Jeffrey Lucas - Chief Financial Officer Andrew Sculley - Chief Executive Officer

Kevin Dede - Rodman Mike Malouf - Craig-Hallum Tom Maguire - Private Investor Dennis Van Zelfden - Brazos Research

Good morning, and welcome to the eMagin Second Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Jeffrey Lucas, Chief Financial Officer. Please go ahead, sir.

Thank you. Good morning, everyone. We are glad to have you join us today for our Second Quarter 2017 Earnings Conference Call. 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. You should not place undue reliance on these forward-looking statements because they involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. Please refer to our earnings release for the second quarter 2017 and the company's filings with the Securities and Exchange Commission for information concerning factors that would cause actual results to differ materially from those expressed or implied by such statements. We undertake no obligation to update or revise any forward-looking statements to reflect future events or circumstances. With that, I would like to turn the call over to eMagin's Chief Executive Officer, Andrew Sculley. Andrew?

Good morning, everyone and thank you for joining us on the call today. I'll discuss a few things this morning - our progress on the commercial front and high volume manufacturing, give you an update on our military business, a few comments on our yield improvement efforts and the advancements that we have made and demonstrated with our direct patterning technology. After that, I'll turn the call over to Jeff to review the financial highlights. First of all, I'm very excited about the progress we've made in advancing our discussions with a number of potential commercial customers for consumer applications of our technology. The pace of our discussions has accelerated which gives me great confidence that we will have an additional agreement by year-end with a major consumer electronics company. We're also making substantial progress in our partnering efforts with manufacturing partners to work with us for high volume manufacturing to support these programs. I believe the timing for signing and agreement is the end of 2017 or early 2018. As you can see from today's release, we have a couple of programs currently in place where we are designing and developing micro displays for AR/VR applications, partnering with consumer electronics companies. Well, today, the revenue is in R&D and the future will be based on display sales. Turning to our military business, we are pleased to report that we are progressing nicely in a number of programs - both U.S. and international. We continue to benefit from the ramp up of several new military programs on which our displays are designed in. And as these programs progress from low rate initial production of prototype phase over the next several quarters, we anticipate a continuation of the sequential product revenue growth we have seen over the past several quarters. These program wins speak to the superiority of OLED microdisplays in a broad range of military applications. We're seeing great interest in the aviation industry where we have developed high brightness OLED for this industry because of the poor contrast of LCD displays in use today. One can find numerous references and defense industry for applications about the green globe problem in current Fixed Wing Aircraft helmet. With LCD displays, the pilot has to turn up the intensity of the display, so high that it creates a green glare that impedes the pilot's vision. The Navy has stated that this green glare from LCD displays is a major safety hazard for pilots and is looking at OLED microdisplays as the solution. We are supplying eye brightness OLED green displays for fixed wing aircraft program currently qualifying the helmet with our displays. We have begun to see the impact of the newer military programs after we saw the wind down last year of a number of existing contracts. We won a million dollar order for a new thermal weapon site with a major European customer. Also, the company was selected last quarter as the sole source provider of OLED microdisplays for a major U.S. Army helicopter helmet upgrade program. We are on track with this program, having procured tooling and delivering the initial OLED display, taper and lens assemblies to the prime contractor. As well, we delivered our first 2Kx2K display to a defense contractor for integration in a new HND prototype. We also delivered high brightness displays to another defense contractor for the U.S. Army's Soldier Visual Interface Technology Program. That's SVIT for short. So while we accomplished all of these and more for our military customers, we were still able - as I mentioned above - to make significant progress on our discussions with potential consumer electronic companies and prospective mass production partners. As you may remember, we have been actively involved in a multi-year program to improve our manufacturing yield in throughput. In connection with this effort, we have acquired a new metals deposition tool and during the process of completing the design specs for another tool used in our process. While we expect these tools to help us improve overall yields, up time and therefore production quantities, there may be some temporary impact to our production volumes as we bring them online. We are working very hard to strengthen our production resources wherever we can. The increasing complexity of our products and a variety of products that customers want provides an ongoing challenge. We continue to make progress with our market-leading technology. Recently, we delivered engineering samples of our very high brightness full-color microdisplays incorporating our proprietary direct patterning technology to current and potential consumer and military customers. Our technology uniquely meets the requirement of next-generation AR/VR displays and is helping to drive the interest we are seeing from potential consumer electronics partners, as well as mass production partners. It's important to note that we hear time and time again from the consumer electronic companies with whom we are in discussions just how absolutely critical high brightness is to both their AR and VR applications. AR needs high brightness in order to fight the external light; VR needs high brightness to eliminate the motion artifacts by running the display for only a part of each frame and to compensate for the inefficiencies inherent in the [indiscernible]. That is why brightness is one of the overarching objectives of our research and development's strategic road map. Our full color OLED direct patterning technology on silicon chips is the only display technology in the market place that has demonstrated the high brightness, high pixel density - for example, over 2,500 ppi and very small spaces between the pixels. Our display at 5,000 nit is over 10x brighter than any of the other 2Kx2Ks introduced by competitors based on display analyst devaluations. Everyone we speak with about the VR market wants above 3,000 nit. Hence, we are the only company that has demonstrated this capability. We demonstrated what we know to be the highest resolution and highest brightness OLED micro display available in the market today at the society for Information Display's annual conference this past May. This is the premier event for display technology whose audience represents the leading and cutting edge display manufacturers and users worldwide. I'm pleased to report that the response from the attendees to our 2Kx2K display was absolutely terrific and generated a great deal of interest. With that, I'll turn the call over to Jeff and then we'll open the call up for questions.

