanks, Den.

The next question comes from Tom Rath of Davidson Investment Advisors.

Hi guys, how are you doing? In your press release you've mentioned the new U.S. Government program that you stated was strategically important, are you free to name that program?

We are not unfortunately.

For fear of our lives, I think.

Okay.

It’s really unfortunate we can’t just say this stuff but --

All right, and then on the technology side, I know you’re progressing on high brightness part, can you kind of update us more specifically on where you are with direct patterning in three colors?

Yes. Actually we have direct patterns in three colors and we showed our bulleted picture up on the direct pattern display, blown up picture so you can see the pixels and the gaps between the pixel and then we put up Samsung cell phone blow up right next to it. It is amazing difference. As I said, so we've done three colors, the color looks pretty good. We've done it at the small pixel pitch, our pixels, we're using the WUXGA which is a 9.6 micron pixel and therefore the actual OLED area is about two and three quarter microns, and then there is a three quarter micron gap. So we've done that and lit the displays, they look good. We need to do some work to get that to run more smoothly with the equipment we put in there, and we need to do work on the enhancement of the OLED stack efficiency and we have sold some of these displays to the Government for their evaluation. So, no problem with three colors.

Okay. So you have the evaluation units out?

Yes.

Okay. Great, how long do you think that evaluation process takes?

Well, we had another goal for them, that during the rest of this year we need to continue to supply them displays at – and we're increasing brightness, and it won't be until further down the road expected to get to that 10,000 nits. So I would say by the end of this year, we'll have some very nice displays using direct patterning alone, and we will continue to work on the enhancement, the OLED architecture getting into next year.

Okay, great. And then these large new international orders that you called out, are those – is that business that can ship during 2015?

Yes, we will be shipping that during 2015 and during 2016. It's in a country that we haven't been in before and actually Asia is - a couple of spots in Asia we’ve been doing nicely with those orders.

Okay. So are those sort of international defense related, is that – what to understand?

Yes. There are some international defense related areas.

Okay, great. And then let me see, just one more, curious about your statement about tier 1 AR, VR company that weren't introduced in the foundry partner, presumably that would be the - to the sort of high volume over cost. Can you kind of talk about a timeframe on something of that nature?

We are working on that. And there is two things I should just mention so you understand that. A foundry, we obviously work with foundries now, they supply us wafers. But if you really want the yield to go well, it’s good to work together. So that you are more than a team and you want to optimize the whole. So that's why it’s very important for us to work with the foundry, but also lower cost and since we need to have higher volume it will be good to work with a foundry partner for that as well.

So it's more of wafer supply than anything else?

It would be wafer supply and potentially OLED as well.

Okay. All right, that's it from me. Thank you very much.

There was one other thing that you made me think of, just don't worry that - given your question about how soon you’re going to have write direct patterning et cetera, remember that ManTech program is 30 months and you might say, somebody on the call might say, why does it take so long if you're going to have it soon, well we need to advance the displays manufacturing readiness, that’s part of this, therefore you need to get to a certain level of your yield, has to be good and all that sort of stuff and we also 10,000 nits is a high goal. So even 6,500 we're not there yet. So that’s something I just wanted to review with as well.

Okay. Might you exceed expectations on that contract and deliver the end result a little bit early?

Certainly we'll have display well before 30 months.

We’ve actually sold some samples already.

Yes, so we will certainly do that. But we take the 30 months to keep on improving the manufacturing, we'll take it.

Okay. Got you. All right, thanks very much.

The next question is from Kevin Dede of Rodman & Renshaw.

Hi gentlemen, so I couldn't read the upper hook. Paul, could you just talk a little bit to the expense run rate you're thinking going forward. I guess when I chatted with you in March, you thought they would bump up little bit, they certainly did. I’m wondering if you think this is pretty good baseline going forward?

Yes, we actually did a lot of expense optimization middle of last year. So we’re seeing the benefits in the year-over-year comparisons. But we do this from time to time also, we view this as an expense we can control. So, when needed I think we can go in and make some reductions, but we also need to spend where we want to have exemplary results like in the HMD side. So we've been managing that pretty well. I think, cutting in some places and then spending more in another place with higher priorities. As far as the baseline, yes, Q2 is pretty clean as far as where we are in spending right now. So going forward I don’t see huge increases nor huge decreases. So it’s probably a pretty good baseline.

Okay. Thank you. Andrew you mentioned your display is being used in a DARPA program, I’m wondering if you think the military is going to - I guess deploy that weapon system and if so what sort of volume you think it might lead to?

Well you can actually find it on the web, so take a look at it. DARPA is usually way out in front, it’s a need technology and we actually put together not only display but a module technical now. So we are hoping yes.

Okay. Now you mentioned that you're working with partners to get your VR headset together and there are couple of little tweaks that you need to fix before your CES?

Yes.

So could you just speak to I guess some of the other things that have to be adjusted so that you feel more comfortable running to volume production and whether or not you think your partner is able to meet the demand that you think you’ll need to meet?

First the easy thing for me to comment on is, as we need to change the display a little bit and this is in the re-spin which would take nine months or so. This is an easy spin for us that we can do in-house. So that's the first thing, so part it doesn't matter at all in that respect. The other things are as I mentioned things that the way the hookup is, it's going to be more robust and we’re looking at and working with this partner to look at high volume manufacturing, it may not be done in-house with the partner but jointly we’ll decide how we can do that.

Okay. Last question from me just sort of a follow-up on early your question, another gentlemen post. Specifically Paul regard to the product gross margin sequentially from March to June, my number show going for about 40% to 35%. And I'm wondering if you could just help me understand, number one, why you think that happened and number two what are some of the other major factors in moving that?

The product gross margin is the cost that are in there, are the manufacturing cost which would include all the manufacturing people their cost, as well as the direct cost, which would be the chemicals and all materials and things like that. So one of the things that really moves that number around is the number of displays produced. So when you produce more displays, the cost per display therefore your - it translates into a lower cost of goods sold percentage. So that's probably all things being equal unless there is some big cost reductions somewhere in wafers or chemicals or something like that. Usually that's what moving our gross margin around a little bit. The yield matters, it doesn't matter quite as much, yield actually did go down a little bit from Q1 even though it was up from Q2 last year. So we had a little bit of a yield reduction there. And as far as units produced, we were the - we shipped fewer units and we produced fewer units in Q2.

Okay, perfect. Thank you very much for entertaining my questions once again.

At this time I'm showing no further questions. I would like to turn the conference back over to Mr. Sculley for closing remarks.

Well thank you all very much again for joining the conference call. This is an exciting time for us. We couldn't be more excited with some of the discussions that we’re having. As I said, military is very important to us and we’re really doing a good job there on the R&D side. So thanks to Amal and team and we got some new products comings out, we need to get those done, [indiscernible] company is doing that. So everybody is working very hard to get this done. At the same time we're looking at these VR and AR opportunities and what displays we will have. We had some great creative people, I just mentioned Evan doing some creativity on this. So the team is pulling together very, very well, and I mean that from the hopes here in Bellevue, closing the books all the way to through manufacturing and the quality group et cetera. So I want to thank everybody and eMagin for doing the outstanding work, which you're doing right now. We have a long way to go and I think this is the team that can make it happen. So thank you again for your questions and being on the call. Don't hesitate to let us know what you think and if you have anything that we should be thinking about or not please tell us. Thank you everyone.

Thank you very much.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.