Thank you, Andrew. We are seeing growing interest in our displays and in particular, our direct patterning technology. As Andrew mentioned, we are in the midst of actively negotiating with several potential consumer electronics and manufacturing partners. Our number at this point however, do not yet reflect the full story. As we communicate in previous quarter's calls, our product revenue and consequently our performance has been impacted by the anticipated line down beginning in mid-2016 of our number of our older military program. We are seeing a take up from product revenues as the third quarter of 2016 as several new military programs that's coming online in low-rate initial production mode. Our revenues are reflecting that ramp up as we see sequential quarter-to-quarter improvements in our product revenues for the third consecutive quarter. We expect this revenue growth to accelerate beginning in later this year as the production volumes on these programs pick up. So let me begin by walking you through the income statement. Revenue for the second quarter was $5.3 million, down 5% from $5.5 million in the second quarter of 2016. Focusing on the revenue components, product revenue was essentially flat as $4.7 million versus $4.8 million in the second quarter of last year. However, on a sequential basis from the first quarter, product revenues increase 7% from the gradual ramp up of these new programs in the sale of $300,000 of newly developed display supported by internal R&D efforts over the past few years. For the second quarter, R&D contract revenues totaled approximately $605,000, a decrease of 20% versus $752,000 reported in the prior year quarter. The overall figures masks the growing significance of our commercial contract R&D work as the decline in military R&D contract revenues year-over-year were largely offset by the commercial R&D contract revenues earned for multiple major consumer electronics companies in which no R&D revenues were earned in 2016. However, if you look at the six months R&D revenues, they are up 57% over the same period last year. This is due to the addition of commercial R&D contracts with several major consumer electronics companies as we work closely with them on the design development of new displays for the consumer products. Gross margin for the second quarter was 24% and gross profit at $1.2 million in-line with gross margin of 24% on growth profit of $1.3 million in the second quarter of 2016. Gross profit from product sales were up 2.4% to $997,000 versus $974,000 from the second quarter of 2016. Product gross margins are 21% this quarter, were comparable to the 20% prior year period. For the six months ended June 30, 2017, gross margins were 21% versus 30% in the comparable 2016 period. This is due to a slightly lower average selling price in the current period and the impact on our cost structure of lower production volumes than the year ago period. Contract gross profit was $300,000, or 42% of revenue as compared to $400,000 or 48% of revenues for the comparable 2016 period. The higher profit in the prior year period reflect strong profit margins on a number of smaller projects that were completed during 2016 as well as favorable cost to complete adjustments last year on the ManTech government project. Now I'm moving to our expenses. Total operating expenses for the second quarter of 2017 including R&D expenses decreased to $3.3 million or 6% from $3.5 million in the second quarter of 2016. R&D expenses in the quarter total $1.2 million, or 22% of revenues compared to $1.5 million or 27% of revenues from the year ago quarter. We continue to focus our engineering efforts and invest in our direct patterning technology. This is the technology that our perspective commercial partners are demanding and that we have been developing for several years. However, our R&D expenses overall decreased on a percentage basis for the June quarter as compared to the prior year due to a greater allocation of our R&D resources to R&D contract work. Selling, general and administrative expenses or SG&A increased $200,000 quarter-over-quarter to $2.2 million compared to $2 million in the same quarter of last year. This increase is reflective of higher travel and professional services including legal fees, associated with our negotiations with perspective consumer electronics in volume manufacturing partners, as well as higher stock-based compensation cost in 2017. We also recorded interest expense of $188,000 in the second quarter of 2017 which included a non-cash $158,000 write off of capitalized debt issuance cost associated with the exploration of an unsecured debt finance amendment upon the completion of our equity raise in May. Operating loss for the second quarter was $2.1 million versus operating loss of $2.2 million in the second quarter of last year. Net loss for the first quarter of 2017 was $2.3 million, or $0.07 per diluted share compared to a net loss of $2.2 million or $0.07 per diluted share in the first quarter of 2016. As of June 30, cash and cash equivalents were $4.9 million. We had no debt outstanding and about $4 million of borrowing availability under our unused working capital facility. In closing, I want to emphasize that our base business continues to grow as the military programs begin to ramp up and as you would in new ones, while the same time making further in roads into the commercial market. We have been unable to accomplish all of this while still aggressively advancing our negotiations with several major potential partners. We are absolutely laser-focused on our commercial efforts and knowing that we have the right technology for the market, we are determined to be a commercial partner on board this year. With that we'll now open for questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Kevin Dede with Rodman. Please go ahead.

Good morning, Jeff, Andrew. Can you hear me okay?

Yes, Kevin. Good morning.

Fine, Kevin. Good morning.

Great. There was a little pause there for a while. I got tripped up. Thanks for taking the question. I've got a few. Can we start just going over the consumer opportunities that you've seen? I know there were a few in the works and I'm kind of wondering where they stand - not to mention the development work that you did last year. I'm wondering if you can give us an update on how you see your customers there proceeding?

Okay. There are a few programs and I apologize, I can't mention names. But I'll go through them in a rational order, I hope. There is a one company that is very interested in our current 2Kx2K display and that company wants a number of them this year - small number - and then it will grow from there and that would fit very well in with our work with the mass production partner. That's an easier one, it doesn't take any development. Of course later on, they'd like to develop new displays. The next company were actually kicked off a development in April this year as we mentioned, so we're working on a new display. It's a significantly new design that would really, it's what we wanted to do with regard to the consumer market for VR applications or advanced AR as well. That's what we're working on there and few million dollars is a development of this particular display. There's one other that actually, we have mentioned the company paid us money in the first quarter. We mentioned that last earnings call and this company was checking, needed to have some checks to see if this technology has lights and it does. So we're working now on what is the next step. This is a tough one. There are many, many next steps to go. As we said on the earnings call, we expect another one of these agreements to go before the end of the year. Although there are other ones, you mentioned one that we talked about last year, we had an idea, agreement, we continue talking to that company and they are interested in our displays, but more like the 2Kx2K display. We'll have another meeting with them last week, we'll have another one this week. That's still very exciting. We're not writing anyone off yet, but we are concentrating on those first three that I mentioned. The other thing to talk about as very important is we have a few companies that we're talking about mass production. That is very important for us because we need to supply the displays after the designs are done and that's an exciting thing, too. These are heating up these discussions.

But let me just add a little bit to that, Kevin. Andrew talked about the company with whom I'm working with, the perspective partners. Another point to make here, we try to emphasize just how quickly these discussions are accelerating and then moving very fast now. We've talked in the past how maybe they were on exploratory phase or on discussions. Now we are in the act of negotiations with many parties working out the actual terms of condition. But these things are indeed happening quite quickly.

And just to give you one other feeling, we have multiple companies, meetings every week on progress and getting agreements done.

Okay. Well, congratulations on that.

Thank you.

Jeff, could you, just for a little insight, inventory was up to $9 million, up about a million sequentially and almost $2 million, is what it was in March last year. And I'm just wondering what's going on with the [indiscernible] product you're building.

Sure. The inventory that we're doing here is a twofold. One is it's impart in anticipation of the growing revenues that we're experiencing and we'll continue to experience particularly in some of our military programs. Secondly, inventory build associated with the night vision consumer products and the line share that's being displayed, displays that we are using both for the night vision product, but also for some foreign military customers who expect the interest in that as well. That's really been the line share of what's happening there and I think a lot of this inventory build is largely behind us at this point. We don't need to -- to see much of that further inventory build going forward.

Okay. Andrew, you mentioned green glow and both Fixed Wing and helicopter, helmet. I know that there was an issue with I think a helmet that Rockwell Collins is making for the F-35 and I was just kind of curious what you think the situation might be there?

I think certainly the Navy realizes this is a problem they try to do and fix, but it's not working. So OLED is the next step and we are working on this with more of the Fixed Wing Aircraft with that company. Our displays are the ones.

Okay.

And just to add to this a little bit, Kevin. This has been a major issue for some time now. They've been a lot of research and exploratory work. We've been actually closely involved with that and they got a point now where this is going to be addressed going forward.

There is one other thing to say that this would be the first - not the first, really, but this is a major Fixed Wing Aircraft with an OLED display from us. The good news about that is once this is qualified and everybody sees how well it works, then there is likely to be retrofit in the other Fixed Wing Aircraft and that's a big deal for us.

We've talked in our earlier earnings call for the previous quarters about our greater presence in the aviation market and this firmly cements that. It opens a wealth of doors in terms of further opportunities, that we're going to drive revenues from over the next several years. It was very promising on that regard.

Yes. So, Andrew, in integrating screen, my understanding is that that aircraft has infrared cameras all around it and are those cameras and their feed integrated into the visual display?

Well, the idea was an aircraft helmet is that during the day, they have icons on the visor to the helmet, so you don't have to look down at anything. And then during the night, it's full night vision. So yes, that is the way the aircraft work and the same thing with that helicopter program we mentioned, but we can't say anything about the name there.

Okay. You mentioned adding two new tools and I was wondering if you could add a little color to that. I know that I think last time you added a deposition tool - one from Korea, was a pretty big deal getting your process up and running on it. I think you mentioned one new deposition tool and I missed the second one. I was just wondering if you could just [indiscernible] on some of the blanks and give us an idea on when you think you'll have them integrated in your production line.

In this case, the deposition tools and anode deposition, so it's not OLED. In the case, we have tools already that we're not bringing this other tool up. It will not be a tough thing to do. It is as much of a struggle as it was on the older tool and the other tool in the process is a simple process - it doesn't meant the tool is cheap, but nowhere near that DSNU cost. The second tool is below the million dollars. It's not a terribly tough one to bring up, but it's important because you'll have - as new tools comes out, this will have additional capability to make the process much better and that's important for us.

Okay.

So both of those tools, we mentioned the metals and we mentioned this second one, both of these have capabilities that are beyond the tools we have today. The other thing is the metals deposition tool also gives us a back up because the old one also can step in. So if we have a tool down issue, we have a spare tool that we can run. That's another thing that is a big plus for us.

To boil it down for a simpleton like me, it's just adding depth to your production process and not adding another production line?

No. It is adding depth. In other words, you can go to Tool A or Tool B. You choose. Usually we'll go to Tool A, ie the new tool, but if Tool A is down, we can go to Tool B. That's the idea.

Okay. Got it.

Kevin, just one comment here. But keep in mind that this also helps us in terms of capacity and throughput because it helps that more production runs and greater shift into that nature. So it does benefit us certainly in the bottom line as well. That can help us get more product out the door. Given the heavily fixed cost nature of our manufacturing process, that's anyone in the semiconductor space, when you increase your throughput, that could have very dramatic impact over your new gross margins and in turn on your bottom line. Sorry to interrupt there.

No problem. And there is one other thing that given the new capability in the tools - for example at second one, I don't want to describe, but it's a unique process. But given the capabilities there, the yield will actually be better because of it.

Yes. That was how you introduced it in your yield improvement initiatives. Okay. So my understanding is that you still have essentially two manufacturing line? Or you have your original tool and then the new [indiscernible] the new that you procured in Korea? That's still the essence of your production.

Yes. Let me just back up one moment because the OLED process requires more than just an OLED deposition tool. The SNU tools and all that deposition tool, we have a seal system after it, but prior to that, we actually take the wafer without the last metal from the wafer fab and put a metal down which is the anode - special unique process, unique anode and then it goes into the OLED tool. We just simply have two OLED tools - one is the old one, it's the Sotello [ph], the other is DSNU's newer tool.

Okay. I'll hop back in the queue. I'm sure there are other people anxious to ask you things.

Yes, no problem.

We'd be happy to talk to you and map that out a little better for you.

Okay. Thank you very much, Andrew and Jeff.

Sure, Kevin.

Thanks.

[Operator Instructions] The next question comes from Mike Malouf with Craig-Hallum Capital Group. Please go ahead.

Great. Thanks for taking my questions. I'm wondering if we could just talk a little bit about the contract revenue. Can you help us with just the mix between consumer and military as it stands now with the roughly $600,000 in the quarter? And then how much visibility do you have? I guess when you talk about $3 million deal that you have for the new design, should we expect to see that over the next six months coming through? How does your visibility on the contract side particularly on the consumer portion of that looks for you now? Thanks.

Just to note, it was a few million, not a specific number of three. But that new display design takes approximately a year. This one's a little tougher because it's unique and very important for the space that we're going into. It will give us a leg up. So the revenue that will occur over the next 12-15 months, actually.

What other contract revenues do you have visibility on with regards to the consumer's side?

[Indiscernible] mentioned that we're working with another company to get another display design. So just for now, you can simply take it as the same as that. We have other work that there's more to it than that, but can't really talk about what it is. [Technical Difficulty] that we're doing there.

Mike, just to give you a comment [Technical Difficulty]. Generally, you can see a pretty sizable ramp up in that over the next several quarters. Not only for what we have in place now, what we just spoke to, but also for ones that were in process now of finalizing. What you are going to see in terms of our contract R&D is it's going to be increasing over the next several quarters and that consumer efforts there is offsetting some of the maturing existing programs in which we're working. We've talked for the past several years about the ManTech program and we are actually now in discussions about some of the next steps there, but [indiscernible] in the final stages. It's expected to be completed this year. But again, overall, we are going to see a continued ramp up in our contract R&D, primarily and exclusively because of what's happening on the consumer's side.

I'll just add one other thing. As Jeff mentioned, we have submitted white papers for government R&D that would help with the products that they want and some of those can also be accepted.

Okay, great. And then haven't heard anything mentioned about the consumer night vision products. Is it through in the quarterly report on the call? Can you give us an update on that and what we could expect with that product strategy going forward?

Yes. I can speak to that, actually. I think we're pretty clear on the last earnings call that we mechanize that the way to capture the greatest value here was with shifting away from the direct consumer approach, which is what we originally had in mind here, and now focusing utilities in first responders. What we've also pointed out and is certainly as borne fruit here, the fact that while those markets are indeed have great promise, it's a much longer sales cycle because you work on major companies, major utilities and as we're working with them and as they're sorting our products in the field and as they're exploring further application of our products, it's going to take a little while for us for these products really to begin achieving notable revenue. So what we're doing here is we're continuing our efforts in that area, we've scaled back very dramatically what we're doing and to address consumer state and at so doing, we're also - while there's [indiscernible] going on, it's going on its own to bid off in the side because clearly, the focus of our engineering and management teams here are on the consumer partnerships. So it's moving ahead, but we are cautious in terms of how we present that business because you'll recognize that the sale cycle is indeed so long with the utilities in this first responder.

Got it. Okay. Thanks for taking my questions.

Sure.

Thank you, Mike.

Thanks, Mike.

[Operator Instructions] The next question comes from Tom Maguire who is a private investor. Please go ahead.

Hey. Good morning, gentlemen. It's exciting to hear you advance in these discussions with these consumer electronic companies. My question is where are you in terms of the discussion and what do you want out of this? Obviously, your past the stage where there's questions whether you're the company to do the displays, et cetera. But what kind of a structure of a deal do you want? Do you want an upfront payment, an equity investment, royalty, or sales? Is that where the discussion is leading or am I ahead of myself in that? Thank you.

Clearly, all of them are different, but to give you an example, we talked to a company about a display design that we're actually doing and we've also talked to that company about mass production partner. They want us to have one and they're interested in investment in the equipment needed for them as production partner. It would be display design now and then later it would be revenue based on the production of displays with the mass production partner.

But Tom, just to expand upon that a bit here, there's not necessarily one exact model because since we're talking to different parties or different approaches here. First of all, they all encompass of course design and development as initial phase here. But some are talking with [indiscernible] greater role and funding and building the low-rate production, and others, we actually in discussions with the joint venture where our contribution clearly would be the technology that we're bringing and also of course the process know-how. But in all those situations, we recognize a great opportunity here. Certainly what we get in terms of the back end, however that's done when it's a license fee or some of that nature. That's part of how we structure these things in our discussions going forward.

Thank you.

Sure.

[Operator Instructions] Our next question comes from Dennis Van Zelfden with Brazos Research. Please go ahead.

Thank you. Good morning, gentlemen.

Good morning, Dennis.

I was wondering. Even if you signed a volume manufacturing partner between now and the end of the year and given the long lead time, what would be the earliest that one of these Tier 1s could bring a product to market?

Good question. It's a good question. When we talk to the Tier 1s about products, they have their own road map and the road map goes out to two years, actually. So there's enough time to bring up a line and to design the product for this.

Okay.

Let me just add one thing because the one that I'm forgetting, remember there's one that once the 2Kx2K display we have today?

Right.

That one will be here soon and that company is interested in investing in the line. So that will be here as soon as we can get the line up and the deal struck.

Okay. All right, thanks.

And we can make 2Kx2K today.

Thank you.

You're welcome.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Andrew Sculley for any closing remarks.

I do want to thank everyone on the call for being here with us today. It is an exciting time for us. We worked very hard on this high-brightness technology and it is the only technology in the world that will satisfy both AR and VR and I'd be happy to explain in detail to anyone who wants to contact me, 'Why VR?' in detail was really needed. And we are at the place where we can do this, we've demonstrated it at SID both last year and this year and we have proposed displays that will do what the AR/VR community wants and that's why today we have a development going, we have a company interested in our 2Kx2K display and we have a company that we're working with also a development project for the next generation. That's why the manufacturing partners are talking to us now. It is an extremely exciting time for us.

And a very fast-paced time as well. We have the proverbial pedal to the metal here and we encourage all of you to stay closely, too.

Thank you very much.

Take care.

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